The University of Birmingham College of Social Sciences Birmingham Business School Department of Accounting and Finance Accounting Theory

(07 !7"#

Term Time $uestions 00%&'0

The questions below have been taken from the summer 2009 accounting theory examination paper. The questions should be attempted in your own time and handed in at the lecture on the following Mondays

!ate 0#.02.$0 22.02.$0 0#.0+.$0 22.0+.$0

"uestion %urrent purchasing power accounting & 'ames (lc )eplacement cost accounting & *liot (lc %ash flow reporting & %onrad (lc !epreciation & ,usten (lc

Current (urchasing (o)er Accounting

On the 1st April 2008 James Plc, a manufacturing company, was incorporated with an opening ordinary share capital of 100 million all contributed in cash On the same day, the company drew down a long!term loan of "0 million at an interest rate of " per cent per annum #he first interest is payable on 1st April 200$ and the company%s financial year ends on &1 'arch 200$

On 1st July 2008, the company signed a 2" year lease on industrial buildings which cost 80 million (epreciation of the lease is on a straight line basis o)er its term

On 1st October 2008, the company purchased plant and machinery for *0 million #hese non current assets ha)e an estimated useful life of 10 years and an estimated residual )alue of * million (epreciation is charged on a straight line basis o)er the assets% 10 year life from the moment production commences

Production and trading began on 1st October 2008 with the purchase of initial in)entory to the )alue of 10 million +e)enues a)eraged 1" million each month with customers paying one month in arrears Purchases a)eraged 10 million each month with payables settled one month in arrears Other operating e,penses, paid in cash, were 1 million each month At &1 'arch 200$, closing in)entory was )alued at 12 million and had been purchased e)enly o)er the last si, months #he company does not intend to pay a di)idend and because it has in)ested in a depri)ed area of the country in which unemployment is high the company is e,empt from corporation ta, for the first year of its operations 'o)ements in the +etail Price -nde, .+P-/ ha)e been as follows0

(ate

+P-

1 April 2008 1 July 2008 1 October 2008 &1 'arch 200$

100 10* 112 121

Required:

a/ Prepare an income statement for the year ended &1 'arch 200$ and a balance sheet as at that date using current .constant/ purchasing power accounting Pro)e the monetary gain or loss arising for the year . [18]

b/ #o what e,tent does the income figure calculated in part .a/ abo)e satisfy 2ic3s%s definitions of economic income4 [7]

Total Marks: [25]

Replacement cost accounting 5liot Plc is a high street retailer and detailed below are its summarised historical cost accounts for the year ended &0 April 200$ -ncome statement year ending &0 April 200$ +e)enues 6ost of sales .opening in)entory ! &1" m/ 8ross profit Other operating e,penses (epreciation of properties (epreciation of e9uipment Profit before ta, #a,ation Profit after ta, (i)idends +etained profit for year :alance sheet as at &0 April 200$ ;on current assets Properties 59uipment *00 1"0 7"0 6urrent assets -n)entory .purchased at a)erage price for the last * months of year/ #rade recei)ables 6ash at ban3 m 21$ 2" "0 2$1 221 7" 11$ "0 $$ m m m 1,2$* 778 "18

1&0 10 &12 782

6urrent liabilities #rade and other payables "12 270 1,020 59uity

Ordinary share capital +etained profits

"00 "20 1,020

(uring the year ended &0 April 200$, after a period of prolonged price stability, the company e,perienced significant price inflation as detailed in the indices detailed below -nde, 1 'ay 2008 1 ;o)ember 2008 &0 April 200$

Properties 59uipment -n)entory +etail Price -nde,

100 100 100 100

110 11" 10" 10*

120 1&0 110 112

As a result of the abo)e price rises, the company wishes to maintain its physical capital, defined as the replacement cost of its property, e9uipment and in)entory Properties had an opening balance sheet )alue of *2" million and are depreciated o)er a 2" year period on a straight line basis from 1 'ay 2008 59uipment had an opening boo3 )alue of 200 million and is being depreciated on a straight line basis o)er a four year period from 1 'ay 2008 +eplacement cost in the income statement is to be charged at the a)erage for the year while in the balance sheet replacement costs are to be at year end prices Required: .a/ Prepare for 5liot Plc an income statement for the year ending &0 April 200$ and a balance sheet as at that date on a replacement cost basis [18] .b/ #he company%s property manager is concerned that the holding gains shown in these accounts for properties will not be <real% because their calculation does not ta3e into account mo)ements in the +P- +ecalculate the holding gains for properties ta3ing into account the property manager%s concerns and e,plain the capital maintenance basis underlying his criticism of the replacement cost accounts. [7] Total Marks: [25]

Cas !lo" reporting #he financial director of 6onrad Plc has prepared the following opening balance sheet as at 1 April 2008 in which all assets ha)e been stated at their net realisable )alues

:alance sheet as at 1 April 2008

+ealised assets 6ash at ban3 +eadily realisable assets =and and buildings 'otor )ehicles >inished goods #rade recei)ables $20 1*2 &1* 17" 1,"7& 6urrent liabilities *1* $"7 1,0*& ;ot readily realisable assets Plant and machinery ?or3 in progress 111 212 *2* 1,*8$ =ong!term loan "1$ 1,170 59uity Ordinary share capital +etained profits 2"0 $20 1,170 #he financial director intends to prepare a set of accounts for the financial year ending &1 'arch 200$ using cash flow reporting #he following additional data ha)e been collected for this purpose 10*

Additional data

6ash recei)ed from customers 6ash paid to suppliers Other operating e,penses paid in cash

1,1$* 1,122 112

-nterest paid -ncrease in long!term loan 6ash purchase of motor )ehicles ;et realisable )alues as at &1 'arch 200$0 6ash at ban3 =and and buildings 'otor )ehicles >inished goods #rade recei)ables 6urrent liabilities Plant and machinery ?or3 in progress =ong!term loan Required:

1* "0 72

&00 $"0 110 &11 180 720 &"2 2&2 "*$

.a/ As far as the gi)en information allows, prepare for 6onrad Plc a set of cash flow reporting accounts for the year ending &1 'arch 200$ [2#] .b/ #he chief e,ecuti)e of 6onrad Plc has stated that the cash flow reporting accounts are of little use because the company has no intention of selling its non current assets Answer this criticism [5] Total Marks: [25]

$epreciation Austen Plc is a manufacturing company that operates a number of plant and machinery assets of a similar type #he typical cash flow pattern for one of these assets is as follows

@ear (etail

1 000

2 000

& 000

1 000

" 000

Purchase price +epairs (isposal )alue

80 " *0 " "" 10 "0 10 10 2" 10

#he production manager wants to 3now the optimum life cycle for this type of machine -n addition, the manager wants to 3now the financial effect upon the income statement of each of the different depreciation methods currently being used within the company Assume that Austen Plc%s cost of capital is 10 per cent per annum Apart from the initial purchase price, assume all cash flows occur at the end of the year Required:

.a/ 6alculate how often this type of machine should be replaced

[1#]

.b/ 6alculate the annual depreciation charge using the following methods0 straight line, reducing balance, sum!of!digits and economic depreciation [8] .c/ 5,plain the principle which should determine the depreciation method to be selected by the production manager [7] Total Marks: [25]