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“Double Entry Accounting System”

State what is meant by the term book-keeping.
The recording of all financial transactions in the books of account

State one purpose of accounting.

To monitor progress, to prepare financial statements, for decision making

Explain the meaning of the following terms.

Asset – anything owned by or owed to the business
Liability – anything owed by the business
Owner’s capital – funds and resources provided by the owner OR amount owed by the business
to the owner
Inventory – goods for resale

Give one example of an intangible asset

Goodwill/patents/trademarks/another suitable example

State the difference between a non-current asset and a current asset.

Non-current asset – an item held for more than 12 months, an item which is not for resale.
Current asset – short term, an item which can be turned into cash quickly.

State the difference between a non-current liability and a current liability.

Non-current liability – long term debt
Current liability –an amount owed to be paid within a year

Name one form (other than in cash or from the bank) in which a business owner might
take drawings.
Goods for own use
Private expenses paid by business
Business asset taken over by owner

State reasons for maintain the full set of double entry records
Help to prevent fraud / Easy reference
Balances are more easily available / Help to check accuracy/arithmetic errors
More detail available in income statement

Important of Accounting records

Provide information about the assets and liabilities of the business
Provide details about the amounts owed by trade receivables and owed to trade payables
Provide details of the payments and receipts
Provide information to enable financial statements to be prepared
Ensures that no transaction is overlooked

Reasons for measuring profit / loss at regular intervals

Enable profit or loss for the period to be calculated
Provide information for comparison with previous periods and other businesses
Assist with decision-making
Assist with monitoring the progress of a business
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Reasons for preparing financial statements at regular intervals

to calculate the profit or loss earned by the business during a period of time
to know the financial position of the business at regular intervals
to be able to measure the progress of the business over several periods
to assist in decision-making and future planning

Definitions
An income statement shows incomes and expenses and is prepared for a period of time.
A statement of financial position shows assets and liabilities and is prepared at a particular
date.
A trade payable is an amount owed to a person or business to whom the trader owes an
amount of money for goods purchased on credit.
A trade receivable is an amount receivable from a person or business who owes the trader an
amount of money of goods sold to them on credit.

State one difference between an income statement and a statement of financial position.
An income statement deals with revenues and costs, whilst a statement of financial position
deals with assets and liabilities.
An income statement covers a period of time, whilst a statement of financial position is for a
specified date.

Reason to prepare income statement

To know if he has made a profit/has an adequate return on his investment

State the difference between Trading/Manufacturing business and a service business.

Trading/Manufacturing business buys or manufactures goods which it then sells.
A service business provides a service to its customers or clients.

Users of financial statements

State two reasons why bank manager would be interested in his financial statements.
Assess prospects of any requested loan/overdraft being repaid when due
Assess prospects of any interest on loan/overdraft being paid when due
Assess security available to cover any loan/overdraft

Reasons why supplier would be interested in financial statement

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“Ledgers”
State which types of accounts are maintained in the sales ledger and purchases ledger.
Sales ledger – accounts of individual credit customers
Purchases ledger – accounts of individual credit suppliers

Name one ledger account which might be found in the nominal (general) ledger.
Any non-current asset, any expense, any income, purchases, sales, returns, inventory, loan,
capital, drawings, etc.

Name one other type of ledger which a business might maintain.

Sales ledger / Purchases ledger

Explain why dividing the ledger into sections makes it easier to use.
Work can be shared between several people
Easier for reference
Same type of accounts is kept together

State one reason why accounts are maintained in different ledgers

So that accounts of the same type can be kept together (1)
Ease of maintenance/navigation
Speed / Easier to check/locate error
Frees up the general ledger
Divides the work between several people

***State the purpose of the narrative of journal entries

Useful because it may be necessary to recall the reasons / it can invoice non-regular
transactions/ can contain a reference to any prime documents.

State why the purchases account has a debit balance.

Because purchases represent costs to the business
Purchases are amounts which reduce profit
Purchases are amounts paid by the business

An expense account usually has a DEBIT balance. At the end of the financial year the
cost for the year is transferred to the INCOME STATEMENT. This transfer is recorded
with an entry on the CREDIT side of the expense account. Any balance remaining on
the account is included in the STATEMENT OF FINANCIAL POSITION.
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“Books of Prime Entry/ Day Books/ Journals”

State what is meant by a book of prime (original) entry.

The book where transactions (and other entries) are first recorded.

State one reason why a trader might use books of prime (original) entry.
So that accounts of the same type can be kept together
Ease of maintenance , Speed, Easier to check/locate error , Frees up the general ledger
Divides the work between several people

Name books of prime entry which Owner may maintain. In each case give an
example of a transaction which might be recorded in it.
 Sales returns journal – return of goods sold on credit
 Purchases journal – purchase of good bought on credit
 Purchases returns journal – return of goods bought on credit
 Cash book – cash sales/receipt from credit customer/any sort of payment
 Petty cash book – any minor expense
 General journal – correction of error/purchase of non-current asset on credit

Name two of the books of prime (original) entry which a business may maintain
Cash book/petty cash book/sales journal/sales returns journal/purchases journal/purchases
returns journal/general journal/returns inwards and returns outwards journals

State how credit sales are posted at the end of the month from the sale journal
The total sales are credited to the sales account.
Each sale is debited to the individual debtor's account on a daily basis.

State when each of the following documents is usually sent.

Invoice – when goods are sold
Credit note – when goods are returned
Statement of account – at end of the period, usually a month

*********State the purpose of a debit note received

To notify an overcharge/faulty goods
To notify goods being returned
To reduce the amount of the invoice/ request credit note
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State the purpose of a statement of account issued by Supplier to customer

To inform customer of the amount due
To provide a summary of the transactions for the month/period
To allow customer to check his records

State why a credit note may later be issued

If goods are returned
If goods are reported faulty
If there has been an overcharge on an invoice

Name the book of prime (original) entry used when a trader brings cash into the business as
capital introduced. Cash Book

Name the book of prime (original) entry used when a trader transfers his private vehicle to the
business. General Journal
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“Trial Balance”
State one reason why a trader might prepare a trial balance.
To check the arithmetical accuracy of the double entry
As a basis for the preparation of the financial statements/final accounts

Explain what is meant by the term trial balance.

list of balances of ledger accounts at a particular date

Name the account owner could have opened to enable the trial balance to balance.
Suspense

Give the date to which the inventory in the trial balance relates. (opening date)

Name and explain errors which do not affect the balancing of a trial balance.
Omission- transaction totally omitted from the books
Commission - transaction posted to wrong account of right class
Principle - transaction posted to account of wrong class
Original entry - transaction incorrectly recorded in book of prime entry
Reversal - debit entry posted on credit side and vice versa
Compensating - errors cancel one another out

***Methods to check errors in books of account

preparing of trial balance
preparing of control account
preparing a bank reconciliation statement

State the errors which affect the trial balance

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“Cash book / Petty cash book”

Explain why there could be a credit balance on a bank account but not on the cash
account
Can withdraw more from bank than put in / can have overdraft
Cannot take more cash than is physically present

Explain how a bank overdraft can arise.

A business has paid out more from the bank than it has paid in

Explain what is meant by a bank overdraft.

Paying more from the bank account then there is in it.
This means that the business owes the bank money (the bank is a current liability)

State (two) differences between a bank overdraft and a bank loan.

A loan is of fixed amount but an overdraft is of varying amount.
A loan is for a fixed term but an overdraft may be paid back at any time.
A loan may require security but an overdraft may be unsecured.
A loan may have a fixed rate of interest but an overdraft will have a variable rate.

Name the two accounts which are posted with the totals from a three-column cash book.
Discount allowed; Discount received

Reason for cash discount Reasons for Trade discount

For early payment/ to reward prompt to encourage bulk purchases
payment to reward business in the same trade
to allow customers to make a profit

State what is meant by a dishonored cheque.

The debtor’s bank refused payment

State how to record the dishonoring of the cheque.

Trade Receivable (Debit) – Bank (Credit)

State one reason why a cheque may be dishonored.

 insufficient funds in account
 no signature on cheque / no date
 wrong signature
 words and figures do not agree
 cheque is out of date

Suggest two possible reasons for the change in business’s bank balance.
making a loss, excess drawings, purchase of non-current assets, bad debts, debtors not
paying, paying trade payables sooner, increased expenditure on inventory, repayment of
loan.

State two reasons for maintaining a petty cash book.

Reduce the number of entries in the main cash book
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Removes the small cash payments from the main cash book
Reduces the number of entries in the ledger / Provides training for junior staff members
Allows the chief cashier to delegate some of the work
Explain the meaning of imprest system.
At any time, amount paid out from the float (represented by vouchers/receipts) plus remaining
cash must equal the fixed amount of the float.

State one advantage of the imprest system of petty cash.

Control/limit/keep track of petty cash expenditure
The cash remaining and the vouchers received should equal the imprest
Can help to reduce fraud

“Bank Reconciliation”
State reasons to prepare a bank reconciliation statement.
To check for errors and omissions in his books of account
To check the errors in the bank statement
To identify stale cheques
To identify unpresented cheques
To identify amounts not credited
To calculate the correct bank balance in his cash book
To verify the balance in his cash book
To correct/amend his cash book

State two reasons why a trader should reconcile the cash book balance with the balance
shown on the bank statement at the end of each month.
Obtain correct bank balance
Identify errors on the bank account
Identify errors on the bank statement
Assist in discovering fraud and embezzlement
Identify amounts not credited by the bank
Identify cheques not presented
Identify any stale cheques

State what is meant by a bank statement.

Copy of the customer’s account as it appears in the books of the bank

Give one example of each of the following.

1 An item in the cash book not in the bank statement
Unpresented cheque/uncredited deposit/book-keeper error
2 An item in the bank statement not in the cash book.
Bank charges /bank interest/ dishonored cheque/ standing order/ credit transfer/direct
debit/bank error/ dishonored cheque

Name the statement prepared by Owner to ensure that his bank account is free from
error.
Bank reconciliation statement
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State why the bank statement balance is on the opposite side to that shown in the cash
book.
The bank statement is a copy of the account of the business as it appears in the books of the
bank/ the bank statement is prepared from the viewpoint of the bank.
The bank account in the cash book is prepared from the viewpoint of the business
“Control Accounts”
Meaning
A contra entry is one which appears on the debit side of the purchase’s ledger control account
and the credit side of the sales ledger control account.
Reason
The entry is made when a sales ledger account is set off against a purchase’s ledger account of
the same person/business

State the benefits of maintain sale ledger control account

Explain why Arun and Rupa decided to make the set-off.

Save on administration costs
The debt can be settled by using one cheque only

Explain why the preparation of control accounts would have helped Jason discover why
the totals of the trial balance did not agree.
By comparing control account totals to the totals of balances of the sales and purchases
ledgers, Jason might be able to locate the error.

Suggest why Vijay Singh charged a credit customer interest.

The customer had not paid the balance owed by the end of the period of credit allowed

*State two reasons why Owner does not use the information contained in the sales
ledger to prepare the sales ledger control account.
An error in the sales ledger would not be revealed
Any fraud would not be revealed

State two reasons why it is possible to have a debit balance on a purchases ledger
control account.
Overpayment of amount owing
Failure to deduct cash discount due
Goods returned after account settled
Payment made in advance

Explain the contra entry to the purchase’s ledger

This is when the balance of an account in the purchase’s ledger is set against the balance of an
account of the same person in the sales ledger.
It is used when a trader both buys’ goods from and sells goods to another business
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“Depreciation (Non-current Assets)”

State the effect the purchase of NCA had on Owner’s capital. None

State two causes of depreciation

Physical deterioration
Economic reasons
Passage of time
Depletion

Name methods of depreciation and explain how it is calculated.

Straight-line method (on cost)

The straight-line method of depreciation uses the same amount of depreciation each year.
This method is used where each year is expected to benefit equally from the use of the asset.
Buildings – straight line method

Reducing (diminishing) balance method

Annual percentage rate is applied to the net book value of the asset.
This method is used where the greater benefits from the use of the asset will be gained in the
early years of its life.
Computer equipment – reducing balance method

Revaluation method
The difference between the opening and closing valuations is taken (1) and adjusted for any
purchases or disposals.
This method is used where it is impractical or difficult to maintain detailed records of the asset.
Motor vehicle – reducing balance method

State the type of asset for which the revaluation method of depreciation is suitable.
* Small items of equipment e.g. loose tools, packing cases, small items of equipment

Suggest one reason why the loose tools are revalued at the end of each financial year
rather than by using the straight line (equal instalment) or reducing (diminishing) balance
method of depreciation.
Low value items which are not easy to depreciate separately/ Not practical to keep detailed
records of such assets/other suitable comment.

****State how providing depreciation is an application of the accounting principle of

accruals (matching).
The cost of the non-current asset and the revenues arising from its use are matched in an
accounting period. / The cost of the non-current asset is spread over its useful life.
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Name one accounting principle which is applied when depreciation is provided -

Prudence

*****Explain how charging depreciation is an example of the application of the principle

of prudence.
Ensures that non-current assets are shown at more realistic values
Ensures that the profit for the year is not overstated

Profit OR Loss on disposal = Proceed on sale + provision for depreciation – Cost Price
(vertical format)

Explain the factors owner should consider when making the decision about purchasing
these business premises.
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“Irrecoverable debt / Provision for doubtful debt”

Irrecoverable debts
Amounts owing to a business which will not be paid by credit customers

Irrecoverable debts recovered

When a credit customer pays some, or all, of the amount owed after the amount was previously
written off

Provision for doubtful debts

An estimate of the amount a business will lose in a financial year because of bad debts that
reduces the value of trade receivables

Name the two accounting principles applying by maintaining a provision for doubtful
debts account.
Accruals/ matching, Prudence

Name the two items in the statement of financial position which might be overstated if
not maintain a provision for doubtful debts account.
Trade receivables , Capital/profit

Suggest two ways to reduce the risk of bad debts.

Reduce credit sales/sell on a cash basis
Obtain references from new credit customers
Fix a credit limit for each customer
Improve credit control/issue invoices and monthly statements promptly
Refuse further supplies until outstanding balance is paid

State how maintaining a provision for doubtful debts account is an application of the
accounting principle of prudence.
A provision for doubtful debts stops current assets from being overstated and profit from
being overstated

Explain how accounting for bad debts and providing for doubtful debts applies the
following accounting principles.
(i) accruals (matching) - Any expense/loss for the financial year is matched/set against the
revenue for that same period (1)
(ii) Prudence - Ensures that the profit for the year is not overstated. Ensures that the trade
receivables/ current assets are not overstated (1)

**State two reasons why the amount received in from trade receivable was not included
in the income statement.
To apply the matching (accruals) principle
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Because the income statement accounts for sales made during the year
Because receipts may not arise in the same year as the sale is made

Comment on the adequacy or otherwise of the rate of Ashvar’s provision for doubtful
debts.
*The provision was $246 but the actual bad debts were higher.
The provision may not be adequate.
Trader propose its clients to pay cash instead of offering credits term

Suggest two ways in which Owner could reduce the possibility of Irrecoverable debts.
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“Accrual and prepayment”

An adjustment for a prepayment reduces expenses and increases profit.
An adjustment for an accrual increases expenses and decrease profit.

Explain how the accruals (matching) principle has been applied in the preparation of the
rent and rates account.
The accruals principle has been applied when only the expense for the year was transferred to
the income statement.

1 June 2013 Balance – rates $70

Explanation This represents rates prepaid. This was paid in the year ended 31 May 2013 but
relates to the year ended 31 May 2014.
Statement of financial position section Current assets

1 June 2013 Balance – rent $120

Explanation This represents rent accrued. This relates to the year ended 31 May 2013 and
remained unpaid at the end of the year.
Statement of financial position section Current liabilities

31 May 2014 Bank $2570

This represents the total amount paid by cheque for rent and rates during the year ended 31
May 2014.

31 May 20134 Income statement $2280

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This is the amount transferred to the income statement which represents the rent and rates for
that financial year. Only the rent and rates relating to the current year are transferred to the
income statement. Adjustments are made for accruals and prepayments

“Accounting Principles”

Accounting principle that applied Drawings……

Business entity
A distinction is made between the financial transactions of a business and those of its Owner

Name the accounting principle applied when the double entry system of book-keeping is
used. Duality / dual aspect

Accruals (matching)
Income should be matched with costs in an accounting period

Explain how the business entity principle has been applied in the preparation of the
stationery account.
The business entity principle has been applied when the stationery taken for personal use was
transferred from the stationery account to the drawings account.

Explain why the outstanding loan interest should not be credited to the loan account.
Loan interest is an expense account/any accrued interest is a current liability.
The loan is a non-current liability
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Explain the difference between capital expenditure and revenue expenditure.

Capital expenditure Revenue expenditure
Purchase of non-current asset Day-to-day running expense
Provides benefit for over 1 year Provides benefit for less than 1 year
Appears in statement of financial position Appears in income statement

Capital receipts
Amounts received which do not form part of the day-to-day trading activities.

Capital expenditure
Money spend on acquiring improving and installing non-current assets.

Revenue receipts
Amounts received in the day-to-day trading activities from revenue and other items of income.

Revenue expenditure
Money spent on running a business on a day-to-day basis.

If an item of capital expenditure is wrongly recorded as revenue expenditure profit will be

…………………….
If an item of revenue expenditure is wrongly recorded as capital expenditure profit will
be…………………….

example of a capital receipt.

capital introduced
proceeds of sale of non-current asset
receipt of loan

example of a revenue receipt.

sales
commission received
rent received
interest received
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Rani is concerned about the increase in the level of inventory and is considering a
different basis of valuation.
Prudence – a business should not overstate profits/assets and so should value inventory at the
lower of cost and net realisable value
Realisation – a business should not account for profit until it is realised and should use cost
price than selling price for inventory valuation

Explain why inventory should be valued on this basis.

To avoid overstating the profit for the year
To avoid overstating the current assets
To apply the principle of prudence

State how inventory should be valued.

Lower of cost and net realisable value

Explain the meaning of the term Cost and ‘net realisable value’.
Cost is the purchase price of the goods plus any additional costs incurred in bringing the
inventory to its present condition and position
Net realisable value is the estimated receipts from the sale of the inventory less any
costs of completing or selling the goods

State one advantage and one disadvantage to a business of reducing its level of
inventory.
Advantage Disadvantage
 Money can be used elsewhere  If buying in smaller quantity risk of
 Cash is not tied up losing quantity discounts
 Reduces risk of theft/ deterioration/  Risk of inventory running out
obsolescence/ damage  Risk of not meeting customer demand
 Reduces inventory holding cost e.g.
insurances

State how reducing the value of inventory would be an application of the accounting
principle of prudence.
It avoids inventory/current assets/profit being overstated

State how reducing the value of inventory would be an application of the accounting
principle of accruals (matching).
The loss arising from the damage is recorded in the same year as the damage occurred

State two reasons why two business owners might find it difficult to compare their
financial
statements.
different accounting policies
different locations, different capital structures, different size of business
different type of business, different type of goods sold
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different year end , non-monetary items

Name one accounting objectives

Comparability,
Understandability
Relevance
Reliability

State the meaning of the accounting objective of relevance.

Financial information is relevant if it affects the business decisions

Explain what is meant by the accounting policy of comparability.

Financial statements are only useful if the information they contain can be compared with
previous periods or other businesses

State what is meant by the objective of ‘reliability’.

Financial information is reliable only
if it can be depended on to represent actual events
if it is free from error , if it free from bias
State what is meant by the accounting objective of understandability
A financial report must be capable of being understood by the users of that report

State how International Accounting Standards help to achieve understandability.

By narrowing areas of difference in financial statements

Business has received positive feedback about its service. No entry has been made in the
accounting record to reflect his success.
Money Measurement
Accounting transactions should only be recorded if it can be expressed in term of money

Limitation of financial statements

(i) Historical cost
The financial transactions are recorded at the actual cost because of this it is difficult to
compare transactions taking place at different times

(ii) Non-financial aspects

The accounting records only show information which can be expressed in monetary terms/non-
monetary items cannot be recorded.
There are many other factors which affect the performance of the business

Explain two factors Syed Zilani should consider when comparing his results with those
of another business.
Should compare with a business in the same trade
Should compare with a business of approximately the same size/same capital
Should compare with a business of the same type (sole trader)

The financial statements may be for one year which will not show trends
The financial statements may be for one year which is not a typical year
The financial year may end on different dates (when inventories are high/low)
The businesses may operate different accounting policies
The statements do not show non-monetary factors
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It may not be possible to obtain all the information needed to make comparisons

“Club and society”

Subscriptions
Amount paid by members of a club to use the facilities provided by the club
Accumulated fund
Surpluses which accumulate over the years/equivalent to capital of a business
Receipts and payments account
Account summarizing the money received and paid by a club during a financial year

Speedy Runner Sports Club maintains a subscriptions account. Explain why this account
can have two opening balances.
Some members of the club may be in arrears with their subscriptions and other members may
have prepaid their subscriptions

Explain why there are no drawings in a club or society.

Members have not invested any capital so there can be no drawings which represent amounts
taken from the return on an investment

Suggest two ways in which the shop profit could be increased.

increase the selling price (1)
Buy cheaper goods

State two reasons why the closing balance in the receipts and payments account is
different from the final figure in the income and expenditure account. For each reason
give one example taken from the question.
Only the receipts and payments account contain capital receipts (Loan received)
Only the receipts and payments account contain capital expenditure (Equipment)
Loan repayment Only the income and expenditure account contain non-cash items
(Depreciation)
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Figures in the income and expenditure account are adjusted for prepayments and accruals
(Rent owed) (Subscriptions in advance) (Subscriptions in arrears) (Money owed for coach
travel)

Suggest two reasons why the surplus or deficit shown in the income and expenditure
account is not equal to the bank balance.
Income and expenditure account includes non-monetary items
Income and expenditure account has adjustments for accruals and prepayments
Income and expenditure account includes only revenue items

Suggest two reasons why the managing committee continues to run the shop despite it
making a loss.
to provide a service to members
because the club can still make a surplus
because the loss is small in relation to subscriptions
because it encourages members to join this club rather than another one
because the rent would still be payable even if the shop closed

Explain how the financial statements of the club would be affected if the managing
committee decided not to charge the shop with its share of the rent
the surplus would not change
the shop’s loss would decrease
rent in the income and expenditure account would increase

State how the accumulated fund has risen

It is the total of all the surpluses made by the club less all the deficits since at the start of the
club

*Items included in receipts and payments and not in income and expenditure accounts
Bank balance, repayment of loan, purchase of equipment, insurance prepaid, subscription
prepaid

*Items included in income and expenditure accounts and not in receipts and payments
Deficit, depreciation of equipment, accrued general expenses

“Manufacturing”

State what is meant by a direct cost.

A cost which can be linked to a specific unit of production

State what is meant by the term work in progress.

Units of production which have been started but which have not been completed

Explain the term ‘prime cost’ which appears in the financial statements.
Direct materials plus direct labour plus direct expenses OR Cost of production excluding
overheads
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Reasons for purchasing finished goods

It is cheaper to buy than produce
Demand is higher than production at full capacity

Name three types of inventory which might be held by a manufacturing business.

Raw materials, work in progress, finished goods/purchased finished goods

All the goods sold by Highfield Manufacturing Limited are produced in its factory. Name the
term which replaces ‘ordinary goods purchased’ in its trading section of the income statement.
Cost of production

Name one indirect cost

Salary of factory supervisor
Factory rent
Depreciation of factory machinery
Administration and selling costs

Suggest two items which might be included in the total of administration and selling
costs.
Office rent/rates
Office salaries
Office general expenses
Office insurance
Salaries/commission of sales staff
Advertising expenses

State two possible reasons why total direct costs in the year ended 30 April 2015 were
higher than in the previous year.
Increase in costs of raw materials (higher prices) direct labour (higher rates)
Increase in level of production

State one reason why work in progress is more likely to appear in the financial
statements of a boat builder than those of a business making bread rolls.
Because a boat takes longer to make than a bread roll

Factory Making clothes….

Reasons to reduce cost of productions

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“Partnerships”
State what is meant by a ‘partnership’.
A business in which two or more people work together as owners.

State one reason why a partner may make a loan to the business rather than investing
additional capital.
Greater security than capital

The partnership agreement could be amended to introduce a partner’s salary/interest on

drawings/change in the profit-sharing ratio.

State one advantage of maintaining both a capital account and a current account for
each partner.
Easier to see the profit retained by each partner
Easier to calculate interest on capital
Or other suitable advantage

Suggest one reason how the debit balances on the current accounts could have arisen.
The partnership was making losses
The drawings exceeded the partners’ profit share, interest and salary

State one reason why it is helpful for a partnership agreement to be prepared.

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To avoid disagreements in the future

Advantages of partnership
Increase in finance
Additional knowledge/skills/expertise
Share risks
Sharing of tasks and responsibilities
Can discuss decision-making
Losses can be shared between partners

Disadvantages of partnership
profits must be shared
– decision making may be more difficult
– disagreements may occur

State one reason why each of the following might be included in a partnership agreement
Interest on capital – to reward partners who invest more
Interest on drawings – to discourage drawings

State why it might be useful if the partnership agreement contained a provision for
interest on Drawings
Interest on drawings might encourage partners to reduce drawings

Suggest two reasons why Syed Mirza would like to have interest on capital included in
the partnership agreement
To compensate him for investing the most capital
To encourage Sanchi to invest more
State one reason why a current account is maintained for each partner.
To record the difference between the amounts earned from the partnership and the amounts
withdrawn from the partnership
To show the retained profit of each partner
To make it easier to calculate interest on capital
To reveal excess drawings

State what the current account balance of partner represents.

(Balance b/d – Debit) Partner owes money to the partnership.
(Balance b/d – Credit) The partnership owes money to partner.

Suggest one reason why Sanchi Mirza would like to have partner’s salary included in the
partnership agreement.
To compensate Sanchi for extra workload
To reward Sanchi for extra skills

Explain how the financial statements would have been affected if Amina had made a loan
to the partnership instead of introducing additional capital.
Profit for the year would be lower by the amount of the loan interest.
Interest on capital would be lower by the interest on the additional capital.
Shares of profit might be higher or lower depending on rate of loan interest.

Discuss how an increase in selling price may affect Rashida’s business

Increase in selling price will increase margin/mark-up so gross profit will increase
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Increase in selling price may make customers go elsewhere so gross profit will decrease

State three factors owner should consider before formally inviting another one to
become a partner.
How much capital will invest?
Will the annual profit be increased with the injection of more capital?
What share of profit will require?
Will work in the business?
Will require an annual salary?
What areas of expertise will bring to the business?
Are they going to be able to work together without disputes arising?

Samara has a debit balance on her current account which means that she owes funds to
the business. Samara’s drawings are greater than her total allocation of profit, which
means she is reducing the capital of the business.
Amina has had to introduce additional capital in order to run the day to day
business/cover what Samara has taken as drawings.

“Limited Liability Company”

Define shareholders and limited liability
Owners of the share capital of a limited liability company
The liability of the shareholders for the debts of the company is limited to the amount they agree
to pay for their shares

State the meaning of owner’s equity.

The amount owed by the business to the owner.
The funds put into the business/contributed by the owner (plus profits net of drawings).

Issued share capital

The amount of share capital which is actually issued to the shareholders
Called-up share capital
The total amount the company has requested from the shareholders
Paid-up share capital
That part of the called-up share capital for which a company has received the money from its
shareholders.

Name the financial statement in which any dividend paid would have been recorded
In statement of changes in equity

State three reasons why a sole trader might wish to turn his business into a limited
company.
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Separate legal identity from its owner

Limited liability
Can issue shares to raise capital
May find it easier to obtain loans/issue debentures
Continuity

The company’s statement of financial position contains entries for ordinary share capital,
preference share capital, debentures and a bank loan.

Explain why a limited company might decide not to distribute all of its profit for the year
in the form of a dividend.
For reinvestment in the business, For allocating dividends in the future,
If there is not enough actual cash available to pay a dividend, To plough back profits

Suggest one reason why the directors might have taken out the loan.
To reduce the overdraft
To fund an increase in inventory
To purchase new non-current assets
Growth/expansion

Suggest two reasons why the directors decided that the total dividend should be less
than the profit for the year.
Because insufficient cash was available to pay more
To retain cash/profits for investment in the business

State one reason why D Limited paid a dividend.

To distribute profit to shareholders
OR To reward shareholders for their investment

State why the company made a transfer to general reserve.

To indicate that part of the profit is for long term use within the company and is not available
for distribution.

State why the directors chose to issue debentures rather than issue more ordinary
shares.
To avoid dilution of control because debentures don’t have voting rights
Ensure existing owners retain control of business

State two ways in which the ordinary shareholders may be affected if Nyeko Limited
raised
the additional funds by the issue of preference shares.
Reduction in profit available for ordinary shareholders
Prior claim on the profits of the company
Prior claim on the assets of the company in the event of a winding-up

Suggest two disadvantages to the existing ordinary shareholders if the funds are raised
by the issue of additional ordinary shares.
Dilution of ownership of company
New shares rank equally with existing ordinary shares with regard to dividend (even though
profit expected to increase after two years dividend may reduce)
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New shares rank equally with existing ordinary shares with regard to repayment in a winding up

D Limited wishes to raise additional finance and is considering issuing more ordinary
shares or taking out a long-term bank loan.
It may not be easy to sell the shares.
There will be loss of control by existing shareholders.
Dividends payable may increase.
If the interest rate is variable interest payable could increase.
The company would have to pay interest irrespective of profit made.
The bank may require security.

Suggest two disadvantages to the ordinary shareholders of issuing debentures instead

of
ordinary shares.
Prior claim on the profits of the company
Interest must be paid irrespective of whether there is a profit
Prior claim on the assets of the company in a winding-up
Funds must be available when repayment is due

Suggest two ways in which the ordinary shareholders may be affected if the directors
decide to raise funds from an issue of debentures.
Reduction in profit available for the ordinary shareholders or receive less dividends or receive
dividend later
Debenture holders or debentures have prior claim on the assets of the company in the event of
a winding-up

One of the directors has made the following alternative proposals for raising the necessary
funds.
Proposal 1 – use the general reserve
General reserve is not necessarily represented by actual money
Proposal 2 – request a bank overdraft
Bank overdraft not appropriate for long-term borrowing

Proposal
Issuing share – no effect on profits
Ordinary shares dividend is an appropriation of profit not an expense in the I/S
Issuing debenture – decrease effect on profits
Debenture interest is an expense in the income statement/or deducted from operating profit
Overdraft facilities

Explain one difference

(i) between ordinary shares and preference shares
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(ii) between ordinary shares and debentures

“Ratios”
Profitability ratios
State the difference between margin and mark-up.
Margin is the gross profit measured as a percentage of selling price
Mark-up is the gross profit measured as a percentage of cost price

State two ratios that could calculate from a detailed income statement.
Gross profit margin
Net profit margin

State one reason why the directors would wish to know the ROCE
To compare with other businesses
To compare with rate of finance cost on debentures etc

State whether the efficiency of the business has increased or decreased.

Example answer for decreased - The percentage of profit for the year to revenue (sales)
decreased
The percentage of expenses to revenue (sales) increased

State two possible reasons why the return on capital employed (ROCE) had decreased
from the previous year.
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Profit has fallen

Selling price has decreased
Worse control of expenses
Worsening credit control/increased bad debts
Poorer control of inventory
Capital employed has increased/non-current liability created
Any two reasonable comments for (1) each

HS Limited had a percentage of gross profit to revenue which was lower than the
industry average and a percentage of profit to revenue which was higher than the
industry average. Suggest one reason for each of these differences.
Percentage of gross profit to revenue
 Lower selling prices
 Undercutting competitors
 Use of promotional pricing/trade discount to enter market
 Higher purchase prices
 Lack of trade discount on purchases

Percentage of profit to revenue

 Better control of expenses

Antoinette’s brother, Louis, has a business selling similar type of goods.

His gross profit margin is 40% and his net profit margin is 20%.
State one reason for the difference in the ratios.
The brother has better control of his expenses
The brother has a larger business and experiences economies of scale on overheads such as
rent
The brother buys goods for resale at a lower price
The brother sells the goods at a higher price
Suggest two reasons why Nzita’s gross profit margin was lower than in the previous
year.
Lower selling prices
Introduction of trade discount
Sales promotions
Higher purchases prices not passed on to customers
Change in mix of goods sold
Higher cost of sales

State how capital employed is calculated.

Capital employed = owner’s capital + non-current liabilities
OR
Capital employed = assets less current liabilities

State one reason why Tyler would want to calculate his return on capital employed.
To know the return earned on total funds used in the business
Or to compare with other businesses

Suggest two reasons why JW Limited’s return on capital employed (ROCE) is lower than
the industry average.
mark up applied to goods for resale is lower
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poorer control of expenses

profit is lower
higher interest payable
poorer utilisation of resources
capital used less efficiently

Suggest three ways in which JW Limited could increase its return on capital employed
(ROCE).
increase sale
reduce cost of sales/find cheaper supplier
reduce expenses
reduce interest payments
reduce capital employed
reduce loans and debentures

Suggest problems if the working capital is inadequate.

Explain two reasons why Owner is right to be concerned about his working capital
position.
He may not be able to meet liabilities as they fall due.
He may not be able to pay day to day running expenses.
He may not be able to take advantage of discounts.
He has a lot of cash tied up in inventory.
Inventory makes up more than half of his current assets.
His trade payables are greater than his trade receivables.
He has a bank overdraft.

Discuss the possible effects on the gross profit of each of the following proposals:
increase the selling price of the finished goods
Will reduce cost of production and so increase gross profit
Factory workers may take industrial action resulting in reduction of production/reduction of
revenue and so gross profit may decrease
reduce the wages of the factory employees
Reduce/control expenses
Increase other income
Increase profit margin
Reduce costs of manufacturing
Increase sales activity

Comment on the possible effects of Ravi’s proposal to increase the mark-up from 20% to
25%.
Increase in selling price so possibility of greater gross profit
Customers may go to cheaper suppliers, so sales and profit may decrease
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Explain why the difference between the gross profit percentage and the percentage of
profit to revenue is an indication of the efficiency of the company.
The difference between the two percentages represents the percentage of expenses to revenue
The lower the percentage the more efficiently the expenses are being controlled

Explain the effect on the return on capital employed (ROCE) of extending the loan
repayment date.
The return on capital employed will decrease because the capital employed will increase****

Ways to increase the profits margin

Liquidity ratios

What is meant by current ratio?

Why calculated the quick (acid test) ratio as well as the current ratio.
Inventory is not included in the calculation of the quick ratio
Either The quick ratio shows whether the business would have any surplus liquid funds if all the
current liabilities were paid
immediately from the liquid assets
OR Shows the ability of the business to pay immediate / current liabilities from immediate/liquid
assets
In the previous year the quick ratio (acid test ratio) was 1.45 : 1. Now only 0.59 : 1.
Suggest two reasons for the change.
Holding excessive inventory/increase in inventory
Reduction in bank balance because of one of the following
Purchase of non-current assets
OR increase in partners’ drawings
OR repayment of long-term loan

Suggest a consequence of the change in quick ratio (acid test ratio).

Cannot meet debts when due
Cannot take advantage of cash discounts
Cannot take advantage of business opportunities as they arise
May have difficulty in obtaining further supplies

On 31 January 2014 the ratios were as follows.

Current ratio 1.61 : 1 Quick (acid test) ratio 0.98 : 1
Comment on the liquidity of Amangul’s business.
Inventory holding is very high.
Too much cash is tied up in inventory.
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The current ratio has increased whilst the quick ratio has decreased which indicates that
inventory has increased.
2014 ratios appear fairly ‘normal’.
2015 current ratio may be too high.
2015 quick ratio may be too low.
Business may be unable to pay liabilities when they fall due.
Trade payables are greater than trade receivables.
Prepaid insurance
Stock may be turned into cash to pay debts.
Bank is in overdraft
Higher than ideal current ratio / Lower than ideal quick ratio
Quick assets less than liabilities
Business may face bankruptcy/at risk

Comment on the liquidity position of the company (0.37: 1)

Liquidity is poor
There is insufficient cash to meet current liabilities as they fall due
Current assets do exceed current liabilities
There is already a bank overdraft
Too high a proportion of current assets is made up of inventory
Trade payables are much higher than trade receivables
Overdraft facilities could be withdrawn at any time
Relationship with credit suppliers could be damaged

Inventory turnover - Comment on the liquidity of Morwenna’s business. (1.19 : 1)

Actual current ratio below that originally calculated
Shortage of liquid funds/there is an overdrawn bank balance
Trade payables higher than trade receivables / Rather a lot of money is tied up in inventory
Can only just meet current liabilities from current assets
Cannot take advantage of business opportunities which may arise
May have difficulty in paying trade payables
May depend on receipts from trade receivables to pay trade payables
Suggest two reasons why Louis’ inventory turnover is faster than Antoinette’s.
Increasing sales
Decreasing inventory levels
More efficient purchasing of inventory / Change in type of goods sold
Increase in business activity / Lower inventory levels
More sales activity
Suggest one reason for the lower inventory value.
Theft,damage, obsolescence

Suggest two reasons why inventory turnover has fallen from the previous year.
Sales have slowed down
Inventory has increased

What is measured by the rate of inventory turnover?

The number of times the inventory is sold and replaced in the financial year.

Comment on the change in the rate of inventory turnover (falling)

May indicate reduction in efficiency
May indicate that sales are slowing down
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May indicate the inventory is too high

State how the calculation of the quick ratio differs from the calculation of the current
ratio
Excludes the inventory from the calculation

Suggest two ways in which the collection period for trade receivables could be improved
Offer cash discount for prompt payment
Charge interest on overdue accounts
Improve credit control
Refuse further supplies until outstanding balance paid
Invoice and discount factoring

State the problems if the trade payable period is unsatisfied

Advantages and disadvantages of paying credit suppliers before the due date
May be able to take advantage of cash discounts
Improve the relationship with suppliers , Avoid paying interest
But the business is deprived of the use of the money earlier than necessary

Suggest two ways in which Dylan Kelly could improve the collection period for trade
receivables.
Offer cash discount for prompt payment , Charge interest on overdue accounts
Improve credit control/send invoices or statements promptly
Refuse further supplies until outstanding balance paid
Invoice discounting and debt factoring
Lydia allows her credit customers a cash discount of 2% if accounts are settled within 30
days. From 1 June 2018 Lydia is proposing to offer a cash discount of 3% if accounts are
settled within 21 days.
Discuss how this proposal could affect Lydia’s:
(i) future liquidity
If trade receivables take up the offer Lydia will receive the money earlier
This money could then be used within the business
Will receive a lower amount than previously
(ii) future profit for the year
Profit for the year will decrease because of the extra cash discount
This policy may reduce bad debts so may increase profit

Lili’s credit suppliers are proposing to reduce the credit period to 30 days and increase
the cash discount to 3%. ( Discuss the affects)
Opportunity to earn more cash discount/pay smaller amount
Have to pay earlier/deprived of use of the money earlier/may create cash flow problems
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If credit customers delay in paying the business will have to use existing money to pay the credit
suppliers if wish to earn the cash discount
If cannot pay on time may be charged interest on overdue account
If cannot pay on time relationship with suppliers may be damaged
Will have little impact as is not earning the cash discount now