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Diploma in Financial Management

Time allowed

Reading and planning: 15 minutes

Writing: 3 hours

This paper is divided into three sections:

Section A ALL 20 questions are compulsory and MUST be attempted

Section B THREE questions in total to be attempted

and Candidates MUST attempt ONE question from

Section C Section B, ONE question from Section C and ONE

further question from either Section B or Section C

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may

be annotated. You must NOT write in your answer booklet until

instructed by the supervisor.

This question paper must not be removed from the examination hall. M

oduleA

Paper DA1 Incorporatingsubject areas: Interpretation of Financial

Statements Performance Management

Monday 1 June 2009

The Association of Chartered Certified Accountants

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Section A ALL 20 questions are compulsory and MUST be attempted

Please use the Candidate Registration Sheet provided to indicate your chosen answer to each multiple choice question.

Each question in this section is worth 2 marks.

1 The basic accounting equation states that assets liabilities = capital.

Which of the following is correct?

A if assets increase, capital must also increase

B if capital is reduced, liabilities must have increased

C profit arises when the increase in liabilities exceeds the increase in assets

D a loss arises when the increase in liabilities exceeds the increase in assets

2 In the year to 31 May 2007 Ordov Co recognised an increase of $125,000 in the value of land and buildings. In the

year to 31 May 2008, a further increase of $12,000 was recognised. During the year to 31 May 2009, the land and

buildings suffered an impairment of $30,000.

Based on the above information, what are the changes in value of retained profits and shareholders funds overthe three years?

Retained profits Shareholders funds

A an increase of $107,000 an increase of $107,000

B an increase of $137,000 an increase of $107,000

C an increase of $107,000 no change

D no change an increase of $107,000

3 Silur Co buys and restores items of exclusive vintage jewellery. At 31 May 2009, the company had three items in

inventory. Details of the items were:

$ Necklace Bracelet PendantPurchase cost 12,000 31,000 45,000

Expected selling price 25,000 38,000 53,000

Restoration costs to date 6,000 5,000 2,000

Further costs before sale 2,000 3,000 1,000

What was the total value of Silurs inventory at 31 May 2009?

A $88,000

B $100,000

C $106,000

D $107,000

4 A customer of Pern Co claims that, on 22 March 2009, a fault in a product sold by Pern caused damage to its

production line. The customer is seeking damages of $85,000. Pern has accepted liability and offered to pay

$40,000 to repair the damage. The customer has refused this offer. The matter will be settled in a court case which

is scheduled for July 2010. Perns legal representative has indicated that the court is almost certain to accept the

customers claim for $85,000.

How should this matter be dealt with in Perns financial statements for the year to 30 April 2009?

A as a current liability of $40,000

B as a non-current liability of $40,000

C as a current liability of $85,000

D as a non-current liability of $85,000

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5 On 6 May 2009, there was a fire in a factory owned by Triass Co. The cost of repairing the damage was $125,000.

As the company had insurance cover, the balance of $125,000 was reported as a receivable in the draft financial

statements for the year to 30 April 2009. In May 2009, the insurance company reported that due to non-compliance

with the terms of the insurance contract, only $12,500 would be paid to Triass.

What is the correct treatment of this matter in the financial statements for the year to 30 April 2009?

A only a charge of $112,500 should be reportedB only a receivable for $12,500 should be reported

C both a charge of $112,500 and a receivable for $12,500 should be reported

D only a disclosure note is required

6 Historical cost and current cost are possible measurement bases which could be used when preparing financial

statements.

Which of the following statements is correct?

A Historical cost is the most appropriate basis for inter-company comparisons of performance

B Current cost values are not related to cash valuesC A statement of financial position prepared on the historical cost basis values all assets at the amount of cash paid

D Current cost values will always be higher than historical cost values

7 The Statements of financial position of Jurric Co at 30 April 2008 and 2009 include the following:

2008 2009

$ $

Inventory 164,843 193,885

Payables 87,996 62,887

How should the changes in these values be reflected in the Statement of cash flows for the year to 30 April 2009?

Change in inventory as a . . . Change in payables as a . . .

A cash inflow of $29,042 cash inflow of $25,109

B cash outflow of $29,042 cash outflow of $25,109

C cash inflow of $29,042 cash outflow of $25,109

D cash outflow of $29,042 cash inflow of $25,109

8 Based on the current assets value of $172,793 reported in the draft financial statements of Palene, the companys

current ratio at 31 May 2009 is 134. Since the draft financial statements were prepared, the chief accountant has

calculated that the liability for current tax should be increased from $85,000 to $95,399.

What is the current ratio following the increase in the current tax balance?

A 124

B 126

C 142

D 146

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9 The debt/equity ratio of Cretac Co at 31 May 2009 is higher than the debt/equity ratio at 31 May 2008.

Which of the following would be a reason for the increase?

A a loan due for repayment in 2010 has been replaced by a loan due over the three years to 2012

B the terms of a fixed rate loan have been renegotiated and the interest rate will increase from June 2009

C in February 2009 the company reduced the number of shares in issue by buying back a number of shares

D in March 2009 the shareholders agreed to an increase in the amount the company can borrow to financeexpansion

10 Consider the following statements about the Framework for the Preparation and Presentation of Financial Statements

(the framework):

(i) as it sets out underlying concepts, the framework will not be changed

(ii) the framework is intended to assist users to interpret financial statements

(iii) the framework is an International Accounting Standard

Which of the above statements is/are correct?

A (i) onlyB (ii) only

C (iii) only

D (i) (ii) and (iii)

11 The sales budget of Cambri Co includes the following sales volumes for one of the companys products:

July 150,900 units

August 144,800 units

September 164,800 units

The sales director estimates that 10% of customers will pay in the month of sale, with 70% paying in the followingmonth. The remaining customers will take a further months credit.

All sales will be at $550 per unit, with customers paying in the month of sale obtaining a 10% settlement discount.

What is the budgeted value of cash received from customers in September for sales of this product?

A $758,362

B $749,298

C $805,046

D $814,110

12 Devin Co sells a single product at a selling price of $85. Direct costs are $38 per unit and overheads are $24 perunit. 60% of overheads represent the recovery of fixed costs. Both sales and production are budgeted to be 50,000

units.

How many units are sold at the breakeven point (to the nearest unit)?

A 14,724

B 19,251

C 25,532

D 31,304

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13 The directors of Carifer Co wish to use the maximin decision rule to select which one of four mutually exclusive

projects to accept.

The following payoff table has been calculated in $000:

Demand Low Medium High

Project A 129 155 182

Project B 143 181 188

Project C 115 139 166Project D 138 164 191

Using the maximin decision rule, which project should be selected?

A Project A

B Project B

C Project C

D Project D

14 Which of the following comments about sales pricing is correct?

A market penetration will normally be achieved by a low price on initial entry to the marketB market skimming will lead to a constant price throughout the products life

C cost plus pricing will lead to profit being maximised

D a target cost price will generate profit immediately following market entry

15 Which of the following statements about transfer pricing is correct?

A head office managers should never be involved in transfer pricing decisions

B the market price will always be the most appropriate transfer price

C the transfer price will not affect divisional profits

D the transfer price should promote goal congruence

16 Which of the following statements about divisionalisation is/are correct?

(i) divisionalisation leads to head office managers having reduced control over operational decisions in an operating

unit

(ii) achieving corporate goals will be the only factor considered by divisional managers when they are making

decisions

(iii) divisionalisation allows operating decisions to reflect the local conditions of an operating unit

A (i) and (ii) only

B (ii) and (iii) only

C (i) and (iii) onlyD (i), (ii) and (iii)

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This is a blank page.

Section B begins on page 8.

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Section B Candidates MUST attempt ONE question from Section B, ONE question from Section C and ONE further

question from either Section B or Section C.

1 Adage is an advertising agency which is a limited liability company and is privately owned by the three founding

directors, who each hold 1/3 of the companys shares and oversee the main activities, which are:

(i) artistic development

(ii) campaign production(iii) finance and administration.

The director of artistic development is planning to retire and the remaining directors intend to buy his share of the

business for $1,500,000, funding the purchase with a bank loan for the full purchase price. The directors wish to

secure the loan on the assets of the company.

You are a lending advisor at the bank which the directors have approached for funding. You are due to meet with the

directors to discuss their proposal.

The summary financial statements for the last two years are shown below:

Adage Summarised Income statements for years ended 30 April

2008 2009

$000 $000Revenue 3,255 3,482

Costs:

Production costs 1,275 1,387

Administration expenses 944 1,048

Other expenses 538 636 2,757 3,071

Profit for year 498 411

Adage Summarised Statements of financial position at 30 April2008 2009

$000 $000

Non-current assets 1,463 1,848

Current assets

Receivables 352 462

Prepayments 27 31

Cash 40 21

419 514

Total assets 1,882 2,362

Equity

Share capital ($1 shares) 348 348

Retained profit 1,089 1,500 1,437 1,848

Current liabilities

Payables 430 497

Accruals 15 17

445 514

Total liabilities and capital 1,882 2,362

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You have also obtained the following information:

(i) The net book values (NBV) and potential market values (MV) of non-current assets at 30 April 2009 were:

NBV MV

$000 $000

Property 946 1,200

Equipment 644 390

Vehicles 258 204

(ii) Receivables includes two disputed balances. One of these ($58,000) is the fee for a campaign which was not

well received. The client claims that their reputation was damaged as a result of the campaign. As well as refusing

to pay the outstanding balance, the client is threatening to commence legal proceedings for compensation if

Adage does not write the balance off. The directors are unsure what the outcome of proceedings will be, but

estimate that damages could be as high as $100,000 if the decision is in favour of the client.

The other balance ($28,000) is due from a client who has been experiencing trading difficulties and may cease

to trade.

(iii) All other assets and liabilities are likely to be settled at their book value.

Your objectives for the meeting with the directors are: to demonstrate to them that their objectives for the loan arrangement will be different to the objectives of the

bank; and

to obtain additional information to assist your decision making.

Required:

(a) (i) Explain the differences between the objectives of the owners and the objectives of the bank with

regard to the loan. (8 marks)

(ii) Identify the additional information that you will request. (4 marks)

(b) It is the banks policy to consider the worst possible outcome which might arise before agreeing any loan. Thisis done by considering the proceeds which would result from a realisation of the companys assets and liabilities.

Loans are only agreed in those cases where the resulting funds are forecast to be sufficient to repay the loan. You

have been asked to assess Adages application on this basis, using the statement of financial position at 30 April

2009 and the other information which is currently available.

Required:

Using the statement of financial position at 30 April 2009, together with the other information which is

currently available, assess Adages loan application, based on the banks policy of considering the worst

possible outcome.

(8 marks)

(20 marks)

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2 You are employed as a training consultant with a firm which provides training for non-executive directors of quoted

companies. You are currently preparing material for a course dealing with the treatment of research and development

expenditure.

You plan to differentiate between research expenditure and development expenditure; explain the generally accepted

accounting practice (GAAP) for such expenditure; and illustrate how key accounting ratios are affected by research

and development expenditure, using return on capital employed and earnings per share as examples.

The examples of expenditure which you plan to use are:

(i) $15 million on a project to investigate improvements in the production process;

(ii) $2 million on re-designing tools. It is expected that this re-design will improve the production process; and

(iii) $12 million on assessing the characteristics of materials which are not currently used in the production process

To demonstrate the impact of the expenditure on key accounting ratios, you plan to use the following data taken from

an assumed company with a year end of 31 May 2009:

$000

Retained profit for the year 75,700 note (i)

Total non-current assets 293,800 note (ii)

Current assets 95,890Current liabilities 69,800

Non-current liabilities 104,000

Shareholders funds 215,890 note (iii)

Note (i) This represents the profit for the year, after the following:

$000

Taxation 8,650

Interest 822

Dividend 6,800

Note (ii) The total expenditure to be used in your example ($47 million) has been included in this value.

Note (iii) This includes 50 million ordinary shares of $1 each. Of these, 10 million were issued onincorporation. The remainder is the result of two bonus issues. In each of these, 20 million shares

were issued. The first bonus issue took place in February 2007, and the second bonus issue took

place on 1 January 2009.

The remainder of the value of shareholders funds represents retained profits.

Required:

(a) Explain the difference between research expenditure and development expenditure. (4 marks)

(b) Outline the generally accepted accounting practice with regard to research and development expenditure.

(6 marks)

(c) Indicate how each of the three items of expenditure should be treated. (3 marks)

(d) Calculate the values for return on capital employed and earnings per share following any adjustments which

are needed to comply with generally accepted accounting practice. (7 marks)

(20 marks)

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This is a blank page.

Question 3 begins on page 12.

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3 (a) On 1 June 2007, Herbie Co acquired 160,000 shares in Sumber Co, at a price of $375 per share. At that date,

the book value of the net assets of Sumber was $506,000. The fair value of all of the assets and liabilities was

equivalent to book value, with the exception of land which was valued at $60,000 above the book value. In the

period since the acquisition, the land has increased in value by a further $15,000. The terms of the acquisition

are such that Sumber is to be treated as a subsidiary of Herbie.

The directors of Herbie estimate that at 31 May 2009, the goodwill attributable to the group had been impaired

by $30,000.At 31 May 2009, the statements of financial position of Herbie and Sumber were:

ASSETS Note Herbie Sumber

$000 $000

Non-current assets

Property, plant and equipment 4,375 545

Investment in subsidiary 600 Nil 4,975 545

Current assets

Inventories 1 124 30

Trade receivables 237 45

Other current assets 53 12

Cash and cash equivalents 7 3

421 90

Total assets 5,396 635

EQUITY AND LIABILITIES

Share capital 2 2,500 200

Share premium 750 100

Retained earnings 1,204 263

Total equity 4,454 563

Non-current liabilities

Long-term borrowings 750 25

Current liabilities

Trade and other payables 144 29

Short-term borrowings 19 8

Other current liabilities 29 10

Total current liabilities 192 47

Total equity and liabilities 5,396 635

Notes

1 During the year, Sumber sold goods to Herbie for $60,000. Sumber obtained a profit margin of 15% on the

sale of these goods.

At 31 May 2009, 1/3 of the goods were unsold.

2 The issued share capital of both companies comprises shares with a nominal value of $1.

3 No fair value adjustments have been recognised in the statements of financial position.

Required:

Calculate the value of:

(i) the goodwill on acquisition attributable to both the group and non controlling interest; and (5 marks)

(ii) consolidated reserves at 31 May 2009. (7 marks)

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(b) The directors of Header Co are considering making an investment in Slo Co, one of their materials suppliers. The

directors wish to clarify how any investment will be treated for financial reporting purposes. They are aware that

it will be necessary to prepare consolidated financial statements, and that, depending on a number of factors,

the investee will be treated as either a subsidiary or an associate. However, they are not sure what factors govern

the classification of an investment as either a subsidiary or an associate, or the difference in accounting treatment

in the consolidated financial statements.

Required:

Explain:

(i) the factors which govern whether an investee is treated as an associate or a subsidiary in the

consolidated financial statements; and (5 marks)

(ii) the difference in accounting treatment of an associate and a subsidiary in the consolidated financial

statements. (3 marks)

(20 marks)

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Section C Candidates MUST attempt ONE question from Section B, ONE question from Section C and ONE further

question from either Section B or Section C.

4 Domeng Co is a company which carries out servicing of, and repairs to, a range of domestic appliances, such as

central heating boilers, washing machines and air conditioning units. The company is structured into two divisions

servicing and repairs. Each of these is subdivided into operating units for each type of appliance. The operating units

are managed as cost centres.

Cost variances are reported on a monthly basis. The variance report for May 2009 for one of the operating units is

shown below:

Materials usage $3,105 Adverse

Materials price $4,296 Favourable

Labour efficiency $4,842 Adverse

Labour rate $2,550 Adverse

Variable overhead expenditure $2,554 Favourable

Variable overhead volume $1,846 Adverse

Fixed overhead expenditure $433 Favourable

Fixed overhead volume $984 Adverse

In your role of section manager, you have been asked to prepare a report for the attention of the divisional operations

manager, explaining the reasons for the variances. To prepare your report, you have noted the following points which

may be relevant:

(i) customers are charged a standard price per service. Therefore the divisional profit is improved when engineers

complete services in less than standard time.

(ii) a service consists of a set range of tasks, including replacing specified parts. These parts are included in a

standard service pack which can be obtained from a number of suppliers.

(iii) for each service completed in less than standard time allowed, engineers are paid a $30 bonus.

(iv) the standard time for each service includes an allowance for travel time to the customers premises;(v) if a service pack is subsequently found to have included parts which are faulty, all parts in the pack will be

replaced at no cost to the customer. As the customer cannot be expected to pay a further fee, this is not regarded

(or reported) as an additional service.

(vi) all divisions are required to achieve planned cost savings on an ongoing basis.

(vii) Statistics for May were:

Budgeted volume of services 500

Actual volume of services 433

Replacement packs issued 90

Services completed in less than standard time 85

Required:

Prepare a report for the attention of the divisional operations manager which:

(a) identifies possible causes for the variances which have been reported; and (12 marks)

(b) suggests actions which should be considered to reduce the overall adverse variance. (8 marks)

(20 marks)

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5 Birndan Co is structured into two divisions Albirn (A) and Boldan (B). The performance of the divisions is assessed

on the basis of the divisional return on investment (ROI). ROI is calculated using the average of the opening and

closing asset values. If divisional ROI is greater than 16%, the divisional managers are paid a bonus of 10% of the

amount by which actual profit exceeds the target ROI of 16%.

The following forecast data is available for the two divisions for the next year:

Division A B

Net book value of non-current assets:at start of year $6,230,000 $19,409,800

at end of year $5,032,000 $16,756,600

Average book value of working capital $511,200 $2,324,000

Profit for year $1,195,376 $3,411,856

The data above does not take into account the following proposed projects which are currently under consideration:

Division A B

Investment required:

Initial investment in non-current assets $1,650,000 $964,000

Average investment in working capital $100,000 $55,000

Profit in first year $278,844 $124,964Useful life 5 years 4 years

One of the head office managers has suggested that the calculation of the bonus should be revised so that it is based

on residual income (RI). She has noted that ROI can sometimes lead to managers rejecting proposals which are

beneficial to the company. She has suggested that the bonus should be a percentage of residual income. Her

argument is that if the percentage was set at a level which would result in the same bonus being paid for the forecast

results before investment in any additional projects, any projects which produce a residual income would be accepted.

This would encourage goal congruence as the company would benefit, and managers would also benefit as they

would receive a higher bonus. The companys cost of capital is estimated to be 12%.

Required:

(a) Based on the forecast data excluding the proposed projects:

(i) calculate the forecast ROI of each division; and (3 marks)

(ii) based on the head office managers suggestion, calculate the percentage of RI which should be used in

each division so that the bonus amounts are the same as would be paid under the current bonus

arrangement; (5 marks)

(b) Assuming that ROI continues to be used as the basis of the bonus calculations, calculate the increase or

decrease in the bonuses if the proposed projects are accepted. (7 marks)

(c) Indicate, with reasons, whether it is likely that divisional managers would accept the proposed projects if

bonuses are based on RI rather than ROI. (5 marks)

(20 marks)

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