NOTES

Answer Question 1
and three of the remaining four Questions.
Note: Students have optional use of the Extended Trial
Balance, which if used, must be included in the answer booklet.
PRO-FORMA INCOME STATEMENT BY NATURE, INCOME STATEMENT BY FUNCTION
AND BALANCE SHEET ARE PROVIDED
TIME ALLOWED:
3.5 hours, plus 10 minutes to read the paper.
INSTRUCTIONS:
During the reading time you may write notes on the examination paper but you may not commence
writing in your answer book.
Marks for each question are shown. The pass mark required is 50% in total over the whole paper.
Start your answer to each question on a new page.
You are reminded that candidates are expected to pay particular attention to their communication skills
and care must be taken regarding the format and literacy of the solutions. The marking system will take
into account the content of the candidates' answers and the extent to which answers are supported with
relevant legislation, case law or examples where appropriate.
List on the cover of each answer booklet, in the space provided, the number of each question(s)
attempted.
ACCOUNTING FRAMEWORK
FORMATION 2 EXAMINATION - AUGUST 2007
The Institute of Certified Public Accountants in Ireland, 9 Ely Place, Dublin 2.
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND
ACCOUNTING FRAMEWORK
FORMATION 2 EXAMINATION - AUGUST 2007
Time allowed: 3.5 hours plus 10 minutes to read the paper Answer Question 1 and three
of the remaining four Questions.
Note: Students have optional use of the Extended Trial
Balance, which if used, must be included in the answer booklet.
1. (a) (i) Outline the differences between shareholders and debenture holders.
(ii) Contrast Preference shares with Ordinary shares.
(iii) List three ways in which reserves may be categorised.
(iv) Explain the difference between provisions and reserves.
(10 marks)
(b) The following trial balance was extracted from the books of Wicklow Enterprises plc. at close of
business on 31 December 2006.
Debit Credit

Buildings 3,150,000
Plant and equipment 2,625,000
Vehicles 560,000
Profit and loss account 991,375
Ordinary shares 25c each 1,400,000
Buildings Depreciation 525,000
Plant & equipment Depreciation 1,137,500
Depreciation of Vehicles 148,750
10% Red. preference share capital 350,000
Share Premium account 175,000
8% Debentures 350,000
Discounts 40,250
Returns 15,225
Inventories 554,750
Purchases 2,373,000
Sales 6,014,750
Trade receivables 320,250
Trade payables 215,600
Returns 13,650
Discounts 56,000
Provision for doubtful debts 9,050
Bad debts 11,750
Bank 30,800
Ordinary dividends 14,000
Preference dividends 17,500
Rent and rates 241,500
Postage and stationery 56,000
Wages and salaries 1,331,500
Carriage out 48,300
11,388,250 11,388,250
Page 1
The following additional information is available:
1. Inventory on hand (per stock take) 31 December 2006: 247,125. This includes:
a) 1,875 for items accidentally destroyed on the 6 January 2007.
b) 4,000, the cost of an item of plant intended for use in the factory. This had been recorded as
a purchase of goods for resale in the books.
c) 750, the cost of a damaged component which will be repaired at a cost of 225 and then sold
for 825.
2. Included in sales is an amount of 11,250 for goods sent on approval to a customer. The mark up on
the goods was 50%.
3. A customer has been declared bankrupt owing 5,000. This is to be written off
4. The provision for doubtful debts should be 4% of trade receivables.
5. The annual charge for rates is 90,000 and these are paid up to 30 September 2006.
6. Included in the sales figure is an amount of 37,500 which was the proceeds from the disposal of a
van purchased in 2003 for 80,000.
7. Depreciation is provided on assets held at balance sheet date as follows:
a) Buildings: 2% on cost
b) Plant and equipment: 20% on cost
c) Vehicles: 25% on written down value
8. It is proposed to pay a final dividend on the ordinary shares of 3.75c per share.
REQUIREMENT:
Prepare, for internal use, Income Statement for the year ending 31 December 2006 and a Balance Sheet
as at that date. Please support all accounting adjustments.
(30 marks)
[Total: 40 marks]
2. Explain, quoting examples, the meaning of recognition and measurement in financial statements.
[Total: 20 marks]
Page 2
3. The treasurer of the Xeros R & R Club has produced the following receipts and payments account for the
year ended 31 December 2006:
Receipts Euro Payments Euro
Balance at bank 1/1/06 1,603 Bar purchases 18,494
Building Society a/c 3,000
Members subscriptions 12,768 Rates 840
Entrance fees 1,120 Staff wages 5,880
Bar takings 22,225 Electricity and water 3,045
Competition receipts 2,884 Competition prizes 1,470
Postage and stationery 2,240
Rent 4,200
Balance at bank, 31/12/06 1,431
40,600 40,600
The assets of the club on 1 January 2006 were furniture and equipment 22,400, Building Society account
(Per Pass Book) 2,800, prizes 350 and bar stocks 1,260. Bar suppliers were owed 2,030.
On the 31 December 2006 bar suppliers were owed 2,170; bar stocks amounted to 1,225 and prizes on
hand had cost 210; subscriptions unpaid totalled 350.
During the year ended 31 December 2006 subscriptions received included 245 in respect of the previous
year and 140 in respect of the year beginning 1 January 2007.
The barman is to receive a bonus of 5% of the bar profits after deducting the bonus.
Interest on the building society account is credited on 2 January and 2 July each year. On the 2 January
2006 105 was credited; 140 was credited on 2 July 2006 and 175 on 2 January 2007.
Furniture and equipment should be depreciated by 10%.
The rent paid was for the year ending 30 June 2007. The rent for the year ending 30 June 2006 was 3,360.
REQUIREMENT:
(a) A bar trading account for the year ending 31 December 2006; (3 marks)
(b) An income and expenditure account for the year ending 31 December 2006; (8 marks)
(c) A balance sheet as at 31 December 2006; (5 marks)
(d) The club is considering introducing a life membership scheme whereby by paying a lump sum a
member may avail of the facilities for the rest of their life without paying the annual subscription.
Explain how the club should account for these life membership receipts. (4 marks)
[Total: 20 marks]
Page 3
4. Peter O'Toole, a sole trader, does not keep a set of ledgers to record his accounting transactions. Instead
he relied on details of cash receipts and payments, bank statements and files of invoices. He started
business on 1 July 2005 with private capital of 25,000 which comprised a second-hand van valued at
7,500 and cash which he deposited in a business bank account on that date. He has not prepared
accounts since he commenced trading and you have agreed to prepare his first set of accounts for him in
respect of the 18 months ended 31 December 2006.
You have discovered:
(1) A summary of his cash transactions from his cash book for the period was:

Receipts: Capital introduced 17,500
Cash sales receipts 106,250
Sale of van 4,250 128,000
Payments: Cash paid to bank 106,750
Cash purchases 10,800
General expenses 2,370
Motor expenses 4,595 124,515
Cash on hand at 31 December 2006 3,485
(2) A summary of his bank statement shows:
Receipts: Cash paid into bank 105,950
Bank loan 22,500
Credit sales receipts 9,775 138,225
Payments: Purchase of goods 36,575
Office equipment 6,400
Van 20,000
Drawings 27,000
Rent and rates 9,250
Light and heat 4,615 103,840
Balance at 31 December 2006 34,385
(3) The office equipment was purchased on 1 October 2005.
(4) The new van was purchased on 1 April 2006 to replace the original second-hand van which was sold
on the same date.
(5) Peter expects the office equipment to last 5 years but to have no value at the end of its life. The van
bought on 1 April 2006 is expected to be used for 3 years and to be sold for 3,500 at the end of that
time.
(6) The cost of goods unsold on 31 December 2006 was 7,125. Peter thought he would sell these for
12,800, with no item being sold for less than its original cost.
(7) On the 31 December 2006 Peter owed 3,745 for goods bought on credit and was owed 2,155 for
goods sold on credit. Of these amounts 945 was due from/to AB Ltd which is both a customer and
supplier of Peter's. A contra settlement arrangement has been agreed by both Peter and AB Ltd.
(8) Rent and rates paid includes an invoice for 6,000 for the rates due for the year to 31 March 2007.
(9) No invoice was received for light and heat in respect of November and December 2006 until 15
February 2007. This showed that the amount due for three months ended 31 January 2007 was 570.
(10) The bank loan was received on 1 January 2006. Interest is charged at 10% per annum on the amount
outstanding.
REQUIREMENT:
Prepare Peter's income statement for the period ended 31 December 2006 and his balance sheet at that
date.
[Total: 20 marks]
Page 4
5. The outline balance sheets of Carlow Traders were as shown:
Balance Sheets as at 31 December
2005 2006
'000 '000 '000 '000
Fixed assets (at WDV)
Land and buildings 26,000 39,200
Plant and machinery 32,000 64,800
58,000 104,000
Current assets
Inventories 12,480 38,120
Trade receivables 7,880 12,280
Bank and cash 6,240 10,600
26,600 61,000
Current liabilities
Trade payables 9,560 22,320
Corporation tax 4,560 8,340
Declared dividends 6,800 6,800
20,920 37,460
Working capital 5,680 23,540
63,680 127,540
Less 7% Debentures 20,000 40,000
Net assets employed 43,680 87,540
Ordinary share capital 30,000 60,000
Share Premium Account 6,000 20,000
Reserves 7,680 7,540
Shareholders' funds 43,680 87,540
The turnover for the years ended 31 December 2004 and 2006 was 81,160,000 and 196,280,000
respectively, and on the 31 December 2005 reserves were 9,840,000.
REQUIREMENT:
(a) Calculate, for each of the two years, six suitable ratios to highlight the financial stability, liquidity and
profitability of the company.
(10 marks)
(b) State what external funds were raised by Carlow Traders and briefly indicate how they were used.
(6 marks)
(c) Comment on the situation revealed by the figures you have calculated in your answer to (a) and (b)
above.
(4 marks)
[Total: 20 marks]
END OF PAPER
Page 5
ACCOUNTING FRAMEWORK
FORMATION 2 EXAMINATION - AUGUST 2007
SOLUTION 1
(a) (i) Shareholders are the owners of the company whereas debenture holders are lenders to the company.
Shareholders receive dividends which can only be paid out of realised profits. Debenture holders receive
interest which is treated as an expense of the business. Profit is calculated after interest is charged.
Normally debenture holders may appoint a receiver to manage the company on their behalf if the company
fails to pay interest due. Debenture holders may have a charge on specific assets of the company.
(ii) Preference shareholders are normally preferred over 'ordinary' (equity) shareholders firstly in that they
receive their dividends before ordinary shareholders; secondly in the event of a winding up preference
shareholders receive their capital before ordinary shareholders. Preference shareholders dividends are
limited to the stated (coupon) rate, ordinary shareholders have no such limitation.
(iii) Statutory or non statutory
Capital or revenue
Distributable or non distributable
(iv) Provisions are liabilities of uncertain timing or amount. It is the uncertainty that distinguish them from other
liabilities such as trade creditors and accruals. They are charged to the Income Statement. Examples are
provisions for depreciation or bad debts. Reserves are amounts set aside from profits. Examples are the
general reserve, share premium account and the revaluation reserve.
(b)
Wicklow Enterprises plc.
Income statement for the year ended 31 December 2006
Euro Euro Euro
Revenue: Sales 5,966,000
Less returns 13,650
5,952,350
Cost of sales
Inventory 1/1/06 554,750
Purchases 2,373,000
Less: Returns 15,225
Fixed assets 4,000 2,353,775
2,908,525
Less inventory 31/12/06 250,475 2,658,050
3,294,300
Discounts 56,000
Profit on disposal of vehicle 3,750
3,354,050
Buildings Depreciation 63,000
Plant & Equipment Depreciation 525,800
Depreciation of Vehicles 94,375 683,175
Discounts 40,250
Provision for doubtful debts 3,110
Bad debts 16,750
Debenture Interest 28,000
Rent and rates 264,000
Postage and stationery 56,000
Wages and salaries 1,331,500
Carriage out 48,300 2,471,085
Net Profit 882,965
Red. preference dividends 35,000
847,965
Ordinary dividends 14,000
Retained 833,965
Balance b/f 991,375
Balance c/f 1,825,340
Page 6
SUGGESTED SOLUTIONS
Balance Sheet as at 31 December 2006
Euro Euro Euro
Non current assets Cost Deprec.
Buildings 3,150,000 588,000 2,562,000
Plant and equipment 2,629,000 1,663,300 965,700
Vehicles 480,000 196,875 283,125
6,259,000 2,448,175 3,810,825
Current assets
Inventories 250,475
Trade receivables 304,000
Provision for bad debts 12,160 291,840
Bank 30,800 573,115
Total Assets 4,383,940
Equity and Liabilities
Equity
Ordinary shares 25c each 1,400,000
Share Premium account 175,000
Retained earnings 1,825,340
Total equity 3,400,340
Non current liabilities
10% Red. Preference shares 350,000
8% Debentures 350,000
Total non current liabilities 700,000
Current liabilities
Trade payables 215,600
Debenture interest 28,000
Dividends Preference 17,500
Accruals 22,500
Total current liabilities 283,600
Total equity and liabilities 4,383,940
Page 7
SOLUTION 2
The Framework for the preparation and presentation of financial statements issued by the International Board
deals with these issues.
Recognition in financial statements.
Recognition is the process of incorporating in the balance sheet or income statement an item that meets the
definition of an element. 'Recognised' means depicting an item both in words and by a monetary amount and
including that amount in the primary financial statement totals. When the reporting entity undertakes a transaction
or when some other relevant event occurs, the effect of that transaction or event on the elements of financial
statements will need to be recognised in the financial statements if certain criteria are met.
If a transaction or other event has created a new asset or liability or added to an existing asset or liability, that
effect will be recognised if:
G It is probable that any future economic benefit associated with the item will flow to or from the enterprise;
and
G The item's cost or value can be measured with reliability.
Based on these general criteria:
G An asset is recognised in the balance sheet when it is probable that the future economic benefits will flow
to the enterprise and the asset has a cost or value that can be measured reliably.
G A liability is recognised in the balance sheet when it is probable that an outflow of resources embodying
economic benefits will result from the settlement of a present obligation and the amount at which the
settlement will take place can be measured reliably.
Income is recognised in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect,
that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in
liabilities (for example, the net increase in assets arising on a sale of goods or services or the decrease in
liabilities arising from the waiver of a debt payable).
Expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an
increase of a liability has arisen that can be measured reliably. This means, in effect, that recognition of expenses
occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets (for example, the
accrual of employee entitlements or the depreciation of equipment).
In a transaction involving the provision of services or goods for a net gain, the recognition criteria described above
will be met on the occurrence of the critical event in the operating cycle involved.
An asset or liability will be wholly or partly derecognised if:
(a) sufficient evidence exists that a transaction or other past event has eliminated all or part of a previously
recognised asset or liability; or
(b) although the item continues to be an asset or liability, the criteria for recognition are no longer met.
To summarise there are three stages of recognising elements for inclusion in financial statements: initial
recognition, subsequent remeasurement and derecognition.
Measurement in financial statements.
Measurement involves assigning monetary amounts at which the elements of the financial statements are to be
recognised and reported. It entails deciding on the measurement basis to be used and determining the monetary
amount that is appropriate for that basis.
The Framework acknowledges that a variety of measurement bases are used today to different degrees and in
varying combinations in financial statements, including:
Historical cost
Current cost (value)
Net realisable (settlement) value
Present value (discounted)
Page 8
A measurement basis needs to be selected for each category of assets or liabilities. The basis selected will be
the one that best meets the objective of financial statements and the demands of the qualitative characteristics
of financial information, bearing in mind the nature of the assets or liabilities concerned and the circumstances
involved.
Historical cost is the measurement basis most commonly used today, but it is usually combined with other
measurement bases. The Framework does not include concepts or principles for selecting which measurement
basis should be used for particular elements of financial statements or in particular circumstances. The qualitative
characteristics do provide some guidance, however.
An asset or liability being measured using the historical cost basis is recognised initially at transaction cost. An
asset or liability being measured using current value basis is recognised initially at its current value at the time it
was acquired or assumed.
Subsequent remeasurement will occur if it is necessary to ensure that
(a) assets measured at historical cost are carried at the lower of cost and recoverable amount.
(b) Assets and liabilities measured on the current value basis are carried at up to date current values.
Page 9
SOLUTION 3
Bar trading account for the year ended 31 December 2006
Euro
Sales 22,225
Cost of sales
Stock 1/1/06 1,260
Purchases 18,634
19,894
Stock 31/12/06 1,225 18,669
Gross profit 3,556
Bonus 168
Profit 3,388
Xeros R & R Club
Income and expenditure account for the year ended 31 December 2006
Income Euro
Subscriptions 12,733
Building Society Interest 315
Entrance fees 1,120
Surplus on competitions 1,274
Bar profit 3,388
18,830
Expenditure
Rent 3,780
Rates 840
Staff wages 5,880
Electricity & water 3,045
Postage & stationery 2,240
Depreciation 2,240 18,025
Surplus 805
Balance Sheet as at 31 December 2006
Euro Euro
Furniture 20,160
Current assets
Stocks: bar 1,225
prizes 210 1,435
Prepayment: Rent 2,100
Subscriptions in arrears 350
Building society a/c 6,045
Interest due 175
Bank 1,431
31,696
Current liabilities
Bar creditors 2,170
Subscriptions in advance 140
Bonus due to barman 168 2,478
Excess assets 29,218
Accumulated fund: Balance 1/1/2006 28,413
Surplus 2003 805
Balance 31 December 2006 29,218
Building Society account (2,800 + 105 + 140 + 3,000)
Page 10
(d) Life membership receipts should not be treated as income in the income and expenditure account solely in the
year of receipt. It should be credited to a life membership account, and transfers should be made from that
account to the credit of the income and expenditure of an appropriate amount annually. This amount should be
based on how long members are expected to continue to use the club.
The credit balance on the Life membership account should be shown on the balance sheet as a liability.
Page 11
SOLUTION 4
Peter O'Toole
Income statement for the eighteen months ended 31 December 2006.
Euro Euro
Sales 118,180
Cost of sales: Purchases 51,120
Less closing inventory 7,125 43,995
Gross profit 74,185
Expenses
General expenses 2,370
Motor expenses 4,595
Rent and rates 7,750
Light and heat 4,995
Interest on bank loan 2,250
Depreciation
Office equipment 1,600
Van 4,125
Loss on sale of van 3,250 30,935
Net profit 43,250
Balance Sheet as at 31 December 2006.
Euro Euro Euro
Cost Depreciation
Non current assets
Office equipment 6,400 1,600 4,800
Van 20,000 4,125 15,875
26,400 5,725 20,675
Current assets
Inventory 7,125
Receivables / Debtors 1,210
Prepayments 1,500
Cash at bank 35,185
Cash in hand 3,485
48,505
Current liabilities
Payables / Creditors 2,800
Accruals 380
Interest on bank loan 2,250 5,430 43,075
63,750
Financed by
Capital: Opening 25,000
Profit for the period 43,250
Less drawings (27,000)
41,250
Bank loan 22,500 63,750
Page 12
SOLUTION 5
1. Net assets turnover:
2005 81,160
63,680 = 1.27
2006 196,240
127,540 = 1.54
2. Current ratio / working capital ratio
2005 26,600
20,920 = 1.274
2006 61,000
37,460 = 1.628
3. Quick ratio
2005 14,120
20,920 = 0.675
2006 22,880
37,460 = 0.611
4. Debt collection period.
2005 7,880
81,160 = 35.4 days
2006 12,280
196,280 = 22.8 days
5. ROCE
2005 10,600
63,680 = 16.65%
2006 17,800
127,540 = 13.96%
6. Profit before interest and tax / sales
2005 10,600
81,160 = 13.06%
2006 17,800
196,280 = 9.07%
7. Gearing
2005 20,000
43,680 = 45.8%
2006 40,000
87,540 = 45.7%
(b) The company raised 20,000,000 debt by way of 7% debentures and 44,000,000 (30m + 14m) in equity. This
was used, broadly, to acquire premises, plant and equipment and working capital, in particular trading stock. It
should be noted that dividends of 6.8m were paid in 2006 although after tax profits in 2005 were only 4.6m.
The proposed dividend for 2006 at 6.8m is not covered by after tax earnings, which were 6.66m. Perhaps the
directors should reconsider this policy?
(c) The ratios calculated in (a) suggest that the company's trading performance has worsened despite turnover
increasing from 81,160,000 to 196,280,000.
Although the asset turnover ratio has improved, indicating an efficient utilisation of the newly acquired assets
(Ratio 1), the profit figure of earnings before tax and interest on sales shows a decline from 2005 to 2006 (Ratio
6).
The ROCE ratios have been calculated using the profit before interest and tax (Ratio 5) and show that the higher
asset turnover is not sufficient to compensate for the lower margin on sales.
The current ratio (Ratio 2) appears to suggest liquidity has improved, but the quick ratio (which excludes stock)
shows a slight worsening. The debt collection period has significantly decreased. The company is apparently
embarking on an expansion programme. Perhaps to increase market share it has reduced its prices and is also
offering a significant settlement discount, which would explain why the debt collection period has decreased.
The overall gearing has not altered significantly and would appear to be acceptable.
Page 13
Calculation of profits.
2005 2006
'000 '000
Reserves at the end of year 7,680 7,540
Add back:
Dividends 6,800 6,800
Corporation tax 4,560 8,340
Interest 1,400 2,800
0,440 25,480
Less reserves at beginning of the year 9,840 7,680
Profit before interest and tax 10,600 17,800
Page 14
Marking scheme
Question 1
(a) 2.5 marks for each
(b) Notes adjustments 20;
Income statement 5;
Balance sheet 5;
Total 40
Question 2
Marks awarded fairly for following points and clarity
10 Recognition
Definition
Example
Conditions
Income recognition
Derecognition
10 Measurement
Definition
Basis list
Discuss
Remeasurement
Total 20
Question 3
(a) 3
(b) 8
(c) 5
(d) 4
Total 20
Question 3.
14 marks for income statement
6 marks for Balance sheet
Total 20
Question 5
10
6
4
Total 20
Page 15