Chapter 6 Cash Accounting for Service Businesses Solutions to Review Questions

Chapter 6 – Cash Accounting for Service Businesses– solutions to review questions

Review Questions 6.1

1Define the term ‘service business’.

A small business that operates by providing its time, labour or expertise (or a combination of all three) in return for a fee or charge

2List five typical service businesses.

Plumbers
Motor mechanics
Editors
Hairdressers
Architects

3Explain the relationship between a firm’s cash receipts, cash payments and its bank balance.

Cash receipts will increase a firm’s bank balance, while cash payments will decrease a firm’s bank balance.

4List three items that are treated as ‘cash’ in an accounting system.

Notes and coins
Cash in the firm’s bank account
Cheques a firm may have received from customers

Review Questions 6.2

1Draw a flowchart to show the accounting process as it relates to cash transactions.

2State the source documents that provide evidence of:

cash receipts – cash receipt, cash register roll or bank statement
cash payments – cheque butt or bank statement.

3Explain the function of the following elements of a single-entry accounting system:

source documents – the verifiable evidence of transactions to be recorded in the cash journals
cash journals –accounting recordsthat classify and summarise cash transactions during a particular reporting period
Statement of Receipts and Payments – an accounting report that shows the firm’s cash receipts and payments and the consequent change in its bank balance over a reporting period.

Review Questions 6.3

1Explain the function of the Cash Receipts Journal.

A Cash Receipts Journal is an accounting record that summarises all cash received from other entities during a particular reporting period.

2Referring to one Qualitative Characteristic, explain why receipt numbers must be recorded in the Cash Receipts Journal.

Receipt numbers must be recorded so that there is reference to the source document used for a particular transaction. This will provide the verifiable evidence and ensure that the reports are free from bias and subjectivity (Reliability).

3Explain why transactions must be recorded in both the Bank column and a classification column.

While the Bank column records all cash received during a particular reporting period, the classification column is used to record the source of that cash; it allows for frequent cash receipts to be summarised, so that only the totals needs to be reported in the Statement of Receipts and Payments.

4Explain the function of the sundries column in a Cash Receipts Journal.

The sundries column is used to record any receipts that are infrequent.

5Explain the mechanism used to check the totals of the Cash Receipts Journal.

The total of the Bank column should equal the sum of the totals of the other (classification and sundries) columns.

6Explain why GST on cash fees creates a GST liability.

The business collects GST on cash fees from its customers on behalf of the government. It becomes a liability for the business and creates a present obligation, the settlement of which will result in an outflow of economic benefits that must be paid to the ATO.

Review Questions 6.4

1Explain the function of the Cash Payments Journal.

The Cash Payments Journal is an accounting record that classifies and summarises all cash paid to other entities during a particular reporting period.

2Explain why cancelled cheques should be recorded in the Cash Payments Journal.

All cheques must be accounted for in the Cash Payments Journal, even cancelled ones, so that the firm has a record of all cheques issued (and Reliability is upheld).

3Explain why a Cash Payments Journal usually has more classification columns than a Cash Receipts Journal.

Cash payments for most businesses will be more varied/diverse than its cash receipts. Therefore, there will be a need to create more classification columns in the Cash Payments Journal.

4Explain why GST paid to suppliers reduces the GST liability.

When GST is paid to suppliers, it is allowed to deduct this from the GST it owes to the ATO. That is, because the GST will be forwarded to the ATO by the firm’s suppliers, it is treated as if the business had actually paid the GST straight to the government. Thus, GST paid to suppliers will actually decrease the firm’s GST liability.

Review Questions 6.5

1State three pieces of information regarding a firm’s cash position, which are not shown in the cash journals.

The firm’s bank balance at the start of the period
The firm’s bank balance at the end of the period
The overall change (increase or decrease) in the firm’s bank balance.

2Explain the function of a Statement of Receipts and Payments.

The Statement of Receipts and Payments is an accounting report that lists summarised cash receipts and cash payments during a reporting period, the change in the bank balance, and the opening and closing bank balance.

3Show the formula to calculate a cash surplus or cash deficit.

Surplus (Deficit) = Cash Receipts – Cash Payments.

4Explain the effect on the firm’s bank balance of a:

cash surplus – will lead to an increase in the bank balance
cash deficit – will lead to a decrease in the bank balance.

5Distinguish between a cash deficit and a bank overdraft.

A cash deficit refers to a decrease in a firm’s bank balance, the change, but it does not necessarily mean a negative balance. A bank overdraft refers to a negative balance; it describes not a change but a level of cash.

6Explain how the Statement of Receipts and Payments can be used to assist decision-making.

It can be useful for decision-making because it summarises all the information relating to the firm’s cash position. It can then be used to help the owner make decisions about the firm’s cash receipts, payments and level of cash on hand. For example, a high bank balance means the owner may wish to use the excess cash to pay off loans, take extra drawings or purchase newer non-current assets. A low bank balance means the owner may need to make lower loan repayments, lower drawings, use credit for some purchases, or perhaps make a capital contribution.

Review Questions 6.6

1Define the term ‘GST payable’.

GST owed by the business to the ATO when the amount of GST the business has received on its fees is greater than the GST it has paid to its suppliers.

2Explain why most small businesses will end up with GST payable.

Because selling prices are usually higher than cost prices, GST received on fees will usually be greater than GST paid to suppliers. This will mean that under normal circumstances, most small businesses will end up with a liability in relation to GST.

3Explain how GST payable is reported in the Balance Sheet.

GST payable is reported as a current liability in the Balance Sheet as the business has a present obligation, which is expected to result in an outflow of economic benefits (when GST is paid to the ATO) sometime in the next 12 months.

4Explain why a GST settlement must be recorded in the sundries column of the Cash Payments Journal.

The ‘GST’ column of the Cash Payments Journal is used to record GST paid to suppliers. As the ATO is not a supplier to the firm, the GST settlement must be recorded in the sundries column.

5Define the term ‘GST receivable’.

GST owed to the business by the ATO when the amount of GST the business has paid to its suppliers is greater than the GST it has received on its fees.

6State two ways a small business could end up with GST receivable.

If the business makes a bulk purchase of goods/supplies (which it has not yet sold/used) or if the business purchases expensive non-current assets

7Explain how GST receivable is reported in the Balance Sheet.

GST receivable is reported as a current asset in the Balance Sheet as it is a resource of which future economic benefit is expected to flow to the entity (when the business will receive the refund from the ATO) sometime in the next 12 months.