Examiners ' Commentaries 2012: AC1025 Principles of Accounting

Examiners commentaries 2012

AC1025 Principles of accounting
Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 201112. 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 (2012).
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 answering more
questions than 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 should then adhere to these time allocations. The
1
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 Sections 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 Examiners require. Far too many candidates
include every scrap of knowledge they have on a topic without specifically
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, 2010) third edition [ISBN 9780077124786],
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.
2
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 specific questions for Zone
A and Zone B indicate where certain topics may be found in the current
edition of the subject guide (2012), 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.
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.

AC1025 Principles of accounting Zone A
Important note

Comments on specific questions

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.
Section A
Answer Question 1 from this section.
Question 1
(a) Swallow commenced business on 1st October 2010 purchasing fixtures
and fittings for 25,000 and a motor vehicle for 16,000. The fixtures and
fittings were estimated to have a useful life of 8 years and a residual value
of 1,800. Further fittings were purchased on 1 November 2011 for 15,200
with nil residual value and a useful life of 8 years.
During December 2011 the motor vehicle was involved in an accident and
the insurance assessors considered it a write-off. A cheque for 3,200 was
received in December from the insurers in full settlement. Another vehicle
was purchased on 5 January 2012 at a cost of 18,500.
The depreciation policy of Swallow is to charge a full years depreciation
in the year of purchase and none in the year of disposal, and to depreciate
fixtures and fittings on a straight-line basis and vehicles by 25% reducing
balance.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide, Chapter 4.
Perks, R. and D. Leiwy Accounting: understanding and practice. (Maidenhead:
McGraw-Hill, 2010) third edition [ISBN 9780077124786] Chapter 1.
Approaching the question

One of the key aims of this course is to be able to apply financial
accounting techniques and concepts to a set of data. Depreciation
is a key accounting concept. Part (ii) requires a discussion of the
advantages and disadvantages of the two methods of depreciation.
Swallow Income statement for year ended 30th September

i.
2011
2012
6,900
9,425
8,800
2011
2012
41,000
58,700
Accumulated depreciation
6,900
*12,325
*(2900 + 4800 + 4625)
34,100
46,375
Depreciation
Loss on disposal of vehicle
Statement of financial position at 30 September
Non-current assets
Cost
Workings
y/e 30.09.11
Purchases
Fixtures
Vehicles
25,000
16,000
Depreciation
(25,000 1,800) 8
(25%) ( 4,000)
(2,900)
_______
22,100
12,000
y/e 30.9.12
Proceeds
3,200
Loss
8,800
Purchases
15,200
Depreciation
2,900 + (15,200 8)
18,500
(25%) (4,625)
(4,800)
______
32,500
13,875
ii.
The pros of using the straight line method are that it is easier to
understand and the computations are simpler than other methods.
Also it gives the same charge for depreciation in each year of the
assets life which means that this method is more appropriate for assets
which are depleted as a result of the passage of time such as buildings
and patents. However, the cons are that it may not give an accurate
measure of the loss in value or reduction in the useful economic life of
an asset.
The pros of the reducing balance method are that it gives a decreasing
annual charge for depreciation over the useful life of an asset. This
means that it is more appropriate for assets which deteriorate primarily
as a result of usage where this is greater in the earlier years of their
life such as plant and machinery and motor vehicles. It is also said to
provide a more realistic measure of the reduction in the market value
of non-current assets. However, the cons of using this method are that
the computations are more complex and difficult to understand.
5
(b) Required:
Explain the objective of published financial statements and identify the two
principal characteristics of financial statements which contribute to achieving
this objective.
(6 marks)
Subject guide Chapter 1.
Perks and Leiwy (2010) Chapter 3.

Understanding of the objectives and characteristics of financial statements
is a fundamental conceptual underpinning to this course. Answers which
discuss the content of financial statements (income, assets, etc.) or the
format (income statement, cash flow statements, etc.) do not address the
issue raised in the question.
Answers should explain that the objective of financial statements is to
provide information that users (investors, lenders and creditors) need in
making decisions about the reporting entity.
The two principal (qualitative) characteristics of financial statements
are relevance and faithful representation (or reliability). Good answers
will explain the predictive and confirmatory value of relevance, and the
comparability and understandability of faithful representation.
(c) Required:
In the context of cost-volume-profit (CVP) analysis explain the meaning, and
give an example of each of the following terms:
i. Non-linear variable costs
ii. Stepped fixed costs
iii. Relevant range
(6 marks)


This question tests candidates ability to explain the three terms used in
cost-volume-profit (CVP) analysis. An example of each of the terms should
be used to demonstrate the meaning and application of the terms.
i. Non-linear variable costs vary with volume of activity but with a cost
per unit which is different for different levels of activity.
Example Direct material where there are discounts available for
larger orders.
ii. Stepped fixed costs are those which do not vary with volume of activity
between two levels of activity but which, at the higher level, will
require an extra resource.
Example Rental of storage facility which has a maximum capacity
after which a new facility will have to be rented.
iii. The relevant range is the range of outputs over which the assumption
that a cost-volume relationship is a linear relationship is realistic.
Example A firm may determine variable and fixed costs which will be
realistic between 10,000 and 15,000 units; outside of this range these
costs will no longer behave in the assumed linear fashion.
(d) Kestrel Ltd manufactures a single product which sells at 1.20 per unit. The
variable cost of this product is 60p per unit. At present the fixed expenses of
the company are 30,000 p.a. Kestrel is currently selling its full productive
capacity of 100,000 units p.a. at what the companys directors believe is
the optimum price-volume relationship for the product. However, they are
considering selling the product under an additional brand name. While
being virtually identical from the manufacturing point of view, brands will
be differentiated by the packaging and the marketing approaches adopted.
Sales of the existing and the new brand when both are priced at 90p per unit
are expected to total 250,000 units.

A key learning outcome of this course is to apply decision-making
techniques using accounting information. This question requires basic
calculations of information which would be useful to a company in
deciding between two schemes. Answers should show understanding of
the techniques and an ability to assess the information and draw reasoned
conclusions.
i.
Existing
BEP
30,000
1.20 0.6
50,000 units
Proposed scheme
60,000 = 150,000
0.9 0.5
Profit
(0.6 u 100,000) 30,000 =

(0.4 u 250,000) 60,000 =
Margin of safety
ii.
Existing profit level =

Sales volume at predicted sales price
= 60,000 + 30,000 =
0.4
30,000
40,000
50,000 units
= 50%
100,000 units
= 40%
30,000
225,000
Sales price at predicted volume

Cost = 60,000 + 30,000 = 36p
250,000
Price = 36 + 50 =
iii.
86p
The proposed scheme

gives 33% increase in profits if predictions are achieved
has a higher break-even point but if predicted sales are achieved, a similar unit
margin of safety but in percentage terms it is riskier

if the scheme is adopted the level of sales needed to at least achieve current
profits is 90% of predicted levels

Or, sales price can be dropped from 90p to 86p.
Overall the proposed scheme seems to give reasonably low risk with higher profits.
Section B
Answer Question 2 from this section, and one further question from either
Section B or C
Question 2
The following is the trial balance of Nightingale Ltd as at 30 April 2011:
100,000 equity shares of 1 each
100,000
50,000 7% preference shares of 50p each

Land and buildings, at valuation
25,000
240,000
Accumulated depreciation: Buildings

Plant and equipment, at cost
13,100
13,000
Accumulated depreciation: Plant and equipment

Inventory
Trade receivables
3,900
9,400
11,200
Trade payables
8,300
Bank overdraft
7,800
Purchases
49,700
Sales
135,900
Administrative expenses
28,400
Distribution costs
11,700
Interest on debentures
1,200
10% debentures
Investments (current assets)
24,000
8,000
Provision for bad debts
910
Share premium
35,000
General reserve
10,200
Interim dividend paid on equity shares

Bed debts written off
3,250
700
Revaluation reserve
9,860
Retained earnings
2,580
_______
______
376,550
376,550
The following additonal information is available:

(1) Inventory at 30 April 2011 is valued at 13,480.
(2) Administrative expenses of 1,150 were prepaid on 30 April 2011.
(3) Depreciation on buildings is to be provided at a rate of 15% per annum
on the carrying value of 80,000 and the plant and equipment should
be depreciated to result in a net book value of 7,800 on 30 April 2011.
Depreciation is to be included in administrative expenses.
(4) The provision for bad debts is to be adjusted to 10% of the trade receivables
at the period end. Bad debts and changes to the provision are to be treated
as administrative expenses.
(5) The corporation tax on this years profit of 6,370 is to be provided for.
(6) The preference share dividends are outstanding at the period end (30 April
2011) and the last half years interest on the debentures has not been paid.
(7) The directors propose to declare a final dividend on the equity shares of 13
pence per share and transfer 2,500 to general reserves.
(8) The account policies of Nightingale Ltd include the following:
Preference shares are to be treated as a non-current liability and the
preference dividend as a finance cost.
Equity dividends are only accounted for when paid and are shown as part
of the changes in equity.
Subject guide Chapters 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 are given in order that
marks are awarded for all work which 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. The
workings may be shown on the face of the accounts or separately but
candidates should try and help the Examiners to award all appropriate
marks by clear presentations. The 8-column accounting paper provided
is particularly useful for presenting the financial statements. You should
pay attention to the presentation of your 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.
(a)
i. Income statement for the year ended 30 April 2011
Sales revenue
135,900
Cost of sales [W1]
(45,620)
Gross profit
90,280
Distribution costs
(11,700)
Administrative expenses [W2]
(41,460)
Profit before Interest and Tax
37,120
Finance costs [W6]
(4,150)
Profit before tax
32,970
Taxation
(6,370)
Profit for the year
26,600
ii. Statement of changes in equity for the year ended 30 April 2011
Balance at 1/5/10
Share
capital
100,000
Share Revaluation
premium
reserve
35,000
9,860
General
reserve
10,200
Retained
Total
earnings
2,580 157,640
Changes in equity:
Equity dividends paid
(3,250)
Total income (profit)
26,600
Transfer
Balance at 30/4/11
2,500
100,000
35,000
9,860
12.700
(2,500)
(3,250)
26,600
23,430 180,990
iii. Statement of financial position as at 30 April 2011
Land and buildings
240,000
25,100
214,900
Fixtures and fittings
13,000
253,000
5,200
30,300
7,800
222,700
ASSETS
Non-current assets:
Current assets:
Inventory
Trade debtors
Less: provision for doubtful debts
Prepayments
Investments
Total assets
EQUITY AND LIABILITIES
Non-current liabilities:
10% debentures
50,000 7% preference shares
Total non-current liabilities
Current liabilities:
Bank overdraft
Trade creditors
Accrued tax
Accrued debenture interest
Preference dividend
Total current liabilities
Total liabilities:
Equity
Share capital
Reserves
Total equity and liabilities
13,480
11,200
(1,120)
10,080
1,150
8,000
255,410
24,000
25,000
49,000
7,800
8,300
6,370
1,200
1,750
25,420
74,420
100,000
80,990
180,990
255,410
Presentation
10
(b)
Answers should include the following:
Land and buildings might have historical cost figures which do not
bear much relationship to market value. In order to provide a more
relevant statement of financial position a recalculation might be
considered.
The revaluation might not have a large impact on income as the
depreciation on land and buildings is likely to be relatively small.
A revaluation results in a gain which is accounted for as follows:
DR Asset account
CR Revaluation reserve
The revaluation reserve is not distributable so will not lead to higher
dividend payments.
Workings
[W1] Cost of sales:
Opening inventory
Add: Purchases
Less: Closing inventory
[W2] Administrative expenses:
TB (less prepaid of 1,150)
Depreciation of buildings [W3]
Depreciation of P and E [W4]
Provision for doubtful debts [W5]
Bad debts
9,400
49,700
(13,480)
45,620
27,250
12,000
1,300
210
700
41,460
[W3] Depreciation of buildings:

15% u 80,000 = 12,000
[W4] Depreciation of plant and equipment:
Opening NBV is (13,000 3,900) = 9,100
Closing valuation is 7,800
Depreciation for year: (9,100 7,800) = 1,300
[W5] Provision for doubtful debts:
Opening debtors*
Provision @ 10%
Existing provision
Increase in provision
Bad debt of 700 already accounting for since in TB.
11,200
1,120
(910)
210
[W6] Finance costs:

Interest on debentures: 24,000 u 10% =
Preference dividend: 25,000 u 7% =
2,400
1,750
4,150
11
Question 3
The statement of financial position of Lapwing plc for the year ended 31
December 2011, together with comparative figures for the previous year, is
shown below:
2011
000
2010
000
270
(90)
180
180
(56)
124
Total assets
50
40
90
270
42
33
11
86
210
EQUITY AND LIABILITIES

Equity
Equity share capital 1 shares
Share premium
Retained earnings
Total equity
25
10
93
128
20
8
81
109
80
60
33
19
10
62
142
270
24
17
41
101
210
ASSETS
Non-current assets
Property, plant and equipment cost
Current assets
Inventory
Trade receivables
Cash
Non-current liabilities
15% debentures repayable 2015
Current liabilities
Trade and operating payables
Current tax payable
Bank overdraft
Total current liabilities
Total liabilities
Additional information:
(1) Plant had been sold during the year for 15,000 with a loss on disposal of
5,000. The cost of the plant sold was 27,000.
(2) The company declared a final dividend of 26,000 for 2011 (2010 was
28,000).This is paid immediately after the AGM that takes place after the
year end.The company did not pay any interim dividends.
(3) New debentures and shares issued in 2011 were issued on 1 January.
(4) The taxation liability at each year end is settled in full in the following year.

This question requires preparation of a cash flow statement (CFS). You
should adopt a systematic approach which will enable you to extract the
cash flows from the accruals based income statement and statement of
12
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 will be well presented, correctly describing the
component cash flows with well laid out workings. In 2012 part (c) was
often not attempted and candidates should remember to attempt all
sections of the questions in the paper.
(a) Computation of operating profit
000
12
28
19
59
Increase in retained earnings (9381)

Dividends
Taxation
Operating profit
(b) Lapwing plc
Statement of cash flows for the year ended 31 December 2011
Cash flows from operating activities
000
Profit before taxation
59
Depreciation charges
41
Loss on disposal
5
Loan interest (15% u 800,000)
12
Operating profit before working capital changes
117
Increase in trade receivables
(7)
Increase in inventories
(8)
Increase in trade payables
9
Cash generated from operations
111
Interest paid
(12)
Taxation
(17)
Net cash from operating activities
Cash flows from investing activities
Sale of property, plant and equipment
15
(117)
Payments to acquire property, plant and equipment
Net cash from investing activities
Cash flows from financing
Issue of debentures
20
Issue of equity share capital
7
(28)
Equity dividends paid
Net cash used in financing activities
Decrease in cash and cash equivalents
Net cash and cash equivalents at 12 January 2011
Net cash and cash equivalents at 31 December 2011
000
82
(102)
(1)
(21)
11
(10)
Statement of cash and cash equivalents
Cash at bank
Overdraft
Total cash and cash equivalents
2010
000
11
11
Cash flow
000
(11)
(10)
(21)
2011
000
(10)
(10)
(c) A statement of cash flows presented under the direct method shows
operating cash receipts and payments (including, in particular,
cash receipts from customers, cash payments to suppliers and cash
payments to and on behalf of employees), aggregating to the net cash
flow from operating activities.
13
The direct method shows actual inflows and outflows of activities.

The indirect method shows users can assess quality of earnings by
referring to reconciliation of earnings/cash flows.
Workings
Cost
A/c Depn
180
(27)
117
___
270
56
(7)
1. PPE
As at 2010
Disposal
Additions (B/F)
Depreciation (B/F)
As at 2011
41
90
Question 4
Osprey plc is a family-owned clothes manufacturer. For a number of years the
chairman and managing director was David Bird. During his period of office,
sales revenue had grown steadily at a rate of two to three per cent each year.
David Bird retired on 30 November 2011 and was succeeded by his son Simon.
Soon after taking office, Simon decided to expand the business. Within weeks
he had successfully negotiated a five-year contract with a large clothes retailer
to make a range of sports and leisurewear items. The contract will result in an
additional 2m in sales revenue during each year of the contract. To fulfill the
contract, Osprey Ltd acquired new equipment and premises.
Financial information concerning the business is given below.
Income statements for the year ended 30 November
Revenue
Operating profit
Interest charges
Profit before taxation
Taxation
Profit for the year
2011
000
9,482
914
(22)
892
(358)
534
2012
000
11,365
1,042
(81)
961
(386)
575

Perks and Leiwy (2010) Chapters 4, 5 and 7.

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 technique is
often testing by a mini-case study of the type used in this question. It
is important that 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 will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspectives of the lenders and
shareholders.
14
You should carefully read the requirements of the question which, in this
case, specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case study
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
Osprey plc
(a)
i.
2011
914 u 100
9482
9.6%
1042 u 100
11365
ii.
9.2%
Net profit margin

534 u 100
9482
5.6%
5.1%
575 u 100
11365
iii.
Asset turnover
9482
12541 1508
0.86 x
11365
19117 5174
iv.
ROCE
914 u 100
11033
0.81 x
8.28%
1042 u 100
13943
v.
Current ratio
4926
1508
7.47%
3.3 : 1
7700
5174
vi.
2012
Operating profit margin
1.5 : 1
Quick assets
4926 2386
1508
7700 3420
5174
1.7 : 1
0.8 : 1
15
vii.
Receivables collection period

2540 u 365
9482
98 days
4280 u 365
11365
viii.
Gearing
1120 u 100
11033
3675 u 100
13943
137 days
11.1%
26.4%
(b) The operating and net profit margins were slightly lower in 2012 than
in 2011. Although there was an increase in sales revenue in 2012, this
could not prevent a slight fall in return on capital employed (ROCE) in
that year. The lower operating margin and increases in sales revenue
may well be due to the new contract. The capital employed by the
company increased in 2012 by a larger percentage than the increase in
revenue. Hence, the sales revenue to capital employed ratio decreased
over the period. The increase in capital during 2012 is largely due to
an increase in borrowing. However, the gearing ratio is probably still
low in comparison with other businesses. Comparison of the premises
and borrowing figures indicates possible unused borrowing (debt)
capacity.
The major cause for concern has been the dramatic decline in liquidity
during 2012. The current ratio has decreased by more than half during
the period. There has also been a similar decrease in the quick assets
ratio. The balance sheet shows that the business now has a large
overdraft and the trade payables outstanding have nearly doubled in
2012.
The trade receivables outstanding and inventories have increased
much more than appears to be warranted by the increase in sales
revenue. This may be due to the terms of the contract that has been
negotiated and may be difficult to influence. If this is the case, the
business should consider whether it is overtrading. If the conclusion is
that it is, increasing its long-term funding may be a sensible policy.
16
Section C
Answer one question from this section, and one further question from either
Section B or C
Question 5
Hoopoe Ltd makes two products in one of its factories. The products comprise
different mixes of two basic raw materials. One grade of direct labour is
employed in the mixing process and another grade in final packaging.
Standard (budgeted) direct material and direct labour costs for the two products
in the year ended 31 March 2012 were:
Product Y
( per hundred units)
Product Z
( per hundred units)
Raw material A
156.00
78.00
Raw material B
54.00
72.00
Manufacturing
11.25
11.25
Packaging
20.00
20.00
Direct materials:
Direct labour:
The direct material included in the budget is after taking into account a standard
loss of material A in the process.

The preparation of budgets is a key learning outcome of Chapter 13 of
the course. This question provided a relatively complex scenario which
required a logical and well structured approach to extracting the figures
and preparing the budgets.
(a)
Product Y
Product Z
Standards for 31/3/13

Direct materials:
A: 29.333 kg (2) at 5.46 per kg
160.16
14.667 kg (3) at 5.46 kg

B: 30 kg at 1.89 per kg
80.08
56.70
40 kg at 1.89 per kg
75.60
Direct labour:
Mixing (2.5 hours at 4.86)
12.15
12.15
Packaging (5 hours at 4.32)
21.60
21.60
17
Notes:
1. Standards for 31/3/12
Direct materials:
A:
B:
156.00
78.00
54.00
Direct labour:
72.00
Mixing (2.5 hours at 4.50)

Packaging (5 hours at 4)
2. X- Revised input for material A = 30 u (1.10/1.125) = 29.333
11.25
11.25
20.00
20.00
3. Y- Revised input for material A = 15 u (1.10/1.125) =14.667

(b)
i.
Production budget:
Sales
Add closing stock
Less closing stock
Production
Product Y (units)
1,700,000
200,000
1,900,000
Product Z (units)
950,000
125,000
1,075,000
190,000
1,710,000
150,000
925,000
Kilos
ii. Material B purchases budget:
Required for production:
Product Y:
1,710,000 units at 30 kg per hundred
Product Z:
925,000 units at 40 kg per hundred
Add: Closing stock
Less: Opening stock
Required purchases
Required purchase cost =
iii. Mixing labour budget:
Total production:
Product Y
Product Z
1,710,000
925,000
2,635,000 units
at 2.5 hours per hundred

= 65,875 hours
18
513,000
370,000
883,000
90,000
(95,000)
878,000
1,659,420
Question 6
Heron Electronics Ltd is an established company which has continued to be
profitable in recent years despite operating at below full capacity. Continued
investment in research and development has produced a new innovative
product, the microwave drier.
(1) Market research supports the proposed price of 400 per drier with the
following predicted sales over the next five years:
Year
1
2
3
4
5
Unit sales
20,000
30,000
35,000
42,000
40,000
(2) The company accountant has collated the following costing information
relating to the drier proposal:

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) is to construct a columnar
table in which relevant cash flows can be inserted. It is important to give
workings of all figures and to explain clearly 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 be stated. Having determined the net cash flow
for each year, these are discounted using the discount factors taken from
the tables provided. Thus a net present value and payback can be arrived
at and a decision recommended and justified. This type of question
requires use of a significant amount of data and it is very important
that your work is clearly presented and that all workings are legible and
understandable. The 8-column accounting paper can help in this respect.
A suggested presentation of the answer is given below.
Part (b) was a fairly straightforward comparison of the strengths and
weaknesses of NPV and Payback methods.
19
(a) Relevant cash flows and calculation of NPV

[Note that the 200,000 R&D is a sunk cost and therefore irrelevant.]
All figures in 000
Year
R&D and capital
Working capital
0
(7,500)
(200)
(200)
(300)
(400)
(500)
5
300
1,600
Fixed costs (manuf)

Fixed costs (S&D)
(1,200)
(300)
(1,200)
(300)
(1,200)
(400)
(1,800)
(500)
(1,800)
(500)
Lost rents
(600)
(600)
(900)
(1,200)
(1,200)
_____
3,000
4,500
5,250
6,300
6,000
(7,700)
700
2,100
2,350
2,300
1
0.893
0.797
0.712
0.636
4,400
0.567
Contribution
Net Cash Flow
(b) 12% PV Factor
NPV
(7,700)
625.1
1673.7
1673.2
1462.8
2494.8
Overall NPV = 230,000

Payback is just over 4 years
Alternative answer
If the original fixed costs (M, S and D) were not treated as relevant
costs and only the changes at the higher output levels were included
then the cash flows increase by 1,500k for each of the years 25; this
gives a NPV of 5,637,100 and a payback of two and a half years.
Working 1
Calculation of contribution per drier
Selling price
Direct labour
Direct material
Variable manuf. overheads
Variable S & D costs
Contribution
75
75
75
25
400
(250)
150 per drier
(c) The strengths and weaknesses of the two investment appraisal

methods are outlined below. Although payback is generally thought to
be a weaker technique overall, it may be of relevance to Heron because
of their liquidity problems.
The strengths of payback are:
simple to calculate and understand
favours early cash receipts
minimises time related risks
informative if there are liquidity problems.
The weaknesses of payback are:
ignores cash flows after payback period
ignores timing of cash flows even before payback
not an absolute measure (poor for tanking projects of different size)
20
The strengths of NPV are:

takes into account time value of money
money sooner is better than money later because of:
1. Real Interest Rate (or opportunity cost).
2. Inflation
3. Risk
(1 and 2 are included in money interest rates)
considers all cash flows and the whole life of the project
an absolute measure (therefore good for ranking projects).
The weaknesses of NPV are:
more complicated to calculate and understand
may give impression of accurate figures but only as good as the
estimates of relevant cash flows
has a long term view but does not consider liquidity and is not
popular with managers who are assessed by short term performance
measures.
Question 7
Dunnock Ltd manufactures a single product, a laminated kitchen unit, which has
a standard cost of 80 made up as follows:
Direct material
Direct labour
Variable overheads
Fixed overheads
15sq metres @ 3 per sq m

5 hours @ 4 per hour
5 hours @ 2 per hour
45
20
10
5
80
Variable overheads are charged on a direct labour hour rate.

The standard selling price of the kitchen is 100.
The month budget projects production and sales of 1,000 units.
Actual figures for the month of April are as follows:
Sales 1,400 units @ 102
Production 1,400 units
Direct materials 22,000 sq metres @ 4 per sq m
Direct labour 6,800 hours @ 5
Variable overheads 11,000
Fixed overheads 6,000
There are no inventories of materials at the beginning or end of the period.

This is a question which tests candidates ability to apply standard costing,
budgeting and variance analysis to a given set of data. Your answer
should set out clearly all of your workings and cross-refer these to the
final operating statement and relevant variances. It is important that you
identify variances as either favourable or adverse (unfavourable). These
21
techniques are clearly demonstrated by examples in the subject guide and

you should be prepared to apply them in questions at this level.
Part (b) tests your understanding of the variances and their
interpretations. Good answers will provide a well-explained commentary
for management.
(a)
Report on kitchen unit sales and production for April
Budgeted profit
Sales variances Price
Volume
Cost variances
Materials
Price
Efficiency
Labour
Price
Efficiency
V. overhead Price
Efficiency
F. overhead Spending
20,000
2,800 F
10,000 F
32,800
Fav
800
2,600
400
_____
3,800
Adv
(22,000)
(3,000)
(6,800)
(1,000)
32,800
Actual profit
(29,000)
3,800
(b) Commentary
Overall budgeted profits of 20,000 have not been achieved due
principally to material cost overruns.
Sales volume has increased even after a 2p increase in sales price.
If costs had been on target, a profit of 32,800 could have been
achieved.
Materials suffered a large price rise and management should
investigate the cause of this; for example, have we changed
supplier, purchased better quality or is this a result of a market price
increase?
Material usage was also worse than budget (which may mean better
quality of material is unlikely). Management should investigate
wastage and production processes.
Labour rates have increased. This could be due to higher skilled
staff mix, bonus schemes, overtime or a response to higher market
rates.
The efficiency of labour is better than anticipated; this could be due
to higher skilled employees or production process efficiencies. The
amount is relatively small compared to other cost variances.
Variable overheads have cost less than anticipated. An analysis of
the components would reveal where the reductions have occurred.
The efficiency savings will relate to the labour efficiency referred to
above.
Fixed overheads have increased and management should
investigate the components of this cost.
22
Workings
1.
2.
Budgeted and actual figures April

Original budget
Materials
45,000
Labour
20,000
Variable overhead
10,000
5,000
Fixed overhead
80,000
Sales
100,000
Profit
20,000
Flexed budget
63,000
28,000
14,000
5,000
110,000
140,000
30,000
Actual
88,000
34,000
11,000
6,000
139,000
142,800
3,800
Variances
Sales price
(AQ u AP) (AQ uSP)
(1400 u102) (1400 u100)
= 2,800 F
Sales volume
30,000 20,000
Materials price
=10,000 F
(AQ uAP) (AQ uSP)

(22,000 u4) (22,000 u3)
= 22,000 A
Materials efficiency
(AQ uSP) (SQ uSP)
(22,000 u 3) (21,000 u 3)
= 3,000 A
Labour price
(AQ uAP) (AQ uSP)
(6,800 u5) (6,800 u4)
= 6,800 A
Labour efficiency
(AQ uSP) (SQ uSP)
(6,800 u4) (7,000 u4)
= 800 F
Variable overhead price

(AQ uAP) (AQ uSP)
(11,000) (6,800 u2)
= 2,600 F
Variable overhead efficiency

(AQ uSP) (SQ uSP)
(6,800 u2) (7,000 u2)
= 400 F
Fixed overhead spending
1000 A
23

AC1025 Principles of accounting Zone B
Important note

Comments on specific questions

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.
Section A
Answer Question 1 from this section.
Question 1
(a) Required:
Explain the objective of published financial statements and identify the two
principal characteristics of financial statements which contribute to achieving
this objective.
(6 marks)
Subject guide, Chapter 1.
Perks, R. and D. Leiwy Accounting: understanding and practice. (Maidenhead:
McGraw-Hill, 2010) third edition [ISBN 9780077124786] Chapter 3.

Understanding of the objectives and characteristics of financial statements
is a fundamental conceptual underpinning to this course. Answers which
discuss the content of financial statements (income, assets, etc.) or the
format (income statement, cash flow statements, etc.) do not address the
issue raised in the question.
Answers should explain that the objective of financial statements provide
information that users (investors, lenders and creditors) need in making
decisions about the reporting entity.
The two principal (qualitative) characteristics of financial statements
are relevance and faithful representation (or reliability). Good answers
will explain the predictive and confirmatory value of relevance, and the
comparability and understandability of faithful representation.
24
(b) The following data show the trading transactions of Othello Ltd for its
first six months of trading. The company operates the weighted average
assumption for calculation of cost of sales. Closing inventory and the cost of
sales is calculated whenever a sale is made.
(1)
2011
July
August
September
October
November
December
40 units at
80 units at
Purchases
1,000 each
900 each
40 units at
20 units at
20 units at
1,100 each
700 each
1,200 each
Sales
50 units at 1,500
90 units at 1,700
The December sale occurred before the purchase in that month.

(2)The 20 units purchased in November incurred a transport charge of
2,500 to move them to the company premises. This amount is not
included in the cost of 700 per unit.
(3)The 20 units purchased in December had been made to order for a
customer who has now gone into liquidation. Othello Ltd can only sell
these for a price of 1,000 per unit after a modification costing 150
per unit.
(4)Operating expenses for the six months amounted to 10% of sales
revenue.
Required:
Prepare the Income Statement for Othello Ltd for the six months to 31st
December 2011 from the above information.
(6 marks)
Perks and Leiwy (2010) Chapters 1 and 2.

The learning outcomes in Chapter 9 require candidates to be able to
prepare and contrast stock valuations under different costing methods.
This question tests the use of one method. It is important to set out the
statements and calculations in a clear and organised manner. The most
common failures were the incorrect treatment of the transport costs and
using a periodic valuation rather than, as the question required, using a
transaction-based valuation.
Othello Ltd
Income Statement for the six months to 31 December 2011
Sales
Purchases
Less: Closing inventory
Gross profit
Operating expenses (10% u 228,000)
Operating profit
(196,500)
55,718
228,000
(140,782)
________
87,218
(22,800)
64,418
25
Workings
1. Purchases
Cost
Transport costs
2.
Inventory valuation
At 31 August
Sale
Purchases (October November)
Sale
December (NRV)
3.
194,000
2,500
196,500
Units
120
(50)
70
60
130
(90)
40
20
60
Net Realisable Value

Sale price
Less: costs
20 units =
Cost
112,000
(46,667)
65,333
60,500*
125,833
(87,115)
38,718
17,000
55,718
1,000
150
850
17,000
(c) Required:
Outline the main purposes and benefits of budgeting.
(6 marks)


A key learning outcome is to understand the role of budgetary control in
organisations. This is a straightforward test of this knowledge. Candidates
should not spend time in detailed explanation of the techniques of
budgeting but concentrate on the requirement to outline the purposes and
benefits of budgeting.
The main purposes and benefits of budgeting are:
Planning and anticipation. Management are forced to think ahead
and plan for future eventualities. Regular budget-setting and review
procedures also lead to regular examination of the organisations goals
and decisions.
Communication and coordination. Preparation of budgets
encourages communication between different parts of the organisation
and different levels of management. A cohesive budget allows activities
to be coordinated. For example, the production department needs to
know how much the sales department is planning to sell in order to set
its target for production.
Motivation. Budgets and standard costs provide targets and, as such,
can motivate staff to achieve them, especially if staff are rewarded on
the basis of meeting budget (e.g. in the form of a bonus). The simple
presence of a target of any kind can often improve performance.
However, care must be taken to ensure that the target is set at an
appropriate level.
26
Authorisation and responsibility. Managers know that budgeted

expenditure has been authorised and can act accordingly. Setting
individual budget for particular business activities or departments can
be used to assign responsibility to individual managers for meeting
those budgets.
Evaluation and control. Budgets provide plans against which
subsequent performance can be judged. Management monitor and
evaluate whether budgets are fulfilled. Management performance can
also be assessed and rewarded on this basis.
(d) Cordelia plc manufactures three spice mixes for catering firms: Mild, Spicy
and Hot. The selling price and the variable costs per unit for each product are
as follows:
Mild
30
Spicy
40
Hot
60
Spice A
10
23
25
Spice B
10
15
Selling price
Variable cost
Spice B is in short supply and this year Cordelia is only able to purchase
240,000 kilos at 5 per kilo. Spice A is plentiful.
The marketing manager predicts that the maximum demand for each product
for the year will be:

A key learning outcome of this course is to explain and apply decisionmaking techniques using accounting information. This question tests your
understanding of contribution analysis and limiting factors. It is important
that answers calculate the contribution per unit of limiting factor in
reaching the optimum mix of products. Answers to part (ii) need to be
specific in identifying an appropriate technique.
i. Contribution per unit of Spice B
Sales price
Variable cost
Spice B input (k)
Contribution per kilo of Spice B
Optimum mix is:
Mild
30
(20)
10
2
Spicy
40
(28)
12
1
Hot
60
(40)
20
3
12
6.67
Product units
16,000
Kilos of Spice A
16,000
Hot
30,000
90,000
Mild
67,000
134,000
240,000
Spicy
27
Operating profits
Profit Spicy
16,000 u 12 =
192,000
Hot
30,000 u 20 =
600,000
Mild
67,000 u 10 =
670,000
1,462,000
300,000
1,162,000
Fixed costs
Profit for year
ii. This situation gives multiple limiting factors and can only be resolved
using linear programming.
Section B
Answer Question 2 from this section, and one further question from either
Section B or C.
Question 2
Macbeth plc prepares its financial statements for the year ended 31 March. The
company has extracted the following trial balance at 31 March 2012:
000
6% Loan notes (redeemable 2016)
Trade payables
Trade receivables
Accumulated depreciation at 31 March 2011:
9,930
Plant and equipment

Vehicles
Administrative expenses
Bank
Purchases returns
Distribution costs
Dividends paid
Dividends received
Equity shares, 20p each, fully paid
Interest paid on 6% loan notes
Inventories
Investments, non-current
Plant and equipment, at cost
Proceeds from issue of share capital
Provision for doubtful debts at 31 March 2011
Purchases
Retained earnings at 31 March 2011
Sales
Taxation
Vehicles, at cost
6,460
1,670
16,141
456
106
9,060
5,800
850
19,000
615
4,852
15,000
27,315
1,500
600
94,160
14,677
124,900
4
5,720
________
188,593
The following further information is available:

(1) Non-current assets are to be depreciated as follows:
Plant and equipment 20% per annum straight-line
Vehicles
25% per annum reducing balance
28
000
10,250
8,120
_______
188,593
(2) An invoice for telephone charges for the quarter ended 1 May 2012 for
15,000 was received by the company after the above trial balance was
extracted. Telephone expenses are included in administrative expenses.
(3) The company paid 156,000 insurance premiums for the year 1 November
2011 to 30 October 2012. This amount is included in administrative expenses.
Subject guide Chapters 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 are given in order that
marks are awarded for all work which is correct. If figures in the final
accounts comprise a number of items marks will be awarded accordingly
but without workings one error may result in several marks being lost.
The workings may be shown on the face of the accounts or separately
but candidates should try and help markers to award all appropriate
marks by clear presentations. The 8-column accounting paper provided
is particularly useful for presenting the financial statements. You should
pay attention to the presentation of your 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.
Part (b) of this question tests the ability to calculate and explain
the dividends a shareholder will receive and how this relates to the
information in the financial statements.
(a) Macbeth plc
i. Income statement for the year ended 31 March 2012
000
Sales
Cost of sales
Opening inventory
Purchases (94,160 106)
Closing inventory
(4,852)
(94,054)
(98,906)
5,180
(93,726)
31,174
850
32,024
Gross profit
Dividends received
Expenses
Administrative expenses 16,141 + (2/3 u 15) (7/12 u 156)
Distribution costs
Bad debts 75% u 348
Decrease in provision for doubtful debts [5% u (9,930 348)] 600
Depreciation: Plant and equipment 20% u 27,315
Motor vehicles 25% u (5,720 1,670)
000
124,900
(16,060)
(9,060)
(261)
120.9
(5,463)
(1,012.5)
(31,735.6)
29
Profit before interest and tax

Interest payable
Loss for the year before tax
Taxation
288.4
(615)
(326.6)
(26.0)
352.6
ii. Macbeth plc

Statement of changes in equity for the year ended 31 March 2012
Balance at 1 April 2011

Issue of shares
Loss for the year
Dividends paid
Balance at 31 March 2012
Equity share
capital
000
19,000
1,000
Share
premium
000
Retained
earnings
000
14,677
Total
(352.6)
(5,800)
8,524.4
000
33,677
1,500
(352.6)
(5,800)
29,024.4
000
Cost
27,315
000
Accum Deprn
11,923
000
NBV
15,392
5,720
33,035
2,682.5
14,605.5
3,037.5
18,429.5
15,000
33,429.5
500
20,000
500
iii. Macbeth plc

Statement of financial position at 31 March 2012
ASSETS
Non-current assets
Plant and equipment
Motor vehicles
Investments
Current assets
Inventory
Trade receivable (9,930 261)
Less: provision for doubtful debts
Prepayments
5,180
9,669
(479.1)
9,189.9
91
14,460.9
47,890.4
Total assets
EQUITY & LIABILITIES
Equity
Equity share capital
Share premium
Retained earnings
20,000
500
8,524.4
29,024.4
10,250
67% loan notes

Current liabilities
Bank overdraft
456
Trade payables
8,120
Accruals
10
Corporation tax
30

30
8,616
47,890.4
(b) Information for Mrs Macduff
Dividends received in 31/3/12
2011 Final dividend (1000 u 4p)
40
2012 Interim dividend (1000 u 2p)
20
60
Dividend yield for 31/3/12
Interim (as above)

2012 Final (1000 u 5p)
20p
50p
70p
Yield 7 u 100 =
200
3.5%
Question 3
Falstaff plcs statements of financial position for the years ended 31 December
2011 and 2010 are shown below:
Statements of financial position at 31 December
2011
000
Non-current assets
Property
Cost
2010
000
000
2,100
700
1,725
555
1,400
Fixtures and fittings

Cost
1,900
1,060
1,170
1,493
840
840
2,240
Current assets
Inventory
Accounts receivable
Equity
Ordinary share capital
Share premium
Accumulated profits
435
255
910
3,150
1,800
250
282
8% debentures
Current liabilities
Bank
Accounts payable
Taxation
653
1,823
620
290
Total assets
000
690
2,513
1,500
187
2,332
1,687
450
360
70
248
50
222
176
68
368
3,150
466
2,513
[For the full question, please refer to the examination paper.]

31

This question requires an understanding of how specific items are shown
in a cash flow statement (CFS) which is part of the learning outcome
which refers to the preparation of financial statements from structured
data. You should adopt a systematic approach which will enable you to
extract the cash flows from the accruals-based income statement and
statement of financial position. Good answers will be well presented,
correctly describing the component cash flows with laid out workings.
Answers which prepare a full cash flow statement would be appropriately
awarded but candidates are advised to produce only the answers required
by the rubric of the question as the marks are allocated to the amount of
time and effort required for such answers.
Part (a) tests candidates understanding of the difference between cash
flows and accruals based accounting. Candidates should note that three
examples are required.
(a) Income statement prepared according to accounting convention of
accruals: The accruals concept means profit is the difference between
income earned and expenses incurred cash doesnt have to be
received or paid for time to be recorded.
The statement of cash flows shows actual movements of cash (monies
passing through current or near-current bank accounts) as well as
cash receipts and payments and shows whether more cash has come in
than has gone out over the accounting period. Net cash flow reconciles
opening and closing bank and cash balances.
Examples could include depreciation, receivables/prepayments and
payables/accruals effect on profit, acquisition of non-current assets,
share and loan movements.
(b) i. Interest paid = 8% u [(360 u 9/12) + (450 u 3/12)] = 30,600.
This is shown in the statement of cash flows as a separate line in
operating activities.
ii. Loss on sale of non-current assets = 30 (250 204) = 16,000.
This is added back to profit before tax in reconciliation of this to
cash flow from operating activities.
iii. Taxation paid = 68 + (90 50) = 108,000.
This is shown in statement of cash flows as a separate line in
operating activities.
iv Payments to acquire non-current assets = 1,032,000
Property = 2,100 1,725 = 375
F + F = 1,900 (1,493 250) = 657
This is shown in statement of cash flows as a separate line in
investing activities.
v. Increase in accounts receivable = 290 255 = 35,000.
This is deducted from profit before tax in reconciliation of this to
cash flow from operating activities.
vi. Dividends paid = Profit for year difference between SoFP
retained earnings
= 175 (282 187)
= 80,000
This is shown in a statement of cash flows as a separate line in
financing activities but could also be shown as part of operating
cash flows.
32
Question 4
Duncan plc operates a mobile phone network for personal and business
customers. The latest annual report has just been released on the companys
website. The annual report includes the following:
Duncan plc Extract from the financial review for the year ended 31 December
2011.
Highlights for the year:
A review of operating and administrative systems resulted in investment
in non-current assets with a significant reduction in staffing levels.
Growth has been offset by competitive pricing due to strong competition.
Average revenue per personal customer per month (2011 = 10.56, 2010
= 11.20) has been affected by increased regulatory pressures on the
pricing of mobile phone tariffs.
Customers registered during 2011 have increased by 7% (2010: 3%).
10 million has been spent in 2011 on new advertising and sports
sponsorship to boost brand awareness.
Subject guide Chapter 7
Perks and Leiwy (2010) Chapters 4, 5 and 7.

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 technique is
often testing by a mini-case study of the type used in this question. It
is important that 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 will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspectives of potential users.
You should carefully read the requirements of the question, which in this
case, specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case study
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
(a)
2010
Return on capital employed
(755 (4945 + 2050)) u 100
(985 (5220 + 2080)) u 100
10.8%
Net profit margin

(755 2610) u 100
(1060 2695) u 100
28.9%
Asset turnover
2610 6995
2695 7300
0.37 x
2011
14.5%
39.3%
0.37 x
33
Gross profit margin

(1115 2610) u 100
(1400 2695) u 100
42.7%
Current ratio
(735 : 660)
(1095 : 910)
1.1 : 1
Quick ratio
((735 95) : 660)
((1095 15) : 910)
1.0 : 1
Gearing
(2050 6995) u 100
(2080 7300) u 100
29.3%
EPS
(445 2660) u 100
(590 2670) u 100
16.7p
51.9%
1.2 : 1
1.2 : 1
PE No.
200 16.7
309 22.1
28.5%
22.1p
12
14
(b) Commentary (summary of key points):

ROCE Improved return on capital employed
Increase due to improved margins with stable asset
turnover
Net profit margin
Significant increase
Staffing cost savings
Even better if take out increased marketing costs
Selling and distribution costs reduced
Administrative costs are similar
Asset turnover
Remained constant
Increase in volume of customers but fall in revenue per customer
due to competitive pricing and regulatory pressures.
Net asset increases but note PPE investment and fall in
intangibles.
Gross margin
Significant increase
See net margin for analysis
Current ratio
Constant at reasonable level
Quick ratio
Improvement in solvency/liquidity
Large cash balance
But higher payables
34
EPS
Significant improvement for reasons explained above.
PE No.
Market price indicates that investors are happy with the
strategies adopted by the company (If the PE had remained at
12 price would now be 2.65 rather than 3.09).
Section C
Answer ONE question from this section, and ONE further question from either
Section B or C
Question 5
Ophelia plc operates a chain of furniture stores and is considering its strategy
on distribution and transport. The present position is that distribution is outsourced to a transport company. The expected cost for the year ended 30 June
2013 is 250,000. This cost, it is projected, will rise by 10% per annum over the
next five years.
The Directors of Ophelia plc are considering an alternative strategy of acquiring
a company owned and managed transport fleet. The initial cost of the transport
fleet on 1 July 2012 would be 750,000 and it is estimated that the fleet would
be sold at the end of year 2017 for 150,000.
It is estimated that the following costs would be incurred over the next five
years:
Drivers costs
Repairs and
maintenance
Other costs
33,000
35,000
36,000
38,000
40,000
8,000
13,000
15,000
16,000
18,000
230,000
235,000
240,000
236,000
242,000
Year ended 30th June

2013
2014
2015
2016
2017
The figure for Other Costs includes depreciation on the fleet on the straightline basis. The head office administration costs of Ophelia plc are expected to be
300,000 per annum and the running of the fleet would take up approximately
10% of the administrative time. However, the finance director believes that
there is sufficient spare capacity in the head office to carry out the additional
work.

The application of capital investment techniques is an important element
of the syllabus for this course and learning outcomes for Chapter 12 of
the subject guide. The most effective approach is to construct a columnar
table in which relevant cash flows can be inserted. It is important to give
workings of all figures and to explain clearly 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 be stated. Having determined the net cash
flow for each year, these are discounted using the discount factors taken
from the tables provided. Thus a net present value can be arrived at and
35
a decision recommended and justified. This type of question requires use

of a significant amount of data and it is very important that your work
is clearly presented and that all working are legible and understandable.
The 8-column accounting paper can help in this respect. A suggested
presentation of the answer is given below.
Part (c) gave good candidates an opportunity to show their understanding of
the decision-making process and place this into a business context.
Part (d) required an understanding of Internal Rate of Return (IRR) and the
problems in its application.
(a) Incremental cash flows Transport Fleet Project
2012
2013
2014
Out-source costs
250,000
275,000
Drivers costs
(33,000)
(35,000)
Repairs and maintenance
(8,000)
(13,000
Other costs
(110,000)
(115,000)
Fleet costs
(750,000)
Sub-contract income
50,000
50.000
_______ _______
______
(750,000)
149,000
162,000
2015
302,500
(36,000)
(15,000)
(120,000)
2016
332,750
(38,000)
(16,000)
(116,000)
50,000
______
181,500
50,000
_______
212,750
N.B. Ignore overheads

(b) i. Payback
Initial cost
750,000
Cumulative cash inflow

2013
149,000
2014 (+ 162,000)
311,000
2015 (+ 181,500)
492,500
2016 (+ 212,750)
705,250
2017 (+ 44,750)
75,000
Payback = 4 years 1.4 months.

ii. Net Present Value
2012
2013
2014
2015
2016
2017
Net present value
CF.
(750,000)
149,000
162,000
181,500
212,750
386,025
Discount Factor
0.893
0.797
0.721
0.636
0.567
(c) Recommendation:
Reject the transport fleet project
Accept the alternative project.
Answers should explain the following:
The project has a longer payback period than the alternative.
36
P.V.
(750,000)
133,057
129,114
129,228
135,309
218,876
(4,416)
2017
366,025
(40,000)
(18,000)
(122,000)
150,000
50,000
_______
386,025
The project has = negative NPV thus the project would reduce
shareholder wealth. The alternative has a positive NPV at discount
rate of 12%.
Subject to reliability of assumptions.
The project would give more control over future service and costs
whereas outsourcing would not.
(d) IRR = the discount rate at which the NPV of the project is equal to
zero. It is not appropriate for decisions involving mutually exclusive
projects.
Workings
1. Other costs
2013
230,000
2014
235,000
2015
240,000
2016
236,000
2017
242,000
Depreciation
(120,000)
(120,000)
(120,000)
(120,000)
(120,000)
20% u (750,000 150,000)
_______
110,000
_______
115,000
_______
120,000
_______
116,000
_______
122,000
Per Q
Question 6
Portia Ltd is a specialist manufacturer of components for luxury yachts. A
contract has been offered to Portia by Nerrisa Supermarine plc for the supply
over the next twelve months of 400 identical components, ZK44.
The data relating to the production of each component ZK44 is as follows:
Material requirements:
3 kg material M1 see note (i) below.
2 kg material P2 see note (ii) below
1 part No. 678 see note (iii) below.
Note (i) Material M1 is in continuous use by the company. 1,000 kg are currently
held in stock at a book value of 4.70 per kg but it is known that future
purchases will cost 5.50 per kg.
[For the full question please refer the examinatin question.]
Perks and Leiwy (2010) Chapters 14 and 15.

Relevant and opportunity cost recognition are key techniques in shortterm decision-making. This question tests candidates ability to apply
these techniques. It is important in answering such questions that
you 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 will set out the
computations in a clear, logical and coherent manner.
Candidates should note that the question required a full explanation of
the figures used in the analysis and marks were awarded as appropriate.
Part (b) requires candidates to place the calculations in the context of the
wider business considerations by identifying three appropriate factors.
37
(a) Contract for manufacture of ZK44.

Analysis of production and sale of 400 units to Nerissa Supermarine plc.
Notes
M1 (1,200 kg at 5.50
6,600
P2 (800 kg at 2 per kg) (1)
1,600
Part no. 678 (400 at 50)
20,000
Skilled (2,000 hours at 4 per hour)
8,000
Semi-skilled (2,000 hours at 3 per hour)
6,000
Materials
28,200
Labour:
14,000
Overheads:
Variable (1,600 machine hours at 7 per hour)
11,200
Fixed: Incremental fixed costs
3,200
Total relevant cost
56,600
Contract price (400 components at 145 per component)
58,000
Contribution
The incremental revenues exceed the incremental costs. Therefore the
contract should be accepted subject to the comments in (b) below.
Notes:
1. Material M1 Opportunity cost is replacement cost.
2. Material P2:
If material P2 is not used on the contract it will be used as a
substitute for material P4. Using P2 as a substitute for P4 results in
a saving of 2 (3.60 1.60) per kg. Therefore the relevant cost of
P2 consists of the opportunity cost of 2 per kg.
3. Part No. 678 actual impact cost
4. Skilled labour opportunity cost is replacement labour cost.
5. Semi-skilled cost of additional labour.
6. Overhead variable overhead only is relevant.
additional fixed overhead is an incremental cost.
(b) Factors which should be considered are:
i. Can a price higher than 145 per component be negotiated? The
contract only provides a contribution of 1,400 to general fixed
costs. If the company generates insufficient contribution from
its activities to cover general fixed costs then it will incur losses
and will not be able to survive in the long tier. It is assumed that
acceptance of the contract will not lead to the rejection of other
profitable work.
ii. Will acceptance of the contract lead to repeat orders which are
likely to provide a better contribution to general fixed costs?
iii. Acceptance of the contract will provide additional employment for
12 months and this might have a significant effect on the morale of
the workforce.
iv. If there are few manufacturers, then acceptance of the contract may
be necessary to build a client relationship.
38
1,400
v. Given market conditions, should Portia be looking at strategies for

entering new markets?
Question 7
Cymbeline Ltd manufactures a single product. The company has two production
departments, 1 and 2, and a service department. The following are the variable
costs per product unit for April:
Direct materials
7.00
Direct labour
5.50
Manufacturing overhead
2.00
The selling price of the product is 36.00 per unit. Fixed manufacturing costs
are budgeted to be 1,340,000 for April. Fixed selling costs are budgeted to be
875,000. Fixed manufacturing costs can be analysed between the departments
as follows:
Production
1
380,000
Production
2
465,000
Service
Department
265,000
In addition there are budgeted general factory fixed costs of 230,000, these
represent space costs, for example, lighting and heating. Space utilisation is as
follows:
Production department 1
40%
Production department 2
50%
Service department
10%
In allocating the service department costs it is assumed that 60% of service

department costs are labour related and the remaining 40% machine related.
[For the full question please refer the examinatin question.]

The use of absorption costing is relevant to the learning outcomes of the
preparation of costs under different costing methods. Part (a) examines
the ability to apply allocation assumptions to a data set. The information
appears to be lengthy but in fact the calculations are straightforward if a
careful reading of the question is applied in a logical manner.
Parts (b) and (c) require the preparation of profit statements using full
absorption and managerial costing respectively. Again this requires a
logical and well-structured approach to well-understood concepts.
39
Allocated
Allocation of general factory
Share of service department
Labour related costs (60&)
Machine related costs (40%
Prodn.
Prodn.
Dept 1
Dept 2
380.0
465.0
92.0 (40%) 115.0 (50%)
76.8
(8/18)
96.0 (10/18)
57.6
57.6
606.4
Units of output
Overhead rate per unit
120
5.05
Service
Dept
265
23 (10%)
288
(172.8)
General
Factory
230
(230)
Total
1,340
_____
(115.2)
733.6
1,340
120
6.11 (rounded to nearest p)
(a) Calculation of total manufacturing cost per unit
7.00
5.50
2.00
5.05
6.11
25.66
Direct materials
Direct labour
Variable overhead
Fixed overhead: Department 1
Department 2
Manufacturing cost
(b) Absorption costing profit statement
Production cost (116,000 u 25.66)
Less: closing stocks m (2,000 u 25.66)
Cost of sales
Under-absorption of overhead:
Department 1 ((20,000 + (4,000 u 5.05))
Department 2 (4,000 units u 6.11)
Non-manufacturing costs
Total cost
Sales (114,000 u 36)
Net profit
2,976,560
51,320
2,925,240
40,200
24,440
875,000
3,864,880
4,104,000
239,120
Note that the under-recovery of fixed overheads consists of 20,000

arising from actual overheads exceeding estimated overheads plus 4,000
times the fixed overhead rate because actual volume was 4,000 units less
than estimated volume.
(c)
Marginal costing profit statement

Variable production cost (116,000 u 14.50)
Less: closing stocks (2,000 u 14.50)
Fixed manufacturing overhead (1,340 + 20)
Non-manufacturing overhead
Sales
Net profit
40
1,682,000
29,000
1,653,000
1,360,000
875,000
3,888,000
4,104,000
216,000

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