Units 3 and 4: Financial Accounting and Management Accounting
What you must understand
Units 3 and 4 require you to record, report and analyse. You must be able to prepare journals, ledgers and a trial balance with balance-day adjustments, then produce an income statement, balance sheet and cash flow statement (or reconciliation) in accordance with the qualitative characteristics and accounting assumptions. Key adjustments include accruals, prepayments, depreciation, bad and doubtful debts, and inventory write-downs. You must also understand the difference between profit and cash flow, the purpose of the cash flow statement, and the analysis tools: profitability, liquidity, efficiency, solvency and cash flow indicators. Unit 4 adds management accounting: budgeting (cash and budgeted income statement), variance analysis, cost-volume-profit analysis including contribution margin and break-even, and decisions such as pricing and whether to make or buy.
Traps that appear in questions
- Recording an accrued expense as a cash payment or omitting it from the income statement.
- Treating a prepaid expense as an expense of the current period.
- Forgetting to adjust depreciation for part-year ownership.
- Confusing doubtful debts (allowance estimate) with bad debts (written off).
- Reporting GST collected as revenue rather than a liability to the ATO.
- Mixing cash flow from operations with investing or financing activities.
- Using profit instead of contribution margin in break-even calculations.
Worked example
Fixed costs $30,000; selling price $50; variable cost $30. Contribution margin per unit = $20. Break-even = $30,000 / $20 = 1,500 units. To earn a target profit of $10,000: ($30,000 + $10,000) / $20 = 2,000 units.
Rule of thumb
Always check the reporting period, adjust for accruals and prepayments before calculating profit, and remember that profit is not the same as cash.