Accounting Principles Question Paper, Answers and€¦ · Unit 02 Level 3 Diploma in Credit Management June 2014 Instructions to candidates Answer any FIVE questions. All questions

June 2014 7B/PQP/1 continued

Accounting Principles

Question Paper, Answers and

Examiner’s Comments

Level 3 Diploma June 2014


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Institute of Credit Management

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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 important

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

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


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 2013.

DR CR

£ £

Capital 1 January 2013 55,410

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 2013 10,000

Bank 2,100

Purchases and sales 101,000 144,250

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 249,700 249,700

Notes as at 31 December 2013:

1. Stock was valued at £9,500

2. 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 £300

4. Provision for doubtful debts is to be maintained at 5% of debtors.


TASK

Use the trial balance and the accompanying notes to prepare the final accounts of the

business for the year ended 31 December 2013. (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

143,000

less Cost of Sales

Opening Stock

10,000

Purchases

101,000

less Purchases Returns/Returns

Outwards

1,000

100,000

add Carriage Inwards

1,150

101,150

111,150

less Closing Stock

9,500

101,650

= Gross Profit

41,350

less Expenses

Carriage Outwards

1,240

Motor Expenses

3,400

Sundries

3,160

Wages & Salaries (12,300 + 1,200)

13,500

Telephone and Insurance

(1,800 - 300)

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

120

30,395

Net Profit

10,955


Working 1: 5% x 11200 = 560. 560 - 440 = 120

Working 2: 2% x 50000 = 1000 PL BS PFD = 4400

Working 3: 12.5% x 13000 = 1625 PL BS PFD = 4225

Working 4: 28000 - 8600 = 19400 x 25% = 4850 PL PFD 8600 + 4850 = 13450

Balance Sheet for Rely On Me as at 31 December 2013

£

£

£

Cost Acc Dep N.B.V.

Fixed Assets

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

91,000

22,075

68,925

Current Assets

Stock

9,500

Debtors

11,200

less Provision for DD

560

10,640

Prepayments

300

Bank

2,100

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

10,100

855

56,265


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.

Total 20 marks


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. (2 marks)

iii) Sold goods on credit to J Sullivan for £800. (2 marks)

iv) Bought a computer for £1,500 paying by cheque. (2 marks)

v) The owner took £500 out of the bank for his own personal use. (2 marks)

vi) Bought a machine on credit from J Smith £700. (2 marks)

vii) J Sullivan paid part of what she owes £450. (2 marks)

viii) The owner of the business arranged a loan for £2,500. (2 marks)

Total 20 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.


b) Learners might offer their answer in a table such as below:

Assets Liabilities Capital

i) +£10,000 Bank +£10,000

ii) +£1,750 Stock +£1,750 Creditors

(I Johnson)

iii)

-£800 Stock

+£800 Debtors

(J Sullivan)

iv) +£1,500 Computer

-£1,500 Bank

v) -£500 Bank -£500 Drawings

vi) +£700 Machine +£700 Creditors

(J Smith)

vii)

+£450 Bank

-£450 Debtors

(J Sullivan)

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) -£800 Stock (Assets) and +£800 Debtors (J Sullivan) (Assets)

iv) +£1,500 Computer (Assets) and -£1,500 Bank (Assets)

v) -£500 Bank (Assets) and -£500 Drawings (Capital)

vi) +£700 Machine (Assets) and +£700 Creditors (J Smith) (Liabilities)

vii) +£450 Bank (Assets) and -£450 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.

Total 20 marks


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 2014.

Jan 1 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.

Jan 3 A credit note for £3,600 including VAT was received from G Gillies in respect

of returned goods.

Jan 6 A sale of £1,200 including VAT was made to PS Limited, who paid by

cheque.

Jan 16 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.

Jan 17 Invoice received from G Gillies for stock £1,750 plus VAT.

Jan 19 A sales invoice for £3,750 including VAT was sent to C Bradshaw.

Jan 20 TLC purchases a machine for £2,900 plus VAT which is paid for in full by

cheque. (VAT can be reclaimed on this machine).

Jan 24 The owner of TLC, Billy, takes £200 out of the bank for his own personal

use.

Jan 25 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)

Total 20 marks


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


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


01/01/14 Bal b/f 90

01/01/14 C Bradshaw 840 930

Account: Discount received


01/01/14 Bal b/f (90)

16/01/14 G Gillies (600) (690)

Account: G Gillies


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


01/01/14 Bal b/f 12,790

01/01/14 Bank (11,950) ½ 840

01/01/14 Discount A (840) ½ 0

19/01/14 Sales 3,750 3,750


Account: Bank


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) 900

20/01/14 Machine (3,480) (2,580)

24/01/14 Drawings (200) (2,780)

28/01/14 Revenue &

Customs (195) (2,975)

Account: VAT


01/01/14 Bal b/f 300

03/01/14 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


01/01/14 Bal b/f 1,800

Account: Purchases returns


01/01/14 Bal b/f (2,800)

03/01/14 G Gillies (3,000) (5,800)

Account: Machine ½


20/01/14 Bank 2,900 2,900

Account: Drawings


24/01/14 Bank 200 200

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.


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.

Total 20 marks


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 2012 31 December 2013

£ £

Sales 940,000 1,400,000

Opening stock 48,000 68,000

Closing stock 62,000 114,000

Purchases 780,000 880,000

Debtors 97,000 177,000

Creditors 51,000 91,000

Bank 101,000 120,000

Fixed assets 350,000 750,000

Total 20 marks

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.


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

828,000


174,000

Trading Profit & Loss Account – year ended 31 December 2013

£ £ £

Sales 1,400,000

Less cost of sales

Opening stock 68,000

Purchases 880,000

948,000


566,000

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 Debtor Days + Stock Turnover – Creditor Days

Cycle


i)

2012 2013

Stock Turnover 55,000 x 365 = 26 days 91,000 x 365 = 40 days

766,000 834,000

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

780,000 880,000

Working Capital Cycles 38 + 26 – 24 = 40 days 46 + 40 – 38 = 48 days

Stock Turnover 26 40

Debtor Days 38 46

Creditor Days 24 38

Working Capital Cycles 40 48

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 2012 44 days and for 2013 58 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.


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). Total 20 marks


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)

Total 20 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 accounted for is:

Original cost – expected value on disposal / number of expected years of life.


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:

£8,000 - £500 = £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


4,250 2,000


2.375 1,000

Depreciation Year 4 1,875 50% of £1,000 500

500 500

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.


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.

Total 20 marks


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 01.01.2013 (amended exemplar figure) 125,000

Stock 31.12.2013 160,000

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 31.12.2013 80,000

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 2013. (14 marks)

b) What information can be gleaned from the Director’s Report which will be of use

to the credit manager? (6 marks)

Total 20 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 31/12/2013 149,500


*Profit for the year calculated as follows:

Operating profit before tax 31/12/2013 £80,000

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.

£ £ £

Cost Acc Dep N.B.V.

Fixed assets

Plant and equipment 250,000 40,000 210,000

Vehicles 200,000 30,000 170,000

380,000

Current assets

Stock 160,000

Debtors 95,750

Prepayments 25,000

Cash 15,000 295,750

Less current liabilities

Creditors 60,750

Bank overdraft 80,000

Corporation tax 8,000

Dividends 27,500 176,250

Net current assets/Working

capital

119,500

499,500

Less long-term liabilities

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

399,500


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.

Total 20 marks


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)

Total 20 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.


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.

Total 20 marks


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 2013 106,149

Freehold factory at cost 360,000

Motor vehicles at cost 126,000

Stock at 1 January 2013 37,500

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 2013. (10 marks)

c) Outline, using specific examples, three types of error that might not be revealed

by a trial balance. (6 marks)

Total 20 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.


b)

Trial Balance for L Smith as at 31/12/13 Account Dr Cr

£ £

Capital on 1.1.13

106,149

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

318,000

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 831,735 831,735

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 2014 7B/PQP/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.

Total 20 marks

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Documents

Accounting Principles Question Paper, Answers and€¦ · Unit 02 Level 3 Diploma in Credit Management June 2014 Instructions to candidates Answer any FIVE questions. All questions