Contents
Basic accounting concepts and principles ......................................................................................................................................... 2
Irrecoverable and doubtful debt ....................................................................................................................................................... 5
Accruals and prepayment .................................................................................................................................................................. 8
Control account .................................................................................................................................................................................. 9
Bank reconciliation Statement ........................................................................................................................................................ 12
Depreciation of NCA ......................................................................................................................................................................... 13
Valuation of Inventory ..................................................................................................................................................................... 18
Incomplete Records.......................................................................................................................................................................... 20
Partnership and dissolution ............................................................................................................................................................. 20
Limited Companies ........................................................................................................................................................................... 28
Suspense Accounts and Correction of Errors .................................................................................................................................. 33
Ratio Analysis ................................................................................................................................................................................... 35
Cost Classification and Behavior ...................................................................................................................................................... 46
Overheads ........................................................................................................................................................................................ 47
Unit, Job, Batch Costing ................................................................................................................................................................... 52
Marginal and Absorption Costing .................................................................................................................................................... 53
Break Even analysis .......................................................................................................................................................................... 56
Decision Making ............................................................................................................................................................................... 58
Business Planning ............................................................................................................................................................................. 70
1
Basic accounting concepts and principles
M/J 16 P22 Q1(c) + M/J 14 P22 Q2(b)(ii)
State two types of entries, other than the correction of errors, which would usually be recorded in the general journal.
Opening entries (1)
Purchase and sale of non-current assets (1)
Non-regular transactions (such as year-end transfers) (1)
Calculating opening capital (1)
Write off bad debts (1)
Depreciation (1)
M/J 14 P22 Q2(b)(i)
Explain the purposes of the journal
It is used to record the double entry (1) of non-routine transactions (1)
M/J 14 P21 Q1(d)
Explain the following concepts:
(i) Matching
Matching ensures that all income (1) and expenditure (1) are recognised in the financial (1) period in which they occur.
The timing of payment (1) is irrelevant, i.e. if goods are sold in year one but not paid for until year two, then the sale is
recognised in year one (1).
(ii) Materiality
Materiality allows that if the amount of a transaction is insignificant 1, then the accepted treatment of that transaction
may be disregarded (1). For example, the purchase of an stapler, which may last for several years, would tend to be
treated as revenue rather than capital expenditure, and the stapler itself would not be included in non-current assets (1).
Materiality is decided on the following factors: Will the cost of using the normal treatment of an item outweigh the
benefit obtained? (1) Will the disclosure of an item (e.g., the stapler mentioned above) make any difference to the
decisions made by the person reading the financial statement? (1)
O/N 12 P23 Q1(c)
Define the prudence concept. State three examples of how this has been applied in the financial statements.
Assets should not be overstated (1)
Liabilities should be understated (1)
Revenue should not be bought into the financial statements until realised (1)
Inventory (1) Provision for doubtful debts (1) Depreciation (1)
M/J 12 P21 Q1(b)
Explain how the preparation of a departmental income statement might assist Alana in managing the business.
• To aid management decision making.
• To measure the efficiency (control of costs) and effectiveness sales income, and to compare one department
profitability by using ratios like GP percentage, ROST, etc.
• Helps to compare performance with similar industrial sectors.
• Useful for motivation through target setting.
O/N 15 P22 Q2(c) + O/N 13 P23 Q2(a) + M/J 08 P2 Q1(d)(ii) + O/N 19 P23 Q3(c)
Name five external users of accounting information and state their interest in the information
2
1
Trade creditors (suppliers)
Need to know the organisation’s ability to pay its debts and continue to supply .
2
Providers of finance to the business (e.g. banks).
Need to know that business can pay interest/repay loans/grant finance.
3
Trade unions.
Need to know financial situation as a means of discussing working conditions and pay/job security.
4
Financial analysts (e.g. stockbrokers)
Need information to help advise clients
5
Government and its agencies
Interested in allocation of resources also to provide a basis for national statistics Inland revenue for taxation
purposes.
6
The public
Need information regarding jobs and may be local suppliers
7
Trade receivables (customers)
Interested in continuity of business for supply of goods/services
8
Competitors
To compare to their own business.
9
(Potential) investors
Need to know whether the investment is worthwhile.
10
Auditors
Need to examine the accounts.
M/J 19 P22 Q1(c)
State two benefits and two drawbacks of operating as a sole trader
Benefits: (Max 2)
Entitled to all profits (1)
Quicker decision making (1)
Full control of business operations (1)
Drawbacks: (Max 2)
Unlimited liability / no separate legal entity (1)
All the risk / responsibilities (1)
Limited opportunities for new ideas (1)
O/N 09 P22 Q1(a)
Explain, briefly, the difference between a liability and a provision.
The amount of a liability may be determined with some accuracy (1) e.g. rent accrued at the year-end (or other relevant
example) (1) whereas the amount of a provision is not readily determinable (1)
M/J 20 P21 Q1(e)
Explain the accounting concepts of:
Business entity: a business has its existence separate from its owners (1) only transactions that affect the business
should be recorded in the accounting records (1)
Substance over form: financial statements must give a complete and accurate picture of events (1) so economic impact
is taken into account and legal form is disregarded (1)
O/N 20 P21 Q1(d)
State four benefits to a business of keeping a full set of accounting records.
• giving access to more detailed information (1)
3
• easier to assess business performance (1),
• possible to prepare comprehensive financial statements (1)
• more effective decision making (1)
• provides support for bank loan applications (1)
• provides evidence to support tax assessments (1)
• possibility of improved credit control (1)
• allows comparisons with previous years/other businesses (1)
O/N 20 P22 Q2(c)
State which accounting concept Khalid did not apply in each of the following scenarios.
O/N 20 P22 Q2(d)
State the purpose of financial statements
To provide information about the financial performance of the business (1) the financial position of the business (1) and
to facilitate decision making/ comparison to previous years / other businesses (1).
M/J 21 P21 Q1(a)
State two reasons why the owner of a small business may decide not to maintain full accounting records.
May not have the skills/time to prepare full accounting records (1)
Maybe content with the information provided by her current accounting records (1)
Maybe cannot afford the services of a bookkeeper/accountant or accounting software (1)
Maybe business too small to warrant full accounting records (1)
M/J 21 P21 Q1(b)
Explain how these accounting concepts are applied when a business prepares financial statements.
Matching requires costs and revenues to be matched for a financial period (1) irrespective of amounts received or paid
(1).
Prudence requires losses to be realised as soon as they are anticipated (1) to avoid profits and assets being
overstated/losses and liabilities being understated (1).
4
Irrecoverable and doubtful debt
Irrecoverable Debt: when a customer cannot pay the amount that is owed. Should be written off as an expense in the income
statement.
Balance on irrecoverable debt recovered account will be credited to the income statement.
Doubtful debt: a debt due from a customer where it is uncertain whether or not till be repaid.
Specific provision: made against a specific doubtful debt.
General provision: is calculated as a percentage of the total trade receivables.
Specific provisions must always be deducted from the trade receivables first before the general provision is calculated.
Accounting Concepts:
Prudence concept:
Ensure that the trade receivables and current assets are not overstated
Profit for the year is not overstated
Capital is also not overstated
Matching concept: any expense or loss for the financial year is matched against the revenue for that same period.
Ways to reduce irrecoverable debts:




Follow up of overdue accounts
Credit control: fix a credit limit for each customer
Obtain references from new credit customers
Refuse further supplies until outstanding balance is paid.
How does a provision for doubtful debts differ from irrecoverable debt:
An irrecoverable debt arises when it is certain that a customer will not pay. A provision for doubtful debt arises when it is
considered that a customer might not pay. Irrecoverable debts have actually occurred whereas provision for doubful dets are
estimate of future irrecoverable debt.
M/J 19 P21 Q1(d) + O/N 18 P22 Q1(g) + F/M 17 Q2(a)(i) + M/J 15 P21 Q2(e) + O/N 15 P23 Q1(d)
Explain why a business may create a provision for doubtful debts.
-
Application of concept of prudence (1)
Application of matching concept (1)
Profit may be overstated in the event of irrecoverable debts (1)
Trade receivables / current assets may be overstated (1)
M/J 19 P22 Q2(d) + F/M 19 Q3(b) + F/M 17 Q2(a)(ii)
Explain one accounting concept which is applied when making a provision for doubtful debts.
5
Prudence (1) Profit/current assets/trade receivables should not be overstated (1)
OR
Matching / accruals (1) Revenue of an accounting period is matched against the costs of the same period (1)
F/M 17 Q2(b)
Explain how a provision for doubtful debts is treated in: (i) the statement of financial position (ii) the income statement
The new provision is deducted from trade receivables under current assets in the statement of financial position (1)
(ii) An increase in provision for doubtful debts is shown as an expense (1)
A decrease in provision for doubtful debts is shown as additional income after the gross profit (1).
O/N 11 P21 Q1(e) + M/J 09 P21 Q2A(a)(ii) + M/J 20 P23 Q2(f) + M/J 21 P22 Q2(f) + O/N 21 P21 Q1(f)
State three factors that the directors should consider when creating a provision for doubtful debts.
-
Past experience
Specific knowledge about a customer
The state of the economy
Consistency concept
Industry average
Length of time
Size of debtors
Comparing with previous years or with competitors.
M/J 15 P22 Q2(d)
Kim has provided for doubtful debts at a rate of 2%.
Chan would like to change the existing rate of the provision to 5%.
Explain why this change might be necessary.
-
increase in credit sales/more credit customers/increase in debtors(trade receivables)
deteriorating economic situation
less efficient credit control procedures
state of aged debtors’ list
past experience.
M/J 09 P21 Q2A(a)(iii)
Explain the difference between the accounting treatment of a bad debt and a doubtful debt.
A bad debt should be written off when it becomes bad, whereas a provision is set up to cover doubtful debts.
M/J 21 P22 Q2(c)
State two ways in which the risk of irrecoverable debts may be reduced
• Reduce credit sales (1)
• Better credit control (1)
• Regular telephone contact with customers (1)
• Credit checks on customers (1)
• Issue regular statements of account/invoices (1)
• Setting credit limits for customers (1)
• Stop supply to late paying customers (1)
O/N 21 P22 Q1(d)
State two ways in which the level of trade receivables of a business could be reduced.
Offer discount for early settlement (1)
Charge interest on overdue accounts (1)
6
Regular chasing of debts / improve credit control (1)
Encourage cash sales rather than credit sales/discourage credit sales (1)
Debt factoring (1)
7
Accruals and prepayment
Accrued expenses
Prepaid expenses
Prepaid income
Accrued income
Effect on Income/ Expenses
↑ Expenses
↓ Expenses
↓Income
↑ Income
Effect on profit
↓
↑
↓
↑
Effect on assets/ liabilities
↑ CL
↑ CA
↑ CL
↑ CA
O/N 18 P21 Q1(b)
Explain the accounting treatment at the year-end in the income statement and statement of financial position of: (i)
Prepayments (ii)Accruals
Prepayments:
Deducted from expenses (1) and shown as a current asset (1)
OR Added to income (1) and shown as a current liability (1)
Accruals: Added to expenses (1) and shown as a current liability (1)
OR Deducted from income (1) and shown as a current asset (1)
8
Control account
Control accounts: used to verify accuracies of entries made in Sales and Purchases Ledger.
Uses of control accounts:

Provides total of trade receivables and trade payables quickly when a trial balance is prepared.

Enables financial statements to be prepared quickly.

Acts as an internal check and helps to deter fraud because of segregation of duties – individual personal
accounts and control accounts are under the responsibility of different persons.

Verify the arithmetical accuracy of the sales ledger and purchases ledger.

Detect errors in the ledger.
Contra entry: when a transfer is made from an account of a person in the sales ledger to an account of the same person in the
purchases ledger. This may occur when a person is both a customer and a supplier.
Credit balance in SLC:



Overpayment from customer
Goods are returned after full settlement has been made
Advance payment from customer
Debit balance in PLC:




Business has overpaid an outstanding balance
Cash discount not deducted before payment made
Returned goods after payment of amount due
Payment to supplier made in advance
Limitations of control accounts:
Errors not revealed by the control accounts: error of omission, error of commission, error of original entry, compensating error.
F/M 19 Q2(e)
Suggest two reasons why the trade receivables did not pay the full amount they owed.
Credit control was not up-to-date. (1)
There were uncorrected errors in the receivables ledger overstating certain accounts. (1)
Becoming aware that the partnership was ceasing, certain receivables avoided paying. (1)
Customer bankrupt (1)
May have been some irrecoverable debts (1)
Offered cash discount (1)
M/J 19 P23 Q3(a) + F/M 18 Q1(a) + M/J 18 P21 Q1(g) + M/J 18 P23 Q2(b) + M/J 10 P23 Q2(c) + O/N 19 P21 Q2(c) + O/N 16 P22
Q3(a)(ii) + O/N 11 P22 Q2(c) + M/J 20 P23 Q3(b) + M/J 21 P22 Q2(a) + O/N 21 P22 Q2(c)
Explain two benefits to a business of maintaining control accounts.
Provides an arithmetical check on the accuracy of the ledgers (1), as the balances on each control account should agree
with the total of balances in each ledger. (1)
Helps prevent fraud (1) as the work of those employees working on each ledger is independently checked by another
employee. (1)
9
Provides a figure for total trade receivables and total trade payables (1) aiding preparation of financial statements. (1)
For sales ledger control account: It enables a reconciliation to be made between the sales ledge control account and the
individual accounts in the sales ledger to enable errors to be identified and corrected (1).
M/J 08 P2 Q2(b)
State three possible reasons why a debtor's account might have a credit balance
Overpayment
Payment in advance
Credit note issued
Deposit received
O/N 19 P21 Q2(d)
State two types of errors that will not be identified by producing a sales ledger control account.
Error of omission (1)
Error of commission (1)
Compensating error (1)
Error of original entry (1)
M/J 19 P21 Q2(c)(i)
Explain the effect on a business of not updating customers’ accounts in the sales ledger.
Incorrect sales ledger balances could mean Lawrence not collecting the right amount from credit customers. (1) It may also
risk resulting in irrecoverable debts. (1)
Non-collection of debts would negatively impact cash balances. (1)
May lead to incorrect financial statements (1)
M/J 19 P21 Q2(c)(ii)
Explain the effect on a business of not updating suppliers’ accounts in the purchases ledger.
Incorrect purchase ledger balances could mean possible disputes with suppliers affecting deliveries (1) and may result in
credit facilities being withdrawn. (1)
May lead to overpaying suppliers (1)
May result in loss of opportunities of settlement discount. (1)
O/N 19 P22 Q1(d)(i)
State one advantage and one disadvantage to a business of making all sales on a cash basis only
Advantages
• Will improve overall cash flow (1)
• Reduces the possibility of irrecoverable debts (1)
Disadvantages
• Maybe a reduction in number of customers (1)
• May have to reduce selling price to attract new customers (1)
O/N 19 P22 Q1(d)(ii)
State one advantage and one disadvantage to a business of making all purchases on a cash basis only
Advantages
• May improve the relationships with the suppliers (1)
10
• May be able to negotiate a better purchase price (1)
Disadvantages
• Overall cash flow will decrease (1)
• Not making use of available credit terms (1)
O/N 21 P21 Q3(c)
Explain how the preparation of a sales ledger control account assists in the prevention of fraud.
The sales ledger control account should be maintained by a supervisor or member of staff who is not responsible for that
particular ledger (1). This segregation of duties will both act as a deterrent to fraud and also make the discovery of fraud
much easier (1).
11
Bank reconciliation Statement
Reasons for differences between cashbook and bank statement:

Timing differences:
Unpresented or outstanding cheques are cheques sent to suppliers but not yet cleared by the bank.
Outstanding or uncleared lodgements are cheques received by the business but not yet cleared by the bank.
These items are recorded in the Cash Book but not in the bank statement due to clearing process.

Unrecorded items : Are present in the bank statement but not in the cash book:
 Interest
 Bank charges
 Dishonoured cheque
 Direct debits or standing orders
 Direct credits

Errors in the cash book or in the bank statement
Purpose of bank reconciliation statement:




The objective of a bank reconciliation statement is to reconcile the difference between the Cash Book balance and the
Bank Statement.
Used to check the accuracy of the Cash Book and the accuracy of the Bank Statement.
Helps to discover payments made and items received by the bank not entered in the Cash Book.
Helps to maintain a good system of internal control for receipts and payments to prevent frauds and other
irregularities.
O/N 19 P21 Q2(c)
State two reasons why a business would prepare a bank reconciliation statement.
-
To identify errors in the cash book (1)
To identify errors on the bank statement (1)
To identify uncleared lodgements (1)
To identify unpresented cheques (1)
To verify accuracy of accounting records (1)
To update the cash book with transactions only on the bank statement (1)
To identify out of date cheques (1)
O/N 20 P21 Q2(a)
State four benefits to a business of preparing a bank reconciliation statement
• Helps identify errors made by the bank (1)
• Helps identify errors in the cash book (1)
• Accurate preparation of financial statements (1)
• Helps prevent/identify fraud (1)
• Ensures cash book is up to date (1)
• Helps identify out of date/dishonoured cheques (1)
O/N 20 P21 Q2(b)
12
State two differences between a bank standing order and a direct debit
Standing order is for a fixed amount; amount of direct debit varies (1) Bank triggers payment of standing order;
recipient triggers payment of direct debit (1)
Standing order is paid at fixed intervals; direct debit payments occur irregularly (1)
M/J 18 P22 Q2(d)
Directors of M Limited are considering obtaining a long-term bank loan to raise additional capital.
Explain two advantages to the company of this course of action.
-
Long-term bank loan Interest on loan is fixed (1) whereas dividends are discretionary (1)
Ownership remains the same therefore (1)
No loss of control to existing shareholders (1)
Funds received quicker (1) than a share issue (1)
Repayments are fixed (1) enabling future planning (1)
M/J 15 P21 Q1(c) O/N 13 P22 Q1(c)
Patel wishes to expand his business and is undecided about taking out a five year loan or asking the bank for an overdraft.
State one advantage and one disadvantage of each option
Five year loan
Advantage:
Fixed rate of interest
Helps plan cash flow
Disadvantage:
May pay more interest if rates fall Interest payable for whole period
May be secured on assets
Bank overdraft
Advantage
No interest charged if not used
Can be paid off whenever you like
Disadvantage
Higher rate of interest than loan
Can be called in by the bank at any time
M/J 13 P21 Q2(e)
Suggest two ways Bach could improve his budgeted bank balance at 31 March 2013.
Delay payment to suppliers; reduce expenses if possible; take deposits from customers; offer settlement discounts
M/J 11 P23 Q2(d)
Give three reasons why the bank column balance in the cash book does not always agree with the balance shown in the bank
statement at the same date.
Standard practice to enter the following in the cash
book after receipt of the bank statement:
• Direct debits
• Standing orders
• Bank charges
• Interest on overdrafts
• Cheques dishonoured
Timing differences
• Money lodged with the bank near the end of the
month
• Cheques paid but not yet presented for payment
• Cheques received but not yet credited by the bank
• Errors in recording by thbank and/or the business
Depreciation of NCA
13
M/J 16 P22 Q2(a)
State what is meant by depreciation of non-current assets.
Depreciation is the allocation of the cost of a (non-current) asset over its expected working life. (1) The allocation of the
cost of using the asset over the year (1)
M/J 15 P23 Q1(c) + M/J 14 P23 Q2(a) + O/N 11 P23 Q2(c)
Explain why a business should depreciate its non-current assets
Depreciation represents that part of the cost of an asset that is consumed during the accounting period (1). This follows
the matching (accruals) concept (1). The value of an asset decreases over time due to, for example, wear and tear,
obsolescence (max 1 mark for examples). Depreciating the value of a non-current asset avoids overstating the net assets
of the business (1) and ensures that the statement of financial position shows a true and fair view (1).
M/J 18 P21 Q2(c) + M/J 18 P22 Q3(d) + O/N 18 P21 Q2(a) + O/N 16 P22 Q1(e) + O/N 15 P23 Q2(d)
Explain two accounting concepts that apply to making the annual charge for depreciation.
Consistency (1)
• to assist comparisons of performance between years. (1)
• using the same depreciation method each year. (1)
OR
Prudence (1)
• avoid overstating profits / net assets (1)
• charging depreciation as an expense and so not overstating profits (1)
OR
Accruals / matching (1)
• match the cost of an asset with the income generated from its use (1)
• matching wear and tear of the asset against the reduction in value (1)
O/N 18 P23 Q1(e)
Advise the directors whether or not they should decrease the depreciation rates. Justify your answer.
Reasons for:
Profit would increase in the short term.
The capital base /asset base of the company would rise in the short term.
Reasons against:
The change would not be in accordance with the accounting concept of consistency.
The change would not be prudent / against prudence concept.
Assets/profit could be overstated.
Lower depreciation charges would mean higher losses on disposal.
The change would not help profit in the long term.
F/M 17 Q3(d) + M/J 16 P22 Q2(b) + O/N 15 P23 Q2(c) + M/J 10 P22 Q2(b) + M/J 20 P22 Q2(d)
State three causes of depreciation.
- Wear and tear
- Obsolescence
- Changes in technology
- Changes in fashion tastes and trends
- Depletion of resources
- Passage of time
14
-
Economic reasons
State four factors which must be taken into account when deciding how much depreciation to charge.
1 Cost or Market value
2 Useful life
3 Residual value at end of useful life
4 Expected length of ownership
5 Rate of usage
6 Method of depreciation
7 Type of asset
8 Machine hours
M/J 18 P22 Q3(b)
Explain why a business may use reducing balance method of depreciation for plant and machinery.
Plant and machinery often loses more value in the earlier years of its life (1) due to usage (1) and maintenance costs may
be higher in the later years (1)
M/J 18 P22 Q3(c)
Explain two accounting treatments for loose tools.
It is written off as an expense (1) If the cost of the item is not material (1)
The revaluation method should be used (1) If the cost is significant (1)
O/N 19 P23 Q2(c)(i)
Explain why the reducing balance method of depreciation is more appropriate than the straight-line method for assets such
as computer equipment.
Computer equipment tends to fall in value more in the early years. (1) They lose value very quickly due to
obsolescence/ technological changes. (1) The reducing balance method depreciates the assets more in the earlier years
and less in later years (1) which matches the fall in value of computer equipment (1).
The straight line method of depreciation depreciates assets at the same amount each year (1) which does not match
the rapid loss in value. (1)
M/J 14 P23 Q2(b)
Explain why machinery is usually depreciated using the straight line method while motor vehicles are usually depreciated
using the reducing balance method.
Assets suffer wear and tear, etc. and lose their value at different rates (1). This might depend on the degree of use of
the asset. Vehicles tend to lose more value in the early years of use (1); hence the reducing balance method is more
appropriate. Buildings tend to lose value (1) more consistently over their lifetime; therefore, the straight line method
tends to be more appropriate (1)
O/N 21 P23 Q2(c)
Discuss the reasons why a business may choose to depreciate plant and machinery using the reducing balance method.
Depreciation is charged to comply with the matching/accruals concept (1). As machinery is likely to be more productive
in its early years, the reducing balance method initially charges higher depreciation in those years (1). This ensures that
the value of plant and machinery is more realistic and represents a true and fair view (1)
O/N 19 P23 Q2(c)(ii) + F/M 21 P22 Q2(d)
Explain why the revaluation method of depreciation is appropriate for assets such as loose tools.
It is not worthwhile keeping individual records of loose tools (1) as they are usually many small value items (1) and are
difficult to keep track of. (1) They are easily broken, damaged or lost and have to be regularly replaced. (1)
O/N 15 P23 Q2(e)
15
State why the reducing balance method of depreciation is more appropriate for non-current assets like motor vehicles.
Motor vehicles tend to fall in value more in the early years. (1) They lose value the minute they are registered for use.
Repair and maintenance costs increase as the motor vehicle gets older (1). The straight line method of depreciation
depreciates the vehicle at the same amount each year which does not balance up the increasing repair and
maintenance costs in later years. (1) However, the reducing balance method depreciates the motor vehicle more in the
earlier years and less in later years. The reducing balance method therefore depreciates the asset less in later years
which balances with the increasing repair and maintenance costs thus providing a fairer matching of costs with income
generated (1).
M/J 14 P22 Q2(c)(ii)
SMC is considering changing the depreciation method for equipment to reducing balance method – previously straight line
Straight line depreciation is easy to calculate (1) and therefore there is less chance of errors (1) whereas reducing
(diminishing) balance depreciation is more complex.
Reducing (diminishing) balance depreciation is appropriate for assets that have a heavier fall in value in earlier years (1)
and is therefore appropriate for equipment (1). Reducing (diminishing) balance depreciation has a higher depreciation
charge in earlier years (1) which more accurately reflects the profit (1) – prudence (1) and matches costs to revenues (1)
– matching / accruals (1). Straight-line depreciation is an equal charge each year (1)
As equipment gets older maintenance costs increase (1) and with reducing (diminishing) balance method depreciation
will decrease (1) therefore ensuring a more even charge (1) over the life of the asset
O/N 19 P23 Q2(a)
State how a disposal of a non-current asset would affect the income statement and the statement of financial position.
Income statement
Only a profit or loss on disposal would appear in the income statement (1)
Charge for depreciation would reduce (1)
Statement of financial position
Disposal proceeds would increase the bank account / the current assets total in the statement of financial position. (1)
The asset cost and accumulated depreciation would be eliminated from noncurrent assets. (1)
O/N 16 P22 Q1(d)
State the difference between capital and revenue expenditure
Capital expenditure is expenditure on non-current assets (1) with an expected life of more than 12 months (1)
Revenue expenditure is expenditure on running costs to generate income / day-to-day operating expenses (1)
M/J 20 P22 Q2(a)
Explain one advantage and one disadvantage to a business of using the reducing balance method of depreciation.
Advantage (Max 1 advantage)
Provides a more realistic charge against profits (1) as some assets lose more value in their first years (1)/as the asset
reduces in value so the depreciation charge reduces (1).
1 + 1 mark for development Accept other valid responses.
Disadvantage ( Max 1 disadvantage)
Is more complicated to calculate (1) as the charge changes each year because it is based on the decreasing net book value
at the beginning of each year (1) rather than the more straightforward equal charge per year when using the straight-line
method (1).
1 + 1 mark for development
O/N 20 P22 Q2(b)
Advise Khalid which method of depreciation he should use for each asset. Justify your advice
16
Motor vehicle – reducing balance (1). The asset loses value more quickly at the beginning of its life therefore more
depreciation is charged in the early years (1). More maintenance expenditure is expected in later years so less depreciation
(1). Max. 3
Machine – straight line (1). The asset loses value at a steady rate (1). The same benefit is received over the life so equal
depreciation is charged in accordance with the accruals concept (1) spreading the cost over the useful economic life (1).
F/M 21 P22 Q1(d)
State how an annual depreciation charge is calculated using the revaluation method
The depreciation charge is calculated by comparing the closing valuation of the non-current asset with the opening
valuation (1).
O/N 13 P21 Q3(c)
Advise Shostakovich Limited on why the distinction between capital and revenue expenditure is important when preparing
financial statements.
Capital expenditure is entered in the Statement of Financial Position (1) as a non-current asset (1) with only the
depreciation for the asset (1) being included in the Income Statement (1).
Capital expenditure is charged over consecutive accounting periods (1) in accordance with the matching/accruals concept
(1).
If there was incorrect classification and the Capital Expenditure was included in the Income Statement then the profit for
the year would be understated (1) and the asset value in the Statement of Financial Position would be understated (1).
Revenue expenditure should be entered in the Income Statement (1) as an expense (1). If this expenditure was placed in
the Statement of Financial Position ‘profit for the year’ would be overstated (1) and the asset total in the Statement of
Financial Position would be overstated (1). This would contravene the prudence concept (1).
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Valuation of Inventory
O/N 19 P21 Q4(g)
Explain two advantages and one disadvantage of using the AVCO method of inventory valuation.
Advantages (max 4, 1 + 1 for development)
• Averaging smooths out fluctuations in costs making comparison between periods more valid
• Averaged prices used to value closing inventory likely to be closer to latest prices • Avoids identical items being
charged to a job at different prices
Disadvantages (max 2, 1 + 1 for development)
• Average price has to be re-calculated after each purchase – time consuming
• Average price does not represent any price actually paid
M/J 12 P21 Q1(c) + M/J 11 P23 Q1(c) + O/N 16 P23 Q1(a)(i)
Alana’s accountant values some inventory at cost of purchase and some at net realisable value. Explain these terms to Alana:
(i) cost of purchase
Cost is expenditure incurred in the normal course of business to bring the product to its present location and condition
and includes import duties, transport and handling costs less trade discounts.
(ii) net realisable value.
NRV is the actual or estimated selling price (less trade discount) but before cash discount less all further conversion
costs and costs incurred in marketing, selling and delivering the goods to the customer.
M/J 13 P23 Q3(c) + M/J 19 P22 Q4(b)
State one advantage and one disadvantage of using the following methods of inventory valuation:
(i) FIFO
Advantages
• Relatively easy to calculate.
• Realistic – Inventory is bought and sold in order.
• Inventory values are based on actual prices paid for Inventory.
• Closing Inventory valuation is based on most recent prices paid.
• Acceptable under IAS.
Disadvantages
• The price at which Inventory is issued to production is likely to be out of date.
• When the prices of Inventory rise, the FIFO method values the Inventory at the
highest (latest prices). This would reduce cost of sales and therefore increase profit.
This would mean more tax would have to be paid.
(ii) AVCO
Advantages
• It is logical since all identical units of Inventory are given an equal value.
• Fluctuations in the purchase price of Inventory are evened out so the impact on
costs and profit is reduced.
• It conforms to the IAS.
Disadvantages
• The average cost has to be recalculated every time the price of purchased
Inventory changes.
• The average cost might not be the same as the actual cost paid.
• If Inventory prices are rising rapidly, the average cost will be lower than the
replacement price.
M/J 13 P23 Q3(d)
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Brahms currently uses FIFO to value his inventory. He is considering changing the method to show a lower profit each year.
State two reasons why he should not do this. Make reference to any relevant accounting principles, concepts and
conventions.
• Needs to be consistent
• Window dressing of accounts not allowed
• Comparing results from one year to the next meaningless
• Falsely manipulating of accounts/true and fair view
O/N 13 P21 Q3(b)
Explain three reasons why a business cannot normally use the latest selling price of its products to value the inventory.
Inventory must be valued at the lower of cost (1) and net realisable value (1).
The accounting concept of prudence (1) must be applied when valuing inventory. Prudence states that profits and asset
values must not be overstated (1).
The use of the selling price would overstate profit for the year (1) and the current asset/net asset value of the business
would be overstated (1)
O/N 10 P23 Q2(c)
Advise Paula Bridgewater how the inventory (stock) should be valued in the final accounts. Give reasons for your advice.
Stock should be valued at the lower of cost and net realisable value. IAS states companies should either use the FIFO or
AVCO method of stock valuation. Whichever method is used should be used consistently – Consistency concept.
Prudence concept states that companies should choose the lowest value when valuing their assets
19
Incomplete Records
M/J 19 Q1(a)
State three advantages to business owners of using the double entry system of book-keeping.
It will have up-to-date information of assets and liabilities / and will inform decision making (1)
The business can more easily chase trade receivables and keep up to date with trade payables (1)
The preparation of the financial statements is easier and more accurate / reducing the possibility of errors (1)
M/J 18 P21 Q1(f) + M/J 18 P21 Q1(a)
Advise Bilal whether or not he should maintain a full set of accounting records. Give reasons for your answer.
Advice
Yes he should maintain a full set of accounting records (1)
Reasons
Advantages (Max 2)
Business is growing fast
Enables closer monitoring of performance
Enables Bilal to control the business performance
Enable Bilal to maximise opportunities
Enables the preparation of financial statements (1)
Improves accuracy and reduces errors (1)
Reduces fraud (1)
Disadvantages (Max 2)
More time consuming
Need to employ specialist staff
M/J 18 P23 Q3(d)
State three benefits to a business of preparing annual financial statements.
Helps future planning/targets/goals (1)
Decision making (1)
Able to assess performance/comparisons (1)
Valuation of assets, liabilities and capital (1)
For tax purposes (1)
To present to bank for additional finance (1)
O/N 18 P22 Q1(f)
Advise Finn whether or not he should employ a book-keeper at a cost of $500 a month. Justify your answer.
-
Could maintain full up-to-date accurate records (1)
Will improve decision-making (1)
Could provide credit control systems (1)
Improve cash flow / reduce irrecoverable debts (1)
Making sufficient profits to afford bookkeeper’s wages (1)
Increased wages ($6 000) / affordability would result in decreased profits (1)
Failure to maintain full up to date records could lead to business failure (1)
Partnership and dissolution
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A partnership is defined as the relationship which exist between persons carrying on a business in common with a view to profit.
A partnership is a business which has two or more joint owners who undertake to share the risks and rewards.
Contents of a partnership agreement:





The amount of capital to be contributed by each partner
The ratio in which profits and losses are to be shared between the partners
Rate of interest, if any, to be changed on partners’ drawings
Rate of interest, if any, to be allowed on partners’ capital
Amounts of partners’ salaries
The agreement between partners is usually written down in a formal Deed of Partnership in order to reduce the possibility of
disputes.
If there is no agreement:





Profits and losses are shared equally
Partners are not entitled to interest on capital and salaries
Interest on drawings is not charged
Any loan made to the partnership by a partner will carry interest at the rate of 5% per annum
Partners are entitled to contribute equally to the capital
Advantages of a partnership over a sole trader




Partners bring to the business more capital
Partners can share the workload
Partners share knowledge, skills and expertise
Partners share risks and losses between people
Disadvantages of a partnership





There may be disputes in the running of the business
A partner may be legally liable for acts of the other partners
Partners have less independence than sole traders. Decisions have to be agreed by all partners.
Partners have unlimited liability.
There may be issues of continuity of business in the event of death or illness of the partners.
F/M 19 Q2(a) + M/J 19 P23 Q2(a) + M/J 21 P23 Q3(c)
State four reasons why a partnership may be dissolved.
Death / ill health / retirement of a partner (any one) (1)
A partner has been declared bankrupt (1)
Disagreement between partners (1)
Insufficient level of profits / incurring losses (1)
Insufficient levels of cash reserves (1)
Partnership has achieved its purpose (1)
M/J 19 P21 Q1(e)+ F/M 21 P22 Q1(g)
Option 1: To loan this amount to the partnership and receive an annual interest of 10%.
21
Option 2: To invest the full amount and become an equal partner. Through his business contacts he feels that he will be able
to improve the total revenue.
Advise the partners which option, if either, they should accept. Justify your answer.
Loan Max 3
Annual interest will reduce /eliminate profit (1)
Does he want any security? (1)
Will he want capital repaid? (1)
However, it will clear the overdraft in the short-term. (1)
Becoming a partner Max 3
Will bring in expertise / new ideas (1)
May generate additional gross profit (1)
May be able to reduce wages which is the main expense (1)
There may be conflict between the three partners (1)
Possibly less profit for Ahmed and Raji (1)
1 for Advice
M/J 20 P21 Q1(f)
Advise which option the partners should choose. Justify your advice.
Advice (1)
Option 1 (maximum 2 marks)
Potential benefits
• Permanent source of finance/no security required (1)
• May bring new ideas/skills (1)
• Shared management responsibilities (1)
Potential drawbacks
• May not be possible to find a suitable partner (1)
• Risk of disagreements (1)
• Profits will have to be shared (1)
Option 2 (maximum 2 marks)
Potential benefits
• Profits still shared by the two partners (1)
• Fixed interest rate will aid planning (1)
Potential drawbacks
• Interest charges will reduce profits (1)
• May not be able to obtain bank loan (1)
• Have too little collateral to offer for size of loan (1)
O/N 19 P21 Q3(e) + O/N 14 P22 Q2(a)(i)
State two reasons why partners may agree to provide interest on capital.
To reward partners for their fixed investment in the business (1)
To encourage further capital investment in the business (1)
O/N 19 P21 Q3(f) + O/N 14 P22 Q2(a)(ii) + F/M 21 P21 Q1(a)
State two reasons why partners may agree to charge interest on drawings.
To discourage large amounts of drawings by the partners (1)
22
To penalise partners who make excessive drawings (1)
O/N 19 P21 Q3(g)
State two further terms that may appear in a partnership agreement.
The amount of salary payable to partners (1)
Rate of interest on partners’ loans (1)
Management responsibilities of partners (1)
Any limits on partners’ drawings (1)
Amount of partners’ capital (1)
F/M 18 Q3(a)(i) + O/N 15 P21 Q2(c) + M/J 12 P22 Q2(d)
State two advantages to existing partners of introducing a new partner.
More capital investment (1)
Losses will be shared with more partners (1)
New ideas (1)
Shared workload (1)
Shared responsibility (1)
Shared risk (1)
More specialist skills (1)
F/M 18 Q3(a)(ii)
State two disadvantages to existing partners of introducing a new partner.
Profits must be shared (1)
More potential disputes (1)
Slower decision making (1)
Loss of control (1)
F/M 18 Q3(d) + F/M 21 P22 Q1(e)
Explain why an adjustment for goodwill may be made when a new partner joins a business
To reward the existing partners (1) for having established the business and built the reputation (1)
F/M 18 Q3(e) + O/N 19 P21 Q1(b)(i) + M/J 13 P22 Q2(c)
State two factors that may result in the creation of goodwill for a business.
A business making profits each year and these could be increasing over time
An established reputation
Customer loyalty and repeat business
Brand name and image
Value of the business as a going concern exceeds the value of the net separable assets.
Good location
Quality of staff / products
M/J 18 Q1(e)
State two advantages to a partnership of converting to a limited company
23
Separate entity
Limited liability for owners
Ability to raise finance
M/J 18 P21 Q1(a)
Explain three disadvantages of operating as a partnership rather than being in business as a sole trader
Profits will be shared in the partnership (1), whereas sole traders would be entitled to all the profits (1).
Decision making may take longer as both partners will need to agree (1), whereas sole traders can make instant decisions
(1).
There is the risk of disagreement/conflict between partners (1), whereas sole traders would make decisions on their own
(1).
Each partner’s actions are binding on all partners (1), whereas a sole trader has to account to no other parties for his
actions (1)
Control of the business by each partner maybe difficult (1) whereas the sole trader retains control over the business (1).
M/J 18 P23 Q1(g)
Advise the partners whether or not they should take this course of action. Justify your answer.
Remaining as a partnership
Disadvantages:
The partners usually have unlimited liability
Profits need to be shared with other partners
There is the possibility of disputes between the partners
Decisions made by one partner are legally binding on the others
Partnership will need to be dissolved if partner dies
Becoming a limited company
Disadvantages:
Potential loss of control as additional shareholders invest
There will be costs associated with setting up the company
More detailed financial information
Available for public scrutiny
O/N 18 P21 Q3(c)
Identify three ways, other than using bank finance, in which a partnership could raise funds to purchase a non-current asset
Partners increase capital (1)
Partners reduce/not taking drawings/salaries (1)
Partners introduce a loan (1)
New partner introduced (1)
Sale of surplus non-current asset (1)
24
Loan from family members (1)
O/N 18 P21 Q3(d)
State three items that may be included in the appropriation account before the division of residual profit
Interest on capital (1)
Interest on drawings (1)
Partners’ salaries (1)
O/N 18 P22 Q2(b) + O/N 19 P21 Q1(b)(i) + M/J 14 P21 Q2(c) + F/M 21 P22 Q1(d)
State what is meant by the term ‘goodwill’.
The difference between the value of a business as a whole and the separate value of the net tangible assets (1).
OR The (intangible) value of reputation/customer base/location, etc. (1)
O/N 18 P22 Q2(c)
Explain why a partnership may make an adjustment for goodwill when they admit a new partner.
The adjustment will ensure that the original partners benefit, because it is their efforts which have created the goodwill.
O/N 18 P22 Q2(d)
Explain why partners may agree not to maintain a goodwill account in the books of the partnership on the admission of a new
partner.
The value is just a matter of opinion / subjective (1) so it is difficult to value (1)
The value could be subject to sudden change (1) for example if a problem arose which caused damage to the
partnership’s reputation (1).
O/N 18 P23 Q2(d) + M/J 16 P22 Q2(c) + O/N 19 P22 Q3(c) + M/J 21 P12 Q2(a)
Explain why partners may each have a separate capital account and current account.
Partners may want separate capital accounts to:
Show the permanent investment (1)
Show the impact of any changes in capital (1) (e.g. goodwill, capital introduced, revaluations)
Facilitate the calculation of interest on capital (1)
Partners may want separate current accounts to:
Show the ongoing transactions between the partners and the partnership (1)
Show the amount of drawings compared with the share of profit (1)
Facilitate the calculation of interest on drawings (1)
F/M 16 Q2(c)
State the advantages of interest on capital and interest on drawings.
(i) To the partners
reward the partners for their investment in the business (1)
To the partnership
encourage partners to invest in the business not elsewhere (1)
(ii) To the partners
reduce the drawings (1)
To the partnership
defer the partners from drawing cash out of the business possibly causing cash flow problems (1)
25
M/J 16 P22 Q2(c) + M/J 15 P22 Q2(c) + M/J 11 P21 Q1(c) + O/N 10 P23 Q1(c)
State three advantages to a sole trader of forming a partnership.
Access to increased capital
Increased knowledge expertise
Losses shared by all partners
Able to offer greater range of services
Availability of cover
Shared responsibilities
O/N 16 P23 Q1(a)(ii)
State two reasons why assets are revalued on the change of a partnership.
To give the benefit of the change in value of the business to the existing partners and any partner who may be retiring. (1)
So that the statement of financial position on the entry of the new partner shows a true and fair view. (1)
O/N 16 P23 Q1(a)(iii)
Identify two situations where the capital accounts of partners may be adjusted for goodwill.
On the introduction of a new partner. (1)
On the retirement of an existing partner. (1)
On a change in the profit sharing ratio. (1)
O/N 16 P23 Q2(c)
Assess the impact of Alice’s retirement on the partnership’s statement of financial position
Reduced cash flow after paying Alice to leave the business in view of the current overdraft (1)
Having to raise additional finance to pay Alice off (1)
Impacts on profitability having to raise additional capital (1)
Lower capital investment in the business (1)
Difficult to raise additional finance to pay to Alice due to the current overdraft (1)
M/J 14 P21 Q2(d)
Explain how goodwill should be treated in the books of partnership.
As this is not purchased goodwill (1) it is not shown in the books of account (1) and must be written off against the capital
accounts (1) of the partners in their profit sharing ratios (1).
O/N 12 P23 Q2(d)
The partners are now considering changing their business from a partnership to a limited company. Explain to the partners
the meaning of the term ‘limited liability’
Liability for the debts of the business (1) is limited (1) to the amount of capital invested by each partner (1)
O/N 16 P23 Q1(a)(ii)
State two reasons why assets are revalued on the change of a partnership.
To give the benefit of the change in value of the business to the existing partners and any partner who may be retiring. (1)
So that the statement of financial position on the entry of the new partner shows a true and fair view. (1)
M/J 20 P21 Q1(a)
State how profits and losses are shared in a partnership where there is no agreement. [1]
Profits and losses should be shared equally (1) among partners
M/J 20 P21 Q1(b)
26
Explain two reasons why you would recommend partners to have a written agreement, other than stating a ratio for sharing
profits and losses.
Avoidance of disputes (1). The deed usually states management responsibilities (1) and also agreed limits on drawings and
agreed amounts of fixed capital (1). Ensure partners are properly rewarded (or penalised) for their contributions (1). The
deed may include rewards for partners who have undertaken more management responsibilities/provided more
capital/and penalised partners whose drawings have been the most (1)
Max 2 reasons (2 marks per reason, 1 mark for identifying + 1 mark for developing)
M/J 20 P22 Q3(a)
State three reasons why a partnership might be dissolved
Business is making a loss (1) Partners cannot agree (1) A partner has died/retired (1) The objectives of the partnership have
been achieved (1) Legal reasons such as insanity of partner (1)
27
Limited Companies
F/M 20 Q1(c) + O/N 19 P21 Q1(c) + M/J 16 P21 Q1(d) + F/M 20 Q1(e) + M/J 21 P22 Q1(b) + O/N 21 P22 Q1(e)
The directors wish to raise additional finance. They are considering making either a further rights issue of ordinary shares or
issue another debenture.
Advise the directors which option they should choose. Justify your answer.
Rights issue (Max 2)
Rights issue does not dilute ownership. (1)
Rights issue is attractive to shareholders. (1)
Rights issue may be less expensive than debentures. (1)
However, there has been a recent rights issue. Shareholders may not want another one. (1)
May result in a fall in the share price. (1)
Payment of dividends is discretionary. (1)
Debentures (Max 2)
Debentures increase debt. (1)
Lender may require security. (1)
Regular payment of interest and capital. (1)
Debentures need to be repaid. (1)
However, debentures do not affect ownership. (1)
No voting rights to debenture holders. (1)
1 mark for decision + Max 4 marks for justification
M/J 19 P23 Q1(c) + O/N 19 P21 Q3(d)
Explain two differences between a bonus issue of shares and a rights issue of shares.
Bonus shares are not paid for, (1) Rights issue are paid for (1)
Bonus shares do not change the net assets, (1) Rights issue increases net assets (1)
Bonus shares are issued to all shareholders, (1) Shareholders have a choice whether to take up rights issue. (1)
Bonus shares are issued at par value, (1) Rights issue may be made at a discount to market value/at a premium (1)
Bonus shares do not give additional capital/equity, (1) Rights issue gives additional capital/equity (1)
O/N 19 P21 Q1(d)
Identify two internal stakeholders with an interest in the financial statements of a limited company.
Shareholders (1) Directors/employees (1)
O/N 19 P21 Q1(e)
Name two ratios that a business may use to assess: (i) profitability (ii) liquidity
Gross margin (1) Profit margin (1) Return on capital employed (1) Expenses to revenue ratio (1)
O/N 19 P22 Q1(c)
Advise the directors which option should be chosen to raise finance to acquire the building. Justify your answer.
O/N 19 P23 Q1(d)
Option 1: paying the shareholders a dividend of $0.50 per share
28
Option 2: making a bonus issue of 1 ordinary share for every 2 shares held.
Advise the directors on which option they should choose. Justify your answer.
Option 1
Would require an immediate cash outflow (1)
The company already has a bank overdraft (1)
The debenture is due for repayment in the near future (1)
Payment of dividends is discretionary (1)
Option 2
The company will not require a cash outflow (1)
They have sufficient retained earnings to issue bonus shares (1)
They have a share premium account which can be used (1)
Will keep the shareholders happy (1)
Will not dilute voting rights (1)
Decision (1)
F/M 18 Q2(c) + O/N 19 P21 Q3(c) + O/N 18 P22 Q3(a)(ii)
State three uses of a share premium account.
Issue of bonus shares
Pay premium on the redemption of debentures
To write off expenses relating to:
company formation
the issue of debentures
the issue of shares
redemption of debentures
M/J 18 P21 Q2(b)
State two reasons why capital reserves may be used before revenue reserves to fund a bonus issue of shares for a limited
company.
To retain reserves in the most distributable or flexible form (1)
Revenue reserves are needed to fund the payment of dividends (1)
M/J 18 P21 Q2(c)(i)
State two benefits to a limited company of making a rights issue.
Quicker and cheaper than a new share issue (1)
More likely to be fully subscribed than a new share issue (1)
Results in a cash inflow (1)
Does not have to be repaid (1)
Would avoid any dilution of ownership (1)
M/J 18 P22 Q2(c)(ii)
State one limitation to a limited company of making a rights issue.
Can lead to a fall in the share price (1)
O/N 18 P22 Q3(a)(i) + F/M 16 Q2(c) + F/M 18 Q2(d) + M/J 21 P21 Q3(a)
Explain two reasons why a company may make a bonus share issue
Improves the perception of the company size (1) by increasing the issued share capital of the company (1)
29
To capitalise non-distributable reserves (1) but overall, total equity will remain the same (1)
To reward the company’s investors (1) when profits are not sufficient to pay dividends (1)
Can be used to keep existing shareholders happy (1) and may be attractive to potential investors (1)
It is less expensive than making a rights issue or an ordinary issue of shares (1)
It enables the company to match long-term assets with long term capital (1)
O/N 18 P23 Q1(b)(ii)
Explain why the entry made on 10 February 2016 (bonus issue) was made to the share premium account rather than the
retained earnings account.
because the share premium account is a capital reserve with limited uses (1)
so that reserves are kept in their most flexible form (1)
to maximise the future dividends which could be paid (1)
O/N 18 P23 Q1(b)(iv)
State why the directors decided to create a general reserve.
to retain profits for reinvestment in the business (1)
F/M 16 Q3(d) + O/N 16 P23 Q2(b)
State three differences between ordinary shares and preference shares.
Preference shareholders receive a fixed rate of dividend (1) Preference shareholders are paid their dividend before
ordinary shareholders (1) Preference share dividend is not dependent on profits (1) Preference shareholders do not have
a vote at the annual general meeting (1) Preference shareholders are repaid before ordinary shareholders in the event of
the company being wound-up (1)
O/N 21 P21 Q2(b)
The directors of G Limited wish to raise $500000 additional capital for expansion. They have identified two options to raise
the full amount.
Option 1: Issue ordinary shares of $1 each.
Option 2: Issue 8% preference shares.
Advise the directors which option they should choose. Justify your answer.
Option 1 (max 2 marks)
The new share issue would dilute current shareholders’ investment (1)
The shares would have voting rights which may leave the current owners vulnerable to loss of control (1)
But dividend payments would be discretionary (1)
Option 2 (max 2 marks)
8% dividend rate is more expensive than current borrowings (1)
The shares do not have voting rights so no likelihood of loss of control (1)
Dividends have to be paid whether the company makes a profit or loss (1)
M/J 19 Q1(e) + M/J 19 Q3(c) + O/N 21 P22 Q3(b)
Explain the difference between a capital reserve and a revenue reserve
Capital reserves are not normally created by transfer from profits (1). They usually represent gains that have not been
realised (1). Capital reserves cannot be used to pay dividends (1).
30
Revenue reserves are created by transfer from profits (1). They may be created for a specific purpose (1), or simply to
strengthen the financial position of the company (1). Revenue reserves may be used to pay dividends (1).
O/N 19 P21 Q3(b)
Explain why the company should not use its revaluation reserve to pay dividends to shareholders.
The revaluation reserve is a capital reserve. (1) Capital reserves are not allowed to be used for the payment of a cash
dividend. (1) The creation of a revaluation reserve is not a cash transaction as no cash has been generated for the
payment of dividends. (1)
The capital reserve will increase the asset value (1) of the company and the shareholders interest and is in the accounts
to reflect a true and fair view of the company accounts.(1)
Cash gain can only be realised if the asset is sold. (1)
O/N 16 P22 Q2(e)
State why an issue of debentures does not appear in the statement of changes in equity
Because it is a long term liability (1) and is shown as a non-current liability in the statement of financial position. (1)
O/N 16 P22 Q2(c)
State two differences between ordinary shares and debentures.
O/N 18 P23 Q1(b)(v)
Explain why a long-term bank loan received by the company on 1 July 2016 was not recorded in the statement of changes in
equity.
because the loan is a non-current liability/loan capital (1) and does not affect equity (1)
M/J 13 P23 Q1(c)
Explain how the following will be affected if the company makes a loss in the year:
(i) Dividend payable for cumulative preference shares
The shareholders will have their dividend deferred (1) to the next year or when there is a profit. (1)
(ii) Dividend payable for ordinary shares
The directors need not declare a dividend.
(iii) Dividend payable on non-cumulative preference shares
The dividend will not be paid (1) or deferred (1).
(iv) Interest payable on debentures.
The interest will still have to be paid.
F/M 20 Q1(b)
Explain what is meant by ‘Reserves were maintained in their most flexible form’.
Using capital reserves before revenue reserves (1) to facilitate future payments of dividends (1).
M/J 20 P23 Q1(c)
State three advantages to the shareholders of trading as a limited company.
31
• Limited liability for the debts of the business (1)
• Shareholders enjoy a separate legal identity from the company (1)
• Shareholders can easily transfer ownership. (1)
O/N 20 P21 Q3(b)
Describe one way in which a shareholder can benefit from taking up a rights issue.
• Opportunity to purchase additional shares at a favourable price (1) as issue price is usually below market price (1)
• Can maintain same degree of control (1) in the company as shareholder will own same proportion of issued capital (1)
O/N 20 P21 Q3(e)
Describe two factors directors should take into account when deciding on a dividend to be paid to the shareholders.
• The amount of profit available/revenue reserves (1) must be sufficient to finance the dividends (1)
• The amount of liquid funds will be sufficient (1) to cover the dividend payment/avoid liquidity problems (1)
• That shareholders will expect/feel entitled to a dividend (1) as a reward for their investment (1)
O/N 21 P22 Q3(c)
Explain one reason why a company might make a bonus issue of shares.
To compensate shareholders (1) in the event of shortage of liquid resources to pay a dividend (1)
Increases the issued share capital (1) creating a perception of success (1)
To capitalise revenue reserves (1) to strengthen the statement of financial position (1)
32
Suspense Accounts and Correction of Errors
Errors that cannot be revealed by the Trial Balance
Type of Errors
1. Error of Omission
2. Error of Commission
3. Error of Principle
4. Errors of original entry
A transaction is completely omitted from the books.
A purchase of goods of Simpson is not recorded and there is
neither a debit nor a credit entry for the transaction.
A transaction is recorded in a wrong account, but within the
same class off accounts.
A sale of goods to T.Reema is posted to J.Reema’s account.
Both of them are customers.
An item is entered in a completely wrong account which is
not of the same type as the correct amount.
A purchase of non-current asset is posted to the purchases
account.
A wrong amount is entered in a book of prime entry and this
figure is then used for posting to the ledger.
5. Complete reversal of entries
A sales invoice for $500 is entered in the sales journal as $50.
The account which should have been debited has been
credited and vice versa.
6. Compensating errors
A cash sale is debited to the sales account and credited to the
cash account.
Two or more errors cancel each other out. The error on the
debit side of trial balance compensates for an error on the
credit side.
Errors that can be detected or revealed by the trial balance
Transposition error: this occurs when two amounts are transposed, for example $ 350 is incorrectly transposed and posted as
$530.
Partial omission: This occurs when the omission is one-sided.
Unequal posting errors: This occurs when the debit side of the posting does not equal the credit side.
Addition error: It may be in form of overcast or undercast.
Suspense account: a temporary account which is opened to record the difference between the debit and credit totals of the trial
balance.
O/N 16 P22 Q3(a)(i)
State the use of a suspense account
Examples
A suspense account is a temporary account used to balance the trial balance (1)
Used to help correct errors when the trial balance / books of account do not balance (1)
M/J 18 P23 Q3(b) + M/J 21 P22 Q3(c)
33
State four types of error that will not be revealed by the trial balance.
Error of omission
Error of commission
Error of principle
Compensating error
Error of original entry
Error of reversal
M/J 19 P21 Q2(b)
Explain what is meant by the term ‘error of commission’.
A transaction recorded in the wrong account of the same class (1) but using the correct amount and on the correct side. (1)
34
Ratio Analysis
Ratio expresses one figure in terms of another.
Ratio analysis provides information about a number of different relationships that are not highlighted in the company’s financial
statements. Ratios are used to assess the performance of companies through trend analysis (results from one year to another
year) and inter-firm comparison (a business’s performance with that of other businesses).
Limitations of ratios:
The ratios of different firms cannot be properly compared because different businesses use different accounting bases.
1) Financial statements use historical data and therefore give no indication of future performance.
2) It is difficult to compare like with like between two businesses because they may have different
management teams, different staff, and different customers.
3) Financial statements ignore non-financial aspects of a business such as staff morale, quality of management,
staff strengths and weaknesses.
4) Ratios do not provide causes or reasons for changes but only indicate areas of concern. Further investigation
is usually required to discover causes of the concern.
5) Window dressing: It is difficult to compare ratios of two firms due to window dressing. Window dressing
describes an attempt by directors of a company to make financial statements look better than they really
are, for example, directors of a company may attempt to inflate retained earnings figure by including
unrealised profits in the income statement.
M/J 08 P2 Q1(d)(i)
State two reasons for calculating ratios.
Ratios are used to compare a firm's performance with another year, or with another business of the same type.
M/J 16 P22 Q1(e)
State three benefits to a business of using ratios.
Compare the results of the business over time
Compare the performance of businesses of different sizes
Compare the performance of the business with the market leader
Compare the performance of the business against industry averages
O/N 13 P21 Q2(b) + M/J 19 P22 Q3(a) + M/J 18 P21 Q3(c) + F/M 17 Q1(e)(ii) + M/J 16 P21 Q2(c) + M/J 18 P21 Q3(c) + F/M 17
Q1(e)(ii) + M/J 13 P23 Q2(c) + F/M 21 P22 Q3(d) + O/N 21 P23 Q1(f)
State and explain five limitations of using ratio analysis as an indicator of business performance.
Reliability – information from which ratios are prepared may not be reliable as there could
be errors.
Seasonal variations – date of accounts may affect ratios; for example a toy-maker might
have low stock during the month before his busy season but have many debtors at that time.
Timing – by their nature, final accounts are almost out-of-date by the time they are
published.
Monthly fluctuations – these cannot be ascertained from yearly accounts.
Cosmetic accounting – Despite regulation it is still possible to alter ratios by, for example,
undertaking a robust debt collection exercise or delaying stock purchases thus “modifying”
ratios for the year end.
Comparability – Comparisons between businesses are only valid if they are of the same
35
type and size. Use of different accounting policies also limit comparisons.
Non-financial matters – such items as staff loyalty, level of competition and customer base
cannot be measured by ratios.
The ratios do not show the cause of the changes.
Economic – changes may be due to a downturn or inflation.
O/N 08 P2 Q2B
State six possible reasons for the decrease in the ratio of net profit to sales.
Stock wastage
Stock pilferage
Sales price reduced
Purchase price increased
Opening stock overstated
Closing stock understated
Theft from till
Sales mix altered
Increased carriage in
Increased expenses
More bad debt
O/N 12 P22 Q1(d)
Advise Sharon Woo how she can use the figure for return on capital employed to assess the performance of her business.
• Allows investor to make decisions between alternatives
• Allows comparison with similar businesses
• Allows comparison with less risky investments, e.g. Bank
O/N 18 P23 Q3(a) + M/J 09 P21 Q2B(a) + M/J 15 P21 Q2(a)
Explain the difference between gross margin and mark-up.
the gross margin looks at gross profit in relation to revenue (1) whereas mark-up looks at gross profit in relation to
cost of sales. (1)
O/N 18 P23 Q3(b)(i)
Name one cost recorded in an income statement which would not be included in the calculation of the expenses to revenue
ratio.
purchases / cost of sales / carriage inwards (1)
O/N 18 P23 Q3(e)
Suggest two reasons why H Limited’s gross margin may have been higher than the previous year.
increase in selling price combined with constant purchase price (1)
decrease in purchase price with no change in selling price (1)
change in product mix (1)
M/J 13 P22 Q1(d)(i)
Define the term liquidity.
The ability of current assets (1) to meet current liabilities (1)
F/M 16 Q1(c)
Explain the importance to a business of the current ratio.
36
It shows the funds available in the short term (1) to pay the current liabilities (1). It does not show the liquid assets
available (1) because it includes inventory (1) It provides a judgement on liquidity (1) by comparing current assets with
current liabilities (1)
M/J 11 P23 Q1(f)
Explain why the liquid ratio (acid test) is a more reliable indicator of liquidity than the current ratio.
Inventory is regarded as the least liquid asset
A buyer has to be found
Some goods may prove to be unsaleable
The quick ratio shows if the business would have any surplus liquid funds if all the current liabilities were paid
immediately
F/M 17 Q1(e)(i)
Name two other ratios a business could calculate to explain its liquidity position.
Inventory turnover
Trade payables turnover
Trade receivables turnover
Working capital ratio
Gearing
M/J 11 P23 Q1(e)
State four ways in which Klingsman could improve his working capital.
Injection of cash/additional capital
Long term loan
Sales of surplus non-current assets
Reduction in drawings
Factor debt
Effective inventory management to reduce damage to inventory
O/N 19 P22 Q2(c)
Identify three drawbacks for a business of holding too much inventory.
Theft (1) Storage costs (1) Insurance (1) Obsolescence (1) Damage (1) Opportunity cost (1)
M/J 18 P22 Q1(f)
Advise which course of action the partners should take in order to improve the rate of inventory turnover. Justify your advice
by discussing both of the suggested options.
Advertising campaign
May raise public perception (1) May increase sales of the business (1) Would incur costs (1)
Reducing inventory levels
Would lead to an increase in the rate of inventory turnover (1) Would reduce the risk of obsolete/damaged inventory
(1) Would reduce customer choice/danger of not being able to fulfil orders (1)
M/J 18 P23 Q1(e)
Assess the working capital position of the partnership at 31 July 2017.
-
Positive working capital. (1)
37
-
The trade receivables collection period has deteriorated from 31 days to 46 days which could
increase the possibility of bad debts. (1)
The trade payables payment period has decreased by 3 days suggesting that creditors are being
paid faster than they need to be or less credit has been extended by suppliers. (1)
Cash flow problems may result. (1)
The above may have led to the increased bank overdraft and associated bank interest. (1)
There may be less effective credit control in place/may not be carrying out adequate credit
referencing checks on new customers. (1)
M/J 18 P23 Q1(f)
Advise the partners of three ways in which they could improve the cash position of the business.
-
The partners could reduce their salaries. (1)
The partners could reduce their drawings. (1)
Additional capital could be introduced by the existing partners. (1)
A new partner, or partners, could be admitted to the partnership. (1)
A loan could be negotiated. (1)
The partnership could dispose of surplus/unused non-current assets. (1)
F/M 19 Q1(e)
State three ways in which a business could reduce trade receivables turnover.
Put in place measures to more closely monitor trade receivable accounts (frequent reminders; issuing of statements of
account). (1)
Refuse credit terms to late payers. (1)
Offer cash discounts to encourage prompt payment. (1)
Charge interest on overdue accounts (1) Ask for cash with order / increase cash sales (1)
F/M 19 Q1(f)
State three drawbacks of increasing trade payables turnover.
Delaying payments to suppliers may mean the loss of cash discounts which would have an impact on profits. (1)
Cause some suppliers to refuse credit terms which would have an adverse effect on liquidity. (1)
Force the business to find alternative suppliers who are unable to supply goods on the same quality. (1)
May create a bad relationship with suppliers. (1)
May incur interest charges (1)
M/J 15 P21 Q2(d)(i)+ O/N 21 P23 Q1(e)
Explain what the non-current asset turnover measures.
It shows the efficiency of assets to generate income (1). It shows how much every dollar of non- current assets (1)
generates in sales revenue (1). A higher value indicates better utilisation of resources (1).
M/J 18 P21 Q1(e)
Analyse the efficiency of the business using these ratios.
Non-current asset turnover
The non-current asset turnover ratio has improved from being weaker than the industry average to being better than
the industry average and/or has also improved on the previous year (1). The partnership may have purchased new and
improved non-current assets and/or are using existing non-current assets more efficiently. (1)
Trade payables turnover
The partnership is now paying suppliers faster than in the previous year and/or quicker than the industry average (1)
Whilst this may have been good for the supplier liquid funds that could have been used for other purposes are being
used unnecessarily. (1)
F/M 20 Q1(d)
The directors have provided the following information:
38
Analyse the effect that the changes in each of these ratios had on the company’s liquidity using all the available information.
Effect on liquidity
Both changes will have an adverse effect on liquidity (1)
Suppliers’ accounts are now being settled more quickly than customers pay their accounts. (1)
Both ratios are now worse than industry average. (1)
O/N 19 P22 Q2(b)
Discuss the liquidity of Nibali’s business based on the available information.
Inventory turnover indicates that it is taking longer than the industry average to sell goods (1) resulting in a delay in
receipt of payment from customers (1)
Nibali’s customers are taking 6 days over the credit terms to settle their accounts and Nibali is paying his suppliers 5 days
early (1) resulting in cash leaving the business before settlement is received (1)
Conclusion/advice Overall, Nibali’s efficiency ratios indicate poor liquidity (1)
O/N 19 P23 Q3(b)
Suggest possible reasons for the changes in Maria’s business between 2017 and 2018 in respect of: (i) profitability (ii)
liquidity.
Profitability
Gross margin in 2018 improves due to either the selling price increased or cost of sales decreased or both (1)
Reduction the profit margin due to increased expenses (1)
ROCE has deteriorated probably due to reduction in profit for the year or increase in capital employed or both (1)
Liquidity
The current ratio has reduced which means there are fewer current assets and / or more current liabilities. (1)
The liquid ratio has reduced due to either increased trade payables or reduced liquid assets.
Slower rate of inventory turnover due to either increased inventory levels or reduced sales. (1)
F/M 18 Q1(e)
Delph has calculated the following ratios for the year ended 30 June 2017 for his own business and for his main competitor,
Nadia. Delph Nadia Gross margin 26% 21% Profit margin 9% 12%
(e) Advise Delph whether or not his business is more profitable than Nadia’s business. Justify your answer.
Nadia may have had to buy from new suppliers who were more expensive
Suppliers may have increased their prices but Nadia may not have been able to pass these increases onto her customers
Nadia may have started selling new products at lower prices or margin
To maintain or increase sales, Nadia may have had to run promotions or offer higher discounts
Nadia may have had old or obsolete inventory that had to be cleared at reduced prices
Increased amounts of inventory may have been damaged or stolen
Nadia may have been controlling her overheads better resulting in the higher profit margin
If the business has been expanding, some overhead costs do not increase proportionately with sales
39
Delph may be operating from larger premises with higher property costs
Delph may experience low profitability due to first year of trading
Advice
Nadia’s business is more profitable (1)
M/J 18 P21 Q3(b)
Anna has also obtained the following data in respect of Yuan, another possible customer.
Current ratio 3.82 : 1
Liquid (acid test) ratio 1.63 : 1
Rate of inventory turnover 6.69 times per year
Anna’s main concern when choosing the customer is that they should pay her promptly.
Advise Anna which customer she should choose. Justify your answer.
Yuan has the higher current ratio (1) and liquid (acid) test ratio (1) Ravi has a negative liquid (acid) test ratio (1) therefore
he would be less able to pay promptly (1) as he has more of his current assets tied up in inventory (1) She would need to
consider that Yuan has more assets lying idle and so he may not be as efficient. (1) She should try to discover more about
their long term assets and liabilities (1)
Decision (1) mark
O/N 18 P21 Q1(f)
Francesco’s brother, Marco, runs a similar business. He has calculated the following ratios for his own business:
Discuss the liquidity position of Marco’s business using only the current and liquid (acid test) ratios.
-
Current ratio has worsened (by 1.4: 1)
Current ratio was too high and suggested wasted resources
Current ratio now is too low and would not have to get much worse before liabilities could not be
paid
Acid test ratio has worsened (by 0.6: 1)
Acid test ratio is now below 1: 1 and so cannot pay debts without relying on using inventory.
Inventory is a problem as it may be difficult to convert into cash
O/N 18 P21 Q1(g)
Advise a potential new supplier whether or not to sell goods to Marco on a credit basis. Justify your answer.
-
The supplier may have difficulty receiving payments from Marco (1) based on his liquidity position
(1)
The supplier would have an increased risk of irrecoverable debts, (1) which would reduce profits (1)
The supplier would need strict credit control procedures (1) which increases costs (1)
The supplier could consider supplying on a cash only basis (1) or on a prepayment basis (1)
Marco could become a regular customer (1)
F/M 17 Q1(f)
Advise Razia whether or not she should increase the mark-up on her goods. Justify your answer by discussing advantages and
disadvantages of doing this.
For increasing mark-up
• Reduce bank overdraft
40
• Increase (gross) profit
• Improve liquidity
• May enable to increase drawings
Against increasing mark-up
• Lose customers
• May not be able to sell
• Hard to decide the products this may be applied to
• Competitors may enter/ need to consider competitors’ price
F/M 16 Q1(d)
The directors of Seema Limited have calculated the current ratio to be 8.87 : 1. They regard the ratio calculated to be too high
and are considering repaying the debentures. Discuss the effect of this course of action on:
(i) Working capital Will reduce the bank (1) to only $2200 (1) Working capital will fall (1) and the ratio will become
5.25: 1 (1) It may cause some cash flow problems (1) [2]
(ii) The return on capital employed Now 17.28% would be 18.78% if no debentures (1) This will rise (1) as the capital
employed falls (1) If profits are maintained (1)
F/M 16 Q1(e)
Advise the directors on whether they should repay the debentures early. Justify your answer
It will seriously weaken the cash position (1)
Interest cost is relatively low (1)
It is not due for repayment for a minimum of 5 years (1). If it was repaid and there was a need for another loan it
might be much higher interest (1)
Increase the profit, due to removal of interest payable (1).
M/J 16 P22 Q1(d)
Jing calculated the gross margin and the profit margin for his business. He discovered that the gross margin had decreased for
the year ended 30 April 2015. For the same period the profit margin had increased.
Assess the performance of the business for the year ended 30 April 2015. Suggest possible reasons for the changes.
Gross Profit
Valid comments may include
Jing may have had to pay higher prices from his usual suppliers but have been unable to pass on these higher prices to
his customers. Or Jing may have had to purchase from new suppliers who were more expensive.
To be competitive with other businesses, Jing may have had to reduce his prices and therefore his gross margin has
reduced Jing may have introduced some new products at a lower introductory price. To increase his volume of sales,
Jing may have had more seasonal sales promotions
Jing’s closing inventory has reduced significantly so there may have been out-of-date inventory that he wanted to
clear at reduced prices.
Jing’s inventory control may not have been as good and if more inventory was being lost, damaged or stolen, this
would increase his cost of sales.
Closing inventory may be understated/miscalculated.
Profit for the year
Valid comments may include
The increase in the profit margin could have resulted from Jing controlling his overheads better
The increase in the profit margin could have resulted from a decrease in total overheads
Most overheads, including rent, do not normally increase in proportion to sales
Jing may have moved to smaller premises such that his rent has reduced compared to the previous year.
41
O/N 19 P21 Q1(e)
The partners have calculated the following ratios for the business:
(i) Comment on the changes in liquidity of the partnership from 30 September 2014 to 30 September 2015.
the liquidity ratio (which excludes inventory) has fallen from 1.1 to 0.85. The partnership would be unable to pay all
short-term liabilities from liquid assets (1) without selling inventory. (1)
trade receivable collection days have increased from 34 to 42 days. This may suggest that credit control is not
working as well (1) or that longer terms are being allowed to maintain the level of sales. (1) Increased risk of bad
debts. (1)
the partnership may find it difficult to obtain further supplies on credit (1) and may be unable to take advantage of
cash discounts offered by suppliers. (1)
(ii) Suggest ways in which the partnership liquidity may be improved.
the partners may need to consider introducing some additional capital (1) or Max could reduce his salary in
exchange for a higher profit share. (1)
if there are any surplus non-current assets in the partnership, these could be sold. (1) The partnership may need to
negotiate a non-current loan. (1)
the partners should review their credit control policy and make any necessary improvements such as sending
statements or telephoning ahead of the due date and promptly chasing overdue accounts. (1)
the partners could consider offering cash discounts for early settlement, charging interest on overdue amounts and
refusing further sales unless overdue debts are cleared. (1)
to help with liquidity, if debtors are taking longer to pay then the partners could consider taking longer to pay their
trade payables. (1)
O/N 14 P23 Q1(d)
Asif is considering introducing a system of credit control.
Explain the benefits this may bring to the business.
Improved cash flow (1 + 1 for development)
Reduction in bad debts (1 + 1 for development)
O/N 14 P23 Q2(c)
Evaluate the change in Lance’s liquidity position over the three years
Current ratio improved in 2013 (1) but became worse in 2014 (1). This should be a concern to Lance as it may
indicate worsening liquidity (1), especially with the bank overdraft (1).
This is shown by the liquid (acid test) ratio which has worsened each year (1). Lance has a large amount of inventory
which indicates cash may be tied up (1). Lance may have difficulty paying the interest on the loan, overdraft. (1) and
suppliers (1).
M/J 13 P21 Q1(c)
The prices of food and drink sold had been planned to obtain a gross margin of 70%. Compare this figure with the figure
calculated in (b) and state two reasons why these figures may differ.
The gross margin obtained is less (worse) than planned.
The cost of the goods purchased for resale may have been higher than anticipated. More wastage than anticipated.
Theft of inventory or cash
Closing inventory was understated
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Discount on selling price
M/J 13 P22 Q1(a)
State and explain which business is the computer manufacturer and which is the food wholesaler.
X manufactures computers, Y is a food wholesaler (1)
For example:
Gross profit/net profit ratio (1) – computers have a much higher mark-up than food (1)
Long term loan (1) – higher capital investment for a computer manufacturer (1)
Trade receivables (1) – higher for a computer manufacturer (1)
ROCE (1) – lower ROCE for a computer manufacturer (1)
M/J 11 P22 Q2(c)
Using the profitability ratios (i) – (v) compare the performance of the Northern and Southern Divisions of Blackford Industries
and explain the significance of each ratio.
O/N 13 P21 Q2(a)
Complete the following table stating the formula used to calculate the ratio, what the ratio measures and reasons why it may
change.
43
M/J 20 P21 Q2(b)
Analyse the trend in Ayesha’s business’s liquidity.
• She is paying trade payables more quickly than before (1) – by 2 days (1)OF
• Trade receivables are paying more slowly than before (1) – by 3 days (1)OF
• Trade payables used to be paid more slowly than trade receivables paid Ayesha; now the position is reversed (1) –
there was a favourable gap of 2 days, now the gap is adverse by 3 days (1)
• The current ratio has weakened so that the business will it more difficult than before to meet its immediate
obligations (1)
• A bank loan is due for repayment within the next twelve months. The business may find it difficult to meet the
repayment date (1). If this obligation cannot be met the business is at risk of assets being seized (1)
M/J 20 P21 Q2(c)
State two factors that should be considered when choosing businesses with which to compare a business.
Same type of ownership (1) Same trade (1) Similar size (1) Same business cycle (1)
M/J 20 P22 Q1(f)
Tariq has become concerned about his business’s liquidity. He is considering two options.
Option 1: reduce the inventory levels
44
Option 2: delay payments to suppliers
Advise Tariq which of these actions he should take. Justify your advice
Advice (1)
Reducing inventory: Would achieve improvement in liquidity (1)
Would reduce storage costs (1) Would reduce chance that items become out of date and are wasted (1)
But negative impact if inventories run out and demand not met (1)
Delaying payments to suppliers: Would achieve improvement in liquidity (1)
Might cause the loss of cash discounts/negative impact on profits (1)
But negative impact if credit terms not met leading to loss of suppliers/credit terms/interest charges (1)
M/J 20 P23 Q1(d)
Assess the performance of Q plc based on these ratios.
General: the ratios show the company’s performance has deteriorated over the three-year period (1)
Non-current assets to turnover ratio: has remained better than the industry average (1) indicating a more efficient use
of non-current assets than other similar businesses/a larger turnover than other similar businesses (1).
Return on capital employed: has been worse than the industry average for the last year (1), indicating a less efficient
use of capital employed than other similar businesses/a poorer profit than other similar businesses (1).
F/M 21 P22 Q1(d)
State two ways in which a company could improve its current ratio.
Reduce dividend payments (1) Increase long-term borrowing/issue debentures (1) Issue shares (1) Selling off surplus
non-current assets (1)
M/J 21 P22 Q1(f)
The directors are concerned about the company’s credit control and wish to improve the company’s liquidity position. They
are considering a proposal to offer a 5% cash discount to customers for settlement within 30 days on all invoices of more than
$2000.
Advise the directors whether or not they should go ahead with this proposal. Justify your answer.
For proposal (Max 2)
• May improve cash flows/liquidity/as customer may pay more quickly (1)
• May encourage larger orders (1)
• May make irrecoverable debts less likely (1)
Against proposal (Max 2)
• Will reduce profits by the amount of discounts allowed (1), (and company is already making a loss) (1)
• Will also reduce cash receipts (1)
• Possible loss of customers who do not qualify for cash discount (1)
45
Cost Classification and Behavior
O/N 11 P22 Q3(c)
Explain what is meant by the term ‘stepped costs’.
Stepped costs occur when a business increases capacity. As a result of expansion overheads such as insurance, rent and
rates and bank interest payments are likely to increase. On a break even chart these increases would result in a horizontal
fixed cost line moving to a higher level beyond the output at which increased capacity occurs.
O/N 11 P22 Q3(b)
State three fixed costs a business typically incurs.
Depreciation
Admin costs Rent
Insurance Advertising/marketing
Rates Indirect wages
Loan interest
46
Overheads
Overheads is the cost incurred in the course of making a product, but which cannot be identified directly and in full to the
product.
Overhead is the total of indirect materials, indirect labour and indirect expenses.
Cost Allocation
Cost allocation is the process of charging costs directly to a cost ceentre.
A cost centre is any location (department) in a business to which costs may bee attributed. A cost centre may be a production
department, a service department or an administrative department.
Production cost centres are directly involved in producing goods whereas service cost centres are not involved in the production
of goods but provide services for the production cost centres.
Cost apportionment
Cost apportionment is the process of charging overhead costs to cost centres using suitable bases because these costs cannot be
directly identified with a particular cost centre.
Overhead
Rent and rates
Heating and lighting
Depreciation of NCAs
Power
Basis of apportionment to cost centres
Floor area
Floor area
Cost or book values of assets
Kilowatt Hours
Apportionment of service cost centre overheads to production cost centres
Only production departments produce goods that will be sold. The total cost of producing each unit must bee determined in
order to fix the selling price. The total cost of goods produced includes overheads of both production and service departments.
There are two main ways of apportioning service departments costs to the production departments:
(i)
(ii)
Elimination or direct method (Most common)
Continuous or repeated method
Calculation of Overheads Absorption Rates (OAR)
OAR = Budgeted Overhead / Budgeted Activity level
Overhead absorption rates are calculated on budgeted overhead and budgeted activity level because cost of production must be
known in advance in order to fix selling price.
When both direct labour and machine hours are given for a cost centre, it is recommended to choose the higher.
Other bases:
(a)
(b)
(c)
(d)
Cost unit or rate per unit (effective when all units of production are identical)
Direct material cost
Direct labour cost
Prime cost
Overhead cost sharing process:
1)
2)
3)
4)
Cost allocation
Cost Apportionment
Re-apportionment of service cost centres
Calculation of OAR
Over and under absorption overheads occur because the overhead are based on estimates.
47
Overabsorption occurs when:
Under absorption occurs when:
Budgeted expenditure > Actual expenditure
Budgeted expenditure < Actual expenditure
Budgeted production < Actual production
Budgeted production > Actual production
Absorption of non-production overheads
Nonproduction overheads
Absorption Bases
Selling and distribution costs
Administrative costs
Sales value
Production cost or direct production cost
Factory Wide rate or Single Factory overhead Absorption Rate
A factory-wide rate is an absorption rate used throughout a factory and for all jobs and units of output irrespective of the
department in which they were produced. It is cheaper and easy to calculate OAR using a factory-wide rate.
A factory wide rate is not appropriate when there is more than one department or where jobs do not spend an equal amount of
time in each department. If a single OAR is used, some products will receive a higher overhead charge while other products will
be undercharged. It is, therefore recommended to use a separate OAR for each department resulting in a fair charge of
overheads.
O/N 19 P22 Q4(a) + M/J 12 P22 Q1(c)
Explain two drawbacks for a business of using a budgeted overhead absorption rate.
Estimated figures used may be inaccurate (1) leading to under or over absorption of overheads (1)
Over absorption of overheads may lead to prices being set too high (1) which may lead to loss of customers (1)
Under absorption of overheads may lead to prices being set too low (1) which would result in lower profits (1)
O/N 19 P23 Q4(d)
Explain why a business calculates separate overhead absorption rates for each production department rather than a single
rate for the whole factory.
The overhead absorption rate should be chosen to reflect the activity of that department (1).
If the department is machine-intensive then machine hours should be chosen / If the department is labour intensive then
labour hours should be chosen (1)
This should lead to a more accurate absorption of overheads (1) which in turn leads to a more accurate cost figure / selling
price (1)
Overhead allocation is charging costs to a cost centre (1) those costs which are directly attributable to it. (1)
Overhead apportionment is charging costs to a cost centre which are not directly attributable (1) to it using a suitable basis
(1)
F/M 18 Q4(a)(i)
Name the accounting term which describes the splitting of a service department’s costs based on stores requisitions
apportionment (1)
F/M 18 Q4(a)(ii)
Explain how the cost of direct materials is charged to each production department.
48
direct materials are allocated (1) because they are directly attributable to production units (1)
F/M 18 Q4(b)
State the bases which the company may have used to split each of the following costs between the two departments. (i)
factory rent (ii) depreciation of factory machinery
(i)factory rent – by floor area (1)
(ii)depreciation of factory machinery – by cost or NBV of factory machinery (1)
Machine hours (1)
O/N 18 P21 Q4(h) + O/N 14 P22 Q3(f) + O/N 19 P23 Q4(a) + O/N 16 P23 Q4(e) – def of allocation only + F/M 20 P22 Q4(a)
State the meaning of each of the following terms. (i) Allocation (ii) Apportionment (iii) Absorption
Allocation. Charging overheads/costs to a specific cost centre (1) where those overheads are clearly identified with
that cost centre. (1)
Apportionment. Charging overheads/costs that cannot be clearly identified with a specific cost centre (1), to cost
centres on an appropriate basis. (1)
Absorption. Where the total of allocated and apportioned overheads/costs (1) is charged to units of production. (1)
F/M 20 P22 Q4(b)
State what is meant by:
(i) a production department
A production department is one which is directly involved in manufacturing the products (1).
(ii) a service department
A service department is one which is not directly involved in manufacturing the products but provides support to other
departments (1).
F/M 17 Q4(a)
State the difference between a cost unit and a cost centre.
A cost unit is a unit of production (1) whereas a cost centre is part of a business to which costs can be attributed /
allocated to (1)
F/M 17 Q4(b)
State the difference between a production cost centre and a service cost centre.
Production cost centre is directly involved in producing the goods e.g machining, assembly (1) Service cost centre
provides a service for the production cost centres /not involved in the production of goods (1)
M/J 16 P22 Q4(d)
Explain how over absorption and under absorption of overheads can affect the profit of a manufacturing business.
Over absorption of overheads will mean that too much overhead is charged to the product (1). This means that a
higher price is charged to the customer (1) leading to increased profits (1).
Or
Over absorption of overheads could also lead to a higher selling price (1) leading to lower demand (1) and lower
profits (1).
Under absorption of overheads could lead to insufficient overhead being charged to a product (1). This means a
lower price is charged to the customer (1) which fails to cover costs and reduces profit (1).
Or
Under absorption of overheads could also lead to a lower selling price (1) leading to higher demand (1) and higher
profits (1).
O/N 10 P23 Q3(e)
State two alternative methods the business could use to absorb their overheads.
49
Single factory rate
Machine hour rate
Unit cost
% prime cost
% direct labour cost
% direct material cost
Activity based costing
O/N 10 P23 Q3(d)
Explain why Mandar Limited absorbs its overheads using direct labour hours.
Overheads tend to be related to time.
The company may be labour intensive
Using a departmental labour rate is appropriate if different grades of labour are used in each department.
M/J 14 P23 Q3(a)
State one advantage and one disadvantage to Chester Limited of using a single overhead absorption rate.
Advantage: Easier to calculate (1) by avoiding the necessity to allocate and apportion costs into departments. (1)
Disadvantage: Where different products spend differing amounts of time in departments (1) there is a danger that product costs
will be under or overstated. (1)
O/N 16 P23 Q1(g)
Explain why overhead costs are re-apportioned from service cost centres.
So that each unit of production (1) contains a share of total overhead costs. (1)
F/M 20 P22 Q4(e)
Explain the reason for the re-apportionment of the service department costs.
Service centres incur overhead costs and these costs are charged to the product by transferring to the production centres
on an appropriate basis (1). To ensure that all costs are recovered in the sale of products (1).
M/J 15 P22 Q3(e)
Explain why estimated figures are used to calculate overhead absorption rates.
The total expected cost of production (1) must be known in advance (1) to enable selling prices to be calculated (1) and to
ensure that expected overhead costs are fully recovered (1). Actual figures are not available (1)
O/N 15 P21 Q3(d)
Explain the meaning of the following terms. Illustrate your answer by reference to the additional information and, where
appropriate, your answer to part (b).
(i) Overhead over absorption
Machining department over absorbed. (1)
Over absorption of overheads means that the absorbed overheads were more than the actual overhead expenditure
incurred. (1)
In the machining department indirect wages of $2720 were absorbed into production. This was $700 more than the
actual overhead. Over-absorption of overhead occurred. (1)
A credit for $700 should be made to the income statement. (1)
(ii) Overhead under absorption
Assembling department under-absorbed. (1)
Under-absorption of overheads means that the amount of overheads absorbed into production was less than the amount
of actual overheads incurred. (1)
In the assembly department the number of direct labour hours worked was less than estimated.
50
Absorption rate from (b) (ii) was $3.10 per direct labour hour.
Total overhead to be absorbed was $18 624. #
Using the actual labour hours worked the overhead absorbed would be 5570 × $3.10 = $17 267 (1)
Conclusion – overhead under- absorbed of $1357 – This would be debited to the income statement. (1)
O/N 21 P22 Q4(f)
Advise Hayden whether or not he should use one factory-wide absorption rate. Justify your answer.
For factory-wide (max 2 marks)
Easier/less complicated to calculate (1)
Saves time (1)
Therefore, saves money (1)
Against factory-wide (max 2 marks)
Does not differentiate capital intensive production from labour intensive production (1)
Produces less accurate selling prices (1)
Produces less accurate overhead absorption rate (1)
Products may spend differing amounts of time in each department/ Does not reflect accurate departmental usage (1)
Advice (1)
51
Unit, Job, Batch Costing
Unit costing is used to ascertain the cost of a single unit of production or single unit of providing a service. The unit cost of a
product is calculated as the total of variable costs and fixed costs divided by the number of units produced.
Service costing is a costing method concerned with establishing the costs of services rendered.
Cost per serving unit = Total costs for period/ Number of service units in the period
The main problem with services costing is the difficulty in defining a ‘cost unit’ that represents a suitable measure of the service
provided. Each organization should ascertain the cost unit is most appropriate to its activities.
Job costing is a costing method applied where work is carried out according to customers’ specific orders and each order is of
comparatively short duration. Each order becomes a cost unit and each unit is separately identifiable, it becomes necessary to
calculated the cost of each unit separately.
Each job is a allocated a Job number and the costs of each job are collected in a Job cost sheet or job card. The total costs of
each job is necessary for the purpose of fixing a selling price. The main purpose of job costing is to determine the profit or loss
made on each job.
The usual method of fixing prices in job costing is cost plus pricing. Cost plus pricing means that a desired profit margin is added
to total cost to arrive at the selling price.
Batch costing is similar to Job costing and is used when an order from a customer involves the production of a number of
identical units. The cost per unit in a batch is the total batch cost divided by the number of units in the batch.
52
Marginal and Absorption Costing
The marginal cost of a product is its variable cost. Under marginal costing only the variable production costs are allocated to the
product and are included in the inventory valuation.
Absorption costing is the basis of all financial accounting statements. Under absorption costing, all costs are absorbed into
production and thus operating statements do not distinguish between fixed and variable costs. The valuation of opening and
closing inventories contains both fixed and variable costs.
Production = Sales [Absorption Cost Profit = Marginal Cost profit}
Production > Sales [Absorption Cost Profit > Marginal Cost profit]
Production < Sales [Absorption Cost Profit < Marginal Cost profit]
Marginal Costing





Closing inventory is valued at marginal production cost.
Fixed costs are period costs and written off in the period they are incurred.
Cost of sales does not include a share of fixed costs.
Marginal costing helps in short term decision making.
Marginal costing is easy to operate but relies upon cost being split into fixed and variable.
Absorption Costing





Closing inventory is valued at full production cost, that is at a higher value.
Cost of sales includes a share of fixed costs.
Absorption costing helps to set selling price.
Absorption costing is used in long run rather than short run.
It is more acceptable for financial statements.
M/J 18 P23 Q4(h)(ii) + M/J 18 P21 Q4(d) + F/M 20 P22 Q4(f)
Explain one limitation of absorption costing.
Based on budgeted data (1) which may lead to inaccurate absorption rates (1)
Can artificially inflate profits (1) when there are changes in inventory values (1)
Not useful for short-term decision making (1) as each unit of production includes fixed costs which remain the same
(1)
Not useful as a basis for responsibility accounting (1) as fixed costs are out of control of managers (1)
O/N 15 P22 Q3(f) + O/N 18 P22 Q4(b) + F/M 19 Q4(e) + O/N 14 P23 Q3(g)
The company uses marginal costing in order to calculate its break-even point for its ‘make or buy’ decisions.
State three further reasons why a business might use a marginal costing system.
• Making decisions on allocation (1) of scarce/limited resources (1)
• Accept orders below normal selling price (1) if spare capacity (1)
• Determine the selling prices (1) of entering into a new market (1)
• The use of sensitivity analysis (1) if there is a change in output/cost structure (1)
53
• Accept or reject orders (1) below normal selling price (1)
• Whether to close down a department/discontinue a product (1) positive/negative
contribution (1)
• To ascertain the additional overhead (1) in producing one extra unit (1)
• To ascertain the required turnover (1) to achieve a target profit (1)
O/N 16 P23 Q1(h) + F/M 17 Q4(h) + O/N 20 P22 Q4(f)
Rajesh has been advised to change to a marginal costing system.
Advise Rajesh whether or not he should change. Justify your answer.
Reasons to change to marginal costing: (max 2)
• simple and quick to operate
• no apportionment of fixed costs
• fixed costs are treated as period costs and so remain unchanged at different activity levels
• no over/under absorption of overhead costs to calculate
• no further adjustment needed in the income statement for over/under absorption
• closing inventory is realistically valued at variable production cost
• allows easy calculation of profit when changes in activity occur
• great aid in decision making/pricing/make or buy situation.
Reasons to keep absorption costing: (max 2)
• it shares fixed production costs to units of production, which is fair as these costs are incurred in order to make the
output
• it is easier to determine profitability of several products as they include a share of fixed overheads.
• it values closing inventory fairly
M/J 16 P21 Q4(i)
State one advantage and one disadvantage of marginal costing.
Advantage
Good for short term decision (1) because it only considers variable costs (1)
Good for special orders (1) enables accurate price to be set (1)
Make or buy (1) enables comparison (1) (Max 1) (1 mark for stating and 1 for development)
Disadvantage
Inaccurate / harder to calculate / time consuming (1) because it is difficult to split costs into fixed and variable (1)
Not useful for financial statements (1) because the inventory value would be understated (1)
O/N 14 P23 Q3(h)
Evaluate the limitations of marginal costing.
Marginal costing should only be used for short term decision making (1)
However, it is necessary to split all costs into fixed and variable (1) which may be difficult (1)
Difficult to use if more than one product is sold (1) as it is difficult to split fixed overheads over several products (1)
O/N 14 P23 Q3(e) + M/J 13 P22 Q3(f) + M/J 14 P22 Q3(f) + M/J 15 P23 Q3(f) + M/J 18 P21 Q4(f)
Explain why the absorption costing statement produces a different profit figure to the marginal costing statement.
54
Absorption costing will produce a different profit figure to marginal costing whenever opening and closing inventory
differ. (1)
Absorption costing values inventory at total production cost including a portion of fixed costs. (1)
Marginal costing values inventory at variable cost only, treating fixed costs as period costs. (1) When closing inventory is
higher than opening inventory, absorption costing will produce the higher profit. (1)
When closing inventory is lower than opening inventory, marginal costing will produce the higher profit. (1)
O/N 19 P21 Q4(a)
State three advantages to a business of using a system of absorption costing.
Enables selling prices to be set, because all costs are included in the pricing of a product. (1)
Supports long-term planning, because this depends on revenue. It must cover not just direct costs but overhead costs as
well. (1)
Absorption costing conforms to the accruals concept, because the total cost of unsold inventory is charged to the period in
which it is sold. (1)
M/J 20 P21 Q2(a)
Explain three benefits to a business of using absorption costing.
• Takes account of fixed costs when determining product cost (1); as a result is useful in setting a selling price for a product
(1).
• Avoids separating fixed costs from variable costs (1) which can be difficult and so lead to inaccuracies (1)
• As it takes account of all costs it conforms to the matching principle (1) which requires costs to be matched to revenues
for a period (1)
• As it takes account of all costs (1) it is the recognised method for inventory valuation (1)
O/N 20 P21 Q4(a)
State two limitations of absorption costing.
• It is more time consuming to calculate the overhead absorption rate and adjust for over / under absorption. (1)
• It is more complicated to calculate and managers may need training. (1)
• It is irrelevant in short-term decision making as fixed costs don’t change. (1)
• Fixed costs relate to a period in time and so can be misleading to charge to production units. (1)
• The basis used to apportion and absorb overheads may be arbitrary. (1)
O/N 21 P22 Q4(g)
Explain two effects that the over-absorption of overheads may have on a business.
Selling prices may be too high (1) making products uncompetitive/leading to lower demand (1)
Lower demand (1) can lead to lower profits (1)
The value of closing inventory may be overstated (1) causing profit to be overstated (1)
Less expenses are recognised in the income statement (1) resulting in more profit being reported (1)
55
Break Even analysis
M/J 19 P23 Q4(a)
State what is meant by ‘piecework payments’.
Payment to employee is based on the number of completed units they produce (1)
M/J 19 P23 Q4(b) + O/N 16 P23 Q4(f)
Explain what is meant by ‘production overheads’.
Production overheads include all factory indirect costs (1) that cannot be traced directly to a unit of production (1)
M/J 18 P23 Q4(f)
Explain the purpose of costvolumeprofit analysis.
Used to determine the effect that changes in costs and volume (1) will have on the company’s operating income and
net income (1)
M/J 18 P23 Q4(g) + O/N 18 P23 Q4(d) + M/J 21 P23 Q4(c)
State four assumptions of costvolumeprofit analysis.
Sales price per unit is constant (1)
Total fixed costs are constant (1)
Variable cost per unit is constant (1)
All production is sold (1)
If the company sells more than one product, the product mix remains constant (1)
Costs are only affected as a result of changes in activity (1)
O/N 18 P22 Q4(a)
State what is meant by the term ‘break-even point’.
The point where the business is making neither a profit nor a loss (1)
F/M 17 Q4(c)
State what is meant by contribution.
The amount each unit of production makes towards covering the fixed costs (1) and providing a profit. (1)
Or
The difference between sales revenue and variable costs (1) contributing toward making a profit (or towards the fixed
costs)(1)
F/M 16 Q4(b)
State what is meant by P/V ratio.
A measure of how much contribution is earned from each $1 of sales (1 mark)
F/M 16 Q4(c) + O/N 18 P23 Q4(f) – advantages + M/J 19 P23 Q4(f) + O/N 21 P23 Q4(h)(i)
State two benefits and two drawbacks of CVP analysis.
Benefits:
• useful for planning
• provides quick estimates
• changes in costs can be easily incorporated
• forecasts profit at various levels of output
• identifies breakeven point
• charts provide a clear way of presenting information – better for non accountants
Drawbacks:
• can be time consuming to prepare charts
56
• assumes fixed costs are constant
• assumes variable costs per unit are the same at all levels of output
• assumes selling price per unit is the same at all levels of output
• assumes sales and production levels are the same
• ignores uncertainty in estimates of fixed costs and variable costs
M/J 10 P22 Q3(a)(i)
Define the break-even point.
The break-even point is the level of activity at which the business makes neither a profit nor a loss – i.e. total contribution =
total fixed costs. (accept a relevant formula)
M/J 10 P22 Q3(a)(ii) + F/M 21 P22 Q4(b)
Define the margin of safety.
The margin of safety is the distance between the break-even point and the expected level of activity. It is the amount by
which actual activity can fall short of expected activity before a loss is incurred.
O/N 15 P22 Q3(e) + O/N 11 P21 Q3(f) + M/J 10 P23 Q3(e) - Limitations
State three assumptions the accountant must make when preparing a break-even chart.
1 All variable costs per unit remain constant.
2 Fixed costs do not change within the relevant range.
3 Deals with only a single product or a constant sales mix.
4 Total costs and total revenue are linear.
5 Costs can be accurately classified into fixed or variable.
6 Chart applies to the relevant range only.
7 Chart covers only the short-term.
8 All units produced are sold i.e. there is no inventory.
9 It assumes that the selling price is constant at all levels of output.
57
Decision Making
Marginal costing is a costing technique where variable costs and fixed costs are separated.
Useful for the following short-term decisions:





Make or buy decision
Accepting or rejecting an order (special order decision)
Decision making in the face of a limiting factor
Decision whether to cease manufacture of a product
Decision whether to close a department
Make or Buy decisions
It is profitable to purchase a component, rather than to manufacture it, if its purchase price is lower than its marginal cost of
production. [Note: do not take into account selling costs as they will be incurred whether the components are naufactured or
purchased.]
Accepting or rejecting an order
Firms should decide if its profitable to accept a special order at a price below the normal selling price. These decisions are
considered when a firm has spare capacity and in the following circumstances:







The selling price must exceed the marginal cost of production in order to obtain contribution
To promote a new product
To dispose slow moving inventory
The order does not displace normal sales
To make use of idle production facilities
To act as a loss leader
There is no alteration in fixed cost as it has already been incurred by the existing output.
Limiting Factor
Limiting factor (key factor) is a factor which is binding constraint in an organisation.
From time to time, thee key factor in an organisation changes. In a situation where a firm is faced with a limiting factor,
management should aim at earning the maximum contribution per unit of the limiting factor. The products must be ranked
according to the amount of contribution they make from each unit of scarce resource.
Advantages of Marginal Costing






It is used to decide whether a business should make or buy a product.
Marginal costing helps in short term decision making.
Fixed costs are treated as period costs and so remain unchanged at different activity levels.
There is no need to calculate under absorption and over absorption of overhead costs.
Closing inventory is valued at variable production cost.
Marginal costing is used to calculate break-even level of output.
Disadvantages of Marginal Costing




It is only useful for short term decision making.
Marginal costing is easy to operate but can only be used if costs can be split into fixed and variable.
Under marginal costing, the fixed costs remain constant and variable costs vary with the level of output.
However, in the long run all costs become variable.
It is only useful for a business which makes a single product because allocation of fixed costs becomes
difficult when a company manufactures several products.
58
F/M 19 Q4(c)
Advise the directors which option they should choose. Justify your answer using both financial and non-financial factors. [7]
Financial factors: Max 3
If the production level is as budgeted, machine rental is ($8000) lower / profit is ($8000) more with the new agreement.
(1)
Fixed costs will reduce by $72 000 (1)
If the production level is below budget, the saving is greater with the new agreement. Therefore, the new agreement
reduces risk. (1)
Even if production levels rise and increase the total cost, unit contribution is still positive. (1)
If production levels rise, machine rental will become higher than before under the new agreement. (1)
The removal of the old machinery and installation of the new may incur additional costs. (1)
There could be costs of staff training with the new machinery. (1)
Non-financial factors: Max 3
The new agreement could mean new machinery which is more up-to-date / reliable / economical to run. (1)
The removal of the old machinery and installation of the new would be very disruptive . (1)
There could be teething problems with the new machinery. (1)
There would be a learning curve. (1)
Will new machinery produce equivalent quality The new machinery has unknown reliability/availability of spare parts.
(1)
Overall max 6 for justification + (1) for decision
F/M 19 Q4(d)
Explain how unit contribution can be used by a business manufacturing multiple products when there is a shortage of
production materials. [4]
The business can calculate contribution per unit of scarce resource. (1)
Thus, it can rank its products (1) and prepare a production schedule (1) to maximise profit (1) by prioritising products
with the highest contribution per unit of scarce resource. (1)
M/J 19 P21 Q4(e)
Ravi is concerned that the budgeted profit for Wye is not very high. He believes the following changes could increase the
profit but will have no effect on sales volume.
1 Increase the selling price per unit by 5%.
2 Use skilled labour which will increase the cost per hour by 5%.
3 Use better quality material which will increase the cost per kilo by 2%.
4 Increase the advertising cost by $6000.
5 Offer the sales team a bonus of 2% of the sales revenue earned from all sales above 80000 units.
Recommend whether or not Ravi should proceed with these changes. Justify your answer.
Recommend: The changes are not worthwhile. (1)
Because:
Although budgeted contribution is higher, the profit after the changes is lower (1), due to allocated fixed costs increasing –
advertising and sales bonus. (1)
The margin of safety is lower (1) which means there is less of a buffer / comfort zone before Wye starts to make a loss. (1)
The break-even point is higher (1) which increases the risk (1) of Wye not making enough sales to cover fixed costs. (1)
M/J 19 P22 Q4(f)
59
The same customer offers to pay Jessie the quoted price less a 10% discount. Jessie’s factory has spare capacity.
Advise Jessie whether or not she should accept the offer. Justify your answer.
The offer still provides a positive contribution/generates profit (1)
This will result in increased overall profits for the business (1) albeit the offer price will not achieve the usual mark up of
25% (1)
The order will make use of existing spare capacity (1) which could be used to manufacture goods with a better mark-up (1)
Is this a one-off order or will the customer expect future orders at the same price (1). Other customers could also want to
buy at a reduced price (1) , and it could cause ill feeling with other customers (1)
Decision (1)
M/J 19 P23 Q4(e)
Advise Ethan whether or not he should accept the order. Justify your answer taking into account both financial and nonfinancial factors.
Accept / Reject (1)
Financial (Max 2)
Will provide increase in sales revenue.
The order provides positive contribution/profit OF so is worthwhile.
Will there be an increase in the fixed cost?
Would it be less expensive to pay the existing workforce a premium for the additional units?
Non-financial (Max 2)
What effect will the lower price have on other customers who are paying $12?
Will the temporary labour be available immediately/ existing workforce be willing to work overtime?
Will the product quality remain the same if temporary labour is used / do they have the necessary skills for hand painted
pots?
Will the morale of the existing workforce go down if temporary labour is employed?
O/N 19 P21 Q4(f)
Recommend whether or not production of the model which provides the least profit should be discontinued. Justify your
answer using both financial and non-financial factors.
Financial – Max 2
All models make a positive contribution. (1)
If any model was discontinued fixed costs would be reallocated to the remaining models. (1)
Method of allocating fixed costs may be inappropriate. (1)
Non-financial – Max 4
Discontinuing any model may result in loss of customers/sales. (1)
Would the workforce be fully employed on the remaining models? (1)
Would employees need training to produce alternative models? (1)
Possible redundancies. (1)
Demotivated workforce. (1)
Adverse publicity. (1)
.
O/N 19 P22 Q4(e)
60
A new customer has approached Aramis and offered to pay him $1300 for his product. The normal selling price for this
product is $1750.
Advise Aramis whether or not he should accept the order. Justify your answer using both financial and non-financial factors.
Financial factors (Max 3)
Makes a positive contribution (1) ($1300 – (710 + 225 + 85 + 140) = $140 (1)
Does not achieve the required profit margin (1)
Makes a loss of $160 (1) The allocation of fixed overheads may be inaccurate (1)
Non-financial factors (Max 3)
This is a new customer. Will there be repeat orders? (1)
What will be the reaction of the existing customers? (1)
Does the company have spare capacity/other resources? (1)
Will the quality of the product be affected (1)
Decision (1)
O/N 19 P22 Q4(f) + O/N 18 P21 Q4(g)
State four factors that a business should consider before changing its supplier.
Quality – will the product quality be the same? (1)
Price – is the new supplier likely to offer a lower price? (1)
Credit terms – will the new supplier offer the same credit terms? (1)
Reliability – is the supplier reliable? (1)
Delivery – will the supplier offer delivery? (1)
F/M 18 Q4(e)
The sales director has suggested that the company should reduce production of bicycles by 500 a month and increase
production of scooters by 500 a month.
Advise the directors whether or not they should proceed with this suggestion. Justify your answer using both financial and
non-financial factors.
Financial (max 3)
The budgeted profit per unit is higher for scooters (1) as is the selling price (1) and it would appear that taking up the
suggestion would increase profit (1).
There might be staff retraining costs to be paid. (1)
Would it be necessary to make staff redundant involving redundancy costs? (1)
Non financial (max 3)
Is there demand for the extra scooters? (1)
If Department B is working at less than full capacity production of scooters could be increased without affecting
Department A. (1)
Machinery used in making bicycles might not be suitable for producing scooters. (1) Do staff have the necessary skills (1)
It might only be possible to make say 400 extra scooters by using the resources freed from the 500 bicycles. (1)
May lead to customer dissatisfaction (1)
Decision (1)
M/J 18 P21 Q4(h)
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Advise Zinan whether or not he should go ahead with the marketing campaign. Justify your answer using both financial and
non-financial factors.
Proceed or not (1)
The campaign will result in a loss of profit but will still have positive contribution. How short term is the price decrease /
is it only for this one order? Will it affect year 2 profits? Will fixed costs be covered in the long term? Will the increase in
advertising be enough to generate the expected level of demand? What will the existing customers reactions be to the
price decrease for new customers?
If they do not get new customers:
What will the morale of the existing workers be like after staff reduction? Will the quality of the goods go down if there
are fewer workers? How temporary will the loss of staff be? Will Zinan be able to re-recruit the skilled staff in year 2
when new orders come in? At what extra cost?
M/J 18 P22 Q4(e)
The directors have been informed that a competitor has quoted a price $600 more for the same conference. They are
considering revising their own pricing policy to increase accommodation prices by 20%.
Advise the directors whether or not they should increase their accommodation prices. Give reasons for your answer.
Price will still be lower than competitor (1)OF which will result in increased profits (1)OF Increased accommodation prices
may reduce the demand for Leisure and Conferences (1) and may affect overall occupancy rates (1)
May affect the reputation of the hotel and leisure complex (1) resulting in lost customers (1)
M/J 18 P23 Q4(e)
Advise the directors whether or not they should proceed with the promotion. Justify your answer using both financial and
non-financial factors.
Based on directors’ forecasts, incremental loss $960 (1)(OF).
The required increase of $960 is only slightly higher than the directors’ expectations. (1)
Positive contribution made (1)(OF).
How accurate are the directors’ forecasts of sales/additional costs? (1)
The promotion may have a positive/negative impact on the company’s other products. (1)
Have the directors considered the reaction of employees to the promotion? (1)
Have the directors considered the reaction of competitors? (1)
Does the company have the spare capacity to service the promotion? (1)
O/N 18 P21 Q4(f)
Advise the directors whether or not they should proceed with their plans to reduce the selling price. Give reasons for your
answer.
Positive (max 3)
Margin of safety is high at 49.82% (1)
Budgeted profit shows an increase of $17 500 (1)
Will increase market share (1)
Factory will be working at 100% capacity (1)
Negative (max 3)
How reliable are the directors’ estimates? (1)
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Will competitors reduce their price affecting the estimated sales growth? (1)
Will employees be willing to work the overtime? (1)
Will quality suffer because of working overtime? (1)
Overall max (4) for comments Decision (1)
O/N 18 P22 Q4(c)
Suggest a reason for: (i) the decrease in the direct material price (ii) the increase in the direct labour rate.
(i) bulk buying /economies of scale / supplier price reduction
(ii) overtime rates /increase basic wage rates
O/N 18 P22 Q4(d)
Explain why fixed costs might increase by 50%.
Fixed costs are only fixed over a given range of activity (1)
As this business is expanding its capacity, some fixed costs may increase (1) Such as:
• Rates – larger floor area used (1)
• Supervisors’ salaries – increase in staff numbers (so more supervisors required) (1)
• Depreciation – additional machinery required (1)
• Maintenance – increased operations (therefore more servicing required) (1)
O/N 18 P22 Q4(g)
Explain how the proposed expansion of the factory might affect the shareholders’ view of the safety of their investment.
Shareholders’ investment has become riskier (1) because of the increased external borrowing (1). Loan interest has to
be paid (1) whether profit is earned or not (1), but overall profit should increase (1). Repayment of the external
borrowing may result in future cash flow problems (1)
O/N 18 P22 Q4(h)
Advise the directors whether or not they should proceed with the expansion of the factory. Justify your answer.
Positive
Market share should increase (1) overall profit may increase (1). Expansion may encourage further shareholder
investment (1)
Negative
As a result of reducing the selling price and increased costs, the profit per unit will fall (1) and the breakeven point will
increase (1)
The directors should consider how certain the company are that all of the increased production will be sold (1) how
reliable the directors other estimates are (1) and whether suitable labour and other resources will be available (1).
They must also ensure that funds will be available to repay the loan. (1)
1 mark for decision
O/N 18 P23 Q4(c)
If the directors decide to proceed with the sales manager’s plan they would do so for a period of 3 years.
If the directors decide not to proceed with the sales manager’s plan they estimate that profit for the years ending 31 March
2019, 31 March 2020 and 31 March 2021 will be $522 000, $322000 and $220 000 respectively.
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Advise the directors whether or not they should accept the sales manager’s plan. Justify your answer using both financial and
non-financial factors and any relevant calculations.
Financial (max 4)
If the company did not adopt the sales manager’s proposal it would achieve the following profits over three years:
$ 522000 + 322 000 + 220 000 = 1064 000 (1)
If the sales manager’s proposal were to be accepted the following profits would be earned over three years; 209 500 +
459 500 + 459 500 = 1 128 500 (1) OF
Comparison of the two profit figures (1) OF
How reliable are the directors’ estimates of costs and revenues (1)
Non-financial (Max 4)
Availability of labour – would the current labour force be able to absorb the additional work or will additional staff
need to be recruited and trained? (1)
Machinery – would additional machinery be required to absorb a 25% increase in production? (1)
Space – would the company have sufficient space available? (1)
Competitors – would they respond and reduce their price? (1)
Advertising – will sales target be reached in years 2 and 3? (1)
Will the direct material quality suffer with the cost reduction (1)
Overall max (6) for comments plus (1) for recommendation
F/M 16 Q4(e)
Discuss whether or not Lin should continue to produce all three products. Justify your answer.
• continue with all three/do not cease production of X as they all make a contribution (1) towards fixed costs (1)
• Y has the highest contribution per unit (1) so should maximise its sales (1)
• X has the lowest contribution per unit (1) so should consider a price increase (1)
M/J 16 P21 Q4(h)
Rahel has to meet the forecast demand in April as she has contracts with her customers. In order to achieve this she has two
alternatives.
1 Ask the workers to work overtime.
2 Buy in the products from another supplier.
Advise Rahel which option she should choose. Justify your answer.
Overtime
Disadvantages
Advantages
Workers may refuse
Reduce contribution
Possibility of lower quality
Additional other costs
Will meet demand
Rahel knows ability of workers
Rahel knows quality of work
Buy-in
Doesn’t know quality / reliability of supplier
May be more expensive
May allow competition into market
Will meet demand
May obtain better price
M/J 16 P22 Q4(c)
Advise the directors whether or not they should make this change. Justify your answer.
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Easier to calculate
Cheaper to calculate
Some products may require more labour hour/machine hours
Less accurate
Different products may spend different time in each department.
O/N 19 P21 Q4(f)
Having considered the situation, the directors have decided to quote a price of $29 per bookcase to the retailer. The
additional work will involve employing one additional member of staff at a weekly salary of $140. The contract with Dando
plc to produce 220 bookcases per week would still be maintained at the price of $30 per bookcase.
Advise the directors whether or not they should proceed with the additional order for the retailer. Give reasons for your
answer.
Reasons for proceeding:
• Additional $13 520 profit
• Utilisation of spare capacity
• Less reliant on only one customer
• Only small increase in fixed costs
• Positive contribution
Reason for not proceeding
• Dando plc may cause problems due to lower price being offered to retailer
• Competitors may lower price and start price war
O/N 16 P22 Q4(c)
The company has two possible options to enable it to achieve the budgeted production.
Option 1 Pay existing staff overtime. This will be paid at a rate of $5.75 per hour.
Option 2 Buy in the required products from an external supplier at a cost of $50 per unit.
Evaluate the options available to the company to achieve the budgeted production. Support your answers with calculations.
Option 1
Calculation (Max 2)
Contribution would be an extra $1050 (2 / 1OF)
OR profit would be $37 200 (2 / 1OF)
Evaluation (Max 3)
• Quality / reputation is maintained via in house production (1)
• Will quality and productivity be affected by working overtime (1)
• There would be no delivery implications due to in-house production (1) 7
• Positive contribution / increased profit, but less than the outsourcing option (1)
• Will staff be willing to work overtime (1)
(3 marks + 2 marks for calculation) Max 5
Option 2
Calculation (Max 2)
Contribution would be an extra $2000 (2 / 1OF)
OR profit would be $38 150 (2 / 1OF)
Evaluation (Max 3)
• Need to consider the reliability of supply and delivery (1)
• Need to consider the quality of the products (1)
• Higher risk but larger financial returns (1)
• Effect on morale of staff if using external supplier (1)
• Possibility of loss of market to competitor (1)
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M/J 14 P22 Q3(g)
The directors of Sparkle have discovered that $7500 fixed production overhead was incorrectly analysed as direct materials.
Explain the effect that this error will have on contribution and profit when using marginal costing.
The marginal cost of producing one unit of Esprit will reduce (1) resulting in an increase in contribution (1). The profit for
the year will stay the same (1) because fixed production overheads will increase (1).
O/N 14 P21 Q1(d)
Discuss the advantages and disadvantages to the company if it purchases Ewes from the outside supplier.
Advantages
– Enables Zumbi to meet maximum demand for Ewe. (1)
– Enables Zumbi to meet maximum demand for Ess. (1)
– Zumbi may be able to use the space saved to make another profitable product. (1)
Disadvantages
– Quality of product may not be as good as own (1)
– Supplier may not be reliable (1)
– May not be able to save all the costs (1)
– Fixed costs will now be shared among less products (1)
O/N 13 P22 Q3(e)
State two disadvantages if Kirkton decides to buy the Kirks from the competitor
• The product quality may not be the equivalent of the company’s own quality (1)
• The competitor may not deliver on time (1)
• The competitor may increase the price (1)
• Kirkton will have to continue to pay wages (1)
• Competitive advantage (1)
• Kirkton will make a lower profit (1of)
O/N 12 P23 Q3(e)
Identify three factors which ABG Ltd should consider when deciding whether to accept this additional order for Gamma.
Customers paying full price will be annoyed to discover others paying less.
Possible business will be taken elsewhere.
Reaction of competitors needs consideration – price wars.
Will acceptance of the offer take up capacity that could be better used for future full price business?
An over reliance on special orders is not a long term solution and the company should put priority on achieving full price
orders.
M/J 09 P21 Q3(c)
Other factors need to be taken into consideration before introducing a new shift system. Discuss, briefly, three of these
factors
1 Are extra workers available?
2 Can new workers be trained?
3 Is it worth training workers for what might be a one-off situation?
4 There may be additional costs of transport and administration to be considered.
5 Additional maintenance of equipment?
6 Can quality be maintained?
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O/N 13 P22 Q1(b)
Joe is considering closing the car wash department due to its poor profitability. Advise Joe on the long term effects of this
decision.
Fixed costs will be reallocated
Alternative uses of the vacant space
Customers making additional purchases when having car washed
Loss of business and goodwill
Staff redundancies
Disposal of closing inventory
Sale of equipment
Decrease in profit/revenue
Closure costs
M/J 09 P22 Q3(c)
Explain the implications for the local community if Alberta Limited decides to extend its product range.
Additional employment available
Increased pollution
Work for local suppliers
Training for new employees
F/M 20 P22 Q4(h)
Advise Cuthbert whether or not he should accept the order. Justify your answer.
Accept the order (1).
There is both a positive contribution (1) and profit / lower profit margin (1)
Is there spare capacity? (1) Would acceptance of the order restrict other orders that would be more profitable? (1)
Consider whether customer is likely to make more orders (1) and at which price (1). Consider effect on other customers
learning of reduced price (1).
M/J 20 P21 Q2(a)
Advise the directors whether or not they should accept the offer from Wendy. Justify your answer.
Advice (1)
Accept the offer
The company will make more profit in April than had been forecast (1).
Profit in April would have been: (680 units × $24)(1) – $10 200, i.e. $6 120 (1)
The company will be in full production (1) avoiding cancellation of orders for materials which might cause a deterioration
in relationships with suppliers (1), avoiding laying off staff which could affect morale (1), avoiding machinery lying idle
which could affect their efficiency (1)
Max 2 marks Accept other valid points.
Not accept the offer
The company will have to reduce its usual output (1) which could mean that some regular customers’ orders are not
fulfilled (1) leading to a possible long-term loss of their custom (1) and a loss of profit if the special offer is not repeated
(1).
The directors need to consider whether the order can be produced to the quality expected (1), whether the labour force
have the appropriate skills for the products if they vary from the normal output (1) and whether the machinery is
capable of producing the products if they vary from the normal output (1).
O/N 20 P21 Q4(f)
Option A
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1 Reduce the selling price of each bookcase by $3 per unit.
2 Introduce a sales commission of 5% of selling price.
3 It is expected that demand will be 3800 units.
Option B
1 Change the design to improve quality resulting in an increase of 20% in the material cost per unit.
2 Labour hours per unit will increase by 10%.
3 The revised selling price of each bookcase will be $59.
4 Start an advertising campaign at a cost of $24000 per annum.
5 It is expected that demand will be 3040 units.
Recommend which option the directors should choose. Justify your answer.
Option A Max 4 Reasons for
• Will achieve target profit (1)
• Makes full use of capacity (1)
• Reduced price may increase sales (1)
Possible drawbacks
• Will sales commission be effective? (1)
• Will forecast increase in demand materialise/are forecasts reliable? (1)
• Reduced price may be perceived as reduced quality (1)
Option B Max 4 Reasons for
• Will achieve highest profit (1)
• Will achieve target profit (1)
• Increased price may be perceived as increased quality (1)
Possible drawbacks
• There will be unused factory capacity/what will happen about unused labour (1)
• Will forecast demand materialise/are forecast reliable? (1)
• Will advertising campaign be effective? (1)
• Increased price may reduce sales(1)
Overall maximum 6 marks Recommendation (1)
F/M 21 P22 Q4(g)
The company has a regular order to supply one major customer with 50% of the output of each product per month. Two
options are being considered to deal with the shortage of machine hours.
Option 1: The finance director has recommended the company makes the maximum profit possible in August 2021 and if
necessary not complete all of the major customer’s order.
Option 2: The sales director has recommended that the company should ensure it fulfils the major customer’s order.
Advise which option the company should choose. Justify your advice by discussing both options. (Consider both financial and
non-financial factors.)
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O/N 21 P21 Q4(f)
Explain two disadvantages to a business of offering a bonus payment to its employees.
• May cause workers to rush (1) which may affect the quality of the product (1)
• Will incur additional expenses (1) which may not be able to be passed on to the customer/may reduce profit (1)
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Business Planning
A budget is a plan of what an organization is aiming to achieve whereas a forecast is an estimate of what is likely to occur in the
future.
Budget is a short-term financial plan expressed in monetary terms.
A budget facilitates planning, and all businesses need to plan to survive.
Objectives: EPMC3
Evaluating performance so as to award bonuses or promotions to employees based on achievement of targets specified in the
budget.
Motivating device to improve performance of the organization, A bottom-up budget (participatory budget) motivates
employees because they are involved in setting the budget of the organization.
Planning for business activities
Coordinating various departmental activities
Communicating so that everyone in the organization is aware of what they are supposed to do.
Controlling activities for which managers are responsible
Planning:
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Ensures sufficient finance is available to continue operations.
Ensure sufficient skilled labour is available to meet production.
Estimate the likely future position of business both in short term and long term.
Identifies areas of responsibility of managers.
Assists management in decision making.
Helps avoid departmental conflicts.
Supports application of funding.
Ensures coordination of the business activities.
Coordination
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Ensure minimum effort towards common goal.
Communication
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Ensures that each person is fully informed of the plans, policies, and constraints of the organisation.
Helps operate efficiently.
Control
Management by exception: a manager’s attention and effort should be concentrated on the significant deviations from the
expected results. By investigating the deviations, managers can identify inefficiencies and hence initiate appropriate corrective
action to remedy the situation.
Advantages of budgeting and budgetary control
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Budget acts as a very useful tool for planning and control. It helps management to look ahead and plan for the future. It
allows targets to be set.
It helps to control the use of resources.
Budget preparation ensures that all functions of a business are properly coordinated. It improves coordination between
departments.
Budget clearly defines tithe areas of responsibility of managers who are involved in various business activities in order
to achieve budget targets.
Budget helps to identify the limiting factors so that remedial measures may be taken.
When employees participate in budget preparation, they are motivated and committed to achieve it.
Budget helps managers to know the expected cash inflows and cash outflows in order to highlight times when there will
be a shortage.
Financial benefits of budgeting and budgetary control
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It is a powerful tool to control costs
It compares budget and actual, identifies variances, and suggests corrective action.
It helps to monitor performance and assists in decision making.
It helps capital expenditure planning.
It enhances cash flow by identifying future inflows and outflows.
It facilitates profits maximisation.
Disadvantages of Budgeting and budgetary control
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Budget may act as a demotivator if it is imposed.
Budget plans are based on estimates and data could be inaccurate.
Managers may set budgets to ensure that they are achievable, thus making managers appear efficient
.
Introduction of budgetary control system in an organisation is an expensive programme and may be resist6ed by some
employees who are not as much efficient as others.
It loses its usefulness if it is not revised with the changing circumstances.
Managers may aim to meet only the lowest targets and not attempting to outdo the targets.
Organisation mission is to achieve the budget even if it results in undesirable actions.
It is time consuming and often requires specialist knowledge to prepare cash budget and the master budget.
It does not take account of unforeseen circumstances.
It could lead to conflict between departments.
M/J 19 P21 Q4(f) + F/M 16 Q4(h)
State four advantages to a business of planning for the future.
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Identify underperforming products (1)
Ensure sufficiently skilled labour is available to meet production (1)
Ensure sufficient finance is available to continue operations and any planned investments (1)
Ensure the correct quality/cost of material / discounts can be obtained from suppliers (1)
Be able to adapt to changes in the future / provides alternatives if financial targets are not being met (1)
Price products competitively (1)
Avoid ‘firefighting’ / avoid potential problems in the future (1)
Assess any competition / markets for products (1)
Estimate the likely future position of business − short term and long term (1)
Identify areas of responsibility of managers (1)
O/N 19 P23 Q4(g)
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Although the business is successful and expanding, the directors feel that the four departments do not always appear to be
working well together. The directors are planning to introduce a system of budgetary control which would initially reduce
annual profits by 5%.
Advise the directors whether or not they should proceed with their plans. Justify your answer.
Benefits
Formal budget will inform all departments of the common goal (1) and therefore improve communication between the
departments. (1)
Will provide clear indication of individual managers’ areas of responsibility (1) and therefore improve co-ordination
between departments. (1)
Will motivate managers and employees (1) thus improving company performance. (1)
Facilitates planning (1) which enables targets to be set (1) and improve performance by analysing variances. (1)
Drawbacks
Short term costs will increase (1) which would reduce profits though long term benefits should accrue. (1)
May be problems implementing the control system (1), employees may be resistant to change. (1)
Causes a straightjacket effect (1) which may prevent innovation (1) and missed opportunities (1)
May result in demotivation (1) if the budgets are unrealistic (1)
Decision 1 mark
M/J 18 P22 Q4(f) + O/N 16 P22 Q4(d)(i)
State two benefits to a company of operating a system of budgetary control.
• Assists with planning for the future (1)
• Helps to monitor performance (1)
• Compares budget and actual, identifying, variances enabling corrective action to be taken (1) • Enables delegation to
departments (1)
• Assists with decision making (1)
• Helps with responsibility accounting / enables assessment of managers (1)
• May motivate staff (1)
M/J 18 P22 Q4(g) + O/N 16 P22 Q4(d)(ii) + M/J 21 P23 Q4(g) + O/N 21 P21 Q4(g)
State two limitations to a company of operating a system of budgetary control.
• Budgets are an estimate and could be inaccurate (1)
• Budget are time consuming and/or expensive to create and monitor (1)
• Could lead to conflict between departments (1)
• Could demotivate employees (1)
• May have to employ specialist staff (1)
• Budget may be set an unrealistic level (1)
• Does not take account of unforeseen circumstances (1)
• Can restrict staff innovation (1)
M/J 20 P22 Q4(a)
Explain three ways in which the introduction of a system of budgetary control will affect the departmental managers of a
business.
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Managers could be involved in setting targets/budgets for their areas of responsibility (1) resulting in possible increase in
motivation (1) If managers are not involved in setting targets/budgets motivation could be reduced (1) especially if
targets are seen to be unachievable/unrealistic (1) Managers’ efficiency could be improved (1) as a result of having clear
objectives/targets (1)
However, budgetary control might prove to be restrictive (1) resulting in otherwise beneficial opportunities being rejected
by managers (1)
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