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Paper P7 Financial Accounting and Tax PrinciplesPost Exam GuideMay 2005 Exam

The Chartered Institute of Management Accountants Page 1

General Comments

This first paper of the new syllabus applied the new question paper format for the first time. Theoverall result was generally very pleasing with a good standard of answer being produced by manycandidates. 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 tacklemost of the sub-questions in questions one and two and prepare good answers to one of the optionalquestions. 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 toeither question one or question two. Some candidates may have used more time on the optionalquestion and not spent sufficient time on the shorter sub-questions. This was evidenced by the lackof workings and questions requiring some calculation being left out to save time. Question one is 50marks and should be given approximately 50% of the time.

Question one was generally well done, but no one scored full marks. Most candidates providedworkings for the three and four mark questions, but a number did not. If workings are not given, nomarks 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 questionsfrom each of sections C and D. Question two will continue to include questions from all sections ofthe 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 fordeferred tax, long-term contracts and finance leases and many did not know what the five elements offinancial statements were.

Question three required the preparation of an income statement and balance sheet with someadjustments. This question was expected by candidates and most of those attempting this questionwere 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 anumber of candidates scoring full marks.

The following guide provides guidance to candidates preparing for future examinations and has beenprepared with that in mind. It therefore may give the impression that there were few good marks andfew passes as all the main errors have been listed for each question. It must be remembered thoughthat not all candidates made the errors listed and that overall there was a good result for this paper.


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SECTION A 50 MARKS

Question One

Question 1.1

The term GAAP is used to mean

A Generally accepted accounting proceduresB General accounting and audit practiceC Generally agreed accounting practiceD 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 paidB the person or entity that finally bears the cost of the taxC the date the tax assessment is issuedD 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 equityinstruments or financial liabilities. An entity has the following categories of funding on its balancesheet:

(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 liabilityA (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


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Question 1.4

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

(4 marks)The answer is

Trade creditBank overdraftTerm loanFactoring

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 thedevelopment of International Accounting Standards?

A International Accounting Standards BoardB International Financial Reporting Interpretations CommitteeC International Accounting Standards Committee Foundation TrusteesD Standards Advisory Council

(2 marks)

The answer is C


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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 unsurewhich 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 asprimary 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 105%

Workings

Using cumulative present value table and present value table. Calculate cumulative present value ofannual interest received and add on the present value of the $100 receivable in 8 years time. Use t=8and assume an interest rate. Calculate with the first rate (10% in answer below), check how close thisis to the cost of $82 and select a second interest rate that will give an answer the other side of thecost $82. A rate of 10% gives $84045 so a higher rate is required, using 12% the answer is $75176,by interpolation we can then calculate the approximate rate of 10.5%.

t = 8; r = 10(7 x 5335) + (100 x 0467) = 37345 + 467 = $84045

t = 8; r = 12(7 x 4968) + (100 x 0404) = 34776 + 404 = $75176

By interpolation:10% + (((84045 - 820)/(84045 - 75176)) x 2) =10% + (2045/8869 x 2) =10% + 0461 = 10461% 105%


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Question 1.9

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

$000Operating costs (excluding depreciation) 23Finance costs 4Capital repayment of loans 10Payments for the purchase of new computer equipment for use in ACsbusiness 20

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

(3 marks)

The answer is $4,000

Workings

$000 $000Revenue 45Operating costs 23Finance costs 4Tax allowances - computer 2 29

16Tax @ 25% 4

Question 1.10

Financial statements prepared using International Standards and the International AccountingStandards Boards (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 IASBs 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


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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 theperiod ended 31 January 2005? The financial statements were approved for publication on 15 May2005.

A Notice was received on 31 March 2005 that a major customer of AN had ceased trading andwas 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, legaladvisers 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 ANs main warehouse which destroyed 50% of ANs totalinventory.

(2 marks)

The answer is D

Question 1.12

ALs 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 15% discount for payment within 14 days.

Calculate the implied annual (interest) cost to AL of offering the discount, using compound interestmethodology and assuming a 365 day year.

(3 marks)

The answer is 404%Workings for 1.12

AL offers 15% interest for 16 days(100/985)

(365/16) - 1 =(1015) 22813 - 1 = 404%

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


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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 isAn 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 plusexcise duty.

AE purchased 200 items for $30 each and after importing them sold all of the items for $50 each plusVAT at 15%.

How much is due to be paid to the tax authorities for these transactions?

A $450B $1,450C $2,050D $2,500

(3 marks)

The answer is B

Workings for 1.14

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


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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) Storekeepers 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 ofacquisition its expected useful economic life was 10 years. Depreciation was provided on a straightline 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 assetwas reviewed and the remaining useful economic life was reduced to 5 years, a total useful life of 8years.

Calculate the amounts that would be included in the balance sheet for the asset cost/valuation andprovision 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 95,000Accumulated depreciation (28,500)Net book value 66,500

OrAlternative treatment allowed by IAS 16:

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


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Workings

$Cost 100,000

Two years depreciation at 10% 20,00080,000

Revaluation 15,00095,000

Depreciation at 125% 11,87583,125

Depreciation at 20% 16,625Net 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 inJanuary 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 March2005?

Legal action against AP Legal action by APA Disclose by a note No disclosureB Make a provision No disclosureC Make a provision Disclose as a noteD 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


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Question 1.19

IAS 16 Property, Plant and Equipmentprovides 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 assets cost or valuation less its residual value.

Question 1.20

The OECD model tax convention defines a permanent establishment to include a number of differenttypes 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 OECDs 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

Examiners CommentsMost candidates set out their answers in an easily readable format, but some candidates made itdifficult to mark by not distinguishing their answer clearly from their workings. Most candidatesincluded 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 aregiven zero marks.

Common Errors

This section applies to the questions that required candidates to provide an answer and excludes themultiple 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 importantconcept that will be required in later CIMA papers.

1.9 Many candidates incorrectly included capital repayment of loans and/or the payment for thenew 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.


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

1.16 The asset revaluation caused some problems. Some candidates charged three yearsdepreciation before revaluing and many did not recalculate depreciation correctly after therevaluation. 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 togive a correct definition of this basic concept.


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SECTION B 30 MARKSANSWERALL SIX SUB-QUESTIONS

Question Two (a)

AB acquired non-current assets on 1 April 2003 costing $250,000. The assets qualified foraccelerated first year tax allowance at the rate of 50% for the first year. The second and subsequentyears 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 hasno 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 2004Deferred tax $22,500Balance sheet at 31 March 2005Deferred tax $16,875Income statement for the year ended 31 March 2005Income tax expense reduction in deferred tax $5,625 credit

Workings

Tax depreciation $Purchase cost 1 April 2003 250,000First year allowance at 50% 125,000

125,000Tax depreciation second year at 25% 31,250Tax written down value 93,750

Accounting depreciation $Purchase cost 1 April 2003 250,000Straight line depreciation at 20% 50,000

200,000Straight line depreciation at 20% 50,000Accounting book value 150,000

Deferred tax provision: at 31 March 2004 at 31 March 2005$ $

Accounting book value 200,000 150,000Tax written down value 125,000 93,750

75,000 56,250Tax at 30% = 22,500 16,875Change in deferred tax = 22,500 - 16,875 = 5,625


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

Examiners Comments

If the IAS 12 approach was followed, this should have been a straight forward question. However veryfew candidates provided a fully correct answer.

Common ErrorsSome 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 ofdeferred taxation the most common errors were:

Calculating figures for three years, 2003 to 2005 instead of two 12 month periods April 2003 toMarch 2005. The answer was then given based on the second and third years, which gives thewrong answer, even when the calculations are correct.

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


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Question Two (b)

AD, a manufacturing entity, has the following balances at 30 April 2005:

Extract from financial statements: $000Trade receivables 216Trade payables 97

Revenue (all credit sales) 992Cost of sales 898Purchases in year 641

Inventories at 30 April 2005:Raw materials 111Work in progress 63Finished goods 102

Required:Calculate ADs Working Capital Cycle.

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

ADs working capital cycle can be expressed as:

Raw materials inventory less payables days plus production time plus finished goods inventory plusreceivables days.

632 + 256 + 414 + 795 - 552 = 1545 days

Workings

DaysRaw materials inventory

purchases

inventorymaterialsraw 111/641* 365 = 632

Payables days

purchases

payables

97/641 * 365 = (552)

Production time

salesofcost

progressinwork

63/898 * 365 = 256

Finished goods inventory

salesofcost

inventorygoodsfinished

102/898 * 365 = 414

Receivables days

salescredit

sreceivableTrade

216/992 * 365 = 795

Working capital cycle days 1545

Rationale

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


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

Examiners 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 treatedseparately, as raw materials are related to purchases whereas work in progress and finishedgoods are related to cost of sales.

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

A few candidates did not deduct payables.


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Question Two(c)

List the FIVE elements of financial statements defined in the IASBs Frameworkand explain the

meaning of each. (Total for requirement (c) = 5 marks)

Answer

According to the IASBs 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 whichfuture 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 ofwhich 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 orenhancements 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 ordepletions of assets that result in decreases in equity, other than those relating todistributions to equity participants.

Rationale

To test candidates ability to explain the IASBs Framework for the Presentation and Preparation ofFinancial 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 1Explain liability 1Explain equity 1

Explain income 1Explain expenditure 1


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Examiners 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 ErrorsA high proportion of candidates did not answer the question correctly as they failed to identify themeaning given by the Framework to the elements of financial statements. Those not identifying theelements gave completely wrong answers and scored no marks. The incorrect interpretationsincluded:

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 ofmarks was giving insufficient detail or defining an element without any reference to the Frameworksapproach, for example saying income was as a result of sales or equity was share capital.


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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 $000Total contract value 60,000Cost incurred up to 31 March 2005:

Attributable to work completed 21,000Inventory 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 thiscontract, 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

$000Revenue from long-term contract 30,000Cost of sales 21,500Profit 8,500

Balance sheet as at 31 March 2005 extract $000ReceivablesLong-term contract gross amounts due from customers 7,500

Workings

Overall profitability check: $000 $000Revenue 60,000Costs incurred to 31 March 2005 24,000Costs to completion 19,000

43,000

Profit 17,000

Income statement:Contract 50% complete therefore recognise 50% profit 8,500Revenue recognised 50% of contract value 60,000/2 30,000

Balance sheet:Total contract costs incurred 24,000Recognised profit 8,500

32,500Less: Progress payments received 25,000Gross amount due from customers 7,500

Note: Alternative approaches to calculations are acceptable.


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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 IASsdealing 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% ofturnover and 50% of total cost in the income statement.

Calculate the balance sheet figures for the gross amount due from customers as the differencebetween the income statement amounts recognised and the amounts paid or received to date.

Marking Guide Marks

Calculate profit 1Calculate the income statement figures 2Calculate gross amounts due on balance sheet 2

Examiners 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 theother 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 headinggross amounts due from customers as required by IAS 11.


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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 and90 days. The balance is written off as irrecoverable. Other overheads, including salaries, are paidwithin 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 BudgetedFeb Mar Apr May Jun Jul

Credit sales 100 100 110 110 120 120Cash sales 30 30 35 35 40 40Credit purchases 45 50 50 55 55 60Other overheadexpense

40 40 40 50 50 50

Required:Prepare a monthly cash budget for the period May to July 2005 and assess the likelihood of AMbeing 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 receiptsCash sales 35 40 40Credit sales receipts (W1) 101 104 111Total receipts 136 144 151Credit purchase payments (W2) 50 54 55

Expenses paid 50 50 50Equipment purchase paid 250Total payments 100 104 355Net cash movement in month 36 40 (204)Balance b/fwd 96 132 172Balance c/fwd 132 172 (32)

AM will not be able to pay for the equipment on time unless further finance is arranged.


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Workings

(W1) Credit sales receipts:

Total May June July$000 $000 $000 $000February sales 100 5March sales 100 30 5April sales 110 66 33 6May sales 110 66 33June sales 120 72Totals 101 104 111

(W2) Credit purchases payments

Total May June July$000 $000 $000 $000

March 50 15April 50 35 15May 55 39 16June 55 39Totals 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 salesand cash paid to payables and expenses.

Prepare a short conclusion identifying whether the non-current asset purchase is possible ornot.

Marking Guide Marks

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


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Examiners 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 ofcandidates 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.


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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 interestallocations 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 forthe 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 extractNon-current assets Tangible $Finance lease 116,000Less: Depreciation (116,000/5 x 2) 46,400

69,600

Non-current liabilitiesAmounts due under finance lease $53,200

Current liabilitiesAmounts due under finance lease $23,200(76,400 - 53,200)

Workings$

Total payments under the lease ($30,000 x 5) 150,000Fair value of the asset 116,000Finance 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 11,3332004/05 4/15 9,0672005/06 3/15 6,8002006/07 2/15 4,5332007/08 1/15 2,267


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Year Balanceb/fwd

Financecharge

Repayment Balance c/fwd

$ $ $ $2003/04 116,000 11,333 (30,000) 97,333

2004/05 97,333 9,067 (30,000) 76,4002005/06 76,400 6,800 (30,000) 53,2002006/07 53,200 4,533 (30,000) 27,7332007/08 27,733 2,267 (30,000) 0

Rationale

To test candidates ability to explain the principles of the accounting rules contained in IASs dealingwith leases (lessee only).

Suggested Approach

Calculate the finance cost by taking the fair value of the asset away from the total paymentsdue. Calculate the sum of digits and multiply the finance cost with the appropriate proportionallocating the finance cost to each year. Calculate the balance outstanding at the end of yearstwo 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 2Calculation of finance charge to income statement 1

Calculation of non-current assets tangible (balance sheet) 1Calculation of liabilities and split between non-current and current liabilities 1

Examiners Comments

Most candidates were able to calculate the finance cost and apportion it to each period. Most werealso able to calculate the outstanding balances at each year end. However many candidates wereunable to use the correctly calculated figures and produce correct income statement and balancesheet 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.


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SECTION C 20 MARKSANSWERONE QUESTION ONLY

Question Three

Prepare the income statement for AF for the year to 31 March 2005 and a balance sheet at thatdate, in a form suitable for presentation to the shareholders and in accordance with therequirements of International Financial Reporting Standards.

Notes to the financial statements are NOT required, but all workings must be clearly shown. DO NOTprepare 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, withappropriate notes. To apply the accounting rules contained in IAS 12 for current and deferredtaxation.

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 7Preparation of Balance Sheet using correct format 11Marks available for format and correct headings 2


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Examiners 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 tothe operating lease.

Common Errors

Stating that as there was no payment for the lease there was no charge in the incomestatement.

Treating the operating lease as a finance lease, putting the total liability on the balance sheetand 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 questionspecified cost of sales.

Including dividends paid as a current liability.


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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 theaccounting 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 9Cash Flow Statement Calculation of cash flows from investing activities 5Cash Flow Statement Calculation of cash flows from financing activities 2Cash and cash equivalents 1Marks available for format and correct headings 1

Examiners 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.

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