WAEC SSCE - Financial Accounting - 2017 (Essay)

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(a) Explanation of terms

1. Trade discount: a reduction granted off the list (catalogue) price of goods, usually for buying in bulk or for being a fellow trader. It is deducted before the invoice total is arrived at, so only the net amount is recorded; trade discount never appears as a separate entry in the books.
2. Cash discount: an allowance given to a debtor for settling an account promptly, within a stated credit period. It is recorded in the books - as discount allowed (an expense) by the seller and discount received (an income) by the buyer.
3. Bad debts: debts owed by customers that have become irrecoverable and are written off as a loss (an expense) in the profit and loss account.
4. Provision for doubtful debts: an estimated amount set aside out of profit, on the prudence principle, to cover debts that may prove irrecoverable in the future. It is a charge against profit and reduces debtors in the balance sheet.
5. Bad debts recovered: amounts previously written off as bad but later paid by the debtor; they are treated as an income/gain in the profit and loss account.

(b) Errors that do not affect the agreement of the trial balance

• Error of omission - a transaction completely left out of the books.
• Error of commission - correct amount posted to the wrong account of the same class (e.g. wrong debtor).
• Error of principle - posting to a wrong class of account (e.g. an asset treated as an expense).
• Error of original entry / error of amount - a wrong figure entered from the source document into both accounts.
• Complete reversal of entries - the account to be debited is credited and vice versa.
• Compensating errors - two or more errors that cancel each other out.
• Error of duplication - a transaction recorded twice.

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(a) What is a Bank Reconciliation Statement?

A bank reconciliation statement is a statement prepared to explain and reconcile the difference between the balance shown by the cash book (bank column) and the balance shown by the bank statement (pass book) on a particular date.

(b) Three reasons for preparing a bank reconciliation statement

• To detect errors and omissions made in the cash book or by the bank.
• To identify the causes of the difference, such as unpresented and uncredited cheques and bank charges.
• To reveal dishonoured cheques and possible fraud, and to bring the cash book up to date so the true bank balance is known.

(c) Explanation of terms

• Unpresented cheques: cheques drawn and issued by the firm and already entered (credited) in the cash book, but not yet presented to or paid by the bank.
• Standing order: a written instruction by a customer to the bank to make fixed, regular payments on the customer's behalf on stated dates (e.g. rent, insurance).
• Credit transfer: money paid directly into the firm's bank account by a third party (e.g. a debtor) without passing through the firm's cash book until discovered.

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(a) Four main groups of accounting ratios

• Profitability ratios (e.g. gross profit percentage, net profit margin, return on capital employed).
• Liquidity ratios (e.g. current ratio, acid-test/quick ratio).
• Efficiency / activity ratios (e.g. rate of stock turnover, debtors and creditors periods).
• Gearing / investment (long-term solvency) ratios (e.g. interest cover, gearing ratio).

(b) Ratio relating to each statement

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(a) Terms used in not-for-profit making organisations

1. Accumulated fund: the capital of the organisation - the excess of its total assets over its total liabilities.
2. Subscription in arrears: subscriptions that are due and have been earned for the period but have not yet been received from members; treated as a current asset (income owing).
3. Receipts and Payments Account: a summarised cash book showing all cash and bank receipts and payments during the period, with opening and closing balances; it records both capital and revenue items on a cash basis.
4. Income and Expenditure Account: the equivalent of the profit and loss account; it records revenue incomes and expenses on the accruals basis to determine the surplus or deficit for the period.
5. Entrance fees: fees paid by new members on admission to the organisation.

(b) Distinction between shares and debentures

• A share is a unit of the ownership capital of a company; a shareholder is a member/owner. A debenture is a loan to the company; a debenture holder is a creditor.
• Shares earn a dividend that depends on profit (an appropriation of profit); debentures earn a fixed interest that is a charge payable whether or not profit is made.
• Shareholders have voting rights; debenture holders do not.
• Debentures are usually secured and repaid before shareholders on winding up; ordinary shareholders rank last.

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(a) What is a source document?

A source document is the original written record or evidence of a business transaction, from which entries are first made in the books of account. It provides proof that a transaction took place and shows its date, parties and amount.

(b) Six types of source documents

• Invoice
• Receipt
• Credit note
• Debit note
• Cheque (and its counterfoil)
• Cash memo / payment voucher

(Others acceptable: bank paying-in slip, purchase order, statement of account.)

(c) Three uses of subsidiary books

• They relieve the ledger of excessive detail by recording similar transactions together, keeping the ledger neat.
• They group transactions of the same type (e.g. all credit sales, all credit purchases), making reference and posting to the ledger easier and faster.
• They allow the division of book-keeping work among several clerks, which speeds up work and helps reduce and locate errors.

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(a) and (b) Accounting ratios explained

1. Accounting ratios: mathematical relationships between two related figures in the financial statements, used to measure and interpret a firm's profitability, liquidity, efficiency and financial position.
2. Current ratio \( = \dfrac{\text{Current assets}}{\text{Current liabilities}} \). It measures short-term liquidity - the ability to meet current obligations as they fall due (a level around 2:1 is often regarded as satisfactory).
3. Rate of stock turnover \( = \dfrac{\text{Cost of goods sold}}{\text{Average stock}} \). It shows the number of times, on average, stock is sold and replaced during a period; a higher rate suggests brisk trading.
4. Return on capital employed (ROCE) \( = \dfrac{\text{Net profit}}{\text{Capital employed}} \times 100 \). It measures how efficiently the capital invested is used to generate profit.
5. Average collection period \( = \dfrac{\text{Debtors}}{\text{Net credit sales}} \times 365 \). It shows the average number of days debtors take to settle their accounts.
6. Gross profit percentage \( = \dfrac{\text{Gross profit}}{\text{Net sales}} \times 100 \). It measures the profitability of trading before deducting operating expenses.

(c) Importance of accounting ratios

• They measure profitability, liquidity and operating efficiency.
• They allow comparison of performance over time and between businesses.
• They assist management in planning, control and decision-making.
• They help investors and lenders judge the safety of their money.
• They reveal the solvency and financial strength of the business.
• They highlight trends, strengths and weaknesses for corrective action.

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(a) Deba Duwa Enterprise — Journal Proper

(b) Suspense Account

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(a) Terms used in the accounts of not-for-profit making organisations

• Accumulated fund: the capital of the organisation - the excess of its assets over its liabilities.
• Receipts and Payments Account: a summary of all cash and bank receipts and payments for the period, similar to a cash book, with opening and closing balances.
• Income and Expenditure Account: the equivalent of a profit and loss account; it records incomes and expenses on the accruals basis to show a surplus or deficit.
• Subscriptions: the periodic dues paid by members; the main source of income.
• Entrance (admission) fees: fees paid by new members on joining.
• Life membership: a lump sum paid for membership that lasts a member's lifetime.
• Surplus/Deficit: the excess of income over expenditure (surplus) or of expenditure over income (deficit).
• Honorarium: a token payment made to an officer for voluntary services rendered.

(b) Distinction between shares and debentures

• A share is a unit of the ownership capital of a company; a shareholder is a part-owner/member. A debenture is a loan to the company; a debenture holder is a creditor.
• Shares earn a dividend, which depends on profits and is an appropriation of profit. Debentures earn a fixed rate of interest, which is a charge/expense payable whether or not profit is made.
• Shareholders have voting rights; debenture holders do not.
• Debentures are usually secured and are repaid before shareholders on winding up; ordinary shareholders are paid last.

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(a) Suspense account

A suspense account is a temporary account into which an amount is placed either when the source or correct account of a transaction is unknown (pending investigation), or when the totals of a trial balance fail to agree, the difference being held there pending the location and correction of the errors. Once the errors are found and corrected, the suspense account is cleared and closes to nil.

(b)(i) Provisions and Reserves

(b)(ii) Expenses and Revenue

(b)(iii) Capital reserves and Revenue reserves