Accounting

Budgetary control and Decision making

Question (1) November 2019
Exe Ltd is considering purchasing a new machine and has provided the following data for two machines.
Machine A Machine B
Cost 250.000 $240,000
Residual value after 4 years Nil $20,000
Accounting rate of return 15% 13.08%
Net present value $21.490 20.269

(b) Evaluate whether Exe Ltd should purchase Machine A or Machine B. You
must justify your decision,
Answer,
The cost of Machine B is lower which will reduce the finance charges and will provide the additional funds
in the form of residual value at the end of year 4 to replace the machine.
Machine A has the higher/better the accounting rate of return and net present value which indicate
better return on investment compared to cost of capital and better value for money over the four years
due to repairs cost during its life. Exe Ltd should purchase Machine A.

Question (2) November 2019

Astrid sells goods on a two -month credit basis,
(c)Explain one benefit to Astrid of introducing cash sales.
(d) State two other budgets that Astrid could prepare.
(e) Discuss whether Astrid was correct to Offer customers a cash discount, You must justify your
decision.
Answer
(c) Cash will be received immediately which will enable to pay her supplier prompt/benefit from cash
discount.
(d) Inventory budget, Trade payables budget. Cash budget
(e) A cash discount will encourage customers to pay promptly which will improve
liquidity however the overall cash Astrid will receive will be lower.
A cash discount is an expense which will decrease profitability however the possibility of
irrecoverable debts may decrease which would improve profitability.
Astrid was correct to offer a cash discount as half the credit customers now pay one month after sale.

Question (3) December 2019

(a) State one purpose of, (2)
Management accounting
Financial accounting
(b) State two limitations Of budgetary control (2)
(c) State one stakeholder who may be interested in Neha's budgeted statement of financial position.
(1)
Answer

(a) Management accounting is mainly for internal purposes.

Financial accounting is for both internal and external purposes.
(b) May be inaccurate. Only takes account of financial issues
May be time consuming /costly May demotivate the employees
(c) Manager/Customer/Supplier
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Question (4) December 2019
(d) Explain to the directors why the net present value method Of capital investment appraisal is
considered better than. (4)
• Payback
• Accounting rate Of return
Zed Ltd produces 10,000 shirts per year and provided the following information for one units of
production.

Units cost $
Materials 10.20
Labour 7.80
Direct expenses 2.50
Royalties 1.50
Factory fixed overheads 3.50
Total costs 25.50

During the year ended 30 November 2019 they produced and sold 9.000 shirts, of which 8,000 were sold at
$35 per unit and 1,000 were sold at $30 per unit.
(g) Explain what action Zed Ltd should take if a customer offers to purchase units at $20 each.

Answer
(d) Payback
Net present value uses cash flows for the entire project rather than focusing on the early years
because long term project normally take time to generate net cash inflows.
Accounting rate of return
Net present value use cash flow rather than profit as profit is subjective such as business policy

(g) Decision

Selling price $20

Variable cost per unit ($22)
Contribution ($2)
Zed Ltd should not accept/reject the order as it will have negative contribution will reduce profits.

Question (5) September 2020

The directors decide not to purchase this machine. However, they are considering purchasing one Of the
following two machines and provide the following data.

Machine
B C
Purchase price $150.000 $250 000
Residual value after 3 years Nil $100,000
Payback period 1 year 11 months 2 years 4 months
Net present value $47,000 S30 000
Accounting rate of return 40% 33%

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 (c) Discuss which machine they should purchase.
You must justify your decision,
Email message
To a Student
From Accounts Manager
Thank you for helping me with this investment appraisal.
My friend works for the company supplying machine B and C. He has told me the company is in
financial difficulties.
He will give me a car if I place the order for the new machine this week, so we need to get this order
through quickly
(d)(i) State whether the accounts mangers should accept the car. Yes / No
(ii) Explain referring to one principle of professional ethics, the reason for your
answer.
Principle
Explanation

Answer
(c) Machine B should purchase.
Payback period method Of Machine B is better than Machine C as it has shorter payback period.
Net present value of Machine B is better than Machine C as it gives greater positive net
present value.
Accounting rate of return of Machine B is better than Machine C as it higher return rate. so,
Machine B is better investment as it requires less initial investment and less risky
(d) (i) NO
(ii) Objectivity as decision should not be made with bias.

Question (6) September 2020

Currently Elan tries to keep inventory levels a low as possible so only orders small quantities. His supplier
has offered him a trade discount of 20% if he purchases larger quantities of 1 ,OOO units at a time.
(c) Discuss the possible effects on Elan’s profitability of the proposal.

Answer
(c) The trade discount offered will lower cost of sales which will improve profitability.
The increase volume Of inventory may result in additional storage costs/the possibility deterioration
which will worsen/decrease profitability
Elan should purchase 1000units at a time as the increase profit should exceed the potential costs
involved.

Question (7) November 2020

(a) State two methods of funding the purchase of a non-current asset,

(b) State two difference between the net present value and payback method Of investment appraisal
Instead of purchasing a new machine. Liberty could modify an existing machine at a cost of $100,000 to
extent its life by four years. after which it would be scrapped.
(d) Discuss which option Liberty should choose. You
must justify your decision.

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Answer

(a) Trade-in allowance. Hire purchase / leasing. Bank loan (1)

(b) • The NPV method considers cashflows throughout the life of the project / payback
method ignores cashflows after the project has been repaid.
• The NPV method considers the time value of money / payback method takes no
account of this.
(d) Purchasing the new machine will require a higher initial outlay than repairing the existing machine
which will increase borrowing costs which will reduce profits,
As the new machine will only cost $30 000 more and may have lower running costs which will
increase profits,
Liberty should purchase the new machine.

Question (8) November 2020

(c) Evaluate the effect on a business's cash flow if it decides to sell goods on a cash basis only.
Answer
(c) Initial cash flow may improve because cash will be received immediately.
However, cash flow may decrease as customers may switch to suppliers offering credit terms.
Selling on a cash basis only may improve cash flows but may reduce profits.

Question (9) December 2020

(ii) State two other methods of capital investment appraisal.
(iii) State two accounting concept that apply when recording the purchase of non-current
assets,
(b) Define the following terms;
Breakeven point
The company provided the following information for the new machine based on annual production and
sales of 18,000 units.

Revenue 162 000

Direct material 43.200
Direct labour 28 800 (72.000)
Contribution 90000
Fixed costs 66000
Profit for the year 24000

Having purchased the new machine. which has a capacity of 30,000 units per year, a special
order is received to supply 6,000 units for $27,000.
(d) Discuss whether Dells Ltd should accept the order, You must, justify your decision.

Answer
(ii) Payback. Net present value/ discounted cash flow
(iii) Consistency, Prudence, Accruals
(b)The point at which a business makes neither a profit nor a loss.
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 The difference between actual sales and break-even sales.

(d)The special order will increase contribution to fixed costs as the company is already covering its
fixed costs, accepting the order will increase total profits.
However, the selling price from this order is significantly less than the normal selling price which if
existing customers were to become aware of could affect customer loyalty. The directors should
not accept the one-off order as the potential increase in profit is only small.

Question (10) December 2020

Neroo is considering changing to a supplier who offer two months' credit terms with an early payment
discount for payment within one month.
(b)Evaluate this proposal in term Of profitability and liquidity
Profitability
Liquidity
Evaluation

Answer
(b)Profitability Overall profitability will improve due to the potential receipt of an early payment discount.
Liquidity Overall liquidity will improve due to the delay in cash leaving the business.
Evaluation Profitability and liquidity will improve so Neroo should go with this proposal.

Question (11) January 2021

(a) State one purpose Of calculating the;
(i) breakeven point
(ii) margin of safety (1)
(b) State two advantages of forming a limited company. (2)

Answer
(a)(i) To show the point at which the business makes neither a profit nor a loss.
(ii) To show the amount Of sales that are above the breakeven point.
(e) Lower prices may attract new customers to his business which will enable Jordi to generate
increased profits. However, Jordi's breakeven point will increase and he should consider whether
quality may suffer as a result Of cheaper direct materials If Jordi wishes to increase profit he
should go ahead with the proposed expansion.
(f) Liability limited to the amount paid for shares, Separate legal identity to the owners.

Question (12) January 2021

(a) State two disadvantages to a business of budgeting (2)

Answer
(a) May not be accurate. Can restrict innovation. Can demotivate staff.

Question (13) April 2021

(a) State two example Of a variable cost
Explain one reason why a business would calculate the payback period (2)

Answer
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 (a) Labour . Materials , Royalties
(c) To know how long it will take to recover the investment which enables the business
to compare investments.

Question (14) April 2021

(c) State two expenses that may appear in a budgeted statement or profit or loss but not in
the cash budget.
(d) Discuss whether Daphne should produce a cash budget. You must justify your decision.

Answer
(c) Irrecoverable debts Depreciation
(d) A cash budget would enable Daphne to see where cash is
coming (rom/going to which will enable her to see when to
arrange an overdraft if cash shortages are forecast,
However. Daphne may not have the necessary skills to produce the cash budget so may need to
employ an accountant to help her. which will incur additional costs.
Yes. Daphne should produce a cash budget as it will enable, he to better manage the cash.

Question (15) June 2021

(a) State two differences between financial accounting and management accounting, (2)
(b) State two limitation of break-even analysis.
KO is concerned about his break-even point and margin or safety and is proposing an increases
in the selling price of the product. (d) Evaluate the effect Of this proposal,

Answer
(a) Financial accounting is primarily for external use /
management accounting is primarily for internal use.
Financial accounting has a Set layout [Or presentation /
management accounting has no set layout for presentation.
(b)
o Assumes all units produced are sold / there is no inventory.
o Assumes fixed costs are fixed throughout the period
o Assumes that variable costs are linear.
o Assumes the selling price remains fixed throughout the period
o Assumes that all costs are categorised as either fixed or variable} ignores semivariable
costs.
o Does not allow for a mix of products
o Does not take account or external factors.

(d) Assuming that customers are prepared to pay the increased selling price then there will be an
increase in the contribution per unit sold resulting in less units required to be sold to break even
which will increase the margin Of safety.
Overall profit for the year will increase assuming no increase in expenditure,

Question (16) June 2021

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(a) State one difference between a cash budget and a statement of cash flows. (1) Sparky is considering
taking out a 3% bank loan, repayable in monthly instalments over 10 years, instead of introducing
additional capital to finance the purchase of the machine.
(e) Discuss how Sparky should finance the purchase of the machine. You must
justify your decision

Answer
(a) A cash budget is used to plan for cash shortages or surpluses / a Statement of cashflows is used
to show how cash was generated/used
Or A cash budget is a forecast / a statement of cashflows is based on historical information,
Or A cash budget is for internal users a statement of cash flow in primarily for external users.

(e) Sparky were to take out a bank loan, then this will increase the liabilities of the business which
will need to be repaid,
If he introduced additional capital. then this will not require repayment as it will increase his equity
in the business.
The bank loan would require the payment interest whereas no interest is paid on the additional
capital
The bank loan interest is an expense on the statement Of profit or loss which will reduce the profit
for the year.
Sparky should take out a bank loan to finance the machine and introduce additional capital to clear
the bank overdraft.

Question (17) July 2021

(a) State one advantage or each method of investment appraisal.
-Net present
-Payback period
-Accounting rate of return
(c) Discuss whether a business should use the net present value or the accounting rate Of
return to assist in decision making You must justify your decision.
Answer
(a) Net present value - Considers the time value of money
Payback period - Easy to calculate
Accounting rate of return - Uses accounting profits

(c) Net present value:

• takes the time value of money into account
• allows decisions to be taken depending on the outcome accounting rate of return
• uses profit which is subjective
• allows decisions to be taken by comparing the outcome with the target profit / cost of finance
As the accounting rate of return ignores the time value of money the net present value method
should be used.

Question (18) July 2021

(b) Explain one benefit and one limitation of budgetary control.
Benefit
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 Limitation (4)
(c) State the accounting concept Elaine applies in each scenario. (3)
Scenario Accounting concept
She records inventory at the lower of cost or net realisable
value.
She records inventory for her own use separately,
She records inventory of stationary as an expense.

Answer
(b) Benefit -To control expenditure which will enable corrective action to be taken.
Limitation - Based on estimated data which may not be accurate leading to bad decision making.
Scenario Accounting concept

She records inventory at the lower of cost and net realizable value Prudence

She records inventory for her own use separately Business entity
She records inventory of stationary as an expense Materiality

Question (19) September 2021

(d) State two ways in which a business could finance the purchase of a new machine.
(e) Explain one reason why a business would calculate the accounting rate of return.

Answer (d) Capital

Bank loan
Hire purchase 'Leasing
(e) To know the return generated from the capital invested (1) which enables the business to
compare investments.

Question (20) September 2021

(a) Explain one reason for preparing a trade payables budget.
Yeo is considering changing when he purchases goods from one month before sale to two months
before sale.
(c) Evaluate the effect of this proposal change on both profitability and liquidity,
Profitability
Liquidity
Evaluation

Answer
(a) To calculate the amount owed to credit suppliers at the end of the accounting period so that this can
be included in the budgeted statement of financial position.
(c) Profitability
This will increase the inventory holding cost which will reduce profitability.

Liquidity
Liquidity may deteriorate as Yeo will have more money tied up in inventory which could mean that
additional finance may need to be raised.

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 Evaluation
Although this proposal may cause an increase in holding costs and a deterioration in liquidity. Yeo
should proceed if it avoids the possibility of not having sufficient inventory to meet demand,

Question (21) November 2021

(a) (i) State the meaning of the terms;
Break-even point
Margin of safety
Ana manufactures one product. the Ero, which sells for $26 per unit.
The budgeted production costs are difference material $8 per unit, direct labour $6 per unit and total
fixed costs Of $110,400 per year.
Ana currently has the capacity to manufacture 17.000 Eros,
She has been approached by a new customer who wishes to purchase 3,000 Eros and has offered to pay
$20 per unit,
(b) Evaluate whether Ana should accept this special order, You must justify your decision.
(c) State two Other uses of marginal costing.

Answer
(a) (i) Breakeven point
The point at which revenue equals total cost
Margin Of safety
The difference between budgeted output and breakeven point.
(b) Selling to a new customer will still produce a positive
contribution/increased profit and the new customer may
become a regular customer.
The new customer has offered to pay $6 less per unit. If the existing customers became aware Of this,
they may demand a lower price.
Ana should accept this offer to maximise profit,
(c) Make or buy
use of scarce resources

Question (22) November 2021

(b) Explain one reason why a cash budget is important.
At the start Of Period 2 Vasil intends to rent a delivery at an inclusive charge Of $500 per week. payable in
advance on this date, to cope with an expected increase in demand. The cost price Of this delivery vehicle
would be $50,000. He also intends to employ a driver at a cost of $400 per week.
(c) Discuss whether Vasil should purchase or rent the delivery vehicle at the Start or Period 2.
Your must justify your decision.

Answer
(b) Allows businesses to predict possible Cash shortages and take corrective action.
(c) Purchasing the delivery vehicle will mean raising a large amount Of finance, which may not have
available at the moment.
If he continues to hire the vehicle at $500 per week, his profit will reduce by $26 000 each year and at the
end of year 2 he will still not own the vehicle.
Vasil should purchase the delivery vehicle as his cash budget shows he is expecting to have a positive cash
balance.

Question (1)
Sohalna Ltd is planning to invest in either Nima Ltd or Rosie Ltd.

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 Nima Ltd Rosie Ltd
Trade receivables collection period 35 days 30 days
Trade payables payment period 40 days 30 days
Inventory turnover
10 times 12 times
Asset turnover 2 times 3.5 times

Required: Evaluate which business is better to invest.

Answer
Rosie Ltd's trade receivables collection day are better than Nima Ltd, which helps to improve the cash flow
Of Rosie Ltd.
Rosie Ltd's trade payables payment period is better than Nima Ltd which show Rosie Ltd has enough funds
to pay her payables.
Rosie Ltd's inventory turnover is better than Nima Ltd. which indicates that Rosie Ltd converts inventory
into revenue faster than Nima Ltd,
Rosie Ltd's asset turnover is better than Nima Ltd which indicates that Rosie Ltd utilizes its assets more
efficiently to generate revenue.
Overall Rosie Ltd's business is better to invest as it is performing better than Nima Ltd.

Question (2) April 2018

Makhana obtained the following budgeted information relating to tow business.
Ratio Aung Susan
Trade receivables collection period 48 days 54 days

Trade payables payment period

30 days 40 days

Inventory turnover 5 times 7.5 times

Current ratio 1.6:1 0.9:1
Required; Evaluate which business is forming better.

Answer:
 Trade receivable collection period for both businesses is more than normal credit period but Susan's
credit control procedures are worse than Aung/ has relaxed terms to encourage sales as indicated by
inventory turnover.
 Both businesses make payments to the trade payables before collecting the money from the trade
receivable which indicates stronger liquidity position/ Susan is making full us Of the money available
free of charge as taking longer to make payment / Susan may have problem with her suppliers in
long term/ Aung has better relationship with her suppliers compared to Susan.
 Susan has better inventory turnover compared to Aung which means the inventory is turned into
revenue faster than Aung.
 Aung's current ratio is better than Susan, as Susan may struggle to pay her short- term liabilities.

Question (3)
Sachin is considering merging with another sole trader, Verat, to form a partnership. He has been provided
with the following information about both businesses for the year ended 31 August 2016.
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 Ratio Sachi Verat
n
Gross profit margin 20% 25%
Net profit percentage 8% 6%
Return on capital employed 15% 20%
Current ratio 0.75:1 2.10:1
Quick ratio acid test 0.601 0.90:1
Required; Evaluate the profitability and liquidity Of both businesses and advise Sachin Whether he should
proceed with this merger.

Answer:

Profitability
The gross profit margin Of Verat is better, indicating he has sold goods at a higher selling price than
sachin or his cost Of sales was lower,
Sachin’s net profit percentage is better that Verat's, which may indicate that he has better control of
expenses. Although the net profit percentage of Verat is lower his return on capital employed (ROCE) is
better than Sachin's, indicating more efficient use Of capital employed to generate profit.

Liquidity
Sachin's current ratio is low in comparison to Verat's, which indicates that he may not be able to pay his
short-term liabilities,
Verat's quick ratio decreased in higher proportion from current ratio in comparison to Sachin which
indicates that he is holding too much inventory,

Conclusion
Overall Sachin is advised to merge with Verat as Verat's profitability is better because ROCE being the
primary ratio is higher and Verat’s Liquidity is also better as it is closer to the benchmark. Or
Sachin is advised not to merge with Verat as his net profit percentage is low and he is holding too much
inventory which could lead to cash flow problems in the long term.

Question (5)

Millo provided the following ratios.

31 August
Ratio 2018 2017
Gross profit percentage/margin 20% 20%
Profit for the year to revenue percentage/margin 10% 15%
Asset turnover (turnover/net assets) 1.5 times 2 times
Trade receivables collection period 45 days 30 days
Trade payables payment period 40 days 35 days

The trading year consisted of 360 days

Required; Evaluate the performance of Millo's business.

Answer

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The profit for the year as a percentage Of revenue percentage/ margin for 2018 has deteriorated which
indicates poorer control over operating expenses.
Asset turnover for 2018 decreased indicating the business is not generating the same amount of revenue in
comparison to the assets used/ due to poor utilization of resources.
Trade payables payments period for 2018 increased indicating liquidity problem as business is paving
suppliers before collecting money from customers/ may impact future relationship with suppliers/supply of
goods in future.
Trade receivables collection period for 2018 has increased indicating poorer credit control/ may have
negative impact on cash flow,

Question (6)

31 March 31 March 2016

2017
Gross profit percentage/margin 28% 30%

Profit for the year to revenue percentage 18% 15%

Return on capital employed 5.41% 4.35%

Answer:
Gross profit margin —has slightly decreased, it shows cannot control over cost of sales.
Net profit margin — has improved compared to last year, indicating better control over operating expense.
Return on capital employed — has improved significantly, indicating better utilisation of resources
compared to last year.

Question (7)
Hamza provided the following information
Ratio
Trade receivables collection period 39 days
Trade payable payment period 43days
Required; Evaluate the action that Hamza should take in order to reduce these two ratios to 30 days.

Answer
Evaluate the action that Hamza should take in order to reduce these two ratios to 30 days.
Employ a Credit controller who should ensure prompt submission Of invoices and Statements / regular calls
to chase Outstanding amounts, Receiving monies sooner will result in improved cash flow and a reduction in
the trade receivables collection period. Receiving movies from customers promptly will enable Hamza to
settle amount due to suppliers promptly and as a result will benefit from available cash discounts.

Overall, effective credit control will reduce both the trade receivables collection period and trade payables
payment period.

Question (8)
The following accounting ratios are available from the financial statement of Cee Ltd.
Ratio 2019 2020
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 Profit for the year as a percentage of revenue 9.3% 10.2%
Return on capital employed/ROCE 12% 10%
Current ratio 1:7:1 2.1:1
Quick ratio acid test 1.2:1 0.7:1
Required; Evaluate the performance Of Cee Ltd.

Answer:
The profit for the year as a percentage Of revenue has improved by almost One percentage point, but
despite this the return on capital employed has worsened by two percentage points. This may indicate that
Cee Ltd has higher capital employed than last year.

Despite the improve in the current ratio to the quick ratio (acid test) has worsened to 0.7:1 indicating the
Cee Ltd may have difficulty meeting short-term current liabilities without liquidating inventory.
Overall liquidity has worsened despite an improvement in profitability.
Advantages and Disadvantages of being a sole trader
Advantages Disadvantages
Control is in your hands Unlimited liability

All of profit can be own by one owner. All of risk responsible to one owner.
Difficult to raise finance,
Establishing / operating / winding up is simple.
Difficult to continuity if the business owner of death.
Profit / information no need to sharing

Can be highly flexible

NO audit requirement

NO requirement to make financial account to public.

Owner has complete control over the business.

Owner is entitled to all profits.

Advantages and Disadvantages of being a company

Advantages Disadvantages
i. Limited liability i. Comply with rule and regulation
ii. Easier to raise finance ii. Regularly issue annual financial statement

iii. Transfer of ownership is easy iv. Audited

iv. Separate legal identity from its shareholders. v. Start-up cost are higher

vi. Double taxation

Advantages and disadvantages Of being partnership

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 Advantages Disadvantages
1. Loss (risk) sharing between partners 1. Profit sharing between partners
2. Knowledge and skill sharing between partners 2. Conflict between partners
3. Addition capital available 3. Unlimited liabilities
4, Sharing responsibilities and duties 4. Slower decision making

Stakeholders Interest reason

1. Customers To see whether the business be able to provide the products and
services in the near future.
2. Suppliers To know whether the business will be able to make the payments on
due date for the goods supplied.
(To check sufficient cash for payment of goods.)
3. Government/ Tax To ensure that the business is paying the right amount of tax.
inspector
4. Banks/ Providers of To know whether the business will be able to service the finance
external finance provided and repay the finance provided.
5. Local communities To know how the business contributing towards the community in
terms of job opportunities etc.
6. Potential investors To know whether the business would be able to provide the return on
their investment or not.
7. Managers To know the performance of their strategies.
8. Owners To know the overall profitability and liquidity of the business.
9. Employees To know the security Of their job/ bonus / Commission.
10. Trade association To know how the business is operating in the industry.
11. Trade unions To know how the business is complying with policies to project its
members. (or)
To ensure the interest Of their member are protected.
12. Competitors To know comparative business performance.
13. Shareholders To check sufficient cash to pay dividends.
14. Financial analysis and Financial analysis and advisers need information for their clients or
advisers audience.
15. Government and their To know how to allocation of resources.
agencies
16. Public To know how to provide to a local economy by providing employment
and using local suppliers.

Accounting concepts

(1) Going Concern concept

(2) Accruals concept / Matching concept
(3) Consistency concept
(4) Prudence concept
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 (5) Substance over form
(6) Materiality
(7) Business Entity concept

1. Going Concern concept

Financial statements should be prepared on the assumption that the enterprise will in fact continue.

2. Accruals concept / Matching concept

The accruals concept means that transactions and events are recognized when they occur.
not when cash is received or paid for them.
The matching convention requires that revenue earned is with the expenses incurred in earning it,

3. Consistency of presentation
The presentation and classification Of items in the financial statements should be retained from One
period to next unless:
(Consistency can be break down the following conditions)
(a) It is clear that a change will result appropriate presentation; Or true and fair
(b) A change is required a Standard.

4. Prudence
Assets or incomes are not overstated and Liabilities or Expenses are not understated.
When a loss is foreseen, it should be anticipated and taken into account immediately. Profit should
only be recognized when realized in the form of cash or another asset with a reasonably certain cash
value. e.g.

5. Substance over Form

Transactions and events are accounted for and presented in accordance with their substance and
economic reality and not merely their legal form.

6. Materiality concept
 If a transaction is material, it must be disclosed
 If material information is omitting it or misstating, it could influence decisions that users make on
the basis Of financial information about a specific reporting entity.

7. Business Entity Concept

Financial statements always treat the business as a separate entity.

8. Realization Concept
The realization concept that revenue can only be recognized once the underlying goods or services
associated with the revenue have been delivered Or rendered, respectively. Thus, revenue can only be
recognized after it has been earned.

Practice questions
(a)State the accounting concept applied in each scenario.

Scenario Accounting concept

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 Non-current assets are shown at historical cost rather than Going concern
market value
The business always uses the straight -line method of Consistency
depreciation for non-current assets
Goods taken for own use recorded as drawings Business entity
The method Of depreciation motor vehicles should not be Consistency
changed to reducing (diminishing) balance.
Customer order received on the last day of the Realisation
financial year. not invoiced or paid, should be
excluded from the revenue of the current year.
The value of closing inventory should be deducted from the Accruals
cost of sales.
An adjustment for the writing off of an irrecoverable debt. Prudence

An adjustment for goods sold on a sale or return basis. Accruals

An adjustment for bank loan interest owing An Business entity
adjustment for goods taken by the owner for personal
use

She records inventory at the lower of cost Or net realizable Prudence

value.
She records inventory for her own use separately Business entity
She records inventory of stationery as an expense Materiality

Ethics

An understanding of the fundamental principles of professional ethics, including:

Integrity
Objectivity
Professional competence and due care
Confidentiality
professional behaviour

Integrity
A professional accountant should be straightforward and honest in all professional and business
relationships.

Objectivity
A professional accountant should not allow bias, conflict Of interest or undue influence Of others to
override professional or business judgments.

Professional Competence and due care

A professional accountant has a continuing duty to maintain professional knowledge and skill at the level
required to ensure that a client or employer receives competent professional service based on current
developments in practice, legislation and techniques. A professional accountant should act diligently and in
accordance with applicable technical and professional standards when providing professional services.

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Confidentiality
A professional accountant should respect the Confidentiality Of information acquired as a result Of
professional and business relationships and should not disclose any such information to third parties
without proper and specific authority unless there is a legal or professional right or duty to disclose
Confidential information acquired as a result of professional and business relationships should not be used
for the personal advantage of the professional accountant or third parties.

Professional behaviour
A professional accountant should comply with relevant laws and regulations and should avoid any action
that discredits the profession.

Example (1)

Email message
TO a student
From Accounts Manager
Thank you for helping me with this investment appraisal,
My friend works for the company supplying machine B and C. He has told me the company is in financial
difficulties.
He will give ma a car if place the order for the new machine this week, so we need to get this order through
quickly.

Required
(i) State whether the accounts managers should accept the car. Yeas / No
(ii) Explain, referring to One principle of professional ethics, the reason for your answer
Principle
Explanation

Answer
(i) No
(ii) Principle = Objectivity
Explanation =

Example (2)
State the principle Of professional ethics that the accounts have not complied with in each scenario.
Scenario Principle of professional ethics
He valued the land but has no experience in land valuation Professional competence and duecare
He produced misleading financial statements Integrity
He shared information about the company with friend. Confidentiality

The qualitative characteristics of financial information (IASB)

1) Relevance
2) Faithful representation
3) Comparability
4) Verifiability
5) Timeliness
Describe qualitative characteristics Of financial reporting under the International Accounting Standard
Board (IAS•B) framework.
Answer:
Relevance
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Information Is relevant for its users, It is material enough to make decisions.

Faithful representation
Means financial information must be free from bias and errors.

Comparability
Financial statements can be compared with previous year.

Verifiability
The final information should have supporting evidence to verify the information.

Timeliness
The final information must be in time to aid its users to make decisions.

Understandability
Understandability for users to understand the financial information it must be presented in a clear and
concise manner.

Question (1)
State two purpose Of calculating cash flows from.

Answer:
(i) Operating activities
To understand the difference between profit and
cash.
To understand changing cash due to working capital
changes.
(ii) Investing activities
To understand the investment in non-current assets,
To understand any cash generated from investments.

(iii) Financing activities

Helps to understand how cash is generated through issue of share
Helps to understand changes in external borrowing.

Question (2)
State two provisions that apply in the absence of partnership agreement, (November 2018)
Answer: Profit and loss is shared equally
No interest on capital
NO interest on drawings
No salary
5% interest on partner loan

Question (3)
Give two advantages of a cash flow statement over the Other accounting statements.
Answer: Advantages
There is little scope for manipulating the figures.
The figures are more objective.
The figures are easier to compare with previous years / Other firms.

Question (4)
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Explain one purpose of preparing a cash budget. (April 2018)
Answer:
Cash budget will help to identify deficit or surplus during a period which help the business to decide to
borrow money/arrange overdraft or invest surplus funds in short investments to generate future income.

Question (5)
State two other funding (financing) methods the purchase of non-current asset. (December 2017)
Answer: Owner capital
(Commercial) mortgage
Hire purchase
Leasing
Part exchange

Question (6)
State two advantages Of maintaining full accounting records. (November 2018)
Answer: Help to prepare financial statements.
Help to monitor profitability
Help to monitor liquidity

Question (7)
State two limitations Of budgetary control. (November 2018)
Answer:
 Demotivates if unrealistic budget
 Does not encourage creativity
 Expensive / time consuming
 Only take account of financial issues.

Question (8)
Define the term
(i)absorption costing
(ii) marginal costing

Answer;
(i) The absorption costing takes into account both variable costs and the fixed cost of the product.
In absorption costing the fixed overheads incurred are taken to the next period in the form Of closing
inventory,
(Il) Marginal costing takes into account the variable cost only. In marginal costing the fixed overheads are
taken as period cost.

Question (9)
A new customer has approached Motta Ltd wishing to buy 5 000 units at $37.50 per unit
Discuss whether Matta Ltd should accept
the order. You must justify your decision.
Answer
(c) Motta Ltd should accept the order as the Offer price 52.50 more than the variable cost which will
contribute towards the fixed Overheads,
The variable cost / fixed costs can increase over the life time of the product which will affect the
profitability of the business.
The other customers' loyalty may be affected if they find out that the company is supplying Product X
elsewhere at a lower price which will result in a loss of revenue from existing customers. Business may
not have the spare capacity.
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Question (10) Chapter - 8 (Question 8.3)
(a) State two differences between the role of the financial accountant and that of the management
accountant.
(b) Explain one benefit to a business of budgeting.
(e) State two other budgets that Zara could prepare.
(f) (i) Explain one reason, referring to an appropriate ratio, why Zahra 's employees would be interested in
the profitability of her business.
(iii) Explain one reason, referring to an appropriate ratio, why a new credit supplier would be
interested in the liquidity of Zahra's business.

Answer
(a) Financial accountants provide information for internal and external use / Management accountants
provide information for internal use,
(b) Budget helps to forecast income and expenditure which help to identify future potential profitability,
(e) Inventory budget
- Trade payable budget
- Sales
- Purchases
- Cash budget

(f)(i) Ratio_ Gross profit margin, net profit margin, returns on capital employed
For the continuity of their security / for bonuses.
(ii) Ratio_ Current ratio / acid test ratio.
They want to know whether the business is able to pay suppliers

Question (11) Chapter 8 (Question 8.4)

(a) State two stakeholders who may be interested in a cash budget,
(e) Explain One reason why a business shows different figures in the statement Of profit or loss and cash
budget.
(f) Explain One reason why Homcomp Ltd should be concerned about it cash flow in the first three months
of the business.

Answer
(a) Bank, Supplier, Owners, Managers, Directors
(e) A statement Of profit or loss is prepared on accruals basic/concept but the figures Of the cash budget
are different as they are prepared on receipts and payment basis.
(f) They will be concerned in the month of July as there is no sales revenue. In future months only 20% of
total sales are for cash and remaining are paying after two months.

Question (12)
State One difference between a right issue and a bonus issue. (June 2017)
Answer: Right issue to raise finance / bonus issue without raising any finance.
Share- holders does not automatically receive a right issue/
bonus shares are automatically allocated,

Question (13)
State one different between tangible and intangible non-current assets, (November 2017)
Answer:
Tangible non-current assets can be seen/ intangible non-current assets cannot be seen.

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Parent - An entity that control one or more another entities.
Subsidiary - An entity that is control by another entity.
Group - A parent and its subsidiaries.

Non-Controlling Interest (NCI)

Equity in a subsidiary not attributable, directly or indirectly to a parent.
Consolidated financial statements
The parent and its subsidiary are presented as those of a single entity.

Goodwill
Excess purchase consideration over the fair value of net assets acquired at acquisition date. Goodwill is an
intangible asset.

Define the following terms;

(i) Breakeven point
(ii) Margin Of safety
Answer
(i) The point at which a business makes neither a profit nor a loss,
(ii) The difference between actual sales and break-even sales.

State one purpose of calculating the;

(i) Break-even point
(ii) margin of safety

Answer
(i) To show the point at which the business makes neither a profit nor a loss.
(ii) To show the amount of sales that are above the breakeven point.

State two limitation of break-even analysis

Answer
Assumes all units produced are sold / there is no inventory, Assumes fixed costs are fixed
throughout the period, assumes that variable costs are linear.
Assumes the selling price remains fixed throughout the period.
Assumes that all costs are categorised as either fixed or variable/ ignores semi-variable costs,
Does not allow for a mix of products.
Does not take account Of external factors.

State one difference a cash budget and a statement of cash flows.

Answer
A cash budget is used to plan for cash shortages or surpluses / a statement of cashflows is used to show
how cash was generated/used. (Or)
A cash budget is a forecast / a statement of cashflows is based on historical information.
(or)
A cash budget is for internal users / a statement of cashflows in primarily for external users

Explain one benefit and one limitation of budgetary control.

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Answer
Benefit - To control expenditure which will enable corrective action to be taken,
Limitation - Based on estimated data which may not be accurate leading to bad decision making.

State the name of two capital reserves / non-distributable reserves.

Answer
Share premium
Revaluation reserve

State the name of two revenue reserve / distributable reserves.

Answer
 General reserve
 Retained earnings

Payback period
Advantages
(i) Uses cash flow which likely to be
objective.
(ii) Easy to understand and calculate.
Disadvantages
(i) Does not consider time value of money.
(ii) Does not consider cash flow after the payback period.

Accounting Rate of Return (ARR)

Advantages
(i) It considers the accounting return on the investment for the project which could be compared with
target profit / cost of capital.
(ii) It takes at the entire project life.
Disadvantages
(i) Uses profit which could be subjective due to the accounting policies used in difference business.
(ii) Time value of money is not taken into account

Net present value

Advantages
(i) Net present value method taken cash flow throughout the life Of
project.
(ii) Take time value on cash flow.

Disadvantages
(i) It is difficult to estimate the expected cash flow the whole life Of
project.
(ii) Selecting an appropriate discount rate for the project can be
problematic.

The non-current asset register

Detail about each non-current asset include the following,
 The internal reference number (for physical identification purposes)
 Manufacturer's serial number (for maintenance purposes)

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  Description of asset
 Location of asset
 Department which 'owns' asset
 Purchase date (for calculation of depreciation)
 Cost
 Depreciation method and estimated useful life (for calculation of depreciation)
 Carrying value (or written down value or net book value)

Use of asset register

From time to time, the asset register should be checked to the accounting records. And discrepancies must
be investigated and the records corrected, For example, an asset may have been scrapped and the asset
register updated, but the asset had not yet been written Off in the accounting records. Periodically, all
physical non-current assets should be checked to the current register. This helps to deter theft.

Authorised share capital

The amount Of share capital that a company is allowed to issue by the memorandum of
Association.

Issued Share Capital

The amount of the share capital that a company has actually issued.

Uses of share premium

1. Discount on issued of debenture

2. premium on redemption Of debenture
3. Bonus issue (Share dividend)
4. Issued cost

Three common differences between preferred share and ordinary share.

1. Preferred shares received a fixed dividend

2. Preferred shares must received a dividend in priority to ordinary share.
3. Preferred shares do not normally have voting right

State two difference between share and debentures Differences

1. Dividends paid on shares, Interest paid on debenture
2. Shareholders normally have votes, debenture holders do not have
3. Shareholders are owners, debenture holders are Account payables.

Bonus issue
Bonus issue is an issue of ordinary share to existing shareholders out Of the company's reserve.

Right issue
Right issue is an issue of shares to the existing shareholders of a company at a price that is less than
the existing market price Of the share.

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Debenture
A debenture is a written acknowledgement Of a loan by a company. It will normally be given under
the company's seal and contain clauses on
(i)Interest rate, the date(s) Of payment Of interest
(ii)Repayment dates and amount and whether at par, at premium.

Distributable profit
Distributable profit in an amount of total profit which are distributed to shareholders

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