You are on page 1of 28

Accounting Principles

Question Paper, Answers and

Examiner’s Comments

Level 3 Diploma January 2015

 Copyright of the Chartered Institute of Credit Management

January 2015 7B/PQP/2 continued

Accounting Principles questions, answers and
examiners’ comments
Level 3 Diploma in Credit Management


Instructions to candidates

Answer any FIVE questions. All questions carry equal marks. Time allowed: 3 hours

All ledger accounts must be prepared in continuous balance format

Final accounts must be prepared in vertical format

Where appropriate, VAT is to be calculated at 20%

Again there appears to be a marginal improvement on the last exam series with some very good
scripts being submitted. Structure, format and presentation have certainly improved and
many students display a high level of knowledge and understanding of the subject matter. This is
witnessed in both the numerical and narrative questions which is an encouraging development.

As indicated last time, it is important that students address the practical applications of accounting
techniques, practices and conventions from a credit management perspective. At times though
there are some instances of poor technique especially in the construction of the Trading and Profit
and Loss account (Statement of Profit and Loss) and the Balance Sheet Statement of Financial
Position). Some still are a little confused with regard to the difference between a debit and credit
balance and how they are shown in the individual ledgers.

Ratio analysis (especially the interpretation of the calculations) and suspense accounts continue to
cause problems for a few students. Questions 1, 3 and 8 were by far the most popular, questions 5
and 6 the least, with student preferences being equally divided amongst the rest.

Questions start on the next page

January 2015 7B/PQP/3 continued

1. a) What are the main reasons for organisations maintaining financial and management
accounts? (4 marks)

b) What information can be gleaned from the final accounts of a business that will assist the
credit management in making a more informed decision? (6 marks)

c) For each of the following stakeholders, identify the accounting information that will be of
interest to them and why?

i) Investors. (2 marks)

ii) Lenders. (2 marks)

iii) Employees and their representatives. (2 marks)

iv) Customers. (2 marks)

v) The general public. (2 marks)

Total 20 marks

Question aims
 To test the candidate’s knowledge and understanding of why organisations need to have
financial and management accounts
 To assess the candidate’s ability to identify what information can be obtained from the final
accounts in helping the credit manager to make a more informed decision
 To identify the candidate’s ability to highlight the accounting information that will be of use to
internal and external stakeholders.

Suggested answer

a) Financial accounting is concerned with the collection and classification of historic data in order
to prepare the annual financial statements of the business. These statements are prepared
for users outside of the business such as owners or shareholders, prospective investors,
providers of loan capital, receivables and payables and the Government.

Management accounting on the other hand is about providing management with the
information that it needs to carry out its functions properly for planning, control and decision-

Businesses are required to keep accounting records for a number of reasons:

Legal – the final financial statements of incorporated businesses must be prepared according
to a prescribed statutory format and must usually be audited by an external auditor.

Monitoring performance and calculating profit – has the business achieved what it had
planned to achieve e.g. are sales levels on target and costs as budgeted? Has it made a
profit, and to what extent?

Forecasting performance – what growth in sales may be realistically achieved given past
performance, state of the market, competition etc. Information on past performance will
come from the financial statements. How much will it cost to run the business next year? All
this information can be found in the management accounts.

 Assess the owners’ liability for income tax

 The company’s liability for corporation tax

 The business’s liability for VAT

January 2015 7B/PQP/4 continued

 Assess amounts owing to payables

 What are the business’s short-term liabilities to suppliers?

 Also indicates what is owed from customers with implications for cash flow and credit

b) The final accounts of the business compiled annually are the Income Statement and
Statement of Financial Position. There is a plethora of information that can be obtained from
these two documents which will enhance the decision whether to grant or extend credit or
establish or extend terms.

Income statement indicates:

 the level of sales and profit.

- Are they increasing or decreasing?
- How do they compare with previous years?
- How is the organisation performing in the industry?
This will be of particular use to the credit manager.

 the type, form and structure of costs for the year.

- How do they compare to previous years?
- Any particular expense increased dramatically?

Statement of Financial Position indicates:

 the type, structure and form of assets and liabilities.

- How long have the assets got to run?
- Depreciation levels?

 shows the level of debt and when it needs to be repaid.

- Can the organisation service it?

 displays the availability of cash and near cash items that can be readily turned into cash to
meet the business debts.
- Is of particular interest to the credit manager.

 Profitability ratios will assess the level of profits in comparison to the sales generated and
capital employed

 Liquidity ratios are very important in assessing the credit worthiness of an organisation
- Can an organisation pay its debts as and when they fall due?

 Efficiency ratio will assess the ability of management to control working capital

 Receivables ratio shows how long it takes invoices to be paid

 Payables ratio gives the average length of time that the company takes to pay its

c) i) Investors will be interested in profit levels and past performance to ensure that not only is
the investment safe but that it will produce a good return.

ii) Lenders will be concerned again with profit levels and liquidity ratios to satisfy themselves
that the firm has both the ability and resources to repay any loan granted albeit in the
short, medium or long-term.

January 2015 7B/PQP/5 continued

iii) Employees and their representatives will be concerned with levels of profit. This will
possibly indicate job security and can form the basis for bargaining for improvements in
pay and conditions.

iv) For customers the price paid for the final product would be a key consideration. They will
also desire that the company will be in existence for after sales service and warranty.
Customers will look to all aspects of the final accounts to determine its financial stability.

v) The general public will want to see all the financial statements in order to determine
whether or not the business has the resources to be environmentally friendly and can
service sustainability in all its forms in the future.
Total 20 marks

This area of the syllabus has not been tested for a while and in the main the candidates handled
it well. Most could highlight reasons why organisations maintain financial and management
accounts in a) though a minority did not make the distinction. Many though could differentiate
and come up with some very pertinent answers.

Part b) witnessed some very good responses though a few failed to address the implications from
a credit management perspective which the question required.

Part c) was tackled well by the vast majority though the majority of candidates just cited profit as
the most important piece of financial information for the stakeholders cited. This was apt for the
first three but with regard to the other two, I would like to have seen more reference to prices,
after sales service, warranties, sustainability and environmental issues.

January 2015 7B/PQP/6 continued

2. All businesses whether they are incorporated or unincorporated require additional sources of
finance to fund their operations.


Identify the key characteristics together with one advantage and one limitation for each of
the following:

a) Bank overdraft. (4 marks)

b) Trade credit. (4 marks)

c) Term loans. (4 marks)

d) Factoring. (4 marks)

e) Retained profits. (4 marks)

Total 20 marks

Question aims
To test the candidate’s knowledge and understanding of the different types of finance available to
organisations to finance their activities in the short, medium or long-term.

Suggested answer

a) Bank overdraft


 Short-term facility used to finance working capital requirements

 Used to cover cash deficits before income is received

 The bank balance will have a negative figure (credit balance) and is classed as a current


 Flexible as the bank may be willing to increase the limit for short periods

 Relatively cheap as interest is charged on the daily amount overdrawn typically 2 – 3%

+base rate.


 Repayable on demand

 If the overdraft is very large the bank may require an arrangement fee and security.

January 2015 7B/PQP/7 continued

b) Trade credit


Credit given by the company’s suppliers, the norm being 30 days from the date of invoice,
though in some industries it might be 60 to 90 days. In reality this is giving the organisation
credit as it is borrowing at the suppliers’ expense. Firms use trade credit as a source of
working capital rather than rely on a bank overdraft which has a cost.


 Trade credit is easier to obtain than a bank overdraft or loan

 Readily available subject to credit clearance

 Trade creditors have an interest in developing and extending the working relationship and
are more flexible than a bank

 No interest charges or other costs providing terms are adhered to.


 The buyer may lose cash discounts given for prompt payment and may also lose the
opportunity to negotiate more favourable prices or lose supplier goodwill and not be able
to take advantage of discounts for bulk buying

 Strictly a short-term facility

 Credit can be withdrawn

 May get a poor reputation in credit circles.

c) Term loans


Loans provide finance generally for the medium to long-term. They are granted for a specific
amount for a specific period and be either secured against the assets of the business i.e. if the
debt is not repaid the bank can take possession of the borrowers’ assets or unsecured, where
it can not.

The period of the loan is agreed at the outset and interest rates are based on the amount
borrowed and prevailing economic conditions. Interest payments can be fixed throughout the
period of the loan or may be variable subject to market conditions.


 Easily arranged subject to the status of the business

 Fixed rate of interest can be arranged

 Although interest payments are based on the full amount borrowed, they tend to be at a
lower % rate than overdrafts.

January 2015 7B/PQP/8 continued


 Secured loans are secured against the assets of the business, which can restrict their use

 Cost of interest will reduce profit levels

 Increased indebtedness to third-parties generates increasing gearing levels.

d) Factoring


Another short-term method of financing. Here the company sells its book debts to a factor.
The factoring company will then pay an agreed percentage of the value of these debts which
can be as much as 85% of the value of invoices outstanding. The balance will be paid, less
fees, when the customers have paid the factoring company. The factoring company may also
take responsibility for bad debts which is a form of insurance with an additional fee attached.


 An immediate cash injection

 Reduces debt collection costs.


 A high percentage of invoice value has to be paid to the factor

 The relationship with the customer(s) whose debts have been factored might be damaged.

e) Retained profits


Profits can be retained in the business rather than given out to shareholders in the form of
dividends in the case of incorporated businesses or taken out in the form of drawings by sole
traders or partners. This increases the funds available to the business which might lead to an
expansion of the business or an increase in its share valuation. It can be used to finance
either working capital or the purchase of non-current assets.


 No costs involved and immediate cash is available

 No third-party involvement


 Takes time to build up retained earnings

 Can be restricted by the need to pay dividends to shareholders.

Total 20 marks

January 2015 7B/PQP/9 continued

This question proved very popular with students. Some very good answers were
offered showing a high level of understanding of this section of the syllabus. A common error
though for some was to either just detail the characteristic of each without discussing the
merits and limitations of each or vice-versa.

No problems with overdrafts, trade credit and factoring but there was a little confusion with
regard to term loans and retained profits. With the former many did not detail they would not
be apt in the medium and long term, nor did they highlight in enough detail the costs involved
with regard to interest rates and the time period involved. With the latter, many could not offer
a clear definition of what constituted retained profits nor could they indicate that there were no
costs involved as such in utilising this type of financing.

January 2015 7B/PQP/10 continued

3. P Scott owns a small engineering firm. The following balances have been extracted from the
accounts as at 31 December 2014.

£ £
Capital 72,100
Bank 11,690
Carriage Inwards 640
Carriage Outwards 1,270
Discounts 1,510 2,190
 At cost 77,360
 Provision for depreciation 16,840

Drawings 10,740
Long-term Loan 20,000
Motor Expenses 16,740
 At cost 60,000
 Provision for depreciation 10,000
Purchases and Sales 132,700 276,300

Shop Expenses 21,380

Stock as at 1 January 2014 35,820
Debtors and Creditors 12,490 9,210
Wages 46,330
Telephone and Insurance 1,750
Returns 1,300 1,700

Total 420,030 420,030

You have also been given the following information:

1. Stock as at 31 December 2014 was valued at £29,700.
2. Motor expenses paid in advance were £350.
3. Wages unpaid at year end amounted to £1,840.
4. Equipment is to be depreciated at 12½% using the reducing balance method.
5. Premises need to be depreciated using the straight-line method at 5%.


a) Prepare an income statement (formerly a trading and profit and loss account) for the year
ended 31 December 2014. (11 marks)

b) Prepare a statement of financial position (formerly a balance sheet) as at 31 December 2014.

(9 marks)

Total 20 marks

January 2015 7B/PQP/11 continued

Question aims
To test the candidates’ ability to prepare a trading and profit account and balance sheet from a
trial balance taking into account all adjustments re accruals, prepayments and depreciation.

Suggested answer

a) Income statement of P Scott for the year ended 31 December 2014

£ £ £
Sales 276,300

less Sales returns 1,300

Less cost of sales
Opening stock 35,820
Purchases 132,700

Carriage inwards 640

less Purchase returns 1,700


Less closing stock 29,700

Gross profit 137,240

Discount received 2,190

Less expenses
Discount allowed 1,510
Carriage outwards 1,270
Motor expenses (£16,740 - £350) 16,390
Shop expenses 21,380
Wages (£46,330 + £1,840) 48,170
Telephone and insurance 1,750
Depreciation: Equipment (w1) 7,565
Premises (w2) 3,000 101,035
Net profit 38,395

January 2015 7B/PQP/12 continued

b) Statement of Financial Position of P Scott as at 31 December 2014.

£ £ £
Fixed assets
Premises (w3) 60,000 13,000 47,000
Equipment (w4) 77,360 24,405 52,955

137,360 37,405 99,955

Current assets

Stock 29,700
Debtors 12,490
Prepayments 350 42,540

Less current liabilities

Creditors 9,210
Bank overdraft 11,690

Accruals 1,840 22,740

Net current assets 19,800


Less long-term liabilities

Bank loan 20,000


Financed by
Capital 72,100

add Net profit 38,395

less Drawings (10,740)


W1 Equipment £77,360 – £16,840 = £60,520 x 12½% = £7,565 2014 depreciation

W2 Premises £60,000 x 5% = £3,000 2014 depreciation
W3 Premises £60,000 – (£10,000 + £3,000) = £47,000 2014 Net book value

W4 Equipment £77,360 – (£16,840 + £7,565) = £52,955 2014 Net book value

Total 20 marks

January 2015 7B/PQP/13 continued

This was probably the most popular question on the paper with the vast majority of candidates
securing a pass mark. As indicated, the presentation of the final accounts of businesses has
improved significantly though there are still isolated incidents of poor practice. In the main, the
TPLA (SPL) was handled well, though the odd candidate did confuse purchase and sale returns
and discount allowed and discount received.

In a couple of instances, opening and closing stock (inventory) were inserted the wrong way
round. Most students addressed the accruals and prepayments adjustments, though a few
found the depreciation calculation problematic. The PLA (SFP) was well constructed though
many did not recognise that the bank balance was a credit one, i.e., overdrawn and should
appear as a current liability.

January 2015 7B/PQP/14 continued

4. As credit manager of ABC Limited, you have been asked by your financial director to assess
the feasibility of increasing the credit facility of Doyle and Scott Limited.

You have been given the extracts from their most recent financial accounts below:

Income Statement of Doyle and Scott Limited for the year ended 31 December:

2012 2013 2014

£000 £000 £000
Sales 240 360 540
Less: cost of sales 160 270 432

Gross profit 80 90 108

Less: expenses 56 74 94

Operating profit 24 16 14

Statement of Financial Position for Doyle and Scott Limited as at 31 December:

2012 2013 2014
£000 £000 £000 £000 £000 £000
Non current assets 60 120 160
Current assets

 Inventory 48 50 80
 Receivables 52 80 110
 Bank 40 20 0

140 150 190

Current liabilities
 Payable 40 70 90
 Bank 0 0 20
Net current assets 100 80 80

160 200 240

Financed by
Ordinary shares 100 124 150

Reserves 60 76 90

160 200 240

Note: Opening inventory in 2012 (in £000s) = 40

January 2015 7B/PQP/15 continued


a) Calculate the following ratios for both of the years 2013 and 2014 (the relevant figures
for 2012 have been given in brackets):

i) Gross profit margin (2012: 33%).

ii) Operating profit margin (2012: 10%).

iii) Return on capital employed (2012: 15%).

iv) Current ratio (2012: 3.5:1).

v) Quick ratio/Acid test (2012: 2.3:1).

vi) Inventory days (2012: 100 days).

vii) Receivables days (2012: 79 days).

viii) Payables days (2012: 91 days). (8 marks)

b) Using the ratio calculations which have been supplied for 2012 and your own calculations
from part a) for 2013 and 2014, assess whether an increase in the credit facility would
be appropriate, giving your reasons for your decision. (12 marks)

Total 20 marks

Question aims
To test the candidate’s knowledge and understanding of the key financial ratios and how they can
be employed to assist the credit manager in making a more informed decision as to whether to
increase a credit facility.

Suggested answer

a) Ratios for the last two years are:

2013 2014
i) Gross profit margin 25% 20%
ii) Operating margin 4.4% 2.6%

iii) Return on capital employed 8% 5.8%

iv) Current ratio 2.14:1 1.73:1

v) Quick ratio 1.43:1 1.1

vi) Inventory days 66 days 55 days
vii) Receivables days 81 days 74 days

viii) Payables days 95 days 76 days

January 2015 7B/PQP/16 continued

b) There is no model answer as such for this, though the calculation for each ratio should be
correct to get credit. Students should look at trends in offering observations and marks
will be awarded for developing these and other reasonable points:

 Turnover has increased by more than 50% over the period. Although gross profit has
increased all the profit margins i.e., gross, operating and return on capital employed) have

 Both the current ratio and acid test ratios have declined, but from quite a high position in
the first instance. The 2014 figure is acceptable still though. However if this trend is to
continue the 2015 accounts are likely to show a further decline in working capital and the
business might find itself in an overtrading situation

 Control over working capital items, inventory, receivables and payables have been good.
Receivable days have improved as has inventory days but payables has slightly worsened.
The organisation though is still getting its invoices paid before they pay their suppliers,
which is good. Some students might make reference to the fact that the cash operating
cycle has improved from 91 days to 53 days

 Expenses as a percentage of turnover has reduced which demonstrates that these are
clearly under control

 Share capital has increased but the return on capital employed has fallen quite
significantly and must be of concern to the shareholders

On the basis of the previous, students might indicate that on balance given the key ratios
identified that it might be apt to increase the facility but it does need to be carefully

Some could argue that it might be appropriate before increasing credit to get sight of the
management accounts which will show, amongst other things, projected sales and cash flow

The organisation at present is clearly solvent but the liquidity ratios have been moving in an
adverse manner over the last couple of years and if this should continue could cause problems
with the company’s ability to pay its debts as and when they fall due.

January 2015 7B/PQP/17 continued


2012 2013 2014

Gross profit margin
Gross profit x 100 80 x 100 90 x 100 108 x 100
Sales 240 = 33% 360 = 25% 540 = 20%

Operating profit margin

Operating profit x 100 24 x 100 16 x 100 14 x 100
Sales 240 = 10% 240 = 4.4% 540 = 2.6%

Return on capital employed

Operating profit x 100 24 x 100 16 x 100 14 x 100
Ordinary shares and reserves 160 = 15% 200 = 8% 240 = 5.8%

Current ratio
140 150 190
Current assets
40 = 3.5:1 70 = 2.14:1 110 = 1.73:1
Current liabilities

Quick ratio/Acid Test

140-48 150-50 190-80
Current assets – closing stock
40 = 2.3:1 70 = 2.43:1 110 = 1:1
Current liabilities

Inventory days
[(40+48)÷2] x 365 [(48+50)÷2] x 365 [(50+80)÷2] x 365
[(Opening stock + closing
160 270 432
stock)/2] x 365
= 100 days = 66 days = 55 days
Cost of sales

Receivables days
52 x 365 80 x 365 180 x 365
Receivables x 365
240 360 540
= 79 days = 81 days = 74 days
Payables days 40 x 365 70 x 365 90 x 365
Payables x 365 160 270 432
Cost of sales = 91 days = 95 days = 76 days

Working Capital Cycle 79+100-91 81+66-95 74+55-76

Receivables days + Inventory = 88 days = 52 days = 53 days
days – Payables days

Total 20 marks

Financial ratios form an integral part of the syllabus and are also a very important tool for a credit
manager in assessing the credit worthiness of both new and existing customers. In the main, the
vast majority of candidates who attempted this question scored well although not as highly as one
would expect given the importance and possibly the familiarity of the subject matter. Most of the
ratios were computed correctly though some of the efficiency ratios, especially stock turnover,
caused a few problems.

Part b) responses were either very good or poor. The interpretation of financial data is just as
important as the calculation of the said ratios so students should take note. The topic, given its
importance, will continue to be examined in future diets.

January 2015 7B/PQP/18 continued

5. There are four general assumptions that specifically underlie the preparation of the financial
(final) accounts of an incorporated business.


a) What is the purpose of these four key accounting concepts? (4 marks)

b) Describe and assess the importance of each of those concepts with regards to the
interpretation of prepared financial statements. (16 marks)

Total 20 marks

Question aims
To test the candidate’s knowledge and understanding of the key accounting concepts and
conventions that underpin the compilation and publication of the final accounts of an incorporated

Suggested answer

a) The concepts and conventions used in preparing the final accounts are aimed at conferring
uniformity on the financial statements. In preparing the income statement, statement of
financial position and cash flow statements, accountants apply these rules that establish the
way in which the financial performance of a business is recorded. Ultimately the aim of these
concepts is to produce objectivity in financial accounts and allow ‘like-for-like’ comparisons to
be made.

b) These concepts and conventions are broad basic assumptions which have been applied in
preparing the final accounts of a business and require no explanation or disclosure unless
otherwise stated. They are incorporated in various Companies’ Acts and associated laws and
regulations as fundamental accounting principles. The over-riding rule in financial statements
is that they should show a ‘true and fair view’ of the financial position of a given organisation.

Four can be detailed as impacting directly upon the preparation of final accounts:

i) Going concern – financial statements are prepared on the assumption that the company
will continue to operate as a viable business venture in the foreseeable future; that there
will be no significant reduction in the scale of its operations and it is not likely to become
insolvent. This means all assets will be valued in the balance sheet at either historical cost
less accumulated depreciation or at a revalued amount.

If the company is not to continue as a going concern and ceases trading and has to have
its assets sold then the market value of these will be significantly lower than the book
value held in the accounts. The Board must then write down the value of the assets in the
balance sheet to the amount they would realise in a forced sale and adjust liabilities

ii) Accruals (matching) concept – reviews and costs are recognised as earned or incurred
in the income statement of the period to which they relate, not when the cash is received
or paid. This ensures that the revenue relating to the year is matched against the related
expenses for the year. This enables the income of one period to be matched more fairly
against the expenditure of the same period.

The accruals concept is widely recognised as a more objective way of measuring profit
than on a cash basis. This gives a true and fair view of the profit for the year and the
assets and liabilities in the balance sheet.

January 2015 7B/PQP/19 continued

iii) Comparability objective (consistency) – similar items in the accounts must be dealt
with in the same way in every branch and in each accounting period and then from one
accounting period to the next. Once an accounting policy has been adopted it cannot be
changed as this would distort profits and the valuation of assets. One accounting policy
can be changed in exceptional circumstances only where it could improve the quality of
the statements and provide a fair profit/asset figure. The board must disclose any change
and have the approval of the auditors.

iv) Prudence principle – in preparing the final accounts, a number of estimates and
judgements have to be made. The natural tendency would be to be over-optimistic about
profits and the overall financial position of the business. The prudence principle deems it
apt to be conservative or pessimistic when making a judgement on anticipated profit or
losses of a company. Accountants should always exercise caution when there is

Revenues and profits must not be recognised until they are realised or there is a high
degree of certainty that they will be realised. Prudence also needs to be applied to other
items which cannot be measured with certainty and are very subjective, e.g., stock
valuation, profit or loss on the sale of a fixed asset etc. It also prevails over accruals,
should the two conflict.
Total 20 marks

Note: Marks will not be awarded when a student cites materiality, business entity, duality,
money measurement, periodically, historic costs, realisation and substance over form as these do
not apply to the preparation of the final accounts.

A question that did not require any accounting activity which curiously was not a favourite with
candidates. Answers in the main were fine although a few failed to address and indicate that the
purpose of standards is to bring uniformity in the compilation and content of final accounts of

Part b) was well answered by most although a number did cite and talk about materiality, business
entity and money measurement, which although are other accepted standards, do not apply to
final accounts.

January 2015 7B/PQP/20 continued

6. The final accounts of an incorporated business contain a great deal of information that will
help the credit manager in making a more informed decision whether to grant or extend
credit facilities.


Assess the credit intelligence that might be gleaned from the following:

a) The Auditors’ Report. (6 marks)

b) The Directors’ Report. (8 marks)

c) The Chairman’s Statement or Report. (6 marks)

Total 20 marks

Question aims
To assess the candidate’s appreciation of the type of credit information that might be obtained
from the final accounts of a business which could enhance the decision made by a credit manager
with regard to credit terms and limits.

Suggested answer

a) The auditor’s report

 The shareholders are investors in the company and in order to safeguard their interests it
is a statutory requirement that the final accounts of an incorporated business are
examined and scrutinised by an independent auditor appointed by the shareholders,
unless the company is exempt from doing so

 The auditor is required to report to the members of the company on all the accounts
presented at the annual general meeting

 The auditor has to comment on whether the financial statements presented to them,
- the income statement,
- statement of financial position
- statement of cash flow
show a ‘true and fair view’ of the company or the group’s state of affairs at the end of
the financial period. Also whether the financial statements have been prepared in
accordance with the appropriate Companies Act legislation.

 A report can be qualified i.e., the auditors disagree with the treatment or disclosure of
an item in the financial statement and in the opinion of the auditors the effect of this
does not give a true and fair view

 The financial accounts are one of the main tools for the credit manager whose main task
is to ensure the credit worthiness of new or existing customers. A clean, unqualified,
audit report indicates that the auditor is confident that the final accounts give a true and
fair view of the company’s financial affairs for the year. The credit manager then can
have some confidence of the financial standing of the given organisation. Also a clean
audit implies that proper records have been kept and in accordance with all relevant

A qualified audit report though should be a warning sign as it implies some

disagreement in one or more areas of the final accounts which should alert the credit
manager that all is not financially ‘well’. This obviously would have some bearing on the
credit manager’s decision whether to grant or extend credit to the customer.

January 2015 7B/PQP/21 continued

b) The director’s report

The director’s report is an objective overview of the company’s activities and performance
during the year. There is a plethora of information here which will help the credit manager in
making a more informed credit decision.


 It details the company’s financial position at year end including any changes to share
capital, proposed dividend and transfers to reserves. Important information for the
credit manager

 It details changes in the consistency and numbers of shareholders. Any major changes
require clarification

 It discusses the business’ principal activities and any changes to these, i.e., whether the
core business is still the same

 It talks about any significant development which might affect future performance and
results which could be either negative or positive

 It highlights post balance sheet events i.e., major events that have occurred after the
year end which will affect future results. This could have a bearing on credit worthiness

 It will detail any significant changes to fixed assets during the year. Again, this may
impact on an organisation’s ability to pay its debts as and when they fall due

 It will inform the shareholders of any acquisitions made by the company of its own

 Names of directors and details of their interest in shares and debentures will be
disclosed. Also any changes to the Board during the year. This would require
investigation by the credit manager

 There will also be a statement regarding the supplier payment policy of how many days
the company takes to pay its suppliers which is very useful information for credit risk

c) The chairman’s statement or report

 This is a review by the chairman of the major activities and events of the organisation for
the past year

 It discusses the company’s general performance and comments on events during the
year which might be of interest to shareholders

 The future prospects of the business are also outlined

 The aim of the statement is to emphasise the positive aspects of the trading performance
of the organisation over the past year

 It will also try to detail the reasons for any adverse results or negative trading

 The report is not mandatory, nor subject to the scrutiny of auditors, so needs its content
to be treated with caution. Nonetheless, if the auditors and directors’ reports are
detailed in a positive manner and this is supported by the chairman’s report, the credit
manager can rate this as a favourable piece of credit intelligence. It must though not be
totally relied upon to assess any aspect of credit worthiness.
Total 20 marks

January 2015 7B/PQP/22 continued

Another question that required a narrative answer. The Auditors’, Directors’ and Chairman’s
Reports are important supplements to the final accounts of incorporated businesses and
information can be gleaned from them which will help the credit manager in making a more
informed decision. Although the latter is more qualitative in nature, the other two contain
important credit intelligence which in some cases is possibly just as important as the quantitative
evidence from the final accounts.

January 2015 7B/PQP/23 continued

7. When extracting the ledger balances from an organisation’s accounts, the debit and credit
sides did not balance, as follows:

£ £
Capital 45,000
Debtors and Creditors 32,900 5,000
Returns 2,500 2,710
Purchases and Sales 25,000 30,485
Discounts 6,800 5,630
Drawings 8,220
Wages and Salaries 7,000
Equipment 8,000

Total 90,420 88,825

The following errors were discovered by Sandy, the internal auditor, on 31 December 2014:

i) The Purchases account had been undercast by £4,500.

ii) Cash sales of £24,205 had not been entered into the Sales account.

iii) A credit note of £3,450 was entered in P White’s customer account but no entry was
made in the relevant returns account.

iv) The Sales account was overcast by £3,900.

v) £4,590 of goods was taken out of the business for I Johnson’s personal use. This was
recorded in the Drawings account but there were no other entries.

vi) An invoice for J Sullivan was discovered behind the computer. No accounting entries had
been made for the £1,650.

vii) £2,700 in respect of debtor J Smith was debited in error to the account of J Smythe Ltd.

viii) A discount allowed of £4,275 was credited in error to the Discount Received account.

ix) A bad debt of £6,800 had been entered into the customer’s account only.


a) What is the purpose of a trial balance? (2 marks)

b) Correct the above errors and prepare the resulting suspense account. (18 marks)
Note: journal entries are not required.
Total 20 marks

January 2015 7B/PQP/24 continued

Question aims
 To test the candidates’ knowledge and understanding of how suspense accounts can be used
to correct errors found in the trial balance
 To test the students’ appreciation of the reason why a trial balance is extracted for the
compilation of the final accounts of a business.

Suggested answer

a) The purpose of a trial balance is to check the arithmetical accuracy of the double entry in the
ledger accounts and to provide information required for the preparation of the final accounts.

b) Suspense account

Dr Cr Balance
Date Details
£ £ £
31.12.14 Trial balance 1,595 (1,595)

Purchases 4,500 (6,095)

Sales 24,205 18,110

Sales returns 3,450 14,660

Sales 3,900 10,760

Purchases 4,590 15,350

Discount received 4,275 11,075

Discount allowed 4,275 6,800

Bad debts 6,800 Nil

Students should identify that transactions (vi) and (vii) would not require any posting to the
suspense account but that a journal entry would be pertinent.
Total 20 marks

Not as popular as in previous exam series but answered well by those who attempted, even
though there were a couple of woeful responses. Most knew the role and importance of suspense
accounts and many came up with a nil balance after the appropriate corrections and postings.
Some of the narratives in the ledger itself could have been better. Only a few though could
identify the two errors that required only a journal entry, which is a little surprising.

January 2015 7B/PQP/25 continued

8. J Jones is a small high street business selling computer software. The following account
balances were brought forward on 1 January 2014.

Bank (overdrawn) 1,675
VAT owing 850
Sales 14,500
Purchases 8,700
Discount Allowed 750

Discount Received 450

C Mulhearn (a supplier) 3,400
P Hughes (a customer) 5,500

During January the following transactions took place:

2 January 2014 An invoice for £1,200 plus VAT was sent to P Hughes.

A credit note for £750 plus VAT was received from C Mulhearn in
3 January 2014
respect of returned goods.

A cheque for £2,200 was sent to C Mulhearn in full settlement of their

8 January 2014
account. The balance remaining is to be treated as a discount.

A credit note was sent to P Hughes for £1,500 including VAT in respect
9 January 2014
of damaged software.

P Hughes sent a cheque for £4,900 in full settlement of the amount

12 January 2014
outstanding. The rest is to be treated as a discount.

15 January 2014 J Jones took £350 out of the bank for his own personal use.

An invoice is received from C Mulhearn for £790 plus VAT for the supply
17 January 2014
of new software.

20 January 2014 A cheque was sent to HMRC for VAT owing.

A water bill of £1,500 is now due to be paid. There is no VAT on this

25 January 2014


a) Open all the appropriate accounts that are necessary to record the above
transactions and enter all balances brought forward on 1 January 2014. (4 marks)

b) Make the necessary entries in the relevant accounts to record the transactions
including discounts and value added tax at 20%. (16 marks)

Total 20 marks

January 2015 7B/PQP/26 continued

Question aims
To test the candidates’ ability to:
 Apply the rules of double entry book-keeping using a continuous balance format
 Carry out double entry book-keeping to record a range of transactions
 Correctly calculate and account for VAT

Suggested answer

a) and b)

Account: Bank
Date Details DR CR Balance
1.1.14 Balance b/f (1,675)
8.1.14 C Mulhearn 2,200 (3,875)
12.1.14 P Hughes 4,900 1,025
15.1.14 Drawings 350 675
20.1.14 Revenue and customs 832 (157)
25.1.14 Water 1,500 (1,657)

Account: VAT
Date Details DR CR Balance
1.1.14 Balance b/f (850)
2.1.14 P Hughes 240 (1,090)
3.1.14 C Mulhearn 150 (1,240)
9.1.14 P Hughes 250 (990)
17.1.14 C Mulhearn 158 (832)
20.1.14 Bank 832 Nil

Account: Sales
Date Details DR CR Balance
1.1.14 Balance b/f (14,500)
2.1.14 P Hughes 1,200 (15,700)

Account: Purchases
Date Details DR CR Balance
1.1.14 Balance b/f 8,700
17.1.14 C Mulhearn 790 9,490

Account: Discount allowed

Date Details DR CR Balance
1.1.14 Balance b/f 750
12.1.14 P Hughes 540 1,290

Account: Discount received

Date Details DR CR Balance
1.1.14 Balance b/f (450)
17.1.14 C Mulhearn 300 (750)

January 2015 7B/PQP/27 continued

Account: C Mulhearn purchases
Date Details DR CR Balance
1.1.14 Balance b/f (3,400)
3.1.14 Purchase returns 900 (2,500)
8.1.14 Bank 2,200 (300)
8.1.14 Discount received 300 Nil
17.1.14 Purchases 948 (948)

Account: P Hughes sales

Date Details DR CR Balance
1.1.14 Balance b/f 5,500
2.1.14 Sales 1,440 6,940
9.1.14 Sales returns 1,500 5,440
12.1.14 Bank 4,900 540
12.1.14 Discount allowed 540 Nil

Account: Purchase returns

Date Details DR CR Balance
3.1.14 C Mulhearn 750 (750)

Account: Sales returns

Date Details DR CR Balance
9.1.14 P Hughes 1,250 1,250

Account: Drawings
Date Details DR CR Balance
15.1.14 Bank 350 350

Account: Water
Date Details DR CR Balance
25.1.14 Water 1,500 1,500

Total 20 marks

This question, as ever, proved the most popular on the paper and candidate responses are
certainly getting better. The vast majority identified the appropriate balance in the question
and opened appropriate accounts. The postings were tackled well, although a few failed to
arrive at a nil balance on the VAT account. There was a bit of confusion between sales and
purchases returns amongst a few candidates as was there with discounts. The double entry
for a sole trader taking money out of the business for his/her own personal use as usual
caused a few problems, as did the accounting treatment of the payment of a water bill, which
is a little disappointing.


January 2015 7B/PQP/28