Principles and Practice of Financial Accounting

This document provides a statement of comprehensive income, statement of changes in equity, and statement of financial position for a company. It also includes a discussion on the purpose of accounting standards and a ratio analysis of two companies. Additionally, it explains the differences between finance lease and operating lease, factors indicating a finance lease, and disclosure requirements for lessors and lessees.

Principles and Practice of
Financial Accounting

Section A
Question 1
1 (a)
Statement of comprehensive income for the year to 31
December 2019
£000 £000
Revenue 5165
Cost of sales (W1) 2833
Gross profit 2332
Other income (Rent) 66
Distribution costs (W2, W3 & W4) 553
Administration cost 946 1499
Profit from operations 899
Interest on loan (170*10%) 17
Profit before tax 882
Taxation (140-6) 134
Profit for the year 748
1(b)
Statement of changes in equity for the to 31 december 2019
Share
capital
Revaluation
reserve
Retained
earnings
Total
equity
£000 £000 £000 £000
Balance 500 1055 1555
Total comprehensive income 350 748 1098
Dividends paid 32 32
Balance at 31 december 2019 500 350 1771 2621
1(c)
Statement of financial position as at 31 December 2019
£000 £000
Assets (in order of permanence)
Non-current assets
Property, plant and equipment (W3) 2942
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Non depreciable land 1755
Current assets
Inventory 432
Trade receivables (356-6-7) 343
775
5472
Equity
Revaluation reserve 350
Retained earnings (1053+748-32) 1769 2119
Liabilities
Current liabilities
Trade and other payables (TB) 414
Bank (TB) 107
Tax payable 140 661
Total equity and liabilities 2780
5472
Working notes:
W1 Cost of goods sold
£000
Opening stock 432
Purchase 2826
Closing stock 425
Cost of goods sold 2833
£000
W2 Depreciation on equipment
Equipment at cost 480
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Accumulated depreciation at 1 January
2019 240
Carrying value 240
Depreciation for 31 december 2019 (10%) 24
W3 Carrying value for PPE £000 £000 £000
Land at valuation 1670
Building at cost 1200
Depreciation 24
Accumulated depreciation 120 144 1056
Equipment at cost 480
Depreciation 240
Depreciation for 31 december 2019 (10%) 24 264 216
Carrying value 2942
£000
W4 Distribution cost
Distribution costs 258
Wages and salary (434*50%) 217
Building depreciation (120*50%) 60
Equipment depreciation (24*75%) 18
Distribution costs 553
W5 Administration expenses
Director's fees 195
Administrative expenses 463
Wages and salary (434*50%) 217
Building depreciation (120*50%) 60
Equipment depreciation (24*25%) 6
Bed debts 6
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Decrease in allowance for receivable 1
356-6= 350*2%: 7-6
Administrative expenses 946
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Purpose of accounting standards: Accounting standards plays a key role in order to manage
financial transactions in an effective manner. Herein, below key role of these standards are
mentioned in such manner:
 Improves Reliability of fiscal Statements- It is one of the key importance of accounting
standards as by help of different accounting standards, reliability of financial statement
increase. This becomes possible because of accuracy in recorded financial data and
applying common standards for management of financial information.
 Prevents fraud and manipulation- The accounting standards help to stop all types of
frauds and manipulations. This is so because by using different accounting standards,
transparency in financial statement becomes possible.
 Assists audit- In addition to this, different accounting standards help to auditors in order
to provide systematic data for auditing. Due to this, it becomes feasible for auditors to do
auditing in less time and cost.
Section B
Question 3
(a) Ratios for Ruislip plc and Hayes plc
(i) Return on capital employed
Formula = PBIT/share capital & Reserves + NCL x 100%
Ruislip plc Hayes plc
PBIT 1600 1000
Share capital &
reserves 2540 2480
NCL (noncurrent
liabilities) 900 1100
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Calculation 1600/(2540+900)*100 1000(2480+1100)*100
Result 46.51% 27.93%
(ii) Gross profit margin
Formula = Gross profit/Sales x100%
Ruislip plc Hayes plc
Gross profit 2500 1500
Sales 8000 6500
Calculation 2500/8000*100 1500/6500*100
Result 31.25% 23.08%
(iii) Net profit margin
Formula = PBT/Sales x 100%
Ruislip plc Hayes plc
PBT 1380 730
Sales 8000 6500
Calculation 1380/8000*100 730/6500*100
Result 17.25% 11.23%
(iv) Quick assets ratio
Formula = CA-INVENTORY/CL
Ruislip plc Hayes plc
CA 2480 2150
Inventory 860 780
CL 1240 1070
Calculation (2480-860)/1240 (2150-780)/1070
Result 1.31 1.28
(v) Dividend cover
Formula = PAT&Pdiv/Ordinary dividends
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Ruislip plc Hayes plc
PAT 1035 550
Ordinary dividends 425 395
Calculation 1035/425 550/395
Result 2.435294118 1.392405063
(vi) Dividend yield
Formula = DPS/MPS
Ruislip plc Hayes plc
Total dividend 425000 395000
Number of ordinary
shares 1500000 1500000
Calculation 425000/1500000 395000/1500000
DPS 0.283333333 0.263333333
MPS 2.5 2.25
Calculation 0.28/2.5*100 0.26/2.25*100
Result 11.20% 11.20%
(vii) Capital gearing
Formula = Pref Share capital + NCL/ Total SC & Res + NCL x 100%
Ruislip plc Hayes plc
Pref share capital 0 0
NCL 900 1100
Total share capital
and reserves 2540 2480
Calculation 900/(2540+900)*100 1100/(2480+1100)*100
Result 26.16% 30.73%
(viii) Interest cover
Formula = PBIT/Interest payable
Ruislip plc Hayes plc
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PBIT 1600 1000
Interest payable 220 270
Calculation 1600/220 1000/270
Result 7.27 3.70
Comment on the results
The ratio analysis which has been undertaken above includes ratios such profitability, liquidity,
efficiency etc from which it has been seen that Ruislip plc Is more effective.
(b) Limitations of ratio analysis
There are various limitations of ratio analysis which both users and organisation faces, these
limitations are:
 Ratio analysis neglects the qualitative aspects of an organisation as it only considers
monetary and numeric values due to which various important is neglected while
calculating ratios.
 Ratio analysis is not governed by any uniform authority due to which there is a high
possibility of inaccuracies. For example: few companies consider inventory in calculation
of quick ratio and some not due to which comparison is not accurate.
 The ratio analysis is done by using the historic costs and not the current market costs due
to which various variables such as inflation are missed that result into inaccuracies.
 Ratio analysis is only a technique of determining performance of an organisation and it
does not benefit organisation in providing recommendations to resolve an issue or to
acquire growth.
QUESTION 4
(a) Distinguishing between a finance lease and operating lease
Financial and operating lease are two different contracts having few differences; these
differences are:
 Financial lease is a contract between two or more parties in which lessor lets the lessee to
use a specific asset for a particular period of time which is usually long, in exchange of
periodical payments. On the other hand, operating lease is a type of commercial contract
in which an asset is leased for shorter period of time in exchange of periodic payments.
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 In the case of financial lease, the ownership of the asset is transferred to the lessee but in
case of operating lease, the ownership remains in the hands of lessor.
 Financial lease is referred as a loan agreement; on the other hand, operating lease is
regarded as a rental agreement.
 The responsibility of maintenance and risk is transferred to lessee in financial lease but in
case of operating lease there is low responsibility and risk of assets in hands of lessee.
(b) Explaining the factors that which indicate a finance lease
There are various factors which indicate a lease as finance lease; such factors are stated
and explained below:
 Time – A long term contract which usually more than a year indicates a lease as financial
lease and the payments are done in pre-determined periods.
 Transferability – A contract which provides the transferability and ownership of an asset
indicates towards a financial lease.
 Tax advantage – This is the major factor which indicates a financial lease as such lease
comes with allowance of depreciation and tax deduction.
 Option to purchase – According this factor, a contract having a purchase option or an
option under which lessee can purchase the asset is a financial lease.
(c) Discussing the disclosure requirements for lessors in relation to the two types of leases
For finance and operating leases, the disclosure requirements for lessors include as
follows:
Operating lease disclosures:
 Lessors are required to mention the minimum amount of each lease payment; these lease
payment periods include the next year and beyond five years.
 Lessors are required to disclose all significant leasing arrangements.
 The amount of contingent rent which is the income of lessor.
For finance lease:
 All the requirements which are stated for operating lease are required to be disclosed
under finance lease as well.
 The finance income which is unearned from the lease.
 The residual values which are associated with finance lease but are unguaranteed.
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 Lessor required to disclose payments which are considered as accumulated allowance
for uncollectable lease payments.
(d) Briefly explain the presentation and disclosure requirements for lessees
Lessees are the parties who gains the leased assets and there are various presentation and
disclosure requirements for such parties which includes:
 Lessees are required to present the carrying amount of an assets along with the minimum
lease payments.
 Such parties are also required to disclose contingent rent which is considered as an
expense.
 Amount of sub lease is also required to be disclosed along with all significant leasing
arrangements.
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