Focusing on understanding balance sheets is critical. Know how to calculate assets, liabilities, and equity, and be able to distinguish between current and non-current items. Mastering the equation Assets = Liabilities + Equity is non-negotiable for any evaluation.
Another important area is understanding the methods for tracking income and expenses. You should be able to classify and calculate revenue, cost of goods sold, and net profit using straightforward formulas. Practice identifying and correcting discrepancies in trial balances, ensuring that debits equal credits.
For cash flow analysis, make sure you understand the direct and indirect methods of preparation. Being able to determine cash flows from operating, investing, and financing activities will ensure you can respond quickly to related prompts.
Lastly, be prepared for questions on financial ratios such as liquidity ratios, profitability ratios, and debt-to-equity ratios. Knowing how to compute these and what they indicate about a company’s financial health will give you an edge in any situation.
Basic Accounting Exam Questions and Answers
1. What is the difference between current and non-current assets?
Current assets are expected to be converted into cash or used up within one year, such as inventory or accounts receivable. Non-current assets are long-term investments that are not expected to be liquidated within the year, including property, plant, and equipment.
2. Explain the purpose of a trial balance.
A trial balance is used to verify that the total debits equal the total credits. If the trial balance is balanced, it indicates that the ledger accounts are mathematically correct, though it doesn’t guarantee the absence of errors like transaction omissions.
3. What are the two main types of financial statements?
The two main financial statements are the income statement, which shows a company’s profitability over a period of time, and the balance sheet, which provides a snapshot of the company’s financial position at a particular moment.
4. How is depreciation calculated?
Depreciation can be calculated using different methods such as straight-line, which allocates the same amount of depreciation each year, or reducing balance, where depreciation is higher in earlier years. The calculation depends on the asset’s cost, useful life, and residual value.
5. What is the matching principle?
The matching principle dictates that expenses should be recognized in the same period as the revenues they help generate. This ensures that the income statement reflects a more accurate picture of a company’s profitability for a given period.
6. Describe the purpose of double-entry bookkeeping.
Double-entry bookkeeping ensures that every transaction is recorded in at least two accounts, maintaining the accounting equation: Assets = Liabilities + Equity. This system helps to detect errors and ensures the integrity of financial records.
7. What are liabilities?
Liabilities are obligations that a company must settle in the future, typically in the form of money or services. They are categorized into current liabilities (due within a year) and non-current liabilities (due after a year).
8. What is the difference between gross profit and net profit?
Gross profit is the revenue from sales minus the cost of goods sold (COGS), whereas net profit accounts for all expenses, including operating expenses, taxes, and interest. Net profit is considered the actual profit of the company.
9. How do you calculate working capital?
Working capital is calculated by subtracting current liabilities from current assets. This measure indicates the liquidity available to meet short-term obligations.
10. What are equity and its components?
Equity represents the ownership value in a company. It includes common stock, retained earnings, and additional paid-in capital. Changes in equity result from profits, losses, and distributions like dividends.
Understanding Financial Statements: Key Questions
Reviewing financial statements involves analyzing specific components that reveal the health and performance of an organization. Focus on these areas to grasp the critical aspects of financial reporting:
1. How are assets categorized?
- Assets are typically split into current and non-current categories based on their expected time of conversion into cash.
- Current assets include cash, receivables, and inventories, while non-current assets cover long-term investments and fixed assets like property and equipment.
2. What is the significance of liabilities?
- Liabilities are classified as either current or non-current, depending on their due date.
- Current liabilities, such as short-term debt and accounts payable, are obligations due within one year.
- Non-current liabilities, including long-term loans, represent debts due after one year or more.
3. How to assess profitability?
- Profitability is often assessed through the income statement, focusing on key metrics like gross profit margin and net profit margin.
- Compare revenues and expenses to determine whether the business generates sufficient income after all costs.
4. What does cash flow reveal?
- The cash flow statement shows how cash moves in and out of the company, highlighting operational, investing, and financing activities.
- A positive cash flow ensures that the business has enough liquidity to meet its obligations and invest in growth.
5. How does equity reflect ownership?
- Equity represents the owners’ claim on the business after liabilities have been settled.
- Changes in equity over time, such as through retained earnings or new investments, reveal how well the company is maintaining or growing value for shareholders.
Commonly Tested Accounting Ratios and How to Calculate Them
Focus on mastering these ratios to understand a company’s financial health and performance.
1. Liquidity Ratio (Current Ratio)
Formula: Current Assets ÷ Current Liabilities
This ratio measures a company’s ability to meet short-term obligations. A ratio above 1.0 suggests a firm can cover its short-term debts with current assets.
2. Profitability Ratio (Net Profit Margin)
Formula: Net Income ÷ Revenue × 100
This shows the percentage of revenue that remains after all expenses. A higher value indicates better profitability.
3. Efficiency Ratio (Inventory Turnover)
Formula: Cost of Goods Sold ÷ Average Inventory
This ratio tracks how efficiently inventory is sold and replaced over time. A higher turnover rate indicates efficient inventory management.
4. Leverage Ratio (Debt to Equity Ratio)
Formula: Total Debt ÷ Shareholders’ Equity
This indicates the proportion of company financing coming from debt compared to equity. A lower ratio suggests less reliance on debt.
5. Activity Ratio (Asset Turnover)
Formula: Revenue ÷ Average Total Assets
This measures a company’s ability to generate revenue from its assets. A higher ratio indicates better asset utilization.
6. Market Ratio (Earnings per Share – EPS)
Formula: Net Income – Preferred Dividends ÷ Average Outstanding Shares
EPS indicates how much profit a company generates for each share of stock, giving investors insight into earnings performance.
Practical Approaches to Handling Journal Entries in Exams
Focus on identifying the correct accounts to debit and credit. Analyze each transaction carefully and break it down into its core components–whether it’s an increase or decrease in an asset, liability, equity, income, or expense. Pay attention to whether the transaction affects the balance sheet or the income statement. This understanding will help you avoid mistakes under time pressure.
Step-by-Step Method
Start by writing down the transaction in its simplest form. Identify which accounts are impacted, then classify each account by its nature–whether it is an asset, liability, income, or expense. From there, decide whether the account increases or decreases, and determine the corresponding debit or credit. For example, if cash is received, debit the cash account and credit the revenue account.
Practical Tips for Efficiency
Use a systematic approach to minimize errors. Practice common transactions regularly, such as recording sales, purchases, or payments. Ensure you understand the rules of debits and credits for different account types. Additionally, always double-check your work by ensuring that the debits equal the credits in each entry to maintain the balance.