ACCA Accounting Technician Examination Level C

Managing Finances
December 1998 Thursday Morning
Question Paper Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

The Association of Chartered Certified Accountants

paper C5

ALL FOUR questions are compulsory and MUST be answered.

Frames Ltd is a small wholesaler of building materials. The company sells on credit to a wide variety of building contractors. You have recently been appointed to the newly created position of credit manager to implement credit control procedures in order to avoid potential bad debts. Extracts from the companys most recent accounts are as follows: Balance sheet as at 30 June 1998 000 Fixed assets Land and buildings at cost Less accumulated depreciation Fixtures and fittings at cost Less accumulated depreciation Current assets Stocks Trade debtors Bank 000 600 200 200 75 000

400 125 525

400 400 2 802

Creditors: (Amounts falling due in less than 1 year ) Trade creditors Taxation Creditors: (Amounts falling due after 1 year) Term loan (10%) Capital and reserves Called up share capital (50p par value) Share premium Revenue reserves (retained profit)

346 30

376

426 951 300 651 100 200 351 651

Profit and loss account for the year ended 30 June 1998 000 Sales Less Cost of sales Opening stock Purchases Less Closing stock Gross profit Administration expenses Selling expenses Finance expenses Pre-tax profit Taxation 30% Profit after taxation 2 200 270 30 400 1,400 1,800 400 1,400 600 000 2,000

500 100 30 70

Notes: 1. 2. All sales and purchases are on credit. The managing director is considering increasing the credit period given to customers by 15 days. It is anticipated that: (a) This will increase annual sales by 20%. (b) To cope with the increase in sales, stocks will be increased by 10% effective immediately, and are forecast to remain constant at this increased level. (c) Gross profit margin on the additional sales will be the same as at present (i.e. 30%). (d) Credit period received from suppliers will remain unchanged. (e) Administration and selling expenses are not expected to change. 3. To finance any extra working capital requirement the company intends to increase its term loan effective immediately. Interest on this term loan is currently 10% per annum. (Any increase in the term loan will result in an increase in the finance expenses in the profit and loss account).

Required: (a) (i) Explain the term net working capital (cash operating) cycle. (ii) Calculate the existing cash operating cycle to the nearest day. (Use 30 June 1998 year end figures). (2 marks) (6 marks)

(iii) If the proposed credit policy change is implemented, calculate the increase or decrease in each of the following: Cash operating cycle to the nearest day Net investment in stock, debtors and creditors to the nearest 000. Net profit after tax to the nearest 000. (Use 30 June 1999 year end figures) (14 marks)

(b) It has been suggested that Frames Ltd., considers factoring and/or invoice discounting to finance the expansion of the business. You are required to explain three ways in which factoring differs from invoice discounting. (6 marks) (c) (i) Identify and briefly discuss four factors which need to be taken into account when assessing the credit worthiness of new customers. (8 marks) (ii) Briefly outline four reasons why small companies like Frames Ltd., may find the management of debtors a particular problem. (4 marks) (40 marks)

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Toyz Ltd is a medium sized company engaged in the manufacture of a range of educational toys. The business is growing rapidly and the company is experiencing some cash flow difficulties. The companys toys are sold to a number of retail outlets throughout the country. Prior to departing for an extended Christmas holiday, the financial controller had prepared a cash flow forecast for the managing director for the period January to March 1999. The managing director has reviewed the cash flow forecast and is concerned with the trend exhibited in the cash position. He has asked you, as assistant accountant, to prepare the profit and loss account for the period January to March 1999 using the information on which the financial controller had based the cash flow forecast. You have been given the financial controllers working papers which include the following information: January 99 February 99 March 99 Inflows Receipts from debtors 200,000 125,000 125,000 Note 1 Rental income 40,000 Note 2 Total inflows Outflows Payments to creditors Wages & salaries Overheads Dividends Production machinery Total outflows Net cash flow Opening cash balance Closing cash balance Notes: 1. Debtors take an average of 3 months to pay. Sales in the period January to March 1999 are forecast to be 650,000 and no bad debts are expected. 2. Rental income from sub-letting of warehouse space is receivable quarterly in arrears. 3. Toyz Ltd takes an average of 3 months to pay creditors. Raw material purchases in the period January to March 1999 are budgeted to be 250,000. 4. Wages and salaries are paid in the month incurred. 5. Overheads are paid in the month incurred. 6. The dividends paid in February are the annual dividend for year ended 31 December 1998. 7. The payment in March relates to the acquisition of a new production machine which will be commissioned (installed) in March. All fixed assets are depreciated at 10% per annum commencing in the month following commissioning. Depreciation on assets held at January 1 is budgeted to be 50,000 for the next year. 8. The companys overdraft limit is 30,000. 9. There is no opening or closing raw material or work-in-progress, but finished goods are expected to be 80,000 higher at the end of March than as at January 1 1999. 10. The companys year end is 31 December. Ignore taxation. Required: (a) (i) Prepare the forecast profit and loss account for Quarter 1 1999 to identify the profit after depreciation. (10 marks) (ii) Calculate the forecast closing debtors and trade creditors figures as at the end of March 1999. (2 marks) (b) Briefly outline four possible actions which could be considered by Toyz Ltd, in an attempt to improve the cash position. (8 marks) (20 marks) 4 200,000 (55,000) (55,000) (30,000) 125,000 (45,000) (55,000) (30,000) (90,000) (220,000) (95,000) 60,000 (35,000) 165,000 (35,000) (55,000) (30,000) (50,000) (140,000) 60,000 Nil 60,000 (170,000) (5,000) (35,000) (40,000) Note 8 Note 3 Note 4 Note 5 Note 6 Note 7

Quick Freeze Foods plc produces a range of convenience processed foods for a number of supermarket chain stores. Its success has been based on the expertise and customer-driven emphasis of its research and development team. The R&D team has identified three mutually exclusive projects which could be undertaken. The finance director has recruited you as assistant accountant to carry out a financial evaluation of each project. Details of the three projects cash flows are shown below: Cash Flow Timing Initial Outlay 1 2 3 4 Indian range (80,000) 26,500 26,500 26,500 26,500 Chinese range (20,000) 5,000 6,000 8,000 10,000 Italian range (20,000) 12,000 8,000 6,000 Nil

Ignore taxation and inflation. Assume that cash flows occur at the ends of each of the years shown. Note: The present value of 1 in n years is as follows: n (year) 1 2 3 4 Required (a) Using each of the following appraisal methods rank the projects in order of their investment potential. (i) Net present value (NPV) at 10% (ii) Approximate internal rate of return (IRR) (b) (i) Critically compare each of the above investment appraisal methods. (7 marks) (7 marks) (4 marks) at 10 % 0909 0826 0751 0683 at 15 % 0870 0756 0658 0572

(ii) Explain which method you regard as the most useful for project appraisal and which project you would recommend. (2 marks) (20 marks)

Sparx Ltd is a rapidly expanding chain of retail outlets specialising in electrical goods. The board of directors has recently decided to implement improvements in internal controls and to investigate the possibility of creating an internal audit function. Required: (a) (i) Briefly describe the concept of internal control. (2 marks)

(ii) Identify and briefly describe four fundamental requirements in the design of internal controls which may help Sparx Ltd to prevent or detect errors or fraud. (8 marks) (b) (i) Briefly outline three advantages to Sparx Ltd of having an internal audit function. (ii) Briefly outline two main differences between the internal and external audit functions. (6 marks) (4 marks)

(20 marks)

End of Question Paper 5 [P.T.O.