Zhenghua POA Summary Notes - O Levels

1 POA Summary Notes 1. Accounting Theories 2. Definitions 3. Double entry/ Journals 4. Formulas 5. Financial Statements 6. POA theory questions

2 1. Accounting Theories • state the general explanation of each accounting theory • explain how each accounting theory is applied in specific scenarios Accounting theory General explanation Specific application Objectivity Accounting information recorded must be supported by reliable and verifiable evidence so that financial statements will be free from opinions and biases. A source document provides evidence (objectivity theory) to capture occurrence of a transaction. The transaction is recorded at the original cost that it occurred (historical cost theory). Historical cost Transactions should be recorded at their original cost. Monetary Only business transactions that can be measured in monetary terms are recorded. Accounting entity The activities of a business are separate from the actions of the owner. All transactions are recorded from the point of view of the business. Explain how the accounting entity theory is applied to account for capital and drawings. According to the accounting entity theory, only transactions that affect the business are recorded while transactions relating to the owner that do not affect the business are not recorded. Accounting period The life of a business is divided into regular time intervals. As businesses are assumed to operate forever (going concern theory), financial statements should be prepared at regular time intervals (accounting period theory) to provide timely information for stakeholders to make decisions. Going concern A business is assumed to have an indefinite economic life unless there is credible evidence that it may close down.

3 Accounting theory General explanation Specific application Revenue Recognition Revenue is earned when goods have been delivered or services have been provided. Explain the revenue recognition theory behind the accounting of revenue and other income. According to the revenue recognition theory, • revenue is recognised when goods are sold and delivered. • service fee revenue is recognised when services have been provided. Accrual basis of accounting Business activities that have occurred, regardless of whether cash is paid or received, should be recorded in the relevant accounting period. Explain the accrual basis of accounting behind the accounting of revenue and other income. Based on the accrual basis of accounting, • service fee revenue received before services are provided should not be recognised until the services are provided to the customer regardless of whether payment has been received or not. • other income that relate to services that have been provided but not received must be recorded as other income in the current financial period. Explain the accrual basis of accounting behind the accounting of other expenses. According to the accrual basis of accounting, other expenses must be recognised in the period the services have been used, regardless of whether they have been paid for or not.

4 Accounting theory General explanation Specific application Matching Expenses incurred must be matched against income earned in the same period to determine the profit for that period. Explain the matching theory behind the accounting of cost of sales and other expenses. According to the matching theory • the cost incurred to buy inventory must be matched against the sales revenue earned from selling the inventory in the same accounting period to determine the gross profit for that period. • other costs incurred during the operation of a business to generate revenue and other income must be matched against revenue and other income earned in the same accounting period to determine the profit for that period. Explain the accounting of depreciation expense in relation to the matching theory. When a business uses non-current assets to generate income, a portion of the original cost of the non-current assets has to be recorded as depreciation expense. It will be matched against the income earned in the same financial period (matching theory) to arrive at the profit for the period. Explain the accounting of impairment loss on trade receivables using the matching theory. The change in estimated amount of debts likely to be uncollectible will be reported as impairment loss on trade receivables (expense) in the same financial period as credit sales (income) was earned. The matching of expenses incurred to the income earned is in accordance to the matching theory.

5 Accounting theory General explanation Specific application Consistency Once an accounting method is chosen, this method should be applied to all future accounting periods to enable meaningful comparison. Explain the accounting of depreciation expense in relation to the consistency theory. Unless there is a change of usage pattern, a business should use the same method of depreciation (consistency theory) and rate of depreciation every financial period to enable meaningful comparison of the net book value of non-current assets over time. Materiality Relevant information should be reported in the financial statements if it is likely to make a difference to the decision-making process. Explain the treatment of capital expenditure and revenue expenditure in relation to the materiality theory. If the amount spent on a non-current asset is insignificant to decision-making when compared to the size of the income, profit, assets or equity of the business, it does not need to be classified as a capital expenditure and be reported as a non-current asset. Instead, it can be classified as revenue expenditure and be reported as an expense. This is in accordance with the materiality theory.

6 Accounting theory General explanation Specific application Prudence The accounting treatment chosen should be the one that least overstates assets and profits and least understates liabilities and losses. Explain the valuation of inventory in relation to prudence theory. According to the prudence theory, inventory is valued at the lower of cost and net realisable value to ensure that inventory is not overstated. Explain the accounting of allowance for impairment of trade receivables using the prudence theory. The estimated amount of debts likely to be uncollectible will be reported as allowance for impairment of trade receivables and shown as a deduction against the book value of trade receivables. This is to ensure that trade receivables balance is not overstated (prudence theory) and reflects the net amount that is collectible.

7 2. Definitions • Define assets, liabilities, equity, income and expenses and their examples Assets: resources a business owns or controls that are expected to provide future benefits. Non-current assets Current assets Office equipment electronic appliances used in office (e.g. computers, printers) Cash at bank cash deposited with the bank Motor vehicles vehicles for business use (e.g. vans, trucks) Cash in hand physical cash kept by the business Fixtures and fittings furniture and items that are attached to a building by nail or screw for business use (e.g. tables, shelves) Inventory goods bought by the business to sell to its customers Machinery heavy-duty electronic appliances used to perform complex tasks (e.g. drills) Trade receivables revenue earned but not yet collected from credit customers Premises / Property buildings and land owned and used by the business Income receivable income earned but not yet collected from credit customers Prepaid expense expenses not incurred but paid in advance Allowance for impairment of trade receivables estimated