Accounting Fundamentals: A Step-by-Step Guide
1. What is the main purpose of accounting?
The main purpose of accounting is to systematically record, report, and analyze financial transactions of a business or organization. This process ensures that stakeholders can make informed decisions based on financial performance and position. It provides users with necessary financial information to assess the profitability, liquidity, and stability of a business, thereby facilitating economic decisions and compliance with legal requirements.
2. List any two users of accounting information.
- Management: Internal users such as management rely on accounting information for strategic planning, decision-making, and operational control.
- Investors: External users, including shareholders and potential investors, utilize accounting information to evaluate the financial health and performance of a company, influencing their investment decisions.
3. Define a Sole Trader.
A Sole Trader is an individual who owns and operates a business independently. This business structure means that the sole trader personally bears all responsibilities, debts, and profits from the business. It is characterized by ease of formation, complete control by the owner, and a limited regulatory framework compared to larger business structures.
4. What is the meaning of “faithful representation” in accounting?
"Faithful representation" in accounting refers to the concept that financial statements should accurately reflect the true economic events and transactions of a business. This means that the information presented should be complete, neutral, and free from error, providing a true and fair view of the financial performance and position of the entity.
5. Identify any two elements of financial statements.
- Assets: Resources owned by a business that have economic value and can provide future economic benefits.
- Liabilities: Obligations or debts that a business owes to external parties, which will require future sacrifices of economic benefits.
6. A business purchases goods worth K15, 000 and pays K5, 000 in cash. Record the transaction in the journal.
Journal Entry:
Date | Description | Debit | Credit
-------------|--------------------------|---------------|--------------
DD/MM/YYYY | Purchases (Goods) | K15,000 |
| Cash | | K5,000
| Accounts Payable | | K10,000
Explanation: The business has increased its assets (goods purchased) and decreased cash (cash paid). The remaining balance owed is recorded as a liability (accounts payable).
7. State the rule of double-entry for an asset purchased.
The rule of double-entry for an asset purchased states that for every transaction, at least two accounts are affected – one account is debited, and another is credited. Specifically, when an asset is purchased:
- The asset account (e.g., Inventory) is debited (increased).
- Either cash is credited (decreased) if paid in cash or an accounts payable is credited (increased) if owed on credit.
8. From the following balances, prepare a trial balance:
Account Title | Balance
-----------------------|--------
Cash | K4,000
Capital | K10,000
Inventory | K3,000
Sales | K7,000
Purchases | K5,000
-----------------------|--------
Total | K29,000
Explanation: A trial balance lists all accounts with their respective balances to ensure that total debits equal total credits.
9. Prepare a Trading, Profit, and Loss Account from the following:
Trading, Profit, and Loss Account
Sales: K25,000
Cost of Sales: (K10,000)
-------------------------
Gross Profit: K15,000
Expenses:
Rent: (K3,000)
Wages: (K4,000)
-------------------------
Net Profit: K8,000
10. Machinery bought for K20, 000, expected life: 5 years, no residual value. Calculate depreciation using the straight-line method.
Depreciation Calculation:
- Cost of Machinery: K20,000
- Useful Life: 5 years
- Residual Value: K0
Annual Depreciation = (Cost - Residual Value) / Useful Life
= (K20,000 - K0) / 5 = K4,000 per year
11. Distinguish between capital expenditure and revenue expenditure.
- Capital Expenditure: Expenditures that result in the acquisition of long-term assets or improvements to existing assets, which provide benefits over multiple periods (e.g., purchasing machinery).
- Revenue Expenditure: Expenditures for the day-to-day functioning of the business that are consumed within a year and do not add long-term value (e.g., repair and maintenance costs).
12. K500 is owed by a customer who has gone bankrupt. What type of adjustment is this, and how is it recorded?
This is classified as a bad debt adjustment. It indicates that the amount owed is unlikely to be collected. It is recorded by:
- Debiting the Bad Debts Expense account (to recognize the loss).
- Crediting the Accounts Receivable account (to remove the owed amount).
13. If rent of K1, 200 for December is unpaid at year-end, what adjustment is needed?
An adjustment for accrued expense is needed. The transaction will involve:
- Debiting the Rent Expense account by K1,200 (to recognize the expense incurred).
- Crediting the Accounts Payable account by K1,200 (to recognize the liability).
14. If insurance of K2, 400 was paid in advance for 12 months, but only 3 months relate to this year, what is the prepayment adjustment?
The prepayment adjustment recognizes that K2, 400 is paid for 12 months; therefore, the monthly insurance cost is K200.
Prepayment for this year: K600 (K200 x 3 months).
Adjustment needed:
- Insurance Expense: K600 (for the current year).
- Prepaid Insurance: K1,800 (which will be recognized as an asset for the remaining 9 months).
These steps provide a comprehensive understanding of basic accounting principles and transactions.