Institute of Chartered Accountants Ghana (ICAG) Paper 1.1 Financial Accounting

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1 Institute of Chartered Accountants Ghana (ICAG) Paper 1.1 Financial Accounting Final Mock Exam 1 and suggested solutions DO NOT TURN THIS PAGE UNTIL YOU HAVE COMPLETED THE MOCK EXAM

2 ii Final Mock Exam: Answers Financial Accounting The Institute of Chartered Accountants Ghana First edition 15 ISBN All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BPP Learning Media Ltd. Published by BPP Learning Media Ltd BPP House, Aldine Place London W12 8AA The Institute of Chartered Accountants Ghana 15

3 Final Mock Exam 1: Answers 1 Question 1 Partners' accounts: NF 1 OR 1 PN 2 4 Realisation account ½ to 1 mark per correct entry 10 Cash and bank account ½ to 1 mark per correct entry 6 (a) PARTNERS' ACCOUNTS NF OR PN NF OR PN Realisation a/c 18,000 Capital a/cs 90,000 60,000 30,000 Cash 112,510 76,906 25,604 Current a/cs 19,500 14,900 12,600 Realisation a/c 3,010 2,006 1, ,510 76,906 43, ,510 76,906 43,604 (b) REALISATION ACCOUNT Furniture and fittings (Carrying 100,000 Loan a/c 36,000 Amount) Motor vehicles (Carrying Amount) 70,000 Payables 53,000 Inventory 50,000 Receivables 84,000 Cash and bank Cash and bank Loan 36,000 Furniture and fittings 97,600 Payables 50,880 Motor vehicles 59,000 Dissolution expenses 2,000 Inventory 55,500 Receivables 79,800 Profit on realisation PN (motor vehicle) 18,000 NF 3/6 3,010 OR 2/6 2,006 PN 1/6 1, , ,900

4 2 Final Mock Exam 1: Answers (c) CASH AND BANK Balance b/f 12,000 Realisation a/c Realisation a/c Furniture and fittings 97,600 Loan 36,000 Motor vehicles 59,000 Payables 50,880 Inventory 55,500 Dissolution expenses 2,000 Receivables 79,800 Partners NF 112,510 OR 76,906 PN 25, , ,900 Question 2 (a) 2 marks per ratio available 10 Maximum 9 (b) ½ to 1 mark per valid point 11 (a) (i) Return on capital employed* Net profit before interest & tax Capital employed / = 13.9% (ii) Gross profit percentage Gross profit 100 1/3 100 =37.5% Revenue (iii) Net profit percentage* Net profit before interest and tax Revenue /3 100 =15.6% (iv) Quick/acid test ratio Current assets inventory Current liabilities :1 (150 90)/90 :1 = 0.67 :1 (b) (v) Receivables collection period Receivable Revenue * Alternative definitions are also acceptable Brief Report /3 365 = 57 days To: From: A Student Date June X5 Subject: Financial appraisal of FR using accounting ratios Introduction The purpose of this report is to analyse the financial performance of FR over the last three years using accounting ratios.

5 Final Mock Exam 1: Answers 3 The report specifically comments on the following ratios: Return on capital employed Gross profit percentage Net profit percentage Quick/acid test ratio Receivables collection period The report also highlights what other information would be useful to help interpret the ratios. Return on capital employed The return on capital employed has declined over the last three years from 16.2% to 13.9% and is now well below the industry average (16.2%). This should be a cause for concern to the board of directors because if investors can obtain a higher return elsewhere then they may withdraw their investment. Alternatively they may seek to change the management board. It would be helpful to have more information on the market in which FR operates eg is the market growing or declining, are there many buyers and sellers or just a few? Gross profit percentage The gross profit percentage has risen over the period from 30.4% to 37.5%. Clearly the company has either: (i) Increased the selling price of its goods, eg perhaps it is able to sell at a premium because of perceptions regarding the quality of the goods sold, or (ii) Reduced the cost of its supplies, possibly changing suppliers or obtaining greater discounts as sales volume has increased. It would be useful to know what the company is selling and the volume of sales analysed by product and year. Net profit percentage The net profit percentage has declined over the period from 19.3% to 15.6% and is significantly below the industry average of 17.3%. This is worrying considering the increase in the gross profit percentage over the same period. The decline in the net profit percentage suggests that the costs may not be tightly controlled within the company. More detailed information on expenditure during the period would be helpful in identifying the reasons for the decline in profitability. Quick (or acid test) ratio The quick ratio has also declined significantly during the period from 1.5:1 to 0.67:1 suggesting the company may be experiencing liquidity problems. This view is also supported when the ratio is compared to the industry average which is over double that of FR. The level of inventory may be a concern as it is tying up cash. More information on the type of inventory and the level of inventory turnover would be useful. Receivables collection period The time taken to collect debts has increased over the period from 32 days to 57 days. This seems very high when compared to the industry average debt collection period of just 35 days. The period suggests that there is little control over debt collection. In addition, the lengthening of the collection period means it is more likely that some debts will not be paid by customers. The poor control over debt collection will be a factor contributing to the adverse liquidity situation of the company. Conclusion Although the company has managed to increase its gross profit over the period, this has not resulted in a similar increase in net profit. In summary the ratios indicate poor internal control of costs and poor management of working capital. The return on capital employed is unlikely to be sufficiently attractive to potential investors or to existing shareholders.

6 4 Final Mock Exam 1: Answers Question 3 Net profit before tax 1 Depreciation 1 Loss on sale of tangible non-current assets 1 Interest 1 Increase in inventory 1 Increase in receivables 1 Increase in payables 1 Interest paid 1 Tax paid 2 Dividends paid 1 Purchase of non-current assets 2 Receipts from sale of tangible non-current assets 1 Proceeds from issue of shares 1 Repayment of long-term borrowing 1 Net decrease in cash and cash equivalents 1 Cash and cash equivalents at beginning of period 1 Cash and cash equivalents at end of period 1 Presentation 1 Prepared in accordance with IAS7 SD Statement of cash flows for the year ended 31 May X5,000,000 Cash flows from operating activities Profit before interest and tax (2,064 + ) 2,084 Adjustments for: Depreciation 1,400 Loss on sale of tangible non-current assets ( ) 40 Increase in inventory (160) Increase in receivables (260) Increase in payables 170 Cash generated from operations 3,274 Interest paid () Tax paid (W2) (290) Net cash from operating activities 2,964 Cash flow from investing activities Purchase of non-current assets (W1) (5,600) Receipts from sales of tangible non-current assets 360 Net cash used in investing activities (5,240) Cash flows from financing activities Dividends paid (540) Proceeds from issue of shares 2,560 Repayment of long term borrowing (0) Net cash used in financing activities 1,8 Net decrease in cash and cash equivalents (456) Cash and cash equivalents at the beginning of period 340 Cash and cash equivalents at end of period 116

7 Final Mock Exam 1: Answers 5 Workings 1 NON-CURRENT ASSETS '000 '000 Balance b/f 5,400 Depreciation 1,400 New non-current assets (bal) 5,600 Disposals 400 Balance c/f 9,0 11,000 11,000 2 TAX Question 4 '000 '000 Tax paid (balancing figure) 290 Balance b/f 290 Balance c/f 360 Statement of profit or loss (a) Two reasons (1 mark each) 2 Two items (1 mark each) 2 (b) (i) Nominal ledger bank a/c Opening balance correct place 1 Cheque error 1 Bank charges 1 Cancelled cheque 1 Returned cheque 1 Closing balance 1 Balance c/f 1 (ii) Balance per bank statement 1 Incorrect interest credited 2 Outstanding cheques 2 Outstanding lodgement 1 Revised balance 1 (c) Overdrawn 1 Current liability (a) A bank reconciliation is carried out for the following reasons: (i) (ii) (iii) (iv) To confirm the accuracy of entries in the cash book To uncover any error which may have been made by the bank To provide a reliable cash figure for the trial balance To identify any items, such as bank charges, which need to be entered in the accounting records, including the cash book Items appearing in the bank reconciliation are: (i) The corrected cash book balance (ii) Unpresented cheques (iii) Outstanding lodgements

8 6 Final Mock Exam 1: Answers (iv) (v) Any adjustment to be made by the bank The balance on the bank statement (You only needed two of each of these.) (b) (i) BANK ACCOUNT (1) Error in recording cheque 90 Opening balance 226 (7) Cancelled cheque 1,250 (2) Bank charges 766 Closing balance 292 (3) Returned cheque 640 1,632 1,632 Balance b/f 292 (ii) Balance per bank statement 456 Less: (4) interest incorrectly credited 440 (6) unpresented cheques (3,258 1,250) 2,008 (2,448) (1,992) Add: (5) outstanding lodgement 1,700 Revised balance agreed to ledger account (292) (c) The bank balance is 292 overdrawn. This will be reported as a current liability in the statement of financial position. Question 5 (a) ½ to 1 mark per valid point maximum 5 (b) Items (i) to (iv) marks as indicated 15 (a) Advantages of being sole proprietorships This type of structure is ideal if the business is not complicated, and especially if it does not require a great deal of outside capital. Advantages include: Limited paperwork and therefore cost in establishing this type of structure Owner has complete control over the business Owner is entitled to profits and the ownership of assets Less stringent reporting obligations compared with other business structures no requirement to make financial accounts publicly available, no audit requirement Can be highly flexible Disadvantages of being sole proprietorships Owner is personally liable for all debts (unlimited liability) Personal property may be vulnerable for debts and other business liabilities. Large sums of capital are less likely to be available to a sole proprietorship, leading to reliance on overdrafts and personal savings.

9 Final Mock Exam 1: Answers 7 May lead to long working hours without the normal employee recreation leave and other benefits May be issues of continuity of business in the event of death or illness of the owner (b) (i) There is a conflict here between the accruals or matching concept and the Conceptual Framework criteria for recognition of an asset. The accruals concept states that costs should be matched against revenue which they generate. Thus it might be argued that, since half the revenue expected to result from the advertising campaign will be achieved in X6, it might be appropriate to defer half the costs of the advertising campaign until X6. This would mean that 2,800 would be treated as deferred expenditure (an asset) in the financial statements for the year ended 31 December X5. However, it is not possible to reliably measure the future revenue expected to be generated from the advertising campaign, so the revenue should not be anticipated but provision should be made for all known losses (and expenses). Therefore all the costs of the advertising campaign should be written off as an expense in the X5 accounts. (ii) (iii) (iv) Question 6 When the proprietor of a business takes inventory for his own use, it counts as drawings, which are a deduction from the owner's capital. The entries to record the drawings are: DEBIT Drawings 1,000 CREDIT Purchases 1,000 The receipt of compensation from the insurance company is contingent upon the outcome of the court case. As such it is a contingent asset and the accounting treatment is governed by IAS 37 Provisions, contingent liabilities and contingent assets. As the asset is only contingent, it should not be recognised in the financial statements for the year ended 31 December X5. If the cash inflow is 'probable' it should be disclosed in a note to the accounts. If the contingent asset is only 'possible' it should not be disclosed at all. It is not clear whether the term 'reasonable' means probable or possible and the solicitor would need to be consulted further to determine the accounting treatment. Under the business entity concept the business is a separate entity from JB as a person. This applies for accounting purposes, although not for legal purposes. The loan should, therefore, be recognised in the financial statements of the business: as the loan was made specifically for the business and not for the personal use of JB it is a business transaction. (a) ½ to 1 mark per valid point maximum 3 (b) 1 mark per valid point maximum 2 (c) as indicated 9 (d) Non-current assets 1 Current assets 2 Proprietor's capital (detailed, not just as a balancing figure) 2 Current liabilities 1 6 (a) The accruals, or matching, concept requires that the revenue earned in a period is matched with the expenses incurred in earning that profit. Therefore if a payment includes a prepayment for the following period, this must be excluded from expenses in the statement of profit or loss. In other words, costs are recognised on the basis of the period covered by those costs, not by the timing of the payment.

10 8 Final Mock Exam 1: Answers (b) Depreciation is a way of charging for the use of an asset in earning the current period's profits. It spreads the cost of a non-current asset over its useful life. This is an example of the accruals or matching concept. (c) (i) Accrued expenses Electricity (2/3 13,740) 9,160 (ii) (iii) (iv) Prepayment Rent (3/6 57,000) 28,500 Allowance for receivables Allowance Balance required days 54,400 % 10,880 Over 60 days 9,672 Irrecoverable debt (1,3) 8,352 75% 6,264 Allowance required 17,144 Existing allowance 15,800 Increase in allowance 1,344 Accumulated depreciation Balance at 1 April X4 170,800 Depreciation charge for year (179,0 %) 35,840 6,640 (d) CORRECTED STATEMENT OF FINANCIAL POSITION AT 31 MARCH X5 Non-current assets Equipment at cost 350,000 Accumulated depreciation (a(iv)) (6,640) Current assets Inventory 84,678 Trade receivables (W1) 296,158 Prepayment (a(ii)) 28,500 Bank 12, , , ,256 Proprietor's capital (W2) 382,976 Current liabilities Trade payables 173,1 Accrual (c(i)) 9,160 Workings 182, ,256 1 Trade receivables Balance per draft SOFP (net of existing allowance) 298,822 Irrecoverable debt (note 4) (1,3) Increase allowance (c(iii)) (1,344) 296,158

11 Final Mock Exam 1: Answers 9 2 Capital Balance from draft SOFP 402,140 Accrual (9,160) Prepayment 28,500 Irrecoverable debt (1,3) Increase in allowance (1,344) Depreciation (35,840) 382,976 Question 7 Statement of profit or loss and other comprehensive income Revenue ½ Cost of sales 2½ Distribution costs 1½ Administrative expenses 1½ Finance costs 1 Other comprehensive income 1 Statement of financial position Non-current assets 3 Inventory 1 Receivables 1½ Cash ½ Shares ½ Capital surplus 1 Income surplus 1 Loan notes ½ Payables 1½ Interest ½ 11 Presentation 1 8 AT Co STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 JUNE X9 '000 Revenue (14,800 24) (W1) 14,776 Cost of sales (W1) (10,280) Gross profit 4,496 Distribution costs (1, ) (1,422) Administration expenses (1, ) (1,742) Finance cost (2,000 10% 3/12) (50) Profit for the year 1,282 Other comprehensive income Revaluation gains 1,500 Total comprehensive income for the year 2,782

12 10 Final Mock Exam 1: Answers ATOK CO STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE X9 '000 '000 Assets Non current assets Property, plant and equipment (W3) 25,470 Current assets Inventories (W1) 1,566 Receivables (4, ) 4,276 Cash and cash equivalents 160 6,002 Total assets 31,472 Equity Stated capital 18,000 Income surplus 4,422 Capital surplus 4,500 26,922 Non current liabilities 10% loan notes X8 2,000 Current liabilities Trade payables 2,240 Accruals ( ) 310 Total current liabilities 2,250 Total equity and liabilities 31,472 Workings 1 Cost of sales '000 Opening inventory 1,390 Purchases 8,280 9,670 Closing inventories ((1, ) see below) (1,566) 8,104 Depreciation (W2) 2,176 Cost of sales 10,280 Inventory adjustments (i) Lower of cost (80,000) and NRV (90,000,000) = 70,000. Therefore 10,000 (80,000 70,000) adjustment. (ii) Inventory understated by 16,000 Sales overstated by 24,000 2 Depreciation '000 Buildings 2%) 160 Plant %) 2,560 2,7 80% to cost of sales: 2, % to distribution and 10% to administration: Property, plant and equipment '000 Land and buildings (12, ,000 2, ) 17,710 Plant and equipment (12,800 2,480 2,560) 7,760 25,470