Key Definitions

Question 1

Accounting Equation

Answer 1

A = L + OE
(A = Assets, L = Liabilities, OE = Owner’s Equity)

Question 2

Current Assets

Answer 2

A present economic resource controlled by the entity (as a result of past events) that is reasonably expected to be converted to cash, sold or consumed within the next 12 months after the end of the reporting period.

Question 3

Non-current Asset

Answer 3

A present economic resource controlled by the entity (as a result of past events) that is not held for resale and is reasonably expected to be used for more than the next 12 months after the end of the reporting period.

Question 4

Current Liability

Answer 4

A present obligation of the entity (arising from past events) that are reasonably expected to be settled with a transfer of an economic resource within the next 12 months after the end of the reporting period.

Question 5

Non-current liability

Answer 5

A present obligation of the entity (arising from past events) that are not expected to be settled with a transfer of an economic resource within the next 12 months after the end of the reporting period.

Question 6

Owner’s equity

Answer 6

Residual interest in the assets of the entity after the liabilities are deducted.

Question 7

Accounting Entity Assumption

Answer 7

The assumption that the accounting records of assets, liabilities and business activities of the entity are kept separate from those of the owner of the entity, as well as from other entities.

Question 8

Classified Balance Sheet

Answer 8

an accounting report that details a firm’s financial position at a particular point in time by reporting its assets, liabilities and owner’s equity.

Question 9

Accounting Process

Answer 9

Accounting process: the process of taking financial data and converting it into financial information in order to be able to make decisions.

Source documents: documents that provide both the evidence that a transaction has occurred and the details of the transaction itself.
Recording: sorting, classifying and summarising the data contained in the source documents so that it is more useable.
Reporting: the preparation of financial statements that communicate financial information to the owner.
Advice: the provision to the owners of a range of options available to their aims/objectives, together with recommendations as to the suitability of those aims / objectives

Question 10

Impact of transactions on the accounting equation

Answer 10

1. A transaction: an exchange of a good or a service with another party.
2. Once a transaction has occurred, this changes the “financial position” of the business
3. Every transaction that a business is involved in affects at least two items in the accounting equation.
4. After recording each transaction, the accounting equation should still equal.
5. After a transaction two things must remain true:
   * Every transaction will affect at least two “items” in the accounting equation.
   * After recording these changes, the accounting equation must still balance.

Question 11

Liquidity

Answer 11

The ability of the business to meet its short term debts as they fall due.

Question 12

Stability

Answer 12

The ability of the business to meet its debts and continue operations in the long term.

Question 13

Working Capital Ratio

Answer 13

Working Capital Ratio is a liquidity indicator that measures the ratio of current liabilities to current assets to assess the firm’s ability to meet its short – term debts.

In other words, it measures whether the business has sufficient economic resources to cover its present obligations.

Question 14

Assessing the working capital ratio

Answer 14

1:1 → is adequate and indicates sufficient liquidity, as there are enough current assets to cover the current liabilities of the business.

Less than 1:1 → worrying as current assets cannot cover current liabilities.

More than 2:1 → good because there are plenty of current assets to cover current liabilities. However, above 2:1 is also a concern as it means that there is a large amount of current assets that are not being employed effectively or sitting idle.

Question 15

Debt Ratio

Answer 15

Debt ratio measures the proportion of the firm’s assets that are funded by external sources of finance. It is a measure on the stability of a business.

Question 16

Assessing the Debt Ratio

Answer 16

There is no set level for the Debt ratio to be satisfactory.

A high debt ratio means that a high amount of the firm’s assets are funded by external sources, leading to pressure on the firm’s cash flow to meet principal and interest payments. Therefore, there is a higher risk of financial collapse.

However, there is a strong link between risk and return for a business. High risk (carrying a high debt ratio) is likely to lead to a higher return.

A low debt ratio could be a missed opportunity, as a business could be funding an expansion through debt or investing in new, more productive assets.

Question 17

Internal sources of finance

Answer 17

1. Capital contribution from an owner.
2. Retained profits from a previous year.

Question 18

External source of finance

Answer 18

1. Accounts Payable (Trade Credit)
2. Bank Overdraft
3. Term Loan
4. Mortgage

Question 19

Classification columns

Answer 19

The classification columns allow for frequent cash receipts to be summarised leading to totals that can then be used to generate reports (such as a Statement of Receipts and Payments).

If the source of the transaction is a frequent one, then a dedicated classification column will be provided in the journal (e.g. Fees).
If the purpose of that cash is from an infrequent transaction, it would be recorded in the Sundries column.

Question 20

A single-entry accounting system

Answer 20

is a system that allows financial data to be sorted, classified and recorded so that financial information needed to complete Accounting Reports (such as a Balance Sheet) can be generated.

Question 21

Cash Receipts Journal

Answer 21

Accounting record that summarises all transactions where cash is received from other entities during a particular reporting period.

Question 22

Cash Payments Journal

Answer 22

accounting record which classifies and summarises all transactions where cash is paid to other entities during a particular reporting period.

Question 23

Statement of Receipts and Payments

Answer 23

is a report that summarises the financial information that has been sorted, classified and recorded in the cash journals.

Question 24

Cash Surplus

Answer 24

an excess of cash receipts over cash payments, leading to an increase in a positive bank balance or a decrease in bank overdraft (negative bank balance).

Question 25

Cash Deficit

Answer 25

an excess of cash payments over cash receipts, leading to a decrease in a positive bank balance or an increase in bank overdraft (negative bank balance).

Question 26

Uses of a Statement of Receipt and Payment: Cash Surplus or a high closing bank balance or both -

Answer 26

To have a cash surplus and/or a high closing bank balance is positive for a business. 1. The business can take any of the following actions as a result: 2. Make higher loan repayments to reduce debt 3. The owner can take greater drawings in cash from the business 4. Upgrade/purchase newer non-current assets 5. Expand the businesses operations or open a new store in a new location.

Question 27

Uses of a Statement of Receipts and Payments: Cash Deficit or a low closing bank balance or both -

Answer 27

This would be a concern for the business. The business can take any of the following actions as a result: 1. Effective advertising to boost cash fees / sales 2. Reduce loan repayments 3. Reduce drawings 4. Purchase more inventory of supplies using credit facilities. 5. Ask the owner to make a cash capital contribution 6. Borrow cash from a bank (a loan) 7. Organise a Bank Overdraft Facility

Question 28

GST Formula

Answer 28

Opening balance of GST: + GST received from customers – GST paid to suppliers + GST refund (to settle previous GST receivable) OR – GST settlement (to settle previous GST payable) = GST balance

Question 29

GST Payable

Answer 29

GST payable: GST owed by the business to the ATO when the amount of GST the business has received on its fees is greater than the GST it has paid to its suppliers. GST Payable is classified as a Current Liability in the Balance Sheet. *Do not confuse GST Payable with GST Paid

Question 30

GST Settlement

Answer 30

If the balance is GST Payable (Current Liability) the present obligation will result in a transfer of an economic resource to the ATO (cash) as a GST settlement recorded in the Cash Payments Journal. GST Settlement in the Details column and the amount must appear in the Sundries column, not the GST column.

Question 31

GST Refund

Answer 31

If the balance is GST Receivable (a Current Asset) the economic resource (cash) will be received from the ATO as a GST refund. It will be recorded in the Cash Receipts Journal. GST Refund in the Details column and the amount in the Sundries column, not the GST column.

Question 32

GST Receivable

Answer 32

GST Receivable: GST owed to the business by the ATO when the amount of GST the business has paid to its suppliers is greater than the GST it has been received from customers. GST Receivable is classified as a Current Asset in the Balance Sheet. *Do not confuse GST Receivable with GST Received.

Question 33

Net Profit Margin

Answer 33

Net Profit Margin (NPM) is a financial indicator that provides an indication of the profitability of the business.

Question 34

Evaluating the performance of a business

Answer 34

Past performance (this helps determine trends – i.e. patterns over time) Budgeted performance / Targets or KPIs Industry averages

Question 35

Strategies to improve profitability

Answer 35

1. Renegotiate with existing suppliers to secure a cheaper price for supplies/materials 2. Change suppliers to access a cheaper price for supplies/materials 3. Buy materials in bulk in order to access a discount 4. Review staff rostering to minimise wage expense 5. Effective advertising that will boost sales by a greater amount than the amount spent on advertising. 6. Improve service delivery in order to build positive word of mouth in the market = boost to sales

Question 36

Profitability

Answer 36

the ability of the business to generate a profit compared against a base of sales, assets or owners equity.

Question 37

Return on Assets

Answer 37

A profitability indicator that assesses how effectively a business has used its assets to earn profit.

Question 38

Strategies that will improve ROA

Answer 38

Increase Net Profit * Renegotiate with existing supplier to secure a cheaper price for supplies/materials * Change suppliers to access a cheaper price for supplies/materials * Buy materials in bulk in order to access a discount making materials * Review staff rostering in order to minimise wage expense * Effective marketing / advertising that will boost sales by a greater amount that the amount spent on marketing / advertising. * Improve service delivery in order to build positive word of mouth in the market = boost to sales Reduce average total assets: * Sell unproductive / idle / obsolete assets. * Sell assets, and then lease back

Question 39

Structure of a Cash vs Profit question

Answer 39

Cash and Profit are two different measures of performance. Net profit is revenues earned minus expenses incurred, whilst net cash is cash receipts minus cash payments. There are some items that will impact net loss but not net cash and vice versa. One example is ... Another example is ...

Question 40

Earning a Net Profit but a Cash Deficit

Answer 40

There are cash payments that are not expenses, therefore contribute to a cash deficit however do not affect net profit. Examples that can be the reason? * Cash drawings * A loan repayment * A cash purchase of a non-current asset * A GST Settlement

Question 41

Earning a Net Loss but a Cash Surplus

Answer 41

There are cash receipts that are not revenues, therefore contribute to a cash surplus however do not effect/prevent a net loss. Examples that can be the reason? * Capital contribution * GST Received * GST Refund * Loan received

Question 42

Budgeting

Answer 42

Budgeting is the process of predicting/estimating the financial consequences of future events.

Question 43

Purpose of Budgeting

Answer 43

* Budgeting assists planning by predicting what is likely to happen in the future so corrective action can be taken if necessary * Budgeting aids decision-making by providing a standard (a benchmark) against which actual performance can be measured.