Flashcards in accounting 11-12 Deck (62):
1 Referring to the definitions, identify the characteristics common to both assets and expenses.
Assets, in common with expenses, are necessary to help earn revenue and generate profit. They both refer to the economic benefit that is brought to the business.
2 Explain the key difference between an asset and an expense.
An asset is defined as future economic benefit, while an expense is defined as the consumption of an economic benefit. That is, expenses refer to economic benefit that has already been consumed, whereas assets refer to economic benefits that are yet to be consumed.
3 Identify the characteristics of a depreciable non-current asset
Depreciable assets have a finite life, and will be useful for a fixed period of time
4 Explain why it is not necessary to calculate depreciation for assets such as land
Assets that have an infinite life should not be depreciated, as they may be used, but are never ‘used up’ or consumed.
5 Referring to one accounting principle, explain why the entire cost of a non-current asset should not be reported as an expense.
When a business purchases a non-current asset, it is clearly classified as such as the benefit will be provided for more than 12 months. It cannot be reported as an expense as its entire benefit has not been consumed in the current Reporting Period.
6 Explain why GST is excluded from the consideration of depreciation.
GST is excluded because it is not included in the cost of a non-current asset; it actually represents a reduction in the GST liability owed to the ATO.
1 Define the term ‘depreciation’.
Depreciation is the allocation of the cost of a non-current asset over its useful life.
2 Define the term ‘depreciation expense’
Depreciation expense is the part of the cost of a non-current asset that has been consumed in the current Reporting Period.
3 Referring to one accounting principle, explain the purpose of depreciating a non-current asset.
Because a non-current asset is not consumed entirely within the one Reporting Period, depreciation is an attempt to calculate how much of the asset’s value has been consumed in the current Reporting Period.
4 Explain the effect of depreciation on a firm’s bank balance.
Depreciation has no effect on a firm’s bank balance because depreciation does not involve any payment of cash. The cash payment relating to each non-current asset will be recorded only at the time when the asset is purchased.
1 Explain the assumption that underlies the straight-line method of depreciation in relation to how assets contribute to revenue.
The straight-line method of depreciation assumes that non-current assets contribute evenly to revenue. Given that it assumes that the value of the non-current asset is consumed evenly over its life, the depreciation expense is the same every year.
2 State the formula for calculating depreciation using the straight-line method.
Depreciation expense ($ per annum) = HC – RV/Life
define historical cost
the original purchase price of the non-current asset
define residual value
– the estimated value of the non-current asset at the end of its useful life
define useful life
the estimated period of time for which the non-current asset will be used by the current entity to earn revenue. This is usually measured in years.
4 Explain why each non-current asset must be depreciated individually rather than as a total.
Because each non-current depreciable asset is different in terms of its useful life and residual value, each must be depreciated individually.
5 Referring to one accounting principle, explain why residual value is deducted from Historical Cost when calculating depreciation using the straight-line method.
Residual value is deducted from the historical cost, as this is the amount that will not be consumed by the business, but by another entity.
1 Show the General Journal entries to record the balance day adjustment for depreciation expense.
Depreciation of Van Debit
Accumulated Depreciation of Van Credit
Yearly depreciation on van – s/line method (Memo x)
2 State one reason why the ledger accounts must name the asset being depreciated.
Given that most businesses will depreciate more than one non-current asset, it is imperative to identify precisely which asset is being depreciated.
3 State the effect of depreciation on the accounting equation
Assets Decrease (increase Accumulated Depreciation of Van)
Liabilities No effect
Owner’s Equity Decrease (Depreciation of Van expense decreases Net Profit)
4 Referring to one accounting principle, explain the difference between depreciation expense and accumulated depreciation.
Whereas depreciation expense refers to the amount consumed in the current Reporting Period, accumulated depreciation refers to depreciation that has accumulated over the life of the asset so far (over a number of Reporting Periods).
5 State two reasons why the Depreciation expense account must be closed at the end of the Reporting Period.
• to transfer Depreciation Expense to the Profit and Loss Summary account in order to calculate profit for the current Reporting Period
• to reset the Depreciation Expense account to zero in preparation for the next Reporting Period
6 State one reason why the Accumulated Depreciation account is balanced at the end of the Reporting Period
Accumulated Depreciation is a negative asset account and is an ongoing account; its balance will be carried forward to the next Reporting Period.
1 Referring to one accounting principle, explain why the original purchase price of a non-current asset must be disclosed in the Balance Sheet.
In order to keep the reports free from bias, the asset must always be reported initially at its Historical Cost (its original purchase price), as this amount is verifiable by reference to a source document.
2 Define the term ‘carrying value’.
Carrying value is the value of a non-current asset that is yet to be consumed/allocated as an expense, plus any residual value.
3 Referring to one qualitative characteristic, explain why non-current assets must be reported at their carrying value in the Balance Sheet.
The carrying value is reported in the Balance Sheet as this is information that is useful for decision-making for the owner (Relevance). For example, the owner will be able to see if the asset is nearing the end of its useful life (low carrying value) and may need replacement.
1 Show the formula for calculating the rate of depreciation.
Depreciation rate (% per annum) = Depreciation expense/Historical Cost x 100
2 Show the formula for calculating depreciation expense using the rate of depreciation.
Depreciation expense ($ per annum) = Depreciation rate x Historical Cost
1 Define the term ‘cost’ as is relates to non-current assets.
The cost of a non-current asset is defined as all costs incurred in order to bring the asset into a location and condition ready for use, which will provide a benefit for the life of the asset.
2 Identify three costs that might be included in the cost of a non-current asset.
• the purchase price/supplier’s price
• delivery costs
• modification costs
• installation costs
3 Explain why GST is excluded from the cost of a non-current asset.
GST is excluded because it actually represents a reduction in the GST liability owed to the ATO and does not become part of the cost of a non-current asset.
4 Explain why yearly costs are excluded from the cost of a non-current asset.
Yearly costs are excluded as their benefit will be consumed within a year, and so they do not fit the definition of the ‘cost’ of a non-current asset.
1 Referring to one accounting principle, explain why it is not always accurate to report depreciation expense per annum.
If by the end of the Reporting Period, the firm has had control of the asset for less than a year, the depreciation figure will need to be applied on a pro-rata basis.
2 Explain the process for calculating depreciation of an asset when the firm has had control of the asset for less than a year.
After calculating the depreciation expense per annum, multiply this number by the number of months (that the business has had control of the asset) out of 12.
1 Explain how depreciation can undermine the Reliability of accounting reports.
When calculating depreciation, the residual value and the useful life of the non-current asset are estimates, and are therefore not based on verifiable evidence. This makes the accounting reports not free from bias.
2 Explain how depreciation ensures relevance in the:
• Income Statement – depreciation ensures that the Income Statement includes all information that is useful for decision-making about profit, by showing the consumption of non-current assets in the current Reporting Period
• Balance Sheet – By showing accumulated depreciation in the Balance Sheet, it ensures that assets are shown at their carrying value, which is vital for decision-making about their replacement.
1 Explain the basic function of all accounting reports.
Accounting reports have the function of communicating financial information to the owner to assist decision-making.
2 Explain why it is important to report on both cash and profit.
Cash and profit are different measures of performance, and there may be many possible reasons why a firm that is earning a profit can still suffer from a lack of cash.
1 Explain the function of a Statement of Receipts and Payments
A Statement of Receipts and Payments details cash received and paid during a Reporting Period, and the change in the firm’s bank balance over that period.
2 Explain why the information reported in the Statement of Receipts and Payments is taken from the cash journals rather than directly from the source documents.
If the information was taken directly from the source documents, it would not be classified or summarised in any way. Instead, the Statement of Receipts and Payments is based on the cash journals.
3 Define the following terms: cash surplus
– an excess of cash receipts over cash payments, leading to an increase in the bank balance.
Define cash deficit
an excess of cash payments over cash receipts, leading to a decrease in the bank balance.
1 Define the following terms as they relate to the Cash Flow Statement: operating activities, investing activities, financing activities.
• Operating activities – cash flows related to the firm’s day-to-day trading activities
• Investing activities – cash flows relating to the purchase or sale of non-current assets
• Financing activities – cash flows that are the result of changes in the firm’s financial structure.
2 Explain one reason why it may be more beneficial to prepare a Cash Flow Statement than just a Statement of Receipts and Payments.
While the Statement of Receipts and Payments classifies the cash transactions as receipts or payments, the Cash Flow Statement is more useful for decision-making as it classifies common sources of cash (into operating, investing and financing activities), and separately identifies their effect on the bank balance.
3 Explain how the preparation of a Cash Flow Statement can assist in decision-making
It can aid decision-making by detailing the sources and uses of cash in a particular period. In particular, the owner would want to assess whether the business is generating enough cash from its operating activities to fund its investing and financing activities.
4 Explain how the preparation of a Cash Flow Statement can assist in planning for the future.
By providing a basis for the next budget, the Cash Flow Statement will aid in the setting of targets for the future.
1 Explain why cost of sales is not reported in the Cash Flow Statement.
Cost of sales is not reported as it is not a cash flow, but rather a stock flow; it records the cost price of stock rather than the cash received from the sale.
2 State one reason why the total of the Debtors Control column of the Cash Receipts Journal may not represent cash received from debtors.
The Debtors Control column represents the total amount by which debtors will decrease and, in most cases, this figure will comprise some cash, but also some discount expense.
3 Show how receipts from debtors is calculated when discount expense has been recorded in the Cash Receipts Journal.
Receipts from debtors = Debtors Control (column total) – Discount Expense (column total)
4 Explain why the total of the Creditors Control column of the Cash Payments Journal is not reported in the Cash Flow Statement.
The Creditors Control column of the Cash Payments Journal includes both the cash payments to creditors and the discount revenue, but only the cash paid should be reported in the Cash Flow Statement.
5 Identify the four GST items that may be reported in the Cash Flow Statement.
• GST received
• GST refund
• GST paid
• GST settlement
1 Identify the three main reasons why the change in a firm’s Cash Position may be different from its profit over the same period.
• Some cash items do not affect profit.
• Some profit items do not affect cash.
• Some items affect both cash and profit, but by differing amounts.
2 Identify two cash inflows that are not revenues. Explain the effect these items will have on both cash and Net Profit.
• capital contribution
• loan received
Both these items are cash inflows that increase cash, but are not revenues and so have no effect on Net Profit.
3 Identify three cash outflows that are not expenses. Explain the effect these items will have on both cash and Net Profit.
• cash drawings
• loan repayments
• cash payments for non-current assets
• GST paid (including GST settlement)
All of these items are cash outflows that decrease cash, but are not expenses so have no effect on Net Profit.
4 Explain how a stock gain may be the reason why a firm can earn a profit, despite suffering a cash deficit.
Stock gain is a revenue that increases Net Profit, but is not a cash inflow (it represents a gain of stock) so has no effect on Bank.
5 Identify three items that will be reported as expenses in the Income Statement, but will not be reported as cash outflows in the Cash Flow Statement.
• stock loss
• bad debts
6 Explain the effect on both cash and profit if: • Credit sales is greater than Receipts from Debtors
The revenue item increases Net Profit more than the corresponding cash inflow increases Bank.
6 Explain the effect on both cash and profit if:
credit sales is less than receipts from debtors
– The revenue item increases Net Profit less than the corresponding cash inflow increases Bank.
6 Explain the effect on both cash and profit if
• Cost of Sales is greater than Payments for Stock :
The expense item decreases Net Profit more than the corresponding cash outflow decreases Bank.
6 Explain the effect on both cash and profit if:• Cost of Sales is less than Payments for Stock
The expense item decreases Net Profit less than the corresponding cash outflow decreases Bank.
6 Explain the effect on both cash and profit if: • expenses are accrued at the end of the Reporting Period
The expense item decreases Net Profit more than the corresponding cash outflow decreases Bank.