Bonus issues

• A company issues free shares to existing shareholders
• Uses reserves that have built up and capitalising them (turned into permanent share capital)
• NO CASH FLOWS IN OR OUT OF THE COMPANY
• Made to acknowledge that reserves now belong to shareholders
• Capital or revenue reserves can be used, but capital is used first because they have fewer uses overall

Rights issues

• Raises further finance by issuing shares to existing shareholders at a favourable price
• Rights can be sold on stock market

Ordinary shareholders

• Carry voting rights
• Receive dividends (interim and final) - amounts vary depending on profit
• No dividend may be paid if company makes a loss, dividend not carried forward to next year
• In the event of insolvency, ordinary share holders will be paid off last
• Not repayable - company will have finance for the foreseeable future

Preference shareholders

• Carry no voting rights
• Carry a fixed percentage rate of dividend
• Paid in preference to ordinary shareholders but only paid if there is a profit, otherwise are carried into next year
• In the event of insolvency preference shareholders will be paid off first
• Sometimes repayable

Loans

• Money borrowed from lenders such as banks
• Medium to long term basis
• Fixed rate of interest (finance costs)
• Generally repayments are made throughout period of loan
• Lenders require security - if the owner has an asset the loan can be secured to that so it may be sold if repayments are not made

Debentures

• Formal certificates raising long term finance
• Often traded on stock exchange
• Commonly secured against an asset
• Repayments made on the date stated on the debenture
• Fixed rate of interest (finance costs)
• In the event of insolvency, loans and debentures paid off first

Benefits

• Assists planning - setting out objectives in a budget allows the business to ensure it’s plans are achievable within all areas of the business. It is able to see what actions are necessary to achieve the aims set out in the budget.
• Co-ordinates business - the budget should be agreed by all managers of the business so all staff will be working together to achieve the same results. If there any problems these should be discussed while the budget is being set.
• Decision making - by planning ahead the business can decide how much it needs to spend on specific areas of the business to meet targets. Changes can be made where appropriate.
• Monitoring and control - it is important to compare the budget with the actual results so action can be taken to modify the operation of the business or change the budget over time, if it becomes unachievable.

Limitations

• The budget is only a prediction and the real figures may not reflect the original budget. 
• For the budget to be most accurate, it is essential the figures going into it are also as accurate as they can be. The more inaccurate it is, the less use it is to the business as a planning and control mechanism. A lot of care needs to be taken to estimate figures.
• The benefits of the budget must exceed the cost - preparing a budget is a fairly complex process and some businesses may find the task is not worth it for only limited benefits. 
• De-motivation - employees not involved in setting the budget may feel demotivated to achieve the budget. 
• Dysfunctional management - employees in one department may over-achieve their budget whilst others in another department may not achieve theirs as a result of the over achievers. An example would be the production department achieving extra output but the sales department might find this extra stock difficult to sell.
• Too low a level - if budgets are set at too low a level it will have no benefit to the business if it is too easy to achieve. They should be set at realistic levels to make the best use of the resources available.

Advantages

• Accuracy - transactions can be entered on a more accurate basis as usually only one entry per transaction, eliminating errors of only recording one side of the double entry system
• Legibility - figures are typed and therefore more legible to avoid the wrong figures being read
• Speed - it is far quicker to enter transactions on a computer than to manually record them in the written ledgers
• What-if? calculations - figures can be altered to show the business the effects certain changes will have on their profitability and liquidity. Especially useful in cash budget.
• Documents can be quickly prepared, for example invoices and statement of accounts, as debtor’s information will be stored on the computer. Payslips can also be quickly and efficiently issued.
• Work can quickly be shared between different members of the business through the software.

Disadvantages

• Cost - high installation costs and then the costs of updates and additional software which will be a recurring expense to the business.
• Disruption during time of installation - work may be disrupted when they are initially installed, resulting in reduced sales and unhappy workers.
• Files may be lost if a regular back up is not kept in the event of a system failure.
• Computer hackers may be able to gain access to information, threatening the security of the business.
• Employees may dislike computers and may be worried of bad backs and RSI.
• Having to train the employees to use the computers may cost money and time.
• Still the danger of errors as errors of omission, commission, original entry and principle will not be revealed.

Advantages to employees

• Being trained to use the computers would improve their future employment prospects or increase wages.
• Motivated to learn new skills.
• They will be able to work quicker and get more work done in the same amount of time.

Disadvantages to employees

• They may dislike computers and favour the traditional way of doing their job.
• Communication within the office between employees may be restricted as they are sat at a desk all day.
• Health risks such as eye strain and RSI.
• May fear redundancies as less people will be required to do the same amount of work as they did before now they have computers.

Gross profit margin (improvement - problems)

• Increase selling price with cost of sales remaining the same - customers may not want to pay new price, therefore negatively affecting profit in the long run
• Decrease cost of sales (purchase price) without selling price remaining the same - the quality of the product may be reduced and customers may go elsewhere

Net profit margin (improvement - problems)

• Increase gross profit margin
• Find other sources of income 
• Reduce expenses in relation to sales e.g. wages, advertising or operating expenses - this may be difficult to achieve as reducing wages will impact on staff and the ability to produce the product, reducing advertising may reduce sales

Rate of inventory (stock) turnover (improvement - problems)

• Reducing stock levels, for example only purchasing enough stock you know is able to sell - this could lead to stock-outs if enough stock is not readily available, there may not be enough to meet demand, reducing overall profitability
• Increase sales without increasing stock level, perhaps through advertising - these may create additional expenses
• Install a stock control system - may increase expenses initially

Final Accounts

1. Discuss the reasons for accounting for accruals and prepayments in the final accounts. [8]

We use accruals and prepayments during the production of final accounts because accounts are prepared on a credit basis, meaning transactions are recorded as the legal ownership of goods changes, rather than when a payment is made. Because of this, the accounts have to show when transactions occurred legally but not when cash physically was received. This is why accruals and prepayments are matched to the accounting period to which they relate, rather than just recording the actual cash that has been paid or received during the year. Accrued expenses are when the business has not paid for an expense which it has taken use for in the current accounting year. It intends to pay the remaining debt in the following year, but as the benefit has been received in the year to which it relates, the amount of the accrual is added to the expense in the income statement and shown as a current liability in the balance sheet, because the business still owes the amount. Prepaid expenses are expenses that have been paid by the business for an expense that relates to the following year. As the business has not received the benefit of the expense yet, it is deducted from the expense in the income statement and shown as a current asset in the balance sheet, as the business has yet to use the expense and will reduce next year’s payment. An common example of an accrual is wages and an example of a prepayment is insurance. They are used to ensure a true and fair view of the businesses financial position at the end of each year is accurate.

2. Explain how the creation of a provision for doubtful debts is an application of the prudence concept. [6]

The prudence concept involves taking the conservative, lower figure if there is any doubt for the value of fixed assets or profit. Creating a provision for doubtful debts is prudent because it is the realisation that some of your debtors may not pay, resulting in bad debts. By already allowing for this possibility, profit will not be overstated so the businesses final accounts will present it in a more accurate light. As the provision is created based on the previous years bad debt, the provision is usually an accurate figure which alters based on the total debtors figure so it is likely the net profit figure will be reliable. 

3. Distinguish between ‘purchases’ and ‘cost of sales’ [8]

Purchases are the goods a business buys to sell to it’s customers. They can be bought either on credit or by cash and make up the businesses stock. Cost of sales is the amount a business spends to get it’s stock to a resalable state. The formula for cost of sales is opening stock + purchases + carriage in - purchase returns - closing stock. The difference is that cost of sales accounts for carriage in, the money spent to transport goods to the business once it has purchased them, and purchase returns that the business has returned to the supplier. It also adds last year’s closing stock to the total as this has been sold and subtracts the closing stock for this year, as the business has not yet sold it.

4. Why is the distinction important when calculating the gross profit of a business? [2] (linked to question above)

Gross profit is net sales - cost of sales, as this accounts for all the costs involved in getting stock to a resalable state and also takes into account stock that has not been sold at the end of the accounting year and stock that already exists left over from the previous year.

5. Evaluate the usefulness of a double entry book system to a business. [8]

Double-entry bookkeeping is useful to a business as recording accounts will allow the business to prepare financial statements to see their profitability and liquidity for the year. This can then be compared to previous years or other similar businesses to evaluate the efficiency of a business and to see where improvements could be made. It is also helpful in tracing errors as each transaction will have two entries in different accounts, making up the double entry transaction. If one of the accounts does not balance, they can then be investigated to make sure one part of the double entry has not be omitted from the accounts. It is also useful to prepare double entry accounts because it is an aid to decision making as cash budgets, projected income statements and balance sheets can be produced to predict how the business will perform in the future and to assess liquidity and profitability. It also helps reduce fraud as the transactions have been recorded and if they are backed up with source document evidence, there is proof the transaction took place. The bank may also be interested in viewing the accounts of a business if it is looking to be granted an overdraft or a loan, as the bank would be interested in the liquidity of the business to ensure it is able to pay off it’s debts, along with offering advice.

6. Evaluate the problems of inadequate record keeping for a sole trader. [10]

If inadequate accounting records are kept, a sole trader may find themselves struggling to manage their finances properly as they may be spending too much on certain things as they are unable to produce budgets to assess where money needs to be going. Fraud is more likely as there would be less credible references to where transactions have occurred. If a business does not have good accounting records, it will be difficult to prepare accurate financial accounts which gives a bad impression of the business to potential suppliers and customers, as they will not feel secure that the business will supply them with the right goods or pay their debts quickly. 

Depreciation

1. Explain the purpose of providing for depreciation in the accounts of a business. [6]

Depreciation accounts for the fall in the value of an asset over a period of time. This could be due to wearing out, obsoleteness, inadequacy or damage. It is prudent to depreciate as it does not overstate the value of fixed assets to provide a conservative view of the business. Depreciation is a non-cash expense and although it appears in the profit and loss account as an expense, it is not physical cash that is being taken from the business. When a fixed asset is sold, the net book value (cost - provision for depreciation) is compared against the sales proceeds to decide whether the business has made a loss or profit on disposal. 

2. Discuss the problems involved in accounting for depreciation. [8]

Depreciation is only an estimate and the value of an asset is subjective and depends entirely on the person who is valuing it. Some assets, such as land or property, go up in value, rendering depreciation useless in this case as they are not going to depreciate constantly, this is why some businesses have different policies on depreciation depending on what kind of asset it is. The straight line method of depreciation is calculated by “cost of asset - residual value/years it will be used”, but the residual value (expected value at the end of it’s life) may not be an accurate figure therefore the amount of depreciation may be inaccurate.

3. “Depreciation is a movement of cash from the business. Discuss why this statement is a misunderstanding of the depreciation process.” [6]

Depreciation is a non-cash expense and no cash is involved when depreciation is used. Depreciation is solely the fall in value of a fixed asset over it’s lifetime, but there are no costs involved in depreciating.

Discounts
1. Differentiate between cash discount and trade discount. [6]

Cash discount is offered to customers in return for an early payment on their debts owing to the business. It is listed under “terms” in the invoice and only applies if the debtor pays within the time stipulated by the supplier. If they pay longer than this time, the normal sales price applies. It is a discount offered to encourage faster payment to speed up liquidity. Trade discount is offered to businesses in the same trade as the business, where stock is sold at a lower price to the business compared to what it would be sold for to the general public. This is not recorded on the invoice, aside from the reduced invoice total.

2. Explain why a business might use a three column cash book rather than a two column cash book. [2]

When a three column cash book is used, it accounts for discounts allowed and discounts received all in the same place and also aids in the basic arithmetic to ensure the discount is calculated accurately. Instead of being balanced off and brought down to the next month, discounts are transferred to the T accounts in the ledgers.

3. Outline the full accounting entries for cash discount for:
a. purchases; [4]
b. sales [4]

Purchased £100 on credit, 5% cash discount: Dr purchases £100, Cr supplier £100, Cr bank £95, Cr discount recieved £5, Dr supplier £95, Dr supplier £5

Sold £200 on credit, 2.5% cash discount: Cr sales £200, Dr customer £200, Dr bank £195, Dr discount allowed £5, Cr customer £195, Cr customer £5

Bad and Doubtful Debts

1. What is the difference between a bad debt and a provision for doubtful debts? [2]

A bad debt is a debt that the business has written off and accepted that they will never receive payment for, possibly due to the debtor going bust. Provision for doubtful debts is the possibility of a debtor not paying, not that they definitely won’t.

2. Explain why a business would create a provision for doubtful debts. [4]

As not to overstate profit, it is prudent to account for some debtor not paying their debts as it is likely not everybody will pay.

4. How would a bad debt and a provision for doubtful debts be treated in the final accounts? [4]

Bad debt would be deducted as an expense in the profit and loss account and taken away from the total debtors figure under current assets in the balance sheet. Provision for doubtful debts is an expense and is deducted from total debtors in the balance sheet. When adjusting the provision, an increase is shown as an expense and a decrease is added as an income.

5. Identify two ways in which a business could reduce bad debts. [2]

By improving credit control by chasing up debtors with telephone calls and letters to encourage them to pay their debts. They could introduce cash discounts to encourage faster payment as they would receive discount, however this reduces the businesses profit.

Errors

1. Using an appropriate example, explain what is meant by an error of principle. [2]

An error of principle is when a transaction has been entered in the wrong type of account, an example being debiting vehicles instead of vehicle expenses, as one is a fixed asset and the other is an expenses account.

2. Identify and explain three types of error which would not affect the balancing of a trial balance. [9]

An error of omission would not affect the balancing of a trial balance because if both sides of the double entry transaction have been missed out, the trial balance will still balance as it will not detect the missing entry. Another error that would not be identified is an error of commission as the trial balance is only a check on arithmetical accuracy and will not know the transaction had been entered in the wrong person’s account, for example J Smith rather than J Smith Ltd. A compensating error would not be shown either because it consists of two errors cancelling each other out, therefore the trial balance would still be shown to balance.

Control Accounts

1. Evaluate how control accounts would assist in each of the following:
(i) detection of errors; [3]

Control accounts detect errors because they can pinpoint which individual ledger the error is in and allow it to be investigated, as the sales ledger control account should balance with the sales ledger. It is a check on arithmetic accuracy and locates the ledger which the error has been made in to allow for it to be fixed faster.

(ii) prevention of fraud. [3]

The control account and the regular ledgers are usually managed by different people, meaning the chances of fraud are reduced as the accounts not balancing will need to be investigated so the fraudulent entries can be discovered. 

2. Discuss three advantages of using control accounts. [9]

Control accounts provide a check on the arithmetical accuracy of the accounts and will locate any errors as the balances will not balance if there are problems. They allow instant figures for debtors and creditors to be taken from the accounts for management, this is faster than having to add up all of the individual ledger accounts. They also prevent fraud as they are usually managed by different people and unless they are working together, the fraudulent entries will be identified.