Pacc-text-type Questions In Past Papers

Reference to HKALE Principles of Accounts Appendix Text-Type Questions in Past Papers

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Text-Type Questions in Past Papers I. Purposes of Financial Accounting Purposes of accounting that would facilitate business management [2007-2(c)]


Reporting: a properly prepared set of financial statements might be required by users including the tax authority, creditors, bankers, etc




Controlling: proper accounting records facilitate debts collection as well as time payment of debts




Evaluating: properly presented trading results and financial position in accordance with generally accepted accounting principles facilitate results comparison across years and between firms




Planning: proper books of accounts would facilitate owners’ decision-making with respect to manpower planning, future expansion, etc

A true and fair view [2004-I-2(C)(a)]


Truth: facts and reality which are NOT false or erroneous




Fairness: the impression/perception of users of financial statements that the info. contained in the financial statements is fairly represented




In virtually all circumstances, a true and fair view is achieved by compliance with applicable accounting standards and relevant sections of the Companies Ordinance




A true and fair view requires: 

selecting and applying accounting policies so that the financial statements comply with all requirements of applicable accounting standards.



presenting information in a manner that is relevant, reliable, comparable and understandable.



providing additional disclosures when the requirements in the accounting standards are insufficient to enable users to understand the impart of particular transactions or events on the enterprise’s financial position and performance.




Departure from accounting standards is only allowed in extremely rare circumstances when the treatment required is clearly inappropriate and thus a true and fair view cannot be given either by applying the standards or through additional disclosures alone. Disclosure of reasons and financial effect MUST be made in the financial statement.

II. Financial Accounting Purpose of depreciation [2001-II-5(c), 2007-I-5(a)]


Allocation of the cost/depreciable amount of an asset over its useful life in a systematic manner




If the value of the noncurrent asset is revalued upward, depreciation is still required. Depreciation is calculated to allocate the depreciable amount (on revalued basis) of the asset over its remaining useful life.




A depreciation method should reflect the pattern in which the asset’s economic benefits are consumed by the company through production




Straight-line method: (assumption) there is an even usage of the asset throughout its useful life




Reducing balance method: (assumption) the asset falls in value at a faster rate in earlier years

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Reference to HKALE Principles of Accounts Appendix Text-Type Questions in Past Papers




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Sum of the years’ digit method: accelerated depreciation method which assumes a higher usage in earlier years than in later years




For assets which fall in value at a faster rate in earlier years, the reducing balance method will be a fairer method of allocating costs




The decreasing deprecation over the years, together with the increasing maintenance charge, will result in a stable level of expenses on the asset




On the basis the usage of the asset will be gradually decreasing, the sum of the years’ digit method will be more appropriate

Advantages for maintaining both current and capital accounts in partnership [2008-I-3(b)]


Maintaining fixed capital accounts helps to distinguish the fund contributed by partners from that generated from recurrent operations




Fixed capitals help to ensure the capital base is NOT eroded by excessive drawings, which will be revealed by a negative balance in the current account

Reasons for not maintaining goodwill account [2006-I-2(c)]


Valuation may be subjective; estimated value may NOT be reliable




Not arise from arms’ length transaction




Intangible nature of the asset




Relationship will future economic benefit NOT easily identifiable or measurable

Purpose of making revaluation adjustment upon a change in profit & loss sharing ratio among partners [2005-I-4(d)]



in P/L sharing ratio among partners  assets revaluation needed to reflect their fair values




There may be unrealised holding gains/losses which have NOT been accounted for in the books as at the date of
in P/L sharing ratio




Through revaluation, partners’ capital accounts are credited with their respective share of gains (or debited with the share of losses) using the OLD P/L sharing ratio




If revaluation is NOT done, the partners would be entitled to a share of these gains (or losses) using the new P/L sharing ratio when the assets are EVENTUALLY realised, even though they arouse prior to
in the ratio

Reasons for paying a premium to take-over a business incurring a heavy loss [2007-I-3(c)]


The purchase consideration has taken into account earning potential of assets in the partnership




The heavy loss only temporary  profitability may improve after restructuring/business take-over




The premium could have been paid for the existing customer and supplier network




The purchase consideration has taken into account the business owners’ expertise in the area, i.e. specialist knowledge

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Reference to HKALE Principles of Accounts Appendix Text-Type Questions in Past Papers

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Comparison between equity capital and loan capital [2008-I-1(a)] Equity Capital

Loan Capital





Shareholders have voting rights




Dividend is an appropriation of profit, with


Debenture holders have NO voting rights Interest is an expense, with fixed rate

rate NOT fixed


No stipulated date for repayment of capital







In case of liquidation, shareholders rank the


In case of liquidation, debenture holders rank

last to receive back the fund invested

before shareholders

Stipulated date for redemption of debentures

Purpose of preparing consolidated financial statements [2004-I-1(A)(a)]


To present the group’s operating performance AND financial position from the perspective of the group as a whole




Group accounts are legally required

III. Analysis and Interpretation of Financial Statements Comparison between liquidity ratios and cash flow statements [2006-I-1(c)(ii)]


Sources and uses of cash are given in the cash flow statement.




The cash flow statement presents both the current cash position AND an indication of the future cash position. These sources of fund affect the company’s future cash position, but they are NOT included in the liquidity ratios.




Each ratio focuses on just one aspect of liquidity and NOT a comprehensive view as given in the cash flow statement.

Circumstances in which cash flows from operating activities offer a clearer picture of operating performance than earnings [2007-I-4(c)]


A company reports large non-cash expenses, such as write-offs, depreciation, and provisions for future obligations. Earnings may give an overly pessimistic view of the firm.




A company is growing rapidly. Reported earnings may be positive, but operations are actually consuming rather than generating cash.




A company purposely shows a more favourable position than the actual, e.g. when applying for a major loan. In such cases, cash flow from operations provides a better reality check for reported earnings.

Common remarks used in analysis of cash flows (revealed by the cash flow statement) [2003-I-1(c), 2005-I-2(b), 2006-I-1(c)(i), 2008-I-2(c)]


Positive and recurrent cash flow from operating activities (crucial to survival of company)  current cash flow position considered promising




Strong cash generating power from operations relative to regular short-term and long-term commitments/regular cash payments  no problem in interest payments

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Reference to HKALE Principles of Accounts Appendix Text-Type Questions in Past Papers

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(A substantial amount of ) Fixed deposits will mature next year  enhance the short-term ability to repay




Major use of cash is fixed assets acquisition (non-recurring)  expand business / increase production capacity, hence generating future cash inflow




Funds can be generated upon disposal of noncurrent assets




Debentures is only repayable after 6 years  NOT impose pressing demand for short-term liquidity




There should be sufficient cash in near future to pay off bank overdraft




Negative cash flow in operating activities + cash inflow mainly from sale of fixed assets  difficulty in sustaining daily operations




A large portion of assets sold (which could generate future economic benefits)  company’s ability to generate future profit in doubt




New bank loan obtained and new asset financed by finance lease  has to repay loan and bear high interest expenses in future




Surplus cash should be used to finance expansion of production capacity and/or operations; if not, repayment difficulty when bank loan is due 2 years later

Uses and limitations of financial statements and ratio analysis [1999-II-4(a)] Uses:


Financial statements interpretation/analysis is a process of evaluating relationship between component parts of financial statements to obtain a better understanding of a firm’s financial position and operating performance




By ratio analysis, the performance of the firm can be evaluated in terms of its profitability, solvency/liquidity and capital structure (gearing)




Main purpose: to help users appraise a firm’s past performance and from that appraisal, to make predictions about its likely future performance




Ratios are used as they can eliminate the effects of scale and size of different firms or different years of the same firm, so that comparison can be made

Limitations:


Financial statements are usually prepared on a historical cost basis  may NOT be relevant for predicting future performance




Different firms may adopt different accounting policies which make comparisons difficult




The uniqueness (e.g. the environment where the firm is operated) of a particular year or a particular firm has to be considered before a meaningful comparison can be made

III. An Introduction to Managerial Accounting Types of costs [2004-II-4(B) & 5(A), 2007-II-2(b)]


Fixed cost

does NOT change regardless of production level; beyond relevant range of output and time period, even total fixed cost may change (*increase in volume  UNIT fixed cost, NOT total fixed cost, will

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decrease)


Stepped cost / semi-fixed cost

does NOT change within a range of activity




Semi-variable cost

consists of fixed and variable elements; the variable cost changes in DIRECT proportion with production level




cost that has been incurred by a decision made in the past and that

Sunk cost

CANNOT be changed by any decision that will be made in future


measures the best opportunity that is lost or sacrificed when the choice

Opportunity cost

of one course of action requires an alternative course of action be given up Job Costing Method versus of Process Costing Method [2005-II-4(A)(a)] Job Costing Method



Costs

attributable

to

individual

Process Costing jobs

and


NO specific costs assigned to individual units;

calculated on job basis

unit cost calculated on average cost basis

Commonly used for customised or one-off


Commonly applied to mass produced, similar

products that are tailor-made to meet the

products

customers’ specifications

continuous or repetitive operations incurring

going

through

a

sequence

of

direct costs and overheads from process to process Reasons for Increasing Trend to Adopt ABC systems [2004-II-2(B)]


To allow for allocation of non-manufacturing overheads to products




To eliminate cross-subsidisation when more than one product is manufactured




To provide more accurate cost information available for various products and hence flexible pricing is possible




To help to monitor the production efficiency of various production activities




Sophisticated overhead allocation methods enabled by lower information processing costs

Advantages of using standard absorption costing approach for stock valuation [2008-II-4(c)]


The use of absorption costing (rather than marginal costing) for stock valuation is recommended as production overheads, whether fixed or variable, are necessary costs for manufacturing process




For cost control on producing standardised products, standard costing for stock valuation is more appropriate than actual costing as variance could be identified




It helps alert management of deviations from standards or planned estimates

Definition of margin of safety [2005-II-5(a)(ii)]


Amount of sales that can be reduced before a loss occurs




Difference between actual sales revenue and sales revenue at break-even point

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Reasons for opening a provision for unrealised profit account and how it would be disclosed in the balance sheet [1999-I-5(b)]


Internal (manuf.) profit may arise as a result of the transfer of finished goods at loaded price from manuf. section to the trading section. The manuf. section then turns from a cost centre to a profit centre.




Where some of the finished goods produced during the year have not been sold at period end, provision for unrealised profit is required to account for the unrealised profit element in the closing stock of finished goods.




Provision for unrealised profits is an adjustment for unsold finished stock in the trading section under the profit and loss account. It is necessary because until the goods are sold there is NO real profit earned by the company.




When there is opening stock of finished goods, the adjustment shown in the profit and loss account would be the increase (debited to the profit and loss account) or decrease (credited to the profit and loss account) in the provision for realised profit during the period.




In preparing the balance sheet at period end, any closing balance of provision for unrealised profit on finished goods MUST be deducted from the gross value of the stock of finished goods to arrive at the cost of the stock of the finished goods.

Purposes of Cash Flow Statements [2006-II-2(b), 2008-II-1(c)]


To direct and coordinate cash inflows and outflows




To facilitate the planning and coordination of business activities to match with sources of fund




To provide advance notice of future cash positions




To evaluate actual performance against budgeted flows




To alert the management of any need to deal with potential cash shortages problems or cash surplus opportunities and to decide on any necessary action

Ways of incorporating risk in investment appraisal calculations [2006-II-5(d)]


Risk-adjusted discount rate: Higher rate used for discounting to include the risk incurred in the investment  discounting cash flows in future more heavily, i.e. smaller NPV




Higher payback period/IRR requirement: Earlier pay-back of investment  lower risk incurred as the firm can recoup the initial amount of investment earlier




Sensitivity analysis




Scenario analysis

Examples of non-financial factors in decision-making [2004-II to 2008-II] * When attempting examination questions of this type, it is reminded that ALL factors suggested should be specifically related to the scenario in question. The factors provided below are common suggestions only. General factors




Accuracy/reliability of the estimates that should be ascertained




Availability of spare production capacity

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Reference to HKALE Principles of Accounts Appendix Text-Type Questions in Past Papers




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Possibility of improving profitability, e.g. making similar deals with other corporate clients, raising the price on all future sales




Concern over whether demand is a short-term upsurge




Impact on staff morale; skills and expertise of staff




Strategy of competitors

Taking special orders,


Policy/management implications on different mark-ups for different products

e.g. bulk order with Feedback discounts offered

from


The order should be one-off or clearly differentiated from the general retail sales  no expectation of price

ordinary customers

reduction by individual customers aroused


Their dissatisfaction

Feedback from the


Possibility of starting up a

special client

relationship with the client, i.e. his/her future purchase

long-term business

volume Deciding on the use of


Stakeholders’ risk preference on suggested proposals

the vacant factory space,


Creditworthiness of the new tenant, customers and relevant parties

e.g. using it to facilitate


Matching cash flow pattern from the proposals with uses and sources of fund or

production, selling it,

those of other projects

signing

a

tenancy


agreement with a client,

Medium-term business direction requiring the use of space, e.g. new market segments, new products/services, new technology, system or logistic re-engineering

IV. Accounting Theory Cash basis versus Accrual basis [2006-I-4(b)]


Cash basis: all transactions are recorded on the dates of receipt or payment




Accrual basis: all amounts are analysed and recorded according to their dates of incurrence, NOT receipts or payments

Capital expenditure versus Revenue expenditure [1998-II-4(a)]


Capital expenditure: amount spent on the acquisition of long-term assets and not assets for resale, including the addition of value to the existing assets (e.g. purchase of furniture)




Revenue expenditure: amount spent on the acquisition of assets for resale or for the purpose of earning revenue income (e.g. purchase of trading stock)

Characteristics of operating lease [2006-II-5(c)]


The lessor retains most of the risks and rewards of the ownership of an asset




the NPV under leasing arrangement is less than 90% of the fair market value of the asset (*** in the NEW accounting standard, NO numerical thresholds are specified with the intention to draw attention away from such strict criterion)

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Reference to HKALE Principles of Accounts Appendix Text-Type Questions in Past Papers

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Development cost capitalisation [2005-I-2(c)] Development cost should NOT be capitalised when:


Project NOT clearly defined, technically feasible OR commercially viable




Future benefits NOT reasonably certain or CANNOT recover costs




NOT enough resources to complete the project




Costs attributable to the project CANNOT be separately identified or measured reliably

Normal identification of stock loss under perpetual and periodic inventory systems [2005-I-5(C)]


Perpetual: quantity of goods that should be in stock are kept up-to-date  stock loss can be identified quite easily by comparing it with physical stock count




Periodic: stock loss cannot be identified UNLESS all sales are made at a standard mark-up; and is ascertained ONLY upon the end-of-period stocktaking

Advantages of using IT in operating perpetual inventory system [2005-I-5(D)]


Perpetual inventory made more feasible in a business environment supported with good computer systems, esp. when a large volume of data is involved




Tedious data recording work performed by computers accurately and quickly involving less manpower




IT permits instantly and/or continually perpetual inventory record




IT permits tracking of stock movements between different locations

FIFO Method versus LIFO Method in stocktaking [2007-II-1(f)] FIFO Method





LIFO Method

Assumes that stock items purchased first are


Could distort current period’s profit/loss when

issued first  stock value at year end will carry

preserved old layers of stock are presumed to

the more recent purchase cost  more realistic

be used when the prevailing physical stock is

asset valuation

substantially reduced

More realistic assumption whereby the oldest


Disallowed in professional practice

items of stock are assumed to be sold first and those remaining are the newer items  better representation of actual stock flows

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