2

Introduction to Accounting
Problem 1
You are to complete the gaps
Assets Liabilities Equity
₤ ₤ ₤
(a) 12,500 1,800 ?
(b) 28,000 4,900 ?
(c) 16,800 ? 12,500
(d) 19,600 ? 16,450
(e) ? 6,300 19,200
(f) ? 11,650 39,750

Problem 2
Distinguish from the following list the items that are liabilities from those that are assets:
(a) Office machinery (d) Motor vehicles
(b) Loan from C Smith (e) We owe for goods
(c) Fixtures and fittings (f) Bank balance

Problem 3
State which of the following are shown under the wrong classification for J White’s business:
Assets Liabilities
Loan from C Smith Inventory
Cash in hand Accounts receivable
Machinery Money owing to bank
Accounts payable
Premises
Motor vehicles

Problem 4
Mr. S sets up a new business. Before he actually sells anything, he has bought motor vehicle
₤2,000, premises ₤5,000, stock of goods ₤1,000. He did not pay in full for his stock of goods
and still owes ₤400 in respect of them. He had borrowed ₤3,000 from B. After the evens just
described, and before trading starts, he has ₤100 cash in hand and ₤700 cash in bank

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Required:
Calculate the amount of his capital.

Problem 5
Draw up a balance sheet from the following as at 31 December 2018:
Capital 23,750
Accounts receivable 4,950
Motor vehicles 5,700
Accounts payable 2,450
Fixtures 5,500
Inventory 8,800
Cash at bank 1,250

Problem 6
Complete the columns to show the effects of the following transactions:
Effect upon
Assets Liabilities Capital
(a) We pay a creditor ₤70 in cash.
(b) Bought fixtures ₤200 paying by cheque.
(c) Bought goods on credit ₤275.
(d) The proprietor introduces another ₤500 cash into the firm.
(e) Mr. X lends the firm ₤200 in cash.
(f) A debtor pays us ₤50 by cheque.

Problem 7
C.S. has the following items in his balance sheet as on 30 April 2018:
Capital ₤20,900; Creditors (or accounts payable) ₤1,600; Fixtures ₤3,500; Motor vehicle
₤4,200; Stock of goods (or inventory) ₤4,950; Debtors (or accounts receivable) ₤3,280; Cash
at bank ₤6,450; Cash in hand ₤120.
During the first week of May 2018:
(a) He bought extra stock of goods ₤770 on credit.
(b) One of the debtors paid him ₤280 in cash.
(c) He bought extra fixtures by cheque ₤1,000.

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Required:
Draw up a balance sheet as on 7 May 2018 after the above transactions have been completed.

Problem 8
The following are transactions of the business for a period. You are required to state the effect
of each on the balance sheet items. Be detailed where the capital is affected, showing the type
of effect:
(a) Bought stock in trade on credit terms for ₤1,200.
(b) The owner paid a trade creditor ₤1,500 for some stock in trade bought on credit recently.
Since the owner did not have the business bank account cheque book with him, he drew a
cheque on his personal account.
(c) Stock in trade, which had cost ₤1,700, was sold on credit for ₤2,500.
(d) The owner withdrew ₤500 by drawing a cheque on the business bank account, payable to
himself.
(e) Paid wages of ₤750 by cheque.
(f) Paid bank interest of ₤100 by having amount charged on the business bank account.
(g) Received a ₤2,000 cheque from a trade debtor.
(h) Paid a trade creditor ₤1,200 by a cheque drawn on the business bank account.

Problem 9
Explain:
(a) What is a revenue?
(b) What is an expense?
(c) What is a profit?
(d) The owner pays himself a regular ₤100 from the business account each week, is it an
expense?
(e) Why is the purchase of some stock in trade not an expense?

Problem 10
Explain and provide comments:
(a) Why is it necessary to put a date in the heading of the balance sheet?
(b) Jim just bought a new motor van. Will this have an effect on the balance sheet of his
business?

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(c) Comment: “Why is it that my capital is shown with the liabilities in the balance sheet of
my business? Surely it is an asset”.
(d) Which of the following would you expect to find among the items of the balance sheet:
- The fact that the business owes money
- The fact that the owner has very good business skills
- The fact that the demand for the output of the business is expected to increase greatly
in the future leading to a large increase in profits.
- The fact that the assets of the business are highly specialized and in the main part
could only be used for the current purposes.
(e) The total of the balance sheet tells the owner how much his business is worth.
(f) The amount of equity on the balance sheet tells the owner how much his business is worth.

Problem 11
Consulting Agency Statement of Financial Position as at October 31st, 2018
ASSETS LIABILITIES
Cash ₤1,400 Notes Receivable ₤11,000
Advertising Expense ₤300 Interest Expense ₤2,000
Land ₤31,500 Office supplies ₤800
Salary Expense ₤3,300 Accounts Receivable ₤1,600
Office furniture ₤4,700 Note Payable ₤20,000
Accounts Payable ₤3,000
Utilities Expense ₤1,100 OWNER’S EQUITY
Equity ₤8,900
Total Assets ₤44,300 Total Liabilities & Equity ₤44,300
The bookkeeper of Consulting Agency prepared the statement of financial position of the
company while the accounting was ill. The statement of financial position contains a lot of
errors. In particular, the bookkeeper knew that the statement of financial position should
balance, that’s why he put in the owner’s equity the amount needed to achieve this balance.
But in reality the equity data is not correct.
Required:
(a) Prepare the correct statement of financial position as at October 31st, 2018.
(b) Identify the accounts listed in the statement of financial position made by the bookkeeper
that should not be presented on the true statement of financial position.
(c) Explain why you excluded some accounts from the correct statement of financial position.

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Problem 12
Harold Davies is the owner of a small building firm. He does not understand the item
“statement of financial position” and asks you to explain to him whether the following items
should be on his statement of financial position. Indicate the nature of the item (e.g., current
asset, long-term liability, not applicable) and give the reason for your answer.
(a) Inventory of sand and cement
(b) Air compressor purchased for cash
(c) Air compressor hired for three weeks
(d) Wages paid to labourer
(e) Lorry used for transporting materials
(f) Diesel fuel in lorry fuel tanks
(g) Washing machine bought for Mrs. Davies
(h) Bank overdraft
(i) Petty cash in hand
(j) ₤2,000 owing to an uncle who says Harold need not pay until five years later

Problem 13
King Pharmaceuticals plc has just spent £50 million on developing a new medicine that is
expected to yield substantial profits over the next four years. Use this example to help explain
the distinction between the terms 'relevance' and 'reliability' when preparing financial
statements for shareholders. Why are 'relevance' and 'reliability' seem to be important
qualitative characteristics of accounting information?
You should structure your answer well. Your answer should not exceed 250 words.

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 Double-Entry Bookkeeping
Problem 14
The transactions of Wheels Repair Shop for January 2019 are shown below:
January 3 – Debby Star opened a bank account under the name of her new business
and deposited ₤30,000 in cash.
January 4 – She rented a temporary shop and paid ₤300 for the January rent, issued
cheque.
January 5 – Rented automotive tools and equipment until the firm could purchase its
own. Rent in the amount of ₤80 was paid for January, issued cheque.
January 5 – Purchased motorcycle parts and supplies described on invoice from the
Southern Supply Company for ₤400 on account.
January 10 – Purchased land as a prospective building site for ₤10,000. Paid ₤4,000 in
cash and issued a one-year note payable for the balance.
January 12 – Made repairs on George Shipman’s motorcycle for ₤40. Shipman asked
that a charge account be opened in his name. He promised to settle the account within 30
days. This arrangement was authorized by service manager.
January 26 – Made repairs on Jay Munson’s motorcycle for ₤180. A charge account
was opened in his name.
January 29 – Purchased motorcycle parts and supplies from Delco Supply House for
₤250 on account
January 29 – Paid the Southern Supply ₤300 on account (cheque)
January 31 – Paid electricity and water bills of ₤80 for January
January 31 – Paid ₤1,700 in salaries for the month
January 31 – Made motorcycle repairs for various cash customers for ₤4,800
January 31 – Debby Star withdrew ₤300 in cash in anticipation that at least as much
income had been earned
January 31 – Purchased automotive tools and equipment for cash ₤4,000. The list price
was 5,000.
January 31 – Paid a premium of ₤600 on a 12 months insurance policy, it becomes
effective on February 1, 2019.
January 31 – Received a cheque for ₤10 from George Shipman.
Required:
(a) Analyze the transactions using extended accounting equation formula

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(b) Journalize the transactions
(c) Post to the ledger
(d) Prepare a trial balance sheet / footing
(e) Explain adjusting entries

Problem 15
Bill Cashing sets up practice as an architect, transferring ₤20,000 of his own money on 1 June
2018 from this personal bank account into a new business bank account with NatMid Bank
plc to represent the opening capital of the business. The following transactions took place
during June 2018:
June 1 – Paid rent for office for June ₤400 by cheque.
June 1 – Purchased office equipment for ₤2,000, from Equipit Ltd on credit.
June 1 – Purchased office supplies, costing ₤300 from W Brown on credit.
June 1 – Employed an office junior at a monthly wage of ₤500.
June 5 – Surveyed a property for A Bond and sent out and invoice for ₤200.
June 7 – Decided to transfer his own car to the business at a value of ₤4,000.
June 9 – Bought petrol for the car costing ₤20, paying by cheque.
June 12 – Took a client, P Brosnan, to lunch at a cost of ₤40, paying by cheque, and
was asked to prepare plans for a new factory, for which work he estimated he would earn
₤5,000.
June 16 – Carried out another property survey for A Bond and invoiced him for ₤240.
June 20 – Took another possible client to lunch at a cost of ₤60, paying by cheque, but
found that he would not be able to undertake work for that client.
June 23 – Bought further office supplies from W Brown on credit for ₤100.
June 30 – Paid the office junior her monthly wage.
June 30- Sent a cheque to Equipit Ltd for ₤2,000.
June 30 – Sent a cheque to W Brown for office supplies for ₤300.
June 30 – Banked a cheque received from A Bond for ₤200.
June 30 – Drew out ₤500 from the bank for personal living expenses.
Required:
Enter these transactions in Bill Cashing’s accounting records, and test the arithmetical
accuracy of your work by preparing a trial balance when you have completed the necessary
entries.

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Problem 16
The following transactions took place during May 2019:
May 1 – Started firm with capital in cash of ₤250.
May 2 – Bought goods on credit from the following persons: D ₤54; C ₤87; K ₤25; B
₤76; L ₤64.
May 4 – Sold goods on credit to: CB ₤43; BH ₤62; HS ₤176.
May 6 – Paid rent by cash ₤10
May 9 – CB paid us his account by cheque ₤43.
May 10 – HS paid us ₤150 by cheque.
May 12 – We paid the following by cheque: K ₤25; D ₤54.
May 15 – Paid carriage by cash ₤23.
May 18 – Bought goods on credit from C ₤43; B ₤110.
May 21 – Sold goods on credit to BH ₤67.
May 31 Paid rent by cheque ₤18.
Required:
Enter these transactions in a company’s accounting records, and then balance off the accounts
and extract a trial balance as at May 31st, 2019.

Problem 17
B’s Trial Balance as on 31 December 2018
Dr Cr
₤ ₤
Sales 18,462
Purchases 14,629
Salaries 2,150
Motor expenses 520
Rent 670
Insurance 111
General expenses 105
Premises 1,500
Motor vehicles 1,200
Debtors 1,950
Creditors 1,538

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 Cash at bank 1,654
Cash in hand 40
Drawings 895
Capital _____ 5,424
25,424 25,424
Stock at 31 December 2018 was ₤2,548.
Required:
Using the trial balance of B that was extracted after one year’s trading, prepare an income
statement for the year ended December 31st, 2018 and a statement of financial position as at
December 31st, 2018.

Problem 18
The following transactions took place during March 2019:
March 1 – Started business with ₤800 in the bank.
March 2 – Bought goods on credit from the following persons: K ₤76; M ₤27; B ₤56.
March 5 – Cash sales ₤87.
March 6 – Paid wages in cash ₤14.
March 7 – Sold goods on credit to: H ₤35; L ₤42; J ₤72.
March 9 – Bought goods for cash ₤46
March 10 – Bought goods on credit from M ₤57; B ₤98.
March 12 – Paid wages in cash ₤14.
March 13 – Sold goods on credit to: L ₤32; J ₤23.
March 15 – Bought shop fixtures on credit from B Ltd ₤50.
March 17 – Paid M by cheque ₤84.
March 18 – We returned goods to B ₤20.
March 21 – Paid B Ltd a cheque for ₤50.
March 24 – J paid us his account by cheque ₤95.
March 27 – We returned goods to K ₤24.
March 30 – J lent us ₤60 by cash.
March 31 – Bought a motor van paying by cheque ₤400.
Required:
Enter these transactions in a company’s accounting books, and then balance off the accounts
and extract a trial balance as at 31 March 2019.

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Problem 19
C’s Trial Balance as on 30 June 2018
Dr Cr
₤ ₤
Sales 28,794
Purchases 23,803
Rent 854
Lighting and heating expense 422
Salaries and wages 3,164
Insurance 105
Buildings 50,000
Fixtures 1,000
Debtors 3,166
Sundry expenses 506
Creditors 1,206
Cash at bank 3,847
Drawings 2,400
Motor vans 5,500
Motor running expenses 1,133
Capital _____ 65,900
95,900 95,900
Stock at 30 June 2018 was ₤4,166.
Required:
From the trial balance of C after his first year’s trading, prepare an income statement for the
year ended 30 June 2018 and a statement of financial position as at June 30th, 2018.

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 Adjustments
Problem 20
The following trial balance was extracted from the accounts of a business as at December 31st,
2017:
Dr Cr
₤ ₤
Sales 150,000
Sales return 3,000
Purchases 70,000
Carriage in 1,000
Inventory as at 1st January 2017 10,000
Wages 20,000
Administration expenses 25,000
Insurance 1,000
Selling & distribution expenses 10,000
Purchase returns 500
Drawings 10,000
Capital 50,000
Premises 20,000
Equipment 20,000
Accounts receivable 15,000
Accounts payable 10,000
Cash 5,500 _____
₤210,500 ₤210,500

At the year end (31st December) the following information is available:

(1) ₤1,000 of the wages relate to the next accounting period.
(2) ₤2,000 is owed for administration expenses relating to 2017.
(3) Equipment is to be depreciated by ₤4,000.
(4) Closing inventory is estimated to have cast ₤8,000.
Required:
(a) Enter the records in the Trial balance.
(b) Indicate which data from trial balance relates to the statement of financial position.

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(c) Prepare an income statement for the year ended December 31st, 2017.
(d) Explain the role of adjustments you made.

Problem 21
Mr. Simple has been trading for some years as a wine merchant. The following list of
balances has been extracted from his ledger as at 30th April 2018, the end of his most recent
financial year.
₤
Capital 83,887
Sales 259,870
Trade creditors 19,840
Returns out 13,407
Provision for doubtful debts 512
Discounts allowed 2,306
Discounts received 1,750
Purchases 135,680
Returns inwards 5,624
Carriage outwards 4,562
Drawings 18,440
Carriage inwards 11,830
Rent, rates and insurance 25,973
Heating and lighting 11,010
Postage, stationery and telephone 2,410
Advertising 5,980
Salaries and wages 38,521
Bad debts 2,008
Cash in hand 534
Cash at bank 4,440
Stock as at 1st May 2017 15,654
Trade debtors 24,500
Fixtures and fittings – at cost 120,740
Provision for depreciation on fixtures and fittings – as at 30th April 2018 63,020
Deprecation 12,074

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The following additional information as at 30th April 2018 is available:
(1) Stock at the close of business was valued at ₤17,750.
(2) Insurances have been prepaid by ₤1,120.
(3) Heating and lighting is accrued by ₤1,360.
(4) Rates have been prepaid by ₤5,435.
(5) The provision for doubtful debts is to be adjusted so that it is 3% of trade debtors.
Required:
Prepare Mr. Simple’s income statement for the year ended April 30th, 2018 and a statement of
financial position (in vertical format) as at that date.

Problem 22
The following trial balance was extracted from the books of Charles as the close of business
on 28 February 2018.
Dr Cr
₤ ₤
Purchases and sales 11,280 19,740
Cash at bank 1,140
Cash in hand 210
Capital account 1st March 2017 9,900
Drawings 2,850
Office furniture 1,440
Rent 1,020
Wages and salaries 2,580
Discounts 690 360
Accounts receivable and payable 4,920 2,490
Stock 1st March 2017 2,970
Provision for doubtful debts 1st March 2017 270
Delivery van 2,400
Van running costs 450
Bad debts written off 810
₤32,760 ₤32,760

The following additional information as at 28th February 2018 is available:

(1) Stock at 28th February 2018 ₤3,510.

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(2) Wages and salaries accrued at 28th February 2018 ₤90.
(3) Rent prepaid at 28th February 2018 ₤140.
(4) Van running costs owing at 28th February 2018 ₤60.
(5) Increase the provision for doubtful debts by ₤60.
(6) Provide for depreciation as follows: Office furniture ₤180; Delivery van ₤480.
Required:
Draw up an income statement for the year ending 28th February 2018 together with a
statement of financial position as at 28th February 2018, using vertical formats throughout.

Problem 23
The statement of financial position of Johnson’s shop as at 1st October 2018 was as follows:
₤ ₤ ₤ ₤
Non-current assets Capital
Shop premises 45,000 At 1 October 2018 51,000
Shop fittings 12,000
Delivery van 4,000 61,000
Current assets Current liabilities
Inventory 14,000 Trade payables 12,000
Cash in hand 2,000 16,000 Bank overdraft 14,000 26,000
₤77,000 ₤77,000

The following in a summary of the transactions which took place during the year to 30th
September 2019:
(1) Sales were made, all for cash, of ₤145,000. The inventory sold cost ₤83,000.
(2) Inventory was bought, all on credit, for ₤78,000.
(3) Cash of ₤113,000 was taken from the till (cash register) and paid into the bank.
(4) The trade creditors were paid ₤73,000 by cheque.
(5) Johnson borrowed ₤30,000 from Black which was paid into the bank. The loan is for 5
years.
(6) Wages of ₤17,000 were paid by cash.
(7) Rates of ₤2,900 were paid by cheque.
(8) Additional shop fittings costing ₤9,000 were bought and paid for by cheque
(9) The bank charged overdraft interest of ₤2,000 direct to the account.
(10) Sundry expenses of ₤6,000 were paid in cash.

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(11) Electricity bills of ₤1,600 were paid by cheque.
(12) The owners of the business withdrew ₤9,000 in cash.

At 30th September 2019 you discover the following:

(13) Interest ₤2,500 due to Black for the year was unpaid.
(14) Shop fittings are to be depreciated at 10% per annum on the total at the year end; the
delivery van is to be depreciated by 20% per annum of the total at the year end.
(15) The rates payments during the year included ₤1,000 in respect of the period 1.10.2019 to
31.3.2020.
(16) The electricity bill for the quarter to 30.9.2019 for ₤500 was unpaid.
Required:
Prepare a balance sheet (in vertical format) as at 30th September 2019 and a profit and loss
account for the year to that date.

Problem 24
Adagio plc. is a wholesale supplier of musical instruments to the retail and educational
sectors. The bookkeeper has extracted the following balances from the accounting records for
the year ended 31st May 2020. The totals of the debit and credit balances did not agree, and
the balancing figure was placed in a suspense account.
£000
Freehold property, at cost 3,600
Plant, equipment and vehicles, at cost 2,060
Provision for depreciation at 1st June 2019
Freehold buildings 440
Plant, equipment and vehicles 1,080
Purchases 13,100
Sales 21,180
Distribution and selling costs 2,300
Administration costs 1,240
Directors remuneration 1,110
Inventories at 1st June 2019 1,320
Trade payables 972
Trade receivables 1,834

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 Bank balance (debit balance) 95
Ordinary share capital (£1 shares, fully paid) 3,300
Retained earnings at 1st June 2019 222
Loan interest paid 30
10% loan, repayable in 2025 500
Suspense account (debit balance) 1,005
The following information is available.
(1) The accountant of Adagio plc. has now reviewed the accounting records and has
discovered the following errors which require adjustment:
(i) On 31st May 2020 stocks were valued at £1,280,000. This figure has been credited to the
purchases account but no other entries have been made.
(ii) A motor vehicle was sold for cash on 1st June 2019 for £15,000. The cash received has
been recorded in the cash book but no other entries have been made. The motor vehicle
originally cost £40,000 on June 1st , 2018.
(iii) A debtor balance of £130,000 was eliminated from the trade debtors balance as it was
considered to be irrecoverable. No other entries have been made.
(iv) A directors’ bonus of £390,000 was calculated on the basis of expected profits and was
added to the directors’ remuneration account but no other entries were made.
(2) No provision has been made at the year-end for the following:
(i) Depreciation on plant, equipment and vehicles at 10% on the straight line method. There
are no fully depreciated assets in this category.
(ii) Depreciation at 5% on cost of freehold buildings which represent 25% of the cost of
freehold property.
Depreciation charges and profits or losses on asset disposals are allocated 50% to cost of sales
and 25% each to distribution costs and administration costs.
(3) Directors’ remuneration is allocated as 80% to administration and 20% to selling costs.
Bad debts written off are treated as selling costs.
(4) Provision is required at the year-end for:
(i) outstanding loan interest,
(ii) auditors’ remuneration of £80,000, (treated as administration costs),
(iii) corporation tax for the year of £600,000
(5) The company has paid insurance premiums of £20,000 relating to periods after the year
end. Insurance is included in administration costs.

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Required:
(a) Prepare an income statement for Adagio plc. for the year ended May 31st, 2020 and a
statement of financial position as at that date in a form suitable for the directors.
(b) During the year the company had paid £40,000 training costs which were included in
administration costs. The human resources director has argued that this should not be seen as
an expense but as an asset. Briefly discuss her proposal.

Problem 25
The draft accounts prepared for the directors of Snodrop plc. for the year ended 31 December
2019 show a profit before taxation of £573,580. In the course of subsequent checking, the
following errors and omissions were found:
(1) During the year the company had acquired an additional factory unit at an annual rent of
£64,000, payable quarterly in advance commencing on 31 March 2019. By 31 December
2019 four quarterly payments had been made. The total paid during the year had been treated
as capital expenditure and included in fixed assets. No depreciation had been provided on the
factory unit.
(2) Some goods were included in the closing stock valuation at their selling price of £9,750.
The gross profit margin on these goods was 30%.
(3) A delivery vehicle held as a fixed asset had been sold during the year for £5,200. The
original cost was £16,000 and, at 1 January 2019, depreciation of £9,600 had been provided.
The proceeds of sale had been credited to sales account. The company depreciates delivery
vehicles at 20% per year using straight-line basis. Its policy is to provide for depreciation in
the year of purchase but not in the year of sale.
(4) The brought forward balance of £1,700 for the accrued telephone charges at 1 January
2019 had been omitted when calculating the year’s telephone charge.
(5) £9,820, being the total of returns inwards for the year, had been credited to purchases and
debited to trade creditors.
(6) At 1 January 2019 there was a provision for doubtful debts of £29,320. Snodrop plc. has a
policy of making a 3% provision for doubtful debts based on closing trade debtors. The entry
for 31 December had not been made and the trade debtors then totaled £1,260,500.
(7) Items included in closing stock at £7,900, and which would normally be sold for £10,200,
were in a damaged state and were worth only £6,850.

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(8) A legal action brought against the company during 1999 for damage to property was
decided shortly after the balance sheet date and, as a result, it will have to pay costs and
damages totaling £24,000. No provision had been made in the accounts for this event.
(9) Salaries paid for October 2019 of £24,530 had been incorrectly recorded as £42,530.
There was a compensating error affecting trade creditors which meant that the end of year
trial balance agreed.
Required:
(a) Calculate the correct figure for Snodrop plc. for profit before taxation for 2019. Show each
adjustment separately and indicate which entries in the draft income statement are affected. If
you consider that any of the above information does not affect profit explain clearly why this
is the case.
(b) Identify, and briefly explain, the reasons for your adjustments relating to (1), (2), (6) and
(8) above. Refer to accounting concepts where relevant.

Problem 26
Ko-Furn Limited is an office furniture manufacturer. The following is a list of balances
extracted from its accounting records at 31 December 2019:
Dr Cr
000$ 000$
Land, at valuation 240
Buildings: cost 500
Buildings: accumulated depreciation at 1.1.19 180
Equipment: cost 392
Equipment: accumulated depreciation at 1.1.19 152
Vehicles: cost 568
Vehicles: accumulated depreciation at 1.1.19 264
Inventory at 1.1.19 214
Trade receivables 366
Provision for doubtful debts at 1.1.19 16
Prepayment at 1.1.19 12
Accrual at 1.1.19 18
Cash 408
Trade payables 248

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 Share capital: ordinary 50c shares 50
Share premium 350
Retained earnings 606
Sales 2,924
Purchases 976
Wages and salaries 540
Distribution costs 200
Other administrative expenses 360
Corporation tax 12
Disposal account 20
Dividend paid 40
4,828 4,828
You are given the following information:
(1) Ko-furn prices its furniture using a normal 30% mark-up policy. A stock count carried out
at 31 December 2019 valued stock at selling price of $325,000. This included two board
tables at normal selling price of $20,800 each, which the directors have decided should be
reduced in price to $5,000 each.
(2) The land was valued at $600,000 at 31 December 2019. The directors decided to reflect
the revalued amount in the balance sheet.
(3) On 1 February 2019, the company sold a vehicle for $20,000. While the proceeds of sale
were credited to the Disposal account, no other entries were made in the books of account in
relation to this transaction. The vehicle had cost $88,000 in August 2016. The company
charges a full year’s depreciation in the year of acquisition and no depreciation in the year of
disposal.
(4) The company’s depreciation policy is as follows:
Land: nil
Buildings: 4% straight line
Equipment: 40% reducing balance
Vehicles: 25% straight line.
(5) Trade receivables at 31 December 2019 include a debt of $16,000 from a customer
recently declared bankrupt. The company has decided to maintain the provision for doubtful
debts at 4% of remaining trade receivables.
(6) The balance of prepayments at 1.1.19 refers to insurance charges. Prepaid insurance,
included in general distribution costs at 31 December 2019 amounted to $24,000.

20
(7) The balance of accruals at 1.1.19 refers to electricity charges. After the year end, the
company received an electricity invoice for $30,000 covering the period 1 November 2019 to
31 January 2020. Electricity charges are included in other administrative expenses.
(8) Corporation tax for the year ended 31 December 2019 is estimated to be $190,000.
(9) The company issued 100,000 additional shares at 50c each on 30 December 2019 for
$140,000. This transaction has not been recorded in the accounting records.
Required:
Prepare an income statement, a statement of changes in equity for the year ended 31
December 2019 and a statement of financial position at that date for Ko-Furn Limited in a
form suitable for presentation to the directors.

21
 Accounting for Current Assets
Problem 27
Bought Sold
January 10 at ₤30 each April 8 for ₤46 each
March 10 at ₤34 each December 12 for ₤56 each
September 20 at ₤40 each
Required:
(a) Calculate the closing inventory that would be shown using (i) FIFO, (ii) LIFO, (iii) AVCO
methods on a perpetual inventory basis.
(b) Draw up the extract from an income statement for the year showing sales, cost of sales and
gross profit that would have been reported using (i) FIFO, (ii) LIFO, (iii) AVCO methods.

Problem 28
Bought Sold
January 24 at ₤10 each June 30 for ₤16 each
April 16 at ₤12.50 each November 34 for ₤18 each
October 30 at ₤13 each
Required:
(a) Calculate the closing inventory that would be shown using (i) FIFO, (ii) LIFO, (iii) AVCO
methods on a perpetual inventory basis.
(b) Draw up the extract from an income statement for the year showing sales, cost of sales and
gross profit that would have been reported using (i) FIFO, (ii) LIFO, (iii) AVCO methods.

Problem 29
An evaluation of a physical stock count on 30th April, 2020 in respect of the financial year
ending on that date at Cranfleet Commodities has produced a figure of ₤187,033.
The firm’s book-keeper has approached you, as the accountant, for assistance in dealing with
the following matters to enable him to arrive at a final figure of closing inventory for
inclusion in the annual accounts:
(1) 320 components included at their original cost of ₤11 each can now be bought in for only
₤6 each due to over production by the manufacturer. This drop in price is expected to be only
temporary and the purchase price is expected to exceed its original figure within 12 months.

22
Cranfleet Commodities intends to continue selling the existing stock at the present price of
₤15 each.
(2) It has been discovered that certain items which had cost ₤5,657 have been damaged. It will
cost ₤804 to repair them after which they can be sold for ₤6,321.
(3) On one stock sheet a sub-total of ₤9,105 has been carried forward as ₤1,095.
(4) 480 units which cost ₤1.50 each have been extended at ₤15.00 each.
(5) The firm has sent goods with a selling price of ₤1,500 (being cost plus 25%) to a customer
on a sale or return basis. At 30th April 2020, the customer had not signified acceptance, but
the goods have not been returned, and consequently had not been included in the physical
stock count.
(6) Included in stock were goods bought on credit for ₤4,679 from Byfleet Enterprises. At 30th
April 2020, Cranfleet Commodities had not paid this account.
(7) Byfleet Enterprises had also sent some free samples (for advertising purposes only). These
have been included in stock at their catalogue price of ₤152.
Required:
Taking account of such of the above facts as are relevant, calculate a closing stock figure for
inclusion in the 2020 annual accounts of Canfleet Commodities, giving reasons for the action
you have taken in each individual case.

Problem 30
The draft accounts of Trayderrs plc for the year ended 31st December 2018 show a net profit
before tax of ₤543,350 and closing inventory at cost of ₤316,740 following a physical stock
count.
During the audit of the accounts the following matters have come to light:
(1) Inventory costing ₤25,000 has been omitted from the closing inventory figure.
(2) Items included in inventory at ₤10,200, and which would normally be sold for ₤18,350,
were in a damaged state and were worth only ₤7,600.
(3) Trayderrs plc received an order on 27th December 2018 to supply goods at a total price of
₤52,000. The goods, which had cost ₤34,000, were moved on the following day from the
warehouse to the packing department and were dispatched on 3rd January 2019 when the
customer was invoiced. Trayderrs plc had included the order in sales for 2018 and had
excluded the goods from closing inventory.
(4) 3,100 items costing ₤21 each were recorded on the stock sheets in error as 1,300 items at
₤12 each.

23
(5) Inventory costing ₤10,000 was lost in a fire in the warehouse during the year. The
company’s insurers have agreed to pay Trayderrs plc ₤11,200 in respect of its insurance
claim. No entry has yet been made in the accounting records.
(6) Included in purchases is ₤41,500 for goods purchased in December and which were
received into the warehouse on 5th January 2019.
(7) Inventory costing ₤18,000 has in error been treated as a fixed asset and depreciation of
10% of cost has been provided for.
(8) Returned item costing ₤825 has been treated in the accounting records as a return inward
instead of a return outward.
(9) An item is included in the closing inventory at its selling price of ₤8,200. The gross profit
margin on this item is 40%.
Required:
(a) Calculations to show the correct figure for Trayderrs plc for
(i) inventory at 31st December 2018, and
(ii) net profit before tax for 2018.
(b) Your answer to the following questions posed by the purchasing director of Trayderrs plc:
“Prices are rising all the time and I think we should change our inventory valuation method
from FIFO to LIFO or average cost. What do you think about this? Can we do it?”

24
 Accounting for Non-Current Assets
Problem 31
A company started in business on 1st January 2019. Bought two motor vans for ₤1,200 each
on 1st January 2019. Bought one motor van for ₤1,400 on 1st July 2019.
Required:
Write up the motor vans account and the provision for depreciation account for the year ended
31st December 2019. Depreciation is at the rate of 20 per cent per annum, using the basis of
one month’s ownership needs one month’s depreciation.

Problem 32
A company maintains its fixed assets at cost. Depreciation provision accounts for each asset
are kept. At 31st December 2018 the position was as follows:
Total cost Total depreciation
to date to date
Machinery 52,590 25,670
Office furniture 2,860 1,490
(1) The following additions were made during the financial year ended 31st December 2019:
machinery ₤2,480, office furniture ₤320.
(2) Some old machines bought in 2015 for ₤2,800 were sold for ₤800 during the year.
(3) The rates of depreciation are: machinery - 10 per cent, office equipment - 5 per cent, using
the straight line basis, calculated on the assets in existence at the end of each financial year
irrespective of date of purchase.
Required:
Show the asset and depreciation accounts for the year ended 31st December 2019 and the
statement of financial position entries at that date.

Problem 33
A firm buys a non-current asset for ₤10,000. The firm estimates that the asset will be used for
5 years. After exactly 2½ years, however, the asset is suddenly sold for ₤5,000. The firm
always provides a full year’s depreciation in the year of purchase and no depreciation in the
year of disposal.
Required:

25
(a) Write up the relevant accounts including disposal account but not profit and loss account
for each of Years 1, 2 and 3:
(i) Using the straight line depreciation method (assume 20% p.a.);
(ii) Using the reducing balance depreciation method (assume 40% p.a.);
(b) What is the purpose of deprecation? In what circumstances would each of the two
methods you have used be preferable?
(c) What is the meaning of the net figure for the fixed asset in the balance sheet at the end of
Year 2?
(d) If the asset was bought at the beginning of Year 1, but was not used at all until Year 2 (and
it is confidently anticipated to last until Year 6), state under each method the appropriate
depreciation charge in Year 1, and briefly justify your answer.

Problem 34
A company depreciates its plant at the rate of 20% per year, straight-line method, for each
month of ownership. Details:
2014 bought plant costing 900 on January 1
bought plant costing 600 on October 1
2016 bought plant costing 550 on July 1
2017 sold plant which had been bought for 900 on 1st January 2014 for the sum of 275 on
30th September 2017.
Required:
Draw up:
(a) the Plant account
(b) the Provision for depreciation account
(c) Disposal account
(d) extracts from the statement of financial position at the end of each year.

Problem 35
Explain:
(a) How is the consistency concept applied to depreciation?
(b) Since the calculation of depreciation is based on estimate, why bother to make this
calculation?

26
Problem 36
Edgar Ltd is preparing its financial statements for the year ended 31 December 2018. At 31
December 2017 it had computer equipment that cost £1,004,408, all of which had been
purchased on 1 January 2016, and had accumulated depreciation at 31 December 2017 of
£697,600. Computer equipment is depreciated on a straight line basis with no residual value
over four years and is charged on a monthly basis. A computer system, costing £6,800, was
sold on 1 January 2018 for £1,800. On 1st April 2018 Edgar exchanged a computer part which
had cost £24,000, for a new computer, costing £34,600, paying a cheque in final settlement of
£18,000.
Required:
Show how the computer equipment of Edgar Ltd will be shown in the:
i. Income statement for the year ended 31 December 2018, and
ii. Statement of financial position as at 31 December 2018.

Problem 37
On 1 January 2018 Ay Ltd bought some factory equipment for £100,000. There was no
estimated residual value and the equipment is being depreciated using the decreasing-balance
method at the rate of 20% per year.
At the end of 2020 the market value of the equipment is expected to be £40,000 due to a more
advanced design having appeared on the market. The equipment is as efficient in operation as
originally anticipated and there is no intention of replacing it during the next few years.
Required:
(a) Referring to accounting concepts and to the above information, explain whether or not the
annual charge for depreciation of the equipment needs amending and what the charge for
2020 should be.

Problem 38
Raj Ltd purchased a machine on 1st January 2019 for ₤100,000. Transporting the machine to
its factory cost ₤1,600 and ₤1,000 was spent on installing it. Maintenance of the machine cost
₤750 in 2019 and the expenditure on maintenance increased by ₤200 in each of the following
four years. The machine was expected to last until 31st December 2026 with a scrap (or
residual) value at that date of ₤6,600. The company uses the straight-line method of
depreciation. It provides for a full year’s depreciation in the year of acquisition and none in
the year of sale.

27
The machine was sold for ₤34,000 on 30th June 2023.
Required:
Explain briefly what you understand by the term “depreciation” as used by accountants. In
what circumstances would straight-line be the most appropriate method to use for an asset?
Give the following calculations:
(i) the depreciation charge for 2019;
(ii) the profit or loss on sale of the machine in 2023.

Problem 39
According to a survey of investment analysts, more than half of them believe that all
internally generated intangible assets should be capitalized on a company’s balance sheet.
Discuss the advantages and problems of reporting these assets.

Problem 40
“We live in a society where the real wealth creators are often the intangible assets yet few
companies include these assets in their balance sheets”. Why is this? Explain the issues
involved.

Problem 41
Given that amongst the most significant assets of professional football clubs are its
footballers, it has become more common in recent years for such companies to account for the
cost of players on their balance sheets. Other clubs, however, account for their players as
expenses on their Profit and Loss accounts.
Required:
Express the arguments behind these two alternative treatments, using any principles or
conventions you are applying in your explanation and explaining any terms you use.

Problem 42
The following is an extract from the accounting policies of Manchester United plc (a leisure
company) as reported in its annual report and accounts for the year ended 31st July 2018:
Depreciation
“Depreciation is provided on tangible fixed assets at annual rates appropriate to the estimated
useful lives of the assets, as follows:

28
 Reducing Balance Straight Line
Freehold land Nil Nil
Freehold buildings 1.33% 75 years
Assets in the course of construction Nil Nil
Computer equipment and software 33% 3 years
Plant and machinery 20%-25% 4-5 years
General fixtures and fittings 15% 7 years
“During the year the depreciation method was changed [from reducing balance] to the straight
line basis…”
Required:
(a) Explain briefly what you understand by the two methods of depreciation referred to in the
above extract.
(b) What effect is the change in accounting policy likely to have on the profit and loss account
and the balance sheet?

Problem 43
The annual accounts of Sen Manufacturing Ltd. are being prepared for the year ended 31
March 2019 and the closing trial balance includes the following figures:
£ £
Freehold land and factory buildings 2,800,000
Depreciation of factory buildings at 01.04.18 750,000
Land revaluation reserve 400,000
Plant and machinery at cost 1,900,000
Depreciation of plant and machinery at 01.04.18 1,150,000
Motor vehicles at cost 153,000
Depreciation of motor vehicles at 01.04.18 36,000
The following information has been supplied:
(1) The figure for freehold land and factory buildings comprises land at valuation
(£1,200,000) and buildings at cost (£1,600,000). The land originally cost £800,000 and was
professionally revalued in 2007 and the revaluation reserve created. It was revalued again in
March 2019 and the revised figure of £1,450,000 is to be included in the accounts.
(2) Factory buildings include expenditure in 2018 on constructing a new warehouse
(£220,000), maintenance of buildings (£60,000) and redecoration (£20,000).

29
(3) Factory buildings owned at 31 March 2019 are to be depreciated for the year at 3% of
cost.
(4) Plant and machinery also includes £450,000 being the cost of a machine purchased some
years ago. It had a written down value at 1 April 2018 of £40,000 and was sold on the
following day for £30,000. The proceeds have been debited to cash and credited in error to
sundry income account. No adjustment has been made yet to correct this error.
(5) All plant and machinery owned at 31 March 2019 is to be depreciated for the year at 20%
of cost.
(6) The figure for motor vehicles includes £9,000 paid to Speedy Motors for a new vehicle
costing £17,800 from which was deducted £8,800 for an old vehicle taken in part exchange.
The old vehicle cost £23,000 in April 2015 and three years’ depreciation, using the decreasing
balance method and an annual rate of 30%, is included in the depreciation figure in the trial
balance.
(7) All motor vehicles owned at 31 March 2019 are to be charged depreciation at the rate of
30% using the decreasing-balance method.
Required:
(a) Prepare a table with eight columns using a separate column for each of the seven balances
shown in the trial balance extract and head the final column “Profit”. For each item numbered
from (1) to (8) above, show on the table which of the seven balances needs correcting, and
how (+ or - ), and show the correct balances at 31 March 2019. For each adjustment, show in
the final column by how much the figure of profit for the year will be affected (+ or - ).
(b) Prepare the non-current assets section of Sen Manufacturing Ltd’s statement of financial
position as at 31 March 2019 in good style.
(c) Your answer to the following questions put to you by a colleague:
“What is the purpose of having a land revaluation reserve? Why haven’t the other non-current
assets been revalued?

30
 Accounting for Equity, Capital and Dividends
Problem 44
The balance sheet of C Ltd is as follows:
Assets ₤
Sundry net assets ₤1,200,000
Share capital
₤1 ordinary shares fully paid 400,000
Reserves
General reserve 500,000
Profit and loss account (unappropriated profit) 300,000
₤1,200,000
The directors decide to make a 1 for 5 bonus issue. This will be followed by 1 for 3 rights
issue. Rights shares will be offered at a price of ₤1.60 per share.
Required:
Show the revised balance sheet of C Ltd after both share issues have taken place.

Problem 45
Meta Plc has the following share capital and reserves as at 20th August 2018:
₤
1,500,000 ordinary shares of 25p, each fully paid 375,000
Share premium 225,000
Retained profit 200,000
800,000
The directors resolve to use the reserves to issue fully-paid bonus shares at par in the ratio of
two shares for every three currently held.
Required:
(a) Show the revised “equity and reserves” section of the statement of financial position for
Mera Plc after the above transactions have been carried out.
(b) Assuming that the market value of each share has tended to stay around 50p ex div (i.e.
excluding any dividend expected in the very near future) and the total annual dividend has
been ₤75,000, what would you expect the market price of each share to be after the bonus
issue?

31
Problem 46
At 1.1.2018 Company C's statement of financial position showed the following:
£
Cash 25,000
Share capital 160,000 shares of 25p each 40,000
Share premium 90,000
Revaluation reserve 44,000
Retained profits 57,000
On that day, the company made a rights issue of 60,000 shares at a price of £1.40.
Required:
Show the accounts of Company C after the issue have taken place.

Problem 47
Refer to Problem 46 above. If the market value of each share before the rights issue was
£1.66, other things being equal, what will the market value of each of the old shares and each
of the new shares be after the rights issue?

Question 48
At 1.1.2018, Company D's balance sheet showed the following:
£
Cash 25,000
Share capital 160,000 shares of 25p each 40,000
Share premium 50,000
Revaluation reserve 44,000
Retained profits 57,000
On that day, the company made a 5 for 2 bonus issue.
Required:
Show the accounts of Company C after the transaction.

Problem 49
For the Company D in Problem 48 above, if the market value of each share before the bonus
issue was £1.10, other things being equal, what will the market value of each of the old shares
and each of the new shares be after the bonus issue?

32
Question 50
Company F has 500,000 ordinary shares of 25p each. In the year ended 31.12.2019 the
company paid an interim dividend of 1p per share on 1.4.2019, and on 30.11.2019 the
company declared a final dividend of 3p per share to be paid on 2.4.2020. What is the total
dividend which is to be shown in the Statement of movements in equity for the year ended
31.12.2019?

Question 51
Company G has 1,500,000 ordinary shares of 10p each. In the year ended 31.12.19 the
company paid an interim dividend of 2p per share on 1.8.2019, and on 30.11.2019 the
company declared a final dividend of 5p per share to be paid on 2.2.2020. On 2.8.2020, the
company paid an interim dividend of 2.5p per share. On 1.12.2020, the company declared a
final dividend of 6p per share to be paid on 4.3.2021. What is the total dividend which is to be
shown in the Statement of movements in equity for the year ended 31.12.2020?

Question 52
Company H started business on 1.1.19 and apart from its ordinary shares, it has 1,000,000 6%
redeemable preference shares of £1 each and a £3m 5% loan repayable in 15 years time. The
dividends on the prefs and the interest on the loan is payable each year on 1 July and the
following 1 January.
Required
Calculate are the figures appearing in the Statement of Movements in Equity for dividends
and in the Income Statement for financial expenses for the y/e 31.12.2019.

Problem 53
The following information has been extracted from the Statement of Financial Position of
Shelley plc as at 1 January 2018:
£000
Issued equity shares of 50p each 2,000
Retained earnings 950

There were no other reserves in the Statement of Financial Position as at 1 January 2018.
You are given the following additional information relating to the year ended 31 December
2018:

33
1. The company issued one million equity shares at a price of 75p per share on 1 January
2018.
2. The company made a bonus issue of 1 for 5 ordinary shares on 30 September 2018 utilising
any available share premium.
3. At 31 December 2018, the management have decided to revalue land and buildings that had
a net book value of £400,000 to a value of £600,000.
4. The profit after tax for the year ended 31 December 2018 was £280,000.
5. On 12 February 2018 the company paid the previous year’s final equity dividend of 9p per
share and on 31 July 2018 paid an interim dividend of 2p per equity share. The directors have
proposed a final dividend of 10p on each equity share.
Required:
Prepare a statement of changes in equity of Shelley plc for the year ended 31 December 2018.

Problem 54
Paxton plc had the following share capital and reserves as at 1st May 2017:
£
1,000,000 ordinary shares of £1 each 1,000,000
Retained earnings 1,500,000

The following are transactions relating to shareholders:

1. On 31st July 2017, Paxton plc made a one-for-five rights issue of £1 ordinary shares to its
existing shareholders at £2.50 per share. This issue was fully taken up.
2. On 30th September 2017, Paxton plc made a bonus issue of one for three £1 ordinary shares
to its existing shareholders at that date. The directors of Paxton plc wish to use as little of the
retained earnings as possible in respect of this bonus issue.
3. Retained earnings of Paxton plc for the year ended 30th April 2018 amounted to £500,000.
4. The directors have proposed a final dividend of 10p on each equity share.
Required:
Prepare a statement of movements in equity for Paxton plc for the year ended 30th April 2018.

Problem 55
The S Ltd commenced operations on 1st January 2018. For the first four years the following
results were achieved:

34
 Year ended 31 Trading profit (loss) Profit (loss) on sale Profit on revaluation
December of fixed asset on land use
₤ ₤ ₤
2018 (100,000)
2019 80,000
2020 90,000 30,000
2021 60,000 (10,000) 40,000
Required:
State, for each year, the maximum dividend company could pay (assuming a maximum
dividend is paid whenever possible)

Problem 56
Refer to Problem 55 above. Assume that S Ltd issued 300,000 ₤1 Preference Shares with a
10% fixed rate on dividend at the commencement of business.
Required:
State, for each year, maximum dividend the company could pay its ordinary shareholders if:
(i) the preference shares were non-cumulative, and
(ii) the preference shares were cumulative.

Problem 57
A major international company recently reported the worst results in its century-long history
with a 90% fall in net income and the chairman was reported to be worried about keeping his
job. However, the total dividend proposed for the year was 4% up on the previous year’s.
Required:
Give possible reasons for the dividend increase. How would you check whether the increase
is legal?

Problem 58
Wonda plc. has an issued share capital of two million ₤1 shares. The directors are considering
whether the company should buy back and cancel 10% of its issued share capital at the
current market price of 220 pence per share.
(i) Why would the directors of a company like Wonda plc. wish it to buy back and cancel
some of its shares?
(ii) How do you consider the buyback should be reflected in the balance sheet of Wonda plc.?

35
(iii) Would you expect the share price of Wonda plc. to remain at 220 pence after the share
buyback? Explain your answer.

Problem 59
“This is certainly the record dividend payment of the year: O’Mara plc is paying 75 pence for
each ₤1 share! It represents 80% of the company’s earnings for the year. Even the big banks
are not that generous!”
Required:
Comment on the above quotation which has been adapted from an article in a national
newspaper and explain whether you consider that the company has necessarily been generous
to its shareholders. Specify what further information you would need for your answer, if any,
and what use you would make of it.

Problem 60
Your aunt has held 1,000 ordinary shares in a quoted company for several years. She has very
little understanding of financial matters. She has asked you to write her a short note to explain
the following:
(1) why the company has only paid a dividend of approximately 30% of the profit after tax;
(2) why the company is making a 1 for 1 scrip (or bonus) issue and what effect this is likely to
have on the market value of each share.
Required:
Explain to your aunt:
(a) the factors which determine a company’s dividend;
(b) the purpose, the effect on the balance sheet and the effect on the market value of each
share of a 1 for 1 scrip issue.

Problem 61
In a recent article on a leading engineering company, a financial journalist drew attention to
the fact that, according to its recent balance sheet, the net asset value per share was £4.15 yet
the company’s ordinary shares had been quoted on the stock exchange at around £7.80 for the
past few months.
Required:
Give reasons that might explain why the two figures are different.

36
Problem 62
The country of Yugalia has experienced a financial crisis over the past year and, for the
typical company, share price has been below net asset value per share yet the company has
reported a profit.
Required:
Do these apparent anomalies necessarily imply that there is something wrong with financial
reporting in Yugalia? Explain the issues involved.

Problem 63
Wizz.com, an online consumer information provider, has seen its share price treble in value
over the past eight months. It has been in business for five years and has never earned a profit.
Last year’s pre-tax loss was £32 million on a turnover of £23 million.
Required:
How can the shares of a company with such a poor profitability record and a negative
price/earnings ratio be in such demand?

37
 Cash Flow Statement
Problem 64
Roseanne owns shares in Inchem plc, a large chemicals company with world-wide interests,
and she is worried because the share price has shown a downward trend over the past two
years. Roseanne has asked you to explain what the cash flow statement can tell her about the
company’s progress and current position.
She has supplied you with the following information taken form Inchem’s recent annual
reports:
Cash flow statement for the year ended 31st December
2018 2019
£m £m
I. Cash Flow from operating activities
Operating profit 378 405
add: Depreciation 434 402
add: Decrease in inventory 18 62
less: Increase in receivables (31) (86)
less/add: Decrease/increase in payables (42) 223
Cash generated from operations 757 1,006
Interest paid (171) (356)
Taxation paid (151) (126)
Net cash from operating activities 435 524
II. Cash Flow from investing activities
Payments to acquire non-current assets (623) (935)
Payments to acquire subsidiaries (4,366) (234)
Proceeds from disposal of subsidiaries 2,124 74
Net cash used in investing activities (2,865) (1,095)
III Cash flow from financing activities
Equity dividends paid (ordinary shares) (225) (225)
Increase/decrease in long-term liabilities 2,937 (50)
Net cash used in financing activities 2,712 (275)
Net cash inflow/outflow for the year 282 (846)

Required:
(a) An analysis of the above figures to assist Roseanne in understanding Inchem plc’s
financial performance in 2019 and its financial position at the year end. Indicate what
additional information you require to help you with your analysis and what use you would
make of it.
(b) Explain to Roseanne what use published financial reports are in explaining share price
movements and indicate what other information might be useful.

38
Problem 65
C Willis
Income Statement for the year ended 31st December 2018
£ £
Gross profit 29,328
Add Discounts received 298
Add Profit on sale of motor van 570 868
30,196
Less Expenses
Motor expenses 1,590
Wages 8,790
General expenses 2,144
Bad debts 340
Increase in bad debt provision 120
Depreciation: Motor van 1,090 14,074
16,122
Statement of Financial Position as at 31st December
2017 2018
£ £ £ £
Non-current assets
Motor vans at cost 11,200 7,200
Less Depreciation to date 4,160 7,040 2,980 4,220
Current assets
Stock 10,295 17,150
Debtors less provision* 5,190 3,380
Bank 1,568 2,115
17,053 22,645
Current liabilities
Creditors 2,770 14,283 2,920 19,725
21,323 23,945
Long-term liability
Loan form P Bond 6,000 5,000
15,323 18,945

39
 Capital
Opening balance b/d 12,243 15,323
Add Net profit 14,080 16,122
26,323 31,445
Less Drawings 11,000 15,323 12,500 18,945

* Debtors 2017 £5,490 – provision £300

Debtors 2018 £3,800 – provision £420.
Note: The motor van was sold for £2,300 during 2018.
Required:
Draft a cash flow statement for C Willis for the year ended 31st December 2018

Problem 66
The directors of Alexay plc are concerned about the substantial increase in the company's
bank overdraft in 2019.
The summarised balance sheets of the company at 31st December were:
2018 2019
£000 £000
Non-current assets (net of depreciation) 1,315 2,090
Current assets
Stock at cost 290 670
Trade debtors 385 675 610 1,280
Total assets 1,990 3,370

Current liabilities
Bank overdraft 72 440
Trade creditors 345 210
Corporation tax 185 602 275 925
Long-term liabilities 290 480
Share capital and reserves
Issued share capital (1£ shares) 520 620
Share premium 330 380
Revaluation reserve for land - 500

40
 Profit and loss account 248 1,098 465 1,965
Total liabilities and equity 1,990 3,370

The summarised income statement for Alexay plc for the year ended 31st December 2019
was:
£000
Sales 3,900
Cost of sales 2,600
Gross profit 1,300
Administration expenses 460
Depreciation 115
Interest payable 59 634
Net profit before corporation tax 666
Corporation tax 170
Net profit after corporation tax 496
Dividends 279
Retained profit for the year 217

No fixed assets were disposed of during the year ended 31st December 2019.
Required:
(a) Calculate the net cash flow from operating activities for 2019.
(b) Prepare a cash flow statement in good style for 2019.
(c) Calculate and comment on the following for 2019:
(i) current ratio
(ii) gearing ratio
(iii) interest cover
(d) Reply to the following queries put to you by one of the directors of Alexay plc:
"Can you please explain to me how we have a healthy profit yet our bank overdraft has
reached a record level? Surely there must be something wrong with the profit calculations,
isn't there?"

Problem 67
The balance sheets of R Lester are as follows:

41
 31.12.2018 31.12.2019
£ £ £ £
Non-current assets
Equipment at cost 28,500 26,100
Less Depreciation to date (11,450) 17,050 (13,010) 13,090
Current assets
Stock 18,570 16,250
Debtors 8,470 14,190
Less Bad debts provision (420) (800)
Cash and bank balances 4,060 30,680 3,700 33,340
Total Assets 47,730 46,430
Current liabilities
Creditors 4,140 5,730
Loan from J Gorsey 10,000 4,000
Capital
Opening balances b/d 35,760 33,590
Add Net profit 10,240 11,070
Add Cash introduced _____ 600
46,000 45,260
Less Drawings (12,410) 33,590 (8,560) 36,700
Total Liabilities and Capital 47,730 46,430
Notes: Equipment with a book value of £1,350 was sold for £900. Depreciation written off
equipment during the year was £2,610.
Required:
Prepare a cash flow statement for R Lester for the year ended 31st December 2019.

Problem 68
The following are the financial statements of Eccles Foods plc for the two years ended 31st
March 2009 and 2010:

Statement of Financial Position as at 31st March 2020 2019

£m £m
Non-current assets

42
 Tangible 431 410
Intangible 19 23
Investments 82 532 64 497
Current assets
Inventories 482 401
Debtors 290 251
Cash 3 775 7 659
Total Assets 1,307 1,156
Creditors falling due within 1 year 422 367
Creditors falling due after 1 year
Loan stock 181 181 213 213
Equity and reserves
Called-up share capital of £1 each 385 247
Share premium account - 50
Retained earnings 319 704 279 576
Total Liabilities and Equity 1,307 1,156

Income Statement for the year ended 31st March

2020 2019
£m £m
Turnover 1,240 990
Cost of sales (902) (704)
Gross profit 338 286
Distribution costs (98) (81)
Administrative expenses (73) (56)
Operating profit 167 149
Net interest paid (3) (9)
Exceptional item (4) __
Profit before taxation 160 140
Taxation (90) (80)
Profit after taxation 70 60
Dividend paid (30) (20)
Retained profit for the year 40 40

43
The following further information is available:
(1) Tangible fixed assets:
Cost Accumulated Net
Depreciation
£m £m £m
As at 1st April 2019 621 211 410
Additions, at cost 82 82
Disposals (30) (13) (17)
Depreciation for the year ___ 44 (44)
As at 31st March 2020 673 242 431
The assets were disposed of cash proceeds of £10 million. Any profit or loss arising is
included in operating profit for the year.
(2) Intangible fixed assets:
The value of goodwill has fallen during the year and the resulting write down of book value
was treated as an exceptional item in the profit and loss account.
(3) Fixed asset investments:
Additional shares were purchased for cash. No other changes occurred during the year. The
interest received during the year on these investments was £5 million, this amount is included
in net interest paid.
(4) Creditors falling due within one year are as follows:
2020 2019
£m £m
Trade 110 130
Taxation 90 80
Bank overdraft 222 157
422 367
(5) On 1st May 2019 80 million £1 ordinary shares were issued at £1.10 each. On 1st October
2019 the share premium account was utilized in making a bonus issue of ordinary shares.
Required:
(a) Prepare a cash flow statement for Eccles Foods plc for the year ended 31st March 2020
(b) “A cash flow statement provides information on the financial performance of a company
which is not immediately available from the balance sheet or profit and loss account”.
Identify two such items from the cash flow statement of Eccles Foods plc and explain how
they illustrate the above statement.

44
Problem 69
Extracts from the financial statements for Titania Ltd for the year ended 31 March 2016 are as
follows:
Statement of profit or loss for the year ended 31 March 2016
£
Profit from operations 819,640
Finance costs (89,600)
Profit before tax 730,040
Income tax (245,700)
Profit for year 484,340

Statements of financial position at 31 March 2016 2015

£ £
Non-current assets
Property, plant and equipment 982,600 797,500
Intangible assets 580,040 386,900
Current assets
Inventories 430,040 285,550
Trade receivables 342,700 224,150
Government bonds 40,000 10,000
Cash 37,470 3,800
Total assets 2,412,850 1,707,900
Equity share capital (£1 shares) 312,400 232,800
Share premium 398,200 351,000
Retained earnings 534,800 282,100
Non-current liabilities
Borrowings 567,400 423,000
Preference shares 75,000 -----
Current liabilities
Borrowings 115,600 51,000
Bank overdraft 51,200 27,230
Tax payable 201,800 192,520
Trade payables 146,700 135,900

45
 Accrued interest 9,750 12,350
Total equity and liabilities 2,412,850 1,707,900

Additional Information
1. Included in profit from operations is a loss of £84,810 in respect of the disposal of
machinery in the year. This machinery had a net book value of £127,800 at the disposal date.
All additions were paid for in cash.
2. The depreciation charge on property, plant and equipment for the year was £232,900.
3. Intangible assets costing £251,340 were purchased for cash during the year. Intangible
assets with a carrying amount of £17,000 were sold for £24,000 during the year. The profit on
disposal has been offset against operating costs. An impairment review at 31 March 2016
identified a fall in the recoverable amount of intangible assets. As a result, an impairment loss
of £20,000 was identified and written off to administrative expenses. Amortisation has been
charged against profit from operations.
4. On 1 April 2015 Titania Ltd made a one for ten bonus issue from share premium. A further
share issue took place in December 2015 for cash.
5. Titania Ltd declared and paid a dividend during the year.
6. Redeemable preference shares in the amount of £75,000 were issued for cash during the
year.
7. The government bonds are highly liquid and management has decided to class them as cash
equivalents.
Required:
Prepare a Statement of Cash Flows for Titania for the year ended 31 March 2016 showing
operating cash flows using the indirect method.

Problem 70
Dolente Ltd is a small company which designs, manufactures and sells innovative electronic
instruments. The directors of the company have discussed the financial statements prepared
for the year ended 31st March 2020 and have made the following remarks.
“We are surprised to see that we have a loss for the year as our bank balance seems to be
healthy and has increased from the 2019 figure”.
The following are the financial statements of Dolente Ltd for the two years ended 31st March
2020.

46
 2020 2019
Statement of Financial Position as at 31st March £000 £000 £000 £000
Non current assets
Tangible 862 820
Intangible 134 996 128 948
Current assets
Inventories 520 488
Trade debtors 280 302
Prepayments 38 46
Bank 306 1,144 214 1,050
Total Assets 2,140 1,998

Creditors falling due within 1 year 800 820

Creditors falling due after 1 year
Loans 462 462 426 426
Equity and reserves
Ordinary shares of £1 each 700 600
Share premium 90 50
Retained earnings 88 878 102 752
Total Liabilities and Equity 2,140 1,998

Income Statement for the year ended 31st March

2020
£000
Turnover 2,480
Cost of sales (2,004)
Gross profit 476
Distribution costs (290)
Administrative expenses (134)
Operating profit 52
Interest payable (46)
Exceptional items (20)
Loss before taxation (14)

47
 Taxation -
Loss for the year (14)

The following further information is available:

(1) Tangible non-current assets:
Cost Accumulated Net
depreciation
£000 £000 £000
As at 1st April 2019 1,242 422 820
Additions, at cost 164 164
Disposals (60) (26) (34)
Depreciation for the year 88 (88)
As at 31st March 2020 1,346 484 862
The assets were sold for cash proceeds of £10,000. Any profit or loss arising is included in the
operating profit for the year.
(2) Intangible non-current assets: These are patents on innovative electronic instruments.
£000
As at 1st April 2019 128
Purchases 40
Amortization (in operating profit) (14)
Exceptional write down (20)
As at 31st March 2020 134
(3) Prepayments all relate to expenses charged against operating profits.
(4) Creditors falling due within one year
2020 2019
£000 £000
Trade creditors 786 650
Accrued interest 14 10
Taxation - 160
800 820
(5) On 1st May 2019 100,000 £1 ordinary shares were issued at £1.40 each.
Required:
(a) Prepare a cash flow statement for Dolente Ltd for the year ended 31st March 2020.

48
(b) Using the information provided by the cash flow statement, comment on the remarks of
the directors on the results for the year.

49
 Ratio analysis
Problem 71
Karen has been told that Wahib & Wills plc is a fast growing company and she seeks your
advice on whether or not to buy shares in the company. She has provided you with the
following summarized information taken from the recent annual accounts of Wahib & Wills
plc:
Profit and loss account ₤000
Turnover 7,200
Gross profit 2,160
Net profit 300
Dividend 150
Balance sheet
Fixed assets 2,680
Stock 360
Trade debtors 240
Cash at bank 200
Trade creditors 840
Share capital (₤1 shares fully paid) 2,400
Profit and loss account 240
The share price of Wahib & Wills plc is currently 160 pence and it has been around this level
for the past few months.
The trade association to which Wahib & Wills plc belongs compiles statistics taken from the
annual accounts of its members, and from other sources, and you have obtained the following
recently prepared data which give the industry average for seven statistics as:
Gross profit margin 50%
Current ratio 2.54
Quick (liquid) ratio 1.87
Debtors collection period (days) 28
Stock holding period (days) 36
Trade credit period (days) 54
Price/earnings ratio 10

Required:

50
(a) Compute comparable ratios to those listed above for Wahib & Wills plc. All calculations
must be clearly shown.
(b) Make use of your calculations in (a) above to comment on the firm’s financial position.

Problem 72
The chairman of Badwa plc, which owns a chain of hotels, is concerned about recent
comments in the financial press to the effect that the company is too highly geared. The
following figures appear in the company’s recent balance sheet:
₤
Called up share capital 1,000,000
Share premium account 4,800,000
Profit and loss account 6,100,000
8% Debentures 13,990,000
Total assets less current liabilities 25,890,000
The chairman feels that the accounts do not portray the company’s true financial position. In
particular, he makes the following points:
(1) The company’s freehold property was bought five years ago for ₤18 million which is also
its current book value. The market value is now ₤32 million.
(2) The reputation of Badwa plc is as asset in itself. Customers are attracted to the hotels
because of their reputation for quality and service. The chairman reckons that the reputation
must be worth at least ₤13 million.
(3) Stock includes ₤400,000 for fine wines at cost; their current replacement cost is ₤600,000.
(4) Amongst the fixtures and fittings are works of art that cost ₤1,200,000 and whose book
value is ₤300,000. They are currently worth ₤1,000,000.

Required:
(a) Give reasoned arguments to indicate what values you would like to see in the balance
sheet of Badwa plc for each of the four items referred to above. If any are controversial,
explain why this is so.
(b) Redraft the balance sheet extract incorporating you suggestions in (a) above and calculate
the gearing ratio before and after any changes you have made.
(c) Is high gearing necessarily a bad thing? Do you consider that increasing asset values in a
balance sheet is likely to lead to less criticism by the financial press of a company’s gearing?
Explain your reasoning carefully.

51
Problem 73
Although MX plc. has a large cash balance, it offered its shareholders the choice of whether
to have the final dividend for the year ended 31st March 2019 in shares (a scrip dividend) or in
cash. The majority opted for shares and the necessary accounting entries were made in the
published accounts for 2019.
Required:
For each of the following ratios, state whether it is higher, lower or unchanged as compared
with ratios calculated to reflect a 100% cash dividend and explain briefly why this is so.
(a) Return on shareholders’ equity
(b) Return on net assets
(c) Current ratio
(d) Creditors turnover ratio
(e) Gearing ratio
(f) Dividend cover.

Problem 74
The summarized balance sheet of G Ltd is given below:
Total assets less current liabilities 2,300
Financed by:
Share capital, 25p shares 400
Share premium account 360
Revaluation reserve 300
Profit and loss account 440
10% debenture loan, 2006 800
2,300
Required:
Explain briefly the nature of the share premium account and how it arises, and calculate the
following:
(i) the company’s gearing ratio
(ii) the maximum dividend per share that company could legally declare assuming that it has
sufficient cash.

Problem 75
The following statistics relates to Gandee plc for 2018:

52
 Profit before interest and tax £120,000
Retained profit for the year £20,000
Dividend for the year £19,200
Interest cover 5
Dividend cover 4
Required:
What was the tax charge for 2018? Give three possible reasons why the directors of Gandee
plc have chosen not to distribute all the after tax profit of the year as dividend.

Problem 76
The following information relates to two companies in the same industry whose financial year
end is the same:
Cax plc Dox plc
Profit before interest and tax ₤1,680,000 ₤1,680,000
Operating profit margin 10.50% 16.00%
Return on net assets ? 12.00%
Asset turnover ratio 1.6 ?
Required:
Calculate the return on net assets for Cax plc and the asset turnover ratio for Dox plc. Give
possible reasons for the differences in the three ratios for the two companies.

Problem 77
Company A B C
₤000 ₤000 ₤000
Ordinary shares 600 400 50
12% debentures ___ 200 550
600 600 600
The return on capital employed was 20 per cent for each firm in 2018 and in 2019 was 10 per
cent. Corporation tax in both years was assumed to be 55 per cent, and debenture interest is as
allowable expense against corporation tax.
Required:
(a) Calculate the percentage return on the shareholders’ capital for each company for 2018
and 2019. Assume that all profits are distributed.
(b) Use your answer to explain the merits and the dangers of high gearing.

53
Problem 78
Adrian Frampton was considering the purchase of one of two businesses. However Frampton
had only been provided with limited information about the businesses, as follows:
Summarised financial information for the year ended 31st December 2018:
Business Business
X Y
Cost of goods sold ₤400,000 ₤600,000
Administrative expenses ₤50,000 ₤60,000
Average stock at cost ₤40,000 ₤50,000
Working capital as at 31st December 2018 ₤90,000 ₤250,000
Selling and distribution expenses ₤15,000 ₤35,000
Proprietor’s capital at 1st January 2018 ₤200,000 ₤350,000
Gross profit percentage mark-up on cost 20 25

Additional information:
(1) Average stock had been calculated by using the year’s opening and closing stocks.
Subsequently it was discovered that Business Y had overvalued its stock on 31st December
2018 by ₤10,000.
(2) Business X’s administrative expenses included a payment for rent of ₤15,000 which
covered a three-year period to 31 December 2020.
(3) A sum of ₤2,500 was included in the administrative expenses of Business Y in respect of a
holiday taken by the owner and his family.
(4) Cash drawings for the year ended 31 December 2018 were:
₤
Business X 20,000
Business Y 25,000
(5) The owners of the businesses had stipulated the following prices for their businesses:
₤
Business X 190,000
Business Y 400,000
Required:
(a) Based on the information available prepare comparative income statement for the year
ended 31st December 2018.

54
(b) Using the information provided and the accounting statements prepared in (a), calculate
relevant accounting ratios in order to give Frampton a basis for assessing the performances of
the two businesses. Comment on the results.
(c) What additional information is needed in order to assess more accurately
(i) the liquidity of the businesses
(ii) the future prospects of the businesses?

Problem 79
The following balances remained in the accounts of Durham Limited after the income
statement had been prepared for the year ended 30th April 2019:
Dr Cr
₤ ₤
Premises at cost 86,000
General reserve 4,000
Ordinary shares of ₤1 each 100,000
8% Preference shares of 50p each 50,000
Electricity 100
Cash at bank 12,100
Profit and loss account balance 1st May 2018 14,500
Accounts receivable and payable 20,000 12,900
Profit before interest and tax (year ended 30th April 16,500
2019)
Machinery and plant at cost 60,000
Provision for depreciation on machinery and plant 40,000
Inventory 60,000
Interim dividend paid 1,000
Provision for doubtful debts 4,000
Insurance 900
Preference share dividend paid 2,000
242,000 242,000

The Directors have recommended:

(1) a transfer of ₤5,000 to general reserve;
(2) a final ordinary dividend of ₤0.15p per share; and

55
(3) a provision for the unpaid preference share dividend.
Required:
(a) Redraft the income statement for year ended 30th April 2019 (from the line «profit before
interest and tax» to the line «profit after tax».)
(b) Prepare the statement of changes in equity for the year ended 30th April 2019.
(c) Prepare the statement of financial position as at 30th April 2019, in a form which shows
clearly the shareholders’ funds.
(d) Identify and calculate:
(i) one ratio indicating the firm’s profitability;
(ii) two ratios indicating the firm’s liquidity position.
(e) Make use of your calculations in (d) above to comment on the firm’s financial position.
(f) Name two points of comparison which are not available from the information above in this
question but which could make your comments in (e) above more meaningful.

Problem 80
The summarised accounts of Hope Ltd for the year 2018 and 2019 are given below:
Income Statement for the year ended 31 December
19X8 19X9
₤000 ₤000
Sales 200 280
Less Cost of sales 150 210
Gross profit 50 70
Less
Administration expenses 38 46
Debenture interest _ 4
Net profit 12 20

Statement of financial position as at 31 December

2018 2019 2018 2019
₤000 ₤000 ₤000 ₤000
Ordinary share capital 100 100 Non-current assets, at cost
Retained profit 30 41 Less Depreciation 110 140
8% Debentures 50

56
Accounts payable 15 12 Inventory 20 30
Bank 10 Accounts receivable 25 28
_ _ Bank _ 5
155 203 155 203
Inventory at 1st January 2019 was ₤50,000.
Required:
(a) Calculate the following ratios for 2018 and 2019:
(i) Gross profit maigin
(ii) Stock turnover
(iii) Net profit margin
(iv) Quick (‘acid test’)
(v) Working capital
(vi) Net profit : Capital employed
(b) State the possible reasons for and significance of any changes in the ratios shown by your
calculations.

Problem 81
Answer the following questions put to you by a friend:
“Do you think the shares in Rahman and Shah plc are worth buying at the present price of 150
pence? I see from the balance sheet that the net assets per share are 220 pence. Why are the
two figures different?”

57
 Control accounts
Problem 82
On 30th April 2019 the closing balance on the creditors control account of Dyson Ltd is
₤2,900. The total of the list of balances from the creditors ledger is ₤3,990. Further
investigation reveals the following errors:
(1) An invoice of ₤600 for goods purchased was included in the creditors ledger but was not
recorded in the purchases day book.
(2) A cash payment of ₤400 to a supplier recorded in the cash book was not recorded in the
creditors ledger.
(3) A cash payment of ₤560 was correctly recorded in the creditors ledger but was recorded as
₤650 in the cash book.
(4) An invoice for ₤250 was not recorded in either the purchase day book or the creditors
ledger.
Required:
Show the corrected total of the list of creditors ledger balances and the corrected balance on
the creditors control account at 30th April 2019.

Problem 83
Jefferson Limited finalised its accounts for the year ended 31st December 2016, reporting a
net profit for the year of £348,600 and a balance at the bank at 31st December 2016 of
£79,800. However the bookkeeper has failed to balance the trial balance and has placed the
difference in a suspense account. He did not produce a bank reconciliation as at 31st
December 2016.
Further enquires revealed the following:
i. Bank charges of £1,600 and dividend income of £3,600 had not been entered into the books.
ii. A cheque received from a customer for £11,600 had been posted in error to the sales
account as £1,160.
iii. Cheques entered into the books before 31st December 2016 for payments to suppliers of
£12,900 did not appear on the bank statements until January 2017.
iv. A cheque for £2,600 for motor repairs had been accidentally destroyed and a replacement
cheque issued. The only entries made in this connection were posting of both cheques in the
cashbook and motor expenses account.
Required:

58
(a) Calculate the corrected profit for the year ended 31 December 2016 and the bank balance
to be shown in the balance sheet as at 31 December 2006 after taking account of the above.
(b) Prepare a bank reconciliation statement as at 31st December 2016.

Problem 84
Waits opened a business bank account with ₤16,000 on 1st April 2019. During April he issued
cheques totaling ₤72,760 and banked cheques totaling ₤80,060. These transactions were
entered into his cash book up to 30th April 2019. On receiving his bank statement for April he
discovered the following:
(1) A cheque for ₤4,800, which was banked (and included in the receipts above), had been
returned by the bank marked “No funds available”. No adjustment has been made in the cash
book.
(2) Bank charges debited on the bank statement for April amounted to ₤600. No entries for
these have been made in the cash book.
(3) Cheques totaling ₤16,860 recorded in the cash book and sent to suppliers were not
presented to the bank until May 2019.
(4) Cheques totaling ₤12,100 had been entered into the cash book but not credited by the bank
until May 2019.
Required:
Calculate the corrected bank balance which should appear in the business cash book at 30th
April 2019 and prepare a bank reconciliation statement at 30th April 2019.

Problem 85
Miss Leung runs a business selling holidays. At 31 January 2020, the balance on the creditors
control account was $8,700. The total of the list of balances in the creditors ledger was
$11,720. The following information has come to light:
(i) an invoice of $750 was not recorded in the purchase day book
(ii) a cash payment of $1,680 was correctly recorded in the cash book but was recorded as
$1,860 in creditors ledger.
(iii) A cash payment of $1,200 to a supplier was recorded in the cash book but was not
recorded in the creditors ledger.
(iv) A credit note for a price reduction from a supplier of $1,800 was recorded in the purchase
day book but not recorded in the creditors ledger.

59
(v) In January, the company paid a refund of $200 to a customer for a price reduction. This
was wrongly treated as a payment to a supplier and entered in the Creditors Control Account.
Required:
Show the corrections to the:
(a) list of creditors ledger balance at 31 January 2020 and
(b) creditors control account at 31 January 2020.

Problem 86
In the books of Beveridge Ltd the creditors ledger control account shows as at 31st December
2017 a credit balance of £321,700. The list of individual creditors’ balances extracted from
the creditors ledger on the same date shows credit balances totaling £330,800. The following
errors have been identified since then:
(1) A debit balance of £1,700 in a supplier’s account has been listed in error as a credit
balance.
(2) A credit note received from a supplier for £3,600 is still to be accounted for.
(3) A cash payment to a supplier of £250 was correctly recorded in the cash book but was
entered as £520 in the creditors ledger.
(4) An invoice for £600 recorded in the purchases day book was not recorded in the supplier’s
account in the creditors ledger.
(5) A returns outwards day book page has been totalled as £43,000 instead of £40,000.
(6) The remainder of the errors arose from the failure to post a payment to a supplier’s
account.
Required:
(a) Calculate the corrected creditors ledger control account balance, and,
(b) reconcile this with the total of the individual creditors’ balances in the creditors ledger.

Problem 87
In preparing the trial balance, you notice that the debit side exceeds the credit side by $970.
Upon investigation, you identify the following mistakes:
(1) Goods returned to suppliers amounts to $250 have been entered as a debit in the goods
returns outward account by mistake.
(2) A cash payment for $560 has been entered in the cash book as $650.
(3) A computer purchased for $2,000 as at office machine has been entered as debit in the
purchases account.

60
(4) A credit note for $220 given to a customer has been credited twice in the customer’s
account.
(5) A cheque for $780 from a customer has been entered in the cash book and subsequently
banked before the year end. However, no other entry has been made to the customer’s
account.
Required:
Explain how each of the above mistakes should be dealt with by means of a suspense account.

61
 Introduction to Costing
Problem 88
Porter company manufactures a number of furniture products. The accountant of the company
unfortunately is on vacation. There is a need to prepare the data for cost analysis and
planning. Selected costs are given below. You are just appointed for internship in accounting
department and asked for help.
(a) Wood is used in the manufacturing of the tables at a cost of £100 per table.
(b) The tables are assembled by workers, at a cost of £40 per table.
(c) Workers assembling the tables are supervised by a factory supervisor who is paid £25,000
per year.
(d) Electrical costs of £2 per machine-hour are incurred in the factory in the manufacturing
department. Four machine-hours are required to produce the table.
(e) The depreciation cost of the machines in the manufacturing department totals to £10,000
per year.
(f) The salary of the president of Porter is £100,000 per year.
(g) Porter spends £250,000 to advertise its products.
(h) Salespersons are paid at a commission of £30 for each table sold.
(i) Instead of producing the tables, Porter could rent its factory space out at a rental income of
£50,000 per year.
Required:
Fill in the table below.
Item VC FC Period Direct Direct Manufac. Direct Indirect Sunk Opportunity
Material Labour Overheads
(a)
(b)

Problem 89
The following information has been taken from the ledger accounts of Klear-Seal Company
for the year ended December 31, 2018:
$
Selling expenses 140,000
Raw materials inventory, January 1 90,000
Raw materials inventory, December 31 60,000

62
Utilities, factory 36,000
Direct labor cost 150,000
Depreciation, factory 162,000
Purchases of raw materials 750,000
Sales 2,500,000
Insurance, factory 40,000
Supplies, factory 15,000
Administrative expenses 270,000
Indirect labor 300,000
Maintenance, factory 87,000
Work in process inventory, January 1 180,000
Work in process inventory, December 31 100,000
Finished goods inventory, January 1 260,000
Finished goods inventory, December 31 210,000
Management wants to organize these data into a better format so that statements can be
prepared for the year.
Required:
(a) Prepare a schedule of cost of goods manufactured for 2018.
(b) Compute the cost of goods sold for 2018.
(c) Using data as needed from (a) and (b), prepare an income statement for 2018.

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 Job-Order Costing
Problem 90
Hogle Company is a manufacturing firm that uses job-order costing. On January 1, 2018, the
company’s inventory balances were as follows:
$
Raw materials 20,000
Work in process 15,000
Finished goods 30,000
The company applies overhead cost to jobs on the basis of machine-hours worked. For 2018,
the company estimated that it would work 75,000 machine-hours and incur $450,000 in
manufacturing overhead cost. The following transactions were recorded for the year:
(a) Raw materials were purchased on account, $410,000.
(b) Raw materials were requisitioned for use in production, $380,000 ($360,000 direct and
$20,000 indirect).
(c) The following costs were incurred for employee services: direct labor, $75,000; indirect
labor, $110,000; sales commissions, $90,000; and administrative salaries $200,000.
(d) Sales travel costs were incurred, $17,000.
(e) Utility costs were incurred in the factory, $43,000.
(f) Advertising costs were incurred, $180,000.
(g) Depreciation was recorded for the year, $350,000 (80 percent relates to factory operations,
and 20 percent relates to selling and administrative activities).
(h) Insurance expired during the year, $10,000 (70 percent related to factory operations, and
the remaining 30 percent relates to selling and administrative activities).
(i) Manufacturing overhead was applied to production. Due to greater than expected demand
for its products, the company worked 80,000 machine-hours during the year.
(j) Goods costing $900,000 to manufacture were completed during the year.
(k) Goods were sold on account to customers during the year at a total selling price of
$1,500,000. The goods cost $870,000 to manufacture.
Required:
(a) Prepare journal entries to record the transactions above.
(b) Post the entries in (a) to T-accounts (don’t forget to enter the opening balances in the
inventory accounts).

64
(c) Is Manufacturing Overhead underapplied or overapplied for the year? Prepare a journal
entry to close any balance in the Manufacturing Overhead account to Cost of Goods Sold.
(d) Prepare an income statement for the year.

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 Allocation of overheads: Traditional Approach
Problem 91
Dinghy Products Ltd makes two products, masts and booms. There are two production
departments, Turning and Finishing. There is also a sales administration office and a
storeroom for parts and materials. The following information is available.
Turning Finishing Office Storeroom
Floor space (m²) 300 150 10 40
Issues of parts and materials per month 20 5
Direct labour hours per mast 3 4
Direct labour hours per boom 4 3
The following are the budgeted output and costs for a month:
Output of masts 200
Output of booms 800
Factory rent £1,000
Salary of storeman (all storeroom costs) £1,300
Salary of office clerk (all office costs) £1,500
There are the only indirect costs of production and a direct labour hour basis of absorption
should be used for the two production departments.
Required:
Calculate the indirect cost of producing a mast and a boom.

Problem 92
The following information is available for a factory which houses the assembly, finishing and
machining departments:
Assembly Finishing Machining
Department Department Department
Floor areas 40,000 sq ft 35,000 sq ft 25,000 sq ft
Number of employees 150 100 50
NBV of machines $1,800,000 $1,200,000 Nil
During the month of January 2007, the factory incurred the following indirect overheads:
Rent $50,000
Heating and Electricity $25,000
Indirect labour $70,000

66
The management have decided to allocate the above indirect overheads using the following
bases: floor areas for both rent and heating and electricity, and number of employees for
indirect labour cost.
As the machining department’s task is to look after the machines in the assembly and
finishing department, the management feel that it should be re-allocated to the assembly and
finishing department based on the NBV of machines.
Required:
Calculate the allocation overheads to the assembly and finishing departments based on the
information available above.

Problem 93
The indirect costs incurred by the business on behalf of all departments taken together are
given below:
Cost item Total cost
this month,
£
Indirect materials 36,000
Indirect labour 40,000
Rent 1,000
Insurance 1,600
Depreciation 2,000
Total 80,600
The costs must be apportioned (shared) over the departments because there is insufficient
information to permit allocation of costs as a whole. The following table sets out relevant
information about each department which will be used in the process of determining an
overhead cost rate:
Assembly Finishing Maintenance
Direct materials used for production £400,000 £500,000 not applicable
Number of employees 10 25 5
Floor area 100 sq m 200 sq m 100 sq m
Value of machinery £30,000 £50,000 £20,000
Number of direct labour hours 55,000 64,000 not applicable
worked on production
Required:

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Calculate the overhead cost allocated to the product. Suppose to produce the product you need
to spend 2 hours in assembly department and 3 hours in finishing department.

Problem 94
Bannock plc manufactures satellite navigation systems. The manufacturing facility has three
departments. Departments A and B are production and Department C is a service support
department. Bannock plc operates a full absorption costing system.
The following data relates to the month of June:
1. Overheads are allocated on the following basis.
Overhead Allocation basis Cost for June, £
Supervisors salaries Number of employees 250,000
IT Support staff cost Number of employees 180,000
Property rent Floor area 160,000
Plant depreciation Plant cost 210,000
Maintenance Actual spend 40,300

2. Relevant data
Dept A Dept B Dept C
Employees (Number) 50 150 50
Floor area (sq.m) 10,000 6,000 4,000
Plant costs (£) 300,000 100,000 -
Maintenance spend (£) 28,000 12,300 -
Direct labour hours 30,000 200,000 -
Machine hours 100,000 40,000 -

3. Department C works approximately 60% for Department A and 40% for Department B.
4. Hourly overhead absorption rates are based on either direct labour hours or machine hours
depending on which is larger for each department.
5. The top-range satnav system provided by Bannock has total direct costs per unit of £198.50
and uses the following resources:
Dept. A Dept B
Labour hours per unit 1 3
Machine hours per unit 2 1

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Required:
i. Calculate the overhead absorption rates for Department A and Department B.
ii. Calculate the full absorption cost of a top-range satnav system unit.

Problem 95
Clinton Ltd is a small company, which was established a year ago to produce and sell two
products, A and B, within a local area. Two local competitors also produced A, but B was a
new development and there was no competitor in the market. Although their prime costs are
very different, each product requires the same number of machine hours to produce one unit.
The finance director has based the selling prices upon the manufacturing cost plus a mark-up
of 25% to cover non-manufacturing costs and profit. The following figures apply:
A B
Budgeted output (units) 700 1,400
£ £
Prime cost 80.00 9.00
Overhead (8 machine hours) 152.40 152.40
232.40 161.40
Mark-up (25% of cost) 58.10 40.35
Selling price 290.50 201.75
As the other producers of A maintained their previous selling price of £380 per unit, the
company has had no difficulty in attaining the desired sales of 700 units of A. B also sold well
and the target of selling 1,400 units has been achieved. The company achieved full recovery
of overheads.
The management director has just heard that both competitors have announced their intention
to stop producing A. However, one of them has also declared that they will be starting to
produce B and will offer it for sale at £160 per unit, undercutting Clinton’s selling price of B.
The management director has sought your advice and after some investigation you have
established the following additional information
(i) The production process comprises two distinct cost centers, Assembly and Finishing.
(ii) The machine hours required to produce each product are:
A B
Machine hours in: Assembly 6 2
Finishing 2 6

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 Total 8 8
The aggregate overhead budgeted and spent in the first year, £320,000 is attributable as
follows:
£000
Assembly 240
Finishing 80
Total 320
Required:
(a) Explain with supporting calculation how the finance director’s allocation of £152.40
overhead cost per unit of both products would have been arrived at. Comment on this method
and its potential effects on business decisions.
(b) Prepare product costs and selling prices using an alternative allocation of overheads to A
and B, and support your method with reasoned arguments. Offer your suggested explanation
for the competitors’ behavior and advise the managing director.
(c) Briefly discuss the issue of, and methods for, allocating non-manufacturing overheads to
products.

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 Absorption and Variable Costing
Problem 96
Palit Ltd. commenced business on 1 April 2018 and purchased equipment for £170,000 to
manufacture product NPQ as from that date. The results for the year to 31 March 2019 and
the budget for the following year are as follows:
2018/19 2019/20
Actual Budget
NPQs produced (units) 2,000 2,200
NPQs sold (units) 1,500 2,000
£ £
Unit selling price of NPQs 160 160
Cost of raw materials purchased 70,000 77,000
Direct wages 50,000 55,000
Manufacturing expenses:
Variable 10,000 11,000
Fixed 30,000 30,000
Selling and administrative expenses 50,000 50,000
No stock of materials and work in progress are held at any time. The NPQ manufacturing
equipment is expected to last until 31 March 2022 and it will then be sold for an estimated
sum of £30,000. The straight-line method is to be used for depreciation.
Annual accounts for the year ended 31 March 2019 and a budget for the following year are
now being prepared and you are asked to advise on how to value stocks of finished goods.
The directors of Palit Ltd. are keen to use a method which will be helpful to management in
understanding how the business is progressing. The following alternative bases have been
suggested:
(i) absorption costing
(ii) variable costing
Required:
(a) Using absorption costing, draw an income statement for Palit Ltd. for the year ended 31
March 2019 and a budgeted income statement for the following year.
(b) Using variable costing, draw an income statement for Palit Ltd. for the year ended 31
March 2019 and a budgeted income statement for the following year.

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(c) Discuss the two stock valuation bases and give advice to the directors of Palit Ltd. on
which to use for management information purposes and why.

Problem 97
Coase Ltd is a single-product manufacturing company which uses a marginal costing system
for internal management reports. The company’s annual profit and loss accounts for external
reporting purposes are based on full absorption costing.
The following data refer to the years ended 30th June 2018 and 2019:
2018 2019
£ £
Selling price 90
Marginal cost per unit
Direct materials 21 23
Direct labour 19 22
Marginal factory overheads 8 10
Marginal selling and administrative expenses 2 3
Fixed factory overheads 170,000 180,000
Units Units
Opening stock 1,500 2,000
Closing stock 2,000 1,500
Sales 20,000 25,000
The normal volume used for the purpose of absorption costing is 28,000 units in both years.
The company uses the first-in first-out assumption for the calculation of cost of sales.
Required:
(a) Prepare internal management profit statement for the year ended 30th June 2019 using
marginal costing.
(b) Prepare a draft profit and loss account for the year ended 30th June 2019 using full
absorption costing.
(c) Give calculations showing why the profits for 2008 are not the same in your answers to (a)
and (b) above. Explain your answer.

Problem 98
John Smith, a friend of yours, has been trading for the past two years producing and selling
skids. Although his accountant has drawn up accounts for his he feels they do not give an

72
accurate picture of the business performance for decision-making purposes. He has asked you
to look at his records and to draw up alternative profit and loss accounts for each of the past
two years.
The selling price for skids has been £9 per unit for the past two years and the following
information is available:
2018 2019
Units Units
Sales 1,500 2,000
Production 1,900 1,800
£ £
Costs:
Factory variable 5,700 5,400
Factory fixed 3,800 3,330
Administration fixed 2,000 2,200
Selling variable 1,800 2,400
John Smith commenced business in 2018 with no stock and he uses FIFO for stock valuation
purposes.
Required:
(a) Produce profit and loss accounts for 2018 and 2019 using absorption costing.
(b) Produce profit and loss accounts for 2018 and 2019 using variable costing.
(c) Assume now that if John Smith decided to spend £600 in 2019 on improved quality
control procedures in the factory then sales volume for the year would rise by 5%. Explain
which costing method would give the more useful measure to indicate the profitability of the
decision. Make use of the data in this question to illustrate your explanation.

Problem 99
Gladstown Manufacturing has added two new products to its range. Its accountant has
produced the following summarised financial statement showing the profit earned on these
products for the first year using absorption costing.
Beta Delta
£ £
Materials 25,000 7,500
Direct labour 60,000 30,000

73
 Production overheads 120,000 60,000
Cost of sales 205,000 97,500
Sales 250,000 105,500
Gross profit 45,000 8,000
Other overheads 20,500 9,700
Net profit / (loss) 24,500 (1,700)
Units Units
Sales 25,000 7,500
Closing stock of finished goods 2,000 1,250
There is concern that Delta is showing a loss and it has been suggested that the use of
marginal (variable) costing would give a fairer picture of the financial results.
Further analysis shows that one-third of the production overhead charged to each product
varies according to the level of production whereas two-thirds of the charge is product-related
and is fixed. 75% of the other overheads are company overheads that have been allocated to
the products and 25% vary with the level of sales of each product.
Required:
(a) Redraft the absorption costing statement in more detail showing such matters as the cost
of goods produced, stocks, fixed overheads and variable overheads,
(b) Prepare a statement showing the contribution and net profit of each product using
marginal (variable) costing.
(c) Explain why the net profit figures are different under the two methods.

74
 Cost-Volume-Profit Analysis
Problem 100
Drake Ltd’s cost and revenues for the current year are expected to be:
£
Direct labour 6,000
Direct materials 7,000
Factory indirect expenses:
Variable 4,500
Fixed 500
5,000
Administration expenses 1,200
Selling and distribution expenses 600
Finance expenses 200
£20,000

It was expected that 2,000 units would be manufactured and sold, the selling price being £11
each.
Suddenly during the year two enquiries were made at the same time which would result in
extra production being necessary. They were:
(A) An existing customer said that he would take an extra 100 units, but the price would have
to be reduced to £9 per unit on this extra 100 units. The only costs that would be involved
would be in respect of variable costs.
(B) A new customer would take 150 units annually. This would mean extra variable costs and
also an extra machine would have to be bought costing £1,500 which would last for 5 years
before being scrapped. It would have no scrap value. Extra running costs of this machine
would be £600 per annum. The units are needed for an underdeveloped country and owing to
currency difficulties the highest price that could be paid for the units was £10 per unit.
Required:
On the information above, and assuming that there are no alternatives open to Drake Ltd,
should the company accept or reject these orders? Draft the memo that you would give to the
managing director of Drake Ltd.

75
Problem 101
Greatsound Ltd manufactures and sells compact disc players, the cost of which is made up as
follows:
£
Direct material 74.80
Direct labour 18.70
Variable overhead 7.50
Fixed overhead 30.00
Total cost 131.00
The current selling price is £187.
Greatsound Ltd. works a day shift only, at present producing 120,000 compact disc players
per annum, and has no spare capacity.
Market research has shown that there is a demand for an additional 60,000 compact disc
players in the forthcoming year. However, these additional sales would have a selling price of
£150 each. One way of achieving the extra production required is to work a night shift.
However, this would increase fixed costs by £2,500,000 and the labour force would to be paid
an extra 20 per cent over the day shift rate.
The company supplying the materials to Greatsound Ltd. has indicated that it will offer a
special discount of 10 per cent on total purchases if the annual purchases of materials increase
by 50 per cent.
The selling price and all other cots will remain the same
Required:
Assuming that the additional purchases will only be made if the night shift runs, you are
required to:
(a) advise Greatsound Ltd whether it should proceed with the proposal to commence the night
shift, based on financial considerations.
(b) calculate the minimum increase in sales and production required to justify the night shift.
(c) give four other matters which should be taken into consideration when making a decision
of this nature.

Problem 102
Beacher Motors specializes in producing one specialty vehicle. It is called Surfer and is styled
to easily fit multiple surfboards in its back area and top-mounted storage racks.
Beacher has the following manufacturing costs:

76
 Plant management costs, $1,200,000 per year
Cost of leasing equipment, $1,800,000 per year
Workers’ wages, $700 per Surfer vehicle produced
Direct materials costs: Steel, $1,500 per Surfer; Tires, $125 per tire, each Surfer
takes 5 tires (one spare).
City license, which is charged monthly based on the number of tires used in
production:
0–500 tires $ 50,000
501–1,000 tires $ 74,500
more than 1,000 tires $200,000
Beacher currently produces 110 vehicles per month.
1. What is the variable manufacturing cost per vehicle? What is the fixed manufacturing cost
per month?
2. Plot a graph for the variable manufacturing costs and a second for the fixed manufacturing
costs per month. How does the concept of relevant range relate to your graphs? Explain.
3. What is the total manufacturing cost of each vehicle if 100 vehicles are produced each
month? 225 vehicles? How do you explain the difference in the manufacturing cost per unit?

Problem 103
Xebec Ltd manufactures three perfumes, Silk, Musk and Opia. The selling prices and the
variable costs per unit of each product are as follows:
Silk Musk Opia
£ £ £
Selling price 15 20 30
Variable cost 10 14 20
Xebec’s fixed costs are £150,000 per year.
There is a shortage of the raw material called Essence which is used in all three products. Silk
uses 2 kilos, Musk uses 1 kilo and Opia uses 3 kilos of Essence per unit of output. Only
120,000 kilos of Essence will be available for the year.
In addition, market constraints are expected to restrict the production and sales of each
product for the year to:
Units
Silk 40,000

77
 Musk 8,000
Opia 15,000
Required:
Calculate the mix of sales which would enable Xebec Ltd to maximize profits, and calculate
the profit for the year which would be achieved by that sales mix.

Problem 104
A summary of Pareto Company’s profit statement for last year is presented below. Exept as
noted, the cost and sales relationship for the current year is expected to follow the same
pattern. The company is operating at full capacity.
£
Sales (1,000,000 bottles at £0,50) 500,000
Variable costs 300,000
Fixed costs 100,000
Total costs 400,000
Profit 100,000
Required:
(a) What is the break-even point in units?
(b) What is the margin of safety in units?
(c) If an extension to the factory is built it would add £50,000 to the fixed costs and increase
production capacity by 60 per cent. Variable costs per unit are also expected to increase by 10
per cent. The management of the company feels that it should earn at least £10,000 each year
on the new investment. Calculate whether the proposed extension provides sufficient capacity
for the company to maintain existing profits and earn the minimum required on the new
investment, assuming that all of the increased capacity can be sold.

Problem 105
Mento Company manufactures and sells a single product. The company’s sales and expenses
for the last quarter follow:
Total Per Unit
Sales $450,000 $30
less Variable expenses $180,000 $12
Contribution margin $270,000 $18

78
 less Fixed expenses $216,000
Net income $54,000
Required:
(a) What is the quarterly break-even point in units sold and in sales dollars?
(b) Without resorting to computations, what is the total contribution margin at the break-even
point?
(c) How many units would have to be sold each quarter to earn a target net income of
$90,000? Use the unit contribution method. Prove your answer by preparing a contribution
income statement at the target level of sales.
(d) Refer to the original data. Compute the company’s margin of safety (MS) in both dollar
and percentage terms.
(e) What is the company’s contribution margin ratio (CM ratio)? If sales increase by $50,000
per quarter, by how much would you expect quarterly net income to increase? (Do not prepare
an income statement; use CM ratio to compute your answer).

Problem 106
A building company constructs a standard unit which sells for £30,000. The company’s costs
can be readily identifiable between fixed and variable costs.
Budgeted data for the coming six months include the following:
Sales Profit
(in units) (£)
January 18 70,000
February 20 100,000
March 30 250,000
April 22 130,000
May 24 160,000
June 16 40,000
You are told that the fixed costs for the six months have been spread evenly over the period
under review to arrive at the monthly profit projections.
Required:
(a) Prepare a graph for the total sales, costs and output for the six months under review that
shows:
(i) the break-even point in units and revenue;
(ii) total fixed costs;

79
 (iii) the variable cost line;
(iv) the margin of safety for the total budgeted sales.
(b) The company is worried about the low level of sales. The sales director says that if the
selling price of the unit was reduced by £5,000 the company would be able to sell 10% more
units. All other costs would remain the same, you are told. Determine whether the company
should reduce the selling price to attract new sales in order to maximize profit. Clearly show
any workings.
(c) Evaluate whether the assumption that costs are readily identifiable as either fixed or
variable throughout a range of production is realistic. Give examples of any alternative
classification.

Problem 107
You are provided with the following information relating to the sales, estimated demands and
production costs for each bench, table and chair.
Bench Table Chair
Estimated selling price £60 £71 £45
Maximum demand In units 1,800 1,500 3,000
Raw materials - timber £10 £12 £2
- metal fittings £3 £4 £7
- fabric - - £6
Packing £2 £2 £1
Each bench, table or chair involves in two separate stages of processing.
1. The timber is machined, finished and assembled. Metal fittings are fixed.
2. The products are painted and varnished to packaging in polythene and cardboard.
Labour costs are based on the following estimated time (in minutes) required for each
processing stage:
Stage 1 Stage 2
Benches 180 20
Tables 150 60
Chairs 60 40
The following rates for labour are applied:
Stage 1 Stage 2
£ per hour 4 3
There are a maximum of 10,500 hours of labour available for stage 1.

80
Required:
(a) Advise the management the maximum output for each product and the total contribution
of the proposed optimal production plan.
(b) Explain clearly the basis method used in (a).
(c) Identify two factors that should be considered before a final decision is made.

81
 Cash Budget
Problem 108
The following figures have been taken from the budget of Solaja Ltd, a company in the retail
trade, for the year to 31 December 2018:
January February March April
Sales (units) 5,000 6,000 7,000 5,000
£ £ £ £
Expenses:
Distribution 4,500 4,700 5,200 4,500
Administration 3,000 3,600 4,400 3,000
Depreciation 1,000 1,000 1,500 1,500
The following additional information is available:
(1) The selling price is £6 per unit. It will increase to £6.70 per unit for all sales in April and
subsequent months. 25% of budgeted sales revenue is expected to be received in the month of
sale and 70% in the following month. 5% of all sales are expected to lead to bad debts.
(2) The budgeted number of units of stock held at the end of each month is equal to the
budgeted sales for the following month.
(3) The purchase price of stock has been £3.50 per unit since October 2017 and this is
expected to increase to £4 per unit for all purchases in February and subsequent months.
(4) 60% of all purchases are paid in the month of purchase and 40% in the following month.
(5) All expenses are paid in the month in which they are incurred.
(6) Solaja Ltd plans to buy new non-current assets for £43,000 paying a deposit of £15,000 in
February. The balance will be paid in monthly instalments of £2,000 commencing in March.
(7) The chairman has suggested that he might be willing to lend up to £12,000 to the company
for a maximum of four months to avoid asking the bank for an overdraft.
(8) The business is seasonal and, as indicated in the above budget, results in April are
expected to be similar to those in January. There is a three month cycle so the results in May
and June are expected to be similar to those in February and March respectively.
(9) Summarised statement of financial position at 31 December 2017:
£
Non-current assets (at book value) 12,500
Inventory 17,500
Accounts receivable (after bad debt provision) 29,400

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 Cash at bank 2,000
Accounts payable (7,000)
Equity and reserves 54,400
Required:
(a) A monthly cash budget for Solaja Ltd for January, February, March and April and the total
for the four months presented in the form of a table.
(b) A budgeted statement of financial position at 30 April 2018.
(c) Your comments on the impact on the company if it were to borrow up to £12,000 from the
chairman to help finance the purchase of the new non-current assets.

Problem 109
The management director of Pumpkin Ltd was reviewing the results of the company for the
financial year ended 31 March 2020. The following summarized information was available:
Balances as at 1 April 2019 £
Issued ordinary share capital:
£1 fully paid shares 150,000
Share premium account 100,000
Balance of retained earnings 40,000

Balances as at 31 March 2020 £

Net profit for the year 2019/2020 70,0000
Fixed assets 300,000
Bank overdraft 150,000
Other net current assets 210,000
Note: There were no other accounts with balances. The balances as at 1 April 2019 had
remained unchanged throughout the year.

The management director was pleased that the company had made a good profit, but he was
rather concerned that a healthy bank balance at the beginning of the year had now become a
large bank overdraft.
Consequently he asked the company accountant to prepare forecast information for
2020/2021 in order that the cash situation could be improved.
The following information was prepared by the accountant:
(1) Company sales – March 2020

83
 £
Cash sales 30,000
Credit sales 65,000
In each month April to September (inclusive) the sales per month would be:
£
Cash sales 40,000
Credit sales 70,000
All credit sales are settled the month after the sale.
(2) All goods purchased are from a single supplier. The goods are purchased on credit and
each month’s purchases are paid for three months after the month of purchase (three months
in arrears).
The following purchase schedule had been prepared for the first 9 months of 2020:
January February March
Purchases £60,000 £58,000 £61,000
Purchases in April, May and June
£55,000 in each month
Purchases in July, August and September
£45,000 in each month
Note: the company had successfully negotiated lower prices from its supplier commencing 1
July 2020.
(3) Dividends would be paid as follows:
(i) Final ordinary dividend of 5p per share payable on 31 May 2020 in respect of
financial year 2019/2020.
(ii) Interim ordinary dividend of 2p per share payable on 31 July 2020 in respect of
financial year 2020/2021.
(4) Selling and distribution expenses are expected to be 6 per cent of a given month’s total
sales. They are paid one month in arrears.
(5) Administration charges would be incurred as follows:
2020 February, March, April £10,000 per month
2020 May to September (inclusive) £13,500 per month
Administration charges are settled two months after the month in which they were incurred.
(6) The company had decided to make a bonus issue of shares of one share for every three
held. The issue would be made on 30 April 2020. The bonus shares would not qualify for the

84
final dividend of 2019/2020, but would qualify for the interim dividend to be paid on 31 July
2020.
Required:
(a) Comment on the liquidity of the company as at 31 March 2020 and explain to the
managing director why a company can apparently make a good profit but have no cash in
bank.
(b) Prepare a cash budget for each of the four months ending 31 July 2020.
(c) Comment on the forecast bank balance as shown by your cash budget. Identify ways in
which the bank overdraft could be reduced over the last five months of 2020.

Problem 110
The management of Hooke plc have been informed that the union representing the direct
production workers at one of their factories, where a standard product is produced, intends to
call a strike. The accountant has been asked to advise the management of the effect the strike
will have on cash flow.
The following data has been made available:
(1)
Week 1 Week 2 Week 3
Budgeted sales 400 units 500 units 400 units
Budgeted production 600 units 400 units Nil
(2) The strike will commence at the beginning of week 3 and it should be assumed that it will
continue for at least four weeks. Sales at 400 units per week will continue to be made during
the period of the strike until stocks of finished goods are exhausted. Production will stop at
the end of week 2. The current stock level of finished goods is 600 units.
(3) The selling price of the product is £60 and the budgeted manufacturing cost is made up as
follows:
£
Direct materials 15
Direct wages 7
Variable overheads 8
Fixed overheads 18
Total 48
(4) Direct wages are regarded as a variable cost. Direct wages are paid one week in arrears.

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(5) The company operates a full absorption costing system and the fixed overhead absorption
rate is based upon a budgeted fixed overhead of £9,000 per week. Included in the total fixed
overheads is £700 per week for depreciation of equipment. During the period of the strike
direct wages and variable overheads would not be incurred and the cash expecded on fixed
overheads would be reduced by £1,500 per week. It should be assumed that all relevant
overheads are paid for immediately the expense is incurred.
(6) The current stock of raw materials cost £7,500: it is intended that these stocks should
increase of £11,000 by the end of week 1 and then remain at this level during the period of the
strike. All direct materials are paid for one week after they have been received.
(7) All sales are on credit. 70% of the sales value is received in cash from the debtors at the
end of the first week after the sales have been made and the balance at the end of the second
week.
(8) The current amount outstanding to material suppliers is £8,000 and direct wage accruals
amount to £J3,200. Both of these will be paid in week 1. The current balance owing from
debtors is £31,200, of which £24,000 will be received during week 1 and the remainder
during week 2. The current balance of cash at the bank and in hand is £1,000.
Required:
(a) Prepare a cash budget for weeks 1 to 6 showing the balance of cash at the end of each
week together with a suitable analysis of the receipts and payments during each week.
(b) Comment upon any matters arising from the cash budget which you consider should be
brought to management’s attention.

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 Variance Analysis
Problem 111
Cleanahull Ltd operates a small boat cleaning service. Boats are cleaned using a special
machine that requires a skilled operator and are finished using unskilled labour. Cleanahull
has produced a standard cost schedule as all boats go through the same process. Overheads
are absorbed using standard labour hours. The materials come in packs; each boat cleaned
should use one pack of materials. Cleanahull budgets to clean 288 boats per month.
Standard cost for cleaning a boat:
£
Skilled labour: 2 hours at £8 per hour 16
Unskilled labour: 1 hour at £5 per hour 5
Materials: 1 pack at £3 per pack 3
Variable overheads: 3 hours at £2 per hour 6
Fixed overheads: 3 hours at £10 per hour 30
Total standard cost 60
Profit mark-up at 30% cost 18
Price charged 78
Actual results for May 2018:
£ £
Sales: 330 boats cleaned 26,400
Less costs
Skilled labour: 594 hours 5,049
Unskilled labour: 396 hours 1,881
Materials:350 packs 1,190
Variable overheads 1,815
Fixed overheads 8,500
Total costs for May 18,435
Profit for May 7,965
Required:
(a) Prepare an operating statement, reconciling budgeted and actual profit for Cleanahull Ltd
for May 2018 showing two variances for sales and each cost category.
(b) Prepare a brief report to the owner of Cleanahull Ltd commenting on the performance in
May 2018 suggesting possible reasons for any unexpected results.

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Problem 112
Smith Plc. manufactures and sells a range of small household products. The following
information relates to the “Adam” for the month of July.
Budgeted volume 6,000 units
Budgeted selling price £6,00 per unit
Budgeted variable cost £2 per unit
Budgeted fixed overheads for July £6,000
During July 8000 “Adams” were actually sold for £40,000.
Required:
(a) Compute the following variances for product “Adam: for July:
(i) Sales price variance;
(ii) Sales contribution volume variance;
(iii) Sales margin volume variance.
(b) Explain and reconcile the difference between your answers to (ii) and (iii).

Problem 113
Thatcher Ltd uses a standard costing system. The standard cost card for direct materials used
in production of product NUM is as follows:
8 kgs @ £0.40 per kg = £3.20 per unit
Budgeted production in April 2018 was 850 units.
The relevant data for actual production of product NUM for April 2018 was as follows:
Actual production 870 units
Materials purchased 8,200 kgs at a cost of £3,444
Materials issued to production 7150 kg
Required:
(a) Calculate the total materials variance for April 2018.
(b) Calculate the materials price variance and materials efficiency variance for April 2018.

Problem 114
Thompson plc operates a standard costing system. The standard cost specification for the
company’s principal product line shows the following information for labour cost per unit:
2 hours at £5.50 per hour
Budgeted production for April 2018 was 900 units.
The relevant data for actual production of the product for April 2018 was as follows:

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 Actual production 780 units
Labour costs 1710 hours at £5.80 per hour.
The factory manager has informed you that due to a power failure workers were unable to
work for a total of 100 man-hours but were paid for these hours and are included in the 1710
hours.
Required:
Calculate labour variances for April 2018 for the management of Thompson plc.

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 Investment appraisal techniques
Problem 115
The government of Nopia is considering operating a series of toll roads which will be
operated by companies in the private sector.
Contracts to run the toll roads will be for five years at which time contracts will be put out to
competitive tender again. As the finance director of QFE plc, a transport operator, you are
interested in bidding for one of the first series of contracts.
It is anticipated that you will need to pay the government of Nopia an initial fee of £15
million to acquire the right to operate the toll road plus an annual fee of £1.5 million payable
at the end of the year 1, increasing by 15% per year thereafter. In addition, the government
will take 20% of all revenues generated by the toll road.
Operating costs to monitor traffic and collect tolls are expected to be £3 million in year 1 and
will then increase by 10% per year.
Based on current estimates of usage there will be 112 million miles of vehicle travel per year
for each of the five years.
The government of Nopia will allow QFE plc to set the toll fee which will be based on the
number of miles a vehicle travels on the toll road. Once set, the toll per mile will remain
constant for the duration of the contract.
Given the risk profile of this project QFE pls will require a return of 12% per year on its
investment.
Assume all cash flows, apart from the initial fee, will occur at the end of the year concerned.
Required:
(a) As finance director of QFE plc what is the minimum toll per mile you would be prepared
to charge?
(b) Assume the government of Nopia is prepared to accept an alternative to the initial fee of
£15 million. The alternative is to pay five equal annual instalments to the government
commencing immediately. What is the maximum QFE plc should be prepared to pay per year
to avoid the initial fee of £15 million?
(c) Assume that the government now states that the toll charge must fall by 4% per year from
the end of year 1. How would this effect your recommendation in part (a) above?
All calculations should be expressed in millions and rounded to two decimal places.

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Problem 116
Hayek Plc. is considering investing in either project P or project Q:
Time Project P Project Q
(years) £ £
Equipment cost 0 100,000 100,000
Expected annual profit/loss 1 34,000 4,000
2 24,000 4,000
3 14,000 12,000
4 4,000 16,000
5 (36,000) 4,000
Estimated resale value of equipment 5 20,000 20,000
Hayek Plc depreciates equipment on the straight-line basis. Profits and losses are earned
evenly throughout the year.
Required:
(a) Calculate the payback period for each project and on this basis advise Hayek Plc which
project to invest in.
(b) Briefly explain two disadvantages of payback period as a method of investment appraisal.

Problem 117
The directors of Welch plc are considering which of the following projects to invest in:
Year Alpha Beta Gamma
£ £ £
Initial capital investment 0 50,000 50,000 50,000
Expected cash inflows 1 30,000 30,000 20,000
2 20,000 20,000 20,000
3 6,000 6,000 10,000
4 4,000 4,000 10,000
Scrap proceeds 4 10,000 0 10,000
Welch plc uses the straight-line method of depreciation.
Required:
(a) Calculate the payback period of each project.
(b) Calculate the average accounting rate of return of each project.
(c) Based on your calculations in (a) and (b), advise the directors which project they should
invest in.

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Problem 118
As a member of the finance director’s team at Londy plc. you have been asked to approve at
investment proposal recently received from the company’s subsidiaries, Franly Ltd, whose
directors consider that the project should be supported as it yields a forecast profit of
£460,000 over its anticipated five year life.
The following financial information has been provided to support the proposal:
Five year forecast profit and loss account for years ending on 31 May
2019 2020 2021 2022 2023
£000 £000 £000 £000 £000
Sales 1,500 2,000 2,500 2,000 1,000
Less: Cost of sales 900 1,200 1,500 1,200 600
Gross profit 600 800 1,000 800 400
Less: Depreciation 240 240 240 240 240
Wages 150 170 170 170 150
Overheads 200 270 320 220 120
Forecast not profit/loss 10 120 270 170 (110)
Notes:
(1) Closing stock (in £000s) is expected to be as follows:
2019 2020 2021 2022 2023
100 150 100 50 0
The project will commence on 1 June 2018 with no opening stock.
(2) Franly Ltd uses the straight-line method of depreciation. The value of the machinery
needed for the project is expected to be £300,000 and the end of its five year life.
(3) The wages figure includes £48,000 for a manager and £27,000 for a supervisor who are
already employed by Franly Ltd. If the project goes ahead, the company will need to hire an
additional supervisor at a cost of £25,000 per year. If the project does not proceed, the
existing manager and supervisor will remain in their present posts.
(4) 10% of the overhead charge varies with the value of sales revenue and 90% in an
allocation of group overheads.
(5) The equipment will be paid for on 1 July 2018. The required amount of materials and
components for the year’s production will be paid for at the beginning of the year concerned.
All other cash flows will occur at the end of the year.

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(6) Londy plc. uses the discounted cash flow method for project appraisal and the discount
rate to be used for this project is 10% per year.
Required:
(a) Based upon the above information, advise the finance director whether or not the project
should be accepted.
(b) If it were possible to lease the equipment by paying five equal annual instalments, the first
being on 1 June 2018, what is the maximum Franly Ltd should be willing to pay? Explain
your answer.
(c) Explain to the directors of Franly Ltd why the discounted cash flow approach to project
evaluation is often preferred to the forecast profit approach and discuss any limitations the
method may have.

Problem 119
Parsons plc. is considering an investment proposal for recycling waste production materials
into a product, which can be sold to the packaging industry. The company’s accountant has
rejected the project on the basis that it results in a forecast loss of £890,000 over its expected
five-year life. The company’s board of directors are concerned about the carbon footprint of
the company and are looking for ways to improve its environmental impact and have agreed
that a maximum loss of half a million pounds over a five year period is acceptable. They have
requested you to re-examine the financial consequences of the product.
You are provided with the following financial information about the project:
(1) The accountant’s forecast is as follows based on the project commencing on 1st January
2019.
Five year forecast profit and loss account for years ending on 31 December
2019 2020 2021 2022 2023
£000 £000 £000 £000 £000
Sales 1,300 2,000 2,200 2,200 2,200
Less: Cost of sales 1,100 1,300 1,450 1,500 1,500
Gross profit 200 700 750 700 700
Less: Depreciation 320 320 320 320 320
Labour costs 175 195 205 195 195
Overheads 150 325 300 300 300
Forecast loss (445) (140) (75) (115) (115)
The following additional information is made available:

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(2) The recycling process uses up waste materials which have no resale value. At present,
disposal of the production waste is arranged by paying an annual fee to a local waste disposal
company. If the project is undertaken, these costs will no longer be incurred. The yearly
estimated cost of waste disposal (in £000s) is as follows:
2019 2020 2021 2022 2023
80 80 80 80 160
(3) The process will require the purchase of additional materials which are included as cost of
sales in the company accountant’s forecast. The project commenced with no opening stock,
but the forecast includes the following projected closing stock of materials (in £000s) at 31st
December:
2019 2020 2021 2022 2023
100 200 150 50 0
The materials needed for the year will be purchase and paid for on the first day of the year.
(4) On 1st January 2019 the company will purchase and pay for special recycling machinery.
The scrap value at 31st December 2023 is estimated at £50,000. Parsons plc uses the straight-
line method of depreciation which results in a charge of £320,000 per annum.
(5) 80% of the overhead charge is an allocation of existing company fixed overheads and 20%
represents the overheads incrementally incurred on the new recycling project.
(6) In August 2018, the company spent £20,000 on commissioning a report investigating the
environmental impact of its waste products.
(7) Each year’s labour costs include £55,000 for the environmental manager and £25,000 for a
production supervisor. Both are already employed by Parsons plc. If the project does not
proceed, these two employees will remain in their present posts. The remaining labour costs
reflect additional workers needed for the process.
(8) The board of Parsons wish you to use the discounted cash flow method for the project
appraisal and the discount rate to be used for this project is 12% per year. Assume all cash
flows occur at the year end, unless otherwise indicated.
Required:
(a) Based upon the above information, advise the finance director whether or not the recycling
project should be accepted. State any assumptions and use a tabular format for your
calculations. All figures to the nearest £000.
(b) In the context of project evaluation, what do you understand by the term “sensitivity
analysis”? Give (without calculations) two examples of sensitivity analysis considerations for
the recycling projects.

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Problem 120
Over the last year Wyman plc has spent £100,000 developing a new product, the “MC5”
which if launched is expected to have a life of 6 years. The development work is now
complete and the company is considering whether to start production and, if so, what
production method would be best. The alternative production methods have been narrowed
down to two options.
Option A involves the purchase of a special machine to manufacture MC5. This machine has
a capacity of 18,000 units of MC5 per annum and an estimated life of 6 years. It would cost
£78,000 to purchase and a further £15,000 per annum in maintenance and power costs. At the
end of six years its residual value would be nil.
Option B would involve using a readily available smaller machine with a capacity of 10,000
units pa and a life of three years. At the end of the first three years the smaller machine would
be replaced by 2 similar machines to cope with the extra demand. The current cost of the
machine is £30,000 but by the time it is replaced at the end of the third year the two new
machines would cost £78,000 in total. All machines have a zero scrap value at the end of their
three year life. Running costs of the smaller machines would be £10,000 per annum for each
machine.
1. Variable costs of material and direct labour are expected to be £6 per unit of MC5. Wyman
has corporate fixed overheads of £120,000 per annum, there will be no increase in corporate
fixed overheads if the MC5 is introduced.
The machine will be depreciated using the straight line basis.
The company would also need to invest £10,000 in working capital at the start of production.
This would be recouped at the end of the project.
2. Each MC5 is expected to sell for £10 per unit. The expected demands for sales of MC5
over the product life are estimated as follows:
Year 1 4,000 units
Year 2 6,000 units
Year 3 10,000 units
Year 4 16,000 units
Year 5 16,000 units
Year 6 16,000 units
The company has a cost of capital of 12% (the present value of £1 discounted at 12% for 6
years is 0.507)
Required

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a) Calculate of the Net Present Value of each option and indicate which you would
recommend.
b) Identify and explain the relative merits and disadvantages of internal rate of return and net
present value as decision models for project appraisal.

Problem 121
Polonius Manufacturing makes components for the telecoms industry. The development
department has designed a new product and incurred development costs of £30,000.
The following information is available.
1. The new product is expected to have an initial life span of four years and demand has been
estimated at 10,200 units in year 1 with sales increases of 10% in each of years 2 and 3 and
sales of 9,000 units in year 4. The unit selling price will be £34. There will be no stocks of
finished goods.
2. Since the production cycle is very short, both production and sales could start immediately,
should the production go ahead. Each unit of the new product will require 2 hours of labour
which will need to be hired. There will be no problem hiring at £8.00 per hour.
3. Each unit of the new product will require one component, a capacitor. The company has a
stock of 15,000 capacitors which were purchased two years ago for £4.00 each. These have no
resale value or alternative use. Any capacitors to be purchased from now on will cost £5.00
each.
4. Each unit produced will also require £8.00 of sundry raw materials such as wire and a
circuit board. The company holds no stock of the sundry raw materials.
5. The company already owns the machinery that could be used in the manufacture of this
product. If it is not used for this product it will be sold immediately for £200,000. If it is used
for this production, after four years it is likely to have a residual value of £40,000.
6. Fixed production overheads allocated to this project will cost £40,000 per annum. The cost
of capital is 15% per annum. Assume all cash flows occur on the last day of each year except
for the immediate disposal of the existing machinery.
Required:
(a) Calculate the Net Present Value (NPV) of this project.
(b) Calculate the payback period of this project using both nominal and discounted cash flow.
(c) Advise Polonius Company on the project and outline two other factors that you would take
into account in your decision.

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Extracts from compound interest tables
Present value of £1
% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

Annuity of £1
% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

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