Question 1. Diversity Ltd. shows the following final balances for the different accounts on
31st December 2021 (the accounting-year end):
Account name
Value (£)
Sales
600,000
Purchases
230,000
Administration expenses
60,000
Distribution expenses
20,000
Inventory at 31/12/2020
340,000
Buildings
110,000
Accumulated depreciation Buildings at 01/01/2021
30,000
Capital (ordinary shares £1 each)
200,000
Retained earnings at 31/12/2020
30,000
Share premium
5,000
Trade payables
25,000
Long-term debts
86,500
Trade receivables
12,500
Cash
214,000
Allowance for trade receivables
10,000
Required:
a) Prepare the Trial Balance for Diversity Ltd. on 31st December 2021 corresponding to
the previous information.
b) Considering the following additional information, prepare the Income Statement for
Diversity Ltd. on 31st December 2021:
Additional Information:
1) Inventory was valued at £130,000 on 31st December 2021.
2) Buildings have a useful life of 10 years. Diversity Ltd. uses the straight line method
for depreciation.
3) Directors have decided to write off £1,000 of trade receivables as bad debt.
4) The figure for administration expenses includes a prepayment of £35,000 for
insurance.
5) On 31st December 2021, Diversity Ltd. has salaries still outstanding amounting to
£2,000.
6) Distribution expenses from the trial balance correspond to services consumed by
the company but not paid during the current accounting period.
7) Corporation tax rate equals 20%.
c) Draw the journal entries corresponding to the additional information of b). 2
Question 1 Solutions:
a) The Trial Balance is as follows:
DEBIT CREDIT
Account name
Sales
600,000
Purchases
230,000
Administration expenses
60,000
Distribution expenses
20,000
Inventory at 31/12/2020
340,000
Buildings
110,000
Accumulated depreciation Buildings at 01/01/2021
30,000
Capital (ordinary shares £1 each)
200,000
Retained earnings at 31/12/2020
30,000
Share premium
5,000
Trade payables
25,000
Long-term debts
86,500
Trade receivables
12,500
Cash
214,000
Allowance for trade receivables
10,000
TOTAL
986,500 986,500
b) To generate the Income Statement, we need to think about the accounts
movement (and journal entries) related to each of the 7 points within additional
information.
1) Inventory was valued at £130,000 on 31st December 2021.
With this information and the information from the trial balance we can calculate the cost of
goods sold.
Cost of Goods Sold = Opening Inventory + Purchases – Closing Inventory
2) Buildings have a useful life of 10 years. Diversity Ltd. uses the straight line method
for depreciation.
Depreciation annual amount is (Buildings Value-residual value)/useful life = £110,000/10 =
£11,000
3) Directors have decided to write off £1,000 of trade receivables as bad debt.
This generates an expense of £1,000 and a decrease in trade receivables of £1,000.
4) The figure for administration expenses includes a prepayment of £35,000 for
insurance.3
This generates a decrease in expenses of £35,000 and a Prepaid Expenses (asset) of
£35,000.
5) On 31st December 2019 Diversity Ltd. has salaries still outstanding amounting to
£2,000.
This generates an expense of £2,000 and Accrued Expenses (liability) of £2,000.
6) Distribution expenses from the trial balance correspond to services consumed by the
company but not paid during the current accounting period.
This generates an expense of £20,000 and Accrued Expenses (liability) of £20,000.
7) Corporation tax rate equals 20%.
This creates a tax expense and tax payable. We need to calculate 20% of profit before tax.
INCOME STATEMENT (30/12/2021)
Sales
600,000
Cost of goods sold
(440,000)
Gross Profit
160,000
Admin expenses
(25,000)
Salaries
(2,000)
Distribution expenses
(20,000)
Depreciation expense
(11,000)
Bad debt expense
(1,000)
Operating Profit
101,000
Profit before tax
101,000
Tax
(20,200)
Profit after tax
80,800
c)
1) Inventory was valued at £130,000 on 31st December 2021.
With this information we can calculate the cost of good sold.
COGS = 340,000+230,000-130,000 = 440,000
Closing inventory (it will appear at the Statement of Financial Position) = 130,000
2) Buildings have a useful life of 10 years. Diversity Ltd. uses the straight line method for
depreciation.
Depreciation amount: 110,000/10 = £11,000
Debit
Credit
Depreciation expense
(buildings)
11,000
Accumulated depreciation
(buildings)
11,0004
3)_Directors have decided to write off £1,000 of trade receivables as bad debt.
Directors have decided to write off £1,000 of trade receivables as bad debt.
Debit
Credit
Bad debt expense
1,000
Trade receivables
1,000
4)_The figure for administration expenses includes a prepayment of £35,000 for insurance.
Debit
Credit
Administration expenses
35,000
Prepayment
35,000
5)_On 31st December 2021, Diversity Ltd. has salaries still outstanding amounting to £2,000.
Debit
Credit
Salary expenses
2,000
Accrued expenses
2,000
6)_Distribution expenses from the trial balance correspond to services consumed by the
company but not paid during the current accounting period.
Debit
Credit
Distribution expenses
20,000
Accrued expenses
20,000
7) Corporation tax rate equals 20%.
Debit
Credit
Tax expenses
20,200
Tax payables
20,2005
Question 2. Following the information from Question 1 and additionally considering that
£20,200 need to be added to prepayments and £200 of purchases have not been paid on
cash, prepare the Statement of Financial Position for Diversity Ltd. on 31st December
2021.
Question 2 Solutions:
With this information, before creating the Statement of Financial Position of Diversity Ltd. on
31/12/2021, we need to increase prepayments in £20,200 and Trade Payables in £200.
Statement of Financial Position (31/12/2021)
Non-Current Assets
Buildings
110,000
Accumulated Depreciation (Buildings)
(41,000)
Current Assets
Inventory
130,000
Trade Receivables
11,500
Allowance for trade receivables
(10,000)
Prepaid expenses
55,200
Cash
214,000
Total Assets
469,700
Equity
Capital (ordinary shares)
200,000
Retained Profit
110,800
Share premium
5,000
Long term Liabilities
Long-term debt
86,500
Current Liabilities
Trade Payables
25,200
Accrued Expenses
22,000
Tax Payable
20,200
Total Equity and Liabilities
469,700Question 3. Pantalaimon Ltd. plans to start a business on 01/09/2023 making and selling
golden compasses. The budget details are as follows:
• The budgeted sales for the first three months of activity are expected to be £850,000 in
total. It is expected that 70% of the total sales will be achieved in September, 20% in
October and the rest in November.
• Customers must pay a deposit of 10% of the value of the order when they sign the
contract and the other 90% is paid three months later. No bad debts are anticipated in
the first three months of trading.
• Wages and salaries will be payable on the last day of the month. Pantalaimon Ltd. will
have 6 employees, each of them with an annual gross salary of £35,000.
• A marketing and advertising campaign will be launched in October 2023 at a cost of
£10,000 on that month. There will also be monthly payments of £4,000 starting in
November 2023.
• Compasses components will be purchased each month equal to 5% of that month’s
sales. Trade creditors are paid in full in cash in the month following the purchase.
• The company will have £10,000 of cash in the bank on 01/09/2023.
Required:
a) Prepare the cash budget by month and in total for the three months period
September 2023 to November 2023.
b) Considering the net cash flow for September 2023, October 2023 and November
2023, which would be your advice for Pantalaimon Ltd.? Explain your answer in
detail.
67
Question 3 Solution:
a)_Prepare the cash budget by month and in total for the three months period September
2023 to November 2023.
September
2023
October
2023
November
2023
Total
SALES
595,000
170,000
85,000
850,000
Cash Budget for Pantalaimon
Ltd
September
2023
October
2023
November
2023
Total
Receipts
Customers
59,500
17,000
8,500
85,000
after three months
0
TOTAL RECEIPTS
59,500
17,000
8,500
85,000
Payments
Salaries*
17,500
17,500
17,500
52,500
Marketing
10,000
4,000
14,000
Compasses components
29,750
8,500
38,250
TOTAL PAYMENTS
17,500
57,250
30,000
104,750
Net cash flow
42,000
-40,250
-21,500
-19,750
Opening Balance
10,000
52,000
11,750
10,000
Closing Balance
52,000
11,750
-9,750
-9,750
*Salaries are calculated as (£35,000×6)/12 = 17,500
b)_Considering the net cash flow for September 2023, October 2023 and November 2023,
which would be your advice for Pantalaimon Ltd.? Explain your answer in detail.
The net cash flow is negative on October 2023 and November 2023. The closing balance is
negative in November. The company should maybe reconsider the agreement with the
customers. The company could also reduce the payments. 8
Question 4. Pikachu Ltd. manufactures and sells pokeballs. Current sales output is 5 million
annually at a selling price of £0.50 per unit. Total annual fixed costs are £900,000. Variable
costs are £0.30 per unit.
Required:
(consider each case separately)
a) What is the current annual operating profit?
b) Which amount of pokeballs needs to be sold by Pikachu Ltd. in a year for the total
contribution to be equal to total fixed costs?
c) How would your answers in question a) and b) change if there is a 10% increase in
the selling price and £20,000 increase in fixed costs (ceteris paribus).
Question 4 Solution:
a)_What is the current annual operating profit?
Contribution per unit = Price per unit – Variable cost per unit
= £0.50 – £0.30 = £0.20 (per unit)
Profits = Total Revenues – Total costs
= (5,000,000 x £0.50) – (5,000,000 x £0.30) – £900,000 =
= 2,500,000 – 1,500,000 – 900,000 = £100,000
The company is doing positive profits selling 5 million units. Thus, the current amount sold
by Pikachu Ltd. (5 million units) is larger than the Break-even point.
£
Revenue
2,500,00
Total Variable Cost
(1,500,000)
Total Contribution
1,000,000
Total Fixed Costs
(900,000)
Profit
100,000
b)_Which amount of pokeballs needs to be sold by Pikachu Ltd. in a year for the total
contribution to be equal to total fixed costs?
BEP = Fixed Cost / Contribution per unit
= £900,000 / £0.20 = 4,500,000 pokeballs
BEP (£ of sales) = BEP (in units) x unit selling price
= 4,500,000 x £0.50 = £2,250,0009
c)_How would your answers in question a) and b) change if there is a 10% increase in the
selling price and £20,000 increase in fixed costs (all the rest remains constant).
New selling price = £0.50 x 1.1 = £0.55
New Contribution = New selling price – variable cost per unit = £0.55 – £0.30 = £0.25
New Fixed Costs = £900,000 + £20,000 = £920,000
• Profit if selling 5 million units: Total Revenues – Total costs
= (5,000,000 x £0.55) – (5,000,000 x £0.30) – £920,000 = £330,000
£
Revenue
2,750,00
Total Variable Cost
(1,500,000)
Total Contribution
1,250,000
Total Fixed Costs
(920,000)
Profit
330,000
• New break-even point = New Fixed Costs / New contribution per unit
= £920,000 / £0.25 = 3,680,000 pokeballs
£
Revenue
20,240,000
Total Variable Cost
(11,040,000)
Contribution
920,000
Total Fixed Costs
(920,000)
Profit
0
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