NOTES

You are required to answer Question 1. You are also required to answer any three out of Questions 2 to 5.
(If you provide answers to all of Questions 2 to 5, you must draw a clearly distinguishable line through the
answer not to be marked. Otherwise, only the first three answers to hand for Questions 2 to 5 will be marked.)
Note: Students have optional use of the Extended Trial
Balance, which if used, must be included in the answer booklet.
PRO-FORMA INCOME STATEMENT BY NATURE, INCOME STATEMENT BY FUNCTION
AND BALANCE SHEET ARE PROVIDED
TIME ALLOWED:
3.5 hours, plus 10 minutes to read the paper.
INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence
writing in your answer book.
Marks for each question are shown. The pass mark required is 50% in total over the whole paper.
Start your answer to each question on a new page.
You are reminded that candidates are expected to pay particular attention to their communication skills
and care must be taken regarding the format and literacy of the solutions. The marking system will take
into account the content of the candidates' answers and the extent to which answers are supported with
relevant legislation, case law or examples where appropriate.
List on the cover of each answer booklet, in the space provided, the number of each question(s)
attempted.
FINANCIAL ACCOUNTING
FORMATION 2 EXAMINATION - APRIL 2008
The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
FINANCIAL ACCOUNTING
FORMATION 2 EXAMINATION - APRIL 2008
Time allowed: 3.5 hours plus 10 minutes to read the paper. Answer Question 1 and three
of the remaining four questions.
Note: Students have optional use of the Extended Trial
Balance, which if used, must be included in the answer booklet.
1. (a) List and briefly explain five barriers to international harmonisation / convergence in financial reporting.
(10 marks)
(b) The following trial balance was extracted from the books of Torres Ltd. as at 31 March 2008:
Debit Credit

Property (Buildings) (Cost 720,000) 600,000
Plant and equipment (Cost 600,000) 340,000
Vehicles (Cost 128,000) 94,000
Retained earnings 227,160
Ordinary shares 25c each 320,000
Share Premium account 120,000
8% Debentures 80,000
Discounts 9,200
Returns 3,480
Inventory 126,800
Purchases / Sales 542,400 1,374,800
Trade accounts receivable 73,760
Trade accounts payable 49,280
Returns 3,120
Discounts 12,800
Provision for doubtful debts 2,240
Bank 7,040
Ordinary dividends 7,200
Rent and rates 55,200
Postage and stationery 12,800
Wages and salaries 307,200
Motor expenses 11,040
2,189,760 2,189,760
The following additional information is available:
1. During the year an extension to the buildings was erected.
Materials costing 12,000 were specially purchased for this job and in addition inventory having a selling
price of 12,000 (mark up of 50%) was used. All were put through purchases and trade accounts payable,
though the special materials had not been paid for on 31 March.
2. Inventory on hand 31 March 2008: 140,680.
3. Inventory on hand at 1 April 2007 had been overstated by 8,000.
4. A customer has gone into liquidation and you are advised to write off the full balance owing 1,760.
5. The provision for doubtful debts should be 5% of trade accounts receivable.
Page 1
6. The annual charge for rates is 24,000 and these are paid up to 30 June 2008.
7. Depreciation is provided on assets held at balance sheet date as follows:
a) Buildings: 2% on cost.
b) Plant and machinery: 20% on cost.
c) Vehicles: 25% on written down value.
8. During the year 12,000 was credited to sales. This had been the proceeds from the issue of 4,000
ordinary shares.
9. Dividends paid during the year were as follows:
Final dividend for the year to 31 March 2007: 4,000.
Interim dividend for the year to 31 March 2008: 3,200.
The directors are considering that the final dividend for the year to 31 March 2008 will be 3 cent per share.
REQUIRED:
Prepare, for internal use, an income statement for the year ending 31 March 2008 and a draft balance sheet as
at that date. Please show all workings.
(30 Marks)
[Total: 40 marks]
2. Historical cost accounting has been the normal method of accounting in most countries for many years.
REQUIRED:
(a) Explain four respects in which the use of historical cost accounting may distort financial statements or their
interpretation. (12 marks)
(b) Give four reasons why historical cost accounting continues in use despite its limitations. (8 marks)
[Total: 20 marks]
Page 2
3. John McGrath is a retailer in Galway with a branch in Athlone. The following trial balances have been extracted
from the books of account as at 30 June 2007:
Galway Athlone
Dr Cr Dr Cr
'000 '000 '000 '000
Fixed assets 3,150 900
Accumulated depreciation 1,260 270
Current a/cs 1,575 1,080
Goods sent to branch 3,420 3,375
Inventory 72 180
Capital 2,106
Purchases / Sales 8,226 7,650 3,933
Provision for unrealised profit 36
Provision for doubtful debts 45 18
Distribution expenses 720 45
Administrative expenses 180 144
Receivables / Payables 540 450 540
Drawings 360
Bank 144 117
14,967 14,967 5,301 5,301
Additional Information:
1. All goods are purchased by Galway. Those goods sent to Athlone are invoiced at cost plus 25%.
2. Stocks were valued at 30 June 2007: Galway 108,000; Athlone 135,000 invoice price.
3. Depreciation is to be provided for the year on fixed assets at a rate of 10% on cost.
4. The provision for doubtful debts is to be maintained at a rate of 5%.
5. As at the 30 June 2007, there was 450,000 cash in transit from Athlone to Galway. Goods invoiced at
45,000 were in transit from Galway to Athlone.
REQUIRED:
Prepare in adjacent columns: (a) the head office, (b) the branch and (c) the combined income statements for the
year ended 30 June 2007; and a combined balance sheet as at that date.
[Total: 20 marks]
4. A meeting of the Directors of PEP plc is scheduled to discuss the following matters with a view to finalising the
accounts for the year ending 31 December 2007:
(1) On the 17 January 2008 Walsh Ltd. who owed PEP plc 50,000 went into liquidation and it is expected
that nothing will be recovered. The debt has been written off and charged in full in the income statement
for the year ended 31 December 2007. (7 marks)
(2) An ex-employee of PEP plc has commenced proceedings against PEP for unfair dismissal. The legal
advice available to PEP is that the claim is unlikely to succeed but if it does the award is likely to be
150,000. The legal costs are expected to be 25,000 even if the claim is unsuccessful. (6 marks)
(3) During 2006 PEP plc decided to enter the Far East tourist market. During 2007 a large sum was spent on
investigating particular areas of this market and some proposals are at an early stage of development.
Because the sums involved are large, some consider that the costs should be spread evenly over this year
and the next four years. (7 marks)
REQUIRED:
Advise the board of PEP on the accounting treatment of these issues. Your answer should include an explanation
of the provisions of the relevant accounting regulations.
[Total: 20 marks]
Page 3
5. The following are extracts from the financial statements of Fog plc:
Balance sheets as at 31 December
2007 2006
'000 '000 '000 '000
Non-Current assets
Deferred development expenditure 1,605 1,395
Freehold land 18,000 13,500
Plant and machinery 5,850 6,345
Investments (at cost) 3,600 3,750
29,055 24,990
Current assets
Inventory 10,050 8,700
Trade Receivables 6,150 7,800
Short term investments 1,710 840
Cash 195 435
18,105 17,775
Current Liabilities
Trade payables 5,850 5,250
Corporation Tax 1,275 975
Bank overdraft 2,385 6,540
9,510 12,765
Working capital 8,595 5,010
37,650 30,000
12% Debentures 2004 - 2009 7,500 9,000
30,150 21,000
Capital and reserves
Share capital (50c ordinary shares) 18,000 15,000
Reserves
Share premium 1,500 750
Land revaluation 4,500 -
Retained Earnings 6,150 5,250
30,150 21,000
Appropriation account for the year ended 31 December 2007
'000
Net profit before tax 2,400
Tax 900
Profit after tax 1,500
Dividends 600
Retained profit for the year 900
Notes:
1. Profit for the year is after charging: '000
Depreciation on plant and machinery 1,155
Development expenditure 90
2. During the year plant with a net book value of 750,000 was sold for 1,470,000. The assets
had originally cost 3,000,000.
3. Debentures were redeemed on 30 June 2007.
4. Dividends: Proposed at 31 Dec 2006 and paid in April 2007: 450,000.
Paid September 2007: 150,000.
Proposed at 31 Dec 2007: 500,000.
REQUIRED:
Prepare a cash flow statement for Fog plc for the year ended 31 December 2007.
[Total: 20 marks]
END OF PAPER
Page 4
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
FINANCIAL ACCOUNTING
FORMATION 2 EXAMINATION - APRIL 2008
Solution 1
(a) Any five of the following or similar:
(i) Different purposes of financial reporting. In some countries the purpose is solely for tax assessment, while
in others is for investor decision-making.
(ii) Different legal systems. These prevent the development of certain accounting practices and restrict the
options available.
(iii) Different user groups. Countries have different ideas about who the relevant user groups are and their
respective importance. In the USA investor and creditor groups are given prominence, while in Europe
employees enjoy a higher profile.
(iv) Needs of developing countries. Developing countries are obviously behind in the standard setting process
and they need to develop the basic standards and principles already in place in most developed countries.
(v) Nationalism is demonstrated in an unwillingness to accept another countrys standard.
(vi) Cultural differences result in objectives for accounting systems differing from country to country.
(vii) Unique circumstances. Some countries may be experiencing unusual circumstances which affect all aspects
of everyday life and impinge on the ability of companies to produce proper reports, for example
hyperinflation, civil war, currency restrictions and so on.
(viii) The lack of strong accountancy bodies. Many countries do not have strong independent accountancy or
business bodies which would press for better standards and greater harmonisation.
Torres Ltd
Income statement for the year ended 31 March 2008.

Revenue 1,362,800
Less returns 3,120
1,359,680
Cost of sales
Inventory 1/4/2007 118,800
Purchases 522,400
Less Returns: 3,480 518,920
637,720
Inventory 31/3/2008 140,680 497,040
Gross profit 862,640
Discount received 12,800
875,440
Provision for bad debts 1,360
Debenture interest 6,400
Depreciation:
Buildings 14,800
Plant & machinery 120,000
Vehicles 23,500 158,300
Discounts allowed 9,200
Bad debts 1,760
Rent and rates 49,200
Postage and stationery 12,800
Wages and salaries 307,200
Motor expenses 11,040 557,260
318,180
Dividends: Ordinary paid 7,200
Retained 310,980
Balance c/f 227,160 8,000 219,160
Balance b/f 530,140
Page 6
SUGGESTED SOLUTIONS
Balance sheet as at 31 March 2008

Non current assets Cost Depreciation
Property: Buildings 740,000 134,800 605,200
Plant and equipment 600,000 380,000 220,000
Vehicles 128,000 57,500 70,500
1,468,000 572,300 895,700
Current assets
Inventories 140,680
Trade and other receivables 72,000
Provision for doubtful debts 3,600 68,400
Bank 7,040
Prepayment 6,000 222,120
Total assets 1,117,820
Equity and liabilities
Ordinary shares 25c each 321,000
Share Premium account 131,000
Retained earnings 530,140 982,140
Long term liabilities
8% Debentures 80,000
Current liabilities
Trade and other payables 49,280
Debenture interest 6,400
55,680
1,117,820
Solution 2
(a)
(i) Fixed asset values are unrealistic. This is particularly marked when one looks at how property values can
increase. Land and buildings stated at historical cost will be so undervalued that it could be argued that it
affects the true and fair view. The sale of such property would result in a large holding gain being realized in
one accounting period rather than over the period in which it was owned.
(ii) Depreciation is inadequate to finance the replacement of fixed assets. Linked with this is that the income
statement does not fully reflect the value of the asset consumed during the accounting year, thus leading to
an overstatement of profits.
(iii) Holding gains on inventories are included in profit. During a period of high inflation the monetary value of
inventories held may increase significantly while they are being processed. The conventions of historical cost
accounting result in the realized part of the holding gain being included in profit for the year.
(iv) the true effect of inflation on capital maintenance is not shown. In effect, by failing to take this into account
before calculating profit available for distribution, dividends may effectively be paid out of capital.
(b)
Despite its limitations, historical cost accounting is still used for a number of reasons:
(i) Historical cost accounts are easy to prepare and easy for users to understand. All of the inflation accounts
proposed over the last 25 years have been difficult or time consuming to prepare and difficult for users to
understand.
(ii) In times of low inflation, historical cost convention costs give as true and fair a view of a companys positions
as any other convention. This is particularly true where fixed assets are included at valuation.
(iii) Fixed asset revaluation is allowed, reducing the problem of underestimating of value.
(iv) Figures are objective and verifiable because they are tied to an actual transaction.
Page 7
Solution 3
John McGrath
Income statement for the year ended 30 June 2007
Galway Athlone Total
000 000 000
Sales 7,650 3,933 11,583
Cost of sales
Inventory 1/7/05 72 144 216
Purchases 8,226 8,226
8,298 8,442
Gds sent to branch 2,700 2,700
5,598 2,844
Inventory 30/6/06 144 5,454 108 2,763 252 8,190
Gross profit 2,196 1,197 3,393
Depreciation 315 90 360
Distribution costs 720 45 765
Admin. expenses 180 144 324
Bad debt provision (9) 1,197 9 288 (9) 1,485
Net profit 999 909 1,908
Balance sheet as at 30 June 2007
000 000
Fixed Assets 4,050 Capital:
Less depreciation 1,935 Balance 1/7/05 2,106
2,115 Net profit 1,908
Current Assets 4,014
Inventory 252 Drawings 360
T. receivables 1,080 3,654
Prov. b.d. 54 1,026
Bank 711
1,989
Current Liabilities
T. payables 450 1,539
3,654
Page 8
Solution 4
(1) This is a 'post balance sheet event' as defined in IAS 10. It is an event, either favourable or unfavourable,
which occurs between the balance sheet date and the date on which the financial statements are authorised
for issue. They may be either adjusting or non-adjusting in nature. The IAS states that:
G
an enterprise should adjust its financial statements for events after the balance sheet date that provide
further evidence of conditions that existed at the end of the reporting period, including events that
indicate that the going concern assumption in relation to the whole or part of the enterprise is not
appropriate.
G
an enterprise should not adjust its financial statements for events after the balance sheet date that are
indicative of conditions that arose after the balance sheet date;
G
an enterprise should disclose the date when the financial statements were authorised for issue and
who gave that authorisation. If the enterprise's owners or others have the power to amend the financial
statements after issuance, the enterprise should disclose that fact; and
G
an enterprise should update disclosures that relate to conditions that existed at the balance sheet date
in the light of any new information that it receives after the balance sheet date about those conditions.
The insolvency of a debtor (trade account receivable), on the grounds that it provides additional evidence of
a condition existing at the balance sheet date applies here. Hence a provision for this bad debt should be
made in the financial statements.
(2) IAS 37 defines a contingent liability as:
G
A possible obligation that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the enterprises
control; or
G
A present obligation that arises from past events but is not recognised because:
It is not probable that a transfer of economic benefits will be required to settle the obligation; or
The amount of the obligation cannot be measured with sufficient reliability.
If an obligation is probable it is not a contingent liability and a provision should be made.
An entity should never recognise a contingent liability. The IAS requires a contingent liability to be disclosed
unless the possibility of any outflow of economic benefits to settle it is remote.
As the claim is unlikely to succeed, the potential settlement of 250,000 should be disclosed as a contingent
liability. However, given that the legal costs of 25,000 must be paid whether the claim is successful or not,
this amount should be provided for in the PEP's financial statements.
(3) This proposal is not in accordance with the requirements of IAS 38 as it is a research project i.e. original and
planned investigation undertaken with the prospect of gaining new scientific knowledge or understanding.
This requires research costs to be written off in full to the income statement in the accounting period in which
they are incurred. There is no scope for capitalising such costs and amortising them over a number of years
unless the expenditure relates to capital expenditure on research facilities.
Development costs may only be deferred to future periods when all of the following criteria are met:
G
The product or process is clearly defined and the costs attributable to the product or process can be
separately identified and measured reliably
G
The product or process is technically feasible
G
The enterprise intends to produce and market the product or process and has the ability to do so.
G
The existence of a market for the product or process or, if it is to be used internally rather than sold,
its usefulness to the enterprise can be demonstrated
G
Overall profit expected
G
Resources exist to complete project
Page 9
Solution 5
FOG plc
Cash flow statement for the year ended 31 December 2006.
m m
Cash flows from operating activities
Net profit before tax 3,390
Add: Depreciation
Buildings 1155
Development 90
Profit on disposals (720) 525
3,915
Less: Increase in inventories 1350
2,565
Add: Decrease in receivables 1650
Increase in trade payables 600 2250
Cash generated from operations 4,815
Interest received
Interest paid (990)
Dividends paid (600)
Corporation tax paid (600)
Net cash flows from operating activities 2,625
Cash flows from investing activities
Purchase of property , plant and equipment (1410)
Proceeds from sale of property , plant and equipment 1470
Development expenditure (300)
Receipts from sale of investments 150
Net cash outflow from investing activities (90)
Cash flows from financing activities
Issue of shares 3750
Debentures redeemed (1500)
Purchase of short-term investments.
Net cash from financing activities 2250
Increase in cash and cash equivalents 4,785
Notes to the cash flow statement
Analysis of the balances of cash and cash equivalents as shown in the balance sheet.
2005 2004 Change in year
m m m
Cash in hand 195 435 240
Overdrafts (2385) (6540) (4155)
Short term investments 1710 840 (870)
(480) (5265) (4785)
Page 10
Debit Credit Notes Adjustments Income statement Balance sheet
Debit Credit Debit Credit Assets Liabilities
Property (Buildings)
(Cost 720,000) 720,000 4 20000 740,000
Plant and equipment
(Cost 600,000) 600,000 600,000
Vehicles (Cost 128,000) 128,000 128,000
Retained earnings 227,160 2 8000 310,980 530,140
Dep. Property (Buildings) 120,000 14800 134,800
Dep. Plant and equipment 260,000 120000 380,000
Vehicles (Cost 128,000) 34,000 23500 57,500
Ordinary shares 25c each 320,000 7 1000 321,000
Share Premium account 120,000 7 11000 131,000
8% Debentures 80,000 80,000
Discounts 9,200 9,200
Returns 3,480 3,480
Inventory 126,800 2 8000 118,800 140680 140680
Purchases / 542,400 4 20000 522,400
Sales 1,374,800 7 12000 1,362,800
Trade accounts receivable 73,760 3 1760 72,000
Trade accounts payable 49,280 49,280
Returns 3,120 3,120
Discounts 12,800 12,800
Provision for doubtful debts 2,240 5 1,360 3600
Bank 7,040 7,040
Ordinary dividends 7,200 7,200
Rent and rates 55,200 6 49,200 6000
Postage and stationery 12,800 12,800
Debenture Interest 6400 6400
Wages and salaries 307,200 307,200
Motor expenses 11,040 11,040
2,603,760 2,603,760 40,000 40,000 1,519,760 1,519,760 1,693,720 1,693,720
Marking scheme
Question 1
(a) 2 marks for each 10
(b) Notes adjustments 20
Income statement 5
Balance sheet 5
Total 40
Question 2
(a) 4 x3 12
(b) 4 x2 8
Total 20
Question 3
(a) 15 marks for income statments 15
(b) 5 marks for Balance sheet 5
Total 20
Question 4
(1) 7
(2) 6
(3) 7
Total 20
Question 5
operating activities 10
investing activities & financing activities 10
Total 20.
Page 11