e-Consult | Revision Qns

1.

Question 3: A business purchases a machine for £50,000 on January 1st. The machine has an estimated useful life of 5 years and is to be depreciated using the straight-line method. Calculate the annual depreciation expense. Explain how the depreciation expense is 'matched' with revenue earned during the 5 years.

Calculation of Annual Depreciation:

Annual Depreciation = (Cost - Salvage Value) / Useful Life

Assuming a salvage value of £0:

Annual Depreciation = (£50,000 - £0) / 5 = £10,000

How Depreciation is Matched with Revenue:

The annual depreciation expense of £10,000 is recognized each year for the 5 years the machine is used. This means that each year, a portion of the machine's cost is allocated to the period in which the machine is generating revenue. For example, if the business earns £30,000 in revenue in year 1, £10,000 of that revenue is 'matched' with the £10,000 depreciation expense. This ensures that the profit reported in year 1 reflects the actual profitability of the business, considering the cost of using the machine to generate that revenue. This process continues for each of the 5 years.

2.

A business is considered a sole trader. Outline the key features of this business structure and discuss the implications of unlimited liability for the owner.

A sole trader is a business owned and controlled by a single individual. Key features include:

Single Ownership: The business is owned and run by one person.

Simple Setup: Relatively easy and inexpensive to set up.

Direct Control: The owner makes all the decisions.

All Profits to Owner: The owner receives all the profits generated by the business.

Implications of Unlimited Liability:

Unlimited liability is a significant drawback for a sole trader. This means the owner is personally responsible for all the debts and obligations of the business. This can lead to the owner losing their personal assets, such as their house, savings, and other possessions, if the business cannot pay its debts. This is a major risk associated with being a sole trader and is a key consideration when deciding on a business structure.

3.

Question 1: Explain the meaning of realisation in accounting and describe two methods used to realise assets. Include a discussion of the potential impact of realisation on a business's financial statements.

Answer: Realisation in accounting refers to the process of converting assets into cash. This typically happens when a business decides to sell an asset, such as inventory, equipment, or a property. It's a crucial step in ensuring that the carrying value of assets is brought up to date with their actual market value.

Two methods of realisation include:

Sale of Inventory: This is the most common method. Inventory is sold to customers, and the cash received is recorded. The cost of goods sold is then calculated.

Sale of Fixed Assets: Fixed assets, like machinery or buildings, can be sold. The proceeds from the sale are recorded as cash, and any difference between the selling price and the original cost (or revalued amount) is recognised as a gain or loss.

Impact on Financial Statements:

Balance Sheet: Realisation can impact the balance sheet by reducing the value of assets. For example, if a fixed asset is sold for less than its book value, the asset's value will be reduced.

Profit and Loss Account: The profit or loss on the realisation of an asset is recorded in the profit and loss account. A gain is added to profit, while a loss is deducted. The cost of goods sold (for inventory) directly impacts gross profit.

Statement of Cash Flows: The cash received from the sale of an asset is recorded as a cash inflow from operating activities.

7.1 Accounting principles (3)