Working Capital Current Assets Current Liabilities Accounting Essay

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Working capital: Current assets minus current liabilities. Working capital measures how much in liquid asset as company has available to build its business. The number can be positive or negative, depending on how much debt the company is carrying. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations. Companies with negative working capital may lack the funds necessary for growth. also called net current assets or current capital.

Current Assets: Current assets are those assets that are expected to be used (sold or consumed) within a year, unlike fixed assets. Current assets are shown on the balance sheet, and are listed in order of increasing liquidity (i.e. how easy they are to convert to cash). Usually stocks will be listed first, followed by debtors, with cash last.

Current Liabilities: Liabilities that will be due within a short time (less than one year) and that are to be paid out of current assets are called current liabilities. The most common liabilities in this group are notes payable and account payable

(c) The main problem that a business may face if there is no enough working capital is financial difficulties. With out proper funding a business cannot meet there day to day operations. Every business need some amount to purchase the raw material. Rate of return on investments also fall with the shortage of working capital. Excess working capital may result into over all inefficiency in organization. Excess working capital means idle funds which earn but no profits. If there is no profit in business it is not possible to run a business for a long time. If there is no enough working capital the owner may face unlimited liabilities and it is difficulties to obtain external finance

(d)A sole trader can increase their working capital by increasing their current assets and putting more money to business which includes the cash in the bank and the small cash in hand. And for increasing the working capital they can take bank loan which they have to pay back within one to three years or they can take mortgage loan which is a contract in which the provision that title reverts o the borrowers when the loan is fully paid back. It is usually a long term loan with the repayment period usually exceeding more than five years. it can also can called long term liabilities.

QUESTION:2

(A) (a) Distinguish accrual-basis accounting from cash-basis accounting

The cash method. 

Cash basis is used, revenue are reported in the period in which cash s received, and expenses are reported in the period in which cash is paid. For example, sales is only recorded only when cash is received from the customers, and salaries expense is only recorded when the salary is pad to the employee. Net income would be the difference between cash receipts and the cash disbursements.

The accrual method. Under the accrual method, revenues are recognized in the period earned and expenses are recognized in the period incurred in the process of generating revenues

.

(b) (b) Explain what is meant by Prepayments and Accruals by giving examples of each

Accruals

An expense or revenue that are gradually increase with the passage of time. These accounts include, among many others, accounts payable, accounts receivable, goodwill, future tax liability and future interest expense.

Cash actually paid

- Any accrual brought forward from the previous period

+The accrual at the end of the period

An example of an accrual ('accrued expense').

Martin john started a welders business on 1st April 2008, and used 31st March 2009 as his financial year-end. The electricity bills for his first year had been paid as follows :

date paid

amount

covering the period

2008

18th July

$66

1st April to 30th June 2008

2008

16th Oct

$96

1st July to 30th Sept 2008

2009

20th Jan

$56

1st Oct to 31st Dec 2008

Unpaid

$98

1st Jan to 31st Mar 2009

At the end of the year (after the profit and loss account is drawn-up), the electricity account would look as follows:

ELECTRICITY

Date

Debits

$

Date

Credits

$

18.07.08

Bank

66

 

 

 

16.10.08

Bank

96

 

 

 

20.01.09

Bank

56

31.03.09

balance c/d

218

 

 

218

 

 

218

31.03.09

balance b/d

218

31.03.09

to profit and loss

316

31.03.09

balance c/d

98

 

 

___

 

 

316

 

 

316

 

 

 

01.04.09

balance b/d

98

Prepayments

Prepayments are included within debtors on the balance sheet, as an asset.

This is where money is paid in advance period before the one to which the

expense relates. In other words, it is something that has been paid in

advance.

..

The total amount included as an expense in the period would be:

Cash actually paid

+ Any prepayment brought forward from the previous period

- The prepayment at the end of the period

An example of prepayment

An Agency pays $120,000 (GST exclusive) for software licence and support services for six months in advance on 1 April X2. This transaction was initially (and incorrectly) fully recorded as an expense in the month in which the payment was made. Initial journal to record six months licence and support services as an expense:

DR Licensing Charges Expense

(Increase in Expense - Operating Statement)

$120,000

CR Cash at Bank (Decrease in Asset - Balance Sheet) $120,000

The following journal is processed to correctly recognise the prepayment, along with a reduction in

expenses:

DR Other Prepaid Expenses (Increase in Asset - Balance Sheet) $120,000

CR Licensing Charges Expense

(Decrease in Expense - Operating Statement)

$120,000

The monthly journal to recognise a reduction in a prepayment and recognition of an expense would be:

DR Licensing Charges Expense

(Increase in Expense - Operating

Statement)

$20,000

CR Other Prepaid Expenses (Decrease in Asset - Balance Sheet) $20,000

(c) Describe and explain with examples Matching concept and Historical Cost concept.

Matching Concept

Under this concept coasts are matched with revenue such that coast are related to the product sold or serviced rendered. Similarly, costs are related to the time period during which revenue is earned. This concept is fundamental to the accrual basis of accounting

 

For Example: - the salaries of the manager or the administrative staff. The best course is to charge these expenses in the Income Statement of the Accounting period in which they are incurred. Such expenses are designated as period expenses as distinct from those expenses known as product expenses which can be related to products.

 

The justification for the matching concept arises from the accounting period concept. The profits of the accounting period are calculated after deducting the costs of the period from the Revenues of the same period. Any costs which cannot be associated with the future revenues are written off as they are incurred.

Historical cost 

Historical cost is relevant in making economic decisions. As managers make decisions concerning future commitments, they need data on past transactions. They must be able to review their past efforts, and the measure of this efforts is historical cost.

For example, land purchased in 2009at cost of $90,000 and still owned by the buyer will be reported on the buyer's balance sheet at its cost or historical cost of $90,000 even though its current cost,  replacement cost, and inflation-adjusted cost is much higher today.

The cost principle or historical cost principle states that an asset should be reported at its cost (cash or cash equivalent amount) at the time of the exchange transaction and should include all costs necessary to get the asset in place and ready for use.

(d) Monetary concept: Money is used as the basic measuring unit for financial reporting. An implicit assumption made is that the accounting is only as accurate as the dollar is a stable unit of value. Intangible assets such as the goodwill of the company is also not measured

Prudence Concept: A principle used in the preparation of a state meant of financial condition that requires that the statement should be prepared on a conservative basis. The basic principles is to be cautious, to recognize all coast, committed or incurred , but not to recognize revenues or profit until actually received

(e)objectivity concept: All information must be maintained objectively, which means that it is free of bias and subject to verification. Objectivity is closely tied to reliability. Objective evidence consists of anything that can be physically verified such as a bill, check, invoice, or bank statement. In the event something cannot be supported objectively, a number of subjective methods are used to develop an estimate. The determination of items such as depreciation expense and allowance for doubtful accounts are based on subjective factors. Still even subjective factors are influenced by objective evidence such as past experience.

Consistency concept : The consistency concept implies that a particular accounting method, once adopted , will not be changed from period to period. It does not prohibit a company from changing from one to another acceptable method if this will better reflect the company's activity, but it does prohibit frequent or opportunistic change

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