Professional Documents
Culture Documents
JANUARY 2015
Instructions to candidates
Answer any FIVE questions. All questions carry equal marks. Time allowed: 3 hours
Again there appears to be a marginal improvement on the last exam series with some very good
scripts being submitted. Structure, format and presentation have certainly improved and
many students display a high level of knowledge and understanding of the subject matter. This is
witnessed in both the numerical and narrative questions which is an encouraging development.
As indicated last time, it is important that students address the practical applications of accounting
techniques, practices and conventions from a credit management perspective. At times though
there are some instances of poor technique especially in the construction of the Trading and Profit
and Loss account (Statement of Profit and Loss) and the Balance Sheet Statement of Financial
Position). Some still are a little confused with regard to the difference between a debit and credit
balance and how they are shown in the individual ledgers.
Ratio analysis (especially the interpretation of the calculations) and suspense accounts continue to
cause problems for a few students. Questions 1, 3 and 8 were by far the most popular, questions 5
and 6 the least, with student preferences being equally divided amongst the rest.
b) What information can be gleaned from the final accounts of a business that will assist the
credit management in making a more informed decision? (6 marks)
c) For each of the following stakeholders, identify the accounting information that will be of
interest to them and why?
i) Investors. (2 marks)
Total 20 marks
Question aims
To test the candidate’s knowledge and understanding of why organisations need to have
financial and management accounts
To assess the candidate’s ability to identify what information can be obtained from the final
accounts in helping the credit manager to make a more informed decision
To identify the candidate’s ability to highlight the accounting information that will be of use to
internal and external stakeholders.
Suggested answer
a) Financial accounting is concerned with the collection and classification of historic data in order
to prepare the annual financial statements of the business. These statements are prepared
for users outside of the business such as owners or shareholders, prospective investors,
providers of loan capital, receivables and payables and the Government.
Management accounting on the other hand is about providing management with the
information that it needs to carry out its functions properly for planning, control and decision-
making.
Legal – the final financial statements of incorporated businesses must be prepared according
to a prescribed statutory format and must usually be audited by an external auditor.
Monitoring performance and calculating profit – has the business achieved what it had
planned to achieve e.g. are sales levels on target and costs as budgeted? Has it made a
profit, and to what extent?
Forecasting performance – what growth in sales may be realistically achieved given past
performance, state of the market, competition etc. Information on past performance will
come from the financial statements. How much will it cost to run the business next year? All
this information can be found in the management accounts.
Also indicates what is owed from customers with implications for cash flow and credit
management.
b) The final accounts of the business compiled annually are the Income Statement and
Statement of Financial Position. There is a plethora of information that can be obtained from
these two documents which will enhance the decision whether to grant or extend credit or
establish or extend terms.
displays the availability of cash and near cash items that can be readily turned into cash to
meet the business debts.
- Is of particular interest to the credit manager.
Profitability ratios will assess the level of profits in comparison to the sales generated and
capital employed
Liquidity ratios are very important in assessing the credit worthiness of an organisation
- Can an organisation pay its debts as and when they fall due?
Efficiency ratio will assess the ability of management to control working capital
Payables ratio gives the average length of time that the company takes to pay its
creditors.
c) i) Investors will be interested in profit levels and past performance to ensure that not only is
the investment safe but that it will produce a good return.
ii) Lenders will be concerned again with profit levels and liquidity ratios to satisfy themselves
that the firm has both the ability and resources to repay any loan granted albeit in the
short, medium or long-term.
iv) For customers the price paid for the final product would be a key consideration. They will
also desire that the company will be in existence for after sales service and warranty.
Customers will look to all aspects of the final accounts to determine its financial stability.
v) The general public will want to see all the financial statements in order to determine
whether or not the business has the resources to be environmentally friendly and can
service sustainability in all its forms in the future.
Total 20 marks
This area of the syllabus has not been tested for a while and in the main the candidates handled
it well. Most could highlight reasons why organisations maintain financial and management
accounts in a) though a minority did not make the distinction. Many though could differentiate
and come up with some very pertinent answers.
Part b) witnessed some very good responses though a few failed to address the implications from
a credit management perspective which the question required.
Part c) was tackled well by the vast majority though the majority of candidates just cited profit as
the most important piece of financial information for the stakeholders cited. This was apt for the
first three but with regard to the other two, I would like to have seen more reference to prices,
after sales service, warranties, sustainability and environmental issues.
TASK
Identify the key characteristics together with one advantage and one limitation for each of
the following:
d) Factoring. (4 marks)
Total 20 marks
Question aims
To test the candidate’s knowledge and understanding of the different types of finance available to
organisations to finance their activities in the short, medium or long-term.
Suggested answer
a) Bank overdraft
Characteristics
The bank balance will have a negative figure (credit balance) and is classed as a current
liability.
Advantages
Flexible as the bank may be willing to increase the limit for short periods
Limitations
Repayable on demand
If the overdraft is very large the bank may require an arrangement fee and security.
Characteristics
Credit given by the company’s suppliers, the norm being 30 days from the date of invoice,
though in some industries it might be 60 to 90 days. In reality this is giving the organisation
credit as it is borrowing at the suppliers’ expense. Firms use trade credit as a source of
working capital rather than rely on a bank overdraft which has a cost.
Advantages
Trade creditors have an interest in developing and extending the working relationship and
are more flexible than a bank
Limitations
The buyer may lose cash discounts given for prompt payment and may also lose the
opportunity to negotiate more favourable prices or lose supplier goodwill and not be able
to take advantage of discounts for bulk buying
c) Term loans
Characteristics
Loans provide finance generally for the medium to long-term. They are granted for a specific
amount for a specific period and be either secured against the assets of the business i.e. if the
debt is not repaid the bank can take possession of the borrowers’ assets or unsecured, where
it can not.
The period of the loan is agreed at the outset and interest rates are based on the amount
borrowed and prevailing economic conditions. Interest payments can be fixed throughout the
period of the loan or may be variable subject to market conditions.
Advantages
Although interest payments are based on the full amount borrowed, they tend to be at a
lower % rate than overdrafts.
Secured loans are secured against the assets of the business, which can restrict their use
d) Factoring
Characteristics
Another short-term method of financing. Here the company sells its book debts to a factor.
The factoring company will then pay an agreed percentage of the value of these debts which
can be as much as 85% of the value of invoices outstanding. The balance will be paid, less
fees, when the customers have paid the factoring company. The factoring company may also
take responsibility for bad debts which is a form of insurance with an additional fee attached.
Advantages
Disadvantages
The relationship with the customer(s) whose debts have been factored might be damaged.
e) Retained profits
Characteristics
Profits can be retained in the business rather than given out to shareholders in the form of
dividends in the case of incorporated businesses or taken out in the form of drawings by sole
traders or partners. This increases the funds available to the business which might lead to an
expansion of the business or an increase in its share valuation. It can be used to finance
either working capital or the purchase of non-current assets.
Advantages
No third-party involvement
Disadvantages
No problems with overdrafts, trade credit and factoring but there was a little confusion with
regard to term loans and retained profits. With the former many did not detail they would not
be apt in the medium and long term, nor did they highlight in enough detail the costs involved
with regard to interest rates and the time period involved. With the latter, many could not offer
a clear definition of what constituted retained profits nor could they indicate that there were no
costs involved as such in utilising this type of financing.
DR CR
£ £
Capital 72,100
Bank 11,690
Carriage Inwards 640
Carriage Outwards 1,270
Discounts 1,510 2,190
Equipment:
At cost 77,360
Provision for depreciation 16,840
Drawings 10,740
Long-term Loan 20,000
Motor Expenses 16,740
Premises:
At cost 60,000
Provision for depreciation 10,000
Purchases and Sales 132,700 276,300
TASK
a) Prepare an income statement (formerly a trading and profit and loss account) for the year
ended 31 December 2014. (11 marks)
Total 20 marks
Suggested answer
£ £ £
Sales 276,300
275,000
Less cost of sales
Opening stock 35,820
Purchases 132,700
131,640
167,460
Less closing stock 29,700
137,760
139,430
Less expenses
Discount allowed 1,510
Carriage outwards 1,270
Motor expenses (£16,740 - £350) 16,390
Shop expenses 21,380
Wages (£46,330 + £1,840) 48,170
Telephone and insurance 1,750
Depreciation: Equipment (w1) 7,565
Premises (w2) 3,000 101,035
Net profit 38,395
£ £ £
Fixed assets
Premises (w3) 60,000 13,000 47,000
Equipment (w4) 77,360 24,405 52,955
Current assets
Stock 29,700
Debtors 12,490
Prepayments 350 42,540
119,755
99,755
Financed by
Capital 72,100
99,755
Total 20 marks
In a couple of instances, opening and closing stock (inventory) were inserted the wrong way
round. Most students addressed the accruals and prepayments adjustments, though a few
found the depreciation calculation problematic. The PLA (SFP) was well constructed though
many did not recognise that the bank balance was a credit one, i.e., overdrawn and should
appear as a current liability.
You have been given the extracts from their most recent financial accounts below:
Income Statement of Doyle and Scott Limited for the year ended 31 December:
Operating profit 24 16 14
Inventory 48 50 80
Receivables 52 80 110
Bank 40 20 0
Current liabilities
Payable 40 70 90
Bank 0 0 20
Net current assets 100 80 80
Financed by
Ordinary shares 100 124 150
Reserves 60 76 90
a) Calculate the following ratios for both of the years 2013 and 2014 (the relevant figures
for 2012 have been given in brackets):
b) Using the ratio calculations which have been supplied for 2012 and your own calculations
from part a) for 2013 and 2014, assess whether an increase in the credit facility would
be appropriate, giving your reasons for your decision. (12 marks)
Total 20 marks
Question aims
To test the candidate’s knowledge and understanding of the key financial ratios and how they can
be employed to assist the credit manager in making a more informed decision as to whether to
increase a credit facility.
Suggested answer
2013 2014
i) Gross profit margin 25% 20%
ii) Operating margin 4.4% 2.6%
Turnover has increased by more than 50% over the period. Although gross profit has
increased all the profit margins i.e., gross, operating and return on capital employed) have
declined
Both the current ratio and acid test ratios have declined, but from quite a high position in
the first instance. The 2014 figure is acceptable still though. However if this trend is to
continue the 2015 accounts are likely to show a further decline in working capital and the
business might find itself in an overtrading situation
Control over working capital items, inventory, receivables and payables have been good.
Receivable days have improved as has inventory days but payables has slightly worsened.
The organisation though is still getting its invoices paid before they pay their suppliers,
which is good. Some students might make reference to the fact that the cash operating
cycle has improved from 91 days to 53 days
Expenses as a percentage of turnover has reduced which demonstrates that these are
clearly under control
Share capital has increased but the return on capital employed has fallen quite
significantly and must be of concern to the shareholders
On the basis of the previous, students might indicate that on balance given the key ratios
identified that it might be apt to increase the facility but it does need to be carefully
monitored.
Some could argue that it might be appropriate before increasing credit to get sight of the
management accounts which will show, amongst other things, projected sales and cash flow
forecasts.
The organisation at present is clearly solvent but the liquidity ratios have been moving in an
adverse manner over the last couple of years and if this should continue could cause problems
with the company’s ability to pay its debts as and when they fall due.
Current ratio
140 150 190
Current assets
40 = 3.5:1 70 = 2.14:1 110 = 1.73:1
Current liabilities
Inventory days
[(40+48)÷2] x 365 [(48+50)÷2] x 365 [(50+80)÷2] x 365
[(Opening stock + closing
160 270 432
stock)/2] x 365
= 100 days = 66 days = 55 days
Cost of sales
Receivables days
52 x 365 80 x 365 180 x 365
Receivables x 365
240 360 540
Sales
= 79 days = 81 days = 74 days
Payables days 40 x 365 70 x 365 90 x 365
Payables x 365 160 270 432
Cost of sales = 91 days = 95 days = 76 days
Total 20 marks
Financial ratios form an integral part of the syllabus and are also a very important tool for a credit
manager in assessing the credit worthiness of both new and existing customers. In the main, the
vast majority of candidates who attempted this question scored well although not as highly as one
would expect given the importance and possibly the familiarity of the subject matter. Most of the
ratios were computed correctly though some of the efficiency ratios, especially stock turnover,
caused a few problems.
Part b) responses were either very good or poor. The interpretation of financial data is just as
important as the calculation of the said ratios so students should take note. The topic, given its
importance, will continue to be examined in future diets.
TASK
b) Describe and assess the importance of each of those concepts with regards to the
interpretation of prepared financial statements. (16 marks)
Total 20 marks
Question aims
To test the candidate’s knowledge and understanding of the key accounting concepts and
conventions that underpin the compilation and publication of the final accounts of an incorporated
business.
Suggested answer
a) The concepts and conventions used in preparing the final accounts are aimed at conferring
uniformity on the financial statements. In preparing the income statement, statement of
financial position and cash flow statements, accountants apply these rules that establish the
way in which the financial performance of a business is recorded. Ultimately the aim of these
concepts is to produce objectivity in financial accounts and allow ‘like-for-like’ comparisons to
be made.
b) These concepts and conventions are broad basic assumptions which have been applied in
preparing the final accounts of a business and require no explanation or disclosure unless
otherwise stated. They are incorporated in various Companies’ Acts and associated laws and
regulations as fundamental accounting principles. The over-riding rule in financial statements
is that they should show a ‘true and fair view’ of the financial position of a given organisation.
Four can be detailed as impacting directly upon the preparation of final accounts:
i) Going concern – financial statements are prepared on the assumption that the company
will continue to operate as a viable business venture in the foreseeable future; that there
will be no significant reduction in the scale of its operations and it is not likely to become
insolvent. This means all assets will be valued in the balance sheet at either historical cost
less accumulated depreciation or at a revalued amount.
If the company is not to continue as a going concern and ceases trading and has to have
its assets sold then the market value of these will be significantly lower than the book
value held in the accounts. The Board must then write down the value of the assets in the
balance sheet to the amount they would realise in a forced sale and adjust liabilities
accordingly.
ii) Accruals (matching) concept – reviews and costs are recognised as earned or incurred
in the income statement of the period to which they relate, not when the cash is received
or paid. This ensures that the revenue relating to the year is matched against the related
expenses for the year. This enables the income of one period to be matched more fairly
against the expenditure of the same period.
The accruals concept is widely recognised as a more objective way of measuring profit
than on a cash basis. This gives a true and fair view of the profit for the year and the
assets and liabilities in the balance sheet.
iv) Prudence principle – in preparing the final accounts, a number of estimates and
judgements have to be made. The natural tendency would be to be over-optimistic about
profits and the overall financial position of the business. The prudence principle deems it
apt to be conservative or pessimistic when making a judgement on anticipated profit or
losses of a company. Accountants should always exercise caution when there is
uncertainty.
Revenues and profits must not be recognised until they are realised or there is a high
degree of certainty that they will be realised. Prudence also needs to be applied to other
items which cannot be measured with certainty and are very subjective, e.g., stock
valuation, profit or loss on the sale of a fixed asset etc. It also prevails over accruals,
should the two conflict.
Total 20 marks
Note: Marks will not be awarded when a student cites materiality, business entity, duality,
money measurement, periodically, historic costs, realisation and substance over form as these do
not apply to the preparation of the final accounts.
A question that did not require any accounting activity which curiously was not a favourite with
candidates. Answers in the main were fine although a few failed to address and indicate that the
purpose of standards is to bring uniformity in the compilation and content of final accounts of
businesses.
Part b) was well answered by most although a number did cite and talk about materiality, business
entity and money measurement, which although are other accepted standards, do not apply to
final accounts.
TASK
Assess the credit intelligence that might be gleaned from the following:
Total 20 marks
Question aims
To assess the candidate’s appreciation of the type of credit information that might be obtained
from the final accounts of a business which could enhance the decision made by a credit manager
with regard to credit terms and limits.
Suggested answer
The shareholders are investors in the company and in order to safeguard their interests it
is a statutory requirement that the final accounts of an incorporated business are
examined and scrutinised by an independent auditor appointed by the shareholders,
unless the company is exempt from doing so
The auditor is required to report to the members of the company on all the accounts
presented at the annual general meeting
The auditor has to comment on whether the financial statements presented to them,
namely
- the income statement,
- statement of financial position
- statement of cash flow
show a ‘true and fair view’ of the company or the group’s state of affairs at the end of
the financial period. Also whether the financial statements have been prepared in
accordance with the appropriate Companies Act legislation.
A report can be qualified i.e., the auditors disagree with the treatment or disclosure of
an item in the financial statement and in the opinion of the auditors the effect of this
does not give a true and fair view
The financial accounts are one of the main tools for the credit manager whose main task
is to ensure the credit worthiness of new or existing customers. A clean, unqualified,
audit report indicates that the auditor is confident that the final accounts give a true and
fair view of the company’s financial affairs for the year. The credit manager then can
have some confidence of the financial standing of the given organisation. Also a clean
audit implies that proper records have been kept and in accordance with all relevant
legislation.
The director’s report is an objective overview of the company’s activities and performance
during the year. There is a plethora of information here which will help the credit manager in
making a more informed credit decision.
Specifically
It details the company’s financial position at year end including any changes to share
capital, proposed dividend and transfers to reserves. Important information for the
credit manager
It details changes in the consistency and numbers of shareholders. Any major changes
require clarification
It discusses the business’ principal activities and any changes to these, i.e., whether the
core business is still the same
It talks about any significant development which might affect future performance and
results which could be either negative or positive
It highlights post balance sheet events i.e., major events that have occurred after the
year end which will affect future results. This could have a bearing on credit worthiness
It will detail any significant changes to fixed assets during the year. Again, this may
impact on an organisation’s ability to pay its debts as and when they fall due
It will inform the shareholders of any acquisitions made by the company of its own
shares
Names of directors and details of their interest in shares and debentures will be
disclosed. Also any changes to the Board during the year. This would require
investigation by the credit manager
There will also be a statement regarding the supplier payment policy of how many days
the company takes to pay its suppliers which is very useful information for credit risk
assessment.
This is a review by the chairman of the major activities and events of the organisation for
the past year
It discusses the company’s general performance and comments on events during the
year which might be of interest to shareholders
The aim of the statement is to emphasise the positive aspects of the trading performance
of the organisation over the past year
It will also try to detail the reasons for any adverse results or negative trading
developments
The report is not mandatory, nor subject to the scrutiny of auditors, so needs its content
to be treated with caution. Nonetheless, if the auditors and directors’ reports are
detailed in a positive manner and this is supported by the chairman’s report, the credit
manager can rate this as a favourable piece of credit intelligence. It must though not be
totally relied upon to assess any aspect of credit worthiness.
Total 20 marks
DR CR
£ £
Capital 45,000
Debtors and Creditors 32,900 5,000
Returns 2,500 2,710
Purchases and Sales 25,000 30,485
Discounts 6,800 5,630
Drawings 8,220
Wages and Salaries 7,000
Equipment 8,000
The following errors were discovered by Sandy, the internal auditor, on 31 December 2014:
ii) Cash sales of £24,205 had not been entered into the Sales account.
iii) A credit note of £3,450 was entered in P White’s customer account but no entry was
made in the relevant returns account.
v) £4,590 of goods was taken out of the business for I Johnson’s personal use. This was
recorded in the Drawings account but there were no other entries.
vi) An invoice for J Sullivan was discovered behind the computer. No accounting entries had
been made for the £1,650.
vii) £2,700 in respect of debtor J Smith was debited in error to the account of J Smythe Ltd.
viii) A discount allowed of £4,275 was credited in error to the Discount Received account.
ix) A bad debt of £6,800 had been entered into the customer’s account only.
TASK
b) Correct the above errors and prepare the resulting suspense account. (18 marks)
Note: journal entries are not required.
Total 20 marks
Suggested answer
a) The purpose of a trial balance is to check the arithmetical accuracy of the double entry in the
ledger accounts and to provide information required for the preparation of the final accounts.
b) Suspense account
Dr Cr Balance
Date Details
£ £ £
31.12.14 Trial balance 1,595 (1,595)
Students should identify that transactions (vi) and (vii) would not require any posting to the
suspense account but that a journal entry would be pertinent.
Total 20 marks
Not as popular as in previous exam series but answered well by those who attempted, even
though there were a couple of woeful responses. Most knew the role and importance of suspense
accounts and many came up with a nil balance after the appropriate corrections and postings.
Some of the narratives in the ledger itself could have been better. Only a few though could
identify the two errors that required only a journal entry, which is a little surprising.
£
Bank (overdrawn) 1,675
VAT owing 850
Sales 14,500
Purchases 8,700
Discount Allowed 750
2 January 2014 An invoice for £1,200 plus VAT was sent to P Hughes.
A credit note for £750 plus VAT was received from C Mulhearn in
3 January 2014
respect of returned goods.
A credit note was sent to P Hughes for £1,500 including VAT in respect
9 January 2014
of damaged software.
15 January 2014 J Jones took £350 out of the bank for his own personal use.
An invoice is received from C Mulhearn for £790 plus VAT for the supply
17 January 2014
of new software.
TASK
a) Open all the appropriate accounts that are necessary to record the above
transactions and enter all balances brought forward on 1 January 2014. (4 marks)
b) Make the necessary entries in the relevant accounts to record the transactions
including discounts and value added tax at 20%. (16 marks)
Total 20 marks
Suggested answer
a) and b)
Account: Bank
Date Details DR CR Balance
1.1.14 Balance b/f (1,675)
8.1.14 C Mulhearn 2,200 (3,875)
12.1.14 P Hughes 4,900 1,025
15.1.14 Drawings 350 675
20.1.14 Revenue and customs 832 (157)
25.1.14 Water 1,500 (1,657)
Account: VAT
Date Details DR CR Balance
1.1.14 Balance b/f (850)
2.1.14 P Hughes 240 (1,090)
3.1.14 C Mulhearn 150 (1,240)
9.1.14 P Hughes 250 (990)
17.1.14 C Mulhearn 158 (832)
20.1.14 Bank 832 Nil
Account: Sales
Date Details DR CR Balance
1.1.14 Balance b/f (14,500)
2.1.14 P Hughes 1,200 (15,700)
Account: Purchases
Date Details DR CR Balance
1.1.14 Balance b/f 8,700
17.1.14 C Mulhearn 790 9,490
Account: Drawings
Date Details DR CR Balance
15.1.14 Bank 350 350
Account: Water
Date Details DR CR Balance
25.1.14 Water 1,500 1,500
Total 20 marks
This question, as ever, proved the most popular on the paper and candidate responses are
certainly getting better. The vast majority identified the appropriate balance in the question
and opened appropriate accounts. The postings were tackled well, although a few failed to
arrive at a nil balance on the VAT account. There was a bit of confusion between sales and
purchases returns amongst a few candidates as was there with discounts. The double entry
for a sole trader taking money out of the business for his/her own personal use as usual
caused a few problems, as did the accounting treatment of the payment of a water bill, which
is a little disappointing.
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