POST EXM GUIE May 2001 Exam Financial ccounting Fundamentals (FFN) IM publishes a Question and nswer booklet for each paper of the May 2001 exam which is essential reading for students and tutors. The published answers are written by the Examiner and should be read together with the post exam guide. The hartered Institute of Management ccountants 2001
Objective test questions are awarded 2 marks each. Explanations are provided for answers to objective test questions involving calculations. Question 1.1 The fundamental objective of an external audit of a limited company is to give advice to shareholders detect fraud and errors measure the performance and financial position of a company provide an opinion on the financial statements The answer is. Question 1.2 receives goods from on credit terms and subsequently pays by cheque. then discovers that the goods are faulty and cancels the cheque before it is cashed by. How should record the cancellation of the cheque in his books? ebit creditors redit returns outwards redit bank ebit creditors ebit bank redit creditors redit creditors ebit returns outwards The answer is. Question 1.3 The profit of a business may be calculated by using which one of the following formulae? Opening capital - drawings + capital introduced - closing capital losing capital + drawings - capital introduced - opening capital Opening capital + drawings - capital introduced - closing capital losing capital - drawings + capital introduced - opening capital The answer is. Post Exam Guide May 2001 2
Question 1.4 The turnover in a company was 2 million and its debtors were 5% of turnover. The company wishes to have a provision for doubtful debts of 4% of debtors, which would make the provision 33% higher than the current provision. What figure would appear in the profit and loss account in respect of doubtful debts? debit 1,000 credit 1,000 debit 1,333 credit 1,333 The answer is. Workings Turnover 2 million x 5% gives debtors of 100,000 Provision for doubtful debts is 4% x 100,000 4,000 Existing provision is 4,000 x ¾ 3,000 Increase in provision to profit and loss account 1,000 Question 1.5 Which one of the following should be accounted for as capital expenditure? The cost of painting a building. The replacement of windows in a building. The purchase of a car by a garage for re-sale. Legal fees incurred on the purchase of a building. The answer is. Post Exam Guide May 2001 3
Question 1.6 business purchases a machine on credit terms for 15,000 plus value added tax (VT) at 15%. The business is registered for VT. How should this transaction be recorded in the books? r r Machinery 15,000 reditors 15,000 Machinery 17,250 reditors 17,250 Machinery 15,000 VT 2,250 reditors 17,250 Machinery 17,250 VT 2,250 reditors 15,000 The answer is. Question 1.7 Which one of the following statements most closely expresses the meaning of true and fair? There is only one true and fair view of a company s financial statements. True and fair is determined by compliance with accounting standards. True and fair is determined by compliance with company law. True and fair is largely determined by reference to generally accepted accounting practice. The answer is. Post Exam Guide May 2001 4
Question 1.8 On 1 May 2000, Ltd pays a rent bill of 1,800 for the period to 30 pril 2001. What are the charge to the profit and loss account and the entry in the balance sheet for the year ended 30 November 2000? 1,050 charge to profit and loss account and prepayment of 750 in the balance sheet. 1,050 charge to profit and loss account and accrual of 750 in the balance sheet. 1,800 charge to profit and loss account and no entry in the balance sheet. 750 charge to profit and loss account and prepayment of 1,050 in the balance sheet. The answer is. Workings 1,800 for one year is 150 per month harge to profit and loss account 7 x 150 = 1,050 Prepaid 5 x 150 = 750 Question 1.9 S Ltd exchanged stock for a delivery vehicle with T Ltd. The stock had cost S Ltd 10,000 and the normal selling price was 12,000; the delivery vehicle had cost T Ltd 9,000 and the normal selling price was 13,000. How should S Ltd value the vehicle in its balance sheet? 9,000 10,000 12,000 13,000 The answer is. Question 1.10 Z s bank statement shows a balance of 825 overdrawn. The bank statement includes bank charges of 50, which have not been entered in the cash book. There are unpresented cheques totalling 475 and deposits not yet credited of 600. The bank statement incorrectly shows a direct debit payment of 160, which belongs to another customer. The figure for the bank balance in the balance sheet should be 590 overdrawn. 540 overdrawn. 790 overdrawn. 840 overdrawn. The answer is. Post Exam Guide May 2001 5
Workings (Question 1.10) ank statement balance overdrawn (825) Unpresented cheques (475) Outstanding deposits 600 ank error 160 ash book credit balance (540) Question 1.11 There is 100 in the cash till at the year end at F Ltd, but the accountant has discovered that some cash has been stolen. t the beginning of the year there was 50 in the cash till and debtors were 2,000. Total sales in the year were 230,000. ebtors at the end of the year were 3,000. heques banked from credit sales were 160,000 and cash sales of 50,000 have been banked. How much cash was stolen during the year? 18,950 19,000 19,050 20,950 The answer is. Workings Sales ledger control account Opening debtors 2,000 heques banked credit sales 160,000 redit sales (balancing figure) 161,000 losing debtors 3,000 163,000 163,000 ash account Opening balance 50 ash banked 50,000 ash sales ( 230,000-161,000) 69,000 ash missing (balancing figure) 18,950 losing balance 100 69,050 69,050 Post Exam Guide May 2001 6
Question 1.12 car was purchased for 12,000 on 1 pril 1997 and has been depreciated at 20% each year straight line, assuming no residual value. The company policy is to charge a full year s depreciation in the year of purchase and no depreciation in the year of sale. The car was traded in for a replacement vehicle on 1 ugust 2000 for an agreed figure of 5,000. What was the profit or loss on the disposal of the vehicle for the year ended 31 ecember 2000? Loss 2,200 Loss 1,400 Loss 200 Profit 200 The answer is. Workings 1 pril 1997 ost 12,000 epreciation charge at 20% 1997 2,400 1998 2,400 1999 2,400 7,200 Net book value 1 ugust 2000 4,800 Proceeds 1 ugust 2000 5,000 Profit 200 Question 1.13 company includes in stock goods received before the year end, but for which invoices are not received until after the year end. This is in accordance with the historical cost convention. the accruals concept. the consistency concept. the materiality concept. The answer is. Post Exam Guide May 2001 7
Question 1.14 I Ltd operates the imprest system for petty cash. t 1 July there was a float of 150, but it was decided to increase this to 200 from 1 ugust onwards. uring July, the petty cashier received 25 from staff for using the photocopier and a cheque for 90 was cashed for an employee. In July, cheques were drawn for 500 for petty cash. How much cash was paid out as cash expenses by the petty cashier in July? 385 435 515 615 The answer is. Workings 1 July balance b/d 150 heques banked credit control 90 Photocopying 25 ash paid out (balancing figure) 385 ash from bank 500 31 July balance c/d 200 675 675 Question 1.15 Which one of the following sentences does NOT explain the distinction between financial accounts and management accounts? Financial accounts are primarily for external users and management accounts are primarily for internal users. Financial accounts are normally produced annually and management accounts are normally produced monthly. Financial accounts are more accurate than management accounts. Financial accounts are audited by an external auditor and management accounts do not normally have an external audit. The answer is. Post Exam Guide May 2001 8
Question 1.16 The movement on the plant and machinery account for X Ltd is shown below: ost b/fwd 10,000 dditions 2,000 isposals (3,000) ost c/fwd 9,000 epreciation b/fwd 2,000 harge for the year 1,000 isposals (1,500) epreciation c/fwd 1,500 Net book value b/fwd 8,000 Net book value c/fwd 7,500 The profit on the sale of the machine was 500. What figures would appear in the cash flow statement of X Ltd? Movement on plant account 500 and profit on disposal of 500. Movement on plant account 500 and proceeds on sale of plant 2,000. Purchase of plant 2,000 and profit on disposal of 500. Purchase of plant 2,000 and proceeds on sale of plant 2,000. The answer is. Workings Purchase of plant = additions = 2,000 Net book value of disposals ( 3,000-1,500) 1,500 Profit on disposal 500 Proceeds on sale of plant 2,000 Question 1.17 When there is inflation, the historical cost convention has the effect of overstating profits and understating balance sheet values. understating profits and overstating balance sheet values. understating cash flow and overstating cash in the balance sheet. overstating cash flow and understating cash in the balance sheet. The answer is. Post Exam Guide May 2001 9
Question 1.18 When reconciling the creditors ledger control account with the list of creditors ledger balances of M, the following errors were found: the purchase day book had been overstated by 500 and the personal ledger of a supplier had been understated by 400. What adjustment must be made to correct these errors? ontrol account List of creditor balances r 500 decrease by 400 r 500 increase by 400 r 400 increase by 500 r 400 decrease by 500 The answer is. Question 1.19 Extracts from the financial statements of FS Ltd are set out below: Profit and loss account for the year ended 31 ecember 2000 000 000 Turnover 300 ost of sales 150 Gross profit 150 Profit on sale of fixed asset 75 225 Expenses 15 epreciation 30 45 Net profit 180 Stock, debtors, current liabilities (net) alances at 31 ecember 1999 2000 000 000 40 50 What figure would appear in the cash flow statement of FS Ltd for the year ended 31 ecember 2000 in respect of net cash flow for cash from operating activities? 125,000 145,000 215,000 235,000 The answer is. Post Exam Guide May 2001 10
Workings (Question 1.19) 000 Net profit 180 dd back: epreciation 30 Less: Profit on sale (75) 135 Increase in working capital (10) ash from operations 125 Question 1.20 is a builder with a staff of ten employees. In pril 2001, he paid the following amounts: net salaries after tax and national insurance 14,000 tax and employees national insurance for March 2001 5,000 employer s national insurance for March 2001 1,400 He owes the following amounts in respect of tax and national insurance for pril 2001: tax and employees national insurance 6,000 employer s national insurance 1,500 The correct expense for employee costs to be shown in the profit and loss account for pril 2001 is 19,000 20,000 20,400 21,500 The answer is. Workings Net salaries for pril 14,000 Tax and employees national insurance 6,000 Employer s national insurance 1,500 21,500 Post Exam Guide May 2001 11
Question 1.21 The following information relates to M Ltd: t 30 September 2000 1999 000 000 Stock of raw materials 75 45 Work-in-progress stock 60 70 Stock of finished goods 100 90 For the year ended 30 September 2000 Purchases of raw materials 150,000 Manufacturing wages 50,000 Factory overheads 40,000 The prime cost of production in the manufacturing account for the year ended 30 September 2000 is 165,000 170,000 210,000 270,000 The answer is. Workings Prime cost is direct materials and direct labour Opening stock of raw materials 45,000 Purchases 150,000 losing stock of raw materials (75,000) Raw materials consumed 120,000 Manufacturing wages 50,000 170,000 Question 1.22 When valuing stock at cost, which of the following shows the correct method of arriving at cost? Include inward Include transport costs production overheads Yes No No Yes Yes Yes No No The answer is. Post Exam Guide May 2001 12
Question 1.23 fixed asset register is an alternative name for the fixed asset ledger account. a list of the physical fixed assets rather than their financial cost. a schedule of planned maintenance of fixed assets for use by the plant engineer. a schedule of the cost and other information about each individual fixed asset. The answer is. Question 1.24 The difference between a profit and loss account (which may also be referred to as an income statement ) and an income and expenditure account is that an income and expenditure account is an international term for a profit and loss account. a profit and loss account is prepared for a business and an income and expenditure account is prepared for a not-for-profit making organisation. a profit and loss account is prepared on an accruals basis and an income and expenditure account is prepared on a cash flow basis. a profit and loss account is prepared for a manufacturing business and an income and expenditure account is prepared for a non-manufacturing business. The answer is. Question 1.25 In a debtors report, which one of the following would you NOT expect to see? Total debtor balances outstanding for current and previous months. ebtor balances excluding VT. redit limit. Sales to date. The answer is. Post Exam Guide May 2001 13
Question 2 sole proprietor produces a trial balance at the year end and some information about adjustments, from which financial statements should be prepared. (a) Prepare a trading, profit and loss account for the year ended 31st July 2000 and a balance sheet at that date. (14 marks) (b) alculate the following, as at 31 July 2000: current ratio; gearing; debtor days. (6 marks) Total marks = 20 Rationale The purpose of this question is: (a) To test a candidate's ability to prepare final statements from a trial balance, after making adjustments. (b) To test a candidate's knowledge of ratios and their calculations. Suggested pproach Part (a) Produce financial statements as described above. Part (b) alculate three ratios from the accounts prepared above. Marking Guide Marks awarded Part (a) The question requires the correct identification of which items in the trial balance are entered into the profit and loss account or balance sheet. It requires adjustments for stock, accruals, prepayments, doubtful debts and depreciation. In each case, the correct adjustment must be made in the profit and loss account and in the balance sheet. 2 The profit and loss account and the balance sheet should each be set out with titles and major headings These headings include gross profit, net profit, fixed assets, current assets, current liabilities, capital and long-term liabilities. 6 (alance sheet) 6 (Profit & Loss) The balance sheet should articulate with the profit and loss account using the own number rule. Own number rule : the balance sheet should be consistent with the candidate s own results from the profit and loss account. Post Exam Guide May 2001 14
Part (b) The gearing ratio may be calculated in two different ways and these are acceptable alternative answers. The question asks for stock debtor days, not months. 6 andidates are rewarded for the correct use of their own results from part (a), when calculating the ratios. Examiner s omments The answers to part (a) were generally good. Most candidates were able to prepare financial statements which were numerically correct and which conformed to an acceptable style of presentation. The answers to part (b) were generally of a pass standard. andidates were asked to calculate three ratios but a number of mistakes were made, such as the numerator and denominator the wrong way round, or using inappropriate figures in the ratio. The own number rule was applied and the correct use of figures from a candidate s own financial statements in part (a) was awarded marks. Post Exam Guide May 2001 15
Question 3 The trial balance of E Ltd did not balance and the following errors have been discovered: (i) cheque for 1,000 received from a debtor had been credited to the sales account and debited to the bank account. (ii) The cash book had been undercast by 250. (iii) machine costing 5,000 had been debited to the machinery repairs account. Machinery is depreciated at 10% on cost and no residual value is assumed. (a) orrect the above errors by showing which ledger accounts should be debited or credited. (4 marks) (b) Explain why financial controls are necessary and give TWO examples. (6 marks) Total marks = 10 Rationale (a) The purpose of the question is to test a candidate's understanding of errors and their correction using principles of double entry. (b) The purpose of this question is to test a candidate's understanding of financial controls. Suggested pproach Part (a) schedule of journal entry columns labelled ebit and redit may be presented, which shows the ledger accounts to be debited/credited and the amount. lternatively, a candidate may show the ledger accounts. Part (b) brief explanation should be provided with relevant examples. Marking Guide Marks awarded Part (a) It is important both to identify the ledger account and the amount to be debited or credited. It is important to recognise where a one-sided entry may be required. It is important to identify situations where the error may have a secondary effect in part (iii) the error affects the machinery account and the depreciation charge. 4 Part (b) There are two parts to this question an explanation and two examples. These are marked as overlapping parts; it is therefore possible to gain extra marks for a good explanation and vice versa for good examples. Furthermore, there are separate marks for each example. 6 Post Exam Guide May 2001 16
Examiner s omments The answers to part (a) were acceptable, although the answers to (i) and (iii) were better than (ii). This was probably because it was necessary to recognise in (ii) that the error would affect the trial balance balancing. Many candidates provided a very full answer to part (b) and a large variety of acceptable examples was given. The suggested answer should therefore be seen as only indicative of what was expected in an answer to a six mark question. Post Exam Guide May 2001 17
Question 4 (a) efine depreciation. (b) State the purpose of depreciation. (2 marks) (4 marks) (c) transport company conducts various transactions related to motor vehicles. Write up the following ledger accounts: Motor vehicle cost account Provision for depreciation on motor vehicles account isposal of motor vehicles account. You should include entries for each relevant year, and work to the nearest. (4 marks) (6 marks) (4 marks) Total marks = 20 Rationale The purpose of this question is to test a candidate's understanding of the nature and purpose of depreciation. The candidate is then required to apply this knowledge and understanding to a practical situation. Suggested pproach Parts (a) and (b) brief definition should be provided followed by an explanation of the purpose of depreciation. Part (c) The approach is first to calculate for each vehicle the cost and depreciation charge for each year. This may be shown in a columnar format. This information may then be shown, in total, in the ledger accounts. Marking Guide Marks awarded Part (a) There is no single definition of depreciation and a direct quotation from a standard is not required. The important points are (i) that it is a measure of an expense and (ii) the reasons why this expense occurs (wearing out, time and obsolescence). It is important for candidates to demonstrate their understanding that it is not a method of valuing a fixed asset. 2 Part (b) good statement on the purpose of depreciation should include (i) that it is an expense which is incurred over the life of an asset, and (ii) that it is an application of the accruals concept. 4 Post Exam Guide May 2001 18
Part (c) This is a comprehensive question. It includes: the purchase and sale of vehicles; the purchase of vehicles part way through a financial year; the sale of vehicles part way through a financial year; residual values of vehicles; part-exchange of vehicles; the profit and loss on the sale of vehicles; straight line method of depreciation; reducing balance method of depreciation. These are recorded in the: motor vehicle cost account provision for depreciation account motor vehicle disposal account 4 6 4 correct answer would show that the candidate could account for all of these situations. The own number rule will apply; where, for example, a candidate calculates a depreciation charge on a vehicle incorrectly, but then shows this figure correctly in the ledger accounts, marks will only be forgone once. Examiner s omments majority of candidates were able to provide a satisfactory definition of depreciation in part (a). However, a minority did make the mistake of defining depreciation as a means of replacing an asset or valuing an asset, which is not correct. In part (b), most candidates referred to the allocation of the cost of a fixed asset over its useful economic life. Fewer candidates made reference to the matching of this expense to the benefits from using the asset. Part (c) is a traditional question on depreciation and it was surprising how many candidates did not comply with the question. The question asked for the ledger accounts; too many candidates provided workings in a columnar format but did not transfer these to ledger accounts. The question also asked for separate vehicle cost accounts and provision for depreciation accounts. Some candidates attempted to combine these and in doing so made mistakes. Post Exam Guide May 2001 19
Question 5 (a) State the rule for valuing stock. (b) Explain the purposes of the rule for valuing stock. (2 marks) (8 marks) (c) Trading and stock figures are given for a limited company. (i) alculate gross profit if the trading account was prepared using a stock valuation basis of LIFO. (2 marks) (ii) alculate stock days, using the average method, on the assumption that stock is valued: on the FIFO basis; on the LIFO basis. (3 marks) (iii) Identify and explain any change in the gross profit and in stock days as a consequence of using LIFO rather than FIFO to value stock. (5 marks) Total marks = 20 Rationale The purpose of this question is to test whether a candidate is able to state the rule for valuing stock and then relate this to the purpose of valuing stock. The candidate is then required to apply this knowledge and understanding to a practical situation, with reference to the FIFO and LIFO methods of stock valuation. Suggested pproach Parts (a) and (b) brief statement of the rule should be provided, followed by the purpose of this rule for valuing stock. Part (c) andidates should produce a revised trading account using LIFO rather than FIFO and calculate stock days, using both LIFO and FIFO. andidates should then be able to explain the differences in profit and 'stock days. Marking Guide Marks awarded There is no single definition of the rule for valuing stock and a direct quotation from a standard is not required. The important points are that cost and net realisable value are two possible methods, and these are combined in a single rule. 2 n explanation of the purposes of the rule for valuing stock should include the fact that it is necessary both to measure the expense of cost of sales in the trading account and to measure the asset of stock in the balance sheet. This treatment is supported by the concepts of matching and prudence. 8 Post Exam Guide May 2001 20
In part (c)(i), all the figures are given and the candidate needs to substitute the correct figures in the trading account. 2 In (ii), the candidate needs to know how to calculate stock days and to repeat this for LIFO and FIFO. 3 In (iii), the candidate needs to appreciate the fact that as the LIFO stock valuation is lower than the FIFO stock valuation this implies that prices of stock items are rising. Thus the gross profit is lower when LIFO is used because it uses more up-to-date prices. Similarly, there is a dual effect of using up-to-date (LIFO method) prices on stock days - cost of sales is higher and stock valuation is lower, hence the effect on stock days. 5 The own number rule will apply; where, for example, a candidate calculates the trading account incorrectly but then uses these figures correctly to calculate stock days, then marks will only be forgone once. Examiner s omments The marks for parts (a) and (b) were very high; most candidates knew the rule for valuing stock and the purposes of this rule. Part (c), the numerical section, was less well answered. lthough most could re-calculate gross profit in part (i) using LIFO, there were many mistakes in part (ii) on calculating stock days. This confirms the statement made in question 2(b) regarding the calculation of ratios. Few candidates approached part (c)(iii) logically. candidate should have considered the effect on the cost of goods sold of changing from FIFO to LIFO and how this would affect the gross profit. Stock days has two components and a candidate needed to assess the effect of changing from FIFO to LIFO for each component and then the overall effect on stock days. Post Exam Guide May 2001 21