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Profit Loss

UNIT 3 CH 9

QuestionAnswer
profit eq. profit = rev-exp
accrual accounting: calculating profit by comparing rev against exp incurred in a particular R.P
revenues an inflow of economic benefits (or saving in outflows) in the form of an increase in assets (or decrease in liabilities) that increases owner’s equity, except for capital contributions by the owner
expense an outflow or consumption of economic benefits (or reduction in inflows) in the form of a decrease in assets (or increase in liabilities) that reduces owner’s equity, except for drawings by the owner
narration for closing revenues: Closing revenue accounts to P&L Summary account (Memo)
narration for closing expenses: Closing expense accounts to P&L Summary account (Memo)
RP principle is important for determining profit: allows us to divide the life of the business into arbitrary periods in order to determine profit
how long is RP? arbitrary, subjective, determined by owner, usually one month,or quarterly etc. but no longer than one year due to taxation requirements
how is relevance ensured when calculating profit? it is important that the calc of profit includes only rev and expenses and only those R and E that have occurred during the current RP___if not: e.g. incl. drawings or loan repayments, or last yrs wages, reports contain info not useful for decision makin
closing the ledger transferring balances from revenue and expense ledger accounts to the Profit and Loss Summary account so that profit can be calculated
process of closing the ledger. Closing the ledger involves transferring balances from revenue and expense ledger accounts to the Profit and Loss Summary account so that profit can be calculated.
two reasons for closing the ledger. Transfer revenues and expenses to the P & L Summary account in order to calculate profit for the current R.P ______Reset revenue and expense accounts to zero in preparation for the next Reporting Period.
asset and liability accounts are not closed? Assets and liabilities will exist into the future. That is, the Balance Sheet items involve a future benefit or future sacrifice and so should not be reset to zero, but their balances should carry forward into the next Reporting Period.
Profit and Loss Summary: an account in the GL (entries are first recorded in the GJ though) P&L summary is a temporary OE account: it is not reported anywhere
hree entries that will be recorded in the Profit and Loss Summary account. total revenues, total expenses, and net profit/loss figure
Referring to revenues and expenses, explain why the cross-references in the Profit and Loss Summary account are not ledger account names. Rather than list each and every one of these account names, the cross-reference is simply ‘revenues’ or ‘expenses’ to indicate that there are a number of revenue and expense accounts linked to these total figures.
Explain how the Profit and Loss Summary account would be classified in the Balance Sheet. (Beware!) it is not entered in the BS. it is a temporary account that opens and closes on the same day. *simply facilitates the calc of profit
to close revenue accounts: debit
to close expense accounts: credit
to close stock gain accounts: debit
to close stock loss accounts: credit
State one reason why transactions with the owner are recorded separately in the Drawings account (rather than directly in the Capital account). It is recorded separately so that the owner’s transactions for a particular Reporting Period can be isolated. This is useful for decision-making so that the owner can assess the level of drawings.
State one reason why the Drawings account is closed to the Capital account. The Drawings account is closed to the Capital account so that the Capital account can reflect the net effect of all transactions with the owner.
Referring to the definition of an expense, explain why the Drawings account is not closed to the Profit and Loss Summary account. Although Drawings is an outflow of economic benefits in the form of a decrease in assets that reduces owner’s equity, it is expressly excluded from the definition of an expense, as it is a transaction with the owner.
Referring to one qualitative characteristic, explain why Drawings are not included in the calculation of profit. Relevance. Drawings is a transaction with owner. relevance states acc reports contain info useful for decision making. to include drawings is a breach of relevance.
process to close drawings account: capital: debit ___ drawings: credit
narration for closing drawings account: Transfer of Drawings account to Capital account
Explain why it is necessary to prepare an Income Statement even when the profit figure is known. IS details Rev and Exp fro RP and in the process shows both Gross Profit and Net Profit. Shows why they occurred, giving owner more info to base their decisions.
relationship between P & L Summary and IS: Net Profit value in both should be the same, because they both will deduct expenses incurred from revenues earned for a particular RP
Explain why the Income Statement is titled for the period rather than as at a particular date. The information it reports is not confined to a single day, but covers a period of time.
Explain the difference between Cost of Sales and Cost of Goods Sold. Cost of Goods Sold is a heading referring to all costs incurred in getting goods into a condition and location ready for sale, with Cost of Sales simply one of the items that may be reported under this heading.
Identify two revenues that would be classified as ‘Other Revenue’. Discount Revenue___ Interest Revenue ___ Commission Revenue
purpose of IS: detail individual R and E items and to identify Gross profit and Net profit, making the report more useful as a decision -making tool
how does IS assist decision making? allows owner to assess: 1__firm's ability to earn rev, + types of stock held for sale, level/type of ads, s.p, __2__adequacy of mark.up, and adjusting s.p or controlling cost price. __3__ expense control: e.g managing wages, stock loss, internal control
how can IS assist in planning for future? By providing a basis for the next budget, the Income Statement will aid in the setting of targets for the future. This may include stock levels, staffing requirements or advertising expenditure.
Explain why stock control is balanced not closed: Because as a current asset, it represents a future economic benefit, which will be carried forward into the next Reporting Period
Explain How closing ledgers ensures Relevance in financial reports It ensures that only those revenues earned and expenses incurred in the current Reporting Period are used to calculate profit, as it is only this information that is useful for decision-making.
Explain why drawings is not closed to the Profit and Loss Summary account: It is neither an expense nor revenue, does not affect profit of business.
Explain why businesses should prepare IS even if they know their net profit for a reporting period: 1. aids decision making about firms trading op. by showing particular rev and exp that caused net profit __2._the owner can examine Gross Profit to assess the adequacy of the mark up, assess control of particular expenses
An owner has stated that since owners equity has increased *due to Net Profit assets must also have increased. why is this incorrect? Liabilities may have decreased.
Suggest how owner may improve Net profit: 1. Increase selling prices (to increase m/up)/increase advertising (to generate sales) _2_ Find a cheaper supplier/Negotiate cheaper rent (or move!)/Assess staff rostering
Explain how reducing discount offered to debtors may decrease net profit: It may mean customers are less willing to buy from the business, leading to lower Sales revenue and thus lower Net Profit.
Why must ledgers must be closed: 1. reporting period _2._ rev and esp amounts must be transferred to the P&L summary account in order to determine profit for the current RP _3._ rev and exp accounts must be reset to zero in readiness for next RP
Suggest how owner can improve adjusted gross profit without affecting gross profit: 1. improve physical security measures (such as locking the storeroom/security cameras) _2__check purchase invoices against delivery dockets _3__change store layout surveillance/protect stock from the damage_4__more regular stocktakes
Explain how an increase in Other Expenses might lead to an increase in Net profit: 1_Expenses are incurred in order to earn revenue _2_so increased advertising/discount rate_3__rent (from a better location)_4__wages (from more staff and therefore better customer service) could lead to increased Sales revenue and increased Net Profit.
Use of IS: 1.assist decision making by identifying problem areas(rev earning,exp control)so remedial action can be taken_2_assist planning by providing basis for the next budgeted IS. e.g. pricing, staffing levels,stock purchases, and ads
Created by: 96.0