Examiners' Commentaries 2014: AC1025 Principles of Accounting

Examiners’ commentaries 2014

AC1025 Principles of accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 2013–14. The format and structure of the examination may change in future years,
and any such changes will be publicised on the virtual learning environment (VLE).
Information about the subject guide
Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2013).
You should always attempt to use the most recent edition of any Essential reading textbook, even if
the commentary and/or online reading list and/or subject guide refers to an earlier edition. If
different editions of Essential reading are listed, please check the VLE for reading supplements – if
none are available, please use the contents list and index of the new edition to find the relevant
section.
General remarks
Learning outcomes
At the end of this course, and having completed the Essential reading and activities, you should be
able to:
• distinguish between different uses of accounting information and relate these uses to the
needs of different groups of users
• explain the limitations of such statements and their analysis
• categorise cost behaviour, and prepare and contrast inventory valuations under different
costing methods
• describe the budgeting process and discuss the use of budgets in planning and control
• explain, discuss and apply relevant techniques to aid internal users in decision-making.
What the Examiners are looking for
The examination paper covers a range of financial and management accounting topics, all of which
the well-prepared candidate will have studied. The questions are designed to encourage candidates
to think about the theories and principles of accounting and to demonstrate their ability to apply
relevant concepts in a variety of situations or to a given set of information. Where appropriate,
questions are sub-divided to help candidates answer in a logical manner. The examination will
always include questions designed to test candidates’ ability in interpretation and analysis of
financial information.
The rubric of the examination paper is set out on the front cover and you should ensure that you
precisely follow these instructions. It is very important that you do not waste time and effort in
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answering more questions than is required, as marks will only be awarded to the correct number of
questions. You are advised to read all of the questions before deciding which to answer in each
section. Time allocation is an important factor in accounting examinations. You should decide how
much time to spend on each question, based on the overall marks for the question and for each
section, and you should then adhere to these time allocations. The format of the examination
requires you to answer Question 1 of Section A, which is in four parts. It is important that you
allocate your time on this question so that you attempt all of the four parts. You are then required
to answer Question 2 of Section B, and two further questions, one from Section C and one from
either Section B or C. Please note that failure to comply with these requirements may result in some
of your work not being marked.
The rubric of the examination states that workings must be submitted for all questions requiring
calculations. The importance of this cannot be overstated, as in the absence of workings, simple
arithmetic errors cannot be distinguished from errors of principle and understanding. Thus the
absence of workings will very often lead to an over-penalisation of errors. Of course, arithmetic
errors may in some instances result in some loss of marks, and you should always be careful to check
your calculations. The rubric also states that any necessary assumptions introduced into answering a
question should be stated. If you do not understand what a question is asking (a circumstance the
Examiners endeavour to avoid), then you must state any consequent assumptions that you have
made. Even if you do not answer in precisely the way the Examiners had hoped, you may get a good
mark providing your assumptions are reasonable. The most frequent reason for failing to do well in
the examination, apart from lack of knowledge, is not answering the question actually set. You
should take time to read each question carefully, and then attempt to answer everything that the
Examiner requires. Far too many candidates include every scrap of knowledge they have on a topic
without specically addressing the question and this can have a disastrous effect on their marks.
Read the question carefully and tailor your answer to precisely what it asks and you should do well.
Accounting is a progressive subject where it is essential to understand a particular topic before you
go on to the next. Make sure that you understand the basic concepts and can apply them in an
appropriate manner so that there is a logical structure to your answers. Do not write something that
you do not understand for, if you do, you are likely to produce a muddled response. In answering
computational questions, think carefully about the layout and logical progression of your answer
before writing and set out your answer in a structured and easily readable format. You will be
rewarded for an appropriate, logical and sensible method even if the figures contain errors. The
subject guide and textbook contain numerous worked examples, which you should have studied
carefully, and practice questions with solutions which should form a key part of your study and
revision.
You will find 8-column accounting paper is incorporated into the answer booklet. It may be
particularly useful where tables of figures are required because it keeps answers neat and saves ruling
lines for different columns. You are strongly advised to practise using it while you are preparing
answers as part of your study of accounting. A sheet is available to download from the AC1025 page
on the VLE and you can print off as many sheets of the paper as you need.
This subject does not require a lot of reading beyond the core text of Perks, R. and D. Leiwy
Accounting: understanding and practice. (Maidenhead: McGraw-Hill, 2013) fourth edition [ISBN
9780077139131], but it is essential that you adopt an approach of thorough study, plenty of practice
answering questions and an ability and willingness to think logically. All major topics are covered at
the appropriate level in the recommended text by Perks and Leiwy and others are covered in the
subject guide. References presented in the ‘Comments on specic questions’ for Zone A and Zone B
indicate where certain topics may be found in the current edition of the subject guide (2013), which
is an essential part of the study material for this course. You are also encouraged to read the
financial press, including accounting journals and listen to, or watch, financial programmes and visit
appropriate websites. This will enable you to keep abreast of current issues and help you to develop
your ideas and opinions about them.
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Question spotting
Many candidates are disappointed to find that their examination performance is poorer
than they expected. This can be due to a number of different reasons and the Examiners’
commentaries suggest ways of addressing common problems and improving your performance.
We want to draw your attention to one particular failing – ‘question spotting’, that is,
confining your examination preparation to a few question topics which have come up in past
papers for the course. This can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in the same depth, but
you need to be aware that Examiners are free to set questions on any aspect of the syllabus.
This means that you need to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the ‘Course information sheet’ in the section of the VLE dedicated
to this course. You should read the syllabus very carefully and ensure that you cover sufficient
material in preparation for the examination.
Examiners will vary the topics and questions from year to year and may well set questions that
have not appeared in past papers – every topic on the syllabus is a legitimate examination
target. So although past papers can be helpful in revision, you cannot assume that topics or
specific questions that have come up in past examinations will occur again.
If you rely on a question spotting strategy, it is likely you will find yourself in
difficulties when you sit the examination paper. We strongly advise you not to
adopt this strategy.
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Important note
section.
Comments on specific questions – Zone A
Candidates should answer FOUR of the following SEVEN questions: QUESTION 1 of Section
A, QUESTION 2 of Section B, ONE question from Section C and ONE further question from
either Section B or C. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary assumptions
introduced in answering a question are to be stated.
Section A
Answer question 1 from this section.
Question 1
(a) Cordelia commenced in business as an executive taxi service on 1st January

2012. She purchased two cars, a Mercedes for £20,000 and a BMW for £36,000.
In March 2013 the Mercedes was involved in a collision and damaged beyond
repair. The insurance company gave Cordelia £15,000 in settlement of her claim.
She replaced the Mercedes with an Audi at a cost of £40,000 in April 2013.
Cordelia’s accountant adopted a policy of charging a full year’s depreciation in
the year of acquisition and no depreciation in the year of disposal. It is assumed
that the cars will be used until the end of their useful life and thus will have no
residual value.
Required:
i. Show extracts from Cordedlia’s income statement and statement of financial
position for the years ended 31 December 2012 and 2013 on the basis of:
I. Depreciation using the straight line method over 10 years.
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II. Depreciation at 20% using the reducing balance method.

(5 marks)
ii. Explain how management of a business should decide on an appropriate
method of allocating depreciation.
(1 mark)
Reading for this question

Subject guide, Chapter 4, pp.70–77.
Perks, R. and D. Leiwy Accounting: understanding and practice. (Maidenhead:
McGraw-Hill, 2013) fourth edition [ISBN 9780077139131] Chapter 1.
Approaching the question
The depreciation of non-current assets is a recurring topic in this course. This question
required candidates to apply both the straight line and the reducing balance methods to a
data set, with the resulting information presented as extracts from the financial statements.
It is important that candidates follow these requirements and show all their workings neatly
and clearly. Part (ii) only required an explanation of how management chooses between
these methods. Answers should not have included a detailed discussion of how these
methods are applied.
i.
(I) Straight line depreciation
31/12/12 31/12/13
Income statement
Depreciation 5,600 7,600
Loss on disposal 3,000
Statement of financial position

Cost 56,000 76,000
Acc depn 5,600 11,200
N.B.V. 50,400 64,800
(II) Reducing balance
Income statement
Loss on disposal 1,000
Statement of financial position

Cost 56,000 76,000
Acc depn 11,200 20,960
44,800 55,040
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Workings
1. Straight line M BMW
2012
Cost 20,000 36,000
18,000 32,400
2013
Proceeds 15,000
Loss 3,000
Audi
Cost 40,000
Book value 36,000 28,800
2. Reducing balance
M BMW
2012
Cost 20,000 36,000
16,000 28,800
2013
Proceeds 15,000
Loss 1,000
Audi
Cost 40,000
32,000 23,040
ii. Management should choose the method that most closely matches the cost to the pattern
of benefit obtained from the assets used.
(b) The conceptual framework of accounting recognises four qualitative

characteristics of financial information that is useful for decision making.
Required:
Identify and briefly explain these four qualitative characteristics.
(6 marks)
Perks, R. and D. Leiwy (2013), Chapter 3, pp.58–61.
The conceptual framework of accounting is an important topic in this course, as it provides
a theoretical underpinning to financial reporting. The qualitative characteristics are a key
part of the framework. Candidates should not try and supplement their answer with
irrelevant issues, such as going concern or accruals. The answer given below indicates,
briefly, the terms that should have been identified and explained.
• Relevance – predictive value and confirmatory value.
• Faithful representation (reliability):
∗ completeness, neutrality
∗ freedom from error
∗ correspondence with economic criteria
• Comparability – consistency and disclosure.
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• Understandability – nature of users’ knowledge.
(c) Edmund plc has prepared the following data for a new product to be launched
on 1 January 2015:
Standard costs per unit: £

Direct materials 20.80
Direct labour 36.40
Variable production overhead 15.60
Standard variable cost 72.80
Other data:
Fixed production overhead 1,950,000 per annum
Selling price £135.20 per unit
Budgeted production data (in units)

Opening inventory 0
Production 190,000
Sales 160,000
Closing inventory 30,000
Required:
i. Prepare budgeted profit statements for the year ended 31 December 2015 on
the basis of:
• Marginal costing, showing contribution and gross profit. (3 marks)

• Total absorption costing, showing gross profit. (2 marks)
Show your figures to the nearest £000.
ii. Explain the accounting implications for fixed overheads if the actual
production for 2015 was 180,000 units. The reduction in production was due
to flooding of the factory.
(2 marks)
Perks, R. and D. Leiwy (2013), Chapter 14.
The learning outcomes for Chapter 9 require candidates to be able to prepare and contrast
stock valuations under different costing methods. This question tested that ability. It is
important that candidates set out the statements and calculations in a clear and organised
manner.
Good answers demonstrated that candidates had thought about the layout of their answers
carefully and had designed them to bring out the key elements of each method. This topic
has been tested regularly, but it has usually been poorly answered. Candidates are strongly
advised to master these concepts and techniques.
Part (ii) required an explanation of how a drop in production, due to an unforeseen event,
resulted in an under-recovery of fixed overheads.
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i.
(a) Marginal costing £000
Sales 21,632
Opening inventory 0
Variable costs 13,832
Closing inventory (2,184) (11,648)
Contribution 9,984
Fixed overheads 1,950
Gross profit 8,034
(b) Total absorption costing

Sales 21,632
Opening inventory 0
Total costs 15,782
Closing inventory (22,192)
Gross profit 8,342
Workings
1. Marginal cost of closing stock (30,000 × 72.8) = 2,184,000
2. TAC – Cost of closing inventory

Variable cost 72.80
Fixed overhead
1,950,000 = 10.26
190,000 83.06
× 30,000 = 2,491,800
ii. Fixed overheads would not change due to over-production but inventories would be
valued on the basis of budgeted production. There would be an under-recovery of fixed
overheads of 10,000 × 10.26 = £102,600 due to the flooding.
(d) Compare and contrast the Accounting Rate of Return and the Internal Rate of
Return methods of investment appraisal.
(6 marks)

Subject guide, Chapters 11 and 12.
Long-term investment appraisal is a key topic, and one of the important learning outcomes is
for candidates to be able to explain the uses and limitations of the main appraisal methods.
Candidates should note the need to compare and contrast these methods. The framework of
the answer below is one way in which candidates could have structured their answer. The
answer given here is in a summary form; candidates should write their answer out in full.
Average annual profit
ARR =
Investment
Disadvantages
Uses profit not cash flows.
Does not provide an absolute measure - percentage net value.
Ignores size of investment and cash flows.
Ignores time and true value of money.
Advantages
Simple and intuitive.*
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Related to required rates of return.

IRR = discount rate at which NPV of project is zero.
Advantages
D. Recognises true value of money.
A. Uses relevant cash flows, not profit.
E. Related to cost of capital.
Disadvantages
C. Ignores size of project. May not be unique*
B. Does not provide an absolute measure.
Letters A–D are related comments for compare/contrast. * more specific can be given credit.
Section B
Answer question 2 and not more than one further question from this section.
Question 2
The Lear Co. Ltd has the following balances on its books at 31 December 2013:
Debit Credit
£ £
Equity shares (50p each) 20,000
Revaluation reserve at 1 January 2013 14,000
Purchases 240,000
Sales revenue 310,000
Inventories at 1 January 2013 20,000
Directors’ fees 6,000
Retained earnings at 1 January 2013 35,700
10% debentures 20,000
Debenture interest paid 1,000
Discounts allowed 500
Administrative expenses 18,000
Sales staff salaries 18,500
Selling and distribution expenses 6,500
Bad debts written off 400
Insurance 1,700
Trade receivables 14,000
Provision for doubtful debts at 1 January 2013 300
Trade payables 9,700
Land and buildings at cost 65,000
Motor vehicles at cost less depreciation 19,800
Bank 2,100
Dividend paid 400
411,800 411,800
The following information is also given:
1. The inventory at 31 December 2013 has been valued at £32,000. Further

investigation reveals that this includes some items originally purchased for
£3,000, which have been in inventory for a long time. They need modification,
probably costing about £600, after which it is hoped they will be saleable for
£3,200. Items with a cost price of £5,000 have been sent to an agent and are
still at his premises awaiting sale. These items have incorrectly been treated as
a sale on credit at a mark-up of 10% on cost.
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2. The balance on the motor vehicles account is made up as follows:

£
Motor vehicles at cost (as at 1 Jan 2013) 30,000
Less: Provision for depreciation to 1 Jan 2013 13,800
16,200
Additions during 2013 at cost 3,600
19,800
Depreciation is provided at 15 per cent per annum on the straight line method.
A full year’s depreciation is provided in the year of purchase.
3. The discounts allowed were given to customers for early payment.
4. The directors wish to make a provision for doubtful debts of 5 per cent of the
balance of trade receivables at 31 December 2013.
5. Insurance prepaid at 31 December 2013 amount to £400, and sales staff ’s

salaries owing at that date were £443. An adjustment is required for debenture
interest due.
6. The directors have proposed an equity dividend of 5p per share.
7. Taxation payable on the profit for the year is estimated at £4,200.
Required:
(a) Prepare for Lear Co Ltd for the year ended 31 December 2013:
i. Income Statement for the year.

(11 marks)
ii. Statement of changes in equity for the year.
(2 marks)
iii. Statement of financial position for the year.
(8 marks)
(b) Explain the meaning of the terms ‘provision’ and ‘reserve’, giving one example
of each from the statement of financial position you have prepared.
(4 marks)
Subject guide, Chapters 4, 5 and 6.
The preparation of final accounts from structured information is a key learning outcome. A trial
balance with several adjusting items has been the format for the compulsory question over recent
years. In answering this type of question, a methodical and organised approach was needed. It is
very important that detailed, legible workings are given in order that marks are awarded for all
work which is correct. If figures in the final accounts comprise of a number of items, marks will
be awarded accordingly. Without workings, one error may result in several marks being lost.
Candidates should allow the Examiners to award all available marks. The 8-column accounting
paper provided is particularly useful for presenting the financial statements. Candidates should
pay attention to the presentation of their answer, taking care to use the appropriate descriptions
of line items in the income statement and statement of financial position. The format of the
statement of changes in equity should follow best practice.
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(a) i. Income statement for the year ended 31 December 2013

£ £
Sales 310,000
Less: Cost of sales
See correction sheet Opening
for replacement
inventory
text. 20,000
Purchases 240,000
260,000
Less: Closing inventory (31,600) 228,400
Gross profit 81,600
Expenses
Discounts allowed (500)
Directors fees (6,000)
Sales staff salaries (18,500 + 443) (18,943)
Administrative expenses (18,000)
Selling and distribution costs (6,500)
Depreciation (15% × 33,600) (5,040)
Insurance (1,700 − 400) (1,300)
Bad and doubtful debts (400 + 50) (450)
(56,733)
Profit before interest and tax 24,867
Debenture interest (1,000 + 1,000) (2,000)
Profit before tax 22,867
Taxation (4,200)
Profit for the year 18,667
ii. & iii. Statement of changes in equity for year ended
Share Revaluation Retained Total
capital reserve earnings
£ £ £ £
As at 1 January 2013 20,000 14,000 35,700 69,700
Profit for the year 18,667 18,667
Dividend paid (400) (400)
As at 31 December 2013 20,000 14,000 53,967 87,967
Workings
1. Closing inventory
Valuation 32,000
NRV adjustment 3,000 − (3,200 − 600) (400)
Goods with agent 5,000
36,600
2. Provision for doubtful debts

As at 1 January 300
Increase 125
As at 31 December (5% × 8,500) 425
(b) Part (b) required an explanation of two key accounting terms, but answers demonstrated a
lack of understanding of these terms by many candidates.
Provisions are liabilities of uncertain amount or timing. Examples are provisions for
warranties or legal costs.
Reserves are part of equity and they represent retained earnings or gains. They may be
distributable (revenue) or non-distributable (capital).
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Question 3
The following information relates to the activities of Goneril plc:
Income statement for the year ended 30 April 2014
£000
Sales 13,560
Cost of sales (10,260)
Gross profit 3,300
Expenses (2,298)
Tax (450)
Profit after tax 552
Statement of changes in equity for the year ended 30 April 2014
Share Share Revaluation Retained

Capital Premium Reserve Earnings Total
£000 £000 £000 £000 £000
Balance at 1 May 2013 1,200 480 — 1,128 2,808
Issue of shares 300 60 360
Revaluation of freehold 240 240
Profit for the year 552 552
Dividend paid (210) (210)
1,500 540 240 1,470 3,750
Statements of financial position as at 30 April
2013 2014
£000 £000
Non-current assets
Freehold land, cost 2,100 2,340
Plant and Equipment 990 1,092

3,090 3,432
Current assets
Inventory 1,068 1,494
Receivables 990 912
Bank 90 —
2,148 2,406
Total assets 5,238 5,838
Current liabilities
Payables 720 690
Taxation 360 270
Overdraft — 378
1,080 1,338
Non-current liabilities
6% Debentures 1,350 750
Total liabilities 2,430 2,088
Equity 2,808 3,750
Total equity and liabilities 5,238 5,838
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Additional information:
1. Plant and Equipment

Cost Acc. Depn Net
£000 £000 £000
As at 1 May 2013 1,680 690 990
Disposal (240) (174) (66)

Additions 540 540
Depreciation for year — 372 (372)
As at 30 April 2014 1,980 888 1,092
The plant was disposed of for proceeds of £42,000. Depreciation and any profit
or loss on disposal are included in expenses.
2. The debentures were repaid on 31 October 2013. Interest for the year was fully
paid by 30 April 2014 and is included in expenses.
Required:
(a) Prepare the Statement of Cash Flows for Goneril plc for the year ended 30
April 2014.
(19 marks)
(b) Explain how a statement of Cash Flows provides information about a company’s
financial performance in addition to that provided by the other financial
statements. Use the answer to (a) to illustrate your answer.
(6 marks)
This question required the preparation of a cash flow statement (CFS). Candidates should adopt
a systematic approach, which would enable them to extract the cash flows from the
accruals-based income statement and statement of financial position. The resulting increase or
decrease in cash balances should be reconciled to the relevant figures in the statement of financial
position. Good answers would be well presented, correctly describing the component cash flows
with clearly laid out workings. Part (b) of this question required an explanation of the usefulness
of a CFS. Good answers would have taken note of the requirement to use the answer to part (a)
to illustrate the points made.
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(a) Goneril plc

Statement of cash flows for the year ended 31 March 2014
Cash flows from operating activities
See correction sheet for replacement text. £000
Profit before tax 1002
Add back interest (W1) 63
Profit from operations 1065
Add back: Depreciation (W2) 372
Loss on sale of plant (W3) 24
Increase in inventory (426)
Decrease in receivables 78
Decrease in trade payables (30)
Cash flow from operating activities 1083
Interest paid (63)
Tax paid (W4) (540) (603)
Net cash from operating activities 480
Cash flows from investing activities

Purchase on non-current assets (W5) (780)
Proceeds from sale of non-current assets 42 (738)
Net cash used in investing activities
Cash flows from financing activities

Issue of shares 600
Repayment of debentures (450 − 250) (600)
Dividends paid (210) (210)
Net cash used in financing activities (468)
Decrease in cash and cash equivalents

Cash and cash equivalents at start of year 90
Cash and cash equivalents at end of year (378)
Workings
(W1) Interest on debentures
6% × 1350 × 6/12 + 6% × 750 × 6/2 63
Plant − WDV 66
(W2) Proceeds 42
Loss 24
(W3)
Profit/loss on sale of plant = Proceeds − NBV of plant
= 14,000 − (80,000 − 58,000)
= £(8,000) (loss)
(b) A statement of cash flow focuses on operating, inventory and financing activities, which the
other financial statements do not specifically do.
It explains why, despite a healthy profit, the company had lost cash over the year – mainly
through the acquisition of non-current assets, which was not financed by any means other
than operating activities.
Much cash from operating activities was used to pay tax liabilities.
Although the company issued shares, the funds raised had been used in their entirety to
repay the debentures.
Reconciliation of profit before tax to cash flows from operations provides useful information;
although, for this company, the profit and cash flow figures were similar. However, this aids
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understanding of management of working (liquid) capital, and it showed that the large
increase in inventories had reduced the cash available for other purposes. This information
was not obvious from just the income statement and statement of financial position.
Statement of cash flows eliminates the impact of accruals accounting, and it might be a way
of highlighting earnings management by the company to manipulate reported profits.
Other valid comments would be given appropriate credit.
Question 4
Regan Products plc is a company which has had some problems with its overseas
supply chain and would like to acquire a suitable company based in the UK that
manufactures certain items from its product range. It has identified two possible
private limited companies, Edgar Ltd and Oswald Manufacturing Ltd, and obtained
the following draft financial statements for each. The management of each company
has indicated that they would be receptive to a takeover.
Income statements for the year ended 31 March 2013
Edgar Oswald
£000 £000
Revenue 12,000 20,500
Cost of sales (9,330) (15,440)
Gross profit 2,670 5,060
Administrative expenses (920) (2,040)
Distribution costs (490) (1,020)
Finance costs
Loan notes (210) (300)
Overdraft — (10)
Bank loan — (290)
Profit before tax 1,050 1,400
Income tax (150) (400)
Profit for the year 900 1,000
Statements of financial position at 31 March 2013
Edgar Oswald
£000 £000
Assets
Non-current assets
Freehold factory 4,400 —
Plant and machinery 4,200 6,200
Fixtures and fittings 800 1,300
9,400 7,500
Current assets
Inventories 2,000 3,600
Trade receivables 2,400 3,700
Bank and cash 600 —
5,000 7,300
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Equity and liabilities
Equity
Equity shares of £1 each 2,000 2,000
Share premium 900 —
Revaluation reserve 1,200 —
Retained earnings 3,000 800
7,100 2,800
Bank loan — 3,700
7% loan notes 3,000 —
10% loan notes — 3,000
3,000 6,700
Current liabilities
Bank overdraft — 1,200
Trade payables 3,700 3,900
Taxation 600 200
4,300 5,300
Notes:
1. Both companies operate from similar premises. Edgar Ltd, owns the freehold of
its factory, and Oswald Manufacturing Ltd, rents its premises. Edgar Ltd
adopts the revaluation method for its premises.
2. The original cost of the plant and machinery in each company was:
Edgar Ltd £5,800,000
Oswald Manufacturing Ltd £18,700,000
There were no significant disposals of non-current assets during the year by
either company.
3. The companies paid the following dividends during the year:
Edgar Ltd £250,000
Oswald Manufacturing Ltd £700,000
Required: Produce a report which compares the financial performance, financial

position and liquidity of Edgar Ltd. and Oswald Manufacturing Ltd and contains
clear recommendation as to which company Regan Products should acquire.
Your report should include:
(a) Calculations of the following ratios for both companies:

i. Return on capital employed
ii. Asset turnover
iii. Gross profit percentage
iv. Operating profit margin
v. Current ratio
vi. Liquid ratio (Quick Assets ratio)
vii. Inventory holding period
viii. Trade receivables’ collection period
ix. Trade payables’ payment period
x. Gearing
xi. Interest cover
xii. Dividend cover (12 marks)
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N.B .You should use closing balances rather than averages for computing the
ratios.
(b) A comparison of the financial performance, financial position and liquidity of

Edgar Ltd, and Oswald Manufacturing Ltd.
(9 marks)
(c) Conclusions and recommendations for the board of Regan Products plc, which
should also identify two items of further information that you consider should
be obtained before a decision is taken.
(4 marks)
Subject guide, Chapter 7.
Perks, R. and D. Leiwy (2013), Chapters 4 and 5.
The learning outcomes for Chapter 7 of the subject guide include the ability to analyse, interpret
and communicate the information contained in financial statements. The most common
analytical is the use of accounting ratios. This technique is often tested by a mini-case study of
the type used in this question. It is important that candidates’ answers go beyond simply stating
that a particular ratio has gone up or down; the interpretation should use the contextual
information given in the question and make links between different ratios. Good answers would
draw conclusions from the ratios and the background information, which provided insight into
the financial position and performance of the companies.
Excellent answers would use the analysis to draw appropriate conclusions that would be
discussed from the perspective of potential users.
Candidates should carefully read the requirements of the questions, which in this case specify the
number and nature of the ratios to be calculated. If candidates do not follow these instructions
their work might not be marked.
There are no absolute answers to this type of question, and candidates would be rewarded for a
logical and informed analytical approach to the case described in the question.
(a) Calculations of the following ratios for both companies:
Edgar Oswald
1,050 + 210 1,400 + 600
i ROCE 7,100 + 3,000 12.5% 2,800 + 6,700 21.1%
12,000 20,500
ii. Asset turnover 7,100 + 3,000 1.2 2,800 + 6,700 2.2
2,670 5,060
iii. Gross profit 12,000 22.3% 20,500 24.7%
percentage
1,050 + 210 1,400 + 600

iv. Operating profit 12,000 10.5% 20,500 9.8%
margin
5,000 7,300
v. Current ratio 4,300 1.2 5,300 1.4
17
2,400 + 600 3,700

vi. Liquid ratio 4,300 0.7 5,300 0.7
2,000×365 3,600×365
vii. Inventory holding 9,330 78 days 15,440 85 days
period
2,400×365 3,700×365
viii. Trade receivables 12,000 73 days 20,500 66 days
collection period
3,700×365 3,900×365
ix. Trade payables 9,330 145 days 15,440 92 days
payment period
3,000 6,700
x. Gearing 7,100 42.2% 2,800 239%
1,050 + 210 1,400 + 600

xi. Interest cover 210 6 times 600 3.3 times
900 1,000
xii. Dividend cover 250 3.6 times 700 1.4 times
(b) Assessment of the relative performance and financial position of Edgar Ltd and Oswald
Manufacturing
Profitability
• The ROCE measures the overall efficiency of management. The ROCE of Oswald (21%)
is far superior to that of Edgar (13%). Oswald’s superior performance is partly due to its
efficiency in the use of its net assets; a net asset turnover for Oswald (2.2 times)
compared to Edgar’s (1.2 times).
• However, this is tempered by the profit margins – although Oswald has a higher gross
profit margin, its operating profit margin is 9.8%, compared to Edgar’s 10.5%. Oswald’s
overhead expenses (as a proportion of sales) are higher than Edgar’s – possibly due to
rent expense being included.
• Components of the ROCE.
• Carrying amount of the non-current assets. Oswald rents premises, whereas Edgar owns
its premises. If Oswald’s rental cost, as a percentage of the value of the related factory,
was less than its overall ROCE, then it would be contributing to its higher ROCE.
• Oswald’s owned plant is nearing the end of its useful life (carrying amount is only 33% of
its cost) leading to lower equity and higher ROCE.
• Valuation basis of the companies’ non-current assets. Edgar’s factory is at current value
and this adversely impacts on Edgar’s ROCE. Oswald does not suffer this deterioration
as it does not own its premises.
Gearing
• Gearing ratio – Oswald’s high gearing ratio with over twice the amount of debt as equity.
This is very high in absolute terms compared to Edgar’s level of gearing, and increases
the risk of investment for Regan Products.
• The effect of the higher gearing means that more of the operating profit of Oswald is
used for interest, although the company can comfortably cover its interest payments 3.3
times. However, Edgar can meet its debt servicing 6 times out of its operating profit.
• Oswald’s lower interest cover is a direct consequence of its high gearing, and it makes
profits vulnerable to relatively small changes in operating activity. For example, small
reductions in sales, profit margins or small increases in operating expenses could result in
losses, and mean that interest charges would not be covered.
• Dividend cover of Edgar illustrates a policy of retaining more profits.
Liquidity
• Both companies have relatively low current ratios of 1:2 and 1:4 for Edgar and Oswald
respectively. As manufacturers, their liquid ratios – at less than 1 – may be of concern.
18
• Edgar has £600,000 in the bank, whereas Oswald has a £1.2 million overdraft.
• Both companies have similar inventory days; Oswald collects its receivables one week
earlier than Edgar (perhaps its credit control procedures are more active due to its large
overdraft).
• Edgar receives (or takes) a lot longer credit period from its suppliers (145 days compared
to 92 days). This may be a reflection of Edgar being able to negotiate better credit terms
because it has a higher credit rating.
(c) Conclusion and recommendation
• Although both companies may operate in a similar industry, and have similar profits
after tax, they would represent very different purchases.
• Oswald’s sales revenues are over 70% more than those of Edgar; it is financed by
high-levels of debt, and it rents rather than owns property. Also, its remaining owned
plant is nearing the end of its life. Its replacement will either require a cash injection – if
it is to be purchased – (Oswald’s overdraft of £1.2 million already requires serious
attention) or create even higher levels of gearing, if it funds this purchase through other
forms of debt.
• In short, although Oswald’s overall return seems more attractive than that of Edgar, it
would represent a much riskier investment.
• Ultimately, the investment decision may be determined by Regan Products’ attitude to
risk, possible synergies with its existing business activities, and not least, by the asking
price of each investment.
Other information that should be considered includes:
• Due dates for debt repayments in both companies.
• Details of Oswald’s bank overdraft facility.
• Financial forecasts.
• Past years’ financial statements – one for each company is insufficient.
• Details of the companies’ operating expenses.
• Customer and supplier payment terms.
• Details of the companies’ inventories and whether any is obsolete.
Section C
Answer one question and no more than one further question from this section.
Question 5
The Hathaway Hang-glider Manufacturing Co Ltd produces and sells hang-gliders in

standard kit form.
The company operates a standard costing system.
The following information is provided:
Budgeted Sales = 80 Hang-gliders per month @ £3,000 each.
Standard cost of a hang-glider:
Fabric 50 sq ft per glider @ £6 per sq ft

Labour 300 hours per glider @ £3 per hour
Fittings(Standard Units) £500 per glider which are bought in
Variable Overheads £0.20 per hour
Fixed Overheads £72,000 per annum
19
The following actual results were obtained for the month of March 2014:
Sales 75 hang-gliders
Revenue £217,500
Fabric 3,900 sq ft was used, costing £23,010
Labour 22,800 hours at a cost of £63,840
Fittings bought – in at a price of £550 each
Variable Overheads £4,350
Fixed Overheads £7,000
NB Variable Overhead recovery is calculated on the basis of Direct Labour Hours.

There were no opening or closing stocks.
Required:
(a) Prepare an Operating Statement showing the budgeted profit and reconciling
this with the actual profit for the month of March 2014. Calculate two variances
for each element of cost.
(20 marks)
(b) The company considers the Purchasing Department responsible for the price at
which materials are purchased and the Manufacturing Department responsible
for the quantities of material used. Explain how this division of responsibility
would affect the evaluation of the relevant variances and any subsequent
management actions.
(5 marks)
This question tested candidates’ ability to apply standard costing, budgeting and variance
analysis to a given set of data. Candidates should set out clearly all their workings and
cross-refer them to the final operating statement and relevant variances. It is important that
candidates identify variances as either favorable or adverse (unfavorable). Examples of these
techniques are clearly demonstrated in the subject guide, and candidates should be prepared to
use them when answering questions at this level. Part (b) tested candidates’ understanding of
the variances and their interpretations. Good answers would highlight the problems of variances
in providing information for evaluation of managers.
20
See correction sheet for replacement text.
(b) Relevant variances
Fabric Price 390 F

Efficiency (900) U
If the price variance was due to purchasing cheaper grade fabric, it could be that this
resulted in more wastage and thus adverse efficiency variance.
The division of responsibility might result in a lack of optimal decision for the company,
that is an unfavourable materials variance of (900 − 390) £510.
This illustrates the problems of devolved responsibility accounting.
Workings
1.
Profit Budget Actual
Sales 240,000 217,500
Fabric 24,000 23,010

Labour 72,000 63,840
Fittings 40,000 41,250
VO 4,800 4,350
FO 6,000 7,020
146,800 139,450
Profit 93,200 78,050
Flexed profit 87,375
Volume Var 5,825 U
21
2.
Variances
Sales price = AQ × AP − AQ × SP
217,500 − (75 × 3,000) = (7,500) A
Fabric
Price AQ × AP − AQ × SP
23,010 − (3,900 × 6) = 390 F
Efficiency AQ × SP − SQ × SP
(3,900 × 6) − (3,750 × 6) = (900) U
Labour price
Price AQ × AP − AQ × SP
63,840 − (22,800 × 3) = (4,560) F
Efficiency AQ × SP − SQ × SP
(22,800 × 3) − (22,500 × 3) = (900) U
Fittings price (37,500 − 41,250) = (3,750) U
VO : Price 4,350 − (22,800 × 0.2) = 210 F

: Eff (22,800 × 0.2) − (22,500 × 0.2) (60) U
FO : Spending AC − SC = (1,000) U
7,000 − 6,000
: Volume SC − AQ × SP
6,000 − (75 × 7,020)/80) = (375) U
Question 6
Curan plc is tendering for a contract which will take three months to complete. The
company is in a specialised, highly competitive market and new contracts are
difficult to win and keep. If the contract is taken, Curan still expects to complete
current contracts. The management accountant has submitted the cost estimate
shown below:
£
Direct materials
Type A – already in stock 6,000
Type B – firm order placed 4,000
Type C – not yet ordered – current replacement cost 2,000
Direct Labour 22,000
Manufacturing overheads:
Variable – 20% of direct labour 4,400
Depreciation of equipment – straight line basis 5,000
Supervisor salaries – 2 supervisors @ £1,000 each per month 6,000
General fixed overhead – 40% of direct labour 8,800
Total costs 58,200
Since the original submission of the contract the following additional information
has become available:
1. Type A material is already in stock and cost £6,000. The material is not in
common use and would realise about £4,000 if sold. If Material A is not used on
this contract, all of the material could be used later in the year as a substitute
for material now quoted at 20% less than A’s original cost.
22
2. Type B material is in regular use by the company. Due to a world-wide

shortage which is expected to continue for the foreseeable future, Material B’s
price has now doubled since the order was placed. Material B could be sold at
this new higher price (after deducting 20% selling costs) to a competitor who
urgently needs this material. Alternatively, it can be used on other contracts
during the year.
3. Labour costing £12,000 will be recruited locally especially for the duration of
this contract. To be able to complete this contract, additional labour will need
to be allocated specifically for this contract from within the company. Staff who
would be reallocated already work in the company and are currently being paid
although there is no work for them to do. The estimated wages for these
workers for the period of the contract is £8,000. Even with this re-allocation of
labour it is estimated that an additional £2,000 of overtime will need to be
incurred by specialist workers who are currently fully employed on other jobs.
4. The management accountant has allocated variable overheads for the contract
using the company’s pre-determined policy of 20% of direct labour. The project
manager has estimated that the incremental variable overhead due to the
contract is likely to be about £3,000.
5. The equipment to be used on the contract cost £80,000 five years ago. It was
planned to keep it for ten years after which its scrap value was expected to be
£10,000. The depreciation charge in the cost estimate is based on this data. At
present, the equipment is worth £30,000. If used on the contract, its realisable
value is likely to decline to about £28,000. The company has no further use for
the equipment and, if the contract is not accepted, they would sell it now.
6. The new contract is so specialised that it has now been realised that one of the
supervisors will have to be recruited from a competitor. She will be expected to
be paid a premium salary of £2,000 per month. The second supervisor, who is
currently paid £1,000 per month, can be transferred from another department.
However, he will only transfer to the project if he is offered a one-off bonus
payment of £500. His role will be replaced by a temporary upgrading of an
existing worker which is estimated to cost an additional £200 per month.
7. The management accountant has allowed fixed overheads for the contract using
the company’s pre-determined policy of 40% of direct labour. The general fixed
overhead recovery rate consists of allocated rent, rates, general expenses and
similar fixed costs. However, it is anticipated that this additional contract
would make general expenses increase by £500 per month for the duration of
the contract.
Required:
(a) Define opportunity cost.

(2 marks)
(b) Prepare a revised cost estimate for the contract in the light of the above
information. Clearly explain for each item why your calculations differ from the
original estimate submitted by the management accountant.
(19 marks)
(c) Identify two other considerations which should be taken into account in
deciding whether to tender for the contract.
(4 marks)
23
Relevant and opportunity cost recognition are key techniques in short-term decision-making. This
question tested candidates’ ability to apply these techniques. It is important when answering
such questions that candidates keep in mind the basic contribution approach to the analysis, and
clearly distinguish between those costs and revenues that are relevant to the decision and those
that are not. Good answers would set out the computations in a clear, logical and coherent way.
Candidates should note that the question required a full explanation of the figures used in the
analysis and marks were awarded as appropriate.
(a) This question was a straightforward textbook explanation of terms.

Opportunity cost – ‘maximum contribution foregone by using scarce resources for an
alternative purpose’.
(b)
Curan plc £
Revised cost estimate
Direct materials – A 4,800

–B 6,400
–C 2,000
Direct labour 14,000
Variable overhead – Incremental 3,000
Depreciation 2,000
Supervisors 7,100
General overhead 1,500
Revised cost 40,800

Explanations
Material A – Past cost is irrelevant. Alternative use saves £4,800, which is higher than sale
value of £4,000.
Material B – Opportunity cost is realisable value of 4,000 × 2 × 0.8 = £6,400.
Direct labour – £12,000 is specific to contract. Reallocated internal labour is a sunk cost.
Overtime is an additional cost.
Variable overhead – 20 per cent allocation is not relevant. Only incremental overhead should
be included.
Depreciation – Allocated depreciation is irrelevant. Fall in realisable value is opportunity
cost.
Supervisors – New supervisor is relevant cost of £6,000. Additional cost of current staff is
500 (3 x 200).
General fixed overhead – Increase in general expenses (500 x 3).
(c) This required candidates to place the calculations in the context of the wider business
considerations by identifying two appropriate factors.
Examples: Competitive market with new contracts difficult to win.
Disruption of current production
Reversal of actions if no further contracts (e.g. new supervisor).
24
Question 7
Over the last two years Edgar plc has spent £100,000 developing a new product
“Endeavour” which, if launched, is expected to have a life of 6 years. The
development work is now complete and the company is considering whether to start
production and, if so, what production method would be best. The alternative
production methods have been narrowed down to two options.
Option 1 involves the purchase of a large heavy duty press to manufacture

“Endeavour”. This press has a capacity of 18,000 units per annum and an estimated
life of 6 years. It would cost £78,000 to purchase and a further £15,000 per annum
in maintenance and other running costs. At the end of six years its residual value
would be nil.
Option 2 would involve using a smaller press with a capacity of 10,000 units per
annum and a life of three years. At the end of the first three years the press would
be replaced by 2 similar presses to cope with the extra demand. The current cost of
the press is £30,000 but, by the time it is replaced at the end of the third year, the
two replacement presses would cost £78,000 in total. The presses would have a zero
scrap value at the end of their three year life. Running costs of the smaller
machines would be £10,000 per annum for each machine.
Other information about ‘Endeavour’ is as follows
Expected demand
Year 1 4,000 units
Year 2 6,000 units
Year 3 10,000 units
Year 4 16,000 units
Year 5 16,000 units
Year 6 16,000 units
Endeavour is expected to sell for £10 per unit. The product is perishable and is sold
in the year of manufacture.
Variable costs of material and direct labour are expected to be £6 per unit. Edgar
has fixed overhead of £120,000 per annum.
The machines will be depreciated using the straight line basis.
The company would also need to invest £10,000 in working capital at the start of
production. This would be recouped at the end of the project.
The company has a cost of capital of 12%.
The Board is undecided on the best way forward. One of the members of the Board
has calculated the Internal Rate of Return for each alternative and on this basis
favours option 2 as it ‘gives an IRR of at least 20%’. She also claims that ‘on the
same basis option 1 has an IRR which is just below 20% and therefore does not
meet our normal criteria for acceptance’. At this point the Board decides to defer a
decision until it has a more detailed report.
Required:
(a) Calculation of the Net Present Value of each project in columnar form.
(17 marks)
(b) A discussion of the relative merits of each of the two assessment methods:
internal rate of return and net present value.
(6 marks)
25
(c) A clear recommendation to the board on which project to accept.

(2 marks)
The application of capital investment techniques is an important element of the syllabus and a
learning outcome for Chapter 12 of the subject guide. The most effective approach to part (a)
was to construct a columnar table in which relevant cash flows could be inserted. It was
important that candidates gave workings of all figures and clearly explained the treatment of all
amounts; for example, if a cost was to be treated as sunk and therefore not included as a relevant
cost, this should have been stated. Having determined the net cash flow for each year these
would have been discounted using the discount factors taken from the tables provided. Therefore
a net present value could have been arrived at and a decision recommended and justified. This
question required the use of a significant amount of data, and it was very important that
candidates’ answers were clearly presented and that all their workings were legible and
understandable; candidates are encouraged to use the 8-column accounting paper provided. A
suggested presentation of the answer is given below.
(a) OPTION 1
0 1 2 3 4 5 6
£000
Sales 40 60 100 160 160 160
Cost (78)
Working capital (10)
Running cost (15) (15) (15) (15) (15) (15)
V. Cost – Labour (24) (36) (60) (96) (96) (96)
Net cash flow (88) 1 9 25 49 49 59
Disc factor 1 0.893 0.797 0.712 0.636 0.567 0.507
P.V (88) 0.893 7.173 17.800 31.164 27.783 29.913
NPV + £26,726
26
OPTION 2
0 1 2 3 4 5 6
£000
Sales 40 60 100 160 160 160
Cost (30) (78)
Working capital (10) (10)
Running cost (10) (10) (10) (20) (20) (20)
V. Cost – Labour (24) (36) (60) (96) (96) (96)
Net cash flow (40) 6 14 (48) 44 44 54
Disc factor 1 0.893 0.797 0.712 0.636 0.567 0.507
P.V (40) 5.358 11.158 (34.176) 27.984 24.948 27.378
NPV + £22,650
Ignore development cost and fixed overhead.
(b) This required an evaluation of the relative merits of net present value (NPV) and internal
rate of return (IRR). This question should not have given any difficulty to a well-prepared
candidate.
Advantages and disadvantages of NPV and IRR
Both NPV and IRR:
• recognise the time value of money
• use relevant costs and revenues.
As such, both discounted cash flow (DCF) methods are superior to payback period and
ARR.
However, NPV is the best DCF method to use for investment appraisal because it:
• considers the magnitude of a project (projects with positive NPVs increase wealth, and
projects with greater positive NPVs increase wealth more than those with smaller
positive NPVs).
The NPV is additive and allows managers to determine the total sum of NPV of a group of
investments. The IRR of a group of investments does not equal the sum of IRR of each
individual investment.
In contrast:
• IRR cannot distinguish between projects involving investment (initial cash outflows) and
projects involving borrowing (initial cash inflows).
• IRR does not provide an absolute measure. It is necessary to compare the IRR with a
discount rate, in order to make a decision (it is impossible to know whether an IRR of,
say, 12%, makes a project worthwhile or not, without also at least knowing the
appropriate discount rate to apply).
IRR cannot distinguish between mutually exclusive projects. If two projects have IRRs of,
say, 15% and 20%, we cannot assume that the project with the highest IRR is also the one
with the highest NPV at a particular discount rate.
• IRR ignores the absolute size of project cash flows.
• IRR may not be unique (certain projects may have more than one IRR).
(c) This required a reasoned recommendation to management on which project to accept based
on the answer to (a).
Key points:
• Option 1 has a higher NPV, and it is the best option.
• Both options give the NPVs, but they are mutually exclusive.
27
• On the basis of IRR, both are higher than the cost of capital – if the director’s
calculations are correct, Option 2 is better.
• Overall, the decision is to take Option 1.
28

Important note
section.
Comments on specific questions – Zone B
Candidates should answer FOUR of the following SEVEN questions: QUESTION 1 of Section
A, QUESTION 2 of Section B, ONE question from Section C and ONE further question from
either Section B or C. All questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any necessary assumptions
introduced in answering a question are to be stated.
Section A
Answer question 1 from this section.
Question 1
(a) The following information has been extracted from the Statement of Financial
Position of Shelley plc as at 1 January 2013:
£000
Issued equity shares of 50p each 2,000
Retained earnings 950
There were no other reserves in the Statement of Financial Position as at 1
January 2013.
You are given the following additional information relating to the year ended 31
December 2013:
1. The company issued one million equity shares at a price of 75p per share on
1 January 2013.
2. The company made a bonus issue of 1 for 5 ordinary shares on 30 September
2013 utilising any available share premium.
29
3. At 31 December 2013, the management have decided to revalue land and

buildings that had a net book value of £400,000 to a value of £600,000.
4. The profit after tax for the year ended 31 December 2013 was £280,000.
5. On 12 February 2013 the company paid the previous year’s final equity
dividend of 9p per share and on 31 July 2013 paid an interim dividend of 2p
per equity share. The directors have proposed a final dividend of 10p on each
equity share.
Required:
Show the Statement of Financial Position of Shelley plc as at 31 December 2013
which shows the composition of the equity.
(6 marks)

Perks, R. and D. Leiwy Accounting: understanding and practice. (Maidenhead:
McGraw-Hill, 2013) fourth edition [ISBN 9780077139131] Chapter 1.
This question tested candidates’ understanding of accounting for changes in the equity of a
company. Understanding the impact of the changes in composition required a logical
approach and a tabular such as that given below would have been an effective way of
calculating figures.
Shelley plc as at 31 December 2013 £000
Equity
Ordinary share capital (50p each) 3,000
Reserves
Revaluation 200
Retained earnings 520
Total equity 3,720

Workings
S.Capital S Premium Revaluation Retained
Reserve Earnings
As at 1/1/13 2,000 950
Issue of shares 500 250

Bonus Issue 500 (250) (250)
Revaluation 200
Profit 280
Dividends paid
2012 Final (4m × 9p) (360)
2013 Interim (5m × 2p) (100)
3,000 — 200 520

No entry for final dividend.
(b) Compliance with Accounting Standards, such as International Financial

Reporting Standards, is now required for companies by regulators in almost all
countries.
Required:
i. Explain the advantages of accounting standards for financial reporting by
companies.
(4 marks)
30
ii. Identify two possible drawbacks of accounting standardisation.

(2 marks)

This module does not require detailed knowledge of individual accounting standards, but it
does require that candidates understand the need for and limitations of standardisation.
This question tested this understanding. Part (ii) required candidates to identify only two
possible drawbacks; it is very important that candidates do not waste their time and effort
in providing more points than is necessary. The answer given below is in summary bullet
point form; candidates should write out their answers in full.
Advantages of accounting standards (explanation)
• Reduces accounting choice.
• Improves comparability.
• Based on a conceptual framework.
• Improves disclosures.
• Reduces opportunity for creative accounting.
• Overall, it improves discipline and credibility of financial reporting.
Disadvantages (only two required)
• Some choice is often still allowed (so it is still difficult to compare financial statements
prepared under different accounting policy choices) estimates and judgement inevitably
introduces subjectivity, which users may think is eliminated by standards.
• If there is no choice at all, some businesses may be forced to apply inappropriate
accounting policies.
• Standards cannot eliminate creative accounting and earnings management (particularly
if rule driven)
• The economic and reporting environment is changing so rapidly that new accounting
standards (or changes to old ones) are always being required.
• New standards may be inconsistent with old standards.
It can be difficult to get everyone to agree on a new accounting standard, so compromises
have to be made.
(c) Compare and contrast the Accounting Rate of Return and the Internal Rate of
Return methods of investment appraisal.
(6 marks)

Subject guide, Chapters 11 and 12.
Long-term investment appraisal is a key topic, and one of the important learning outcomes
from these chapters is to be able to explain the uses and limitations of the main appraisal
methods. Candidates should note the need to compare and contrast the methods, and the
framework of the answer below is one way in which they could have structured their answer.
The answer given here is in a summary form; candidates’ answers should be written out in
full.
Average annual profit
ARR = .
Investment
31
Disadvantages
• Uses profit not cash flows.
• Does not provide an absolute measure – percentage net value.
• Ignores size of investment and cash flows.
• Ignores time and true value of money.
Advantages
• Simple and intuitive*.
• Related to required rates of return.
IRR = discount rate at which NPV of project is zero.
Advantages
D. Recognises true value of money.
A. Uses relevant cash flows not profit.
E. Related to cost of capital.
Disadvantages
C. Ignores the size of the project. May not be unique*
B. Does not provide an absolute measure.
Letters A–D are related comments for compare/contrast.
* more specific can be given credit.
(d) Clare Ltd makes two types of chair, Wing and Club. There are two production
departments, Machinery and Assembly. There is also a sales administration
office and a storeroom for parts and materials. The following information is
available:
Machinery Assembly Office Storeroom

Floor space (m2 ) 300 150 10 40
Issues of parts from stores per month 20 5
Direct labour hours per Wing chair 30 40
Direct labour hours per Club chair 40 30
The following are the budgeted output and cost for a month:
Output of Wing chairs 20
Output of Club chairs 80
Factory rent £1,000
Salary of storeman (all storeroom costs) £1,300
Salary of office clerk (all administration costs). £1,500
The factory rent is to be allocated on the basis of floor space and the storeroom
costs (inclusive of allocated rent) reallocated on the basis of issues of parts.
These are the only indirect costs of production and a direct labour hour basis of
absorption should be used for the two production departments. Administration
costs are all post production.
Required:
Calculate the indirect cost of producing a Wing chair and a Club chair.
(7 marks)
32
The learning outcomes from this chapter refer to the ability to apply costing methods, including
absorption costing. This question required the allocation of overheads and their application to
cost units. A tabular approach to the allocation would be best, and it is important that
candidates show each individual stage of their workings.
The total indirect cost for a Wing is £20.64 and for a Club £23.32 (rounded).
Costing calculations:
Machinery Assembly Office Storeroom Total(not needed)

£ £ £ £ £
Indirect costs
Storeman’s salary 1,300 1,300
Office clerk’s salary 1,500 1,500
Rent (basis: floor space) 600 300 20 80 1,000
Sub-total 600 300 1,520 1,380 3,800
Reapportion (basis: issues) 1,104 276 (1,380) —
Total departmental costs 1,704 576 1,520 — 3,800

Total direct labour hours (W) 3,800 3,200
Indirect cost per labour hour 0.448 0.18
Indirect cost per Wing 13.44 7.20 20.64
Indirect cost per Club 17.92 5.40 23.32
Workings:
Rent: Total factory floor space = 300m2 + 150m2 + 10m2 + 40m2 = 500m2 , so rent is
apportioned on the basis of £1,000/500m2 = £2 per m2 .
Storeroom: Total monthly issues = 25 so reapportion storeroom costs on the basis of £1,380/25
issues = £55.20 per issue.
Direct labour hours:
Total direct labour hours in Machinery = 20 Wings × 30 hrs per wing + 80 Clubs × 40 hrs per
Club = 3,800 hrs.
Total direct labour hours in Assembly = 20 Wings × 40 hrs per Wings + 80 Clubs × 30 hrs per
Club = 3,200 hrs.
33
Section B
Answer Question 2 and not more than one further question from this section.
Question 2
The trial balance of Byron plc at 31 December 2013 appeared as follows:
Debit Credit
£ £
Equity shares of £1 – fully paid 50,000
Purchases 220,000
Retained earnings 30,000
Freehold property – cost 80,000
Fixtures – cost 15,000
Fixtures – accumulated depreciation 9,000
Data services rental 3,000
Motor vehicles – cost 28,000
Motor vehicles – accumulated depreciation 14,000
Insurance 2,000
Inventories at 1 January 2013 40,000
Trade receivables 30,000
Sales revenue 310,000
Bank 12,100
12% debentures 40,000
Debenture interest 2,400
Wages and salaries 34,000
Heat and light 4,100
Directors’ fees 1,400
Motor expenses 3,200
Provision for doubtful debts at 1 January 2013 1,000
Bad debts written off 300
Dividend paid 2,500
478,000 478,000
1. During the year a motor vehicle purchased on 31 March 2010 for £8,000 was
sold for £3,000. The sale proceeds were debited to the bank account and
credited to the sales account, and no other entries have been made in the
financial statements relating to this transaction.
2. Depreciation has not yet been provided for the year. Depreciation is on the
straight line basis, with the assumption of no residual value based on the
following useful lives:
Fixtures and fittings 10 years
Motor vehicles 5 years
The company’s policy is to provide a full year’s depreciation in the year of
acquisition and no depreciation in the year of disposal.
3. Inventory at 31 December 2013 amounted to £45,000. Some goods sent out on a
sale or return basis have been treated as credit sales. These goods cost £3,000
and had been invoiced to the customer for £4,000. The customer has informed
the company that it now intend to return these goods.
4. Data services rental paid in advance amounts to £400. Insurance includes £200
paid in advance. An electricity bill covering the quarter to 31 December 2013
and amounting to £320 was not received until February 2014. It is estimated
that the audit fee for 2013 will be £1,500. An accrual also needs to be made for
debenture interest.
34
5. A general provision for doubtful debts of 4 per cent of trade receivables is to be

carried forward.
6. Taxation for the year is estimated as £6,500.
7. The directors propose a dividend of £10,000.
Required:
(a) Prepare for Byron plc for the year ended 31 December 2013:
i. Income statement for the year.
(11 marks)
ii. Statement of changes in equity for the year.
(2 marks)
iii. Statement of financial position at the year end.
(8 marks)
(b) Explain the meaning of the terms ‘provision’ and ‘reserve’, giving one
example of each.
(4 marks)
Subject guide, Chapters 4, 5 and 6.
The preparation of final accounts from structured information is a key learning outcome. A trial
balance with several adjusting items has been the format for the compulsory question over recent
years. In answering this type of question, a methodical and organised approach is needed. It is
very important that detailed, legible workings be given so that marks are awarded for all work
that is correct. If figures in the final accounts comprise a number of items, marks will be awarded
accordingly. Without workings, one error may result in several marks being lost. Candidates
should allow Examiners to award all appropriate marks. The 8-column accounting paper
provided is particularly useful for presenting the financial statements. Candidates should pay
attention to the presentation of their answer, taking care to use the appropriate descriptions of
line items in the income statement and statement of financial position. The format of the
statement of change in equity should follow best practice.
35
(a) i. Byron plc

Income Statement for the year ended 31 December 2013
£
Sales revenue (310,000 − 4,000−3,000) 303,000
Less cost of sales

Opening inventory 40,000
Purchases 220,000
260,000
Less: closing inventory (45,000 + 3,000) 48,000 212,000
Gross Profit 91,000
Wages and Salaries 34,000
Directors fees 1,400
Insurance (2,000− 200) 1,800
Data services rental (3,000 − 400) 2,600

Heat and light 4,420
Audit fees 1,500
Motor expenses 3,200
Bad and doubtful debts (300 + 40) 340
Depreciation: Fixtures 1,500

Motor vehicles 4,000
Loss on disposal 200 54,960
Profit before interest and tax 36,040
Less: Debenture interest (2,400 + 2,400) 4,800
Less: Taxation (6,500)
Profit for the year 24,740

ii. Statement of changes in equity
Share capital Retained earnings Total
As at 1 Jan 2013 50,000 30,000 80,000
Profit for the year 24,740 24,740
Dividends paid (2,500) (2,500)

50,000 52,240 102,240
36
iii. Byron plc

Statement of Financial Position as at 31 December 2013
£ £ £
Cost Acc. Depn. Net
Non-current assets
Freehold property 80,000 — 80,000
Fixtures 15,000 10,500 4,500
Motor vehicles 20,000 13,200 6,800
115,000 23,700 91,300
Current assets
Inventories 48,000
Trade receivables (30,000 − 4,000) 26,000

Less: Provision (1,040) 24,960
Prepayments 600
Bank 12,100
85,660
Total assets 176,960
Current liabilities
Accruals (320 + 1,500 + 2,400) 4,220
Taxation 6,500
34,720
Debentures 40,000
Total liabilities 74,720
Equity
Share capital 50,000
Reserves 52,240
102,240
Total equity and liabilities 176,960

Workings
1.
Non-current assets
Fixtures depreciation for year
15,000 ÷ 10 = 1,500
Motor vehicles
Cost 28,000 − 8,000 = 20,000
Acc Depreciation
= 14,000 − (3 × 8, 000)/5
= 14,000 − 4,800 = 9,200
For the year = 20,000 ÷ 5 = 4,000

13,200
Loss on disposal
3,000 − (8,000 − 4,800) = 200
37
2.
Provisions for doubtful debts
B/fwd 1,000
Increase 40
C/fwd (30,000 − 4,000) × 4% 1,040

(b) This required an explanation of two key accounting terms, but answers demonstrated a lack
of understanding of these terms by many candidates.
The answer given here is in summary form. Provisions are liabilities of an uncertain amount
or timing. Examples are provisions for warranties or legal costs (accept doubtful debts not
depreciation).
Reserves are part of equity and represent retained earnings or gains. They may be
distributable (revenue) or non-distributable (capital). Examples are share premium,
revaluation reserve and retained earnings.
Question 3
Keats plc is a company which wholesales non-electrical office equipment – from pens
and paper to filing cabinets. The company has just one warehouse and, during 2013,
replaced much of its shelving as well as investing in new computer equipment, to
maintain its inventory and other records. In April 2013, the company tendered for,
and obtained, a significant contract to supply goods to a high street office supplies
and stationery chain.
Keats plc
Income statements for the years ended 31 December
2013 2012
£000 £000
Revenue 3,000 2,500
Cost of sales 1,800 1,425
Gross profit 1,200 1,075
Administrative expenses (544) (453)
Distribution costs (250) (245)
Profit from operations 406 377
Finance costs (66) (60)
Profit before tax 340 317
Taxation (180) (122)
Profit for the year £160 £195
Statement of changes in equity for the years ended 31 December
Equity Retained Total

share earnings £000
capital £000
£000
Balance at 1 January 2012 1,200 640 1,840
Balance at 31 December 2012 1,200 740 1,940
Balance at 31 December 2013 1,200 800 2,000
38
Statements of financial position at 31 December
2013 2012
£000 £000
Non-current assets 2,320 2,080
Current assets
Inventory 400 290
Receivables 450 350
Cash at bank 50 200
900 840
Equity
Equity shares (£1 each) 1,200 1,200
Retained earnings 800 740
2,000 1,940
10% debentures 720 600
Current liabilities
Payables 400 300
Tax 100 80
500 380
The value of a share of Keats plc at 31 December 2013 was £1.80 and at 31
December 2012 £1.65.
Required:
(a) Calculate the following accounting ratios (to one decimal place) for Keats plc
for 2013 and 2012:
i. Profitability ratios
• Return on Capital Employed
• Operating profit margin
• Asset turnover
ii. Liquidity and Working capital control ratios
• Quick assets ratio
• Inventory turnover
• Receivables collection period (Days)
• Payables payment period (Days)
iii. Gearing and financial risk ratios
• Debt to capital employed
• Interest cover
• Investor ratio
• Price Earnings ratio
(13 marks)
N.B. You should use closing balances rather than averages for computing the
ratios.
(b) Evaluate, using the ratios calculated above and the other information provided,
the financial position and financial performance of Keats plc.
(12 marks)
39
Perks. R and D. Leiwy (2013), Chapters 4 and 5.
The learning outcomes of Chapter 7 of the subject guide include the ability to analyse, interpret
and communicate the information contained in financial statements. The most common
analytical method is the use of accounting ratios. This technique is often tested by a mini-case
study of the type used in this question. It is important that candidates’ answers go beyond
simply stating that a particular ratio has gone up or down; the interpretation should use the
contextual information given in the question and make links between the different ratios. Good
answers would draw conclusions from the ratios and the background information that provided
insight into the financial position and performance of the companies.
Excellent answers would have used the analysis to draw appropriate conclusions that would be
discussed from the perspective of potential users.
Candidates should carefully read the requirements of the questions, which, in this case, specify
the number and nature of the ratios to be calculated. If candidates do not follow these
instructions their work might not be marked.
There are no absolute answers to this type of question, and candidates would be rewarded for a
logical and informed analytical approach to the case described in the question.
(a) i.
2013 2012
Return on capital 406 377
2,720 = 14.9% 2,540 = 14.8%
employed
Operating profit margin 406 377
3,000 = 13.5% 2,500 = 15.1%
3,000 2,500
Asset turnover 2,720 = 1.10 2,540 = 0.98
ii.
2013 2012
Quick assets ratio 500 = 1:1 550
500 380 = 1.4:1
Inventory turnover 400×365 = 81 days 290×365 = 74 days

1,800 1,425
(4.5 times) (4.9 times)
Receivables collection 450×365 = 55 days 350×365 = 51 days

3,000 2,500
Payables payment 400×365 = 81 days 300×365 = 77 days

1,800 1,425
iii.
2013 2012
Gearing 720 600
720 + 2,000 = 26.5% 600 + 1,940 = 23.6%
Interest cover 406 = 6.2 377 = 6.3

66 60
iv.
EPS = 160 ÷ 1200 = 13.3 195 ÷1200 = 16.25
Price 180 165
PE = 13.5 = 10.15
(b) Profitability
• Similar return generated from capital invested in the company in 2013.
40
• Profit from operations and capital have both increased by the same proportion, but
revenue shows large growth.
• More sales generated from the use of assets (more efficient use of new assets?), but
profitability (NP %) has fallen.
• Impact of new contract: is it at lower margin?
• Impact of depreciation charge on new assets on operating costs.
All liquidity and working capital asset ratios have increased
• Inventory is being held longer – impact of new contact?
• It is taking longer to receive monies from customers – again new contract effect?
• It is taking longer to pay suppliers.
• Cash-to-cash cycle indicates less efficient cash management (not calculated).
• Leading to reduced cash balances.
• However, the liquidity of the company is still sound at 1:1.
Gearing and financial risk ratios
• Although gearing has increased, the company is not highly geared.
• Long-term debt (and equity) have increased, cash balances have fallen – increase in
gearing.
• The company can comfortably meet its interest obligations from its operating profits.
Price earnings ratio
• EPS (Earnings per share) has fallen due to the fall in profit – abnormally-looking large
tax charge is unexplained.
• PE ratio has increased substantially due to both an increase in share price and the fall in
EPS.
• Indicates confidence in the company – perhaps because of good growth in 2013, liquidity
showing little cause for concern and low-gearing
• Company has increased dividend per share (not calculated).
• As a result, dividend cover has fallen and may be of concern to shareholders looking for
growth in the company (not calculated).
41
Question 4
The following information relates to the activities of Wordsworth plc:
Statements of financial position at 31 March 2014 2013

£000 £000 £000 £000
Non-current assets
Freehold land at cost 780 700
Plant and equipment – cost 660 560
Less: Accumulated depreciation 296 230
364 330
1,144 1,030
Current assets
Inventory 498 356
Receivables 304 330
Bank — 30
802 716
Equity
Ordinary £1 shares 550 400
Share premium 210 160
Retained earnings 490 376
1,250 936
6% debentures 250 450
Current liabilities
Trade payables 230 240
Tax 90 120
Bank overdraft 126 —
446 360
Income statement for the year ended 31 March
2014
£000
Sales 4,520
Cost of sales 3,420
Gross profit 1,100
Expenses 766
Tax 150
Profit after tax 184
Statement of changes in equity for the year ended 31 March 2014
Share Share Retained Total

Capital Premium Earnings
£000 £000 £000 £000
Balance at 1 April 2013 400 160 376 936
Issue of share capital 150 50 200
Balance at 31 March 2014 550 210 490 1,250
42
You are informed that:
1. Plant which originally cost £80,000 was sold for cash of £14,000. The profit/loss
on disposal is included in expenses. Accumulated depreciation relating to the
plant sold amounted to £58,000.
2. The debentures were repaid on 30 September 2013. Interest for the year was
fully paid by 31 March 2014 and is included in expenses.
Required:
(a) Prepare the Statement of Cash Flows for Wordsworth plc for the year ended 31
March 2014. (18 marks)
(b) Explain how a statement of Cash Flows provides information about a company’s
financial performance in addition to that provided by the other financial
statements. Use the answer to (a) to illustrate your answer.
(7 marks)
Subject guide, Chapter 6, pp. 113–20.
This question required the preparation of a cash flow statement (CFS). Candidates should adopt
a systematic approach, which would enable them to extract the cash flows from the
accruals-based income statement and statement of financial position. The resulting increase or
decrease in cash balances should be reconciled to the relevant figures in the statement of financial
position. Good answers would be well presented, correctly describing the component cash flows
with clearly laid out workings. Part (b) of this question required an explanation of the usefulness
of a CFS. Good answers would have taken note of the requirement to use the answer to part (a)
to illustrate the points made.
(a) Wordsworth plc

Statement of cash flows for the year ended 31 March 2014
Cash flow from operating activities
£000
Add back interest (W1) 21
Profit from operations 355
Add back: Depreciation (W2) 124
Loss on sale of plant (W3) 8
Increase in inventory (142)
Decrease in receivables 26
Decrease in trade payables (10)
Cash flow from operating activities 361
Interest paid (21)
Tax paid (120+150 − 90)) (180)
160
Net cash from investing activities
Cash flows from investing activities
Purchase of non-current assets (660 − (560 − 80)) + 80 (260)
Proceeds from sale of non-current assets 14
Net cash used in investing activities (246)
43
Cash flows from financing activities

Issue of shares 200
Repayment of debentures (450 − 250) (200)
Dividends paid (70)
Net cash used in financing activities (70)
Decrease in cash and cash equivalents (156)

Cash and cash equivalents at start of year 30
Cash and cash equivalents at end of year (126)
Workings
(W1) Interest on debentures
6% × 450 × 6/12 + 6% × 250 × 6/12 21
Accumulated depreciation at 31 March 2013 230

Less: depreciation on plant sold (58)
(W2) Depreciation 172
Accumulated depreciation at 31 March 2014 296
Depreciation for year 124
(W3) Profit/loss on sale of plant = Proceeds − NBV of plant = 14,000 − (80,000 −
58,000) = £(8,000) (loss).
(b) • A statement of cash flows focuses on operating, investing and financing activities, which
the other financial statements do not specifically do.
• It explains why, despite a healthy profit, the company had lost cash over the year –
mainly through the acquisition of non-current assets, which was not financed by any
other means other than operating activities.
• 50% cash from operating activities was used to pay tax liabilities.
• Although the company issued shares, the funds raised had been used in their entirety to
repay the debentures.
• Reconciliation of profit before tax to cash flows from operations provides useful
information; although, for this company, the profit and cash flow figures were similar.
• However, this aided understanding of management of working (liquid) capital, and it
showed that the large increase in inventories had reduced the cash available for other
purposes. This information was not obvious from just the income statement and
statement of financial position.
• Statement of cash flows eliminated the impact of accruals accounting, and it might be a
way of highlighting earnings management by the company to manipulate reported profits.
• Other valid comments should be given appropriate credit.
44
Section C
Answer one question and no more than one further question from this section.
Question 5
Longfellow Security Ltd is a small company that installs alarm systems into
commercial properties. The company sells a standard system which is its main
activity but can modify this if necessary. The equipment for the standard system is
purchased from an alarm manufacturer. The budget for the quarter ended 31
December 2013 based on installing 50 systems was as follows:
£
Sales (50 systems at £1,260) 63,000
Equipment 20,000
Labour (£8 per hour) 8,000
Variable Overhead (£5 per hour) 5,000
Fixed overhead 12,000
45,000
Budgeted Profit 18,000
The actual number of units sold for the quarter was 54 and the results for the
quarter were as follows:
£
Sales 64,800
Equipment 20,900
Labour (1,100 hours) 9,200
Variable Overhead 5,100
Fixed overhead 14,000
49,200
Actual Profit 15,600
• The company had purchased 55 alarm systems from the manufacturer but one
had been damaged during installation. The partial installation and removal of
the damaged system and the installation of the new system had taken an
additional 20 hours of labour. An allowance of £200 against the normal sales
price had been given to the customer for the inconvenience caused by the
removal and reinstallation of the system.
• Except for the reinstalled system all sales were invoiced at the budgeted price
but. allowances against sales price had been given to a few customers for delays
caused by bad weather conditions.
• This information has been reflected already in the actual results as reduced
sales and increased costs.
Required:
(a) Prepare an operating statement for Longfellow Security Ltd for the quarter
ended 31 December 2013 which reconciles budgeted and actual profit. You
should show two variances for each cost.
(20 marks)
(b) Calculate the effect on the profits for the quarter of:
i. the damaged alarm and reinstallation.
ii. the bad weather.
(5 marks)
45
This question tested candidates’ ability to apply standard costing, budgeting and variance
analysis to a given set of data. Candidates should set out clearly all of their workings and
cross-refer them to the final operating statement and relevant variances. It is important that
they identify variances as either favorable or adverse (unfavorable). Examples of these techniques
are clearly demonstrated in the subject guide, and candidates should be prepared to use them in
questions at this level. Part (b) required candidates to calculate the impact of two specific events
using the variances calculated in (a). This is a testing section that needed candidates to think
about the causes and effects underlying the variances.
(a) Operating statement

Fav Unfav £
See correction
Budgeted sheet for replacement text.
profit 18,000
Sales variances : Volume 1,440 —
Price — 3,240 1,800
16,200
Cost variances
Materials : Price 1,100 —
Efficiency — 400
Labour : Price — 400

Efficiency — 160
Variable overhead : Price 400 —

Efficiency — 100
Fixed overhead : Spending — 2,000

Volume 960 —
2,460 3,060 600
Actual profit 15,600
(b)
Effect of damaged alarm
Cost of one alarm (standard cost) 400
Additional labour (20 × 8) 160
Additional variable overhead (20 × 5) 100
Sales allowance 200
860
Effect of bad weather

Sales price variance 3,240
Less Sales allowance on damaged alarm (200)
3,040
46
Workings
1. Sales variances
Volume margin
AQ × SM − SQ × SM
(54 × 360) − (50 × 360) = 1440 F
Price
AQ × AP − AQ × SP)
(64.800) − (54 × 1,260) = 3,240 U
2. Materials variances
Price
AQ × AP − AQ × SP
(20,900) − (55 × 400) = 1,100 F
Efficiency
AQ × SP − SQ × SP
(55 × 400) − (54 × 400) = 400 U
3. Labour variances
Price
(9,200) − (1,100 × 8) = 400 U
Efficiency
(1,100 × 8) − (1,080 × 8) = 160 U
4. Variable overhead
Price
(5,100) − (1,100 × 5) = 400 F
Efficiency
(1,100 × 5) − (1,080 × 5) = 100 U
5. Fixed overhead
Spending
AC × − SC
14,000 − (240 × 50) = 2,000 U
Volume
SC × − (AQ × SP)
(240 × 50) − (54 × 240) = 960 F
Question 6
Lewis Outdoors Ltd is a new company which has recently been set up to specialise
in manufacturing a new type of tent for sale to youth groups using a recently
developed synthetic material. You are the Management Accountant for the
company and have been approached by the management team to give some advice.
The Sales Manager predicts that the tents can be sold at a price of £80 each.
Variable cost estimates for the production of each tent, together with the overhead
costs, are set out below:
Variable costs of production £ per tent

Cost of synthetic material (£2 per sq metre). 20
Poles and pegs 5
Cost of labour 20
47
Overheads:
Rent of factory premises £20,000 per month payable quarterly in
advance commencing January 2013
Lease of machines £8,000 per month payable in same
month
Other overheads £14,000 per month payable in following
month plus £3 per tent payable in the
same month
The Sales Manager predicts that sales will start in January 2013 with 1,000 units
and increase as shown in the table below. By June the monthly sales will have
reached 2,000 units per month and will remain at that level for the foreseeable
future. Production levels each month would be the same as the sales estimates.
Month Planned Sales (units)

Jan 1,000
Feb 1,200
Mar 1,400
April 1,600
May 1,800
June 2,000
Labour is paid in the month incurred. An initial purchase of synthetic material is to

be made in January sufficient for the first three month’ production; this initial
purchase is to be paid for in January. In March and subsequent months sufficient
synthetic material is to be purchased for the following months’ production; these
purchases are paid for in the following month. Poles and pegs are purchased and
paid for in the month of production. Sales receipts are all in the month following
the sale. The financial accountant informs you that the cash balance at the start of
trading on 1 January is expected to be £100,000 and that the company has
negotiated an overdraft limit with the bank of £70,000.
Required:
(a) Calculate the following for the new venture:

i. Contribution per tent,
(1 mark)
ii. The forecast profit for the period Jan–June 2013,
(3 marks)
iii. The level of monthly sales required to break even,
(2 marks)
iv. The margin of safety at the planned level of sales in June 2013
(2 marks)
(b) Prepare a cash flow forecast for the six months January – June 2013 showing
the forecast cash flows for each month and the cash balance at the end of each
month.
(13 marks)
(c) Reconcile the forecast profit for the period with the total net cash flow for the
period.
(4 marks)
48
Subject guide, Chapter 10, pp.168–72; Chapter 13.
Perks, R. and D. Leiwy (2013), Chapters 15 and 17.
This question drew together two parts of the syllabus. Part (a) required an understanding and
application of cost/volume/profit principles and contribution analysis. Part (b) required the
construction of a cash budget, which is best shown in a columnar form. It is important that
candidates show their workings clearly for each figure of the answer, as there are many marks to
be earned independently in this type of question. Part (c) tested understanding of the difference
between profit and cash flows.
(a) i.
£
Sales price 80
Variable cost (45 + 3) 48
Contribution 32
ii.
Forecast profit for period
Sales (9,000 × 80) 720,000
Variable cost (9,000 × 48) (432,000)
Contribution 288,000
Fixed costs (42,000 × 6) (252,000)
Profit 36,000
iii.
BEP monthly
= 42,000/32 = 1,313 tents
iv.
Margin of safety – June
100 × (2,000 − 1,313)/2,000 = 34% or 687 tents
(b) Cash flow statement
J F M A M J
£ £ £ £ £ £
Sales — 80,000 96,000 112,000 128,000 144,000
Material (72,000) — — (32,000) ( 36,000) (40,000)

Poles and pegs (5,000) (6,000) (7,000) (8,000) (9,000) (10,000)
Variable overhead (3,000) (3,600) (4,200) (4,800) (5,400) (6,000)
Labour (20,000) (24,000) (28,000) (32,000) (36,000) (40,000)
Rent (60,000) (60,000)
Lease (8,000) (8,000) (8,000) (8,000) (8,000) (8,000)
Fixed overhead — (14,000) (14,000) (14,000) (14,000) (14,000)
(168,000) (55,600) (61,200) (158,800) (108,400) (118,000)
Net cash flow (168,000) 24,400 34,800 (46,800) 19,600 26,000
Opening cash 100,000 (68,000) (43,600) (8,800) (55,600) (36,000)
Closing cash (68,000) (43,600) (8,800) (55,600) (36,000) (10,000)

(c) Reconciliation (any format/order is OK). *None needed for materials as payable = inventory.
Net cash outflow
100,000 + 10,000 = (110,000)
Adjustments *
: Receivables = 160,000
: Fixed overhead = 14,000
36,000
49
Question 7
Hardy Limited has undertaken research into launching a new product which will
take it into a new market area. Hardy feels it has expanded its existing operation to
its maximum potential, and it is the market leader in its existing field.
The proposed new product would offer new opportunities and, although there is
strong competition in its field already, the management feel it can use its existing
brand name to break into this product line. The new product is in car cleaning
accessories, but will offer items in a single package not currently available. The
management believe that ,although the proposed product may be relatively short
lived, the penetration of new markets is worthwhile as long as the product does not
make a loss.
Details of the project are as follows:
• Market research costs incurred to date amount to £250,000

• Investment in plant at the start: £2,900,000. At the end of the product’s life
the plant will have a disposal value of £80,000
• The project is estimated to have a life of 5 years
• The sales price of each unit is initially forecast at £25.
• The production cost is £13 per unit including a depreciation charge of £3 per
unit
• Selling and distribution costs are estimated to be £3 per unit
• An initial injection of additional working capital of £100,000 will be needed and
should be recoverable in full at the end of the product’s life.
Estimated sales volumes:
Year 1 Year 2 Year 3 Year 4 Year 5

Sales volumes (units) 100,000 150,000 200,000 100,000 50,000
To maintain sales, advertising will have to be undertaken throughout the life of the
project as follows:
Year 1 £200,000
Year 2 £250,000
Advertising costs: Year 3 £100,000
Year 4 £150,000
Year 5 £100,000
The selling price will be maintained at £25 for the first two years and will decrease
to £20 in year 3 and to £18 in year 4 and £15 in year 5.
Hardy charges fixed overheads to products at 5% on the production cost.
Hardy estimates that, as a result of the project, additional administration costs of

£100,000 per annum will be incurred and additional maintenance costs of £150,000
in year 4 and £200,000 in year 5. These are in addition to the costs given above.
Hardy Limited currently has a cost of capital of 7%. Assume all cash flows occur at
year ends except for the purchase of plant and additional working capital which
occur at the start of the project.
Required:
(a) Calculation of the net present value of the project, presented in columnar form
to the nearest £000.
(14 marks)
50
(b) Calculation of the payback period of the project.

(3 marks)
(c) Advice on the proposed project.

(4 marks)
(d) Two limitations of your analysis above.

(4 marks)
The application of capital investment techniques is an important element of the syllabus and the
learning outcomes for Chapter 12 of the subject guide. The most effective approach to Part (a)
was to construct a columnar table in which relevant cash flows could be inserted. It was
important that candidates gave workings of all figures and clearly explained the treatment of all
amounts; for example, if a cost is to be treated as sunk and therefore not included as a relevant
cost, this should have been stated. Having determined the net cash flow for each year these
would have been discounted using the discount factors taken from the tables provided. Therefore
a net present value could have been arrived at and a decision recommended and justified. This
question required the use of a significant amount of data, and it was very important that
candidates’ answers were clearly presented and that all their workings were legible and
understandable; candidates are encouraged to use the 8-column accounting paper provided. A
suggested presentation of the answer is given below.
Part (c) required candidates to provide reasoned and clear advice based on their calculations.
Part (d) required two (not more) limitations of the analysis – these might have been on the use
of either NPV or Payback. The answer given here is a bullet point summary of a few potential
answers to this question; candidates should write out their answers in full.
(a) Ignore market research and ignore fixed overhead allocation.

0 1 2 3 4 5
. (2,900) 80
Working capital (100) 100
Sales 2,500 3,750 4,000 1,800 750
Production costs (1,000) (1,500) (2,000) (1,000) (500)
Selling and dist. (300) (450) (600) (300) (150)
Admin costs (100) (100) (100) (100) (100)
Advertising (200) (250) (100) (150) (100)
Maintenance (150) (200)
Net cash flow (3,000) 900 1,450 1,200 100 (120)
Discount rate 1 0.935 0.873 0.816 0.763 0.713
Present value (3,000) 841 1,266 979 76 (86)
Net present value + 76K (or 77K)
51
(b) Payback calculation (DCF)

Year CF Cumulative CF
0 (3,000) (3,000)
1 841 (2,159)
2 1,266 (893)
3 979 86
4 76 162
5 (86) 76
Payback is in 2 years, 11 months. There is a negative cash flow in Year 5, but overall the
payback is + VE (accept on nominal CF at 2.54 years).
(c) Hardy should accept the product proposal as:
• Gives a + VE NPV.
• Payback is in under 3 years.
Therefore the project meets the company’s target and gives penetration into new markets.
(d) Possible limitations:
• It ignores tax.
• It ignores changing prices.
• Assumes a discount rate.
• Based on sales predictions.
• Assumes a new market penetration.
• Other relevant points.
52

Examiners' Commentaries 2014: AC1025 Principles of Accounting

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Examiners’ commentaries 2014

Examiners’ commentaries 2014

Information about the subject guide

What the Examiners are looking for

Examiners’ commentaries 2014

Information about the subject guide

Comments on specific questions – Zone A

Answer question 1 from this section.

(a) Cordelia commenced in business as an executive taxi service on 1st January

II. Depreciation at 20% using the reducing balance method.

Reading for this question

Statement of financial position

(II) Reducing balance

Statement of financial position

(b) The conceptual framework of accounting recognises four qualitative

• Understandability – nature of users’ knowledge.

Standard costs per unit: £

Budgeted production data (in units)

• Marginal costing, showing contribution and gross profit. (3 marks)

Show your figures to the nearest £000.

Reading for this question

Subject guide, Chapter 9, pp.152–62.

Perks, R. and D. Leiwy (2013), Chapter 14.

Approaching the question

(b) Total absorption costing

2. TAC – Cost of closing inventory

Reading for this question

Related to required rates of return.

The following information is also given:

1. The inventory at 31 December 2013 has been valued at £32,000. Further

2. The balance on the motor vehicles account is made up as follows:

3. The discounts allowed were given to customers for early payment.

5. Insurance prepaid at 31 December 2013 amount to £400, and sales staff ’s

6. The directors have proposed an equity dividend of 5p per share.

7. Taxation payable on the profit for the year is estimated at £4,200.

i. Income Statement for the year.

Reading for this question

Subject guide, Chapters 4, 5 and 6.

Perks, R. and D. Leiwy (2013), Chapter 10.

Approaching the question

(a) i. Income statement for the year ended 31 December 2013

2. Provision for doubtful debts

The following information relates to the activities of Goneril plc:

Income statement for the year ended 30 April 2014

Statement of changes in equity for the year ended 30 April 2014

Share Share Revaluation Retained

Statements of financial position as at 30 April

Plant and Equipment 990 1,092

Total assets 5,238 5,838

Equity 2,808 3,750

Total equity and liabilities 5,238 5,838

1. Plant and Equipment

Disposal (240) (174) (66)

Reading for this question

Subject guide, Chapter 6, pp.113–20.

Perks, R. and D. Leiwy (2013), Chapter 6.

Approaching the question

(a) Goneril plc

Net cash from operating activities 480