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RETURNS OF STOCK
Purchase return: the return of stock to a trade creditor (by our firm).
Sales return: the return of stock (to our firm) by a trade debtor.
Credit Note: a source document that verifies the return of stock (either to a trade creditor or by a
trade debtor)
Recording a Purchase return (General Journal)
DR
Creditors Control
DR
Creditor - X
CR

Stock Control
CR

GST Clearing
(Number of units & stock line) returned to supplier - [reason] (Cr. Note X)
Recording a Sales return (General Journal)
DR
Sales Returns
DR
GST Clearing
CR

Debtors Control
CR

Debtor - X
DR
Stock Control
CR

Cost of Sales
(Number of units & stock line) returned by customer - [reason] (Cr. Note X)
Explain how the cost price of the stock is determined when a sales return is recorded in the
stock card.
By applying FIFO in reverse, which assumes the last stock to leave the business is the stock being
returned by the customer. The most recent transaction in the OUT column is recorded as being
returned to the business.
Explain the effect of GST on the cost price of stock.
GST has no effect on the valuation of stock. It does not affect the economic benefit represented by
the stock and is not a cost incurred by the business. It represents a reduction in the GST liability owed
to the ATO (or increase in the GST asset owed by the ATO)
Why are purchase and sales returns recorded in the General Journal?
Purchase and sales returns are infrequent, non-cash transactions that do not belong in any of the
special journals.
Explain the benefit derived from offering returns to customers.
Offering returns encourages the customer to return to the business, as they feel they can trust the
business, (greater goodwill) which in turn leads to greater sales, and greater profit.
Why are Sales Returns identified/recorded separately to Sales?
Sales returns are identified separately so that the owner can see the value of the stock returned to the
business, which aids decision making about the suitability of stock, and allows the owner to take
corrective action such as improving stock handling techniques and purchasing better quality stock.
What is the effect of Sales Returns on the Profit and Loss Statement?
Sales Returns is a negative revenue which decreases Net Sales and Revenues (by $ amount), and
decreases Cost of Sales (by $ amount) which decreases Profit (by $ amount)
Sales - Sales Returns = NET SALES
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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STOCK VALUATION
Explain why stock cannot be valued at its selling price?
Historical Cost - The selling price is not the original purchase price of the stock, and is not verifiable
by source document evidence.
Conservatism - Using the selling price to value stock would recognise a gain before it is certain,
which would overstate assets (Stock Control) as there is no guarantee that the stock will be sold.
Product Cost: a cost incurred in order to bring stock into a location and condition ready for sale,
which can be allocated to individual units of stock on a logical basis.
Period Cost: a cost incurred in order to bring stock into a location and condition ready for sale that is
not allocated to individual units of stock as there is no logical basis to do so.
Explain the benefit of using product costing over period costing.
Product costing ensures that an accurate cost price of stock is determined which is more useful for
the owner’s decision making in regards to setting selling prices and applying an adequate mark-up.
Why is it important that the cost price of stock is calculated accurately?
An accurately calculated cost price of stock (using product costing) will be more useful to the owner’s
decision making in regards to setting selling prices and applying an adequate mark-up.
What is the effect of period costing on profit?
Unless all the stock is sold, the business will recognise the entire period cost as an expense at the
time the stock was purchased, rather than when the stock is sold. This will overstate Cost of Goods
Sold (by $ amount), which understates Profit.
What is the effect of period costing on the balance sheet?
Period costing understates Stock Control which understates Assets (by $ amount). Net profit is
understated by an overstated Cost of Goods Sold which understates Owner’s Equity (by $ amount).
The effect of using period costing as opposed to product costing can be calculated using:
Fraction of stock unsold x Period cost
Insurance on stock is usually recorded as a period cost as it is incurred on a per-annum basis (and
thus, cannot be allocated on a logical basis). It must also be recorded as a prepaid expense, and
allocated as an expense as it is consumed over the one-year period.
Why must stock be recorded at the lower of cost and NRV? (Conservatism)
So that losses are recorded when probable (on the sale of the stock) so that expenses are not
understated and assets (Stock Control) are not overstated.
Stock write down: an expense incurred when the NRV of stock falls below its cost price.
Reasons for a stock write down:
• Physical deterioration
• Purposeful decrease in price
• Decrease in demand
• Obsolescence
Net Realisable Value: the estimated selling price of stock less any costs involved in its selling,
marketing or distribution.
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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(Assuming the stock must be written down) Explain why the stock can no longer be valued
at its Historical cost. (Relevance)
The Net Realisable Value has fallen below the cost price due to (reason). The Historical Cost is no
longer useful for decision making.
Recording a Stock write down (General Journal)
DR
Stock write down
CR

Stock Control
Stock written down to NRV: [reason] (Memo X)
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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ACCOUNTING FOR NON-CURRENT ASSETS
Recording the credit purchase of a Non-Current Asset (General Journal)
DR
NCA
DR
GST Clearing
CR

Sundry Creditor - X
Credit purchase of NCA (Inv. X)
Why is the credit purchase of a Non-Current Asset recorded in the General Journal?
The credit purchase of a Non-Current Asset is an infrequent, non-cash transaction that does not
belong in any of the special journals.
Explain the difference between Creditors Control and a Sundry Creditor.
Creditors Control is the summary of all transactions involving trade creditors and credit purchases of
stock. Sundry Creditors are creditors derived from the credit purchase of Non-Current Assets.
Payments to Sundry Creditors are recorded in the Sundries column of the Cash Payments Journal.
Discounts may also apply to Credit Purchases of Non-Current Assets (recorded in the Discount
Revenue column).
What is included in the cost of a Non-Current Asset?
All costs incurred in order to bring the asset into a location and condition ready for use, that will
provide benefit for the life of the asset.
Recording the cash sale of a Non-Current Asset involves 3 steps:
• Transferring the carrying value (the cost price) - General Journal
• Recording the proceeds from the sale (the selling price) - Cash Receipts Journal
• Transferring the profit or loss on disposal - General Journal
Recording the sale of a Non-Current Asset
Cash Receipts Journal
Rec.
Disc.
Cost of
Date
Details
Bank
Debtors
Sales
GST
Sundries
No.
Exp.
Sales
Disposal of NCA
X
X
X
General Journal
DR
Disposal of NCA
CR

NCA
DR
Accumulated Depreciation - NCA
CR

Disposal of NCA
DR
Loss on disposal of NCA

OR

DR
Disposal of NCA
CR

Disposal of NCA



CR

Profit on disposal of NCA
Cash sale of NCA (Rec. X)
Loss on disposal of asset: an expense incurred when the carrying value of the asset is greater than
the proceeds from its disposal.
Profit on disposal of asset: a revenue earned when the carrying value of the asset is less than the
proceeds from its disposal.
Trade-in: When instead of receiving cash for the sale of a non-current asset, a firm uses the
proceeds from the sale to reduce the amount payable for the purchase of a new non-current asset.
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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Recording the trade-in of a Non-Current Asset (General Journal)
DR
Disposal of NCA
CR

NCA
DR
Accumulated Depreciation - NCA
CR

Disposal of NCA
DR
Sundry Creditor - X
CR

Disposal of NCA
DR
Loss on disposal of NCA

OR

DR
Disposal of NCA
CR

Disposal of NCA



CR

Profit on disposal of NCA
DR
NCA
DR
GST Clearing
CR

Sundry Creditor - X
Trade-in of NCA (Inv. X)
Reasons for a loss on disposal:
• The Carrying Value was greater than the proceeds (ie. the Carrying Value was overstated)
• Accumulated Depreciation was understated, the asset was under-depreciated
• The Residual Value and/or Useful Life were overstated
• This may have been because the asset was no longer in demand (due to damage, out of date,
obsolescence)
Reasons for a profit on disposal:
• The Carrying Value was less than the proceeds (ie. the Carrying Value was understated)
• Accumulated Depreciation was overstated, the asset was over-depreciated
• The Residual Value and/or Useful Life were understated
• This may have been because the asset was in higher demand than expected (ie. in better
condition, rare)
Under-Depreciation: when insufficient depreciation has been allocated over the life of the asset, so
that the carrying value of the asset is overstated.
Over-Depreciation: when excess depreciation has been allocated over the life of the asset, so that
the carrying value of the asset is understated.
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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BALANCE DAY ADJUSTMENTS - REVENUES
Explain the purpose of Balance Day Adjustments (Reporting Period/Relevance)
Balance Day Adjustments ensure profit is calculated accurately by matching Revenues earned against
Expenses incurred in the current Reporting Period which ensures reports contain all information which
is useful for decision making.
Prepaid Revenue: a revenue received but yet to be earned.
Prepaid revenues are a current liability to the business, a present obligation of the entity, as a result of
past events, which is expected to result in an outflow of economic benefit within the next 12 months,
when the obligation is delivered to the customer.
Recording a prepaid revenue (Cash Receipts Journal)
Rec.
Disc.
Cost of
Date
Details
Bank
Debtors
Sales
GST
Sundries
No.
Exp.
Sales
Prepaid Revenue
X
X
X
X
GST is recognised when the cash is received.
Adjusting for prepaid revenues earned (General Journal)
DR
Prepaid Revenue
CR

Revenue
Adjusting entry to record revenue earned (Memo X)
Adjusting for prepaid sales revenues earned (General Journal)
DR
Prepaid sales revenue
CR

Sales
DR
Cost of Sales
CR

Stock Control
Adjusting entry to record sales earned (Memo X)
Accrued Revenue: a revenue that has been earned but not yet received.
Accrued revenues are a current asset to the business, a resource controlled by the entity, as a result
of past events, from which future economic benefit is expected within the next 12 months, when the
cash is received.
Adjusting for prepaid revenues earned (General Journal)
DR
Accrued Revenue
CR

Revenue
Adjusting entry to record revenue earned but not yet received (Memo X)
Recording the receipt of an accrued revenue in subsequent periods (Cash Receipts Journal)
Rec.
Disc.
Cost of
Date
Details
Bank
Debtors
Sales
GST
Sundries
No.
Exp.
Sales
Revenue/
X
X
X
X
Accrued revenue
X
In the case of interest revenue, the source document may be the Bank Statement (B/S)
Explain why the receipt of an accrued revenue in a subsequent period requires the receipt
to be split in the Cash Payments Journal.
Part of the cash received was earned in a previous Reporting Period (ie. was accrued). The remainder
has been earned in the current Reporting Period.
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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BUDGETS
Budgeting: the process of predicting/estimating the financial consequences of future events.
Difference between actual and budgeted reports
1.
Budgets report future events rather than historical events.
2.
Budgets use estimates rather than actual, verifiable data.
Budgeting assists planning by predicting what is likely to occur in the future. This allows the owner
to prepare for what is likely to occur so that possible problems may be managed, and possible
opportunities may be taken.
Budgeting aids decision-making by providing a benchmark or yardstick (a standard) against which
actual performance can be measured. This allows the owner to identify areas in which performance is
unsatisfactory, so that remedial action can be taken.
Explain the importance of budgeted Sales.
Sales is the main revenue for a business and usually generates significant cash inflows (either through
Cash sales or Receipts from debtors). The level of sales will also vary with estimates of some
expenses (such as Cost of Sales and Wages). The level of sales will also affect the amount of stock
purchased (which may also affect Payments to Creditors)
Explain the benefit of preparing more frequent budgets.
More frequent budgets are likely to be more accurate, and more useful as for decision making. This
allows for variances to be identified earlier so that corrective action can be taken sooner.
Budgeted Cash Flow Statement: an accounting report that shows estimates of cash receipts and
cash payments, and the estimated cash balance, at a particular point in time in the future.
Explain the benefit of preparing a Budgeted Cash Flow Statement for consecutive periods.
Allows for the identification of monthly and seasonal trends, which can assist decision making in
regards to deciding when to undertake certain cash activities (such as purchasing a Non-Current
asset or repayment of a loan)
Explain the use of a Budgeted Cash Flow Statement for Decision making.
Assists decision making by providing a benchmark against which actual trading performance can be
measured (using a Cash Variance Report), which allows for problematic areas to be identified so that
corrective action can be taken.
Explain the use of a Budgeted Cash Flow Statement for Planning.
By allowing the owner to prepare for an expect cash surplus or deficit.
If the budget predicts a cash deficit, the owner may want to: defer the purchase of non-current
assets, or use credit facilities or a loan for their purchase, defer loan repayments, reduce cash
drawings, make a cash capital contribution, extend/organise an overdraft facility
If the budget predicts a cash surplus, the owner may want to: purchase newer/more non-
current assets, increase loan repayments, increase cash drawings, expand trading activities (such as
purchasing more advertising)
Cash versus Profit
Cash inflows that are not revenues: Cash sale of NCA, Cash capital contribution, Receipt of loan,
Receipt of an accrued revenue
Cash outflows that are not expenses: Cash payment of NCA/Payment to Sundry Creditor, Cash
drawings, Repayment of loan principle, Payment for an accrued expense
Revenues that are not cash inflows: Stock gain, Profit on disposal of NCA
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Expenses that are not cash inflows: Stock loss, Stock write down, Loss on disposal of NCA, Bad
debts, Depreciation
Items which affect both profit and cash: Credit sales/Receipts from debtors, Cost of Sales/
Payments to Creditors, Other revenue earned/Other revenue received (due to an Accrued/Prepaid
revenue), Other expense incurred/Other revenue paid (due to an Accrued/Prepaid expense)
Budgeted Profit and Loss Statement: an accounting report that shows estimates of revenues and
expenses, and the Gross profit, Adjusted gross profit and Net profit, at a particular point in time in the
future.
Explain the use of a Budgeted Profit and Loss Statement for Decision making.
Assists decision making by providing a benchmark against which actual trading performance can be
measured (using a Profit Variance Report), which allows for problematic areas to be identified so that
corrective action can be taken.
Explain the use of a Budgeted Profit and Loss Statement for Planning.
By indicating future requirements of the firm relating to issues like staffing, stock levels, or advertising
campaigns.
Budgeted Balance Sheet: an accounting report that shows estimates of Assets, Liabilities and
Owner’s Equity, at a particular point in time in the future.
Explain the use of a Budgeted Balance Sheet for Decision making.
By setting a benchmark for indicators that assess liquidity and stability, such as the Working Capital
Ratio, which will determine whether the business will be able to meet its short term debts as they fall
due.
Explain the use of a Budgeted Balance Sheet for Planning.
It aids planning for the replacement of non-current assets by detailing the expected carrying value at
some point in the future.
Variance Report: an accounting report that compares actual and budgeted figures, highlighting
variances, so that problematic areas can be identified and corrective action can be taken.
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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ASSESSMENT OF PERFORMANCE
Profitability: the ability of the business to earn profit, as compared against a base such as sales,
assets or owner’s equity.
Benchmarks for profitability indicators:
• Performance of previous periods
• Budgeted performance
• Performance of similar businesses/industry averages
Return on Owner’s Investment (ROI): a profitability indicator that measures how effectively a
business has used the owner’s capital to earn a profit.
The ROI should also be benchmarked against alternative investments in order to determine whether
the business was more profitable than the investment.
Return on Assets (ROA): a profitability indicator that measures how effectively a business has used
its assets to earn a profit.
Explain why Return on Owner’s Investment will always be higher than Return on Assets.
Because Assets will always be higher than Owner’s equity, due to the liabilities of the firm.
Asset Turnover (ATO): an efficiency indicator which measures how productively a business has used
its assets to earn revenue.
Expense Control: the ability of the firm to manage its expenses so that they can either decrease, or
in the case of variable expenses, increase no faster than sales revenue.
Net Profit Rate (NPR): a profitability indicator that measures expense control by calculating the
percentage of sales revenue that is retained as net profit.
Gross Profit Rate (GPR): a profitability indicator that measures average mark-up by calculating the
percentage of sales revenue that is retained as Gross profit.
Improving Profitability
Earning Revenue:
• Selling prices could be decreased to generate more sales volume, or increased to generate
greater revenue per sale.
• Advertising could be increased to generate greater sales.
• An appropriate stock mix should be kept on hand so that only products that are in demand
are sold and slow-moving lines removed.
• More efficient non-current assets will enable to firm to earn more revenue.
• Improved customer service will promote repeat sales.
Controlling Expenses:
• Management of stock: an alternative supplier may be able to provide cheaper and/or better
quality stock. A change in ordering procedures could reduce storage costs and stock loss.
• Management of staff: different rostering systems, appropriate incentives, and extra training
may improve staff productivity and performance.
• Management of NCAs: Inefficient/under-utilised/unreliable Non-Current assets should be
replaced or removed
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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Liquidity: the ability of the business to meet its short-term debts as they fall due.
Explain the importance of the budgeted Cash Flow Statement in assessing liquidity.
Details all expected cash inflows and cash outflows and determines whether the business is able to
meet its short-term cash obligations as they fall due.
Working Capital Ratio (WCR): a liquidity indicator that measures the ratio of current assets to
current liabilities, to assess the firm’s ability to meet its short term debts.
Benchmarks: WCR can be measured against WCR from previous periods or budgeted WCR to
determine whether it has increased or decreased. However, a satisfactory WCR is achieved when the
ratio is at least 1:1, ie There is at least $1 of current assets for every $1 of liabilities, so that the
business is able to meet its short term debts as they fall due.
Consequences of a Working Capital Ratio less than 1:1
The business has insufficient current assets to meet its financial obligations. The owner may be
required to make a cash capital contribution, extend/organise an overdraft facility, or defer certain
payments such as the purchase of a non-current asset.
Consequences of a Working Capital Ratio much greater than 1:1
The business may have idle current assets that are not being employed effectively. Excessive cash at
bank could be invested in a term deposit in order to earn a greater return on idle business funds.
Excessive amounts of stock will attract higher storage costs and risks damage/obsolescence. A large
amount of debtors may lead to ‘ageing’ debtors which are less likely to pay and be written off as bad
debts.
Explain how a firm with an unsatisfactory WCR could still avoid liquidity problems.
If the firm is able to sell its stock fast enough, and collect the cash from debtors quickly enough to
meet its Creditors’ terms, the business should not have liquidity problems.
Quick Assets Ratio (QAR): a liquidity indicator that measures the ratio of quick assets to quick
liabilities, to assess the firm’s ability to meet its immediate debts.
The calculation of QAR excludes:
• Stock/Prepaid expenses: there is no guarantee that these assets can be easily liquified so
that the business can use the funds to pay its debts immediately
• Bank Overdraft: is an arrangement with the bank that is unlikely to be recalled in the short-
term.
Cash Flow Ratio (CFR): a liquidity indicator that measures the number of times Net Operating Cash
flows is able to cover average current liabilities.
How does the Cash Flow Ratio assess liquidity?
By identifying the actual cash the business generates from its Operating activities to meet its financial
obligations.
Interest Cover: a liquidity indicator that measures the number of times Net Operating Cash Flows is
able to cover interest.
Stock Turnover (STO): The average number of days it takes for a business to covert its stock into
sales.
Strategies to increase a slow Stock Turnover:
• Increase sales (through better advertising, changing selling prices, or adopting a more suitable
stock mix)
Accounting Unit 4 Notes - Chris D’Alessandro - Last Updated September 12
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