Chapter 1 – The Nature and Role of Accounting in Small Business – solutions to exercises

Exercise 1.1

Order Accounting Process

b Collecting Source documents like receipts and cheque butts
a Recording transactions in the journals and stock cards
d Preparing financial reports
c Providing advice to the owner of the business

Exercise 1.2

Action Accounting Process Stage

Preparing an Income Statement Reporting Output
Filing sales invoices Collecting Source Input
Documents
Entering transactions in a cash journal Recording Processin
g
Presenting the owner with alternative sources of Advice Advice
finance

Exercise 1.3
a

Principle Entity
Explanation The owner and the business are separate accounting entities therefore
the business’ assets (bank account) should not be used for personal
purposes. This payment should be recorded as drawings by the business
as the owner has taken business funds for personal use.

Principle Reporting Period

Explanation The business is deemed to be a going concern. Michael cannot wait until
the end of the business’ life to calculate profit as that may never come.
Therefore the life of the business must be broken up into periods so that
performance can be determined. Also the tax office would require the
business’ financial statements at the end of the financial year.

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Chapter 1 – The Nature and Role of Accounting in Small Business – solutions to exercises

Principle Historical Cost

Explanation The Musical instruments must be valued at their original purchase price as
this value is verified by source document evidence. Valuing the
instruments at their perceived market value ‘estimates’ their worth which
may be swayed by the owners opinion of their value and thus make the
valuation biased and unreliable.

Principle Monetary Unit

Explanation This principle states that all items must be recorded and reported in the
currency of the country of location where the reports are to be repaired.
Michael recording the tour’s earnings in Yen would make it impossible to
use with the existing financial information. The tour’s earnings should be
converted from Yen to Australian dollars and then incorporated in the
financial reports.

Principle Consistency
Explanation This principle states that accounting methods used by the business should
be consistent to allow the comparison of reports from one period to the
next. If Michael was to change accounting methods every year he would
not know whether the business improved due to changes in business
performance or the changes in accounting methods.

Principle Going Concern

Explanation The business is deemed to have a continuous life and its records should
be kept on that basis. Michael cannot list a three year loan as current
because that implies that this liability and all others will have to be paid
within 12 months. This is not the case as the business should be able to
distinguish between which liabilities are current (to be paid within 12
months) and those that do not have to be paid for a period greater than 12
months – Non Current!

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Chapter 1 – The Nature and Role of Accounting in Small Business – solutions to exercises

Exercise 1.4
a

Qualitative Characteristic Relevance

Explanation Pat does not need to list all 35 individual debtors as this information would
not be seen as material, that is it would not aid or improve decision
making. In fact it would probably have the opposite effect because it would
make the Balance Sheet more difficult to read. The same information could
be shown with one ‘debtors’ figure and have the same impact on
decisions.

Qualitative Characteristic Comparability

Explanation The accounting methods used by the business should be consistent from
one period to the next to allow the comparison of reports. If Pat was to
change accounting methods every year he would not know whether the
business improved due to changes in business performance or the change
in accounting method. The change in accounting method should be
disclosed in the financial reports of the business.

Qualitative Characteristic Reliability

Explanation Pat has recorded the electricity as an estimate and hence this information
is unreliable as there is no source document evidence to verify the amount
and thus the information contained in the reports will not be free from bias.

Qualitative Characteristic Relevance

Explanation Pat has paid for business expenses using his personal cheque book which
means that the reports of the business will not include all information that
will be useful for decision making. He will need to record these transaction
as a capital contribution as he is a separate accounting entity to the
business

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Chapter 1 – The Nature and Role of Accounting in Small Business – solutions to exercises

Qualitative Characteristic Reliability

Explanation The plumbing equipment must be valued at its original purchase price as
this value is verified by source document evidence. Valuing the
instruments at their perceived market value ‘estimates’ their worth which
may be swayed by the owners opinion of their value and thus make the
valuation biased and unreliable.

Qualitative Characteristic Relevance

Explanation Pat should only include information that relates to the current reporting
period that will help us to determine the business’ performance and
provide information useful for decision-making. The amount received has
yet to be earned and thus does not relate to this reporting period but
should be reported in the next reporting period.

Exercise 1.5
a

Principle Historical Cost

Explanation Betty must keep all the firm’s source documents as these provide the
evidence of the assets original purchase price. This is the only value that
can be verified and ensure that the figures in the Balance Sheet are
accurate and free from bias.

Qualitative Characteristic Reliability

Explanation Betty must keep the source documents as they provide verifiable evidence
of transactions and this ensures that all information contained in the
financial reports are free from bias.

Exercise 1.6
a

Qualitative Characteristic Relevance

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Chapter 1 – The Nature and Role of Accounting in Small Business – solutions to exercises

Explanation The owner should only include information that relates to the current
reporting period that will help to determine the business’ performance and
provide information useful for decision-making. The receipt is two years old
and may have already been recorded. This transaction does not relate to
the current reporting period and if included would alter the final result and
may mislead decision makers.

Principle Reporting Period

Explanation The business should have recorded and reported the cash receipt two
years ago in the reporting period in which the transaction occurred.
Therefore the financial reports would have included all significant
information for decision-making.

Exercise 1.7
a

Principle Entity
Explanation The owner and the business are separate accounting entities therefore the
business’ assets (bank account) should not be used for personal purposes.
Beria’s payment should be recorded as drawings by the business as the
owner has taken business funds for personal use.

Qualitative Characteristic Relevance

Explanation If this transaction is not recorded or reported then the reports of the
business will not include all information that will be useful for decision-
making. Beria has withdrawn business assets for personal use, this must
be recorded from the business’ perspective because the business and
Beria are separate accounting entities. By making drawings she has
reduced her claim on the assets of the business.

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