Accounting Study Guide

Solutions to Exercises

SOLUTIONS TO EXERCISES

Lesson 1:

Definition of Accounting

1.

What is accounting? What are its main functions? Accounting is the process of financially measuring, recording, summarizing and communicating the economic activity of an organization. Accounting provides financial information about an organizations economic activities which is intended to be used as a basis for decision making. It provides the information required to answer important questions such as: what are the resources of the organization? What debts does it owe? How do its operating expenses compare with its revenue? Is it sustainable?

2.

What is the difference between Financial and Management Accounting? Financial accounting presents a summary view of the financial results of past operations and its reports are generally aimed at external audiences. Management accounting information is tracked and presented at a much more detailed level, such as by programme or branch. Projected financial information is also a part of management accounting and is aimed primarily at internal audiences.

3.

Name the three key financial statements and briefly describe each. The Balance Sheet is a summary of the organizations uses of funds (assets) and sources of funds (liabilities and equity) at a specific point in time. A Balance Sheet always balances, in that assets are equal to the sum of liabilities plus equity. The Income Statement reports the organizations economic performance over a specified period of time. The Statement of Changes in Financial Position reports the organization's sources and uses of funds (also referred to as the Statement of Changes in Sources and Uses of Funds or the Cash Flow Statement). It explains how an organization obtains cash (sources of funds) and how it spends cash (use of funds) including the borrowing and repayment of debt, capital transactions, and other factors that may affect the cash position.

4.

Name five of the Basic Accounting Principles: I. ii. iii. iv. v. the Business Entity Concept the Cost Principle the Going Concern Concept Double-entry Accounting the Realization Principle

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Solutions to Exercises

5.

Write the meaning of the following Principles: i. Cost Principle All assets must be recorded on the books of a business at their actual cost. This amount may be different from what it would cost today to replace them or the amount the assets could be sold for. ii. Consistency Principle Organizations must consistently apply the same accounting principles from period to period. This ensures that reports from various periods may be compared to produce meaningful conclusions on the financial position of the organization, and the results of its operations.

iii.

Business Entity Concept Every business is a separate entity, distinct from its owner and from every other business. Therefore, the records and reports of a business should not include the personal transactions or assets of either its owner(s) or those of another business.

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Solutions to Exercises

Lesson 2:
1.

The Balance Sheet

What are the main elements of a Balance Sheet? The main elements of a Balance Sheet are: Assets, Liabilities and Equity.

2.

What is the Accounting Equation? TOTAL ASSETS = TOTAL LIABILITIES + EQUITY

3.

Define: Asset, Liability and Equity. Assets represent what is owned by the organization or owed to it. Assets are those items in which an organization has invested its funds for the purpose of generating future receipts of cash. On the Balance Sheet, total assets are always equal to the sum of liabilities plus equity. Liabilities represent what is owed by the organization to others either in the form of a loan which has been extended to it or obligations for the organization to provide goods and services in the future. Equity is equal to assets less liabilities. Unlike liabilities, the Equity of an organization does not have to be repaid. It therefore represents the value or net worth of the organization. Equity includes capital contributions of any investors or donors, retained earnings, and the current year surplus.

4.

Put ( ) in the appropriate column: ITEMS Cash Equipment Client Savings Net Deficit - current year Restricted/Deferred Revenue Building Loans Outstanding - current Loan Fund Capital Long-term Investments Long-term Debt (concessional) Loans Outstanding - Past Due Loan Loss Reserve* Restructured Loans
*Is sometimes treated as a liability.

ASSETS

LIABILITIES

EQUITY

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5.

For the following transactions, show how these affect the Balance Sheet: i. ii. iii. iv. v. Purchase land on credit (> one year) Disburse loan to client Purchase motorcycles for staff - pay half cash; half short-term credit Purchase office furniture on short-term credit Take loan from bank at commercial rate of interest (> one year) vi. vii. viii. ix. x. Purchase a Treasury Bill for cash Client withdraws savings Receive an unrestricted donation A Current loan becomes past due Receive a restricted donation for operations (3 years)

ASSETS
Cash Current Loans Outstanding Loans Past Due Investments

=
Property & Equipment Short-term Borrowing

LIABILITIES
Client Savings Long-term Debt

+
Restricted /Deferred Revenue

EQUITY
Equity

Purchase land on credit (> one year) Disburse loan to client Purchase motorcycles for staff - pay half cash, half short-term credit Purchase office furniture on short-term credit Take loan from bank (> one year) Purchase a T-Bill for cash Client withdraws savings Receive an unrestricted donation Current loan becomes past due Receive restricted donation

Accounting Study Guide

Solutions to Exercises

6.

Draw the general format of a Balance Sheet. Balance Sheet As at ----------------Liabilities

Assets

Equity Total Assets Total Liabilities and Equity

7.

Prepare a Balance Sheet for MicroFund Inc. as at June 30, 1995, on the basis of the information supplied.

MicroFund Inc. BALANCE SHEET

As at June 30, 1995 ASSETS LIABILITIES & EQUITY LIABILITIES Cash & Bank Current Accounts Interest Bearing Deposits Loans Outstanding: Current Past Due Restructured Loans Outstanding (Gross) (Loan Loss Reserve) Net Loans Outstanding Other Current Assets Total Current Assets Long-term Investments Property and Equipment: Cost (Accumulated Depreciation) Net Property and Equipment Net Long-term Assets TOTAL ASSETS 11,000 7,366 18,366 350,000 70,000 10,000 430,000 (21,000) 409,000 2,500 429,866 104,500 134,386 (23,219) 111,167 215,667 645,533 Short-term Borrowings (commercial) Client Savings Total Current Liabilities Long-term Debt (commercial rate) Long-term Debt (concessional rate) Restricted/Deferred Revenue TOTAL LIABILITIES EQUITY Loan Fund Capital Retained Net Surplus/(Deficit) prior Net Surplus/(Deficit) current year TOTAL EQUITY TOTAL LIABILITIES & EQUITY 7,500 146,512 154,012 100,000 150,000 139,800 543,812 84,621 6,900 10,200 101,721 645,533

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Solutions to Exercises

Lesson 3:
1.

Income Statement

What is an Income Statement? How does it differ from a Balance Sheet? The Income Statement summarizes all revenue earned and expenses incurred during a specified accounting period, and shows the net income (or net loss) earned over that period. Unlike the Balance Sheet, which reflects a static position at a point-in-time, the Income Statement reflects all transactions which have occurred during the accounting period'.

2.

Why is an Income Statement prepared? An Income Statement is prepared so that an organization can determine its net income. To determine net income, an organization must measure for a specified period of time (i) the revenue received (or accrued) for goods and services provided to its clients and (ii) the cost incurred for goods and services which it used. The technical accounting terms for these elements of net income are revenue and expenses. Net Income is the difference between revenue and expenses.

3.

Define and give examples of revenue and expenses. Revenue refers to money received (or to be received) by the organization for goods sold and services rendered during a given accounting period. Revenue for a micro-finance organization includes: interest earned on loans to clients; fees earned on loans to clients; interest earned on funds on deposit with a bank; etc. Expenses represent the costs incurred for goods and services used in the process of earning revenue. Direct expenses for a micro-finance organization include financial costs, operating expenses and loan loss provisions

4.

Put ( ) in the appropriate box:

ITEMS Salaries Interest earned on Interest Bearing Deposits Provision for Loan Losses Depreciation Interest paid on Debt Interest earned on Current Loans Outstanding Rent Loan Fees Bank Charges

REVENUE

EXPENSES

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Accounting Study Guide

Solutions to Exercises

5.

Prepare an Income Statement for MicroFund Inc. for the period ended December 31, 1993, on the basis of the information supplied.

MicroFund Inc. INCOME STATEMENT

For the period ended December 31, 1993 FINANCIAL INCOME: Interest on Current & Past Due Loans Interest on Investments Loan Fees/Service Charges Total Financial Income FINANCIAL COSTS: Interest on debt Interest paid on deposits Total Financial Costs GROSS FINANCIAL MARGIN Provision for Loan Losses NET FINANCIAL MARGIN Operating Expenses Salaries & Benefits Rent Utilities Office Expenses Travel Depreciation Equipment Leasing Software Other Total Operating Expenses NET INCOME FROM OPERATIONS Grant Revenue for Operations Excess of Income over Expenses 2,000 425 35 275 145 110 700 500 200 4,390 190 2,000 2,190 4,500 200 1,500 6,200 600 20 620 5,580 1,000 4,580

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Solutions to Exercises

Lesson 4:

Recording Changes in Financial Position

1.

Indicate, with a check mark, how the following would be recorded:

Debit
- an increase in cash - a decrease in loans outstanding - receipt of interest revenue

Credit

2.

What is the difference between Cash and Accrual based accounting? Cash accounting records transactions only when the revenue has been received or the expense incurred. Accrual accounting records the revenue when the transaction takes place before the cash has been received.

3.

Explain what is meant by Double-entry accounting. Double-entry Accounting is based on the concept that every transaction affects and is recorded in at least two accounts on an organizations books. Therefore each transaction requires entries in two or more places. Each transaction affects either Assets, Liabilities and/or Equity. The accounting equation states that: ASSETS = LIABILITIES + EQUITY. For every account affected by a transaction there is an equal affect on other accounts which keeps the accounting equation balanced. Therefore, an increase in an organizations assets must be offset by either a decrease in another asset, or an increase in liabilities or equity.

4.

Why are vouchers prepared? Vouchers are prepared in order to create a paper trail for each transaction. This paper trail enables an organization to have adequate internal control over its record keeping.

5.

Why should the bank account statement be reconciled with accounting records? The bank account statement should be reconciled with accounting records as it is important to ensure that all cash transactions are properly recorded, including bank charges, in order to determine the financial position of the organization. In addition, the number of cash transactions is large in most organizations or businesses and therefore the chances of fraud being committed regarding cash are higher as compared to other assets.

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Solutions to Exercises

6.

Indicate how the following transactions would be recorded (debits/credits), using T-Accounts: a. 800 b. 1,000 c. 4,000 Purchased a Treasury Bill for $4,000. Paid with Cash. Interest Bearing Deposits Cash 4,000 $1,000 Salaries and Benefits paid to staff in Cash. Salaries and Benefits Cash 1,000 $800 Cash collected in Client Savings. Cash Client Savings 800

d. 7,500 e. 1,500 f. 500

Received $7,500 Cash when a Long-term investment matured. Cash Long-term Investments 7,500 Purchased equipment for $1,500 with a credit card. Furniture Short-term Borrowings 1,500 Earned $500 in interest on current loans. Cash Interest on Current Loans 500

g. 2,000 h. 45 i. 150

Paid a $2,000 traveling expense. Travel Expenses Cash 2,000 Collected $45 in client service charges. Cash Service Charges 45 Paid $150 interest on client savings. Interest Paid on Deposits Cash 150

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Solutions to Exercises

7.

Create a General Journal with the previous transactions.

GENERAL JOURNAL
Date Mar 1 1 10 15 17 20 25 27 30 Account Title and Explanation Cash Client Savings (collected client savings) Salaries & Benefits Cash (paid staff salaries) Interest Bearing Deposits Cash (purchased a Treasury Bill) Cash Long-term Investments (long-term investment matured) Equipment Short-term Borrowings (purchased furniture on credit) Cash Interest on Current Loans (interest earned on current loans) Travel Expenses Cash (paid travel expenses) Cash Service Charges (collected client service charges) Interest Paid on Client Savings Cash (paid interest on client savings) Ref.* Debit 800 800 1,000 1,000 4,000 4,000 7,500 7,500 1,500 1,500 500 500 2,000 2,000 45 45 150 150 Credit

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Solutions to Exercises

Lesson 5:

Summarizing Changes in Financial Position

1.

What is a ledger account? A ledger account represents the accumulation of all information about changes in an asset, liability, equity, revenue or expense item in one place. For example, a ledger account for the asset cash would record each cash disbursement over a period of time as well as all cash received by the organization. Each ledger account is identified by its account name and its account number. The accounts are numbered based on whether they are an Asset, Liability, Equity, Revenue or Expense account.

2.

What is the difference between the General Journal and the General Ledger? The General Journal lists every transaction in chronological order. summarizes the transactions by account number. The General Ledger

3.

Which of the following have opening balances: a. Balance Sheet accounts ( )

4.

Give two examples of adjustments made at the end of the accounting period. i. ii. Depreciation Expense Provision for Loan Losses

5.

Why is a Trial Balance created? A Trial Balance is created to verify that the debits and credits entered into the General Ledger are balanced.

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6.

On the basis of the Loan Fund transactions supplied and the opening balances from the Sample Balance Sheet, prepare the following documents for the month of April, 1996: i. ii. iii. General Journal General Ledger Trial Balance

(i)

GENERAL JOURNAL

Date April 2 2 2 2 3

Account Title and Explanation Cash Interest-Bearing Deposits (withdrawal from bank account) Equipment Cash (purchased furniture) Loans Outstanding - Current Cash (disbursed loan to client) Cash Service Charges (collected service charge) Cash Loans Outstanding - Current Interest on Current Loans Client Savings (collected current loan - $3,480 principal) (collected $400 client savings) Loans Outstanding - Past Due Loans Outstanding - Current (current loan outstanding becomes past due) Utilities Expense Telephone Expense Cash (paid utilities and telephone bills) Travel Expenses Short-term Borrowings (staff travel on credit card) Loans Outstanding - Current Cash (disburse loan to client) Cash Service Charges (collected service charge)

Ref. 101 102 116 101 103 101 101 404 101 103 401 202 104 103 515 512 101 524 201 103 101 101 404

Debit 500

Credit 500

1,000 1,000 2,500 2,500 75 75 4,400 3,480 520 400 1,000 1,000 109 125 234 5,000 5,000 5,000 5,000 150 150

10 10

16 16 16

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(i) contd GENERAL JOURNAL (Contd)

Date April 27 27 27 Account Title and Explanation Salaries & Benefits Cash (paid staff salaries) Interest Paid on Long-term Debt Cash (paid interest on loan) Cash Loans Outstanding - Current Interest on Current Loans (collected current loan payment) Rent Cash (rent paid on office space) Loans Outstanding - Current Cash (disbursed loan to client) Cash Loan Fees/Service Charges (collected service charge from client) Loans Outstanding - Restructured Loans Outstanding - Past Due (restructured a past due loan) Loan Loss Reserve (negative asset) Loans Outstanding - Past Due (to write-off a past due loan) Cash Long-term Debt (Commercial) (borrow from bank) Ref. 510 101 503 101 101 103 401 514 101 103 101 101 404 105 104 106 104 101 203 Debit 5,500 5,500 36 36 1,020 1,000 20 1,000 1,000 1,000 1,000 30 30 2,500 2,500 2,000 2,000 10,000 10,000 Credit

29 29 29 30 30 30

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Accounting Study Guide

Solutions to Exercises

(ii)
Date 101 Cash April 2 2 2 2 3 10 16 16 27 27 27 29 29 29 30 102 Deposits April April 2

GENERAL LEDGER
Explanation Debit 500 1,000 2,500 75 4,400 234 5,000 150 5,500 36 1,020 1,000 1,000 30 10,000 500 103 Loans O/S - Current 2 3 10 16 27 29 104 Loans O/S - Past Due 10 30 30 105 Loans - Restructured 30 106 Loan Loss Reserve 30 107 Other Current Assets 114 Long-term Investments 116 Equipment 2,500 3,480 1,000 5,000 1,000 1,000 1,000 2,500 2,000 2,500 2,000 Credit Balance 5,000 5,500 4,500 2,000 2,075 6,475 6,241 1,241 1,391 (4,109) (4,145) (3,125) (4,125) (5,125) (5,095) 4,905 8,000 7,500 66,000 68,500 65,020 64,020 69,020 68,020 69,020 17,000 18,000 15,500 13,500 1,000 3,500 (7,000) (5,000) 500 12,500 4,000 5,000 (700)

April

April April

April

2 117 Accumulated Depreciation

1,000

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Accounting Study Guide

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(ii) contd GENERAL LEDGER Contd

Date April April April 16 202 Client Savings 3 203 Long-term Debt (comm.) 30 204 Long-term Debt (conn.) 301 Loan Fund Capital 302 Retained Net Surplus/(Deficit) 401 Int. - Current/Past Due Loans April April April 3 27 404 Service Charges 3 16 29 503 Int. Pd. on L-T Debt April April April April April April 27 510 Salaries & Benefits 27 512 Telephone 10 514 Rent 29 515 Utilities 27 524 Travel 16 5,000 5,000 109 109 1,000 1,000 125 125 5,500 5,500 36 36 75 150 30 75 225 255 520 20 10,000 400 Explanation 201 Short-term Borrowings 5,000 Debit Credit Balance 18,000 23,000 0 400 12,000 22,000 35,000 40,100 1,200 520 540

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Solutions to Exercises

(iii) TRIAL BALANCE April 30, 1996

Ref 101 102 103 104 105 106 107 114 116 117 201 202 203 204 301 302 401 404 501 510 512 513 515 524 Ledger Accounts Cash Deposits Loans O/S - Current Loans O/S - Past Due Loans - Restructured Loan Loss Reserve Other Current Assets Long-term Investments Equipment Accumulated Depreciation Short-term Borrowing Client Savings Long-term Debt (Commercial) Long-term Debt (Concessional) Loan Fund Capital Retained Net Surplus/Deficit Interest on Current & Past-due Loans Loan Fees/Service Charges Interest Paid on Long-Term Debt Salaries & Benefits Telephone Rent Utilities Travel Totals Debit 4,905 7,500 69,020 13,500 3,500 (5,000) 500 12,500 5,000 (700) 23,000 400 22,000 35,000 40,100 1,200 540 255 36 5,500 125 1,000 109 5,000 122,495 Credit

122,495

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Solutions to Exercises

Lesson 6:

Relationship between Financial Statements

1.

What are two examples of non-cash items? i. ii. Depreciation Expense Provision for Loan Losses

2.

What is the purpose of creating the Statement of Changes in Financial Position? The Statement of Changes in Financial Position is created in order to determine whether an organization has enough cash flow (or working capital) from operations and other sources and uses of cash. It is important that cash flow be forecasted accurately for two reasons: (i) Idle funds are expensive. If an Organization has branches which it charges for funds disbursed to them then excess cash sitting at the branch is expensive due to the cost of funds charged to the branches by Head Office. (ii) If the Organization is left without enough cash, bills may go unpaid or clients may go without their loans.

3.

What are the elements which change Equity? There are three elements which change equity: (i) income (ii) investments by owner(s) (iii) distribution to owner(s)

4.

Choose the right answer:

Net Surplus - current year Donation to Loan Fund Capital Dividend payment to shareholders Net Loss - current year

Equity Increases

Equity Decreases

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Solutions to Exercises

5.

On the basis of the Loan Fund information supplied, show the relationship between financial statements as at December 31, 1994:

RELATIONSHIP BETWEEN FINANCIAL STATEMENTS

PARTICULARS
Salaries & Benefits Grant income - fund capital Cash & current accounts Communications Loans outstanding - gross Provision for Loan Losses Property & equipment - gross Travel Short-term borrowings Interest paid on deposits Accumulated depreciation Rent Interest income - investments Interest bearing deposits Staff training Long-term investments Interest paid on debt Client savings Depreciation Loan Loss Reserve Interest income - current loans Long-term debt Loan fees Loan fund capital
Net Retained Surplus/(Deficit)
prior

BS.
24,000 4,560 16,800 3,840 336,000 14,400 19,200 12,000 48,000 2,400 1,440 12,000 8,880 33,600 9,600 52,800 14,400 9,600 1,440 24,000 57,600 216,000 24,000 158,400 0

INCOME STATEMENT
Revenue Expenses 24,000 3,840

BALANCE SHEET
Assets Liabilities Equity 4,560 16,800 336,000

14,400 19,200 12,000 48,000 2,400 (1,440) 12,000 8,880 33,600 9,600 52,800 14,400 9,600 1,440 (24,000) 57,600 216,000 24,000 158,400 0 90,480 94,080 (3,600) 90,480 432,960 432,960 273,600 273,600 162,960 (3,600) 159,360

Net (Deficit) - current year TOTALS 90,480

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