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Accounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015
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Page 1: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

Accounting Principles

Question Paper, Answers and

Examiner’s Comments

Level 3 Diploma January 2015

Page 2: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/2 continued

Copyright of the Chartered Institute of Credit Management

Page 3: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/3 continued

Accounting Principles questions, answers and examiners’ comments

Level 3 Diploma in Credit Management

JANUARY 2015

Instructions to candidates

Answer any FIVE questions. All questions carry equal marks. Time allowed: 3 hours

All ledger accounts must be prepared in continuous balance format

Final accounts must be prepared in vertical format

Where appropriate, VAT is to be calculated at 20%

Again there appears to be a marginal improvement on the last exam series with some very good

scripts being submitted. Structure, format and presentation have certainly improved and

many students display a high level of knowledge and understanding of the subject matter. This is

witnessed in both the numerical and narrative questions which is an encouraging development.

As indicated last time, it is important that students address the practical applications of accounting

techniques, practices and conventions from a credit management perspective. At times though

there are some instances of poor technique especially in the construction of the Trading and Profit

and Loss account (Statement of Profit and Loss) and the Balance Sheet Statement of Financial

Position). Some still are a little confused with regard to the difference between a debit and credit

balance and how they are shown in the individual ledgers.

Ratio analysis (especially the interpretation of the calculations) and suspense accounts continue to

cause problems for a few students. Questions 1, 3 and 8 were by far the most popular, questions 5

and 6 the least, with student preferences being equally divided amongst the rest.

Questions start on the next page

Page 4: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/4 continued

1. a) What are the main reasons for organisations maintaining financial and management

accounts? (4 marks)

b) What information can be gleaned from the final accounts of a business that will assist the

credit management in making a more informed decision? (6 marks)

c) For each of the following stakeholders, identify the accounting information that will be of

interest to them and why?

i) Investors. (2 marks)

ii) Lenders. (2 marks)

iii) Employees and their representatives. (2 marks)

iv) Customers. (2 marks)

v) The general public. (2 marks)

Total 20 marks

Question aims

To test the candidate’s knowledge and understanding of why organisations need to have

financial and management accounts

To assess the candidate’s ability to identify what information can be obtained from the final

accounts in helping the credit manager to make a more informed decision

To identify the candidate’s ability to highlight the accounting information that will be of use to

internal and external stakeholders.

Suggested answer

a) Financial accounting is concerned with the collection and classification of historic data in order

to prepare the annual financial statements of the business. These statements are prepared

for users outside of the business such as owners or shareholders, prospective investors,

providers of loan capital, receivables and payables and the Government.

Management accounting on the other hand is about providing management with the

information that it needs to carry out its functions properly for planning, control and decision-

making.

Businesses are required to keep accounting records for a number of reasons:

Legal – the final financial statements of incorporated businesses must be prepared according

to a prescribed statutory format and must usually be audited by an external auditor.

Monitoring performance and calculating profit – has the business achieved what it had

planned to achieve e.g. are sales levels on target and costs as budgeted? Has it made a

profit, and to what extent?

Forecasting performance – what growth in sales may be realistically achieved given past

performance, state of the market, competition etc. Information on past performance will

come from the financial statements. How much will it cost to run the business next year? All

this information can be found in the management accounts.

Assess the owners’ liability for income tax

The company’s liability for corporation tax

The business’s liability for VAT

Page 5: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/5 continued

Assess amounts owing to payables

What are the business’s short-term liabilities to suppliers?

Also indicates what is owed from customers with implications for cash flow and credit

management.

b) The final accounts of the business compiled annually are the Income Statement and

Statement of Financial Position. There is a plethora of information that can be obtained from

these two documents which will enhance the decision whether to grant or extend credit or

establish or extend terms.

Income statement indicates:

the level of sales and profit.

- Are they increasing or decreasing?

- How do they compare with previous years?

- How is the organisation performing in the industry?

This will be of particular use to the credit manager.

the type, form and structure of costs for the year.

- How do they compare to previous years?

- Any particular expense increased dramatically?

Statement of Financial Position indicates:

the type, structure and form of assets and liabilities.

- How long have the assets got to run?

- Depreciation levels?

shows the level of debt and when it needs to be repaid.

- Can the organisation service it?

displays the availability of cash and near cash items that can be readily turned into cash to

meet the business debts.

- Is of particular interest to the credit manager.

Profitability ratios will assess the level of profits in comparison to the sales generated and

capital employed

Liquidity ratios are very important in assessing the credit worthiness of an organisation

- Can an organisation pay its debts as and when they fall due?

Efficiency ratio will assess the ability of management to control working capital

Receivables ratio shows how long it takes invoices to be paid

Payables ratio gives the average length of time that the company takes to pay its

creditors.

c) i) Investors will be interested in profit levels and past performance to ensure that not only is

the investment safe but that it will produce a good return.

ii) Lenders will be concerned again with profit levels and liquidity ratios to satisfy themselves

that the firm has both the ability and resources to repay any loan granted albeit in the

short, medium or long-term.

Page 6: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/6 continued

iii) Employees and their representatives will be concerned with levels of profit. This will

possibly indicate job security and can form the basis for bargaining for improvements in

pay and conditions.

iv) For customers the price paid for the final product would be a key consideration. They will

also desire that the company will be in existence for after sales service and warranty.

Customers will look to all aspects of the final accounts to determine its financial stability.

v) The general public will want to see all the financial statements in order to determine

whether or not the business has the resources to be environmentally friendly and can

service sustainability in all its forms in the future. Total 20 marks

This area of the syllabus has not been tested for a while and in the main the candidates handled

it well. Most could highlight reasons why organisations maintain financial and management

accounts in a) though a minority did not make the distinction. Many though could differentiate

and come up with some very pertinent answers.

Part b) witnessed some very good responses though a few failed to address the implications from

a credit management perspective which the question required.

Part c) was tackled well by the vast majority though the majority of candidates just cited profit as

the most important piece of financial information for the stakeholders cited. This was apt for the

first three but with regard to the other two, I would like to have seen more reference to prices,

after sales service, warranties, sustainability and environmental issues.

Page 7: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/7 continued

2. All businesses whether they are incorporated or unincorporated require additional sources of

finance to fund their operations.

TASK

Identify the key characteristics together with one advantage and one limitation for each of

the following:

a) Bank overdraft. (4 marks)

b) Trade credit. (4 marks)

c) Term loans. (4 marks)

d) Factoring. (4 marks)

e) Retained profits. (4 marks)

Total 20 marks

Question aims

To test the candidate’s knowledge and understanding of the different types of finance available to

organisations to finance their activities in the short, medium or long-term.

Suggested answer

a) Bank overdraft

Characteristics

Short-term facility used to finance working capital requirements

Used to cover cash deficits before income is received

The bank balance will have a negative figure (credit balance) and is classed as a current

liability.

Advantages

Flexible as the bank may be willing to increase the limit for short periods

Relatively cheap as interest is charged on the daily amount overdrawn typically 2 – 3%

+base rate.

Limitations

Repayable on demand

If the overdraft is very large the bank may require an arrangement fee and security.

Page 8: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/8 continued

b) Trade credit

Characteristics

Credit given by the company’s suppliers, the norm being 30 days from the date of invoice,

though in some industries it might be 60 to 90 days. In reality this is giving the organisation

credit as it is borrowing at the suppliers’ expense. Firms use trade credit as a source of

working capital rather than rely on a bank overdraft which has a cost.

Advantages

Trade credit is easier to obtain than a bank overdraft or loan

Readily available subject to credit clearance

Trade creditors have an interest in developing and extending the working relationship and

are more flexible than a bank

No interest charges or other costs providing terms are adhered to.

Limitations

The buyer may lose cash discounts given for prompt payment and may also lose the

opportunity to negotiate more favourable prices or lose supplier goodwill and not be able

to take advantage of discounts for bulk buying

Strictly a short-term facility

Credit can be withdrawn

May get a poor reputation in credit circles.

c) Term loans

Characteristics

Loans provide finance generally for the medium to long-term. They are granted for a specific

amount for a specific period and be either secured against the assets of the business i.e. if the

debt is not repaid the bank can take possession of the borrowers’ assets or unsecured, where

it can not.

The period of the loan is agreed at the outset and interest rates are based on the amount

borrowed and prevailing economic conditions. Interest payments can be fixed throughout the

period of the loan or may be variable subject to market conditions.

Advantages

Easily arranged subject to the status of the business

Fixed rate of interest can be arranged

Although interest payments are based on the full amount borrowed, they tend to be at a

lower % rate than overdrafts.

Page 9: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/9 continued

Limitations

Secured loans are secured against the assets of the business, which can restrict their use

Cost of interest will reduce profit levels

Increased indebtedness to third-parties generates increasing gearing levels.

d) Factoring

Characteristics

Another short-term method of financing. Here the company sells its book debts to a factor.

The factoring company will then pay an agreed percentage of the value of these debts which

can be as much as 85% of the value of invoices outstanding. The balance will be paid, less

fees, when the customers have paid the factoring company. The factoring company may also

take responsibility for bad debts which is a form of insurance with an additional fee attached.

Advantages

An immediate cash injection

Reduces debt collection costs.

Disadvantages

A high percentage of invoice value has to be paid to the factor

The relationship with the customer(s) whose debts have been factored might be damaged.

e) Retained profits

Characteristics

Profits can be retained in the business rather than given out to shareholders in the form of

dividends in the case of incorporated businesses or taken out in the form of drawings by sole

traders or partners. This increases the funds available to the business which might lead to an

expansion of the business or an increase in its share valuation. It can be used to finance

either working capital or the purchase of non-current assets.

Advantages

No costs involved and immediate cash is available

No third-party involvement

Disadvantages

Takes time to build up retained earnings

Can be restricted by the need to pay dividends to shareholders.

Total 20 marks

Page 10: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/10 continued

This question proved very popular with students. Some very good answers were

offered showing a high level of understanding of this section of the syllabus. A common error

though for some was to either just detail the characteristic of each without discussing the

merits and limitations of each or vice-versa.

No problems with overdrafts, trade credit and factoring but there was a little confusion with

regard to term loans and retained profits. With the former many did not detail they would not

be apt in the medium and long term, nor did they highlight in enough detail the costs involved

with regard to interest rates and the time period involved. With the latter, many could not offer

a clear definition of what constituted retained profits nor could they indicate that there were no

costs involved as such in utilising this type of financing.

Page 11: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/11 continued

3. P Scott owns a small engineering firm. The following balances have been extracted from the

accounts as at 31 December 2014.

DR CR

£ £

Capital 72,100

Bank 11,690

Carriage Inwards 640

Carriage Outwards 1,270

Discounts 1,510 2,190

Equipment:

At cost 77,360

Provision for depreciation 16,840

Drawings 10,740

Long-term Loan 20,000

Motor Expenses 16,740

Premises:

At cost 60,000

Provision for depreciation 10,000

Purchases and Sales 132,700 276,300

Shop Expenses 21,380

Stock as at 1 January 2014 35,820

Debtors and Creditors 12,490 9,210

Wages 46,330

Telephone and Insurance 1,750

Returns 1,300 1,700

Total 420,030 420,030

You have also been given the following information:

1. Stock as at 31 December 2014 was valued at £29,700.

2. Motor expenses paid in advance were £350.

3. Wages unpaid at year end amounted to £1,840.

4. Equipment is to be depreciated at 12½% using the reducing balance method.

5. Premises need to be depreciated using the straight-line method at 5%.

TASK

a) Prepare an income statement (formerly a trading and profit and loss account) for the year

ended 31 December 2014. (11 marks)

b) Prepare a statement of financial position (formerly a balance sheet) as at 31 December 2014. (9 marks)

Total 20 marks

Page 12: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/12 continued

Question aims

To test the candidates’ ability to prepare a trading and profit account and balance sheet from a

trial balance taking into account all adjustments re accruals, prepayments and depreciation.

Suggested answer

a) Income statement of P Scott for the year ended 31 December 2014

£ £ £

Sales 276,300

less Sales returns 1,300

275,000

Less cost of sales

Opening stock 35,820

Purchases 132,700

Carriage inwards 640

less Purchase returns 1,700

131,640

167,460

Less closing stock 29,700

137,760

Gross profit 137,240

Discount received 2,190

139,430

Less expenses

Discount allowed 1,510

Carriage outwards 1,270

Motor expenses (£16,740 - £350) 16,390

Shop expenses 21,380

Wages (£46,330 + £1,840) 48,170

Telephone and insurance 1,750

Depreciation: Equipment (w1) 7,565

Premises (w2) 3,000 101,035

Net profit 38,395

Page 13: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/13 continued

b) Statement of Financial Position of P Scott as at 31 December 2014.

£ £ £

Fixed assets

Premises (w3) 60,000 13,000 47,000

Equipment (w4) 77,360 24,405 52,955

137,360 37,405 99,955

Current assets

Stock 29,700

Debtors 12,490

Prepayments 350 42,540

Less current liabilities

Creditors 9,210

Bank overdraft 11,690

Accruals 1,840 22,740

Net current assets 19,800

119,755

Less long-term liabilities

Bank loan 20,000

99,755

Financed by

Capital 72,100

add Net profit 38,395

less Drawings (10,740)

99,755

W1 Equipment £77,360 – £16,840 = £60,520 x 12½% = £7,565 2014 depreciation

W2 Premises £60,000 x 5% = £3,000 2014 depreciation

W3 Premises £60,000 – (£10,000 + £3,000) = £47,000 2014 Net book value

W4 Equipment £77,360 – (£16,840 + £7,565) = £52,955 2014 Net book value

Total 20 marks

Page 14: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/14 continued

This was probably the most popular question on the paper with the vast majority of candidates

securing a pass mark. As indicated, the presentation of the final accounts of businesses has

improved significantly though there are still isolated incidents of poor practice. In the main, the

TPLA (SPL) was handled well, though the odd candidate did confuse purchase and sale returns

and discount allowed and discount received.

In a couple of instances, opening and closing stock (inventory) were inserted the wrong way

round. Most students addressed the accruals and prepayments adjustments, though a few

found the depreciation calculation problematic. The PLA (SFP) was well constructed though

many did not recognise that the bank balance was a credit one, i.e., overdrawn and should

appear as a current liability.

Page 15: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/15 continued

4. As credit manager of ABC Limited, you have been asked by your financial director to assess

the feasibility of increasing the credit facility of Doyle and Scott Limited.

You have been given the extracts from their most recent financial accounts below:

Income Statement of Doyle and Scott Limited for the year ended 31 December:

2012

£000

2013

£000

2014

£000

Sales 240 360 540

Less: cost of sales 160 270 432

Gross profit 80 90 108

Less: expenses 56 74 94

Operating profit 24 16 14

Statement of Financial Position for Doyle and Scott Limited as at 31 December:

2012 2013 2014

£000 £000 £000 £000 £000 £000

Non current assets 60 120 160

Current assets

Inventory 48 50 80

Receivables 52 80 110

Bank 40 20 0

140 150 190

Current liabilities

Payable 40 70 90

Bank 0 0 20

Net current assets 100 80 80

160 200 240

Financed by

Ordinary shares 100 124 150

Reserves 60 76 90

160 200 240

Note: Opening inventory in 2012 (in £000s) = 40

Page 16: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/16 continued

TASK

a) Calculate the following ratios for both of the years 2013 and 2014 (the relevant figures

for 2012 have been given in brackets):

i) Gross profit margin (2012: 33%).

ii) Operating profit margin (2012: 10%).

iii) Return on capital employed (2012: 15%).

iv) Current ratio (2012: 3.5:1).

v) Quick ratio/Acid test (2012: 2.3:1).

vi) Inventory days (2012: 100 days).

vii) Receivables days (2012: 79 days).

viii) Payables days (2012: 91 days). (8 marks)

b) Using the ratio calculations which have been supplied for 2012 and your own calculations

from part a) for 2013 and 2014, assess whether an increase in the credit facility would

be appropriate, giving your reasons for your decision. (12 marks)

Total 20 marks

Question aims

To test the candidate’s knowledge and understanding of the key financial ratios and how they can

be employed to assist the credit manager in making a more informed decision as to whether to

increase a credit facility.

Suggested answer

a) Ratios for the last two years are:

2013 2014

i) Gross profit margin 25% 20%

ii) Operating margin 4.4% 2.6%

iii) Return on capital employed 8% 5.8%

iv) Current ratio 2.14:1 1.73:1

v) Quick ratio 1.43:1 1.1

vi) Inventory days 66 days 55 days

vii) Receivables days 81 days 74 days

viii) Payables days 95 days 76 days

Page 17: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/17 continued

b) There is no model answer as such for this, though the calculation for each ratio should be

correct to get credit. Students should look at trends in offering observations and marks

will be awarded for developing these and other reasonable points:

Turnover has increased by more than 50% over the period. Although gross profit has

increased all the profit margins i.e., gross, operating and return on capital employed) have

declined

Both the current ratio and acid test ratios have declined, but from quite a high position in

the first instance. The 2014 figure is acceptable still though. However if this trend is to

continue the 2015 accounts are likely to show a further decline in working capital and the

business might find itself in an overtrading situation

Control over working capital items, inventory, receivables and payables have been good.

Receivable days have improved as has inventory days but payables has slightly worsened.

The organisation though is still getting its invoices paid before they pay their suppliers,

which is good. Some students might make reference to the fact that the cash operating

cycle has improved from 91 days to 53 days

Expenses as a percentage of turnover has reduced which demonstrates that these are

clearly under control

Share capital has increased but the return on capital employed has fallen quite

significantly and must be of concern to the shareholders

On the basis of the previous, students might indicate that on balance given the key ratios

identified that it might be apt to increase the facility but it does need to be carefully

monitored.

Some could argue that it might be appropriate before increasing credit to get sight of the

management accounts which will show, amongst other things, projected sales and cash flow

forecasts.

The organisation at present is clearly solvent but the liquidity ratios have been moving in an

adverse manner over the last couple of years and if this should continue could cause problems

with the company’s ability to pay its debts as and when they fall due.

Page 18: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/18 continued

Workings

2012 2013 2014

Gross profit margin

Gross profit x 100

Sales

80 x 100

240 = 33%

90 x 100

360 = 25%

108 x 100

540 = 20%

Operating profit margin

Operating profit x 100

Sales

24 x 100

240 = 10%

16 x 100

240 = 4.4%

14 x 100

540 = 2.6%

Return on capital employed

Operating profit x 100

Ordinary shares and reserves

24 x 100

160 = 15%

16 x 100

200 = 8%

14 x 100

240 = 5.8%

Current ratio

Current assets

Current liabilities

140

40 = 3.5:1

150

70 = 2.14:1

190

110 = 1.73:1

Quick ratio/Acid Test

Current assets – closing stock

Current liabilities

140-48

40 = 2.3:1

150-50

70 = 2.43:1

190-80

110 = 1:1

Inventory days

[(Opening stock + closing

stock)/2] x 365

Cost of sales

[(40+48)÷2] x 365

160

= 100 days

[(48+50)÷2] x 365

270

= 66 days

[(50+80)÷2] x 365

432

= 55 days

Receivables days

Receivables x 365

Sales

52 x 365

240

= 79 days

80 x 365

360

= 81 days

180 x 365

540

= 74 days

Payables days

Payables x 365

Cost of sales

40 x 365

160

= 91 days

70 x 365

270

= 95 days

90 x 365

432

= 76 days

Working Capital Cycle

Receivables days + Inventory

days – Payables days

79+100-91

= 88 days

81+66-95

= 52 days

74+55-76

= 53 days

Total 20 marks

Financial ratios form an integral part of the syllabus and are also a very important tool for a credit

manager in assessing the credit worthiness of both new and existing customers. In the main, the

vast majority of candidates who attempted this question scored well although not as highly as one

would expect given the importance and possibly the familiarity of the subject matter. Most of the

ratios were computed correctly though some of the efficiency ratios, especially stock turnover,

caused a few problems.

Part b) responses were either very good or poor. The interpretation of financial data is just as

important as the calculation of the said ratios so students should take note. The topic, given its

importance, will continue to be examined in future diets.

Page 19: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/19 continued

5. There are four general assumptions that specifically underlie the preparation of the financial

(final) accounts of an incorporated business.

TASK

a) What is the purpose of these four key accounting concepts? (4 marks)

b) Describe and assess the importance of each of those concepts with regards to the

interpretation of prepared financial statements. (16 marks)

Total 20 marks

Question aims

To test the candidate’s knowledge and understanding of the key accounting concepts and

conventions that underpin the compilation and publication of the final accounts of an incorporated

business.

Suggested answer

a) The concepts and conventions used in preparing the final accounts are aimed at conferring

uniformity on the financial statements. In preparing the income statement, statement of

financial position and cash flow statements, accountants apply these rules that establish the

way in which the financial performance of a business is recorded. Ultimately the aim of these

concepts is to produce objectivity in financial accounts and allow ‘like-for-like’ comparisons to

be made.

b) These concepts and conventions are broad basic assumptions which have been applied in

preparing the final accounts of a business and require no explanation or disclosure unless

otherwise stated. They are incorporated in various Companies’ Acts and associated laws and

regulations as fundamental accounting principles. The over-riding rule in financial statements

is that they should show a ‘true and fair view’ of the financial position of a given organisation.

Four can be detailed as impacting directly upon the preparation of final accounts:

i) Going concern – financial statements are prepared on the assumption that the company

will continue to operate as a viable business venture in the foreseeable future; that there

will be no significant reduction in the scale of its operations and it is not likely to become

insolvent. This means all assets will be valued in the balance sheet at either historical cost

less accumulated depreciation or at a revalued amount.

If the company is not to continue as a going concern and ceases trading and has to have

its assets sold then the market value of these will be significantly lower than the book

value held in the accounts. The Board must then write down the value of the assets in the

balance sheet to the amount they would realise in a forced sale and adjust liabilities

accordingly.

ii) Accruals (matching) concept – reviews and costs are recognised as earned or incurred

in the income statement of the period to which they relate, not when the cash is received

or paid. This ensures that the revenue relating to the year is matched against the related

expenses for the year. This enables the income of one period to be matched more fairly

against the expenditure of the same period.

The accruals concept is widely recognised as a more objective way of measuring profit

than on a cash basis. This gives a true and fair view of the profit for the year and the

assets and liabilities in the balance sheet.

Page 20: Accounting Principles Question Paper, Answers and -  · PDF fileAccounting Principles Question Paper, Answers and Examiner’s Comments Level 3 Diploma January 2015

January 2015 7B/PQP/20 continued

iii) Comparability objective (consistency) – similar items in the accounts must be dealt

with in the same way in every branch and in each accounting period and then from one

accounting period to the next. Once an accounting policy has been adopted it cannot be

changed as this would distort profits and the valuation of assets. One accounting policy

can be changed in exceptional circumstances only where it could improve the quality of

the statements and provide a fair profit/asset figure. The board must disclose any change

and have the approval of the auditors.

iv) Prudence principle – in preparing the final accounts, a number of estimates and

judgements have to be made. The natural tendency would be to be over-optimistic about

profits and the overall financial position of the business. The prudence principle deems it

apt to be conservative or pessimistic when making a judgement on anticipated profit or

losses of a company. Accountants should always exercise caution when there is

uncertainty.

Revenues and profits must not be recognised until they are realised or there is a high

degree of certainty that they will be realised. Prudence also needs to be applied to other

items which cannot be measured with certainty and are very subjective, e.g., stock

valuation, profit or loss on the sale of a fixed asset etc. It also prevails over accruals,

should the two conflict. Total 20 marks

Note: Marks will not be awarded when a student cites materiality, business entity, duality,

money measurement, periodically, historic costs, realisation and substance over form as these do

not apply to the preparation of the final accounts.

A question that did not require any accounting activity which curiously was not a favourite with

candidates. Answers in the main were fine although a few failed to address and indicate that the

purpose of standards is to bring uniformity in the compilation and content of final accounts of

businesses.

Part b) was well answered by most although a number did cite and talk about materiality, business

entity and money measurement, which although are other accepted standards, do not apply to

final accounts.

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January 2015 7B/PQP/21 continued

6. The final accounts of an incorporated business contain a great deal of information that will

help the credit manager in making a more informed decision whether to grant or extend

credit facilities.

TASK

Assess the credit intelligence that might be gleaned from the following:

a) The Auditors’ Report. (6 marks)

b) The Directors’ Report. (8 marks)

c) The Chairman’s Statement or Report. (6 marks)

Total 20 marks

Question aims

To assess the candidate’s appreciation of the type of credit information that might be obtained

from the final accounts of a business which could enhance the decision made by a credit manager

with regard to credit terms and limits.

Suggested answer

a) The auditor’s report

The shareholders are investors in the company and in order to safeguard their interests it

is a statutory requirement that the final accounts of an incorporated business are

examined and scrutinised by an independent auditor appointed by the shareholders,

unless the company is exempt from doing so

The auditor is required to report to the members of the company on all the accounts

presented at the annual general meeting

The auditor has to comment on whether the financial statements presented to them,

namely

- the income statement,

- statement of financial position

- statement of cash flow

show a ‘true and fair view’ of the company or the group’s state of affairs at the end of

the financial period. Also whether the financial statements have been prepared in

accordance with the appropriate Companies Act legislation.

A report can be qualified i.e., the auditors disagree with the treatment or disclosure of

an item in the financial statement and in the opinion of the auditors the effect of this

does not give a true and fair view

The financial accounts are one of the main tools for the credit manager whose main task

is to ensure the credit worthiness of new or existing customers. A clean, unqualified,

audit report indicates that the auditor is confident that the final accounts give a true and

fair view of the company’s financial affairs for the year. The credit manager then can

have some confidence of the financial standing of the given organisation. Also a clean

audit implies that proper records have been kept and in accordance with all relevant

legislation.

A qualified audit report though should be a warning sign as it implies some

disagreement in one or more areas of the final accounts which should alert the credit

manager that all is not financially ‘well’. This obviously would have some bearing on the

credit manager’s decision whether to grant or extend credit to the customer.

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January 2015 7B/PQP/22 continued

b) The director’s report

The director’s report is an objective overview of the company’s activities and performance

during the year. There is a plethora of information here which will help the credit manager in

making a more informed credit decision.

Specifically

It details the company’s financial position at year end including any changes to share

capital, proposed dividend and transfers to reserves. Important information for the

credit manager

It details changes in the consistency and numbers of shareholders. Any major changes

require clarification

It discusses the business’ principal activities and any changes to these, i.e., whether the

core business is still the same

It talks about any significant development which might affect future performance and

results which could be either negative or positive

It highlights post balance sheet events i.e., major events that have occurred after the

year end which will affect future results. This could have a bearing on credit worthiness

It will detail any significant changes to fixed assets during the year. Again, this may

impact on an organisation’s ability to pay its debts as and when they fall due

It will inform the shareholders of any acquisitions made by the company of its own

shares

Names of directors and details of their interest in shares and debentures will be

disclosed. Also any changes to the Board during the year. This would require

investigation by the credit manager

There will also be a statement regarding the supplier payment policy of how many days

the company takes to pay its suppliers which is very useful information for credit risk

assessment.

c) The chairman’s statement or report

This is a review by the chairman of the major activities and events of the organisation for

the past year

It discusses the company’s general performance and comments on events during the

year which might be of interest to shareholders

The future prospects of the business are also outlined

The aim of the statement is to emphasise the positive aspects of the trading performance

of the organisation over the past year

It will also try to detail the reasons for any adverse results or negative trading

developments

The report is not mandatory, nor subject to the scrutiny of auditors, so needs its content

to be treated with caution. Nonetheless, if the auditors and directors’ reports are

detailed in a positive manner and this is supported by the chairman’s report, the credit

manager can rate this as a favourable piece of credit intelligence. It must though not be

totally relied upon to assess any aspect of credit worthiness. Total 20 marks

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January 2015 7B/PQP/23 continued

Another question that required a narrative answer. The Auditors’, Directors’ and Chairman’s

Reports are important supplements to the final accounts of incorporated businesses and

information can be gleaned from them which will help the credit manager in making a more

informed decision. Although the latter is more qualitative in nature, the other two contain

important credit intelligence which in some cases is possibly just as important as the quantitative

evidence from the final accounts.

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January 2015 7B/PQP/24 continued

7. When extracting the ledger balances from an organisation’s accounts, the debit and credit

sides did not balance, as follows:

DR CR

£ £

Capital 45,000

Debtors and Creditors 32,900 5,000

Returns 2,500 2,710

Purchases and Sales 25,000 30,485

Discounts 6,800 5,630

Drawings 8,220

Wages and Salaries 7,000

Equipment 8,000

Total 90,420 88,825

The following errors were discovered by Sandy, the internal auditor, on 31 December 2014:

i) The Purchases account had been undercast by £4,500.

ii) Cash sales of £24,205 had not been entered into the Sales account.

iii) A credit note of £3,450 was entered in P White’s customer account but no entry was

made in the relevant returns account.

iv) The Sales account was overcast by £3,900.

v) £4,590 of goods was taken out of the business for I Johnson’s personal use. This was

recorded in the Drawings account but there were no other entries.

vi) An invoice for J Sullivan was discovered behind the computer. No accounting entries had

been made for the £1,650.

vii) £2,700 in respect of debtor J Smith was debited in error to the account of J Smythe Ltd.

viii) A discount allowed of £4,275 was credited in error to the Discount Received account.

ix) A bad debt of £6,800 had been entered into the customer’s account only.

TASK

a) What is the purpose of a trial balance? (2 marks)

b) Correct the above errors and prepare the resulting suspense account. (18 marks)

Note: journal entries are not required. Total 20 marks

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January 2015 7B/PQP/25 continued

Question aims

To test the candidates’ knowledge and understanding of how suspense accounts can be used

to correct errors found in the trial balance

To test the students’ appreciation of the reason why a trial balance is extracted for the

compilation of the final accounts of a business.

Suggested answer

a) The purpose of a trial balance is to check the arithmetical accuracy of the double entry in the

ledger accounts and to provide information required for the preparation of the final accounts.

b) Suspense account

Date Details Dr

£

Cr

£

Balance

£

31.12.14 Trial balance 1,595 (1,595)

Purchases 4,500 (6,095)

Sales 24,205 18,110

Sales returns 3,450 14,660

Sales 3,900 10,760

Purchases 4,590 15,350

Discount received 4,275 11,075

Discount allowed 4,275 6,800

Bad debts 6,800 Nil

Students should identify that transactions (vi) and (vii) would not require any posting to the

suspense account but that a journal entry would be pertinent.

Total 20 marks

Not as popular as in previous exam series but answered well by those who attempted, even

though there were a couple of woeful responses. Most knew the role and importance of suspense

accounts and many came up with a nil balance after the appropriate corrections and postings.

Some of the narratives in the ledger itself could have been better. Only a few though could

identify the two errors that required only a journal entry, which is a little surprising.

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January 2015 7B/PQP/26 continued

8. J Jones is a small high street business selling computer software. The following account

balances were brought forward on 1 January 2014.

£

Bank (overdrawn) 1,675

VAT owing 850

Sales 14,500

Purchases 8,700

Discount Allowed 750

Discount Received 450

C Mulhearn (a supplier) 3,400

P Hughes (a customer) 5,500

During January the following transactions took place:

2 January 2014 An invoice for £1,200 plus VAT was sent to P Hughes.

3 January 2014 A credit note for £750 plus VAT was received from C Mulhearn in

respect of returned goods.

8 January 2014 A cheque for £2,200 was sent to C Mulhearn in full settlement of their

account. The balance remaining is to be treated as a discount.

9 January 2014 A credit note was sent to P Hughes for £1,500 including VAT in respect

of damaged software.

12 January 2014 P Hughes sent a cheque for £4,900 in full settlement of the amount

outstanding. The rest is to be treated as a discount.

15 January 2014 J Jones took £350 out of the bank for his own personal use.

17 January 2014 An invoice is received from C Mulhearn for £790 plus VAT for the supply

of new software.

20 January 2014 A cheque was sent to HMRC for VAT owing.

25 January 2014 A water bill of £1,500 is now due to be paid. There is no VAT on this

service.

TASK

a) Open all the appropriate accounts that are necessary to record the above

transactions and enter all balances brought forward on 1 January 2014. (4 marks)

b) Make the necessary entries in the relevant accounts to record the transactions

including discounts and value added tax at 20%. (16 marks)

Total 20 marks

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January 2015 7B/PQP/27 continued

Question aims

To test the candidates’ ability to:

Apply the rules of double entry book-keeping using a continuous balance format

Carry out double entry book-keeping to record a range of transactions

Correctly calculate and account for VAT

Suggested answer

a) and b)

Account: Bank

Date Details DR CR Balance

1.1.14 Balance b/f (1,675)

8.1.14 C Mulhearn 2,200 (3,875)

12.1.14 P Hughes 4,900 1,025

15.1.14 Drawings 350 675

20.1.14 Revenue and customs 832 (157)

25.1.14 Water 1,500 (1,657)

Account: VAT

Date Details DR CR Balance

1.1.14 Balance b/f (850)

2.1.14 P Hughes 240 (1,090)

3.1.14 C Mulhearn 150 (1,240)

9.1.14 P Hughes 250 (990)

17.1.14 C Mulhearn 158 (832)

20.1.14 Bank 832 Nil

Account: Sales

Date Details DR CR Balance

1.1.14 Balance b/f (14,500)

2.1.14 P Hughes 1,200 (15,700)

Account: Purchases

Date Details DR CR Balance

1.1.14 Balance b/f 8,700

17.1.14 C Mulhearn 790 9,490

Account: Discount allowed

Date Details DR CR Balance

1.1.14 Balance b/f 750

12.1.14 P Hughes 540 1,290

Account: Discount received

Date Details DR CR Balance

1.1.14 Balance b/f (450)

17.1.14 C Mulhearn 300 (750)

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January 2015 7B/PQP/28

Account: C Mulhearn purchases

Date Details DR CR Balance

1.1.14 Balance b/f (3,400)

3.1.14 Purchase returns 900 (2,500)

8.1.14 Bank 2,200 (300)

8.1.14 Discount received 300 Nil

17.1.14 Purchases 948 (948)

Account: P Hughes sales

Date Details DR CR Balance

1.1.14 Balance b/f 5,500

2.1.14 Sales 1,440 6,940

9.1.14 Sales returns 1,500 5,440

12.1.14 Bank 4,900 540

12.1.14 Discount allowed 540 Nil

Account: Purchase returns

Date Details DR CR Balance

3.1.14 C Mulhearn 750 (750)

Account: Sales returns

Date Details DR CR Balance

9.1.14 P Hughes 1,250 1,250

Account: Drawings

Date Details DR CR Balance

15.1.14 Bank 350 350

Account: Water

Date Details DR CR Balance

25.1.14 Water 1,500 1,500

Total 20 marks

This question, as ever, proved the most popular on the paper and candidate responses are

certainly getting better. The vast majority identified the appropriate balance in the question

and opened appropriate accounts. The postings were tackled well, although a few failed to

arrive at a nil balance on the VAT account. There was a bit of confusion between sales and

purchases returns amongst a few candidates as was there with discounts. The double entry

for a sole trader taking money out of the business for his/her own personal use as usual

caused a few problems, as did the accounting treatment of the payment of a water bill, which

is a little disappointing.

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