Mid sem answers PDF

Preview

Summary

Mid Sem Sample question answers...

Description

Q1. Financial statements are prepared for a range of different business entities: 1. Identify the different entities financial statements can be prepared for: Sole Proprietors, Corporations, Partnerships 2. Identify the different financial statements and explain the type of information contained within each of the financial statements Income Statement: displays the revenues and expenses generated through an accounting period. Yielding net profit/loss linking to the statement of changes in equity. Statement of changes in equity: adds net profit/loss to the opening balance of the Retained earnings less dividends, yielding the closing balance of retained earnings linking to balance Balance sheet: Displays current/noncurrent asset and liabilities also equity and is used to assess the company’s worth and standing for a period Cash Flows statements: Shows a company’s inflows and outflows of cash over a specific accounting period which should add up to the cash balance on the balance sheet. +/- Operating cash flows +/- Investing cash flows +/- Financing cash flows = Net Change in cash 3. Explain the purpose of accounting information and how this purpose is linked to the needs of stakeholders involved with different entities: The purpose of accounting information is to identify, record, summaries and communicate transactions of a company allowing stakeholders to assess the performance of a company along with effectiveness of business strategies and internal control procedures in making business decision Q2. Accounting information is guided by various principles, assumptions and qualitative characteristics. 1. Describe the process of generating accounting information. Accounting information is first needing to be identified and separated from unrelated economic events. Accounting transactions are then recorded and journalized which are then Posted into ledger (collection of t accounts) and then finally into a trial balance where it is then recorded into its respective financial statement. 2. Identify and describe the assumptions, qualitative characteristics and framework which guide the preparation of accounting information. There are many assumptions and qualitative characteristics and framework which guide the preparation of accounting information including; Assumptions Economic entity: financial activities of a business can be separated from those of the business owner Time Period: Economic information can be meaningfully captured and communicated over short periods of time Monetary unit: accountants assume that the dollar is the most effective means to communicate economic activity Going Concern: accountants assume that a company will continue to operate into the foreseeable future.

Qualitative Characterisitcs Understandability Relevance :(ability of information to make a difference in decision making) Reliability: (Verifiable and true) Comparability: (ability weigh up against other businesses) Consistency (comparing within own entity) Materially: refers to the threshold at which an item begins effecting business decisions Conservatism: the way accountants deal with uncertainty regarding economic situations so present it in a way as to least likely to overstate Framework: is the collection of concepts which guide the manner in which accountis pracised. Where standards and certain terms are standardised around the accounting field. Matching principle: expenses should be recorded in period where resources are used to generate revenue Revenue Recognition Principle: revenue should be recorded when a resource has been earned Cost Principle: assets should be recorded at the cost paid to acquire them. 3. Explain why accountants have flexibility in accounting choices As not all entities are similar, differing in size business models industry. Not one standard can be applied to every situation and therefore discretion is needed to display a firm in a fair and true view. 4. Explain how the assumptions and qualitative characteristics of accounting guide the choice of the following accounting methods. a. Revenue recognition: revenue should be recorded when a resource has been earned. As accountants have assumptions on the information they deal with and expect it to be understandable, relevant, comparable, consistent, material and conservative in order to make important business decisions. The revenue recognition principle states that revenue should be recorded when a resource has been earned which agrees with the above assumptions alongside the qualitative characteristics required by the AASB b. Accounting for bad debts: dealing with uncollectible receivables.

Q3. Accountants have the ability to choose different ways to report accounting information, and this choice can have an impact on the reported financial performance and position of an entity. 1. Identify and describe in detail the different methods and/or approaches available when making reporting decisions for: a. Revenue recognition Revenue Recognition Principle: states that revenue should be recorded when a resource has been earned and not just when cash is received. The accounting policies adopted for the recognition of revenue including the methods adopted to determine the stage of completion of transactions involving the rendering of service. You can’t just write revenue you have to state where the revenue comes from. Sales of goods, rendering of service, interest. Accrual accounting basically b. Accounting for uncollectible receivables (bad debts, e.g. Direct write-off method, Allowance method, % of sales approach, % of receivables approach, ageing of accounts receivable approach) Direct write-off method: Method in which bad debt expense is recorded when a company determines that a receivable is uncollectible and removes it from its records and records it as a bad dept expense as amounts receivable. This violates the matching principle which is prohibited by GAAP unless the bad debt is Immaterial. Allowance method: Splits the transaction into 2 entries one to record an estimate of bad debt expense and another to write off receivables when they become uncollectible. because of the inability to know which specific receivables will turn out uncollectible the allowance method requires an allowance account which is a contra asset account. Which is increase the allowance for doubtful debt account which represents the dollar amount of receivables that a company believes will ultimately be uncollectible Used for estimating bad debt expenses under the allowance method % of sales approach: bad debt expense is a function of a company’s sales by multiplying sales by a set percentage % of receivables approach: method that estimates the bad debt expense as a percentage of receivables. What the balance should be is calculated accounts receivables x percentage set by company. The second step is to adjust the allowance for bad debt. this adjustment difference is the bad debt expense. Ageing of accounts receivable approach: Listing accounts receivable by their age. More refined version of the percentage of receivables approach. Recognising that receivables become less collectible as they get older. They are group by how old they are current and older with companies applying increasing percentages of uncollectibility as receivables get older. 2. Explain the advantages and disadvantages of each method you have just described in part one of this question. Revenue Recognition Principle(accrual accounting vs cash basically): Pros Cons Company can match revenue with Creates a need for other balance sheet associated expense regardless of timing items e.g. acc receivable, acc payable Provides better information for management decision making (more accurate)

Not as simple as NOT recognition Does not defer some taxes

Allowance Method Pros Follows matching principle – more accurate financial records

Cons Management might inaccurately estimate write-offs by a large margin – cause companies to misstate net income

Accurately reports accounts receivable – benefits investors and management Direct write-off method: Pros Simplicity

% of Sales approach Pros Simplicity Very good matching

% of Receivables approach Pros Results in meaningful Net realisable value. Due to allowance account is a set percentage of receivables

Ageing of accounts receivables Pros - provides a more accurate estimate of the allowances for doubtful debts and therefore better estimate of bad debt expense - Good internal control activity

Cons Violates matching principle and GAAP prohibits its use unless bad debt expense is immaterial.

Cons No consideration is given to the resulting balance in the allowances for doubtful debts account

Cons Does not match expenses as well as the percentage of sale approach due to the adjustment necessary is due to the set percentage and companies’ prior experiences with right offs.

Cons

3. Explain why accountants are able to choose different ways to report accounting information. In your answer you may like to discuss the advantages and disadvantages of being able to make different accounting choices with brief reference to the article Gowthorpe and Amat (2005), Creative Accounting: Some Ethical Issues of Macroand Micro-Manipulation. Accountants are able to choose different ways to report information as their environment and current scenarios may only yield fair and true information using various methods. As not all company’s or entities are similar differing in size industry and goals Not one standard can be applied to every situation and entity and therefore discretion is needed to display a firm in a fair and true view. There may be advantages that rise from using different reporting methods such as higher profit or more or less cost of goods sold. Some accounting reporting system such inventory costing methods are varied due to

the various uses as not all companies are physically able to distinguish one product from another therefore using Specific identification is not possible in this situation while the FIFO method could be used along with the moving average. Gowthorpe and Amat outline the ethical issues that arise from macro and micro manipulate and creative accounting. As stakeholders and people who access and utilise these financial reports assume the information held within them is reliable, consistent and true and fit for purpose. If earnings management is undertaken such true perception may be distorted in a biased favour. Ultimately besmirching the accounting and communicating entities of a frim. 4. Explain how the choice of these accounting methods and/or approaches can be used by managers for earnings management. In your answer you may like to refer to how the assumptions and qualitative characteristics of accounting reduce earnings management. The choices of accounting methods can be used to increase or decrease numbers and distort the standing and financial prosperity of a company which may intern display the management and directors of a company to be more successful. Earning management is the distortion of accounting information and its communication by activities of financial statement preparers who which to alter the content of the messages being transmitted.

Q4. Predicting future cash flows is important to determine the viability and value of a company. 1. Describe the different components of the cash flow statement and the information it provides to users. Operating operations: after the proper equipment is acquired a business can begin operations. Operating a business includes the purchase of supplies, the payment of employees and sales of products Investing operations: once a company has raised sufficient capital from creditors and investors, it usually acquires the revenue generating assets that it needs for operations. The buying and selling of such assets are considered investing activities. Financing operations: Borrowing money from creditors and receiving contributions from investors are both ways to finance business operations. Generating and repaying cash from creditors and investing is financing activities. 2. Explain the relation between the following accruals and future cash flow as suggested by Barth, Cram and Nelson (2001). a. Accounts receivable + b. Accounts payable c. Inventory + d. Depreciation and amortization +...