A Level Accounting: The Role of the Accountant and Financial Statements — Practice Questions

These are original questions written for Marlbridge, in the style and at the standard of the examination. They are not reproduced past-paper questions — examination boards hold copyright in their own papers. Use these alongside the official past papers available free from your board.

Related: The Role of the Accountant revision notes

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Section A

1. Distinguish between financial accounting and management accounting. [4]

2. Name four users of financial statements and state what each wants to know. [4]

Section B

3. A business has revenue $400 000, cost of sales $260 000, expenses $85 000.

(a) Calculate gross profit and profit for the year. [2] (b) Calculate the gross profit margin and the profit margin. [4] (c) Suggest two reasons why the gross margin might have fallen from last year. [2]

4. Explain the two main methods of depreciation and state a suitable asset for each.

(a) Straight-line: an asset costs $50 000, has a residual value of $5000 and a useful life of 5 years. Calculate the annual charge. [3] (b) Reducing balance at 20%: calculate the charge for years 1 and 2 on the same asset. [4] (c) Explain why depreciation is charged at all. [3]

5. Explain the treatment of accruals and prepayments at the year end, giving the effect on profit and on the statement of financial position. [6]

6. Explain what the current ratio and the acid test ratio measure, and why a business might have a healthy current ratio yet still face liquidity problems. [5]

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Section C

7. Distinguish between capital expenditure and revenue expenditure, giving one example of each. [2]

State the effect on profit and on non-current assets of mistakenly treating capital expenditure as revenue expenditure. [2]

8. A business has cost of sales $260 000, average inventory $40 000, credit sales $500 000 and receivables of $60 000.

(a) Calculate the inventory turnover, in times per year. [2]

(b) Calculate the receivables collection period, in days. [2]

9. State two limitations of ratio analysis. [2]

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Answers

1. Financial accounting records past transactions and produces statements for external users, in a legally prescribed format, usually annually [1] [1]. Management accounting produces forecasts, budgets and costings for internal use by managers, in any format that is useful, as frequently as required [1] [1].

2. Any four: owners/shareholders — the return on their investment [1]; lenders — whether the business can repay [1]; employees — job security and ability to pay wages [1]; suppliers — creditworthiness [1]; government — tax due; managers — performance against plan.

3. (a) Gross profit = 400 000 − 260 000 = $140 000 [1]; profit for the year = 140 000 − 85 000 = $55 000 [1]. (b) Gross margin = (140 000 ÷ 400 000) × 100 [1] = 35% [1]. Profit margin = (55 000 ÷ 400 000) × 100 [1] = 13.75% [1]. (c) Purchase prices from suppliers have risen without a corresponding increase in selling price [1]; selling prices have been cut to meet competition, or the sales mix has shifted towards lower-margin goods [1].

4. (a) (50 000 − 5000) ÷ 5 [1] [1] = $9000 per year [1]. Suitable for an asset used evenly over its life, such as fixtures or buildings. (b) Year 1: 50 000 × 20% = $10 000 [1] [1]. Year 2: (50 000 − 10 000) × 20% = $8000 [1] [1]. Suitable for an asset that loses more value early on, such as a motor vehicle. (c) To apply the matching concept, spreading the cost of the asset over the periods that benefit from it [1]; to avoid overstating the asset’s value in the statement of financial position [1]; and so that profit is not overstated by omitting the cost of using up the asset [1].

5. Accruals are expenses incurred in the period but not yet paid [1]; the expense is added to the income statement charge, reducing profit [1], and shown as a current liability [1]. Prepayments are expenses paid in advance for the next period [1]; they are deducted from the income statement charge, increasing profit [1], and shown as a current asset [1].

6. The current ratio = current assets ÷ current liabilities, measuring whether short-term assets cover short-term debts [1]. The acid test excludes inventory from current assets, since inventory is the least liquid and may not sell quickly [1] [1]. A business can have a healthy current ratio yet still struggle if most of its current assets are slow-moving inventory or receivables from customers who pay late [1], so it does not have the cash available when liabilities fall due [1].

7. Capital expenditure acquires or improves a non-current asset, e.g. buying a delivery van (including delivery and installation costs) [1]. Revenue expenditure is a running cost, e.g. repairs, fuel or maintenance [1]. Treating capital expenditure as revenue expenditure by mistake understates profit (it is wrongly charged as an expense instead of being capitalised) [1] and understates non-current assets in the statement of financial position [1].

8. (a) Inventory turnover = 260 000 ÷ 40 000 [1] = 6.5 times per year [1].

(b) Receivables days = (60 000 ÷ 500 000) × 365 [1] = 43.8 days [1].

9. Any two: it uses historic data, which may not reflect current conditions [1]; it ignores non-financial factors, such as staff morale or brand reputation [1]; it can be distorted by different accounting policies between firms, making comparison unreliable [1]; a single figure can be manipulated by year-end timing of transactions [1].

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Where marks are usually lost

• Calculating margins on cost rather than on revenue.
• Applying the reducing balance percentage to cost in year 2.
• Getting the profit effect of prepayments the wrong way round.
• Saying a high current ratio always means good liquidity.
• Charging capital expenditure to the income statement as an expense, rather than capitalising it as a non-current asset.
• Quoting a ratio without a comparison (previous year, competitor or industry norm) or a reason for the change.