BY MUJAHID AMAN

Accounting o-level theories

Business Document: This are sources of information which proofs that a transaction has occurred.

Books of Prime Entry: This is the first book of entry where a business records its transaction.

Trade Discount: Discount given to encourage customers to buy in bulk. No double-entry or

transaction is recorded for trade discount.

Cash Discount: Discount given to encourage customers to pay promptly. Cash discount is recorded in
the books.

Cashbook: It is a self balancing form of a ledger and a book of prime entry where all the cash and
bank transactions are recorded.

Petty Cash Book: It is a cash book that is used for making small (petty) payments. It is used to record
transactions involving petty cash funds.

Cash Floats/Petty Cash Fund: A sum of money held by petty cashier.

Imprest System: It is a system for maintaining the petty cash funds. A fixed sum called imprest
amount or float is maintained. Petty cash fund is reimbursed to original amount after making
approved payment.

Advantages of Imprest System:

● Provides internal control

● Avoid overcrowding of the cashbook.

Trail Balance: Trail balance is a list of the ending balances of all accounts at a given date.

Purpose/ Advantages of Trail Balance:

● Check arithmetical accuracy of the ledger accounts.

● Helps in the preparation of financial statements.

Limitation of trail balance: A balanced trail balance does not mean that the entries in the accounts
contains no error. There are errors that are not revealed by the trail balance. Errors include: Error of
omission, commission, principle, original entry, compensating error, complete reversal.

Purpose/ Advantages of Suspense account:

● To temporarily balance a trail balance until the errors are discovered and corrected.

● To facilitate the preparation of draft financial statement.

Bank Reconciliation Statement: It shows the difference between the cash balance and bank balance

Purpose/ Advantage of Bank Reconciliation Statement:

● Determine accurate bank balance.

● Identify errors in the bank statement and bank account.

● Deterrence against fraud.

Bank Statement: It is a statement prepared by the bank which shows the transactions which took
place between the bank and the account holder over a period of time.
Credit Transfer: Money directly deposited deposited in the bank by a debtor.

Standing Order: A firm can construct its bank to pay a regular and certain amount of money at
stated dates or regular intervals to person or firms.

Direct Debit: An order given to a holder of an account, instructing it to pay to a specified person or
organisation any sum demanded.

Dishonoured cheque: A cheque that the bank refuses to pay.

Sales ledger Control Account: It is the summary of sales ledger.

Purchase Ledger Control Account: It is the summary of purchase ledger.

Purpose/Advantages of Control Account:

 Independent check on the accuracy of postings in the sales and purchase ledger.
 Avoid overcrowding in the general ledger with voluminous details.
 Deter and detect errors.
 Provide total of trade receivables and trade payables.

Contra or Offset transaction: It refers to the transfer of amount owing between a trade receivables
who is also a trade payable.

Capital Expenditure:

 The cost of acquiring asset and improving or extending non-current asset.

 Benefit will last for more than one accounting period.
 Recorded as non-current asset.

Capital Receipt:

 A receipt from the sale of fixed asset.

 A loan received.
 Additional capital.
 Income/Revenue from non-trading activity.

Revenue Expenditure:

 The purchase of goods for resale or services to run a business on a daily basis.
 Benefit last for less than one accounting period.
 Recorded as current asset or expenses.

Revenue Receipt: Income arising from normal trading activity and are entered in the income
statement.

Straight-line Method of depreciation:

 Depreciation expense remains constant over the asset’s useful life.

 Effect on profit for the year is constant.

Reducing Balance Method of depreciation:

 Depreciation expenses decreases over the asset’s useful life.

 Profit for the year increases as depreciation expenses decreases.
Irrecoverable Debts: Debts that are confirmed not collectable from trade receivables. They are
treated as expense.

Recovery of Irrecoverable Debts: Debts that are previously written off as irrecoverable was
subsequently recovered. It is treated as income.

Provision for Doubtful Debts: Provision for debt that are deemed uncollectible based on reasonable
estimation. It is a contra-asset.

Advantages of Partnership:

 Bigger pool of capital.

 Combined skills and experience of partners.
 Sharing of business task or duties between partners.

Disadvantages of Partnership:

 Disagreements due to conflicting views of partners.

 All partners are held responsible for losses of the business.
 Profits are shared.

Partnership Agreement: Its purpose is to specify matters of concern to the partners so that all
partners are clear on how the partnership operates to avoid future disputes.

Content of Partnership Agreement:

 Contribution of capital.
 Appropriation of profit/losses.
 Drawings of asset for personal use.
 Interest chargeable on drawings.
 Interest payable on capital.
 Partner’s salary.
 Interest chargeable on loans from partners.

Advantages of Limited Company:

 Large amount of capital can be raised.

 Business is managed by professionals.

Disadvantages of Limited Company:

 Expensive and complicated to start.

 Has to comply with more rules and regulations.
 High administration cost.

Issued Share Capital: Amount of share capital issued to shareholders.

Called-up Capital: The amount of issued share capital that the company has requested for payments
from the shareholders.

Paid-up Capital: The amount of called-up capital that the company has actually received the
payment from shareholders.

Preference Share Capital: These are shares that a company issued to its shareholder where a fixed
rate of dividend is payable.
Characteristics of Preference Share:

 No voting rights at shareholders’ meetings.

 Dividends are paid before ordinary shareholders.
 Fixed amount of dividend is paid.
 Upon company’s closure, preference shareholders are paid after outside liabilities and
before ordinary share.

Ordinary Share Capital: These are shares that a company issues to its shareholders where dividend
payable vary according to the profit of the company.

Characteristics of Ordinary Share Capital:

 Voting rights at shareholder’s meeting.

 Dividends are paid after preference shareholders.
 There dividend vary according to the profit of the company.
 Upon company’s closure, are paid after outside liabilities and preference shareholders.

General Reserves: It is a portion of profit for the year that was reserved for the future development
of the company.

Retained Earnings: It is an accumulation of balances of profit after distribution of dividend and

transfer of general reserves since the beginning of the company’s operation.

Debentures: It is a long term loan that carry a fixed rate of interest which is payable whether or not
the company makes a profit.

Receipt and Payment Account: It is a summary of the cashbook. It records all money that is
received and paid.

Accumulated Fund: It is the capital fund accumulated within the organisation from surpluses
obtained from running the club.

Direct Materials: It is the raw materials required to make finished goods.

Direct Labour: Wages of people directly involved in producing the finished goods.

Prime Cost: Total cost of producing the finished goods. (Direct Materials + Direct Labour + Direct
Expense)

Factory overheads: This are the indirect factory costs involved in operating the factory which cannot
be directly linked with the manufacturing of the finished goods.

Liquidity: It measures the ability of a business to repay current debts and fund its daily business
operation.

Working Capital: It refers to the excess of current assets over current liabilities.

Effects of insufficient working capital:

 Unable to repay debts on time.

 Unable to purchase goods on credit.
 Lose the trust of customers.
Improving working capital:

 Owner may inject more capital.

 Take up a long term loan.
 Sell excess of non-current assets.

Current ratio (or working capital ratio): It measures the ability of the business to pay its short term
debts using its current asset.

Liquid ratio (or acid test ratio): Measures the ability to pay its short term debts using its quick
assets.

Rate of Inventory Turnover: Measures the rate at which a business sell and replenishes its
inventory during the financial year.

Effects of inventory on liquidity and Profit:

High Inventory Levels Lower Inventory Levels

1. Cash is tied up causing liquid ratio to 1. Unable to meet customer demand resulting
decrease. in lost sales which leads to decrease in profit
for the year and lesser cash.

2. Increase in expense which reduces profit for 2. Increase in cost of sales which reduces profit
the year due to higher storage and holding for the year due to frequent replenishing
cost. which result in high cost of purchase.

Improving Inventory Management: Increase in sales of inventory by:

 Reducing selling price.

 Giving trade discount or special promotions.
 Advertising to raise brand awareness.

Trade receivables turnover: Measures the average time a business takes to collect from its credit
customers during the financial year. It indicates how efficient a business is in managing its trade
receivables.

Disadvantage of high trade receivables turnover:

 Not efficient in collecting its debts.

 Lead to cash flow problems.

Trade Payables Turnover: Measures the average time a business takes to pay its credit suppliers
during the financial year. It indicates how well a business manages its cash flow.

Higher Trade Payables:

Advantages Disadvantages
1. Increase in business working capital. 1. Business losses out cash discount.
2. Free short term cash flow. 2. Suppliers may not provide trade credit in
future.
Profitability: It measures the ability of a business to generate enough income to cover its expenses.

Purpose of profitability analysis:

 Identify areas to improve revenue.

 Identify areas to improve operating efficiency.
 Allow investors to determine their return on investment.

Ways to improve profitability:

 Source for cheaper supplier to reduce cost of purchase of inventory.

 Hold promotion for increase sales.
 Increase product variety to attract more customers.
 Source for other income.
 Reduce expenses through cost cutting measures.

Gross Margin: It is the amount of gross profit that a business earns for every sales revenue earned.

Ways to increase gross margin:

 Increase in selling price.

 Decrease in cost price.

Mark-up: It is the amount of gross profit that a business earns for every cost of sale.

Ways to increase mark up on cost:

 Increase in selling price

 Loss of quantity sold if inventory turnover rate decreases.

Profit Margin: It is the amount of profit that a business earns for every sales revenue earned.

Ways to increase profit margin:

 Increase in gross profit.

 Decrease in expense.

Return on capital employed: It indicates the amount of profit a business generates for every capital
invested. A high in return on capital employed suggests that the business is profitable and gives high
return on investment.