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AFC 1000 PRINCIPLES OF ACCOUNTING AND FINANCE


FINAL EXAMINATION, SEMESTER 1 2013
SOLUTIONS

______________________________________________________________________________
Part A






Please circle the correct answer on the question sheet below and hand in with your exam
booklet

(Questions 1 7 are based on the following transactions recorded by MN Company:)0...0

MN Company closed its books on October 31
st
, 20XX

20XX
March 1
st
Purchased equipment for $72,000. Estimated useful life: 5 years, Residual value: $6000
April 1
st
Paid $1000 for five advertisements, with one advertisement scheduled to appear every two
months. The first advertisement appeared on June 1
st
, and the remaining advertisements
were each slated to appear every two months, thereafter.
September 1
st
MN Company rented out excess office space, charging $500 per month. Its tenant paid six
months rental in advance on September1
st
.
October 31
st
The inventory recorded in MNs books amounted to $47,000. A physical stock count revealed
inventory of $46,750.










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Question 1
Which of the following correctly records the depreciation expense for MN Company for the fiscal year
ended 20XX?
a. Depreciation Expense
Accumulated Depreciation

6600
6600
b.

Depreciation Expense
Accumulated Depreciation

8800
8800
c.

Depreciation Expense
Accumulated Depreciation

11000
11000
d.

Depreciation Expense
Accumulated Depreciation
13200
13200
Question 2
Assume that MN Company uses the EXPENSE method to record its advertising expenses. Which of the
following is the correct balance day adjustment for the advertising expenses incurred on April 1
st
?
a. Advertising Expense
Prepaid Advertisement

600
600
b.

Prepaid Advertisement
Advertising Expense

600
600
c.

Advertising Expense
Prepaid Advertisement

400
400
d.

Prepaid Advertisement
Advertising Expense
400
400
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Question 3
Assume that MN Company uses the ASSET method to record its advertising expenses. Which of the
following is the correct balance day adjustment for the advertising expenses incurred on April 1
st
?
a. Advertising Expense
Prepaid Advertisement

600
600
b.

Prepaid Advertisement
Advertising Expense

600
600
c.

Advertising Expense
Prepaid Advertisement

400
400
d.

Prepaid Advertisement
Advertising Expense

400
400






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Question 4
Assume that MN Company uses the REVENUE method to record its rental revenues. Which of the
following is the correct balance day adjustment for the rental revenues recorded on September 1st?
a. Rental Revenues
Rental paid in advance

1000
1000
b.

Rental paid in advance
Rental Revenues

1000
1000
c.

Rental Revenues
Rental paid in advance

2000
2000
d.

Rental paid in advance
Rental Revenues

2000
2000












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Question 5
Assume that MN Company uses the LIABILITY method to record its rental revenues. Which of the
following is the correct balance day adjustment for the rental revenues recorded on September 1st?
a. Rental Revenues
Rental paid in advance

1000
1000
b.

Rental paid in advance
Rental Revenues

1000
1000
c.

Rental Revenues
Rental paid in advance

2000
2000
d.

Rental paid in advance
Rental Revenues

2000
2000



Question 6:
Which of the following is the correct adjustment for MNs inventory?
a. Inventory 250
Inventory loss 250

b. Inventory loss 250
Inventory 250

c. Inventory 250
Cost of Goods Sold 250

d. Cost of Goods Sold 250
Inventory 250



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Question 7

While completing the worksheet, the accountant extended an amount from the adjusted trial balance
to the wrong set of financial statement columns. After the error the Balance Sheet columns balanced,
but net profit was wrong. Which of the following errors was made?

a An expense was extended to the Balance Sheet credit column
b A revenue was extended to the Balance Sheet debit column
c A liability was extended to the Profit and Loss Statement credit column
d An asset was placed in the Balance Sheet credit column
e A liability was placed in the Balance Sheet debit column




Question 8

.The four perspectives taken by the Balanced Scorecard are:
a. ROI, RI, EPS and EVA
b. Financial, Customer, Process, Learning & growth
c. Customer, Process, Technology, People
d. Cost, Profit, Revenue, Volume












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Part B
Question 1 6 marks

Large amounts were spent on acquiring new non-current assets ($259m + $491 +
$815m).Namely amounts spent on obtaining child care licences, other child care
centres and PP&E (2 marks)
Most of this spending was financed by borrowings (financing activities $1,629m).
Looking at the Balance Sheet, a large proportion of the borrowings were short-term (2 marks)

Short term borrowings e.g. Bank overdraft should be used for short term expenditure.
Long term borrowings (Debt and Equity) should be used for purchase of non-current assets
which may not generate immediate cash flows.(2 marks)




Question 2 14 marks (10 +4)

(a)
Perpetual Inventory Account

1/4/13 Balance 60,000 Accounts Payable 1,500
Accounts Payable 30,000 Cost of Goods Sold 33,000
COGS 4,500
Stock Loss 3,000
Balance 57,000

94,500 94,500
COGS Account Perpetual

Inventory 33,000 Inventory (S/R) 4,500
P/L summary 28,500
33,000 33,000


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(a) Physical Inventory Account
1/4/13Balance 60,000 30/4/13 COGS 60,000
30/4/13 COGS 57,000 30/4/13 Balance 57,000








COGS Account Physical

30/4/13 OB Inventory 60,000 Purchase Returns 1,500
Purchases 30,000 Inventory on Hand 57,000
Balance to P/L 31,500
90,000 90,000










-1 for any error either amount or name


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(b) Income Statement Perpetual Physical


Sales 54,000 54, 000
Less sales returns 6,000 6, 000

Net Sales 48,000 48,000

Less COGS 28,500 31,500* Breakdown
acceptable

Gross Profit 19,500 16,500
Minus Stock Loss 3,000

Adj Gross Profit 16,500

Less Finance Expenses
Discount allowed 900 900
Discount received ( 600) ( 600)
(or after adjusted GP as other rev)


Profit $16,200 $16,200

-1 for any error either amount or name up to -4












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Question 3 6 marks
Solution
Need to discuss whether the contract satisfies the element definition and recognition criteria associated
with a liability
Definition Criteria 4 marks
Present obligation-This is where discussion should centre!
Assuming the contract is one which is non cancellable a present obligation is owed by the airline
company once the contract has been signed by both parties
If the contract is cancellable by either one or both parties then par 91 may apply ie (equally
proportionally unperformed ) which will generally not be recognised as a liability
Outflow of an economic benefit Once the aeroplane is delivered company must pay cash to the
creditor
Past event- signing the contract
Therefore likely to meet the element definition of a Liability
Recognition Criteria 2 marks
1 Reliably Measured?
Assumed agreed contract price
2 Probable?
Assuming non cancellable and contract agreed on by both parties
Note if cancellable then par 91 may apply and not recognised

Students need to discuss both recognition and element definitions
Minus 1 if dont mention cancellable or non cancellable or words to that affect







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Question 4 (5+6+5=16 marks)

(a) Given the above ratios, comment on the movement in liquidity and profitability of Mattys
Fitness HQ in its first two years of operation. Include a discussion of why return on assets
has changed.
The current ratio represents the proportion of current assets to current liabilities. Higher is
generally a good indicator, as it implies that an entity would have sufficient current assets to
pay off current liabilities. However, an excessive current ratio might indicate that an entity
would be better off investing rather than holding large amounts of cash on hand, inventory or
prepayments. It may also suggest obsolete inventory is being carried that has not been written
down and/or there are significant debts that are unlikely to be collected. . The current ratio has
improved over the two years, with both appearing to be at comfortable levels with a likely
ability to repay its short term obligations. Information regarding the timing of the inflows and
outflows needs to be known before a proper assessment can be made 2 marks

The acid test ratio also measures liquidity, but excludes inventory and prepayments from the
calculation as they are not liquid assets. As a result, this ratio will be lower than the current
ratio. There is no ideal quick asset ratio,it will depend on the organisations ability to convert its
immediate current assets Interestingly, the acid-test ratio is not much lower for this business,
indicating that inventory and/or prepayments are not a large portion of current assets. In both
years, the acid-test ratio is at a very comfortable level. 1.5 marks

The creditors turnover indicates the frequency in which the business pays its creditors
All things being equal the more times per annum the better in terms of an insight into the
entities ability to repay its pressing obligations.
A lengthening of this period may be a result of the entitys deliberate intention of availing itself
to interest free credit 1.5 marks (Max 5 marks)

b)
The return on assets ratio reveals how efficiently assets were used to generate profit. A higher
ratio is better, and this entity has shown a positive increase over the two years. This would
indicate that the entity is more profitable 1 mark

The asset turnover ratio indicates the efficiency with which assets were used to generate
revenue. Higher is better, and there has been a good improvement over the two years. In 2013,
the entity is generating revenue almost equal to half the value of assets. 1 mark

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The profit margin ratio indicates the proportion of each dollar of revenue that is earned as
profit. Higher is better, The ratio has only slightly improved over the two years. The business
may have charged more (increased SP) to customers or may have reduced expenses
2 marks
maximum 4

The movement in return on assets can be explained by examining the asset turnover and profit
margin ratios, as the three are inter-related. The slight increase in profit margin contributed,
but the main reason is that the asset turnover increased. The entity was able to generate much
more income in its second year of operations.
2 marks
Max 6 Marks

c)
Limitations include
Limited time series analysis
CA ratio and QAR are static measures they gives no insight into the timing of the cash
flows ie need a cash budget
No Stock or debtors T/O figures to aid point above
No industry or competitors benchmarks
Limitations of financial data-subjective
Need to look at non financial data also eg BSCard
Need to know creditors terms
Ignores price level changes eg using HC in periods of increasing prices overstates the
return on assets ratio

1 mark for each limitation( max 5 marks)








Total marks for Question 5 = 16








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______________________________________________________________________________

Question 5 (12 marks)

Part A
(i) Determine how many spa treatments would need to be sold per year for Mattys
Fitness HQ to break even from this area of the business.
Breakeven = fixed costs / contribution margin per unit
Contribution margin per unit = selling price less variable costs ($2.50 $0.80) = $1.70
Break even = $14,500 / $1.70 = 8,529.4 = 8,530 treatments (2 marks)
(ii) Determine how many spa treatments the break-even point would equate to per
day (assuming Mattys Fitness HQ is open every day of the year), and comment on
the feasibility of this number.

8,530 / 365 days = 23.37
Approximately 24 spa treatments per day x15 per treatment = min 360 people (1 mark)

Whether this is feasible or not depends on the number of gym members that do a workout at
the gym each day on average. Not all members would have the time or money to do the spa
treatment every day. (1 mark)

(iii) Another option Matt Blake is considering involves a hot/cold spa combination. It
would be more expensive lease and operate annually ($23,000), but cheaper to run
(at $0.70 per person using the spa). Matt could charge up to $4.50 per visit for this
extra service. Determine how many spa treatments would be needed each year to
break even.
Breakeven = fixed costs / contribution margin per unit
Contribution margin per unit = selling price less variable costs ($4.50 $0.70) = $3.80
Break even = $23,000 / $3.80 = 6,052.6 = 6,053 treatments (2 marks)
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(iv) Explain how and why the break-even point you calculated in part (c) differs from
the break-even point you calculated in part (a).
Even though fixed costs increased, there has been a greater increase in the contribution margin
to help cover those fixed costs. As a result, fewer treatments are required each year to reach
the break-even point. (2 marks)

Part B
Outline the implications, both positive and negative, of following the Accountants
recommendation.
Students could provide any valid implication and gain the four marks. Examples include:
Positive implications:
- A higher price being charged means more income being earned
- A more accurate pricing policy should result in better management of expenses
- A pay for what you use policy would better suit some gym members so they dont pay
for facilities they dont use

Negative implications:
- Some members might not be happy with the new pricing structure, particularly those
charged more as a result of wanting access to all facilities
- Some members may be lost to competing gyms
- More detailed recording keeping may be involved

4 marks, 1 for each valid point (2 positive, 2 negative)
Total marks for Question 5 = 12
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_____________________________________________________________________________





Question 6 (14 marks)

Part A


(i) Explain the benefit of preparing budgets in an organisation.

Budgets assist management to plan and control for the future and formalise their goals. They
enable actual results to be compared against expected results, to assist in performance
evaluation. They provide early warnings of potential problems, and enable activities within a
business to be co-ordinated. They can also assist with employee motivation.
3 marks

(ii) Identify which of the items Matt Blake has listed above would appear in the cash
budget, and which would appear in the budgeted income statement.

The cash budget would include:

The budgeted income statement would
include:
Wages to be paid Wages expense
Purchase of equipment Depreciation expense
Loan repayment Interest expense incurred
Cash drawings
Prepaid advertising


mark for each correct classification = 4 marks




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Part B

(i) Explain how Matt Blake can determine which investment is likely to generate more
interest on his investment. Provide the formulas he would use to assist in making
the decision.

The interest rates cannot be compared as they are written, as one is compounding annually
and the other daily. The rate compounding daily will more frequently add interest to the
account, potentially increasing the return. 2 marks
The formulas would be:

Future value = present value of investment x (1.053)^1 1 mark
And
Future value = present value of investment x (1+(0.051/365))^(365) 1 mark
0r
Effective annual interest rate i = (1 +j/m)
m
-1 = (1 + .051/365)
365
-1 =.0523
which is a lower annual effective interest rate therefore choose 5.3% compounded annually
2 marks

(ii) Apart from investing in banks, identify three (3) other investment options Matt
Blake could consider.
Investments could include:
- Shares
- Property
- Debt securities
- Antiques
1 mark for each example, maximum 3
Total marks for Question 7 = 14


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______________________________________________________________________________

Question 7 (12 marks)

(a) Calculate the net present value of the proposed project.



Year


Net Cash Flow
(using formulae)
Present Value of
Net Cash Flow


Marks
0 ($480,000)
480,000/(1.04)^0 =
(480,000.00) (0.5)
1 $80,000
80,000/(1.04^1 =
76923.08 (1)
2 $95,000
95,000/(1.04)^2 =
87832.84 (1)
3 $100,000
100,000/(1.04)^3 =
88899.64 (1)
4 $100,000
100,000/(1.04)^4 =
85480.42 (1)
5 $110,000
110,000/(1.04)^5 =
90411.98 (1)
Net present value $(50,452) (0.5)

(b) Based on your answer to part (a), comment on the feasibility of expanding the gym
business to a second location. Justify your answer.
The proposal to open a second location for the gym is not favourable, as a negative NPV is
estimated. If the cash flow estimates are correct, Matt will lose money on the expansion, which
is detrimental to his business.
2 marks

(c) Identify some general risks associated with going ahead with such an expansion.

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An expansion like this is risky due to the uncertainty associated with it. There is a chance the
business may not attract as many members as expected. Costs might be higher or lower than
estimates. There is a problem of what to do in 5 years when the lease is ended etc.
2 marks for any valid risks identified









(d) To acquire equipment for the new location, Matt Blake can pay $350,000 cash immediately,
or pay $185,000 in two equal instalments at the end of year 1 and year 2. Calculate the
present value of the instalment option assuming a discount rate of 6% per annum to
determine which is the cheaper payment alternative.

$350,000 cash immediately is already at present value

Instalment option:

PV = $185,00/(1.06)^1 + $185,000/(1.06)^2
= 174,528 + 164,649
= $339,177 (approx.) 1 mark

The cheaper alternative is to pay in two instalments. 1 mark




















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Question 8 (12 marks)

Answer a
Financial accounting Management accounting
Users External Internal
Frequency Annual Monthly
Orientation Past Current & future
Content Business as a whole Each business unit
Aggregated Detailed
Financial Financial & non-financial
Regulation IFRS/Companies Act None needs of business
Verification External audit None
3 marks
Answer b
(i) The Balanced Scorecard establishes performance measures and targets for four
aspects of business performance: financial, customer, process, and learning/growth.
These are related such that learning contributes to improved business processes
which in turn leads to improved customer satisfaction and ultimately to financial
performance.

3 marks
(ii) Financial measures alone are necessary but not sufficient to reflect the performance
of a business. Non-financial measures are leading indicators of business
performance which provide early warning, compared with financial measures which
are lagging, i.e. they are only known after financial reports are produced. Leading
indicators can more readily result in early corrective action where targets are not
being achieved.

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3 marks
Answer c
The overhead allocation problem arises because overhead has increased in proportion to total
business costs. Overhead by definition cannot easily be traced to products/services and is often
arbitrarily allocated across multiple products/ services for example on the basis of direct labour
hours even when labour hours do not reflect the incurrence of overhead costs. Overheads can
comprise a substantial part of product/service costs and can result in prices that are either too
high or too low. This affects the volume of sales and perceived product/service profitability. The
extent to which products/services actually consume overhead may therefore be spread
throughout the product/service range inequitably without reflecting the real demand made by
those product/services on the resources of the business. 3 marks