Accounting Theory
John Taylor
edited by Art Ruiséil
Vital Leaving Cert Guidebook: Accounting Theory
John Taylor
Introduction
The theory aspects of the Accounting paper in the Leaving Cert is often poorly answered.
It is important to understand that often the difference between someone achieving a H1 and a H2 is their understanding of Accounting Theory.
This book takes the theory elements of the accounting course, which can account for up to 10% of the exam, and combines them together in one easy to follow guidebook.
In essence, this book is a “one stop shop” for the theory elements of the accounting course, thereby saving students the task of locating this information throughout their textbook.
To further assist students in preparing for the examination, the information is presented in exam question format.
In the LC Accounting exam, except for question 1 on final accounts and questions on Tabular Statements, all other questions of the course are examined with a theory element which can account for up to 10% of the marks for that question.
So, Accounting Theory is vital to success in this subject.
Key Exam tip –
When answering your questions make sure to develop your points using figures from the question that you are answering as an example where appropriate.
A lot of students, just write down the points from the question without including the figures from that question and as a result do not maximise their marks.
Interpretation & Analysis of Accounts
Theory
1) State the formula for “Gross Profit Percentage”.
Gross Profit x 100 Sales
2) Outline the main reasons why the gross profit percentage may decrease from one year to the next.
The main reasons why a firm’s gross profit percentage may decrease from one year to the next are:
There has been a fall in the number of units sold or a reduction in the selling price per unit.
There has been an increase in the cost of buying materials, which has so far not been passed onto the consumer through an increase in the selling price.
Stock, has been stolen, damaged or has gone out of date.
There has been an increase in carriage inwards or custom duties which have not been passed onto the consumer through an increase in the selling price.
Stocks have been valued incorrectly.
3) Outline how a company could improve its gross profit percentage.
A business could improve its gross profit percentage in the following ways:
Try to increase sales for example by undertaking an advertising campaign.
Increase sales revenue by increasing the selling price of the goods.
Make sure that a good stock control system is in place to ensure that appropriate stock levels are maintained by the business.
Buy materials from a cheaper source.
4) Outline the main reasons why the net profit percentage might decrease from one year to the next.
The main reasons why a firm’s net profit percentage may decrease from one year to the next are:
There has been an increase in the firm’s administrative or selling expenses, which have not been passed on to the consumer through an increase in the selling price.
There has been a reduction in rental or other non-trading income.
Because of a fall in the gross profit
5) Explain the difference between the terms ‘Liquidity’ and ‘Solvency’ when used in Ratio Analysis. Refer to relevant ratios in your explanation.
Liquidity measures how able a firm is to pay its short term debts e.g. creditors, loan interest etc., when they are due. The best ratio to test liquidity is the Acid Test Ratio which is a good indicator of liquidity as it includes only actual cash or things that can be easily converted to cash e.g. debtors.
Solvency measures how able a firm is to pay all of its debts i.e. short-term and long-term debts, when they are due. Solvency is therefore a good measure of a company’s ability to stay in business in the long term. The solvency ratio of total assets to external liabilities is the relevant ratio and of course total assets should exceed the total of the external liabilities.
6) Explain the main limitations to the use of ratio analysis as a means of assessing a firm’s performance.
The main limitations to the use of ratio analysis as a means of assessing a firm’s performance are:
It analyses past figures only and these figures can quickly go out of date. Therefore, the results are only an indication of what future performance might be and are not guaranteed
The results do not consider seasonal changes which can be very significant to some firms.
Different firms may use different accounting methods and therefore accurate comparisons cannot always be made.
The results do not consider other important factors which affect a business such as the current economic climate or the industrial relations climate in the firm.
7) Explain the term ‘Gearing’.
Gearing is a measure of how a business is financed on a long-term basis.
It expresses the total of debt capital (loans/debentures + preference shares) as a percentage of total capital employed.
If the result is less than 50% the business is low geared. Above 50%, it is high geared.
Gearing therefore examines how much of a firms’ finance comes from borrowing (known as debt capital) compared to how much has been contributed by the ordinary shareholders (known as equity capital).
Interest must be paid on borrowed finance and of course the finance must be repaid. No interest has to be paid on equity finance and the finance does not have to be repaid
SAMPLE
John has been a teacher of Leaving Certificate Accounting for over 30 years and a school Principal for 11 years. In addition, he is the author of several books including Eurobusiness, Smart Business, Rapid Revision Business and LC Accounting – A Simple Approach to Q1.
He has also been a contributor to the education supplement for Business and Finance magazine and the Folens’ Business Journal and has prepared educational resources for The Irish Banks Information Service, The Central Bank, The Irish Times and Ulster Bank. In addition, he is the Former Chairperson of the Dublin Branch and Vice President of the Business Studies Teachers Association of Ireland.
John presently teaches Accounting in the Institute of Education, Dublin.
SAMPLE
This book is a “one stop shop” for the theory elements of the accounting course, thereby saving students the task of locating this information throughout their textbook. mcandrewbooks.com
