Accounting Fundamentals February 2011

Accounting Fundamentals February 2011 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 The pass rate for this paper increased to 74%, from 48% for the previous session. A competent group of candidates continue to provide a balanced set of answers across all three sections of the paper. However, some candidates appeared to have been poorly prepared for the paper and need to reflect on their preparation strategy. Some candidates neglected to include workings in their final solution in parts of Section C. Candidates need to focus on the whole syllabus and not seek to overlook what may to them seem minor areas. Any area from the whole syllabus can be tested at each sitting. ICSA, 2011 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 accounting equation is made up of sources and uses of funds. The sources of funds include: A. Assets and liabilities. B. Assets and expenses. C. Income and liabilities. D. Income and expenses. (ii) Which of the following is an example of revenue expenditure? A. Expenditure on shop equipment. B. Expenditure on an improvement to a house. C. A loft extension. D. Repairs to a roof in the conservatory. (iii) The purchase of goods for resale on credit is recorded in which of the following accounts? Debit Credit A. Supplier s account Purchases account B. Purchases account Bank account C. Purchases account Supplier s account D. Supplier s account Sales account (iv) The creditors control account is also known as the: A. Debtors control account. B. Sales ledger control account. C. Purchase ledger control account. D. Purchase ledger. ICSA, 2011 Page 2 of 16

(v) On 31 January 2011 Dead Slow sold on credit 8,000 of raw materials to Verri Goode. The accountant at Dead Slow should credit which of the following accounts? A. Cr Sales 8,000 B. Cr Verri Goode 8,000 C. Cr Purchases 8,000 D. Cr Dead Slow 8,000 (vi) On 31 January 2011 Verri Goode purchased on credit 8,000 of raw materials from Dead Slow. The accountant at Verri Goode should credit which of the following accounts? A. Cr Sales 8,000 B. Cr Verri Goode 8,000 C. Cr Purchases 8,000 D. Cr Dead Slow 8,000 (vii) The purchase ledger records which of the following? A. Credit transactions with suppliers. B. Credit transactions with customers. C. Cash transactions with suppliers. D. Cash transactions with customers. (viii) Both the sales daybook and purchases daybook were undercast by 2,000. This resulted in which one of the following? A. Error of omission. B. Compensating error. C. Error of commission. D. Error of principle. (ix) Which of the following combination of items would you expect to find on the balance sheet of a sole trader? A. Fixed assets, current assets, ordinary shares, current liabilities. B. Fixed assets, gross profit, ordinary shares, current liabilities. C. Drawings, fixed assets, gross profit, current liabilities. D. Drawings, fixed assets, long term liabilities, current liabilities. ICSA, 2011 Page 3 of 16

(x) Sole trader George Finns has an accounting year-end of 31 January 2011. An advertising bill of 900 is owing, which relates to the period 1 January 2011 to 31 March 2011. If the total expenses before adjustment are 6,000, what are the total expenses after the adjustment? A. 5,700 B. 6,300 C. 6,600 D. 6,900 (Total: 20 marks) (i) C Income and Liabilities. Explanation Liabilities are people to whom the business owes money and income is generated from sales. (ii) D Repairs to a roof in the conservatory. Explanation Repairs are general operational expenditure whereas all the other options are items of capital expenditure. (iii) C Purchases account/supplier s account. Explanation The recipient account is purchases and the donor account is the supplier s. (iv) C Purchase ledger control account. (v) A Dr Verri Goode, Cr Sales. Explanation A credit sale was made to Verri Goode. This gives rise to a debtor Verri Goode (they have yet to pay for the goods) and creates a sales for the goods supplied by Dead Slow to the debtor (Verri Goode). Thus Dr Verri Goode Cr Sales. (vi) D Dr Purchases, Cr Dead Slow. Explanation A credit purchase was made by Verri Goode. This gives rise to a creditor Dead Slow (they have yet to be paid for the supply of goods) and creates a debit on the purchases account for the goods they have bought although unpaid as yet. Thus Dr Purchases Cr Dead Slow. (vii) A (viii) B Credit transactions with suppliers. Compensating error. (ix) D Drawings, fixed assets, long term liabilities, current liabilities. ICSA, 2011 Page 4 of 16

(x) B 6,300. Explanation TB at 31 Jan 2011 6,000 Plus Unpaid at 31 Jan 2011 900 3 Total 300 6,300 Examiner s Comments The multiple choice questions in Section A seek to provide candidates with an opportunity to demonstrate their breadth of knowledge of the Accounting Fundamentals syllabus. Wellprepared candidates continue to perform well in this section and set a good platform for the remainder of the paper. It is important for candidates to recognise the fact that the multiplechoice questions will continue to be a mixture as in all sections, i.e. a combination of numerical questions and the assessment of principles. ICSA, 2011 Page 5 of 16

Section B (Answer all five questions) 2. List six books of prime entry found in an accounting system. (6 marks) Sales daybook. Purchase daybook. Cashbook. Sales returns daybook. Purchases returns daybook. Petty cashbook. Journal. 3. At the close of business on 31 December 2010, Ashmore Ltd was 2,456 inside its overdraft limit of 12,000. During January 2011, the following transactions took place: (i) (ii) (iii) (iv) (v) (vi) 5 January, sent cheque 2069 for the sum of 1,116 to Wig & Gown Solicitors. 16 January, received 3,966 bank transfer from Jay Flynn, an established client. 21 January, received January s rental invoice from Realtee for the sum of 4,250. Cheque number 2070 was written out to Realtee on 26 January but it was still in the cheque book as at 31 January. 28 January, direct debit 955 paid to Quill & Co Accountants. 29 January, received a loan of 7,500 from Ashmore s local Credit Union. 29 January, signed a direct debit for the monthly sum of 1,356 payable to Zencom, to commence on 5 April. Prepare Ashmore Ltd s cashbook for the period ended 31 January 2011. (6 marks) Cashbook Date Narrative Dr Cr Balance 01-Jan-11 Balance bd 9,544 (9,544) 05-Jan-11 Wig & Gown Solicitors 1,116 (10,660) 16-Jan-11 Jay Flyn 3,966 (6,694) 28-Jan-11 Quill & Co 955 (7,649) 29-Jan-11 Credit Union 7,500 (149) 31-Jan-11 Balance cd 149 ICSA, 2011 Page 6 of 16

4. With the aid of one suitable example of each, explain the difference between a long-term liability and an intangible fixed asset. (6 marks) Long term liability is a debt which is due and payable more than 12 months from the balancesheet date. A liability on the balance sheet. For example, a bank loan. Intangible fixed asset is an asset which does not have a physical existence. It cannot be touched. For example, goodwill or a patent. ICSA, 2011 Page 7 of 16

The following scenario relates to Questions 5 and 6 only. Ossie Gilzean owns a small snack bar. His financial year ended on 31 January 2011. A summary of an extract from Ossie s accounting records, excluding his purchases for the period, is set out below: Gross profit 403,212 Sales 548,000 Carriage in 15,325 Closing stock 73,592 Opening stock 105,687 5. Prepare a trading account for the business for the year ended 31 January 2011, clearly show Ossie s purchases and cost of sales. Sales 548,000 Opening stock 105,687 Purchases 97,368 Carriage in 15,325 218,380 Closing stock (73,592) Cost of goods sold 144,788 Gross profit 403,212 Sales 548,000 Opening stock 105,687 Purchases 97,368 Carriage in 15,325 218,380 Closing stock (73,592) Cost of goods sold 144,788 Gross profit 403,212 (6 marks) 6. (a) Calculate the snack bar s gross profit margin (GPM). (3 marks) (a) Gross profit margin = Gross profit x 100 Sales 403,212 x 100 548,000 73.58% ICSA, 2011 Page 8 of 16

(b) State two ways in which knowing the snack bar s GPM can be useful. (3 marks) Knowledge of the snack bar s GPM is useful in the following ways: It allows the comparison with other accounting periods or comparison with other snack bars. It can be used to provide an understanding of the behaviour or relationship between the cost of sales relative to changes in sales. Examiner s Comments Questions 2 and 4 were answered well by most candidates. However, a less satisfactory performance was demonstrated by many candidates in response to questions 3 and 5. Answers to Question 3 highlighted the fact that some candidates were unable to produce a cash book, which is a key element of the syllabus. This was compounded by the number of candidates who reversed the debit and credit entries. This suggested that candidates were either unprepared or lacked the required level of understanding for this paper. In preparing for the exam, candidates should recognise that rote learning of examples without understanding the principle concerned is not enough. This rote learning appeared to be what was being demonstrated in many of the candidate s responses to Question 4. ICSA, 2011 Page 9 of 16

Section C (Answer two questions only) 7. (a) Robert Nesta is the owner of Nesta Wholesale, a small fruit and vegetable wholesale business. For the quarter ended 31 January 2011, the following items were extracted from the books of Nesta Wholesale. Sales 129,602 Purchases 92,558 Returns outwards 8,114 Returns inwards 17,346 Received from credit customers 119,624 Paid to credit suppliers 82,617 Discounts received 4,594 Discounts allowed 6,053 Sales ledger balance 31 January 2011 33,188 Purchases ledger balance 31 January 2011 22,231 For the quarter ended 31 January 2011, prepare Nesta Wholesale s: (i) (ii) Debtors control account. Creditors control account. (7 marks) (7 marks) Debtors Control Account Date Narrative Date Narrative 31/01/2011 Bal b/d 33,188.00 Credit Customers 119,624.00 Sales 129,602.00 Returns inwards 17,346.00 Discounts allowed 6,053.00 bal c/d 19,767.00 162,790.00 162,790.00 Creditors Control Account Date Narrative Date Narrative Return outwards 8,114.00 31/01/2011 Bal b/d 22,231.00 Paid to credit suppliers 82,617.00 92,258.00 Discounts received 4,594.00 bal c/d 19,164.00 114,489.00 114,489.00 ICSA, 2011 Page 10 of 16

(b) (i) Explain why a bank reconciliation is important. (2 marks) (ii) Explain three items that make it necessary to undertake a bank reconciliation. (9 marks) (i) (ii) A bank reconciliation is the process or system that is used to identify and account for any differences between the cashbook and bank account in a business. Three items that make a bank reconciliation process necessary are; errors, bank charges, timing differences. Errors arise in the recording of transactions, either in the cashbook or in the banking of monies. Errors may also occur as a result in the calculation of items such as summing up of totals. Bank charges are often made by the bank for account management fees or other banking services and the absence of an invoice often results in these items not being shown in the cashbook because they are unknown until receipt of the bank statement. Timing differences arises from monies paid out by cheque which although recorded in the cashbook, have not been shown on the bank statement because the recipient has yet to deposit the cheque into their account or the cheque has yet to be processed through the bank clearing system as at the bank statement date. Secondly, monies received may be recorded in the cashbook but not deposited in the bank or if deposited in the bank it has not been cleared by the bank as at the bank statement date. 8. (a) Define and explain, with examples, the bedrock and two desirable accounting concepts from FRS18 that underpin accounting principles. (16 marks) BEDROCK Going Concern The business will continue in operation and existence for the foreseeable future and there is no intention to put the company into liquidation or make cutbacks in the scale of operations. Example A fixed asset is shown on the balance sheet at its historic cost less its accumulated depreciation to date. Thus the assumption is that the fixed asset will be written off over the future life of the fixed asset. Accruals The recognition of revenue and costs in the accounting period in which they are earned or incurred is the accrual concept. The period in which the money is received or paid is not the basis upon which we prepare financial statements. ICSA, 2011 Page 11 of 16

Example Suppose a business has its financial year end at 31 January 2011. The payment of its rent until 30 April 2011 will result in the payment for the three months ended 30 April 2011 being recorded as a prepayment in the accounts and it will not appear in the profit and loss account for the year ended 31 January 2011. DESIRABLE Prudence Whenever there are alternative measures, procedures or basis of valuations, the appropriate method to apply is that which produces the most cautious presentation of the financial position of the business. Example At the end of the year or accounting period, stock is valued at the lesser of historic cost and net realisable value. Consistency Similar items should be treated accordingly within the financial statements. Any departure between periods requires an explanation within the annual accounts. Example The same rate of depreciation should be applied to the same class of items within and between accounting periods. If a change is to be made to the depreciation policy or the rate being charged then an explanation of the change and the effects it is having on the results must be shown as a note to the accounts being presented. (b) Explain, with the aid of a suitable example, each of the following terms: (i) (ii) Working capital. Duality. (3 marks) (3 marks) Working Capital The difference between current assets and current liabilities within a business. Also known as net current assets. Example Current Assets 10,000 Current liabilities 8,000 Working Capital 2,000 Duality Every transaction has two accounting book entries, a debit and a credit. Example When an asset is purchased the asset account receives the debit and the paying account is credited, ie Dr Asset Cr Bank. ICSA, 2011 Page 12 of 16

(c) With the aid of an example, explain the main distinction between a fixed asset and a current asset. (3 marks) The main distinction between a current and fixed asset is the purpose which the asset has been obtained and used within the business. A car can be either a fixed or current asset dependent upon the use in the business. 9. (a) Sunita Binn is the owner of Binn Cleaning Stores. The business year end is 31 January 2011. A summary of the balances extracted from the accounting records is shown below: Trade creditors 15,252 Return outwards 3,117 Discounts allowed 3,011 Purchases 72,018 Returns inwards 9,587 Drawings 12,855 Rent and rates 12,514 Heat and lighting 997 Salaries and wages 32,144 Cash 107 Bank overdraft 11,598 Stock 12,595 Sales 168,856 Trade debtors 9,003 Fixtures and fittings 50,000 Computer equipment 14,000 Produce a trial balance for Binn Cleaning Stores for the year ended 31 January 2011 and derive the balance of the capital account. (7 marks) ICSA, 2011 Page 13 of 16

Binn Cleaning Stores Trial Balance As at 31 January 2011 Trade creditors 15,252 Purchase returns 3,117 Discounts allowed 3,011 Purchases 72,018 Sales returns 9,587 Drawings 12,855 Rent and rates 12,514 Heat and lighting 997 Salaries and wages 32,144 Cash 107 Bank overdraft 11,598 Opening stock 12,595 Sales 168,856 Trade debtors 9,003 Fixtures and fittings 50,000 Computer equipment 14,000 Capital 30,008 Total 228,831 228,831 ICSA, 2011 Page 14 of 16

(b) The following additional notes were found with the above balances: i. Mopsco Limited, a debtor, has gone into liquidation owing Binn Cleaning 5,000, and the likelihood of recovering anything owed is remote. ii. iii. iv. Fixtures and fittings are depreciated at 25% p.a. on the reducing balance basis. Computers are expected to have an economic life of 10 years, with a nil residual value using the straight line method. Rent and rates excludes an unpaid amount for the last month which totalled 216. v. The closing stock on 31 January 2011 was 10,246. Produce a trading profit and loss account for Binn Cleaning Stores for the year ended 31 January 2011. (12 marks) Binn Cleaning Stores Trading Profit and Loss Account For the year ended 31 January 2011 Sales 168,856 Cost of sales Opening stock 12,595 Purchases 72,018 Purchase returns (3,117) 81,496 Closing stock 10,246 Cost of goods sold 71,250 Gross Profit 97,606 Expenses Rent and rates 12,730 Heat and lighting 997 Salaries and wages 32,144 Depreciation Fixtures and fittings 12,500 Computer 1,400 Bad debt 5,000 64,771 Net profit for the year 32,835 ICSA, 2011 Page 15 of 16

(c) Explain the difference between the uses of a trial balance and a profit and loss account. (6 marks) A profit and loss account records the income generated and expenditure incurred for a given accounting period, usually one year. It shows whether the business has made a profit or loss. A trial balance, in contrast, is an assembly of ledgers balances at the end of the accounting period that is used to: Check on the double entry Produce the financial statements such as the profit and loss account. Examiner s comments Candidates continue to perform well in the mechanical production of trading, profit and loss accounts as demonstrated in Question 9. However, the responses in relation to the production of a trial balance with the correct entries for debit and credit items were often less satisfactory. Answers to Question 8 demonstrated that many candidates appear able to memorise examples of accounting principles, but sometimes lack the understanding to explain the principles that underpin accountancy. Consequently, candidates need to ensure they have an all-round understanding of the syllabus and be prepared to display all facets of the syllabus. It appears as though some candidates seem to rely on their numerical skills alone and this often proves a flawed strategy for success in this paper. 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, 2011 Page 16 of 16