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FINANCIAL ACCOUNTING REVIEW by a2302339

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									                      FINANCIAL ACCOUNTING REVIEW
Accounting is the interactive and integrated process of reviewing, forecasting,
planning, recording, classifying, reporting , and interpreting the financial activities in the
organization. This allows the custodians to make informed judgments and decisions
pertaining to the performance and financial position of the organization. It also
facilitate those who may have a vested interest in the business to assess their relationship
and expectations from the operations.

To this end accounting information should be

-   Relevant : to the users so as to influence their ability to make informed decision
-   Reliable : free from material error and bias, giving a truthful representation of the firm
-   Comparable: presented in a consistent manner so at to allow for reasonable comparisons
-   Understandable : uncomplicated, structured, and clearly presented.
-   Timely : provided when needed, or on time as required by law
-   Unqualified : not subjected to unnecessary modifications or restrictions

Accounting information are subjected to various rules or standards. These are referred to
as concepts of accounting, and include

o Business entity : the firm’s accounting records must only reflect the activities
  of the firm. It should not include the personal affairs or other economic activities
  of the owners

o Going concern : it must be assumed that the business will continue indefinitely,
  unless it can be proven otherwise. Factors negating this assumption include
  bankruptcy, expiration of contract, illegality, and takeover.

o Money measurement : all transactions and their results are expressed in monetary
  units. Hence the firm’s records will not show non financial situations such as
  management styles, industrial climate, marketing programmes, staff relations, etc.

o Cost concept : the firm’s resources must be recorded at their historic cost and not at
  prevailing market values or replacement cost, except where a re-valuation has been
  approved

o Periodicity or time interval : a reading of the results of the business must be done
  periodically, at least once per year. This involves the preparation of the income
  statement, the balance sheet, and associated statements and disclosures.

o Accrual or matching concept : revenue and expenses, must be accounted for during the
  period when they were incurred, and not necessarily when they were honoured

o Full disclosure : events or activities that are expected to occur shortly after the date
  of the final accounting statements must be disclosed as post balance sheet notes


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o Consistency : the accounting methods employed must remain unchanged throughout the
  time of the business, unless the change is governed by law or by significant
  changes in the firm’s operations

o Conservatism or prudence : accounting results must reflect the minimum level of profit.
  Hence all items of cost, including non cash transactions, should be appropriately
  accounted for

o Materiality : year to year accounts are only maintained for resources that are of a
  material value. These are classified as assets and liabilities. Complementary or
  immaterial items are written off as expenses or revenue for the period.


o Objectivity : all transactions must be supported by documentary evidences, such as
  invoices, receipts, authorization record, and permits

o Substance over form : the firm must account for all resources from which it is
  benefiting, although it may not be the legal owner of these resources. Hence the presence
  of the physical substance takes precedence over the legal form

o Dual aspects : there are two aspects to the recording of a transaction. The accounts
  must reflect the gains or benefit to the firm ( debit entry ), as well as the associated
  claims or obligations ( credit entry )

o Realization : the firm can only recognize and record revenue when there is a
  complete legal transfer in the claims to the goods or services from seller to buyer, and
  not necessarily when payment or delivery was made.



THE ACCOUNTING CYCLE

Most firms maintain their accounts within a specific time interval. This may be
monthly, quarterly, or annually, according to the firm’s policy. The Companies Act
require a reading at least once each year.

During each interval, the transactions are recorded in their appropriate books. A transaction
is an exchange of value, resulting in a gain ( Dr) from it as well as a claim ( Cr) against it.
The recording of the transaction is called a posting, and the record is called an account.
Generally source documents must be kept to confirm each transaction. These include
invoice, receipt, returned cheque, bills, etc. This is in keeping with the objectivity
concept.




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CLASSES OF ACCOUNTS

Accounts may be classified as :

a. Assets : non-human resources, whether tangible or intangible, accessible to the firm,
   quantifiable in monetary units, acquired from past events, and from which the firm
   will realize benefits beyond the current accounting period, e.g motor vehicle, machinery,
   cash, as well as patents, & copyrights

b. Liabilities : obligations arising from prior negotiations, from which the firm have
   benefited, and which must be honored after the current accounting period , e.g loans,
   mortgages, accounts payable. It also include the amount that can be claimed by the
   owners, ie, the owners equity

c. Revenue : income earned during an accounting period, e.g. sales, commission received

d. Expenses : cost incurred during an accounting period, e.g. rent, office expenses, wages
   purchases; as well as non-cash items such as bad debts and depreciation.

TYPES OF EXPENDITURE

Most accounting transactions involve the expending of funds in return for some
benefits derived. The expenditure may be one of two types :

a. Revenue expenditure : these are expenses for the regular day to day running of
   the business such as wages, utilities, stationery. These are accounted for in the
   income statement

b. Capital expenditure : these are transactions for the acquisition or improvement to
   the book value of fixed asset item, e.g. purchase of asset, delivery, installation,
   inspection, testing, legal fees, contractors costs, cost involved in the removal of an
   older asset item. Capital expenditure items are accounted for in the balance sheet

Capital expenditure is financed via the balance sheet ( i.e capital, loans, reserves,
retained profits ). However revenue expenditure should only be financed via the
income statement ( i.e turnover or other revenue).

In some cases an extended expenditure may be divided to include both capital and
revenue sections. E.g. acquiring and installing a vending machine ( capital) which is then
suited out with sodas for sale ( revenue ).

There are some activities that do not involve the expending of cash. These are called
non cash transactions. When they have had only a current impact on the firm’s
resources they are written off in the income statement, e.g. bad debts, and discounts.
However where their impact extends into the future they are passed through the
income statement and the balance sheet, e.g. provision for depreciation.



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ACCOUNTING RECORDS

All accounting transactions must be supported by appropriate       accounting records.
These fall into three main categories :

a. Preliminary records : these are the source documents such as invoices, receipts, notes, etc

b. Intermediary records : source documents         are transferred to intermediary records
   such as the journals or the cash book

c. Ledger records : all the activities and resources in the firm are accounted for in
   their respective account. These accounts are grouped into one of four main ledgers :
   the cashbook, the purchases ledger, the sales ledger, and the general ledger.

The ledger records are maintained under the double entry system, ie, for every debit
there must be a corresponding credit.

At the end of an accounting period, the ledger accounts are balanced off, and listed in a
trial balance. This serves to check the accuracy of the double entry, and also aids in the
preparation of the final accounting statements.

THE FINAL ACCOUNTS STATEMENTS


At the end of a period, the firm prepares a summary of its transactions, and interpret
their results. This involves two main accounting statements :

a. the income statement : this matches the revenue against the expenses in order to
   determine the profit or loss for the period. It has four main sections - net sales, cost of
   sales, other income, other expenses.

b. the balance sheet : this shows the relative financial position at the end of the period; in
   terms of the assets value, and the liabilities including the owners’ equity . Here we find
   five main sections : non - current (fixed ) assets, current assets, owners equity, non
   current ( long term ) liabilities, and current liabilities.


END OF YEAR ADJUSTMENTS

Prior to the preparation of the final accounts, the firm must taken into account various
end of period adjustments. These may include




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- Accruals and prepayments : At the end of the accounting period there may be un
unpaid portion of an expense or revenue (accrual). In the income statement, this must
be added to the portion already accounted for. Expenses or revenues may be paid in
excess of the amount due ( prepayment). This must be subtracted from the amount
recorded when posting to the income statement. There must also be a corresponding
entry in the balance sheet as follows : expense owing and revenue prepaid - listed as
current liability; expense prepaid and revenue owing - current asset.

- Bad Debts : amount owing by a client may be irrecoverable. This is written off as an
expense called bad debt. Where it is anticipated that another client may go bad
eventually, a further amount is provided for as an expense for this eventuality. This is
called the Provision for Bad Debts ( PFDB), and is deducted from the amount for
debtors in the balance sheet. The PFBD does not accumulate each year. Instead it
fluctuates, with the difference being either an expense ( increase) , or a revenue (
reduction).



- Depreciation : this represents a reduction in value of the non current or fixed assets,
due to wear and tear, or other means of deterioration. The annual depreciation may be
calculated based on the straight line method ( % of the cost ) or on the reducing
balance method ( % of the written down value to date ), and is charged each year as
an expense in the income statement. The accumulated amount at the end of each year
is recorded in the Provision for Depreciation account, which is deducted from the
respective fixed asset in the balance sheet.

The items in the final accounts will vary somewhat based on the type of business
ownership.



TYPES OF BUSINESS OWNERSHIP

The ownership status in the organization may fall under one of three types - sole trader
(ownership by one person), unincorporated association ( two or more persons operating
together. The most common example is a partnership) and the corporation, or company
( an incorporated entity comprising several persons ).

There is a thread of similarity in the final accounting statements under each type of
business ownership. However, there are some areas of difference as well.


a. Sole Trader : the final accounts consist of the income statement and the balance
sheet The net profit derived in the income statement is transferred intact to the balance
sheet, as it is claimed by one person. Throughout the year, the sole trader is allowed to
make drawings for his personal use from the business.



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b. Partnership : here we find the income statement, the appropriation account, the
current account, and the balance sheet. The Appropriation account shows adjustments to
the net profit as it pertains to the partners, such as interest on capital, interest on drawings,
and share of profit.

A current account is maintained in addition to the capital account. The current account
shows the accumulative amount for each partner at the end of each trading period, while
the capital account shows the amount invested by each partner. The partners are
allowed to make drawing from the business for their personal use.


c. The Corporation : This is an entity that has been incorporated under the
Companies Act, or some other related Acts. The company’s accounts consist of the
income statement, statement of change in equity, and the balance sheet. Shareholders
are not allowed to make drawings from the business for personal use.


There is an old African saying : No man can be happy without his friends, nor be
sure of his friends until he is unhappy.


TUTORIAL QUESTIONS

1. Discuss some of the characteristics of accounting information

2. Identify and explain the concept that is involved in each of the following :

   a. A case of food poisoning occurred in a restaurant. The owner is being sued by a
      number of clients who were affected. The amount that the restaurant is likely to
      suffer from this lawsuit in coming months is unascertained at present, so it is
      shown as a post balance sheet note

   b. A hotel has traditionally depreciated its fixed assets using the straight line
      method. However this year it is contemplating a change to the reducing balance
      method.

    c. The company has two motor vehicles which were acquired on hire purchase.
       Although these have not been fully paid for as yet, they are still shown in the
       balance sheet as leasehold assets.

    d. There are several minor expenses classified under ‘miscellaneous expenses’. No
       receipts were kept for these expenses

    e. A number of reams of paper and boxes of pencil are in stores at the end of
        the year. However they were not included in the closing stock, but were
       classified as office expenses for the period.



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    f    The production manager thinks that it is a waste of time to be preparing
         financial statements every year, since most production contracts are on a long
         term basis

    g. Several clients have either enquired about our service or has promised to place
       substantial orders, but we have not yet negotiated any business

    h. The managing director wished that the excellent working conditions and
       worker relations that they have worked so hard to maintain should be reflected
       in the accounting statements

    i. There is some uncertainty about the future of the company, and some
       shareholders are contemplating the sale of their shares as quickly as possible

    j. Most of the assets were bought a long time ago, and would worth much more that
       the books show today.

    k.    During the year, the company was contracted as commissioned agent for the
          Gleaner Company. The commission earned was 5% of the $3 m transacted.
          However at year end, only one half of this income was received.


    l. The cashbook had various credit entries for cash donated to charity. No other
       record was made for these as they were for small amounts


    m. Prior to the preparation of the income statement, the firm took into account
       the significant reduction in the value of the fixed assets that were used during
       the year


3. Distinguish between capital expenditure and revenue expenditure. Indicate which of
the following transactions involve capital or revenue expenditure

   a.    the purchase of a new equipment
   b.    redecorating and repainting the office
   c.    purchase of a vending machine, and 10 cases of soft drinks
   d.    legal fees on the acquiring of a new premises
   e.    purchase of new motor van
   f.    annual insurance premium for the premises and other fixed assets
   g.     the cost of clearing the site for the erection of new store house


4. Explain the types of business ownership, and state the relative advantages and
   disadvantages of each.



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5. From the following list of Balances in the books of Winnie the Pooh, as at
   August 31, 1992, prepare the Trading and Profit and Loss Account and the
   balance sheet:

            Capital                                     125,000
            Loan                                         75,000
            Land & Building             134,385
            Fixtures & Fittings          32,000
            Machinery & Equipment       25,000
            Debtors                     12,500
            Carriage Inwards              1,250
            Return Inwards                2,700
            Return Outwards                             2,300
            Carriage Outwards            1,085
            Creditors                                  13,200
            Sales                                     125,000
            Purchases                    82,345
            Commission Received                          5,500
            Motor Vehicle                30,400
            Rent Received                                4,200
            Wages & salaries            22,400
            Telephone charges            2,500
            Stock at Sept 1. 1991        10,000
            Drawings                      5,000
            Bank                                        12,400
            Cash                          1,035
                                       -----------   --------------
                                       362,600          362,600
                                       ========      =========

End note:

Stock at August 31, 1992 was 35,000.




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6. The following is a list of accounts obtained from the books of James Bond as
at December 31, 1994:

            Loan                                          60,000
            Land & Building            140,000
            Fixtures & Fittings         35,000
            Machinery & Equipment       40,000
            Debtors                     16,500
            Capital                                     110,000
            Carriage Inwards             1,500
            Return Inwards               1,700
            Return Outwards                                2,500
            Carriage Outwards            2,500
            Creditors                                    12,000
            Sales                                       223,480
            Purchases                   92,345
            Commission Received                            5,500
            Motor Vehicle               40,000
            Rent Received                                  4,200
            Wages & salaries           35,000
            Drawings                    7,000
            Telephone charges           5,500
            Stock at Jan 1. 1994       21,000
            Bank                                          22,400
            Cash                         2,035
                                      -----------     --------------
                                       440,080           440,080
                                      ========        ========

End note:

Stock at December 31, 1994 was 37,500.


Required : Prepare the trading and profit and loss account for the year ending
December 31, 1994, and the balance sheet as at that date




                                           9
7. The following is a list of accounts obtained from the books of The Chutney
   Shop as at August 31, 1993:

          Land & Building                150,000
          Fixtures & Fittings             55,000
          Prov. For depn on Fix. & Fit                         11,000
          Machinery & Equipment           60,000
          Prov. For depn on Mach & Equip                       12,000
          Debtors                          23,500
          Provision for bad debts                             3,000
          Capital                                           180,000
          Carriage Inwards                  2,500
           Return Inwards                   2,500
           Return Outwards                                    1,700
           Loan                                              75,000
           Carriage Outwards                3,500
           Creditors                                         15,000
           Sales                                            250,000
          Purchases                       112,500
          Commission Received                                 9,000
          Motor Vehicle                    80,000
          Rent Received                                       6,000
          Wages & salaries                35,000
          Insurance                         2,500
          Stock at Sept 1. 1992           21,000
          Bank                              7,665
          Cash                              7,035
                                        -----------      --------------
                                         562,700          562,700
                                        ========          ========
End note:
1. Stock at August 31, 1993 was 35,200.
2. On May 1, 1993 the firm rented space to Sharrelle Beauty Shop at 1,000 per month
3. The insurance premium is set at 250 per month starting September 1, 1992
4. Wages are prepaid by 5,000
5. The provision for bad debts must be adjusted to 20% of debtors.
6. Provide for depreciation on fixtures and fittings at 10% on the straight line
    machinery and equipment at 10% on the reducing balance, and motor vehicle
    5% on cost

Required : Prepare the final accounts for the year ending December 31, 1994




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8. The following balances were extracted from the books of Millennium Designs
   at the end of December 31, 1992. :

      Sales                                                   250,000
      Capital                                                 150,000
      Stock at January 1, 1992              35,250
      Purchases                             90,500
      Return Inwards                         2,200
      Wages                                 40,500
      Return Outwards                                           2,500
      Rent Payable                           8,000
      Rates                                  5,500
      Motor Vehicle                         55,000
      Provision for Depn - Motor Vehicle                        5,500
      Drawings                                8,000
      Loan                                                    75,000
      Building                             120,000
      Provision for Depn - Building                           12,000
      Equipment                             50,000
      Provision for Depn - Equipment                           5,000
      Debtors                               22,400
     Fixtures & Fittings                    50,000
     Provision for Depn – Fix. & Fit                           5,000
      Provision for bad debts                                  1,500
     Commission Received                                       6,000
     Carriage Outwards                       2,000
     Carriage Inwards                        2,050
     Rent Received                                            8,000
     Creditors                                               15,240
     Bank                                    42,840
     Cash                                     1,500
                                           -----------    ----------
                                            535,740        535,740
                                           =======        =======
Year end notes :
a) Stock at December 31, 1992      25,300
b) Depreciate Building at 5 % on the straight line, equipment at 10% on reducing
    balance, the motor vehicles at 15% on the reducing balance, fixtures & Fittings
   10% straight line
c) Wages prepaid 8,000
d) Rates is payable at 500 per month
e) Commission Received is owing by 2,000
f) On Sept.1, 1992 the firm rented office space to Nokia Dist. at 1,500 per month
g) The Provision for bad debts is to be revised to 5 % of debtors

Required : Prepare the set of final accounts for the year.



                                              11
9. From the following list of balances in the books of Laura Ingall’s LITTLE
HOUSE, as at August 31, 1992, prepare the set of final accounts:

            Capital                                       125,000
            Loan                                           75,000
            Land & Building                150,385
            Fixtures & Fittings             32,000
            Prov. for depn on Fix & Fit                     6,000
            Machinery & Equipment           25,000
            Prov for depn on Mach. & Equip                 10,000
            Debtors                       12,500
            Prov. for Bad Debts                             2,200
            Carriage Inwards               1,250
            Return Inwards                  2,700
            Return Outwards                                2,300
            Carriage Outwards              1,085
            Creditors                                     13,200
            Sales                                        125,000
            Purchases                     82,345
            Commission Received                             5,500
            Motor Vehicle                   30,400
            Prov for Depn on Motor Veh                      3,040
            Rent Received                                  4,200
            Wages & salaries              22,400
            Telephone charges              2,500
             Bad Debts                     4,000
            Stock at Sept 1. 1991         15,000
            Bank                                          12,400
            Cash                           2,275
                                        -----------   --------------
                                        383,840          383,840
                                        =======       =========


End note:

i. Stock at August 31, 1992 was 35,000.
ii. Wages owing by 7,600
iii. Telephone charges prepaid by 1,000
iv. Commission due 2,500
v. On April 1, 1992 the firm rented office space to Soundkey Ent. at 2000 per month
vi. The provision for bad debt is to be adjusted to 10% of debtors
vii Provide for depreciation as follows : Fixture and fittings at 10% straight line,
      machinery and equipment at 15% reducing balance, and motor vehicle at 10%
     straight line.




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