Paper P7 – Financial Accounting and Tax Principles

Post Exam Guide

May 2005 Exam

General Comments

This first paper of the new syllabus applied the new question paper format for the first time. The
overall result was generally very pleasing with a good standard of answer being produced by many
candidates. The overall average mark and pass rate were slightly above expectations. There was
evidence of a number of well-prepared candidates with a wide range of knowledge, able to tackle
most of the sub-questions in questions one and two and prepare good answers to one of the optional
questions. There were, however, still candidates who struggled to gain a quarter of the marks.

Time allocation seemed to be a problem for some candidates, with evidence of rushed answers to
either question one or question two. Some candidates may have used more time on the optional
question and not spent sufficient time on the shorter sub-questions. This was evidenced by the lack
of workings and questions requiring some calculation being left out to save time. Question one is 50
marks and should be given approximately 50% of the time.

Question one was generally well done, but no one scored full marks. Most candidates provided
workings for the three and four mark questions, but a number did not. If workings are not given, no
marks can be awarded for wrong answers using the correct principle.

Question two included one question from each of sections A and B of the syllabus and two questions
from each of sections C and D. Question two will continue to include questions from all sections of
the syllabus. This question was generally not as well done as the other questions on the paper,
although a few candidates did achieve full marks. Some candidates were obviously ill-prepared for
deferred tax, long-term contracts and finance leases and many did not know what the five elements of
financial statements were.

Question three required the preparation of an income statement and balance sheet with some
adjustments. This question was expected by candidates and most of those attempting this question
were well prepared, resulting in good marks being achieved.

Question four required the preparation of a cash flow statement in accordance with IAS 7. This
question was very well done by those attempting this question with some excellent answers and a
number of candidates scoring full marks.

The following guide provides guidance to candidates preparing for future examinations and has been
prepared with that in mind. It therefore may give the impression that there were few good marks and
few passes as all the main errors have been listed for each question. It must be remembered though
that not all candidates made the errors listed and that overall there was a good result for this paper.

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

SECTION A – 50 MARKS
Question One

Question 1.1

The term GAAP is used to mean

A Generally accepted accounting procedures

B General accounting and audit practice
C Generally agreed accounting practice
D Generally accepted accounting practice
(2 marks)

The answer is D

Question 1.2

The effective incidence of a tax is

A the date the tax is actually paid

B the person or entity that finally bears the cost of the tax
C the date the tax assessment is issued
D the person or entity receiving the tax assessment
(2 marks)

The answer is B

Question 1.3

IAS 32 Financial Instruments – Disclosure and Presentation classifies issued shares as either equity
instruments or financial liabilities. An entity has the following categories of funding on its balance
sheet:

(i) A preference share that is redeemable for cash at a 10% premium on 30 May 2015.
(ii) An ordinary share which is not redeemable and has no restrictions on receiving dividends.
(iii) A loan note that is redeemable at par in 2020.
(iv) A cumulative preference share that is entitled to receive a dividend of 7% a year.

As an equity instrument As a financial liability

A (i) and (ii) (iii) and (iv)
B (ii) and (iii) (i) and (iv)
C (ii) (i), (iii) and (iv)
D (i), (ii) and (iii) (iv)
(2 marks)

The answer is C

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Question 1.4

List FOUR forms of short-term finance generally available to small entities.

(4 marks)

The answer is

Trade credit
Bank overdraft
Term loan
Factoring

Any other relevant sources, such as hire purchase or leasing were acceptable alternatives.

Question 1.5

In no more than 15 words, define the meaning of “competent jurisdiction”.

(2 marks)

The answer is

The competent jurisdiction is the country whose tax laws apply to the entity.

Question 1.6

Which ONE of the following is responsible for governance and fundraising in relation to the
development of International Accounting Standards?

A International Accounting Standards Board

B International Financial Reporting Interpretations Committee
C International Accounting Standards Committee Foundation Trustees
D Standards Advisory Council
(2 marks)

The answer is C

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 Paper P7 – Financial Accounting and Tax Principles
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Question 1.7

An entity is preparing a segmental analysis in accordance with IAS 14 Segment Reporting. The
directors have elected to disclose business segments as the primary reporting format, but are unsure
which of the following items need disclosure.

(i) external revenue

(ii) cost of sales
(iii) capital employed
(iv) segment profit

Which TWO of the above require separate disclosure under IAS 14 in respect of segments reported as
primary segments?

A (i) and (ii) only.

B (i) and (iv) only.
C (i) and (iii) only.
D (iii) and (iv) only.
(2 marks)

The answer is B

Question 1.8

A bond with a coupon rate of 7% is redeemable in 8 years’ time for $100. Its current purchase price is
$82. What is the percentage yield to maturity?
(4 marks)

The answer is 10⋅5%

Workings

Using cumulative present value table and present value table. Calculate cumulative present value of
annual interest received and add on the present value of the $100 receivable in 8 years time. Use t=8
and assume an interest rate. Calculate with the first rate (10% in answer below), check how close this
is to the cost of $82 and select a second interest rate that will give an answer the other side of the
cost $82. A rate of 10% gives $84⋅045 so a higher rate is required, using 12% the answer is $75⋅176,
by interpolation we can then calculate the approximate rate of 10.5%.

t = 8; r = 10
(7 x 5⋅335) + (100 x 0⋅467) = 37⋅345 + 46⋅7 = $84⋅045

t = 8; r = 12
(7 x 4⋅968) + (100 x 0⋅404) = 34⋅776 + 40⋅4 = $75⋅176

By interpolation:
10% + (((84⋅045 - 82⋅0)/(84⋅045 - 75⋅176)) x 2) =
10% + (2⋅045/8⋅869 x 2) =
10% + 0⋅461 = 10⋅461% ≈ 10⋅5%

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Question 1.9

AC made the following payments during the year ended 30 April 2005:

$000
Operating costs (excluding depreciation) 23
Finance costs 4
Capital repayment of loans 10
Payments for the purchase of new computer equipment for use in AC’s
business 20

AC’s revenue for the period was $45,000 and the corporate income tax rate applicable to AC’s
profits was 25%. The computer equipment qualifies for tax allowances of 10% per year on a straight
line basis. Calculate AC’s tax payable for the year ended 30 April 2005.
(3 marks)

The answer is $4,000

Workings

$000 $000
Revenue 45
Operating costs 23
Finance costs 4
Tax allowances - computer 2 29
16
Tax @ 25% 4

Question 1.10

Financial statements prepared using International Standards and the International Accounting
Standards Board’s (IASB) Framework for the Preparation and Presentation of Financial Statements
(Framework) are presumed to apply two of the following four underlying assumptions:

(i) Relevance
(ii) Going concern
(iii) Prudence
(iv) Accruals

Which TWO of the above are underlying assumptions according to the IASB’s Framework?

A (i) and (ii) only.

B (ii) and (iii) only.
C (iii) and (iv) only.
D (ii) and (iv) only.
(2 marks)

The answer is D

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 Paper P7 – Financial Accounting and Tax Principles
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Question 1.11

Which ONE of the following would be treated as a non-adjusting event after the balance sheet date,
as required by IAS 10 Events after the Balance Sheet Date, in the financial statements of AN for the
period ended 31 January 2005? The financial statements were approved for publication on 15 May
2005.

A Notice was received on 31 March 2005 that a major customer of AN had ceased trading and
was unlikely to make any further payments.

B Inventory items at 31 January 2005, original cost $30,000, were sold in April 2005 for
$20,000.

C During 2004, a customer commenced legal action against AN. At 31 January 2005, legal
advisers were of the opinion that AN would lose the case, so AN created a provision of
$200,000 for the damages claimed by the customer. On 27 April 2005, the court awarded
damages of $250,000 to the customer.

D There was a fire on 2 May 2005 in AN’s main warehouse which destroyed 50% of AN’s total
inventory.
(2 marks)

The answer is D

Question 1.12

AL’s customers all pay their accounts at the end of 30 days. To try and improve its cash flow, AL is
considering offering all customers a 1⋅5% discount for payment within 14 days.

Calculate the implied annual (interest) cost to AL of offering the discount, using compound interest
methodology and assuming a 365 day year.
(3 marks)

The answer is 40⋅4%

Workings for 1.12

AL offers 1⋅5% interest for 16 days

(100/98⋅5) (365/16) - 1 =
(1⋅015) 22⋅813 - 1 = 40⋅4%

An alternative approach is to use the compound interest formula and then convert the answer to an
annualised rate.

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Question 1.13

List the THREE criteria set out in IAS 37 Provisions, Contingent Liabilities and Contingent Assets for
the recognition of a provision.
(3 marks)

The answer is
An entity has a present obligation as a result of a past event.
It is probable that an outflow of resources will be required to settle the obligation.
A reliable estimate can be made of the amount.

Question 1.14

AE purchases products from a foreign entity and imports them into a country A. On import, the
products are subject to an excise duty of $5 per item and Value Added Tax (VAT) of 15% on cost plus
excise duty.

AE purchased 200 items for $30 each and after importing them sold all of the items for $50 each plus
VAT at 15%.

How much is due to be paid to the tax authorities for these transactions?

A $450
B $1,450
C $2,050
D $2,500
(3 marks)

The answer is B

Workings for 1.14

$
Sales 200 x $50 = 10,000
VAT on sales @ 15% 1,500
Less: VAT paid on import 200 x $35 x 15% = 1,050
VAT Due 450
Excise duty due 200 x $5 = 1,000
Total to be paid to tax authorities 1,450

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Question 1.15

The economic order quantity formula includes the cost of placing an order. However, the Management
Accountant is unsure which of the following items should be included in “cost of placing an order”:

(i) Administrative costs

(ii) Postage
(iii) Quality control cost
(iv) Unit cost of products
(v) Storekeeper’s salary

Which THREE of the above would usually be regarded as part of the cost of placing an order?

A (i), (ii) and (iii) only.

B (i), (iv) and (v) only.
C (ii), (iii) and (iv) only.
D (i), (ii) and (v) only.
(2 marks)

The answer is A

Question 1.16

An item of plant and equipment was purchased on 1 April 2001 for $100,000. At the date of
acquisition its expected useful economic life was 10 years. Depreciation was provided on a straight
line basis, with no residual value.

On 1 April 2003, the asset was revalued to $95,000. On 1 April 2004, the useful life of the asset
was reviewed and the remaining useful economic life was reduced to 5 years, a total useful life of 8
years.

Calculate the amounts that would be included in the balance sheet for the asset cost/valuation and
provision for accumulated depreciation at 31 March 2005.
(4 marks)

The answer is:

Balance Sheet at 31 March 2005 $
Non-current assets – plant and equipment at valuation 95,000
Accumulated depreciation (28,500)
Net book value 66,500
Or
Alternative treatment allowed by IAS 16:
Balance Sheet at 31 March 2005 $
Non-current assets – plant and equipment at valuation 115,000
Accumulated depreciation (48,500)
Net book value 66,500

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Workings
$
Cost 100,000
Two years’ depreciation at 10% 20,000
80,000
Revaluation 15,000
95,000
Depreciation at 12⋅5% 11,875
83,125
Depreciation at 20% 16,625
Net book value 66,500

Question 1.17

AP has the following two legal claims outstanding:

• A legal action claiming compensation of $500,000 filed against AP in March 2004.

• A legal action taken by AP against a third party, claiming damages of $200,000 was started in
January 2003 and is nearing completion.

In both cases, it is more likely than not that the amount claimed will have to be paid.

How should AP report these legal actions in its financial statements for the year ended 31 March
2005?

Legal action against AP Legal action by AP

A Disclose by a note No disclosure
B Make a provision No disclosure
C Make a provision Disclose as a note
D Make a provision Accrue the income
(2 marks)

The answer is C

Question 1.18

Which ONE of the following powers is a tax authority least likely to have granted to them?

A Power of arrest.
B Power to examine records.
C Power of entry and search.
D Power to give information to other countries’ tax authorities.
(2 marks)

The answer is A

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Question 1.19

IAS 16 Property, Plant and Equipment provides definitions of terms relevant to non-current assets.
Complete the following sentence, in no more than 10 words.

“Depreciable amount is…”

(2 marks)

The answer is “the asset’s cost or valuation less its residual value.”

Question 1.20

The OECD model tax convention defines a permanent establishment to include a number of different
types of establishments:

(i) A place of management

(ii) A warehouse
(iii) A workshop
(iv) A quarry
(v) A building site that was used for 9 months

Which of the above are included in the OECD’s list of permanent establishments?

A (i), (ii) and (iii) only.

B (i), (iii) and (iv) only.
C (ii), (iii) and (iv) only.
D (iii), (iv) and (v) only.
(2 marks)

The answer is B

Examiner’s Comments
Most candidates set out their answers in an easily readable format, but some candidates made it
difficult to mark by not distinguishing their answer clearly from their workings. Most candidates
included workings for the three and four mark questions, but a sizable minority omitted all workings.
Without workings, answers marked as correct are given full marks, answers marked as wrong are
given zero marks.

Common Errors
This section applies to the questions that required candidates to provide an answer and excludes the
multiple choice questions.

1.4 Some candidates could not tell the difference between short- and long-term financing methods.
There were also a number of candidates who included investment methods.
1.5 Most candidates omitted to state the relevance to the entity.
1.8 Very few candidates had any idea how to calculate the yield to maturity. This is an important
concept that will be required in later CIMA papers.
1.9 Many candidates incorrectly included capital repayment of loans and/or the payment for the
new equipment in the taxable profit.
1.13 Most candidates were able to give an answer, but few scored full marks as some key points
were missed out.

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1.14 Most candidates scored part of the marks on this question as their workings showed partially
correct answers
1.16 The asset revaluation caused some problems. Some candidates charged three years
depreciation before revaluing and many did not recalculate depreciation correctly after the
revaluation. The change in the useful life caused problems for many candidates.
1.19 IAS 16 gives a clear definition of “depreciable amount”, but very few candidates were able to
give a correct definition of this basic concept.

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

SECTION B – 30 MARKS
ANSWER ALL SIX SUB-QUESTIONS

Question Two (a)

AB acquired non-current assets on 1 April 2003 costing $250,000. The assets qualified for
accelerated first year tax allowance at the rate of 50% for the first year. The second and subsequent
years were at a tax depreciation rate of 25% per year on the reducing balance method.

AB depreciates all non-current assets at 20% a year on the straight line basis.

The rate of corporate income tax applying to AB for 2003/04 and 2004/05 was 30%. Assume AB has
no other qualifying non-current assets.

Required:
Apply IAS 12 Income Taxes and calculate:

(i) the deferred tax balance required at 31 March 2004;

(ii) the deferred tax balance required at 31 March 2005;
(iii) the charge to the income statement for the year ended 31 March 2005.
(Total for requirement (a) = 5 marks)

The answer is:

Balance sheet at 31 March 2004
Deferred tax $22,500
Balance sheet at 31 March 2005
Deferred tax $16,875
Income statement for the year ended 31 March 2005
Income tax expense – reduction in deferred tax $5,625 credit

Workings

Tax depreciation $
Purchase cost 1 April 2003 250,000
First year allowance at 50% 125,000
125,000
Tax depreciation second year at 25% 31,250
Tax written down value 93,750

Accounting depreciation $
Purchase cost 1 April 2003 250,000
Straight line depreciation at 20% 50,000
200,000
Straight line depreciation at 20% 50,000
Accounting book value 150,000

Deferred tax provision: at 31 March 2004 at 31 March 2005

$ $
Accounting book value 200,000 150,000
Tax written down value 125,000 93,750
75,000 56,250
Tax at 30% = 22,500 16,875
Change in deferred tax = 22,500 - 16,875 = 5,625

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Rationale

To test candidates’ ability to calculate current and deferred taxation under the accounting rules in IAS
12 Income Taxes.

Suggested Approach

• Calculate tax written down value at the end of each year.

• Calculate the accounting book value at the end of each year.
• Deduct the tax written down value from the accounting book value and multiply by the tax rate to
give deferred tax balance at each year end. The difference between the two year ends is a
credit to the income statement as there has been a reduction in the deferred tax provision.

Marking Guide Marks

Calculation of deferred tax provision for 2004 2

Calculation of deferred tax provision for 2005 2
Calculation of income tax credit 1

Examiner’s Comments

If the IAS 12 approach was followed, this should have been a straight forward question. However very
few candidates provided a fully correct answer.

Common Errors
Some candidates demonstrated very little knowledge of deferred taxation and gave an answer based
purely on the tax depreciation figures. Of those candidates demonstrating some knowledge of
deferred taxation the most common errors were:
• Calculating figures for three years, 2003 to 2005 instead of two 12 month periods April 2003 to
March 2005. The answer was then given based on the second and third years, which gives the
wrong answer, even when the calculations are correct.
• Calculating the second year based on the change in the year rather then the change in the
balance at the year end. This is an acceptable method as long as the change is identified as
the income statement figure and the balance calculated by adjusting the previous year’s
balance by the income statement figure. Most candidates using this method however reversed
the answer and called the change in the year the balance on the provision and identified the
balance as the income statement figure.
• Many candidates correctly calculated the year end balances for accounting and tax but did not
multiply their answers by the tax rate to calculate the tax liability.
• Some candidates with correct answers failed to gain full marks as they called the income
statement amount a charge or expense and failed to identify it as a credit.

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 Paper P7 – Financial Accounting and Tax Principles
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Question Two (b)

AD, a manufacturing entity, has the following balances at 30 April 2005:

Extract from financial statements: $000

Trade receivables 216
Trade payables 97

Revenue (all credit sales) 992

Cost of sales 898
Purchases in year 641

Inventories at 30 April 2005:

Raw materials 111
Work in progress 63
Finished goods 102

Required:
Calculate AD’s Working Capital Cycle.
(Total for requirement (b) = 5 marks)

The answer is:

AD’s working capital cycle can be expressed as:

Raw materials inventory less payables days plus production time plus finished goods inventory plus
receivables days.
63⋅2 + 25⋅6 + 41⋅4 + 79⋅5 - 55⋅2 = 154⋅5 days

Workings

Days
Raw materials inventory raw materials inventory 111/641* 365 = 63⋅2
purchases

Payables days payables 97/641 * 365 = (55⋅2)

purchases
Production time work in progress 63/898 * 365 = 25⋅6
cost of sales
Finished goods inventory finished goods inventory 102/898 * 365 = 41⋅4
cost of sales

Receivables days Trade receivables 216/992 * 365 = 79⋅5

credit sales
Working capital cycle – days 154⋅5

Rationale

To test candidates’ ability to calculate and interpret working capital ratios for business sectors.

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Suggested Approach

• Calculate individual ratios for each type of inventory, payables and receivables.
• Add together the inventory days and receivables days and deduct payables days.

Marking Guide Marks

Calculation of raw materials inventory days 1

Calculation of payables days 1
Calculation of production time – WIP days 1
Calculation of finished goods inventory days 1
Calculation of receivables days 1

Examiner’s Comments

Most candidates did well on this sub-question, many gaining full marks.

Common Errors
• The most common error was not identifying that each type of inventory needs to be treated
separately, as raw materials are related to purchases whereas work in progress and finished
goods are related to cost of sales.
• Some candidates failed to include all types of inventory in their calculations whilst many
candidates grouped all inventory together.
• A few candidates did not deduct payables.

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 Paper P7 – Financial Accounting and Tax Principles
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May 2005 Exam

Question Two(c)

List the FIVE elements of financial statements defined in the IASB’s Framework and explain the
meaning of each.
(Total for requirement (c) = 5 marks)

Answer

According to the IASB’s Framework, the FIVE elements of financial statements are:

Asset An asset is a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity;
Liability A liability is a present obligation of the entity arising from past events, the settlement of
which is expected to result in an outflow of resources from the entity;
Equity The residual interest in the assets of the entity after deducting all its liabilities;
Income Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity,
other than those relating to combinations from equity participants;
Expenses Decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets that result in decreases in equity, other than those relating to
distributions to equity participants.

Rationale

To test candidates’ ability to explain the IASB’s Framework for the Presentation and Preparation of
Financial Statements.

Suggested Approach

• List the five elements and then explain each in turn.

• The exact words of the Framework do not need to be quoted, as long as the correct meaning
is conveyed.

Marking Guide Marks

Explain asset 1
Explain liability 1
Explain equity 1
Explain income 1
Explain expenditure 1

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Examiner’s Comments

The Framework is quite specific as to what the five elements are. Candidates either scored well on
this sub-question or they scored zero as they did not know what the elements were.

Common Errors
A high proportion of candidates did not answer the question correctly as they failed to identify the
meaning given by the Framework to the elements of financial statements. Those not identifying the
elements gave completely wrong answers and scored no marks. The incorrect interpretations
included:

• The topics covered by the Framework

• The objectives of financial statements, including the financial statements themselves
• The underlying assumptions
• The qualitative characteristics

Of the candidates correctly identifying the five elements, the most common error causing loss of
marks was giving insufficient detail or defining an element without any reference to the Framework’s
approach, for example saying income was as a result of sales or equity was share capital.

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 Paper P7 – Financial Accounting and Tax Principles
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Question Two(d)

AE has a three year contract which commenced on 1 April 2004. At 31 March 2005, AE had the
following balances in its ledger relating to the contract:

$000 $000
Total contract value 60,000
Cost incurred up to 31 March 2005:
Attributable to work completed 21,000
Inventory purchased for use in 2005/6 3,000 24,000
Progress payments received 25,000

Other information:
Expected further costs to completion 19,000

At 31 March 2005, the contract was certified as 50% complete.

Required:
Prepare the income statement and balance sheet extracts showing the balances relating to this
contract, as required by IAS 11 Long Term Contracts.
(Total for requirement (d) = 5 marks)

The answer is:

Income statement for the year to 31 March 2005 – extract
$000
Revenue from long-term contract 30,000
Cost of sales 21,500
Profit 8,500

Balance sheet as at 31 March 2005 – extract $000

Receivables
Long-term contract – gross amounts due from customers 7,500

Workings

Overall profitability check: $000 $000

Revenue 60,000
Costs incurred to 31 March 2005 24,000
Costs to completion 19,000
43,000
Profit 17,000

Income statement:
Contract 50% complete therefore recognise 50% profit 8,500
Revenue recognised 50% of contract value 60,000/2 30,000

Balance sheet:
Total contract costs incurred 24,000
Recognised profit 8,500
32,500
Less: Progress payments received 25,000
Gross amount due from customers 7,500

Note: Alternative approaches to calculations are acceptable.

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Rationale

To test candidates’ ability to prepare financial statements reporting on performance, tangible non-
current assets and inventories. Explain the principles of the accounting rules contained in IASs
dealing with construction contracts.

Suggested Approach

• First check the overall profitability of the contract.

• The contract is stated as being 50% complete. Therefore recognise 50% of total profit, 50% of
turnover and 50% of total cost in the income statement.
• Calculate the balance sheet figures for the gross amount due from customers as the difference
between the income statement amounts recognised and the amounts paid or received to date.

Marking Guide Marks

Calculate profit 1
Calculate the income statement figures 2
Calculate gross amounts due on balance sheet 2

Examiner’s Comments

Few candidates were able to produce a correct answer.

Common Errors
• Not calculating overall profitability of the contract. Without this it is difficult to get any of the
other figures correct, except the revenue figure.
• Leaving the work in progress inventory out of total cost and profit calculations
• Showing inventory separately on the balance sheet, instead of including it under the heading
“gross amounts due from customers” as required by IAS 11.

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 Paper P7 – Financial Accounting and Tax Principles
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Question Two(e)

AM is a trading entity operating in a country where there is no sales tax. Purchases are on credit, with
70% paid in the month following the date of purchase and 30% paid in the month after that.

Sales are partly on credit and partly for cash. Customers who receive credit are given 30 days to pay.
On average 60% pay within 30 days, 30% pay between 30 and 60 days and 5% pay between 60 and
90 days. The balance is written off as irrecoverable. Other overheads, including salaries, are paid
within the month incurred.

AM plans to purchase new equipment at the end of June 2005, the expected cost of which is
$250,000. The equipment will be purchased on 30 days credit, payable at the end of July.

The cash balance on 1 May 2005 is $96,000.

The actual/budgeted balances for the six months to July 2005 were:

All figures $000 Actual Budgeted

Feb Mar Apr May Jun Jul
Credit sales 100 100 110 110 120 120
Cash sales 30 30 35 35 40 40
Credit purchases 45 50 50 55 55 60
Other overhead 40 40 40 50 50 50
expense

Required:
Prepare a monthly cash budget for the period May to July 2005 and assess the likelihood of AM
being able to pay for the equipment when it falls due. (Round all figures to the nearest $000)
(Total for requirement (e) = 5 marks)

Answer

Cash budget for the three month period May to July 2005:

May June July

$000 $000 $000
Cash receipts
Cash sales 35 40 40
Credit sales receipts (W1) 101 104 111
Total receipts 136 144 151
Credit purchase payments (W2) 50 54 55
Expenses paid 50 50 50
Equipment purchase paid 250
Total payments 100 104 355
Net cash movement in month 36 40 (204)
Balance b/fwd 96 132 172
Balance c/fwd 132 172 (32)

AM will not be able to pay for the equipment on time unless further finance is arranged.

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

Workings

(W1) Credit sales – receipts:

Total May June July
$000 $000 $000 $000
February sales 100 5
March sales 100 30 5
April sales 110 66 33 6
May sales 110 66 33
June sales 120 72
Totals 101 104 111

(W2) Credit purchases – payments

Total May June July

$000 $000 $000 $000
March 50 15
April 50 35 15
May 55 39 16
June 55 39
Totals 50 54 55

Rationale

To test candidates’ ability to prepare and analyse cash-flow forecasts over a three-month period.

Suggested Approach

• Apply the information provided on credit sales and calculate cash receipts from receivables.
• Apply the information provided on credit purchases and calculate cash paid to payables.
• Prepare a three month cash budget including cash receipts from receivables and cash sales
and cash paid to payables and expenses.
• Prepare a short conclusion identifying whether the non-current asset purchase is possible or
not.

Marking Guide Marks

Calculate credit sales receipts 1½

Calculate credit purchase payments 1
Prepare a cash budget, including cash receipts and payments 2
Advise whether entity will be able to pay for the equipment when it is due ½

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

Examiner’s Comments

Some candidates misinterpreted receipts from credit customers being given 30 days to pay as
meaning they paid within the month of sale instead of in the next month. A significant number of
candidates failed to assess the likelihood of being able to pay for equipment.

Common Errors
• Treating receipts from credit sales as received in the month of sale.
• Treating purchases on credit as being paid in month of purchase.
• Including bad debts as a cash flow.
• Not giving a conclusion.

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

Question Two(f)

A five year finance lease commenced on 1 April 2003. The annual payments are $30,000 in arrears.
The fair value of the asset at 1 April 2003 was $116,000. Use the sum of digits method for interest
allocations and assume that the asset has no residual value at the end of the lease term.

Required:

In accordance with IAS 17 Operating and Finance Leases:

(i) calculate the amount of finance cost that would be charged to the income statement for
the year ended 31 March 2005;
(ii) prepare balance sheet extracts for the lease at 31 March 2005.

(Total for requirement (f) = 5 marks)

The answer is:

Finance charge for year ended 31 March 2005 is the second year of the lease.
The finance charge to the income statement for the year ended 31 March 2005 is $9,067

Balance sheet as at 31 March 2005 – extract

Non-current assets – Tangible $
Finance lease 116,000
Less: Depreciation (116,000/5 x 2) 46,400
69,600

Non-current liabilities
Amounts due under finance lease $53,200

Current liabilities
Amounts due under finance lease $23,200
(76,400 - 53,200)

Workings
$
Total payments under the lease ($30,000 x 5) 150,000
Fair value of the asset 116,000
Finance cost 34,000

Five periods gives sum of digits (5 x (5 + 1))/2 = 15

Year Proportion Allocation (proportion x $34,000)

$
2003/04 5/15 11,333
2004/05 4/15 9,067
2005/06 3/15 6,800
2006/07 2/15 4,533
2007/08 1/15 2,267

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

Year Balance Finance Repayment Balance c/fwd

b/fwd charge
$ $ $ $
2003/04 116,000 11,333 (30,000) 97,333
2004/05 97,333 9,067 (30,000) 76,400
2005/06 76,400 6,800 (30,000) 53,200
2006/07 53,200 4,533 (30,000) 27,733
2007/08 27,733 2,267 (30,000) 0

Rationale

To test candidates’ ability to explain the principles of the accounting rules contained in IAS’s dealing
with leases (lessee only).

Suggested Approach

• Calculate the finance cost by taking the fair value of the asset away from the total payments
due. Calculate the sum of digits and multiply the finance cost with the appropriate proportion
allocating the finance cost to each year. Calculate the balance outstanding at the end of years
two and three.
• Prepare the income statement and balance sheet extracts required by the question.

Marking Guide Marks

Calculation of finance cost and allocation to years 2

Calculation of finance charge to income statement 1
Calculation of non-current assets – tangible (balance sheet) 1
Calculation of liabilities and split between non-current and current liabilities 1

Examiner’s Comments

Most candidates were able to calculate the finance cost and apportion it to each period. Most were
also able to calculate the outstanding balances at each year end. However many candidates were
unable to use the correctly calculated figures and produce correct income statement and balance
sheet extracts.

Common Errors
• Calculating the sum of digits for 4 years instead of 5 years.
• Applying the proportions using 1 in the first year and two in the second year etc.
• Giving income statement finance charge as the charge for year three.
• Giving the income statement charge as the annual repayment figure.
• Applying the sum of digits to the annual repayment instead of the finance charge.
• Not giving any non-current asset figures on the balance sheet extract.
• Using wrong years to calculate the liabilities.
• Not splitting the liability between non-current and current.

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

SECTION C – 20 MARKS
ANSWER ONE QUESTION ONLY

Question Three

Prepare the income statement for AF for the year to 31 March 2005 and a balance sheet at that
date, in a form suitable for presentation to the shareholders and in accordance with the
requirements of International Financial Reporting Standards.

Notes to the financial statements are NOT required, but all workings must be clearly shown. DO NOT
prepare a statement of accounting policies or a statement of changes in equity.

(Total for Question Three = 20 marks)

Rationale

To test candidates’ ability to prepare financial statements in a form suitable for publication, with
appropriate notes. To apply the accounting rules contained in IAS 12 for current and deferred
taxation.

Suggested Approach

• Using the additional information provided and the trial balance figures, prepare workings to:
1. Calculate depreciation of buildings and plant and equipment for the year and cumulative.
2. Calculate the operating lease charge to income statement.
3. Calculate the cost of sales.
4. Calculate tax charge and outstanding balances.
• Prepare the income statement using IAS 1 format.
• Prepare workings to calculate the balances on reserves and retained earnings.
• Prepare the balance sheet using IAS 1 format.

Marking Guide Marks

Preparation of Income Statement using correct format 7

Preparation of Balance Sheet using correct format 11
Marks available for format and correct headings 2

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

Examiner’s Comments

This question was generally very well done by candidates, many obtaining near full marks. Very few
gained full marks as very few candidates could apply IAS 17 Operating and finance leases correctly to
the operating lease.

Common Errors
• Stating that as there was no payment for the lease there was no charge in the income
statement.
• Treating the operating lease as a finance lease, putting the total liability on the balance sheet
and in a few cases also capitalising the asset and including it under non-current assets.
• Including the available for sale investments under current assets.
• Not accruing interest due on the loan notes.
• Incorrectly deducting deferred tax from income tax charge for the year.
• Incorrectly applying the reducing balance method to the plant and equipment.
• Deducting dividends from revaluation reserve.
• Including deferred tax as a current asset.
• Including depreciation as part of administration or distribution expenses when the question
specified cost of sales.
• Including dividends paid as a current liability.

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 Paper P7 – Financial Accounting and Tax Principles
Post Exam Guide
May 2005 Exam

Question Four

Prepare a cash flow statement, using the indirect method, for AG for the year ended 31 March
2005, in accordance with IAS 7 Cash Flow Statements.

(Total for Question Four = 20 marks)

Rationale

To test candidates’ ability to prepare a cash flow statement in accordance with IAS 7. Apply the
accounting rules contained in IAS 12 for current and deferred taxation.

Suggested Approach

• Use workings to calculate the cash flows for accrued expenditure, interest, income taxes,
purchase of property, plant and equipment, development expenditure and issue of shares.
• Use the IAS 7 format to prepare a cash flow statement using the indirect method.

Marking Guide Marks

Cash Flow Statement – Calculation of cash flows from operating activities 9½

Cash Flow Statement – Calculation of cash flows from investing activities 5½
Cash Flow Statement – Calculation of cash flows from financing activities 2½
Cash and cash equivalents 1
Marks available for format and correct headings 1½

Examiner’s Comments

There were some excellent answers to this question, with a number of candidates gaining full marks.

Common Errors
• Not using the correct IAS 7 format, for example:
o Starting with operating profit instead of profit before tax.
o Putting all items in one long list.
o Putting items under the wrong headings.
o Attempting to use the direct method.
• Mixing up proceeds of sale and gain on disposal.
• Calculating accrued expenses without adjusting for interest balances.
• Calculating tax paid without adjusting for deferred tax.
• Missing out depreciation and/or revaluation when calculating cash paid for non-current assets.

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