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Answers to activities, practice exercises

and exam practice questions


This text has not been through the Cambridge endorsement process.
All answers that appear in this publication have been written by the author.

1 Double-entry bookkeeping: cash transactions


Practice exercises
1
Debit account Credit account
1 Noel pays a cheque into his Bank Noel – Capital
business bank account as
capital
2 Purchases some goods for Purchases Bank
[1] The cheque which
resale and pays by cheque
Noel cashed was for his
personal expenses. It is 3 Sells some goods and banks Bank Sales
therefore debited to the the takings
Drawings account.
4 Pays rent by cheque Rent payable Bank
5 Purchases shop fittings and Shop fittings Bank
pays by cheque
[2] Following the
principle of purchases 6 Cashes cheque for personal Drawings Bank
returns, sales returns are expenses [1]
always debited to their
own account, never to 7 Pays wages by cheque Wages Bank
2 the sales account. 8 Returns goods to supplier and Bank Purchases returns
banks refund
9 Receives rent from tenant and Bank Rent receivable
[3] The costs of running banks cheque
motor vehicles (petrol,
licence, insurance,
10 Refunds money to customer by Sales returns Bank
repairs, etc.) are not cheque for goods returned [2]
debited to the motor 11 Motor vehicle purchased and Motor vehicles Bank
vehicles account. A
paid for by cheque
new account, motor
expenses, is opened to 12 Pays for petrol for motor vehicle Motor expenses Bank
record them. and pays by cheque [3]

2 Bank account
$ $
May 1 Martine – capital 300 May 3 Rent payable 100
May 2 Charline – loan 1 000 May 4 Shop fittings 400
May 5 Purchases 20 May 4 Purchases 300
returns
May 6 Sales 40 May 7 Wages 60
May 8 Drawings 100

Martine capital account


$ $
May 1 Bank 300

Charline – Loan account


$ $
May 2 Bank 1 000
Answers to activities, practice exercises and exam practice questions: Chapter 1

Rent payable account


$ $
May 3 Bank 100

Shop fittings account


$ $
May 4 Bank 400

Purchases account
$ $
May 4 Bank 300

Purchases returns account


$ $
May 5 Bank 20

Sales account
$ $
May 6 Bank 40

Wages account
$ $
May 7 Bank 60

Drawings account 3
$ $
May 8 Bank 100

Notes:
1 The narrative must always contain the name of the account where the
opposite entry can be made.
2 Purchases returns are always posted to their own account, never to the
credit of the purchases account.
3 a 
Debit account Credit account
July 1 Lee started business by paying $20 000 of his savings into a Bank Capital
business bank account
He also had $500 in cash which he decided to use to pay Cash Capital
cash expenses for the business
2 Bought some goods for resale for $1300, paying by cheque Purchases Bank
3 Paid $2500 by cheque to rent some business premises Rent payable Bank
4 Bought some office furniture by cheque for $750 Office furniture Bank
Bought office stationery for $120, paying by cash Stationery Cash
6 Sold some goods for $1700 and paid the money into the bank Bank Sales
Sold more goods for $180. He received cash for this sale Cash Sales
8 Retuned some faulty goods valued at $60 to the supplier and Bank Purchases
received a cheque refund returns
9 A customer returned some faulty goods. Lee gave the Sales returns Cash
customer a cash refund of $25
10 Sold goods for $420. Lee received cash for the goods. Cash Sales
He kept $200 as business cash and banked the rest Bank
11 Lee took cash drawings of $160 Drawings Cash
Cambridge International AS and A Level Accounting

b Bank account
$ $
July 1 Capital 20 000 July 2 Purchases 1 300
July 6 Sales 1 700 July 3 Rent 2 500
July 8 Purchases returns 60 July 4 Office furniture 750
July 10 Sales 220

Cash account
$ $
July 1 Capital 500 July 4 Stationery 120
July 6 Sales 180 July 9 Sales returns 25
July 10 Sales 200 July 11 Drawings 160

Capital account
$ $
July 1 Bank 20 000
Cash 500

Purchases account
$ $
July 2 Bank 1 300

4 Sales account
$ $
July 6 Bank 1 700
Cash 180
July 10 Bank 220
Cash 200

Purchases returns account


$ $
July 8 Bank 60

Sales returns account


$ $
July 9 Cash 25

Rent account
$ $
July 3 Bank 2 500

Office furniture account


$ $
July 4 Bank 750
Answers to activities, practice exercises and exam practice questions: Chapter 1

Stationery account
$ $
July 4 Cash 120

Drawings account
$ $
July 11 Cash 160

4 Debit account Credit account


1 Local taxes paid by cheque Taxes Bank
2 Bank pays interest to trader Bank Interest received
3 Other operating expenses paid by cheque Other operating expenses Bank
4 Postage and stationery paid by cheque Postage and stationery Bank
5 Telephone bill paid by cheque Telephone Bank
6 Carriage inwards paid by cheque Carriage inwards Bank
7 Carriage outwards paid by cheque Carriage outwards Bank
8 Interest paid by cheque to brother in Interest payable Bank
respect of a loan received from him
9 Interest paid to bank Interest payable / Bank
bank interest

5 Bank account
$ $ 5

June 1 Farook – capital 15 000 June 2 Premises 8 000


Amna – loan 5 000 June 3 Office furniture 2 000
June 5 Sales 1 500 June 4 Purchases 5 000
June 10 Sales 2 400 June 6 Insurance 600
June 12 Purchase returns 900 June 7 Motor van 3 000
June 13 Insurance 100 June 8 Motor expenses 50
June 14 Office furniture 800 June 9 Purchases 2 000
June 10 Wages 400
June 11 Sales returns 1 200
June 13 Drawings 200
June 15 Loan 1 000

Capital account
$ $
June 1 Bank 15 000

Loan account
$ $
June 15 Bank 1 000 June 1 Bank 5 000

Premises account
$ $
June 2 Bank 8 000
Cambridge International AS and A Level Accounting

Office furniture account


$ $
June 3 Bank 2 000 June 14 Bank 800

Purchases account
$ $
June 4 Bank 5 000
June 9 Bank 2 000

Sales account
$ $
June 5 Bank 1 500
June 10 Bank 2 400

Insurance account
$ $
June 6 Bank 600 June 13 Bank 100

Motor van account


$ $
June 7 Bank 3 000

6 Motor expenses account


$ $
June 8 Bank 50

Wages account
$ $
June 10 Bank 400

Sales returns account


$ $
June 11 Bank 1 200

Purchases returns account


$ $
June 12 Bank 900

Drawings account
$ $
June 13 Bank 200

Exam practice questions


Multiple-choice questions
1 B
2 B
3 D
4 B
Answers to activities, practice exercises and exam practice questions: Chapter 2

2 Double-entry bookkeeping: credit transactions


Practice exercises [1] The goods which
1 Geraud returned to Khor
Khor account will have had the trade
$ $ discount deducted from
them when they were
June 10 Purchases returns [1] 180 June 1 Purchases 2 700 purchased. This must be
June 30 Bank 2 394 adjusted when the goods
are returned. Their cost
June 30 Discounts received 126 was $200 - 10% trade
discount of $20 = 180.
Lim account
$ $
June 30 Bank 2 394 June 15 Purchases 2 520
June 30 Discounts received 126

Lai account
$ $
June 5 Sales 600 June 25 Sales returns 180
June 30 Bank 399
June 30 Discounts allowed 21

Chin account
$ $
June 20 Sales 1 300 June 30 Bank 1 235
7
June 30 Discounts allowed 65

Purchases account
$ $
June 1 Khor 2 700
June 15 Lim 2 520

Purchases returns account


$ $
June 10 Khor 180

Sales account
$ $
June 5 Lai 600
June 20 Chin 1 300

Sales returns account


$ $
June 25 Lai 180 [2]

[2] The same is true for the goods returned by Lai, which had cost $200 but
need to have the 10% trade discount deducted.
Cambridge International AS and A Level Accounting

Bank account
$ $
June 30 Lai 399 June 30 Khor 2 394
June 30 Chin 1 235 June 30 Lim 2 394

Discounts received account


$ $
June 30 Khor 126
June 30 Lai 126

Discounts allowed account


$ $
June 30 Lai 21
June 30 Chin 65

Note:
Remember trade discount is never entered in the ledger.
2 In the books of Brian:

Ken account
$ $
April 1 Sales 1 500 April 2 Purchases 400
April 3 Sales 600 April 6 Purchases 720
8 April 12 Bank 380 April 10 Bank 1 455
Discount received 20 Discount allowed 45

Sales account
$ $
April 1 Ken 1 500
April 3 Ken 600

Purchases account
$ $
April 2 Ken 400
April 6 Ken 720

Bank account
$ $
April 10 Ken 1 455 April 12 Ken 380

Discounts allowed account


$ $
April 10 Ken 45

Discounts received account


$ $
April 12 Ken 20
Answers to activities, practice exercises and exam practice questions: Chapter 2

In the books of Ken:

Brian account
$ $
April 2 Sales 400 April 1 Purchases 1 500
April 6 Sales 720 April 3 Purchases 600
April 10 Bank 1 455 April 12 Bank 380
Discount received 45 Discount allowed 20

Sales account
$ $
April 2 Brian 400
April 6 Brian 720

Purchases account
$ $
April 1 1 500
April 3 600

Bank account
$ $
April 10 Brian 380 April 12 Brian 1 455

Discounts allowed account


9
$ $
April 12 Brian 20

Discounts received account


$ $
April 10 Brian 45

3 Adams account
$ $
July 5 Purchases returns 510 July 1 Purchases 4 250
July 14 Bank 3 590
Discount received 150

Bond account
$ $
July 14 Bank 2 160 July 4 Purchases 2 250
Discount received 90

Astle account
$ $
July 9 Purchases returns 640 July 7 Purchases 5 600
July 14 Bank 4 712
Discount received 248
Cambridge International AS and A Level Accounting

Cairns account
$ $
July 14 Bank 3 591 July 10 Purchases 3 780
Discount received 189

Purchases account
$ $
July 1 Adams 4 250
July 4 Bond 2 250
July 7 Astle 5 600
July 10 Cairns 3 780

Purchases returns account


$ $
July 5 Adams 510
July 9 Astle 640

Bank account
$ $
July 14 Adams 3 590
Bond 2 160
Astle 4 712
Cairns 3 591
10
Discount received account
$ $
July 14 Adams 150
Bond 90
Astle 248
Cairns 189

4 Blignaut account
$ $
March 1 Sales 2 250 March 15 Bank 2 160
Discount allowed 90

Ebrahim account
$ $
March 4 Sales 3 400 March 6 Sales returns 170
March 15 Bank 3 069
Discount allowed 161

Friend account
$ $
March 8 Sales 2 560 March 15 Bank 2 432
Discount allowed 128
Answers to activities, practice exercises and exam practice questions: Chapter 2

Flower account
$ $
March 12 Sales 1 800 March 14 Sales returns 315
March 15 Bank 1 426
Discount allowed 59

Sales account
$ $
March 1 Blignaut 2 250
March 4 Ebrahim 3 400
March 8 Friend 2 560
March 12 Flower 1 800

Sale returns account


$ $
March 6 Ebrahim 170
14 Flower 315

Bank account
$ $
March 15 Blignaut 2 160
Ebrahim 3 069
Friend 2 432
11
Flower 1 426

Discount allowed account


$ $
March 15 Blignaut 90
Ebrahim 161
Friend 128
Flower 59

Exam practice questions


Multiple-choice questions
1 A
2 B
3 A
Cambridge International AS and A Level Accounting

3 Books of prime entry


Activities
Activity 1

Purchases journal Sales journal


$ $
March 1 Tikolo 8 000 March 4 Snyman 1 080
March 6 Walters 7 200 March 10 Karg 2 250
March 13 Burger 5 250 March 17 Kotze 2 700
March 18 Tikolo 4 800 March 25 Snyman 1 620
25 250 7 650
Purchases returns journal Sales returns journal
$ $
March 12 Tikolo 400 March 11 Snyman 200
March 22 Burger 1 000 March 20 Karg 300
1 400 500

Cash book
Discounts Bank Discounts Bank
$ $ $ $
March 31 Snyman 100 2 400 March 31 Tikolo 620 11 870
12 March 31 Karg 78 1 872 March 31 Walters 360 6 840
March 31 Kotze 135 2 565 March 31 Burger 170 4 080
313 1150

Purchases account
$ $
March 31 Purchases journal total 25 250

Purchases returns account


$ $
March 31 Purchases returns 1 400
journal total

Sales account
$ $
March 31 Sales journal total 7 650

Sales returns account


$ $
March 31 Sales returns 500
journal total

Discounts allowed account


$ $
March 31 Cash book total 313
Answers to activities, practice exercises and exam practice questions: Chapter 3

Discounts received account


$ $
March 31 Cash book total 1 150

Tikolo account
$ $
March 12 Purchases returns 400 March 1 Purchases 8 000
March 31 Bank 11 780 March 18 Purchases 4 800
March 31 Discounts received 620

Walters account
$ $
March 31 Bank 6 840 March 6 Purchases 7 200
Discounts received 360

Burger account
$ $
March 22 Purchases returns 1 000 March 13 Purchases 5 250
March 31 Bank 4 080
March 31 Discounts received 170

Snyman account
$ $
March 4 Sales 1 080 March 11 Sales returns 200 13
March 25 Sales 1 620 March 31 Bank 2 400
March 31 Discounts allowed 100

Karg account
$ $
March 10 Sales 2 250 March 20 Sales returns 300
March 31 Bank 1 872
March 31 Discounts allowed 78

Kotze account
$ $
March 17 Sales 2 700 March 31 Bank 2 565
March 31 Discounts allowed 135

Activity 2

Cash book
Disc Cash Bank Disc Cash Bank
$ $ £ $ $ $
March 1 Sales 1 100 March 2 Electricity 130
March 3 Sales 900 March 4 Bank 1 700
March 4 Cash 1 700 March 5 Other operating expenses 25
March 6 Bank 800 March 6 Cash 800
March 7 Purchases 750
Cambridge International AS and A Level Accounting

Activity 3

Accounts Dr Cr
$ $
a A & Co. 120
A. Cotter 120
Correction of credit note no. 964 received from A and Co. Ltd. in the sum of $120 debited to A. Cotter in error.
b Purchases 400
Hussain 400
Correction of invoice no. 104 in the sum of $400 received from Hussain omitted from the purchases journal.
 c Maya 45
Sales 45
Correction of posting error: invoice no. 6789 in the sum of $150 sent to Maya entered in the sales journal as $105.
 d Machinery 2 300
Purchases 2 300
Correction of purchase of machine posted in error to purchases account.
e Sales returns 68
Hanif 68
Correction of omission of credit note no.23 for $68 and sent to Hanif, omitted from the sales returns journal.

Practice exercises
1 a  Purchases journal Purchases returns journal
14 $ $
April 1 Bilal 2 400 April 8 Bilal [1] 100
April 3 Asad 1 040 April 21 Asma [1] 600
[1] It is assumed April 15 Asma 3 000
that the value of the April 26 Bilal 3 200
goods returned were
after adjusting for 9 640 700
the trade discount.
Whether a returns
amount given needs Sales journal Sales returns journal
to be adjusted for $ $
the trade discount
should be clear. April 2 Imran 720 April 13 Imran [1] 60
April 10 Raza 880 April 24 Amna [1] 300
April 16 Amna 1 200
April 17 Raza 1 280
4 080 360

Journal
Accounts Dr Cr
$ $
5 April Motor vehicles/delivery van 6 000
Syed 6 000
Purchase of delivery van, from Syed, invoice no. 324.
Answers to activities, practice exercises and exam practice questions: Chapter 3

b  Bank account
Discount Bank Discount Bank
allowed received
$ $ $ $
April 30 Imran 33 627 April 30 Bilal 275 5 225
April 30 Raza 108 2 052 April 30 Asma 120 2 280
April 30 Amna 45 855 April 30 Asad 52 988
April 30 Syed 6 000
186 447

Bilal account
$ $
April 8 Purchase returns 100 April 1 Purchases 2 400
April 30 Bank (5600 - 100 × 95%) 5 225 April 26 Purchases 3 200
Discount received 275
5 600 5 600

Asad account
$ $
April 30 Bank (1040 × 95%) 988 April 3 Purchases 1 040
Discount received 52
1 040 1 040
15

Asma account
$ $
April 21 Purchase returns 600 April 15 Purchases 3 000
April 30 Bank (3000 - 600 × 95%) 2 280
Discount received 120
3 000 3 000

Purchases account
$ $
April 30 Purchases journal total 9 640

Purchases returns account


$ $
April 30 Purchases returns journal total 700

Imran account
$ $
April 2 Sales 720 April 13 Sales returns 60
April 30 Bank (720 - 60 × 95%) 627
Discount allowed 33
720 720
Cambridge International AS and A Level Accounting

Raza account
$ $
April 10 Sales 880 April 30 Bank (2160 × 95%) 2 052
April 17 Sales 1 280 Discount allowed 108
2 160 2 160

Amna account
$ $
April 16 Sales 1 200 April 24 Sales returns 300
April 30 Bank (1200 - 300 × 95%) 855
Discount allowed 45
1 200 1 200

Sales account
$ $
April 30 Sales journal total 4 080

Sales returns account


$ $
April 30 Sales returns journal total 360

16
Discount allowed account
$ $
April 30 Bank 176

Discount received account


$ $
April 30 Bank 447

Syed account
$ $
April 30 Bank 6 000 April 5 Del. Van (Inv 324) 6 000

Delivery van account


$ $
April 5 Syed 6 000
Answers to activities, practice exercises and exam practice questions: Chapter 3

2 Date Accounts Dr Cr
$ $
a March 3 Machinery 10 000
Mumtaz 10 000
Purchase of machinery on credit on invoice 506.
b March 6 Sales 675
Wayne 675
Correction of invoice 495 entered twice in error.
c March 7 Delivery van 4 250
Younas 4 250
Purchase of new delivery van from Younas on invoice 998.
d March 10 Sales returns 190
Browne 190
Credit note 103 omitted from sales returns journal.
e March 15 Geeta 1 300
Sandra 1 300
Transfer of invoice no. 854 from Sandra posted to Geeta’s account in error.

Exam practice questions


Multiple-choice questions
1 C
2 B 17
3 B
4 C
Cambridge International AS and A Level Accounting

4 Balancing accounts
Practice exercise
1 Three-column cash book
Discounts Cash Bank Discounts Cash Bank
allowed received
$ $ $ $ $ $
March 1 Capital 10 000 March 2 Rent 1 000
March 3 Sales 550 March 7 Joe 190 3 610
March 7 Postages 20
March 7 Balance c/d 530 5 390
550 10 000 190 550 10 000
March 8 Balance b/d 530 5 390

Capital account
$ $
March 7 Balance c/d 10 000 March 1 Bank 10 000
360 March 8 Balance b/d 10 000

Purchases account
$ $
March 2 Joe 4 000 March 7 Balance c/d 4 000
18 March 8 Balance b/d 4 000
  

Joe account
$ $
March 5 Purchases returns 200 March 2 Purchases 4 000
March 7 Bank ($4000 − $200 × 95%) 3 610
March 7 Discount received 190
4 000 4 000

Purchases returns account


$ $
March 7 Balance c/d 200 March 5 Joe 200
March 8 Balance b/d    200

Barney account
$ $
March 3 Sales 2 000 March 7 Balance c/d 2 000
March 8 Balances b/d 2 000
Answers to activities, practice exercises and exam practice questions: Chapter 4

Sales account
$ $
March 7 Balance c/d 2 550 March 3 Barney 2 000
March 3 Cash 550
2 550 2 550
March 8 Balance b/d 2 550

Rent account
$ $
March 2 Bank 1 000 March 7 Balance c/d 1 000
March 8 Balance b/d 1 000

Postages account
$ $
March 7 Cash 20 March 7 Balance c/d 20
March 8 Balance b/d 20

19
Cambridge International AS and A Level Accounting

5 The classification of accounts and division of the ledger


Activities
Activity 1

Account Personal Non-current Current asset Revenue or Expense


asset other income
Capital ✓
Sales returns ✓
Delivery vans ✓
Purchases ✓
Rent payable ✓
Trade receivables2 ✓ ✓
Inventory ✓
Discount allowed ✓
Drawings ✓
Bank1 ✓
Rent receivable ✓
Trade payables3 ✓
Computer ✓
Wages ✓
20 Discount received ✓

Notes:
1 The bank account would be a ‘current liability’ if it was overdrawn.
2 Trade payables is the International Accounting Standards terminology for the aggregate
amount owing to suppliers. It is not literally a personal account but is a description given
to the total of the credit balances on the supplier personal accounts. Trade payables are
presented as a ‘current liability’ in the statement of financial position (see later chapters)
at the end of an accounting period.
3 Trade receivables is the International Accounting Standards terminology for the aggregate
amount receivable from customers. It is not literally a personal account but is a description
given to the total of the debit balances on the customer personal accounts. Trade receivables
are presented as a ‘current asset’ in the statement of financial position (see later chapters) at
the end of an accounting period.
Answers to activities, practice exercises and exam practice questions: Chapter 5

Practice exercises
1 Statement True or false
The purchase of a motor car is revenue expenditure False
The payment of wages to employees is revenue expenditure True
The accounts for customers are kept in the sales ledger True
Repairs to the office windows is an example of capital expenditure False
The purchase of office stationery is revenue expenditure True
The sales account is a nominal account True
The fixtures and fittings account is a real account True
Suppliers’ accounts are kept in the nominal ledger False
The day-to-day costs of running the business is an example True
of revenue expenditure

2 a The sales account records the revenue of the business and is an example of a
nominal account.
b The purchase of a new machine is an example of capital expenditure and the
account is an example of a real account
c Small items of expenditure are recorded in the petty cash book.
d A non- current asset is bought to keep in the business for a long period of time.

21
Cambridge International AS and A Level Accounting

6 The trial balance


Activities
Activity 1

The grocer’s trial balance at 31 December


Account Dr Cr
$ $
Premises 50 000
Motor vans 8 000
Office furniture 2 000

Computer 3 000
Sales 60 000
Sales returns 700
Purchases 4 000
Purchases returns 500
Motor vehicle running expenses 4 200
Wages 1 800
Rent 2 000
Bank 1 650
Capital 20 000
Drawings 3 150
80 500 80 500
22
Activity 2
a Complete reversal of entries b Error of principle
c Error of omission d Compensating errors
e Error of commission f Error of original entry

Practice exercises
1 Hassan’s trial balance at 31 December 2015
Account Dr Cr
$ $
Sales 160 000
Sales returns 2 600
Purchases 84 000
Purchases returns 3 400
Wages 26 000
Heating and lighting 3 160
Rent payable 5 000
Rent receivable 1 000
Advertising 2 900
Postage and telephone 2 740
Discounts allowed 6 100
Discounts received 5 900
Plant and machinery 50 000
Delivery van 9 000
Answers to activities, practice exercises and exam practice questions: Chapter 6

$ $
Bank 2 300
Trade receivables 7 400
Trade payables 3 700
Drawings 8 800
Capital 36 000
210 000 210 000

Notes:
• Items in the debit column are mainly assets or expenses.
• Items in the credit column are mainly income or liabilities.

2
Andrea’s corrected trial balance at 31 December 2015
Account Dr Cr
$ $
Premises 70 000
Plant and machinery 30 000
Office equipment 5 000
Wages 7 600
Rent payable 4 000
Heating and lighting 1 500
23
Other operating expenses 1 720
Sales 133 000
Purchases 57 000
Discounts allowed 2 450
Discounts received 1 070
Bank 2 910
Trade receivables 14 000
Trade payables 10 140
Purchases returns 2 400
Sales returns 3 150
Rent receivable 1 200
Capital 80 000
Drawings 28 480
227 810 227 810

Exam practice questions


Multiple-choice questions
1 B
2 B
3 C
4 C
Cambridge International AS and A Level Accounting

7 Income statements for sole traders


Activities
Activity 1

Liz
Trading section of the income statement for the year ended 31 March 2016
Debit Credit
$ $
Purchases 68 000 Sales 150 000
Less: purchases returns 1 700 Less: sales returns 4 200
66 300 145 800

Activity 2

Rodney
Trading section of the income statement for the year ended 30 September 2015
Debit Credit
$ $
Purchases 84 000 Sales 140 000
Less: purchases returns 1 400 Less: sales returns 1 200
82 600 138 800
Less: closing inventory 4 900
24 Cost of sales 77 700
Gross profit 61 100
138 800 138 800

Activity 3

Sofia
Income statement for the year ended 31 December 2015
$ $
Revenue 200 000
Less: sales returns 6 300
193 700
Cost of sales
Purchases 86 500
Less: purchases returns 5 790
80 710
Less: inventory at 31 December 2015 10 000 70 710
Gross profit 122 990
Add: rent received 3 000
Add: discounts received 3 210
129 200
Less:
Wages 61 050
Rent payable 12 000
Electricity 5 416
Insurance 2 290
Answers to activities, practice exercises and exam practice questions: Chapter 7

Income statement for the year ended 31 December 2015


$ $
Motor van expenses 11 400
Discounts allowed 5 110
Other operating expenses 3 760
Loan interest 1 000 102 026
Profit for the year 27 174

Activity 4

Khor
Extract from the income statement for the year ended 31 December 2015
$ $ $
Revenue 48 000
Less: sales returns 1 600
Less: cost of sales 46 400
Opening inventory 4 000
Purchases 21 000
Less: purchases returns 900 20 100
24 100
Less: closing inventory 7 500 16 600
Gross profit 29 800
25
Activity 5

Lamar
Income statement for the year ended 31 March 2016
$ $ $
Revenue 104 000
Less: sales returns 3 700
100 300

Less: cost of sales


Opening inventory 6 000
Purchases 59 000
Less: purchases returns 2 550 56 450
62 450
Less: closing inventory 10 000 52 450
Gross profit 47 850
Rent receivable 1 800
Discounts receivable 770
50 420
Less:
Wages 13 000
Rent payable 2 000
Heating and lighting 2 700
Repairs to machinery 4 100
(cont.)
Cambridge International AS and A Level Accounting

Income statement for the year ended 31 March 2016


$ $ $
Discounts allowed 1 030
Loan interest 750 23 580
Profit for the year 26 840

Activity 6

Sara
Income statement for the year ended 31 March 2016
$ $ $
Sales 40 000
Less: cost of sales
Opening inventory 5 000
Purchases 20 500
Carriage inwards 1 320 21 820
26 820
Less: closing inventory 3 000
Cost of sales 23 820
Gross profit 16 180
Less:
Wages 6 000
26 Rent 10 000
Electricity 2 600
Carriage outwards 1 080
Other operating expenses 1 250 20 930
Loss for the year (4 750)

Practice exercises
1 Hadlee
Income statement for the year ended 31 December 2015
$ $ $
Sales 72 800
Less: sales returns 1 600
71 200
Less: cost of sales
Opening inventory 11 000
Purchases 28 540
Less: purchases returns 2 144
26 396
37 396
Less: closing inventory 9 000 28 396
Gross profit 42 804
Less: expenses
Wages 3 100
Rent 4 000
Heating and lighting 5 120
Answers to activities, practice exercises and exam practice questions: Chapter 7

$ $ $
Advertising 2 400
Other operating expenses 2 010
Loan interest 250
16 880
Profit for the year 25 924

Tikolo
2
Income statement for the year ended 31 March 2016
$ $ $
Sales 204 000
Less: sales returns 3 600
200 400
Less: cost of sales
Opening inventory 18 000
Purchases 118 000
$(120 000 − 2 000)
Less: purchases returns 4 440
113 560
Add: carriage inwards 5 000 118 560
136 560
Less: closing inventory 20 000 116 560
27
Gross profit 83 840
Add: other income
Discounts received 3 160
87 000
Less: expenses
Wages 36 800
Rent 8 000
Heating and lighting 6 450
Discounts allowed 5 020
Carriage outwards 3 724
Other operating expenses 1 143 61 137
Profit for the year 25 863

Exam practice questions


Multiple-choice questions
1 A
2 C
3 C
4 D
5 A
Cambridge International AS and A Level Accounting

8 Statements of financial position for sole traders


Practice exercises
1 Sofia
Statement of financial position at 31 December 2015
$
Non-current assets
Land and buildings 84 000
Plant and machinery 22 000
Motor vans 19 000
125 000
Current assets
Inventory 10 000
Trade receivables 12 425
Cash and cash equivalents 5 065
27 490
Total assets 152 490
Capital and liabilities
Capital at 1 January 2015 127 000
Add: profit for the year 27 174
28
154 174
Less: drawings 25 904
128 270
Non-current liability
Loan 20 000
Current liabilities
Trade payables 4 220
Total capital and liabilities 152 490

2 Lamar
Statement of financial position at 31 March 2016
$
Non-current assets
Premises 60 000
Plant and machinery 12 000
72 000
Current assets
Inventory 10 000
Trade receivables 1 624
Cash and cash equivalents 5 000
16 624
Total assets 88 624
Answers to activities, practice exercises and exam practice questions: Chapter 8

$
Capital and liabilities
Capital at 1 April 2016 55 000
Add: profit for the year 26 840
81 840
Less: drawings 10 096
71 744
Non-current liability
Loan 15 000
Current liabilities
Trade payables 1 880
Total capital and liabilities 88 624

3 Hadlee
Statement of financial position at 31 December 2015
$
Non-current assets
Plant and machinery 25 000
Office furniture 6 000
31 000 29
Current assets
Inventory 9 000
Trade receivables 4 740
Cash and cash equivalents 3 327
17 067
Total assets 48 067
Capital and liabilities
Opening capital 20 000
Add: profit for the year 25 924
45 924
Less: drawings (4 833)
41 091
Non-current liabilities
Loan 5 000
Current liabilities
Trade payables 1 976
Total capital and liabilities 48 067
Cambridge International AS and A Level Accounting

Tikolo
Statement of financial position at 31 March 2016
$
Non-current assets
Fixtures and fittings 9 000
Office furniture 2 000
11 000
Current assets
Inventory 20 000
Trade receivables 1 970
Cash and cash equivalents 2 496
24 466
Total assets 35 466
Capital and liabilities
Opening capital 30 000
Add: profit for the year 25 863
55 863
Less: drawings $(20 527 + 2 000) (22 527)
33 336
30 Current liabilities
Trade payables 2 130
Total capital and liabilities 35 466

Exam practice questions


Multiple-choice questions
1 D
2 A
3 B
4 C
Answers to activities, practice exercises and exam practice questions: Chapter 9

9 Accounting principles or concepts


Exam practice questions
Multiple-choice questions
1 B
2 A
3 A
4 B
5 B
6 D

31
Cambridge International AS and A Level Accounting

10 Accruals and prepayments (the matching concept)


Activities
Activity 1
a
Telephone account
2015 2015
$ $
Dec 31 Bank 1 450 Dec 31 Balance c/d 400
(rental prepaid)
Dec 31 Bank 2 000 Dec 31 Income 3 410
statement
Dec 31 Balance c/d
(calls owing) 360
3 810 3 810
2016 2016
Jan 1 Balance b/d 400 Jan 1 Balance b/d 360

b Alexander’s total telephone expense for the year is $3410. This is made up of calls
$(1450 + 360) = $1810 + line rental $(2000 − 400) = $1600.
c The amount of $360 for calls owing will appear under current liabilities. The figure of
$400 will appear under current assets. Never net off the two amounts.

Activity 2
32
Rent payable account
2015 2015
$ $
Dec 31 Bank 1 000 Dec 31 Income 800
statement
Dec 31 Balance c/d 200
(rent prepaid)
1 000 1 000
2016
Jan 1 Balance b/d 200

Electricity account
2015 2015
$ $
Dec 31 Bank 630 Dec 31 Income 810
statement
Dec 31 Balance c/d 180
(accrued
expense)
810 810
2016
Jan 1 Balance b/d 180
Answers to activities, practice exercises and exam practice questions: Chapter 10

Stationery account
2015 2015
$ $
Dec 31 Bank 420 Dec 31 Income 410
statement
Dec 31 Balance c/d Dec 31 Balance c/d
(amount owing) 130 (inventory) 140
550 550
2016
Jan 1 Balance b/d 140 Jan 1 Balance b/d 130

Rent receivable account


2015 2015
$ $
Dec 31 Income Dec 31 Bank
statement 400 300
Dec 31 Balance c/d
(rent owing) 100
400 400
2016
Jan 1 Balance b/d 100

Activity 3 33
a
Devram
Income statement for the year ended 31 December 2015
$ $
Gross profit 30 000
Rent $(2 600 − 300) 2 300
Electricity $(926 + 242) 1 168
Stationery $(405 + 84 − 100) 389
Motor expenses $(725 + 160) 885
Interest on loan $(500 + 500) 1 000 5 742
Profit for the year 24 258

Note:

Unpaid interest on the loan must be accrued although it is not mentioned
in the question.
b Devram
Statement of financial position at 31 December 2015
$ $
Non-current assets 40 000
Current assets
Inventory 7 000
Stationery inventory 100 7 100
Trade receivables 1 600
(cont.)
Cambridge International AS and A Level Accounting

Statement of financial position at 31 December 2015


$ $
Other receivables: prepaid rent 300
Cash and cash equivalents 2 524
11 524
Total assets 51 524
Capital and liabilities
Capital at 1 January 2015 20 000
Profit for the year 24 258
44 258
Less: drawings 5 120
39 138
Non-current liabilities
Long-term loan 10 000
Current liabilities
Trade payables 1 400
Other payables 986
$(242 + 84 + 160 + 500)
2 386
Total capital and liabilities 51 524

34
Practice exercises
1 a Prudence; accruals
b Antonia
Income statement for the year ended 31 December 2015
$ $ $
Sales 120 000
Less: sales returns 7 300
112 700
Less: cost of sales
Opening inventory 5 660
Purchases 62 400
Less: purchases returns 4 190
58 210
63 870
Less: closing inventory 8 000 55 870
Gross profit 56 830
Less: expenses
Wages $(17 310 + 558) 17 868
Rent $(3 200 − 800) 2 400
Heating and lighting $(2 772 + 328) 3 100
Motor expenses 1 284
Loan interest $(500 + 250) 750
25 402
Profit for the year 31 428
Answers to activities, practice exercises and exam practice questions: Chapter 10

c
Antonia
Statement of financial position at 31 December 2015
$
Non-current assets
Premises 24 000
Motor vehicles 7 400
31 400
Current assets
Inventory 8 000
Trade receivables 12 440
Other receivables: prepaid rent 800
Cash and cash equivalents 5 055
26 295
Total assets 57 695
Capital and liabilities
Opening capital 16 000
Profit for the year 31 428
47 428
Less: drawings 7 036
40 392
Non-current liabilities
Loan 10 000
35
Current liabilities
Trade payables 6 167
Other payables $(558 + 328 + 250) 1 136
7 303
Total capital and liabilities 57 695

d The loan received is shown as a non-current liability as it is not due for repayment within
12 months from the date of the statement of financial position (31 December 2015). Any
part of it which becomes due for repayment within 12 months will be shown as a current
liability.

2 a Desmond
Income statement for the year ended 31 March 2016
$ $ $
Sales 219 740
Less: sales returns 17 420
202 320
Less: cost of sales
Opening inventory 9 000
Purchases 100 100
Less: purchases returns 8 777
91 323
Add: carriage inwards $(5 170 + 330) 5 500 96 823
105 823
Less: closing inventory 11 000 94 823

(cont.)
Cambridge International AS and A Level Accounting

Income statement for the year ended 31 March 2016


$ $ $
Gross profit 107 497
Add: other income
Rent receivable $(2 600 − 200) 2 400
Interest receivable $(840 + 160) 1 000
Discounts received 1 040
111 937

Less: expenses
Wages 67 000
Rent payable $(8 000 + 2 000) 10 000
Discounts allowed 2 826
Carriage outwards $(7920 + 280) 8 200
Stationery and other operating 1 643 89 669
expenses $(1 963 − 200 − 120)
Profit for the year 22 268

b Desmond
Statement of financial position at 31 March 2016
$
Non-current assets
36
Plant and machinery 36 000
Motor vehicles 17 000
53 000
Current assets
Inventory 11 000
Trade receivables 7 060
Other receivables (other operating expenses, 480
stationery inventory and interest accrued)
Cash and cash equivalents 5 400
23 940
Total assets 76 940
Capital and liabilities
Opening capital 70 000
Add: profit for the year 22 268
92 268
Less: drawings 22 088
70 180
Current liabilities
Trade payables 3 950
Other payables $(2000 + 330 + 280 + 200) 2 810
6 760
Total capital and liabilities 76 940
Answers to activities, practice exercises and exam practice questions: Chapter 10

c Carriage inwards is the cost of bringing the goods from the supplier. It is regarded as part
of the cost of the item bought and appears in the calculation of the cost of sales.
Carriage outwards is the cost of delivering goods to the customer. It is regarded as a
business expense and appears with other expenses in the income statement.
3 a The annual financial statements of a business are prepared using the accruals basis.
Expenses of the period are matched with the income of the same period. It doesn’t matter
whether or not the expenses have been paid. Therefore, any amounts owing but unpaid
for in a particular year are brought into the financial statements for that year (accruals). Any
amounts paid during the year, but relating to a future period (prepayments) are excluded
from the financial statements for that year.

b b Rent account
2015 2015
$ $
Jan 1 Balance b/d 2 000 Dec 31 Income statement 9 500
$(2 000 + [3 × 2 500])
Dec 31 Bank Dec 31 Balance c/d
$(2500 × 4) 10 000 2 500
12 000 12 000
2016
Jan 1 Balance b/d 2 500

Electricity account
2015 2015 37

$ $
Dec 31 Bank 1 800 Jan 1 Balance b/d 150
Balance c/d Dec 31 Income
($480 ÷ 3 × 2) 320 statement 1 970
2 120 2 120
2016
Jan 1 Balance b/d 320

Exam practice questions


Multiple-choice questions
1 D
2 B
3 B
4 A
Cambridge International AS and A Level Accounting

11 Provisions for the depreciation of non-current assets


Activities
Activity 1
a
Provision for depreciation of motor vehicles account
$ $
Year 1 Balance c/d 2 000 Year 1 Income statement 2 000
Year 2 Balance c/d 4 000 Year 2 Balance b/d 2 000
Income statement 2 000
4 000 4 000
Year 3 Balance c/d 6 000 Year 3 Balance b/d 4 000
Income statement 2 000
6 000 6 000
Year 4 Balance c/d 8 000 Year 4 Balance b/d 6 000
Income statement 2 000
8 000 8 000
Year 5 Balance c/d 10 000 Year 5 Balance b/d 8 000
Income statement 2 000
10 000 10 000
Year 6 Balance c/d 12 000 Year 6 Balance b/d 10 000
Income statement 2 000
12 000 12 000
38 Year 7 Balance c/d 14 000 Year 7 Balance b/d 12 000
Income statement 2 000
14 000 14 000
Year 8 Year 8 Balance b/d 14 000

b Statement of financial position extracts


Cost Depreciation Net book value
$ $ $
Year 1: Motor vehicles 18 000 2 000 16 000
Year 2: Motor vehicles 18 000 4 000 14 000
Year 3: Motor vehicles 18 000 6 000 12 000
Year 4: Motor vehicles 18 000 8 000 10 000
Year 5: Motor vehicles 18 000 10 000 8 000
Year 6: Motor vehicles 18 000 12 000 6 000
Year 7: Motor vehicles 18 000 14 000 4 000
Activity 2
a
Provision for depreciation of machinery account
$ $
Year 1 Balance c/d 12 000 Year 1 Income statement 12 000
Year 2 Balance c/d 20 400 Year 2 Balance b/d 12 000
Income statement 8 400
20 400 20 400
Year 3 Balance c/d 26 280 Year 3 Balance b/d 20 400
Income statement 5 880
26 280 26 280
Answers to activities, practice exercises and exam practice questions: Chapter 11

$ $
Year 4 Balance c/d 30 396 Year 4 Balance b/d 26 280
Income statement 4 116
30 396 30 396
Year 5 Balance c/d 33 277 Year 5 Balance b/d 30 396
Income statement 2 881
33 277 33 277
Year 6 Year 6 Balance b/d 33 277

b Statement of financial position extracts


Cost Depreciation Net book value
$ $ $
Year 1: Machinery 40 000 12 000 28 000
Year 2: Machinery 40 000 20 400 19 600
Year 3: Machinery 40 000 26 280 13 720
Year 4: Machinery 40 000 30 396 9 604
Year 5: Machinery 40 000 33 277 6 723

Activity 3
a Machinery at cost account
2016 2016
$ $ 39
Jan 1 Balance b/d 18 000 May 7 Disposal of 6 000
machinery
Jun 3 Bank 7 000 Jun 3 Disposal of 12 000
machinery
Disposal of 3 000 Dec 31 Balance c/d 10 000
machinery
28 000 28 000
2017
Jan 1 Balance b/d 10 000

b Provision for depreciation of machinery account


2016 2016
$ $
May 7 Disposal of 2 400 Jan 1 Balance b/d 9 600
machinery (2 400 + 7 200)
Jun 3 Disposal of 7 200 Dec 31 Income statement 1 000
machinery
Dec 31 Balance c/d 1 000

10 600 10 600
2017
Jan 1 Balance b/d 1 000
Cambridge International AS and A Level Accounting

c
Disposal of machinery account
2016 2016
$ $
May 7 Machinery at 6 000 May 7 Provision for depreciation 2 400
cost of machinery
Bank 1 500
Income statement (loss) 2 100
June 3 Machinery at 12 000 June 3 Provision for depreciation 7 200
cost of machinery
Machinery at cost – part 3 000
exchange
Income statement (loss) 1 800
18 000 18 000

Practice exercises
1 a The straight-line method of depreciation is calculated by charging the rate of depreciation
on the cost of the non-current asset. The reducing balance method of depreciation is
calculated by charging the rate of depreciation on the cost of the non-current asset minus
the accumulated depreciation to date before making the charge.

b Piccolo
Income statement for the year ended 31 May 2016
40
$ $
Sales 300 000
Less: cost of sales
Opening inventory 30 000
Purchases $(190 000 − 4 000) 186 000
216 000
Less: closing inventory 42 000 174 000
Gross profit 126 000
Less: expenses
Wages 56 000
Heating and lighting $(17 600 + 1 800) 19 400
Repairs to machinery 5 100
Advertising $(7 000 − 6 000) 1 000
Depreciation of freehold buildings ($80 000 × 4%) 3 200
Depreciation of plant and machinery 11 000 95 700
($76 000 − $32 000 × 25%)
Profit for the year 30 300
Answers to activities, practice exercises and exam practice questions: Chapter 11

Piccolo
Statement of financial position at 31 May 2016
Cost Accumulated Net book value
depreciation
$ $ $
Non-current assets
Freehold land and buildings 100 000 43 200 56 800
Plant and machinery 76 000 43 000 33 000
176 000 86 200 89 800
Current assets
Inventory 42 000
Trade receivables 14 000
Other receivables (prepaid 6 000
advertising)
Bank 5 500
67 500
Total assets 157 300
Capital and liabilities
Opening capital 150 000
Add: net profit 30 300
180 300 41

Less: drawings $(27 100 + 4000) 31 100


149 200
Trade payables 6 300
Other payables (heat and light) 1 800
8 100
Total capital and liabilities 157 300

c Piccolo should not change his method of charging depreciation. To do so will go against
the concept of consistency. There is no valid reason why a change should be made.
2 a Wilhelmina
Income statement for the year ended 31 March 2016
$ $
Sales 80 600
Less: sales returns 1 590
79 010
Less: cost of sales
Opening inventory 13 000
Purchases 50 914
Less: purchases returns 825 50 089
63 089
(cont.)
Cambridge International AS and A Level Accounting

Income statement for the year ended 31 March 2016


Cost Depreciation Net book value
$ $ $
Less: closing inventory 16 000 47 089
Gross profit 31 921
Less: expenses
Wages 13 017
Electricity $(1 012 + 300) 1 312
Repairs to machinery 643
Other operating expenses $(1 234 − 180) 1 054
Interest on loan and HP 2 200
$(1 000 + 1 000 + 200)
Depreciation of leasehold property 3 000
($45 000 ÷ 15)
Depreciation of plant and machinery 8 950
($21 000 +
$[30 000 − 6 000] - $9 200 × 25%)
Depreciation of office equipment
($7 000 × 15%) 1 050 31 226
Profit for the year 695

b Wilhelmina
42
Statement of financial position at 31 March 2016
Cost Accumulated Net book
depreciation value
$ $ $
Non-current assets
Leasehold property 45 000 16 500 28 500
Plant and machinery 45 000 18 150 26 850
Office equipment 7 000 3 450 3 550
97 000 38 100 58 900
Current assets
Inventory 16 000
Trade receivables 1 526
Other receivables (other operating 180
expenses)
Bank 1 964
19 670
Total assets 78 570
Capital and liabilities
Opening capital 50 000
Add: net profit 695
50 695
Less: drawings 18 598
32 097
Answers to activities, practice exercises and exam practice questions: Chapter 11

$ $ $
Non-current liabilities
Loan (repayable 2020) 20 000
Trade payables 973
Other payables (electricity 1 300
and loan)
Loan for machinery (including
accrued interest $200) 24 200
26 473
Total capital and liabilities 78 570

Notes:
• Hire purchase is not on the syllabus. However, the amount due to the company from
whom the machinery was bought is $24 000 $(30 000 − 6 000). This is added on to the
cost of the machinery $(21 000 + 24 000).
• Interest to be paid over the course of HP agreement is $800 (4 × $200) and as the
agreement was for one year and began on 1 January 2016, three month’s interest,

( 3
12
1
)
or 4 × $800 = $200 must be accrued at 31 March 2016.
• The entire loan for the machinery is repayable within 12 months from the date of the
statement of financial position. This means that the whole of the amount is treated as a
current liability.

Exam practice questions 43


Multiple-choice questions
1 D
2 C
3 A

4 A

Structured question
1 a 
Businesses will use different methods of depreciation because non-current assets
lose value at different rates during their working life. For example, a motor vehicle will
depreciate more in the early years of its life. Thus, the reducing balance method of
depreciation is best for this asset. On the other hand, something like office furniture will
lose its value evenly over its life and is depreciated using the straight-line method.
b Asset disposal account
2016 2016
$ $
May 31 Motor vehicles 8 000 May 31 Motor vehicles
at cost accumulated depreciation 4 000
Bank 3 000
Income statement 1 000
8 000 8 000
Cambridge International AS and A Level Accounting

c i Motor vehicles at cost


000 − 8 000 + 12 000) = $32 000
$(28 
ii Motor vehicles accumulated depreciation
Beginning of year less vehicle sold $(12 000 − 4 000) = $8 000
Depreciation charge for the year $(32 000 − 8 000) × 25% = $6 000
(Add to get) Accumulated depreciation at end of year = $14 000
iii Office equipment at cost
$(20 000 + 2 000) = $22 000
iv Office equipment accumulated depreciation
Beginning of the year $8 000
Assets charged a full year of depreciation $20 000 × 10% = $2 000
1
Assets bought in year and held for only 3 months $2 000 × 10% × = $50
4
(Add to get) Accumulated depreciation at end of year $10 050

44
Answers to activities, practice exercises and exam practice questions: Chapter 12

12 Irrecoverable and doubtful debts


Activities
Activity 1
a 2012: $(4 000 + 1 150) = $5 150
2013: $(6 400 + 1 375) = $7 775
2014: $(7 500 + 1 125) = $8 625
2015: $(3 000 + 1 250) = $4 250
2016: $(8 300 + 1 420) = $9 720
b Provision for doubtful debts account
$ $
2012 2012
Mar 31 Balance c/d 5 150 Mar 31 Income statement 5 150
Apr 1 Balance b/d 5 150
2013 2013
Mar 31 Balance c/d 7 775 Mar 31 Income statement 2 625
7 775 7 775
Apr 1 Balance b/d 7 775
2014 2014
Mar 31 8 625 Mar 31 Income statement 850
8 625 8 625
Apr 1 Balance b/d 8 625
45
2015 2015
Mar 31 Income statement 4 375
Balance c/d 4 250
8 625 8 625
Apr 1 Balance b/d 4 250
2016 2016
Mar 31 Balance c/d 9 720 Mar 31 Income statement 5 470
9 720 9 720
Apr 1 Balance b/d 9 720

Practice exercises
1 a
David
Income statement for the year ended 31 March 2016
$ $ $
Revenue $(210 000 − 4 000) 206 000
Less: sales returns 9 240
196 760
Less: cost of sales
Opening inventory 4 000
Purchases 84 000
Less: purchases returns 5 112
78 888
Add: carriage inwards 1 840 80 728
84 728
(cont.)
Cambridge International AS and A Level Accounting

Income statement for the year ended 31 March 2016


$ $ $
Less: closing inventory $(5 000 + 3 000) 8 000 76 728
Gross profit 120 032
Add: other income
Reduction in provision for doubtful
debts |$(800 − 550) 250
Discounts received 2 480
122 762
Less: expenses
Wages $(37 000 + 400) 37 400
Rent $(7 600 − 1600) 6 000
Telephone $(900 + 100) 1 000
Electricity $(1 027 + 360) 1 387
Postage and stationery 359
Carriage outwards 1 220
Discounts allowed 6 015
Irrecoverable debts $(3 100 +1 700) 4 800
Depreciation of leasehold premises
($70 000 × 5%) 3 500
Depreciation of delivery vans
($18 000 - $3 600 × 25%) 3 600
46 Depreciation of office furniture
($3 000 × 10%) 300 65 581

Profit for the year 57 181

Notes:
1 The calculation for the adjustment is as follows:

Trade receivables account


$ $
Opening balance 19 800 Goods on sale or return 4 000
Specific irrecoverable debt 1 700
Specific provision 3 100
Balance 11 000
19 800 19 800

Provision required = 11 000 × 5% = $550
Existing provision $800
Reduction in provision $250
2 It would have been possible to combine the specific provision for the irrecoverable debt
into the provision for doubtful debts account. This would be shown as:

Provision for doubtful debts account


$ $
Specific irrecoverable debt 3 100 Opening balance 800
Balance c/d 550 Income statement 2 850
3 650 3 650

Answers to activities, practice exercises and exam practice questions: Chapter 12

3 The net effect on the income statement is the same. In the statement above
there is a credit of $250, being the reduction in the provision, and expenses of
$3100 included in the figure for irrecoverable debts. You can use either approach.
In practice it is usual to keep irrecoverable debts and the provision for doubtful
debts as two separate accounts.

b David
Statement of financial position at 31 March 2016
Cost Accumulated Net book
depreciation value
$ $ $
Non-current assets
Leasehold premises 70 000 8 500 61 500
Delivery vans 18 000 7 200 10 800
Office furniture 3 000 1 800 1 200
91 000 17 500 73 500
Current assets
Inventory 8 000
Trade receivables
$(19 800 − 4 000 − 1 700 − 3 100) 11 000
Less: provision for doubtful receivables 550 10 450
Other receivables (rent prepaid) 1 600
Cash and cash equivalents 1 245
47
21 295
Total assets 94 795
Capital and liabilities
Opening capital 50 000
Add: profit for the year 57 181
107 181
Less: drawings 20 446
86 735
Current liabilities
Trade payables 7 200
Other Payables $(400 + 360 + 100) 860
8 060
Total capital and liabilities 94 795

Note:
 he total assets equal the total capital and liabilities, thus the statement of financial
T
position balances. If you don’t get the two figures the same then look for the difference,
but don’t waste time.
Cambridge International AS and A Level Accounting

2 a Saul
Income statement for the year ended 31 May 2016
$ $ $
Sales 700 000
Less: sales returns 6 670
693 330
Less: cost of sales
Opening inventory 40 000
Purchases (410 890 − 2 400) 408 490
Less: purchases returns 3 112 405 378
445 378
Add: carriage inwards 4 240
449 618
Less: closing inventory 58 000 391 618
Gross profit 301 712
Add: other income
Rent receivable $(1 020 + 280) 1 300
Discounts received 2 942
305 954
Less: expenses
Wages 137 652
48 Rent payable $(10 000 − 2 000) 8 000
Heating and lighting $(4 720 + 400) 5 120
Telephone and postage 3 217
Stationery $(6195 + 220 − 450) 5 965
Repairs to machinery 17 600
Discounts allowed 3 220
Carriage outwards 1 819
Increase in provision for doubtful debts
[($34 600 − $1 800) × 5%] − 1 200 440
Irrecoverable debt written off 1 800
Depreciation − Freehold property 7 200
($180 000 × 4%)
Depreciation − Plant and machinery 14 550
($97 000 × 15%)
Depreciation − Motor vehicles
($41 000 − 27 000 × 30%) 4 200 210 783
Profit for the year 95 171
Answers to activities, practice exercises and exam practice questions: Chapter 12

b Saul
Statement of financial position at 31 May 2016
Cost Accumulated Net book
depreciation value
$ $ $
Non-current assets
Freehold property 180 000 52 200 127 800
Plant and machinery 97 000 67 550 29 450
Motor vehicles 41 000 31 200 9 800
318 000 150 950 167 050
Current assets
Inventory 58 000
Other operating inventory 450
(stationery)
Trade receivables $(34 600 − 1 800) 32 800
Less: provision for doubtful debts 1 640 31 160
$(1 200 + 440)
Other receivables $(280 + 2 000) 2 280
Cash and cash equivalents 11 374
103 264
Total assets 270 314
Capital and liabilities
49
Opening capital 200 000
Add: profit for the year 95 171
295 171
Less: drawings $(28 797 + 2 400) 31 197
263 974
Current liabilities
Trade payables 5 720
Other Payables $(400 + 220) 620
6 340
Total capital and liabilities 270 314

Exam practice questions


Multiple-choice questions
1 C
2 B
3 D
4 B
Cambridge International AS and A Level Accounting

13 Bank reconciliation statements


Activities
Activity 1
$475 Debit
Activity 2
$540 Debit (overdrawn)
Activity 3
a Revised cash book balance:
$80 − $210 = $130 overdrawn
b Bank reconciliation statement at 31 March 2016
$
Balance per bank statements $(650 + 220) 870
Less: cheque not sent (1 000)
Balance per cash book (130)

Note:
 otice that the final figure is in brackets. This identifies that the balance in the cash book is
N
overdrawn.

Activity 4
Adjusted trial balance items:
50 Debit Credit
$ $
Trade receivables $(1 055 − 420 + 323) 958
Trade payables $(976 − 360) 616
Rent $(800 + 200) 1 000
Bank $(1 245 − 360 + 420 − 200 − 323) 782

Practice exercise
1 Changes Starting totals Calculation Revised totals
Debit Credit Debit Credit
$ $ $ $ $
Trade receivables 400 −78 322
Trade payables 380 −298 82
Rent receivable 750 +150 900
Interest receivable +10 10
Bank charges 100 +130 230
Bank 990 (+10 − 130 − 298 + 78 + 150) 800

Exam practice questions


Multiple-choice questions
1 C
2 C
3 B
4 A
5 B
Answers to activities, practice exercises and exam practice questions: Chapter 14

14 Control accounts
Activities
Activity 1

Byit Limited
Purchase ledger control account
2016 $ 2016 $
Mar 1 Balance b/d 16 Mar 1 Balance b/d 10 000
Mar 31 Purchases returns 824 Mar 31 Purchases journal 33 700
Bank 27 500 Balance c/d 156
Discounts received 1 300
Balance c/d 14 216
43 856 43 856
Apr 1 Balance b/d 156 Apr 1 Balance b/d 14 216

Activity 2

Soldit Limited
Sales ledger control account
2016 $ 2016 $
May 1 Balance b/d 27 640 Balance b/d 545
May 31 Sales journal 109 650 Sales returns 2 220
Irrecoverable debt recovered 490 Bank 98 770
51
Balance c/d 800 Discounts allowed 3 150
Bank – irrecoverable 490
debt recovered
Purchase ledger 2 624
contra
Balance c/d 30 781
138 580 138 580
Jun 1 Balance b/d 30 781 Jun 1 Balance b/d 800

Activity 3
a
Purchase ledger Sales ledger
balances balances
Debit Credit Debit Credit
$ $ $ $
Before amendment 64 7 217 Before amendment 23 425 390
Deduct invoice (100) Correction of invoice
entered twice $326 entered as $362 (36) –
Debit balance Corrected balances 23 389 390
incorrectly listed as
credit balance 50 (50)
Corrected balances 114 7 067
Cambridge International AS and A Level Accounting

b Corrected purchase ledger control


2015 $ 2015 $
Dec 31 Cancellation of invoice 100 Dec 31 Balance b/d 7 847
Discounts received 84 Balance c/d 114
Sales ledger contra – 710
Trazom
Balance c/d 7 067
7 961 7 961
2016 2016
Jan 1 Balance b/d 114 Jan 1 Balance b/d 7 067

Corrected sales ledger control


2015 $ 2015 $
Dec 31 Balance b/d 22 909 Dec 31
Sales journal 800 Purchase ledger 710
understatement contra – Trazom
Balance c/d 390 Balance c/d 23 389
24 099 24 099
2016 2016
Jan 1 Balance b/d 23 389 Jan 1 Balance b/d 390

c Amended profit for the year ended 31 December 2015
52
$
Profit per draft income statement 31 000
Add:
Reduction in purchases 100
Discounts received omitted 84
Increase in sales 800
Amended profit for the year 31 984

d Statement of financial position extract at 31 December 2015


$ $
Trade receivables
Sales ledger 23 389
Purchase ledger 114 23 503
Trade payables
Purchase ledger 7 067
Sales ledger 390 7 457

52
Answers to activities, practice exercises and exam practice questions: Chapter 14

Practice exercises
1 Peter
Sales ledger control account
$ $
Mar 1 Balance b/d 55 650 Mar 31 Bank 36 900
Mar 31 Sales 47 700 Irrecoverable debts 2 250
Bank 1 920 Discounts allowed 930
Returns inwards 580
Purchase ledger control 810
Balance c/d 63 800
105 270 105 270
Apr 1 Balance b/d 63 800

Peter
Purchase ledger control account
$ $
Mar 31 Bank 24 300 Mar 1 Balance b/d 34 020
Discounts received 600 Mar 31 Purchases 21 840
Returns outwards 330
Sales ledger control 810
Balance c/d 29 820
55 860 55 860
53
Apr 1 Balance b/d 29 820

2 a Sellit
Sales ledger control account
$ $
Dec 31 Balance b/d 17 584 Dec 31 P. Ford 900
Discounts allowed 210 Sales 578
P. Williams 180 Balance c/d 17 096
Sales 600
18 574 18 574
Dec 31 Balance b/d 17 096

b Calculation of sales ledger balances before corrections


$
Corrected balance per sales ledger control account 17 096
Add Minus
$ $
Adjustment 2 900
Adjustment 3 (180)
Adjustment 5 578
Adjustment 6 450
1 928 (180) 1 748
Uncorrected balance of sales ledger accounts 18 844

53
Cambridge International AS and A Level Accounting

Proof

Sales ledger control account Sales ledger balances


$ $
Balances from above 17 584 18 844
Adjustment 1 210
Adjustment 2 (900) (900)
Adjustment 3 180 180
Adjustment 4 600
Adjustment 6 (450)
17 674 17 674

Note:
The goods treated as a sale to Will Dither will be in both balances at the time they are
calculated.
c
Journal entries
Account Debit Credit
$ $
P. Ford 900
B. Ford 900
Receipt from customer posted to wrong account
Note: the control accounts do not require correction
54 P. Williams 180
Sales 180
Correction of sales invoice recorded in error
Note: the sales ledger personal and control accounts and the
revenue account all require correction
Sales 578
Will Dither 578
Correction of goods on sale or return treated as sale in error
Note: the sales ledger personal and control accounts and
the revenue account all require correction. In addition, the
goods held by Dither will have to be included in the year end
inventory
W. Yeo 450
Correction of sales invoice for $3160 recorded as $3600 in error
Note: the only error was in the personal account
3 a There may be a credit balance on the sales ledger control account because of:
• an overpayment by a customer
• a payment in advance by a customer.

54
Answers to activities, practice exercises and exam practice questions: Chapter 14

b Julie
Corrected sales ledger control account
2016 $ 2016 $
May 31 Balance b/d 18 640 May 31 Purchase ledger control 650
Irrecoverable debts 400
Cash sales 1 760 Balance c/d 20 586
Balance c/d 436
21 236 21 236
June 1 Balance b/d 20 586 June 1 Balance b/d 436

Exam practice questions


Multiple-choice questions
1 B
2 C
3 C

Structured questions
1 a Two advantages to a business of maintaining sales and purchase ledger control accounts:
• provides quick totals of trade receivables and payables
• helps to detect errors in the accounts.
b Haeun Joo
Purchase ledger control account
55
2016 $ 2015 $
Apr 30 Bank 1 118 970 May 1 Balance b/d 64 680
Discounts received 47 100 2016
Returns outwards 18 600 Apr 30 Purchases 1 236 210
Sales ledger control 7 815
Balance c/d 108 405
1 300 890 1 300 890
May 1 Balance b/d 108 405

Haeun Joo
c Amended purchase ledger control account
$ $
Contra with sales ledger 1 275 Balance from (a) 108 405
Bank 2 175 Discounts received 1 500
Balance c/d 109 515 Purchases 3 060
112 965 112 965
Balance b/d 109 515

55
Cambridge International AS and A Level Accounting

d Statement to reconcile balances


Add Minus Purchase
ledger balances
$ $ $
Starting balances at 30 April 2016 101 490
Adjustment 2 3 060 3 060
Adjustment 3 150 150
Adjustment 6 4 815 4 815
Amended balance on purchase ledger 109 515
control account at 30 April 2016

2 Three reasons for keeping a control account are (any two):


• provides a quick total for year-end financial statements
• helps identify possible fraud
• helps to detect errors in the accounts.
3 a It is sometimes the case where the customer of a business is also a supplier to the
business. They will, therefore, have an account in both the sales and purchase ledger.
In order to cut down on paperwork and the need to send cheques to each other, the
balance on the sales ledger will be offest against the balance in the purchase ledger.
This means that only one party needs to send a cheque to the other. Whatever action is
taken in the individual accounts in the sales and purchase ledgers, the same thing has
to be done in the respective control accounts in the nominal ledger.

56
b Dinh Truong
Purchase ledger control account
2016 $ 2015 $
Apr 30 Bank 745 980 May 1 Balance b/d 43 120
Discounts received 31 400 2016
Purchases returns 12 400 Apr 30 Purchases 824 140
Sales ledger control 5 210
Balance c/d 72 270
867 260 867 260
May 1 Balance b/d 72 270

c
Amended purchase ledger control account
2016 $ 2016 $
May 1 Balance b/d 72 270
Sales ledger 850 Discounts 1 000
control received
Bank 1 450 Purchases 2 040
Revised balance c/d 73 010
75 310 75 310
May 1 Balance b/d 73 010

56
Answers to activities, practice exercises and exam practice questions: Chapter 14

d Purchase ledger Purchase


control account ledger balances
$ $
Starting balances (purchase ledger control 72 270 67 660
account was calculated in part a, purchase ledger
balances is the balancing figure)
Adjustment 1 1 000
Adjustment 2 2 040 2 040
Adjustment 3 – 100
Adjustment 4 (850) –
Adjustment 5 (1 450) –
Adjustment 6 3 210
73 010 73 010

57

57
Cambridge International AS and A Level Accounting

15 Suspense accounts
Activities
Activity 1
a
Lee
Suspense account
$ $
Sales 90 Difference on trial balance 58*
Doyle 18 Irrecoverable debt (expense) 50
108 108

*Balancing figure
b Debit Credit
$ $
Purchases 150
Bilder, purchase ledger 150
Machinery at cost 400
Machinery repairs 400
Income statement 40
Provision for depreciation of machinery 40
c
Decrease Increase
Dr Cr
58 $ $ $
Profit for the year per draft accounts 3 775
(1) Increase in sales 90
(2) Increase in purchases 150
(4) Increase in irrecoverable debts 50
(5) Decrease in machinery repairs 400
(5) Increase in provision for depreciation of machinery 40
240 490
(240) 250
Correct profit for the year 4 025

Activity 2
a
Journal entries to correct the errors
Dr Cr
$ $
1 Suspense 2 700
Note. No debit entry is required.
2 Note. The trial balance was not affected because the
closing inventory was not shown in it.
3 Repairs to machinery 3 500
Suspense 1 800
Machinery at cost 5 300
4 Suspense 800
Sales 800
5 Suspense 126
Note. No credit entry is required.
Answers to activities, practice exercises and exam practice questions: Chapter 15

b Jayesh
Suspense account
$ $
Machinery at cost 1 800 Trial balance difference 26
Sales 800 Adjustment of opening 2 700
inventory
Adjustment to trade 126
payables
2 726 2 726

c
$
Net working capital per draft statement of financial position 3 200
Add: increase in closing inventory 2 000
Deduct: credit balance $63 extracted as debit balance (126)
Corrected net working capital at 31 December 2015 5 074

Practice exercises
1 Bastien journal
Account Debit Credit
$ $
1 Veeraj 70
 Suspense 70 59
 Discount received from Veeraj not
posted to their account.
2 Bernard 50
 Suspense 50
 Correction of amount posted to
Bernard’s account.
3 Suspense 800
 Rodney 800
 Correction of amount debited to
Rodney’s account in error.
4  Motor vehicles at cost 12 000
 Purchases 12 000
 Transfer of purchase of new vehicle
posted to purchases account in error.
5 Drawings 60
  Other operating expenses 60
 Transfer of drawings posted to other
operating expenses.

59
Cambridge International AS and A Level Accounting

2 a Boulder journal
Account Debit Credit
1 Suspense 644
 Head 644
 Correction of amount and misposting
of receipt from Head $(313 + 331).
2 Suspense 100
 Joey 100
 Return of goods from Joey not entered
in his account.
3  Motor vehicles at cost 3 000
  Motor vehicle expenses 3 000
 Transfer of purchase of motor vehicle
posted to motor expenses in error.
4  Discount allowed 300
 Suspense 300
 Correction of overcast of discounts
allowed column in cash book.
5  Theft of cash 700
 Cash 700
  Theft of $700 by employee written off.

b Boulder
60 Suspense account
$ $
Mar 31 Head 644 Mar 31 Balance per trial balance 444
(balancing figure)
Joey 100 Discounts allowed 300
744 744

c
Working capital
original balance
Add Minus
$ $ $
Original balance 2 400
Head 644
Joey 100
Cash 700 (1 444)
956

60
Answers to activities, practice exercises and exam practice questions: Chapter 15

3 a Account Debit Credit


$ $
1 Bank 90
  Purchase ledger control, Victor 90
2  Purchase ledger control 420
 Suspense 180
  General expenses 240
3  Sales returns 900
 Purchases 900
4  Purchase ledger control 350
  Purchases returns 350
5  Discounts received 600
  Purchase ledger control 600

b Amber
Suspense account
$ $
Mar 31 Per trial Mar 31 Purchase ledger
balance 180 control 180

4 a Account Debit Credit


$ $
1  Discount received 55
  Discount allowed 55 61
 Suspense 110
2 Suspense 216
  Sales returns 108
  Purchases returns 108
3  Sales control account 400
 Bank 400
4 Equipment 4 400
 Purchases 4 400
5  Drawings 800
 Purchases 800
6 Suspense 90
  General expenses 90
 Drawings 90
  General expenses 90

b Logan
Suspense account
$ $
Mar 31 Sales returns 108 Mar 31 Balance per trial 196
balance
Purchases returns 108 Discounts received 55
General expenses 90 Discounts allowed 55
306 306

61
Cambridge International AS and A Level Accounting

c
Logan
Corrected trial balance at 31 March 2016
Account Debit Credit
$ $
Sales 131 940
Purchases
$(33 000 − 4400 − 800) 27 800
Sales returns
$(260 − 108) 152
Purchase returns
$(315 + 108) 423
Opening inventory 6 900
Sales ledger control
$(14 125 + 400) 14 525
Purchase ledger control 16 070
Discounts allowed
$(700 + 55) 755
Discounts received 559
$(614 − 55)
Wages and salaries 20 600
Advertising 1 000
General expenses $(2 340 − 180) 2 160
62 Bank
$(13 710 − 400) 13 310
Premises 70 000
Motor vehicle 5 000
Equipment
$(3 500 + 4 400) 7 900
Capital 25 000
Drawings
$(3 000 + 800 + 90) 3 890
173 992 173 992

d Logan
Statement to show corrected profit for the year ended 31 March 2016
Add Minus Original profit
for the year
$ $ $
Per question 68 069
Adjustment 1 110
Adjustment 2 216 –
Adjustment 3 – –
Adjustment 4 4 400
Adjustment 5 800
Adjustment 6 180
5 596 (110) 5 486
Corrected profit for the year 73 555
Answers to activities, practice exercises and exam practice questions: Chapter 15

Exam practice questions


Multiple-choice questions
1 A
2 B
3 C
4 B
5 C
6 C
7 A

63

63
Cambridge International AS and A Level Accounting

16 Incomplete records
Activities
Activity 1

Statements of affairs at 1 January 2015 at 31 December 2015


$ $
Premises at cost or valuation 4 000 9 000*
Motor van at cost 5 000 4 000
Motor car at cost – 3 000
Plant and equipment 1 100 1 300
Inventory of parts 400 200
Trade receivables for work done 700 800
Balance at bank 1 300 900
12 500 19 200
Less:
Owing to suppliers 170 340
Capital 12 330 18 860
Less capital introduced: motor car 3 000**
Less capital increase due to property valuation 5 000*
10 860
Add: drawings ($120 × 52) 6 240
17 100
Deduct capital at 1 January 12 330
64
Profit for the year ended 31 December 4 770

*The increase in the value of property is not regarded as part of the trading profit, but is in fact an
unrealised capital profit.
**The cost of the car is deducted because it was capital introduced during the year.

Activity 2

Ammar
Trading section of the income statement for the year ended 30 June
$ $
Sales (balancing figure) 35 000
Less:
Opening inventory 4 000
Purchases (balancing figure) 31 000
(Balancing figure) 35 000
Closing inventory 7 000
Cost of sales 28 000
Gross profit (margin 20%, so mark-up is 25%) 7 000
Answers to activities, practice exercises and exam practice questions: Chapter 16

Activity 3

Neha
Pro forma trading section of the income statement for the period
30 June 2015 to 5 November 2015
$ $
Sales $(122 000 − 16 000 + 37 000 + 17 000) 160 000
Less: cost of sales
Inventory at 30 June 2015 47 000
Purchases $(138 000 − 23 000 + 28 000) 143 000
190 000
Less: inventory at 5 November 2015
(Balancing figure) 70 000 120 000
Gross profit (25% of $160 000) 40 000

Cost of inventory lost in fire: $(70 000 − 12 000) = $58 000.

Practice exercices
1 a (i and ii) and b

Seng
Statement of affairs at: 1 January 2015 31 December 2015
$ $
Assets
65
Shop premises 20 000
Motor van 8 000
Shop fittings 3 000
Inventory 4 000
Trade receivables 1 000
Bank 60 000 5 000
60 000 41 000
Liabilities
Trade payables (6 000)
Loan from brother (20 000) (16 000)
40 000 19 000

Opening capital 40 000 40 000


Loss for the year (balancing figure) (15 800)
Less: drawings (5 200)
40 000 19 000

65
Cambridge International AS and A Level Accounting

2
Miriam
Statement of affairs at: 1 July 2015 30 June 2016
Assets $ $
Land and buildings at cost 60 000 60 000
Fixtures and fittings 10 000 12 000
Office machinery 8 000 7 000
Inventory 17 000 21 000
Trade receivables 4 000 5 000
Rent prepaid 1 000 600
Bank 14 000 16 000
114 000 121 600
Liabilities (3 000) (1 600)
Trade payables
Wages owing (2 000) (1 000)
109 000 119 000
Opening capital 109 000
Capital introduced 1 400
Profit for the year 21 000
Less: drawings (12 400)
Closing capital 109 000 119 000

Note: The revaluation of the land and buildings is ignored as this is a capital profit.

66 3 Workings:

Trade payables control account


$ $
Payments from bank 54 000 Opening balance 3 600
Closing balance 5 200 Credit purchases 55 600
59 200 59 200

Calculation of closing inventory

$
Per question 11 000
Less: damaged inventory at cost (5 000)
6 000
Add: damaged inventory at NRV 2 500
Value for trading account 8 500

Calculation of revenue

$
Opening inventory 16 000
Add: purchases $(55 600 − 1 300) 54 300
70 300
Less: closing inventory1, 2 (11 000)
Cost of sales 59 300

Mark up = $59 300 ÷ 60% = $98 833

66
Answers to activities, practice exercises and exam practice questions: Chapter 16

Check:

Sales 98 833
Less: cost of sales (59 300)
Gross profit 39 533

Gross profit margin = $39 533 ÷ $98 833 × 100 = 40%

Kim
Trading section of income statement for the year ended 30 June 2016
$ $
Sales 98 833
Opening inventory 16 000
Add: purchases $(55 600 − 1300) 54 300
70 300
Less: closing inventory3 (8 500)
Cost of sales (61 800)
Gross profit (36 600)

Notes:
1 The value given for closing inventory in the question ($11 000) is assumed to be
the value of goods at their full price.
2 The mark-up has been calculated using the full value of closing inventory.
3 $(11 000 − (5 000 × 50%)) It is further assumed that all damaged goods were 67
still inventory (i.e. that none of them had been sold before the year end).

4 a Cornelius
Statement of affairs at: 1 April 2014 31 March 2015
$ $
Assets
Equipment 15 000 28 000
Premises 80 000
Inventory 37 500 52 000
Trade receivables 22 400
Other operating expenses 700
Bank 30 000 116 000
82 500 299 100
Liabilities
Bank loan (40 000)
Trade payables (56 000)
Other operating expenses (2 280)
Loan from father (20 000) (20 000)
62 500 180 820
Opening capital 62 500 62 500
Capital introduced 40 000
Profit for the year (balancing figure) 99 120
Less: drawings (20 800)
62 500 180 820

67
Cambridge International AS and A Level Accounting

b Cornelius
Income statement for the year ended 31 March 2016
$ $
Sales 468 650
Less: Cost of sales
Opening inventory 52 000
Purchases 382 750
434 750
Less: closing inventory 74 250 360 500
Gross profit 108 150
Less: expenses
Other operating expenses
$(27 000 − 2 280 + 700 + 875 − 4 050) 22 245
Bank loan interest 6 000
Loan interest – father 1 600
Depreciation – equipment
$(28 000 + 24 000 − 45 900) 6 100 35 945
Profit for the year 72 205

Workings:
i Trade payables control account
$ $
68 Payments from bank 371 340 Opening balance 56 000
Closing balance 67 410 Credit purchases 382 750
438 750 438 750

ii Calculation of cost of sales

$
Opening inventory 52 000
Add: purchases 382 750
434 750
Less: closing inventory (74 250)
Cost of sales 360 500

iii Calculation of sales
Cost of sales + 30% = $468 650
iv Trade receivables control account
$ $
Opening balance 22 400 Receipts banked 456 850
Credit sales for the year 468 650 Closing balance 34 200
491 050 491 050

Answers to activities, practice exercises and exam practice questions: Chapter 16

v
Bank account
$ $
Opening balance 116 000 Suppliers 371 340
From customers 456 850 Drawings 26 000
Equipment 24 000
Other operating expenses 27 000
Bank loan interest 6 000
Interest on loan from father 1 600
Drawings for holiday 5 000
Additional drawings (bal fig) 800
Closing balance 111 110
572 850 572 850

c
Cornelius
Statement of financial position at 31 March 2016
Cost Accumulated Net book
depreciation value
Assets
Non-current assets
Premises 80 000 – 80 000
Equipment 45 900
80 000 125 900
69
Current assets
Inventory 74 250
Trade receivables 34 200
Other receivables 4 050
Cash and cash equivalents 111 110
223 610
Total assets 349 510
Capital and liabilities
Opening capital 180 820
Add: net profit 72 205
253 025
Less: drawings
$(26 000 + 5 000 + 800) (31 800)
221 225
Non-current liabilities
Bank loan 40 000
Loan from father 20 000
60 000
Current liabilities
Trade payables 67 410
Other payables 875
68 285
Total capital and liabilities 349 510

69
Cambridge International AS and A Level Accounting

Exam practice questions


Multiple-choice questions
1 B
2 B
3 C
4 D
5 D
6 B
7 D
8 D
9 B
10 D

Structured questions
1 a Benefits of maintaining proper books of account (any three):
• helps Ahmed to control the businesses
• helps to identify errors
• aids future planning
• satisfies the tax authorities
• helps when approaching banks or other lenders for loans.
b $
70 Assets
Premises 60 000
Motor van 8 000
Inventory 6 250
Trade receivables 3 200
Rent prepaid 400
Bank 9 450
Cash 50
87 350
Liabilities
Trade payables (1 800)
Electricity owing (600)
Loan interest owing (150)
Loan from brother (2 000)
82 800
Opening capital 82 800

c
Cash account
$ $
Opening balance 50 Payments
Cash sales for the year 21 750 $(3140 + 300 + 600 + 400) 4 440
Cash banked 17 000
Cash drawings (bal figure) 310
Closing balance 50
21 800 21 800
70
Answers to activities, practice exercises and exam practice questions: Chapter 16

d Ahmed
Income statement for the year ended 30 September 2016
$ $
Revenue 49 800
Less: cost of sales
Opening inventory 6 250
Purchases 26 060
32 310
Less: closing inventory 8 000 24 310
Gross profit 25 490
Other income
Discount received 420
25 910
Less: expenses
Wages 7 400
Electricity $(2200 − 600 + 320) 1 920
Rent ($4000 + 400 − 450) 3 950
Motor van expenses $(1800 + 600) 2 400
Loan interest $(2 000 × 10% − 150 + 150) 200
Telephone and stationery $(1650 + 300) 1 950
Irrecoverable debt 250
Other operating expenses 400
Depreciation – motor van $(8000 − 6000) 2 000 71
Depreciation – fixtures and fittings
($3000 × 25%) 750 21 220
Profit for the year 4 690

Workings:

Trade receivables control account


$ $
Opening balance 3 200 Receipts banked 29 400
Credit sales for the year 28 050 Irrecoverable debts written off 250
31 250 Closing balance 1 600
31 250

Total sales for the year = credit sales $28 050 + cash sales $21 750 = $49 800.

Trade payables control account


$ $
Payments from bank 23 000 Opening balance 1 800
Discount received 420 Credit purchases 22 920
Closing balance 1 300
24 720 24 720

Total purchases for the year = credit purchases $22 920 + cash purchases $3140 = $26 060.

71
Cambridge International AS and A Level Accounting

e Yes he should, in order to reflect the usage of the premises with the revenue generated by
using them (matching principle).
If the premises are recorded at cost and were purchased some time ago then it is more
likely that they have increased in value. He could revalue them and then begin depreciating
them with a charge based on their new valuation.
2 a Margin (or gross margin) refers to the ratio between the gross profit earned on sales and
the revenue figure, expressed as a percentage. The calculation is:
Gross profit
× 100
Revenue
Alternatively:
Revenue − Cost of sales
× 100 = Margin
Cost of sales
Mark-up is the amount which is added to the purchase cost of an item to arrive at its selling
price, usually expressed as a percentage. The calculation is:
Gross profit
× 100
Cost price
Alternatively:
Cost of sales × (100 + mark-up (as a %))
= Sales (or sales price)
Cost of sales
b Nadia
Calculation of inventory at cost at 31 December 2015

72
Add Minus Total
$ $ $
Value at 8 January 62 040
1  $62 040 × 20% 12 408
2 $2000 × 80% 1 600
3  i  Cost of goods from suppliers 4 400
  ii $12 000 × 80% 9 600
11 200 16 808 5 608
56 432

c
$ $
Revenue 225 000
Less: sales returns (3 200)
221 800
Opening inventory 65 000
Add: purchases (balancing figure) 168 872
Less: closing inventory from above (56 432)
Cost of sales 177 440
Gross profit ($221 800 × 20%) 44 360

72
Answers to activities, practice exercises and exam practice questions: Chapter 16

3 a i Calculation of credit sales


Trade receivables control account
$ $
Opening balance 20 400 Receipts banked 170 430
Credit sales for the year 182 030 Closing balance 32 000
202 430 202 430

 otal sales for the year = credit sales $182 030 + cash sales banked $103 000 +
ii T
cash taken as drawings before banking ($300 × 52) $15 600 = $300 630.
iii Trade payables control account
$ $
Payments from bank 227 668 Opening balance 7 500
Closing balance 6 900 Credit purchases 227 068
234 568 234 568

Total purchases = credit purchases $227 068 − goods taken for own use
$1 350 = $225 718.
b Korn
Income statement for the year ended 30 April 2016
$ $
Sales 300 630
Less: cost of sales
73
Opening inventory 22 400
Purchases $(227 068 − 1 350) 225 718
248 118
Less: closing inventory ($21 923 ÷ 130 × 100) 16 864 231 254
Gross profit 69 376
Less: expenses
Wages $(17 200 − 800 + 600) 17 000
Rent $(8 000 − 800 + 1000) 8 200
Electricity 9 670
General expenses 5 150
Loan interest ($30 000 × 10%) 3 000
Loss on sale of motor vehicle $(2 000 − 3 500) 1 500
Loss on sale of fixtures and fittings $(400 − 800) 400
Depreciation − motor van
$(10 000 − 3 500 + 10 000 − 8 000) 8 500
Depreciation – fixtures and fittings 4 200 57 620
$(8 000 − 800 + 7 000 − 10 000)
Profit for the year 11 576

73
Cambridge International AS and A Level Accounting

c
Korn
Statement of financial position at 30 April 2016
Cost Accumulated Net book
depreciation value
Assets
Non-current assets
Premises 70 000 – 70 000
Motor van 8 000
Fixtures and fittings 10 000
70 000 88 000
Current assets
Inventory 16 864
Trade receivables 32 000
Bank including loan from
brother (balancing figure here
or in cash book) 50 142
99 006
Total assets 187 006
Capital and liabilities
Opening capital 150 700
Add: net profit 11 756
162 456
74 Less: drawings $(15 600 + 1 350) (16 950)
145 506
Non-current liabilities
Loan from brother 30 000

Current liabilities
Trade payables 6 900
Other payables
$(600 + 1000 + 3000) 4 600
11 500
Total capital and liabilities 187 006

d Korn should not value his inventory at selling price.


• It would be contrary to the concept of realisation, as he has not yet obtained the
selling price value from the inventory.
• It woud be contrary to the matching principle when he does sell the inventory in the
next year, such sales will show nil profit.
• Accounting standards (accordingly) require the application of the rule ‘lower of
cost and net realisable value’.

74
Answers to activities, practice exercises and exam practice questions: Chapter 17

17 Partnership accounts
Activities
Activity 1
a
Tee and Shirt
Income statement and appropriation account
for the year ended 31 March 2016
$ $ $
Sales 215 000
Less: cost of sales
Inventory at 1 April 2015 16 000
Purchases 84 000
100 000
Less: inventory at 31 March 2016 20 000 80 000
Gross profit 135 000
Selling expenses 24 000
Administration expenses 46 000
Depreciation:
Fixtures and fittings 4 800
Office equipment 5 400 10 200
Interest on loan 600 80 800
Profit for the year 54 200
Share of profit: 75
 1 27 100
Tee  
2

 1 27 100 54 200
Shirt  2

b Partners’ current accounts


Tee Shirt Tee Shirt
2016 $ $ 2015 $ $
Mar 31 Drawings 29 000 31 000 Apr 1 Balances b/d 5 000 10 000
2016
Balance c/d 3 100 6 700 Mar 31 Interest on loan 600
Share of profit 27 100 27 100
32 100 37 700 32 100 37 700
Apr 1 Balance b/d 3 100 6 700

c
Statement of financial position at 31 March 2016
Cost Accumulated Net book
depreciation value
$ $ $
Non-current assets
Fixtures and fittings 48 000 12 800 35 200
Office equipment 27 000 10 400 16 600
75 000 23 200 51 800

(cont.)
Cambridge International AS and A Level Accounting

Statement of financial position at 31 March 2016


Cost Accumulated Net book
depreciation value
$ $ $
Current assets
Inventory 20 000
Trade receivables 24 000
Other receivables 6 000
Cash and cash equivalents 85 000
135 000
Total assets 186 800
Capital and liabilities
Capital accounts:
Tee 100 000
Shirt 50 000
150 000
Current accounts:
Tee 3 100
Shirt 6 700
9 800
Non-current liability
Loan – shirt 12 000
76
Current liabilities
Trade payables 11 000
Other payables 4 000
15 000
Total capital and liabilities 186 800

Activity 2
Tee and Shirt
a Income statement and appropriation account
for the year ended 31 March 2016
$ $ $
Sales 215 000
Less: cost of sales
Inventory at 1 April 2015 16 000
Purchases 84 000
100 000
Less: inventory at 31 March 2016 20 000 80 000
Gross profit 135 000
Selling expenses 24 000
Administration expenses 46 000
Depreciation:
Fixtures and fittings 4 800
Office equipment 5 400 10 200
Interest on loan 1 200 81 400
Profit for the year 53 600
76
Answers to activities, practice exercises and exam practice questions: Chapter 17

$ $ $
Add Interest on drawings:
Tee 2 900
Shirt 3 100 6 000
59 600
Less: interest on capitals
Tee 10 000
Shirt 5 000 (15 000)
Less: salary
Shirt (4 000)
40 600
Share of profit:
Tee   3
 5
24 360

Shirt  
2

5
16 240 40 600

b Partners’ current accounts
Tee Shirt Tee Shirt
2016 $ $ 2015 $ $
Mar 31 Drawings 29 000 31 000 Apr 1 Balances b/d 5 000 10 000
Interest on drawings 2 900 3 100 2016
Balances c/d 7 460 2 340 Mar 31 Interest on capital 10 000 5 000 77
Interest on loan 1 200
Salary 4 000
Share of profit 24 360 16 240
39 360 36 440 39 360 36 440
Apr 1 Balance b/d 7 460 2 340

c
Statement of financial position at 31 March 2016
Cost Accumulated Net book
depreciation value
$ $ $
Assets
Non-current assets
Fixtures and fittings 48 000 12 800 35 200
Office equipment 27 000 10 400 16 600
75 000 23 200 51 800
Current assets
Inventory 20 000
Trade receivables 24 000
Other receivables 6 000
Cash and cash equivalents 85 000
135 000
Total assets 186 800

(cont.)
77
Cambridge International AS and A Level Accounting

Statement of financial position at 31 March 2016


$ $ $
Capital and liabilities
Capital accounts:
Tee 100 000
Shirt 50 000
150 000
Current accounts:
Tee 7 460
Shirt 2 340
9 800
Non-current liability
Loan – shirt 12 000
Current liabilities
Trade payables 11 000
Other payables 4 000
15 000
Total capital and liabilities 186 800

Practice exercises
1 a
Bell and Binn
78 Income statement and appropriation account for the year ended 30 April 2016
$ $
Revenue 425 000
Less: cost of sales
Opening inventory 30 000
Add: purchases 200 000
230 000
Less: closing inventory (27 000) 203 000
Gross profit 222 000
Less: expenses
Wages 98 000
Rent $(25 000 − 1 500) 23 500
Heat and light 16 000
Office expenses 12 600
Vehicle expenses 5 510
Advertising $(3 500 − 2 000) 1 500
Irrecoverable debts written off 416
Bank charges $(314 + 860) 1 174
Depreciation of motor vehicles 3 800
Depreciation of plant and machinery 12 500 175 000
Profit for the year 47 000

78
Answers to activities, practice exercises and exam practice questions: Chapter 17

$ $
Add: interest on drawings
Bell 3 000
Binn 1 350 4 350
51 350
Less: interest on capital
Bell 5 000
Binn 4 000 9 000
Less: partner’s salary
Bell 10 000
Binn 8 000 18 000
Share of profit:
Bell 14 610
Binn 9 740 24 350

b Partners’ current accounts


Bell Binn Bell Binn
$ $ $ $
Drawings 30 000 13 500 Opening balance b/d 7 000 3 000
Interest on drawings 3 000 1 350 Interest on capital 5 000 4 000
Closing balance c/d 3 610 9 890 Salary 10 000 8 000
Share of profit 14 610 9 740
79
36 610 24 740 36 610 24 740
Balance b/d 3 610 9 890

c Statement of financial position at 30 April 2016


Cost Accumulated Net book
depreciation value
$ $ $
Non-current assets
Plant and machinery 125 000 48 500 76 500
Motor vehicles 41 000 25 800 15 200
166 000 74 300 91 700
Current assets
Inventory 27 000
Trade receivables 45 750
Less: provision for doubtful receivables (1 000) 44 750
Other receivables $(1500 + 2000) 3 500
Cash and cash equivalents 14 550
$(15 724 - 314 - 860)
89 800
Total assets 181 500

(cont.)

79
Cambridge International AS and A Level Accounting

Statement of financial position at 30 April 2016


$ $ $
Capital and liabilities
Partners’ capital and current accounts
Bell Binn
$ $
Capital account 50 000 40 000 90 000
Current account 3 610 9 890 13 500
53 610 49 890 103 500
Non-current liability
Long-term loan – Bell 60 000
Current liabilities
Trade payables 18 000
Total capital and liabilities 181 500

2 a Miller and Meredith
Forecast income statement and appropriation account
for the year ended 31 December 2016
$ $
Forecast net profit for the year $(21 560 + 21 600) 43 160
Less: interest on capital
Miller 2 000
80 Meredith 3 000 (5 000)
Forecast profit 38 160
Share of profit:
Miller 19 080
Meredith 19 080 (38 160)

b 
If the two businesses combine then Miller will have a forecast total income of $21 080
compared with $19 600 he earned for himself in the previous year. Meredith will have a
forecast income of $22 080 compared with $18 000 for the previous year as a sole trader.
It appears from the figures that both partners will be better off by combining their businesses.
However, there is no guarantee that the forecast increases in net profit will happen. Had they
stayed as sole traders and the forecast increases had happened then Miller would be worse off,
by $(21 560 − 21 080). Meredith, on the other hand would be better off by $(22 080 − 21 600).
On a strictly short term calculation, Miller should not agree to a partnership with Meredith
on those terms. However, the figures in both cases are very close together. On that basis,
therefore, he should consider whether there are longer term factors that may outweigh the
short term loss. There may be more scope to increase future net profits as a partnership
than by trading alone.
Workings:

Miller Meredith
$ $
Net profit for y/e 31 Dec 2015 19 600 18 000
Add: estimated increase 1 960 3 600
Forecast net profit 21 560 21 600
80
Answers to activities, practice exercises and exam practice questions: Chapter 17

Exam practice questions


Multiple-choice questions
1 C
2 D
3 A
Note
Since interest on loans is an expense of the business, the profit for the year can be assumed to
have allowed for this. Accordingly, to answer the questions, no adjustment to profit should be
made for interest; nor is the interest received to be viewed as part of a partner’s profit share.
Similarly, a partner’s salary reduces the amount of profit to be shared, and in that strict sense her
share of the remainder is her profit share.

Structured question
a Advantages of forming a partnership (any two):
• The capital invested by partners is often more than can be raised by a sole trader.
• A greater fund of knowledge, experience and expertise in running a business is available to
a partnership.
• A partnership may be able to offer a greater range of services to its customers (or clients).
• The business does not have to close down, or be run by inexperienced staff, in the absence
of one of the partners; the other partner(s) will provide cover.
• Losses are shared by all partners.
Disadvantages of forming a partnership (any two):
81
• A partner doesn’t have the same freedom to act independently as a sole trader has.
• A partner may be frustrated by the other partner(s) in their plans for the direction and
development of the business.
• Profits have to be shared by all partners.
• A partner may be legally liable for acts of the other partner(s).
b Partners maintain separate capital and current accounts to keep better control of the
amounts introduced into the business and drawn from the business by each partner. The
capital account identifies how much each partner has introduced into the business. From this
it is possible to calculate any interest on capital agreed between the partners. The capital
account is adjusted only very occasionally, for example when a partner is admitted or retires,
or when there is a substantial change in the business’s need for capital.
The current account records each partner’s share of profits, either by way of profit share
or interest on capital/salary. It also shows how much a partner draws. Keeping the current
account also helps partners not to withdraw from the business more than their share of
profit. This ensures cash is retained and partners do not withdraw capital. (A partner that
deliberately withdrew excessive drawings would in effect have repaid himself some of his
capital whilst still charging interest on the full amount.)

81
Cambridge International AS and A Level Accounting

c
Up and Down
Corrected statement of financial position at 30 June 2016
$ $
Assets
Non-current assets
Fixtures and fittings at cost 33 500
$(45 000 − 15 000 + 3 500)
Less: depreciation to date 22 500
$(34 500 − 10 500 − 1 500)
11 000
Current assets
Inventory $(28 500 + 10 000) 38 500
Trade receivables 24 000
Less: provision for doubtful debt 960 23 040
Other receivables 750
Cash and cash equivalents 9 000
71 290
Total assets 82 290
Capital and liabilities
Capital accounts:
Up 22 000
Down 14 000
82 36 000
Current accounts:
Up $(7 500 + 2 200 + 3579) 13 459
Down $(1 500 + 1 400 − 1075 + 2506) 4 331
17 790
Total capital 53 790
Non-current liability
Loan – Up 15 000
Current liabilities
Trade payables 12 000
Other payables 1 500
13 500
Total capital and liabilities 82 290

Workings:

Adjustments to profit
$
Loss on disposal of fixtures and fittings
$(15 000 − 10 500 − 3 500) (1 000)
Depreciation of fixtures sold written back 1 500
Loan interest on Up’s loan (1 500)
Undervalue of closing inventory 10 000
Provision for doubtful debts ($24 000 × 4%) (960)
Prepaid rent 750

82
Answers to activities, practice exercises and exam practice questions: Chapter 17

$
Goods taken for personal use 1 075
Adjusted profit 9 865
Less: interest on capital
Up 2 200
Down 1 400
6 265
Share of profit:
Up 3 759
Down 2 506
6 265

d Up and Down
Revised current accounts at 30 June 2016
Up Down Up Down
$ $ $ $
Original balances 7 500 1 500
Goods taken 1 075
Balance c/d 13 459 4 331 Interest on capital 2 200 1 400
Share of profit 3 759 2 506
13 459 5 406 13 459 5 406
Opening balances b/d 13 459 4 331
83
e There are really only two ways in which Down could increase the balance on his capital
account. The first is to introduce some assets into the business rather than cash. This would
mean him purchasing, say, some inventory and introducing that into the business. He could
also bring in some of his personal assets into the business, say, his car or computer. If he
decides to purchase some assets then his ability to do so will depend on how much personal
cash he has available. If he has very little then this is not a viable option. Likewise, he may not
want to introduce his own assets into the business.
The other option is for Down to explore ways in which he can give up a part of his other
entitlements from the partnership and turn these into a further capital contribution. For
example, he could agree that some of his current account can be credited to the capital
account instead. Based on the above figures, he could contribute up to $4 331 this way.
However, that would mean that Down would not have any balance left on his current account to
draw for his immediate needs, and in any case, Up wishes him to increase his capital by $8 000.
Another idea would be for the partners to agree that a portion of Down’s future shares of
profit are credited to the capital account, instead of to the current account. (For example,
$2 000 for each of the next four years. If the partnership is highly profitable, it may be possible
to complete this exercise in a shorter time or even in one year.)
Down’s options are limited and it may be that he is unable to increase the balance on his
capital account without introducing some more cash into the business. He may have to
borrow money to do so.

83
Cambridge International AS and A Level Accounting

18 Partnership changes
Activities
Activity 1
a
Revaluation account
$000 $000
Property (old value) 120 Property (new value) 150
Plant and machinery (old value) 60 Plant and machinery (new value) 51
Inventory (old value) 20 Inventory (new value) 17
Trade receivables (old value) 30 Trade receivables (new value) 28
Trade payables (new value) 22 Trade payables (old value) 24
Profit on revaluation – Ann 12
Profit on revaluation – John 6
270 270

b Capital accounts
$000 $000 $000 $000
Ann John Ann John
Balance c/f 132 66 Opening balances 120 60
Profit on revaluation 12 6
132 66 132 66
Balance b/d 132 66
84
Statement of financial position at 31 October 2016 following revaluation
c
$000
Non-current assets
Property 150
Plant and machinery 51
201
Current assets
Inventory 17
Trade receivables 28
Bank account 1
46
Total assets 247
Capital and liabilities
Capital accounts:
Ann 132
John 66
198
Current accounts:
Ann 17
John 10
27
Current liabilities
Trade payables 22
Total capital and liabilities 247
Answers to activities, practice exercises and exam practice questions: Chapter 18

Activity 2
Workings:

Journal
Name of account Dr Cr
$ $
Freehold premises 25 000
Fixtures and fittings 3 000
Office equipment 2 000
Inventory 3 000
Trade receivables control 1 000
Revaluation account 16 000
Revaluation of assets at 1 September 2016 as agreed by partners
Revaluation account 16 000
Capital account – Tom 8 000
Capital account – Tilly 8 000
Apportionment of profit on revaluation of assets to partners in profit-sharing ratios

a
Revaluation account
$ $
Journal on allocation of revaluation gains 16 000 Journal on revaluation of assets 16 000

Journal
85
Name of account Dr Cr
$ $
Freehold premises 25 000
Revaluation account 25 000
Revaluation account 3 000
Fixtures and fittings 3 000
Revaluation account 2 000
Office equipment 2 000
Revaluation account 3 000
Inventory 3 000
Revaluation account 1 000
Trade receivables control 1 000
Revaluation account 8 000
Capital account – Tom 8 000
Revaluation account 8 000
Capital account – Tilly 8 000
Revaluations of assets at 1 September 2016 as agreed by partners,
and apportionment of net profit on revaluation of assets to partners in
profit-sharing ratios.

85
Cambridge International AS and A Level Accounting

Revaluation account
$ $
Fixtures and fittings 3 000 Freehold premises 25 000
Office equipment 2 000
Inventory 3 000
Trade receivables control 1 000
Capital account – Tom 8 000
Capital account – Tilly 8 000
25 000 25 000

b Tom and Tilly


Statement of financial position as at 1 September 2016

$ $
Assets
Non-current assets at new values
Freehold premises 65 000
Fixtures and fittings 15 000
Office equipment 5 000
85 000
Current assets
86 Inventory 14 000
Trade receivables 3 000
Cash and cash equivalents 6 000
23 000
Total assets 108 000
Capital and liabilities
Capital account – Tom 56 000
Capital account – Tilly 49 000
105 000
Current liabilities
Trade payables 3 000
Total capital and liabilities 108 000

c As the terms of the partnership changed, with Tilly now being entitled to a salary as well as
a share of profits, then the partners were correct to revalue the assets. This ensures that any
effort by the partners in the 'old' partnership that has generated a profit (or gain, or loss) that
will be divided up in the future is rewarded in the proportions that were agreed to apply to the
earlier period.

86
Answers to activities, practice exercises and exam practice questions: Chapter 18

Activity 3
a
Vera and Ken
Calculation of goodwill
Value of net assets $
Premises 140 000
Fixtures and fittings 65 000
Motor vehicles 35 000
Office equipment 15 000
Inventory 6 500
Trade receivables 11 800
Bank 3 620
276 920
Less:
Trade payables 5 830
Net asset value 271 090

Value of goodwill: $(300 000 − 271 090) = $28 910


b Amounts to be credited to capital accounts for goodwill:

( )
Vera  1  of $28 910 : $14 455
 2

(
 1
Ken   of $28 910 :
2 ) $14 455

Activity 4 87

a
Old New Adjustments to capital
profit-sharing ratios profit-sharing ratios ­accounts (net)
$ $ $
Punch 12 000 10 800 1 200 credit
Judy 6 000 7 200 1 200 debit
18 000 18 000

b Capital accounts
Punch Judy Punch Judy
2016 $ $ 2016 $ $
Oct 1 Goodwill 1 200 Oct 1 Balance b/f 36 000 14 000
Goodwill 1 200
Oct 1 Balance c/d 37 200 12 800
37 200 14 000 37 200 14 000
Oct 1 Balance b/d 37 200 12 800

Note:
In this case the net adjustment for each partner has been made. It would be equally correct to:
• credit Punch’s capital account with $12 000 and debit it with $10 800
• credit Judy’s capital account with $6 000 and debit it with $7 200.

87
Cambridge International AS and A Level Accounting

Activity 5

Hook, Line and Sinker


Trading section of the income statement and appropriation
account for the year ended 31 December 2016
$
Sales 129 500
Less cost of sales 66 500
Gross profit carried down 63 000

Hook, Line and Sinker


Income statement and appropriation account for the
year ended 31 December 2016
Six months to Six months to Year to
30 June 2016 31 December 2016 31 December 2016
$ $ $ $ $ $
Gross profit brought down 31 500 31 500 63 000
Wages 7 000 7 000 14 000
General expenses 1 750 3 500 5 250
Interest on loan 200 400 600
Depreciation 875 9 825 875 11 775 1 750 21 600
Profit for the year 21 675 19 725 41 400
Salary – Hook 3 000 3 000 3 000
88 16 725 38 400
Share of profit:
 3  1
Hook   10 838   5 575 16 413
6   3   

 2  1
Line     7 225   5 575 12 800
6 3   

 1  1
Sinker     3 612 21 675   5 575 16 725 9 187 38 400
6 3   

Activity 6
a
Income statement and appropriation account for the year ended
31 December 2016
$
Turnover 600 000
Less: cost of sales (330 000)
Gross profit 270 000

For eight months For four months


Gross profit 270 000 → 8 : 4 180 000 90 000
Less: operating expenses:
Manager salary (24 000 × 8/12) 16 000 −
Wages and salaries (106 000 − 16 000) → 8 : 4 60 000 30 000
Rent (42,000 → 8 : 4) 28 000 14 000
Heating and lighting (6 000 → 8 : 4) 4 000 2 000
Answers to activities, practice exercises and exam practice questions: Chapter 18

Other operating expenses (12 000 → 8 : 4) 8 000 4 000


Depreciation:

( )
8
Premises   180 000 × 4% × 4 800
12

      (210 000 × 4% × )
4
2 800
12

Plant    (90 000 × 20% × )


8
12
12 000

     (27 000 × 20% × )
4
1 800
12

Motor car   (30 000 × 25% × )


8
5 000
12

      (5 000 + 7 000 × 25% × )


4
1 000
12

Equipment   (21 000 × 10% × )


8
1 400
12

      (6 000 × 10% × )
4 200
12

Interest on loan (20 000 × 12% × )


4 (139 200) 800 (56 600)
12
Profit for the periods 40 800 33 400
Less: appropriation:
Interest on capital:

(
Hardeep   100 000 × 10% ×
12
8
) 6 667
89
      (158 800 × 10% × )
4 5 293
12

Nasma   (60 000 × 10% × ) 4 000


8
12

      (87 400 × 10% × )
4 2 913
12

Arfan    (45 000 × 10% × )
4 1 500
12
Total interest 10 667 9 707

(15 000 × )
Salary – Nasma  
8
12
10 000

        (18 000 × )
4 – (20 667) 6 000 (15 707)
12
Residual profits 20 133 17 693
Share of profit

(
Hardeep   20133 × ) 2
3
13 422

     (17 693 × )
2 7 077
5

Nasma   (20 133 × )
1 6 711
3

      (17 693 × )
2 7 077
5

(
Arfan     17 693 ×
1
5 ) (20 133) 3 539 (17 693)

– –
89
Cambridge International AS and A Level Accounting

b Capital acounts
Hardeep Nasma Arfan Hardeep Nasma Arfan
Balance b/d 100 000 60 000
Gain on revaluation 62 800 31 400
Goodwill written off 24 000 24 000 12 000 Goodwill 40 000 20 000
Transfer to loan a/c 20 000 Bank 50 000
Balance c/d 158 800 87 400 45 000 Motor car 7 000
202 800 111 400 57 000 202 800 111 400 57 000
Balance b/d 158 800 87 400 45 000

Working for gain on revaluation

Assets Book value Dep for 8m Book value Revalued Gain


on 1 Jan 2016 on 1 Jan 2016 1 Sept 2016
Premises 135 000 (4 800) 130 200 210 000 79 800
Plan 30 000 (12 000) 18 000 27 000 9 000
Motor van 5 000 (5 000) – 5 000 5 000
Office equipment 7 000 (1 400) 5 600 6 000 400
Total (23 200) (94 200) →2:1


Current acounts
Hardeep Nasma Arfan Hardeep Nasma Arfan
Drawings 30 000 40 000 4 000 Balance b/d 16 000 12 000
90 Interest on loan 800
Interest on capital 11 960 6 913 1 500
Salary 16 000
Balance c/d 19 260 8 702 1 039 Share of profit 20 500 13 788 3 539
49 260 48 702 5 039 49 260 48 702 5 039
Balance b/d 19 260 8 702 1 039

Note: Rounding differences have not been eliminated in presenting this answer.

Activity 7
a
Wilfrid, Hide and Wyte
Income statement and appropriation account for the year ended 30 June 2016
Six months ended Six months ended
31 Dec 2015 30 June 2016
$ $ $ $
Gross profit 93 500 93 500
Wages 45 500 45 500
Rent 6 000 6 000
Electricity 4 200 4 200
Interest on loan – 3 750
Other operating expenses 4 500 60 200 4 500 63 950
Profit for the year 33 300 29 550
Interest on capital: –
Wilfrid 4 000
Hide 2 500 1 650†
Wyte 1 500 8 000 325†† 1 975
25 300 27 575
Answers to activities, practice exercises and exam practice questions: Chapter 18

$ $ $ $
Share of profit:
Wilfrid  3  12 650
 
6

Hide  2  1
  8 433   13 788
6 2

Wyte  1 4 217  1
25 300 27 575
    13 787
6 2

 1
† $33 000 × 10% ×   = $1 650
 2

 1
†† $6 500 × 10% ×   = $325
 2

b Partners’ capital accounts


Wilfrid Hide Wyte Wilfrid Hide Wyte
2015 $ $ $ 2015 $ $ $
Dec 31 Goodwill 10 000 20 000 Jul 1 Balance b/d 80 000 50 000 30 000
Revaluation 10 500 7 000 3 500 Dec 31 Goodwill 30 000
of assets
Loan a/c 75 000 Current a/c 5 650
Bank 30 150
91
2016
Jun 30 Balance c/d 33 000 6 500
115 650 50 000 30 000 115 650 50 000 30 000
2016
Jul 1 1 Balance b/d 33 000 6 500
Note: The goodwill adjustments have been shown net.

Partners’ current accounts


Wilfrid Hide Wyte Wilfrid Hide Wyte
2015 $ $ $ 2015 $ $ $
Dec 31 Drawings 23 000 Jul 1 Balance b/d 12 000 3 000 4 000
Capital a/c 5 650 Dec 31 Interest 4 000
Profit 12 650
2016
Jun 30 Drawings 28 000 18 000 2016
Balance c/d 1 371 5 829 Jun 30 Interest 4 150 1 825
Profit 22 221 18 004
28 650 29 371 23 829 28 650 29 371 23 829

Jul 1 Balance b/d 1 371 5 829

Note: Some questions will combine the revaluation of assets with the introduction of a new partner. In this
case, work through the revaluation account, transferring any profit or loss on revaluation to the old partners in
their old profit sharing ratios. Then introduce the new partner and adjust the capital accounts for goodwill in
line with Section 18.7.
Cambridge International AS and A Level Accounting

Activity 8
a Realisation account
$000 $000
Property (book value) 80 Bank – sale of property 106
Motor vehicles (book value) 20 Samir’s capital account – value of car taken 7
Inventory (book value) 19 Bank – sale of vehicles 9
Trade receivables (book value) 16 Bank – sale of inventory 18
Bank – payments to trade payables 10 Bank – from trade receivables 13
Bank – expenses of sale 3 Trade payables (book value) 10
Profit on realisation:
Raul (3/5) 9
Samir (2/5) 6
163 163

b Capital accounts
Raul Samir Raul Samir
$000 $000 $000 $000
Vehicle taken 7 Opening balances 60 55
Current account – 4 Current accounts 10 –
Bank 79 50 Profit on realisation 9 6
79 61 79 61

92 c
Bank account
$000 $000
Sale of property 106 Opening balance 4
Sale of vehicles 9 Trade payables 10
Sale of inventory 18 Expenses of sale 3
From trade receivables 13 Capital account – Raul 79
Capital account – Samir 50
146 146

Practice exercises
1 a 
When a new partner is admitted, it is only fair that the old partners are rewarded for their
efforts in building up the business. The assets should be revalued prior to admitting a new
partner, because any profit on revaluation belongs to the old partners. The new partner
should not benefit from any of this profit.
b i Revaluation account
$ $
Property account (current value) 40 000 Property account (new value) 60 000
Inventory account (current value) 12 000 Inventory account (new value) 10 000
Capital account – Ali 9 000
Capital account – Siri 9 000
70 000 70 000

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Answers to activities, practice exercises and exam practice questions: Chapter 18

Note:
This is the first account to be tackled because any profit or loss on revaluing assets
belongs to the old partners. Fiona, the new partner, isn’t entitled to any of this profit as
she has not been part of the business which generated it. It would have been acceptable
to shortcut the answer by showing the changes in the value of the assets rather than
show their old value and new value. This is shown below:

Revaluation account
$ $
Inventory account – loss 2 000 Property account – profit 20 000
$(12 000 – 10 000) $(60 000 – 40 000)
Capital account – Ali 9 000
Capital account – Siri 9 000
20 000 20 000

Both approaches would be acceptable. It’s very much a question of how confident
students feel. Putting in both the old and new values (the first approach) helps track
everything better. There is too much opportunity to make an arithmetic mistake by
shortcutting the approach.
ii Capital accounts
Ali Siri Fiona Ali Siri Fiona
$000 $000 $000 $000 $000 $000
Goodwill account 8 8 8 Opening balance 36 36 – 93

Balance c/d 49 49 22 Profit on revaluation 9 9 –


Bank 30
Goodwill 12 12 –
57 57 30 57 57 30
Balance b/d 49 49 22

c The treatment of goodwill is similar to the treatment of any profit arising on revaluation of
assets. The old partners’ capital accounts are credited with their share of goodwill in the
old profit sharing ratio. The capital accounts of all three partners are then debited with
goodwill in the new profit sharing ratio. This is done as the old partners have given up a
share of their goodwill to the incoming partner.
2 a
Capital accounts
Wilson Betty Keppel Wilson Betty Keppel
$000 $000 $000 $000 $000 $000
Goodwill account 12 12 – Opening balance 40 15 30
Current account 6 Goodwill 8 8 8
Bank 36
Balance c/d 40 15 – Profit on revaluation 4 4 4
52 27 42 52 27 42
Balance b/d 40 15 –

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Cambridge International AS and A Level Accounting

b Partners’ capital accounts for the period from 1 May 2015 to 30 April 2016
Wilson Betty Imogen Wilson Betty Imogen
2015 $000 $000 $000 2015 $000 $000 $000
Nov 30 Goodwill 16 16 8 May 1 Opening 52 15 –
account balance
2016 Nov 30 Bank 20
April 30 Balance c/d 56 19 12 Goodwill 20 20 –
72 35 20 72 35 20
2016
May 1 Balance b/d 56 19 12

c Two advantages of partners preparing a partnership agreement are:


• 
It shows clearly how much of the profit earned by the partnership each partner is
entitled to. It also shows how much each partner must bear of any loss incurred.
• It will prevent future disputes between the partners.

d Partnership appropriation account for the year ended 30 April 2016


7 months to 5 months to
30 November 2015 30 April 2016
$ $ $ $
Profit for the period 81 666 58 334
Less: interest on capital
94
Wilson 3 033 2 333
Betty 875 791
Imogen – 3 908 500 3 624
Residual profit 77 758 54 710
Share of residual profit
Wilson 38 879 21 884
Betty 38 879 21 884
Imogen – 10 942
77 758 54 710

e
Partners’ current accounts
Wilson Betty Imogen Wilson Betty Imogen
$ $ $ $ $ $ $
Balance b/d 1 000 Balance b/d 2 000
Drawings 52 000 48 000 20 000 Interest on capital 5 366 1 666 500
Balances c/d 16 129 13 429 Share of profit 60 763 60 763 10 942
Balances c/d 8 558
68 129 62 429 20 000 68 129 62 429 20 000
Balance b/d 8 558 Balance b/d 16 129 13 429

94
Answers to activities, practice exercises and exam practice questions: Chapter 18

f It is possible that the partners will benefit from converting their business to a limited
company. It will give them limited liability for the debts of the business, unlike now where
they are all fully liable for the partnership debts and may have to use their own personal
assets to meet payment for them.
A limited company can issue shares to passive investors who share in the risk and reward

instead of taking a lender’s return in interest. Small parcels of shares can be awarded or
sold to key employees as a motivational bonus arrangement. Having the option to issue
shares or to take loans, or a mixture, may make raising capital easier in the future.
However, there is the need to decide how many shares each partner will be issued with.
If they are issued in proportion to the balances on their capital and current accounts
then Wilson will clearly have the most shares. This will give him control of the company
in making decisions on the way it is developed in the future. This may upset Betty and
Imogen as at the moment all three have an equal share in the decision making. This could
cause future friction between all three, leading to the business failing.
Clearly then, the shares should be issued in the same proportions as the partners intend

to share the profits going forward. This may mean that some amounts of capital are
repaid on incorporation, or are converted to loans from the individuals to the company,
or that Imogen will have to take out some personal loans so that she has enough to pay
for her full portion of the new shares. All this should be a matter for agreement between
the partners based around the capital needs of the business and their personal financial
circumstances.
The primary drawback of being a limited company is that there is extensive legislation
(in the UK in the Companies Act 2006) which regulates the conduct of companies and
their directors, and requires that information, including the annual accounts, are placed
on public record. In contrast, partnerships are allowed considerable privacy and relative 95
freedom of conduct.
It is usual to consider incorporation when the scale or nature of the business are such that
the advantage of limited liability outweighs the additional administrative burden.

Exam practice questions


Multiple-choice questions
1 D
2 A
3 D
4 B
5 A

95
Cambridge International AS and A Level Accounting

19 An introduction to the accounts of limited companies


Activities
Activity 1
a
Year 2011 2012 2013 2014 2015 2016
$ $ $ $ $ $
Profit 10 000 5 000 7 000 4 000 7 000 12 000
Preference dividend paid 6 000 5 000 6 000 4 000 6 000 6 000
Profit left for ordinary shareholders 4 000 nil 1 000 nil 1 000 6 000
Maximum ordinary dividend payable 4% – 1% – 1% 6%

b Year 2011 2012 2013 2014 2015 2016


$ $ $ $ $ $
Profit 10 000 5 000 7 000 4 000 7 000 12 000
Preference dividend for year 6 000 5 000 6 000 4 000 6 000 6 000
Arrears of dividend carried forward – – 1 000 – 1 000 1 000
Profit left for ordinary shareholders 4 000 nil nil nil nil 5 000
Maximum ordinary dividend payable 4% – – – – 5%

Activity 2
a Premium Share Limited
Journal
96
Dr Cr
$ $
Bank 120 000
Ordinary share capital 100 000
Share premium account 20 000
Issue of 100 000 ordinary shares of $1 at $1.20 per share

b Cash book
Bank account (extract)
$ $
June 1 Ordinary share capital 100 000
Share premium 20 000

Ordinary share capital account


$ $

June 1 Bank 100 000

Share premium account


$ $

June 1 Bank 20 000


Answers to activities, practice exercises and exam practice questions: Chapter 19

Activity 3
a
Doingwell Limited
Journal
Dr Cr
Details $ $
Aug 1 Bank account 220 000
Ordinary share capital account 110 000
Share premium account 110 000
Receipt of first payment on application for the issue of
150 000 ordinary shares at $1.50 each
First payment = 220 000 × $1. This represents $0.50 share
capital and the full share premium of $0.50 per share
Sep 1 Ordinary share capital account 35 000
Share premium account 35 000
Bank account 70 000
Refund of payment to unsuccessful applicants
Ordinary share capital 70 000 shares × $0.50
Share premium 70 000 shares × $0.50
Oct 1 Bank account 75 000
Ordinary share capital account 75 000
Balance of money due from successful applicants
97
b Cash book
Bank account (extract)
$ $
Aug 1 Ordinary share capital 110 000 Sep 1 Ordinary share capital 35 000
Share premium 110 000 Share premium 35 000
Oct 1 Ordinary share capital 75 000
Share premium 75 000

Note:
The bank account is only showing the transactions relating to the issue of shares. It is only
an extract, as during the period from August 1 to October 1 there would have been other
transactions which affected the bank account.

Ordinary share capital account


$ $
Sep 1 Bank 35 000 Aug 1 Bank 110 000

Oct 1 Bank 75 000

Share premium account


$ $

Sep 1 Bank 35 000 Aug 1 Bank 110 000

97
Cambridge International AS and A Level Accounting

Activity 4
Journal Dr Cr
Details $ $
Freehold premises at cost 60 000
Freehold premises accumulated depreciation 18 000
Revaluation reserve 42 000
Transfer of existing balances to revaluation reserve account
Freehold premises at cost 80 000
Revaluation reserve 80 000
Revaluation of premises at new valuation

Note:
Any depreciation to be charged on the premises will be calculated on the new
valuation of $80 000.

The alternative journal, following the style on page 268 of the text, is also perfectly acceptable:

Journal
Name of account $ $
Freehold premises at cost 20 000
Freehold premises accumulated depreciation 18 000
Revaluation reserve 38 000
98
Revaluation of premises at new valuation

Activity 5
Total of ordinary share capital and reserves:

$(200 000 + 50 000 + 100 000 − 40 000) = $310 000


 $310 000
Net asset value of 100 ordinary shares = × 100 = $155
200 000

Activity 6
a Michel Pillay Limited
Income statement for the year ended 30 April 2016
$000 $000
Revenue 300
Opening inventories 20
Purchases 113
133
Closing inventories 31
Cost of sales 102
Gross profit 198
Overheads:
Sales office salaries 57
Selling expenses 39
General office wages 32
Other general expenses 35

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Answers to activities, practice exercises and exam practice questions: Chapter 19

$000 $000
Depreciation:
Warehouse machinery 8
Office machinery 10 181
Profit for the year 17

b
Michel Pillay Limited
Statement of changes in equity for the year ended 30 April 2016
Share Share General Retained Total
capital premium reserve earnings
$000 $000 $000 $000 $000 [1] The transfer to
Balance at 30 April 2015 60 15 25 8 108 general reserves is
made from retained
Profit for the year 17 17 earnings. Thus no
Transfer to general reserve [1] 10 (10) entry appears in the
‘Total’ column.
Balance at 30 April 2016 60 15 35 15 125

c
Michel Pillay Limited
Statement of financial position at 30 April 2016
Cost Accumulated Net book
depreciation value
$000 $000 $000
Assets 99

Non-current assets:
Warehouse machinery 70 38 32
Office machinery 42 30 12
112 68 44
Current assets
Inventories 31
Trade receivables 38
Cash and cash equivalents 28
97
Total assets 141
Equity and liabilities
Capital and reserves
Share capital 60
Share premium 15
General reserve 35
[1] Notice that
Retained earnings 15
the total of capital
[1] 125 and reserves
Non-current liabilities ($125 000) matches
the closing total on
10% debentures 2023/2025 5 the statement of
Current liabilities changes in equity.

Trade payables 11
Total liabilities 141

99
Cambridge International AS and A Level Accounting

Activity 7
Good Offers Limited
Re-drafted statement of financial position
$000
Assets
Non-current assets 1 400
Current assets 350
1 750
Equity and liabilities
Capital and reserves
Ordinary shares of $1[ 800 + (800 ÷ 4 × 3)] 1 400
Share premium 200
General reserves 100
Retained earnings 50
1 750

Note:
The least flexible reserve is the revaluation reserve. This was $600 000 and exactly matched the
increase in ordinary shares resulting from the bonus issue. Hence it was used first. Had any more
reserves been required then the share premium would have been used as this is less flexible than
the general reserve and retained earnings.

Activity 8
100
a
Journal Dr Cr
2016 Details $ $
July 1 Share premium 500 000
Revaluation reserve 300 000
Ordinary share capital 800 000
Issue of bonus shares at 4 for every 5 held, leaving the
reserves in their most flexible form

b Bonarite Limited
Statement of financial position at 1 July 2016, immediately
after the issue of the bonus shares
$
Net assets 2 000
Equity
Share capital and reserves
Ordinary shares of $1 1 800
General reserves 120
Retained earnings 80
2 000
Answers to activities, practice exercises and exam practice questions: Chapter 19

c
Journal Dr Cr
2016 Details $ $
July 1 Bank 750 000

(  1
Ordinary share capital   × 1 800 000 = 600 000
 3 ) 600 000

Share premium (600 000 × $1.25) 150 000


Rights issue of one ordinary share for every three held

d Bonarite Limited
Statement of financial position at 1 July 2016, immediately after the rights issue shares
$000
Net assets 2 750
Equity
Share capital and reserves
Ordinary shares of $1 2 400
Share premium 150
General reserves 120
Retained earnings 80
2 750

Practice exercise
1 a Bracket and Racket Limited 101
Income statement for six months ended 30 September 2016
$000
Revenue (W1 + W2) 2451
Cost of sales $(1540 + W3 − 704) (2132)
Gross profit 319
Expenses $(25 + 823 + 103 − 192) (759)
 1
Depreciation $(350 − 70) × 25% ×   (six months) (35)
  2

Provision for doubtful debts ($420 × 5%) (21)


Loss from operations before non-recurring items (496)
Loss on disposal of unused buildings (17)
(513)
Finance cost (20)
Loss before tax 533)
Taxation (–)
Loss for the period (533)

101
Cambridge International AS and A Level Accounting

Bracket and Racket Limited - Working 1 (W1)


Two-column cash book
Cash Bank Cash Bank
$000 $000 $000 $000
Brought down 3 – – 203
Sales ledger (2 784 − 53) 2 731 Purchase ledger 1 996
Sale of property 53 Expenses 823
Cash sales 120 Interest 20
(balancing figure)
Wages 25
Loan repayments 90
Carried down (195 + 63) – 258 Carried down 8 –
123 3 042 123 3 042

Bracket and Racket Limited - Working 2 (W2)


Sales ledger
$000 $000
Brought down 820 Bank 2 731
Sales (balancing figure) 2 331 Carried down 420
3 151 3 151

Bracket and Racket Limited - Working 3 (W3)


102
Purchase ledger
$000 $000
Bank 1 996 Brought down 1 210
Carried down 510 Purchases 1 296
(balancing figure)
2 506 2 506

Bracket and Racket Limited


Statement of changes in equity for six months ended 30 September 2016
Details Share capital Retained earnings Total
$000 $000 $000
At start of year 25 910 1 108
Loss for six months (533) (533)
Loan repayments – (90)
Balance at 30 Sept 25 377 4 850


Note:

Although not specifically asked for, a statement of changes in equity has been shown.
Included in the statement of changes in equity is the loan account. The reason for this
is that in the original data the loan account was included as part of the equity. However,
as we have seen, it is not part of the equity in the new statement of financial position.

102
Answers to activities, practice exercises and exam practice questions: Chapter 19

b Bracket & Racket Limited


Statement of financial position at 30 September 2016
Net book value
$000 $000
Assets
Non-current assets
Buildings $(250 − 70) 180
Less: depreciation (22.50) 157.50
Fixtures and fittings 100.00
Less: depreciation (12.50) 87.50
245
Current assets
Inventory 704
Trade receivables $(420 − 21) 399
Cash 8
1 111
Total assets 1 356
Equity and liabilities
Capital and reserves
Share capital 25
Retained earnings 377
402
103
Non-current liabilities
Loan accounts $(173 − 90) 83
Current liabilities
Trade payables 510
Accruals 103
Bank overdraft (195 + 63) 258
871
Total equity and liabilities 1 356

Exam practice questions


Multiple-choice questions
1 C
2 B
3 B
4 A
5 C
6 A
7 A
8 D
9 D
10 C
11 D
12 B
13 A
14 C
103
Cambridge International AS and A Level Accounting

Structured questions
1 a Cash book
Bank account (extract)
$ $
May 1 Ordinary share capital 60 000 Jun 1 Ordinary share capital 10 000
Share premium 60 000 Share premium 10 000
Jul 1 Ordinary share capital 25 000
Aug 1 Ordinary share capital 25 000

Ordinary share capital account


$ $
Jun 1 Bank 10 000 May 1 Bank 60 000
Jul 1 Bank 25 000
Aug 1 Bank 25 000

Share premium account


$ $
Jun 1 Bank 10 000 May 1 Bank 60 000

b An ordinary share entitles the holder to a part ownership of the company. They are paid a
dividend out of the company’s profits, if sufficient, as a reward on their investment.
A debenture is a loan to the company, repayable at some time in the future. The person
104 or company is not an owner of the company but a long-term creditor. They will receive
interest on the money lent. This will be payable before any dividends are paid to the
ordinary shareholders.
c Morecap Limited
[1] Apart from the
Statement of changes in equity for the year ended 31 March 2016
opening and closing Details [1] Share Share Retained Total
balances, the other
items can be shown
capital premium earnings
in any order. $000 $000 $000 $000
At 31 March 2015 400 40 55 495
Issue of ordinary shares 100 50 150
Profit for the year 180 180
Interim dividend (50) (50)
At 31 March 2016 500 90 185 [2]775

[2] Notice that the bottom line adds across to $775 000, as does the total
column downwards. This is always a useful check to make sure students work
is accurate.

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Answers to activities, practice exercises and exam practice questions: Chapter 19

2 a Pecnut Limited
Income statement for the year ended 31 March 2016
$000
Revenue 2 683
Cost of sales $(85 000 + 1 152 000 − 105 000) (1 132)
Gross profit 1 551
Selling and distribution expenses $(540 + 21) (561)
Administrative expenses (648)
Profit from operations 342
Finance cost (36)
Profit before tax 306
Taxation (–)
Profit for the year 306

Notes:
1 In this illustration, the calculation of the cost of sales has been shown in brackets after
the label. This is perfectly acceptable. Alternatively, students could have shown the
calculation as separate workings.
2 Always show full labels. This is particularly important for gross profit and profit for the
year. The notations GP and NP are not acceptable even if the calculations are correct.
3 The question states very plainly that the depreciation of the motor vehicles is to be
classed as a distribution expense. Ordinarily the choice would depend on the use
made of the vehicles; for example depreciation on salesmen’s cars or delivery vans are
selling expenses, but the costs of a company car for the chief accountant would be an 105

administrative expense.
4 The interest on debentures is 10%. That means that a total of $36 000 should be brought
into the income statement for finance costs for the year. At the moment there is only
$18 000 in the trial balance. Therefore a further $18 000 needs to be provided. This will
also need to be brought into the statement of financial position as an other payable.

b Pecnut Limited
Statement of changes in equity for the year ended 31 March 2016
Details Share Share General Retained Revaluation Total
capital premium reserve earnings reserve
$ $ $ $ $ $
$000 $000 $000 $000 $000 $000
At start of year 600 – 120 69 – 789
Profit for year 306 306
Dividends paid – final – –
Dividends paid – interim – –
Share issue – – –
Revaluation of assets 680 680
Transfer to reserves 10 (10) –
Balance at year end 600 – 130 365 680 1 775

105
Cambridge International AS and A Level Accounting

Notes:
1 This answer has used the full format from section 2, although there are quite a few
items where there are no entries. Students only need to show the items where an
amount needs to be shown.
2 The figure of $1 775 is a check total as the items above it and to the left all add to it. This
is an important cross check and students should always do it as it will act as a cross
check when they prepare the statement of financial position.
3 In the further Information section of the question note 5 mentions the
recommendation of a final dividend. Under IAS 1 this is not shown in the accounts for
the current year. It is now shown as a note to the accounts.
4 A calculation of the revaluation of the freehold land is as follows:
Revaluation reserve account
$000 $000
Balance c/d 680 Freehold buildings at cost account 500
Provision for depreciation of
freehold buildings account 180
680 680
Balance b/d 680
The figure of $500 is the increase in the cost value for $1 500 to $2 000. However, the
provision for depreciation which exists must now be written off as it no longer exists.
c   Preparation of accounts on a going concern basis is one of the fundamental accounting
concepts. It means the business is expected to continue in operation for the foreseeable
106 future. This is at least the next trading period. Thus, assets are valued on this basis, usually
at their current net book values, unless any revaluation has taken place.
   If this is not the case then the assets will be recorded in the accounts at a value which is as
close as possible to their value if the company is forced to sell them on the open market.
This is likely to be considerably lower that their net book value. Further, provision is made
for the expected costs of closing down the business, such as redundancy payments.
3 a Square Limited
Income statement for the year ended 30 June 2016
$000 $000
Revenue 1 000
Opening inventories 46
Purchases 630
676
Closing inventories (38)
Cost of sales (638)
Gross profit 362
Overheads:
Sales office salaries 79
Administration wages 36
Delivery vehicle expenses $(38 + 2) 40
Advertising $(34 − 6) 28
Office expenses $(24 + 3) 27

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Answers to activities, practice exercises and exam practice questions: Chapter 19

$000 $000
Depreciation:
Delivery vehicles 13
Office machinery 7
(230)
Profit from operations 132
Finance costs $(6 + 6) (12)
Profit before tax 120
Tax (16)
Profit for the year 104

b Square Limited
Statement of changes in equity for the year ended 30 June 2016
Share Revaluation General Retained Total
capital reserve reserve earnings
$000 $000 $000 $000 $000
Balance at 30 April 2015 900 50 7 957
Profit for the year 104 104
Transfer to general reserve 50 (50) –
Revaluation reserve 260 260
Dividends paid (7) (7)
Balance at 30 April 2016 900 260 100 54 1 314

c Square Limited
107

Statement of financial position at 30 June 2016


Cost Accumulated Net book
depreciation value
$000 $000 $000
Assets
Non-current assets
Freehold premises 1 200 – 1 200
Delivery vehicles 80 41 39
Office machinery 70 28 42
1 350 69 1 281
Current assets
Inventories 38
Trade receivables 82
Other receivables 6
Cash and cash equivalents 67
193
Total assets 1 474
Equity and liabilities
Capital and reserves
Ordinary Share capital 900
General reserve 100
Revaluation reserve $(200 + 60) 260
Retained earnings 54
1 314
107
(cont.)
Cambridge International AS and A Level Accounting

Cost Accumulated Net book


depreciation value
$000 $000 $000
Non-current liabilities
12% debentures 2025/2027 100
Current liabilities
Trade payables 33
Other payables $(2 + 3) 5
Debenture interest 6
Taxation 16
60
Total equity and liabilities 1 474

Notes:
1 The recommended final dividend on the ordinary shares is shown by way of a note to
the accounts.
2 However, the debentures are a long-term loan and the unpaid interest on them is
treated as an accrual.
3 Amounts prepaid are shown as other receivables.
4 Similarly, the accrued amounts owing are shown as other payables. Strictly speaking
the total should also include the unpaid debenture interest. However, this is shown
separately to enable readers to follow the workings.
108 d Two uses of the share premium account are:
• to issue fully paid bonus shares
• to pay the expenses of a new share issue.

e The choice of whether to issue shares or take a debenture to fund the future expansion will
depend on a number of factors. If the directors are happy to take additional loans, then a
debenture can be considered. It will increase the amount of loan interest, which is a fixed
charge on the profit and must be paid before any dividends to ordinary shareholders. But
it does mean that that all profit (in excess of the interest charge) that is generated by the
expansion will fall to the existing shareholders.
At the present time the company is not highly geared and an additional loan of $150 000
may be a good option. The directors may also be able to negotiate a rate of interest
below the 12% currently payable on the existing debenture. The principal advantage of a
debenture is that the current ownership and control of the company is not diminished.
On the other hand, an issue of shares will not increase the gearing. Specifically this means
that the additional funds received are not a liability of the business. There will not be any
need to have to repay either the capital (which they will have to do with a debenture), or
any dividend on the shares, if profits are low in future years. Thus, issuing shares will help
future cash flows.

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Answers to activities, practice exercises and exam practice questions: Chapter 19

The 100 000 new shares could be issued to the existing shareholders if they have access to the
funds necessary to buy the shares. Alternatively, some or all of the new shares could be sold
to a third party. It is likely that any large scale investor would expect also to become a director
so that they could share in the decision making that will affect the future value of their shares,
which the present directors may or may not consider advantageous.
The more confident the directors are that their expansion plans will succeed, the more they
should favour taking a loan; the more risky the venture they have in mind, the wiser it would
be to seek to raise the capital by a share issue.
Note: Provided cogent reasoning based on the above arguments is given, students could justify
either method of raising the funds.

109

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Cambridge International AS and A Level Accounting

20 Manufacturing accounts
Activities
Activity 1

The Fabric Company


Manufacturing account and income statement for the year ended 31 March 2016
$000 $000
Raw materials
Inventory at 1 April 2015 10
Purchases 130
Carriage in 14 144
154
Less: inventory at 31 March 2016 20
Cost of raw materials consumed 134
Direct labour 170
Direct expenses 16
Prime cost 320
Factory overheads 128
Depreciation of machinery 12 140
460
Work in progress:
1 April 2015 12
110
31 March 2016 (22) (10)
Factory cost of goods produced 450
Factory profit (20%) 90
Transferred to income statement 540

Sales 700
Less: cost of sales
Inventory of finished goods at 1 April 2015 24
Transferred from manufacturing account 540
564
Inventory of finished goods at 31 March 2016 36 528
Gross profit 172
Office overheads (96)
Office depreciation (3) (99)
73
Add: factory profit 90
Less:
Adjustment to provision for unrealised profit (2) 88
$(36 − 24) × 20
120
Profit for the year 161
Answers to activities, practice exercises and exam practice questions: Chapter 20

Activity 2

Glue-making company
Manufacturing account and income statement for the year ended 30 April 2016
$ $
Direct materials:
Inventory at 1 May 2015 11 250
Purchases 132 000
Carriage inwards 11 505 143 505
154 755
Less: inventory at 30 April 2016 13 125
Cost of raw material consumed 141 630
Direct labour 146 250
Prime cost 287 880
Factory overheads
Indirect wages 19 500
3
Rent $(45 000 + 3 750) 36 563
4

2
Heating and lighting $(42 300 + 2 700) 30 000
3

9
Insurance $(3 150 – 900) 2 025
10

(
Motor vehicle expenses $6 000 ×
1

2 ) 3 000 111

Depreciation:
Factory 3 000
Machinery 10 000

(
Motor vehicles 8 000 ×
1

2 ) 4 000 108 088

395 968
Work in progress:
at 1 May 2015 18 000
Less: at 30 April 2016 15 750 2 250
Factory cost of goods produced 398 218
Factory profit (20%) 79 644
Transferred to income statement 477 862

Sales 800 000
Less: cost of sales
Inventory of finished goods at 1 May 2015 27 000
Transferred from manufacturing account 477 862
504 862
Less: inventory of finished goods at 30 April 2016 24 000 480 862
Gross profit 319 138
Office salaries 51 450
1
Rent $(45 000 + 3 750) 12 187
4
111
(cont.)
Cambridge International AS and A Level Accounting

$000 $000
1
Heating and lighting $(42 300 + 2 700) 15 000
3
1
Insurance $(3 150 − 900) 225
10
Carriage outwards 2 520
Advertising $(7 000 − 3 500) 3 500

Motor vehicle expenses $6 000 × ( 1

2 ) 3 000

Depreciation:
Office machinery 4 000

(
Motor vans $8 000 ×
1

2 ) 4 000 95 882

223 256
Add: factory profit 79 644
Add: reduction in provision for unrealised profit
1
$(27 000 − 24 000) 500 80 144
6
Profit for the year 303 400

Practice exercises
112 1 a Television manufacturing company
Manufacturing account for the year ended 30 April 2016
$ $
Opening inventory of raw materials 42 000
Add: purchases 390 000
Add: carriage inwards 26 000 416 000
458 000
Less: closing inventory (36 000)
Cost of raw materials consumed 422 000
Add: direct wages 280 000
Add: royalty (direct expenses) 40 000
Prime cost 742 000
Factory overheads
Indirect wages and labour $(12 000 + 8 000) 20 000
Depreciation:
Premises (50% × $12 500) 6 250
Motor vehicles (90% × $8 000) 7 200
Plant and machinery (80% × $14 000) 11 200 44 650
786 650
Opening inventory of work in progress 50 000
Closing inventory of work in progress (46 000) 4 000
Factory cost of finished goods 790 650
Add: factory profit (20% × $790 650) 158 130
Transferred to income statement 948 780
112
Answers to activities, practice exercises and exam practice questions: Chapter 20

b Television manufacturing company


Income statement for the year ended 30 April 2016
$ $
Sales 1 240 000
Opening inventory of finished goods 48 000
Add: transfer from manufacturing account 948 780
996 780
Less: closing inventory (62 400) 934 380
Gross profit 305 620
Expenses:
Selling expenses 42 000
Administrative expenses 62 000
Depreciation:
Premises 6 250
Motor vehicles 800
Plant and machinery 2 800 113 850
Net profit on trading 191 770
Add: factory profit 158 130
Adjustment for unrealised profit (2 400) 155 730
Profit for the year 347 500

Workings:
113
Provision for unrealised profit account
$ $
Closing balance c/d 10 400 Opening balance b/d 8 000
(62 400 ÷ 120 × 20) (48 000 ÷ 120 × 20)
Income statement 2 400
10 400 10 400

c Inventory must always be shown at the lower of cost and net realisable value, in line with
IAS 2. As a result, the closing inventory of finished goods must be shown in the statement
of financial position at cost, not the transfer price. The calculation for this is:

$
Inventory at transfer price 62 400
Less: provision for unreralised profit 10 400
52 000

d A
 dding an element of factory profit to the cost of goods manufactured is purely an
internal adjustment. It does not mean that the company will make any more overall profit
for the year. It is a way of measuring the performance of the factory. For example, the
transfer price with the profit added can be compared to the cost of buying in the product
ready-made. This comparison will measure the efficiency of the company’s production
department with that of competitors. It may also allow management to focus on areas of
the production process where cost savings can be made, or costs are currently not being
tightly controlled.

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Cambridge International AS and A Level Accounting

Managers in the manufacturing department can also be motivated by being rewarded with
payment of a bonus based on the factory profit. However, this must be done carefully to
ensure that factory output is still ideal for the company overall. If, for example, the factory
reduced quality to maximise factory profit, that would create other difficulties for the
business.
Further, the amount of the factory profit is an arbitrary management decision;
if it set at 10% it will appear as if the sales team has made a greater contribution
than if it is set at 25%, for example. Thus, adding factory profit may cause friction between
the factory manager and the sales manager, who may believe that the factory manager
is taking some of his/her profit. Provided the significance and use of factory profit is fair
and is explained, then it shouldn’t cause an issue. The calculation is not a difficult one to
make or to adjust based on experience or changes in circumstances. Overall, therefore,
the company is probably wise to retain an addition for factory profit to its factory cost of
production.

2 a Yendor
Manufacturing account for the year ended 31 March 2016
$ $
Opening inventory of raw materials 450 000
Add: purchases 2 250 000
Add: carriage inwards 162 000 2 412 000
2 862 000
114 Less: closing inventory (440 000)
Cost of raw materials consumed 2 422 000
Add: direct wages 900 000
Prime cost 3 322 000
Factory overheads
Indirect wages 90 000
Indirect materials 45 000
Other factory overheads 245 000
Depreciation:

(
Premises 4% × $1m ×
3
4 ) 30 000

Plant and machinery (30% × $250 000) 75 000 485 000


3 807 000
Opening inventory of work in progress 375 000
Closing inventory of work in progress (562 000) (187 000)

Factory cost of finished goods 3 620 000


Add: factory profit (20% × $3 620 000) 724 000
Transferred to income statement 4 344 000
Answers to activities, practice exercises and exam practice questions: Chapter 20

b Yendor
Income statement for the year ended 31 March 2016
$ $
Sales 6 075 000
Opening inventory of finished goods 390 000
Add: transfer from manufacturing account 4 344 000
4 734 000
Less: closing inventory (594 000) 4 140 000
Gross profit 1 935 000
Expenses:
Office salaries 391 000
Other administrative expenses 675 000
Depreciation:
Premises 10 000
Office equipment 30 000 1 106 000
Net profit on trading 829 000
Add: factory profit 724 000
Adjustment for unrealised profit (34 000) 690 000
Profit for the year 1 519 000

c
Provision for unrealised profit account
$ $ 115
Closing balance c/d 99 000 Opening balance b/d 65 000
(594 400 ÷ 120 × 20) (39 000 ÷ 120 × 20)
Income statement 34 000
99 000 99 000

d Extract from statement of financial position at 31 March 2016


$ $
Current assets
Inventory
Raw materials 440 000
Work in progress 562 000
Finished goods at transfer price 594 000
Less: provision for unrealised profit 99 000 495 000
1 497 000

e 
By producing a manufacturing account, Yendor is fully aware of his costs of manufacturing his
product. This will allow him to control his costs and compare his transfer price with the cost
of competitor’s products. If he doesn’t produce a manufacturing account then the costs of
producing his product may get ‘lost’ in with the other costs of the business. Thus, he won’t be
able to identify areas where savings can be made or wastage is occurring. Whilst the production
of a manufacturing account requires additional work, and possibly additional costs in recording
the data and employing staff to collect it, it is felt that the benefits to be gained are greater than
the costs incurred. Thus, Yendor should continue to prepare the manufacturing account.

115
Cambridge International AS and A Level Accounting

Exam practice questions


Multiple-choice questions
1 B
2 C
3 B
4 C

Structured question
1 Spinners & Co.
Manufacturing account for the year ended 31 December 2015
$ $
Opening inventory of raw materials 8 000
Add: purchases 140 000
148 000
Less: closing inventory (10 000)
Cost of raw materials consumed 138 000
Add: direct wages $(40 000 + 600) 40 600
Licence fees (direct expense) 16 000
Prime cost 194 600
Factory overheads
Indirect wages $(28 000 + 400) 28 400
Heat and light $(5 000 − 180) 4 820
116
General expenses $(14 000 + 300) 14 300
Insurance $(6 000 − 400) 5 600
Depreciation of plant and machinery 7 000 60 120
254 720
Opening inventory of work in progress 12 000
Closing inventory of work in progress (9 700) 2 300
Factory cost of finished goods 257 020
Add: factory profit (10% × $257 020) 25 702
Transferred to income statement 282 722

Note:
It is very important to show the labels which are in bold. It is important that the label
for the figure is also shown.

116
Answers to activities, practice exercises and exam practice questions: Chapter 21

21 Not-for-profit organisations
(clubs and societies)
Activities
Activity 1
a
Golf club
Subscriptions account
Year 3 $ Year 3 $
Balance b/d (4 × $450) 1 800 Balance b/d (3 × $450) 1 350
Income and expenditure 90 000 Bank – receipts for year 88 650
account (200 × $450)
Balance c/d (1 × $450) 450 Balance c/d 2 250
92 250 92 250
Year 4
Balance b/d 2 250 Balance b/d 450

b On the assumption that all of the year 2 debtors have now paid, the balance brought down
represents five members who owe their subscriptions for year 3, net of the one member’s
paid in advance.

Activity 2
Entry fees account
2016 2016 117
$ $
Income and expenditure 500 Balance b/d 1 200
account (5 × $100)
Balance c/d (Working) 1 700 Bank – receipts for year 1 000
2 200 2 200
2017
Balance b/d 1 700

Working:

Original three members at $300 remaining + two new members with $400 remaining.

Activity 3
a
Drama club
Subscriptions account
2016 2016
$ $
Jan 1 Balance – Subscriptions owing b/d 280 Dec 31 Bank 2 640
Dec 31 Income and expenditure account 2 400
Balance – subscriptions prepaid c/d 360 Balance – subscriptions owing c/d 400
3 040 3 040

2017 2017
Jan 1 Balance b/d 400 Jan 1 Balance b/d 360
Cambridge International AS and A Level Accounting

b Drama club
Income and expenditure account for the year ended 31 December 2016
$ $
Income
Subscriptions 2 400
Sales of tickets 20 000
Sales of programmes 3 000
Sales of refreshments 3 500
Less: cost of refreshments 2 200 1 300
26 700
Less: expenditure
Hire of costumes 4 700
Hire of hall 2 600
Copyright fees 1 400
Printing 180 8 880
Surplus of income over expenditure 17 820
Donation to Actors Benevolent Fund (50%) 8 910
Balance carried to accumulated fund 8 910
17 820

c
Drama club
Statement of financial position extract at 31 December 2016
118
$
Current assets Subscriptions owing 400
Current liabilities Subscriptions in advance 360

Activity 4
a Hutt River Dining Club
Statement of affairs at 1 January 2016
$ $
Catering equipment 8 000
Inventory of food 200
Inventory of books 1 100
Subscriptions owing 180
Bank 1 520
11 000
Less:
Trade payables for supplies of food 40
Subscriptions in advance 60 100
Accumulated fund at 1 January 2016 10 900

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Answers to activities, practice exercises and exam practice questions: Chapter 21

b Hutt River Dining Club


Receipts and payments account for the year ended 31 December 2016
2016 2016
$ $
Jan 1 Balance b/f 1 520 Dec 31 Staff wages 39 000
Dec 31 Subscriptions 5 000 Purchase of food 24 980
Restaurant takings 73 760 Purchase of books 4 840
Sales of books 12 150 Catering equipment 3 750
Heating and lighting 8 390
Other operating expenses 2 270
Balance c/d 9 200
92 430 92 430
2017
Jan 1 Balance b/d 9 200

c
Hutt River Dining Club
Subscriptions account
2016 2016
$ $
Jan 1 Balance b/f 180 Jan 1 Balance b/f 60
Dec 31 Income and 4 780 Dec 31 Bank 5 000
expenditure
account 119

Balance c/d 140 Dec 31 Balance c/d 40


5 100 5 100
2017 2017
Jan 1 Balance b/d 40 Jan 1 Balance b/d 140

d Hutt River Dining Club


Book trading account for the year ended 31 December 2016
$ $
Sales 12 150
Less: cost of sales
Inventory at 1 January 2016 1 100
Purchases $(4 840 + 200) 5 040
6 140
Inventory at 31 December 2016 (965) 5 175
Profit transferred to income and expenditure account 6 975

119
Cambridge International AS and A Level Accounting

e
Hutt River Dining Club
Restaurant account for the year ended 31 December 2016
$ $
Takings 73 760
Less:
Cost of food
Inventory at 1 January 2016 200
Purchases (24 980 + 360 − 40) 25 300
25 500
Inventory at 31 December 2016 (270) 25 230
Gross profit 48 530
Staff wages 39 000
Depreciation of catering equipment
10% × $(11 000 + 3 750) 1 475 40 475
Profit transferred to income and expenditure account 8 055

f Hutt River Dining Club


Income and expenditure account for the year ended 31 December 2016
$ $
Income
Subscriptions 4 780
120
Profit on sales of books 6 975
Profit on restaurant 8 055
19 810
Expenditure
Heating and lighting 8 390
Other operating expenses 2 270 10 660
Surplus of income over expenditure 9 150

g
Hutt River Dining Club
Statement of financial position at 31 December 2016
$ $
Non-current assets
Catering equipment $(11 000 + 3 750) 14 750
Less: depreciation $(3 000 + 1 475) 4 475 10 275
Current assets
Inventory:
Books 965
Food 270
1 235
Subscriptions owing 40
Bank 9 200
10 475
Total assets 20 750

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Answers to activities, practice exercises and exam practice questions: Chapter 21

$ $
Financed by:
Accumulated fund at 1 January 2016 10 900
Surplus of income over expenditure 9 150
Accumulated fund at 31 December 2016 20 050
Current liabilities
Trade payables:
Food 360
Books 200
Subscriptions in advance 140
700
Total accumulated fund and liabilities 20 750

Practice exercises
1 a Not-for-profit organisation Trading business
Surplus of income over expenditure Profit for the year
Accumulated fund Owner's capital

b The International Athletics Club


Subscription account for the year ended 31 May 2016
2015 2015
$ $ 121
Jun 1 Balance b/f 330
2016 2016
May 31 Income and 7 935 May 31 Bank 7 970
expenditure account
Subscriptions written off 20
Balance c/d 275
8 265 8 265
Jun 1 Balance b/d 275

c
The International Athletics Club
Refreshments trading account for the year ended 31 May 2016
$ $
Takings 4 112
Opening inventory 150
Purchases (2 654 − 15 + 40) 2 679
2 829
Less: closing inventory (180) 2 649
Gross profit 1 463
Wages (900)
Profit on refreshments 563

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Cambridge International AS and A Level Accounting

d The International Athletics Club


Income and expenditure account for the year ended 31 May 2016
$ $
Income
Subscriptions 7 935
Profit on refreshments 563
Dance tickets 1 897
Donation 90
Profit in disposal of old equipment (94 − 70) 24
10 509
Less: expenditure
Wages (4 000 − 900) 3 100
Rent 540
Travelling expenses 995
Subscriptions written off 20
Depreciation of equipment
(4 700 + 1 778 − 70 − 6 000) 408 5 063
Surplus for the year 5 446

Notes:
1 In the refreshments trading account it is perfectly acceptable to call the final figure a
profit.
122
2 However, with the income and expenditure account the final figure must always be
referred to as a surplus (or deficit if expenditure is greater than income).
3 The exercise does not give any treatment for donations. As it is a small amount there is
no reason why it should not be treated as income in the year it is received.
e If a life membership scheme is introduced, the club will receive potentially large sums from
those members who can afford it and choose to take out a life membership. This might be
a way to raise funds for some capital outlay, such as for the purchase of a new clubhouse.
However, the club will never receive any further subscriptions from these life members, so
that in future years, subscriptions income may not cover costs. (This would eventually be
an issue even if there had been no initial outlay of the life subscriptions; these funds will
eventually be used up, so that the club would need new members to keep going.)
There is also a difficulty in determining a fair price for life membership: if it is too low, funds
will run out quickly and those members still paying annually will feel unfairly treated; if it is
too high, there will be very few takers.
So unless there is an urgent need for funds that can be raised in no other way, the club
should not consider introducing a life membership.

122
Answers to activities, practice exercises and exam practice questions: Chapter 21

2 a
The Cooking Club
Subscription account for the year ended 30 September 2016
2015 2015
$ $
Oct 1 Balance b/d ($40 × 15) 600 Oct 1 Balance b/d ($40 × 12) 480
2016 2016
Sep 30 Income and 6 000 Sep 30 Bank 6 435
expenditure account
(150 × $40)
Balance c/d 315
6 915 6 915
Oct 1 Balance b/d 315

b The Cooking Club


Club shop trading account for the year ended 30 September 2016
$ $
[1] The cash float
Takings (7 168 + 20) [1] 7 188 for the shop has
Opening inventory 500 increased by $20
over the year. This
Purchases (3 745 − 1 450 + 1 260) 3 555 has been treated as
4 055 unrecorded sales
made in the shop
Less: closing inventory (850) 3 205 and has increased
Gross profit 3 983 the total takings
for the year. 123
Wages (4 000)
Loss on shop (17)

c The shop has not performed well. Despite making a good gross profit of $3 983 (55%),
the wages are too high and this has resulted in an overall loss for the shop. Action needs
to be taken to reduce the wages in order to ensure an overall net profit for the shop.
d The Cooking Club
Income and expenditure account for the year ended 30 September 2016
$ $
Income
Subscriptions 6 000
Donations 600
Cash taken at door 3 500
Deposit account interest 800
Grant from council (6 000 + 4 000) 10 000
20 900
Less: expenditure
Loss on club shop 17
General expenses (1500 + 65) 1 565
Rent 8 000
Income from annual dance 1 400
Less: costs (1 490) 90
Depreciation of equipment (2000 × 20%) 400
10 072
Surplus for the year 10 828 123
Cambridge International AS and A Level Accounting

e The accumulated fund for a club represents the total of accumulated surpluses less any deficits
for the period the club has been operating. It belongs to the members of the club. However, it
will not be paid out to them. This is different from the capital of a sole trader. The full amount
belongs to the sole trader and he/she can withdraw any of it or add to it at any time.

Exam practice questions


Multiple-choice questions
1 B
2 B
3 C

Structured questions
[1] Note 4 in 1 a The Retired Actors Club
the question Calculation of accumulated fund at 1 July 2015
indicates that the
equipment had $
been depreciated Shop inventories 1 600
at $1 400 per
annum for 5 years = Trade payables (400)
$7 000. This means Subscriptions owing ($30 × 20) 600
that at 1 July
2015 it had been Bank balance 16 800
fully depreciated Equipment (fully depreciated) [1] –
and therefore
Deposit account 10 000
shown at no value
when calculating Accumulated fund at 1 July 2015 28 600
the opening
124 accumulated fund.
b The Retired Actors Club
Club shop trading account for the year ended 30 June 2016
$ $
Takings 12 348
Opening inventory 1 600
Purchases (8 220 + 210 − 400) 8 030
9 630
Less: closing inventory (1 850) 7 780
Gross profit 4 568
Wages (6 000)
Loss on shop (1 432)

c
The Retired Actors Club
Subscription account for the year ended 30 June 2016
2015 2016
$ $
Jul 1 Balance b/d ($30 × 20) 600 Jun 30 Bank 10 730
2016
Jun 30 Income and expenditure
account (200 × $40) 8 000
Balance c/d 2 280 Balance c/d (5 × $30) 150
10 880 10 880
Jul 1 Balance b/d 150 Jul 1 Balance b/d 2 280

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Answers to activities, practice exercises and exam practice questions: Chapter 21

d The Retired Actors Club


Income and expenditure account for the year ended 30 June 2016
$ $
Income
Subscriptions 8 000
Cash taken at door 9 456
Annual dance receipts 3 720
Less: cost of dance (2 600) 1 120
Deposit account interest

(  1  1
10 000 × 4% ×   + 30 000 × 4% ×    
2 2
) 800

Grant from council (4 000 + 4 000) 8 000


27 376
Less: expenditure
Loss on club shop 1 432
Secretary’s expenses 2 125
Depreciation of equipment (5 000 × 20%) 1 000
4 557
Surplus for the year 22 819

e
The Retired Actors Club
Statement of financial position at 30 June 2016
125
$ $
Non-current assets
Equipment at cost (7 000 + 5 000) 12 000
Less: depreciation (7 000 + 1 000) (8 000)
4 000
Current assets
Inventory 1 850
Subscriptions owing 150
Deposit account interest due 800
Council grant due 4 000
Deposit account 30 000
Bank balance 13 775
50 575
Total assets 54 575
Financed by:
Opening accumulated fund at 1 July 2015 28 600
Add: surplus for the year 22 819
51 419
Memorial fund 666
Closing accumulated fund at 30 June 2016 52 085
Current liabilities
Trade payables 210
Subscriptions in advance 2 280
2 490
Total accumulated fund and liabilities 56 575 125
Cambridge International AS and A Level Accounting

Notes:
1 The number of members and the annual subscription they should pay is provided. This
means that the transfer to the income and expenditure account is the product of those
two figures.
2 The loss on the club shop should always be shown under expenditure rather than as
negative income.
3 Note that the receipts from the annual dance are netted off against the costs of the
dance to show a surplus for the year. In this type of exercise this should always be done.

2 a Sailing club
Snack bar trading account for the year ended 31 March 2016
$ $
Takings 77 000
Opening inventory 1 250
Purchases (53 000 + 970 − 1 030) 52 940
54 190
Less: closing inventory (1 600) 52 590
Gross profit 24 410
Wages (14 000 + 400) (14 400)
Profit on refreshments 10 010

Sailing club
Income and expenditure account for the year ended 31 March 2016
126
$ $
Income
Subscriptions for the year (Working 2) 187 600
Profit in refreshments 10 010
Hire of yachts and boats (43 000 + 34 000) 77 000
Training school income 34 500
Less: wages (16 500 + 700) (17 200) 17 300
Yacht racing 28 900
Less: expenses (13 000) 15 900
307 810
Expenditure
Repairs and maintenance (23 400 + 1 350) 24 750
Other operating expenses 26 000
Depreciation
Freehold premises 17 500
Yacht maintenance shop 4 200
Boatyard and launch 3 700
Fixtures and fittings 2 800
Boats and yachts 26 300
105 250
Surplus for the year 202 560

126
Answers to activities, practice exercises and exam practice questions: Chapter 21

b Sailing club
Statement of financial position at 31 March 2016
$ $
Non-current assets
Freehold premises (350 0000 − 17 500) 332 500
Yard and maintenance shop (42 000 − 4 200) 37 800
Boatyard and launch (74 000 − 3700) 70 300
Fixtures and fittings (28 000 − 2800) 25 200
Boats and yachts (465 000 + 61 000 − 26 300) 499 700
965 500
Current assets
Inventory 1 600
Subscriptions owing 2 000
Bank balance (opening balance plus all 290 500
receipts less all payments given in question)
294 100
Total assets 1 259 600
Financed by:
Opening accumulated fund at 1 April 2015 1 050 220
Add: surplus for the year 202 560
Closing accumulated fund at 31 March 2016 1 252 780
Current liabilities
127
Trade payables (700 + 400 + 1350 + 970) 3 420
Subscriptions in advance 3 400
6 820
Total accumulated fund and liabilities 1 259 600

Workings:
1 Calculation of opening accumulated fund at 1 April 2015:
$
Non-current assets (350 + 42 + 74 + 28 + 465) 959 000
Subscriptions in arrears 3 000
Subscriptions in advance (6 000)
Bank balance 94 000
Inventory of refreshments 1 250
Trade payables for refreshments (1 030)
Accumulated fund at 1 April 2015 1 050 220

2 Subscription account:
Subscription account for the year ended 30 June 2016
2015 2015
$ $
Apr 1 Balance b/d 3 000 Apr 1 Balance b/d 6 000
2016 2016
Mar 31 Income and expenditure account 187 600 Mar 31 Bank 186 000
Balance c/d 3 400 Balance c/d 2 000
194 000 194 000 127

Cambridge International AS and A Level Accounting

22 Published company accounts


Activities
Activity 1
ABC Stationery Company:
20 boxes × $3 per box = $60 (Lower of cost $100 and net realisable value $60).

Activity 2
Weaver Limited
$
Direct materials 8 840
Direct labour 6 630
Factory overheads 4 420
Total costs 19 890

Completed units:
2000 completed and sold + 200 completed units in inventory + (20 × 50% part completed
units at the month end = 10 equivalent) = 2 210.
[1] 1 A total column has been included.
a Cost per unit = $19 890 / 2 210 = $9. This is normal practice as it provides
b Value of work in progress = 20 units × (50% × $9) = $90. the link to the figures that will appear
in the statement of financial position.
Value of finished goods = 200 × $9 = $1 800. However, it may be that a total column
is not required. In which case don't
128 Activity 3 waste time preparing one.

[2] The cost of the old plant Approval Limited


sold was $60 000. It had Non-current assets schedule
been sold for $6 000, which
had resulted in a loss of Freehold land Plant and Motor Total [1]
$4 000. The net book value and buildings machinery vehicles
must therefore have been
$10 000 ($10 000 − $6 000 =
$000 $000 $000 $000
$4 000) so that accumulated Cost
depreciation on the plant
At start of year 1 000 600 870 2 470
sold must have been
$(60 000 − [6000 + 4000]) = Additions 320 32 352
$50 000. Revaluation of land 400 400
[3] The cost of land and
Disposals (60) (24) (84)
buildings at the start of the At end of year 1 400 860 878 3 138
year was $1 000 000. We
Depreciation
are told that the land cost
$800 000, so the buildings At start of year 40 250 660 950
cost was $200 000. The Disposals – (50) [2] (22) (72)
depreciation of 2% is only
calculated on this figure. Charge for the year 4 [3] 172 [4] 60 [5] 236
At end of year 44 372 698 1 114
[4] Plant and machinery is Net book value at start of year [6] 960 350 210 1 520
calculated at 20% on the
cost at the end of the Net book value at end of year [6] 1 356 488 180 2 024
year = 20% × $860 000, in
other words after adjusting [6] The opening and closing net
for additions and disposals. [5] The depreciation charge on motor vehicles is calculated
book values must always be
at 25% on the net book value at the end of the year before
included in the schedule. No
charging the depreciation. The net book value at the end of
dates were given so it is perfectly
the year before depreciation was:
acceptable to identify them as the
start and end of year figures. If dates $878 000 − (660 000 − 22 000) = $240 000. The charge for the
are given then they must be used. year was therefore 25% of this figure.
Answers to activities, practice exercises and exam practice questions: Chapter 22

Activity 4
The calculation of earnings per share is to use the profit for the year after any preference dividend
on non-redeemable preference shares. In other words, the profit for the year attributable to the
ordinary shareholders.
Thus the profit for the year of $1 000 000 must be reduced by the 10% dividend on the 400 000
non-redeemable preference shares = $1 000 000 − (400 000 × 10%) = $960 000.
The earnings per share in this case are therefore:
$960 000 = $0.48 per share.
2 000 000

Practice exercises
1 a A true and fair view means that the financial statements are free from any material
misstatement and error and faithfully represent the financial performance of the business
for the period under review.
b X Limited
Revised statement of financial position at 31 December 2015
$000
Non-current assets
Tangible assets (1 810 − 50 − 1) 1 759
Current assets
Inventory (105 − 2) 103
Trade receivables (96 − 6) 90
193 129
Total assets 1 952
Equity and liabilities
Share capital and reserves
Share capital 1 000
General reserve 130
Retained earnings (342 − 1 − 2 − 6 + 10) 343
Total equity 1 473
Non-current liability
Debentures 2 022/24 360
Current liabilities
Trade payables 50
Other payables 18
Bank overdraft 51
119
Total equity and liabilities 1 952

c Non-current assets:
The revaluation of the land ($50 000) has been taken out. The valuer was not qualified to
make the valuation so there must be at least some doubt as to whether this is a reliable
estimate. In principle, IAS 16, Property, Plant and Equipment permits a company to include
its land at a revalued amount, but the auditor must be satisfied that there is sufficient
evidence for the value adopted.

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IAS 16, Property, Plant and Equipment requires that assets with a finite useful life, such as
buildings, are depreciated over their estimated useful life. In order to illustrate the point, a
useful life of 40 years has been assumed, requiring a depreciation charge of $1 000.
Goodwill:
The goodwill has not been purchased (which occurs when a business is acquired). IAS 38,
Intangible Assets does not permit the recognition of internally generated goodwill, so this
must be eliminated (even if the amount concerned is considered to be a good estimate).
Inventory:
The inventory must be valued at the lower of cost and net realisable value. Therefore the
$6 000 damaged inventory must be included at the realisable value of $4 000, with the
$2 000 written off from retained earnings.
Trade receivables:
A provision for $6 000 has been made against the receivable as there is some evidence
(three missing payments) that the asset may be impaired. Whether this is the correct
extent of impairment, or indeed, whether any impairment is necessary, cannot be properly
determined from the information given, but an adjustment has been proposed for the
amount of the missed payments.
The directors and the auditors will each review the available evidence and form their
opinion of what the most appropriate level of impairment is (see also part e, below).
Revaluation reserve:
This has been completely eliminated with the removal of the revaluation of the land and
goodwill.
Retained earnings:
130
These have been reduced by the depreciation, the loss in value of inventory and the
provision for the doubtful debt. However, the proposed dividend should not be included
under IAS 1 (IAS 10 makes clear that a proposed dividend is a non-adjusting event), so has
been added back and eliminated from the current liabilities.
d Proposed dividend:
The directors propose that a final dividend of XXc per share, amounting to $10 000 in total
is paid to the ordinary shareholders, subject to shareholder approval at the AGM, on [date].
Contingent liability:
The company is being sued by a customer that alleges that it has been sold faulty goods
and seeks $8 000 in compensation. The directors have not made any provision for this or
any other amount as, based on the advice of the company’s solicitors, they believe that the
company is more likely than not to win the case.
 Note: Published financial statements contain many notes but these are the two items
amongst those dealt with in the question that appear only as notes. Had there been any
dividends paid during the year, the dividend note to the financial statements would have
followed the format on page 273 in the coursebook.
e The auditors must consider the materiality of the proposed adjustments in deciding what
action to take; if material adjustments are necessary to ensure that a true and fair view is
given but are not made, then a qualified audit report is required.
In the case of X Ltd, of the actual errors, the goodwill ($250 000) is clearly material, but it
could be argued that the depreciation ($1 000), the inventory ($2 000) and the dividend
($10 000) are immaterial.
The other two matters are a little less clear cut because amounts have been estimated.
The auditor is unable to confirm the reliability of the revaluation ($50 000) so should qualify
for this matter too, if the amount is considered material.
Similarly, there can be no definitive estimate of the necessary provision to be made against
the trade receivable, so the auditor must conclude that there is no material uncertainty
130
Answers to activities, practice exercises and exam practice questions: Chapter 22

or disagreement (between their own opinion and that of the directors) over the carrying
amount, or otherwise treat this as another error. It is quite possible that in this instance
their difference of opinion may not be material.
Even with these adjustments being made, the accounts show a strong company with good
profitability. The directors are better advised to explain the company’s real circumstances
to the bank than try to mislead the bank. The bank overdraft may be simply down to a
timing issue. No doubt when the directors approach the bank for a loan, a cash budget will
also be presented to show how this can be eliminated or managed.
2 a Y Limited
Non-current assets schedule
Freehold Freehold Office Motor Total
land buildings equipment vehicles
$000 $000 $000 $000 $000
Cost
At 1 April 2015 250 400 300 360 1 310
Additions 32 32
Revaluation of land 200 200
Disposals (20) (24) (44)
At 31 March 2016 450 400 280 368 1 498
Depreciation
At 1 April 2015 10 50 150 200 410
Revaluation (10) (10)
Disposals (15) (15) 131
Impairment 5 5
Charge for the year – 16 28 92 136
At 31 March 2016 – 66 168 292 526
Net book value at 1 April 2015 240 350 150 160 900
Net book value at 31 March 2016 450 334 112 76 972

Note:
Office equipment depreciation is to be charged at 20% of net book value (NBV) as it would
be immediately before that charge is calculated. Cost of office equipment at the year end is
$300 000 − $20 000 = $280 000. Accumulated depreciation before this last adjustment is
$150 000 − $15 000 + $5 000. = $140 000, meaning that the NBV to be depreciated is
$280 000 – $140 000.= $140 000. At 20% (per the question) depreciation is $28 000.
b
Y Limited
Statement of changes in equity for the year ended 31 March 2016
Share Share General Retained Revaluation
Details ­capital premium reserve earnings reserve
$000 $000 $000 $000 $000
At 31 March 2015 675 425 – 215 –
Profit for year 169
Dividends paid – final (60)
Dividends paid – interim (35)
Bonus share issue 225 (225) (25)
Revaluation of land 210
Balance at 31 March 2016 900 200 – 405 210
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Cambridge International AS and A Level Accounting

Notes:
1 The balance on the revaluation reserve is $200 000 added to the cost, plus $10 000
added back for previously charged depreciation.
2 The draft profit for the year was $175 000. This was after charging the three items, which
totalled $(60 000 + 35 000 + 40 000) = $135 000.
However, the proposed dividend should not have been deducted and the other two
dividends are presented in the statement of changes in equity (not as deductions in
arriving at profit for the year) so they all need to be added back. Thus the draft profit for
the year should be $(175 000 + 135 000) = $310 000. In addition we are told that the draft
profit is ‘before depreciation’, so we must charge $136 000 depreciation as calculated in
part a of the question and adjust also for the $5 000 impairment of inventory to lower of
cost and net realisable value (additional information item 3). Thus profit for the year is
$(175 000 + 135 000 − 136 000 − 5000) = $169 000.
As the share capital at 31 March 2016 was $900 000, which included a 1 for 3 issue of
bonus shares, then the share capital at the start of the year must have been $900 000 /
4 × 3 = $675 000. The bonus issue therefore amounted to $225 000. As $200 000 remains
in the share premium account, and as this an inflexible reserve, it can be assumed that
the entire bonus issue was capitalised from the share premium account.
We were told to not prepare a total column; if the question is silent on the matter you
are recommended to include one as this is the IAS format. The general reserve column
has been left in as a reminder of another possible column but you should not introduce
redundant columns if they are not necessary.
c The directors of Y Limited are responsible for the preparation of the financial statements
and ensuring that adequate and comprehensive accounting records are kept. It is also
132
their duty to ensure that the financial statements are free from any material misstatement
and error.
The auditors, on the other hand, are employed by the shareholders to report to them on
whether the financial statements prepared by the directors give a true and fair view.
d The responsibility for the preparation of the financial statements lies firmly with the
directors; this is specified in law. Thus, they must undertake this work or employ someone
to do it for them.
The role of the auditor has been described above (in part c). It is not the responsibility
of the auditor to prepare the financial statements of the business. If they were to do so,
then this work is undertaken in the role of accountants, not auditors. Ethical standards
permit the auditors of a private company to assist the directors in this way, but this
assistance is not permitted if the company is quoted.

Exam practice questions


Multiple-choice questions
1 D
2 C
3 B
4 A
5 A
6 A
7 D
8 B
9 D
10 D
Answers to activities, practice exercises and exam practice questions: Chapter 22

Additional questions
11 The ordinary shareholder is a financial supporter of the company as they invest money into
the business, if asked to do so, through rights issues and/or at the time the company is first
formed. They are, therefore, also the owners of the company. As a result, they are entitled
to attend and vote at the annual general meeting (AGM). They can vote to elect or re-elect
directors and on major decisions when asked to do so. The preference shareholder isn't an
owner of the company, but lends the company money through the purchase of preference
shares. Often these shares can be redeemed by the company. They also do not have the right
to attend the AGM.
On the other hand, the directors are those responsible for the day-to-day running and
management of the company. This is usually because the shareholders lack the expertise to
do this. However, in some cases, directors may also be shareholders. In this case, they have
dual responsibilities - one as the owner and one as a manager.
12 An internal auditor is an employee of the company, responsible to the directors of the
company for the performance of their day-to-day duties. Their work will involve looking at
the financial systems in place in the company, ensuring the proper day-to-day management
of the company finances. They may also take some involvement in the preparation of the
financial statements of the company on behalf of the directors.
External auditors are not employees of the company and the process of auditing is separate
from the preparation of the financial statements. They are appointed by the shareholders
to act on their behalf. Their role is to consider whether the financial statements prepared
by the directors and presented to the ordinary shareholders are free from any material
misstatement or error and to report their findings.

133

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Cambridge International AS and A Level Accounting

23 Statements of cash flows


Activities
Activity 1

Everyday Limited
Statement to show cash flow from operating activities for the year
$
Profit from operations 175 000
Depreciation charge for the year 42 100
Profit on disposal of non-current assets (2 300)
Decrease in inventories 5 800
Increase in trade receivables (2 600)
Increase in trade payables 3 400
Tax paid (27 500)
Net cash from operating activities 193 900

Activity 2
Exchange Limited
Statement of cash flows for the year ended 31 December 2016
$ $
Cash flow from operating activities:
134 Profit from operations (before tax and interest) 94
Adjustments for:
Depreciation charge for the year 50
Profit less losses on sale on non-current assets (10)
Decrease in inventories (100 − 85) 15
Increase in trade receivables (40 − 52) (12)
Increase in trade payables (60 − 73) 13 56
Cash (used in)/from operations 150
Interest paid (during the year) (7)
Tax paid (during the year) from workings (36)
Net cash (used in)/from operating activities 107
Cash flows from investing activities:
Purchase of non-current assets (90 + 70) (160)
Proceeds from the sale of non-current assets (50 + 4 + 1) 55
Net cash (used in)/from investing activities (105)
Cash flows from financing activities:
Proceeds from issue of share capital 55
Repayment of debentures (30)
Dividends paid (46)
Net cash (used in)/from financing activities (21)
Net increase/(decrease) in cash and cash equivalents (19)
Cash and cash equivalents at the beginning of the year 55
Cash and cash equivalents at the end of the year 36
Answers to activities, practice exercises and exam practice questions: Chapter 23

Workings:

Freehold buildings at cost Freehold building disposal


$ $
At 31 December 2015 400 Cost (36)
Disposal (36) Proceeds 50
At 31 December 2015 364 Profit on disposal 14

Taxation
$ $
Tax paid 36 At 31 December 2015 39
At 31 December 2016 43 From income statement 40
79 79

Taxation
Plant and Plant and machinery Plant and machinery
machinery at cost depreciation disposal
$ $ $
At 31 December 2015 80 At 31 December 2015 35 Cost 20
Disposals (20) On disposals (16) Depreciation (16)
Additions 90 Provided in year 20 Proceeds (1)
(balancing figure) (balancing figure)
At 31 December 2016 150 At 31 December 2016 39 Loss on disposal 3
135
Motor vehicles Motor vehicles Disposal
at cost depreciation
$ $ $
At 31 December 2015 120 At 31 December 2015 90 Cost 30
Disposals (30) On disposals (30 − 5) (25) Depreciation (25)
Additions 70 Provided in year 30 Proceeds (4)
(balancing figure) (balancing figure)
At 31 December 2016 160 At 31 December 2016 95 Loss on disposal 1

Activity 3

Indus Limited
Statement of financial position at 31 July 2016
Cost Accumulated Net book
depreciation value
$ $ $
Assets
Non-current assets
Freehold premises 300 142 158
Plant & machinery
(Cost: 125 + 48 − 30 Acc Dep: 75 − 18 + 60) 143 117 26
443 259 184

(cont.)

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Cambridge International AS and A Level Accounting

Cost Accumulated Net book


depreciation value
$ $ $
Current assets
Inventory (36 + 4) 40
Trade receivables (79 + 19) 98
Cash and cash equivalents 112
250
Total assets 434
Equity and liabilities
Capital and reserves
Share capital (150 + 20) 170
Share premium (20 + 20) 40
General reserve (40 + 30) 70
Retained earnings 50
330
Non-current liability
10% debentures 2023/24 (50 − 20) 30
Current liabilities
Trade payables (43 + 6) 49
Tax 25
74
136
Total equity and liabilities 434

Workings:
Calculation of the figure for retained earnings:

$
Retained earnings at 1 August 2015 56
Profit for the year 39
95
Transfer to reserves (30)
Dividends paid (15)
Retained earnings at 31 July 2016 50

Activity 4

Janine
Reconciliation of profit from operations to net cash flow from
operating activities for the year ended 31 October 2016
$
Profit for the year before interest 21
Adjustments for:
Depreciation charge for the year 5
Profit on sale of non-current assets (1)
Increase in inventories (5)
Decrease in trade receivables 3
136
Answers to activities, practice exercises and exam practice questions: Chapter 23

$000
Decrease in trade payables (8)
Cash (used in)/from operations 15
Interest paid (during the year) (1)
Net cash (used in)/from operating activities 14

Workings:
The profit for the year before interest is:

$000
Profit for the year from the income statement extract 25
Less: depreciation (5)
Add: profit on disposal 1
Profit for the year before interest 21

Note: The profit on the revaluation of land is not included as this increases the
value of the land and is included in Janine’s capital on the statement of financial
position. Also, of course, this is a book entry and does not give rise to any cash
flow, so we do not expect it to appear in the statement of cash flows.

The calculation of loss on the sale of the plant and machinery and the
purchase of new machinery is as follows:

Plant and machinery at cost account


137
$ $
Opening balance 39 Closing balance 55
Bank – purchases
(balancing figure) 22 Asset disposal 6
61 61

Plant and machinery accumulated depreciation account


$000 $000
Asset disposal account
(balancing figure) 1 Opening balance 21
Closing balance 25 Charge for the year 5
26 26

Asset disposal account


$000 $000
Cost of plant scrapped 6 Depreciation 1
Sale proceeds
Profit on disposal 1 (balancing figure) 6
7 7

Note: In this case we have found/calculated that the items were sold for
scrap. Our initial reaction might have been to assume that there were no
proceeds from scrapping plant and machinery.

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Cambridge International AS and A Level Accounting

Janine
Statement of cash flows for the year ended 31 October 2016
$000 $000
Net cash (used in)/from operating activities 14
Cash flows from investing activities:
Purchase of non-current assets (plant) (22)
Sale of non-current assets 6
Net cash (used in)/from investing activities (16)
Cash flows from financing activities:
Capital introduced 10
New loan 8
Drawings (21)
Net cash (used in)/from financing activities (3)
Net increase/(decrease) in cash and cash equivalents (5)
Cash and cash equivalents at the beginning of the year 3
Cash and cash equivalents at the end of the year (2)

The possible reasons why Janine has an overdraft are:


• The purchases of non-current assets ($22 000) have been financed from the loan ($8 000),
capital introduced ($10 000) and the proceeds of the sale of non-current assets ($6 000), so this
is not the issue.
• The high drawings figure ($21 000) is higher than the cash generated from operations, but is
138
in broadly line with the profit for the year, so it is clear that Janine did not make the mistake of
believing that the revaluation of the land is a cash profit rather than a book adjustment.
• Although Janine has reduced her trade receivables, she has increased her inventory and
reduced her trade payables. The net effect of this has been to reduce the cash in the business.
Although all these factors combined to affect the overall cash flow, it seems that the latter
two items, Janine’s drawings and her management of working capital (short term assets and
liabilities), have been the causes of more cash leaving the business than coming in.

Practice exercises
1 a A statement of cash flows is based on historical information and is required to be prepared
for a limited company in line with the format set out in IAS 7. It is published as part of the
annual financial statements. It shows how cash has been generated by a business and how
it has been applied.
A cash budget is an internal document prepared by the management of the company. It is
an estimated projection or forecast used for planning and control (monitoring) purposes
and may be presented to bankers and other lenders when the company is seeking
additional finance.
b i Working:
Asset disposal account
$000 $000
Cost of disposals (balancing figure) 34 Depreciation 20
Sale proceeds 10
Loss 4
34 34

Answers to activities, practice exercises and exam practice questions: Chapter 23

DH plc
Non-current assets at cost account
$000 $000
Opening balance b/d 9 000 Closing balance c/d 10 000
Purchases (balancing figure) 1 034 Asset disposal 34
(working above)
10 034 10 034

Purchases made during the year = $1 034 000.
ii Working:
DH plc
Non-current assets accumulated depreciation account
$000 $000
Disposal 20 Opening balance b/d 1 500
Closing balance c/d 1 800 Income statement 320
(balancing figure)
1 820 1 820

Depreciation charge for the year = $320 000.
c
DH plc
Net cash from operating activities for the year
$000 139
Profit from operations 1 998
[1] From above
Depreciation charge for the year [1] 320
Loss on sale of non-current assets 4
Increase in inventories (85 − 70) (15)
Decrease in trade receivables (250 – 270) 20 [2] Under IAS 7, dividends
paid can be shown either as
Increase in trade payables (105 − 80) 25 part of the calculation of net
Dividends paid [2] (150) cash from operating activities,
or under cash flows from
Tax paid (280 + 700 − 290) (690)
financing activities.
Net cash from operating activities 1 512

d Cash refers to money in the bank or cash in hand and is affected by receipts and payments
on the day that those transactions take place. However, profit is the difference between
the income and expenditure of the business. When calculating income and expenditure,
the accruals and prudence principles are applied. These have the effect of allocating
income and expenditure to the most appropriate accounting period (or of apportioning
income and expenditure over several accounting periods) which will therefore often
not coincide with the date or accounting period of the related receipts and payments.
Accordingly, the increase (or decrease) in cash in a period will not equal the profit (or loss)
for a period except in the simplest of circumstances.
e DH plc has made a good profit for the year. However, the cash and cash equivalents has
only increased by $10 000. The cash has been boosted by the issue of ordinary shares at a
premium. However, all of this cash, and most of the cash generated from operating activities,
has been spent on purchasing new non-current assets and the repayment of the loan.

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2 a Two advantages of preparing a statement of cash flows are:


• It links the income statement and statement of financial position, showing the areas
where the business has generated and spent its cash.
• It may indicate potential going concern problems.
• It may indicate whether the business is generating enough cash to fund its investment
or dividends, and also therefore give an indication of whether these situations might be
likely to change.
There are no real disadvantages to preparing a statement of cash flows except for the
minor matter of the effort involved. Publishing a statement of cash flows voluntarily also
gives away some information that might otherwise have remained private to the company.
Some disadvantages of a statement of cash flows are:
• It can be distorted by large receipts or payments made just before or just after
the year end.
• (By definition) important transactions that have not involved cash flows, such
as impairments and revaluations, are not included but might be necessary to an
understanding and interpretation of the cash position.
• It only shows the inflow and outflow of cash but gives only a limited indication of
why they have occurred (although it may just as reasonably be said that an income
statement gives only a limited indication of why income and expenditure has occurred).
b Woodpecker Limited
Statement of cash flows for the year ended 31 December 2016
$000
140 Cash flow from operating activities:
Loss from operations (before tax and interest) (119)
Adjustments for:
Debenture interest paid 1
Depreciation charge for the year
10% × (500 + 85 − 35) 55
Loss on sale on non-current assets 3
Cash (used in)/from operations (60)
Increase in current assets ([72 − 6] − 68) (2)
Decrease in current liabilities (54 − [36 − 3]) (21)
Interest paid (during the year) (1)
Net cash (used in)/from operating activities (84)
Cash flows from investing activities:
Purchase of non-current assets (85)
Net cash (used in)/from investing activities (85)
Cash flows from financing activities:
Proceeds from issue of share capital 120
Issue of debentures 40
Net cash (used in)/from financing activities 160
Net decrease in cash and cash equivalents (9)
Cash and cash equivalents at 1 January 2016 6
Cash and cash equivalents at 31 December 2016 (3)

c Woodpecker has made a significant loss for the year and so lost cash on its trading
activities for the year ($60 000). It has also not managed its working capital very well as
140
Answers to activities, practice exercises and exam practice questions: Chapter 23

changes in both current assets and current liabilities have resulted in cash outflows for the
business.
However, the issue of additional shares and a debenture have generated sufficient cash to
cover the deficit on trading, the poor management of working capital and the purchase of
additional non-current assets.
The final result has meant that the net effect of these cash movements has only had a
small impact on the final bank balance. There is work for the directors to do in terms of
better management of working capital and reversing their negative trading activities.
d I f the directors issue additional shares to fund the company’s increased operations it will
have both positive and negative effects. The positive effects are that the money does not
have to be repaid. Neither do the directors have to pay dividends on the shares if profits are
not sufficient. However, the issue of shares may give new shareholders significant influence
if the shares are not issued to existing shareholders by a rights issue. New owners could
have a serious impact on the future plans of the directors and may even replace them.
The issue of a further debenture will increase the gearing of the company. It will also create
future strains on the cash flow as both interest and capital will have to be repaid. The
lender may also require some security on the company's assets. The two positive aspects
are that the debenture holder gets only a fixed return, and that issuing a debenture will not
change the ownership of the business.
Overall, the company does not appear to be performing well. The directors could consider
postponing the raising of more finance until such time as the future profitability of the
business is assured. However, if they are set on raising additional finance (because the
proposed expansion is the key to future profitability, for example) then they should
proceed, and a rights issue of ordinary shares is the best option.
141
Exam practice questions
Multiple-choice questions
1 A
2 C
3 D
4 C
5 C
6 A

Structured question
1 a
Winston plc
Budgeted statement of financial position at 31 October 2017
Cost Accumulated Net book
depreciation value
$000 $000 $000
Assets
Tangible non-current assets
Freehold premises 1 000 – 1 000
Plant and machinery 1 380 (580) 800
2 380 (580) 1 800
Current assets
Inventory (191 - 76) 115

(cont.)

141
Cambridge International AS and A Level Accounting

Cost Accumulated Net book


depreciation value
$000 $000 $000
Trade receivables (82 + 15) 97
Cash and cash equivalents 251
463
Total assets 2 263
Equity and liabilities
Share capital and reserves
Share capital (950 + 150) 1 100
Share premium (150 + 60) 210
Revaluation reserve 240
General reserve (100 + 80) 180
Retained earnings 226
1 956
Non-current liabilities
Debentures 2021/2023 (300 − 100) 200
Current liabilities
Trade payables (73 − 26) 47
Other payable: taxation (40 − 40 + 60) 60
107
Total equity and liabilities 2 263
142
Notes:
In most cases it is simply a question of adjusting the figure in the statement of financial
position with the increase or decrease in the statement of cash flow. Where this has been
done, the workings are shown in brackets. However, there are some items where it is easier
to show the individual ‘T’ accounts:

Asset disposal
$000 $000
Plant and machinery at cost 110 Bank 41
Profit on disposal 20 Plant and machinery accumulated 89
depreciation
130 130

1 As this account (and the others below) are workings, there is no need to bring down any
balances.
2 The debit of $110 000 is from additional information note 1.
3 The profit on disposal ($20 000) is from the statement of cash flows under cash flow
from operating activity.
4 The credit of $41 000 is also from the statement of cash flow under cash flow from
investing activities.
5 This means that the figure to balance the account must be the depreciation written off
from the machinery which was sold ($89 000).

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Answers to activities, practice exercises and exam practice questions: Chapter 23

Plant and machinery at cost account


$000 $000
Opening balance 1197 Disposal 110
Additions 293 Balance c/d 1380
1490 1490

1 The credit of $110 000 is the double entry from the disposal account.
2 The debit of $293 000 is from the statement of cash flow under cash flow from investing
activities.
3 The balance on the account must, therefore, be the closing balance to take to the
statement of financial position.
Plant and machinery accumulated depreciation account
$000 $000
Disposal account 89 Opening balance 469
Balance c/d 580 Charge for year 200
669 669

1 The credit of $200 000 is from the statement of cash flow under cash from operating
activities.
2 The debit of $89 000 is the double entry from the disposal account.
3 So the closing balance must be $580 000 which then is entered in the budgeted
143
statement of financial position.
Revaluation account
$000 $000
Balance c/d 240 Freehold premises at cost 150
Freehold premises depreciation 90
240 240

1 The credit of $150 000 is the amount required to take the cost of the premises from its
present book figure of $850 000 to the revalued amount of $1 000 000.
2 The credit of $90 000 is the depreciation already charged on the freehold premises in
the past. This must also be written back as it no longer exists.
3 This means that the balance on the revaluation account is $240 000, which then is
entered in the equity section of the statement of financial position.
Retained earnings account
$000 $000
Dividends paid 30 Balance b/f 173
Transfer to general reserve 80 Profit for the year after tax 163
Balance c/d 226
336 336

143
Cambridge International AS and A Level Accounting

1 The credit of $173 000 comes from the retained earnings figure in the statement of
financial position at 31 October 2016.
2 The credit of $163 000 is from the additional information.
3 The debit of $30 000 comes from the statement of cash flow under cash flow from
financing activities.
4 The debit of $80 000 is per note 2 from the additional information.
5 The closing balance is then taken to the budgeted statement of financial position.
b Having done a lot of the workings for part a, this will help in answering part b, which is to
show the budgeted statement of changes in equity:

Winston plc
Budgeted statement of changes in equity for the year ended 31 October 2017
Details Share Share General Retained Revaluation Total
capital premium reserve earnings reserve
$000 $000 $000 $000 $000 $000
At start of year 950 150 100 173 – 1 373
Profit for year attributable to equity 163 163
holders
Dividends paid – final (30) (30)
Dividends paid – interim – –
Share issue 150 60 210
144 Revaluation of assets 240 240
Transfer to reserves 80 (80) –
Balance at year end 1 100 210 180 226 240 1 956

Note: Notice that the figure at the bottom right hand corner ($1 956 000) is the one which
appears as the total equity in the answer to part a.

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Answers to activities, practice exercises and exam practice questions: Chapter 24

24 Business purchase and merger


Activities
Activity 1
a and b
Capital accounts
Nitin Maria Sam Nitin Maria Sam
$000 $000 $000 $000 $000 $000
Goodwill 15 15 15 Opening balance b/d 120 120
Balances c/d 151 128 95 Profit on revaluation 16 8
Goodwill 30 15
Non-current assets 98
Inventory 12
166 143 110 166 143 110
Balances b/d 151 128 95

c
Nitin, Maria and Sam
Statement of financial position at 1 June 2016 after the
admission of Sam to the partnership
$000
Assets
Non-current assets (220 + 98 + 24) 342
Current assets (80 + 12) 92 145
Total assets 434
Capital accounts
Nitin 151
Maria 128
Sam 95
374
Current accounts
Nitin 16
Maria (4)
Sam –
12
Current liabilities 48
Total capital and liabilities 434

Activity 2
a
Hamil Limited
Journal
$ $
Goodwill 29 000
Freehold property 70 000
Plant and machinery 12 000
Office furniture 4 000
Inventory 2 500
Trade receivables 5 500
(cont.)
Cambridge International AS and A Level Accounting

$ $
Trade payables 3 000
Cash and cash equivalents 20 000
Ordinary share capital 80 000
Share premium account 20 000
123 000 123 000

Purchase of Abdul’s business for $120 000 and settlement by $20 000 in

cash and 80 000 ordinary shares of $1 in Hamil Ltd at $1.25.
b Hamil Limited
Statement of financial position at 30 June 2016 after the
­acquisition of Abdul’s business
$
Assets
Non-current assets
Intangible
Goodwill 29 000
Tangible
Freehold property (100 000 + 70 000) 170 000
Plant and machinery (60 000 + 12 000) 72 000
Office equipment 14 000
Office furniture 4 000
146
289 000
Current assets
Inventory (10 000 + 2 500) 12 500
Trade receivables (7 000 + 5 500) 12 500
Cash and cash equivalents (25 000 − 20 000) 5 000
30 000
Total assets 319 000
Capital and liabilities
Equity and reserves
Ordinary shares (150 000 + 80 000) 230 000
Share premium (20 000 + 20 000) 40 000
Retained earnings 40 000
310 000
Current liabilities
Trade payables (6000 + 3000) 9 000
Total equity and liabilities 319 000

Activity 3
5
a $60 000 × = $37 500
8
5
b $60 000 × = $75 000
4

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Answers to activities, practice exercises and exam practice questions: Chapter 24

Activity 4

Digger Limited
Statement of financial position at 31 December 2016 immediately
after the acquisition of Christofere and Sarah
$
Assets
Non-current assets
Land and buildings (90 000 + 60 000) 150 000
Fixtures and fittings (30 000 + 14 000) 44 000
Office machinery (15 000 + 10 000) 25 000
Goodwill (working) 25 000
244 000
Current assets
Inventory (20 000 + 15 000) 35 000
Trade receivables (5 000 + 6 000) 11 000
Cash and cash equivalents (60 000 − 28 000) 32 000
78 000
Total assets 322 000
Capital and liabilities
[1] No of shares at
Equity and reserves $1.25 per share = 60 000
Ordinary shares (200 000 + 60 000 [1]) 260 000
[2] Share premium
Share premium 15 000 [2] 147
60 000 × $0.25 = $15 000
Retained earnings 4 000
279 000
Non-current liability

(
8% debenture 12 000 ×
8
10 ) 15 000

Current liabilities
Trade payables (16 000 + 12 000) 28 000
Total equity and liabilities 322 000

$ $
Shares issued:
Purchase consideration 118 000
Less: cash 28 000
Debenture 15 000 43 000
Value of shares 75 000

Share premium 60 000 × $0.25 = $15 000

147
Cambridge International AS and A Level Accounting

Digger Limited
Journal – working for goodwill
$ $
Goodwill (balancing figure) 25 000
Land and buildings 60 000
Fixtures and fittings 14 000
Office machinery 10 000
Inventory 15 000
Trade receivables 6 000
Trade payables 12 000
Cash and cash equivalents 28 000
Debenture for Christofere 15 000
Ordinary share capital 60 000
Share premium account 15 000
130 000 130 000

Practice exercises
1 a Journal entry to record the acquisition of Eric and Tia in the books of Istaimy plc:

Journal
Name of account Debit Credit
$ $
148 Freehold land and buildings at cost 878 000
Freehold land and buildings accumulated depreciation 128 000
Plant and machinery at cost 100 000
Inventory 30 000
Trade receivables (76 000 − [5 000 × 0.80]) 72 000
Trade payables 29 000
10% debenture $100 000 × 80 ÷ 100) 80 000
Ordinary share capital 700 000
Share premium 140 000
Cash (balancing figure) 3 000
1 080 000 1 080 000

Notes:
1 The inventory has been valued on a line-by-line basis as identified by IAS 2, as this is the
method that Istaimy will have to use.
2 It has been assumed that the cash and cash equivalents in the statement of financial
position of the partners will be retained by them.
b The advantages to Eric and Tia of selling their business is that they no longer have to spend
their time on or worry about managing it in the future. They have been issued with shares
in Istaimy plc on which they can expect to receive dividends in the future. Their investment
in Istaimy, being in a larger and possibly more diverse business than theirs, may be less
risky. It may be practical to sell the shares piecemeal (unlike portions of a partnership!)
and the shares may increase (or decrease) in value. Eric has also received a debenture
paying an amount equal to that which he received from their old business. They may wish

148
Answers to activities, practice exercises and exam practice questions: Chapter 24

to retire, or take up employment, or they may be able to start a new business with the cash
taken from their old one, although this was not a large sum.

There are though, several disadvantages to consider. It may be that they receive less in
dividends on the shares in Istaimy plc than the profit their business previously earned.
Indeed, they may not receive any dividends at all if Istaimy plc fails to make a profit. They
will also have no involvement in the management of Istaimy plc.
The journal shows that the purchase price matched the agreed net asset values and that
Istaimy made no payment for goodwill. This is unusual (to say the least) in the acquisition
of a profitable business and indicates that they may have sold their business to Istaimy plc
too cheaply.

Overall, however, if they were looking to retire and also have some sort of income in the
future, then selling their business to Istaimy plc may have been the correct option if no
higher offers were available.
2 a
Joel Limited
Statement of financial position
immediately after the purchase of Kay and Ola's business
$000
Assets
Non-current assets
Intangible
Tangible
Land and buildings (1 425 + 220) 1 645
Plant and machinery (803 + 170) 973
149
2 618
Current assets
Inventory (381 + 128) 509
Trade receivables (519 + 105) 624
Cash and cash equivalents (420 + 69) 489
1 622
Total assets 4 261
Capital and liabilities
Equity and reserves
Ordinary share capital (1 350 + 300) 1 650
Share premium 150
Retained earnings 1 248
3 048
Non-current liabilities
(Existing) 8% debenture 450
(New) 10% loan (100 × 1.25) 125
575
Current liabilities
Trade payables (500 + 138) 638
Total capital and liabilities 4 261

149
Cambridge International AS and A Level Accounting

Working:
1 We are told that Joel pays out the residual element of the partners’ capital accounts, but it
seems that one partner owes the other:

Realisation account (K and O partnership)


$000 $000
Land and buildings 150 Trade payables 130
Plant and machinery 280
Inventory 150 Purchase consideration:
Trade receivables 141 Debenture 125
Cash and cash equivalents 69 Shares 450
Loss on realisation (85)
Kay   42.5
Ola   42.5
790 790

2 Capital accounts (K and O partnership)
Kay Maria Kay Maria
$000 $000 $000 $000
Current a/c Balance b/d 300 260
Debenture 125 Loan account
Ordinary shares 225 225
150 Loss on realisation 42.5 42.5
Bank (from Orla) 7.5 Bank (to Kay) 100   7.5
400 267.5 400 267.5

Note: In preparing the statement of financial position of Joel, it is assumed that


Kay and Orla have settled up, whether via Joel or independently.

3 Journal entry to record the acquisition of Kay and Ola in the books of Joel:
Journal
Name of account Debit Credit
$000 $000
Land and buildings 220
Plant and machinery 170
Inventory 128
Trade receivables 105
Cash and cash equivalents 69
Trade payables 138
Loan to Kay (100 × 1.125) 125
Ordinary share capital 300
Share premium 150
Cash*

Goodwill (balancing figure)** 21 –


713 713

150
Answers to activities, practice exercises and exam practice questions: Chapter 24

*Assume nil as settled between the partners. Alternatively + 7.5 − 7.5 = net nil, settled via
Joel; a second alternative is to show a receivable of 7.5 from one partner and 7.5 payable
to the other; this method only would affect the statement of financial position.
** Being the assets and liabilities acquired at the agreed valuations, and the consideration
issued in the purchase of Kay and Orla.
b I f Joel requires a 25% return on its investment then it must make additional profit of
575 0000 × 25% = $143 750.

Exam practice questions


Multiple-choice questions
1 C
2 D
3 D

Structured questions
1 a When a business is purchased by another business then the business which has been
bought ceases to exist. The owners of that business will either retire or become workers or
directors in the business which bought theirs.
However, when business assets are purchased by another business that is simply a
commercial transaction. For example, Business A may decide to buy some old plant
and machinery from Business B for an agreed amount. Both businesses will continue to
operate after the transaction has been completed.
b i Realisation account
$000 $000 151
Property account 100 Trade payables account 20
Vehicle taken over by Ann 4
Vehicles account 20 Purchase consideration:
Inventory account 15 Debenture (30 × 0.8) 24
Trade receivables 12 Shares 100
Expense of realisation 1
Profit on realisation: Cash (152 − 100 − 24) 28
Anne* 11
Bridget* 11
Chris* 6
176 176

*The profits on realisation are $28 000 and have been allocated in round thousands in
approximately the ratio 2:2:1.
ii Capital accounts
Ann Bridget Chris Ann Bridget Chris
$000 $000 $000 $000 $000 $000
Current a/c 3 Balance b/d 35 30 20
Debenture 24 Current a/c 10 8
Ordinary shares 40 40 20 Loan account 30
Vehicle taken over 4
Bank 18 9 3 Profit on realisation 11 11 6
86 49 26 86 49 26

Bank: 3 − 1 + 28 − (18 + 9 + 3 = 30) = 0 151


Cambridge International AS and A Level Accounting

c If Ann accepts the offer for her shares and loan from Janty Limited she will receive:

$40 000 × 0.75 = $30 000 for her shares and $24 000 × 75% = $18 000 for her loan; a total of
$48 000. This will mean that she will need to borrow $150 000 − $48 000 = $102 000
plus $20 000 for working capital; a total of $122 000 in order to buy her new business.
A ssuming the worst position, she will have to pay interest on the loan of $102 000 × 5% =

$5100 a year, plus $20 000 × 7% = $1 400 on the overdraft, assuming she requires it for a
year; a total of $6 500.

From her projections the profit she expects to make in the first three years is greater than
the interest she will pay. It also seems to be increasing steadily over the three year period.

On this basis, provided that she feels comfortable with the move, it makes sense for her to
buy the business. She will again be her own boss and, unlike in the previous partnership,
all the profit will belong to her. The only negative aspect is the risk of starting the new
venture and the accuracy of the profit projections. If she is happy to take the risk and
confident in the profit figures, the venture should be taken. She is giving up the interest
paid to her on the loan, but Janty Limited is not paying any dividends on the shares, so
again it points to the fact that she should start the new venture.

The apparent fall in the value of the Janty shares may reflect a real downturn, or it may
indicate the relative bargaining power of the two parties. However this position has been
reached, Ann must make her calculations based on the current value of the shares. In
theory, she could also try and find another buyer willing to pay more than 75c per share.
2 a A merger is when two independent businesses join together to form a new business. The
152 two original businesses are closed and all, or some, of their assets are transferred to the
new business, but both underlying trades continue within the new business.

When a business is sold to another business, then the business which has been sold
ceases to exist. All, or some, of the assets are sold to the new business. Both underlying
trades continue within the acquiring business. The owners of the business which has been
sold will either retire or become workers or directors (or partners) in the business which
bought theirs.
b Calculation of opening capital account balances at 1 April 2015

Brian Maye
[1] There is no indication
from the data that the $000 $000
owners will not transfer Non-current assets 130 190
their cash and bank
balances to the new
Inventory 25 24
partnership. Thus they Trade receivables 55 39
have been included here.
Cash and cash equivalents [1] 2 1
Trade payables (17) (29)
Goodwill at owner's valuation 30 20
Goodwill written off (25) (25)
Opening balances 200 220

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Answers to activities, practice exercises and exam practice questions: Chapter 24

c Brian and Maye


Opening statement of financial position at 1 April 2015
$000
Assets
Non-current assets 320
Current assets
Inventory 49
Trade receivables 94
Cash and cash equivalents 3
146
Total assets 466
Capital and liabilities
Capital account:
Brian 200
Maye 220
420
Current liabilities
Trade payables 46
Total capital and liabilities 466

d Brian and Maye


Appropriation account for the year ended 31 March 2016
153
$000 $000
Profit for the year 27
Less: partners' salaries:
Brian 6
Maye 4 10
17
Interest on capital:
Brian 10
Maye 11 21
(4)
Share of loss:
Brian (2)
Maye (2) (4)

e For the year ended 31 March 2016, Brian's total share of the profit for the year was $14 000
and Maye's share was $13 000. Thus Brian earned more than he would in his own business
and Maye earned less than she would in her own business. On this basis Brian was right to
form the partnership and Maye was wrong.
However, this is based on the profit for the new partnership for one year only. Future profits
may well give each partner a greater income than their old businesses.
Another way of looking at this leads us to conclude that they combined their businesses
on terms that were unfair to Maye. Her old business was twice as profitable as Brian’s,
suggesting in broad terms that her goodwill and her profit share could each have been
more fairly agreed at double Brian’s.
153
Cambridge International AS and A Level
level Accounting
Accounting

25 Consignment and joint venture accounts


Activities
Activity 1
In Bertie’s ledger:

Consignment with Calum account


$ $
Goods on consignment 16 000 Sales 25 000
Calum – shipping costs 450 Balance c/d 3 200
Balance c/d 11 750
28 200 28 200

[1] At this point Calum account


Bertie has not
$ $
paid a cheque
to Calum as Consignment account 25 000 Consignment account – shipping 450[1]
reimbursement costs
of the shipping
costs. When he
Balance c/d 24 550
does so, the 25 000 25 000
entry will be to
credit Bertie's Goods sent on consignment account
bank account
and debit $ $
Calum's account. Income statement 16 000 Consignment with Calum 16 000

154 Activity 2
a In the books of Nettie:
Consignment with Alfonso account
$ $
Goods on consignment 15 000 Sales 16 000
Bank – shipping fees (N) 1 800 Consignment loss 600
Landing fees (A) 1 200
Commission 1 600 Balance c/d 3 000
19 600 19 600
Balance b/d 3 000
If Nettie has not yet settled the landing fees:
Alfonso account
$ $
Consignment account 16 000 Commission 1 600
Consignment account – landing fees 1 200
Bank 10 000
Balance c/d 3 200
16 000 16 000
Balance b/d 3 200
Answers to activities, practice exercises and exam practice questions: Chapter 25

If Nettie has settled the landing fees:


Alfonso account
$ $
Consignment account 16 000 Commission 1 600
Bank – landing fees 1 200 Consignment account – landing fees 1 200
Bank 10 000
Balance c/d 4 400
17 200 17 200
Balance b/d 4 400

Goods sent on consignment account


$ $
Consignment with Alfonso 15 000

b In the books of Alfonso:


If Nettie has not yet settled the landing fees:
Nettie account
$ $
Bank – landing fees 1 200 Customer accounts/SLC 16 000
Bank 10 000
Income statement – commission 1 600
Balance c/d 3 200
16 000 16 000 155

Balance b/d 3 200


If Nettie has settled the landing fees:
Nettie account
$ $
Bank – landing fees 1 200 Bank – refund of landing fees 1 200
Bank 10 000 Customer accounts/SLC 16 000
Income statement – commission 1 600
Balance c/d 4 400
17 200 17 200
Balance b/d 4 400

Activity 3
a In the books of Henry:
Consignment with Jasmine account
$ $
Goods on consignment 12 000 Goods on consignment 1 200
Sales 14 900
Bank – shipping fees (H) 2 800
Landing fees (J) 850
CN for shipping costs (J) 340
Consignment profit 1 870 Balance c/d 1 760
17 860 17 860
Balance b/d 1 760
Cambridge International AS and A Level Accounting

Jasmine account
$ $
Consignment account 14 900 Landing fees 850
Consignment account – credit note for 340
shipping costs
Bank 8 300
Balance c/d 5 410
14 900 14 900
Balance b/d 5 410

Goods sent on consignment account


$ $
Consignment with Jasmine 1 200 Consignment with Jasmine 12 000
Balance c/d 10 800
12 000 12 000
Balance b/d 10 800

b In the books of Jasmine:


Henry account
$ $
Bank – landing fees 850
Bank – shipping costs (CN received) 340
156
Bank 8 300 Customer accounts/SLC 14 900
Balance c/d 5 410
14 900 14 900
Balance b/d 5 410
If Janine has posted the shipping costs from bank payments to the Henry account, the credit
note requires her to make no further entry; it is paperwork that confirms that she can remit
$340 less than the other transactions would require, but the accounting entry is already made.
If Janine had posted the shipping costs from bank payments to her own shipping costs account,
the credit note ‘authorises’ her to treat this as, instead, receivable from Henry; it is paperwork that
supports a journal by which she transfers $340 from shipping costs (her expense account) to the
Henry account, thus ensuring that she remits $340 less than the other transactions would require.
The crucial point is that Janine must make only one (debit) entry of $340, so as to reduce her
net liability to Henry.

Practice exercises
1 a In the books of Marty:
Joint venture with Jerry account
$ $
Bank – materials 32 600 Bank – sales 120 000
Bank – legal fees 4 100 Bank – from Jerry* 6 350
Share of profit (from part b) 89 650
126 350 126 350

* This is the balancing figure. Alternatively, this could be carried down as an amount due
from Jerry.
Answers to activities, practice exercises and exam practice questions: Chapter 25

b Joint venture with Jerry memorandum account


$ $
Materials bought by Marty 32 600 Sales by Marty 120 000
Materials bought by Jerry 30 000 Sales by Jerry 126 000
Legal fees 4 100
Share of profit – Marty 89 650
Share of profit – Jerry 89 650
246 000 246 000

c Calculation of amount due from one party to the other:


At the end of the venture Jerry owes Marty $6 250, assuming no separate bank account
was opened.
d 
At first sight, there appears to be no reason why Marty should not form a partnership with
Jerry. The house building venture was successful, with considerable profits made. If they
form a partnership then there is perhaps no reason why this may not be the case in future.
However, it may be that one or other of the parties saw what was only a ‘one-off’
opportunity to build the houses. There seems to be no intention by either to form a
partnership in future. We do not know what type of business each runs (if any). Forming a
partnership means a long-term commitment by both and one, or perhaps both, may not
want this. They may want to concentrate on their own businesses.
Should Marty want to go into partnership with Jerry then they must agree on the type of
business and how any profits will be shared.

157
Exam practice questions
Structured questions
1 a i  In the books of Krystal:
Consignment with Chen account
$ $
Goods on consignment 29 700 Sales* 50 000
Shipping fees (K) 4 900 Balance c/d 3 800
Export charges (K) 3 300
Landing fees (Ch) 4 400
Commission* 5 000
Consignment profit 6 500
53 800 53 800
Balance b/d 3 800
*The balancing figure excluding these items is $45 000 and it must comprise sales less
commission, i.e. 90% of the sales figure. Hence sales = $50 000 and commission = $5 000.
ii    Chen account
$ $
Consignment account 50 000 Landing fees 4 400
Commission 5 000
Bank 8 000
Balance c/d 32 600
50 000 50 000
Balance b/d 32 600
Cambridge International AS and A Level Accounting

b In the books of Chen:


Consignment with Krysal account
$ $
Bank – landing fees 4 400 Customers a/c 50 000
Bank – to Krystal 8 000
Income statement – commission 5 000
Balance c/d 32 600
50 000 50 000
Balance b/d 32 600
c 
A consignment arrangement may remain suitable if, for example, the transactions are
irregular or are a small part of the activities of either party. Each party may operate a
successful business in their own country. Thus, forming a more legal tie between them
may mean that they are no longer free to do what they please. It would then be better if the
consignment arrangement continued in the future.
However, a partnership (or a limited company) arrangement might motivate Chen more,
and make it easier for her to expand the Chinese business if both parties are ready to take
that path.
If Krystal and Chen form a partnership, then given the geographical distance between
the two parties, it is essential that a partnership agreement is prepared. This is in order to
protect both parties.
It is easier now with IT for parties to keep in close contact even over long distances.
However, either Krystal or Chen could do something which the other one does not know
about, or would not approve of, such as purchasing inventory. This would break the trust
158
between them if the other discovered the actions. It is also worth remembering that the
actions of one partner binds the other. Thus if the inventory is bought on credit and not
paid for, then the other partner will have to pay. Less melodramatically, potential partners
usually have a good understanding of each other’s abilities to contribute to the business
and so can agree a fair allocation of responsibilities and rewards (profit shares). It seems to
be too early to begin a partnership. It is not recommended that a partnership is formed so
near the beginning of a business relationship.
A limited company will provide more security for both parties, especially in terms of liabilities
for debts. If one is formed then the distribution of shares is crucial as if one member holds
more shares than the other then they have control of the business. If equal numbers of
shares are held by both then it may lead to stalemate in respect of making future decisions.
Whether to choose a partnership or a limited company will depend on whether the higher
costs in administrative burdens of a limited company are considered less significant
than the benefit of limited liability. This is a judgment that may change over time, as the
business develops.
2 a In the books of Alan:
Consignment with Zac account
$ $
Goods on consignment 100 000 Sales 123 000
Freight charges 7 200 Balance c/d 9 900
Landing dues 3 800
Commission 12 300
Consignment profit 9 600
132 900 132 900
Balance b/d 9 900
Answers to activities, practice exercises and exam practice questions: Chapter 25

b Zac account
$ $
Sales 123 000 Landing dues 3 800
Commission 12 300
Bank 85 000
Balance c/d 21 900
123 000 123 000
Balance b/d 21 900
c Unit cost = 100 000 + (7 200 + 3 800) = 110 000 ÷ 1 000 = $110 each.
Number of unsold bicycles at 31 March 2016 = $9 900 ÷ $110 = 90.
d 
The bicycles have been valued in line with IAS 2. This means that they are valued at cost
plus any costs incurred in bringing them to a saleable condition. Whilst they only cost
$100, that is the value at which they would be valued had they been sold in England. There
would be no further costs of bringing them to a saleable condition.
However, it is fair to add on the freight charges and landing dues incurred in bringing the
bicycles to Botswana as part of their inventory valuation.
e 
Alan is paying Zac a commission of 10%. He may now think this is too much, but he had
agreed it with Zac prior to entering into the consignment arrangement.
There is no great difference between the suitability of consignment and joint venture
arrangements; each is relatively informal and suitable for occasional transactions or for
one-off ventures.
The key difference is that joint venturers share the risks and the rewards of their venture
and specifically they share in the net profit. If Alan and Zac enter into a joint venture, 159
then they will need to agree profit sharing arrangements. If Zac is risk averse he may
want to have a first share in the profit akin to a salary to compensate him for the loss of
commission, so that Alan will be no further forward in reducing Zac’s rewards. On the other
hand, having a share in the net profit may motivate Zac to greater efforts, to the net benefit
of both parties.
As Alan’s success and reward from business in Botswana are entirely attributable to Zac’s
efforts, Alan needs to discuss his concerns and alternative possible future arrangements
with Zac, so that they can move forward with an arrangement that offers the best mutual
advantage.
This may enable him to expand his market overseas, perhaps into other countries in Africa,
depending on Zac’s trading contacts.
3 a There are basically three ways in which the transactions of a joint venture can be recorded:
• One party records all the transactions of the venture.
• Each party records their own transactions in respect of the venture.
• A separate set of accounting records is kept for the whole of the transaction to the venture.
The parties have agreed to use the second method mentioned above.
b In the books of Bob:
i
Joint venture with Sue account
$ $
Aug 2 Purchase of cars 50 000 Aug 31 Bank – sales 80 000
Aug 5 Licences and insurance 8 000
Aug 31 Income statement – profit 17 000
Balance due to Sue c/d 5 000
80 000 80 000
Cambridge International AS and A Level Accounting

ii Joint venture memorandum account


$ $
Purchase of cars 100 000 Sales – Bob 80 000
Licences and insurances (B) 8 000 Sales – Sue 80 000
Licences and insurances (S)* 8 000
Discount 10 000
Share of profit – Bob 17 000
Share of profit – Sue 17 000
160 000 160 000

*it is assumed that Sue asked for a 50% contribution.


c Sue should have recorded sales of $100 000, not the $80 000 she has declared. She has
obviously tried to mislead Bob and perhaps in a fraudulent way. This means that the overall
profit for the venture should have been more and Bob’s share should be $27 000, based on this
error only. There is also the aspect of how much Sue actually paid for the licences; it appears
that Bob is entitled to another $2 000 back from overpaying for licences and insurances.
On this basis Sue should make a full disclosure to Bob of what she actually sold and paid in
respect of the venture. A new memorandum joint venture should be prepared, a true profit
figure calculated, and Sue must pay Bob anything more she owes him.
Bob has every right to ask Sue for all this information. If Sue does not provide it, or he feels
that she is still holding something back then he might have to seek help from his solicitor.
d A joint venture is a project undertaken by two parties for a specific project. When that
project has been completed the joint venture is over and each party can go back to their own
160 business, once any cash differences between them have been settled.
A partnership is where two or more parties join together in business for the foreseeable future.
There is no intention to cease working together and they run a single business with a view to
that business making a profit and the profit being shared between them annually.
e Bob would be advised not to enter into a partnership with Sue. He has discovered that she
tried to cheat him previously with the joint venture. The accounts she has produced have been
prepared by her brother. This too is suspicious as her brother may not have prepared true
accounts.
The accounts do show more profit than Bob is making, so there may be a business
opportunity for him. If Bob is seriously considering entering into a partnership with Sue,
he should instruct his own accountant to review the figures prepared by Sue’s brother to
establish the true profit. He should then prepare a partnership agreement setting out every
detail of any partnership to ensure Sue does not try to mislead him again.
Answers to activities, practice exercises and exam practice questions: Chapter 26

26 Computerised accounting systems


Activities
Activity 1
a Buying from an IT provider in your town:
Advantages:
• local so can contact easily if any problems
• can build trust and working relationship
• may be able to sell a tried and tested package and offer regular maintenance / updates /
upgrades.
Disadvantages:
• if looking at an accounting package then may not have the necessary expertise in
accounting if there are problems
• may be restricted in the package they can sell as often operate as a dealer for a specific
product – this means you may not get the type of package required
• may also try to sell other packages which you don’t need.
b Buying over the internet:
Advantages:
• may be cheaper than anyone else
• the internet provides access to wider market so may be able to find more accounting
packages
• as with a locally supplied tried and tested package, a widely used package will in effect 161
have been ‘tested’ by thousands, or perhaps millions, of users, and a responsible supplier
will have been making continuous improvements and supplying ‘bug fixes’ since the
software was first produced.
Disadvantages:
• probably no backup services offered, so may be issues if system breaks down/crashes
• may have to buy service contract as part of deal – this can be expensive and if system fails
then time may be lost in seeking help
• may not offer regular upgrades.
c Getting someone who is computer literate to write a package:
Advantages:
• local so can ask if in difficulty
• can write a specific package for your business
Disadvantages:
• may lack expertise in accounting so you may not get what you want
• supplier may not be able to produce the software quickly
• significant risk of errors or bugs in a first release product
• with only one user, there is a risk that errors are not detected quickly
• neither you nor any potential employee will be familiar how the software operates;
probably more learning time than with a ‘standard’ commercially available package
• probably won’t be able to offer regular upgrades
• may be expensive.
Cambridge International AS and A Level Accounting

Activity 2
This issue depends on what Karly and Viji want from computerising their accounting system.
Transferring everything to a computer will save them time and storage space. It should also make
the processing of data more accurate and quicker, especially if there is a large volume of postings
and their current system is divided into several ledgers. Computerising everything will mean
everything can be found in one place.
However, there is an issue over who is posting data to the system. If they are leaving it to one
person other than themselves then there is a possible fraud issue that the person processing the
data can make fraudulent entries. There is also the issue of how computer literate they are.
If they are not confident with computers, they may prefer to look at something in a book that has
been handwritten. By not computerising everything, it may be difficult to reconcile everything at
the month end. Someone will also have to maintain the manual elements of the system.
Overall, if they are going to make the switch to computerising their accounting system then it
should ideally be ‘all or nothing’. There is little benefit in only transferring part of their system.
True, it will take more time for them to get used to everything and they may feel that information
is not as available as before, but the benefits of transferring everything are greater.

Activity 3
They should certainly have two categories of sales:
• garden furniture
• garden equipment.
Depending on how much analysis of their sales they require they may expand on this.
For example, with garden furniture they may consider garden seats, umbrellas and tables.
162 For equipment, they may consider lawn mowers and garden tools. How many they decide will
depend upon how many sales categories their accounting system allows and what benefit they
gain by increasing the number of categories.
The number of purchases categories must match their sales. So they must have:
• puchases of garden furniture
• purchases of garden equipment.

Activity 4
a
Date Customer Customer Invoice Credit note Amount
[1] The name of [1] reference [2] number [3] number [4] $ [5]
the customer
would be October
entered here. November
December

[2] This could be the customer reference [3] This will be the [4] This will be [5] The amount
they currently use with their manual system number on the the credit note of the invoice or
or the customer reference generated by the invoice which they number they credit note should
computer system when they enter the data. sent to the customer. have used. be entered here.

b The immediate benefit they have obtained by doing this is that they now have an aged
receivables listing for the customer. It shows them how long the debt has been outstanding.
Thus they can now start to chase the customer for overdue payments. This will immediately
benefit their cash flow.

Activity 5
a Reconciling all the balances which will be transferred to the computer system will ensure
that accurate data is transferred. There may be errors in their manual data and it is pointless
transferring this to a new system. Ideally they want a ‘clean’ set of data with the new system.
Answers to activities, practice exercises and exam practice questions: Chapter 26

b Apart from inventory they should also reconcile:


• the petty cash
• the bank account
• loan accounts
• non-current assets at cost and accumulated depreciation.

Activity 6
Everything which will be transferred to the computerised accounting system will be the balances
on the statement of financial position:
• Non-current assets at cost, broken down by category, such as land, buildings,
motor vehicles, etc.
• Non-current assets’ accumulated depreciation using the same categories as their cost.
• Current assets:
i trade receivables – these will be transferred by individual customer and the total
reconciled back to the total of the trade receivables
ii inventory – this can be done either line-by-line or in total
iii other receivables to their individual accounts, such as rent or telephone
iv cash and cash equivalents.
• Owner’s equity – the partners’ capital, current drawings accounts balances.
• Non-current liabilities, such as loans.
• Current liabilities:
i trade payables, again by individual supplier 163
ii other payables to their respective account, such as heat and light or telephone
iii any bank overdrafts.

Practice exercises
1 This is a summary of the detailed information in the chapter:
• select the computerised system which the business will use
• set up the chart of accounts for the new system
• prepare the final financial statements at the date of the transfer
• reconcile any balances at that date (bank, petty cash, etc.)
• transfer to the new system the opening balances – these will be the balances from the
closing manual statement of financial position
• produce a trial balance from the computerised system and match this back to the manual
balances
• operate a system of parallel running with regular checks between the manual and
computerised system
• pick a final date on which the computerised system will take over entirely from the manual
system.
2 Three advantages of a computerised accounting system:
• saves time in processing data
• saves storage space, no longer any need for books and ledgers
• should be more accurate than a manual system as data is only input once and the
computer provides the double entry.
Cambridge International AS and A Level Accounting

Three disadvantages of a computerised accounting system:


• initial cost of buying the system
• training costs
• possible hacking of the data.
3 The integrity of the data which is transferred to the computerised system depends on reconciling
and backups. Most computer packages will have a set-up procedure. However, it is critical that
the data which is entered at this stage is accurate. Thus, a trial balance must be taken which is
effectively the closing balances on the statement of financial position. All the balances must be
verified and, where necessary, reconciled. If incorrect data is entered at this stage the integrity of
the new system is already compromised. Where necessary backup schedules of individual items
must be prepared. This is particularly the case with trade receivables and payables, where an
aged receivables and payables analysis must be prepared showing the individual balances due
for customers and due to suppliers. The total of these individual accounts must be reconciled
back to the totals appearing in the statement of financial position. Once all the balances have
been reconciled they can be entered on to the new system.
As previously mentioned, it is likely that any accounting package will have a set-up procedure.
All the balances will be entered in a set sequence. It is important that regular backups are
taken as the data is input and where possible the input data on the screen is reconciled back
to any manual totals, for example the total of the individual customers input with the overall
total of trade receivables. Once all the data has been input, a trial balance must be produced.
This must be reconciled with the trial balance taken from the manual system. If the two agree
then the computer can start to be used for regular work. If not, then any differences must be
found and eliminated before work with the new computerised system can start.
4 a
164 John
Rent account
Date Details Debit Credit Balance
2016 $ $ $
May 31 Bank 42 000 42 000
Income statement 36 000 6 000
Prepayments 6 000 0

b
John
Prepayments account
Date Details Debit Credit Balance
2016 $ $ $
May 31 Rent 6 000 6 000

c The balance on the prepayments account will be automatically transferred by the


system at the year end to the statement of financial position. It will appear under other
receivables.
At 1 June 2016, if the system does not automatically transfer the balance back to the rental
account, John will have to prepare a journal to do this. His journal entry will be:

$ $
June 1 Rent account 6 000
Prepayments account 6 000
Answers to activities, practice exercises and exam practice questions: Chapter 27

27 Analysis and communication of accounting


information
Activities
Activity 1
a i Gross margin 2015 gross profit 60308
× 100 = × 100 = 35%
revenue 172308
2016 60000
= × 100 = 32%
187500
ii Profit margin 2015 profit for the year (after interest) 21539
× 100 = × 100 = 12.5%
revenue 172308
2016 27322
= × 100 = 14.57%
187500
iii Non-current 2015 net revenue 172308
× 100 = = 2.2 times
asset turnover total NBV of non - current assets 78322
2016 187500
= = 2 times
93750
iv Inventory 2015 cost of sales 112000
= = 8 times
turnover average inventory (12000 + 16000) ÷ 2
2016 127500
= = 8.5 times
(16000 + 14 000) ÷ 2
v Trade 2015 trade receivables 9914
× 365 = × 365 = 35 days
receivables credit sales 60% of 172308
turnover
2016 12511 165
= × 365 = 40.59 days
60% of 187500
(or 41 days)
vi Trade payables 2015 trade payables 13984
× 365 = × 365 = 44 days
turnover credit purchases 116000
2016 17192
= × 365 = 50 days
125500
vii Current ratio 2015 current assets: current liabilities = 30 765 : 13 984
= 2.2 : 1
2016 = 33 696 : 17 192
= 1.96 : 1
viii Liquid (acid 2015 current assets – inventory: current = 14 765 : 13 984
test) ratio liabilities = 1.06 : 1
2016 = 19 696 : 17 192
= 1.15 : 1

b i Sales have increased by over $15 000, or nearly 9%, but the gross margin has decreased
from 35% in 2015 to 32% in 2016, a reduction of 3%. This may be due to:
• a reduction in selling prices to increase turnover
• an increase in the cost of sales not passed on to customers
• sales made at less than the normal mark-up (seasonal sales or disposal of old or
damaged inventory)
• some inventory valued at less than cost because it is old or has deteriorated
• inventory which has been stolen.
 Whether or not the gross margin is acceptable depends upon the normal margin
expected on sales, but information about this is not provided.
Cambridge International AS and A Level Accounting

ii The profit margin has improved from 12.5% in 2015 to 14.57% in 2016. This is in spite
of a reduction of 3% in the gross margin. This has been achieved by tighter control on
overhead expenditure, down from $38 769 in 2015 to $32 678 in 2016, a reduction of
15.7% although sales have increased by 8.8%.
iii Non-current asset turnover has remained almost steady. Without further information
about the nature of the business, it is not possible to comment on this ratio. There
has been a considerable increase in the value of non-current assets employed in the
business in 2016. The additional assets would have to have been brought in to use early
in the year for the full commercial and accounting (depreciation) effects to have
been felt.
iv Inventory turnover has increased slightly from 8 times in 2015 to 8.5 times in 2016.
The average time that goods remain in inventory is 6.5 weeks which may seem
reasonable, but as nothing is known about the type of business, further comment is
not possible.
v Trade receivables turnover has increased by 6 days, from 35 in 2015 to 41 in 2016. This
deterioration may be due to one or more of the following factors:
• more lenient terms for debtors, to promote sales
• a deliberate policy to attract customers from competitors
• general economic conditions
• poor credit control.
A deterioration in the trade receivables turnover incurs the risk of an increase in
irrecoverable debts as old debts usually become irrecoverable. Najim should monitor the
166 situation carefully.
vi Trade payables turnover has increased by 6 days, from 44 days in 2015 to 50 days in 2016.
While this may help the cash flow at a time when debtors are taking 6 days longer to pay,
care must be taken to retain the goodwill of suppliers, otherwise the suppliers may insist
on cash basis and this would greatly harm Najim’s cash flow.
vii  The current ratio has decreased slightly from 2.2 : 1 in 2015 to 1.96 : 1 in 2016. It remains
satisfactory by normal standards.
viii The liquid (acid test) ratio has remained almost steady at 1.06 : 1 in 2015 and 1.15 : 1
in 2016. As 60% of sales are on credit, the very low ratios on which businesses such as
supermarkets work are not appropriate for Najim’s business, and his present ratios may
be considered satisfactory.
General comments:
There are no indications that the business is not a going concern. Its cash position is
positive and there are no bank loans or overdrafts that could cause embarrassment in the
near future.
There is no sign of overtrading as inventory and debtors are not excessive. Overtrading places
businesses at great risk.
Note:
Part b requires more than a simple repetition of the ratios already calculated in part a. It is
necessary to compare the ratios and to recognise trends and their significance. Students
should avoid irrelevant comments and repetition. Statements which cannot be supported
by information provided should be avoided, but possible reasons for an improvement or
deterioration in a trend may be suggested.
Answers to activities, practice exercises and exam practice questions: Chapter 27

Activity 2
a i Gearing:
600
Flora Ltd × 100 = 54.54%
600 + 500
1 000
Fauna Ltd × 1 000 = 26.31%
2800 + 1 000
ii Interest cover:
300
Flora Ltd = 5 times
60
420
Fauna Ltd = 3.5 times
120
iii Earnings per share:
240
Flora Ltd = $0.8 (=80c) per share
300
300
Fauna Ltd = $0.27 (=27c) per share
1125
iv Dividend per share:
90
Flora Ltd = $0.3 (=30%)
300
150
Fauna Ltd = $0.13 (=14%)
1125
v Dividend cover:
240
Flora Ltd = 2.67 times
90
300
Fauna Ltd = 2 times (twice)
150
vi
Price earnings ratio:
$2.70 167
Flora Ltd = 3.375
$ 0 .8
$3.60
Fauna Ltd = 13.33
$0.27
vii Dividend yield:
$ 0 .3
Flora Ltd × 100 = 11.11%
$2.70
$0.13
Fauna Ltd × 100 = 3.7%
$3.60
b i 
Gearing: Flora Limited is highly geared (54.54%) and Fauna Limited is low geared (26.31%).
This makes Flora Limited a little more risky from the point of view of shareholders and
creditors, but neither company is far from neutral gearing (50%).
ii Interest cover: Flora Limited’s interest is covered 5 times by the operating profit, but Fauna
Limited’s is only covered 3½ times. Both ratios are satisfactory. Flora Limited’s ordinary
shareholders are less at risk of having their dividend curtailed if profits fall than Fauna
Limited’s shareholders.
iii Earnings per share: Flora Limited’s EPS is much higher at 80 cents than Fauna Limited’s
at 27 cents. Arithmetically, this is mainly due to Fauna Limited having raised more money
from its shareholders and having a lower gearing than Flora Limited. The implication
is that Fauna has had to invest proportionately more capital to achieve a return for its
shareholders than Flora. This suggests that Flora Limited is potentially the better company
for dividend/capital growth.
iv Dividend per share: Flora Limited is paying an ordinary dividend of $0.30 per $1 share,
equal to 30 % of the nominal value of the shares. Fauna Limited is paying $0.13 per $2 share,
Cambridge International AS and A Level Accounting

equal to 6.5% of the nominal value of its shares. At first sight, this makes Flora Limited’s
shares seem the more attractive, but an investor buying existing shares must pay the
market price, so that yield on the amount invested is a more directly useful and relevant
ratio.
Note: We will use the dividend per share in order to work out the dividend yield in part vii
below.
v Dividend cover: Flora Limited’s dividend cover is 2.7 times, which is generally considered
to be satisfactory. Fauna Limited’s dividend is covered 2 times and may be slightly more at
risk if profits decline in the future.
vi 
Price earnings ratio. Flora Limited’s PER is 3.375 and Fauna Limited’s PER is 11.25. The
share prices may be influenced by factors not mentioned, and in particular we do not
know anything about the future prospects of either company. Fauna Limited’s future
trading prospects may be affected by various favourable factors not mentioned; a low
price earnings ratio commonly indicates that investors anticipate significant future growth
in profit.
vii Dividend yield. Flora Limited’s dividend yield based on the current market price is
11.11% compared with the yield of 3.7% on Fauna Limited’s shares. This makes Flora
Limited’s shares more attractive from an income-earning view point. However, it
should be considered along with the potential for capital growth and, as has already
been stated, Flora Limited’s earnings per share has permitted adequate profits to be
retained for capital growth, especially if a conservative dividend policy is continued in
future.
Conclusion:
Every ratio except gearing is favourable to Flora Limited and even the gearing should not
168 give rise to serious concern. Based on the figures presented, an investment in Flora is to be
recommended. However, an investment should be based on the future prospects of the entity
and the financial consultant should also have regard to the natures of the underlying
businesses.

Activity 3
a Patience
Income statement for the year ended 31 December 2016
$ $
Step 6 Revenue (495 000 × 100/65) 761 538
Cost of sales
Step 2 Inventory at 1 Jan 2016 (54 000 × 5/6) 45 000
Step 5 Purchases (balancing figure) 504 000
Step 4 (balancing figure) 549 000
Step 1 Inventory at 31 Dec 2016 (given) 54 000
Step 3 Cost of sales 54 000 + 45000 495 000
10 ×
2
Step 7 Gross profit (35% of 761 538) 266 538
Step 9 Expenses (balancing figure) 99 000
Step 8 Profit for the year (22% of 761 538) 167 538
Answers to activities, practice exercises and exam practice questions: Chapter 27

Patience
Statement of financial position at 31 December 2016
$
Assets
Step 10 Non-current assets (761 538 / 4) 190 385
Current assets
Step 11 Inventory 54 000
Step 12 Trade receivables (761 538 × 34/365) 70 938
Step 15 Cash and cash equivalents (balancing figure) 20 050
Step 14 (balancing figure) 144 988
Step 16 Total assets 335 373
Capital and liabilities
Step 21 Capital at 1 Jan 2016 (balancing figure) 249 840
Step 20 Profit for the year 167 538
Step 19 (balancing figure) 417 378
Step 18 Less: drawings (given) 140 000
(from step 17) 277 378
Current liabilities
Step 13 Trade payables (504 000 × 42/365) 57 995
Step 17 Total capital and liabilities 335 373

Workings:
169
Step 14: As we know that the current ratio is 2.5:1, having calculated the trade payables at
step 13 as $57 995, then the total current assets must be $57 995 × 2.5 = $144 988.
b Virtue’s inventory turnover is 12 compared with 10 for Patience. Virtue earns his profit at a
faster rate than Patience. His cash flow may be improved by the higher inventory turnover, if
he can also collect receivables as quickly as Patience.
Virtue’s gross profit margin of 40% is more than Patience’s 35% which indicates that he
earns a higher margin on his sales. He may have cheaper sources of supply than Patience,
or Patience’s mark-up may be lower than Virtue’s. Without more information about their
individual circumstances, further comment is not possible.
Virtue’s net profit margin (20%) is 2% lower than Patience’s (22%). This shows that Patience’s
overheads are comparatively lower than Virtue’s. Not all overheads are easily controllable,
and Virtue may have to pay higher rent, for example, because of the situation or size of his
premises.
Virtue’s turnover is 5 times his non-current assets but Patience’s turnover is only 4 times.
Virtue is using his non-current assets more efficiently and making them more profitable.
Virtue’s trade receivables turnover is 31 days, which is 3 days less than that of Patience (34
days). This indicates that Virtue controls his debtors more efficiently and his cash flow is
improved as a result.
Virtue pays his creditors 6 days earlier than Patience pays hers (36 days compared to 42 days).
No information is provided regarding the credit terms each receives. If Virtue obtains his
goods more cheaply than Patience, as suggested, the period of credit he is allowed may be
less than Patience receives. On the other hand, if Virtue is not taking the full period of credit
he is allowed, he is not managing his cash flow to the best advantage. Or it may be that he
takes more advantage of early settlement discounts, thus improving his profitability; there are
advantages and disadvantages to either course of action.
Cambridge International AS and A Level Accounting

Conclusion:
With the exception of the net profit margin and the possible exception of his payment of
creditors, Virtue appears to be running his business more efficiently than Patience.

Practice exercises
1 a Two advantages of ratio analysis:
• allows a business to compare performance with competitors / previous years
• helps planning for future.
Two disadvantages of ratio analysis:
• only shows results – it doesn’t explain why the ratios may have changed from year to
year
• based on historic data.
b
Goswami Limited
Calculation of ratios
Ratio Calculation Answer Industry
average
i Gross margin $105 000 ÷ 350 000 30% 30%
ii Profit margin $45 850 ÷ 350 000 13.1% 18.07%
iii Current ratio $88 000 ÷ 47 150 1.87:1 2.21:1
iv Liquid (acid test) ratio $(88 000 − 66 500) ÷ 47 150 0.46:1 1.02:1
v Rate of inventory turnover $245 000 ÷ ([31 500 + 66 500] ÷ 2) 5 times 8 times
170
vi Trade receivables turnover ($21 500 ÷ 350 000) × 365 23 days 25 days
vii Trade payables turnover ($21 000 ÷ 280 000) × 365 28 days 30 days

c i Profitabilitiy:
The gross margin of the company is exactly the same as the industry average. Goswami
Limited is performing well in this respect. However, the profit margin of Goswami
Limited is lower than the industry average. This is poor and indicates that the company
may not be controlling its expenses very well, or may be a consequence of having
incurred significant ‘start-up’ costs.
ii
Liquidity:
Both the current ratio and liquid ratio of Goswami Limited are worse than the industry
average. This indicates poor control over working capital and thus over liquidity. This
is also shown by the inventory turnover which is worse than the industry average. The
result of this is probably the reason why the bank is overdrawn.
d 
The directors of Goswami Limited need to take the following actions to improve their
results for the business:
• Control their running costs as far as they are able to by looking for cost savings in
respect of overheads.
• Reduce inventory – too much cash is tied up in inventory. The directors need to perhaps
sell off surplus or slow moving inventory and only purchase more as it is necessary.
Answers to activities, practice exercises and exam practice questions: Chapter 27

2 a i
Techno Hub
Income statement for the year ended 30 April 2016
Step $000 $000
Revenue 5 750
Opening inventory 2 30
Purchases 4 465
Less: closing inventory 1 45
Cost of sales 3 450
Gross profit 6 300
Expenses 8 165
Profit for the year 7 135

ii
Techno Hub
Statement of financial position at 30 April 2016
Step $
Assets
Non-current assets 1 250
Current assets
Inventory 4 45
Trade receivables 5 73
Cash and cash equivalents 6 35
3 153
171
Total assets 7 403
Capital and liabilities
Capital 12 362
Profit for the year 11 135
Less: drawings 10 125
9 352
Current liabilities
Trade payables 2 51
Total capital and liabilities 8 403

b
Ratio Techno Hub Zenapod
Inventory turnover 12 times 10 times
Gross margin 40% 45%
Profit margin 18% 20%
Non-current asset turnover 3 times 3½ times
Trade receivables turnover 36 days 30 days
Trade payables turnover 40 days 28 days

Evaluation of performance:
Techno Hub has a better inventory turnover than Zenapod which shows good
management of inventory. Not too much is held at any one time.
The gross margin of Techno Hub is worse than Zenapod, which means that they are either
not marking up their goods as much or buying from a more expensive supplier.
Cambridge International AS and A Level Accounting

The business could improve its margin by increasing the mark-up, or if this would result in
a loss of sales, then try to find a cheaper supplier.
The profit margin of Techno Hub is worse than Zenapod. This could be partly due to
the poorer gross margin. However, it also means that Techno Hub is not controlling its
expenses as well as the rest of the industry. This is an area which needs improvement,
perhaps by trying to reduce cost through cost savings.
Zenapod has better utilisation of its non-current assets than Techno Hub as it generates
more revenue per $ of non-current assets. This may be due to Techno Hub having
purchased new non-current assets which have yet to generate better sales.
The trade receivables turnover is worse than Zenapod. This means that Techno Hub needs
to improve its credit control. However, Techno Hub is holding on to its cash for longer by not
paying its suppliers as fast as Zenapod. This is acceptable, provided that it does not result in
damaging supplier relationships. Techno Hub has a high bank balance. It could perhaps try
to negotiate better prices with its suppliers. This will help improve the gross margin.
c i Return on capital employed.
ii 
This measures how much profit is earned by every dollar of capital invested in the
firm. Capital invested here means not only owner’s capital, but also any non-current
liabilities such as long-term loans or debentures.
3 a
Oitar plc
Calculation of ratios
Ratio Calculation Answer
i Interest cover $1 000 ÷ 250 4 times
ii Dividend cover $750 ÷ 470 1.60 times
172 iii Earnings per share $(750) ÷ 550 $1.36 per share
iv Price earnings ratio $30 ÷ $1.36 22
v Dividend yield $(470 ÷ 550) ÷ 30 2.84%
vi Gearing ($250 ÷ 12.5%) ÷ (5 500 + 900 + 2 000) 23.81%

b 
Interest cover is important as it indicates how much of the profit for the year can be paid
out as dividends. It is a measure of risk: the higher the interest cover the better as more
profit is available to pay dividends to the ordinary shareholders.
Dividend cover shows how many times the profit for the year covers the dividend paid to
the shareholders. A high figure means that the company is retaining profits, perhaps for
future expansion and growth, which will help future dividend prospects.
Earnings per share measures how much each ordinary share generates in profit for the
year. The higher the better as it is likely to increase the market price of the shares.
Price earnings ratio measures the confidence that the stock market has in the company.
Again, the higher the better. It means that professional investors are confident of the
future growth in the company. Alternatively, it could mean that professional investors have
been too optimistic and that the share price is overvalued. A potential investor needs to
understand the nature of the underlying business to interpret this ratio.
Dividend yield measures the return on the share. It can be compared with the return which
could be earned by investing the shareholder’s cash in a risk-free investment rather than a
share in the company. Again, the higher the better.
Gearing measures the capital invested in the company on which a fixed and obligatory
return must be paid with the total capital invested in the company, including shareholder’s
funds. It is a measure of risk as the more fixed cost capital there is, the more risky the
investment and the more profits the company has to earn to pay its fixed costs investors
before it can pay dividends to the ordinary shareholders.
Answers to activities, practice exercises and exam practice questions: Chapter 27

c 
The ordinary shareholders would need to see the full set of published accounts produced
by the directors of the company. This would include a statement from the chairman
which would give an indication of possible future performance. The document would also
contain a statement of cash flows, which would allow investors to see how the company
generates funds and spends them. Finally, the accounts would contain an audit report. If
this is unqualified, it is likely to give the shareholders confidence that their analysis is based
on reliable financial information.
4 a i Return on capital employed:
Profit before interest
× 100
Capital employed
(total equity + non-current liabilities)
1 000
× 100 = 10%
(7000 + 3000)
ii
Dividends per share:
Ordinary dividends for the year
Dividends per share =
Number of ordinary shares isssued
In this example we know that the company has already paid an interim dividend of
$0.02 per share. We know that the proposed final dividend will be a total of $300 000.
This means that each shareholder will receive:
$300000
= $0.05 per share
6000000
So the total dividend per share for the year is $0.02 + $0.05 = $0.07 per share.
iii
Dividend cover:
Profit attributable to equity holders
Ordinary dividends paiid

The total amount of the interim dividend was $0.02 × 6 000 000 shares = $120 000. 173
So the total dividend paid for the year was $120 000 + $300 000 = $420 000.
This means the dividend cover was:
600000
= 1.43 times
420000
iv
Dividend yield:
Dividend paid per share
× 100
Market price of a share
$0.07
× 100 = 3.5%
$2.00
v Earnings per share:
Profit attributable to equity holders
Number of ordinary shaares issued
600
= $0.10 per share
6000
vi
Price/earnings ratio:
Market price per share
Earnings per share
$2.00
= 20
$0.00
(from the previous question)
Notice here that there is no suffix. The price earnings ratio is usually calculated and
expressed only as a figure.
Cambridge International AS and A Level Accounting

b Solution:
• Gemmaton’s return on capital employed is worse than JAH Limited as it is a lower
percentage.
• However, Gemmaton’s return on equity is better because it is higher.
• Gemmaton’s earnings per share is also better.
• Gemmaton’s gearing is better.
JAH Limited has a large amount of fixed cost capital which is shown by the higher gearing
ratio. Thus, Gemmaton would be a better company to invest in if interest rates increased.
Solution:
• Gemmaton is providing a better dividend per share by $0.03 ($0.07 − $0.04).
• However, JAH has a better dividend cover (2 times compared with 1.43 times).
• Gemmaton has a better dividend yield (3.5% compared with 2%).
• Gemmaton has a higher price earnings ratio.
Overall I would advise Abdul to invest in . . . . . . . . (student answers will vary).
Note: It is perfectly acceptable to advise Abdul either way: to invest or not to invest. All that
needs to be added is a final comment to justify an overall conclusion.
c Benefits of ratio analysis (any two):
• It allows managers to make comparisons between different years and between
different businesses in the same trading sector. However, the businesses should ideally
be of a similar size.

174
• It helps identify where improvements need to be made for the future.
• It allows a trend of performance to be built up over a number of years.
Limitations of ratio analysis (any two):
• To be useful and reliable, ratios must be reasonably accurate. They should be based
on information in accounts and notes to the accounts. Some useful information may
not be disclosed in the accounts and some account headings may not indicate the
contents clearly.
• Information must be timely to be of use. It may not be available until some time after
the end of a company’s financial year.
• Ratios do not explain the cause of the changes in the results but may indicate areas of
concern; further investigation is usually necessary to discover causes of the concern.
• Ratios usually do not recognise seasonal factors in business.

Exam practice questions


Multiple-choice questions
1 D
2 B
3 C
4 D
5 C
6 D
7 B
8 A
Answers to activities, practice exercises and exam practice questions: Chapter 28

28 Costing for materials, labour and overheads


Activities
Activity 1
Fiford Ltd
Inventory of fifolium at 31 October
Oct 1 10 15 22 29
Price ($) 5.00 5.20 5.24 5.28 5.32
Quantity (kg) 100 80 50 70 100
Sales
3 (40)
60
12 (60) (15)
– 65
14 (50)
15
17 (15) (30)
– 20
30 (20) (50) –
31 – 20 100
Value $105.60 $532.00
Total $637.60
175
Activity 2
A. V. Co.
Inventory of digital hammers at 30 June
Date Quantity Price per unit Average price Balance
$ $ $
Jun 1 Balance b/f 200 5.00 5.000 1 000
4 Purchased 100 5.20 520
Balance 300 5.067 1 520
10 Sold (75) (380)
Balance 225 1 140
13 Purchased 100 5.35 535
Balance 325 5.154 1 675
20 Sold (150) (773)
Balance 175 902
26 Purchased 80 5.40 432
Balance 255 5.231 1 334
30 Sold (90) (471)
Balance 165 5.231 863

Activity 3
a Basic pay for the week = 40 hours × $18 = $720.
Note: Basic pay is usually understood to mean the normal pay for normal hours, rather than
the amount that would be paid if all hours worked were paid at the basic rate.
Cambridge International AS and A Level Accounting

b Overtime = 4 hours × $18 × 1½ = $108.


Premium = 108 − (4 hours × $18 = 72) = $36.
c For a basic week, Chan is expected to produce 360 units in 40 hours = 9 units per hour.
For the week ended 31 March, Chan worked 44 hours so should have produced
44 × 9 = 396 units.
He actually made 414 units, so excess production = 414 − 396 = 18 at $5 per unit = $90.
d 414 units should have taken 414 ÷ 9 = 46 hours.
Chan took 44 hours so saved 46 − 44 = 2 hours at $12 = $24.
e Chan’s total gross pay for the week = $(720 + 108 + 90 + 24) = $942.

Activity 4
a
Expense Basis Total Machining Painting Assembly Packing
$000 $000 $000 $000 $000
Indirect labour Actual 125 51 32 28 14
Factory:
Rent Floor area 90 45 18 18 9
Heating and lighting Floor area 70 35 14 14 7
Maintenance Floor area 30 15 6 6 3
Insurance Floor area 20 10 4 4 2
Plant and
machinery:
Depreciation Cost 80 45 20 5 10
176 Repairs Cost 32 18 8 2 4
Insurance Cost 16 9 4 1 2
Total overhead 463 228 106 78 51

Note: Alternatively ‘maintenance’ could have been allocated in proportion to plant and
machinery cost.
b
Expense Basis Total Machining Painting Assembly Packing
$000 $000 $000 $000 $000
Direct Allocation 117 80 20 5 12
materials
Direct labour Allocation 323 136 74 68 45
Overhead Apportioned 463 228 106 78 51
Total cost 903 444 200 151 108

Activity 5
Mixing Bakery Packaging Stores Canteen
$000 $000 $000 $000 $000
Overheads 165.00 124.00 87.00 80.00 90.00
Reapportion stores 54.55 14.54 3.64 (80.00) 7.27
Reapportion canteen 32.42 43.23 21.62 – (97.27)
251.97 181.77 112.26 – –
Answers to activities, practice exercises and exam practice questions: Chapter 28

Activity 6
a No. of direct labour hours required:
First: 5 000 × 1.3 = 6 500
Second: 7 000 × 0.7 = 4 900
 11 400
$129276
OAR = == $$11.34
7250 per hour.
11400
i OAR per unit: First: $11.34 × 1.3 = $14.742 per unit.
ii OAR per unit: Second: $11.34 × 0.7 = $7.938 per unit.
b Overhead absorbed:
$
Firsts: 5 000 × $14.742 73 710
Seconds: 7 000 × $7.938 55 566
Total overhead 129 276

Activity 7
a Total number of machine hours in a 13 week period = 10 × 7 × 6 × 13 = 5 460.
$141960
Machine hour OAR = = $26
5 460
5 460
b Each unit requires machine hours to make = 4.55 machine hours.
1 200
Therefore each unit absorbs $26 × 4.55, or $118.30 overhead.
(Proof: $118.30 × 1 200 = $141 960.)

Activity 8 177

a OARs
$301875
Moulding: Direct labour hourly rate = $8.75
34500
$115200
Machining: Machine hourly rate = $6.40
18000
$47250
Paint shop: Direct labour hourly rate = $5.25
9000
b Overhead absorbed per unit:
Sovrin Ginny
$ $
Moulding (4 × $8.75) 35.00 (3½ × $8.75) 30.625
Machining (2 × $6.40) 12.80 (2 × $6.40) 12.800
Paint shop (1 × $5.25) 5.25 (1 × $5.25) 5.250
53.05 48.675

c Total overhead recovery:



Sovrin Ginny Total
$ $ $
Moulding (6 000 × $35.00) 210 000 (3 000 × $30.625) 91 875 301 875
Machining (6 000 × $12.80) 76 800 (3 000 × $12.800) 38 400 115 200
Paint shop (6 000 × $5.25) 31 500 (3 000 × $5.250) 15 750 47 250
318 300 146 025 464 325
Cambridge International AS and A Level Accounting

d Total cost per unit:


Sovrin Ginny
$ $
Direct material 102.00 85.000
Direct labour 190.00 151.000
Overhead 53.05 48.675
345.05 284.675
e Selling prices are therefore: Sovrin $690.10 and Ginny $569.35.

Activity 9
Upandown Limited
Three months Three months Three months Three months
to 31 March to 30 June to 30 September to 31 December
$ $ $ $
OAR 124 128 130 131
Overhead recovered 111 600 134 400 143 000 128 380
Actual overhead 128 000 125 000 129 500 132 800
(Under-)/over-recovery (16 400) 9 400 13 500 (4 420)

Practice exercises
1 a 
Overhead expenses in relation to costing are costs which the business incurs when making
the product (or service), but which cannot be directly traced to the units of production.
178
b i 
Overhead allocation refers to overheads which can be identified with specific cost
centres, for example packing materials for the packing department or oil for the
machine shop.
ii 
Certain overheads cannot be traced directly to a cost centre, for example rent of the
whole factory. Such overheads are apportioned (split) between cost centres on a
suitable basis, such as floor space for rent.
c i 
Once overheads have been apportioned to cost centres, the next step is to calculate
an overhead absorption rate. These rates are then used to calculate the amount of
overhead to be attributed or charged to each cost unit in each cost centre.
ii 
Under-absorption of overheads occurs when the actual expenditure on overheads is
more than the budgeted amount, and/or production is less than the planned level.
iii 
Over-absorption occurs when the actual expenditure on overheads is less than the
budgeted amount, and/or when actual production is more than the planned level.
d 
A company may recover more in overheads than the amount spent in the period when
the actual expenditure on overheads is less than the budgeted amount, and/or when
actual production is more than the planned level. This can occur because of such things
as receipt of a new order from a customer in excess of the orders planned, when invoiced
costs were lower than expected or when planned overhead work was not carried out.
e 
Estimated figures are used to calculate an overhead absorption rate because the rate has
to be calculated in advance of production. For this reason budgeted costs are used. This
allows the managers of the business to work out prices in advance, or if a special order is
received then to work out a price to charge the customer. This would be impossible to do
after the event.
Answers to activities, practice exercises and exam practice questions: Chapter 28

2 Three ways in which labour can be remunerated are:


• hourly rate, usually regarded as a direct cost because it is paid to production workers
• piece rate, likewise regarded as a direct cost as it is usually paid to production workers in
direct proportion to their output in units
• annual salary, regarded as an indirect cost, because this is the normal basis of
remuneration for administrative and management staff.
3 Two ways an employee can earn a bonus for work carried out (if her contract includes such an
arrangement):
• by producing more in the time available than the amount of production set down by
management
• as a percentage on the amount sold (e.g. commission for a salesperson).
4 a Arthur’s basic pay for the week = 44 hours + 4 hours for Saturday = 48 hours × $20 = $960.
Alternatively: 40 × $20 = $800.
b Overtime work = 4 hours at time and a half = 6 hours. 4 hours at double time = 8 hours.
6 hours at $20 (= $120) + 8 hours × $20 (= 160) = $280. Of this, 2 of the 6 hours and 4 of the
8 hours are overtime premium = 6 hours × $20 = $120.
Alternatively: Overtime = 4 × $30 + 4 × $40 = $280. Premium = 4 × $10 + 4 × $20 = $120.

c For a 40 hour week Arthur was expected to produce 480 units = 12 per hour.
He worked 48 hours so should have produced 48 × 12 = 576 units.
He actually produced 600 units, so he made 600 − 576 = 24 extra units.
For this he would be paid 24 × $3 = $72.
d The 600 units should have taken 600 ÷ 12 = 50 hours, so he saved 50 − 48 = 2 hours. 179
For this he is paid 2 × $10 = $20.
e Arthur’s gross pay for the week was:
$960 + 120 + 72 + 20 = $1 172.
Alternatively : $800 + 280 = 72 + 20 = $1 172.

Exam practice questions


Multiple-choice questions
1 C
2 B
3 B
4 D
5 A
6 D
7 D

Structured questions
1 a i  A cost centre is a location, usually a department within a business, to which costs can
be charged. It may also be a person (e.g. a salesperson) or an item of equipment.
ii A cost unit is a unit of production, for example a computer or a dress.
Cambridge International AS and A Level Accounting

b Overhead cost Total Moulding Sanding Painting Maintenance Canteen


$ $ $ $ $ $
Administration 104 000 20 000 25 000 20 000 20 000 19 000
Electricity 70 000 28 000 32 000 3 000 3 800 3 200
Depreciation 50 000 16 200 17 500 4 000 8 000 4 300
Indirect wages 78 565 6 000 11 250 6 375 36 190 18 750
Rent 80 500 21 875 16 625 17 500 14 000 10 500
Total 383 065 92 075 102 375 50 875 81 990 55 750
Reapportionment 13 118 16 396 13 118 13 118 (55 750)
of canteen costs

Reallocation of 37 152 28 235 29 721 (95 108)


maintenance
costs
Total costs of 142 345 147 006 93 714
production cost
centres

c Moulding = $142 345 ÷ 8 000 = $17.79 per labour hour.


Sanding = $147 006 ÷ 8 650 = $16.99 per machine hour.
Painting = $93 714 ÷ 7 500 = $12.50 per direct labour hour.
Note: Part c has been answered using the additional information.
d
180 Cost Calculation Amount
$
Direct material 50.00
Direct labour:
Moulding 1 × $8 8.00
Sanding 1.5 × $6 9.00
Painting 2.5 × $10 25.00
92.00
Factory overheads:
Moulding 1 × $17.79 17.79
Sanding 2 × $16.99 33.98
Painting 2.5 × $12.50 31.25
Factory cost 175.02
Add: required profit 116.68
Selling price $175.02 ÷ 60% 291.70

(Proof: $116.68 ÷ 291.70 × 100 = 40%, the required margin.)


e 
The directors should not change to a factory-wide overhead absorption rate. The painting
cost centre is labour intensive, whilst the other two cost centres are machine intensive.
The overhead absorption rate used should reflect most closely what happens in the cost
centre. If a factory-wide rate is used then will it be based on direct labour hours or machine
hours? Whichever is chosen will not reflect what goes on in all the cost centres.
Answers to activities, practice exercises and exam practice questions: Chapter 28

2 a Expense Basis of Total Machining Assembly Maintenance Power


apportionment house
$000 $000 $000 $000 $000
Indirect Given 1 064 298 482 132 152
materials
Indirect Given 2 578 706 918 282 672
labour
Rent & taxes Floor area 1 426 465 775 155 31
Supervision Indirect labour 660 176 352 88 44
Plant Plant value 1 650 975 375 180 120
depreciation
Total 7 378 2 620 2 902 837 1 019
allocated

b Expense Basis of Total Machining Assembly Maintenance Power


apportionment house
$000 $000 $000 $000 $000
Total 7 378 2 620 2 902 837 1 019
allocated
Reallocation Units of power 713 204 102 (1 019)
of power
house
Reallocation of Maintenance 704 235 (939) -
181
maintenance hours
Final total for 7 378 4 037 3 341 -
production
areas

c The overhead absorption rates are, therefore:


Machining Assembly
Overheads allocated $4 037 000 $3 341 000
Hours 11 080 4 800
Absorption rate $364.35 $696.04
per machine hour per direct labour hour
d 
Certain costs can be attributed directly to cost centres, for example indirect labour costs
of workers within a particular cost centre. These costs are therefore allocated directly to
the cost centre in which they occur.
Other costs though cover a number of cost centres, for example rent of a factory. These
costs have to be split across cost centres using a pre-determined basis, for example the
floor space of each cost centre can be used when splitting rent. This process of splitting
overheads on a pre-determined basis is known as apportionment.
e 
Over-absorption of overheads occurs when production passing through a cost centre is
charged with more budgeted overhead than the cost centre actually incurs.
Cambridge International AS and A Level Accounting

f
Machining Assembly
Actual hours (A) 12 000 4 600
Budgeted absorption rate (B) $364.35 $696.04
Overheads absorbed (A × B) $4 372 200 $3 201 784
Actual overheads $4 100 000 $3 300 000
$272 000 $98 216
over-absorbed under-absorbed
g $9 500 × 1.30 = $12 350, ÷ 100 = $123.50 per unit.
h 
A s there is spare capacity, the directors should consider making the special order. To do so
will increase the utilisation of the factory. It will mean that the fixed costs are spread over a
greater number of units produced. This will reduce the overall cost per unit of the product.
In order to make a final decision the directors need to identify the variable and fixed costs
associated with the order. If the selling price offered results in a positive contribution, then
the order should be accepted. If not then it should be rejected.

182
Answers to activities, practice exercises and exam practice questions: Chapter 29

29 Unit, job and batch costing


Activities
Activity 1
$
Direct materials 398 000
Direct labour 996 000
Overheads 1 687 250
3 081 250

$3081250
Cost per cost unit of 1 000 packets = = $7250
425

Activity 2
Two actions the directors could take in future to improve profit:
• look for a cheaper supplier of materials
• look for faster ways of working
• look for cheaper staff
• review the make-up of the overheads to see if any costs can be saved.

Activity 3
a
$
Labour: Geoffrey (200 × $100) 20 000
Susan (100 × $60) 6 000
183
Overhead recovery (300 × $40) 12 000
Amount to charge 38 000

b Geoffrey has certain things to consider when deciding whether or not to accept the work for
$30 000:
• How much work does he currently have? If he accepts the offer he will cover the two direct
cost figures of wages. If it is his only possible work then it must be accepted.
• The difference will also contribute $4 000 towards covering his overheads. If he has no
other work this is important.
• What exactly is included in the overheads figure? If all of it is fixed, then the $4 000 will help
towards covering that. However, if any is variable, then the amount of fixed overheads the
$4 000 contributes towards will be reduced.
Overall, provided the contribution is positive then Geoffrey should accept the work.

Activity 4
No. of rolls = 6 000 (1 000 × 6)
No. of labour hours = 10 (6 000/[100 × 6])
a
$
Raw materials (6 000 × $0.08) 480.00
Labour (10 × $6) 60.00
Setting up machinery 30.00
Labour hour overhead recovery 93.50
663.50

b Cost of one roll: 663.50/6 000 = $0.1 106


Cambridge International AS and A Level Accounting

Practice exercises
1 a Dept A: $36 000 ÷ 24 000 = $1.50
Dept B: $26 000 ÷ 20 000 = $1.30
Dept C: $24 000 ÷ 8 000 = $3.00
All overheads are per direct labour hour.
b Monthly production units: 4 000
$ $
Direct material ($8 × 4 000) 32 000
Direct labour:
Dept A (4 000 × [1½ × $8.75]) 52 500
Dept B (4 000 × [1 × $8.75]) 35 000
Dept C (4 000 × [½ × $8.75]) 17 500 105 000
Factory overhead:
Dept A (4 000 × 1½ × [$36 000 ÷ 24 000]) 9 000
Dept B (4 000 × 1 × [$26 000 ÷ 20 000]) 5 200
Dept C (4 000 × ½ × [$24 000 ÷ 8 000]) 6 000 20 200
Production cost for one month’s production of Super Burling 157 200
2 a Overhead recovery is the term given to the amount of total overhead for a cost centre which
is charged to the total production going through that cost centre in a period. The calculation
is based on the overhead absorption rate multiplied by the actual amount worked.
For example, suppose the budgeted total overhead for a cost centre is $5 000 and the
budgeted overhead rate is $2 per direct labour hour. If 2 400 direct labour hours are worked
184
in a period then the amount of overhead recovered will be 2 400 × $2 = $4 800.
b Printing: $127 400 ÷ 3 640 = $35 per direct labour hour.
Marketing and promotion: $267 540 ÷ 6 370 = $42 per direct labour hour.
c
$ $
Direct material:
Printing 1 300
Marketing and promotion 1 600 2 900
Direct labour:
Printing (120 × $8) 960
Marketing and promotion (300 × $12) 3 600 4 560
Overhead:
Printing (120 × [$127 400 ÷ 3 640]) 4 200
Marketing and promotion (300 × [$267 540 ÷ 6 370]) 12 600 16 800
Total cost 24 260
Add: required profit ($24 260 × 40%) 9 704
Price to charge clients 33 964

d 
If the price of $25 000 is accepted, then it will only just cover the total calculated cost of
$24 260. It depends on how much work Successful Promotions Limited has. If they have
no other work then it should be accepted as it does at least cover the costs. If they don’t
have any work then the company may have to consider making staff redundant. This could
have a negative effect on their image. They may also have to cancel some deliveries from
suppliers, which again may have a negative impact on relationships with their suppliers.
Clearly, if they do want to accept the quote and make some profit then they have to look
for cost savings. In doing so, the savings can only be made from costs over which the
Answers to activities, practice exercises and exam practice questions: Chapter 29

directors have control. This is likely to be the labour cost. They could try to cut down the
time taken, without harming the quality of the work. If possible they may try to negotiate a
discount for the materials with their suppliers, although this may be difficult.
The other aspect is if they accept the work at the lower price then they may be forced to do
this again in the future. If their other customers find out about the deal they too may try to
get a lower price. This could have a damaging effect on future profits.
Successful Promotions Limited should try to negotiate a better price, before accepting the
work.
e Overheads recovered = 3 750 × $35 = 131 250
Less: actual overheads   130 000
Over-absorption  1 250
f 
The over-absorption may lead to an increase in profits, as the fixed costs are now spread
across probably a greater number of units.
Note: Strictly speaking costing and overhead absorption are ways only of classifying costs,
they do not directly change the overall profit of a company. However, if the overhead recovery
rate was slightly higher than necessary, the implication could be that the selling price was
also set slightly higher (if it was based on a target mark-up) and therefore this ‘extra’ sales
income would have increased profit.
3 a 
A production cost centre is an area within the factory where production actually takes
place. A service cost centre is one which provides a service of some sort to all the
production cost centres, for example a canteen or maintenance department.
b 
When calculating an overhead absorption rate it is essential that all the costs of running
the factory are included. If the service cost centre costs are not reapportioned to the
production cost centres then an element of cost will not be charged to the product. This
may result in the selling price being too low to cover all the company’s costs and perhaps 185

not generate any profit at all.


c Moulding: $21 840 ÷ 7 280 = $3 per machine hour
375 ÷ 4 550 = $2.50 per direct labour hour
Lining: $11 
368 ÷ 1 820 = $2.40 per direct labour hour
Finishing: $4 
d Production (units): 2 000 pairs
$ $
Direct material:
Moulding ($2 × 2 000) 4 000
Lining ($3 × 2 000) 6 000 10 000
Direct labour:
Moulding ($7 × [0.25 × 2 000]) 3 500
Lining ($6 × [0.5 × 2 000]) 6 000
Finishing ($6 × [0.25 × 2 000]) 3 000 12 500
Factory overhead:
Moulding (0.5 × 2 000 × [$21 840 ÷ 7 280]) 3 000
Lining (0.5 × 2 000 × [$11 375 ÷ 4 550]) 2 500
Finishing (0.25 × 2 000 × [$4 368 ÷ 1 820]) 1 200 6 700
Total cost of 2 000 pairs of children’s boots 29 200

e Cost of one pair of boots:


200 ÷ 2 000 = $14.60.
$29 
Cambridge International AS and A Level Accounting

f 
The directors should not change to a factory-wide overhead absorption rate. The lining
and finishing cost centres are labour intensive, whilst moulding is machine intensive.
The overhead absorption rate used should reflect what happens in the cost centre. If a
factory-wide rate is used then will it be based on direct labour hours or machine hours?
Whichever is chosen will not reflect what goes on in all the cost centres.

Exam practice questions


Multiple-choice questions
1 B
2 A

186
Answers to activities, practice exercises and exam practice questions: Chapter 30

30 Marginal costing
Activities
Activity 1
a Contribution from 1 unit = $146 250 ÷ 3 000 = $48.75
Contribution from 3 000 units = $(48.75 × 3 000) = $146 250
Profit from 3 000 units = $(146 250 – 82 000) = $64 250
b Contribution from 4 000 units = $(48.75 × 4 000) = $195 000
Profit from 4 000 units = $(195 000 − 82 000) = $113 000
c Contribution from 1 200 units = $(48.75 × 1 200) = $58 500
Loss from 1 200 units = $(82 000 − 58 500) = $23 500

Activity 2
a i Contribution per unit = $(95 − 65) = $30
$7500
Break-even point = = 2 500 units;
$30
$75000
Break-even revenue = = $237 500
0.31579
500 × $95 = $237 500)
(or 2 
2500
ii Margin of safety = × 100 = 50%
5000
b $000

475
450 Total revenue
400 Total costs 187
350
Break even
300
250
237.5
200
150
100 Fixed costs
50
0
2500

Break-even chart for product Q

Activity 3
No. of phones a 10 000 b 15 000 c 20 000
$ $ $
Contribution $(50–41) 90 000 $(48–41) 105 000 $(42–41) 20 000
Fixed overheads 70 000 70 000  70 000
Profit/(loss) 20 000 35 000 (50 000)

Activity 4
Marginal cost per 1 000 cans of fruit: $14 250
a Additional contribution from order for 5 000 cans at $16 000 per 1 000 cans:
5 × $(16 000 − 14 250) = $8 750 profit
The order should be accepted.
b Loss if order for 3 000 cans at $14 100 is accepted:
3 × $(14 100 − 14 250) = $450 loss
The order should not be accepted unless it will prevent the company from having to lay off
valuable skilled staff because of a temporary slump in trade.
Cambridge International AS and A Level Accounting

Activity 5
Present position (tools produced by Canterbury Planes Limited):
$
Selling price per tool 16.00
Direct costs: material 3.00
Labour 2.50
Other expenses   1.00
Marginal cost of production 6.50
Variable selling expenses   2.00
Marginal cost of sales   8.50
Contribution   7.50

Contribution from sale of 15 000 tools = $112 500


Profit on sale of 15 000 tools = $(112 500 − 74 000) = $38 500
$74 000
Break-even point: = 9 867 tools
$7.50

a i North Island Tool Co.:


Cost per tool $6. This is $0.50 less than the present cost of production.
Effect on profit: Increase by (15 000 × $0.50) = $7 500 to $46 000.
$74 000
Effect on break-even point: = 9 250 tools.
$8
ii South Island Tool Co.:
188
Cost per tool $6.80. This is $0.30 more than the present cost of production.
Effect on profit: Decrease by (15 000 × $0.30) = $4 500 to $34 000.
$74 000
Effect on break-even point: = 10 278 tools.
$7.20
b Tools should be purchased from North Island Tool Co. because:
• the cost will be $0.50 less than the cost of production
• profit will increase by $7 500 to $46 000
• the break-even point will be reduced from 9 867 tools to 9 250 tools.
Tools should not be purchased from South Island Tool Co. because:
• the cost will be $0.30 more than the cost of production
• profit will decrease by $4 500 to $34 000
• the break-even point will increase from 9 867 tools to 10 278.

Activity 6
Gimie Gros Petit
Per unit $ $ $
Selling price 14 25.00 20
Direct material 5 6.50 8
Direct labour 5 14.00  6
Marginal cost 10 20.50 14
Contribution 4  4.50  6
Contribution per litre of material 1.6 1.38 1.5
Ranking 1 3 2

188
Answers to activities, practice exercises and exam practice questions: Chapter 30

Castries Limited
Revised production budget to maximise profit from available materials
Units Litres Contribution
$
Gimie (maximum) 1 000 2 500 4 000
Petit (maximum) 800 3 200 4 800
Gros (4 875 / 3.25) 1 500   4 875  6 750
10 575 15 550
Less: fixed expenses 10 000
Profit  5 550

Activity 7
Gimie Gros Petit
$ $ $
Contribution 4 4.50 6
Contribution per direct labour hour 8 3.21 10
Ranking 2 3 1

Castries Limited
Revised production budget to maximise profit from available direct labour hours
Units Labour hours Contribution 189
$
Petit 800 480 4 800.00
Gimie 1 000 500 4 000.00
Gros 1 725 2 415 7 762.50

3 395 16 562.50
Less: fixed expenses 10 000.00
Profit 6 562.50

Activity 8
a Market Limited
Per unit Product A Product B Product C
$ $ $
Material 20 40 50
Labour   36 60 72
Marginal cost 56 100 122
Selling price 80 130 150
Contribution per unit 24 30 28
Total budgeted contribution    24 000 60 000 112 000
Total contribution 196 000
Less: fixed expenses  115 000
Profit     81 000

189
Cambridge International AS and A Level Accounting

b
Market Limited
Revised production budget
Contribution Units Materials Total
A 12.0 1 000 2 000 24 000
B 7.5 2 000 8 000 60 000
C 5.6 3 600 18 000 100 800
28 000 184 800
Less: fixed expenses 115 000
Profit   69 800

c Reconciliation of profit per revised budget with profit in original budget:


$ $
Profit per original budget 81 000
Budgeted production of C (units) 4 000
Revised budget for C 3 600
Reduction in production 400
Loss of contributions 400 × 28 11 200
Revised profit 69 800

Activity 9
a Fixed costs increase by $12 000 and profit is reduced to $23 000.
$92000
190 Break-even = = 16 000 units
$5.75*
* Contribution = $(8.75 − 3)
b Variable costs increase by $9 000 and profit is reduced to $26 000.
$80000
Break-even = = 15 095 units
$5.30 *
* Contribution = $(8.75 − 3.45)
c Costs and revenue increase by $21 000 and profit is maintained at $35 000.
Break-even = $92000 = 14 489 units.
$6.35 *
Costs have increased by $21 000; revenue becomes $196 000 ($9.80 per unit).
*Unit marginal cost is $3.45; contribution = $(9.80 − 3.45) = $6.35

Activity 10
a
Monthly profit using marginal costing
Month 1 Month 2
$ $
Revenue 50 000 65 000
Less: variable costs 30 000 39 000
Less: fixed costs 15 000 15 000
Monthly profit 5 000 11 000
Answers to activities, practice exercises and exam practice questions: Chapter 30

b
Monthly profit using full absorption costing
Month 1 Month 2
$ $
Revenue 50 000 65 000
Opening inventory – 20 000
Cost of production:
Variable costs: 1 500 units x $30 45 000 45 000
Fixed costs 15 000 15 000
60 000 80 000
Less: closing inventory (20 000) (28 000)
Cost of sales 40 000 52 000
Monthly profit 10 000 13 000

Notes:
1 Closing inventory is valued at $40 per unit ($60 000 ÷ 1 500 = $40).
2 Closing inventory at the end of month 1 is 500 units (1 500 – 1 000). At the end of month 2
the closing inventory is (500 + 1 500 – 1 300) = 700 units.
c
Reconciliation of profit using each method
Month 1 Month 2
$ $
Profit using marginal costing 5 000 11 000
191
Add: fixed overheads in closing inventory 5 000 7 000
Less: fixed overheads in opening inventory – (5 000)
Profit using full absorption costing 10 000 13 000

Note:
The fixed overheads included in the closing inventory is $15 000 ÷ 1 500 = $10 per unit. The
total overheads included in the closing inventory at the end of each month, therefore, are: in
month 1: 500 units × $10 = $5 000; and in month 2: 700 units × $10 = $7 000.

Practice exercises
1 Working:
Cost of each order on each machine:
X – 123/P X – 382/Q Y – 123/P Y – 382/Q
$ $ $ $
Direct material (material cost 4 000.00 5 000.00 3 680.00 4 600.00
per unit × number of units)
Direct labour (hourly rate × 200.00 250.00 150.00 200.00
number of operatives × hours)
Variable overhead per order 2.40 2.40 2.60 2.60
Total variable cost 4 202.40 5 257.40 3 742.60 4 802.60
Fixed costs per order 200.00 200.00 500.00 500.00
Total cost 4 402.40 5 457.40 4 242.60 5 502.60
Required profit + 25% 1 050.60 1 060.65
Cambridge International AS and A Level Accounting

a i 123/P order is more cheaply done on machine Y.


ii 382/Q order is more cheaply completed on machine X.
b
Machine X Machine Y
$ $
Selling price (cost plus profit from above) 5 453.00 5 303.25
Variable cost 4 202.40 3 742.60
Contribution = SP – VC 1 250.60 1 560.65
c • Rights issue:
Advantage: shares offered to existing shareholders, therefore no loss of control.
Disadvantage: not all the rights may be taken up by existing shareholders, therefore all
the money may not be raised. (They may not have sufficient spare funds to invest.)
• Issue of shares to the public:
Advantage: all the money should be received.
Disadvantage: will result in reduced extent of control of the company by the present
owners / majority shareholders
• Issue of debentures:
Advantage: all the money should be received.
Disadvantage: lenders may require security for the debt from the company and the
company has a fixed commitment to repay both the capital and interest.
2 a i 15 000 units:
Per unit $
192
Direct material (4 × $4.10) 16.40
1 4.00
Direct labour ( × $12)
3
Variable overhead  1.80
Marginal cost 22.20
Selling price 25.00
Contribution  2.80

Profit: $(15 000 × 2.8) − $30 000* = $(42 000 − 30 000) = $12 000.


*($1.5 × 20 000 = $30 000)
ii 18 000 units:
Per unit $
Material 16.40
Labour 4.00
Variable overhead 1.79
Marginal cost 22.19
Selling price 25.00
Contribution 2.81

Profit = (18 000 × $2.81) – $30 000 = $50 600 (rounded) – $30 000 = $20 600.


*(16 000 × $1.8 + 2 000 × $1.7) = 18 000
Answers to activities, practice exercises and exam practice questions: Chapter 30

b Fixed costs are (full production) 20 000 × $1.50 = $30 000.


Contribution per unit (up to 16 000 units from i, above) = 2.80.
Contribution from 16 000 units = $44 800. This is in excess of break-even, so no need to
consider production when semi-variable costs change.
Break-even point = fixed costs / contribution per unit – 30 000 / 2.80 = 10 715 units.
c 20 000 units sold at $24 per unit:
$ $ $
Revenue 480 000
Material (20 000 × $16.40) 328 000
Labour (20 000 × $4) 80 000
Variable overhead
16 000 × $1.80 28 800
4 000 × $1.70 6 800 35 600 443 600
Contribution 36 400
Less: fixed overheads 30 000
Profit 6 400

d A selling price may be lowered with advantage to:


• increase demand for the good
• undercut the prices of competitors
• maintain full production
• sell slow-moving inventory
193
• introduce a new product.
Possible disadvantages are:
• the start of a price war with competitors
• fixed overheads may not be covered
• the product may be sold below the cost of production if the marginal cost is not known.
The price of $24 earns a positive contribution, so could be accepted if there is no other
work available and maximum sales are assured. However the calculations show that the
company makes more profit at lower volumes of sales if it is able to maintain the selling
price at the original level.
e The following assumptions are made when break-even charts are prepared (any three):
• Fixed costs remain fixed at all levels of activity, but costs are only fixed within certain
limits of activity and are more likely to be ‘stepped’ as activity increases.
• All costs may be classified as either fixed or variable. But many costs cannot easily be
classed as fixed or variable.
• Variable costs vary directly with the output in units. But variable costs may decrease
with the level of activity because quantity discounts are received on purchases of
materials, or labour costs increase because overtime has to be paid to workers to
achieve the level of activity.
• Revenue will increase proportionately to the volume of sales. But it may be necessary
to discount prices to achieve the desired volume of sales.
• All the resources required for production will be available. But there may be limiting
factors affecting materials, labour or demand for the product.
Cambridge International AS and A Level Accounting

Exam practice questions


Multiple-choice questions
1 C
2 D
3 D
4 D

Structured questions
1 a i  A variable cost is one which can be attributed directly to the unit of production. It
increases in direct proportion to changes in the level of activity.
ii A fixed cost is one which does not change as production increases or decreases within
a certain range.
iii A semi-variable cost is one which contains both a fixed and variable element.
b Calculation of break-even point in units and value:
Calculation Per unit
$
Revenue $80 000 ÷ 4 000 20
Direct material $32 000 ÷ 4 000 8
Direct labour $12 000 ÷ 4 000 3
Semi-variable cost (W1) 2
Total variable cost 13
Contribution 7
194
Break-even point calculation
Total fixed costs $(10 000 + 6 000) ÷ 7 = 2 286 units
Break-even point = 2 286 × $20 = $45 720
W1:

Units Value
$
6 000 18 000
4 000 14 000
Change 2 000 4 000

Variable element = $4 000 ÷ 2 000 = $2


Fixed element = $18 000 – (6 000 × $2) = $6 000
c Margin of safety = 6 000 units – 2 286 units = 3 714
d To make a profit of $40 000:
Total required = fixed costs $16 000 + required profit $40 000 = $56 000 ÷ 7 = 8 000 units
e Although the company has spare capacity and is able to produce the extra units, should
it do so? By producing them it may avoid having to make staff redundant or cut down
on deliveries from suppliers, both of which may have a negative effect on the image of
the company. If it does increase production then it may not be able to sell the extra, or
sell it at the full price. If it fails to sell the extra then it will have surplus inventory which
may deteriorate and have to be scrapped at a cost to the company, both of the original
production and scrapping. If it has to reduce the selling price to get rid of the extra then
Answers to activities, practice exercises and exam practice questions: Chapter 30

existing customers who are paying full price may find out. They will also ask for a lower
price or may even change suppliers.
However, if management can work through these possible difficulties then it may be
possible to produce and sell the extra production. In essence, the management needs to
be confident that it can obtain a positive contribution from the additional sales without
there being any negative effect on future selling prices.
f (Assuming the current budgeted output is 6 000 units.)
Option 1:
Additional fixed costs = $9 800
Additional contribution = 1 200 units × $7 = $8 400
Cost to company = $(9 800 – 8 400) = $1 400
Option 2:
Contribution on 8 750 units = 8 750 × $(7-2) = $43 750
Contribution on 6 000 units = 6 000 × $7 = $42 000
On the basis of these calculations the company should choose option 2. Doing so will
increase the total contribution and, assuming that there is no increase in fixed costs, then
it will also increase the overall profit. With option 1, the cost of advertising is greater than
the extra contribution earned and should not be considered.
2 a A limiting factor is something which stops a company making its budgeted production. It
may be a shortage of material or labour, space or cash. Once it has been identified then
any budget should be constructed taking the limiting factor into account.
b
Exe Wye Zed
Material per unit (kg) 2 3 4 195
Total budgeted output 5 000 4 000 2 000
Total kg per product 10 000 12 000 8 000 = 30 000 kg
c
Exe Wye Zed Total
Budgeted sales (units) 5 000 4 000 2 000
Contribution per unit ($) 13 12 14
Total contribution ($) 65 000 48 000 28 000 141 000
Budgeted fixed costs ($) 82 000
Budgeted profit ($) 59 000

d
Exe Wye Zed
Contribution per kg ($) 6.50 4.00 3.50
Order of production 1 2 3
i If 2 000 of each unit is made:
Total Exe Wye Zed
Kgs 18 000 4 000 6 000 8 000
Available 6 000 6 000 - -
24 000 10 000 6 000 8 000
Contribution per kg ($) 6.50 4.00 3.50
Total contribution ($) 117 000 65 000 24 000 28 000
Fixed costs ($) 82 000
Profit ($) 35 000
Cambridge International AS and A Level Accounting

ii Make as much as possible in most profitable order if no minimum production requirement


of any product is put in place:
Total Exe Wye Zed
Output 5 000 4 000 500
Total kgs 24 000 10 000 12 000 2 000
Contribution per kg ($) 6.50 4.00 3.50
Total contribution ($) 120 000 65 000 48 000 7 000
Fixed costs ($) 82 000
Profit ($) 38 000

e There is very little difference in budgeted total profit between the two options (because Wye
and Zed make similar levels of contribution). Purely on financial grounds option ii should be
chosen as it makes the most profit. However, this will result in only 500 units of Zed being
made. Option i means that all of Zed and Exe will be made, but less Wye. This may affect the
decision when taking into account customer requirements. If by choosing option i they make
customers for Wye unhappy, then option ii should be chosen. If by choosing option ii they
make customers of Zed unhappy then option i should be chosen.

196
Answers to activities, practice exercises and exam practice questions: Chapter 31

31 Activity-based costing (ABC)


Activities
Activity 1
a Budgeted overhead absorption rate using direct labour hours:
Total storage costs $60000
= $2.40
Total direct labour hours 25000
b Amount of storage costs charged to each product using direct labour hours:
Children’s Adult’s
Direct labour hours 10 000 15 000
Storage costs charged $24 000 $36 000
c Storage costs charged when using activity based costing:
Total storage costs $60000
= $12.00
Total rolls of cloth 5000
Amount charged to each product:
Children’s Adult’s
Rolls of cloth 1 000 4 000
Storage costs charged $12 000 $48 000

Activity 2
a Total overheads $216 000 ÷ total direct labour hours (12 000 + 24 000) = $6 per direct
labour hour.
b Tables Chairs 197

$ $
Selling price per unit 200 80
Less:
Direct material and labour 80 30
Factory overhead* 24 12
Profit per unit 96 78

* Factory overhead per unit = 4 × $6 for tables and 2 × $6 for chairs.

Activity 3
a Activity Tables Chairs Total Cost Absorption rate
for cost driver
$ $
Machine 3 500 5 500 9 000 108 000 12
maintenance
Materials handling 500 700 1 200 72 000 60
Packing 700 1 100 1 800 36 000 20
216 000
Cambridge International AS and A Level Accounting

b Allocation of total costs:


Activity Tables Chairs Total
$ $ $
Machine maintenance 42 000 66 000 108 000
Materials handling 30 000 42 000 72 000
Packing 14 000 22 000 36 000
Total cost 86 000 130 000 216 000
Cost per unit (to two decimal places) $86 000 / 3 000 $130 000 / 12 000
(units from Activity 2) units = $28.66 units = $10.83

Activity 4
a Tables b Chairs
$ $
Selling price per unit 200.00 80.00
Less:
Direct materials and labour 80.00 30.00
Factory overhead using ABC
$86 000 ÷ 3 000 28.66
$130 000 ÷ 12 000 10.83
Profit per unit using ABC 91.34 39.17

198 Practice exercises


Total overheads $110 000 ÷ total direct labour hours (14 000 + 13 500) = $4.00 per direct
1 a 
labour hour.
b Pin Qua
$ $
Selling price per unit 500.00 300.00
Less:
Direct material and labour 200.00 80.00
Factory overhead* 20.00 6.00
Profit per unit 280.00 214.00

* Factory overhead per unit = 5 × $4.00 for Pin and 1.5 × $4.00 for Qua.
c Two advantages of ABC:
• links overheads with their cause
• identifies areas where cost savings can be made.
Two disadvantages of ABC:
• time consuming to identify costs drivers and not every cost has a cost driver
• expensive to set up and collect data as often requires specialist staff.
Answers to activities, practice exercises and exam practice questions: Chapter 31

d Allocation of overheads allocated to each product using ABC:



Activity Pin Qua Total Cost Absorption rate for
cost driver
$ $
Machine set up costs 300 100 400 20 000 50.00
Machine maintenance 8 000 2 000 10 000 40 000 4.00
Forklift truck costs 350 150 500 50 000 100.00
110 000

Allocation of total costs:


Activity Pin Qua Total
$ $ $
Machine set up costs 15 000 5 000 20 000
Machine maintenance 32 000 8 000 40 000
Forklift truck costs 35 000 15 000 50 000
82 000 28 000 110 000
Per unit:
Pin ($82 000 ÷ 2 800) 29.29
Qua ($28 000 ÷ 9 000) 3.11
e Profit per product using ABC:
Pin Qua 199
$ $
Selling price per unit 500.00 300.00
Less:
Direct materials and labour 200.00 80.00
Factory overhead using ABC 29.29 3.11
Cost per unit 229.29 83.11
Profit per unit using ABC 270.71 216.89

f
Pin Qua
$ $
Profit using absorption costing 280.00 214.00
Profit using ABC 270.71 216.89
Difference (9.29) 2.89

This is also the difference in overheads per unit under the two methods.
g 
There is very little difference between the two profit per unit figures. On this basis,
therefore, there seems little point in Khalid changing his method of costing. By the same
token, the data may give Khalid some ideas as to which areas to concentrate on in order
to reduce his total costs for that particular activity. Using ABC, Khalid can ask price
and operational questions: Can I reduce the cost of machine set-up? Can I rearrange
production to reduce the frequency of machine set-ups? He can ask himself similar
questions about maintenance costs and time spent, and on fork lift costs and numbers of
movements.
Cambridge International AS and A Level Accounting

In this respect, the analysis by ABC can have some benefit. However, Khalid is recommended
not to change from his present method unless he considers that these advantages will
outweigh the extra time and cost of setting up the system and collecting the data.
2 a
Straight Flared
Per unit $ $
Direct material 13.00 15.00
Direct labour 3.00 3.00
Production overheads* 15.00 20.00
Total cost per unit 31.00 38.00
Add: profit 15.50 19.00
Budgeted selling price 46.50 57.00

* Factory overheads:
Absorption rate = $360 000 ÷ 12 000 = $30 per hour.
Machine hours per unit:
Straight = 4 000 ÷ 8 000 = 0.5. 0.5 hours × $30 = $15.
Flared = 8 000 ÷ 12 000 = 0.67. 0.67 hours × $30 = $20.
b 
Absorption costing charges overheads to products on some predetermined basis, often
reflecting the method of production. In this case, they are charged on the basis of machine
hours, presumably because the manufacturing process is machine intensive.
ABC charges overheads to products on the basis of cost drivers, that is, to key activities
that form part of the production process. This identifies how much of a particular cost the
200 production of the product generates. To do this means all the activities involved in producing
a product have to be identified. The different activities are placed in cost pools. So there may
be cost pools for machine set up costs and machine maintenance costs. It is then necessary
to determine how much of each activity the production of a product takes. The theory is
that if no production of a product takes place then none of that cost will be incurred. In other
words, the production of a product is responsible for the cost being incurred, or the amount of
the cost is driven (cost driver) by the level of production of a particular product.
c i Allocation of total costs:
Activity Straight Flared Total
$ $ $
Machine stet up costs 40 000 56 000 96 000
Machine maintenance 73 333 126 667 200 000
Inspection 25 600 38 400 64 000
Total 138 933 221 067 360 000
Per unit:
Straight ($138 933 ÷ 8 000) $17.37
Flared ($221 067 ÷ 12 000) $18.42
   Budgeted cost per unit:
Straight Flared
$ $
Direct material 13.00 15.00
Direct labour 3.00 3.00
Overheads 17.37 18.42
33.37 36.42
Answers to activities, practice exercises and exam practice questions: Chapter 31

ii
Budgeted selling price:
Straight Flared
$ $
Cost per unit 33.37 36.42
Mark up +50% 16.69 18.21
50.06 54.63

d 
By changing from absorption costing, using machine hours as the basis of absorbing
overheads to ABC, Straight dresses become slightly more expensive and Flared dresses
slightly less expensive to make.
At present, the Straight style is the lower seller of the two in terms of unit sales. If ABC is
used and their price is increased then the number of sales may decrease. By the same
token, if Flared dresses are reduced in price then their sales may increase.
Liz needs to identify by how much the unit sales may change for each style if she changes
the selling price as a result of ABC. It is also worth stating that the difference in cost (and
therefore in budgeted selling price) between each method is very little.
Both methods of costing are approximations, but the purpose of ABC is to try and give
a more complete picture of how costs are incurred and thus enable management to try
to identify potential cost savings, either by reducing costs or by reducing the numbers
of activities (the cost drivers) that occur, for example by better planning. For example,
can either or both production processes be rearranged to reduce the number of times
machines need to be set up?
It is recommended, therefore, that whilst she takes into account the findings of ABC, she
should not change her selling price as a result of it. ABC is more complicated to calculate
201
and there is no guarantee that the allocation of overheads made by it make it any more
accurate.
Cambridge International AS and A Level Accounting

32 Budgeting and budgetary control


Activities
Activity 1

Martha and Florence Limited


Sales budget for six months ending 30 June
January February March April May June
Unit sold 1 000 1 200 1300 1 500 1 700 1 800
Price per unit $20 $20 $20 $22 $22 $22
Revenue $20 000 $24 000 $26 000 $33 000 $37 400 $39 600

Activity 2

Martha and Florence Limited


Production budget for six months ending 30 June
December January February March April May June
Production (following 1 000 1 200 1 300 1 500 1 700 1 800 2 000
month’s sales in units)
Add 10% 100 120 130 150 170 180 200
Monthly production 1 100 1 320 1 430 1 650 1 870 1 980 2 200

Activity 3
a
202
J Limited
Direct labour budget
Jan Feb March
Production (units) 2 200 2 400 2 600
Direct labour (hours) 4 400 4 800 5 200
Direct labour cost ($) 44 000 48 000 52 000
b Direct labour to be included in cash budget:
J Limited
Direct labour budget
Dec Jan Feb March
$ $ $ $
Direct labour cost in month 40 000 44 000 48 000 52 000
Paid in month (80%) 35 200 38 400 41 600
From previous month (20%) 8 000 8 800 9 600
To include in cash budget 43 200 47 200 51 200

Answers to activities, practice exercises and exam practice questions: Chapter 32

Activity 4

Martha and Florence Limited


Purchases budget for the period December to June
November* December January February March April May June
Units of 1 100 1 320 1 430 1 650 1 870 1 980 2 200 2 100
production
Material 2 750 3 300 3 575 4 125 4 675 4 950 5 500 5 250
required
(litres)
Price per $4.10 $4.10 $4.10 $4.10 $4.25 $4.25 $4.25 $4.25
litre
Purchases $11 275 $13 530 $14 658 $16 913 $19 869 $21 038 $23 375 $22 313

*November has been included as part of the answer in order to show the build-up for the
December purchases.

Activity 5

Martha and Florence Limited


Expenditure budget for six months ending 30 June
January February March April May June
$ $ $ $ $ $
Purchases 13 530 14 658 16 913 19 869 21 038 23 375
Wages 4 000 4 000 4 000 4 000 4 000 4 000
Bonus – – 160 240 520 696 203
Electricity – 2 400 – – 1 800 –
Other expenses 6 000 6 000 6 000 6 600 6 600 6 600
Interest on loan – – 500 – – 500
Dividend – – – 4 000 – –
Purchase of machine – – – – 15 000 –
23 530 27 058 27 573 34 709 48 958 35 171

Activity 6
a Workings:

November December January February March April May June


$ $ $ $ $ $ $ $
Revenue 18 000 17 600 20 000 24 000 26 000 33 000 37 400 39 600
Cash sales  9 000  8 800 10 000 12 000 13 000 16 500 18 700 19 800
Credit sales  9 000  8 800 10 000 12 000 13 000 16 500 18 700 19 800
After one month  7 200  7 040  8 000  9 600 10 400 13 200 14 960
Discount    180    176    200    240    260    330    374
Cash after  7 020  6 864  7 800  9 360 10 140 12 870 14 586
one month
After two months  1 800  1 760  2 000  2 400  2 600  3 300
Cambridge International AS and A Level Accounting

Martha and Florence Limited


Trade receivables budget
January February March April May June
$ $ $ $ $ $
Opening balance (1 800 + 8 800) 10 600 11 760 14 000 15 400 19 100 22 000
Credit sales for month 10 000 12 000 13 000 16 500 18 700 19 800
20 600 23 760 27 000 31 900 37 800 41 800
Less: cash received
1 month  6 864  7 800  9 360 10 140 12 870 14 586
Discount    176    200    240    260    330    374
2 months  1 800  1 760  2 000  2 400  2 600  3 300
Closing balance 11 760 14 000 15 400 19 100 22 000 23 540

b Workings:

November December January February March April May June


Purchases 11 275 13 530 14 658 16 913 19 869 21 038 23 375 22 313
Payment 13 530 14 658 16 913 19 869 21 038 23 375

Martha and Florence Limited


Trade payables budget
January February March April May June
$ $ $ $ $ $
204
Opening balance 13 530 14 658 16 913 19 869 21 038 23 375
Purchases 14 658 16 913 19 869 21 038 23 375 22 313
28 188 31 571 36 782 40 907 44 413 45 688
Less: payments 13 530 14 658 16 913 19 869 21 038 23 375
Closing balance 14 658 16 913 19 869 21 038 23 375 22 313

Activity 7
a
Greenfields Limited
Cash budget for the four months ending 30 April 2017
January February March April
$ $ $ $
Receipts
Cash sales 25 000 28 000 30 000 33 000
Trade receivables 42 500 37 500 42 000 45 000
67 500 65 500 72 000 78 000
Payments
Trade payables 22 500 25 000 20 000 30 000
Selling and distribution  6 250  7 000  7 500  8 250
Administration 20 000 20 000 20 000 20 000
Purchase of plant – – 60 000 –
Dividend – – –  6 500
48 750 52 000 107 500 64 750
Net receipts/(payments) 18 750 13 500 (35 500) 13 250
Balance b/f 20 750 39 500 53 000 17 500
Balance c/f 39 500 53 000 17 500 30 750
Answers to activities, practice exercises and exam practice questions: Chapter 32

b Greenfields Limited
Budgeted income statement for the four months ending 30 April 2017
$ $
Revenue 290 000
Cost of sales
Opening inventory  30 000
Purchases 112 500
142 500
Closing inventory  22 500 120 000
Gross profit 170 000
Selling and distribution expenses (W2)  32 500
Administration expenses (W3)  83 500 116 000
Profit from operations  54 000
Interest on debentures (W4)   1 000
Profit for the year  53 000
Ordinary dividend  6 500
Transfer to general reserve 25 000  31 500
Retained earnings for the year  21 500
Workings:
1 Depreciation: Premises 4/12 × 3% × $50 000  = 500
P&M 4/12 × 20% × $97 500  = 6 500
Total $7 000 205

(Working 1 is needed for workings 2 and 3.)


2 Selling and distribution 10% × $290 000 + 50% × $7 000
Administration 4 × $20 000 + 50% × $7 000
3
Debenture interest 4/12 × 12% × $25 000
4

Note:
Although this is not the correct layout for published accounts, as there is no request for a
statement of changes in equity, it is perfectly acceptable for management accounts.
c Greenfields Limited
Budgeted statement of financial position at 30 April 2017
Cost Accumulated Net book
depreciation value
Non-current assets $ $ $
Freehold premises  50 000 10 500  39 500
Plant and machinery  97 500 29 000  68 500
147 500 39 500 108 000
Current assets
Inventory  22 500
Trade receivables  49 500
Cash and cash equivalents  30 750
102 750
Total assets 210 750

(cont.)
Cambridge International AS and A Level Accounting

Cost Accumulated Net book


depreciation value
$ $ $
Equity and liabilities
Capital and reserves
Ordinary shares of $1  65 000
General reserve  55 000
Retained earnings  27 250
147 250
Non-current liability
12% debentures 2019/2020  25 000
Current liabilities
Trade payables  37 500
Other payables
Debenture interest accrued   1 000
 38 500
Total equity and liabilities 210 750

Practice exercises
1 a
Banner Limited
Cash budget for four months January to April
206 Details January February March April
$ $ $ $
Income
From sales: one month after sale 180 000 205 000 212 000 230 000
From sales: two months after sale 400 000 360 000 410 000 424 000
Sale of old machine   4 000
Total receipts 580 000 565 000 622 000 658 000
Expenditure
Purchases of material paid in month  28 600  29 700  33 000  32 000
Materials paid two months after purchase  81 000  79 500  85 800  89 100
Wages paid in month  20 000  22 000  24 000  26 000
Wages paid in following month  10 000  10 000  11 000  12 000
Overheads paid in month 180 000 195 000 206 000 210 000
Overheads paid in following month 190 000 180 000 195 000 206 000
Purchase of new machine 45 000
Total expenditure 509 600 516 200 599 800 575 100
Surplus/(deficit) of income over expenditure  70 400  48 800  22 200  82 900
Opening bank balance (63 000)   7 400  56 200  78 400
Closing bank balance  7 400  56 200  78 400 161 300
Answers to activities, practice exercises and exam practice questions: Chapter 32

b Accruals appearing in the statement of financial position at 30 April:


$ $
Direct material
March ($132 × ¾) 99
April ($128 × ¾) 96 195
Wages: April ($39 × ⅓)  13
Overheads: April ($420 × ½) 210
New machine  45
Accruals (Other payables) 463

2 a i Roh Limited
Production budget in units For month of July 2017 For month of August 2017
Units Units
Sales  800 1 000
Less: opening inventory  (880) (1 100)
Add: closing inventory 1 100  990
Production 1 020  890

Note: The July budget is needed later in the question.


ii
Roh Limited
Purchases budget For the month of For the month of
July 2017 August 2017 207
Production in units   1 020     890
Kgs of material required (units × 3)   3 060   2 670
Cost of purchases (kgs × $4) $12 240 $10 680

Note: The July budget is needed later in the question.

iii
Roh Limited
Cash budget for the month of August 2017
$
Income
From sales (July units × $60) 48 000
Expenditure
Purchases of (July) material 12 240
Wages (monthly production × 2 hours × $8) 14 240
Variable overheads (monthly production × 2 hours × $14) 24 920
Fixed overheads (monthly production × 2 hours × $3.50)  6 230
Total expenditure 57 630
Surplus/(deficit) of income over expenditure (9 630)
Opening bank balance (per question) 16 000
Closing bank balance  6 370
Cambridge International AS and A Level Accounting

b A principal budget factor is something which limits the activities of the organisation. It is
also known as a limiting factor. It may be sales level or quantity of raw materials, cash or
space. It is important that this is identified as it indicates which budget should be prepared
first. Usually it is the sales budget which is the principal budget factor.
c Budgets are an essential part of managing a business. They force managers to think about
what will happen in the next year, or even years, as far as the business is concerned. The
planning aspect is one of the two principal benefits of preparing a budget. The second
aspect is control. By collecting the actual data, it can then be compared with the planned
(budget) data and corrective actions taken as necessary. The directors are correct that it
takes time to prepare a budget, but that time is well spent as it gives the business direction
and focus, by co-ordinating all the business activities.
Therefore the accountant should continue to prepare the budgets for Roh Limited.

3 a Alan
Cash budget for three months ending 30 June 2017
Details April May June
Income from customers from two months ago  2 400  2 200
Income from customers from previous month  9 600  8 800 11 200
Total income from customers  9 600 11 200 13 400
Expenditure
Payments to suppliers 10 000  8 000  9 000
Monthly overheads  4 000  4 000  4 000
Monthly drawings  2 000  2 000  2 000
New delivery vehicle  4 000
208
Total expenditure 16 000 14 000 19 000
Surplus/(deficit) of income over expenditure (6 400) (2 800) (5 600)
Opening bank balance (2 000) (8 400) (11 200)
Closing bank balance (8 400) (11 200) (16 800)

b Alan
Budgeted income statement for three months ending 30 June 2017
$ $
Revenue ($11 000 + $14 000 + $15 000) 40 000
Opening inventory  4 000
Add: purchases ($8 000 + $9 000 + $9 500) 26 500
30 500
Less: closing inventory (5 000) 25 500
Gross profit 14 500
Expenditure
Monthly overheads ($4 000 × 3) 12 000

(
Loan interest $15 000 × 10% ×
3
12 )   375

Depreciation (36 000 × 10% for 3 months)   900 13 275


Profit for the period  1 225
Answers to activities, practice exercises and exam practice questions: Chapter 32

c Two advantages of preparing budgets:


• It aids business planning and control.
• It is motivational as it gives managers a target to work towards.
Two disadvantages of preparing budgets (any two):
• It takes time to prepare them.
• Managers may try to build some ‘slack’ into their budget in order to achieve them.
• Managers may aim to ‘achieve budget’ rather than do their best.
d In every month Alan’s cash income is exceeded by his cash expenditure. The closing bank
balance is increasingly overdrawn; the bank may threaten to close the business.
• 
Alan has just about broken even for the three-month period. As he is making very
little profit, Alan’s drawings are not only a drain on cash flow, but are in excess of his
entitlement.
• He should consider reducing his drawings.
• 
He is paying his suppliers more quickly than his customers are paying him. This is not a
good situation, as it worsens cash flow.
• He should try to reverse this so that his customers pay him before he pays his suppliers.
• 
He might also consider delaying the purchase of the new vehicle or perhaps leasing one
rather than buying it.
• Perhaps he could also reduce his purchases to reduce his inventory.
• 
He should urgently assess whether he can take sufficient actions in total to ensure that the
business can achieve sustained profits and positive cash flows in the future:
• If he cannot do so, he will have to consider closing the business.
• If he thinks he can do so, he should consider raising additional finance. 209

Exam practice questions


Multiple-choice questions
1 C
2 B
3 B
4 A
Cambridge International AS and A Level Accounting

33 Standard costing
Activities
Activity 1
Jumal
Budgeted profit statement for next six months
$ $
Revenue:
Bicycles (4 000 × $600) 2 400 000
Tricycles (2 500 × $250) 625 000
3 025 000
Cost of sales:
Direct material
Bicycles (10 × $45 × 4 000) 1 800 000
Tricycles (4 × $45 × 2 500) 450 000
Direct labour
Bicycles (2 × $10 × 4 000) 80 000
Tricycles (1 × $10 × 2 500) 25 000 2 355 000
Gross profit 670 000
Fixed overheads 42 000
Profit for the period   628 000

210 Activity 2
Breakfast Limited
Flexed budget for the production of 110 000 packets of cereal
$
Variable expenses
Direct materials 22 000
Direct labour 16 500
Production expenses 6 600
45 100
Fixed expenses
Production expenses 13 000
Administration 29 000
87 100

Activity 3
a Selling and distribution costs for 8000 pairs of sunglasses:
$4 000 + (8 000 × $3) = $28 000.
b Flexed budget cost statement for 8 000 pairs of sunglasses:
$
Direct materials 16 000
Direct labour 24 000
Production overheads 22 000
Selling and distribution 28 000
Administration   12 000
Total cost 102 000
Answers to activities, practice exercises and exam practice questions: Chapter 33

Activity 4
No. of locks 9 000
$
Direct materials 22 500
Direct labour 54 000
Production overhead 34 000
Selling and distribution 30 000
Administration   80 000
220 500

Activity 5
Underpart Limited
Flexed budget statement
Flexed budget Actual Variances
No. of units 6300 6300
$ $ $
Revenue 157 500 163 800 6 300
Direct materials 21 420 20 890 530
Direct labour 42 525 44 065 (1 540)
Variable overheads 3 150 3 250 (100)
Fixed overhead 62 000 62 000 –
Total cost 129 095 130 205 (1 110)
211
Profit 28 405 33 595 5 190

Activity 6
a Sales volume variance = (9 500 − 10 000) × $15 = $7 500 adverse.
b Sales price variance = $(15.50 − 15) × 9 500 = $4 750 favourable.

Activity 7
a Direct materials usage variance = (9 500 − 9 700) × $6 = $1200 adverse.
b Direct materials price variance = $6 − [$57 715 ÷ 9 700] × 9 700 = $485 favourable.
c Total direct material variance = ($6 × 9 500) − $57 715 = $715 adverse.
This is equal to the net of the price and usage variances $(1 200 − 485) = $715 adverse.

Activity 8
a Direct labour efficiency variance = (9 500 − 9 450) × $4 = $200 favourable.
b Direct labour rate variance = $(4 − 3.98) × 9 450 = $189 favourable.
c Total direct labour variance = (9 500 × $4) − (9 450 × $3.98) = $389 favourable.
This is equal to the sum of the two favourable variances for rate and efficiency
$(200 + 189) = 389 favourable.

Activity 9
The standard total direct labour cost for the production of 12 000 packets of Pickup:
= $10 × 12 000 = $120 000.
Actual hours taken 12 000 × 1.25 = 15 000.
The direct labour efficiency variance = (12 000 − 15 000) $10 = $30 000 (A).
Cambridge International AS and A Level Accounting

The direct labour rate variance = $(10 − 8.50) 15 000 = $22 500 (F).
Check:
Actual labour cost of production of 12 000 packets of Pickup:
= 1.25 hours × $8.50 × 12 000 = $127 500.
Total labour variance = $7 500 (A) = $(30 000 (A) – $22 500 (F)) (as above).

Activity 10
a Fixed overhead expenditure variance = $(20 000 − 19 800) = $200 favourable.
Before calculating the remaining overhead variances it is first necessary to work out the
budgeted fixed overhead absorption rate:
Budgeted fixed overhead absorption rate = $20 000 ÷ 10 000 = $2 per direct labour hour.
b Fixed overhead volume variance:
9500 units should have taken 9 500 hours.
10 000 units should have taken 10 000 hours.
Volume variance = (10 000 − 9 500) × $2= $1 000 adverse (because less hours were worked
than planned).
c Fixed overhead capacity variance:
Budgeted direct labour hours = 10 000.
Actual direct labour hours = 9 450.
Capacity variance = (10 000 − 9 450) × $2 = $1 100 adverse.
d Fixed overhead efficiency variance:
212 9500 units should have taken 9500 hours.
They actually took 9 450 hours.
Efficiency variance = (9 500 − 9 450) × $ 2 = $100 favourable.
Proof: the fixed overhead volume variance = $1 000 adverse. This is equal to capacity variance
$1 100 adverse + efficiency variance $100 favourable.
e 
Statement reconciling total fixed overhead variance with the expenditure and volume
variances:
$
Fixed overhead expenditure variance 200 (F)
Fixed overhead capacity variance 1 100 (A)
Fixed overhead efficiency variance 100 (F)
Total fixed overhead variance 800 (A)

Activity 11
Before preparing the statement it is first necessary to calculate the budgeted cost per unit for
Polonius Limited, using the results of previous activities:

$
Direct material 6
Direct labour 4
Fixed overhead 2
Budgeted cost per unit 12
Answers to activities, practice exercises and exam practice questions: Chapter 33

Polonius Limited
Statement to reconcile the standard cost of production
with the actual cost of production
Favourable Adverse Total
variances variances
$ $ $
Standard cost of production (9500 × $12) 114 000
Direct material price variance 485
Direct material usage variance (1200)
Direct labour rate variance 189
Direct labour efficiency variance 200
Fixed overhead expenditure variance 200
Fixed overhead volume variance*   (1000)
1074 (2200) (1 126)
Actual cost of production** 115 126

*The total overhead volume variance has been included. The overhead capacity and efficiency
variances could have been used with the same net result, but not all three variances.
**Actual cost:

$
Direct materials 57 715
Direct labour 37 611
Fixed overheads 19 800 213

115 126

Activity 12
Calculation of profit:

Budget Actual
$ $
Revenue 142 500 147 250
Less: costs (114 000) (115 126)
Profit   28 500   32 124

Polonius Limited
Statement reconciling actual and flexed budget profits
$
Flexed budget profit 28 500
Sales price variance 4 750
33 250
Less: total cost variances (1 126)
Actual profit 32  124

Note: Notice only the sales price variance is included in this reconciliation.
The volume variance is ignored.
Cambridge International AS and A Level Accounting

Activity 13
Cantab Limited
Calculation of actual profit made in a three-month period
$ $
Profit per master budget 98 970
Add: favourable variances
Sales volume 6 210
Materials price 9 635
Labour efficiency 10 500
125 315
Less: adverse variances
Quantity 17 009
Sales price 3 730
Materials usage 6 280
Labour rate 7 840
Overhead expenditure 5 760 40 619
Actual profit 84 696

Activity 14
a Workings:
Direct material:
Standard cost per kg $7 200 = $6 per kg.
300 × 4
214 Standard usage for 400 units = 4 × 400 kg = 1 600 kgs.
Actual material per unit: $9 000 = 3.6 kgs.
$6.25 × 400
Actual usage 400 × 3.6 kg = 1 440 kgs.
Direct labour: standard hours per unit $6 600 = 2 hours.
$11 × 300
Standard hours for 400 units = 800.
Actual hours for 400 units = 400 × 2.25 = 900.
Actual cost per hour $10 890 = $12.10.
400 × 2.25
i Direct material usage variance:
(1 600 − 1 440) × $6 = $960 (F).
ii Direct material price variance:
$(6.00 − 6.25) × 1 440 = $360 (A).
iii Direct labour efficiency variance:
(800 − 900) × $11 = $1 100 (A).
iv Direct labour rate variance:
$(11.00 − 12.10) × 900 = $990 (A).
b The favourable material usage variance may be due to a better quality of material being used
resulting in less wastage during production. This view may be supported by the adverse price
variance which suggests that a better quality of material was more expensive than standard.
Both of the labour variances are adverse. The higher hourly rate of pay has not resulted in a
favourable efficiency variance, even though the workers may have been working with a better
quality of material. The adverse efficiency variance does not suggest that the higher rate of
pay was due to the employment of a more skilled work force. It is possible that a pay increase
given to the workers was below their expectation and they are poorly motivated as a result. The
reason for the adverse variances can only be discovered by further investigation.
Answers to activities, practice exercises and exam practice questions: Chapter 33

Practice exercises
1 a 
If a business does not prepare a flexed budget then it is not comparing like with like. It is
very rare that the actual and budgeted figures are the same. In order to make a meaningful
comparison between the two sets of data then the budget must be flexed to what the
figures would have been for the actual output and sales.
b Workings:
Actual direct material cost $(80 000 − 6 200) = $73 800.
Actual cost per kg = $73 800 ÷ 18 000 = $4.10 per kg.
Actual direct labour cost = $(300 000 + 18 400) = $318 400.
Actual direct labour hours = $318 400 ÷ $9.95 = 32 000 hours.
Budgeted overhead absorption rate = $77 550 ÷ (11 000 × 3) = $2.35 per direct labour hour.
i Material price variance = $(4.00 − 4.10) × 18 000 = $1 800 adverse.
ii Material usage variance = (20 000 − 18 000) × $4 = $8 000 favourable.
iii Labour rate variance = $(10.00 − 9.95) × 32 000 = $1 600 favourable.
iv Labour efficiency variance = (30 000 − 32 000) × $10 = $20 000 adverse.
v Fixed overhead expenditure variance = $(77 550 − 74 000) = $3 550 favourable.
vi Fixed overhead volume variance = [(11 000 × 3) − 32 000] × $2.35 = 2350 adverse.
c i  ossible causes for the material price variance is change to a more expensive supplier
P
or supplier increased price more than budgeted.
Possible causes for the labour efficiency variance are poor management control over
workers, perhaps more were recruited than was budgeted, or perhaps the material
which was bought, if from a new supplier, was of a lower quality meaning more scrap
and workers having to work longer to complete the output.
215
Also possible was that the workforce was less skilled than planned (for example due to
high staff turnover).
ii 
In order to improve the adverse labour variance, tighter control over labour is required.
An alternative is to offer labour a bonus to complete the work more quickly. However,
the cost of any bonus must be less than the efficiency variance and output quality
must be monitored to ensure workers are not rushing to complete the work at the
expense of reduced quality. Training may help.
2 a 
When the actual results for a period are compared with the flexed budget results, there is
usually a difference between the two sets of figures. This difference is known as a variance.
Management needs to analyse variance to identify the cause of the difference between
the two sets of figures. Once the causes have been identified then corrective action can be
taken as necessary.
b i Total material variance:
Flexed budget fuel cost = (130 000 × $1.20) ÷ (6 500 × 5 900) = $141 600.
Total material variance = $141 600 − 175 000 = $33 400 adverse.
ii Total labour variance:
Budget labour cost = $82 875 ÷ 9 750 = $8.50 per direct labour hour.
Flexed budget direct labour hours = 9 750 ÷ 6 500 × 5900 = 8850.
Total labour variance = (8 850 × $8.50) − (9 000 × $8.65) = $2 625 adverse.
iii Fixed overhead expenditure variance = $62 400 − 58 000 = $4 400 favourable.
iv Fixed overhead absorption rate = $62 400 / 7 800 units = $8 / unit. Hence:
Fixed overhead capacity variance = (7 800 − 7 200) × $8 =$4 800 adverse.
v Fixed overhead efficiency variance:
Flexed budget operating hours = (7 800 ÷ 6 500) × 5 900 = 7 080.
Variance = (7 080 − 7 200) × 8 = 960 adverse.
Cambridge International AS and A Level Accounting

c Calculation of flexed budgeted cost of sailings:


$
Fuel 141 600
Direct labour (8850 × $8.50) 75 225
Fixed overheads (7080 × $8) 56 640
Total flexed budgeted cost 273 465

Seaview Ferries Limited


Statement to reconcile the actual cost of sailings with the standard cost of sailings
Favourable Adverse Total
variances variances
$ $ $
Standard cost of actual sailings 273 465
Total fuel variance (33 400)
Total direct labour variance (2 625)
Fixed overhead expenditure variance 4 400
Fixed overhead capacity variance (4 800)
Fixed overhead efficiency variance   (960)
4 400 (41 785) (37 385)
Actual cost of actual sailings* 310  850

*Actual cost:
$
216
Fuel 175 000
Direct labour 77 850
Fixed overheads   58 000
310 850

d 
The directors should include sales variances in their analysis. By doing so it will enable
them to find out more information on performance which, at present, they don’t seem to
have. By setting and analysing sales variances, the directors could assess the impact on
profitability of changing passenger numbers and changing fares, respectively. In order to
analyse the profitability of each route, they would also need to prepare cost budgets for
each of the three journeys (‘products’).
3 a Calculation of budgeted selling price per unit:
$
Direct material (2 kg × $5 per kg) 10
Direct labour (3 hours × $10 per hour) 30
Total variable cost 40
Add: Mark-up (40 × 50%) 20
Budgeted selling price per unit 60

b Statement to show the actual contribution for the month of June:


$ $
Revenue (5200 × $58) 301 600
Direct material (10 920 × $4.80) 52 416
Direct labour (16 640 × $10.50) 174 720 227 136
Actual contribution 74 464
Answers to activities, practice exercises and exam practice questions: Chapter 33

c i   Sales price variance = $(58 − 60) × 5 200 = $10 400 (A)


ii Direct material price variance = $(5.00 − 4.80) × 10 920 = $2 184 (F)
iii Direct material usage variance = [(5 200 × 2) − 10 920 × $5] = $2 600 (A)
iv Direct labour rate variance = $(10.00 − 10.50) × 16 640 = $8 320 (A)
v Direct labour efficiency variance = [(5 200 × 3) − 16 640 × $10] = $10 400 (A)
d 
Statement reconciling the flexed budget contribution with the actual contribution for the
month of June:
A F Total
$ $ $
Flexed budget contribution
Revenue (5200 × $60) 312 000
Direct material ([5200 × 2) × 5 (52 000)
Direct labour ([5200 × 3) × $10) (156 000)
Budgeted contribution 104 000
Sales price variance 10 400
Direct material price variance 2184
Direct material usage variance 2 600
Direct labour rate variance 8 320
Direct labour efficiency variance  10 400
(31 720) 2184 (29 536)
Actual contribution  74 464

217
e 
Perhaps as a result of market competition or his own decision to drop the selling price, the
result has been to sell more units than budgeted. However, this has cost him over $10 000
in lost revenue.
Bertie does need to pay attention to his direct costs. His only favourable variance is
material price, which means he may have found a cheaper supplier. However, this has
impacted negatively on the usage of material, which showed a negative variance.
Both labour variances were adverse. The rate variance may have been a result of workers
working overtime to produce the extra sales units. This in turn could have made them tired
and, as a result, less efficient.
Overall the negative variances have had a serious impact on the contribution earned. This
in turn will have a negative impact on his overall profit for the month.

Exam practice questions


Multiple-choice questions
1 A
2 B
3 A
4 C
5 C
6 C
Cambridge International AS and A Level Accounting

34 Investment appraisal
Activities
Activity 1
Ignore the machine that was acquired some years earlier as it is a sunk cost.
Average profit = $150 000 ÷ 6 = $25 000.
120 000
Average investment = $( + 25 000) = $85 000.
2
25 000
ARR = × 100 = 29.4%.
85 000

Activity 2
a Calculation of payback periods:
First Last
$ $
Year 0 (90 000) (90 000)
1 30 000 40 000
2 36 000 40 000
3 24 000 10 000
Payback 20
2 + 10 years
2+ years
40 40

24
2+( × 12) years
40

2 years 7.2 months


218
2 years 8 months 2 years 3 months
b Last should be chosen because it has the shorter payback period and its pattern of cash flows
will benefit the liquidity of Martinez Limited.

Activity 3
Nomen Limited
Machine A Machine B Machine C
Year Discounting factor Cash NPV Cash NPV Cash NPV
at 12% flows flows flows
$ $ $ $ $ $
0 1.000 (135 000) (135 000) (135 000) (135 000) (135 000) (135 000)
1 0.893 50 000 44 650 38 000 33 934 26 000 23 218
2 0.797 50 000 39 850 38 000 30 286 26 000 20 722
3 0.712 38 000 27 056 38 000 27 056 38 000 27 056
4 0.636 26 000 16 536 38 000 24 168 50 000 31 800
5 0.567 26 000 14 742 38 000 21 546 50 000 28 350
Net present values 7 834 1 990  (3 854)

Nomen Limited should choose machine A as it has the highest NPV. Machine C should not be
considered because it has a negative NPV.
Answers to activities, practice exercises and exam practice questions: Chapter 34

Activity 4
Machine A Machine B
Year Discounting factor Cash flows NPV Cash flows NPV
at 20%
$ $ $ $
0 1.000 (135 000) (135 000) (135 000) (135 000)
1 0.833 50 000 41 650 38 000 31 654
2 0.694 50 000 34 700 38 000 26 372
3 0.579 38 000 22 002 38 000 22 002
4 0.482 26 000 12 532 38 000 18 316
5 0.402 26 000 10 452 38 000 15 276
Net present values (13 664) (21 380)

IRR for machine A: 12% + 8% ×


( 7834
7834 + 13664 ) = 14.9%

IRR for machine B: 12% + 8% ×


( 1990
1990 + 21380 )
= 12.7%.

Activity 5
Workings:

1A 1B

Annual $140000 −$20000 $180000 −$30000


= $24 000 = $30000
depreciation 5 5
cash outflows 219

Costs 1A 1B
$ $
Year 1 $(70 000 − 24 000) 46 000 $(84 000 - 30 000) 54 000
2 $(84 000 − 24 000) 60 000 $(98 000 - 30 000) 68 000
3 $(91 000 - 24 000) 67 000 $(105 000 - 30 000) 75 000
4 $(98 000 - 24 000) 74 000 $(112 000 - 30 000) 82 000
5 $(95 000 - 24 000) 71 000 $(100 000 - 30 000) 70 000

Net receipts 1A 1B
$ $
Year 1 $(98 000 - 46 000) 52 000 $(101 000 - 54 000) 47 000
2 $(112 000 - 60 000) 52 000 $(118 000 - 68 000) 50 000
3 $(126 000 - 67 000) 59 000 $(126 000 - 75 000) 51 000
4 $(126 000 - 74 000) 52 000 $(140 000 - 82 000) 58 000
5 $(100 000 - 71 000) 29 000 $(110 000 - 70 000) 40 000

Average profit 1A 1B
$ $
Year 1 $(98 000 - 70 000) 28 000 $(101 000 - 84 000) 17 000
2 $(112 000 - 84 000) 28 000 $(118 000 - 98 000) 20 000
3 $(126 000 - 91 000) 35 000 $(126 000 - 105 000) 21 000
4 $(126 000 - 98 000) 28 000 $(140 000 - 112 000) 28 000
5 $(100 000 - 95 000) 5 000 $(110 000 - 100 000) 10 000
$124 000 ÷ 5 24 800 $96 000 ÷ 5 19 200
Cambridge International AS and A Level Accounting

a i 1A 1B
24 800 19 200
ARP = × 100 = 35.4% × 100 = 21.3%
70 000 90 000

ii Payback period:
1A 1B
$ $
Year 0 (140 000) (180 000)
1 52 000 47 000
2 52 000 50 000
3 36 000 Year 3 51 000
4 32 000

36 000 32000
Year 3 × 12 = 8 months Year 4 × 12 = 7 months
59 000 58000
Payback = 2 years 8 months 3 years 7 months

iii Net present values at 10%:


1A 1B
Year Factor Net (payment)/ NPV Net (payment)/ NPV
receipt receipt
$ $ $ $
220
0 1.000 (140 000) (140 000) (180 000) (180 000)
1 0.909 52 000 47 268 47 000 42 723
2 0.826 52 000 42 952 50 000 41 300
3 0.751 59 000 44 309 51 000 38 301
4 0.683 52 000 35 516 58 000 39 614
5 0.621 29 000 18 009 40 000 28 840
Net present values 48 054 6 778

iv IRR (40%):
1A 1B
Year Factor Net (payment)/ NPV Net (payment)/ NPV
receipt receipt
$ $ $ $
0 1.000 (140 000) (140 000) (180 000) (180 000)
1 0.714 52 000 37 128 47 000 33 558
2 0.510 52 000 26 520 50 000 25 500
3 0.364 59 000 21 476 51 000 18 564
4 0.260 52 000 13 520 58 000 15 080
5 0.186 29 000 5  394 40 000 7 440
Net present values (35 962) (79 858)
Answers to activities, practice exercises and exam practice questions: Chapter 34

IRR:
   30% × 48 054
1A: 10% + = 27.2%
48 054 + 35 962

1B:  10% + 30% × 6 778 = 12.3%


778 + 79 858
b Flags Limited should purchase 1A because:
• it has a higher accounting rate of return: 35.4% (1B: 21.3%)
• it has the shorter payback period: 2 years 8 months, lower risk (1B: 3 years 7 months)
• it has higher net present value: $48 054 (1B: $6 778)
• it has higher internal rate of return: 27.2% (1B: $12.3%).
Activity 6
Net present value: - $150 000 + $(50 000 × 3.169) = $8450.
The net present value will become negative if:
1 the cost of the machine rises by $8450, i.e. an increase of 5.6%, or
2 the annual savings in operational costs fall below $47 333, i.e. they fall short by 5.3%.
Activity 7
A Co Limited should invest in the order C, A and B. By dividing the net present value by the capital
cost C yields a net present value of 20%. Similarly, A yields 17.5% and C 12%. Thus C, A, B will be
the most advantageous for the company.

Practice exercises
1 a 
Payback refers to how long it takes to pay back (in cash terms) the original investment.
It is expressed as a period of time, usually years and months. Accounting rate of return 221
measures the profit which an investment makes. The return (average profit) is expressed as
a percentage of the average investment.
b Calculation of the net present value of each machine:
Machine 1 (Red)
Year Cash income Cash Net cash flow Discount Discounted
expenditure factor 10% cash flow
$ $ $ $
0 (100 000) (100 000) 1.00 (100 000)
1 70 000 (25 000) 45 000 0.909 40 905
2 80 000 (35 000) 45 000 0.826 37 170
3 90 000 (40 000) 50 000 0.751 37 550
4 90 000 (45 000) 45 000 0.683 30 735
Net present value 46 360

Machine 2 (Green)
Year Cash income Cash Net cash flow Discount Discounted
expenditure factor 10% cash flow
$ $ $ $
0 (130 000) (130 000) 1.00 (130 000)
1 72 000 (27 500) 44 500 0.909 40 451
2 84 000 (37 500) 46 500 0.826 38 409
3 90 000 (42 500) 47 500 0.751 35 673
4 100 000 (47 500) 52 500 0.683 35 858
Net present value 20 391
Cambridge International AS and A Level Accounting

c The directors should choose Red for two reasons:


1 The net present value is higher than Green.
2 It generates a return of 46.36% on the capital invested. Green only generates a return of
$20 391 ÷ $130 000 × 100 = 15.69%. Thus it fails on two criteria.
d Calculation of the internal rate of return of Red:
Year Cash income Cash Net cash Discount Discounted
expenditure flow factor 20% cash flow
$ $ $ $
0 (100 000) (100 000) 1.00 (100 000)
1 70 000 (25 000) 45 000 0.833 37 485
2 80 000 (35 000) 45 000 0.694 31 230
3 90 000 (40 000) 50 000 0.579 28 950
4 90 000 (45 000) 45 000 0.482 21 690
Net present value 19 355

At a 20% discount factor, the net present value is still positive. This means the internal rate
of return is greater than 20%.
The calculation is:
10% + [(20% - 10%) × {46 360 / (46 360 - 19 355)} = 27%
As this return (27%) is greater than the 25% benchmark, it is acceptable.
2 a Two advantages of the payback method over the net present value method (any two):
• The payback method considers cash returns. The method is also easy to calculate and
222 is understood by non-accountants.
• It tells you when funds are recouped and available for other investments.
• On the other hand, net present value requires the identification of the cost of capital
which is not always easy, and is also subjective to a degree. It is also more complicated
to calculate than payback.
b Workings:
Year Cash cost Annual cash Annual cash Net cash flow
income (a) expenses (b) (a - b)

$ $ $ $
0 (100 000) (100 000)
1 10 000 × $20 = 200 000 (10 000 × $15) + $15 000 = (165 000) 35 000
2 11 000 × $21 = 231 000 (11 000 × $16) + $16 000= (192 000) 39 000
3 12 000 × $22 = 264 000 (12 000 × $17) + $17 000 = (221 000) 43 000

4 13 000 × $23 = 299 000 (13 000 × $18) + $18 000 = (252 000) 47 000

i Step 1
To work this out, add up the net cash flows for each year, starting with year 1.
At the end of year 1 the net cash flow is $35 000.
At the end of year 2 the total net cash flow is $35 000 + $39 000 = $74 000.
At the end of year 3 the total net cash flow is $74 000 + $43 000 = $117 000.
This means that by the end of year 3, the company will have received back more cash
than the equipment cost.
However, students are required to work out exactly when the cash cost will be
covered. The data indicates that it is some time in year 3.
Answers to activities, practice exercises and exam practice questions: Chapter 34

Step 2
Deduct the total cash flow at the end of year 2 from the capital cost of the project:
$100 000 - $74 000 = $26 000. This is how much more is required for the cost to be
covered.
Step 3
Divide the amount required by the full receipts in year 3 and multiply the answer by 12.
This shows how many months it takes to reach the figure required.
$26 000 × 12 = 7.3 months
$43 000

Step 4
Add the answer to the two years. This gives 2 years 7.3 months. Often it can be
rounded to 2 years and 8 months. Always go up to the higher month.
The payback period is 2 years 8 months.
ii The sum of the cash flows before they were discounted is:
$35 000 + $39 000+ $43 000 + $47 000 = $164 000.
If the machine is scrapped at the end of the project it will have been depreciated in full
over the four year period. This means that the profit made by this project would have
been:
$164 000- $100 000 = $64 000.
The calculation for the accounting rate of return is:
Average profit
× 100
Average investment 223
In this case it is:
64 000 4
÷ × 100 = 32%
100 000 2

The accounting rate of return is 32%.


c Comparison of data:
Machine 1 Alternative
Capital cost $100 000 $150 000
Payback 2 years 7 months 3 years
NPV (Working) $22 846 $15 000
ARR 30.5% 25%

Working:
Year Net cash flow (a) Discount factor Net present value
at 12% (b) (NPV) (a) × (b)
$ $
0 (100 000) 1.0 (100  000)
1 35 000 0.893 31 255
2 39 000 0.797 31 083
3 43 000 0.712 30 616
4 47 000 0.636 29 892
NPV 22 846
Cambridge International AS and A Level Accounting

In terms of financial data, the machine we are considering is better than the alternative in
all respects considered: payback, NPV and ARR. It also has a lower capital outlay.
A company usually bases its decision on the results from the payback and net present
value calculations. Therefore, the machine we are considering should be chosen.
In terms of non-financial factors, the directors should consider the impact on the
workforce of both machines. It may be that one of the machines will lead to (more)
redundancies of staff, which will have a negative effect on the image of the company. It
may also be that one machine is more environmentally friendly in terms of pollution and/
or waste that the other. However, on purely financial grounds the machine costing $100 000
should be chosen.

Exam practice questions


Multiple-choice questions
1 C
2 A
3 D
4 B

Structured question
1 a Accounting rate of return (ARR):
$(80  000 - [46 000 + 30 000]) = $4 000 average annual profit
$120  000 ÷ 2 = $60 000 average investment
ARR = $(4 000 ÷ 60 000) × 100 = 6.67%
b Net present value:
224
As all the yearly cash f