Sample theory questions

1. Depreciation of fixed assets Why does a company charge depreciation in calculating profit?

Depreciation is an expense. Failure to include depreciation in the final accounts will result in the profits being overstated and the net assets in the balance sheet will not show a true value.

Explain what is meant by depreciation.

Depreciation is the measure of the wearing away or loss in value of a fixed asset as a result of wear and tear, passage of time, obsolescence or extraction.

2. Revaluation of fixed assets

What factors are taken into account in arriving at an annual depreciation charge?

• Cost of asset

• Estimated life of asset

• Estimated residual/scrap value of asset

• Selection of appropriate method of depreciation

3. Creditors control account

Give reasons why the balance in the creditors’ control account may not agree with the balance in the schedule of creditors.

• Errors in either the control account or in the schedule but not in the other.

• Failure to complete the double entry/errors in the ledger.

• Incorrect totalling of subsidiary books sent to the control account.

4. Debtors control account

Which books of first entry are used in the production of the debtors control account? Sales, sales returns, general journal, cash book, receipts and payments.

Explain the importance of control accounts.

They act as a check on the accuracy of the ledgers by comparing the balance of the control account with the total as per the schedule.

They locate errors quickly and narrow searching for errors to confined areas.

They are useful when a firm needs to find credit sales or credit purchases from incomplete records.

They allow amounts owed by debtors and amounts owed to creditors to be ascertained quickly by simply balancing the control accounts.

5. Farm accounts

Give three reasons why farmers should keep a full set of accounts.

• To find out the profit of the farm.

• To find out the net worth of the farm.

• To find out the profit of each section of the farm.

Which account other than drawings is affected by ‘farm produce used by family’?

Drawings are debited and sales are credited. Sales are credited instead of purchases because the farm produce is produced rather than purchased.

6. Published accounts

Explain the term ‘exceptional item’ and give an example.

This is a material item of significant size. It is a profit or loss that must be shown separately in the profit and loss account because of its size, e.g. profit or loss on sale of fixed asset or large bad debt.

7. Cash flow statements

Explain why earning profit does not always result in a corresponding increase in cash balance.

• Credit sales/purchases affect profit but do not affect cash.

• Non-cash losses and gains affect profit but not cash.

• Purchase and sale of fixed assets by cash affect cash but not profit.

• Introduction or withdrawal of capital in cash affect cash but not profit.

Identify a non-cash expense and a non-cash gain.

Expense: Depreciation, increase in provision for bad debts. Gain: Reduction in provision for bad debts, profit on sale of assets.

8. Service accounts

Explain why service firms prepare accounts.

• To show profit or loss

• To show statement of assets and liabilities in the balance sheet

• To obtain information for tax purposes

9. Suspense accounts

List six types of error not revealed by the trial balance.

• Error of original entry

• Error of omission

• Error of commission

• Error of principle

• Compensating error

• Reversal of entries

Explain with examples what is meant by error of commission and error of principle.

An error of commission occurs when the correct amount is posted to the correct side of the incorrect account, e.g. goods sold on credit to Brian Brady debited in error to John Brady’s account.

An error of principle arises when an item is posted to the incorrect class of account, e.g. a boutique owner purchased a vehicle and treated it as a purchase of stock.

10. Incomplete records

What additional information would be available if accounts were prepared using the ‘double entry’ system?

Total sales figure, total purchases figure, trial balance, bank balance, capital, goodwill, bad debts, expenses due and prepaid, discounts.

Summary of advice you would give in relation to the information given.

The company should keep a detailed cash book and general ledger supported by appropriate subsidiary day books. This would enable the company to prepare an accurate trading and profit and loss account and therefore would avoid reliance on estimates.

11. Club accounts

Explain with the use of an example what is meant by a special purpose profit and loss account?

Sometimes non profit making organisations such as a club prepare a profit and loss account for activities that are carried out to make a profit, e.g. running a club lottery, dances, bar, restaurants etc. All expenses and revenues relating to that particular activity are entered in a special profit and loss account and the profit is then transferred to the income and expenditure account.

State and explain two limitations of a receipts and payments account

Does not show whether the club is raising enough funds to cover the running costs.

Amounts due but unpaid at the end of the accounting period are not included.

Only shows an increase or decrease in cash although there could be outstanding bills.

Does not take into account losses such as depreciation. Does not show whether the club bar or restaurant is profitable.

Does not distinguish between receipts for the current year and other years.

12. Management accounting

Explain the difference between management and financial accounting.

Explain principal budget factor.

Often referred to as the limiting budget factor or the key budget factor. This is the factor that limits output and therefore prevents continuous expansion.

Name items that could be considered the principal budget factor.

Sales demand Supply of materials Availability of labour Capacity of the plant Availability of capital