Question 2 (10 marks) a) Explain the meaning of each accounting concept with the

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Question 2 (10 marks) a) Explain the meaning of each accounting concept with the examples. b) Describe the treatment of outstanding expenses and prepaid expenses with the examples. (10 marks) Question 3 After six months of business, Sony bridal material shop had the following account balances Cash OMR10,500, Account Receivable OMR1,500, Office Supplies OMR750, Bridal dress OMR63,000, Account Payable OMR13,500, and Share Capital OMR62,250. The following transactions took place in the month of July: 2016 Purchased wedding gowns for cash Received wedding jewelry hire charges Paid shop rent Paid beautician salary Collected from customers for previous wedding make up 600 Purchased office supplies for cash Purchased hair accessories on credit OMR 7,500 22,500 1,500 1,200 2 July 4 July 6 July 10 July 11 July 14 July 15 July 20 July 22 July 25 July 30 July 300 3,000 1,500 450 Made part payment of purchases on July 15 Paid electricity bill Paid payables due at the beginning of the month Declared and paid dividends 6,000 i. Construct a table of assets, liabilities and owner's equity in equation form. (26 marks i. Anatyse the effects of the transactions on the accounting equation. (4 marks Version1 Pag

Explanation / Answer

2 (a) Accounting Concepts

Under the entity concept, there has be a clear distinction between the business and the owner. That is, business and owner are to separate entities. Entries concerning the business transactions shall only be recorded in the business books of accounts. Entries concerning the owner shall be recorded in his/her personal books of accounts. The entity is liable only for the capital invested by the owner.

Let's say Ms. Ginger pays 500 OMR as property tax on personal property from her business cash.

Such a payment shall not be considered as a business expense and shall be considered as a withdrawal from her capital.

An entity may have 100 employees. Their hard work accrues significant benefits to the entity in the future. But it cannot recognize these employees as an asset because their hard work cannot be quantified.Only the salary paid to them is recognized which may or may not be a true reflection of their hard work.

Similarly, when these employees quit the entity will suffer but even this loss cannot be quantified and charged to books of accounts.

Under this concept, an entity shall recognize all the incomes and expenses corresponding to an accounting period in that period solely whether or not they have been received or paid in cash.

The unpaid expense is recognized as outstanding/unpaid expense. (liability)

The unreceived income is recognized as a outstanding income. (asset)

Income received in advance is recognized as unearned income. (liability)

Expense paid in advance is recognized as prepaid expense. (asset)

PQR Ltd. trades in stationery. It purchased stationery of 5000 OMR in 2016. It sold stationery worth 4000 OMR at a 20% markup on purchase price. Thus,

Revenue = 1.20*4000=4800

Cost of goods sold= 4000

Here, the expense of 1000 of purchases will not be considered because these goods were not sold during the year and thus failed to match with the income earned.

Mr George runs a shoe manufacturing business. He imported a machinery for 5000 OMR to speed up the production process. However due to improvement in technology, there is a new model available of the machine purchased and the market value of his machine has fallen to 2500 OMR.

Now, since we assume Going Concern, we will not mark down the value of machine. Because since the business is assumed to run infinitely, the benefits received from the machine will far outweigh its fair value.

Under the Cost concept, the assets are reflected in the books of accounts at their historical cost, that is their cost of acquisition.

This concept is followed for ease because it is difficult to reliably determine the current values or fair values of a an asset from the market data.

Under this concept, the business recognizes the movements in the value of an asset only when it is finally disposed off.

This concept moves in tandem with the Cost concept as the changes in the value of the asset are not recorded in periods preceding the final disposal of asset.

Ms. Lana had purchased furniture for 2500 OMR on 1.1.2006.

The value of the furniture was 3000 OMR on 1.1.2009

She sold the furniture for 3000 on 1.1.2010.

In this case, Ms. Lana will not revalue furniture on the basis of changes in valiue identified on 1.1.2009

She will recognize the profit made (3000-2500= 500) on the final sale of furniture.

Under this concept, it is explained that every transaction has two sides to it. That, is every transaction will affect either both the assets and liabilities or will affect two or more assets or two or more liabilities.

This is the backbone of double entry bookkeeping.

Ram invests OMR 5000 in his business.

This transaction increases the cash (asset) and increases the capital (liability) of the business.

Ram buys telephone for his business.

This increases fixed assets (telephone) and decreases current assets (cash).

Under this concept, an entity should account for all the future losses; however it shall not account for all the future gains.

That is, it deemed prudent to make provisions for a future loss in a business. But it shall not account for ann anticipated gain in the future.

ABC Ltd. estimates that on an average 10% of their trade debtors default on debts every year. So, they should make a provision every year to account for future bad debts.

In the following year, the actual bad debts will be charged to the Provision made previous year. Any excess provision will be reversed to the Income Statement. In case actual bad debts exceed the provision made, the remaining excess is charged to Income Statement.

Under this concept, every entity shall follow the same accounting policies for every accounting period to ensure that the financial results are comparable.

However the accounting policies can be changed in order to represent a true and fair view or compliance with a statute or accounting standard.

Under this concept, only those transactions shall be recorded in the books of accounts that have a significant bearing on the business and the users of financial statements.

Any insignificant/irrelevant transaction shall be ignored. However what is to be deemed material is a matter of personal judgement.

2 (b) Outstanding Expense: An expense pertaining to the current accounting period which remains unpaid at the end of such accounting period is called an outstanding expense.

Treatment of Outstanding Expense:

Salary A/c Dr. 4000

To Outstanding Salary A/c 4000

Outstanding Salary A/c Dr. 4000

To Salary A/c 4000

This ensures that when the amount is paid by debiting salary a/c, a corresponding credit has already been given in the salary a/c and only salary of the current period will reflect as a closing balance.

Salary A/c Dr. 4000

To Bank 4000

Prepaid Expenses: When whole/part of an expense paid during the accounting period pertains to the following accounting periods such an expense is called a prepaid expense. In case of a prepaid expense, the underlying benefit/asset is for a following period.

Treatment of Prepaid Expense:

Rent A/c Dr. 400

Prepaid Rent A/c Dr. 800

To Bank A/c 1200

Rent A/c Dr. 800

To Prepaid Rent 800

S. No. Concept Meaning Example 1 Entity

Under the entity concept, there has be a clear distinction between the business and the owner. That is, business and owner are to separate entities. Entries concerning the business transactions shall only be recorded in the business books of accounts. Entries concerning the owner shall be recorded in his/her personal books of accounts. The entity is liable only for the capital invested by the owner.

Let's say Ms. Ginger pays 500 OMR as property tax on personal property from her business cash.

Such a payment shall not be considered as a business expense and shall be considered as a withdrawal from her capital.

2 Money Measurement Under this concept, an entity will record only those transactions in the books of accounts that are capable of being recognized in monetary terms. This implies that any transaction which cannot be quantified in monetary terms will not be recorded in the books.

An entity may have 100 employees. Their hard work accrues significant benefits to the entity in the future. But it cannot recognize these employees as an asset because their hard work cannot be quantified.Only the salary paid to them is recognized which may or may not be a true reflection of their hard work.

Similarly, when these employees quit the entity will suffer but even this loss cannot be quantified and charged to books of accounts.

3 Periodicity Under this concept, the life of a business is divided into periods and the profitability of the business is identified at the end of each period. This enables the entity to measure the financial performance of its business. PQR Ltd. follows an accounting period of April -March. Thus it will prepare an income statement pertaining to April- March and Balance Sheet as on 31st March every year. 4 Accrual

Under this concept, an entity shall recognize all the incomes and expenses corresponding to an accounting period in that period solely whether or not they have been received or paid in cash.

The unpaid expense is recognized as outstanding/unpaid expense. (liability)

The unreceived income is recognized as a outstanding income. (asset)

Income received in advance is recognized as unearned income. (liability)

Expense paid in advance is recognized as prepaid expense. (asset)

Mr. Ram fails to pay the electricity bill of his plant for the last month of the accounting period. The amount of the bill will be expensed during the period and a corresponding liability will be raised in the books. 5 Matching Under this concept, only those expenses should be recognized in a period which can be matched with the income earned during the period.

PQR Ltd. trades in stationery. It purchased stationery of 5000 OMR in 2016. It sold stationery worth 4000 OMR at a 20% markup on purchase price. Thus,

Revenue = 1.20*4000=4800

Cost of goods sold= 4000

Here, the expense of 1000 of purchases will not be considered because these goods were not sold during the year and thus failed to match with the income earned.

6 Going Concern Under this concept, it is assumed that the business of an entity shall remain in operation infinitely. That is, the business will continue to run in the foreseeable future and the owner has no intention to close the business.

Mr George runs a shoe manufacturing business. He imported a machinery for 5000 OMR to speed up the production process. However due to improvement in technology, there is a new model available of the machine purchased and the market value of his machine has fallen to 2500 OMR.

Now, since we assume Going Concern, we will not mark down the value of machine. Because since the business is assumed to run infinitely, the benefits received from the machine will far outweigh its fair value.

7 Cost

Under the Cost concept, the assets are reflected in the books of accounts at their historical cost, that is their cost of acquisition.

This concept is followed for ease because it is difficult to reliably determine the current values or fair values of a an asset from the market data.

Mr. Lawson acquired a piece of land for his business in 2005 for OMR 18000. It will continue to be measured at OMR 18000 in his books till the land is sold/disposed off. 8 Realisation

Under this concept, the business recognizes the movements in the value of an asset only when it is finally disposed off.

This concept moves in tandem with the Cost concept as the changes in the value of the asset are not recorded in periods preceding the final disposal of asset.

Ms. Lana had purchased furniture for 2500 OMR on 1.1.2006.

The value of the furniture was 3000 OMR on 1.1.2009

She sold the furniture for 3000 on 1.1.2010.

In this case, Ms. Lana will not revalue furniture on the basis of changes in valiue identified on 1.1.2009

She will recognize the profit made (3000-2500= 500) on the final sale of furniture.

9 Dual Aspect

Under this concept, it is explained that every transaction has two sides to it. That, is every transaction will affect either both the assets and liabilities or will affect two or more assets or two or more liabilities.

This is the backbone of double entry bookkeeping.

Ram invests OMR 5000 in his business.

This transaction increases the cash (asset) and increases the capital (liability) of the business.

Ram buys telephone for his business.

This increases fixed assets (telephone) and decreases current assets (cash).

10 Conservatism

Under this concept, an entity should account for all the future losses; however it shall not account for all the future gains.

That is, it deemed prudent to make provisions for a future loss in a business. But it shall not account for ann anticipated gain in the future.

ABC Ltd. estimates that on an average 10% of their trade debtors default on debts every year. So, they should make a provision every year to account for future bad debts.

In the following year, the actual bad debts will be charged to the Provision made previous year. Any excess provision will be reversed to the Income Statement. In case actual bad debts exceed the provision made, the remaining excess is charged to Income Statement.

11 Consistency

Under this concept, every entity shall follow the same accounting policies for every accounting period to ensure that the financial results are comparable.

However the accounting policies can be changed in order to represent a true and fair view or compliance with a statute or accounting standard.

DEF Ltd. depreciates its assets on Written Down Value method in 2008. It will have to follow the same method every year. It cannot adopt Straight Line Method in 2009. 12 Materiality

Under this concept, only those transactions shall be recorded in the books of accounts that have a significant bearing on the business and the users of financial statements.

Any insignificant/irrelevant transaction shall be ignored. However what is to be deemed material is a matter of personal judgement.

ABC Ltd. purchases notebooks for 10 OMR. Even though the notebooks have a useful life beyond the current period, the accountant may charge the entire amount as an expense because it is a trivial expense and carrying it forward will unnecessarily cause inconvenience.

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