1 Pearson Edexcel International GCSE Accounting (9-1)

Introduction to Bookkeeping and Accounting - The Accounting Environment

What is business?
An organization set up to meet customer demand and to make a profit for its owners
Or
A business is an organization that provides goods and services.

What do businesses do?

Businesses identify the needs of consumers or other firms. They then purchase resources
or factors of production in order to produce goods and services that satisfy these needs,
usually with the aim of making a profit.

What is Organization?
An organization or organization is an entity, such as a company, an institution, or an
association, comprising one or more people and having a particular purpose.

A business has many features.

 Decision making
 Workers (employees), managers, directors and shareholders
 Customers, suppliers, competitors, the environment, local, national and other
governments
 Uses factors of production
 To produce and sell goods and/or services
 So as to make a profit.

Types of business organization

Public sector organizations & Private sector organizations

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Almost every country consists of two business sectors, the private sector and the public
sector. Private sector businesses are operated and run by individuals, while public sector
businesses are operated by the government.

Private sector organizations

Businesses owned by/part of the national economy individuals/not under direct state
control.
Mark Scheme Definition

Private sector firms are set up by individuals, entrepreneurs who seek to make profit from
their business activities. Although many private sector firms are controlled by
entrepreneur(s), they may be owned by different people (or organizations)

Key Terms under the Private sector firms

Unincorporated Business
A business that does not have a separate legal identity from its owner(s) e.g. If the
business is sued, the owner is responsible and may need to cover the cost with their own
personal money.
 Does not have a separate legal identity from its owner(s)
 Owners have unlimited liability
 Types: sole trader / proprietor, partnership

Incorporated Business
Companies in the private sector that want to expand can go through the process of
incorporation. This allows the business organization to create its own legal identity.
Business that has a separate legal identity from its owner(s) e.g. If the business goes
bankrupt, the owners won’t be held responsible and only lose the money they invested.
 Is a separate legal identity from its owner(s) / shareholder(s)
 Owners have limited liability
 Types: private limited company, public limited company

Unlimited Liability
Owners are held liable for the business. If the business goes in debt, the owner needs to
pay back with their own money.
 Means owners are personally responsible for all debts of the business
 The liability of the owners is not limited just to what they invested in the business
 Note: owners can be declared bankrupt if they cannot repay all debts even using
Their own personal money

Limited Liability
Separate legal status allows the owner to have limited liability, which will make it easier for
the business to raise finance. Limited liability means that the owners, are not liable for the
company’s debts and can only lose the capital or equity that they have invested in the
business.
(Opposite of Unlimited liability, if a business fails, the owners only lose what they invested)
 Means the legal responsibility of the shareholders in a company to repay its debts
is only limited to the amount they invested into the company
 Shareholders are not personally responsible for the business.
 Note: whatever happens, the most the owners can lose is (limited to) only what
They have invested

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Divorce of ownership from control

Business owned by shareholders but controlled by managers/directors. Distinction is likely
to be more pronounced in larger business organizations such as PLC’s. Known as the
principal agent problem.

The Annual General Meeting (AGM) is held every year and all shareholders are invited to
attend so that they can elect their Board of Directors. Normally, Director are majority
shareholders who has the power to do whatever they want. However, this is not the case
for public limited companies since there can be millions of shareholders. Anyway, when
directors are elected, they have to power to make important decisions. However, they must
hire managers to attend to day to day decisions.
Therefore:
 Shareholders own the company
 Directors and managers control the company

This is called the divorce between ownership and control.

Because shareholders invested in the company, they expect dividends. The directors could
do things other than give shareholders dividends, such as trying to expand the company.
However, they might loose their status in the next AGM if shareholders are not happy with
what they are doing. All in all, both directors and shareholders have their own objectives.

Auditor
Auditor an independent accountant
Who examines the accounts of a limited company on behalf of the owners to see if they
show a ‘true and fair’ view of how the business is performing
The accounts of Limited Liability Companies need to be checked and approved by an
independent accountant, known as an auditor.

Sole traders
Define ‘sole trader’
Ownership of business in the hands of one individual/person or
unincorporated business owned by one person

What is meant by a ‘sole trader’? Ownership of business in

the hands of one individual/person.

An individual who runs an unincorporated business on his

or her own. Sometimes otherwise known as a "sole
proprietor" or (in the case of professional services) a"sole
practitioner".
A sole trader has unlimited liability. This means that, in the eyes of the law, the owner and
the business are the same. If the business is unable to meet its financial obligations and
cannot pay its bills, a court has the authority to hand over the sole trader’s personal assets
to cover these debts. The sole trader may have to sell his or her home or car.

Features
 Simple to startup and setup with less legal requirements than other organization
types.
 No account documentation required by the government
 Owner usually carries out most operations and tasks himself / herself
 Excellent for smaller and simpler businesses
 No legal separation between owner and business

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 Unlimited liability – full legal liability (responsibility) for all company obligations by the
owner

Advantages of Sole Trader

Easy to set up
 There are very few legal formalities involved in starting and running a sole
proprietorship. A less amount of capital is enough by sole traders to start the
business. There is no need to publish annual financial accounts.
Full control
 The sole trader has full control over the business. Decision-making is quick and
easy, since there are no other owners to discuss matters with.
Sole trader receives all profit
 Since there is only one owner, he/she will receive all of the profits the company
generates.
Personal
 Since it is a small form of business, the owner can easily create and maintain contact
with customers, which will increase customer loyalty to the business and also let the
owner know about consumer wants and preferences.

Disadvantages of Sole Trader

Unlimited liability
 If the business has bills/debts left unpaid, legal actions will be taken against the
investors, where their even personal property can be seized, if their investments
don’t meet the unpaid amount. This is because the business and the investors are
the legally not separate (unincorporated).
Full responsibility
 Since there is only one owner, the sole owner has to undertake all running activities.
He/she doesn’t have anyone to share his responsibilities with. This workload and
risks are fully concentrated on him/her.
Lack of capital
 As only one owner/investor is there, the amount of capital invested in the business
will be very low. This can restrict growth and expansion of the business. Their only
sources of finance will be personal savings or borrowing or bank loans (though
banks will be reluctant to lend to sole traders since it is risky).
Lack of continuity
 If the owner dies or retires, the business dies with him/her.

Partnerships

A partnership is a legal agreement between two

or more (usually, up to twenty) people to own,
finance and run a business jointly and to share all
profits.

Unincorporated business with unlimited liability

A contract is usually drawn up to show how profits and
losses are shared. This contract is called the deed of
partnership.
An accountant or solicitor normally draws up this deed
of partnership to avoid potential problems.

Features

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 Unlimited liability – Same as sole traders

 Appropriate for family businesses where partners have a high level of trust for each
other and may not be harmed from the unlimited liability of the business.
 Partners get percentage of profits based on agreed upon in the Partnership
Agreement.
 Sharing responsibilities , risks and benefiting from the advantages of collaboration

Partnership Deed
A partnership is a business set up by the deed of partnership document (deed of
partnership a formal agreement to begin a partnership).
The deed of partnership document sets out the terms of the partnership.
• The capital or equity contributed by each partner
It states how much money each partner invested in the partnership and what role each
partner will have in the partnership.
•How profits or losses should be divided (the ratio at which profits and losses are to be
shared)
•Salaries to be paid to partners
•Interest, if any, to be paid on capital or equity
•Interest, if any, to be charged on partners’ drawings.
•How many votes each partner has (usually based on proportion of capital provided).
•Rules on how to take on new partners.
•How the partnership is brought to an end, or how a partner leaves.

Limited partnership a type of partnership where partners are responsible for the
partnership’s debts only up to the amount they originally invested.

A partnership may be unlimited or limited. In a limited partnership, there must be at least

one partner who is not limited. Limited partners are not liable for the debts of the business.
They can only lose the capital or equity they have invested in the business. All limited
partners must be registered with the Registrar of Companies.

The Public sector organizations

The public sector consists of organizations owned by, accountable to and controlled by the
State (central or local government).Maximizing welfare in the society.
Mark Scheme Definition

This sector provides goods and services to the community through public corporations,
local government and other statutory agencies (e.g. the National Health Service). The profit
motive is not so prominent: the emphasis in the public sector is on providing for the
community by the community, using funding supplied through taxes and government
borrowing.
In order to increase the welfare of their citizens, they don’t work to earn a profit. It is funded
by the taxpaying citizens’ money, so they work in the interest of these citizens to provide
them with services.

Objectives:
Financial
 Although these businesses do not aim to maximize profits, they will have to meet the
profit target set by the government. This is so that it can be reinvested into the
business for meeting the needs of the society
Service
 The main aim of this organization is to provide a service to the community that must
meet the quality target set by the government

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Social
 Most of these social enterprises are set up in order to aid the community. This can
be by providing employment to citizens, providing good quality goods and services at
an affordable rate, etc.
 They help the economy by contributing to GDP, decreasing unemployment rate and
raising living standards.

Stakeholder

A Stakeholder is any person or business who is affected by the actions of that business.
These include: owners, managers, employees, customers, suppliers, competitors, providers
of external finance and the government.

‘Stakeholder ‘
Defined as people or groups of people who can be affected by, and therefore, have an
interest in, a business/organization.
Mark scheme
 Owners who are interested in how much profit the business makes.
 Managers who are concerned about their salary.
 Workers who want to earn high wages and keep their jobs.
 Customers who want the business to produce quality products at reasonable prices.
 Suppliers who want the business to continue to buy their products.
 Lenders who want to be repaid on time and in full.
 The community which has a stake in the business as employers of local people.
Business activity also affects the local environment. For example, noisy night-time
deliveries or a smelly factory would be unpopular with local residents.

Internal Stakeholders
Are those impacted by business activity inside the business: owners, shareholders,
managers and employees.

Shareholder/ Owners
These are the risk takers of the business. They invest capital into the business to set up
and expand it. These shareholders are liable to a share of the profits made by the business.
They compare the business performance with the previous year to judge how safe their
capital or equity is and whether they would get a return on their investment. The owners
look at the Income Statement to assess if they will receive any share of profit.

Objectives:
 Shareholders are entitled to a rate of return on the capital they have invested into the
business and will therefore have profit maximization as an objective.

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 Business growth will also be an important objective as this will ensure that the value
of the shares will increase.
Workers
These are the people that are employed by the business and are directly involved in its
activities.

Objectives:
 Contract of employment that states all the right and responsibilities to and of the
employees.
 Regular payment for the work done by the employees.
 Workers will want to benefit from job satisfaction as well as motivation.
 The employees will want job security– the ability to be able to work without the fear
of being dismissed or made redundant.

Managers
They are also employees but managers control the work of others. Managers are in charge
of making key business decisions.

Objectives:
 Like regular employees, managers too will aim towards a secure job.
 Higher salaries due to their jobs requiring more skill and effort.
 Managers will also wish for business growth as a bigger business means that
managers can control a bigger and well known business.

External stakeholders
Are not owners or employees but are affected by the activity of the business. For example,
customers, government, banks, local community and suppliers.

Customers
They are a very important part of every business. They purchase and consume the goods
and services that the business produces/ provides. Successful businesses use market
research to find out customer preferences before producing their goods.

Objectives:
 Price that reflects the quality of the good.
 The products must be reliable and safe. i.e., there must not be any false
advertisement of the products.
 The products must be well designed and of a perceived quality.

Government
The role of the government is to protect the workers and customers from the business’
activities and safeguard their interests.

Objectives:
 The government will want the business to grow and survive as they will bring a lot of
benefits to the economy. A successful business will help increase the total output of
the country, will improve employment as well as increase government revenue
through payment of taxes.
 They will expect the firms to stay within the rules and regulations set by the
government.

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Banks
These banks provide financial help for the business’ operations’

Objectives:
 The banks will expect the business to be able to repay the amount that has been lent
along with the interest on it. The bank will thus have business liquidity as its
objective.

Community
This consists of all the stakeholder groups, especially the third parties that are affected by
the business’ activities.

Objectives:
 The business must offer jobs and employ local employees.
 The production process of the business must in no way harm the environment.
 Products must be socially responsible and must not pose any harmful effects from
consumption.

Suppliers
Suppliers and other strategic alliances are interdependent, where the success of one will
impact the success of another. As a result, suppliers are closely related to organizations as
key external stakeholders. Timely payments, shipments, communication, and operational
processes are key to maintaining a strong relationship with this stakeholder group.

Providers of external finance

Assess the company’s ability to pay back any money that they lend the business, such as
loans. They would look at the Statement of Financial Position to assess the liquidity of the
business.
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Use of technology in accounting

Introduction to technology in accounting

Accounting was once done by hand but now technology has made it possible and also very
easy to record information in real-time, collect and compile information from various
sources and also automate repetitive tasks.
This allows the professionals to focus more on other important tasks like giving financial
advice and monitoring the performance. IT has also helped industries and companies
reduce errors and make better financial decisions.

This software provides an accessible and online information panel with information about
the business’s funds, clients, liabilities, assets, equities, expenses, revenues and sales, and
advertising directions and merchandise. The data be able to use by managers about
deciding which products advertise or cut of expenditures and unnecessary costs, and
where to remove expenses, when to position the supply and raw material orders and which
customers require support.

What Is Accounting Software?

Accounting software is a computer program that assists bookkeepers and accountants in
recording and reporting a firm's financial transactions. The functionality of accounting
software differs from product to product. Larger firms may choose to implement a
customized solution that integrates a vast amount of data from many different departments.
Small firms often choose an off-the-shelf product.

Off-the-shelf packages
Already made and available in shops rather than being designed for a specific customer.
Off the Shelf Software, also called commercial software, is any kind of software solution
that has been developed for the mass market. It is a ready-made product that you can
purchase.

The Advantages of Off the Shelf Software

 Initially the cheaper option
 Quick to implement
 Can access reviews and advice from existing users
 There are pre-existing solutions
 Updates usually included
 Can offer you more functionality than you need
 Some have support included (but not all so remember to check)
 Owned by someone else, so they foot the development/upgrade costs

The Disadvantages of Off the Shelf Software

 Can be more expensive over time
 Can be impossible or inflexible to change should you need it
 You have no control
 May not be supported after time
 Upgrades can cost extra
 Too many features and functions
 Too few features and functions
 May have integration issues

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 Might not fit your work process

Functions of accounting software

Computerized accounting system offers similar functions as a manual system. However, it

also provides useful reports and management information. The system is integrated, so
basic data that is entered is processed and automatically posted to supplier and customer
accounts. The nominal (general) ledger, and the inventory records, are also automatically
updated. In some instances, automatic re-ordering systems are in place.

Accounting software allows financial statements to be produced more quickly than

traditional hand-written methods. The use of pre-programmed formulae and layouts means
that financial data only needs to be entered once. The software can then make various
uses of this information, and can store it in different ways. The software can use data
provided to complete all aspects of a transaction, such as generating documentation (once
programmed by the user) and providing reporting functions.

Revenue
This involves preparation and printing of revenue invoices, credit notes and month end
statements. Data from these documents is entered, processed and recorded:
 In the customer accounts in the receivables ledger
 By automatic update of the inventory records.

Purchases
Data from purchase invoices and credit notes is entered, processed and recorded:
 In the supplier accounts in the payables ledger
 By automatic update of the inventory records
 Via a print-out of remittance.

Online Bank account and APPs

Accounting systems record data such as customer receipts, supplier payments, other
payments and receipts.

Many banks offer online banking facilities. These mean the organization’s bank account is
always up to date.

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All receipts and payments are linked to the personal accounts of the trade receivables and
trade payables. The system allows for such transactions to automatically update these
accounts.

Many banks now offer apps (applications) that you can download for your phone. They
allow you to access your account anywhere, as long as you have internet access. This is
known as mobile banking.

Accounting systems automatically update the ledger.

Wages/Salaries
Organizations have the option of using a combined computerized accounting and
wages/salary package. Alternatively, they may use a separate payroll package. Such
packages perform all the necessary payroll functions.

Inventory control
Includes raw materials and ordinary goods purchased for resale. This means that inventory
records are automatically updated after each revenue invoice or purchase invoice is
entered into the system. This ensures an accurate figure of inventory is held in the system
at all times.
At the end of the financial year when an organization undertakes an inventory check, it is
crucial to have an up-to-date inventory list. A computerized accounting system ensures this
list is available. Inventory lists are used in the physical inventory check and allow variances
to be identified and amended.

Management reports
One of the main features of a computerized accounting system is the facility to provide the
owners and/or managers of the business with useful financial data and reports. At the end
of each month or specific accounting period, certain ‘month end/year end’ functions are
carried out to provide the following information:
 Day books for customers and suppliers
 General (nominal) ledger and bank account transactions
 Activity reports on all ledger transactions
 An audit trail
 Analysis reports for aged trade receivables and trade payables
 Financial statements including the trial balance, income statement, statement of
financial position
 Ratio analysis
 Reports (such as on staff attendance etc.) for human resources and payroll.

Spreadsheets

Spreadsheets are used to provide financial budgets or cash-

flow budgets, and non-current asset registers. They are also
used to calculate loan interest payments, and many other
sums.

Spreadsheet is a software tool to capture, show and control

information organized in lines and columns. Spreadsheets
are well known among bookkeepers and among those who
like to gather and track information.

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Advantages and disadvantages of using accounting packages (Software)

Advantages
 Data is entered and processed very rapidly, much faster than in a manual system.
 Accuracy is improved since data is only entered once and documents are updated
automatically. In a manual system, data may have to be entered twice or more.
 Documents such as invoices, credit notes, statements and remittance advices can
be produced easily and quickly.
 Accounting records are updated in real time, so they accurately reflect customers’
accounts. This enables remedial action to be taken if necessary.
 Management information can quickly be made available in report form, for example,
aged trade receivables and trade payables analysis reports.
 A system connected to the internet can make financial transactions electronically.
 Resources can be used more efficiently, for example, by needing fewer accounting
staff.
 Documents can be shared online, or scanned and saved, reducing filing space.

Disadvantages
 Installation can be expensive. Ongoing maintenance and updating costs can also be
high.
 The introduction of the system will affect most other areas of the business, which
may lead to considerable disruption. Staff may also be resentful of a new system.
 Staff will need to be trained to use the system. There will be training costs.
 System downtime can be very disruptive.
 Data back-up at regular intervals is essential.
 Fraudulent access can seriously affect the business’s operation and its profitability.
 Security measures are vital. For example, passwords for staff and protection against
viruses and hacking.
 There are health risks associated with the use of computer keyboards and screens.
These include eyestrain, back problems due to poor posture, and muscular fatigue in
the arms and wrists from keyboard use. Regular rest intervals away from
workstations are essential.

Security
All organizations regard their financial information as sensitive. Most want their financial
information to remain confidential, except when legislation demands that certain information
is made available to external bodies. Preventing unauthorized access to electronic
accounting data is vital.
Staff working on computerized accounting systems are allocated passwords that restrict
access to their area of work. Passwords should be changed regularly to help prevent the
possibility of non-authorized persons accessing the system. Most computer systems have
packages to resist viruses and attack by hacking. These systems must be constantly
reviewed and updated.
Most medium-sized or large organizations will use computer networks rather than
standalone computers. This calls for extra security measures, such as ensuring that the
network is not public.

To protect your hardware and software it is worth taking the following actions.
Install a firewall »»»» This helps to control the information that goes to and from your
computer. It can block internet traffic based on the security features you select.

Install antivirus software »»»» This will search for, detect and remove any possible viruses
on your computer and prevent new viruses from damaging your files.

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Install anti-spyware software »»»» This stops programs such as malware from being
installed on your computer. Malware allows other users to look at your work and may allow
someone else to take control of your computer.

Use complex and secure passwords »»»» Always make sure your password contains upper
and lowercase letters, numbers and symbols. Never write down your passwords. You must
change your password regularly.

Check the security settings on your internet Browsers »»»» You can set your internet zone
security to high or medium.

Professional ethics

Ethics
The moral principles that guide the way a business behaves distinguishing between ‘right’
and ‘wrong’ and then making the ‘right’ choice.

Define the term ‘ethics’.

Use of concepts/practices/principles/rules/code/guidelines. Having morals/being morally
correct.

The Principles of Professional Ethics

Professional ethics are the personal and corporate rules that govern behavior within a
particular organization or profession. They are professionally accepted standards of
personal and business behavior. Sometimes they are called codes of practice.
Professionals use these rules as a guide to perform their jobs based on sound and
consistent ethical principles.

Code of ethics

Professional ethics in accounting has five main aspects

Integrity

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This refers to fair dealing and trustworthiness. An accountant must be straightforward and
honest in all professional and business relationships. An accountant must not knowingly
produce financial statements or financial reports that contain false or misleading
information. In addition, they must not produce financial statements or financial reports that
deliberately omit any data that could lead to misunderstandings. Behaving with integrity
also includes not taking bribes to change the data they are presenting.

Objectivity
All accountants must make their own judgments on the accounts.
Accountants must be free from bias or conflict of interest and must not be under the
influence of others. Behaving with integrity includes not preparing the accounts of a family
member or for a company that they have shares in.

Professional Competence and Due care

This rule requires all accountants to keep up to date with any changes in accounting
policies and regulations. Accountants’ knowledge and skills must be relevant so their clients
receive a professional service. This includes becoming qualified to the appropriate level and
maintaining the standard expected of a professional accountant.

Confidentiality
Accountants have a legal obligation to maintain the confidentiality of materials they have
been given. This includes not giving key information to third parties such as competitors or
investors, as this could break confidentiality agreements.

Adopt professional behavior

This imposes an obligation on all accountants to comply with all relevant laws and
regulations so as not to bring the accounting profession into disrepute. An example would
be exaggerating your accounting skills or making unprofessional comments about
colleagues or other accounting professionals.

Public interest
Accountants need to behave in the public interest, i.e. in a manner so that the public can
have confidence that profits stated are true and fair. They must not mislead the public with
overstated figures when producing accounts for a firm.

Accounting Roles and Functions

There are many different roles within an accounting department. Departments are
organized in different ways and the way they operate can vary greatly. Accounting roles
usually cover the same five areas.

Accounts payable.
This role is responsible for keeping a check on the money that goes out of the business to
pay for bills and expenses. Payments have to go out on time. The role also involves
maintaining good relationships with trade payables and checking the business is getting the
best deals, for example by seeing if any discounts are available. In this role, it is important
to ensure no costs are incurred for late payments and no interest is incurred.

Accounts receivable.
This role involves checking that the business has received all the money it is entitled to.
This includes tracking invoices to make sure they are paid on time. A ‘friendly’ reminder
service can be set up for customers to make sure no irrecoverable debts occur.

Payroll.

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This is a critical part of an accountancy department, ensuring that all staff are paid on time
and the government receives the correct amount of tax.

Reporting and financial statements.

This role involves preparing financial reports for internal and external use. This could
include budgets and forecasting to check the viability of a new product or store. The Income
Statement, Statement of Financial Position and Statement of Cash Flow for the company’s
Annual Report, may also need to be provided, as well as information for possible investors,
banks and other professionals who are involved in the development of the company.

Checking the accounts.

This role is responsible for controlling the finances of the business, for example, ensuring
that the correct procedures are followed and the correct accounting standards are adhered
to. This role also involves putting systems in place to show compliance and to protect
against fraud and theft. This is sometimes called the internal audit.

Public Interest
To understand the term public interest, it is easier to look at what is meant by the term
‘public’ and what is meant by the term ‘interest’. For accountants, the term ‘public’ includes
the following.

Investors,
Owners and business owners of public sector and private sector organizations. These
parties require good financial information that is free from bias. They need to base their
actions and decisions on the most reliable data.

Customers and competitors.

These parties rely on sound financial information as decisions based on this data could
have significant impacts on the costs and benefits to them.

Taxpayers.
Any financial information that may have a detrimental impact on taxpayers is of significant
interest to these parties.

The term ‘interest’ can be defined as all things that are valued by society.
This includes economic wellbeing and certainty in the business environment. Sound
financial information must be given to stakeholders so that they are not misled.

Comparing the financial information from two different companies allows investors to make
the best decisions. Sound financial data can improve the efficiency and lower the costs of
government and private organizations. The term ‘interest’ also includes financial information
that leads to the protection of the environment and reduces the depletion of natural
resources.

To act in the ‘Public interest’,

Accountants must work towards the highest levels of ethical and professional standards.
Accountants are required to produce high quality financial statements that are audited to
ensure accuracy.
There is an international code of conduct for all accountants across the globe. They also
need to guarantee that there are rigorous checking systems.
Accountants who behave in an unethical manner are dealt with through strict structures of
disciplinary measures and sanctions.

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Accounting Concepts
What are Accounting Concepts?
Accounting concepts are the basic rules, assumptions, and conditions that define the
parameters and constraints within which accounting operates. In other words, accounting
concepts are generally accepted accounting principles, which form the fundamental basis of
consistently preparing the universal form of financial statements.

Accounting principles
Basic rules that are applied in recording transactions & preparing financial statements. They
are also known as concepts.

The Accounting Principles They are several assumptions concerned with the recording
of transactions in the books. The most important is that the financial statements
known as the final accounts must be drafted in the same way. This is so that there is a
common format that all accounting users of information can understand.

The following accounting principles are followed to provide consistent usable financial
statements.

1) Relevance
Financial information is considered relevant if it affects the business decisions.

2) Reliability
Information should be free from significant errors, bias & independently verified.

3) Comparability
Could be compared with other periods and similar business.

4) Understandability
The financial report "Income statement (trading & profit & loss account) & balance sheet"
must be capable of being understood by the users of the report.

Objectives of Accounting Concepts

Here are the major objectives of accounting concepts:
 Maintains consistency and regularity in preparing accounting statements
 Helps accountants to maintain business records
 Aims to help businesses understand rules and regulations

Entity concept
Entity concept assumes that business Enterprise is separate from its owners. Accounting
transactions should be recorded with this concept only.
The main intention of this concept is to keep the business transactions keep away from the
influence of personal transactions of its owners.
 Only the business transactions are recorded and reported and not the personal
transactions of the owners.
 Income or profit is the property of the business unless distributed among the owners.
 The personal assets of the owners or shareholders are not considered while
recording and reporting the assets of the business entity.

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Accounting Period Concept / Periodicity Concept

As per going concern concept an entity is assumed to have indefinite life. If we want to
measure the financial performance of an entity then we need to divide the operations of
entity for a specific period, otherwise it’s very difficult to ascertain the performance of
business.
Periodicity concept assumes a small but workable fraction of time period for measuring the
business performance. Generally it assumes 1 year is taken for this purpose.

Money measurement concept

As per this concept transactions which can be measured in monetary terms only are to be
recorded in books of accounts. Any transactions which cannot be converted into monetary
terms should not be recorded in books. Since money is the medium of exchange and unit of
measurement for showing the financial performance, it doesn’t accept the transactions
other than monetary to record in books of accounts.

Events which cannot be expressed in money terms do not find place in the books of
account though they may be very important for the business.
Non-monetary events like, death, dispute, sentiments, efficiency etc. are not recorded in the
books, even though these may have a great effect.

Accrual concept
As per this concept transactions should be recognized in the books of accounts only when
they occur and not on any cash basis. The main advantage of this concept is that financial
Statements prepared as per this concept inform the users not only about past events
involving payment and receipt of cash but also about obligations to pay cash in the future
and resources that represent cash to be received in the future.

Matching concept
As per this concept all the expenses which can be matched with the revenue of that period
only should be taken into consideration for financial reporting. This concept is based on
Accrual concept as it gives importance to occurrence of an expense which is spent for
generating a revenue. This concept leads to adjustments at the end like outstanding
expenses, income and prepaid expenses, incomes.

Going concern concept

As per this concept financial statements are prepared on an assumption that enterprise will
continue its operations for the foreseeable future. Thus, it says that enterprise has neither
the intention nor the need to liquidate or curtail the scale of its operations. Valuation of
assets of a business entity is dependent on this assumption.

Consistency
Transactions of a similar nature should be recorded in the same way (that is, consistently)
in the same accounting period & the future accounting periods.

Historic cost / Cost concept

As per this concept valuation of assets should be done at historical costs/acquisition cost.
These assets are recorded after subtracting depreciation. It is absolutely necessary for a
business to maintain a proper account record of every product purchased and utilised.

Realisation concept
This concept says that any change in value of an asset is to be recorded only when the
business relaises it. This concept highly prefers Realisation of the value for which we want
to give effect in books of accounts.

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An expense should be recognized when goods are bought or services are received,
whether cash is paid or not.

Example: If the buyer has made the payment for corresponding goods before the delivery is
made, then according to the realization concept, the revenue is not going to be recognized
until and unless the goods are transferred to the buyer, even though the cash has been
received.

Advantages
 The realization concept gives more importance to the recognition of revenue.
 It is commonly followed in a business organization as per the accrual system of
accounting.
 It guides the accounting process and recognition of revenue.
 Through realization principles, the inflation of revenue and profits can be controlled.
 The true and fair view is better reflected in the realization concept.

Duality / Dual Aspect concept

This concept is base for double entry accountings of a transaction. Under the system,
aspects of transactions are classified into two main types:
 Debit
 Credit
Every transaction should have a Debit and credit. Debit is the portion of transaction that
accounts for the increase in assets and expenses, and the decrease in liabilities, equity and
income. And credit is the portion which is a results of decreases the asset, increases the
liability, income, gains, equity.

Materiality
Recognizes that some types of expenditure are less important in a business context than
others & the business should not waste time recording transactions that involve small
amounts of money

Prudence Concept or Conservatism principle

Is a key accounting principle that makes sure that assets and income are not overstated,
and provision is made for all known expenses and losses whether the amount is known for
certain or just an estimation, i.e., expenses and liabilities are not understated in the books
of accounting.

The prudence concept refers to a crucial principle used in accounting to ensure that income
and assets are not overstated in financial statements. Alternatively known as the
conservatism principle, it also makes sure that liabilities are not understated and provisions
are made for income and losses.

Advantages
 Keeps financial reporting realistic
 Prevents overly optimistic income projections from providing an unrealistic overview
of business finances
 Can help to prevent cash flow problems
 Ensures that there are enough funds to cover liabilities without resorting to high-
interest bridging loans
 Can be used as a comparison to other reporting methods.

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May 2014 1 Mark

Ans C 1 Mark

May 2015
6 When depreciating his machinery, a trader always uses the reducing balance method.
Which accounting concept is he applying?
A Accrual
B Consistency
C Dual aspect
D Going concern
1 Mark

14 Rekha believes that if the closing stock is valued at selling price, the partnership profit
Will increase.
(e) Evaluate this statement, making reference to relevant accounting concepts. (5 Marks)
Award (1) mark for confirming that this will increase her profits.
Award (1) mark for stating how stock should be valued and (1) mark for identifying that this
suggestion would be in contravention of the prudence concept.
A further (1) mark for stating the effect on both profit and assets and (1) mark for an
appropriate conclusion.

Sample Answer
Rekha is correct in her statement that valuing the closing stock at selling price will increase
her profits as the cost of sales will be reduced (1). However, stock should be valued at the
lower of cost or net realisable value (1) which is an application of the concept of prudence
(1). By over valuing the stock both the profit and the assets will be over-valued (1). Hence
Rekha should be advised that her suggestion is not appropriate (1).

May 2017
6 A business decides to include the cost of small items of office equipment as expenses in
the profit and loss account. Which accounting concept is being applied?
A accruals
B business entity
C materiality
D prudence

12 (e) State two accounting concepts that are relevant to the calculation of depreciation.
Consistency/consistency (1)
Accruals/accruals / Matching/matching (1)
(2 Marks)

May 2018

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14 (b) State which accounting concept has not been complied with in each of the following
situations.
(3 Marks)

Materiality(1)
Consistency (1)
Business entity/ entity (1)

15 Stavros has been in business for some years as a sole trader. He has recently been
Approached by a friend who wishes to join him in business and form a partnership.
(a) State two advantages and two disadvantages for Stavros of forming a partnership.

Advantages
• additional capital
• share the risk
• share the workload
• new ideas
• additional skills

Disadvantages
• receiving less profit
• delaying business decisions
• possible conflicts
• responsible for all debts

May 2019
7 Which one of the following is an accounting concept?
A Comparability
B Materiality
C Objectivity
D Understandability

14 (c) State which accounting concept has not been applied in each scenario.

(2 Marks)
Business entity (1)
Materiality (1)

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17 (c) Evaluate how the introduction of accounting software will improve the accuracy of a
business’s accounts. (5 Marks)
Business accounts will be more accurate because all the ledger accounts will be updated
automatically (1), however, if the wrong amount is entered this will not be identified (1).
The business will be able to reduce the number of errors through constant monitoring (1)
therefore producing accurate financial statements (1).
Overall, Mohan’s business accounts would be more accurate (1).

17 (d) State two ways to protect the security of electronic data. (2 Marks)
Passwords (1).
Firewall (1).

18 (a) State two advantages of operating a business as a sole trader. (2 Marks)

Easy to set up (1).
Keeps all profit (1).
Retains full control (1).
Quick decision making (1).

18 (b) State two stakeholders who may be interested in a business’s financial statements.
Suppliers (1).
Providers of external finance (1).
Customers (1).
Owners (1).
Competitors (1).
Employees (1).
Government (1).
Investors (1).
(2 Marks)

Extra assessment material (September 2017)

4 A trader changes his depreciation accounting policy from the reducing balance
Method to the straight line method. Which accounting concept is not being followed? B

12 (a) State one characteristic of a public sector organisation.

• Owned and operated by the government
• Objective is to serve the community
• Raises money from public revenue (taxes, duties, etc.)
(1 Mark)

(b) State two examples of public sector organisations.

• Government Health Service
• Tax authority
(2 Marks)

(c) State two characteristics of a partnership.

• At least two partners
• An agreement between the partners to share profits

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• Partners have unlimited liability

(2 Marks)

13 Evaluate the effect that the introduction of a computerized bookkeeping system may
Have on a business. (5 Marks)
By introducing a computerised bookkeeping system the business owner will find that time
will be saved (1) as the system will process the double entry without the need to make two
entries (1). However there will be a cost (1) involved in this decision which may include the
cost of training staff to use the system together with the cost of purchasing the system itself
(1)
Time saved may eventually cover the costs of purchasing the system and training staff. (1)

(d) Explain, with reference to an accounting concept, why it may be necessary to make a
provision for irrecoverable debts.
Concept
Prudence (1)

Explanation
By not overstating the value of trade receivables (1), hence ensures that a true and fair
view is presented (1).

Sample assessment material-September 2017

17 Arianna is considering investing in a computerized accounting system to help with her
business.
(d) Explain two advantages and two disadvantages for Arianna of this proposal. (8 Marks)
Advantages
Arianna may experience an increase in the processing of transactions
(1) as the program will complete the double entry automatically. (1)
Arianna may be able to monitor her business’s performance more
closely (1) as she will be able to produce more routine reports. (1)

Disadvantages
Arianna may incur additional costs including the cost of the software
and hardware (1) and, in addition, Arianna may have to pay to train
staff on new technology. (1)
There may be technical issues or viruses (1) which could reduce the
effectiveness of the business. (1)

18 (a) Complete the following table to show four groups of stakeholders and the interests
they would have in the financial statements of a business. (8 Marks)

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Employees (1)-To check the possibility of receiving a pay rise/ensuring job security (1)
Customers (1)-To check on security of supply (1)
Suppliers (1)-To ensure that payment will be made (1)
Government (1)-To monitor profit for tax purposes (1)
Investors (1)-To check the security of their investment (1)
Providers of external finance (1)-To ensure that repayments will be made (1)

18 (c) State four of the fundamental principles of professional ethics. (4 Marks)

 Professional behaviour (1)
 Professional/technical competence and due care (1)
 Confidentiality (1)
 Integrity (1)
 Objectivity (1)

January 2020
4 Inventory should be valued at the lower of cost or net realizable value. Which accounting
concept is this an application of?
A Accruals
B Consistency
C Materiality
D Prudence

6 Which one of the following is not a principle of professional ethics?

A Confidentiality
B Integrity
C Materiality
D Objectivity

18 Nyat is considering purchasing a computerized accounting package. (5 Marks)

(c) Evaluate the benefits of this proposal.
It will improve accuracy (1) as all calculations will be done automatically (1).
It will improve the speed of processing financial data (1) as Nyat will only have to make one
entry and the other entry will be automatically processed (1).
As a result, Nyat’s business should benefit from this purchase (1).

May 2020
2 Which is not an accounting concept?
A Business entity
B Confidentiality
C Consistency
D Materiality

18 (a) State two benefits of using technology in accounting. (2 Marks)

Speed (1)
Accuracy (1)

June 2021
4 Identify which of the following is not a principle of professional ethics.
A Confidentiality
B Duality

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C Integrity
D Objectivity

Nov 2021
17 (c) State three accounting concepts together with a brief description of each. (6 Marks)

June 2022
7 Identify the accounting concept being described.
“Financial statements can record only information that has a monetary value”
A Business entity
B Materiality
C Money measurement
D Prudence

9 Identify the principle of professional ethics being described.

“Accountants must make their own judgements on the accounts”
A Confidentiality
B Integrity
C Objectivity
D Professional behaviour

12 (a) State one difference between the objectives of private sector organisations and
public sector organisations. (2 Marks)
The objective of private sector organisations is to generate a profit (1) whereas the
objective of public sector organisations is to provide a service to the general public (1).

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(b) Identify three stakeholders that may have an interest in the financial statements of a
private sector organisation. (3 Marks)
• Suppliers / Trade payables
• Customers / Trade receivables
• Providers of finance / Banks
• Government
• Employees
• Owners

18 Lucas is proposing to change from a manual system to a computerised system of

bookkeeping.
(c) Evaluate whether Lucas should proceed with this proposal. (5 Marks)
Changing to a computerised system will help eliminate mistakes (1) which will create a
more professional image to customers (1).
However, Lucas may not have the necessary skills to operate a computerised system (1)
which will result in lower profits by incurring additional wages costs (1).
Overall, changing to a computerised system will be of benefit to Lucas (1).

June 2023
4 Inventory should be valued at the lower of cost and net realisable value. Identify which
accounting concept this is an application of.
A Accruals
B Consistency
C Money measurement
D Prudence

5 Identify which is not a principle of professional ethics.

A Confidentiality
B Integrity
C Materiality
D Objectivity

17 (c) State two ways Carson could maintain the security of his computerized data.
• Firewall (1)
• Anti-spyware software (1)
• Anti-virus software (1)
• Passwords (1)

January 2014
7 Which item would appear in the appropriation account of a limited company?
A debenture interest paid
B directors’ remuneration
C dividends paid
D investment income received

8 A trader owes a month’s rent at the end of his financial year. He adds this amount to the
rent actually paid during the year to obtain the total rent expense for the year.
Which accounting concept is he applying?
A accruals/matching
B business entity
C consistency
D going concern

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12 Cable and Carr are in partnership sharing profits and losses equally.
Their partnership agreement also provides for the following: interest on capital at 10% per
annum Cable to have a salary of £7 000 per annum.
(a) State two differences between a partnership and a limited liability company. (2 Marks)
A limited liability company has separate identity from its owners.
The owners (shareholders) in a company have limited liability, unlike a
partnership where each partner is liable for all debts of the partnership.
Companies can raise capital through the issue of shares.
Companies pay dividends to their shareholders

January 2016
10 Which accounting concept is being applied when a business uses the same method of
depreciation each year?
A business entity
B consistency
C money measurement
D prudence

12 (b) Making appropriate reference to the accounting concepts that you have used, explain
your treatment of additional information (4) and (5).
Sample answer
 It was necessary to adjust business rates and insurance in order to comply with the
accruals concept (1). These adjustments ensure that the business’ profits are not
understated or overstated (1).

 It was necessary to adjust the purchases figure by the amount of stock withdrawn by
the owner of the business in order to comply with the business entity concept (1).
This adjustment ensures that the correct purchases figure is shown in the trading
thus ensuring that a correct gross profit figure is shown (1).

 All of these adjustments also ensure that the balance sheet of the business shows a
true and fair view of the business’ assets and liabilities (1).

January 2017
7 A trader always uses the diminishing balance method of depreciation for machinery.
Which accounting concept is being applied?
A accrual
B consistency
C dual aspect
D going concern

13 Adam and Bob are in partnership. Their partnership agreement provides for Adam to
Receive a salary of £20 000 per annum.
(a) State two advantages of forming a partnership. (2 Marks)
Share workload
Additional capital
Expertise

13 Adam and Bob are considering dissolving their partnership and forming a limited
company.
(f ) Evaluate this proposal and explain the implications for the partners of this change of
business structure.

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Sample answer
This change of structure will result in the partners having limited liability (1) which means
that each partner’s liability is limited to the amount of money they have invested in the
business (1).

The partners may lose some control of their business (1) due to the issue of shares and
may also suffer financially as they will now be rewarded through dividends (1)

However they may be able to have access to more sources of finance and see their
business grow. (1)

January 2018
7 At the end of the financial year a trader added monies outstanding for rent to the rent
amount paid during the year to obtain the total rent for the year. Which accounting concept
was being adhered to?
A accruals
B business entity
C going concern
D materiality

8 To whom do the reserves in a limited company belong?

A creditors
B debenture holders
C directors
D ordinary shareholders

13 (c) Evaluate Finn Bar’s decision to purchase accounting software to help him run his
business. (5 Marks)
By introducing accounting software to help him run his business Finn Bar will find that he
will save time (1) as the software will process the double entry without the need to make
two entries (1). However there will be a cost (1) involved in this decision which may include
the cost of training staff to use the software together with the cost of purchasing the
software itself (1)
Time saved may eventually cover the costs of purchasing the software and training staff. (1)

January 2019
4 A sole trader included the purchase of a motor vehicle for private use as a business
Asset. Which accounting concept has not been complied with?
A accruals
B business entity
C going concern
D materiality

14 Stylos and Kristos are considering converting their business to a private limited
company.
(c) Evaluate this proposed change to their business structure.
Advantages
Both partners will become shareholders of the business and as such will have limited
liability which means that the extent of their liability for business debts will be limited to the
amount of money they have invested in the business (1).

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The partners may also become employees of this new business as directors and as such
will receive a directors salary as opposed to just one of them receiving a salary as at
present (1)
They may be able to attract more investment from outside agencies such as banks that are
more likely to lend money where the ownership of the business is wider (1).

Disadvantages
However they may find that they have less control over the day to day operations of the
business as they may have other shareholders who have a say in the running of the
business (1).

There will also be a change to the way in which the accounts are prepared and to the type
of taxation paid on the business profits (1)

They will also have to ensure that they abide by all the legislation which relates to the
management and administration of companies. (1)

Conclusion
Although there are many advantages to the partnership of this proposal Stylos and Kristos
will be well advised to seek professional advice before embarking on this change as they
need to be aware of the disadvantages too. (1)

SPECIMEN PAPER 2020

34 What is the going concern principle?
A Accounting records are prepared assuming that the business will continue to operate in
the foreseeable future.
B Income and expense should be accounted for in the same way they were accounted for
in previous periods.
C Profit should not be anticipated and losses should be written off as soon as they are
known.
D Revenue and costs should be recognised as they are earned or incurred, not when the
money is received or paid.

35 Which accounting objective is being applied when financial information affects business
decisions?
A comparability
B relevance
C reliability
D understandability

2018 May
1 Which statement about a computerized accounting system is correct?
A The general ledger does not include non-current asset accounts.
B The income statement always shows a profit.
C The statement of financial position does not include non-current assets.
D The trial balance always balances.

30 A trader spreads the cost of a machine over the years which benefit from the use of that
machine.
Which accounting principle is being applied?
A accounting year
B dual aspect
C matching / accruals

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D materiality

2019 May
28 A business prepares its accounts on the basis that it will continue to trade in the
foreseeable future.
Which accounting principle is being applied?
A accounting entity
B accounting year
C going concern
D matching/accruals

29 A cheque paid by a business for fuel for the delivery vehicle was recorded in the books
of the business. A cheque paid by the business owner for fuel for his motorcycle was not
recorded in the books of the business.
Which accounting principle was applied?
A accounting entity
B going concern
C materiality
D money measurement

May/June 2020
32 Which external parties would be interested in the accounting ratios of a business?
A government
B investors
C managers
D tax authorities

33 At the end of the financial year, a company did not account for the unused stationary
valued at $50.
Which accounting principle did the company apply?
A matching
B materiality
C money measurement
D prudence

34 A trader wrote off the balance on a credit customer’s account as irrecoverable.

Which accounting principle was applied?
A business entity
B consistency
C money measurement
D prudence

35 A limited company applied the accounting objective of comparability in preparing its

financial statements.
What is the effect of this on the interested parties?
A They can be sure that information in the financial statements is up to date.
B They can identify similarities with the financial statements of other businesses.
C They can understand the financial statements easily.
D They can use the financial statements in decision-making.

May/June 2021
25 What is an advantage of forming a partnership?

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A Decisions have to be recognised by all partners.

B Each partner is responsible for actions of other partners.
C Profits have to be shared among the partners.
D Responsibilities can be shared between the partners.

October/November 2021
35 Which accounting objective requires that financial information is provided in time for a
decision to
be made?
A comparability
B relevance
C reliability
D understandability

May/June 2017
1 What is a disadvantage of Information and Communications Technology in book-
keeping?
A accuracy of calculations
B capacity of information storage
C cost of training staff
D speed of processing information

30 Mario has decided that all items purchased by his business should be recorded at the
amount he actually paid for them.
Which accounting principle is Mario applying?
A accounting entity
B consistency
C going concern
D historical cost

[Link]
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[Link]

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