paper p7 financial accounting and tax principles may 2005

Paper P7 – Financial Accounting and Tax Principles Post Exam Guide May 2005 Exam

The Chartered Institute of Management Accountants

General Comments This first paper of the new syllabus applied the new question paper format for the first time. The overall result was generally very pleasing with a good standard of answer being produced by many candidates. The overall average mark and pass rate were slightly above expectations. There was evidence of a number of well-prepared candidates with a wide range of knowledge, able to tackle most of the sub-questions in questions one and two and prepare good answers to one of the optional questions. There were, however, still candidates who struggled to gain a quarter of the marks. Time allocation seemed to be a problem for some candidates, with evidence of rushed answers to either question one or question two. Some candidates may have used more time on the optional question and not spent sufficient time on the shorter sub-questions. This was evidenced by the lack of workings and questions requiring some calculation being left out to save time. Question one is 50 marks and should be given approximately 50% of the time. Question one was generally well done, but no one scored full marks. Most candidates provided workings for the three and four mark questions, but a number did not. If workings are not given, no marks can be awarded for wrong answers using the correct principle. Question two included one question from each of sections A and B of the syllabus and two questions from each of sections C and D. Question two will continue to include questions from all sections of the syllabus. This question was generally not as well done as the other questions on the paper, although a few candidates did achieve full marks. Some candidates were obviously ill-prepared for deferred tax, long-term contracts and finance leases and many did not know what the five elements of financial statements were. Question three required the preparation of an income statement and balance sheet with some adjustments. This question was expected by candidates and most of those attempting this question were well prepared, resulting in good marks being achieved. Question four required the preparation of a cash flow statement in accordance with IAS 7. This question was very well done by those attempting this question with some excellent answers and a number of candidates scoring full marks. The following guide provides guidance to candidates preparing for future examinations and has been prepared with that in mind. It therefore may give the impression that there were few good marks and few passes as all the main errors have been listed for each question. It must be remembered though that not all candidates made the errors listed and that overall there was a good result for this paper.



SECTION A – 50 MARKS Question One Question 1.1 The term GAAP is used to mean A Generally accepted accounting procedures B General accounting and audit practice C Generally agreed accounting practice D Generally accepted accounting practice

(2 marks)

The answer is D

Question 1.2 The effective incidence of a tax is A the date the tax is actually paid B the person or entity that finally bears the cost of the tax C the date the tax assessment is issued D the person or entity receiving the tax assessment

(2 marks)

The answer is B

Question 1.3 IAS 32 Financial Instruments – Disclosure and Presentation classifies issued shares as either equity instruments or financial liabilities. An entity has the following categories of funding on its balance sheet: (i) A preference share that is redeemable for cash at a 10% premium on 30 May 2015. (ii) An ordinary share which is not redeemable and has no restrictions on receiving dividends. (iii) A loan note that is redeemable at par in 2020. (iv) A cumulative preference share that is entitled to receive a dividend of 7% a year.

As an equity instrument

As a financial liability

A (i) and (ii) (iii) and (iv) B (ii) and (iii) (i) and (iv) C (ii) (i), (iii) and (iv) D (i), (ii) and (iii) (iv)

(2 marks)

The answer is C



Question 1.4 List FOUR forms of short-term finance generally available to small entities.

(4 marks) The answer is Trade credit Bank overdraft Term loan Factoring Any other relevant sources, such as hire purchase or leasing were acceptable alternatives. Question 1.5 In no more than 15 words, define the meaning of “competent jurisdiction”.

(2 marks) The answer is The competent jurisdiction is the country whose tax laws apply to the entity.

Question 1.6 Which ONE of the following is responsible for governance and fundraising in relation to the development of International Accounting Standards? A International Accounting Standards Board B International Financial Reporting Interpretations Committee C International Accounting Standards Committee Foundation Trustees D Standards Advisory Council

(2 marks)

The answer is C



Question 1.7 An entity is preparing a segmental analysis in accordance with IAS 14 Segment Reporting. The directors have elected to disclose business segments as the primary reporting format, but are unsure which of the following items need disclosure.

(i) external revenue (ii) cost of sales (iii) capital employed (iv) segment profit

Which TWO of the above require separate disclosure under IAS 14 in respect of segments reported as primary segments? A (i) and (ii) only. B (i) and (iv) only. C (i) and (iii) only. D (iii) and (iv) only.

(2 marks)

The answer is B

Question 1.8 A bond with a coupon rate of 7% is redeemable in 8 years’ time for $100. Its current purchase price is $82. What is the percentage yield to maturity?

(4 marks)

The answer is 10⋅5%

Workings Using cumulative present value table and present value table. Calculate cumulative present value of annual interest received and add on the present value of the $100 receivable in 8 years time. Use t=8 and assume an interest rate. Calculate with the first rate (10% in answer below), check how close this is to the cost of $82 and select a second interest rate that will give an answer the other side of the cost $82. A rate of 10% gives $84⋅045 so a higher rate is required, using 12% the answer is $75⋅176, by interpolation we can then calculate the approximate rate of 10.5%. t = 8; r = 10 (7 x 5⋅335) + (100 x 0⋅467) = 37⋅345 + 46⋅7 = $84⋅045 t = 8; r = 12 (7 x 4⋅968) + (100 x 0⋅404) = 34⋅776 + 40⋅4 = $75⋅176 By interpolation: 10% + (((84⋅045 - 82⋅0)/(84⋅045 - 75⋅176)) x 2) = 10% + (2⋅045/8⋅869 x 2) = 10% + 0⋅461 = 10⋅461% ≈ 10⋅5%



Question 1.9 AC made the following payments during the year ended 30 April 2005:

$000 Operating costs (excluding depreciation) 23 Finance costs 4 Capital repayment of loans 10 Payments for the purchase of new computer equipment for use in AC’s business

20

AC’s revenue for the period was $45,000 and the corporate income tax rate applicable to AC’s profits was 25%. The computer equipment qualifies for tax allowances of 10% per year on a straight line basis. Calculate AC’s tax payable for the year ended 30 April 2005.

(3 marks)

The answer is $4,000

Workings

$000

$000 Revenue 45 Operating costs 23 Finance costs 4 Tax allowances - computer 2 29 16 Tax @ 25% 4

Question 1.10 Financial statements prepared using International Standards and the International Accounting Standards Board’s (IASB) Framework for the Preparation and Presentation of Financial Statements (Framework) are presumed to apply two of the following four underlying assumptions: (i) Relevance (ii) Going concern (iii) Prudence (iv) Accruals Which TWO of the above are underlying assumptions according to the IASB’s Framework? A (i) and (ii) only. B (ii) and (iii) only. C (iii) and (iv) only. D (ii) and (iv) only.

(2 marks)

The answer is D



Question 1.11 Which ONE of the following would be treated as a non-adjusting event after the balance sheet date, as required by IAS 10 Events after the Balance Sheet Date, in the financial statements of AN for the period ended 31 January 2005? The financial statements were approved for publication on 15 May 2005. A Notice was received on 31 March 2005 that a major customer of AN had ceased trading and

was unlikely to make any further payments. B Inventory items at 31 January 2005, original cost $30,000, were sold in April 2005 for

$20,000. C During 2004, a customer commenced legal action against AN. At 31 January 2005, legal

advisers were of the opinion that AN would lose the case, so AN created a provision of $200,000 for the damages claimed by the customer. On 27 April 2005, the court awarded damages of $250,000 to the customer.

D There was a fire on 2 May 2005 in AN’s main warehouse which destroyed 50% of AN’s total

inventory. (2 marks)

The answer is D

Question 1.12 AL’s customers all pay their accounts at the end of 30 days. To try and improve its cash flow, AL is considering offering all customers a 1⋅5% discount for payment within 14 days. Calculate the implied annual (interest) cost to AL of offering the discount, using compound interest methodology and assuming a 365 day year.

(3 marks)

The answer is 40⋅4%

Workings for 1.12 AL offers 1⋅5% interest for 16 days

(100/98⋅5) (365/16) - 1 = (1⋅015) 22⋅813 - 1 = 40⋅4%

An alternative approach is to use the compound interest formula and then convert the answer to an annualised rate.



Question 1.13 List the THREE criteria set out in IAS 37 Provisions, Contingent Liabilities and Contingent Assets for the recognition of a provision.

(3 marks) The answer is An entity has a present obligation as a result of a past event. It is probable that an outflow of resources will be required to settle the obligation. A reliable estimate can be made of the amount. Question 1.14 AE purchases products from a foreign entity and imports them into a country A. On import, the products are subject to an excise duty of $5 per item and Value Added Tax (VAT) of 15% on cost plus excise duty. AE purchased 200 items for $30 each and after importing them sold all of the items for $50 each plus VAT at 15%. How much is due to be paid to the tax authorities for these transactions? A $450 B $1,450 C $2,050 D $2,500

(3 marks)

The answer is B

Workings for 1.14 $ Sales 200 x $50 = 10,000 VAT on sales @ 15% 1,500 Less: VAT paid on import 200 x $35 x 15% = 1,050 VAT Due 450 Excise duty due 200 x $5 = 1,000 Total to be paid to tax authorities 1,450



Question 1.15 The economic order quantity formula includes the cost of placing an order. However, the Management Accountant is unsure which of the following items should be included in “cost of placing an order”: (i) Administrative costs (ii) Postage (iii) Quality control cost (iv) Unit cost of products (v) Storekeeper’s salary Which THREE of the above would usually be regarded as part of the cost of placing an order? A (i), (ii) and (iii) only. B (i), (iv) and (v) only. C (ii), (iii) and (iv) only. D (i), (ii) and (v) only.

(2 marks)

The answer is A

Question 1.16 An item of plant and equipment was purchased on 1 April 2001 for $100,000. At the date of acquisition its expected useful economic life was 10 years. Depreciation was provided on a straight line basis, with no residual value. On 1 April 2003, the asset was revalued to $95,000. On 1 April 2004, the useful life of the asset was reviewed and the remaining useful economic life was reduced to 5 years, a total useful life of 8 years. Calculate the amounts that would be included in the balance sheet for the asset cost/valuation and provision for accumulated depreciation at 31 March 2005.

(4 marks) The answer is: Balance Sheet at 31 March 2005 $ Non-current assets – plant and equipment at valuation 95,000 Accumulated depreciation (28,500) Net book value 66,500 Or Alternative treatment allowed by IAS 16:

Balance Sheet at 31 March 2005 $ Non-current assets – plant and equipment at valuation 115,000 Accumulated depreciation (48,500) Net book value 66,500



Workings

$ Cost 100,000 Two years’ depreciation at 10% 20,000 80,000 Revaluation 15,000 95,000 Depreciation at 12⋅5% 11,875 83,125 Depreciation at 20% 16,625 Net book value

66,500

Question 1.17 AP has the following two legal claims outstanding: • A legal action claiming compensation of $500,000 filed against AP in March 2004. • A legal action taken by AP against a third party, claiming damages of $200,000 was started in

January 2003 and is nearing completion. In both cases, it is more likely than not that the amount claimed will have to be paid. How should AP report these legal actions in its financial statements for the year ended 31 March 2005? Legal action against AP Legal action by AP A Disclose by a note No disclosure B Make a provision No disclosure C Make a provision Disclose as a note D Make a provision Accrue the income

(2 marks)

The answer is C

Question 1.18 Which ONE of the following powers is a tax authority least likely to have granted to them? A Power of arrest. B Power to examine records. C Power of entry and search. D Power to give information to other countries’ tax authorities.

(2 marks)

The answer is A



Question 1.19 IAS 16 Property, Plant and Equipment provides definitions of terms relevant to non-current assets. Complete the following sentence, in no more than 10 words.

“Depreciable amount is…” (2 marks)

The answer is “the asset’s cost or valuation less its residual value.”

Question 1.20 The OECD model tax convention defines a permanent establishment to include a number of different types of establishments: (i) A place of management (ii) A warehouse (iii) A workshop (iv) A quarry (v) A building site that was used for 9 months Which of the above are included in the OECD’s list of permanent establishments? A (i), (ii) and (iii) only. B (i), (iii) and (iv) only. C (ii), (iii) and (iv) only. D (iii), (iv) and (v) only.

(2 marks)

The answer is B

Examiner’s Comments Most candidates set out their answers in an easily readable format, but some candidates made it difficult to mark by not distinguishing their answer clearly from their workings. Most candidates included workings for the three and four mark questions, but a sizable minority omitted all workings. Without workings, answers marked as correct are given full marks, answers marked as wrong are given zero marks. Common Errors This section applies to the questions that required candidates to provide an answer and excludes the multiple choice questions. 1.4 Some candidates could not tell the difference between short- and long-term financing methods.

There were also a number of candidates who included investment methods.

1.5 Most candidates omitted to state the relevance to the entity.

1.8 Very few candidates had any idea how to calculate the yield to maturity. This is an important concept that will be required in later CIMA papers.

1.9 Many candidates incorrectly included capital repayment of loans and/or the payment for the new equipment in the taxable profit.

1.13 Most candidates were able to give an answer, but few scored full marks as some key points were missed out.



1.14 Most candidates scored part of the marks on this question as their workings showed partially correct answers

1.16 The asset revaluation caused some problems. Some candidates charged three years depreciation before revaluing and many did not recalculate depreciation correctly after the revaluation. The change in the useful life caused problems for many candidates.

1.19 IAS 16 gives a clear definition of “depreciable amount”, but very few candidates were able to give a correct definition of this basic concept.



SECTION B – 30 MARKS ANSWER ALL SIX SUB-QUESTIONS Question Two (a)

AB acquired non-current assets on 1 April 2003 costing $250,000. The assets qualified for accelerated first year tax allowance at the rate of 50% for the first year. The second and subsequent years were at a tax depreciation rate of 25% per year on the reducing balance method. AB depreciates all non-current assets at 20% a year on the straight line basis. The rate of corporate income tax applying to AB for 2003/04 and 2004/05 was 30%. Assume AB has no other qualifying non-current assets.

Required: Apply IAS 12 Income Taxes and calculate: (i) the deferred tax balance required at 31 March 2004; (ii) the deferred tax balance required at 31 March 2005; (iii) the charge to the income statement for the year ended 31 March 2005.

(Total for requirement (a) = 5 marks) The answer is: Balance sheet at 31 March 2004 Deferred tax $22,500 Balance sheet at 31 March 2005 Deferred tax $16,875 Income statement for the year ended 31 March 2005 Income tax expense – reduction in deferred tax

$5,625 credit

Workings Tax depreciation

$

Purchase cost 1 April 2003 250,000 First year allowance at 50% 125,000 125,000 Tax depreciation second year at 25% 31,250 Tax written down value 93,750 Accounting depreciation $ Purchase cost 1 April 2003 250,000 Straight line depreciation at 20% 50,000 200,000 Straight line depreciation at 20% 50,000 Accounting book value 150,000

Deferred tax provision: at 31 March 2004 at 31 March 2005 $ $ Accounting book value 200,000 150,000 Tax written down value 125,000 93,750 75,000 56,250 Tax at 30% = 22,500 16,875 Change in deferred tax = 22,500 - 16,875 =

5,625



Rationale To test candidates’ ability to calculate current and deferred taxation under the accounting rules in IAS 12 Income Taxes. Suggested Approach • Calculate tax written down value at the end of each year. • Calculate the accounting book value at the end of each year. • Deduct the tax written down value from the accounting book value and multiply by the tax rate to

give deferred tax balance at each year end. The difference between the two year ends is a credit to the income statement as there has been a reduction in the deferred tax provision.

Marking Guide

Marks

Calculation of deferred tax provision for 2004

2

Calculation of deferred tax provision for 2005 2 Calculation of income tax credit 1

Examiner’s Comments If the IAS 12 approach was followed, this should have been a straight forward question. However very few candidates provided a fully correct answer. Common Errors Some candidates demonstrated very little knowledge of deferred taxation and gave an answer based purely on the tax depreciation figures. Of those candidates demonstrating some knowledge of deferred taxation the most common errors were: • Calculating figures for three years, 2003 to 2005 instead of two 12 month periods April 2003 to

March 2005. The answer was then given based on the second and third years, which gives the wrong answer, even when the calculations are correct.

• Calculating the second year based on the change in the year rather then the change in the balance at the year end. This is an acceptable method as long as the change is identified as the income statement figure and the balance calculated by adjusting the previous year’s balance by the income statement figure. Most candidates using this method however reversed the answer and called the change in the year the balance on the provision and identified the balance as the income statement figure.

• Many candidates correctly calculated the year end balances for accounting and tax but did not multiply their answers by the tax rate to calculate the tax liability.

• Some candidates with correct answers failed to gain full marks as they called the income statement amount a charge or expense and failed to identify it as a credit.



Question Two (b) AD, a manufacturing entity, has the following balances at 30 April 2005: Extract from financial statements: $000 Trade receivables 216 Trade payables 97 Revenue (all credit sales) 992 Cost of sales 898 Purchases in year 641 Inventories at 30 April 2005: Raw materials 111 Work in progress 63 Finished goods 102 Required: Calculate AD’s Working Capital Cycle.

(Total for requirement (b) = 5 marks) The answer is: AD’s working capital cycle can be expressed as: Raw materials inventory less payables days plus production time plus finished goods inventory plus receivables days.

63⋅2 + 25⋅6 + 41⋅4 + 79⋅5 - 55⋅2 = 154⋅5 days Workings Days Raw materials inventory

purchasesinventory materialsraw

111/641* 365 = 63⋅2

Payables days purchasespayables 97/641 * 365 = (55⋅2)

Production time sales of cost

progress in work 63/898 * 365 = 25⋅6

Finished goods inventory sales of cost

inventory goods finished

102/898 * 365 = 41⋅4

Receivables days sales credit

sreceivable Trade 216/992 * 365 = 79⋅5

Working capital cycle – days 154⋅5

Rationale To test candidates’ ability to calculate and interpret working capital ratios for business sectors.



Suggested Approach • Calculate individual ratios for each type of inventory, payables and receivables. • Add together the inventory days and receivables days and deduct payables days. Marking Guide

Marks

Calculation of raw materials inventory days

1

Calculation of payables days 1 Calculation of production time – WIP days 1 Calculation of finished goods inventory days 1 Calculation of receivables days

1

Examiner’s Comments Most candidates did well on this sub-question, many gaining full marks. Common Errors • The most common error was not identifying that each type of inventory needs to be treated

separately, as raw materials are related to purchases whereas work in progress and finished goods are related to cost of sales.

• Some candidates failed to include all types of inventory in their calculations whilst many candidates grouped all inventory together.

• A few candidates did not deduct payables.



Question Two(c) List the FIVE elements of financial statements defined in the IASB’s Framework and explain the meaning of each.

(Total for requirement (c) = 5 marks) Answer According to the IASB’s Framework, the FIVE elements of financial statements are: Asset An asset is a resource controlled by the entity as a result of past events and from which

future economic benefits are expected to flow to the entity; Liability A liability is a present obligation of the entity arising from past events, the settlement of

which is expected to result in an outflow of resources from the entity; Equity The residual interest in the assets of the entity after deducting all its liabilities; Income Increases in economic benefits during the accounting period in the form of inflows or

enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to combinations from equity participants;

Expenses Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets that result in decreases in equity, other than those relating to distributions to equity participants.

Rationale To test candidates’ ability to explain the IASB’s Framework for the Presentation and Preparation of Financial Statements. Suggested Approach • List the five elements and then explain each in turn. • The exact words of the Framework do not need to be quoted, as long as the correct meaning

is conveyed. Marking Guide

Marks

Explain asset

1

Explain liability 1 Explain equity 1 Explain income 1 Explain expenditure 1



Examiner’s Comments The Framework is quite specific as to what the five elements are. Candidates either scored well on this sub-question or they scored zero as they did not know what the elements were. Common Errors A high proportion of candidates did not answer the question correctly as they failed to identify the meaning given by the Framework to the elements of financial statements. Those not identifying the elements gave completely wrong answers and scored no marks. The incorrect interpretations included:

• The topics covered by the Framework • The objectives of financial statements, including the financial statements themselves • The underlying assumptions • The qualitative characteristics

Of the candidates correctly identifying the five elements, the most common error causing loss of marks was giving insufficient detail or defining an element without any reference to the Framework’s approach, for example saying income was as a result of sales or equity was share capital.



Question Two(d) AE has a three year contract which commenced on 1 April 2004. At 31 March 2005, AE had the following balances in its ledger relating to the contract: $000 $000 Total contract value 60,000 Cost incurred up to 31 March 2005:

Attributable to work completed 21,000 Inventory purchased for use in 2005/6 3,000 24,000

Progress payments received 25,000 Other information: Expected further costs to completion 19,000 At 31 March 2005, the contract was certified as 50% complete. Required: Prepare the income statement and balance sheet extracts showing the balances relating to this contract, as required by IAS 11 Long Term Contracts.

(Total for requirement (d) = 5 marks) The answer is: Income statement for the year to 31 March 2005 – extract $000 Revenue from long-term contract 30,000 Cost of sales 21,500 Profit 8,500 Balance sheet as at 31 March 2005 – extract $000 Receivables Long-term contract – gross amounts due from customers

7,500

Workings Overall profitability check:

$000

$000

Revenue 60,000 Costs incurred to 31 March 2005 24,000 Costs to completion 19,000 43,000 Profit 17,000 Income statement: Contract 50% complete therefore recognise 50% profit 8,500 Revenue recognised 50% of contract value 60,000/2 30,000 Balance sheet: Total contract costs incurred 24,000 Recognised profit 8,500 32,500 Less: Progress payments received 25,000 Gross amount due from customers 7,500 Note: Alternative approaches to calculations are acceptable.



Rationale To test candidates’ ability to prepare financial statements reporting on performance, tangible non-current assets and inventories. Explain the principles of the accounting rules contained in IASs dealing with construction contracts. Suggested Approach • First check the overall profitability of the contract. • The contract is stated as being 50% complete. Therefore recognise 50% of total profit, 50% of

turnover and 50% of total cost in the income statement. • Calculate the balance sheet figures for the gross amount due from customers as the difference

between the income statement amounts recognised and the amounts paid or received to date. Marking Guide

Marks

Calculate profit

1

Calculate the income statement figures 2 Calculate gross amounts due on balance sheet 2

Examiner’s Comments Few candidates were able to produce a correct answer. Common Errors • Not calculating overall profitability of the contract. Without this it is difficult to get any of the

other figures correct, except the revenue figure. • Leaving the work in progress inventory out of total cost and profit calculations • Showing inventory separately on the balance sheet, instead of including it under the heading

“gross amounts due from customers” as required by IAS 11.



Question Two(e) AM is a trading entity operating in a country where there is no sales tax. Purchases are on credit, with 70% paid in the month following the date of purchase and 30% paid in the month after that. Sales are partly on credit and partly for cash. Customers who receive credit are given 30 days to pay. On average 60% pay within 30 days, 30% pay between 30 and 60 days and 5% pay between 60 and 90 days. The balance is written off as irrecoverable. Other overheads, including salaries, are paid within the month incurred. AM plans to purchase new equipment at the end of June 2005, the expected cost of which is $250,000. The equipment will be purchased on 30 days credit, payable at the end of July. The cash balance on 1 May 2005 is $96,000. The actual/budgeted balances for the six months to July 2005 were: All figures $000 Actual Budgeted Feb Mar Apr May Jun Jul Credit sales 100 100 110 110 120 120 Cash sales 30 30 35 35 40 40 Credit purchases 45 50 50 55 55 60 Other overhead expense

40 40 40 50 50 50

Required: Prepare a monthly cash budget for the period May to July 2005 and assess the likelihood of AM being able to pay for the equipment when it falls due. (Round all figures to the nearest $000)

(Total for requirement (e) = 5 marks) Answer Cash budget for the three month period May to July 2005: May June July $000 $000 $000 Cash receipts Cash sales 35 40 40 Credit sales receipts (W1) 101 104 111 Total receipts 136 144 151 Credit purchase payments (W2) 50 54 55 Expenses paid 50 50 50 Equipment purchase paid 250 Total payments 100 104 355 Net cash movement in month 36 40 (204) Balance b/fwd 96 132 172 Balance c/fwd 132 172 (32) AM will not be able to pay for the equipment on time unless further finance is arranged.



Workings (W1) Credit sales – receipts: Total May June July $000 $000 $000 $000 February sales 100 5 March sales 100 30 5 April sales 110 66 33 6 May sales 110 66 33 June sales 120 72 Totals 101 104 111 (W2) Credit purchases – payments Total May June July $000 $000 $000 $000 March 50 15 April 50 35 15 May 55 39 16 June 55 39 Totals 50 54 55 Rationale To test candidates’ ability to prepare and analyse cash-flow forecasts over a three-month period. Suggested Approach • Apply the information provided on credit sales and calculate cash receipts from receivables. • Apply the information provided on credit purchases and calculate cash paid to payables. • Prepare a three month cash budget including cash receipts from receivables and cash sales

and cash paid to payables and expenses. • Prepare a short conclusion identifying whether the non-current asset purchase is possible or

not. Marking Guide

Marks

Calculate credit sales receipts

1½

Calculate credit purchase payments 1 Prepare a cash budget, including cash receipts and payments 2 Advise whether entity will be able to pay for the equipment when it is due

½



Examiner’s Comments Some candidates misinterpreted receipts from credit customers being given 30 days to pay as meaning they paid within the month of sale instead of in the next month. A significant number of candidates failed to assess the likelihood of being able to pay for equipment. Common Errors • Treating receipts from credit sales as received in the month of sale. • Treating purchases on credit as being paid in month of purchase. • Including bad debts as a cash flow. • Not giving a conclusion.



Question Two(f) A five year finance lease commenced on 1 April 2003. The annual payments are $30,000 in arrears. The fair value of the asset at 1 April 2003 was $116,000. Use the sum of digits method for interest allocations and assume that the asset has no residual value at the end of the lease term. Required: In accordance with IAS 17 Operating and Finance Leases: (i) calculate the amount of finance cost that would be charged to the income statement for

the year ended 31 March 2005; (ii) prepare balance sheet extracts for the lease at 31 March 2005.

(Total for requirement (f) = 5 marks) The answer is:

Finance charge for year ended 31 March 2005 is the second year of the lease. The finance charge to the income statement for the year ended 31 March 2005 is $9,067 Balance sheet as at 31 March 2005 – extract

Non-current assets – Tangible $ Finance lease 116,000 Less: Depreciation (116,000/5 x 2) 46,400 69,600 Non-current liabilities Amounts due under finance lease $53,200 Current liabilities Amounts due under finance lease $23,200 (76,400 - 53,200)

Workings $ Total payments under the lease ($30,000 x 5) 150,000 Fair value of the asset 116,000 Finance cost 34,000 Five periods gives sum of digits (5 x (5 + 1))/2 = 15 Year Proportion Allocation (proportion x $34,000) $ 2003/04 5/15 11,333 2004/05 4/15 9,067 2005/06 3/15 6,800 2006/07 2/15 4,533 2007/08 1/15 2,267



Year Balance

b/fwd Finance charge

Repayment Balance c/fwd

$ $ $ $ 2003/04 116,000 11,333 (30,000) 97,333 2004/05 97,333 9,067 (30,000) 76,400 2005/06 76,400 6,800 (30,000) 53,200 2006/07 53,200 4,533 (30,000) 27,733 2007/08

27,733 2,267 (30,000) 0

Rationale To test candidates’ ability to explain the principles of the accounting rules contained in IAS’s dealing with leases (lessee only). Suggested Approach • Calculate the finance cost by taking the fair value of the asset away from the total payments

due. Calculate the sum of digits and multiply the finance cost with the appropriate proportion allocating the finance cost to each year. Calculate the balance outstanding at the end of years two and three.

• Prepare the income statement and balance sheet extracts required by the question. Marking Guide

Marks

Calculation of finance cost and allocation to years

2

Calculation of finance charge to income statement 1 Calculation of non-current assets – tangible (balance sheet) 1 Calculation of liabilities and split between non-current and current liabilities

1

Examiner’s Comments Most candidates were able to calculate the finance cost and apportion it to each period. Most were also able to calculate the outstanding balances at each year end. However many candidates were unable to use the correctly calculated figures and produce correct income statement and balance sheet extracts. Common Errors • Calculating the sum of digits for 4 years instead of 5 years. • Applying the proportions using 1 in the first year and two in the second year etc. • Giving income statement finance charge as the charge for year three. • Giving the income statement charge as the annual repayment figure. • Applying the sum of digits to the annual repayment instead of the finance charge. • Not giving any non-current asset figures on the balance sheet extract. • Using wrong years to calculate the liabilities. • Not splitting the liability between non-current and current.



SECTION C – 20 MARKS ANSWER ONE QUESTION ONLY Question Three Prepare the income statement for AF for the year to 31 March 2005 and a balance sheet at that date, in a form suitable for presentation to the shareholders and in accordance with the requirements of International Financial Reporting Standards. Notes to the financial statements are NOT required, but all workings must be clearly shown. DO NOT prepare a statement of accounting policies or a statement of changes in equity.

(Total for Question Three = 20 marks) Rationale To test candidates’ ability to prepare financial statements in a form suitable for publication, with appropriate notes. To apply the accounting rules contained in IAS 12 for current and deferred taxation. Suggested Approach • Using the additional information provided and the trial balance figures, prepare workings to:

1. Calculate depreciation of buildings and plant and equipment for the year and cumulative. 2. Calculate the operating lease charge to income statement. 3. Calculate the cost of sales. 4. Calculate tax charge and outstanding balances.

• Prepare the income statement using IAS 1 format. • Prepare workings to calculate the balances on reserves and retained earnings. • Prepare the balance sheet using IAS 1 format. Marking Guide

Marks

Preparation of Income Statement using correct format

7

Preparation of Balance Sheet using correct format 11 Marks available for format and correct headings

2



Examiner’s Comments This question was generally very well done by candidates, many obtaining near full marks. Very few gained full marks as very few candidates could apply IAS 17 Operating and finance leases correctly to the operating lease. Common Errors • Stating that as there was no payment for the lease there was no charge in the income

statement. • Treating the operating lease as a finance lease, putting the total liability on the balance sheet

and in a few cases also capitalising the asset and including it under non-current assets. • Including the available for sale investments under current assets. • Not accruing interest due on the loan notes. • Incorrectly deducting deferred tax from income tax charge for the year. • Incorrectly applying the reducing balance method to the plant and equipment. • Deducting dividends from revaluation reserve. • Including deferred tax as a current asset. • Including depreciation as part of administration or distribution expenses when the question

specified cost of sales. • Including dividends paid as a current liability.



Question Four Prepare a cash flow statement, using the indirect method, for AG for the year ended 31 March 2005, in accordance with IAS 7 Cash Flow Statements.

(Total for Question Four = 20 marks) Rationale To test candidates’ ability to prepare a cash flow statement in accordance with IAS 7. Apply the accounting rules contained in IAS 12 for current and deferred taxation. Suggested Approach • Use workings to calculate the cash flows for accrued expenditure, interest, income taxes,

purchase of property, plant and equipment, development expenditure and issue of shares. • Use the IAS 7 format to prepare a cash flow statement using the indirect method. Marking Guide

Marks

Cash Flow Statement – Calculation of cash flows from operating activities

9½

Cash Flow Statement – Calculation of cash flows from investing activities 5½ Cash Flow Statement – Calculation of cash flows from financing activities 2½ Cash and cash equivalents 1 Marks available for format and correct headings

1½

Examiner’s Comments There were some excellent answers to this question, with a number of candidates gaining full marks. Common Errors • Not using the correct IAS 7 format, for example:

o Starting with operating profit instead of profit before tax. o Putting all items in one long list. o Putting items under the wrong headings. o Attempting to use the direct method.

• Mixing up proceeds of sale and gain on disposal. • Calculating accrued expenses without adjusting for interest balances. • Calculating tax paid without adjusting for deferred tax. • Missing out depreciation and/or revaluation when calculating cash paid for non-current assets.

paper p7 financial accounting and tax principles may 2005

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