SUBJECT NO 15J FINANCIAL ACCOUNTING PILOT PAPER The examination paper is divided into TWO Sections. Section A is compulsory and carries 40 marks. Candidates should attempt THREE questions from Section B, all of which carry 20 marks each. You should allow yourself approximately 70 minutes in total to answer the questions in Section A, and 35 minutes for each of the questions attempted in Section B. SECTION A (Compulsory answer all parts of this question) Time allowed: 3 hours 1. (a) Explain the nature and purpose of the auditor s report. (4 marks) Distinguish between the capital maintenance concepts on which the following three accounting models are based: historical cost accounting (HCA); current purchasing power accounting (CPP); and current cost accounting (CCA). (4 marks) (c) FRS 18 entitled Accounting Policies was issued by the Accounting Standards Board in December 2000. Identify and explain the purpose of the two underlying accounting concepts covered by this standard. (4 marks) (d) The need for regulations is driven by the inability of the market to ensure adequate accountability from corporate management. Explain why the provision of accounting information does not accord with perfect market assumptions. (4 marks) (e) The following information is provided for Lackore Ltd. Year to 31 December 20X1 Operating profit after charging depreciation of 200,000 620 and crediting a profit on the sale of temporary investments of 420,000 Balances at 31 December 20X0 20X1 Debtors 281 242 Creditors 316 216 Stocks 175 375
Calculate the cash flow from operating activities of Lackore Ltd, based on the above information, and explain briefly its significance. (4 marks) f) Define what is meant by the term impairment and explain the circumstances in which an impairment review must take place. (4 marks) g) State the basic rule for the valuation of stock and apply it to the following information provided in respect of a group of items of stock belonging to Crane Ltd: Item of Stock Cost Selling price Selling costs I 300 380 20 II 240 270 35 III 470 600 31 IV 760 600 16 (4 marks) h) The directors of Middon plc, which makes up its accounts on the calendar year basis, announced the decision to restructure one of its divisions on 30 September 20X1. The main changes were to occur at its Morganstown factory resulting in the redesign of its production line at a cost of 4 million and redundancy costs due to reduced staffing requirements of 2.1 million. The plan is expected to be implemented by 31 March 20X2 and agreement from relevant trade unions and employees has been obtained. You are required to explain whether any provision for restructuring should be recognised in the accounts for 20X1. (4 marks) (Note: Ignore the time value of money) i) Overseas plc opened a bank account in Australia on 1 January 20X1 by acquiring and depositing A$1,000,000 which remained in the account at 31 December 20X1. During 20X1, the exchange rate moved from A$2.5= 1 to A$2= 1. Compute the change in the sterling value of the cash held in the Australia account and comment on the result. (4 marks) j) The following information is provided for Uzzell Ltd which enters into purchase and sale transactions entirely on a credit basis. Year to 31 December 20X1 Sales 1,500 Purchases 700 Cost of goods sold 710 Balances at 31 December 20X1 Debtors 250 Creditors 105 Stocks 140
Calculate the cash operating cycle (i.e. the time lag between making payment to suppliers and collecting cash from customers) of Uzzell Ltd, based on the above information, and explain briefly its significance. Notes: Assume a 360-day year for the purpose of your calculations and that all transactions take place at an even rate. (4 marks) (Total: 40 marks) SECTION B (Answer THREE questions from this Section) 2. Wadebridge plc is a listed company that operates a range of separate activities organised on a divisional basis. The following information relates to its group results for the year to 31 March 20X1: (i) m Sales 1,700 Cost of sales 920 Sale of land and buildings 350 Book value of land and buildings sold 300 Operating costs 274 Proposed dividend 350 (ii) (iii) The company sold one of its divisions during the financial year with the result that it had completely withdrawn from that business sector on 31 March 20X1. The division was sold for exactly the amount at which its related net assets were carried in the books, and so neither a profit nor a loss resulted from the sale. The operating results of that division from 1 April 20X0 to the date of disposal, included in i above, were: m Sales 320 Cost of sales 240 Operating expenses 155 On 1 April 20X0 the company purchased the entire share capital of Hollywell Ltd. The results for the year to 31 March 20X1, included in i above, include the following in respect of this acquisition: m Sales 422 Cost of sales 265 Operating expenses 105 (iv) The land and buildings disposed of during the year (see i above) had cost 165 million in 19X3 and had been revalued to 355 million in 19X8. This was the only asset the company had ever revalued, and the balance on the revaluation reserve at 1 April 20X0 amounted to 190 million.
(v) (vi) When preparing the accounts for the year to 31 March 20X1, it was discovered that an error had been made in the published accounts for the previous year. A debit balance of 27 million had been included in the balance sheet as cash, when in fact the balance related to obsolete stock. The figure for shareholders funds at 31 March 20X0 was 1,257 million. On 1 March 20X1, the company learned that one of its customers had been unexpectedly placed in liquidation. As a result of this development Wadebridge plc was likely to suffer an abnormally large bad debt of 26 million which is not included in the figures given under 1 above. Required: (a) Prepare, in accordance with the requirements of FRS3 entitled Reporting financial performance, the following financial statements for the Wadebridge plc group of companies for the year to 31 March 20X1: the profit and loss account the reconciliation of movement on shareholders funds You should include any note to the accounts that you consider appropriate. (12 marks) Discuss the role of FRS 3 is assisting shareholders generally, and those of Wadebridge plc in particular, to assess the likely future results of their company. (8 marks) 3. The balance sheet of Falmouth plc at 1 January 20X1 contained the following information Balance Sheet of Falmouth plc at 1 January 20X1 Fixed assets 8,600 Current assets 6,200 Creditors falling due within one year -2,400 Total assets less current liabilities 12,400 12% Debentures -4,000 8,400 Shareholders equity 8,400 Falmouth plc entered into an arrangement with Monetary plc to lease an item of plant for its entire expected useful life of four years commencing 1 January 20X1. The lease contract provides for an initial payment of 2 million on 1 January 20X1 and three further annual payments of the same amount on 1 January each year. The plant can be purchased for cash, 6,976,000, and the interest rate implicit in the lease is 10%. The company applies straight-line depreciation to all its fixed assets and assumes a zero residual value at the end of their useful life.
Required: (a) Prepare revised balance sheets for Falmouth plc as at 1 January 20X1 that take account of the lease arrangement entered into with Monetary plc on the separate assumptions that it should be accounted for as: (i) an operating lease (ii) a finance lease (6 marks) Show how, if at all, the lease arrangement should be reflected in the profit and loss account of Falmouth plc for the year ended 31 December 20X1 and the balance sheet at that date on the separate assumptions that it should be accounted for as: (i) an operating lease (ii) a finance lease (7 marks) (c) Compare and contrast the methods of accounting for leases illustrated by your calculations under (a) and paying particular attention to the concept of substance over form and the effect on the gearing ratio. (7 marks) Note: Calculations to nearest. 4. The following is the balance sheet, as at 20 November 20X1, of Ramsey Ltd which is a company that has suffered a succession of operating losses in recent years. Balance Sheet at 20 November 20X1 Goodwill at book value 225 Freehold properties at book value 300 Plant and machinery at book value 900 1,425 Current assets Stock 780 Trade debtors 420 1,200 Creditors: amounts falling due within one year Bank overdraft 30 Preferential creditors 255 Trade creditors 1,200 1,485 Net current liabilities -285 1,140 Financed by: Share capital ( 1 ordinary shares) 1,200 Accumulated losses -60 1,140
The following reconstruction scheme has been prepared by the directors for approval by the company s shareholders and creditors (i) Goodwill to be written off and the remaining assets to be restated at the following amounts: Freehold properties 885 Plant and machinery 60 Stock 510 Trade debtors 270 (ii) (iii) (iv) A loan of 300,000 to be received from a major supplier. The loan is to carry interest at the rate of 10% per annum. The existing 1 ordinary shares to be reduced in value to shares with a nominal value of 20 pence each, to then be consolidated into new ordinary shares of 1 each. One quarter of the trade creditors, by value, to receive 300,000 new shares of 1 each in exchange for the amount due to them. Required: (a) A revised balance sheet for Ramsey Ltd assuming the reconstruction scheme is put into effect. (7 marks) Your assessment of complaints from the existing ordinary shareholders that they are being unfairly required to suffer the entire loss arising from the reconstruction. (8 marks) (c) Calculations of the amounts receivable over each of the next three years by the existing shareholders, assuming the entire profits attributable to shareholders are paid out in dividends. Operating profits are estimated to be: Year 1, 30,000; Year 2, 90,000; Year 3, 150,000. Briefly comment on your findings. (5 marks) Notes: Ignore taxation Assume all calculations are made on 20 November 20X1 and that the proposed scheme can be given immediate effect. 5. On 1 January 20X1, Bexhill Ltd, a newly established company, raised capital of 3,000,000 from the issue of 3,000,000 1 ordinary shares issued at par. On the same date it acquired the following shareholdings: Waterhall Ltd: 800,000 shares of 1 each, fully paid, for 1,000,000 Crowborough Ltd: 2,160,000 shares of 1 each, fully paid, for 1,440,000 Hollingbury Ltd: 100,000 shares of 1 each, fully paid, for 560,000
The following are the summarised draft balance sheets as on 31 December 20X1 of the companies in which shareholdings were acquired: Waterhall Crowborough Hollingbury Freehold property 440 820 1,300 Plant 320 600 240 Stock 200 580 420 Debtors 70 220 500 Owed by Crowborough Ltd 20 - - Cash at bank 30 40 70 1,080 2,260 2,530 Share Capital: ordinary shares of 1 each 800 2,400 2,000 Profit and loss account 180-400 450 Owed to Waterhall Ltd - 20 - Trade creditors 100 240 80 1,080 2,260 2,530 The following information is relevant: (i) No entries have been made in the books of Waterhall Ltd to reflect the fact that the market value of the property owned by that company, at 1 January 20X1, was 430,000; at that date its book value was 350,000. Additional depreciation of 20,000 for 20X1 is needed to reflect this revaluation. Other than as detailed in this note, the balance sheets of the companies given above reflected the fair values of all the assets and liabilities at 1 January 20X1. (ii) On 31 December 20X1, Waterhall Ltd paid, in cash, a dividend of 100,000 to Bexhill Ltd. (iii) The balances of retained profits on 1 January 20X1 (acquisition date) were: Waterhall Ltd 40 (credit) Crowborough Ltd 300 (debit) Hollingbury Ltd 80 (credit) (iv) Bexhill Ltd does not take an active involvement in running the companies in which it invests unless they are subsidiary companies. Required: (a) Prepare the balance sheet of Bexhill Ltd as at 31 December 20X1 (5 marks) Prepare the consolidated balance sheet of Bexhill Ltd and its subsidiary companies as at 31 December 20X1. (12 marks) (c) Explain your treatment of the results of Hollingbury Ltd when preparing the group accounts. (3 marks) Note: Ignore amortisation of any goodwill arising on consolidation
6. (a) Discuss the nature and purpose of accounting ratios (5 marks) Identify five accounting ratios that may be used to assess the solvency and financial stability of a company. Give the formula to be used for the calculation in each case. (5 marks) (c) Identify and discuss five limitations of ratio analysis. (10 marks)