AS Level Accounting formulas and key facts

Financial accounting

Types of business entity

• Sole trader: one owner who keeps all the profit and makes all the decisions, but has unlimited liability and limited capital.
• Partnership: more capital and a wider range of skills, but profit is shared and each partner may be liable for debts made by the other partners.
• Limited company: separate legal entity, limited liability, can issue shares; but more legal rules apply and its accounts must be filed for the public to see.
• Limited liability: a shareholder can lose only the amount paid, or still owing, on the shares.
• Secured loan: the lender can sell named assets if the loan is not repaid, so the interest rate is lower than on an unsecured loan.
• Bank overdraft: flexible and short-term, interest is charged only on the amount overdrawn, but the bank can demand repayment at any time.
• Companies only: ordinary shares (dividends are not compulsory, shareholders vote) and debentures (fixed interest must be paid even in a loss, no votes).

The accounting system

• Assets = Capital + Liabilities, so Capital = Assets − Liabilities.
• Closing capital = opening capital + capital introduced + profit − drawings.
• Debit balances: assets, expenses, drawings. Credit balances: liabilities, capital, income (for example discounts received).
• Credit sales go in the sales journal and credit purchases of goods for resale in the purchases journal; credit notes issued go in the sales returns journal and credit notes received in the purchases returns journal.
• The cash book records all cash and bank items. It is both a book of prime entry and a ledger account.
• The general journal takes everything else: non-current assets bought on credit, irrecoverable debts written off, correction of errors.
• Concepts to know: business entity, money measurement, going concern, consistency, prudence, realisation, materiality, matching (accruals), historic cost, substance over form, duality.

Accounting for non-current assets

• Straight-line: depreciation per year = (cost − residual value) ÷ useful life. The charge is the same every year.
• Reducing balance: depreciation = rate × net book value at the start of the year. The charge falls each year.
• Net book value = cost − accumulated depreciation.
• Yearly charge: debit Depreciation expense, credit Provision for depreciation.
• Disposal account: debit the cost; credit the accumulated depreciation and the sale proceeds (or part-exchange allowance). Proceeds above net book value give a profit; below give a loss.
• Revaluation model: surplus = revalued amount − net book value. It is credited to the revaluation reserve, not to profit.
• Revenue expenditure treated as capital: profit and non-current assets are both overstated. Capital treated as revenue: both are understated.

Reconciliation and verification

• Errors the trial balance does not show: omission, commission (wrong account of the right type), principle (wrong type of account), original entry, complete reversal, compensating.
• Errors the trial balance does show: one side not posted, different amounts on the two sides, two entries on the same side, an addition error in one account.
• The suspense account is opened on the side of the trial balance with the smaller total. Only errors that stop the trial balance agreeing are corrected through it.
• Update the cash book first for bank charges, direct debits, standing orders, credit transfers and dishonoured cheques.
• Balance on bank statement = updated cash book balance + unpresented cheques − outstanding lodgements.
• Sales ledger control account: debit credit sales; credit receipts, discounts allowed, sales returns, irrecoverable debts and contra entries.
• Purchases ledger control account: credit credit purchases; debit payments, discounts received, purchases returns and contra entries.

Preparation of financial statements

• Expense for the year = amount paid + opening prepayment − opening accrual + closing accrual − closing prepayment.
• Accrued expenses and income received in advance are current liabilities. Prepaid expenses and income owing to the business are current assets.
• Write off irrecoverable debts first, then calculate the allowance on the remaining trade receivables. Only the change in the allowance goes to profit or loss.
• Inventory is valued at the lower of cost and net realisable value (selling price − costs still needed to sell it).
• Incomplete records: profit = closing capital − opening capital + drawings − capital introduced.
• Partnership: residual profit = profit for the year + interest on drawings − interest on capital − partners' salaries, then shared in the profit-sharing ratio. Interest on a partner's loan is an expense, not an appropriation.
• Company: share premium = (issue price − nominal value) × number of shares. A rights issue brings in cash; a bonus issue does not. Debenture interest for the full year is a finance cost.

Analysis and communication of accounting information

• Gross profit margin = gross profit ÷ revenue × 100. Mark-up = gross profit ÷ cost of sales × 100.
• Profit margin = profit for the year ÷ revenue × 100. Operating expenses to revenue ratio = operating expenses ÷ revenue × 100.
• Return on capital employed = profit from operations ÷ capital employed × 100, where capital employed = equity + non-current liabilities.
• Current ratio = current assets : current liabilities. Acid test ratio = (current assets − inventory) : current liabilities.
• Trade receivables turnover (days) = trade receivables ÷ credit sales × 365. Trade payables turnover (days) = trade payables ÷ credit purchases × 365.
• Inventory turnover (days) = average inventory ÷ cost of sales × 365. Rate of inventory turnover (times) = cost of sales ÷ average inventory.
• Non-current asset turnover = net revenue ÷ net book value of non-current assets.

Cost and management accounting

Costs and cost behaviour

• Fixed cost: total stays the same within the relevant range, so the cost per unit falls as output rises. Variable cost: total rises in proportion to output; cost per unit stays the same.
• Semi-variable cost = fixed part + variable part. Stepped cost: fixed over a range of output, then jumps to a higher level.
• High-low method: variable cost per unit = difference in total cost ÷ difference in units; fixed cost = total cost − (units × variable cost per unit).
• Prime cost = direct materials + direct labour + direct expenses.
• FIFO: issues are priced at the oldest costs, so closing inventory is valued at the most recent costs.
• AVCO: average cost = total cost of units held ÷ number of units held. Perpetual: recalculated after every receipt. Periodic: one average for the whole period.
• When prices are rising, FIFO gives a higher closing inventory and a higher profit than AVCO.

Traditional costing methods

• Overhead absorption rate = budgeted overheads ÷ budgeted activity (machine hours or direct labour hours). Overhead absorbed = rate × actual activity.
• Absorbed less than actual overhead: under-absorbed, which reduces profit. Absorbed more than actual: over-absorbed, which increases profit.
• Contribution per unit = selling price − variable cost per unit. Contribution to sales ratio = contribution ÷ selling price.
• Break-even point (units) = fixed costs ÷ contribution per unit. Break-even revenue = fixed costs ÷ contribution to sales ratio.
• Units for a target profit = (fixed costs + target profit) ÷ contribution per unit. Margin of safety = budgeted sales − break-even sales.
• Absorption profit − marginal profit = (closing inventory units − opening inventory units) × fixed production overhead per unit.
• Decisions: ignore fixed costs that will not change. With a limiting factor, rank products by contribution per unit of the scarce resource.