ay: Summer 2010 examination AC100 Elements of Accounting and Finance Suitable for 2009/2010 syllabus only — not for resit candidates Instructions to candidates Time allowed: 3 hours + 15 minutes reading time ‘You are allowed 15 minutes for reading the question paper. During this time you may NOT write anything in your answer book but you may annotate the question paper if you wish. You are then allowed 3 hours in which to answer the paper. Show all workings clearly, and state clearly any assumptions you need to make. If accounting paper or graph paper is used for any answer, fasten the sheets securely inside the answer book with the string provided. Answer the following questions: Section A: answer any SIX of the twelve questions in this section Section B: answer the question in this section Section C: answer any TWO of the four questions in this section Marks are allocated as follows: Section A: 5 marks for each question 30 marks: Section 8: 30 marks Section C: 20 marks for each question TOTAL: ‘You are supplied with: Graph paper Accounting paper Present Valve Tables attached to this examination paper You may also use: Electronic calculator (as prescribed in the examination regulations) except during the period allowed for reading the question paper. All workings should be to the nearest £ unless otherwise stated. © LSE 2010/AC100 Page 1 of 18Section A Answer SIX questions from the twelve questions in this section - each question in this section is worth 5 marks Provide up to five examples where the choice of accounting methods or accounting estimates increases the profit reported in the financial statements. [5 marks] Mark Smith seeks your assistance to decide whether he should invest in Ruby ple or Sapphire plc. The shares were recently quoted at Ruby 475p and Sapphire 480p. The performance of the two companies during the year ended 30 June 2008 is summarised as follows Ruby Sapphire £000 £000 Profit before tax 424 300 Tax (144) (60) Profit after tax 280 240 ‘Companies’ capital structures at 30 June 2009 were as follows: Ruby Sapphire £000 £000 Ordinary shares of 50p each 4,000 1,500 Share premium 60 - Retained earnings 250 450 17% Debentures 800 12% Debentures 500 2710 2,450 Required: a) Calculate the earnings per share (EPS) and the price/earnings ratio (PE) of each company at 30 June 2008. Explain which company's shares you would recommend to Mark [3 marks] b) Identify matters that Mark should consider about the two companies’ gearing position. [2 marks] Trotal: 5 marks] © LSE 2010/AC100 Page 2 of 153. In seeking to explain the financial crisis, the spotlight has turned to fair value accounting. Briefly discuss the arguments put forward by proponents and opponents of fair value accounting in the current fair value debate. [5 marks] 4. On 1 April 2005 Black acquired 5.6million of White's ordinary shares paying £3.5 each. At the date of acquisition the retained earnings of White were £8million. The draft balance sheets of the two companies at 31 March 2009 were as follows: Black White £000 £000 Non-current assets Land and buildings 22,000 12,000 Plant and equipment 19,350 40,220 Investment in White 19,600 : 60,950 22,220 Current assets 24,760 10,420 Current liabilities (8.870 (7.040 Net current assets 12,890 3,380 Total assets less current 73,840 25,600 liabilities Long-term liabilities (12,000) (4,000 Net assets 61,840 21,600 Common shares of £1 10,000 7,000 Retained earnings 51,840 14.600 61,840 21,600 The following information is available: (Included in the land and buildings of White is a large area of land at its cost of £5million. Its fair value at the date White was acquired was £9milion and has not risen since then. (ii) The directors estimate that goodwill has been impaired by £2million at 31 March 2009. There has been no other impairment of goodwill since Black acquired the shares in White. (iii) During the year White sold goods to Black for £1.8million and half of those goods are included in Black's stock at 31 March 2009. White adds a 20% mark-up on cost to all its sales. Required: Calculate Goodwill and Consolidated Retained Earnings to be included in the consolidated balance sheet of Black at 31 March 2009. [5 marks] © LSE 2010/AC 100 Page 3 of 155. Ina current research survey by The Aziz Corporation, the UK's leading independent executive leadership and development consultancy, 89% of executives agreed that a culture which ‘encouraged and rewarded the taking of excessive risk’ contributed to the current financial crisis. Briefly outline ways that companies may structure managerial compensation to curtail excessive risk-taking by managers. [5 marks] 6. In most financial reporting jurisdictions across the world there is a local monopoly in financial reporting standards for publicly held firms. Few countries permit their corporations to choose among two or more sets of competing standards. Briefly discuss your stance on having competing financial reporting frameworks instead of a uniform financial reporting framework. [5 marks] 7. DIY Tools Ltd manufactures one type of screwdriver. It purchases the direct materials used for the production of the screwdrivers from two different suppliers. In the Assembly Department of DIY Tools Ltd, handles and shafts of the screwdrivers are put together. DIY Tools Ltd uses the FIFO method of process costing. Below is the costing information for the Assembly Department for January 2010: Physical units Direct Conversion, (screwdrivers) materials costs Work in progress, 1 January * 6,000 £15,000 £4,250 Started during January 2010 66,000 Completed during January 2010 60,000 Work in progress, 30 January 12,000 2010" Costs added during January 2010 £140,000 £85,000 ® Degree of completion: direct materials 100%; conversion costs 40%. » Degree of completion: direct materials 100%; conversion costs 25%, Required: a) Calculate the cost per equivalent unit of opening work in progress for direct materials and conversion costs. Show your workings. (1 mark] b) Calculate the cost per equivalent unit of work done in the current period for direct materials and conversion costs. Show your workings. [4 marks] [Total: 5 marks] © LSE 2010/AC100 Page 4 of 1510. “It is important to distinguish between the performance of a anager and the performance of the organisational subunit for which the manager is responsible.” Critically evaluate this statement, supporting your answer with examples. [5 marks] Bookkeeping & Co. is engaged in selling a standard tax advice service. ‘Summarised below are the results for November and December 2009: November December Sales (number of advice 300 450 services sold) Sales revenue £7,500 £11,250 Operating profit £1,500 £3,300 There were no price changes during these two months. Required: a) Calculate the breakeven point in terms of units of advice services. Show all workings. [2 marks] b) Calculate the margins of safety in percentage terms for November and December. Show all workings. [1 mark] ©) Explain why the business might find it useful to know its margins of safety. [2 marks] [Total: 5 marks] Comment critically on both of the following statements: a) ‘Direct labour hours are the most appropriate basis for charging indirect cost (overheads) to jobs in the modern manufacturing environment where people are so important.” [3 marks] b) “Activity-based costing is a means of more accurately accounting for direct labour cost.” [2 marks] [Total: § marks] © LSE 2010/AC100 Page 5 of 151 12. New Light Ltd produces a standard desk lamp using LEDs (lightemitting diodes) as light source. The budgeted selling price and costs for one desk lamp are as follows: Budget for one desk amp: £ Selling price 45.00 Direct materials 27.00 Direct labour 3.75 Variable production 2.25 overhead Total_variable costs 33.00 The fixed production overhead cost for one month is budgeted as £30,000. The budgeted production volume is 3,750 units per month. In the month of March sales are lower than expected. At the start of April there are 150 unsold units in stock. Production is maintained at 3,750 in the month of April Actual sales during April are 3,525. Required: a) Calculate the operating profit for April under full (absorption) costing and variable (marginal) costing. Show your workings. [4 marks] b) Identify and explain one of the drawbacks of full (absorption) costing. [1 mark] [Total: 5 marks] Drawing from Lord Turner's 2009 Mansion House speech and from the lectures’ material, answer the following two questions: What are some of the positive roles played by the financial system? What are some of the problems = highlighted by the current financial crisis — with some of the functions of the financial system? [5 marks} © LSE 2010/0100 Page 6 of 15Section B Answer this question The following information has been extracted from the bookkeeping records of Lifetime plc, a manufacturing company, at 30 September 2009. Trial Balance at 30 September 2009 £7000 £000 Accrued expenses at 1 October 2008 8 Administration expenses 1,154 Bank 33 Capital reserve 200 Delivery vehicles — cost 120 Delivery vehicles — accumulated depreciation 78 Disposal account 10 Distribution costs 632 Dividends received 4 Dividends paid 200 Factory — cost 8,000 Factory - accumulated depreciation 320 Interest 60 Inventory at 1 October 2008 610 Loan stock (10% repayable 2015) 4,200 Manufacturing equipment — cost 1,800 Manufacturing equipment — accumulated depreciation 540 Prepayments at 1 October 2008 12 Provision for doubtful debts 20 Purchases 6,800 Retained earnings 974 Sales revenue 12,000 Share capital (£1 ordinary shares) 3,500 Share premium 1,600 Tax 7 Trade payables 660 Trade receivables 1,700 —_ 21,121 21.421 You have also been provided with the following information: (i) On September 2009 inventory was counted and valued at cost of £780,000. Included in this total is old stock costing £75,000, which could be sold at 60% of its cost. i) Depreciation is still to be charged for the year on the following bases: Factory — 2% p.a. straight line Manufacturing equipment — 10% p.a. straight line Delivery vehicles ~ 25% p.a. reducing balance A full year’s depreciation is charged in the year an asset is acquired and none in the year in which it is disposed of. © LSE 2010/AC100 Page 7 of 15(i) (wy) wy) (wi) vi) (vill) (0) During the year, a delivery vehicle that had been purchased in August 2006 for £30,000 was sold for £10,000. No entries have been made in the books for this disposal, apart from recording the disposal proceeds. The directors have decided that a further £100,000 of trade receivables should be written off and that the trade receivables provision should then be adjusted to 3% of the outstanding balance. ‘The balance of accrued expenses at 1 October 2008 refers to accrued electricity expense. After the year-end the company received an electricity bill for £15,000 covering the period 1 August ~ 31 October 2009. The company classifies heat and light costs under administrative expenses. The loan stock was issued on 1 October 2008. Interest is payable half-yearly ‘on 1 April and 1 October. The interest due on 1 April 2009 was paid on the due date. Accrued interest at 30 September 2009 has not yet been accounted for. The balance of prepayments at 1 October 2008 refers to insurance charges. Prepaid insurance included in general distribution costs at 30 September 2009 amounted to £14,000. ‘The external auditor's fee for the year has been estimated at £80,000. The balance of the tax account is the result of an over-provision for the year ended 30 September 2008. The corporation tax charge for the year to 30 September 2009 has been estimated at £150,000, Required: a) b) Prepare the income statement of Lifetime ple for the year ended 30 September 2009 and the balance sheet at that date in a form suitable for presentation to the directors of the company (i.e. compliance with the accounting requirements of the Companies Act 2006 or with IAS1 is not required). [25 marks] Calculate net assets per ordinary share of Lifetime pic at 30 September 2009. Given that the stock price of Lifetime plc was 382.1p on the earnings announcement date, suggest factors that might explain the difference between the two figures. [5 marks] [Total: 30 marks] @ LSE 2010/AC100 Page d af 15Section C Answer TWO questions from the four questions in this section 1. Codling ple manufactures computer hardware. in recent years, the company has faced severe competition and its safes volume has hardly changed. The company has recently applied for an increase in its bank overdraft limit from £750,000 to £1,500,000. The bank manager has asked you, as the bank's credit analyst, to look at the company’s application, You have the following information: Balance Sheet at 31 December 2008 2009 £000 £000 Non-current assets Freehold land and buildings 1,800 1,800 Plant and equipment 3,150 3,300 Long-term investments 300 - 5.250 5.100 Current Assets Inventory 4,125 1,500 Trade receivables 825 1.425 1,950 2,625 Bank overdraft 225 675 Trade payables 300 375 Taxation payable 375 300 Dividends payable 225 225 4,125 1.575 Non-current liabilities 8% debenture loan 2016 1,500 1,500 Net assets 4.575 4.651 Equity Ordinary shares of £1 2,250 2,250 Share premium 750 750 Retained earnings 1.575 1,650 4.575 4,650 © LSE 2010/AC100 Page 9 of 15Income Statement for the year to 31 December 2008 2009 £000 £'000 Revenue 6,300 6,600 Cost of sales 4.410 4,680 Gross profit 1,890 1,920 Administrative expenses 1,020 1.125 Operating profit 870 795 Investment income 45 _- 885 795 Interest payable 135 195 Profit before taxation 750 600 Taxation 375 300 Profit for the financial year 375 200 Notes: (i) Additions to plant and equipment in 2009 amounted to £450,000 (ii) Depreciation provided in 2009 was £300,000. Required: a) Prepare the cash flow statement of Codling plc for the year ended 31 December 2009. [9 marks] b) Calculate liquidity and efficiency ratios to use along with the cash flow statement from a) as a basis for 2 report to the bank manager. For the ratios show the basis of your calculation and use year-end figures where you would normally use average figures. Draft the outline of the report to the manager, highlighting key areas of concer and providing your view on the application of Codling plc. [14 marks] [Total: 20 marks] © LSE 2010/AC 100 Page 10 of 152. Living Ltd manufactures and assembles one type of sofa-bed. The following information is available for the year ended 31 December 2009. The budgeted costs and the actual costs incurred during the year were as follows: Cost Budgeted Actual production production overhead overhead Nature of cost cost cost £000 £000 Supervision 150.0 127.5 Fixed Machine power 45.0 33.0 Varies with machine hours Heat and light 45.0 40.5 Varies with direct labour hours Rates and 330.0 304.5 Fixed insurance Lubricants 90.0 875 Varies with machine hours Indirect materials 75.0 57.0 Varies with units of output Machine 270.0 270.0 Fixed depreciation Maintenance and 420.0 90.0 Varies with machine repairs hours 1,125.0 290.0 The budgeted and actual activity for the year was as follows: Machine Direct Units of output hours labour hours Budget 382,500 750,000 150,000 Actual 270,000 660,000 __120,000 At the end of the year, the production director made the following report to his colleagues on the board of directors: ‘We budgeted for £1,125,000 overhead cost based on 750,000 direct labour hours. We incurred £990,000 actual cost but only worked 660,000 hours. This appears to me to be a satisfactory proportionate reduction in costs and there are consequently no unfavourable variances from the budget to be explained.’ The other directors felt this comment ignored the distinction between fixed overhead cast and variable overhead cost. They were also concerned that the production director referred only to the fall in direct labour hours worked, © LSE 2010/AC100 Page 11 of 15when it was known that some overheads depended on the number of machine hours worked. They asked for a more detailed analysis of the expected level of overhead costs in relation to the activity levels achieved. Required: a) Set out a more detailed variance analysis, which distinguishes fixed overheads from variable overheads. Calculate flexi-pudget overhead variances. For the computation of the variable overhead variances use: = machine hours as the allocation base for machine power, lubricants, maintenance and repairs; - direct labour hours as the allocation base for heat and light; and - units of output as the allocation base for indirect materials. Show ali workings. 1 marks} b) Explain and discuss the results you calculated above [6 marks] ©) Why are variance reports a useful tool of management? What are potential problems? Explain and discuss. 17 marks} [Total: 20 marks] 3, “Budgets (or any planning and measurement frameworks, for that matter) don't exist in a vacuum. They determine how people behave in any given situation. Focusing leaders’ minds on the stewardship of shareholders’ funds and ensuring that managers worried about controlling costs were its original functions, and leaders and managers, by and large, behaved accordingly. But budgets have since been hijacked by a generation of financial engineers that nave used them as remote contro! devices to ‘manage by the numbers'.” (Hope & Fraser, 2003: xviii) Required: Critically evaluate this statement considering the various uses and limitations of budgeting. Support your discussion with examples and insights from the academic literature on budgeting, [20 marks] © LSE 2010/AC100 Page 12 of 15