Chapter 10 Flashcards
Explain how the period assumption assists in the calculation of Profit
Allows the business to divide its life into arbitrary periods in order to determine profit
Explain how revenues and expenses are recognised under the accrual basis assumption
Under the Accrual basis assumption, revenues are recognised in the Period in which the expected inflow of economic benefits can be measured, or when the revenue is earned. expenses are recognised when the consumption of goods and/or services can be measured, or when the expense is incurred
reffering to an accounting assumption, explain two reasons for closing the ledger
- To transfer revenues and expenses to the Profit and Loss Summary account in order to calculate profit for the CURRENT period
- To reset revenue and expense accounts to zero in preparation for the NEXT period
State why transactions with the owner are recorded separately in the drawings account
so that the owner’s transactions for a particular Period can be isolated. This is useful for decision-making so that the owner can assess the level of drawings compard to profit for that Period
State why the drawings account is closed to the capital account
so that the capital account can reflect the net effect of all transactions with the owner
Explain why drawings are not included in the calculation of profit, reffering to a QC
Drawings is a transaction with the owner. Thus, to include drawings in the calculation of profit would breach Relevance, as including drawings would mean including information that is not useful for business decision-making
Explain why it is necessary to prepare an income statment even when the profit figure is known
It details the revenues earned and expenses incurred during the period and identifies reasons why the profit or loss occured, giving the owner far more information on which to base their decisions, compared to simply the profit figure itself. This fulfils relevance as the information provided in the income statement is capable of making a difference to decision-making
Explain why Discount revenue is reported after adjusted gross profit
It is not earned at the time of the sale, it occurs when the business is paid by the Accounts Receivable, and is only earned when the payment is made.
Explain how an income statement can be used by a business to assess its performance
It allows the owner to compare against its revenue and expense targets so that areas of over and under performance can be identified, in order to improve profit in the next period
Explain how an income statement can be used by a business to plan for future trading activities
It can be used to inform the next set of revenue and expense targets, incuding sales levels and advertising expenditure, or inventory levels and staffing requirements
Explain why ethical considerations must be taken into account by business owners when choosing strategies to improve profitability
A business may decude to choose a strategy because it is more socially or environmentaly responsible. The owner must consider the health of the business within the society and environment in which it operates.
Further, ethical businss may generate greater sales and therefore higher profit as customers prefer to purchase from ethically responsible suppliers
Profitability
The ability of a business to earn profit as expressed in relative terms by comparing profit against a base like sales, assets or owner’s equity
Explain how the Net Profit Margin can be used to assess profitability
It measures how much fo each dollar of Net sales revenue remains as net profit after expenses are deducted. As a result, it is a good indicator of overall expense control
Explain how the Gross Profit Margin can be used to assess profitability
It calculates the percentage of Net sales revenue that is retained as Gross Profit, indicating the average mark-up on all goods sold during a particular Period and allowing for an assessment of expense control specifically as it relates to inventory and Cost of Goods Sold
Explain why the Gross Profit Margin is always higher than the Net Profit Margin
It does not account for Other expenses, as due to other expenses, gross profit will always be higher than net profit (unless the business had no Other expenses, but this is highly unlikely)
