AC1025 Commentary 2018

Examiners’ commentaries 2018

AC1025 Principles of accounting
Important note
This commentary reflects the examination and assessment arrangements for this course in the
academic year 2017–18. 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 and the Essential reading

references
Unless otherwise stated, all cross-references will be to the latest version of the subject guide (2015).
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 refer 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 subdivided 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.
1
The rubric of the examination paper is set out on the front cover and you should ensure that you
follow these instructions precisely. It is very important that you do not waste time and effort in
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 examination has three sections. Section A consists of 20 multiple-choice questions covering the
entire syllabus in financial and management accounting. In Section A you will need to answer all the
questions for which the maximum mark will be 30.
Section B consists of questions on financial accounting. Question 1 is compulsory and is worth 30

marks requiring preparation of financial statements from a trial balance with adjustments, the
question includes an additional section which asks for a short essay explaining financial accounting
principles or concepts. In Section B there are two further financial accounting questions worth 20
marks.
Section C consists of the longer questions in management accounting worth 20 marks each. There
will be three questions, you will be asked to answer one question in this section. You will then need
to answer one further question from either Section B or Section C.
The rubric of the examination states that workings must be submitted for all questions in Sections B
and C 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 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.
Note: Workings will not be marked for MCQs – the answers will be entered on a
pre-printed sheet supplied in the examination. There will not be negative marking –
you will get marks for all correct answers without deduction for wrong answers.
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
Principles of accounting page of the VLE and you can print off as many sheets of the paper as
you need.
2
This subject does not require a lot of reading beyond the core text of Leiwy D. and R.E. Perks
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 specific questions’ Zone A and Zone B
indicate where certain topics may be found in the current edition of the subject guide (2015), 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.
Examination revision strategy
Many candidates are disappointed to find that their examination performance is poorer than they
expected. This may be due to a number of reasons, but one particular failing is ‘question
spotting’, that is, confining your examination preparation to a few questions and/or topics which
have come up in past papers for the course. This can have serious consequences.
We recognise that candidates might 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 available on the VLE. You should read
the syllabus 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. Examination papers may legitimately include
questions on any topic in the syllabus. So, although past papers can be helpful during your 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. We strongly advise you not to adopt this strategy.
3

Important note

references
section.
Comments on specific questions – Zone A
Section A of this examination consists of 20 Multiple Choice Questions. You should attempt to
answer ALL the questions. Each question has four possible answers (a–d). There is only one correct
answer to each of the questions. Please mark the correct answer on the special sheet provided. The
maximum mark for this part is 30.
Sections B and C: Please answer QUESTION 21 (30 marks) of Section B; ONE question from
Section C and ONE further question from either section B or C (except for Question 21 all
questions are worth 20 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 ALL questions from this section.
Correct answers are shown in bold.
Question 1
Which of the following statements is correct?
(i) a debit entry in the cash book will decrease the bank overdraft
(ii) a credit entry in the cash book will decrease a bank balance
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a (i) is true but (ii) is false

b (i) is false but (ii) is true
c Both are true
d Both are false
Question 2
At 31.3.18, the cash book of Company 2 showed an overdraft of £21,111 while the
bank statement showed a positive balance of £2,590. On 30.3.18, the bank wrote to
Company 2 stating that a cheque of £525 received from a customer and banked on
25.3.18 has bounced and had been dishonoured. This letter was only received by
Company 2 on 2.4.18. Receipts of £30,555 banked on 31.3.18 were not cleared
through the banking system until April 2018, while cheques totalling £54,931, issued
by the company in March 2018 were also not cleared through the banking system
until April 2018. Bank charges of £150 had not been entered in the cash book.
What was the corrected bank balance in the Statement of financial position at
31.3.18?
a £(46,162)
b £(21,786)
c £(26,291)
d £26,291
Corrected Cash book balance: (21,111) − 525 − 150 = £(21,786).
Bank rec: 2,590 + 30,555 − 54,931 = £(21,786).
Question 3
The selling price of inventory of Company 3 at 30.4.18 is £200,000. The company

sells its goods at a 40% mark-up. 20% of the inventory has been damaged in a fire
and will be sold for £14,000. Which of the following will be the correct value for
closing inventory at that date appearing in the statement of financial position?
a £128,286
b £121,143
c £254,000
d £110,000
Cost price is selling price divided by 140%. Cost is 200,000/140% = £142,857.
20% of it with a selling price of £40,000 has a cost price of 40,000/140% = £28,571. It will be
sold for £14,000 so the loss will be £14,571. Hence inventory will be valued at the lower of cost
or net realisable value = £142,857 − £14,571 = £128,286.
Question 4
On 1.4.18, Company 4 had 20 units in inventory costing £21 each. During the
month, the following transactions occurred:
Date Buy/sell Units Price

2.4.18 Buy 28 £25
11.4.18 Sell 32 £52
13.4.18 Buy 60 £24
17.4.18 Buy 70 £27
25.4.18 Sell 64 £55
5
What is (i) the value of inventory at 30.4.18 and (ii) the cost of goods sold (COGS)
for the month of April 2018 using the FIFO basis?
Inventory COGS
£ £
a 2,178 5,184
b 2,912 2,178
c 1,938 2,512
d 2,178 2,272
Inventory: 12 @ £24 = £288 + 70 @ £27 = £1,890 = £2,178.
COGS: 20 × £21 + 28 × £25 + 48 × £24 = £2,272.
Question 5
On 1.1.18, the equity of Company 5 was as follows:

£
Share capital: 50,000 shares of 50p each 25,000
Share premium: 6,000
Retained profits: 290,000
321,000
On that day, the company made a rights issue, issuing 50,000 shares for £1.30 each
and then made a 8 for 5 bonus issue. A dividend of 15p per share was then paid.
What will the balance be on the retained profits at the end of the day, assuming the
company offsets the bonus issue against the share premium, to the extent that is
possible?
Retained profits
a £347,000
b £217,000
c £251,000
d £244,600
SC: 25,000 + (50,000 × 50p) = 50,000 + 80,000 = £130,000.
SP: 6,000 + 50,000 × 80p = 46,000 − 46,000 = £0.
RP: 290,000 = 290,000 − 34,000 − (260,000 × 15p) = £217,000.
Total equity = £347,000 = 321,000 + 65,000 − 39,000 = £347,000.
Number of shares = £130,000/50p = 260,000.
Dividend = 260,000 shares @ 15p = £39,000.
Question 6
At 1.4.18, trade payables were £34,700. Payments to trade payables in April 2018
were £36,600. At 30.4.18 trade payables were £24,200 and closing inventory was
£21,000. Cost of goods sold in the month of April 2018 were £39,200.
What was the inventory of Company 6 at 1 April 2018?
6
Opening inventory
£
a 34,100
b 26,100
c 52,800
d 44,400
Opening payables + purchases − payments = Closing payables.
34,700 + purchases − 36,600 = 24,200, so purchases = 26,100.
COGS = Opening inventory + purchases − closing inventory.
39,200 = opening inventory + 26,100 − 21,000, so opening inventory = 34,100.
Question 7
At 1.4.18, trade receivables were £156,500. Sums received from trade receivables in
April 2018 were £144,300. At 30.4.18, trade receivables were £170,700. Cost of
goods sold in the month of April 2018 were £81,000. What was the company’s gross
profit for the month of April 2018?
Gross profit
£
a 63,300
b 77,500
c 87,700
d 90,300
Opening receivables + Sales − Receipts = Closing receivables.
156,500 + sales − 144,300 = 170,700, so sales = 158,500.
Gross profit = sales − COGS = 158,500 − 81,000 = £77,500.
Question 8
The following information is available relating to Company 100 and Company 200:
Company Company
100 200
Profit before tax for the year ended 31.3.18 £40 million £74 million
Profit after tax for the year ended 31.3.18 £32 million £48 million
Nominal value of 1 ordinary share 25p 10p
Share capital at 31.3.18 £22 million £20 million
Market value of one ordinary share at 30.4.18 £1.20 £1.95
Which of the following describes these companies’ The Price Earnings (PE) ratios of
these two companies at 31.3.18?
Company 100 Company 200

a 33 18.1
b 3.3 8.1
c 36.3 24
d 8 17
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Earnings per share = profit after tax/number of ordinary shares.
Company 100 = 32/88 = 36.36p, Company 200 = 48/200 = 24p.
PE ratio = Market value/EPS.
Company 100 = 120/36.36 = 3.3, Company 200 = 195/24 = 8.13.
Question 9
Company 300 has a dividend cover of 2 while Company 400 has a dividend cover of
20.
Assume you were advising elderly shareholders. Which of these two companies is
likely to be the more attractive investment to the majority of such investors?
a Company 300
b Company 400
c both companies are equally suitable
d the dividend cover has no relevance to an investment decision of such an
investor
A low dividend cover indicates that the company is paying a higher proportion of its profits as a
dividend. Generally, elderly investors are likely to be more interested in receiving dividends than
in companies which retain a higher proportion of its profits. Hence Company 300 is likely to be
the preferred investment to most elderly investors.
Question 10
Company 10’s accounting period ends on 31.12.17.
Insurance for the year ended 31.7.17, paid on 1.8.16 was £156,000.
What was the insurance expense in the income statement for the year ended
31.12.17?
What was the prepaid insurance in the statement of financial position at 31.12.17?
Insurance expense £ Prepaid insurance £

a 118,000 77,000
b 146,000 77,000
c 142,000 55,000
d 122,000 55,000
The opening prepayment at 1.1.17 was 7/12 × £156,000 = £91,000.
The closing prepayment at 31.12.17 is 7/12 × £132,000 = £77,000.
The expense = Opening prepayment + sum paid in the year − Closing prepayment = 91,000 +
132,000 − 77,000 = £146,000.
Question 11
A direct cost is which of the following?
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a a cost which is directly attributable to a particular job, product or service

b a cost which varies with output
c a semi-variable cost
d a cost which is apportioned to the cost of a unit of production
Question 12
In deciding which costs are direct costs and which are indirect costs for the
purposes of determining the costs in a university, is the salary and other
employment costs of the senior departmental manager of the Department of
Accounting & Finance a direct cost or an indirect cost when the university’s Chief
Financial Officer is computing (i) and (ii) below:
(i) the cost associated with one student studying for a degree in the Department?
(ii) the costs of the Department of Accounting?
one student the Department

in the Department of Accounting
a Direct Indirect
b Indirect Direct
c Direct Direct
d Indirect Indirect
In determining the cost of ‘running a single student’, the department manager’s employment
costs are indirect since the Departmental manager is working for all the students in the
Department (plus many other activities he/she will be working on).
However, in determining the total costs of the Department of Accounting, the departmental
manager is a direct costs since it wholly relates to the activity of the cost object (i.e. the thing
we are trying to establish the total costs).
Question 13
Company 13 makes and sells pizzas in its fast-food stall in a local shopping mall.
The selling price of the product is £7, variable costs per unit are £2.25. Fixed costs,
for 2018, such as rent, are expected to be £80,000. The company wish to make a
profit for the year of £100,000. How many meals will have to be sold in the year to
achieve this objective?
a 16,842
b 25,714
c 35,556
d 37,895
The number of meals required to achieve a given profit:
fixed costs + required profit 80,000 + 100,000

= = = 37,895 meals (rounded up).
contribution per unit 4.75
Question 14
Using the information in Question 13, if the budgeted sales are 24,000 meals sold,
what is the margin of safety, expressed as a percentage?
9
a 29.8%
b 42.5%
c 14.4%
d 40.1%
We have:
Fixed costs 80,000
BEP = = = 16,843 meals
Contribution/unit 4.75
and:
budget units − BEP 24,000 - 16,843
M of S = = = 29.8%.
budgeted units 24,000
Question 15
Company 15 makes expensive, hand-made handbags – ‘superior’, ‘royal’, and

‘imperial’. Unit costs and revenues relating to the three products are as follows:
Superior Royal Imperial

£ £ £
Selling 499 799 1,399
Direct materials 90 190 290
Direct labour 60 60 120
Variable overheads 45 85 145
Fixed overheads 50 100 100
Total costs 245 435 655
Profit per unit 254 364 744
All three products use material which costs £500 per kilogram but there is not
enough material to meet the demand for all three products. In what order should
these three products be produced if the company wishes to maximise its profit?
Best 2nd best 3rd best

a Superior Royal Imperial
b Imperial Royal Superior
c Superior Imperial Royal
d Imperial Royal Superior
We have:
Superior Royal Imperial
Contribution/unit, £ 304 464 844
Materials: kg/unit 0.18 0.38 0.58
Contribution/kg of material, £ 1,688.89 1,221.05 1,455.17
Ranking 1 3 2
With one scarce resource, products should be ranked according to the contribution per unit of
scarce resource (in this case, materials).
Question 16
Company 16’s Cash budget shows there is likely to be a hefty cash deficit at the end
of the forthcoming quarter and the expected balance will exceed the company’s
existing agreed overdraft limit. Which of the following courses of action would you
consider to be appropriate in these circumstances?
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(i) Delay payment to its suppliers

(ii) Delay payment of the monthly salaries until the following month
(iii) Offer more generous credit terms to its customers
(iv) Offer customers a discount for payment within 7 days of sales invoice date
a (i), (ii) and (iv)

b (i) and (iv)
c (i), (iii) and (iv)
d (ii) and (iv)
(i) This will have a short-term cash benefit but it might strain relations with the Company’s
suppliers.
(ii) Not only will this destroy labour relations but it is likely to be contrary with contracts of
employment.
(iii) This will delay the receipt of payment from customers.
(iv) A discount will bring money in earlier but, of course, there is a cost in this since less will be
collected in the end.
Question 17
Furniture Ltd manufactures high quality executive desks. Budgeted production for
April was as follows:
Budget £
Material 600 kg @ £35 per kg 21,000
Labour 800 hours @ £20 per hour 16,000
Fixed overheads 2,000
Total expenses 39,000
Sales revenue 20 desks 52,000
Profit 13,000
Actual figures were as follows:
Actual £
Material 648 kg 25,272
Labour 864 hours 18,576
Fixed overheads 2,100
Total expenses 45,948
Sales revenue 24 desks 59,760
Profit 13,812
The labour rate and labour efficiency variances are which of the following?
Labour rate Labour efficiency

variance variance
a £1,296 F £16 F
b £1,296 A £1,920 F
c £1,296 A £16 F
d £1,296 F £1,920 A
Labour rate variance = AH (AR − SR) = 864 × (21.50 − 20) = £1,296 A.
Labour efficiency variance = SR(AH − SH) = 20 × ((864 − (24 × 40 hrs)) = £1,920 F.
Total labour variance £624 F.
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Check:
Budget: 24 × 40hrs × £20 = 19,200
Actual 18,576
Labour variance 624 F
Question 18
With reference to the information in Question 17, the sales price variance and sales
contribution variances are which of the following?
Sales price variance Sales cont’n volume

variance
a £2,200 A £3,000 F
b £2,200 F £2,600 F
c £2,640 A £2,600 F
d £2,640 A £3,000 F
Sales price variance = Actual volume (ASP − SSP) = 24 × (2,490 − 2,600) = £2,640 A.
Sales contribution volume variance = Std contribution (AV − SV) = 750 × (24 − 20) = £3,000
F.
Question 19
Company 19 is considering replacing all its machinery. The financial controller has
computed the Net Present Value of the project at two different discount rates. NPV
at a discount rate of 8% is £45,500 positive and at a discount rate of 18%, it is
£9,400 positive. You are required to compute the Internal Rate of Return (IRR)
using linear interpolation or extrapolation.
The Internal Rate of Return of this project is which of the following?
a 22.1%
b 15.4%
c 20.6%
d More information is needed to compute the IRR
We have:
rate NPV
8% 45,500
18% 9,400
Change 10% 36,100
Therefore 1% 3,610
So IRR = 18% + (9,400/3,610)% = 20.6%.
Question 20
The budgeted costs of Company 20, for the year ended 31.12.18, were as follows:
£
Direct materials 200,000
Direct labour 1,200,000
Indirect costs 720,000
Total costs 2,120,000
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Budgeted direct labour hours for the year were 100,000 while budgeted machine
hours were 90,000. The Company absorbs its indirect costs on the basis of labour
hours.
The details of Job 401 were as follows:

Raw materials £25,000
Direct labour hours 4,000
Machine hours 1,900
The full cost of Job 401 was which of the following?
a £73,000
b £88,200
c £101,800
d £30,900
Raw materials: 25,000

Labour: 4,000 hours @ £12/hour 48,000
Indirect costs: 4,000 labour hours @ £7.20/machine hour 28,800
Total cost £101,800
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Section B
Answer QUESTION 21 and NOT MORE THAN ONE further question from this section.
Question 21
Answer both parts of the question in this section.
Edgware Ltd retails clothes from several shops in London. The company’s trial
balance at 31.3.18 before any adjustments have been made is as follows:
Dr Cr
£000 £000
Shop fittings at cost 300
Shop fittings, accumulated depreciation at 1 April 2017 120
Delivery vans at cost 70
Delivery vans, accumulated depreciation at 1 April 2017 31
Inventory at 1 April 2017 290
Trade receivables 22
Provision for bad debts at 1 April 2017 5
Accruals at 1 April 2017 100
Bank 196
Trade payables 164
Taxation 5
8% debenture loan repayable in 2030 40
Ordinary share capital, 25p shares 50
Retained profits at 1 April 2017 105
Sales revenue 1,910
Purchases 950
Administrative and distribution expenses 127
Electricity 347
Advertising expenses 50
Rent 150
Interest paid 3
Interim dividend paid 25
2,530 2,530
The following additional information is available:
1. The figure for accruals in the trial balance is in respect of electricity accrued at
1.4.17. Electricity paid in the year ended 31.3.18 is for the period up until
31.1.18. An electricity invoice of £72,000 was received from London Electricity
for the three months ended 30.4.18 and this was paid on 1.5.18.
2. Unpaid debenture interest at 31.3.18 is to be provided.
3. On 31.3.18 the company sold a delivery van for £10,000 in cash. The vehicle was
purchased in 2015 for £40,000. The cash received from this sale will be banked
on 2.4.18. This transaction has not yet been recorded in the accounting records.
4. Depreciation is to be provided on the non-current assets using the following
annual rates:
Shop fixtures and fittings 25% per year on a straight line basis
Delivery vans 40% per year on a reducing balance basis
A full year’s depreciation is provided in the year of acquisition and no
depreciation is provided in the year of disposal.
5. The inventory was counted on 31.3.18 and valued at the retail selling price of
£240,000. Goods are generally sold with a margin of 40%. Some of these goods
with a selling price of £18,000 are no longer fit to be sold in the company’s
stores and will be sold to a market trader for £3,000 in April 2018.
14
6. The company has some credit customers and it has just been told that an old
customer has gone bankrupt, owing Edgware Ltd £2,000. A provision for bad
debts of 2% of remaining receivables is to be made.
7. Corporation tax for the year ended 31.3.18 is estimated to be £18,000 and is to
be paid on 1.1.19.
8. On 25.3.18, the company issued 200,000 shares for £950,000. This sum is, at
present, in a separate bank account in the name of the company but this
transaction has not yet been brought into the company’s accounting records.
9. The directors plan to pay a dividend in respect of the current year of 20p per
share, payment to be made in May 2018.
Required:
(a) Prepare an income statement for Edgware Ltd for the year ended 31.3.18,
statement of financial position at 31.3.18 and statement of movements in equity
for the year ended 31.3.18 in a form suitable for presentation to the directors.
(25 marks)
(b) The company’s Marketing Director has asked you, as the Finance Director, to
explain why the cost of the recent television advertising campaign amounting to
£50,000 paid for by the company in March 2018, due to appear on television in
May 2018, has been included in advertising expenses in the draft income
statement. ‘After all,’ she says in her email to you, ‘this will boost sales in the
next financial year so surely it should be treated as an asset in the Statement of
Financial Position. Not only that. I can’t understand while the good name and
reputation of the company, which our Chief Executive boasts is one of our most
valuable assets isn’t listed in the assets, either. It must be worth a huge sum of
money’.
(5 marks)
(Total 30 marks)
Reading for this question
This question has many of the usual adjustments one has seen in past examples of this
compulsory examination question and can be found in the subject guide Chapters 5–8, especially
Chapter 8, and in Leiwy & Perks Chapter 10.
Approaching the question
(a) You need to be able to correctly head up the Income Statement and the Statement of
Financial Position and the Statement of Movements of Equity. Such a question appears in
every examination and yet it is clear that candidates have not yet mastered the basic
techniques and adjustments. In many cases, candidates seem to be memorising standard
answers and not always successfully. Very few candidates, for example, can correctly
complete the adjustments relating to the sale of a non-current asset (adjustment 3, in this
question).
Every adjustment affects two figures. In each case, you can consider these adjustments in
terms of debits and credits or in terms of adding or subtracting from two figures in the trial
balance.
1.
Dr: Electricity expense
Cr: Accruals with the closing accrual
Dr: Rent
Cr: prepayments with the opening prepayment
2.
Dr: interest expense
Cr: accrued interest with any interest unpaid at the year end
15
3. The cost and accumulated depreciation of the item sold must be removed from those two
balances appearing in the trial balance. Then we can compute the depreciation on the
van on the reducing balance basis. By comparing the net book value of the item sold
with the disposal proceeds, we can establish the profit or loss on its sale. In this
instance, the proceeds of disposal were not accounted for correctly so that figure must be
deducted from sales revenue.
Dr: Disposal account
Cr: Cost, with the cost of the asset sold
Dr: Accumulated depreciation
Cr: Disposal account, with the accumulated
depreciation of the asset sold
In this question, also:
Dr: Bank
Cr: Disposal account, with the proceeds of sale not yet accounted for
4.
Dr: Depreciation expense
Cr: Accumulated depreciation with the depreciation
expense for each of the non-current assets after
Adjustment 3, dealing with disposals of non-current assets
5. Inventory is to be valued at the lower of cost and net realisable value, in accordance with
the prudence concept. The expected loss should be deducted from the inventory cost
given.
In respect of the cost of these items:
Dr: Inventory
Cr: COGS
Margin is a % of selling price.
6. The provision for bad debts is 5% of the receivables after having written off the bad
debt. The change in the provision will appear as an expense in the income statement, an
increase of the provision, in this case, hence an expense.
Dr: Bad debt expense
Cr: Receivables
Then:
Dr: Bad debt provision, with any decrease
in the provision
Cr: Decrease in bad debt provision expense
which is shown as a sundry revenue or as a
minus expense in the income statement.
The revised provision figure, which is deducted from Receivables in the current assets, is
calculated on the receivables figure after having written off the bad debt.
7. The tax for the year appears as a deduction from Profit before tax in the Income
Statement and as current liability, since it has not yet been paid.
8.
Dr: Bank with the proceeds of the share issue
Cr: share capital with the par value
Cr: share premium with the excess of
the proceeds over the par value
This share issue must be reported in the Statement of Movements in Equity.
9. Only dividends paid in the year appear in the figures (in the Statement of Movements in
Equity).
10. The profit after tax will be added to the opening retained profits in the Statement of
Movements in Equity and the ordinary dividend paid (appearing in the Trial Balance) is
deducted there.
16
17
(b) This question relates to the conflict between the accruals and the pruidence concepts and
the definition of an asset. This question deals with the application of these ideas. It is
covered in the subject guide in Chapter 3 and Leiwy & Perks Chapter 3.
18
Question 22
The statements of financial position of Hampstead Limited as at 31 March 2018 and

2017 and a summary of the income statement for the year ended 31 March 2018
appear below:
Statements of financial position at 31 March
2018 2017
£000 £000
Non-current assets
Land and buildings 277 140
Plant and machinery 89 87
366 227
Current Assets
Inventory 45 54
Trade receivables 62 45
Cash at bank 6 20
113 119
Total assets 479 346
Equity & liabilities

Equity
Ordinary share capital 90 26
Share premium 15 10
Revaluation reserve 126 110
Retained earnings 23 133
Total equity 254 279
Non-current liabilities
Long-term loans 100 20
Current liabilities
Trade payables 56 25
Interest accrued 4 1
Tax 25 16
Bank overdraft 40 5
125 47
Total equity and liabilities 479 346
You are given the following information:
1. During the year items of machinery were sold. These machines had originally
cost £27,000 and had a net book value at the disposal date of £11,000. The
disposal proceeds were £15,000.
2. A dividend of £155,000 was paid during the year.
3. In the income statement for the year ended 31.3.18, the following figures appear:
Depreciation on plant and machinery £25,000
Interest expense £8,000
Taxation £12,000
Required:
(a) Prepare a cash flow statement, together with the reconciliation statements of
operating profit and cash balance, for Hampstead Limited for the year ended
31.3.18. (15 marks)
(b) Critically evaluate this company’s cash flow statement.
(5 marks)
(Total 20 marks)
19
The factors to be considered when evaluating a cash flow statement are explained in Leiwy &
Perks Chapter 6 and the subject guide Chapter 11.
A typical cash flow statement question. It is important to know what appears in the cash flow
statement and where it appears. Most of the figures are very straightforward. The difficult
figures involve four computations. These are as follows:
Interest paid, which is the current liability at the beginning of the year, plus the interest expense
less the sum still payable. The tax paid in the year is calculated in exactly the same way. Sum
paid to acquire non-current assets, both land and buildings and plant and machinery are
computed on the basis that the opening balance, less the net book value of any asset sold in the
year, less any depreciation expense plus any revaluation in the year plus sums paid to acquire
non-current assets will equal the closing balance. The sum raised from the issue of shares is
calculated on the basis of the movement in the share capital and the share premium.
A particular complication in this question relates to the calculation of profit before tax. Usually,
in cash flow statement questions, the profit before tax is given. In this case, however, it is
computed much like the retained profits column of a statement of movements in equity; Opening
retained profits + profit for the year − dividends paid = closing retained profits. Then, since you
are given the tax expense in Note 3, you can compute the profit before tax.
20
21
Question 23
Morden Limited, a company which operates in the retail trade, has approached its
bankers to negotiate overdraft facilities of £3m which will be used to repay a
shortterm loan currently outstanding and to provide working capital. You have
been asked, as a newly appointed credit analyst, to comment on the short-term
liquidity position of the company as part of the initial screening process. The
following preliminary figures have been made available to you:
2017 2016
£000 £000
Income statement:
Sales revenue 36,720 30,360
Gross profit 9,915 9,180
Operating profit for the year 2,220 2,775
Depreciation expense 810 750
2017 2016
£000 £000
Statement of financial position:
Inventory 2,460 1,620
Trade receivables 1,176 195
Cash at bank 729 3,480
Short-term loan 1,200 —
Trade payables 2,670 1,701
Taxation payable 780 810
Interest payable 1,680 1,200
Required:
(a) Compute suitable ratios relating to the company’s profitability, liquidity, and
working capital management. Express your ratios with the correct notation.
(8 marks)
(b) Write a brief report for your manager commenting on these issues.
(7 marks)
(c) What information would you need in order to advise your senior managers on
whether overdraft facilities should be granted? Give your reasons?
(5 marks)
(Total 20 marks)
Usually, one question in Section B is a ratio analysis question asking for the calculation of a
number of ratios and then interpretation of the results by comparing 2017 with 2016. Here, you
were asked to choose your own ratios to assess the company’s profitability, liquidity and working
capital management. See Leiwy & Perks Chapter 6 and subject guide Chapter 11.
(a) It is important in such a question to:

• Use the correct notation when writing each ratio. Is it a percentage, for example return
on capital employed 18.5%, a number of days, for example inventory period, 35 days, or
simply a number, for example current ratio 1.6?
• It is suggested that you show all ratios other than the working capital ratios to one
decimal place, unless told otherwise.
22
(b) When writing a report on the ratios, as in part (b) of this question, write something about
every ratio or perhaps two or three comments about each group of ratios (such a liquidity).
It is not enough to say the ratio is higher or lower than the previous year.. You must say
whether it is better or worse or impossible to say and give possible reasons for significant
differences in these comparisons.
(c) This question is not asking about ratios but other information one might need to give to a
bank when asking for an overdraft facility. Any examination of the accounts of a listed
company will reveal all sorts of reports and data which a bank would want to look at
together with budgets and other statements of future expectations. See Leiwy & Perks
Chapters 7 and 8, for example.
23
Section C
Answer ONE question from this section and ONE further question from either Section B or Section
C.
Question 24
Miss Becky Tooting began to trade in 2016 producing racing bicycles. Her
accountants, Balham Stockwell & Co have drawn up accounts for the business but
she is not entirely convinced these accounts give an accurate picture of the
performance of the business for decision-making purposes. Hence, Becky has asked
you to look at the accounting records and draw up alternative income statements
for 2016 and 2017.
The selling price of each bicycle was £500 per unit in 2016 and £550 in 2017.
2016 2017
Sales (units) 3,000 4,000
Production (units) 3,800 3,600
£ £
Costs:
Factory: fixed 570,000 590,000
Factory: variable 478,800 330,000
Administration: fixed 200,000 220,000
Selling: variable 180,000 240,000
Becky values inventory on a FIFO basis.
Requirements:
(a) Prepare income statements using absorption costing, for each of the years 2016
and 2017.
(8 marks)
(b) Prepare income statements using marginal costing, showing clearly your
calculation of contribution, for each of the years 2016 and 2017.
(8 marks)
(c) Reconcile to profits calculated on a marginal costing basis with the profits
calculated on an absorption costing basis for 2016 only. You are required to
reconcile the figures with a numerical computation and also to explain the
difference in a brief written statement for the directors of the business.
(4 marks)
(Total 20 marks)
See Leiwy & Perks Chapters 16 and 17 and subject guide Chapter 14.
This is a straightforward question on absorption costing and marginal costing of the type which
has been asked many times in previous examinations.
In the marginal costing approach, each unit of production is valued at its marginal cost of
production. In order to calculate ‘contribution’, other variable costs must also be taken into
consideration – variable sales expenses in this example. And to compute profit, the fixed costs,
including fixed production overheads and fixed administration expenses must be deducted from
the contribution.
24
In absorption costing, each unit is valued at its total production cost comprising both its variable
production cost per unit together with its fixed production cost per unit. In fact, this was a
simpler question since there was no budgeted level of production given and, hence, no over- or
under-production volume variance arose.
(a)
(b)
25
(c) The difference in profit when using the marginal costing methods compared to the
absorption costing method arises from the treatment of the fixed production overheads. In
marginal costing, it is simply a period expense when it is incurred while in the absorption
costing income statement, it only hits the income statement when the goods are sold since
the £150 per unit is included in the value of each unit produced. Since the inventory has
risen by 500 units in Year 1 800 units @ £150 = £120,000 is not a cost but included in the
additional inventory valuation.
26
Question 25
Colindale Cereals manufactures dog biscuits. The standard costs and revenues of
each tonne of their most popular product is as follows:
Selling price £160 per tonne

Materials 1.2 tonnes @ £30 per tonne
Labour 2 hours @ £22.50 per hour
Variables production overheads 2 hours @ £10 per hour
Fixed production costs £175,000
Budgeted production and sales for the month of January 2018 were 25,000 tonnes.
Fixed overheads are absorbed on the basis of budgeted units. In fact, 26,500 tonnes
were produced and sold for £4,160,500.
Costs incurred were as follows:

Materials 30,475 tonnes £956,915
Labour 58,300 hours £1,270,940
Variable production overheads £606,320
Fixed production overheads £164,000
Required:
(a) Produce a statement reconciling the actual profit with the budgeted profit.
Calculate all the appropriate variances using the contribution approach with
just one fixed overhead variance.
(14 marks)
(b) Present a brief report summarising possible reasons for each variance including
any possible inter-connection between any of these variances.
(6 marks)
(Total 20 marks)
These issues are explained very clearly in Leiwy & Perks Chapter 14 and in the subject guide
Chapters 18 and 19.
Again, a very straightforward variance analysis much like that appearing in the subject guide
page 228 (Newdigate).
You are to produce a performance report reconciling the budgeted profit to the actual profit.
The difference between them is a total the standard variances outlined in the subject guide
Chapter 17 and Leiwy & Perks Chapter 18.
You are then asked to explain a reason for each variance and good answers referred to possible
connections between these variances.
(a) This is a straightforward NPV question involving no ‘relevant costing’ issues NPV
computations must be arranged in columnar form.
27
(b) This involves comparing the present value of the sums paid in years 0 and 1 for purchasing a
machine with the PV of an annuity of five payments. At the point where the PV of these
two payments and the five annual payments are equal, the company will be indifferent
between the two investment alternatives.
28
Question 26
Burnt Oak Waste Disposal (BOWD) is considering a contract to develop and

operate a waste disposal scheme for the local municipal council. The contract
specifies that waste would be disposed of by means of incineration and through a
landfill site. Initial development of the landfill site and the building of the
incinerator would require significant investment. It is assumed that in year 4 those
facilities would have to be expanded to reflect the planned growth in the local
population and the local economy. The local municipal council would pay a constant
annual fee for the five years of the contract. The estimated cash flows are as shown
in the table below (all figures in £millions). Assume that all cash flows take place at
the end of the respective year:
Year Investment Operating Fees received Annual net

in facilities costs from local council cash flows
£million £million £million £million
1 (2.4) (1.1) 2.3 (1.2)
2 (0.7) (1.2) 2.3 0.4
3 (1.3) 2.3 1
4 (1.2) (1.4) 2.3 (0.3)
5 (0.5) 2.3 1.8
Additionally, and not reflected in this table of figures, at the end of the contract,
BOWD would have to seal the landfill site and dispose of the incinerator, which is
estimated to cost an additional £0.8m. The cost of capital for BOWD is 9%.
Required:
(a) Calculate the project’s net present value.

(5 marks)
(b) What is the project’s internal rate of return?
(4 marks)
(c) Calculate the project’s payback period, assuming the cash flows arise evenly
throughout each year.
(2 marks)
(d) Should the company accept this project? Explain your answer.
(3 marks)
(e) If different methods of capital investment appraisal give conflicting evaluations
of a project, how should a decision-maker use such conflicting information?
(6 marks)
(Total 20 marks)
This is all discussed in the subject guide Chapters 18 and 19 and Leiwy & Perks Chapter 14.
This question, with some simple figures, not requiring any selection of relevant costs asked you to
assess one capital investment product using the NPV, IRR and payback methods of capital
investment appraisal and then to advise, in the light of your answers, whether to accept of reject
the project. In part (d), you were asked to evaluate each method by comparing its merits and
defects thereby identifying which method was, in your view, the best method to use for such an
evaluation.
29
30

Important note

references
section.
Comments on specific questions – Zone B
Section A of this examination consists of 20 Multiple Choice Questions. You should attempt to
answer ALL the questions. Each question has four possible answers (a–d). There is only one correct
answer to each of the questions. Please mark the correct answer on the special sheet provided. The
maximum mark for this part is 30.
Sections B and C: Please answer QUESTION 21 (30 marks) of Section B; ONE question from
Section C and ONE further question from either section B or C (except for Question 21 all
questions are worth 20 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 ALL questions from this section.
Correct answers are shown in bold.
Question 1
Which of the following statements is correct?
(i) a debit entry in the cash book will increase the bank overdraft
(ii) a credit entry in the cash book will increase a bank balance
31
a (i) is true but (ii) is false

b (i) is false but (ii) is true
c Both are true
d Both are false
Question 2
At 31.3.18, the cash book of Company 2 showed an overdraft of £21,111 while the
bank statement showed a positive balance of £2,590. On 30.3.18, the bank wrote to
Company 2 stating that a cheque of £525 received from a customer and banked on
25.3.18 has bounced and had been dishonoured. This letter was only received by
Company 2 on 2.4.18. Receipts of £30,555 banked on 31.3.18 were not cleared
through the banking system until April 2018, while cheques totalling £54,931, issued
by the company in March 2018 were also not cleared through the banking system
until April 2018. Bank charges of £150 had not been entered in the cash book.
What was the corrected bank balance in the Statement of financial position at
31.3.18?
a £(46,162)
b £(21,786)
c £(26,291)
d £26,291
Corrected Cash book balance: (21,111) − 525 − 150 = £(21,786).
Bank rec: 2,590 + 30,555 − 54,931 = £(21,786).
Question 3
The selling price of inventory of Company 3 at 30.4.18 is £200,000. The company

sells its goods at a 40% margin. One-quarter of the inventory has been damaged in
a fire and will be sold for £14,000. Which of the following will be the correct value
for closing inventory at that date appearing in the statement of financial position?
a £104,000
b £121,143
c £294,000
d £164,000
Cost price is selling price × 60%. Cost is 200,000 × 60% = £120,000.
25% of it with a selling price of £50,000 has a cost price of 50,000 × 60% = £30,000. It will be
sold for £14,000 so the loss will be £16,000. Hence inventory will be valued at the lower of cost
or net realisable value = £120,000 − £16,000 = £104,000.
Question 4
On 1.4.18, Company 4 had 10 units in inventory costing £21 each. During the
month, the following transactions occurred:
Date Buy/sell Units Price

2.4.18 Buy 14 £25
11.4.18 Sell 16 £52
13.4.18 Buy 30 £24
17.4.18 Buy 35 £27
25.4.18 Sell 32 £55
32
What is (i) the value of inventory at 30.4.18 and (ii) the cost of goods sold (COGS)
for the month of April 2018 using the FIFO basis?
Inventory COGS
£ £
a 1,089 1,136
b 1,089 1,456
c 969 1,256
d 1,185 1,040
Inventory: 6 @ £24 = £144 + 35 @ £27 = £945 = £1,089.
COGS: 10 × £21 + 14 × £25 + 6 × £24 = £1,136.
Question 5
On 1.1.18, the equity of Company 5 was as follows:

£
Share capital: 100,000 shares of 25p each 25,000
Share premium: 4,000
Retained profits: 260,000
289,000
On that day, the company made a rights issue, issuing 40,000 shares for £1.20 each
and then made a 7 for 5 bonus issue. A dividend of 10p per share was then paid.
What will the balance be on the retained profits at the end of the day, assuming the
company offsets the bonus issue against the share premium, to the extent that is
possible?
Retained profits
a £169,000
b £177,400
c £219,400
d £244,600
SC: 25,000 + (40,000 × 25p) = 35,000 + 49,000 = £84,000.
SP: 4,000 + 40,000 × 95p = 42,000 − 42,000 = £0.
RP: 260,000 = 260,000 − 7,000 = (253,000 − 33,600) = £219,400.
Total equity = £303,400 = 289,000 + 48,000 − 33,600 = £303,400.
Number of shares = £84,000/25p = 336,000.
Dividend = 336,000 shares @ 10p = £33,600.
Question 6
At 1.4.18, trade payables were £64,700. Payments to trade payables in April 2018
were £66,600. At 30.4.18 trade payables were £70,200 and closing inventory was
£44,000. Cost of goods sold in the month of April 2018 were £81,000.
What was the inventory of Company 6 at 1 April 2018?
33
Opening inventory
at 1.4.18
£
a 68,200
b 36,300
c 52,800
d 73,500
Opening payables + purchases − payments = Closing payables.
64,700 + purchases − 66,700 = 70,200, so purchases = 72,200.
COGS = Opening inventory + purchases − closing inventory.
81,000 = opening inventory + 72,200 − 44,000, so opening inventory = 52,800.
Question 7
At 1.4.18, trade receivables were £156,500. Sums received from trade receivables in
April 2018 were £144,300. At 30.4.18, trade receivables were £170,700. Cost of
goods sold in the month of April 2018 were £81,000. What was the company’s gross
profit for the month of April 2018?
Gross profit
£
a 77,500
b 85,000
c 86,300
d 90,300
Opening receivables + Sales − Receipts = Closing receivables.
156,500 + sales − 144,300 = 170,700, so sales = 158,500.
Gross profit = sales − COGS = 158,500 − 81,000 = £77,500.
Question 8
The following information is available relating to Company 100 and Company 200:
Company Company
100 200
Profit before tax for the year ended 31.3.18 £250 million £84 million
Profit after tax for the year ended 31.3.18 £210 million £68 million
Nominal value of 1 ordinary share 10p 25p
Share capital at 31.3.18 £80 million £120 million
Market value of one ordinary share at 30.4.18 £4.20 £5.40
Which of the following describes these companies’ The Price Earnings (PE) ratios of
these two companies at 31.3.18?
Company 100 Company 200

a 16 38
b 1.6 9.5
c 19 47
d 8 17
34
Earnings per share = profit after tax/number of ordinary shares.
Company 100 = 210/800 = 26.25p, Company 200 = 68/480 = 14.17p.
PE ratio = Market value/EPS.
Company 100 = 420/26.25 = 16, Company 200 = 540/14.17 = 38.
Question 9
Company 300 has a PE ratio of 6 while Company 400 has a PE ratio of 40.
Assume you were advising elderly shareholders. Which of these two companies is
likely to be the more attractive investment to the majority of such investors?
a Company 300
b Company 400
c Both companies are equally suitable
d The PE ratio has no effect on an investment
decision of such an investor
A high PE ratio indicates that the market believes the company’s future EPS will rise
significantly from its present level and is, therefore, a more speculative investment.
Question 10
Company 10’s accounting period ends on 31.12.17.
What was the insurance expense in the income statement for the year ended
31.12.17?
The insurance expense in the income statement for the year ended 31.12.17 and the
prepaid insurance in the statement of financial position at 31.12.17 were which of
the following?
Insurance expense £ Prepaid insurance £

a 75,000 75,000
b 85,000 75,000
c 95,000 15,000
d 89,000 15,000
The closing prepayment is 10/12 × £90,000 = £75,000.
The expense = Opening prepayment + sum paid in the year − Closing prepayment = 70,000 +
90,000 − 75,000 = £85,000.
Question 11
A direct cost is which of the following?
a a cost which is directly attributable to a particular job, product or service

b a cost which varies with output
c a semi-variable cost
d a cost which is apportioned to the cost of a unit of production
35
Question 12
In deciding which costs are direct costs and which are indirect costs for the
purposes of determining the costs in a university, is the salary and other
employment costs of the senior departmental manager of the Department of
Accounting & Finance a direct cost or an indirect cost when the university’s Chief
Financial Officer is computing (i) and (ii) below:
(i) The cost associated with one student studying for a degree in the Department?
(ii) The costs of the Department of Accounting?
one student the Department

in the Department of Accounting
a Direct Direct
b Indirect Indirect
c Direct Indirect
d Indirect Direct
In determining the cost of ‘running a single student’, the department manager’s employment
costs are indirect since the Departmental manager is working for all the students in the
Department (plus many other activities he/she will be working on).
However, in determining the total costs of the Department of Accounting, the departmental
manager is a direct costs since it wholly relates to the activity of the cost object (i.e. the thing
we are trying to establish the total costs).
Question 13
Company 13 makes and sells sushi in its fast-food stall in a local shopping mall. The
selling price of the product is £12, variable costs per meal are £7.50. Fixed costs for
2018 such as rent are expected to be £140,000. The company wish to make a profit
for the year of £120,000. How many meals will have to be sold in the year to achieve
this objective?
a 31,112
b 26,667
c 34,667
d 57,778
The number of meals required to achieve a given profit:

fixed costs + required profit 140,000 + 120,000
= = = 57,778 meals (rounded up).
contribution per unit 4.50
Question 14
Using the information in Question 13, if the budgeted sales are 60,000 meals sold,
what is the margin of safety, expressed as a percentage?
a 3.7%
b 48.1%
c 92.9%
d 55.6%
We have:
Fixed costs 140,000
BEP = = = 31,111 meals
Contribution/unit 12 − 7.50
36
and:
budget units − BEP 60,000 - 31,111

M of S = = = 48.1%.
budgeted units 60,000
Question 15
Company 15 makes expensive, hand-made dining room suites. Their products are
the ‘de-luxe’, ‘superior’ and ‘royal’ models. Unit costs and revenues relating to the
three products are as follows:
De-luxe Superior Royal

£ £ £
Selling 2,999 3,999 4,999
Direct materials 1,000 1,000 1,500
Direct labour 800 1,100 1,600
Variable overheads 150 180 225
Fixed overheads 200 400 400
Total costs 2,150 2,680 3,725
Profit per unit 849 1,319 1,274
All three products use materials which cost £100 per kilogram but there is not
enough material to meet the demand for all three products. In what order should
these three products be produced if the company wishes to maximise its profit?
Best 2nd best 3rd best

a De-luxe Superior Royal
b De-luxe Royal Superior
c Royal Superior De-luxe
d Superior Royal De-luxe
We have:
De-luxe Superior Royal
Contribution/unit, £ 1,049 1,719 1,674
Materials: kg/unit 10 10 15
Contribution/kg of material, £ 104.90 171.90 111.60
Ranking 3 1 2
With one scarce resource, products should be ranked according to the contribution per unit of
scarce resource (in this case, materials).
Question 16
Company 16’s Cash budget shows there is likely to be a hefty cash deficit at the end
of the forthcoming quarter and the expected balance will exceed the company’s
existing agreed overdraft limit. Which of the following courses of action would you
consider to be appropriate in these circumstances?
37
(1) Delay payment to its suppliers

(2) Delay payment of the monthly salaries until the following month
(3) Offer more generous credit terms to its customers
(4) Offer customers a discount for payment within 7 days of sales invoice date
a 1, 2 and 4
b 1 and 4
c 1, 3 and 4
d 2 and 4
(1) This will have a short-term cash benefit but it might strain relations with the Company’s
suppliers.
(2) Not only will this destroy labour relations but it is likely to be contrary with contracts of
employment.
(3) This will delay the receipt of payment from customers.
(4) A discount will bring money in earlier but, of course, there is a cost in this since less will be
collected in the end.
Question 17
Projects L and M have the following (costs) and revenues:
Year Project L Project M

£000 £000
0 (150) (60)
1 32 22
2 60 16
3 50 20
4 48 12
5 5 10
On the assumption that the cash inflows occur evenly throughout each year, the
payback period of these two projects is which of the following?
Project L Project M
a 3 years and 8 months 3 years and 4 months
b 3 years and 4 months 3 years and 6 months
c 3 years and 2 months 3 years and 2 months
d 4 years 4 years
Question 18
With reference to the information in Question 17 for Project L, but assuming the
machine will be sold at the end of the project for £25,000, the accounting rate of
return of Project L, using the average investment method, is which of the following?
a 16.0%
b 22.4%
c 31.2%
d 44.6%
38
We have:
Cash flow Depreciation Profit
1 32,000 25,000 7,000
2 60,000 25,000 35,000
3 50,000 25.000 25,000
4 48,000 25,000 23,000
5 5,000 25000 (20,000)
Total profit 70,000
ARR = (average profit)/(average investment) = (70,000/5)/((150,000 + 25,000)/2) = 16%.
Question 19
Company 19 is considering replacing all its machinery. The financial controller has
computed the Net Present Value of the project at two different discount rates. The
NPV at a discount rate of 6% is £190,500 positive and at a discount rate of 20%, it
is £64,400 negative. You are required to compute the Internal Rate of Return
(IRR) using linear interpolation or extrapolation.
The Internal Rate of Return of this project is which of the following?
a 16.5%
b 9.6%
c 16.0%
d More information is needed to compute the IRR
We have:
rate NPV
6% 190,500
20% (64,400)
Change 14% 254,900
Therefore 1% 18,207
So IRR = 20% − (64,400/18,207)% = 16.5%.
Question 20
The budgeted costs of Company 20, for the year ended 31.12.18, were as follows:
£
Direct materials 200,000
Direct labour 1,200,000
Indirect costs 720,000
Total costs 2,120,000
Budgeted direct labour hours for the year were 100,000 while budgeted machine
hours were 90,000. The Company absorbs its indirect costs on the machine hour
basis.
The details of Job 401 were as follows:

Raw materials £25,000
Direct labour hours 4,000
Machine hours 1,900
The full cost of Job 401 was which of the following?
39
a £73,000
b £88,200
c £101,800
d £30,900
Raw materials: 25,000

Labour: 4,000 hours @ £12/hour 48,000
Indirect costs: 1,900 machine hours @ £8/machine hour 15,200
Total cost £88,200
40
Section B
Answer question 1 and not more than one further question from this section.
Question 21
Lestrade Ltd is a builders’ merchants, selling items to tradesmen and the wholesale
trade. The company’s trial balance at 31.12.17, before any adjustments have been
made, is as follows:
Dr Cr
£ £
Land 120,000
Buildings at cost 280,000
Buildings, accumulated depreciation at 1 January 80,000
2017
Delivery vans at cost 65,000
Delivery vans, accumulated depreciation at 1 January 23,000
2017
Inventory at 1 January 2017 74,820
Trade receivables 91,200
Provision for bad debts at 1 January 2017 2,750
Prepayments at 1 January 2017 3,250
Bank balance 7,380
Trade payables 48,400
12% debenture loan repayable in 2030 50,000
Ordinary share capital of £1 each 70,000
Retained profits at 1 January 2017 111,200
Sales revenue 1,095,440
Purchases 643,200
Administrative expenses 96,400
Distribution costs 87,100
Rent 21,600
Interim dividend paid 5,600
1,488,170 1,488,170
The following additional information is available:
1. The figure for prepayments in the trial balance is in respect of two months’ rent
paid in advance at 1.1.17. As from 1.9.17, rent had been increased to £24,000
per year, payable quarterly, in advance.
2. Provision is to be made for the audit fee of £3,000. A full year’s debenture
interest which was due on 31.12.17 was paid on 5.1.2018.
3. In 2017 the company sold a delivery van for £2,000 in cash. The vehicle was
purchased in 2015 for £15,000. The cash received from the sale was paid into
the business bank account and credited to sales revenue.
4. Depreciation is to be provided on the non-current assets using the following
annual rates:
Land nil
Buildings 1% per year on a straight line basis
Delivery vans 20% per year on a reducing balance basis
A full year’s depreciation is provided in the year of acquisition and no
depreciation is provided in the year of disposal.
5. The inventory was counted on 31.12.17 and valued, at cost, at £71,220.
Included in this were some damaged goods which had cost £3,250 and which
would normally be sold for £5,500. However, they were sold in a clearance sale
in January 2018 for £1,200.
41
6. A customer notified the company on 28.12.17 that he was returning goods with
the wrong specification for which he had been invoiced the sum of £5,200. The
returned goods were received into the shop on 2.1.18 on which date the return
was recorded in the accounting records. The goods had cost Lestrade Ltd
£2,580 and were returned in good condition.
7. A customer owing £2,700 has recently been declared bankrupt. The company
does not expect to recover any of this. A provision for bad debts of 5% of
remaining trade receivables is to be provided.
8. Corporation tax for the year ended 31.12.17 is estimated to be £40,000 and is to
be paid on 1.10.18.
9. The directors plan to pay a dividend in respect of the current year of 12p per
share, payment to be made in January 2018.
Required:
(a) Prepare an income statement for Lestrade Ltd for the year ended 31.12.17,
statement of financial position at 31.12.17 and statement of movements in equity
for the year ended 31.12.17 in a form suitable for presentation to the directors.
(26 marks)
(b) Answer to the following email you have recently received from the company’s
sales director:
‘Why do you value the inventory at cost? Surely it would be much more helpful
to the shareholders to know its current value which is a much higher total
figure. Don’t you agree?’
(4 marks)
(Total 30 marks)
This question has many of the usual adjustments one has seen in past examples of this
compulsory examination question and can be found in the subject guide Chapters 5–8, especially
Chapter 8, and in Leiwy & Perks Chapter 10.
(a) You need to be able to correctly head up the Income Statement and the Statement of
Financial Position and the Statement of Movements of Equity. Such a question appears in
every examination and yet it is clear that candidates have not yet mastered the basic
techniques and adjustments. In many cases, candidates seem to be memorising standard
answers and not always successfully. Very few candidates, for example, can correctly
complete the adjustments relating to the sale of a non-current asset (adjustment 3, in this
question).
Every adjustment affects two figures. In each case, you can consider these adjustments in
terms of debits and credits or in terms of adding or subtracting from two figures in the trial
balance.
1.
Dr: Prepayments
Cr: Rent with the closing prepayment
Dr: Rent
Cr: prepayments with the opening prepayment
2.
Dr: interest expense
Cr: accrued interest with any interest unpaid at the year end
Dr: Audit fee
Cr: accruals with the unpaid audit fee
42
3. The cost and accumulated depreciation of the item sold must be removed from those two
balances appearing in the trial balance. Then we can compute the depreciation on the
van on the reducing balance basis. By comparing the net book value of the item sold
with the disposal proceeds, we can establish the profit or loss on its sale. In this
instance, the proceeds of disposal were not accounted for correctly so that figure must be
deducted from sales revenue.
Dr: Disposal account
Cr: Cost, with the cost of the asset sold
Dr: Accumulated depreciation
Cr: Disposal account, with the accumulated
depreciation of the asset sold
In this question, also:
Dr: Sales revenue
Cr: Disposal account, with the proceeds of sale originally included
in sales revenue in error
4.
Dr: Depreciation expense
Cr: Accumulated depreciation with the depreciation
expense for each of the non-current assets after
Adjustment 3, dealing with disposals of non-current assets
5. Inventory is to be valued at the lower of cost and net realisable value, in accordance with
the prudence concept. The expected loss of £2,050 should be deducted from the
inventory cost given.
In respect of the cost of these items:
Dr: Inventory
Cr: COGS
Margin is a % of selling price.
6. In respect of the sales revenue of these items returned:
Dr: Sales revenue
Cr: Receivables
7. The provision for bad debts is 5% of the receivables after having written off the bad
debt. The change in the provision will appear as an expense in the income statement, an
increase of the provision, in this case, hence an expense.
Dr: Bad debt expense
Cr: Receivables
8. The tax for the year appears as a deduction from Profit before tax in the Income
Statement and as current liability, since it has not yet been paid.
9. Only dividends paid in the year appear in the figures (in the Statement of Movements in
Equity).
10. The profit after tax will be added to the opening retained profits in the statement of
movements in equity and the ordinary dividend paid (appearing in the trial balance) is
deducted there.
43
44
(b) This question relates to the prudence concept, when the realisation of profits is recognised
and the uncertainty of the market value of the inventory. This question deals with the
application of these ideas. It is covered in the subject guide in Chapter 3 and Leiwy & Perks
Chapter 3.
45
Question 22
The statements of financial position of Moran Limited as at 31 December 2017 and

2016 and a summary of the income statement for the year ended 31 December 2017
appear below:
Statements of financial position at 31 December
2017 2016
£ £
Non-current assets
Land and buildings 150,000 60,000
Plant and machinery 27,950 23,100
177,950 83,100
Current Assets
Inventory 39,500 22,540
Trade receivables 55,500 45,670
Cash at bank 6,110 10,900
101,110 79,110
Total assets 279,060 162,210
Equity & liabilities

Equity
Ordinary share capital 26,000 20,000
Share premium 13,000 3,000
Revaluation reserve 75,000 10,000
Retained earnings 30,175 13,285
Total equity 144,175 46,285
Non-current liabilities
Long-term loans 27,000 50,000
Current liabilities
Trade payables 21,090 44,555
Interest accrued 2,000 7,000
Tax 41,000 4,270
Bank overdraft 43,795 10,100
107,885 65,925
Total equity and liabilities
279,060 162,210
Summary Income Statement for the Year Ended 31.12.17
£
Operating profit (after depreciation on plant and machinery of 160,425
£13,350)
Loss on sale of plant and machinery (1,250)
Interest expense (4,200)
Profit before tax 154,975
Tax (39,085)
Profit after tax 115,890
You are given the following information:
(i) During the year items of machinery were sold. The machines had originally cost
£12,000 and had a net book value at the disposal date of £7,250.
(ii) A dividend was paid during the year.
46
Required:
(a) Prepare a cash flow statement, together with the reconciliation statements of
operating profit and cash balance, for Moran Limited for the year ended
31.12.17. (16 marks)
(b) Critically evaluate this company’s cash flow statement.
(4 marks)
(Total 20 marks)
The factors to be considered when evaluating a cash flow statement are explained in Leiwy &
Perks Chapter 6 and the subject guide Chapter 11.
A typical cash flow statement question. It is important to know what appears in the cash flow
statement and where it appears. Most of the figures are very straightforward. The difficult
figures involve four computations. These are as follows:
Interest paid, which is the current liability at the beginning of the year, plus the interest expense
less the sum still payable. The tax paid in the year is calculated in exactly the same way. Sum
paid to acquire non-current assets, both land and buildings and plant and machinery are
computed on the basis that the opening balance, less the net book value of any asset sold in the
year, less any depreciation expense plus any revaluation in the year plus sums paid to acquire
non-current assets will equal the closing balance. The sum raised from the issue of shares is
calculated on the basis of the movement in the share capital and the share premium.
A particular complication in this question relates to the dividend paid. In this question, it must
be deduced from the following relationship: Opening retained profits + profit for the year −
dividends paid = closing retained profits.
47
48
Question 23
Max Moriarty has been told that Holmes & Watson plc is a fast growing company
and he seeks your advice on whether to buy shares in the company. He has provided
you with the following summarised information taken from the recent annual
accounts of Holmes & Watson plc:
£000
Income statement:
Sales revenue 6,200
Gross profit 1,800
Profit for the year 200
£000
Statement of financial position:
Non-current assets 2,290
Inventory 600
Trade receivables 300
Cash at bank 200
Trade payables 700
Share capital (25p shares, fully 600
paid)
Retained profits 190
The share price of Holmes & Watson plc is presently trading at 120p and it has
been around this level for the past few months. The dividend paid during the year
was £100,000. The trade association to which Holmes & Watson plc belongs
compiles statistics taken from the annual accounts of its members and from other
sources. You have obtained the following recently prepared data which give the
industry averages for seven statistics as:
Gross profit percentage 34%

Current ratio 1.2
Quick (acid test) ratio 0.5
Trade receivables period (days) 25
Inventory period (days) 60
Trade payables period (days) 40
Price earnings ratio 9.9
Required:
(a) Compute the above seven statistics for Holmes & Watson plc.
(8 marks)
(b) Comment on how the company’s overall performance compares to the average
for its industry, pointing out any significant features.
(7 marks)
(c) What other information would you advise Max to seek about the company
before he decides whether or not to buy shares in Holmes & Watson plc?
(5 marks)
(Total: 20 marks)
In a typical Section B ratios question, such as this one, you are required to compute about 8
ratios out of the 16 ratios explained in the subject guide and interpret the results in comparison
with the previous year and/or industry averages. In this case, both. See Leiwy & Perks Chapter
6 and subject guide Chapter 11.
49
(a) It is important in such a question to:

• Use the correct notation when writing each ratio. Is it a percentage, for example return
on capital employed 18.5%, a number of days, for example inventory period, 35 days, or
simply a number, for example current ratio 1.6?
• It is suggested that you show all ratios other than the working capital ratios to one
decimal place, unless told otherwise.
(b) When writing a report on the ratios, as in part (b) of this question, write something about
every ratio or perhaps two or three comments about each group of ratios (such a liquidity).
It is not enough to say the ratio is higher or lower than the previous year.. You must say
whether it is better or worse or impossible to say and give possible reasons for significant
differences in these comparisons.
(c) This question is not asking about ratios but other information one might need to give to a
bank when asking for an overdraft facility. Any examination of the accounts of a listed
company will reveal all sorts of reports and data which a bank would want to look at
together with budgets and other statements of future expectations. See Leiwy & Perks
Chapters 7 and 8, for example.
50
Section C
Answer ONE question from this section and ONE further question from either Section B or Section
C.
Question 24
Oldacre plc is planning to launch a home shopping page on the internet. Customers
would be able to place their orders via the company’s new website and the goods
would be delivered within 72 hours.
1. To prepare for the launch, Oldacre has spent £200,000 developing the website.
At launch, a marketing campaign will be instigated which is likely to cost
£1,000,000, payable in advance. To support the project, £440,000 would be
spent on advertising each year from year 2 onwards, payable in advance.
2. Oldacre expects demand to be initially low, but to build up once the reputation
of the company is established. In the first year of operation, it is anticipated
that 50,000 orders will be made. Orders will then be expected to increase by
30% per year for the next three years before falling by 50% in year 5 after
which the project will be terminated.
3. The average sales revenue per order is anticipated to be £40 in year 1 which will
rise in line with inflation which is anticipated to be 3% per year. The cost of
goods sold is 76% of sales revenue, excluding delivery costs. The company will
not hold any inventory.
4. Oldacre will make a fixed charge of £5 per order for delivery which is
anticipated to remain unchanged throughout the 5 year life of the project.
5. One van and driver will be required for each 7,500 deliveries per year, or part
thereof. Drivers will each be paid £25,000 per year.
6. The activity relating to the new product will occupy an empty floor occupying
one quarter of the company’s rented office building. The annual rental of the
building is £800,000 per year. Oldacre has received an offer to rent out the
spare floor of the building for £120,000 per annum, payable, in advance.
7. Overheads are charged to products at the rate of 5% of sales revenue. An
additional administrator whose salary is £40,000 will be employed if this new
project proceeds.
8. The appropriate discount rate is 12% per year.
9. Assume that all transactions are in cash and that all cash flows arise at the end
of the year concerned, except where indicated above.
Required:
(a) Assess whether Oldacre plc should proceed with the website.
(14 marks)
(b) Briefly explain why discounted cash flow analysis is appropriate when evaluating
long-term projects.
(6 marks)
(Total: 20 marks)
This is all discussed in the subject guide Chapter 19 and Leiwy & Perks Chapter 14.
51
This is a fairly straightforward NPV question in which you have to identify relevant costs and
ignore those costs considered to be not relevant.
You are then required to assess DCF techniques. It is not enough to trot out a phrase like ‘it
takes into account the time value of money’ without explaining what that means.
52
Question 25
Baskerville Cereals manufactures dog biscuits. The standard costs and revenues of
each tonne of their most popular product is as follows:
Selling price £160 per tonne

Materials 1.2 tonnes @ £30 per tonne
Labour 2 hours @ £22.50 per hour
Variables production overheads 2 hours @ £10 per hour
Fixed production costs £175,000
Budgeted production and sales for the month of January 2018 were 25,000 tonnes.
Fixed overheads are absorbed on the basis of budgeted units.
In fact, 26,500 tonnes were produced and sold for £4,160,500.
Costs incurred were as follows:

Materials 30,475 tonnes £956,915
Labour 58,300 hours £1,270,940
Variable production overheads £606,320
Fixed production overheads £164,000
Required:
(a) Produce a statement reconciling the actual profit with the budgeted profit.
Calculate all the appropriate variances using the contribution approach with
just one fixed overhead variance.
(14 marks)
(b) Present a brief report summarising possible reasons for each variance including
any possible inter-connection between any of these variances.
(6 marks)
(Total 20 marks)
These issues are explained very clearly in Leiwy & Perks Chapter 14 and in the subject guide
Chapters 18 and 19.
Again, a very straightforward variance analysis much like that appearing in the subject guide
page 228 (Newdigate).
You are to produce a performance report reconciling the budgeted profit to the actual profit.
The difference between them is a total the standard variances outlined in the subject guide
Chapter 17 and Leiwy & Perks Chapter 18.
You are then asked to explain a reason for each variance and good answers referred to possible
connections between these variances.
(a) This is a straightforward NPV question involving no ‘relevant costing’ issues NPV
computations must be arranged in columnar form.
53
(b) This involves comparing the present value of the sums paid in years 0 and 1 for purchasing a
machine with the PV of an annuity of five payments. At the point where the PV of these
two payments and the five annual payments are equal, the company will be indifferent
between the two investment alternatives.
54
Question 26
Miss Violet Smith began to trade in 2016 producing racing bicycles. Her
accountants, Woodleigh and Carruthers, have drawn up accounts for the business
but she is not entirely convinced these accounts give an accurate picture of the
performance of the business for decision-making purposes. Hence, Violet has asked
you to look at the accounting records and draw up alternative income statements
for 2016 and 2017.
The selling price of each bicycle was £500 per unit in 2016 and £550 in 2017.
2016 2017
Sales (units) 3,000 4,000
Production (units) 3,800 3,600
£ £
Costs:
Factory: fixed 570,000 590,000
Factory: variable 380,000 330,000
Administration: fixed 200,000 220,000
Selling: variable 180,000 240,000
Violet values inventory on a FIFO basis.
Requirements:
(a) Prepare income statements using absorption costing, for each of the years 2016
and 2017.
(8 marks)
(b) Prepare income statements using marginal costing, showing clearly your
calculation of contribution, for each of the years 2016 and 2017.
(8 marks)
(c) Reconcile to profits calculated on a marginal costing basis with the profits
calculated on an absorption costing basis for 2016 only. You are required to
reconcile the figures with a numerical computation and also to explain the
difference in a brief written statement for the directors of the business.
(4 marks)
(Total 20 marks)
See Leiwy & Perks Chapters 16 and 17 and subject guide Chapter 14.
This is a straightforward question on absorption costing and marginal costing of the type which
has been asked many times in previous examinations.
In the marginal costing approach, each unit of production is valued at its marginal cost of
production. In order to calculate ‘contribution’, other variable costs must also be taken into
consideration – variable sales expenses in this example. And to compute profit, the fixed costs,
including fixed production overheads and fixed administration expenses must be deducted from
the contribution.
In absorption costing, each unit is valued at its total production cost comprising both its variable
production cost per unit together with its fixed production cost per unit. In fact, this was a
simpler question since there was no budgeted level of production given and, hence, no over- or
under-production volume variance arose.
55
(a)
Note: Violet Smith does not give us the budgeted level of production and, therefore, we
have to absorb overheads on the basis of the actual level of production. If we were given the
budgeted level of production, overheads would be absorbed on the basis of the budgeted
level of production and this would give rise to a production overhead variance
(b)
56
(c) The difference in profit when using the marginal costing methods compared to the
absorption costing method arises from the treatment of the fixed production overheads. In
marginal costing, it is simply a period expense when it is incurred while in the absorption
costing income statement, it only hits the income statement when the goods are sold since
the £150 per unit is included in the value of each unit produced. Since the inventory has
risen by 500 units in Year 1 800 units @ £150 = £120,000 is not a cost but included in the
additional inventory valuation.
57

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Examiners’ commentaries 2018

Examiners’ commentaries 2018

Information about the subject guide and the Essential reading

What the examiners are looking for

Section B consists of questions on financial accounting. Question 1 is compulsory and is worth 30

Examination revision strategy

Examiners’ commentaries 2018

Information about the subject guide and the Essential reading

Comments on specific questions – Zone A

Answer ALL questions from this section.

Correct answers are shown in bold.

Which of the following statements is correct?

a (i) is true but (ii) is false

Corrected Cash book balance: (21,111) − 525 − 150 = £(21,786).

Bank rec: 2,590 + 30,555 − 54,931 = £(21,786).

The selling price of inventory of Company 3 at 30.4.18 is £200,000. The company

Cost price is selling price divided by 140%. Cost is 200,000/140% = £142,857.

Date Buy/sell Units Price

Inventory: 12 @ £24 = £288 + 70 @ £27 = £1,890 = £2,178.

COGS: 20 × £21 + 28 × £25 + 48 × £24 = £2,272.

On 1.1.18, the equity of Company 5 was as follows:

SC: 25,000 + (50,000 × 50p) = 50,000 + 80,000 = £130,000.

SP: 6,000 + 50,000 × 80p = 46,000 − 46,000 = £0.

RP: 290,000 = 290,000 − 34,000 − (260,000 × 15p) = £217,000.

Total equity = £347,000 = 321,000 + 65,000 − 39,000 = £347,000.

Number of shares = £130,000/50p = 260,000.

Dividend = 260,000 shares @ 15p = £39,000.

What was the inventory of Company 6 at 1 April 2018?

Opening payables + purchases − payments = Closing payables.

34,700 + purchases − 36,600 = 24,200, so purchases = 26,100.

COGS = Opening inventory + purchases − closing inventory.

39,200 = opening inventory + 26,100 − 21,000, so opening inventory = 34,100.

Opening receivables + Sales − Receipts = Closing receivables.

156,500 + sales − 144,300 = 170,700, so sales = 158,500.

Gross profit = sales − COGS = 158,500 − 81,000 = £77,500.

Company 100 Company 200

Earnings per share = profit after tax/number of ordinary shares.

Company 100 = 32/88 = 36.36p, Company 200 = 48/200 = 24p.

PE ratio = Market value/EPS.

Company 100 = 120/36.36 = 3.3, Company 200 = 195/24 = 8.13.

Company 10’s accounting period ends on 31.12.17.

Insurance expense £ Prepaid insurance £

The opening prepayment at 1.1.17 was 7/12 × £156,000 = £91,000.

The closing prepayment at 31.12.17 is 7/12 × £132,000 = £77,000.

A direct cost is which of the following?

a a cost which is directly attributable to a particular job, product or service

one student the Department

The number of meals required to achieve a given profit:

fixed costs + required profit 80,000 + 100,000

Company 15 makes expensive, hand-made handbags – ‘superior’, ‘royal’, and

Superior Royal Imperial

Best 2nd best 3rd best

(i) Delay payment to its suppliers

a (i), (ii) and (iv)

Actual figures were as follows:

Labour rate Labour efficiency

Labour rate variance = AH (AR − SR) = 864 × (21.50 − 20) = £1,296 A.

Labour efficiency variance = SR(AH − SH) = 20 × ((864 − (24 × 40 hrs)) = £1,920 F.

Total labour variance £624 F.

Sales price variance Sales cont’n volume

The Internal Rate of Return of this project is which of the following?

So IRR = 18% + (9,400/3,610)% = 20.6%.