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SCHOOL OF ACCOUNTING

ACCT 1511: Accounting and Financial Management 1B

FINAL EXAMINATION

October/November 2008 Time Allowed: 3 Hours Reading Time: 10 minutes Total Number of Questions: 7

Answer ALL questions. The questions are NOT of equal value. • Answers to Questions 1 to 6 must be written in ink on the lines or in

spaces provided in this Booklet.

• Question 7 must be answered on the separate Generalised Answer Sheet provided using a 2B pencil.

This paper is NOT to be retained by the candidate.

DO NOT OPEN THIS PAPER UNTIL INSTRUCTED BY THE EXAM

SUPERVISOR

Official Use Only

Q Mark

1

2

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Total (/75)

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QUESTION 1 (15 MARKS): CASH FLOW STATEMENTS Part A: (10 marks) NoWhere Community College (NWCC) is a not-for-profit educational organisation which, like most traditional non-profit organisations, uses cash-based accounting in preparing its financial statements. Recently, NWCC has been seeking to re-finance a $250,000 mortgage loan on a property that it owns. To facilitate the loan application, the accountant of NWCC has prepared the following schedule of sources and uses of cash for the year ending 30 June 2008.

Sources of cash: From tuition $450,000 From other fees 140,000 From bookstore revenue 220,000 From interest on investment 6,000 From disposal of investment 18,000 From issuance of note for equipment 50,000 From depreciation 30,000 Total sources of cash $914,000 Uses of cash: For salaries & wages $380,000 For utilities expense 85,000 For purchase of insurance 26,000 For rental payment 33,000 For purchase of equipment by issuing note 50,000 For purchase of computer system 210,000 For purchase of building 100,000 For repayment of short-term loan 40,000 Total uses of cash $924,000 Net decrease in cash $(10,000)

After speaking to four local banks, NWCC was still unable to secure the mortgage. The banks had doubts about the accuracy of the information regarding cash above and believe that NWCC might not be able to continue its operations.

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Required: (a) Prepare a correct Statement of Cash Flows using the direct method for NoWhere

Community College (NWCC). (7 marks)

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(b) Based on the Statement of Cash Flows in part (a), do you think NWCC now stands a better chance of obtaining the mortgage from one of the local banks? Explain your answer. (3 marks)

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Part B: (5 marks) You are working for a brokerage firm as a stock analyst and your boss is asking you to evaluate and recommend the stocks of Cherry Crumble Ltd. and Violet Ripe Ltd. to your clients. Since both companies operate in the same industry, earn about the same net income and have similar financial positions, your final recommendation depends very much on their statement of cash flows. Cherry Crumble Violet Ripe Net cash from operations $130,000 $110,000 Purchase of plant assets $(180,000) $(20,000) Sale of land 20,000 50,000 Net cash from investing activities (160,000) 30,000 Issuance of shares 50,000 - Repayment of long-term loan - (120,000) Net cash from financing activities 50,000 (120,000) Net increase in cash $20,000 $20,000 Required: Based on all the cash flow information given, how would you choose between the two companies? Give your reasons.

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QUESTION 2 (10 MARKS): FINANCIAL STATEMENT ANALYSIS Part A: (4 marks) (a) Discuss one reason why financial statement analysis may be conducted. (2 marks)

DO NOT WRITE BEYOND THIS LINE (b) Discuss one limitation of financial statement analysis. (2 marks)

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Part B: (6 marks) Mr. Tate O’Stew is a financial consultant who is considering recommending a catering company, ROAST Ltd, to his clients. However, before he makes any recommendations, Tate would like to know the answers to several questions. The financial information for ROAST Ltd for the last three (3) years is summarised in the table below:

2008 2007 2006 Current ratio 2.9 2.4 1.6 Quick ratio 0.7 1.0 1.5 Debtors turnover 6.9 8.2 10.5 Inventory turnover 6.5 7.7 8.8 Dividends per share $2.20 $2.20 $2.20 Return on assets (ROA) 0.112 0.131 0.148 Return on equity (ROE) 0.06 0.07 0.09 Industry average ROE 0.08 0.07 0.05

Required: Support your answers with appropriate ratios (if any). Ratio formulae are provided on page 10. (a) Comment on the liquidity of ROAST Ltd. over the last three (3) years. (1 mark)

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(b) Are customers of ROAST Ltd. paying their invoices faster now than they did in 2006? (1 mark)

(c) ROAST Ltd.’s dividend per share has remained the same for the last three (3) years at $2.20. Do you believe that this is keeping in line with the trend in its financial performance? (2 marks)

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(d) Should Tate recommend investment in ROAST Ltd.? Why? (2 marks)

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Note: Use the following formulae for ratio calculations if required. Ratio Formulae: Performance Ratios

Return on Equity (ROE) = Net Profit After Tax / Shareholders’ Equity ���Return on Assets (ROA) = Earnings before Interest & Tax (EBIT) / Total Assets Profit Margin = Net Profit After Tax / Sales Revenue���Gross Margin = Gross Profit / Sales Revenue

Activity Ratios

Asset Turnover = Sales Revenue / Total Assets ���Inventory Turnover = COGS / Average Inventory���Days Inventory on Hand = 365 / Inventory Turnover���Debtors (receivables) Turnover = Credit Sales / Average Trade Debtors Days in Debtors = 365 / Debtors turnover

Creditors Turnover = Purchases (or COGS) / Average Accounts Payable���Days in Creditors = 365 / Creditors Turnover���Cash Flow Cycle = Days in Inventory + Days in Receivables – Days in Creditors

Liquidity and Financial Structure Ratios

Current Ratio = Current Assets / Current Liabilities ���Quick Ratio = (Current Assets – Inventories) / Current Liabilities ���Interest Coverage = EBIT / Interest Expense (net)���Debt to Equity Ratio = Total Liabilities / Total Equity���Debt to Assets = Total Liabilities / Total Assets ���Leverage = Total Assets / Shareholders’ Equity [expressed as a multiple] Leverage Ratio = Shareholders’ Equity / Total Assets [expressed as a percentage]

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QUESTION 3 (10 MARKS): ACCOUNTING POLICY CHOICE Part A: (3 marks) Jemaine Bret is the new chief accountant of Plight of the Cormorants Ltd, a company devoted to environmental issues. For the financial year ending 30 June 2008, he has made the following recommendations for accounting policy changes. He has been called upon by the company’s chief managing officer to explain the possible effects of the policy changes on some of the company’s accounts. Accounting policy changes

Accounts

1 Straight line instead of reducing balance depreciation of the anti-whaling boat bought on 1 January 2008

Net profit

2 FIFO instead of weighted average for inventory (prices have been increasing)

Assets

3 Capitalising development expenses

Net profit

4 Changing doubtful debt policy from 10% of sales to 5%. Sales remain constant.

Total assets

5 Using market value instead of historical cost for buildings (prices have been decreasing)

Cash flow from operations (current year)

6 Using market value instead of historical cost for land (prices have been increasing)

Net profit

Required: If the accounting policy changes are accepted, what will be the effect (increase, decrease, or no effect) on the selected accounts in the table above? Write your answers in the following table:

Accounts Effect (increase, decrease, or no effect)

1 Net profit

2 Assets

3 Net profit

4 Total assets

5 Cash flow from operations (current year)

6 Net profit

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Part B: (7 marks) You are assisting in the preparation of the financial statements of Plight of the Cormorants Ltd., and Jemaine has asked you to expense $50,000 worth of set-up costs previously capitalised during the current financial year. The company has a 30% tax rate. Required: (a) What journal entries would you use to record this transaction? In your journal

entry, clearly indicate the type of each account (revenue, expense, asset, liability). (1 mark)

(b) What would be the effect (in dollars) on the company’s net assets? (1 mark)

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(c) What would be the effect (in dollars) on net cash flow this year? (1 mark) (d) What will be the effect (in dollars) on next year’s net cash flow? (1 mark) (e) Give three possible reasons for Jemaine’s decision to expense previously

capitalised set-up costs. (3 marks)

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QUESTION 4 (10 MARKS): INTRODUCTION TO MANAGEMENT ACCOUNTING AND COST CONCEPTS Note: the cost of goods manufactured is not examinable in 1B for 2015 onwards. QUESTION 5 (20 MARKS): BUDGETING FOR PLANNING AND CONTROL Part A: (15 marks) SportsKraft Ltd. is one of the oldest wholesale companies in the Asia-Pacific region. The company specialises in manufacturing and selling top-of-the-line sport goods, including cricket bats made of willow wood and treated with linseed oil. While the company performed beyond expectations in the last financial year, Sidney Greenspan, the managing director of SportsKraft Ltd., is worried about the ever-increasing price of raw materials and its effect on the company’s profit margin. He wishes to prepare the company’s master budget for the next quarter. On 30 June 2008, SportsKraft Ltd. had finished goods inventory of 10,000 cricket bats, $200,000 worth of raw materials (comprising $200,000 willow wood, but no linseed oil), and Accounts Receivable totalling $2,500,000 (net of bad debts). Gross profit for the period ending 30 June 2008 was $14,350,000. The company plans to increase its mark-up policy to 25% in order to cater for the expected increase in the price of raw materials. The selling price therefore is expected to be $150 per bat for the next quarter. The sales budget for the next 4 months is as follows: July 45,000 bats @ $150 $ 6,750,000 August 50,000 bats @ $150 $ 7,500,000 September 60,000 bats @ $150 $ 9,000,000 October 65,000 bats @ $150 $ 9,750,000 November 70,000 bats @ $150 $10,500,000 SportsKraft Ltd. has a policy of setting its finished goods inventory level at the end of each month to equal 30% of the next month’s budgeted bat sales. Each cricket bat requires 2 metres of willow wood planks and 1 litre of linseed oil. Direct labour is projected to be 3.5 hours per production of each bat, and the company incurs a cost of $45 per hour for direct labour wages. Willow planks cost $10.50 per metre, and linseed oil is $20 per litre. The company ends each month with enough planks to cover 10 per cent of the next month’s production requirements; linseed oil, however, is all used up each month. Currently, SportsKraft Ltd.’s customers pay 45% of sales in the month of the sale, 50% in the following month, and any outstanding balance is considered to be not collectable and written off straight away. The company also has a policy of paying its supplier in instalments: 55% in the month of purchase and 45% in the following month.

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Required:

(a) Prepare a production budget for the quarter ending 30 September 2008. (3 marks)

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(b) Prepare a raw materials budget for the quarter ending 30 September 2008. (7 marks)

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(c) Prepare a schedule of expected cash collections for the quarter ending 30 September 2008. (5 marks) Note: this is no longer examinable in 1B from 2015 onwards. Part B: (5 marks) Flexibility has been identified as one of the key features of effective operating budgets. Identify one of the operating budgets, and explain why flexibility is required for it to be effective in aiding organisations’ planning and controlling processes.

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QUESTION 6 (10 MARKS): CORPORATE GOVERNANCE

NOTE: CORPORATE GOVERNANCE IS NO LONGER EXAMINABLE FROM 2015 ONWARDS. QUESTION 7 (25 MARKS): MULTIPLE CHOICE QUESTIONS There are twenty five (25) Multiple Choice Questions. Choose one (1) best answer per question. Answers are to be recorded on the separate Generalised Answer Sheet provided using a 2B pencil by blackening appropriate boxes. You must record your student number and name on the provided answer sheet. 1. Which of the following statements about prepaid expenses is NOT true? A They are expenses which should be recognised in the income statement as soon as

they are paid. B They are usually classified as current assets. C They are expenses which have not yet been incurred but have been paid for during

the current period. D They are usually associated with cash outflows. E Both A and C are NOT true.

2. Which of the following items would be recognised in the balance sheet as a

liability? A Advances from customers for goods and services to be provided next year. B Payment in advance to suppliers for raw materials to be delivered next year. C Allowances made for potential bad debts in the current period. D Contingent liabilities. E A and D.

3. ProVice Ltd issued 10,000 ordinary shares for $2.50 each, payable $1 on

application, 50 cents on allotment and $1 in calls as required. The journal entries to record the allotment of 10,000 shares would include a:

A Credit to Cash, $5,000 B Credit to Allotment, $10,000 C Credit to Share Capital, $25,000 D Credit to Share Capital, $5,000 E Credit to Allotment, $5,000

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4. Which of the following statements about the general reserve account is NOT true? A A transfer to this account may be used to indicate to shareholders that it is unlikely

to be paid out in dividends. B Funds can be transferred back from it to retained profits. C It provides an indication of where funds are invested. D It appears under shareholders’ equity in the balance sheet. E Both A and C are NOT true.

5. Which of the following statements about bonus issues is NOT true? A They can be a useful takeover defence. B They reduce shareholders’ equity as well as assets. C They do not affect cash. D They are also referred to as share dividends. E Both B and C are not true.

6. What is the usual journal entry to create a General Reserve account? A Dr Asset Revaluation Reserve

Cr General Reserve B Dr General Expenses

Cr General Reserve C Dr Profit and Loss Summary

Cr General Reserve D Dr Retained Profits

Cr General Reserve E Dr General Reserve

Cr Cash 7. Which of the following can NOT be an example of an investing cash flow? A Purchase of land. B Payment to acquire shares of other companies. C Sale of shares previously purchased. D Dividend received. E Shares issued.

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8. Which of the following could NOT explain an increase in the Return On Equity (ROE)?

A Creating a general reserve account. B Payment of an interim dividend. C Increase in net profits. D Declaring a final dividend. E Share buyback.

9. Which of the following ratios may indicate the efficiency with which the resources

of the company are being utilised to generate profit? A Current ratio B Debt to assets ratio C Quick ratio D Return on assets E B and D.

10. Which of the following statements about the current ratio is true? A It indicates whether the company has enough short-term assets to cover its short-

term liabilities. B An extremely high ratio always is a favourable sign. C A ratio above 1 indicates that working capital is negative. D It will increase when cash is collected from debtors. E A and D.

11. Which of the following transactions may decrease the current ratio? A Slow cash collection from debtors. B Sale of a major non-current asset. C A large prepayment. D Existence of a large obsolescent inventory stock. E Increasing the allowance for doubtful debts.

12. Which of the following is NOT an area in which companies typically make

accounting policy choices? A How to calculate amortisation of development costs. B How to calculate depreciation on land. C How to value inventories. D Whether to capitalise development costs. E None of the above: that is, all are accounting policy choices available to

companies.

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13. Which of the following is an accounting method that could be chosen by a

company to decrease reported profits? A Overstating allowance for doubtful debts B Increasing the useful life of plant and equipment which is being depreciated using

straight line method. C Classifying longer-term debts as current liabilities D Creating a general reserve account using the company’s retained profits account. E A and D.

Questions 14 – 16 are based on the following information. Turnaround Ltd, which has been in business one year, has an income tax rate of 40%. The company makes it a practice to capitalise its advertising costs as a ‘deferred asset’ and to amortise it at 25% per annum. The accountant has suggested to the general manager that the policy of capitalising advertising should be ended because the economic benefit of such expenditure is not clearly determinable. The amount of advertising capitalised this year was $150,000. 14. What effect would such a policy change have on Net Profit After Tax this year? A $112,500 reduction B $45,000 reduction C $60,000 reduction D $67,500 reduction E $25,000 reduction

15. What effect would such a policy change have on total assets this year? A $150,000 reduction B $67,500 reduction C $112,500 reduction D $45,000 reduction E No effect

16. What effect would such a policy change have on cash flows from operations this

year? A $150,000 reduction B $67,500 reduction C $45,000 increase D $45,000 reduction E No effect

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17. Which of the following statements is true regarding manufacturing overhead costs?

A They consist of direct material and direct labour costs. B They are easily traced to jobs. C They include all selling costs. D They should not be assigned to individual jobs because they bear no obvious

relationship to them. E They are a heterogeneous pool of indirect production costs that can include

gas and electricity costs and depreciation associated with manufacturing. 18. Which of the following statements is NOT correct regarding Work In Process?

A Work In Process is partially completed inventory. B Work In Process consists of direct labour, direct material and manufacturing

overhead. C Work In Process is debited as product costs are incurred. D Work In Process is credited when goods are sold. E A and C 19. Process costing is normally used when:

A Small numbers of distinctly different products are manufactured. B Large numbers of different products are manufactured. C Large numbers of nearly identical products are manufactured. D Small numbers of nearly identical products are manufactured. E The fixed costs of manufacturing exceed the variable cost of manufacturing. 20. Which of the following statements is true regarding “cost”?

A A cost is always an expense. B A cost is always an asset. C A cost is something quite different from either an expense or an asset. D It can be either an expense or an asset. E It is always a liability.

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21. Which of the following is a manufacturing cost?

A Marketing costs. B Administrative costs. C Research and development costs. D Indirect material costs. E Sales personnel salaries. 22. Which of the following statements is true?

A Budgets are usually available as part of the company’s annual report. B Budgets are part of the organisation’s planning and control processes. C Budgets ensure that accounting records comply with GAAP. D Budgets are not always used to aid in setting up of the short-term goals of the

company. E All of the above: that is, all statements are true. 23. Winter Ltd’s sales are 30% in cash and 70% on credit. 60% of the credit sales are

collected in the month of sale, 25% in the month following sale, and 12% in the second month following sale. The remainder is uncollectible. Based on the following budgeted sales data, what is the total Budgeted Cash Receipts in April? January February March April Total sales $60,000 $70,000 $50,000 $30,000

A $27,230 B $36,230 C $38,900 D $47,900 E None of the above. 24. Cooks Ltd has budgeted $40,000 in sales for the month of December. The

company's cost of goods sold is 30% of sales. If the company has budgeted to purchase $18,000 in merchandise during December, then the budgeted change in inventory levels by the end of December is:

A $6,000 increase B $10,000 decrease C $15,000 increase D $22,000 decrease E $45,000 increase

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25. Exterminator Ltd. forecasts sales for the second quarter at 5,000 units and for the third quarter at 10,000 units. The desired ending inventory for the second quarter is 1,000 units and for the third quarter, 4,000 units. How many units must be produced in the third quarter?

A 5,000 units B 11,000 units C 12,000 units D 13,000 units E 15,000 units ---------------------------------END OF PAPER----------------------------------