Answers to activities, practice exercises and exam practice ...

Answers to activities, practice exercises and exam practice questions

1 Double-entry bookkeeping: cash transactionsPractice exercises1 Debit account Credit account

1 Noel pays a cheque into his business bank account as capital

Bank Noel – Capital

2 Purchases some goods for resale and pays by cheque

Purchases Bank

3 Sells some goods and banks the takings

Bank Sales

4 Pays rent by cheque Rent payable Bank5 Purchases shop fittings and

pays by chequeShop fittings Bank

6 Cashes cheque for personal expenses [1]

Drawings Bank

7 Pays wages by cheque Wages Bank8 Returns goods to supplier and

banks refundBank Purchases returns

9 Receives rent from tenant and banks cheque

Bank Rent receivable

10 Refunds money to customer by cheque for goods returned [2]

Sales returns Bank

11 Motor vehicle purchased and paid for by cheque

Motor vehicles Bank

12 Pays for petrol for motor vehicle and pays by cheque [3]

Motor expenses Bank

2 Bank account $ $

May 1 Martine – capital 300 May 3 Rent payable 100May 2 Charline – loan 1 000 May 4 Shop fittings 400May 5 Purchases

returns20 May 4 Purchases 300

May 6 Sales 40 May 7 Wages 60May 8 Drawings 100

Martine capital account$ $

May 1 Bank 300

Charline – Loan account$ $

May 2 Bank 1 000

[3] The costs of running motor vehicles (petrol, licence, insurance, repairs, etc.) are not debited to the motor vehicles account. A new account, motor expenses, is opened to record them.

[1] The cheque which Noel cashed was for his personal expenses. It is therefore debited to the Drawings account.

This text has not been through the Cambridge endorsement process.

All answers that appear in this publication have been written by the author.

2

[2] Following the principle of purchases returns, sales returns are always debited to their own account, never to the sales account.

Rent payable account$ $

May 3 Bank 100

Shop fittings account$ $

May 4 Bank 400

Purchases account$ $

May 4 Bank 300

Purchases returns account$ $

May 5 Bank 20

Sales account$ $

May 6 Bank 40

Wages account$ $

May 7 Bank 60

Drawings account$ $

May 8 Bank 100

Notes:

1 The narrative must always contain the name of the account where the opposite entry can be made.

2 Purchases returns are always posted to their own account, never to the credit of the purchases account.

3 a Debit account Credit account

July 1 Lee started business by paying $20 000 of his savings into a business bank account

Bank Capital

He also had $500 in cash which he decided to use to pay cash expenses for the business

Cash Capital

2 Bought some goods for resale for $1300, paying by cheque Purchases Bank3 Paid $2500 by cheque to rent some business premises Rent payable Bank4 Bought some office furniture by cheque for $750 Office furniture Bank

Bought office stationery for $120, paying by cash Stationery Cash6 Sold some goods for $1700 and paid the money into the bank Bank Sales

Sold more goods for $180. He received cash for this sale Cash Sales

8 Retuned some faulty goods valued at $60 to the supplier and received a cheque refund

Bank Purchases returns

9 A customer returned some faulty goods. Lee gave the customer a cash refund of $25

Sales returns Cash

10 Sold goods for $420. Lee received cash for the goods. He kept $200 as business cash and banked the rest

Cash Bank

Sales

11 Lee took cash drawings of $160 Drawings Cash

3

Answers to activities, practice exercises and exam practice questions: Chapter 1

b Bank account$ $

July 1 Capital 20 000 July 2 Purchases 1 300July 6 Sales 1 700 July 3 Rent 2 500July 8 Purchases returns 60 July 4 Office furniture 750July 10 Sales 220

Cash account$ $

July 1 Capital 500 July 4 Stationery 120July 6 Sales 180 July 9 Sales returns 25July 10 Sales 200 July 11 Drawings 160

Capital account$ $

July 1 Bank 20 000Cash 500


July 2 Bank 1 300

Sales account$ $

July 6 Bank 1 700Cash 180

July 10 Bank 220Cash 200


July 8 Bank 60

Sales returns account$ $

July 9 Cash 25

Rent account$ $

July 3 Bank 2 500

Office furniture account$ $

July 4 Bank 750

Cambridge International AS and A Level Accounting

4

Stationery account$ $

July 4 Cash 120

Drawings account$ $

July 11 Cash 160

4 Debit account Credit account1 Local taxes paid by cheque Taxes Bank

2 Bank pays interest to trader Bank Interest received3 Other operating expenses paid by cheque Other operating expenses Bank4 Postage and stationery paid by cheque Postage and stationery Bank5 Telephone bill paid by cheque Telephone Bank6 Carriage inwards paid by cheque Carriage inwards Bank7 Carriage outwards paid by cheque Carriage outwards Bank8 Interest paid by cheque to brother in

respect of a loan received from himInterest payable Bank

9 Interest paid to bank Interest payable / bank interest

Bank

5 Bank account $ $

June 1 Farook – capital 15 000 June 2 Premises 8 000Amna – loan 5 000 June 3 Office furniture 2 000

June 5 Sales 1 500 June 4 Purchases 5 000June 10 Sales 2 400 June 6 Insurance 600June 12 Purchase returns 900 June 7 Motor van 3 000June 13 Insurance 100 June 8 Motor expenses 50June 14 Office furniture 800 June 9 Purchases 2 000

June 10 Wages 400June 11 Sales returns 1 200June 13 Drawings 200June 15 Loan 1 000

Capital account$ $

June 1 Bank 15 000

Loan account$ $

June 15 Bank 1 000 June 1 Bank 5 000

Premises account$ $

June 2 Bank 8 000


5

Office furniture account$ $

June 3 Bank 2 000 June 14 Bank 800


June 4 Bank 5 000June 9 Bank 2 000

Sales account$ $

June 5 Bank 1 500June 10 Bank 2 400

Insurance account$ $

June 6 Bank 600 June 13 Bank 100

Motor van account$ $

June 7 Bank 3 000

Motor expenses account$ $

June 8 Bank 50

Wages account$ $

June 10 Bank 400

Sales returns account$ $

June 11 Bank 1 200


June 12 Bank 900

Drawings account$ $

June 13 Bank 200

Exam practice questionsMultiple-choice questions1 B

2 B

3 D

4 B

6


2 Double-entry bookkeeping: credit transactionsPractice exercises1 Khor account

$ $June 10 Purchases returns [1] 180 June 1 Purchases 2 700June 30 Bank 2 394June 30 Discounts received 126

Lim account $ $

June 30 Bank 2 394 June 15 Purchases 2 520June 30 Discounts received 126

Lai account $ $

June 5 Sales 600 June 25 Sales returns 180June 30 Bank 399June 30 Discounts allowed 21

Chin account $ $

June 20 Sales 1 300 June 30 Bank 1 235June 30 Discounts allowed 65

Purchases account $ $

June 1 Khor 2 700June 15 Lim 2 520

Purchases returns account $ $

June 10 Khor 180

Sales account $ $

June 5 Lai 600June 20 Chin 1 300

Sales returns account $ $

June 25 Lai 180 [2]

[1] The goods which Geraud returned to Khor will have had the trade discount deducted from them when they were purchased. This must be adjusted when the goods are returned. Their cost was $200 - 10% trade discount of $20 = 180.

[2] The same is true for the goods returned by Lai, which had cost $200 but need to have the 10% trade discount deducted.

7


Bank account $ $

June 30 Lai 399 June 30 Khor 2 394June 30 Chin 1 235 June 30 Lim 2 394

Discounts received account $ $

June 30 Khor 126June 30 Lai 126

Discounts allowed account $ $

June 30 Lai 21June 30 Chin 65

Note:

Remember trade discount is never entered in the ledger.

2 In the books of Brian:

Ken account $ $

April 1 Sales 1 500 April 2 Purchases 400April 3 Sales 600 April 6 Purchases 720April 12 Bank 380 April 10 Bank 1 455

Discount received 20 Discount allowed 45

Sales account $ $

April 1 Ken 1 500April 3 Ken 600


April 2 Ken 400April 6 Ken 720

Bank account $ $

April 10 Ken 1 455 April 12 Ken 380


April 10 Ken 45


April 12 Ken 20


8

In the books of Ken:

Brian account $ $

April 2 Sales 400 April 1 Purchases 1 500April 6 Sales 720 April 3 Purchases 600April 10 Bank 1 455 April 12 Bank 380

Discount received 45 Discount allowed 20

Sales account $ $

April 2 Brian 400April 6 Brian 720


April 1 1 500April 3 600

Bank account $ $

April 10 Brian 380 April 12 Brian 1 455


April 12 Brian 20


April 10 Brian 45

3 Adams account $ $

July 5 Purchases returns 510 July 1 Purchases 4 250July 14 Bank 3 590

Discount received 150

Bond account $ $

July 14 Bank 2 160 July 4 Purchases 2 250Discount received 90

Astle account $ $

July 9 Purchases returns 640 July 7 Purchases 5 600July 14 Bank 4 712



9

Cairns account $ $

July 14 Bank 3 591 July 10 Purchases 3 780Discount received 189


July 1 Adams 4 250July 4 Bond 2 250July 7 Astle 5 600July 10 Cairns 3 780


July 5 Adams 510July 9 Astle 640

Bank account $ $

July 14 Adams 3 590Bond 2 160Astle 4 712Cairns 3 591

Discount received account $ $

July 14 Adams 150Bond 90Astle 248Cairns 189

4 Blignaut account $ $

March 1 Sales 2 250 March 15 Bank 2 160Discount allowed 90

Ebrahim account $ $

March 4 Sales 3 400 March 6 Sales returns 170March 15 Bank 3 069

Discount allowed 161

Friend account $ $

March 8 Sales 2 560 March 15 Bank 2 432Discount allowed 128


10

Flower account $ $

March 12 Sales 1 800 March 14 Sales returns 315March 15 Bank 1 426

Discount allowed 59

Sales account $ $

March 1 Blignaut 2 250March 4 Ebrahim 3 400March 8 Friend 2 560March 12 Flower 1 800

Sale returns account $ $

March 6 Ebrahim 17014 Flower 315

Bank account $ $

March 15 Blignaut 2 160Ebrahim 3 069Friend 2 432Flower 1 426

Discount allowed account $ $

March 15 Blignaut 90Ebrahim 161Friend 128Flower 59

Exam practice questionsMultiple-choice questions1 A

2 B

3 A


11

3 Books of prime entryActivitiesActivity 1

Purchases journal Sales journal $ $

March 1 Tikolo 8 000 March 4 Snyman 1 080March 6 Walters 7 200 March 10 Karg 2 250March 13 Burger 5 250 March 17 Kotze 2 700March 18 Tikolo 4 800 March 25 Snyman 1 620

25 250 7 650

Purchases returns journal Sales returns journal$ $

March 12 Tikolo 400 March 11 Snyman 200March 22 Burger 1 000 March 20 Karg 300

1 400 500

Cash bookDiscounts Bank Discounts Bank

$ $ $ $March 31 Snyman 100 2 400 March 31 Tikolo 620 11 870

March 31 Karg 78 1 872 March 31 Walters 360 6 840March 31 Kotze 135 2 565 March 31 Burger 170 4 080

313 1150


March 31 Purchases journal total 25 250


March 31 Purchases returns journal total

1 400

Sales account $ $

March 31 Sales journal total 7 650


March 31 Sales returns journal total

500


March 31 Cash book total 313

12



March 31 Cash book total 1 150

Tikolo account $ $

March 12 Purchases returns 400 March 1 Purchases 8 000March 31 Bank 11 780 March 18 Purchases 4 800March 31 Discounts received 620

Walters account $ $

March 31 Bank 6 840 March 6 Purchases 7 200Discounts received 360

Burger account $ $

March 22 Purchases returns 1 000 March 13 Purchases 5 250March 31 Bank 4 080March 31 Discounts received 170

Snyman account $ $

March 4 Sales 1 080 March 11 Sales returns 200March 25 Sales 1 620 March 31 Bank 2 400

March 31 Discounts allowed 100

Karg account $ $

March 10 Sales 2 250 March 20 Sales returns 300March 31 Bank 1 872March 31 Discounts allowed 78

Kotze account $ $

March 17 Sales 2 700 March 31 Bank 2 565March 31 Discounts allowed 135

Activity 2

Cash bookDisc Cash Bank Disc Cash Bank

$ $ £ $ $ $March 1 Sales 1 100 March 2 Electricity 130March 3 Sales 900 March 4 Bank 1 700March 4 Cash 1 700 March 5 Other operating expenses 25March 6 Bank 800 March 6 Cash 800

March 7 Purchases 750

13


Activity 3

Accounts Dr Cr $ $

a A & Co. 120A. Cotter 120

Correction of credit note no. 964 received from A and Co. Ltd. in the sum of $120 debited to A. Cotter in error.

b Purchases 400Hussain 400

Correction of invoice no. 104 in the sum of $400 received from Hussain omitted from the purchases journal.

c Maya 45Sales 45

Correction of posting error: invoice no. 6789 in the sum of $150 sent to Maya entered in the sales journal as $105.

d Machinery 2 300Purchases 2 300

Correction of purchase of machine posted in error to purchases account.

e Sales returns 68Hanif 68

Correction of omission of credit note no.23 for $68 and sent to Hanif, omitted from the sales returns journal.

Practice exercises1 a Purchases journal Purchases returns journal

$ $April 1 Bilal 2 400 April 8 Bilal [1] 100April 3 Asad 1 040 April 21 Asma [1] 600April 15 Asma 3 000April 26 Bilal 3 200

9 640 700

Sales journal Sales returns journal $ $

April 2 Imran 720 April 13 Imran [1] 60April 10 Raza 880 April 24 Amna [1] 300April 16 Amna 1 200April 17 Raza 1 280

4 080 360

Journal

Accounts Dr Cr $ $

5 April Motor vehicles/delivery van 6 000Syed 6 000

Purchase of delivery van, from Syed, invoice no. 324.

[1] It is assumed that the value of the goods returned were after adjusting for the trade discount. Whether a returns amount given needs to be adjusted for the trade discount should be clear.

14


b Bank accountDiscount allowed

Bank Discount received

Bank

$ $ $ $April 30 Imran 33 627 April 30 Bilal 275 5 225April 30 Raza 108 2 052 April 30 Asma 120 2 280April 30 Amna 45 855 April 30 Asad 52 988

April 30 Syed 6 000186 447

Bilal account $ $

April 8 Purchase returns 100 April 1 Purchases 2 400April 30 Bank (5600 - 100 × 95%) 5 225 April 26 Purchases 3 200

Discount received 2755 600 5 600

Asad account $ $

April 30 Bank (1040 × 95%) 988 April 3 Purchases 1 040Discount received 52

1 040 1 040

Asma account $ $

April 21 Purchase returns 600 April 15 Purchases 3 000April 30 Bank (3000 - 600 × 95%) 2 280


3 000 3 000


April 30 Purchases journal total 9 640


April 30 Purchases returns journal total 700

Imran account $ $

April 2 Sales 720 April 13 Sales returns 60April 30 Bank (720 - 60 × 95%) 627

Discount allowed 33

720 720


15

Raza account $ $

April 10 Sales 880 April 30 Bank (2160 × 95%) 2 052April 17 Sales 1 280 Discount allowed 108

2 160 2 160

Amna account $ $

April 16 Sales 1 200 April 24 Sales returns 300April 30 Bank (1200 - 300 × 95%) 855

Discount allowed 45

1 200 1 200

Sales account $ $

April 30 Sales journal total 4 080


April 30 Sales returns journal total 360

Discount allowed account $ $

April 30 Bank 176

Discount received account $ $

April 30 Bank 447

Syed account $ $

April 30 Bank 6 000 April 5 Del. Van (Inv 324) 6 000

Delivery van account $ $

April 5 Syed 6 000


16

2 Date Accounts Dr Cr $ $

a March 3 Machinery 10 000Mumtaz 10 000

Purchase of machinery on credit on invoice 506.

b March 6 Sales 675Wayne 675

Correction of invoice 495 entered twice in error.

c March 7 Delivery van 4 250

Younas 4 250

Purchase of new delivery van from Younas on invoice 998.

d March 10 Sales returns 190

Browne 190

Credit note 103 omitted from sales returns journal.

e March 15 Geeta 1 300

Sandra 1 300

Transfer of invoice no. 854 from Sandra posted to Geeta’s account in error.

Exam practice questionsMultiple-choice questions1 C

2 B

3 B

4 C


17

4 Balancing accountsPractice exercise

1 Three-column cash bookDiscounts allowed

Cash Bank Discounts received

Cash Bank

$ $ $ $ $ $March 1 Capital 10 000 March 2 Rent 1 000March 3 Sales 550 March 7 Joe 190 3 610

March 7 Postages 20March 7 Balance c/d 530 5 390

550 10 000 190 550 10 000March 8 Balance b/d 530 5 390

Capital account $ $

March 7 Balance c/d 10 000 March 1 Bank 10 000360 March 8 Balance b/d 10 000


March 2 Joe 4 000 March 7 Balance c/d 4 000March 8 Balance b/d 4 000

Joe account $ $

March 5 Purchases returns 200 March 2 Purchases 4 000March 7 Bank ($4000 − $200 × 95%) 3 610March 7 Discount received 190

4 000 4 000


March 7 Balance c/d 200 March 5 Joe 200March 8 Balance b/d 200

Barney account $ $

March 3 Sales 2 000 March 7 Balance c/d 2 000March 8 Balances b/d 2 000


18

Sales account $ $

March 7 Balance c/d 2 550 March 3 Barney 2 000March 3 Cash 550

2 550 2 550

March 8 Balance b/d 2 550

Rent account $ $

March 2 Bank 1 000 March 7 Balance c/d 1 000March 8 Balance b/d 1 000

Postages account $ $

March 7 Cash 20 March 7 Balance c/d 20March 8 Balance b/d 20


19

5 The classification of accounts and division of the ledgerActivitiesActivity 1

Account Personal Non-current asset

Current asset Revenue or other income

Expense

Capital ✓

Sales returns ✓

Delivery vans ✓

Purchases ✓

Rent payable ✓

Trade receivables2 ✓ ✓

Inventory ✓

Discount allowed ✓

Drawings ✓

Bank1 ✓

Rent receivable ✓

Trade payables3 ✓

Computer ✓

Wages ✓

Discount received ✓

Notes:

1 The bank account would be a ‘current liability’ if it was overdrawn.

2 Trade payables is the International Accounting Standards terminology for the aggregate amount owing to suppliers. It is not literally a personal account but is a description given to the total of the credit balances on the supplier personal accounts. Trade payables are presented as a ‘current liability’ in the statement of financial position (see later chapters) at the end of an accounting period.

3 Trade receivables is the International Accounting Standards terminology for the aggregate amount receivable from customers. It is not literally a personal account but is a description given to the total of the debit balances on the customer personal accounts. Trade receivables are presented as a ‘current asset’ in the statement of financial position (see later chapters) at the end of an accounting period.

20


Practice exercises1 Statement True or false

The purchase of a motor car is revenue expenditure False

The payment of wages to employees is revenue expenditure True

The accounts for customers are kept in the sales ledger True

Repairs to the office windows is an example of capital expenditure False

The purchase of office stationery is revenue expenditure True

The sales account is a nominal account True

The fixtures and fittings account is a real account True

Suppliers’ accounts are kept in the nominal ledger False

The day-to-day costs of running the business is an example of revenue expenditure

True

2 a The sales account records the revenue of the business and is an example of a nominal account.

b The purchase of a new machine is an example of capital expenditure and the account is an example of a real account

c Small items of expenditure are recorded in the petty cash book.

d A non- current asset is bought to keep in the business for a long period of time.

21


6 The trial balanceActivitiesActivity 1

The grocer’s trial balance at 31 December Account Dr Cr

$ $Premises 50 000Motor vans 8 000Office furniture 2 000Computer 3 000Sales 60 000Sales returns 700Purchases 4 000Purchases returns 500Motor vehicle running expenses 4 200Wages 1 800Rent 2 000Bank 1 650Capital 20 000Drawings 3 150

80 500 80 500

Activity 2a Complete reversal of entries b Error of principle

c Error of omission d Compensating errors

e Error of commission f Error of original entry

Practice exercises1 Hassan’s trial balance at 31 December 2015

Account Dr Cr$ $

Sales 160 000Sales returns 2 600Purchases 84 000Purchases returns 3 400Wages 26 000Heating and lighting 3 160Rent payable 5 000Rent receivable 1 000Advertising 2 900Postage and telephone 2 740Discounts allowed 6 100Discounts received 5 900Plant and machinery 50 000Delivery van 9 000

22


$ $Bank 2 300Trade receivables 7 400Trade payables 3 700Drawings 8 800Capital 36 000

210 000 210 000

Notes:

• Items in the debit column are mainly assets or expenses.

• Items in the credit column are mainly income or liabilities.

2 Andrea’s corrected trial balance at 31 December 2015Account Dr Cr

$ $

Premises 70 000

Plant and machinery 30 000

Office equipment 5 000

Wages 7 600

Rent payable 4 000

Heating and lighting 1 500

Other operating expenses 1 720

Sales 133 000

Purchases 57 000

Discounts allowed 2 450

Discounts received 1 070

Bank 2 910

Trade receivables 14 000

Trade payables 10 140

Purchases returns 2 400

Sales returns 3 150

Rent receivable 1 200

Capital 80 000

Drawings 28 480

227 810 227 810


2 B

3 C

4 C

23


7 Income statements for sole tradersActivitiesActivity 1

LizTrading section of the income statement for the year ended 31 March 2016

Debit Credit$ $

Purchases 68 000 Sales 150 000Less: purchases returns 1 700 Less: sales returns 4 200

66 300 145 800

Activity 2

RodneyTrading section of the income statement for the year ended 30 September 2015

Debit Credit$ $

Purchases 84 000 Sales 140 000Less: purchases returns 1 400 Less: sales returns 1 200

82 600 138 800Less: closing inventory 4 900Cost of sales 77 700Gross profit 61 100

138 800 138 800

Activity 3

SofiaIncome statement for the year ended 31 December 2015

$ $Revenue 200 000Less: sales returns 6 300

193 700Cost of salesPurchases 86 500Less: purchases returns 5 790

80 710Less: inventory at 31 December 2015 10 000 70 710Gross profit 122 990Add: rent received 3 000Add: discounts received 3 210

129 200Less:Wages 61 050Rent payable 12 000Electricity 5 416Insurance 2 290


24

Income statement for the year ended 31 December 2015$ $

Motor van expenses 11 400Discounts allowed 5 110Other operating expenses 3 760Loan interest 1 000 102 026Profit for the year 27 174

Activity 4

KhorExtract from the income statement for the year ended 31 December 2015

$ $ $Revenue 48 000Less: sales returns 1 600Less: cost of sales 46 400Opening inventory 4 000Purchases 21 000Less: purchases returns 900 20 100

24 100Less: closing inventory 7 500 16 600Gross profit 29 800

Activity 5

LamarIncome statement for the year ended 31 March 2016

$ $ $Revenue 104 000Less: sales returns 3 700

100 300

Less: cost of salesOpening inventory 6 000Purchases 59 000Less: purchases returns 2 550 56 450

62 450Less: closing inventory 10 000 52 450Gross profit 47 850Rent receivable 1 800Discounts receivable 770

50 420Less:Wages 13 000

Rent payable 2 000Heating and lighting 2 700Repairs to machinery 4 100

(cont.)


25

Income statement for the year ended 31 March 2016$ $ $

Discounts allowed 1 030Loan interest 750 23 580Profit for the year 26 840

Activity 6

SaraIncome statement for the year ended 31 March 2016

$ $ $Sales 40 000Less: cost of salesOpening inventory 5 000Purchases 20 500Carriage inwards 1 320 21 820

26 820Less: closing inventory 3 000Cost of sales 23 820Gross profit 16 180Less:Wages 6 000Rent 10 000Electricity 2 600Carriage outwards 1 080Other operating expenses 1 250 20 930Loss for the year (4 750)

Practice exercises1 Hadlee

Income statement for the year ended 31 December 2015$ $ $

Sales 72 800Less: sales returns 1 600

71 200Less: cost of salesOpening inventory 11 000Purchases 28 540Less: purchases returns 2 144

26 39637 396

Less: closing inventory 9 000 28 396Gross profit 42 804Less: expensesWages 3 100Rent 4 000Heating and lighting 5 120

26


$ $ $Advertising 2 400Other operating expenses 2 010Loan interest 250

16 880Profit for the year 25 924

2 Tikolo


Sales 204 000Less: sales returns 3 600

200 400Less: cost of salesOpening inventory 18 000Purchases $(120 000 − 2 000)

118 000

Less: purchases returns 4 440113 560

Add: carriage inwards 5 000 118 560136 560

Less: closing inventory 20 000 116 560Gross profit 83 840Add: other incomeDiscounts received 3 160

87 000Less: expenses Wages 36 800Rent 8 000Heating and lighting 6 450Discounts allowed 5 020Carriage outwards 3 724Other operating expenses 1 143 61 137Profit for the year 25 863


2 C

3 C

4 D

5 A


27

8 Statements of financial position for sole tradersPractice exercises1 Sofia

Statement of financial position at 31 December 2015

$

Non-current assets

Land and buildings 84 000


Motor vans 19 000

125 000

Current assets

Inventory 10 000


Cash and cash equivalents 5 065

27 490

Total assets 152 490

Capital and liabilities

Capital at 1 January 2015 127 000

Add: profit for the year 27 174

154 174

Less: drawings 25 904

128 270

Non-current liability

Loan 20 000

Current liabilities


Total capital and liabilities 152 490

2 LamarStatement of financial position at 31 March 2016

$

Non-current assets

Premises 60 000


72 000

Current assets

Inventory 10 000



16 624

Total assets 88 624


28

$


Capital at 1 April 2016 55 000


81 840

Less: drawings 10 096

71 744

Non-current liability

Loan 15 000

Current liabilities



3 Hadlee

Statement of financial position at 31 December 2015

$

Non-current assets


Office furniture 6 000

31 000

Current assets

Inventory 9 000



17 067

Total assets 48 067


Opening capital 20 000


45 924

Less: drawings (4 833)

41 091

Non-current liabilities

Loan 5 000

Current liabilities




29

Tikolo

Statement of financial position at 31 March 2016

$

Non-current assets

Fixtures and fittings 9 000

Office furniture 2 000

11 000

Current assets

Inventory 20 000



24 466

Total assets 35 466




55 863

Less: drawings $(20 527 + 2 000) (22 527)

33 336

Current liabilities



Exam practice questionsMultiple-choice questions1 D

2 A

3 B

4 C


30

9 Accounting principles or conceptsExam practice questionsMultiple-choice questions1 B

2 A

3 A

4 B

5 B

6 D


31

10 Accruals and prepayments (the matching concept)ActivitiesActivity 1a

b Alexander’s total telephone expense for the year is $3410. This is made up of calls $(1450 + 360) = $1810 + line rental $(2000 − 400) = $1600.

c The amount of $360 for calls owing will appear under current liabilities. The figure of $400 will appear under current assets. Never net off the two amounts.

Activity 2

Rent payable account2015 2015

$ $Dec 31 Bank 1 000 Dec 31 Income

statement800

Dec 31 Balance c/d (rent prepaid)

200

1 000 1 0002016

Jan 1 Balance b/d 200

Electricity account2015 2015

$ $Dec 31 Bank 630 Dec 31 Income

statement810

Dec 31 Balance c/d (accrued expense)

180

810 8102016


Telephone account2015 2015

$ $Dec 31 Bank 1 450 Dec 31 Balance c/d

(rental prepaid)400

Dec 31 Bank 2 000 Dec 31 Income statement

3 410

Dec 31 Balance c/d (calls owing)

360

3 810 3 8102016 2016

Jan 1 Balance b/d 400 Jan 1 Balance b/d 360

32


Stationery account2015 2015

$ $Dec 31 Bank 420 Dec 31 Income

statement410

Dec 31 Balance c/d (amount owing)

130

Dec 31 Balance c/d (inventory)

140

550 5502016

Jan 1 Balance b/d 140 Jan 1 Balance b/d 130

Rent receivable account2015 2015

$ $Dec 31 Income

statement

400Dec 31 Bank

300

Dec 31 Balance c/d (rent owing)

100

400 4002016


Activity 3a Devram

Income statement for the year ended 31 December 2015$ $

Gross profit 30 000Rent $(2 600 − 300) 2 300Electricity $(926 + 242) 1 168Stationery $(405 + 84 − 100) 389Motor expenses $(725 + 160) 885Interest on loan $(500 + 500) 1 000 5 742Profit for the year 24 258

Note:

Unpaid interest on the loan must be accrued although it is not mentioned in the question.

b DevramStatement of financial position at 31 December 2015

$ $Non-current assets 40 000Current assetsInventory 7 000Stationery inventory 100 7 100Trade receivables 1 600

(cont.)

33


Statement of financial position at 31 December 2015$ $

Other receivables: prepaid rent 300Cash and cash equivalents 2 524

11 524Total assets 51 524Capital and liabilitiesCapital at 1 January 2015 20 000Profit for the year 24 258

44 258Less: drawings 5 120

39 138Non-current liabilitiesLong-term loan 10 000Current liabilitiesTrade payables 1 400Other payables $(242 + 84 + 160 + 500)

986

2 386Total capital and liabilities 51 524

Practice exercises1 a Prudence; accruals

b AntoniaIncome statement for the year ended 31 December 2015

$ $ $Sales 120 000Less: sales returns 7 300


58 21063 870

Less: closing inventory 8 000 55 870Gross profit 56 830Less: expensesWages $(17 310 + 558) 17 868Rent $(3 200 − 800) 2 400Heating and lighting $(2 772 + 328) 3 100Motor expenses 1 284Loan interest $(500 + 250) 750

25 402 Profit for the year 31 428

34


c AntoniaStatement of financial position at 31 December 2015

$Non-current assetsPremises 24 000Motor vehicles 7 400

31 400Current assetsInventory 8 000Trade receivables 12 440Other receivables: prepaid rent 800Cash and cash equivalents 5 055

26 295Total assets 57 695Capital and liabilitiesOpening capital 16 000Profit for the year 31 428


40 392Non-current liabilitiesLoan 10 000Current liabilitiesTrade payables 6 167Other payables $(558 + 328 + 250) 1 136


d The loan received is shown as a non-current liability as it is not due for repayment within 12 months from the date of the statement of financial position (31 December 2015). Any part of it which becomes due for repayment within 12 months will be shown as a current liability.

2 a DesmondIncome statement for the year ended 31 March 2016



91 323Add: carriage inwards $(5 170 + 330) 5 500 96 823

105 823Less: closing inventory 11 000 94 823

(cont.)


35


Gross profit 107 497Add: other incomeRent receivable $(2 600 − 200) 2 400Interest receivable $(840 + 160) 1 000Discounts received 1 040

111 937

Less: expensesWages 67 000Rent payable $(8 000 + 2 000) 10 000Discounts allowed 2 826Carriage outwards $(7920 + 280) 8 200Stationery and other operating expenses $(1 963 − 200 − 120)

1 643 89 669

Profit for the year 22 268

b DesmondStatement of financial position at 31 March 2016

$Non-current assetsPlant and machinery 36 000Motor vehicles 17 000

53 000Current assetsInventory 11 000Trade receivables 7 060Other receivables (other operating expenses, stationery inventory and interest accrued)

480

Cash and cash equivalents 5 40023 940

Total assets 76 940Capital and liabilitiesOpening capital 70 000Add: profit for the year 22 268


70 180Current liabilitiesTrade payables 3 950Other payables $(2000 + 330 + 280 + 200) 2 810



36

c Carriage inwards is the cost of bringing the goods from the supplier. It is regarded as part of the cost of the item bought and appears in the calculation of the cost of sales.

Carriage outwards is the cost of delivering goods to the customer. It is regarded as a business expense and appears with other expenses in the income statement.

3 a The annual financial statements of a business are prepared using the accruals basis. Expenses of the period are matched with the income of the same period. It doesn’t matter whether or not the expenses have been paid. Therefore, any amounts owing but unpaid for in a particular year are brought into the financial statements for that year (accruals). Any amounts paid during the year, but relating to a future period (prepayments) are excluded from the financial statements for that year.

b b


2 B

3 B

4 A

Rent account2015 2015

$ $Jan 1 Balance b/d 2 000 Dec 31 Income statement

$(2 000 + [3 × 2 500])9 500

Dec 31 Bank $(2500 × 4)

10 000

Dec 31 Balance c/d 2 500

12 000 12 0002016

Jan 1 Balance b/d 2 500

Electricity account 2015 2015

$ $Dec 31 Bank 1 800 Jan 1 Balance b/d 150

Balance c/d ($480 ÷ 3 × 2)

320

Dec 31 Income statement

1 970

2 120 2 1202016



37

11 Provisions for the depreciation of non-current assetsActivitiesActivity 1a

b Statement of financial position extractsCost Depreciation Net book value

$ $ $Year 1: Motor vehicles 18 000 2 000 16 000Year 2: Motor vehicles 18 000 4 000 14 000Year 3: Motor vehicles 18 000 6 000 12 000Year 4: Motor vehicles 18 000 8 000 10 000Year 5: Motor vehicles 18 000 10 000 8 000Year 6: Motor vehicles 18 000 12 000 6 000Year 7: Motor vehicles 18 000 14 000 4 000

Activity 2a

Provision for depreciation of machinery account $ $

Year 1 Balance c/d 12 000 Year 1 Income statement 12 000Year 2 Balance c/d 20 400 Year 2 Balance b/d 12 000

Income statement 8 40020 400 20 400

Year 3 Balance c/d 26 280 Year 3 Balance b/d 20 400Income statement 5 880

26 280 26 280


Provision for depreciation of motor vehicles account$ $

Year 1 Balance c/d 2 000 Year 1 Income statement 2 000Year 2 Balance c/d 4 000 Year 2 Balance b/d 2 000



6 000 6 000Year 4 Balance c/d 8 000 Year 4 Balance b/d 6 000



10 000 10 000Year 6 Balance c/d 12 000 Year 6 Balance b/d 10 000



14 000 14 000Year 8 Year 8 Balance b/d 14 000

38

$ $Year 4 Balance c/d 30 396 Year 4 Balance b/d 26 280



33 277 33 277Year 6 Year 6 Balance b/d 33 277

b Statement of financial position extracts

Cost Depreciation Net book value$ $ $

Year 1: Machinery 40 000 12 000 28 000Year 2: Machinery 40 000 20 400 19 600Year 3: Machinery 40 000 26 280 13 720Year 4: Machinery 40 000 30 396 9 604Year 5: Machinery 40 000 33 277 6 723

Activity 3

a Machinery at cost account2016 2016

$ $Jan 1 Balance b/d 18 000 May 7 Disposal of

machinery6 000

Jun 3 Bank 7 000 Jun 3 Disposal of machinery

12 000

Disposal of machinery

3 000 Dec 31 Balance c/d 10 000

28 000 28 0002017


b Provision for depreciation of machinery account2016 2016

$ $May 7 Disposal of

machinery2 400 Jan 1 Balance b/d

(2 400 + 7 200)9 600

Jun 3 Disposal of machinery

7 200 Dec 31 Income statement 1 000

Dec 31 Balance c/d 1 000

10 600 10 6002017



39

c Disposal of machinery account2016 2016

$ $May 7 Machinery at

cost6 000 May 7 Provision for depreciation

of machinery2 400

Bank 1 500Income statement (loss) 2 100

June 3 Machinery at cost

12 000 June 3 Provision for depreciation of machinery

7 200

Machinery at cost – part exchange

3 000

Income statement (loss) 1 800

18 000 18 000

Practice exercises1 a The straight-line method of depreciation is calculated by charging the rate of depreciation

on the cost of the non-current asset. The reducing balance method of depreciation is calculated by charging the rate of depreciation on the cost of the non-current asset minus the accumulated depreciation to date before making the charge.

b Piccolo

Income statement for the year ended 31 May 2016$ $

Sales 300 000Less: cost of salesOpening inventory 30 000Purchases $(190 000 − 4 000) 186 000

216 000Less: closing inventory 42 000 174 000Gross profit 126 000Less: expensesWages 56 000Heating and lighting $(17 600 + 1 800) 19 400Repairs to machinery 5 100Advertising $(7 000 − 6 000) 1 000Depreciation of freehold buildings ($80 000 × 4%) 3 200

Depreciation of plant and machinery ($76 000 − $32 000 × 25%)

11 000 95 700


40


Piccolo

Statement of financial position at 31 May 2016

Cost Accumulated depreciation

Net book value

$ $ $Non-current assetsFreehold land and buildings 100 000 43 200 56 800Plant and machinery 76 000 43 000 33 000

176 000 86 200 89 800

Current assetsInventory 42 000Trade receivables 14 000

Other receivables (prepaid advertising)

6 000

Bank 5 500

67 500

Total assets 157 300



Add: net profit 30 300

180 300

Less: drawings $(27 100 + 4000) 31 100

149 200


Other payables (heat and light) 1 800

8 100


c Piccolo should not change his method of charging depreciation. To do so will go against the concept of consistency. There is no valid reason why a change should be made.

2 a

Wilhelmina

Income statement for the year ended 31 March 2016

$ $Sales 80 600Less: sales returns 1 590

79 010Less: cost of salesOpening inventory 13 000Purchases 50 914Less: purchases returns 825 50 089

63 089

(cont.)


41

Income statement for the year ended 31 March 2016

Cost Depreciation Net book value$ $ $

Less: closing inventory 16 000 47 089Gross profit 31 921Less: expenses

Wages 13 017Electricity $(1 012 + 300) 1 312Repairs to machinery 643Other operating expenses $(1 234 − 180) 1 054Interest on loan and HP $(1 000 + 1 000 + 200)

2 200

Depreciation of leasehold property ($45 000 ÷ 15)

3 000

Depreciation of plant and machinery ($21 000 + $[30 000 − 6 000] - $9 200 × 25%)

8 950

Depreciation of office equipment ($7 000 × 15%)

1 050

31 226

Profit for the year 695

b Wilhelmina



Net book value

$ $ $Non-current assetsLeasehold property 45 000 16 500 28 500Plant and machinery 45 000 18 150 26 850Office equipment 7 000 3 450 3 550

97 000 38 100 58 900Current assetsInventory 16 000Trade receivables 1 526Other receivables (other operating expenses)

180

Bank 1 96419 670

Total assets 78 570Capital and liabilitiesOpening capital 50 000Add: net profit 695


32 097


42

$ $ $Non-current liabilitiesLoan (repayable 2020) 20 000Trade payables 973Other payables (electricity and loan)

1 300

Loan for machinery (including accrued interest $200)

24 200


Notes:

• Hire purchase is not on the syllabus. However, the amount due to the company from whom the machinery was bought is $24 000 $(30 000 − 6 000). This is added on to the cost of the machinery $(21 000 + 24 000).

• Interest to be paid over the course of HP agreement is $800 (4 × $200) and as the agreement was for one year and began on 1 January 2016, three month’s interest,

( 3

12 or 1

4 × $800 = $200) must be accrued at 31 March 2016.

• The entire loan for the machinery is repayable within 12 months from the date of the statement of financial position. This means that the whole of the amount is treated as a current liability.


2 C

3 A

4 A

Structured question1 a Businesses will use different methods of depreciation because non-current assets

lose value at different rates during their working life. For example, a motor vehicle will depreciate more in the early years of its life. Thus, the reducing balance method of depreciation is best for this asset. On the other hand, something like office furniture will lose its value evenly over its life and is depreciated using the straight-line method.

b

Asset disposal account 2016 2016

$ $May 31 Motor vehicles

at cost8 000 May 31 Motor vehicles

accumulated depreciation

4 000

Bank 3 000Income statement 1 000

8 000 8 000


43

c i Motor vehicles at cost

$(28 000 − 8 000 + 12 000) = $32 000

ii Motor vehicles accumulated depreciation

Beginning of year less vehicle sold $(12 000 − 4 000) = $8 000

Depreciation charge for the year $(32 000 − 8 000) × 25% = $6 000

(Add to get) Accumulated depreciation at end of year = $14 000

iii Office equipment at cost

$(20 000 + 2 000) = $22 000

iv Office equipment accumulated depreciation

Beginning of the year $8 000

Assets charged a full year of depreciation $20 000 × 10% = $2 000

Assets bought in year and held for only 3 months $2 000 × 10% × 14

= $50

(Add to get) Accumulated depreciation at end of year $10 050


44

12 Irrecoverable and doubtful debtsActivitiesActivity 1a 2012: $(4 000 + 1 150) = $5 150 2013: $(6 400 + 1 375) = $7 775 2014: $(7 500 + 1 125) = $8 625 2015: $(3 000 + 1 250) = $4 250 2016: $(8 300 + 1 420) = $9 720

b

Practice exercises1 a

Provision for doubtful debts account$ $

2012 2012Mar 31 Balance c/d 5 150 Mar 31 Income statement 5 150

Apr 1 Balance b/d 5 1502013 2013

Mar 31 Balance c/d 7 775 Mar 31 Income statement 2 6257 775 7 775

Apr 1 Balance b/d 7 7752014 2014

Mar 31 8 625 Mar 31 Income statement 8508 625 8 625

Apr 1 Balance b/d 8 6252015 2015

Mar 31 Income statement 4 375Balance c/d 4 250

8 625 8 625Apr 1 Balance b/d 4 250

2016 2016Mar 31 Balance c/d 9 720 Mar 31 Income statement 5 470

9 720 9 720Apr 1 Balance b/d 9 720

DavidIncome statement for the year ended 31 March 2016

$ $ $Revenue $(210 000 − 4 000) 206 000Less: sales returns 9 240


78 888Add: carriage inwards 1 840 80 728

84 728


(cont.)

4545


Less: closing inventory $(5 000 + 3 000) 8 000 76 728Gross profit 120 032Add: other incomeReduction in provision for doubtful debts |$(800 − 550)

250

Discounts received 2 480122 762

Less: expensesWages $(37 000 + 400) 37 400Rent $(7 600 − 1600) 6 000Telephone $(900 + 100) 1 000Electricity $(1 027 + 360) 1 387Postage and stationery 359Carriage outwards 1 220Discounts allowed 6 015Irrecoverable debts $(3 100 +1 700) 4 800Depreciation of leasehold premises ($70 000 × 5%)

3 500

Depreciation of delivery vans ($18 000 − $3 600 × 25%)

3 600

Depreciation of office furniture ($3 000 × 10%)

300

65 581


Notes:

1 The calculation for the adjustment is as follows:

Trade receivables account$ $

Opening balance 19 800 Goods on sale or return 4 000Specific irrecoverable debt 1 700Specific provision 3 100Balance 11 000

19 800 19 800

Provision required = 11 000 × 5% = $550

Existing provision $800

Reduction in provision $250

2 It would have been possible to combine the specific provision for the irrecoverable debt into the provision for doubtful debts account. This would be shown as:

Provision for doubtful debts account$ $

Specific irrecoverable debt 3 100 Opening balance 800Balance c/d 550 Income statement 2 850

3 650 3 650


46

3 The net effect on the income statement is the same. In the statement above there is a credit of $250, being the reduction in the provision, and expenses of $3100 included in the figure for irrecoverable debts. You can use either approach. In practice it is usual to keep irrecoverable debts and the provision for doubtful debts as two separate accounts.

b

Note:

The total assets equal the total capital and liabilities, thus the statement of financial position balances. If you don’t get the two figures the same then look for the difference, but don’t waste time.

David



Net book value

$ $ $Non-current assetsLeasehold premises 70 000 8 500 61 500Delivery vans 18 000 7 200 10 800Office furniture 3 000 1 800 1 200

91 000 17 500 73 500Current assetsInventory 8 000Trade receivables $(19 800 − 4 000 − 1 700 − 3 100)

11 000

Less: provision for doubtful receivables 550 10 450Other receivables (rent prepaid) 1 600Cash and cash equivalents 1 245

21 295Total assets 94 795Capital and liabilitiesOpening capital 50 000Add: profit for the year 57 181


86 735Current liabilitiesTrade payables 7 200Other Payables $(400 + 360 + 100) 860



47

2 a Saul

Income statement for the year ended 31 May 2016


693 330Less: cost of salesOpening inventory 40 000Purchases (410 890 − 2 400) 408 490Less: purchases returns 3 112 405 378

445 378Add: carriage inwards 4 240

449 618Less: closing inventory 58 000 391 618Gross profit 301 712Add: other incomeRent receivable $(1 020 + 280) 1 300Discounts received 2 942

305 954Less: expensesWages 137 652Rent payable $(10 000 − 2 000) 8 000Heating and lighting $(4 720 + 400) 5 120Telephone and postage 3 217Stationery $(6195 + 220 − 450) 5 965Repairs to machinery 17 600Discounts allowed 3 220Carriage outwards 1 819Increase in provision for doubtful debts[($34 600 − $1 800) × 5%] − 1 200 440Irrecoverable debt written off 1 800Depreciation − Freehold property ($180 000 × 4%)

7 200

Depreciation − Plant and machinery ($97 000 × 15%)

14 550

Depreciation − Motor vehicles ($41 000 − 27 000 × 30%)

4 200

210 783



48

b Saul

Statement of financial position at 31 May 2016


Net book value

$ $ $Non-current assetsFreehold property 180 000 52 200 127 800Plant and machinery 97 000 67 550 29 450Motor vehicles 41 000 31 200 9 800

318 000 150 950 167 050Current assetsInventory 58 000Other operating inventory (stationery)

450

Trade receivables $(34 600 − 1 800) 32 800Less: provision for doubtful debts $(1 200 + 440)

1 640 31 160

Other receivables $(280 + 2 000) 2 280Cash and cash equivalents 11 374

103 264Total assets 270 314Capital and liabilitiesOpening capital 200 000Add: profit for the year 95 171

295 171Less: drawings $(28 797 + 2 400) 31 197

263 974Current liabilitiesTrade payables 5 720Other Payables $(400 + 220) 620



2 B

3 D

4 B


49

13 Bank reconciliation statementsActivitiesActivity 1$475 Debit

Activity 2$540 Debit (overdrawn)

Activity 3a Revised cash book balance:

$80 − $210 = $130 overdrawn

b Bank reconciliation statement at 31 March 2016

$Balance per bank statements $(650 + 220) 870 Less: cheque not sent (1 000)Balance per cash book (130)

Note:

Notice that the final figure is in brackets. This identifies that the balance in the cash book is overdrawn.

Activity 4Adjusted trial balance items:

Debit Credit

$ $Trade receivables $(1 055 − 420 + 323) 958Trade payables $(976 − 360) 616Rent $(800 + 200) 1 000 Bank $(1 245 − 360 + 420 − 200 − 323) 782

Practice exercise1

Changes Starting totals Calculation Revised totals

Debit Credit Debit Credit$ $ $ $ $

Trade receivables 400 −78 322Trade payables 380 −298 82Rent receivable 750 +150 900Interest receivable +10 10Bank charges 100 +130 230Bank 990 (+10 − 130 − 298 + 78 + 150) 800


2 C

3 B

4 A

5 B

50


50

14 Control accountsActivitiesActivity 1

Byit Limited Purchase ledger control account

2016 $ 2016 $Mar 1 Balance b/d 16 Mar 1 Balance b/d 10 000Mar 31 Purchases returns 824 Mar 31 Purchases journal 33 700

Bank 27 500 Balance c/d 156Discounts received 1 300Balance c/d 14 216

43 856 43 856Apr 1 Balance b/d 156 Apr 1 Balance b/d 14 216

Activity 2

Soldit Limited Sales ledger control account

2016 $ 2016 $May 1 Balance b/d 27 640 Balance b/d 545May 31 Sales journal 109 650 Sales returns 2 220

Irrecoverable debt recovered 490 Bank 98 770Balance c/d 800 Discounts allowed 3 150

Bank – irrecoverable debt recovered

490

Purchase ledger contra

2 624

Balance c/d 30 781138 580 138 580

Jun 1 Balance b/d 30 781 Jun 1 Balance b/d 800

Activity 3a Purchase ledger

balancesSales ledger

balancesDebit Credit Debit Credit

$ $ $ $Before amendment 64 7 217 Before amendment 23 425 390Deduct invoice entered twice

(100) Correction of invoice $326 entered as $362

(36)

–

Debit balance incorrectly listed as credit balance

50

(50)

Corrected balances 23 389 390

Corrected balances 114 7 067

51


52

b Corrected purchase ledger control2015 $ 2015 $

Dec 31 Cancellation of invoice 100 Dec 31 Balance b/d 7 847Discounts received 84 Balance c/d 114

Sales ledger contra –Trazom

710

Balance c/d 7 0677 961 7 961

2016 2016Jan 1 Balance b/d 114 Jan 1 Balance b/d 7 067

Corrected sales ledger control2015 $ 2015 $

Dec 31 Balance b/d 22 909 Dec 31Sales journal understatement

800 Purchase ledger contra – Trazom

710

Balance c/d 390 Balance c/d 23 38924 099 24 099

2016 2016Jan 1 Balance b/d 23 389 Jan 1 Balance b/d 390

c Amended profit for the year ended 31 December 2015$

Profit per draft income statement 31 000Add:Reduction in purchases 100Discounts received omitted 84Increase in sales 800Amended profit for the year 31 984

d Statement of financial position extract at 31 December 2015$ $

Trade receivablesSales ledger 23 389Purchase ledger 114 23 503Trade payablesPurchase ledger 7 067Sales ledger 390 7 457


52

53

Practice exercises1 Peter

Sales ledger control account$ $

Mar 1 Balance b/d 55 650 Mar 31 Bank 36 900Mar 31 Sales 47 700 Irrecoverable debts 2 250

Bank 1 920 Discounts allowed 930Returns inwards 580Purchase ledger control 810Balance c/d 63 800

105 270 105 270Apr 1 Balance b/d 63 800

PeterPurchase ledger control account

$ $Mar 31 Bank 24 300 Mar 1 Balance b/d 34 020

Discounts received 600 Mar 31 Purchases 21 840

Returns outwards 330Sales ledger control 810

Balance c/d 29 82055 860 55 860

Apr 1 Balance b/d 29 820

2 a SellitSales ledger control account

$ $Dec 31 Balance b/d 17 584 Dec 31 P. Ford 900

Discounts allowed 210 Sales 578P. Williams 180 Balance c/d 17 096Sales 600

18 574 18 574Dec 31 Balance b/d 17 096

b Calculation of sales ledger balances before corrections$

Corrected balance per sales ledger control account 17 096Add Minus

$ $Adjustment 2 900Adjustment 3 (180)Adjustment 5 578Adjustment 6 450

1 928 (180) 1 748Uncorrected balance of sales ledger accounts 18 844


53

54

Proof

Sales ledger control account Sales ledger balances$ $

Balances from above 17 584 18 844Adjustment 1 210Adjustment 2 (900) (900)Adjustment 3 180 180Adjustment 4 600Adjustment 6 (450)

17 674 17 674

Note:

The goods treated as a sale to Will Dither will be in both balances at the time they are calculated.

c Journal entriesAccount Debit Credit

$ $P. Ford 900B. Ford 900Receipt from customer posted to wrong accountNote: the control accounts do not require correctionP. Williams 180Sales 180Correction of sales invoice recorded in errorNote: the sales ledger personal and control accounts and the revenue account all require correction

Sales 578Will Dither 578Correction of goods on sale or return treated as sale in errorNote: the sales ledger personal and control accounts and the revenue account all require correction. In addition, the goods held by Dither will have to be included in the year end inventory

W. Yeo 450Correction of sales invoice for $3160 recorded as $3600 in errorNote: the only error was in the personal account


3 a There may be a credit balance on the sales ledger control account because of:

• an overpayment by a customer

• a payment in advance by a customer.

54

55

b JulieCorrected sales ledger control account

2016 $ 2016 $May 31 Balance b/d 18 640 May 31 Purchase ledger control 650

Irrecoverable debts 400Cash sales 1 760 Balance c/d 20 586Balance c/d 436

21 236 21 236June 1 Balance b/d 20 586 June 1 Balance b/d 436


2 C

3 C

Structured questions1 a Two advantages to a business of maintaining sales and purchase ledger control accounts:

• provides quick totals of trade receivables and payables

• helps to detect errors in the accounts.

b Haeun JooPurchase ledger control account

2016 $ 2015 $Apr 30 Bank 1 118 970 May 1 Balance b/d 64 680

Discounts received 47 100 2016Returns outwards 18 600 Apr 30 Purchases 1 236 210Sales ledger control 7 815Balance c/d 108 405

1 300 890 1 300 890May 1 Balance b/d 108 405

c Haeun Joo

Amended purchase ledger control account$ $

Contra with sales ledger 1 275 Balance from (a) 108 405Bank 2 175 Discounts received 1 500Balance c/d 109 515 Purchases 3 060

112 965 112 965

Balance b/d 109 515


55

56

d Statement to reconcile balancesAdd Minus Purchase

ledger balances$ $ $

Starting balances at 30 April 2016 101 490Adjustment 2 3 060 3 060Adjustment 3 150 150Adjustment 6 4 815 4 815Amended balance on purchase ledger control account at 30 April 2016

109 515

2 Three reasons for keeping a control account are (any two):

• provides a quick total for year-end financial statements

• helps identify possible fraud

• helps to detect errors in the accounts.

3 a It is sometimes the case where the customer of a business is also a supplier to the business. They will, therefore, have an account in both the sales and purchase ledger. In order to cut down on paperwork and the need to send cheques to each other, the balance on the sales ledger will be offest against the balance in the purchase ledger. This means that only one party needs to send a cheque to the other. Whatever action is taken in the individual accounts in the sales and purchase ledgers, the same thing has to be done in the respective control accounts in the nominal ledger.

b Dinh TruongPurchase ledger control account

2016 $ 2015 $Apr 30 Bank 745 980 May 1 Balance b/d 43 120

Discounts received 31 400 2016Purchases returns 12 400 Apr 30 Purchases 824 140Sales ledger control 5 210Balance c/d 72 270

867 260 867 260May 1 Balance b/d 72 270

c Amended purchase ledger control account2016 $ 2016 $

May 1 Balance b/d 72 270Sales ledger control

850 Discounts received

1 000

Bank 1 450 Purchases 2 040Revised balance c/d 73 010

75 310 75 310May 1 Balance b/d 73 010


56

57

d Purchase ledger control account

Purchase ledger balances

$ $Starting balances (purchase ledger control account was calculated in part a, purchase ledger balances is the balancing figure)

72 270 67 660

Adjustment 1 1 000Adjustment 2 2 040 2 040Adjustment 3 – 100Adjustment 4 (850) –Adjustment 5 (1 450) –Adjustment 6 3 210

73 010 73 010


57

15 Suspense accountsActivitiesActivity 1a Lee

Suspense account$ $

Sales 90 Difference on trial balance 58*Doyle 18 Irrecoverable debt (expense) 50

108 108

*Balancing figure

b Debit Credit$ $

Purchases 150Bilder, purchase ledger 150Machinery at cost 400Machinery repairs 400Income statement 40Provision for depreciation of machinery 40

c Decrease IncreaseDr Cr$ $ $

Profit for the year per draft accounts 3 775(1) Increase in sales 90(2) Increase in purchases 150(4) Increase in irrecoverable debts 50(5) Decrease in machinery repairs 400(5) Increase in provision for depreciation of machinery 40

240 490(240) 250

Correct profit for the year 4 025

Activity 2

a Journal entries to correct the errorsDr Cr$ $

1 Suspense 2 700Note. No debit entry is required.

2 Note. The trial balance was not affected because the closing inventory was not shown in it.

3 Repairs to machinery 3 500Suspense 1 800Machinery at cost 5 300

4 Suspense 800Sales 800

5 Suspense 126Note. No credit entry is required.


58

59

b JayeshSuspense account

$ $Machinery at cost 1 800 Trial balance difference 26Sales 800 Adjustment of opening

inventory2 700

Adjustment to trade payables

126

2 726 2 726

c $

Net working capital per draft statement of financial position 3 200Add: increase in closing inventory 2 000Deduct: credit balance $63 extracted as debit balance (126)Corrected net working capital at 31 December 2015 5 074

Practice exercises1 Bastien journal

Account Debit Credit$ $

1 Veeraj Suspense Discount received from Veeraj not

posted to their account.

7070

2 Bernard Suspense Correction of amount posted to

Bernard’s account.

5050

3 Suspense Rodney Correction of amount debited to

Rodney’s account in error.

800800

4 Motor vehicles at cost Purchases Transfer of purchase of new vehicle

posted to purchases account in error.

12 00012 000

5 Drawings Other operating expenses Transfer of drawings posted to other

operating expenses.

6060


59

60

2 a Boulder journalAccount Debit Credit1 Suspense Head Correction of amount and misposting

of receipt from Head $(313 + 331).

644644

2 Suspense Joey Return of goods from Joey not entered

in his account.

100100

3 Motor vehicles at cost Motor vehicle expenses Transfer of purchase of motor vehicle

posted to motor expenses in error.

3 0003 000

4 Discount allowed Suspense Correction of overcast of discounts

allowed column in cash book.

300300

5 Theft of cash Cash Theft of $700 by employee written off.

700700

b BoulderSuspense account

$ $Mar 31 Head 644 Mar 31 Balance per trial balance

(balancing figure)444

Joey 100 Discounts allowed 300

744 744

c Working capital original balance

Add Minus$ $ $

Original balance 2 400Head 644Joey 100Cash 700 (1 444)

956


60

61

3 a Account Debit Credit$ $

1 Bank Purchase ledger control, Victor

9090

2 Purchase ledger control Suspense General expenses

420180240

3 Sales returns Purchases

900900

4 Purchase ledger control Purchases returns

350350

5 Discounts received Purchase ledger control

600600

b AmberSuspense account$ $

Mar 31 Per trial balance 180

Mar 31 Purchase ledger control 180

4 a Account Debit Credit$ $

1 Discount received Discount allowed Suspense

5555

1102 Suspense Sales returns Purchases returns

216108108

3 Sales control account Bank

400400

4 Equipment Purchases

4 4004 400

5 Drawings Purchases

800800

6 Suspense General expenses Drawings General expenses

9090

9090

b LoganSuspense account$ $

Mar 31 Sales returns 108 Mar 31 Balance per trial balance

196

Purchases returns 108 Discounts received 55General expenses 90 Discounts allowed 55

306 306


61

c LoganCorrected trial balance at 31 March 2016

Account Debit Credit$ $

Sales 131 940Purchases $(33 000 − 4400 − 800) 27 800

Sales returns$(260 − 108) 152

Purchase returns$(315 + 108) 423

Opening inventory 6 900Sales ledger control$(14 125 + 400) 14 525

Purchase ledger control 16 070Discounts allowed$(700 + 55) 755

Discounts received$(614 − 55)

559

Wages and salaries 20 600Advertising 1 000General expenses $(2 340 − 180) 2 160Bank$(13 710 − 400) 13 310

Premises 70 000Motor vehicle 5 000Equipment$(3 500 + 4 400) 7 900

Capital 25 000Drawings

3 890$(3 000 + 800 + 90)173 992 173 992

d LoganStatement to show corrected profit for the year ended 31 March 2016

Add Minus Original profit for the year

$ $ $Per question 68 069Adjustment 1 110Adjustment 2 216 –Adjustment 3 – –Adjustment 4 4 400Adjustment 5 800Adjustment 6 180

5 596 (110) 5 486Corrected profit for the year 73 555


62

63

Exam practice questionsMultiple-choice questions1 A2 B3 C4 B5 C6 C7 A


63

16 Incomplete recordsActivitiesActivity 1

Statements of affairs at 1 January 2015 at 31 December 2015$ $

Premises at cost or valuation 4 000 9 000*Motor van at cost 5 000 4 000Motor car at cost – 3 000Plant and equipment 1 100 1 300Inventory of parts 400 200Trade receivables for work done 700 800Balance at bank 1 300 900

12 500 19 200Less:Owing to suppliers 170 340Capital 12 330 18 860Less capital introduced: motor car 3 000**Less capital increase due to property valuation 5 000*

10 860Add: drawings ($120 × 52) 6 240

17 100Deduct capital at 1 January 12 330Profit for the year ended 31 December 4 770

*The increase in the value of property is not regarded as part of the trading profit, but is in fact an unrealised capital profit.

**The cost of the car is deducted because it was capital introduced during the year.

Activity 2

AmmarTrading section of the income statement for the year ended 30 June

$ $Sales (balancing figure) 35 000 Less:Opening inventory 4 000Purchases (balancing figure) 31 000(Balancing figure) 35 000Closing inventory 7 000Cost of sales 28 000Gross profit (margin 20%, so mark-up is 25%) 7 000


64

65

Activity 3

NehaPro forma trading section of the income statement for the period

30 June 2015 to 5 November 2015

$ $Sales $(122 000 − 16 000 + 37 000 + 17 000) 160 000Less: cost of salesInventory at 30 June 2015 47 000Purchases $(138 000 − 23 000 + 28 000) 143 000

190 000Less: inventory at 5 November 2015(Balancing figure) 70 000 120 000Gross profit (25% of $160 000) 40 000

Cost of inventory lost in fire: $(70 000 − 12 000) = $58 000.

Practice exercices1 a (i and ii) and b

SengStatement of affairs at: 1 January 2015 31 December 2015

$ $Assets Shop premises 20 000Motor van 8 000Shop fittings 3 000Inventory 4 000Trade receivables 1 000Bank 60 000 5 000 60 000 41 000Liabilities Trade payables (6 000)Loan from brother (20 000) (16 000) 40 000 19 000 Opening capital 40 000 40 000Loss for the year (balancing figure) (15 800)Less: drawings (5 200) 40 000 19 000


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2 Miriam

Statement of affairs at: 1 July 2015 30 June 2016 Assets $ $Land and buildings at cost 60 000 60 000Fixtures and fittings 10 000 12 000Office machinery 8 000 7 000Inventory 17 000 21 000Trade receivables 4 000 5 000Rent prepaid 1 000 600Bank 14 000 16 000 114 000 121 600Liabilities (3 000) (1 600)

Trade payables Wages owing (2 000) (1 000) 109 000 119 000Opening capital 109 000Capital introduced 1 400Profit for the year 21 000Less: drawings (12 400)Closing capital 109 000 119 000

Note: The revaluation of the land and buildings is ignored as this is a capital profit.

3 Workings:

Trade payables control account$ $

Payments from bank 54 000 Opening balance 3 600Closing balance 5 200 Credit purchases 55 600

59 200 59 200

Calculation of closing inventory

$Per question 11 000Less: damaged inventory at cost (5 000)

6 000Add: damaged inventory at NRV 2 500Value for trading account 8 500

Calculation of revenue

$Opening inventory 16 000Add: purchases $(55 600 − 1 300) 54 300

70 300Less: closing inventory1, 2 (11 000)Cost of sales 59 300

Mark up = $59 300 ÷ 60% = $98 833


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Check:

Sales 98 833Less: cost of sales (59 300)Gross profit 39 533

Gross profit margin = $39 533 ÷ $98 833 × 100 = 40%

Kim

Trading section of income statement for the year ended 30 June 2016

$ $Sales 98 833Opening inventory 16 000Add: purchases $(55 600 − 1300) 54 300

70 300Less: closing inventory3 (8 500)Cost of sales (61 800)Gross profit (36 600)

Notes:

1 The value given for closing inventory in the question ($11 000) is assumed to be the value of goods at their full price.

2 The mark-up has been calculated using the full value of closing inventory.

3 $(11 000 − (5 000 × 50%)) It is further assumed that all damaged goods were still inventory (i.e. that none of them had been sold before the year end).

4 a CorneliusStatement of affairs at: 1 April 2014 31 March 2015

$ $Assets Equipment 15 000 28 000Premises 80 000Inventory 37 500 52 000Trade receivables 22 400Other operating expenses 700Bank 30 000 116 000 82 500 299 100Liabilities Bank loan (40 000)

Trade payables (56 000)Other operating expenses (2 280)Loan from father (20 000) (20 000) 62 500 180 820 Opening capital 62 500 62 500Capital introduced 40 000Profit for the year (balancing figure) 99 120Less: drawings (20 800)

62 500 180 820


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b CorneliusIncome statement for the year ended 31 March 2016

$ $Sales 468 650Less: Cost of salesOpening inventory 52 000Purchases 382 750

434 750Less: closing inventory 74 250 360 500Gross profit 108 150Less: expensesOther operating expenses $(27 000 − 2 280 + 700 + 875 − 4 050) 22 245

Bank loan interest 6 000Loan interest – father 1 600Depreciation – equipment $(28 000 + 24 000 − 45 900) 6 100 35 945Profit for the year 72 205

Workings:

i Trade payables control account$ $


438 750 438 750

ii Calculation of cost of sales

$Opening inventory 52 000Add: purchases 382 750

434 750Less: closing inventory (74 250)Cost of sales 360 500

iii Calculation of sales

Cost of sales + 30% = $468 650

iv Trade receivables control account$ $

Opening balance 22 400 Receipts banked 456 850Credit sales for the year 468 650 Closing balance 34 200

491 050 491 050


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v Bank account$ $

Opening balance 116 000 Suppliers 371 340From customers 456 850 Drawings 26 000

Equipment 24 000Other operating expenses 27 000Bank loan interest 6 000Interest on loan from father 1 600Drawings for holiday 5 000Additional drawings (bal fig) 800Closing balance 111 110

572 850 572 850

c CorneliusStatement of financial position at 31 March 2016


Net book value

AssetsNon-current assetsPremises 80 000 – 80 000Equipment 45 900

80 000 125 900Current assetsInventory 74 250Trade receivables 34 200Other receivables 4 050Cash and cash equivalents 111 110

223 610Total assets 349 510Capital and liabilitiesOpening capital 180 820Add: net profit 72 205 253 025Less: drawings $(26 000 + 5 000 + 800) (31 800) 221 225Non-current liabilities Bank loan 40 000Loan from father 20 000 60 000Current liabilities Trade payables 67 410Other payables 875 68 285Total capital and liabilities 349 510


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Exam practice questionsMultiple-choice questions1 B2 B3 C4 D5 D6 B7 D8 D9 B10 D

Structured questions1 a Benefits of maintaining proper books of account (any three):

• helps Ahmed to control the businesses

• helps to identify errors

• aids future planning

• satisfies the tax authorities

• helps when approaching banks or other lenders for loans.

b $Assets Premises 60 000Motor van 8 000Inventory 6 250Trade receivables 3 200Rent prepaid 400Bank 9 450Cash 50 87 350Liabilities Trade payables (1 800)Electricity owing (600)Loan interest owing (150)Loan from brother (2 000) 82 800Opening capital 82 800

c Cash account$ $

Opening balance 50 PaymentsCash sales for the year 21 750 $(3140 + 300 + 600 + 400) 4 440

Cash banked 17 000Cash drawings (bal figure) 310Closing balance 50

21 800 21 800


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d AhmedIncome statement for the year ended 30 September 2016

$ $Revenue 49 800Less: cost of salesOpening inventory 6 250Purchases 26 060 32 310Less: closing inventory 8 000 24 310Gross profit 25 490Other incomeDiscount received 420 25 910

Less: expensesWages 7 400Electricity $(2200 − 600 + 320) 1 920Rent ($4000 + 400 − 450) 3 950Motor van expenses $(1800 + 600) 2 400Loan interest $(2 000 × 10% − 150 + 150) 200Telephone and stationery $(1650 + 300) 1 950Irrecoverable debt 250Other operating expenses 400Depreciation – motor van $(8000 − 6000) 2 000Depreciation – fixtures and fittings ($3000 × 25%)

750

21 220


Workings:

Trade receivables control account$ $

Opening balance 3 200 Receipts banked 29 400Credit sales for the year 28 050 Irrecoverable debts written off 250

31 250 Closing balance 1 60031 250

Total sales for the year = credit sales $28 050 + cash sales $21 750 = $49 800.


Payments from bank 23 000 Opening balance 1 800Discount received 420 Credit purchases 22 920Closing balance 1 300

24 720 24 720

Total purchases for the year = credit purchases $22 920 + cash purchases $3140 = $26 060.


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e Yes he should, in order to reflect the usage of the premises with the revenue generated by using them (matching principle).

If the premises are recorded at cost and were purchased some time ago then it is more likely that they have increased in value. He could revalue them and then begin depreciating them with a charge based on their new valuation.

2 a Margin (or gross margin) refers to the ratio between the gross profit earned on sales and the revenue figure, expressed as a percentage. The calculation is:

Gross profit × 100

Revenue

Alternatively:

Revenue − Cost of sales × 100 = Margin

Cost of sales

Mark-up is the amount which is added to the purchase cost of an item to arrive at its selling price, usually expressed as a percentage. The calculation is:

Gross profit × 100

Cost price

Alternatively:

Cost of sales × (100 + mark-up (as a %)) = Sales (or sales price)

Cost of sales b Nadia

Calculation of inventory at cost at 31 December 2015

Add Minus Total$ $ $

Value at 8 January 62 0401 $62 040 × 20% 12 4082 $2000 × 80% 1 6003 i Cost of goods from suppliers 4 400 ii $12 000 × 80% 9 600

11 200 16 808 5 60856 432

c $ $Revenue 225 000Less: sales returns (3 200)

221 800Opening inventory 65 000Add: purchases (balancing figure) 168 872Less: closing inventory from above (56 432)Cost of sales 177 440Gross profit ($221 800 × 20%) 44 360


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3 a i Calculation of credit sales

Trade receivables control account$ $

Opening balance 20 400 Receipts banked 170 430Credit sales for the year 182 030 Closing balance 32 000

202 430 202 430

ii Total sales for the year = credit sales $182 030 + cash sales banked $103 000 + cash taken as drawings before banking ($300 × 52) $15 600 = $300 630.

iii

Total purchases = credit purchases $227 068 − goods taken for own use $1 350 = $225 718.

b KornIncome statement for the year ended 30 April 2016

$ $Sales 300 630Less: cost of salesOpening inventory 22 400Purchases $(227 068 − 1 350) 225 718

248 118Less: closing inventory ($21 923 ÷ 130 × 100) 16 864 231 254Gross profit 69 376Less: expensesWages $(17 200 − 800 + 600) 17 000Rent $(8 000 − 800 + 1000) 8 200

Electricity 9 670General expenses 5 150Loan interest ($30 000 × 10%) 3 000Loss on sale of motor vehicle $(2 000 − 3 500) 1 500Loss on sale of fixtures and fittings $(400 − 800) 400Depreciation − motor van $(10 000 − 3 500 + 10 000 − 8 000) 8 500Depreciation – fixtures and fittings 4 200 57 620$(8 000 − 800 + 7 000 − 10 000)Profit for the year 11 576



234 568 234 568


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c KornStatement of financial position at 30 April 2016


Net book value

AssetsNon-current assetsPremises 70 000 – 70 000Motor van 8 000Fixtures and fittings 10 000

70 000 88 000Current assetsInventory 16 864Trade receivables 32 000Bank including loan from brother (balancing figure here or in cash book) 50 142

99 006Total assets 187 006Capital and liabilitiesOpening capital 150 700Add: net profit 11 756 162 456Less: drawings $(15 600 + 1 350) (16 950)

145 506Non-current liabilitiesLoan from brother 30 000 Current liabilitiesTrade payables 6 900Other payables $(600 + 1000 + 3000) 4 600 11 500Total capital and liabilities 187 006

d Korn should not value his inventory at selling price.

• It would be contrary to the concept of realisation, as he has not yet obtained the selling price value from the inventory.

• It woud be contrary to the matching principle when he does sell the inventory in the next year, such sales will show nil profit.

• Accounting standards (accordingly) require the application of the rule ‘lower of cost and net realisable value’.


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17 Partnership accountsActivitiesActivity 1a Tee and Shirt

Income statement and appropriation account for the year ended 31 March 2016

$ $ $Sales 215 000Less: cost of salesInventory at 1 April 2015 16 000Purchases 84 000

100 000Less: inventory at 31 March 2016 20 000 80 000Gross profit 135 000Selling expenses 24 000Administration expenses 46 000Depreciation:Fixtures and fittings 4 800Office equipment 5 400 10 200Interest on loan 600 80 800Profit for the year 54 200Share of profit:

Tee 1

2

27 100

Shirt 1

2

27 100 54 200

b Partners’ current accountsTee Shirt Tee Shirt

2016 $ $ 2015 $ $Mar 31 Drawings 29 000 31 000 Apr 1 Balances b/d 5 000 10 000

2016Balance c/d 3 100 6 700 Mar 31 Interest on loan 600

Share of profit 27 100 27 100

32 100 37 700 32 100 37 700

Apr 1 Balance b/d 3 100 6 700

c Statement of financial position at 31 March 2016Cost Accumulated

depreciationNet book

value$ $ $

Non-current assetsFixtures and fittings 48 000 12 800 35 200Office equipment 27 000 10 400 16 600

75 000 23 200 51 800

(cont.)


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Statement of financial position at 31 March 2016Cost Accumulated


value$ $ $

Current assetsInventory 20 000Trade receivables 24 000Other receivables 6 000Cash and cash equivalents 85 000

135 000Total assets 186 800Capital and liabilitiesCapital accounts:Tee 100 000Shirt 50 000

150 000Current accounts:Tee 3 100Shirt 6 700

9 800Non-current liability Loan – shirt 12 000Current liabilitiesTrade payables 11 000Other payables 4 000


Activity 2

a Tee and Shirt

Income statement and appropriation account for the year ended 31 March 2016

$ $ $Sales 215 000Less: cost of salesInventory at 1 April 2015 16 000Purchases 84 000

100 000Less: inventory at 31 March 2016 20 000 80 000Gross profit 135 000Selling expenses 24 000Administration expenses 46 000Depreciation:Fixtures and fittings 4 800Office equipment 5 400 10 200Interest on loan 1 200 81 400Profit for the year 53 600


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$ $ $Add Interest on drawings:Tee 2 900Shirt 3 100 6 000

59 600Less: interest on capitalsTee 10 000Shirt 5 000 (15 000)Less: salaryShirt (4 000)

40 600Share of profit:

Tee 35

24 360

Shirt 25

16 240 40 600

b Partners’ current accountsTee Shirt Tee Shirt

2016 $ $ 2015 $ $Mar 31 Drawings 29 000 31 000 Apr 1 Balances b/d 5 000 10 000

Interest on drawings 2 900 3 100 2016Balances c/d 7 460 2 340 Mar 31 Interest on capital 10 000 5 000

Interest on loan 1 200Salary 4 000Share of profit 24 360 16 240

39 360 36 440 39 360 36 440Apr 1 Balance b/d 7 460 2 340

c Statement of financial position at 31 March 2016


Net book value

$ $ $AssetsNon-current assetsFixtures and fittings 48 000 12 800 35 200Office equipment 27 000 10 400 16 600

75 000 23 200 51 800Current assetsInventory 20 000Trade receivables 24 000Other receivables 6 000Cash and cash equivalents 85 000

135 000Total assets 186 800

(cont.)


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Statement of financial position at 31 March 2016$ $ $

Capital and liabilitiesCapital accounts:Tee 100 000Shirt 50 000

150 000Current accounts:Tee 7 460Shirt 2 340

9 800Non-current liabilityLoan – shirt 12 000Current liabilitiesTrade payables 11 000Other payables 4 000


Practice exercises1 a Bell and Binn

Income statement and appropriation account for the year ended 30 April 2016

$ $Revenue 425 000Less: cost of sales Opening inventory 30 000Add: purchases 200 000 230 000Less: closing inventory (27 000) 203 000Gross profit 222 000

Less: expenses Wages 98 000Rent $(25 000 − 1 500) 23 500Heat and light 16 000Office expenses 12 600Vehicle expenses 5 510Advertising $(3 500 − 2 000) 1 500Irrecoverable debts written off 416Bank charges $(314 + 860) 1 174Depreciation of motor vehicles 3 800Depreciation of plant and machinery 12 500 175 000Profit for the year 47 000

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$ $Add: interest on drawings Bell 3 000Binn 1 350 4 350 51 350Less: interest on capital Bell 5 000Binn 4 000 9 000Less: partner’s salary Bell 10 000Binn 8 000 18 000Share of profit: Bell 14 610Binn 9 740 24 350

b Partners’ current accountsBell Binn Bell Binn

$ $ $ $Drawings 30 000 13 500 Opening balance b/d 7 000 3 000Interest on drawings 3 000 1 350 Interest on capital 5 000 4 000Closing balance c/d 3 610 9 890 Salary 10 000 8 000

Share of profit 14 610 9 74036 610 24 740 36 610 24 740

Balance b/d 3 610 9 890

c Statement of financial position at 30 April 2016Cost Accumulated


value$ $ $

Non-current assetsPlant and machinery 125 000 48 500 76 500Motor vehicles 41 000 25 800 15 200

166 000 74 300 91 700Current assetsInventory 27 000Trade receivables 45 750Less: provision for doubtful receivables (1 000) 44 750Other receivables $(1500 + 2000) 3 500Cash and cash equivalents $(15 724 − 314 − 860)

14 550


(cont.)


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Statement of financial position at 30 April 2016$ $ $

Capital and liabilitiesPartners’ capital and current accounts

Bell Binn$ $

Capital account 50 000 40 000 90 000Current account 3 610 9 890 13 500

53 610 49 890 103 500Non-current liabilityLong-term loan – Bell 60 000Current liabilitiesTrade payables 18 000Total capital and liabilities 181 500

2 a Miller and MeredithForecast income statement and appropriation account

for the year ended 31 December 2016$ $

Forecast net profit for the year $(21 560 + 21 600) 43 160Less: interest on capitalMiller 2 000Meredith 3 000 (5 000)Forecast profit 38 160Share of profit:Miller 19 080Meredith 19 080 (38 160)

b If the two businesses combine then Miller will have a forecast total income of $21 080 compared with $19 600 he earned for himself in the previous year. Meredith will have a forecast income of $22 080 compared with $18 000 for the previous year as a sole trader.

It appears from the figures that both partners will be better off by combining their businesses. However, there is no guarantee that the forecast increases in net profit will happen. Had they stayed as sole traders and the forecast increases had happened then Miller would be worse off, by $(21 560 − 21 080). Meredith, on the other hand would be better off by $(22 080 − 21 600).

On a strictly short term calculation, Miller should not agree to a partnership with Meredith on those terms. However, the figures in both cases are very close together. On that basis, therefore, he should consider whether there are longer term factors that may outweigh the short term loss. There may be more scope to increase future net profits as a partnership than by trading alone.

Workings:

Miller Meredith

$ $Net profit for y/e 31 Dec 2015 19 600 18 000Add: estimated increase 1 960 3 600Forecast net profit 21 560 21 600


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2 D

3 A

NoteSince interest on loans is an expense of the business, the profit for the year can be assumed to have allowed for this. Accordingly, to answer the questions, no adjustment to profit should be made for interest; nor is the interest received to be viewed as part of a partner’s profit share. Similarly, a partner’s salary reduces the amount of profit to be shared, and in that strict sense her share of the remainder is her profit share.

Structured questiona Advantages of forming a partnership (any two):

• The capital invested by partners is often more than can be raised by a sole trader.

• A greater fund of knowledge, experience and expertise in running a business is available to a partnership.

• A partnership may be able to offer a greater range of services to its customers (or clients).

• The business does not have to close down, or be run by inexperienced staff, in the absence of one of the partners; the other partner(s) will provide cover.

• Losses are shared by all partners.

Disadvantages of forming a partnership (any two):

• A partner doesn’t have the same freedom to act independently as a sole trader has.

• A partner may be frustrated by the other partner(s) in their plans for the direction and development of the business.

• Profits have to be shared by all partners.

• A partner may be legally liable for acts of the other partner(s).

b Partners maintain separate capital and current accounts to keep better control of the amounts introduced into the business and drawn from the business by each partner. The capital account identifies how much each partner has introduced into the business. From this it is possible to calculate any interest on capital agreed between the partners. The capital account is adjusted only very occasionally, for example when a partner is admitted or retires, or when there is a substantial change in the business’s need for capital.

The current account records each partner’s share of profits, either by way of profit share or interest on capital/salary. It also shows how much a partner draws. Keeping the current account also helps partners not to withdraw from the business more than their share of profit. This ensures cash is retained and partners do not withdraw capital. (A partner that deliberately withdrew excessive drawings would in effect have repaid himself some of his capital whilst still charging interest on the full amount.)


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c Up and Down

Corrected statement of financial position at 30 June 2016$ $

AssetsNon-current assetsFixtures and fittings at cost 33 500$(45 000 − 15 000 + 3 500)Less: depreciation to date 22 500$(34 500 − 10 500 − 1 500)

11 000Current assetsInventory $(28 500 + 10 000) 38 500

Trade receivables 24 000Less: provision for doubtful debt 960 23 040Other receivables 750Cash and cash equivalents 9 000

71 290Total assets 82 290Capital and liabilitiesCapital accounts:Up 22 000Down 14 000

36 000Current accounts:Up $(7 500 + 2 200 + 3579) 13 459Down $(1 500 + 1 400 − 1075 + 2506) 4 331

17 790Total capital 53 790Non-current liabilityLoan – Up 15 000Current liabilitiesTrade payables 12 000Other payables 1 500


Workings:

Adjustments to profit

$Loss on disposal of fixtures and fittings$(15 000 − 10 500 − 3 500) (1 000)Depreciation of fixtures sold written back 1 500Loan interest on Up’s loan (1 500)Undervalue of closing inventory 10 000Provision for doubtful debts ($24 000 × 4%) (960)Prepaid rent 750


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$Goods taken for personal use 1 075Adjusted profit 9 865

Less: interest on capitalUp 2 200Down 1 400

6 265Share of profit:Up 3 759Down 2 506

6 265

d Up and DownRevised current accounts at 30 June 2016

Up Down Up Down$ $ $ $

Original balances 7 500 1 500Goods taken 1 075Balance c/d 13 459 4 331 Interest on capital 2 200 1 400

Share of profit 3 759 2 50613 459 5 406 13 459 5 406

Opening balances b/d 13 459 4 331

e There are really only two ways in which Down could increase the balance on his capital account. The first is to introduce some assets into the business rather than cash. This would mean him purchasing, say, some inventory and introducing that into the business. He could also bring in some of his personal assets into the business, say, his car or computer. If he decides to purchase some assets then his ability to do so will depend on how much personal cash he has available. If he has very little then this is not a viable option. Likewise, he may not want to introduce his own assets into the business.

The other option is for Down to explore ways in which he can give up a part of his other entitlements from the partnership and turn these into a further capital contribution. For example, he could agree that some of his current account can be credited to the capital account instead. Based on the above figures, he could contribute up to $4 331 this way. However, that would mean that Down would not have any balance left on his current account to draw for his immediate needs, and in any case, Up wishes him to increase his capital by $8 000.

Another idea would be for the partners to agree that a portion of Down’s future shares of profit are credited to the capital account, instead of to the current account. (For example, $2 000 for each of the next four years. If the partnership is highly profitable, it may be possible to complete this exercise in a shorter time or even in one year.)

Down’s options are limited and it may be that he is unable to increase the balance on his capital account without introducing some more cash into the business. He may have to borrow money to do so.


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18 Partnership changesActivitiesActivity 1a Revaluation account

$000 $000Property (old value) 120 Property (new value) 150Plant and machinery (old value) 60 Plant and machinery (new value) 51Inventory (old value) 20 Inventory (new value) 17Trade receivables (old value) 30 Trade receivables (new value) 28Trade payables (new value) 22 Trade payables (old value) 24Profit on revaluation – Ann 12Profit on revaluation – John 6

270 270

b Capital accounts$000 $000 $000 $000Ann John Ann John

Balance c/f 132 66 Opening balances 120 60Profit on revaluation 12 6

132 66 132 66Balance b/d 132 66

c Statement of financial position at 31 October 2016 following revaluation

$000Non-current assetsProperty 150Plant and machinery 51

201Current assetsInventory 17Trade receivables 28Bank account 1

46Total assets 247Capital and liabilitiesCapital accounts:Ann 132John 66

198Current accounts:Ann 17John 10

27Current liabilitiesTrade payables 22Total capital and liabilities 247


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Activity 2Workings:

Journal

Name of account Dr Cr

$ $Freehold premises 25 000Fixtures and fittings 3 000Office equipment 2 000Inventory 3 000Trade receivables control 1 000Revaluation account 16 000Revaluation of assets at 1 September 2016 as agreed by partners Revaluation account 16 000 Capital account – Tom 8 000Capital account – Tilly 8 000Apportionment of profit on revaluation of assets to partners in profit-sharing ratios

a Revaluation account$ $

Journal on allocation of revaluation gains 16 000 Journal on revaluation of assets 16 000

Journal

Name of account Dr Cr

$ $Freehold premises 25 000 Revaluation account 25 000Revaluation account 3 000Fixtures and fittings 3 000Revaluation account 2 000Office equipment 2 000Revaluation account 3 000Inventory 3 000Revaluation account 1 000Trade receivables control 1 000Revaluation account 8 000

Capital account – Tom 8 000

Revaluation account 8 000

Capital account – Tilly 8 000

Revaluations of assets at 1 September 2016 as agreed by partners, and apportionment of net profit on revaluation of assets to partners in profit-sharing ratios.


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Revaluation account$ $

Fixtures and fittings 3 000 Freehold premises 25 000Office equipment 2 000

Inventory 3 000

Trade receivables control 1 000

Capital account – Tom 8 000

Capital account – Tilly 8 000

25 000 25 000

b Tom and TillyStatement of financial position as at 1 September 2016

$ $AssetsNon-current assets at new values Freehold premises 65 000Fixtures and fittings 15 000Office equipment 5 000 85 000Current assets Inventory 14 000Trade receivables 3 000Cash and cash equivalents 6 000

23 000Total assets 108 000Capital and liabilitiesCapital account – Tom 56 000Capital account – Tilly 49 000

105 000Current liabilitiesTrade payables 3 000Total capital and liabilities 108 000

c As the terms of the partnership changed, with Tilly now being entitled to a salary as well as a share of profits, then the partners were correct to revalue the assets. This ensures that any effort by the partners in the 'old' partnership that has generated a profit (or gain, or loss) that will be divided up in the future is rewarded in the proportions that were agreed to apply to the earlier period.

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Activity 3

a Vera and KenCalculation of goodwill

Value of net assets $Premises 140 000Fixtures and fittings 65 000Motor vehicles 35 000Office equipment 15 000Inventory 6 500Trade receivables 11 800Bank 3 620

276 920Less:Trade payables 5 830Net asset value 271 090

Value of goodwill: $(300 000 − 271 090) = $28 910

b Amounts to be credited to capital accounts for goodwill:

Vera ( 1

2

of $28 910): $14 455

Ken ( 1

2

of $28 910): $14 455

Activity 4a Old

profit-sharing ratiosNew

profit-sharing ratiosAdjustments to capital

accounts (net)

$ $ $Punch 12 000 10 800 1 200 creditJudy 6 000 7 200 1 200 debit

18 000 18 000

b Capital accountsPunch Judy Punch Judy

2016 $ $ 2016 $ $Oct 1 Goodwill 1 200 Oct 1 Balance b/f 36 000 14 000

Goodwill 1 200Oct 1 Balance c/d 37 200 12 800

37 200 14 000 37 200 14 000

Oct 1 Balance b/d 37 200 12 800

Note:

In this case the net adjustment for each partner has been made. It would be equally correct to:

• credit Punch’s capital account with $12 000 and debit it with $10 800

• credit Judy’s capital account with $6 000 and debit it with $7 200.


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Activity 5

Hook, Line and SinkerTrading section of the income statement and appropriation

account for the year ended 31 December 2016

$Sales 129 500Less cost of sales 66 500Gross profit carried down 63 000

Hook, Line and SinkerIncome statement and appropriation account for the

year ended 31 December 2016

Six months to 30 June 2016

Six months to 31 December 2016

Year to31 December 2016

$ $ $ $ $ $Gross profit brought down 31 500 31 500 63 000Wages 7 000 7 000 14 000General expenses 1 750 3 500 5 250Interest on loan 200 400 600Depreciation 875 9 825 875 11 775 1 750 21 600Profit for the year 21 675 19 725 41 400Salary – Hook 3 000 3 000 3 000

16 725 38 400Share of profit:

Hook3

6

10 8381

3

5 575 16 413

Line2

6

7 225

1

3

5 575 12 800

Sinker1

6

3 612 21 675

1

3

5 575 16 725 9 187 38 400

Activity 6

a Income statement and appropriation account for the year ended 31 December 2016

$Turnover 600 000Less: cost of sales (330 000)Gross profit 270 000

For eight months For four monthsGross profit 270 000 → 8 : 4 180 000 90 000Less: operating expenses:Manager salary (24 000 × 8/12) 16 000 −Wages and salaries (106 000 − 16 000) → 8 : 4 60 000 30 000Rent (42,000 → 8 : 4) 28 000 14 000Heating and lighting (6 000 → 8 : 4) 4 000 2 000


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Other operating expenses (12 000 → 8 : 4) 8 000 4 000Depreciation:

Premises (180 000 × 4% × 8

12) 4 800

(210 000 × 4% × 4

12) 2 800

Plant (90 000 × 20% × 8

12) 12 000

(27 000 × 20% × 4

12) 1 800

Motor car (30 000 × 25% × 8

12) 5 000

(5 000 + 7 000 × 25% × 4

12) 1 000

Equipment (21 000 × 10% × 8

12) 1 400

(6 000 × 10% × 4

12) 200

Interest on loan (20 000 × 12% × 4

12) (139 200) 800 (56 600)

Profit for the periods 40 800 33 400Less: appropriation:Interest on capital:

Hardeep (100 000 × 10% × 8

12 ) 6 667

(158 800 × 10% × 4

12) 5 293

Nasma (60 000 × 10% × 8

12) 4 000

(87 400 × 10% × 4

12) 2 913

Arfan (45 000 × 10% × 4

12) 1 500

Total interest 10 667 9 707

Salary – Nasma (15 000 × 8

12) 10 000

(18 000 × 4

12) – (20 667) 6 000 (15 707)

Residual profits 20 133 17 693Share of profit

Hardeep (20133 × 2

3) 13 422

(17 693 × 25) 7 077

Nasma (20 133 × 13) 6 711

(17 693 × 25 ) 7 077

Arfan (17 693 × 1

5) (20 133) 3 539 (17 693)

– –


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Current acountsHardeep Nasma Arfan Hardeep Nasma Arfan

Drawings 30 000 40 000 4 000 Balance b/d 16 000 12 000Interest on loan 800Interest on capital 11 960 6 913 1 500Salary 16 000

Balance c/d 19 260 8 702 1 039 Share of profit 20 500 13 788 3 53949 260 48 702 5 039 49 260 48 702 5 039

Balance b/d 19 260 8 702 1 039

Note: Rounding differences have not been eliminated in presenting this answer.

b Capital acountsHardeep Nasma Arfan Hardeep Nasma Arfan

Balance b/d 100 000 60 000Gain on revaluation 62 800 31 400

Goodwill written off 24 000 24 000 12 000 Goodwill 40 000 20 000Transfer to loan a/c 20 000 Bank 50 000Balance c/d 158 800 87 400 45 000 Motor car 7 000

202 800 111 400 57 000 202 800 111 400 57 000Balance b/d 158 800 87 400 45 000

Working for gain on revaluation

Assets Book valueon 1 Jan 2016

Dep for 8m Book valueon 1 Jan 2016

Revalued1 Sept 2016

Gain

Premises 135 000 (4 800) 130 200 210 000 79 800Plan 30 000 (12 000) 18 000 27 000 9 000Motor van 5 000 (5 000) – 5 000 5 000Office equipment 7 000 (1 400) 5 600 6 000 400Total (23 200) (94 200) → 2 : 1

Activity 7a Wilfrid, Hide and Wyte

Income statement and appropriation account for the year ended 30 June 2016

Six months ended 31 Dec 2015

Six months ended 30 June 2016

$ $ $ $Gross profit 93 500 93 500Wages 45 500 45 500Rent 6 000 6 000Electricity 4 200 4 200Interest on loan – 3 750Other operating expenses 4 500 60 200 4 500 63 950Profit for the year 33 300 29 550Interest on capital: –Wilfrid 4 000Hide 2 500 1 650†Wyte 1 500 8 000 325†† 1 975

25 300 27 575

90

b Partners’ capital accountsWilfrid Hide Wyte Wilfrid Hide Wyte

2015 $ $ $ 2015 $ $ $Dec 31 Goodwill 10 000 20 000 Jul 1 Balance b/d 80 000 50 000 30 000

Revaluation of assets

10 500 7 000 3 500 Dec 31 Goodwill 30 000

Loan a/c 75 000 Current a/c 5 650Bank 30 150

2016Jun 30 Balance c/d 33 000 6 500

115 650 50 000 30 000 115 650 50 000 30 000

2016

Jul 1 1 Balance b/d 33 000 6 500

Note: The goodwill adjustments have been shown net.

Partners’ current accountsWilfrid Hide Wyte Wilfrid Hide Wyte

2015 $ $ $ 2015 $ $ $Dec 31 Drawings 23 000 Jul 1 Balance b/d 12 000 3 000 4 000

Capital a/c 5 650 Dec 31 Interest 4 000

Profit 12 6502016

Jun 30 Drawings 28 000 18 000 2016Balance c/d 1 371 5 829 Jun 30 Interest 4 150 1 825

Profit 22 221 18 004

28 650 29 371 23 829 28 650 29 371 23 829

Jul 1 Balance b/d 1 371 5 829

Note: Some questions will combine the revaluation of assets with the introduction of a new partner. In this case, work through the revaluation account, transferring any profit or loss on revaluation to the old partners in their old profit sharing ratios. Then introduce the new partner and adjust the capital accounts for goodwill in line with Section 18.7.

† $33 000 × 10% × 1

2

= $1 650

†† $6 500 × 10% × 1

2

= $325

$ $ $ $Share of profit:Wilfrid 3

6

12 650

Hide 2

6

8 4331

2

13 788

Wyte 1

6

4 217 25 300 1

2

13 787 27 575


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b Capital accountsRaul Samir Raul Samir$000 $000 $000 $000

Vehicle taken 7 Opening balances 60 55Current account – 4 Current accounts 10 –Bank 79 50 Profit on realisation 9 6

79 61 79 61

c Bank account$000 $000

Sale of property 106 Opening balance 4Sale of vehicles 9 Trade payables 10Sale of inventory 18 Expenses of sale 3From trade receivables 13 Capital account – Raul 79

Capital account – Samir 50146 146

Practice exercises1 a When a new partner is admitted, it is only fair that the old partners are rewarded for their

efforts in building up the business. The assets should be revalued prior to admitting a new partner, because any profit on revaluation belongs to the old partners. The new partner should not benefit from any of this profit.

b i Revaluation account$ $

Property account (current value) 40 000 Property account (new value) 60 000Inventory account (current value) 12 000 Inventory account (new value) 10 000Capital account – Ali 9 000Capital account – Siri 9 000

70 000 70 000

Activity 8a Realisation account

$000 $000Property (book value) 80 Bank – sale of property 106Motor vehicles (book value) 20 Samir’s capital account – value of car taken 7Inventory (book value) 19 Bank – sale of vehicles 9Trade receivables (book value) 16 Bank – sale of inventory 18Bank – payments to trade payables 10 Bank – from trade receivables 13Bank – expenses of sale 3 Trade payables (book value) 10Profit on realisation:Raul (3/5) 9Samir (2/5) 6

163 163

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Note:

This is the first account to be tackled because any profit or loss on revaluing assets belongs to the old partners. Fiona, the new partner, isn’t entitled to any of this profit as she has not been part of the business which generated it. It would have been acceptable to shortcut the answer by showing the changes in the value of the assets rather than show their old value and new value. This is shown below:

Revaluation account$ $

Inventory account – loss $(12 000 – 10 000)

2 000 Property account – profit $(60 000 – 40 000)

20 000

Capital account – Ali 9 000Capital account – Siri 9 000

20 000 20 000

Both approaches would be acceptable. It’s very much a question of how confident students feel. Putting in both the old and new values (the first approach) helps track everything better. There is too much opportunity to make an arithmetic mistake by shortcutting the approach.

ii

Capital accountsAli Siri Fiona Ali Siri Fiona

$000 $000 $000 $000 $000 $000Goodwill account 8 8 8 Opening balance 36 36 –Balance c/d 49 49 22 Profit on revaluation 9 9 –

Bank 30Goodwill 12 12 –

57 57 30 57 57 30

Balance b/d 49 49 22

c The treatment of goodwill is similar to the treatment of any profit arising on revaluation of assets. The old partners’ capital accounts are credited with their share of goodwill in the old profit sharing ratio. The capital accounts of all three partners are then debited with goodwill in the new profit sharing ratio. This is done as the old partners have given up a share of their goodwill to the incoming partner.

2 a Capital accounts

Wilson Betty Keppel Wilson Betty Keppel$000 $000 $000 $000 $000 $000

Goodwill account 12 12 – Opening balance 40 15 30Current account 6 Goodwill 8 8 8Bank 36Balance c/d 40 15 – Profit on revaluation 4 4 4

52 27 42 52 27 42Balance b/d 40 15 –


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e Partners’ current accountsWilson Betty Imogen Wilson Betty Imogen

$ $ $ $ $ $ $Balance b/d 1 000 Balance b/d 2 000Drawings 52 000 48 000 20 000 Interest on capital 5 366 1 666 500Balances c/d 16 129 13 429 Share of profit 60 763 60 763 10 942

Balances c/d 8 55868 129 62 429 20 000 68 129 62 429 20 000

Balance b/d 8 558 Balance b/d 16 129 13 429

b Partners’ capital accounts for the period from 1 May 2015 to 30 April 2016Wilson Betty Imogen Wilson Betty Imogen

2015 $000 $000 $000 2015 $000 $000 $000Nov 30 Goodwill

account16 16 8 May 1 Opening

balance52 15 –

2016 Nov 30 Bank 20

April 30 Balance c/d 56 19 12 Goodwill 20 20 –72 35 20 72 35 20

2016May 1 Balance b/d 56 19 12

c Two advantages of partners preparing a partnership agreement are:

• It shows clearly how much of the profit earned by the partnership each partner is entitled to. It also shows how much each partner must bear of any loss incurred.

• It will prevent future disputes between the partners.

d Partnership appropriation account for the year ended 30 April 20167 months to

30 November 20155 months to 30 April 2016

$ $ $ $Profit for the period 81 666 58 334Less: interest on capitalWilson 3 033 2 333Betty 875 791Imogen – 3 908 500 3 624Residual profit 77 758 54 710

Share of residual profitWilson 38 879 21 884Betty 38 879 21 884Imogen – 10 942

77 758 54 710

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f It is possible that the partners will benefit from converting their business to a limited company. It will give them limited liability for the debts of the business, unlike now where they are all fully liable for the partnership debts and may have to use their own personal assets to meet payment for them.

A limited company can issue shares to passive investors who share in the risk and reward instead of taking a lender’s return in interest. Small parcels of shares can be awarded or sold to key employees as a motivational bonus arrangement. Having the option to issue shares or to take loans, or a mixture, may make raising capital easier in the future.

However, there is the need to decide how many shares each partner will be issued with. If they are issued in proportion to the balances on their capital and current accounts then Wilson will clearly have the most shares. This will give him control of the company in making decisions on the way it is developed in the future. This may upset Betty and Imogen as at the moment all three have an equal share in the decision making. This could cause future friction between all three, leading to the business failing.

Clearly then, the shares should be issued in the same proportions as the partners intend to share the profits going forward. This may mean that some amounts of capital are repaid on incorporation, or are converted to loans from the individuals to the company, or that Imogen will have to take out some personal loans so that she has enough to pay for her full portion of the new shares. All this should be a matter for agreement between the partners based around the capital needs of the business and their personal financial circumstances.

The primary drawback of being a limited company is that there is extensive legislation (in the UK in the Companies Act 2006) which regulates the conduct of companies and their directors, and requires that information, including the annual accounts, are placed on public record. In contrast, partnerships are allowed considerable privacy and relative freedom of conduct.

It is usual to consider incorporation when the scale or nature of the business are such that the advantage of limited liability outweighs the additional administrative burden.


2 A

3 D

4 B

5 A


95

19 An introduction to the accounts of limited companiesActivitiesActivity 1a

Year 2011 2012 2013 2014 2015 2016$ $ $ $ $ $

Profit 10 000 5 000 7 000 4 000 7 000 12 000Preference dividend paid 6 000 5 000 6 000 4 000 6 000 6 000Profit left for ordinary shareholders 4 000 nil 1 000 nil 1 000 6 000Maximum ordinary dividend payable 4% – 1% – 1% 6%

b Year 2011 2012 2013 2014 2015 2016$ $ $ $ $ $

Profit 10 000 5 000 7 000 4 000 7 000 12 000Preference dividend for year 6 000 5 000 6 000 4 000 6 000 6 000Arrears of dividend carried forward – – 1 000 – 1 000 1 000Profit left for ordinary shareholders 4 000 nil nil nil nil 5 000Maximum ordinary dividend payable 4% – – – – 5%

Activity 2

a Premium Share LimitedJournal

Dr Cr$ $

Bank 120 000Ordinary share capital 100 000Share premium account 20 000Issue of 100 000 ordinary shares of $1 at $1.20 per share

b Cash bookBank account (extract)

$ $June 1 Ordinary share capital 100 000

Share premium 20 000

Ordinary share capital account$ $

June 1 Bank 100 000

Share premium account$ $

June 1 Bank 20 000


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Activity 3a Doingwell Limited

JournalDr Cr

Details $ $Aug 1 Bank account 220 000

Ordinary share capital account 110 000Share premium account 110 000Receipt of first payment on application for the issue of 150 000 ordinary shares at $1.50 each

First payment = 220 000 × $1. This represents $0.50 share capital and the full share premium of $0.50 per share

Sep 1 Ordinary share capital account 35 000Share premium account 35 000Bank account 70 000Refund of payment to unsuccessful applicantsOrdinary share capital 70 000 shares × $0.50Share premium 70 000 shares × $0.50

Oct 1 Bank account 75 000Ordinary share capital account 75 000Balance of money due from successful applicants

b Cash bookBank account (extract)

$ $Aug 1 Ordinary share capital 110 000 Sep 1 Ordinary share capital 35 000

Share premium 110 000 Share premium 35 000

Oct 1 Ordinary share capital 75 000

Share premium 75 000

Note:

The bank account is only showing the transactions relating to the issue of shares. It is only an extract, as during the period from August 1 to October 1 there would have been other transactions which affected the bank account.


Sep 1 Bank 35 000 Aug 1 Bank 110 000

Oct 1 Bank 75 000


Sep 1 Bank 35 000 Aug 1 Bank 110 000


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98

Activity 4

Journal Dr CrDetails $ $Freehold premises at cost 60 000Freehold premises accumulated depreciation 18 000Revaluation reserve 42 000Transfer of existing balances to revaluation reserve account

Freehold premises at cost 80 000

Revaluation reserve 80 000Revaluation of premises at new valuation

Note:Any depreciation to be charged on the premises will be calculated on the new valuation of $80 000.

The alternative journal, following the style on page 268 of the text, is also perfectly acceptable:

JournalName of account $ $

Freehold premises at cost 20 000Freehold premises accumulated depreciation 18 000Revaluation reserve 38 000Revaluation of premises at new valuation

Activity 5Total of ordinary share capital and reserves:

$(200 000 + 50 000 + 100 000 − 40 000) = $310 000

Net asset value of 100 ordinary shares = $310 000

× 100 = $155 200 000

Activity 6a Michel Pillay Limited

Income statement for the year ended 30 April 2016$000 $000

Revenue 300Opening inventories 20Purchases 113

133Closing inventories 31Cost of sales 102Gross profit 198Overheads:Sales office salaries 57Selling expenses 39General office wages 32Other general expenses 35


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99

$000 $000Depreciation:Warehouse machinery 8Office machinery 10 181Profit for the year 17

b Michel Pillay LimitedStatement of changes in equity for the year ended 30 April 2016

Share capital

Share premium

General reserve

Retained earnings

Total

$000 $000 $000 $000 $000Balance at 30 April 2015 60 15 25 8 108Profit for the year 17 17Transfer to general reserve [1] 10 (10)Balance at 30 April 2016 60 15 35 15 125

c Michel Pillay Limited Statement of financial position at 30 April 2016


Net book value

$000 $000 $000AssetsNon-current assets:Warehouse machinery 70 38 32Office machinery 42 30 12

112 68 44Current assetsInventories 31Trade receivables 38Cash and cash equivalents 28

97Total assets 141Equity and liabilitiesCapital and reservesShare capital 60Share premium 15General reserve 35Retained earnings 15

[1] 125Non-current liabilities10% debentures 2023/2025 5Current liabilities Trade payables 11Total liabilities 141

[1] The transfer to general reserves is made from retained earnings. Thus no entry appears in the ‘Total’ column.

[1] Notice that the total of capital and reserves ($125 000) matches the closing total on the statement of changes in equity.


99

Activity 7

Good Offers LimitedRe-drafted statement of financial position

$000AssetsNon-current assets 1 400Current assets 350

1 750Equity and liabilitiesCapital and reservesOrdinary shares of $1[ 800 + (800 ÷ 4 × 3)] 1 400Share premium 200General reserves 100Retained earnings 50

1 750

Note:

The least flexible reserve is the revaluation reserve. This was $600 000 and exactly matched the increase in ordinary shares resulting from the bonus issue. Hence it was used first. Had any more reserves been required then the share premium would have been used as this is less flexible than the general reserve and retained earnings.

Activity 8a Journal Dr Cr

2016 Details $ $July 1 Share premium 500 000

Revaluation reserve 300 000Ordinary share capital 800 000Issue of bonus shares at 4 for every 5 held, leaving the reserves in their most flexible form

b Bonarite LimitedStatement of financial position at 1 July 2016, immediately

after the issue of the bonus shares$

Net assets 2 000EquityShare capital and reservesOrdinary shares of $1 1 800General reserves 120Retained earnings 80

2 000


100

101

c Journal Dr Cr2016 Details $ $July 1 Bank 750 000

Ordinary share capital ( 1

3

× 1 800 000 = 600 000) 600 000

Share premium (600 000 × $1.25) 150 000Rights issue of one ordinary share for every three held

d Bonarite LimitedStatement of financial position at 1 July 2016, immediately after the rights issue shares

$000Net assets 2 750EquityShare capital and reservesOrdinary shares of $1 2 400Share premium 150General reserves 120Retained earnings 80

2 750

Practice exercise1 a Bracket and Racket Limited

Income statement for six months ended 30 September 2016

$000Revenue (W1 + W2) 2451Cost of sales $(1540 + W3 − 704) (2132)Gross profit 319Expenses $(25 + 823 + 103 − 192) (759)

Depreciation $(350 − 70) × 25% × 1

2

(six months) (35)

Provision for doubtful debts ($420 × 5%) (21)Loss from operations before non-recurring items (496)Loss on disposal of unused buildings (17)

(513)Finance cost (20)Loss before tax 533)Taxation (–) Loss for the period (533)


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Bracket and Racket Limited - Working 1 (W1)Two-column cash book

Cash Bank Cash Bank$000 $000 $000 $000

Brought down 3 – – 203Sales ledger (2 784 − 53) 2 731 Purchase ledger 1 996Sale of property 53 Expenses 823Cash sales (balancing figure)

120 Interest 20

Wages 25Loan repayments 90

Carried down (195 + 63) – 258 Carried down 8 –123 3 042 123 3 042

Bracket and Racket Limited - Working 2 (W2)Sales ledger

$000 $000Brought down 820 Bank 2 731

Sales (balancing figure) 2 331 Carried down 4203 151 3 151

Bracket and Racket Limited - Working 3 (W3)Purchase ledger

$000 $000Bank 1 996 Brought down 1 210

Carried down 510 Purchases (balancing figure)

1 296

2 506 2 506

Bracket and Racket LimitedStatement of changes in equity for six months ended 30 September 2016

Details Share capital Retained earnings Total$000 $000 $000

At start of year 25 910 1 108Loss for six months (533) (533)Loan repayments – (90)Balance at 30 Sept 25 377 4 850

Note:

Although not specifically asked for, a statement of changes in equity has been shown. Included in the statement of changes in equity is the loan account. The reason for this is that in the original data the loan account was included as part of the equity. However, as we have seen, it is not part of the equity in the new statement of financial position.


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103

b Bracket & Racket LimitedStatement of financial position at 30 September 2016

Net book value$000 $000

AssetsNon-current assetsBuildings $(250 − 70) 180Less: depreciation (22.50) 157.50Fixtures and fittings 100.00Less: depreciation (12.50) 87.50

245Current assetsInventory 704Trade receivables $(420 − 21) 399Cash 8

1 111Total assets 1 356Equity and liabilitiesCapital and reservesShare capital 25Retained earnings 377

402Non-current liabilitiesLoan accounts $(173 − 90) 83Current liabilitiesTrade payables 510Accruals 103Bank overdraft (195 + 63) 258

871Total equity and liabilities 1 356

Exam practice questionsMultiple-choice questions1 C2 B3 B4 A5 C6 A7 A8 D9 D10 C11 D12 B13 A14 C


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Structured questions1 a Cash book

Bank account (extract)

$ $May 1 Ordinary share capital 60 000 Jun 1 Ordinary share capital 10 000

Share premium 60 000 Share premium 10 000Jul 1 Ordinary share capital 25 000Aug 1 Ordinary share capital 25 000


Jun 1 Bank 10 000 May 1 Bank 60 000Jul 1 Bank 25 000Aug 1 Bank 25 000


Jun 1 Bank 10 000 May 1 Bank 60 000

b An ordinary share entitles the holder to a part ownership of the company. They are paid a dividend out of the company’s profits, if sufficient, as a reward on their investment.

A debenture is a loan to the company, repayable at some time in the future. The person or company is not an owner of the company but a long-term creditor. They will receive interest on the money lent. This will be payable before any dividends are paid to the ordinary shareholders.

c Morecap LimitedStatement of changes in equity for the year ended 31 March 2016

Details [1] Share capital

Share premium

Retained earnings

Total

$000 $000 $000 $000At 31 March 2015 400 40 55 495Issue of ordinary shares 100 50 150Profit for the year 180 180Interim dividend (50) (50)At 31 March 2016 500 90 185 [2]775

[1] Apart from the opening and closing balances, the other items can be shown in any order.

[2] Notice that the bottom line adds across to $775 000, as does the total column downwards. This is always a useful check to make sure students work is accurate.

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2 a Pecnut LimitedIncome statement for the year ended 31 March 2016

$000Revenue 2 683Cost of sales $(85 000 + 1 152 000 − 105 000) (1 132)Gross profit 1 551Selling and distribution expenses $(540 + 21) (561)

Administrative expenses (648)Profit from operations 342Finance cost (36)Profit before tax 306Taxation (–)Profit for the year 306

Notes: 1 In this illustration, the calculation of the cost of sales has been shown in brackets after

the label. This is perfectly acceptable. Alternatively, students could have shown the calculation as separate workings.

2 Always show full labels. This is particularly important for gross profit and profit for the year. The notations GP and NP are not acceptable even if the calculations are correct.

3 The question states very plainly that the depreciation of the motor vehicles is to be classed as a distribution expense. Ordinarily the choice would depend on the use made of the vehicles; for example depreciation on salesmen’s cars or delivery vans are selling expenses, but the costs of a company car for the chief accountant would be an administrative expense.

4 The interest on debentures is 10%. That means that a total of $36 000 should be brought into the income statement for finance costs for the year. At the moment there is only $18 000 in the trial balance. Therefore a further $18 000 needs to be provided. This will also need to be brought into the statement of financial position as an other payable.

b Pecnut LimitedStatement of changes in equity for the year ended 31 March 2016

Details Share capital

Share premium

General reserve

Retained earnings

Revaluationreserve

Total

$ $ $ $ $ $$000 $000 $000 $000 $000 $000

At start of year 600 – 120 69 – 789Profit for year 306 306Dividends paid – final – –Dividends paid – interim – –Share issue – – –Revaluation of assets 680 680Transfer to reserves 10 (10) –

Balance at year end 600 – 130 365 680 1 775


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106

Notes:

1 This answer has used the full format from section 2, although there are quite a few items where there are no entries. Students only need to show the items where an amount needs to be shown.

2 The figure of $1 775 is a check total as the items above it and to the left all add to it. This is an important cross check and students should always do it as it will act as a cross check when they prepare the statement of financial position.

3 In the further Information section of the question note 5 mentions the recommendation of a final dividend. Under IAS 1 this is not shown in the accounts for the current year. It is now shown as a note to the accounts.

4 A calculation of the revaluation of the freehold land is as follows: Revaluation reserve account

$000 $000

Balance c/d 680 Freehold buildings at cost account 500

Provision for depreciation of freehold buildings account 180

680 680

Balance b/d 680

The figure of $500 is the increase in the cost value for $1 500 to $2 000. However, the provision for depreciation which exists must now be written off as it no longer exists.

c Preparation of accounts on a going concern basis is one of the fundamental accounting concepts. It means the business is expected to continue in operation for the foreseeable future. This is at least the next trading period. Thus, assets are valued on this basis, usually at their current net book values, unless any revaluation has taken place.

If this is not the case then the assets will be recorded in the accounts at a value which is as close as possible to their value if the company is forced to sell them on the open market. This is likely to be considerably lower that their net book value. Further, provision is made for the expected costs of closing down the business, such as redundancy payments.

3 a Square LimitedIncome statement for the year ended 30 June 2016

$000 $000Revenue 1 000Opening inventories 46Purchases 630

676Closing inventories (38)Cost of sales (638)Gross profit 362Overheads:Sales office salaries 79Administration wages 36Delivery vehicle expenses $(38 + 2) 40Advertising $(34 − 6) 28Office expenses $(24 + 3) 27


106

107

$000 $000Depreciation:Delivery vehicles 13Office machinery 7

(230)Profit from operations 132Finance costs $(6 + 6) (12)Profit before tax 120Tax (16)Profit for the year 104

b Square Limited Statement of changes in equity for the year ended 30 June 2016

Share capital

Revaluation reserve

General reserve

Retained earnings

Total

$000 $000 $000 $000 $000Balance at 30 April 2015 900 50 7 957Profit for the year 104 104Transfer to general reserve 50 (50) –Revaluation reserve 260 260Dividends paid (7) (7)Balance at 30 April 2016 900 260 100 54 1 314

c Square Limited Statement of financial position at 30 June 2016


Net book value

$000 $000 $000AssetsNon-current assetsFreehold premises 1 200 – 1 200Delivery vehicles 80 41 39Office machinery 70 28 42

1 350 69 1 281Current assetsInventories 38Trade receivables 82Other receivables 6Cash and cash equivalents 67

193Total assets 1 474Equity and liabilitiesCapital and reservesOrdinary Share capital 900General reserve 100Revaluation reserve $(200 + 60) 260Retained earnings 54

1 314

(cont.)


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108



Net book value

$000 $000 $000Non-current liabilities12% debentures 2025/2027 100Current liabilitiesTrade payables 33Other payables $(2 + 3) 5Debenture interest 6Taxation 16


Notes:

1 The recommended final dividend on the ordinary shares is shown by way of a note to the accounts.

2 However, the debentures are a long-term loan and the unpaid interest on them is treated as an accrual.

3 Amounts prepaid are shown as other receivables.

4 Similarly, the accrued amounts owing are shown as other payables. Strictly speaking the total should also include the unpaid debenture interest. However, this is shown separately to enable readers to follow the workings.

d Two uses of the share premium account are:

• to issue fully paid bonus shares

• to pay the expenses of a new share issue.

e The choice of whether to issue shares or take a debenture to fund the future expansion will depend on a number of factors. If the directors are happy to take additional loans, then a debenture can be considered. It will increase the amount of loan interest, which is a fixed charge on the profit and must be paid before any dividends to ordinary shareholders. But it does mean that that all profit (in excess of the interest charge) that is generated by the expansion will fall to the existing shareholders.

At the present time the company is not highly geared and an additional loan of $150 000 may be a good option. The directors may also be able to negotiate a rate of interest below the 12% currently payable on the existing debenture. The principal advantage of a debenture is that the current ownership and control of the company is not diminished.

On the other hand, an issue of shares will not increase the gearing. Specifically this means that the additional funds received are not a liability of the business. There will not be any need to have to repay either the capital (which they will have to do with a debenture), or any dividend on the shares, if profits are low in future years. Thus, issuing shares will help future cash flows.

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109

The 100 000 new shares could be issued to the existing shareholders if they have access to the funds necessary to buy the shares. Alternatively, some or all of the new shares could be sold to a third party. It is likely that any large scale investor would expect also to become a director so that they could share in the decision making that will affect the future value of their shares, which the present directors may or may not consider advantageous.

The more confident the directors are that their expansion plans will succeed, the more they should favour taking a loan; the more risky the venture they have in mind, the wiser it would be to seek to raise the capital by a share issue.

Note: Provided cogent reasoning based on the above arguments is given, students could justify either method of raising the funds.


109

20 Manufacturing accountsActivitiesActivity 1

The Fabric CompanyManufacturing account and income statement for the year ended 31 March 2016

$000 $000Raw materialsInventory at 1 April 2015 10Purchases 130Carriage in 14 144

154Less: inventory at 31 March 2016 20Cost of raw materials consumed 134Direct labour 170Direct expenses 16Prime cost 320Factory overheads 128Depreciation of machinery 12 140

460Work in progress: 1 April 2015 1231 March 2016 (22) (10)Factory cost of goods produced 450Factory profit (20%) 90Transferred to income statement 540

Sales 700Less: cost of salesInventory of finished goods at 1 April 2015 24Transferred from manufacturing account 540

564Inventory of finished goods at 31 March 2016 36 528Gross profit 172Office overheads (96)Office depreciation (3) (99)

73Add: factory profit 90Less: Adjustment to provision for unrealised profit

$(36 − 24) × 20 120

(2) 88

Profit for the year 161


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Activity 2

Glue-making companyManufacturing account and income statement for the year ended 30 April 2016

$ $Direct materials:Inventory at 1 May 2015 11 250Purchases 132 000Carriage inwards 11 505 143 505

154 755Less: inventory at 30 April 2016 13 125Cost of raw material consumed 141 630Direct labour 146 250Prime cost 287 880Factory overheadsIndirect wages 19 500

Rent 3

4 $(45 000 + 3 750) 36 563

Heating and lighting 2

3 $(42 300 + 2 700) 30 000

Insurance 9

10 $(3 150 – 900) 2 025

Motor vehicle expenses ($6 000 × 1

2 ) 3 000

Depreciation:Factory 3 000Machinery 10 000

Motor vehicles (8 000 × 1

2 ) 4 000 108 088

395 968Work in progress:at 1 May 2015 18 000Less: at 30 April 2016 15 750 2 250Factory cost of goods produced 398 218Factory profit (20%) 79 644Transferred to income statement 477 862

Sales 800 000Less: cost of salesInventory of finished goods at 1 May 2015 27 000Transferred from manufacturing account 477 862

504 862Less: inventory of finished goods at 30 April 2016 24 000 480 862Gross profit 319 138Office salaries 51 450

Rent 1

4 $(45 000 + 3 750) 12 187

(cont.)


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112

$000 $000

Heating and lighting 1

3 $(42 300 + 2 700) 15 000

Insurance 1

10 $(3 150 − 900) 225

Carriage outwards 2 520Advertising $(7 000 − 3 500) 3 500

Motor vehicle expenses ($6 000 × 1

2 ) 3 000

Depreciation:Office machinery 4 000

Motor vans ($8 000 × 1

2 ) 4 000 95 882

223 256Add: factory profit 79 644Add: reduction in provision for unrealised profit

1

6 $(27 000 − 24 000) 500 80 144


Practice exercises1 a Television manufacturing company

Manufacturing account for the year ended 30 April 2016

$ $Opening inventory of raw materials 42 000Add: purchases 390 000Add: carriage inwards 26 000 416 000

458 000Less: closing inventory (36 000)Cost of raw materials consumed 422 000Add: direct wages 280 000Add: royalty (direct expenses) 40 000Prime cost 742 000Factory overheadsIndirect wages and labour $(12 000 + 8 000) 20 000Depreciation:Premises (50% × $12 500) 6 250Motor vehicles (90% × $8 000) 7 200Plant and machinery (80% × $14 000) 11 200 44 650

786 650Opening inventory of work in progress 50 000Closing inventory of work in progress (46 000) 4 000Factory cost of finished goods 790 650Add: factory profit (20% × $790 650) 158 130Transferred to income statement 948 780


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b Television manufacturing companyIncome statement for the year ended 30 April 2016

$ $Sales 1 240 000Opening inventory of finished goods 48 000Add: transfer from manufacturing account 948 780

996 780Less: closing inventory (62 400) 934 380Gross profit 305 620Expenses:Selling expenses 42 000Administrative expenses 62 000Depreciation:Premises 6 250Motor vehicles 800Plant and machinery 2 800 113 850Net profit on trading 191 770Add: factory profit 158 130Adjustment for unrealised profit (2 400) 155 730Profit for the year 347 500

Workings:

Provision for unrealised profit account$ $

Closing balance c/d (62 400 ÷ 120 × 20)

10 400 Opening balance b/d (48 000 ÷ 120 × 20)

8 000

Income statement 2 400

10 400 10 400

c Inventory must always be shown at the lower of cost and net realisable value, in line with IAS 2. As a result, the closing inventory of finished goods must be shown in the statement of financial position at cost, not the transfer price. The calculation for this is:

$Inventory at transfer price 62 400Less: provision for unreralised profit 10 400

52 000

d Adding an element of factory profit to the cost of goods manufactured is purely an internal adjustment. It does not mean that the company will make any more overall profit for the year. It is a way of measuring the performance of the factory. For example, the transfer price with the profit added can be compared to the cost of buying in the product ready-made. This comparison will measure the efficiency of the company’s production department with that of competitors. It may also allow management to focus on areas of the production process where cost savings can be made, or costs are currently not being tightly controlled.


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Managers in the manufacturing department can also be motivated by being rewarded with payment of a bonus based on the factory profit. However, this must be done carefully to ensure that factory output is still ideal for the company overall. If, for example, the factory reduced quality to maximise factory profit, that would create other difficulties for the business.

Further, the amount of the factory profit is an arbitrary management decision; if it set at 10% it will appear as if the sales team has made a greater contribution than if it is set at 25%, for example. Thus, adding factory profit may cause friction between the factory manager and the sales manager, who may believe that the factory manager is taking some of his/her profit. Provided the significance and use of factory profit is fair and is explained, then it shouldn’t cause an issue. The calculation is not a difficult one to make or to adjust based on experience or changes in circumstances. Overall, therefore, the company is probably wise to retain an addition for factory profit to its factory cost of production.

2 a YendorManufacturing account for the year ended 31 March 2016

$ $Opening inventory of raw materials 450 000Add: purchases 2 250 000Add: carriage inwards 162 000 2 412 000

2 862 000Less: closing inventory (440 000)Cost of raw materials consumed 2 422 000Add: direct wages 900 000Prime cost 3 322 000Factory overheadsIndirect wages 90 000Indirect materials 45 000Other factory overheads 245 000Depreciation:

Premises (4% × $1m × 34 ) 30 000

Plant and machinery (30% × $250 000) 75 000 485 0003 807 000

Opening inventory of work in progress 375 000Closing inventory of work in progress (562 000) (187 000)Factory cost of finished goods 3 620 000Add: factory profit (20% × $3 620 000) 724 000Transferred to income statement 4 344 000


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115

b YendorIncome statement for the year ended 31 March 2016

$ $Sales 6 075 000Opening inventory of finished goods 390 000Add: transfer from manufacturing account 4 344 000

4 734 000Less: closing inventory (594 000) 4 140 000Gross profit 1 935 000Expenses:Office salaries 391 000Other administrative expenses 675 000Depreciation:Premises 10 000Office equipment 30 000 1 106 000Net profit on trading 829 000Add: factory profit 724 000Adjustment for unrealised profit (34 000) 690 000Profit for the year 1 519 000

c Provision for unrealised profit account

$ $Closing balance c/d (594 400 ÷ 120 × 20)

99 000 Opening balance b/d (39 000 ÷ 120 × 20)

65 000

Income statement 34 000

99 000 99 000

d Extract from statement of financial position at 31 March 2016$ $

Current assetsInventoryRaw materials 440 000Work in progress 562 000Finished goods at transfer price 594 000Less: provision for unrealised profit 99 000 495 000

1 497 000

e By producing a manufacturing account, Yendor is fully aware of his costs of manufacturing his product. This will allow him to control his costs and compare his transfer price with the cost of competitor’s products. If he doesn’t produce a manufacturing account then the costs of producing his product may get ‘lost’ in with the other costs of the business. Thus, he won’t be able to identify areas where savings can be made or wastage is occurring. Whilst the production of a manufacturing account requires additional work, and possibly additional costs in recording the data and employing staff to collect it, it is felt that the benefits to be gained are greater than the costs incurred. Thus, Yendor should continue to prepare the manufacturing account.


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2 C

3 B

4 C

Structured question1 Spinners & Co.

Manufacturing account for the year ended 31 December 2015

$ $Opening inventory of raw materials 8 000Add: purchases 140 000

148 000Less: closing inventory (10 000)Cost of raw materials consumed 138 000Add: direct wages $(40 000 + 600) 40 600Licence fees (direct expense) 16 000Prime cost 194 600Factory overheadsIndirect wages $(28 000 + 400) 28 400Heat and light $(5 000 − 180) 4 820General expenses $(14 000 + 300) 14 300Insurance $(6 000 − 400) 5 600Depreciation of plant and machinery 7 000 60 120

254 720Opening inventory of work in progress 12 000Closing inventory of work in progress (9 700) 2 300Factory cost of finished goods 257 020Add: factory profit (10% × $257 020) 25 702Transferred to income statement 282 722

Note:

It is very important to show the labels which are in bold. It is important that the label for the figure is also shown.


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21 Not-for-profit organisations (clubs and societies)

ActivitiesActivity 1a

Golf clubSubscriptions account

Year 3 $ Year 3 $Balance b/d (4 × $450) 1 800 Balance b/d (3 × $450) 1 350Income and expenditure account (200 × $450)

90 000 Bank – receipts for year 88 650

Balance c/d (1 × $450) 450 Balance c/d 2 25092 250 92 250

Year 4Balance b/d 2 250 Balance b/d 450

b On the assumption that all of the year 2 debtors have now paid, the balance brought down represents five members who owe their subscriptions for year 3, net of the one member’s paid in advance.

Activity 2

Entry fees account2016 2016

$ $Income and expenditure account (5 × $100)

500 Balance b/d 1 200

Balance c/d (Working) 1 700 Bank – receipts for year 1 0002 200 2 200

2017Balance b/d 1 700

Working:

Original three members at $300 remaining + two new members with $400 remaining.

Activity 3 a Drama club

Subscriptions account2016 2016

$ $Jan 1 Balance – Subscriptions owing b/d 280 Dec 31 Bank 2 640Dec 31 Income and expenditure account 2 400

Balance – subscriptions prepaid c/d 360 Balance – subscriptions owing c/d 4003 040 3 040

2017 2017Jan 1 Balance b/d 400 Jan 1 Balance b/d 360


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b Drama club Income and expenditure account for the year ended 31 December 2016

$ $IncomeSubscriptions 2 400Sales of tickets 20 000Sales of programmes 3 000Sales of refreshments 3 500Less: cost of refreshments 2 200 1 300

26 700Less: expenditureHire of costumes 4 700Hire of hall 2 600Copyright fees 1 400Printing 180 8 880Surplus of income over expenditure 17 820Donation to Actors Benevolent Fund (50%) 8 910Balance carried to accumulated fund 8 910

17 820

c Drama clubStatement of financial position extract at 31 December 2016

$Current assets Subscriptions owing 400Current liabilities Subscriptions in advance 360

Activity 4a Hutt River Dining Club

Statement of affairs at 1 January 2016

$ $Catering equipment 8 000Inventory of food 200Inventory of books 1 100Subscriptions owing 180Bank 1 520

11 000Less:Trade payables for supplies of food 40Subscriptions in advance 60 100Accumulated fund at 1 January 2016 10 900


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b Hutt River Dining ClubReceipts and payments account for the year ended 31 December 2016

2016 2016$ $

Jan 1 Balance b/f 1 520 Dec 31 Staff wages 39 000Dec 31 Subscriptions 5 000 Purchase of food 24 980 Restaurant takings 73 760 Purchase of books 4 840 Sales of books 12 150 Catering equipment 3 750 Heating and lighting 8 390 Other operating expenses 2 270 Balance c/d 9 200 92 430 92 4302017 Jan 1 Balance b/d 9 200

c Hutt River Dining ClubSubscriptions account

2016 2016$ $

Jan 1 Balance b/f 180 Jan 1 Balance b/f 60Dec 31 Income and

expenditure account

4 780 Dec 31 Bank 5 000

Balance c/d 140 Dec 31 Balance c/d 405 100 5 100

2017 2017Jan 1 Balance b/d 40 Jan 1 Balance b/d 140

d Hutt River Dining ClubBook trading account for the year ended 31 December 2016

$ $Sales 12 150Less: cost of salesInventory at 1 January 2016 1 100Purchases $(4 840 + 200) 5 040

6 140Inventory at 31 December 2016 (965) 5 175Profit transferred to income and expenditure account 6 975


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e Hutt River Dining ClubRestaurant account for the year ended 31 December 2016

$ $Takings 73 760Less:Cost of foodInventory at 1 January 2016 200Purchases (24 980 + 360 − 40) 25 300

25 500Inventory at 31 December 2016 (270) 25 230Gross profit 48 530Staff wages 39 000Depreciation of catering equipment 10% × $(11 000 + 3 750) 1 475 40 475Profit transferred to income and expenditure account 8 055

f Hutt River Dining Club Income and expenditure account for the year ended 31 December 2016

$ $Income Subscriptions 4 780Profit on sales of books 6 975Profit on restaurant 8 055

19 810ExpenditureHeating and lighting 8 390Other operating expenses 2 270 10 660Surplus of income over expenditure 9 150

g Hutt River Dining ClubStatement of financial position at 31 December 2016

$ $Non-current assetsCatering equipment $(11 000 + 3 750) 14 750Less: depreciation $(3 000 + 1 475) 4 475 10 275Current assetsInventory:Books 965Food 270

1 235Subscriptions owing 40Bank 9 200



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$ $Financed by:Accumulated fund at 1 January 2016 10 900Surplus of income over expenditure 9 150Accumulated fund at 31 December 2016 20 050Current liabilitiesTrade payables:Food 360Books 200Subscriptions in advance 140

700Total accumulated fund and liabilities 20 750

Practice exercises 1 a Not-for-profit organisation Trading business

Surplus of income over expenditure Profit for the yearAccumulated fund Owner's capital

b The International Athletics Club Subscription account for the year ended 31 May 2016

2015 2015$ $

Jun 1 Balance b/f 3302016 2016May 31 Income and

expenditure account7 935 May 31 Bank 7 970

Subscriptions written off 20

Balance c/d 275

8 265 8 265Jun 1 Balance b/d 275

c The International Athletics ClubRefreshments trading account for the year ended 31 May 2016

$ $Takings 4 112Opening inventory 150Purchases (2 654 − 15 + 40) 2 679

2 829Less: closing inventory (180) 2 649

Gross profit 1 463Wages (900)Profit on refreshments 563


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d The International Athletics ClubIncome and expenditure account for the year ended 31 May 2016

$ $IncomeSubscriptions 7 935Profit on refreshments 563Dance tickets 1 897Donation 90Profit in disposal of old equipment (94 − 70) 24

10 509Less: expenditureWages (4 000 − 900) 3 100Rent 540Travelling expenses 995Subscriptions written off 20Depreciation of equipment (4 700 + 1 778 − 70 − 6 000)

408

5 063

Surplus for the year 5 446

Notes:

1 In the refreshments trading account it is perfectly acceptable to call the final figure a profit.

2 However, with the income and expenditure account the final figure must always be referred to as a surplus (or deficit if expenditure is greater than income).

3 The exercise does not give any treatment for donations. As it is a small amount there is no reason why it should not be treated as income in the year it is received.

e If a life membership scheme is introduced, the club will receive potentially large sums from those members who can afford it and choose to take out a life membership. This might be a way to raise funds for some capital outlay, such as for the purchase of a new clubhouse. However, the club will never receive any further subscriptions from these life members, so that in future years, subscriptions income may not cover costs. (This would eventually be an issue even if there had been no initial outlay of the life subscriptions; these funds will eventually be used up, so that the club would need new members to keep going.)

There is also a difficulty in determining a fair price for life membership: if it is too low, funds will run out quickly and those members still paying annually will feel unfairly treated; if it is too high, there will be very few takers.

So unless there is an urgent need for funds that can be raised in no other way, the club should not consider introducing a life membership.


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2 a The Cooking ClubSubscription account for the year ended 30 September 2016

2015 2015$ $

Oct 1 Balance b/d ($40 × 15) 600 Oct 1 Balance b/d ($40 × 12) 480

2016 2016Sep 30 Income and

expenditure account (150 × $40)

6 000 Sep 30 Bank 6 435

Balance c/d 315

6 915 6 915

Oct 1 Balance b/d 315

b The Cooking ClubClub shop trading account for the year ended 30 September 2016

$ $Takings (7 168 + 20) [1] 7 188Opening inventory 500Purchases (3 745 − 1 450 + 1 260) 3 555

4 055Less: closing inventory (850) 3 205Gross profit 3 983Wages (4 000)Loss on shop (17)

c The shop has not performed well. Despite making a good gross profit of $3 983 (55%), the wages are too high and this has resulted in an overall loss for the shop. Action needs to be taken to reduce the wages in order to ensure an overall net profit for the shop.

d The Cooking ClubIncome and expenditure account for the year ended 30 September 2016

$ $IncomeSubscriptions 6 000Donations 600Cash taken at door 3 500Deposit account interest 800Grant from council (6 000 + 4 000) 10 000

20 900Less: expenditureLoss on club shop 17General expenses (1500 + 65) 1 565Rent 8 000Income from annual dance 1 400Less: costs (1 490) 90Depreciation of equipment (2000 × 20%) 400

10 072

Surplus for the year 10 828

[1] The cash float for the shop has increased by $20 over the year. This has been treated as unrecorded sales made in the shop and has increased the total takings for the year. 123

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e The accumulated fund for a club represents the total of accumulated surpluses less any deficits for the period the club has been operating. It belongs to the members of the club. However, it will not be paid out to them. This is different from the capital of a sole trader. The full amount belongs to the sole trader and he/she can withdraw any of it or add to it at any time.


2 B

3 C

Structured questions1 a The Retired Actors Club

Calculation of accumulated fund at 1 July 2015

$Shop inventories 1 600Trade payables (400)Subscriptions owing ($30 × 20) 600Bank balance 16 800Equipment (fully depreciated) [1] –Deposit account 10 000Accumulated fund at 1 July 2015 28 600

b The Retired Actors ClubClub shop trading account for the year ended 30 June 2016

$ $Takings 12 348Opening inventory 1 600Purchases (8 220 + 210 − 400) 8 030

9 630Less: closing inventory (1 850) 7 780Gross profit 4 568Wages (6 000)Loss on shop (1 432)

c The Retired Actors ClubSubscription account for the year ended 30 June 2016

2015 2016$ $

Jul 1 Balance b/d ($30 × 20) 600 Jun 30 Bank 10 730

2016Jun 30 Income and expenditure

account (200 × $40)

8 000

Balance c/d 2 280 Balance c/d (5 × $30) 15010 880 10 880

Jul 1 Balance b/d 150 Jul 1 Balance b/d 2 280

[1] Note 4 in the question indicates that the equipment had been depreciated at $1 400 per annum for 5 years = $7 000. This means that at 1 July 2015 it had been fully depreciated and therefore shown at no value when calculating the opening accumulated fund.124

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d The Retired Actors ClubIncome and expenditure account for the year ended 30 June 2016

$ $IncomeSubscriptions 8 000Cash taken at door 9 456Annual dance receipts 3 720Less: cost of dance (2 600) 1 120Deposit account interest

(10 000 × 4% × 1

2

+ 30 000 × 4% ×

1

2

)

800

Grant from council (4 000 + 4 000) 8 00027 376

Less: expenditureLoss on club shop 1 432Secretary’s expenses 2 125Depreciation of equipment (5 000 × 20%) 1 000

4 557Surplus for the year 22 819

e The Retired Actors ClubStatement of financial position at 30 June 2016

$ $Non-current assetsEquipment at cost (7 000 + 5 000) 12 000Less: depreciation (7 000 + 1 000) (8 000)

4 000Current assetsInventory 1 850Subscriptions owing 150Deposit account interest due 800Council grant due 4 000Deposit account 30 000Bank balance 13 775

50 575Total assets 54 575Financed by:Opening accumulated fund at 1 July 2015 28 600Add: surplus for the year 22 819

51 419Memorial fund 666Closing accumulated fund at 30 June 2016 52 085Current liabilitiesTrade payables 210Subscriptions in advance 2 280

2 490Total accumulated fund and liabilities 56 575


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Notes: 1 The number of members and the annual subscription they should pay is provided. This

means that the transfer to the income and expenditure account is the product of those two figures.

2 The loss on the club shop should always be shown under expenditure rather than as negative income.

3 Note that the receipts from the annual dance are netted off against the costs of the dance to show a surplus for the year. In this type of exercise this should always be done.

2 a Sailing clubSnack bar trading account for the year ended 31 March 2016

$ $Takings 77 000Opening inventory 1 250Purchases (53 000 + 970 − 1 030) 52 940

54 190Less: closing inventory (1 600) 52 590Gross profit 24 410Wages (14 000 + 400) (14 400)Profit on refreshments 10 010

Sailing clubIncome and expenditure account for the year ended 31 March 2016

$ $IncomeSubscriptions for the year (Working 2) 187 600Profit in refreshments 10 010Hire of yachts and boats (43 000 + 34 000) 77 000Training school income 34 500Less: wages (16 500 + 700) (17 200) 17 300Yacht racing 28 900Less: expenses (13 000) 15 900

307 810ExpenditureRepairs and maintenance (23 400 + 1 350) 24 750Other operating expenses 26 000DepreciationFreehold premises 17 500Yacht maintenance shop 4 200Boatyard and launch 3 700Fixtures and fittings 2 800Boats and yachts 26 300

105 250Surplus for the year 202 560

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b Sailing clubStatement of financial position at 31 March 2016

$ $Non-current assetsFreehold premises (350 0000 − 17 500) 332 500Yard and maintenance shop (42 000 − 4 200) 37 800Boatyard and launch (74 000 − 3700) 70 300Fixtures and fittings (28 000 − 2800) 25 200Boats and yachts (465 000 + 61 000 − 26 300) 499 700

965 500Current assetsInventory 1 600Subscriptions owing 2 000Bank balance (opening balance plus all receipts less all payments given in question)

290 500

294 100Total assets 1 259 600Financed by:Opening accumulated fund at 1 April 2015 1 050 220Add: surplus for the year 202 560Closing accumulated fund at 31 March 2016 1 252 780Current liabilitiesTrade payables (700 + 400 + 1350 + 970) 3 420Subscriptions in advance 3 400

6 820Total accumulated fund and liabilities 1 259 600

Workings:1 Calculation of opening accumulated fund at 1 April 2015:

$Non-current assets (350 + 42 + 74 + 28 + 465) 959 000Subscriptions in arrears 3 000Subscriptions in advance (6 000)Bank balance 94 000Inventory of refreshments 1 250Trade payables for refreshments (1 030)Accumulated fund at 1 April 2015 1 050 220

2 Subscription account:

Subscription account for the year ended 30 June 20162015 2015

$ $Apr 1 Balance b/d 3 000 Apr 1 Balance b/d 6 000

2016 2016Mar 31 Income and expenditure account 187 600 Mar 31 Bank 186 000

Balance c/d 3 400 Balance c/d 2 000194 000 194 000


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22 Published company accountsActivitiesActivity 1

ABC Stationery Company:

20 boxes × $3 per box = $60 (Lower of cost $100 and net realisable value $60).

Activity 2

Weaver Limited$

Direct materials 8 840Direct labour 6 630Factory overheads 4 420Total costs 19 890

Completed units:

2000 completed and sold + 200 completed units in inventory + (20 × 50% part completed units at the month end = 10 equivalent) = 2 210.

a Cost per unit = $19 890 / 2 210 = $9.

b Value of work in progress = 20 units × (50% × $9) = $90.

Value of finished goods = 200 × $9 = $1 800.

Activity 3

Approval LimitedNon-current assets schedule

Freehold land and buildings

Plant and machinery

Motor vehicles

Total [1]

$000 $000 $000 $000CostAt start of year 1 000 600 870 2 470Additions 320 32 352Revaluation of land 400 400Disposals (60) (24) (84)At end of year 1 400 860 878 3 138DepreciationAt start of year 40 250 660 950Disposals – (50) [2] (22) (72)Charge for the year 4 [3] 172 [4] 60 [5] 236At end of year 44 372 698 1 114Net book value at start of year [6] 960 350 210 1 520Net book value at end of year [6] 1 356 488 180 2 024

[1] 1 A total column has been included. This is normal practice as it provides the link to the figures that will appear in the statement of financial position. However, it may be that a total column is not required. In which case don't waste time preparing one.

[2] The cost of the old plant sold was $60 000. It had been sold for $6 000, which had resulted in a loss of $4 000. The net book value must therefore have been $10 000 ($10 000 − $6 000 = $4 000) so that accumulated depreciation on the plant sold must have been $(60 000 − [6000 + 4000]) = $50 000.

[3] The cost of land and buildings at the start of the year was $1 000 000. We are told that the land cost $800 000, so the buildings cost was $200 000. The depreciation of 2% is only calculated on this figure.

[4] Plant and machinery is calculated at 20% on the cost at the end of the year = 20% × $860 000, in other words after adjusting for additions and disposals. [5] The depreciation charge on motor vehicles is calculated

at 25% on the net book value at the end of the year before charging the depreciation. The net book value at the end of the year before depreciation was:

$878 000 − (660 000 − 22 000) = $240 000. The charge for the year was therefore 25% of this figure.

[6] The opening and closing net book values must always be included in the schedule. No dates were given so it is perfectly acceptable to identify them as the start and end of year figures. If dates are given then they must be used.

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129

129

Activity 4The calculation of earnings per share is to use the profit for the year after any preference dividend on non-redeemable preference shares. In other words, the profit for the year attributable to the ordinary shareholders.

Thus the profit for the year of $1 000 000 must be reduced by the 10% dividend on the 400 000 non-redeemable preference shares = $1 000 000 − (400 000 × 10%) = $960 000.

The earnings per share in this case are therefore:

$960 000 = $0.48 per share.2 000 000

Practice exercises1 a A true and fair view means that the financial statements are free from any material

misstatement and error and faithfully represent the financial performance of the business for the period under review.

b X LimitedRevised statement of financial position at 31 December 2015

$000Non-current assetsTangible assets (1 810 − 50 − 1) 1 759Current assetsInventory (105 − 2) 103Trade receivables (96 − 6) 90

193Total assets 1 952Equity and liabilitiesShare capital and reservesShare capital 1 000General reserve 130Retained earnings (342 − 1 − 2 − 6 + 10) 343Total equity 1 473Non-current liabilityDebentures 2 022/24 360Current liabilitiesTrade payables 50Other payables 18Bank overdraft 51


c Non-current assets:

The revaluation of the land ($50 000) has been taken out. The valuer was not qualified to make the valuation so there must be at least some doubt as to whether this is a reliable estimate. In principle, IAS 16, Property, Plant and Equipment permits a company to include its land at a revalued amount, but the auditor must be satisfied that there is sufficient evidence for the value adopted.


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130

IAS 16, Property, Plant and Equipment requires that assets with a finite useful life, such as buildings, are depreciated over their estimated useful life. In order to illustrate the point, a useful life of 40 years has been assumed, requiring a depreciation charge of $1 000.

Goodwill: The goodwill has not been purchased (which occurs when a business is acquired). IAS 38,

Intangible Assets does not permit the recognition of internally generated goodwill, so this must be eliminated (even if the amount concerned is considered to be a good estimate).

Inventory: The inventory must be valued at the lower of cost and net realisable value. Therefore the

$6 000 damaged inventory must be included at the realisable value of $4 000, with the $2 000 written off from retained earnings.

Trade receivables: A provision for $6 000 has been made against the receivable as there is some evidence

(three missing payments) that the asset may be impaired. Whether this is the correct extent of impairment, or indeed, whether any impairment is necessary, cannot be properly determined from the information given, but an adjustment has been proposed for the amount of the missed payments.

The directors and the auditors will each review the available evidence and form their opinion of what the most appropriate level of impairment is (see also part e, below).

Revaluation reserve: This has been completely eliminated with the removal of the revaluation of the land and

goodwill.

Retained earnings: These have been reduced by the depreciation, the loss in value of inventory and the

provision for the doubtful debt. However, the proposed dividend should not be included under IAS 1 (IAS 10 makes clear that a proposed dividend is a non-adjusting event), so has been added back and eliminated from the current liabilities.

d Proposed dividend: The directors propose that a final dividend of XXc per share, amounting to $10 000 in total

is paid to the ordinary shareholders, subject to shareholder approval at the AGM, on [date].

Contingent liability: The company is being sued by a customer that alleges that it has been sold faulty goods

and seeks $8 000 in compensation. The directors have not made any provision for this or any other amount as, based on the advice of the company’s solicitors, they believe that the company is more likely than not to win the case.

Note: Published financial statements contain many notes but these are the two items amongst those dealt with in the question that appear only as notes. Had there been any dividends paid during the year, the dividend note to the financial statements would have followed the format on page 273 in the coursebook.

e The auditors must consider the materiality of the proposed adjustments in deciding what action to take; if material adjustments are necessary to ensure that a true and fair view is given but are not made, then a qualified audit report is required.

In the case of X Ltd, of the actual errors, the goodwill ($250 000) is clearly material, but it could be argued that the depreciation ($1 000), the inventory ($2 000) and the dividend ($10 000) are immaterial.

The other two matters are a little less clear cut because amounts have been estimated. The auditor is unable to confirm the reliability of the revaluation ($50 000) so should qualify for this matter too, if the amount is considered material.

Similarly, there can be no definitive estimate of the necessary provision to be made against the trade receivable, so the auditor must conclude that there is no material uncertainty


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131

or disagreement (between their own opinion and that of the directors) over the carrying amount, or otherwise treat this as another error. It is quite possible that in this instance their difference of opinion may not be material.

Even with these adjustments being made, the accounts show a strong company with good profitability. The directors are better advised to explain the company’s real circumstances to the bank than try to mislead the bank. The bank overdraft may be simply down to a timing issue. No doubt when the directors approach the bank for a loan, a cash budget will also be presented to show how this can be eliminated or managed.

2 a Y LimitedNon-current assets schedule

Freehold land

Freehold buildings

Office equipment

Motor vehicles

Total

$000 $000 $000 $000 $000CostAt 1 April 2015 250 400 300 360 1 310Additions 32 32Revaluation of land 200 200Disposals (20) (24) (44)At 31 March 2016 450 400 280 368 1 498DepreciationAt 1 April 2015 10 50 150 200 410Revaluation (10) (10)Disposals (15) (15)Impairment 5 5Charge for the year – 16 28 92 136At 31 March 2016 – 66 168 292 526

Net book value at 1 April 2015 240 350 150 160 900Net book value at 31 March 2016 450 334 112 76 972

Note: Office equipment depreciation is to be charged at 20% of net book value (NBV) as it would

be immediately before that charge is calculated. Cost of office equipment at the year end is $300 000 − $20 000 = $280 000. Accumulated depreciation before this last adjustment is $150 000 − $15 000 + $5 000. = $140 000, meaning that the NBV to be depreciated is $280 000 – $140 000.= $140 000. At 20% (per the question) depreciation is $28 000.

b Y LimitedStatement of changes in equity for the year ended 31 March 2016

Details

Share capital

Sharepremium

Generalreserve

Retainedearnings

Revaluation reserve

$000 $000 $000 $000 $000At 31 March 2015 675 425 – 215 –Profit for year 169Dividends paid – final (60)Dividends paid – interim (35)Bonus share issue 225 (225) (25)Revaluation of land 210Balance at 31 March 2016 900 200 – 405 210


132


Notes: 1 The balance on the revaluation reserve is $200 000 added to the cost, plus $10 000

added back for previously charged depreciation.

2 The draft profit for the year was $175 000. This was after charging the three items, which totalled $(60 000 + 35 000 + 40 000) = $135 000.

However, the proposed dividend should not have been deducted and the other two dividends are presented in the statement of changes in equity (not as deductions in arriving at profit for the year) so they all need to be added back. Thus the draft profit for the year should be $(175 000 + 135 000) = $310 000. In addition we are told that the draft profit is ‘before depreciation’, so we must charge $136 000 depreciation as calculated in part a of the question and adjust also for the $5 000 impairment of inventory to lower of cost and net realisable value (additional information item 3). Thus profit for the year is $(175 000 + 135 000 − 136 000 − 5000) = $169 000.

As the share capital at 31 March 2016 was $900 000, which included a 1 for 3 issue of bonus shares, then the share capital at the start of the year must have been $900 000 / 4 × 3 = $675 000. The bonus issue therefore amounted to $225 000. As $200 000 remains in the share premium account, and as this an inflexible reserve, it can be assumed that the entire bonus issue was capitalised from the share premium account.

We were told to not prepare a total column; if the question is silent on the matter you are recommended to include one as this is the IAS format. The general reserve column has been left in as a reminder of another possible column but you should not introduce redundant columns if they are not necessary.

c The directors of Y Limited are responsible for the preparation of the financial statements and ensuring that adequate and comprehensive accounting records are kept. It is also their duty to ensure that the financial statements are free from any material misstatement and error.

The auditors, on the other hand, are employed by the shareholders to report to them on whether the financial statements prepared by the directors give a true and fair view.

d The responsibility for the preparation of the financial statements lies firmly with the directors; this is specified in law. Thus, they must undertake this work or employ someone to do it for them.

The role of the auditor has been described above (in part c). It is not the responsibility of the auditor to prepare the financial statements of the business. If they were to do so, then this work is undertaken in the role of accountants, not auditors. Ethical standards permit the auditors of a private company to assist the directors in this way, but this assistance is not permitted if the company is quoted.


2 C

3 B

4 A

5 A

6 A

7 D

8 B

9 D

10 D

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Additional questions11 The ordinary shareholder is a financial supporter of the company as they invest money into

the business, if asked to do so, through rights issues and/or at the time the company is first formed. They are, therefore, also the owners of the company. As a result, they are entitled to attend and vote at the annual general meeting (AGM). They can vote to elect or re-elect directors and on major decisions when asked to do so. The preference shareholder isn't an owner of the company, but lends the company money through the purchase of preference shares. Often these shares can be redeemed by the company. They also do not have the right to attend the AGM.

On the other hand, the directors are those responsible for the day-to-day running and management of the company. This is usually because the shareholders lack the expertise to do this. However, in some cases, directors may also be shareholders. In this case, they have dual responsibilities - one as the owner and one as a manager.

12 An internal auditor is an employee of the company, responsible to the directors of the company for the performance of their day-to-day duties. Their work will involve looking at the financial systems in place in the company, ensuring the proper day-to-day management of the company finances. They may also take some involvement in the preparation of the financial statements of the company on behalf of the directors.

External auditors are not employees of the company and the process of auditing is separate from the preparation of the financial statements. They are appointed by the shareholders to act on their behalf. Their role is to consider whether the financial statements prepared by the directors and presented to the ordinary shareholders are free from any material misstatement or error and to report their findings.


23 Statements of cash flowsActivitiesActivity 1

Everyday LimitedStatement to show cash flow from operating activities for the year

$Profit from operations 175 000Depreciation charge for the year 42 100Profit on disposal of non-current assets (2 300)Decrease in inventories 5 800Increase in trade receivables (2 600)Increase in trade payables 3 400Tax paid (27 500)Net cash from operating activities 193 900

Activity 2

Exchange LimitedStatement of cash flows for the year ended 31 December 2016

$ $Cash flow from operating activities:Profit from operations (before tax and interest) 94Adjustments for:Depreciation charge for the year 50Profit less losses on sale on non-current assets (10)Decrease in inventories (100 − 85) 15Increase in trade receivables (40 − 52) (12)Increase in trade payables (60 − 73) 13 56Cash (used in)/from operations 150Interest paid (during the year) (7)Tax paid (during the year) from workings (36)Net cash (used in)/from operating activities 107Cash flows from investing activities:Purchase of non-current assets (90 + 70) (160)Proceeds from the sale of non-current assets (50 + 4 + 1) 55Net cash (used in)/from investing activities (105)Cash flows from financing activities:Proceeds from issue of share capital 55Repayment of debentures (30)Dividends paid (46)Net cash (used in)/from financing activities (21)Net increase/(decrease) in cash and cash equivalents (19)Cash and cash equivalents at the beginning of the year 55Cash and cash equivalents at the end of the year 36


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135

Workings:

Freehold buildings at cost Freehold building disposal$ $

At 31 December 2015 400 Cost (36)Disposal (36) Proceeds 50At 31 December 2015 364 Profit on disposal 14

Taxation$ $

Tax paid 36 At 31 December 2015 39 At 31 December 2016 43 From income statement 40

79 79

TaxationPlant and

machinery at cost Plant and machinery

depreciation Plant and machinery

disposal

$ $ $At 31 December 2015 80 At 31 December 2015 35 Cost 20Disposals (20) On disposals (16) Depreciation (16)Additions (balancing figure)

90 Provided in year (balancing figure)

20 Proceeds (1)

At 31 December 2016 150 At 31 December 2016 39 Loss on disposal 3

Motor vehicles at cost

Motor vehicles depreciation

Disposal

$ $ $At 31 December 2015 120 At 31 December 2015 90 Cost 30Disposals (30) On disposals (30 − 5) (25) Depreciation (25)Additions (balancing figure)

70 Provided in year (balancing figure)

30 Proceeds (4)

At 31 December 2016 160 At 31 December 2016 95 Loss on disposal 1

Activity 3

Indus LimitedStatement of financial position at 31 July 2016


Net book value

$ $ $AssetsNon-current assetsFreehold premises 300 142 158Plant & machinery(Cost: 125 + 48 − 30 Acc Dep: 75 − 18 + 60)

143

117

26

443 259 184

(cont.)


136

136


Net book value

$ $ $Current assetsInventory (36 + 4) 40Trade receivables (79 + 19) 98Cash and cash equivalents 112

250Total assets 434Equity and liabilitiesCapital and reservesShare capital (150 + 20) 170Share premium (20 + 20) 40General reserve (40 + 30) 70Retained earnings 50

330Non-current liability10% debentures 2023/24 (50 − 20) 30Current liabilitiesTrade payables (43 + 6) 49Tax 25

74Total equity and liabilities 434

Workings:

Calculation of the figure for retained earnings:

$Retained earnings at 1 August 2015 56Profit for the year 39

95Transfer to reserves (30)Dividends paid (15)Retained earnings at 31 July 2016 50

Activity 4

JanineReconciliation of profit from operations to net cash flow from

operating activities for the year ended 31 October 2016$

Profit for the year before interest 21Adjustments for:Depreciation charge for the year 5Profit on sale of non-current assets (1)Increase in inventories (5)Decrease in trade receivables 3


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137

$000Decrease in trade payables (8)Cash (used in)/from operations 15Interest paid (during the year) (1)Net cash (used in)/from operating activities 14

Workings:

The profit for the year before interest is:

$000Profit for the year from the income statement extract 25Less: depreciation (5)Add: profit on disposal 1Profit for the year before interest 21

Note: The profit on the revaluation of land is not included as this increases the value of the land and is included in Janine’s capital on the statement of financial position. Also, of course, this is a book entry and does not give rise to any cash flow, so we do not expect it to appear in the statement of cash flows.

The calculation of loss on the sale of the plant and machinery and the purchase of new machinery is as follows:

Plant and machinery at cost account

$ $Opening balance 39 Closing balance 55Bank – purchases(balancing figure) 22 Asset disposal 6

61 61

Plant and machinery accumulated depreciation account

$000 $000Asset disposal account (balancing figure) 1 Opening balance 21Closing balance 25 Charge for the year 5

26 26

Asset disposal account

$000 $000Cost of plant scrapped 6 Depreciation 1

Profit on disposal

1

Sale proceeds (balancing figure)

6

7 7

Note: In this case we have found/calculated that the items were sold for scrap. Our initial reaction might have been to assume that there were no proceeds from scrapping plant and machinery.


138


JanineStatement of cash flows for the year ended 31 October 2016

$000 $000Net cash (used in)/from operating activities 14Cash flows from investing activities:Purchase of non-current assets (plant) (22)Sale of non-current assets 6Net cash (used in)/from investing activities (16)Cash flows from financing activities:Capital introduced 10New loan 8Drawings (21)Net cash (used in)/from financing activities (3)Net increase/(decrease) in cash and cash equivalents (5)Cash and cash equivalents at the beginning of the year 3Cash and cash equivalents at the end of the year (2)

The possible reasons why Janine has an overdraft are:

• The purchases of non-current assets ($22 000) have been financed from the loan ($8 000), capital introduced ($10 000) and the proceeds of the sale of non-current assets ($6 000), so this is not the issue.

• The high drawings figure ($21 000) is higher than the cash generated from operations, but is in broadly line with the profit for the year, so it is clear that Janine did not make the mistake of believing that the revaluation of the land is a cash profit rather than a book adjustment.

• Although Janine has reduced her trade receivables, she has increased her inventory and reduced her trade payables. The net effect of this has been to reduce the cash in the business.

Although all these factors combined to affect the overall cash flow, it seems that the latter two items, Janine’s drawings and her management of working capital (short term assets and liabilities), have been the causes of more cash leaving the business than coming in.

Practice exercises1 a A statement of cash flows is based on historical information and is required to be prepared

for a limited company in line with the format set out in IAS 7. It is published as part of the annual financial statements. It shows how cash has been generated by a business and how it has been applied.

A cash budget is an internal document prepared by the management of the company. It is an estimated projection or forecast used for planning and control (monitoring) purposes and may be presented to bankers and other lenders when the company is seeking additional finance.

b i Working:

Asset disposal account

$000 $000Cost of disposals (balancing figure) 34 Depreciation 20

Sale proceeds 10Loss 4

34 34

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139

DH plcNon-current assets at cost account

$000 $000Opening balance b/d 9 000 Closing balance c/d 10 000Purchases (balancing figure) 1 034 Asset disposal

(working above)34

10 034 10 034

Purchases made during the year = $1 034 000.

ii Working:

DH plcNon-current assets accumulated depreciation account

$000 $000Disposal 20 Opening balance b/d 1 500Closing balance c/d 1 800 Income statement

(balancing figure)320

1 820 1 820

Depreciation charge for the year = $320 000.

c DH plcNet cash from operating activities for the year

$000Profit from operations 1 998Depreciation charge for the year [1] 320Loss on sale of non-current assets 4Increase in inventories (85 − 70) (15)Decrease in trade receivables (250 – 270) 20Increase in trade payables (105 − 80) 25Dividends paid [2] (150)Tax paid (280 + 700 − 290) (690)Net cash from operating activities 1 512

d Cash refers to money in the bank or cash in hand and is affected by receipts and payments on the day that those transactions take place. However, profit is the difference between the income and expenditure of the business. When calculating income and expenditure, the accruals and prudence principles are applied. These have the effect of allocating income and expenditure to the most appropriate accounting period (or of apportioning income and expenditure over several accounting periods) which will therefore often not coincide with the date or accounting period of the related receipts and payments. Accordingly, the increase (or decrease) in cash in a period will not equal the profit (or loss) for a period except in the simplest of circumstances.

e DH plc has made a good profit for the year. However, the cash and cash equivalents has only increased by $10 000. The cash has been boosted by the issue of ordinary shares at a premium. However, all of this cash, and most of the cash generated from operating activities, has been spent on purchasing new non-current assets and the repayment of the loan.

[1] From above

[2] Under IAS 7, dividends paid can be shown either as part of the calculation of net cash from operating activities, or under cash flows from financing activities.


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140

2 a Two advantages of preparing a statement of cash flows are:

• It links the income statement and statement of financial position, showing the areas where the business has generated and spent its cash.

• It may indicate potential going concern problems.

• It may indicate whether the business is generating enough cash to fund its investment or dividends, and also therefore give an indication of whether these situations might be likely to change.

There are no real disadvantages to preparing a statement of cash flows except for the minor matter of the effort involved. Publishing a statement of cash flows voluntarily also gives away some information that might otherwise have remained private to the company.

Some disadvantages of a statement of cash flows are:

• It can be distorted by large receipts or payments made just before or just after the year end.

• (By definition) important transactions that have not involved cash flows, such as impairments and revaluations, are not included but might be necessary to an understanding and interpretation of the cash position.

• It only shows the inflow and outflow of cash but gives only a limited indication of why they have occurred (although it may just as reasonably be said that an income statement gives only a limited indication of why income and expenditure has occurred).

b Woodpecker LimitedStatement of cash flows for the year ended 31 December 2016

$000Cash flow from operating activities:Loss from operations (before tax and interest) (119)Adjustments for:Debenture interest paid 1Depreciation charge for the year 10% × (500 + 85 − 35) 55Loss on sale on non-current assets 3Cash (used in)/from operations (60)Increase in current assets ([72 − 6] − 68) (2)Decrease in current liabilities (54 − [36 − 3]) (21)Interest paid (during the year) (1)Net cash (used in)/from operating activities (84)Cash flows from investing activities:Purchase of non-current assets (85)Net cash (used in)/from investing activities (85)Cash flows from financing activities:Proceeds from issue of share capital 120Issue of debentures 40Net cash (used in)/from financing activities 160Net decrease in cash and cash equivalents (9)Cash and cash equivalents at 1 January 2016 6Cash and cash equivalents at 31 December 2016 (3)

c Woodpecker has made a significant loss for the year and so lost cash on its trading activities for the year ($60 000). It has also not managed its working capital very well as


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141

changes in both current assets and current liabilities have resulted in cash outflows for the business.

However, the issue of additional shares and a debenture have generated sufficient cash to cover the deficit on trading, the poor management of working capital and the purchase of additional non-current assets.

The final result has meant that the net effect of these cash movements has only had a small impact on the final bank balance. There is work for the directors to do in terms of better management of working capital and reversing their negative trading activities.

d If the directors issue additional shares to fund the company’s increased operations it will have both positive and negative effects. The positive effects are that the money does not have to be repaid. Neither do the directors have to pay dividends on the shares if profits are not sufficient. However, the issue of shares may give new shareholders significant influence if the shares are not issued to existing shareholders by a rights issue. New owners could have a serious impact on the future plans of the directors and may even replace them.

The issue of a further debenture will increase the gearing of the company. It will also create future strains on the cash flow as both interest and capital will have to be repaid. The lender may also require some security on the company's assets. The two positive aspects are that the debenture holder gets only a fixed return, and that issuing a debenture will not change the ownership of the business.

Overall, the company does not appear to be performing well. The directors could consider postponing the raising of more finance until such time as the future profitability of the business is assured. However, if they are set on raising additional finance (because the proposed expansion is the key to future profitability, for example) then they should proceed, and a rights issue of ordinary shares is the best option.


2 C

3 D

4 C

5 C

6 A

Structured question1 a Winston plc

Budgeted statement of financial position at 31 October 2017


Net book value

$000 $000 $000AssetsTangible non-current assetsFreehold premises 1 000 – 1 000Plant and machinery 1 380 (580) 800

2 380 (580) 1 800Current assetsInventory (191 − 76) 115

(cont.)


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142


Net book value

$000 $000 $000Trade receivables (82 + 15) 97Cash and cash equivalents 251

463Total assets 2 263Equity and liabilitiesShare capital and reservesShare capital (950 + 150) 1 100

Share premium (150 + 60) 210Revaluation reserve 240General reserve (100 + 80) 180Retained earnings 226

1 956Non-current liabilitiesDebentures 2021/2023 (300 − 100) 200Current liabilitiesTrade payables (73 − 26) 47Other payable: taxation (40 − 40 + 60) 60


Notes:

In most cases it is simply a question of adjusting the figure in the statement of financial position with the increase or decrease in the statement of cash flow. Where this has been done, the workings are shown in brackets. However, there are some items where it is easier to show the individual ‘T’ accounts:

Asset disposal

$000 $000Plant and machinery at cost 110 Bank 41Profit on disposal 20 Plant and machinery accumulated

depreciation89

130 130

1 As this account (and the others below) are workings, there is no need to bring down any balances.

2 The debit of $110 000 is from additional information note 1.

3 The profit on disposal ($20 000) is from the statement of cash flows under cash flow from operating activity.

4 The credit of $41 000 is also from the statement of cash flow under cash flow from investing activities.

5 This means that the figure to balance the account must be the depreciation written off from the machinery which was sold ($89 000).


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143

Plant and machinery at cost account

$000 $000Opening balance 1197 Disposal 110Additions 293 Balance c/d 1380

1490 1490

1 The credit of $110 000 is the double entry from the disposal account.

2 The debit of $293 000 is from the statement of cash flow under cash flow from investing activities.

3 The balance on the account must, therefore, be the closing balance to take to the statement of financial position.

Plant and machinery accumulated depreciation account

$000 $000Disposal account 89 Opening balance 469Balance c/d 580 Charge for year 200

669 669

1 The credit of $200 000 is from the statement of cash flow under cash from operating activities.

2 The debit of $89 000 is the double entry from the disposal account.

3 So the closing balance must be $580 000 which then is entered in the budgeted statement of financial position.

Revaluation account

$000 $000Balance c/d 240 Freehold premises at cost 150

Freehold premises depreciation 90240 240

1 The credit of $150 000 is the amount required to take the cost of the premises from its present book figure of $850 000 to the revalued amount of $1 000 000.

2 The credit of $90 000 is the depreciation already charged on the freehold premises in the past. This must also be written back as it no longer exists.

3 This means that the balance on the revaluation account is $240 000, which then is entered in the equity section of the statement of financial position.

Retained earnings account

$000 $000Dividends paid 30 Balance b/f 173Transfer to general reserve 80 Profit for the year after tax 163Balance c/d 226

336 336


144

144

1 The credit of $173 000 comes from the retained earnings figure in the statement of financial position at 31 October 2016.

2 The credit of $163 000 is from the additional information.

3 The debit of $30 000 comes from the statement of cash flow under cash flow from financing activities.

4 The debit of $80 000 is per note 2 from the additional information.

5 The closing balance is then taken to the budgeted statement of financial position.

b Having done a lot of the workings for part a, this will help in answering part b, which is to show the budgeted statement of changes in equity:

Note: Notice that the figure at the bottom right hand corner ($1 956 000) is the one which appears as the total equity in the answer to part a.

Winston plcBudgeted statement of changes in equity for the year ended 31 October 2017

Details Share capital

Sharepremium

Generalreserve

Retainedearnings

Revaluationreserve

Total

$000 $000 $000 $000 $000 $000At start of year 950 150 100 173 – 1 373Profit for year attributable to equity holders

163 163

Dividends paid – final (30) (30)Dividends paid – interim – –Share issue 150 60 210Revaluation of assets 240 240Transfer to reserves 80 (80) –Balance at year end 1 100 210 180 226 240 1 956


24 Business purchase and mergerActivitiesActivity 1a and b

Capital accountsNitin Maria Sam Nitin Maria Sam$000 $000 $000 $000 $000 $000

Goodwill 15 15 15 Opening balance b/d 120 120Balances c/d 151 128 95 Profit on revaluation 16 8

Goodwill 30 15Non-current assets 98Inventory 12

166 143 110 166 143 110Balances b/d 151 128 95

c Nitin, Maria and SamStatement of financial position at 1 June 2016 after the

admission of Sam to the partnership

$000AssetsNon-current assets (220 + 98 + 24) 342Current assets (80 + 12) 92Total assets 434Capital accountsNitin 151Maria 128Sam 95

374Current accountsNitin 16Maria (4)Sam –

12Current liabilities 48Total capital and liabilities 434

Activity 2a Hamil Limited

Journal

$ $Goodwill 29 000Freehold property 70 000Plant and machinery 12 000Office furniture 4 000Inventory 2 500Trade receivables 5 500

(cont.)


145

146

146


$ $Trade payables 3 000Cash and cash equivalents 20 000Ordinary share capital 80 000Share premium account 20 000

123 000 123 000

Purchase of Abdul’s business for $120 000 and settlement by $20 000 in cash and 80 000 ordinary shares of $1 in Hamil Ltd at $1.25.

b Hamil LimitedStatement of financial position at 30 June 2016 after the

acquisition of Abdul’s business

$AssetsNon-current assetsIntangibleGoodwill 29 000TangibleFreehold property (100 000 + 70 000) 170 000Plant and machinery (60 000 + 12 000) 72 000Office equipment 14 000Office furniture 4 000

289 000Current assetsInventory (10 000 + 2 500) 12 500Trade receivables (7 000 + 5 500) 12 500Cash and cash equivalents (25 000 − 20 000) 5 000

30 000Total assets 319 000Capital and liabilitiesEquity and reservesOrdinary shares (150 000 + 80 000) 230 000Share premium (20 000 + 20 000) 40 000Retained earnings 40 000

310 000Current liabilitiesTrade payables (6000 + 3000) 9 000Total equity and liabilities 319 000

Activity 3a $60 000 × 5

8 = $37 500

b $60 000 × 54

= $75 000

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147


Activity 4

Digger LimitedStatement of financial position at 31 December 2016 immediately

after the acquisition of Christofere and Sarah

$AssetsNon-current assetsLand and buildings (90 000 + 60 000) 150 000Fixtures and fittings (30 000 + 14 000) 44 000Office machinery (15 000 + 10 000) 25 000Goodwill (working) 25 000

244 000Current assetsInventory (20 000 + 15 000) 35 000Trade receivables (5 000 + 6 000) 11 000Cash and cash equivalents (60 000 − 28 000) 32 000

78 000

Total assets 322 000Capital and liabilitiesEquity and reservesOrdinary shares (200 000 + 60 000 [1]) 260 000Share premium 15 000 [2]Retained earnings 4 000

279 000Non-current liability

8% debenture (12 000 × 8

10 ) 15 000

Current liabilitiesTrade payables (16 000 + 12 000) 28 000Total equity and liabilities 322 000

$ $Shares issued:Purchase consideration 118 000Less: cash 28 000Debenture 15 000 43 000Value of shares 75 000

Share premium 60 000 × $0.25 = $15 000

[1] No of shares at $1.25 per share = 60 000

[2] Share premium 60 000 × $0.25 = $15 000

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148


Digger LimitedJournal – working for goodwill

$ $Goodwill (balancing figure) 25 000Land and buildings 60 000Fixtures and fittings 14 000Office machinery 10 000Inventory 15 000Trade receivables 6 000Trade payables 12 000Cash and cash equivalents 28 000Debenture for Christofere 15 000Ordinary share capital 60 000Share premium account 15 000

130 000 130 000

Practice exercises1 a Journal entry to record the acquisition of Eric and Tia in the books of Istaimy plc:

JournalName of account Debit Credit

$ $Freehold land and buildings at cost 878 000Freehold land and buildings accumulated depreciation 128 000Plant and machinery at cost 100 000Inventory 30 000Trade receivables (76 000 − [5 000 × 0.80]) 72 000Trade payables 29 00010% debenture $100 000 × 80 ÷ 100) 80 000Ordinary share capital 700 000Share premium 140 000Cash (balancing figure) 3 000

1 080 000 1 080 000

Notes:

1 The inventory has been valued on a line-by-line basis as identified by IAS 2, as this is the method that Istaimy will have to use.

2 It has been assumed that the cash and cash equivalents in the statement of financial position of the partners will be retained by them.

b The advantages to Eric and Tia of selling their business is that they no longer have to spend their time on or worry about managing it in the future. They have been issued with shares in Istaimy plc on which they can expect to receive dividends in the future. Their investment in Istaimy, being in a larger and possibly more diverse business than theirs, may be less risky. It may be practical to sell the shares piecemeal (unlike portions of a partnership!) and the shares may increase (or decrease) in value. Eric has also received a debenture paying an amount equal to that which he received from their old business. They may wish

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149

to retire, or take up employment, or they may be able to start a new business with the cash taken from their old one, although this was not a large sum.

There are though, several disadvantages to consider. It may be that they receive less in dividends on the shares in Istaimy plc than the profit their business previously earned. Indeed, they may not receive any dividends at all if Istaimy plc fails to make a profit. They will also have no involvement in the management of Istaimy plc.

The journal shows that the purchase price matched the agreed net asset values and that Istaimy made no payment for goodwill. This is unusual (to say the least) in the acquisition of a profitable business and indicates that they may have sold their business to Istaimy plc too cheaply.

Overall, however, if they were looking to retire and also have some sort of income in the future, then selling their business to Istaimy plc may have been the correct option if no higher offers were available.

2 a Joel LimitedStatement of financial position

immediately after the purchase of Kay and Ola's business

$000AssetsNon-current assetsIntangibleTangibleLand and buildings (1 425 + 220) 1 645Plant and machinery (803 + 170) 973

2 618Current assetsInventory (381 + 128) 509Trade receivables (519 + 105) 624Cash and cash equivalents (420 + 69) 489

1 622Total assets 4 261Capital and liabilitiesEquity and reservesOrdinary share capital (1 350 + 300) 1 650Share premium 150Retained earnings 1 248

3 048Non-current liabilities(Existing) 8% debenture 450(New) 10% loan (100 × 1.25) 125

575Current liabilitiesTrade payables (500 + 138) 638



150

150


Working:

1 We are told that Joel pays out the residual element of the partners’ capital accounts, but it seems that one partner owes the other:

Realisation account (K and O partnership) $000 $000

Land and buildings 150 Trade payables 130Plant and machinery 280Inventory 150 Purchase consideration:Trade receivables 141 Debenture 125Cash and cash equivalents 69 Shares 450

Loss on realisation (85)Kay 42.5Ola 42.5

790 790

2 Capital accounts (K and O partnership)Kay Maria Kay Maria

$000 $000 $000 $000Current a/c Balance b/d 300 260Debenture 125 Loan account

Ordinary shares 225 225Loss on realisation 42.5 42.5Bank (from Orla) 7.5 Bank (to Kay) 100 7.5

400 267.5 400 267.5

Note: In preparing the statement of financial position of Joel, it is assumed that Kay and Orla have settled up, whether via Joel or independently.

3 Journal entry to record the acquisition of Kay and Ola in the books of Joel:

JournalName of account Debit Credit

$000 $000Land and buildings 220Plant and machinery 170Inventory 128Trade receivables 105Cash and cash equivalents 69Trade payables 138Loan to Kay (100 × 1.125) 125Ordinary share capital 300Share premium 150Cash*

Goodwill (balancing figure)** 21 –713 713

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151

*Assume nil as settled between the partners. Alternatively + 7.5 − 7.5 = net nil, settled via Joel; a second alternative is to show a receivable of 7.5 from one partner and 7.5 payable to the other; this method only would affect the statement of financial position.

** Being the assets and liabilities acquired at the agreed valuations, and the consideration issued in the purchase of Kay and Orla.

b If Joel requires a 25% return on its investment then it must make additional profit of 575 0000 × 25% = $143 750.


2 D

3 D

Structured questions1 a When a business is purchased by another business then the business which has been

bought ceases to exist. The owners of that business will either retire or become workers or directors in the business which bought theirs.

However, when business assets are purchased by another business that is simply a commercial transaction. For example, Business A may decide to buy some old plant and machinery from Business B for an agreed amount. Both businesses will continue to operate after the transaction has been completed.

b i Realisation account$000 $000

Property account 100 Trade payables account 20

Vehicle taken over by Ann 4Vehicles account 20 Purchase consideration:Inventory account 15 Debenture (30 × 0.8) 24Trade receivables 12 Shares 100Expense of realisation 1Profit on realisation: Cash (152 − 100 − 24) 28Anne* 11Bridget* 11Chris* 6

176 176

*The profits on realisation are $28 000 and have been allocated in round thousands in approximately the ratio 2:2:1.

ii Capital accountsAnn Bridget Chris Ann Bridget Chris$000 $000 $000 $000 $000 $000

Current a/c 3 Balance b/d 35 30 20Debenture 24 Current a/c 10 8Ordinary shares 40 40 20 Loan account 30Vehicle taken over 4Bank 18 9 3 Profit on realisation 11 11 6

86 49 26 86 49 26

Bank: 3 − 1 + 28 − (18 + 9 + 3 = 30) = 0


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152


c If Ann accepts the offer for her shares and loan from Janty Limited she will receive:

$40 000 × 0.75 = $30 000 for her shares and $24 000 × 75% = $18 000 for her loan; a total of $48 000. This will mean that she will need to borrow $150 000 − $48 000 = $102 000 plus $20 000 for working capital; a total of $122 000 in order to buy her new business.

Assuming the worst position, she will have to pay interest on the loan of $102 000 × 5% = $5100 a year, plus $20 000 × 7% = $1 400 on the overdraft, assuming she requires it for a year; a total of $6 500.

From her projections the profit she expects to make in the first three years is greater than the interest she will pay. It also seems to be increasing steadily over the three year period.

On this basis, provided that she feels comfortable with the move, it makes sense for her to buy the business. She will again be her own boss and, unlike in the previous partnership, all the profit will belong to her. The only negative aspect is the risk of starting the new venture and the accuracy of the profit projections. If she is happy to take the risk and confident in the profit figures, the venture should be taken. She is giving up the interest paid to her on the loan, but Janty Limited is not paying any dividends on the shares, so again it points to the fact that she should start the new venture.

The apparent fall in the value of the Janty shares may reflect a real downturn, or it may indicate the relative bargaining power of the two parties. However this position has been reached, Ann must make her calculations based on the current value of the shares. In theory, she could also try and find another buyer willing to pay more than 75c per share.

2 a A merger is when two independent businesses join together to form a new business. The two original businesses are closed and all, or some, of their assets are transferred to the new business, but both underlying trades continue within the new business.

When a business is sold to another business, then the business which has been sold ceases to exist. All, or some, of the assets are sold to the new business. Both underlying trades continue within the acquiring business. The owners of the business which has been sold will either retire or become workers or directors (or partners) in the business which bought theirs.

b Calculation of opening capital account balances at 1 April 2015

Brian Maye$000 $000

Non-current assets 130 190Inventory 25 24Trade receivables 55 39Cash and cash equivalents [1] 2 1Trade payables (17) (29)Goodwill at owner's valuation 30 20Goodwill written off (25) (25)Opening balances 200 220

[1] There is no indication from the data that the owners will not transfer their cash and bank balances to the new partnership. Thus they have been included here.

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c Brian and MayeOpening statement of financial position at 1 April 2015

$000AssetsNon-current assets 320Current assetsInventory 49Trade receivables 94Cash and cash equivalents 3

146Total assets 466Capital and liabilitiesCapital account:Brian 200Maye 220

420Current liabilitiesTrade payables 46Total capital and liabilities 466

d Brian and MayeAppropriation account for the year ended 31 March 2016

$000 $000Profit for the year 27Less: partners' salaries:Brian 6Maye 4 10

17Interest on capital:Brian 10Maye 11 21

(4)Share of loss:Brian (2)Maye (2) (4)

e For the year ended 31 March 2016, Brian's total share of the profit for the year was $14 000 and Maye's share was $13 000. Thus Brian earned more than he would in his own business and Maye earned less than she would in her own business. On this basis Brian was right to form the partnership and Maye was wrong.

However, this is based on the profit for the new partnership for one year only. Future profits may well give each partner a greater income than their old businesses.

Another way of looking at this leads us to conclude that they combined their businesses on terms that were unfair to Maye. Her old business was twice as profitable as Brian’s, suggesting in broad terms that her goodwill and her profit share could each have been more fairly agreed at double Brian’s.


Cambridge International AS and A level Accounting

25 Consignment and joint venture accountsActivitiesActivity 1In Bertie’s ledger:

Consignment with Calum account

$ $Goods on consignment 16 000 Sales 25 000Calum – shipping costs 450 Balance c/d 3 200Balance c/d 11 750

28 200 28 200

Calum account

$ $Consignment account 25 000 Consignment account – shipping

costs450[1]

Balance c/d 24 55025 000 25 000

Goods sent on consignment account

$ $Income statement 16 000 Consignment with Calum 16 000

Activity 2a In the books of Nettie:

Consignment with Alfonso account

$ $Goods on consignment 15 000 Sales 16 000Bank – shipping fees (N) 1 800 Consignment loss 600Landing fees (A) 1 200Commission 1 600 Balance c/d 3 000

19 600 19 600Balance b/d 3 000

If Nettie has not yet settled the landing fees:

Alfonso account

$ $Consignment account 16 000 Commission 1 600

Consignment account – landing fees 1 200Bank 10 000Balance c/d 3 200

16 000 16 000Balance b/d 3 200

[1] At this point Bertie has not paid a cheque to Calum as reimbursement of the shipping costs. When he does so, the entry will be to credit Bertie's bank account and debit Calum's account.


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If Nettie has settled the landing fees:

Alfonso account

$ $Consignment account 16 000 Commission 1 600Bank – landing fees 1 200 Consignment account – landing fees 1 200

Bank 10 000 Balance c/d 4 400

17 200 17 200Balance b/d 4 400


$ $Consignment with Alfonso 15 000

b In the books of Alfonso:

If Nettie has not yet settled the landing fees:

Nettie account

$ $Bank – landing fees 1 200 Customer accounts/SLC 16 000Bank 10 000Income statement – commission 1 600Balance c/d 3 200

16 000 16 000Balance b/d 3 200

If Nettie has settled the landing fees:

Nettie account

$ $Bank – landing fees 1 200 Bank – refund of landing fees 1 200Bank 10 000 Customer accounts/SLC 16 000Income statement – commission 1 600Balance c/d 4 400

17 200 17 200Balance b/d 4 400

Activity 3a In the books of Henry:

Consignment with Jasmine account

$ $Goods on consignment 12 000 Goods on consignment 1 200

Sales 14 900Bank – shipping fees (H) 2 800Landing fees (J) 850CN for shipping costs (J) 340Consignment profit 1 870 Balance c/d 1 760

17 860 17 860Balance b/d 1 760


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Jasmine account

$ $Consignment account 14 900 Landing fees 850

Consignment account – credit note for shipping costs

340

Bank 8 300 Balance c/d 5 410

14 900 14 900Balance b/d 5 410


$ $Consignment with Jasmine 1 200 Consignment with Jasmine 12 000Balance c/d 10 800

12 000 12 000Balance b/d 10 800

b In the books of Jasmine:

Henry account

$ $Bank – landing fees 850Bank – shipping costs (CN received) 340Bank 8 300 Customer accounts/SLC 14 900Balance c/d 5 410

14 900 14 900Balance b/d 5 410

If Janine has posted the shipping costs from bank payments to the Henry account, the credit note requires her to make no further entry; it is paperwork that confirms that she can remit $340 less than the other transactions would require, but the accounting entry is already made.

If Janine had posted the shipping costs from bank payments to her own shipping costs account, the credit note ‘authorises’ her to treat this as, instead, receivable from Henry; it is paperwork that supports a journal by which she transfers $340 from shipping costs (her expense account) to the Henry account, thus ensuring that she remits $340 less than the other transactions would require.

The crucial point is that Janine must make only one (debit) entry of $340, so as to reduce her net liability to Henry.

Practice exercises1 a In the books of Marty:

Joint venture with Jerry account

$ $Bank – materials 32 600 Bank – sales 120 000Bank – legal fees 4 100 Bank – from Jerry* 6 350Share of profit (from part b) 89 650

126 350 126 350

* This is the balancing figure. Alternatively, this could be carried down as an amount due from Jerry.


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b Joint venture with Jerry memorandum account

$ $Materials bought by Marty 32 600 Sales by Marty 120 000Materials bought by Jerry 30 000 Sales by Jerry 126 000Legal fees 4 100Share of profit – Marty 89 650Share of profit – Jerry 89 650

246 000 246 000

c Calculation of amount due from one party to the other:

At the end of the venture Jerry owes Marty $6 250, assuming no separate bank account was opened.

d At first sight, there appears to be no reason why Marty should not form a partnership with Jerry. The house building venture was successful, with considerable profits made. If they form a partnership then there is perhaps no reason why this may not be the case in future.

However, it may be that one or other of the parties saw what was only a ‘one-off’ opportunity to build the houses. There seems to be no intention by either to form a partnership in future. We do not know what type of business each runs (if any). Forming a partnership means a long-term commitment by both and one, or perhaps both, may not want this. They may want to concentrate on their own businesses.

Should Marty want to go into partnership with Jerry then they must agree on the type of business and how any profits will be shared.

Exam practice questionsStructured questions1 a i In the books of Krystal:

Consignment with Chen account

$ $Goods on consignment 29 700 Sales* 50 000Shipping fees (K) 4 900 Balance c/d 3 800Export charges (K) 3 300Landing fees (Ch) 4 400Commission* 5 000Consignment profit 6 500

53 800 53 800Balance b/d 3 800

*The balancing figure excluding these items is $45 000 and it must comprise sales less commission, i.e. 90% of the sales figure. Hence sales = $50 000 and commission = $5 000.

ii Chen account

$ $Consignment account 50 000 Landing fees 4 400

Commission 5 000Bank 8 000

Balance c/d 32 60050 000 50 000

Balance b/d 32 600


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b In the books of Chen:

Consignment with Krysal account

$ $Bank – landing fees 4 400 Customers a/c 50 000Bank – to Krystal 8 000Income statement – commission 5 000Balance c/d 32 600

50 000 50 000Balance b/d 32 600

c A consignment arrangement may remain suitable if, for example, the transactions are irregular or are a small part of the activities of either party. Each party may operate a successful business in their own country. Thus, forming a more legal tie between them may mean that they are no longer free to do what they please. It would then be better if the consignment arrangement continued in the future.

However, a partnership (or a limited company) arrangement might motivate Chen more, and make it easier for her to expand the Chinese business if both parties are ready to take that path.

If Krystal and Chen form a partnership, then given the geographical distance between the two parties, it is essential that a partnership agreement is prepared. This is in order to protect both parties.

It is easier now with IT for parties to keep in close contact even over long distances. However, either Krystal or Chen could do something which the other one does not know about, or would not approve of, such as purchasing inventory. This would break the trust between them if the other discovered the actions. It is also worth remembering that the actions of one partner binds the other. Thus if the inventory is bought on credit and not paid for, then the other partner will have to pay. Less melodramatically, potential partners usually have a good understanding of each other’s abilities to contribute to the business and so can agree a fair allocation of responsibilities and rewards (profit shares). It seems to be too early to begin a partnership. It is not recommended that a partnership is formed so near the beginning of a business relationship.

A limited company will provide more security for both parties, especially in terms of liabilities for debts. If one is formed then the distribution of shares is crucial as if one member holds more shares than the other then they have control of the business. If equal numbers of shares are held by both then it may lead to stalemate in respect of making future decisions.

Whether to choose a partnership or a limited company will depend on whether the higher costs in administrative burdens of a limited company are considered less significant than the benefit of limited liability. This is a judgment that may change over time, as the business develops.

2 a In the books of Alan:

Consignment with Zac account

$ $Goods on consignment 100 000 Sales 123 000Freight charges 7 200 Balance c/d 9 900Landing dues 3 800Commission 12 300Consignment profit 9 600

132 900 132 900Balance b/d 9 900


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b Zac account

$ $Sales 123 000 Landing dues 3 800

Commission 12 300Bank 85 000

Balance c/d 21 900123 000 123 000

Balance b/d 21 900

c Unit cost = 100 000 + (7 200 + 3 800) = 110 000 ÷ 1 000 = $110 each.

Number of unsold bicycles at 31 March 2016 = $9 900 ÷ $110 = 90.

d The bicycles have been valued in line with IAS 2. This means that they are valued at cost plus any costs incurred in bringing them to a saleable condition. Whilst they only cost $100, that is the value at which they would be valued had they been sold in England. There would be no further costs of bringing them to a saleable condition.

However, it is fair to add on the freight charges and landing dues incurred in bringing the bicycles to Botswana as part of their inventory valuation.

e Alan is paying Zac a commission of 10%. He may now think this is too much, but he had agreed it with Zac prior to entering into the consignment arrangement.

There is no great difference between the suitability of consignment and joint venture arrangements; each is relatively informal and suitable for occasional transactions or for one-off ventures.

The key difference is that joint venturers share the risks and the rewards of their venture and specifically they share in the net profit. If Alan and Zac enter into a joint venture, then they will need to agree profit sharing arrangements. If Zac is risk averse he may want to have a first share in the profit akin to a salary to compensate him for the loss of commission, so that Alan will be no further forward in reducing Zac’s rewards. On the other hand, having a share in the net profit may motivate Zac to greater efforts, to the net benefit of both parties.

As Alan’s success and reward from business in Botswana are entirely attributable to Zac’s efforts, Alan needs to discuss his concerns and alternative possible future arrangements with Zac, so that they can move forward with an arrangement that offers the best mutual advantage.

This may enable him to expand his market overseas, perhaps into other countries in Africa, depending on Zac’s trading contacts.

3 a There are basically three ways in which the transactions of a joint venture can be recorded:

• One party records all the transactions of the venture.

• Each party records their own transactions in respect of the venture.

• A separate set of accounting records is kept for the whole of the transaction to the venture.

The parties have agreed to use the second method mentioned above.

b In the books of Bob:

i Joint venture with Sue account

$ $Aug 2 Purchase of cars 50 000 Aug 31 Bank – sales 80 000Aug 5 Licences and insurance 8 000Aug 31 Income statement – profit 17 000

Balance due to Sue c/d 5 000 80 000 80 000


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ii Joint venture memorandum account

$ $Purchase of cars 100 000 Sales – Bob 80 000Licences and insurances (B) 8 000 Sales – Sue 80 000Licences and insurances (S)* 8 000Discount 10 000Share of profit – Bob 17 000Share of profit – Sue 17 000

160 000 160 000

*it is assumed that Sue asked for a 50% contribution.

c Sue should have recorded sales of $100 000, not the $80 000 she has declared. She has obviously tried to mislead Bob and perhaps in a fraudulent way. This means that the overall profit for the venture should have been more and Bob’s share should be $27 000, based on this error only. There is also the aspect of how much Sue actually paid for the licences; it appears that Bob is entitled to another $2 000 back from overpaying for licences and insurances.

On this basis Sue should make a full disclosure to Bob of what she actually sold and paid in respect of the venture. A new memorandum joint venture should be prepared, a true profit figure calculated, and Sue must pay Bob anything more she owes him.

Bob has every right to ask Sue for all this information. If Sue does not provide it, or he feels that she is still holding something back then he might have to seek help from his solicitor.

d A joint venture is a project undertaken by two parties for a specific project. When that project has been completed the joint venture is over and each party can go back to their own business, once any cash differences between them have been settled.

A partnership is where two or more parties join together in business for the foreseeable future. There is no intention to cease working together and they run a single business with a view to that business making a profit and the profit being shared between them annually.

e Bob would be advised not to enter into a partnership with Sue. He has discovered that she tried to cheat him previously with the joint venture. The accounts she has produced have been prepared by her brother. This too is suspicious as her brother may not have prepared true accounts.

The accounts do show more profit than Bob is making, so there may be a business opportunity for him. If Bob is seriously considering entering into a partnership with Sue, he should instruct his own accountant to review the figures prepared by Sue’s brother to establish the true profit. He should then prepare a partnership agreement setting out every detail of any partnership to ensure Sue does not try to mislead him again.


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26 Computerised accounting systemsActivitiesActivity 1a Buying from an IT provider in your town:

Advantages:

• local so can contact easily if any problems

• can build trust and working relationship

• may be able to sell a tried and tested package and offer regular maintenance / updates / upgrades.

Disadvantages:

• if looking at an accounting package then may not have the necessary expertise in accounting if there are problems

• may be restricted in the package they can sell as often operate as a dealer for a specific product – this means you may not get the type of package required

• may also try to sell other packages which you don’t need.

b Buying over the internet:

Advantages:

• may be cheaper than anyone else

• the internet provides access to wider market so may be able to find more accounting packages

• as with a locally supplied tried and tested package, a widely used package will in effect have been ‘tested’ by thousands, or perhaps millions, of users, and a responsible supplier will have been making continuous improvements and supplying ‘bug fixes’ since the software was first produced.

Disadvantages:

• probably no backup services offered, so may be issues if system breaks down/crashes

• may have to buy service contract as part of deal – this can be expensive and if system fails then time may be lost in seeking help

• may not offer regular upgrades.

c Getting someone who is computer literate to write a package:

Advantages:

• local so can ask if in difficulty

• can write a specific package for your business

Disadvantages:

• may lack expertise in accounting so you may not get what you want

• supplier may not be able to produce the software quickly

• significant risk of errors or bugs in a first release product

• with only one user, there is a risk that errors are not detected quickly

• neither you nor any potential employee will be familiar how the software operates; probably more learning time than with a ‘standard’ commercially available package

• probably won’t be able to offer regular upgrades

• may be expensive.


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Activity 2This issue depends on what Karly and Viji want from computerising their accounting system. Transferring everything to a computer will save them time and storage space. It should also make the processing of data more accurate and quicker, especially if there is a large volume of postings and their current system is divided into several ledgers. Computerising everything will mean everything can be found in one place.

However, there is an issue over who is posting data to the system. If they are leaving it to one person other than themselves then there is a possible fraud issue that the person processing the data can make fraudulent entries. There is also the issue of how computer literate they are.

If they are not confident with computers, they may prefer to look at something in a book that has been handwritten. By not computerising everything, it may be difficult to reconcile everything at the month end. Someone will also have to maintain the manual elements of the system.

Overall, if they are going to make the switch to computerising their accounting system then it should ideally be ‘all or nothing’. There is little benefit in only transferring part of their system. True, it will take more time for them to get used to everything and they may feel that information is not as available as before, but the benefits of transferring everything are greater.

Activity 3They should certainly have two categories of sales:

• garden furniture

• garden equipment.

Depending on how much analysis of their sales they require they may expand on this. For example, with garden furniture they may consider garden seats, umbrellas and tables. For equipment, they may consider lawn mowers and garden tools. How many they decide will depend upon how many sales categories their accounting system allows and what benefit they gain by increasing the number of categories.

The number of purchases categories must match their sales. So they must have:

• puchases of garden furniture

• purchases of garden equipment.

Activity 4a

Date Customer [1]

Customer reference [2]

Invoice number [3]

Credit note number [4]

Amount$ [5]

OctoberNovemberDecember

b The immediate benefit they have obtained by doing this is that they now have an aged receivables listing for the customer. It shows them how long the debt has been outstanding. Thus they can now start to chase the customer for overdue payments. This will immediately benefit their cash flow.

Activity 5a Reconciling all the balances which will be transferred to the computer system will ensure

that accurate data is transferred. There may be errors in their manual data and it is pointless transferring this to a new system. Ideally they want a ‘clean’ set of data with the new system.

[1] The name of the customer would be entered here.

[2] This could be the customer reference they currently use with their manual system or the customer reference generated by the computer system when they enter the data.

[3] This will be the number on the invoice which they sent to the customer.

[4] This will be the credit note number they have used.

[5] The amount of the invoice or credit note should be entered here.


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b Apart from inventory they should also reconcile:

• the petty cash

• the bank account

• loan accounts

• non-current assets at cost and accumulated depreciation.

Activity 6Everything which will be transferred to the computerised accounting system will be the balances on the statement of financial position:

• Non-current assets at cost, broken down by category, such as land, buildings, motor vehicles, etc.

• Non-current assets’ accumulated depreciation using the same categories as their cost.

• Current assets:

i trade receivables – these will be transferred by individual customer and the total reconciled back to the total of the trade receivables

ii inventory – this can be done either line-by-line or in total

iii other receivables to their individual accounts, such as rent or telephone

iv cash and cash equivalents.

• Owner’s equity – the partners’ capital, current drawings accounts balances.

• Non-current liabilities, such as loans.

• Current liabilities:

i trade payables, again by individual supplier

ii other payables to their respective account, such as heat and light or telephone

iii any bank overdrafts.

Practice exercises1 This is a summary of the detailed information in the chapter:

• select the computerised system which the business will use

• set up the chart of accounts for the new system

• prepare the final financial statements at the date of the transfer

• reconcile any balances at that date (bank, petty cash, etc.)

• transfer to the new system the opening balances – these will be the balances from the closing manual statement of financial position

• produce a trial balance from the computerised system and match this back to the manual balances

• operate a system of parallel running with regular checks between the manual and computerised system

• pick a final date on which the computerised system will take over entirely from the manual system.

2 Three advantages of a computerised accounting system:

• saves time in processing data

• saves storage space, no longer any need for books and ledgers

• should be more accurate than a manual system as data is only input once and the computer provides the double entry.


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Three disadvantages of a computerised accounting system:

• initial cost of buying the system

• training costs

• possible hacking of the data.

3 The integrity of the data which is transferred to the computerised system depends on reconciling and backups. Most computer packages will have a set-up procedure. However, it is critical that the data which is entered at this stage is accurate. Thus, a trial balance must be taken which is effectively the closing balances on the statement of financial position. All the balances must be verified and, where necessary, reconciled. If incorrect data is entered at this stage the integrity of the new system is already compromised. Where necessary backup schedules of individual items must be prepared. This is particularly the case with trade receivables and payables, where an aged receivables and payables analysis must be prepared showing the individual balances due for customers and due to suppliers. The total of these individual accounts must be reconciled back to the totals appearing in the statement of financial position. Once all the balances have been reconciled they can be entered on to the new system.

As previously mentioned, it is likely that any accounting package will have a set-up procedure. All the balances will be entered in a set sequence. It is important that regular backups are taken as the data is input and where possible the input data on the screen is reconciled back to any manual totals, for example the total of the individual customers input with the overall total of trade receivables. Once all the data has been input, a trial balance must be produced. This must be reconciled with the trial balance taken from the manual system. If the two agree then the computer can start to be used for regular work. If not, then any differences must be found and eliminated before work with the new computerised system can start.

4 a John

Rent account

Date Details Debit Credit Balance

2016 $ $ $May 31 Bank 42 000 42 000

Income statement 36 000 6 000Prepayments 6 000 0

b John

Prepayments account

Date Details Debit Credit Balance

2016 $ $ $May 31 Rent 6 000 6 000

c The balance on the prepayments account will be automatically transferred by the system at the year end to the statement of financial position. It will appear under other receivables.

At 1 June 2016, if the system does not automatically transfer the balance back to the rental account, John will have to prepare a journal to do this. His journal entry will be:

$ $June 1 Rent account 6 000

Prepayments account 6 000


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27 Analysis and communication of accounting informationActivitiesActivity 1a i Gross margin 2015 gross profit

revenue×100 = ×60308

172308100 = 35%

2016 = ×60000187500

100 = 32%

ii Profit margin 2015 profit for the year (after interest)revenue

×100 = ×21539172308

100 = 12.5%

2016 = ×27322187500

100 = 14.57%

iii Non-current asset turnover

2015 net revenuetotal NBV of non current assets-

×100 = 17230878322

= 2.2 times

2016 = 18750093750

= 2 times

iv Inventory turnover

2015 cost of salesaverage inventory

=+ ÷

11200012000 16000 2( )

= 8 times

2016 =+ ÷

12750016000 14000 2( )

= 8.5 times

v Trade receivables turnover

2015 trade receivablescredit sales

× 365 = ×991460

365% of 172308

= 35 days

2016 = ×1251160

365% of 187500

= 40.59 days (or 41 days)

vi Trade payables turnover

2015 trade payablescredit purchases

× 365 = ×13984116000

365 = 44 days

2016 = ×17192125500

365 = 50 days

vii Current ratio 2015 current assets: current liabilities = 30 765 : 13 984 = 2.2 : 1

2016 = 33 696 : 17 192 = 1.96 : 1

viii Liquid (acid test) ratio

2015 current assets – inventory: current liabilities

= 14 765 : 13 984 = 1.06 : 1

2016 = 19 696 : 17 192 = 1.15 : 1

b i Sales have increased by over $15 000, or nearly 9%, but the gross margin has decreased from 35% in 2015 to 32% in 2016, a reduction of 3%. This may be due to:

• a reduction in selling prices to increase turnover

• an increase in the cost of sales not passed on to customers

• sales made at less than the normal mark-up (seasonal sales or disposal of old or damaged inventory)

• some inventory valued at less than cost because it is old or has deteriorated

• inventory which has been stolen.

Whether or not the gross margin is acceptable depends upon the normal margin expected on sales, but information about this is not provided.


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ii The profit margin has improved from 12.5% in 2015 to 14.57% in 2016. This is in spite of a reduction of 3% in the gross margin. This has been achieved by tighter control on overhead expenditure, down from $38 769 in 2015 to $32 678 in 2016, a reduction of 15.7% although sales have increased by 8.8%.

iii Non-current asset turnover has remained almost steady. Without further information about the nature of the business, it is not possible to comment on this ratio. There has been a considerable increase in the value of non-current assets employed in the business in 2016. The additional assets would have to have been brought in to use early in the year for the full commercial and accounting (depreciation) effects to have been felt.

iv Inventory turnover has increased slightly from 8 times in 2015 to 8.5 times in 2016. The average time that goods remain in inventory is 6.5 weeks which may seem reasonable, but as nothing is known about the type of business, further comment is not possible.

v Trade receivables turnover has increased by 6 days, from 35 in 2015 to 41 in 2016. This deterioration may be due to one or more of the following factors:

• more lenient terms for debtors, to promote sales

• a deliberate policy to attract customers from competitors

• general economic conditions

• poor credit control.

A deterioration in the trade receivables turnover incurs the risk of an increase in irrecoverable debts as old debts usually become irrecoverable. Najim should monitor the situation carefully.

vi Trade payables turnover has increased by 6 days, from 44 days in 2015 to 50 days in 2016. While this may help the cash flow at a time when debtors are taking 6 days longer to pay, care must be taken to retain the goodwill of suppliers, otherwise the suppliers may insist on cash basis and this would greatly harm Najim’s cash flow.

vii The current ratio has decreased slightly from 2.2 : 1 in 2015 to 1.96 : 1 in 2016. It remains satisfactory by normal standards.

viii The liquid (acid test) ratio has remained almost steady at 1.06 : 1 in 2015 and 1.15 : 1 in 2016. As 60% of sales are on credit, the very low ratios on which businesses such as supermarkets work are not appropriate for Najim’s business, and his present ratios may be considered satisfactory.

General comments:

There are no indications that the business is not a going concern. Its cash position is positive and there are no bank loans or overdrafts that could cause embarrassment in the near future.

There is no sign of overtrading as inventory and debtors are not excessive. Overtrading places businesses at great risk.

Note:

Part b requires more than a simple repetition of the ratios already calculated in part a. It is necessary to compare the ratios and to recognise trends and their significance. Students should avoid irrelevant comments and repetition. Statements which cannot be supported by information provided should be avoided, but possible reasons for an improvement or deterioration in a trend may be suggested.


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Activity 2a i Gearing:

Flora Ltd 600600 500+

× 100 = 54.54%

Fauna Ltd 1000

2800 1000+ × 1 000 = 26.31%

ii Interest cover:

Flora Ltd 30060

= 5 times

Fauna Ltd 420120

= 3.5 times

iii Earnings per share:

Flora Ltd 240300

= $0.8 (=80c) per share

Fauna Ltd 300

1125 = $0.27 (=27c) per share

iv Dividend per share:

Flora Ltd 90300

= $0.3 (=30%)

Fauna Ltd 150

1125 = $0.13 (=14%)

v Dividend cover:

Flora Ltd 24090

= 2.67 times

Fauna Ltd 300150

= 2 times (twice)

vi Price earnings ratio:

Flora Ltd $ .$ .2 700 8

= 3.375

Fauna Ltd $ .$ .3 600 27

= 13.33

vii Dividend yield:

Flora Ltd $ .$ .

0 32 70

× 100 = 11.11%

Fauna Ltd $ .$ .

0 133 60

× 100 = 3.7%

b i Gearing: Flora Limited is highly geared (54.54%) and Fauna Limited is low geared (26.31%). This makes Flora Limited a little more risky from the point of view of shareholders and creditors, but neither company is far from neutral gearing (50%).

ii Interest cover: Flora Limited’s interest is covered 5 times by the operating profit, but Fauna Limited’s is only covered 3½ times. Both ratios are satisfactory. Flora Limited’s ordinary shareholders are less at risk of having their dividend curtailed if profits fall than Fauna Limited’s shareholders.

iii Earnings per share: Flora Limited’s EPS is much higher at 80 cents than Fauna Limited’s at 27 cents. Arithmetically, this is mainly due to Fauna Limited having raised more money from its shareholders and having a lower gearing than Flora Limited. The implication is that Fauna has had to invest proportionately more capital to achieve a return for its shareholders than Flora. This suggests that Flora Limited is potentially the better company for dividend/capital growth.

iv Dividend per share: Flora Limited is paying an ordinary dividend of $0.30 per $1 share, equal to 30 % of the nominal value of the shares. Fauna Limited is paying $0.13 per $2 share,


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equal to 6.5% of the nominal value of its shares. At first sight, this makes Flora Limited’s shares seem the more attractive, but an investor buying existing shares must pay the market price, so that yield on the amount invested is a more directly useful and relevant ratio.

Note: We will use the dividend per share in order to work out the dividend yield in part vii below.

v Dividend cover: Flora Limited’s dividend cover is 2.7 times, which is generally considered to be satisfactory. Fauna Limited’s dividend is covered 2 times and may be slightly more at risk if profits decline in the future.

vi Price earnings ratio. Flora Limited’s PER is 3.375 and Fauna Limited’s PER is 11.25. The share prices may be influenced by factors not mentioned, and in particular we do not know anything about the future prospects of either company. Fauna Limited’s future trading prospects may be affected by various favourable factors not mentioned; a low price earnings ratio commonly indicates that investors anticipate significant future growth in profit.

vii Dividend yield. Flora Limited’s dividend yield based on the current market price is 11.11% compared with the yield of 3.7% on Fauna Limited’s shares. This makes Flora Limited’s shares more attractive from an income-earning view point. However, it should be considered along with the potential for capital growth and, as has already been stated, Flora Limited’s earnings per share has permitted adequate profits to be retained for capital growth, especially if a conservative dividend policy is continued in future.

Conclusion:

Every ratio except gearing is favourable to Flora Limited and even the gearing should not give rise to serious concern. Based on the figures presented, an investment in Flora is to be recommended. However, an investment should be based on the future prospects of the entity and the financial consultant should also have regard to the natures of the underlying businesses.

Activity 3

a PatienceIncome statement for the year ended 31 December 2016

$ $Step 6 Revenue (495 000 × 100/65) 761 538

Cost of salesStep 2 Inventory at 1 Jan 2016 (54 000 × 5/6) 45 000Step 5 Purchases (balancing figure) 504 000Step 4 (balancing figure) 549 000Step 1 Inventory at 31 Dec 2016 (given) 54 000Step 3 Cost of sales

1054000 45000

2× + 495 000

Step 7 Gross profit (35% of 761 538) 266 538Step 9 Expenses (balancing figure) 99 000Step 8 Profit for the year (22% of 761 538) 167 538


168

PatienceStatement of financial position at 31 December 2016

$Assets

Step 10 Non-current assets (761 538 / 4) 190 385Current assets

Step 11 Inventory 54 000Step 12 Trade receivables (761 538 × 34/365) 70 938Step 15 Cash and cash equivalents (balancing figure) 20 050Step 14 (balancing figure) 144 988Step 16 Total assets 335 373

Capital and liabilitiesStep 21 Capital at 1 Jan 2016 (balancing figure) 249 840Step 20 Profit for the year 167 538Step 19 (balancing figure) 417 378Step 18 Less: drawings (given) 140 000

(from step 17) 277 378Current liabilities

Step 13 Trade payables (504 000 × 42/365) 57 995Step 17 Total capital and liabilities 335 373

Workings:

Step 14: As we know that the current ratio is 2.5:1, having calculated the trade payables at step 13 as $57 995, then the total current assets must be $57 995 × 2.5 = $144 988.

b Virtue’s inventory turnover is 12 compared with 10 for Patience. Virtue earns his profit at a faster rate than Patience. His cash flow may be improved by the higher inventory turnover, if he can also collect receivables as quickly as Patience.

Virtue’s gross profit margin of 40% is more than Patience’s 35% which indicates that he earns a higher margin on his sales. He may have cheaper sources of supply than Patience, or Patience’s mark-up may be lower than Virtue’s. Without more information about their individual circumstances, further comment is not possible.

Virtue’s net profit margin (20%) is 2% lower than Patience’s (22%). This shows that Patience’s overheads are comparatively lower than Virtue’s. Not all overheads are easily controllable, and Virtue may have to pay higher rent, for example, because of the situation or size of his premises.

Virtue’s turnover is 5 times his non-current assets but Patience’s turnover is only 4 times. Virtue is using his non-current assets more efficiently and making them more profitable.

Virtue’s trade receivables turnover is 31 days, which is 3 days less than that of Patience (34 days). This indicates that Virtue controls his debtors more efficiently and his cash flow is improved as a result.

Virtue pays his creditors 6 days earlier than Patience pays hers (36 days compared to 42 days). No information is provided regarding the credit terms each receives. If Virtue obtains his goods more cheaply than Patience, as suggested, the period of credit he is allowed may be less than Patience receives. On the other hand, if Virtue is not taking the full period of credit he is allowed, he is not managing his cash flow to the best advantage. Or it may be that he takes more advantage of early settlement discounts, thus improving his profitability; there are advantages and disadvantages to either course of action.


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Conclusion:

With the exception of the net profit margin and the possible exception of his payment of creditors, Virtue appears to be running his business more efficiently than Patience.

Practice exercises1 a Two advantages of ratio analysis:

• allows a business to compare performance with competitors / previous years

• helps planning for future.

Two disadvantages of ratio analysis:

• only shows results – it doesn’t explain why the ratios may have changed from year to year

• based on historic data.

b Goswami LimitedCalculation of ratios

Ratio Calculation Answer Industry average

i Gross margin $105 000 ÷ 350 000 30% 30%ii Profit margin $45 850 ÷ 350 000 13.1% 18.07%iii Current ratio $88 000 ÷ 47 150 1.87:1 2.21:1iv Liquid (acid test) ratio $(88 000 − 66 500) ÷ 47 150 0.46:1 1.02:1v Rate of inventory turnover $245 000 ÷ ([31 500 + 66 500] ÷ 2) 5 times 8 timesvi Trade receivables turnover ($21 500 ÷ 350 000) × 365 23 days 25 daysvii Trade payables turnover ($21 000 ÷ 280 000) × 365 28 days 30 days

c i Profitabilitiy:

The gross margin of the company is exactly the same as the industry average. Goswami Limited is performing well in this respect. However, the profit margin of Goswami Limited is lower than the industry average. This is poor and indicates that the company may not be controlling its expenses very well, or may be a consequence of having incurred significant ‘start-up’ costs.

ii Liquidity:

Both the current ratio and liquid ratio of Goswami Limited are worse than the industry average. This indicates poor control over working capital and thus over liquidity. This is also shown by the inventory turnover which is worse than the industry average. The result of this is probably the reason why the bank is overdrawn.

d The directors of Goswami Limited need to take the following actions to improve their results for the business:

• Control their running costs as far as they are able to by looking for cost savings in respect of overheads.

• Reduce inventory – too much cash is tied up in inventory. The directors need to perhaps sell off surplus or slow moving inventory and only purchase more as it is necessary.


170

2 a i Techno HubIncome statement for the year ended 30 April 2016

Step $000 $000Revenue 5 750Opening inventory 2 30Purchases 4 465Less: closing inventory 1 45Cost of sales 3 450Gross profit 6 300Expenses 8 165Profit for the year 7 135

ii Techno HubStatement of financial position at 30 April 2016

Step $AssetsNon-current assets 1 250Current assetsInventory 4 45Trade receivables 5 73Cash and cash equivalents 6 35

3 153Total assets 7 403Capital and liabilitiesCapital 12 362Profit for the year 11 135Less: drawings 10 125

9 352Current liabilitiesTrade payables 2 51Total capital and liabilities 8 403

b Ratio Techno Hub Zenapod

Inventory turnover 12 times 10 timesGross margin 40% 45%Profit margin 18% 20%Non-current asset turnover 3 times 3½ timesTrade receivables turnover 36 days 30 daysTrade payables turnover 40 days 28 days

Evaluation of performance: Techno Hub has a better inventory turnover than Zenapod which shows good

management of inventory. Not too much is held at any one time.

The gross margin of Techno Hub is worse than Zenapod, which means that they are either not marking up their goods as much or buying from a more expensive supplier.


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The business could improve its margin by increasing the mark-up, or if this would result in a loss of sales, then try to find a cheaper supplier.

The profit margin of Techno Hub is worse than Zenapod. This could be partly due to the poorer gross margin. However, it also means that Techno Hub is not controlling its expenses as well as the rest of the industry. This is an area which needs improvement, perhaps by trying to reduce cost through cost savings.

Zenapod has better utilisation of its non-current assets than Techno Hub as it generates more revenue per $ of non-current assets. This may be due to Techno Hub having purchased new non-current assets which have yet to generate better sales.

The trade receivables turnover is worse than Zenapod. This means that Techno Hub needs to improve its credit control. However, Techno Hub is holding on to its cash for longer by not paying its suppliers as fast as Zenapod. This is acceptable, provided that it does not result in damaging supplier relationships. Techno Hub has a high bank balance. It could perhaps try to negotiate better prices with its suppliers. This will help improve the gross margin.

c i Return on capital employed.

ii This measures how much profit is earned by every dollar of capital invested in the firm. Capital invested here means not only owner’s capital, but also any non-current liabilities such as long-term loans or debentures.

3 a Oitar plc

Calculation of ratios

Ratio Calculation Answeri Interest cover $1 000 ÷ 250 4 timesii Dividend cover $750 ÷ 470 1.60 timesiii Earnings per share $(750) ÷ 550 $1.36 per shareiv Price earnings ratio $30 ÷ $1.36 22v Dividend yield $(470 ÷ 550) ÷ 30 2.84%vi Gearing ($250 ÷ 12.5%) ÷ (5 500 + 900 + 2 000) 23.81%

b Interest cover is important as it indicates how much of the profit for the year can be paid out as dividends. It is a measure of risk: the higher the interest cover the better as more profit is available to pay dividends to the ordinary shareholders.

Dividend cover shows how many times the profit for the year covers the dividend paid to the shareholders. A high figure means that the company is retaining profits, perhaps for future expansion and growth, which will help future dividend prospects.

Earnings per share measures how much each ordinary share generates in profit for the year. The higher the better as it is likely to increase the market price of the shares.

Price earnings ratio measures the confidence that the stock market has in the company. Again, the higher the better. It means that professional investors are confident of the future growth in the company. Alternatively, it could mean that professional investors have been too optimistic and that the share price is overvalued. A potential investor needs to understand the nature of the underlying business to interpret this ratio.

Dividend yield measures the return on the share. It can be compared with the return which could be earned by investing the shareholder’s cash in a risk-free investment rather than a share in the company. Again, the higher the better.

Gearing measures the capital invested in the company on which a fixed and obligatory return must be paid with the total capital invested in the company, including shareholder’s funds. It is a measure of risk as the more fixed cost capital there is, the more risky the investment and the more profits the company has to earn to pay its fixed costs investors before it can pay dividends to the ordinary shareholders.


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c The ordinary shareholders would need to see the full set of published accounts produced by the directors of the company. This would include a statement from the chairman which would give an indication of possible future performance. The document would also contain a statement of cash flows, which would allow investors to see how the company generates funds and spends them. Finally, the accounts would contain an audit report. If this is unqualified, it is likely to give the shareholders confidence that their analysis is based on reliable financial information.

4 a i Return on capital employed:

Profit before interestCapital employed

×100

(total equity + non-current liabilities)

1000

(7000 + 3000)× 100 = 10%

ii Dividends per share:

Dividends per share = Ordinary dividends for the year

Number of ordinary shares isssued

In this example we know that the company has already paid an interim dividend of $0.02 per share. We know that the proposed final dividend will be a total of $300 000. This means that each shareholder will receive:

$3000006000000

= $0.05 per share

So the total dividend per share for the year is $0.02 + $0.05 = $0.07 per share.

iii Dividend cover:

Profit attributable to equity holdersOrdinary dividends paiid

The total amount of the interim dividend was $0.02 × 6 000 000 shares = $120 000. So the total dividend paid for the year was $120 000 + $300 000 = $420 000.

This means the dividend cover was:

600000420000

= 1.43 times

iv Dividend yield:

Dividend paid per shareMarket price of a share

×100

$0.07$2.00

× =100 3 5. %

v Earnings per share:

Profit attributable to equity holdersNumber of ordinary shaares issued

6006000

= $ .0 10 per share

vi Price/earnings ratio:

Market price per shareEarnings per share

$2.00$0.00

= 20

(from the previous question)

Notice here that there is no suffix. The price earnings ratio is usually calculated and expressed only as a figure.


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b Solution:

• Gemmaton’s return on capital employed is worse than JAH Limited as it is a lower percentage.

• However, Gemmaton’s return on equity is better because it is higher.

• Gemmaton’s earnings per share is also better.

• Gemmaton’s gearing is better.

JAH Limited has a large amount of fixed cost capital which is shown by the higher gearing ratio. Thus, Gemmaton would be a better company to invest in if interest rates increased.

Solution:

• Gemmaton is providing a better dividend per share by $0.03 ($0.07 − $0.04).

• However, JAH has a better dividend cover (2 times compared with 1.43 times).

• Gemmaton has a better dividend yield (3.5% compared with 2%).

• Gemmaton has a higher price earnings ratio.

Overall I would advise Abdul to invest in . . . . . . . . (student answers will vary).

Note: It is perfectly acceptable to advise Abdul either way: to invest or not to invest. All that needs to be added is a final comment to justify an overall conclusion.

c Benefits of ratio analysis (any two):

• It allows managers to make comparisons between different years and between different businesses in the same trading sector. However, the businesses should ideally be of a similar size.

• It helps identify where improvements need to be made for the future.

• It allows a trend of performance to be built up over a number of years.

Limitations of ratio analysis (any two):

• To be useful and reliable, ratios must be reasonably accurate. They should be based on information in accounts and notes to the accounts. Some useful information may not be disclosed in the accounts and some account headings may not indicate the contents clearly.

• Information must be timely to be of use. It may not be available until some time after the end of a company’s financial year.

• Ratios do not explain the cause of the changes in the results but may indicate areas of concern; further investigation is usually necessary to discover causes of the concern.

• Ratios usually do not recognise seasonal factors in business.


2 B

3 C

4 D

5 C

6 D

7 B

8 A


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28 Costing for materials, labour and overheadsActivitiesActivity 1

Fiford LtdInventory of fifolium at 31 October

Oct 1 10 15 22 29Price ($) 5.00 5.20 5.24 5.28 5.32Quantity (kg) 100 80 50 70 100Sales

3 (40)60

12 (60) (15)– 65

14 (50)15

17 (15) (30)– 20

30 (20) (50) –31 – 20 100

Value $105.60 $532.00 Total $637.60

Activity 2

A. V. Co.Inventory of digital hammers at 30 June

Date Quantity Price per unit Average price Balance$ $ $

Jun 1 Balance b/f 200 5.00 5.000 1 0004 Purchased 100 5.20 520

Balance 300 5.067 1 52010 Sold (75) (380)

Balance 225 1 14013 Purchased 100 5.35 535

Balance 325 5.154 1 67520 Sold (150) (773)

Balance 175 90226 Purchased 80 5.40 432

Balance 255 5.231 1 33430 Sold (90) (471)

Balance 165 5.231 863

Activity 3a Basic pay for the week = 40 hours × $18 = $720.

Note: Basic pay is usually understood to mean the normal pay for normal hours, rather than the amount that would be paid if all hours worked were paid at the basic rate.


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b Overtime = 4 hours × $18 × 1½ = $108.

Premium = 108 − (4 hours × $18 = 72) = $36.

c For a basic week, Chan is expected to produce 360 units in 40 hours = 9 units per hour.

For the week ended 31 March, Chan worked 44 hours so should have produced 44 × 9 = 396 units.

He actually made 414 units, so excess production = 414 − 396 = 18 at $5 per unit = $90.

d 414 units should have taken 414 ÷ 9 = 46 hours.

Chan took 44 hours so saved 46 − 44 = 2 hours at $12 = $24.

e Chan’s total gross pay for the week = $(720 + 108 + 90 + 24) = $942.

Activity 4a

Expense Basis Total Machining Painting Assembly Packing

$000 $000 $000 $000 $000Indirect labour Actual 125 51 32 28 14Factory:Rent Floor area 90 45 18 18 9Heating and lighting Floor area 70 35 14 14 7Maintenance Floor area 30 15 6 6 3Insurance Floor area 20 10 4 4 2Plant and machinery:Depreciation Cost 80 45 20 5 10Repairs Cost 32 18 8 2 4Insurance Cost 16 9 4 1 2Total overhead 463 228 106 78 51

Note: Alternatively ‘maintenance’ could have been allocated in proportion to plant and machinery cost.

b Expense Basis Total Machining Painting Assembly Packing

$000 $000 $000 $000 $000Direct materials

Allocation 117 80 20 5 12

Direct labour Allocation 323 136 74 68 45Overhead Apportioned 463 228 106 78 51Total cost 903 444 200 151 108

Activity 5

Mixing Bakery Packaging Stores Canteen

$000 $000 $000 $000 $000Overheads 165.00 124.00 87.00 80.00 90.00Reapportion stores 54.55 14.54 3.64 (80.00) 7.27Reapportion canteen 32.42 43.23 21.62 – (97.27)

251.97 181.77 112.26 – –


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Activity 6a No. of direct labour hours required:

First: 5 000 × 1.3 = 6 500

Second: 7 000 × 0.7 = 4 900

11 400

OAR = $ $12927611400

7250= = $11.34 per hour.

i OAR per unit: First: $11.34 × 1.3 = $14.742 per unit.

ii OAR per unit: Second: $11.34 × 0.7 = $7.938 per unit.

b Overhead absorbed:

$Firsts: 5 000 × $14.742 73 710Seconds: 7 000 × $7.938 55 566Total overhead 129 276

Activity 7a Total number of machine hours in a 13 week period = 10 × 7 × 6 × 13 = 5 460.

Machine hour OAR = $141960

5460 = $26

b Each unit requires 54601200

machine hours to make = 4.55 machine hours.

Therefore each unit absorbs $26 × 4.55, or $118.30 overhead.

(Proof: $118.30 × 1 200 = $141 960.)

Activity 8a OARs

Moulding: Direct labour hourly rate $30187534500

= $8.75

Machining: Machine hourly rate $11520018000

= $6.40

Paint shop: Direct labour hourly rate $47250

9000 = $5.25

b Overhead absorbed per unit:

Sovrin Ginny

$ $Moulding (4 × $8.75) 35.00 (3½ × $8.75) 30.625Machining (2 × $6.40) 12.80 (2 × $6.40) 12.800Paint shop (1 × $5.25) 5.25 (1 × $5.25) 5.250

53.05 48.675

c Total overhead recovery:

Sovrin Ginny Total

$ $ $Moulding (6 000 × $35.00) 210 000 (3 000 × $30.625) 91 875 301 875Machining (6 000 × $12.80) 76 800 (3 000 × $12.800) 38 400 115 200Paint shop (6 000 × $5.25) 31 500 (3 000 × $5.250) 15 750 47 250

318 300 146 025 464 325


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d Total cost per unit:

Sovrin Ginny

$ $Direct material 102.00 85.000Direct labour 190.00 151.000Overhead 53.05 48.675

345.05 284.675

e Selling prices are therefore: Sovrin $690.10 and Ginny $569.35.

Activity 9

Upandown Limited

Three months to 31 March

Three months to 30 June

Three months to 30 September

Three months to 31 December

$ $ $ $OAR 124 128 130 131Overhead recovered 111 600 134 400 143 000 128 380Actual overhead 128 000 125 000 129 500 132 800(Under-)/over-recovery (16 400) 9 400 13 500 (4 420)

Practice exercises1 a Overhead expenses in relation to costing are costs which the business incurs when making

the product (or service), but which cannot be directly traced to the units of production.

b i Overhead allocation refers to overheads which can be identified with specific cost centres, for example packing materials for the packing department or oil for the machine shop.

ii Certain overheads cannot be traced directly to a cost centre, for example rent of the whole factory. Such overheads are apportioned (split) between cost centres on a suitable basis, such as floor space for rent.

c i Once overheads have been apportioned to cost centres, the next step is to calculate an overhead absorption rate. These rates are then used to calculate the amount of overhead to be attributed or charged to each cost unit in each cost centre.

ii Under-absorption of overheads occurs when the actual expenditure on overheads is more than the budgeted amount, and/or production is less than the planned level.

iii Over-absorption occurs when the actual expenditure on overheads is less than the budgeted amount, and/or when actual production is more than the planned level.

d A company may recover more in overheads than the amount spent in the period when the actual expenditure on overheads is less than the budgeted amount, and/or when actual production is more than the planned level. This can occur because of such things as receipt of a new order from a customer in excess of the orders planned, when invoiced costs were lower than expected or when planned overhead work was not carried out.

e Estimated figures are used to calculate an overhead absorption rate because the rate has to be calculated in advance of production. For this reason budgeted costs are used. This allows the managers of the business to work out prices in advance, or if a special order is received then to work out a price to charge the customer. This would be impossible to do after the event.


178

2 Three ways in which labour can be remunerated are:

• hourly rate, usually regarded as a direct cost because it is paid to production workers

• piece rate, likewise regarded as a direct cost as it is usually paid to production workers in direct proportion to their output in units

• annual salary, regarded as an indirect cost, because this is the normal basis of remuneration for administrative and management staff.

3 Two ways an employee can earn a bonus for work carried out (if her contract includes such an arrangement):

• by producing more in the time available than the amount of production set down by management

• as a percentage on the amount sold (e.g. commission for a salesperson).

4 a Arthur’s basic pay for the week = 44 hours + 4 hours for Saturday = 48 hours × $20 = $960.

Alternatively: 40 × $20 = $800.

b Overtime work = 4 hours at time and a half = 6 hours. 4 hours at double time = 8 hours.

6 hours at $20 (= $120) + 8 hours × $20 (= 160) = $280. Of this, 2 of the 6 hours and 4 of the 8 hours are overtime premium = 6 hours × $20 = $120.

Alternatively: Overtime = 4 × $30 + 4 × $40 = $280. Premium = 4 × $10 + 4 × $20 = $120.

c For a 40 hour week Arthur was expected to produce 480 units = 12 per hour.

He worked 48 hours so should have produced 48 × 12 = 576 units.

He actually produced 600 units, so he made 600 − 576 = 24 extra units.

For this he would be paid 24 × $3 = $72.

d The 600 units should have taken 600 ÷ 12 = 50 hours, so he saved 50 − 48 = 2 hours.

For this he is paid 2 × $10 = $20.

e Arthur’s gross pay for the week was:

$960 + 120 + 72 + 20 = $1 172.

Alternatively : $800 + 280 = 72 + 20 = $1 172.


2 B

3 B

4 D

5 A

6 D

7 D

Structured questions1 a i A cost centre is a location, usually a department within a business, to which costs can

be charged. It may also be a person (e.g. a salesperson) or an item of equipment.

ii A cost unit is a unit of production, for example a computer or a dress.


179

b Overhead cost Total Moulding Sanding Painting Maintenance Canteen

$ $ $ $ $ $Administration 104 000 20 000 25 000 20 000 20 000 19 000Electricity 70 000 28 000 32 000 3 000 3 800 3 200Depreciation 50 000 16 200 17 500 4 000 8 000 4 300Indirect wages 78 565 6 000 11 250 6 375 36 190 18 750Rent 80 500 21 875 16 625 17 500 14 000 10 500Total 383 065 92 075 102 375 50 875 81 990 55 750Reapportionment of canteen costs

13 118 16 396 13 118 13 118 (55 750)

Reallocation of maintenance costs

37 152 28 235 29 721 (95 108)

Total costs of production cost centres

142 345 147 006 93 714

c Moulding = $142 345 ÷ 8 000 = $17.79 per labour hour.

Sanding = $147 006 ÷ 8 650 = $16.99 per machine hour.

Painting = $93 714 ÷ 7 500 = $12.50 per direct labour hour.

Note: Part c has been answered using the additional information.

d Cost Calculation Amount

$Direct material 50.00Direct labour:Moulding 1 × $8 8.00Sanding 1.5 × $6 9.00Painting 2.5 × $10 25.00

92.00Factory overheads:Moulding 1 × $17.79 17.79Sanding 2 × $16.99 33.98Painting 2.5 × $12.50 31.25Factory cost 175.02Add: required profit 116.68Selling price $175.02 ÷ 60% 291.70

(Proof: $116.68 ÷ 291.70 × 100 = 40%, the required margin.)

e The directors should not change to a factory-wide overhead absorption rate. The painting cost centre is labour intensive, whilst the other two cost centres are machine intensive. The overhead absorption rate used should reflect most closely what happens in the cost centre. If a factory-wide rate is used then will it be based on direct labour hours or machine hours? Whichever is chosen will not reflect what goes on in all the cost centres.


180

2 a Expense Basis of apportionment

Total Machining Assembly Maintenance Power house

$000 $000 $000 $000 $000Indirect materials

Given 1 064 298 482 132 152

Indirect labour

Given 2 578 706 918 282 672

Rent & taxes Floor area 1 426 465 775 155 31Supervision Indirect labour 660 176 352 88 44Plant depreciation

Plant value 1 650 975 375 180 120

Total allocated

7 378 2 620 2 902 837 1 019

b Expense Basis of apportionment

Total Machining Assembly Maintenance Power house

$000 $000 $000 $000 $000Total allocated

7 378 2 620 2 902 837 1 019

Reallocation of power house

Units of power 713 204 102 (1 019)

Reallocation of maintenance

Maintenance hours

704 235 (939) -

Final total for production areas

7 378 4 037 3 341 -

c The overhead absorption rates are, therefore:

Machining Assembly

Overheads allocated $4 037 000 $3 341 000Hours 11 080 4 800Absorption rate $364.35

per machine hour$696.04per direct labour hour

d Certain costs can be attributed directly to cost centres, for example indirect labour costs of workers within a particular cost centre. These costs are therefore allocated directly to the cost centre in which they occur.

Other costs though cover a number of cost centres, for example rent of a factory. These costs have to be split across cost centres using a pre-determined basis, for example the floor space of each cost centre can be used when splitting rent. This process of splitting overheads on a pre-determined basis is known as apportionment.

e Over-absorption of overheads occurs when production passing through a cost centre is charged with more budgeted overhead than the cost centre actually incurs.


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f Machining Assembly

Actual hours (A) 12 000 4 600Budgeted absorption rate (B) $364.35 $696.04Overheads absorbed (A × B) $4 372 200 $3 201 784Actual overheads $4 100 000 $3 300 000

$272 000 $98 216over-absorbed under-absorbed

g $9 500 × 1.30 = $12 350, ÷ 100 = $123.50 per unit.

h As there is spare capacity, the directors should consider making the special order. To do so will increase the utilisation of the factory. It will mean that the fixed costs are spread over a greater number of units produced. This will reduce the overall cost per unit of the product.

In order to make a final decision the directors need to identify the variable and fixed costs associated with the order. If the selling price offered results in a positive contribution, then the order should be accepted. If not then it should be rejected.


182

29 Unit, job and batch costingActivitiesActivity 1

$Direct materials 398 000Direct labour 996 000Overheads 1 687 250

3 081 250

Cost per cost unit of 1 000 packets = $ $3081250

4257250=

Activity 2Two actions the directors could take in future to improve profit:

• look for a cheaper supplier of materials

• look for faster ways of working

• look for cheaper staff

• review the make-up of the overheads to see if any costs can be saved.

Activity 3a $

Labour: Geoffrey (200 × $100) 20 000Susan (100 × $60) 6 000Overhead recovery (300 × $40) 12 000Amount to charge 38 000

b Geoffrey has certain things to consider when deciding whether or not to accept the work for $30 000:

• How much work does he currently have? If he accepts the offer he will cover the two direct cost figures of wages. If it is his only possible work then it must be accepted.

• The difference will also contribute $4 000 towards covering his overheads. If he has no other work this is important.

• What exactly is included in the overheads figure? If all of it is fixed, then the $4 000 will help towards covering that. However, if any is variable, then the amount of fixed overheads the $4 000 contributes towards will be reduced.

Overall, provided the contribution is positive then Geoffrey should accept the work.

Activity 4No. of rolls = 6 000 (1 000 × 6)

No. of labour hours = 10 (6 000/[100 × 6])

a $

Raw materials (6 000 × $0.08) 480.00Labour (10 × $6) 60.00Setting up machinery 30.00Labour hour overhead recovery 93.50

663.50

b Cost of one roll: 663.50/6 000 = $0.1 106


183

Practice exercises1 a Dept A: $36 000 ÷ 24 000 = $1.50

Dept B: $26 000 ÷ 20 000 = $1.30

Dept C: $24 000 ÷ 8 000 = $3.00

All overheads are per direct labour hour.

b Monthly production units: 4 000

$ $Direct material ($8 × 4 000) 32 000Direct labour:Dept A (4 000 × [1½ × $8.75]) 52 500Dept B (4 000 × [1 × $8.75]) 35 000Dept C (4 000 × [½ × $8.75]) 17 500 105 000Factory overhead:Dept A (4 000 × 1½ × [$36 000 ÷ 24 000]) 9 000Dept B (4 000 × 1 × [$26 000 ÷ 20 000]) 5 200Dept C (4 000 × ½ × [$24 000 ÷ 8 000]) 6 000 20 200Production cost for one month’s production of Super Burling 157 200

2 a Overhead recovery is the term given to the amount of total overhead for a cost centre which is charged to the total production going through that cost centre in a period. The calculation is based on the overhead absorption rate multiplied by the actual amount worked.

For example, suppose the budgeted total overhead for a cost centre is $5 000 and the budgeted overhead rate is $2 per direct labour hour. If 2 400 direct labour hours are worked in a period then the amount of overhead recovered will be 2 400 × $2 = $4 800.

b Printing: $127 400 ÷ 3 640 = $35 per direct labour hour.

Marketing and promotion: $267 540 ÷ 6 370 = $42 per direct labour hour.

c $ $Direct material:Printing 1 300Marketing and promotion 1 600 2 900Direct labour:Printing (120 × $8) 960Marketing and promotion (300 × $12) 3 600 4 560Overhead:Printing (120 × [$127 400 ÷ 3 640]) 4 200Marketing and promotion (300 × [$267 540 ÷ 6 370]) 12 600 16 800Total cost 24 260Add: required profit ($24 260 × 40%) 9 704Price to charge clients 33 964

d If the price of $25 000 is accepted, then it will only just cover the total calculated cost of $24 260. It depends on how much work Successful Promotions Limited has. If they have no other work then it should be accepted as it does at least cover the costs. If they don’t have any work then the company may have to consider making staff redundant. This could have a negative effect on their image. They may also have to cancel some deliveries from suppliers, which again may have a negative impact on relationships with their suppliers.

Clearly, if they do want to accept the quote and make some profit then they have to look for cost savings. In doing so, the savings can only be made from costs over which the


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directors have control. This is likely to be the labour cost. They could try to cut down the time taken, without harming the quality of the work. If possible they may try to negotiate a discount for the materials with their suppliers, although this may be difficult.

The other aspect is if they accept the work at the lower price then they may be forced to do this again in the future. If their other customers find out about the deal they too may try to get a lower price. This could have a damaging effect on future profits.

Successful Promotions Limited should try to negotiate a better price, before accepting the work.

e Overheads recovered = 3 750 × $35 = 131 250

Less: actual overheads 130 000

Over-absorption 1 250

f The over-absorption may lead to an increase in profits, as the fixed costs are now spread across probably a greater number of units.

Note: Strictly speaking costing and overhead absorption are ways only of classifying costs, they do not directly change the overall profit of a company. However, if the overhead recovery rate was slightly higher than necessary, the implication could be that the selling price was also set slightly higher (if it was based on a target mark-up) and therefore this ‘extra’ sales income would have increased profit.

3 a A production cost centre is an area within the factory where production actually takes place. A service cost centre is one which provides a service of some sort to all the production cost centres, for example a canteen or maintenance department.

b When calculating an overhead absorption rate it is essential that all the costs of running the factory are included. If the service cost centre costs are not reapportioned to the production cost centres then an element of cost will not be charged to the product. This may result in the selling price being too low to cover all the company’s costs and perhaps not generate any profit at all.

c Moulding: $21 840 ÷ 7 280 = $3 per machine hour

Lining: $11 375 ÷ 4 550 = $2.50 per direct labour hour

Finishing: $4 368 ÷ 1 820 = $2.40 per direct labour hour

d Production (units): 2 000 pairs

$ $Direct material:Moulding ($2 × 2 000) 4 000Lining ($3 × 2 000) 6 000 10 000Direct labour:Moulding ($7 × [0.25 × 2 000]) 3 500Lining ($6 × [0.5 × 2 000]) 6 000Finishing ($6 × [0.25 × 2 000]) 3 000 12 500Factory overhead:Moulding (0.5 × 2 000 × [$21 840 ÷ 7 280]) 3 000Lining (0.5 × 2 000 × [$11 375 ÷ 4 550]) 2 500Finishing (0.25 × 2 000 × [$4 368 ÷ 1 820]) 1 200 6 700Total cost of 2 000 pairs of children’s boots 29 200

e Cost of one pair of boots:

$29 200 ÷ 2 000 = $14.60.


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f The directors should not change to a factory-wide overhead absorption rate. The lining and finishing cost centres are labour intensive, whilst moulding is machine intensive. The overhead absorption rate used should reflect what happens in the cost centre. If a factory-wide rate is used then will it be based on direct labour hours or machine hours? Whichever is chosen will not reflect what goes on in all the cost centres.


2 A


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30 Marginal costingActivitiesActivity 1a Contribution from 1 unit = $146 250 ÷ 3 000 = $48.75

Contribution from 3 000 units = $(48.75 × 3 000) = $146 250

Profit from 3 000 units = $(146 250 – 82 000) = $64 250

b Contribution from 4 000 units = $(48.75 × 4 000) = $195 000

Profit from 4 000 units = $(195 000 − 82 000) = $113 000

c Contribution from 1 200 units = $(48.75 × 1 200) = $58 500

Loss from 1 200 units = $(82 000 − 58 500) = $23 500

Activity 2a i Contribution per unit = $(95 − 65) = $30

Break-even point = $

$7500

30 = 2 500 units;

Break-even revenue = $.75000

0 31579 = $237 500

(or 2 500 × $95 = $237 500)

ii Margin of safety = 25005000

× 100 = 50%

b

Break even

$000

2500

Break-even chart for product Q

0

50

100

150200

250

300

350

400

450

237.5

475

Total revenue

Total costs

Fixed costs

Activity 3

No. of phones a 10 000 b 15 000 c 20 000$ $ $

Contribution $(50–41) 90 000 $(48–41) 105 000 $(42–41) 20 000Fixed overheads 70 000 70 000 70 000 Profit/(loss) 20 000 35 000 (50 000)

Activity 4Marginal cost per 1 000 cans of fruit: $14 250

a Additional contribution from order for 5 000 cans at $16 000 per 1 000 cans:

5 × $(16 000 − 14 250) = $8 750 profit

The order should be accepted.

b Loss if order for 3 000 cans at $14 100 is accepted:

3 × $(14 100 − 14 250) = $450 loss

The order should not be accepted unless it will prevent the company from having to lay off valuable skilled staff because of a temporary slump in trade.


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188

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Activity 5

Present position (tools produced by Canterbury Planes Limited):

$Selling price per tool 16.00Direct costs: material 3.00Labour 2.50Other expenses 1.00Marginal cost of production 6.50Variable selling expenses 2.00Marginal cost of sales 8.50Contribution 7.50

Contribution from sale of 15 000 tools = $112 500Profit on sale of 15 000 tools = $(112 500 − 74 000) = $38 500

Break-even point: $$ .740007 50

= 9 867 tools

a i North Island Tool Co.:

Cost per tool $6. This is $0.50 less than the present cost of production.

Effect on profit: Increase by (15 000 × $0.50) = $7 500 to $46 000.

Effect on break-even point: $$

740008

= 9 250 tools.

ii South Island Tool Co.:

Cost per tool $6.80. This is $0.30 more than the present cost of production.

Effect on profit: Decrease by (15 000 × $0.30) = $4 500 to $34 000.

Effect on break-even point: $$ .740007 20

= 10 278 tools.

b Tools should be purchased from North Island Tool Co. because:

• the cost will be $0.50 less than the cost of production

• profit will increase by $7 500 to $46 000

• the break-even point will be reduced from 9 867 tools to 9 250 tools.

Tools should not be purchased from South Island Tool Co. because:

• the cost will be $0.30 more than the cost of production

• profit will decrease by $4 500 to $34 000

• the break-even point will increase from 9 867 tools to 10 278.

Activity 6

Gimie Gros Petit

Per unit $ $ $Selling price 14 25.00 20Direct material 5 6.50 8Direct labour 5 14.00 6Marginal cost 10 20.50 14Contribution 4 4.50 6Contribution per litre of material 1.6 1.38 1.5Ranking 1 3 2

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Castries Limited Revised production budget to maximise profit from available materials

Units Litres Contribution$

Gimie (maximum) 1 000 2 500 4 000Petit (maximum) 800 3 200 4 800Gros (4 875 / 3.25) 1 500 4 875 6 750

10 575 15 550Less: fixed expenses 10 000Profit 5 550

Activity 7

Gimie Gros Petit

$ $ $Contribution 4 4.50 6Contribution per direct labour hour 8 3.21 10Ranking 2 3 1

Castries Limited Revised production budget to maximise profit from available direct labour hours

Units Labour hours Contribution$

Petit 800 480 4 800.00Gimie 1 000 500 4 000.00Gros 1 725 2 415 7 762.50

3 395 16 562.50Less: fixed expenses 10 000.00Profit 6 562.50

Activity 8

a Market Limited

Per unit Product A Product B Product C$ $ $

Material 20 40 50Labour 36 60 72Marginal cost 56 100 122Selling price 80 130 150Contribution per unit 24 30 28Total budgeted contribution 24 000 60 000 112 000Total contribution 196 000 Less: fixed expenses 115 000 Profit 81 000

b Market Limited Revised production budget

Contribution Units Materials TotalA 12.0 1 000 2 000 24 000B 7.5 2 000 8 000 60 000C 5.6 3 600 18 000 100 800

28 000 184 800Less: fixed expenses 115 000Profit 69 800

c Reconciliation of profit per revised budget with profit in original budget:

$ $Profit per original budget 81 000Budgeted production of C (units) 4 000Revised budget for C 3 600Reduction in production 400Loss of contributions 400 × 28 11 200Revised profit 69 800

Activity 9a Fixed costs increase by $12 000 and profit is reduced to $23 000.

Break-even = $92000$5.75*

= 16 000 units

* Contribution = $(8.75 − 3)

b Variable costs increase by $9 000 and profit is reduced to $26 000.

Break-even = $$ . *800005 30

= 15 095 units

* Contribution = $(8.75 − 3.45)

c Costs and revenue increase by $21 000 and profit is maintained at $35 000.

Break-even = $$ . *920006 35

= 14 489 units.

Costs have increased by $21 000; revenue becomes $196 000 ($9.80 per unit).

*Unit marginal cost is $3.45; contribution = $(9.80 − 3.45) = $6.35

Activity 10a

Monthly profit using marginal costing

Month 1 Month 2$ $

Revenue 50 000 65 000Less: variable costs 30 000 39 000Less: fixed costs 15 000 15 000Monthly profit 5 000 11 000


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b Monthly profit using full absorption costing

Month 1 Month 2$ $

Revenue 50 000 65 000Opening inventory – 20 000Cost of production:Variable costs: 1 500 units x $30 45 000 45 000Fixed costs 15 000 15 000

60 000 80 000Less: closing inventory (20 000) (28 000)Cost of sales 40 000 52 000Monthly profit 10 000 13 000

Notes:

1 Closing inventory is valued at $40 per unit ($60 000 ÷ 1 500 = $40).

2 Closing inventory at the end of month 1 is 500 units (1 500 – 1 000). At the end of month 2 the closing inventory is (500 + 1 500 – 1 300) = 700 units.

c Reconciliation of profit using each method

Month 1 Month 2$ $

Profit using marginal costing 5 000 11 000Add: fixed overheads in closing inventory 5 000 7 000Less: fixed overheads in opening inventory – (5 000)Profit using full absorption costing 10 000 13 000

Note:

The fixed overheads included in the closing inventory is $15 000 ÷ 1 500 = $10 per unit. The total overheads included in the closing inventory at the end of each month, therefore, are: in month 1: 500 units × $10 = $5 000; and in month 2: 700 units × $10 = $7 000.

Practice exercises1 Working:

Cost of each order on each machine:

X – 123/P X – 382/Q Y – 123/P Y – 382/Q

$ $ $ $Direct material (material cost per unit × number of units)

4 000.00 5 000.00 3 680.00 4 600.00

Direct labour (hourly rate × number of operatives × hours)

200.00 250.00 150.00 200.00

Variable overhead per order 2.40 2.40 2.60 2.60Total variable cost 4 202.40 5 257.40 3 742.60 4 802.60Fixed costs per order 200.00 200.00 500.00 500.00Total cost 4 402.40 5 457.40 4 242.60 5 502.60Required profit + 25% 1 050.60 1 060.65


191

a i 123/P order is more cheaply done on machine Y.

ii 382/Q order is more cheaply completed on machine X.

b Machine X Machine Y

$ $Selling price (cost plus profit from above) 5 453.00 5 303.25Variable cost 4 202.40 3 742.60Contribution = SP – VC 1 250.60 1 560.65

c • Rights issue:

Advantage: shares offered to existing shareholders, therefore no loss of control.

Disadvantage: not all the rights may be taken up by existing shareholders, therefore all the money may not be raised. (They may not have sufficient spare funds to invest.)

• Issue of shares to the public:

Advantage: all the money should be received.

Disadvantage: will result in reduced extent of control of the company by the present owners / majority shareholders

• Issue of debentures:

Advantage: all the money should be received.

Disadvantage: lenders may require security for the debt from the company and the company has a fixed commitment to repay both the capital and interest.

2 a i 15 000 units:

Per unit $

Direct material (4 × $4.10) 16.40

Direct labour (13

× $12) 4.00

Variable overhead 1.80Marginal cost 22.20Selling price 25.00Contribution 2.80

Profit: $(15 000 × 2.8) − $30 000* = $(42 000 − 30 000) = $12 000.

*($1.5 × 20 000 = $30 000)

ii 18 000 units:

Per unit $

Material 16.40Labour 4.00Variable overhead 1.79Marginal cost 22.19Selling price 25.00Contribution 2.81

Profit = (18 000 × $2.81) – $30 000 = $50 600 (rounded) – $30 000 = $20 600.

*(16 000 × $1.8 + 2 000 × $1.7) = 18 000


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b Fixed costs are (full production) 20 000 × $1.50 = $30 000.

Contribution per unit (up to 16 000 units from i, above) = 2.80.

Contribution from 16 000 units = $44 800. This is in excess of break-even, so no need to consider production when semi-variable costs change.

Break-even point = fixed costs / contribution per unit – 30 000 / 2.80 = 10 715 units.

c 20 000 units sold at $24 per unit:

$ $ $

Revenue 480 000Material (20 000 × $16.40) 328 000Labour (20 000 × $4) 80 000Variable overhead16 000 × $1.80 28 8004 000 × $1.70 6 800 35 600 443 600Contribution 36 400Less: fixed overheads 30 000Profit 6 400

d A selling price may be lowered with advantage to:

• increase demand for the good

• undercut the prices of competitors

• maintain full production

• sell slow-moving inventory

• introduce a new product.

Possible disadvantages are:

• the start of a price war with competitors

• fixed overheads may not be covered

• the product may be sold below the cost of production if the marginal cost is not known.

The price of $24 earns a positive contribution, so could be accepted if there is no other work available and maximum sales are assured. However the calculations show that the company makes more profit at lower volumes of sales if it is able to maintain the selling price at the original level.

e The following assumptions are made when break-even charts are prepared (any three):

• Fixed costs remain fixed at all levels of activity, but costs are only fixed within certain limits of activity and are more likely to be ‘stepped’ as activity increases.

• All costs may be classified as either fixed or variable. But many costs cannot easily be classed as fixed or variable.

• Variable costs vary directly with the output in units. But variable costs may decrease with the level of activity because quantity discounts are received on purchases of materials, or labour costs increase because overtime has to be paid to workers to achieve the level of activity.

• Revenue will increase proportionately to the volume of sales. But it may be necessary to discount prices to achieve the desired volume of sales.

• All the resources required for production will be available. But there may be limiting factors affecting materials, labour or demand for the product.


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2 D

3 D

4 D

Structured questions1 a i A variable cost is one which can be attributed directly to the unit of production. It

increases in direct proportion to changes in the level of activity.

ii A fixed cost is one which does not change as production increases or decreases within a certain range.

iii A semi-variable cost is one which contains both a fixed and variable element.

b Calculation of break-even point in units and value:

Calculation Per unit

$Revenue $80 000 ÷ 4 000 20Direct material $32 000 ÷ 4 000 8Direct labour $12 000 ÷ 4 000 3Semi-variable cost (W1) 2Total variable cost 13Contribution 7

Break-even point calculation

Total fixed costs $(10 000 + 6 000) ÷ 7 = 2 286 units

Break-even point = 2 286 × $20 = $45 720

W1:

Units Value

$6 000 18 0004 000 14 000

Change 2 000 4 000

Variable element = $4 000 ÷ 2 000 = $2

Fixed element = $18 000 – (6 000 × $2) = $6 000

c Margin of safety = 6 000 units – 2 286 units = 3 714

d To make a profit of $40 000:

Total required = fixed costs $16 000 + required profit $40 000 = $56 000 ÷ 7 = 8 000 units

e Although the company has spare capacity and is able to produce the extra units, should it do so? By producing them it may avoid having to make staff redundant or cut down on deliveries from suppliers, both of which may have a negative effect on the image of the company. If it does increase production then it may not be able to sell the extra, or sell it at the full price. If it fails to sell the extra then it will have surplus inventory which may deteriorate and have to be scrapped at a cost to the company, both of the original production and scrapping. If it has to reduce the selling price to get rid of the extra then


194

existing customers who are paying full price may find out. They will also ask for a lower price or may even change suppliers.

However, if management can work through these possible difficulties then it may be possible to produce and sell the extra production. In essence, the management needs to be confident that it can obtain a positive contribution from the additional sales without there being any negative effect on future selling prices.

f (Assuming the current budgeted output is 6 000 units.)

Option 1:

Additional fixed costs = $9 800

Additional contribution = 1 200 units × $7 = $8 400

Cost to company = $(9 800 – 8 400) = $1 400

Option 2:

Contribution on 8 750 units = 8 750 × $(7-2) = $43 750

Contribution on 6 000 units = 6 000 × $7 = $42 000

On the basis of these calculations the company should choose option 2. Doing so will increase the total contribution and, assuming that there is no increase in fixed costs, then it will also increase the overall profit. With option 1, the cost of advertising is greater than the extra contribution earned and should not be considered.

2 a A limiting factor is something which stops a company making its budgeted production. It may be a shortage of material or labour, space or cash. Once it has been identified then any budget should be constructed taking the limiting factor into account.

b Exe Wye Zed

Material per unit (kg) 2 3 4Total budgeted output 5 000 4 000 2 000Total kg per product 10 000 12 000 8 000 = 30 000 kg

c Exe Wye Zed Total

Budgeted sales (units) 5 000 4 000 2 000Contribution per unit ($) 13 12 14Total contribution ($) 65 000 48 000 28 000 141 000Budgeted fixed costs ($) 82 000Budgeted profit ($) 59 000

d Exe Wye Zed

Contribution per kg ($) 6.50 4.00 3.50Order of production 1 2 3

i If 2 000 of each unit is made:

Total Exe Wye Zed

Kgs 18 000 4 000 6 000 8 000Available 6 000 6 000 - -

24 000 10 000 6 000 8 000Contribution per kg ($) 6.50 4.00 3.50Total contribution ($) 117 000 65 000 24 000 28 000Fixed costs ($) 82 000Profit ($) 35 000


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ii Make as much as possible in most profitable order if no minimum production requirement of any product is put in place:

Total Exe Wye Zed

Output 5 000 4 000 500Total kgs 24 000 10 000 12 000 2 000Contribution per kg ($) 6.50 4.00 3.50Total contribution ($) 120 000 65 000 48 000 7 000Fixed costs ($) 82 000Profit ($) 38 000

e There is very little difference in budgeted total profit between the two options (because Wye and Zed make similar levels of contribution). Purely on financial grounds option ii should be chosen as it makes the most profit. However, this will result in only 500 units of Zed being made. Option i means that all of Zed and Exe will be made, but less Wye. This may affect the decision when taking into account customer requirements. If by choosing option i they make customers for Wye unhappy, then option ii should be chosen. If by choosing option ii they make customers of Zed unhappy then option i should be chosen.


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31 Activity-based costing (ABC)ActivitiesActivity 1a Budgeted overhead absorption rate using direct labour hours:

Total storage costsTotal direct labour hours

$$

6000025000

= 22 40.

b Amount of storage costs charged to each product using direct labour hours:

Children’s Adult’s

Direct labour hours 10 000 15 000Storage costs charged $24 000 $36 000

c Storage costs charged when using activity based costing:

Total storage costsTotal rolls of cloth

$$ .

600005000

12 00=

Amount charged to each product:

Children’s Adult’s

Rolls of cloth 1 000 4 000Storage costs charged $12 000 $48 000

Activity 2a Total overheads $216 000 ÷ total direct labour hours (12 000 + 24 000) = $6 per direct

labour hour.

b Tables Chairs

$ $Selling price per unit 200 80Less:Direct material and labour 80 30Factory overhead* 24 12Profit per unit 96 78

* Factory overhead per unit = 4 × $6 for tables and 2 × $6 for chairs.

Activity 3a Activity Tables Chairs Total Cost Absorption rate

for cost driver

$ $Machine maintenance

3 500 5 500 9 000 108 000 12

Materials handling 500 700 1 200 72 000 60Packing 700 1 100 1 800 36 000 20

216 000


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b Allocation of total costs:

Activity Tables Chairs Total

$ $ $Machine maintenance 42 000 66 000 108 000Materials handling 30 000 42 000 72 000Packing 14 000 22 000 36 000Total cost 86 000 130 000 216 000Cost per unit (to two decimal places)(units from Activity 2)

$86 000 / 3 000 units = $28.66

$130 000 / 12 000 units = $10.83

Activity 4

a Tables b Chairs

$ $Selling price per unit 200.00 80.00Less:Direct materials and labour 80.00 30.00Factory overhead using ABC$86 000 ÷ 3 000 28.66$130 000 ÷ 12 000 10.83Profit per unit using ABC 91.34 39.17

Practice exercises1 a Total overheads $110 000 ÷ total direct labour hours (14 000 + 13 500) = $4.00 per direct

labour hour.

b Pin Qua

$ $Selling price per unit 500.00 300.00Less:Direct material and labour 200.00 80.00Factory overhead* 20.00 6.00Profit per unit 280.00 214.00

* Factory overhead per unit = 5 × $4.00 for Pin and 1.5 × $4.00 for Qua.

c Two advantages of ABC:

• links overheads with their cause

• identifies areas where cost savings can be made.

Two disadvantages of ABC:

• time consuming to identify costs drivers and not every cost has a cost driver

• expensive to set up and collect data as often requires specialist staff.


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d Allocation of overheads allocated to each product using ABC:

Activity Pin Qua Total Cost Absorption rate for

cost driver

$ $Machine set up costs 300 100 400 20 000 50.00Machine maintenance 8 000 2 000 10 000 40 000 4.00Forklift truck costs 350 150 500 50 000 100.00

110 000

Allocation of total costs:

Activity Pin Qua Total

$ $ $Machine set up costs 15 000 5 000 20 000Machine maintenance 32 000 8 000 40 000Forklift truck costs 35 000 15 000 50 000

82 000 28 000 110 000Per unit:Pin ($82 000 ÷ 2 800) 29.29Qua ($28 000 ÷ 9 000) 3.11

e Profit per product using ABC:

Pin Qua

$ $Selling price per unit 500.00 300.00Less:Direct materials and labour 200.00 80.00Factory overhead using ABC 29.29 3.11Cost per unit 229.29 83.11Profit per unit using ABC 270.71 216.89

f Pin Qua

$ $Profit using absorption costing 280.00 214.00Profit using ABC 270.71 216.89Difference (9.29) 2.89

This is also the difference in overheads per unit under the two methods.

g There is very little difference between the two profit per unit figures. On this basis, therefore, there seems little point in Khalid changing his method of costing. By the same token, the data may give Khalid some ideas as to which areas to concentrate on in order to reduce his total costs for that particular activity. Using ABC, Khalid can ask price and operational questions: Can I reduce the cost of machine set-up? Can I rearrange production to reduce the frequency of machine set-ups? He can ask himself similar questions about maintenance costs and time spent, and on fork lift costs and numbers of movements.


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In this respect, the analysis by ABC can have some benefit. However, Khalid is recommended not to change from his present method unless he considers that these advantages will outweigh the extra time and cost of setting up the system and collecting the data.

2 a Straight Flared

Per unit $ $Direct material 13.00 15.00Direct labour 3.00 3.00Production overheads* 15.00 20.00Total cost per unit 31.00 38.00Add: profit 15.50 19.00Budgeted selling price 46.50 57.00

* Factory overheads:

Absorption rate = $360 000 ÷ 12 000 = $30 per hour.

Machine hours per unit:

Straight = 4 000 ÷ 8 000 = 0.5. 0.5 hours × $30 = $15.

Flared = 8 000 ÷ 12 000 = 0.67. 0.67 hours × $30 = $20.

b Absorption costing charges overheads to products on some predetermined basis, often reflecting the method of production. In this case, they are charged on the basis of machine hours, presumably because the manufacturing process is machine intensive.

ABC charges overheads to products on the basis of cost drivers, that is, to key activities that form part of the production process. This identifies how much of a particular cost the production of the product generates. To do this means all the activities involved in producing a product have to be identified. The different activities are placed in cost pools. So there may be cost pools for machine set up costs and machine maintenance costs. It is then necessary to determine how much of each activity the production of a product takes. The theory is that if no production of a product takes place then none of that cost will be incurred. In other words, the production of a product is responsible for the cost being incurred, or the amount of the cost is driven (cost driver) by the level of production of a particular product.

c i Allocation of total costs:

Activity Straight Flared Total

$ $ $Machine stet up costs 40 000 56 000 96 000Machine maintenance 73 333 126 667 200 000Inspection 25 600 38 400 64 000Total 138 933 221 067 360 000Per unit:Straight ($138 933 ÷ 8 000) $17.37Flared ($221 067 ÷ 12 000) $18.42

Budgeted cost per unit:

Straight Flared

$ $Direct material 13.00 15.00Direct labour 3.00 3.00Overheads 17.37 18.42

33.37 36.42


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ii Budgeted selling price:

Straight Flared

$ $Cost per unit 33.37 36.42Mark up +50% 16.69 18.21

50.06 54.63

d By changing from absorption costing, using machine hours as the basis of absorbing overheads to ABC, Straight dresses become slightly more expensive and Flared dresses slightly less expensive to make.

At present, the Straight style is the lower seller of the two in terms of unit sales. If ABC is used and their price is increased then the number of sales may decrease. By the same token, if Flared dresses are reduced in price then their sales may increase.

Liz needs to identify by how much the unit sales may change for each style if she changes the selling price as a result of ABC. It is also worth stating that the difference in cost (and therefore in budgeted selling price) between each method is very little.

Both methods of costing are approximations, but the purpose of ABC is to try and give a more complete picture of how costs are incurred and thus enable management to try to identify potential cost savings, either by reducing costs or by reducing the numbers of activities (the cost drivers) that occur, for example by better planning. For example, can either or both production processes be rearranged to reduce the number of times machines need to be set up?

It is recommended, therefore, that whilst she takes into account the findings of ABC, she should not change her selling price as a result of it. ABC is more complicated to calculate and there is no guarantee that the allocation of overheads made by it make it any more accurate.


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32 Budgeting and budgetary controlActivitiesActivity 1

Martha and Florence LimitedSales budget for six months ending 30 June

January February March April May JuneUnit sold 1 000 1 200 1300 1 500 1 700 1 800Price per unit $20 $20 $20 $22 $22 $22Revenue $20 000 $24 000 $26 000 $33 000 $37 400 $39 600

Activity 2

Martha and Florence LimitedProduction budget for six months ending 30 June

December January February March April May JuneProduction (following month’s sales in units)

1 000 1 200 1 300 1 500 1 700 1 800 2 000

Add 10% 100 120 130 150 170 180 200Monthly production 1 100 1 320 1 430 1 650 1 870 1 980 2 200

Activity 3a J Limited

Direct labour budgetJan Feb March

Production (units) 2 200 2 400 2 600Direct labour (hours) 4 400 4 800 5 200Direct labour cost ($) 44 000 48 000 52 000

b Direct labour to be included in cash budget:

J LimitedDirect labour budget

Dec Jan Feb March$ $ $ $

Direct labour cost in month 40 000 44 000 48 000 52 000Paid in month (80%) 35 200 38 400 41 600From previous month (20%) 8 000 8 800 9 600To include in cash budget 43 200 47 200 51 200

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Activity 4

Martha and Florence LimitedPurchases budget for the period December to June

November* December January February March April May JuneUnits of production

1 100 1 320 1 430 1 650 1 870 1 980 2 200 2 100

Material required (litres)

2 750 3 300 3 575 4 125 4 675 4 950 5 500 5 250

Price per litre

$4.10 $4.10 $4.10 $4.10 $4.25 $4.25 $4.25 $4.25

Purchases $11 275 $13 530 $14 658 $16 913 $19 869 $21 038 $23 375 $22 313

*November has been included as part of the answer in order to show the build-up for the December purchases.

Activity 5

Martha and Florence LimitedExpenditure budget for six months ending 30 June

January February March April May June$ $ $ $ $ $

Purchases 13 530 14 658 16 913 19 869 21 038 23 375Wages 4 000 4 000 4 000 4 000 4 000 4 000Bonus – – 160 240 520 696Electricity – 2 400 – – 1 800 –Other expenses 6 000 6 000 6 000 6 600 6 600 6 600Interest on loan – – 500 – – 500Dividend – – – 4 000 – –Purchase of machine – – – – 15 000 –

23 530 27 058 27 573 34 709 48 958 35 171

Activity 6a Workings:

November December January February March April May June$ $ $ $ $ $ $ $

Revenue 18 000 17 600 20 000 24 000 26 000 33 000 37 400 39 600Cash sales 9 000 8 800 10 000 12 000 13 000 16 500 18 700 19 800Credit sales 9 000 8 800 10 000 12 000 13 000 16 500 18 700 19 800After one month 7 200 7 040 8 000 9 600 10 400 13 200 14 960Discount 180 176 200 240 260 330 374

Cash after one month

7 020 6 864 7 800 9 360 10 140 12 870 14 586

After two months 1 800 1 760 2 000 2 400 2 600 3 300

203


Martha and Florence LimitedTrade receivables budget


Opening balance (1 800 + 8 800) 10 600 11 760 14 000 15 400 19 100 22 000Credit sales for month 10 000 12 000 13 000 16 500 18 700 19 800

20 600 23 760 27 000 31 900 37 800 41 800Less: cash received1 month 6 864 7 800 9 360 10 140 12 870 14 586Discount 176 200 240 260 330 3742 months 1 800 1 760 2 000 2 400 2 600 3 300Closing balance 11 760 14 000 15 400 19 100 22 000 23 540

b Workings:

November December January February March April May JunePurchases 11 275 13 530 14 658 16 913 19 869 21 038 23 375 22 313

Payment 13 530 14 658 16 913 19 869 21 038 23 375

Martha and Florence LimitedTrade payables budget


Opening balance 13 530 14 658 16 913 19 869 21 038 23 375Purchases 14 658 16 913 19 869 21 038 23 375 22 313

28 188 31 571 36 782 40 907 44 413 45 688Less: payments 13 530 14 658 16 913 19 869 21 038 23 375Closing balance 14 658 16 913 19 869 21 038 23 375 22 313

Activity 7a Greenfields Limited

Cash budget for the four months ending 30 April 2017January February March April

$ $ $ $ReceiptsCash sales 25 000 28 000 30 000 33 000Trade receivables 42 500 37 500 42 000 45 000

67 500 65 500 72 000 78 000PaymentsTrade payables 22 500 25 000 20 000 30 000Selling and distribution 6 250 7 000 7 500 8 250Administration 20 000 20 000 20 000 20 000Purchase of plant – – 60 000 –Dividend – – – 6 500

48 750 52 000 107 500 64 750Net receipts/(payments) 18 750 13 500 (35 500) 13 250Balance b/f 20 750 39 500 53 000 17 500Balance c/f 39 500 53 000 17 500 30 750

204


b Greenfields LimitedBudgeted income statement for the four months ending 30 April 2017

$ $Revenue 290 000Cost of salesOpening inventory 30 000Purchases 112 500

142 500Closing inventory 22 500 120 000Gross profit 170 000Selling and distribution expenses (W2) 32 500Administration expenses (W3) 83 500 116 000Profit from operations 54 000Interest on debentures (W4) 1 000Profit for the year 53 000Ordinary dividend 6 500Transfer to general reserve 25 000 31 500Retained earnings for the year 21 500

Workings:

1 Depreciation: Premises 4/12 × 3% × $50 000 = 500

P&M 4/12 × 20% × $97 500 = 6 500

Total $7 000

(Working 1 is needed for workings 2 and 3.)

2 Selling and distribution 10% × $290 000 + 50% × $7 000

3 Administration 4 × $20 000 + 50% × $7 000

4 Debenture interest 4/12 × 12% × $25 000

Note:

Although this is not the correct layout for published accounts, as there is no request for a statement of changes in equity, it is perfectly acceptable for management accounts.

c Greenfields Limited Budgeted statement of financial position at 30 April 2017

Cost Accumulateddepreciation

Net bookvalue

Non-current assets $ $ $Freehold premises 50 000 10 500 39 500Plant and machinery 97 500 29 000 68 500

147 500 39 500 108 000Current assetsInventory 22 500Trade receivables 49 500Cash and cash equivalents 30 750


(cont.)


205


Cost Accumulateddepreciation

Net bookvalue

$ $ $Equity and liabilitiesCapital and reservesOrdinary shares of $1 65 000General reserve 55 000Retained earnings 27 250

147 250Non-current liability12% debentures 2019/2020 25 000Current liabilitiesTrade payables 37 500Other payablesDebenture interest accrued 1 000

38 500Total equity and liabilities 210 750

Practice exercises1 a Banner Limited

Cash budget for four months January to AprilDetails January February March April

$ $ $ $IncomeFrom sales: one month after sale 180 000 205 000 212 000 230 000From sales: two months after sale 400 000 360 000 410 000 424 000Sale of old machine 4 000Total receipts 580 000 565 000 622 000 658 000ExpenditurePurchases of material paid in month 28 600 29 700 33 000 32 000Materials paid two months after purchase 81 000 79 500 85 800 89 100Wages paid in month 20 000 22 000 24 000 26 000Wages paid in following month 10 000 10 000 11 000 12 000Overheads paid in month 180 000 195 000 206 000 210 000Overheads paid in following month 190 000 180 000 195 000 206 000Purchase of new machine 45 000Total expenditure 509 600 516 200 599 800 575 100Surplus/(deficit) of income over expenditure 70 400 48 800 22 200 82 900Opening bank balance (63 000) 7 400 56 200 78 400Closing bank balance 7 400 56 200 78 400 161 300

206


b Accruals appearing in the statement of financial position at 30 April:

$ $Direct materialMarch ($132 × ¾) 99April ($128 × ¾) 96 195Wages: April ($39 × ⅓) 13Overheads: April ($420 × ½) 210New machine 45Accruals (Other payables) 463

2 a i Roh LimitedProduction budget in units For month of July 2017 For month of August 2017

Units UnitsSales 800 1 000Less: opening inventory (880) (1 100)Add: closing inventory 1 100 990Production 1 020 890

Note: The July budget is needed later in the question.

ii Roh LimitedPurchases budget For the month of

July 2017For the month of

August 2017Production in units 1 020 890Kgs of material required (units × 3) 3 060 2 670Cost of purchases (kgs × $4) $12 240 $10 680

Note: The July budget is needed later in the question.

iii Roh LimitedCash budget for the month of August 2017

$IncomeFrom sales (July units × $60) 48 000ExpenditurePurchases of (July) material 12 240Wages (monthly production × 2 hours × $8) 14 240Variable overheads (monthly production × 2 hours × $14) 24 920Fixed overheads (monthly production × 2 hours × $3.50) 6 230Total expenditure 57 630Surplus/(deficit) of income over expenditure (9 630)Opening bank balance (per question) 16 000Closing bank balance 6 370


207

b A principal budget factor is something which limits the activities of the organisation. It is also known as a limiting factor. It may be sales level or quantity of raw materials, cash or space. It is important that this is identified as it indicates which budget should be prepared first. Usually it is the sales budget which is the principal budget factor.

c Budgets are an essential part of managing a business. They force managers to think about what will happen in the next year, or even years, as far as the business is concerned. The planning aspect is one of the two principal benefits of preparing a budget. The second aspect is control. By collecting the actual data, it can then be compared with the planned (budget) data and corrective actions taken as necessary. The directors are correct that it takes time to prepare a budget, but that time is well spent as it gives the business direction and focus, by co-ordinating all the business activities.

Therefore the accountant should continue to prepare the budgets for Roh Limited.

3 a AlanCash budget for three months ending 30 June 2017

Details April May JuneIncome from customers from two months ago 2 400 2 200Income from customers from previous month 9 600 8 800 11 200Total income from customers 9 600 11 200 13 400ExpenditurePayments to suppliers 10 000 8 000 9 000Monthly overheads 4 000 4 000 4 000Monthly drawings 2 000 2 000 2 000New delivery vehicle 4 000Total expenditure 16 000 14 000 19 000Surplus/(deficit) of income over expenditure (6 400) (2 800) (5 600)Opening bank balance (2 000) (8 400) (11 200)Closing bank balance (8 400) (11 200) (16 800)

b AlanBudgeted income statement for three months ending 30 June 2017

$ $Revenue ($11 000 + $14 000 + $15 000) 40 000Opening inventory 4 000Add: purchases ($8 000 + $9 000 + $9 500) 26 500

30 500Less: closing inventory (5 000) 25 500Gross profit 14 500ExpenditureMonthly overheads ($4 000 × 3) 12 000

Loan interest ($15 000 × 10% × 3

12 ) 375

Depreciation (36 000 × 10% for 3 months) 900 13 275Profit for the period 1 225


208

c Two advantages of preparing budgets:

• It aids business planning and control.

• It is motivational as it gives managers a target to work towards.

Two disadvantages of preparing budgets (any two):

• It takes time to prepare them.

• Managers may try to build some ‘slack’ into their budget in order to achieve them.

• Managers may aim to ‘achieve budget’ rather than do their best.

d In every month Alan’s cash income is exceeded by his cash expenditure. The closing bank balance is increasingly overdrawn; the bank may threaten to close the business.

• Alan has just about broken even for the three-month period. As he is making very little profit, Alan’s drawings are not only a drain on cash flow, but are in excess of his entitlement.

• He should consider reducing his drawings.

• He is paying his suppliers more quickly than his customers are paying him. This is not a good situation, as it worsens cash flow.

• He should try to reverse this so that his customers pay him before he pays his suppliers.

• He might also consider delaying the purchase of the new vehicle or perhaps leasing one rather than buying it.

• Perhaps he could also reduce his purchases to reduce his inventory.

• He should urgently assess whether he can take sufficient actions in total to ensure that the business can achieve sustained profits and positive cash flows in the future:

• If he cannot do so, he will have to consider closing the business.

• If he thinks he can do so, he should consider raising additional finance.


2 B

3 B

4 A


209

33 Standard costingActivitiesActivity 1

Jumal Budgeted profit statement for next six months

$ $Revenue:Bicycles (4 000 × $600) 2 400 000Tricycles (2 500 × $250) 625 000

3 025 000Cost of sales:Direct materialBicycles (10 × $45 × 4 000) 1 800 000Tricycles (4 × $45 × 2 500) 450 000Direct labourBicycles (2 × $10 × 4 000) 80 000Tricycles (1 × $10 × 2 500) 25 000 2 355 000Gross profit 670 000Fixed overheads 42 000Profit for the period 628 000

Activity 2Breakfast Limited

Flexed budget for the production of 110 000 packets of cereal

$Variable expensesDirect materials 22 000Direct labour 16 500Production expenses 6 600

45 100Fixed expensesProduction expenses 13 000Administration 29 000

87 100

Activity 3a Selling and distribution costs for 8000 pairs of sunglasses:

$4 000 + (8 000 × $3) = $28 000.

b Flexed budget cost statement for 8 000 pairs of sunglasses:

$Direct materials 16 000Direct labour 24 000Production overheads 22 000Selling and distribution 28 000Administration 12 000Total cost 102 000


210

Activity 4No. of locks 9 000 $Direct materials 22 500Direct labour 54 000Production overhead 34 000Selling and distribution 30 000Administration 80 000 220 500

Activity 5Underpart Limited

Flexed budget statement

Flexed budget Actual VariancesNo. of units 6300 6300

$ $ $Revenue 157 500 163 800 6 300Direct materials 21 420 20 890 530Direct labour 42 525 44 065 (1 540)Variable overheads 3 150 3 250 (100)Fixed overhead 62 000 62 000 –Total cost 129 095 130 205 (1 110)Profit 28 405 33 595 5 190

Activity 6a Sales volume variance = (9 500 − 10 000) × $15 = $7 500 adverse.

b Sales price variance = $(15.50 − 15) × 9 500 = $4 750 favourable.

Activity 7a Direct materials usage variance = (9 500 − 9 700) × $6 = $1200 adverse.

b Direct materials price variance = $6 − [$57 715 ÷ 9 700] × 9 700 = $485 favourable.

c Total direct material variance = ($6 × 9 500) − $57 715 = $715 adverse.

This is equal to the net of the price and usage variances $(1 200 − 485) = $715 adverse.

Activity 8a Direct labour efficiency variance = (9 500 − 9 450) × $4 = $200 favourable.

b Direct labour rate variance = $(4 − 3.98) × 9 450 = $189 favourable.

c Total direct labour variance = (9 500 × $4) − (9 450 × $3.98) = $389 favourable.

This is equal to the sum of the two favourable variances for rate and efficiency $(200 + 189) = 389 favourable.

Activity 9The standard total direct labour cost for the production of 12 000 packets of Pickup:

= $10 × 12 000 = $120 000.

Actual hours taken 12 000 × 1.25 = 15 000.

The direct labour efficiency variance = (12 000 − 15 000) $10 = $30 000 (A).


211

The direct labour rate variance = $(10 − 8.50) 15 000 = $22 500 (F).

Check:

Actual labour cost of production of 12 000 packets of Pickup:

= 1.25 hours × $8.50 × 12 000 = $127 500.

Total labour variance = $7 500 (A) = $(30 000 (A) – $22 500 (F)) (as above).

Activity 10a Fixed overhead expenditure variance = $(20 000 − 19 800) = $200 favourable.

Before calculating the remaining overhead variances it is first necessary to work out the budgeted fixed overhead absorption rate:

Budgeted fixed overhead absorption rate = $20 000 ÷ 10 000 = $2 per direct labour hour.

b Fixed overhead volume variance:

9500 units should have taken 9 500 hours.

10 000 units should have taken 10 000 hours.

Volume variance = (10 000 − 9 500) × $2= $1 000 adverse (because less hours were worked than planned).

c Fixed overhead capacity variance:

Budgeted direct labour hours = 10 000.

Actual direct labour hours = 9 450.

Capacity variance = (10 000 − 9 450) × $2 = $1 100 adverse.

d Fixed overhead efficiency variance:

9500 units should have taken 9500 hours.

They actually took 9 450 hours.

Efficiency variance = (9 500 − 9 450) × $ 2 = $100 favourable.

Proof: the fixed overhead volume variance = $1 000 adverse. This is equal to capacity variance $1 100 adverse + efficiency variance $100 favourable.

e Statement reconciling total fixed overhead variance with the expenditure and volume variances:

$Fixed overhead expenditure variance 200 (F)Fixed overhead capacity variance 1 100 (A)Fixed overhead efficiency variance 100 (F)Total fixed overhead variance 800 (A)

Activity 11Before preparing the statement it is first necessary to calculate the budgeted cost per unit for Polonius Limited, using the results of previous activities:

$Direct material 6Direct labour 4Fixed overhead 2

Budgeted cost per unit 12


212

Polonius Limited Statement to reconcile the standard cost of production

with the actual cost of production

Favourable variances

Adverse variances

Total

$ $ $Standard cost of production (9500 × $12) 114 000Direct material price variance 485Direct material usage variance (1200)Direct labour rate variance 189Direct labour efficiency variance 200Fixed overhead expenditure variance 200Fixed overhead volume variance* (1000)

1074 (2200) (1 126)Actual cost of production** 115 126

*The total overhead volume variance has been included. The overhead capacity and efficiency variances could have been used with the same net result, but not all three variances.

**Actual cost:

$Direct materials 57 715Direct labour 37 611Fixed overheads 19 800

115 126

Activity 12Calculation of profit:

Budget Actual

$ $Revenue 142 500 147 250Less: costs (114 000) (115 126)Profit 28 500 32 124

Polonius Limited Statement reconciling actual and flexed budget profits

$Flexed budget profit 28 500Sales price variance 4 750

33 250Less: total cost variances (1 126)Actual profit 32 124

Note: Notice only the sales price variance is included in this reconciliation. The volume variance is ignored.


213

Activity 13Cantab Limited

Calculation of actual profit made in a three-month period

$ $Profit per master budget 98 970Add: favourable variances Sales volume 6 210Materials price 9 635Labour efficiency 10 500 125 315Less: adverse variances Quantity 17 009 Sales price 3 730 Materials usage 6 280 Labour rate 7 840 Overhead expenditure 5 760 40 619Actual profit 84 696

Activity 14a Workings:

Direct material:

Standard cost per kg $7 200300 × 4

= $6 per kg.

Standard usage for 400 units = 4 × 400 kg = 1 600 kgs.

Actual material per unit: $9 000$6.25 × 400

= 3.6 kgs.

Actual usage 400 × 3.6 kg = 1 440 kgs.

Direct labour: standard hours per unit $6 600$11 × 300

= 2 hours.

Standard hours for 400 units = 800.

Actual hours for 400 units = 400 × 2.25 = 900.

Actual cost per hour $10 890400 × 2.25

= $12.10.

i Direct material usage variance:

(1 600 − 1 440) × $6 = $960 (F).

ii Direct material price variance:

$(6.00 − 6.25) × 1 440 = $360 (A).

iii Direct labour efficiency variance:

(800 − 900) × $11 = $1 100 (A).

iv Direct labour rate variance:

$(11.00 − 12.10) × 900 = $990 (A).

b The favourable material usage variance may be due to a better quality of material being used resulting in less wastage during production. This view may be supported by the adverse price variance which suggests that a better quality of material was more expensive than standard.

Both of the labour variances are adverse. The higher hourly rate of pay has not resulted in a favourable efficiency variance, even though the workers may have been working with a better quality of material. The adverse efficiency variance does not suggest that the higher rate of pay was due to the employment of a more skilled work force. It is possible that a pay increase given to the workers was below their expectation and they are poorly motivated as a result. The reason for the adverse variances can only be discovered by further investigation.


214

Practice exercises1 a If a business does not prepare a flexed budget then it is not comparing like with like. It is

very rare that the actual and budgeted figures are the same. In order to make a meaningful comparison between the two sets of data then the budget must be flexed to what the figures would have been for the actual output and sales.

b Workings:

Actual direct material cost $(80 000 − 6 200) = $73 800.

Actual cost per kg = $73 800 ÷ 18 000 = $4.10 per kg.

Actual direct labour cost = $(300 000 + 18 400) = $318 400.

Actual direct labour hours = $318 400 ÷ $9.95 = 32 000 hours.

Budgeted overhead absorption rate = $77 550 ÷ (11 000 × 3) = $2.35 per direct labour hour.

i Material price variance = $(4.00 − 4.10) × 18 000 = $1 800 adverse.

ii Material usage variance = (20 000 − 18 000) × $4 = $8 000 favourable.

iii Labour rate variance = $(10.00 − 9.95) × 32 000 = $1 600 favourable.

iv Labour efficiency variance = (30 000 − 32 000) × $10 = $20 000 adverse.

v Fixed overhead expenditure variance = $(77 550 − 74 000) = $3 550 favourable.

vi Fixed overhead volume variance = [(11 000 × 3) − 32 000] × $2.35 = 2350 adverse.

c i Possible causes for the material price variance is change to a more expensive supplier or supplier increased price more than budgeted.

Possible causes for the labour efficiency variance are poor management control over workers, perhaps more were recruited than was budgeted, or perhaps the material which was bought, if from a new supplier, was of a lower quality meaning more scrap and workers having to work longer to complete the output.

Also possible was that the workforce was less skilled than planned (for example due to high staff turnover).

ii In order to improve the adverse labour variance, tighter control over labour is required. An alternative is to offer labour a bonus to complete the work more quickly. However, the cost of any bonus must be less than the efficiency variance and output quality must be monitored to ensure workers are not rushing to complete the work at the expense of reduced quality. Training may help.

2 a When the actual results for a period are compared with the flexed budget results, there is usually a difference between the two sets of figures. This difference is known as a variance. Management needs to analyse variance to identify the cause of the difference between the two sets of figures. Once the causes have been identified then corrective action can be taken as necessary.

b i Total material variance:

Flexed budget fuel cost = (130 000 × $1.20) ÷ (6 500 × 5 900) = $141 600.

Total material variance = $141 600 − 175 000 = $33 400 adverse.

ii Total labour variance:

Budget labour cost = $82 875 ÷ 9 750 = $8.50 per direct labour hour.

Flexed budget direct labour hours = 9 750 ÷ 6 500 × 5900 = 8850.

Total labour variance = (8 850 × $8.50) − (9 000 × $8.65) = $2 625 adverse.

iii Fixed overhead expenditure variance = $62 400 − 58 000 = $4 400 favourable.

iv Fixed overhead absorption rate = $62 400 / 7 800 units = $8 / unit. Hence:

Fixed overhead capacity variance = (7 800 − 7 200) × $8 =$4 800 adverse.

v Fixed overhead efficiency variance:

Flexed budget operating hours = (7 800 ÷ 6 500) × 5 900 = 7 080.

Variance = (7 080 − 7 200) × 8 = 960 adverse.


215

c Calculation of flexed budgeted cost of sailings:

$Fuel 141 600Direct labour (8850 × $8.50) 75 225Fixed overheads (7080 × $8) 56 640Total flexed budgeted cost 273 465

Seaview Ferries Limited Statement to reconcile the actual cost of sailings with the standard cost of sailings

Favourable variances

Adverse variances

Total

$ $ $Standard cost of actual sailings 273 465Total fuel variance (33 400)Total direct labour variance (2 625)Fixed overhead expenditure variance 4 400Fixed overhead capacity variance (4 800)Fixed overhead efficiency variance (960)

4 400 (41 785) (37 385)Actual cost of actual sailings* 310 850

*Actual cost:

$Fuel 175 000Direct labour 77 850Fixed overheads 58 000

310 850

d The directors should include sales variances in their analysis. By doing so it will enable them to find out more information on performance which, at present, they don’t seem to have. By setting and analysing sales variances, the directors could assess the impact on profitability of changing passenger numbers and changing fares, respectively. In order to analyse the profitability of each route, they would also need to prepare cost budgets for each of the three journeys (‘products’).

3 a Calculation of budgeted selling price per unit:

$Direct material (2 kg × $5 per kg) 10Direct labour (3 hours × $10 per hour) 30Total variable cost 40Add: Mark-up (40 × 50%) 20Budgeted selling price per unit 60

b Statement to show the actual contribution for the month of June:

$ $Revenue (5200 × $58) 301 600Direct material (10 920 × $4.80) 52 416Direct labour (16 640 × $10.50) 174 720 227 136Actual contribution 74 464


216

c i Sales price variance = $(58 − 60) × 5 200 = $10 400 (A)

ii Direct material price variance = $(5.00 − 4.80) × 10 920 = $2 184 (F)

iii Direct material usage variance = [(5 200 × 2) − 10 920 × $5] = $2 600 (A)

iv Direct labour rate variance = $(10.00 − 10.50) × 16 640 = $8 320 (A)

v Direct labour efficiency variance = [(5 200 × 3) − 16 640 × $10] = $10 400 (A)

d Statement reconciling the flexed budget contribution with the actual contribution for the month of June:

A F Total

$ $ $Flexed budget contribution Revenue (5200 × $60) 312 000Direct material ([5200 × 2) × 5 (52 000)Direct labour ([5200 × 3) × $10) (156 000)Budgeted contribution 104 000Sales price variance 10 400Direct material price variance 2184Direct material usage variance 2 600Direct labour rate variance 8 320Direct labour efficiency variance 10 400

(31 720) 2184 (29 536)Actual contribution 74 464

e Perhaps as a result of market competition or his own decision to drop the selling price, the result has been to sell more units than budgeted. However, this has cost him over $10 000 in lost revenue.

Bertie does need to pay attention to his direct costs. His only favourable variance is material price, which means he may have found a cheaper supplier. However, this has impacted negatively on the usage of material, which showed a negative variance.

Both labour variances were adverse. The rate variance may have been a result of workers working overtime to produce the extra sales units. This in turn could have made them tired and, as a result, less efficient.

Overall the negative variances have had a serious impact on the contribution earned. This in turn will have a negative impact on his overall profit for the month.


2 B

3 A

4 C

5 C

6 C


217

34 Investment appraisalActivitiesActivity 1Ignore the machine that was acquired some years earlier as it is a sunk cost.

Average profit = $150 000 ÷ 6 = $25 000.

Average investment = $( )120 000

225 000+ = $85 000.

ARR = 25 00085 000

× 100 = 29.4%.

Activity 2a Calculation of payback periods:

First Last

$ $Year 0 (90 000) (90 000)

1 30 000 40 0002 36 000 40 0003 24 000 10 000

Payback 2 + 20

40 years 2 + 10

40 years

2 + (24

40 × 12) years

2 years 7.2 months2 years 8 months 2 years 3 months

b Last should be chosen because it has the shorter payback period and its pattern of cash flows will benefit the liquidity of Martinez Limited.

Activity 3

Nomen Limited

Machine A Machine B Machine CYear Discounting factor

at 12%Cashflows

NPV Cashflows

NPV Cashflows

NPV

$ $ $ $ $ $0 1.000 (135 000) (135 000) (135 000) (135 000) (135 000) (135 000)1 0.893 50 000 44 650 38 000 33 934 26 000 23 2182 0.797 50 000 39 850 38 000 30 286 26 000 20 7223 0.712 38 000 27 056 38 000 27 056 38 000 27 0564 0.636 26 000 16 536 38 000 24 168 50 000 31 8005 0.567 26 000 14 742 38 000 21 546 50 000 28 350 Net present values 7 834 1 990 (3 854)

Nomen Limited should choose machine A as it has the highest NPV. Machine C should not be considered because it has a negative NPV.


218

Activity 4

Machine A Machine B

Year Discounting factor at 20%

Cash flows NPV Cash flows NPV

$ $ $ $0 1.000 (135 000) (135 000) (135 000) (135 000)1 0.833 50 000 41 650 38 000 31 6542 0.694 50 000 34 700 38 000 26 3723 0.579 38 000 22 002 38 000 22 0024 0.482 26 000 12 532 38 000 18 3165 0.402 26 000 10 452 38 000 15 276 Net present values (13 664) (21 380)

IRR for machine A: 12% + (8% × 78347834 13664+ ) = 14.9%

IRR for machine B: 12% + (8% × 19901990 21380+ ) = 12.7%.

Activity 5Workings:

1A 1B

Annual depreciation cash outflows

$140000 $200005

$24000− = $180000 $30000

5$30000

− =

Costs 1A 1B

$ $Year 1 $(70 000 − 24 000) 46 000 $(84 000 − 30 000) 54 000 2 $(84 000 − 24 000) 60 000 $(98 000 − 30 000) 68 000 3 $(91 000 − 24 000) 67 000 $(105 000 − 30 000) 75 000 4 $(98 000 − 24 000) 74 000 $(112 000 − 30 000) 82 000 5 $(95 000 − 24 000) 71 000 $(100 000 − 30 000) 70 000

Net receipts 1A 1B

$ $Year 1 $(98 000 − 46 000) 52 000 $(101 000 − 54 000) 47 000 2 $(112 000 − 60 000) 52 000 $(118 000 − 68 000) 50 000 3 $(126 000 − 67 000) 59 000 $(126 000 − 75 000) 51 000 4 $(126 000 − 74 000) 52 000 $(140 000 − 82 000) 58 000 5 $(100 000 − 71 000) 29 000 $(110 000 − 70 000) 40 000

Average profit 1A 1B

$ $Year 1 $(98 000 − 70 000) 28 000 $(101 000 − 84 000) 17 000 2 $(112 000 − 84 000) 28 000 $(118 000 − 98 000) 20 000 3 $(126 000 − 91 000) 35 000 $(126 000 − 105 000) 21 000 4 $(126 000 − 98 000) 28 000 $(140 000 − 112 000) 28 000 5 $(100 000 − 95 000) 5 000 $(110 000 − 100 000) 10 000 $124 000 ÷ 5 24 800 $96 000 ÷ 5 19 200


219

a i 1A 1B

ARP = =24 80070 000

×100 35 4. %1920090000

100 21 3× = . %

ii Payback period:

1A 1B

$ $Year 0 (140 000) (180 000)

1 52 000 47 0002 52 000 50 0003 36 000 Year 3 51 000

4 32 000

Year months Year months33600059 000

12 8 43200058000

12 7× = × =

Payback = 2 years 8 months 3 years 7 months

iii Net present values at 10%:

1A 1B

Year Factor Net (payment)/receipt

NPV Net (payment)/receipt

NPV

$ $ $ $0 1.000 (140 000) (140 000) (180 000) (180 000)1 0.909 52 000 47 268 47 000 42 7232 0.826 52 000 42 952 50 000 41 3003 0.751 59 000 44 309 51 000 38 3014 0.683 52 000 35 516 58 000 39 6145 0.621 29 000 18 009 40 000 28 840 Net present values 48 054 6 778

iv IRR (40%):

1A 1B

Year Factor Net (payment)/receipt

NPV Net (payment)/receipt

NPV

$ $ $ $0 1.000 (140 000) (140 000) (180 000) (180 000)1 0.714 52 000 37 128 47 000 33 5582 0.510 52 000 26 520 50 000 25 5003 0.364 59 000 21 476 51 000 18 5644 0.260 52 000 13 520 58 000 15 0805 0.186 29 000 5 394 40 000 7 440 Net present values (35 962) (79 858)


220

IRR:

1A: 10% + 30% × 48 054 = 27.2% 48 054 + 35 962

1B: 10% + 30% × 6 778 = 12.3% 778 + 79 858

b Flags Limited should purchase 1A because:

• it has a higher accounting rate of return: 35.4% (1B: 21.3%)

• it has the shorter payback period: 2 years 8 months, lower risk (1B: 3 years 7 months)

• it has higher net present value: $48 054 (1B: $6 778)

• it has higher internal rate of return: 27.2% (1B: $12.3%).

Activity 6Net present value: − $150 000 + $(50 000 × 3.169) = $8450.

The net present value will become negative if:

1 the cost of the machine rises by $8450, i.e. an increase of 5.6%, or

2 the annual savings in operational costs fall below $47 333, i.e. they fall short by 5.3%.

Activity 7A Co Limited should invest in the order C, A and B. By dividing the net present value by the capital cost C yields a net present value of 20%. Similarly, A yields 17.5% and C 12%. Thus C, A, B will be the most advantageous for the company.

Practice exercises1 a Payback refers to how long it takes to pay back (in cash terms) the original investment.

It is expressed as a period of time, usually years and months. Accounting rate of return measures the profit which an investment makes. The return (average profit) is expressed as a percentage of the average investment.

b Calculation of the net present value of each machine:

Machine 1 (Red)

Year Cash income Cash expenditure

Net cash flow Discount factor 10%

Discounted cash flow

$ $ $ $0 (100 000) (100 000) 1.00 (100 000)1 70 000 (25 000) 45 000 0.909 40 9052 80 000 (35 000) 45 000 0.826 37 1703 90 000 (40 000) 50 000 0.751 37 5504 90 000 (45 000) 45 000 0.683 30 735

Net present value 46 360

Machine 2 (Green)


Net cash flow Discount factor 10%


$ $ $ $0 (130 000) (130 000) 1.00 (130 000)1 72 000 (27 500) 44 500 0.909 40 4512 84 000 (37 500) 46 500 0.826 38 4093 90 000 (42 500) 47 500 0.751 35 6734 100 000 (47 500) 52 500 0.683 35 858



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c The directors should choose Red for two reasons:

1 The net present value is higher than Green.

2 It generates a return of 46.36% on the capital invested. Green only generates a return of $20 391 ÷ $130 000 × 100 = 15.69%. Thus it fails on two criteria.

d Calculation of the internal rate of return of Red:


Net cash flow

Discount factor 20%


$ $ $ $0 (100 000) (100 000) 1.00 (100 000)1 70 000 (25 000) 45 000 0.833 37 4852 80 000 (35 000) 45 000 0.694 31 2303 90 000 (40 000) 50 000 0.579 28 9504 90 000 (45 000) 45 000 0.482 21 690


At a 20% discount factor, the net present value is still positive. This means the internal rate of return is greater than 20%.

The calculation is:

10% + [(20% − 10%) × {46 360 / (46 360 − 19 355)} = 27%

As this return (27%) is greater than the 25% benchmark, it is acceptable.

2 a Two advantages of the payback method over the net present value method (any two):

• The payback method considers cash returns. The method is also easy to calculate and is understood by non-accountants.

• It tells you when funds are recouped and available for other investments.

• On the other hand, net present value requires the identification of the cost of capital which is not always easy, and is also subjective to a degree. It is also more complicated to calculate than payback.

b Workings:

Year Cash cost Annual cash income (a)

Annual cash expenses (b)

Net cash flow (a − b)

$ $ $ $0 (100 000) (100 000)

1 10 000 × $20 = 200 000 (10 000 × $15) + $15 000 = (165 000) 35 000

2 11 000 × $21 = 231 000 (11 000 × $16) + $16 000= (192 000) 39 000

3 12 000 × $22 = 264 000 (12 000 × $17) + $17 000 = (221 000) 43 000

4 13 000 × $23 = 299 000 (13 000 × $18) + $18 000 = (252 000) 47 000

i Step 1To work this out, add up the net cash flows for each year, starting with year 1.

At the end of year 1 the net cash flow is $35 000.

At the end of year 2 the total net cash flow is $35 000 + $39 000 = $74 000.

At the end of year 3 the total net cash flow is $74 000 + $43 000 = $117 000.

This means that by the end of year 3, the company will have received back more cash than the equipment cost.

However, students are required to work out exactly when the cash cost will be covered. The data indicates that it is some time in year 3.


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Step 2

Deduct the total cash flow at the end of year 2 from the capital cost of the project:

$100 000 − $74 000 = $26 000. This is how much more is required for the cost to be covered.

Step 3

Divide the amount required by the full receipts in year 3 and multiply the answer by 12. This shows how many months it takes to reach the figure required.$$26 00043 000

× 12 = 7.3 months

Step 4

Add the answer to the two years. This gives 2 years 7.3 months. Often it can be rounded to 2 years and 8 months. Always go up to the higher month.

The payback period is 2 years 8 months.

ii The sum of the cash flows before they were discounted is:

$35 000 + $39 000+ $43 000 + $47 000 = $164 000.

If the machine is scrapped at the end of the project it will have been depreciated in full over the four year period. This means that the profit made by this project would have been:

$164 000− $100 000 = $64 000.

The calculation for the accounting rate of return is:

Average profit × 100Average investment

In this case it is:

64 000100 000

42

÷ × 100 = 32%

The accounting rate of return is 32%.

c Comparison of data:

Machine 1 Alternative

Capital cost $100 000 $150 000Payback 2 years 7 months 3 yearsNPV (Working) $22 846 $15 000ARR 30.5% 25%

Working:

Year Net cash flow (a) Discount factor at 12% (b)

Net present value (NPV) (a) × (b)

$ $0 (100 000) 1.0 (100 000)1 35 000 0.893 31 2552 39 000 0.797 31 0833 43 000 0.712 30 6164 47 000 0.636 29 892

NPV 22 846


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In terms of financial data, the machine we are considering is better than the alternative in all respects considered: payback, NPV and ARR. It also has a lower capital outlay. A company usually bases its decision on the results from the payback and net present value calculations. Therefore, the machine we are considering should be chosen.

In terms of non-financial factors, the directors should consider the impact on the workforce of both machines. It may be that one of the machines will lead to (more) redundancies of staff, which will have a negative effect on the image of the company. It may also be that one machine is more environmentally friendly in terms of pollution and/or waste that the other. However, on purely financial grounds the machine costing $100 000 should be chosen.


2 A

3 D

4 B

Structured question1 a Accounting rate of return (ARR):

$(80 000 − [46 000 + 30 000]) = $4 000 average annual profit

$120 000 ÷ 2 = $60 000 average investment

ARR = $(4 000 ÷ 60 000) × 100 = 6.67%

b Net present value:

As all the yearly cash flows are the same, then the discount factors for each year can be added together.

= 0.909 +0.826 + 0.751 + 0.683 = 3.169

$34 000 × 3.169 = $107 746

NPV at 10% = $(−120 000 + 107 746) = − $12 254

c Internal rate of return (IRR):

At 15% the total of the discount factors = 2.856

$34 000 × 2.856 = $97 104

NPV at 15% = $(−120 000 + 97 104) = − $22 896

Both NPVs are negative.

Therefore the IRR will be calculated as:

IRR = + × −

− − −

= −=

10 512 254

12 254( )

( 22 896)

10 5.76

4.24%


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