AC

Question 1    (Students must express answers in own words, not provide memorised answers. Students should be given credit for other relevant points)

(a) Accrual accounting – transactions and events are recorded in the periods in which they    occur, which is not necessarily in the same period as they are received or paid.  Income is recorded when earned and expenses when incurred.

Using the fundamental timing of the transaction rather than the receipt or payment of cash gives a better measure of an entity’s profit performance as it better aligns measured profit with the effort expended in earning that profit and results in a profit measure which is       more consistent and comparable from period to period.

Goodwill –

Fair value of assets - $4,100,000

Fair value of liabilities - $500,000

Fair value of net assets acquired - $3,600,000

Acquisition cost $3,900,000

Less value of net assets $3,600,000

Goodwill $300,000

Goodwill is classified as an intangible asset, under the non-current assets, in the balance sheet

c)   Discussion of 4 worthwhile points required such as

     Working capital is the difference between the amounts of current assets and current

liabilities

     Businesses need to have cash available to meet their commitments on time.  If they are

unable to do this they face the prospect of failing.   Working capital must be sufficient to maintain liquidity at all times as the consequences of not doing can be very serious.

     However holding assets such as cash, inventory and debtors or maintaining a bank

overdraft also involves costs.  For example, storage costs for inventory.

     There is also the opportunity cost of having resources tied up in unproductive assets when

they could be employed in increasing profits.

     The benefits of holding working capital must be weighed up against its cost and a suitable

balance needs to be struck.  If the level of working capital maintained is above what is needed to maintain liquidity then the firm is using resources inefficiently and cutting  profits.

d)   (i) Definition and recognition criteria of assets

Definition – future economic benefit, controlled by the entity and as a result of a past transaction

Recognition – probable and reliable measurement

Illustrative example required

(ii) Equity is the residual value after deducting liabilities from assets

Alternative form A – L = E. This tells us that net assets, (A-L) is always equal to owner’s equity.

e)   All transactions are initially recorded at historical cost.

Items on the balance sheet can then be valued in a number of ways – measurement issues – eg fair value, as either market value or replacement cost; Property, plant and equipment – cost (carrying amount cannot be > recoverable amount) or revalued.  Students could also discuss depreciation

f)   Definition of fixed costs (costs remain same in total within a given range of activity and timeframe) and variable costs (costs that change as the level of activity changes).

Some costs may appear to possess fixed and variable characteristics, that is, they cannot be neatly classified as fixed or variable – mixed costs.

Assumes that cost behavior is linear.

Fixed costs may not remain constant over time or over a range.

Given the above issues, then the CVP technique can result in incorrect break even points.

g)  The advantages are that it does provide a form of immediate finance to the borrowing  entity. The factoring company can either buy the invoices outright from the borrowing entity or it can give a loan to the borrowing entity, collect the outstanding amounts,      subtract its fees, the amount outstanding and return the balance to the borrower. The     disadvantages are that it is a rather expensive form of finance. The factoring fees or the discounting of the invoices can be quite high and can substantially reduce the amounts outstanding. This can have implications for the working capital of the business,            particularly if the total debtors were a large proportion of the working capital.

h)  The balanced scorecard provides a set of performance measures that reflect the entity’s   goals and strategies. The framework includes measures from four perspectives, financial, customer, internal operation and innovation and improvement.

Any three of thefollowing

Possible performance measures relevant to the innovation and improvement perspective could be:

-       Employee satisfaction

-       Number of employee suggestions

-       Number of employees receiving bonuses

-       Number of employees attending training

-       Time taken to develop new technology

-       Time taken to introduce new product introduction vs competition

-      Product focus

Question 2

a) Cash flows from operating

activities

Receipts from customers* Payments to suppliers and employees#

Net cash provided from

operating activities

*Cash from customers = opening accounts receivable + sales – closing accounts receivable

#Cash paid to suppliers = opening accounts payable + purchases – closing accounts payable

$171,000

$135,000

$36,000

=34000 + 183,000 – 46,000

$171,000

=33,000 + (132,000-5,000) – 28,000

$132,000

Cash paid to other suppliers = other expenses +/- increase (decrease) in prepayments +/- decrease (increase) in accruals = 0 + 8,000 - 5,000 + 0

$3,000

Cash paid to suppliers = $132,000 + $3,000 =       $135,000

b) students’ answers must demonstrate understanding:

operating:

     relates to provision of goods and services and other activities in course of trading      relates to income statement and CA and CL accounts

investing

     relating to acquisition and disposal of non ‐ current assets

     relate to NCA accounts

financing

     activities that change size or composition of financial structure

     relate to NCL and equity accounts

c) Students to identify, and explain significance of three items, e.g.

     payments to suppliers > receipts from customers

     Proceeds of sale relative to payments for PPE

     Size of distributions paid relative to other Financial inflows and the low level of OCF

     Or any other reasonable observation

Question 3

a) D = (H ‐ RV)/N, therefore N = 180,000/3600 = 50 years.

Given the business is in provision of services, 50 years seems a very long time. On the       other hand, give marks if student’s alternative view is plausible. Key to getting marks is the answer is thoughtful/critical.

b) New D = 180,000/10 = $18,000                  New profit = 15,200 ‐ $18,000 = $2,800 loss

c) Example illustrates how accounting information is subject to estimations and policy  choices of managers, and these can significantly affect the reported numbers and hence decisions of users.

Any well ‐ explained example (other than depreciation), such as accrual estimates of incurred expense and unrecognised revenue.

d) The adjustment changes the story from one of profit to one of loss.

EBITDA, which is a good proxy for OCF, remains unchanged.

Question 4

a)

September

October

November

December

Total receipts

$140,000 $160,000 $200,000 $230,000

8%

30%

60%

November   $11,200 $48,000

$120,000

$179,200

$12,800

$60,000

$138,000

$210,800

b) 1 mark for each of four worthwhile points, e.g.

     it itemises budgeted receipts and payments by month

     so that periods of small or negative inflows can be identified

     and the balance of cash monitored

     so that decisions about timing or payments can be made

c) 1 mark for each of 4 worthwhile points such as

     timing is bad given negative inflow expected for August

     insufficient funds means overdraft or similar may be required

     therefore consider delaying purchase to September when (barely) sufficient funds

are forecast to be available or delay even later

     else investigate possibility of purchasing on credit with no fees

Question 5

a)  CM/unit = $2.5M/250K units = $10 per unit BE = $2M/$10 = 200,000 units

b) 10% higher means $10 more contribution from extra 25K units, therefore profit increases from $500K to $750K.

Revenue          11,550,000

Variable costs   8,800,000

Fixed costs    2,000,000

Net profit         750,000

c) Vol = ($2M + 0.6M)/$10 = 260,000

d) Relevant costs are those that differ between two options being chosen between.

Up to 2 marks for each of the two examples depending on how clearly and accurately they are expressed.