Question

Assuming, you have been asked to prepare a final account for Transatlantic, an entrepreneur or a sole trader for the year ended 31 December 2019. Jesse U., has forwarded to you all books of prime entry and ledgers and in addition has given you the following information:
i) Jesse U., had taken $3,000 out of the business bank account to take his wife on vacation.
ii) Up to last year the machinery and vehicle used in the business had been depreciated using the reducing balance method. Jesse U., thinks that they should now be depreciated using the straight-line method.
iii) Jesse U., is confident that given his order book that the business will continue to operate in its present form for many years.
iv) Jesse U., had purchased ten staplers, four flip charts and four packets of whiteboard markers which will be used in the business for the next couple of years.
v) Jesse U., informs you that he has just found an unopened electricity bill for $800 which was for the quarter October to December 2019.

REQUIRED:
Identify and explain the main accounting concepts being highlighted, then indicate how each should be treated in the final accounts.

Answer 1

Part I)

Entity concept :

According to this concept business is treated as a seperate entity than it's owner.

The money brought by the owner into the business is credited into the capital account of the entity .

Capital is the obligation of the entity and it is shown in liability side of balance sheet.

Any profits arising from the business operations is credited to capital account at the year end, and

Any money withdrawn by the owner for his personal use is treated as drawings and deducted from the capital account.

In the given question $ 3,000 withdrawn from business bank account by jesse for his wife's vacation will be treated as drawings and will be deducted from capital account as per the entity concept.

Part ii )

Concept of Accounting estimates :

Accounting estimate is an approximate amount that is to be debited or credited for an item for which no precise measurement is available.

It involves specialised knowlesge and judgement.

For example : useful life of an asset.

Depreciation is based on concept of accounting estimates.

A change in the method of depreciation is a change in accounting estimate.

In the given question, previously depreciation was being calculated on reducing balance method .

Now it is changed and will be calculated on straight line method .

Firstly , the remaining useful life of the asset to be estimated and then depreciation will be calculated using following formula.

Depreciation for every remaining year =( purchase cost of asset - accumulated depreciation) ÷ useful life of asset in years.

Part iii)

Concept of going concern and accrual concept

This is an accounting assumption that business will continue its operations in foreseeable future . And will not liquidate or be closed .

Business entity assumes that the business will continue for an indefinite period of time.

And having the assumption of going concern business uses the concepts of accrual and prepaid expenses.

In the given question jesse is confident that his business will continue for many coming years, this his business affirms with the fundamental accounting assumption of going concern. So while preparing his final accounts we will prepare it on accrual basis .

Part iv.

Materiality concept:

According to materiality concept, if an item of income or expence is of large amount or relatively important ,it should be shown seperately in financial statement for better presentation of accounts.

But also if an item is relatively immaterial , accounting standard is need not necessarily be applied on it.

Materiality is a matter of professional judgement.

For example : a computer purchase can be material so it's need to be shown seperately as fixed assets.

But office supplies such as stapelers, marker pens etc are immaterial to be shown seperately as fixed assets even if they will be utilised for a time of more than a year.

They can be shown as office supplies as a part of closing inventory in the current assets of balance sheet.

Part v )

Accrual concept:

According to the accrual concept , income and expenses must be recognised in the books of accounts in the year which they relate, whether actual cash is paid or recieved or not.

Thus in the given question , the amount of electricity bill $800 , which relates to the current year for last quarter ( from oct to dec 2019 ) will be shown as expense item in the statement of profit and loss, and

As it is unpaid in the current year, it will also be shown as outstanding expense in liability side of balance sheet as per accrual concept.

Finish.

Thanx.