FIA-FA2-2019 - OpenTuition Lecture Notes For FA2 PDF

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OpenTuition Lecture Notes can be downloaded FREE from opentuition Copyright belongs to OpenTuition - please do not support piracy by downloading from other websites.MaintainingFinancial RecordsFAFIA####### Please spread the word about####### OpenTuition, so that all ACCA####### students can benefit....

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FA2 Maintaining Financial Records (2019 Exams)

1

FA2 Maintaining Financial Records 1.

Financial statements, accounting principles and accounting standards

3

2.

Recording business transactions within the accounting and double entry system

15

3.

Sales Tax, The day books and Control Accounts

37

4.

Cash

49

5.

More on sales and receivables

63

6.

Accruals and Prepayments

75

7.

Accounting for Inventory

79

8.

Non-Current Assets

89

9.

Trial balances and correcting errors

97

10.

Incomplete Records

111

11.

Partnerships

119

Answers To Tests

127

Answers To Examples

139

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FA2 Maintaining Financial Records (2019 Exams)

2

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FA2 Maintaining Financial Records (2019 Exams)

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Chapter 1 FINANCIAL STATEMENTS, ACCOUNTING PRINCIPLES AND ACCOUNTING STANDARDS 1. Introduction The income statement and the statement of financial position are the key documents in the financial statements of any business. You need to know how these are usually set out and the terminology that is used.

2. Types of business transaction An organisation can be defined as: A social arrangement which pursues collective goals, which controls its own performance and which has a boundary separating it from its environment.

Organisations can include businesses such as companies and partnerships, clubs, charities, government departments, hospitals and schools. Even if not strictly a ‘business’ all organisations will have business transactions. Typically these will include: ๏

Purchasing goods and materials. Purchases can be for cash or credit. Cash purchases are paid for immediately and are fairly rare in most businesses. Credit purchases are paid for after some time, typically a month or so

๏

Purchasing services, for example, repair s to equipment, advertising, printing costs.

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Sales. Cash sales, for example in shops, are paid for immediately. Credit sales are paid for after some time.

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Paying wages and salaries.

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Purchase of non-current assets.

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Raising finance and paying rewards to the suppliers of finance. For example, owners putting in capital or loans being raised form banks. Owners of the business expect rewards based on a share of the profit; banks usually expect interest to be paid.

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Accounting for and paying tax.

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Movements of cash and money in the bank account. These movements usually arise from the transactions above.

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FA2 Maintaining Financial Records (2019 Exams)

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3. Types of business documentation Each type of business transaction has its own set of documentation. The documentation is needed to: ๏

Control the progress of the transaction

๏

Record the transaction

๏

Provide a history of how the transaction proceeded. This is sometimes known as an ‘audit trail’

Sometimes the documentation is purely internal; sometimes it arises externally or is sent outside the business. Nowadays, the term ‘documentation’ is not confined to paper documents only as many business transactions are mostly handled using computerised records. Typical documentation is as follows:

Purchase of goods and materials: this will usually be initiated by someone in the warehouse or factory who can see that more materials will soon be needed. Often this person raises a purchase requisition which goes the buyers’ department. Buyers will then raise a purchase order to order goods from the most suitable supplier. Goods, accompanied by the supplier’s delivery note, will be received in the warehouse, where a goods received note will be raised. These must be checked back to the order to ensure that the correct goods are being received. Invoices from suppliers will be received and recorded by the accounting department first in a purchases day book (just a list of invoices received) and then in the payables ledger. Usually suppliers will send statements of account setting out the amounts still owed. Statements act as reminders and also they can be used to check that buyers agree with suppliers’ versions of events. Later the invoices will be paid and a remittance advice sent by the customer to indicate which invoices have been settled. If goods are returned to suppliers (for example their quality was poor) then buyers will ask for a credit note. This acts like a negative invoice. Purchasing services: often, these will be recurring items such as rent, electricity, telephone and insurance, and an invoice will be received Sometimes they will be once-off like paying for an advertisement in a newspaper or for the repair of a piece of equipment. These services should have a purchase order. The invoices will be processed by the accounting department who will make sure that the expenses look reasonable compared to previous amounts or who will ensure that the services have been properly ordered and received. Sales: in a retail organisation sales will be initiated by customers either in a shop or through the internet. Payment will usually take place immediately and the customer given a till (cash register) receipt; a copy of the sales is also recorded by the cash register system. In businesses selling to other businesses, the sales representatives (sales men and sales women) will be responsible for encouraging customers to place sales orders. Once received, orders should result in goods despatch notes being raised and these act as authorisation to despatch the goods from the warehouse and for also sales invoices being created and sent to the customers by the accounting department. The accounting department will also record each invoice in a sales day book (just a list of invoices) and will then record what each customer owes in the receivables ledger. Most businesses will send customers statements of account which set out the amounts still owed by customers. Statements act as reminders to customers about what needs to be paid and they also allow customers to check that they agree with the seller’s version of events. Payments by credit customers should be accompanied by remittance advices which detail what is being paid. If goods are returned by customers (for example their quality was poor) then customers will ask for a credit note. This acts like a negative invoice.

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FA2 Maintaining Financial Records (2019 Exams)

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Paying employees: large organisations will have a wages and salaries department which is responsible for calculating amounts owing, and dealing with employees who leave and with new joiners. Sometimes the payments are the same every week or month; sometimes they depend on time records (such as clock cards). In both cases employees will receive a wage or salary slip showing their pay and any deductions for tax etc. The amounts to be paid will usually be passed to the accounting department which will look after the cash transfers to employees. Purchase of non-current assets: The purchase of these assets will often begin with en employee raising a purchase requisition, for example for a new printer, which is then authorised by a manager or by the company accountant. When the invoice is received, someone needs to ensure that the asset has been received and that it is working properly. These payments are handled in a similar way to purchases of goods and raw materials. Finance. In companies, shares can be issued in exchange for new share capital. Loans will usually be accompanied by a loan agreement setting out the terms of the loan. Tax will be paid in response to an assessment by the tax authorities. Movements in cash and bank account amounts require careful documentation. Cash payments are usually small and usually made through the petty cash system where payments will be supported by petty cash vouchers. Payments from bank accounts will be by cheque or credit transfer. Credit transfers can be: ๏

Specially initiated by the company

๏

Automatic constant amounts (standing orders)

๏

Initiated by the person receiving the money (direct debits).

In all cases there should be documentation to back up the payments. All to these transactions are recorded in the books of account (described in detail in a later chapter). The information is summarised at the end of accounting periods into two statements: ๏

Income statement

๏

Statement of financial position

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4. Income statement This shows the sales made and the costs incurred in a period. Sales less costs will show the profit made in the period (or if costs are greater than sales, the loss for the period). You might sometimes still hear this document referred to as the ‘Profit and loss account’, but that is no longer official terminology and you should try not to use it. If the income statement is for a limited company its presentation is usually defined by statute, because limited companies are closely regulated. If it is for a sole trader or a partnership, then there can be more flexibility. The typical layout is: Notes 1

ABC Limited

2

Income statement for the year end ded 31 December 2014 $

3

Sales

4

Less: cost of sales

5

Gross profit

6

Selling costs

X

6

Distribution costs

X

6

Administration costs

X

$ X (X) X

X 7

Net profit

X

Notes 1.

The name of the entity must be stated.

2.

Income statements are for periods. Typically they show income, expenses and profits for a period of a year. However, other periods are also possible.

3.

Sales, or revenue, is what is sold in the period. This will exclude any sales tax that customers are charged because that is a tax passed onto the government, not a sale.

4.

Cost of sales. The cost of sales is the direct costs of buying or making whatever is sold. Cost of sales is not generally the same as what was purchased because there can be opening and closing inventory. Cost of sales = Opening inventory + Purchases – Closing inventory The inventory adjustment ensures that sales are properly matched with the cost off the goods sold: Opening inventory + Purchases equal all the items that were available for sale. Closing inventory is what was not sold.

5.

The gross profit is sales less cost of sales. Think of this as the main-spring of the business. If gross profit is poor, very poor profits will be made overall.

6.

In a company’s income statement, typically other expenses are grouped and summarised as shown into selling, distribution and administration costs. This keeps the income statement relatively uncluttered. More details can be provided as notes to the financial statements.

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FA2 Maintaining Financial Records (2019 Exams)

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The net profit is what’s left after all expenses. Out of this, companies will pay their corporation tax (for example a simple percentage of the new profit). Anything left can be kept in the business or paid out as dividends to reward shareholders) or taken as drawings in an unincorporated business).

The income statement of an unincorporated business (a sole trader for example) could look identical, but often the expenses will be listed in greater detail.

5. The statement of financial position As the name of this document suggests the statement of financial position (“SOFP”) shows the financial position of a business at a point in time. You might sometimes hear this document referred to as a ‘balance sheet’, but this is old terminology and you should try to avoid it. It shows: ๏

Assets

๏

Liabilities (non-current liabilities and current liabilities)

๏

Capital

(non-current assets and current assets)

The typical layout is: Notes 1 2 3

ABC Limited Statement of financial position as at 31 Decembe er 2014 $ $ Non current assets: Land and buildings X Machinery X X Vehicles X

4

Current assets Inventory Receivables Cash at bank and in hand

X X X X X X

5

Capital Capital introduced Retained profits

X X X

Non-current liabilities Bank loan Current liabilities Payables Overdraft

X X X X X

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FA2 Maintaining Financial Records (2019 Exams)

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Notes 1.

The name of the entity must be stated.

Statements of financial position are drafted for a point in time. Non-current assets are used by the business to make profits and have a life of longer than one accounting period. They are not regularly bought and sold as trading goods are. Current assets are either cash or expected to become cash within one year. They are presented in increasing order of liquidity. So, inventory has to be first sold and then the sales proceeds have to be collected. That could all take many months. Customers (receivables) are usually expected to pay within a month or so. Cash is already cash. So, the ‘bad news’ comes first because some inventory might never sell and might never become cash. Capital arises from capital introduced by the owners of the business and from retained profits. Any withdrawal of profits by the owners will reduce the retained profit and therefore will reduce the capital of the business. Non-current liabilities are liabilities that have to be settled after more than 12 months. For example, a bank loan being repaid over five years. Current liabilities have to be settled in less than 12 months. Note that overdrafts are repayable on demand. The figures marked by the arrows should be equal: Assets = Liabilities + Capital (amounts owed to the owners) In essence, the statement of financial position sets out the accounting equation covered in more detail in a later chapter).

6. The conceptual framework of accounting There are certain principles which underpin accounting and accounts preparation. You need to know what these are: 1.

Going concern: the assumption that the business will continue functioning in the foreseeable future. This can affect the valuation of many assets because if the business closes, assets might have to be disposed of at their scrap values.

2.

Accruals: income and expenses should be matched on a time basis, not just when cash is received or paid.

3.

Consistency: financial statements should be drawn up using the same approaches each year. If, for example, the way an amount is measured is altered, then profits could be affected or manipulated.

4.

Double entry: every transaction has matching Debit and Credit entries in the bookkeeping system.

5.

Business entity: accounting records record the transactions of the business entity, not the transactions of its owners.

6.

Materiality: an item is material if its misstatement could alter the economic decisions of user of the financial statements. Immaterial items do not have to be disclosed – indeed too much information can be confusing.

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FA2 Maintaining Financial Records (2019 Exams)

7.

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Historical cost: transactions are recorded at their historical cost.

There are also certain qualitative characteristics of accounting, which you also need to know. These are: 1.

Relevance: financial information is regarded as relevant if it is capable of influencing the decisions of users. Therefore, all relevant information should be included in financial statements.

2.

Faithful representation: financial information must be complete, neutral and free from error otherwise it will mislead users of the financial statements.

3.

Comparability: financial information should be capable of being compared over time and with similar information about other entities. If it is not comparable, then interpretation and understanding is difficult.

4.

Verifiability: the accounting information should be capable of being verified through auditing procedures. This allows users to place more trust in the information.

5.

Timeliness: information should be provided quickly enough to be of use in decision-making.

6.

Understandability: information should be presented in a way that makes it understandable to users. This can be done, for example, by good layout, accurate descriptions and, where necessary, notes explaining the information.

7. Accounting standards At one time accountants had an enormous amount of discretion when it came to producing financial statements. For example: ๏

There are many way in which inventory can be valued.

๏

There are different views on how money spent on research should be treated (is it an expense or an investment)

๏

How should profits be take on large construction contracts which last several years...