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AC1025 2012-Principles of Accounting Main EQP and

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Principles of accounting (University of London)

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This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON AC1025 ZA

(279 0025)

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route

Principles of Accounting

Monday, 14 May 2012 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions: QUESTION 1 of

Section A, QUESTION 2 of Section B, ONE question from Section C and ONE further
question from either Section B or C. All questions carry equal marks.

Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.

Extracts from compound interest tables are given after the final question on this paper.

8-column accounting paper is provided at the end of this question paper. If used, it must be
detached and fastened securely inside the answer book.

A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.

© University of London 2012

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SECTION A

Answer question 1 from this section.

1 (a) Swallow commenced business on 1st October 2010 purchasing fixtures and fittings for £25,000
and a motor vehicle for £16,000. The fixtures and fittings were estimated to have a useful life of
8 years and a residual value of £1,800. Further fittings were purchased on 1 November 2011 for
£15,200 with nil residual value and a useful life of 8 years.

During December 2011 the motor vehicle was involved in an accident and the insurance
assessors considered it a write-off. A cheque for £3,200 was received in December from the
insurers in full settlement. Another vehicle was purchased on 5 January 2012 at a cost of
£18,500.

The depreciation policy of Swallow is to charge a full year’s depreciation in the year of purchase
and none in the year of disposal, and to depreciate fixtures and fittings on a straight-line basis
and vehicles by 25% reducing balance.

Required:

i. Show the appropriate extracts for non-current assets from Swallow’s statement of financial
position and income statement for the years ended 30 September 2011 and 2012.
(4 marks)

ii. Comment briefly on the relative merits of the straight line and reducing balance methods
of depreciation. (2 marks)

(b) Required:

Explain the objective of published financial statements and identify the two principal
characteristics of financial statements which contribute to achieving this objective.
(6 marks)

(c) Required:

In the context of cost-volume-profit analysis explain the meaning, and give an example of each
of the following terms:

i. Non-linear variable costs

ii. Stepped fixed costs
iii. Relevant range (6 marks)

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(d) Kestrel Ltd manufactures a single product which sells at £1.20 per unit. The variable cost of this
product is 60p per unit. At present the fixed expenses of the company are £30,000 p.a. Kestrel
is currently selling its full productive capacity of 100,000 units p.a. at what the company’s
directors believe is the optimum price-volume relationship for the product. However, they are
considering selling the product under an additional brand name. While being virtually identical
from the manufacturing point of view, brands will be differentiated by the packaging and the
marketing approaches adopted. Sales of the existing and the new brand when both are priced at
90p per unit are expected to total 250,000 units.

The introduction of the additional brand will require the company to increase its productive
capacity. To do this will increase Kestrel’s fixed costs to £60,000 p.a. However, as this will
involve some re-equipment, there will be economies of operation arising which will reduce
variable costs to 50p per unit.

Required:

i. For both the existing and the proposed scheme, calculate:

• Break-even point (in units)
• Profit at predicted sales volume
• Margin of safety (in %age terms) (3 marks)

ii. If the existing profit is the minimum target calculate the following for the proposed
scheme:
• Sales volume at predicted sales price
• Sales price at predicted sales volume (2 marks)

iii. Discuss whether the proposed scheme should be accepted by the company. (2 marks)

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SECTION B

Answer question 2 from this section, and one further question from either Section B or C
2. The following is the trial balance of Nightingale Ltd as at 30 April 2011:

£ £
100,000 equity shares of £1 each 100,000
50,000 7% preference shares of 50p each 25,000
Land & Buildings, at valuation 240,000
Accumulated depreciation: Buildings 13,100
Plant & Equipment, at cost 13,000
Accumulated depreciation: Plant & Equipment 3,900
Inventory 9,400
Trade receivables 11,200
Trade payables 8,300
Bank overdraft 7,800
Purchases 49,700
Sales 135,900
Administrative expenses 28,400
Distribution costs 11,700
Interest on debentures 1,200
10% Debentures 24,000
Investments (current assets) 8,000
Provision for bad debts 910
Share premium 35,000
General reserve 10,200
Interim dividend paid on equity shares 3,250
Bed debts written off 700
Revaluation reserve 9,860
Retained earnings 2,580
_______ ______
376,550 376,550
The following additonal information is available:
1. Inventory at 30 April 2011 is valued at £13,480.
2. Administrative expenses of £1,150 were prepaid on 30 April 2011.
3. Depreciation on buildings is to be provided at a rate of 15% per annum on the carrying value of
£80,000 and the plant and equipment should be depreciated to result in a net book value of £7,800
on 30 April 2011. Depreciation is to be included in administrative expenses.
4. The provision for bad debts is to be adjusted to 10% of the trade receivables at the period end. Bad
debts and changes to the provision are to be treated as administrative expenses.
5. The corporation tax on this year’s profit of £6,370 is to be provided for.
6. The preference share dividends are outstanding at the period end (30 April 2011) and the last half
year’s interest on the debentures has not been paid.
7. The directors propose to declare a final dividend on the equity shares of 13 pence per share and
transfer £2,500 to general reserves.
8. The account policies of Nightingale Ltd include the following:
• Preference shares are to be treated as a non-current liability and the preference dividend as a
finance cost.
• Equity dividends are only accounted for when paid and are shown as part of the changes in
equity.
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Required:

(a) Prepare the following for Nightingale Ltd:

i. An Income Statement for the year ended 30 April 2011. (9 marks)
ii. A Statement of Changes in Equity for the year ended 30 April 2011 (5 marks)
iii. A Statement of Financial Position as at 30 April 2011. (8 marks)

(b) Briefly explain why a company might choose to revalue its land and buildings and the
accounting implications of a revaluation. (3 marks)

3. The statement of financial position of Lapwing plc for the year ended 31 December 2011, together
with comparative figures for the previous year, is shown below:

2011 2010
£’000 £’000
ASSETS
Non-current assets
Property, plant & equipment – cost 270 180
Accumulated depreciation (90) (56)
180 124
Current assets
Inventory 50 42
Trade receivables 40 33
Cash - 11
90 86
Total assets 270 210

EQUITY AND LIABILITIES

Equity
Equity share capital £1 shares 25 20
Share premium 10 8
Retained earnings 93 81
Total equity 128 109

Non-current liabilities
15% debentures repayable 2015 80 60

Current liabilities
Trade and operating payables 33 24
Current tax payable 19 17
Bank overdraft 10 -
Total current liabilities 62 41
Total liabilities 142 101
Total equity and liabilities 270 210

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Additional information:

1. Plant had been sold during the year for £15,000 with a loss on disposal of £5,000.
The cost of the plant sold was £27,000.
2. The company declared a final dividend of £26,000 for 2011 (2010 was £28,000).
This is paid immediately after the AGM that takes place after the year end.
The company did not pay any interim dividends.
3. New debentures and shares issued in 2011 were issued on 1 January.
4. The taxation liability at each year end is settled in full in the following year.

Required:

(a) Calculate the operating profit of Lapwing plc for the year ended 31 December 2011.
(3 marks)

(b) Prepare a statement of cash flows for the year ended 31 December 2011 using the indirect
method for showing net cash flow from operations. (18 marks)

(c) Explain the direct method of arriving at the net cash flow from operations and give one argument
in favour of each of the direct and indirect methods. (4 marks)

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4. Osprey plc is a family-owned clothes manufacturer. For a number of years the chairman and
managing director was David Bird. During his period of office, sales revenue had grown steadily at a
rate of 2 to 3 per cent each year. David Bird retired on 30 November 2011 and was succeeded by his
son Simon. Soon after taking office, Simon decided to expand the business. Within weeks he had
successfully negotiated a five-year contract with a large clothes retailer to make a range of sports and
leisurewear items. The contract will result in an additional £2m in sales revenue during each year of
the contract. To fulfill the contract, Osprey Ltd acquired new equipment and premises.

Financial information concerning the business is given below.

Income statements for the year ended 30 November

2011 2012
£000 £000
Revenue 9,482 11,365
Operating profit 914 1,042
Interest charges (22) (81)
Profit before taxation 892 961
Taxation (358) (386)
Profit for the year 534 575

Statement of Financial Position

2011 2012
£000 £000
Non-current assets
Property, plant and equipment (cost less depreciation)
Premises 5,240 7,360
Plant and equipment 2,375 4,057
7,615 11,417
Current assets
Inventories 2,386 3,420
Trade receivables 2,540 4,280
4,926 7,700
Total assets 12,541 19,117
Equity
Share capital 2,000 2,000
Reserves 7,813 8,268
9,813 10,268
Non-current liabilities
Borrowing – loans 1,220 3,675
Current liabilities
Trade payables 1,157 2,245
Taxation 179 193
Short-term borrowing (all bank overdraft) 172 2,736
1,508 5,174
Total equity and liabilities 12,541 19,117

Dividends of £120,000 were paid on ordinary shares in respect of each of the two years.

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Required:

(a) Calculate for Osprey Ltd, for both years the following ratios (to one place of decimals):

i. Operating profit margin

ii. Net profit margin (after taxation)
iii. Asset Turnover ratio
iv. Return on capital employed
v. Current ratio
vi. Quick Assets ratio
vii. Receivables Collection period
viii. Gearing ratio (debt to capital employed) (16 marks)

(b) Using the above ratios, and any other ratios or information you consider relevant, comment on
the results of the expansion programme. (9 marks)

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SECTION C

Answer one question from this section, and one further question from either Section B or C

5. Hoopoe Ltd makes two products in one of its factories. The products comprise different mixes of two
basic raw materials. One grade of direct labour is employed in the mixing process and another grade
in final packaging.

Standard (budgeted) direct material and direct labour costs for the two products in the year ended 31
March 2012 were:

Product Y Product Z
(£ per hundred (£ per hundred
units) units)
Direct materials:
Raw material A 156.00 78.00
Raw material B 54.00 72.00

Direct labour:
Manufacturing 11.25 11.25
Packaging 20.00 20.00

The direct material included in the budget is after taking into account a standard loss of material A in
the process.
The standard purchase prices of the raw materials and standard direct labour rates in the year ended 31
March 2012 were:

Raw material A £5.20 per kilo

Raw material B £1.80 per kilo
Manufacturing labour £4.50 per hour
Packaging labour £4.00 per hour

Management is preparing the budgets for the year ended 31 March 2013 and have decided to make the
following changes to the 2012 figures:

• Standard material loss on raw material A of 10% of input, rather than the existing standard loss
of 12.5%, is to be included.
• Increases in raw material purchase prices and labour rates, of 5% and 8% respectively, are to
be incorporated in the new standards for the following period.

The budgeted sales for the year ended 31 March 2013 for Products Y and Z is as follows:

Product Y 1,700,000 units

Product Z 950,000 units

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Stocks of raw materials and finished goods are budgeted as follows for the year ended 31 March 2013:

Opening stocks Closing stocks

Raw material A (kilos) 40,000 25,000
Raw material B (kilos) 95,000 90,000
Product Y (units) 190,000 200,000
Product Z (units) 150,000 125,000

Required:

(a) Calculate, and show in as much detail as possible, the standard direct material and direct labour
costs (per hundred units) for the year ended 31 March 2013. (12 marks)

(b) Establish the budgets for the year ended 31 March 2013 for:

i. production of each product (units)

ii. purchases of material B (kilos and £)
iii. manufacturing labour (hours). (13 marks)

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6. Heron Electronics Ltd is an established company which has continued to be profitable in recent years
despite operating at below full capacity. Continued investment in research and development has
produced a new innovative product, the microwave drier.

(1) Market research supports the proposed price of £400 per drier with the following predicted sales
over the next five years:

Year Unit Sales

1 20,000
2 30,000
3 35,000
4 42,000
5 40,000

(2) The company accountant has collated the following costing information relating to the drier
proposal:

£000’s
Research and Development Costs incurred to date 200
Additional pre-production development costs 800
Capital cost of production machinery 6,700
Resale value of machinery after 5 years 300

(3) Due to the additional manufacturing and selling activity Heron’s working capital requirements
will increase by £200,000 at the start of the project, with further increases at the start of each
subsequent year as follows: start of year 2, £200,000; start of year 3, £300,000; start of year 4,
£400,000; start of year 5, £500,000. This additional working capital is assumed to be recovered
at the end of year 5.

(4) Costings per unit/per annum:

£ per drier £000s
Per annum
Manufacturing Costs
Direct Labour 75
Direct Materials 75
Variable Overheads 75
Depreciation of Machinery 1,280
Amortisation of R&D costs 200
Other fixed costs (Note 1) 1,200
Selling and Distribution Costs
Variable 25
Fixed (Note 2) 300

Note 1 To increase output above 38,000 driers, shift working will be introduced and annual
fixed manufacturing costs will rise by £600,000.
Note 2 Annual fixed selling and distribution costs will increase by £100,000 for sales to
exceed 33,000 driers and a further £100,000 for sales to exceed 38,000 driers.

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(5) The accountant has specifically excluded all costs relating to the factory unit in which the new
machinery will be installed and operated. She explains that this unit is on a short lease which
has only 7 years left to run and Heron pays £1,500,000 per annum rental. There is no prospect
of Heron using this unit unless the current project is accepted. Whilst Heron has not been using
this unit, part of it has been sub-let to a neighbouring company for use as a warehouse at a
monthly rent of £100,000. This arrangement could continue until the lease expires. If the drier
project goes ahead Heron can initially share the unit but the rental income will fall to £50,000
per month. Once output exceeds 30,000 units Heron will need additional packing and storage
space, so rent will be reduced to £25,000 per month. If output exceeds 38,000 driers Heron will
need the whole factory unit.

(6) Heron normally ignores tax and inflation when considering such capital assessments and uses a
discount rate of 12%.

Required:

(a) Prepare a table which shows the total contribution and all other relevant cash flows for each of
the five years of the project. (16 marks)

(b) Calculate the net present value and payback period for the project. (4 marks)

(c) Briefly outline the strengths and weaknesses of the investment appraisal methods used in (b).
(5 marks)

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7. Dunnock Ltd manufactures a single product, a laminated kitchen unit, which has a standard cost of
£80 made up as follows:

Direct material 15sq metres @ £3 per sq m £45

Direct labour 5 hours @ £4 per hour £20
Variable overheads 5 hours @ £2 per hour £10
Fixed overheads £5
£80

• Variable overheads are charged on a direct labour hour rate.

• The standard selling price of the kitchen is £100.
• The month budget projects production and sales of 1,000 units.
• Actual figures for the month of April are as follows:
Sales 1,400 units @ £102
Production 1,400 units
Direct materials 22,000 sq metres @ £4 per sq m
Direct labour 6,800 hours @ £5
Variable overheads £11,000
Fixed overheads £6,000
There are no inventories of materials at the beginning or end of the period.

Required:

(a) Prepare a report, showing all appropriate variances, which reconciles actual profit with budgeted
profit. (You should calculate only a spending variance for fixed overhead.) (15 marks)

(b) Write a commentary for management on the information shown in your report. (10 marks)

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Present value of £1
P

%
R 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

%
" 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

Annuity of £1
% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

END OF PAPER

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This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON AC1025 ZB

(279 0025)

BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route

Principles of Accounting

Monday, 14 May 2012 : 2.30pm to 5.45pm

Candidates should answer FOUR of the following SEVEN questions: QUESTION 1 of

Section A, QUESTION 2 of Section B, ONE question from Section C and ONE further
question from either Section B or C. All questions carry equal marks.

Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.

Extracts from compound interest tables are given after the final question on this paper.

8-column accounting paper is provided at the end of this question paper. If used, it must be
detached and fastened securely inside the answer book.

A calculator may be used when answering questions on this paper and it must comply in all
respects with the specification given with your Admission Notice. The make and type of
machine must be clearly stated on the front cover of the answer book.

© University of London 2012

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SECTION A

Answer question 1 from this section.

1. (a) Required:

Explain the objective of published financial statements and identify the two principal
characteristics financial statements which contribute to achieving this objective. (6 marks)

(b) The following data show the trading transactions of Othello Ltd for its first six months of
trading. The company operates the weighted average assumption for calculation of cost of sales.
Closing inventory and the cost of sales is calculated whenever a sale is made.

(1) 2011 Purchases Sales

July 40 units at £1,000 each
August 80 units at £ 900 each
September 50 units at £1,500
October 40 units at £1,100 each
November 20 units at £ 700 each
December 20 units at £1,200 each 90 units at £1,700

The December sale occurred before the purchase in that month.

(2) The 20 units purchased in November incurred a transport charge of £2,500 to move them to
the company premises. This amount is not included in the cost of £700 per unit.

(3) The 20 units purchased in December had been made to order for a customer who has now
gone into liquidation. Othello Ltd can only sell these for a price of £1,000 per unit after a
modification costing £150 per unit.

(4) Operating expenses for the six months amounted to 10% of sales revenue.

Required:

Prepare the Income Statement for Othello Ltd for the six months to 31st December 2011 from the
above information. (6 marks)

(c) Required:

Outline the main purposes and benefits of budgeting. (6 marks)

Question continues on following page.

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(d) Cordelia plc manufactures three spice mixes for catering firms: Mild, Spicy and Hot. The
selling price and the variable costs per unit for each product are as follows:

Mild Spicy Hot

£ £ £
Selling price 30 40 60
Variable cost
Spice A 10 23 25
Spice B 10 5 15

Spice B is in short supply and this year Cordelia is only able to purchase 240,000 kilos at £5 per
kilo. Spice A is plentiful.
The marketing manager predicts that the maximum demand for each product for the year will be:

Units
Mild 80,000
Spicy 16,000
Hot 30,000

The fixed costs for the year are estimated at £300,000.

Required:

i. Calculate, using a contribution based approach, the mix of sales which would enable
Cordelia to maximise profits and the resulting profit for the year. (6 marks)

ii. What technique could be used to determine the optimal mix if Spice A was also in short
supply? (1 mark)

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SECTION B

Answer question 2 from this section, and one further question from either Section B or C.

2. Macbeth plc prepares its financial statements for the year ended 31 March. The company has
extracted the following trial balance at 31 March 2012:

£000 £000
6% Loan notes (redeemable 2016) 10,250
Trade payables 8,120
Trade receivables 9,930
Accumulated depreciation at 31 March 2011:
Plant & Equipment 6,460
Vehicles 1,670
Administrative expenses 16,141
Bank 456
Purchases returns 106
Distribution costs 9,060
Dividends paid 5,800
Dividends received 850
Equity shares, 20p each, fully paid 19,000
Interest paid on 6% loan notes 615
Inventories 4,852
Investments,non-current 15,000
Plant & equipment, at cost 27,315
Proceeds from issue of share capital 1,500
Provision for doubtful debts at 31 March 2011 600
Purchases 94,160
Retained earnings at 31 March 2011 14,677
Sales 124,900
Taxation 4
Vehicles, at cost 5,720
________ _______
£188,593 £188,593

The following further information is available:

(1) Non-current assets are to be depreciated as follows:

Plant & equipment 20% per annum straight-line
Vehicles 25% per annum reducing balance

(2) An invoice for telephone charges for the quarter ended 1 May 2012 for £15,000 was received by
the company after the above trial balance was extracted. Telephone expenses are included in
administrative expenses.

(3) The company paid £156,000 insurance premiums for the year 1 November 2011 to 30 October
2012. This amount is included in administrative expenses.

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(4) The closing inventory at 31 March 2012 was £5,180,000.

(5) Subsequent to drawing up the trial balance, the company has been informed that a major
customer owing £348,000 has gone into administration, and Macbeth plc will receive only 25%
of the amount owing. Macbeth plc has also decided to change its provision for doubtful debts to
5% of the remainder of receivables balances.

(6) Tax due for the year to 31 March 2012 is estimated at £30,000. The taxation balance in the trial
balance relates to an overestimate of the tax charge in the year ended 31 March 2011.

(7) On 1 October 2011, Macbeth plc issued 5,000,000 equity shares at 30p each. The proceeds were
credited to the ‘Proceeds from the issue of share capital account’.

(8) The final dividend for the year ended 31 March 2011 of 4p per share was paid in August 2011
and an interim dividend for the year ended 31 March 2012 of 2p per share was paid in November
2011. The final 2012 dividend is proposed at 5p per share. Macbeth plc shows dividends paid
in the Statement of Changes in Equity and does not provide for final dividends.

Required:

(a) Prepare Macbeth plc’s (£000s to one place of decimals):

i. Income Statement for the year ended 31 March 2012. (10 marks)
ii. Statement of Changes in Equity for the year ended 31 March 2012. (4 marks)
iii. Statement of Financial Position at 31 March 2012. (8 marks)

(b) Mrs MacDuff has owned 1,000 Ordinary Shares in Macbeth plc for a number of years. She has
asked you to clarify the following in respect of the dividend income on her shares:

• What was the amount of dividends she should have received in the year ended 31 March
2012?
• If the share price is 200p what was the dividend yield for the year ended 31 March 2012?

Prepare a note which answers her questions. (3 marks)

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3. Falstaff plc’s statements of financial position for the years ended 31 December 2011 and 2010 are
shown below:

Statements of financial position at 31 December

2011 2010
£000 £000 £000 £000
Non-current assets
Property
Cost 2,100 1,725
Accumulated depreciation 700 555
1,400 1,170
Fixtures and fittings
Cost 1,900 1,493
Accumulated depreciation 1,060 840
840 653
2,240 1,823
Current assets
Inventory 620 435
Accounts receivable 290 255
910 690
Total assets £ 3,150 £ 2,513

Equity
Ordinary share capital 1,800 1,500
Share premium 250 -
Accumulated profits 282 187
2,332 1,687
Non-current liabilities
8% debentures 450 360

Current liabilities
Bank 70 222
Accounts payable 248 176
Taxation 50 68
368 466
Total equity and liabilities £ 3,150 £ 2,513

Income Statement extract for the year ended 31 December 2011

£000
Profit before tax 265
Tax 90
Profit for the year £ 175

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The following information is also relevant:

(1) During 2011 the company sold fixtures and fittings, which had originally cost £250,000, for
£30,000. At the date of sale these assets had accumulated depreciation of £204,000.

(2) Further 8% debentures were issued on 1 October 2011. All interest due on the debentures had
been paid up to 31 December 2011.

Required:

(a) Using three examples to illustrate your answer, discuss the difference between a statement of
cash flows and an income statement. (7 marks)

(b) Calculate the following figures, and explain in which part of the statement of cash flows they
would appear:

i. Interest paid
ii. Profit or loss on the disposal of non-current assets
iii. Taxation paid
iv. Payments to acquire non-current assets
v. Change in accounts receivable
vi. Dividends paid (18 marks)

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4. Duncan plc operates a mobile phone network for personal and business customers. The latest annual
report has just been released on the company’s website. The annual report includes the following:

Duncan plc – Extract from the Financial Review for the year ended 31 December 2011.

Highlights for the year:

• A review of operating and administrative systems resulted in investment in non-current assets
with a significant reduction in staffing levels.
• Growth has been offset by competitive pricing due to strong competition.
• Average revenue per personal customer per month (2011= £10.56, 2010= £11.20) has been
affected by increased regulatory pressures on the pricing of mobile phone tariffs.
• Customers registered during 2011 have increased by 7% (2010: 3%).
• £10 million has been spent in 2011 on new advertising and sports sponsorship to boost brand
awareness.

Duncan plc – Income Statement for the year ended 31 December 2011

2011 2010
£m £m
Revenue 2,695 2,610
Cost of sales (1,295) (1,495)
Gross profit 1,400 1,115
Selling and distribution costs (190) (215)
Administrative expenses (150) (145)
______ ______
Profit from operations 1,060 755
Finance costs (75) (80)
Profit before taxation 985 675
Tax (395) (230)
Profit for the year 590 445

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Duncan plc – Statement of Financial Position at 31 December 2011

2011 2010
£m £m £m £m
ASSETS
Non-current assets
Property, plant and equipment 2,500 1,530
Intangibles 4,615 5,390
7,115 6,920
Current assets
Inventories 15 95
Trade receivables 460 450
Cash and cash equivalents 620 190
1,095 735
Total assets 8,210 7,655

EQUITY & LIABILITIES

Equity
Issued capital – 50p ordinary shares 1,335 1,330
Share premium 2,600 2,590
Other reserves 270 235
Retained earnings 1,015 790
Equity 5,220 4,945
Non-current liabilities
Borrowings 2,080 2,050

Current liabilities
Trade payables 565 350
Taxation and other liabilities 345 310
910 660
Total equity and liabilities 8,210 7,655

Required:

(a) Compute the following accounting ratios (to one place of decimals) for Duncan plc for 2010 and
2011.

• Return on Capital Employed

• Net profit margin
• Asset Turnover ratio
• Gross profit margin
• Current Ratio
• Quick Ratio
• Gearing (Debt to Capital Employed)
• Earnings per share
• PE Ratio (Assume relevant share prices for 2011 of £3.09 and for 2010 of £2.00)
(12 marks)

(b) Evaluate, using the ratios calculated above and the other information provided, the financial
performance and financial position of Duncan plc. (13 marks)

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SECTION C

Answer one question from this section, and one further question from either Section B or C

5. Ophelia plc operates a chain of furniture stores and is considering its strategy on distribution and
transport. The present position is that distribution is out-sourced to a transport company. The
expected cost for the year ended 30 June 2013 is £250,000. This cost, it is projected, will rise by 10%
per annum over the next five years.

The Directors of Ophelia plc are considering an alternative strategy of acquiring a company owned
and managed transport fleet. The initial cost of the transport fleet on 1 July 2012 would be £750,000
and it is estimated that the fleet would be sold at the end of year 2017 for £150,000.
It is estimated that the following costs would be incurred over the next five years:

Drivers’ Repairs and Other

Year ended Costs Maintenance Costs
30th June £ £ £
2013 33,000 8,000 230,000
2014 35,000 13,000 235,000
2015 36,000 15,000 240,000
2016 38,000 16,000 236,000
2017 40,000 18,000 242,000

The figure for ‘Other Costs’ includes depreciation on the fleet on the straight-line basis. The head
office administration costs of Ophelia plc are expected to be £300,000 per annum and the running of
the fleet would take up approximately 10% of the administrative time. However, the finance director
believes that there is sufficient spare capacity in the head office to carry out the additional work.
You can assume that the fleet will be paid for at the beginning of the project and all income and
expenditure would be incurred at the end of each relevant year.
The project manager for the new fleet also believes that the vehicles will not be fully utilised on
company business and she estimates that the spare capacity could be used for sub-contract work which
would generate £50,000 per annum.
To raise funds for the project the company proposes to raise a loan at 12% interest rate per annum.
You are told that there is an alternative project that could be invested in using the fund raised.
The projected results of the alternative project are:
Payback = 3 years
Net Present Value = £140,000
As funds are limited, investment can only be made in one project.

Required:

(a) Prepare a table showing the incremental cash flows to Ophelia plc for each year over the life of
the transport fleet. (10 marks)

(b) Calculate the following for the transport fleet project:

i. Payback period
ii. Net Present Value (6 marks)

(c) State and explain your recommendations to Ophelia plc in respect of the Transport fleet project.
(5 marks)

(d) Explain the term Internal Rate of Return and why it would not be appropriate to use it as a
decision model in the above example. (4 marks)

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6. Portia Ltd is a specialist manufacturer of components for luxury yachts. A contract has been offered
to Portia by Nerrisa Supermarine plc for the supply over the next twelve months of 400 identical
components, ZK44.

The data relating to the production of each component ZK44 is as follows:

(1) Material requirements:

3 kg material M1 – see note (i) below.
2 kg material P2 – see note (ii) below
1 part No. 678 – see note (iii) below.

Note (i) Material M1 is in continuous use by the company. 1,000 kg are currently held in
stock at a book value of £4.70 per kg but it is known that future purchases will cost £5.50
per kg.

Note (ii) 1,200 kg of material P2 are held in stock. The original cost of this material was
£4.30 per kg but, as the material has not been required for the last two years, it has been
written down to £1.50 per kg scrap value. The only foreseeable alternative use is as a
substitute for material P4 (in current use) but this would involve further processing costs of
£1.60 per kg. The current cost of material P4 is £3.60 per kg.

Note (iii) It is estimated that Part No. 678 could be bought for £50 each.

(2) Labour requirements: Each component would require five hours of skilled labour and five hours
of semi-skilled. An employee possessing the necessary skills is available and is currently paid
£5 per hour. A replacement would, however, have to be obtained at a rate of £4 per hour for the
work which would otherwise be done by the skilled employee. The current rate for semi-skilled
work is £3 per hour and an additional employee could be appointed for this work.

(3) Overhead: Portia Ltd absorbs overhead by a machine hour rate, currently £20 per hour of which
£7 is for variable overhead and £13 for fixed overhead. If this contract is undertaken it is
estimated that fixed costs will increase for the duration of the contract by £3,200. Spare machine
capacity is available and each component would require four machine hours.

Nerrisa Supermarine plc, one of a small number of companies who manufacture luxury yachts, has
offered a price of £145 per component ZK44. The global recession has particularly affected the luxury
yacht market.

Required:

(a) State whether or not the contract should be accepted and support your conclusion with
appropriate figures for presentation to management. Your analysis should explain in full the
figures you have used. (16 marks)

(b) Comment briefly on three factors which management should consider before making a final
decision on the contract. (9 marks)

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7. Cymbeline Ltd manufactures a single product. The company has two production departments, 1 and
2, and a service department. The following are the variable costs per product unit for April:

Direct materials £7.00

Direct labour £5.50
Manufacturing overhead £2.00

The selling price of the product is £36.00 per unit. Fixed manufacturing costs are budgeted to be
£1,340,000 for April. Fixed selling costs are budgeted to be £875,000. Fixed manufacturing costs can
be analysed between the departments as follows:

Production Production Service

1 2 Department
£380,000 £465,000 £265,000

In addition there are budgeted general factory fixed costs of £230,000, these represent space costs, for
example, lighting and heating. Space utilization is as follows:

Production department 1 40%

Production department 2 50%
Service department 10%

In allocating the service department costs it is assumed that 60% of service department costs are
labour related and the remaining 40% machine related.

Normal production department activity is:

Direct labour hours Machine hours Production units

Department 1 80,000 2,400 120,000
Department 2 100,000 2,400 120,000

Fixed manufacturing overheads are absorbed at a predetermined rate per unit of production for each
production department, based upon normal activity.

Costs for the period were as per budget, except for additional expenditure of £20,000 on fixed
manufacturing overhead in Production Department 1. Production and sales were 116,000 and 114,000
units respectively for the period.

Required:

(a) Calculate the budgeted fixed overhead absorption rate per unit and the budgeted total
manufacturing cost per unit for April. (8 marks)

(b) Prepare a profit statement for April using the full absorption costing system described above and
showing each element of cost separately. (10 marks)

(c) Prepare a profit statement for April using marginal costing principles. (7 marks)

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Present value of £1
P

%
R 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

%
" 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

Annuity of £1
% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

END OF PAPER

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Examiners’ commentaries 2012

Examiners’ commentaries 2012

AC1025 Principles of accounting

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2011–12. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

Information about the subject guide

Unless otherwise stated, all cross-references will be to the latest version
of the subject guide (2012).

General remarks

Learning outcomes
At the end of this course, and having completed the Essential reading and
activities, you should be able to:
• distinguish between different uses of accounting information and relate
these uses to the needs of different groups of users
• explain the limitations of such statements and their analysis
• categorise cost behaviour, and prepare and contrast inventory
valuations under different costing methods
• describe the budgeting process and discuss the use of budgets in
planning and control
• explain, discuss and apply relevant techniques to aid internal users in
decision-making.

What the Examiners are looking for

The examination paper covers a range of financial and management
accounting topics, all of which the well-prepared candidate will have
studied. The questions are designed to encourage candidates to think
about the theories and principles of accounting and to demonstrate their
ability to apply relevant concepts in a variety of situations or to a given
set of information. Where appropriate, questions are sub-divided to help
candidates answer in a logical manner. The examination will always
include questions designed to test candidates’ ability in interpretation and
analysis of financial information.
The rubric of the examination paper is set out on the front cover and
you should ensure that you precisely follow these instructions. It is very
important that you do not waste time and effort in answering more
questions than required, as marks will only be awarded to the correct
number of questions. You are advised to read all of the questions before
deciding which to answer in each section. Time allocation is an important
factor in accounting examinations. You should decide how much time to
spend on each question, based on the overall marks for the question and
for each section, and should then adhere to these time allocations. The
1

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AC1025 Principles of accounting

format of the examination requires you to answer question 1 of Section A,

which is in four parts. It is important that you allocate your time on this
question so that you attempt all of the four parts. You are then required
to answer question 2 of Section B, and two further questions, one from
Section C and one from either Sections B or C. Please note that failure
to comply with these requirements may result in some of your work not
being marked.
The rubric of the examination states that workings must be submitted
for all questions requiring calculations. The importance of this cannot be
overstated as, in the absence of workings, simple arithmetic errors cannot
be distinguished from errors of principle and understanding. Thus the
absence of workings will very often lead to an over-penalisation of errors.
Of course, arithmetic errors may, in some instances, result in some loss
of marks and you should always be careful to check your calculations.
The rubric also states that any necessary assumptions introduced into
answering a question should be stated. If you do not understand what a
question is asking (a circumstance the Examiners endeavour to avoid),
then you must state any consequent assumptions that you have made.
Even if you do not answer in precisely the way the Examiners had hoped,
you may get a good mark – providing your assumptions are reasonable.
The most frequent reason for failing to do well in the examination, apart
from lack of knowledge, is not answering the question actually set. You
should take time to read each question carefully, and then attempt to
answer everything that the Examiners require. Far too many candidates
include every scrap of knowledge they have on a topic without specifically
addressing the question and this can have a disastrous effect on their
marks. Read the question carefully and tailor your answer to precisely
what it asks and you should do well.
Accounting is a progressive subject where it is essential to understand
a particular topic before you go on to the next. Make sure that you
understand the basic concepts and can apply them in an appropriate
manner so that there is a logical structure to your answers. Do not write
something that you do not understand for, if you do, you are likely to
produce a muddled response. In answering computational questions,
think carefully about the layout and logical progression of your answer
before writing and set out your answer in a structured and easily readable
format. You will be rewarded for an appropriate, logical and sensible
method, even if the figures contain errors. The subject guide and textbook
contain numerous worked examples, which you should have studied
carefully, and practice questions with solutions, which should form a key
part of your study and revision.
You will find 8-column accounting paper is incorporated into the answer
booklet. It may be particularly useful where tables of figures are required
because it keeps answers neat and saves ruling lines for different columns.
You are strongly advised to practise using it while you are preparing
answers as part of your study of accounting. A sheet is available to
download from the AC1025 page on the VLE and you can print off as
many sheets of the paper as you need.
This subject does not require a lot of reading beyond the core text
of Perks, R. and D. Leiwy Accounting: understanding and practice.
(Maidenhead: McGraw-Hill, 2010) third edition [ISBN 9780077124786],
but it is essential that you adopt an approach of thorough study, plenty
of practice answering questions and an ability and willingness to think
logically.

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Examiners’ commentaries 2012

All major topics are covered at the appropriate level in the recommended
text by Perks and Leiwy and others are covered in the subject guide.
References presented in the ‘Comments on specific questions’ for Zone
A and Zone B indicate where certain topics may be found in the current
edition of the subject guide (2012), which is an essential part of the study
material for this course. You are also encouraged to read the financial
press, including accounting journals and listen to, or watch, financial
programmes and visit appropriate websites. This will enable you to keep
abreast of current issues and help you to develop your ideas and opinions
about them.

Question spotting
Many candidates are disappointed to find that their examination
performance is poorer than they expected. This can be due to a number
of different reasons and the Examiners’ commentaries suggest ways
of addressing common problems and improving your performance.
We want to draw your attention to one particular failing – ‘question
spotting’, that is, confining your examination preparation to a few
question topics which have come up in past papers for the course. This
can have very serious consequences.
We recognise that candidates may not cover all topics in the syllabus in
the same depth, but you need to be aware that Examiners are free to
set questions on any aspect of the syllabus. This means that you need
to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the Course information sheet in the
section of the VLE dedicated to this course. You should read the
syllabus very carefully and ensure that you cover sufficient material in
preparation for the examination.
Examiners will vary the topics and questions from year to year and
may well set questions that have not appeared in past papers – every
topic on the syllabus is a legitimate examination target. So although
past papers can be helpful in revision, you cannot assume that topics
or specific questions that have come up in past examinations will occur
again.

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AC1025 Principles of accounting

Examiners’ commentaries 2012

AC1025 Principles of accounting – Zone A

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2011–12. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

Information about the subject guide

Unless otherwise stated, all cross-references will be to the latest version
of the subject guide (2012).

Comments on specific questions

Candidates should answer FOUR of the following SEVEN questions: QUESTION
1 of Section A, QUESTION 2 of Section B, ONE question from Section C and ONE
further question from either Section B or C. All questions carry equal marks.

Section A
Answer Question 1 from this section.

Question 1
(a) Swallow commenced business on 1st October 2010 purchasing fixtures
and fittings for £25,000 and a motor vehicle for £16,000. The fixtures and
fittings were estimated to have a useful life of 8 years and a residual value
of £1,800. Further fittings were purchased on 1 November 2011 for £15,200
with nil residual value and a useful life of 8 years.
During December 2011 the motor vehicle was involved in an accident and
the insurance assessors considered it a write-off. A cheque for £3,200 was
received in December from the insurers in full settlement. Another vehicle
was purchased on 5 January 2012 at a cost of £18,500.
The depreciation policy of Swallow is to charge a full year’s depreciation
in the year of purchase and none in the year of disposal, and to depreciate
fixtures and fittings on a straight-line basis and vehicles by 25% reducing
balance….
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide, Chapter 4.
Perks, R. and D. Leiwy Accounting: understanding and practice. (Maidenhead:
McGraw-Hill, 2010) third edition [ISBN 9780077124786] Chapter 1.
Approaching the question
One of the key aims of this course is to be able to apply financial
accounting techniques and concepts to a set of data. Depreciation
is a key accounting concept. Part (ii) requires a discussion of the
advantages and disadvantages of the two methods of depreciation.

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Examiners’ commentaries 2012

Swallow – Income statement for year ended 30th September

i.
2011 2012
£ £
Depreciation 6,900 9,425
Loss on disposal of vehicle – 8,800

Statement of financial position at 30 September

2011 2012
Non-current assets £ £
Cost 41,000 58,700
Accumulated depreciation 6,900 *12,325
*(2900 + 4800 + 4625) 34,100 46,375

Workings

Fixtures Vehicles
y/e 30.09.11 £ £
Purchases 25,000 16,000
Depreciation (25%) ( 4,000)
(25,000 – 1,800) ÷ 8 (2,900) _______
22,100 12,000
y/e 30.9.12
Proceeds 3,200
Loss 8,800

Purchases 15,200 18,500

Depreciation (25%) (4,625)
2,900 + (15,200 ÷ 8) (4,800) ______
32,500 13,875

ii.
The pros of using the straight line method are that it is easier to
understand and the computations are simpler than other methods.
Also it gives the same charge for depreciation in each year of the
asset’s life which means that this method is more appropriate for assets
which are depleted as a result of the passage of time such as buildings
and patents. However, the cons are that it may not give an accurate
measure of the loss in value or reduction in the useful economic life of
an asset.
The pros of the reducing balance method are that it gives a decreasing
annual charge for depreciation over the useful life of an asset. This
means that it is more appropriate for assets which deteriorate primarily
as a result of usage where this is greater in the earlier years of their
life such as plant and machinery and motor vehicles. It is also said to
provide a more realistic measure of the reduction in the market value
of non-current assets. However, the cons of using this method are that
the computations are more complex and difficult to understand.

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AC1025 Principles of accounting

(b) Required:
Explain the objective of published financial statements and identify the two
principal characteristics of financial statements which contribute to achieving
this objective. (6 marks)
Reading for this question
Subject guide Chapter 1.
Perks and Leiwy (2010) Chapter 3.
Approaching the question
Understanding of the objectives and characteristics of financial statements
is a fundamental conceptual underpinning to this course. Answers which
discuss the content of financial statements (income, assets, etc.) or the
format (income statement, cash flow statements, etc.) do not address the
issue raised in the question.
Answers should explain that the objective of financial statements is to
provide information that users (investors, lenders and creditors) need in
making decisions about the reporting entity.
The two principal (qualitative) characteristics of financial statements
are relevance and faithful representation (or reliability). Good answers
will explain the predictive and confirmatory value of relevance, and the
comparability and understandability of faithful representation.
(c) Required:
In the context of cost-volume-profit (CVP) analysis explain the meaning, and
give an example of each of the following terms:
i. Non-linear variable costs
ii. Stepped fixed costs
iii. Relevant range (6 marks)
Reading for this question
Subject guide Chapter 10.
Perks and Leiwy (2010) Chapter 15.
Approaching the question
This question tests candidates’ ability to explain the three terms used in
cost-volume-profit (CVP) analysis. An example of each of the terms should
be used to demonstrate the meaning and application of the terms.
i. Non-linear variable costs vary with volume of activity but with a cost
per unit which is different for different levels of activity.
Example Direct material where there are discounts available for
larger orders.
ii. Stepped fixed costs are those which do not vary with volume of activity
between two levels of activity but which, at the higher level, will
require an extra resource.
Example Rental of storage facility which has a maximum capacity
after which a new facility will have to be rented.
iii. The relevant range is the range of outputs over which the assumption
that a cost-volume relationship is a linear relationship is realistic.
Example A firm may determine variable and fixed costs which will be
realistic between 10,000 and 15,000 units; outside of this range these
costs will no longer behave in the assumed linear fashion.

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Examiners’ commentaries 2012

(d) Kestrel Ltd manufactures a single product which sells at £1.20 per unit. The
variable cost of this product is 60p per unit. At present the fixed expenses of
the company are £30,000 p.a. Kestrel is currently selling its full productive
capacity of 100,000 units p.a. at what the company’s directors believe is
the optimum price-volume relationship for the product. However, they are
considering selling the product under an additional brand name. While
being virtually identical from the manufacturing point of view, brands will
be differentiated by the packaging and the marketing approaches adopted.
Sales of the existing and the new brand when both are priced at 90p per unit
are expected to total 250,000 units.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 10.
Perks and Leiwy (2010) Chapter 15.
Approaching the question
A key learning outcome of this course is to apply decision-making
techniques using accounting information. This question requires basic
calculations of information which would be useful to a company in
deciding between two schemes. Answers should show understanding of
the techniques and an ability to assess the information and draw reasoned
conclusions.

i. Existing Proposed scheme

• BEP 30,000 60,000 = 150,000
50,000 units
1.20 – 0.6 0.9 – 0.5

• Profit
(0.6  100,000) – 30,000 = £30,000
(0.4  250,000) – 60,000 = £40,000

• Margin of safety 50,000 units 100,000 units

= 50% = 40%

ii. Existing profit level = £30,000

Sales volume at predicted sales price 225,000
= 60,000 + 30,000 =
0.4
Sales price at predicted volume
Cost = 60,000 + 30,000 = 36p
250,000
Price = 36 + 50 = 86p
iii. The proposed scheme
• gives 33% increase in profits if predictions are achieved

• has a higher break-even point but if predicted sales are achieved, a similar unit
margin of safety – but in percentage terms it is riskier
• if the scheme is adopted the level of sales needed to at least achieve current
profits is 90% of predicted levels
• Or, sales price can be dropped from 90p to 86p.

Overall the proposed scheme seems to give reasonably low risk with higher profits.

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Section B
Answer Question 2 from this section, and one further question from either
Section B or C

Question 2
The following is the trial balance of Nightingale Ltd as at 30 April 2011:

£ £
100,000 equity shares of £1 each 100,000
50,000 7% preference shares of 50p each 25,000
Land and buildings, at valuation 240,000
Accumulated depreciation: Buildings 13,100
Plant and equipment, at cost 13,000
Accumulated depreciation: Plant and equipment 3,900
Inventory 9,400
Trade receivables 11,200
Trade payables 8,300
Bank overdraft 7,800
Purchases 49,700
Sales 135,900
Administrative expenses 28,400
Distribution costs 11,700
Interest on debentures 1,200
10% debentures 24,000
Investments (current assets) 8,000
Provision for bad debts 910
Share premium 35,000
General reserve 10,200
Interim dividend paid on equity shares 3,250
Bed debts written off 700
Revaluation reserve 9,860
Retained earnings 2,580
_______ ______
376,550 376,550
The following additonal information is available:
(1) Inventory at 30 April 2011 is valued at £13,480.
(2) Administrative expenses of £1,150 were prepaid on 30 April 2011.
(3) Depreciation on buildings is to be provided at a rate of 15% per annum
on the carrying value of £80,000 and the plant and equipment should
be depreciated to result in a net book value of £7,800 on 30 April 2011.
Depreciation is to be included in administrative expenses.
(4) The provision for bad debts is to be adjusted to 10% of the trade receivables
at the period end. Bad debts and changes to the provision are to be treated
as administrative expenses.

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(5) The corporation tax on this year’s profit of £6,370 is to be provided for.
(6) The preference share dividends are outstanding at the period end (30 April
2011) and the last half year’s interest on the debentures has not been paid.
(7) The directors propose to declare a final dividend on the equity shares of 13
pence per share and transfer £2,500 to general reserves.
(8) The account policies of Nightingale Ltd include the following:
• Preference shares are to be treated as a non-current liability and the
preference dividend as a finance cost.
• Equity dividends are only accounted for when paid and are shown as part
of the changes in equity.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapters 5 and 6.
Perks and Leiwy (2010) Chapter 18.
Approaching the question
The preparation of final accounts from structured information is a key
learning outcome. A trial balance with several adjusting items has been
the format for the compulsory question over recent years. In answering
this type of question a methodical and organised approach is needed. It
is very important that detailed, legible workings are given in order that
marks are awarded for all work which is correct. If figures in the final
accounts comprise a number of items, marks will be awarded accordingly.
Without workings one error may result in several marks being lost. The
workings may be shown on the face of the accounts or separately but
candidates should try and help the Examiners to award all appropriate
marks by clear presentations. The 8-column accounting paper provided
is particularly useful for presenting the financial statements. You should
pay attention to the presentation of your answer, taking care to use
the appropriate descriptions of line items in the income statement and
statement of financial position. The format of the Statement of Changes in
Equity should follow best practice.
(a)
i. Income statement for the year ended 30 April 2011

£
Sales revenue 135,900
Cost of sales [W1] (45,620)
Gross profit 90,280
Distribution costs (11,700)
Administrative expenses [W2] (41,460)
Profit before Interest and Tax 37,120
Finance costs [W6] (4,150)
Profit before tax 32,970
Taxation (6,370)
Profit for the year 26,600

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ii. Statement of changes in equity for the year ended 30 April 2011
Share Share Revaluation General Retained Total
capital premium reserve reserve earnings
£ £ £ £ £ £
Balance at 1/5/10 100,000 35,000 9,860 10,200 2,580 157,640
Changes in equity:
Equity dividends paid (3,250)
(3,250)
Total income (profit) 26,600
26,600
Transfer 2,500 (2,500)
Balance at 30/4/11 100,000 35,000 9,860 12.700 23,430 180,990

iii. Statement of financial position as at 30 April 2011

£ £ £
ASSETS
Non-current assets:
Land and buildings 240,000 25,100 214,900
Fixtures and fittings 13,000 5,200 7,800
253,000 30,300 222,700
Current assets:
Inventory 13,480
Trade debtors
Less: provision for doubtful debts 11,200 10,080
Prepayments (1,120) 1,150
Investments 8,000
Total assets 255,410

EQUITY AND LIABILITIES

Non-current liabilities:
10% debentures 24,000
50,000 7% preference shares 25,000
Total non-current liabilities 49,000
Current liabilities:
Bank overdraft 7,800
Trade creditors 8,300
Accrued tax 6,370
Accrued debenture interest 1,200
Preference dividend 1,750
Total current liabilities 25,420
Total liabilities: 74,420
Equity
100,000
Share capital
80,990
Reserves
180,990
Total equity and liabilities 255,410
Presentation

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(b)
Answers should include the following:
• Land and buildings might have historical cost figures which do not
bear much relationship to market value. In order to provide a more
relevant statement of financial position a recalculation might be
considered.
• The revaluation might not have a large impact on income as the
depreciation on land and buildings is likely to be relatively small.
• A revaluation results in a gain which is accounted for as follows:
• DR Asset account
• CR Revaluation reserve
• The revaluation reserve is not distributable so will not lead to higher
dividend payments.
Workings
[W1] Cost of sales:
£
Opening inventory 9,400
Add: Purchases 49,700
Less: Closing inventory (13,480)
45,620
[W2] Administrative expenses:
TB (less prepaid of £1,150) 27,250
Depreciation of buildings [W3] 12,000
Depreciation of P and E [W4] 1,300
Provision for doubtful debts [W5] 210
Bad debts 700
41,460
[W3] Depreciation of buildings:
15%  £80,000 = £12,000

[W4] Depreciation of plant and equipment:

Opening NBV is £(13,000 – 3,900) = £9,100
Closing valuation is £7,800
Depreciation for year: £(9,100 – 7,800) = £1,300

[W5] Provision for doubtful debts:

Opening debtors* 11,200
Provision @ 10% 1,120
Existing provision (910)
Increase in provision 210
Bad debt of £700 already accounting for since in TB.

[W6] Finance costs:

£
Interest on debentures: £24,000  10% = 2,400
Preference dividend: £25,000  7% = 1,750
4,150

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Question 3
The statement of financial position of Lapwing plc for the year ended 31
December 2011, together with comparative figures for the previous year, is
shown below:
2011 2010
£’000 £’000
ASSETS
Non-current assets
Property, plant and equipment – cost 270 180
Accumulated depreciation (90) (56)
180 124
Current assets
Inventory 50 42
Trade receivables 40 33
Cash – 11
90 86
Total assets 270 210

EQUITY AND LIABILITIES

Equity
Equity share capital £1 shares 25 20
Share premium 10 8
Retained earnings 93 81
Total equity 128 109

Non-current liabilities
15% debentures repayable 2015 80 60

Current liabilities
Trade and operating payables 33 24
Current tax payable 19 17
Bank overdraft 10 –
Total current liabilities 62 41
Total liabilities 142 101
Total equity and liabilities 270 210
Additional information:
(1) Plant had been sold during the year for £15,000 with a loss on disposal of
£5,000. The cost of the plant sold was £27,000.
(2) The company declared a final dividend of £26,000 for 2011 (2010 was
£28,000).This is paid immediately after the AGM that takes place after the
year end.The company did not pay any interim dividends.
(3) New debentures and shares issued in 2011 were issued on 1 January.
(4) The taxation liability at each year end is settled in full in the following year.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 6.
Perks and Leiwy (2010) Chapter 6.
Approaching the question
This question requires preparation of a cash flow statement (CFS). You
should adopt a systematic approach which will enable you to extract the
cash flows from the accruals based income statement and statement of
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financial position. The resulting increase or decrease in cash balances

should be reconciled to the relevant figures in the statement of financial
position. Good answers will be well presented, correctly describing the
component cash flows with well laid out workings. In 2012 part (c) was
often not attempted and candidates should remember to attempt all
sections of the questions in the paper.
(a) Computation of operating profit
£’000
Increase in retained earnings (93–81) 12
Dividends 28
Taxation 19
Operating profit 59

(b) Lapwing plc

Statement of cash flows for the year ended 31 December 2011
Cash flows from operating activities £’000 £’000
Profit before taxation 59
Depreciation charges 41
Loss on disposal 5
Loan interest (15%  £800,000) 12
Operating profit before working capital changes 117
Increase in trade receivables (7)
Increase in inventories (8)
Increase in trade payables 9
Cash generated from operations 111
Interest paid (12)
Taxation (17)
Net cash from operating activities 82
Cash flows from investing activities
Sale of property, plant and equipment 15
Payments to acquire property, plant and equipment (117)
Net cash from investing activities (102)
Cash flows from financing
Issue of debentures 20
Issue of equity share capital 7
Equity dividends paid (28)
Net cash used in financing activities (1)
Decrease in cash and cash equivalents (21)
Net cash and cash equivalents at 12 January 2011 11
Net cash and cash equivalents at 31 December 2011 (10)

Statement of cash and cash equivalents

2010 Cash flow 2011
£’000 £’000 £’000
Cash at bank 11 (11) –
Overdraft – (10) (10)
Total cash and cash equivalents 11 (21) (10)

(c) A statement of cash flows presented under the direct method shows
operating cash receipts and payments (including, in particular,
cash receipts from customers, cash payments to suppliers and cash
payments to and on behalf of employees), aggregating to the net cash
flow from operating activities.

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The direct method shows actual inflows and outflows of activities.

The indirect method shows users can assess quality of earnings by
referring to reconciliation of earnings/cash flows.
Workings
Cost A/c Depn
1. PPE
As at 2010 180 56
Disposal (27) (7)
Additions (B/F) 117
Depreciation (B/F) ___ 41
As at 2011 270 90

Question 4
Osprey plc is a family-owned clothes manufacturer. For a number of years the
chairman and managing director was David Bird. During his period of office,
sales revenue had grown steadily at a rate of two to three per cent each year.
David Bird retired on 30 November 2011 and was succeeded by his son Simon.
Soon after taking office, Simon decided to expand the business. Within weeks
he had successfully negotiated a five-year contract with a large clothes retailer
to make a range of sports and leisurewear items. The contract will result in an
additional £2m in sales revenue during each year of the contract. To fulfill the
contract, Osprey Ltd acquired new equipment and premises.
Financial information concerning the business is given below.
Income statements for the year ended 30 November
2011 2012
£000 £000
Revenue 9,482 11,365
Operating profit 914 1,042
Interest charges (22) (81)
Profit before taxation 892 961
Taxation (358) (386)
Profit for the year 534 575
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 7.
Perks and Leiwy (2010) Chapters 4, 5 and 7.
Approaching the question
The learning outcomes for Chapter 7 of the subject guide include the
ability to analyse, interpret and communicate the information contained
in financial statements. The most common analytical technique is
often testing by a mini-case study of the type used in this question. It
is important that answers go beyond simply stating that a particular
ratio has gone up or down; the interpretation should use the contextual
information given in the question and make links between different ratios.
Good answers will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspectives of the lenders and
shareholders.

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You should carefully read the requirements of the question which, in this
case, specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case study
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
Osprey plc
(a)
2011 2012
i. Operating profit margin
914  100
9.6%
9482

1042  100 9.2%

11365

ii. Net profit margin

534  100 5.6%
9482

5.1%
575  100
11365

iii. Asset turnover

9482 0.86 x
12541 – 1508

11365 0.81 x
19117 – 5174

iv. ROCE
914  100 8.28%
11033

1042  100 7.47%

13943

v. Current ratio
4926
1508 3.3 : 1

7700 1.5 : 1
5174

vi. Quick assets

4926 – 2386
1508
1.7 : 1

7700 – 3420 0.8 : 1

5174

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vii. Receivables collection period

2540  365 98 days
9482

4280  365 137 days

11365

viii. Gearing
1120  100
11033 11.1%

3675  100 26.4%

13943

(b) The operating and net profit margins were slightly lower in 2012 than
in 2011. Although there was an increase in sales revenue in 2012, this
could not prevent a slight fall in return on capital employed (ROCE) in
that year. The lower operating margin and increases in sales revenue
may well be due to the new contract. The capital employed by the
company increased in 2012 by a larger percentage than the increase in
revenue. Hence, the sales revenue to capital employed ratio decreased
over the period. The increase in capital during 2012 is largely due to
an increase in borrowing. However, the gearing ratio is probably still
low in comparison with other businesses. Comparison of the premises
and borrowing figures indicates possible unused borrowing (debt)
capacity.
The major cause for concern has been the dramatic decline in liquidity
during 2012. The current ratio has decreased by more than half during
the period. There has also been a similar decrease in the quick assets
ratio. The balance sheet shows that the business now has a large
overdraft and the trade payables outstanding have nearly doubled in
2012.
The trade receivables outstanding and inventories have increased
much more than appears to be warranted by the increase in sales
revenue. This may be due to the terms of the contract that has been
negotiated and may be difficult to influence. If this is the case, the
business should consider whether it is overtrading. If the conclusion is
that it is, increasing its long-term funding may be a sensible policy.

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Section C
Answer one question from this section, and one further question from either
Section B or C

Question 5
Hoopoe Ltd makes two products in one of its factories. The products comprise
different mixes of two basic raw materials. One grade of direct labour is
employed in the mixing process and another grade in final packaging.
Standard (budgeted) direct material and direct labour costs for the two products
in the year ended 31 March 2012 were:
Product Y Product Z
(£ per hundred units) (£ per hundred units)
Direct materials:
Raw material A 156.00 78.00
Raw material B 54.00 72.00

Direct labour:
Manufacturing 11.25 11.25
Packaging 20.00 20.00

The direct material included in the budget is after taking into account a standard
loss of material A in the process.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 13.
Perks and Leiwy (2010) Chapter 13.
Approaching the question
The preparation of budgets is a key learning outcome of Chapter 13 of
the course. This question provided a relatively complex scenario which
required a logical and well structured approach to extracting the figures
and preparing the budgets.
(a) Product Y Product Z
£ £
Standards for 31/3/13
Direct materials:
A: 29.333 kg (2) at £5.46 per kg 160.16
14.667 kg (3) at £5.46 kg 80.08
B: 30 kg at £1.89 per kg 56.70
40 kg at £1.89 per kg 75.60
Direct labour:
Mixing (2.5 hours at £4.86) 12.15 12.15
Packaging (5 hours at £4.32) 21.60 21.60

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Notes:
1. Standards for 31/3/12
Direct materials:
A: 30 kg at £5.20 per kg
15 kg at £5.20 per kg 156.00
B: 30 kg at £1.80 per kg 78.00
40 kg at £1.80 per kg 54.00
Direct labour: 72.00
Mixing (2.5 hours at £4.50)
Packaging (5 hours at £4) 11.25 11.25
2. X- Revised input for material A = 30  (1.10/1.125) = 29.333 20.00 20.00
3. Y- Revised input for material A = 15  (1.10/1.125) =14.667

(b) i. Production budget: Product Y (units) Product Z (units)

Sales 1,700,000 950,000
Add closing stock 200,000 125,000
1,900,000 1,075,000
Less closing stock 190,000 150,000
Production 1,710,000 925,000

Kilos
ii. Material B purchases budget:
Required for production:
Product Y:
1,710,000 units at 30 kg per hundred 513,000
Product Z:
925,000 units at 40 kg per hundred 370,000
883,000
Add: Closing stock 90,000
Less: Opening stock (95,000)
Required purchases 878,000
Required purchase cost = £ 1,659,420

iii. Mixing labour budget:

Total production:
Product Y 1,710,000
Product Z 925,000
2,635,000 units
at 2.5 hours per hundred
= 65,875 hours

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Question 6
Heron Electronics Ltd is an established company which has continued to be
profitable in recent years despite operating at below full capacity. Continued
investment in research and development has produced a new innovative
product, the microwave drier.
(1) Market research supports the proposed price of £400 per drier with the
following predicted sales over the next five years:
Year Unit sales
1 20,000
2 30,000
3 35,000
4 42,000
5 40,000
(2) The company accountant has collated the following costing information
relating to the drier proposal:
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 12.
Perks and Leiwy (2010) Chapter 12.
Approaching the question
The application of capital investment techniques is an important element
of the syllabus and the learning outcomes for Chapter 12 of the subject
guide. The most effective approach to Part (a) is to construct a columnar
table in which relevant cash flows can be inserted. It is important to give
workings of all figures and to explain clearly treatment of all amounts, for
example if a cost is to be treated as sunk and therefore not included as a
relevant cost this should be stated. Having determined the net cash flow
for each year, these are discounted using the discount factors taken from
the tables provided. Thus a net present value and payback can be arrived
at and a decision recommended and justified. This type of question
requires use of a significant amount of data and it is very important
that your work is clearly presented and that all workings are legible and
understandable. The 8-column accounting paper can help in this respect.
A suggested presentation of the answer is given below.
Part (b) was a fairly straightforward comparison of the strengths and
weaknesses of NPV and Payback methods.

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(a) Relevant cash flows and calculation of NPV

[Note that the £200,000 R&D is a sunk cost and therefore irrelevant.]

All figures in £’000

Year 0 1 2 3 4 5
R&D and capital (7,500) – – – – 300
Working capital (200) (200) (300) (400) (500) 1,600

Fixed costs (manuf) – (1,200) (1,200) (1,200) (1,800) (1,800)

Fixed costs (S&D) – (300) (300) (400) (500) (500)

Lost rents – (600) (600) (900) (1,200) (1,200)

Contribution _____ 3,000 4,500 5,250 6,300 6,000

Net Cash Flow (7,700) 700 2,100 2,350 2,300 4,400

(b) 12% PV Factor 1 0.893 0.797 0.712 0.636 0.567

NPV (7,700) 625.1 1673.7 1673.2 1462.8 2494.8

Overall NPV = £230,000

Payback is just over 4 years

Alternative answer
If the original fixed costs (M, S and D) were not treated as relevant
costs and only the changes at the higher output levels were included
then the cash flows increase by £1,500k for each of the years 2–5; this
gives a NPV of £5,637,100 and a payback of two and a half years.
Working 1
Calculation of contribution per drier
£ £
Selling price 400
Direct labour 75
Direct material 75
Variable manuf. overheads 75
Variable S & D costs 25 (250)
Contribution 150 per drier

(c) The strengths and weaknesses of the two investment appraisal

methods are outlined below. Although payback is generally thought to
be a weaker technique overall, it may be of relevance to Heron because
of their liquidity problems.
The strengths of payback are:
• simple to calculate and understand
• favours early cash receipts
• minimises time related risks
• informative if there are liquidity problems.
The weaknesses of payback are:
• ignores cash flows after payback period
• ignores timing of cash flows even before payback
• not an absolute measure (poor for tanking projects of different size)

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The strengths of NPV are:

• takes into account time value of money
• money sooner is better than money later because of:
1. Real Interest Rate (or opportunity cost).
2. Inflation
3. Risk
(1 and 2 are included in money interest rates)
• considers all cash flows and the whole life of the project
• an absolute measure (therefore good for ranking projects).
The weaknesses of NPV are:
• more complicated to calculate and understand
• may give impression of ‘accurate figures’ but only as good as the
estimates of relevant cash flows
• has a long term view but does not consider liquidity and is not
popular with managers who are assessed by short term performance
measures.

Question 7
Dunnock Ltd manufactures a single product, a laminated kitchen unit, which has
a standard cost of £80 made up as follows:
Direct material 15sq metres @ £3 per sq m £45
Direct labour 5 hours @ £4 per hour £20
Variable overheads 5 hours @ £2 per hour £10
Fixed overheads £5
£80
• Variable overheads are charged on a direct labour hour rate.
• The standard selling price of the kitchen is £100.
• The month budget projects production and sales of 1,000 units.
• Actual figures for the month of April are as follows:
Sales 1,400 units @ £102
Production 1,400 units
Direct materials 22,000 sq metres @ £4 per sq m
Direct labour 6,800 hours @ £5
Variable overheads £11,000
Fixed overheads £6,000
There are no inventories of materials at the beginning or end of the period.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 14.
Perks and Leiwy (2010) Chapter 16.
Approaching the question
This is a question which tests candidates’ ability to apply standard costing,
budgeting and variance analysis to a given set of data. Your answer
should set out clearly all of your workings and cross-refer these to the
final operating statement and relevant variances. It is important that you
identify variances as either favourable or adverse (unfavourable). These

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techniques are clearly demonstrated by examples in the subject guide and

you should be prepared to apply them in questions at this level.
Part (b) tests your understanding of the variances and their
interpretations. Good answers will provide a well-explained commentary
for management.
(a)
Report on kitchen unit sales and production for April
£
Budgeted profit 20,000
Sales variances – Price 2,800 F
Volume 10,000 F
32,800

Cost variances Fav Adv

Materials – Price (22,000)
– Efficiency (3,000)
Labour – Price (6,800)
– Efficiency 800
V. overhead – Price 2,600
– Efficiency 400
F. overhead – Spending _____ (1,000)
3,800 32,800 (29,000)
Actual profit 3,800
(b) Commentary
• Overall budgeted profits of £20,000 have not been achieved due
principally to material cost overruns.
• Sales volume has increased even after a 2p increase in sales price.
If costs had been on target, a profit of £32,800 could have been
achieved.
• Materials suffered a large price rise and management should
investigate the cause of this; for example, have we changed
supplier, purchased better quality or is this a result of a market price
increase?
• Material usage was also worse than budget (which may mean better
quality of material is unlikely). Management should investigate
wastage and production processes.
• Labour rates have increased. This could be due to higher skilled
staff mix, bonus schemes, overtime or a response to higher market
rates.
• The efficiency of labour is better than anticipated; this could be due
to higher skilled employees or production process efficiencies. The
amount is relatively small compared to other cost variances.
• Variable overheads have cost less than anticipated. An analysis of
the components would reveal where the reductions have occurred.
The efficiency savings will relate to the labour efficiency referred to
above.
• Fixed overheads have increased and management should
investigate the components of this cost.

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Workings
1. Budgeted and actual figures – April
Original budget Flexed budget Actual
Materials 45,000 63,000 88,000
Labour 20,000 28,000 34,000
Variable overhead 10,000 14,000 11,000
Fixed overhead 5,000 5,000 6,000
80,000 110,000 139,000
Sales 100,000 140,000 142,800
Profit 20,000 30,000 3,800

2. Variances
Sales price
(AQ  AP) – (AQ SP)
(1400 102) – (1400 100) = 2,800 F

Sales volume
30,000 – 20,000 =10,000 F
Materials price
(AQ AP) – (AQ SP)
(22,000 4) – (22,000 3) = 22,000 A

Materials efficiency
(AQ SP) – (SQ SP)
(22,000  3) – (21,000  3) = 3,000 A

Labour price
(AQ AP) – (AQ SP)
(6,800 5) – (6,800 4) = 6,800 A

Labour efficiency
(AQ SP) – (SQ SP)
(6,800 4) – (7,000 4) = 800 F

Variable overhead price

(AQ AP) – (AQ SP)
(11,000) – (6,800 2) = 2,600 F

Variable overhead efficiency

(AQ SP) – (SQ SP)
(6,800 2) – (7,000 2) = 400 F

Fixed overhead – spending 1000 A

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Examiners’ commentaries 2012

AC1025 Principles of accounting – Zone B

Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 2011–12. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).

Information about the subject guide

Unless otherwise stated, all cross-references will be to the latest version
of the subject guide (2012).

Comments on specific questions

Candidates should answer FOUR of the following SEVEN questions: QUESTION
1 of Section A, QUESTION 2 of Section B, ONE question from Section C and ONE
further question from either Section B or C. All questions carry equal marks.

Section A
Answer Question 1 from this section.

Question 1
(a) Required:
Explain the objective of published financial statements and identify the two
principal characteristics of financial statements which contribute to achieving
this objective. (6 marks)
Reading for this question
Subject guide, Chapter 1.
Perks, R. and D. Leiwy Accounting: understanding and practice. (Maidenhead:
McGraw-Hill, 2010) third edition [ISBN 9780077124786] Chapter 3.
Approaching the question
Understanding of the objectives and characteristics of financial statements
is a fundamental conceptual underpinning to this course. Answers which
discuss the content of financial statements (income, assets, etc.) or the
format (income statement, cash flow statements, etc.) do not address the
issue raised in the question.
Answers should explain that the objective of financial statements provide
information that users (investors, lenders and creditors) need in making
decisions about the reporting entity.
The two principal (qualitative) characteristics of financial statements
are relevance and faithful representation (or reliability). Good answers
will explain the predictive and confirmatory value of relevance, and the
comparability and understandability of faithful representation.

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(b) The following data show the trading transactions of Othello Ltd for its
first six months of trading. The company operates the weighted average
assumption for calculation of cost of sales. Closing inventory and the cost of
sales is calculated whenever a sale is made.
(1) 2011 Purchases Sales
July 40 units at £1,000 each
August 80 units at £ 900 each
September 50 units at £1,500
October 40 units at £1,100 each
November 20 units at £ 700 each
December 20 units at £1,200 each 90 units at £1,700
The December sale occurred before the purchase in that month.
(2)The 20 units purchased in November incurred a transport charge of
£2,500 to move them to the company premises. This amount is not
included in the cost of £700 per unit.
(3)The 20 units purchased in December had been made to order for a
customer who has now gone into liquidation. Othello Ltd can only sell
these for a price of £1,000 per unit after a modification costing £150
per unit.
(4)Operating expenses for the six months amounted to 10% of sales
revenue.
Required:
Prepare the Income Statement for Othello Ltd for the six months to 31st
December 2011 from the above information. (6 marks)
Reading for this question
Subject guide Chapter 4.
Perks and Leiwy (2010) Chapters 1 and 2.
Approaching the question
The learning outcomes in Chapter 9 require candidates to be able to
prepare and contrast stock valuations under different costing methods.
This question tests the use of one method. It is important to set out the
statements and calculations in a clear and organised manner. The most
common failures were the incorrect treatment of the transport costs and
using a periodic valuation rather than, as the question required, using a
transaction-based valuation.
Othello Ltd
Income Statement for the six months to 31 December 2011
£ £
Sales 228,000
Purchases (196,500)
Less: Closing inventory 55,718 (140,782)
________
Gross profit 87,218
Operating expenses (10%  228,000) (22,800)
Operating profit 64,418

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Workings
1. Purchases
Cost 194,000
Transport costs 2,500
196,500
2. Inventory valuation Units Cost
At 31 August 120 112,000
Sale (50) (46,667)
70 65,333
Purchases (October – November) 60 60,500*
130 125,833
Sale (90) (87,115)
40 38,718
December (NRV) 20 17,000
60 55,718

3. Net Realisable Value

Sale price 1,000
Less: costs 150
850
20 units = 17,000
(c) Required:
Outline the main purposes and benefits of budgeting. (6 marks)
Reading for this question
Subject guide Chapter 13.
Perks and Leiwy (2010) Chapter 13.
Approaching the question
A key learning outcome is to understand the role of budgetary control in
organisations. This is a straightforward test of this knowledge. Candidates
should not spend time in detailed explanation of the techniques of
budgeting but concentrate on the requirement to outline the purposes and
benefits of budgeting.
The main purposes and benefits of budgeting are:
• Planning and anticipation. Management are forced to think ahead
and plan for future eventualities. Regular budget-setting and review
procedures also lead to regular examination of the organisation’s goals
and decisions.
• Communication and coordination. Preparation of budgets
encourages communication between different parts of the organisation
and different levels of management. A cohesive budget allows activities
to be coordinated. For example, the production department needs to
know how much the sales department is planning to sell in order to set
its target for production.
• Motivation. Budgets and standard costs provide targets and, as such,
can motivate staff to achieve them, especially if staff are rewarded on
the basis of meeting budget (e.g. in the form of a bonus). The simple
presence of a target of any kind can often improve performance.
However, care must be taken to ensure that the target is set at an
appropriate level.

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• Authorisation and responsibility. Managers know that budgeted

expenditure has been authorised and can act accordingly. Setting
individual budget for particular business activities or departments can
be used to assign responsibility to individual managers for meeting
those budgets.
• Evaluation and control. Budgets provide plans against which
subsequent performance can be judged. Management monitor and
evaluate whether budgets are fulfilled. Management performance can
also be assessed and rewarded on this basis.
(d) Cordelia plc manufactures three spice mixes for catering firms: Mild, Spicy
and Hot. The selling price and the variable costs per unit for each product are
as follows:
Mild Spicy Hot
£ £ £
Selling price 30 40 60
Variable cost
Spice A 10 23 25
Spice B 10 5 15
Spice B is in short supply and this year Cordelia is only able to purchase
240,000 kilos at £5 per kilo. Spice A is plentiful.
The marketing manager predicts that the maximum demand for each product
for the year will be:
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 10.
Perks and Leiwy (2010) Chapter 15.
Approaching the question
A key learning outcome of this course is to explain and apply decision-
making techniques using accounting information. This question tests your
understanding of contribution analysis and limiting factors. It is important
that answers calculate the contribution per unit of limiting factor in
reaching the optimum mix of products. Answers to part (ii) need to be
specific in identifying an appropriate technique.
i. • Contribution per unit of Spice B
Mild Spicy Hot
Sales price 30 40 60
Variable cost (20) (28) (40)
10 12 20
Spice B – input (k) 2 1 3

Contribution per kilo of Spice B 5 12 6.67

• Optimum mix is: Product units Kilos of Spice A

Spicy 16,000 16,000
Hot 30,000 90,000
Mild 67,000 134,000
240,000

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• Operating profits
Profit Spicy 16,000  12 = 192,000
Hot 30,000  20 = 600,000
Mild 67,000  10 = 670,000
1,462,000
Fixed costs 300,000
Profit for year 1,162,000

ii. This situation gives multiple limiting factors and can only be resolved
using linear programming.

Section B
Answer Question 2 from this section, and one further question from either
Section B or C.

Question 2
Macbeth plc prepares its financial statements for the year ended 31 March. The
company has extracted the following trial balance at 31 March 2012:
£000 £000
6% Loan notes (redeemable 2016) 10,250
Trade payables 8,120
Trade receivables 9,930
Accumulated depreciation at 31 March 2011:
Plant and equipment 6,460
Vehicles 1,670
Administrative expenses 16,141
Bank 456
Purchases returns 106
Distribution costs 9,060
Dividends paid 5,800
Dividends received 850
Equity shares, 20p each, fully paid 19,000
Interest paid on 6% loan notes 615
Inventories 4,852
Investments, non-current 15,000
Plant and equipment, at cost 27,315
Proceeds from issue of share capital 1,500
Provision for doubtful debts at 31 March 2011 600
Purchases 94,160
Retained earnings at 31 March 2011 14,677
Sales 124,900
Taxation 4
Vehicles, at cost 5,720
________ _______
£188,593 £188,593
The following further information is available:
(1) Non-current assets are to be depreciated as follows:
Plant and equipment 20% per annum straight-line
Vehicles 25% per annum reducing balance

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(2) An invoice for telephone charges for the quarter ended 1 May 2012 for
£15,000 was received by the company after the above trial balance was
extracted. Telephone expenses are included in administrative expenses.
(3) The company paid £156,000 insurance premiums for the year 1 November
2011 to 30 October 2012. This amount is included in administrative expenses.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapters 5 and 6.
Perks and Leiwy (2010) Chapter 17.
Approaching the question
The preparation of final accounts from structured information is a key
learning outcome. A trial balance with several adjusting items has been
the format for the compulsory question over recent years. In answering
this type of question a methodical and organised approach is needed. It
is very important that detailed, legible workings are given in order that
marks are awarded for all work which is correct. If figures in the final
accounts comprise a number of items marks will be awarded accordingly
but without workings one error may result in several marks being lost.
The workings may be shown on the face of the accounts or separately
but candidates should try and help markers to award all appropriate
marks by clear presentations. The 8-column accounting paper provided
is particularly useful for presenting the financial statements. You should
pay attention to the presentation of your answer taking care to use
the appropriate descriptions of line items in the income statement and
statement of financial position. The format of the Statement of Changes in
Equity should follow best practice.
Part (b) of this question tests the ability to calculate and explain
the dividends a shareholder will receive and how this relates to the
information in the financial statements.
(a) Macbeth plc
i. Income statement for the year ended 31 March 2012
£000 £000
Sales 124,900
Cost of sales
Opening inventory (4,852)
Purchases (94,160 – 106) (94,054)
(98,906)
Closing inventory 5,180
(93,726)
Gross profit 31,174
Dividends received 850
32,024
Expenses
Administrative expenses 16,141 + (2/3  15) – (7/12  156) (16,060)
Distribution costs (9,060)
Bad debts 75%  348 (261)
Decrease in provision for doubtful debts [5%  (9,930 – 348)] – 600 120.9
Depreciation: Plant and equipment 20%  27,315 (5,463)
Motor vehicles 25%  (5,720 – 1,670) (1,012.5)
(31,735.6)

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Profit before interest and tax 288.4

Interest payable (615)
Loss for the year before tax (326.6)
Taxation (26.0)
352.6
ii. Macbeth plc
Statement of changes in equity for the year ended 31 March 2012
Equity share Share Retained Total
capital premium earnings
£000 £000 £000 £000
Balance at 1 April 2011 19,000 14,677 33,677
Issue of shares 1,000 500 1,500
Loss for the year (352.6) (352.6)
Dividends paid (5,800) (5,800)
Balance at 31 March 2012 20,000 500 8,524.4 29,024.4

iii. Macbeth plc

Statement of financial position at 31 March 2012
ASSETS £000 £000 £000
Non-current assets Cost Accum Deprn NBV
Plant and equipment 27,315 11,923 15,392
Motor vehicles 5,720 2,682.5 3,037.5
33,035 14,605.5 18,429.5
Investments 15,000
33,429.5
Current assets
Inventory 5,180
Trade receivable (9,930 – 261)
9,669
Less: provision for doubtful debts 9,189.9
(479.1)
Prepayments 91
14,460.9
Total assets 47,890.4

EQUITY & LIABILITIES

Equity
Equity share capital 20,000
Share premium 500
Retained earnings 8,524.4
29,024.4
Non-current liabilities
10,250
67% loan notes

Current liabilities
Bank overdraft 456
Trade payables 8,120
Accruals 10
Corporation tax 30
8,616
Total equity and liabilities 47,890.4

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(b) Information for Mrs Macduff

£
• Dividends received in 31/3/12

2011 Final dividend (1000  4p) 40

2012 Interim dividend (1000  2p) 20
60
• Dividend yield for 31/3/12

Interim (as above) 20p

2012 Final (1000  5p) 50p
70p
Yield 7  100 = 3.5%
200
Question 3
Falstaff plc’s statements of financial position for the years ended 31 December
2011 and 2010 are shown below:
Statements of financial position at 31 December
2011 2010
£000 £000 £000 £000
Non-current assets
Property
Cost 2,100 1,725
Accumulated depreciation 700 555
1,400 1,170
Fixtures and fittings
Cost 1,900 1,493
Accumulated depreciation 1,060 840
840 653
2,240 1,823
Current assets
Inventory 620 435
Accounts receivable 290 255
910 690
Total assets £ 3,150 £ 2,513

Equity
Ordinary share capital 1,800 1,500
Share premium 250 –
Accumulated profits 282 187
2,332 1,687
Non-current liabilities
8% debentures 450 360

Current liabilities
Bank 70 222
Accounts payable 248 176
Taxation 50 68
368 466
Total equity and liabilities £ 3,150 £ 2,513

[For the full question, please refer to the examination paper.]

Reading for this question
Subject guide Chapter 6.
Perks and Leiwy (2010) Chapter 6.

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Approaching the question

This question requires an understanding of how specific items are shown
in a cash flow statement (CFS) which is part of the learning outcome
which refers to the preparation of financial statements from structured
data. You should adopt a systematic approach which will enable you to
extract the cash flows from the accruals-based income statement and
statement of financial position. Good answers will be well presented,
correctly describing the component cash flows with laid out workings.
Answers which prepare a full cash flow statement would be appropriately
awarded but candidates are advised to produce only the answers required
by the rubric of the question as the marks are allocated to the amount of
time and effort required for such answers.
Part (a) tests candidates’ understanding of the difference between cash
flows and accruals based accounting. Candidates should note that three
examples are required.
(a) Income statement prepared according to accounting convention of
accruals: The accruals concept means profit is the difference between
income earned and expenses incurred – cash doesn’t have to be
received or paid for time to be recorded.
The statement of cash flows shows actual movements of cash (monies
passing through current or near-current bank accounts) as well as
cash receipts and payments and shows whether more cash has come in
than has gone out over the accounting period. Net cash flow reconciles
opening and closing bank and cash balances.
Examples could include depreciation, receivables/prepayments and
payables/accruals effect on profit, acquisition of non-current assets,
share and loan movements.
(b) i. Interest paid = 8%  [(360  9/12) + (450  3/12)] = £30,600.
This is shown in the statement of cash flows as a separate line in
operating activities.
ii. Loss on sale of non-current assets = 30 – (250 – 204) = £16,000.
This is added back to profit before tax in reconciliation of this to
cash flow from operating activities.
iii. Taxation paid = 68 + (90 – 50) = £108,000.
This is shown in statement of cash flows as a separate line in
operating activities.
iv Payments to acquire non-current assets = £1,032,000
Property = 2,100 – 1,725 = 375
F + F = 1,900 – (1,493 – 250) = 657
This is shown in statement of cash flows as a separate line in
investing activities.
v. Increase in accounts receivable = 290 – 255 = £35,000.
This is deducted from profit before tax in reconciliation of this to
cash flow from operating activities.
vi. Dividends paid = Profit for year – difference between SoFP
retained earnings
= 175 – (282 – 187)
= £80,000
This is shown in a statement of cash flows as a separate line in
financing activities but could also be shown as part of operating
cash flows.
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Question 4
Duncan plc operates a mobile phone network for personal and business
customers. The latest annual report has just been released on the company’s
website. The annual report includes the following:
Duncan plc – Extract from the financial review for the year ended 31 December
2011.
Highlights for the year:
• A review of operating and administrative systems resulted in investment
in non-current assets with a significant reduction in staffing levels.
• Growth has been offset by competitive pricing due to strong competition.
• Average revenue per personal customer per month (2011 = £10.56, 2010
= £11.20) has been affected by increased regulatory pressures on the
pricing of mobile phone tariffs.
• Customers registered during 2011 have increased by 7% (2010: 3%).
• £10 million has been spent in 2011 on new advertising and sports
sponsorship to boost brand awareness.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 7
Perks and Leiwy (2010) Chapters 4, 5 and 7.
Approaching the question
The learning outcomes for Chapter 7 of the subject guide include the
ability to analyse, interpret and communicate the information contained
in financial statements. The most common analytical technique is
often testing by a mini-case study of the type used in this question. It
is important that answers go beyond simply stating that a particular
ratio has gone up or down; the interpretation should use the contextual
information given in the question and make links between different ratios.
Good answers will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspectives of potential users.
You should carefully read the requirements of the question, which in this
case, specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case study
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
(a) 2010 2011
Return on capital employed
(755 ÷ (4945 + 2050))  100 10.8%
(985 ÷ (5220 + 2080))  100 14.5%
Net profit margin
(755 ÷ 2610)  100 28.9%
(1060 ÷ 2695)  100 39.3%
Asset turnover
2610 ÷ 6995 0.37 x
2695 ÷ 7300 0.37 x
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Gross profit margin

(1115 ÷ 2610)  100 42.7%
(1400 ÷ 2695)  100 51.9%
Current ratio
(735 : 660) 1.1 : 1
(1095 : 910) 1.2 : 1
Quick ratio
((735 – 95) : 660) 1.0 : 1
((1095 – 15) : 910) 1.2 : 1
Gearing
(2050 ÷ 6995)  100 29.3%
28.5%
(2080 ÷ 7300)  100
EPS
(445 ÷ 2660)  100 16.7p
(590 ÷ 2670)  100 22.1p
PE No.
200 ÷ 16.7 12
309 ÷ 22.1 14

(b) Commentary (summary of key points):

• ROCE – Improved return on capital employed
Increase due to improved margins with stable asset
turnover
• Net profit margin
• Significant increase
• Staffing cost savings
• Even better if take out increased marketing costs
• Selling and distribution costs reduced
• Administrative costs are similar
• Asset turnover
• Remained constant
• Increase in volume of customers but fall in revenue per customer
due to competitive pricing and regulatory pressures.
• Net asset increases but note PPE investment and fall in
intangibles.
• Gross margin
• Significant increase
• See net margin for analysis
• Current ratio
• Constant at reasonable level
• Quick ratio
• Improvement in solvency/liquidity
• Large cash balance
• But higher payables

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• EPS
• Significant improvement for reasons explained above.
• PE No.
• Market price indicates that investors are happy with the
strategies adopted by the company (If the PE had remained at
12 price would now be £2.65 rather than £3.09).

Section C
Answer ONE question from this section, and ONE further question from either
Section B or C

Question 5
Ophelia plc operates a chain of furniture stores and is considering its strategy
on distribution and transport. The present position is that distribution is out-
sourced to a transport company. The expected cost for the year ended 30 June
2013 is £250,000. This cost, it is projected, will rise by 10% per annum over the
next five years.
The Directors of Ophelia plc are considering an alternative strategy of acquiring
a company owned and managed transport fleet. The initial cost of the transport
fleet on 1 July 2012 would be £750,000 and it is estimated that the fleet would
be sold at the end of year 2017 for £150,000.
It is estimated that the following costs would be incurred over the next five
years:
Repairs and
Drivers’ costs Other costs
maintenance
Year ended 30th June
2013 33,000 8,000 230,000
2014 35,000 13,000 235,000
2015 36,000 15,000 240,000
2016 38,000 16,000 236,000
2017 40,000 18,000 242,000

The figure for ‘Other Costs’ includes depreciation on the fleet on the straight-
line basis. The head office administration costs of Ophelia plc are expected to be
£300,000 per annum and the running of the fleet would take up approximately
10% of the administrative time. However, the finance director believes that
there is sufficient spare capacity in the head office to carry out the additional
work.
[For the full question please refer to the examination paper.]
Reading for this question
Subject guide Chapter 12.
Perks and Leiwy (2010) Chapter 12.
Approaching the question
The application of capital investment techniques is an important element
of the syllabus for this course and learning outcomes for Chapter 12 of
the subject guide. The most effective approach is to construct a columnar
table in which relevant cash flows can be inserted. It is important to give
workings of all figures and to explain clearly treatment of all amounts,
for example if a cost is to be treated as sunk and therefore not included
as a relevant cost this should be stated. Having determined the net cash
flow for each year, these are discounted using the discount factors taken
from the tables provided. Thus a net present value can be arrived at and
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a decision recommended and justified. This type of question requires use

of a significant amount of data and it is very important that your work
is clearly presented and that all working are legible and understandable.
The 8-column accounting paper can help in this respect. A suggested
presentation of the answer is given below.
Part (c) gave good candidates an opportunity to show their understanding of
the decision-making process and place this into a business context.
Part (d) required an understanding of Internal Rate of Return (IRR) and the
problems in its application.
(a) Incremental cash flows – Transport Fleet Project
2012 2013 2014 2015 2016 2017
£ £ £ £ £ £
Out-source costs 250,000 275,000 302,500 332,750 366,025
Drivers costs (33,000) (35,000) (36,000) (38,000) (40,000)
Repairs and maintenance (8,000) (13,000 (15,000) (16,000) (18,000)
Other costs (110,000) (115,000) (120,000) (116,000) (122,000)
Fleet costs (750,000) 150,000
Sub-contract income 50,000 50.000 50,000 50,000 50,000
_______ _______ ______ ______ _______ _______
(750,000) 149,000 162,000 181,500 212,750 386,025

N.B. Ignore overheads

(b) i. Payback

Initial cost 750,000

Cumulative cash inflow

2013 149,000
2014 (+ 162,000) 311,000
2015 (+ 181,500) 492,500
2016 (+ 212,750) 705,250
2017 (+ 44,750) 75,000
Payback = 4 years 1.4 months.
ii. Net Present Value
CF. Discount Factor P.V.
2012 (750,000) - (750,000)
2013 149,000 0.893 133,057
2014 162,000 0.797 129,114
2015 181,500 0.721 129,228
2016 212,750 0.636 135,309
2017 386,025 0.567 218,876
Net present value (4,416)

(c) Recommendation:
• Reject the transport fleet project
• Accept the alternative project.
Answers should explain the following:
• The project has a longer payback period than the alternative.

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Examiners’ commentaries 2012

• The project has = negative NPV thus the project would reduce
shareholder wealth. The alternative has a positive NPV at discount
rate of 12%.
• Subject to reliability of assumptions.
• The project would give more control over future service and costs
whereas outsourcing would not.
(d) IRR = the discount rate at which the NPV of the project is equal to
zero. It is not appropriate for decisions involving mutually exclusive
projects.
Workings
1. Other costs
2013 2014 2015 2016 2017
Per Q 230,000 235,000 240,000 236,000 242,000

Depreciation (120,000) (120,000) (120,000) (120,000) (120,000)

20%  (750,000 – 150,000) _______ _______ _______ _______ _______
110,000 115,000 120,000 116,000 122,000

Question 6
Portia Ltd is a specialist manufacturer of components for luxury yachts. A
contract has been offered to Portia by Nerrisa Supermarine plc for the supply
over the next twelve months of 400 identical components, ZK44.
The data relating to the production of each component ZK44 is as follows:
Material requirements:
3 kg material M1 – see note (i) below.
2 kg material P2 – see note (ii) below
1 part No. 678 – see note (iii) below.
Note (i) Material M1 is in continuous use by the company. 1,000 kg are currently
held in stock at a book value of £4.70 per kg but it is known that future
purchases will cost £5.50 per kg.
[For the full question please refer the examinatin question.]
Reading for this question
Subject guide Chapter 10.
Perks and Leiwy (2010) Chapters 14 and 15.
Approaching the question
Relevant and opportunity cost recognition are key techniques in short-
term decision-making. This question tests candidates’ ability to apply
these techniques. It is important in answering such questions that
you keep in mind the basic contribution approach to the analysis and
clearly distinguish between those costs and revenues that are relevant
to the decision and those that are not. Good answers will set out the
computations in a clear, logical and coherent manner.
Candidates should note that the question required a full explanation of
the figures used in the analysis and marks were awarded as appropriate.
Part (b) requires candidates to place the calculations in the context of the
wider business considerations by identifying three appropriate factors.

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AC1025 Principles of accounting

(a) Contract for manufacture of ZK44.

Analysis of production and sale of 400 units to Nerissa Supermarine plc.
Notes £ £
Materials
M1 (1,200 kg at £5.50 1 6,600
P2 (800 kg at £2 per kg) (1) 2 1,600
Part no. 678 (400 at £50) 3 20,000 28,200

Labour:
Skilled (2,000 hours at £4 per hour) 4 8,000
Semi-skilled (2,000 hours at £3 per hour) 5 6,000 14,000

Overheads:
Variable (1,600 machine hours at £7 per hour) 6 11,200
Fixed: Incremental fixed costs 3,200

Total relevant cost 56,600

Contract price (400 components at £145 per component) 58,000

Contribution 1,400
The incremental revenues exceed the incremental costs. Therefore the
contract should be accepted subject to the comments in (b) below.
Notes:
1. Material M1 – Opportunity cost is replacement cost.
2. Material P2:
If material P2 is not used on the contract it will be used as a
substitute for material P4. Using P2 as a substitute for P4 results in
a saving of £2 (£3.60 – £1.60) per kg. Therefore the relevant cost of
P2 consists of the opportunity cost of £2 per kg.
3. Part No. 678 – actual impact cost
4. Skilled labour – opportunity cost is replacement labour cost.
5. Semi-skilled – cost of additional labour.
6. Overhead – variable overhead only is relevant.
– additional fixed overhead is an incremental cost.
(b) Factors which should be considered are:
i. Can a price higher than £145 per component be negotiated? The
contract only provides a contribution of £1,400 to general fixed
costs. If the company generates insufficient contribution from
its activities to cover general fixed costs then it will incur losses
and will not be able to survive in the long tier. It is assumed that
acceptance of the contract will not lead to the rejection of other
profitable work.
ii. Will acceptance of the contract lead to repeat orders which are
likely to provide a better contribution to general fixed costs?
iii. Acceptance of the contract will provide additional employment for
12 months and this might have a significant effect on the morale of
the workforce.
iv. If there are few manufacturers, then acceptance of the contract may
be necessary to build a client relationship.
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Examiners’ commentaries 2012

v. Given market conditions, should Portia be looking at strategies for

entering new markets?

Question 7
Cymbeline Ltd manufactures a single product. The company has two production
departments, 1 and 2, and a service department. The following are the variable
costs per product unit for April:
Direct materials £7.00
Direct labour £5.50
Manufacturing overhead £2.00
The selling price of the product is £36.00 per unit. Fixed manufacturing costs
are budgeted to be £1,340,000 for April. Fixed selling costs are budgeted to be
£875,000. Fixed manufacturing costs can be analysed between the departments
as follows:
Production Production Service
1 2 Department
£380,000 £465,000 £265,000
In addition there are budgeted general factory fixed costs of £230,000, these
represent space costs, for example, lighting and heating. Space utilisation is as
follows:
Production department 1 40%
Production department 2 50%
Service department 10%
In allocating the service department costs it is assumed that 60% of service
department costs are labour related and the remaining 40% machine related.
[For the full question please refer the examinatin question.]
Reading for this question
Subject guide Chapter 9.
Perks and Leiwy (2010) Chapter 14.
Approaching the question
The use of absorption costing is relevant to the learning outcomes of the
preparation of costs under different costing methods. Part (a) examines
the ability to apply allocation assumptions to a data set. The information
appears to be lengthy but in fact the calculations are straightforward if a
careful reading of the question is applied in a logical manner.
Parts (b) and (c) require the preparation of profit statements using full
absorption and managerial costing respectively. Again this requires a
logical and well-structured approach to well-understood concepts.

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AC1025 Principles of accounting

Prodn. Prodn. Service General Total

Dept 1 Dept 2 Dept Factory
Allocated 380.0 465.0 265 230 1,340
Allocation of general factory 92.0 (40%) 115.0 (50%) 23 (10%) (230)
Share of service department 288
Labour related costs (60&) 76.8 96.0 (10/18) (172.8)
Machine related costs (40% (8/18) 57.6 _____
57.6 (115.2)
606.4 733.6 1,340

Units of output 120 120

Overhead rate per unit 5.05 6.11 (rounded to nearest p)

(a) Calculation of total manufacturing cost per unit

£
Direct materials 7.00
Direct labour 5.50
Variable overhead 2.00
Fixed overhead: Department 1 5.05
Department 2 6.11
Manufacturing cost 25.66

(b) Absorption costing profit statement

Production cost (116,000  £25.66) 2,976,560
Less: closing stocks m (2,000  £25.66) 51,320
Cost of sales 2,925,240
Under-absorption of overhead:
Department 1 ((£20,000 + (4,000  £5.05)) 40,200
Department 2 (4,000 units  £6.11) 24,440
Non-manufacturing costs 875,000
Total cost 3,864,880
Sales (114,000  £36) 4,104,000
Net profit 239,120
Note that the under-recovery of fixed overheads consists of £20,000
arising from actual overheads exceeding estimated overheads plus 4,000
times the fixed overhead rate because actual volume was 4,000 units less
than estimated volume.

(c) Marginal costing profit statement

Variable production cost (116,000  £14.50) 1,682,000
Less: closing stocks (2,000  £14.50) 29,000
1,653,000
Fixed manufacturing overhead (1,340 + 20) 1,360,000
Non-manufacturing overhead 875,000
3,888,000
Sales 4,104,000
Net profit 216,000

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