Summer 2012 examination

AC100
Elements of Accounting and Finance
Suitable for 2011/2012 candidates Suitable for resit/deferred candidates from 2010/2011 and 2009/2010
Instructions to candidates Time allowed: 3 hours + 15 minutes reading time You are allowed 15 minutes for reading the question paper. During this time you may NOT write anything in your answer book but you may annotate the question paper if you wish. You are then allowed 3 hours in which to answer the paper. Show all workings clearly, and state clearly any assumptions you need to make. If accounting paper or graph paper is used for any answer, fasten the sheets securely inside the answer book with the string provided. Answer the following questions: Section A: Section B: Section C: answer any SIX of the twelve questions in this section answer the question in this section answer any TWO of the four questions in this section 30 marks 30 marks 40 marks 100 marks

Marks are allocated as follows: Section A: 5 marks for each question Section B: Section C: 20 marks for each question TOTAL: You are supplied with:

Graph paper Accounting paper Present Value of Annuities Table attached to this examination paper

You may also use: Electronic calculator (as prescribed in the examination regulations) except during the period allowed for reading the question paper. All workings should be to the nearest unless otherwise stated.
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SECTION A: Answer SIX questions from this section

Question 1 Briefly discuss whether companies prepare annual reports only for shareholders or for a wider group of stakeholders and whether there has been a shift in focus over time. [5 marks] Question 2 The following information is available for Adelphi plc. Income statement for the year ended 31 December 2011 000 Revenue 320 Cost of sales (143) Gross profit 177 General and administrative expenses (13) Depreciation (39) Loss on disposal of equipment (3) Operating profit 122 Interest expense (6) Profit before taxation 116 Taxation (38) Profit for the period 78 Extracts from the Statements of financial position at 31 December 2010 2011 000 000 Current assets Inventory 30 22 Trade receivables 27 24 Cash and cash equivalents 48 _8 105 54 Current liabilities Trade payables Interest payable Tax payable 33 9 35 77 25 11 38 74

Required: Calculate the cash flow from operating activities for the period ended 31 December 2011. [5 marks]

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Question 3 The following financial statements relate to Joy plc. Income statement for the year ended 31 December 2011 000 Revenue 6,200 Cost of sales (2,750) Gross profit 3,450 Administration and selling expenses (2,194) Operating profit 1,256 Interest expense (84) Profit before taxation 1,172 Taxation (480) Profit for the period 692 Statement of financial position as at 31 December 2011 000 Non-current assets (net book value) 1,750 Current assets 2,360 Current liabilities Trade and other payables Interest payable Net current assets Total assets less current liabilities Non-current liabilities 6% Debentures Net assets Share capital and reserves Issued share capital Retained earnings 1,156 84 1,240 1,120 2,870 1,400 1,470 450 1,020 1,470

Required: (a) Calculate each of the following ratios for the year ended 31 December 2011: (i) Return on shareholders funds (ii) Gross profit margin (iii) Interest cover ratio (iv) Asset turnover ratio For each ratio show the basis of your calculation and use year-end figures where you would normally use average figures. [2 marks] (b) Identify three limitations in using ratio analysis to interpret a set of accounts. [3 marks] [Total: 5 marks]

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Question 4 If you were an investor, would you invest in ordinary shares or debentures/ corporate bonds? Discuss. Ignore taxation consequences. [5 marks]

Question 5 Discuss how the choice of depreciation method can be used as a tool to increase reported profits. Evaluate this method of managing reported profits in the financial statements. [5 marks]

Question 6 The accountant of Bluzoo Ltd is calculating corporation tax for the year ended 31 March 2012. The trial balance at that date shows a debit balance of 3,940 on the taxation account reflecting an underprovision of corporation tax in the previous year. The companys profit before taxation for the year ended 31 March 2012 is 168,000. In arriving at that profit figure, the following items have been included in the income statement: __ Release of provision for doubtful debts 3,600 Bad debt written off (12,100) Expenses of entertaining customers (3,400) Depreciation of plant and equipment (23,000) Depreciation of freehold buildings (43,000) Capital allowances are estimated to be 45,000. The rate of corporation tax is 21%. Required: Calculate the following: (a) The amount of corporation tax that will appear in the income statement for the year ended 31 March 2012. [3 marks] (b) The amount of profit after taxation that will appear in the income statement for the year ended 31 March 2012. [1 mark] (c) The amount of corporation tax liability that will appear in the statement of financial position at 31 March 2012. [1 mark] [Total: 5 marks]

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Question 7 Traditional approaches to overhead allocation are inadequate for businesses in the 21st century. Critically discuss the above statement. [5 marks] Question 8 The Rye Village Clinic provides primary health care to local residents. For costing purposes, the clinic classifies its departments into three operating departments (Clinic, Radiology, and Laboratory) and three support departments (Administration, Housekeeping, and Medical Records). The allocation of Administration costs is based on the percentage of time spent in the department. The allocation of Housekeeping costs is based on floor space. The allocation of Medical Records cost is based on the number of entries to patient files. For the first week of May, the department managers report the following data:
Admin. Total costs [] Time spent [percentage] Floor space [square feet] Entries to patient files 250 10 1,000 Housekeeping 50 10 500 Medical Records 200 20 2,500 500 Clinic 800 30 5,000 2,000 Radiology 500 20 3,000 500 Lab. 400 10 2,000 1,500 Total 2,200 100 14,000 4,500

Required: (a) Allocate the three support department costs to the three operating departments using the step-down method. The first ranked support department is Administration. The second ranked support department is Housekeeping. The third ranked support department is Medical Records. Round your results to the nearest 10p. [3.5 marks] (b) Comment on the decision to rank the Medical Records support department third in the allocation of costs using the step-down method. [1.5 marks] [Total: 5 marks]

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Question 9 Funny Fizz Company produces carbonated soft drinks. The Concentrate Production is the first product department in a three stage production process. The direct ingredients are added at the beginning of the concentrate production process. Conversion costs are added uniformly during the process. The production data for the Concentrate Production Department for April 2012 are:
Direct ingredients Physical units [Litres] Opening work in process, 1 April Units started in production during April Ending work in process, 30 April Costs added during April 15,000 Degree of completion 100% Costs [] 19,400 Conversion costs Degree of completion 66.66% Costs [] 14,400

435,000 50,000 100% 426,300 20% 412,000

Required: (a) Using the FIFO costing method, assign costs to units completed (and transferred out) and to ending work in process for the Concentrate Production Department for April 2012. [4 marks] Explain the concept of transferred-in costs in process costing. [1 mark] [Total: 5 marks]

(b)

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Question 10 The LSESU Accounting Society is planning a dinner and dance party for students on AC100 to celebrate the end of the academic year. The planning committee has assembled the following expected costs for the event: Expected cost Room rental DJ Dinner Buffet per person Welcome drink per person Advertising 1,400 700 16 4 300

The planning committee members would like to set the ticket price at 32 per person. Required: (a) How many tickets must be sold for the event to break even? [1.5 marks] (b) Last year 150 students attended the end of year party. If the same number attended this year, what price per ticket must be charged to break even? [1 mark] (c) Assuming a sales level of 300 tickets, calculate the degree of operating leverage for the price of 32 per ticket and for the price per ticket that you calculated to part (b) of this question. Explain your results. [2.5 marks] [Total: 5 marks]

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Question 11 Manufactum Ltd uses two approaches to product costing; full (absorption) costing for external reporting purposes and variable (marginal) costing for internal decisionmaking by management. The following comparative information about the effects of each method on recorded income is available: 2010 28 8 20 2011 27 42 -15

Operating income (using full costing) Operating income (using variable costing) Differences

Additional information: At the end of 2010, 20 units of finished goods remained unsold and were added to inventory. Required: (a) Without making further computations, explain why Manufactum Ltd records different measures of income in a period using full (absorption) costing and variable (marginal) costing. [3 marks] (b) Discuss why Manufactum Ltd may prefer to use variable costing as a basis for managerial decision-making. [2 marks] [Total: 5 marks]

Question 12 During the early 2000s some banking activities switched from a traditional banking model to an originate and distribute model. Discuss the two models including for each model a sketch of the flow of funds diagram, with just enough details to illustrate the differences. Why is this change relevant to understanding the 2007 financial crisis? [5 marks]

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SECTION B: Answer THIS question Question 13 Marathon plc is a manufacturer of sports goods. The following trial balance was extracted from its accounting records as at 30 September 2011. Trial Balance at 30 September 2011 Land at valuation at 1 October 2010 Buildings at cost Equipment at cost Vehicles at cost Goodwill at cost Accumulated depreciation at 1 October 2010 Buildings Equipment Vehicles Inventory 1 October 2010 Trade receivables Prepayments 1 October 2010 Bank Accrued expenses 1 October 2010 Trade and other payables Provision for doubtful debts 10% Debenture loan 2014 Sales Purchases Purchase returns Wages and salaries Rent and rates Auditors fees Interest paid Selling, general and administrative expenses Electricity expense Dividends paid Share capital (1 ordinary shares) Retained earnings Share premium Revaluation reserve Disposal of vehicles 000 2,400 3,600 1,680 690 600 000

720 900 370 1,050 860 140 340 200 1,040 20 1,400 12,340 6,520 150 1,230 700 360 140 1,410 480 980 1,960 2,400 560 900 220 23,180

23,180

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The following information is also available: 1. The land is not depreciable. It was valued at 2,900,000 on 30 September 2011 and the directors have decided to incorporate this valuation in the accounts for the year to 30 September 2011. 2. The buildings were acquired on 1 October 2000. At that time, their useful life was estimated to be 50 years and it was decided to adopt the straight-line method of depreciation, assuming no residual value. On 1 October 2010, it was determined that the useful life of the buildings would end on 30 September 2040 (i.e. they only had 30 years life remaining). The estimate of residual value remains unchanged. 3. Equipment is depreciated at 25% per annum on the reducing balance basis and vehicles are depreciated at 20% per annum on a straight-line basis with no residual value. A full years depreciation is charged in the year of acquisition. No depreciation is charged in the year of disposal. In March 2011 a fleet of delivery vehicles which had been acquired for a total of 520,000 in January 2008 was sold for a total of 220,000. This amount was debited to the bank account and credited to a disposal account, but no other entries have yet been made with regards to this disposal. 4. The directors have estimated that goodwill has not been impaired in the year to 30 September 2011. 5. The cost of inventory on 30 September 2011 was 1,100,000. Included in this total is mens sportswear costing 150,000 whose colour has faded. It has been decided to sell these clothes at 30% of their cost. 6. The directors have decided that 80,000 of trade receivables should be written off and that the provision for doubtful debts should then be adjusted to 5% of the outstanding balance. 7. The balance on the prepayments account at 1 October 2010 refers to rent charges. Prepaid rent included in rent and rates at 30 September 2011 amounts to 120,000. 8. The debenture loan bears 10% interest per annum. Three months interest was due on 30 September 2011. The same amount of interest was due on 30 September 2010. 9. The remaining balance of accrued expenses at 1 October 2010 refers to accrued electricity expense. The next electricity bill for the period 1 July 2011 to 30 September 2011 is expected in January 2012. The estimated electricity charge for this period is 145,000. 10. The company issued 400,000 additional ordinary shares on 20 September 2011. The proceeds of issue were 650,000. The proceeds were paid into a separate bank account and no entries have yet been made in the companys accounting records with respect to the cash received or the shares issued.

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11. A dividend of 50p per ordinary share was paid on 31 July 2011. No further dividends are proposed for the year to 30 September 2011.

Required: a) Prepare the income statement of Marathon plc for the year ended 30 September 2011 and the statement of financial position at that date in a form suitable for presentation to the directors of the company (i.e. compliance with the accounting requirements of the Companies Act 2006 or with IAS1 is not required). You should ignore taxation. [25 marks] b) One of the directors queries the accrued electricity expense. Since we did not receive an electricity bill for the last quarter before the end of the fiscal year, why should we include an estimate for it in this years income statement? Provide a brief answer to his query. [5 marks] [Total: 30 marks]

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SECTION C: Answer TWO questions from this section. Question 14 Perea plc is a technology equipment manufacturing company. On 1 January 2010 it acquired 80% of the issued shares of its customer Liana Ltd. The statements of financial position of the two companies at 31 December 2011 were as follows: Perea plc 000 Non-current assets Freehold land Property and equipment Investment in subsidiary 450 394 300 1,144 Liana Ltd 000 115 186 301

Current assets Inventory Trade receivables Cash at bank

176 294 146 616

73 106 37 216

Current liabilities Trade and other payables Tax payable Net current assets Total assets less current liabilities Non-current liabilities Long-term loan Net assets Equity Ordinary share capital (1 shares) Retained earnings

368 178 546 70 1,214

81 69 150 _66 367

300 914

82 285

600 314 914

150 135 285

The following information is relevant: 1. The balance of Lianas retained earnings at 1 January 2010 was 55,000. 2. At the date of acquisition, Lianas freehold land was valued at 150,000 and this valuation has been reflected in subsequent consolidated statements of financial position. There were no additions to Lianas freehold land since that date. The book values of the other net assets of Liana were equal to their fair values.

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3. Included in Lianas balance of property and equipment is a packaging machine which had been acquired on 1 January 2011 for 40,000. Liana depreciates the equipment using the straight-line method over four years. For similar equipment, Perea uses the reducing balance method at a rate of 20% per annum, and this is to be reflected as the group depreciation policy in the consolidated financial statements. 4. During the year ended December 2011, Perea sold inventory to Liana Ltd for 28,000. Perea sets its selling prices by marking up the cost by 40%. During the year ended December 2011, Liana sold 70% of the inventory purchased from Perea. 5. On 31 December 2011 Liana Ltd had unpaid invoices totalling 20,000 payable to Perea. Pereas trade receivables include an equal balance of 20,000 owing from Liana. 6. There has been no change in Lianas issued share capital since 1 January 2010. 7. At the end of 2011, the directors estimate that goodwill has been impaired by 1,600. There has been no other impairment of goodwill since Perea acquired the shares in Liana. Required: Prepare a consolidated statement of financial position for Perea plc and its subsidiary as at 31 December 2011. All workings should be to the nearest hundred pounds. [20 marks]

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Question 15 La Mamma Ltd manufactures gourmet pasta dishes for supermarkets in the UK. Its offices and production site are located in North London. La Mamma Ltd sources all ingredients for its products from suppliers in Italy. The company operates in a competitive marketplace and has increasingly felt pressure from its customers to reduce the selling price of its products. One of the companys products is the Lasagne al Forno ready meal. The standard cost card for the Lasagne al Forno is shown below. It is common practice at La Mamma Ltd to set standards and prepare the annual budget at the beginning of January. Standard cost Lasagne al Forno Units of output Direct ingredients Direct labour Variable production overhead Fixed cost Selling price

4,500 meals per calendar month 0.4kg per meal at 2.00 per kg 0.08h per meal at 6.08 per hour 1.00 per direct labour hour 1,200 2.30 per meal

During November, the company produced and sold 4,000 of the Lasagne al Forno meals using 400 direct labour hours. The total actual amount of direct ingredients used during the month was 1,800kg. The actual results for the month were as follows: Actual results November 2011 Revenue 7,960.00 Variable costs Direct ingredients 3,960.00 Direct labour 2,432.00 Variable production 520.00 overhead Fixed costs 1,200.00 Operating loss (152.00) Required: (a) Prepare a flexible budget for the Lasagne al Forno product for the actual level of production during November and compute the flexible budget variance for each element of operating profit/loss. [5 marks] (b) Using the appropriate variances, prepare a more detailed analysis of the flexible budget variances for direct and indirect variable costs. [8 marks] (c) Assuming that the budget was well set and achievable, suggest at least one possible reason for each of the variances identified in part (b) of this question. [7 marks] [Total: 20 marks]
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Question 16 Budgetary control systems provide the most effective way to encourage individuals to behave in a manner which is consistent with the overall aims of the organisation. Critically evaluate the above statement. Support your discussion with examples and references to the relevant literature. [20 marks]

Question 17 A BSc student is considering her financial circumstances just before starting university (i.e. at the end of Year 0). This is the information available to her. She will receive a tuition fee loan from the UK government. The loan consists of three payments of 3,465 each, made at the beginning of each of the three years of her BSc Programme. She will also receive a loan for maintenance expenses of 3,300 per annum paid by the government in the same way as the fee loan. The interest rate charged by the government is 1.5% per annum for the three years of the BSc programme. Required: a) Calculate the total Future Value, including interest, at the end of Year 3 of the payments made by the government to the student. [2 marks] The amount you found in Part (a) is the value of the total loan that the student has obtained from the government calculated at the end of Year 3. For the rest of the question consider this as the Present Value of the total loan amount.

Suppose that this loan has a 30-year maturity starting from the end of the university degree. The nominal interest rate on this loan is 4% per annum. The student repays the loan to the government with a fixed yearly payment at the end of each year. Required: b) What is the yearly payment that the student will make? [Hint: use Table with Annuity Factors attached on page 17]. [2 marks] Suppose now that the maturity of the loan is only 10 years instead of 30 years. Required: c) What is the yearly payment that the student will make? [1 mark]

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Question 17 (continued) Suppose now that the loan has no maturity, i.e. it goes on forever. Required: d) What is the yearly payment that the student will make? [1 mark] e) Briefly explain how a change in the maturity of the loan affects borrowers and lenders. [2 marks] Suppose that the maturity is again 30 years and that you are now told that inflation is 2.7% per annum between Year 3 and Year 33. Required: f) What are the nominal Future Value and the real Future Value of the total loan amount at maturity? [3 mark]

Suppose now that inflation is 4.5% per annum between Year 3 and Year 33. The loan has still a 30-year maturity. Required: g) What is the real Future Value of the loan at maturity? [2 marks] h) Briefly explain how a change in inflation affects borrowers and lenders. [2 marks] Finally, suppose that the government decides to change the compounding of the 4% per annum interest from yearly, as above, to quarterly compounding. In this case ignore inflation. Required: i) j) What is the Annual Effective Rate? [2 marks] What is the Future Value of the loan at maturity? [1 mark] k) Briefly explain how a change in the frequency of compounding affects borrowers and lenders. [2 marks] [Total: 20 marks]

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Appendix

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