Accounts Refresher PDF

Accounts Refresher
November, 2010
ZIGEDU Learning Solutions
Question 1
2
What do you mean by Accrual Basis of Accounting?
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Answer 1
3
It is the most commonly used accounting method, which reports income when earned and expenses when incurred, as opposed to cash basis accounting, which reports income when received and expenses when paid. Under the accrual method, companies do have some discretion as to when income and expenses are recognized, but there are rules governing the recognition. Under the accrual basis accounting, revenues and expenses are recognized as follows: Revenue recognition: Revenue is recognized when both of the following conditions are met: a. Revenue is earned. b. Revenue is realized or realizable. Revenue is earned when products are delivered or services are provided. Realized means cash is received. Realizable means it is reasonable to expect that cash will be received in the future. Expense recognition: Expense is recognized in the period in which related revenue is recognized (Matching Principle).
Question 2
4
What is Cash basis of Accounting and what kind of timing differences can occur if accrual accounting is used instead of cash accounting?
Answer 2
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Under the cash basis accounting, revenues and expenses are recognized as follows: Revenue recognition: Revenue is recognized when cash is received. Expense recognition: Expense is recognized when cash is paid. There are potential timing differences in recognizing revenues and expenses between accrual basis and cash basis accounting. Four types of timing differences a. b. c. d. Accrued Revenue: Revenue is recognized before cash is received. Accrued Expense: Expense is recognized before cash is paid. Deferred Revenue: Revenue is recognized after cash is received. Deferred Expense: Expense is recognized after cash is paid.
Question 3
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What is a Bank Reconciliation?
Answer 3
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A bank reconciliation is a process performed by a company to ensure that the companys records (check register, general ledger account, balance sheet, etc.) are correct and that the banks records are also correct. The bank reconciliation for a companys checking account begins with the company noting the balance per the bank statement and then making some notations about that balance. For example, the balance on the bank statement is probably not the amount that appears in the companys records. In all likelihood the checks written by the company in the days immediately before the date of the bank statement will not have cleared (been deducted from) the checking account. These are called outstanding checks. Another possibility is that the company received money on the closing date of the bank statement and properly recorded the amount in its records. However, the money was deposited into the bank too late in the day and will appear on the next bank statement. This is known as a deposit in transit. Lets look at a bank reconciliation by assigning some amounts to the items just mentioned: Balance per bank statement at October 31 Rs 6,442.56; outstanding checks as of October 31 Rs 3,400.00; deposits in transit at October 31 Rs 1,000.00. The adjusted balance per the bank statement on October 31 is Rs 4,042.56 (Rs 6,442.56 + Rs 1,000.00 Rs 3,400.00). Next, the bank reconciliation requires that the amount in the companys records (for this bank statement account) be noted. In all likelihood the amount in the companys records will not agree with the adjusted bank amount. One explanation could be the bank fees that the bank took out of the checking account, but the fees were not yet recorded in the companys records.
Answer 3 (Contd.)
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A common example is the bank service charge for maintaining the checking account, handling returned checks, and check printing fees. The bank might also deduct loan payments or process other transactions that the company has not yet entered into its records. Lets illustrate the companys adjusted balance with some amounts: Balance per the companys records (account register, general ledger account) Rs4,340.56; bank service charge Rs63.00; check printing charge Rs120.00. The adjusted balance per the companys records, or per books, is Rs4,157.56 (Rs4,340.56 - Rs63.00 - Rs120.00). If the adjusted balance per the bank agrees with the adjusted balance per the books, the bank reconciliation is completed. In our example, the adjusted balance per the bank is Rs4,042.56 and the adjusted balance per the companys books is Rs4,157.56. The difference of Rs115.00 means that the bank reconciliation is not completed. The Rs115.00 difference must be identified. Finding the difference is likely to be tedious, but it must be done. After all differences have been identified, any adjustments to the companys balance must be entered into the companys records with a journal entry. It is the reconciled, adjusted balance that is to be reported on the companys balance sheet. As mentioned above, performing a bank reconciliation is necessary for the accuracy of the accounting records and for the companys financial statements. Bank reconciliations are also associated with a companys internal controls over cash. If the bank reconciliation is performed by someone other than the authorized check signers and record keepers, the company has improved its internal control over cash.
Question 4
9
What are Fixed Assets? What do you mean by capitalization of Fixed Assets? How many kinds of Fixed Assets are there?
Answer 4
10
Fixed Assets are assets such as land, machines, office equipments, buildings, patents, trademarks, copyrights, etc. held for the purpose of production of goods or rendering of services and are not held for the purpose of sale in the ordinary course of business. If a company purchase plant & machinery for its factory use by investing large amount of money and assume that expected life of P&M is 10 years and which generates revenue for more one financial year. Hence this investment cannot be treated expenses for one Financial year. Therefore it is capitalized as a fixed asset under P&M head and depreciation is charged every year based on applicable rates & transferred to profit and loss a/c. There are two kinds of Fixed Assets: tangible and intangible assets. Tangible assets: A physical asset whose presence can be felt and touched. Eg. Furniture and Fixtures Plant and Machinery Intangible Assets: Assets whose presence cannot be felt or touched. Eg: Goodwill patents trademarks.
Question 5
11
Differentiate between Capital Expenditure and Revenue Expenditure
Answer 5
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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 immediatelythereby 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.
Question 6
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Derive ROE using Dupont Analysis
Answer 6
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DuPont analysis is an expression which breaks ROE (Return On Equity) into three parts. ROE = (Profit margin)*(Asset turnover)*(Equity multiplier) = (Net profit/Sales) * (Sales/Assets) * (Assets/Equity) = (Net Profit/Equity)
Three components: Operating efficiency (measured by profit margin) Asset use efficiency (measured by asset turnover) Financial leverage (measured by equity multiplier)
Question 7
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Identify the type of ratio on the basis of what it measures: Liquidity/ Profitability/ Leverage/ Activity Ratios and give their formulae: Gross Margin Current Ratio Return on Equity Return on Capital Employed Asset Turnover Debt Service Coverage Ratio Inventory Turnover Acid Test Ratio/ Quick Ratio
Answer 7
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Ratio Gross Margin
Type Profitability Ratio
Formulae Gross Profit/ Net Sales OR (Net Sales COGS)/ Net Sales Current Asset/ Current Liability Net Income/ Avg. Share holder Equity EBIT/ Capital Employed Net Sales/ Total Assets Net Operating Income/ Total Debt Service COGS/ Avg. Inventory (Cash and Cash Equivalent + Marketable Securities + Accounts Receivable)/ Current Liabilities
Current Ratio/ WC Ratio Return on Equity Return on Capital Employed Asset Turnover Debt Service Coverage Ratio Inventory Turnover Acid Test Ratio/ Quick Ratio
Liquidity Ratio Profitability Ratio Profitability Ratio Activity Ratio Leverage Ratio Activity Ratio Liquidity Ratio
Question 8
17
There are 3 main types of Cash Flows : Operating, Investing and Financing. For each of the following items, indicate which type will be affected.
1. 2. 3. 4. 5. 6. 7. 8.
Depreciation Expense Proceeds from the sale of equipment used in the business The Loss on the Sale of Equipment in #2. Declaration and payment of dividends on company's stock Gain on the Sale of Automobile formerly used in the business An increase in the balance in Accounts Payable The purchase of a new delivery truck to be used in the business The proceeds from issuing additional Common Stock
Answer 8
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1. 2. 3. 4. 5. 6. 7. 8.
Depreciation Expense - Operating Proceeds from the sale of equipment used in the business - Investing The Loss on the Sale of Equipment in #2 - Operating Declaration and payment of dividends on company's stock - Financing Gain on the Sale of Automobile formerly used in the business - Operating An increase in the balance in Accounts Payable - Operating The purchase of a new delivery truck to be used in the business - Investing The proceeds from issuing additional Common Stock - Financing
Question 9
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What is a Contingent Liability? How is it recorded?
Answer 9
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A contingent liability is a potential liabilityit depends on a future event occurring or not occurring. If a company is sued by a former employee for Rs500,000 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.
Question 10
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What is an Impairment?
Answer 10
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The term impairment is usually associated with a long-lived asset that has a market which has decreased significantly. For example, a steel plant may have recently spent large amounts for capital expenditures and then experienced a dramatic drop in the plants value due to business and community conditions. If the undiscounted future cash flows from the asset (including the sale amount) are less than the assets 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 assets fair value from its carrying value.
Question 11
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What is the difference between accounts payable and accounts receivable?
Answer 11
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When a company purchases goods or services on credit, it will increase its accounts payable (a current liability). When a company sells goods or services on credit, it will increase its accounts receivable (a current asset). Just as one companys purchase is another companys sale, the accounts payable of one company will be the accounts receivable of another company.
Question 12
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What is the Materiality Concept in Accounting?
Answer 12
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In accounting, the concept of materiality allows one 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 Rs10 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 to expense the entire Rs10 in the year it is acquired instead of recording depreciation expense of Rs1 per year for 10 years. The reason is 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, Rs5,000 might be immaterial for a large, profitable corporation, but it will be material or significant for a small company that has very little profit.
Question 13
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Fill in the Blanks: 1. Rent expense for the executive offices is part of _____________________________ (manufacturing overhead/ non-operating expenses/ SG&A expense 2. Real estate tax on the factory building is part of ______________________________ (income tax expense/ manufacturing overhead/ SG&A expense) 3. _______________________ (Factory supplies/ Quality control/ Interest expense) would not be included in a product's cost for inventory valuation for the financial statements. 4. In ABC the assumption is that __________________ (Activities/ Products) use resources or cause costs.
Answer 13
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1.
SG & A Expense Manufacturing Overhead Interest Expense Activities
2.
3.
4.
Question 14
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What do you mean by Cost Allocation?
Answer 14
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Cost allocation is the assigning of a common cost to several cost objects. For example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that use the system. A company with only one electric meter might allocate the electricity bill to several departments in the company. Allocation implies that the assigning of the cost is somewhat arbitrary. Some people describe the allocation as the spreading of cost, because of the arbitrary nature of the allocation. Efforts have been made over the years to improve the bases for allocation. In manufacturing, the overhead allocations have moved from plant-wide rates to departmental rates, from direct labor hours to machine hours to activity based costing. The goal is to allocate or assign the costs based on the root causes of the common costs instead of merely spreading the costs.
Question 15
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What do you mean by Activity Based Costing?
Answer 15
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Activity based costing (ABC) is a more sophisticated and logical way to allocate a companys costs to its products (or other objects) than traditional costing. (Traditional costing might allocate all of the overhead costs solely on the basis of machine hours.) Activity based costing identifies the many activities that actually cause the company to consume resources. Next, it calculates the cost of each of the activities. Then it assigns each activitys cost only to the products that actually use the activities. Obviously this is important when some products require few activities, and other products require many activities. In the case of a manufacturer, some products may require special engineering, sophisticated testing, unique storage arrangements, and are low-volume items. Other products might be high-volume items that run continuously and require no special attention. In other words, some products require lots of activities (engineering, testing, storing, many machine setups, and running the production machine), while some products require just one activityrunning the production machine. Under activity based costing, the products that require the activities mentioned above will be assigned the costs of engineering, testing, storing, setups, and producing activities. The products that run continuously will not be assigned costs for engineering, etc. These products will only be assigned the cost of the production activity. (If activities were not considered, and all costs were allocated solely on machine hours, the high-volume, easy-tomanufacture products would be assigned an enormous amount of overhead, and the low-volume, activityintensive products would be assigned too little overhead cost.) Activity based costing is useful for service businesses as well as manufacturers. The process of identifying and determining the cost of activities can lead to improvements in a companys operations.
Question 16
33
Is Land depreciated? How is Sale of Land recorded?
Answer 16
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Land is not depreciated because land is assumed to have an unlimited useful life. 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 lands life is not limited, there is no need to allocate the cost of land to any accounting periods. If a company sells land that it was holding for future use, the company will 1) debit Cash for the amount it receives, 2) credit Land for the amount in the general ledger account that applies to the land being sold, and 3) record the difference as a gain or loss on sale of land. Since land does not get depreciated, there is no depreciation expense to be recorded up to the date of the sale, nor is there any accumulated depreciation to be removed from the books of the company
Question 17
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What is Net Realizable Value?
Answer 17
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Net realizable value is used in connection with accounts receivable and inventory. In the case of accounts receivable, net realizable value means the debit balance in the asset account Accounts Receivable minus the credit balance in the contra asset account Allowance for Uncollectible Accounts. For example, if Accounts Receivable has a debit balance of Rs100,000 and the Allowance for Doubtful Accounts has a proper credit balance of Rs8,000, the resulting net realizable value of the accounts receivable is Rs92,000. In the context of inventory, net realizable value is used in the calculation of the lower of cost or market. In this situation, net realizable value or NRV means the expected selling price in the ordinary course of business minus any costs to complete and dispose. Net realizable value amount becomes the ceiling for the replacement cost. NRV minus the normal profit becomes the floor.
Question 18
37
Differentiate between an Operating Lease and a Capital Lease
Answer 18
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A lease is defined as a contractual agreement between a lessor and lessee that gives the lessee the right to use specific property, either owned by or in the possession of the lessor, for a specified period of time in return for stipulated, and generally periodic, cash payment. In accounting, a lease is classified either as an operating lease or a capital lease (finance lease). An operating lease records no asset or liability on the financial statements, the amount paid is expensed as incurred. On the other hand, a capital lease is recorded as both an asset and a liability on the financial statements, generally at the present value of the rental payments (but never greater than the asset's fair market value). To distinguish the two, FASB provided criteria for when a lease should be capitalized, and if any one of the criteria for capitalization is met, the lease is treated as a capital lease and recorded on the financial statements. The basic criteria for capitalization of a lease by lessee are as follows:

The lessor transfers ownership of the asset to the lessee at the end of the lease term. A bargain purchase option is given to the lessee. This is an option that allows the lessee, upon termination of the lease, to purchase the leased asset at a price significantly lower than the expected fair market value of the asset. The life of the lease is equal to or greater than 75% of the economic life of the asset. The present value of the minimum lease payments (MLP) is equal to or greater than 90% of the fair market value of leased property.
Question 19
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What are the components in a Procurement to Pay Cycle?
Answer 19
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Processes in procure to pay cycle may differ from company to company but the process more or less remains the same. Following is an exhaustive list of various steps involved in Procure to Pay cycle Identification of requirement: At this stage the team member of user department (Maintenance, Production, Sales and distribution, administration etc) identifies the requirement and raises the Purchase requisition PR). This document normally contains description of material, quantity, approx cost, material requirement date, preferred or Standard vendor etc Authorisation of Purchase Requisition : If the purchasing value of the PR is higher than that of approval limit of originator then this document is sent to the next higher level (normally immediate supervisor of the originator) for approval. At this stage, the supervisor may return the PR to the originator for modification or can approve it. Final Approval of PR/Role of Inventory Controller: Once the PR has been authorised by user department then it is available to the inventory controller. Inventory controller shall review the PR and shall check the Open Purchase orders (PO), any other scheduled or planned delivery for the material. If there is any planned delivery or any existing open PO then Inventory controller can return the PR or request the user department to revise the quantity of the material. After the approval of Inventory controller, the approved PR is available to the Procurement department Procurement: After final authorization of PR, it is available to Buyer. Buyer checks for any existing Annual Rate Contract or any other contract for the material. If any contract exists then a PO is generated and sent to the supplier. In case no contract exists then the Buyer initiates supplier search and floating of enquiries Identification of Suppliers: Buyer shall interact with the user for the possible suppliers, search on the Internet, use referrals, search data base, etc. to identify the suppliers for the material.
Answer 19 (Contd.)
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Floating of Enquiries: Once the suppliers are identified, Buyer shall send the Request For Quotations/Proposal ( RFQ/RFP) to the supplies. RFQ normally contains Description, Technical Specifications of the material, quantity of the material, term and conditions, delivery date of the material, date of submission of the RFQ, Quality standards, Validity of the suppliers offer, etc. Receipt of Technical Quotations: After sending the RFQ/RFP to vendors , the buyer shall receive the quotations from the suppliers. Normally, vendors are instructed to send their quotation in a sealed envelope, mentioning only RFQ reference no on it. Quotations are normally opened and signed by 2 or more persons of the department. Technical Evaluation of Quotations : Quotations are sent to technical department for technical evaluations of the quotations. Here, technical department shall shortlist the quotations based on the technical specifications Receipt of Commercial Quotations: Once the Technical Evaluation is over, the buyer shall send the advice to shortlisted suppliers for commercial quotations, After receiving the commercial quotations, these shall be opened by two people. Quotation comparison statement is prepared by the buyer to compare all the quotations of the supplies and suppliers are short listed for negotiations. Negotiation: Short listed suppliers are invited for negotiations. In negotiation buyer can negotiate with the supplier for Reduction in the prices of the materials, Delivery Terms and conditions, etc. Selection of the Vendor: After negotiations with all the selected vendors revised quotations are prepared and vendor is finalized for award of contract based on the weightage to the commercial, technical parameters, previous performance of the vendor, delivery dates of the material, etc.
Answer 19 (Contd.)
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Award of Contract : After the vendor is finalized LOI can be sent to him and he may be asked to deposit security or bank guaranty before signing the agreement. Purchase Order : A PO is raised specifying the quantity, delivery condition etc and sent to supplier. PO acknowledgement: After receiving the PO the supplier send the acknowledgement to buyer and buyer records the acknowledgement. If any ERP is being used for procurement functions then supplier can remotely download purchase orders and can acknowledge the PO Advance Shipment Note : The supplier sends the Advance Shipment to buyer as soon as he ships the material to the buying organization. This note normally contains Ship Date, Transporters name , Airway Bill No, No of packages, weight of the packages, receiving location address, PO No, description of goods, etc Goods Receipt : When the goods are received at the warehouse of buyer organization, the receiving staff checks the delivery note, PO no etc and acknowledges the receipt of material. After the material is received the same is checked for quantity/ quality and in case of discrepancy the same is reported to the vendor.The sound material is moved to respective warehouse locations. In the ERP of the buying organization stock account gets debited and liability account gets credited. Invoice Recording : Vendor send the invoice to accounts department of buying organization for claiming payment. This invoice is entered in to the system, After the entry of invoice in the system, supplier account gets credited and liability account gets debited. Payment to Supplier : After the supplier account gets credited the payment is released to the vendor
Question 20
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What is the basic accounting equation? What is its expanded form?
Answer 20
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The financial position of a company is measured by the following items: Assets (what it owns) Liabilities (what it owes to others) Owners Equity (the difference between assets and liabilities) The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a corporation is: Assets = Liabilities + Stockholders Equity In the expanded accounting equation for a corporation, Stockholders Equity in the basic accounting equation (Assets = Liabilities + Stockholders Equity) is replaced by these components: Paid-in Capital + Revenues - Expenses - Dividends - Treasury Stock. The resulting expanded accounting equation for a corporation is: Assets = Liabilities + Paid-in Capital + Revenues - Expenses - Dividends - Treasury Stock. The expanded accounting equation allows you to see separately
(1) (2)
the impact on equity from net income (increased by revenues, decreased by expenses), and the effect of transactions with owners (draws, dividends, sale or purchase of ownership interest).
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Varun Malik Director Email: varun.malik@zigedu.com Mobile No: 0 9999 48 64 72 Registered Office 94, Gagan Vihar(Main), Vikas Marg, Delhi -110051 Corporate Office 301, 3rd Floor, DDA Building, Laxmi Nagar District Center, Near Nirman Vihar Metro Station, Delhi-110092
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ZIGEDU Learning Solutions

What do you mean by Accrual Basis of Accounting?

What is a Bank Reconciliation?

Differentiate between Capital Expenditure and Revenue Expenditure

Derive ROE using Dupont Analysis

Ratio Gross Margin

Type Profitability Ratio

What is a Contingent Liability? How is it recorded?

What is the difference between accounts payable and accounts receivable?

What is the Materiality Concept in Accounting?

SG & A Expense Manufacturing Overhead Interest Expense Activities

What do you mean by Cost Allocation?

What do you mean by Activity Based Costing?

Is Land depreciated? How is Sale of Land recorded?

What is Net Realizable Value?

Differentiate between an Operating Lease and a Capital Lease

What are the components in a Procurement to Pay Cycle?

What is the basic accounting equation? What is its expanded form?

ZIGEDU Learning Solutions - Transforming Learning Methods

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