AC1025 Principles of Accounting 2018 Preliminary exam

Examiner’s Report

Section A

Q1
In the context of financial accounting, which of the following is not a characteristic of
‘an asset’?

A Something owned by a business

B Something controlled by a business
C Something expected to produce expected future benefits to the business
D Something arising from a past transaction of the business

Solution A

Q2
At 1.1.18, the statement of financial position showed a bank balance of $45,790
(credit). During January 2018, receipts were $90,444 and payments were $87,905.
On 31.1.18, the company received a letter from their bank informing them a cheque
from a customer banked on 24.1.18 for $6,500 had been dishonoured (ie had
‘bounced’). This letter had not been opened until 2.2.18.
Unpresented payments at 31.1.18 were $14,550 and uncleared receipts were $5,135.

What was the bank statement balance at 31.1.18.?

A $51,244
B $(59,166)
C $(27,336)
D $(40,336)

Solution: D
Cash book balance: (45,790) +90,444 – 87,905 -6,500 = $(49,751)
Bank rec: X + 5,135-14,550 = (49751)
X = (49,751 – 5135 + 14,550
X = (40,336)

Q3
The selling price of inventory of Company 3 at 28 February is $175,000. The
company marks up its goods by 34%. One-third of the inventory has been damaged
in a flood and will be sold for $19,000. Which of the following will be the correct
value for closing inventory at 28 February in the statement of financial position?

A $111,597
B $106,065
C $59,500
D $50,500

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Solution: B
Selling price is cost x 1.34. Cost is $130,597.
2/3 of this cost $87,065
1/3 of this cost $43,532. It’s NRV is $19,000.
Hence inventory will be valued at the lower of cost or NRV = 87,065 + 19,000 =

Q4
On 1 February 2018, Computer 4 had 40 units in inventory costing $26 each.
During the month, the following transactions occurred:

Date Buy/sell Units Price

2.2.X8 Buy 70 $28
11.2.X8 Sell 90 $60
13.2.X8 Buy 60 $31
17.2.X8 Buy 65 $29.
25.2.X8 Sell 100 $55

What is the (i) value of inventory at 28.2.X8 and (ii) the cost of goods sold (COGS)
for the month of February 2018 using the LIFO basis?
Inventory COGS
$ $
A 1,295 5,450
B 1,305 5,440
C 1,345 5,400
D 1,180 5,565
Solution: A

Inventory: 25 @ $31 = $775 + 20 @ $26 = $520 = $1,295

COGS: 70 @ $28 + 20 @ $26 + 35 @ $31 + 65 @ $29 = $5,450

Q5
On 1.1.18, the equity of Company 5 was as follows:
$
Share capital: 150,000 shares of 50c each 75,000
Share premium: 145,000
Revaluation reserve: 30,000
Retained profits 210,000
460,000

On that day, the company made a rights issue, issuing 120,000 shares for $7.50 each
And then made a 4 for 1 bonus issue. What will the balance on the share capital and
share premium accounts at the end of the day, assuming the company offsets the
bonus issue against the Revaluation reserve, to the extent that is possible?

Share capital $ Share premium $

A 735,000 415,000
B 735,000 475,000
C 675,000 505,000
D 675,000 475,000

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Solution: D

SC: 75,000 + 60,000 = 135,000 + (4 x 135,000) = $675,000

RR: 30,000 – 30,000 = $0
SP: 145,000 + 840,000 – (540,000-30,000) = $475,000
RP: $210,000
Total: $1,360,000

Check: total equity before: $460,000

After: 460,000 + 900,00 = $1,360,000

Q6
At 1.4.2017, The Sales ledger (receivables) control account balance at 1.1.2018 and
31.1.18 of Company 6 were $45,008 and $51,402, respectively. During January, the
following transactions occurred:

$
Cash received from customers 61,045
Sales returned by customers 1,000
Dishonoured (bounced) cheques 960
A bad debt was written off 1,680
Discounts allowed 350
Sales ledger/purchase ledger contra 375

What was the total of sales invoices issued during the month?

$
A 69,534
B 69,454
C 53,996
D 69,884

Solution D

Dr Cr
Opening balances 45,008
Sales invoices XXXXX
Cash received 61,045
Sales returns 1,000
Bounced cheques 960
Bad debts w/off 1,680
Discounts allowed 350
Sales ledger/purchase leger contra 375
Closing balances 51,402
115,852 115,852
Opening balances 51,402

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Q7
Company 7 has made the following payments for invoices issued by their local water
supplier in the 15months 1 February 2017 to 30 April 2018:

$
Period from 1.2.17 to 30.4.17 450
Period from 1.5.17 to 31.7.17 425
Period from 1.8.17 to 31.10.17 395
Period from 1.11.17 to 31.1.18 425
Period from 1.2.18 to 30.4.18 480

The company received these water invoices within two weeks of the end of the period
to which they relate and then paid those invoices within one week of receiving them.

What will be the expense appearing in the Company’s income statement for the year
ended 31.3.18?

$
a 1,715
b 1,675
c 1,695
d 2,175

Solution A:

The opening accrual would have been 2/3 x 450 = $300.

The sum paid in the y/e 31.3.18 will be 450+425+395+425 = $1,695
The closing accrual will be 2/3 x 480 = $320.
So, the expense for the y/e 31.3.18 will be 1,695 – 300 + 320 = $1,715

Q8
Company 8’s insurance company has sent them a letter to say that their insurance
premium for the year ended 31.5.18 will be 10% more than the premium paid in the
previous year which was $2,700. The insurance premium is payable, in advance,
each year on the 1 June. What will be the insurance expense appearing in the
income statement of Company 8 for the year ended 31.3.18?

$
a 3,015
b 2,970
c 2,925
d 2,475

Solution C:

The opening prepayment would have been 2/12 x 2,700 = $450.

The sum paid in the y/e 31.3.18 would be 2,700 + 10% = $2,970
The closing prepayment will be 2/12 x 2,970 = $495.

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So, the expense for the y/e 31.3.18 will be 2,970 + 450 - 495 = $2,925

Q9
The Taxation expense of Company 9 for the year ended 31.12.16 was estimated to be
$23,000. The accounts for the year ended 31.12.16 were published on 20.5.17 On
1.9.17, the tax authority disputed the calculation and it was agreed that the tax liability
for the year was actually £24,400 and this sum was paid by Company 9 on 1.10.17.
The taxation expense for the year ended 31.12.17 was estimated to be $28,500.

What figures will appear in the Company’s income statement for the year ended
31.12.17 as the total tax expense for the year and in the Company’s statement of
financial position as the total tax liability at 31.12.17?.

Tax expense $ Tax liability $

a 28,500 28,500
b 29,900 29,900
c 29,900 28,500
d 28,500 29,900

Solution: C

The tax expense is $28,500 + the underprovision for the previous year of $1,400 =
$29,900.
The tax liability at 31.12.17 is $28,500

Q10
The profit before tax and the profit after tax of Company 10 for the year ended
31.12.17 are $15m and $11m, respectively.
Throughout 2017, there were 30 million shares issued.

The profit before tax and the profit after tax of Company 200 for the year ended
31.12.17 are $27m and $21m, respectively.
Throughout 2017, there were 20 million shares issued.

If you were asked to advise your client which is the better company solely on the
basis if their EPS (earnings per share) for this year, which of the two companies
would you select?

a Company 100
b Company 200
c Both companies are equally good
d It’s impossible to tell

Solution: D

It’s impossible to tell. You cannot compare two companies on the basis of
comparing their EPS. One company might have shares with the nominal value of
$1 each while the other might have shares with a nominal value of 10c each. Other
things being equal, you would expect the first company to have an EPS 10 times the
EPS of the second company.

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Eg: If both companies have a profit after tax of $10m and Co A has 50m shares of
$1 each while Co B has 500m shares of 10c each, the
EPS of Co A will be 10/50 = 20c/share and the
EPS of Co B will be 10/500 = 2c/share

The EPS of Co A is higher but we can tell the two companies both have share capital
of $50m and both have the same profit. Hence, these two companies are doing
equally well.
EPS is only useful when comparing one company with itself over time.

Q11
An indirect 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

Solution: D

Q12

Company 12 sells a single product. The selling price of the product is $72, variable
costs per unit are $55. Fixed costs for the year are expected to be $400,000. The
directors of the company wish to make a profit of $1.1m. How many units will have
to be sold to meet to achieve this objective.

a 20,834
b 23,530
c 88,236
d 64,706

Solution: C

The number of units required to achieve a given profit = fixed costs + required profit
contribution per unit

= 400,000 + 1,100,00
17
= 88,236 units (rounded up)

Q13
In 2017, Company 13 sold its only product for $16. Variable costs per unit were
$7.40. Fixed costs were $750,000. In 2018, the selling price is expected to fall by
10%, variable costs are expected to rise by 15%, while fixed costs are expected to rise
by 4%. The budgeted sales for 2017 were 150,000 units and for 2018 are 160,000
units. The margin of safety for 2018 is:

a 20.8%
b 17.2%

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 c 45.5%
d 39.9%
.
Solution: B

BEP = Fixed costs

Contribution/unit

= 780,000
14.40-8.51

= 132,428
M of S = budget units – BEP
budgeted units
= (160,000 – 132,428)/160,000
= 17.2%

Q14
Company 14 makes three products, A, B and C. Unit costs and revenues relating to
the three products are as follows:

A B C
Selling price 680 600 686
Direct materials 288 240 210
Direct labour 160 185 200
Variable overheads 76 69 151
Fixed overheads 81 54 79
Total costs 605 548 640
Profit per unit 75 52 46

All three products use labour which costs $25 per labour hour but there is not enough
labour 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 A B C
b A C B
c C B A
d B A C

Solution: B

A B C
Contn/unit 156 106 125
Labour hrs/unit 6.4 7.4 8
Contn/labr hour 24.4 14.3 15.6
Ranking 1 3 2

Contn/unit: A=156 B=106 C=125

No f labour hrs/unit
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Q15
Company 15 makes furniture. The standard cost of making a table is as follows:

$
Direct material 120
Direct labour @ $50/hour 25
Variable overheads 45
Fixed overheads 15
Standard cost 205
Selling price 270
Standard profit 65

The budget sales for February sales were $2,079,000. In February, in fact, 8,100
units were sold for $2,114,100 Labour was 3,564 hours costing $192,456.

The sales price variance and the sales contribution volume variance for the month
were:

Sales price variance $ Sales contribution volume variance $

a 72,900 favourable 32,000 unfavourable
b 72,900 unfavourable 32,000 favourable
c 69,300 favourable 26,000 unfavourable
d 72,900 unfavourable 26,000 favourable

Solution: B
Sales price var: Actual units (ASP-SSP)) = 8,100 (261-270)= 72,900 A
Sales contn vol var: Std contn/unit (actual units – std units)
80 (8,100-7,700) = 32,000 F

Q16
Using the same information shown in Question 15, the labour rate and efficiency
variances were as follows::

labour rate variance $ labour efficiency variance $

a 14,256 unfavourable 24,300 favourable
b 286 favourable 24,300 favourable
c 14,256 favourable 24,300 unfavourable
d 286 unfavourable 24,300 unfavourable

Solution: A

Labour rate var: AH (AR-SR) 3,564 (54-50) =14,256 A

Labour efficiency var: SR (AH-SH) 50((3,564 – (8,100 x 0.5)) =24,300F
Total: =10,044 F

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 Check: budget: 8,100 x 0.5 x $50 = 202,500
Actual 192,456
Total variance 10,044A

Q17
Company 17’s Cash budget shows there is likely to be a hefty cash surplus at the end
of the forthcoming quarter. Which of the following courses of action would you
consider to be appropriate in these circumstances?

(1) Delay payment to its suppliers

(2) Offer more generous credit terms to its customers
(3) Take out a long-term loan
(4) Put the surplus sum on deposit on the Money Market

A 1, 2 and 4
B 1,3 and 4
C 1 and 3
D 2 and 4

Solution: D

Q18
Projects X and Y has the following (costs) and revenues:

Year Project X Project Y

$’000 $’000
0 (40) (40)
1 8 12
2 12 16
3 14 10
4 4 6
5 3 4

On the assumption that the cash inflows occur evenly throughout each year, the
payback period of these two projects investment is as follows:

Project X Project Y
a 4 years and 8 months 3 years and 4 months
b 4 years and 4 months 3 years and 3 months
c 5 years 4 years
d 4 years 4 years

Solution: A

Q19
With reference to the information in Question 18, but assuming the machine will be
sold at the end of the project for $5,000, the accounting rate of return of Project X,
using the average investment method, is which of the following?
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 a 3.0%
b 18.5%
c 6.9%
d 5.3%%

Solution D:

Cash flow Depreciation Profit

1 8000 7000 1000
2 12000 7000 5000
3 14000 7000 7000
4 4000 7000 (3000)
5 3000 7000 (4000)
Total profit 6,000

ARR = average profit = 6000/5 5.3%

Average investment (40000+5000)/2

Q20
Company 20 is considering replacing all its machinery. The financial controller has
computed Net Present Value of the project at two different discount rates. NPV at
a discount rate of 12% is + $421,150 and at a discount rate of 18%, it is + $51,200.
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:

a 17.2%
b 19.3%
c 18.8%
d More information is needed to compute the IRR

Solution: C

rate NPV
12% 421,150
18% 51,200
Change 6% 369,950
therefore: 1% 61,658

So IRR = 18% + (51,200/61,658)% = 18.8%

Section B

Q1(a)
The usual problem! 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.
This question has many of the usual adjustments one has seen in past examples of Q2

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 and can be found in the Subject Guide Ch 5-8, especially Ch 8 and in Leiwy & Perks
Ch 10.
Every adjustment affects two figures.
• 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 vehicle 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 and instead the
$12,000 disposal proceeds were paid out to staff as a Christmas bonus. Hence, a
further adjustment, increasing wages and salaries and deducted from the net book
value of the van sold is needed.
• Inventory is to be valued at the lower of cost and net realisable value, in accordance
with the prudence concept.
• The provision for bad debts is 4% of the receivables AFTER having written off the
bad debt. The change in the provision will appear as an expense in the income
statement, a decrease of the provision, in this case.
• Dividends on ordinary shares are accounted for when paid so any proposed dividend
only appears as a ‘note to the accounts’ but not in the two statements, themselves.
• Dividends on ordinary shares are only accounted for when paid. If an ordinary has
been paid in the year, a debit balance will appear in the TB – not the case in this
question. Any ordinary dividends proposed for the year is ignored and won’t appear
in the accounts. Actually, details of such a proposed dividend would appear in a note
to the accounts. But it won’t be accrued or shown in the statement of movements in
equity or in any figure in the accounts.
• 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.
• The profit after tax will be added to the opening retained profits in the statement of
movements in equity and the ordinary dividend paid – in this case there isn’t such a
dividend paid - is deducted there.
• A revaluation increases the land and revaluation reserve. Revaluation reserve is an
element of ‘equity’ and such an increase will be disclosed in the ‘Statement of
movements in equity’.
• A revaluation of land? It’s not a realised profit so it can’t be shown in the income
statement. Why do we do it? Consider such published financial statements
accounting characteristics as ‘relevance’, ‘accuracy’ and the notion of a ‘true and fair
view’. This is explained in the Subject Guide pages 78-79. As with all the
accounting characteristics and concepts and terminology, it is vital you know and
understand all of them and can apply them and justify them when asked to do so.

Q1(b) Factors which the directors of a company will consider when they decide on a
dividend are explained in the Subject Guide in Chapter 7.

Q2:
A typical AC1025 cash flow statement questions. It’s important to know what
appears in the CFS and where it appears. Most of the figures are very

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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. Usually, in CFS
questions, the dividend paid in the year 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. In this case, the dividends paid can be calculated from the other three
figures.
The advantages and disadvantages of a cash flow statement are detailed and
explained in Leiwy & Perks Ch 6 and the Subject Guide Ch 11
Q3
Usually, one question in Section B is a ratio analysis question asking for the
calculation of, in this case, ten ratios and then interpretation of the results by
comparing 2017 with 2016 but also with the industry average ratios quoted in the
question. See L&P Ch 6 and Subject Guide Ch11. It is important in such a
question to:
a) Use the correct notation when writing each ratio. Is it a percentage, eg return
on capital employed 18.5%, a number of days eg inventory period, 35 days or
simply a number eg urgent ratio 1.6.
b) I would suggest you shown all ratios other than the working capital ratios to
one decimal place, unless told otherwise
c) When writing a report on the ratios, as in part (b) of this question, write
something about every ratio or perhaps two or three comment about each royp
of ratios (such a liquidity). It is not enough to say the ratio is higher or lower
that the previous year or the industrial average. You must say whether it is
better or worse or impossible to say and give possible reason for significant
differences in these comparisons.

Section C

(a) This is a straightforward NPV question involving no ‘relevant costing’ issues

NPV computations must be arranged in columnar form..
(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.

These issues are explained very clearly in Leiwy & Perks Ch 14 and in the Subject
Guide Ch 18 and 19

Q5:
This question relates to the preparation of different parts of a company’s budget, each
of which is driven by the sales budget. The number of units a company expects to
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sell will determine how many units it needs to produce. The will affect the material it
needs to buy, given the levels of inventory it needs to keep. The production budget
will also determine the labour budget. All of these budgeted will feed into the cash
budget since sales, purchases of goods and labour will affect bank receipts and
payments and hence the company will be able to produce a cash budget. Hence these
various elements of a company budget are interconnected.
The method of producing a budget and the key functions of a budget are considered in
L& P ch 15 and the Subject Guide ch 16.

Q6:
(a) 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.
This is based upon the budgeted level of production of 6,000 units per month. Since
in month 1 units produced are less than the budgeted level of production while in
month 2 the level of production exceeds the budgeted level of production, these give
rise to an adverse production volume variance of 1,000 units @ $5 each while in moth
2, there is a favourable production variance of 300 units @ $5 per unit..

(b) The difference in profit when using the marginal costing methods compared to te
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 $5 per unit is included in the value of each unit
produced. Since the inventory has risen by 500 units in January 500 units @ $5 =
$25,00 is not a cost but included in the additional inventory valuation. In February,
the inventory has fallen by 300 units and hence, an additional 300 units @ $5 =
$1,500 has hit the income statement.
See L&P Ch 16 and 17 and Subject Guide Ch 14.

30.3.18

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