Accounting Principles. Question Paper, Answers and Examiner s Comments

Transcription

1 Accounting Principles Question Paper, Answers and Examiner s Comments Level 3 Diploma January 2015

2 Copyright of the Chartered Institute of Credit Management January B/PQP/2 continued

3 Accounting Principles questions, answers and examiners comments Level 3 Diploma in Credit Management JANUARY 2014 Instructions to candidates Answer any FIVE questions. All questions carry equal marks. Time allowed: 3 hours All ledger accounts must be prepared in continuous balance format Final accounts must be prepared in vertical format Where appropriate, VAT is to be calculated at 20% Again there appears to be a marginal improvement on the last exam series with some very good scripts being submitted. Structure, format and presentation have certainly improved and many students display a high level of knowledge and understanding of the subject matter. This is witnessed in both the numerical and narrative questions which is an encouraging development. As indicated last time, it is important that students address the practical applications of accounting techniques, practices and conventions from a credit management perspective. At times though there are some instances of poor technique especially in the construction of the Trading and Profit and Loss account (Statement of Profit and Loss) and the Balance Sheet Statement of Financial Position). Some still are a little confused with regard to the difference between a debit and credit balance and how they are shown in the individual ledgers. Ratio analysis (especially the interpretation of the calculations) and suspense accounts continue to cause problems for a few students. Questions 1, 3 and 8 were by far the most popular, questions 5 and 6 the least, with student preferences being equally divided amongst the rest. Questions start on the next page January B/PQP/3 continued

4 1. a) What are the main reasons for organisations maintaining financial and management accounts? (4 marks) b) What information can be gleaned from the final accounts of a business that will assist the credit management in making a more informed decision? (6 marks) c) For each of the following stakeholders, identify the accounting information that will be of interest to them and why? i) Investors. (2 marks) ii) Lenders. (2 marks) iii) Employees and their representatives. (2 marks) iv) Customers. (2 marks) v) The general public. (2 marks) Question aims To test the candidate s knowledge and understanding of why organisations need to have financial and management accounts To assess the candidate s ability to identify what information can be obtained from the final accounts in helping the credit manager to make a more informed decision To identify the candidate s ability to highlight the accounting information that will be of use to internal and external stakeholders. Suggested answer a) Financial accounting is concerned with the collection and classification of historic data in order to prepare the annual financial statements of the business. These statements are prepared for users outside of the business such as owners or shareholders, prospective investors, providers of loan capital, receivables and payables and the Government. Management accounting on the other hand is about providing management with the information that it needs to carry out its functions properly for planning, control and decisionmaking. Businesses are required to keep accounting records for a number of reasons: Legal the final financial statements of incorporated businesses must be prepared according to a prescribed statutory format and must usually be audited by an external auditor. Monitoring performance and calculating profit has the business achieved what it had planned to achieve e.g. are sales levels on target and costs as budgeted? Has it made a profit, and to what extent? Forecasting performance what growth in sales may be realistically achieved given past performance, state of the market, competition etc. Information on past performance will come from the financial statements. How much will it cost to run the business next year? All this information can be found in the management accounts. Assess the owners liability for income tax The company s liability for corporation tax The business s liability for VAT January B/PQP/4 continued

5 Assess amounts owing to payables What are the business s short-term liabilities to suppliers? Also indicates what is owed from customers with implications for cash flow and credit management. b) The final accounts of the business compiled annually are the Income Statement and Statement of Financial Position. There is a plethora of information that can be obtained from these two documents which will enhance the decision whether to grant or extend credit or establish or extend terms. Income statement indicates: the level of sales and profit. - Are they increasing or decreasing? - How do they compare with previous years? - How is the organisation performing in the industry? This will be of particular use to the credit manager. the type, form and structure of costs for the year. - How do they compare to previous years? - Any particular expense increased dramatically? Statement of Financial Position indicates: the type, structure and form of assets and liabilities. - How long have the assets got to run? - Depreciation levels? shows the level of debt and when it needs to be repaid. - Can the organisation service it? displays the availability of cash and near cash items that can be readily turned into cash to meet the business debts. - Is of particular interest to the credit manager. Profitability ratios will assess the level of profits in comparison to the sales generated and capital employed Liquidity ratios are very important in assessing the credit worthiness of an organisation - Can an organisation pay its debts as and when they fall due? Efficiency ratio will assess the ability of management to control working capital Receivables ratio shows how long it takes invoices to be paid Payables ratio gives the average length of time that the company takes to pay its creditors. c) i) Investors will be interested in profit levels and past performance to ensure that not only is the investment safe but that it will produce a good return. ii) Lenders will be concerned again with profit levels and liquidity ratios to satisfy themselves that the firm has both the ability and resources to repay any loan granted albeit in the short, medium or long-term. January B/PQP/5 continued

6 iii) Employees and their representatives will be concerned with levels of profit. This will possibly indicate job security and can form the basis for bargaining for improvements in pay and conditions. iv) For customers the price paid for the final product would be a key consideration. They will also desire that the company will be in existence for after sales service and warranty. Customers will look to all aspects of the final accounts to determine its financial stability. v) The general public will want to see all the financial statements in order to determine whether or not the business has the resources to be environmentally friendly and can service sustainability in all its forms in the future. This area of the syllabus has not been tested for a while and in the main the candidates handled it well. Most could highlight reasons why organisations maintain financial and management accounts in a) though a minority did not make the distinction. Many though could differentiate and come up with some very pertinent answers. Part b) witnessed some very good responses though a few failed to address the implications from a credit management perspective which the question required. Part c) was tackled well by the vast majority though the majority of candidates just cited profit as the most important piece of financial information for the stakeholders cited. This was apt for the first three but with regard to the other two, I would like to have seen more reference to prices, after sales service, warranties, sustainability and environmental issues. January B/PQP/6 continued

7 2. All businesses whether they are incorporated or unincorporated require additional sources of finance to fund their operations. TASK Identify the key characteristics together with one advantage and one limitation for each of the following: a) Bank overdraft. (4 marks) b) Trade credit. (4 marks) c) Term loans. (4 marks) d) Factoring. (4 marks) e) Retained profits. (4 marks) Question aims To test the candidate s knowledge and understanding of the different types of finance available to organisations to finance their activities in the short, medium or long-term. Suggested answer a) Bank overdraft Characteristics Short-term facility used to finance working capital requirements Used to cover cash deficits before income is received The bank balance will have a negative figure (credit balance) and is classed as a current liability. Advantages Flexible as the bank may be willing to increase the limit for short periods Relatively cheap as interest is charged on the daily amount overdrawn typically 2 3% +base rate. Limitations Repayable on demand If the overdraft is very large the bank may require an arrangement fee and security. January B/PQP/7 continued

8 b) Trade credit Characteristics Credit given by the company s suppliers, the norm being 30 days from the date of invoice, though in some industries it might be 60 to 90 days. In reality this is giving the organisation credit as it is borrowing at the suppliers expense. Firms use trade credit as a source of working capital rather than rely on a bank overdraft which has a cost. Advantages Trade credit is easier to obtain than a bank overdraft or loan Readily available subject to credit clearance Trade creditors have an interest in developing and extending the working relationship and are more flexible than a bank No interest charges or other costs providing terms are adhered to. Limitations The buyer may lose cash discounts given for prompt payment and may also lose the opportunity to negotiate more favourable prices or lose supplier goodwill and not be able to take advantage of discounts for bulk buying Strictly a short-term facility Credit can be withdrawn May get a poor reputation in credit circles. c) Term loans Characteristics Loans provide finance generally for the medium to long-term. They are granted for a specific amount for a specific period and be either secured against the assets of the business i.e. if the debt is not repaid the bank can take possession of the borrowers assets or unsecured, where it can not. The period of the loan is agreed at the outset and interest rates are based on the amount borrowed and prevailing economic conditions. Interest payments can be fixed throughout the period of the loan or may be variable subject to market conditions. Advantages Easily arranged subject to the status of the business Fixed rate of interest can be arranged Although interest payments are based on the full amount borrowed, they tend to be at a lower % rate than overdrafts. January B/PQP/8 continued

9 Limitations Secured loans are secured against the assets of the business, which can restrict their use Cost of interest will reduce profit levels Increased indebtedness to third-parties generates increasing gearing levels. d) Factoring Characteristics Another short-term method of financing. Here the company sells its book debts to a factor. The factoring company will then pay an agreed percentage of the value of these debts which can be as much as 85% of the value of invoices outstanding. The balance will be paid, less fees, when the customers have paid the factoring company. The factoring company may also take responsibility for bad debts which is a form of insurance with an additional fee attached. Advantages An immediate cash injection Reduces debt collection costs. Disadvantages A high percentage of invoice value has to be paid to the factor The relationship with the customer(s) whose debts have been factored might be damaged. e) Retained profits Characteristics Profits can be retained in the business rather than given out to shareholders in the form of dividends in the case of incorporated businesses or taken out in the form of drawings by sole traders or partners. This increases the funds available to the business which might lead to an expansion of the business or an increase in its share valuation. It can be used to finance either working capital or the purchase of non-current assets. Advantages No costs involved and immediate cash is available No third-party involvement Disadvantages Takes time to build up retained earnings Can be restricted by the need to pay dividends to shareholders. January B/PQP/9 continued

10 This question proved very popular with students. Some very good answers were offered showing a high level of understanding of this section of the syllabus. A common error though for some was to either just detail the characteristic of each without discussing the merits and limitations of each or vice-versa. No problems with overdrafts, trade credit and factoring but there was a little confusion with regard to term loans and retained profits. With the former many did not detail they would not be apt in the medium and long term, nor did they highlight in enough detail the costs involved with regard to interest rates and the time period involved. With the latter, many could not offer a clear definition of what constituted retained profits nor could they indicate that there were no costs involved as such in utilising this type of financing. January B/PQP/10 continued

11 3. P Scott owns a small engineering firm. The following balances have been extracted from the accounts as at 31 December DR CR Capital 72,100 Bank 11,690 Carriage Inwards 640 Carriage Outwards 1,270 Discounts 1,510 2,190 Equipment: At cost 77,360 Provision for depreciation 16,840 Drawings 10,740 Long-term Loan 20,000 Motor Expenses 16,740 Premises: At cost 60,000 Provision for depreciation 10,000 Purchases and Sales 132, ,300 Shop Expenses 21,380 Stock as at 1 January ,820 Debtors and Creditors 12,490 9,210 Wages 46,330 Telephone and Insurance 1,750 Returns 1,300 1,700 Total 420, ,030 You have also been given the following information: 1. Stock as at 31 December 2014 was valued at 29, Motor expenses paid in advance were Wages unpaid at year end amounted to 1, Equipment is to be depreciated at 12½% using the reducing balance method. 5. Premises need to be depreciated using the straight-line method at 5%. TASK a) Prepare an income statement (formerly a trading and profit and loss account) for the year ended 31 December (11 marks) b) Prepare a statement of financial position (formerly a balance sheet) as at 31 December (9 marks) January B/PQP/11 continued

12 Question aims To test the candidates ability to prepare a trading and profit account and balance sheet from a trial balance taking into account all adjustments re accruals, prepayments and depreciation. Suggested answer a) Income statement of P Scott for the year ended 31 December 2014 Sales 276,300 less Sales returns 1, ,000 Less cost of sales Opening stock 35,820 Purchases 132,700 Carriage inwards 640 less Purchase returns 1, , ,460 Less closing stock 29, ,760 Gross profit 137,240 Discount received 2, ,430 Less expenses Discount allowed 1,510 Carriage outwards 1,270 Motor expenses ( 16, ) 16,390 Shop expenses 21,380 Wages ( 46, ,840) 48,170 Telephone and insurance 1,750 Depreciation: Equipment (w1) 7,565 Premises (w2) 3, ,035 Net profit 38,395 January B/PQP/12 continued

13 b) Statement of Financial Position of P Scott as at 31 December Fixed assets Premises (w3) 60,000 13,000 47,000 Equipment (w4) 77,360 24,405 52, ,360 37,405 99,955 Current assets Stock 29,700 Debtors 12,490 Prepayments ,540 Less current liabilities Creditors 9,210 Bank overdraft 11,690 Accruals 1,840 22,740 Net current assets 19, ,755 Less long-term liabilities Bank loan 20,000 99,755 Financed by Capital 72,100 add Net profit 38,395 less Drawings (10,740) 99,755 W1 Equipment 77,360 16,840 = 60,520 x 12½% = 7, depreciation W2 Premises 60,000 x 5% = 3, depreciation W3 Premises 60,000 ( 10, ,000) = 47, Net book value W4 Equipment 77,360 ( 16, ,565) = 52, Net book value January B/PQP/13 continued

14 This was probably the most popular question on the paper with the vast majority of candidates securing a pass mark. As indicated, the presentation of the final accounts of businesses has improved significantly though there are still isolated incidents of poor practice. In the main, the TPLA (SPL) was handled well, though the odd candidate did confuse purchase and sale returns and discount allowed and discount received. In a couple of instances, opening and closing stock (inventory) were inserted the wrong way round. Most students addressed the accruals and prepayments adjustments, though a few found the depreciation calculation problematic. The PLA (SFP) was well constructed though many did not recognise that the bank balance was a credit one, i.e., overdrawn and should appear as a current liability. January B/PQP/14 continued

15 4. As credit manager of ABC Limited, you have been asked by your financial director to assess the feasibility of increasing the credit facility of Doyle and Scott Limited. You have been given the extracts from their most recent financial accounts below: Income Statement of Doyle and Scott Limited for the year ended 31 December: Sales Less: cost of sales Gross profit Less: expenses Operating profit Statement of Financial Position for Doyle and Scott Limited as at 31 December: Non current assets Current assets Inventory Receivables Bank Current liabilities Payable Bank Net current assets Financed by Ordinary shares Reserves Note: Opening inventory in 2012 (in 000s) = 40 January B/PQP/15 continued

16 TASK a) Calculate the following ratios for both of the years 2013 and 2014 (the relevant figures for 2012 have been given in brackets): i) Gross profit margin (2012: 33%). ii) Operating profit margin (2012: 10%). iii) Return on capital employed (2012: 15%). iv) Current ratio (2012: 3.5:1). v) Quick ratio/acid test (2012: 2.3:1). vi) Inventory days (2012: 100 days). vii) Receivables days (2012: 79 days). viii) Payables days (2012: 91 days). (8 marks) b) Using the ratio calculations which have been supplied for 2012 and your own calculations from part a) for 2013 and 2014, assess whether an increase in the credit facility would be appropriate, giving your reasons for your decision. (12 marks) Question aims To test the candidate s knowledge and understanding of the key financial ratios and how they can be employed to assist the credit manager in making a more informed decision as to whether to increase a credit facility. Suggested answer a) Ratios for the last two years are: i) Gross profit margin 25% 20% ii) Operating margin 4.4% 2.6% iii) Return on capital employed 8% 5.8% iv) Current ratio 2.14:1 1.73:1 v) Quick ratio 1.43:1 1.1 vi) Inventory days 66 days 55 days vii) Receivables days 81 days 74 days viii) Payables days 95 days 76 days January B/PQP/16 continued

17 b) There is no model answer as such for this, though the calculation for each ratio should be correct to get credit. Students should look at trends in offering observations and marks will be awarded for developing these and other reasonable points: Turnover has increased by more than 50% over the period. Although gross profit has increased all the profit margins i.e., gross, operating and return on capital employed) have declined Both the current ratio and acid test ratios have declined, but from quite a high position in the first instance. The 2014 figure is acceptable still though. However if this trend is to continue the 2015 accounts are likely to show a further decline in working capital and the business might find itself in an overtrading situation Control over working capital items, inventory, receivables and payables have been good. Receivable days have improved as has inventory days but payables has slightly worsened. The organisation though is still getting its invoices paid before they pay their suppliers, which is good. Some students might make reference to the fact that the cash operating cycle has improved from 91 days to 53 days Expenses as a percentage of turnover has reduced which demonstrates that these are clearly under control Share capital has increased but the return on capital employed has fallen quite significantly and must be of concern to the shareholders On the basis of the previous, students might indicate that on balance given the key ratios identified that it might be apt to increase the facility but it does need to be carefully monitored. Some could argue that it might be appropriate before increasing credit to get sight of the management accounts which will show, amongst other things, projected sales and cash flow forecasts. The organisation at present is clearly solvent but the liquidity ratios have been moving in an adverse manner over the last couple of years and if this should continue could cause problems with the company s ability to pay its debts as and when they fall due. January B/PQP/17 continued

18 Workings Gross profit margin Gross profit x 100 Sales x = 33% 90 x = 25% 108 x = 20% Operating profit margin Operating profit x 100 Sales 24 x = 10% 16 x = 4.4% 14 x = 2.6% Return on capital employed Operating profit x 100 Ordinary shares and reserves 24 x = 15% 16 x = 8% 14 x = 5.8% Current ratio Current assets Current liabilities = 3.5: = 2.14: = 1.73:1 Quick ratio/acid Test Current assets closing stock Current liabilities = 2.3: = 2.43: = 1:1 Inventory days [(Opening stock + closing stock)/2] x 365 Cost of sales [(40+48) 2] x = 100 days [(48+50) 2] x = 66 days [(50+80) 2] x = 55 days Receivables days Receivables x 365 Sales 52 x = 79 days 80 x = 81 days 180 x = 74 days Payables days Payables x 365 Cost of sales 40 x = 91 days 70 x = 95 days 90 x = 76 days Working Capital Cycle Receivables days + Inventory days Payables days = 88 days = 52 days = 53 days Financial ratios form an integral part of the syllabus and are also a very important tool for a credit manager in assessing the credit worthiness of both new and existing customers. In the main, the vast majority of candidates who attempted this question scored well although not as highly as one would expect given the importance and possibly the familiarity of the subject matter. Most of the ratios were computed correctly though some of the efficiency ratios, especially stock turnover, caused a few problems. Part b) responses were either very good or poor. The interpretation of financial data is just as important as the calculation of the said ratios so students should take note. The topic, given its importance, will continue to be examined in future diets. January B/PQP/18 continued

19 5. There are four general assumptions that specifically underlie the preparation of the financial (final) accounts of an incorporated business. TASK a) What is the purpose of these four key accounting concepts? (4 marks) b) Describe and assess the importance of each of those concepts with regards to the interpretation of prepared financial statements. (16 marks) Question aims To test the candidate s knowledge and understanding of the key accounting concepts and conventions that underpin the compilation and publication of the final accounts of an incorporated business. Suggested answer a) The concepts and conventions used in preparing the final accounts are aimed at conferring uniformity on the financial statements. In preparing the income statement, statement of financial position and cash flow statements, accountants apply these rules that establish the way in which the financial performance of a business is recorded. Ultimately the aim of these concepts is to produce objectivity in financial accounts and allow like-for-like comparisons to be made. b) These concepts and conventions are broad basic assumptions which have been applied in preparing the final accounts of a business and require no explanation or disclosure unless otherwise stated. They are incorporated in various Companies Acts and associated laws and regulations as fundamental accounting principles. The over-riding rule in financial statements is that they should show a true and fair view of the financial position of a given organisation. Four can be detailed as impacting directly upon the preparation of final accounts: i) Going concern financial statements are prepared on the assumption that the company will continue to operate as a viable business venture in the foreseeable future; that there will be no significant reduction in the scale of its operations and it is not likely to become insolvent. This means all assets will be valued in the balance sheet at either historical cost less accumulated depreciation or at a revalued amount. If the company is not to continue as a going concern and ceases trading and has to have its assets sold then the market value of these will be significantly lower than the book value held in the accounts. The Board must then write down the value of the assets in the balance sheet to the amount they would realise in a forced sale and adjust liabilities accordingly. ii) Accruals (matching) concept reviews and costs are recognised as earned or incurred in the income statement of the period to which they relate, not when the cash is received or paid. This ensures that the revenue relating to the year is matched against the related expenses for the year. This enables the income of one period to be matched more fairly against the expenditure of the same period. The accruals concept is widely recognised as a more objective way of measuring profit than on a cash basis. This gives a true and fair view of the profit for the year and the assets and liabilities in the balance sheet. January B/PQP/19 continued

20 iii) Comparability objective (consistency) similar items in the accounts must be dealt with in the same way in every branch and in each accounting period and then from one accounting period to the next. Once an accounting policy has been adopted it cannot be changed as this would distort profits and the valuation of assets. One accounting policy can be changed in exceptional circumstances only where it could improve the quality of the statements and provide a fair profit/asset figure. The board must disclose any change and have the approval of the auditors. iv) Prudence principle in preparing the final accounts, a number of estimates and judgements have to be made. The natural tendency would be to be over-optimistic about profits and the overall financial position of the business. The prudence principle deems it apt to be conservative or pessimistic when making a judgement on anticipated profit or losses of a company. Accountants should always exercise caution when there is uncertainty. Revenues and profits must not be recognised until they are realised or there is a high degree of certainty that they will be realised. Prudence also needs to be applied to other items which cannot be measured with certainty and are very subjective, e.g., stock valuation, profit or loss on the sale of a fixed asset etc. It also prevails over accruals, should the two conflict. Note: Marks will not be awarded when a student cites materiality, business entity, duality, money measurement, periodically, historic costs, realisation and substance over form as these do not apply to the preparation of the final accounts. A question that did not require any accounting activity which curiously was not a favourite with candidates. Answers in the main were fine although a few failed to address and indicate that the purpose of standards is to bring uniformity in the compilation and content of final accounts of businesses. Part b) was well answered by most although a number did cite and talk about materiality, business entity and money measurement, which although are other accepted standards, do not apply to final accounts. January B/PQP/20 continued

21 6. The final accounts of an incorporated business contain a great deal of information that will help the credit manager in making a more informed decision whether to grant or extend credit facilities. TASK Assess the credit intelligence that might be gleaned from the following: a) The Auditors Report. b) The Directors Report. (6 marks) (8 marks) c) The Chairman s Statement or Report. (6 marks) Question aims To assess the candidate s appreciation of the type of credit information that might be obtained from the final accounts of a business which could enhance the decision made by a credit manager with regard to credit terms and limits. Suggested answer a) The auditor s report The shareholders are investors in the company and in order to safeguard their interests it is a statutory requirement that the final accounts of an incorporated business are examined and scrutinised by an independent auditor appointed by the shareholders, unless the company is exempt from doing so The auditor is required to report to the members of the company on all the accounts presented at the annual general meeting The auditor has to comment on whether the financial statements presented to them, namely - the income statement, - statement of financial position - statement of cash flow show a true and fair view of the company or the group s state of affairs at the end of the financial period. Also whether the financial statements have been prepared in accordance with the appropriate Companies Act legislation. A report can be qualified i.e., the auditors disagree with the treatment or disclosure of an item in the financial statement and in the opinion of the auditors the effect of this does not give a true and fair view The financial accounts are one of the main tools for the credit manager whose main task is to ensure the credit worthiness of new or existing customers. A clean, unqualified, audit report indicates that the auditor is confident that the final accounts give a true and fair view of the company s financial affairs for the year. The credit manager then can have some confidence of the financial standing of the given organisation. Also a clean audit implies that proper records have been kept and in accordance with all relevant legislation. A qualified audit report though should be a warning sign as it implies some disagreement in one or more areas of the final accounts which should alert the credit manager that all is not financially well. This obviously would have some bearing on the credit manager s decision whether to grant or extend credit to the customer. January B/PQP/21 continued

22 b) The director s report The director s report is an objective overview of the company s activities and performance during the year. There is a plethora of information here which will help the credit manager in making a more informed credit decision. Specifically It details the company s financial position at year end including any changes to share capital, proposed dividend and transfers to reserves. Important information for the credit manager It details changes in the consistency and numbers of shareholders. Any major changes require clarification It discusses the business principal activities and any changes to these, i.e., whether the core business is still the same It talks about any significant development which might affect future performance and results which could be either negative or positive It highlights post balance sheet events i.e., major events that have occurred after the year end which will affect future results. This could have a bearing on credit worthiness It will detail any significant changes to fixed assets during the year. Again, this may impact on an organisation s ability to pay its debts as and when they fall due It will inform the shareholders of any acquisitions made by the company of its own shares Names of directors and details of their interest in shares and debentures will be disclosed. Also any changes to the Board during the year. This would require investigation by the credit manager There will also be a statement regarding the supplier payment policy of how many days the company takes to pay its suppliers which is very useful information for credit risk assessment. c) The chairman s statement or report This is a review by the chairman of the major activities and events of the organisation for the past year It discusses the company s general performance and comments on events during the year which might be of interest to shareholders The future prospects of the business are also outlined The aim of the statement is to emphasise the positive aspects of the trading performance of the organisation over the past year It will also try to detail the reasons for any adverse results or negative trading developments The report is not mandatory, nor subject to the scrutiny of auditors, so needs its content to be treated with caution. Nonetheless, if the auditors and directors reports are detailed in a positive manner and this is supported by the chairman s report, the credit manager can rate this as a favourable piece of credit intelligence. It must though not be totally relied upon to assess any aspect of credit worthiness. January B/PQP/22 continued

23 Another question that required a narrative answer. The Auditors, Directors and Chairman s Reports are important supplements to the final accounts of incorporated businesses and information can be gleaned from them which will help the credit manager in making a more informed decision. Although the latter is more qualitative in nature, the other two contain important credit intelligence which in some cases is possibly just as important as the quantitative evidence from the final accounts. January B/PQP/23 continued

24 7. When extracting the ledger balances from an organisation s accounts, the debit and credit sides did not balance, as follows: DR CR Capital 45,000 Debtors and Creditors 32,900 5,000 Returns 2,500 2,710 Purchases and Sales 25,000 30,485 Discounts 6,800 5,630 Drawings 8,220 Wages and Salaries 7,000 Equipment 8,000 Total 90,420 88,825 The following errors were discovered by Sandy, the internal auditor, on 31 December 2014: i) The Purchases account had been undercast by 4,500. ii) Cash sales of 24,205 had not been entered into the Sales account. iii) A credit note of 3,450 was entered in P White s customer account but no entry was made in the relevant returns account. iv) The Sales account was overcast by 3,900. v) 4,590 of goods was taken out of the business for I Johnson s personal use. This was recorded in the Drawings account but there were no other entries. vi) An invoice for J Sullivan was discovered behind the computer. No accounting entries had been made for the 1,650. vii) 2,700 in respect of debtor J Smith was debited in error to the account of J Smythe Ltd. viii) A discount allowed of 4,275 was credited in error to the Discount Received account. ix) A bad debt of 6,800 had been entered into the customer s account only. TASK a) What is the purpose of a trial balance? (2 marks) b) Correct the above errors and prepare the resulting suspense account. (18 marks) Note: journal entries are not required. January B/PQP/24 continued

25 Question aims To test the candidates knowledge and understanding of how suspense accounts can be used to correct errors found in the trial balance To test the students appreciation of the reason why a trial balance is extracted for the compilation of the final accounts of a business. Suggested answer a) The purpose of a trial balance is to check the arithmetical accuracy of the double entry in the ledger accounts and to provide information required for the preparation of the final accounts. b) Suspense account Date Details Dr Cr Balance Trial balance 1,595 (1,595) Purchases 4,500 (6,095) Sales 24,205 18,110 Sales returns 3,450 14,660 Sales 3,900 10,760 Purchases 4,590 15,350 Discount received 4,275 11,075 Discount allowed 4,275 6,800 Bad debts 6,800 Nil Students should identify that transactions (vi) and (vii) would not require any posting to the suspense account but that a journal entry would be pertinent. Not as popular as in previous exam series but answered well by those who attempted, even though there were a couple of woeful responses. Most knew the role and importance of suspense accounts and many came up with a nil balance after the appropriate corrections and postings. Some of the narratives in the ledger itself could have been better. Only a few though could identify the two errors that required only a journal entry, which is a little surprising. January B/PQP/25 continued

26 8. J Jones is a small high street business selling computer software. The following account balances were brought forward on 1 January Bank (overdrawn) 1,675 VAT owing 850 Sales 14,500 Purchases 8,700 Discount Allowed 750 Discount Received 450 C Mulhearn (a supplier) 3,400 P Hughes (a customer) 5,500 During January the following transactions took place: 2 January 2014 An invoice for 1,200 plus VAT was sent to P Hughes. 3 January January January January 2014 A credit note for 750 plus VAT was received from C Mulhearn in respect of returned goods. A cheque for 2,200 was sent to C Mulhearn in full settlement of their account. The balance remaining is to be treated as a discount. A credit note was sent to P Hughes for 1,500 including VAT in respect of damaged software. P Hughes sent a cheque for 4,900 in full settlement of the amount outstanding. The rest is to be treated as a discount. 15 January 2014 J Jones took 350 out of the bank for his own personal use. 17 January 2014 An invoice is received from C Mulhearn for 790 plus VAT for the supply of new software. 20 January 2014 A cheque was sent to HMRC for VAT owing. 25 January 2014 A water bill of 1,500 is now due to be paid. There is no VAT on this service. TASK a) Open all the appropriate accounts that are necessary to record the above transactions and enter all balances brought forward on 1 January (4 marks) b) Make the necessary entries in the relevant accounts to record the transactions including discounts and value added tax at 20%. (16 marks) January B/PQP/26 continued

27 Question aims To test the candidates ability to: Apply the rules of double entry book-keeping using a continuous balance format Carry out double entry book-keeping to record a range of transactions Correctly calculate and account for VAT Suggested answer a) and b) Account: Bank Date Details DR CR Balance Balance b/f (1,675) C Mulhearn 2,200 (3,875) P Hughes 4,900 1, Drawings Revenue and customs 832 (157) Water 1,500 (1,657) Account: VAT Date Details DR CR Balance Balance b/f (850) P Hughes 240 (1,090) C Mulhearn 150 (1,240) P Hughes 250 (990) C Mulhearn 158 (832) Bank 832 Nil Account: Sales Date Details DR CR Balance Balance b/f (14,500) P Hughes 1,200 (15,700) Account: Purchases Date Details DR CR Balance Balance b/f 8, C Mulhearn 790 9,490 Account: Discount allowed Date Details DR CR Balance Balance b/f P Hughes 540 1,290 Account: Discount received Date Details DR CR Balance Balance b/f (450) C Mulhearn 300 (750) January B/PQP/27 continued

28 Account: C Mulhearn purchases Date Details DR CR Balance Balance b/f (3,400) Purchase returns 900 (2,500) Bank 2,200 (300) Discount received 300 Nil Purchases 948 (948) Account: P Hughes sales Date Details DR CR Balance Balance b/f 5, Sales 1,440 6, Sales returns 1,500 5, Bank 4, Discount allowed 540 Nil Account: Purchase returns Date Details DR CR Balance C Mulhearn 750 (750) Account: Sales returns Date Details DR CR Balance P Hughes 1,250 1,250 Account: Drawings Date Details DR CR Balance Bank Account: Water Date Details DR CR Balance Water 1,500 1,500 This question, as ever, proved the most popular on the paper and candidate responses are certainly getting better. The vast majority identified the appropriate balance in the question and opened appropriate accounts. The postings were tackled well, although a few failed to arrive at a nil balance on the VAT account. There was a bit of confusion between sales and purchases returns amongst a few candidates as was there with discounts. The double entry for a sole trader taking money out of the business for his/her own personal use as usual caused a few problems, as did the accounting treatment of the payment of a water bill, which is a little disappointing. ---o0o--- January B/PQP/28