Financial Accounting CPA revision questions and answers

Financial Accounting CPA revision questions and answers

Question one

The following is the trial balance of Scem Farm on 31st  Dec 2018:

Debts   Land and buildings Farm machine Sundry debtors Cash in hand Stock 1.1.2018 Growing crops, wheat seeds and fertilizers Livestock Feeding materials Manager’s salary Farm labour Office expenses Crop expenses Livestock purchases Livestock expense Farm house expenses Staff meals Repairs on machinery Interest on loan (crop) Tool and implements

210,000 108,000 30,000 26,000     20,000 25,000 6,000 6,000 5,000 4,000 10,000 12,000 28,300 12,000 500 1,000 4,000     2,500 500,000

Creditors Capital Profit & Loss account Loan Provision for depreciation Sale of wheat Sale of livestock Managers personal a/cs Bank overdraft Sandy creditors

270,00 10,000 60,000 60,000 30,000 35,000 75,000 2,000 3,000 15,000                             500,000

 

Additional information

1.Stock on 31.12.2018

 

Growing crops, wheat, seeds and fertilizers Livestock Tools and implements Feeding materials

Shs.’000’ 10,000 40,000 2,000 1,000

2. Depreciation on tool and implements is to be apportioned between crops and livestock equally.
3. The livestock is charged with 20% of manager’s salary and staff meals.

Required:

Prepare Crop Account, Livestock Account, Profit and Loss Accounts and a balance sheet as at that date.

Answer:

 

 

Crop and Livestock A/c

 

Opening stock	Crop	Livestock
Growing  crops,  wheat,  seeds and fertilizers Livestock Feeding material Salaries and wages:   Manager’s salary Labor Crop expenses Livestock expenses Livestock purchases Farmhouse expenses Staff meals Repairs to machinery Interest loan Sale of wheat Sale of livestock   Closing stock Crops,wheat,seeds and fertilizers Live stock F. materials Net loss	20,460   4,800 5000 10,000 1200 400 1000       35,000         10,000   1650	25,000 6000   1,200 28,300 12,500   100   250 42,650   75,000       40,000   1,000
Dep: tools and implements Net profits	46,650	116,000

  Profit and Loss A/c                                

Crop net loss Office expenses Net profit         P & L bal c/d

1,650 4,000 37,000 42,650     47,000 47,000

Net profit Live stock     Net profit P & L b/f

42,650 42,650 37,000 10,000 47,000

 

Balance sheet as at 31 December

Capital Profit & Loss Loan Current Liabilities Creditors Manager’s personal A/c Bank overdraft

Land & buildings Farm machinery (net of Dept) Tool and implements Current Assets Growing  crops,  wheat,  seeds  and fertilizers. Livestock Farm materials Debtors Cash in Hand 397,000

210,000 78,000   20,000     10,000 40,000 1,000 30,000   26,000

290,000             107,000 397,000

 

Working

.          1.Depreciation of tools and implements

Balance b/f Less: balance b/f       Depreciation: Crop Livestock

Sh. 2,500 2,000 500        250    250

 

2. Manager Salary

Crop A/c 80% Livestock 20%

Sh. 4,800 1,200 6,000

 

3.Staff meals

Crop A/c 80% Livestock 20%

Sh.   400 100 500

 

Question 2

Excel Business services sells its goods in containers which are returnable.  These containers are purchased by the  company  at  Sh.20  per  container  but  each  container  is  written  down  to  the  book  value  of  Sh.15  per container immediately it is purchased.  For stock taking purposes all containers are valued Sh.15 per container irrespective of whether they are still in stock or in the hands of customers.   Containers are charged out to customers at Sh.25 per container, but the customer is credited with Sh.18 per container if it is returned in good condition within three months of receipt.

The following information relates to the year ended on 31st  March 2018

(i) .Stock at 1.4.2018

Premises:                   10,000

Customers:                  2,000

(ii). During the year 15,000 containers were purchased

(iii). 40,000 containers were returned by customers within the time limit

(iv) .3,000  containers  were  not  returned  by  customers  within  the  time  limit.These  were considered as kept by the customers permanently.

(v) .1,000 containers were scrapped and sold for Sh.3,000

vi)  Shs.7,000 were spent on the repair of the containers.

(vii) On 31st  March 2003, 4,000 containers were in the possession of customers.

Required:

Prepare container stock and suspense account for the year ended 31st  March 2003 and find the profit or loss made on containers

Answers

Statement showing the profit on containers

Hiring charge Add profit on containers kept by customers (3 x 3000) Less:Repaires Depreciation on containers (5 x 15,000) Less: loss on scrapped containers (15,000 –30,000) Profit on containers

7,000 75,000   12,000

280,000       9,000 289,000      94,000   195,000

 

Question 3

(a) Explain briefly the application of the accruals and prudence concepts in the accounting for long term construction contracts

Answer

Accruals:   Revenues and costs are accrued i.e. recognized as they are earned or incurred (not when money  is  received  or  paid)  and  recorded  in  the  financial  statements  of  the  periods  to  which  they relate.  It means an expense which is incurred in one period should be charged against profit of that period whether or not it has been paid for by the accounting date.   As per IAS 11 this concept is followed under:

(i)  The costs attributable to the contract can be clearly identified.

(ii) The cost included in the amount of the construction contract should comprise those costs that relate directly to specific contracts.

Prudence  Concept:  Uncertainties  inevitably  surround  many  transaction  and  revenue  and  profits should not be anticipated but recognized only when they are realized in form of cash or other assets which  can  be  treated  as  cash.   This  concept  means  that  all  anticipated  losses  must  be  taken  into consideration e.g. provision for bad debts etc.  However the prudence does not justify the creation of secret or hidden reserves. As per IAS 11 “a foreseeable loss on contract should be provided for in the statement both for the stage of completion of contract reached on the contract and for future work on the contract.

 

(b) Ujenzi Limited are engaged in a number of long-term contracts. The following details relate to the three uncompleted contracts in the company’s books at 31 August 2017

 

Contract No.	X012 Sh.’000’	X022 Sh.’000’	X023 Sh.’000’
Cost of work to 31st  Aug. 2017	1,218	1,091	545.6
Cost of work to 31st  Aug. 2017 Value of work 31 Aug. 2017 as certified by contract architects	1,540	880	572
Progress payments invoice to 31 Aug. 2017	1,320	704	440
Process payment received by 31 Aug. 2017	1100		440
Final cost including future costs of rectification and guarantee work	1320	1540	2,640
Final contract price	1,672	1,232	3,520

 

Note 1: The cost of work to 31 Aug. 2003 has been determined after crediting unused materials and written down for plant of use.

Required:

(a) Prepare a statement for the managing director showing your calculations for each contract of valuation  of  W.I.P  at  31  Aug.  2003  and  of  profit  or  loss  included  therein  (use  %  of completion) (12 marks)

(b) Show as an extract the information which should appear in the balance sheet for the work in progress.

 

Answer

1. Notes contract No. X022

Has a foreseeable loss of Sh.308,000 which is to be charged in full against the Profit & Loss account for the year.  Actual loss to date is Sh. 211,200.

2. Contract No. X023

Has not advanced since its degree of completion of 16% is less than the recommended 20%. No profit is to be recognized in this contract.

3. Value of W.I.P for balance sheet W.I.P is valued less invoiced amount.

4. The  difference  between  the  invoiced  and  paid  amount  is  either  amount  retained  or  the receivable and is shown as separate asset in the balance sheet.

(b) Show as an extract the information which should appear in the balance sheet for the work in progress.(3 marks)

 

Question four

The following  figures  have  been  extracted  from  the  books  of  Mwananchi  Bank  Ltd.  for  the  year  ended 31.12.2017

Share capital authorized and issued	Sh.’000’
1,000,000 shares of Sh.100, Sh.50 paid	50,000
Reserve Fund	2,500
Fixed deposit account	9,500
Saving bank deposits	30,000
Current account	80,000
Money at call and short notice	3,000
Investment (cost	30,000
Interest accrued and paid	2,000
Salaries (including directors fee Sh.50,000)	800
Rent	200
General expenses including auditors fee Sh.20,000	100
Profit and loss (1.1.2017)	60,600
Dividend for 2,000	500
Premises (after depreciation to 1.12.000 Sh.10M)	120,000
Cash in hand	600
Cash with Central Bank	15,000
Cash with other banks	13,000
Borrowed from other banks	7,000
Interest and discounts	11,500
Bills discounted and purchased	6,000
Bills payable	8,000
Loan overdraft and cash credits	70,000
Unclaimed dividends	300
Bills for collection	1,400
Acceptance and endorsements	2,000
Sundry creditors	300

 

Notes:
(i) Rebate on bills discounted and purchased for unexpired term amounts to Sh.50,000.
(ii) Depreciation on premises is on straight line, 5% on cost while the provision for
doubtful debts Sh.300,000 is required.
(iii) The bank has no business in outside Kenya, a provision for taxation Sh.1,000,000 is to
be credited.

 

Required:
Prepare:
(a) Profit & Loss A/c for the year ended 31.12.2000
(b) Balance sheet as at that date. (Total 20 Marks)

 

Answer

Mwananchi Bank
Profit and loss for the year ended 31 .12.2017

Turnover Profit before taxation Taxation Profit after tax Balance b/f Balance c/d

Notes 2

Sh.’000’ 11,450 1550 1,000 550 60,600 61,150

 

Balance sheet as at 31.12.2017

Current liabilities

Financed by:

Issued and authorized share capital 1,000,000

Ordinary shares of Sh.100 each, Sh.50 paid	50,000
Reserves:
Share premium	3,500
Profit and loss a/c	61,150
	114,650

 

Notes to accounts
1. Turnover: Based on interest and discount earned Net rebate on bills discounted for Sh.50,000

2. Profit before taxation: this is after accounting for:

Depreciation charge: 6,500
Directors’ fee: 50
Auditors fee: 20

3. Bills discounted and purchased: This is net of Sh.50,000 being rebate on bills discounted

4. Loans, overdraft and cash credits – Is shown net of Sh.300,000 provisions for doubtful debts.

 

.

 

Question five

1 (a).Internal control systems are designed, among other things, to prevent error and  misappropriation.

Required:

Describe the errors and misappropriations that may occur if the following are not properly controlled:

(i) Receipts paid into bank accounts; (2 marks)
(ii) Payments made out of bank accounts; (3 marks)
(iii) Interest and charges debited and credited to bank accounts. (2 marks)

Answer

i) Receipts

-Money paid into the bank may be stolen. If cash is not properly controlled it is possible to falsify documentation in relation to receivables, and to pay company receipts into private bank accounts. This is sometimes known as ‘teeming and
lading’.

-Money paid into the bank may be incorrectly accounted for, either by the bank or by the company, if there are no controls to check the accuracy of the company’s records or the bank statements. This could mean that the internal records and the
financial statements are incorrect.

 

(ii) Payments

-Money paid out of the bank may be paid to incorrect suppliers, or may be paid for incorrect amounts resulting in operational difficulties with cash and supplier management;

-Money paid out of bank accounts may also be misappropriated by payments for goods and services that are not received, or simply by payments into private bank accounts if there are no controls to prevent this.

 

(iii) Interest and charges

Banks make errors in calculating interest and charges. If the company does not check these, it may lose money and the amounts appearing in the financial statements may be incorrect. This is particularly important for companies that hold high levels of cash

 

1.(b) A book-selling company has a head office and 25 shops, each of which holds cash  (banknotes, coins, and credit card vouchers) at the balance sheet date. There are no receivables. Accounting records are held at shops. Shops make returns to head office and head office holds its own accounting records. Your firm has been the external auditor to the company for many years and has offices near to the location of some but not all of the shops.

 

Required:

List the audit objectives for the audit of cash and state how you would gain the audit evidence in relation to those objectives at the year-end. (8 marks)

Audit objectives are dealt with in ISA 500 ‘Audit Evidence’

(i) Existence: to ensure that the cash actually exists at a given date. The related  evidence will include cash counts. Cash counts need not necessarily be conducted at each location (unless the amounts are material), the firm might consider conducting counts on a rotational basis, year on year. The decision as to which sites to visit might be determined on the basis of materiality and analytical
procedures. Cash balances should be reconciled to records held at the shop and records held at head office. Any shortfalls in cash, or ‘IOUs’ should be thoroughly investigated

(ii) Completeness: to ensure that there is no unrecorded cash. This means  reconciling cash balances to records held at the shop and records held at head office, as above, ensuring that proper sales cut-off has been achieved.

(iii) Rights and obligations: to ensure that the company has a right to the cash.This means checking to ensure that credit card vouchers are correctly made payable to the company, and not to third parties.

(iv) Occurrence: to ensure that the cash belongs to the company at the year-end  date.This means checking to ensure that no credit card vouchers are post-dated.

(v) Measurement: to ensure that amounts are correctly recorded in the proper  period. This means ensuring that cut-off is correct and consistent between the records held at shops, the returns to head office, and the records held at head office

(vi) Presentation and disclosure:  to ensure that the cash balance and related income statement entries are correctly disclosed in the financial statements in accordance with legislation and accounting standards.

 

1. (c) The external auditors of companies often write to companies’ bankers asking for  details of bank balances and other matters at the year-end.

Required:
Explain why auditors write to companies’ bankers and list the matters you would expect banks to confirm. (5 marks)

This matter is noted in ISA 505 ‘External Confirmations’. Auditors seek bank confirmations in order to provide third party, written evidence  in relation to the balance sheet disclosure of cash, liabilities and related items.

The matters typically confirmed by the bank include:

(i) Details of all bank balances, overdrafts and loans held at all branches.
(ii) The charges or restrictions over any such accounts.
(iii) The terms and repayment conditions of loans and overdrafts.
(iv) Any right of set-off between accounts in credit and other balances.
(v) Any securities held by the bank (such as fixed assets charged as security).
(vi) Any relationships with other banks the bank is aware of.

 

Question six

Towards the end of an audit, it is common for the external auditor to seek a letter of representation (written representations) from the management of the client company.

Required:
(a) Explain why auditors seek letters of representation. (5 marks)

Answer

-Auditors seek a letter of representation in order to obtain written audit evidence on matters that are material to the financial statements when other sufficient appropriate audit evidence cannot reasonably be expected to exist (ISA 580 ‘Management Representations’).

-Representations may be the only evidence, which can reasonably be expected to be available, but they cannot be a substitute for other audit evidence that could reasonably be expected to be available. Such matters may include management’s intention to hold an item for long-term appreciation.

-The letter also ensures that directors acknowledge their collective responsibility forthe presentation and approval of the financial statements. The letter is signed by those with knowledge of the matters concerned, on behalf of management.

(b) List the matters commonly included in the letter of representation. (6 marks)

Answer

• Confirmation of responsibility for, and approval of, the financial statements.
• Confirmation that all of the accounting records, and all related documentation
  (such as minutes of management and shareholder meetings) have been made
  available, and that company transactions have been properly reflected therein.
• Confirmation of the expected outcome of legal claims.
• Confirmation of company plans in relation to certain tax provisions.
• Confirmation of the completeness of disclosure of related party transactions.
• Confirmation that there have been no post-balance sheet events that require revisions to the financial statements.

 

c) Explain why it is important to discuss the content of the letter of representation at an early stage during the audit. (3 marks)

Answer

• It is important to discuss the contents of the letter at an early stage because directors may disagree with what the auditors wish them to sign.
• It is important in such cases for negotiations to take place and the letter to be redrafted until it is acceptable to both auditor and client.
• The management representation letter is often regarded as a critical piece of audit evidence and if it is left to a late stage in the audit, when there is pressure on auditors and clients alike, negotiations may be difficult.

(d) Explain why management is sometimes unwilling to sign a letter of representation and describe the actions an external auditor can take if management refuses to sign a letter of representation.

• Management is sometimes unwilling to sign because they feel that auditors should be able to obtain independent evidence in relation to the relevant matters. Alternatively, they may feel that the auditors are trying to shift responsibility for the audit to them;
• Sometimes, management is genuinely uncertain about whether it is sure of the matters included. However, there are occasions on which management is trying to ‘hide’ from the auditors the fact that the income recorded is incomplete, or
  the fact that there is an outstanding undisclosed legal claim against the company, for example;
• Auditors should attempt to negotiate an agreement, as noted above. A formal letter may not be necessary, if management is able to provide some other written confirmation, such as a note of a meeting. Alternatively, a list of issues may be taken to the client to establish exactly which representations are causing the problem, and the letter redrafted;
• If management still refuses to sign, and the auditor feels that the matter is critical to the financial statements, it may be necessary to qualify the audit report with an ‘except for’ (or even disclaimer of) opinion, on the basis of a limitation in the scope of the audit.

Question 7

The responsibilities of external auditors are not always well understood, especially with regard to the detection and reporting of fraud. When external auditors provide non-audit services to their audit clients, it is essential that the auditors make a clear
distinction between their audit and non-audit responsibilities.

Required:
a) Explain the responsibilities of external auditors to directors and shareholders. (5  marks)

Answer

•  The external auditors are required to prepare a report to shareholders on the truth and fairness (or fair presentation) of financial statements prepared by management for the benefit of shareholders.
• The auditors, if appointed by shareholders, act as agents for the shareholders in the same way as directors act as agents for the company.
• Auditors have no specific duties to directors although it is clearly necessary that an adequate working relationship is formed in order that the audit can be performed properly. Directors generally have a duty to provide auditors with
  the information and explanations they require to perform the audit.
• Auditing standards require that auditors report weaknesses in systems that they discover during the course of their audit to management (ISA 400 ‘RiskAssessments and Internal Control’).

b) Describe the limitations of the external audit in relation to the detection and  reporting of fraud. (5 marks)

Answer

• Auditing standards require that auditors plan and perform their audits with a reasonable expectation of detecting fraud and error if they are material to the financial statements (ISA 240 ‘Fraud and Error’).
• It is commonly believed that the purpose of the external audit is to detect, and report, fraud and error. The detection and reporting of such matters is secondary to forming an opinion on the financial statements.
• Material fraud is often very difficult to detect, however, and an auditor has not necessarily failed in his duty if he fails to detect such a fraud.
• Most frauds are small, and immaterial to the financial statements. If auditors detect frauds, they have a duty to report such matters to the management of the company regardless of whether they are material or immaterial. Only
  matters that are material need to be reported in the financial statements.

C) Explain why it is essential for external auditors to be independent of their clients.  (5 marks)

Answer

• External auditors are unable to fulfill their duties to shareholders if they are not independent of the entity on which they are reporting.
• If external auditors have an interest in the financial statements on which they are reporting, they may not be objective. For example, if, in the case of a listed company, they have prepared the financial statements on which they are
  reporting, their view may not be considered objective.
• If they have financial or employment connections with the company on which they are reporting they will not be objective.
• If they provide a significant level of additional services to the entity, it is argued that they cannot report objectively as auditors to shareholders.

 

d) Explain the advantages and disadvantages of external auditors providing  consulting services to their audit clients. (5 marks)

Answer

• The principal advantage of providing consulting services lies in the fact that auditors are best placed to provide such services, because they have an intimate knowledge of the operations of the company.
• Equally, if they provide consulting services, the knowledge so obtained will be useful in conducting the audit, and experience in general of consulting better enables auditors to conduct their duties as auditors, because knowledge of
  other industries can be brought to bear on the client.
• The principal disadvantage is that auditors often make a lot of money from such work, and it is argued that auditors are not objective in these circumstances because they would be unwilling to challenge directors or issue a
  qualified audit report for fear of losing the fees for consulting work.
• The other disadvantage is that if they have implemented systems that produce the financial statements, they are unlikely to give a qualified audit report on the information that those systems produce.