Financial Accounting II

2nd Year Examination

August 2010

Paper, Solutions & Examiner’s Report

Financial Accounting II August 2010 2nd Year Paper

NOTES TO USERS ABOUT THESE SOLUTIONS

The solutions in this document are published by Accounting Technicians Ireland. They are intended to
provide guidance to students and their teachers regarding possible answers to questions in our
examinations.

Although they are published by us, we do not necessarily endorse these solutions or agree with the views
expressed by their authors.

There are often many possible approaches to the solution of questions in professional examinations. It
should not be assumed that the approach adopted in these solutions is the ideal or the one preferred by us.
Alternative answers will be marked on their own merits.

This publication is intended to serve as an educational aid. For this reason, the published solutions will
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particularly the case where discursive answers are involved.

This publication is copyright 2010 and may not be reproduced without permission of Accounting
Technicians Ireland.

© Accounting Technicians Ireland, 2010.

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 Accounting Technicians Ireland

2nd Year Examination: Autumn 2010

Paper : FINANCIAL ACCOUNTING II
Monday 16th August 2010 – 2.30 p.m. to 5.30 p.m.
INSTRUCTIONS TO CANDIDATES

PLEASE READ CAREFULLY

Candidates must indicate clearly whether they are answering the paper in
accordance with the law and practice of Northern Ireland or the Republic of
Ireland.
In this examination paper the £ symbol may be understood and used by candidates in Northern
Ireland to indicate the UK pound sterling and the € symbol by candidates in the Republic of
Ireland to indicate the Euro.

Answer ALL THREE questions in Section A and TWO of the THREE questions in Section B. If more
than TWO questions are answered in Section B, then only the first TWO questions, in the order
filed, will be corrected.

Candidates should allocate their time carefully.

All workings should be shown.

All figures should be labelled, as appropriate, e.g. €’s, £’s, units etc.

Answers should be illustrated with examples, where appropriate.

Question 1 begins on Page 2 overleaf.

The following insert is enclosed with this paper:

• Multiple choice question answer sheet [QUESTION 2]

Note:
This paper uses both the language of International Accounting Standards (I.A.S’s) and Financial Reporting
Standards (F.R.S’s) where appropriate (e.g. Receivables/Debtors). Examinees are permitted to use either
terminology when preparing financial statements but the use of the language of the International
Accounting Standards (e.g. Receivables rather than Debtors) is preferred.
Financial Accounting II August 2010 2nd Year Paper
SECTION A

Answer ALL THREE Questions in this Section

QUESTION 1 (Compulsory)

(a) IAS 1, Presentation of Financial Statements, sets down a number of principles that
govern the preparation and presentation of financial statements.

Describe the following principles as discussed in the standard:

i. Accruals
ii. Going concern
iii. Materiality and aggregation
iv. Consistency

12 Marks

(b) Both internal and external auditors play a very important role in ensuring that
financial statements show a true and fair view of the financial performance of a
company. However the role and function of the internal and external auditor is
very different.

Briefly discuss three key differences between the role of the internal and external
auditor.
8 Marks
Total 20 Marks

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 2 (Compulsory)

The following multiple choice question consists of TEN parts, each of which is followed by
FOUR possible answers. There is ONLY ONE right answer in each part.

Each part carries 1½ marks.

Requirement

Indicate the right answer to each of the following ten parts. Total 15 Marks

NB Candidates should answer this question by ticking the appropriate boxes on the
specified green answer sheet which is supplied with the examination paper.

[1] With regard to IAS 16 (Property, Plant and Equipment), which of these statements
is true?

[a] If an item of plant and equipment is re-valued, the entire class of property,
plant and equipment to which it belongs must be re-valued.
[b] If an item of plant and equipment is re-valued, there is no obligation to re-
value other assets within the same class of property, plant and equipment.
[c] If an item of plant and equipment is re-valued, the same item must be re-
valued annually thereafter to ensure that the carrying value of the asset does
not differ materially from the fair value at the balance sheet date.
[d] If an item of plant and equipment is re-valued depreciation continues to be
calculated on the original cost price as the revaluation surplus/deficit is not a
realised gain/loss.

[2] With regard to IAS 7 (Cash flow Statement), which of the following statements is
true:

[a] The acquisition of assets by means of a finance lease must be excluded from a
cash flow statement.
[b] The direct method of preparing the cash flow statement is often used as the
information required is available in the financial statements.
[c] An increase in payables reflects a cash inflow and therefore should be added
back when calculating net cash flow from operating activities.
[d] Dividends must always be shown as a cash flow from operating activities.

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 2 (Cont’d)

[3] In January 2009, ENVY Limited acquired a new machine with a list price of
£/€180,000. Spare parts totalling £/€12,000 for future repairs were also
purchased and delivery costs of £/€4,500 were also paid. The company incurred
£/€8,800 site preparation costs, which was made up of material costs of £/€4,800
and labour costs of £/€4,000. All work was carried out by employees of ENVY.

How much of the above expenditure may ENVY capitalise in its balance sheet?

[a] £/€193,300
[b] £/€205,300
[c] £/€184,500
[d] £/€189,300

[4] According to IAS 17 (Leases), which of the following statements is true:

[a] A finance lease is a lease which has a minimum period of over 5 years.
[b] A finance lease is a lease that transfers substantially all of the risks and
rewards of ownership to the lessee.
[c] A lease of land would normally be treated as a finance lease.
[d] IAS 17 applies to all leases including lease agreements to explore for, or use,
natural resources.

[5] Where a partnership exists and there is no partnership agreement, then:

[a] the partners share profits in relation to the combined balances on their capital
and current account.
[b] the partners share profits equally and interest is paid on capital balances at
5% per annum.
[c] the partners share profits in relation to the balances on their capital accounts.
[d] the partners share the profits equally and no remuneration is paid to the
partners for acting in the business.

[6] Partners drawing are:

[a] charged against the partners in their current accounts.

[b] charged against the partners in their capital accounts.
[c] credited to the partners capital accounts.
[d] credited to the partners current accounts.

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 2 (Cont’d)

[7] Interest paid to a partner for a loan extended to the business must be accounted
for:

[a] in the partners current account.

[b] in the appropriation account.
[c] in the partners capital account.
[d] in the income statement as an expense.

[8] The IASB Framework for the Preparation and Presentation of Financial Statements
lists four qualitative characteristics of financial information. These are:

[a] Relevance, reliability, materiality and comparability.

[b] Understandability, relevance, reliability and comparability.
[c] Relevance, prudence, materiality and comparability.
[d] Understandability, relevance, materiality and prudence.

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 2 (Cont’d)

BACKGROUND INFORMATION TO PARTS [9] & [10]

Jen and Brad are in partnership and their capital account balances are £/€63,000 and
£/€92,000 respectively. The partnership agreement details appropriation of partnership
profits as follows:

Jen Brad

Annual salary £/€18,000 £/€24,000

Interest on capital 8% 8%
Share of residual profit 45% 55%

[9] If the profit for the year, before appropriation, was £/€124,000, what would Jen’s
entitlement be in total:

[a] £/€23,040
[b] £/€36,360
[c] £/€54,360
[d] £/€49,320

[10] If the profit for the year, before appropriation, was £/€124,000, what would Brad’s
entitlement be in total:

[a] £/€69,640
[b] £/€45,640
[c] £/€31,360
[d] £/€62,280

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 Financial Accounting II August 2010 2nd Year Paper

QUESTION 3 (Compulsory)
(a) The Statement of Financial Position, Statement of Changes in Equity and other
relevant information of BUBBLES Limited, for the year ended 31 December 2009,
are as follows:
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER

2009 2009 2008 2008

£/€'000 £/€'000 £/€'000 £/€'000
ASSETS
Non current assets
Property, plant & equipment 143,000 114,400
Investments 6,500 19,500

Current assets
Inventory 47,200 65,000
Receivables 65,000 32,500
Cash & cash equivalents 130,000 1,300
242,200 98,800

Total assets 391,700 232,700

EQUITY and LIABILITIES

Capital and reserves

Ordinary share capital 58,500 26,000
Share premium 45,500 32,500
Revaluation reserve 9,750 6,500
Retained earnings 239,200 109,200
Total shareholders equity 352,950 174,200

Current liabilities
Trade & other payables 21,200 39,000
Bank overdraft 9,750 6,500
Tax 7,800 38,750 13,000 58,500

Total equity and liabilities 391,700 232,700

STATEMENT OF CHANGES IN EQUITY

Ordinary Reval-
share Share uation Retained Total
capital premium reserve profits equity
£/€'000 £/€'000 £/€'000 £/€'000 £/€'000

As at 1 January 2009 26,000 32,500 6,500 109,200 174,200

Net profit for year end 31 December
2009 149,500 149,500
Share issue 32,500 113,000 45,500
Land revaluation 3,250 3,250

Ordinary dividends (19,500) (19,500)

58,500 45,500 9,750 239,200 352,950

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 3 (Cont’d)

NOTE: Disclosure notes for Non-Current

Assets
Plant &
Property Equipment Total
€/£'000 €/£'000 €/£'000
Cost
At 1 January 2009 58,500 84,500 143,000
Additions 16,250 45,500 61,750
Revaluations 3,250 3,250
(Disposals) (19,500) (19,500)

At 31 December 2009 78,000 110,500 188,500

Accumulated depreciation
At 1 January 2009 5,850 22,750 28,600
(Disposals) (13,000) (13,000)
Charge for year 650 29,250 29,900

At 31 December 2009 6,500 39,000 45,500

Net book value

At 1 January 2009 52,650 61,750 114,400

At 31 December 2009 71,500 71,500 143,000

The following additional information was also available:

1. Proceeds from the sale of equipment and investments amounted to £/€3,900,000

and £/€19,500,000 respectively.

2. During the year ordinary dividends of £/€19,500,000 were declared and paid.

3. The tax charge in the income statement for the year was £/€6,500,000.

4. There was no interest charged or paid during the year.

Requirement

Prepare a cash flow statement for BUBBLES Limited for the year ended 31 December
2009 in accordance with the requirements of IAS 7 Cash Flow Statement. Notes to the
cash flow statement are not required.
18 Marks
(b) ‘Profits do not always translate into a positive cash balance at year end’. Briefly
discuss two reasons why profit and cash are different.
5 Marks
Presentation 2 Marks
Total 25 Marks

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Financial Accounting II August 2010 2nd Year Paper

SECTION B
Answer TWO of the THREE questions in this Section

QUESTION 4
WAVERLEY Limited, which operates a chain of restaurants, made up its financial
statements to 31 December 2009. During a year end review of the accounts, and before
approval of the financial statements by the Board of Directors, the external auditor
identified the following:

(i) Slow moving goods which cost £/€60,000 are included in inventory at year end.
This inventory is expected to realise £/€40,000 at a discount warehouse.
Commission costs of 2.5% will be incurred.

(ii) Receivables at year end, valued at £/€520,000, include a debt of £/€15,000 owing
by a company which the auditor knows has ceased trading and will be unable to
meet its debts. Additionally the company has not made any adjustments for the
general bad debt provision, which has always been calculated to be 5% of
receivables. The provision for bad debts at the start of the year was £/€35,000.

(iii) The company opened a new restaurant during the year however the following costs
were not provided for in the accounts at year end:
Promotional and advertising costs £/€35,000
Equipment testing costs £/€22,000
No depreciation is charged in the first year of operation.

(iv) On 12 December 2009 the board of directors decided to close down one of the
restaurants as it continued to make losses. The directors estimate that closure costs
will amount to approximately £/€110,000. No other steps were taken to implement
the decision or communicate it to the people affected.

(v) On 30 November 2009 a provision had been made for £/€45,000 in respect of any
remedial work required on restaurant equipment supplied and installed as part of a
joint venture. No remedial work had been carried out and on 30 March 2010 it was
confirmed that no remedial work would be required and no further liability would be
incurred.

Requirement
(a) Prepare the journal entries to show how each of the above items should be dealt
with in the final accounts for the year ended 31 December 2009. You should use
your understanding of the relevant IAS’s in dealing with each item.
14 marks
(b) Compute the adjusted net profit before taxation for the year ended 31 December
2009 taking into account the adjustments made at (a) above. The net profit
before taxation as per the draft accounts was £/€410,000.
4 marks
Presentation 2 marks
Total 20 marks

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 5

JACK N JILL Limited has an authorised share capital of £/€2,500,000 made up of

5,000,000 ordinary shares of 50 pence/cent each.

The following trial balance was extracted from the books and records of the company at
31 December 2009.

TRIAL BALANCE AS AT 31 DECEMBER 2009

£/€'000 £/€'000

Ordinary share capital @ 1 January 2009 1,100

Share premium account @ 1 January 2009 170
Retained profits at 1 January 2009 185
General reserve @ 1 January 2009 145
6% Debenture loan 450
Premises at cost @ 1 January 2009 1,150
Premises accumulated depreciation @ 1 January 2009 210
Plant and machinery at cost @ 1 January 2009 780
Plant and machinery accumulated depreciation @ 1 Jan 2009 300
Motor vehicles at cost @ 1 January 2009 155
Motor vehicles accumulated depreciation @ 1 January 2009 55
Goodwill 140
Long term investments 110
Short term investments 20
Inventory @ 31 December
2009 375
Receivables 425
Trade payables 230
Bank 45
Cash 25
Accrued expenses 80
Prepaid expenses 120
Corporation tax 65
Government grants 25
Retained profit for the year 180
Director’s loan 60

3,300 3,300

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 5 (Cont’d)

ADDITIONAL INFORMATION

1. Depreciation is to be provided on non-current assets as follows:

Premises ................................. 2% on cost

Plant and machinery .................. 15% reducing balance
Motor vehicles ........................... 20% on cost

A full year’s depreciation is charged in year of acquisition and none in the year of
disposal.

2. During the year motor vehicles that cost £/€30,000 in 2006 were sold for
£/€5,000. No entries were made to record this transaction.

3. The government grant of £/25,000 that was received during the year relates to
staff training costs incurred, however, it was treated as a capital grant in error.

4. Expenses in the Income Statement include £/€25,000 that relates to prepaid

insurance costs.

5. Full year debenture interest to be provided for.

6. Ordinary dividend of 1.5pence/cent per share to be provided for at year end.

Requirement

Prepare, in a form suitable for publication, the Statement of Financial Position as at 31

December 2009

18 marks
Presentation 2 marks
Total 20 marks

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 6

(a)

George, Penny and Chloe are in partnership, sharing profits in the ratio 4:4:2. The
following information is available for the partnership for the year ended 31 December
2009:

Profit for the year £/€64,500

George Penny Chloe

£/€ £/€ £/€

Drawings 12,000 6,500 3,700

Salary 17,000 8,500
Balance on capital accounts 31 December 2009 13,500 21,000 16,500
Balance on current accounts 31 December 2009 2,600 4,700 5,100

Interest on drawings is charged at 10% per

annum.

Interest on capital is paid at 5% per annum.

Requirement

(a) Prepare the appropriation account for the year ended 31 December 2009.
3marks
(b) Prepare the partner’s current accounts for the year ended 31 December 2009.
3 marks

Presentation 1 mark

QUESTION 6 CONTINUED OVERLEAF

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 6 (Cont’d)

(b)

The following are the Income Statement, Statement of Financial Position and appropriate
notes to the accounts of TREETOPS Limited for the year ended 31 December 2009 (with
comparative figures for the year ended 31 December 2008).

INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2009

2009 2008
£/€'000 £/€'000 £/€'000 £/€'000

Sales (90% of which are credit sales) 5,600 4,300

Less: Cost of goods sold 3,500 2,900

Gross profit from trading 2,100 1,400

Administration expenses 1,060 660

Distribution expenses 560 320
1,620 980

Profit before interest 480 420

Interest paid (60) (45)

Profit before tax 420 375

Taxation (210) (145)

Profit after tax 210 230

Dividends (60) (85)

Retained profit for the year 150 145

Retained profit brought forward 725 580

875 725

QUESTION 6 CONTINUED OVERLEAF

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 6 (Cont’d)

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER

2009 2008
£/€'000 £/€'000 £/€'000 £/€'000
ASSETS
Non-current assets

Property, plant & equipment 1,850 1,750

Current assets

Inventory 330 360

Receivables 290 310

Cash at bank 30 10

650 680

Total assets 2,500 2,430

EQUITY and LIABILITIES

Capital and reserves

Ordinary share capital 860 780

Retained earnings 875 725

Total shareholders equity 1,735 1,505

Non-current liabilities

10% debenture stock 365 365

Current liabilities

Payables 180 235

Bank overdraft - 20

Taxation 160 220

Dividends 60 400 85 560

Total equity and liabilities 2,500 2,430

ADDITIONAL
INFORMATION
Inventory at 1 January 2008 was £/€310,000.

QUESTION 6 CONTINUED OVERLEAF

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Financial Accounting II August 2010 2nd Year Paper

QUESTION 6 (Cont’d)

Requirement

Calculate each of the following ratios for TREETOPS Limited for the years ended 31
December 2009 and 2008 and comment briefly on the performance of the company in
2009 using the ratios calculated.

(i) Current ratio

(ii) Liquid ratio (acid test)
(iii) Stock turnover ratio
(iv) Gross profit %
12 marks

Presentation 1 mark
Total 20 marks

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Financial Accounting II August 2010 2nd Year Paper

2nd Year Examination: August 2010

Financial Accounting II

Solutions

Students please note: These are suggested solutions only; alternative answers may
also be deemed to be correct and will be marked on their own merits.

Solution 1
[a]

(i) Accruals

Financial statements, with the exception of the cash flow statement, are prepared
on the accruals basis of accounting where transactions are recognised in the
period in which they take place irrespective of the when the cash flow arising
from these transactions occurs.

(ii) Going concern

Financial statements are normally prepared on the assumption that an entity is a

going concern and will continue in operation for the foreseeable future.
Foreseeable future is considered to be twelve months from the date the financial
statements are signed. In the event that management decide that it is no longer
appropriate to prepare the financial statements on a going concern basis this
must be disclosed.

(iii) Materiality

Information is material to a set of financial statements if its omission or

misstatement could influence the economic decisions of users. However some
transactions are deemed to be material by their very nature for example, all
transactions involving a company and a director of that company are deemed to
be material regardless of the value of the transaction. With respect to
aggregation, each material class of similar items must be presented separately in
the financial statements. Items of dissimilar nature should be presented
separately unless they are immaterial.

(iv) Consistency

The presentation and classification of items in the financial statements should be

consistent from one reporting period to the next unless a change is justified by a
change in circumstance or by a new IFRS. If there were no regulations in this
regard and changes in the presentation of financial statements were allowed then
the comparability of financial statements would be greatly compromised.

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Financial Accounting II August 2010 2nd Year Paper

Solution 1 (Cont’d)

[b]

The role of the external auditor is to examine the financial statements and books and
records of a company in order to form an opinion as to whether the information
contained in the financial statements can be relied upon.
The role of the internal auditor is to help directors discharge their responsibility for the
prevention and detection of fraud and error. The internal audit department, where one
exists within a company, will examine the internal controls within an organisation to help
determine if they are operating efficiently and effectively.
Key differences between the external and internal auditor:

1. Scope of their work

The external auditor has a narrow focus that is the truth and fairness of the
financial statements. The external auditor must also consider such matters as
compliance with legislation to ensure that the financial impact of new legislative
requirements is reflected in the financial statements.

The internal auditor has a much wider focus which is looking at the internal
operations of the entire business. The internal auditor must make sure that the
operational, compliance and financial controls within a company are operating
effectively.

2. Independence

The external auditor is an accountant from an independent firm of accountants.

The external auditor must be independent of the company it audits. The
independence of the auditor is critical and is a key factor which enables users of
financial statements to rely upon the opinion expressed regarding the truth and
fairness of the financial statements.
The internal auditor is employed by the company and therefore is not
independent. However, the independence of the internal auditor can be improved
by deciding to whom the internal auditor reports. If the internal auditor reports
directly to an audit committee this is considered to be more independent and
therefore objective than if it were to report to the head of the finance function on
which it is reporting.

3. Reporting

The reporting lines of both the external and internal auditor are very different.
The external auditor reports externally to the shareholders on the truth and
fairness of the financial statements. The internal auditor usually reports to the
board of directors, or the audit committee who in turn report to the board of
directors, on the effectiveness of the internal control environment within the
company.

4. Legal requirement

There is a legal requirement in Ireland and the UK for all companies, other than
those which meet the criteria to avail of audit exemption, to engage an external
auditor to undertake an audit of the year end financial statements. There is

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Financial Accounting II August 2010 2nd Year Paper

currently no legal requirement, in Ireland or the UK, for companies to have an

internal audit function. However, best practice, as outlined in the Combined Code
of Corporate Governance, states that public limited companies should have an
internal audit function and where one does not exist directors must assess the
need for one on an annual basis.

Solution 1 (Cont’d)

NOTE:
The question asks for only three differences. Four differences are discussed above as a
study aid. No additional marks were awarded where more than three differences were
given.

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Financial Accounting II August 2010 2nd Year Paper

Solution 2

MCQ

1. A
2. C
3. A (£/€180,000 + £/€4,500 + £/€8,800 = £/€193,300)
4. B
5. D
6. A
7. D
8. B
9. C (see below)
10. A (see below)

Workings to Q9 and Q10 Jen & Brad

Jen Brad

Capital 63,000 92,000

Salary 18,000 24,000

Interest on capital
(8% x 63,000)5,040
(8% x 92,000) 7,360

Subtotal 23,040 31,360

Profit avail for distribution:

(124,000 – 23,040 – 31,360 = 69,600)

Profit share
69,600 x 45% 31,320
69,600 x 55% 38,280

TOTAL 54,360 (c) 69,640 (a)

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Financial Accounting II August 2010 2nd Year Paper

Solution 3
[a]
BUBBLES Limited
Statement of Cash Flows for the year ended 31
December 2009

£/€'000 £/€'000

Cash flows from operating activities

Net profit before tax W1 156,000
Adjustments for:
Depreciation 29,900
Interest 0
Loss on sale of non-current
assets W2 2,600
Profit on sale of investments W3 (6,500)
Changes in working capital
(Increase)/Decrease in
inventory 17,800
(Increase)/Decrease in
receivables (32,500)
Increase in prepayments
Increase/(Decrease) in
payables (17,800)
(6,500)
Cash generated from operations 149,500

Interest paid 0
Tax paid W4 (11,700)
(11,700)
Net cash from operating activities 137,800

Cash flows from investing activities

Payments to acquire non-current assets (61,750)
Receipt from sale of non-current assets 3,900
Receipt from sale of investments 19,500
Net cash used in investing activities (38,350)

Cash flows from financing activities

Proceeds of share issue, incl premium 45,500
Dividends paid (19,500) 26,000
Increase in cash and cash equivalents 125,450

Cash and cash equivalents at start of

year W5 (5,200)
Cash and cash equivalents at end of
year 120,250

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Financial Accounting II August 2010 2nd Year Paper

Solution 3 (Cont’d)

Note: Cash and cash equivalents

Change
2009 2008 in year
£/€'000 £/€'000 £/€'000

Bank 130,000 1,300 128,700

Bank overdraft (9,750) (6,500) (3,250)

120,250 (5,200) 125,450

Workings
1 Net profit before interest £/€'000

Net profit for the year 149,500

Tax charge for the year 6,500

156,000

2 Disposal of equipment £/€'000

Cost 19,500
Acc
depreciation (13,000)

6,500
Sale proceeds (3,900)

Loss on sale of equipment 2,600

3 Disposal of investments £/€'000

Sale
proceeds 19,500
Cost 13,000

Profit on sale 6,500

4 Tax paid
Taxation
Bank 11,700 Opening balance 13,000
P&L 6,500
Closing
balance 7,800

19,500 19,500

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Financial Accounting II August 2010 2nd Year Paper

Solution 3
(Cont’d)

5
Cash and cash equivalents at start of year
£/€'000

Cash at bank 1,300

Bank
overdraft (6,500)

(5,200)

[b] Profit versus cash

While businesses need both profits and cash to survive in the long term, businesses can
survive without profits in the short term however a company can only survive for a much
shorter period without cash. Businesses need cash on a daily basis to meet all the
expenses incurred while running the business, for example wages, electricity, purchases.
The following briefly discusses the key differences between profit and cash:

1. Treatment of capital expenditure

Capital expenditure is expenditure on items which are used by the companies in

the production and/or supply of goods or services. Capital expenditure can be
quite significant and is long term in nature. Capital expenditure will have a
negative impact on cashflow as the organisation has to meet the cost of the capital
expenditure however the capital expenditure incurred will not have any effect on
the income statement and therefore on profit.

2. Non-cash items

The income statement will usually contain transactions which have no cash impact
on the business and these items are referred to as non-cash items. An example of
a non-cash item is depreciation. Depreciation is charged to the income statement
on an annual basis and accordingly reduces profit, however it has no cash
implications for the business in the period in which it is charged to the income
statement.

3. Accruals concept

IAS 1 states that with the exception of the cash flow statement the financial
statements of an organisation are to be prepared using the accruals concept. The
accruals concept states that transactions must be recorded in the period in which
they were incurred not the period in which the corresponding cash transaction too
place. This concept therefore gives rise to timing differences between when the
profit/loss from an activity is recorded and when the cash is received/paid.

NOTE:
The question asks for only two differences. Three differences are discussed above
as a study aid. No additional marks were awarded where more than two
differences were given.

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Financial Accounting II August 2010 2nd Year Paper

Solution 4

WAVERLEY Limited
[a] Journal DR CR

£/€ £/€

a) Inventory (P&L a/c) 21,000

Inventory (B/S) 21,000
[Being slow moving stock written down to net realisable value as per IAS 2]

b) Bad debt (P&L a/c) 15,000

Receivables (B/S) 15,000
[Being write-off of bad debt at year end]

Bad debt provision (B/S) 9,750

Bad debt provision (P&L a/c) 9,750
[Being reduction in bad debt provision at year end]

c) Selling and distribution cost (P&L a/c) 35,000

Trade payables (B/S) 35,000
[Being promotional and advertising costs not capitalised]

Non-current assets (B/S) 22,000

Trade payables (B/S) 22,000
[Being capitalisation of equipment testing costs per
IAS 16]

d) No provision required as per IAS 37. No obligating event

so there is no obligation.

e) Provision (B/S) 45,000

Remedial work expense (P&L a/c) 45,000
[Being reversal of provision for remedial work]

[b] £/€

Profit before taxation per draft accounts 410,000

Adjustments:
Inventory write down (21,000)
Bad debt at year end (15,000)
Decrease in bad debt provision 9,750
Promotional and advertising costs (35,000)
Remedial work 45,000
(16,250)
Adjusted profit before taxation 393,750

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Financial Accounting II August 2010 2nd Year Paper

Solution 5
JACK N JILL Limited

Statement of Financial Position as at 31

December 2009
£/€'000 £/€'000

Non-current assets

Property, plant and equipment (Note 1) W1 1,388

Goodwill 140
Other financial assets 110
1,638

Current assets

Inventories 375
Trade receivables 425
Prepayments W5 145
Cash and cash equivalents W4 50 995

Total assets 2,633

Equity and liabilities

Capital and reserves

Issued share capital 1,100

Share premium 170
Reserves 145
Retained earnings W3 228

Total equity 1643

Non-current liabilities

Long term borrowings 450

Loan from director 60 510

Current liabilities

Overdraft 45
Trade and other payables 310
Interest payable W6 27
Dividend payable W7 33
Tax payable 65 480

Total equity and liabilities 2633

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Financial Accounting II August 2010 2nd Year Paper

Solution 5 (Cont’d)

Workings
1 Depreciation
Freehold Plant & Motor
premises machinery vehicles TOTAL
15% red 20%
2% cost bal cost

Cost at 1 January 1,150 780 155 2,085

Disposals (30) (30)
Additions 0
Cost at 31 December 1150 780 125 2,055

Depreciation at 1 January 210 300 55 565

Disposals (18) (18)
Charge for year 23 72 25 120
Depreciation at 31 December
2009 233 372 62 667

NBV at 1 January 940 480 100 1,520

NBV at 31 December 917 408 63 1,388

2 Disposal
Cost 30
Acc depreciation (18)
12
Sale proceeds 5
Loss on disposal (7)

3 Retained earnings

Per trial balance 180

Less:
Depreciation (120)
Loss on disposal (7)
Dividend (33)
Debenture interest (27) (187)
Add:
Government grant 25
Prepaid expenses 25 50
Revised retained earnings 43

Retained profit brought fwd 185

Retained profits at year end 228

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Financial Accounting II August 2010 2nd Year Paper
4 Solution 5 (Cont’d)

Cash and cash equivalents

Cash per trial balance 25

Short term investments 20
Add:
Sale of motor vehicles 5
50

5 Prepayments

Prepayments per trial balance 120

Prepayments included in P&L in
error 25
145

6 Debenture interest

Debenture loan (6%) 450

Interest accrued 27

7 Dividend

No shares 2,200,000
Dividend per share 0.015

Total dividend payable 33,000

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Financial Accounting II August 2010 2nd Year Paper

Solution 6
[A]

(a) Statement of appropriated

profits

£/€ £/€

Profit for the

year 64,500

Salaries George 0
Penny (17,000)
Chloe (8,500) (25,500)

Interest on drawings
George 12,000 1,200
Penny 6,500 650
Chloe 3,700 370 2,220

Interest on capital accounts

George 13,500 (675)
Penny 21,000 (1,050)
Chloe 16,500 (825) (2,550)

38,670

Share of profit George 15,468

Penny 15,468
Chloe 7,734

38,670

(b) Partners current

accounts
Current Accounts
G P C G P C
£/€ £/€ £/€ £/€ £/€ £/€
Drawings 12,000 6,500 3,700 Balance b/d 2,600 4,700 5,100
Interest on
drawings 1,200 650 370 Salaries 0 17,000 8,500
Interest on
capital 675 1,050 825
Balance c/d 5,543 31,068 18,089 Share of profit 15,468 15,468 7,734

18,743 38,218 22,159 18,743 38,218 22,159

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Financial Accounting II August 2010 2nd Year Paper

Solution 6
(Cont’d)

[B] TREETOPS Ltd

2009 2008
Current ratio
Current assets/ current liabilities

650/400 1.625 : 1
680/560 1.214 : 1

Liquid ratio
Current assets less stock/current liabilities

320/400 0.80 : 1
320/560 0.57 : 1

Stock turnover
Cost of goods sold/average stock

3,500/(330+360)/2 10.1 times (36 days)

2,900/(360+310)/2 8.7 times (42 days)

Gross profit percentage

Gross profit/sales * 100

2100/5600 37.50%
1400/4300 32.50%

Commentary on financial performance in 2009

As can be seen from the current ratio and the acid test ratio the liquidity position of the
company has improved in 2009. The company is less likely to experience cash
difficulties and should be able to pay its debts as they fall due. The acid test ration has
shown a much needed improvement from what was a very low ratio of 0.57:1. The
company’s healthier cash position is also helped by a reduction in trade creditors and the
return to a positive bank balance.
The stock turnover has also improved with the company now turning its stock over an
average of 10 times. This reduces the amount of finance tied up in stock and reflects a
quicker conversion of stock into debtors and subsequently cash. The gross profit
percentage has also improved in 2009. The company has effectively increased its
turnover whilst controlling direct costs which increased at a slower rate.
Overall the company performed well in 2009.

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Financial Accounting II August 2010 2nd Year Paper

2nd Examination: August 2010

Financial Accounting

Examiner’s Report

General comment

The students who studied and prepared well for the autumn exam did well. However,
for many students it appeared that they weren’t prepared and this manifest itself in a
poor attempt at all questions rather than being caught out by one or two particular
questions. As with the summer paper, cash flow statements and journals are two areas
in which students clearly struggle. This perhaps caused greater difficult for students as
the cash flow question appeared on the compulsory section of the paper. Having said
the above the pass rate increased this year which is a positive move.

Question 1

This question was made up of two parts, part (a) which sought definitions and part (b)
which asked for differences between internal and external auditors. Part (a) included
two definitions which were straight from the compulsory section of the summer paper
and a surprising number of candidates were unable to provide reasonable answers. This
should have been an easy start to the exam.
Part (b) was met with a surprising amount of difficulty and this was the main cause of
such a low average mark for this question (7.9%). Many students were just unfamiliar
with the role of either auditor and therefore made very poor attempts at answering this
part. Again, this was an easy 8 marks for those who knew the area.

Question 2

Students made reasonable attempts at the multiple choice question. However while
most students answered the partnership theoretical questions correctly many were
unable to calculate partner entitlements correctly as per question 9 and 10.

Question 3

Although this cash flow question was a compulsory question there was a very obvious
bias away from it and an obvious high level of discomfort from those who attempted it.
The average mark was 8.2% out of a possible 25%. Most candidates were unable to
calculate the correct net profit before interest. Once again, the tax paid and
depreciation figures caused the greatest difficulties. Students need to be a lot more
comfortable with the preparation and presentation of cash flow statements.
There was a part (b) to this question which asked students to discuss two differences
between profit and cash. This part was very poorly answered with many students opting
to discuss the ‘cash is king’ principle and the intangible nature of profit versus cash
rather than differences between cash and profit.

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Financial Accounting II August 2010 2nd Year Paper

Question 4

This question asked students to prepare journal entries and then calculate the adjusted
profit figure. Only 39 students attempted this question. As with the summer exam this
question highlights a very poor working knowledge of journals and basic double entry
accounting. Very few students correctly calculated the reduction in bad debt provision or
the correct inventory write down. Additionally very few students knew which costs
should or should not be capitalised as per IAS 16. Overall both knowledge and
presentation were poor.

Question 5

This question required students to prepare a Statement of Financial Position taking into
account year end adjustments and therefore re-calculating retained earnings. While
students were familiar with the layout of the statement the adjustments were very
poorly dealt with. Most students failed to identify the need to re-calculate retained
earnings and out of those who did few, if any, correctly calculated this figure. Also, most
students failed to address the profit/loss on disposal. And once again dividends and the
simple maths involved caught most students out.

Question 6

This question was made up of two topics, partnerships and ratios. In relation to the
ratios part of the question students have shown a good ability in this area and are
comfortable calculating ratios, their understanding of what the ratios actually mean is
less fluid.
In respect of the partnership section it was surprising how many students struggled, it
seemed as though students had not studied this topic as many solutions were muddled
and unsure. Where students were familiar with this topic it was an easy and quick 7
marks.

32