P7_pilot_paper

 The Chartered Institute of Management Accountants 2004 1 MANAGERIAL LEVEL FINANCIAL MANAGEMENT PILLAR PAPER P7 – FINANCIAL ACCOUNTING AND TAX PRINCIPLES This is a Pilot Paper and is intended only to be an indicative guide for tutors and students of the style and type of questions that are likely to appear in future examinations. It does not seek to cover the full range of the syllabus learning outcomes for this subject. Financial Accounting and Tax Principles will be a three hour paper with two compulsory sections (50 marks and 30 marks respectively) and one section with a choice of questions for 20 marks. CONTENTS Pilot Question Paper Section A: Twenty one objective test questions Pages 2-13 Section B: Six short answer questions Pages 14-16 Section C: Two scenario questions Pages 17-20 Indicative Maths Tables and Formulae Pages 21-23 Pilot Answers Pages 24-36 P7 – F in an ci al A cc ou nt in g an d Ta x Pr in ci pl es P7 PILOT PAPER 2 SECTION A – 50 MARKS ANSWER ALL TWENTY-ONE SUB-QUESTIONS Question One 1.1 Which ONE of the following transactions is most likely to affect the overall amount of working capital? A Receipt of full amount of cash from a customer to settle their trade receivable account. B Payment of a trade payable account in full. C Sale of a non-current asset on credit at its net book value. D Purchase of inventory on credit. (2 marks) REQUIRED: On the indicative ANSWER SHEET, either write your answer in the space provided where the sub-question requires a written response, or place a circle “O” around the letter that gives the correct answer to the sub-question where a list of distractors has been provided. If you wish to change your mind about an answer to such a sub-question, block out your first answer completely and then circle another letter. You will not receive marks if more than one letter is circled. Space has been provided on the four-page answer sheet for workings. If you require further space, please use the last page of your answer book and clearly indicate which question(s) these workings refer to. You must detach the answer sheet from the question paper and attach it to the front cover of your answer book before you hand it to the invigilators at the end of the examination. P7 PILOT PAPER 3 Financial Accounting and Tax Principles Write here your full examination number: Centre Code Hall Code INDICATIVE ANSWER SHEET FOR SECTION A Desk Number 1.1 A B C D 1.2 A B C D 1.3 A B C D No more than 15 additional words: A direct tax is one that1.4 1.5 The optimal amount to the nearest $100 to be transferred is: 1 2 3 1.6 Maximum 5 words per item 4 1.7 The annual rate of interest is: % 1.8 A B C D 1.9 The average working capital cycle is: 1.10 A B C D 1.11 A B C D 1.12 A B C D 1.13 Cash expected to be received is: $ 1.14 A B C D 1.15 Tax due is: $ 1.16 A B C D THIS ANSWER SHEET CONTINUES ON PAGE 4 P In no more than 30 words:1.17 In no more than 30 words:1.18 7 PILOT PAPER 4 1.19 The value of goodwill to be included in the accounts is: $ 1.20 The optimal order size is: 1.21 A B C D You must detach this Answer sheet from the question paper and attach it to the inside front cover of your answer book before you hand it in to the invigilators at the end of the examination. P7 PILOT PAPER 5 Space for workings for Section A P7 PILOT PAPER 6 Space for workings for Section A P7 PILOT PAPER 7 1.2 B entered into a three-year contract to build a leisure centre for an enterprise. The contract value was $6 million. B recognises profit on the basis of certified work completed. At the end of the first year, the following figures were extracted from B's accounting records: $000 Certified value of work completed (progress payments billed) 2,000 Cost of work certified as complete 1,650 Cost of work-in-progress (not included in completed work) 550 Estimated cost of remaining work required to complete the contract 2,750 Progress payments received from enterprise 1,600 Cash paid to suppliers for work on the contract 1,300 What values should B record for this contract as "gross amounts due from customers" and "current liabilities – trade and other payables"? Gross amounts due from Current liabilities – trade and customers other payables A $950,000 $350,000 B $950,000 $900,000 C $1,250,000 $600,000 D $2,550,000 $900,000 (2 marks) 1.3 IAS 8 – Net Profit or Loss for the Period, Fundamental Errors and Changes in accounting policies specifies the definition and treatment of a number of different items. Which of the following is NOT specified by IAS 8? A The effect of a change in an accounting estimate. B Prior period adjustments. C Provisions. D Extraordinary items. (2 marks) P7 PILOT PAPER 8 1.4 In no more than 15 words, complete the following sentence: “A direct tax is one that…” (Write your answer in the space provided on the answer sheet) (2 marks) 1.5 A company uses the Baumol cash management model. Cash disbursements are constant at $20,000 each month. Money on deposit earns 5% a year, while money in the current account earns a zero return. Switching costs (that is, for each purchase or sale of securities) are $30 for each transaction. What is the optimal amount (to the nearest $100) to be transferred in each transaction? (Write your answer in the space provided on the answer sheet) (2 marks) 1.6 List (using no more than five words per item) the four main sources of tax rules in a country. (Write your answer in the space provided on the answer sheet) (4 marks) 1.7 WM’s major supplier, INT, supplies electrical tools and is one of the largest companies in the industry, with international operations. Deliveries from INT are currently made monthly, and are constant throughout the year. Delivery and invoicing both occur in the last week of each month. Details of the credit terms offered by INT are as follows: Normal credit period Cash discount Average monthly purchases 40 days 2% for settlement in 10 days $100,000 WM always takes advantage of the cash discount from INT. Calculate the annual rate of interest (to two decimal places) implied in the cash discount offered by INT. Assume a 365-day year. (Write your answer in the space provided on the answer sheet) (3 marks) P7 PILOT PAPER 9 1.8 A company has a current ratio of 2 :1. Due to having significant surplus cash balances, it has decided to pay its trade payable accounts after 30 days in future, rather than after 50 days, as it has in the past. What will be the effect of this change on the company's current ratio and its cash operating cycle? Current ratio Cash operating cycle A Increase Increase B Increase Decrease C Decrease Increase D Decrease Decrease (2 marks) 1.9 The following balances were extracted from the books of A: Year ended 31 March 2003 $000 Revenue 300 Cost of sales 200 Gross profit 100 At 31 March 2003 $000 Closing inventory 15 Trade receivables 36 Trade payables 28 Assume all revenue is credit sales and cost of sales equates to inventory purchases. What is A's average working capital cycle for the year ended 31 March 2003? (Write your answer in the space provided on the answer sheet) (3 marks) 1.10 Double tax relief is used to A ensure that you do not pay tax twice on any of your income. B mitigate taxing overseas income twice. C avoid taxing dividends received from subsidiaries in the same country twice. D provide relief where a company pays tax at double the normal rate. (2 marks) P7 PILOT PAPER 10 1.11 A withholding tax is: A tax withheld from payment to the tax authorities. B tax paid less an amount withheld from payment. C tax deducted at source before payment of interest or dividends. D tax paid on increases in value of investment holdings. (2 marks) 1.12 Tax on an enterprise’s trading profits could be referred to as: (i) Income tax (ii) Profits tax (iii) Indirect tax (iv) Direct tax (v) Earnings tax Which TWO of the above would most accurately describe tax on an enterprise’s trading profits: A (i) and (iii) B (i) and (iv) C (ii) and (iii) D (iv) and (v) (2 marks) 1.13 An enterprise commenced business on 1 April 2002. Revenue in April 2002 was $20,000, but this is expected to increase at 2% a month. Credit sales amount to 60% of total sales. The credit period allowed is one month. Bad debts are expected to be 3% of credit sales, but other customers are expected to pay on time. Cash sales represent the other 40% of revenue. How much cash is expected to be received in May 2002? (Write your answer in the space provided on the answer sheet) (3 marks) P7 PILOT PAPER 11 1.14 Which of the following types of taxes is regarded as an indirect tax? A Taxes on income. B Taxes on capital gains. C Taxes on inherited wealth. D Sales tax (Value added tax). (2 marks) 1.15 E has an accounting profit before tax of $95,000. The tax rate on trading profits applicable to E for the year is 25%. The accounting profit included non-taxable income from government grants of $15,000 and non-tax allowable expenditure of $10,000 on entertaining expenses. How much tax is E due to pay for the year? (Write your answer in the space provided on the answer sheet) (2 marks) 1.16 Which TWO of the following are underlying assumptions in the International Accounting Standards Board’s Framework for the preparation and presentation of financial statements? (i) Accruals (ii) Relevance (iii) Comparability (iv) Going concern (v) Reliability A (i) and (v) B (ii) and (v) C (iii) and (iv) D (i) and (iv) (2 marks) 1.17 The International Accounting Standards Board’s Framework for the preparation and presentation of financial statements defines elements of financial statements. In no more than 30 words define an asset. (Write your answer in the space provided on the answer sheet) (2 marks) P7 PILOT PAPER 12 The following data is to be used to answer questions 1.18 and 1.19 below X acquired the business and assets from the owners of an unincorporated business: the purchase price was satisfied by the issue of 10,000 equity shares with a nominal market value of $10 each and $20,000 cash. The market value of X shares at the date of acquisition was $20 each. The assets acquired were: • Net tangible non-current assets with a book value of $20,000 and current value of $25,000. • Patents for a specialised process valued by a specialist valuer at $15,000. • Brand name, valued by a specialist brand valuer on the basis of a multiple of earnings at $50,000. • Publishing rights of the first text from an author that the management of X expects to become a best seller. The publishing rights were a gift from the author to the previous owners at no cost. The management of X has estimated the future value of the potential best seller at $100,000. However, there is no reliable evidence available to support the estimate of the management. 1.18 In no more than 30 words, explain the accounting treatment to be used for the publishing rights of the first text. (Write your answer in the space provided on the answer sheet) (2 marks) 1.19 Calculate the value of goodwill to be included in the accounts of X for this purchase. (4 marks) 1.20 SK sells bathroom fittings throughout the country in which it operates. In order to obtain the best price, it has decided to purchase all its annual demand of 10,000 shower units from a single supplier. RR has offered to provide the required number of showers each year under an exclusive long-term contract. Demand for shower units is at a constant rate all year. The cost to SK of holding one shower unit in Inventory for one year is $4 plus 3% of the purchase price. RR is located only a few miles from the SK main showroom. It has offered to supply each shower unit at $400 with a transport charge of $200 per delivery. It has guaranteed such a regular and prompt delivery service that SK believes it will not be necessary to hold any safety Inventory (that is buffer Inventory) if it uses RR as its supplier. Using the economic order quantity model (EOQ model), calculate the optimal order size, assuming that RR is chosen as the sole supplier of shower units for SK. (Write your answer in the space provided on the answer sheet) (3 marks) P7 PILOT PAPER 13 1.21 Which of the following would be LEAST LIKELY to arise from the introduction of a Just-in-Time stock ordering system? A Lower stockholding costs. B Less risk of stock shortages. C More frequent deliveries. D Increased dependence on suppliers. (2 marks) (Section A = 50 marks) End of Section A P7 PILOT PAPER 14 SECTION B – 30 MARKS ANSWER ALL SIX SHORT-ANSWER QUESTIONS Question Two A new type of delivery vehicle, when purchased on 1 April 2000 for $20,000, was expected to have a useful economic life of four years. It now appears that the original estimate of the useful economic life was too short, and the vehicle is now expected to have a useful economic life of six years, from the date of purchase. All delivery vehicles are depreciated using the straight-line method and are assumed to have zero residual value. Required: As the trainee management accountant, draft a memo to the transport manager explaining whether it is possible to change the useful economic life of the new delivery vehicle. Using appropriate International Accounting Standards, explain how the accounting transactions relating to the delivery vehicle should be recorded in the income statement for the year ended 31 March 2003 and the balance sheet at that date. (5 marks) Question Three NDL drilled a new oil well, which started production on 1 March 2003. The licence granting permission to drill the new oil well included a clause that requires NDL to "return the land to the state it was in before drilling commenced". NDL estimates that the oil well will have a 20-year production life. At the end of that time, the oil well will be de-commissioned and work carried out to reinstate the land. The cost of this de-commissioning work is estimated to be $20 million. Required: As the trainee management accountant, draft a memo to the production manager explaining how NDL must treat the de-commissioning costs in its financial statements for the year to 31 March 2003. Your memo should refer to appropriate International Accounting Standards. (5 marks) P7 PILOT PAPER 15 Question Four HRD owns a number of small hotels. The room occupancy rate varies significantly from month to month. There are also high fixed costs. As a result, the cash generated each month has been very difficult to estimate. Christmas is normally a busy period and large cash surpluses are expected in December. There is, however, a possibility that a rival group of hotels will offer large discounts in December and this could damage December trade for HRD to a significant extent. January is a poor period for the industry and therefore all the company's hotels will close for the month, resulting in a negative cash flow. The Finance Director has identified the following possible outcomes and their associated probabilities: $000 Probability Expected cash balance at 30 November 2003 +175 1·0 Net operating cash flow in December 2003 +700 0·7 -300 0·3 Net operating cash flow in January 2004 -900 1·0 Assume cash flows arise at month ends. After January 2004, trade is expected to improve, but there is still a high degree of uncertainty in relation to the cash surpluses or deficits that will be generated in each month. Required: Calculate the expected cash balance or overdraft of HRD at 31 January 2004. Explain why your answer may not be useful for short-term cash planning and outline alternative approaches that could be used. (5 marks) P7 PILOT PAPER 16 Question Five On 1 January 2003, SPJ had an opening debit balance of $5,000 on its tax account, which represented the balance on the account after settling its tax liability for the previous year. SPJ had a credit balance on its deferred tax account of $1⋅6 million at the same date. SPJ has been advised that it should expect to pay $1 million tax on its trading profits for the year ended 31 December 2003 and increase its deferred tax account balance by $150,000. Required: Prepare extracts from the income statement for the year ended 31 December 2003, balance sheet at that date and notes to the accounts showing the tax entries required. (5 marks) Question Six IAS 37 defines the meaning of a provision and sets out when a provision should be recognised. Required: Using the IAS 37 definition of a provision, explain how a provision meets the International Accounting Standards Board’s Framework for the preparation and presentation of financial statements definition of a liability. (5 marks) Question Seven A lessee leases a non-current asset on a non-cancellable lease contract of five years, the details of which are: • The asset has a useful economic life of five years. • The rental is $21,000 per annum payable at the end of each year. • The lessee also has to pay all insurance and maintenance costs. • The fair value of the asset was $88,300. The lessee uses the sum of digits method to calculate finance charges on the lease. Required: Prepare income statement and balance sheet extracts for years one and two of the lease. (5 marks) (Section B = 30 marks) End of section B P7 PILOT PAPER 17 SECTION C – 20 MARKS ANSWER ONE QUESTION ONLY Question Eight AZ is a quoted manufacturing enterprise. Its finished products are stored in a nearby warehouse until ordered by customers. AZ has been re-organising the business to improve performance. The trial balance for AZ at 31 March 2003 was as follows: $000 $000 7% Loan Notes (redeemable 2007) 18,250 Accumulated profits at 31 March 2002 14,677 Administrative expenses 16,020 Bank & Cash 26,250 Cost of goods manufactured in the year to 31 March 2003 (excluding depreciation) 94,000 Distribution costs 9,060 Dividends paid 1,000 Dividends received 1,200 Equity shares $1 each, fully paid 20,000 Interest paid 639 Inventory at 31 March 2002 4,852 Plant & Equipment 30,315 Provision for Depreciation at 31 March 2002: Plant & Equipment 6,060 Vehicles 1,670 Provision for doubtful trade receivables 600 Restructuring costs 121 Sales revenue 124,900 Share issue expenses 70 Share premium 500 Trade payables 8,120 Trade receivables 9,930 Vehicles 3,720 195,977 195,977 Additional information provided: (i) Non-current assets are being depreciated as follows: Plant & Equipment 20% per annum straight line Vehicles 25% per annum reducing balance Depreciation of plant and equipment is considered to be part of cost of sales, while depreciation of vehicles should be included under distribution costs. (ii) Tax due for the year to 31 March 2003 is estimated at $15,000. (iii) The closing inventory at 31 March 2003 was $5,180,000. P7 PILOT PAPER 18 (iv) A dividend of 5 cents per ordinary share was paid in February 2003. (v) The 7% loan notes are 10-year loans due for repayment by 31 March 2007. AZ incurred no other interest charges in the year to 31 March 2003. (vi) The restructuring costs in the trial balance represent the cost of the final phase of a major fundamental restructuring of the enterprise to improve competitiveness and future profitability. (vii) At 31 March 2003, AZ was engaged in defending a legal action against the enterprise. Legal advisers have indicated that it is reasonably certain that the outcome of the case will be against the enterprise. The amount of compensation is currently estimated at $25,000 and has not been included in the trial balance. (viii) On 1 October 2002, AZ issued 1,000,000 equity shares at $1⋅50 each. All money had been received and correctly accounted for by the year end. Required: Prepare AZ's income statement for the year to 31 March 2003, a balance sheet at that date, and a statement of changes in equity for the year. The