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AC1025 2011-Principles of Accounting Main EQP and

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Principles of accounting (University of London)

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This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON 279 0025 ZA

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for
External Students

Principles of Accounting

Wednesday, 11 May 2011 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions: QUESTION 1 of

Section A, QUESTION 2 of Section B, ONE question from Section C and ONE further
question from either Section B or C. All questions carry equal marks.

Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.

Extracts from compound interest tables are given after the final question on this paper.

8-column accounting paper is provided at the end of this question paper. If used, it must be
detached and fastened securely inside the answer book.

A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.

© University of London 2011

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SECTION A

Answer question 1 from this section.

1. (a) The following table shows the figures for equity from the Statement of Financial Position
(Balance Sheet) of the Pembroke Group plc as at 31st December 2010.

Ordinary Share Premium Retained Total

Shares of Earnings
£1each
£000 £000 £000 £000
300 60 128 488

The directors are proposing the following transactions:

(1) 1st January 2011 – a 1-for-5 rights issue of ordinary shares at a price of £1.80.
(2) 31st December 2011 – a bonus of 200,000 £1 ordinary shares which utilises the
minimum amount of retained earnings.

The directors estimate that the profits for the year ended 31 st December 2011 will represent
Earnings per Share of 5p on the shares in issue during the year. A dividend will be paid
which will result in dividend cover of 3 times.

Required

i. Prepare for the Pembroke Group plc a statement of changes in equity, in tabular
form, which incorporates the above transactions and estimates, showing the balances
as at 31st December 2011 for each of the elements of equity shown in the above
table. (4 marks)

ii. Briefly explain the nature of consolidated accounts. (2 marks)

(b) Distinction is often made between financial and management accounting.

Explain the differences between these two types of accounting. (6 marks)

(c) Keble Ltd manufactures and sells bicycles. The company uses a standard cost system to
help in the control of costs. Overhead is applied to production on the basis of labour
hours.The original production budget for the three months ended 31st March 2011 was for
35,000 labour hours and the overhead costs were as follows:

£
Variable overhead 87,500
Fixed overhead 210,000

The following operating results for the three months were recorded:

Activity
Actual hours worked 30,000
Standard labour hours for output 32,000
Cost
Actual variable overhead incurred £78,000
Actual fixed overhead incurred £209,400

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Required

i. Calculate the flexed budget figures (based on actual output) for variable and fixed
overheads. (2 marks)

ii. Calculate the variable overhead price and efficiency variances. (2 marks)

iii. Calculate the fixed overhead spending and volume variances. (2 marks)

(d) Wadham plc is tendering for a contract which will take 3 months to complete. The
following details relate to labour used in the contract.

 Labour costing £12,000 will be recruited locally specially for the duration of this
contract. To be able to complete this contract, additional labour will need to be
allocated specifically for this contract from within the company. Staff who would be
reallocated already work in the company and are currently being paid although there
is no work for them to do. The estimated wages for these workers for the period of
the contract are £8,000. Even with this re-allocation of labour it is estimated that an
additional £2,000 of overtime will need to be incurred by specialist workers who are
currently fully employed on other jobs.

 An employee who is due to retire has agreed to remain and supervise the project.
She will expect to be paid £2,000 per month as the work is very specialised.

 A second supervisor, who is currently paid £1,000 per month, will be transferred
from another department. However, he will only transfer to the project if he is
offered a one-off bonus payment of £500. His current role will be filled by a
temporary upgrading of an existing worker which is estimated to cost an additional
£200 per month.

Required

i. Explain the concepts of opportunity cost and limiting factors in decision making.
(4 marks)

ii. Using the principles of opportunity cost, how much should the labour cost of the
contract be? (3 marks)

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SECTION B

Answer question 2 from this section, and one further question from either Section B or C

2. Brasenose plc manufactures and sells specialist teaching equipment for universities and colleges.
The following list of balances has been extracted from the Company’s books as at 31 st March
2011. The accountant has discovered that a preliminary trial balance using these figures does
not balance and has therefore credited £20,000 to a suspense account (not shown below).

£000
Accumulated depreciation at 1st April 2010 5480
Administrative expenses 14400
Bank balance (debit) 4400
Goodwill 6000
Inventories (stock) at 1st April 2010 11320
Interest paid 100
Loan (Repayable 2017) 4000
Payables (creditors) 1280
Property, plant and equipment, at cost 19280
Purchases 39400
Receivables (debtors) 1900
Retained earnings at 1st April 2010 5400
Sales 65020
Selling and distribution costs 3800
Share premium account 1400
Ordinary shares at £1 each 18,000

The following further information is available:

i. The auditors of Brasenose plc discovered the following in the course of their audit;
 A piece of equipment was purchased for £80,000 on 1st April 2010. The purchase
price was met in part by a cheque payment of £50,000 with the balance being met by
the trade- in of a machine with a book value at 31st March 2010 of £20,000 (original
cost £100,000).The only entry made in respect of this transaction was to credit the
bank with the amount of the cheque payment.
 The inventories at 1st April 2010 were incorrectly recorded in the trial balance; the
correct figure was £11,230,000.
 The remaining balance on the suspense account was due to addition errors in the
bank account.

ii. The schedule of non-current (fixed) assets at 1st April 2010 was as follows:

Land and Plant and Total

buildings Equipment
£000 £000 £000
Cost 8000 11280 19280
Accumulated depreciation (900) (4580) (5480)
Net book value 7100 6700 13800

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Depreciation for the year ended 31st March 2011 is to be provided as follows:

 Freehold buildings at 5% per annum on the cost of £6,000,000.

 Plant and equipment at 20% per annum using the reducing balance method.

Depreciation and profits or losses on asset disposals are to be apportioned 50% to

administration expenses and 50% to selling and distribution costs.

iii. The loan repayable in 2017 carries interest at 5% per annum and the interest paid relates to
the six months to 30th September 2010.

iv. The administrative expenses require accrual for auditors’ remuneration due of £85,000,
accrued expenses of £145,000 and payments in advance of £60,000.

v. Inventories on hand at 31st March 2011 amounted to £12,600,000 at cost.

vi. Corporation tax based on the year’s profits is estimated at £1,600,000 and will be paid in
October 2011.

Required

(a) Prepare an income statement (profit and loss account) for Brasenose plc for the year ended
31st March 2011 and a statement of financial position (balance sheet) as at that date.
(20 marks)

(b) Brasenose plc has made a specific accounting policy choice in respect of its depreciation.
Explain why companies have choices between accounting policies, the limitations on such
choices and how the choices should be made. (5 marks)

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3. The following are the accounts of Balliol plc, a company that manufactures gardening
equipment, for the year ended 30 November 2010.

Statements of comprehensive income for years ended 30 November

2010 2009
£000 £000
Profit before interest and tax 2200 1570
Interest expense 170 150
Profit before tax 2030 1420
Taxation 730 520
Profit after tax 1300 900
Dividends paid 250 250
Retained profit 1050 650

Statements of financial position as at 30 November

2010 2009
£000 £000
Non-current assets (written-down value) 6350 5600
Current assets
Inventories 2100 2070
Receivables 1710 1540
Total assets 10160 9210

Current liabilities
Trade payables 1040 1130
Taxation 550 450
Bank overdraft 370 480
1960 2060
Non-current liabilities
10% debentures 2011 1500 1500
Total liabilities 3460 3560

Share capital ordinary shares of 50p fully paid up 3000 3000

Share premium 750 750
Retained earnings 2950 1900
6700 5650
Total equity and liabilities 10160 9210

The directors are considering two schemes to raise £6,000,000 in order to repay the debentures
and to finance expansion.

Scheme 1 will involve a new issue of debentures redeemable in 15 years

Scheme 2 will involve a rights issue of ordinary shares at £1.50 per share. The current market
price of the shares is £1.80. The share price in December 2010 was £1.75 and in
December 2009 was £1.40.

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Required

(a) Calculate, for 2009 and 2010, and comment on the following ratios from a potential
lender’s (debenture holder’s) viewpoint:

 Return on capital employed.

 Liquidity (Quick ratio).
 Interest cover.
 Debt to equity (10 marks)

(b) Calculate, for 2009 and 2010, and comment on the following ratios from a shareholder’s
viewpoint:

 Return on equity.
 Earnings per share.
 Dividend cover.
 Debt to capital employed. (10 marks)

(c) Explain the usefulness of the Price Earnings Ratio for investors. Calculate and comment
on the Price Earnings Ratio of Balliol plc at December 2009 and 2010. (The average Price
Earnings ratio for relevant competitors in 2010 was 7.5). (5 marks)

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4. The following are the summarized financial statements of Merton plc for the years ended 31 st
December 2009 and 2010.

Statements of Financial Position as at 31st December

2009 2010
£m £m
Non-current assets
Tangible 1000 1200
Intangible 40 140
1040 1340
Current assets
Inventories 430 480
Receivables 712 680
Prepayments 100 180
Cash at bank 48 160
1290 1500
Total assets 2330 2840
Current liabilities
Trade payables 270 500
Taxation 200 240
470 740
Non-current liabilities
Loans 200 160
Total liabilities 670 900
Net assets 1660 1940

Equity 1660 1940

Income Statement for the year ended 31 st December 2010.

£m
Turnover 2400
Cost of sales (1620)
Gross profit 780
Administrative expenses (240)
Selling and distribution costs (16)
Operating profit 524
Finance costs(net) (44)
Profit before tax 480
Taxation (240)
Profit for the year 240

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Statement of changes in equity for the year ended 31st December 2010
Ordinary Share Revaluation Retained
shares Premium Reserve Earnings Total
£m £m £m £m £m
As at 1st January 2010 1300 100 - 260 1660
Issue of shares 100 40 - - 140
Revaluation - - 60 - 60
Profit for the year - - - 240 240
Dividend paid -
____ -
____ -
____ (160) (160)
1400 140 60 340 1940

The following information is available:

i. The movement in non-current tangible assets is summarized as follows:

£m
Net book value at 1st January 2010 1000
Additions at cost 400
Revaluation 60
Disposals at book value (140)
Depreciation for the year (120)
1200

The asset disposal was for cash proceeds of £160m and the profit on disposal is included in
operating profit.

ii. The non-current intangible assets are patent rights. New rights were purchased for £110m
cash in the year. Amortization of £10m has been charged to cost of sales during 2010.

iii. Loans were repaid at a premium during the year for £46m cash. The premium has been
charged to net finance costs. No new loans had been taken out. Net finance costs of £44m
for 2010 are stated after deducting £16m of interest received.

iv. The issue of shares at a premium was made for cash on 1st July 2010.

Required

(a) Prepare a cash flow statement for Merton plc for the year ended 31 st December 2010.
(19 marks)

(b) Explain three ways in which cash flow statements provide information useful to investors.
(6 marks)

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SECTION C

Answer one question from this section, and one further question from either Section B or C

5. Oriel plc manufactures UPVC windows for the building trade. The production process is
classified into two cost centres, the Fabrication Department and the Finishing Department.
These are supported by two service cost centres the Canteen and the Maintenance Department.

Forecast information for the year ended 31st March 2011 was as follows:

Total Fabrication Finishing Canteen Maintenance

£ £ £ £ £
Indirect labour 340,000 120,000 140,000 30,000 50,000
Consumables 82,000 24,000 32,000 20,000 6,000
Heating and lighting 24,000
Rent and rates 36,000
Depreciation 60,000
Supervision 48,000
Power 40,000
630,000

The following information is also available:

Total Fabrication Finishing Canteen Maintenance

Floor space (sq metres) 60,000 20,000 24,000 6,000 10,000

Book value of machinery (£) 600,000 300,000 240,000 20,000 40,000
Number of employees 160 80 60 10 10
Kilowatt hours 20000 9,000 8,000 1,000 2,000
Direct materials (£) 100,000 50,000
Direct labour (£) 50,000 42,000
Maintenance hours 8,000 6,000
Labour hours 12,640 8,400
Machine hours 15,700

The production process requires a range of materials and involves workers with differing hourly
wage rates.

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Required

(a) Prepare an overhead cost statement which clearly shows the bases of apportionment.
(9 marks)

(b) Calculate the labour hour overhead absorption rate for the Fabrication Department and the
machine hour overhead absorption rate for the Finishing Department. (2 marks)

(c) A batch of 200 windows for a customer is estimated to require the following resources:

Direct material £3,000

Direct labour
Fabrication Dept. 100 hours at £8 per hour
Finishing Dept. 40 hours at £6 per hour
Machine hours
Fabrication Dept. 20 hours
Finishing Dept. 80 hours

Calculate the selling price per window if Oriel plc adds a 40% mark up on total production
cost. (6 marks)

(d) The production manager has suggested that the company could simplify its costs by using
a percentage mark up for overheads based on direct material cost or direct labour cost or
prime cost. Discuss this suggestion. (8 marks)

6. Trinity plc operates a motel close to a ski resort. The following forecasts have been made for
the year ended 31st March 2012.

 Occupancy
Low season (6 months) 4500 rooms
High season (6 months) 6500 rooms
There are 40 rooms in total and the motel is open 7 days per week for 52 weeks.

 Income
The standard room rate is £80 per day.

 Costs
Low season High season
Variable cost per day £20 £25
Fixed cost per annum £ £
Staff costs 110,000 130,000
Maintenance 32,000 40,000
Depreciation 20,000 20,000
Miscellaneous 20,000 30,000

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The management of Trinity plc is considering two alternative policies.

Alternative 1 To reduce the room rate for the low season to £70 per day. This is expected to
increase occupancy by 10%. Additional advertising costs of £20,000 for the
season will be incurred.

Alternative 2 To close the motel for three months in the low season. The closure would save
all staff and miscellaneous costs for the three months and 50% of the
maintenance costs but depreciation would remain unchanged. Set up costs to
reopen would be £9,000.

Required.

(a) Calculate the number of rooms occupancy required to break even in each of the seasons
based on original forecasts. (3 marks)

(b) Calculate the margin of safety in number of rooms for each of the seasons based on
original estimates. (2 marks)

(c) Calculate the percentage of total capacity which would be occupied at forecast and break
even capacity for each of the seasons. (3 marks)

(d) Evaluate with supporting calculations each of the alternative policies outlined above.
Explain the limitations of your analysis. (17 marks)

7. New College plc is an electronic game manufacturer. The company has recently developed a
new game and the directors are considering whether to proceed with production. The
development costs incurred were £220,000.

A market research report costing £30,000 was received and paid for in May 2010. The report
suggested that the game had an expected four year market life and provided forecasts of demand.
On the basis of these the following forecast profit and loss accounts have been prepared:

Forecast profit and loss accounts for the year ended 30 June
2011 2012 2013 2014
£ £ £ £
Sales 500 640 480 320
Cost of goods sold (200) (256) (192) (128)
Gross profit 300 384 288 192
Variable overheads (100) (128) (96) (64)
Fixed overheads (50) (50) (50) (50)
Depreciation (130) (130) (130) (130)
Net profit (loss) 20 76 12 (52)

In order to commence production on the new game a machine costing £550,000 will have to be
purchased at the end of June 2010. The salvage value of this machine at the end of four years is
estimated to be £30,000. Additional working capital of £40,000 will also be required at the end
of June 2010.
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Fixed overheads of £40,000 per annum have been charged as a result of a reallocation of existing
overheads. The remaining £10,000 p.a. represents additional fixed overheads resulting from the
decision to undertake production of the new game.

The chairman of New College plc called a meeting of the product development team soon after
receiving the forecast profit figures. At this meeting he said:

“I am sorry to say that the forecast profit figures for the new product are very
disappointing. In three out of the four years of the product’s life the net profit margin is
less than 5 per cent. However, the cost of capital to finance the new product is 10 per cent.
The projected profit margins are particularly disappointing given that the development
costs, market research costs and new equipment costs total £800,000. It does not seem,
therefore, that the product is financially viable.”

Required

(a) Set out in tabular format a calculation of the net present value of manufacturing and selling
the new game using the information provided above. Identify and explain any costs not
included in your analysis. (12 marks)

(b) Describe any two assumptions which underlie your calculations in (a). (4 marks)

(c) Evaluate the comments made by the chairman and the conclusion he reached.
(6 marks)

(d) Briefly explain how sensitivity analysis can contribute to management decision making.
(3 marks)

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Present value of £1
P

%
R 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

%
" 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

Annuity of £1
% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

END OF PAPER

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This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON 279 0025 ZB

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route for
External Students

Principles of Accounting

Wednesday, 11 May 2011 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions: QUESTION 1 of

Section A, QUESTION 2 of Section B, ONE question from Section C and ONE further
question from either Section B or C. All questions carry equal marks.

Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.

Extracts from compound interest tables are given after the final question on this paper.

8-column accounting paper is provided at the end of this question paper. If used, it must be
detached and fastened securely inside the answer book.

A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.

© University of London 2011

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SECTION A

Answer question 1 from this section.

1. (a) Distinction is often made between financial and management accounting.

Explain the differences between these two types of accounting. (6 marks)

(b) Breda owns a gym. In her financial year ended 30 April 2011 she buys a new exercise
bike for £450. The date of purchase was 1 November 2010. Breda aims to keep exercise
bikes for three years. After three years she finds the bikes are usually well worn and worth
very little. She advertises old equipment to her members, and would usually expect to
receive about £30 for an old exercise bike.

Breda charges depreciation on exercise bikes using the straight-line method, with a time
pro-rated charge in the first and final years of ownership, depending on the dates of
acquisition and disposal.

Required

i. Calculate the depreciation charge on the exercise bike for the years ended 30 April
2011 and 2012 (1 mark)

ii. Calculate the cost, accumulated depreciation and net book value of the exercise bike
as at 30 April 2011 and 2012. (2 marks)

iii. Assume that on 31 January 2013 Breda receives an offer for the bike for £250, and
that she accepts the offer. Calculate the profit or loss on disposal of the bike.
(1 mark)

iv. Identify one other depreciation method and explain how Breda should choose which
method to use. (2 marks)

(c) Burford Brown Ltd makes hen houses. The following information is from January’s
budget, which is based on a production volume of 6,000 houses:

£
Opening stock of houses 0
Fixed manufacturing overhead 72,000
Variable manufacturing overhead 18,000
Selling and administrative expenses (all fixed) 25,000
Direct labour 120,000
Direct material used 90,000
Selling price (per unit) 64

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The actual production and sales volumes for the first two months of the year were as
follows:

Number of houses: January February

Production level 6,000 5,000
Sales 4,000 6,000

Actual variable cost per unit and total fixed overheads incurred were exactly as forecast.

Required

Calculate the profit for each month using absorption costing. (6 marks)

(d) Dorking plc is contemplating acceptance of one of two alternative projects, P and Q. The
following data have been collected for the projects:

P Q
£000 £000
Capital outlay (15,000) (18,000)
Net cash inflows:
Year 1 7,000 6,000
Year 2 4,000 6,000
Year 3 3,000 6,000
Year 4 2,000 6,000
Year 5 1,000 6,000

Dorking plc intends to rank the projects on the basis of (i) average accounting rate of
return on original capital investment and (ii) payback period. Both projects have a zero
scrap value at the end of year 5.

Required

Prepare a statement ranking the two projects on the basis of (i) average accounting rate of
return and (ii) payback period. (7 marks)

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SECTION B

Answer question 2 from this section, and one further question from either Section B or C.

2. The following balances have been extracted from the books of Blackfoot plc for the year ended
31st March 2011.

£000
st
Accumulated depreciation at 1 April 2010 2200
Administrative expenses 870
Bank overdraft 280
Cost of goods sold 5616
Goodwill 200
Inventories (stocks) at 31st March 2011 600
Interest paid 60
Loan (repayable 2015) 1200
Payables (creditors) 790
Property, plant and equipment, at cost 7000
Receivables (debtors) 800
Retained earnings at 1st April 2010 860
Sales 8076
Selling and distribution costs 500
Share premium account 440
Ordinary shares at £1 each 1800

The following further information is available:

(1) The schedule of non-current (fixed) assets at 1st April 2010 was as follows:

Property(Land Plant and Total

and buildings) Equipment
£000 £000 £000
Cost 3200 3800 7000
Accumulated depreciation (800) (1400) (2200)
Net book value 2400 2400 4800

Depreciation for the year ended 31st March 2011 is to be provided as follows:

 Freehold buildings at 5% per annum on cost of £2,000,000.

 Plant and equipment at 20% per annum on the reducing-balance method.

Depreciation is to be allocated 50% to administration expenses and 50% to selling and

distribution costs.

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(2) The auditors of Blackfoot plc have pointed out that the cost of goods sold and inventories
at 31st March 2011 require adjustment for the following:

 The product manager for one product line has mistakenly used the last-in first-out
method of stock valuation. The company policy is to adopt the first-in first-out
method. The manager’s valuation is included in the above list of balances. The
transactions for the year ended 31st March for the relevant product line are:

Purchases Sales
2011
January 10 units @ £1400 each 2 units
February 20 units @ £1500 each 18 units
March 10 units @ £1700 each 6 units

Assume all purchases and receipt of goods took place on 1st of the month and all
sales and goods despatched on 15th of the month.

 Another product line was discovered to have a safety fault. There are 10 units of this
product included in the inventory at a cost of £1500 per unit. The cost of fixing the
fault for all 10 units will be £2000 in total. The publicity in respect of the fault has
reduced the expected selling price to £1000 per unit.

(3) Interest is payable at 10% per annum on the loan repayable in 2015 and the interest paid
relates to the six months to 30th September 2010.

(4) The administrative expenses require adjustments for payments in advance of £6,000,
accrued expenses of £14,000 and auditors’ remuneration of £40,000.

(5) Corporation tax based on the year’s profits is estimated at £60,000 and is payable on 1st
October 2011.

Required

(a) Prepare an income statement (profit and loss account) for Blackfoot plc for the year ended
31st March 2011 and a statement of financial position (balance sheet) as at that date.
(20 marks)

(b) Blackfoot plc has made a specific accounting policy choice in respect to its valuation of
inventory. Explain why companies have choices between accounting policies, the
limitations on such choices and how the choices should be made. (5 marks)

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3. Ancona plc manufactures and distributes agricultural machinery. The following are extracts
from the financial statements of Ancona plc for the years ended 31 st March 2011 and 2010.
Income Statement for the year ended 31 st March 2011
£m
Turnover 2470
Cost of sales (1804)
Gross profit 666
Administrative expenses (196)
Selling and distribution costs (137)
Operating profit 333
Investment income 15
Interest (18)
Profit before tax 330
Taxation (160)
Profit for the year 170
Statement of changes in equity for the years ended 31st March 2011
Ordinary Share Retained
shares Premium Earnings Total
£m £m £m £m
As at 1st April 2010 200 49 277 526
Bonus issue 100 (49) (51) -
Issue of shares 23 15 38
Profit for the year 170 170
Dividend paid ____ ____ (80) (80)
323 15 316 654
Statements of Financial Position as at 31st March
2011 2010
£m £m
Non-current assets
Tangible 600 583
Investments 77 59
677 642
Current assets
Inventories 435 314
Receivables 285 246
Bank balances 9 53
729 613
Total assets 1406 1255
Current liabilities
Trade payables 62 72
Taxation 160 140
Accrued interest 6 4
Bank overdraft 194 151
422 367
Non-current liabilities
Loans 330 362
Total liabilities 752 729
____ ____
Net assets 654 526

Equity 654 526

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The following information is available:

(1) Non-current assets – Tangible

Accumulated
Cost Depreciation Net
£m £m £m
As at 1st April 2010 771 188 583
Disposal (110) (40) (70)
Additions at cost 162 162
Depreciation for the year ____ 75 (75)
823 223 600

The assets were disposed of for cash proceeds of £80m and any profit or loss on the sale
was included in operating costs.

(2) Non-current assets – Investments

These are shares held in another company; additional shares were purchased for cash
during 2011.

(3) Loans were repaid at a premium during the year ended 31st March 2011. The premium of
£4m was included in interest paid.

(4) Equity
The 1 for 2 bonus issue took place on 1st April 2010 utilising all of the share premium
account and the balance by capitalising retained earnings. The issue of shares for cash
took place on 1st January 2011.

Required

(a) Prepare a cash flow statement for Ancona plc for the year ended 31 st March 2011.
(19 marks)

(b) Explain three ways in which cash flow statements provide information useful to investors.
(6 marks)

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4. Wyandotte plc manufactures electrical machinery. In recent years, the company has faced
severe competition from overseas businesses and its sales volume has hardly changed. The
company has recently applied for an increase in its bank overdraft limit from £750,000 to
£1,500,000. The bank manager has asked you, as the bank’s credit analyst, to look at the
company’s application.

You have the following information:

Statements of financial position as at 31 December 2009 and 2010

2009 2010
£000 £000
Tangible non-current assets
Freehold land and buildings, at cost 1800 1800
Plant and equipment, at net book value 3150 3300
4950 5100
Current assets
Inventory 1125 1500
Trade receivables 825 1125
Short-term investments 300 -
2250 2625
Total assets 7200 7725
Current liabilities
Bank overdraft 225 675
Trade payables 525 600
Taxation payable 375 300
1125 1575
Non-current liability
8% debentures, 2012 1500 1500
Total liabilities 2625 3075
Equity
Ordinary shares of £1 each 2250 2250
Share premium account 750 750
Retained earnings 1575 1650
4575 4650
Total equity and liabilities 7200 7725

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Statements of comprehensive income for the years ended 31 December 2009 and 2010
2009 2010
£000 £000 £000 £000
Turnover 6300 6600
Cost of sales: materials 1500 1575
: labour 2160 2280
: production overheads 750 825
4410 4680
Gross profit 1890 1920
Administrative expenses 1020 1125
Operating profit 870 795
Investment income 15 -
885 795
Interest payable: debentures 120 120
: bank overdraft 15 75
135 195
Profit before taxation 750 600
Taxation 375 300
Profit attributable to shareholders 375 225

You are also provided with the following information:

(1) The general price level rose on average by 10% between 2009 and 2010. Average wages
also rose by 10% during this period.

(2) The debenture stock is secured by a fixed charge over the freehold land and buildings,
which have recently been valued at £3,000,000. The bank overdraft is unsecured.

Required

(a) Calculate for the years ended 31st December 2009 and 2010 the return on capital employed
and two other ratios which provide insight into the profitability and efficiency of
Wyandotte plc (Answer to 2 places of decimals). (6 marks)

(b) Calculate for the years ended 31st December 2009 and 2010 the gearing ratio and three
ratios which provide insight into the liquidity and working capital control of Wyandotte
plc. (Answer to 2 places of decimals). (8 marks)

(c) Based on the above calculations and the other information provided, draft a set of notes for
a discussion with the bank manager which highlight the key areas she should consider
when deciding upon the proposed increased overdraft limit. Indicate any further
information which would be useful in reaching the decision. (11 marks)

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SECTION C

Answer one question from this section, and one further question from either Section B or C

5. The Cotswold Hotel is run by John Brown and his sister Wendy. John is a trained landscape
gardener who could earn £25,000 per annum if he worked part- time but he prefers to help his
sister run the hotel. The profits from the hotel are shared equally between them.

The hotel has 40 rooms which are currently let at a daily rate of £60. The hotel is open for 7
days a week for 52 weeks a year. The business is very seasonal; the forecasts for the year ended
31stMarch 2012 are as follows:

Rooms occupied at full daily rate

April – September (26 weeks) 6500 rooms
October – March (26 weeks) 4500 rooms

The forecast costs for the year are:

 Variable costs at £16 per room per day throughout the year.
 Fixed costs
April-September October-March
£ £
Reception and office staff 65,000 50,000
Maintenance 39,000 30,000
Depreciation 75,000 75,000
General running costs 23,600 18,600

John and Wendy are concerned about the weak economic climate and are considering a number
of mutually exclusive (only one may be adopted) options.

Option 1 - To reduce the room rate for the October-March period to £55 per day. This is
expected to increase room occupancy by 10%.

Option 2 - To close the hotel in November and February. In these months no reception or office
staff would be needed, maintenance and general running costs would be reduced by
50% but depreciation would remain unchanged. Assume occupancy is the same for
each month in the six month period.

Option 3 - John Brown to work part time as a landscape gardener and in the hotel only at
weekends. A full time hotel manager to be employed for £40,000 per annum. It is
estimated that this manager would introduce efficiencies which would reduce
variable costs by 10% and reception and office costs by 20%. The share of profits
would be changed to John Brown 30% and Wendy Brown 70%.

Required

(a) Calculate the number of rooms occupancy required to break even in each of the six month
periods based on original forecasts. (3 marks)

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(b) Calculate, and briefly comment on, the profit for the year based on:

i. Original forecasts
ii. Option 1
iii. Option 2 (14 marks)

(c) Calculate and briefly comment on the income of John Brown and Wendy Brown if Option
3 is implemented. (8 marks)

6. Maran plc is a single-product company and employs a standard absorption costing system. The
standard cost per unit is calculated as follows:
£
Direct labour 4 hours at £3.00 12.00
Direct materials 10 kg at £1.00 10.00
Overhead 10.00
Total standard cost per unit 32.00

The standard volume of output is 10,000 units per month. The variable overhead cost
component is £1.00 per standard direct labour hour.
The following information is available for the month of December 2010:

£
Units completed 10,000
Direct materials used 83,000 kg at £1.05 87,150
Direct labour hours 43,000 hours at £3.10 133,300
Variable overhead costs incurred 32,500
Fixed overhead costs incurred 65,000
Required

(a) Calculate, showing your workings, the following variances clearly stating whether adverse
or favourable:
- direct material variances;
- direct labour variances;
- variable overhead variances;
- fixed overhead variance (Only one required). (14 marks)

(b) Reconcile the budgeted and actual costs. (4 marks)

(c) The production manager was informed that the actual cost for the period was very close to
the budget. He has made the following comments:

“I don’t see the need for any further analysis but in some ways I am a bit surprised as I
thought we would be below the budget.
We purchase top quality material and have cut our waste to a minimum.
The workers are paid high rates and should be very efficient and make best use of all of
our resources.
Our overheads have been specifically targeted for a cost reduction exercise.”

Evaluate the production manager’s comments. (7 marks)

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7. Cochin Ltd is a small research-based company which is engaged in the development of a new
product. The directors of Cochin Ltd are currently reviewing this development project as it has
proved to be more costly than originally anticipated and there is a concern that the project is
likely to be a financial burden for the company for the next three years.

The manager responsible for development of the product has provided the following
information:
(1) To date, the company has invested £220,000 in developing the product and it is estimated
that a further three years of development will be required before the new product can be
sold to a manufacturing company for commercial exploitation.
(2) The company believes it will be able to sell the patent for the new product for £800,000,
when it is finally developed, to a large international company which has already shown
interest in the new product.
(3) In order to complete the development programme, additional materials will be required.
The outlay cost of the main type of additional material is expected to be £120,000 per
annum over the next three years. Some other material, already in stock, will also have to
be used in developing the product. This other material originally cost £30,000. It has a
replacement cost of £35,000 and could be sold immediately to another company for
£25,000. If Cochin Ltd decides against further development of the product, this other
material could not be used in any other project undertaken by the company.
(4) Special equipment will be required to complete the development programme. The cost of
the equipment will be £90,000 payable immediately and it can be sold, once the product is
developed, for £60,000. Depreciation charges on equipment are calculated by the
company on a straight-line basis.
(5) The research staff currently working on the project will be made redundant whenever the
project ends. The redundancy payments will be £80,000. The cost of employing the
research staff is £90,000 per annum.
(6) The non-research staff will continue to be employed by the company whether or not the
development project continues. The cost of employing these staff is £75,000 per annum.
(7) If the development project is abandoned, the findings to date could be sold immediately to
another research-based company for £25,000. This company would then complete the
development work for the product.
(8) The project is charged with an appropriate portion of the total overheads of the business.
This overhead allocation is estimated to be £40,000 per annum over the next three years.
However, the project manager estimates that the additional overheads arising as a result of
the project are only likely to be £15,000 per annum over the next three years.
(9) The project manager estimates that the interest charges relating to the cost of financing the
project are likely to be around £12,000 per annum over the next three years.

The company has a cost of capital of 12%.

Required

(a) Set out in tabular form a calculation of the net present value of the investment project
above. (12 marks)

(b) Explain and justify your treatment of the items (1) to (9) above. (7 marks)

(c) Based on the financial analysis undertaken in (a) above, should the company continue with
the development of the new product? What other factors may have a bearing on the final
decision? (6 marks)

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Present value of £1
P

%
R 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

%
" 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

Annuity of £1

% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

END OF PAPER

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Examiners’ commentaries 2011

Examiners’ commentaries 2011

25 Principles of accounting

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2010–11. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

General remarks

Learning outcomes
At the end of this course, and having completed the Essential reading and
activities, you should be able to:
• distinguish between different uses of accounting information and relate
these uses to the needs of different groups of users
• explain and apply financial accounting qualitative characteristics,
concepts and conventions
• prepare basic financial statements from both structured and
unstructured data
• analyse, interpret and communicate the information contained in basic
financial statements, and explain the limitations of such statements
and their analysis
• categorise cost behaviour, and prepare and contrast inventory
valuations under different costing methods
• describe the budgeting process and discuss the use of budgets in
planning and control
• explain, discuss and apply relevant techniques to aid internal users in
decision making.

General remarks
The examination paper covers a range of financial and management
accounting topics, all of which the well-prepared candidate will have
studied. The questions are designed to encourage candidates to think
about the theories and principles of accounting and to demonstrate their
ability to apply relevant concepts in a variety of situations or to a given
set of information. Where appropriate, questions are sub-divided to help
candidates answer in a logical manner. The examination will always
include questions designed to test candidates’ ability in interpretation and
analysis of financial information.
The rubric of the examination paper is set out on the front cover and
you should ensure that you precisely follow these instructions. It is very
important that you do not waste time and effort in answering more
questions than required, as marks will only be awarded to the correct
number of questions. You are advised to read all of the questions before
deciding which to answer in each section. Time allocation is an important
factor in accounting examinations. You should decide how much time to
1

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25 Principles of accounting

spend on each question, based on the overall marks for the question and
for each section, and should then adhere to these time allocations. The
format of the examination requires you to answer question 1 of Section A,
which is in four parts. It is important that you allocate your time on this
question so that you attempt all of the four parts. You are then required
to answer question 2 of Section B, and two further questions, one from
Section C and one from either Sections B or C. Please note that failure
to comply with these requirements may result in some of your work not
being marked.
The rubric of the examination states that workings must be submitted
for all questions requiring calculations. The importance of this cannot be
overstated, as in the absence of workings simple arithmetic errors cannot
be distinguished from errors of principle and understanding. Thus the
absence of workings will very often lead to an over-penalisation of errors.
Of course, arithmetic errors may, in some instances, result in some loss
of marks and you should always be careful to check your calculations.
The rubric also states that any necessary assumptions introduced into
answering a question should be stated. If you do not understand what a
question is asking, a circumstance the Examiners endeavour to avoid, then
you must state any consequent assumptions that you have made. Even
if you do not answer in precisely the way the Examiners had hoped, you
may get a good mark – providing your assumptions are reasonable.
The most frequent reason for failing to do well in the examination, apart
from lack of knowledge, is not answering the question actually set. You
should take time to read each question carefully, and then attempt to
answer everything that the Examiner requires. Far too many candidates
include every scrap of knowledge they have on a topic without specifically
addressing the question and this can have a disastrous effect on their
marks. Read the question carefully and tailor your answer to precisely
what it asks and you should do well.
Accounting is a progressive subject where it is essential to understand
a particular topic before you go on to the next. Make sure that you
understand the basic concepts and can apply them in an appropriate
manner so that there is a logical structure to your answers. Do not write
something that you do not understand for, if you do, you are likely to
produce a muddled response. In answering computational questions,
think carefully about the layout and logical progression of your answer
before writing and set out your answer in a structured and easily readable
format. You will be rewarded for an appropriate, logical and sensible
method, even if the figures contain errors. The subject guide and textbook
contain numerous worked examples, which you should have studied
carefully, and practice questions with solutions, which should form a key
part of your study and revision.
Eight-column accounting paper is incorporated into the answer booklet. It
may be particularly useful where tables of figures are required because it
keeps answers neat and saves ruling lines for different columns. You are
strongly advised to practise using it while you are preparing answers as
part of your study of accounting. A sheet is available to download from
the course 25 page on the VLE and you can print off as many sheets of the
paper as you need.
This subject does not require a lot of reading beyond the core text of
Barone, but it is essential that you adopt an approach of thorough study,
plenty of practice answering questions and an ability and willingness to
think logically.

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Examiners’ commentaries 2011

All major topics are covered at the appropriate level in the recommended
text by Barone and others are covered in the subject guide. References
presented in the ‘Specific comments on questions’ for Zone A and Zone
B indicate where certain topics may be found in the current edition of
the subject guide, which is an essential part of the study material for this
course. You are also encouraged to read the financial press, including
accounting journals and listen to, or watch, financial programmes and
visit appropriate websites. This will enable you to keep abreast of current
issues and help you to develop your ideas and opinions about them.

Question spotting
Many candidates are disappointed to find that their examination
performance is poorer than they expected. This can be due to a number
of different reasons and the Examiners’ commentaries suggest ways
of addressing common problems and improving your performance.
We want to draw your attention to one particular failing – ‘qu e s tio n
s p o ttin g ’, that is, confining your examination preparation to a few
question topics which have come up in past papers for the course. This
can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in
the same depth, but you need to be aware that Examiners are free to
set questions on a n y aspect of the syllabus. This means that you need
to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the ‘course information sheet’ in the
section of the VLE dedicated to this course. You should read the
syllabus very carefully and ensure that you cover sufficient material in
preparation for the examination.
Examiners will vary the topics and questions from year to year and
may well set questions that have not appeared in past papers – every
topic on the syllabus is a legitimate examination target. So although
past papers can be helpful in revision, you cannot assume that topics
or specific questions that have come up in past examinations will occur
again.
If yo u re ly o n a qu e s tio n s p o ttin g s tra te g y, it is like ly
yo u w ill fin d yo u rs e lf in d ifficu ltie s w h e n yo u s it th e
e xa m in a tio n p a p e r. We s tro n g ly a d vis e yo u n o t to a d o p t
th is s tra te g y.

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Examiners’ commentaries 2011

Examiners’ commentaries 2011

25 Principles of accounting – Zone A

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2010–11. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

Rubric of the examination paper

Candidates should answer fo u r of the following s e ve n questions:
Qu e s tio n 1 of Section A, Qu e s tio n 2 of Section B, o n e question
from Section C and o n e further question from either Section B or C. All
questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any
necessary assumptions introduced in answering a question are to be stated.
Extracts from compound interest tables are given after the final question
on this paper.
Eight-column accounting paper is provided at the end of this question
paper. If used, it must be detached and fastened securely inside the
answer book.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.

Comments on specific questions

Section A
1. a. The follow ing table show s the figures for equity from the Statement of
Financial Position (Balance Sheet) of the Pembroke Group plc as at 31st
December 2010.
Ordinary Shares of £1each Share Premium Retained Earnings Total
£000 £000 £000 £000
300 60 128 488
The directors are proposing the follow ing transactions:
1. 1st January 2011 – a 1-for-5 rights issue of ordinary shares at a price
of £1.80.
2. 31st December 2011 – a bonus of 200,000 £1 ordinary shares w hich
utilises the minimum amount of retained earnings.
The directors estimate that the profits for the year ended 31st December
2011 will represent Earnings per Share of 5p on the shares in issue during
the year. A dividend will be paid which will result in dividend cover of 3
times.
[For the full question, please refer to the Examination paper]
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25 Principles of accounting

Re a d in g fo r th is qu e s tio n
Subject guide (SG) pp.108–12.
Barone (B) Chapter 9.
Ap p ro a ch in g th e qu e s tio n
Part (i) tests your understanding of accounting for changes in
shareholders’ funds. The requirement asks for a ‘tabular form’ of answer
and you should always follow such specific instructions. In this case the
required format would have helped you in recording the relevant changes
in the shareholders’ funds.
In part (ii) the question requires a brief explanation of consolidated
financial statements and good answers would set out the basic definition
of a group and the fundamental accounting implications.
i. Pembroke plc
Ordinary Share Retained Total
share of £1 premium earnings
£000 £000 £000 £000
1/1/11 300 60 128 488
Rights issue 60 48 – 108
Bonus issue 200 (108) (92) –
Profits for year 18 18
Dividend paid (6) (6)

31/12/11 560 – 48 608

Workings:
• Profits for year (£000)
360 × 0.05 = 18
• Dividend paid
18 ÷ 3 = 6
ii. Consolidated accounts incorporate the assets, liabilities and results of
a parent company and its subsidiaries, that is of a group of companies
under common control.
Some items only appear in consolidated accounts i.e. goodwill on
consolidation and non-controlling (minority) interests.
b. Distinction is often made betw een financial and management accounting.
Explain the differences betw een these tw o types of accounting.
Re a d in g fo r th is qu e s tio n
SG pp.18–19.
B pp.17–19.
Ap p ro a ch in g th e qu e s tio n
The learning outcomes require you to distinguish between different users
of accounting information. The conventional differences between the roles
of the financial and the management accountant are one way of exploring
the distinctions. Your answer should compare and contrast these roles; the
format below is one way of doing this.

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Examiners’ commentaries 2011

Financial accounting M anagement accounting

• Concerned with the preparation of • Concerned with the preparation of
accounting information for the needs of accounting information for the needs
users who are external to the business. of users who are internal to the
business.

• Prepared on a periodic basis (most • Prepared frequently, as and when

companies publish their financial it is needed (most large businesses
statements only once a year, in the will prepare some information on a
annual report). monthly basis and many use daily
accounting information).

• Based on past events and historic data. • More likely to contain forward looking
information (such as forecasts and
budgets).

• Comprised solely of financial • More likely to incorporate non-

information. financial information (such as
quantities of products sold or number
of customer complaints).

• Governed by rules and regulations. • Not regulated (managers are free to

produce whatever information they
need in whatever format is most
helpful to them, subject to available
data and technology).

c. Keble Ltd manufactures and sells bicycles. The company uses a standard cost
system to help in the control of costs. Overhead is applied to production
on the basis of labour hours. The original production budget for the three
months ended 31st M arch 2011 w as for 35,000 labour hours and the
overhead costs w ere as follow s:
£
Variable overhead 87,500
Fixed overhead 210,000
The follow ing operating results for the three months w ere recorded:
Activity
Actual hours w orked 30,000
Standard labour hours for output 32,000
Cost
Actual variable overhead incurred £78,000
Actual fixed overhead incurred £209,400

[For the full question, please refer to the Examination paper.]

Re a d in g fo r th is qu e s tio n
SG pp.214–33.
B Chapter 21.
Ap p ro a ch in g th e qu e s tio n
Variance analysis is an important and often tested method of performance
evaluation. This question requires calculation of variable and fixed
overhead variances from original standards and actual costs for a year. It is
important that you set out the formulae that you use in your calculations
and clearly identify the variances as favourable or adverse.

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25 Principles of accounting

i. Flexed budget
Variable overhead 87,500 = 2.5 per hour × 32,000
35,000 = £80,000
Fixed overhead 210,000 = 6 per hour × 32,000
35,000 = £192,000
ii. VO price variance
(AQ × AP) – (AQ × SP)
(30,000 × 2.6) – (30,000 × 2.5) = (3,000)
VO efficiency variance
(AQ × SP) – (SQ × SP)
75,000 – 80,000 = 5,000
2,000
iii. FO spending variance
Actual – Budget
209,400 – 210,000 = (600)
FO volume variance
Budget – Applied
210,000 – 192,000 = 18,000
17,400
d. Wadham plc is tendering for a contract w hich w ill take 3 months to complete.
The follow ing details relate to labour used in the contract.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.172–76.
B Chapter 16.
Ap p ro a ch in g th e qu e s tio n
A key learning outcome of this course is to explain and apply decision
making techniques using accounting information. This question tests your
understanding of opportunity cost and limiting factors. Good answers
would clearly identify in (ii) which were relevant opportunity costs.
i. Opportunity cost – maximum contribution foregone by using a secure
resource for an alternative purpose.
Limiting factor – the factor (or factors) which constrain the capacity
of a business to increase the level of activity or undertake a specific
course of action.
ii. Opportunity cost of labour £
Note (i) Labour cost – local 12,000
– overtime 2,000
(ii) Supervisor 6,000
(iii) 2nd supervisor – bonus 500
– upgrade 600
21,100

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Examiners’ commentaries 2011

Section B

Question 2
Brasenose plc manufactures and sells specialist teaching equipment for
universities and colleges. The follow ing list of balances has been extracted from
the Company’s books as at 31st M arch 2011. The accountant has discovered
that a preliminary trial balance using these figures does not balance and has
therefore credited £20,000 to a suspense account (not show n below ).

£000
Accumulated depreciation at 1st April 2010 5,480
Administrative expenses 14,400
Bank balance (debit) 4,400
Goodw ill 6,000
Inventories (stock) at 1st April 2010 11,320
Interest paid 100
Loan (Repayable 2017) 4,000
Payables (creditors) 1,280
Property, plant and equipment, at cost 19,280
Purchases 39,400
Receivables (debtors) 1,900
Retained earnings at 1st April 2010 5,400
Sales 65,020
Selling and distribution costs 3,800
Share premium account 1,400
Ordinary shares at £1 each 18,000
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG Chapter 5.
B Chapter 10.
Ap p ro a ch in g th e qu e s tio n
The preparation of final accounts from structured information is a key
learning objective. A trial balance with several adjusting items has been
the format for the compulsory question over recent years. In answering
this type of question a methodical and organised approach is needed. It
is very important that detailed, legible workings are given in order that
marks are awarded for all work which is correct. If figures in the final
accounts comprise a number of items marks will be awarded accordingly
but without workings one error may result in several marks being lost.
The workings may be shown on the face of the accounts or separately but
candidates should try and help Examiners to award all appropriate marks
by clear presentation. The eight-column accounting paper provided is
particularly useful for presenting the financial statements. Good answers
will clearly apply to the instructions in the question for the classification of
costs, for example the allocation of depreciation between administration
and distribution costs. You should pay attention to the presentation of
your answer taking care to use the appropriate descriptions of line items
in the income statement and statement of financial position.

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25 Principles of accounting

Brasenose plc
Income statement for the year ended 31st March 2011.

£000
Sales 65,020
Cost of goods sold (38,030)
Gross profit 26,990
Administrative expenses (15,391)
Selling and distribution costs (4,621)
Profit before interest and tax 6,978
Interest (100 + 100) (200)
Profit before tax 6,778
Taxation (1,600)
Profit for the year 5,178

Statement of financial position as at 31st March 2011

Assets £000
Non-current assets
Tangible 12,208
Intangible 6,000
18208
Current assets
Inventories 12,600
Receivables 1,900
Payments in advance 60
Bank 4,420
18,980
Total assets 37,188
Liabilities and equity
Current liabilities
Payables (1280 + 85) 1,365
Accrued expenses (145 + 100) 245
Taxation 1,600
3,210
Non-current liabilities
Loans 4,000
Total liabilities 7,210
Equity
Ordinary shares 18,000
Share premium 1,400
Retained earnings (5400 + 5178) 10,578
29,978
Total liabilities and equity 37,188

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1. Suspense account
£000
Balance (Cr) 20
Adjustments:
Payment for equipment (Cr) 50
Inventories (Dr) (90)
Increase in bank balance 20

2. Non-current assets
• Book value
Property Plant & equipment Total
£000 £000 £000
Cost
1st April 2010 8,000 11,280 19,280
Disposal (100) (100)
Addition 80 80
8,000 11,260 19,260

Acc. Depn.
1st April 2010 900 4,580 5,480
Disposal (80) (80)
Current year 300 1,352 1,652
1,200 5,852 7,052
Book value 6,800 12,208
• Depreciation – current year
Property (5% × 6,000,000) = 300
P & E (20% × 6,760,000) = 1,352
1,652
Admin 50% 826
Selling & Dist. 50% 826
• Profit on disposal
Book value 20
Trade-in (80 – 50) 30
Profit 10
Admin 50% 5
Selling & Dist 50% 5

3. Cost of goods sold

Opening stock 11,230
Purchases 39,400
50,630
Closing stock 12,600
38,030

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25 Principles of accounting

4. Administrative expenses

Per Q 14,400
Depreciation 826
Profit on disposal (5)
Auditors’ remuneration 85
Accrued expenses 145
Payments in advance (60)
15,391

5. Selling and distribution costs

Per Q 3,800
Depreciation 826
Profit on disposal (5)
4621

b. Brasenose plc has made a specific accounting policy choice in respect of

its depreciation. Explain w hy companies have choices betw een accounting
policies, the limitations on such choices and how the choices should be
made.
Re a d in g fo r th is qu e s tio n
SG Chapter 5.
B Chapter 10.
Ap p ro a ch in g th e qu e s tio n
This question tests your understanding of the choice of accounting policy
in financial reporting. Answers were not required to examine the specific
issues in choosing a depreciation policy and lengthy discussion of this
would be a wasted effort.
b. Answers should briefly explain:
• Accounting policy choice exists because of the difficulty in
establishing a single solution to accounting for economic actions
and events. Different companies and different economic contexts
may require different solutions.
• Policy choice is contained by compulsory accounting standards
which restrict the range of accounting policies which may be used.
• Companies should choose the accounting policy which gives the
most faithful representation of its economic actions and events and
which provide the most relevant information for users.

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Examiners’ commentaries 2011

Question 3
The follow ing are the accounts of Balliol plc, a company that manufactures
gardening equipment, for the year ended 30 November 2010.
Statements of comprehensive income for years ended 30 November
2010 2009
£000 £000
Profit before interest and tax 2,200 1,570
Interest expense 170 150
Profit before tax 2,030 1,420
Taxation 730 520
Profit after tax 1,300 900
Dividends paid 250 250
Retained profit 1,050 650

Statements of financial position as at 30 November

2010 2009
£000 £000
Non-current assets (w ritten-dow n value) 6,350 5,600
Current assets
Inventories 2,100 2,070
Receivables 1,710 1,540
Total assets 10,160 9,210

Current liabilities
Trade payables 1,040 1,130
Taxation 550 450
Bank overdraft 370 480
1,960 2,060
Non-current liabilities
10% debentures 2011 1,500 1,500
Total liabilities 3,460 3,560

Share capital ordinary shares of 50p fully paid up 3,000 3,000

Share premium 750 750
Retained earnings 2,950 1,900
6,700 5,650
Total equity and liabilities 10,160 9,210

The directors are considering tw o schemes to raise £6,000,000 in order to repay

the debentures and to finance expansion.
Scheme 1 w ill involve a new issue of debentures redeemable in 15 years
Scheme 2 w ill involve a rights issue of ordinary shares at £1.50 per share. The
current market price of the shares is £1.80. The share price in December 2010
w as £1.75 and in December 2009 w as £1.40.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG Chapter 7.
B Chapters 13–15.

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25 Principles of accounting

Ap p ro a ch in g th e qu e s tio n
The learning outcomes include the ability to analyse, interpret and
communicate the information contained in financial statements. The
most common analytical technique is the use of ratios. This technique
is often tested by a mini case study of the type used in this question.
It is important that answers go beyond simply stating that a particular
ratio has gone up or down. The interpretation should use the contextual
information given in the question and make links between different ratios.
Good answers will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspectives of the lenders and
shareholders.
You should carefully read the requirements of the question which in this
case specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
Requirements (a) and (b) clearly set out the ratios to be analysed and
perspective to be used (lenders’ and shareholders’). Requirement (c)
was concerned with the price earnings (PE) ratio and good answers will
comment on the relative ratios for the two years and the competitors and
reach justified conclusions on the company’s share price performance.
3 Balliol plc
a. Solvency ratios for a potential lender
• Debt equity Debt equity 1,500:6,700 1,500:5,650
= 1:4.5 = 1:3.8
• Interest cover Profit before interest: 2,200/170 1,570/150
interest = 13 times = 10 times
• Liquidity Current assets – stock: 1,710:1,960 1,540:2,060
current liabilities = 0.87:1 = 0.75:1
• Return on cap employed 2,200/8,200 1,570/7,150
= 27% = 22%

b. Ratios for a shareholder

• Return on equity Profit after tax /ordinary 1,300:6,700 900:5,650
share capital + reserves = 19.4% = 15.9%
• Earnings per share Profit after tax /no. of 1,300/6,000 900/6,000
ordinary shares = 21.67p = 15p
• Dividend cover Equity profits/proposed 1,300/250 900/250
dividend = 5.2 times = 3.6 times
• Gearing Debt capital/debt + 1,500/8,200 1,500/7,150
equity = 18.3% = 21.0%

Co m m e n ts fro m vie w p o in t o f le n d e r
The return on capital employed has increased by 23 per cent. The current
ratio at 1.9 and acid test ratio of 0.87 are both improving, and interest
is well covered at 13 times. Gearing is low and when coupled with the
improving return on equity and sound interest cover, it means that the
company is able to increase its long-term borrowing.
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Examiners’ commentaries 2011

Co m m e n t fro m p o te n tia l s h a re h o ld e r’s vie w p o in t

The return on equity has improved by approximately 25 per cent. The
dividend is well covered, and has improved in 2010 from 3.6 in 2009 to
5.2 in current year. The EPS figure is in line with the return on equity and
is acceptable. The gearing is low at 18.3 per cent, so that the business
enjoys lower earnings risk.
c. The PE ratio compares a company’s earnings and its share price and
can help investors in deciding whether the shares are under or over-
valued by comparison with the PE ratios of companies of similar risk.
A high PE ratio might reflect confidence in the company’s management
and prospects. A low PE ratio might show a lack of confidence.
PE ratios for Balliol plc
December 2010
1.75 = 8.1
21.67
December 2009
140 = 9.3
15
These ratios illustrate that the market’s confidence in Balliol’s ability
to increase its earnings in 2010 was reflected in the high PE number.
The ratio is still higher than a competitor which shows remaining
confidence.

Question 4
The follow ing are the summarised financial statements of M erton plc for the
years ended 31st December 2009 and 2010.
The follow ing information is available:
i. The movement in non-current tangible assets is summarised as follow s:
£m
Net book value at 1st January 2010 1000
Additions at cost 400
Revaluation 60
Disposals at book value (140)
Depreciation for the year (120)
1200
The asset disposal w as for cash proceeds of £160m and the profit on disposal is
included in operating profit.
ii. The non-current intangible assets are patent rights. New rights w ere
purchased for £110m cash in the year. Amortization of £10m has been
charged to cost of sales during 2010.
iii. Loans w ere repaid at a premium during the year for £46m cash. The premium
has been charged to net finance costs. No new loans had been taken out. Net
finance costs of £44m for 2010 are stated after deducting £16m of interest
received.
iv. The issue of shares at a premium w as made for cash on 1st July 2010.
[For the full question, please refer to the Examination paper.]

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25 Principles of accounting

Re a d in g fo r th is qu e s tio n
SG pp.112–20.
B Chapter 11.
Ap p ro a ch in g th e qu e s tio n
This question requires preparation of a cash flow statement (CFS) which
is part of the learning outcome that refers to the preparation of financial
statements from structured data. You should adopt a systematic approach
which will enable you to extract the cash flows from the accruals based
income statement and statement of financial position. The resulting
increase or decrease in cash balances should be reconciled to the relevant
figures in the statement of financial position. Good answers will be well
presented, correctly describing the component cash flows with well laid
out workings.
a. Merton plc
Cash flow statement for the year ended 31 December 2010
£ £
Operating profit 524
Depreciation (120 + 10) 130
Profit on disposal of fixed assets (20)
Increase in inventory (50)
Decrease in receivables 32
Increase in prepayments (80)
Increase in trade payables 230
Net cash from operating activities 766

Returns on investment and servicing of finance

Investment income
Interest paid (44 + 16 – 6)
16
(54) (38)
728
Taxation (200)
Capital expenditure
Purchase of tangible non-current assets
(400)
Disposal of tangible non-current assets
160
Purchase of intangible assets
(110) (350)

Equity dividends paid (160)

Net cash flow before financing 18
Financing
Issue of ordinary shares
140
Repayment of loans
(46) 94
112
Increase in cash balances
Reconciliation of cash balances
Increase in cash at bank
112
Revaluation – no cash flow

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Examiners’ commentaries 2011

b. Explain three w ays in w hich cash flow statements provide information useful
to investors.
Re a d in g fo r th is qu e s tio n
SG pp.112–20.
B Chapter 11.
Ap p ro a ch in g th e qu e s tio n
In addition to being able to prepare a CFS you should be able to explain
how it provides information useful to investors. Answers which simply
explain ‘how’ the CFS is prepared would gain few marks, the question is
looking for ‘why’ the CFS is published.
• A cash flow statement can provide information which is not available
from balance sheets and income statements. It may assist users of
financial statements in making judgment on the amount, timing and
degree of certainty of future cash flows.
• It gives an indication of the relationship between profitability and cash
generating ability, and thus of the quality of the profit earned.
• Analysts and other users of financial information often, formally or
informally, develop models to assess and compare the present value of
the future cash flow of entities. Historical cash flow information could
be useful to check the accuracy of past assessments.
• A cash flow statement in conjunction with a balance sheet provides
information in liquidity, viability and adaptability. The balance sheet
is often used to obtain information on liquidity, but the information
is incomplete for this purpose as the balance sheet is drawn up at a
particular point in time.
You only needed to give three of these.

Section C

Question 5
Oriel plc manufactures UPVC w indow s for the building trade. The production
process is classified into tw o cost centres, the Fabrication Department and the
Finishing Department. These are supported by tw o service cost centres the
Canteen and the M aintenance Department.
Forecast information for the year ended 31st M arch 2011 w as as follow s:
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.155–63.
B Chapter 18.
Ap p ro a ch in g th e qu e s tio n
The use of absorption costing is relevant to the learning outcome of
the preparation of costs under different costing methods. This question
examines the ability to apply allocation assumptions to a data set. The
information appears to be lengthy but in fact the calculations are straight
forward. The choice of absorption rate for each department is clearly
indicated in the question and should applied in (c) in determining a batch
cost. Part (d) required consideration of different absorption methods
and good answers would discuss the relative merits and problems of the
different methods.

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25 Principles of accounting

a.

Expense (basis) Total Fabrication Finishing Canteen Maintenance

Indirect labour (given) 340,000 120,000 140,000 30,000 50,000

Consumables (given) 82,000 24,000 32,000 20,000 6,000

Heating and lighting (area) 24,000 8,000 9,600 2,400 4,000

Rent and rates (area) 36,000 12,000 14,400 3,600 6,000

Depreciation (capital values) 60,000 30,000 24,000 2,000 4,000

Supervision (number of employees) 48,000 24,000 18,000 3,000 3,000

Power (kWh) 40,000 18,000 16,000 2,000 4,000

630,000 236,000 254,000 63,000 77,000

Canteen (number of employees) 33,600 25,200 (63,000) 4,200

Maintenance (maintenance hours) 81,200

46,400 34,800 – (81,200)

630,000 316,000 314,000 – –

b.
Fabrication
Labour hours 12,640
= £25/direct labour hour
Finishing
Machine hours 15,70
= £20/machine hour

c.
Batch cost £
Direct materials 3,000
Direct labour (800 + 240) 1,040
Overheads
Fabrication (100 × 25)
2,500
Finishing (80 × 20)
1,600
8,140
Cost per window (÷ 200) 40.70
Mark up 40% 16.28
Selling price £56.98

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Examiners’ commentaries 2011

d. Dire ct m a te ria l co s t p e rce n ta g e

This method is best used when the price of materials is constant and
there is a direct relationship between the materials and labour costs
incurred to manufacture the product. Consider the following example:
Job A Job B Budget
£ £ £
Materials 250 100 150,000
Labour 100 100 92,000

The overheads charges to a job will be distorted. Job A is charged with

a greater proportion of overheads than Job B even thought the labour
costs were the same.
In the case of Oriel the production uses a range of materials and this
method would be inappropriate.
Dire ct w a g e s co s t p e rce n ta g e
This method is best used when the wages rates are the same
throughout the company and the same for each job.
In the case of Oriel the production involves differing hourly rates and
this method would be inappropriate.
Prim e co s t p e rce n ta g e ra te
This method combines the faults of the direct materials cost percentage
and the direct labour cost percentage rates.
Labour hours method could have been used in the Finishing
department. But on the basis of the labour hours and machine hours
for this department it is obviously machine-intensive and therefore,
machine hours should be used.

Question 6
Trinity plc operates a motel close to a ski resort. The follow ing forecasts have
been made for the year ended 31st M arch 2012.
• Occupancy
Low season (6 months) 4500 rooms
High season (6 months) 6500 rooms
There are 40 rooms in total and the motel is open 7 days per w eek for
52 w eeks.
• Income
The standard room rate is £80 per day.
• Costs
Low season High season
Variable cost per day £20 £25
Fixed cost per annum £ £
Staff costs 110,000 130,000
M aintenance 32,000 40,000
Depreciation 20,000 20,000
M iscellaneous 20,000 30,000
The management of Trinity plc is considering tw o alternative policies.
[For the full question, please refer to the Examination paper.]

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25 Principles of accounting

Re a d in g fo r th is qu e s tio n
SG pp.167–77.
B Chapters 16–17.
Ap p ro a ch in g th e qu e s tio n
Break-even and cost-volume-profit analysis are key techniques in short
term decision making. This question tests your ability to apply the
techniques to a number of increasingly complex scenarios. It is important
in answering such questions that you keep in mind the basic contribution
approach to the analysis and clearly distinguish between those costs
and revenues which are relevant to the decision and those which are
not. Good answers will set out the computations in a clear, logical and
coherent manner. Part (d) which carries the majority of the marks requires
evaluation of the calculations and the alternative policies. Good answers
would reflect the importance of this evaluation and explanation of its
limitations.
a. Low season High season
Fixed costs £182,000 £220,000
Contribution per room per day
(80 – 20) £60
(80 – 25) £55
Break-even point Room Room
3,033 days 4,000 days

b. Margin of safety
Low season room
(4,500 – 3,033) = 1,467 days
High season room
(6,500 – 4,000) = 2,500 days

c. Occupancy percentages Low High

Total capacity 7280 7280
Forecast 62% 89%
Break-even 42% 55%

d. Forecast profits
Low season
Contribution (60 × 4,500) 270,000
Fixed costs (182,000)
Profit 88,000
Alternative 1
Contribution (70 – 20) × (4,500 × 1.1) 247,500
Fixed costs (182,000)
Advertising costs (20,000)
Profit 45,500

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Examiners’ commentaries 2011

Alternative 2
Contribution (60 × 2,250) 135,000
Fixed costs
Maintenance (16,000)
Depreciation (20,000)
Set up costs (9,000)
90,000
Eva lu a tio n
Alternative 1 would give lower profits. Subject to uncertainty about
increased occupancy. Is the advertising a recurring cost?
Alternative 2 increases profits but may lose customer loyalty. Subject
to avoiding fixed costs. Both are subject to limitations of CVP analysis,
answers might give other appropriate considerations.

Question 7
New College plc is an electronic game manufacturer. The company has recently
developed a new game and the directors are considering w hether to proceed
w ith production. The development costs incurred w ere £220,000.
A market research report costing £30,000 w as received and paid for in M ay
2010. The report suggested that the game had an expected four year market life
and provided forecasts of demand. On the basis of these the follow ing forecast
profit and loss accounts have been prepared:
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG Chapter 12.
B pp.479–520.
Ap p ro a ch in g th e qu e s tio n
The application of capital investment techniques is an important element
of the syllabus and learning outcomes. The most effective approach is to
construct a columnar table in which relevant cash flows can be inserted.
It is important to give workings of all figures and to clearly explain
treatment of all amounts, for example if a cost is to be treated as sunk
and therefore not included as a relevant cost this should be stated. Having
determined the net cash flow for each year these are discounted using
the discount factors taken from the tables provided. Thus a net present
value can be arrived at and a decision recommended and justified. This
type of question requires use of a significant amount of data and it is very
important that your work is clearly presented and that al workings are
legible and understandable. The eight-column accounting paper can help
in the respect. A suggested presentation of the answer is given below.
Part (b) requires description of underlying assumptions of the calculations
in (a) and should not simply reiterate the basis of the calculations.
Part (c) provides an opportunity for good candidates to use their
understanding of these techniques in evaluating the comments of the
chairman.
Part (d) tests your understanding of sensitivity analysis and good answers
would explain the mechanisms of the technique and how it is used by
management in decision making.

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25 Principles of accounting

a. 2010 2011 2012 2013 2014

£000 £000 £000 £000 £000
Machinery (550) 30
Working capital (40) 40
Sales 500 640 480 320
Cost of sales (200) (256) (192) (128)
Variable costs (100) (128) (96) (64)
Fixed costs (10) (10) (10) (10)
Net cash flows (590) 190 246 182 188
Discount factor 1.0 0.909 0.826 0.751 0.683
Present value (590) 172.7 203.2 136.7 127.8
NPV 50.4
: development costs – sunk cost
: market research – sunk cost
Excluded
: depreciation – not a cash flow
: £40,000 fixed overhead – allocations

b. Assumptions could include

• Year end timing of cash flows
• No inventories
• No other changes in working capital
• 10 per cent is appropriate cost of capital.
c. Evaluation
• Concentrates on profits not cash flows
• Treats sunk costs as relevant
• Assumes that profit margin lower than 5 per cent equates to lack of
financial viability
• Reaches an incorrect conclusion/ explain why positive NPV gives
correct view.
d. Sensitivity analysis
This approach identifies each of the key variables influencing the
investment decision and examines the extent to which they could
change before affecting the viability of the project. The approach
gives managers a feel for the margin of error that is available for each
variable; however, it does not provide a clear indication of whether to
accept or reject the project. This is left to managerial judgement.

18

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Examiners’ commentaries 2011

Examiners’ commentaries 2011

25 Principles of accounting – Zone B

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2010–11. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

Rubric of the examination paper

Candidates should answer fo u r of the following s e ve n questions:
Qu e s tio n 1 of Section A, Qu e s tio n 2 of Section B, o n e question
from Section C and o n e further question from either Section B or C. All
questions carry equal marks.
Workings should be submitted for all questions requiring calculations.
Any necessary assumptions introduced in answering a question are to be
stated.
Extracts from compound interest tables are given after the final question
on this paper.
Eight-column accounting paper is provided at the end of this question
paper. If used, it must be detached and fastened securely inside the
answer book.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.

Comments on specific questions

Section A
1. a. Distinction is often made betw een financial and management accounting.
Explain the differences betw een these tw o types of accounting.
Re a d in g fo r th is qu e s tio n
Subject guide (SG) pp.18–19.
Barone (B) pp.17–19.
Ap p ro a ch in g th e qu e s tio n
The learning outcomes require you to distinguish between different users
of accounting information. The conventional differences between the roles
of the financial and the management accountant are one way of exploring
the distinctions. Your answer should compare and contrast these roles, the
format below is one way of doing this.

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25 Principles of accounting

Financial accounting M anagement accounting

• Concerned with the preparation of • Concerned with the preparation of
accounting information for the needs of accounting information for the needs
users who are external to the business. of users who are internal to the
business.

• Prepared on a periodic basis (most • Prepared frequently, as and when

companies publish their financial it is needed (most large businesses
statements only once a year, in the will prepare some information on a
annual report). monthly basis and many use daily
accounting information).

• Based on past events and historic data. • More likely to contain forward looking
information (such as forecasts and
budgets).

• Comprised solely of financial • More likely to incorporate non-

information. financial information (such as
quantities of products sold or number
of customer complaints).

• Governed by rules and regulations. • Not regulated (managers are free to

produce whatever information they
need in whatever format is most
helpful to them, subject to available
data and technology).

b. Brenda ow ns a gym. In her financial year ended 30 April 2011 she buys a
new exercise bike for £450. The date of purchase w as 1 November 2010.
Brenda aims to keep exercise bikes for three years. After three years she
finds the bikes are usually w ell w orn and w orth very little. She advertises old
equipment to her members, and w ould usually expect to receive about £30
for an old exercise bike.
Brenda charges depreciation on exercise bikes using the straight-line method,
w ith a time pro-rated charge in the first and final years of ow nership,
depending on the dates of acquisition and disposal.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.70–76.
B pp.116–26.
Ap p ro a ch in g th e qu e s tio n
One of the key learning outcomes of this course is to apply financial
accounting concepts. Depreciation is a key accounting concept. The
information in the question is straight forward, but you should take care
with the time pro-rated changes in the first and final years of ownership.
In (iv) you need to explain how the choice of methods should be made
and not just how the methods are calculated.

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i. Depreciation per annum

= 450 – 30 = 140
3
Depreciation charge Year ended 30 April 2011
140 × 6 = 70
12
Year ended 30 April 2012 = 140
ii.
Cost Acc Depn NBV
As at
30/4/2011 450 70 380
30/4/2012 450 210 240
iii.
Proceeds 250
NBV: Cost
Acc Depn. (210 + (140 × 9)) 450 135
12 (315)
Profit on sale 115
iv. Reducing balance (or other).
Fair allocation of cost over useful life of asset.
c. Burford Brow n Ltd make hen houses. The follow ing information is from
January’s budget, w hich is based on a production volume of 6,000 houses:

£
Opening stock of houses 0
Fixed manufacturing overhead 72,000
Variable manufacturing overhead 18,000
Selling and administrative expenses (all fixed) 25,000
Direct labour 120,000
Direct material used 90,000
Selling price (per unit) 64
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.156–59.
B pp.321–55.
Ap p ro a ch in g th e qu e s tio n
The learning outcomes require candidates to be able to prepare and
contrast stock valuations under different costing methods. This question
tests this ability. It is important to set out the statements and calculations
in a clear and organised manner. The most common failure was the
incorrect computation of the absorption stock valuation and under-
absorption figures.
Good answers demonstrate that candidates have thought about the
layout of their answers carefully and have designed them to bring out
the key elements of each method. This topic has been tested regularly
but has usually been poorly answered. You are advised to take some time
mastering these concepts and techniques.

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25 Principles of accounting

Jan Feb Marks

Opening stock 0 100 1
Add: Production cost 300 250 1
Less: Closing stock (100) (50) 1
Under/(Over) absorption 0 12 1
Cost of sales 200 312
Sales revenue 256 384
Gross profit 56 72 ½
Non-production overhead 25 25 1
Net profit 31 47 ½
Workings
January
Direct labour 120,000
Direct materials 90,000
Variable production overhead 18,000
Variable cost 228,000
Fixed production overhead 72,000
Absorption cost 300,000

Absorption cost/ unit = £300,000/ 6,000 units = £50/ unit

Fixed production overhead/ unit = £72,000/ 6,000 units = £12/ unit
Physical stock changes (number of units).
Jan Feb
Opening stock 0 2,000
Actual production 6,000 5,000
Actual sales 4,000 6,000
Closing stock 2,000 1,000

P Q
£000 £000
Capital outlay (15,000) (18,000)
Net cash inflows:
Year 1 7,000 6,000
Year 2 4,000 6,000
Year 3 3,000 6,000
Year 4 2,000 6,000
Year 5 1,000 6,000
d. Dorking plc is contemplating acceptance of one of tw o alternative projects,
P and Q. The follow ing data have been collected for the projects:
Dorking plc intends to rank the projects on the basis of (i) average
accounting rate of return on original capital investment and (ii) payback
period. Both projects have a zero scrap value at the end of year 5.
Prepare a statement ranking the tw o projects on the basis of (i) average
accounting rate of return and (ii) payback period.
Re a d in g fo r th is qu e s tio n
SG Chapter 11.
B pp.467–78.

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Ap p ro a ch in g th e qu e s tio n
This question tests your understanding of two investment approval
methods, ARR and payback. Although the data is straightforward care
must be taken in following the instructions to compute the ARR on the
basis of original capital investment and to adjust for depreciation in
arriving at profits.
d. Calculation of Accounting Rate of Return
P Q
£000 £000
Total net cash inflow 17,000 30,000
Capital outlay (15,000) (18,000)
Total profit 2,000 12,000

Life (years) 5 5
Average annual profit 400 2,400
Initial investment £15,000 £18,000

Accounting rate of return % 2.7 13.3

Ranking 2 1

Calculation of payback
3½ years 3 years
Ranking 2 1

Section B
Question 2
The follow ing balances have been extracted from the books of Blackfoot plc for
the year ended 31st M arch 2011.
£000
Accumulated depreciation at 1st April 2010 2,200
Administrative expenses 870
Bank overdraft 280
Cost of goods sold 5,616
Goodw ill 200
Inventories (stocks) at 31st M arch 2011 600
Interest paid 60
Loan (repayable 2015) 1,200
Payables (creditors) 790
Property, plant and equipment, at cost 7,000
Receivables (debtors) 800
Retained earnings at 1st April 2010 860
Sales 8,076
Selling and distribution costs 500
Share premium account 440
Ordinary shares at £1 each 1,800
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG Chapter 5.
B Chapter 10.

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25 Principles of accounting

Ap p ro a ch in g th e qu e s tio n
The preparation of final accounts from structured information is a key
learning objective. A trial balance with several adjusting items has been
the format for the compulsory question over recent years. In answering
this type of question a methodical and organised approach is needed. It
is very important that detailed, legible workings are given in order that
marks are awarded for all work which is correct. If figures in the final
accounts comprise a number of items marks will be awarded accordingly
but without workings one error may result in several marks being lost.
The workings may be shown on the face of the accounts or separately but
candidates should try and help markers to award all appropriate marks
by clear presentation. The eight-column accounting paper provided is
particularly useful for presenting the financial statements. Good answers
will clearly apply to the instructions in the question for the classification of
costs, for example the allocation of depreciation between administration
and distribution costs. You should pay attention to the presentation of
your answer taking care to use the appropriate descriptions of line items
in the income statement and the statement of financial position.
a. Blackfoot plc
In co m e s ta te m e n t fo r th e ye a r e n d e d 3 1 s t Ma rch 2 0 1 1
£000
Sales 8,076
Cost of goods sold (5,621)
Gross profit 2,455
Administrative expenses (1,208)
Selling and distribution costs (790)
Profit before interest and tax 457
Interest (60 + 60) (120)
Profit before tax 337
Taxation (60)
Profit for the year 277

Statement of financial position as at 31st M arch 2011

Assets £000
Non-current assets
Tangible 4,220
Intangible 200
4,420
Current assets
Inventories 595
Receivables 800
Payments in advance 6
1,401
Total assets 5,821

Liabilities and equity

Current liabilities
Payables (790 + 60) 830
Accrued expenses 74
Taxation 60
Bank overdraft 280
1,244
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Non-current liabilities
Loans 1,200
Total liabilities 2,444
Equity
Ordinary shares 1,800
Share premium 440
Retained earnings (860 + 277) 1,137
3,377
Total liabilities and equity 5,821

Wo rkin g s
1. Cost of goods sold/ Inventory
• Cost of goods sold £000
Per Q 5,616
Adjustment: LIFO/FIFO (2)
: NRV 7
5,621

• Inventory
Per Q 600
Adjustment: LIFO/FIFO 2
: NRV (7)
595

• LIFO/FIFO Adjustment
• Inventory value under
LIFO 8 @ 1,400 = 1,120
2 @ 1,500 = 3,000
4 @ 1,700 = 6,800
21,000
FIFO 4 @ 1,500 = 6,000
10 @ 1,700 = 17,000
Increase inventory value by 23,000
2,000

• NRV Adjustment 15,000

Cost 10 @ 1,500 =
NRV 10 @ 1,000 = 10,000
Less: Cost 2,000
8,000
Decrease inventory value by 7,000

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25 Principles of accounting

1. Depreciation/ Non-current assets

£000
• Depreciation for the year
Freeholds (5% × £2m) 100
P and E (20% × £2400k) 480
580
Admin 50% 290
Selling and Dist 50% 290

• Non-current assets – Tangible

PPE: Cost 7000
: Accumulated depn.
(2200 + 580) (2,780)
4,220
3. Administrative expenses
Per Q 870
Depreciation 290
Accrued expenses 14
Auditors Remuneration 40
Payments in advance (6)
1,208

4. Selling and distribution costs

Per Q 500
Depreciation 290 ½
790

b. Blackfoot plc has made a specific accounting policy choice in respect to

its valuation of inventory. Explain w hy companies have choices betw een
accounting policies, the limitations on such choices and how the choices
should be made.
Re a d in g fo r th is qu e s tio n
SG Chapter 5.
B Chapter 10.
Ap p ro a ch in g th e qu e s tio n
This question tests your understanding of the choice of accounting policy
in financial reporting. Answers were not required to examine the specific
issues in choosing a valuation of inventory policy and lengthy discussion
of this would be a wasted effort.
b. Answers should briefly explain:
• Accounting policy choice exists because of the difficulty in
establishing a single solution to accounting for economic actions
and events. Different companies and different economic contexts
may require different solutions.

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Examiners’ commentaries 2011

• Policy choice is contained by compulsory accounting standards

which restrict the range of accounting policies which may be used.
• Companies should choose the accounting policy which gives the
most faithful representation of its economic actions and events and
which provide the most relevant information for users.

Question 3
Ancona plc manufactures and distributes agricultural machinery. The follow ing
are extracts from the financial statements of Ancona plc for the years ended 31st
M arch 2011 and 2010.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.112–20.
B Chapter 11.
Ap p ro a ch in g th e qu e s tio n
This question requires preparation of a cash flow statement (CFS)
which is part of the learning outcome that refers to the preparation of
financial statements from structured data. You should adopt a systematic
approach which will enable you to extract the cash flows from the
accruals based income statement and statement of financial position.
The resulting increase or decrease in cash balances should be reconciled
to the relevant figures in the balance sheet. Good answers will be well
presented, correctly describing the component cash flows with well-laid-
out workings.
a. Ancona plc
Cash flow statement for the year ended 31st March 2011
£ £
Operating profit 333
Depreciation 75
Profit on disposal of assets (10)
Increase in inventory (121)
Increase in receivables (39)
Decrease in trade payables (10)
Net cash flow from operating activities 228

Returns on investment and servicing of finance

Investment income 15
Interest paid (18 + 4 – 6 – 4) (12) 3
231

Taxation (140)
Capital expenditure
Purchase of tangible fixed assets (162)
Disposal of tangible fixed assets 80
Purchase of fixed asset investments (18) (100)

Equity dividends paid (80)

Net cash flow before financing (89)

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25 Principles of accounting

Financing
Issue of ordinary shares 38
Repayment of loans (32 + 4)
(36) 2
Decrease in cash balances (87)
Reconciliation of cash balances
Decrease in cash at bank (44)
Increase in bank overdraft (43)
(87)

b. Explain three w ays in w hich cash flow statements provide information useful
to investors.
Re a d in g fo r th is qu e s tio n
SG pp.112–20.
B Chapter 11.
Ap p ro a ch in g th e qu e s tio n
In addition to being able to prepare a CFS you should be able to explain
how it provides information useful to investors. Answers which simply
explain ‘how’ the CFS is prepared would gain few marks, the question is
looking for ‘why’ the CFS is published.
• A cash flow statement can provide information which is not available
from balance sheets and income statements. It may assist users of
financial statements in making judgement on the amount, timing and
degree of certainty of future cash flows.
• It gives an indication of the relationship between profitability and cash
generating ability, and thus of the quality of the profit earned.
• Analysts and other users of financial information often, formally or
informally, develop models to assess and compare the present value of
the future cash flow of entities. Historical cash flow information could
be useful to check the accuracy of past assessments.
• A cash flow statement in conjunction with a balance sheet provides
information in liquidity, viability and adaptability. The balance sheet
is often used to obtain information on liquidity, but the information
is incomplete for this purpose as the balance sheet is drawn up at a
particular point in time.
You only needed to give three of these.

Question 4
Wyandotte plc manufactures electrical machinery. In recent years, the company
has faced severe competition from overseas businesses and its sales volume has
hardly changed. The company has recently applied for an increase in its bank
overdraft limit from £750,000 to £1,500,000. The bank manager has asked you,
as the bank’s credit analyst, to look at the company’s application.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG Chapter 7.
B Chapters 13–15.

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Examiners’ commentaries 2011

Ap p ro a ch in g th e qu e s tio n
The learning outcomes include the ability to analyse, interpret and
communicate the information contained in financial statements. The
most common analytical technique is the use of ratios. This technique
is often tested by a mini case study of the type used in this question.
It is important that answers go beyond simply stating that a particular
ratio has gone up or down. The interpretation should use the contextual
information given in the question and make links between different ratios.
Good answers will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspective of the bank manager.
You should carefully read the requirements of the question which in this
case specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
Good answers would make full use of the information provided in the
question in producing a draft set of notes for the relevant discussions
including indication of further information useful in reaching the
bank manager’s decision. This shows how important it is to read the
requirements very carefully and ensure that you answer all that is asked
for. Note that part (c) is worth 11 marks and you should allocate your
time accordingly.
2009 2010
a. • Return on capital employed (Compulsory).
885  100 = 14.56%
4575 + 1500

795  100 = 12.93%

4,650 + 1,500
• Net profit margin
885  100 = 14.05%
6,300

795  100 = 12.05%

6,600
• Asset turnover (based on cap. Emp)
6,300 = 1.04 x
6,075

6,600
6,150 =
1.07 x

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25 Principles of accounting

• Gross profit
1,890  100 = 30%
6,300
29.09%
1,920  100 =
6,600

Other profit related margins may be given.

2009 2010
b. Gearing
Debt to capital employed
1,500  100 = 24.69%
6,075
1500  100 = 24.39%
6,150

Current ratio
:1,125 2:1
2,625 : 1,575 1.48 : 1
Quick ratio
1,125 : 1,125 1:1
1,125 : 1,575 0.71 : 1
Stock turnover
4,410 3.92 x
1,125
4,680 3.12 x
1,500
Debtor collection period
825  365 48 days
6,300

1125  365 62 days

6,600
Other working capital ratios may be given.
c. Main points in the answer should cover the following.
Profitability
• Significant fall in ROCE which is due to decreased margins (gross
and net). The asset turnover has increased but the question states
that sales volume is unchanged.
• Given unchanged sales volume (cannot tell from HC accounts
without date on specific price movements), price rises have been
below the level of general inflation (4.8 per cent). Is this deliberate
policy or just poor management? If deliberate, it appears not to
have improved sales.
• Cost of materials and labour also increased below the level of
inflation (5 per cent and 5.6 per cent respectively).
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• Overheads increased by 10 per cent – in line with inflation (both

production and administrative) – led to falling margins (gross and
net). (Further information by product might help see if one particular
areas is a problem – or if it is right across the board.)
• Increased interest has caused profit before tax to fall by 20 per cent
although interest cover still looks ok.
Gearing, liquidity and working capital
• Gearing ratio is stable – but the problem is one of liquidity at the
moment.
• Could argue that the overdraft appears to be a permanent feature of
this firm. The gearing ratio looks worse if the overdraft is included
(+ an overdraft of £1,500,000 makes it look even more unhealthy).
(Gearing ratios calculated using book values may not be too useful
– could recalculate using market values of debt and equity, where
quoted.)
• Working capital (current ratio lower) is falling even though inventories
and receivables are higher.
• Reflected in worsening liquid ratio – quite a large fall.
• Inventory turnover is getting worse – 3.85 months’ inventory on hand
(2009 3.06). Need more information here – slow-moving inventory? Or
is it just poor management of working capital?
• Trade receivables’ turnover ratio has got worse. In their state they need
to be collecting more quickly. Is there one or a few debts causing this,
or is it general sloppiness?
• Flow of funds – company is investing in new equipment, and so is
presumably not contracting operations. Need information as to the use
the equipment is being put to, and future capital expenditure plans.
• Purchases of assets (+ payment of tax + dividend) have been partly
paid for by selling off short-term investments. This is a one-off instance
– a bad sign.
• Could use previous 5 years funds flow statements – trends quite
important.
• The increased overdraft is financing the increased stocks and debtors.
• Gearing ratio is stable – but the problem is one of liquidity at the
moment.
General points
• Why does the firm want to increase the overdraft? Seems to be finance
working capital. Could be risk for the bank if the firm’s profitability is
in a long-term decline. (Does not mean don’t lend – could charge more
interest.)
• Or could secure the overdraft – market value of the land and buildings
is well in excess of the debentures.
• How will the firm pay off the overdraft? Need to ask for cash forecasts
for next few years (firm should have – if not, poor management).
(Historical cost accounts are generally of little help with respect to
forward-looking data.)
• More data on management. Old, young? Likely to let firm stagnate?
Also need to see strategic plans – in what direction is the firm going?
Do they know?

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25 Principles of accounting

Section C
Question 5
The Cotsw old Hotel is run by John Brow n and his sister Wendy. John is a trained
landscape gardener w ho could earn £25,000 per annum if he w orked part-time
but he prefers to help his sister run the hotel. The profits from the hotel are
shared equally betw een them.
The hotel has 40 rooms w hich are currently let at a daily rate of £60. The hotel
is open for 7 days a w eek for 52 w eeks a year. The business is very seasonal; the
forecasts for the year ended 31st M arch 2012 are as follow s:
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.167–77.
B Chapters 16–17.
Ap p ro a ch in g th e qu e s tio n
Break-even and cost-volume-profit analyses are key techniques in short-
term decision making. This question tests your ability to apply the
techniques to a number of increasingly complex scenarios. It is important
in answering such questions that you keep in mind the basis contribution
approach to the analysis and clearly distinguish between those costs and
revenues which are relevant to the decision and those which are not. Good
answers will set out the computations in a clear, logical and coherent
manner. Part (c) required calculation and comment on option 3, this
carried eight marks and once more shows how important it is to answer
all parts of the question and to make sure that you pay careful attention to
the detailed requirements.
a.
April–Sept Oct–March
Fixed costs £202,600 £173,600

Contribution per room per day

(60 – 16) £44 £44
Break-even point 4,605 3,945
(room occupancy in days) or 3,946

b.
(i) Original forecasts April–Sept Oct–March
£ £

Contribution (44  6,500) 286,000 (44  4,500) 198,000

Fixed costs 202,600 173,600
Profit 83,400 24,400

Total profits = £107,800

(ii) Option 1 £
Contribution
(55  16) – (4,500  1.1) 193,050
Fixed costs 173,600
Profit Oct–March 19,450
Profit April–September 83,400
102,850

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Examiners’ commentaries 2011

Option 2
Contribution (see working) 132,000
Fixed costs (see working) 148,333
Profit Oct–March (16,833)
Profit April–September 83,400
66,567

Workings
Number of rooms 4500 × 4 3,000
6
Contribution per room £44
Total contribution £132,000
Fixed costs
Reception and office staff 33,333
Maintenance 25,000
Depreciation 75,000
General running costs 15,500
148,833

Comments
Option 1 gives lower profit
Option 2 gives lower profit
Both are subject to accuracy of predictions and limitations of
CVP analysis.
c.
Option 3
April–Sept Oct–March
£ £
Contribution
(45.6  6500) 296,400 (45.6  4,500) 205,200
Fixed costs 189,600 163,600

Profit 106,800 41,600

Total 148,400
Manager’s salary 40,000
104,400
Income
John Brown : 104,400  30% = 31,320
Gardening income 25,000
56,320
Wendy Brown 104,400  70% = £73,080

Comment
John Brown would be marginally better off (original income
£53,900) but Wendy Brown benefits significantly.

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25 Principles of accounting

Question 6
M aran plc is a single-product company and employs a standard absorption
costing system. The standard cost per unit is calculated as follow s:
£
Direct labour 4 hours at £3.00 12.00
Direct materials 10 kg at £1.00 10.00
Overhead 10.00
Total standard cost per unit 32.00
The standard volume of output is 10,000 units per month. The variable overhead
cost component is £1.00 per standard direct labour hour.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG pp.214–23.
B Chapter 21.
Ap p ro a ch in g th e qu e s tio n
This is a question which tests your ability to apply standard costing,
budgeting and variance analysis to a given set of data. Your answer
should set out clearly all of your workings and reference these to the
final operating statement and relevant variances. It is important that you
identify variances as either favorable or adverse (unfavorable). These
techniques are clearly demonstrated by examples in the course texts and
you should be prepared to apply them in questions at this level.
Part (c) tests your understanding of the variances and their interpretation.
Good answers will evaluate the manager’s comments using the results of
the preceding variance analysis.
(a) Direct material variances £
Price (AQ  AP) – (AQ  SP)
(83,000  1.05) – (83,000  1.00)
87,150 – 83,000 = (4150) A
Efficiency (AQ  SP) – (SQ  SP)
(83,000  1.00) – (100,000  1.00)
83,000 – 100,000 = 17,000 F
Total materials variance 12,850 F

Direct labour variances

Price (AQ  AP) – (AQ  SP)
(43,000  3.10) – (43,000  3.00)
133,300 – 129,000 = (4,300) A
Efficiency (AQ  SP) – (SQ  SP)
(43,000 × 3.00) – (40,000 × 3.00)
129,000 – 120,000 = (9,000) A
(13,300) A
7,500 F

Fixed overhead variance

Actual – Budget*
65,000 – 60,000 = (5,000) A
* Budgeted FO per unit = 10 – 4 = 6
Total 10,000 × 6 = 60,000

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Examiners’ commentaries 2011

(b) Reconciliation £
Budgeted cost
Variances 10,000 32 320,000
Materials (12,850)
Labour 13,300
VO (7,500)
FO 5,000
Actual cost per Q £317,950

c. Answers should cover the following points:

• Overall – further analysis is needed as the variances reveal adverse
and favourable outcomes.
• Materials – the variances confirm his view with a small adverse
price variance and a large favourable efficiency variance.
• Labour – although the price variance reflects high rates the
efficiency variance is at odds with his comment.
• Overheads:
• Variable – as above the efficiency variance does not show
efficient use of resources. However, the price variance reflects
the cost reduction exercise.
• Fixed – this is not in line with the reduction in variable overheads.

Question 7
Cochin Ltd is a small research-based company w hich is engaged in the
development of a new product. The directors of Cochin Ltd are currently
review ing this development project as it has proved to be more costly than
originally anticipated and there is a concern that the project is likely to be a
financial burden for the company for the next three years.
[For the full question, please refer to the Examination paper.]
Re a d in g fo r th is qu e s tio n
SG Chapter 12.
B pp.479–520.
Ap p ro a ch in g th e qu e s tio n
The application of capital investment techniques is an important element
of the syllabus and learning outcomes. The most effective approach is to
construct a columnar table in which relevant cash flows can be inserted.
It is important to give workings of all figures and to clearly explain
treatment of all amounts, for example if a cost is to be treated as sunk
and therefore not included as a relevant cost this should be stated. Having
determined the net cash flow for each year these are discounted using
the discount factors taken from the tables provided. Thus a net present
value can be arrived at and a decision recommended and justified. This
type of question requires use of a significant amount of data and it is very
important that your work is clearly presented and that al workings are
legible and understandable. The eight-column accounting paper can help
in the respect. A suggested presentation of the answer is given below.
Part (b) required you to explain and justify treatment of every item given
in the question. Good answers would refer to the underlying concepts of
relevant, sunk and opportunity costs.
Part (c) gave good candidates an opportunity to show their understanding
of the decision making process and place this into a business context.
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25 Principles of accounting

a. Years
0 1 2 3
Sale of patent 800
Purchase of materials (120) (120) (120)
Sale of material (25)
Equipment (90) 60
Research staff wages (90) (90) (90)
Redundancy costs 80 (80)
Sale of findings (25)
Overheads ___ (15) (15) (15)
(60) (225) (225) 555
Discount rate 1.00 0.89 0.80 0.71
Present value (60) (200.3) (180.0) 394.1
Net present value (46.2)

b. i. Cost to date ignored – sunk cost

ii. Income at end of period
iii. Material in stock – opportunity cost
Additional material
iv. Ignore depreciation – not a cash flow
Cash inflows and outflows included
v. Redundancy – cost saved in year 0
– cost incurred in year 3
vi. Not a relevant cost
vii. Opportunity cost of undertaking project
viii. Overhead allocation is not relevant
Additional cost
ix. Interest charge not included as financing and included in cost of
capital.
c. The calculations above reveal a negative NPV for the project. This
means that acceptance of the project would lead to a reduction in
shareholder wealth and therefore suggests that the project should be
abandoned. However, the managers of the company should consider
whether or not there are any factors which have not been quantified
but which might influence the final decision. Consideration should be
given to the following:
• How accurate are the cost estimates? Is there a likelihood that there
will be a cost over-run?
• Is there a risk that the project will not produce a successful product
after three years?
• Is there a likelihood that the patent could be sold for more than
£800,000 at the end of the project?
• Will continuing with this project result in other, more profitable,
projects being rejected?
• What will be the effect of abandoning the project on the reputation
of the business and on staff morale?

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Examiners’ commentaries 2011

Other factors could have been identified in answering this part of the
question.
Alternative timing of purchase of materials
Years
0 1 2
Sale of patent
Purchase of materials (120) (120) (120)
Sale of material (25)
Equipment (90) (90)
Research staff wages (90)
Redundancy costs 80
Sale of findings (25)
Overheads (15) (15)
Net cash flow (180) (225) (225)
Discount rate 1.00 0.89 0.80
Present value (180) (200.3) (180.0)
Net present value (81.0 )

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