Day 12 Review of the Financial Accounting book

Summary of studying Financial Account

The first chapter barely explained the accounting system. There are 4 major types of accounting: financial accounting , management accounting, public accounting and private accounting. This book is focused on providing business operating information to outsiders of the company, by which is financial accounting.This chapter also introduced the basic accounting principle:entity, accounting period, matching inputs/outputs to goods/service, profit recognition and conservatism(prudent) principle. In addition, the accounting equation is outlined along with types of financial statements. Basically, this is an introduction chapter.

The 2nd chapter taught the process of recording transactions with double entry accounting. There is not much to write about, except two technique to correcting balancing errors. To divide the outbalance amount by two and 9, in order to find slide and other error.

The following two chapters explained the adjusting balance and closing account at the end of accounting cycle. It includes to adjust unearned revenue (L) prepaid expenses (A) and the opposite, accrued expense (L).This is performed in order to measure profit more accurately in the income statement, and to updated related assets/liabilities account with correct profit in the balance sheet.The closing process is exceeded later, because the earnings/expenses/drawings account only reflects on the current accounting period(nominal account), thus need to be closed to prevent carry it to the next period. All the revenues and expenses balances are transfer to income summary account and the drawing to capital account. The current ratio and debt ratio are also mentioned in this chapter.

Chapter 5 is about retailer operations. A retailer purchase goods/service and hold them as inventory to resell. They use perpetual or integrated inventory recording system. Which the difference between them is whether keep a running record of all goods bought and sold or not. Settlement discount can be received in most credit purchase, we debit inventory account and GST Clearing for the discount amount received. The purchase return & allowance is the account for return the damaged goods. There is another issue about freight charges(in/out), freight in normally use point of delivery which care buyers. So the delivery expense is recorded as part of inventory(debit and GST).Freight out recorded as delivery expense. Contrast to purchase of inventory, the sale is more complicated. We need to record the cost of goods sold against inventory for the sale. The adjustment of inventory will occur in the sales return,but not allowance since nothing returned. Sales counted is discount as an expense account. After the physical count of stock, the error may be found. Therefore a stock loss might be record against inventory. The gross profit percentage and the inventory turnover are also included.

The next chapter is about the inventory cost method. There are four major types: Unit of Cost, FIFO, LIFO and average cost method. FIFO has the lowest COGS so the highest profit. LIFO is the opposite and can leads to a decrease on income tax. Average cost is in the middle. The cost of goods sold calculates differently on average method, is the total cost in inventory/ no. units available for sale.Furthermore, the lower of cost and net realistic value on inventory are applied. If the NRV <historical cost, the a loss on inventory journal entry occurs. It is important for us to estimate the inventory volume under some cases, we can use gross profit method or a retail inventory method to compare the cost with its price.

Chapter seven consists with account framework theory. It states the establish process of accounting standards in Australia. AASB sets the standard on due process which a new standard is created then debated in the public to decide to accept/reject. The other part in this chapter introduce the conceptual framework and it provides concepts&principles to use in preparing financial statements.It defines the objective o financial reporting plus the general principles of reporting. Understandbility, relevance which combined with materiality, reliability(free from material error and bias), and comparability. At the end, the book concludes the four ways to recognize profit: sales method, collection method, installment method(gross profit percentage*collections) and percentage-of-completion method(must use on construction contract, defined by cos for year/total cost times total revenue).

Chapter eight introduces the four most common special journals in accounting information system.

Cash receipts/payment journal, sales journal and purchase journal. These accounts are used to summarize all the relative subsidiary accounts, for the purpose of avoiding multiple journal entries.All subsidiary ledger needs to be posted daily, however the general ledger posting can be performed monthly.There is a brief notes of the credit note for sales return and debit note of purchase return.

The following chapter focused on internal control of cash. The internal control is the related measures intend to :

1.safe guard assets 

2.encourage adherence to business policies

3.Promote operational efficiency

4.Ensure accurate & reliable accounting records

The effective internal control system must consists:

1.Competent & ethical personal

2.Assignment of responsibility

3.Proper authorization

4.Separation of duties-most important

5.Internal&external audits

6.Documents & records

7.Electronic devices & computer controls: e.g. Electronic sensors

8.Other controls: vault, POS terminal, job rotation etc.

It can be limited by colluding and cost issues.

To perform internal control over cash, we need to use bank reconciliation as the tool.

It is divided into two parts, bank or the book error. The bank may miss the outstanding cheque or deposit in transit. The book may miss recording the bank collections on behalf/service charges, electronic fund transfer,interest revenue, dishonored cheque/other returned/rejected cheque and the cost of printing special cheque. Other than these, it can simply be an error made by either parties.

The process is to add deposit in transit and subtract outstanding cheque on the bank Statement balance. Then adjust the business’ book so we can compare these two adjusted value in the end.There are other internal control techniques over cash flow in the company. For instant, use point-of-sale terminal and mail reception room to control cash receipts. Use cash short & over to control the mathematical error made during daily sales.. And establish a corresponded purchasing purchase process.Moreover, the control over Petty cash fund is also told in the chapter. We should assign a specific person to scrutiny the certain amount of petty cash on hand. The balance of petty cash fun never changes, and will be replenish in a time period.

Chapter 10 presented two major proportion of receivables. The accounting for bad-debt and bills receivables. The allowance method is normally used for bad-debt, because it is more accurate to assign the bad debt expense to the period it occurred. The allowance of bad debt reduce the account receivable on balance sheet. In order to estimate the allowance amount, we combine the percentage of sales with the aging of account receivable method. Which we use POS method for the monthly or quarterly report, and aging method at the end of financial year. Sometimes business may decide some debt is unrecoverable, hence we need to perform a write-off. We can debit the allowance of bad-debt against account receivable to journalize the write-off.If the write off amount are eventually recovered, we need to do the opposite recording. In modern days, many business accept credit card or bank card for sale. However, wee need to record the credit-card discount expense as the subtraction of account receivable against sales revenue. By the way, bank card will directly care your cash at bank account instead of account receivable.The next part in chapter 10 is the bill payable. The promissory note and bill of exchange are both bills payable, which acceptor agrees to pay the drawer of the bill a specific amount with interest at a fixed or determinable future. The interest can be calculated as principal*rate*time. The account receivable can transfer to bill receivable, and can be transfer in the contrary when a dishonored bill appears. Normally people will hold the bill till maturity, but they can also sell it to the bank with a discounted price. The sellers proceeds is the maturity less (maturity value*bank’s discount rate* times remaining on this bill). When the proceeds exceeds the principle amount, there is a interest revenue, otherwise a interest expense.

Chapter 11 is about non-current assets. There are two main categories: tangible and intangible. For tangible asset, the cost is the purchase price plus and cost associate with bring the asset to a intended usable position. However, we need to identify which cost we need to capitalize to asset and others as expenses. For example the custom duty and charge for clear the lands can be capitalize as cost of asset. But the fencing, paving etc need to be recorded as land improvement expenses. In this case, we define the capital expenditure as is will increase asset’s capacity ,efficiency or extend its useful life. Otherwise, as expenses such as painting the truck. The non-current faces depreciation over its useful life. There are 3 ways to estimate the depreciation expense: Straight Line method, Units of Production method and reducing balance method.The SL method is better on asset producing profit over its useful life, due to the matching principle we need to related the revenue to any expense made to generate it. The UOP method is prefer to describe wear and tear. And the RB method is suitable for the asset generate lager revenue at the first year because the depreciation expense is larger as well using this method. The accounting process of changing the useful life of depreciable asst, disposal/selling/exchanging assets, the writing-down and revaluation of non-current are also introduced.In most situation, we need to bring the depreciation up to date and off-set the accumulated depreciation account by the non-current asst account. The accounting of intangibles asset follow the same pattern, despite to use amortization expense account. The goodwill is a company is phrasing another, the excess amount from total assets less total liabilities that company willing to pay.A loss on goodwill may be recorded.

Chapter is 12 a disclosure of current liabilities. We understand that: account receivable, bill payable, payroll liability, current portion of non-current liabilities, GST payable, accrued expense and unearned revenue are the ordinary current liabilities. There are also liabilities must be estimated, such as warranty payable. It appears after the sales, and record as warranty expense and estimated warranty payable. We have already studied about the other liabilities, so this chapter concentrates on payroll liabilities. An empolyee’s payroll is showed as following chart.

The employee payroll relation

Gross Payable   -  Income tax payable-Deductions  

In business we use a payroll information system to clarify each employee’s payroll, they will receive a payroll cheque and the PAYG payment summary for the salary to explain the payment with deductions. For convenience, company report payroll liabilities as ‘Remuneration and Benefits payable in balance sheet. Which combine all payroll liabilities together.

Chapter 13 grants us with the knowledge of partnership. Unlike to company or sole proprietor ship, partnership is two or more people caring business in common with a view to make profit. To commence a partnership does not need any registration, but a written agreement about how the bossiness run between partners. As partnership, there are some specific characteristic of it. To illustrate, It has limited life(ceased if partner withdraw), unlimited liability, co-ownership of the property, mutual agency( every partner present as the agent of business) and no partnership income tax( as tax allocated to partners’ personal income). At commencement of partnership, all non-cash capital contribution needs to be record at market value. Because the partnership is buying the asset and assuming liabilities. Partners can split profit/loss by a stated fraction or base on capital contribution and service. Normally they use a current(retained earnings) account to record profit/loss, and add this amount under the partner’s capital. When the business want to add a new partner, he can either purchase a current partner’s interest or investing in the partnership. However, both of them will end the old partnership. When investing into the partnership, there can be a bonus to the old/new partners, the gain/loss are allocated base on old partners’ profit/loss sharing ratio. Before a partner withdraw, the non-current assets need to be evaluate to their market value, and the gain/loss are assigned to partners base on P/L sharing ratio. No matter the partner withdraw at/less/more than his capital caring amount, the gain/loss still shared in the other partners with their sharing ratio. If the partnership is going out of business, there are three steps to liquidize the business. Firstly, sell the non-current assets and allocated gain/loss to partner’s capital. Secondly, pay off all the liabilities. Thirdly, distribute remaining cash to partners. Due to the unlimited liability feature, the partner needs to use his own asset to cover capital deficiency. If he can not afford to pay, the loss is allocated with other partners base on the proportion of the capital balances prior to the liquidation.