Accounting Principles Question Paper, Answers and Examiner's Comments
Accounting Principles Question Paper, Answers and Examiner's Comments
Accounting Principles Question Paper, Answers and Examiner's Comments
Examiner’s Comments
1. Be prepared.
Read the Accounting Principles unit syllabus contained in the Level 2 and Level 3
Diploma in Credit Management Syllabus booklet, free to download from the CICM
website if you do not already have an up-to-date copy. It contains all the learning
objectives that might be tested in the examination, along with indicative content of
what the unit is about. You can use it to help plan your learning and to check you are
adequately prepared.
d) Each question contains parts a), b) and c) which are worth different mark values
up to the 20 available for the entire question. In each question, part a) will be a
straight-forward task worth 4 marks, part b) will be some form of substantive task
for between 10 and 12 marks, and part c) will be for remaining marks up to 20 and
may have some connection with or develop the part b) task.
e) A certain amount of account ledger paper is included in the supplied writing booklet,
so you do not have to draw account grids if you need to tackle a book-keeping task.
f) The pass mark for a Level 2 exam is 40% and marks of 50% and above will receive
a Level 3 pass. Unfortunately, marks below 40% are not pass marks.
3. General approach.
More exams are failed through poor technique during the examination than from poor
knowledge and understanding. The key things to do are:
a) Read the detail within each question task very carefully, so you are sure what the
examiner is asking you to do.
b) Allocate your examination time carefully. Remember that you should spend
roughly the same time on each question overall, but that each question part will
need a different amount of time to be spent within that.
a) The unit and examination is written with the credit industry in mind, so often carries
a viewpoint of a customer relationship or credit control situation.
d) There is plenty to write about too! It is not just about identifying what a number
is, but showing you understand what it means, and why or what its relevance is.
e) The unit’s learning objectives also ask that you construct recognised financial and
management statements, undertake accurate tasks, and give explanations. Use
the published exam materials to practice this.
f) It is worthwhile practising in advance not just the subject matter, but also how to
use your non-programmable calculator if you choose to bring one to your exam.
a) Ensure you fully address the tasks set for you. They are not tripwires, but simply
to ensure that everyone sits same tasks and that marks are awarded fairly.
b) Stick to the task and avoid drifting from the set task onto a tangent. Frequently
check with the task to ensure you are central to it, as that is where marks are
available. Responses not on the set task, or which provide surplus-to-task
material, waste exam time and are unlikely to score marks, even if accurate.
c) Use clear, well-constructed, labelled and accurate layouts to help you get good
marks. Where commentary or written explanation is required, it should be clearly
expressed and relevant to the task. Whilst not needing a ‘beginning, middle, and
end’ essay, remember these are opportunities for you to show your knowledge and
understanding of the syllabus topics under question. A response which is easy to
follow is easy to mark.
d) Take great care to ensure responses are not too brief for purpose. If the task was
to ‘explain what steps might be needed?’ there is a huge difference in response
quality (and therefore numbers of marks awarded) between stating that, e.g. more
care should be taken, and explaining why more care should be taken. Use linking
words, such as ‘because’, or ‘meaning that’, or ‘such as’ to prompt a developed on-
task response.
e) Whilst bullet points can be carefully used in responses, ensure you develop each
point you make, rather than simply leave a bullet list absent of meaning and
understanding, and absent of marks. Go back over bullet points and make sure
their meaning is clear. Note that whilst suggested response areas in unit past
question papers may be in the form of bullet point responses, you will see that each
bullet simply separates one discrete idea from another and that each bullet is
extended and developed. This is a safe style if you choose to use bullet points.
g) Practise extended writing by hand using a ball-point pen or similar – firstly, if you
are accustomed to using a keyboard of whatever size to produce written text for
work and study, you might find handwriting at length may be quite tiring; secondly,
it is an ideal opportunity to practice accurate recall of frameworks, and the
extended and developed writing techniques discussed on these pages! Keep
handwriting as legible as you can and help the examiner to read your response.
Good luck!
JUNE 2017
Instructions to Candidates
Answer all questions. All questions carry equal marks. Time allowed 3 hours
This was the second sitting of the Accounting Principles examination on the revised
syllabus using the new structure of five compulsory 3-part questions and in the main it
was handled well by the majority of candidates. Most appeared conversant with the
accounting and bookkeeping principles, practices, concepts and methods featured in
the unit and there was good evidence of preparation and practice with regard to
structure, format and presentation of accounting data and information among the
sound financial statements, double-entry bookkeeping and cash budgets submitted.
That said, this is not a unit solely of numbers or arithmetic and there was an
improvement in narratives explaining the results of given or calculated data.
Candidates and learning supporters should be mindful that interpretation of results and
calculations remains an integral part of this unit and further improvement is still looked
for. Nevertheless, congratulations are extended to candidates who were successful at
either Level 2 or Level 3, with best wishes for their achievements and their ongoing
studies.
However, it was also noted that not everyone was able to achieve a pass this time.
There was a smaller, but noticeable, number of candidates who were not able to offer
responses to every set task, or where responses given were brief, inaccurate, or did not
evidence sufficient preparation and an appropriate volume of study practice for this
Lastly, a reminder that the terminology used within the unit and its learning materials
is based upon international standards and it is firmly recommended that future
candidates work with the CICM terminology, become familiar with it, and use it in their
preparations for their examination.
b) The following are extracted balances from Harbhajan’s business accounts along
with other information relating to the business’s year end on 30 April 2017.
For some reason, the figure for Capital at the beginning of the year has not
been supplied, although you have been given the year end net profit figure:
£
Capital as at 1 May 2016 unknown
Machinery at cost 100,000
Sales Revenue 59,000
Motor Vehicles at cost 50,000
Purchases 25,000
Trade Receivables 13,500
Trade Payables 12,500
Accumulated [provision for] depreciation: Machinery 10,000
HM Revenue and Customs: VAT (owing) 7,750
Net Profit as at 30 April 2017 7,105
Accumulated [provision for] depreciation: Motor Vehicles 5,000
Water and Utilities 4,500
Inventory as at 1 May 2016 3,500
Wages and Salaries 3,500
Rent 3,000
Bank (in funds) 1,800
Purchases Returns 1,355
Business Rates 1,250
Bad Debts written off 1,150
Sales Returns 1,250
Discounts Allowed 950
Cash in Hand 760
Drawings 750
Discounts Received 550
The Rent figure includes £600 relating to May, June and July 2017.
The Machinery still has to be depreciated at year end by 10% straight line.
There was unpaid Wages and Salaries at year end 30 April 2017 of £800.
Stocktake at year end 30 April 2017 valued Inventory at £5,000.
c) Explain the problems from a working capital perspective for a business which
has i) too many orders and ii) too few orders. (4 marks)
Total 20 marks
Question aims
To test candidates’ ability to:
Explain the place of a suspense account as part of the process to correct unresolved
errors detected by a trial balance
Construct the financial statements for an unincorporated sole trader business,
including adjustments
Explain the importance of working capital in a business in decline or overtrading
Where the trial balance does not agree, in that the debit and credit columns
come to different hash totals, the difference is most likely caused by an
arithmetical error or a combination of arithmetical errors. These are errors
which are identified by an imbalanced trial balance and the imbalance should
be investigated and resolved.
Examples of these errors might include omission of one side of the double-
entry, recording two debits or two credits instead of one of each, recording
different amounts in the two entries or extracting account balances to the trial
balance incorrectly [Further details of example errors are not required beyond
naming typical examples, and examples of errors not identified by a trial
balance are not relevant to the task].
If the error(s) cannot be found and the imbalance not entirely resolved even
after investigation, then the trial balance totals should be made to agree with
each other by inserting the amount of the difference between the two sides in
the ‘lower’ column and creating a suspense account entry in that sum,
supported by a journal entry (as no ‘true’ transaction has taken place). The
Suspense Account sits in the Nominal Ledger and the suspense account entry
has the effect of balancing the trial balance at the higher hash total.
As errors are subsequently identified and corrected, journal entries are made
to support the corrective action taken, and double entry transactions posted
featuring the Suspense Account in respect of each error resolved. The
corrections made ultimately clear the original suspense account entry if all
errors made and detected by the trial balance are resolved.
Current Assets
Inventory 5,000
Trade Receivables 13,500
Prepaid Receivables 600
Bank 1,800
Cash in hand 760 21,660
Current Liabilities
Trade Payables 12,500
Accrued Payables 800
HMRC: VAT 7,750 21,050
Working Capital/
610
Net Current Assets
121,110
Non-Current Liabilities 0
Financed by:
Capital 114,755
Drawings 750
114,005
Net Profit 7,105
121,110
Many firms may undertake all their transactions on a credit basis but accounts
have eventually to be settled with cash. Many firms go bankrupt or into
liquidation not because they are unable to trade profitably, but because they
run out of cash. A shortage of working capital is one of the most frequent
reasons why businesses get into financial difficulties and is typified by a cash
flow crisis.
Overtrading occurs when a business tries to expand too rapidly without having
sufficient working capital, and although it has a full order book it has insufficient
cash to pay its way and support the level of business. It is particularly common
at the end of a recession when orders start to pick up and the business takes
on as many orders as possible.
All Tasks a) in this and future papers effectively seek to check knowledge and
understanding of the ‘nuts and bolts’ foundations of particular issues, so the key to
successful responses in Part a) tasks relate to the central issues of those topics.
In this particular Part a) task, it was given that suspense accounts featured as part of
the error correction process, so the task for candidates was to identify how the errors
arose to justify using a suspense account, what the function of the suspense account
was, what the mechanism was to isolate the errors, or the mechanism by which those
errors were corrected, what the end result would be, and so on. Mention of these or
other relevant factors such as the need to use journals to correct the transactions
would have received credit accordingly to the maximum available. Discussion of the
errors that a trial balance would not detect was not correct as that would not give rise
to the use of a suspense account.
It was interesting also that a number of responses omitted to identify the original issue
as inability to agree the debit and credit totals within a trial balance because of one or
more arithmetic errors in the ledgers, so it is important not to assume that nothing is
too obvious to be worth a mark.
In Part b), construction of the sole trader statement of final position by candidates
leading to a net asset value which balanced with the underpinning capital and reserves
received many of the available marks. There were very good examples of appropriate
format, structure and presentation with a clear statement heading incorporating the
phrase “as at [date]” and showing column headings also. To do this required practice
in exercises and revision, and prospective candidates are freely advised that there is
likely to be the need to construct financial statements of one kind or another in future
examinations. Even from candidates who responded well otherwise however, was the
incorrectly ordered listing of current assets which should be listed in increasing order of
liquidity, as in the suggested response.
Several responses did not score marks so readily however, and errors such as using
the phrase “for the year ended” in the heading, using a framework which was
inappropriate for the task, errors in presenting accumulated depreciation and
Part c) posed few problems for most candidates. Many could identify what overtrading
was and give a good overview as to how this would impact on working capital
arrangements, going on to discuss the problems of cash shortfalls preventing prompt
payment to suppliers or other commitments. Better responses then also briefly tackled
the working capital issue caused by lack of sales. Whilst good papers received
maximum marks for this section, some just defined working capital, failing to offer any
clear analysis as required by the task.
b) ABC Dealing is a business owned and run by Alan B Crick. Whilst the following
events took place in the first few days of this month, ledger accounts have not
yet been written up and that will become your task here.
01-Jun Sold goods to Joan’s Phones on credit and sent an invoice for
£3,500 plus VAT.
01-Jun Alan B Crick puts £2,500 into the business bank account and
puts £2,500 into the office safe. This is all new money to his
business.
02-Jun Purchased goods for resale in cash from MTC Wholesale and
their cash invoice/receipt was £2,000 goods, plus VAT.
03-Jun Sold more goods for £2,700 including VAT and all customers
paid by cheque.
05-Jun Goods returned by Joan’s Phones and ABC issued a credit note
for £250 plus VAT.
06-Jun Alan purchased a second-hand van solely for use within ABC
Dealing from D Trotter in cash for £1,200 including VAT.
c) Explain the principles and characteristics of Value Added Tax from a business
accounting perspective. (4 marks)
Total 20 marks
Question aims
To test candidates’ ability to:
Explain the construction of the accounting ledger
Apply the rules of double-entry bookkeeping
Record transactions relating to cash and credit sales, cash and credit purchases,
owner’s capital, purchase of non-current assets, and value added tax
Overview VAT from an accounting principles perspective
Purchase Ledger (PL) - contains the accounts of trade payables (so, suppliers
who grant credit facilities) and records transactions as they appear on the
suppliers’ accounts, such as purchases made on credit, purchase returns,
settlement made to payables and any discounts received
Cash Book (CB) – holds double-entry Bank and Cash accounts within the
business, so records transactions associated with cheques, bank transfers and
other inputs/outputs to the business bank account, and records cash in hand
held or transacted for whatever reason, so that none is unaccounted for
Nominal Ledger (NL) - contains the remaining double entry accounts of the
business for assets and liabilities, capital and drawings, income and expenses,
VAT, etc.
Value Added Tax (VAT) is an indirect tax and is levied on most supplies of goods
and services. Whilst a business can voluntarily register for VAT, a business is
required to register if its quarterly turnover reaches a particular monetary
threshold. An unregistered business must not charge VAT, but must pay it to
pay the VAT charged by VAT-registered suppliers. VAT is collected on behalf
of the Government Treasury by HM Revenue and Customs (HMRC).
Once registered for VAT, a business must include VAT on all invoices and credit
notes issued and it is a legal requirement that the organisation opens a VAT
account in the books of account to record input and output VAT. On an invoice
or credit note, the net goods/services amount excludes VAT. When the VAT is
added, this shows the gross invoice or credit note amount.
When registered for VAT, the organisation must charge VAT on every sale it
makes in accordance with VAT law. This is referred to as output VAT. The
organisation will in turn have to pay the VAT it is charged on goods and services
it obtains from other businesses. This is called input VAT which can be
reclaimed from HMRC by deducting it from the output tax when the firm makes
its regular VAT return and pays what tax is due.
VAT law requires that particular goods or services attract different rates of VAT
and whilst the standard rate of VAT is 20%, a lower level of 5% is levied on
household fuel supplies. Books, children’s clothing and food are ‘zero-rated’
(that is 0% VAT), but that is not the same as being completely ‘exempt’ from
VAT.
Total 20 marks
Part a) posed few problems for candidates with most identifying the four ledger divisions
correctly. For maximum marks, the typical content of each ledger division then required a
short accurate description. Where there were issues, it involved the Cash Book (either
because it was omitted as a division or ignored transactions involving the bank), Sales
Revenue and Purchases accounts were wrongly offered as examples of accounts within the
Sales Ledger and Purchase Ledger, and incorrectly suggestions that the Nominal Ledger
contained the names of all the customers and suppliers.
Whilst the Part b) double-entry bookkeeping exercise was also handled well by the
majority of students, though there is still a minority who find this type of question
troublesome. The principles of accurate bookkeeping do need to be mastered by as much
practice as is necessary though as tasks will continue to be set. A completely accurate
exercise involving appropriately named accounts with resident ledger names
(abbreviations for which are fine so, e.g. ‘Sales Revenue NL’ is acceptable), a running
balance throughout each account, an appropriate ‘detail’ identifying the account where the
other part of the double-entry will be found, and the right figure placed in the correct debit
or credit column as appropriate, will always attract maximum marks.
Where there were issues this time, most will be resolved by better attention to the
following errors (prospective candidates take note!):
Whether account transactions were debit or credit (still being confused)
Just because a trading party has been named does not signify the transaction has a credit
basis and has been recorded on an invoice. VAT has often been calculated incorrectly or
the double entry has been confused, with some ignoring the posting required to the VAT
account, or posting the entry gross to the Sales Revenue NL or Purchases NL account.
Returns continued to cause a problem under several of the headings above.
Part c) was answered well in the majority of cases although common errors were to ignore
the circumstances in which VAT must be charged, make no distinction between output or
input VAT, sidestepping the notion of offsetting one from the other to determine the
balance due to/from HMRC, and confusing the organisation’s year end/end of reporting
period with the VAT reporting period.
b) Neha has drafted the ledger accounts and financial statements at year end for
her promotions and marketing business and is pleased that Gross Profit is
£74,500 and Net Profit is £14,500. However, on checking the details more
closely, she identifies the following:
C. A bill for £650 for repairing some office equipment has been debited to
the Vehicle Expenses account.
D. The price of a motor vehicle for business use, namely £7,500, has been
debited to the Vehicle Expenses account.
E. Carriage in of £80 has been entered to the Postage and Delivery account.
F. £18,000 from the sale of the outbuilding has been credited to the Sales
Revenue account.
ii) Ignoring depreciation and other adjustments, and starting with Neha’s
draft gross and net profit figures, briefly show the effect upon profit of
correcting each issue and then give the revised Gross Profit and Net Profit
figures after amendments have been made. (6 marks)
c) Explain the significance of a ‘true and fair view’ in relation to the accounts and
financial statements of a company or other incorporated business. (4 marks)
Total 20 marks
Question aims
To test candidates’ ability to:
Explain the usefulness of auditors and audit reports to companies
Apply the rules of double-entry bookkeeping and accounting concepts in the
calculation of different levels of profit in an organisation
They will also oversee financial procedures and systems for integrity, such as
those relating to the purchase and sale of non-current assets, cash collection
and allocation, banking and other similar issues, and the integrity of computer
and other systems.
Their role is perhaps similar to that of an external auditor, and internal auditors
will often review statutory audit issues before the actual external audit takes
place or where corrective action has been required.
Asset purchase for long-term use in the business, rather than purchase
of goods for short-term inventory and resale
c) A bill for £650 for repairing some office equipment has been debited to
the Vehicle Expenses account.
d) The price of a motor vehicle for business use, namely £7,500, has been
debited to the Vehicle Expenses account.
Asset purchase for long-term use in the business, rather than the
expenses of running/repairing a vehicle
e) Carriage in of £80 has been entered to the Postage and Delivery account.
Carriage in is a cost of sale and impacts upon the value of purchases, and
therefore gross profit; Postage and Delivery, as an expense account,
would impact upon net profit as a cost of generally running the business,
rather than a cost of trading
f) £18,000 from the sale of the outbuilding has been credited to the Sales
Revenue account.
Above are guidelines only. There may be many variations on the actual
responses given and, if relevant, marks will be awarded.
c) The significance of a ‘true and fair view’ in relation to the accounts and financial
statements of a company of other incorporated business includes:
The external auditor normally expresses an opinion in the audit report to all
connected stakeholders that the financial accounts and financial statements of
the company show a ‘true and fair view’ of the financial affairs of that company
at the time of the audit.
‘True’ suggests that the accounts and statements are, for instance, free from
significant errors or omissions, and factually correct; ‘fair’ suggests free from
deliberate and misleading bias, and reflect reality for the organisation.
Consequently, those accounting statements should be objectively and
consistently prepared using applicable accounting frameworks and regulations.
UK company law puts the burden of ensuring this upon the directors and
discharge of that duty is checked by auditors, so that the actual business
dealings and business results of the organisation are properly represented by
the financial statements.
Part b) caused problems for the number of candidates who wrongly associated the issues
given with undetected trial balance errors and responded accordingly, or who identified
how the double-entry was apparently incorrect and advised how it should have
happened. Some stated the transaction was an error of principle, commission, omission,
etc., which the question did not require. In fact, it was a task involving activities which
in effect contradicted the ‘rules’ of bookkeeping and accounting and asking for
clarification as to how long-accepted accounting principles had been breached. For
instance, if payment of rent was received from a client for the short term use of a
building, this was non-trading income to the firm, not payment for buying the asset, nor
sales revenue. Acquiring a colour photocopier was acquisition of a non-current asset for
long-term use in the business, not the purchase of inventory (goods for resale), and so
on.
The supplementary task asked about the effect upon Gross Profit and Net Profit of
correcting the issue. In correcting the issue regarding receipt of rent, it would show on
the Income Statement as Other Additional Income (so below Gross Profit and above
Expenses) thereby improving Net Profit by that figure. Correction by removing the
photocopier cost from Purchases would reduce the Cost of Sales, therefore increasing
Gross Profit, and so on. Any reasonable presentation starting with the draft Gross Profit
and Net Profit figures to show the impact of each correction in turn would be acceptable,
and an example is given as a suggested response. Again, another reminder to do what
the task requires – not all responses started with the draft figures, nor gave end figures
for both levels of profit.
Part c) was answered reasonably well though there was frequent confusion with regard
to what a ‘true and fair view’ actually means in practice: “true” (the accounts are free
from errors or omissions) and “fair” (the accounts are free from bias), consequently, the
accounts reflect reality for the organisation from an accounting perspective. These are
characteristics that the accounts must possess and directors are responsible for bringing
that about. External auditors therefore do not ‘give’ that to the accounts, but certify it
is there already as part of their inspection. Most candidates secured some marks, even
where explanations were a little unclear.
b) The following information relates to Whyzee Limited in 2017 and comes from
its various budgets, management decisions, activities and expectations during
the year:
It has agreed to buy new machinery in July for £200,000 and a finance
arrangement to pay for it in 5 equal monthly instalments, the first due on
the date of purchase.
Rent payable for their premises is £24,000 per year, payable quarterly in
advance. The next payment is due in July.
Cash sales are treated as fully paid at the time of purchase and Whyzee
Ltd.’s standard credit term for its customers is full payment by the end
of the following month. The pattern of sales is expected to be:
Using the information given above relating to Whyzee Limited, prepare their
cash budget for the four months from July to October 2017. (12 marks)
Total 20 marks
All calculations should be presented to the nearest whole £
Question aims
To test candidates’ ability to:
Explain the relationship between budgets and the construction, purposes and process
of budgetary control
Prepare a cash budget
Interpret a cash budget
a) Budgets are interrelated and the sales budget is the budget on which the other
budgets are based as sales represent the level of activity that is expected for the
whole business, particularly if it involves manufacturing. The sales budget can take
two forms, namely volume (the number of items within a sales line) or values (the
amount of money raised by selling that volume of items).
Sales ambitions must be met from holding adequate goods inventories at the
appropriate time, so sales demands inform a manufacturing or production budget.
Since it is cost price of individual materials, labour, overheads, etc., rather than
selling price, that is relevant to this, volumes relate to the number of items required
to meet sales ambitions, and values relate to the costs of production.
The cash budget is concerned with the actual time that cash is paid out or received,
not with the time period the original activity giving rise to the payment or receipt
relates, and is compiled on the basis of the information contained in all the other
budgets indicated above. For instance, the sales budget suggests incoming cash
flow from sales revenue so the cash budget highlights what cash is expected and
when. The production budget indicates the cash requirement for the business’
operating costs, and settlement of suppliers’ invoices, etc., so indicates the timing
and value of cash outflows. The difference between overall cash inflow and cash
outflow represents surplus funds, upon which returns can be made on investment,
or unsatisfied cash needs for which sources of finance or incoming investment must
satisfy.
Payments
Machinery Finance 0.00 40,000.00 40,000.00 40,000.00 40,000.00
Rent for Premises 0.00 6,000.00 0.00 0.00 6,000.00
Raw Materials' Purchases 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00
Other Overheads:
Wages 5,000.00 5,000.00 5,000.00 5,000.00 5,000.00
Electricity, Water, Gas 1,350.00 1,350.00 1,350.00 1,350.00 1,350.00
Administration 1,950.00 2,100.00 2,250.00 2,400.00
Overdraft Fees 0.00 0.00 20.00 20.00
As it stands in the absence of other information, Whyzee Ltd are in a cash flow
downward spiral, so they must identify new sources of investment/finance, but
must also attend to the reasons why cash outflow is outstripping cash inflow.
At present, the bank will need to support this haemorrhage of cash by a rapidly
growing overdraft, although someone evidently thinks that the organisation is
creditworthy enough to grant the investment finance for the machinery [Note:
finance may be briefly and appropriately mentioned, but detailed and extended
discussion is now beyond the current syllabus].
That said, there is a heavy financial burden in the short term from the new
machinery, but it may be that such an investment is exactly what will be needed
to bring about a change in performance for the organisation by say opening a new
or upgraded product line.
Max 20 marks
Part a) required mention of the major practical differences between a cash budget and
other budgets within the system. Candidates comparing one to the others (whether they
forecast cash flows, or anticipated volumes of production, or expected sales income, etc.)
and showing major differences received all available marks. A common error here would
be to discuss cash budgets in detail with little or no reference to any other budgets (so
effectively half a response), or to focus on the budget system and how they feed into one
another from a planning viewpoint (not a response to the set task).
Part b) as ever caused problems for many students. Aside from those well-scoring
responses where candidates produced orderly frameworks to show anticipated incoming
cash flow streams one by one with activity under the appropriate month, followed by a
similar treatment of anticipated outgoing cash flow streams, concluding with a monthly
summary of net cash flow and its impact upon bank account balances, format, structure
and presentation was a general issue. In that cash flow is mapped in the cash budget, it
is the anticipated cash income, not the volume of sales revenue, which should be shown.
Given that the scenario simulates monthly sales revenue being paid for over two or more
months (as is reality) with incoming cash flow allocated accordingly, the principle is that
goods to be sold in January and to be paid for in March will appear in March’s incoming
cash receipts. Therefore where Credit Sales Revenue was confused with its respective
cash flow, this lead to incorrect cash receipts’ figures.
Those candidates presenting their work well (a likely consequence of persevering with
exercises, practice and revision) were also likely to deal with the more complex elements
of the task more effectively. Calculation of the administration fees presented challenges
as did the computation of interest on bank funds and for overdraft fees. However, of
greatest and worrying concern was that the majority of candidates included depreciation
in the budget as a cash item.
c) The following data has been extracted from the business information report for
Lucrative Prospects Ltd. Analyse the changes for each between 2015 and 2016,
showing the potential impact upon Lucrative Prospects Ltd in general and
making reference to its management of its working capital in particular.
(6 marks)
Receivables Collection
49.5 days 33.3 days
Period
Payables Settlement
24.8 days 28.7 days
Period
Total 20 marks
Question aims
To test candidates’ ability to:
Explain the recognised concepts which underpin the principles of accounting and
bookkeeping
Describe the usefulness of ratios in reviewing business performance
Use ratio data to analyse business performance
a) Accruals concept:
The accruals or matching concept requires that the costs of an activity must be
matched to the same time period that the activity occurred in. Therefore, sales
revenue for an item and expenses associated with that sale (such as the costs
of sale) must be included in the financial statements of the same accounting
period.
So, the income statement for instance should always include the amount of the
expenses that have been incurred as a consequence of a particular sale and
the expenditure associated with running the business for the year, whether or
not payment has taken place.
b) Current Ratio indicates whether a firm has sufficient current assets to cover its
current liabilities. It is an indication of the firm’s solvency and levels of working
capital. Each type of business will have a different ratio, but as a general rule 2.0:1
would be considered safe, where the firm has twice as many current assets as the
demands upon it, the current liabilities.
However, a large retailer might have a much lower ratio than this, and indeed could
be near negative, whereas a large construction company would have a higher ratio
than 2.0:1 because of the different timescales and volumes of inventory. The retailer
will generate cash quickly, but there will be a considerable time gap between the
construction company buying materials and resources and the final payment for the
building, so it needs a higher level of working capital.
Acid Test Ratio follows the same logic as the Current Ratio, but removes the
influence of the firm’s inventories, which are excluded. This is a more critical
measure of the firm’s liquidity, as only the liquid (cash or near cash) assets are
considered. Inventory as the least liquid of the current assets, still has to be sold
and cash may not be received for it for several weeks. Consequently, 1.0:1 is the
normal minimum level unless constant incoming cash flow, such as that enjoyed by
a large supermarket retailer, can support a lower short-term level.
Consequences of a high RCP include the need for a new (or extension of an existing)
overdraft, delay to payments for suppliers of goods and services through lack of
incoming cash flow, finance costs on consequential borrowings and bad debt through
lack of prompt collections, which also impacts upon profitability.
Inventory Turnover Period is the average number of days inventory is held, and
it indicates the length of time it takes for inventory to be sold. This period will depend
on the type of product and business, so needs to be referenced to the industry
involved. A greengrocer will have a very high rate as the goods sold have a short
shelf life, and a furniture store will have a low rate as goods have a long shelf life.
However this can also depend on the sector. For example, clothes stores selling
fashion clothing would want a high rate. Although the goods have a long shelf life,
once they go out of fashion they may be unable to sell them and they may be classed
as obsolete. So, efficient inventory control policies should be in place to ensure that
there is sufficient to be used in production to meet sales demand. Overstocking
means that money is tied up unnecessarily in unsold inventory and can lead to loss
of sales and customers. The quicker inventory is sold, the faster cash is generated.
Above are guidelines only. There may be many variations on the responses and marks
will be awarded where relevant.
Current ratio has increased indicating that the company has more current
assets to meet its current liabilities than in previous years and hence better
liquidity. It could mean though that inventories or trade receivables have
increased rather than bank funds or cash itself, so it does not necessarily mean
an improvement in liquidity.
Acid test ratio has moved adversely which means that there are less current
assets that are quickly convertible into cash to meet current liabilities which
means decreased liquidity. The fact that the current ratio has increased during
the period could suggest that there has been an increase in inventories during
the period. Also, because the acid test includes receivables it might be hiding
further liquidity problems.
Receivables collection period has worsened as it now takes an average 16
days longer to collect debts than it did last year. This might indicate liquidity
problems of XYZ’s customers or a failure to chase up debts as and when they
fall due, which points to poor management of working capital.
Payables settlement period has also fallen over the period. This might be
due to the fact that XYZ suppliers are pushing for payment far quicker which
might indicate suspicions about the liquidity of the company. It might though
point to the fact that management of XYZ have failed to make full use of the
credit facilities on offer.
Above are guidelines only. There may be many variations on the responses and marks
will be awarded for coverage and relevance.
Total 20 marks
Here, Part a) asks specifically about one of the concepts that underpin acceptable
accounting practices, the Accruals or Matching Concept, so the focus of anticipated
responses was the concept itself, its characteristics, specific reference to costs and
revenues appearing in different accounting periods, how it works, what it ensures, and
so on, all of which would be given credit to the maximum available. Whilst many
candidates made central reference to accrued payables/’accruals’ and prepaid
receivables/’prepayments’, and credit was given for this, these were examples of how
the concept is seen in practice, rather than definitions and characteristics of the concept
itself. Most candidates however had a fair idea of the nature of this important accounting
concept and obtained some marks.
For Part b), there were some very good responses with candidates clearly displaying a
high level of knowledge and understanding of this very important part of the syllabus.
However, other responses consisted of discussions regarding the components of the
named ratios, typical formulae for each, descriptively verbalising the formulae or ratio
name (e.g. the Receivables Collection Period is how long it takes on average for
receivables to be collected), and so on, none of which were central to the set task, nor
showed the usefulness of knowing that ratio. Best responses and maximum marks were
awarded to responses which addressed the task and showed, as required, how useful it
is to reviewing the performance of a business having knowledge of each given ratio is.
For instance, the usefulness of the Current Ratio and Acid Test might be whether the
organisation had enough liquid (cash) assets to cover its bills (current liabilities) as and
when they fall due, to what extent the need to sell inventory influences that, what an
ideal ratio might look like, or how the impact of a sudden cash demand (say, a recalled
overdraft) would be covered by available current assets, or an explanation from the
viewpoint of a credit manager. Whilst not all of this is required in a single response to
obtain maximum credit, to explain the simple relationship that the Current Ratio
compares current assets with current liabilities is not showing that ratio’s usefulness in
reviewing a business’s performance.
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