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O-LevelAccountingAnalysis and interpretation7707/22 · May/June 2018 · Q420 Marks

The following balances remained in the books of Dharma on 30 April 2018 after preparation of the financial statements. | | $ | |:------------------|:-----| | Non-current assets | 25000 | | Dharma's capital | 20000 | | Bank loan (repayable 2022) | ? | | Bank overdraft | 2000 | | Trade receivables | 8500 | | Trade payables | 6000 | | Inventory | ? | Additional information 1 Profit for the year is $7400. 2 Working capital ratio (current ratio) is 2.5:1.

  1. (a)(i)Calculate the value at 30 April 2018 of the: inventory[2]
  2. (a)(ii)bank loan (repayable 2022)[2]
  3. (b)Calculate the following ratios to two decimal places. The previous year's ratios are shown in the last column. | Workings | 30 April 2018 | 30 April 2017 | |:---------|:--------------|:--------------| | Quick ratio (acid test ratio) | | 1.35:1 | | Profit for the year to capital employed | | 14.00% |[4]
  4. (c)(i)Comment on the change in each ratio over the two years. Give one possible reason for the change in each ratio. Quick ratio (acid test ratio) Comment Reason[2]
  5. (c)(ii)Profit for the year to capital employed Comment Reason[2]
  6. (d)Dharma is considering four proposals for the next financial year but is concerned about the effect on his working capital and his profit for the year. Proposal 1 Sell some non-current assets on credit at book value. Proposal 2 Convert the bank overdraft into a 5-year bank loan at a lower rate of interest. Proposal 3 Offer a 5% cash discount to trade receivables. It is expected that all of the trade receivables will accept the offer. Proposal 4 Reduce credit sales and increase cash sales. REQUIRED (d) Complete the table by placing a tick (✔) to indicate the effect of each proposal on Dharma's working capital and his profit for the year. The first item has been completed as an example. | Proposal | Working capital | Profit for the year | |:---------|:---------------------------------|:---------------------------------| | | increase | decrease | no effect | increase | decrease | no effect | | 1 | | | ✓ | | | ✓ | | 2 | | | | | | | | 3 | | | | | | | | 4 | | | | | | |[6]
  7. (e)State two advantages to Dharma of using International Accounting Standards (IAS) when preparing his financial statements.[2]

Mark scheme

Marking points from the official mark scheme (May/June 2018). The mark or mark type is shown in brackets.

  1. [1] Current liabilities $2000 + $6000 = $8000. $8000 × 2.5 = Current assets $20000
  2. [1] Current assets $20000 – $8500 = inventory $11500
  3. [1] Assets 25000 + 8500 + 11500 = 45000
  4. [1] Liabilities 20000 + 2000 + 6000 = 28000. 45000 – 28000 = Bank loan 17000 (OF)
  5. [1] Quick ratio (acid test ratio) Workings (8500 / (2000 + 6000)) or (8500 / 8000)
  6. [1] Quick ratio 1.06:1 (OF)
  7. [1] Profit for the year to capital employed Workings (7400 / (20000+17000)) * 100
  8. [1] Profit for the year to capital employed 20.00% (OF)
  9. [1] Comment: The quick ratio has deteriorated OR but is still at the accepted level of 1:1
  10. [1] Reason: Trade payables / inventory have increased. Bank overdraft caused by higher expenses/purchase of non-current assets. (Accept other valid reasons)
  11. [1] Comment: Profit to the year to capital employed has improved
  12. [1] Reason: Lower expenses/higher profit. Lower non-current liabilities. Increased drawings. (Accept other valid reasons)
  13. [1] Proposal 2: Working capital decrease
  14. [1] Proposal 2: Profit no effect
  15. [1] Proposal 3: Working capital decrease
  16. [1] Proposal 3: Profit decrease
  17. [1] Proposal 4: Working capital no effect
  18. [1] Proposal 4: Profit no effect
  19. [1] Narrows the effect of difference and variation in accounting practice with other businesses
  20. [1] Improves comparability to other businesses
  21. [1] Improves reliability of financial statements
  22. [1] Improves understandability of financial statements (1 mark for each reason, maximum 2)

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About this question

Topic
Analysis and interpretation, O-Level Accounting (syllabus 7707). Structured question, 20 marks.
Source
O-Level Accounting, May/June 2018 Paper 2 Variant 2, question 4.

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