AS Level Accounting

ZM AS Review Book

1` BANK RECONCILIATION ZM

BANK RECONCILIATION STATEMENTS

BUSINESS BANK
MAINTAINS MAINTAINS

CASH BOOK BANK STATEMENT

ADJUST ADJUST
 Bank charges  Outstanding cheques
 Standing order  Uncleared lodgements
 Direct debit
 Dishonored cheque
 Bank giro credit

RECONCILE

IMPORTANCE OF BANK RECONCILIATION

 It identifies any errors in the cash book.
 It identifies any errors on the bank statement.
 It enables any missing entries in the cash book to be accounted for.
 It identifies any out-of-date cheques.
 It identifies dishonored cheques.
 It acts as a deterrent to fraud.

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AS Level Accounting
ZM AS Review Book

Differences
Items in Cashbook but not in Bank Statement Items in Bank Statement but not in Cashbook
Uncleaned/Uncredited Cheques Bank Giro Credit/Credit Transfer/Direct Credit
Unpresented/Outstanding Cheques Standing Order
Errors in Cashbook Direct Debit
Dishonored Cheque
Bank Charges
Error in Bank Statement

ZM

PAST PAPERS - BANK RECONCILIATION STATEMENT

MAY 2011 P23 Q.2 (C & D)

Q.1. Give three reasons why the bank column balance in the cash book does not always
agree with the balance shown in the bank statement at the same date. [6]

A.1. ● Cheques paid but not yet presented for payment (un-presented cheques)

● Cheques received but not yet credited by the bank (un-credited cheques)

● Errors in recording by the bank and / or the business.

● Items recorded by the bank but omitted from the cash book unless bank
statement is received e.g. Direct credit, direct debit, standing orders, bank
charges, dishonoured cheques etc.

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AS Level Accounting
ZM AS Review Book

2 FINANCIAL STATEMENTS

(INCLUDING BAD DEBTS & ALLOWANCE FOR DOUBTFUL DEBTS)

ZM
Trial balance
Lists out all the balances on the ledger accounts

Reasons Adjustments
− Facilitate in preparation − Closing inventory
of Financial Statement. − Depreciation
− To check arithmetic − Accruals and prepayments
Accuracy of Double − Bad debts and allowance for doubtful debts
Entry. − Inventory destroyed
− Sale or return

Income statement Statement of financial position

Shows the financial performance of the business. Shows the financial position of the business.

ACCRUED PREPAID / ADVANCE

EXPENSE INCOME EXPENSE INCOME

− Increase Expense − Increase Revenue − Decrease Expense − Decrease Income

− Current Liability − Current Assets − Current Assets − Current Liability

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Irrecoverable Debts (Bad Debts) & Allowance (Provision) For Doubtful Debts

BAD DEBTS ALLOWANCE FOR DOUBTFUL DEBTS

− Amounts that the business will  There may be some doubt as to
not receive from its customers the collectability of some of the
− May be due to bankruptcy, business’ receivables balance.
fraud disputes, insolvency, or  An allowance is made to
out of approach. recognize the possible expense
− Matching Concept Applies. of not receiving the cash
 Prudence Concept Applies.

ACCOUNTING FOR BAD DEBTS

To recognize the expense in the ACCOUNTING FOR THE ALLOWANCE
income statement: FOR DOUBTFUL DEBTS

Dr. Bad debts expense To record an increase or setting up

Cr. Receivables the allowance:
Dr. Profit & Loss Account
Cr. Allowance for Doubtful Debts
The journal entry is reversed if the
allowance is reduced
ACCOUNTING FOR BAD DEBTS
RECOVERED

Dr. Cash
Cr. Bad Debt recovered

FINANCIAL STATEMENTS

STATEMENT OF FINANCIAL POSITION INCOME STATEMENT

Bad debts written off as expense.
Receivables X
Allowance for doubtful debts (X) Increase in allowance for doubtful debts as
Net receivables X expense.
Decrease in allowance for doubtful debts as income.

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AS Level Accounting
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PAST PAPERS - FINANCIAL STATEMENTS

MAY 2009 P2 Q.2.(A) ZM

Q.2. (i) Give one reason why Jeremiah decided to set up this account. [2]

(ii) Describe two factors Jeremiah might consider when deciding the amount to be
provided for in the provision for doubtful debts accounts. [2]

(iii) Explain the difference between the accounting treatment of a bad debt and a
doubtful debts. [2]

A.2. (i) Jeremiah opened provision for doubtful debts account to prepare himself for the
losses likely to arise in future (Prudence concept) and to avoid overstatement of
profits.

Moreover as future bad debts relate to current year sales so they are offset
against current year income (Matching concept) to avoid overvaluation of trade
receivables in balance sheet.

(ii) ● Past experience relating to collection from trade receivables.

● Present market and industry conditions.

●ClassificaDon of trade receivables according to their ages (ageing schedule).

(iii) Bad debts are credited to trade receivables’ account(s) whereas for doubtful
debts a separate provision account is kept. Bad debt is a confirmed loss
(irrecoverable debt) whereas doubtful debt is an expected loss.

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AS Level Accounting
ZM AS Review Book

NOVEMBER 2011 P21 Q.2

Q.3. (a) (i)

ZM
Explain how this change would affect the company’s income statement
and statement of financial position. [2]

(ii) Explain why this change might be necessary. [4]

(b) State three factors that the directors should consider when creating a provision
for doubtful debts. [3]

A.3. (a) (i) Increase in provision for doubtful debts will reduce net profit in income
statement and will also be subtracted from the value of trade receivables
(current asset) in the balance sheet.

(ii) Prudence concept requires to anticipate all expected losses. Current

provision for doubtful debts is $742 (2% of trade receivables) where actual
bad debts are $1,500. This may suggest the provision amount and rate in
existing system is insufficient.

(b) ● Nature of industry

● Past experience relating to customers

● The economic conditions

● Amount and age of trade receivables

● Knowledge of previous trends or policies of competitors.

● Specific information about each customer

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AS Level Accounting
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3 DEPRECIATION (ACCOUNTING FOR NON-CURRENT ASSETS)

Chapter summary

Definition of Depreciation
Depreciation is the part of the cost of asset consumed during its period of use by the firm. It is an expense for the
services consumed from the assets; therefore it must charge to the profit and loss account.
Reasons for Accounting for Depreciation
1. Wear and tear because of its use.
2. With the lapse of time
3. Obsolesce or out dated
Why Depreciation is calculated?
Depreciation is calculated: to charge the expenses to the income statement, & to calculate book value of the asset in
the balance sheet. Matching Principle on depreciation.

Suitable methods for Depreciation

Assets Method of Reasons

depreciation
Buildings / Straight line Cost of the asset consumed is spread evenly over its useful
Furniture method life.
Computers / Motor Reducing balance Asset is more efficient in early years of use. It becomes
Vehicle / Machine method obsolete rapidly.
Loose tools / Revaluation It is difficult to depreciate each item of loose tools. Therefore
their value is put together & they are depreciated
Double Entry of Depreciation
Dr. Income Statement X
Cr. Accumulated Depreciation account X

Advantages of Different Methods of Depreciation:

Methods Advantages
1. Straight Line Method An equal amount of depreciation is charged each year.
If percentage is given then applied on cost, directly.

2. Reducing Balance Every year the amount of depreciation is reduced.

Method Depreciation is charged on Net Book Value (NBV) of the asset which
is more realistic.
NBV = Cost of asset – Provision for depreciation.
3. Revaluation Method If the fixed asset is revalued downward at year-end the difference
between value at the beginning of the year and value at the end of
the year amounts to depreciation.

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AS Level Accounting
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ZM
CAPITAL & REVENUE EXPENDITURE
CAPITAL EXPENDITURE REVENUE EXPENDITURE
 Buying of fixed assets that can be used by  Day to day running expenses of the
the business. business
 Assets give benefits for more than one  Expenses give benefit for short period only
accounting period.  The entire amount of the expenses are
 Cost of the asset is written off over the written off in one accounting period
estimated life of the asset.  It appears in the Income Statement as a
 It appears in the Statement of Financial reduction to profit.
Position as an increase in the value of assets  Those expenditure that maintain the value
 Those expenditure that increase the value of of existing assets.
existing assets.

Capital receipts Revenue Receipts

Any money received that is not from normal Revenue receipts arise from the normal business
trading activities is classed as a capital receipt. activities, for example the sale goods or services.
Examples include: They may also be incidental to the main business
 Receipts from disposed of non-current assets. activity.
 Receipt of loan finance from banks or other
lenders Examples include:
 Capital introduced into the business by the  Rents received
owners.  Commission received
Capital receipts do not appear on the income  Interest received
statement but are accounted for on the statement Revenue receipts are credited to the income
of financial position. statement.

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AS Level Accounting
ZM AS Review Book

PAST PAPERS - DEPRECIATION (ACCOUNTING FOR NON-CURRENT ASSETS)

NOVEMBER 2009 P22 Q.2

ZM
Q.4. Explain the term ‘depreciation’ and give one example. [5]

A.4. Depreciation is the permanent and continuing diminution in the quality, quantity or value
of an asset. It recognizes the fact that assets with finite lives lose value over time through
the passing of time and/or wear and tear from its use.
Depreciation Accounting deals with the allocation of costs of non-current assets over
their useful life. More simply depreciation is recorded as an expenses in the income
statement to spread the initial price of the assets over their useful lives to match the
revenue the asset is generating.

MAY 2010 P22 Q.2

Q.5. (i) State three causes of depreciation. [3]

(ii) Give an example of a non-current (fixed) asset for which each cause given in (b)
(i) above might be appropriate. [3]

(iii) State four factors which must be taken into account when deciding how much
depreciation charge. [4]

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AS Level Accounting
ZM AS Review Book

A.5. (i) The following are the main causes of depreciation:

 Wear and tear [physical using up like corrosion, rot, rust and decay’];

 Obsolescence [change of fashion or new substitutes or inventions’’;

 Inadequacy or superfluous [business operation increased hence non-current

assets inadequate].
ZM
(ii) Wear and Tear: Furniture and fixtures may physically deteriorate due to
factors like corrosion, rot, rust and decay.

Obsolescence: With the improvement in technology older version of

computers or machines may become obsolete.

Inadequacy: An internal telephone exchange with twenty lines may be

inadequate when business expands and new lines are
needed.

(iii) Whichever method or rate is used to calculate depreciation, we must always

consider the following:

 The original cost of asset;

 The probable / estimated useful economic life of the asset;
 The approximate residual value at the end of its life;
 Estimated amount of expenditure on repairs during the asset’s useful life;
 Possibility of obsolescence etc.

MAY 2012 P23 Q.2 (A TO D)

Q.6. Explain why it is appropriate to use the reducing (diminishing) balance method for
motor vehicles. [3]

A.6. The reducing balance method is suited to non-current assets such as motor vehicles. As
vehicles in the early years, have lower maintenance costs but give more benefits than in
later year. So in early years more depreciation is charged due to greater benefits and less
is charged in the later years. Moreover increasing costs are offset by decreasing
depreciation charge.

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AS Level Accounting
ZM AS Review Book

4 INVENTORY VALUATION

Chapter summary

INVENTORY

Valued at the lower

of cost and NRV

ADJUSTMENTS FOR INVENTORY VALUATION OF INVENTORY

Opening inventory must be transferred Methods used:
to the income statement &  FIFO
Closing inventory must be entered into  AVCO
the accounts at the year end.

RECORD INVENTORY SYSTEM USED

 Closing inventory:
DR Inventory a/c
ZM 

Perpetual: regular recording
Periodic valued at the end of
CR Income Statement period
 Drawings of Inventory
Dr Drawings
Cr Purchases.
COST INCLUDED IN INVENTORY
 Purchase cost ● Conversion Cost
1. Purchase price 1. Labour
CONCEPT APPLIED 2. Carriage inward 2. Overhead
3. Duties & Taxes
 Prudence
4. Handling changes
 Consistency

COST EXCLUDED IN INVENTORY

NRV  Admin overhead
Estimated selling price:  Selling overhead
 Estimated selling expense  Abnormal storage
 Estimated cost of completion.  Abnormal wastage

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AS Level Accounting
ZM AS Review Book

PAST PAPERS - INVENTORY VALUATION

NOVEMBER 2010 P23 Q.2 (A, B & C)

Q.6. Advice Paula Bridgewater how the inventory should be valued in the final accounts. Give
reasons for your advice. [6]

A.6. According to “Prudence concept” inventory should be value at lower of cost and net
realizable value. International Accounting standard 2 (Ias-2) states companies should
either use the FIFO or AVCO method for inventory valuation. However according to
“Consistency concept” whichever method is selected should be used consistently.

MAY 2011 P23 Q.1 Q1(c)

Q.7. Goods in inventory of Marshall Kilingsman, a sole trader, at 30 April 2011 at, valued at
cost $15,000, were found to be damaged.

Required:
(i) Explain two differences between cost and net realizable value.
(ii) Discuss the accounting treatment of the damaged inventory in item 1. [4]

A.7. (i) Cost means expenditures, which have been incurred in the normal course of
business in bringing the product or service to its present location and condition.

Net realizable value is the actual or estimated selling price less;

 All further costs to completion; and

 All costs to be incurred in marketing, selling and distributing

(ii) Inventory should be valued at lower of cost and net realizable value. This
treatment is in compliance with prudence and matching concepts.

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AS Level Accounting
ZM AS Review Book

5 CONTROL ACCOUNTS

Chapter summary ZM
CONTROL ACCOUNTS INDIVIDUAL
 Control accounts include a
summary of transactions and − Ledger accounts include a
prepared at the end of period. separate account for each
customer / credit supplier.
 They are prepared in the − They are memorandum
general (nominal) ledger. accounts and not part of
the double entry system.
 They are part of the double
entry system.  List of account balances is
Prepared at the end.

CONTROL ACCOUNTS RECONCILIATION

− These are a means of checking that the balance on the control account
agrees with the balance on the ledger account.
− There may be errors in the ledger account, the control account or both.

REASONS OF CONTROL ACCOUNT

− Internal check
- Missing Figures
− Identify errors
− Detect frauds
− Get total outstanding quickly

Limitations of control accounts:

(i) In single entry records errors cannot be located
(ii) Individual’s debtors and creditors balances cannot be checked.

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AS Level Accounting
ZM AS Review Book

PAST PAPERS - CONTROL ACCOUNT

NOVEMBER 2004 P2 Q.2

Q.10. Give three reasons for preparing control accounts. [3]

A.10. (i) As control accounts are not handled by sales / purchase ledger clerks so provide
a check on the internal accuracy of the ledger.
(ii) It identifies the ledger or ledgers in which errors have been made when there is
a difference on trial balance.
(iii) It provides trade receivables’ and trade payables’ balance quickly when a trial
balance is being prepared.

MAY 2008 P2 Q.2 (B)

Q.11. (a) State three possible reasons why a trade receivable’s account might have a
credit balance. [3]
(b) State three reasons for keeping control accounts. [3]

A.11. (a) (i) Advance payments from customers.

(ii) Over / duplicated payments by customers.

(iii) Return of goods after full payment.

(b) Reasons for keeping Control Accounts

(i) Trade receivables and trade payables figures for inclusion in Trial Balance
& Balance Sheet can be easily & quickly found.

(ii) Corresponding records of control account items in the subsidiary books

act as check on frauds and misappropriations, which can easily be
detected.

(iv) Mistakes and errors in trade receivables and trade payables control
accounts can easily and quickly be detected and corrected by comparing
totals of subsidiary books with the amounts shown in control accounts.

(v) Control accounts minimize chances of fraud and also make fraud easier
to find.

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AS Level Accounting
ZM AS Review Book

MAY 2010 P23 Q.2

Q.12. State three advantages of keeping control accounts. [6]

A.12. ● Control accounts provide trade receivables’ and trade payables balance quickly
when a trial balance is being prepared.

● They identify the ledger or ledgers in which errors have been made when there
is a difference on trial balance.

● Control accounts provide a check on the internal accuracy of the ledger.

● Act as independent check on the arithmetical accuracy of the total of Sales

ledger and purchase ledger balances

NOVEMBER 2011 P22 Q.2(A)

Q.13. Explain two advantages of using a sales ledger control account. [04]

A.13. (i) A sales ledger control provides a check on the internal accuracy of the sales
ledger.

(ii) Sectional ledgers make detection of mistakes and errors easier.

(iii) Through sales ledger control accounts figure for total trade receivables is easily
available.

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AS Level Accounting
ZM AS Review Book

6 INCOMPLETE RECORDS

INCOMPLETE RECORDS

IDENTIFICATION OF IDENTIFICATION OF
PROFIT FIGURE INDIVIDUAL BALANCES
WITHIN FINANCIAL
STATEMENTS

METHOD I: NET WORTH METHOD: METHOD II: ANALYSIS METHOD

Capital at end  Capital at Start
+ Drawing  Cash & Bank A/c

 Trade receivables A/c

- Capital at start
 Trade payables A/c
- Additional capital  Expense accounts A/c
= Profit  Markup / Margin

ZM

Gross profit can be expressed as a percentage of either sales or cost of sales.

GROSS PROFIT MARGIN MARK UP

C = S ( I – i) S = C (1 + i )

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AS Level Accounting
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PAST PAPERS - ACCOUNTS FORM INCOMPLETE RECORDS

MAY 2003 P2 Q.1

Q.14. The Company needs to improve its premises but the bank refuses either to allow a
further increases in overdraft or to grant a loan.

State four other possible sources of finance. [06]

A.14. (i) Further investment by the owner.

(ii) Borrowing from other banks or mortgage.

(iii) Personal borrowing from friends, relatives.

(i) Buying on hire purchase or on finance lease.

NOVEMBER 2009 P22 Q.1

Q.15. Explain, briefly, the difference between a liability and a provision. [03]

A.15. A liability is a present obligation as a result of past events and its amount may be
determined with some level of accuracy. Examples include trade payables, accrued
expenses etc. A provision is a liability of uncertain timing or amount as is not readily
determinable with substantial accuracy. Examples of provisions include warranty
obligation; legal or constructive obligations to clean up contaminated land or restore
facilities; and a retailer’s policy to refund customers.

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AS Level Accounting
ZM AS Review Book

7 PARTNERSHIP

PARTNERSHIP
A business with two or more joint owners.

PROFIT SHARED BETWEEN PARTNERS

IN ABSENCE OF PARTNERSHIP AGREEMENT In statement of division of profit
(appropriation account)
 No interest on capital
 Salaries
 No interest on drawing
 Interest on capital
 No salaries to partners
 Interest on drawings
 Profit / loss share equally
 Interest on loan from partner at 6% p.a.  Profit – share ratio
 Minimum guaranteed profit share

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AS Level Accounting
ZM AS Review Book

PAST PAPERS - FINANCIAL STATEMENTS OF PARTNERSHIP

NOVEMBER 2007 P2 Q.1

Q.20. Identify two methods of raising extra finance and state one advantage and the
disadvantage of each method. [06]

A.20. (i) Non-current borrowing from bank:

Advantage: It will provide ease in working capital condition and business can
plan for the future as the repayment of such borrowing can be
done over a longer period.

Disadvantage: High rate of interest.

(ii) Additional capital by partners

Advantage: No outsider’s influence on the business and interest payment can

be saved.

Disadvantage: Capital is limited to personal resources.

(iii) Admission of a new partner

Advantage: It will provide ease in working load.

Disadvantage: Reduction in future profit shares of the existing partners.

NOVEMBER 2008 P2 Q.1

Q.21. Explain, briefly, why partnership may keep both capital accounts and current accounts. [04]

A.21. Separate Capital accounts show original investment made by the partners a long-term
basis. Separate capital account also facilitates the crediting / payment of interest on
capital account balances.

Current accounts show increase or decrease (changes) in partner’s capitals due to

business operations like drawings, interest on drawings, share of residue profits,
interest on capital and partnership salaries. Separate current account roughly specifies a
limit up to which drawings may be made.

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AS Level Accounting
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NOVEMBER 2010 P23 Q.1 (A)

Q.22. State three advantages for James and Gemma of trading as a partnership rather than as
sole traders. (03)

A.22. The advantages of a partnership compared to a sole trade are:

 Availability of additional capital

 Sharing of managerial responsibilities resulting in shared worked and less stress
 Spread of risk as losses will be shared
 Different skills of different partners may be beneficial to the business
 More ideas from more partners.

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AS Level Accounting
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8 COMPANY ACCOUNTS

LIMITED COMPANIES
 Separate legal entity.
 Limited liability.
 Management vs ownership.
 Formalities

IAS-1 PRESENTATION OF
FINANCIAL OF FINANCIAL
STATEMENTS (EXTERNAL USED)

STATEMENT OF STATEMENT OF
INCOME
ZM
FINANCIAL CHANGES IN
STATEMENT
POSITION EQUITY

DIVIDENDS Amount
INCOME TAX paid to shareholders
Show full liability in statement of financial & from profit in
position show charge in income statement return of their
investment in
company

Issue of Shares
DEBENTURE
 Public Issue: Shares offered to public for cash
 These are long term loans to the company.
at market price
 Fixed interest is charged on it.
 Right issue: Offered to exiting shareholders for
cash at lower than the market price  It is to be repay at specific time period.
 Bonus issue: Issued to existing shareholders for  No voting rights to debenture holders.
free at face value.

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AS Level Accounting
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Characteristics of limited companies

Limited liability company Sole trader

Separate legal A limited company is a separate A sole trader is legally not
entity legal entity, i.e. in the eyes of the separate from his business
law it is a person in its own right even though he is treated as
and is distinct from its owners. such for accounting purpose.
Liability A company is fully liable for its If a sole trader goes into
own debts. This means that if the liquidation then he is
company goes into liquidation, personally liable for any
the owners (shareholders) of the outstanding debts of his
company are liable only for business.
amounts that they have not yet
paid for their shares. Thus the
shareholders are said to have
limited liability.
Ownership and A company is owned by A sole trader is generally
management shareholders. The managers of both the owner and
the company are called directors management of his or her
and are appointed by the business.
shareholders. The directors may
or may not be shareholders in the
company
Formalities Formalities involved vary from No such formalities exist for
country to country, but frequently sole traders.
require public availability of
financial statements and an
annual audit by quailed auditors.

Statement of charges in equity for XYZ Ltd.

ZM
Share Share General retained Total
capital premium reserve profits
$m $m $m $m $m
Balance at 1 January X X X X X
Equity shares X X X
Transfer to General reserve X (X)
Net profit X X
Dividends (X) (X)
X X X X X

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AS Level Accounting
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TYPES OF SHARE CAPITAL

ORDINARY SHARES PREFERENCE SHARES

(EQUITY SHARES) (PREFERRED SHARES)

 Carry voting rights.

− Do not generally carry voting
 Shareholders receive a
rights.
dividend at the discretion
− Shareholders receive a fixed
of the company directors.
dividend (calculated as % x
 Dividend is paid out profits
nominal value of shares held.
after the preference
− Dividend is paid out in priority
shareholders receive their
to ordinary dividend.
dividend.

Cumulative Non-cumulative
preference preference
shares
shares
if the dividend is
if the dividend is
not paid in a
not paid in a
given year, it is given year, then
still owed to the in the following
shareholder in year, only that
the following year year’s only that
(and must be paid year’s preference
ahead of any dividend need be
ordinary paid before an
ordinary
dividend).
dividend.
Types of Preference Shares: ZM
Non-Redeemable Redeemable
Preference Shares Preference Shares

Issued as permeant, they Issued for a particular

never buy back by the period, which may be bought
Company back from preference
shareholders

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AS Level Accounting
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Types of Reserves

CAPITAL RESERVES REVENUE RESERVES

They are created by law Are created from the profits
cannot be paid out as a of the business. These may be
dividend paid out as dividends

 Accumulated profits
 Share premium records
(retained earnings)
any premium on issue of
records all retained
shares.
profits of the company.

 Revaluation reserve  General reserve is an

records any unrealized extension of the
gain arising on non- accumulated profits
current asset revaluation. reserve.

DIVIDENDS

INTERIM FINAL
ZM Not shown in Accounts

 It is recorded in Financial
Statements. DECLARED
PROPOSED  Shareholders
 It is paid during the year.  Directors propose
 Show in Statement of approved
to shareholders.  Pay Generally next
Changes in Equity  Not yet approved accounting period

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PAST PAPERS - FINANCIAL STATEMENTS OF COMPANIES

MAY 2002 P2 Q.1
Q.27. Identify and comment on four trends shown in the company’s result for the three years.
(08)

A.27. Although net sales have increased consistently but Gross Profit is falling not only in ratio
but also in money ($) value. This indicates higher rate of increase in cost of sales than
sales which also resulted in a loss of $3,000 in 2000. Because of all in profits business
could not pay dividend to its shareholders in 2001 in contrast to first two years.

Company’s liquidity position has also deteriorated in 2001 as positive bank balances of
$51,000 and $45,000 respectively in 1999 and in 2000 were converted into bank
overdraft of $52,000.
Because of weak liquidity position company borrowed loan of $68,000 in 2001 to
finance purchase of additional non-current assets. Before that ordinary shareholders
made all financing. Company also piled up large quantity of inventories in 2001 (218% of
inventory of 2000). There was also a new issued of shares in 2001 but it could not help
to improve liquidity position as funds generated through loans and shares were used in
buying new non-current assets which were not fully utilized in 2001 resulting in a loss of
$3,000.

NOVEMBER 2004 P2 Q.1 (E)

Q.28. State five advantages and disadvantages of limited liability companies over sole traders
or partnership. (05)
ZM
A.28. The main advantages of limited companies over other forms of business organizations
are as follows:
(i) The shareholders enjoy limited liability. Private property of the shareholders is
not liable to settle the business obligations.
(ii) Company, as a separate legal entity, continues to exist despite changes in the
ownership by transfer of shares. A company therefore enjoys perpetual
succession.
(iii) The shares of a company can easily be transferred to other persons without the
consent of other shareholders.
The main disadvantages of forming a limited company:
(i) Compliance with the Companies Act imposes an increased administrative burden
on the company.
(ii) Tighter government regulations and more extensive public disclosure.
(iii) A company’s affairs are less private than those of a sole trader or partnership,
since company accounts are made available for public inspection.

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MAY 2005 P2 Q.2 (A & C)

Q.29. Explain the function of an Appropriation Account in: (06)

(i) a partnership
(ii) a Limited Company

A.29. (i) ● Profit and Loss appropriation account of a partnership only shows how
profits of a firm are distributed among the partners on account of
interest on capital, salaries etc.
● There is no last year profit or loss to be adjusted to current year profit.

(ii) ● Profit and Loss appropriation account of a company not only shows the
distribution of Profits among the shareholders as dividend but also
retention of profits as reserves.

● Last year profits / losses are adjusted to current year profits / losses.

NOVEMBER 2005 P2 Q.1

Q.30. Explain share premium and state how it may be used. (04)

A.30. A share premium arises when a company issues shares for a price which is higher than
their nominal value.

A share premium account can be used in a number of ways.

 To pay up un-issued ordinary shares to existing ordinary shareholders as bonus

shares.
 To write off preliminary expenses
 To write off expenses incurred in the issue of shares and debentures
 To provide for any premium payable on the redemption of shares and
debentures.

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Q.31. Barkis & Co. Ltd require more funds to purchase an additional machine to complete
further orders. Three methods of doing so have been discussed. Give one advantage and
one disadvantage of each method.
(i) A right issue;
(ii) An issue of shares to the public;
(iii) An issue of debentures.
ZM
A.31. (i) Right Issue:
Advantage:
Control on company’s affairs remains with the existing shareholders.

Disadvantage:
Dividend paid to them is not an allowance expenses for tax purposes. A dilution
in the list price of the ordinary shares may occur.

(ii) Issue of Share to Public:

Advantage:
Control not being lost or transferred to debenture holders
Disadvantage:
Management control cannot be with the existing shareholders.

(iv) Issue of Debentures:

Advantage:
Debenture interest is an allowable expense for tax purposes.
Disadvantages:
Debenture interest has to be paid whether or not company makes a profit.

NOVEMBER 2002 P2 Q.2 (A)

Q.32. (i) Describe three different types of preference share. (06)
(ii) State the major differences between shares, preference shares and debentures.
(06)
A.32. (i) Redeemable preference shares may be issued by a company with the condition
that the amount subscribed may be refunded to the shareholders at the option
of the company.

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Participating preference shares entitle holders, not only to a fixed dividend rate
but also to an additional distribution of profits in good trading years whereas in
case of non-participating preference shares, shareholders’ right to dividend is
ordinarily limited to a specified amount and mostly preference shares are non-
participating in nature.
ZM
Cumulative preference shares are entitled to the paid any arrears of their
dividend before ordinary shares receive any dividends whereas preference
shares that do not have this cumulative right called non-cumulative.

(ii) Ordinary shares represent ownership whereas preference shares and

debentures are debts of the business.

Ordinary shareholders have voting rights whereas preference shareholders &

debenture holders do not have the voting rights.

Debentures earn interest at a fixed rate. Preference shares earn dividend at a

fixed rate whereas ordinary shares receive dividends; the amount of which varies
from year to year and depends upon profit & company’s policy.

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9 Ratios
Purpose of Ratios
ZM
 Accounting ratios and percentages are computed to analyze the business performance over time (e.g
compare the year 2002 performance to the year 2001 performance)
 Accounting ratios and percentages of one firm can be compared to those of other firms in the same
industry (compare Firm A’s performance to firm B’s performance)

Ratio Explanation
Mark-up  Ratio relates gross profit to cost of goods sold
(or Gross Profit Markup)  Mark-up = Gross profit x 100
Cost of Sales
 Indicates the gross profit that is added to the cost of
goods sales to determine the selling price
The ratio Increases by an Increase in selling price or
by a decrease in the purchase price
Gross profit margin percentage  Indicates the gross profit earned for each dollar of
sales
 Gross margin percentage
= Gross profit x 100
Net Sales
 The ratio Increases by an Increase in selling price or
by a decrease in the purchase price
Net margin percentage  Indicates the net profit earned for each dollar of sales
 Net margin percentage
= Net profit x 100
Net Sales
 Increase shows better control on expenses

Percentage of expenses to  Ratio compares expenses incurred to turnover

turnover  Percentage of expenses to turnover
= Expenses x 100
Turnover
 The lower is better in this ratio
Rate of turnover or rate of stock  Rate refers to the number of times the average stock
turnover is replaced or sold in the accounting period
 Rate of turnover = Cost of sales
Average stock
 High stock turnover indicates fast-moving to sell the
stock and greater profit
Return on capital or  Measures the return on capital invested at the
(Return on owner’s equity) beginning of the accounting period Return on capital
= Net profit x 100
Opening capital
 The higher is better and increase the confidence of
the owner

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Return on capital employed or  Measures the return on total investment in the

(Return on net assets) business = Operating profit x 100
Capital Employed
 The higher is better and increase the confidence of
the investers
Working capital ratio  Measures the ability of the business to pay its debts
or (current ratio) when they fall due
 Working capital ratio = Current assets
Current liabilities
 The ideal ratio is 2:1 and shows good cash flow
management
Quick ratio or liquid ratio or acid  Measures the ability of the business to pay its debts
test ratio when they fall due without inventory
 Quick ratio = Current assets – Inventory
Current liabilities
 The ideal ratio is 1:1. Low in this ratio indicates poor
management of liquid resources and businesses may
face liquidity problems.
Inventory Turnover  How many days it takes to finish the inventory held
for sale
 Inventory turnover = Average Inventory x 365
Cost of Sales
 The shorter is better, less chances of obselence and
increase profitability.
Receivables Turnover  How many days it takes to to recover the amount
From credit customer
 Receivable turnover = Trade Receivables x 365


ZM Credit Sales
The shorter is better, less chances of bad debts and
better cashflow management.
Payable Turnover  How many days it takes to pay credit suppliers of the
business
 Payable turnover = Trade Payable x 365
Credit Purchases
The shorter is better, improve reputation of the
business.
Owner’s equity  It is the investment of the owner or shareholders in the
busines
 Owner’s equity
= Total assets – Total liabilities
= Capital (beginning) + Net profit – drawings
Capital employed  Refers to the long term funds available to the
business
 Capital employed
= Capital + long- term liabilities
= Non Current assets + Net current assets
= Non Current assets +Current Assets -Current
Liabilities
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Other Formals  Gross Profit = Sales – Cost of Sales

 Gross Profit = Net Profit + Expense
 Net Profit = Gross Profit – Expenses
 Cost of Sale = O/I + Purchases – C/I
 Cost of Sales = Sales – Gross Profit
 Expenses = Gross Profit – Net Profit

Capital employed can be increased by: ZM

(i) Issue of debentures.
(ii) Obtaining long term loan
(iii) Reduce appropriations / dividends

Working capital (Net Current Assets)

Refers to cash and other current assets used to run the operations of the business.
Working capital = current assets – current liabilities

General Comments on Ratios

Gross profit / sales

This ratio is important in measuring success in selling goods.,
The ratio can be compared against previous years.
The ratio can be compared against other business.
This may be higher due to higher selling prices charged or
More efficient/bulk buying / purchase costs reduced.

Net profit / capital at start of year:

This ratio is used to measure profitability against investment.
Used for comparison with other firms and previous year’s results or profitability.
Comparison can be made with return percentage offered by other organizations in which company invests.

Ways to increase his rate of inventory (stock) turnover:

Reduce inventory levels.
Reduce mark up to be more competitive
Promotions such as advertise products
Offer cash discounts to encourage sales

Disadvatnages of Holding too much stock

 Detoriation of Inventory
 Obselence
 Increase storage cost

Suggested actions to improve bank balance:

1. Issue more shares (owner’s investment)
2. Extend the amount due in more than one year
3. Reduce trade receivables (debtors)
4. Sell non-current (fixed) assets
5. Extend trade payables (creditors)
6. Reduce inventory (stock)
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PAST PAPERS - RATIO ANALYSIS

MAY 2003 P2 Q.2

Q.35. (a) Comment on your findings. ZM (12)

(b) State six shortcomings or dangers in using ratio analysis. (06)

A.35. (a) Poynder’s profitability position as revealed by the ratios calculated in “a” part was
either worse or equal to that of Greenyards in 2001. But in the year 2002
Poynder Ltd showed a consistent profitability performance whereas Greenyards’
GP, NP & ROCE ratios have worsened. Moreover Poynder also controlled its
operating overheads as its 43.5% of sales revenue was absorbed by expenses in
the year 2002 which was lower than its last year ratio and that of its competitor.
Current ratio of both companies was at a reasonable level in 2002, but in year
2001 this was too high for Greenyard. Quick ratio of Poynder has improved by the
ability of Greenyards to pay off its current obligations as measured by quick ratio
has reduced.
Inventory turnover rate has increased for both companies, which is a favourable,
which is a favourable sign for both of them. This can also be related to lower gross
profits margin of the companies in the year 2002. Lastly trade receivables’
collection period has lengthened which means that cash in slower coming in for
Greenyard this looks unfavourable for the company although it may encourage
credit customers to continue buying from it.
(b) The following are the important limitations of accounting ratios.
(i) No fixed standard can laid down for ideal ratios.
(ii) Ratios are limited only on the information, which has been recorded, in
the books of accounts.
(iii) Ratios are only indicators; they should not be taken as final regarding good
or bad financial position of the business. Other things will have to be
seen. Moreover they do not indicate the reasons of poor
performance.
(iv) Ratios have to be interpreted and different people may interpret the ratios
in different ways.
(v) Ratios may be misleading if accounts are not adjusted for inflation.
(vi) They can only be used to compare like with like.
(vii) The accuracy and reliability of ratios depend upton the quality of the
information from which they are calculated.

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MAY 2004 P2 Q.1

Q.36. (a) Comment of the changes in the company from 2002 to 2003, stating for each
ratio whether it is better or worse, and why?
(b) Comment briefly on the advantages and disadvantages of using ratios.

A.36. (a) On the basis of above ratios it may be concluded that performance of the
business has deteriorated in 2003. There is a significant decrease in acid-test ratio
as positive bank balance of $192,000 converted in bank overdraft of
$340,000 in 2003. The decrease in cash balance was due to lengthy collection
period from trade receivables, which shows that business has poor credit control
on trade receivables, resulting in delayed payments from them. Cash balance
was also negative, as business has piled up huge inventories, which seem to be
surplus to the business requirements. Due to high inventory levels frequency of
inventory with which it was converted into sales has also decreased. Normally low
gross profit rate is associated with high inventory turnover but unfortunately this
is not true for the company under review.

Decrease in gross profit ratio may be due to increase in cost price of goods
without corresponding increase in sales prices. Net profit ratio has also reduced
but the differences between gross and net profit ratios suggests that operating
expenses as a percentage of sales have reduced in 2003 which is good indication
for the business. Return on capital employed remains unchanged indicating that
ability of the business to earn profit on capital employed has remained constant.
(b) Ratio analysis helps a business in a number of ways, some of which are given
below:
(i) Ratios help in analyzing the performance trends over a long period of
time.
(ii) They also help a business to compare the financial results to those of
competitors.
(iii) Ratios help the management in decision-making and also point out
problem areas.
Ratios also have some limitations, some of which are given below:
(i) Ratios are based upon what has happened rather than what will happen.
(ii) Ratios are based on historical figures (not adjusted for inflation) so the
conclusions drawn from them may be misleading and unrealistic.
(iii) Inter-firm comparison is made more difficult as firms may use different
accounting methods and techniques.

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ZM
MAY 2006 P2 Q.1 (C)

Q.37. Explain the uses of these two ratios, using Peter Jordan plc as an example. (06)

A.37. From short term solvency (liquidity) point of view assets should be sufficient to pay off
current liabilities as and when they are due. For Peter they are just covering the current
liabilities. Whereas liquid ratio suggests that business may face problems in paying
current liabilities if inventory (least liquid current asset) is excluded from the calculation.
So liquidity ratios are showing poor liquidity position of the business.

NOVEMBER 2006 P2 Q.2

Q.38. State and explain one advantage and one disadvantage of using ratio analysis as a
means of evaluating performance.
(i) Advantage
(ii) Disadvantage

A.38. (i) Advantage: Ratio analysis helps to measure the progress of the enterprise, so
that managers know that how well the company is doing.

(ii) Disadvantage: The difference in accounting policies of different organization can

make it difficult to effect a meaningful comparison.

MAY 2007 P2 Q.2 (E & F)

Q.39. From your calculation in (e) and the balance sheets given in the question discuss briefly
Archie’s financial status on 30 April 2007 compared to 30 April 2006.

A.39. Both current and liquid ratios show improvement in the year ending 30 April 2007
however these ratio were too high in the last year suggesting idle current resources in
2006. Moreover net loss of $11,400 in current year compared to net profit of $83,500 in
the previous year suggests that the profitability of the business has deteriorated a lost.
NOVEMBER 2007 P2 Q.2 (C & D)

Q.40. Explain briefly one of accounting ratios.

A.40. In general, ratios are used for making the following comparison:

(i) They are compared with other ratios in the same set of financial statements.
(ii) They are compared with the same ratio in previous financial statements (trend
analysis).
(iii) They are compared with a performance standard (industry average).

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MAY 2008 P2 Q.1 (C & D)

Q.41. (i) State two reasons for calculating ratios: (02)

(ii) State four user groups who might be interested in or make use of accounting
ratios. (04)

A.41. (i) Ratio analysis helps a business in a number of ways, some of which are given
below:
 Ratios help in analysis the performance trends over a long period of time.
 They also help a business to compare the financial results to those of
competitors.
 Ratios help the management in decision-making and also point out
problem areas.

(ii) Management, prospective and existing shareholders, tax Authorities, stock

brokers, lenders, employees, trade payables, trade receivables, directors,
Government, etc.

NOVEMBER 2008 P2 Q.2 (B)

Q.42. Ahmed Khan is a sole trade. During the year ended 30 September 2007, his percentage
of net profit to sales was 22%. The following year, this dropped to 18%, despite the year’s
net profit having increased from $60,000 to $70,000. (06)

Required: ZM
State six possible reasons for the decrease in the ratio of net profit to sales.

A.42. Net profit to sales ration may decrease due to any of the following reasons.
 Decrease in sales price does not correspond with increase in sales volume.
 Price reducing policy due to competition.
 Stolen inventory not deducted from purchase.
 Increase in purchase prices without corresponding increase in sales price.
 Price cuts for disposing off old inventory.
 Overstatement of opening inventory or understatement of closing inventory
 Lower sales volume of higher margin items.
 More administrative and marketing expenses.

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MAY 2009 P2 Q.1 (C)

Q.43. Using the ratios calculated in (c ) (i) and (ii), comment briefly on Suhail;s performance
over the two years.

A.43. In all respects sole trader seems to achieve better results as compared to previous year,
which represents better management of trading operations. Although in the year 2009
there is slights overspending on expenditures but even then net profit ratio has been
significantly improved.

Suhail’s ability to meet his short-term obligations has significantly improved as can be
seen from liquidity ratios. In 2009, the business was in a better position to meet its
current obligations out of its current resources. Briefly speaking, business has improved
its performance in current year as compared to the previous year.

MAY 2010 P21 Q.2

Q.44. Justify your answer to (b) (i) by comparing four of the ratios which you have calculated
with the same four ratios given for Dakeeri. (12)

A.44. Chikkadea’s gross margin is better than Dakeeri which shows that the makes more gross
profit for every dollar of sales. Though Chikkades’s net profit margin in also better than
Dakeeri however Chikkadea could not control its expenses as Dakeeri did. Return on
capital employed and return on total assets of Chikkadea are also better than Dakeeri
and reveal better utilization of investment in total assets and capital employed.

Chikkadea’s current ratio shows that she has more current assets than Dakeeri against
$1 of current liabilities. Chikkadea’s liquid ratio is also better as it shows that she is better
able to pay her short term debts as and when they are due.

Chikkadea’s receivables’ turnover shows that she has faster collection from her
customers leading to better liquidity position. Chikkadea’s payables’ turnover shows
that she has been given longer credit period to pay her debts and enjoys more time to
make use of that amount of cash.

Chikkadea’s inventory turnover rate indicates that she is able to sell her goods quickly
resulting to higher overall profits.

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MAY 2011 P22 Q.2 (B & C)

Q.45. Using the profitability ratios (i) to (v) compare the performance of the Northern and
Southern Divisions of Blackford Industries and explain the signification of each ratio.(10)

A.45. Northern has a better mark-up and gross profit percentage which could be due to higher
sales price or low costs in comparison to Southern Division. Northern Division, however,
was not able to control its administration and advertising costs as compared to Southern.
The higher operating expenses resulting in lower net profit ratio are not good for Northern
Division; however they could be linked in an effort to sell goods at higher prices. Return
on capital employed of Northern is poorer which could be attributed to low net profit
ratio and underutilized assets employed.

MAY 2011 P23 Q.1 (D, E & F)

Q.46. Explain why the liquid ratio (acid test) is a more reliable indicator of liquidity than the
current ratio. (02)
A.46. The liquid ratio shows the availability of liquid funds to settle all of the current liabilities
immediately. Liquid ratio excludes closing inventory from the calculation as it is
considered as the least liquid current asset. The excluding of inventory from the
calculation may be justified on the ground that some goods in inventory may prove to
be unsaleable or it sometimes becomes difficult to find a buyer for some inventory items.

NOVEMBER 2011 P22 Q.2 (B) ZM

Q.47. Advise which business, if any, she should purchase on the basis of all of the information
provided. Justify your answer.
A.47. On the basis of above ratios it may be advised that Paradise Foods should be purchased
as it has better return on capital employed rate. However its higher current ratio puts a
question mark as it looks as if it is excessively high. In addition it’s liquid (acid-test) shows
that Paradise Foods has overinvested in its inventory and inventory levels needs to be
reviewed.
MAY 2012 P21 Q.2 (D & E)
Q.48. (a) Suggest two reasons for the change in the percentage of gross profit to sales. (04)
(b) Suggest two reasons for the change in the percentage of net profit to sales. (04)
A.48. (a) Increase in sales price no or relatively low increase in cost of sales.
Decrease in cost of sales with no or relatively low decrease in sales price.
Bulk purchases resulting in more trade discounts and reduced purchase costs.
(b) Better control on operating expenses.
Increase in gross profit margin with no or relatively low increase in operating
expenses.

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10. ABSORPTION COSTING

Cost Accounting

- Purpose of cost accounting:

 Planning
 Controlling
 Decision making

Cost Classification

BY FUNCTION: BY NATURE:
BY ELEMENT:
BY TYPE − Production − Variable costs
- Material
DIRECT COST: − Sales & distribution − Fixed costs
- Labour − Administration − Semi-variable
This cost is identified with a - Overhead
specific cost unit (e.g. direct − Finance
labour and direct materials,
which are part of the prime
cost in manufacturing
accounts).

INDIRECT COST:
This cost is not identified with a
specific cost unit. Indirect costs
are also known as factory
overheads in a manufacturing
account.

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ABSORPTION COSTING
It is a costing which includes fixed
production overheads as a part of unit cost

Allocation and apportionment

 Allocation charges overheads directly to specific departments
 If overheads relate to more than one specific department they must be
apportioned (share) between departments.
 Apportioned fixed production overheads include: rent, rates heating and
electricity costs.

Reapportionment of service cost centre costs to production cost centres

Reapportionment involves sharing out the fixed production overheads of
service cost centres between production cost centres

ZM
Overhead Absorption Rate
(OAR)

Appropriate bases for absorption Under-and over-absorption of overheads

 Machine – hour rate. If either or both of the estimates for
 Labour-hour rate budgeted overheads or budgeted level of
 Units Produced activity are different from actual results
 Percentage of direct wages then this will lead to under or over-
absorption (recovery) of overheads.

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Benefits and limitations of absorption costing

Benefits Limitations
 Absorption costing recognizes the fixed  Absorption costing is not useful for
costs in the product cost and is therefore decision-making purposes. In considering
suitable for determining the selling price fixed costs as part of the product cost,
of a product. managers will not have a clear
understanding of whether accepting a
lower price for a product is worthwhile.
 Absorption costing conforms to the  Absorption costing is not useful for
accruals / matching concept that requires responsibility accounting. It would be
costs to be matched with revenues for a unfair to hold managers responsible for
period. fixed costs over which they had no control.

 Absorption costing avoids the necessity

of separating fixed costs from variable
costs.
 Absorption costing is the recognized
method of inventory valuation.

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PAST PAPERS - ABSORPTION COSTING

NOVEMBER 2007 P2 Q.3

Q.50. State the reason for using different methods of calculating the overhead recovery rate
in (b). (02)

A.50. As Assembly department is based on labour intensive operations so direct wages base
(related to labour) is more appropriate. Operations in Finishing department are capital
intensive so machine hour base is more relevant.

NOVEMBER 2010 P23 Q.3

Q.51. (a) Explain why Mandar Limited absorbs its overheads using direct labour hours.(05)

(b) State two alternative methods the business could use to absorbs their
overheads. (02)

A.51. (a) Mandar Limited may be employing labour intensive operations. Nonethless it is
better to absorb overheads in relation to time rather than cost. This becomes more
important if different grades of labour are used in different department.
(b) Direct material cost base ZM
Direct labour cost base
Prime cost base
Machine hour base
Units of production base

MAY 2012 P22 Q.3

Q.52. (a) Explain how the results in (c ) could have occurred.
(b) Explain the problems associated with using predetermined overhead absorption
rates in calculating the price of a product. (06)

A.52. (a) In machine department the actual overheads were more than the absorbed
overheads resulting in increase in increase in overall costs. This could be due to
overspending or due to over estimation of machine hours by machining
department.

In assembly department the actual overheads were less than the absorbed
overheads resulting in reduction in overall costs. This could be due better control
on expenses or due to under estimation of labour hours by assembly department.

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(b) The use of predetermined overhead absorption rate can cause particular
problems where there is a fixed cost, because the volume of activity for the period
ahead has to be estimated as well as of overheads. The use of predetermined
overhead absorption rate may also result in over or under-pricing and affecting
profits of the business.

MAY 2012 P23 Q.3

Q.53. (i) Discuss the problems associated with using predetermined overhead absorption
rate. (02)

(ii) State the effect on profit if the factory does not operate at full capacity. (04)

A.53. (i) The use of predetermined overhead absorption rate can cause particular
problems where there is a fixed cost, because the volume of activity for the period
ahead has to be estimated as well as the amount of overheads. As a result there
could be over or under absorption of over absorption of overheads. The use of
predetermined overhead absorption rate may also result in over or under pricing
of products and affecting profits of the business.

(ii) Factory overheads will be under recovered (Under absorbed) if the actual activity
level of factory is less than the budgeted activity. This under recovery of
overheads may influence profitability as products would be underpriced.

Factory overheads will be over recovered (over absorbed) if the actual activity
level of factory is more than the budgeted activity. This over recovery of
overheads may demand and revenue for the product as products would be
overpriced.

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11 MARGINAL & ABSORPTION COSTING INCOME STATEMENT

ADVANTAGES OF MARGINAL COSTING ADVANTAGES OF ABSORPTION COSTING
1 Contribution per unit is constant 1. Absorption costing includes an
unlike profit per unit which varies element of fixed overheads in
with changes in sales volumes. inventory values.
2 There is no under or over 2. Analysing under/over absorption
absorption of overheads (and of overheads is a useful exercise
hence no adjustment is required in controlling costs of an
in the income statement). organisation.
3 Fixed costs are a period cost and 3. In small organisations, absorbing
are charged in full to the period overheads into the costs of
under consideration. products is the best way of
4 Marginal costing is useful in the estimating job costs and profits
decision-making process. on jobs.

ZM
5 It is simple to operate.

Uses Benefits Limitations

Marginal costing Useful for decision- Easily understood and Indirect and direct costs
making as it identifies applied in decision- are both divided into
the extra costs and making as it is cost either fixed or variable.
revenues incurred by effective. Contribution Fixed costs are not
is identified which is allocated to cost centres
the production and
useful, for example, in and cost units but are
sales of an additional regarded
and linkedastotime based
accounting
unit, for example in make-or-buy
and where theredecisions
are
limiting factors such as
relation to make-or- periods rather than
buy decisions, limiting units of output.
limited labour hours.
factors.
Absorption costing Useful for decision- All costs are The final basis used to
making as it includes considered so a total calculate the QAR
a portion of fixed production cost per may not be relevant
costs in each cost unit is identified. The for all of the
unit, for example effect of an increase overheads in the
when calculating the in any one cost can be production
selling price using the assessed whether department. New
pricing strategy, full direct or indirect. technology has led to
cost plus, a reduction in the use
of labour hours as a
valid basis.
If inventory levels
decrease, absorption
costing records a
lower profit than
marginal as costs
from previous periods
are set against
income.

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

MARGINAL & ABSORPTION COSTING INCOME STATEMENT

PAST PAPERS - NOVEMBER 2005 P2 Q.3

Q.54. Explain why the profit found when using absorption costing differs from the profit found
in marginal costing. (04)

A.54. The difference between profits calculated in marginal and absorption costing is purely a
result of timing of the matching of fixed overheads with products.

Secondly the difference between the two profit calculations is based entirely on the
change in volume of inventory multiplied by the fixed overhead cost rate of $160 per
unit. During the period, inventory increases by 600 units and, as a consequences, profit
under absorption costing is $96,000 (600 x 96) higher than under marginal costing.

Thirdly the overall effect of the positive and negative differences in profits over the
business life is zero. Provided the allocation process is applied consistency. Finally, it may
be said that when inventory levels are decrease profit under absorption costing is lower
and vice-e-versa for the contrary.

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

12. BREAK-EVEN ANALYSIS (Or COST VOLUME PROFIT ANALYSIS)

COST VOLUME PROFIT

ANALYSIS

CONTRIBUTION BREAKEVEN
: +, < 67
 Contribution = sales – variable cost − Breakeven sales units = ) > 2
 Contribution to sales ratio (P/V ratio) : +, < 67
− Breakeven sales revenue = )
= contribution / sales x 100 > +, +

− Margin of safety in units = Budgeted sales – breakeven Sales

S 7 6 +, ?> +Q +,
− Margin of safety % = S 7 6 +,
T100

− Sales revenue for a specific profit target =

: +, < 67 U2 + 3
VWGM$KX&MKWG F#YIF $#MKW

Applying marginal costing in decision making situations

 When deciding whether to make or buy a product
 When deciding whether or not to accept a special order
 When considering how’ to maximize profits when there are limited resources
available.

Assumptions of Break Even Analysis limitations of break-even analysis

It assumes that there are no changes in the Most businesses have changing levels of
levels of inventory inventory throughout the financial year.
It does not allow product mix and is Most of manufacturing firms does have a
usually calculated for a single product. product mix, it is not realistic to calculate
for a single product.
There are only two types of cost, i.e fixed or Many costs have behavior that is not either
variable perfectly fixed or perfectly variable but a
combination of the two.
Fixed costs are assumed to remain fixed for Stepped fixed costs are not considered
the whole period of time
Variable costs are assumed to be perfectly Changes in costs are not considered (for
linear with the level of production example overtime or bulk-buying discounts).
The selling price is assumed to remain fixed Seasonal sales variations or discounts are
throughout the year not considered

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

PAST PAPER - BREAK-EVEN & PROFIT VOLUME ANALYSIS

MAY 2009 P2 Q.3

Q.55. Explain the implication for the local community if Alberta Limited decides to extend its
product range. (06)
ZM
A.55. If Alberta Limited decides to extend its product range then this would create additional
employment opportunities for the local community. Moreover, more diversified products
would be available in local market. This would also open new market for local suppliers
of raw materials. However, increased pollution due to extension of production range
would be injurious to the health of local community.

MAY 2010 P22 Q.3

Q.56. (i) Define the break-even point.

(ii) Define the margin of safety

A.56. (i) It shows the output level (units produced or services rendered) at which total
revenues just equals to total costs or point at which profit or loss is zero.

(ii) Margin of safety is the difference between the actual or budgeted sales as the
case may be and the break-even levels of sales. Margin of safety tells the
management how far sales can fall before the business will move out of profit and
into a loss making situation.

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

NOVEMBER 2011 P22 Q.3

Q.57. (a) State three fixed costs a business typically incurs. (03)

(b) Explain what is meant by the term ‘stepped costs’. (02)

(c) Increasing production will allow the firm to potentially earn more profit.
However, it could pose significant risks to the business.
Evaluate the above statement using your answers to parts (b) and (c).

A.57. (a) Common examples of fixed costs include rents, salaries of permanent
employees, insurance and depreciation.

(b) Step cost is a cost that does not change steadily, but rather at discrete point. In
other words it increases to a new level in step with the significant changes in
activity or usage. For example, supervision costs are fixed for a given range of
production volume, but increased production often requires additional work
leading to added supervisory costs in a lump-sum fashion.

(d) Market research forecasts an increase in sales by 60%. It is a promising increase

and firm should consider every possible step to ensure meeting this additional
demand smoothly. Increasing production capacity is a good option but the
decision should be made after properly evaluation since increasing production
capacity will not only require a huge set up cost but will also increase monthly
overheads for the business. The firm should consider how reliable the market
research is and is this demand increase a temporary one or likely to be more
permanent. Firm should increase capacity only if it expected this demand increase
to be permanent otherwise the additional demand can be met temporarily by sub-
contracting and by overtime payments.

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

13 MARGINAL COSTING OTHER DECISION MAKING

− BREAK-EVEN & PROFIT VOLUME ANALYSIS
− OTHER DECISION MAKING Optimal production plan / Limiting Factors
When limiting factors are present, contribution (and therefore profits) are maximised
when products earning the highest amount of contribution per unit of limiting factor are
manufactured first. The profit-maximising production mix is known as the optimal
production plan.
The optimal production plan is established as follows.
• Step 1 Calculate the contribution per unit of product.
• Step 2 Calculate the contribution per unit of scarce resource.
• Step 3 Rank products.
• Step 4 Allocate the scarce resource to the highest-ranking product.
 Step 5 Once the demand for the highest-ranking product is satisfied, move on to the
next highest-ranking product and so on until the scarce resource (limiting factor) is
used up ZM
DEALING WITH LIMITING
FACTORS

What is the limiting factor?

A limiting factor is a factor that prevents a company
from achieving the level of activity that it would like to.
It is usually sales demand but it might be material,
labour, machine capacity and so on.

Optional production plan where there is a single limiting factory

Make products in order of contribution earned per unit of limiting

factor (start with the highest earner).
Contribution per unit
Units of limiting factor required per unit

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

PAST PAPERS - MARGINAL COSTING & DECISION MAKING

MAY 2004 P2 Q.3

Q.58. Write a brief statement comparing the three options. (03)

A.58. Option ‘2’ should be undertaken as it results in maximum profits. For calculating net
profit from option ‘2’, market research costs were ignored as these costs already spent
and is nothing to do with finalizing the decision. In option ‘1’ there may be administrative
problems relating to employees, moreover in opting “option ‘3’ quality of goods bought
form an outside supplier may become low in future.

NOVEMBER 2004 P2 Q.3

ZM
Q.59. Briefly assess each option.
Option 1. (02)
Option 2. (02)
Option 3. (02)

A.59. If number of units produced is less than 250,000 uni

Option 3 should be undertaken when units of production exceed 250,000 units. Option
2 should not be considered as at neither of the output level if generates profit greater
than other option, so the company should choose the alternative based on the number
of units it expects to sell.

MAY 2008 P2 Q.3

Q.60. State which option should be accepted, giving one advantage and one disadvantage, of
that option.

A.60. Option ‘3’ should be undertaken i.e. evening shift should be introduction as it result in
maximum profits. There may not be teething troubles and possible re-training problems
due to use of exiting labour. However set up costs for evening shift may be relevant. Over
work by the employees may negatively affect their efficiency level.

ZM

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

NOVEMBER 2009 P22 Q.3

Q.61. (i) State how your advice to production manager should differ if the additional
operator is employed. (02)

(ii) State whether the additional operator should be retained for each machine.
Explain your reasoning. (02)

A.61. (i) If an additional operator is hired then Machine C should be e mployed for the
order as it has costs lower than Machine A and Machine B.

(ii) Additional operator should be retained as this brings costs down.

MAY 2010 P23 Q.3

Q.62. State four assumptions made when using break-even analysis. (04)

A.62. ● Every unit produced is sold.

● Business sells all its products at constant selling price.
● Costs can be classified as variable and fixed and there is no semi variable costs.
● Variable cost per unit and fixed costs in total remains the same.
● Business produces only one type of product.
● Sales mix remains constant.

NOVEMBER 2011 P21 (E & F) Q.3 (E & F)

Q.63. State two limitations of break-even analysis. (02)

A.63. ● Breakeven analysis assumes that every item produced is sold but in practice each
business has some inventories (unsold items) at both year start and at year end.

● Breakeven analysis also assumes that fixed costs in total remain unchanged but
in reality total fixed cost may change when output exceeds a particular range
(time period or output level).

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

14. THE APPLICATION OF ACCOUNTING 'TO BUSINESS PLANNING

BUSINESS PLAN

PROCESS BENEFITS LIMITATION

NEED
 Identify objectives  Plan  Estimation
 Financial
 Identify potential  Coordination  Demotivation
 Labour.
strategies  Responsible  Less innovation
 Capacity.
 Evaluate the strategies  Monitoring  Inefficient use of
 Timing.
 Formulate the long-  Performance resources
term plan Measurement
 Implement the long-  Motivation

Business planning

All businesses need to plan. In order to develop the business, or indeed in order to
even survive, an organisation must actively undertake a process involving not only
planning, but also control mechanisms over that planning.

The planning process involves the following 5 steps:

1. Identify objectives: These will differ from organisarion to organisation at

different times. There will be rimes when the objective is to maximise
profitability, there may be other times when the objective is to increase
market share.

2. Identify potential strategies: In other words, having identified the objectives,

the organisation must then identify the different ways in which it may achieve
them.
3. Evaluate the strategies: Certain potential strategies will usually be discarded as
unfeasible, uneconomic or unsuitable for other reasons.

4. Formulate the long-term plan: The chosen strategies are incorporated into a
long-term plan, usually expressed in financial terms as part of the budgetary
process.
5. Implement the long-term plant: This involves breaking down the master plan
into smaller, more manageable, short' term plans. (or budgets).

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

The need for budgets

In any operation, the supply of resources is not infinite. These resources may take
many different forms.

 Financial. An organisation's activities may be restricted by lack of finance. All

products and services must be produced within a clear identified cost.
ZM
 Labour. An organisation's activities may be restricted by lack of available
labour resources.

 Capacity. An organisation's activities must be produced within the confines of

physical capacity.

 Timing. The organisation's products and services must be produced within

the time when they are of use to the customer.

 Quality. The organisation's products and services must be produced within the
tolerance for their own and their customers' quality standards.

Benefits of budget preparation and budgetary control

1. Plan
Budget preparation forces senior managers to look ahead and plan for the
future.

2. Coordination
The preparation of budgets encourages co-ordination and communication between
departments.

3. Responsible
A budget gives a clear indication of managers' areas of responsibility.

4. Monitoring
Budgets provide a framework for budgetary control. This enables constant
monitoring against targets.

5. Performance Measurement
Budgets provide the necessary yardstick for senior managers to measure the
performance of managers.

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

6. Motivation
Budgets motivate employees by providing an achievement target to meet,
especially where employees are involved in the budget-setting process.

Limitations of budget preparation and budgetary control

1. Estimation
ZM
Budgets are based on estimates and it must always be remembered that
forecasting is not an exact science.

2. Demotivation
A budget that is unrealistic or unachievable is of limited use and may do more harm
than good.

3. Less innovation
Budgets can restrict activity so that managers are not innovative and fail to take
advantage of unexpected opportunities due to their actions being too strictly
controlled.

4. Inefficient use of resources

Through careful control of their budgets, managers may have a surplus available
at the end of the year, but rather than save this surplus they will spend it so that
their budget for the following year will not be reduced. In this way, budgets may
inadvertently encourage the inefficient use of resources.

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

18. ACCOUNTING CONCEPT

Accounting Concept Explanation Evidence

Dual Aspect Concept Every transaction has a double One on the debit side and the
(Duality) effect, a basic principle of double other one on credit side.
entry accounting.

Business Entity Concept The business is an entity Personal transactions of the

(Separate/Accounting separate from its owner owner are not recorded in the
Entity) books of accounts

Monetary Convention All financial transactions are Business assets that cannot be
(Money measurement) expressed in monetary units quantified or expressed in
such as dollars and cents, in monetary terms are not
order to record them in the recorded in the books of the
books. business

Historical Cost Assets are shown in the balance Assets bought are recorded at
sheet at their historic cost to the their cost values instead of their
business or at a value which is market or realizable values
based upon actual cost of
purchases.

Going Concern Concept It is assumed that the business Assets are not shown at their
will continue to trade for the liquidating or realizable values
foreseeable future.

Accounting Period Concept The life span of the business is Financial statements are
divided into fixed periods of time produced at yearly intervals

Prudence Concept Never overstate assets and Stock is always valued at lower
profits of cost or net realizable value
(NRV)

Matching Concept Profit is determined by matching Revenue received and expenses

(Accruals) revenue for the period against paid that do not relate to the
the expenses incurred in earning period are excluded from the
that revenue financial statements

Materiality Concept How information is captured and The full amount of stationery
dealt with in the books depends expense is often written off.
on its significance

From the bank of Sir Zeeshan Malik

AS Level Accounting
ZM AS Review Book

Realization Concept Revenue is recognized only when Revenue is not recognized

it is earned when a quotation is given.

Consistency Concept Accounting policies and methods The same method of

are to be applied on consistent depreciation is to be applied for
basis, from one year to another a particular asset year to year
and should not charge without
not charged without specific &
valid reason

Substance over form Substance over form: a principle Hire purchase

stating that information should
show the substance of a
transaction rather than the legal
form.

True and fair view The principle stating that the Follow consistency & Avoid
income statement should show a material errors
‘true and fair view’ of the profit
or loss; the statement of
financial position should show a
true and fair view’ of the
business’s financial position.

From the bank of Sir Zeeshan Malik

Accruals & Prepayments

Expense A/c
2020 Dr $ 2020 Cr $
Prepaid b/d xx Accrual b/d xx

Cash/Bank Paid xx Income Statement xx

Accrual c/d xx Prepaid c/d xx

xx xx

2020 Dr $
ZM
Income A/c
2020 Cr $
Accruals b/d xx Prepaid b/d xx

Income Statement xx Cash/Bank Received xx

Prepaid c/d xx Accruals c/d xx

xx xx
 Bank Reconciliation

Cash book
2022 Dr $ 2022 Cr $
Balance (Closing
31-Mar xx 31-Mar Bank Charges xx
balance of cashbook)
Dishonored Cheque xx
Bank Giro Credit xx Standing Order xx
Direct Debit xx

balance c/d xx

xx xx

ZM
Bank Statement Statement
2022
31-Mar Balance as per Bank Statement xx
Uncleared Cheques xx

Unpresented Cheque xx

Uptodate Cashbook xx
Statement of Comprehensive Income (Company)

$ $
ZM
Revenue (Sales) X
Sales Return (x)
Net Revenue (Net Sales) ZM
X
Cost of Sales
Opening Inventory X
Purchases X
Purchase Return (x)
Carriage Inward X

Closing Inventory (x)

Cost of Sales X
Gross Profit
Other Income

Expenses

(X)
Operating Profit / (Loss) X/(x)
Finance Cost (X)
Profit Before Tax X
Taxation (Not in O level Syllabus) (X)
Profit After tax X
 Statement of Changes in Equity

ZM
ORDINARY PREFERENCE GENERAL RETAINED
SHARES SHARES RESERVE PROFIT
Balance B/d X X X X
Profit X
Transfer to General Reserve X (X)
Dividend Paid: Prefernce (X)
Dividend Paid: Ordinary (X)
Issue of shares X

Balance c/d X X X X
Statement of Financial Position (Company)

Assets
Non-Current Assets $ $ $

X
Current Assets
Inventory X
Account Receivables X
Allowance for Doubtful Debts (X)
Other Receivables X
Cash at Bank X
Cash in Hand X X
Total Assets X

Equity & Liablility

Shareholder's Equity X
Ordinary Share Capital X
Preference Share X
General Reserve X
Retained Profit
ZM X
X
Non-Current Liability
Debenture X

Current Liability
Account Payables X
Other Payables X
Equity & Liabilities X
Income Statement (Partnership)
$ $
Revenue (Sales) X
Sales Return (x)
Net Revenue (Net Sales) X
Cost of Sales
Opening Inventory X
Purchases X
Purchase Return (x)
Carriage Inward X

Closing Inventory (x)

Cost of Sales X
Gross Profit
Other Income

Expenses

(x)
Profit/Loss for the year X/(x)
Statement of Financial Position (Partnership)
Assets
Non-Current Assets $ $ $

X
Current Assets
Inventory X
Account Receivables X
Allowance for Doubtful Debts X
Other Receivables X
Cash at Bank X
Cash in Hand X
X
Total Assets X
Equity & Liablility

Capital Account A X
B X
Current Account A X
B X X

Non-Current Liability
Loan X

Current Liability
Account Payables X
Other Payables X

Capital & Liabilities X

Appropriation Account
Profit & Loss Appropriation Account
$ $
Net Profit X

Interest on Drawing: A X
B X X
Interest on Capital: A X
B X (X)
Salary: A X
B X (X)

Residual Profit X
Share profit as per ratio: A X
B X (X)
Nil

Partner's Current Account

Particulars A B Particulars A B
Bal b/d Balance b/d X X
Interest on loan X
Interest on Drawing X X Interest on Capital X X
Drawings X X Salary X

Profit Share X X
Loss (If any)
X X
Balance c/d X X Balance c/d X X
X X X X
FINANCIAL STATEMENTS OF SOLE TRADER

Income Statement (Sole Trader)

$ $
Revenue (Sales) X
Sales Return (X)
Net Revenue (Net Sales) X
Cost of Sales
Opening Inventory X
Purchases X
Purchase Return (X)
Carriage Inward X

Closing Inventory (X)

Cost of Sales X
Gross Profit
Other Income

Expenses

(x)

Profit/Loss for the year X/(X)

Statement of Financial Position (Sole Trader)
Assets
Non-Current Assets $ $ $

X
Current Assets
Inventory X
Account Receivables X
Allowance for Doubtful Debts X
Other Receivables X
Cash at Bank X
Cash in Hand X
X
Total Assets X
Equity & Liability

Capital X
Profit/(Loss) X/(X)
Drawing (X)
X
Non-Current Liability
Loan X

Current Liability
Account Payables x
Other Payables X
Bank Overdraft X
Capital & Liabilities X
 Absorption Costing Income Statement

Sales x
Cost of Sales
Opening Stock x
X
Cost of Production
X
Closing Stock (x)
Cost of Sales (x)
Gross Profit x
Over / (Under) Absorbed X / (X)

Other Cost
Variable Sales Overheads x
Variable Admin Overheads x
Fixed Sales Overheads x
Fixed Admin Overheads x (x)

Net Profit xx

250
 Marginal Costing Income Statement

Sales x
Cost of Sales
Opening Stock x
X
Variable Cost of Production
X
Closing Stock (x)
Variable Cost of Sales X
Variable Selling X
Variable Admin X
Total Variable Cost (x)
Contribution x

Period Cost (Fixed) X

Fixed Production Overhead X
Fixed Selling Overhead X
Fixed Admin Overhead x x

Net Profit xx

251