Foundations of Accounting

356 Pages·2011·2.22 MB·English

S T U D Y M A N U A L
F o u n d a t i o n l e v e l
Foundations of Accounting
2 0 1 2
Third edition 2012
First edition 2009
ISBN 9781 4453 8008 7
Previous ISBN 9780 7517 8147 2
British Library Cataloguing-in-Publication Data
A catalogue record for this book
is available from the British Library.
Published by BPP Learning Media Ltd
All rights reserved. No part of this publication may
be reproduced or transmitted in any form or by any
means or stored in any retrieval system, electronic,
mechanical, photocopying, recording or otherwise
without the prior permission of the publisher.
We are grateful to CPA Australia for permission to
reproduce the Learning Objectives, the copyright of
which is owned by CPA Australia.
Printed in Australia
©
BPP Learning Media Ltd 2012
ii
Welcome to the next step in your career –
CPA Program
Today’s CPA Program is a globally recognised education program available around the world. All candidates
of CPA Australia are required to attain a predetermined level of technical competence before the CPA
designation can be awarded. The CPA Program foundation level is designed to provide you with an
opportunity to demonstrate knowledge and skills in the core areas of accounting, business and finance.
A pass for each exam is based on a determination of the minimum level of knowledge and skills that
candidates must acquire to have a good chance at success in the professional level of the CPA Program.
In 2012 you have more opportunities to sit foundation level exams, allowing you to progress through to the
professional level of the CPA Program at your own pace.
The material in this study manual has been prepared based upon standards and legislation in effect as at
1 September 2011. Candidates are advised that they should confirm effective dates of standards or
legislation when using additional study resources. Exams for 2012 will be based on the content of this study
manual.
Additional Learning Support

A range of quality learning products will be available in the market for you to purchase to further aid your
core study program and preparation for exams.
These products will appeal to candidates looking to invest in additional resources other than those
provided in this study manual. More information is available on CPA Australia’s website
www.cpaaustralia.com.au/learningsupport
You will also be able to source face-to-face and online tuition for CPA Program foundation level exams
from registered tuition providers. The tuition provided by these registered parties is based on current
CPA Program foundation level learning objectives. A list of current registered providers can be found on
CPA Australia’s website. If you are interested you will need to liaise directly with the chosen provider to
purchase and enrol in your tuition program.

iii
iv
Contents
Page
Introduction
Welcome to CPA Australia iii
Chapter features vi
Chapter summary viii
Answering multiple choice questions x
Learning objectives xi

Chapter
1 Introduction to accounting 1
2 Types of business entity 27
3 Double entry bookkeeping 41
4 Trial balance 63
5 Books of prime entry and subsidiary ledgers 75
6 Accruals and prepayments 105
7 Receivables and payables 121
8 Property, plant and equipment 139
9 Inventory 169
10 Closing entries 191
11 Subsidiary ledgers and reconciliations 209
12 Bank reconciliations 231
13 Statement of financial position and statement of comprehensive income 247
14 Information technology 267
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Introduction v
Chapter features
Each chapter contains a number of helpful features to guide you through each topic.
Learning Show the referenced CPA Australia learning objectives.
objectives
Topic list Tells you what you will be studying in this chapter.
Introduction Presents a general idea of what is covered in this chapter.
Chapter summary Summarises the content of the chapter, helping to set the scene so that you can
diagram understand the bigger picture.
Before you begin This is a small bank of questions to test any pre-existing knowledge that you may
have of the chapter content. If you get them all correct then you may be able to
reduce the time you need to spend on the particular chapter. There is a
commentary section at the end of the Study Manual called Before you begin: answers
and commentary.
Section overview This summarises the key content of the particular section that you are about to
start.

Learning objective This box indicates the learning objective covered by the section or paragraph to
reference which it relates.
LO
1.2
Definition Definitions of important concepts. You really need to know and understand these
before the exam.

Exam comments These highlight points that are likely to be particularly important or relevant to
the exam. (Please note that this feature does not apply in every Foundation Level
study manual.)

Worked example This is an illustration of a particular technique or concept with a solution or
explanation provided.

Question This is a question that enables you to practise a technique or test your
understanding. You will find the solution at the end of the chapter.

Key chapter points Review the key areas covered in the chapter.
vi Foundations of Accounting
Quick revision A quick test of your knowledge of the main topics in this chapter.
questions
The quick revision questions are not a representation of the difficulty of the
questions which will be in the examination. The quick revision Multiple Choice
Questions (MCQs) provide you with an opportunity to revise and assess your
knowledge of the key concepts covered in the materials so far. Use these
questions as a means to reflect on key concepts and not as the sole revision for
the examination.
Revision The revision questions are not a representation of the difficulty of the questions
questions which will be in the examination. The revision MCQs provide you with an
opportunity to revise and assess your knowledge of the key concepts covered in
the materials so far. Use these questions as a means to reflect on key concepts
and not as the sole revision for the examination.
Case study This is a practical example or illustration, usually involving a real world scenario.
Formula to learn These are formulae or equations that you need to learn as you may need to apply
them in the exam.

Bold text Throughout the Study Manual you will see that some of the text is in bold type.
This is to add emphasis and to help you to grasp the key elements within a
sentence and paragraph.

Introduction vii
Chapter summary
This summary provides a snapshot of each of the chapters, to help you to put the syllabus as a whole, and
the Study Manual itself, into perspective.
CChhaapptteerr 11 IInnttrroodduuccttiioonn ttoo aaccccoouunnttiinngg
In this introductory chapter we will consider the purpose of accounting and some of the concepts that
underlie the accounting process. We will also introduce the two main financial statements required for this
syllabus – the statement of financial position and the statement of comprehensive income – as well as the
accounting equation, which is the basis of much of the accounting that will be considered in this Study
Manual.
CChhaapptteerr 22 TTyyppeess ooff bbuussiinneessss eennttiittyy
Here we will consider the different types of business entity in terms of their ownership structure and the
type of business they are involved in. We will also consider the people and organisations which are likely to
be interested in a business entity’s financial statements and the type of information that they will require
from those financial statements.
CChhaapptteerr 33 DDoouubbllee eennttrryy bbooookkkkeeeeppiinngg
In this chapter, we will study the fundamental rules of double entry bookkeeping. In subsequent chapters
details of specific types of transaction will be considered, but in this chapter the basic rules are covered to
give an overall understanding of the concept of double entry bookkeeping.
CChhaapptteerr 44 TTrriiaall bbaallaannccee
Once the transactions of a business for a period have been recorded in the ledger accounts, one method of
checking whether errors have been made is to draw up a trial balance showing the closing balance on each
ledger account. As we will see in later chapters, the trial balance is also a useful starting point for the
preparation of financial statements.
CChhaapptteerr 55 BBooookkss ooff pprriimmee eennttrryy aanndd ssuubbssiiddiiaarryy lleeddggeerrss
This chapter considers in more detail how the many transactions of a business are recorded before being
posted to the ledger accounts. In particular, we introduce the concept of individual accounts for each credit
customer and supplier, which are kept in the subsidiary ledgers for receivables and payables.
CChhaapptteerr 66 AAccccrruuaallss aanndd pprreeppaayymmeennttss
We now start to consider some of the adjustments that will be required to figures in the ledger accounts at
the end of each accounting period. One of the fundamental accounting concepts is that of accruals, or
matching, which requires that income and expenses are included in the financial statements in the period in
which they were incurred, rather than when the cash for them was received or paid. In this chapter we
look at the adjustments which may be necessary to ensure that this is the case.
CChhaapptteerr 77 RReecceeiivvaabblleess aanndd ppaayyaabblleess
In this chapter, we consider two particular adjustments that may be required for receivables balances. In
some cases an amount owing from a receivable may be irrecoverable and therefore must be written out of
the ledger accounts totally. In other cases there may be doubt as to the recoverability of an amount owing,
in which case an allowance for receivables must be made in the financial statements.
viii Foundations of Accounting
CChhaapptteerr 88 PPrrooppeerrttyy,, ppllaanntt aanndd eeqquuiippmmeenntt
Property, plant and equipment are the non-current assets which a business may own for long-term use in
the business. We will study how to record these assets when they are purchased, how to depreciate them
over their useful life and how to account for them when they are eventually sold.
CChhaapptteerr 99 IInnvveennttoorryy
In this chapter we will consider the problem of, not only how to account for inventories at the beginning
and end of a financial period, but also how to value those inventories.
CChhaapptteerr 1100 CClloossiinngg eennttrriieess
We have seen how to account for the transactions of a business and how to put through period end
adjustments that are required. The next stage is to prepare a set of financial statements, but before we
reach that stage it is important to understand the difference between income or expense accounts which
are closed off to the income and expenditure account in order to form the statement of comprehensive
income, and asset, liability and capital accounts on which a balance is carried down and simply listed in the
statement of financial position.
CChhaapptteerr 1111 SSuubbssiiddiiaarryy lleeddggeerrss aanndd rreeccoonncciilliiaattiioonnss
We have already seen how subsidiary ledgers are set up for individual credit customers and suppliers,
whereas the total of transactions with receivables and payables are recorded in the receivables or payables
control accounts. In this chapter we will consider this process further, and in particular, how to use the
control account totals and the individual balance totals as a check on the accuracy of the accounting
records.
CChhaapptteerr 1122 BBaannkk rreeccoonncciilliiaattiioonnss
A bank reconciliation is a further check on the accuracy of the accounting records. The bank statement
issued by the bank is compared to the cash book in the general ledger and any errors or omissions are
corrected. The balance on the bank statement and the balance on the cash account are then reconciled,
taking into account unpresented cheques and outstanding deposits.
CChhaapptteerr 1133 SSttaatteemmeenntt ooff ffiinnaanncciiaall ppoossiittiioonn aanndd ssttaatteemmeenntt ooff ccoommpprreehheennssiivvee
iinnccoommee
We are now in a position to prepare a set of financial statements for a business. This may be done from a
trial balance, or alternatively, an adjusted trial balance can be used as a working paper.
CChhaapptteerr 1144 IInnffoorrmmaattiioonn tteecchhnnoollooggyy
Most accounting systems these days are computerised and in this chapter we will look at some of the
aspects of a computerised accounting system.
Introduction ix
Answering multiple choice questions
(MCQs)
The questions in your exam will each contain four possible answers. You have to choose the option that
best answers the question. The three incorrect options are called distractors. There is a skill in
answering MCQs quickly and correctly. By practising MCQs you can develop this skill, giving you a better
chance of passing the exam.
You may wish to follow the approach outlined below, or you may prefer to adapt it.
Step 1 Attempt each question. Read the question thoroughly. You may prefer to work out the
answer before looking at the options, or you may prefer to look at the options at the
beginning. Adopt the method that works best for you.
Step 2 Read the four options and see if one matches your own answer. Be careful with numerical
questions, as the distractors are designed to match answers that incorporate common errors.
Check that your calculation is correct. Have you followed the requirement exactly? Have you
included every stage of the calculation?
Step 3 You may find that none of the options matches your answer.
• Re-read the question to ensure that you understand it and are answering the
requirement
• Eliminate any obviously wrong answers
• Consider which of the remaining answers is the most likely to be correct and select
the option
Step 4 If you are still unsure make a note and continue to the next question. Some questions will
take you longer to answer than others. Try to reduce the average time per question, to allow
yourself to revisit problem questions at the end of the exam.
Step 5 Revisit unanswered questions. When you come back to a question after a break you often
find you are able to answer it correctly straight away. If you are still unsure have a guess. You
are not penalised for incorrect answers, so never leave a question unanswered!
x Foundations of Accounting