ICAP PRC-1 Fundamentals of Accounting cheat sheet

Accounting is the process of identifying, measuring, recording and communicating economic information to permit informed judgements by users; financial accounting reports to external users, management accounting to internal users.

The IASB Conceptual Framework identifies the objective of general purpose financial reporting as providing financial information useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.

Fundamental qualitative characteristics are relevance and faithful representation; enhancing characteristics are comparability, verifiability, timeliness and understandability.

Faithful representation requires completeness, neutrality and freedom from error; materiality is an entity-specific aspect of relevance.

The elements are assets, liabilities, equity, income and expenses; an asset is a present economic resource controlled by the entity as a result of past events, with the potential to produce economic benefits.

Recognition requires relevance and faithful representation; measurement bases include historical cost, current value (fair value, value in use, current cost) and the cost constraint may justify departures.

Underlying assumption is going concern; accrual basis records transactions when they occur, not when cash is received or paid.

Key users: investors (risk and return), lenders (ability to repay), employees, suppliers, customers, government (tax) and the public; each has different information needs.

Sequence: identify transactions, record in journals, post to ledgers, prepare unadjusted trial balance, make period-end adjustments, prepare adjusted trial balance, prepare financial statements, then post closing entries.

Source documents (invoices, credit notes, receipts, bank statements) provide evidence and support the initial recording of a transaction.

Double-entry rule: every transaction has equal debits and credits, so the trial balance totals agree; the accounting equation Assets = Liabilities + Equity always holds.

Closing entries transfer income and expense balances to the income statement/profit and loss account, leaving only permanent (real) accounts with balances.

Reversing entries may be made at the start of the next period for accrued expenses, accrued income and prepayments to simplify subsequent recording.

The accounting equation can be expanded: Assets = Liabilities + Capital + Income - Expenses - Drawings.

A journal entry records date, accounts debited and credited, amounts, and a narration explaining the transaction.

Errors that do not affect trial balance agreement include errors of principle, omission, commission, original entry, reversal of entries and compensating errors.

Books of prime entry: sales day book (credit sales), purchase day book (credit purchases), sales returns day book, purchase returns day book, cash book, and general journal.

Debit entries increase assets and expenses; credit entries increase liabilities, equity/capital and income.

Sales day book: debit receivables, credit sales; purchase day book: debit purchases, credit payables.

Sales returns: debit sales returns, credit receivables; purchase returns: debit payables, credit purchase returns.

Cash book is both a book of prime entry and a ledger account; debit column records receipts, credit column records payments.

Discounts allowed (settlement discount to customers): debit discount allowed, credit receivables; discounts received: debit payables, credit discount received.

Contra entry between cash book and payables/receivables (e.g. cash paid to a supplier) reduces both balances; record in both ledgers.

Petty cash imprest system: top up the float by the value of vouchers/receipts so the balance returns to the fixed imprest amount.

A trial balance lists all ledger balances at a date, with debit balances in one column and credit balances in another; equal totals indicate arithmetical accuracy only.

Typical debit balances: assets, expenses, drawings, purchases, sales returns; typical credit balances: liabilities, capital, income, sales, purchase returns, provisions.

Errors revealed by a trial balance: single entry, addition error, transposition (e.g. 123 vs 132), and posting a debit as a credit.

Errors not revealed: error of principle, error of omission (whole transaction omitted), error of commission (wrong account of same class), error of original entry, compensating errors, complete reversal.

Suspense account is opened when trial balance totals disagree; the difference is posted there until the error is found and corrected.

Correction of errors is made through the general journal; if the original entry was correct in amount but wrong account, the correction may involve the suspense account only if the trial balance was affected.

A trial balance does not prove that no errors were made, only that debit and credit totals are equal.

Accrual: expense incurred but not yet invoiced - debit expense, credit accruals; income earned but not received - debit accrued income, credit income.

Prepayment: expense paid in advance - debit prepayments, credit expense; income received in advance - debit income, credit deferred/income in advance.

Depreciation of non-current assets is charged to the income statement and accumulated in a provision; it is not a cash movement.

Inventory at year end: closing inventory reduces cost of sales and is a current asset; cost of sales = opening inventory + purchases - closing inventory.

Financial statements: statement of profit or loss (income and expenses), statement of financial position (assets, liabilities, equity), statement of cash flows, statement of changes in equity.

Gross profit = revenue - cost of sales; profit for the period = gross profit - expenses + other income.

Current assets are expected to be realised within 12 months or the normal operating cycle; current liabilities are due within 12 months.

Drawings reduce capital; profit increases capital; closing capital = opening capital + profit - drawings + capital introduced.

Bank reconciliation reconciles the cash book balance with the bank statement balance at a date; differences arise from timing and errors.

Items on the bank statement not yet in the cash book: bank charges, interest, direct debits, standing orders, dividends, dishonoured cheques and bank errors - adjust the cash book.

Items in the cash book not yet on the bank statement: unpresented cheques and outstanding lodgements - adjust the bank reconciliation, not the cash book.

Reconciliation statement: balance per bank statement + lodgements not credited - unpresented cheques +/- bank errors = adjusted bank balance; adjusted cash book balance should equal it.

A credit balance in the cash book (overdraft) is a credit balance in the bank statement's favour when reconciling; be careful with signs.

Dishonoured cheques: reverse the original receipt - debit receivables, credit cash book.

Bank errors are corrected by the bank, not the entity; only errors by the entity are corrected in the cash book.

Petty cash reconciliation compares the imprest amount with cash in hand plus vouchers; a shortage is recorded as an expense.

Sales ledger control account (receivables): debit opening balance, credit sales, debit cash received, discounts allowed, sales returns, irrecoverable debts, contra; closing balance is debit.

Purchase ledger control account (payables): credit opening balance, credit purchases, debit cash paid, discounts received, purchase returns, contra; closing balance is credit.

Control accounts are memorandum accounts summarising the subsidiary ledgers; they help locate errors and deter fraud.

Reconciliation of control account with list of ledger balances: differences arise from errors in the control account, errors in the subsidiary ledger, or omissions.

Contra between sales and purchase ledgers: debit payables control, credit receivables control for the same amount.

Irrecoverable debts written off: debit irrecoverable debts expense, credit receivables; recovered later: debit cash, credit irrecoverable debts recovered income.

Control account balances appear in the statement of financial position as trade receivables and trade payables.

IAS 2: inventory is measured at the lower of cost and net realisable value (NRV = estimated selling price less costs to complete and sell).

Cost includes purchase price, import duties, transport and handling; excludes abnormal waste, storage (unless necessary), and selling costs.

Cost formulas: FIFO and weighted average cost are permitted; LIFO is not permitted under IAS 2.

Closing inventory valuation errors affect profit: overstatement of closing inventory overstates profit and assets; understatement understates both.

Inventory write-down to NRV is recognised as an expense in the period; reversal is permitted only if NRV subsequently increases.

Goods on sale or return / consignment are included in the consignor's inventory until sold; goods sold but not dispatched may be excluded depending on terms.

Inventory count adjustments: record discrepancies as inventory losses; goods in transit belong to the party holding title.

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life; depreciable amount = cost - residual value.

Straight-line: (cost - residual value) / useful life; reducing balance: carrying amount x rate; units of production: (cost - residual)/total units x units used.

IAS 16: initial measurement at cost including directly attributable costs; subsequent measurement at cost or revaluation model.

Revaluation surplus is recognised in other comprehensive income and accumulated in equity; a decrease reverses a previous surplus before being expensed.

Disposal: debit accumulated depreciation and cash proceeds, credit asset cost; difference is profit or loss on disposal.

Profit on disposal = proceeds - carrying amount; carrying amount = cost - accumulated depreciation.

Land is usually not depreciated; assets held for sale under IFRS 5 are not depreciated.

Depreciation method and useful life are reviewed at least annually; changes are prospective accounting estimates.

Irrecoverable debts are written off against receivables when there is no realistic prospect of recovery; allowance for doubtful debts is an estimate of likely losses.

Allowance for receivables: debit irrecoverable debts expense, credit allowance; increase in allowance is an expense, decrease is income.

IAS 37 provisions are recognised when there is a present obligation from a past event, probable outflow of resources and a reliable estimate; if not probable, disclose a contingent liability.

Provisions are measured at the best estimate of the expenditure required to settle the obligation; discount if the time value is material.

Contingent assets are not recognised; disclose only if an inflow is probable.

Trade payables are current liabilities; a supplier's early settlement discount is recognised as a reduction of the purchase cost under IFRS.

A provision for doubtful debts is netted against receivables in the statement of financial position; the expense appears in profit or loss.

Warranty provisions: recognise at the time of sale based on historical claims experience.

Accrued expense: debit expense, credit accruals; prepaid expense: debit prepayments, credit expense; accrued income: debit accrued income, credit income; income received in advance: debit income, credit deferred income.

In the income statement, accrued expenses are added to the expense and prepayments deducted; accrued income added to income and income in advance deducted.

Partnership: profits shared in profit-sharing ratio unless a partnership agreement states otherwise; in the absence of agreement, profits and losses are shared equally.

Partnership appropriation account shows interest on capital, partners' salaries, interest on drawings, then residual profit shared in the agreed ratio.

Current accounts record drawings, salaries, interest on capital and share of profit; capital accounts record capital introduced and revaluation adjustments.

Drawings are debited to the partner's current account; interest on drawings is credited to the appropriation account and debited to the partner.

Goodwill on admission of a partner: raise goodwill in old ratio, write off in new ratio; the difference affects partners' capital accounts.

On dissolution, assets are realised, liabilities settled, and the resulting profit or loss shared in the profit-sharing ratio.

Share capital: ordinary shares recorded at nominal value; share premium is the excess over nominal value; both are equity.

Dividends are distributions of profit, not expenses; interim and final dividends are recorded in the statement of changes in equity.

Loan notes/debentures are liabilities; interest is an expense; finance costs are presented separately in profit or loss.

Ratios: gross margin = gross profit/revenue; net margin = profit before tax/revenue; ROCE = operating profit/(equity + non-current liabilities).

Liquidity: current ratio = current assets/current liabilities; quick ratio = (current assets - inventory)/current liabilities.

Efficiency: inventory turnover = cost of sales/average inventory; receivables collection period = receivables/revenue x 365.

Gearing = debt/(debt + equity) or debt/equity; interest cover = operating profit/finance costs.

Limitations of ratio analysis: different accounting policies, inflation, seasonal effects, and no benchmark without industry data.

Not-for-profit entities prepare a statement of financial activities (receipts and payments account or income and expenditure account) rather than a profit and loss account.

Receipts and payments account is a cash-based summary; income and expenditure account is prepared on an accruals basis.

Subscriptions in arrears are receivables; subscriptions in advance are deferred income; life membership is capitalised and released over the membership period.

Fund accounting: restricted funds can only be used for specified purposes; unrestricted funds are available for general use.

Incomplete records: use the accounting equation to derive missing figures, e.g. opening capital + profit + capital introduced - drawings = closing capital.

Mark-up = gross profit/cost of sales; margin = gross profit/revenue; convert between them: margin = mark-up/(1 + mark-up).

Use a statement of affairs to estimate opening or closing capital when records are incomplete.

Cash stolen or missing is derived by preparing a cash account and comparing expected with actual cash.

Fundamental ethical principles: integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour.

Threats to independence: self-interest, self-review, advocacy, familiarity and intimidation; safeguards include rotation, independent review and disclosure.

Confidentiality: information acquired through professional work must not be disclosed without authority unless there is a legal or professional right or duty to disclose.

Objectivity: do not compromise professional judgement because of bias, conflict of interest or undue influence of others.

Computerised systems: automated double entry, real-time posting, audit trails, access controls, backup and segregation of duties reduce error and fraud risk.

Spreadsheet risk: undocumented formulas, hard-coded values, version control issues; controls include review, testing and locking.

Data protection and privacy laws apply to personal data held in accounting systems; retention and disposal policies are required.

Whistleblowing and reporting suspected money laundering or fraud may override confidentiality obligations where law requires disclosure.