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C02: Fundamentals of Financial Accounting PDF

763 Pages·2009·2.24 MB·English
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CIMA Offi cial Learning System Revised edition relevant for Computer-Based Assessments C2 — Fundamentals of Financial Accounting CIMA Certifi cate in Business Accounting Henry Lunt CIMA Publishing is an imprint of Elsevier Linacre House, Jordan Hill, Oxford OX2 8DP, UK 30 Corporate Drive, Suite 400, Burlington, MA 01803, USA First edition 2008 Copyright © 2009 Elsevier Ltd. All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone ((cid:2) 44) (0) 1865 843830; fax ( (cid:2) 44) (0) 1865 853333; e-mail: [email protected] . Alternatively you can visit the Science and Technology Books website at www.elsevierdirect.com/rights for further information Notice No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions or ideas contained in the material herein. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data A catalogue record for this book is available from the Library of Congress 978-1-85617-785-6 For information on all CIMA publications visit our website at www.elsevierdirect.com Typeset by Macmillan Publishing Solutions (www.macmillansolutions.com) Printed and bound in Italy 09 10 11 11 10 9 8 7 6 5 4 3 2 1 Working together to grow libraries in developing countries www.elsevier.com | www.bookaid.org | www.sabre.org Contents The CIMA Learning System xi How to use your CIMA Learning System xi Guide to the Icons used within this text xii Study technique xii Planning xiii Tips for effective studying xiv Computer-Based Assessments xiv The Fundamentals of Financial Accounting Syllabus xv CIMA Certifi cate in Business Accounting xvii Syllabus Outline xvii Learning Aims xvii Assessment Strategy xviii 1 The Accounting Scene 1 Learning Outcomes 3 1.1 Introduction 3 1.2 What is accounting? 3 1.2.1 The objectives of accounting 4 1.3 Who uses fi nancial statements? 5 1.4 The qualitative characteristics of fi nancial statements 6 1.5 Terminology 7 1.5.1 Bookkeeping 7 1.5.2 Financial accounting 7 1.5.3 Management accounting 7 1.6 The differences between external and internal information 8 1.7 What is a business organisation? 8 1.7.1 Profi t-making organisations 9 1.7.2 Non-profi t-making organisations 9 1.8 Summary 10 Revision Questions 11 Solutions to Revision Questions 1 3 2 The Framework of Financial Statements 15 Learning Outcomes 17 2.1 Introduction 17 2.2 The separate entity convention 17 2.3 The accounting equation 18 2.3.1 The accounting equation in action 19 2.4 The accounting equation and the statement of fi nancial position 22 2.4.1 The contents of a statement of fi nancial position 22 2.4.2 Vertical presentation of a statement of fi nancial position 24 iv FUNDAMENTALS OF FINANCIAL ACCOUNTING C2 S 2.5 The income statement 25 T N E 2.5.1 The cost of goods sold 27 T N 2.6 Profi t and cash 29 O C 2.7 Capital and revenue 30 2.7.1 Capital transactions 30 2.7.2 Revenue transactions 30 2.8 Summary 30 Revision Questions 3 1 Solutions to Revision Questions 3 5 3 The Accounting System in Action 3 9 Learning Outcomes 41 3.1 Introduction 41 3.2 What is a ledger account? 41 3.3 What is double-entry bookkeeping? 42 3.4 Bookkeeping entries for expenses and revenue 46 3.4.1 Bookkeeping entries for purchases and sales 46 3.4.2 Nominal ledger accounts 50 3.5 Balancing the accounts 50 3.5.1 Calculating the balance on the account 51 3.6 Summary 52 Revision Questions 5 3 Solutions to Revision Questions 6 1 4 Summarising the Ledger Accounts 6 7 Learning Outcomes 69 4.1 Introduction 69 4.2 Preparing the trial balance 69 4.2.1 Does the trial balance prove the accuracy of the ledger accounts? 70 4.3 Preparing a statement of profi t 72 4.3.1 The trading account 72 4.3.2 The income statement 76 4.3.3 The balance on the income statement 78 4.3.4 Dealing with drawings 79 4.4 Preparing the statement of fi nancial position 79 4.5 Balancing off the ledger accounts 80 4.6 Columnar ledger accounts 85 4.7 Summary 85 Revision Questions 8 7 Solutions to Revision Questions 9 3 5 Further Aspects of Ledger Accounting 97 Learning Outcomes 99 5.1 Introduction 99 5.2 Accounting for specialised transactions 99 FUNDAMENTALS OF FINANCIAL ACCOUNTING v 5.2.1 Carriage costs 99 C O 5.2.2 Discounts 100 N T 5.3 Accounting for sales tax 102 EN T 5.3.1 Sales tax on non-current assets and expenses 106 S 5.3.2 Sales tax in separate ledger accounts 106 5.3.3 Non-registered businesses 106 5.3.4 Zero-rated and exempt supplies 107 5.4 Accounting for wages and salaries 107 5.4.1 Gross pay and net pay 107 5.4.2 Other deductions 109 5.4.3 Pension contributions 110 5.5 Accruals and prepayments 110 5.5.1 Recording accruals and prepayments in the ledger accounts 112 5.6 Bad debts and allowance for receivables 113 5.6.1 Accounting for bad debts 114 5.6.2 Bad debts recovered 115 5.6.3 Allowance for receivables 116 5.7 The exchange of goods 120 5.8 Summary 122 Revision Questions 123 Solutions to Revision Questions 133 6 Accounting for Non-current Assets 141 Learning Outcomes 143 6.1 Introduction 143 6.2 Capital and revenue expenditure 143 6.3 Depreciation 145 6.4 Calculating depreciation 146 6.4.1 The straight-line method 147 6.4.2 The reducing-balance method 148 6.4.3 The machine-hour method/units of production method 149 6.4.4 The revaluation method 149 6.4.5 Depreciation in the year of acquisition and disposal 150 6.5 Accounting for the disposal of a non-current asset 150 6.6 A comprehensive example 152 6.7 Controlling tangible non-current assets 154 6.8 Accounting for intangible non-current assets 155 6.8.1 What is goodwill? 156 6.9 Summary 157 Revision Questions 159 Solutions to Revision Questions 1 77 7 Preparation of Financial Statements with Adjustments 189 Learning Outcome 191 7.1 Introduction 191 7.2 The trial balance 191 vi FUNDAMENTALS OF FINANCIAL ACCOUNTING C2 S 7.3 The adjustments 192 T N E 7.4 Step1: Labelling the trial balance 193 T N 7.5 Step2: Preparing workings 194 O C 7.6 Step3: Preparing the fi nancial statements 196 7.7 Summary 205 Revision Questions 2 07 Solutions to Revision Questions 2 19 8 Organising the Bookkeeping System 229 Learning Outcomes 231 8.1 Introduction 231 8.2 Organising the ledger accounts 232 8.2.1 Advantages of dividing the ledger 232 8.3 Supporting books and records 232 8.3.1 Source documents 233 8.4 Sales, purchases and returns daybooks 233 8.4.1 Recording transactions in the daybooks 234 8.4.2 Making the ledger entries 235 8.4.3 Extending the use of daybooks 240 8.5 The cash books 241 8.5.1 The banking system 241 8.5.2 The cash book 242 8.5.3 The petty cash book 245 8.6 The journal 246 8.6.1 The layout of the journal 247 8.6.2 Using the journal for miscellaneous transactions 247 8.6.3 Using the journal for end-of-year transactions 248 8.7 Inventory records and methods of inventory measurement 249 8.7.1 The process of inventories measurement 251 8.7.2 Application of methods of inventory measurement (also known as cost formulas) 252 8.7.3 Issues and receipts 255 8.8 Summary 257 Revision Questions 2 59 Solutions to Revision Questions 2 69 9 Controlling the Bookkeeping System 277 Learning Outcomes 279 9.1 Introduction 279 9.2 Preventing errors 279 9.2.1 Authorisation procedures 280 9.2.2 Documentation 280 9.2.3 Organisation of staff 280 9.2.4 Safeguarding assets 281 9.3 Detecting errors 281 9.3.1 Spot checks 281 9.3.2 Comparison with external evidence 281 FUNDAMENTALS OF FINANCIAL ACCOUNTING vii 9.3.3 Reconciliations 281 C O 9.3.4 Carrying out an audit 282 N T 9.4 Bank reconciliation statements 282 EN T 9.5 Reconciliation of suppliers ’ statements 285 S 9.6 Control accounts 287 9.6.1 The status of the control account 290 9.6.2 Contra entries 293 9.6.3 Credit balances in the sales ledger; debit balances in the purchase ledger 294 9.6.4 The control account and allowance for receivables 295 9.6.5 Advantages of control accounts 295 9.6.6 Reconciling control accounts and ledger accounts 295 9.7 Suspense accounts and the correction of errors 296 9.8 Computers in accounting 299 9.8.1 Aspects of computerised accounting systems 300 9.9 Accounting coding systems 300 9.10 Summary 302 Revision Questions 3 03 Solutions to Revision Questions 317 10 The Regulatory Framework of Accounting 327 Learning Outcomes 329 10.1 Introduction 329 10.2 Accounting conventions 330 10.2.1 The business entity convention 330 10.2.2 The money measurement convention 330 10.2.3 The historical cost convention 331 10.2.4 The objectivity convention 331 10.2.5 The dual aspect convention 331 10.2.6 The realisation convention 331 10.2.7 The periodicity convention 332 10.2.8 The accruals and matching conventions 332 10.2.9 The materiality convention 333 10.2.10 The stable monetary unit convention 334 10.2.11 The going concern convention 334 10.2.12 The consistency convention 334 10.2.13 The prudence convention 334 10.3 Accounting policies and estimation techniques 335 10.4 The historical cost convention and its alternatives 336 10.4.1 The theory of capital maintenance 337 10.4.2 Current purchasing power (CPP) accounting 337 10.4.3 Current cost accounting 338 10.4.4 Fair value 338 10.4.5 Value to the business (or deprival value) 338 10.4.6 The valuation of intangible assets 339 10.5 Regulations in accounting 342 10.5.1 Company law 342 10.5.2 The accountancy profession 342 viii FUNDAMENTALS OF FINANCIAL ACCOUNTING C2 S 10.5.3 International accounting standards 342 T N E 10.5.4 The IASB Framework for the Preparation and T N Presentation of Financial Statements (the ‘ Framework ’ ) 344 O C 10.6 The role of the auditor 344 10.6.1 Fair presentation or true and fair 345 10.6.2 The role of the external auditor 346 10.6.3 The role of the internal auditor 347 10.6.4 The value-for-money audit 347 10.7 The role of management 347 10.8 Summary 348 Revision Questions 3 49 Solutions to Revision Questions 357 11 Incomplete Records; Income and Expenditure Statements 361 Learning Outcomes 363 11.1 Introduction 363 11.2 Calculating ‘ missing fi gures ’ 364 11.2.1 Sales fi gures 364 11.2.2 Purchases fi gures 365 11.2.3 Expenses fi gures 365 11.2.4 Opening capital 366 11.2.5 Cash and bank summaries 366 11.3 Financial statements of non-profi t-making bodies 373 11.3.1 Accounting terminology for non-profi t-making bodies 373 11.3.2 Accounting for membership fees and subscriptions 374 11.3.3 The fi nancial statements of non-trading organisations 376 11.4 Summary 381 Revision Questions 3 83 Solutions to Revision Questions 399 12 The Manufacturing Account 4 11 Learning Outcomes 413 12.1 Introduction 413 12.2 Why is a manufacturing account needed? 413 12.2.1 Inventories in manufacturing organisations 414 12.3 Costs to include in the manufacturing account 414 12.3.1 Other direct costs 415 12.3.2 Prime cost 415 12.3.3 Indirect costs 415 12.3.4 Factory cost of production 415 12.3.5 Work in progress 415 12.3.6 Factory cost of goods completed 416 12.4 Layout of manufacturing and trading accounts 416 12.5 Income statement for manufacturing organisations 417 12.6 Statements of fi nancial position for manufacturing organisations 417 FUNDAMENTALS OF FINANCIAL ACCOUNTING ix 12.7 The accounting system for manufacturing organisations 417 C O 12.8 Summary 420 N T E Revision Questions 4 23 N T S Solutions to Revision Questions 427 13 The Financial Statements of Limited Companies and the Statement of Cash Flows 429 Learning Outcomes 431 13.1 Introduction 431 13.2 Limited companies 432 13.2.1 The fi nancial statements of companies 432 13.2.2 Presentation of company income statements 433 13.2.3 Taxation in company fi nancial statements 433 13.2.4 Directors of limited companies 434 13.2.5 Sources of fi nance for a limited company 434 13.2.6 Dividends 436 13.2.7 Reserves 437 13.2.8 Statement of comprehensive income 438 13.2.9 Statement of changes in equity 440 13.3 Statement of cash fl ows 447 13.3.1 What is a statement of cash fl ows? 447 13.3.2 Why does the profi t earned not equal the change in bank and cash balances? 447 13.3.3 Cash fl ows from operating activities – cash generated from operations 448 13.3.4 Cash fl ows from operating activities – net cash from operating activities 450 13.3.5 Cash fl ows from investing activities 450 13.3.6 Cash fl ows from fi nancing activities 450 13.3.7 Statement of cash fl ows for sole traders 453 13.4 Summary 454 Revision Questions 455 Solutions to Revision Questions 483 14 The Interpretation of Financial Statements 501 Learning Outcomes 503 14.1 Introduction 503 14.2 What is meant by ‘ interpretation of fi nancial statements ’ ? 503 14.3 Calculating ratios 505 14.3.1 Using the ratios 505 14.4 Types of ratios 505 14.5 Profi tability ratios 506 14.5.1 Gross profi t margin 507 14.5.2 Gross profi t mark-up 507 14.5.3 Operating profi t margin 508 14.5.4 Return on capital ratios 508

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