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Business Accounting And Finance by Tony Davies And Ian Crawford Solution Manual

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TEXT BOOK SOLUTION WITH ANSWERS

 

 

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SAMPLE QUESTIONS

 

 

 

BUSINESS ACCOUNTING

AND FINANCE

TONY DAVIES

and

IAN CRAWFORD

 

Chapter 1 The importance of accounting

and fi nance

Questions

Q1.1 (i) How many diff erent types of business entity can you think of?

(ii) In what respect do they diff er fundamentally?

Q1.2 (i) Why are accountants required to produce fi nancial information?

(ii) Who do they produce it for and what do they do with it?

Q1.3 Describe the broad regulatory, professional, and operational framework of accounting.

Q1.4 What are conceptual frameworks of accounting?

Q1.5 (i) What are accounting concepts?

(ii) What purpose do they serve?

Q1.6 What is the UK Statement of Principles (SOP)?

Q1.7 (i) What is accountancy?

(ii) What is an accountant?

(iii) What do accountants do?

Q1.8 What do accountants mean by SSAPs and FRSs, and what are they for?

Q1.9 What are IASs and IFRSs and why are they important?

Q1.10 (i) What is fi nancial management?

(ii) How does fi nancial management relate to accounting and perhaps other disciplines?

Q1.11 How do fi nancial statements ensure accountability for the reporting of timely and accurate

information to shareholders is maintained?

Discussion points

D1.1 The managing director of a large public limited company stated: Ive built up my business

over the past 15 years from a one man band to a large plc. As we grew we seemed to spend

more and more money on accountants, fi nancial managers, and auditors. During the next

few months we are restructuring to go back to being a private limited company. This will be

much simpler and we can save a fortune on accounting and auditing costs. Discuss.

(Hint: You may wish to research Richard Branson and, for example, Virgin Air, on the Internet

to provide some background for this discussion.)

D1.2 The managing director of a growing private limited company stated: All these accounting

concepts and standards seem like a lot of red tape to me, and weve got fi nancial accountants

and management accountants as well as auditors. Surely all I need to know at the end of the

day is how much have we made. Discuss.

D1.3 Is accounting objective? Discuss with reference to at least six diff erent accounting concepts.

Exercises

Exercises E1.1 to E1.10 require an essay-type approach. You should refer to the relevant sections in

Chapter 1 to check your solutions.

Level I

E1.1 Time allowed 15 minutes

Discuss the implications of preparation of the income statement if there were no accounting

concepts.

E1.2 Time allowed 30 minutes

At a recent meeting of the local branch of the Womens Institute they had a discussion about what sort

of organisation they were. The discussion broadened into a general debate about all types of organisation,

and someone brought up the term business entity. Although there were many opinions,

there was little sound knowledge about what business entities are. Jane Cross said that her husband

was an accountant and she was sure he wouldnt mind spending an hour one evening to enlighten

them on the subject. Chris Cross fi shed out his textbooks to refresh his knowledge of the subject and

came up with a schedule of all the diff erent business entities he could think of together with the detail

of their defi ning features and key points of diff erence and similarity.

Prepare the sort of schedule that Chris might have drafted for his talk and identify the

category that the Womens Institute might fall into.

E1.3 Time allowed 30 minutes

Mary Andrews was an accountant but is now semi-retired. She has been asked by her local comprehensive

school careers offi cer to give a talk entitled: What is an accountant and what is accounting,

and what are its use and its purpose?.

Prepare a list of bullet points that covers everything necessary for Mary to give a comprehensive

and easy-to-understand presentation to a group of sixth-formers at the school.

Level II

E1.4 Time allowed 30 minutes

Accounting standards in general are reasonably clear and unambiguous.

Are there any major areas where accountants may disagree in balance sheet accounting?

E1.5 Time allowed 30 minutes

Financial statements are produced each year by businesses, using prescribed formats.

Should major plcs be allowed to refl ect their individuality in their own fi nancial statements?

E1.6 Time allowed 45 minutes

Professionals in the UK, for example, doctors, solicitors, accountants etc., normally work within partnerships.

Many tradesmen, such as plumbers, car mechanics, carpenters, and so on, operate as sole

traders. Software engineers seem to work for corporations and limited companies.

Consider the size of operation, range of products, fi nancing, the marketplace and the

geographical area served, to discuss why companies like Microsoft and Yahoo! should operate

as plcs.

E1.7 Time allowed 60 minutes

Bill Walsh has just been appointed Finance Director of a medium-sized engineering company, Nutsan

Ltd, which has a high level of exports and is very sensitive to economic changes throughout the UK

and the rest of the world. One of the tasks on Bills action list is a review of the accounting and fi nance

function.

What are the senior fi nancial roles that Bill would expect to be in place and what are the

important functions for which they should be responsible?

E1.8 Time allowed 60 minutes

Wembley Stadium II (the Football Associations replacement for the original iconic Wembley Stadium)

was planned to open in 2003 but due to numerous problems fi nancing the construction, problems

in the general day-to-day operations, and changes of contractor, it fi nally opened in March 2007.

There were many crises reported in the press during the course of the project and the development

fi nally cost over 1 billion.

You are required to research into the Wembley Stadium II project using the BBC, Financial

Times , and the other serious newspapers, and the Internet, and summarise the fi nancial

aspects of the project that you gather. You should focus on the attitudes expressed by the

general public, Government ministers, and the Football Association management, and consider

examples of bias, non-timeliness, and lack of transparency.

E1.9 Time allowed 60 minutes

Conceptual frameworks of accounting have been developed over many years and in many countries.

Explain how these culminated in the publication of the UK Statement of Principles (SOP) in

1999, and discuss the implications of each of the eight chapters.

E1.10 Time allowed 60 minutes

The International Accounting Standards Board (IASB) decreed the adoption of the International

Financial Reporting Standards (IFRSs) by all listed companies within the European Union mandatory

with eff ect from 1 January 2005.

Discuss the practical and political issues surrounding this decision.

 

 

Chapter 2 Classifying and recording

fi nancial transactions

 

Questions

Q2.1 What are the four basic business transactions and what are their corresponding debit and

credit accounting entries under the convention of double-entry bookkeeping?

Q2.2 (i) Name each of the books of account and ledgers in an accounting system.

(ii) What are they used for?

Q2.3 Describe the use and purpose of the fi ve main accounting adjusting entries.

Q2.4 (i) At a specifi c point in time, what does a companys trial balance show?

(ii) What may the trial balance not show?

Q2.5 How may the fi nancial performance of a company be ascertained from its trial balance?

Q2.6 How may the fi nancial position of a company be ascertained from its trial balance?

Q2.7 How may the cash position of a company be ascertained from its trial balance?

Q2.8 Why is the profi t made during an accounting period not necessarily equal to the cash fl ow

during that period?

Q2.9 In what ways do businesses adjust their accounts for accruals and prepayments?

Q2.10 What is the relevance of the accounting period?

Discussion points

D2.1 Managers who are non-accounting specialists dont need to learn about bookkeeping, debits

and credits, etc. Discuss.

D2.2 Computerised accounts and information systems have speeded up the recording of accounting

data and the presentation of information. What are the other advantages over manual

accounting systems and what are the disadvantages?

Exercises

Solutions are provided in Appendix 3 to all exercise numbers highlighted in colour.

Level I

E2.1 Time allowed 30 minutes

Extracts from the ledgers of Hall Ltd have provided the following information for 2009 and 2010.

Sales revenue 2009 11,000

Sales revenue 2010 12,000

Purchases 2009 7,100

Purchases 2010 8,300

Expenses 2009 2,500

Expenses 2010 2,800

Inventories 1 January 2009 600

Inventories 31 December 2009 700

Inventories 31 December 2010 800

Obsolete inventories included in 31 December 2010 inventories 200

You are required to prepare a basic income statement for the years ended 31 December 2009

and 2010.

E2.2 Time allowed 30 minutes

(a) Explain why there are always problems at the year end in the assessment of the costs

associated with electricity, gas and telephone.

(b) Using the information below, prepare the appropriate year-end accounting entries.

Electricity charges account balance at 15 December 2010: 10,000

Gas charges account balance at 20 December 2010: 5,000

Estimated consumption

Electricity 16 December to 31 December 2010: 300

Gas 21 December to 31 December 2010: 150

E2.3 Time allowed 30 minutes

Arthur Moment set up a table-making business, Forlegco, on 1 July 2010. He had 10,000 available

to invest, which is the amount he estimated was required for setting up costs. In the fi rst month of

trading Forlegco entered into the following transactions:

10,000 from Arthur Moment 10,000

Purchase of hand tools for cash 2,000

Purchase of lathe, power saw and drill on one months credit 6,000

Purchase of printing and stationery invoice received for half the order 100

The total order is 200, and it was all delivered in July and used

Purchase of advertising fl yers for cash 2,000 at 50p each, of which 1,000 will be used in July, and 500

in August and September

Purchases of timber, glue and varnish, from Woodco, payable within the month 1,500 half of this

inventory will be on hand at 31 July 2010

Sales of tables to Gardenfurnco for settlement one month later (10 tables at 700 each)

You are required to present these transactions in T account format, and then prepare a trial

balance for Forlegco for 31 July 2010.

E2.4 Time allowed 30 minutes

From the trial balance for Forlegco for 31 July 2010 (Exercise E2.3)

(i) Prepare a simple income statement for the month of July 2010.

(ii) Has Forlegco made a profi t in July?

(iii) If Forlegco has not made a profi t, why not?

E2.5 Time allowed 30 minutes

From the trial balance for Forlegco for 31 July 2010 (Exercise E2.3) prepare a simple balance

sheet at that date.

E2.6 Time allowed 30 minutes

From the trial balance for Forlegco for 31 July 2010 (Exercise E2.3) prepare a simple statement

of cash fl ows for the month of July 2010.

E2.7 Time allowed 30 minutes

You are required to prepare the appropriate correcting entries in a companys accounts at 31

December 2010 for the following:

(i) A cheque paid for rent amounting to 2,400 has been entered into the car hire account

in error.

(ii) A cheque for 980 was received from a customer in full settlement of a balance of

1,000, but no accounting entry for the discount has been made.

(iii) A cheque paid for insurance on the company cars amounting to 1,200 has been entered

in the cost of motor cars account in error.

(iv) An invoice from a builder for 3,500 has been entered in the buildings cost account, but

in fact it related to redecoration of the reception area of the offi ce and should be treated

as a building repair.

Level II

E2.8 Time allowed 60 minutes

David (Dai) Etcoak decided to set up a drinks wholesale business, Etcoakco, on 1 December 2009. He

had 100,000 available to invest, which is the amount he felt was required to set up the business. In

the fi rst month of trading Etcoakco entered into the following transactions:

100,000 from Dai Etcoak 100,000

Purchase for cash the freehold of a shop 50,000

Purchase for cash the shop fi ttings 7,000

Purchase of a labelling machine payable one month later 20,000

Cash expenses on printing and stationery 400

Purchases of inventory, from Gasco, of bottles of pop, payable three months later

(25,000 bottles at 1.25 each) 31,250

Sales of bottles of Etcoak to Boozah for settlement one month later

(10,000 bottles at 2.30 each) 23,000

Sales of bottles of Etcoak to Disco30, receivable in the month

(12,000 bottles at 2.30 each) 27,600

You are required to:

(i) look at these transactions in detail and then present them in T account format, and

(ii) state any assumptions you have made particularly relating to how you have valued

inventories transactions.

Also:

(iii) Do you think 100,000 was enough money or too much to invest in the business?

(iv) What alternative courses of action are open to Dai?

 

Chapter 3 Balance sheet

 

Questions

Q3.1 (i) What are the three main fi nancial statements?

(ii) What is their purpose?

(iii) What does the statement of changes in equity show?

Q3.2 Consider two ways of looking at the profi t of a business: an increase in the book wealth of the

company; and the net result of the companys trading operations (revenue less expenses).

What do these terms mean, and is the result diff erent using the two approaches?

Q3.3 Explain the format and structure of the balance sheet of a typical limited company.

Q3.4 Explain what assets, liabilities and shareholders equity are, and give some examples of the

items included in each of these categories.

Q3.5 Illustrate the diff erence between current liabilities and non-current liabilities by giving some

examples of each.

Q3.6 (i) What accounting convention is generally used in the valuation of non-current assets?

(ii) What additional costs may sometimes be included within non-current assets costs and

to which assets may these be applied?

Q3.7 Why are current assets and non-current assets shown under diff erent balance sheet classifi cations?

Q3.8 Describe what is meant by intangible assets and give some examples of how they may be

valued.

Q3.9 What factors infl uence the accurate valuation of a companys trade receivables?

Q3.10 Why should a potential investor exercise caution when analysing the balance sheets of potential

companies in which to invest?

Discussion points

D3.1 Surely the purchase of non-current assets is expenditure just like spending on stationery or

photocopy expenses so why should it appear as an entry in the balance sheet? Discuss.

D3.2 It has often been said that the value of every item in a balance sheet is a matter of opinion

and the cash and bank balances are the only numbers that can truly be relied upon.

Discuss.

Exercises

Solutions are provided in Appendix 3 to all exercise numbers highlighted in colour.

Level I

E3.1 Time allowed 30 minutes

Mr IM Green Manager Ian admired the sign on the door to his new offi ce, following his appointment

as manager of the human resources department. The previous manager left fairly suddenly to join

another company but had left Ian with some papers about the costs of his department, which showed

a total of 460,000 together with a list of items of expenditure. This seemed rather a high fi gure to

Ian for a department of fi ve people. Ians boss muttered something to him about capital expenditure

and revenue expenditure, but this was an area about which Ian had never been very clear. The list left

with Ian by his predecessor was as follows:

Legal fees 42,000

Five personal computers 15,000

Specialist HR software 100,000

Three laser printers 10,000

Salaries 158,000

Employee benefi t costs 16,000

Pension costs 14,000

Building repairs 25,000

Equipment repairs 8,000

Health and safety costs 20,000

Staff recruitment fees 10,000

Training costs 20,000

Subsistence and entertaining 10,000

Offi ce furniture 12,000

460,000

Assume that you are the fi nance manager whom Ian has asked for advice and provide him

with a list that separates the items into capital expenditure and revenue expenditure.

E3.2 Time allowed 30 minutes

The balances in the accounts of Vertico Ltd at 31 July 2010 are as follows:

000

Accrued expenses 95

Bank overdraft 20

Accounts receivable 275

Plant and equipment 309

Inventories of fi nished products 152

Computer system 104

Petty cash 5

Equity share capital 675

Accounts payable 293

Final payment on computer system due 1 September 2011 52

Loan for a factory building 239

Buildings 560

Raw materials 195

(i) An important number has been omitted. What is that?

(ii) Using the data provided and the missing data prepare a balance sheet for Vertico Ltd as

at 31 July 2010.

E3.3 Time allowed 45 minutes

You are required to prepare a balance sheet for Trainer plc as at 31 December 2010 using the

trial balance at 31 December 2010 and the additional information shown on the next page.

Debit Credit

000 000

Bank balance 73

Ordinary share capital 320

Land and buildings at cost 320

Plant and machinery at cost 200

Cumulative depreciation provision (charge for year 2010 was

20,000)

80

Inventories 100

Revenue 1,000

Cost of sales 600

Operating expenses 120

Depreciation 20

Bad debts written off 2

Accounts receivable 100

Accruals 5

Accounts payable 130

1,535 1,535

Additional information: the company will be paying 20,000 for corporation tax on the 2010 profi t

during 2011.

E3.4 Time allowed 45 minutes

The following information relates to Major plc at 31 December 2010 and the comparative numbers

at 31 December 2009.

2009 2010

000 000

Accruals 800 1,000

Bank overdraft 16,200

Cash at bank 600

Plant and machinery at cost 17,600 23,900

Debenture loan (interest at 15% per annum) 600 750

Plant and machinery depreciation 9,500 10,750

Proposed dividends 3,000 6,000

Ordinary share capital 5,000 5,000

Preference share capital 1,000 1,000

Prepayments 300 400

Retained earnings 3,000 10,100

Inventories 5,000 15,000

Tax payable 3,200 5,200

Accounts payable 6,000 10,000

Accounts receivable 8,600 26,700

Prepare a balance sheet in the format adopted by most of the leading UK plcs showing the

previous year comparative fi gures.

From the trial balance of Gremlins plc at 31 March 2010 identify the assets and expenses

(debit balances) and income, liabilities and equity (credit balances). Confi rm that the trial

balance is in balance, then prepare a balance sheet for Gremlins Ltd as at 31 March 2010.

000

Depreciation on offi ce equipment and furnishings (administrative expenses) 156

Bank overdraft 609

Accountancy and audit fees 30

Electricity paid in advance 45

Computer system (net book value) 441

Advertising and promotion 135

Share premium account 240

Interest received 15

Plant and equipment (net book value) 927

Amount for fi nal payment on factory machine due March 2012 252

Accounts receivable 1,110

Goodwill 204

Twelve-year lease on factory 330

Rents received 63

Prepaid expenses 885

Interest paid 120

Offi ce electricity 66

Retained earnings at 1 April 2009 513

Inventories of materials at 31 March 2010 585

Telephone 87

Distribution costs 162

Other offi ce utilities 72

Cost of goods sold 1,659

Administrative salaries 216

Sales department salaries 267

Furniture and fi xtures (net book value) 729

Revenue 3,267

Offi ce rent 165

Finished products at 31 March 2010 84

Debenture loan 750

Accounts payable 1,257

Bank and cash 51

Share capital 1,560

Level II

E3.6 Time allowed 60 minutes

Prepare a balance sheet as at 31 December 2010 for Gorban Ltd based on the following trial

balance, and the further information shown below.

Equity share capital 200,000

Retained earnings 108,968

Building at cost 130,000

Machinery at cost 105,000

Provision for depreciation as at 31 December 2010 30,165

Provision for doubtful debts at 31 December 2010 1,725

Accounts payable 35,112

Accounts receivable 42,500

Bank balance 67,050

Loan 20,000

Inventories as at 31 December 2010 51,420

395,970 395,970

You are given the following additional information, which is not refl ected in the above trial balance.

(a) The authorised and issued share capital is divided into 200,000 shares at 1 each.

(b) Wages unpaid at 31 December 2010 amounted to 1,173.

(c) Inventories at 31 December 2010 were found to have been undervalued by 48,000.

(d) The provision for doubtful debts is to be increased by 1,870.

(e) Additional machinery was purchased on 31 December 2010 for cash at a cost of 29,368.

(f) The company issued 50,000 1 ordinary shares at par on 31 December 2010.

(g) A customer owing 10,342 went into liquidation on 9 January 2011 a bad debt which had not

previously been provided for.

(h) The loan was repaid on 31 December 2010.

E3.7 Time allowed 60 minutes

You are required to prepare a balance sheet as at 31 December 2010 from the following summary

of Pip Ltds fi nancial position at 31 December 2010.

Brands worth 10,000 (directors opinion)

Reputation in the local area 10,000 (directors opinion)

Inventories at cost 50,000 and resale value 85,000, with obsolete inventories 5,000 within the

50,000

Bank overdraft facility 20,000 agreed by the bank manager

Cash in the offi ce 1,000

Cash in the bank number one current account 10,000

Overdraft on the bank number two current account 10,000, per the bank statement

Land and buildings at cost 100,000

Plant and equipment at cost 150,000

Plant and equipment cumulative depreciation 50,000

Plant and equipment market value 110,000

Accounts payable 81,000

Invoices outstanding by all customers 50,000, including an invoice of 5,000 owed by a customer

in liquidation (Pip Ltd has been advised by the receiver that 1p in the 1 will be paid to creditors)

Past profi ts reinvested in the business 110,000

Ordinary shares issued 100,000 (authorised ordinary shares 200,000)

 

Chapter 4 Income statement

 

Questions

Q4.1 How would you defi ne the profi t (or loss) earned by a business during an accounting period?

Q4.2 Outline an income statement showing each of the main category headings using the business

functions format.

Q4.3 (i) Which accounting or fi nancial reporting standard contains provisions relating to the

format of the income statement?

(ii) What are the requirements that are relevant to the formats of the income statement of a

limited company?

Q4.4 The income statement and the balance sheet report on diff erent aspects of a companys fi nancial

status. What are these diff erent aspects and how are they related?

Q4.5 (i) Why are the methods used for the valuation of the various types of assets so important?

(ii) Describe the three main categories of asset that are most relevant to asset valuation.

Q4.6 What is depreciation and what are the problems encountered in dealing with the depreciation

of non-current assets?

Q4.7 Describe three of the most commonly used methods of accounting for depreciation.

Q4.8 Describe four of the most commonly used methods of valuing inventory.

Q4.9 How does the valuation of trade receivables impact on the income statement of a business?

Q4.10 Profi t does not equal cash, but how can the one be reconciled with the other for a specifi c

accounting period?

Discussion points

D4.1 My profi t for the year is the total of my pile of sales invoices less the cash I have paid out during

the year. Discuss.

D4.2 The reason why companies make a provision for depreciation of their non-current assets is

to save up enough money to buy new ones when the old assets reach the end of their lives.

Discuss.

D4.3 Why is judgement so important in considering the most appropriate method to use for valuing

inventories? What are the factors that should be borne in mind and what are the pros and

cons of the alternative methods?

Exercises

Solutions are provided in Appendix 3 to all exercise numbers highlighted in colour.

Level I

E4.1 Time allowed 30 minutes

Mr Kumars chemist shop derives income from both retail sales and from prescription charges made

to the NHS and to customers. For the last two years to 31 December 2009 and 31 December 2010 his

results were as follows:

2009 2010

Sales and prescription charges to customers 196,500 210,400

Prescription charges to the NHS 48,200 66,200

Purchases of inventories 170,100 180,600

Opening inventories at the start of the year 21,720 30,490

Closing inventories at the end of the year 30,490 25,300

Wages 25,800 27,300

Mr Kumars drawings* 20,500 19,700

Rent and property taxes 9,400 13,200

Insurance 1,380 1,620

Motor vehicle expenses 2,200 2,410

Other overheads 14,900 15,300

*Note that Mr Kumars drawings are the amounts of money that he has periodically taken out of the business for

his own use and should be shown as a deduction from the profi ts earned by the business rather than an expense

in the income statement.

Rent for the year 2009 includes 2,400 paid in advance for the half year to 31 March 2010, and for

2010 includes 3,600 paid in advance for the half year to 31 March 2011. Other overheads for 2009

do not include the electricity invoice for 430 for the fi nal quarter (included in 2010 other overheads).

There is a similar electricity invoice for 510 for 2010. Depreciation may be ignored.

(i) Prepare an income statement for the two years to 31 December.

(ii) Why do you think that there is a diff erence in the gross profi t to sales % between the two

years.

(iii) Using Mr Kumars business as an example, explain the accruals accounting concept

and examine whether or not it has been complied with.

E4.2 Time allowed 30 minutes

Discuss the concepts that may apply and practical problems that may be encountered when

accounting for:

(i) the acquisition of desktop personal computers, and

(ii) popular brands of products supplied by retailers

with specifi c comments regarding their depreciation reported in the income statement and

their net book values reported in the balance sheet.

E4.3 Time allowed 30 minutes

A friend of yours owns a shop selling CDs and posters for the 12- to 14-year-old market.

From the following information advise him on the potential problems that may be encountered

in the valuation of such items for balance sheet purposes:

(a) greatest hits compilation CDs have sold consistently over the months and cost 5,000 with a

retail value of 7,000

(b) sales of specifi c group CDs, which ceased recording in the previous year, have now dropped off to

zero and cost 500 with a total retail value of 700

(c) specifi c band CDs, which are still constantly recording and selling in the shop every week cost

1,000 with a total retail value of 1,400

(d) specifi c artist posters are currently not selling at all (although CDs are), and cost 50 with a retail

value of 100.

E4.4 Time allowed 30 minutes

The Partex company began trading in 2008, and all sales are made to customers on credit. The company

is in a sector that suff ers from a high level of bad debts, and a provision for doubtful debts of 4%

of outstanding accounts receivable is made at each year end.

Information relating to 2008, 2009 and 2010 is as follows:

Year to 31 December

2008 2009 2010

Outstanding accounts receivable at 31 December* 88,000 110,000 94,000

Bad debts to be written off during year 4,000 5,000 4,000

*before bad debts have been written off

You are required to state the amount that will appear:

(i) in the balance sheet for trade receivables, and

(ii) in the income statement for bad debts.

E4.5 Time allowed 45 minutes

Tartantrips Ltd, a company in Scotland, operates several ferries and has a policy of holding several

in reserve, due to the weather patterns and conditions of various contracts with local authorities. A

ferry costs 5 million and has an estimated useful life of 10 years, at which time its realisable value is

expected to be 1 million.

Calculate and discuss three methods of depreciation that the company may use:

(i) sum of the digits

(ii) straight line

(iii) reducing balance.

E4.6 Time allowed 60 minutes

From the following fi nancial information that has been provided by Lazydays Ltd, for the

year ended 31 March 2010 (and the corresponding numbers for the year to 31 March 2009),

construct an income statement, using the format adopted by the majority of UK plcs, including

comparative fi gures.

2010 2009

Administrative expenses 22,000 20,000

Depreciation 5,000 5,000

Closing inventories 17,000 15,000

Distribution costs 33,000 30,000

Dividends paid 32,000 30,000

Dividends received from non-related companies 5,000 5,000

Interest paid 10,000 10,000

Interest received 3,000 3,000

Opening inventories 15,000 10,000

Purchases 99,000 90,000

Redundancy costs 5,000

Sales revenue 230,000 200,000

Taxation 25,000 24,000

(a) Depreciation is to be included in administrative expenses

(b) Redundancy costs are to be regarded as an exceptional item to be included in administrative

expenses

Level II

E4.7 Time allowed 60 minutes

Llareggyb Ltd started business on 1 January 2010 and its year ended 31 December 2010. Llareggyb

entered into the following transactions during the year.

Received funds for share capital of 25,000

Paid suppliers of materials 44,000

Purchased 11,000 units of a product at 8 per unit, which were sold to customers at 40 per unit

Paid heating and lighting costs for cash 16,000

Further heating and lighting costs of 2,400 were incurred within the year, but still unpaid at

31 December 2010

Mr D Thomas loaned the company 80,000 on 1 January 2010 at 8% interest per annum

Loan interest was paid to Mr Thomas for January to June 2010

8,000 product units were sold to customers during 2010

Customers paid 280,000 to Llareggyb for sales of its products

Rent on the premises 60,000 was paid for 18 months from 1 January 2010, and local business

property taxes of 9,000 were also paid for the same period

Salaries and wages were paid for January to November 2010 amounting to 132,000 but the

December payroll cost of 15,000 had not yet been paid as at 31 December 2010

A lorry was purchased for 45,000 on 1 January 2010 and was expected to last for fi ve years after

which it was estimated that it could be sold for 8,000

The company uses the straight line method of depreciation.

Prepare an income statement for Llareggyb Ltd for the year ended 31 December 2010.

E4.8 Time allowed 60 minutes

From the trial balance of Retepmal Ltd at 31 March 2010 shown below prepare an income

statement for the year to 31 March 2010 and a balance sheet as at 31 March 2010 using the

formats used by most UK companies.

Premises (net book value) 95,000

Accounts receivable 75,000

Purchases of inventories 150,000

Retained earnings at 31 March 2009 130,000

Inventories at 31 March 2009 15,000

Furniture and fi xtures 30,000

Sales revenue 266,000

Distribution costs 40,000

Administrative expenses 50,000

Accounts payable 54,000

Motor vehicles (net book value) 40,000

Cash and bank 35,000

Equity share capital 80,000

Additional information:

(a) Inventories at 31 March 2010 were 25,000.

(b) Dividend proposed for 2010 was 7,000.

(c) An accrual for distribution costs of 3,000 was required at 31 March 2010.

(d) A prepayment of administrative expenses of 5,000 was required at 31 March 2010.

(e) Corporation tax estimated to be payable on 2009/2010 profi t was 19,000.

(f) Annual depreciation charges on premises and motor vehicles for the year to 31 March 2010 are

included in administrative expenses and distribution costs, and in the cumulative depreciation

provisions used to calculate the net book values of 95,000 and 40,000 respectively, shown in

the trial balance at 31 March 2010.

The furniture and fi xtures balance of 30,000 relates to purchases of assets during the year to

31 March 2010. The depreciation charge in administrative expenses and the corresponding depreciation

provision are not included in the trial balance at 31 March 2010. They are required to be

calculated on a straight line basis for a full year to 31 March 2010, based on a useful economic life of

eight years and an estimated residual value of 6,000.

 

Chapter 5 Statement of cash fl ows

Questions

Q5.1 (i) How would you defi ne cash generated by a business during an accounting period?

(ii) Which International Accounting Standard (IAS) deals with cash fl ow?

Q5.2 Give an example of a statement of cash fl ows showing each of the main categories.

Q5.3 Give an example of the supporting analyses and notes that are prepared in support of the

main statement of cash fl ows.

Q5.4 Describe the ways in which both the direct method and the indirect method may be used by

a business to derive cash generated from operations during an accounting period.

Q5.5 (i) Which cash analysis is used to link the statement of cash fl ows to the income statement?

(ii) How does it do that?

Q5.6 (i) Which cash analysis is used to link the statement of cash fl ows to the balance sheet?

(ii) What are the links?

Q5.7 Why is cash so important, compared to the other assets used within a business?

Q5.8 (i) What questions does the statement of cash fl ows aim to answer?

(ii) How far does it go towards answering them?

Discussion points

D5.1 Why is the information disclosed in the income statement and the balance sheet not considered

suffi cient for users of fi nancial information? What is so important about cash fl ow that

it has an International Accounting Standard, IAS 7, devoted to it?

D5.2 Forget your income statements and balance sheets, at the end of the day its the businesss

healthy bank balance that is the measure of its increase in wealth. Discuss.

Exercises

Solutions are provided in Appendix 3 to all exercise numbers highlighted in colour.

Level I

E5.1 Time allowed 60 minutes

Candice-Marie James and Flossie Graham obtained a one-year lease on a small shop which cost

them 15,000 for the year 2010, and in addition agreed to pay rent of 4,000 per year payable one

year in advance. Candyfl oss started trading on 1 January 2010 as a fl orist, and Candice and Flossie

bought a second-hand, white delivery van for which they paid 14,500. The business was fi nanced

by Candice and Flossie each providing 9,000 from their savings, and receipt of an interest-free loan

from Candices uncle of 3,000. Candice and Flossie thought they were doing OK over their fi rst six

months but they werent sure how to measure this. They decided to try and see how they were doing

fi nancially and looked at the transactions for the fi rst six months:

Cash transactions:

Cash sales of fl owers 76,000

Rent paid 4,000

Wages paid 5,000

Payments for other operating expenses 7,000

Purchases of inventories of fl owers for resale 59,500

Legal expenses paid for the lease acquisition 1,0

Chapter 5 Statement of cash fl ows

E5.2 Time allowed 60 minutes

Using the information from Exercise E5.1 prepare a statement of cash fl ows for Candyfl oss

for the fi rst six months of the year 2010, using the indirect method.

E5.3 Time allowed 60 minutes

Jaff rey Packaging plc have used the following information in the preparation of their fi nancial statements

for the year ended 31 March 2010.

000

Dividends paid 25

Issue of a debenture loan 200

Reduction in inventories 32

Corporation tax paid 73

Interest paid 28

Operating profi t for the year 450

Cash and cash equivalents 31 March 2010 376

Purchase of factory equipment 302

Dividends payable at 31 March 2010 25

Interest received 5

Depreciation charge for the year 195

Purchase of a new large computer system 204

Sale of a patent (intangible non-current asset) 29

Increase in trade and other receivables 43

Reduction in trade and other payables 62

Cash and cash equivalents 1 April 2009 202

You are required to prepare a cash generated from operations statement for Jaff rey Packaging

Ltd using the indirect method, and a statement of cash fl ows for the year ended 31 March 2010

in compliance with the provisions of IAS 7, and also an analysis of cash and cash equivalents

for the same period.

In addition, at 30 June 2010:

The business owed a further 4,000 for the purchase of fl owers and 1,000 for other operating

expenses.

Customers had purchased fl owers on credit and the sum still owed amounted to 8,000.

One customer was apparently in fi nancial diffi culties and it was likely that the 1,500 owed would

not be paid.

Inventories of fl owers at 30 June 2010 valued at cost were 9,500.

They estimated that the van would last four years, at which time they expected to sell it for 2,500,

and that depreciation would be spread evenly over that period.

(i) Prepare a statement of cash fl ows for Candyfl oss for the fi rst six months of the year

2010 using the direct method.

(ii) Prepare an income statement for Candyfl oss for the fi rst six months of the year 2010,

on an accruals basis.

(iii) Why is the profi t diff erent from the cash fl ow?

(iv) Which statement gives the best indication of the fi rst six months performance of

Candyfl oss?

E5.4 Time allowed 60 minutes

From the income statement for the year ended 31 December 2010 and balance sheets as at

31 December 2009 and 31 December 2010, and the additional information shown below,

prepare a statement of cash fl ows for Medco Ltd for the year to 31 December 2010 .

Income statement 2010

Operating profi t 2,500

Interest paid (100)

Profi t before tax 2,400

Income tax paid (500)

Profi t for the year 1,900

Balance sheet as at 31 December 2010 2009

Non-current assets 28,000 20,000

Current assets

Inventories 6,000 5,000

Trade and other receivables 4,000 3,000

Investments 5,100 3,000

Cash and cash equivalents 2,150 5,000

Total current assets 17,250 16,000

Total assets 45,250 36,000

Current liabilities

Borrowings and fi nance leases (6,000) (2,000)

Trade and other payables (4,000) (6,000)

Current tax liabilities (500) (400)

Dividend (proposed) (600) (450)

Total current liabilities (11,100) (8,850)

Non-current liabilities

Borrowings and fi nance leases (2,000) (1,000)

Total liabilities (13,100) (9,850)

Net assets 32,150 26,150

Equity

Ordinary share capital 14,000 10,000

Share premium account 6,000 5,000

Retained earnings 12,150 11,150

Total equity 32,150 26,150

During the year 2010 the company:

(a) acquired new non-current assets that cost 12,500

(b) issued new share capital for 5,000

(c) sold non-current assets for 2,000 that had originally cost 3,000 and had a net book value of

2,500

(d) depreciated its non-current assets by 2,000

(e) paid an interim dividend of 300,000 during the year and proposed a fi nal dividend of 600,000.

Level II

E5.5 Time allowed 90 minutes

Llareggyb Ltd started business on 1 January 2010 and its year ended 31 December 2010. Llareggyb

entered into the following transactions during the year.

Received funds for share capital of 25,000

Paid suppliers of materials 44,000

Purchased 11,000 units of a product at 8 per unit, which were sold to customers at 40 per unit

Paid heating and lighting costs for cash 16,000

Further heating and lighting costs of 2,400 were incurred within the year, but still unpaid at

31 December 2010

Mr D Thomas loaned the company 80,000 on 1 January 2010 at 8% interest per annum

Loan interest was paid to Mr Thomas for January to June 2010

8,000 product units were sold to customers during 2010

Customers paid 280,000 to Llareggyb for sales of its products

Rent on the premises 60,000 was paid for 18 months from 1 January 2010, and local business property

taxes of 9,000 were also paid for the same period

Salaries and wages were paid for January to November 2010 amounting to 132,000 but the

December payroll cost of 15,000 had not yet been paid as at 31 December 2010

A lorry was purchased for 45,000 on 1 January 2010 and was expected to last for fi ve years after

which it was estimated that it could be sold for 8,000

The company uses the straight line method of depreciation.

You are required to:

(i) prepare a balance sheet for Llareggyb Ltd as at 31 December 2010.

(ii) prepare a statement of cash fl ows for Llareggyb Ltd for the year ended 31 December

2010.

(Note: you may use the profi t or loss fi gure calculated in Exercise E4.7 to complete this

exercise.)

E5.6 Time allowed 90 minutes

The balance sheets for Victoria plc as at 30 June 2009 and 30 June 2010 are shown below:

Victoria plc

Balance sheet as at 30 June

000 000

2009 2010

Non-current assets

Cost 6,900 9,000

Depreciation provision 900 1,100

Total non-current assets 6,000 7,900

Current assets

Inventories 2,600 4,000

Trade and other receivables 2,000 2,680

Cash and cash equivalents 200

Total current assets 4,800 6,680

Total assets 10,800 14,580

Current liabilities

Borrowings and fi nance leases 600

Trade and other payables 2,000 1,800

Current tax liabilities 300 320

Dividend payable 360 480

Total current liabilities 2,660 3,200

Non-current liabilities

Borrowings and fi nance leases 1,000 1,000

Total liabilities 3,660 4,200

Net assets 7,140 10,380

Equity

Ordinary share capital 4,000 5,500

Share premium account 1,240

Retained earnings 3,140 3,640

Total equity 7,140 10,380

The following information is also relevant:

  1. During the years 2009 and 2010 Victoria plc disposed of no non-current assets.
  2. Interim dividends were not paid during the years ended 30 June 2009 and 2010.
  3. Non-current liabilities borrowing is a 10% 1m debenture and loan interest was paid on

10 February in each year.

You are required to:

(i) Calculate:

(a) profi t before tax for the year ended 30 June 2010

(b) operating profi t for the year ended 30 June 2010

(ii) Prepare for Victoria plc for the year to 30 June 2010 a statement of cash generated from

operations using the indirect method, and a statement of cash fl ows for the year ended

30 June 2010 in compliance with IAS 7, and also an analysis of cash and cash equivalents

for the same period.

E5.7 Time allowed 90 minutes

Sparklers plc have completed the preparation of their income statement for the year ended

31 October 2010 and their balance sheet as at 31 October 2010. During the year Sparklers sold some

non-current assets for 2m that had originally cost 11m. The cumulative depreciation on those assets

at 31 October 2009 was 7.6m.

You have been asked to prepare a statement of cash fl ows for the year ended 31 October

2010 in compliance with IAS 7. The directors are concerned about the large bank overdraft

at 31 October 2010, which they believe is due mainly to the increase in trade receivables as

a result of apparently poor credit control. What is your assessment of the reasons for the

increased short-term borrowings?

Sparklers plc

Income statement for the year ended 31 October 2010

m m

2010 2009

Operating profi t 41.28 18.80

Interest paid (0.56)

Interest received 0.08 0.20

Profi t before tax 40.80 19.00

Income tax expense (10.40) (6.40)

Profi t for the year 30.40 12.60

Dividends:

Preference paid (0.20) (0.20)

Ordinary: interim paid (4.00) (2.00)

fi nal proposed (12.00) (6.00)

Retained profi t for the year 14.20 4.40

Sparklers plc

Balance sheet as at 31 October 2010

2010 2009

m m

Non-current assets

Tangible at cost 47.80 35.20

Depreciation provision (21.50) (19.00)

Total non-current assets 26.30 16.20

Current assets

Inventories 30.00 10.00

Trade and other receivables 54.20 17.80

Cash and cash equivalents 1.20

Total current assets 84.20 29.00

Total assets 110.50 45.20

Current liabilities

Borrowings and fi nance leases 32.40

Trade and other payables 22.00 13.60

Dividends payable 12.00 6.00

Income tax payable 10.40 6.40

Total current liabilities 76.80 26.00

Non-current liabilities

Debenture loan 1.50 1.20

Total liabilities 78.30 27.20

Net assets 32.20 18.00

Equity

Ordinary share capital 1 ordinary shares 10.00 10.00

Preference share capital 1 preferences shares 10% 2.00 2.00

Retained earnings 20.20 6.00

Total equity 32.20 18.00

E5.8 Time allowed 90 minutes

Dimarian plcs income statement for the year ended 31 December 2010, and its balance sheets as at

31 December 2010 and 2009, are shown below. Dimarian plc issued no new ordinary shares during

the year.

During 2010 Dimarian plc spent 100,000 on non-current assets additions. There were no noncurrent

assets disposals during 2010.

Dimarian plc

Income statement for the year ended 31 December 2010

Figures in 000

Revenue 850

Cost of sales (500)

Gross profi t 350

Distribution costs and administrative expenses (120)

230

Other operating income 20

Operating profi t 250

Interest paid (30)

220

Interest received 10

Profi t before tax 230

Income tax expense (50)

Profi t for the year 180

Retained profi t 1 January 2010 230

410

Proposed dividends (80)

Retained earnings 31 December 2010 330

Dimarian plc

Balance sheet as at 31 December 2010

Figures in 000 2010 2009

Non-current assets

Tangible 750 800

Intangible 40 50

Total non-current assets 790 850

Current assets

Inventories 50 60

Trade and other receivables 190 200

Cash and cash equivalents 20 10

Total current assets 260 270

Total assets 1,050 1,120

Current liabilities

Borrowings and fi nance leases 20 10

Trade and other payables 70 80

Dividends payable 80 70

Income tax payable 50 30

Total current liabilities 220 190

Non-current liabilities

Debenture loan 100 300

Total liabilities 320 490

Net assets 730 630

Equity

Share capital 260 260

Share premium account 50 50

Revaluation reserve 90 90

Retained earnings 330 230

Total equity 730 630

You are required to prepare:

(i) An indirect statement of cash fl ows for the year to 31 December 2010.

(ii) A statement of cash fl ows for the year ended 31 December 2010, in the format required

by IAS 7.

(iii) An analysis of cash and cash equivalents for the years ended 31 December 2009 and

31 December 2010.

 

 

Chapter 6 Corporate governance

 

Questions

Q6.1 (i) How was the UK Corporate Governance Code developed?

(ii) Why was it considered necessary?

Q6.2 Refer to the Johnson Matthey section on corporate governance in their annual report and

accounts 2010, shown on pages 192206, and illustrate their areas of compliance (or not)

under the UK Corporate Governance Code (as distinct from the previous Combined Code of

Practice).

Q6.3 (i) Which areas of the business do auditors opinions cover?

(ii) What happens if there is any fundamental uncertainty as to compliance?

Q6.4 Explain the implications of the expectation gap with regard to external auditors.

Q6.5 Explain the obligations of directors of limited companies in terms of their duty of care, their

fi duciary duty, and the Corporate Manslaughter and Corporate Homicide Act (2007).

Q6.6 If the severity of the penalty is determined by the seriousness of the off ence, describe the half

dozen or so most serious off ences under the Company Directors (Disqualifi cation) Act 1986

(as amended by the Enterprise Act 2002), which relate to directors of limited companies.

Q6.7 Outline the general responsibilities of a director of a limited company with regard to the

company, its shareholders and other stakeholders.

Q6.8 What are the key actions that a director of a limited company may take to ensure compliance

with his or her obligations and responsibilities?

Discussion points

D6.1 Discuss, and illustrate with some examples, how far you think the UK Corporate Governance

Code goes to preventing the kind of corporate excesses we have seen in the recent past.

D6.2 I pay my auditors a fortune in audit fees. I look upon this almost as another insurance premium

to make sure that Im protected against every kind of fi nancial risk. Discuss.

D6.3 Everyone who embarks on a career in industry or commerce aspires to become a director

of their organisation, because then all their troubles are over! Directors just make a few

decisions, swan around in their company cars, and pick up a fat cheque at the end of each

month for doing virtually nothing. Discuss.

D6.4 In an age of increasingly sophisticated computer systems is the traditional role of the auditor

coming to an end?

Exercises

Solutions are provided in Appendix 3 to all exercise numbers highlighted in colour.

Level I

E6.1 Time allowed 30 minutes

Discuss why users of fi nancial statements should have information on awards to directors of

share options, allowing them to subscribe to shares at fi xed prices in the future.

E6.2 Time allowed 30 minutes

Outline the basic reasons why there should be openness regarding directors benefi ts and perks.

E6.3 Time allowed 30 minutes

Can you think of any reasons why directors of UK plcs found that their contracts were no

longer to be open-ended under the new regime of corporate governance?

E6.4 Time allowed 60 minutes

William Mason is the managing director of Classical Gas plc, a recently formed manufacturing

company in the chemical industry, and he has asked you as fi nance director to prepare

a report that covers the topics, together with a brief explanation, to be included in a section

on corporate governance in their forthcoming annual report and accounts.

Level II

E6.5 Time allowed 60 minutes

After the birth of her twins Vimla Shah decided to take a couple of years away from her career as

a company lawyer. During one of her coff ee mornings with Joan Turnbull, Joan confi ded in her

that although she was delighted at her husband Ronnies promotion to commercial director of his

company, which was a large UK plc in the food industry, she had heard many horror stories about

problems that company directors had encountered, seemingly through no fault of their own. She was

worried about the implications of these obligations and responsibilities (whatever they were) that

Ronnie had taken on. Vimla said she would write some notes about what being a director of a plc

meant, and provide some guidelines as to the type of things that Ronnie should be aware of, and to include

some ways in which Ronnie might protect himself, that may all off er some reassurance to Joan.

Prepare a draft of what you think Vimlas notes for Joan may have included.

E6.6 Time allowed 60 minutes

Li Nan has recently been appointed managing director of Pingers plc, which is a company that supplies

table tennis equipment to clubs and individuals throughout the UK and Europe. Li Nan is surprised

at the high fi gure that appeared in last years accounts under audit fees.

Li Nan is

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