Fundamentals of Financial Accounting

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PAPER GE01 FUNDAMENTALS OF FINANCIAL ACCOUNTINGAS PER ICMAB NEW SYLLABUS IFRS EDITION: JULY 2017Dhaka, BangladeshFUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 0No part of this publication may be reproduced, stored, transmitted in any form or by any means of electronic, photocopying, recording or otherwise, without the prior written permission of Sabolil Academy. All rights reserved.IFRS Edition: July 2017.Presented by: Saat Publication Dhaka, Bangladesh.Designed by: Times Press Nilkhet, Dhaka, Bangladesh.Price: BDT 290.00 onlyFUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 1MESSAGEThe mathematical questions of this book are solved by showing calculations so that students can understand easily. If any student needs further co-operation or academic support, he/she should contact with us.Sabolil Academy Dhaka, Bangladesh Helpline: +88 01711137039 E-mail: Website: www.sabolilacademy.orgFUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 2PREFACEWith the growing demand of professional education, Cost and Management Accountant has gained a huge popularity. A Cost and Management Accountant degree makes the candidates suitable for lots of opportunities. As more and more multi-nationals are coming into the world, demand for Cost and Management Accountant has further increased. The employment periphery for Cost and Management Accountants are various and can range from holding key positions in a company. To become a Cost and Management Accountant a person needs to qualify the course offered by the Institute of Cost and Management Accountants of Bangladesh (ICMAB). The main objectives of this book is to meet the basic requirements of the CMA course but it is also helpful for other professional students and the persons who are intended to get admission into a professional institute. This book contains suggested questions and answer along with CMA previous examination questions. It covers whole syllabus of ICMAB and includes related topic so that students can be well prepared for the final examination by studying this book. We are grateful and deserve our thanks to the publishers, printers and designers of this book. Any criticism, favorable or unfavorable, and any constructive suggestion in regards of this book will be gratefully received by us.Sabolil AcademyFUNDAMENTALS OF FINANCIAL ACCOUNTING ♌ SABOLIL ACADEMYPAGE 3DEDICATIONWe would like to dedicate this publication to the honorable qualified Cost and Management Accountants for their incredible contribution in the field of Accounting.FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 4TABLE OF CONTENTS SEGMENT – A: CONCEPTUAL AND REGULATORY FRAMEWORKPAGE 10A.1. Definition of financial accounting A.2. Functions of financial accounting A.3. Differences between financial and management accounting A.4. Meaning of accounting records A.5. Need for accounting records A.6. Time required for record keeping A.7. Users of accounting information A.8. Objectives of accounting statements A.9. Qualitative characteristics of financial information A.10. Concept of accounting equation A.11. Definition of asset, liability and shareholder equity A.12. Meaning of international accounting standards A.13. Role of accounting standards in financial statements A.14. Short notes10 10 11 12 12 12 13 13 14 15 15 15 16 16Past exam questions and answers17SEGMENT – B: ACCOUNTING SYSTEMSPAGE 22SUB-SEGMENT–1: JOURNAL ENTRIES, LEDGER ACCOUNTS AND TRIAL BALANCE 23 B.1.1. Definition of single entry system 23 B.1.2. Definition of double entry system 23 B.1.3. Differences between single entry and double entry system 23 B.1.4. Meaning of accounting cycle 24 B.1.5. Steps involved in accounting cycle 24 B.1.6. Differences between bookkeeping and accounting 25 B.1.7. Definition of journal entry and adjusting entry 25 B.1.8. Differences between gross method and net method of recording purchase 26 B.1.9. Short notes 26 Past exam questions and answers Problems and solutions Exercises FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMY28 30 36PAGE 5SUB-SEGMENT–2: ACCOUNTS FOR CASH AND BANK, BANK RECONCILIATIONS 43 B.2.1. Definition of reconciliation 43 B.2.2. Meaning of bank reconciliation 43 B.2.3. Concept of bank reconciliation statement 43 B.2.4. Preparation of a bank reconciliation statement 43 B.2.5. Transactions that are appeared in bank reconciliation statement 44 Past exam questions and answers Problems and solutions Exercises45 47 54SUB-SEGMENT–3: ACCOUNTS FOR PAYROLL B.3.1. Definition of payroll B.3.2. Meaning of payroll accounting B.3.3. Differences between wages and salary B.3.4. Concept of productivity B.3.5. Calculation of productivity B.3.6. Meaning of labour turnover B.3.7. Learning curve theory B.3.8. Short notes64 64 64 64 65 65 65 66 66Past exam questions and answers Problems and solutions Exercises SEGMENT – C: PREPARATION OF ACCOUNTS FOR SINGLE ENTRIES67 68 73 PAGE 79SUB-SEGMENT–1: BAD DEBTS AND ALLOWANCES RECEIVABLES C.1.1. Definition of accruals and prepayments C.1.2. Meaning of accounts receivable and notes receivable C.1.3. Differences between accounts receivable and notes receivable C.1.4. Concept of bad debt expense and allowance for doubtful account C.1.5. Differences between bad debt expense and allowance for doubtful account C.1.6. Methods used to account for uncollectible accounts C.1.7. Reasons for having accounts receivable Past exam questions and answers Problems and solutions Exercises FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYFOR 80 80 80 80 81 81 82 82 83 85 90 PAGE 6SUB-SEGMENT–2: ACCOUNTING TREATMENT DEPRECIATION AND IMPAIRMENT C.2.1. Definition of depreciation C.2.2. Various methods of depreciation C.2.3. Meaning of accelerated depreciation C.2.4. Uses of two methods of depreciation C.2.5. Depreciation of income statement and balance sheet differs C.2.6. Concept of impairment C.2.7. Accounting procedures for impairment of an asset C.2.8. Short notesFOR 95 95 95 96 96 96 97 97 98Past exam questions and answers Problems and solutions Exercises99 102 111SUB-SEGMENT–3: ACCOUNTS FOR INVENTORIES C.3.1. Definition of inventory management C.3.2. Differences between inventory and merchandise inventory C.3.3. Concept of perpetual and periodic inventory system C.3.4. Differences between perpetual and periodic inventory system C.3.5. Advantages of perpetual inventory system C.3.6. Disadvantages of perpetual inventory system C.3.7. Benefits of periodic inventory system C.3.8. Limitations of periodic inventory system115 115 115 115 116 116 117 118 118Past exam questions and answers Problems and solutions Exercises119 120 127SUB-SEGMENT–4: ACCOUNTS FOR ISSUE & REDEMPTION OF SHARES & DEBENTURES 131 C.4.1. Definition of stock 131 C.4.2. Differences between common and preferred stock 131 C.4.3. Concept of treasury stock 132 C.4.4. Meaning of dividend 132 C.4.5. Differences between cash and stock dividend 132 C.4.6. Explanation of stock split 132 C.4.7. Three for two stock split 133 C.4.8. Definition of bond 133 C.4.9. Differences between stock and bond 133 Past exam questions and answers 134 Problems and solutions 137 Exercises 146 FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 7SUB-SEGMENT–5: PREPARATION OF FINANCIAL STATEMENTS FOR A SINGLE COMPANY 154 C.5.1. Definition of financial statement 154 C.5.2. Purposes of financial statement 154 C.5.3. Different types of financial statement 155 C.5.4. Methods of financial statement analysis 156 C.5.5. Users of financial statement analysis 157 C.5.6. Short notes 158 Past exam questions and answers Problems and solutions Exercises160 166 178SUB-SEGMENT–6: STATEMENT OF CASH FLOWS C.6.1. Definition of cash and cash equivalent C.6.2. Meaning of cash flows and statement of cash flows C.6.3. Importance of statement of cash flows C.6.4. Classification of statement of cash flows C.6.5. Reasons for preparing a statement of cash flows C.6.6. Methods of preparing a statement of cash flows C.6.7. Differences between direct and indirect method of cash flows C.6.8. Disclosures of non-cash activities on a statement of cash flows191 191 191 191 192 192 193 193 194Past exam questions and answers Problems and solutions Exercises196 201 227SUB-SEGMENT–7: USE OF BASIC RATIOS IN FINANCIAL PERFORMANCE 245 C.7.1. Definition of working capital 245 C.7.2. Meaning of working capital cycle 245 C.7.3. Concept of ratio analysis 245 C.7.4. Advantages of ratio analysis 245 C.7.5. Limitations of ratio analysis 247 C.7.6. Different types of ratios 248 Problems and solutions ExercisesFUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMY250 256PAGE 8SEGMENT – D: CONTROL OF ACCOUNTING SYSTEMSPAGE 258D.1. Definition of audit D.2. Objectives of audit D.3. Analysis of external audit and internal audit D.4. Differences between external audit and internal audit D.5. Meaning of fair presentation D.6. Concept of true and fair view D.7. Explanation of fraud D.8. Types of fraud D.9. Methods of detection of fraud D.9. Methods of prevention of fraud D.10. Short notes258 258 259 259 260 260 260 260 261 262 262Past exam questions and answers Sample exam question264 308প্রস্তুতি ক্লাসের প্রস াজসে ফ াে করুে! োবতিি একাসেতি - ০১৭১১১৩৭০৩৯FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 9SEGMENT - A CONCEPTUAL AND REGULAORY FRAMEWORK COMPONENTS ♦ definition of financial accounting ♦ functions of financial accounting ♦ differences between financial and management accounting ♦ meaning of accounting record ♦ users of accounting information ♦ objectives of accounting statement ♦ qualitative characteristics of financial information ♦ concept of accounting equation ♦ meaning and role of international accounting standardsA.1. DEFINITION OF FINANCIAL ACCOUNTING Financial accounting is a specialized branch of accounting that keeps track of a company's financial transactions. Using standardized guidelines, the transactions are recorded, summarized, and presented in a financial report or financial statement such as an income statement or a balance sheet. A.2. FUNCTIONS OF FINANCIAL ACCOUNTING i) Recording: This is the basic function of financial accounting. It is essentially concerned with not only ensuring that all business transactions of financial character are in fact recorded but also that they are recorded in an orderly manner. Recording is done in the book “Journal”. ii) Classifying: Classification is concerned with the systematic analysis of the recorded data, with a view to group transactions or entries of one nature at one place. The work of classification is done in the book termed as “Ledger”. iii) Summarizing: This involves presenting the classified data in a manner which is understandable and useful to the internal as well as external end-users of accounting statements. This process leads to the preparation of the following statements: Trial Balance, Income statement and Balance sheet. FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 10iv) Analysis and Interprets: This is the final function of accounting. The recorded financial data is analyzed and interpreted in a manner that the end-users can make a meaningful judgment about the financial condition and profitability of the business operations. The data is also used for preparing the future plan and framing of policies for executing such plans. v) Communicate: The accounting information after being meaningfully analyzed and interpreted has to be communicated in a proper form and manner to the proper person. This is done through preparation and distribution of accounting reports, which include besides the usual income statement and the balance sheet, additional information in the form of accounting ratios, graphs, diagrams, funds flow statements etc. A.3. DIFFERENCES BETWEEN FINANCIAL AND MANAGEMENT ACCOUNTING Financial accounting i. Financial accounting produces information that is used by external parties, such as shareholders and lenders. ii. Financial accounting focuses on history; reports on the prior quarter or year. iii. The main objectives of financial accounting are to disclose the end results of the business, and the financial condition of the business on a particular date. iv. Financial accounts are reported in a specific format, so that different organizations can be easily compared. v. It reports as defined - annually, semi-annually, quarterly, yearly.Management accounting i. Managerial accounting produces information that is used within an organization, by managers and employees. ii. Managerial accounting focuses on the present and forecasts for the future. iii. The main objective of managerial accounting is to help management by providing information that is used to plan, set goals and evaluate these goals. iv. Management accounts are reported in informal format and as on a company basis as needed. v. It reports as needed - daily, weekly, monthly.FUNDAMENTALS OF FINANCIAL ACCOUNTING ♌ SABOLIL ACADEMYPAGE 11A.4. MEANING OF ACCOUNTING RECORDS Accounting records are key sources of information and evidence used to prepare, verify and/or audit the financial statements. They also include documentation to prove asset ownership for creation of liabilities and proof of monetary and non-monetary transactions. A.5. NEED FOR ACCOUNTING RECORDS Keeping accurate and up-to-date accounting records is vital to the success of any business. The business must realise that records kept will be one of the most important management tools it possesses and, therefore, it should be allocated due importance. The business owner is looking for the maximum return from their investment and the maintaining of good accounting records is part of that equation. Proper accounting record provides the business a real-advantage over competition in different ways. • Assists in preparing financial statements quickly and accurately. • Provides information to enable the control of cash in the business. • Provides management information to base business decisions on. • Contributes promptly to assessing the financial situation of the business at any time. • Keeps a good track of the costs of staff and their performance. • Measures the business performance against the projections that were originally set down in the business plan. • Highlights quickly areas where problems could arise and enable remedies to be put in place. • Fulfills the obligations as to taxation law. • Assists in providing information required by your bankers. • Helps in detecting thefts within the business itself. • Provides valuable information and details for the future sale of the business where that is required. • Increases the chances of the business operating and achieving success. A.6. TIME REQUIRED FOR RECORD KEEPING A company should keep records for 3 years from the date of filed the original return or 2 years from the date of paid the tax, whichever is later. It should keep records for 7 years if it files a claim for a loss from worthless securities or bad debt deduction.FUNDAMENTALS OF FINANCIAL ACCOUNTING ♦ SABOLIL ACADEMYPAGE 12A.7. USERS OF ACCOUNTING INFORMATION Accounting information helps users to make better financial decisions. Users of accounting information may be both internal and external to the organization. Internal users (Primary users) of accounting information include the following: i. Management: for analyzing the organization's performance and position and taking appropriate measures to improve the company results. ii. Employees: for assessing company's profitability and its consequence on their future remuneration and job security. iii. Owners: for analyzing the viability and profitability of their investment and determining any future course of action. External users (Secondary users) of accounting information include the following: i. Creditors: for determining the credit worthiness of the organization. Terms of credit are set by creditors according to the assessment of their customers' financial health. Creditors include suppliers as well as lenders of finance such as banks. ii. Tax Authourities: for determining the credibility of the tax returns filed on behalf of the company. iii. Investors: for analyzing the feasibility of investing in the company. Investors want to make sure they can earn a reasonable return on their investment before they commit any financial resources to the company. iv. Customers: for assessing the financial position of its suppliers which is necessary for them to maintain a stable source of supply in the long term. v. Regulatory Authorities: for ensuring that the company's disclosure of accounting information is in accordance with the rules and regulations set in order to protect the interests of the stakeholders who rely on such information in forming their decisions. A.8. OBJECTIVES OF ACCOUNTING STATEMENTS The general objective of the accounting statements is to provide information about the results of operations, financial position, and cash flows of an organization. This information is used by the readers of accounting statements to make decisions regarding the allocation of resources. At a more refined level, there is a different objective associated with each of the accounting statements. The income statement informs the reader about the ability of a business to generate a profit. In addition, it reveals the volume of FUNDAMENTALS OF FINANCIAL ACCOUNTING ♌ SABOLIL ACADEMYPAGE 13sales, and the nature of the various types of expenses, depending upon how expense information is aggregated. When reviewed over multiple time periods, the income statement can also be used to analyze trends in the results of company operations. The objective of the balance sheet is to inform the reader about the current status of the business as of the date listed on the balance sheet. This information is used to estimate the liquidity, funding, and debt position of an entity, and is the basis for a number of liquidity ratios. Finally, the objective of the statement of cash flows is to show the nature of cash receipts and disbursements, by a variety of categories. This information is of considerable use, since cash flows do not always match the revenues and expenses shown in the income statement. A.9. QUALITATIVE INFORMATIONCHARACTERISTICSOFFINANCIALFinancial information presented in financial statements needs to have some key qualities which make it useful for the users. Generally accepted accounting standards normally outline such standards in their frameworks. IASB Conceptual Framework categorizes these into fundamental qualitative characteristics and enhancing qualitative characteristics. These include Relevance: It requires financial information to be relevant to the decision making needs of the users. Materiality: It requires accountants and auditors to focus on financial information which is expected to affect the decisions of the users. Faithful representation: It requires the financial information to be true and fair and free from misstatement. Comparability: It requires the financial information to be comparable across periods and across companies. Verifiability: It requires the information to communicate the underlying economics of the company's business. Timeliness: It requires disclosure of financial information not to be excessively delayed. Understandability: It requires the financial information to be understandable by users with reasonable knowledge of business and economic activities.FUNDAMENTALS OF FINANCIAL ACCOUNTING ♌ SABOLIL ACADEMYPAGE 14A.10. CONCEPT OF ACCOUNTING EQUATION The accounting equation, also called the balance sheet equation is the most basic principle of financial accounting. It represents the relationship between the assets, liabilities and shareholders‟ equity of a business. It is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total cred
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