Accounting Fundamentals July 2012

Accounting Fundamentals July 2012 Suggested answers and examiner s comments Important notice When reading these suggested answers, please note that the answers are intended as an indication of what is required rather than a definitive right answer. In many cases, there are several possible answers/approaches to a question. Please be aware also that the length of the suggested answers given here may be somewhat exaggerated compared with what might be achieved in the reality of an unseen, time-constrained examination. Examiner s general comments This examination was the first sitting of the new syllabus. The overall performance of candidates was good, with a higher pass rate than the last examination based on the old syllabus. However, some candidates appeared unfamiliar with some of the additional subject areas such as accounting ratios in Question 8. Future candidates must ensure they are well prepared to address the whole syllabus. ICSA, 2012 Page 1 of 16

Section A Answer all parts of Question 1. Select only one of the options A, B, C or D for each part. 1. (i) The bookkeeper at Good Hope Designs incorrectly posted a payment of 125 to Safeguard Insurance as a debit to finance charges. This is an example of which one of the following errors? A. Compensation B. Commission C. Principle D. Omission (ii) Which one of the following types of organisation is listed on the stock market? A. Private limited company B. Sole trader C. Partnership D. Public limited company (iii) Which one of the following is a bedrock concept of accounting? A. Going concern B. Prudence C. Money measurement D. Duality (iv) The sales ledger control account is also known as: A. Creditors control account B. Debtors control account C. Sales daybook D. Sales returns daybook ICSA, 2012 Page 2 of 16

(v) On 1 April 2012, Annie Smart purchased a computer for her business and paid by cheque. What was the impact on the accounting equation? Increase Decrease A. Fixed asset Current asset B. Current asset Fixed asset C. Fixed asset Capital D. Fixed asset Current liability (vi) Which one of the following is an example of a current liability? A. Drawings B. Owner s capital C. A prepayment D. An accrual Questions (vii) to (x) relate to the car repair and servicing business of Sam Strong ( Sam ) for the accounting year 1 July 2011 to 30 June 2012. (vii) During the year, Sam paid one month s rent for his home from the business. How should this payment be shown in his financial statements? A. As an expense in the profit and loss account. B. As a debtor in the balance sheet. C. As a deduction from capital in the balance sheet. D. As a current liability in the balance sheet. (viii) Sam had a turnover of 120,000 during the year. The gross profit margin was 25% and the operating costs were 12,000. What was Sam s operating profit margin for the year? A. 25% B. 15% C. 10% D. 7.5% ICSA, 2012 Page 3 of 16

The following extract from Sam s business balance sheet at 30 June 2012 relates to questions (ix) and (x): Current Assets Inventory 16,000 Debtors 9,500 Bank 3,250 Current Liabilities Trade Creditors 11,500 (ix) What was the current ratio for Sam s business as at 30 June 2012? A. 1.11:1 B. 2.5:1 C. 4.59:1 D. 5.98:1 (x) What was the acid test (quick ratio) for Sam s business as at 30 June 2012? A. 1.11:1 B. 2.5:1 C. 4.59:1 D. 5.98:1 (Total: 20 marks) Suggested answers (i) C. Principle (ii) D Public limited company (iii) A Going concern (iv) B Debtors control account (v) A Fixed asset Current asset (vi) D An accrual (vii) C As a deduction from capital in the balance sheet. ICSA, 2012 Page 4 of 16

(viii) B 15% Examiner s explanation: OPM = Operating Profit x 100 Turnover GPM was 25%, therefore gross profit = 30,000 Operating costs = 12,000 Operating profit = 18,000 OPM = Operating Profit x 100 Turnover (ix) B 2.5:1 = 18,000 x 100 120,000 = 15% Examiner s explanation: Current ratio = Current Assets : 1 Current Liability (x) A 1.11:1 = 16,000 + 9,500 + 3,250 : 1 11,500 = 2.5: 1 Examiner s explanation: Acid Test = Current Assets - Inventory : 1 Current Liability = 9,500 + 3,250 :1 11,500 = 1.11 : 1 Examiner s comments Section A was generally well answered. ICSA, 2012 Page 5 of 16

Section B Answer all five questions. 2. Explain how the following are used in book-keeping: (i) (ii) (iii) Purchase returns day book. Petty cashbook. Sales ledger. (6 marks) Suggested answer Purchases returns day book A book of prime entry that records the goods a buyer returns to a supplier. In effect they are negative purchases in that they reduce the amount owed to a supplier. When the entries are entered into the purchases ledger they will reduce the amounts owing to the supplier and will reduce the purchases made by the business. Petty cash book A book of prime entry that records small-value payments. Such payments may be for stamps, taxi fares, tea or coffee for the office or emergency purchases of stationery. Most businesses keep a small amount of cash on their premises for this purpose. Sales ledger The sales ledger contains a record of account for each customer. Invoices raised will be posted to the account to increase the customer s indebtedness, whereas credit notes will be posted to reduce their indebtedness. The balance column on the account shows at any one time how much the customer owes the business. 3. Identify and explain three sources of income shown in the financial statements of clubs and societies. (6 marks) Suggested answer Entrance fees / Joining fees. Fees paid by new applicants on their admission as members of the club or society. Subscriptions. These are the annual amounts receivable from members of the club or society. Life membership fees. A lump sum fee paid by a member that provides them with membership of the club or society for the rest of his or her life. Hire Charges Fees charged to club members and non-members for the use of the club or society s facilities such as meeting rooms or other facilities. ICSA, 2012 Page 6 of 16

Trading Surpluses The income derived from trading activities such as a bar or income-generating activities such as fund raising or sales of merchandise etc. 4. Explain the similarities and differences between a bad debt and a provision for a doubtful debt. (6 marks) Suggested answer Similarities: Bad debt and provision for doubtful debt are both adjustments from debtors which are required to be made to the balance shown on a trial balance at the end of the accounting period. They are both shown as an expense in the profit and loss account. Differences: Bad Debt Bad debts are a fact in that they comprise debtors who cannot or will not pay their debts. Bad debts relate to specific debtors who the business knows for a fact have failed to pay the debt owed by them Provision for a doubtful debt A provision for doubtful debts is a reasonable estimate of the value of debts which may not be collected. A provision for doubtful debts is different from bad debts in that it does not normally relate to specific debtors. 5. In your answer booklet, draw the table below and complete the ledger entries necessary to record the three stages in accounting for the disposal of a fixed asset before any surplus or deficit can be transferred to the income statement. No. Debit Credit 1 2 3 Suggested answer No. Debit Credit 1 Disposal account Fixed asset account 2 Provision for depreciation account Disposal account 3 Bank Disposal account (6 marks) ICSA, 2012 Page 7 of 16

6. Fay Starr began a cake making business on 1 April 2012. Her business transactions for the first month were as follows: 5 Apr Fay opened her business bank account with a deposit of 5,425 from her personal account. 6 Apr She purchased some equipment at a cost of 2,655 on credit from Caterers Enterprise. 9 Apr Fay baked six dozen cup-cakes for resale. 24 Apr Bank agreed an overdraft limit of 7,500. For each date, state the double entry required to record the business activity for the month of April 2012. (6 marks) Suggested answer 5 Apr Dr Bank 5,425 Cr Capital 5,425 6 Apr Dr Equipment 2,655 Cr Caterers Enterprise 2,655 9 Apr No double entry transaction 24 Apr No double entry transactions Examiner s comments Some questions in Section B were generally poorly answered. Many candidates were unable to provide appropriate answers to Questions 4 and 5. In Question 4, many candidates were unable to explain the differences and similarities between two key terms that are central to the Accounting Fundamentals syllabus - bad debt and provision for bad debt. Question 5 was also generally poorly answered. However, in Question 6, some candidates were able to recognise that two transactions did not require any double-entry to be recorded and scored good marks. ICSA, 2012 Page 8 of 16

Section C Answer two questions only. 7. (a) Explain the purpose of the trial balance within the accounting system. (7 marks) (b) Identify and explain six errors a trial balance cannot detect. (18 marks) (Total: 25 marks) Suggested answer (a) A trial balance is a list of the ledger account balances at one point in time. The trial balance lists the ledger accounts and their respective debit or credit balance. A trial balance by definition will result in the total debits and credits being equal. Although a trial balance consists of a list of debit and credit ledger balances based upon the principle of double entry, the trial balance is not a part of the double-entry system. A trial balance is just an arithmetical check of the ledger balances, drawn up in two columns, debits and credits. A trial balance may not be correct even if the total debits equal the total credits. A trial balance is always produced at a point in time and not for a period. Hence it is always titled, as at (in some countries, as of ) followed by the date for the end of the reporting period. Despite the usual practice to produce a trial balance at the end of the accounting period, a trial balance can be produced more frequently to provide an internal check that a business has recorded its business transactions correctly and all its debits are equal to its credits. (b) Errors of Commission An error of commission occurs when the correct amount has been posted in the ledger but it has been posted to the wrong account. Errors of omission An error of omission occurs when a transaction has taken place but it has not been entered in the books of prime entry. Errors of principle An error of principle occurs when a transaction has been posted to the wrong type of account. Error of reversal of entry An error of reversal of entry occurs when a transaction is entered in the correct accounts but each item has been entered on the wrong side of each account. Errors of original entry An error of original entry occurs when a transaction is incorrectly entered into a book of prime entry. ICSA, 2012 Page 9 of 16

Compensating Errors A compensating error occurs when error on one side of the ledger is wholly compensated by an error of equal value on the other side of the ledger. 8. The extracts from the financial statements of Minus Zero plc for the year ended 30 June 2012 are provided below: Minus Zero plc 2012 Sales 90,000 Cost of sales 58,500 Gross profit 31,500 Operating profit 16,200 Retained profit for the year 8,220 Non-current assets 25,000 Inventory 4,200 Receivables 12,329 Cash at bank 2,150 Payables 8,190 Total equity 31,489 Required (a) Calculate the solvency of the company using two suitable ratios. (4 marks) (b) (c) (d) Explain what the results of both ratio calculations you completed in (a) tell us about the assets and liabilities of the company. (4 marks) Identify, calculate and comment on the working capital management of the company using three suitable ratios. (12 marks) Outline and comment upon two problems encountered when using accounting ratios. (5 marks) (Total: 25 marks) Suggested answer (a) Current assets Current ratio = Working capital ratio = : 1 Current liabilities = 4,200+ 12,329 +2,150 : 1 8,190 = 2.28:1 ICSA, 2012 Page 10 of 16

Current assets inventory Acid test = --------- : 1 Current liabilities = 12,329 +2,150 : 1 8,190 = 1.77:1 (b) Minus Zero plc is in a solvent position as measured by both ratios. The current ratio indicates that the company is readily able to cover its short-term debts with its short-term assets. Although its short-term assets include inventories, the acid test indicates that even excluding the inventories it would still be in a position to meet its short-term debts. Both ratios indicate that the company has more current assets and current assets less inventories than current liabilities. (c) Inventories holding days = Closing stock x 365 = 26 days Cost of goods sold 4,200 x 365 = 26 days 58,500 Collection of trade receivables, in days: = Trade Receivables 365 =50 days Sales 12,329 x 365 = 50 days 90,000 Payment of trade payables, in days: = Trade Payables 365 = 51 days Cost of sales 8190 x 365 = 51 days 58,500 Minus Zero plc is holding its inventory for 26 days so its inventory is turning over 14 times a year. The company s management of its trade receivables and payables is such that the two are relatively matched. Trade receivables are being collected in 50 days and trade payables are paid out in 51 days. Therefore, Minus Zero has one day of excess cash holding. Minus Zero should review its credit terms to determine whether the 50 days for its trade receivables exceeds its standard credit terms. If the 50 days does exceed the standard credit terms, it should seek to implement action to reduce the collection period further. ICSA, 2012 Page 11 of 16

Similarly, a review of the terms granted by suppliers should be conducted to assess whether payments are being made within the agreed credit period. If payments are consistently later than its creditors terms, Minus Zero may be exposed to late payment charges or missing early settlement discounts or incurring a reputation as a late payer to suppliers. Minus Zero should compare its performance against its industry s benchmark to determine the level of performance. (d) Problem Accounting ratios are numerical results from elements of the financial statements Changes in an accounting ratio cannot necessarily be interpreted as good or poor management. An over-emphasis is placed on the size of the individual ratio. Company financial statements are based on historic events and performances. Comment Accounting ratios do explain the reason for the results. The drivers of the change factors in the accounting ratios should be identified before the assignment of any responsibility for changes which have been found. This may skew the vision and interpretation of the accounting ratio by its users. Accounting ratios by themselves are not useful for a forward planning for a business. ICSA, 2012 Page 12 of 16

9. The following trial balance was prepared from the ledger balances of J Chivers, trading as Chivers Sportswear ( Chivers ), for the year ended 30 June 2012: Trial balance for Chivers as at 30 June 2012 Sales 195,000 Sales returns 11,010 Purchases 96,000 Purchase returns 766 Debtors 12,113 Provision for doubtful debts 600 Creditors 7,886 Long term loan 7,319 Bank overdraft 9,218 Office & factory rent 12,660 Opening stock 3,834 Plant and machinery at cost 92,022 Accumulated depreciation as at 30 June 2011 14,271 Office furniture at cost 10,988 Accumulated depreciation as at 30 June 2011 1,099 Carriage in 288 Carriage out 219 Travelling expenses 1,316 Administration 7,503 Repairs 191 Salaries 50,970 Telephone 3,014 Drawings 18,205 Discounts allowed 3,440 Capital 87,614 323,773 323,773 Notes to the trial balance: (i) Stock at 30 June 2012 was 2,955. (ii) Accrued expenses at 30 June 2012 were travel expenses 1,155 and telephone 318. (iii) Office & factory rent includes 1,600 for the first quarter of 2012. (iv) (v) (vi) A total of 2,113 has to be written off as bad debt. The provision for doubtful debt has to be 10% of the debtors balance. Plant and machinery is depreciated on the reducing balance basis at 25% per annum. Office furniture is depreciated at 10% on original cost. (continued) ICSA, 2012 Page 13 of 16

Required (a) Prepare a trading, profit and loss account for Chivers for the year ended 30 June 2012. (13 marks) (b) Prepare a balance sheet for Chivers as at 30 June 2012. (12 marks) (Total: 25 marks) Suggested answer (a) J Chivers Trading as Chivers Sportswear Profit & Loss Account For the year ended 30 June 2012 Notes Sales 195,000 Less: Returns inwards 11010 183,990 Cost of goods sold Opening stock 3,834 + Purchases 96000 + Carriage inwards 288 100,122 - Returns outwards 766 99,356 i - Closing Stock 2,955 96,401 Gross Profit 87,589 Expenses Salaries & wages 50,970 iii Rent 11,060 Repairs 191 Administration 7,503 ii Telephone 3,332 Carriage outwards 219 Discounts allowed 3,440 ii Travel 2,471 vi Depreciation 20,537 Bad debts 2,113 v Increase in PBD 400 102,236 Net Profit (14,647) ICSA, 2012 Page 14 of 16

(b) J Chivers Trading as Chivers Sportswear Balance Sheet As at the year ended 30 June 2012 Notes Cost Accum Depn NBV iv Fixed Assets Plant & machinery 92,022 33,709 58,313 Office furniture 10,988 2,198 8,790 103,010 35,907 67,103 Current Assets Stock 2,955 vi Debtors 9,000 ii Prepayments 1,600 13,555 Current Liabilities Creditors 7,886 i, iii Accruals 1,473 Overdraft 9,218 18,577 Notes Net Current Assets (5,022) 62,081 Long Term Liabilities Loan 7,319 Net Assets 54,762 Financed By Capital at 1 July 2011 87,614 Profit (14,647) 72,967 Less: Drawings 18,205 Capital 30 June 2012 54,762 i. Travelling Bal as per trial balance 30 June 2012 1,316 Accrued salaries 1,155 Profit & Loss Account 30 June 2012 2,471 ii. Telephone Bal as per trial balance 30 June 2012 3,014 Accrued telephone 318 Profit & Loss Account 30 June 2012 3,332 ICSA, 2012 Page 15 of 16

iii. Rent Bal as per trial balance 30 June 2012 12,660 Prepaid rent 1,600 Profit & Loss Account 30 June 2012 11,060 iv. Depreciation Cost Depn. NBV Annual Depn 30-Jun-11 30-Jun-11 2011/12 Plant & machinery 92,022 14,271 77,751 19,438 Office furniture 10,988 1,099 9,889 1,099 103,010 15,370 87,640 20,537 v. PDD Bal as per trial balance 30 June 2012 600 Increase in PDD 400 Doubtful debt bal at 30 June 2012 1,000 Only the increase is charged to the profit and loss account vi. Debtors Bal as per trial balance 30 June 2012 12,113 Bad debt write-off 2,113 Revised debtors 10,000 PDD at 10% debtors balance 1,000 Debtors at 30 June 2012 9,000 Examiner s comments Question 7 was generally well answered. Question 8 was a new topic and few candidates attempted it. However, candidates who answered the question produced good answers. The following general points were noted in the spread of answers to Question 9: Unconventional layout of items in the trading account; Errors in making the adjustments as per the notes; Complete neglect of some notes when preparing the profit and loss account; and Some candidates did not separate profit and loss items and balance sheet items. The scenarios included here, except where expressly identified, are entirely fictional. Any resemblance of the information in the scenarios to real persons or organisations, actual or perceived, is purely coincidental. ICSA, 2012 Page 16 of 16