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Leaving Certificate: Accounting Theory

This article condenses parts of the theory section and highlights some of the terminology needed to achieve the highest grade possible. We will be looking at the different types of accounts that would need to be kept.

> Manufacturing Accounts

Are used to test the efficiency of production by comparing the cost of manufacture to current market value of buying in finished goods.

> Club Accounts

Are used to advise members of: the bank balance, I + E, balance sheet value, loans received or paid, money transferred to investments and the value of sponsorship. Entrance fees are not admission but are an income from new members.

> Service Firms

Show profit or loss, provide a balance sheet and give information for tax purposes.

> Farm Accounts

Show the cash position, display profit or loss, show assets and liabilities, compare departments and help with loan applications.

> Incomplete Records

Outline for Incomplete Records person: keep a double entry system, keep full and proper accounts, do not rely on estimates and keep a detailed cash book.

> Cash Flow Statements

Should highlight chief sources of inflows and outflows, to assist the projection of future cash flows, to examine efficiency of cash usage and to assess a company’s liquidity. Differences between cash and profit include collections from debtors, payments to creditors and purchase of fixed assets. Issue of shares does not affect profits.

> Management Accounting

Is for internal use, future projections, specific areas, prepared two or three times per annum.

> Financial Accounting:

External and internal use, past events, general overview, annually prepared.

> Marginal costing is limited in that: it assumes that variable costs are constant and economies of scale are ignored, it assumes that fixed costs do not change but in reality rent or mortgage might increase during the year, it ignores discounts given to encourage sales and it assumes that mixed costs can be easily categorised into fixed and variable.

> Period costs are not linked to activity and relate to a period of time, eg supervisors’ salary.

> Controllable costs are influenced by the firm itself, eg extra costs caused by poor workmanship.

> Uncontrollable costs are influenced by external factors, eg rates are set by the Government.

> Product costing is done to: provide the cost of manufacture in order to calculate selling price, allow a firm to control costs by comparing budgeted costs to actual costs, calculate the value of closing stock based on a breakdown of each component cost.

> Absorption costing is also known as full costing as all costs are included in closing stock.

> Cost centre is an area of activity that attracts costs, eg production line. The advantages of budgeting are: it helps the planning process, it compares results with projections, it improves co-ordination and communications, it helps to set motivational targets, it leads to a more efficient use of resources. The purpose of flexible budgeting is to compare budgeted costs with actual costs at the level of activity, to compare ‘like with like’ and to control costs and plan production levels.

> Principal budgeting factor is the limiting factor in a business. It is the key constraint which prevents expansion.

> Variance is the difference between budgeted and actual costs. If actual is greater than budgeted, it is called an adverse variance.

> Mixed cost is partly fixed and partly variable eg a phone bill.

> Estimating sales for a forecast will take into account: last year’s figures, sales staff and market research.

> Step fixed costs remain the same within certain levels of activity but if production increases, extra factory space may be required.

> Absorption costing is a method of costing products whereby all manufacturing costs are charged to stock. It includes fixed costs in the value of closing stock.

> Overhead absorption rates include rate per unit, rate per direct labour hour and rate per machine hour.

> Over-absorption occurs when the total overhead recovered or absorbed is greater than the actual level of overheads for the period.

> Under-absorption occurs when the total overheads recovered or absorbed is less than the actual overheads incurred in the period.

> Marginal cost is the cost of one unit of the product that could be avoided if that product was not produced.

> Contribution/sales ratio is a measure of the rate at which profit is being earned. It is used where the variable cost per unit and the sales price per unit are not available.

> Sensitivity analysis is a technique that can be used by the management accountant to take into account the effects of any changes in the variables, eg change in selling price.

> Capital budget deals with any long-term expenditure, eg purchase of fixed assets.

> Master budget provides an overview of the planned operations of the company.