Accounting Summary

Accounting Theory for AS Level 9706
Past Papers 2016 - M/J 2018

(9706/2)
utir Sesawi
Summarized by B
CONTENTS
Color Code 0
Basic 1
Partnerships 12
Limited Companies 18
Costing 23
COLOR CODE
Keywords
Keywords dependent on case
Additional notes
Mark Explanation
Basic
● types of entries which would usually be recorded in the general journal

○ Correction of errors (1)
○ Opening entries (1)
○ Purchase and sale of non-current assets (1)
○ Non-regular transactions (such as year-end transfers) (1)
○ Write off bad debts (1)
○ Depreciation (1)
● Depreciation is the allocation of the cost of a (non-current) asset over its expected
working life. (1), or the allocation of the cost of using the asset over the year (1)
● causes of depreciation of non-current assets.

● wear and tear
● technological advance
● passage of time
● Depletion
● why a company should provide for depreciation on its non-current assets

● To comply with the matching / accruals concept (1)
● Accounts for that part of the asset used up in the accounting period (1)
● The value of assets falls due to wear and tear, obsolescence, technological
change, etc. (1)
● Avoids overstating the net assets / non-current assets of the business (1)
● Ensures that the statement of financial position shows a true and fair view (1)
● accounting concept relating to depreciation

● Consistency (1)
• to assist comparisons of performance between years. (1)
• using the same depreciation method each year. (1)
● Prudence (1)
• avoid overstating profits / net assets (1)
• charging depreciation as an expense and so not overstating profits (1)
● Accruals / matching (1)
• match the cost of an asset with the income generated from its use (1)
• matching wear and tear of the asset against the reduction in value (1)
● types of errors that will not be identified by producing a sales ledger control account.
● Error of omission ● Compensating error
● Error of commission ● Error of original entry
butirsesawi.weebly.com 1
● suspense account is a temporary account used to balance the trial balance (1)
Used.. :
● to help correct errors when the trial balance / books of account do not balance (1)
● When the bookkeeper does not know where to post an entry. (1)
● In order to prepare draft financial statements. (1)
● Inventory Valuation: lower of..

○ cost = purchase cost + carriage inwards
and
○ net realisable value = selling price - (cost to completion* + selling expenses)
*doesn’t include purchase cost and carriage inwards
● Provision for doubtful debts

○ a business may make a provision for doubtful debts to avoid trade receivables
being overstated in the statement of financial position.
○ accounting concept applied: - prudence
- matching
○ How it is treated in
■ the statement of financial position
● The new provision is deducted from trade receivables under
current assets in the statement of financial position (1)
■ the income statement
● An increase in provision for doubtful debts is shown as an
expense (1)
● A decrease in provision for doubtful debts is shown as additional
income after the gross profit (1).
■ Advice
● Application of prudence concept (1)
● Trade receivables/Current assets/profit may be o verstated (1)
● Application of matching/accruals concept (1)
● Matches the cost of the provision against the r elevant year (1)
● Double entry book-keeping: system to record business transaction on debit and credit
side
○ benefits a business gains from maintaining a system of double entry book-keeping.
○ It enables checking transactions through the use of a trial balance and control
accounts.
○ It enables the production of the income statement and statement of financial
position to be compiled more easily.
○ It shows the amount due to individual customers and suppliers thus avoiding
overpayment.
○ Helps guard against errors / fraud.
● why there might be a credit balance on a customer’s account in the sales ledger.
○ A customer has overpaid in error
○ A contra has been put through but the customer has ignored it.
○ A customer has paid in advance
○ Customer paid for the goods before returning them.
● sales ledger control account

Advantages
● Provides a total for trade receivables (1)
● Helps in the preparation of the financial statements. (1)
● Helps deter/prevent/reduce fraud, as it is maintained by different person.
(1)
● Verifies the arithmetical accuracy/identifies errors in the sales ledger. (1)
● Can be reconciled with the sales ledger balances to improve accuracy. (1)
Limitation
● Doesn’t identify errors of commission/omission/compensating/original
entry. (1)
● ‘revenue expenditure’ is money spent: on the day-to-day running expenses of the

business; (1) on resources that will generally be used up within one year. (1), while
capital expenditure are infrequent spendings whose benefits could normally be enjoyed
for over a year.
● Maintaining a full set of accounting records

Advantages
○ Business is growing fast
○ Enables closer monitoring of performance
○ Enables owner to control the business performance
○ Enable owner to maximise opportunities
Disadvantages
○ More time consuming
○ Need to employ specialist staff
● why a business may use reducing balance method of depreciation for plant and
machinery.
Plant and machinery often loses more value i n the earlier years of its life (1) due
to usage (1) and maintenance costs may be higher in the later years (1)
● accounting treatments for l oose tools

○ It is written off as an expense (1) If the cost o
f the item is not material (1)
○ The revaluation method should be used (1) If the cost is significant (1)
● types of error that will not be revealed by the trial balance.
○ Error of omission ○ Compensating error
○ Error of commission ○ Error of original entry
○ Error of principle ○ Error of reversal
● benefits to a business of preparing annual financial statements

○ Helps future planning/targets/goals (1)
○ Decision making (1)
○ Able to assess performance/comparisons (1)
○ Valuation of assets, liabilities and c apital (1)
○ For tax purposes (1)
○ To present to bank for additional finance (1)
● Books of prime entry: first books in which transactions are recorded

○ Groups transactions of the same type together
○ Enables specialization of workers
○ Reduces chances of fraud as different types of transactions are recorded by
different individuals
○ May cause salary costs to increase as additional workers need to be paid to
maintain the books
○ Time consuming
● Accounting Concepts
il lary B
mnemonic: “H E SO De
ad C
oncerned Realizi ng An Accrued Me
nstruation C
ould
Mean P
re
gnancy”
● Historical cost ● going Concern ● Materiality

● Business Entity ● Realization ● Consistency
● Substance Over ● Accounting ● Money
form period measurement
● Duality ● Accruals / ● Prudence
matching
Ratio & Analysis
● Importance of Current Ratio

○ shows the funds available in the short term (1) to pay the current liabilities (1).
○ It does not show the liquid assets available (1) because it includes inventory (1)
○ It provides a judgement on liquidity (1) by comparing current assets with current
liabilities (1)
● ratio analysis
○ Benefits
■ Compare the results of the business o ver time
■ Compare the performance of businesses of different sizes
■ Compare the performance of the business with the market leader
■ Compare the performance of the business against industry averages
○ Limitations
■ Only relevant when comparing like with like (1) (same industry, same size
business etc.) (1)
■ Uses historical data (1), therefore gives n o indication of future
performance (1)
■ Only concerned with financial data (1), ignores non-financial aspects such
as staff morale, q
uality of management etc (1)
■ Does not provide causes / reasons for changes (1) – therefore must
deduce reasons (1)
■ Window dressing
● FOR THE CASE WHERE:

5% Debentures (2021 – 2025) 25 000 Cr
Cash and cash equivalents 27 200 Dr
The directors of Seema Limited have calculated the current ratio to be 8.87 : 1.
They regard the ratio calculated to be too high and are considering repaying the
debentures.
the effect of this course of action on:

● working capital
○ Will reduce the bank (1) to only $2200 (1)
○ Working capital will fall (1) and the ratio will become 5.25: 1 (1)
○ It may cause some cash flow problems (1)
● return on capital employed
○ Now 17.28% would be 18.78% if no debentures (1)
○ This will rise (1) as the capital employed falls (1) if profits are
maintained (1)
Advise the directors on whether they should repay the debentures early. Justify
your answer.
● It will seriously weaken the cash position (1)
● Interest cost is relatively low (1)
● It is not due for repayment f or a minimum of 5 years (1). If it was
repaid and there was a need for another loan it might be much
higher interest (1)
● Increase the profit, due to removal of interest payable (1).
1 OF for decision
3 marks for appropriate reasons
Comment on the changes in liquidity of the partnership from 30 September 2014

to 30 September 2015.
○ the liquidity ratio (which excludes inventory) has fallen from 1.1 to 0.85.
The partnership would be unable to pay all short-term liabilities from liquid
assets (1) without selling inventory. (1)
○ trade receivable collection days have increased from 34 to 42 days. This
may suggest that credit control is not working as well (1) or that longer
terms are being allowed to maintain the level of sales. (1) Increased risk
of bad debts. (1)
○ the partnership may find it difficult to o
btain further supplies on credit (1)
and may be unable to take advantage of cash discounts offered by
suppliers. (1)
ways in which the partnership liquidity may be improved:
● the partners may need to consider introducing some additional capital (1)
or Max could r educe his salary in exchange for a higher profit share. (1)
● if there are any surplus non-current assets in the partnership, these could
be sold. (1) The partnership may need to negotiate a non-current loan. (1)
● the partners should review their credit control policy and make any
necessary improvements such as sending statements or telephoning
ahead of the due date and promptly chasing overdue accounts. (1)
● the partners could consider offering cash discounts for early settlement,
charging interest on overdue amounts and refusing further sales unless
overdue debts are cleared. (1)
● to help with liquidity, if debtors are taking longer to pay then the partners
could consider taking longer to pay their trade payables. (1)
● [CASE-DEPENDENT]
possible reasons for the increase in the bank overdraft.
○ Inventory increased by almost $21 000 (1)
○ Trade receivables increased from $ 22 460 to $29000 (1)
○ Trade payables reduced from $ 12 770 to $11 060 (1)
○ Non-current assets expenditure of $5200 (1)
○ Prepayments increased from $ 1 900 to $4 400 (1)
● Advise: to increase mark-up or not to increase mark-up

For increasing mark-up
• Reduce bank overdraft
• Increase (gross) profit
• Improve liquidity
• May enable to increase drawings
Against increasing mark-up
• Lose customers
• May not be able to sell
• Hard to decide the products this may be applied to
• Competitors may enter/need to consider competitors’ price
● Advise: charge interest on the full account balances of customers who d

o not pay
promptly ?
○ May improve trade receivables collection period.
○ Improve cash flow
○ Meena may lose customers
○ May need tighter credit control which may increase cost
Decision (1 mark)
Justification (2 marks)
Discuss the ratios calculated in respect of her liquidity and c omment on the overall
position.
- Trade receivables are taking three months to settle accounts owing
indicating poor credit control.
- As a result, the company are taking over four months to pay suppliers,
which may lead to supplies being stopped.
- Inventory is taking an a verage of almost six months to be sold.
- Whilst the current ratio is acceptable at 1.79:1, much of the current asset
figure is made up of inventory, leading to a liquid (acid test) ratio of less
than 1 : 1.
- Overall, the company’s liquidity is cause for concern.
Max 1 mark own figure for each relevant comment to a max of 3 marks,
plus 1 mark for conclusion.
● Assessing working capital from time to time

○ State positive/negative
○ Compare payment and collection periods, then elaborate effects/significance
○ Suggest reasons for change
○ Mention possible cashflow problem
■ Leading to bank overdraft & bank interest
Jing calculated the gross

margin and the profit margin
for his business. He
discovered that the gross
margin had decreased for
the year ended 30 April
2015. For the same period
the profit margin had
increased.
Assess the performance of

the business for the year
ended 30 April 2015.
Suggest possible reasons
for the changes.
Gross Profit
● Jing may have had to pay higher prices from his usual suppliers but have
been unable to p
ass on these higher prices to his customers. Or Jing may
have had to purchase from new suppliers who were more expensive.
● To be competitive with other businesses, Jing may have had to reduce his
prices and therefore his gross margin has reduced
● Jing may have introduced some new products at a lower introductory
price.
● To increase his volume of sales, Jing may have had more seasonal sales
promotions
● Jing’s closing inventory has reduced significantly so there may have been
out-of-date inventory that he wanted to clear at reduced prices.
● Jing’s inventory control may not have been as good and if more inventory
was being lost, damaged or stolen, this would increase his cost of sales.
● Closing inventory may be understated/miscalculated.
Profit for the year
● The increase in the profit margin could have resulted from Jing controlling
his overheads better
● The increase in the profit margin could have resulted from a decrease in
total overheads
● Most overheads, including rent, d o not normally increase in proportion to
sales
● Jing may have moved to smaller premises such that his rent has reduced
compared to the previous year.
● Discussing the performance of different companies/times with ratios
○ Compare all available ratios
○ For each, state which is better (not just higher/lower)
■ Shorter payment period -> increase supplier’s trust, but funds could have
been used for something else
○ When >1 mark is given for each ratio, give possible reasons why the two may
differ in each ratio respectively
○ Use the terms “profitability”/”efficiency”/”liquidity” in conclusion
● Advise: take loan ?

For (Max 2)
○ A long term loan will allow owner to plan repayments over five years (1)
○ Enables business to repay the bank overdraft (1)
○ Loan is cheaper than bank overdraft (1)
Against (Max 2)
○ business already has a bank overdraft of $19 000 (1)
○ business may be charged a higher interest rate on loan (1)
○ Bank loan will increase its gearing ratio (1)
○ Bank may require security for a loan (1)
● Analysing the effect on profit of using different methods of depreciation

[ provide numbers ]
○ Compare available year’s depreciation expense
○ Compare the loss/gain from sale of NCA
○ Compare the total of depreciation expense and losses/gains on disposal
○ Compare profit for the year
● Choosing a customer
○ Compare all ratios and elaborate
○ Take into account:
■ Subject’s ability to pay
■ Subject’s ability to pay promptly
■ subject’s efficiency in managing funds
● Advise: reduce inventory levels / organise advertising campaign to improve rate of
inventory turnover
Advertising campaign
● May raise public perception (1)
● May increase sales of the business (1)
● Would incur costs (1)
Reducing inventory levels
● Would lead to an increase in the rate of inventory turnover (1)
● Would reduce the risk of obsolete/damaged inventory (1)
● Would reduce customer choice/danger of not being able to fulfil orders (1)
Partnerships
● advantages to a sole trader of forming a partnership.

○ Access to increased capital
○ Increased knowledge expertise
○ Losses shared by all partners
○ Able to offer greater range of services
○ Availability of cover
○ Shared responsibilities
● Advantage of interest on capital

○ To partners
■ reward the partners for their investment in the business (1)
○ To partnership
■ encourage partners to invest in the business not elsewhere (1)
● Advantage of interest on drawings

○ To partners
■ reduce the drawings (1) ~> act as an incentive to not draw, hence
allowing them a higher income from the partnership
○ To partnership
■ defer the partners from drawing cash out of the business possibly causing
cash flow problems (1)
How the terms of the partnership agreement will affect James and Lewis:
○ James
○ James will benefit (1) as he has higher capital (1) and lower
drawings (1).
○ Lewis
○ Lewis will not benefit (1) as he has lower capital (1) and higher
drawings (1).
● reasons why a partner may have an overdrawn current account

○ They may have drawn more than the profits earned (1)
○ Partnership may have sustained losses. (1)
● why partnerships maintain separate capital accounts for each partner

○ They will need to keep their investments separate to d istinguish between
individual partners. (1)
○ To calculate interest on capital. (1)
● why partnerships maintain separate capital accounts and current accounts for each
partner.
○ To keep capital invested separate from profit and drawings
○ To help avoid the possibility of partners overdrawing
○ To reward the partner who has invested more capital with interest on the
amount invested
○ To identify partners’ drawings in order to calculate interest on drawings
● Goodwill is the excess of the valuation of a whole business over the netbook value of its
net assets (1)
● factors which affect the value of goodwill

○ Reputation
○ customer base/monopoly
○ location
○ quality product
○ skilled workforce
● items which may be included in a partnership agreement (other than the share of profit)
○ which will affect appropriation ○ will not affect the appropriation

account account
■ Interest on capital ■ Interest on loans
■ Partners’ salaries ■ Amount of fixed capital
■ Interest on drawings ■ Annual limit on drawings
● Discuss the possible sources of finance which could be used to fund the purchase of the
additional non-current assets.
• External loan
• Partner’s loan
• Introduce new partner
• Partner introduces additional capital
• Sale of unused non-current assets
• Hire purchase
Award 1 mark for identifying source plus max 2 marks for development (max 3
marks per source)
For example
- Bank loan (1)
Has to be paid back with interest at either a fixed or variable rate (1). May
require security / collateral to cover the possibility of loan default (1).
- Introduce new partner (1)
Would introduce capital which doesn’t need to be repaid (1). The partner
would however expect a share of the profits (1).
Advise Maneesh which option he should choose. Justify your answer.

Decision (1)
Loan
● Will cost $5000 in interest over the 5 years
● Means Maneesh will keep all future profit earned
● Loan has to be repaid
Partnership
● Brother may bring in additional expertise
● Will be able to share workload
● Maneesh will lose 10% o f profits earned
● Brother will bear 10% of any losses
● Capital does not have to be repaid
● difference between a realisation account a
nd a revaluation account
○ Realisation account:
Used to close the books of account (1) on the dissolution of a partnership.
○ Revaluation account:
Used to record changes in the value of assets a
nd liabilities on changes in
a partnership. (1)
● why assets are revalued on the change of a p

artnership
○ To give the benefit of the change in value of the business to the existing
partners and any partner who may be retiring. (1)
○ So that the statement of financial position on the entry of the new partner
shows a true and fair view. (1)
● why partners may value goodwill and revalue the assets when one partner retires
○ Fair value of assets may be greater than book value. (1)
○ Partners are rewarded for their efforts in building up the business. (1)
○ It is only fair that the retiring partner is compensated in this way. (1)
● situations where the capital accounts of partners may be adjusted for goodwill.
○ On the introduction of a new partner. (1)
○ On the retirement of an existing partner. (1)
○ On a change in the profit sharing ratio. (1)
● Assess the impact of a partner’s retirement on the partnership’s statement of financial

position.
○ Reduced cash flow after paying the partner to leave the business in view of the
current overdraft (1)
○ Impacts on profitability having to r aise additional capital (1)
○ Lower capital investment in the business (1)
○ Difficult to raise additional finance to pay to leaving partner due to the current
overdraft (1)
● why a partnership may be dissolved

○ Disagreements between partners
○ Death or retirement of a partner
○ Bankruptcy
● what would happen if the dissolution of the partnership resulted in a debit balance on a
partner’s capital account.
○ This means that the partner owes money to the partnership (1)
○ The partner must use his personal funds to repay the partnership bank account
(1) in order that funds owing to other partners may be repaid (1)
● Asses: leaving a partnership
Financial (Maximum 3)
○ Trueman would receive more / less income. (1)OF
○ Interest will be earned on the loan. (1)
○ The decision may be affected by the interest rate which could be obtained
externally on the capital invested. (1)
Non-financial (Maximum 3)
○ Level of risk. (1)
○ Degree of responsibility / decision making. (1)
○ Security of employment. (1)
1 mark for decision plus maximum 4 marks for justification
● provisions which would apply in the absence of a partnership agreement

○ Share profits and losses equally (1)
○ Partners are not entitled to salaries (1)
○ Partners are not charged interest on their d rawings (1)
○ Entitled to contribute equally to the capital of the partnership (1)
○ Partners are not entitled to interest on the capital they have contributed (1)
○ Partners are entitled to interest at 5% per annum on loans they make to the
partnership (1)

Current loan is due to an old partner who had just resigned. No interest is
charged.
Advise: pay loan immediately ?
● Depends on the agreement on the initial loan
● Current loan is free of i nterest
● May need additional capital
● Partnership has insufficient liquid assets at present
● May have to take loan / overdraft which will be charged interest
● Interest would reduce the future profit
● May require security for loan
● To improve cash position:

○ The partners could reduce their s alaries. (1)
○ The partners could reduce their d rawings. (1)
○ Additional capital could be introduced by the existing partners. (1)
○ A new partner, or partners, could be admitted to the partnership. (1)
○ A loan could be negotiated. (1)
○ The partnership could dispose of surplus/unused non-current assets. (1)
● New partner
Advantages Disadvantages
● More capital investment Profits must be shared (1)
(1) More potential disputes (1)
● Losses will be shared Slower decision making (1)
with more partners (1) Loss of control (1)
● New ideas (1)
● Shared workload (1)
● Shared responsibility (1)
● Shared risk (1)
● More specialist skills (1)
Limited Companies
● reasons why a company may make a bonus issue of shares

○ It enables the company to liquidate capital reserves that cannot be used to
pay a dividend (1)
○ It is less expensive than making a rights issue or an ordinary issue of shares
(1)
○ It enables the company to match long-term assets with long term capital (1)
○ If the company has not made a profit in the current year, it enables it to
reward shareholders without paying a dividend (1)
○ They do not affect the debt-equity ratio (1)
● differences between ordinary shares and preference shares

○ Preference shareholders receive a fixed rate of dividend (1)
○ Preference shareholders are paid their dividend before ordinary shareholders
(1)
○ Preference share dividend is not dependent on profits (1)
○ Preference shareholders do not have a vote at the annual general meeting
(1)
○ Preference shareholders are repaid before ordinary shareholders in the event
of the company being wound-up (1)
○ Redeemable preference shareholders are not owners
● the impact on the future profits

○ Issue of ordinary shares
■ Dividends paid to ordinary shareholders do not affect profit (1)
■ they reduce retained earnings (1) in the statement of changes in
equity (1).
■ Does not appear in the income statement (1).
○ Issue of further debenture
■ Interest paid to debenture holders is charged to the income statement
(1) reducing the profit for the year (1).
● differences between ordinary shares and debentures

Ordinary shares Debentures
○ Variable returns Fixed returns
○ Owners Creditors
○ Receive dividend Receive interest
○ Paid dividend after Paid interest before ordinary
debenture holders shareholders
○ Voting rights No voting rights
○ Not repaid Must be repaid
○ In case of liquidation paid last ~> paid first
● Advise the directors: issue of ordinary shares / further debentures. Give reasons.
○ Interest on the debentures must be paid whether the company makes a profit
or a loss (1). Ordinary share dividends are paid at the discretion of the
directors (1).
○ Debentures are a non-current liability (1) and weaken the statement of
financial position and i ncrease gearing (1) whereas ordinary shares are part
of the permanent capital of the company (1).
○ Decision (1)
● differences between a capital reserve and a revenue reserve

○ Capital reserves are not normally created by transfer from profits (1). They
usually represent gains that have not been realised (1). Capital reserves
cannot be used to pay dividends (1).
Max 2 marks
○ Revenue reserves are created by transfer from profits (1). They may be
created for a specific purpose (1), or simply to strengthen the financial
position of the company (1). Revenue reserves may be used to pay dividends
(1).
Max 2 marks
● IN THE CASE WHERE:
6% debentures (2018–2020) $60 000
(2018–2020) means that the debenture loan is repayable between the years 2018 and
2020
● examples of capital reserves:

○ Revaluation reserve
○ share premium
● why the company should not use its revaluation reserve to pay dividends to
shareholders.
○ The revaluation reserve is a capital reserve. (1) Capital reserves are not allowed
to be used for the payment of a cash dividend. (1)
○ The creation of a revaluation reserve is not a cash transaction as no cash has
been generated for the payment of dividends. (1) Cash gain can only be realised
if the asset is sold. (1)
○ The capital reserve will increase the asset value (1) of the company and the
shareholders interest and is in the accounts to reflect a true and fair view of the
company accounts.(1)
● uses of a share premium account
○ Issue of bonus shares
○ Pay premium on the redemption of debentures
○ Write off company formation expenses
○ Write off expenses of a share issue or d
ebenture issue
● difference between a bonus issue of shares and a rights issue of shares

○ A bonus issue of shares is a capitalisation of reserves (1)
○ bonus issue: free issue of shares/no cash (1)
○ A rights issue is to existing shareholders (1)
○ A rights issue generates cash for the business (1)
● an issue of debentures does not appear in the statement of changes in equity because it
is a long term liability (1) and is shown as a non-current liability in the statement of
financial position. (1)
● Bonus issue of shares

Advantages
○ Can be issued instead of paying dividends and so cash flow is not reduced.
○ (1)
○ Keeps existing shareholders satisfied as there is no dilution of ownership. (1)
○ Retains cash in the business for r einvestment. (1)
○ Gives a positive sign to potential shareholders. (1)
○ Enables company to release its c apital reserves. (1)
○ Liquidates capital reserves that cannot be used to pay dividends.
Disadvantage
○ No cash raised from selling the shares.
● [ CASE-DEPENDENT ]
major shareholders demanded that the directors pay a dividend of $0.48 per
share.
Advise: how directors respond to shareholders’ demand
● Shareholders demand would result in a payment of $60 000 (1)
● Retained earnings are o nly $45 000 (1)
● Maximum dividend payable equals 45 000 /125 000 = $0.36 (1)
● There is sufficient cash in the bank ($90 000) to pay the dividend, (1) but
insufficient retained earnings. (1)
● Fewer funds for possible future development. (1)
● Share premium account could be used to issue bonus. (1)
● Advise: Bank loan / Issue of ordinary shares
Bank loan
○ The lender would need to be convinced that the c ompany can meet the
interest and repayment obligations. (1)
○ Bank loan must be repaid. (1)
○ The loan may need to be secured (1) on the plant and equipment purchased.
○ Loan interest will be charged (1) to the Income Statement reducing profits.
○ A loan will increase the gearing of the company. (1)
○ Takes less time to issue. (1)
Share issue
○ The company has flexibility as to the level of dividends payable on the
shares. (1)
○ Share capital does not need to be repaid. (1)
○ There may be loss of control. (1)
○ Issue of more shares may dilute the share price. (1)
○ Share issue is an expensive (1) process.
○ Issuing ordinary shares will not increase the gearing. (1)
○ Takes more time to issue. (1)
○ No interest has to be paid. (1)
● why the balance on a retained earnings account may be lower than the profit for the
year.
○ Previous loss brought forward (1)
○ Payment of dividends ( 1)
○ Bonus issue of shares (1)
● converting to a limited company

○ Advantages
○ Separate entity
○ Limited liability for owners
○ Ability to raise finance
○ Disadvantages
○ Potential loss of control as additional shareholders invest
○ There will be costs associated with setting up the company
○ More detailed financial information
○ Available for public scrutiny
● why capital reserves may be used before revenue reserves t o fund a bonus issue of
shares
● To retain reserves in the most distributable or flexible form (1)
● Revenue reserves are needed to fund the payment of dividends (1)
● Right issue benefits:
○ Quicker and cheaper than a new share issue (1)
○ More likely to be fully subscribed than a new share issue (1)
○ Results in a cash inflow (1)
○ Does not have to be repaid (1)
○ Would avoid any d ilution of ownership (1)
● Long term bank loan compared with share issue as a source of capital
○ Interest on loan is fixed (1) whereas dividends are discretionary (1)
○ Ownership remains the same therefore (1) No loss of control to existing
shareholders (1)
○ Funds received quicker (1) than a share issue (1)
○ Repayments are fixed ( 1) enabling future planning (1)
Costing

Profit/Volume chart
Point A: break-even point in units

Point B: fixed costs
● P/V ratio is a measure of h

ow much contribution is earned from each $1 of sales
● CVP analysis is used to determine the effect t hat changes in costs and volume (1) will
have on the company’s operating income and net income (1).
○ Benefits:
■ useful for planning
■ provides quick estimates
■ changes in costs can be e asily incorporated
■ forecasts profit at v arious levels of output
■ identifies breakeven point
■ charts provide a clear way of presenting information – better for non
accountants
○ Assumptions:
■ Sales price per unit is constant (1)
■ Total fixed costs are constant ( 1)
■ Variable cost per unit is constant (1)
■ All production is sold (1)
■ If the company sells more than one product, the product mix remains
constant (1)
■ Costs are only affected as a result of changes in activity (1)
Discuss whether or not Lin should continue to produce all three products.
Justify your answer.
• continue with all three as they all make a contribution (1) towards fixed costs
(1)
• Y has the highest contribution per unit (1) so should maximise its sales (1)
• X has the lowest contribution per unit (1) so should consider a price increase
(1)
Advise Lin whether or not each of the orders should be accepted. Justify your
decision.
○ Order 1
• reject (1 of)
• offered price doesn’t cover marginal cost/loss of
contribution (1)
○ Order 2
• accept (1 of)
• total contribution gained covers marginal costs (1)
○ General comments:
• proposed order price must equal marginal cost to be
worthwhile. (1)
• fixed costs remain the same and so are irrelevant (1)
● why a business needs to plan for the future.
○ Map the future
○ Support growth
○ Manage cash flow
1 mark for valid point + 1 mark for development
● C/S ratio shows how much contribution is earned from each $1 of sales revenue (1)
● State what is meant by break-even point (1)

○ the point at which a product makes neither a profit or a loss (1)
○ total costs equal total revenue (1)
○ total contribution equals fixed costs (1)
The following budgeted information is available for product X.

Selling price per unit $2.00
Contribution to sales ratio 62.5%
Fixed costs $50000
Production and sales 100000 units
Prepare a break-even chart for product X
Labels on axis and

lines (1 mark)
Lines drawn
correctly (1 mark)
and labelled
correctly (1 mark)
Break-even point
identified and
labelled (1 mark)
● Allocation is the process of charging whole costs directly to a cost unit or cost centre. (1)
● overhead costs a cost incurred which cannot be traced directly (1) to a product, service
or department (1)
an indirect cost (1)
● overhead costs are reapportioned from service cost centres so that each unit of
production (1) contains a share of total overhead costs. (1)
● Advise whether to ask workers to work overtime or to buy in the products from another
supplier. Justify your answer.
Overtime
○ Workers may r efuse
○ Will meet demand
○ Reduce contribution (although still positive and may increase profits)
○ Owner knows ability of w orkers
○ Possibility of lower quality
○ Owner knows quality of w ork
○ Additional other costs
○ No delivery costs
Buy-in
○ Doesn’t know quality / reliability of supplier
○ Will meet demand
○ May be more expensive
○ May obtain better price
● marginal costing
○ Advantage
■ Good for short term decision (1) because it only considers variable
costs (1)
■ Good for special orders (1) enables accurate price to be set (1)
■ Make or buy (1) enables comparison (1)
○ Disadvantage
■ Inaccurate / h arder to calculate / time consuming (1) because it is
difficult to split costs into fixed a
nd variable (1)
■ Not useful for financial statements (1) because the inventory value
would be understated (1)
○ short-term decisions where it would be useful:
■ Make or buy decisions. (1)
■ Special order decisions. (1)
■ Decide whether or not to cease manufacturing of a product. (1)
■ Decide whether to close a department. (1)
■ Deciding production levels when there is a limiting factor
● Advise the directors: change from departmental overhead absorption rates to one
factory-wide rate? Justify your answer.
○ Easier to calculate
○ Cheaper to calculate
○ Some products may require more labour hour/machine hours
○ Less accurate
○ Different products may spend different time in each department.
● how over absorption and under absorption of overheads can affect the profit of a
manufacturing business.
○ Over absorption of overheads will mean that too much overhead is charged to
the product (1). This means that a higher price is charged to the customer (1)
leading to increased profits (1).
OR
Over absorption of overheads could also lead to a higher selling price (1) leading
to lower demand (1) and lower profits (1).
○ Under absorption of overheads could lead to insufficient overhead being charged
to a product (1). This means a lower price is charged to the customer (1) which
fails to cover costs and reduces profit (1).
OR
Under absorption of overheads could also lead to a lower selling price (1) leading
to higher demand (1) and higher profits (1).
● the AVCO method of inventory valuation

○ Advantages (max 4, 1 + 1 for development)
• Averaging smooths out fluctuations in costs making comparison
between periods more valid
• Averaged prices used to value closing inventory likely to be closer to
latest prices
• Avoids identical items being charged to a job at different prices
○ Disadvantages (max 2, 1 + 1 for development)
• Average price has to be re-calculated after each purchase – time
consuming
• Average price does not represent any price actually paid
● A cost unit is a unit of production (1) whereas a c ost centre is part of a business to which
costs can be attributed / allocated to (1)
● Production cost centre is directly involved in producing the goods e.g machining,
assembly (1), while service cost centre provides a service for the production cost centres
/not involved in the production of goods (1)
● Contribution is the amount each unit of production makes towards covering the fixed
costs (1) and providing a profit. (1)
OR
the difference between sales revenue and variable costs (1) contributing toward making
a profit (or towards the fixed costs)(1)
● ‘batch costing’ is method of costing that you apply to the production of a number of
identical items. (1) The cost per unit is found by dividing the total batch cost by the
number of units in the batch. (1)
● budgetary control
○ Advantages:
• Assists with planning for the future (1)
• Helps to monitor performance (1)
• Compares budget and actual, identifying, variances enabling corrective
action to be taken (1)
• Enables delegation to departments (1)
• Assists with decision making (1)
• Helps with responsibility accounting / enables assessment of managers (1)
• May motivate staff (1)
○ Disadvantages:
• Budgets are an estimate and could be inaccurate (1)
• Budget are time consuming and/or expensive to create and monitor (1)
• Could lead to conflict between departments (1)
• Could demotivate employees (1)
• May have to employ specialist staff (1)
• Budget may be set an unrealistic level (1)
• Does not take account of unforeseen circumstances (1)
• Can restrict staff innovation (1)
● margin of safety
○ represents the difference between the budgeted total sales and the budgeted
break-even sales.
○ significance: the amount by which actual s ales can fall short of the budgeted
sales before he reaches break-even point (1) and then makes no profit (1).
● Advise: changing from absorption to marginal (5)
(1 mark for decision)
○ Reasons to change to marginal costing: (max 2)
• simple and quick to operate
• no apportionment of fixed costs
• fixed costs are treated as period costs and so remain unchanged at different
activity levels
• no over/under absorption of overhead costs to calculate
• no further adjustment needed in the income statement for over/under
absorption
• closing inventory is realistically valued at variable production cost
• allows easy calculation of profit when changes in activity occur
• great aid in decision making/pricing/make or buy situation.
• more suitable for short-run
○ Reasons to keep absorption costing: (max 2)
• it shares fixed production costs to u nits of production, which is fair as these
costs are incurred in order to make the output
• it is easier to determine profitability of several products as they include a
share of fixed overheads.
• it values closing inventory fairly
• helps set prices
• more suitable for long-run
● break-even analysis
○ Benefits
○ Calculate the break-even point
○ Calculate margin of safety
○ Helps with (short term) decision making
○ Easy to predict profits and losses at different levels of output.
○ Quick method of calculating to show impact of decision on profits.
○ Limitations
○ Some costs are not easily classified as fixed or variable.
○ Some costs are semi-variable.
○ It assumes fixed costs stay the same.
○ Straight lines can be m isleading – discounts can cause curved lines.
○ A chart can be time consuming to prepare.
○ It assumes the selling price is constant at all levels of output.
○ It can be misleading for those with l imited accounting knowledge.
○ Can only be applied to one product at a time
● Advise: increase selling price?
○ Proceed because
• It covers the budgeted total costs and provides a profit.
• It provides a positive contribution.
○ Need to bear in mind
• The market price of similar products.
• How innovative is his product to justify the price increase / will customers
expect higher quality for higher price.
• Will customers accept the increase or go elsewhere / decrease in demand.
• Fixed costs are covered for now but they may change in the future.
• Short term view – he could lose profit in the long term.
● Absorption costing drawbacks

○ It is more time consuming to calculate the overhead absorption rate and adjust
for over / under absorption.
○ It is more complicated to calculate and managers may need training.
○ It is irrelevant in short-term decision making as fixed costs don’t change.
○ Fixed costs relate to a period in time and so can be misleading to charge to
production units.
○ The basis used to apportion and absorb overheads may be arbitrary.
Recommend to the directors which proposal they should adopt. Justify your answer
by discussing the benefits and drawbacks of each proposal.
Proposal A
Benefits (Max 2)
• Break-even point reduces from 54 640 units to 53 733 units
• Reduced cash outflows on direct materials and administrative expenses
Drawbacks (Max 2)
• Reduced sales commission may result in fewer agency sales
• Reduced administrative backup may hinder g rowth
• Less expensive direct material may affect quality
• Redundancy will incur costs / demotivate staff / result in bad image
Proposal B
Benefits (Max 2)
• Opportunity to market new improved product
• More expensive direct material may enhance quality
• Opportunity to raise awareness with advertising spend
• Sales commission retained at current level
Drawbacks (Max 2)
• Break-even point increases from 54640 units to 57 456 units
• Reduced administrative backup may hinder g rowth
• Increased cash outflow of direct materials and advertising
• Will sufficient sales be made to reach break-even point?
• Redundancy will incur costs / demotivate staff / result in bad image
1 mark for recommendation
● Advise: hire a replacement machine
Advantages (Maximum 2)
○ Will enable company to fulfil maximum demand. (1)
○ Will enable full utilisation of resources. (1)
Disadvantages (Maximum 2)
○ Will reduce profit. (1)
○ Forecast maximum demand may not be achieved thus reducing profit even
further. (1)
● Advise: allowing discounts on order as per request

○ Owner would still make a profit on the order. (1)
○ The order will help ensure the workforce is kept busy. (1)
○ May lead to further orders from customer. (1)
○ However, other customers may also start demanding discount, (1) which would
reduce overall profit. (1)
○ Reaction of competitors who may lower their prices. (1)
○ Could lose order if discount not given. (1)
● Advise: closing factory believed to be unprofitable

Non-financial reasons
○ If Anna doesn’t fulfil the existing orders, the customers will not be happy / loss
of reputation. (1)
○ Could have a knock-on effect for other orders of other products. (1)
○ Can workforce be used elsewhere if they don’t make these orders / lay off
workers. (1)
○ Morale of employees in existing factory.
Financial reasons
○ The orders provide a positive contribution towards fixed costs. (1)
○ At present current level of demand is below break-even point - factory
operates at a loss. (1)
○ Demand may increase in the future and make the new factory profitable. (1)
○ How accurate is the financial data. (1)
○ Will closing the factory result in redundancy costs. (1)
● why profit calculated using absorption costing would be different to profit calculated
using marginal costing.
○ Using marginal costing,
closing inventory is valued at variable production cost and so shows a
lower closing inventory value. (1) Fixed overheads are treated as
period costs (1) and are written off in the period’s income statement.
(1)
○ Using absorption costing,
closing inventory is valued at full production cost and so shows a
higher closing inventory value. (1) Fixed overheads are treated as part
of production costs (1) and are carried forward as part of the inventory
value. (1)
● In advising short-term decisions, take into account:

○ Profits ○ Reliance on single party
○ Target profit ○ Additional costs
○ Contribution ○ Long-term shortage
○ Utilisation of capacity ~> ○ Dependency of product
maximisation of profit with one another
○ Quality ○ Staff skills
■ If workers work to ○ Opportunity cost (MRT)
full capacity ○ Other possible
○ Customer satisfaction suggestions
■ Price ○ Whether fixed costs will
■ Volume be covered in long-term
■ Quality ○ Success of planned
○ Morale/reaction of program
employees
○ Reaction of competitors

Accounting Summary

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Accounting Theory for AS Level 9706

Past Papers 2016 - M/J 2018

● types of entries​ which would usually be recorded in the ​general journal

● causes​ of ​depreciation​ of non-current assets.

● why​ a company should ​provide for depreciation​ on its non-current assets

● accounting concept​ relating to ​depreciation

● Inventory Valuation: ​lower of..

● Provision for doubtful debts

● sales ledger control account

● ‘​revenue expenditure​’ is money ​spent: on the day-to-day ​running expenses of the

● Maintaining a full set of accounting records

● accounting​ treatments ​for l​ oose tools

● benefits​ to a business of preparing ​annual financial statements

● Books of prime entry: first books in which transactions are recorded

● Hi​storical cost ● going ​Concern ● M​ateriality

● Importance of ​Current Ratio

● FOR THE CASE WHERE:

the ​effect​ of this course of action on:

● FOR THE CASE WHERE:

Comment​ on the ​changes in liquidity​ of the partnership from 30 September 2014

● Advise​: to increase ​mark-up​ or not to increase mark-up

● Advise​: ​charge interest​ on the full account balances of ​customers​ who d

● Assessing working capital from time to time

Jing calculated the gross

Assess the performance​ of

● Advise​: take​ loan ​?

● Analysing the effect on profit of using different methods of depreciation

● advantages to a sole trader of ​forming a partnership​.

● Advantage of ​interest on capital

● Advantage of ​interest on drawings

● FOR THE CASE WHERE:

● reasons why a ​partner​ may have an ​overdrawn current account

● why​ partnerships ​maintain separate capital accounts​ for each partner

● factors which ​affect​ the value of ​goodwill

○ which will ​affect appropriation ○ will ​not affect​ the ​appropriation

● FOR THE CASE WHERE:

​Advise​ Maneesh ​which option​ he should choose.​ Justify ​your answer.

● why​ ​assets​ are ​revalued​ on the ​change​ of a p

● Assess the ​impact​ of a​ partner’s retirement​ on the partnership’s ​statement of financial

● why​ a partnership may be ​dissolve​d

● provisions which would apply in the ​absence​ of a ​partnership agreement

● FOR THE CASE WHERE:

● To​ improve cash position​:

● reasons​ why a company may make a ​bonus issue​ of shares

● differences​ between ​ordinary shares​ and ​preference shares

● the ​impact​ on the ​future profits

● differences​ between ordinary shares and debentures

● differences​ between a ​capital reserve​ and a ​revenue reserve

● IN THE CASE WHERE:

6% debentures (2018–2020) $60 000

● examples of ​capital reserves​:

● difference​ between a ​bonus issue​ of shares and a ​rights issue​ of shares

● Bonus issue​ of shares

● converting to a ​limited company

● FOR THE CASE WHERE:

Point A​: break-even point ​in​ units

● P/V ratio​ is a ​measure​ of h

● State ​what​ is meant by ​break-even point​ (1)

● FOR THE CASE WHERE:

The following budgeted information is available for product X.

Prepare a ​break-even chart​ for product X

Labels on axis and

● types of entries which would usually be recorded in the general journal

● causes of depreciation of non-current assets.

● why a company should provide for depreciation on its non-current assets

● accounting concept relating to depreciation

● Inventory Valuation: lower of..

● ‘revenue expenditure’ is money spent: on the day-to-day running expenses of the

● accounting treatments for l oose tools

● benefits to a business of preparing annual financial statements

● Historical cost ● going Concern ● Materiality

● Importance of Current Ratio

the effect of this course of action on:

Comment on the changes in liquidity of the partnership from 30 September 2014

● Advise: to increase mark-up or not to increase mark-up

● Advise: charge interest on the full account balances of customers who d

Assess the performance of

● Advise: take loan ?

● advantages to a sole trader of forming a partnership.

● Advantage of interest on capital

● Advantage of interest on drawings

● reasons why a partner may have an overdrawn current account

● why partnerships maintain separate capital accounts for each partner

● factors which affect the value of goodwill

○ which will affect appropriation ○ will not affect the appropriation

Advise Maneesh which option he should choose. Justify your answer.

● why assets are revalued on the change of a p

● Assess the impact of a partner’s retirement on the partnership’s statement of financial

● why a partnership may be dissolved

● provisions which would apply in the absence of a partnership agreement

● To improve cash position:

● reasons why a company may make a bonus issue of shares

● differences between ordinary shares and preference shares

● the impact on the future profits

● differences between ordinary shares and debentures

● differences between a capital reserve and a revenue reserve

● examples of capital reserves:

● difference between a bonus issue of shares and a rights issue of shares

● Bonus issue of shares

● converting to a limited company

Point A: break-even point in units

● P/V ratio is a measure of h

● State what is meant by break-even point (1)

Prepare a break-even chart for product X

● the AVCO method of inventory valuation

● Advise: allowing discounts on order as per request

● Advise: closing factory believed to be unprofitable