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Financial accounting - Problem set 1 SOLUTION, Exercises of Economics

Solution for the first problem set for the financial accounting course : - Definition of the Accounting principles, transaction analysis, how to create a balance sheet and a profit and loss account.

Typology: Exercises

Pre 2010

Uploaded on 11/14/2009

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Financial Accounting (MiM 2010)
Problem Set 1 - Solution
Part 1 – Accounting Principles
Accounting Conservatism – When there are two ways to measure an asset or an expense,
select the one that yields lower shareholders’ equity or lower reported income, respectively.
Another way to express conservatism is - recognize expected losses immediately but not
expected gains.
The Matching principle – At the same time revenue is recognised, all related expenses must
be matched and recognised as well. This rule ensures that income is unbiased and less
volatile.
The Balance Sheet Equation – Assets are equal to Liabilities plus Owners' Equity. That is,
each asset is owned by creditors or shareholders.
Accounting Consistency – The reporting entity should make all effort to use consistent
methods and estimates over time in preparing financial statements. Changing accounting
methods and estimates is allowed but only when economic conditions are changed.
Accrual Accounting – The method of recording transactions in financial accounting. A
transaction is recorded when it occurs and not necessarily when cash is exchanged.
Verifiability – This is one of the underlying qualities of accounting information.
Transactions are recorded when there is sufficient information to support it and when it is
possible to objectively verify the accounting measures.
Part 2 - Transaction Analysis
Effect on net
income Reason
1. 0 Income is affected by raw material used not paid.
2. 0 Income depends on using materials not on storing them.
3. 0 Dividends are never expenses, income distribution
4. +500
Same output lower cost of goods sold
5. +500
S and A are expensed immediately lower expenses
6. +4,000
Lower expenses higher income
7. +3,000
3,000 more used in production, same output lower COGS
8. 0 Stock issue does not affect income
Part 3 - Transaction Analysis – Tal Corporation
Ignore the effect of taxes
Net Income Total
Assets Total
Liabilities
1. 0 +1,000 0
2. +2,000 +2,000 0
3. 0 +10,000 +10,000
4. +9,000 +9,000 0
5. -2,000 -2,000 0
6. -8,000 0 +8,000
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Financial Accounting (MiM 2010)

Problem Set 1 - Solution

Part 1 – Accounting Principles

Accounting Conservatism – When there are two ways to measure an asset or an expense, select the one that yields lower shareholders’ equity or lower reported income, respectively. Another way to express conservatism is - recognize expected losses immediately but not expected gains. The Matching principle – At the same time revenue is recognised, all related expenses must be matched and recognised as well. This rule ensures that income is unbiased and less volatile. The Balance Sheet Equation – Assets are equal to Liabilities plus Owners' Equity. That is, each asset is owned by creditors or shareholders. Accounting Consistency – The reporting entity should make all effort to use consistent methods and estimates over time in preparing financial statements. Changing accounting methods and estimates is allowed but only when economic conditions are changed. Accrual Accounting – The method of recording transactions in financial accounting. A transaction is recorded when it occurs and not necessarily when cash is exchanged. Verifiability – This is one of the underlying qualities of accounting information. Transactions are recorded when there is sufficient information to support it and when it is possible to objectively verify the accounting measures.

Part 2 - Transaction Analysis

Effect on net income

Reason

  1. 0 Income is affected by raw material used not paid.
  2. 0 Income depends on using materials not on storing them.
  3. 0 Dividends are never expenses, income distribution
  4. +500 (^) Same output ⇒ lower cost of goods sold
  5. +500 S and A are expensed immediately ⇒ lower expenses
  6. +4,000 (^) Lower expenses ⇒ higher income
  7. +3,000 (^) 3,000 more used in production, same output ⇒ lower COGS
  8. 0 Stock issue does not affect income

Part 3 - Transaction Analysis – Tal Corporation

Ignore the effect of taxes

Net Income Total Assets

Total Liabilities

  1. 0 +1,000 0
  2. +2,000 +2,000 0
  3. 0 +10,000 +10,
  4. +9,000 +9,000 0
  5. -2,000 -2,000 0
  6. -8,000 0 +8,

Part 4 – MIF Co.

Reminder:

  • Sales = Cash Collections + End Bal. Trade Debtors - Beg Bal. Trade Debtors;
  • Purchases = Cost of Sales + End Bal Stocks/Inventory – Beg Bal Stocks/Inventory;
  • Purchases = Cost of Sales – Depreciation Expense + End Bal Stocks/Inventory – Beg Bal.

Cash Receivables O.B 10,000 1,000 Dividends O.B 20, (f) 280,000 60,000 (a) 280,000 (f) (e) 16,000 90,000 (b) (f) 283, 80,000 (c) C.B 23, 30,000 (e) 10,000 (i) 20,000 (j) C.B 15,

Raw material Inv. Work in Progress O.B 15,000 O.B 25, (a) 65,000 (a) 63, 63,000 (a) (b) 95, C.B 17,000 (h) 7,000 160,000 (b) C.B 30,

Finished Goods Inventory Fixed Assets- Cost O.B 30,000 O.B 60, (h) 160,000 20,000 (e) 155,000 (b)COGS 30, C.B 35,000 C.B 70,

Accumulating Depr. Factory Wages Payable 20,000 O.B 20,000 O.B (e) 4,000 (b) 90,000 95,000 (b) 9,000 (h)** 25,000 C.B 25,000 C.B

** 2,000 Sand A ; 7,000 Factory overhead

Part 5 - Electric Mousetrap Plc.

Profit and Loss Account

Sales 160, Cost of Sales (60,000)

Gross Profit 100, Distribution Costs (10,000) Administrative Expenses (20,000) Profit before Interest and Tax 70, Interest (5,000) Profit Before Tax 65, Tax (23,000) Profit After Tax 42,

Workings:

Sales = 8,000 x £20 = £160, Cost of Sales = £18,000 + (3 x £14,000) = £60, Interest = 10% x £50,000 = £5, Tax = 35% x £65,000 =£22,750 (£23,000 to nearest £’000) Dividend = 50% x £42,000 = £21,

Part 6 - Rocket Trading Ltd.

Workings:

£100,000 = Ordinary share capital = 2/3 x shareholders’ funds ⇒ Shareholders’ funds = £150,000 ⇒ Retained profits = Shareholders’ funds - ordinary share capital = £(150,000 - 100,000) = £50,000 ⇒ Trade payables = Retained profits = £50,000 ⇒ Fixed assets = 2 x Trade payables = 2 x £50,000 = £100,000 ⇒ Current assets = 3/2 x Fixed assets = 3/2 x £100,000 = £150, Inventory = £70,000 ⇒ Receivables = 1/2 x Inventory = 1/2 x £70,000 = £35,000 ⇒ Cash = Current assets - Inventory - Receivables = £150,000 - £70,000 - £35,000 = £45,

Bank loan = 1/3 x Current assets = 1/3 x £150,000 = £50,000 (£10,000 < 1 year, £40,000 > 1 year)

Balance Sheet

FIXED ASSETS

Plant and Machinery 100,

100,

CURRENT ASSETS Inventory 70, Receivables 35, Cash 45,

150,

CURRENT LIABILITIES Bank Loan 10, Trade payables 50,

60,

TOTAL ASSETS LESS CURRENT LIABILITIES 190,

LONG TERM LIABILITIES

Bank Loan 40,

NET ASSETS 150,

CAPITAL AND RESERVES

Ordinary Share Capital 100, Retained Profits 50,

SHAREHOLDERS’ FUNDS 150,