University of London

Principles of Accounting

Lecture Notes

Revision
Topics Covered

Revision 1 :Financial accounting topics

Revision 2 : Management accounting topics

Total Pages: 51 (Including this cover page)

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Revision Class 1

Format of the POA Examination for 2023:

Section A
15 MCQ Questions (Compulsory) in Management & Financial Accounting, 30 Marks
in total. Each MCQ question is therefore worth 2 marks.

Section B – Financial Accounting

You are required to answer question 16(30 marks) from this section and not more
than a further one question from this section.

Question 16 is compulsory and should be based on financial statement preparation,

that is the preparation of the Income Statement and the Statement of financial position
and the Statement of Changes in Equity.

Question 17 & 18 should be based on Cash Flow Statement, Ratio Analysis and
other financial accounting topics.

Section C – Management Accounting

Question 19, 20, 21

You are required to answer one question from this section and not more than a further
one question from this section.

In Summary:
Answer compulsory MCQs in section A, Question 16 in section B and at least one
Management Accounting question from Section C and one other question in section B
or C.

Exam Tip:
1)You need to be aware of the trends in the question from these past papers to
help you prepare better for the exam.

2)Use the choices available to you intelligently. Some of the topics are mutually
exclusive. For example, you cannot do the question on Cash flow and ratios
together in Section B.

3) The question on capital budgeting (NPV) always appears in Section C.

3) Some topics such as standard costing variances appear very frequently in

Section C.

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 Exam Tip
All the concepts that are reviewed in the revision class are “Must Know” to pass
concepts- NON NEGOTIABLE! Only core topics reviewed in the revision classes.
Also, do review all the important exam tips and notes in text boxes from the lecture
Revision 1 notes.
This lecture will consist of the review of the basic financial Statements
preparation and ratio analysis. The 3 financial statements you will need to be
able to prepare are the:

a) Income Statement - COMPULSORY

b) Statement of Financial Position- COMPULSORY

c) Statement of Changes in Equity- COMPULSORY

d) The Statement of Cash Flow.

The requirements for Section B question 16 are generally preparation of a)

and b) and c) above for a company. In order to do so:

a) You will need to memorise the format of the above statements. For
your convenience the formats are reproduced below.

b) The bulk of the time allocated should be used to unravel the various
adjustments required.

c) There will generally about 8 to 9 adjustments required prior to the

preparation of the statements.

d) A quick way to show your working is to write them beside the final
numbers on the financial statements you prepare.

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Review of the common adjustments: Note: You need to be familiar with all of
these adjustments here as they are the basic
1) Accruals & prepayments. adjustments and will be tested in the exam.

Recall that the purpose of the adjustments for accrual and prepayments is to
ensure that the respective expense & revenues account are recorded in the
correct period.

The following is a summary of the common adjustments required:

CATEGORY DESCRIPTION ACCOUNTS ACTION DR/CR

Accruals Expense Expense Increase DR
consumed but Payable Increase CR
not paid for

Prepayment Expense paid in Prepaid Increase DR

advance Expense Decrease CR

Unearned Revenue not Revenue Decrease DR

Revenue earned but Unearned Increase CR
received & Revenue
recorded

Accrued Revenue Receivable Increase DR

Revenue earned But not Revenue Increase CR
received nor
recorded

2) Depreciation

You will need to be familiar with the 2 methods of depreciation here, namely
the straight line and the reducing balance.

The depreciation is always a standard one as follows:

ACCOUNT ACTION Debit DR/(Credit)CR

Depreciation Expense Increase DR
Accumulated Depreciation Increase CR

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3) Bad & Doubtful Debts

a) Bad Debts to be written off.

This refers to actual existing receivables that are no longer collectible.

ACCOUNT ACTION DR/CR

Bad Debts Expense Increase DR
Accounts Receivable Decrease CR

b) Provision for Doubtful Debts

This refers to the estimated amount of the Accounts Receivables that

are deemed not collectible.

Steps for adjustment:

1) Check if a existing provision exist in the trial balance

2) If yes, adjustment existing provision either up or down according to

the instructions given.

a) Adjustment Upwards (TOP –UP)

ACCOUNT ACTION DR/CR

Doubtful Debts Expense Increase DR
Provision for Doubtful Debts Increase CR

b) Adjustment Downwards

ACCOUNT ACTION DR/CR

Provision for Doubtful Debts Decrease DR
Other Income Increase CR

Points to note:

1) An existing bad debts account may already exists in the trial

balance. This refers to debts already written off during the year.
Show the amount as an expense in the income statement account
only.

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3) Provision for Taxation

ACCOUNT ACTION DR/CR

Tax Expense Increase DR
Tax payable Increase CR

4) Provision for Audit Fees

ACCOUNT ACTION DR/CR

Audit Fees Expense Increase DR
Audit fees payable Increase CR

Inventory (Inventory adjustments)

The following points should be noted for inventory:

a) Inventory System
You will need to read the Trial Balance (TB) to determine if
the company s using a periodic or perpetual inventory
system

Signs to look for

Periodic

1) Purchase account exist in the TB

2) Note given for the closing inventory
3) Inventory value in the TB is therefore for the opening
inventory.

Perpetual

1) COS exist in the TB, NO Purchases Account

2) Inventory value in the TB is therefore the closing
inventory.

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 Remember, this applies to
b) THE Lower of Cost & MV rule (LOCAM) only damaged materials

This rule requires that if the market value of the inventory at

year-end is below its cost, the inventory should be stated at
the lower market value.

Questions in the UOL exam will normally indicate that part of

the inventory is damaged, by stating that the damaged
inventory was sold after year-end for an amount below its
cost. You will therefore adjust the original inventory value for
this.

Formulas Profit margin and mark-up to derive the cost of

inventory

a) Cost = selling price

(100 + mark-up) %
or

b) Cost = selling price x (100 - margin %)

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Format of the Income Statement MEMORISE THE FORMAT

ABS Co.
Income Statement
For the Year ended 31/12/18
$ $
Sales 280,000

Less: Cost of Sales

Opening Inventory 50,000
Add:Net Purchases
Purchases 150,000
Add: Carriage Inwards 15,000
165,000
Less: Purchase Returns 10,000
Net Purchases 155,000
Less: Closing Inventory 65,000
Cost of Sales 140,000
GROSS PROFIT 140,000
Interest Received 1,000
Discount Received 6,000 7,000
Total Revenue 147,000
Less: Operating Expenses

Advertising 10,000
Carriage Outwards 2,000
Discounts Allowed 3,000
Salaries 10,000
Office Expenses 5,000
Rent 10,000
Depreciation 5,000
Total Operating Expense 45,000
Operating Profit 102,000
Less: Finance Cost
Interest Expense 5,000
Redeemable Preference dividends 5,000
Profit before taxation expense 92,000
Less Tax Expense 27,000
Net Profit for the year 65,000

Remember, only redeemable preference

dividends deducted from the IS.

Irredeemable preference dividends deducted

from the retained profit account when paid,
similar to ordinary dividends

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Format of the Statement of Financial Position MEMORISE THE FORMAT

ABS Co.
Statement of Financial Position
As at 31/12/18

$ $ $
Less:
Accumulated Net Book
Non- Current Assets Original Depreciation Value
Cost
Furniture 100,000 30,000 70,000
Motor Vehicles 50,000 10,000 40,000
150,000 40,000 110,000

Current Assets
Bank 120,000
Accounts Receivables 35,000
Less: Provision for Doubtful Debts 5,000
30,000
Inventory 65,000
Prepayment 1,000
Total Current Assets 216,000
Total Assets 326,000
Current Liabilities
Creditors 20,000
Interest Payable 2,000
Total Current Liabilities 22,000

Non-Current Liability
Bank Loan(due 31/12/ 21) 30,000
Redeemable Preference Shares 20,000
Total Liabilities 72,000

Shareholder’s Equity
Share Capital 100,000
Reserves
Share Premium 50,000
Retained Profits 104,000
Total Shareholder’s Equity 254,000
Total Liabilities plus shareholder’s
Equity 326,000

Memorise the sequence from 1 to 7

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Lecture Illustration 1
Tommy Plc is a company which operates as a wholesale distributor of electronic
equipment. The following trial balance has been extracted from the accounting
records as at 30 April 2018.
£ £
100,000 equity shares of £1 each 100,000
50,000 7% redeemable preference shares of 50p each 25,000
Land & Buildings, at valuation 240,000
Provision for depreciation: Buildings -1 May 2017 13,100
Plant & Equipment, at cost 13,000
Provision for depreciation: Plant & Equipment -1 May 2017 3,900
Inventory – 1 May 2017 9,400
Trade receivables 11,200
Trade payables 8,300
Bank overdraft 7,800
Purchases 49,700
Sales 135,900
Administrative expenses 28,400
Distribution costs 11,700
Interest on debentures 1,200
10% Debentures- 31 December 2020 24,000
Investments (Non-current assets) 8,000
Provision for doubtful debts-1 May 2017 910
Share premium 33,500
General reserve 10,200
Interim dividend paid on equity shares 3,950
Revaluation reserve – 1 May 2017 9,860
Retained earnings- 1 May 2017 2,580
Investment Income 1,500_
Total 376,550 376,550

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The following additional information is available:

1.Utilities of £500 for the month of April 2018 were unpaid and administrative
expenses of £1,150 were prepaid on 30 April 2018. Utilities are included in the
administrative expense account.

2.Depreciation on buildings is to be provided at a rate of 15% per annum on

the carrying value of £80,000 and the plant and equipment should be Exam- always follow
depreciated on a straight-line basis at a rate of 10% per annum. instructions
Depreciation is to be included as 80 % in the administrative expense and 20%
in the distribution expense.

3. The provision for doubtful debts is to be adjusted to 10% of the trade

receivables at the period end. Bad debts and changes to the provision are to
be treated as administrative expenses.

4. The Inventory count at 30 April 2018 valued at its sales value of £20,220.
Included in the closing inventory was some damaged goods costing £1,000
which were subsequently sold in May 2018 for £520. The company applies a
general mark-up of 50% on goods sold.

5.The corporation tax on this year’s profit of £6,370 is to be provided for.

6.The preference share dividends are outstanding at the period end (30 April
2018) and the last half year’s interest on the debentures has not been paid.

7.The directors propose to declare a final dividend on the equity shares of 13

pence per share and transfer £2,500 to general reserves.

REQUIRED:
Prepare the following for Tommy Plc:
a) An Income Statement for the year ended 30 April 2018.
b) A Statement of Changes in Equity for the year ended 30 April 2018
c) A Statement of Financial Position as at 30 April 2018.

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a)Tommy Plc
Income Statement
For the Year-ended 30/4/18
£ £
Sales

Less: Cost of sales

Opening inventory balance
Add: Purchases
Less: Closing inventory balance
Cost of Sales

Gross Profit
Add: Investment Income

Less: Operating expenses

Administration expense

Distribution expense

Total operating expense

Operating profit

Less: Finance expense

Redeemable preference dividends

Interest expense
Total finance expense

Profit before taxation

Less: Tax expense

Net Profit for the year

Exam Tip:
1) Observe the time constraint. 1.95 minute per mark
2) Memorise the structure of the IS.
3) Be as neat and organize as possible as marks are awarded for presentation
- Amendments, cancel with ruler and write over.
-Leave spacing between each line if necessary
- Write legibly, remember- cannot read = NO MARK.

4) DO NOT write in pencil!

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c)Tommy Plc
Statement of financial position
As at 30/4/18
£ £ £
Cost Less:
Accumulated Net Book
Non-current Assets Depreciation Value

Land and Building

Plant and equipment
Total 253,000 30,300 227,800
Add: Investment

Current Assets
Trade Receivable
Less: Provision for Doubtful debts

Inventory as at 30/4/18
Prepaids
Total Current Assets
Total Assets 254,930

Current Liabilities
Bank overdraft
Trade payable
Utility payable
Tax payable
Preference dividends payable

Total Current liabilities 25,920

Non-current liabilities
Redeemable Preference shares
Debenture Loan
Total non-current liabilities 49,000

Shareholder’s Equity
Ordinary share capital
100,000 shares @£1 par 100,000

Reserves:
Share Premium
General Reserve
Revaluation reserve
Retained profit
Total Shareholder’s Equity
Total Liabilities and Shareholder’s
Equity

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Tommy Plc
Statement of Changes in Equity
For the year ended 30/4/18
Share Share General Revaluation Retained
Capital Premium Reserve Reserve Profit Total
£ £ £ £ £ £
Balance as at 1 May 2017
Add (Less):
Transfers
Net Profit for year
Ordinary dividends paid

Balance as at 30/4/18
Note :
Examiner’s Comments for Question 1 Section B
Approaching question 16
The preparation of final accounts from structured information is a key
learning objective. A trial balance with several adjusting items has been the
format for the compulsory question over recent years. In answering this type
of question a methodical and organized approach is needed. It is very
important that detailed, legible workings are given in order that marks are
awarded for all work which is correct.

If figures in the final accounts comprise a number of items marks will be

awarded accordingly but without workings one error may result in several
marks being lost. The workings may be shown on the face of the accounts or
separately but candidates should try and help markers to award all
appropriate marks by clear presentation.

The eight-column accounting paper provided is particularly useful for

presenting the financial statements. Good answers will clearly apply to the
instructions in the question for the classification of costs, for example the
allocation of depreciation between administration and distribution costs.

You should pay attention to the presentation of your answer taking care to use
the appropriate descriptions of line items

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Statement of Cash Flow – Format

Objective:
The Statement of Cash Flows explains the change in an organisation’s bank
balance over a period of time by reporting all cash inflows and outflows over
the period.

The statement shows what cash has been generated during the reporting
period and where it has gone.

The Cash Flow statement is normally prepared from 2 consecutive statement

of financial position and the current year’s income statement.

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 MEMORISE FORMAT: IF PLAN TO
Sample Format
DO FOR EXAM
ABC LTD
Cash Flow Statement
For the year-ended 31/12/18
£ £

Cash flow from operating activities

Profit Before taxation x
Add: Depreciation Expense x
Add: Loss on disposal x
Less: Gain on disposal (x)
Add: Interest expense x
Less:Interest (investment)Income (x)
(Increase) decrease inventory x
(Increase)decrease AR x
(Increase) decrease prepayments x
Increase(decrease) AP x
Increase (decrease) accruals* x
Net Cash flow from Operations x
Less
Interest paid (x)
Tax Paid (x)
Net cash flow from operating activities X

Cash flows from investing activities

Proceeds from sale of non-current Assets x
Payment to acquire non-current assets (x)
Interest received x
Dividends received x
Net Cash from Investing activities X

Cash flows from financing activities

Issue of Shares x
Issue of Debentures or long-term loan x
Receipt form Long Term Loan x
Repayment of Long term Loan or Debenture (x)
Dividends Paid (x)
Net Cash from financing activities X
Increase(decrease) in cash & cash equivalent X
Net cash & cash equivalent at 1 January 2018 X
Net cash & cash equivalent at 31 December 2018 (X)

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Lecture Illustration 2

The statement of financial position of Lapwing plc for the year ended 31
December 2018, together with comparative figures for the previous year, is
shown below:

2018 2017
£000 £000

Assets
Non-current assets
Property, plant & equipment – cost 270 180
Accumulated depreciation (90) (56)
180 124

Current assets
Inventory 50 42
Trade receivables 40 33
Cash - 11
90 86
Total assets 270 210

Current liabilities
Trade and operating payables 33 24
Current tax payable 19 17
Bank overdraft 10 -
Total current liabilities 62 41

Non-current liabilities
15% debentures repayable 2025 80 60

Total liabilities 142 101

Shareholder’s Equity
Equity share capital £1 shares 25 20
Reserves
Share premium 10 8
Retained earnings 93 81
Total equity 128 109

Total equity and liabilities 270 210

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Additional information:

1.Plant had been sold during the year for £15,000 with a loss on disposal of
£5,000. The cost of the plant sold was £27,000.

2. The company declared a final dividend of £26,000 for 2018

(2017 was £28,000). This is paid immediately after the AGM that takes
place after the year end. The company did not pay any interim dividends.

3. New debentures and shares issued in 2018 were issued on 1 January.

4. The taxation liability at each year-end is settled in full in the following year.

Required:
Prepare a Cash Flow Statement for the year ended 31 December 2018.

EXAM TIP:
This question is quite unusual as the Income Statement of the current
year 2018 is not provided.

In the exam, expect to see some unusual items as the examiner is also
testing your thinking skills and how you react to unusual situations.

So, be prepared to THINK in the exam!

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 Since the IS not provided, you have to necessary working to determine the relevant
numbers from the IS.

Working: 1)
Income Statement 2018
£000
Operating profit

Less: Interest expense

Profit before tax

Less: Tax expense

Net profit for the year

Less: Equity dividends paid

Change in retained profit balance

2) Disposal of plant £000

Cost

Acc Depreciation

Net Book value

Cash Proceeds

Loss on disposal

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Lapwing Plc
Cash Flow Statement
For the Year– ended 31 December 2018

Cash flow from Operating activities £000 £000

Profit before taxation
Add: Depreciation expense.
Add: Loss on disposal
Add: Interest expense

Increase inventory
Increase Accounts receivable
Increase Accounts payable

Net cash flow from operations 111

Less:
Interest paid
Taxes paid

Net cash inflow from operating activities 82

Cash flow from investing activities

Cash received from sale of plant
Cash used to buy plant

Net cash flow used in investing activities (102)

Cash flow from financing activities

Cash received from debenture issue

Cash from share issue

Cash used to pay equity dividends

Net cash flow used in financing activities (1)

Net decrease in cash and cash equivalent (21)

Net cash and cash equivalent as at 1/1/18 11

Net cash and cash equivalent as at 31/12/18 (10)

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21
Ratio Analysis
Refer to Lecture Notes for Summary of Ratio formulas and what each ratio
measures. EXAM TIP:
Identify the: 1& 2 most important for Section B for exam

1) Profitability Ratios:
2) Liquidity and Working capital ratios
3) Gearing Ratios:
4) Investment performance or shareholder’s ratios:

Lecture Illustration 3
The following information is available in respect of Bagehot Ltd for the year
ending 31st December 2011.

1) Accounts Receivables amount to £33,600 and the receivable

collection period is one month.
2) Gross profit percentage is 25%
3) Opening inventory at 1st January 2011 was £28,000.
4) Purchases of inventory total £360,000.
5) Operating profit margin is 5%.
6) Accounts Payable are equal to one month’s purchases.
7) Cash balance as at 31 December 2011 was £26,400.

Answer the following questions.

1)Compute the operating profit for the year-ended 31 December 2011.

a) £ 20,160
b) £ 100,800
c) £ $33,600
d) Loss of £20,160

2) Compute the Accounts payable balance as at 31 December 2011.

a) £ 360,000
b) £ 30,000
c) £ $33,600
d) £28,000

3) Compute the current ratio as at 31 December 2011 to nearest two decimal

place.

a) 3.97
b) 4.85
c) 2.00
d) 3.00

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4) If the closing inventory balance is understated at the end of the financial
year, then:

a) Cost of sales will be overstated, and profit understated.

b) Cost of sales understated, profit overstated
c) The quick ratio will be understated
d) Total equity will be overstated at year-end.

Exam Tip:

Remember the 5 line IS:

%
1)Sales 100 (ALWAYS 100% FOR SALES)
2)Less: Cost of sales
3)Gross Profit
4)Less: Expenses
5)Net Profit

23
SUMMARY OF ALL RATIOS – REMEMBER, NO FORMULA PROVIDED IN
EXAM

TYPE RATIO FROMULA MEANING COMMENT

Profitability Asset 𝑠𝑎𝑙𝑒𝑠( Measures Higher, better.
𝑛𝑒𝑡 𝑎𝑠𝑠𝑒𝑡
turnover ability of Answer in “times”
maximise
sales
Gross !"#$$ &"#'() Relationship Higher, better
$*+,$
X100%
profit between
margin % selling price
and cost of
sales
Operating 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 Ability to Higher, better
profit 𝑋100% minimise COS
𝑠𝑎𝑙𝑒𝑠
margin % and operating
expense
ROCE 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 Maximise Higher, better
𝑋100% returns to all
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑
investors

Liquidity Current 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠( Ability to Higher, better

Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 repay current
liability

Quick 𝐶𝑎𝑠ℎ, 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 A more Higher, better,

Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 stringent test Exclude inventory
of ability to
pay current
liability
Working Inventory 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 How long it Higher, better
𝑋 365 𝑑𝑎𝑦𝑠
capital days 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 takes to sell
inventory
AR days 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 How long it Shorter, better
𝑋 365 𝑑𝑎𝑦𝑠 takes to
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 collect from
AR
AP day 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 How long it Longer, better but
𝑋 365 𝑑𝑎𝑦𝑠 takes to pay pay on time.
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 from AP
Operating Inventory days + AR days- AP days Length of Shorter, better.
cycle time from
paying
supplier to
time cash
return to
company
Gearing Debt to 𝑁𝑜𝑛 − 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 Level of debt Higher means
ratio equity used higher financial
ratio 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑟𝑒𝑠𝑒𝑟𝑣𝑒 risk

Deb to 𝑁𝑜𝑛 − 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑙𝑖𝑡𝑦 Level of debt Higher means

total used higher financial
capital 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 risk
ratio

24
TYPE RATIO FROMULA MEANING COMMENT
Investmen Dividend 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑎𝑖𝑑 Dividend paid Higher, better
t ratios per share 𝑁𝑢𝑚𝑣𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 per share from
shareholder’s
perspective
Dividend 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 Useful for Higher, better
Yield 𝑋 100% comparing from
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
dividend shareholder’s
payment of perspective.
different
companies
Dividend 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑙𝑒𝑠𝑠 𝑝𝑟𝑒𝑓 𝑑𝑖𝑣 Amount of Higher, better
Cover 𝐷𝑖𝑑𝑖𝑣𝑒𝑛𝑑 𝑝𝑎𝑖𝑑 profit available from
to pay shareholder’s
dividends perspective.
Answer in
times.
Earnings 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑙𝑒𝑠𝑠 𝑝𝑟𝑒𝑓 𝑑𝑖𝑣 Amount of Higher, better.
per share 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 profit per share
(EPS)
Price 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 Indicates High PE means
Earnings 𝐸𝑃𝑆 demand for high growth or
ratio shares low risk
(PER)
Return on 𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑙𝑒𝑠𝑠 𝑝𝑟𝑒𝑓 𝑑𝑖𝑣 𝑋100%Returns to Higher, better.
equity 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 𝑒𝑞𝑢𝑖𝑡𝑦 shareholders
(ROE)

THE END- Revision 1

25
 University of London

Principles of Accounting

Lecture Notes

Revision 2
Topics Covered

Management Accounting Topics

26
 Note:
Only topics 1 to 6 reviewed in class due to
Revision Class 2
time constraint.
Revision 2 will focus on
1) Overhead costing
2) Break –even Analysis
3) Decision Making
4) Relevant Costing
5) Capital Budgeting
6) Variance Analysis
7) Absorption costing versus Marginal costing
8) Cash Budget

Overhead Costing
Process of allocation & Apportionment of Overheads.

This will involve the following steps:

1) Break down the organisation into cost centres.

2) Identify production department cost centres and service department cost

centres.

3) Direct cost is allocated directly to the respective production centres and service
centres.

4) Common Cost is then apportioned to Production Centres and Service Centres

on the basis on the benefit received. Steps 4,
5 and 6
5) Service Centre Cost is then apportioned to Production Centre on the basis of are
the benefit received. crucial
steps
6) Production Centre cost plus apportioned service centre cost is then absorbed
to units produced.

27
Lecture Illustration 1
Wargrin produces a top line hard disk.

Wargrin has two production centres and two service centres to which the
following applies:

Production
Service centres
departments
1 2 Stores Maintenance Total
Floor are (m2) 5,900 1,400 400 300 8,000
Cubic capacity (m3) 18,000 4,000 1,000 1,000 24,000
Number of
14 6 3 2 25
employees
Direct labour hours 2,400 1,040
Machine hours 1,500 4,570

The following overheads were recorded for the month just ended:
£
Rent 12,000
Heat and light 6,000
Welfare costs 2,000
Supervisors
Production 1 1,500
Production 2 1000

The service centres work for the other centres as follows:

1 2
Work done by:
Stores 50% 50%
Maintenance 45% 55%

A unit produced incurred the following:

Dept 1 Dept 2
Direct Material per unit £ 8.00
Direct labour per unit £ 2.00
Labour hours per unit 3 1
Machine hours per unit 1 4
Required:
A) Calculate the overhead absorption rate for each production department.
Justify the basis that you have used.
B) Calculate the cost per unit of the hard disk.
C) Compute the selling price per unit assuming a mark-up of 50%.

28
 Exam Tip:
Answers to these types of question MUST be well organized and structured,
showing the steps and details clearly.

A
Total
Description Cost Basis 1 2 Stores Mtce
£ £ £ £
Direct cost
Supervisor

Common cost
Rent

Heat & Light

Welfare

Total

Apportion
Stores

Mtce

Total

Hours

OAR

b) Cost per unit Per Unit

£
Direct materials

Direct Labour

Overhead absorbed
Prodn 1:

Prodn 2:

Total cost
Add: Mark-up
Selling Price

29
REVIEW:

BREAK EVEN ANALYSIS

REMEMBER THE FORMULAS FOR CVP AS FOLLOWS:

1) B/E Point in units: Fixed Cost________

Contribution per unit

Contribution Margin per unit = Selling Price minus Variable cost per unit

2) B/E in revenue Fixed Cost X Selling Price per unit

Contribution Per Unit

OR
Fixed Cost___________
Contribution Margin Ratio

Contribution Margin Ratio = Contribution per Unit

Selling Price per unit

3) Units sold to Achieve Target Profit = Fixed Cost + Target Profit

Contribution Per unit

4) Total Profit (Loss) equals: ( Be Flexible)

a) Total Sales Less Total cost

b) Total contribution Less Total Fixed cost

c) Margin of safety (units) X Contribution per unit – Best when the BE known.

30
 Exam Tip:
Notice that the questions very practical in exam and involves
a UK setting for example a ski resort that’s open only in the
winter months. So, adapt your thinking accordingly!
Lecture Illustration 2
Bonnington Ltd operates a small ski resort catering for adventure holidays. The
hotel has rooms for 30 guests over an operating season of 20 weeks. The
budgets for the year ended 30t June 2010 have been prepared using the following
data.
£

Weekly income per guest 2,200

Variable weekly cost per guest 1,200
Fixed costs per annum 200,000

The company has in the past expected an average room occupancy over the
season of 60% of total capacity. The directors are concerned that the global
recession will reduce the demand for adventure holidays.

Required:

Question 1
Calculate the break even point in guest weeks and margin of safety.
a) Break-even point is 160 guest weeks & margin of safety is 200 guest weeks.
b) Break-even point is 360 guest weeks & margin of safety is 160 guest weeks.
c) Break-even point is 200 guest weeks & margin of safety is 160 guest weeks.
d) cannot be determined from the information given.

Question 2
Calculate the net profit for the year to 30 June 2010 if past occupancy rates are
maintained.

a) £ 160,000
b) £ 360,000
c) £ 200,000
d) £100,000

31
REVIEW:

RELEVANT COSTING AND DECISION MAKING

Remember that only relevant cost is included for decision making involving 1 off
contracts such as a decision to buy a machine (non-current asset)

A relevant cost is: Remember, an NPV computation

a) future incremental cash flow (Section C) involves a 1 off contract
b) incremental fixed cost and hence the cost object is to identify
c) Opportunity cost the relevant cost.

Irrelevant cost are ignored. These include:

a) sunk cost
b) depreciation expense
c) apportioned fixed cost

Relevant cost for materials

The relevant cost of material used depends on whether the material is obsolete or
not obsolete.

The material is considered not obsolete when it is to be purchased for the job or if
in inventory, it is required for further use (or used regularly).

The material is considered obsolete if it is already in inventory and has no further

use.

Rules: Relevant Cost for Materials

(NO)Not Obsolete = Current Replacement (Purchase) Cost

(O)Obsolete(excess)Materials Relevant Cost = Opportunity Cost of the material

Remember: Opportunity cost represents benefit foregone from the next best
alternative use.

Note:
The issue of whether the material is obsolete or not obsolete is only for
materials in store(already bought).

If the material is required and not in store, the relevant cost is always the
purchase cost as you have to buy the materials for the contract.

One good way to identify “NO” materials is that if you take the material from
the store, the storekeeper will have to replace them.

“O” materials on the other hand, if you take the material from the store, the
storekeeper will not have to replace them.
32
The relevant costing approach should be used for questions involving decision-
making for one-off contracts.

Decision-making questions for one-off contracts are generally of two types:

1) Make accept/ reject decision where the fixed contract price(machine cost)
is given in the question.

Decision criteria:

Where the relevant revenue > relevant cost: Decision Accept

Where the relevant revenue < relevant cost: Decision Reject

2) Computing the minimum or break-even contract price.

The minimum (break-even) price = Total relevant cost.

33
 Exam Tip
The NPV question in exam is often long and
challenging. So, know the expectation if you want to do
Lecture illustration 3 it.

LKL plc is a manufacturer of sports equipment and is proposing to start

project VZ, a new product line. This project would be for the four years.

You have recently joined the company’s accounting and finance team and
have been provided with the following information relating to the project.

Capital expenditure
A feasibility study costing £45,000 was completed and will be paid for next
month. This study recommended that the company buy new plant and
machinery costing £1,640,000 to be paid for at the start of the project. The
machinery and plant would be depreciated at 20% of cost per annum and
sold at the end of the project for £242,000.

As a result of the proposed project it was also recommended that an old

machine be sold for cash at the start of the project for its book value of
£16,000. This machine had been scheduled to be sold for cash at the end
of year 2 for its book value of £12,000.

Other data relating to the new product line

Year 1 Year 2 Year 3 Year 4
£000 £000 £000 £000
Sales 1,000 1,300 1,500 1,800
Receivable (at the year end) 84 115 140 160
Lost contribution
on existing products 30 40 40 36
Purchases 400 500 580 620
Payable (at the year end) 80 100 110 120
Payments to sub- 60 90 80 80
contractors
including prepayments of 5 10 8 8

Fixed overheads and advertising

With new line 1,330 1,100 990 900
Without new line 1,200 1,000 900 800

34
Labour costs
From the start of the project, three employees currently working in another
department and earning £12,000 each would be transferred to work on the new
product line, and an employee currently earning £20,000 would be promoted to
work on the new line at a salary of £30,000 per annum. The effect on the transfer
of employees from the other department to the project is included in the lost
contribution figures given above.

Material costs
Material XNT which is already in Inventory, and for which the company has no
other use cost the company £6,400 last year and can be used in the manufacture
of the new product. If it is not used the company would have to dispose of it at a
cost to the company of £2,000.

Material XPZ is also in Inventory and will be used on the new line. It cost the
company £11,500 some years ago. The company has no other use for it but could
sell it on the open market for £3,000.

Additional Information:
The year-end Accounts Receivable and Accounts Payable are received and paid
in the following year.

The purchase of the £1,640,000 is to be financed by a bank loan at 10% interest.

Estimated Interest expense of £16,400 per annum has not been included in the
fixed overheads above.

It can be assumed that operating cash flows occur at the year-end.

Required
Present a computation to advise on whether or not the project should be
undertaken.

35
 NPV Table Years (relevant cash flows only) £000
Description 1 2 3 4 5
Scrap value

O cost-sale of old
machine

Cash from sales

O cost-lost
contribution

Pay for purchases

Pay to contractor

Incremental fixed
overhead

Promotion

Note: Net cash flow

If you
doing X 10% 0.909 0.826 0.751 0.683 0.621
IRR or
payback Present value
in the £
next part, Total present value =
use the Initial Investment (at present value)
“net cash Net present value
flow”
Initial Investment £000
New machine to buy
Sale of old machine
Material X - Opportunity saving

Material Z- Opportunity cost

Decision:

36
List of Irrelevant cost
Reason
1) Feasibility study £45,000

2) Depreciation expense

3) Transfer salary

4) Materials
XNT £6,400
XPZ £11,500

5) Interest expense

Working:
Accept Reject Difference
£ £ £

37
Exam Tip

The NPV question (section C) in the exam typically involves a detailed NPV
computation in part a), and then may require you to compute the payback period,
IRR or ARR thereafter.

When you do the other parts, you need to use the relevant cash flows (ARR, use
profit) in part a).

For example, if you need to do the payback period, the following should be
produced.

Year Description Cash Flow Cumulative cash

Flow
£000 £000
Start Initial Investment (1,625) (1,625)
1 Cash inflows 366 (1,259)
2 Cash inflows 537 (722)
3A Cash inflows 685 (37) a
4 Cash inflows 1186 b +1,149 Stop
5 Cash inflows

Payback period = 3. 37/1,186 =3.03 years.

Notice that the correct cash flows to use is the “net cash flow” from the NPV
table, not the present values, as payback method ignores the time value of
money.

Note that you need to demonstrate the process of deriving the payback period
clearly as the cash flows you generated in Part a) will most likely be wrong and
the error will “carry forward” to parts b and c.

The examiner however wants to determine if you know the payback concept and
hence even if the actual payback period computed is wrong, marks will still be
awarded for the correct concept. So, show the working clearly!

38
Variance Analysis

Flexible Budget (Standard cost) Variance

A variance is the difference between the budgeted amount and the actual
amounts.

Variances are broken down as follows:

Cost Variances

Variable cost variance

Variable Cost Variances apply to direct materials, direct labour and variable
overheads.

Variable cost variance = Price Variance + Efficiency Variance

Variable Cost price variance =

(AQ X AP) less (AQ X SP)

Variable cost efficiency (Usage) Variance =

(AQ X SP) less (SQ* XSP)

* For actual Production units

AQ = Actual quantity ( KG or hours)

AP = Actual price per kg or per hour
SP = Standard price per kg or per hour
SQ = Standard quantity to be used for actual production

Note:

1) (AQ XAP) = Actual cost in $

2) For variable overheads use, labour hours for AQ and SQ.

3) For variable overheads use the budgeted variable absorption rate per hour
for SP.

39
Fixed Cost Variances

Fixed Cost Variances = Spending + Volume Variance

Spending Variance =
Actual Fixed Overhead less Budgeted Fixed Overheads

Volume Variance =
(Budgeted production volume – Actual production volume) X Fixed overhead
rate per unit

Sales Variance

Sales Variance = Price Variance + Volume variance

Price Variance =

(Budgeted Price – Actual Price) X Actual units sold

Sales Volume Variance (Absorption Costing)

(Budgeted Quantity Sold – Actual Quantity Sold) x Budgeted Margin Per Unit

Budgeted Margin = Budgeted Selling Price – Budgeted Cost

Sales Volume Variance (Marginal Costing)

(Budgeted Quantity Sold – Actual Quantity Sold) x Budgeted Contribution Per

Unit

Budgeted Contribution Per unit = Budgeted Selling Price – Budgeted Variable

Cost
Note:
Variances are either favourable( F) or adverse (A)

40
 This reconciliation only for Section C
question only

Operating (Reconciliation) Statement

$ $
Budgeted Profit X
Add/Less:
Sales margin Variances:
Price X
Volume X X
Profit Before Cost Variances X
Add/Less:
Cost Variances
E.G. Material price X
Material Usage X X
Actual Profit X

Rule for Reconciliation

Action
Favourable variance Add

Adverse variance Deduct

41
Lecture Illustration 4
The Strudel Company makes a single product and has forecast that for the
financial year ended 31 December 2015 it will sell 400,000 units at a price of £40
each.

The standard cost is given below:

£ Per Unit
Direct Material
5 Kg @ £4.00 per KG 20.00
Direct Labour
1 hour @ £3 per hour 3.00
Variable Overheads
1 hour @ £1 per hour 1.00
Total Cost 24.00
Standard Price 40.00
Standard Profit 16.00

For the month of March 2015 the following results were recorded:

Planned production and sales for the month were 40,000 units. In fact, only
36,000 units were produced and all were sold for a total of £1,512,000.

Total spending on material A was £690,000. 180,000 kilos of material A were

used.

46,000 hours were worked for total wages of £128,000.

Variable overhead spend was £38,000.

There are no fixed overheads. Variable Overhead are apportioned based on

labour hours. The company uses an absorption costing system.

REQUIRED:
Prepare an operating statement reconciling budgeted and actual profit for the
month of March 2015 showing a detailed variance analysis. (15 marks)

42
Variable cost Variances
Actual cost Price Efficiency Flexible Budget
(AQ X AP) V AQ X SP Usage V SQ X SP
$ $ $ $

D material

D Labour

V. overhead

Rule for labelling variable cost variance

Variance
1)Left amount > right amount A

2)Left amount< right amount. F

AQ = Actual quantity (kg or hours)

AP = Actual price per kg or per hour
SP = Standard price per kg or per hour
SQ = Standard quantity to be used for actual production

43
Working:
SQ for actual production units

= SQ per unit X Actual production units

Direct Material - SQ
= 5 kg per unit X 36,000 units actual produced
= 180,000 kg

Direct labour - SQ
=

Sales Variance ( Using absorption costing)

Price Variance= (Budgeted selling price – Actual price) X Actual units sold

Volume Variance =
(Budgeted Quantity Sold – Actual Quantity Sold) x Budgeted Margin per
unit
=

Budgeted Margin per unit = Budgeted Selling Price – Budgeted full cost
=

44
Operating (Reconciliation Statement)
$
Budgeted Profit

Add/(Less) Variances
Sales Variance:
Price Variance
Volume Variance

Profit Before Cost Variance

Add/Less Cost Variances

Price V Efficiency V
Direct Materials

Direct Labour

Variable Overheads

ACTUAL PROFIT

45
 MCQ Question

Sheffield operates a standard costing system for production and uses variance
analysis to identify deviations from budget.

Information with regard to direct labour for the period was as follows:

Actual costs £173,800

Actual hours taken 21,000 hours

Standard rate per hour was £7 per hour and the standard hours per unit was 7
hours. 2,700 units were produced in the period.

What was the direct labour rate and efficiency variance?

a. Rate Variance £26,800 (F), efficiency Variance £14,700 (A)

b. Rate Variance £14,700(A), efficiency Variance £26,800 (F)

c. Rate Variance £ 26,800(A), efficiency Variance £14,700 (A)

d. Rate Variance £2,000(F), efficiency Variance 5,000 (A)

46
REVIEW:
MARGINAL VS ABSORPTION COST

Major difference between the two is the treatment of the fixed production
overheads as follows.

Marginal Costing Absorption Costing

Direct Material Product Cost Product Cost
Direct labour Product Cost Product Cost
Variable production
Overheads Product Cost Product Cost
Fixed production
overheads Expense Inventory Cost
Selling & administrative
expenses Period Cost Period Cost

• In periods of rising Inventory levels, that is production exceeds sales

absorption costing produces higher profit.

• In periods of falling Inventory levels, that is sales exceeds production,

marginal costing produces higher profit.

• Ending Inventory valuation always higher for absorption costing

Format of an absorption costing income statement

$
Sales X
Less : Cost of Sales (X)
Gross Profit X

LESS: Other expenses (Period Cost)

Administration X
Marketing , etc X
NET PROFIT X

47
Format of a Marginal Costing Income Statement
$
Sales X
Less : (All) Variable Cost (X)
CONTRIBUTION MARGIN X

LESS: (All) Fixed Cost

Production Fixed X
Marketing Fixed, etc X
NET PROFIT X

CASH BUDGETS
Note:
In order to answer a cash budget question successfully, you need to
memorise the format of the cash budget given below.

Format of the CASH Budget:

The typical cash budget has the general format shown below:
Period 1 Period 2
Cash Receipts
+ Receipts from Accounts Receivable
+ Sales of capital items
+Any Loans Receipts
+ Proceeds from share issue
+ Any other Cash Receipts
E.G. Taxation Refund
GST Refund
Total Cash Receipts

Cash Payments
- Payment to creditors
- Cash Purchases
- Wages & Salaries
- Loan Repayments
-Capital Expenditures
-Dividends paid
-Taxation paid
-Any other cash disbursements
Total Cash Payments
Net Cash Flow for the period
Add: Opening Cash Balance
Equal Closing Cash Balance

48
Note: These are good points to remember if asked to provide recommendation for
improving cash flow.

Recommendation for improving cash position:

The following are practical recommendations for improving the cash position of a
company:

1) Arrange for a Bank Overdraft as soon as possible.

2) Postpone the purchase of non-current asset if possible.
3) Dividends are a discretionary item as they are only payable once declared by
the directors. Therefore the company can always postpone or reduce dividend
payment if there is already insufficient cash.
4) Consider leasing the non-current assets instead of purchase.

49
Present value of £1

%
R 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5
"
0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

Annuity of £1

% 1 2 3 4 5 6 7 8 9 10
Period
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

% 11 12 13 14 15 16 17 18 19 20
Period
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

50
PARTING MOMENT

Best of Luck for the exam, and please do prepare well for POA

But remember, good luck comes to those who are good and hence best
way to make the luck work for you is adequate preparation.

I hope you had enjoyed the lessons as much as I have enjoyed teaching
them and please do enrol for my (AC 2097)Management Accounting next
semester.

Do email to me at balwant@singnet.com.sg if you have any feedback and

also the outcome of the exam.

The END

51