Question 1 (Topic 5) – Accounting Systems & Conceptual Framework
Assessed:
1. Accounting systems – subsidiary ledgers; special journals
2. Regulation & conceptual framework – MCQ’s
Summary:
Special Journals –
Date
Invoice No.
Sales Journal – relates to credit sales
Account
Post Ref
Sales
GST
Payable
Accounts
Receivable
Total
Date
Invoice
No.
Purchases Journal – relates to credit purchases
Account
Terms
Post Ref
Purchases GST
Accounts
Receivable Payable
Total
Date
Invoice
No.
Account
Post
Ref
Cash Receipts Journal
Cash at Discount Sales
Bank
Allowed
Accounts
Other
Receivable Accounts
Total
Date
Total
Invoice
No.
Account
Cash Payments Journal
Post
Other
Accounts
Ref
Accounts Payable
Purchases
Cash at
Bank
Discount
Received
Subsidiary Ledgers –
Operation & Development of an Accounting System –
Important considerations in developing an accounting system:
1. Cost vs Benefit
2. Compatibility
- …with the organisation & business
- Must be comparable; should be appropriate to the size & nature of the business
operations
- Those responsible for recruiting staff must ensure that people have appropriate
qualifications & experience and are appropriately trained & supervised.
3. Flexibility & Adaptability
- … to adapt to expansion & changes in the business e.g.
o develop & offer new products
o expand into new markets
o take over existing businesses
o dispose of parts of business & restructure
4. Internal Control
- An effective system of internal control
Internal control systems:
-
Procedures adopted by an entity to control its activities and protect its assets
Objective: to ensure the reliability of accounting info
Two aspects:
1. Administrative controls: established to provide operational efficiency &
adherence to prescribed policies e.g. manuals identifying procedures
2. Accounting controls: used to protect assets & ensure reliability of accounting
records e.g. procedures for the authorisation of transactions
Principles of Internal Control Systems:
-
-
-
-
-
-
-
Clearly established lines of responsibility
o Assignment of responsibility
o Responsibility should align with ability & authority, and employees should have a
clear understanding of their responsibilities
o There should be no overlap or undefined areas
o E.g. assign a different cash register for each employee
o Should be rotated for review
Separation of record keep & custodianship
o Responsibility for initiating business transactions & for custody of the entity’s
assets should be separated from responsibility for maintaining the accounting
records
o This avoids stealing or misuse of assets
Division of responsibility for related transactions
o To minimise the possibility of errors, fraud & theft, responsibility for a series of
related transactions should be divided among two or employees/departments
o The work of one employee acts as a check on the work of another
Mechanical & electronic devices
o Designed to protect assets & to improve the accuracy of the accounting process
o E.g. cash registers; accurate record of cash sales
o E.g. safe or vault; protects cash on hand
Adequate insurance
Internal auditing
o Internal auditors are responsible for a continuing review & study of the internal
control system
o Non-compliance with established procedures & suggestions for improving the
system are passed on
Programming controls
o The system can confirm that processing of data has been carried out in correct
sequent, highlight where transaction debits do not equal credits, &provide
proof of mathematical calc’s
o Computer hackers, viruses & spyware continue to pose a real threat to the
integrity of an entity’s internal control system
Physical controls
o E.g. safe to hold cash, lockable buildings, external fencing etc.
Qualitative Characteristics of Financial Information –
-
Relevance
Faithful representation
Comparability
Verifiability
Timeliness
Understandability
Question 2 (Topic 6) – Current Asset I: Cash & Receivables
Principles of a Good Internal Control –
-
Cash control through a:
o Bank reconciliation
o Petty cash fund
o Cash budgeting
Bank Reconciliation –
Summary – Part A: Bank Reconciliation
Step 1: Check all items & errors from last reconciliation have cleared
-
Any items not cleared include in current reconciliation
Step 2: Compare
-
Cash receipts journal with the credit column in bank statement
Cash payments journal with the debit column in bank statement
Marking entries that appear in both & identifying differences
Step 3: Update cash journals for items captured by bank statement
-
Enter all the items that appear under item (c) in step 2 in the appropriate cash journals
Step 4: Deal with errors.
-
Adjust cash journals for any errors in them
Notify bank of any errors in statement
o Note these errors on reconciliation until corrected
Step 5: Total cash journals & post to ledgers
Step 6: Prepare bank reconciliation.
Bank Adjustments
+
-
+/-
Ending as per bank statement
Deposits in transit (outstanding deposit)
Unpresented cheques (outstanding EFTs –
online cash payment):
Cheque has been written & accounted for but
not yet paid out by bank.
Bank Errors
= Adjusted cash balance: Bank Statement
Firm Adjustments
+
+/-
Ending as per CAB ledger
Receipts reported on bank statement but not in
ledger
Disbursements reported in bank statement (i.e.
bank fees & charges, direct debit)
Dishonoured cheques (customer insufficient
funds – reversal of entry)
Accounting record errors
= Adjusted cash balance: CAB Ledger
BOTH ADJUSTED FIGURES MUST BALANCE
Summary – Accounting for Receivables (journal entries & calculations):
-
-
Accounting for receivables
o Types of receivables
o Accounts Receivable
o Bad & doubtful debts
o Management policies to control debtors
Accounting for bad & doubtful debts
o Allowance methods
 Estimating bad debts
 % of net credit sale
 Ageing of accounts receivable
 Writing off bad debts
 Recovery of an account written off
o Direct Write-off method
Petty Cash Fund
Establishing the fund:
Jan 2
-
Dr Petty Cash
Cr Cash at Bank
x
x
Established by writing a cheque; cashes (-) the cheque & places proceeds in box
Making Payments from the Fund & Reimbursing the Fund
Jan 31
Dr Expense
Dr GST Receivable
Cr Cash at Bank
x
x
x
Accounts Receivable
-
Need to consider discounts & allowances
Not all amount will be collected (bad debts); major problem lies in estimating the amount of
receivables that will become bad
Bad & Doubtful Debts
-
Unpaid amounts = ‘bad debt expense’
Two methods to account for BD:
1. Allowance method
2. Direct write-off method
1. Allowance Method
- @ end of period, estimate doubtful debts & prepare adjusting entry
- Estimate (BD expense:
Jan 2
-
Dr Bad Debts Expense
Cr Allowance for Doubtful Debts
Allowance = contra-asset account (hence Cr)
x
x
Two Common Methods (estimation):
-
% of net (excludes GST) credit sales – Income Statement method
Ageing of AR – Balance Sheet method
% Method : e.g. 1% of net credit sales each year is written off as BD; net credit sales for current
year is $847,000
Jan 2
Dr Bad Debts Expense
Cr Allowance for Doubtful Debts
1% * 847k
1% * 847k
Ageing Method:
Age Category
Amount
%
Not yet due
1-30 days
31-60 days
61-90 days
91-180 days
Over 180 days
Total
-
61,600
11,660
72,606
4,620
4,180
2,640
91,960
1
5
10
20
30
60
Estimated BD Amount
Amount
X
X
X
X
X
X
Y
Y = amount expected not to be collected (BD expense)
Y * 1/11 = GST
Y * 10/11 = allowance
E.g. total of $5,687; excluding GST is $5170
o Existing balance is $1540.
o Top up needed is $5170-1540 = $3,630
June 30
Dr Bad Debts Expense
Cr Allowance for Doubtful Debts
3,630
3,630
Allowance Method – Writing off Bad Debts
July 31
-
Dr Allowance for DD
Dr GST Payable
Cr Accounts Receivable
x
x
x
Note GST: will not receive, only need to pay. Associated GST must be removed.
Allowance Method – Recovery of an Account Written Off
Nov 4
Need to reinstate sale
Recovery treated as revenue
Dr Accounts Receivable
Cr GST Payable
Cr Bad Debts Recovered
x
x
Dr Cash at Bank
Cr Accounts Receivable
x
x
x
2. Direct Write-Off Method
- No allowance made for expected BD
- Only actual bad debts are charged to expense at the time an account is determined to be
uncollectable
July 31
Dr BD Expense
Dr GST Payable
Cr Accounts Receivable
x
x
x
Disposal of Accounts Receivable
-
Sale of AR:
o Also knowns as factoring
o Minimise costs of credit control
April 15
-
Dr Cash at Bank
Dr Service Charge Expense
Cr Accounts Receivable
Dr Cash at Bank
Dr GST Payable
Cr Sales Revenue
Sales of credit card
April 30
-
x
Disposal of AR:
o Use of Credit Cards
April 22
-
x
x
Merchants’ Fees Expense
Dr GST Receivable
Cr Cash at Bank
Fees on credit card sales for month
x
x
x
x
x
x
Question 3 (Topic 7) – Current Asset II: Inventories
Assessed:
-
Calculations for different valuation systems
o Periodic inventory system
 FIFO, LIFO, Weighted av & Specific ID
o Perpetual inventory system
 FIFO, LIFO, Moving av & Specific ID
Summary: need to know –
-
-
Cost of inventory
Assignment of cost to inventory (periodic inventory system)
o Specific identification/FIFO/LIFO/Weighted Average
o Comparison of costing method
Assignment of cost to ending inventory (perpetual inventory system)
o Specific identification/FIFO/LIFO/Moving Average
o Comparison of costing method
Lower of cost & net realisable value rule
-
Assignment of cost to ending inventory (periodic inventory system)
-
 Specific ID/FIFO/LIFO
 Weighted average method
-
Assignment of cost to ending inventory (perpetual inventory system)
 FIFO/LIFO/Moving Average
Notes:
Determining the Cost of Inventory on Hand
-
The cost of inventory:
o Includes all direct & indirect costs
 Purchase costs
 Conversion costs
 Other costs
o Excludes, wastage, storage, admin etc.
o Incurred in bringing the merchandise to a saleable condition & to its existing
location (hence why freight is included)
o GST excluded
Comparison of Costing Methods
All methods:
-
Same sales revenue
Same beginning inventory value
Same purchases value
Same goods available for sales value
Specific ID:
-
Consistent with the actual movement of the inventory
Offers room for manipulating profit (can choose to intentionally sell a unit with a lower
or higher cost)
-
First purchased = first sold
Reflects current prices in ending inventory
o Does not permit manipulation of profit
Highest ending inventory (based on inflation; rising prices)
Highest profit & highest ending inventory reported (since inventory purchased at
cheaper prices)
o Lower COS = higher profit
FIFO:
-
LIFO:
-
Whatever inventory remaining = sold at lower price
Results in matching current COS with current revenue
Profits can be manipulated (can purchase or not purchase goods @ end of year)
Hence, lowest ending inventory & lowest profit (due to higher COS)
Weighted Average:
-
Results in identical items being assigned the same value
Tends to smooth out profit & inventory values
Perpetual System Templates
FIFO:
LIFO:
Moving Average:
Question 4 (Topic 8) – Accounting for NCA
Assessed:
-
Acquisition, depreciation, overhaul, repairs, revaluation, & disposal of assets
o Calculations & journal entries
Need to understand:
-
-
-
-
-
Determining the cost of PPE
Depreciation:
o Different types of depreciation methods
 Straight-line
 Diminishing balance (reducing balance)
 Sum-of-years digits
 Units-of-production
Depreciable amount = cost – residual value
Carrying amount = cost – accumulated depreciation
Subsequent Costs
o Day-to-day repairs & maintenance (expense)
o Overhauls & replacement of major parts (asset – capitalised)
Revaluation model:
o Revaluation increase
o Revaluation decrease
Derecognition of NCA
o Scrapping NCA
o Sale of NCA
o Exchange NCA
o Others
Intangible assets
Summary Notes:
Cost of PPE:
-
Cost includes:
o Purchase price (including tax/duties)
o Any directly attributable costs (e.g. freight, installation fee)
o Fair value is the price that would be received to sell an asset OR amount paid to
transfer a liability
Depreciation
Quick notes:
-
-
-
Useful life:
o period over which asset is expected to be available for use OR
o no. of production (or similar) units expected to be obtained from the asset
Residual value:
o The estimated amount that an entity could currently obtain from the disposal of
the asset
o After calculating the estimated costs of disposal
Carrying Amount = cost – accumulated depreciation
Depreciable Amount = cost – residual value
Straight-Line Method
𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 =
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝐴𝑚𝑜𝑢𝑛𝑡
𝑈𝑠𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒
Journal Entry:
June 30
-
Depreciation Expense
Annual Dep.
Accumulated Depreciation
Note: AD is a contra-asset account (has a credit balance)
Annual Dep.
Diminshing Balance Method:
-
Depreciation expense for each period is calculated by applying a predetermined
depreciation rate to the declining CA of the asset.
𝑛
𝑟
Depreciation rate: 1 − √𝑐 : n = useful life (years); r = residual value ($); c = original cost ($)
-
Decreasing depreciation charge over the useful life
Asset more productive in earlier years & earns more revenue.
o Incur more depreciation expense @ start of useful life (reduces reported profit)
Depreciation expense = CA @ beginning of year * D.R. of the year
Sum-of-Years Method:
-
Depreciation for each period is determined by multiplying the depreciable amount by
successively smaller fractions.
o Depreciation expense = depreciable amount * fraction
Units of Production:
-
-
Relates depreciation to use rather than to time
Particularly appropriate for assets where consumption of economic benefits varies
significantly from one period to another
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑏𝑙𝑒 𝐴𝑚𝑜𝑢𝑛𝑡
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 ℎ𝑜𝑢𝑟 =
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐻𝑜𝑢𝑟𝑠
o Depreciation expense = depreciation rate * no. of production units used or
produced during the period
Note: production units may be expressed in several ways: km; operating hours; or units
produced/output
Subsequent Costs
-
Additional costs after acquisition:
o Repairs (expense)
o Maintenance (expense)
o Improvements (cost of assets capitalised)
o Modifications (cost of assets capitalised)
Day-to-Day Repairs & Maintenance
June 6
Treated as expense
Dr Repairs & Maintenance Expense
Dr GST Receivable
Cr Cash at Bank
670
67
737
Overhauls & Replacement of Major Parts:
Cost = 34,000
Residual value = 4,000
Useful life = 5 years
Carrying amount @ end of 4th year = 10,000
@ end of 4th year, engine replaced at cost = 4,500; old machine had CA of $500
July 4
July 4
July 4
Dr Accumulated Depreciation
Cr Delivery Van
(Repairs on delivery truck)
AD = (34,000 – 4,000)/5 = 6,000 * 4 = 24,000
24,000
Dr Delivery Van
Dr GST Receivable
Cr Cash at Bank
(Installation of a new engine)
4,500
450
Dr Expense on Disposal
Cr Delivery Van
(Disposal of old engine)
500
24,000
4,950
500
Initial Revaluation Increases
-
Initially recognised in other comprehensive income
Then transferred to a revaluation surplus account (part of the closing process)
o A reserve acc in the equity section
For depreciable assets, existing depreciation is written off before revaluation upward.
Steps:
1. Recognise depreciation expense.
2. Write-off accumulated depreciation prior to the recognition of your revaluation
3. Revaluation increment/decrement
Initial Revaluation Decreases
-
Represents a write-down of a class of NCA from carrying amount to fair value
Must be recognised as an expense, which reduces profit
o Not a reduction in OCI (contrast with increases)
 Reduces reported profit instead
Derecognition of NCA
Scrapping
 For this Example 2, not fully depreciated
Sale of NCA
-
Selling price < carrying amount: loss (expense)
Selling price > carrying amount: gain (income)
Proceeds recorded at the ‘gross amount received’ (income)
Carrying value treated as expense for the period
The difference represents a net gain or loss on sale
Exchanging NCA:
-
A trade in allowance for the old asset is deducted from the price of the new asset, and
the balance is paid in accordance with the normal credit terms
E.g.
o A machine that originally cost $22,000 & had been depreciated by on $15,000
was traded in on a new machine, for a trade-in value of $4,000 & a further
$26,000 was paid in cash
Question 5 (Topic 9) – Liabilities & CF Statement
Assessed:
(Part A & B)
-
-
-
Liabilities – 3 essential characteristics
o Provisions
 Liabilities of uncertain timing or amount
 Provision for warranties/provision for long-service leave (estimate)
o Contingent liabilities
Different types of liabilities & how we account for them
o Warranties
o Bills Payable
o Future employee benefits
o Debentures
CF Statement
o CF from operating activities
 Directs method vs indirect method
o CF from investing activities
o CF from financial activities
Summary Journal Entries:
Summary Notes:
Liabilities Defined:
-
-
Three essential characteristics
o Present obligation to an external party
o Obligation must have resulted from past events
o Must have future outflow of resources embodying economic benefits
Recognition avoids understatement of liabilities & overstatement of equity
o Based on acct equation
Two Types of Provisions
1. Provision for long-service leave (employee benefits)
2. Provision for warranties
- Provision = present obligation arising from a past event
Contingent Liabilities
-
-
A possible obligation arising from a past event that will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events that are not
wholly within the control of the entity.
Not included in balance sheet (disclosed in the notes of financial statements)
A potential event that could occur at a future date due to events beyond a company’s
control
Classification of Liabilities
-
-
Current liabilities
o Accounts payable, bills payable, interest-bearing liabilities (e.g. bank overdraft),
employee benefits, accrued expenses, & provisions
NC liabilities
o Long-term borrowings (e.g., mortgage), provisions for long-service leave; longterm AP
Current Liabilities
Example – Bills Payable
Employee Benefits
-
Wages & salaries
Long-service leave, sick leave, annual leave, maternity leave
Superannuation & post-employment benefits
Fringe benefits (monetary & non-monetary)
Example 1 – Employee Benefits
 Amounts deducted from an employee’s gross pay are liabilities of the employer, who
acts as a collection agent for various organisations.
Example 2 – Employee Benefits
-
Jun 28
Payroll ancillary costs
o Example
 Annual leave
 Sick leave
 Maternity leave
 Long-service leave
Dr Annual Leave Expense
Cr Annual Leave Payable
(Annual leave liability for month)
x
Dr Long-service Leave Expense
Cr Provision for Long-service Leave
(Liability of long-service leave)
x
x
x
Warranties:
-
Estimate of future warranty obligations for inventory sold
Accounting for liabilities involves establishing a liability = Provision for Warranties
o Recognise an equivalent expense against the provision
Example:
June 30
-
Dr Warranty Expense
Cr Provision for Warranties
(Provision for warranty expense related to sales
made in the year ended 30 June)
70,000
70,000
On 15 July, the company spent 350 on the warranty repair
July 15
Dr Provision for Warrantes
Cr Provision for Warranties
(Provision for warranty expense related to sales
made in the year ended 30 June)
350
350
GST Payable
-
Whenever goods or services are sold (subject to GST), GST must be collected on behalf of
ATO
It’s a current liability as it must be submitted on a quarterly basis
Non-Current Liabilities
-
Amounts due for payment more than 1 year from reporting date
Types
o Term loans
o Mortgage payable
o Debentures or bonds
Debentures
Example:
Another form of borrowing – a ‘written promise’
To pay a principal amount at a specified time & interest on the principal at a specified
rate per period
NCA – Advantages & Disadvantages -> POV of firm
(+)
-
Creditors do not have voting rights
Creditors do not share excess
profits – only interest
Owners can receive a greater return
than if more shares are issued
(-)
-
-
-
Interest required regardless of
performance
Default risks – possible bankruptcy
Creditors paid first in the event of
business going bankrupt (debt
covenants; DH’s paid first then
SH’s)
o DC say that you cannot borrow
more than a restricted amount
Ratio Formula
Interpretation
Profit
after
tax/Average
 Indicates how much return the
Return on
company is generating on the
Asset Total Assets


Return on Profit - Preference
(Ordinary) Dividend/Average Total
Equity
Equity



Profit Margin Profit/Revenue


assets under its control
Generally, ROA values range from
5-20%
High ROA values are preferable as
the higher the ratio, the greater the
company's return on the operation
of its business resources
Indicates the company's return on
shareholders' investment
Generally, ROE values range from
5-20%
High ROE values are preferred as
the higher the ratio, the greater the
company's return on the
shareholders investments
Ratio represents the average net
profit on each dollar of sales (e.g. a
10% profit marginal would mean
that on average, each dollar of
sales generated 10c in net profit
after expenses and income tax)
Adequacy of ratio depends on
industry i.e. supermarket chain
would have a low profit marginal
ratio compensated by a large
volume of sales whereas a
jewellery store would generally
have a high profit margin, offset by
a low sales volume.
Earnings Per Profit After Tax Share Preference

Indicates the profit earned on each
ordinary share by relating earnings
attributable to ordinary shares to
the number of ordinary shares
issued
Price-Earnings Market Price per
Ratio Ordinary

Indicates the amount investors are
paying for a dollar of earnings
Based on the idea that market price
should reflect the market's
expectation of future performance,
the ratio compares present
performance with those
expectations
On this basis, a company with a
high P/E is expected to show
greater future performance that its
present level, while one with a low
P/E is not expected to do much
better in future
Dividend/Weighted
Average # of Ordinary
Shares
Share/Earnings per
Share


Dividend Yield Annual Dividend per
Ordinary Share/Market
Price per Ordinary
Share
Dividend Total Dividend per
Payout Ordinary Share/(Profit
After Tax - Preference
Dividend)



Asset Turnover Revenue/Average Total

Asset

Current Ratio Current Assets/Current

Liabilities

Indicates the % of profits paid out
to ordinary shareholders
e.g. a ratio of 40% indicates that
40% of profit was distributed to
SH's and the remaining 60%
represents retained profits
A stable ratio over time suggests
the company has a policy of paying
dividends based on profits whereas
a variable ratio suggests factors
other than profit are important in
deciding whether to declare
dividends
Indicates how much sales volume is
associated with a dollar of assets
Provides a measure of the
effectiveness of the company in
using its assets during the period
Indicates whether the company has
enough short-term assets to cover
its short-term debts
A ratio > 1 (or 2) indicates that
working capital is positive (current
assets exceed current liabilities)


Quick Ratio (Current Assets +

Receivable)/Current
Liabilities



Receivable Net Sales/Average
Turnover Receivable Balance
Inventory COGS/Average
Turnover Inventory




Debt Ratio Total Liabilities/Total

Assets

Times Interest (Profit Before Tax + Net
Earned Finance Costs)/Net

Finance Costs


A ratio < 1 (or 2) indicates that
working capital is negative (current
liabilities exceed current assets)
Generally, the higher the ratio, the
greater the financial stability and
the lower the risk for both creditors
and owners. Generally 1.5:1 is
considered to be an acceptable
ratio for most industries
Indicates whether current liabilities
could be paid without having to sell
inventory
Ratio is the same as the current
ratio except inventor is removed
from the numerator
Benchmark is 1
More useful measure than the
current ratio for companies that
cannot convert inventory into cash
quickly if necessary
Indicate the effectiveness of credit
collection policies
Measures the number of times
trade receivables are converted
into cash in a year or a single
period
Relates the level of inventory to the
volume of activity and therefore
indicates the liquidity of inventory
Measures the number of time
inventory was sold on average
during the period
Indicates the proportion of assets
financed by liabilities
Indicate the degree of leverage (%
of total assets funded through
debt)
Indicates the company's ability to
meet its interest payments out of
current profits
A general rule of thumb is that
earnings should be approx. 3-4
times the interest expense
A low coverage ratio (especially <
1) indicates:
 The company is not
operating at a sufficiently
profitable level to cover the
interest obligations
comfortably
 And/or: solvency problems.