Preparing Financial Statements

PART 1 THURSDAY 6 DECEMBER 2001

(International Stream)

QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A ALL 25 questions are compulsory and MUST be answered Section B ALL FIVE questions are compulsory and MUST be answered

Paper 1.1(INT)

Section A – ALL TWENTY-FIVE questions are compulsory and MUST be attempted Please use the answer sheet provided to indicate your choice in each question Each question within this section is worth 2 marks 1 The trial balance totals of Gamma at 30 September 2001 are: Debit Credit $992,640 $1,026,480

Which TWO of the following possible errors could, when corrected, cause the trial balance to agree? 1. 2. 3. 4. A B C D An item in the cash book $6,160 for payment of rent has not been entered in the rent payable account. The balance on the motor expenses account $27,680 has incorrectly been listed in the trial balance as a credit. $6,160 proceeds of sale of a motor vehicle has been posted to the debit of motor vehicles asset account. The balance of $21,520 on the rent receivable account has been omitted from the trial balance. 1 and 2 2 and 3 2 and 4 3 and 4

2

The trial balance of Delta, a limited liability company, did not agree and a suspense account was opened for the difference. The following errors were subsequently found: 1. 2. 3. 4. 5. A cash refund due to customer A was correctly treated in the cash book and then credited to the accounts receivable ledger account of customer B. The sale of goods to a director for $300 was recorded by debiting sales revenue account and crediting the director’s current account. The total of the discount received column in the cash book had been credited in error to the discount allowed account. Some of the cash received from customers had been used to pay sundry expenses before banking the money. $5,800 paid for plant repairs was correctly treated in the cash book and then credited to plant and equipment asset account.

Which of the above errors would require an entry to the suspense account as part of the process of correcting them? A B C D 1, 3 and 5 1, 2 and 5 1 and 5 3 and 4

3

Beta purchased some plant and equipment on 1 July 2001 for $40,000. The estimated scrap value of the plant in ten years’ time is estimated to be $4,000. Beta’s policy is to charge depreciation on the straight line basis, with a proportionate charge in the period of acquisition. What should the depreciation charge for the plant be in Beta’s accounting period of twelve months to 30 September 2001? A B C D $720 $600 $900 $675

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1D INTAD Paper 1.1(INT)

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Theta prepares its financial statements for the year to 30 April each year. The company pays rent for its premises quarterly in advance on 1 January, 1 April, 1 July and 1 October each year. The annual rent was $84,000 per year until 30 June 2000. It was increased from that date to $96,000 per year. What rent expense and end of year prepayment should be included in the financial statements for the year ended 30 April 2001? A B C D Expense $93,000 $93,000 $94,000 $94,000 Prepayment $8,000 $16,000 $8,000 $16,000

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At 30 September 2000, the following balances existed in the records of Lambda: Plant and equipment: Cost Accumulated depreciation $ 860,000 397,000

During the year ended 30 September 2001, plant with a written down value of $37,000 was sold for $49,000. The plant had originally cost $80,000. Plant purchased during the year cost $180,000. It is the company’s policy to charge a full year’s depreciation in the year of acquisition of an asset and none in the year of sale, using a rate of 10% on the straight line basis. What net amount should appear in Lambda’s balance sheet at 30 September 2001 for plant and equipment? A B C D $563,000 $467,000 $510,000 $606,000

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At 30 September 2000, Z Ltd had a provision for doubtful debts of $37,000. During the year ended 30 September 2001 the company wrote off debts totalling $18,000, and at the end of the year it is decided that the provision for doubtful debts should be $20,000. What should be included in the income statement for bad and doubtful debts? A B C D $35,000 debit $1,000 debit $38,000 debit $1,000 credit

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Which of the following best explains the imprest system of petty cash control? A B C D Weekly expenditure cannot exceed a set amount. The exact amount of expenditure is reimbursed at intervals to maintain a fixed float. All expenditure out of the petty cash must be properly authorised. Regular equal amounts of cash are transferred into petty cash at intervals.

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1D INTAH Paper 1.1(INT)

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In reconciling a business cash book with the bank statement, which of the following items could require a subsequent entry in the cash book? 1. 2. 3. 4. 5. 6. A B C D Cheques presented after date. A cheque from a customer which was dishonoured. An error by the bank. Bank charges. Deposits credited after date. Standing order entered in bank statement. 2, 3, 4 and 6 1, 2, 5 and 6 2, 4 and 6 1, 3 and 5

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The following bank reconciliation statement has been prepared for Omega by a junior clerk: Overdraft per bank statement Add: Deposits not credited Less outstanding cheques Overdraft per cash book $ 68,100 141,200 209,300 41,800 167,500

Which of the following should be the correct balance per the cash book? A B C D $167,500 overdrawn as stated. $31,300 overdrawn $31,300 cash at bank $114,900 overdrawn

10 X and Y are in partnership, sharing profits equally and preparing their accounts to 31 December each year. On 1 July 2000, Z joined the partnership, and from that date profits are shared X 40%, Y 40% and Z 20%. In the year ended 31 December 2000, profits were: 6 months to 31 June 2000 6 months to 31 December 2000 $ 200,000 300,000

It was agreed that X and Y only should bear equally the expense for a bad debt of $40,000 written off in the six months to 31 December 2000 in arriving at the $300,000 profit. Which of the following correctly states X’s profit share for the year? Profit share X $ 216,000 200,000 220,000 224,000

A B C D

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11 S and T are in partnership and prepare their accounts to 31 December each year. On 1 July 2000, U joined the partnership. Profit sharing arrangements are: Salary Share of balance of profit S S T U 6 months to 30 June 2000 6 months to 31December 2000 $15,000 $25,000 60% 40% 40% 40% 20%

The partnership profit for the year ended 31 December 2000 was $350,000 accruing evenly over the year. What are the partners’ total profit shares for the year ended 31 December 2000? S $000 196 217 155 175 T $000 124 108 130 145 U $000 30 25 65 35

A B C D

12 Which of the following four statements about accounting concepts or principles are correct? 1. 2. 3. 4. A B C D The money measurement concept is that items in accounts are initially measured at their historical cost. In order to achieve comparability it may sometimes be necessary to override the prudence concept. To facilitate comparisons between different entities it is helpful if accounting policies and changes in them are disclosed. To comply with the law, the legal form of a transaction must always be reflected in financial statements. 1 and 3 1 and 4 3 only 2 and 3

13 The closing inventory of Epsilon amounted to $284,000 at 30 September 2001, the balance sheet date. This total includes two inventory lines about which the inventory taker is uncertain. 1. 500 items which had cost $15 each and which were included at $7,500. These items were found to have been defective at the balance sheet date. Remedial work after the balance sheet date cost $1,800 and they were then sold for $20 each. Selling expenses were $400. 100 items which had cost $10 each. After the balance sheet date they were sold for $8 each, with selling expenses of $150.

2.

What figure should appear in Epsilon’s balance sheet for inventory? A B C D $283,650 $283,800 $292,150 $283,950

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14 Which of these statements about research and development expenditure are correct? 1. 2. 3. 4. If certain conditions are satisfied, research and development expenditure must be capitalised. One of the conditions to be satisfied if development expenditure is to be capitalised is that the technical feasibility of the project is reasonably assured. If capitalised, development expenditure must be amortised over a period not exceeding five years. The amount of capitalised development expenditure for each project should be reviewed each year. If circumstances no longer justify the capitalisation, the balance should be written off over a period not exceeding five years. Development expenditure may only be capitalised if it can be shown that adequate resources will be available to finance the completion of the project. 2 and 5 3, 4 and 5 2, 3 and 5 1, 2 and 3

5. A B C D

15 On 30 September 2001 part of the inventory of a company was completely destroyed by fire. The following information is available: – – – – – Inventory at 1 September 2001 at cost $49,800 Purchases for September 2001 $88,600 Sales for September 2001 $130,000 Inventory at 30 September 2001 – undamaged items $32,000 Standard gross profit percentage on sales 30%

Based on this information, what is the cost of the inventory destroyed? A B C D $17,800 $47,400 $15,400 $6,400

16 At 1 July 2000 the share capital and share premium account of a company were as follows: Share capital – 300,000 ordinary shares of 25c each Share premium account During the year ended 30 June 2001 the following events took place: 1. 2. On 1 January 2001 the company made a rights issue of one share for every five held, at $1·20 per share. On 1 April 2001 the company made a bonus (capitalisation) issue of one share for every three in issue at that time, using the share premium account to do so. $ 75,000 200,000

What are the correct balances on the company’s share capital and share premium accounts at 30 June 2001? A B C D Share capital $460,000 $480,000 $120,000 $120,000 Share premium account $287,000 $137,000 $137,000 $227,000

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17 In relation to cash flow statements, which, if any, of the following are correct? 1. 2. 3. A B C D The direct method of calculating net cash from operating activities leads to a different figure from that produced by the indirect method, but this is balanced elsewhere in the cash flow statement. A company making high profits must necessarily have a net cash inflow from operating activities. Profits and losses on disposals of non-current assets appear as items under cash flows from investing activities in the cash flow statement or a note to it. Item 1 only Item 2 only Item 3 only None of the items.

18 A cash flow statement prepared in accordance with IAS7 Cash Flow Statements opens with the calculation of cash flows from operating activities from the net profit before taxation. Which of the following lists of items consists only of items that would be ADDED to net profit before taxation in that calculation? A B C D Decrease in inventories, depreciation, profit on sale of non-current assets. Increase in trade payables, decrease in trade receivables, profit on sale of non-current assets. Loss on sale of non-current assets, depreciation, increase in trade receivables. Decrease in trade receivables, increase in trade payables, loss on sale of non-current assets.

19 IAS 10 Events after the Balance Sheet Date defines the extent to which events after the balance sheet date should be reflected in financial statements. Five such events are listed below. 1 2 3 4 5 Merger with another company. Insolvency of a customer. Destruction of a major non-current asset. Sale of inventory held at the balance sheet date for less than cost. Discovery of fraud.

Which three of the listed items are, according to IAS 10, normally to be classified as adjusting? A B C D 1, 2 and 3 2, 4 and 5 1, 2 and 5 1, 4 and 5

20 In preparing the financial statements of a company, the following items have to be considered: 1. 2. 3. The company offers a one year warranty to purchasers, undertaking to replace an item if a defect occurs. Past experience suggests that claims under the warranty will probably arise. The company has an action pending against it for damages for wrongful dismissal of a director. The company’s legal advisor considers it improbable that the action will be successful. The company has guaranteed the overdraft of a subsidiary. The subsidiary is trading profitably and the probability of a liability arising is remote.

How should these items be reflected in the financial statements, if at all? A B C D All three should be disclosed by note. A provision should be created for the best estimate of the liability in 1, and items 2 and 3 should be disclosed by note. A provision should be created for the best estimate of the liability in 1, item 2 should be disclosed by note and item 3 not disclosed at all. A provision should be created for the best estimate of the liabilities in 1 and 2 and item 3 should be disclosed by note. 7 [P.T.O.

1D INTAU Paper 1.1(INT)

21 The analysis of a company’s financial statements revealed that the number of days’ sales in inventory was 80 days. The average for companies in the same industry was 35 days. Which one of the following is LEAST likely to account for the high level of 80 days? A B C D The company’s trade is seasonal Poor inventory control A large purchase was made just before the balance sheet date An increase in the company’s sales in the three months before the balance sheet date.

The following data relates to Questions 22 and 23. Extracts from a company’s financial statements for the year ended 30 September 2001 are given below. Balance sheet Issued share capital Reserves Accumulated profit Non-current liabilities: 10% loan notes $000 500 200 800 1,000 Income statement Operating profit Finance cost Profit before tax $000 300 100 200

22 What is the return on shareholders’ equity as a percentage, based on these figures? A B C D 40% 20% 13·3% 12%

23 What is the return on total capital employed as a percentage, based on these figures? A B C D 12% 8% 13·3% 20%

24 Which of the following correctly states items which should be disclosed in the statement of changes in equity required by IAS 1 Presentation of Financial Statements? A B C D Net profit for the period, surplus on revaluation of non-current assets, dividends paid, proceeds of issue of shares. Proceeds of issue of shares, loan notes issued or repaid, retained profit for the period, surplus on revaluation of non-current assets. Profit on ordinary activities, income tax expense, extraordinary items. Accumulated profits, reserves, issued share capital.

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25 Which of the following statements about financial statements are in accordance with IAS 1? 1. 2. 3. 4. 5. A B C D Extraordinary items must be disclosed on the face of the income statement as additions to or deductions from profit before tax. The authorised share capital of the company must be disclosed by note or on the face of the balance sheet. The total of staff costs for the period must be disclosed by note or on the face of the income statement. The accounting policies adopted by the company must be disclosed but only if they do not comply with accounting standards. Proposed ordinary dividends should not be recognised as liabilities unless they have been proposed or declared before the balance sheet date. 1, 2, 3 and 4 1, 2, 3 and 5 2, 3 and 5 1, 4 and 5

(50 marks)

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Section B – ALL FIVE questions are compulsory and MUST be attempted 1 The following is an extract from the trial balance of Tafford, a limited liability company, at 30 September 2001: Warehouse machinery: Cost: Accumulated depreciation at 1 October 2000 Motor vehicles: Cost Accumulated depreciation at 1 October 2000 Inventory at 1 October 2000 Sales revenue Purchases Distribution costs Administrative expenses Allowance for doubtful debts, 1 October 2000 Bad debts written off 10% loan notes (issued 1999) Interest paid on loan notes Suspense account $000 3,000 $000

1,700

1,180 13,000 22,600 6,000 5,000 600 500

500 41,600

1,300 10,000 100

Notes: (1) Closing inventory at 30 September 2001 was $15,600,000. (2) Bad debts written off and the movement on the allowance for doubtful debts are to be included in administrative costs. The allowance for doubtful debts is to be reduced to $500,000. (3) The balance on the suspense account is the proceeds of sale of motor vehicles, entered to the suspense account pending correct treatment in the records. The vehicles sold had cost $180,000 and had a written down value at 1 October 2000 of $60,000. It is the company’s policy to provide for a full year’s depreciation in the year of purchase of vehicles and none in the year of sale. The vehicles sold were all used in the distribution of the company’s sales. (4) Depreciation is to be provided for on the straight line basis as follows: Warehouse machinery 10 per cent Motor vehicles 25 per cent Depreciation of motor vehicles is to be divided equally between distribution costs and administrative expenses, and depreciation of warehouse machinery charged wholly to distribution costs. (5) Prepayments and accruals at 30 September 2001 were: Prepayments $000 200 100 Accruals $000 100 60

Distribution costs Administrative expenses

(6) The estimated income tax expense for the year is $3,000,000. Required: Prepare Tafford’s income statement, complying as far as possible with the requirements of IAS 1 Presentation of Financial Statements. (10 marks)

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2

You are preparing an income statement and balance sheet for Lamorgan, a sole trader who does not keep adequate accounting records. The following information is available to you to compute the figures for inclusion in the accounts for sales revenue, purchases and closing inventory for the year ended 30 June 2001: (a) Sales revenue Cash received from credit customers Cash sales receipts paid into bank Expenses paid out of cash sales before banking Trade receivables: 30 June 2000 30 June 2001 Refunds to customers Discounts allowed Bad debts written off Amount due from credit customer deducted by Lamorgan in paying supplier’s account Required: Compute the sales revenue figure from this information. (b) Purchases Payments to suppliers Trade payables: 30 June 2000 30 June 2001 Cost of items taken from inventory by Lamorgan for personal use Amount due from credit customer deducted by Lamorgan in settling supplier’s account Required: Compute the purchases figure from this information. (c) Closing inventory Cost of inventory obtained from physical count on 30 June 2001 This figure does NOT include any amounts for the two items below. (i) (3 marks) $ 114,400 22,900 24,800 400 700 (5 marks)

$ 218,500 114,700 9,600 41,600 44,200 800 2,600 1,500 700

$ 77,700

An inventory line which had cost $1,800 was found to be damaged. Remedial work costing $300 is needed to enable the items to be sold for $1,700. Selling expenses of $100 would also be incurred in selling these items.

(ii) Goods sent to a customer on approval in May 2001 were not included in the inventory. The sale price of the goods was $4,000 and the cost $3,000. The customer notified his acceptance of the goods in July 2001. Note: No adjustment to the sales figure in (a) above is required for this item. Required: Compute the adjusted closing inventory figure from this information. (2 marks) (10 marks)

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3

On 1 April 1998, Evon Limited acquired 75% of the ordinary share capital of Orset Limited for $180,000. At that date the balance sheet of Orset Limited was as follows: Sundry net assets Share capital 100,000 Ordinary shares of $1 each Accumulated profit $ 160,000 100,000 60,000 160,000 At 31 March 2001, the balance sheets of the two companies were as follows: Evon Ltd $ 560,000 180,000 740,000 Share capital Shares of $1 each Accumulated profit 500,000 240,000 740,000 Goodwill arising on consolidation is to be amortised over five years. Required: Prepare the consolidated balance sheet of Evon Limited and its subsidiary as at 31 March 2001. (10 marks) Orset Ltd $ 230,000 230,000 100,000 130,000 230,000

Sundry net assets Investment in Orset

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The IASC’s Framework for the Preparation and Presentation of Financial Statements, and IAS 1 Presentation of Financial Statements, together present concepts important in the preparation of financial statements, including materiality, prudence and comparability among others. Required: (a) Explain the meaning of the following terms, giving one example of the application of each of them: (i) Materiality; (ii) Prudence. (b) Explain how international accounting standards and the Framework promote comparability. (6 marks) (4 marks) (10 marks)

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5

The term ‘overtrading’ is used to describe the condition of an enterprise which is increasing its sales revenue with insufficient working capital to support the increase. Required: (a) State FOUR movements in items in financial statements or in accounting ratios that could indicate overtrading. (4 marks) (b) State THREE actions a company suffering from overtrading could take to rectify its position, and explain the likely effect of the actions you propose. (6 marks) (10 marks)

End of Question Paper

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