Ac1025 Excza 11

Examiners commentaries 2011

25 Principles of accounting Zone A
Important note
This commentary reflects the examination and assessment arrangements
for this course in the academic year 201011. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).
Rubric of the examination paper

Candidates should answer four of the following seven questions:
Question 1 of Section A, Question 2 of Section B, one question
from Section C and one further question from either Section B or C. All
questions carry equal marks.
Workings should be submitted for all questions requiring calculations. Any
necessary assumptions introduced in answering a question are to be stated.
Extracts from compound interest tables are given after the final question
on this paper.
Eight-column accounting paper is provided at the end of this question
paper. If used, it must be detached and fastened securely inside the
answer book.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.
Comments on specific questions

Section A
1. a. The following table shows the figures for equity from the Statement of
Financial Position (Balance Sheet) of the Pembroke Group plc as at 31st
December 2010.
Ordinary Shares of 1each
000
300
Share Premium
000
60
Retained Earnings
000
128
Total
000
488
The directors are proposing the following transactions:

1. 1st January 2011 a 1-for-5 rights issue of ordinary shares at a price
of 1.80.
2. 31st December 2011 a bonus of 200,000 1 ordinary shares which
utilises the minimum amount of retained earnings.
The directors estimate that the profits for the year ended 31st December
2011 will represent Earnings per Share of 5p on the shares in issue during
the year. A dividend will be paid which will result in dividend cover of 3
times.
[For the full question, please refer to the Examination paper]
1
25 Principles of accounting
Reading for this question

Subject guide (SG) pp.10812.
Barone (B) Chapter 9.
Approaching the question
Part (i) tests your understanding of accounting for changes in
shareholders funds. The requirement asks for a tabular form of answer
and you should always follow such specific instructions. In this case the
required format would have helped you in recording the relevant changes
in the shareholders funds.
In part (ii) the question requires a brief explanation of consolidated
financial statements and good answers would set out the basic definition
of a group and the fundamental accounting implications.
i.
Pembroke plc
Ordinary
share of 1
Share
premium
Retained
earnings
Total
000
000
000
000
300
60
128
488
Rights issue
60
48
108
Bonus issue
200
(108)
(92)
Profits for year
18
18
Dividend paid
(6)
(6)
48
608
1/1/11
31/12/11
560
Workings:
Profits for year (000)
360 0.05 = 18
Dividend paid
18 3 = 6
ii. Consolidated accounts incorporate the assets, liabilities and results of
a parent company and its subsidiaries, that is of a group of companies
under common control.
Some items only appear in consolidated accounts i.e. goodwill on
consolidation and non-controlling (minority) interests.
b. Distinction is often made between financial and management accounting.
Explain the differences between these two types of accounting.
SG pp.1819.
B pp.1719.
The learning outcomes require you to distinguish between different users
of accounting information. The conventional differences between the roles
of the financial and the management accountant are one way of exploring
the distinctions. Your answer should compare and contrast these roles; the
format below is one way of doing this.
Financial accounting
Management accounting
Concerned with the preparation of

accounting information for the needs of
users who are external to the business.
Concerned with the preparation of

accounting information for the needs
of users who are internal to the
business.
Prepared on a periodic basis (most

companies publish their financial
statements only once a year, in the
annual report).
Prepared frequently, as and when

it is needed (most large businesses
will prepare some information on a
monthly basis and many use daily
accounting information).
Based on past events and historic data.
More likely to contain forward looking

information (such as forecasts and
budgets).
Comprised solely of financial

information.
More likely to incorporate nonfinancial information (such as

quantities of products sold or number
of customer complaints).
Governed by rules and regulations.
Not regulated (managers are free to

produce whatever information they
need in whatever format is most
helpful to them, subject to available
data and technology).
c. Keble Ltd manufactures and sells bicycles. The company uses a standard cost
system to help in the control of costs. Overhead is applied to production
on the basis of labour hours. The original production budget for the three
months ended 31st March 2011 was for 35,000 labour hours and the
overhead costs were as follows:
Variable overhead
87,500
Fixed overhead
210,000
The following operating results for the three months were recorded:
Activity
Actual hours worked
30,000
Standard labour hours for output
32,000
Cost
Actual variable overhead incurred
78,000
Actual fixed overhead incurred
209,400
[For the full question, please refer to the Examination paper.]

SG pp.21433.
B Chapter 21.
Variance analysis is an important and often tested method of performance
evaluation. This question requires calculation of variable and fixed
overhead variances from original standards and actual costs for a year. It is
important that you set out the formulae that you use in your calculations
and clearly identify the variances as favourable or adverse.
3
i. Flexed budget
Variable overhead 87,500 = 2.5 per hour 32,000
35,000
= 80,000
Fixed overhead 210,000 = 6 per hour 32,000

35,000
= 192,000
ii. VO price variance

(AQ AP) (AQ SP)
(30,000 2.6) (30,000 2.5)
= (3,000)
VO efficiency variance
(AQ SP) (SQ SP)
75,000 80,000
= 5,000
2,000
iii. FO spending variance

Actual Budget
209,400 210,000 = (600)
FO volume variance
Budget Applied
210,000 192,000 = 18,000
17,400
d. Wadham plc is tendering for a contract which will take 3 months to complete.
The following details relate to labour used in the contract.
SG pp.17276.
B Chapter 16.
A key learning outcome of this course is to explain and apply decision
making techniques using accounting information. This question tests your
understanding of opportunity cost and limiting factors. Good answers
would clearly identify in (ii) which were relevant opportunity costs.
i. Opportunity cost maximum contribution foregone by using a secure
resource for an alternative purpose.
Limiting factor the factor (or factors) which constrain the capacity
of a business to increase the level of activity or undertake a specific
course of action.
ii. Opportunity cost of labour
Note (i) Labour cost
local
overtime
(ii) Supervisor
(iii) 2nd supervisor
12,000
2,000
6,000
bonus
500
upgrade
600
21,100
Section B
Question 2
Brasenose plc manufactures and sells specialist teaching equipment for
universities and colleges. The following list of balances has been extracted from
the Companys books as at 31st March 2011. The accountant has discovered
that a preliminary trial balance using these figures does not balance and has
therefore credited 20,000 to a suspense account (not shown below).
000
Accumulated depreciation at 1st April 2010
Administrative expenses
5,480
14,400
Bank balance (debit)
4,400
Goodwill
6,000
Inventories (stock) at 1st April 2010

Interest paid
11,320
100
Loan (Repayable 2017)
4,000
Payables (creditors)
1,280
Property, plant and equipment, at cost
19,280
Purchases
39,400
Receivables (debtors)
1,900
Retained earnings at 1st April 2010
5,400
Sales
65,020
Selling and distribution costs
3,800
Share premium account
1,400
Ordinary shares at 1 each
18,000

SG Chapter 5.
B Chapter 10.
The preparation of final accounts from structured information is a key
learning objective. A trial balance with several adjusting items has been
the format for the compulsory question over recent years. In answering
this type of question a methodical and organised approach is needed. It
is very important that detailed, legible workings are given in order that
marks are awarded for all work which is correct. If figures in the final
accounts comprise a number of items marks will be awarded accordingly
but without workings one error may result in several marks being lost.
The workings may be shown on the face of the accounts or separately but
candidates should try and help Examiners to award all appropriate marks
by clear presentation. The eight-column accounting paper provided is
particularly useful for presenting the financial statements. Good answers
will clearly apply to the instructions in the question for the classification of
costs, for example the allocation of depreciation between administration
and distribution costs. You should pay attention to the presentation of
your answer taking care to use the appropriate descriptions of line items
in the income statement and statement of financial position.
5
Brasenose plc
Income statement for the year ended 31st March 2011.
000
Sales
Cost of goods sold
Gross profit
Administrative expenses
65,020
(38,030)
26,990
(15,391)
Selling and distribution costs
(4,621)
Profit before interest and tax
6,978
Interest (100 + 100)
(200)
Profit before tax
6,778
Taxation
Profit for the year
(1,600)
5,178
Statement of financial position as at 31st March 2011

Assets
000
Non-current assets
Tangible
Intangible
12,208
6,000
18208
Current assets
Inventories
12,600
Receivables
1,900
Payments in advance
Bank
60
4,420
18,980
Total assets
37,188
Liabilities and equity

Current liabilities
Payables (1280 + 85)
Accrued expenses (145 + 100)
Taxation
1,365
245
1,600
3,210
Non-current liabilities
Loans
4,000
Total liabilities
7,210
Equity
Ordinary shares
18,000
Share premium
1,400
Retained earnings (5400 + 5178)
10,578
29,978
Total liabilities and equity
37,188
1. Suspense account
000
20
Balance (Cr)
Adjustments:
Payment for equipment (Cr)
Inventories (Dr)
50
(90)
Increase in bank balance
20
2. Non-current assets
Book value
Property
Plant & equipment
Total
000
000
000
8,000
11,280
19,280
Disposal
(100)
(100)
Addition
80
80
8,000
11,260
19,260
900
4,580
5,480
(80)
(80)
300
1,352
1,652
1,200
5,852
7,052
Cost
1st April 2010
Acc. Depn.
1st April 2010
Disposal
Current year
6,800
Book value
12,208
Depreciation current year

Property (5% 6,000,000) =
300
P & E (20% 6,760,000)
1,352
1,652
Admin
50%
826
Selling & Dist. 50%
826
Profit on disposal
Book value
20
Trade-in (80 50)
30
Profit
10
Admin 50%
Selling & Dist 50%
3. Cost of goods sold

Opening stock
11,230
Purchases
39,400
50,630
Closing stock
12,600
38,030
4. Administrative expenses
Per Q
Depreciation
Profit on disposal
Auditors remuneration
Accrued expenses
Payments in advance
14,400
826
(5)
85
145
(60)
15,391
5. Selling and distribution costs

Per Q
Depreciation
Profit on disposal
3,800
826
(5)
4621
b. Brasenose plc has made a specific accounting policy choice in respect of

its depreciation. Explain why companies have choices between accounting
policies, the limitations on such choices and how the choices should be
made.
SG Chapter 5.
B Chapter 10.
This question tests your understanding of the choice of accounting policy
in financial reporting. Answers were not required to examine the specific
issues in choosing a depreciation policy and lengthy discussion of this
would be a wasted effort.
b. Answers should briefly explain:
Accounting policy choice exists because of the difficulty in
establishing a single solution to accounting for economic actions
and events. Different companies and different economic contexts
may require different solutions.
Policy choice is contained by compulsory accounting standards
which restrict the range of accounting policies which may be used.
Companies should choose the accounting policy which gives the
most faithful representation of its economic actions and events and
which provide the most relevant information for users.
Question 3
The following are the accounts of Balliol plc, a company that manufactures
gardening equipment, for the year ended 30 November 2010.
Statements of comprehensive income for years ended 30 November
2010
000
Profit before interest and tax
2,200
Interest expense
170
Profit before tax
2,030
Taxation
730
Profit after tax
1,300
Dividends paid
250
Retained profit
1,050
2009
000
1,570
150
1,420
520
900
250
650
Statements of financial position as at 30 November
Non-current assets (written-down value)

Current assets
Inventories
Receivables
Total assets
Current liabilities
Trade payables
Taxation
Bank overdraft
Non-current liabilities
10% debentures 2011
Total liabilities
Share capital ordinary shares of 50p fully paid up
Share premium
Retained earnings
Total equity and liabilities
2010
000
6,350
2009
000
5,600
2,100
1,710
10,160
2,070
1,540
9,210
1,040
550
370
1,960
1,130
450
480
2,060
1,500
3,460
1,500
3,560
3,000
750
2,950
6,700
10,160
3,000
750
1,900
5,650
9,210
The directors are considering two schemes to raise 6,000,000 in order to repay
the debentures and to finance expansion.
Scheme 1 will involve a new issue of debentures redeemable in 15 years
Scheme 2 will involve a rights issue of ordinary shares at 1.50 per share. The
current market price of the shares is 1.80. The share price in December 2010
was 1.75 and in December 2009 was 1.40.
SG Chapter 7.
B Chapters 1315.

The learning outcomes include the ability to analyse, interpret and
communicate the information contained in financial statements. The
most common analytical technique is the use of ratios. This technique
is often tested by a mini case study of the type used in this question.
It is important that answers go beyond simply stating that a particular
ratio has gone up or down. The interpretation should use the contextual
information given in the question and make links between different ratios.
Good answers will draw conclusions from the ratios and the background
information, which provide insight into the financial position and
performance of the companies.
Excellent answers will use the analysis to draw appropriate conclusions
which will be discussed from the perspectives of the lenders and
shareholders.
You should carefully read the requirements of the question which in this
case specify the number and nature of the ratios to be calculated. If you
do not follow these instructions your work may not be marked.
There are no absolute answers to this type of question and you will be
rewarded for a logical and informed analytical approach to the case
described in the question. The answer below illustrates such an approach,
but for completeness provides more ratios than the question requires.
Requirements (a) and (b) clearly set out the ratios to be analysed and
perspective to be used (lenders and shareholders). Requirement (c)
was concerned with the price earnings (PE) ratio and good answers will
comment on the relative ratios for the two years and the competitors and
reach justified conclusions on the companys share price performance.
3 Balliol plc
a. Solvency ratios for a potential lender
Debt equity
Debt equity
1,500:6,700 1,500:5,650
= 1:4.5
= 1:3.8
Interest cover
Profit before interest:

interest
2,200/170
= 13 times
Liquidity
Current assets stock:

current liabilities
1,710:1,960 1,540:2,060
= 0.87:1
= 0.75:1
Return on cap employed
1,570/150
= 10 times
2,200/8,200 1,570/7,150
= 27%
= 22%
b. Ratios for a shareholder

Return on equity
Profit after tax /ordinary 1,300:6,700 900:5,650

share capital + reserves = 19.4%
= 15.9%
Earnings per share
Profit after tax /no. of

ordinary shares
1,300/6,000 900/6,000
= 21.67p
= 15p
Dividend cover
Equity profits/proposed
dividend
1,300/250
= 5.2 times
Gearing
Debt capital/debt +
equity
1,500/8,200 1,500/7,150
= 18.3%
= 21.0%
900/250
= 3.6 times
Comments from viewpoint of lender

The return on capital employed has increased by 23 per cent. The current
ratio at 1.9 and acid test ratio of 0.87 are both improving, and interest
is well covered at 13 times. Gearing is low and when coupled with the
improving return on equity and sound interest cover, it means that the
company is able to increase its long-term borrowing.
10
Comment from potential shareholders viewpoint

The return on equity has improved by approximately 25 per cent. The
dividend is well covered, and has improved in 2010 from 3.6 in 2009 to
5.2 in current year. The EPS figure is in line with the return on equity and
is acceptable. The gearing is low at 18.3 per cent, so that the business
enjoys lower earnings risk.
c. The PE ratio compares a companys earnings and its share price and
can help investors in deciding whether the shares are under or overvalued by comparison with the PE ratios of companies of similar risk.
A high PE ratio might reflect confidence in the companys management
and prospects. A low PE ratio might show a lack of confidence.
PE ratios for Balliol plc
December 2010
1.75 = 8.1
21.67
December 2009
140 = 9.3
15
These ratios illustrate that the markets confidence in Balliols ability
to increase its earnings in 2010 was reflected in the high PE number.
The ratio is still higher than a competitor which shows remaining
confidence.
Question 4
The following are the summarised financial statements of Merton plc for the
years ended 31st December 2009 and 2010.
The following information is available:
i. The movement in non-current tangible assets is summarised as follows:
m
Net book value at 1st January 2010
1000
Additions at cost
400
Revaluation
60
Disposals at book value
(140)
Depreciation for the year
(120)
1200
The asset disposal was for cash proceeds of 160m and the profit on disposal is
included in operating profit.
ii. The non-current intangible assets are patent rights. New rights were
purchased for 110m cash in the year. Amortization of 10m has been
charged to cost of sales during 2010.
iii. Loans were repaid at a premium during the year for 46m cash. The premium
has been charged to net finance costs. No new loans had been taken out. Net
finance costs of 44m for 2010 are stated after deducting 16m of interest
received.
iv. The issue of shares at a premium was made for cash on 1st July 2010.
11

SG pp.11220.
B Chapter 11.
This question requires preparation of a cash flow statement (CFS) which
is part of the learning outcome that refers to the preparation of financial
statements from structured data. You should adopt a systematic approach
which will enable you to extract the cash flows from the accruals based
income statement and statement of financial position. The resulting
increase or decrease in cash balances should be reconciled to the relevant
figures in the statement of financial position. Good answers will be well
presented, correctly describing the component cash flows with well laid
out workings.
a. Merton plc
Cash flow statement for the year ended 31 December 2010
Operating profit
524
Depreciation (120 + 10)
130
Profit on disposal of fixed assets
(20)
Increase in inventory
(50)
Decrease in receivables
32
Increase in prepayments
(80)
Increase in trade payables
230
Net cash from operating activities
766
Returns on investment and servicing of finance

Investment income
Interest paid (44 + 16 6)
16
(54)
Taxation
Capital expenditure
Purchase of tangible non-current assets
Disposal of tangible non-current assets
Purchase of intangible assets
(200)
(400)
160
(110)
Equity dividends paid
(350)
(160)
Net cash flow before financing

Financing
Issue of ordinary shares
Repayment of loans
(38)
728
18
140
(46)
94
112
Increase in cash balances

Reconciliation of cash balances
Increase in cash at bank
Revaluation no cash flow
12
112
b. Explain three ways in which cash flow statements provide information useful
to investors.
SG pp.11220.
B Chapter 11.
In addition to being able to prepare a CFS you should be able to explain
how it provides information useful to investors. Answers which simply
explain how the CFS is prepared would gain few marks, the question is
looking for why the CFS is published.
A cash flow statement can provide information which is not available
from balance sheets and income statements. It may assist users of
financial statements in making judgment on the amount, timing and
degree of certainty of future cash flows.
It gives an indication of the relationship between profitability and cash
generating ability, and thus of the quality of the profit earned.
Analysts and other users of financial information often, formally or
informally, develop models to assess and compare the present value of
the future cash flow of entities. Historical cash flow information could
be useful to check the accuracy of past assessments.
A cash flow statement in conjunction with a balance sheet provides
information in liquidity, viability and adaptability. The balance sheet
is often used to obtain information on liquidity, but the information
is incomplete for this purpose as the balance sheet is drawn up at a
particular point in time.
You only needed to give three of these.
Section C
Question 5
Oriel plc manufactures UPVC windows for the building trade. The production
process is classified into two cost centres, the Fabrication Department and the
Finishing Department. These are supported by two service cost centres the
Canteen and the Maintenance Department.
Forecast information for the year ended 31st March 2011 was as follows:
SG pp.15563.
B Chapter 18.
The use of absorption costing is relevant to the learning outcome of
the preparation of costs under different costing methods. This question
examines the ability to apply allocation assumptions to a data set. The
information appears to be lengthy but in fact the calculations are straight
forward. The choice of absorption rate for each department is clearly
indicated in the question and should applied in (c) in determining a batch
cost. Part (d) required consideration of different absorption methods
and good answers would discuss the relative merits and problems of the
different methods.
13
a.
Expense (basis)
Total
Fabrication Finishing Canteen Maintenance
Indirect labour (given)
340,000
120,000
140,000
30,000
50,000
Consumables (given)
82,000
24,000
32,000
20,000
6,000
Heating and lighting (area)
24,000
8,000
9,600
2,400
4,000
Rent and rates (area)
36,000
12,000
14,400
3,600
6,000
Depreciation (capital values)
60,000
30,000
24,000
2,000
4,000
Supervision (number of employees) 48,000
24,000
18,000
3,000
3,000
Power (kWh)
40,000
18,000
16,000
2,000
4,000
630,000
236,000
254,000
63,000
77,000
33,600
25,200
(63,000)
4,200
Canteen (number of employees)

Maintenance (maintenance hours)
81,200
630,000
46,400
34,800
(81,200)
316,000
314,000
b.
Fabrication
Labour hours
=
12,640
25/direct labour hour
15,70
20/machine hour
Finishing
Machine hours
c.
Batch cost
Direct materials
3,000
Direct labour (800 + 240)
1,040
Overheads
Fabrication (100 25)
Finishing (80 20)
2,500
1,600
8,140
14
Cost per window ( 200)
40.70
Mark up 40%
16.28
Selling price
56.98
d. Direct material cost percentage

This method is best used when the price of materials is constant and
there is a direct relationship between the materials and labour costs
incurred to manufacture the product. Consider the following example:
Job A
Job B
Budget
Materials
250
100
150,000
Labour
100
100
92,000
The overheads charges to a job will be distorted. Job A is charged with

a greater proportion of overheads than Job B even thought the labour
costs were the same.
In the case of Oriel the production uses a range of materials and this
method would be inappropriate.
Direct wages cost percentage
This method is best used when the wages rates are the same
throughout the company and the same for each job.
In the case of Oriel the production involves differing hourly rates and
this method would be inappropriate.
Prime cost percentage rate
This method combines the faults of the direct materials cost percentage
and the direct labour cost percentage rates.
Labour hours method could have been used in the Finishing
department. But on the basis of the labour hours and machine hours
for this department it is obviously machine-intensive and therefore,
machine hours should be used.
Question 6
Trinity plc operates a motel close to a ski resort. The following forecasts have
been made for the year ended 31st March 2012.
Occupancy
Low season (6 months)
4500 rooms
High season (6 months)
6500 rooms
There are 40 rooms in total and the motel is open 7 days per week for
52 weeks.
Income
The standard room rate is 80 per day.
Costs
Low season
High season
Variable cost per day
20
25
Fixed cost per annum
110,000
130,000
Maintenance
32,000
40,000
Depreciation
20,000
20,000
Miscellaneous
20,000
30,000
Staff costs
The management of Trinity plc is considering two alternative policies.

15

SG pp.16777.
B Chapters 1617.
Break-even and cost-volume-profit analysis are key techniques in short
term decision making. This question tests your ability to apply the
techniques to a number of increasingly complex scenarios. It is important
in answering such questions that you keep in mind the basic contribution
approach to the analysis and clearly distinguish between those costs
and revenues which are relevant to the decision and those which are
not. Good answers will set out the computations in a clear, logical and
coherent manner. Part (d) which carries the majority of the marks requires
evaluation of the calculations and the alternative policies. Good answers
would reflect the importance of this evaluation and explanation of its
limitations.
a.
Fixed costs
Low season
High season
182,000
220,000
Contribution per room per day

(80 20)
60
(80 25)
Break-even point
b.
Room
55
Room
3,033 days
4,000 days
Margin of safety
Low season
room
(4,500 3,033) = 1,467 days

High season
room
(6,500 4,000) = 2,500 days

c.
d.
Occupancy percentages
Low
High
Total capacity
7280
7280
Forecast
62%
89%
Break-even
42%
55%
Forecast profits
Low season
Contribution (60 4,500)
Fixed costs
270,000
(182,000)
Profit
88,000
Alternative 1
Contribution (70 20) (4,500 1.1)
Fixed costs
(182,000)
Advertising costs
(20,000)
Profit
16
247,500
45,500
Alternative 2
Contribution (60 2,250)
135,000
Fixed costs
Maintenance
(16,000)
Depreciation
(20,000)
Set up costs
(9,000)
90,000
Evaluation
Alternative 1 would give lower profits. Subject to uncertainty about
increased occupancy. Is the advertising a recurring cost?
Alternative 2 increases profits but may lose customer loyalty. Subject
to avoiding fixed costs. Both are subject to limitations of CVP analysis,
answers might give other appropriate considerations.
Question 7
New College plc is an electronic game manufacturer. The company has recently
developed a new game and the directors are considering whether to proceed
with production. The development costs incurred were 220,000.
A market research report costing 30,000 was received and paid for in May
2010. The report suggested that the game had an expected four year market life
and provided forecasts of demand. On the basis of these the following forecast
profit and loss accounts have been prepared:
SG Chapter 12.
B pp.479520.
The application of capital investment techniques is an important element
of the syllabus and learning outcomes. The most effective approach is to
construct a columnar table in which relevant cash flows can be inserted.
It is important to give workings of all figures and to clearly explain
treatment of all amounts, for example if a cost is to be treated as sunk
and therefore not included as a relevant cost this should be stated. Having
determined the net cash flow for each year these are discounted using
the discount factors taken from the tables provided. Thus a net present
value can be arrived at and a decision recommended and justified. This
type of question requires use of a significant amount of data and it is very
important that your work is clearly presented and that al workings are
legible and understandable. The eight-column accounting paper can help
in the respect. A suggested presentation of the answer is given below.
Part (b) requires description of underlying assumptions of the calculations
in (a) and should not simply reiterate the basis of the calculations.
Part (c) provides an opportunity for good candidates to use their
understanding of these techniques in evaluating the comments of the
chairman.
Part (d) tests your understanding of sensitivity analysis and good answers
would explain the mechanisms of the technique and how it is used by
management in decision making.
17
a.
2010
2011
2012
2013
2014
000
000
000
000
000
Machinery
(550)
30
Working capital
(40)
40
Sales
500
640
480
320
Cost of sales
(200)
(256)
(192)
(128)
Variable costs
(100)
(128)
(96)
(64)
Fixed costs
(10)
(10)
(10)
(10)
Net cash flows
(590)
190
246
182
188
Discount factor
1.0
0.909
0.826
0.751
0.683
Present value
(590)
172.7
203.2
136.7
127.8
NPV
50.4
: development costs sunk cost
Excluded
: market research sunk cost

: depreciation not a cash flow
: 40,000 fixed overhead allocations
b. Assumptions could include

Year end timing of cash flows
No inventories
No other changes in working capital
10 per cent is appropriate cost of capital.
c. Evaluation
Concentrates on profits not cash flows
Treats sunk costs as relevant
Assumes that profit margin lower than 5 per cent equates to lack of
financial viability
Reaches an incorrect conclusion/explain why positive NPV gives
correct view.
d. Sensitivity analysis
This approach identifies each of the key variables influencing the
investment decision and examines the extent to which they could
change before affecting the viability of the project. The approach
gives managers a feel for the margin of error that is available for each
variable; however, it does not provide a clear indication of whether to
accept or reject the project. This is left to managerial judgement.
18

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Examiners commentaries 2011

Examiners commentaries 2011

Rubric of the examination paper

Comments on specific questions

The directors are proposing the following transactions:

Reading for this question

Profits for year

Examiners commentaries 2011

Concerned with the preparation of

Concerned with the preparation of

Prepared on a periodic basis (most

Prepared frequently, as and when

Based on past events and historic data.

More likely to contain forward looking

Comprised solely of financial

More likely to incorporate nonfinancial information (such as

Governed by rules and regulations.

Not regulated (managers are free to

Standard labour hours for output

Actual fixed overhead incurred

[For the full question, please refer to the Examination paper.]

Fixed overhead 210,000 = 6 per hour 32,000

ii. VO price variance

iii. FO spending variance

Examiners commentaries 2011

Bank balance (debit)

Inventories (stock) at 1st April 2010

Loan (Repayable 2017)

Property, plant and equipment, at cost

Retained earnings at 1st April 2010

Selling and distribution costs

Share premium account

Ordinary shares at 1 each

[For the full question, please refer to the Examination paper.]

Selling and distribution costs

Profit before interest and tax

Interest (100 + 100)

Profit before tax

Statement of financial position as at 31st March 2011

Liabilities and equity

Retained earnings (5400 + 5178)

Total liabilities and equity

Examiners commentaries 2011

Increase in bank balance

Plant & equipment

Depreciation current year

P & E (20% 6,760,000)

Selling & Dist. 50%

Trade-in (80 50)

Selling & Dist 50%

3. Cost of goods sold

5. Selling and distribution costs

b. Brasenose plc has made a specific accounting policy choice in respect of

Examiners commentaries 2011

Statements of financial position as at 30 November

Non-current assets (written-down value)

Approaching the question

Profit before interest:

Current assets stock:

Return on cap employed

b. Ratios for a shareholder

Profit after tax /ordinary 1,300:6,700 900:5,650

Earnings per share