Introduction to Finance 1 March 2016 Marking Scheme€¦ · Introduction to Finance 1 March 2016 Marking Scheme ... Page 2 of 15 Introduction to ... 2 marks for explanation of a forecast

Introduction to Finance

1 March 2016

Marking Scheme

This marking scheme has been prepared as a guide only to markers. This is not a set of model answers, or the exclusive answers to the questions, and there will frequently be alternative responses which will provide a valid answer. Markers are advised that, unless a question specifies that an answer be provided in a particular form, then an answer that is correct (factually or in practical terms) must be given the available marks. If there is doubt as to the correctness of an answer, the relevant NCC Education materials should be the first authority.

Throughout the marking, please credit any valid alternative point.

Where markers award half marks in any part of a question, they should ensure that the total mark recorded for the question is rounded up to a whole mark.

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Introduction to Finance © NCC Education Limited 2016

Answer any FOUR (4) questions

Marks

Question 1 a) Break even analysis is an important management accounting technique. i) Explain with the aid of a suitable labelled chart, the concept of break-even. 6

Drawing and or explanation should recognise that: Sales revenue increases with sales volumes from a zero point of no sales Over a range of production volumes some costs may be considered as fixed (e.g. buildings) Other, variable, costs increase in proportion to production volumes (e.g. materials) Total cost is the sum of fixed and variable costs at any given level of production The break-even point is the level of production at which sales revenue and total cost are equal

1 mark per correct axes identified-Vertical is cost/revenue (and may show profit) and horizontal is output/volume

1 mark for showing revenue as a straight line starting at zero

1 mark for showing total costs starting at the FC line

1 mark for fixed costs line

1 mark for labelling TR, TC & FC lines

1 mark for identifying break-even point on chart or explanation that identifies breakeven is when Revenue= Total Costs

6 marks maximum.

Revenue costs & profit

Output

Total Cost

Total Revenue

Marks

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ii) Provide a suitable formula for the calculation of the break-even point and identify all terms.

2

Breakeven level of output or sales = fixed cost/ contribution per unit (1) Contribution per unit = selling price – variable cost (1)

iii) What is cost volume profit analysis and how is it useful in decision making? 4 “... evaluates the effects of forecast changes in sales, variable costs

and fixed costs, to assist in decision making” (Weetman, 2006, p. 543). Useful in making decisions regarding special orders, cessation of activities, the effect of limiting factors and ‘make or buy’. 2 marks for definition and 2 marks for brief explanation of use.

b) Costs can be very important when making pricing decisions. i) Explain what is meant by the term full cost pricing. 3 In the long-run all costs must be covered by revenue in order for the

business to make a profit. Cost plus pricing policy involves the addition of a profit margin to cost to arrive at a selling price (i.e. a mark-up on cost, say, 10%) The ‘cost’ used as a basis of this calculation may vary depending on the context Alternatives are marginal costing or market based pricing 3 marks- note for full marks concept of adding a % margin must be made clear.

ii) Explain TWO limitations of full cost pricing. 2 Cost-based pricing does not take account of all economic arguments

(e.g. the level of demand (1 mark) OR competitors pricing (1) or potential of new customer/business (1)) Apportionment of fixed costs is imprecise(1) and may not produce an appropriate analysis; the cost of some products may be too low,(1) others too high(1) Risk of price agreement - CARTEL. (1) Award 1 mark per any suitable limitation.

iii) Explain the term marginal cost pricing. 2 Any selling price above marginal cost makes a contribution to fixed

costs; once fixed costs have been covered, later contributions are profit. Thus, a firm may continue to sell at a price above variable cost so long as it has unutilised capacity 1 mark per point made.

Marks

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c) i) Explain how inventory is valued on a balance sheet (statement of financial

position). 2

Measured at the lower of cost(1) or net realisable value (1) ‘Cost’ includes those incurred in bringing the stocks to their current condition and location (1) Award 1 mark per point made

ii) Identify THREE (3) methods for calculating the value of stock issued to

production. 3

– First-in-first-out (FIFO) – Last-in-last-out (LIFO) – Average cost

1 mark per correct method- 3 marks

iii) Suggest ONE reason for the use for any of those methods identified in (ii). 1 Inevitably suppliers’ prices change.

Stocks may be held that have been acquired at different times and prices. Stock may be perishable. 1 mark for any valid reason.

Total 25 Marks

Marks

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Question 2 a) Define the following accounting terms or concepts: i) Management Accounting 3 “The application of the principles of accounting and financial

management to create, protect, preserve and increase value so as to deliver that value to the stakeholders ...”CIMA (2000, p.15). Or equivalent for 3 marks.

ii) Business Entity 3 An organisation and its owners are treated as two separately

identifiable parties for accounting purposes.

This concept is called the business entity concept.

It means that personal transactions of owners are treated separately from those of the business.

Organisations such as partnerships and limited companies are examples of business entities.

1 mark for each suitable point up to a maximum of 3 marks.

iii) Accruals concept 3 The principle of accruals is that:

“... revenue and costs are recognised as they are earned or incurred, are matched with one another, and are dealt with in the profit and loss account to which they relate, irrespective of the period of receipt or payment” (CIMA, 2000, p.9). Students may break it down into the

Sales are shown when made, payment may be received later

Costs are shown as incurred and matched in financial statements to the sales that caused them. They may be paid at a later date

Also known as the ‘matching’ concept

Forms the basis of the difference between simple monetary gains or losses and the more complex concept of ‘profit

Award 1 mark for each valid point (to a maximum of 3)

iv) Trial balance 3 A list of balances in a double entry bookkeeping system

Acts as a check on accuracy of bookings, but will not identify all types of error Forms the basis of production of financial statements Award 1 mark per relevant point 3 marks.

Marks

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b) Identify SIX (6) tasks that involve management accounting. 6 Analysis of costs – what costs have we incurred, how, and what is

their impact on activities?

Budgets – how much have we spent compared to plan?

‘Make or buy’ – should we make it in-house or buy it ready-made?

Performance measurement – how well did we do?

Capital investment appraisal – will the new machinery pay for itself?

Pricing policy – what price should we set?

c) On 1 June 2015, a business paid rent of £2,400 for the period to 30 May 2016.

The year end for the business is 31st December 2015. What are the charges to the income statement and the entry in the statement for the year ended 31st December 2015?

3

The cash paid of £2,400 covers twelve months to 30 May 2016 but the year end is 31st December. This means that the period 1 Jan 2016 to 30 May 2016 falls in the next accounting period and the rent for that period is prepaid. In the income statement the rent cost for the period is £2400 ÷ 12 months = £200 per month (1 mark) 1 June 2015 – 31st December 2015 is 7 months (1 mark) Total cost £200 x 7 months = £1400 (1 mark) 3 marks maximum.

d) For a trading business explain with examples how net profit is calculated.

4

Net profit= Gross profit – other expenses- 1 mark Gross profit= Sales/revenue - cost of goods sold -1mark Cost of goods sold would be any purchases for resale Other expenses could be wages, electricity, depreciation Note: if example for calculating cost of goods sold gives formulae Cost of Goods Sold (COGS) = Beginning Inventory + Inventory Purchases - End Inventory award this is a suitable example. 1 mark per example up to 2 marks-4 marks maximum for question

Total 25 Marks

Marks

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Question 3 a) 6 i) Explain, with examples, the difference between a forecast and a budget. Budget

Detailed plan that sets out, in money terms, plans for income and expenditure in a future period. Prepared in advance, based on agreed objectives and strategy. Start with sales budget, build up master budget. Whereas forecasts involve making predictions. It could be a prediction in words or a prediction in figures. ‘We forecast higher sales next year’. ‘We forecast 5% higher sales volume next year’. Forecast – planning – budget preparation 2marks for clear explanation of a budget + 1 mark for example 2 marks for explanation of a forecast + 1 mark for example 6 marks maximum.

ii) Distinguish between ‘zero based budgeting’ and ‘flexible budgeting’. 4 Zero-based budgets – the budgetary period starts from a zero

position,(1) assumes no expenditure unless specifically justified by plans(1) Flexible budgets – linked to activity levels, (1)higher levels of activity provide greater budgetary cover (1)

Marks

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b) Explain FOUR (4) purposes and associated benefits of budgeting. 8 Planning- the preparation of budgets forces managers to carry out formal

planning exercises which identifies every part of the organisation and brings together the separate parts on a quantified basis. It encourages all parts of the organisation to contribute on a regular basis to the formation of the plan and identify any difficulties at an early stage. Control- The actual outcome may be compared against the budget. Some revenues and costs will be as expected but others will not. Attention can be given to those which are not as expected. It helps identify those that need correction and allows at an early stage corrective action to be undertaken to remedy problems. Communication- The budget is a formal communication channel that allows junior and senior managers to converse. Budgets have an important part to play in the communication of objectives, targets and responsibilities throughout the organisation. Carried out properly, this can have considerable benefits in promoting co-operation at all levels. Co-ordination-The budget allows co-ordination of all parts of the business towards a common corporate goal. It is vital that the plans of each department are related to each other and are integrated together to make a coherent whole. Basis for performance evaluation. Budgets contribute to performance management by providing benchmarks against which to compare actual results (through variance analysis), and develop corrective measures. Motivation The budget can be used as a target for managers to aim for. If targets are set with care there should be motivation for the individual to achieve those targets. Reward should be given for operating within or under budgeted levels of expenditure. This can act as a motivator for managers. 1 mark for identifying purpose and 1 mark for any benefit linked to purpose 8 marks maximum.

Marks

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c) The following cost statement has been prepared for the last accounting period for Company Z.

Description Budget Actual Variance Adverse or favourable

£ 000 £ 000 £ 000

Sales revenue 500 605

Raw materials 200 214

Direct Labour Costs

100 111

Advertising 50 45

i) Calculate the variances and identify whether they are adverse or favourable. 3

Description Budget Actual Variance Adverse or favourable

£ 000 £ 000 £ 000

Sales revenue 500 605 105 F 1 mark

Raw materials 200 214 14 A 1 mark

Direct Labour Costs

100 111 11 A 1 mark

Advertising 50 45 5 F 1 mark

1 mark per correct line as indicated – 3 marks maximum

ii) Explain and justify which of the variances would cause the most concern for

the management of company Z. 4

Sales and advertising variances are positive/favourable, therefore not of concern (1 mark) Raw materials variance is 7% whereas (1) the direct labour is a 10% variance(1) and therefore would be the item of most concern (1)

Total 25 Marks

Marks

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Question 4 a) Using examples as appropriate, explain the difference between direct costs and

indirect costs. 6

Direct costs - expenditure which can be completely attributed to the production of specific goods or services (e.g. costs of materials used in manufacture of cars). Indirect costs - expenditure such as labour, materials or services which cannot be attributed to a specific good or service, (for example, the salary of the finance director of the company manufacturing the cars referred to above). 2 marks for each definition and 1 mark for each example (max 6 marks)

b) In relation to accounting for indirect costs/overheads explain with examples the

following terms:

i) Allocation 2 Allocation - The assignment of costs to a particular cost centre or

centres. In the manufacturing context, there will be service cost centres supporting production cost centres.

ii) Apportionment 2 The spreading of costs over a number of cost centres using an

estimate of the costs paid by each cost centre For example:

Building costs can be apportioned on the basis of the floor area occupied by the each cost centre.

Machinery costs can be apportioned on the basis of the value of machinery in each cost centre.

iii) Absorption 2 Absorption - the process of matching cost centre costs to units of

output. Example- Production overheads are recovered by absorbing them into the cost of a product and this process is therefore called absorption costing.

Marks

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c) Suggest TWO examples of production overheads for both a manufacturing company and a service business.

4

Examples: In a manufacturing business

• Repair of machinery. • Rent of factory buildings. • Safety procedures.

Examples: In a service business • Cost of transport to jobs. • Replacement of tools. • Protective clothing.

All the production overhead costs have to be allocated to the products. 1 mark for any valid non-direct cost- up to 2 marks for manufacturing and up to 2 marks for Services (4 marks in total).

d) Marginal costing is an alternative to absorption costing. i) Explain the term marginal costing. 4 Also known as variable costing (1)

The product carries only the variable costs of production (1), fixed costs are treated as costs of the period(1)

Unsold stock is valued at variable cost (1) Award 1 mark per valid point of explanation (4 marks maximum).

ii) Suggest FIVE benefits of using marginal costing. 5 1. Fixed overheads are largely irrelevant in decision-making

2. Profit is unaffected by changes in stock levels 3. Fixed production overhead is not carried forward to later

accounting periods 4. Minimises contribution-producing sales being lost due to

full-cost pricing policy 5. Provides early warning of profit reductions at times of

continued production Award 1 mark per point made (maximum 5 marks).

Total 25 Marks

Marks

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Question 5 a) ABC has produced a draft income statement for year ended 31st December

2014. £ £ Revenue 1250,000 Cost of sales 700,000 Gross profit 550,000 Rent 10,000 560,000 Operating Expenses 170,000 Director’s pay 150,000 Depreciation 40,000 360,000 Operating profit 200,000

Since the preparation of the income statement the following information has now been provided.

1. Goods sold during the year were returned for credit on the 20 December 2015. These goods have been included as revenue at their selling price of £10,000. The goods originally cost £5,000.

2. The rent receivable relates to the rental of a warehouse; the annual rental income is £9 000. However, the customer paid £10,000.

3. Included in the operating expenses of £170,000 was the provision for doubtful debts at 31st December 2015 of £5000. However, the trade receivables at year end were £120,000 and it is the company’s policy to maintain a provision for doubtful debts of 5%.

4. Included in the directors’ remuneration is the provision for Corporation tax for the year ended 31 December 2015. The provision was estimated to be £50,000.

5. A machine was sold during the year. The disposal had been correctly recorded in the books of account. However, the profit or loss on disposal has not been included in the draft income statement. The machine was purchased on 1 January 2012 for £18 000 and was sold on 30 November 2015 for £5000. The depreciation on the vehicle at 30 November 2014 was £10 000.

6. On 30th June 2015, the directors issued £1,000,000 of 6% debentures repayable in 2026. The interest on the debentures is paid yearly to investors on 30th June.

Prepare a corrected income statement for the year ended 31st December 2015 to show the profit after tax.

20

Marks

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£ £ Revenue 1250,000- 10,000=

1240,000 2 mark

Cost of sales 700,000 -5000= 695,000

2mark

Gross profit 545,000 1 mark

Rent 10,000-1000= 9000 2 mark

554,000 1 mark

Operating Expenses 170,000 +1000= 171,000

2 mark

Director’s pay 150,000- 50,000= 100,000

1 mark

Depreciation 40,000 1 mark

Loss on Disposal 3,000 2 marks

314.000 1 mark

Operating profit 240,000 1 mark

Finance Costs 30,000 1 mark

Profit for the year 210.000 1 mark

Tax provision 50,000 1 mark

Profit After Tax 160.000 1 mark

Notes

1. This impacts upon Revenue and cost of sales as indicated.

2. Rental Income needs to be reduced by 1,000. Only £9,000 can be

booked (accruals and matching concept).

3. So amount of provision should have been 0.06 x 120,000= £6000, not

£5,000 (i.e. provision is £1000 too low- so operating expenses

adjusted).

4. This needs deducting as an expense and showing as a provision

after profit calculated.

5. Cost 18,000

(10,000)

Book Value 8000

Proceeds 5000

Loss 3,000 2 marks

6. 6% of 1,000,000= 60,000 for 6 months this equals £30,000 and needs

adding to the as a FINANCIAL cost.

Marks

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b) Outline the purpose and requirements of segmental reporting. 5 Award 1 mark per valid point (5 marks maximum)

Provides supplementary information (1), particularly useful in considering corporate groups (1)with diverse activities and operating in different markets (1)

Reported by primary segments and secondary segments (1) that are geographical and product/service in the order that dominates risks and returns(1)

Required under IFRS8 (was part of IAS8).(1)

Additional to income statement etc (1)

Total 25 Marks

End of paper

Marks

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Learning Outcomes matrix

Question Learning Outcomes assessed

Marker can differentiate between varying levels of achievement

1 4,3 Yes

2 1,2 Yes

3 4 Yes

4 3,1 Yes

5 2 Yes

Grade descriptors

Learning Outcome

Pass Merit Distinction

Analyse the use of accounting in organisations

Demonstrate adequate ability to analyse

Demonstrate ability to provide detailed and coherent analysis

Demonstrate ability to provide comprehensive, lucid analysis

Prepare and analyse financial statements

Demonstrate adequate ability to analyse

Demonstrate ability to provide detailed and coherent analysis

Demonstrate ability to provide comprehensive, lucid analysis

Examine the use of costs in organisations

Provide examination of the subject with some suitable examples and references

Provide detailed examination of the subject with adequate use of appropriate references and examples

Provide consistently critical and detailed examination of the subject with innovative use of highly appropriate references

Examine how accounting is used to support decision-making

Provide examination of the subject with some suitable examples and references

Provide detailed examination of the subject with adequate use of appropriate references and examples

Provide consistently critical and detailed examination of the subject with innovative use of highly appropriate references

Introduction to Finance 1 March 2016 Marking Scheme€¦ · Introduction to Finance 1 March 2016 Marking Scheme ... Page 2 of 15 Introduction to ... 2 marks for explanation of a forecast

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