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Getting to know FAPS
What you need to know to get a successful result in your Financial Accounting: preparing financial statements assessment
Using advanced bookkeeping skills to record transactions
In order to use advanced bookkeeping skills, a clear understanding of the basics is required, in other words, a strong foundation in double entry bookkeeping.
This starts with knowing the five categories of accounts and understanding how their expected balances are increased and decreased using debits and credits.
This knowledge and understanding is applied in a number of ways in the FAPS unit, one of which is the correction of errors. As errors are not predictable, then correcting them cannot be learnt by rote. Rather it is a skill that tests understanding of accounting theories, for example, the accounting equation, separate entity concept and dual effect, and how accounting systems, based on double entry bookkeeping, work.
A successful strategy for correcting errors is to have a methodical approach.
For each error a series of questions can be asked. Knowing what’s been posted into the accounts, or omitted, is the starting point, even if it’s obvious that some of it is wrong. Write it down or draw a T account. Think about whether what’s happened has resulted in the total debits and credits matching, because if there’s an imbalance, the suspense account will be involved.
Then note what should have been posted. Some of the entries may be correct already so a comparison of what happened and what should have happened will identify what corrections are needed.
Key Questions
- What happened?
- What should have happened?
- What correction(s) are needed?
How to conform with accruals accounting
The purpose of accruals accounting is to ensure that an organisation’s accounts accurately reflect its financial position. This is done by including income that has been generated in a period on the financial statements even if the money is still outstanding. For credit sales, the receivables balance serves as a reminder of receipts that are still to come. Expenses incurred in the period are treated in the same way so that they are matched to the period in which they were incurred, irrespective of the period in which they were paid.
Credit transactions automatically conform to accruals accounting. However, adjustments will be needed for any other income generated and expenditure incurred for which payment has not been made or invoices exchanged, within a period. These adjustments are prepayments and accruals.
Understanding accounting adjustments
A prepayment is an expense that has been paid for, or some income that has been received, in the current period but that needs to be matched to the next period. An accrual is the opposite, an expense or income that won’t go through the bank account until the next period, but which was incurred or generated in this period.
Dealing with prepayments and accruals is predictable and can be learnt. There are three elements that work as a continuous cycle from the start to the end of a period:
However, knowing and understanding the elements needs to be combined with understanding of double entry bookkeeping to accurately make the adjustments.
Regardless of whether an income or expense account is being adjusted:
● Prepayments will decrease balances at year-end. Therefore, they must increase balances at the start of the following year.
● Accruals will increase balances at year-end. So must decrease balances at the start of the following year.
Double entries are posted into prepayment and accruals accounts and their balances will be shown on the Statement of financial position.
Carrying out adjustments
For an organisation’s accounts to be a true and accurate reflection of its financial position, adjustments often need to be made at period end for doubtful receivables. This acknowledges that some sales invoices or customers’ accounts are likely not to be settled. However, unlike an irrecoverable debt, there is not yet certainty that they will become irrecoverable. It may be that concerns are held for a particular debt and therefore a specific allowance is made. Or, previous experience has shown that a percentage of receivables will need to be written off, so that is used as a prudent measure on which to base a general allowance. For some organisations, the period end adjustments will involve writing off irrecoverable debts, rebalancing the receivables account, making a specific allowance, calculating the remaining value of receivables and then calculating the required general allowance.
Once calculated, the adjustment for the total allowance will need to be made using double entry postings. The allowance account will always have a credit balance as its purpose is to decrease the value of the receivables account, which is an asset so has a debit balance. Therefore, depending on whether the allowance needs to be increased or decreased from the previous period, the difference between the current balance and the calculated allowance will be posted and double entered into the allowance adjustment account.
Key takeaway
FAPS applies knowledge and understanding by testing skills. The key therefore is not just knowing the adjustments and calculations but understanding how they are interrelated and applied using advanced double entry bookkeeping and adhering to the accounting concepts.
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