Show total amounts owed by customers or owed to suppliers.
3.4 Error‑correction procedures
Error type
Typical cause
Correction method
Transposition
Digits reversed (e.g., 540 written as 450)
Check column totals; adjust the affected accounts.
Omission
Transaction not recorded
Enter the missing transaction; if the amount is unknown, use a suspense account.
Commission
Debit recorded as credit or vice‑versa
Reverse the entry (swap debit and credit).
Unit 4 – Accounting Procedures
4.1 Capital vs. Revenue Expenditure
Capital expenditure: creates or enhances an asset (e.g., purchase of machinery, building extensions). Recorded as an asset and depreciated over its useful life.
Revenue expenditure: incurred to generate revenue in the current period (e.g., repairs, wages, utilities). Recorded immediately as an expense.
4.2 Depreciation
Allocates the cost of a non‑current asset over its useful life.
Method
Formula
When used
Straight‑line
(Cost – Residual value) ÷ Useful life
Most common for plant & equipment.
Reducing balance
Opening NBV × Depreciation rate
When the asset loses value faster in early years.
4.3 Accruals and Pre‑payments (Adjusting Entries)
Accrued expense – expense incurred but not yet paid (e.g., salaries payable). Journal entry: Debit Expense, Credit Accrued Liability.
Accrued income – revenue earned but not yet received (e.g., interest receivable). Journal entry: Debit Accrued Receivable, Credit Revenue.
Pre‑paid expense – cash paid before the related benefit is received (e.g., insurance). Journal entry (initial payment): Debit Pre‑payment (asset), Credit Cash. Adjustment at period‑end: Debit Expense, Credit Pre‑payment.
Deferred income – cash received before the revenue is earned (e.g., annual subscription received in advance). Initial entry: Debit Cash, Credit Deferred Income (liability). Adjustment: Debit Deferred Income, Credit Revenue.
4.4 Bad Debts & Provision for Doubtful Debts
Specific (direct) write‑off: identify an uncollectible debtor and remove the amount from the ledger.
General (percentage) provision: estimate future uncollectible amounts as a % of total trade receivables.
Journal entry – General provision (5 % of $10 000 receivables)
Debit
Credit
Bad Debt Expense $500
Allowance for Doubtful Debts $500
4.5 Inventory Valuation
Recorded at the lower of cost or net realisable value (NRV).
Interpretation: For every $1 of current liability the business has $1.50 of current assets – a satisfactory liquidity position.
6.3 Interpretation of Ratios (AO3)
Compare the ratio with industry benchmarks or previous periods.
Explain what a high or low figure indicates about the business’s performance and financial health.
Identify any underlying causes (e.g., large inventory, high borrowing).
Unit 7 – Accounting Principles and Policies
7.1 Business Entity
Transactions of the business are recorded separately from those of the owner(s) or other entities.
7.2 Duality (Double‑Entry)
Every transaction has equal debit and credit effects, keeping the accounting equation in balance.
7.3 Going Concern
Assumes the business will continue to operate for the foreseeable future; assets are recorded at cost rather than liquidation values.
7.4 Historic Cost
Assets are recorded at the amount of cash (or cash equivalent) paid to acquire them.
7.5 Money Measurement
Only transactions that can be expressed in monetary terms are recorded.
7.6 Realisation (Revenue Recognition)
Revenue is recognised when it is earned and measurable – normally when goods are delivered or services performed.
7.7 Matching (Expense Recognition)
Expenses are matched with the revenues they help to generate, ensuring profit is measured accurately for the period.
7.8 Prudence (Conservatism)
The prudence principle requires that:
Potential expenses and liabilities are recognised as soon as they are probable.
Potential income and assets are recognised only when they are virtually certain.
Effect on the financial statements:
Profit and loss account – expenses and losses are recorded early, preventing profit from being overstated.
Balance sheet – assets are not overstated (recorded at the lower of cost or NRV) and liabilities are not understated (provisions are created for probable outflows).
Typical Prudence‑related journal entries
Transaction
Debit
Credit
Accrued interest expense $250 (incurred but not yet paid)
Interest Expense $250
Accrued Interest Payable $250
Pre‑paid insurance $1 200 (12‑month policy paid at start of year)
Pre‑paid Insurance $1 200
Cash $1 200
Provision for doubtful debts – 5 % of $10 000 receivables
Bad Debt Expense $500
Allowance for Doubtful Debts $500
Write‑down of inventory to NRV (cost $1 200, NRV $700)
Loss on Inventory Write‑down $500
Inventory $500
Warranty provision at sale ($1 200 estimated)
Warranty Expense $1 200
Warranty Provision $1 200
Prudence Decision Flowchart (description)
Flowchart – From identifying a probable expense or loss → estimating the amount → recording a provision (debit expense, credit liability) → reviewing at year‑end → adjusting the provision (increase, decrease or reverse) based on actual outcome.
7.9 Consistency
Once an accounting method or policy is adopted, it should be applied in the same way from one period to the next, unless a change is justified and disclosed.
7.10 Materiality
Only items that could influence the decisions of users need to be recorded and disclosed.
7.11 Qualitative Characteristics
Relevance – information must be capable of influencing decisions.
Reliability (faithful representation) – free from material error and bias.
Comparability – users can identify similarities and differences over time.
Understandability – information is presented clearly.
Appendix – Summary of Accounting Ratios (Formulas Only)
Ratio
Formula
Gross Profit Margin
Gross Profit ÷ Sales × 100 %
Net Profit Margin
Net Profit ÷ Sales × 100 %
Current Ratio
Current Assets ÷ Current Liabilities
Quick Ratio
(Current Assets – Inventory) ÷ Current Liabilities
Return on Capital Employed
Profit before interest & tax ÷ Capital Employed × 100 %
Debt‑to‑Equity Ratio
Total Liabilities ÷ Owner’s Equity
Inventory Turnover
Cost of Goods Sold ÷ Average Inventory
Average Collection Period
Trade Debtors ÷ (Credit Sales ÷ 12)
Common Examination Questions (AO1‑AO3)
Explain why inventory is recorded at the lower of cost or net realisable value, and illustrate the journal entry when NRV is lower.
Prepare the journal entries for a warranty liability of $1 200 when a product is sold for $8 000, and show how the provision is adjusted at year‑end if the actual cost incurred is $900.
Discuss the impact of the prudence principle on (a) the profit shown in the income statement and (b) the valuation of assets and liabilities on the balance sheet.
Using the data below, calculate and interpret the current ratio and gross profit margin:
Sales $120 000, Cost of Goods Sold $78 000, Current assets $45 000, Current liabilities $30 000.
Describe the steps involved in preparing a trial balance and explain how it helps to detect errors.
Explain the difference between capital and revenue expenditure, giving one example of each and showing the appropriate journal entries.
Outline the process of preparing a post‑closing trial balance and state its purpose.
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