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DA701: Financial Accounting
T2-2018 –MARKING GUIDE
Mid- Term Examination
Level 7 Credits 20
Assessment 1 Total Marks / Weighting 75 marks (50%)
Week Due Week 5 Duration 2.5 hours + 15 minutes reading time

Instructions:
Ensure your name, student ID and date is entered on this page.

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Read each question carefully and answer ALL questions.

Please use a blue or black pen only to write your answers on the sheets provided. Answers written in other colour or pencil will not be marked.

Clearly number your answers and pages, include your name and ID on each page.

Obtain permission from the invigilator before you use a paper dictionary or a calculator. No electronic dictionaries are allowed.

No mobile phones or electronic devices (except for approved calculators) are allowed in the classroom during the test.

You are not allowed to leave the classroom within the first one hour of the test.

Ask for supplementary answer sheets if you require more space for your answers.

You cannot refer to any other student or lecturer for solutions during the assessment.

Please remain silent and seated until all papers are collected and you are told to leave.

Please ensure that all cell phones and any other electronic devices are switched off and put in a place designated by the invigilator.

Students found cheating or talking to other students will be asked to hand in the exam booklet and leave the room immediately. Strict disciplinary action will be taken against students found cheating.

Student Undertaking:
I have read and understood the instructions for the closed book assessment. I understand that I will be required to leave the room if I am found cheating or engaging in any unfair practice.
Student Name

Student ID

Student Signature Date
Assessor Name Total Marks / 75
Assessor Signature % Weighting / 50%

Section Section A Total
Question No Q1 Q2 Q3 Q4 Q5 Total Marks 20 8 12 15 20 75
Allocated DA 701Financial Accounting
Aim: The aim is to develop the knowledge and understanding of accounting fundamental principles and concepts, and to apply these principles to produce financial statements.

Level 7
Credits 20
LEARNING OUTCOMES ASSESSED
Learning Outcome Section Mark Allocation
Percentage Allocation
LO1: Demonstrate an understanding of the context and purpose of financial accounting and the impact of changes in the regulatory framework on accounting treatments and reports. Section A:
Question 1
20 marks
26.67%
LO2: Forward rational arguments to justify the application of conceptual and regulatory framework of financial reporting. Section A:
Question 2
Question 4 23 marks 30.67%
LO3: Critique and interpret financial and non-financial data to enhance strategic decision making. Section A:
Question 3
12 marks
16%
LO4: Construct financial statements that comply with international accounting standards and statutory requirement. Section A:
Question 5 20 Marks 26.67%
Total 75 marks 100%

Question 1
The IASB Conceptual Framework sets out the concepts that underlie the preparation and presentation of general purpose financial statements prepared for the benefit of external users.

Discuss why the Conceptual Framework is important. Explain in general terms what the IASB Conceptual Framework is trying to achieve. (6 Mark)
The Conceptual Framework identifies a number of accounting conventions. Explain what is meant by the prudence concept and provide an example of its application and discuss any two problems associated with this concept. (2+2 marks)
Financial statements are expected to possess some qualitative characteristics. Briefly discuss any four principal qualitative characteristics. 10 marks
Answer:
It forms the theoretical basis for determining what is included in financial statements, how they are measured and how they are communicated.(1 mark)
One of the ideas behind the Conceptual Framework is to avoid the fire-fighting approach, which has characterised the development of accounting standards in the past, and instead develop an underlying philosophy as a basis for consistent accounting principles so that each standard fits into the whole framework. Research began from an analysis of the fundamental objectives of accounting and their relationship to the information needs of accounts users. The Conceptual Framework has gone behind the requirements of existing accounting standards, which define accounting treatments for particular assets, liabilities, income and expenditure, to define the nature of assets, liabilities, income and expenditure. (5 marks)
The prudence concept lays down that revenue and profits are not anticipated but should only be recorded when earning is reasonably certain. Expenses and liabilities should, however, be recorded when anticipated, as best estimates if no actual figures are available. Loss in value of assets, whether realised or not, should be recorded when it arises, but a gain in value of an asset should not be recorded except via an unrealised reserve and only then if properly warranted. An example of the application of the prudence concept is the requirement to value inventory at the lower of cost and net realisable value. 2 marks
Prudence most obviously conflicts with the accrual assumption because it requires that the matching of costs and revenues should not take place if there is any doubt about the future recoverability of deferred costs. Prudence also conflicts with the going concern assumption because it may not be prudent to assume that a business is a going concern (although it is realistic). Prudence makes it difficult to treat items consistently because circumstances in one period may require a different treatment from previous periods in order to be prudent. 2 marks for any two
May discuss any four from the following: (2.5 Marks each)
The Framework states that qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The four principal qualitative characteristics are understandability, relevance, reliability and comparability.

Understandability
Users must be able to understand financial statements. They are assumed to have some business, economic and accounting knowledge and to be able to apply themselves to study the information property. Complex matters should not be left out of financial statements simply due to its difficulty if it is relevant information.

Relevance
Only relevant information can be useful. Information is relevant when it helps users evaluate past, present or future events, or it confirms or corrects previous evaluations. The predictive and confirmatory roles of information are interrelated.

Information on financial position and performance is often used to predict future position and performance and other things of interest to the user, eg likely dividend, wage rises. The manner of showing information will enhance the ability to make predictions, e.g. by highlighting unusual items. The relevance of information is affected by its nature and materiality. Information may be judged relevant simply because of its nature (e.g. remuneration of management). In other cases, both the nature and materiality of the information are important.
Reliability
Information must also be reliable to be useful, i.e free from material error and bias. The user must be able to depend on it being a faithful representation.

Even if information is relevant, if it is very unreliable it may be misleading to recognise it, e.g. a disputed claim for damages in a legal action.

Faithful representation
Information must represent faithfully the transactions it purports to represent in order to be reliable. There is a risk that this may not be the case, not due to bias, but due to inherent difficulties in identifying the transactions or finding an appropriate method of measurement or presentation. Where measurement of the financial effects of an item is so uncertain, enterprises should not recognise such an item, e.g. internally generated goodwill.

Substance over form
Faithful representation of a transaction is only possible if it is accounted for according to its substance and economic reality, not with its legal form.

Neutrality
Information must be free from bias to be reliable. Neutrality is lost if the financial statements are prepared so as to influence the user to make a judgement or decision in order to achieve a predetermined outcome.

Prudence
Uncertainties exist in the preparation of financial information, e.g. the collectability of doubtful receivables.

These uncertainties are recognised through disclosure and through the application of prudence.

Completeness
Financial information must be complete, within the restrictions of materiality and cost, to be reliable. Omission may cause information to be misleading.

Comparability
Users must be able to compare an entity’s financial statements:
(a) Through time to identify trends; and
(b) With other entity’s statements, to evaluate their relative financial position, performance and changes in financial position.

Question 2
At 1 Jan 2011 John Ltd has plant and with an expected economic life of 12 years. Due to technological advances, the plant is expected to become obsolete on 31 Dec 2015. At 31 Dec 2011 the plant has a carrying value of $420,000. The future net cash flows from the use of the plant are:

The expected rate of return on these cash flows is 14% and the residual value at 31 Dec 2015 is $6,000. The net selling price of the asset at 31 Dec 2011 is $180,000.

Required:
Decide whether it is necessary to perform an impairment test. Justify you answer. 1 mark
Compute the value in use of the plant. 5 marks
Determine the recoverable amount. Explain your answer. 1 mark
Determine whether the plant needs to be written down. Provide a relevant journal entry. 1 mark
Solution:
Yes, the test is required as there is evidence of obsolescence and lower economic performance. (1 mark)
As 201,902 is greater than $180,000, use $201,902.

Dr Loss on Plant218,098
Cr Plant218,098
Question 3
You have just been appointed as assistant accountant at Marylebone Croquet Mallets Ltd and have been given the task of analysing the company’s financial performance during 2014 and its financial position for the year. So that you can do this, you have obtained the following financial statements of the company for 2012 and 2013, and the industry average ratios for 2014:
Income Statement for the year ending 31 December 2014
LINK Excel.Sheet.12 “C:\Users\rishi.gorantla\Desktop\Assessments\DA701\T4 2017\Moderated – MID Term Assessment MG T4-2017.docx” “_1593954256!Sheet1!R5C6:R16C8” a f 5 h * MERGEFORMAT
Sales 2,537,500  
Cost of sales 1,852,000  
Gross profit 685,500  
Operating expenses    
Selling 325,000  
Administrative 208,000  
Depreciation 76,000 609,000
Earnings before interest and tax   76,500
Interest   46,500
Earnings before tax   30,000
Tax (at 30%)   9,000
Net profit after tax   21,000

Balance Sheet as at 31 December 2014
LINK Excel.Sheet.12 “C:\Users\rishi.gorantla\Desktop\Assessments\DA701\T4 2017\Moderated – MID Term Assessment MG T4-2017.docx” “_1570255795!Sheet1!R18C6:R35C10” a f 5 h * MERGEFORMAT
  2014   2013  
Current assets        
Cash 12,500   12,050  
AR 402,778   381,950  
Inventory 350,312   381,722  
Total current assets   765,590   775,722
Non-Current assets        
Plant ; Equipment 1,046,910   845,854  
Accumulated depreciation 250,000   174,000  
Net non-current assets   796,910   671,854
Current liabilities        
AP 270,500   385,250  
Accruals 37,500   50,451  
Total current liabilities   308,000   435,701
Non-current liabilities        
Long term loan   582,625   350,000
Net total assets   671,875   661,875
Shareholders’ equity   671,875   661,875

Marylebone Croquet Mallets Ltd historical ratios:
  2012 2013 2014 Industry
Current ratio 1.7 1.8   1.5
Quick ratio 1.0 0.9   1.2
Inventory turnovertimes 5.7 4.9   10.2
Average collection perioddays 50 55   45
Total assets turnovertimes 1.4 1.5   2.0
Debt ratio 45.8% 54.3%   24.5%
Times interest earned ratio 2.4 2.0   2.5
Gross profit ratio 29.5% 28.0%   26.0%
Net profit margin 1.3% 1.0%   1.2%
Required:
Determine financial ratios for the year 2014 and critically analyse the company’s financial position to enhance the strategic planning. In your answer consider the company’s liquidity, efficiency, debt and profitability situations. 12 marks
Solution:

4 marks for the answer as above. Reduce by 0.5 mark for each error
Comments:
Liquidity: MCM has enough current assets to cover current liabilities. The trend is upward and is much higher than the industry average. This is unfavourable because it indicates too much inventory and accounts receivable. However, while barely adequate, the liquid ratio has been fairly stable and currently exceeds the industry average – suggesting that MCM is able to meet its immediate commitments. 2 marks
Activity: Inventory turnover is fluctuating and is much lower than the industry average. This shows that MCM has too much inventory. Average collection period is increasing and much higher than the industry average. Both indicators suggest difficulty in collecting payment. The total asset turnover ratio is rising slowly but is significantly lower than the industry average – indicating that sales volume is too low for the amount of committed assets. 2 marks
Debt: The debt ratio is increasing and is much higher than the industry average, placing MCM at high risk of insolvency. Industries with high capital investment and higher operating risk try to minimise financial risk. MCM has both heavy operating and financial risk. The times-interest-earned ratio also indicates a potential debt service problem. The ratio is decreasing and is well below the industry average. 2 marks
Profitability: The gross profit margin is falling, but still quite favourable when compared with the industry average. The net profit margin, however, has deteriorated and is now well below the industry average. As the gross profit margin is within expectations but the net profit margin is too low, high interest payments may be to blame. The high financial leverage has caused the low profitability. Marylebone Croquet Mallets Ltd clearly has a problem with its inventory level, and sales are not at an appropriate level for its capital investment. As a consequence, the company has acquired a substantial amount of debt which, due to associated high interest payments is depressing profitability. 2 marks
Question 4
AK is a company whose activities are in the field of major construction projects. During the year ended 30 September 2017, it enters into three separate contracts, each with a fixed contract price of $1,000,000. These are contracts where performance obligations are satisfied over time and AK has an enforceable right to payment for performance completed to date. The following information relates to these contracts at 30 September 2017.

$’000
Amounts invoiced and paid up to 30.9.17 540 475 400
Costs incurred to date 500 550 320
Estimate costs to complete the contract 300 550 580
Estimated percentage of obligations satisfied 60% 50% 35%
Required
Show how each contract would be reflected in the statement of financial position of AK at 30 September 2017 under IFRS 15 Revenue from contracts with customers. (7 marks)
Show how each contract would be reflected in the statement of profit or loss of AK for the year ended 30 September 2017 under IFRS 15. (8 Marks)
Solution:
Treatment of construction contracts (contracts where performance obligations are satisfied over time) in the statement of financial position of AK at 30 September 2017.

Treatment of construction contracts in the statement of profit or loss of AK for the year ended 30 September 20X7

Question 5:
USB, a limited liability company, has the following trial balance at 31 December 2017.

Dr Cr
$’000 $’000
Cash at Bank 100 Inventory at 1 January 20X9 2,400 Administrative Expenses 2,206 Distribution Costs 650 Non-Current Assets at Cost: Buildings 10,000 Plant and Equipment 1,400 Motor vehicles 320 Suspense 1,500
Accumulated Depreciation Buildings 4,000
Plant and Equipment 480
Motor vehicles 120
Retained Earnings 560
Trade Receivables 876 Purchases 4,200 Dividend Paid 200 Sales Revenue 11,752
GST Payable 1,390
Trade Payables 1,050
Share Premium 500
$1 ordinary shares 1,000
22,352 22,352
The following additional information is relevant.

Inventory at 31 December 2017 was valued at $1,600,000. While doing the inventory count, errors in the previous year’s inventory count were discovered. The inventory brought forward at the beginning of the year should have been $2.2m, not $2.4m as above.

Depreciation is to be provided as follows:
Buildings at 5% straight line, charged to administrative expenses.

Plant and equipment at 20% on the reducing balance basis, charged to cost of sales.

Motor vehicles at 25% on the reducing balance basis, charged to distribution costs.

No final dividend is being proposed
A customer has gone bankrupt owing $76,000. This debt is not expected to be recovered and an adjustment should be made. An allowance for receivables of 5% is to be set up.

1 million new ordinary shares were issued at $1.50 on 1 December 2017. The proceeds have been left in a suspense account.

Required
Prepare the following using IAS 1 “Presentation of Financial Statements”
Statement of financial performance for the year ended 31 December 2017 (5 Marks)
Statement of changes in equity for the year ended 31 December 2017 (5 Marks)
Statement of financial position as at 31 December 2017 (10 Marks)
All statements are to be prepared in accordance with the requirements of International Financial Reporting Standards. Ignore taxation.

Solution:
a) STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 2017

(5marks)
b) STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2017

(5marks)
c) STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2017

(10 Marks)

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