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195 Accounting
Principles Questions
& Answers
By: Rahat

Kazmi

Please review the Answers of ...
www.SoftSkillsExperts.co.uk
198 Accounting Principles Questions &
Answers
1. What is a capital expenditure versus a revenu...
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not allocated or assigned to (not absorbed by) the products manufactured.
Variable costing is ...
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asset's cost of £100,000 minus its accumulated depreciation of £36,000
(£20,000 + £16,000). Th...
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2. Expenses are reported on the income statement when the cash is paid out.
Under the accrual ...
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If another company with the same financial condition purchased this unique
machine by issuing ...
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The details of capitalized interest are explained in the Financial Accounting
Standards Board'...
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result, period costs cannot be assigned to the products or to the cost of
inventory. The perio...
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was earned in 2012, but will not be paid until 2013. The 2012 financial
statements need to ref...
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account such as Loss on Write-Down of Inventory, an income statement
account.
If the amount of...
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The asset is expected to have a useful life of 10 years and no salvage value.
The company uses...
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dividend. Dividends are a distribution of a corporation's profits. Bonds pay
interest to the b...
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value, and 3) useful life. Depreciation should be thought of as an allocation of
the asset's c...
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25. What is the deferred revenue?
Deferred revenue is not yet revenue. It is an amount that wa...
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paid. The result of accrual accounting is an income statement that better
measures the profita...
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that no investor, creditor, or other interested party would be misled by not
depreciating the ...
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A common characteristic of an adjusting entry is that it will involve one income
statement acc...
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33. What is the difference between the Cash Flow and Funds Flow
statements?
The cash flow stat...
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Under the accrual basis of accounting, accrued income is recorded with an
adjusting entry prio...
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statement. Unfortunately those recorded costs may not measure the
economic reality that is occ...
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41. What is cost incurred?
Cost incurred is a cost that a company has become liable for.
To il...
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44. What are the ways to value inventory?
Generally, the balance sheet of a U.S. company must ...
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In addition to the change in the assets or liabilities, an expense will reduce the
credit bala...
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48. How do you record a payment for insurance?
Since insurance premiums are usually paid prior...
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Other long-lived assets such as land improvements, buildings, furnishings,
equipment, etc. hav...
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Other disclosures in the notes to the financial statements include the effects of
foreign curr...
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The sales revenues minus the cost of goods sold is gross profit.
Cost of goods sold is calcula...
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The agreement is for the £100,000 to be repaid on February 28 along with
£3,000 of interest fo...
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win the case.) On the other hand, Company B will need to make an entry in its
accounts if the ...
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61. How should the sale of gift certificates be recorded in the general
ledger?
The sale of a ...
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64. What is inventory valuation?
Inventory valuation is the dollar amount associated with the ...
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3. The unknown credit might involve a revenue account if the cash was
received for work that w...
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67. Are bonds payable reported as a current liability if they mature in six
months?
Bonds paya...
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statements issued three weeks after the accounting period ends will have
more relevance than f...
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Advertising may be valuable, even crucial for some businesses and will lead
to additional asse...
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74. How do you record money from an insurance claim involving property?
I would use a separate...
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview
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195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview

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These 195 Answers have been put together to most popular Interview Questions. These questions can also be useful for Exams but I would recommend further reading. Please note that the Answers are based on US GAAP, but I have seen these are very similar to UK GAAP. If you like my efforts, please follow me to receive more documents like this in the future.

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195 Accounting Principles Questions and Answers for Accounting Exams and Job Interview

  1. 1. www.SoftSkillsExperts.co.uk 195 Accounting Principles Questions & Answers By: Rahat Kazmi Please review the Answers of first 20 Questions and if you like to receive the answers for remaining of the questions, please Like 3 Pages on Facebook and then sent me an email to receive the remaining Answers. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  2. 2. www.SoftSkillsExperts.co.uk 198 Accounting Principles Questions & Answers 1. What is a capital expenditure versus a revenue expenditure? A capital expenditure is an amount spent to acquire or improve a long-term asset such as equipment or buildings. Usually the cost is recorded in an account classified as Property, Plant and Equipment. The cost (except for the cost of land) will then be charged to depreciation expense over the useful life of the asset. A revenue expenditure is an amount that is expensed immediately—thereby being matched with revenues of the current accounting period. Routine repairs are revenue expenditures because they are charged directly to an account such as Repairs and Maintenance Expense. Even significant repairs that do not extend the life of the asset or do not improve the asset (the repairs merely return the asset back to its previous condition) are revenue expenditures. 2. What is owner's equity? Owner's equity is one of the three main components of a sole proprietorship's balance sheet and accounting equation. Owner's equity represents the owner's investment in the business minus the owner's draws or withdrawals from the business plus the net income (or minus the net loss) since the business began. Mathematically, the amount of owner's equity is the amount of assets minus the amount of liabilities. Since the amounts must follow the cost principle (and others) the amount of owner's equity does not represent the current fair market value of the business. Owner's equity is viewed as a residual claim on the business assets because liabilities have a higher claim. Owner's equity can also be viewed (along with liabilities) as a source of the business assets. 3. What is absorption costing? Absorption costing means that all of the manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labour, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as full costing or the full absorption method. Absorption costing is often contrasted with variable costing or direct costing. Under variable or direct costing, the fixed manufacturing overhead costs are Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  3. 3. www.SoftSkillsExperts.co.uk not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for management's decision-making. However, absorption costing is required for external financial reporting and for income tax reporting. 4. What is the double declining balance method of depreciation? The double declining balance method of depreciation, also known as the 200% declining balance method of depreciation, is a common form of accelerated depreciation. Accelerated depreciation means that an asset will be depreciated faster than would be the case under the straight line method. Although the depreciation will be faster, the total depreciation over the life of the asset will not be greater than the total depreciation using the straight line method. This means that the double declining balance method will result in greater depreciation expense in each of the early years of an asset's life and smaller depreciation expense in the later years of an asset's life as compared to straight line depreciation. Under the double declining balance method, double means twice or 200% of the straight line depreciation rate. Declining balance refers to the asset's book value or carrying value at the beginning of the accounting period. Book value is an asset's cost minus its accumulated depreciation. The asset's book value will decrease when the contra asset account Accumulated Depreciation is credited with the depreciation expense of the accounting period. Let's illustrate double declining balance depreciation with an asset that is purchased on January 1 at a cost of £100,000 and is expected to have no salvage value at the end of its useful life of 10 years. Under the straight line method, the 10 year life means the asset's annual depreciation will be 10% of the asset's cost. Under the double declining balance method the 10% straight line rate is doubled to be 20%. However, the 20% is multiplied times the asset's beginning of the year book value instead of the asset's original cost. At the beginning of the first year, the asset's book value is £100,000 since there has not yet been any depreciation recorded. Therefore, under the double declining balance method the £100,000 of book value will be multiplied by 20% for depreciation in Year 1 of £20,000. The journal entry will be a debit of £20,000 to Depreciation Expense and a credit to Accumulated Depreciation of £20,000. At the beginning of the second year, the asset's book value will be £80,000. This is the asset's cost of £100,000 minus its accumulated depreciation of £20,000. The £80,000 of beginning book value multiplied by 20% results in £16,000. The depreciation entry for Year 2 will be a debit to Depreciation Expense for £16,000 and a credit to Accumulated Depreciation for £16,000. At the beginning of Year 3, the asset's book value will be £64,000. This is the Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  4. 4. www.SoftSkillsExperts.co.uk asset's cost of £100,000 minus its accumulated depreciation of £36,000 (£20,000 + £16,000). The book value of £64,000 X 20% = £12,800 of depreciation expense for Year 3. At the beginning of Year 4, the asset's book value will be £51,200. This is the asset's cost of £100,000 minus its accumulated depreciation of £48,800 (£20,000 + £16,000 + £12,800). The book value of £51,200 X 20% = £10,240 of depreciation expense for Year 4. As you can see, the amount of depreciation expense is declining each year. Over the remaining six years there can be only £40,960 of additional depreciation. This is the asset's cost of £100,000 minus its accumulated depreciation of £59,040. Some people will switch to straight line at this point and record the remaining £40,960 over the remaining 6 years in equal amounts of £6,827 per year. Others may choose to follow the original formula. 5. What is a contingent liability? A contingent liability is a potential liability...it depends on a future event occurring or not occurring. For example, if a parent guarantees a daughter's first car loan, the parent has a contingent liability. If the daughter makes her car payments and pays off the loan, the parent will have no liability. If the daughter fails to make the payments, the parent will have a liability. If a company is sued by a former employee for £500,000 for age discrimination, the company has a contingent liability. If the company is found guilty, it will have a liability. However, if the company is not found guilty, the company will not have an actual liability. In accounting, a contingent liability and the related contingent loss are recorded with a journal entry only if the contingency is both probable and the amount can be estimated. If a contingent liability is only possible (not probable), or if the amount cannot be estimated, a journal entry is not required. However, a disclosure is required. When a contingent liability is remote (such as a nuisance suit), then neither a journal nor a disclosure is required. 6. What is the difference between the cash basis and the accrual basis of accounting? Under the cash basis of accounting... 1. Revenues are reported on the income statement in the period in which the cash is received from customers. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  5. 5. www.SoftSkillsExperts.co.uk 2. Expenses are reported on the income statement when the cash is paid out. Under the accrual basis of accounting... 1. Revenues are reported on the income statement when they are earned--which often occurs before the cash is received from the customers. 2. Expenses are reported on the income statement in the period when they occur or when they expire---which is often in a period different from when the payment is made. The accrual basis of accounting provides a better picture of a company's profits during an accounting period. The reason is that the income statement prepared under the accrual basis will report all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues. The accrual basis of accounting also provides a better picture of a company's financial position at a moment or point in time. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported. The accrual basis of accounting is required because of the matching principle. 7. What is the difference between an implicit cost and an explicit cost? An implicit cost is a cost that has occurred but it is not initially shown or reported as a separate cost. On the other hand, an explicit cost is one that has occurred and is clearly reported as a separate cost. Below are some examples to illustrate the difference between an implicit cost and an explicit cost. Let's assume that a company gives a promissory note for £10,000 to someone in exchange for a unique used machine for which the fair value is not known. The note will come due in three years and it does not specify any interest. Due to the company's weak financial position it will have to pay a high interest rate if it were to borrow money. In this example, there is no explicit interest cost. However, due to the issuer's financial difficulty and the seller having to wait three years to collect the money, there has to be some interest cost. In other words, there is some interest and it is implicit. To properly record the note and the machine, the accountant must determine the amount of the interest, which is known as imputing the interest. In effect the accountant must convert the implicit interest to explicit interest. This is done by discounting the £10,000 by using the interest rate that the issuer of the note would have to pay to another lender. If the rate is 12% per year, the interest that was implicit in the note is £2,880 and the principal portion of the note is the remaining £7,120. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  6. 6. www.SoftSkillsExperts.co.uk If another company with the same financial condition purchased this unique machine by issuing a £7,120 note with a stated interest rate of 12% per year, the interest cost of £2,880 would be explicit. In this situation, there is no need to impute the interest. Another example of an implicit cost is the opportunity cost of a sole proprietor working in her own business. For example, Gina works as a sole proprietor and her business reported a net income of £30,000 for the year. Since a sole proprietor does not receive a salary or wages, there is no explicit cost reported for Gina's work in her business. However, if Gina is foregoing a salary of £40,000 from another company, that is an implicit cost for her business. After considering this implicit cost, Gina is losing £10,000 by working in her proprietorship. If Gina operates her business as a corporation, Gina will be an employee of the corporation. If her annual salary is £40,000 the corporation's income statement would report the £40,000 salary as an explicit cost for Gina's work. 8. How do you calculate accrued vacation pay? Accrued vacation pay is the amount of vacation pay which has been earned by the employee but has not yet been paid to the employee. To illustrate accrued vacation time and accrued vacation pay let's assume that the employee's contract guarantees 120 hours of paid vacation time per year (40 hour work week times 3 weeks). If the employee's hourly pay rate is £26 per hour, the employee is earning vacation pay of £3,120 per year (120 hours x £26), or £60 per week (£3,120 per year divided by 52 weeks). The company is also incurring vacation pay expense and a liability of £60 per week. In terms of vacation time, the employee is earning 2.31 hours of vacation time each week (120 hours per year divided by 52 weeks per year) or 2.45 hours based on 120 hours divided by the 49 weeks not on vacation. At December 31 the company has a liability for the vacation hours and vacation pay that the employee has earned and is entitled to if the company were to close. If the employee has worked 20 weeks since the employee's anniversary date with the company and the last vacation payment, then the company should report a current liability of £1,200 (20 weeks x £60 per week.) 9. What is capitalized interest? Capitalized interest is the interest added to the cost of a self-constructed, long-term asset. It involves the interest on debt used to finance the asset's construction. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  7. 7. www.SoftSkillsExperts.co.uk The details of capitalized interest are explained in the Financial Accounting Standards Board's (FASB) Statement of Financial Accounting Standards No. 34, Capitalization of Interest Cost. You can find this accounting pronouncement at www.FASB.org/st. In short, there must be debt involved (cash and common stock are not considered). The interest specified by the pronouncement is added to the cost of the project, instead of being expensed on the current period's income statement. This capitalized interest will be part of the asset's cost reported on the balance sheet, and will be part of the asset's depreciation expense that will be reported in future income statements. 10. What are accrued expenses and when are they recorded? Accrued expenses are expenses that have occurred but are not yet recorded through the normal processing of transactions. Since these expenses are not yet in the accountant's general ledger, they will not appear on the financial statements unless an adjusting entry is entered prior to the preparation of the financial statements. Here is an example. A company borrowed £200,000 on December 1. The agreement requires that the £200,000 be repaid on February 28 along with £6,000 of interest for the three months of December through February. As of December 31 the company will not have an invoice or payment for the interest that the company is incurring. (The reason is that all of the interest will be due on February 28.) Without an adjusting entry to accrue the interest expense that the company has incurred in December, the company's financial statements as of December 31 will not be reporting the £2,000 of interest (one-third of the £6,000) that the company has incurred in December. In order for the financial statements to be correct on the accrual basis of accounting, the accountant needs to record an adjusting entry dated as of December 31. The adjusting entry will consist of a debit of £2,000 to Interest Expense (an income statement account) and a credit of £2,000 to Interest Payable (a balance sheet account). 11. What is the difference between product costs and period costs? A manufacturer's product costs are the direct materials, direct labour, and manufacturing overhead used in making its products. (Manufacturing overhead is also referred to as factory overhead, indirect manufacturing costs, and burden.) The product costs of direct materials, direct labour, and manufacturing overhead are also "inventorial" costs, since these are the necessary costs of manufacturing the products. Period costs are not a necessary part of the manufacturing process. As a Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  8. 8. www.SoftSkillsExperts.co.uk result, period costs cannot be assigned to the products or to the cost of inventory. The period costs are usually associated with the selling function of the business or its general administration. The period costs are reported as expenses in the accounting period in which they 1) best match with revenues, 2) when they expire, or 3) in the current accounting period. In addition to the selling and general administrative expenses, most interest expense is a period expense. 12. Is there a difference between an expense and an expenditure? An expense is reported on the income statement. An expense is a cost that has expired, was used up, or was necessary in order to earn the revenues during the time period indicated in the heading of the income statement. For example, the cost of the goods that were sold during the period are considered to be expenses along with other expenses such as advertising, salaries, interest, commissions, rent, and so on. An expenditure is a payment or disbursement. The expenditure may be for the purchase of an asset, a reduction of a liability, a distribution to the owners, or it could be an expense. For instance, an expenditure to eliminate a liability is not an expense, while expenditures for advertising, salaries, etc. will likely be recorded immediately as expenses. Here's another example to illustrate the difference between an expense and an expenditure. A company makes an expenditure of £255,500 to purchase equipment. The expenditure occurs on a single day and the equipment is placed in service. Assuming the equipment will be used for seven years, the cost of the equipment will be reported as depreciation expense of £100 per day for the next 2,555 days (7 years of service with 365 days each year). 13. What are accruals? Accruals are adjustments for 1) revenues that have been earned but are not yet recorded in the accounts, and 2) expenses that have been incurred but are not yet recorded in the accounts. The accruals need to be added via adjusting entries so that the financial statements report these amounts. An example of an accrual for revenue involves your electric utility company. The utility used coal and many employees in December to generate electricity that customers received in December. However, the utility doesn't bill the electric customers for the December electricity until the meters are read in January. To have the proper amounts on the utility's financial statements, there needs to be an adjusting entry to increase revenues that were earned in December and the receivables that the utility has a right to as of December 31. An example of an accrual involving an expense is an employee's bonus that Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  9. 9. www.SoftSkillsExperts.co.uk was earned in 2012, but will not be paid until 2013. The 2012 financial statements need to reflect the bonus expense and the bonus liability. Therefore, prior to issuing the 2012 financial statements an adjusting entry is prepared to record this accrual. 14. What is the difference between accounts payable and accrued expenses payable? I would use the liability account Accounts Payable for suppliers' invoices that have been received and must be paid. As a result, the balance in Accounts Payable is likely to be a precise amount that agrees with supporting documents such as invoices, agreements, etc. I would use the liability account Accrued Expenses Payable for the accrual type adjusting entries made at the end of the accounting period for items such as utilities, interest, wages, and so on. The balance in the Accrued Expenses Payable should be the total of the expenses that were incurred as of the date of the balance sheet, but were not entered into the accounts because an invoice has not been received or the payroll for the hourly wages has not yet been processed, etc. The amounts recorded in Accrued Expenses Payable will often be estimated amounts supported by logical calculations. 15. What is the difference between financial accounting and management accounting? Financial accounting has its focus on the financial statements which are distributed to stockholders, lenders, financial analysts, and others outside of the company. Courses in financial accounting cover the generally accepted accounting principles which must be followed when reporting the results of a corporation's past transactions on its balance sheet, income statement, statement of cash flows, and statement of changes in stockholders' equity. Managerial accounting has its focus on providing information within the company so that its management can operate the company more effectively. Managerial accounting and cost accounting also provide instructions on computing the cost of products at a manufacturing enterprise. These costs will then be used in the external financial statements. In addition to cost systems for manufacturers, courses in managerial accounting will include topics such as cost behaviour, break-even point, profit planning, operational budgeting, capital budgeting, relevant costs for decision making, activity based costing, and standard costing. 16. How do you report a write-down in inventory? A write-down in a company's inventory is recorded by reducing the amount reported as inventory. In other words, the asset account Inventory is reduced by a credit. The debit in the entry to write down inventory is reported in an Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  10. 10. www.SoftSkillsExperts.co.uk account such as Loss on Write-Down of Inventory, an income statement account. If the amount of the Loss on Write-Down of Inventory is relatively small, it can be reported as part of the cost of goods sold. If the amount of the Loss on Write-Down of Inventory is significant, it should be reported as a separate line on the income statement. Since the amount of the write-down of inventory reduces net income, it will also reduce the amount reported as owner's or stockholders' equity. Hence for the balance sheet and in the accounting equation, the asset inventory is reduced and the owner's or stockholders' equity is reduced. 17. What are prepaid expenses? Prepaid expenses are future expenses that have been paid in advance. You can think of prepaid expenses as costs that have been paid but have not yet been used up or have not yet expired. The amount of prepaid expenses that have not yet expired are reported on a company's balance sheet as an asset. As the amount expires, the asset is reduced and an expense is recorded for the amount of the reduction. Hence, the balance sheet reports the unexpired costs and the income statement reports the expired costs. The amount reported on the income statement should be the amount that pertains to the time interval shown in the statement's heading. A common prepaid expense is the six-month premium for insurance on a company's vehicles. Since the insurance company requires payment in advance, the amount paid is often recorded in the current asset account Prepaid Insurance. If the company issues monthly financial statements, its income statement will report Insurance Expense that is one-sixth of the amount paid. The balance in the account Prepaid Insurance will be reduced by the amount that was debited to Insurance Expense. 18. Why is depreciation on the income statement different from the depreciation on the balance sheet? Depreciation on the income statement is the amount of depreciation expense that is appropriate for the period of time indicated in the heading of the income statement. The depreciation reported on the balance sheet is the accumulated or the cumulative total amount of depreciation that has been reported as expense on the income statement from the time the assets were acquired until the date of the balance sheet. Let's illustrate the difference with an example. A company has only one depreciable asset that was acquired three years ago at a cost of £120,000. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  11. 11. www.SoftSkillsExperts.co.uk The asset is expected to have a useful life of 10 years and no salvage value. The company uses straight-line depreciation on its monthly financial statements. In the asset's 36th month of service, the monthly income statement will report depreciation expense of £1,000. On the balance sheet dated as of the last day of the 36th month, accumulated depreciation will be reported as £36,000. In the 37th month, the income statement will report £1,000 of depreciation expense. At the end of the 37th month, the balance sheet will report accumulated depreciation of £37,000. 19. How do I compute the units of production method of depreciation? The units of production method of depreciation is based on an asset's usage, activity, or parts produced instead of the passage of time. Under the units of production method, depreciation during a given year will be very high when many units are produced, and it will be very low when only a few units are produced. To illustrate the units of production method, let's assume that a production machine has a cost of £500,000 and its useful life is expected to end after producing 240,000 units of a component part. The salvage value at that point is expected to be £20,000. Under the units of production method, the machine's depreciable cost of £480,000 (£500,000 minus £20,000) is divided by 240,000 units, resulting in depreciation of £2 per unit. If the machine produces 10,000 parts in the first year, the depreciation for the year will be £20,000 (£2 x 10,000 units). If the machine produces 50,000 parts in the next year, its depreciation will be £100,000 (£2 x 50,000 units). The depreciation will be calculated similarly each year until the asset's Accumulated Depreciation reaches £480,000. The units of production method is also referred to as the units of activity method, since the method can be used for depreciating airplanes based on air miles, cars on miles driven, photocopiers on copies made, DVDs on number of times rented, and so on. Depreciation is an allocation technique and the units of production method might do a better job of allocating/matching an asset's cost to the proper period than the straight-line method, which is based solely on the passage of time. 20. What is the difference between stocks and bonds? Stocks, or shares of stock, represent an ownership interest in a corporation. Bonds are a form of long-term debt in which the issuing corporation promises to pay the principal amount at a specific date. Stocks pay dividends to the owners, but only if the corporation declares a Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  12. 12. www.SoftSkillsExperts.co.uk dividend. Dividends are a distribution of a corporation's profits. Bonds pay interest to the bondholders. Generally, the bond contract requires that a fixed interest payment be made every six months. Every corporation has common stock. Some corporations issue preferred stock in addition to its common stock. Many corporations do not issue bonds. The stocks and bonds issued by the largest corporations are often traded on stock and bond exchanges. Stocks and bonds of smaller corporations are often held by investors and are never traded on an exchange. 21. What is the difference between net cash flow and net income? Under the accrual method of accounting, net income is calculated as follows: revenues earned minus the expenses incurred in order to earn those revenues. If a company earns revenues in December but allows those customers to pay in 30 days, the cash from the December revenues will likely be received in January. In this situation the December revenues will increase the December net income, but will not increase the company's December net cash flow. Under accrual accounting, expenses are matched to the accounting period when the related revenues occur or when the costs have expired. For example, a retailer may have purchased and paid for merchandise in October. However, the merchandise remained in inventory until it was sold in December. The company's net cash flow decreases in October when the company pays for the merchandise. However, net income decreases in December when the cost of the goods sold is matched with the December sales. There are many other examples of expenses occurring in one accounting period but the payments occur in a different accounting period. In short, the statement of cash flows is a needed financial statement because the income statement does not report cash flows. 22. What are the effects of depreciation? The depreciation of assets such as equipment, buildings, furnishing, trucks, etc. causes a corporation's asset amounts, net income, and stockholders' equity to decrease. This occurs through an accounting adjusting entry in which the account Depreciation Expense is debited and the contra asset account Accumulated Depreciation is credited. The amount of the annual depreciation that is reported on the financial statements is an estimate based on the asset's 1) cost, 2) estimated salvage Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  13. 13. www.SoftSkillsExperts.co.uk value, and 3) useful life. Depreciation should be thought of as an allocation of the asset's cost to expense (and not as a valuation technique). In other words, the accountant is matching the cost of the asset to the periods in which revenues are generated from the asset. The amount of the annual depreciation reported on the U.S. income tax return is based on the tax regulations. Since depreciation is a deductible expense for income tax purposes, the corporation's taxable income (and associated tax payments) will be reduced by its tax depreciation expense. (In any one year, the depreciation expense for taxes will likely be different from the amount reported on the financial statements.) It should be noted that depreciation is viewed as a noncash expense. That is, the corporation's cash balance is not changed by the annual depreciation entry. (Often the corporation's cash is reduced for the asset's entire cost at the time the asset is acquired.) 23. What is interest expense? Interest expense is the cost of debt that has occurred during a specified period of time. To illustrate interest expense under the accrual method of accounting, let's assume that a company borrows £100,000 on December 15 and agrees to pay the interest on the 15th of each month beginning on January 15. The loan states that the interest is 1% per month on the loan balance. The interest expense for the month of December will be approximately £500 (£100,000 x 1% x 1/2 month). The interest expense for the month of January will be £1,000 (£100,000 x 1%). Since interest on debt is not paid daily, a company must record an adjusting entry to accrue interest expense and to report interest payable. Using our example above, at December 31 no interest was yet paid on the loan that began on December 15. However, the company did incur one-half month of interest expense. Therefore, the company needs to record an adjusting entry that debits Interest Expense £500, and credits Interest Payable for £500. 24. Where does revenue received in advance go on a balance sheet? Revenues received in advance are reported as a current liability if they will be earned within one year. The accounting entry is a debit to the asset Cash for the amount received and a credit to the liability account such as Customer Advances or Unearned Revenues. As the amount received in advance is earned, the current liability account will be debited for the amount earned and the Revenues account reported on the income statement will be credited. This is done through an adjusting entry. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  14. 14. www.SoftSkillsExperts.co.uk 25. What is the deferred revenue? Deferred revenue is not yet revenue. It is an amount that was received by a company in advance of earning it. The amount unearned (and therefore deferred) as of the date of the financial statements should be reported as a liability. The title of the liability account might be Unearned Revenues or Deferred Revenues. When the deferred revenue becomes earned, an adjusting entry is prepared that will debit the Unearned Revenues or Deferred Revenues account and will credit Sales Revenues or Service Revenues. 26. What are goods in transit? Goods in transit refers to merchandise and other inventory items that have been shipped by the seller, but have not yet been received by the purchaser. To illustrate goods in transit, let's use the following example. Company J ships a truckload of merchandise on December 30 to Customer K, which is located 2,000 miles away. The truckload of merchandise arrives at Customer K on January 2. Between December 30 and January 2, the truckload of merchandise is goods in transit. The goods in transit requires special attention if the companies issue financial statements as of December 31. The reason is that the merchandise is the inventory of one of the two companies, but the merchandise is not physically present at either company. One of the two companies must add the cost of the goods in transit to the cost of the inventory that it has in its possession. The terms of the sale will indicate which company should report the goods in transit as its inventory as of December 31. If the terms are FOB shipping point, the seller (Company J) will record a December sale and receivable, and will not include the goods in transit as its inventory. On December 31, Customer K is the owner of the goods in transit and will need to report a purchase, a payable, and must add the cost of the goods in transit to the cost of the inventory which is in its possession. If the terms of the sale are FOB destination, Company J will not have a sale and receivable until January 2. This means Company J must report the cost of the goods in transit in its inventory on December 31. (Customer K will not have a purchase, payable, or inventory of these goods until January 2.) 27. What is the accrual basis of accounting? Under the accrual basis of accounting, revenues are reported on the income statement when they are earned. (Under the cash basis of accounting, revenues are reported on the income statement when the cash is received.) Under the accrual basis of accounting, expenses are matched with the related revenues and/or are reported when the expense occurs, not when the cash is Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  15. 15. www.SoftSkillsExperts.co.uk paid. The result of accrual accounting is an income statement that better measures the profitability of a company during a specific time period. For example, if I begin an accounting service in December and provide £10,000 of accounting services in December, but don't receive any of the money from the clients until January, there will be a difference in the income statements for December and January under the accrual and cash bases of accounting. Under the accrual basis, my income statements will show £10,000 of revenues in December and none of those services will be reported as revenues in January. Under the cash basis, my December income statement will show no revenues. Instead, the December services will be reported as January revenues under the cash method. There will be a difference on the balance sheet, too. Under the accrual basis, the December balance sheet will report accounts receivable of £10,000 and the estimated true profit will be added to owner's equity or retained earnings. Under the cash basis, the £10,000 of accounts receivable will not be reported as an asset, and the true profit will not be included in owner's equity or retained earnings. To illustrate a difference in expenses, we will assume that the heat and light expense that I used in my accounting service is metered by the utility on the last day of the month. The utilities that I used in December will appear on a bill that I receive in January and will pay on February 1. Under the accrual basis of accounting, the utilities that I used in December will be estimated and will be reported as an expense and a liability on the December financial statements. Under the cash basis of accounting, the utilities used in December will be recorded as an expense on February 1, when the utility bills are paid. For financial statements prepared in accordance with generally accepted accounting principles, the accrual method is required because of the matching principle. 28. What is materiality? In accounting, the concept of materiality allows you to violate another accounting principle if the amount is so small that the reader of the financial statements will not be misled. A classic example of the materiality concept or the materiality principle is the immediate expensing of a £10 wastebasket that has a useful life of 10 years. The matching principle directs you to record the wastebasket as an asset and then depreciate its cost over its useful life of 10 years. The materiality principle allows you to expense the entire £10 in the year it is acquired instead of recording depreciation expense of £1 per year for 10 years. The reason is Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  16. 16. www.SoftSkillsExperts.co.uk that no investor, creditor, or other interested party would be misled by not depreciating the wastebasket over a 10-year period. Determining what is a material or significant amount can require professional judgment. For example, £5,000 might be immaterial for a large, profitable corporation, but it will be material or significant for a small company that has very little profit. 29. What is the conservatism principle? The conservatism principle helps an accountant decide between two alternatives. For example, if an item in inventory has a cost of £20, but it can be replaced for £15, the conservatism principle directs the account to report the item in inventory at £15 and to immediately report the loss of £5. For an asset such as inventory it means reporting the lower asset amount on the balance sheet and the lower net income amount on the income statement. From the conservatism principle comes the accountants' the lower of cost or market rule for inventory valuation. The conservatism principle does not say that accountants are to be conservative. Accountants should be fair and objective. The conservatism principle is used to "break a tie" between two reasonable options. It is not intended to motivate accountants to beat down a company's earnings and assets. 30. What are adjusting entries? Adjusting entries are usually made on the last day of an accounting period (year, quarter, and month) so that the financial statements reflect the revenues that have been earned and the expenses that were incurred during the accounting period. Sometimes an adjusting entry is needed because: Revenue has been earned, but it has not yet been recorded. An expense may have been incurred, but it hasn't yet been recorded. A company may have paid for six-months of insurance coverage, but the accounting period is only one month. (This means that five months of insurance expense is prepaid and should not be reported as an expense on the current income statement.) A customer paid a company in advance of receiving goods or services. Until the goods or services are delivered, the amount is reported as a liability. After the goods or services are delivered, an entry is needed to reduce the liability and to report the revenues. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  17. 17. www.SoftSkillsExperts.co.uk A common characteristic of an adjusting entry is that it will involve one income statement account and one balance sheet account. (The purpose of each adjusting entry is to get both the income statement and the balance sheet to be accurate.) 31. How do you amortize goodwill? Prior to 2001, the U.S. accounting rules required goodwill to be amortized to expense over a period not to exceed 40 years. However, in June 2001 the Financial Accounting Standards Board issued its Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets. This accounting pronouncement ended the automatic amortization of goodwill to expense for U.S. financial reporting. While goodwill is no longer amortized to expense in uniform increments, goodwill is to be measured annually to determine if there is an impairment loss. 32. Why isn't the direct write off method of uncollectible accounts receivable the preferred method? Under the direct write off method, a company does not anticipate bad debt expense. Rather, it waits until an account is actually written off as uncollectible before recording bad debt expense. This means its accounts receivable will be reported on the balance sheet at their full amounts— implying that all of the accounts receivable will be turning to cash. If there is some doubt concerning the collectability of some of the receivables, the assets are potentially overstated and the company's profit is potentially overstated. Since there is usually a significant amount of time between a credit sale and the write off of a bad account, the bad debt expense will occur in a much later period than the revenue from the sale. This is a problem under the matching principle. The accounting profession prefers the allowance method over the direct write off method because the accounts receivable will be presented on the balance sheet with a reduction called the allowance for doubtful accounts. This means the net amount of the accounts receivable will be lower and closer to the amount that will actually be collected. Bad debt expense is reported at the time that the allowance for doubtful accounts is created and adjusted. Hence, the bad debt expense is reported closer to the time of the credit sale. It should be noted that the Internal Revenue Service requires the direct write off method. They prefer to see the tax deduction for bad debt expense only when an account receivable is actually written off—as opposed to allowing a deduction for an anticipated potential loss. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  18. 18. www.SoftSkillsExperts.co.uk 33. What is the difference between the Cash Flow and Funds Flow statements? The cash flow statement, known formally as the Statement of Cash Flows, reports a company's change in cash and cash equivalents from one balance sheet date to another. The cash flow statement classifies the amount of the change according to operating, investing, and financing activities. The cash flow statement has been required by the Financial Accounting Standards Board since 1988, when it issued its Statement No. 95. Prior to 1988, accountants prepared a funds flow statement. Generally, the funds flow statement reported on the change in working capital from one balance sheet date to another. 34. Where are accruals reflected on the balance sheet? Accrued expenses are reported in the current liabilities section of the balance sheet. Accrued expenses reported as current liabilities are the expenses that a company has incurred as of the balance sheet date, but have not yet been recorded or paid. Typical accrued expenses include wages, interest, utilities, repairs, bonuses, and taxes. Accrued revenues are reported in the current assets section of the balance sheet. The accrued revenues reported on the balance sheet are the amounts earned by the company as of the balance sheet date that have not yet been recorded and the customers have not yet paid the company. Accrued expenses and accrued revenues are also reflected in the income statement and in the statement of cash flows prepared under the indirect method. However, these financial statements reflect a time period instead of a point in time. 35. What is accrued income? Accrued income is an amount that has been 1) earned, 2) there is a right to receive the amount, and 3) it has not yet been recorded in the general ledger accounts. One example of accrued income is the interest earned on a bond investment. To illustrate, let's assume that a company invested £100,000 on December 1 in a 6% £100,000 bond that pays £3,000 of interest on each June 1 and December 1. On December 31, the company will have earned one month's interest amounting to £500 (£100,000 x 6% per year x 1/12 of a year, or 1/6 of the semi-annual £3,000). No interest will be received in December since it will be part of the £3,000 to be received on June 1. The £500 of interest earned during December, but not yet received or recorded as of December 31 is known as accrued income. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  19. 19. www.SoftSkillsExperts.co.uk Under the accrual basis of accounting, accrued income is recorded with an adjusting entry prior to issuing the financial statements. In our example, there will need to be an adjusting entry dated December 31 that debits Interest Receivable (a balance sheet account) for £500, and credits Interest Income (an income statement account) for £500. 36. When should costs be expensed and when should costs be capitalized? Costs should be expensed when they are used up or have expired and when they have no future economic value which can be measured. For example, the August salaries of a company's marketing team should be charged to expense in August since the future economic value of their August salaries cannot be determined. Costs should be capitalized or recorded as assets when the costs have not expired and they have future economic value. For example, on November 25 a company pays £12,000 for property insurance covering the six months of December through May. The £12,000 is initially recorded as the current asset Prepaid Insurance. On November 30 the company will report this asset at £12,000 since the £12,000 has a future economic value. (It will save making future payments of cash for insurance coverage.) On December 31 the asset will be reported as £10,000---the unexpired cost. It will also report Insurance Expense for the month of December as £2,000---the cost that has expired during December. On January 31 the asset will be reported at the unexpired cost of £8,000. January's insurance expense will be £2,000---the amount that has expired during January. 37. What does the cost principle mean for a company's income statement? If a company has buildings, equipment and inventory, the cost principle will mean that the amount of depreciation expense and the cost of goods sold expense will be based on the costs when the assets were acquired. If these assets have increased in value, the depreciation and cost of goods sold reported on the income statement will be less than the value of the economic capacity being used up. As a result, the reported net income will be greater than the economic reality. To illustrate this point let's assume that the cost of a bank building was £10 million and was fully depreciated during its first 30 years of use. The cost principle requires the depreciation expense on the bank's income statement for year 31 (and each year thereafter) to be £0 even if the bank building's market value has doubled. Similarly, a manufacturer using equipment that is fully depreciated will have lower manufacturing overhead and lower cost of goods sold because the current year's depreciation for the equipment is £0. Generally, the cost principle requires that only the verifiable, historical costs recorded at the time of transactions will appear as expenses on the income Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  20. 20. www.SoftSkillsExperts.co.uk statement. Unfortunately those recorded costs may not measure the economic reality that is occurring in the period of the income statement. 38. What is an impairment? The term impairment is usually associated with a long-lived asset that has a market which has decreased significantly. For example, a meat packing plant may have recently spent large amounts for capital expenditures and then experienced a dramatic drop in the plant's value due to business and community conditions. If the undiscounted future cash flows from the asset (including the sale amount) are less than the asset's carrying amount, an impairment loss must be reported. If the impairment loss must be reported, the amount of the impairment loss is measured by subtracting the asset's fair value from its carrying value. 39. What is historical cost? Historical cost is a term used instead of the term cost. Cost and historical cost usually mean the original cost at the time of a transaction. The term historical cost helps to distinguish an asset's original cost from its replacement cost, current cost, or inflation-adjusted cost. For example, land purchased in 1992 at cost of £80,000 and still owned by the buyer will be reported on the buyer's balance sheet at its cost or historical cost of £80,000 even though it’s current cost, replacement cost, and inflation-adjusted cost is much higher today. The cost principle or historical cost principle states that an asset should be reported at its cost (cash or cash equivalent amount) at the time of the exchange transaction and should include all costs necessary to get the asset in place and ready for use. 40. What are the accounting principles, assumptions, and concepts? The basic or fundamental principles in accounting are the cost principle, full disclosure principle, matching principle, revenue recognition principle, economic entity assumption, monetary unit assumption, time period assumption, going concern assumption, materiality, and conservatism. The last two are sometimes referred to as constraints. Rather than distinguishing between a principle or an assumption, I prefer to simply say that these ten items are the basic principles or the underlying guidelines of accounting. (My reason is that accounting principles also include the statements of financial accounting standards and the interpretations issued by the Financial Accounting Standards Board and its predecessors, as well as industry practices.) There are also "qualities" of accounting information such as reliability, relevance, consistency, comparability, and cost/benefit. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  21. 21. www.SoftSkillsExperts.co.uk 41. What is cost incurred? Cost incurred is a cost that a company has become liable for. To illustrate, let's assume that a new retailer opens on September 1 and its electric meter will be read by the utility on the last day of every month. During September the retailer has incurred the cost of the electricity it used during September. Under accrual accounting the retailer needs to report a liability on September 30 for the amount owed to the utility at that point. On its income statement for September, the retailer needs to report electricity expense equal to the cost of the electricity used during September. (The fact that the utility will not bill the retailer until October and will allow the retailer until November to make payment is not pertinent under accrual accounting.) The matching principle requires that the costs incurred in September be matched with the revenues in September. 42. Is sales tax an expense or a liability? If a company sells £100,000 of product that is subject to a state sales tax of 7%, the company will collect £107,000. It will record sales of merchandise of £100,000 and will record a liability for sales tax of £7,000. In this situation the company is acting as a collection agent for the state by charging the £7,000 in sales tax. The company will have to remit the £7,000 to the state shortly after collecting the money. When the company remits the £7,000 to the state, the company will reduce its cash and its sales tax liability. In this situation the sales tax is not an expense and it is not part of the company's sales revenues. If a company purchases a new delivery van for £30,000 plus £2,100 of sales tax, the company will record the truck as an asset at its total cost of £32,100. In this situation, the sales tax of £2,100 is considered to be a necessary cost of the truck and will be part of the depreciation expense recorded during the useful life of the truck. 43. What is depreciation? Depreciation is the assigning or allocating of a plant asset's cost to expense over the accounting periods that the asset is likely to be used. For example, if a business purchases a delivery truck with a cost of £100,000 and it is expected to be used for 5 years, the business might have depreciation expense of £20,000 in each of the five years. (The amounts can vary depending on the method and assumptions.) In our example, each year there will be an adjusting entry with a debit to Depreciation Expense for £20,000 and a credit to Accumulated Depreciation for £20,000. Since the adjusting entries do not involve cash, depreciation expense is referred to as a noncash expense. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  22. 22. www.SoftSkillsExperts.co.uk 44. What are the ways to value inventory? Generally, the balance sheet of a U.S. company must value inventory at cost. In other words, a company's inventory is not reported at the sales value. (An exception occurs when a company's inventory consists of readily sellable commodities that have quoted market prices.) Since the costs of products may change during an accounting year, a company must select a cost flow assumption that it will use consistently. For instance, should the oldest cost be removed from inventory when an item is sold? If so, the company will select the cost flow assumption known as first-in, first out (FIFO). In the U.S. an alternative is to remove the period's most recent cost when an item is sold. This is known as last-in, first-out (LIFO). Another option is to use an average method such as the weighted-average method or the moving-average method. Both the LIFO method and the average methods will result in different values depending on whether a company uses the perpetual method or the periodic method. Still another option is to use the specific identification method. The LIFO cost flow assumption can be achieved by tracking the units in inventory or by using price indexes. When price indexes are used, it is referred to as dollar-value LIFO. (Retailers often use a technique called dollarvalue retail LIFO.) The accountants' concept of conservatism can result in some inventories being valued at less than cost. Hence, an additional method for valuing inventory is the lower of cost or market. For example, if the replacement cost of a company's inventory has declined to an amount that is less than cost, the company may be required to reduce its inventory cost. The amount of that adjustment will also reduce the current period's net income. A company's inventory must be measured and reviewed very carefully as it is an important amount for determining a company's financial position and profitability. 45. How does an expense affect the balance sheet? An expense will decrease the amount of assets or increase the amount of liabilities, and will reduce the amount of owner's or stockholders' equity. For example an expense might 1) reduce a company's assets such as Cash, Prepaid Expenses, or Inventory, 2) increase the credit balance in a contraasset account such as Allowance for Doubtful Accounts or Accumulated Depreciation, 3) increase the balance in the liability account Accounts Payable, or increase the amount of accrued expenses payable such as Wages Payable, Interest Payable, and so on. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  23. 23. www.SoftSkillsExperts.co.uk In addition to the change in the assets or liabilities, an expense will reduce the credit balance in the Owner Capital account of a sole proprietorship, or will reduce the credit balance in the Retained Earnings account of a corporation. 46. What is accrued payroll? Accrued payroll would be wages, salaries, commissions, bonuses, and the related payroll taxes and benefits that have been earned by a company's employees, but have not yet been paid or recorded in the company's accounts. For example, the accrued payroll as of December 31 would include all of the wages that the hourly-paid employees have earned as of December 31, but will not be paid until the following pay day (perhaps January 5). The employer's portion of the FICA, unemployment taxes, worker compensation insurance, and other benefits pertaining to those wages should also be included as accrued payroll in order to achieve the matching principle of accounting. 47. What is the difference between cost and expense? A cost might be an expense or it might be an asset. An expense is a cost that has expired or was necessary in order to earn revenues. We hope the following three examples will illustrate the difference between a cost and an expense. A company has a cost of £6,000 for property insurance covering the next six months. Initially the cost of £6,000 is reported as the current asset Prepaid Insurance. However, in each of the following six months, the company will report Insurance Expense of £1,000—the amount that is expiring each month. The unexpired portion of the cost will continue to be reported as the asset Prepaid Insurance. The cost of equipment used in manufacturing is initially reported as the long lived asset Equipment. However, in each accounting period the company will report part of the asset's cost as Depreciation Expense. A retailer's purchase of merchandise is initially reported as the current asset Inventory. When the merchandise is sold, the cost of the merchandise sold is removed from Inventory and is reported on the income statement as the expense entitled Cost of Goods Sold. The matching principle guides accountants as to when a cost will be reported as an expense. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  24. 24. www.SoftSkillsExperts.co.uk 48. How do you record a payment for insurance? Since insurance premiums are usually paid prior to the period covered by the payment, it is common to debit Prepaid Insurance and to credit Cash for the amount paid. (Prepaid Insurance is a current asset and is reported on the balance sheet after inventory.) As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance Expense. This is done with an adjusting entry at the end of each accounting period (e.g. monthly). One objective of the adjusting entry is to match the proper amount of insurance expense to the period indicated on the income statement. (The income statement should report the amount of insurance that has expired during the period indicated in the income statement's heading.) Another objective is to report on the balance sheet the unexpired amount of insurance as the asset Prepaid Insurance. If you can arrange for your insurance payments to be the amount applicable to each accounting period, you can simply debit Insurance Expense and credit Cash. For example, if the insurance premiums for one year amount to £12,000 and you can pay the insurance company £1,000 per month, then each monthly payment will be recorded with a debit to Insurance Expense and a credit to Cash. In this case £1,000 per month will be matched on the income statement and there will be no prepaid amount to be reported on the balance sheet. 49. Where is a contingent liability recorded? A contingent liability that is both probable and the amount can be estimated is recorded as 1) an expense or loss on the income statement, and 2) a liability on the balance sheet. As a result, a contingent liability is also referred to as a loss contingency. Warranties are cited as a contingent liability that meets both of the required conditions (probable and the amount can be estimated). Warranties will be recorded at the time of a product's sale with a debit to Warranty Expense and a credit to Warranty Liability. A loss contingency which is possible but not probable, or the amount cannot be estimated, will not be recorded in the accounts. Rather, it will be disclosed in the notes to the financial statements. A loss contingency that is remote will not be recorded and will not have to be disclosed in the notes to the financial statements. 50. Why isn't land depreciated? Land is not depreciated because land is assumed to have an unlimited useful life. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  25. 25. www.SoftSkillsExperts.co.uk Other long-lived assets such as land improvements, buildings, furnishings, equipment, etc. have limited useful lives. Therefore, the costs of those assets must be allocated to those limited accounting periods. Since land's life is not limited, there is no need to allocate the cost of land to any accounting periods. 51. What are inventorial costs? Inventorial costs are 1) the costs to purchase or manufacture products which will be resold, plus 2) the costs to get those products in place and ready for sale. Inventorial costs are also known as product costs. To illustrate, let's assume that a retailer purchases an item for resale by paying £20 to the supplier. The item is purchased FOB shipping point, which means that the retailer must pay the freight from the supplier to its location. If that freight cost is £1, then the retailer's inventorial cost is £21. Assuming this is the only item in the retailer's inventory, the retailer's balance sheet will report inventory at a cost of £21. When the item is sold, the retailer's inventory will decrease by £21 and the £21 will be reported on the income statement as the cost of goods sold. In the case of a manufacturer, a product's inventorial costs are the costs of the direct materials, direct labour and manufacturing overhead incurred in manufacturing the product. 52. What is the full disclosure principle? For a business, the full disclosure principle requires a company to provide the necessary information so that people who are accustomed to reading financial information can make informed decisions concerning the company. The required disclosures can be found in a number of places including the following: - the company's financial statements including any supplementary schedules and notes (or footnotes). - Management's Discussion and Analysis that is included in a publicly-traded corporation's annual report to the U.S. Securities and Exchange Commission. - Quarterly earnings reports, press releases and other communications. The first note or footnote in a company's financial statements will disclose the significant accounting policies such as how and when revenues are recognized, how property is depreciated, how inventory and income taxes are accounted for, and more. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  26. 26. www.SoftSkillsExperts.co.uk Other disclosures in the notes to the financial statements include the effects of foreign currencies, contingent liabilities, leases, related-party transactions, stock options, and much more. Judgement is used in deciding the amount of information that is disclosed. For example, in 1980 large U.S. corporations were required to report as supplementary information the effects of inflation and changing prices on its inventory and property (and cost of goods sold and depreciation expense). After several years, the disclosure became optional since the cost of providing the information exceeded the benefits. 53. What is the cost principle? The cost principle is one of the basic underlying guidelines in accounting. It is also known as the historical cost principle. The cost principle requires that assets be recorded at the cash amount (or its equivalent) at the time that an asset is acquired. For example, if equipment is acquired for the cash amount of £50,000, the equipment will be recorded at £50,000. If the equipment will be useful for 10 years with no salvage value, the straight-line depreciation expense will be £5,000 per year (cost of £50,000 divided by 10 years). The equipment's market value, replacement cost or inflation-adjusted cost will not affect the annual depreciation expense of £5,000. The company's balance sheets will report the equipment's historical cost minus the accumulated depreciation. The cost principle also means that valuable brand names and logos that were developed through effective advertising will not be reported as assets on the balance sheet. This could result in a company's most valuable assets not being included in the company's asset amounts. (On the other hand, a brand name that is acquired through a transaction with another company will be reported on the balance sheet at its cost.) If a company has an asset that has a ready market with quoted prices, the historical cost may be replaced with the current market value on each balance sheet. An example is an investment consisting of shares of common stock that are actively traded on a major stock exchange. 54. What is the cost of goods sold? The cost of goods sold is the cost of the merchandise that a retailer, distributor, or manufacturer has sold. The cost of goods sold is reported on the income statement and can be considered as an expense of the accounting period. By matching the cost of the goods sold with the revenues from the goods sold, the matching principle of accounting is achieved. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  27. 27. www.SoftSkillsExperts.co.uk The sales revenues minus the cost of goods sold is gross profit. Cost of goods sold is calculated in one of two ways. One way is to adjust the cost of the goods purchased or manufactured by the change in inventory of finished goods. For example, if 1,000 units were purchased or manufactured but inventory increased by 100 units then the cost of 900 units will be the cost of goods sold. If 1,000 units were purchased but the inventory decreased by 100 units then the cost of 1,100 units will be the cost of goods sold. The second way to calculate the cost of goods sold is to use the following costs: beginning inventory + the cost of goods purchased or manufactured = cost of goods available - ending inventory. When costs change during the accounting period, a cost flow will have to be assumed. Cost flow assumptions include FIFO, LIFO, and average. 55. Why are loan costs amortized? When loan costs are significant, they must be amortized because of the matching principle. In other words, all of the costs of a loan must be matched to the accounting periods when the loan is outstanding. To clarify this, let's assume that a company incurs legal, accounting, and registration fees of £120,000 during February in order to obtain a £4 million loan at an annual interest rate of 9%. The loan will begin on March 1 and the entire £4 million of principal will be due five years later. The company's cost of the borrowed money will be £360,000 (£4 million X 9%) of interest each year for five years plus the one-time loan costs of £120,000. It would be misleading to report the entire £120,000 of loan costs as an expense of one month. Hence, the matching principle requires that each month during the life of the loan the company should report £2,000 (£120,000 divided by 60 months) of expense for the loan costs in addition to the interest expense of £30,000 per month (£4 million X 9% per year = £360,000 per year divided by 12 months per year). The combination of the amortization of the loan cost plus the interest expense will mean a total monthly expense of £32,000 for 60 months beginning on March 1. 56. What are accrued revenues and when are they recorded? Accrued revenues are fees and interest that have been earned and sales that occurred, but they have not yet been recorded through the normal invoicing paperwork. Since these are not yet in the accountant's general ledger, they will not appear on the financial statements unless an adjusting entry is entered prior to preparing the financial statements. Here's an example. Your company lent a supplier £100,000 on December 1. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  28. 28. www.SoftSkillsExperts.co.uk The agreement is for the £100,000 to be repaid on February 28 along with £3,000 of interest for the three months of December through February. As of December 31 your company will not have a transaction/invoice/receipt for the interest it is earning since all of the interest is due on February 28. Without an adjusting entry to accrue the revenue it earned in December, your company's financial statements as of December 31 will not be reporting the £1,000 (onethird of the £3,000 of interest) that it has earned in December. In order for the financial statements to be correct on the accrual basis of accounting, the accountant needs to record an adjusting entry dated as of December 31. The adjusting entry will consist of a debit of £1,000 to Interest Receivable (a balance sheet account) and a credit of £1,000 to Interest Income or Interest Revenue (income statement accounts). 57. What is a customer deposit? A customer deposit could be an amount paid by a customer to a company prior to the company providing it with goods or services. In other words, the company receives the money prior to earning it. The company receiving the money has an obligation to provide the goods or services to the customer or to return the money. For example, Ace Manufacturing Co. might agree to produce an expensive, custom-made machine for one of its customers. Ace requires that the customer pay £50,000 before Ace begins to design and construct the machine. The £50,000 payment is made in December 2012 and the machine must be finished by June 30, 2013. The £50,000 is a down payment toward the machine's price of £400,000. In December 2012, Ace will debit Cash for £50,000 and will credit Customer Deposits, a current liability account. (The customer will record the £50,000 payment with a debit to a long-term asset account such as Construction Work in Progress or Down payment on New Equipment, and will credit Cash.) 58. What is a contingent asset? A contingent asset is a potential asset associated with a contingent gain. Unlike contingent liabilities and contingent losses, contingent assets and contingent gains are not recorded in accounts, even when they are probable and the amount can be estimated. An example of a contingent gain and contingent asset might be a lawsuit filed by Company A against Company B for infringement of Company A's patent. If it is probable that Company A will win the lawsuit and receive an estimated amount of money, it has a contingent asset and a contingent gain. However, it will not report the asset and gain until the lawsuit is settled. (At most Company A will prepare a very carefully worded disclosure stating that it possibly could Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  29. 29. www.SoftSkillsExperts.co.uk win the case.) On the other hand, Company B will need to make an entry in its accounts if the loss contingency is probable and the amount can be estimated. If one of those are missing, Company B will have to disclose the loss contingency in the notes to its financial statements. 59. How do you account for bond issue costs? The costs associated with issuing bonds should be recorded as a deferred charge in the long term asset section of the balance sheet under the heading of Other Assets. The account title could be Bond Issue Costs. Over the life of the bonds you will need to systematically move the bond issue cost from the balance sheet to the income statement. Accountants refer to this as amortizing the costs. Let's illustrate the amortization of bond issue costs by assuming the total of the bond issue costs were £24,000 and the bonds will mature in 10 years. Each month you would debit Bond Issue Cost Expense for £200 (£24,000 divided by 120 months) and would credit Bond Issue Cost for £200. The concept is to match the £24,000 cost to the accounting periods that are benefiting from the bonds having been issued. Our discussion pertains to financial statement reporting and we are not familiar with income tax reporting. You should discuss the income tax treatment with your tax adviser. 60. What should be the entry when goods are purchased at a discount? If you purchase £1000 of goods having a trade discount of 20%, you can debit Purchases (periodic system) or Inventory (perpetual system) for £800 and Accounts Payable for £800. This is consistent with the cost principle which means the cash or cash equivalent amount. If the invoice allows a 1% discount for paying within 10 days, you can record the 1% discount when you make payment within the allotted time. The entry for paying within 10 days would be: debit Accounts Payable £800, credit Cash for £792, and credit Purchase Discounts £8 (or Inventory £8 if perpetual). If you are certain to always pay vendor invoices within their discount periods, you could initially record the above invoice at £792 (instead of £800). Debit Purchases or Inventory for £792 and credit Accounts Payable £792. When paying the invoice within the discount period, the entry would be a debit to Accounts Payable for £792 and a credit to Cash for £792. If you fail to pay the invoice within the discount period, the payment will have to be £800 and will be recorded with a debit to Accounts Payable £792, a debit to Purchase Discounts Lost £8, and a credit to Cash for £800. Purchase Discounts Lost is an income statement account. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  30. 30. www.SoftSkillsExperts.co.uk 61. How should the sale of gift certificates be recorded in the general ledger? The sale of a gift certificate should be recorded with a debit to the asset account Cash and a credit to the liability account Gift Certificates Outstanding. (Revenue is not recorded until merchandise or services are provided to the customer.) When a customer presents the gift certificate for merchandise or for services, the liability account Gift Certificates Outstanding will be reduced with a debit and a revenue account will be credited. If the revenue is a sale of merchandise, the income statement will match the cost of goods sold and other expenses with the revenue. 62. Where does accrued interest on notes receivable get reported on the balance sheet? Accrued interest on notes receivable is likely to be reported as a current asset such as Accrued Interest Receivable or Interest Receivable. The accrued interest receivable is a current asset if the interest amount is expected to be collected within one year of the balance sheet date. I would expect that even a long-term note receivable that is due in five years will require that the interest on the note be paid quarterly, semi-annually or annually. Hence the accrued interest will be a current asset. If the interest on the note is not expected to be received within one year of the balance sheet date, then the accrued interest receivable should be reported as a long-term asset. 63. Why would a company use double-declining depreciation on its financial statements? Most companies will not use the double-declining balance method of depreciation on their financial statements. The reason is that it causes the company's net income in the early years of an asset's life to be lower than it would be under the straight-line method. One reason for using double-declining balance depreciation on the financial statements is to have a consistent combination of depreciation expense and repairs and maintenance expense during the life of the asset. In other words, in the early years of the asset's life, when the repairs and maintenance expenses are low, the depreciation expense will be high. In the later years of the asset's life, when the repairs and maintenance expenses are high, the depreciation expense will be low. While this seems logical, the company will end up reporting lower net income in the early years of the asset's life (as compared to the use of straight-line depreciation). Most managers will not accept reporting lower net income sooner than required. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  31. 31. www.SoftSkillsExperts.co.uk 64. What is inventory valuation? Inventory valuation is the dollar amount associated with the items contained in a company's inventory. Initially the amount is the cost of those items. However, under certain situations the cost could be replaced with a lower dollar amount. The inventory valuation includes all of the costs to get the inventory items in place and ready for sale. The inventory valuation excludes the costs of selling and administration. Since the inventory items are constantly being sold and restocked and since the costs of the items are constantly changing, a company must select a cost flow assumption. Cost flow assumptions include first-in, first-out; weighted average; and last-in, first out. The company must consistently follow its stated cost flow assumption. A manufacturer's inventory valuation will include the costs of production, namely direct materials, direct labour, and manufacturing overhead. Manufacturers are also required to consistently follow their cost flow assumptions. Inventory valuation is important in that it affects the cost of goods sold reported on the company's income statement. Inventory is also an important component of a company's current assets, working capital, and current ratio. 65. Where in the chart of accounts is a suspense account located? A suspense account could be located in any part of an organization's chart of accounts. In other words, a suspense account could be located in any of these sections: asset, liability, revenue, expense. Let's illustrate why any or all four of these sections of the chart of accounts might contain a suspense account. Assume that a company receives cash of £500 but is not able to determine the reason for the receipt. Because of double-entry accounting or bookkeeping, the company's asset account Cash is debited for £500 and there needs to be at least one other account credited and the total of the credits must be £500. Without knowing exactly the nature of the £500 receipt, the best location of a suspense account could be any of the following: 1. The unknown credit might involve an asset account if the cash was from the sale of another asset or the collection of an asset. In this example, the best suspense account location would be in the asset section. 2. The unknown credit could involve a liability account if the cash was a deposit for future work to be done. Given these facts, the best suspense account location is the liability section. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  32. 32. www.SoftSkillsExperts.co.uk 3. The unknown credit might involve a revenue account if the cash was received for work that was recently earned, but not yet billed. In this situation the best suspense account location would be the revenue section. 4. The unknown credit might involve an expense account if the cash was received as a refund of an earlier expense. In this case the best suspense account location is the expense section of the chart of accounts. Unfortunately the best location is not known at the time of the receipt, and it is hard to say where you will find the suspense account in your own general ledger. Be aware that if the unknown account is a revenue or expense account and the amount is reported in a suspense account in your current liability section of the balance sheet, your company's net income is incorrect and all of the financial statements are incorrect. If the amount is insignificant, the problem is very small. If the amount is significant, you should find out the proper account before issuing the financial statements. 66. What are cost flow assumptions? The phrase cost flow assumptions often refers to the methods available for moving the costs of a company's products from its inventory to its cost of goods sold. In the U.S. the cost flow assumptions include FIFO, LIFO, and average. (If specific identification is used, there is no need to make an assumption.) FIFO, LIFO, and average are cost flow assumptions because the costs flowing out of inventory do not have to match the specific physical units being shipped. Let's illustrate this important point with a company that has four units of the same product in its inventory. The units were purchased at increasing costs and in the following sequence: £40, £41, £43, and £44. If the company ships the oldest unit (the unit with a cost of £40), it will expense via the cost of goods sold: £40 under FIFO, £44 under LIFO, or £42 under the average method. If the company ships the most recently purchased unit (the physical unit having a cost of £44), the inventory will be reduced and the cost of goods sold will be increased by: £40 under FIFO, £44 under LIFO, or the average of £42. In other words, the cost used to reduce the inventory and to increase the cost of goods sold was based on an assumed cost flow without regard to which physical unit was actually shipped. Other than a one-time change to a better cost flow assumption, the company must consistently use the same cost flow assumption. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  33. 33. www.SoftSkillsExperts.co.uk 67. Are bonds payable reported as a current liability if they mature in six months? Bonds payable that mature (or come due) within one year of the balance sheet date will be reported as a current liability if the issuer of the bonds must use a current asset or will create a current liability in order to pay the bondholders when the bonds mature. However, the bonds could be reported as a long-term liability right up to the maturity date if: 1. The company has a sufficient, long-term investment that is restricted for the purpose of paying the bondholders when the bonds mature. This type of investment is known as a bond sinking fund. 2. The company has a binding agreement that guarantees that the existing bonds will be refinanced by issuing new bonds or by issuing shares of stock. 68. What is the consistency principle? The consistency principle requires accountants to be consistent from one accounting period to another in applying accounting principles, methods, practices, and procedures. In other words, the readers of a company's financial statements can presume that the same rules and measurements were followed in all of the years being reported. If a change is made to a more preferred accounting method, the effects of the change must be clearly disclosed. The Financial Accounting Standards Board refers to consistency as one of the characteristics or qualities that makes accounting information useful. 69. What is meant by the term relevance in accounting? In accounting, the term relevance means it will make a difference to a decision maker. For example, in the decision to replace equipment that has been used for the past six years, the original cost of the equipment does not have relevance. In other words, the original cost is irrelevant or is not relevant in the decision to replace the equipment. What will have relevance are the future amounts, such as the cost of the new equipment, and the savings that will occur when the old equipment is replaced. Here's another expression of relevance: Costs that will differ among alternatives. Costs that will not differ among alternatives do not have relevance. In order to have relevance, accounting information must be timely. Financial Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  34. 34. www.SoftSkillsExperts.co.uk statements issued three weeks after the accounting period ends will have more relevance than financial statements issued several months after the period ends. Having timeliness and relevance may mean sacrificing some precision or reliability. 70. What are the limitations of the balance sheet? One limitation of the balance sheet is that only the assets acquired in transactions can be included. Therefore, some of a company's most valuable assets will not be reported on the balance sheet. For example, assume that a company developed an internet business that now attracts millions of visitors each day and has £10 million in annual revenues. Since the internet business was not purchased from another company and its cost to develop was not significant, the company's balance sheet will include the business's cash, receivables and some related payables. However, the company's balance sheet will not be reporting the internet business at anywhere near the £30 million that the company was offered for the internet business. Similarly, the immensely talented designers and content writers employed by an internet business cannot be reported as assets on the company's balance sheet since they were not acquired (and accountants are not able to compute a precise amount for these human resources). This is also the case for a company's reputation, its brand names that were developed through years of effective marketing, its customers' future demand for its unique services, etc. Another limitation of the balance sheet pertains to a company's long-term (or noncurrent) assets which have increased in value since the time they were purchased in a transaction. For instance, a company's land will be reported at an amount no greater than its cost (due to the accountant's cost principle). Its buildings will be reported at their cost minus their accumulated depreciation (due to the cost principle and the matching principle). Hence, the amounts reported on the balance sheet for a company's land and buildings could be much lower than their market value. 71. Is advertising an asset or an expense? Accountants record advertising expenditures as expenses when the ads are run. (A prepayment of a future ad would be recorded as an asset until the ad is run.) The reason advertising is recorded as an expense and not an asset is the problem of measuring the future value of an ad. What amount would the accountant use for recording the advertising expenditure as an asset? (You may recall a very entertaining and memorable ad by an automobile manufacturer during a Super Bowl. Viewers ranked it as one of the best. However, a later analysis showed that the ad did not result in additional sales for the car company.) Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  35. 35. www.SoftSkillsExperts.co.uk Advertising may be valuable, even crucial for some businesses and will lead to additional assets, but accountants and others are unable to quantify the future economic value necessary for reporting it as an asset. As a result, advertising expenditures will be reported as expenses in the accounting period in which the ads are run. 72. What is carriage inwards? Carriage inwards refers to the transportation costs associated with the purchase of merchandise or other assets. The buyer is responsible for the cost of carriage inwards when it buys items and the prices are stated as being FOB shipping point. Carriage inwards is also known as freight-in or transportation-in. When goods or merchandise are purchased FOB shipping point and the periodic inventory method is used, the buyer will likely record the cost of the carriage inwards in the general ledger account Carriage Inwards (or Freight-in or Transportation-in). The carriage inwards costs are considered to be part of the cost of items purchased. In other words, part of the costs of carriage inwards should be assigned to the units in inventory and some should be assigned to the units that have been sold. In the case of assets other than inventory items that are purchased FOB shipping point, the buyer should add the carriage inwards cost to the asset's cost. This is necessary because accountants define an asset's cost as all of the costs that are necessary to get an asset in place and ready for use. 73. What is principles of accounting? Three meanings come to mind when you ask about principles of accounting... 1. Principles of Accounting was often the title of the introductory course in accounting. It was also common for the textbook used in the course to be entitled Principles of Accounting. 2. Principles of accounting can also refer to the basic or fundamental accounting principles: cost, matching, full disclosure, materiality, going concern, economic entity, and so on. In this context, principles of accounting refers to the broad underlying concepts which guide accountants when preparing financial statements. 3. Principles of accounting can also mean generally accepted accounting principles (GAAP). When used in this context, principles of accounting will include both the underlying basic accounting principles and the official accounting pronouncements issued by the Financial Accounting Standards Board (FASB) and its predecessor organizations. The official pronouncements are detailed rules or standards for specific topics. Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts
  36. 36. www.SoftSkillsExperts.co.uk 74. How do you record money from an insurance claim involving property? I would use a separate general ledger account such as Loss from Property Damage to record all costs incurred to get the property back to its previous condition. The costs incurred will be debited to Loss from Property Damage. The amount received from your insurance claim would be credited to the same account. Other money received, such as the salvaging of materials, would also be credited to Loss from Property Damage. If the account Loss from Property Damage ends up with a debit balance, that will be the amount of the loss. If the account has a credit balance, there is actually a gain on the property damage. 75. What does a balance sheet tell us? A balance sheet reports the dollar amounts of a company's assets, liabilities, and owner’s equity (or stockholders' equity) as of a previous date. Assets include cash, accounts receivable, inventory, investments, land, buildings, equipment, some intangible assets, and others. Generally assets are reported at their cost or a lower amount due to depreciation, the cost principle, and conservatism. The cost principle also means that some very valuable aspects of the company are not listed as assets. For example, a company's outstanding reputation, its effective management team, and its amazing brand recognition are not reported as assets if they were not acquired in a transaction involving another party or entity. Liabilities are obligations of a company as of the balance sheet date. These include loans payable, accounts payable, warranty obligations, taxes payable, and more. The stockholders' equity or owner's equity report the amount of the assets that came from the owners and not from its creditors. The balance sheet allows you to easily determine the amount of a company's working capital and whether the company is highly leveraged. With every balance sheet distributed by a company there should be notes or footnotes. These notes provide important additional information about the company's financial position including potential liabilities not yet appearing as amounts on the balance sheet. 76. What is periodicity in accounting? In accounting, periodicity means that accountants will assume that a company's complex and ongoing activities can be divided up and reported in annual, quarterly and monthly financial statements. For example, some earthmoving equipment may require two years to manufacture but the activities will Follow him on Twitter: Join Facebook Fan’s page: Visit the website: Please Like this Page: Please Like this Page: www.twitter.com/srahatkazmi or www.facebook.com/TrainingConsultant www.softskillsexperts.com www.facebook.com/LondonBookkeeping www.facebook.com/SoftSkillsExperts

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