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The Chartered Institute of Management Accountants 2001

POST EXAM GUIDE

May 2001 Exam

Financial Accounting Fundamentals(FAFN)

CIMA publishes a Question and Answer booklet for each paper ofthe May 2001 exam which is essential reading for students andtutors. The published answers are written by the Examiner andshould be read together with the post exam guide.


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Paper 1 - Financial Accounting Fundamentals

Post Exam Guide May 2001 2

Objective test questions are awarded 2 marks each. Explanations are provided foranswers to objective test questions involving calculations.

Question 1.1

The fundamental objective of an external audit of a limited company is to

A give advice to shareholdersB detect fraud and errorsC measure the performance and financial position of a companyD provide an opinion on the financial statements

The answer is D.

Question 1.2

A receives goods from B on credit terms and A subsequently pays by cheque. A thendiscovers that the goods are faulty and cancels the cheque before it is cashed by B.

How should A record the cancellation of the cheque in his books?

A Debit creditors Credit returns outwardsB Credit bank Debit creditorsC Debit bank Credit creditorsD Credit creditors Debit returns outwards

The answer is C.

Question 1.3

The profit of a business may be calculated by using which one of the following formulae?

A Opening capital - drawings + capital introduced - closing capitalB Closing capital + drawings - capital introduced - opening capitalC Opening capital + drawings - capital introduced - closing capitalD Closing capital - drawings + capital introduced - opening capital

The answer is B.


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Question 1.4

The turnover in a company was 2 million and its debtors were 5% of turnover. The companywishes to have a provision for doubtful debts of 4% of debtors, which would make the

provision 33% higher than the current provision.

What figure would appear in the profit and loss account in respect of doubtful debts?

A debit 1,000 B credit 1,000 C debit 1,333 D credit 1,333

The answer isA.

Workings

Turnover 2 million x 5% gives debtors of 100,000

Provision for doubtful debts is 4% x 100,000 4,000Existing provision is 4,000 x 3,000

Increase in provision to profit and loss account 1,000

Question 1.5

Which one of the following should be accounted for as capital expenditure?

A The cost of painting a building.B The replacement of windows in a building.C The purchase of a car by a garage for re-sale.D Legal fees incurred on the purchase of a building.

The answer is D.


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Question 1.6

A business purchases a machine on credit terms for 15,000 plus value added tax (VAT) at15%. The business is registered for VAT. How should this transaction be recorded in thebooks?

Dr Cr A Machinery 15,000Creditors 15,000

B Machinery 17,250Creditors 17,250

C Machinery 15,000VAT 2,250Creditors 17,250

D Machinery 17,250VAT 2,250

Creditors 15,000

The answer is C.

Question 1.7

Which one of the following statements most closely expresses the meaning of true and fair?

A There is only one true and fair view of a companys financial statements.B True and fair is determined by compliance with accounting standards.

C True and fair is determined by compliance with company law.D True and fair is largely determined by reference to generally accepted accounting

practice.

The answer is D.


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Question 1.8

On 1 May 2000, A Ltd pays a rent bill of 1,800 for the period to 30 April 2001. What are thecharge to the profit and loss account and the entry in the balance sheet for the year ended 30November 2000?

A 1,050 charge to profit and loss account and prepayment of 750 in the balancesheet.

B 1,050 charge to profit and loss account and accrual of 750 in the balance sheet.C 1,800 charge to profit and loss account and no entry in the balance sheet.D 750 charge to profit and loss account and prepayment of 1,050 in the balance

sheet.

The answer isA.

Workings

1,800 for one year is 150 per month Charge to profit and loss account 7 x 150 = 1,050Prepaid 5 x 150 = 750

Question 1.9

S Ltd exchanged stock for a delivery vehicle with T Ltd. The stock had cost S Ltd 10,000and the normal selling price was 12,000; the delivery vehicle had cost T Ltd 9,000 and thenormal selling price was 13,000.

How should S Ltd value the vehicle in its balance sheet?

A 9,000 B 10,000 C 12,000 D 13,000

The answer is C.

Question 1.10

Zs bank statement shows a balance of 825 overdrawn. The bank statement includes bank

charges of 50, which have not been entered in the cash book. There are unpresentedcheques totalling 475 and deposits not yet credited of 600. The bank statement incorrectlyshows a direct debit payment of 160, which belongs to another customer.

The figure for the bank balance in the balance sheet should be

A 590 overdrawn. B 540 overdrawn. C 790 overdrawn. D 840 overdrawn.

The answer is B.


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Workings (Question 1.10)

Bank statement balance overdrawn (825)Unpresented cheques (475)

Outstanding deposits 600Bank error 160Cash book credit balance (540)

Question 1.11

There is 100 in the cash till at the year end at F Ltd, but the accountant has discovered thatsome cash has been stolen. At the beginning of the year there was 50 in the cash till anddebtors were 2,000. Total sales in the year were 230,000. Debtors at the end of the yearwere 3,000. Cheques banked from credit sales were 160,000 and cash sales of 50,000

have been banked.

How much cash was stolen during the year?

A 18,950B 19,000C 19,050D 20,950

The answer isA.

Workings

Sales ledger control account

Opening debtors 2,000 Cheques banked credit sales 160,000Credit sales (balancing figure) 161,000 Closing debtors 3,000

163,000 163,000

Cash account

Opening balance 50 Cash banked 50,000Cash sales (230,000 - 161,000) 69,000 Cash missing (balancing figure) 18,950

Closing balance 10069,050 69,050


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Question 1.12

A car was purchased for 12,000 on 1 April 1997 and has been depreciated at 20% eachyear straight line, assuming no residual value. The company policy is to charge a full yearsdepreciation in the year of purchase and no depreciation in the year of sale. The car was

traded in for a replacement vehicle on 1 August 2000 for an agreed figure of 5,000.

What was the profit or loss on the disposal of the vehicle for the year ended 31 December2000?

A Loss 2,200B Loss 1,400C Loss 200D Profit 200

The answer is D.

Workings

1 April 1997 Cost 12,000Depreciation charge at 20%1997 2,4001998 2,4001999 2,400

7,200Net book value 1 August 2000 4,800Proceeds 1 August 2000 5,000Profit 200

Question 1.13

A company includes in stock goods received before the year end, but for which invoices arenot received until after the year end. This is in accordance with

A the historical cost convention.B the accruals concept.C the consistency concept.D the materiality concept.

The answer is B.


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Question 1.14

I Ltd operates the imprest system for petty cash. At 1 July there was a float of 150, but it wasdecided to increase this to 200 from 1 August onwards. During July, the petty cashier

received 25 from staff for using the photocopier and a cheque for 90 was cashed for anemployee. In July, cheques were drawn for 500 for petty cash.

How much cash was paid out as cash expenses by the petty cashier in July?

A 385B 435C 515D 615

The answer isA.

Workings

1 July balance b/d 150 Cheques banked credit control 90Photocopying 25 Cash paid out (balancing figure) 385Cash from bank 500 31 July balance c/d 200

675 675

Question 1.15

Which one of the following sentences does NOT explain the distinction between financialaccounts and management accounts?

A Financial accounts are primarily for external users and management accounts areprimarily for internal users.

B Financial accounts are normally produced annually and management accounts arenormally produced monthly.

C Financial accounts are more accurate than management accounts.D Financial accounts are audited by an external auditor and management accounts do

not normally have an external audit.

The answer is C.


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Question 1.16

The movement on the plant and machinery account for X Ltd is shown below:

Cost b/fwd 10,000Additions 2,000Disposals (3,000)Cost c/fwd 9,000

Depreciation b/fwd 2,000Charge for the year 1,000Disposals (1,500)Depreciation c/fwd 1,500

Net book value b/fwd 8,000Net book value c/fwd 7,500

The profit on the sale of the machine was 500. What figures would appear in the cash flowstatement of X Ltd?

A Movement on plant account 500 and profit on disposal of 500.B Movement on plant account 500 and proceeds on sale of plant 2,000.C Purchase of plant 2,000 and profit on disposal of 500.D Purchase of plant 2,000 and proceeds on sale of plant 2,000.

The answer is D.

Workings

Purchase of plant = additions = 2,000

Net book value of disposals (3,000 - 1,500) 1,500

Profit on disposal 500

Proceeds on sale of plant 2,000

Question 1.17

When there is inflation, the historical cost convention has the effect of

A overstating profits and understating balance sheet values.B understating profits and overstating balance sheet values.C understating cash flow and overstating cash in the balance sheet.D overstating cash flow and understating cash in the balance sheet.

The answer isA.


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Workings (Question 1.19)

000Net profit 180

Add back:Depreciation 30

Less:Profit on sale (75)135

Increase in working capital (10)

Cash from operations 125

Question 1.20

B is a builder with a staff of ten employees. In April 2001, he paid the following amounts:

net salaries after tax and national insurance 14,000 tax and employees national insurance for March 2001 5,000 employers national insurance for March 2001 1,400

He owes the following amounts in respect of tax and national insurance for April 2001: tax and employees national insurance 6,000 employers national insurance 1,500

The correct expense for employee costs to be shown in the profit and loss account for April2001 is

A 19,000B 20,000C 20,400D 21,500

The answer is D.

Workings

Net salaries for April 14,000

Tax and employees national insurance 6,000

Employers national insurance 1,500

21,500


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Question 1.21

The following information relates to M Ltd:

At 30 September 2000 1999000 000Stock of raw materials 75 45Work-in-progress stock 60 70Stock of finished goods 100 90

For the year ended 30 September 2000Purchases of raw materials 150,000Manufacturing wages 50,000Factory overheads 40,000

The prime cost of production in the manufacturing account for the year ended 30 September2000 is

A 165,000B 170,000C 210,000D 270,000

The answer is B.

Workings

Prime cost is direct materials and direct labour

Opening stock of raw materials 45,000

Purchases 150,000Closing stock of raw materials (75,000)

Raw materials consumed 120,000

Manufacturing wages 50,000

170,000

Question 1.22

When valuing stock at cost, which of the following shows the correct method of arriving at

cost?

Include inward Includetransport costs production overheads

A Yes NoB No YesC Yes YesD No No

The answer is C.


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Question 1.23

A fixed asset register is

A an alternative name for the fixed asset ledger account.B a list of the physical fixed assets rather than their financial cost.C a schedule of planned maintenance of fixed assets for use by the plant engineer.D a schedule of the cost and other information about each individual fixed asset.

The answer is D.

Question 1.24

The difference between a profit and loss account (which may also be referred to as an

income statement) and an income and expenditure account is that

A an income and expenditure account is an international term for a profit and lossaccount.

B a profit and loss account is prepared for a business and an income and expenditureaccount is prepared for a not-for-profit making organisation.

C a profit and loss account is prepared on an accruals basis and an income andexpenditure account is prepared on a cash flow basis.

D a profit and loss account is prepared for a manufacturing business and an incomeand expenditure account is prepared for a non-manufacturing business.

The answer is B.

Question 1.25

In a debtors report, which one of the following would you NOT expect to see?

A Total debtor balances outstanding for current and previous months.B Debtor balances excluding VAT.C Credit limit.D Sales to date.

The answer is B.


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Question 2

A sole proprietor produces a trial balance at the year end and some information aboutadjustments, from which financial statements should be prepared.

(a) Prepare a trading, profit and loss account for the year ended 31st July 2000 and abalance sheet at that date. (14 marks)(b) Calculate the following, as at 31 July 2000:

current ratio; gearing; debtor days. (6 marks)

Total marks = 20

Rationale

The purpose of this question is:(a) To test a candidate's ability to prepare final statements from a trial balance, after makingadjustments.

(b) To test a candidate's knowledge of ratios and their calculations.

Suggested Approach

Part (a)

Produce financial statements as described above.

Part (b)

Calculate three ratios from the accounts prepared above.

Marking Guide Marks awarded

Part (a)The question requires the correct identification of which items in thetrial balance are entered into the profit and loss account or balancesheet.

It requires adjustments for stock, accruals, prepayments, doubtfuldebts and depreciation. In each case, the correct adjustment must bemade in the profit and loss account and in the balance sheet. 2

The profit and loss account and the balance sheet should each be setout with titles and major headings These headings include gross profit,net profit, fixed assets, current assets, current liabilities, capital andlong-term liabilities.

The balance sheet should articulate with the profit and loss accountusing the own number rule.

Own number rule: the balance sheet should be consistent with thecandidates own results from the profit and loss account.

6 (Balance sheet)6 (Profit & Loss)


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Part (b)

The gearing ratio may be calculated in two different ways and theseare acceptable alternative answers.

The question asks for stock debtor days, not months.

Candidates are rewarded for the correct use of their own results frompart (a), when calculating the ratios.

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Examiners Comments

The answers to part (a) were generally good. Most candidates were able to prepare financialstatements which were numerically correct and which conformed to an acceptable style ofpresentation.

The answers to part (b) were generally of a pass standard. Candidates were asked tocalculate three ratios but a number of mistakes were made, such as the numerator and

denominator the wrong way round, or using inappropriate figures in the ratio. The ownnumber rule was applied and the correct use of figures from a candidates own financialstatements in part (a) was awarded marks.


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Question 3

The trial balance of E Ltd did not balance and the following errors have been discovered:(i) A cheque for 1,000 received from a debtor had been credited to the sales account

and debited to the bank account.(ii) The cash book had been undercast by 250.(iii) A machine costing 5,000 had been debited to the machinery repairs account.

Machinery is depreciated at 10% on cost and no residual value is assumed.

(a) Correct the above errors by showing which ledger accounts should be debited orcredited. (4 marks)

(b) Explain why financial controls are necessary and give TWO examples. (6 marks)

Total marks = 10

Rationale

(a) The purpose of the question is to test a candidate's understanding of errors and theircorrection using principles of double entry.

(b) The purpose of this question is to test a candidate's understanding of financial controls.

Suggested Approach

Part (a)

A schedule of journal entry columns labelled Debit and Credit may be presented, whichshows the ledger accounts to be debited/credited and the amount. Alternatively, acandidate may show the ledger accounts.

Part (b)

A brief explanation should be provided with relevant examples.


Part (a)It is important both to identify the ledger account and the amount to bedebited or credited.

It is important to recognise where a one-sided entry may be required.

It is important to identify situations where the error may have asecondary effect in part (iii) the error affects the machinery accountand the depreciation charge. 4

Part (b)

There are two parts to this question an explanation and twoexamples. These are marked as overlapping parts; it is thereforepossible to gain extra marks for a good explanation and vice versaforgood examples.Furthermore, there are separate marks for eachexample. 6


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Examiners Comments

The answers to part (a) were acceptable, although the answers to (i) and (iii) were better than(ii). This was probably because it was necessary to recognise in (ii) that the error would affectthe trial balance balancing.

Many candidates provided a very full answer to part (b) and a large variety of acceptableexamples was given. The suggested answer should therefore be seen as only indicative ofwhat was expected in an answer to a six mark question.


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Question 4

(a) Define depreciation. (2 marks)

(b) State the purpose of depreciation. (4 marks)

(c) A transport company conducts various transactions related to motor vehicles.

Write up the following ledger accounts:Motor vehicle cost account (4 marks)Provision for depreciation on motor vehicles account (6 marks)Disposal of motor vehicles account. (4 marks)

You should include entries for each relevant year, and work to the nearest .

Total marks = 20

Rationale

The purpose of this question is to test a candidate's understanding of the nature and purposeof depreciation. The candidate is then required to apply this knowledge and understanding toa practical situation.

Suggested Approach

Parts (a) and (b)

A brief definition should be provided followed by an explanation of the purpose ofdepreciation.

Part (c)

The approach is first to calculate for each vehicle the cost and depreciation charge foreach year. This may be shown in a columnar format. This information may then beshown, in total, in the ledger accounts.


Part (a)There is no single definition of depreciation and a direct quotation froma standard is not required. The important points are (i) that it is ameasure of an expense and (ii) the reasons why this expense occurs(wearing out, time and obsolescence). It is important for candidates todemonstrate their understanding that it is not a method of valuing a

fixed asset. 2

Part (b)

A good statement on the purpose of depreciation should include (i)that it is an expense which is incurred over the life of an asset, and (ii)that it is an application of the accruals concept. 4


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Part (c)

This is a comprehensive question. It includes: the purchase and sale of vehicles; the purchase of vehicles part way through a financial year; the sale of vehicles part way through a financial year;

residual values of vehicles; part-exchange of vehicles; the profit and loss on the sale of vehicles; straight line method of depreciation; reducing balance method of depreciation.

These are recorded in the: motor vehicle cost accountprovision for depreciation accountmotor vehicle disposal account

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A correct answer would show that the candidate could account for allof these situations.

The own number rule will apply; where, for example, a candidatecalculates a depreciation charge on a vehicle incorrectly, but thenshows this figure correctly in the ledger accounts, marks will only beforgone once.

Examiners Comments

A majority of candidates were able to provide a satisfactory definition of depreciation in part(a). However, a minority did make the mistake of defining depreciation as a means ofreplacing an asset or valuing an asset, which is not correct.

In part (b), most candidates referred to the allocation of the cost of a fixed asset over its

useful economic life. Fewer candidates made reference to the matching of this expense to thebenefits from using the asset.

Part (c) is a traditional question on depreciation and it was surprising how many candidatesdid not comply with the question. The question asked for the ledger accounts; too manycandidates provided workings in a columnar format but did not transfer these to ledgeraccounts. The question also asked for separate vehicle cost accounts and provision fordepreciation accounts. Some candidates attempted to combine these and in doing so mademistakes.


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Question 5

(a) State the rule for valuing stock. (2 marks)

(b) Explain the purposes of the rule for valuing stock. (8 marks)

(c) Trading and stock figures are given for a limited company.

(i) Calculate gross profit if the trading account was prepared using a stock valuationbasis of LIFO. (2 marks)

(ii) Calculate stock days, using the average method, on the assumption that stock isvalued: on the FIFO basis; on the LIFO basis. (3 marks)

(iii) Identify and explain any change in the gross profit and in stock days as aconsequence of using LIFO rather than FIFO to value stock. (5 marks)

Total marks = 20

Rationale

The purpose of this question is to test whether a candidate is able to state the rule for valuingstock and then relate this to the purpose of valuing stock. The candidate is then required toapply this knowledge and understanding to a practical situation, with reference to the FIFOand LIFO methods of stock valuation.

Suggested Approach

Parts (a) and (b)

A brief statement of the rule should be provided, followed by the purpose of this rule forvaluing stock.

Part (c)

Candidates should produce a revised trading account using LIFO rather than FIFO andcalculate stock days, using both LIFO and FIFO. Candidates should then be able toexplain the differences in profit and 'stock days.


There is no single definition of the rule for valuing stock and a directquotation from a standard is not required. The important points are that

cost and net realisable value are two possible methods, and these arecombined in a single rule. 2

An explanation of the purposes of the rule for valuing stock shouldinclude the fact that it is necessary both to measure the expense ofcost of sales in the trading account and to measure the asset of stockin the balance sheet. This treatment is supported by the concepts ofmatching and prudence. 8


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In part (c)(i), all the figures are given and the candidate needs tosubstitute the correct figures in the trading account. 2

In (ii), the candidate needs to know how to calculate stock days andto repeat this for LIFO and FIFO. 3

In (iii), the candidate needs to appreciate the fact that as the LIFOstock valuation is lower than the FIFO stock valuation this implies thatprices of stock items are rising. Thus the gross profit is lower whenLIFO is used because it uses more up-to-date prices. Similarly, thereis a dual effect of using up-to-date (LIFO method) prices on stock days- cost of sales is higher and stock valuation is lower, hence the effecton stock days. 5

The own number rule will apply; where, for example, a candidatecalculates the trading account incorrectly but then uses these figurescorrectly to calculate stock days, then marks will only be forgone once.

Examiners Comments

The marks for parts (a) and (b) were very high; most candidates knew the rule for valuingstock and the purposes of this rule. Part (c), the numerical section, was less well answered.Although most could re-calculate gross profit in part (i) using LIFO, there were many mistakesin part (ii) on calculating stock days. This confirms the statement made in question 2(b)regarding the calculation of ratios.

Few candidates approached part (c)(iii) logically. A candidate should have considered theeffect on the cost of goods sold of changing from FIFO to LIFO and how this would affect thegross profit. Stock days has two components and a candidate needed to assess the effect ofchanging from FIFO to LIFO for each component and then the overall effect on stock days.

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