Financial accounting (4)

CIMA C02 Fundamental of
Financial Accounting
zaheerswati@ciit.net.pk 1

zaheerswati@ciit.net.pk
Financial Statements
2

MCQs 1
Which one of the following does not apply to the preparation of
financial accounts?
(a) They are prepared annually.
(b) They provide a summary of the outcome of financial transactions.
(c) They are prepared mainly for external users of accounting
information.
(d) They are prepared to show the detailed costs of manufacturing and
trading
(d) They are prepared to show the detailed costs of
manufacturing and trading

MCQs 2
Which of the following are not part of the income statement (profit
and loss account)?
(a) Sales
(b) Gross profit
(c) Debtors
(d) Rent
(c) Debtors

MCQs 3
Which of the following are not part of the balance sheet?
(a) Prepayments
(b) Short-term loans
(c) Interest
(d) Creditors
(c) Interest

MCQs 4
Which of the following is not part of the statement of movements on
capital?
(a) Capital at the start of the period
(b) Fixed assets
(c) Net profit earned in the period
(d) Capital at the end of the period
(b) Fixed assets

MCQs 5

Accounts for Limited Companies
 Company accounts preparation in the UK is governed by the
Companies Act 2006
 Companies issue shares to shareholders who enjoy limited liability
 There are two classes of limited liability company in the UK
(a) Private companies
(b) Public companies

14
Statement of Changes in Equity

Reserves
 There are two types of reserves: capital reserves and revenue reserves
 The difference between these is that capital reserves may not be
distributed as dividends. Examples of capital reserves are share
premium and revaluation reserves
 Since the increase in value is based on a professional valuation and
has not been realised by a sale, the increase in value (or proﬁt) cannot
be distributed to shareholders.

Revenue reserves are
(a) Accumulated and undistributed profits of a company
(b) Amounts that cannot be distributed as dividends
(c) Amounts set aside out of profits to replace revenue items
(d) Amounts set aside out of profits for a specific purpose
MCQs 6
(a) Accumulated and undistributed profits of a company

Which one of the following would you expect to find in the
appropriation account of a limited company, for the current year?
(a) Ordinary dividend proposed during the previous year, but paid in
the current year
(b) Ordinary dividend proposed during the current year, but paid in
the following year
(c) Directors’ fees
(d) Auditors’ fees
MCQs 7
(a) Ordinary dividend proposed during the previous
year, but paid in the current year

MCQs 8

The record of how the profit or loss of a company has been allocated
to distributions and reserves is found in the?
(a) Capital account
(b) Profit and loss account
(c) Reserves account
(d) Statement of changes in equity
MCQs 9
(d) Statement of changes in equity

MCQs 10

Revenue reserve would decrease if a company?
(a) Sets aside profits to pay future dividends
(b) Transfers amounts into ‘general reserves’
(c) Issues shares at a premium
(d) Pays dividend
MCQs 11
(d) Pays dividend

Retained Earnings
 These are profits earned by the company and not appropriated by
dividends, taxation or transfer to another reserve account
 This reserve generally increases from year to year, as most
companies do not distribute all their profits as dividends
 If a loss is made in one particular year, a dividend can still be paid
from previous years' retained earnings

MCQs 12

MCQs 13

Dividend

Types of Shares

MCQs 14

Which one of the following does not form part of the equity capital of
a limited company?
(a) Debenture
(b) Share premium
(c) Revaluation reserve
(d) Ordinary share capital
MCQs 15
(a) Debenture

MCQs 16

MCQs 18

MCQs 19

35
The Manufacturing Account
So far we have worked with trading accounts of the form:
This is perfectly satisfactory for a retail organisation that purchases
and resells goods.
A manufacturing company will need further details for the cost of
manufacturing its products and these details can be set out in the form
of manufacturing account.

Definitions
• Direct costs are those which can be attributed to a particular unit of
production and will normally include raw materials, productive
wages and other expenses capable of direct identification with
production. These three are often called direct materials, direct wages
and direct expenses.
• Indirect expenses are production expenses which cannot be
attributed to a particular unit of production. They are often called
manufacturing or works overheads and will include such items as
factory power, plant repairs and so on.
• Prime cost is the total of direct expenses.
• Factory cost or works cost is prime cost plus a share of the factory
indirect expenses.

Stocks in Manufacturing Organisations
The manufacturing process will involve three stages:
Stage 1. The acquisition of raw materials
Stage 2. The modification or processing of those materials, with the
addition of labour and other expenses
Stage 3. The production of finished goods
There could be four types of inventories on the balance sheet of
manufacturing organization
Raw materials
Work in progress (partly finished goods)
Finished goods
Bought-in goods

MCQs 21
19,400

43
Cash Flow Statement
• The statement of cash flows is to highlight the major activities that
directly and indirectly impact cash flows and hence affect the
overall cash balance
• The purpose of the statement of cash flow is to report a firm’s cash
inflows and outflows, during a period of time, divided into three
categories are Operating, Investing, and Financing Activities
• The cash flow statement may be presented using either a “direct”
method or an “indirect” method
• The only difference between the direct and indirect methods of
presentation concerns the reporting of operating activities; the
investing and financing activity sections would be identical under
each method

Operating Activities (Indirect Method)
• Direct method is not include in the syllabus of CIMA C02
• Following steps are used to calculate cash flow from operating
activities under the indirect method :
 Start with operating proﬁt
 Add non-cash expenses, such as depreciation and
amortization and loss on disposal of non-current assets
(capital loss)
 Less profit disposal of non-current assets (capital gains)
Continued

 Changes in working capital excluding short term borrowing (note
payable and like nature) and cash equivalents (working Capital is
current assets and current liabilities)
 Inflow of cash is any decrease in non-current asset item or
any increase in an current liability
 Outflow of cash is any increase in non-current asset item or
any decrease in a current liability

49
Net cash from operating activities
We now need to calculate the cash from operating activities by
deducting the following items from cash generated from operations:
(a) Interest paid;
(b) Tax paid;

Investing Activities
Investing activities generally involve Non Current Assets which are
long term investment and fixed assets
Investing activities generate cash inflows and outflows related to
acquiring or disposing of non-current assets such as property, plant,
and equipment, long-term investments, and loans to another entity
(bonds & debenture)

Financing Activities
When there is a change in the balance of a non-current liability
account or a capital stock account or cash dividends are paid, the
related cash flow must be recorded in the financing activities section
Financing activities involve dividend, short term borrowing (Not
Payable and like nature) and Long term Liabilities

The Cash Section
This section determines the ending balance in cash by adding the total
of the net cash flows from the Operating, Investing and Financing
sections to the beginning balance of cash from the balance sheet

57
Ratio Analysis
 Measure relationships between resources and financial flows
 Ratios also allow for better comparison through time or between
companies
 A ratio is simply a comparison of one figure with another
 Ratios can be classified into various groupings, according to the type
of information they convey. The main groupings are as follows
o Profitability (performance) ratios
o Liquidity (solvency) ratios
o Efficiency (use of assets) ratios
o Capital structure (gearing) ratios

The following income statement and balance sheet will be used to
illustrate the calculation of accounting ratios

Profitability Ratio
• These are also known as performance ratios
• They compare profit at different levels with other figures, and are
often presented as percentages
• Assess profits relative to amount of resources used
 Gross Profit Margin
 Gross Profit Mark-up:
 Operating Profit Margin
 Return on Capital Ratios

Gross Proﬁt Margin
This ratio (also known as the gross proﬁt to sales revenue ratio) is
calculated by

Gross Proﬁt Mark-up
This ratio is an alternative measure of proﬁtability

Operating Proﬁt Margin

Return on Capital Ratios
The ratio can be calculated in several different ways, according to the
information required of it, and depending on what is meant by the two
terms ‘capital employed’ and ‘returns’
In these Learning Materials, two methods of calculating the return
on capital are discussed – the return on total capital employed
(ROCE) and the return on equity (ROE)
Capital employed can consist of total capital employed (equity + non-
current liabilities)

Return on Capital Ratios
Working

Return on Equity (ROE)

Liquidity Ratios
 Assess ability to cover current obligations
 These are also known as solvency ratios, as they refer to the ability
of the business to pay its payables in the short term
 There are two main liquidity ratios:
 The Current Ratio
 The Quick Ratio

Current Ratios
This is also known as the working capital ratio, as it is based on
working capital or net current assets

Quick Ratios
This is also known as the acid test ratio and is calculated by

70
Activity /Turnover Ratios / Efﬁciency ratios
• Assess amount of activity relative to amount of resources used
• These are also referred to as use of assets ratios. They measure
the efﬁciency of the management of assets, both non-current and
current
Asset Turnover
Total Capital Employed (Capital Turnover)
Non-current assets (non-current asset turnover)
Inventories days
Receivables days
Payables Days
Total Working Capital Ratio

Asset Turnover
These ratios compare the assets with the sales revenue (turnover) that
they have earned

Total Capital Employed (Capital Turnover)

Non-current assets (non-current asset turnover)

Inventories days
Inventories may be analyzed by calculating the ratio of inventories to
cost of sales, and then multiplying by the number of days in a year to
give inventories days

75
Receivables days
This is a measure of the average time taken by customers to settle their
debts

Payables Days
This is a measure of the average time taken to pay suppliers

Total Working Capital Ratio
 This measures the total length of time for which working capital is
tied up in inventories, receivables and payables, before becoming
available for use
 It is the total of the number of inventories days, receivables days,
less payables days

Leverage Ratios or Capital structure ratios
Different firms have different methods of financing their activities.
Some rely mainly on the issue of share capital and the retention of
profits; others rely heavily on loan finance; most have a combination
of the two.

79
The gearing ratio (or leverage ratio)
Gearing is a measure of the relationship between the amount of ﬁnance
provided by external parties (e.g. debentures) to the total capital
employed
An alternative method of calculating gearing is known as the debt
equity ratio

Interest cover
Connected to the gearing ratio is a measure of the number of times that
the proﬁt is able to “cover” the ﬁxed interest due on long-term loans. It
provides lenders with an idea of the level of security for the payment

Financial accounting (4)

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