CIMA CO2 Official Learning System - Fundamentals of Financial Accounting

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FUNDAMENTALS OF FINANCIAL ACCOUNTING C2

CONTENTS

14.6 Liquidity ratios 510

14.6.1 The current ratio 510

14.6.2 The quick ratio 510

14.7 Efﬁ ciency ratios 511

14.7.1 Asset turnover ratios 511

14.7.2 Inventories days 511

14.7.3 Receivables days 513

14.7.4 Payable days 513

14.7.5 Total working capital ratio 513

14.8 Capital structure ratios 514

14.8.1 The gearing ratio (or leverage ratio) 514

14.8.2 Interest cover 515

14.9 Ratio analysis for sole traders 515

14.10 Summary 515

Revision Questions 517

Solutions to Revision Questions

539

Preparing for the Computer-Based

Assessments (CBAs)

553

Revision technique 555

Planning 555

Getting down to work 556

Tips for the ﬁ nal revision phase 556

Format of the Assessment 556

Structure of the assessment 556

Weighting of subjects 557

Revision Questions 559

Solutions to Revision Questions

639

Mock Assessment 1 681

Mock Assessment 2

707

Index

731

How to use your CIMA Learning System

This Financial Accounting Fundamentals Learning System has been devised as a resource for

students attempting to pass their CIMA computer-based assessments, and provides:

●

a detailed explanation of all syllabus areas;

●

extensive ‘ practical ’ materials;

●

generous question practice, together with full solutions;

●

a computer-based assessments preparation section, complete with computer-based

assessments standard questions and solutions.

This Learning System has been designed with the needs of home-study and distance-

learning candidates in mind. Such students require very full coverage of the syllabus

topics, and also the facility to undertake extensive question practice. However, the

Learning System is also ideal for fully taught courses.

The main body of the text is divided into a number of chapters, each of which is organ-

ised on the following pattern:

●

Detailed learning outcomes . This is expected after your studies of the chapter are com-

plete. You should assimilate these before beginning detailed work on the chapter, so that

you can appreciate where your studies are leading.

●

Step-by-step topic coverage . This is the heart of each chapter, containing detailed explana-

tory text supported where appropriate by worked examples and exercises. You should

work carefully through this section, ensuring that you understand the material being

explained and can tackle the examples and exercises successfully. Remember that in

many cases knowledge is cumulative: if you fail to digest earlier material thoroughly, you

may struggle to understand later chapters.

●

Activities . Some chapters are illustrated by more practical elements, such as comments

and questions designed to stimulate discussion.

●

Question practice . The test of how well you have learned the material is your ability to

tackle exam-standard questions. Make a serious attempt at producing your own answers,

but at this stage do not be too concerned about attempting the questions in computer-

based assessments conditions. In particular, it is more important to absorb the mate-

rial thoroughly by completing a full solution than to observe the time limits that would

apply in the actual computer-based assessments.

The CIMA

Learning System

FUNDAMENTALS OF FINANCIAL ACCOUNTING C2

xii

THE CIMA LEARNING SYSTEM

●

Solutions . Avoid the temptation merely to ‘ audit ’ the solutions provided. It is an illusion

to think that this provides the same beneﬁ ts as you would gain from a serious attempt

of your own. However, if you are struggling to get started on a question you should read

the introductory guidance provided at the beginning of the solution, where provided,

and then make your own attempt before referring back to the full solution.

Having worked through the chapters you are ready to begin your ﬁ nal preparations for the

computer-based assessments. The ﬁ nal section of this CIMA Learning System provides you

with the guidance you need. It includes the following features:

●

A brief guide to revision technique.

●

A note on the format of the computer-based assessments. You should know what to

expect when you tackle the real computer-based assessments and in particular the

number of questions to attempt.

●

Guidance on how to tackle the computer-based assessments itself.

●

A table mapping revision questions to the syllabus learning outcomes allowing you to

quickly identify questions by subject area.

●

Revision questions. These are of computer-based assessments standard and should be tack-

led in computer-based assessments conditions, especially as regards the time allocation.

●

Solutions to the revision questions.

Two mock computer-based assessments. You should plan to attempt these just before the

date of the real computer-based assessments. By this stage your revision should be complete

and you should be able to attempt the mock computer-based assessments within the time

constraints of the real computer-based assessments.

If you work conscientiously through this CIMA Learning System according to the guide-

lines above you will be giving yourself an excellent chance of success in your computer-

based assessments. Good luck with your studies!

Guide to the Icons used within this Text

Key term or deﬁ nition

Exam tip or topic likely to appear in the computer-based assessments

Exercise

Question

Solution

Comment or Note

Study technique

Passing exams is partly a matter of intellectual ability, but however accomplished you are in

that respect you can improve your chances signiﬁ cantly by the use of appropriate study and

revision techniques. In this section we brieﬂ y outline some tips for effective study during

xiii

FUNDAMENTALS OF FINANCIAL ACCOUNTING

THE CIMA LEARNING SYSTEM

the earlier stages of your approach to the computer-based assessments. Later in the text we

mention some techniques that you will ﬁ nd useful at the revision stage.

Planning

To begin with, formal planning is essential to get the best return from the time you

spend studying. Estimate how much time in total you are going to need for each paper

you are studying for the Certiﬁ cate in Business Accounting. Remember that you need to

allow time for revision as well as for initial study of the material. The amount of notional

study time for any paper is the minimum estimated time that students will need to

achieve the speciﬁ ed learning outcomes set out below. This time includes all appropri-

ate learning activities, for example, face-to-face tuition, private study, directed home

study, learning in the workplace, revision time, and so on. You may ﬁ nd it helpful to

read Better Exam Results: A Guide for Business and Accounting Students by Sam Malone,

Elsevier, ISBN: 075066357X. This book will provide you with proven study techniques.

Chapter by chapter it covers the building blocks of successful learning and examination

techniques.

The notional study time for the Certiﬁ cate in Business Accounting paper

Fundamentals of Financial Accounting is 130 hours. Note that the standard amount

of notional learning hours attributed to one full-time academic year of approximately 30

weeks is 1,200 hours.

By way of example, the notional study time might be made up as follows:

Hours

Face-to-face study: upto 40

Personal study: upto 65

‘ Other ’ study – e.g. learning in the workplace, revision, and so on: up to 25

130

Note that all study and learning-time recommendations should be used only as a guide-

line and are intended as minimum amounts. The amount of time recommended for face-

to-face tuition, personal study and/or additional learning will vary according to the type of

course undertaken, prior learning of the student, and the pace at which different students

learn.

Now split your total time requirement over the weeks between now and the exam. This

will give you an idea of how much time you need to devote to study each week. Remember

to allow for holidays or other periods during which you will not be able to study (e.g.

because of seasonal workloads).

With your study material before you, decide which chapters you are going to study in

each week, and which weeks you will devote to revision and ﬁ nal question practice.

Prepare a written schedule summarising the above – and stick to it!

The amount of space allocated to a topic in the Learning System is not a very good

guide as to how long it will take you. For example, the material relating to the ‘ Conceptual

and Regulatory Framework ’ and the ‘ Accounting Systems ’ both account for 20 per cent

of the syllabus, but the latter has more pages because there are more numerical illustra-

tions which take up more space. The syllabus weighting is the better guide as to how long

you should spend on a syllabus topic. It is essential to know your syllabus. As your course

FUNDAMENTALS OF FINANCIAL ACCOUNTING C2

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THE CIMA LEARNING SYSTEM

progresses you will become more familiar with how long it takes to cover topics in sufﬁ -

cient depth. Your timetable may need to be adapted to allocate enough time for the whole

syllabus.

Tips for effective studying

1. Aim to ﬁ nd a quiet and undisturbed location for your study, and plan as far as possible

to use the same period of time each day. Getting into a routine helps to avoid wast-

ing time. Make sure that you have all the materials you need before you begin so as to

minimise interruptions.

2. Store all your materials in one place, so that you do not waste time searching for items

around your accommodation. If you have to pack everything away after each study period,

keep them in a box, or even a suitcase, which will not be disturbed until the next time.

3. Limit distractions. To make the most effective use of your study periods you should

be able to apply total concentration, so turn off all entertainment equipment, set your

phones to message mode, and put up your ‘ do not disturb ’ sign.

4. Your timetable will tell you which topic to study. However, before diving in and becom-

ing engrossed in the ﬁ ner points, make sure you have an overall picture of all the areas

that need to be covered by the end of that session. After an hour, allow yourself a short

break and move away from your Learning System. With experience, you will learn to

assess the pace you need to work at.

5 . Work carefully through a chapter, making notes as you go. When you have covered a

suitable amount of material, vary the pattern by attempting a practice question. When

you have ﬁ nished your attempt, make notes of any mistakes you made, or any areas

that you failed to cover or covered only skimpily.

6. Make notes as you study, and discover the techniques that work best for you. Your

notes may be in the form of lists, bullet points, diagrams, summaries, ‘ mind maps ’ or

the written word, but remember that you will need to refer back to them at a later date,

so they must be intelligible. If you are on a taught course, make sure you highlight any

issues you would like to follow up with your lecturer.

7. Organise your paperwork. Make sure that all your notes, calculations and articles can

be effectively ﬁ led and easily retrieved later.

Computer-Based Assessments

CIMA uses objective test questions in the computer-based assessments. The most common

types are:

●

Multiple choice, where you have to choose the correct answer from a list of four possible

answers. This could either be numbers or text.

●

Multiple choice with more choices and answers, for example, choosing two correct

answers from a list of eight possible answers. This could either be numbers or text.

●

Single numeric entry, where you give your numeric answer, for example, proﬁ t is

$10,000.

●

Multiple entry, where you give several numeric answers, for example, the charge for elec-

tricity is $2,000 and the accrual is $200.

●

True/false questions, where you state whether a statement is true or false, for example,

external auditors report to the directors is FALSE.

FUNDAMENTALS OF FINANCIAL ACCOUNTING

THE CIMA LEARNING SYSTEM

●

Matching pairs of text, for example, the convention ‘ prudence ’ would be matched with

the statement ‘ inventories revalued at the lower of cost and net realisable value ’ .

●

Other types could be matching text with graphs and labelling graphs/diagrams.

In every chapter of this Learning System we have introduced these types of questions.

For convenience we have retained quite a lot of questions where an initial scenario leads to

a number of sub-questions.

The Fundamentals of Financial Accounting

Syllabus

The computer-based assessments for Financial Accounting Fundamentals is a 2-hour

computer-based assessments comprising 50 compulsory questions, with one or more parts.

There will be no choice and all questions should be attempted if time permits. CIMA are

continuously developing the question styles within the CBA system and you are advised to

try the online website demo at www.cimaglobal.com, to both gain familiarity with assess-

ment software and examine the latest style of questions being used.

CIMA publishing have also developed eSuccess CD’s speciﬁ cally for Exam Practice.

These can be bought from http://cimapublishing.com .

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CIMA Certificate in Business

Accounting

Syllabus Outline

The syllabus comprises:

Topic and Study Weighting

A Conceptual and Regulatory Framework 20%

B Accounting Systems 20%

C Control of Accounting Systems 15%

D Preparation of Accounts for Single Entities 45%

Learning Aims

This syllabus aims to test the student’s ability to:

●

explain the conceptual and regulatory framework of accounting;

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explain the nature of accounting systems and understand the control of such systems;

●

prepare and interpret accounts for a single entity;

●

calculate and interpret simple ratios.

Note:

This syllabus deals with the recording of accounting transactions and the preparation of

accounting statements for single entities . Students will be required to be aware of the format

and content of published accounts but are not required to prepare them. No knowledge

of any speciﬁ c accounting treatment contained in the International Financial Reporting

Standards (IFRSs) – including the International Accounting Standards (IASs) – is neces-

sary, except in terms of how they inﬂ uence the presentation of ﬁ nancial statements. IAS 1

and IAS 7 formats will form the basis of those statements. The terminology used for all

entities will be that seen in the IFRSs. This will enable students to use a consistent set of

accounting terms throughout their studies.

Author’s Note:

IAS 1 has been revised and the new terminology and presentation of ﬁ nancial statements

will be assessable from May 2010. These changes mainly affect Chapter 13 ‘The Financial

Statements of Limited Companies and Statement of Cash Flows’. A change, however,

which does affect all of the Learning System is that a ‘Balance Sheet’ will be called a

‘Statement of Financial Position’ in the computer-based assessment from May 2010. The

term ‘statement of ﬁ nancial position’ is used throughout the Learning System.

FUNDAMENTALS OF FINANCIAL ACCOUNTING C2

xviii

Students who are taking the computer based assessment before May 2010 may also use

this book, but they should note the following differences between the old and revised ver-

sions of IAS 1.

IAS 1 Revised IAS 1

CBA Before May 2010 CBA from May 2010

1 Terminology Balance sheet The balance sheet is renamed ‘Statement

of ﬁ nancial position’

2 Terminology Cash ﬂ ow statement The cash ﬂ ow statement has been renamed

‘Statement of cash ﬂ ows’

3 Terminology Income statement In the accounts of limited companies,

this has been renamed ‘Statement of

comprehensive income’

4 Gains on the

revaluation of

property.

The gain does NOT appear in the

income statement.

The gain is entered in the

statement of changes in equity,

and appears on its own separate

line. The gain appears under the

heading ‘revaluation reserve’.

See Chapter 13

The gain is included in the statement of

comprehensive income, in the section

‘other comprehensive income’.

Total comprehensive income is transferred

to the statement of changes in equity,

and the gain on property revaluation is

analysed under the heading ‘revaluation

reserve’

See Chapter 13.

Assessment Strategy

There will be a computer-based assessments of 2 hours duration, comprising 50 compul-

sory questions, each with one or more parts.

A variety of objective test question types and styles will be used within the assessment.

A Conceptual and Regulatory Framework – 20%

Learning Outcomes

On completion of their studies students should be able to:

(i) identify the various user groups which need accounting information and the qualita-

tive characteristics of ﬁ nancial statements;

(ii) explain the function of, and differences between, ﬁ nancial and management account-

ing systems;

(iii) identify the underlying assumptions, policies and changes in accounting estimates;

(iv) explain and distinguish capital and revenue, cash and proﬁ t, income and expendi-

ture, assets and liabilities;

(v) distinguish between tangible and intangible assets;

(vi) explain the historical cost convention;

(vii) identify the basic methods of valuing assets on current cost, fair value and value in

use bases, and their impact on proﬁ t measures and statement of ﬁ nancial position

(previously known as a balance sheet) values;

(viii) explain the inﬂ uence of legislation (e.g. Companies Acts, EC directives) and accounting

standards on the production of published accounting information for organisations.

CIMA CERTIFICATE IN BUSINESS ACCOUNTING

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FUNDAMENTALS OF FINANCIAL ACCOUNTING

Indicative Syllabus Content

●

Users of accounts and the qualitative characteristics of ﬁ nancial statements; functions of

ﬁ nancial and management accounts; purpose of accounting statements; stewardship; the

accounting equation.

●

Underlying assumptions, policies and changes in accounting estimates, capital and rev-

enue, cash and proﬁ t, income and expenditure, assets and liabilities.

●

Tangible and intangible assets.

●

Historical cost convention.

●

Methods of asset valuation and their implications for proﬁ t measurement and the state-

ment of ﬁ nancial position.

●

The regulatory inﬂ uence of company law and accounting standards; items in formats for

published accounts.

B Accounting Systems – 20%

Learning Outcomes

n completion of their studies students should be able to:

(i) explain the purpose of accounting records and their role in the accounting system;

(ii) prepare cash and bank accounts, and bank reconciliation statements;

(iii) prepare petty cash statements under an imprest system;

(iv) prepare accounts for sales and purchases, including personal accounts and control

accounts;

(v) explain the necessity for ﬁ nancial accounting codes and construct a simple coding

system;

(vi) prepare nominal ledger accounts, journal entries and a trial balance;

(vii) prepare accounts for indirect taxes;

(viii) prepare accounts for payroll.

Indicative Syllabus Content

●

The accounting system and accounting records.

●

Ledger accounts; double-entry bookkeeping.

●

Preparation of accounts for cash and bank, bank reconciliations, imprest system for petty

cash.

●

Accounting for sales and purchases, including personal accounts and control accounts.

●

Financial accounting codes and their uses.

●

Nominal ledger accounting, journal entries.

●

Trial balance.

●

Accounting for indirect taxes, for example value added tax (VAT).

●

Accounting for payroll.

C Control of Accounting Systems – 15%

Learning Outcomes

n completion of their studies students should be able to:

(i) identify the requirements for external audit and the basic processes undertaken;

(ii) explain the purpose and basic procedures of internal audit;

(iii) explain the meaning of fair presentation;

CIMA CERTIFICATE IN BUSINESS ACCOUNTING