ACCA Accounting Technician Apprenticeship (Level 4 Trailblazer)

Technician Role Simulation

Specimen Exam applicable from April 2017

Time allowed: 3 hours 15 minutes

This question paper is divided into two sections:

Section 1 – Pre-seen Role Simulation Material

Section 2 – ALL THREE questions are compulsory and MUST be attempted

Do NOT open this question paper until instructed by the supervisor.

You must NOT write in your answer booklet until instructed by the supervisor.

Do NOT record any of your answers on the question paper.

This question paper must not be removed from the examination hall. Tech

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The Association of Chartered Certified

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Section 1 – Pre-seen Role Simulation material

EcoDream Ltd

Background

EcoDream Ltd is a retailer based in the north-west of England. It sells eco and ethical fashion online and through independent clothing retailers. The clothes it sells are made from sustainable materials like organic cotton, bamboo, wool and recycled plastic. The company sources its products from ethical and environmentally friendly producers in the UK and from overseas.

EcoDream Ltd’s company structure

EcoDream Ltd was founded by Peter and Jane Russell 10 years ago. They hold all the company shares 55:45 respectively. They no longer take an active part in the day-to-day running of the business; instead they have appointed Ted Jones as the managing director to manage the company. The shareholders are keen to understand how EcoDream Ltd’s performance and position compares to the industry average. The company is known to pay its staff higher discretionary bonuses than is normal for the industry.

The company operates under the following structure:

*You are the Apprentice Accountant and you report directly to Michael Watson.

Accounting information for EcoDream Ltd

The financial year end for EcoDream Ltd is 31 October 20X6. A first draft of the financial statements is always prepared by Michael Watson with the help of an apprentice accountant.

Ted JonesManagingDirector

ProductionDirector

Sales andMarketingDirector

Purchasing andSupply Director

HumanResourceDirector

PrintingDepartment

Website Team Overseas BuyerMichael Watson

Accountant HR Adviser

Sales Team UK Buyer ApprenticeAccountant*

Finance Director

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Michael Watson has extracted the following balances from the company’s accounting system as at 31 October 20X6.

£000Cash in hand 25Inventory at 1 November 20X5 360Administrative expenses 265Distribution expenses 166Marketing expenses 400Wages and salaries 685Retained earnings at 1 November 20X5 351Allowance for receivables at 1 November 20X5 80Revenue 6,140Suspense account 20 CrBank overdraft 95Trade payables 300Loan stock interest 35Bad debts written off 150Trade receivables 900Purchases 3,6207% Loan stock (long term) 500£1 Ordinary shares 2,000Accumulated depreciation at 1 November 20X5: Buildings 360 Motor vehicles 100 Furniture and equipment 430Buildings at cost 2,320Motor vehicles at cost 250Furniture and equipment at cost 1,200

The ACCA Code of Ethics and Conduct

The finance director has recently circulated a copy of Section 3 from the ACCA Rule Book on the Code of Ethics and Conduct (Appendix 1) and asked you to familiarise yourself with Part A: General Application of the Code, paying particular attention to the five fundamental principles.

Purchasing

EcoDream Ltd has negotiated above-average trade discounts with a number of key suppliers and is therefore able to source products at a cheaper price than its competitors. The trade discounts are based on the volume of goods purchased. High levels of inventory have been held throughout the year.

Future plans

EcoDream Ltd wants to invest in new equipment which will enable it to print its own designs directly onto plain organic cotton t-shirts using environmentally friendly inks. It is considering two mutually exclusive investment options to improve profitability. The directors are keen to improve the company’s procedures and controls relating to expenditure.

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Appendix 1 – Extract from ACCA Rule Book

100 Introduction and fundamental principles

SECTION 100Introduction and fundamental principles

100.1 A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest. Therefore, a professional accountant’s responsibility is not exclusively to satisfy the needs of an individual client or employer. In acting in the public interest, a professional accountant shall observe and comply with this Code. If a professional accountant is prohibited from complying with certain parts of this Code by law or regulation, the professional accountant shall comply with all other parts of this Code.

100.2 This Code contains three parts. Part A establishes the fundamental principles of professional ethics for professional accountants and provides a conceptual framework that professional accountants shall apply to:

(a) Identify threats to compliance with the fundamental principles;

(b) Evaluate the significance of the threats identified; and

(c) Apply safeguards, when necessary, to eliminate the threats or reduce them to an acceptable level. Safeguards are necessary when the professional accountant determines that the threats are not at a level at which a reasonable and informed third party would be likely to conclude, weighing all the specific facts and circumstances available to the professional accountant at that time, that compliance with the fundamental principles is not compromised.

A professional accountant shall use professional judgment in applying this conceptual framework.

100.3 Parts B and C describe how the conceptual framework applies in certain situations. They provide examples of safeguards that may be appropriate to address threats to compliance with the fundamental principles. They also describe situations where safeguards are not available to address the threats, and consequently, the circumstance or relationship creating the threats shall be avoided. Part B applies to professional accountants in public practice. Part C applies to professionalaccountants in business. Professional accountants in public practice may also findPart C relevant to their particular circumstances.

100.4 The use of the word “shall” in this Code imposes a requirement on the professional accountant or firm to comply with the specific provision in which “shall” has been used. Compliance is required unless an exception is permitted by this Code.

Fundamental principles100.5 A professional accountant shall comply with the following fundamental principles:

(a) Integrity – to be straightforward and honest in all professional and business relationships.

(b) Objectivity – to not allow bias, conflict of interest or undue influence of others to override professional or business judgments.

(c) Professional Competence and Due Care – to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional services based on current developments in practice, legislation and techniques and act diligently and in accordance with applicable technical and professional standards.

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100 Introduction and fundamental principles

(d) Confidentiality – to respect the confidentiality of information acquired as a result of professional and business relationships and, therefore, not disclose any such information to third parties without proper and specific authority, unless there is a legal or professional right or duty to disclose, nor use the information for the personal advantage of the professional accountant or third parties.

(e) Professional Behavior – to comply with relevant laws and regulations and avoid any conduct that discredits the profession.

Each of these fundamental principles is discussed in more detail in Sections 110–150.

Conceptual framework approach100.6 The circumstances in which professional accountants operate may create specific

threats to compliance with the fundamental principles. It is impossible to define every situation that creates threats to compliance with the fundamental principles and specify the appropriate action. In addition, the nature of engagements and work assignments may differ and, consequently, different threats may be created, requiring the application of different safeguards. Therefore, this Code establishes a conceptual framework that requires a professional accountant to identify, evaluate, and address threats to compliance with the fundamental principles. The conceptual framework approach assists professional accountants in complying with the ethical requirements of this Code and meeting their responsibility to act in the public interest. It accommodates many variations in circumstances that create threats to compliance with the fundamental principles and can deter a professional accountant from concluding that a situation is permitted if it is not specifically prohibited.

100.7 When a professional accountant identifies threats to compliance with the fundamental principles and, based on an evaluation of those threats, determines that they are not at an acceptable level, the professional accountant shall determine whether appropriate safeguards are available and can be applied to eliminate the threats or reduce them to an acceptable level. In making that determination, the professional accountant shall exercise professional judgment and take into account whether a reasonable and informed third party, weighing all the specific facts and circumstances available to the professional accountant at the time, would be likely to conclude that the threats would be eliminated or reduced to an acceptable level by the application of the safeguards, such that compliance with the fundamental principles is not compromised.

100.8 A professional accountant shall evaluate any threats to compliance with the fundamental principles when the professional accountant knows, or could reasonably be expected to know, of circumstances or relationships that may compromise compliance with the fundamental principles.

100.9 A professional accountant shall take qualitative as well as quantitative factors into account when evaluating the significance of a threat. When applying the conceptual framework, a professional accountant may encounter situations in which threats cannot be eliminated or reduced to an acceptable level, either because the threat is too significant or because appropriate safeguards are not available or cannot be applied. In such situations, the professional accountant shall decline or discontinue the specific professional service involved or, when necessary, resign from the engagement (in the case of a professional accountant in public practice) or the employing organization (in the case of a professional accountant in business).

100.10 Sections 290 and 291 contain provisions with which a professional accountant shall comply if the professional accountant identifies a breach of an independence provision of the Code. If a professional accountant identifies a breach of any other

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provision of this Code, the professional accountant shall evaluate the significance of the breach and its impact on the accountant’s ability to comply with the fundamental principles. The accountant shall take whatever actions that may be available, as soon as possible, to satisfactorily address the consequences of the breach. The accountant shall determine whether to report the breach, for example, to those who may have been affected by the breach, a member body, relevant regulator or oversight authority.

100.11 When a professional accountant encounters unusual circumstances in which the application of a specific requirement of the Code would result in a disproportionate outcome or an outcome that may not be in the public interest, it is recommended that the professional accountant consult with ACCA or the relevant regulator.

Threats and safeguards 100.12 Threats may be created by a broad range of relationships and circumstances. When a

relationship or circumstance creates a threat, such a threat could compromise, or could be perceived to compromise, a professional accountant’s compliance with the fundamental principles. A circumstance or relationship may create more than one threat, and a threat may affect compliance with more than one fundamental principle. Threats fall into one or more of the following categories:

(a) Self-interest threat – the threat that a financial or other interest will inappropriately influence the professional accountant’s judgment or behavior;

(b) Self-review threat – the threat that a professional accountant will not appropriately evaluate the results of a previous judgment made or service performed by the professional accountant, or by another individual within the professional accountant’s firm or employing organization, on which the accountant will rely when forming a judgment as part of providing a current service;

(c) Advocacy threat – the threat that a professional accountant will promote a client’s or employer’s position to the point that the professional accountant’s objectivity is compromised;

(d) Familiarity threat – the threat that due to a long or close relationship with a client or employer, a professional accountant will be too sympathetic to their interests or too accepting of their work; and

(e) Intimidation threat – the threat that a professional accountant will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the professional accountant.

Parts B and C of this Code explain how these categories of threats may be created for professional accountants in public practice and professional accountants in business, respectively. Professional accountants in public practice may also find Part C relevant to their particular circumstances.

100.13 Safeguards are actions or other measures that may eliminate threats or reduce them to an acceptable level. They fall into two broad categories:

(a) Safeguards created by the profession, legislation or regulation; and

(b) Safeguards in the work environment.

100.14 Safeguards created by the profession, legislation or regulation include:

• Educational, training and experience requirements for entry into the profession.

• Continuing professional development requirements.

• Corporate governance regulations.

• Professional standards.

100 Introduction and fundamental principles

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• Professional or regulatory monitoring and disciplinary procedures.

• External review by a legally empowered third party of the reports, returns,communications or information produced by a professional accountant.

100.15 Parts B and C of this Code discuss safeguards in the work environment for professional accountants in public practice and professional accountants in business, respectively.

100.16 Certain safeguards may increase the likelihood of identifying or deterring unethical behavior. Such safeguards, which may be created by the accounting profession, legislation, regulation, or an employing organization, include:

• Effective, well-publicized complaint systems operated by the employingorganization, the profession or a regulator, which enable colleagues, employers and members of the public to draw attention to unprofessional or unethical behavior.

• An explicitly stated duty to report breaches of ethical requirements.

Conflicts of interest100.17 A professional accountant may be faced with a conflict of interest when undertaking a

professional activity. A conflict of interest creates a threat to objectivity and may create threats to the other fundamental principles. Such threats may be created when:

• The professional accountant undertakes a professional activity related to aparticular matter for two or more parties whose interests with respect to thatmatter are in conflict; or

• The interests of the professional accountant with respect to a particular matterand the interests of a party for whom the professional accountant undertakes aprofessional activity related to that matter are in conflict.

100.18 Parts B and C of this Code discuss conflicts of interest for professional accountants in public practice and professional accountants in business, respectively.

Ethical conflict resolution100.19 A professional accountant may be required to resolve a conflict in complying with

the fundamental principles.

100.20 When initiating either a formal or informal conflict resolution process, the following factors, either individually or together with other factors, may be relevant to the resolution process:

(a) Relevant facts;

(b) Ethical issues involved;

(c) Fundamental principles related to the matter in question;

(d) Established internal procedures; and

(e) Alternative courses of action.

Having considered the relevant factors, a professional accountant shall determine the appropriate course of action, weighing the consequences of each possible course of action. If the matter remains unresolved, the professional accountant may wish to consult with other appropriate persons within the firm or employing organization for help in obtaining resolution.

100.21 Where a matter involves a conflict with, or within, an organization, a professional accountant shall determine whether to consult with those charged with governance of the organization, such as the board of directors or the audit committee.

100 Introduction and fundamental principles

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100.22 It may be in the best interests of the professional accountant to document the substance of the issue, the details of any discussions held, and the decisions made concerning that issue.

100.23 If a significant conflict cannot be resolved, a professional accountant may consider obtaining professional advice from ACCA or from legal advisors. The professional accountant generally can obtain guidance on ethical issues without breaching the fundamental principle of confidentiality if the matter is discussed with ACCA on an anonymous basis or with a legal advisor under the protection of legal privilege.

100.24 If, after exhausting all relevant possibilities, the ethical conflict remains unresolved, a professional accountant shall, unless prohibited by law, refuse to remain associated with the matter creating the conflict. The professional accountant shall determine whether, in the circumstances, it is appropriate to withdraw from the engagement team or specific assignment, or to resign altogether from the engagement, the firm or the employing organization.

Communicating with those charged with governance100.25 When communicating with those charged with governance in accordance with the

provisions of this Code, the professional accountant or firm shall determine, having regard to the nature and importance of the particular circumstances and matter to be communicated, the appropriate person(s) within the entity’s governance structure with whom to communicate. If the professional accountant or firm communicates with a subgroup of those charged with governance, for example, an audit committee or an individual, the professional accountant or firm shall determine whether communication with all of those charged with governance is also necessary so that they are adequately informed.

100.26 In some cases, all of those charged with governance are involved in managing the entity, for example, a small business where a single owner manages the entity and no one else has a governance role. In these cases, if matters are communicated with person(s) with management responsibilities, and those person(s) also have governance responsibilities, the matters need not be communicated again with those same person(s) in their governance role. The professional accountant or firm shall nonetheless be satisfied that communication with person(s) with management responsibilities adequately informs all of those with whom the professional accountant or firm would otherwise communicate in their governance capacity.

100 Introduction and fundamental principles

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SECTION 110Integrity

110.1 The principle of integrity imposes an obligation on all professional accountants to be straightforward and honest in all professional and business relationships. Integrity also implies fair dealing and truthfulness.

110.2 A professional accountant shall not knowingly be associated with reports, returns, communications or other information where the professional accountant believes that the information:

(a) Contains a materially false or misleading statement;

(b) Contains statements or information furnished recklessly; or

(c) Omits or obscures information required to be included where such omission or obscurity would be misleading.

When a professional accountant becomes aware that the accountant has been associated with such information, the accountant shall take steps to be disassociated from that information.

110.3 A professional accountant will be deemed not to be in breach of paragraph 110.2 if the professional accountant provides a modified report in respect of a matter contained in paragraph 110.2.

110 Integrity

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120 Objectivity

SECTION 120Objectivity

120.1 The principle of objectivity imposes an obligation on all professional accountants not to compromise their professional or business judgment because of bias, conflict of interest or the undue influence of others.

120.2 A professional accountant may be exposed to situations that may impair objectivity. It is impracticable to define and prescribe all such situations. A professional accountant shall not perform a professional service if a circumstance or relationship biases or unduly influences the accountant’s professional judgment with respect to that service.

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130 Professional competence and due care

SECTION 130Professional competence and due care

130.1 The principle of professional competence and due care imposes the following obligations on all professional accountants:

(a) To maintain professional knowledge and skill at the level required to ensure that clients or employers receive competent professional service; and

(b) To act diligently in accordance with applicable technical and professional standards when providing professional services.

130.2 Competent professional service requires the exercise of sound judgment in applying professional knowledge and skill in the performance of such service. Professional competence may be divided into two separate phases:

(a) Attainment of professional competence; and

(b) Maintenance of professional competence.

130.3 The maintenance of professional competence requires a continuing awareness and an understanding of relevant technical, professional and business developments. Continuing professional development enables a professional accountant to develop and maintain the capabilities to perform competently within the professional environment.

130.4 Diligence encompasses the responsibility to act in accordance with the requirements of an assignment, carefully, thoroughly and on a timely basis.

130.5 A professional accountant shall take reasonable steps to ensure that those working under the professional accountant’s authority in a professional capacity have appropriate training and supervision.

130.6 Where appropriate, a professional accountant shall make clients, employers or other users of the accountant’s professional services aware of the limitations inherent in the services.

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140 Confidentiality

SECTION 140Confidentiality

140.1 The principle of confidentiality imposes an obligation on all professional accountants to refrain from:

(a) Disclosing outside the firm or employing organization confidential information acquired as a result of professional and business relationships without proper and specific authority or unless there is a legal or professional right or duty to disclose; and

(b) Using confidential information acquired as a result of professional and business relationships to their personal advantage or the advantage of third parties.

140.2 A professional accountant shall maintain confidentiality, including in a social environment, being alert to the possibility of inadvertent disclosure, particularly to a close business associate or a close or immediate family member.

140.3 A professional accountant shall maintain confidentiality of information disclosed by a prospective client or employer.

140.4 A professional accountant shall maintain confidentiality of information within the firm or employing organization.

140.5 A professional accountant shall take reasonable steps to ensure that staff under the professional accountant’s control and persons from whom advice and assistance is obtained respect the professional accountant’s duty of confidentiality.

140.6 The need to comply with the principle of confidentiality continues even after the end of relationships between a professional accountant and a client or employer. When a professional accountant changes employment or acquires a new client, the professional accountant is entitled to use prior experience. The professional accountant shall not, however, use or disclose any confidential information either acquired or received as a result of a professional or business relationship.

140.7 As a fundamental principle, confidentiality serves the public interest because it facilitates the free flow of information from the professional accountant’s client or employing organization to the professional accountant. Nevertheless, the following are circumstances where professional accountants are or may be required to disclose confidential information or when such disclosure may be appropriate:

(a) Disclosure is permitted by law and is authorized by the client or the employer;

(b) Disclosure is required by law, for example:

(i) Production of documents or other provision of evidence in the course of legal proceedings; or

(ii) Disclosure to the appropriate public authorities of infringements of the law that come to light; and

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140 Confidentiality

(c) There is a professional duty or right to disclose, when not prohibited by law:

(i) To comply with the quality review of ACCA or another professional body;

(ii) To respond to an inquiry or investigation by ACCA or a regulatory body;

(iii) To protect the professional interests of a professional accountant in legal proceedings; or

(iv) To comply with technical and professional standards, including ethical requirements.

140.8 In deciding whether to disclose confidential information, relevant factors to consider include:

(a) Whether the interests of all parties, including third parties whose interests may be affected, could be harmed if the client or employer consents to the disclosure of information by the professional accountant;

(b) Whether all the relevant information is known and substantiated, to the extent it is practicable; when the situation involves unsubstantiated facts, incomplete information or unsubstantiated conclusions, professional judgment shall be used in determining the type of disclosure to be made, if any;

(c) The type of communication that is expected and to whom it is addressed; and

(d) Whether the parties to whom the communication is addressed are appropriate recipients.

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150 Professional behavior

SECTION 150Professional behavior

150.1 The principle of professional behavior imposes an obligation on all professional accountants to comply with relevant laws and regulations and avoid any conduct that the professional accountant knows or should know may discredit the profession. This includes conduct that a reasonable and informed third party, weighing all the specific facts and circumstances available to the professional accountant at that time, would be likely to conclude adversely affects the good reputation of the profession.

150.2 In marketing and promoting themselves and their work, professional accountants shall not bring the profession into disrepute. Professional accountants shall be honest and truthful and not:

(a) Make exaggerated claims for the services they are able to offer, the qualifications they possess, or experience they have gained; or

(b) Make disparaging references or unsubstantiated comparisons to the work of others.

150.3 A professional accountant shall behave with courtesy and consideration towards all with whom the professional accountant comes into contact in a professional capacity.

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This is a blank page.Section 2 begins on page 16.

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Section 2 – Further information and questions

ALL THREE questions are compulsory and MUST be attempted

1 Michael Watson has been taken ill and will be off work for at least a month. The finance director has asked you to prepare the draft financial statements for EcoDream Ltd for the year ended 31 October 20X6 in accordance with IAS 1. Before Michael was taken ill, he had extracted the following balances from the company’s accounting system as at 31 October 20X6.

£000 Cash in hand 25 Inventory at 1 November 20X5 360 Administrative expenses 265 Distribution expenses 166 Marketing expenses 400 Wages and salaries 685 Retained earnings at 1 November 20X5 351 Allowances for receivables 80 Revenue 6,140 Suspense account 20 Cr Bank overdraft 95 Trade payables 300 Loan stock interest 35 Bad debts written off 150 Trade receivables 900 Purchases 3,620 7% Loan stock (long term) 500 £1 Ordinary shares 2,000 Accumulated depreciation at 1 November 20X5: Buildings 360 Motor vehicles 100 Furniture and equipment 430 Buildings at cost 2,320 Motor vehicles at cost 250 Furniture and equipment at cost 1,200

You have looked through all Michael’s files with the titles ‘Closure of Year End Accounts 20X6’ and identified the following information as important to preparing the financial statements:

1. Buildings are depreciated at 5% of cost. At 31 October 20X6, the buildings were independently professionally valued at £2,500,000 and the managing director wants this valuation to be incorporated into the accounts. The buildings have not previously been revalued. All expenses relating to the buildings are charged to administrative expenses.

2. Depreciation on motor vehicles is charged at 20% on the residual value basis. Depreciation on motor vehicles should be allocated to distribution expenses. Depreciation of furniture and equipment is to be charged at 20% of cost. The depreciation expense should be allocated to administrative expenses.

You also find a file note from the sales and marketing director which states that:

3. Inventory at 31 October 20X6 was valued at £300,000 based on its original cost. However, £55,000 of this inventory has been in the warehouse for over two years and it has been agreed to sell it to an independent retailer in November 20X6 for a cash price of £40,000.

4. The marketing expenses figure of £400,000 also includes £24,000 which relates to November 20X6. The marketing expenses should be allocated to administrative expenses.

5. Based on past experience, the allowance for receivables needs to be increased to 10% of trade receivables. Bad debts written off in the year have already been deducted in arriving at the trade receivables balance in the trial balance. Expenses relating to bad and doubtful debts are included within administrative expenses.

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6. There are wages and salaries outstanding of £50,000 for the year ended 31 October 20X6. The wages and salaries expenses should be allocated to administrative expenses.

7. Following an investigation, the £20,000 credit balance held in the suspense account should be posted to purchases to close off the account.

8. Corporation tax of £200,000 is to be provided for the year.

The purchasing and supply director has sent the following memo for your attention:

Required:

(a) Prepare the following draft statements in accordance with IAS 1:

(i) the statement of profit or loss and other comprehensive income for the year ended 31 October 20X6; and (15 marks)

(ii) the statement of financial position as at 31 October 20X6. (12 marks)

(b) Write an appropriately worded and confidential email to the human resources director regarding any ethical issues which you consider important from the memorandum you received from the purchasing and supply director. You should make reference to the five fundamental principles outlined in Section 3 of The ACCA Rule Book on the Code of Ethics and Conduct. (13 marks)

(40 marks)

Memorandum

To: Apprentice accountant

From: Purchasing and supply director

Re: Cost of supplies

I have become increasingly concerned about the cost of the clothes we buy from ethical sources. I have mentioned this to Michael Watson before but, as he is currently off, I thought I would speak with you instead.

Sourcing ethical and eco-friendly clothing is very expensive, even with the favourable trade discounts we receive. I don’t understand the need for everything to be green myself! I have sourced very similar clothing at a much cheaper price from a supplier who does not claim to be ethical or eco-friendly.

I think we should start buying these goods and selling them alongside our other products. This will improve our financial performance as the gross margin will be better on these products. I know this is not in keeping with our business model, so I suggest that we don’t tell the managing director or our customers about the change and continue to sell these goods as if they were ethical and eco-friendly.

I will raise the invoices from the new supplier and you can process them. No one else needs to know. This should lead to bigger profits for EcoDream Ltd and hopefully bigger bonuses for us. Let me know what you think.

Regards

Purchasing and supply director

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2 The finance director has been asked to prepare a report for Peter and Jane Russell, the owners of EcoDream Ltd, about the financial performance and position of the company.

The table below shows some average ratios the finance director has obtained relating to the industry for 20X6.

Ratio Industry average 20X6 Gross profit percentage (%) 35·3 Net profit percentage (%) 10·0 Quick/Acid test ratio 2·5 Inventory turnover period (days) 15·0 Receivables collection period (days) 42·0 Return on capital employed (%) 14·2 Earnings per share (pence) 25·0

Required:

Using ratio analysis, prepare a brief report for the finance director on the financial performance of EcoDream Ltd for the year ended 31 October 20X6. You should calculate the ratios using the figures from the draft financial statements you have prepared in question 1.

The following information should be included in your report:

– A calculation of each of the following ratios for the year ended 31 October 20X6:

(i) Gross profit percentage; (ii) Net profit percentage; (iii) Quick/Acid test ratio; (iv) Inventory turnover period; (v) Receivables collection period; (vi) Return on capital employed; (vii) Earnings per share. (7 marks)

– A comparison of each ratio to the industry average ratio with a brief explanation of the reasons for any variation. (14 marks)

– Conclusions regarding EcoDream Ltd’s profitability, efficiency and liquidity and suggestions for how these could be improved. (7 marks)

Report format and style (2 marks)

(30 marks)

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3 The directors of EcoDream Ltd want to invest in new equipment which will enable the company to print its own designs directly on to plain organic cotton t-shirts using environmentally friendly inks. EcoDream Ltd is considering two mutually exclusive investment options to achieve this objective.

The investment will result in either one or two new roles being created, depending on the option selected. The first option is a technologically sophisticated solution and will require a computer aided design (CAD) engineer to be recruited. The second option requires two additional machine operatives.

The finance director estimates the cost of capital to be 14%.

You should assume that neither of the options will increase the working capital of the company. The company also has sufficient funds to meet the capital expenditure required. The directors have identified that the following stakeholder groups will be affected by the proposed investment and would like to consider the impact on them: shareholders, employees, customers, suppliers, local community, environmental groups and regulators.

Using the following data, the finance director would like you to evaluate the two options.

Option 1 Cost (immediate outlay) £200,000

Expected annual net cash flows over a three-year period, with one new role created are:

£ Year 1 120,000 Year 2 60,000 Year 3 80,000

Option 2 Cost (immediate outlay) £120,000

Expected annual net cash flows over a three-year period, with two new roles created are:

£ Year 1 82,000 Year 2 32,000 Year 3 56,000

Discount tables (extract)

Period Discount rates (r) (n) 14% 1 0·877 2 0·769 3 0·675

The company is trying to improve its system of internal controls. The finance director has asked for your advice on the procedures and controls you would expect the company to have in place regarding expenditure and the safeguard of assets.

Required:

(a) Prepare a working paper evaluating the two investment options which includes the following:

(i) A net present value (NPV) calculation for both options; (8 marks)

(ii) A comparison of the two options and a recommendation, with reasons, on which option you consider to be the most appropriate for EcoDream Ltd. (8 marks)

(b) Discuss the impact of the proposed investment in printing equipment on FOUR of the key stakeholders identified by EcoDream Ltd. (8 marks)

(c) Prepare a note, using bullet points, which identifies and explains the procedures and controls you would expect to find in relation to the capital and revenue expenditure of the company and the safeguard of assets.

(6 marks)

(30 marks)

End of Question Paper

Answers

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Level 4 – Trailblazer Specimen Exam AnswersAccounting Technician Apprenticeship and Marking Scheme

Marks1 (a) (i) EcoDream Ltd Statement of profit or loss and other comprehensive income for the year ended 31 October 20X6 0·5

£000 Revenue 6,140 0·5 Cost of sales (a) (3,675 ) 2·5 –––––– Gross profit 2,465 Administrative expenses (b) (1,892 ) 5·5 Distribution expenses (c) (196 ) 1·5 –––––– Profit from operations 377 Finance costs (35 ) 0·5 –––––– Profit before tax 342 Taxation (200 ) 0·5 –––––– Profit for the year 142

Other comprehensive income: 0·5 Gains on building revaluation (W6) 656 3 –––––– Total comprehensive income 798 –––––– –––––– –––– 15 ––––

(a) Cost of sales

£000 Opening inventory 360 0·5 Add purchases (W2) 3,600 1 –––––– 3,960 Less closing inventory (300 – 15) (285 ) 1 –––––– –––– Cost of sales 3,675 2·5 –––––– –––– ––––––

(b) Administrative expenses

£000 Administrative expenses 265 0·5 Marketing expenses (W3) 376 1 Bad debts expenses (W4) 160 1 Wages and salaries (W5) 735 1 Depreciation: Buildings (W6) 116 1 Furniture and equipment (W7) 240 1 –––––– –––– 1,892 5·5 –––––– –––– ––––––

(c) Distribution expenses

£000 Per trial balance 166 0·5 Depreciation: motor vehicles (W8) 30 1 –––– –––– 196 1·5 –––– –––– ––––

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Marks (ii) EcoDream Ltd Statement of financial position as at 31 October 20X6 0·5

£000 £000 Non-current assets Property, plant and equipment (d) 3,150 3·5 Current assets Inventory 285 0·5 Trade receivables (900 – 90) 810 0·5 Prepayments 24 1 Cash in hand 25 1,144 0·5 –––– –––––– Total assets 4,294 –––––– ––––––

Equity and liabilities Equity £1 Ordinary shares 2,000 0·5 Revaluation reserve (W5) 656 1 Retained earnings (£351 + £142) 493 1 –––––– 3,149 Non-current liabilities 7% Loan stock 500 0·5 Current liabilities Trade payables 300 0·5 Corporation tax 200 0·5 Accruals 50 1 Bank overdraft 95 645 0·5 –––– –––––– Total equity and liabilities 4,294 –––––– –––––– –––– 12 ––––

(d) Cost/ Accumulated Annual Revaluation Carrying valuation depreciation depreciation surplus value charge £000 £000 £000 £000 £000 Buildings (W6) 2,320 360 116 656 2,500 1·5 Furniture and equipment (W7) 1,200 430 240 530 1 Motor vehicles (W8) 250 100 130 – 120 1 –––––– –––– –––– –––– –––––– –––– 3,770 890 386 656 3,150 3·5 –––––– –––– –––– –––– –––––– –––– –––––– –––– –––– –––– ––––––

Working papers

W1 Suspense account

£ £ Purchases (to clear account) 20,000 Balance as per TB 20,000 ––––––– ––––––– 20,000 20,000 ––––––– ––––––– ––––––– –––––––

W2 Purchases

£ £ Balance as per TB 3,620,000 Suspense account 20,000 SPL 3,600,000 –––––––––– –––––––––– 3,620,000 3,620,000 –––––––––– –––––––––– –––––––––– ––––––––––

W3 Marketing expenses

£ £ Balance as per TB 400,000 SPL 376,000 Prepayment c/f 24,000 –––––––– –––––––– 400,000 400,000 –––––––– –––––––– –––––––– ––––––––

25

Marks W4 Bad debts expense

£ £ Balance as per TB 150,000 Statement of profit or loss 160,000 Allowance for receivables 10,000 –––––––– –––––––– 160,000 160,000 –––––––– –––––––– –––––––– ––––––––

Allowance for receivables

£ £ Balance c/f 90,000 Balance as per TB 80,000 Increase in allowance 10,000 ––––––– ––––––– 90,000 90,000 ––––––– ––––––– ––––––– –––––––

W5 Wages and salaries

£ £ Balance as per TB 685,000 SPL 735,000 Wages accrued c/f 50,000 –––––––– –––––––– 735,000 735,000 –––––––– –––––––– –––––––– ––––––––

W6 Revaluation reserve

Depreciation on buildings for the year is £2,320,000 x 5% = £116,000.

Therefore, the net book value of the buildings is £1,844,000 at the end of the year, i.e. £2,320,000 – (£360,000 + £116,000) (1 mark).

When the buildings are revalued at the end of the year, a revaluation reserve is created of £656,000, i.e. £2,500,000 – £1,844,000 (1 mark, 1 mark post to OCI. Total 3 to SPL and 1 post to SFP).

W7 Furniture and equipment accumulated depreciation

£ £ Balance c/f 670,000 Balance as per TB 430,000 SPL (20% of £1,200,000) 240,000 –––––––– –––––––– 670,000 670,000 –––––––– –––––––– –––––––– ––––––––

W8 Motor vehicles accumulated depreciation

£ £ Balance c/f 130,000 Balance as per TB 100,000 Statement of profit or loss (20% of (£250,000 – £100,000)) 30,000 –––––––– –––––––– 130,000 130,000 –––––––– –––––––– –––––––– ––––––––

(b) A confidential email to the Human Resources director

(Marks are available for identifying the principle and explaining the principle in the context of the ethical issues up to a maximum of 10 marks. An additional 3 marks are available for an email which is appropriately titled, is written in a professional tone, displays sensitivity to the issues raised, etc)

An example of a well written email which highlights the important issues of ethical concern is included below:

To: HR Director From: Apprentice accountant Sensitivity: Confidential Subject: Ethical issue

Dear HR Director

I would like to bring to your attention a memorandum I received from the purchasing and supplies director recently.

Unfortunately, there are clear ethical breaches indicated in the memorandum regarding the suggestion to source the supply of t-shirts from non-ethical suppliers. I realise that this may be contentious but I felt I needed to bring this to your attention.

First, the intention to deceive the stakeholders of the company, internal and external, shows a clear lack of integrity. There is also a clear breach of professional behaviour indicated by the last paragraph of the memo where the director is suggesting concealment of facts to other stakeholders, including the private shareholders

26

Marks who own and have founded the company on clearly defined environmental and ethical principles. The director

is acting without professional competence or due care as he is planning to abandon the business model in secretly sourcing alternative non-ethical or eco-friendly suppliers.

There is a lack of objectivity in this memorandum as indicated by his motivation to change the purchasing and supplies policy. His intentions are not based on independent judgement as should be exercised by an officer of the company and its mission on behalf of the agent of the shareholders, but by self-interest and personal gain.

I am happy to reply to him and explain my position personally and to give him the opportunity to reply, but I thought I had a duty to let you know that I may be involved in some personal conflict and I may be intimidated if I do so.

I would appreciate any professional advice you can give me.

Regards,

Apprentice accountant –––– 13 –––– 40 ––––

2 Report

For: Finance director By: An apprentice accountant Date: December 20X6 Subject: Ratio analysis of EcoDream Ltd

1 Introduction

1.1 The purpose of this report is to analyse the performance of EcoDream Ltd for the year ended 31 October 20X6 using some key ratios. The ratios have been calculated using the draft financial statements.

2 Ratio analysis (up to 14 marks)

2.1 Appendix A shows the formulae and detailed calculations of six key ratios. Table 1 compares EcoDream’s ratios to the industry average ratios and below there is a brief explanation for the variance.

Table 1: A comparison of ratios with the industry average (see Appendix A)

EcoDream Industry average Gross profit percentage (%) 40·1 35·3 Net profit percentage (%) 5·6 15·0 Quick/Acid test ratio 1·33 2·5 Inventory turnover period (days) 28 15 Receivables collection period (days) 48 42 Return on capital employed (%) 10·3 17·0 Earnings per share (pence) 7·1 25

2.2 Gross profit percentage: EcoDream’s ratio is higher than the industry average which is consistent with the trade discounts received which allow EcoDream to obtain its supplies more cheaply than other companies. EcoDream may also be charging higher (or premium) prices for its products. 2

2.3 Net profit percentage: EcoDream’s ratio is lower than the industry average. This suggests that EcoDream expenses are high in comparison to the industry and may need tighter control. We are told that EcoDream pays above average bonuses which may explain some of the high expenses. 2

2.4 Quick/Acid test: EcoDream’s ratio suggests it should be able to meet its debts as they fall due. However, the industry average is much higher signifying that EcoDream’s liquidity is not as good as its competitors. Although not part of acid test, we are also told that the inventory levels are high this year which causes further working capital management concerns. 2

2.5 Inventory turnover period: EcoDream’s inventory turnover period is considerably higher than the industry average. This is too long compared with the industry. This is probably because EcoDream is carrying too much inventory in order to benefit from volume discounts from suppliers. While purchasing costs are lower, holding and inventory financing costs will be greater and there will also be financing consequences when inventory is written down and sold cheaply the following month. 2

2.6 Receivables collection period: EcoDream’s receivables collection period is considerably higher than the industry average. This may indicate poor credit control and that may be having an adverse impact on the company’s liquidity position. 2

27

Marks 2.7 Return on capital employed: EcoDream is making a good return on capital employed (10·3%) but this is

lower than the industry average (17%). This means that EcoDream is not as an attractive investment to potential investors at this level of return. 2

2.8 Earnings per share: EcoDream’s earnings per share is significantly less than the industry average which means that EcoDream is not as profitable given the level of shareholder investment. 2

–––– 14 ––––

3 Conclusions regarding profitability, efficiency and liquidity

Profitability EcoDream Ltd has a good gross profit percentage (40·1%) because it is gaining volume discounts from

suppliers and possibly because it can charge premium prices. The net profit percentage is much lower than the industry average (5·6%) due to higher expenses, possibly through inefficiencies or paying higher salaries and bonuses. Implementing better controls over general expenditure and reconsidering the level of discretionary bonus paid to employees could help improve the net profit margin. Earnings per share is lower than the industry average which is consistent with the lower net profit percentage and the lower return on capital employed indicated in the report.

Efficiency and liquidity The quick ratio suggests the company does not have any immediate liquidity problems, but the amount of

inventory held is high and receivables days are longer than industry average. Consequently, the cash position is suffering and there is currently an overdraft of £95,000. Implementing tighter credit controls to reduce the trade receivables days would improve the cash position. EcoDream Ltd should review the level of inventory held and the order frequency to ensure that cash is not tied up in inventory and avoid any potential write-downs.

Conclusion Better controls over expenditure would improve EcoDream Ltd’s profitability and tighter controls over receivables

collection periods and inventory levels would help improve both efficiency and liquidity. –––– 7 ––––

Report format and style 2 ––––

Appendix A

Workings:

(i) Gross profit percentage Gross profit x 100 2,465 x 100 = 40·1 % 1 ––––––––– –––––– Revenue 6,140

(ii) Net profit percentage* Net profit before tax x 100 342 x 100 = 5·6 % 1 ––––––––––––––––– –––––– Revenue 6,140

(iii) Quick/Acid test ratio Current assets – inventory :1 859 :1 = 1·33 :1 1 –––––––––––––––––––––– –––– Current liabilities 645

(iv) Inventory turnover period Inventory x 365 285 x 365 = 28 days 1 ––––––––––– –––––– Cost of sales 3,675

(v) Receivables collection period Receivables x 365 810 x 365 = 48 days 1 –––––––––– –––––– Revenue 6,140

(vi) Return on capital employed* Operating profit x 100 377 x 100 = 10·3 % 1 ––––––––––––––– –––––––––––– Capital employed (3,149 + 500)

(vii) Earnings per share Profits on ordinary activities after tax 142 = 7·1 pence 1 ––––––––––––––––––––––––––––––– –––––– Ordinary share capital 2,000 –––– *Alternative definitions are also acceptable. 7 –––– 30 ––––

28

Marks3 Option appraisal working paper

Project 1

Net present value calculation

Year 0 Year 1 Year 2 Year 3 £ £ £ £ Net cash flows (200,000 ) 120,000 60,000 80,000 14% discount factor 1 0·877 0·769 0·675 –––––––– –––––––– ––––––– ––––––– Present value (200,000 ) 105,240 46,140 54,000 3 Net present value 5,380 1 –––––––– ––––––––

Project 2

Net present value calculation

Year 0 Year 1 Year 2 Year 3 £ £ £ £ Net cash flows (120,000 ) 82,000 32,000 56,000 8% discount factor 1 0·877 0·769 0·675 –––––––– –––––––– ––––––– ––––––– Present value (120,000 ) 71,914 24,608 37,800 3 Net present value 14,322 1 –––––––– –––––––– –––– 8 ––––

Comparison of the options (up to 8 marks)

Using the NPV appraisal method, both options have positive returns. However, option 2 provides a higher return of £14,322 compared to option 1 of £5,380. 2

Option 2 requires only £120,000 of investment against the £200,000 of investment required by option 1. The availability of capital is an important consideration. 2

Option 1 would require the recruitment of one highly skilled engineer. EcoDream Ltd must consider how to recruit and retain someone of this calibre. Option 2 would require two additional machine operatives, who are likely to be easier to recruit and manage as we have existing experience with such employees. 2

Recommendation – Based on the above, option 2 should be chosen, as it has the greatest positive impact on shareholder wealth. 2

–––– 8 ––––

Stakeholders – select four (up to 8 marks)

– Shareholders – positively impacted by the project as both had positive NPV, IRR which exceeds cost of capital and both will maximise shareholder wealth. 2

– Employees – two new roles are being created which is good for employee morale. Existing employees may be concerned that their roles will become redundant if the company moves to being more of a manufacturing company than a retailer. Existing employees may also be required to learn new skills. 2

– Customers – an expanded product range will be of interest to customers and they will be satisfied that the products continue to be eco-friendly. New customers might be attracted to the company as a result of the new product offering. 2

– Suppliers – EcoDream Ltd will have a new range of suppliers of ink and plain t-shirts which need to be managed. Existing suppliers may be concerned that volumes will fall if the new product range becomes the focus. The trade discount levels may be dependent on order levels. 2

– Local community – the local community will be positively impacted by the two new roles which are being created. They are likely to see the niche company as being favourable due to the positive connotations associated with eco-friendly companies. 2

– Environmental groups – EcoDream Ltd is likely to be viewed positively by environmental groups due to the ethos of being ethical and environmentally friendly. They may be concerned about the potential energy usage and emissions as a result of the new machinery. 2

– Regulators – operating machinery is potentially dangerous and EcoDream Ltd will need to ensure they comply with relevant health and safety regulations. 2

(Award credit for any other reasonable suggestion) –––– Max 8 ––––

29

Marks Internal controls relating to expenditure and purchase/safeguard of assets (up to 6 marks)

Expenditure and purchase of assets

– Segregation of duties – there is adequate separation of duties for requesting the expenditure, those authorising the expenditure or purchase of non-current assets and the receipt of those goods/custody of those assets. 1

– Use of requisition forms to evidence the goods which are needed and the quantity needed. Requisition forms should be authorised/approved. Staff members making purchasing decisions have the right training, qualifications and personal qualities. 1

– Authorisation and approval – staff have clearly defined levels for authorisation and approval of purchases. It is likely that there will be different levels of authority required depending upon the value of the purchase. 1

Major purchases are likely to require approval by the board of directors. Authorisation should be documented and documentation retained. 1

– The purchasing department should obtain the requisition form and create/consult approved supplier lists 1 to ensure they are purchasing goods which are of the appropriate quality, are ethical/eco-friendly, are at a

competitive price and can be delivered on a timely basis. 1

Safeguarding assets

– Goods – Physical controls – there are adequate measures to ensure that the goods are protected from theft and damage. Inventory is held in an appropriate warehouse to avoid damage. 1

– Assets – Physical controls – assets in a secure and appropriate area, with security if necessary and ensuring the assets are appropriately maintained. 1

–––– Max 6 –––– 30 ––––