115 Accounting AS Level (Theory and Practice)

Description

Current financial reporting practices have been under major review with the approach of a single market, moving towards harmonization. Consequently, all global syllabuses, from December 2007 onwards, use international terminology.

The globalized frame work of Cambridge International Advanced Level, in practice over 125 countries, has led to the introduction of an international format and layout for all its syllabuses.

This book Accounting A Level Theory and Practice Article Number 115 is intended to cover the accounting content of CIE Advanced Level syllabus 9706 comprehensively. With a thorough discussion of the basic double entry principles for the beginners, it is also useful for those who have some knowledge. (Accounting AS Level)

The strengths and weaknesses of accounting practices are reinforced by a set of Review Questions at the end of each chapter, enabling the students to put, what is learnt, into practice. These Questions have been developed by the author and are not taken from past exam papers.

(Accounting AS Level)

The Review Questions have been set in increasing order of difficulty and each odd number Question is complimented by an even numbered question with the same difficulty level.

Solutions to odd numbered questions are given in the appendix at the end of the book. In addition solutions to even numbered questions are available in a separate manual. Teachers using “AS Accounting Theory and Practice” as a text book, may get the manual by applying officially on a school letterhead. Providing the students with a solid foundation in the “Why” as well as the “How” of accounting concepts, the emphasis is put on understanding rather than mere cramming.

A brief list of learning objectives at the beginning of each chapter will assist the readers to determine the things they should understand while going through the chapter. Hence, checking back may help them to identify weak areas which still need thorough review. I would like to thank numerous people for the contribution they made to the writing of this book. In particular,

I gratefully acknowledge the input that Mr. Sajid Munir made in developing the Review Questions, text for various chapters and for his constructive criticism throughout the process of developing the book. In addition, my thanks owe to the Sheraz Siddiq, Waseem Zia, Zafar Hashmi, Rabia Malik for their continuous support, insightful comments and suggestions during several stages of the book development.

Following are the topics covered in this book

Table of Contents

1. Preface (Accounting AS Level)
2. Chapter 1 Bookkeeping and Accounting
   1. Branches of accounting
   2. Accounting equation
   3. Assets 17
   4. Liabilities 17
   5. Equity 17
   6. Drawings 17
   7. Transaction
   8. Cash transactions 17
   9. Credit transactions 17
   10. Balance sheet (statement of financial position)
   11. Balance sheet (vertical style) 19
   12. Review questions
3. Chapter 2 Accounting for Assets, Liabilities and Capital 
   1. Evolution of book keeping
   2. Rules of debit and credit
   3. Ledger
   4. Account
   5.  “T” account 26
   6. Double-entry relating to assets and liabilities
   7. Example 27
   8. Balancing of an account
   9. When should accounts be balanced? 30
   10. Trial balance
   11. Uses of a trial balance 31
   12. Why is it necessary for a trial balance to ‘balance’? 31
   13. Trial balance – an aid to financial statements 32
   14. Review questions
4. Chapter 3 Accounting for Inventories
   1. Inventory of goods
   2. Bookkeeping for inventory of goods
   3. Purchases
   4. Cash purchases 35
   5. Credit purchases 36
   6. Sales
   7. Cash sales 36
   8. Credit sales 36
   9. Purchases returns (return outwards)
   10. Sales returns (returns inwards)
   11. Trading section of income statement
   12. Closing of incomes and expenses
   13. Closing inventory
   14. Opening inventory
   15. Calculation of profits for service businesses
   16. Review questions
5. Chapter 4 Accounting for Incomes and Expenses
   1. Incomes
   2. Expenses
   3. Double-entry for expenses and incomes (revenues)
   4. Bookkeeping for incomes and expenses
   5. Calculation of profit for the year
   6. Closing of incomes and expenses
   7. Review questions
6. Chapter 5 Financial Statements – An Introduction
   1. Need for income statement
   2. Uses of income statement
   3. Carriage inwards
   4. Carriage outwards
   5. Income statement and balance sheet-an important consideration
   6. Accounting period
   7. Drawings
   8. Assets
   9. Non-current assets 52
   10. Current assets 52
   11. Liabilities
   12. Current liabilities 52
   13. Non-current liabilities 52
   14. Review questions
7. Chapter 6 Books of Original Entry & Division of Ledger
   1. Advantages of maintaining books of original entry
   2. Components of books of original entry
   3. Sales journal
   4. Posting from the sales journal to the ledger 63
   5. Trade discount 63
   6. Sales on credit card 64
   7. Purchases journal
   8. Posting from the purchases journal to the ledger 64
   9. Return inwards journal
   10. Posting from the returns inwards journal to the ledger 65
   11. Return outwards journal
   12. Posting from the returns outwards journal to the ledger 66
   13. General journal
   14. Posting from the general journal to the ledger 68
   15. Cash book
   16. Two column cash book 68
   17. Cash discounts 69
   18. Three column cash book 69
   19. Nature of discounts columns 69
   20. Folio columns 70
   21. Contra entries 70
   22. Balancing of cash and bank columns 70
   23. Cash book in recent times 70
   24. Personal ledgers
   25. Cash book
   26. General ledger
   27. Private ledger
   28. Review questions
8. Chapter 7 Bank Reconciliation Statements
   1. Reasons for difference between bank statement and cash book balance
   2. Items in the bank statement but not in the cash book 76
   3. Items in the cash book but not in the bank statement 76
   4. Bank reconciliation statement
   5. Steps for preparing a bank reconciliation statement
   6. Uses of bank reconciliation statement
   7. Review questions
9. Chapter 8 Bad Debts and Provision for Doubtful Debts 
   1. Bad debts
   2. Doubtful debts
   3. Provision for doubtful debts
   4. General provision for doubtful debts 86
   5. Specific provision for doubtful debts 87
   6. Calculation of provision for doubtful debts 87
   7. Treatment of provision in financial statements 87
   8. Ageing schedule
   9. Bad debts recovery
   10. Cash discounts allowed and provision for discounts allowed
   11. Benefits of offering cash discounts 89
   12. Recording of provision for discounts allowed in journal 90
   13. Why provisions are made for bad debts and discounts allowed
   14. Salient points to note
   15. Review questions
10. Chapter 9 Accounting for Non-current Asset
    1. Depreciation
    2. Amortization and depletion
    3. Effects on cash flows
    4. Relationship with market value
    5. Causes for depreciation
    6. Factors for calculating depreciation
    7. The original cost of asset 95
    8. The estimated useful economic life 95
    9. The approximate residual value 95
    10. Characteristics of depreciation
    11. Why depreciation is provided for?
    12. Methods for calculating depreciation
    13. Revaluation method 96
    14. Straight line method or original cost method 96
    15. Reducing balance method 97
    16. Annual depreciation under reducing balance & straight line methods
    17. Distinctive features of straight line and reducing balance method
    18. Choice of a method
    19. Difference between depreciation and provision for depreciation
    20. Depreciation policies
    21. Depreciation accounting
    22. Depreciation and accounting concepts
    23. Review questions
11. Chapter 10 Accounting Concepts and Conventions
    1. Conventions and concepts – an implication
    2. Dual aspect (duality) concept
    3. Business entity concept
    4. Prudence concept
    5. Consistency concept
    6. Materiality concept
    7. Realisation concept
    8. Accrual concept
    9. Matching concept
    10. Substance over form
    11. Objectivity
    12. Money measurement concept
    13. Historical cost concept
    14. Going concern concept
    15. Revaluation of assets
    16. A critical review of accounting conventions
    17. Review questions
12. Chapter 11 Capital and Revenue 
    1. Treatment of capital and revenue items in financial statement
    2. Distinction between capital and revenue expenditures
    3. Expenditures for acquisition of a non-current asset 113
    4. Expenditures for improving efficiency /capacity of a non-current asset 113
    5. Expenditure at the initiation of business 114
    6. Expenditure on extension of business 114
    7. Expenditures to increase the useful life of an asset 114
    8. Expenditures of abnormal amounts 114
    9. Application of materiality concept
    10. Difference between capital and revenue receipts
    11. Revenue receipts 114
    12. Capital receipts 114
    13. Effects of wrong treatment of capital and revenue items
    14. Review questions
13. Chapter 12 correction of errors and suspense account
    1. Types of errors
    2. Errors not affecting agreement of trial balance 118
    3. Errors affecting agreement of trial balance 120
    4. Suspense account
    5. Effect on profit of correcting errors
    6. Effects on balance sheet of correcting errors
    7. Review questions
14. Chapter 13 Control Accounts
    1. Control accounts in cambridge a level syllabus
    2. The format of sales ledger and purchase ledger control accounts
    3. How control accounts are prepared?
    4. Contra entry
    5. Two balances of control accounts
    6. Reasons for having two balances of a control account 131
    7. Treatment of two balances in the balance sheet 131
    8. Correction of errors in control accounts
    9. Advantages and uses of control accounts
    10. Limitations (disadvantages) of preparing control accounts
    11. Review questions
15. Chapter 14 Financial Statements with Adjustments
    1. Cash and accrual basis of accounting
    2. Need for adjustments
    3. Types of adjustments
    4. Inventory at year end
    5. Closing inventory in trial balance 143
    6. Drawings of goods for owner’s personal use
    7. Accrued expenses
    8. Accrued incomes
    9. Prepaid expenses (other receivables)
    10. Pre-received /deferred incomes
    11. Treatment of opening accruals or prepayments
    12. Depreciation
    13. Methods of depreciation 146
    14. Depreciation policies 146
    15. Recording of depreciation 146
    16. Bad debts
    17. Bad debts written off (included in the trial balance) 147
    18. Bad debts to be written off (given as an adjustment) 147
    19. Provision for doubtful debts
    20. Adjusting more than two accounts
    21. Calculation of profits for service businesses
    22. Users of financial statements
    23. Limitations of financial statements
    24. Review questions
16. Chapter 15 Accounts from Incomplete Records
    1. The reasons for incomplete records
    2. Need for preparing financial statement from incomplete records
    3. Calculating profits and losses from changes in capital/net assets
    4. Statement of affairs 161
    5. Statement of profit or loss 161
    6. Preparation of financial statements from incomplete records
    7. Calculation of opening capital through statement of affairs 162
    8. Preparation of cash/bank account 162
    9. Calculation of total sales 162
    10. Calculation of total purchases 163
    11. Calculation of incomes/expenses to be shown in income statement 164
    12. Calculation of non-cash expenses 166
    13. Mark-up and margin
    14. Use of mark up and margin to calculate missing items in trading section 167
    15. Conversion of mark-up into margin 169
    16. Conversion of margin into mark-up 170
    17. Calculation of goods lost by theft or fire
    18. Preparing balance sheet from incomplete records
    19. Inventory count and the balance sheet date
    20. Disadvantages or defects of accounts prepared from incomplete records
    21. Review questions
17. Chapter 16 Financial Statements of Partnerships
    1. Characteristics of partnership
    2. Advantages and disadvantages of the partnership
    3. Partnership agreement
    4. Contents of partnership deed 183
    5. Provisions of partnership act 1890 when no partnership agreement exists
    6. Financial statements of a partnership
    7. Appropriations of profit 184
    8. Balance sheet of partnerships 186
    9. Accounting records for partners
    10. Partners’ capital accounts 186
    11. Drawings accounts 187
    12. Partners’ loan account 188
    13. Calculation of interest on capital
    14. Calculation of interest on drawings
    15. Partner’s guaranteed share in profit
    16. Review questions
18. Chapter 17 Changes in Partnerships
    1. Admission of a new partner
    2. Retirement or death of an existing partner
    3. Final settlement of retired or deceased partner’s capital 200
    4. Changes in profit-sharing arrangements
    5. Apportionment of profits
    6. Adjustments for goodwill
    7. Types of goodwill 202
    8. Factors affecting value of goodwill 202
    9. Valuation of inherent goodwill 203
    10. Why goodwill is accounted for in partnership? 204
    11. Accounting treatment of goodwill 204
    12. Case 1: A goodwill account is opened and retained 204
    13. Case 2: A goodwill account is opened and then written off 205
    14. Change in goodwill 206
    15. Revaluation on partnership change
    16. Opening of a revaluation account 207
    17. Profit or loss on revaluation 207
    18. Revaluation of non-current assets with provision for depreciation 209
    19. Revaluation and the accounting conventions 211
    20. Values to remain unaltered in books 211
    21. Capital in profit and loss sharing ratios
    22. Review questions
19. Chapter 18 Dissolution of Partnerships 
    1. Reasons of dissolving a business
    2. Realisation account
    3. Accounting treatment on dissolution
    4. Assets on dissolution 225
    5. Goodwill on dissolution 225
    6. Liabilities on dissolution 225
    7. Expenses on dissolution 226
    8. Profit (loss) on realization account 226
    9. Partners’ loans accounts on dissolution 226
    10. Current account balances on dissolution 226
    11. Cash or bank balance on dissolution 226
    12. Partners’ capital accounts on dissolution 227
    13. Review questions
20. Chapter 19 Financial Statements of Companies
    1. The need for companies
    2. Choice between a partnership and a limited company
    3. Advantages and disadvantages of forming a limited company
    4. Advantages of a limited company 233
    5. Disadvantages of forming a limited company 234
    6. Sources of finance for a company
    7. Types of shares
    8. Ordinary shares 235
    9. Preference shares 235
    10. Debentures
    11. Types of preference shares
    12. Participating preference shares 236
    13. Non-participating preference shares 236
    14. Cumulative preference shares 236
    15. Non-cumulative preference shares 237
    16. Forms of capital
    17. Authorized share capital 237
    18. Issued share capital 237
    19. Called up share capital 238
    20. Paid up capital 238
    21. Financial statements of limited companies
    22. Statement of changes in equity
    23. Equity dividends on ordinary shares
    24. 19 ias rules for equity dividends 239
    25. Transfer to general reserve 239
    26. Shareholders’ equity
    27. Reserves
    28. Capital reserves 239
    29. Revenue reserves 240
    30. Financial statements in cie exams
    31. A comparison of financial statements of business organisations
    32. Review questions
21. Chapter 20 Issue of Shares & Debentures
    1. Prices of a share
    2. Par value 248
    3. Issue price 248
    4. Book value 248
    5. Market value 248
    6. Selling shares to the general public
    7. Issue of shares at par 249
    8. Issue of shares at premium (at a price more than face value) 249
    9. Rights issue
    10. Advantages of rights issue 250
    11. Disadvantages of rights issue 250
    12. Bonus or scrip issue
    13. Reasons for bonus issue 250
    14. Effect on earnings per share (eps) 251
    15. Advantages of bonus issue 251
    16. Disadvantages of bonus issue 252
    17. Difference between rights and bonus issue
    18. Issue of loans and debentures
    19. Issue of debentures at par 253
    20. Issue of debentures at premium (at a price more than face value) 254
    21. Issue of debentures at discount (at a price below face value) 254
    22. Review questions
22. Chapter 21 Ratio Analysis
    1. Financial ratios
    2. Analysis of ratios
    3. Comparing one year with another (trend or time series analysis) 259
    4. Comparing one business with another business (cross-sectional analysis) 260
    5. Rule of thumb 260
    6. Demonstration of ratios
    7. Profitability ratios
    8. Gross profit ratio 260
    9. Profit for the year ratio 261
    10. Operating expenses ratio 261
    11. Return on assets 262
    12. Return on capital employed (roce) 262
    13. Return on equity 262
    14. Activity ratios
    15. Inventory turnover ratio 263
    16. Trade receivables’ collection period 263
    17. Trade payables’ payment period 264
    18. Non-current asset turnover 264
    19. Liquidity ratios
    20. Current ratio 265
    21. Liquid ratio 265
    22. Uses of ratio analysis
    23. Limitations of ratio analysis
    24. Users of financial ratios
    25. Preparation of financial statements with the help of ratios
    26. Review questions
23. Chapter 22 Statement of Cash Flows
    1. Classifications of cash flows – an example
    2. Cash and cash equivalents
    3. Cash 277
    4. Cash equivalents 277
    5. Bank overdrafts 277
    6. Preparation of a statement of cash flows
    7. Cash flow from operating activities
    8. Importance of cash flow from operating activities 277
    9. Calculation of cash flow from operating activities
    10. Cash from operating activities in direct method 277
    11. Cash from operating activities in indirect method 277
    12. Investing activities
    13. Financing activities
    14. Cash flow at a glance
    15. Uses of a statement of cash flows
    16. Review questions
24. Chapter 23 Cost Accounting – An Introduction
    1. Difference between cost and expense
    2. Cost classification by changes in activity
    3. Fixed cost 290
    4. Variable costs 290
    5. Mixed costs 290
    6. Step costs 291
    7. Cost classification by traceability
    8. Direct costs error! Bookmark not defined
    9. Indirect costs 291
    10. Sunk costs 291
    11. Direct labour cost
    12. Indirect labour cost
    13. Labour cost and timekeeping
    14. Clock card (time card) 292
    15. Time sheets 292
    16. Wage sheet 292
    17. Calculation of labour cost
    18. Piece work wage system 292
    19. Time wage system (pay on time basis) 293
    20. Overtime
    21. Incentive schemes and bonus plans
    22. Review questions
25. Chapter 24 Inventory Valuation – Further Issues
    1. Inventory valuation methods
    2. First in first out (FIFO) 300
    3. Last in first out (LIFO) 301
    4. Weighted average cost (AVCO) 301
    5. Relationship of inventory valuation methods with physical flow of goods
    6. Bases of inventory valuation
    7. Role of accounting concepts in inventory valuation
    8. Separate valuation of inventory items
    9. Calculation of cost of work in process
    10. Effects of errors in valuing inventory
    11. Goods on sale or return
    12. Goods sent to customers on sale or return (approval) basis 303
    13. Goods received on sale or return (approval) basis 303
    14. Systems of inventory accounting
    15. Periodic inventory system 304
    16. Perpetual inventory system 304
    17. Review questions
26. Chapter 25 Absorption Costing
    1. Absorption costing
    2. Calculation of total production cost
    3. Features of absorption costing
    4. Absorption costing in price setting
    5. Cost center
    6. Production cost centers 312
    7. Service cost centers 312
    8. Cost unit
    9. Allocation of production overheads
    10. Apportionment of production overheads
    11. Allotment of service department costs to production departments
    12. Production cost centers 313
    13. Service cost centers 314
    14. Allotment of non-reciprocal services 314
    15. Allotment of reciprocal services 315
    16. Calculation of overhead absorption rates
    17. Actual vs predetermined absorption rate 317
    18. Advantages of using predetermined overhead absorption rates 317
    19. Choosing the appropriate absorption base 320
    20. Single (factory wide) overhead absorption rate 320
    21. Departmental overhead absorption rate 320
    22. Absorption of overheads
    23. Over/under absorbed overheads
    24. Over-absorbed overheads 321
    25. Under-absorbed overheads 321
    26. Costing systems/methods
    27. Specific order costing 321
    28. Continuous costing 322
    29. Review questions
27. Chapter 26 Marginal Costing
    1. Marginal cost
    2. Marginal costing
    3. The principles of marginal costing
    4. Advantages and disadvantages of marginal costing technique
    5. Advantages 330
    6. Disadvantages of marginal costing technique 330
    7. The uses of marginal costing
    8. Contribution
    9. Break even analysis
    10. Break-even point 331
    11. Break-even point in sales ($) value 332
    12. Target profits 332
    13. Break even chart 333
    14. Assumptions and limitations of break even analysis 334
    15. Significance of break even analysis 335
    16. Margin of safety
    17. Profit-volume chart
    18. How to increase contribution ratio 337
    19. Income statements under marginal costing and absorption costing
    20. Profits of marginal costing and absorption costing 339
    21. Difference between marginal and absorption costing 339
    22. Short term decision making
    23. Make or buy decision
    24. Qualitative factors for make or buy decision 341
    25. Special order to use up spare capacity
    26. Acceptance of order with negative contribution 343
    27. Conditions for accepting order below normal price 343
    28. Considerations for accepting order below normal price 344
    29. Consequences of acceptance of order below normal price 344
    30. Abandonment of a product line/department
    31. Factors to be considered before closure of a department 345
    32. Limiting factor
    33. Examples of limiting factors 345
    34. Reducing the effects of limiting factors 346
    35. Decision- making process to reduce effects of a limiting factor 346
    36. Review questions
28. Chapter 27 Accounting & Business Planning 359
    1. Difference between budgets and budgetary control
    2. Purposes of budget
    3. Advantages of budgetary control system
    4. Limitations of budgetary control system
    5. Stages in the budgetary planning process
    6. Effects of principal budget factors on the preparation of budgets
    7. Behavioural aspects of budgetary control system
29. Solutions to Odd Numbered Questions
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
    14. Chapter 14
    15. Chapter 15
    16. Chapter 16
    17. Chapter 17
    18. Chapter 18
    19. Chapter 19
    20. Chapter 20
    21. Chapter 21
    22. Chapter 22
    23. Chapter 23
    24. Chapter 24
    25. Chapter 25
    26. Chapter 26
30. Key to Even Numbered Questions
31. Index