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The University of Birmingham College of Social Sciences The Birmingham Business School Department of Accounting and Finance Accounting Theory (07 !7"# Self Test $uestions 00%&'0 (evision )ac* The self test questions attached have all examination. Some of the questions have been slightly modified to reflect better the different approach to be taken in the forthcoming summer 2010 examination. The changes affect mainly part (b of the question! "here applicable. #lease take note. The questions and topic areas are listed belo". Students handing in their ans"ers on $onday 2% &pril at 1pm ('( 1)) "ill receive typed ans"ers to all the questions. $uestion *arsa" #+, San .iego #+, ,ardiff #+, 0stanbul #+, 1uestion 10 Stockholm +td Topic -conomic income /eplacement cost accounting ,ash flo" reporting .eprival value accounting ,onceptual frame"ork .epreciation

+arsa, )-C . /conomic 0ncome *arsa" plc is a company formed to invest capital in shares and irredeemable interest bearing securities. &s at the beginning of its first financial year it had 2100!000 invested "hich "as expected to earn an annual cash return of 210!000 receivable at the end of the financial year in line "ith an expected interest rate of 10 per cent per annum. The interest rate "as as expected for the year but the actual cash inflo" turned out to be 210!)00. &s at the end of the financial year! expectations also changed. 3uture annual cash inflo"s "ere expected to be 211!000 and the rate of interest increased to 12 per cent per annum on the last day of the financial year and "as expected to remain at this level for the foreseeable future. (e1uired2 (a ,alculate the ex ante and ex post measures of (icks4 economic income numbers one and t"o! including both ex post versions. 3'4 mar*s5 (b -xplain the critique of (icks4 economic income numbers as proposed by #aish (1567 . 3'' mar*s5 3 6 mar*s in total5

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8 San Diego )-C . (eplacement cost accounting San .iego plc manufactures compressed air machine tools and its draft financial statements for the financial year ended 80 &pril 2007! prepared on an historical cost basis! "ere as follo"s9 0ncome statement for the year ended 80 &pril 2007 2000s /evenues ,ost of sales (opening inventory ; 21)2!000 <ross profit =perating expenses .epreciation9 >uildings #lant and machinery /etained earnings for the year >alance sheet as at 80 &pril 2007 2000s ?on;current assets >uildings #lant and machinery ,urrent assets 0nventory (bought on average at 81 @anuary 2007 prices Trade receivables ,ash and cash equivalents ,urrent liabilities Trade payables -quity =rdinary share capital /etained earnings 20% 1:2 %2 :10 11% 25: 1!%6: )00 1!16: 1!%6: 2000s :70 500 1!870 2000s 2!:2% 1!:)) 561 %00 20 100 620 2)1

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: &fter a long period of stability! prices during the financial year changed significantly as detailed by the price indices belo"9 #rice index >uildings #lant and machinery 0nventory <eneral prices 1 $ay 2006 100 100 100 100 81 =ctober 2006 10% 112 117 110 80 &pril 2007 112 12: 18% 120

The directors are concerned about the impact of these price changes on their business and have asked the financial accountant to prepare a set of financial statements using replacement cost accounting. The directors "ish to maintain intact the operating capability of the firm defined as the replacement cost of its tangible non;current and current assets. (e1uired2 (a #repare a set of financial statements on a replacement cost basis for the year ending 80 &pril 2007. ,osts in the income statement are to be charged at average replacement cost. #rovide a full analysis of realised and unrealised holding gains. A*ork to the nearest 21!000.B 3'6 mar*s5 (b =ne of the directors claims that the holding gains calculated using replacement cost accounting are not Creal4 because they do not take into account changes in the general price index. -xplain and illustrate numerically this criticism using the example of San .iego plc4s plant and machinery assets. 3'0 mar*s5 3 6 mar*s in total5

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) Cardiff )-C . Cash flo, reporting ,ardiff plc had the follo"ing balance sheet as at 1 &pril 2006 in "hich all the assets and liabilities "ere stated at their net realisable values (?/Ds 9 >alance sheet as at 1 &pril 2006 2000s ?on;current assets +and and buildings #lant and machinery $otor vehicles ,urrent assets 3inished goods inventory *ork in progress inventory Trade receivables ,ash and cash equivalents ,urrent liabilities Trade payables Tax payable Total assets less current liabilities ?on;current liabilities >ank loan -quity =rdinary share capital /etained earnings 8% 2) )% 52 %1 :8 2)2 %1 151 )65 100 :65 2)0 225 :65 2000s 2000s 110 182 1:% 877

The company is considering a complete change to its existing business activities and the directors need to kno" the resources available to the company to implement quickly such a change. They have requested the financial accountant to prepare a set of financial statements for the financial year ending 81 $arch 2007 on a cash flo" reporting basis. /elevant transactions for the year "ere summarised as follo"s9 Transaction ,ash received from trade receivables ,ash paid to trade payables =perating expenses paid 0nterest paid Tax paid Tax provided for the year ending 81 $arch 2007 /eceipt of cash from increase in bank loan (Turn over# 2000s )1% :11 )0 12 2) 1) 20

% &s at 81 $arch 2007! the ?/Ds of the assets and liabilities "ere as follo"s9 .etail +and and buildings #lant and machinery $otor vehicles 3inished goods inventory *ork in progress inventory Trade receivables Trade payables ,ash and cash equivalents 2000s 120 10% 125 :: 111 65 :2 71

The directors consider that the plant and machinery and the "ork in progress inventory are not readily realisable assets. (e1uired2 (a #repare the follo"ing cash flo" reporting statements for the year ended 81 $arch 20079 statement of realised cash flo"E statement of realisable earningsE statement of financial position and the statement of changes in financial position. 3'6 mar*s5 (b & discussion document issued by the 0nstitute of ,hartered &ccountants of Scotland (0,&S $aking ,orporate /eports Daluable (1577 stated9 *e advocate the use of net realisable value as a relevant basis for helping to appraise an entity4s financial "ealth. *hat does the discussion document consider to be the principal merits of this basis of valuationF 3'0 mar*s5 3 6 mar*s in total5

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6 0stan7ul )-C . Deprival value accounting 0stanbul plc manufactures vacuum cleaners and is considering the introduction of the deprival value basis of accounting into its financial statements. (o"ever! before making a final decision! the company "ishes to test the potential effect of this ne" system of valuation on four of its typical assets as detailed belo". Daluation >asis &ye 2 Dalue in use (D0' ?et realisable value (?/D /eplacement cost (/, (e1uired2 (a ,alculate the deprival value of each of the typical assets. A4 mar*s5 100!00 0 )0!000 7)!000 &sset Type >ee 2 1% 1)0 1:2 ,ee 2 20!000 1!000 :%!000 .ee 2 100 1!)00 2!)00

(b #rovide reasoned suggestions! based upon the relationships among the valuation bases provided! as to the possible nature of each of the asset types in the table above. 3" mar*s5 (c =ne of the directors of 0stanbul plc has suggested that the company should use fair values in its financial statements because this valuation basis may be reconciled to the deprival value basis. -valuate this suggestion. 3'8 mar*s5 3 6 mar*s in total5

7 $uestion '0 C0t is possible to identify a number of roles or purposes for accounting theories in general! and for conceptual frame"orks in particular. 0f a theory or frame"ork could be stated in terms that "ere sufficiently rigorous and comprehensive! it could determine the structure and content of actual financial statements. 0t could thus s"eep aside the corpus of legislative requirements! accounting standards and other authoritative pronouncements! established procedures and subsidiary semi; authoritative guidelines that currently determine the structure and content of financial statements and that "e kno" as generally accepted accounting practice (<&&# . 0n practice! none of the theories and frame"orks developed by standard;setters! academics or others have achieved this condition.4 /utherford! >. &. (2000 &n 0ntroduction to $odern 3inancial /eporting Theory! );%. (e1uired2 -xplain and discuss the above quotation "ith reference to the 3&S>4s conceptual frame"ork proGect. 3 6mar*s5

Stoc*holm -imited & Depreciation Stockholm +td has purchased an item of machinery "ith an initial cost of 2100!000. The machine is expected to provide services for five years and to have a scrap value of 210!000 at the end of that time. &t the end of the third year of its life the machine "ill require a maGor overhaul costing 280!000 "hich "ill prolong its life to the end of the fifth year. &s a result! the accounting policy of Stockholm +td is to add the overhaul cost to the initial asset value "hen the asset is first brought into use. The firm estimates that its cost of capital is 20 per cent per annum. (e1uired2 (a ,alculate the net book value of the machinery as at the end of the third year of its useful economic life both "ith and "ithout taking into account the cost of capital of Stockholm +td. 3' mar*s5 (b C.epreciation is thus the "orsening of cash prospects.4 (>axter! 15619 )8 -xplain this comment in the light of the calculations in (a above. 3'8 mar*s5 3 6 mar*s in total5