Mock Examination 2017: Examiner’s Commentary

University of London International Programmes Preliminary Exam 2017

BSc degrees and Diplomas for Graduates in Economics, Management, Finance
and the Social Sciences, the Diplomas in Economics and Social Sciences and
Access Route
Examiner’s report for the 2017 Preliminary Exam

Section A of the examination which consists of 20 Multiple Choice Questions.

Q1

Which of the following statements most accurately explains ‘capital expenditure?

a spending on the purchase or improvement of non-current assets

b spending on the acquisition of expenditure on expensive assets
c spending on the issue of additional share capital
d spending on the maintenance and repair of non-current assets

Capital expenditure relates to the acquisition and improvement on non-current assets.

‘Materiality’ determines the sums won’t be trivial sums. The issue costs arising on
the issue of share capital has nothing to do with ‘capital expenditure’ but is treated as
an expense or can be offset against ‘share premium’. Maintenance and repairs are
simply treated as an expense in the income statement.

Q2

Lee opened his new business on 1.January 2016. On that date, the only asset
was a bank balance of $10,000. During the year, Lee’s drawings from the
business totalled $35,000. On 31 December 2016, the assets and liabilities
of the business were as follows:

Computers and furniture $60,000, inventory of raw materials $16,500,

finished goods, at cost $7,400, bank overdraft $11,600, trade payables, $5,500,
prepayments $1,500, trade receivables $4,500, the provision for bad debts
$2,000, bank loan $39,000, interest payable $500, accrued expenses, $2,600.

What is the profit of the business in the year ended 31 December 2016?

a $63,700
b $123,700
c $62,700
d $53,700

Assets – liabilities = Capital.

The assets are 60,000 + 16,500 – 2,000 + 7,400+ 1,500 +4,500 =

$87,900

The liabilities are 11,600 + 5,500 + 39,000+ 500 + 2,600 =$59,200

The Net assets and therefore capital at 31.12.16 is $28,700

Principles of Accounting AC1025 page -1-

 Profit = increase in net assets + drawings
= 28,700 – 10,000 + 35,000 = $53,700

Q3

The selling price of inventory of Company M at 28 February is $72,000. The

company marks up its goods by 44%. One quarter of the inventory has been damaged
in a fire and will be sold for $9,800. Which of the following will be the correct
value for closing inventory at 28 February in the statement of financial position?

a $50,000
b $39,840
c $63,800
d $47,300

Chapter 5 pp60 - 61. Leiwy & Perks Ch 2 pp36-37

Cost + mark-up = selling price

Cost + 44% = $72,000

Cost = 72,000/1.44%
Cost = $50,000

However, ¼ of this, ie items costing $12,500 with be sold for $9,800 producing a loss
of $2,700 and so the value of inventory at the lower of cost or NRV = 50,000-2,700 =
$47,300

Q4

On 1 February 2017, Computer Deals Limited had 400 computers in inventory

costing $1,220 each. During the month, the following transactions occurred:

Date Buy/sell Units Price

2.2.X7 Buy 600 $1,300
11.2.X7 Sell 800 $1,420
13.2.X7 Buy 900 $1,360
17.2.X7 Buy 400 $1,350.
25.2.X2 Sell 500 $1,500

What is the (i) value of inventory at 28.2.X7 and (ii) the cost of goods sold (COGS)
for the month of February 2017 using the LIFO basis?

Inventory COGS
$ $
a 1,348,000 1,684,000
b 1,316,000 1,716,000
c 1,332,000 1,700,000
d 1,328,000 1,704,00.0

Principles of Accounting AC1025 page -2-

In using the LIFO method, those items sold are those most recently acquired at the
date of each sale You are looking in reverse chronological order.

Chapter 5 pp 58-60

Date Buy/sell
Number Unit cost Inventory COGS
$ $ $
1.2.17 inventory 400 1,220 488,000
11.2.17 sell (200) 1,220 (244,000 244,000
2.2.17 buy 600 1,300 780,000
11.2.17 sell (600) 1,300 (780,000) 788,000
13.2.17 buy 900 1,360 1,224,000
25.2.17 sell (100) 1,360 (136,000) 136,000
17.2.17 buy 400 1,350 540,000
25.2.17 sell (400) 1,350 (540,000) 540,000
1,000 1,332,000 1,700,000

Q5

In the relation to the payment of an ordinary dividend on the first date of the new
accounting year, paid by a company to its shareholders, which of the following
statements is true?

i the maximum dividend cannot exceed the retained profit at the end of the previous
accounting year
ii the dividend cannot exceed the company’s bank balance at the date the dividend is
paid
iii the dividend must be approved by the shareholders at a general meeting
iv the dividend is affected by past dividend policy

Of these statements, which is true?

a i, ii and iii
b i, iii and iv
c i and iv
d ii and iii

The legal maximum is the retained profits at the date the directors approve its
payment.
The company can pay a dividend even if that dividend exceeds the bank balance. Of
course, they need to have agreed an overdraft with the bank. And they need to take
into consideration other cash needs in the near future.
A final dividend has to be approved by shareholders at a general meeting but an
interim dividend can be paid by the directors WITHOUT such approval.
Other things being equal, a company will try to maintain a consistent dividend payout
policy.
Q6

At 1.1.2017, Company D’s statement of financial position showed the following:

Principles of Accounting AC1025 page -3-

 $
Bank (overdraft) (25,000)
Share capital: 600,000 shares of 10c each 60,000
Share premium 40,000
Revaluation reserve 58,000
Retained profits 86,000

On that day the company made a 7 for 4 bonus issue. The directors wish to avoid
capitalising profits if they can manage it.

After this transaction,. which of columns a, b, c or d in the table below reflects the
correct balance in these accounts in the statement of financial position?

Answer a B c d
$ $ $ $
Bank (25,000) (25,000) 80,000 80,000
Share capital: 165,000 105,000 165,000 105,000
Share premium - - 50,000 50,000
Revaluation reserve - 53,000 44,000 13,000
Retained profits 79,000 86,000 57,000 86,000

Chapter 7 pp89-81 Leiwy & Perks Ch 11 pp 277-278

On a bonus issue, shares are given to shareholders ie no cash is received. Hence,

cash is not affected. Share capital rises; in this case, the company is issuing 7 for 4.
There are 600,000 shares of 10c each so it is issuing 1,050,000 shares of 10c each of
which appears in the statement of financial position at its par value of 10c. If one
item of equity rises by $105,000, then others must decrease by $105,000 in total since
the assets must still equal equity + liabilities. Since neither the assets nor the
liabilities change, the equity in total won’t change either. Since share capital
increases, other non-distributable parts of equity will fall but they cannot be negative
figures. Hence share premium will fall to zero, revaluation reserve will fall to zero
and retained profits in this case will have to fall by the remaining $7,000.
On a bonus issue, the double entry is as follows:
Dr: Share premium = $40,000
Dr: Revaluation reserve = $58,000
Dr: Retained profits = $7,000
Cr: Share capital with the par value of the shares (1,050,000 x 10c = $105,000

Q7

At 1 February2017, trade receivables of Company X are $123,690. In

February, cash received from customers was $788,110 and discounts allowed

Principles of Accounting AC1025 page -4-

 were $2,990. Bad debts written off in the month were $17,400. A sales
ledger/purchase ledger contra of $5,400 was agreed with James & Co, a
company which is both a customer of and a supplier to Company X At
28.2.17, trade receivables are $138,004.

What were the sales during February?

Sales
a $817,414
b $828,214
c $811,434
d $1,075,594

Chapter 9 pp 111-113. Leiwy & Perks Ch 19 (online)

Opening receivables + sales – cash received – discounts allowed - bad debts

written off - contra = Closing receivables

So, sales = Closing receivables – opening receivables + cash received +

discounts allowed + bad debts w/off + contra

= 138,004 – 123,690 + 788,110+2,990+17,400 + 5,400

= $828,214

Q8

At 31 January 2017, the cash book of Company B showed a balance of $1,710,

overdrawn.

An examination of the Company’s cash book and bank statements show the
following:

i Bank charges of $100 charged by the bank on 29.1. 2017 have not been
accounted for
ii A $550 cheque received from a customer on 23.1.2017 was dishonoured and
appeared as such on the bank statement on 31.1.2017 but not in the cash book
iii A payment of $456 made directly into the bank account of Company B on
27.1.2017 has not been entered into the Cash Book.
iv Receipts of $905 banked at another branch of the bank on 31.1 2017 were not
cleared until 4.2.2017
v Cheques totalling $8,666 sent to suppliers on 30.1.2017 were not presented to the
bank until February 2017
vi The payments side of the cash book has been undercast by $1,000

What balance appeared on the bank statement at 31 January 2017?

a + $10,665
b + $4,857

Principles of Accounting AC1025 page -5-

c - $ 2,904
d + $8,673

Chapter 10 pp125-127. Leiwy & Sherman Ch 9 pp224-226

Corrected cash book at 31.1.2017 Dr Cr

Balance in cash book 1,710
Bank charges not yet entered in the cash book 100
Bounced cheque 550
Receipt not entered 456
Payments underadded 1,000
456 3,360
Corrected cash book balance 2,904

Bank reconciliation statement

Balance per bank statement Xxx
+ Uncleared receipts 955
.-Unpresented payments (8,666)
.= Closing cash book balance (2,904)

Xxx + 905 -,8666 = -2,904

Xxx = + $4,857

Q9

In the TB of Company Y at 28 February 2017 included a Suspense account.

Investigation showed the following:

I A receipt of $1,650 from a customer, S Yeo, has been debited to the bank but had
not been posted to the Sales ledger because at the time it was received, the
accounting staff did not know which customer it related to. But a series of phone
calls has identified which customer has paid this sum.
Ii A payment of $2,000 for a new computer had been posted to the machinery
repairs t-account, in error
iii A t-account balance of $1,300 arising from the sale proceeds on the disposal of a
van had been omitted from the Trial Balance
iv A t-account balance relating to an increase in the provision for bad debts of $500
had been included in the TB as a credit balance.

What would the balance in the Suspense account have been before making the
required corrections?

a $1,950 Cr
Principles of Accounting AC1025 page -6-
b $1,950 Dr
c $3,950 Dr
d $3,950 Cr

Chapter 10 p128 Leiwy & perks pp 225-226

i The double entry here is:

Dr: Suspense account $1,650

Cr: Receivables. $1,650
This is simply crediting Receivables because this entry was not made at the time
of the transaction because the accounting staff did not know to which Receivables
account to post it
ii The double entry here is:
Dr: Computers: cost . $2,000
Cr: Repairs $2,000
It has no effect on the Suspense account since the double entry was posted
although not to the correct account
iii Dr: Suspense $1,300
Cr: Disposal of computers $1,300
A credit balance which should have been in the TB wasn’t there and thus that Cr
had to appear in the Suspense account
iv Dr: Increase on bad debt provision $1,000
Cr: Suspense $1,000
This had been included in the TB as if it was an decrease in the bad debt
provision of $500 so to correct it to an increase of £500, we must move this
balance by 2 x $500 = $1,000

The Suspense account will look as follows:

$ $
$ $
Opening balance 1,950
i Cr: Receivables 1,650
ii Cr: proceeds of sale on non-CAs 1,300
iv Cr: Increase in bad debt provision 1,000
2,9500 2,950
Balance nil nil

Q10

In Company Y in Q9, if the profit before tax on the original TB was $44,560, what
will the profit before tax be AFTER the corrections in Q9 were made?

a $46,860
b $44,560
c $46,360
d $42,560

Principles of Accounting AC1025 page -7-

Chapter 10 p128 Leiwy & perks pp 225-226
Dr: decrease Cr: increase
Existing profit before tax 44,560
i Receivables: no effect on profit
ii Reduction in repairs expenses 2,000
iii Proceeds of sale of non-CAs 1,300
iv increase in bad debt provision 1,000
1,000 47,860

So, the revised profit is £46,860

Q11

A direct cost is which of the following:

a a cost which is directly attributable to a particular job, product or

service.
b a cost which varies with output
c a semi-variable cost
d A cost which is apportioned to the cost of a unit of production

a direct cost is a cost which can be directed attributable to a particular job, product
or service, It might be fixed, it might be variable or it might be semi-variable.
Whether costs are direct or indirect depends upon the ‘cost object’ being assessed.

Q12

In 20X6, Company B produced and sold 200,000 Peppa Goat 20X6 annuals and the
sales revenue arising was $1m. The variable costs of production were $1.75 each.
They made a loss of $115,000. Assuming there is no change in any costs or
revenues, how many 20X7 annuals must be made and sold to make a profit of
$150,000?

a 312,308
b 250,000
c 164,616
d 281,539
Chapter 15 pp 187-191 Leiwy & Perks Ch 17 pp 402-410

Selling price/unit = 5.00

VC/unit = 1.75
Contribution/unit = 3.25
Total contribution = 200,000 x $3.25=$650,000
Less: Fixed cost = x
= Loss of $115,000
Therefore, fixed costs are $765,000

To make a profit of $250,000, the required contribution is 150,000 + 765,000 =

$915,000

The number of units to be made and sold is therefore $965,000/$3.25 = 281,539 units
Principles of Accounting AC1025 page -8-
Q13

Company C makes a liquid chemical cleaner which sells at $10 a bottle. Variable
costs are $6 a bottle. The business is working at full capacity. What is the
minimum price at which this product could be sold without making a loss for an order
of 10,000 bottles. To fulfil this additional order, the company would incur additional
fixed costs of $45,000 and variable costs of $60,000. You may assume a linear
relationship between costs and selling price.

a $145,000
b $40,000
c $85,000
d $100,000
.
Chapter 15 pp 187-191 Leiwy & Perks Ch 17 pp 402-410

Since the company is working at full capacity, to fulfil this order, it will sacrifice the
existing contribution from10,000 units
Selling price/unit = 10.00
VC/unit = 6.00
Contribution/unit = 4.00
Total contribution = 10,000 x $4 = 40,000
+ additional costs, fixed and variable = 105,000
So, required revenue $145,000

Q14

Company L makes three products, D, E and F. Unit costs and revenues relating to
the three products are as follows:

D E F
Selling price 780 600 720
Direct materials 288 240 270
Direct labour 150 120 150
Variable overheads 120 90 90
Fixed overheads 162 108 158
Total costs 720 558 668
Profit per unit 60 42 52

All three products use the same material which costs $20 per kilogram but there is not
enough material to meet the demand for all three products. In what order shoul d
these three products be produced if the company wishes to maximise its profit?

Best 2nd best 3rd best

A D F E
B F D E
C D E F
D E F D

Principles of Accounting AC1025 page -9-

Chapter 15 pp 195-196 Leiwy & Perks Ch 17 pp 408-409

With one scarce resource, products are ranked in order of their contribution per unit
of scarce resource
.
D E F
Selling price 780 600 720
Direct materials 288 240 270
Direct labour 150 120 150
Variable overheads 120 90 90
Total variable costs 558 450 510
Contribution per unit 222 150 210
Material (kg) 14.4 12 13.5
Contribution per kg $15.42 $12.50 $15.56
Ranking 2 3 1

Q15

The normal credit terms offered by Company F to its customers is payment 60 days
from delivery and the issue of an invoice, both of which always occur on the same
day. At today’s Board meeting, the directors are considering offering customers a
2% cash discount if they pay in 30 days. The company’s bankers, HBSC charge
Company F overdraft interest at 1.8% per month. Consider a sales invoice of
$1,000. Is the company financially better or worse off by offering this discount, and
by how much?

a worse off $2
b better off $2
c better off $2.36
d worse off $2.36

Chapter 16 pp 208-209 Leiwy & Perks Ch 12 pp 300-303

The Company will receive $1,000 one month earlier less 2% = $980 so the cost to the
company is $20

On the other hand, it will save overdraft interest of $1,000 x 1.8% = $18

Hence, it will cost the company $2 net to offer the discount. Ie $2 worse off

Q16

Company S makes cups and saucers. The standard cost of making a souvenir mug
of Singapore is as follows:

$
Direct material 5.40
Direct labour 0.90
Variable overheads 0.45
Fixed overheads 1.00
Principles of Accounting AC1025 page -10-
Standard cost 7.75
Selling price 20.00
Standard profit 12.25

Budgeted for February 20X7 sales were $360,000. In February, in fact, 21,000 units
were sold for $401,100.

The sales price variance and the sales contribution volume variance for the month
were:

Sales price variance $ Sales contribution volume variance $

a $18,900 favourable $36,750 favourable
b $18,900 unfavourable $39,500 unfavourable
c $18,900 favourable $36,750 unfavourable
d $18,900 unfavourable $39,750 favourable

a
Chapter 17 pp 218-219 Leiwy & Perks Ch 18 p 425
Budgeted units = $360,000/$20 = 18,000
Actual units =21,000
Budgeted SP = $20
Actual SP = $401,100/21,000 =$19.10
Standard contribution per unit = selling price – variable costs
= $20 - $6.75 = $13.25
sales price variance = Actual volume sold x (actual SP – standard SP)
= 21,000 x ($19.10 - $20)
=$18,900 unfavourable
Sales contribution variance = (actual units sold – budgeted units)x standard
contribution
= (21,000 – 18,000) x $13.25= $39,750 favourable

Q17

Company R makes crockery. The materials budget for February’s output of 1,500
teapots was 1,200 kg of material, $10,560. In fact, 1,600 pots were made and the
actual material used 1,370kg costing $11,097

The materials price and efficiency variances were as follows::

materials price variance $ Materials efficiency variance $

a $959 unfavourable $792 favourable
b $959 favourable $1,496 favourable
c $959 favourable $1,496 unfavourable
d $959 favourable $792 unfavourable

Chapter 17 pp 219-220 Leiwy & Perks Ch 18 p 417-419

Budgeted quantity = 0.8kg per unit

Actual quantity =0.85625kg per unit

Principles of Accounting AC1025 page -11-

Budgeted price = $10,560/1,200kg) = $8.80 per kg

Actual price = $11,097/1,370kg =$8.10 per kg

Standard contribution per unit = selling price – variable costs

= $20 - $6.75 = $13.25

materials price variance = Actual quantity ((actual price – standard price)

= 1,370kg x ($8.10 - $8.80)
=$959 favourable

Materials efficiency variance = (actual quantity – standard quantity for the ACTUAL
level of output))x standard price

= ((1,370 –(1,600 x (0.8kg) )x $8.80 = $792

unfavourable

Q18

Company A is considering replacing all its offset printing machinery. The cost on
1.1.X3 will be $2m. The expected economic life of the equipment will be 4 years.
The company depreciates its equipment using the straight-line methods. The
company expects to sell this equipment for $200,000, after the end of its useful
economic life. There are expected cost savings arising from this investments of
$900,000 in each of years 1 and 2 and $600,000 in each of years 3 and 4.

The payback period of this investment is which of the following?

a 2 years
b 3 years
c 2 years and 4 months
d 2 years and 8 months

Chapter 18 pp 227-232 Leiwy & Perks Ch 14 pp334-335

The payback period is the period it takes for the cash inflows to equal the outflows.
The investment is £2m. After 2 years, the cash inflows total £1.8m. In year 3, the
inflows are £600,000 and therefore the repayment occurs after one-third of year 3, ie 2
years and 4 months.

Q19

With reference to the information in Question 18, the accounting rate of return using
the average investment is which of the following?

a 33.3%
b 15%
c 12.5%

Principles of Accounting AC1025 page -12-

d 27.3%

Chapter 18 pp 232-233 Leiwy & Perks Ch 14 pp331-334

ARR = Average annual profit/average investment
Profit = cash flows – depreciation expense
Total cash flows= 900k+900k+600k+600k = £3m
Total depreciation = cost – residual value = £2m-£200k = £1.8m
So, total profit £3m-£1.8m = £1.2m
So, average profit = £1.2m/4years = £300,000
Average investment = (initial investment + closing investment)/2
= (£2m+£200,000)/2
= £1.1m
ARR = Average profit/Average investment
= £300,000/£1.1
= 27.3%

Q20

Company A is considering replacing all its offset printing machinery. The cost on
1.1.X3 will be £2.3m. The expected economic life of the equipment will be 4 years.
The company depreciates its equipment using the straight-line method. The
company expects to sell this equipment for £200,000. There are expected cost
savings arising from this investment of £900,000 in each of years 1 and 2 and
£600,000 in each of years 3 and 4. The to the nearest £100, NPV at a discount rate
of 8% is + £369,100 and at a discount rate of 20%, it is - £192,700.

The Internal Rate of Return of this project is:

a 15.9%
b 12.1%
c 14.0%
d More information is needed to compute the IRR

Chapter 19 pp 235-243 Leiwy & Perks Ch 14 pp 335 – 343

By linear interpolation:
Discount rate NPV
8% £369.100
20% £(192,700)
Change 12% £561,800
So, a change of 1% £46,817

So the IRR = 20% - 192,700/46,817

= 20% - 4.1% = 15.9%

Principles of Accounting AC1025 page -13-

Section B
Q1
The usual problem! You need to be able to correctly head up the Income Statement
and the Statement of Financial Position and the Statement of Movements of Equity.
Remember that preference shares are to be treated much like loans, in Non-current
liabilities and preference dividend much like interest on loans.
This question has many of the usual adjustments one has seen in past examples of this
compulsory question and can be found in the Subject Guide Ch 5-8, especially Ch 8
and in Leiwy & Perks Ch 10.
Every adjustment affects two figures.
 Inventory is to be valued at the lower of cost and net realisable value, in
accordance with the prudence concept.
 The cost and accumulated depreciation of the item sold must be removed from
those two balances appearing in the trial balances. Then we can compute the
depreciation on the plant and machinery on the reducing balance basis. By
comparing the net book value of the item sold with the disposal proceeds, we
can establish the profit or loss on its sale.
 A revaluation increases the land and revaluation reserve. Revaluation reserve
is an element of ‘equity’ and such an increase will be disclosed in the
‘Statement of movements in equity’.
 The provision for bad debts is 3% of the receivables AFTER having written
off the bad debt. The change in the provision will appear as an expense (or in
this case, minus expense or sundry income) in the income statement, an
decrease of the provision, in this case.
 Dividends on ordinary shares are accounted for when paid so any proposed
dividend only appears as a ‘note to the accounts’ but not in the two statements,
themselves.
 Dividends on cumulative ‘prefs’ and interest on debentures can be calculated
from the rate information appearing in the trial balance. To the extent these
have NOT been paid – how much has been paid in the year appears in the TB
– those as yet unpaid sums must be accrued and appear in the current
liabilities. Preference dividends and interest on loans appear as expenses in
the income statement.
 The tax for the year appears as a deduction from Profit before tax in the
Income Statement and as current liability, since it has not yet been paid. If
taxation appears on the TB, if it is a debit balance, as in this case, it is an
underprovision for tax in the previous year and it will appear as a tax expense
in the income statement. If it is a credit balance it is an overprovision for tax
in the previous year and has to appear as a minus tax expense in this year’s
income statement..
 The profit after tax will be added to the opening retained profits in the
statement of movements in equity and the ordinary dividend paid is deducted
there.

A revaluation of land? It’s not a realised profit so it can’t be shown in the income
statement. Why do we do it? Consider such published financial statements
accounting characteristics as ‘relevance’, ‘accuracy’ and the notion of a ‘true and fair
view’. This is explained in the Subject Guide pages 78-79. As with all the
Principles of Accounting AC1025 page -14-
accounting characteristics and concepts and terminology, it is vital you know and
understand all of them and can apply them and justify them when asked to do so.

Q2:
A typical AC1025 cash flow statement questions. It’s important to know what
appears in the CFS and where it appears. Most of the figures are very
straightforward. The difficult figures involve four computations. These are as
follows:
Interest paid, which is the current liability at the beginning of the year, plus the
interest expense less the sum still payable. The tax paid in the year is calculated in
exactly the same way. Sum paid to acquire non-current assets are computed on the
basis that the opening balance, less the net book value of any asset sold in the year,
less any depreciation expense plus any revaluation in the year plus sums paid to
acquire non-current assets will equal the closing balance. The sum raised from the
issue of shares is calculated on the basis of the movement in the share capital AND
the share premium. A further complication in this question is that a bonus or scrip
issue occurred in the year and bonus or scrip issues involve the increase in share
capital and a compensating reduction in the retained profits. Usually, it would be the
share premium and/or the revaluation reserve would be reduced, if possible but in this
instance, the question specifies that it is the retained profits which are debited. A
bonus issue does NOT involve the receipt of any cash. Hence the bonus issue won’t
appear in the cash flow statement but it will appear in the working to compute the
actual sum of cash raised from a conventional share issue.
The advantages and disadvantages of a cash flow statement are detailed and
explained in Leiwy & Perks Ch 6 and the Subject Guide Ch 11, as is an approach to
interpreting a CFS.
Q3
Usually, one question in Section B is a ratio analysis question asking for the
calculation of perhaps eight ratios and then interpretation of the results. But this
exam question has three mini-financial accounting problems. Make sure you can
compute all the ratios appearing in Leiwy & Perks and in the Subject Guide, how to
interpret each one and each group of ratios and know the correct notation for each
one, ie a percentage, a number of days or simply a figure. Also is a rise or fall in
each ratio better or worse or in some cases, it depends !! But read Chapters 4 and 7
of Leiwy & Perks thoroughly.

Section C
Q4:
It is very important to produce a cash budget in columnar form and to solve it by
problem, not by month, in other words and in looking at the computation, line by line
not month by month. First show the receipts, then the payments, subtract the
payments from the receipts, to show the surplus or deficit for the month. Add the
surplus or deficit for the month to the opening balance which will identify the closing
bank balance. The closing balance in one year is the opening balance in the next.
To improve a cash flow crisis, accompany can try to induce its customers to pay more
quickly, perhaps offering a prompt payment discount to do so. It could request
additional credit from its suppliers. It could arrange to lease rather than buy the
machine.
In this question, the difficulty is computing the ‘purchases’. We are given COGS and
told that closing inventory each month is the two following months COGS. Of
course, closing inventory one month is the opening inventory the following month.
And since opening inventory + purchases – closing inventory = COGS, if you have
opening inventory, closing inventory and COGS, you can work out the purchases in
Principles of Accounting AC1025 page -15-
each month. And in this question, the purchases in one month are paid the fllowing
month. See L&P Ch 15 and Subject Guide Ch 16
Q5:
In the marginal costing approach, each unit of production is valued at its marginal cost
of production. In order to calculate ‘contribution’, any other variable costs must also
be taken into consideration. And to compute profit, the fixed costs, including fixed
production overheads must be deducted. In absorption cost, each unit of production
is valued at its full cost, including fixed production overhead Of course, in both
period, the production exceeds the budgeted level of production (6,000 units) so there
is a positive production volume variance in both periods. Having computed gross
profit, and then the revised gross profit incorporating the positive production volume
variance, the sales/administration costs, both fixed and variable must be deducted in
order to compute profit. The fixed production cost per unit is the fixed production
overheads divided by the budgeted number of units produced ie $60,000/6,000 units =
$10 per unit and therefore total absorbed cost per unit is $32 + $10 = $42 per unit.

The difference in profit arises from the treatment of the fixed production overheads.
In marginal costing, it is simply a period expense when it is incurred while in the
absorption costing income statement, it only hits the income statement when the
goods are sold since the $10 per unit is included in the value of each unit produced.
Since the inventory has risen by 600 units in period 1, 600 units @ $10 = $6,000 is
not a cost but is included in the additional inventory valuation. In period 2, the
inventory has fallen by 1,000 units and hence, an additional 1,000 units @ $10,
$10,000 has hit the income statement.
See L&P Ch 16 and 17 and Subject Guide Ch 14.
Q6:
This is a NPV question involving both a selection of ‘relevant costs’ ignoring sunk
costs and only incremental future marginal costs. Much like a cash budget, in Q4,
NPV computations must be arranged in columnar form.
In this question, the budgeted production must be computed on the basis of the
probability of the three quoted levels of production. With regard to the capacitors,
each year requires one unit but since there are 14,000 capacitors in stock, these have
no relevant cost and so none are needed in year 1 and in year 2, the company needs to
buy 11,800 units. By using the dangerous chemical in this project, this will SAVE
the company $20,000. The incremental fixed overheads are $10,000 since $20,000
will be incurred anyway.
What other factors would be taken into consideration in such a decision? These are
non-quantifiable factors not already taken into account in the figures used in the
computations.
These issues are explained very clearly in Leiwy & Perks Ch 14 and in the Subject
Guide Ch 18 and 19

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