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SOLUTIONS TO EXERCISES
Lesson 1: Definition of Accounting
- What is accounting? What are its main functions?
Accounting is the process of financially measuring, recording, summarizing and communicating the economic activity of an organization.
Accounting provides financial information about an organization’s economic activities which is intended to be used as a basis for decision making. It provides the information required to answer important questions such as: what are the resources of the organization? What debts does it owe? How do its operating expenses compare with its revenue? Is it sustainable?
- What is the difference between Financial and Management Accounting?
Financial accounting presents a summary view of the financial results of past operations and its reports are generally aimed at external audiences. Management accounting information is tracked and presented at a much more detailed level, such as by programme or branch. Projected financial information is also a part of management accounting and is aimed primarily at internal audiences.
- Name the three key financial statements and briefly describe each.
The Balance Sheet is a summary of the organization’s uses of funds (assets) and sources of funds (liabilities and equity) at a specific point in time. A Balance Sheet always balances, in that assets are equal to the sum of liabilities plus equity.
The Income Statement reports the organization’s economic performance over a specified period of time.
The Statement of Changes in Financial Position reports the organization's sources and uses of funds (also referred to as the Statement of Changes in Sources and Uses of Funds or the Cash Flow Statement). It explains how an organization obtains cash (sources of funds) and how it spends cash (use of funds) including the borrowing and repayment of debt, capital transactions, and other factors that may affect the cash position.
- Name five of the Basic Accounting Principles:
I. the Business Entity Concept ii. the Cost Principle iii. the Going Concern Concept iv. Double-entry Accounting v. the Realization Principle
- Write the meaning of the following Principles:
i. Cost Principle
All assets must be recorded on the books of a business at their actual cost. This amount may be different from what it would cost today to replace them or the amount the assets could be sold for.
ii. Consistency Principle
Organizations must consistently apply the same accounting principles from period to period. This ensures that reports from various periods may be compared to produce meaningful conclusions on the financial position of the organization, and the results of its operations.
iii. Business Entity Concept
Every business is a separate entity, distinct from its owner and from every other business. Therefore, the records and reports of a business should not include the personal transactions or assets of either its owner(s) or those of another business.
For the following transactions, show how these affect the Balance Sheet:
i.^
Purchase land on credit (> one year)
vi.
Purchase a Treasury Bill for cash
ii.
Disburse loan to client
vii.
Client withdraws savings
iii.
Purchase motorcycles for staff - pay half cash; half short-term credit
viii.
Receive an unrestricted donation
iv.
Purchase office furniture on short-term credit
ix.
A Current loan becomes past due
v.
Take loan from bank at commercial rate of interest (> one year)
x.
Receive a restricted donation for operations (3 years)
ASSETS
=^
LIABILITIES
EQUITY
Cash
CurrentLoans Outstanding
Loans Past Due
Investments
Property &Equipment
Short-termBorrowing
ClientSavings
Long-term
Debt
Restricted/DeferredRevenue
Equity
Purchase land on credit (> one year)
Disburse loan to client
Purchase motorcycles forstaff - pay half cash, halfshort-term credit
Purchase office furniture onshort-term credit
Take loan from bank (> one year)
Purchase a T-Bill for cash
Client withdraws savings
Receive an unrestricteddonation
Current loan becomes pastdue
Receive restricted donation
- Draw the general format of a Balance Sheet.
Balance Sheet As at ----------------- Assets Liabilities
Equity
Total Assets Total Liabilities and Equity
- Prepare a Balance Sheet for MicroFund Inc. as at June 30, 1995, on the basis of the information supplied.
MicroFund Inc.
BALANCE SHEET
As at June 30, 1995
ASSETS LIABILITIES & EQUITY
Cash & Bank Current Accounts 11,
LIABILITIES
Interest Bearing Deposits 7,366 Short-term Borrowings (commercial) 7, 18,366 Client Savings 146, Loans Outstanding: Current 350,000 Total Current Liabilities 154, Past Due 70, Restructured 10, Loans Outstanding (Gross) 430,000 Long-term Debt (commercial rate) 100, (Loan Loss Reserve) (21,000) Long-term Debt (concessional rate) 150, Net Loans Outstanding 409,000 Restricted/Deferred Revenue 139, Other Current Assets 2, Total Current Assets 429,866 TOTAL LIABILITIES 543, Long-term Investments 104, Property and Equipment: (^) EQUITY Cost 134,386 Loan Fund Capital 84, (Accumulated Depreciation) (23,219) Retained Net Surplus/(Deficit) prior 6, Net Property and Equipment 111,167 Net Surplus/(Deficit) current year 10,
Net Long-term Assets 215,667 TOTAL EQUITY 101,
TOTAL ASSETS 645,533 TOTAL LIABILITIES & EQUITY 645,
5. Prepare an Income Statement for MicroFund Inc. for the period ended December 31, 1993, on
the basis of the information supplied.
MicroFund Inc.
Lesson 4: Recording Changes in Financial Position
- Indicate, with a check mark, how the following would be recorded:
Debit Credit
- an increase in cash √
- a decrease in loans outstanding √
- receipt of interest revenue √
- What is the difference between Cash and Accrual based accounting?
Cash accounting records transactions only when the revenue has been received or the expense incurred. Accrual accounting records the revenue when the transaction takes place before the cash has been received.
- Explain what is meant by Double-entry accounting.
Double-entry Accounting is based on the concept that every transaction affects and is recorded in at least two accounts on an organization’s books. Therefore each transaction requires entries in two or more places. Each transaction affects either Assets, Liabilities and/or Equity.
The accounting equation states that: ASSETS = LIABILITIES + EQUITY. For every account affected by a transaction there is an equal affect on other accounts which keeps the accounting equation balanced. Therefore, an increase in an organization’s assets must be offset by either a decrease in another asset, or an increase in liabilities or equity.
- Why are vouchers prepared?
Vouchers are prepared in order to create a paper trail for each transaction. This paper trail enables an organization to have adequate internal control over its record keeping.
- Why should the bank account statement be reconciled with accounting records?
The bank account statement should be reconciled with accounting records as it is important to ensure that all cash transactions are properly recorded, including bank charges, in order to determine the financial position of the organization. In addition, the number of cash transactions is large in most organizations or businesses and therefore the chances of fraud being committed regarding cash are higher as compared to other assets.
- Create a General Journal with the previous transactions.
GENERAL JOURNAL
Date Account Title and Explanation Ref.* Debit Credit Mar 1 Cash 800 Client Savings 800 (collected client savings) 1 Salaries & Benefits 1, Cash 1, (paid staff salaries) 10 Interest Bearing Deposits 4, Cash 4, (purchased a Treasury Bill) 15 Cash 7, Long-term Investments 7, (long-term investment matured) 17 Equipment 1, Short-term Borrowings 1, (purchased furniture on credit) 20 Cash 500 Interest on Current Loans 500 (interest earned on current loans) 25 Travel Expenses 2, Cash 2, (paid travel expenses) 27 Cash 45 Service Charges 45 (collected client service charges) 30 Interest Paid on Client Savings 150 Cash 150 (paid interest on client savings)
Lesson 5: Summarizing Changes in Financial Position
- What is a ledger account?
A ledger account represents the accumulation of all information about changes in an asset, liability, equity, revenue or expense item in one place. For example, a ledger account for the asset “cash” would record each cash disbursement over a period of time as well as all cash received by the organization.
Each ledger account is identified by its account name and its account number. The accounts are numbered based on whether they are an Asset, Liability, Equity, Revenue or Expense account.
- What is the difference between the General Journal and the General Ledger?
The General Journal lists every transaction in chronological order. The General Ledger summarizes the transactions by account number.
- Which of the following have opening balances:
a. Balance Sheet accounts (√ )
- Give two examples of adjustments made at the end of the accounting period.
i. Depreciation Expense ii. Provision for Loan Losses
- Why is a Trial Balance created?
A Trial Balance is created to verify that the debits and credits entered into the General Ledger are balanced.
(i) cont’d
GENERAL JOURNAL (Cont’d)
Date Account Title and Explanation Ref. Debit Credit
April 27 Salaries & Benefits 510 5, Cash 101 5, (paid staff salaries) 27 Interest Paid on Long-term Debt 503 36 Cash 101 36 (paid interest on loan) 27 Cash 101 1, Loans Outstanding - Current 103 1, Interest on Current Loans 401 20 (collected current loan payment) 29 Rent 514 1, Cash 101 1, (rent paid on office space) 29 Loans Outstanding - Current 103 1, Cash 101 1, (disbursed loan to client) 29 Cash 101 30 Loan Fees/Service Charges 404 30 (collected service charge from client) 30 Loans Outstanding - Restructured 105 2, Loans Outstanding - Past Due 104 2, (restructured a past due loan) 30 Loan Loss Reserve (negative asset) 106 2, Loans Outstanding - Past Due 104 2, (to write-off a past due loan) 30 Cash 101 10, Long-term Debt (Commercial) 203 10, (borrow from bank)
(ii) GENERAL LEDGER
Date Explanation Debit Credit Balance 101 Cash 5, April 2 500 5, 2 1,000 4, 2 2,500 2, 2 75 2, 3 4,400 6, 10 234 6, 16 5,000 1, 16 150 1, 27 5,500 (4,109) 27 36 (4,145) 27 1,020 (3,125) 29 1,000 (4,125) 29 1,000 (5,125) 29 30 (5,095) 30 10,000 4, 102 Deposits 8, April 2 500 7, 103 Loans O/S - Current 66, April 2 2,500 68, 3 3,480 65, 10 1,000 64, 16 5,000 69, 27 1,000 68, 29 1,000 69, 104 Loans O/S - Past Due 17, April 10 1,000 18, 30 2,500 15, 30 2,000 13, 105 Loans - Restructured 1, April 30 2,500 3, 106 Loan Loss Reserve (7,000) April 30 2,000 (5,000) 107 Other Current Assets 500 114 Long-term Investments 12, 116 Equipment 4, April 2 1,000 5, 117 Accumulated Depreciation (700)
(iii)
- For the period ended December 31, INCOME STATEMENT
- Interest on Current & Past Due Loans 4, FINANCIAL INCOME:
- Interest on Investments
- Loan Fees/Service Charges 1,
- Total Financial Income 6,
- Interest on debt FINANCIAL COSTS:
- Interest paid on deposits
- Total Financial Costs
- GROSS FINANCIAL MARGIN 5,
- Provision for Loan Losses 1,
- NET FINANCIAL MARGIN 4,
- Salaries & Benefits 2, Operating Expenses
- Rent
- Utilities
- Office Expenses
- Travel
- Depreciation
- Equipment Leasing
- Software
- Other
- Total Operating Expenses 4,
- NET INCOME FROM OPERATIONS
- Grant Revenue for Operations 2,
- Excess of Income over Expenses 2, - April 30, TRIAL BALANCE
- 101 Cash 4, Ref Ledger Accounts Debit Credit
- 102 Deposits 7,
- 103 Loans O/S - Current 69,
- 104 Loans O/S - Past Due 13,
- 105 Loans - Restructured 3,
- 107 Other Current Assets 106 Loan Loss Reserve (5,000)
- 114 Long-term Investments 12,
- 116 Equipment 5,
- 201 Short-term Borrowing 23, 117 Accumulated Depreciation (700)
- 202 Client Savings
- 203 Long-term Debt (Commercial) 22,
- 204 Long-term Debt (Concessional) 35,
- 301 Loan Fund Capital 40,
- 302 Retained Net Surplus/Deficit 1,
- 401 Interest on Current & Past-due Loans
- 404 Loan Fees/Service Charges
- 501 Interest Paid on Long-Term Debt
- 510 Salaries & Benefits 5,
- 512 Telephone
- 513 Rent 1,
- 515 Utilities
- 524 Travel 5,
Lesson 6: Relationship between Financial Statements
- What are two examples of non-cash items?
i. Depreciation Expense ii. Provision for Loan Losses
- What is the purpose of creating the Statement of Changes in Financial Position?
The Statement of Changes in Financial Position is created in order to determine whether an organization has enough cash flow (or working capital) from operations and other sources and uses of cash.
It is important that cash flow be forecasted accurately for two reasons:
(i) Idle funds are expensive. If an Organization has branches which it charges for funds disbursed to them then excess cash sitting at the branch is expensive due to the “cost of funds” charged to the branches by Head Office.
(ii) If the Organization is left without enough cash, bills may go unpaid or clients may go without their loans.
- What are the elements which change Equity?
There are three elements which change equity: (i) income (ii) investments by owner(s) (iii) distribution to owner(s)
- Choose the right answer:
Equity Increases Equity Decreases
Net Surplus - current year √
Donation to Loan Fund Capital √
Dividend payment to shareholders √
Net Loss - current year √
