HERIOT-WATT UNIVERSITY

ACCOUNTING – JUNE 2015

Section II

Case Studies

Case Study 1

You are the financial controller of Zurich Watches GmbH, which has a financial year
ending on 31 May 2015.

The company has been having a strong financial year, generating significant profits for
the nine months to 28 February 2015 – as shown in the actual Profit & Loss Account for
that period, as compared to the budgeted Profit & Loss Account (for the twelve months
to 31 May 2015):

Profit & Loss Account Profit & Loss Account

Actual – Nine Months to Budget – Twelve Months
28 February 2015 to 31 May 2015
SF SF
Sales 1,315,020 1,300,000

Cost of Sales 815,164 850,000

Depreciation – Plant 12,456 14,000
827,620 864,000

Gross Profit 487,400 436,000

Less: Overheads
Administration Salaries 145,200 175,000
Insurance 10,000 8,000
Rent 36,000 48,000
Advertising 60,000 75,000
Motor Vehicle Costs 10,400 5,000
Depreciation – Motor Vehicle 5,200 8,000
Other Expenses 17,250 16,000
284,050 335,000

Net Profit 203,350 101,000

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The company’s Balance Sheet as at 28 February 2015 comprised the following items:

SF SF
Plant & Machinery 87,000 Ordinary Shares 135,000
Motor Vehicles 27,625 Share Premium 20,500
Raw Materials 24,333 Retained Profits 232,882
Finished Goods 99,215 Long-term Loan 74,250
Debtors 452,000 Trade Creditors 237,591
Cash at Bank 10,050 700,223
700,223

During the three months to 31 May 2015, the company’s accounting transactions can be
summarised as follows:

1. Cash of SF 183,470 is received from debtors.

2. Raw materials of SF 37,525 are purchased from suppliers on credit.
3. Loan repayment of SF 7,500 is made.
4. Rent of SF 16,000 is paid, in cash.
5. A new motor vehicle, costing SF 13,500, is purchased on credit on 1 May.
6. Raw materials of SF 42,000 are converted into finished goods, incurring SF 13,500
in direct labour costs.
7. Finished goods, costing SF 56,200, are sold for SF 79,275 on credit.
8. Finished goods, costing SF 45,250, are sold for SF 70,785 in cash.
9. Monthly administration salaries of SF 36,000 are paid in cash.
10. Payments of SF 196,250 are made to trade creditors.

Further information is also relevant:

1. Depreciation charge has been provided in the accounts for the nine months to 28
February 2015. The company’s depreciation policy is as follows:

Plant & Machinery - 20% per annum on the reducing balance basis
Motor Vehicles - 25% per annum on the reducing balance basis

Fixed assets purchased in a financial year are to be charged with a proportionate

depreciation charge in their year of purchase.

2. The rent paid covers the period between 1 March 2015 and 30 June 2015.

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Required:

1. Prepare the Accounting Equation as at 31 May 2015, incorporating all of the relevant year-end adjustments in a tabular
format.
(17 marks)

Selected Student Answer

Plant & Motor Raw Finished Debtors Cash Prepaids

Machinery Vehicles Materials Goods (Rent)
Beg 87,000 27,625 24,333 99,215 452,000 10,050 700,223
1 -183,470 +183,470
2 +37,525
3 -7,500
4 -16,000
5 +13,500
6 a) +13,500 -13,500
b) -42,000 +42,000
7 a) +79,275
b) -56,200
8 a) +70,785
b) -45,250
9 -36,000
10 -196,250
Total before 87,000 41,125 19,858 53,265 347,805 (4,945) 544,108
adjustments
1 -4,350 -2,008 See backup calculations on next
page
2 +4,000 See backup calculations on
next page
Totals 82,650 39,117 19,858 53,265 347,805 4,000 4,000 541,750

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 Ordinary Share Retained Profits Long- Trade
Shares Premium term Creditors
Loan
Beg 135,000 20,500 232,882 74,250 237,591 700,223
2 +37,525
3 -7,500
4 -16,000 Rent Exp
5 +13,500
7 a) +79,275 Sales
b) -56,200 Cost of Sales
8 a) +70,785 Sales
b) -45,250 Cost of Sales
9 -36,000 Admin Exp
10 -196,250
Total before 135,000 20,500 229,492 66,750 92,366 544,108
adjustments
1 -4,350 Depn Exp See backup calculations on next
page
Plant Mach
-2,008 Depn Exp
Vehicles
2 +4,000 Rent See backup calculations on
next page
Totals 135,000 20,500 227,134 66,750 92,366 541,750

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Backup Calculations

Depreciation

Plant & Machinery

Beg Balance 87,000

(Includes 9 months * 20% per year
17,400 per year
Only need 3 months
17,400/12 months * 3 = 4,300

Motor Vehicles

Beg Balance 27,625

(Includes 9 months * 25% per year
6,906.25 per year
Only need 3 months
(1) 6,906.25/12 months * 3 = 1,726.56

New additions 1 13,500

* 25% per year
3.375 per year

Only need 1 months

(2) 3,375/12 months * 1 = 281.25

Add together (1) and (2) = 2,007.81

Rent

Expensed 16,000 for 4 months = 4,000 per month

Still have 1 month (June 2015) as a Prepaid Rent, so an adjusting entry for 4,000 must be
made.

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2. Prepare the Profit and Loss Account for the year to 31 May 2015, including relevant comparisons and variances with the
budget for the year.
(14 marks)
Selected Student Answer
Profit & Loss Actual % of Sales Profit & Loss Budget up % of Sales Variances % Change
up to May 31, 2105 to May 31, 2105
Sales 1,465,080 100% 1,300,000 100% +165,080 ↑ 12.7%
1,315,020 + 79,275 + 70,785
Cost of Sales (916,614) 62.56 (850,000) 65.38 (66,614) ↑ 7.84%
815,164 + 56,200 + 45,250
Depn – Plant (16,806) (14,000) (2,806) ↑ 20.04%
12,456 + 4,350
GROSS PROFIT 531,660 36.29% 436,000 33.54 ↑ 2.75%

OVERHEADS:
Administration Salaries (181,200) 12.37 (175,000) 13.46 (6,200) ↑ 3.54%
145,200 + 36,000
Insurance (no change) (10,000) (8,000) (2,000) ↑ 25%
10,000 + 0
Rent (48,000) (48,000) - -
36,000 + 16,000 – 4,000
Advertising (no change) (60,000) (75,000) 15,000 ↓ 20%
Motor Vehicle Costs (no change/no repairs) (10,400) (5,000) (5,400) ↑ 108%
Depreciation – Motor Vehicles (8,000) 230 ↓ 2.88%
5,200 + 2,570 (7,770)
Other Expense (no change) (17,250) (16,000) (1,250) ↑ 7.81%
TOTAL OVERHEADS (334,620) 22.84% (335,000) 25.77 ↓ 2.93%

NET PROFIT 197,040 13.45% 101,000 7.77% +96,040 ↑ 95.09%

Reconcile
B/E R/E 232,882
Ending R/E 226,572
Down 6,310 Loss over 3 months of Mar – May
Profit at Feb 28 203,350
Overall Profit 197,040

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3. Comment on any significant differences between actual and budgeted
performance.
(4 marks)

Selected Student Answer

The significant differences between Actual and Budget are as follows:

1) ↑ in Sales of 12.7% from budget is a great thing. Products are in demand,

prices appear to be good.
2) Cost of Sales is down 2.82% (65.38 – 62.56) compared to budget. This
indicates perhaps that we have control on our Direct Materials, Direct
Manufacturing Labour and Manufacturing Overheads.
3) Overall Overheads are down 2.93% (25.77 – 22.84) compared to budget.
Even with the ↑ in sales we were able to keep these costs under control. We
saved on Advertising (15,000), however it appears that Motor Vehicle Costs
(repairs) were slightly up, but not out of control.
4) With an ↑ to Gross Profit of 2.75% (36.29 – 33.54) from budget AND a
decrease in overall overheads 2.93% this has helped ↑ profit margin from a
budget of 7.77% to a great 13.45% → 5.60% total ↑.

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Case Study 2

The board of directors of Basel Chocolatiers AG is meeting to review the financial

statements for the year ended 30 April 2015 (See Appendix 1).

‘It’s an unusual report,’ opined Georg Weisinger, the unusually upbeat Chairman of the
company. ‘I thought that, with all that investment in new sales outlets and inventory, our
cash position would have got worse. Yet, it appears that the complete opposite has
occurred. Well done, Franck.’

Franck was Franck Lefevre, the long-serving Group Finance Director. Normally, he and
Georg had disagreements at Board meetings, so he was relieved that this was not one of
those occasions.

‘Hold on, it’s not all Franck’s work,’ interrupted Petulia de Klerk, the Operations
Director. ‘We have installed a new purchasing system that is streamlining our
relationships with our suppliers.’

‘Yes, you’re right, Petulia. Also, there’s also the new agreements with our distributors in
Australia and USA that I set up,’ added Annette Leporc, the Marketing Director. ‘They
have really boosted our sales volumes.’

‘You’re quite correct, ladies,’ agreed Franck, somewhat reluctantly. ‘Without your
contributions, our cash flow position would have been considerably different. However,
there are a couple of other factors that also contributed. I will prepare a full Cash Flow
Statement so that you can measure your relative contributions.’

‘Yes, go ahead and do that. Circulate it before close of business today,’ instructed Georg.

‘No problem,’ sighed Franck. ‘It won’t take long to prepare.’

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Appendix 1

The following information has been extracted from the draft audited accounts of Basel
Chocolatiers AG:

2015 2014

Profit and Loss Accounts SF’000 SF’000

Sales 5,560 3,940
Cost of Sales (1,985) (1,205)
Gross Profit 3,575 2,735
Other Expenses (2,212) (1,845)
Operating Profit 1,363 890
Interest (104) (24)
Profit before Taxation 1,259 866
Taxation (301) (247)
Profit after Taxation 958 649
Dividends Payable (150) (50)
Retained profit for the year 808 599

Balance Sheets SF’000 SF’000

Fixed Assets
Property 575 250
Plant & Equipment 1,550 785
Motor Vehicles 445 185
2,570 1,220
Current Assets
Inventory 1,195 447
Debtors 600 986
Cash at Bank 1,702 987
3,497 2,420
Current Liabilities
Creditors 803 350

Net Current Assets 2,694 2,070

Total Assets less Current Liabilities 5,264 3,290

Creditors > One Year

Long-term Loan 916 150

Net Assets 4,348 3,140

Capital and Reserves

Ordinary Share Capital 400 100
Share Premium 150 50
Retained Profits 3,798 2,990
4,348 3,140

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The following additional information is available:

1. The annual depreciation charges for the year were:

Plant & Equipment SF 105,000

Motor Vehicles SF 49,000

There was no depreciation charge on Property during 2015.

2. There were no disposals of motor vehicles during the year.

3. Some items of plant & machinery were sold during the year for SF 39,000, giving
rise to zero profit or loss on disposal.

4. Creditors comprise:
2015 2014
SF’000 SF’000

Trade creditors 502 53

Dividends payable – 50
Taxation payable 301 247
803 350

5. Ordinary share capital comprises only ordinary shares with a nominal value of SF1
per share.

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Required:

1. Prepare a Cash Flow Statement for the year to 30 April 2015, based on the
financial statements in Appendix 1.
(16 marks)

Selected Student Answer

Workings
1.

Fixed Assets (NBV)

SF’000 SF’000
Bal b/d 1,220 Depreciation 154 (105 + 49)
Bank 1,543 Disposal 39 (disposal at book
value)
Bal c/d 2,570
2,763 2,763
New fixed assets purchased

2. Tax paid = 247 + 301 – 301 = 247

3. Issue of shares = (400 – 100) + (150 – 50) = 400

4. Increase in loan = 916 – 150 = 766

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Cash Flow Statement for the year to 30 April 2015

SF’000 SF’000
Cash flows from operating activities
Operating profit 1,363
Depreciation 154
Operating profit before working capital changes 1,517
Increase in inventory (1,195 – 447) (748)
Decrease in debtors (600 – 986) 386
Increase in trade creditors (502 -53) 449
Cash generated from operations 1,604
Tax paid (247)
Interest paid (104)
Net cash (inflow) from operating activities 1,253
Cash flows from investing activities
Purchases of fixed assets (1,543)
Proceeds from sale of fixed assets 39
Net cash (outflow) from investing activities (1,504)
Cash flows from financing activities
Issues of shares 400
Increase in long term loan 766
Dividends paid (200)
Net cash (inflow) from financing activities 966
Net increase in cash 715

SF’000
Cash at bank at 1 Jan 2015 987
Cash at bank at 31 Dec 2015 1702
Net increase in cash 715

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2. Prepare a brief report for circulation to the board, identifying:

(a) the principal reasons for the company’s ability to increase its cash
reserves during the year.
(b) any relevant comments on the other significant cash movements
during the year.
(9 marks)

Selected Student Answer

To: The Board of Directors, Basel Chocolatiers AG

From: Franck Lefevre, Group Finance Director
Subject: Cash flowing position for 2015

The main reasons for the increase in cash reserves came from a substantial
increase in cash from operating activities and from financing activities.

To break this down:

• The increase in cash flow from operating activities was due to better collection
from debtors as shown by decrease in debtors of SF 386,000 and possibly
better credit terms given by trade creditors as seen in an increase in creditors
of SF 449,000. The former could be attributed to the new agreements with
our distributor and the latter could be attributed to the new purchasing system
that is streamlining our relationships with our suppliers.
• However a word of caution as there was a substantial increase in inventory
levels of SF 748,000. This could be detrimental as too much cash could be
tied up in stocks. We need to look into this.
• Increase in loans also has resulted in more profit needed to service interest.
• The increase in cash flow in financing activities was due to the issue of shares
and increase in long-term loans.
• Investing activities saw a substantial outflow due to new purchase of fixed
assets. However this should help generate profit and inflow of cash for future
periods.

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