Accounting Principles. Question Paper, Answers and Examiner s Comments. Level 3 Diploma June June B/PQP/1 continued

Transcription

1 Accounting Principles Question Paper, Answers and Examiner s Comments Level 3 Diploma June 2014 June B/PQP/1 continued

2 Copyright of the Institute of Credit Management Institute of Credit Management The Water Mill, Station Road, South Luffenham, Oakham, Leicestershire LE15 8NB Bookshop Tel: Education Tel: Switchboard Tel: Fax: June B/PQP/2 continued

3 Accounting Marking Scheme Unit 02 Level 3 Diploma in Credit Management June 2014 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 There was a further improvement on the last exam series with most candidates achieving either a Level 2 or 3 pass. Candidates appear better prepared this time with some very good marks being secured. As with the last series, structure and presentation are definitely on the up especially with regard to the trading and profit & loss accounts (income statements) and balance sheets (statement of financial position). However, there are still instances of woeful practices with regard to the nature, form, structure and content of the final accounts of both incorporated and unincorporated businesses. Those questions that require commentary seem better this time and learners are beginning to realise that the understanding and practical application of accounting principles and practices, from a credit management perspective, are just as impo rtant as the calculations. As with last time, learners are reminded that management accounting does form an integral part of the indicative content and questions on areas such as budgeting and variance analysis can and will appear again in future diets. Questions one, three and eight were by far the most popular. Question six was the least popular and otherwise candidate preferences were equally divided amongst the other four. Questions start on the next page June B/PQP/3 continued

4 1. From the following trial balance, you are to construct a set of final accounts for Rely on Me, a sole trader, for the year ending 31 December DR CR Capital 1 January ,410 Land and buildings 50,000 Office equipment 13,000 Motor vehicles (cost) 28,000 Drawings 10,100 Returns inwards and outwards 1,250 1,000 Carriage inwards 1,150 Carriage outwards 1,240 Stock 1 January ,000 Bank 2,100 Purchases and sales 101, ,250 Motor expenses 3,400 Provision for doubtful debts 440 Provision for depreciation: Land and Buildings 3,400 Office Equipment 2,600 Motor Vehicles 8,600 Sundries 3,160 Wages and salaries 12,300 Debtors and creditors 11,200 9,000 Telephone and insurance 1,800 Bank loan 25,000 Total 249, ,700 Notes as at 31 December 2013: 1. Stock was valued at 9, Depreciation is to be charged as follows: Land and buildings 2% straight-line method Office equipment 12.5% straight-line method Motor vehicles 25% reducing balance method 3. Wages owing 1,200. Insurance in advance Provision for doubtful debts is to be maintained at 5% of debtors. June B/PQP/4 continued

5 TASK Use the trial balance and the accompanying notes to prepare the final accounts of the business for the year ended 31 December (20 marks) Question aims To test the candidate s knowledge and understanding of the form, content and construction of the final accounts of a sole trader taking into consideration adjustments. Suggested answer Trading and Profit & Loss Account for Rely On Me for the year ended 31 December 2013 Sales 144,250 less Sales Returns/Returns Inwards 1,250 less Cost of Sales Opening Stock 10,000 Purchases 101,000 less Purchases Returns/Returns Outwards 1, ,000 add Carriage Inwards 1, , ,150 less Closing Stock 9, , ,650 = Gross Profit 41,350 less Expenses Carriage Outwards 1,240 Motor Expenses 3,400 Sundries 3,160 Wages & Salaries (12, ,200) 13,500 Telephone and Insurance (1, ) 1,500 Depreciation: Land and buildings (2% SLM) 1,000 Office equipment (12.5% SLM) 1,625 Motor vehicles (25% RBM) 4,850 Change in provision for doubtful debts ,395 Net Profit 10,955 June B/PQP/5 continued

6 Working 1: 5% x = = 120 Working 2: 2% x = 1000 PL BS PFD = 4400 Working 3: 12.5% x = 1625 PL BS PFD = 4225 Working 4: = x 25% = 4850 PL PFD = Balance Sheet for Rely On Me as at 31 December 2013 Fixed Assets Cost Acc Dep N.B.V. Land and Buildings 50,000 4,400 45,600 Office Equipment 13,000 4,225 8,775 Motor Vehicles 28,000 13,450 14,550 Current Assets Stock 9,500 Debtors 11,200 less Provision for DD ,640 Prepayments 300 Bank 2,100 91,000 22,075 68,925 Cash 0 22,540 less Current Liabilities Trade Creditors 9,000 Accruals 1,200 10,200 Net Current Assets/WC 12,340 81,265 less Long Term Liabilities Bank Loan 25,000 Net Assets/Net Worth 56,265 Financed By: Capital 55,410 Net Profit 10,955 Less Drawings 10, ,265 June B/PQP/6 continued

7 Final accounts of an unincorporated business continue to be very popular with candidates. This question was answered by the vast majority of candidates and in the main was handled well. As mentioned in the introductory comments, the structure format and presentation of the final accounts is still problematic for a number of candidates. Some learners failed to identify whether sales or purchase returns were either a debit or credit balance taken from the trial balance in the question. The same applied to purchase and sales returns. There was also some confusion with regard to the treatment of carriage in and carriage out. As ever, the calculation and treatment of depreciation in the final accounts proved problematic for a number of students. With regard to the balance sheet (statement of financial position), many students still fail to list current assets and current liabilities in the appropriate order and sometimes confuse accruals and prepayments. Nonetheless, in the main most students who tackled this question secured a meaningful mark. June B/PQP/7 continued

8 2. a) Explain what is meant by the accounting equation and identify the key components of it. (4 marks) b) For each of the following transactions below, you are required to state how each part of the accounting equation is affected. (Ignore VAT). i) The owner of the business introduces 10,000 into the firm by cheque. (2 marks) ii) Bought goods for resale on credit from I Johnson Limited 1,750. iii) Sold goods on credit to J Sullivan for 800. iv) Bought a computer for 1,500 paying by cheque. v) The owner took 500 out of the bank for his own personal use. vi) Bought a machine on credit from J Smith 700. vii) J Sullivan paid part of what she owes 450. viii) The owner of the business arranged a loan for 2,500. (2 marks) (2 marks) (2 marks) (2 marks) (2 marks) (2 marks) (2 marks) Question aims To test the candidates awareness of the content, form and structure of the accounting equation and how various accounting transactions can affect each component of the balance sheet. Suggested answer a) The whole of financial accounting is based on a simple idea called the acc ounting equation. The accounting equation is the basis used to record financial information and it displays what the firm owns on one side of the equation (assets, which can be fixed or current) and the funding used to purchase these assets on the other s ide (liabilities, which can be short or long-term). The three components are assets, liabilities and capital. This manifests itself in the balance sheet. June B/PQP/8 continued

9 b) Learners might offer their answer in a table such as below: Assets Liabilities Capital i) + 10,000 Bank + 10,000 ii) iii) iv) + 1,750 Stock Stock Debtors (J Sullivan) + 1,500 Computer - 1,500 Bank + 1,750 Creditors (I Johnson) v) Bank Drawings vi) vii) Machine Bank Debtors (J Sullivan) Creditors (J Smith) viii) + 2,500 Bank + 2,500 Loan Alternatively, learners might take each transaction and record it thus: i) + 10,000 Bank (Assets) and Capital ii) + 1,750 Stock (Assets) and Creditors (I Johnson) (Liabilities) iii) Stock (Assets) and Debtors (J Sullivan) (Assets) iv) + 1,500 Computer (Assets) and - 1,500 Bank (Assets) v) Bank (Assets) and Drawings (Capital) vi) Machine (Assets) and Creditors (J Smith) (Liabilities) vii) Bank (Assets) and Debtors (J Sullivan) (Assets) viii) + 2,500 Bank (Assets) and + 2,500 Loan (Liabilities) The majority of candidates who attempted this question could define and explain t he key components of the accounting equation and offered some apt examples of each of the categories in part a). Some though spent much time detailing expenses and revenues which was not required for the answer. There were some problems with part b) where students were asked to explain how each transaction could affect the various sections of the balance sheet. Marks were primarily available for demonstrating the effects of each transaction in terms of an increase or a decrease on the component elements of the accounting equation, namely assets, liabilities and capital. Many unfortunately offered a commentary on the double entry processes, identifying which accounts would be debited or credited, which totally missed the essence of the task. June B/PQP/9 continued

10 3. The accounts of TLC as at 31 December 2013 include the following balances. Purchases 4,575 Sales 6,575 Discount allowed 90 Discount received 90 G Gillies (supplier) 14,950 C Bradshaw (customer) 12,790 Bank overdrawn 1,500 VAT (owed by HM Revenue & Customs) 300 Sales returns 1,800 Purchases returns 2,800 The following transactions are amongst those which have taken place at TLC during January Jan 1 Jan 3 Jan 6 Jan 16 Jan 17 Jan 19 Jan 20 Jan 24 Jan 25 A cheque for 11,950 was received from C Bradshaw in full settlement of his account; the remaining is to be treated as a discount. A credit note for 3,600 including VAT was received from G Gillies in respect of returned goods. A sale of 1,200 including VAT was made to PS Limited, who paid by cheque. A cheque for 10,750 was sent to G Gillies in full settlement of his account. The balance remaining is to be treated as a discount. Invoice received from G Gillies for stock 1,750 plus VAT. A sales invoice for 3,750 including VAT was sent to C Bradshaw. TLC purchases a machine for 2,900 plus VAT which is paid for in full by cheque. (VAT can be reclaimed on this machine). The owner of TLC, Billy, takes 200 out of the bank for his own personal use. The firm pays what it owes to HM Revenue and Customs. TASK a) Open all the accounts that are necessary to record the above transactions and enter the balances brought forward from the previous accounting period. (5 marks) b) Post the necessary entries in the relevant accounts to record transactions ensuring that you account correctly for any discounts or VAT. (15 marks) June B/PQP/10 continued

11 Question aims To test the candidate s ability to: Complete and correctly account for VAT, Sales, Purchases and Returns. Post entries from Purchases and Sales invoices and credit notes to their relevant accounts in the Sales, Purchase and General Ledger. Currently open individual Ledger accounts with given balances and make relevant entries to record transactions. Correctly complete and calculate VAT -related transactions. Suggested answer Account: Purchases Date Details DR CR Balance 01/01/14 Bal b/f 4,575 17/01/14 G Gillies 1,750 6,325 Account: Sales Date Details DR CR Balance 01/01/14 Bal b/f (6,575) 06/01/14 Bank (1,000) ½ (7,575) 19/01/14 C Bradshaw (3,125) ½ (10,700) Account: Discount allowed Date Details DR CR Balance 01/01/14 Bal b/f 90 01/01/14 C Bradshaw Account: Discount received Date Details DR CR Balance 01/01/14 Bal b/f (90) 16/01/14 G Gillies (600) (690) Account: G Gillies Date Details DR CR Balance 01/01/14 Bal b/f (14,950) 03/01/14 Purchase R 3,600 (11,350) 16/01/14 Bank 10,750 (600) 16/01/14 Discount R 600 Nil 17/01/14 Purchase (2,100) (2,100) Account: C Bradshaw Date Details DR CR Balance 01/01/14 Bal b/f 12,790 01/01/14 Bank (11,950) ½ /01/14 Discount A (840) ½ 0 19/01/14 Sales 3,750 3,750 June B/PQP/11 continued

12 Account: Bank Date Details DR CR Balance 01/01/14 Bal b/f (1,500) 01/01/14 C Bradshaw 11,950 10,450 06/01/14 Sales 1,200 11,650 16/01/14 G Gillies (10,750) /01/14 Machine (3,480) (2,580) 24/01/14 Drawings (200) (2,780) 28/01/14 Revenue & Customs (195) (2,975) Account: VAT Date Details DR CR Balance 01/01/14 Bal b/f /01/14 G Gillies (600) (300) 06/01/14 Sales (200) (500) 17/01/14 G Gillies 350 (150) 19/01/14 C Bradshaw (625) (775) 20/01/14 Machine 580 (195) 25/01/14 Bank 195 Nil Account: Sales returns Date Details DR CR Balance 01/01/14 Bal b/f 1,800 Account: Purchases returns Date Details DR CR Balance 01/01/14 Bal b/f (2,800) 03/01/14 G Gillies (3,000) (5,800) Account: Machine ½ Date Details DR CR Balance 20/01/14 Bank 2,900 2,900 Account: Drawings Date Details DR CR Balance 24/01/14 Bank A very popular question, as ever. Most candidates had no trouble opening the individual accounts with an opening balance, but unfortunately, as in previous examinations, some struggled to differentiate between debit and credit balances in part a). Some failed to identify (by using brackets) whether these were debit or credit entries thus making the closing balance incorrect, forfeiting valuable marks. As a guide, whilst brackets are not critical when entering transactions to the Cr column (a credit transaction is assumed), they are vital in the balance column to determine whether candidates believe the running balance to be a debit balance or a credit balance. June B/PQP/12 continued

13 In the main, posting individual transactions to the ledgers was well handled in part b, although double entry for drawings and the acquisition of a fixed asset by a cheque payment caused a few problems for a number of candidates. Also in some cases, presentation and format could have been better, and descriptions of the transaction, which invariably should be the name of the other account involved in the double entry, were wayward. There were, however, some very good answers and in many cases full or near full marks were awarded. June B/PQP/13 continued

14 4. a) What is the significance of the working capital cycle (cash operating cycle) for the credit manager? (6 marks) b) i) Using the following accounting information, calculate the cash operating cycle for the two years. (8 marks) ii) Evaluate your findings with regard to the performance of XYZ Limited. (6 marks) Balances extracted from the ledgers of XYZ Limited 31 December December 2013 Sales 940,000 1,400,000 Opening stock 48,000 68,000 Closing stock 62, ,000 Purchases 780, ,000 Debtors 97, ,000 Creditors 51,000 91,000 Bank 101, ,000 Fixed assets 350, ,000 Question aims To test the candidate s knowledge and understanding of the three efficiency ratios as applied to the cash operating cycle. To assess the candidates application of the above in his/her assessment of the credit worthiness of a fictitious company. Suggested answer a) The significance of the cash operating cycle is that it is the time period that elapses between buying stock and finally receiving payment from customers. The important point about the cycle is the period of time that has to be funded before payment from debtors is received. A short cash operating cycle is an indication of an efficient organisation in managing its working capital. A credit manager would like to see as short a cycle as possible, taking into account the relevant agreed credit terms, if known. Cash has to be received from debtors before it can be used to pay creditors and if stock is being held for too long and not sold quickly, and then cash is tied up unnecessarily. June B/PQP/14 continued

15 Workings for b) Trading Profit & Loss Account year ended 31 December 2012 Sales 940,000 Less cost of sales Opening stock 48,000 Purchases 780, ,000 Closing stock 62, , ,000 Trading Profit & Loss Account year ended 31 December 2013 Sales 1,400,000 Less cost of sales Opening stock 68,000 Purchases 880, ,000 Closing stock 114, , ,000 Ratios Stock Turnover Average stock x 365 Cost of sales [where Average Stock = (OpSt + ClSt)/2] Debtor Days Debtors x 365 Sales Creditor Days Creditors x 365 Purchases Working Capital Cycle Debtor Days + Stock Turnover Creditor Days June B/PQP/15 continued

16 i) Stock Turnover 55,000 x 365 = 26 days 91,000 x 365 = 40 days 766, ,000 Debtor Days 97,000 x 365 = 38 days 177,000 x 365 = 46 days 940,000 1,400,000 Creditor Days 51,000 x 365 = 24 days 91,000 x 365 = 38 days 780, ,000 Working Capital Cycles = 40 days = 48 days Stock Turnover Debtor Days Creditor Days Working Capital Cycles If closing stock figures is used, stock turnover for 2012 will be 30 days and 2013 is 50 days. This will make the cash operating cycle for days and for days. ii) Stock turnover is the number of days it takes to buy and replace stock. It measures the rate at which stock is sold. If stock is not selling quickly enough then cash is being tied up, so the organisation cannot buy more stock or pay other expenses. There has been an adverse movement from 2012 to 2013, which needs to be addressed. Why is stock not being sold, e.g. poor quality, poor marketing, and greater competition? Debtor days is the average number of days taken to collect payment from debtors. It is important that debtors pay to term. There are two important reasons for this: First, the longer the debt is owed, the more likely it will become a bad debt Second, any payment of money can be used in the firm as soon as it is received to increase profitability and reduce expenses such as overdraft and interest charges. Again, this has shown an adverse movement which requires investigation. Credit control needs to be approached how does XYZ Ltd assess risk, how does it collect overdues, why has this trend occurred, etc. Creditor days measure the number of days taken on average to pay suppliers. This will depend on the credit terms given to the firm by its suppliers. The firm is now taking longer to pay its suppliers which will help their own cash flow. Firms should take full advantage of credit terms, without jeopardising its relationship with the supplier. To pay creditors early reduces cash resources which can be used for other purposes, and increases overdraft and interest charges. To pay creditors too late might lead to credit terms being removed and possibly litigation. June B/PQP/16 continued

17 Cash operating cycle has worsened by 8 days, in part caused by the adverse movement in the stock turnover period and debtor days. Consequently, XYZ now has to find and pay for finance to cover these extra days having an adverse effect upon liquidity. The firm might have to resort to increasing its overdraft, which is expensive. This has been mitigated by the increase in creditor days, but this might in part be due to XYZ s own invoices not being paid to term and their having to request extended terms from their suppliers. Learners might make reference to working capital, current ratio and the acid test ratio, and if in context, should be awarded marks. Some good responses here though some candidates did misinterpret part a) with regard to the significance of the cash operating cycle for the credit manager and gave a wider commentary on working capital generally, which was not the set task. Many could detail its key components but failed to identify what the credit manager could glean from the statistic. The majority of candidates correctly computed appropriate ratios in part b i) (and since a calculation was required, no credit could be given for a prose commentary), though some could not offer an appropriate summary about the ratios calculated from a liquidity and efficiency standpoint in part b ii). June B/PQP/17 continued

18 5. As a recently qualified MICM(Grad) you have been asked to provide a talk at your local branch with regards to accounting concepts. In particular, the delegates have requested that you highlight the difference between, and (where appropriate) the accounting treatment of, the following: a) Revenue and capital expenditure. (5 marks) b) The straight-line and reducing-balance methods of depreciation. (5 marks) c) Bad debts and the provision for doubtful debts. (5 marks) d) Internal and external audit. (5 marks) Question aims To assess the student s appreciation, knowledge and understanding of the distinction between several different accounting concepts and procedures and how they are treated in the final accounts. Suggested answer a) Capital expenditure is expenditure on the purchase of fixed assets or of additions to existing fixed assets. Examples include motor vehicles, premises, plant, equipment, machinery and computers. It is important also to note that items such as the cost of acquiring a fixed asset, the cost of its delivery, legal (e.g. licences to use and installation costs and demolition costs to remove obsolete buildings before new work can begin) all constitute capital expenditure. The benefit from the cost lasts more than one year. Revenue expenditure on the other hand is the costs involved in the day -to-day running of a business. Examples include: purchases, salaries, rent, rates and insurance. Revenue expenditure is expenses, a cost of running the business. The benefit from this cost of expenditure is that it will be less than one accounting year; it has no lasting value so it is fully charged to the current financial year. With regard to the accounting treatment of capital expenditure it is important to note that fixed assets have a useful economic life spread over a number of financial years. As fixed costs will be used by the business to hopefully generate profits for a number of years, the full cost of the asset is not charged to the profit and loss account in the year it was purchased. The treatment of the cost of a fixed asset is that a proportion of the original cost is set against the profits each year of the life of the asset, i.e. it is depreciated. Revenue expenditure on the other hand is classed as an overhead/expense in the profit and loss account and has the effect of reducing the profit for the year. b) The straight-line method of depreciation charges an equal amount to the profit and loss account each year, based on the cost of the asset, its expected useful life and any disposal value that the asset might have. The formula for calculating the annual amount to be account ed for is: Original cost expected value on disposal / number of expected years of life. June B/PQP/18 continued

19 Under the reducing balance method of depreciation, a set percentage of the original cost is charged to profit and loss. In the second and subsequent years, the same percentage is charged on the depreciated value of the asset as at the end of the preceding year. A simple example can illustrate these: ABC Limited buys a machine for 8,000. It will be kept for use for 4 years and will be sold for scrap for 500. The reducing balance percentage is 50%. For the straight-line method the depreciation is calculated by: 8, = 7,500 / 4 = 1,875. Method 1 Method 2 Straight-line Reducing balance Cost 8,000 Cost 8,000 Depreciation Year 1 1,875 50% of 8,000 4,000 6,125 4,000 Depreciation Year 2 1,875 50% of 4,000 2,000 4,250 2,000 Depreciation Year 3 1,875 50% of 2,000 1, ,000 Depreciation Year 4 1,875 50% of 1, For both methods, the accounting treatment is the same. The profit and loss account is charged with one year s depreciation as an expense. In the balance sheet, the overall value of the fixed asset will be reduced each year by the depreciation charge. Each year the balance sheet will show the original cost of the asset less the total amount of depreciation to date and the current value of the asset after the depreciation. The latter figure is known as the net book value. Some students might make reference to the fact that some fixed assets are better suited for a particular type of depreciation. For instance, vehicles are often charged on a reducing balance method whilst fixtures and fittings might be better served by using the straight-line method. c) A bad debt is an amount owed by a specific customer whose debt is not going to be paid due to insolvency or that the customer has gone away. The debt is unlikely to be paid and the decision must be made to write off the amount due as a bad debt. It might be the case that it is believed that some customers may not pay the amount that is due but there is some element of uncertainty as to which customers and how much, if at all, will be paid. In this case, a provision for doubtful debts is made. This is a general provision against debts arising in the future. The accounting treatment of the former is when it becomes clear that the particular customer is not going to pay, the amount should be written of in the debtor s account in the sub-ledger and the account closed. The debtor s account is credited and the bad debt account is debited to show an expense. June B/PQP/19 continued

20 With the latter scenario, the organisation provides an estimate of amounts that may or may not be collected from the outstanding debtors total. To create the provision in the first instance, the procedure is to debit the profit and loss account with the amount of the provision as an expense and credit the provision for doubtful debts account in the general ledger which is deducted from debtors in the balance sheet. d) Internal auditors are employees of the organisation in question, though the function can be outsourced. Appointed by senior management, their brief is to provide an independent appraisal of the company s internal financial control systems. They also evaluate the information supplied by management to see whether it is reliable and complete, and review the implementation of management policies. The findings of the internal auditor are similar to those of an external auditor but there is no statutory requirement. External auditors independently examine the evidence from which the final accounts of a company are derived in order to give an opinion as to whether they show a true and fair view of the financial affairs of a company. Whereas internal auditors are responsible to management, external auditors are appointed and responsible to shareholders. External audits are also required by law, unless the company can and does claim a statutory exemption. Answers to this question were generally quite good with some very high marks being awarded in some instances. Most could explain the distinction between the two types of expenditure but a number failed to identify the accounting treatment in both instances with regard to profit and loss and the balance sheet. The two methods of depreciation were handled generally well, although only a minority displayed how each one was calculated which would have enhanced responses greatly. With part c), the majority of candidates detailed the differences between the two accounting concepts and came up with some very good responses. Their commentary on the accounting treatment was lacking in many cases though. The distinction between an internal and external audit in part d) was tackled well though there was a little confusion about the significance of the former with regard to final published accounts. June B/PQP/20 continued

21 6. Smith and Jones plc have been trading for a number of years. The following balances have been extracted from the ledger accounts. Prepayments 25,000 Plant and equipment 250,000 Plant and equipment: Provision for depreciation 40,000 Vehicles 200,000 Vehicles: Provision for depreciation 30,000 12½% debenture 100,000 Debtors 95,750 Creditors 60,750 Bank (overdrawn) 80,000 Cash 15,000 Retained profit (amended exemplar figure) 125,000 Stock ,000 Issued share capital ( 1 shares) 150,000 Interim dividend for year 20,000 5% 1 preference shares 100,000 Operating profit before tax for the year end ,000 Notes to the accounts: 10% corporation tax is due An ordinary share dividend of 15% is declared before the year end The preference share dividend of 5% will be paid after the year end. TASK a) Starting with profit before tax and using the notes to the accounts, prepare a Retained Profit Reconciliation for Smith and Jones plc and a Balance Sheet (Statement of Financial Position) as at 31 December (14 marks) b) What information can be gleaned from the Director s Report which will be of use to the credit manager? (6 marks) Question aims To test the candidates knowledge and understanding of how to construct a retained profit reconciliation note and a balance sheet. To test the candidates appreciation of the importance of the Directors Report and the information that might be of use to a credit manager. a) Retained Profit Reconciliation Balance brought forward 01/01/2013 (amended exemplar figure) 125,000 Profit for the year* 72,000 Preference share dividend w2 (5,000) Ordinary share dividend w3 (22,500) Interim share dividend (20,000) Profit retained 31/12/ ,500 June B/PQP/21 continued

22 *Profit for the year calculated as follows: Operating profit before tax 31/12/ ,000 Corporation tax w1 ( 8,000) Profit for the year 72,000 Workings W1 80,000 x 10% 8,000 W2 100,000 x 5% 5,000 W3 150,000 x 15% 22,500 Balance Sheet (Statement of Financial Position) for Smith and Jones plc as at 31/12/2013. Fixed assets Cost Acc Dep N.B.V. Plant and equipment 250,000 40, ,000 Vehicles 200,000 30, ,000 Current assets Stock 160,000 Debtors 95,750 Prepayments 25,000 Cash 15, , ,000 Less current liabilities Creditors 60,750 Bank overdraft 80,000 Corporation tax 8,000 Dividends 27, ,250 Net current assets/working capital Less long-term liabilities 119, ,500 12½% debenture 100,000 Net assets (worth) 399,500 Financed by capital and reserves Issued share capital 150,000 5% preference shares 100,000 Retained profit 149, ,500 June B/PQP/22 continued

23 b) The Directors Report will contain the following information: A review of the year s business activities, and the major developments of the company and its subsidiaries during the financial year. This will show the credit manager how the business considers it is performing overall. The company s financial position at the end of the year including any changes to the capital structure. This will indicate the overall capitalisation of the business and its stability. Details of any substantial shareholders. This will indicate whether people think the company is worth investing in. Also details of any acquisitions by the company. Major developments which may affect future performance and results, and any post balance sheet events. Supplier statement policy which is a statement of how many days the company takes to pay its supplies. This is very useful for the credit manager as this indicates how quickly the organisation is paying its trade creditors. An indication of any research and development carried out by the company. This is a sign as to how the senior management team see its strategic plan. Names of directors and details of their interest in shares and debentures of the company. This indicates the interest the management have in the organisation s future performance. Not a popular option with candidates. This was surprising because statutory final accounts of incorporated businesses continue to be an integral part of the syllabus and is sure to be examined in future exam series. The retained profit reconciliation in part a) caused problems with many which may in part be due to its recent inclusion to the syllabus although it is not dissimilar in content to the old appropriation account. Some students subtracted debenture interest from the profit figure which was not strictly speaking required from an operating profit figure and there was some confusion with regard to the treatment of the already paid interim dividend. Consistency of approach was recognised in the marking process. In the balance sheet, structure, format and presentation were lacking in some cases and the content of current assets and current liabilities was rather indifferent in some instances. June B/PQP/23 continued

24 7. a) Why do businesses need to prepare cash budgets? (6 marks) Given below are the budgeted and actual cash flows for the month of June. Actual Budget Cash sales 12,800 18,000 Capital expenditure 28,000 0 Payments to creditors 41,000 33,400 Receipts from debtors 55,600 68,000 Production wages 7,200 7,200 Administration costs 4,200 4,000 Net cash flows (12,000) 41,400 Opening cash balance 6,400 6,400 Closing cash balance (5,600) 47,800 b) Explain the key differences between the budgeted and actual cash flows for June. (6 marks) c) What could this company have done to avoid the closing credit balance at the bank? (8 marks) Question aims To test the candidates understanding of the purpose of cash budgets and how to identify differences in actual and planned cash flows, and offer solutions. Suggested answer a) Firms need to know the timing and level of expected cash flows both in and out of the business. Expenditure then can be allocated for those times where cash is expected to be available, reducing the necessity for potentially expensive short-term borrowing to satisfy working capital arrangements. If a cash shortage is highlighted, steps can be taken to arrange an overdraft facility or, if one is already in existence, to increase it. Alternatively the business might be able to transfer funds from somewhere else. The cash budget will be drawn up from information contained in other budgets, such as the sales budget which highlights mainly sales revenue flows. Other budgets will indicate the cash requirements needed to cover the firm s operating costs such as wages, raw materials, fuel, power and other general expenses. It is important that organisations know when cash is paid out or received. June B/PQP/24 continued

25 b) Cash sales for the organisation are lower than expected which has an impact upon the volume of incoming cash. There is a significant payment for the purchase of a fixed asset which was not planned for in advance in this accounting period. Receipts from debtors are considerably less than has been originally budgeted for, suggesting slack credit control and/or lower than budgeted credit sales in previous periods. Payments to creditors are higher than has been budgeted for, suggesting higher than anticipated stock purchases in the recent past, or unplanned for increases in the price of new stock. Taken together, more cash is going out of the business than was planned for, creating an overall negative cash balance and presumably a bank overdraft situation at the end of the month. c) Solutions to this situation could include: Better credit control to make more customers pay to terms. This would feature better planning and collection procedures. Perhaps also the original credit risk assessment was not as thorough as it should have been. Delaying payments to creditors or arranging longer credit terms with their suppliers. The purchase of the fixed asset was not planned in this accounting period. Why was this? Was the purchase planned in a different accounting period, or the payment made in a different one than planned? If the expenditure had to take place, the organisation might have considered other methods of funding such as a loan (long-term) or entering into a leasing arrangement. Hire purchase might also have been an alternative. Many students could identify the content and form of cash budgets in part a) but many failed to describe their practical use with regard to the timing of cash flows and how this information can flag up any contingencies with regard to cash shortages and surpluses. In part b), most candidates could desc ribe and offer some explanation with regard to actual and planned cash flows cited in the question. The emphasis upon the interpretation of the cause of budgetary differences should be noted, e.g. potential reasons why sales ledger receipts were lower than anticipated, consequently areas of response concerning incorrect budget forecasts did not score well. Part c) caused some problems with only a few offering a detailed argument as to how the overall adverse variance could have been avoided. June B/PQP/25 continued

26 8. a) Explain briefly the principal reasons for constructing a trial balance. (4 marks) b) The following balances have been extracted from the books of L Smith as at 31 December 2013: Capital on 1 January ,149 Freehold factory at cost 360,000 Motor vehicles at cost 126,000 Stock at 1 January ,500 Debtors 15,600 Cash in hand 225 Bank overdraft 82,386 Creditors 78,900 Sales 318,000 Purchases 165,000 Rent and rates 35,400 Discounts allowed 6,600 Insurance 2,850 Sales returns 10,500 Purchase returns 6,300 Loan from bank 240,000 Sundry expenses 45,960 Drawings 26,100 Prepare a trial balance for the year ended 31 December (10 marks) c) Outline, using specific examples, three types of error that might not be revealed by a trial balance. (6 marks) Question aims To test the candidate s: Ability to identify the principal reasons for constructing a trial balance. Knowledge and understanding of the different types of error that might not be picked up by a trial balance. Ability to construct a trial balance from given or prepared financial records and information. Suggested answer a) The trial balance checks the arithmetical accuracy of the double entry in the ledger. It is important to note that if two entries of equal value are made, one debit and one credit for every transaction, then the sum of all the debit entries must equal the sum of all the credit entries. Another reason for drawing up a trial balance is to provide the information required for the preparation of the final accounts. The trial balance is a formal statement of the balances, or total, of every account in all the ledgers nominal, sales and purchases. It must also include the balances from the cash book and petty cash book. June B/PQP/26 continued

27 b) Trial Balance for L Smith as at 31/12/13 Account Dr Cr Capital on ,149 Freehold Factory 360,000 Motor Vehicle 126,000 Opening Stock 37,500 Debtors and Creditors 15,600 78,900 Cash in Hand 225 Bank Overdraft 82,386 Purchases and Sales 165, ,000 Rent and Rates 35,400 Discounts Allowed 6,600 Insurance 2,850 Sales and Purchases Returns 10,500 6,300 Loan from Bank 240,000 Sundry Expenses 45,960 Drawings 26,100 TOTAL 831, ,735 c) Any three from: Error of commission which arises when the double entry has been entered into the wrong account. Error of principle which arises when the double entry is arithmetically correct, but the amount has been entered in the wrong account. Error of omission when a transaction has not been entered into an account at all. Error of original entry when the wrong figure is taken from the source document and then recorded in both ledger accounts. Complete reversal of entries here the correct figure has been entered into the correct accounts, but on the wrong sides, e.g. entering a cash sale as Dr: Sales and Cr: Cash. Compensating error when two or more errors of the same amount cancel each other out. Well answered in the main. The vast majority of candidates could explain the purposes of a trial balance though some did lack detail in their responses. Many candidates could extrapolate the various balances and post them to a trial balance though there were some who could not identify some of the more well-known balances as being debits or credits, which is a little worrying. June B/PQP/27 continued

28 Nevertheless full marks were often awarded for part b). The vast majority of students clearly identified the type of errors that would not be identified by a trial balance. ---o0o--- June B/PQP/28