Examiners commentaries 2008

Examiners commentary 2008

25 Principles of accounting Specific comments on questions Zone A
SECTION A Question 1 Distinction is often made between financial and management accounting. Briefly explain the differences between these terms. This question requires explanation of the differences between financial accounting and management accounting. These differences are covered on pages 16 and 17 of the subject guide. Good answers would link the attributes of the two types of accounting, for example:
Financial accounting Is concerned with the preparation of accounting information for the needs of users who are external to the business. Management accounting Is concerned with the preparation of accounting information for the needs of users who are internal to the business.

Question 2 The chairman of Lateen Ltd [For full question please refer to the examination paper.] Accounting ratios are an important element of the syllabus; this question requires ratios to be used in constructing a balance sheet. The information given was sufficient to determine the following balance sheet figures: Current assets Quick assets ( Cash Stock Fixed assets (1.75 x 125,000) (1.05 x 125,000) 52) = (Quick Assets Debtors) = (Current Assets Quick Assets) = (Total Assets Current Assets) = ((260,000 x 20%) 33,250) Share capital = (Net assets retained profits) = (143,750 18,750) = 125,000 = = = = 71,250 87,500 50,000 18,750 = = = 218,750 131,250 60,000

Debtors (260,000 x 12)

Retained profits = (Gross Profit expenses)

Using these figures and the amount given for current liabilities, a complete summarised balance sheet can be constructed. The topic of accounting ratios is dealt with on pp.106113 of the subject guide and in Chapter 16 of Glautier and Underdown.

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Question 3 Galleon Ltd commenced business [For full question please refer to the examination paper.] Depreciation is one of the fundamental accounting issues and this question tests students ability to apply a given depreciation policy to a set of facts. Part (a) requires computation of the profit and loss account depreciation charge for each of two years (2007: 6,900; 2008: 9,425) together with the loss on disposal of the vehicle (2008: 8,800). Part (b) requires the relevant balance sheet values of cost (2007: 41,000; 2008: 8,700) and accumulated depreciation (2007: 6,900; 2008: 12,325). In this type of question the presentation of clear workings is essential. There are examples of these calculations in the subject guide (pp.5761). Question 4 Dhow Ltds [For full question please refer to the examination paper.] (a) Prepare a forecast outline balance sheet for Dhow Ltd as at 31st March 2009, incorporating the above transactions. (a) It is important to understand the practical implications of different types of share issue on a companys shareholders funds in the balance sheet. This question involves a bonus issue and a subsequent rights issue at a premium. The question also involves an issue of loan stock. These transactions give rise to the following forecast balance sheet:
m Forecast balance sheet as at 31st March 2009 Net assets Loans (20 + 10) 148 (30) 118 60 8 50 118

Ordinary shares of 1 each Share Premium Retained earnings

In this type of question, clear workings are essential; in particular, in the calculation of the impact of each transaction on the companys retained earnings and net assets. The relevant issues are dealt with on pages 88 and 89 of the subject guide. (b) Describe how each of the share issues in the year ended 31st March 2009 will affect the earnings per share of Dhow Ltd. (b) This section requires descriptions of how each share issue will affect the earnings per share (EPS) but did not ask for calculations of EPS. The answers could be quite short as follows: Bonus issue increases shares and thus will reduce the EPS.

Examiners commentaries 2008

Rights issue will increase shares but also generate profits from new funds therefore impact will probably be to increase EPS.

Earnings per Share is explained on page 113 of the subject guide. Question 5 The following data [For full question please refer to the examination paper.] The calculation of stock value by application of a specific accounting base is a common and relatively straightforward examination question. This question requires the use of the FIFO method and the basic data gives a closing stock at 31st December 2007 of 35,500 and cost of sales for the six months ending on that date of 61,500. The above figures needed to be adjusted for the two additional pieces of information. The transport charge should be included in the cost of the relevant units, thus closing stock increases by 2,500. However, as this amount will also be included in purchases, the cost of sales figure remains unchanged. The closing stock figure should be written down by 6,000 to net realisable value. However, this amount should not be included as cost of sales but reflected in the profit and loss account as an exceptional charge. Inventory, purchases and sales calculations are given on pages 52 and 53 of the subject guide. Question 6 Skiff Plc [For full question please refer to the examination paper.] Required: Calculate the profit earned on sales to each of the customers and the net profit margin for each customer (A, B and C). Briefly comment on your answers. This question involves the calculation of profit for different customers where each has different trading terms with the reporting company. The results obtained are as follows:
A 73,000 11.4% B 51,000 12.75% C 63,000 19.7%

Profit after customer costs Net profit margin

The question required brief commentary on these results: The gross profit figures simply show that the largest sales produce the highest gross profit, but the picture becomes more complex when the customer related expenses are included. A, the largest customer, still produces the highest profit, but not the best margin, as B and C are higher. In fact, C the smallest customer produces the highest margin. Question 7 Xebec Ltd manufactures [For full question please refer to the examination paper.] Required: Calculate the mix of sales which would enable Xebec Ltd to maximise profits, and calculate the profit for the year which would be achieved by that sales mix.

25 Principles of accounting

This question requires an application of contribution analysis. The limited factor is clearly identified as raw material Essence and thus the first stage is to calculate the contribution per kilo of Essence for each product (Silk 2.50; Musk 6; Opia 3.33). Having established this, the products are ranked in order of contribution per kilo and after applying the maximum market demand constraint the optimum production schedule is: Units Musk Opia Silk 8,000 15,000 33,500

The resulting maximum net profit is 215,500. An example of this type of calculation is found on pages 159160 of the subject guide. Question 8 Dinghy Products Ltd [For full question please refer to the examination paper.] Required: Calculate the indirect cost of producing a mast and a boom. The topic of overhead (indirect cost) absorption using traditional full cost methods is covered on pages 142145 of the subject guide (a further example is given on page 148) and in detail in Chapter 26 of Glautier and Underdown. This topic has not been tested before in this format therefore a full answer is given below:
Indirect costs Storemans salary Office clerks salary Rent (basis: floorspace) Sub-total Reapportion (basis: issues) Total departmental costs Total direct labour hours (W) Indirect cost per labour hour Indirect cost per mast Indirect cost per boom Turning Finishing Office 1,500 20 1,520 1,520 Storeroom 1,300 80 1,380 (1,380) Total 1,300 1,500 1,000 3,800 3,800

600 600 1,104 1,704 3,800 0.448 1.344 1.792

300 300 276 576 3,200 0.18 0.72 0.54

2.064 2.332

The use of a columnar format would be essential in answering this question. Question 9 What factors should be considered when deciding whether to use full or marginal costing? This question requires a discussion of the factors which should be considered in deciding whether to use full or marginal costing. This topic is specifically dealt with on page 145 of the subject guide. Answers which explained the two techniques in detail would not specifically answer the question being asked. This is a common mistake made by candidates and clearly illustrates the need to read the

Examiners commentaries 2008

question (even very short ones) carefully and to address the specific issues raised. Question 10 Lugger Ltd [For full question please refer to the examination paper.] Required: (a) Calculate the break-even point and margin of safety for the present machine, using current demand. Give your answers in terms of units produced. (b) Comment on the proposal to lease the new machine, giving calculations to support your comments. Break-even and contribution analysis are key areas of the management accounting syllabus. Part (a) of this question needs a calculation of the contribution per unit of 12 (186). Note that this is not reduced by the direct labour cost which is clearly identified as being not dependent on the level of production and thus a fixed cost for this calculation. The contribution per unit is then used to calculate break-even point (18,333 units) and margin of safety (1.667 units). Part (b) requires comment on the leasing proposal including supporting calculations. The break-even point is higher (8.661 units) and margin of safety is lower (1,333 units). At 10,000 units the current and proposed machines give the same total cost and profit figures. Thus, there is no compelling financial support for the leasing of the new machine. This type of analysis is covered on pages 157161 of the subject guide and in Chapter 31 of Glautier and Underdown. Question 11 Proa Ltd [For full question please refer to the examination paper.] Required: (a) Calculate the average accounting rate of return over the life of the project. (b) Calculate the payback period for the project. Investment appraisal using accounting rate of return (ARR) and payback are recurring themes in this examination. In answering part (a) it is necessary to adjust the annual cash flows for depreciation to give average annual profit (13,500) and to calculate average investment (7,500). Thus average ARR is 18 per cent. Part (b) uses the annual cash flows to give a payback period of three years two months. These calculations are explained on pages 166171 of the subject guide. Question 12 Glautier and Underdown [For full question please refer to the examination paper.] The five stages of planning identified by Glautier and Underdown (page 353) are summarised as follows: 1. Setting organisational objectives

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2. Assessing the environment in which the organisation will be operating by reference to the external factors which are likely to affect its operations. For this purpose forecasts have to be made which attempt to predict what will happen in the future, with and without policy changing on the part of the planning organisation. 3. Assessing existing resources, for management is concerned with making the most efficient use of those scarce resources, often called the four Ms: men, machines, materials and money. This aspect of the planning function involves making an estimate both of external resources which are accessible, and resources already held which are either idle or which might be more efficiently utilised. 4. Determining the strategy for achieving the stated objectives by means of an overall plan which specifies strategic goals. Strategic decisions are concerned with establishing the relationship between the firm and its environment. 5. Designing a programme of action to achieve the selected strategic goals by means of both long-range programmes and shortrange programmes; the latter covering a period of a year or less and containing sets of instructions of the type found in annual budgets. Once more it is necessary to read the question carefully; it is quite specific and answers which dealt with, for example, only the advantages of budgets as part of planning would be insufficient. SECTION B Question 13 Clipper Ltd [For full question please refer to the examination paper.] Required: (a) Show the adjustments necessary to eliminate the balance on the suspence account. (5 marks) (a) This question requires a statement showing how the balance on the suspense account should be eliminated. Although this statement could be in any appropriate format a double entry based approach would be shown as follows:
Suspense account Balance

B/ d

50,200 1,000 5.100 700 57,000

Purchases (closing stock)

57,000

Disposal proceeds Provisions Debtors (Bal.fig)

______ 57,000

(b) A profit and loss account for Clipper Ltd for the year ended 31st December 2007 and a balance sheet as at that date, in a form suitable for presentation to the directors. (21 marks) (b) Students are strongly advised to use the eight-column accounting paper in answering this type of question. Often only brief workings are required and therefore a complete set of T accounts or journals is a waste of time. Such workings can be effectively shown on the face of the profit and loss account and balance sheet. However the adjustments necessary to arrive at amounts for cost of

Examiners commentaries 2008

sales, debtors and fixed assets were quite involved and therefore separate clear workings would be necessary to enable candidates to be awarded with all appropriate marks. The profit and loss account and balance sheet for Clipper plc should be properly headed. An acceptable layout with appropriate sub-headings is given in the subject guide (Chapter 6, examples 6.1 and 6.2). The final accounts of Clipper Ltd should be as follows:
Clipper Ltd Profit and loss account for the year ended st 31 December 2007 Sales Cost of sales Gross profit Distribution costs Administration costs Selling costs Directors remuneration Audit fee Bad debts Depreciation Loss on disposal Profit before interest and tax Interest Profit before interest Taxation Profit for the year Dividend paid Retained profit for the year 42,000 56,000 59,500 55,500 4,000 1,850 36,750 5,000

1,050,000 715,000 335,000

260,600 74,400 2,500 71,900 30,000 41,900 15,000 26,900

Fixed assets

Clipper Ltd th Balance sheet as at 30 December 2007 Cost Accumulated Depn/Amor 95,000 180,000 (38,750) (72,000)

Net

Motor vehicles Plant and equipment Current assets Stock (483-24) Debtors Prepayments Bank Creditors: due within one year Trade Accruals Taxation Net current assets (working capital) Total assets less current liabilities Loans Capital and reserves Ordinary share capital Retained Earnings

56,250 108,000 164,250

63,000 75,050 6,000 4,800 148,850 (48,600) (6,500) ( 30,000)

(85,100) 63,750 228,000 (25,000) 203,000 165,000 38,000 203,000

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(c) One of the directors of Clipper Ltd has sent you the following e-mail. Why do we only have 4,800 in the bank when we have retained profits in excess of 30,000? Draft a brief email, without any figures, in response to the director. (4 marks) (c) This question requires a brief explanation of the accounting issues, the confusion is caused by viewing profits as being the same as cash surpluses. Profits represent the increase in the net assets of the firm, that is all assets less all liabilities. Cash represents only one element of the companys resources and profit is the increase in these resources over the year. If you wish to reconcile the increase/decrease in cash balances and the profits for the year you should refer to the cash flow statement attached to the accounts. These fundamental issues are covered in chapter 2 of the subject guide. SECTION C Question 14 (a) Prepare a cash flow statement for Sloop Plc for the year ended 31st March 2008. (16 marks) (a) This question requires preparation of a cash flow statement. Using the eight-column accounting paper is recommended. The direction of cash flows (outflows or inflows) is clearly a key issue and care should be taken to ensure that this is correct. The layout and preparation of a cash flow statement is given on pages 9294 of the subject guide. The cash flow statement of Sloop plc should be as follows:

Examiners commentaries 2008

Cash flow statement for the year ended 31st March 2008 m Operating profit Depreciation Profit on disposal of fixed assets Increase in stock Increase in debtors Increase in prepayments Decrease in trade creditors Net cash flow from operating activities Returns on investment and servicing of finance Investment income Interest paid

m 666 150 (20) (242) (18) (60) (20) 456

30 (34)

(4) (280)

Taxation Capital expenditure Purchase of tangible fixed assets Disposal of tangible fixed assets Purchase of fixed asset investments Equity dividends paid Net cash flow before financing Financing Issue of ordinary shares Repayment of loans Decrease in cash balances Reconciliation of cash balances Decrease in cash at bank Increase in bank overdraft

(324) 160 (36)

(200) (160) (188)

76 (64)

12 (176) 88 88 176

(b) It has been argued that cash flow statements are more reliable than financial statements prepared under the accruals convention. Briefly examine this argument. (4 marks) (b) The argument proposed is that cash flow statements are more reliable than accruals-based financial statements. Answers should examine the comparative objectivity of cash flow statements and the subjective nature of some accruals-based estimates and judgments. Good answers would clearly identify the trade-off between relevance and reliability and assess the usefulness of both conventions in isolation and as a total reporting package. Question 15 Cleanahull Ltd [For full question please refer to the examination paper.] Required: (a) Prepare an operating statement, reconciling budgeted and actual profit for Cleanahull Ltd for May 2008 showing two variances for sales and for each cost category. (13 marks) (a) Budgetary control, performance evaluation and variance analysis are frequently examined in this paper. It is very important that full

25 Principles of accounting

workings are shown and that students ensure they understand and clearly indicate the direction (favourable or unfavourable) of the variances computed. A straightforward layout of the operating statement is given below.
Operating statement for Cleanahull for May 2008 Budgeted profit for month (288 x 18) Sales margin volume variance Standard profit for actual sales Sales price variance Cost variances Material Price variance Efficiency variance Skilled labour Price variance Efficiency variance Unskilled labour Price variance Efficiency variance Variable overheads Spending variance Efficiency variance Fixed overheads Spending variance Volume variance Actual profit for month Fav Unfav 140 60 297 528 99 330 165 140 1,260 2,192 5,184 756 5,940 600 6,600

___ 827

1,365 7,965

(b)Prepare a brief report to the owner of Cleanahull Ltd commenting on the performance in May 2008 suggesting possible reasons for any unexpected results. (7 marks) (b) This part of the question requires a brief report which comments on the variances and suggests possible reasons for unexpected results. Good answers should go beyond statements of the facts, e.g. unfavourable labour variances show they were paid more; instead they should give a more meaningful analysis. Again using labour cost as an example a good answer might be as follows:
Skilled labour has been used very efficiently with 10% less hours than standard; this has resulted in a substantial favourable variance. However the unskilled labour is a similar amount over budget (66 hours), thus producing an unfavourable variance. It appears that Cleanahull is short of skilled labour and may have substituted unskilled. This has led to a cost saving of 198 (66 x [8-5]). As long as there has been no loss in quality this is satisfactory, although Cleanahull should establish whether the use of unskilled labour has been the cause of the overuse of materials. The shortage of skilled labour may also be the cause of the skilled labour price variance labour may be short and those workers may work overtime or be paid more than budget. The unskilled labour is being paid below budget by 5% which again suggests there is no shortage.

Variance analysis, with comprehensive examples, is covered on pages 198206 of the subject guide.

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Examiners commentaries 2008

Question 16 Yawl Ltd [For full question please refer to the examination paper.] (a) Use the net present value method of project appraisal to advise the management of Yawl Ltd whether to go ahead with the product. (12 marks) Required: (a) Investment appraisal using discounting methods is a key part of the syllabus. This question combines application of the Net Present Value method of investment appraisal with an understanding of opportunity costs. It is important to adopt a well-organised approach to the layout of the answer. In answering this type of question it is strongly advised that the eight-column accounting paper be used to produce a table of cash flows and present values for each of the relevant years. The most appropriate way of presenting the answer to this question is as follows:
000s 2009 start 2009 end 0 2010 2011 2012 2013 2014

Sales 800 800 800 640 400 Equipment (480) 80 Stock (60) 60 Working capital (40) 40 Overheads (16) (16) (19.2) (19.2) (19.2) Material (480) (480) (480) (384) (240) Variable costs (80) (80) (80) (64) (40) Cash flow (580) (576) 224 220.8 332.8 520.8 400 Discount factor 0 0.893 0.797 0.712 0.636 0.567 0.507 Discounted cash flow (580) (514.4) 178.5 157.2 211.7 295.3 202.8 NPV = 48,900 A negative NPV indicates that the project is expected to earn less than the opportunity cost of capital of the finance providers. This firm would serve its shareholders best by not proceeding with this project.

(b) List and briefly explain the key points you would make to a management team unfamiliar with discounted cash flow appraisal techniques. (8 marks) (b) The key points should explain the following: the time value of money discounting cash flows to a common point in time opportunity cost of investors funds minimum rate of return required on a project NPV = shareholder wealth increase NPV decision rule the significance of being cash flow-based rather than profit-based only incremental cash flows are considered.

The relevant examples and discussion of disconnected cash flow appraisal techniques is covered in Chapter 13 of the subject guide and pp.490500 of Glautier and Underdown.

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Question 17 Ketch plc [For full question please refer to the examination paper.] Required: (a) Prepare a break-even price report [For full question please refer to the examination paper.] (14 marks) (a) This question requires application of a number of decision-making techniques; in particular the identification of relevant costs, sunk costs and opportunity costs. A key part of the requirement is the explanation of each cost included in the final amount and the reasons for exclusion of any costs which are referred to in the original data. Good answers would clearly link all of the costs included and excluded, with the explanations. A brief summary of these are given below:
Break-even for final order for pump Material A (note 1) Material B (1,000 x 3.15 note 2) Labour (1,000 x x x 12 note 3) Variable overheads - supervisors overtime (note 4) - packaging 1,000 x 50p (note 5) Fixed costs - depreciation (note 6) - maintenance (note 7) Notes: 1. 2. 3. 4. 5. 6. 7. Opportunity cost being half of the sale proceeds. Replacement cost will include the 5 per cent price increase. There is no change in the basic labour costs but half of the 500 hours will be paid at 50 per cent extra this must be included. There is no increase in supervisors overtime as a result of this order. The special packaging is a relevant cost for this order. No depreciation needs to be included. This is an irrelevant sunk cost, so there is no loss of value through additional use. The additional maintenance charge is relevant it would not be paid if this order were not accepted. 1,000 3,150 3,000 500 250 7,900

(b) Prepare a brief report to the sales manager [For full question please refer to the examination paper.] (b) This analytical question should be answered by clearly identifying three issues as required. These should relate the key strategic and operational matters raised by the decision facing the company and relate these appropriately to the answer given to part (a). Good answers go beyond a simple restatement of the facts given in part (a). Information for short-run tactical decisions is covered in the subject guide (pp.151161) and Glautier and Underdown (Chapter 31).

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Examiners commentaries 2008

Examiners commentary 2008

25 Principles of accounting Specific comments on questions Zone B
SECTION A Question 1 Distinction is often made between financial and management accounting. Briefly explain the differences between these terms. This question requires explanation of the differences between financial accounting and management accounting. These differences are covered on pages 16 and 17 of the subject guide. Good answers would link the attributes of the two types of accounting, for example:
Financial accounting Is concerned with the preparation of accounting information for the needs of users who are external to the business. Management accounting Is concerned with the preparation of accounting information for the needs of users who are internal to the business.

Question 2 The following information is available in respect of Bagehot Ltd [For full question please refer to the examination paper.] Required: Prepare for Bagehot Ltd a profit and loss account for the year ended 31st December 2007 and a balance sheet as at that date, in as much detail as possible, taking into account all the above information. This question requires the use of accounting ratios in constructing a set of financial statements from incomplete information. In this situation the key is to adopt a logical approach starting from the actual amounts given; in this case we know the figures for debtors, opening stock, purchases, loans and share capital. If these amounts are placed into the financial statements then the ratios can be used to find most of the other items. There are some items which are deduced as balancing figures, for example expenses and reserves bought forward.
Bagehot Ltd. Profit and Loss Account for the year ended 31st December 2007 Sales (33,600 x 12) Opening stock Purchases Closing stock (Bal fig) Expenses (Bal. Fig) Net Profit (403,200 x 5%) 403,200 28,000 360,000 388,000 (85,600)

302,400 100,800 80,640 20,160

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Balance sheet as at 31st December 2007 Fixed assets (403,200 4) Current assets Stock Debtors Cash at bank (Note 1) Creditors (360,000 12) Loan Share Capital Reserves : Brought forward Current year Note 1 Creditors Acid Test Debtors + Bank Bank = = = = 30,000 2:1 60,000 26,400 100,800 85,600 33,600 26,400 145,600 (30,000)

115,600 216,400 (29,520) 186,880 39,120 147,760 186,880

127,600 20,160

Accounting ratios are covered on pages 106116 of the subject guide. Question 3 In the books of Beveridge Ltd the creditors ledger control account [For full question please refer to the examination paper.] Required: (a) Calculate the corrected creditors ledger control account balance, and, (b) reconcile this with the total of the individual creditors balances in the creditors ledger. Control accounts play an important part in internal control within a record keeping system based on double entry. This is a typical question which involves the correction of the balances in the creditors ledger control account (321.100). The second part of the question requires the reconciliation of this figure with the total of the individual creditors balances in the creditors ledger; the final figure in this reconciliation is an error which is the balancing figure (3,570). The key to this type of question is a clear distinction between the adjustments to the control account on the one hand; and the list of balances on the other. An illustrative example of this type of question is found on page 44 of the subject guide.

Examiners commentaries 2008

Question 4 Hicks Plcs outline balance sheet [For full question please refer to the examination paper.] Required: (a) Prepare a forecast outline balance sheet for Hicks Plc as at 31st March 2009, incorporating the above transactions. (a) It is important to understand the practical implications of different types of share issue on a companys shareholders funds in the balance sheet. This question involves a bonus issue and a subsequent rights issue at a premium. The question also involves an issue of loan stock. These transactions give rise to the following forecast balance sheet:
m
st Forecast balance sheet as at 31 March 2009

Net assets Loans

122 (20) 102 60 8 34 102

Ordinary shares of 1 each Share premium Retained earnings

In this type of question clear workings are essential, in particular in the calculation of the impact of each transaction on the companys retained earnings and net assets. The relevant issues are dealt with on pages 88 and 89 of the subject guide. (b) Describe, without calculations, how each of the share issues in the year ended 31st March 2009 will affect the earnings per share of Hicks Plc. (b) This section requires descriptions of how each share issue will affect the earnings per share (EPS) but did not ask for calculations of EPS. The answers could be quite short as follows: Bonus issue increase shares and thus will reduce the EPS. Rights issue will increase shares but also generate profits from new funds the impact will probably be to increase EPS. Earnings per Share is explained on page 113 of the subject guide. Question 5 Explain, with examples, the terms monetary assets and non-monetary assets and describe their treatment in historical cost accounting and one alternative valuation convention. There are essentially three elements to this question as follows: 1. explain the terms 2. give examples 3. describe the treatment under HCA and one alternative.

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Good answers would have clearly addressed all of these elements as follows. Monetary assets are those which by their nature, or by contract, are expressed in pounds (money values) regardless of changes in price levels. Examples are cash, debtors and bank balances. Non-monetary assets are those which have a value which may be regarded as changing in line with changing price levels of different types of asset: examples are stocks and fixed assets. Accounting treatment Monetary HCA Current money value CPP Current money value OR CVA Current money value Non-monetary HC HC x change in purchasing power of Replacement cost or Realisable value or Value in use.

The issues in this question are dealt with on pages 127128 of the subject guide, and on pages 321336 of Glautier and Underdown. Question 6 Clark Distributors Ltd began business [For full question please refer to the examination paper.] Required: Using only the data in the table above, calculate the cost of sales and closing stock figures for inclusion in the accounts for the six months to 31st December 2007 under both the FIFO and LIFO assumptions. The calculation of cost of sales and stock values by application of the various accounting bases is a common and relatively straightforward examination question. There were no particular problems posed by this question, which gave FIFO values of 6,500 and 35,500; under LIFO the amounts are 60,500 and 36,500. A worked example of this type of question is given on page 53 of the subject guide. It is important to provide your workings for this type of question. Question 7 Smith Plc manufactures and sells a range of [For full question please refer to the examination paper.] Required: (a) Compute the following variances for product Adam for July. (i) (ii) (iii) Sales price variance. Sales contribution volume variance. Sales margin volume variance.

(a) This question involves the calculation of a number of sales variances, as below: i. Sales price variance 8,000 (U) ii. Sales contribution variance 8,000 (F)

Examiners commentaries 2008

iii. Sales margin volume variances 6,000 (F). (b) The difference between (ii) and (iii) is the treatment of fixed overheads. ii. shows the additional contribution from increased sales and thus ignores the fixed overheads. iii. Shows the additional net margin from increased sales but this includes an allocated fixed cost element. It would be necessary to calculate a separate fixed overhead volume variance to reflect the fact that the increase in volume will not result in any additional fixed costs. Thus
Sales margin volume variance Fixed overhead volume variance* (AQ SQ) x FO per unit (8,000 6,000) x 1 Sales contribution volume variance 6,000 F

2,000 8,000

(F)

Students are always advised to show clear workings. For example, in this question a mistake in one element of the computations would only be penalised for that mistake and the correct elements of the computation would be rewarded as appropriate. For this to be done it is important that workings are clear and legible with relevant descriptions and labels. Pages 201 and 202 of the subject guide give illustrative examples. Question 8 A summary of Pareto Companys profit [For full question please refer to the examination paper.] Required: (a) What is the break-even point in units? (b) What is the margin of safety in units? (c) If an extension to the factory [For full question please refer to the examination paper.] This question tests the application of break-even analysis and the use of a contribution approach to decision making. The techniques are relatively straightforward but students need to read the question carefully in order to use the data correctly. The solutions are as follows: (a) (b) (c) 500,000 units 500,000 units Extension to factory Contribution per unit = 0.50 (30 110) 100 = 0.17 Required contribution

25 Principles of accounting

= FC + Profit = 150,000 + 110,000 = 260,000 Required volume = 260,000 0.17 = 1,529.411 units The required volume is less than the new capacity of 1,600,000 units and so there will be sufficient capacity. Good answers would clearly identify the required levels of contribution and volume in order to give full data for decision making. Short term decision making involving these techniques is covered on pages 152 and 156 of the subject guide and in Chapter 28 of Glautier and Underdown. Question 9 Rickwood Ltd [For full question please refer to the examination paper.] Answers should briefly explain the stages in the process of cost determination. 1. Collect and classify overhead costs as between indirect material, indirect labour and other identifiable cost headings (e.g. power, insurance, depreciation). 2. Allocate these costs to the four production and three service departments (cost centres) using appropriate methods (e.g. floor area, capital value) 3. Apportion the costs of the service departments to the production departments using appropriate methods. 4. Absorb the total indirect cost for each production cost centre into the total cost of each of the three different product lines. This question could easily be misinterpreted by students who do not read the question carefully but see the word cost and write about issues which are not relevant to the specific issue being examined. Traditional costing methods are explained on pages 142144 of the subject guide and a comprehensive coverage is given in Chapter 16 of Glautier and Underdown. Question 10 In the context of cost-volume-profit analysis [For full question please refer to the examination paper.] This question requires brief explanations and give examples of three management accounting terms. To gain good marks both of the requirements must be met. (a) Non-linear variable costs vary with volume of activity but with a cost per unit which is different for different levels of activity. Example: Direct material where there are discounts available for larger orders.

Examiners commentaries 2008

(b) Stepped fixed costs are those which do not vary with volume of activity between two levels of activity but which will require an extra resource at the higher level. Example: Rental of storage facility which has a maximum capacity after which a new facility will have to be rented. (c) The relevant range is the range of outputs over which the assumption that a cost-volume relationship is a linear relationship is realistic. Example: A firm may determine variable and fixed costs which will be realistic between 10,000 and 15,000 units; outside of this range these costs will no longer behave in the assumed linear fashion. These terms are explained within Chapter 11 of the subject guide. Question 11 Hayek Plc is considering investing in either project P or project Q: [For full question please refer to the examination paper.] Required: (a) Calculate the payback period for each project and on this basis advise Hayek Plc which project to invest in. (b) Briefly explain two disadvantages of payback period as a method of investment appraisal. Payback is a straightforward investment appraisal method. The only complication here was remembering to adjust profits to cash flows (by adding back depreciation) to give payback periods of 21/3 years for project P and four years for project Q. Part (b) required standard text book appraisal of the disadvantages of payback, which is discussed on pages 166169 of the subject guide. Question 12 Glautier and Underdown state that [For full question please refer to the examination paper.] The five stages of planning identified by Glautier and Underdown (page 353) are summarised as follows: 1. Setting organisational objectives. 2. Assessing the environment in which the organisation will be operating by reference to the external factors which are likely to affect its operations. For this purpose forecasts have to be made which attempt to predict what will happen in the future, with and without policy changing on the part of the planning organisation. 3. Assessing existing resources; management is concerned with making the most efficient use of scarce resources, often called the four Ms: men, machines, materials and money. This aspect of the planning function involves making an estimate both of external resources which are accessible, and resources already held which are either idle or which might be more efficiently utilised. 4. Determining the strategy for achieving stated objectives by means of an overall plan which specifies strategic goals. Strategic decisions are concerned with establishing the relationship between the firm and its environment.

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5. Designing a programme of action to achieve selected strategic goals by means of both long-range programmes and short-range programmes; the latter covering a period of a year or less and containing sets of instructions of the type found in annual budgets. Once more it is necessary to read the question carefully. The question is quite specific and answers which dealt with, for example, only the advantages of budgets as part of planning would be insufficient. SECTION B Question 13 Keynes Plc is a company incorporated [For full question please refer to the examination paper.] Required: (a) Show any necessary adjustments to the bank balance according to the (3 marks) cash book as at 30th April 2008. (a) The reconciliation of the bank balance per the cash book and the balance on the bank statement often reveals errors and omissions. The adjustment of these and of the other accounting records is a recurring question in this examination. In this case the adjustments are as follows:
Bank balance per trial balance Administration standing order Bank interest paid Compensation received Refund received Bad debt recovered Bank balance per cash book (6,600) (12,000) (900) 20,000 5,000 12,000 17,500

Students are strongly advised to use the eight-column accounting paper in answering this type of question. Often only brief workings are required and therefore a complete set of T accounts or journals is a waste of time. Such workings can be effectively shown on the face of the profit and loss account and balance sheet. However, the adjustments necessary to arrive at amounts for cost of sales, administration cost, loss of equipment, and fixed assets were quite involved and therefore separate clear workings are necessary to enable candidates to be awarded with all the appropriate marks. (b) Prepare a profit and loss account for Keynes Plc for the year ended 30th April 2008 and a balance sheet at that date in a form suitable for the directors. (22 marks) The final accounts of Keynes plc should be as follows:

Examiners commentaries 2008

Keynes plc Profit and loss account for the year ended 30th April 2008 Sales Cost of goods sold Gross profit Bad debt recovered Distribution costs Administration costs Auditors remuneration Depreciation/Amortization Loss on equipment Bad debts Profit before interest and tax Interest Profit before tax Taxation Net profit after tax Dividends paid Retained profit for the year 566,500 511,500 5,000 306,000 50,000 18,000 3,960,000 2,444,000 1,516,000 12,000 1,528,000

1,457,000 71,000 18,900 52,100 3,000 49,100 12,000 37,100

25 Principles of accounting

Keynes plc Balance sheet as at 30th April 2008 Cost Accumulated Depn/Amort 132,000 1,572,000 Net

Fixed assets

Leasehold property Plant and equipment

440,000 2,840,000

308,000 1,268,000 1,576,000

Current assets Stock Debtors Prepayments Bank

459,000 206,000 3,000 17,500 685,500

Creditors: due within one year Creditors Accruals Taxation Net current assets (working capital) Total assets less current liabilities Creditors: due after one year Capital and reserves Issued ordinary share capital Reserves: Share premium Retained earnings

(389,400) (24,000) ( 3,000)

(416,400) 269,100 1,845,100 (180,000) 1,665,100 660,000 428,000 577,100 1,005,100 1,665,100

The profit and loss account and balance sheet for Keynes plc should be properly headed and an acceptable layout with appropriate subheadings is given in the subject guide (see Chapter 6 examples 6.1 and 6.2). (c) Draft a note in response to the directors statement. (5 marks) The section requires a draft note in response to the directors statement. The main points to be included in a comprehensive answer were: accounts prepared on the basis of historical cost asset values of non-monetary assets do not reflect current value freeholds are not included at the moment at valuation but could be with change of accounting policy plant and equipment stated at depreciated historical cost and only reduced to realisable value if have a lower value in use

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SECTION C

thus the balance sheet should not be used as a statement of corporate value.

Question 14 The following are the summarised accounts of Toynbee Plc [For full question please refer to the examination paper.] Required: (a) Prepare a cash flow statement for Toynbee Plc for the year ended 31st December 2007. (16 marks) This question requires preparation of a cash flow statement. Using the eight-column accounting paper is recommended. The direction of cash flows (outflows or inflows) is clearly a key issue and care should be taken to ensure that this is correct. The layout and preparation of a cash flow statement is given on pages 9294 of the subject guide. (a) The cash flow statement of Toynbee plc should be as follows:
Toynbee plc Cash flow statement for the year ended 31 December 2007 m Operating profit Depreciation Profit on disposal of fixed assets Increase in stock Increase in debtors Increase in prepayments Decrease in trade creditors Net cash flow from operating activities Returns on investment and servicing of finance Investment income Interest paid m 666 150 (20) (242) (18) (60) (20) 456

30 (34)

(4) (280)

Taxation Capital expenditure Purchase of tangible fixed assets Disposal of tangible fixed assets Purchase of fixed asset investments Equity dividends paid Net cash flow before financing Financing Issue of ordinary shares Repayment of loans Decrease in cash balances Reconciliation of cash balances Decrease in cash at bank Increase in bank overdraft

(324) 160 (36)

(200) (160) (188)

76 (64)

12 (176) 88 88 176

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(b) It has been argued that cash flow statements are more reliable than financial statements prepared under the accruals convention. Briefly examine this argument. (4 marks) (b) This question specifically deals with arguments in respect of the reliability of cash versus accruals accounting. Answers which covered the general advantages/disadvantages of cash flow statements would not address the issue. Students are again strongly advised to read even short questions very carefully and to focus on the specific issue raised. Answers should discuss the following: subjective nature of accruals convention giving examples of estimates and judgments such as stock values, depreciation, debt provisions, etc. comparative objectivity of cash flow statements trade off between reliability and relevance thus while cash flows are more reliable on their own they are less relevant for assessing financial performance and position.

Question 15 Coase Ltd is a single-product manufacturing company [For full question please refer to the examination paper.] Required: (a) Prepare internal management profit statements for the year ended 30th June 2008 using marginal costing. (7 marks) (b) Prepare a draft profit and loss account for the year ended 30th June 2008 using full absorption costing. (8 marks) (c) Give calculations showing why the profits for 2008 are not the same in your answers to (a) and (b) above. Explain your answer. (5 marks) Chapter 10 of the subject guide covers cost accounting and the differences between marginal and traditional absorption costing. This question requires an application of the techniques explained in Chapter 10. Students should think carefully about the layout to be used in presenting their answer. A key issue is the measurement of the value of stocks under each method. Students should carefully structure their layouts to bring out the important features of their answer and give all relevant workings. The question asks for statements for the year ended 30th June 2008 only and anyone producing 2007 figures would be wasting valuable time and effort. A suggested presentation of the answer is as follows:

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Coase Ltd (a) Profit statement using marginal costing for year ended 30 June 2008 Sales (25,000 x 90) Opening stock (2,000 x 48) Production cost (24,500 x 55) Closing stock (1,500 x 55) Cost of sales Selling of admin expenses (25,000 x 3) Contribution Fixed overhead Profit 96,000 1,347,500 1,443,500 (82,500) 2,250,000

1,361,000 889,000 75,000 814,000 180,000 634,000

(b) Profit statement using absorption costing for the year ended 30 June 2008 Sales revenue Opening stock (2,000 x 54.07) Production cost (24,500 x 61.43) Closing stock (1,500 x 61.43) Cost of sales Under-absorption (3,500 x 6.43) Selling and admin costs Profit (c) Marginal profit Fixed overhead B/F in absorption O Stock 2,000 x 6.07 Fixed overhead C/F in absorption C Stock 1,500 x 6.43 Reduction in absorption profit Absorption profit 634,000 12,143 9,643 2,500 631,500 108,143 1,505,000 1,613,143 92,143 1,521,000 729,000 22,500 706,500 75,000 631,500 2,250,000

The difference in profit figures is caused by the different treatments of fixed production overheads. Fixed overheads are all written off as period costs in marginal costing systems, while a proportion is carried forward in stock valuation in absorption costing systems. The above reconciliation shows exactly how the profit figures differ.

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Question 16 Wilkies Ltd [For full question please refer to the examination paper.] Required: (a) Use the net present value method of project appraisal to advice the management of Wilkes Ltd whether to go ahead with the proposed project. (12 marks) (b) List and briefly explain the key points you would make to a management team unfamiliar with discounted cash flow appraisal techniques. (8 marks) (a) Investment appraisal using discounting methods is a key part of the syllabus. This question continues application of the Net Present Value method of investment appraisal with an understanding of opportunity costs. It is important to adopt a well organised approach to the layout of an answer. In answering this type of question it is strongly advised that the eight-column accounting paper be used to produce a table of cash flows and present values for each of the relevant years. The most appropriate way of presenting the answer to this question is as follows:
000s Sales Equipment Stock Working capital Overheads Material Variable costs Cash flow Discount factor Discounted cash flow NPV = -24,500 2009 start (-240) (-30) (-20) (-8) (-240) (-40) (-288) 0.893 (257.2) (-8) (-240) (-40) +112 0.797 89.3 (-9.6) (-240) (-40) +110.4 0.712 78.6 (9.6) (-192) (-32) +166.4 0.636 105.8 2009 end 0 2010 +400 2011 +400 2012 +400 2013 +320 +40 +30 +20 (-9.6) (-120) (-20) +260.4 0.567 147.6 2014 200

(-290) 0 (290)

+200 0.507 101.4

A negative NPV indicates that the project is expected to earn less than the opportunity cost of capital of the finance providers. This firm would serve its shareholders best by not proceeding with this project. Good answers would also explain the omission of sunk costs (research 20,000) and non cash-flow items (depreciation). (a) The key points to be included in this explanation are: the time value of money discounting cash flows to a common point in time opportunity cost of investors funds minimum rate of return required on a project NPV = shareholder wealth increase NPV decision rule the significance of being cash flow-based rather than profit-based only incremental cash flows are considered.

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The relevant examples and discussion of discounted cash flow appraisal techniques is covered in Chapter 13 of the subject guide and pages 490500 of Glautier and Underdown. Question 17 The production manager [For full question please refer to the examination paper.] (a) Cost the project for the production manager, clearly stating how you have arrived at your figures and giving reasons for the exclusion of other figures. (10 marks) (b) State whether the company should tender for the project, giving the reasons why and the price, bearing in mind that the competitor is prepared to undertake the project for 30,000. (6 marks) (c) Identify four non-monetary factors that should be taken into account before tendering for this project. (4 marks) This question involves analysis of a complex set of information in order to determine the relevant costs for a decision on acceptance of a special job. This involves recognition of relevant, incremental and opportunity costs and setting aside of any sunk costs or costs not relevant to the decision. Students should note that the requirement asks for an explanation of each of the figures used. Good answers should explain why the individual costs were or were not included in the calculations. Question 11.2 on page 162 of the subject guide gives a good example of this type of problem. The following provides a summary of the calculations and explanations required. (a) Relevant costs of the project
Material A Material B Direct labour Net cost of machinery Relevant cost Contract price Contribution Notes: There is a saving in material costs of 1,750 if material A is not used. The actual cost of material B represents the incremental cost. The hiring of the labour on the other contract represents the additional cash flows of undertaking this contract. The net cost of purchasing the machinery represents the additional cash flows associated with the contract. Supervision and overheads will still continue even if the contract is not accepted and are therefore irrelevant. (1,750) 8,000 7,000 4,750 18,000 30,000 12,000

(b) The report should indicate that the costs given in the question do not represent incremental cash flows arising from undertaking the contract. Incremental costs will provide an additional contribution which will result in an increase in profits. Assuming that the

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company has spare capacity and that a competitor is prepared to accept the order at 30,000 then a tender price slightly below 30,000 would be appropriate. The price given by the production manager includes non-relevant costs. c) Before accepting the contract the following non-monetary factors might be considered. i. Is there sufficient spare capacity to undertake the project? ii. Is the overseas customer credit worthy? iii. Has the workforce the necessary skills to undertake the project? iv. Is the contract likely to result in repeat business with the customer? Students may have identified other relevant issues and appropriate marks would be awarded. However answers which simply repeated the figures and explanations in (a) would not be sufficient.

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