FINANCIAL ACCOUNTING

FINANCIAL ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2010 NOTES: You are required to answer Question 1. You are also required to answer any three out of Questions 2 to 5. (If you provide answers to all of Questions 2 to 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first three answers to hand for Questions 2 to 5 will be marked.) Note: Students have optional use of the Extended Trial Balance, which if used, must be included in the answer booklet. PRO-FORMA STATEMENT OF COMPREHENSIVE INCOME BY NATURE, STATEMENT OF COMPREHENSIVE INCOME BY FUNCTION AND STATEMENT OF FINANCIAL POSITION ARE PROVIDED. TIME ALLOWED: 3.5 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND FINANCIAL ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2010 Time allowed: 3.5 hours plus 10 minutes to read the paper. Answer Question 1 and three of the remaining four questions. Note: Students have optional use of the Extended Trial Balance, which if used, must be included in the answer booklet. 1. (a) List and define five elements of financial statements as identified in the Framework for the Preparation and Presentation of Financial Statements. (10 marks) (b) The following trial balance was extracted from the books of Sligo Ltd as at 31 December 2009: Debit Credit 000 000 Retained profit 12,000 Ordinary shares 25 cent each 75,000 Share premium account 10,000 10% Debentures 2020 200,000 Buildings 300,000 Land 50,000 Plant and machinery 25,000 Vehicles 70,000 Provision for depreciation: Buildings 90,000 Plant and machinery 10,000 Vehicles 30,375 Discounts 2,000 2,500 Returns 3,500 4,000 Inventory 22,000 Purchases/revenue 225,000 427,625 Rents and rates 25,000 Carriage 7,000 Postage and stationery 4,000 Debenture interest paid 10,000 Wages and salaries 70,000 Bad debts 3,250 VAT 2,000 Electricity 3,000 Trade receivables/trade payables 74,000 42,750 Provision for doubtful debts 3,000 Bank 5,500 Interim ordinary dividends paid 6,000 907,250 907,250 The following additional information is available: 1. Inventory on hand 31 December 2009 was valued at 22,000. This includes the following items, which were valued at cost price. (i) On 1st January 2009, Sligo Ltd purchased a machine, for the factory, at a cost of 2,000. This has been recorded as a purchase of goods for resale in the books. (ii) An item of inventory which was damaged during the year. This item of inventory had a cost price of 1,000 and a net realisable value of 600. Page1

2. Included in revenue is an amount of 25,000 for goods sent on approval to a customer. The mark up on these goods was 25%. 3. Carriage in the trial balance comprises carriage inwards of 3,000, with the remainder being carriage outwards. 4. A customer has been declared bankrupt owing 1,500. This is to be written off. 5. The provision from doubtful debts should be 5% of trade receivables. 6. Included in the revenue figure is an amount of 4,000, which was the sales proceeds from the disposal of a motor vehicle during the year. The vehicle was purchased for 10,000 during 2007. 7. Depreciation is provided on non-current assets as follows: Buildings: Plant & machinery: Vehicles: 2% on cost 20% on cost 25% on written down value A full year s depreciation is charged in the year of purchase and none in the year of sale. 8. On 20 December 2009, the Directors of Sligo Ltd proposed a final dividend of 5 cents per share. This was approved for payment at a subsequent meeting of the Board of Directors on 30 December. The ordinary dividend figure of 6,000, in the trial balance, relates to an interim dividend that was declared and paid during 2009. 9. The debenture interest outstanding should be provided for. 10. When preparing the accounts at 31 December 2008, closing inventory was overvalued by 5,000. This has not been corrected in the accounts. 11. At the 31 December 2009 the company had the following accruals and prepayments: Accruals Electricity 500 Rates 1,000 Prepayments Rent 5,000 REQUIREMENT: Prepare, for internal use, a Statement of Comprehensive Income for the year ending 31 December 2009 and a Statement of Financial Position as at that date. (30 marks) [Total: 40 Marks] 2. List and explain the main differences between companies and partnerships. [Total: 20 Marks] Page 2

3. (a) In relation to IAS 10 Events after the Reporting Period explain the following terms: (i) Events after the reporting period (ii) Adjusting events (iii) Non-adjusting events (4 marks) (b) In relation to IAS 37 Provisions, Contingent Liabilities and Contingent Assets define the following terms: (i) Provision (ii) Contingent liability (iii) Contingent asset (6 marks) (c) A meeting of the Directors of Ardagh Ltd is scheduled for 30 September 2010 to discuss the following matters with a view to finalising the accounts for the year ending 30 June 2010: (i) (ii) (iii) (iv) A fire occurred in one of the warehouses of Ardagh Ltd on 3 July 2010, destroying inventory which had a cost price of 100,000 and a net realisable value of 150,000. In July 2010, Ardagh Ltd received information that one of their largest customers had gone bankrupt. At 30 June 2010, this customer owed Ardagh Ltd 235,000. It is anticipated that Ardagh Ltd will now only receive 10 cents for every 1 they were owed. In July 2010, Ardagh Ltd sold inventory which had been in one of their warehouses for the past two years, for 75,000. This had been included in the financial statements, for the year ended 30 June 2010, as its cost price of 105,000. On 30 June 2010, an employee of Ardagh Ltd fell and injured her back at work. This employee has commenced legal action. The Solicitor for Ardagh Ltd informed the company on 10 August 2010, that it is probable they will be found liable and have to pay this employee 33,000. The employee has worked for Ardagh Ltd for the past 4 years. REQUIREMENT: Advise the board on the accounting treatment of these issues. Your answer should give a detailed reason for the accounting treatment that you have chosen. (10 marks) [Total: 20 Marks] Page 3

4. Tommy Naughton is a retailer in Galway with a branch in Longford. The following trial balances have been extracted from the books of account as at 30 June 2010: Galway Books Longford Books Dr Cr Dr Cr 000 000 000 000 Inventory 16 40 Capital 600 Purchase/Revenue 1,828 1,700 884 Administrative expenses 40 42 Trade receivables/trade payables 120 100 120 Drawings 80 Non Current assets 700 200 Accumulated depreciation 280 60 Current accounts 350 240 Goods sent to branch 760 750 Provision for unrealised profit 8 Provision for doubtful debts 10 4 Distribution expenses 160 10 Bank 164 26 3,458 3,458 1,188 1,188 Additional information: 1. All goods are purchased by Galway. Those goods sent to Longford are invoiced at cost plus 25%. 2. Inventories were valued at 30 June 2010: Galway 24,000; Longford 30,000 invoice price. 3. Depreciation is to be provided for the year on non-current assets at a rate of 10% on cost. 4. The provision for doubtful debts is to be maintained at a rate of 5%. 5. As at 30 June 2010, there was 100,000 cash in transit from Longford to Galway. Goods invoiced at 10,000 were in transit from Galway to Longford. REQUIREMENT: Prepare in adjacent columns: (a) the head office, (b) the branch and (c) the combined income statements for the year ended 30 June 2010; and a combined statement of financial position as at that date. [Total: 20 Marks] Page 4

5. The following are extracts from the financial statements of Ulster Plc: Statement of Financial Position as at 31 December: 2008 2009 Assets Non Current Assets 000 000 Land 2,000 2,400 Plant and equipment 3,400 6,700 Fixtures and fittings 2,000 2,500 7,400 11,600 Current assets Inventory 1,000 1,160 Trade receivables 460 720 Cash 360 15 1,820 1,895 Total Assets 9,220 13,495 Equity & Liabilities Share Capital & reserves Ordinary share capital 6,740 9,000 Share premium 300 600 Land Revaluation 0 400 Retained profit 940 2,104 7,980 12,104 Non Current liabilities 10% Debentures 2020 200 0 Current Liabilities Trade payables 730 900 Bank overdraft 20 131 Corporation tax 290 360 1,040 1,391 Total Equity & liabilities 9,220 13,495 Extract of Statement of Comprehensive Income for the year ended 31 December 2009 000 Net profit before tax 2,064 Taxation (360) Net profit after tax 1,704 The following additional information is provided in relation to the year ended 31 December 2009: Plant and machinery with a book value of 400,000 was sold for 360,000. Depreciation provided on fixtures and fittings amounted to 500,000 and on plant and equipment amounted to 900,000. The debentures were redeemed on 31 December 2009. In July Ulster Plc paid an interim dividend of 540,000. No land or fixtures and fittings were disposed of during the period. REQUIREMENT: (a) In relation to IAS 7 explain what is meant by the term cash equivalents. (3 marks) (b) (c) Describe two benefits, from an investor s perspective, of analysing the information portrayed in a cash-flow statement. (2 marks) Prepare for Ulster Plc, a Cash-Flow Statement for the year ended 31 December 2009, in accordance with the requirements of IAS 7. (15 marks) Page 5 [Total: 20 Marks]

SUGGESTED SOLUTIONS SOLUTION 1 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND FINANCIAL ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2010 (a) The elements of financial statements The elements of financial statements are the building blocks with which financial statements are constructed. The Framework for the Preparation and Presentation of Financial Statements identifies the elements as follows: The elements of financial statements are: (i) (ii) (iii) (iv) (v) Assets: a resource controlled by an entity as a result of a past event and from which future economic benefits are expected to flow to the entity. Liabilities: a present obligation arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits Equity: the residual interest in the assets of an entity after deducting all its liabilities, so EQUITY = NET ASSETS = SHARE CAPITAL + RESERVES Income: Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity Expenses: decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or increases of liabilities that result in decreases in equity Page 7

(b) Income statement of Antrim Ltd for year ended 31 December 2009 Revenue (w1) 398,625 Returns (3,500) 395,125 Less Cost of Sales Opening inventory (w8) 17,000 Purchases (w12) 223,000 Carriage inwards 3,000 Returns (4,000) Closing inventory (w5) (39,600) (199,400) Gross Profit 195,725 loss on disposal of vehicle (w6) (1,625) Reduction in bad debt provision 625 Discount received 2,500 197,225 Less Expenses Discount allowed 2,000 Carriage outwards 4,000 Postage and advertising 4,000 Bad debts (w4) 4,750 Electricity (w11) 3,500 Rent & rates (w11) 21,000 Wages and salaries 70,000 Depreciation (w7) Buildings 6,000 Motor vehicles 8,500 Plant & machinery 5,400 Debenture interest (w11) 20,000 (149,150) Net profit 48,075 Appropriation account Net profit 48,075 Ordinary dividends proposed (w9) (15,000) ordinary dividends paid (6,000) Retained profit b/f(w8) 7,000 Retained profit c/f 34,075 Page 8

Statement of financial Position of Antrim Ltd as at 31 December 2009 Assets Non-Current Assets Cost Depreciation (w7) Net book Value Land 50,000 0 50,000 Buildings 300,000 96,000 204,000 Motor vehicles 60,000 34,500 25,500 Plant and machinery 27,000 15,400 11,600 437,000 145,900 291,100 Current Assets Trade receivables (w2) 47,500 Bad debt provision (w3) (2,375) 45,125 Bank 5,500 VAT 2,000 Closing inventory (w5) 39,600 Rent prepaid 5,000 97,225 Total Assets 388,325 Equity and Liabilities Equity Ordinary share capital 75,000 Share premium 10,000 Retained profit 34,075 119,075 Non-Current Liabilities 10% Debentures 2020 200,000 Current Liabilities Trade payables 42,750 Rates due 1,000 Electricity due 500 Proposed ordinary dividend (w8) 15,000 Debenture interest due (w10) 10,000 69,250 Total equity and liabilities 388,325 Workings 1. Revenue As per trial balance 427,625 Less sale or return (25,000) Less sales proceeds (4,000) 398,625 2. Trade receivables As per trial balance 74,000 Less sale or return (25,000) Bad debt to write off (1,500) 47,500 3. Provision for bad debts Opening provision (trial balance) 3,000 Income statement (625) Required closing provision [47,500*5%] 2,375 4. Bad debts As per trial balance 3,250 Bad debts to be written off (w2) 1,500 4,750 5. Closing inventory As per question 22,000 Sale or return 20,000 Note 1(i) in question- machine (2,000) Note1a(i) in question (400) 39,600 Page 9

6. Profit/loss on disposal of motor vehicle Cost price of motor sold 10,000 Dep to date on vehicle sold [2,500+ 1,875] (4,375) 5,625 Sales proceeds 4,000 Loss on disposal 1,625 7. Depreciation Buildings: [300,000*2%] 6,000 (Income Statement) Buildings: Depreciation to date [90,000 + 6,000] 96,000 (Statement of Financial Position) Motor vehicles: [(70,000 10,000) (30,375 4,375)]*25% 8,500 (Income Statement) Motor vehicles: Depreciation to date [30,375 4,375 + 8,500] 34,500 (Statement of Financial Position) Plant & mach: Plant & mach: [(25,000 + 2,000)*20%] 5,400 (Income Statement) Depreciation to date [10,000 + 5,400] 15,400 (Statement of Financial Position) 8. Error from previous year Retained earning brought forward [12,000 5,000] 7,000 Opening inventory [22,000 5,000] 17,000 9. Ordinary Dividends Proposed 300,000 shares *5c = 15,000 10 Debenture interest [200,000 * 10%] = 20,000 (Income statement) Amount paid (trial balance) 10,000 Therefore amount due = 10,000 (current liability in statement of financial position 11 Accruals/ prepayments Electricity As per Trial balance 3,000 Amount due 500 [current liability] 3,500 [Income Statement] Rent/rates As per trial balance 25,000 Rates due 1,000 [current liability] Rent (5,000) [current asset] 21,000 12 Purchases As per trial balance 225,000 Less machine (2,000) 223,000 Page 10

SOLUTION 2 The essential difference between a company and a partnership is that the company is a legal person separate from its members whereas a partnership is merely two or more persons in a particular form of relationship with each other; a partnership or firm is a group of partners but not a separate legal entity. Advantages and disadvantages of using a company or partnership to carry on business will often derive from special factors such as taxation and limited liability. Other points of comparison to be considered are: (a) (b) (c) (d) (e) (f) (g) (h) (i) COMPANY A company must have a written constitution i.e. Memorandum and Articles of Association A company is a separate legal person and so it may: own property; contract in its own name; sue/be sued in its own name. Shares in a company are in principle transferable though the right of transfer may be restricted. There is no maximum number of members. The members of the company are, such, neither its managers nor its agents. Capital subscribed by members of their share cannot ordinarily be returned to them but they are not liable for its debts. Companies can borrow the same way as individuals but only for purposes covered by their object. They can use current assets as security by creating floating charges in addition to creating fixed charges over fixed assets. Both in their formation and in their subsequent trading and other activities companies are subject to a number of statutory rules of procedure and supply of information available to the public The dissolution of a company usually entails a formal liquidation PARTNERSHIP There need not be a written partnership agreement though it is usual. A partnership is not a separate person and so it is the partners personally who: own property; are partly to contracts and are liable if used. A partner cannot transfer his status as partner to someone else without the consent of all the other partners. The maximum number of partners is 20 (except for professional partnerships) The partners are entitled to share in its management and are agents of the firm for carrying on its business Partners may withdraw capital but are still liable without limit for the firm s debts to its creditors. Partners have unrestricted powers of borrowing in terms of amount and purpose. They cannot create floating charges but can mortgage fixed assets. Partnerships may be created informally and need not disclose any information to the public about their affairs. Partnerships can be dissolved by mere agreement of the partners but the creditors have first claim on the assets and some general legal principles apply. Page 11

Solution 3 (a) (i) (ii) (iii) Events after the reporting period: Are those events, both favourable and unfavourable, that occur between the statement of financial position date and the date when the financial statements are authorised for issue. Adjusting events: Those that provide evidence of conditions that existed at the statement of financial position date Non-adjusting events Those that are indicative of conditions that arose after the statement of financial position date (b) (i) (ii) (iii) Provision A provision is a liability of uncertain timing or amount. Contingent liability A contingent liability is a possible obligation arising from past events whose existence will only be confirmed by the occurrence of future events not wholly within the entity's control. Contingent asset A contingent asset is a possible asset arising from past events whose existence will only be confirmed by future events not wholly within the entities control. Contingent assets may require disclosure but should not be recognised in the accounts. (c) (i) (ii) (iii) (iv) This is an non-adjusting event as it occurred after the statement of financial position date. If it is material it should be disclosed in the financial statements, but it should not be recognised in the financial statements. This is an adjusting event as it provides evidence of conditions that existed at the statement of financial position date. The company should recognise this in the accounts by debiting bad debts 211,500 and crediting trade receivables 211,500 This is also an adjusting event as it confirms the net realisable value of the goods that were in stock at 30 June 2010. The company will have to recognise this by reducing the value of closing inventory in the financial statements. This is an adjusting event. As the injury took place prior to the year end it has now been confirmed that the company will probably have to pay out 33,000 in compensation. The company will have to recognise a provision of 33,000 in the financial statements by debiting provision expense 33,000 and crediting provision statement of financial position 33,000. Page 12

SOLUTION 4 T. Naughton Income Statement for the year ended 30 June 2010 Galway Longford Total 000 000 000 000 000 000 Sales 1,700 884 2.584 Cost of sales Inventory 1/7/09 16 32 48 Purchases 1,828 1,828 1,844 1,876 Goods sent to branch (600) 600 1,244 Inventory 30/6/10 (32) (1,212) (24) (608) (56) (1,820) Gross profit 488 276 764 Depreciation 70 20 90 Distribution costs 160 10 170 Admin expenses 40 42 82 Bad debt provision (4) (266) 2 (74) (2) (340) Net profit 222 202 424 T. Naughton Statement of Financial Position as at 30 June 2010 000 000 Non-current Assets Cost 900 Accumulated depreciation (430) 470 Current Assets Inventory 56 Trade receivables 240 Provision for bad debt (12) Bank 290 574 Total Assets 1,044 Capital & liabilities Capital as at 1/07/09 600 Net profit 424 Drawings (80) 944 Current Liabilities Trade payables 100 Total assets and liabilities 1,044 Page 13

SOLUTION 5 (a) (b) (c) Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. Allows investors to determine any solvency/liquidity issues that the company may have It is useful in assessing the ability of an entity to generate cash/cash equivalents Highlights the relationship between profit and cash-flow of an entity Ulster plc Cash flow statement for the year ended 31 December 2009. Cash flow from operating activity Net profit before tax 2,064 Adjustment for: Depreciation charges 1,400 Interest expense 20 Loss on sale of non-current asset (w1) 40 Operating profit before working capital changes 3,524 Increase in inventories (160) Increase in trade receivables (260) Increase in trade payables 170 Cash generated from operations 3,274 Interest paid (20) Income tax paid (290) Net cash from operating activity 2,964 Cash flow from investing activity Payments to acquire tangible non current assets (5,600) Receipts from sale of tangible fixed assets 360 (5,240) Net cash used in investment activity Cash flow from financing activities Issue of shares 2,560 Redemption of debentures (200) Dividend paid (540) Net cash from financing activities 1,820 Decrease in cash in period (456) Cash and cash equivalent at beginning of period 340 Cash and cash equivalent at end of period (w10) (116) Page 14

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