Accounting Principles

Question Paper, Answers and

Examiner’s Comments

Level 3 Diploma January 2017

 ADVICE TO CICM LEARNER CANDIDATES

HOW TO TACKLE YOUR ACCOUNTING PRINCIPLES EXAMINATION

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.

2. Examination structure and rubric.

Remember that the unit syllabus and examination rubric changed in Summer 2016.
Some features of the examination are now fixed, so you know that:

a) It is a three-hour, handwritten examination and a writing booklet for your answers

is supplied.

b) There will be five (5) questions each worth an overall 20 marks.

c) There are no optional questions or elements in the exam, so you will need to
attempt them all. This is consistent with CICM’s other core units.

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.

g) The language and terminology of the examination is based upon International

Accounting Standards as used in CICM’s own learning materials for this unit.

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.

c) Remember to attempt all parts of all questions. It is always worth giving a

response, even if you are unsure of it.

January 2017 7B/PQP/2 continued

4. Giving an effective response.
As with any examination, preparation is the key and practising an effective response
to an Accounting Principles task is a worthwhile exam room skill, so it is worth a
reminder of what this unit and its exam is about.

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.

b) The exam will require skills in description/explanation, application of the practical

principles of accounting, and commentary/narrative to convey the meaning of the
principles, and the results of applying those principles.

c) It is not, in itself, an assessment of mathematical ability, although accurate

calculations are important and unavoidable in this type of subject.

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.

The following will help you give an effective response:

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.

January 2017 7B/PQP/3 continued

 f) Show workings and calculations to support your figures even if you used a
calculator to produce or check your response. Even if your ‘number’ is incorrect, it
may still be possible to obtain marks from the methods you used where that
was deemed part of the task.

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!

 Copyright of the Chartered Institute of Credit Management

January 2017 7B/PQP/4 continued

Accounting Principles questions, answers and
examiners’ comments
Level 3 Diploma in Credit Management

JANUARY 2017

Instructions to candidates

Answer all questions. All questions carry equal marks. Time allowed 3 hours

Candidates are reminded there are no optional elements in this examination

Ledger accounts must be prepared in continuous running account balance format.

Financial statements must be prepared in vertical format.

FRS terminology should be used in responses wherever possible.

Credit balances should be clearly shown in brackets ( ) for clarity.

Where appropriate, VAT is to be calculated at 20%.

This is the first examination in the new format and was handled well in the main by the
majority of candidates. There were some laudable performances with good scripts being
submitted. Candidates achieving a pass mark at either Level for this examination are
congratulated and it is hoped that candidates who were unsuccessful this time will be
encouraged to continue study of this unit and achieve a pass mark next time.

As pointers to improving performance and as a guide to future candidates, it is clear that

structure, format and presentation is still a basic issue with the content and layout of both
the Income Statement and the Statement of Financial Position. Part of the rationale of
accounting is communication, so attention to detail, appropriate headings and structures to
financial statements, and accuracy in double-entry bookkeeping is assessed in this unit and
rewarded accordingly. Particularly common errors seen this time include: failing to properly
title or date financial statements; not following the convention of increasing liquidity when
listing the current assets in the Statement of Financial Position; listing assets and liabilities
in Income Statements; the ‘Detail’ column of double-entries containing one or more
descriptions of the transaction or activity itself.

January 2017 7B/PQP/5 continued

It is also worth mentioning that adopted terminology for this unit is based upon international
accounting standards, so familiarisation with FRS terminology used in this unit is therefore
strongly encouraged, as is its use in responses.

Another area worthy of attention is not just what numbers are, but what they might mean.
A number of candidates, despite performing well in numerical parts of tasks, did not
maximise their marks because they offered very weak or no responses to the narrative
sections. It is important that candidates prepare better for these parts of questions as the
interpretation of the answers arrived at is just as important as the numeric data being
collated and presented. Whilst numbers and the manipulation of numeric detail are an
unavoidable part of this unit, narrative and commentary are equally important along with
the general focus upon relevance and accuracy. This will continue to be the brief in future
examinations in this unit.

Finally, the key to success is for a candidate to be able to show knowledge and
understanding. So, whilst the stated marks are available for directly addressing the set
task, long and rambling responses are less effective, and few are achieved by generic
three or four word comments such as ‘better credit control needed’, which is not likely to
be a task response in isolation in any event. This is important as, with no optional
elements in the examinations for this unit, candidates are encouraged to be fully
conversant with the syllabus before their assessment date.

January 2017 7B/PQP/6 continued

1. a) i) Explain what is meant by the ‘cash operating cycle’, and its importance
to a business. (2 marks)

ii) Explain the significance of a credit manager knowing the cash operating
cycles of its largest customers. (2 marks)

b) These figures are extracted from the financial statements of Rolling Stock
Credit Limited for 2015 and 2016:

Rolling Stock Credit Limited 2015 2016

£ £
Sales Revenue 350,000 230,000
Cost of Sales 227,500 149,500
Gross Profit 122,500 80,500
Net Worth 113,418 92,418
Ordinary Shares 70,000 70,000

Trade Receivables 61,475 38,815

Non-Current Assets 50,000 100,000

Retained Earnings 43,418 22,418

Cash 35,655 1,800

Inventory 26,690 19,164

Trade Payables 25,980 18,164
Long-term Loans 15,000 50,000

Bank 12,559 0
overdrawn
Expenses 7,500 65,000
Accrued Payables 7,400 0
Prepaid Receivables 537 803

TASKS for part b)

i) Calculate Rolling Stock Credit Limited’s cash operating cycle for 2015 and
2016, and comment on the organisation’s performance in its
management of cash. (8 marks)

ii) How can the credit manager ensure in a practical way that good incoming
cash flow is maintained? (4 marks)

January 2017 7B/PQP/7 continued

 c) The following are financial ratios calculated from the books of two
organisations, one of which is a supermarket business and the other is a heavy
engineering business. Suggest which company (ABC Limited or XYZ Limited)
is in which industry, and use the ratio results and other information to explain
the reasons for your selection. (4 marks)

ABC Limited XYZ Limited

Current Ratio 1.7:1 1.0:1
Acid Test 0.9:1 0.7:1
Receivables Collection
47.0 days 3.0 days
Period
Payables Settlement
67.0 days 51.0 days
Period
Inventory Turnover
43.0 days 16.0 days
Rate
Financial Gearing 65.0% 12.0%

Total 20 marks

Question aims
To test candidates’ knowledge and understanding of cash operating cycle and how it
impacts on an organisation’s liquidity and working capital arrangements.

Suggested grounds for response include:

a) i) The cash operating cycle (COC) is the period of time that elapses between the
purchase and payment for raw materials or other inventory and sales receipts
from credit and non-credit customers. Measured by inventory turnover rate
days + receivables collection period days – payables settlement period days, it
is the period of time that the business subsidises and finances the inventory,
until it is paid by their customers for the ultimate sales of those goods.

ii) It is important to credit managers in their assessment of customers as it

measures how efficient an organisation is in managing its working capital.
Generally, the shorter the time period in days, the better an organisation is
with regard to liquidity and cash management, with factors such as industry
sector taken into account.

b) i) Cash operating cycle for 2015 and 2016 (ratio expressions to one decimal
place):

*nearest available acceptable

2015 2016
data used

Inventory Turnover Rate 26,690 x 365 19,164 x 365

Closing* Inventory x 365 227,500 149,500
Cost of Sales = 42.8 days = 46.8 days

January 2017 7B/PQP/8 continued

 Receivables Collection
61,475 x 365 38,815 x 365
Period
350,000 230,000
Trade Receivables x 365
= 64.1 days = 61.6 days
Sales Revenue*
Payables Settlement Period 25,980 x 365 18,164 x 365
Trade Payables x 365 227,500 149,500
Cost of Sales* = 41.7 days = 44.3 days

42.8 + 64.1 – 41.7 46.8 + 61.6 – 44.3

∴ Cash Operating Cycle =
= 65.2 days = 64.1 days

There has only been a marginal improvement in the cash operating cycle
between 2015 and 2016. The receivables collection period has improved
slightly, probably due to better implementation of credit control policies and
procedures, although still disappointing if agreed terms are 30 days. Inventory
items are taking longer to move, caused by poor inventory management in
holding proportionately higher levels of inventory during, as in this case, a
downturn in sales.

Suppliers have not managed to get their invoices paid quicker in 2016 on
average, although the delay of just over two days is not likely to be critical
where credit terms are being broadly adhered to. The organisation is still not
in a favourable position here. They are making payment to their suppliers
before payment for sales is received and are funding the cash requirement
meanwhile. Whilst the 2015 bank overdraft has apparently been repaid, the
company is over £29,000 worse off in cash terms in 2016.

ii) Examples of how good cash flow can be maintained include ideas based on:

• implementing and maintaining strict credit control policies and

procedures for new and existing customers

• vetting customers thoroughly including checking, validating and follow up

references

• setting and monitoring credit limits and terms, and ensuring they are
adhered to

• swift query resolution and constant liaison with customers

• following up slow or non-paying customers

• preparing detailed aged receivables schedules/reports and holding

regular meetings with the credit control team

January 2017 7B/PQP/9 continued

c) Organisation categorisation:

Ratio ABC Limited XYZ Limited

Current ratio 1.7:1 1.0:1
Acid test 0.9:1 0.7:1
Receivables collection 47.0 days 3.0 days
period
Payables settlement 67.0 days 51.0 days
period
Inventory turnover rate 43.0 days 16.0 days
Financial gearing 65.0% 12.0%

ABC Limited is probably a heavy engineering business, as although the liquidity ratios
are a little on the low side, they are close to acceptable limits of 2.0:1 (CR) and 1.0:1
(AT). Receivables, Payables and Inventory days all point to this, and also that most
sales are seemingly on credit. Receivables are typical of this sector and Payables
are quite high. There is a significant amount of borrowing as suggested by the higher
gearing ratio, but this is not too excessive.

XYZ Limited’s ratios suggest that it sells mostly on cash terms with low working
capital and liquidity ratios supporting the contention that this organisation is a
probably a supermarket. Inventory turnover is quicker and Payables are paid close
to two months after invoice. The Gearing ratio is low indicating that there is scope
for more borrowing if required.
Total 20 marks

Most learners handled this question quite well for an item that has been on this unit’s
syllabus for some time. In part a)i), the definition of the cash operating cycle was
satisfactorily addressed with most offering a clear definition. There were a few
issues in part a)ii) which sometimes did not clearly show how important monitoring
measurements are for management of working capital.

The vast majority of candidates could calculate parts of the cycle in part b)i) with full
marks being awarded in many cases, but inventory turnover rates still caused a
problem for a few. The organisational performance narrative in b)i) varied
considerably from candidate to candidate, with many offering a sound commentary,
but a few offering no comments at all. Learners could have made reference to
inventory management and credit control in this context. Much the same could be
said with the handling of b)ii) as more detail was required regarding how cash flow
could be improved by looking at credit control, processes and procedures.

In part c), most candidates identified the two sectors that each cited organisation
probably belonged to, but a common failing was to not justify their reasoning using
the supplied ratios cited in the question.

January 2017 7B/PQP/10 continued

2. a) With regard to accounting rules, explain what you understand by the
expression ‘dual aspect concept’ (or ‘duality concept’). (4 marks)

b) Martha’s Muffins is a small high street business selling various cakes and
pastries. The following account balances were brought forward on 1 January
2017:

Account Name Ledger Name Balance £

Bank ? (400.00)

Rent and Rates ? (45.00)

Sales Revenue ? (1,145.00)

Purchases ? 850.00

M Smith ? (1,385.50)

J Jones ? 2,600.00

VAT ? 450.00

During the first week of January 2017, the following transactions were
recorded:

January 1 Sales on credit for J Jones for £950.00 plus VAT.

January 2 Paid rent and rates outstanding balance by cheque.

A credit note was received from M Smith for £300.00

January 3
including VAT.
J Jones paid £3,500.00 by cheque in full and final
settlement of the amount outstanding. Treat any balance
January 4
remaining as a discount.
NOTE: Ignore VAT; there are no VAT implications
Purchased additional inventory from M Smith on credit for
January 5
£450.00 plus VAT.
Martha took £300.00 out of the business bank account for
January 7
her own personal use.

TASKS for part b)

Write up Martha’s Muffins’ books for the first week of January 2017, ensuring
you accurately:

i) Open ledger accounts as required and correctly record the ‘brought

forward’ balances on 1 January 2017.

January 2017 7B/PQP/11 continued

 ii) Using the ledger accounts already opened and opening others as
required, correctly record the six transactions which took place between
1 January and 7 January 2017. (12 marks)

c) Explain the key differences between ‘bookkeeping’ and ‘accounting’. (4 marks)

Total 20 marks
Question aims
To test candidates’ knowledge and understanding of how accounting regulations and
concepts impact on the nature, form and control of final accounts.

To test candidates’ ability to open the appropriate individual ledger accounts with the
correct balances and then post transactions to each using a double-entry system of
bookkeeping.

To test candidates’ knowledge and understanding of the key differences between

bookkeeping and accounts.

Suggested grounds for response include:

a) The regulatory framework of the accounting profession provides the rules that
accountants should follow when preparing the final accounts of a business.

The dual aspect concept (or duality concept) states that there are two aspects of
accounting. One represented by the assets for the business and the other by the
claim against them. Put another way, each financial transaction is recorded by two
equal and opposite transactions – one on the credit side and the other on the debit.

Double-entry bookkeeping is an example of the duality or dual aspect concept.

b) Accounts necessary to record required transactions:

Account: Bank CB

Date Details Dr Cr Balance

1 January Balance b/fwd. (400.00)

2 January Rent and Rates NL 45.00 (445.00)

4 January J Jones SL 3,500.00 3,055.00

7 January Drawings NL 300.00 2,755.00

Account: Rent and Rates NL

Date Details Dr Cr Balance

1 January Balance b/fwd. (45.00)

2 January Bank CB 45.00 0.00

January 2017 7B/PQP/12 continued

 Account: Sales Revenue NL

Date Details Dr Cr Balance

1 January Balance b/fwd. (1,145.00)

1 January J Jones SL 950.00 (2,095.00)

Account: Purchases NL

Date Details Dr Cr Balance

1 January Balance b/fwd. 850.00

5 January M Smith PL 450.00 1,300.00

Account: M Smith PL

Date Details Dr Cr Balance

1 January Balance b/fwd. (1,385.50)

Purchases Returns
3 January 300.00 (1,085.50)
NL
5 January Purchases NL 540.00 (1,625.50)

Account: J Jones SL

Date Details Dr Cr Balance

1 January Balance b/fwd. 2,600.00

1 January Sales Revenue NL 1,140.00 3,740.00

4 January Bank CB 3,500.00 240.00

Discount Allowed
4 January 240.00 0.00
NL

January 2017 7B/PQP/13 continued

 Account: VAT NL

Date Details Dr Cr Balance

1 January Balance b/fwd. 450.00

1 January J Jones SL 190.00 260.00

3 January M Smith PL 50.00 210.00

5 January M Smith PL 90.00 300.00

Account: Purchases Returns NL

Date Details Dr Cr Balance

3 January M Smith PL 250.00 (250.00)

Account: Discount Allowed NL

Date Details Dr Cr Balance

4 January J Jones SL 240.00 240.00

Account: Drawings NL

Date Details Dr Cr Balance

7 January Bank CB 300.00 300.00

c) Bookkeeping is the initial recording in financial terms of business transactions in

the books and records of that business, the financial effect of such transactions, and
managing and maintaining these records. This work takes place in ledger accounts,
and is backed up by documentation. Details of the bookkeeper’s work can be
extracted and used in accounting. The border between bookkeeping and accounting
is generally accepted to be the drawing up of the Trial Balance.

Accounting takes the information compiled by the bookkeeper and then presents it
to the owner as management information (management accounting, budgeting and
costing, decision-making) and/or in a specified formats governed by accounting
standards and conventions as performance information (financial accounting, such
as Income Statements, Statements of Financial Position, or Cash Flow Statements).
Total 20 marks

Probably the best answered question on the paper. Part a) was addressed well by the
majority of learners, and the better ones developed their arguments by making a distinction
between assets and liabilities in the context of the question.

January 2017 7B/PQP/14 continued

All candidates could make a bold attempt at the double entry part of the question in b).
Whilst many learners secured near maximum/maximum marks here, there still remains
confusion for some regarding the double entry for drawings, sales returns and purchases
returns and the entries for VAT. Also, a noticeable number of candidates had a habit of
indicating an account nil balance by just leaving it blank or entering a dash ‘ – ‘; learners
should insert a ‘0’ figure, i.e. a zero, when this is the case and tutors may need to instruct
their learners accordingly. Most used the account ledger templates available in current
CICM supplied Answer Script booklets, although there were still some hand-drawn ledger
accounts. In the future, the examining team anticipate candidates will cite alongside each
individual account name what part of the ledger it is attached to, i.e. namely, sales ledger,
purchase ledger, cash book or the nominal ledger, consistent with current CICM study
materials.

Most secured some marks in part c) though in many cases there was a lack of detail and
examples as to the key differences between bookkeeping and accounting.

January 2017 7B/PQP/15 continued

3) a) i) Explain two reasons why organisations prepare budgets. (2 marks)

ii) Explain why a cash budget is important in any business. (2 marks)

b) The following information is given to you about ‘Manufacturer X’.

Table 1 is taken from its cash budget for the last three months of 2016:

Table 1: Cash Budget October November December

4th Quarter 2016 £000 £000 £000
Receipts
From cash sales 1,500 1,200 1,200
From credit sales 1,200 1,150 1,200
2,700 2,350 2,400
Payments
Wages 80 70 80
Raw materials 1,700 1,700 1,800
Rent and rates 150 150 150
Electricity 200 240 260
Administration 128 140 145
2,258 2,300 2,435
Summary
Opening balance 20 ? ?
Net cash flow ? ? ?
Closing balance ? ? ?

Table 2 relates to the actual cash flows arising from the budgeted activities,
as this data is now available:

Table 2: Actual Cash Flows October November December

4th Quarter 2016 £000 £000 £000
Receipts
From cash sales 1,550 1,230 1,275
From credit sales 1,150 1,050 1,170
2,700 2,280 2,445
Payments
Wages 90 80 90
Raw materials 1,650 1,600 1,700
Rent and rates 160 160 160
Electricity 220 250 280
Administration 120 130 125
2,240 2,220 2,355
Summary
Opening balance 20 ? ?
Net cash flow ? ? ?
Closing balance ? ? ?

January 2017 7B/PQP/16 continued

 Table 3 is a Variance Control Sheet between actual and budgeted cash flows
and the budgeted 4th Quarter totals have already been transferred to it:

Table 3:
Budgeted Actual Variance
Variance Control Sheet Fav/Adv.?
£000 £000 £000
4th Quarter 2016
Cash sales receipts 3,900 ? ? ?
Credit sales receipts 3,550 ? ? ?
Wages 230 ? ? ?
Raw materials 5,200 ? ? ?
Rent and rates 450 ? ? ?
Electricity 700 ? ? ?
Administration 413 ? ? ?

TASKS for part b)

i) Plainly copy the Summary Template for Table 2 (below) into your
Examination Response Book and accurately complete it there as
appropriate. (4 marks)

Table 2
Actual Cash October November December
Flows £000 £000 £000
Summary
Opening balance 20
Net cash flow
Closing balance

ii) Plainly copy the Template for Table 3 (below) into your Examination
Response Book. Accurately complete it there in respect of the actual 4th
quarter totals and the resulting variances as appropriate. (8 marks)

Table 3:
Budgeted Actual Variance Show if
Variance Control
£000 £000 £000 Fav/Adv.
4th Quarter 2016
Cash sales
3,900
receipts
Credit sales
3,550
receipts
Wages 230
Raw materials 5,200
Rent and rates 450
Electricity 700
Administration 413

c) Offer a realistic suggestion for each variance you highlight as to factor(s) which
might have caused the differences between the budgeted and actual figures.
(4 marks)

Total 20 marks

January 2017 7B/PQP/17 continued

Question aims
To test candidates’ knowledge and understanding of the nature and purpose of cash
budgets and their importance to business.

To test candidates’ ability to assess the variances between actual figures and budgeted
figures.

Suggested grounds for response include:

a) i) The two major reasons why budgets are prepared are:

• Planning. A business will be more efficient and profitable if it plans its

activities in advance.

• Control. A business can exercise control over its costs if budgets are
accurate and concise.

ii) Organisations might be highly profitable, but if they do not have enough cash
to pay their bills as and when they fall due, then they would easily be forced
to cease trading. A cash budget highlights the amounts expected to be
received and paid out and more importantly the timings of these.

Properly prepared cash budgets can pinpoint when there might be an excess
of outgoings so the organisation can take steps to secure temporary funds by
transferring them from elsewhere or through an overdraft facility, or plan
investment of anticipated surpluses.

b) i) Table 2 Actual Cash Flow Summary

Table 2: Actual Cash Flows October November December

4th Quarter 2016 £000 £000 £000
Receipts
From cash sales 1,550 1,230 1,275
From credit sales 1,150 1,050 1,170
2,700 2,280 2,445
Payments
Wages 90 80 90
Raw materials 1,650 1,600 1,700
Rent and rates 160 160 160
Electricity 220 250 280
Administration 120 130 125
2,240 2,220 2,355

January 2017 7B/PQP/18 continued

 Table 2: Actual Cash Flows October November December
4th Quarter 2016 £000 £000 £000
Summary
Opening balance 20 480 540
Net cash flow 460 60 90
Closing balance 480 540 630

ii) Variance between actual and budgeted cash flows:

Table 3:
Budgeted Actual Variance
Variance Control Sheet Fav/Adv.?
£000 £000 £000
4th Quarter 2016
Cash sales receipts 3,900 4,055 155 F
Credit sales receipts 3,550 3,370 (180) A
Wages 230 260 (30) A
Raw materials 5,200 4,950 250 F
Rent and rates 450 480 (30) A
Electricity 700 750 (50) A
Administration 413 375 38 F

c) Possible reasons for variances include, among other acceptable ideas:

• Improvement in cash sales – perhaps some customers have taken advantage

of suddenly discounted prices, cash only sales campaign or special offer?

• Under target collections from credit sales – poor cash collection activities,
policies and procedures

• Wages higher than budgeted – perhaps caused by unplanned overtime due to

machine breakdown, etc. Labour could have secured a pay rise during the time
period under pressure from trade union activity.

• Lower raw materials costs than expected – perhaps through more efficient use
of materials, less wastage (better quality than expected) or anticipated price
increase lower than feared or negotiated down.

• Rent and rates increase caused by unexpected bill for services or change of
landlord followed by unexpected rent review.

• Electricity higher than planned which might be related to above issues or

unexpected price hikes by the utilities

• Administration costs shows a favourable movement – perhaps related to

efficiency savings in the department by reducing costs and waste

Total 20 marks

January 2017 7B/PQP/19 continued

Contrarily, Question 3 was probably the least well answered overall. There were only a few
candidates who could cite in part a)i) both main reasons why budgeting is undertaken and
budgets prepared by businesses, although the majority made a bold attempt at it. With
regard to a)ii), most candidates highlighted the importance of cash and liquidity for any
organisation, but better responses indicated some context of timing and how planning cash
inflows and outflows is crucial for any organisation’s functioning.

The actual compilation of the cash budget was well handled in b)i) with many securing near
full/full marks, but it was part b)ii) that tended to be problematic with some. Where so,
there was confusion surrounding adverse and favourable variances, with a few unfortunately
expressing them the wrong way round.

However, the major problem for the vast majority of candidates was part c) which required
some evaluation and analysis gleaned from part b). As indicated previously, an
understanding of the numbers is as important as the practical numerical tasks, so candidates
do well to be prepared for this and practice those skills. Reasoning as to why some
variances might have come about, such as causes of poor credit control or better use of raw
materials, was required, but was lacking in many instances, and good reward was difficult
for short responses such as ‘less inventory used’. Management accounting is an important
part of the syllabus and will continue to feature in future examinations..

January 2017 7B/PQP/20 continued

4. a) Explain why profit is not the same as cash, supporting your response with
appropriate examples. (4 marks)

b) A trial balance has been extracted from the books of Real Trading Solutions
(an unincorporated business) as at 31 December 2016 and is given below:

Real Trading Solutions DR CR

£ £
Purchases and Sales Revenue 45,000 97,500
Opening Inventory 19,000
Rent and Rates 1,750
Discounts 850 950
Returns 1,260 1,450
Wages and Salaries 13,600
Bad debts written off 1,250
Carriage in 650
Carriage out 475
Gas and electricity 950
VAT 12,000
Trade Receivables and Trade Payables 14,500 10,750
Bank 13,000
Capital 16,385
Drawings 3,950
Motor Vehicles at cost 20,000
Provision for depreciation [Accumulated
8,000
depreciation]: Motor Vehicles
Fixtures and fittings at cost 50,000
Provision for depreciation [Accumulated
5,000
depreciation]: Fixtures and fittings
Loans [Long term] 34,000
Allowance for doubtful debt 1,000
Advertising 800
187,035 187,035

January 2017 7B/PQP/21 continued

 TASKS for part b)
You are required to prepare an Income Statement for the year end taking
into account the trial balance opposite and the following information as
appropriate:

• Closing inventory at year end has been valued at £14,500

• £250 of the rent and rates figure refers to the quarter ending 31 March
2017

• At the 31 December 2016 there is unpaid gas and electricity of £150

• Depreciation of motor vehicles needs accounting for at 10% using the

diminishing [reducing] balance method

• Fixtures and fittings should be depreciated at 2½% of their original cost

• A revised allowance for doubtful debts in 2017 has been agreed at £725.
(12 marks)

c) “If a Trial Balance ‘balances’, then the accounting entries must be correct”.
Say whether this statement is true or false, explaining your answer. (4 marks)

Total 20 marks

Question aims
To test candidates’ knowledge and understanding of the importance of a trial balance in
assessing the accuracy of the double-entry transactions.

To test candidates’ understanding of the nature, form and structure of the Income
Statement, including adjustments.

Suggested grounds for response include:

a) Profit is not the same as cash. Profit is (e.g.) sales minus costs of sales, whereas
cash is a current asset. For instance if goods are sold on credit this creates sales
revenue but no cash is received. The business makes credit sales thus creating trade
receivables. Costs of sales are entered to the relevant ledger accounts, but are
accounted for in the income statement when they are incurred or the sale made, not
when the cash is actually paid. Similarly, a business will buy goods on credit creating
trade payables, not cash flows. Expenses such as depreciation are charged to the
income statement in order to reduce operating profits, but have no impact upon cash
or cash flows.

January 2017 7B/PQP/22 continued

b) Real Trading Solutions Income Statement for the year ended 31 December
2016

£ £ £
Sales Revenue 97,500
less Sales Returns 1,260

96,240
Less cost of sales
Opening Inventory 19,000
Purchases 45,000
less Purchases Returns 1,450

43,550
plus Carriage in 650 44,200

63,200
less Closing Inventory 14,500 48,700

Gross Profit 47,540

plus Additional Income
Discount received 950
Reduction in Allowance for
275
doubtful debt
48,765

less Expenses
Discount Allowed 850
Rent and Rates
1,500
£1,750 [– PPR £250]
Wages and Salaries 13,600
Bad Debts [written off] 1,250
Carriage out 475
Gas and Electricity
1,100
£950 [+ ACP £150]
Advertising 800
Depreciation for:
Motor Vehicles 1,200
Fixtures and Fittings 1,250 22,025
Net Profit 26,740

January 2017 7B/PQP/23 continued

c) This statement is not true. A trial balance is a list of all ledger accounts and their
balances at a specific date, which is prepared to check the arithmetical, not the
technical, accuracy of the bookkeeping entries.

The total of all the debits may well equal all the credits but this does not confirm that
there are no errors or incorrect postings at all. Certain errors (for example, such as
those of commission, omission, principle, original entry, reversal, and compensating
errors) may have taken place, but the trial balance would not detect them because
they would never imbalance the Dr and Cr columns with each other.

Consequently, the trial balance may ‘balance’ because it is arithmetically correct, but
still potentially contain no, several, or many accounting and bookkeeping errors.

Total 20 marks

For part a), many responses did mention profit and cash, but talked about the two in a
general way without any real contrast or with the examples the task requested. Again, a
reminder that the best chance of good marks is to ensure that responses stick to the
centre of the set task. Better marks here were secured by mention for example that a
credit sale impacts on sales revenue and therefore profits, but has no immediate impact
on cash, or, maybe, that depreciation is an expense impacting upon profit, but not on
cash.

Most candidates had a reasonable idea of the layout of an income statement for a sole
trader in part b), and several candidates did very well, but unfortunately, there were still
some basic errors to be seen. An appropriate heading for financial statements as stated
is necessary in all cases, as is labels for individual items. Discount allowed and discount
received can be confused and misposted, as can purchases and sales returns. Many were
correctly presented here, but some were not. Changes in allowances for doubtful debts,
especially as in this instance when the allowance decreases year-on-year and has a
positive impact on net profit, was not handled particularly well, and sometimes current
liabilities found their way onto the income statement. However, on a more positive note,
there are many instances where full marks were awarded which was pleasing to witness.

Concerning part c), most learners identified that the statement was not correct and then
cited a number of errors that would not be picked up from a trial balance construct –
errors of commission, omission, original entry, etc. Only a handful of candidates could
offer comment why these would not affect the trial balance figure.

January 2017 7B/PQP/24 continued

5. a) Explain the meaning of the word capital from an accounting perspective, and
describe the differences between the capital of a sole trader and the equity of
an incorporated business. (4 marks)

b) Gill Bates has decided to start a business selling specialist computer software
and has secured a £30,000 loan from her bank.

She buys shop premises for £60,000 and fits it out for £25,000. She also
purchases a second-hand van costing £7,500 and inventory for £18,000.

Today, the first day of trading, Gill has £1,900 in the bank, £175 cash in the
till and owes £2,750 to her inventory suppliers.

TASKS for part b)

i) Calculate the capital that Gill has introduced into her business. (5 marks)

ii) Using the available information, draw up a Statement of Financial Position

for Gill’s business as at today’s date. (7 marks)

c) How does the accounting treatment of capital expenditure differ from that of
revenue expenditure? (4 marks)

Total 20 marks
Question aims
To test candidates’ knowledge and understanding of the specific definition of capital from
an accounting perspective.

To test candidates’ understanding of the broad differences in the capital composition of

incorporated and unincorporated businesses

To test candidates’ appreciation of the importance of the accounting equation and its key
components.

To test candidates’ understanding of the structure and composition of a Statement of

Financial Position.

To test candidates’ knowledge of the difference and accounting treatment of capital and
revenue expenditure.

Suggested grounds for response include:

a) Capital is the amount of money invested in the business by the owner, or owners.
The amount is owed by the business to the owner(s). Reference to the business
entity concept might be apt here. It is unlikely to be paid back whilst the business
continues its operations and whilst invested, it facilitates profits or other returns on
investment for the owner(s) through the business.

January 2017 7B/PQP/25 continued

 For a sole trader the capital initially would come from the owner’s savings or loans
from financial institutions or from friends and relatives. As the business expands it
can be added to with profits and reduced with losses. For limited companies its
capital will commonly consist of share equity, reserves and retained profits/earnings.

b) i) Capital calculation

Assets £
Shop Premises 60,000
Fixtures and fittings 25,000
Van 7,500
Inventory 18,000
Bank 1,900
Cash 175
112,575

Liabilities £
Bank loan 30,000
Trade Payables 2,750
32,750

= Capital 112,575 - 32,750 = £79,825

b) ii) Gill Bates’s Software Business Statement of Financial Position as at 16

January 2017
£ £ £

Non-current assets

Premises 60,000

Fixtures and fittings 25,000

Van 7,500

92,500

Current assets

Inventory 18,000

Bank 1,900

Cash 175 20,075

Less current liabilities

Trade Payables 2,750 2,750

Net current assets/working
17,325
capital
109,825

January 2017 7B/PQP/26 continued

 Less Non-current liabilities

Loan 30,000

Net assets 79,825

Financed by

Capital 79,825

79,825

c) Revenue expenditure is incurred in the day-to-day running of a business, such as

wages, salary, rent and rates, and in purchases of inventory, a current (short term)
asset. These costs and expenses are normally paid from available cash flow or short
term overdrafts, and are debited to relevant expense ledger accounts. Inventory
costs appear within the costs of sale and influence Gross Profit. Since business
expenses normally have no long term benefit beyond the current year, and are
intended to generate short term benefits, they appear and are charged to the Income
Statement.

Capital expenditure is the purchase of non-current assets, including the cost of

organisation and installation, or additions to existing non-current assets. Non-
current assets are shown on the Statement of Financial Position normally at cost
price. Since they are held over several reporting periods and for long term benefit,
they are subject to wear and tear over time, and obsolescence, etc. Consequently,
prudence determines that an annual charge (expense) for their depreciation is shown
on the Income Statement and that the Statement of Financial Position shows the
depreciation to date and the asset’s net carrying value, its current value to the
business as determined by accounting convention.

Total 20 marks

Part a) was answered well by the vast proportion of learners though many looked at the
concept from a sole trader perspective, and ignored equity and reserves as capital from an
incorporated business standpoint.

Part b)i) was answered well in the main although some made hard work of calculating capital
in the business. By applying the accounting equation, identifying and adding up all the
assets and then identifying and subtracting all of the liabilities, would result in arriving at
the unknown capital figure. In that task b)i) was ‘Calculate the capital…’ it was regrettable
that a very few responses merely identified the end-figure without any supporting
calculation. The Statement of Financial Position required in part b)ii) was generally well
constructed, but there were still a few responses with no meaningful heading, a few issues
with structure and content, and a lack of labelling.

Happily, most candidates secured some marks with part c), although in the rare instance,
the distinction between revenue and capital expenditure was wholly incorrect.

---o0o---

January 2017 7B/PQP/27