Accounting Principles. Question Paper, Answers and Examiner s Comments

Transcription

1 Accounting Principles Question Paper, Answers and Examiner s Comments Level 3 Diploma June 2015

2 Copyright of the Chartered Institute of Credit Management June B/MS/2 continued

3 Accounting Principles questions, answers and examiners comments Level 3 Diploma in Credit Management JUNE 2015 Instructions to candidates Answer any FIVE questions. All questions carry equal marks. Time allowed: 3 hours All ledger accounts must be prepared in continuous balance format Final accounts must be prepared in vertical format Where appropriate, VAT is to be calculated at 20% Generally, there is further improvement over previous examinations with some very good scripts being submitted. Structure, format and presentation have certainly improved overall and many students display a high level of knowledge and understanding of the subject matter. This is seen in both numerical and narrative questions and continues to be an encouraging development. As indicated last time, it is important that students address the practical applications of accounting techniques, practices and conventions from a credit management perspective. Also, it should be remembered that good communication is an important element of the detail in this subject. At times though there are instances of poor technique especially in the construction of the Trading and Profit and Loss Account/Income Statement and the Balance Sheet/Statement of Financial Position. Candidates should recognise there is no benefit to be obtained in unnecessarily editing out or omitting sub-totals, items, or processes which are a natural part of final accounts/financial statement construction and the tasks set, and doing so may attract a lower mark. Some still continue to be confused with respect to the difference between a debit and credit balance, and how they are shown in the accounts and the individual ledgers. Ratio analysis (especially the interpretation of the calculations) and control accounts are still problematic for a few students, and the nature and form of cash budgets are still troublesome for some. Questions 1, 2, 4 and 5 were the most popular selections, with Question 3 least popular and Question 8, although having credit management applications, was not as popular as anticipated. June B/MS/3 continued

4 1. The following ledger balances were extracted from the books of P Scarr, a sole trader, as at 31 December DR CR Capital 79,000 Land and buildings at cost 70,000 Land and buildings: Provision for depreciation 6,000 Motor vehicles at cost 26,000 Motor vehicles: Provision for depreciation 7,800 Drawings 16,300 Stock/Inventories as at 1 January ,000 Bank 3,500 Cash 1,540 Purchases 106,600 Sales Revenue 160,800 Rent and rates 2,500 Sundry expenses 2,660 Wages and salaries 16,000 Debtors/Receivables 11,200 Creditors/Payables 10,700 Telephone 1,100 Insurance 900 Discount allowed 2,200 Discount received 4,200 Sales returns 1,500 Purchases returns 2,500 Total 271, ,000 You have also been given the following information: 1. Closing Stock/Inventory as at 31 December 2014 was valued at 9, Wages unpaid at year end amounted to 1,400 and unpaid Sundry Expenses were The balance of the Insurance account includes a pre-payment of Depreciation for Motor Vehicles is to be charged at 25% using the reducing balance method 5. Land and Buildings need to be depreciated at 1.5% at cost 6. Provision for Doubtful Debts is 2% of debtors/receivables. June B/MS/4 continued

5 TASK Using the extracted balances and the notes attached, construct for the year end: a) Trading and Profit and Loss Account (Income Statement) (12 marks) b) Balance Sheet (Statement of Financial Position). (8 marks) Question aims To assess the candidates ability to Construct a simple trading and profit and loss account of a sole trader from a trial balance Make adjustments to the final accounts including closing stock, accruals, pre-payments, depreciation and provision for bad or doubtful debts. Suggested answer Workings w1 Depreciation Motor Vehicles Cost 26,000 Provision 7,800 = 18,200 x 25% = 4,550 Profit and Loss w2 Depreciation Land and Buildings 70,000 x 1½% = 1,050 Profit and Loss w3 Provision for Doubtful Debts Debtors 11,200 x 2% = 224 w4 6, ,050 = 7,050 w5 7, ,550 = 12,350 June B/MS/5 continued

6 Trading and Profit and Loss Account/Income Statement of P Scarr for the year ended 31 December 2014 Sales 160,800 less Sales returns 1, ,300 Less cost of sales Opening stock 9,000 Purchases 106,600 less Purchase returns 2, , ,100 Less closing stock 9, ,700 Gross profit 55,600 Discount received 4,200 Less expenses Discount allowed 2,200 Rent and Rates 2,500 Sundry Expenses (2, Accr) 3,010 Telephone 1,100 Wages and Salaries (16,000+1,400Accr) 17,400 Insurance ( PPd) 780 Depreciation: Motor Vehicles (w1) 4,550 Land and Buildings (w2) 1,050 59,800 Provision for Doubtful Debts (w3) ,814 Net profit 26,986 June B/MS/6 continued

7 Balance Sheet/Statement of Financial Position of P Scarr as at 31 December 2014 Fixed/Non-Current assets Land and Buildings 70,000 7,050 w4 62,950 Motor Vehicles 26,000 12,350 w5 13,650 96,000 19,400 76,600 Current assets Stock/Inventory 9,400 Debtors/Rec bles 11,200 Less Provision ,976 Prepayments 120 Bank 3,500 Cash 1,540 25,536 Less current liabilities Creditors/Payables 10,700 Accruals 1,750 12,450 Net current assets/ Working capital 13,086 Net worth 89,686 Financed by Capital 79,000 add Net profit 26, ,986 less Drawings 16,300 89,686 This was the most popular question on the paper and in the main was tackled well by the majority of students. Most were able to construct the final accounts and in many cases full marks were awarded. For some candidates, there was confusion over the required content of each statement and the logical or customary order of items within it. Assets or liabilities were wrongly entered to Profit and Loss Account/Income Statements and expenses appeared in Balance Sheet/Statements of Financial Position. June B/MS/7 continued

8 Where structure, format and presentation quality was unfortunately lacking, examiners reasonably attempt to follow candidates endeavours, however marks cannot be awarded for work which is clearly incorrect, or inappropriately assembled, or demonstrates a lack of understanding. This is frustrating for all concerned, but is easily addressed by taking more preparation and learning time to practice these tasks. Discount received often causes complications, as does the treatment of accruals and prepayments, although none is difficult to deal with. The calculation of depreciation is often problematic as is the creation of a provision for doubtful debts, disappointing since this is credit management related. June B/MS/8 continued

9 2. a) Briefly explain the nature of the Auditors Report within the final accounts/financial statements of an incorporated business and how its content is of interest to the shareholders and other interested parties. (4 marks) b) Assess the significance of a qualified auditor s report from a credit management perspective. (5 marks) c) Explain the true and fair view idea with regard to the credit manager s interpretation of the final accounts. (5 marks) d) How does the role of the internal auditor differ from that of the external auditor? (6 marks) Question aims To assess the candidates understanding of the concept of true and fair view with regard to the final accounts and the problems associated with a qualified report To assess the candidates appreciation of the key differences between the roles of an internal auditor and the external auditor To test the candidates understanding of the key items of what are included in the auditor s report and the usefulness of the information for the credit manager. Suggested answer a) The auditor s report is an independent document addressed to the shareholders and aims to safeguard their interests. The final accounts of the incorporated business are examined by an independent auditor appointed by the shareholders. The auditor will report to the shareholders on the Balance Sheet/Statement of Financial Position, the Profit and Loss Account/Income Statement and other elements of the financial statements e.g., the Cash Flow statement and the notes accompanying the final accounts by giving an opinion as to whether they represent a true and fair view. However, if the auditor is not able to give a clean audit report then the report is then said to be qualified, and their reasons for this are of wider interest. b) A qualified auditor s report is where, for instance, the auditors question the treatment or disclosure of an item in the final accounts/financial statements. They might also query the employment of certain accounting methods in the treatment of particular transactions, e.g., the purchase or leasing of a fixed/non-current asset. The auditor might be unhappy with the actual content and form of the actual accounts or failure to comply with accounting requirements. From a credit management standpoint, a qualified report could be a warning sign as it might indicate anything from disagreement in an area of fundamental importance to the company to uncertainty in an area that might affect granting of credit or extending credit lines and terms. The credit manager is alerted to possible problems that may arise if credit is granted. c) The auditor provides a statement in the report to shareholders that the accounts show a true and fair view of the financial position of that company at that particular point in time. Introduced for the first time with the Companies Act of 1947, the concepts require that the accounts are drawn up following accepted accounting principles. It implies that (International) Financial Reporting Standards ((I)FRS) and Statements of Standard Accounting Practices (SSAPs) as appropriate have been complied with. June B/MS/9 continued

10 Also, the financial accounts have been drawn up using acceptable bases and conventions. It also implies that proper records have been kept and that the financial statements are in agreement with these underlying records. The credit manager, although not directly addressed by the auditor, can therefore enjoy a certain degree of confidence in the report and the conclusions the auditor draws within their statement. d) Internal auditors are employees of the company, though the function can be outsourced. They are appointed by management to provide an independent appraisal of the company s internal financial control systems. Management determine their function and so their precise brief will vary from organisation to organisation. Their functions are in some way similar to those of the external auditor, thought they are not required by statute. The role of the internal auditor is thus: reviewing the design and functioning of the accounting system and internal controls examining the financial information provided for management to see whether it is reliable and complete reviewing the implementation of management policies. External auditors are required by law. An independent auditor reports to the appropriate shareholders on the annual financial accounts prepared by the Board. The auditor gives an opinion as to whether the accounts are a fair reflection of the financial standing of the company i.e., a true and fair view. The key differences between the roles of the two are thus: Internal auditors are responsible to management whereas external auditors are responsible to shareholders Internal auditors have rights and duties defined by management which can therefore be restricted or changed; whereas, as indicated previously, external auditors have rights and duties defined by law and these therefore cannot be changed The internal auditor may have a number of aims in his/her work. The main aim of the external auditor is to examine the truth and fairness of the accounts. Another favourite with candidates, perhaps in part be due to its non-financial content. Performances surprisingly were indifferent with some very good answers offered at one end of the scale and some woefully poor responses at the other. Better responses addressed all questions from a credit management perspective where appropriate and with information that would have a positive or negative bearing on granting credit to an organisation. There was some confusion as to what constitutes qualified auditor s report and what constitutes a true and fair view. A number of candidates could not differentiate between an internal and an external auditor. June B/MS/10 continued

11 3. As a recently qualified MCICM(Grad), you have been asked to give a talk on the capital structure of incorporated businesses. TASK Prepare the script for a short presentation detailing clearly the key differences between: a) Authorised share capital and issued share capital. (5 marks) b) Ordinary shares and preference shares. (5 marks) c) Revenue reserves and capital reserves. (5 marks) d) The following is an extract from the financed by /equity section of the Balance Sheet (Statement of Financial Position) of Mitre plc. Ordinary share capital (1 shares) 400,000 7½% Preference shares 100,000 Share premium account 86,000 Profit and loss/retained profits 214,000 Shareholders Funds 800,000 The company made 180,000 profit after tax for the year and the Board has agreed a 5% ordinary share dividend. i) Calculate the distribution of dividends to shareholders. (3 marks) ii) Show the revised financed by section of the Balance Sheet. (2 marks) Question aims To assess the candidates knowledge and understanding of the key differences between: authorised and issued share capital ordinary shares and preference shares revenue reserves and capital reserves. Suggested answer a) Authorised share capital is the total amount of share capital that a company is allowed to issue. This is contained in a Memorandum of Association. The authorised capital can be increased by the shareholders passing a Special Resolution at a meeting though this is not a common occurrence. Issued share capital is the face value of share capital that has actually been issued to shareholders and is the figure which appears on a Balance Sheet/StFinPos. Where not all the authorised share capital has been issued, there will be a difference in between the two values. Also, this figure will not include any premium paid over and above the face value of the share. June B/MS/11 continued

12 b) Ordinary shares, sometimes called equities, carry voting rights, and are entitled to a variable dividend; each dependent on the level of profit and company policy. The amount of dividend to be paid will be proposed by the Board and approved by the ordinary shareholders at the Annual General Meeting. Ordinary shareholders are ultimately the risk takers as they are the last to receive a share of the profits, the last to be repaid if the company is wound-up and there is no guarantee of a dividend each year. Preference shareholders on the other hand do not carry voting rights but are entitled to a fixed rate of dividend based on the face value of the share, not on profits. They are called preference because they have preferential treatment over ordinary shareholders in the distribution of profits and capital in the case of insolvency. Unless stated, preference shares are cumulative so, if there is insufficient profit available in any year to pay a dividend, the shortfall can be paid in a subsequent year. c) Revenue reserves are those that arise from trading and which are retained at the year end. The Board decides/resolves how the profits of that trading period are to be distributed including paying a fixed dividend to preference shareholders and a variable dividend to ordinary shareholders. The Board might decide not to pay as much as they could to ordinary shareholders and retain the profits in the business for future expansion, replacement of fixed/non-current asset and the early repayment of loans. These retained profits are called revenue reserves as in essence they belong to the ordinary shareholders. Capital reserves are reserves that do not arise from trading but from capital transactions, for instance, selling shares at a premium or revaluing fixed/non-current assets such as premises. d) i) Profit after tax 180,000 Less 7½% Preference share dividend W1 7, ,500 Less Ordinary share dividend W2 20,000 Retained Profit for the year 152,500 ii) Ordinary share capital (1 shares) 400,000 7½% Preference shares 100,000 Share premium account 86,000 Profit and Loss/Retained Profits W3 366,500 Shareholders Funds W4 952,500 June B/MS/12 continued

13 Workings W1 100,000 x 7½% = 7,500 W2 400,000 x 5% = 20,000 W3 214, ,500 = 366,500 W4 800, ,500 = 952,500 Surprisingly, this set of tasks proved extremely unpopular with candidates given that half the question required a narrative answer and half a number-based response. Most who addressed it could detail the differences between the two types of shares, but only a few could discern the differences between revenue and capital reserves, many others focussing upon capital expenditure instead. The computation part of the question proved difficult to the vast majority, with only a few being able to construct the revised financed by /equity section of the Balance Sheet/Statement of Financial Position, although it was effectively a then and now task, with the template given within the task. As this is an important and integral part of the syllabus, future students should note that this area will be examined again. June B/MS/13 continued

14 4) a) What is the difference between a bad debt and a doubtful debt? (4 marks) b) With regard to the provision for doubtful debt, distinguish between a specific provision and a general provision. (3 marks) c) B Shah has the following customers who have failed to pay their outstanding balances due to insolvency and has now decided to write-off the debts: S Peters and K Russell Complete the accounting entries to write-off these two accounts. Assume it is today s date. (4 marks) d) J Jones makes an annual provision of 4% for doubtful debts, having first done so in The total debtor figures for the last three years were as follows: , , ,000 Reproduce the following table in your answer booklet and complete it to show: i) Amount of provision for each year ii) Amount to be charged in the Profit and Loss account for each year iii) Net figure for Debtors in the Balance Sheet for each year. Year Total Debtors Total Provision Profit and Loss Account Balance Sheet Debtors (9 marks) Question aims To test the candidates knowledge and understanding of the accounting treatment of bad debts and provision for doubtful debts, ordinary shares and preference shares Suggested answer a) A bad debt is a specific amount from a specific customer whose debt is not going to be paid due to insolvency, bankruptcy or the customer has absconded or gone away. The debt is unlikely to be paid and should therefore be written-off. A doubtful debt is where there is some uncertainty that the customer might not pay. In this case, a provision is made for doubtful debts because some of the debtors will not pay, but which ones and how much will not be paid is uncertain. June B/MS/14 continued

15 b) A specific provision is an allowance made against individual existing debts which may have an undue risk or chance of not being paid, taking actual payment pattern, etc., into account. A general provision is an allowance made against the debtors/receivables ledger as a whole, normally expressed as a percentage of the debtor balance, reflecting the statistical likelihood that some customers within the ledger will not pay. c) Account: Bad Debts (NL) Date Details DR CR Balance S Peters K Russell , Account: S Peters (SL) Date Details DR CR Balance Balance b/f Bad debts Nil d) Account: K Russell (SL) Date Details DR CR Balance Balance b/f Bad debts Nil Workings: ,000 x 4% = 5,120 Provision ,000 x 4% = 6,240 Provision ,000 x 4% = 5,440 Provision 2012 PL 5,120 BS 128,000-5,120 = 122, PL 1,120 BS 156,000-6,240 = 149,760 June B/MS/15 continued

16 2014 PL (800) BS 136,000-5,440 = 130,560 Charge to PL in 2012 is the entire provision = 5,120 Charge to PL in 2013 is the change in provision (6,240-5,120) = 1,120 Charge to PL in 2014 is the change in provision (5,440-6,240) = (800) Response in Tabular Form: Year Total Debtors Total Provision Profit and Loss Account Balance Sheet Debtors ,000 5,120 5, , ,000 6,240 1, , ,000 5,440 (800) 130,560 This part of the syllabus has not been examined for a while and, in the main, it was well answered. Most could identify the differences between a bad and a doubtful debt, though some answers were a little weak with regard to the latter. Again most students had an idea of the differences between the two in part b), although examples cited for a specific provision were a little indifferent. The double entry part in task c) was very well handled in the main although many students created work for themselves by incorporating VAT into the scenario which was not required by the task. Part d) was often handled well with full marks being awarded. June B/MS/16 continued

17 5. Selected balances brought forward on 1 January 2015 for Ken Smith, a small independent supplier of building materials, were as follows: Bank (in overdraft) 12, VAT owing 14, Sales Revenue 95, Purchases 49, Discount allowed Discount received P Scott (a supplier) 3, C Eaton (a customer) 4, I Johnson T Agale cr During the first month of 2015, the following transactions took place: 3 January 2015 Cheques were banked for sales made in the last week of December for 1, inclusive of VAT. 5 January 2015 Sold building materials to C Eaton for 1, plus VAT. 8 January 2015 Purchased further supplies from P Scott for 3, plus VAT. 10 January 2015 Ken returned damaged goods back to P Scott for plus VAT. 12 January 2015 Issued a credit note for inclusive of VAT in respect of goods returned from C Eaton. 14 January 2015 Ken took 1, out of the bank for his own personal use. 18 January January 2015 TASK Ken pays T Agale in full settlement of the amount owing; the remainder is to be treated as discount (NB: Ignore VAT in the discount calculation here). I Johnson pays to take advantage of an early settlement discount of (NB: Ignore VAT in the discount calculation here). a) Open all the necessary accounts and enter all opening balances. (5 marks) b) Account for all transactions in January 2015 opening appropriate accounts as necessary. (15 marks) June B/MS/17 continued

18 Question aims To test the candidates ability to: Carry out double-entry book-keeping to record sales, purchases and returns in the ledger accounts Calculate and record VAT Record receipts and payments Record discounts. Suggested answer a) and b. Account: Bank CB Date Details DR CR Balance Balance b/f (12,500.00) Sales Revenue 1, (10,925.00) Drawings 1, (11,925.00) T Agale (12,265.00) I Johnson (11,914.25) Account: Sales Revenue NL Date Details DR CR Balance Balance b/f (95,650.00) Bank 1, (96,962.50) C Eaton 1, (98,912.50) Account: Purchases NL Date Details DR CR Balance Balance b/f 49, P Scott 3, , Account: VAT (HMRC) NL Date Details DR CR Balance Balance b/f (14,500.00) Bank (14,762.50) C Eaton (15,152.50) P Scott (14,502.50) P Scott (14,682.50) C Eaton (14,572.50) Account: C Eaton SL Date Details DR CR Balance Balance b/f 4, Sales Revenue 2, , Sales Returns , June B/MS/18 continued

19 Account: P Scott PL Date Details DR CR Balance Balance b/f (3,600.00) Purchases 3, (7,500.00) Purchases Returns 1, (6,420.00) Account: Discount Allowed NL Date Details DR CR Balance Balance b/f I Johnson Account: Discount Received NL Date Details DR CR Balance Balance b/f (48.75) T Agale (99.25) Account: I Johnson SL Date Details DR CR Balance Balance b/f Bank Discount Allowed Account: T Agale PL Date Details DR CR Balance Balance b/f (390.50) Bank (50.50) Discount Received Account: Purchases Returns NL Date Details DR CR Balance P Scott (900.00) Account: Sales Returns NL Date Details DR CR Balance C Eaton Account: Drawings NL Date Details DR CR Balance Bank 1, , June B/MS/19 continued

20 This continues to be a very popular type of question and responses are certainly getting better with often full marks being secured. As with previous examinations, the vast proportion of candidates could open individual accounts correctly, enter correct brought forward balances (showing credit balances where appropriate, although some found a credit bank balance an issue), and apply transactions using the usual rules of double-entry. Discounts and returns caused problems with some candidates, a few had problems identifying the difference between a customer and a supplier; debit and credit entries for VAT proved a little troublesome; and the double-entry for an owner taking money out of the business for personal use drew a number of inappropriate responses. These, it has to be said, are usual errors for this type of question and would be eradicated by proper and careful practice. June B/MS/20 continued

21 6. a) Explain four key advantages of preparing the Sales Ledger Control Account? (12 marks) b) Prepare a Sales Ledger Control Account using the following information. The sales ledger closing debtors/receivables balance on 30 November 2014 was 7,950. The closing balance at the end of December 2014 should be shown. Totals for December 2014: Credit sales returns 1,750 Bad debts written-off 740 Sales Revenue (includes 500 cash sales) 18,900 Cash and cheques from customers 6,750 Discount allowed 450 Dishonoured cheque from an account customer 60 (8 marks) Question aims To test the candidates understanding of the purpose and use of the Sales Ledger Control Account and the key advantages of maintaining it. Suggested answer a) i) Error Detection/Correction: The Sales Ledger Control Account (SLCA) is a check on the arithmetical accuracy of the personal debtors (receivables) accounts. The balance on the SLCA should be the same as the total of all the individual balances in the Debtors/Receivables ledger. Regular preparation of a SLCA means that errors can be identified early which reduces the time spent in looking for and correcting them. However, the SLCA does not detect all errors. For instance, it will not highlight errors of commission where items have been posted to the wrong customer account. ii) iii) Facilitates Trial Balance Extract: The SLCA saves time when extracting a trial balance. The SLCA enables the total debtors figures to be entered into the trial balance in one entry, rather than having to enter every single debtor balance which might run into thousands of lines in the trial balance. If the trial balance does not agree, the debtors/receivables (and indeed creditors/payables from the Purchase Ledger Control Account) figures can be excluded from the search for errors as they have already been verified. Separation of Roles for Fraud Prevention: A more senior member of staff is likely to supervise the preparation of control accounts. Alternatively, responsibility for maintaining control accounts rests with a discrete area within the accounting domain. The main reason for this is to deter and prevent opportunities for fraud by separating the input of data from responsibility for maintaining accounting controls. Consequently, no one person should have dayto-day duties in both areas. June B/MS/21 continued

22 iv) Management, Planning and Control: The SLCA indicates how much customers owe overall. Although manual controls will need to be maintained regularly to do this, with computerised systems, these figures can be obtained almost instantly and provide a verified figure for debtors/receivables in the balance sheet. The summarised information is useful for senior management for planning and financing purposes. b) Account: Sales Ledger Control Date Details Opening balance b/f Dr Cr Balance 7, Sales Returns 1, , Bad Debts writtenoff Credit Sales Revenue , , , Debtors Receipts 6, , Dishonoured Cheque , Discount Allowed , Only Sales Revenue deriving from sales on a credit basis would normally be entered to the SLCA as cash sales are not processed routinely through the sales ledger, consequently cash sales should also be omitted (deducted) from cash and cheques received. Benefit was given for posting a 1 December brought-forward balance and December transaction totals at an end of month date, consistent with the task data, and for giving/showing for the December Closing Balance (as required), otherwise the order of December transaction totals within the control account is not important. As an area of the syllabus tested less frequently, this is perhaps leading to some students deciding not to include control accounts in their study programme. Indeed, the narrative part of the question let many students down with only a few words being offered with regard to the advantages of constructing a SLCA, and the construction and posting to the account in part b) were rather indifferent. Unfortunately there was some confusion with the debit and credit transactions in b) and only a handful computed the correct balance. Many failed to adjust the credit sales to allow for the cash transaction. Also bad debts and returns were often posted incorrectly, as was the returned cheque. June B/MS/22 continued

23 7. a) What is the significance of a cash budget from a credit management perspective? (4 marks) b) From the following information for Brown, Jones and Smith Ltd, prepare a cash budget for the period January to March Sales Purchases Wages Variable Overheads November ,000 20,000 20,000 5,000 December ,000 25,000 20,000 10,000 January ,000 30,000 30,000 5,000 February ,000 45,000 20,000 8,000 March ,000 50,000 20,000 6,000 The bank balance on 1 January 2016 is expected to be 25,000 Fixed overheads are 2,000 per month, payable in the same month. This figure includes 100 depreciation. Receipts from sales follow the following pattern: 50% during the month of sale 25% during the following month 25% during the next following month It is the policy of the firm to pay trade creditors: 20% during the month of sale 60% during the following month 20% during the next following month Wages are paid 30% in the month earned and 70% in the following month Variable overheads are incurred and paid in the same month Fixed assets for 8,000 will be bought in February 2016 and paid for in March Interest is received in the month at 0.25% of a positive cash balance at the start of the month (round up interest to the nearest whole ). (16 marks) June B/MS/23 continued

24 Question aims To test the candidates understanding of the importance of cash budgets in the assessment of the credit worthiness of an organisation To test the candidates ability to construct cash budgets from given simulated data. Suggested answer a) The cash budget indicates the timing and expected cash inflows and outflows. On the basis of this expenditure can be allocated to those periods where cash is expected to be available, reducing the necessity for short-term borrowing. b) If a credit manager has access to a customer s cash budget, he/she will be able to ascertain when funds are available therefore and to indicate the customer s ability to pay debts as and when they fall due. If a cash shortage is indicated, steps can be taken to arrange for an overdraft facility of increasing an existing overdraft or to transfer funds from elsewhere. Jan Feb March Receipts Sales 32,500 47,500 55,000 Interest Total Receipts[TR] 32,563 47,507 55,000 Payments Purchases 25,000 32,000 43,000 Wages 23,000 27,000 20,000 Variable Overheads 5,000 8,000 6,000 Fixed Overheads 1,900 1,900 1,900 Fixed Assets 8,000 Total Payments[TP] 54,900 68,900 78,900 Summary Cash Balance b/f 25,000 2,663 (18,730) Net Receipts for month [TR-TP] (22,337) (21,393) (23,900) Cash Balance c/f 2,663 (18,730) (42,630) June B/MS/24 continued

25 Workings Sales Nov Dec Jan Feb Mar April May June N 10,000 5,000 5,000 D 15,000 7,500 7,500 J 20,000 10,000 10,000 F 30,000 15,000 15,000 M 30,000 15,000 15,000 32,500 47,500 55,000 Purchases Nov Dec Jan Feb Mar April May June N 4,000 12,000 4,000 D 5,000 15,000 5,000 J 6,000 18,000 6,000 F 9,000 27,000 9,000 M 10,000 30,000 10,000 25,000 32,000 43,000 Wages Nov Dec Jan Feb Mar April May June D 6,000 14,000 J 9,000 21,000 F 6,000 14,000 M 6,000 14,000 23,000 27,000 20,000 Interest Jan 0.25% x 25,000 = 63 Feb 0.25% x 2,663 = 7 March 0.25% x 0 = 0 Fixed overheads subtract 100 as depreciation is a non-cash item Each month 2, = 1,900 Addressed by a smaller number than most other questions, few responses obtained high marks with many clustered around the middle of the mark range. In a), not many candidates secured full marks with only a sentence or two being the order of the day for most. Part b) did cause a few problems though many made a bold attempt. The interest receivable was often ignored or was confused with being an expense; sales and purchases were often computed incorrectly; and many failed to adjust fixed overheads for depreciation. Some candidates included pence in their responses which was not necessary and a few were confused into inaccuracy by the volume of superfluous zeros within their response. The Summary Net Receipts and Balance b/f and c/f section of the budget was not tackled well, although there is no set format for a cash budget (the model here is typical) and it hinges upon clarity, communication and anticipation of available funds. June B/MS/25 continued

26 8. Below are extracts of a company s final accounts/financial statements for the last two years: Sales revenue 453, ,186 Cost of sales 362, ,700 Gross profit 90,753 85,486 Expenses 85,411 84,451 Operating profit 5,342 1,035 Fixed/Non-current assets 185, ,700 Closing stock/inventory 22,680 29,256 Debtors/receivables 37,812 43,380 Bank (41,668) (30,177) Creditors/payables 14,624 23,224 Ordinary shares 155, ,000 Retained profits 4,900 5,935 Loan 30,000 24,000 TASK a) Calculate the following ratios for the year 2014 (the ratio calculation for 2013 in each case has been given in brackets): i) Gross profit margin (2013: 20.0%) ii) Operating profit margin (2013: 1.2%) iii) Current ratio (2013: 1.1:1) iv) Acid test/quick ratio (2013: 0.7:1) v) Stock/Inventory turnover period (2013: 22 days) vi) Debtors/Receivables collection period vii) Creditors/Payables payment period viii) Cash operating cycle (2013: 30 days) (2013: 14 days) (2013: 38 days) ix) Gearing (2013: 15.8%). (6 marks) b) Using your calculations and the figures given for 2013, discuss whether you would grant additional credit over and above the current limit of 25,000, giving your reasons why. (10 marks) c) Identify two other ratios which could have been obtained from the financial information given, which might have further assisted the credit manager s decision, justifying your choice. (4 marks) June B/MS/26 continued

27 Question aims To test the candidates knowledge and understanding of financial ratios and how they can be employed to assess the profitability, liquidity and efficiency of an organisation which will have a significant bearing on any decision made by a credit management with regard to limits and terms. Suggested answer a. Ratio calculations: 2013 (given) 2014 i) Gross profit margin 20.0% 17.9% ii) Operating profit margin 1.2% 0.2% iii) Current ratio 1.1:1 1.4:1 iv) Acid Test/Quick ratio 0.7:1 0.8:1 v) Stock/Inventory Days 22 days 27 days vi) Debtors/Receivables Days 30 days 33 days vii) Creditors/Payables Days 14 days 21 days viii) Cash Operating Cycle 38 days 39 days ix) Gearing 15.8% 13.0% Workings Gross profit margin Gross profit x 100 Sales 2013 (given) ,753 x ,750 = 20.0% 85,486 x ,186 = 17.9% Operating profit margin Operating profit x 100 Sales Current ratio Current assets Current liabilities Quick ratio/acid test Current assets closing stock Current liabilities Stock/Inventory Turn. Days Closing stock*/inventory x 365 Cost of sales Debtors/Receivables Days Debtors/receivables x 365 Sales *** Creditors/Payables Days Creditors/payables x 365 Cost of Sales** 5,342 x ,750 = 1.2% 22,680+37,812 = 60,492 41,668+14,624 = 56,292 so 60,492 / 56,292 = 1.1:1 60,492-22,680 = 37,812 41,668+14,624 = 56,292 so 37,812 / 56,292 = 0.7:1 22,680 x 365 = 22.8 days 362,997 37,812 x 365 = 30.4 days 453,750 14,624 x 365 = 14.7 days 362,997 1,035 x ,186 = 0.2% 29,256+43,380 = 72,636 30,177+23,224 = 53,401 so 72,636 / 53,401 = 1.4:1 72,636-29,256 = 43,380 30,177+23,224 = 53,401 so 43,380 / 53,401 = 0.8:1 29,256 x 365 = 27.3 days 391,700 43,380 x 365 = 33.2 days 477,186 23,224 x 365 = 21.6 days 391,700 June B/MS/27 continued

28 Cash Operating Cycle Debtors/Receivables Days + Stock/Inventory Days Creditors/Payables Days Gearing Loans x 100 Capital Employed + Loans = 38.5 days = 38.9 days 30,000 x ,000+4,900+30,000 Therefore 30,000 x 100 = 15.8% 189,900 24,000 x ,000+5,935+24,000 Therefore 24,000 x 100 = 13.0% 184,935 * Use of Closing Stock acceptable as Average Stock figures not available for both years. ** Use of Cost of Sales appropriate as Credit Purchases figure not available for either year. *** Use of Sales is appropriate as Credit Sales figure is not available for either year. b. The candidate might offer the following observations based upon the above data, but benefit would be given for any reasonable and justified interpretation of the data which would support the credit decision as to whether or not to increase the current credit limit: Gross Profit Margin and Operating Profit Margin have both worsened despite turnover increasing. This can be explained in part by the increase in the Cost of Sales. The liquidity ratios are a cause for concern, not helped obviously by the high overdraft, though it has reduced somewhat over the year. There has been an improvement in the current ratio and the acid test/quick ratio has stayed near enough the same but the liquidity position is starting off at a low figure which is certainly a cause for concern. Neither ratio is at the generally anticipated minimum level of 2:1 and 1:1 respectively. Stock/Inventory turnover has worsened slightly as has the debtors/receivables figure, though the organisation is taking longer to pays its bills, which is welcome. This has contributed in part to the favourable movement in the Cash Operating Cycle in days. The organisation s loan liability has reduced contributing to the positive reduction in the Gearing ratio. Given all of this, the company has certainly got a potential problem with liquidity, which will mean the organisation will have trouble paying its bills as and when they are due, and this is not helped by the reliance on the overdraft, which, though reduced, is still quite high in relation to the other figures. What would happen in terms of immediately satisfying the request if the bank called it in, which is their right? Also the credit manager might ask what has happened to the non-current assets and question whether the reduction in asset value is simply depreciation, or whether assets have been sold to alleviate a cash-flow issue. June B/MS/28 continued

29 On balance, the increase requested might not be feasible though the credit manager might request sight of more financial information from the organisation, such as copies of: Management accounts Cash and sub-budgets Order books These might have a bearing on the credit manager s final decision, as might better and more detailed explanations as to how the organisation can manage liquidity ratios at a lower level than other organisations, for instance. c. The credit manager might have chosen any two of the following: i) Return on Capital Employed, the efficiency of generating profit from investment; ii) Expenses to Sales, the efficiency of keeping overheads in line with sales; iii) Asset Turnover, the efficiency of generating sales from fixed assets; iv) Debt to Equity, the balance in between long term debt and shareholder funds. Note: There is not enough information to calculate either Return on Shareholders Funds because there is no profit after tax figure supplied or Interest Cover ratio because there is no interest figure cited. As indicated in the previous exam series, financial ratios form an integral part of the syllabus and are also a very important tool for a credit manager in assessing the credit worthiness of new and existing customers. Not as many students in relative terms attempted the question this time. This may be connected with the focus here upon the interpretation of the data, rather than calculation and not as many marks being available for the calculations of the individual ratios. Profit ratios were handled well, as were the efficiency ratios of stock/inventory, debtors/receivables and creditors/payables. Unfortunately, the liquidity ratios and gearing caused a problem for some which was surprising since these are corner of the scrap paper calculations giving an early picture to the credit manager of the state of finances. Part b) responses were either very good or pretty poor, so unchanged from last time. It is important to emphasise that the interpretation of financial data is just as important as the calculation of the said ratios, so students should take note. Equally, it is also important to stress that interpretation should reason with the data and suggest possible causes it is not an opportunity to state whether things have gone up or down, which is evident from simply looking at the data itself. Most could cite an appropriate ratio in part c). This topic, given its importance, will continue to be examined in future diets. ---o0o--- June /PQP/7B