October 2010 CT2 - financial statements

[Nicole890]

Hi guys,

I'm getting very confused here. I'm looking at question 19 in October 2010 (q8 in revision booklet 4). I'd be incredibly grateful if someone could help me out

The question involves "updating financial statements". I think I understand some the income statement (finance costs is 3months worth of interest at 8% = 80, but why have they not included the 1000 spent on raw materials in cost of sales? I see this has gone into inventories on the balance sheet (which makes sense) but I thought cost of sales was inventory at start + purchases (surely these are the raw materials) - closing stock - depreciation for year. The only change they have made is to alter for depreciation??

Some of the balance sheet also makes no sense to me:
Why has this interest payment of 80 gone into current liabilities? I thought interest payments never went into a balance sheet? And why a liability? since we have deducted it from profit in the income statement?

Really sorry about the length...

 

[Colin McKee]

Good question - it is a tricky one. I have posted some remarks in the middle of your question:

Hi guys,

I'm getting very confused here. I'm looking at question 19 in October 2010 (q8 in revision booklet 4). I'd be incredibly grateful if someone could help me out

The question involves "updating financial statements". I think I understand some the income statement (finance costs is 3months worth of interest at 8% = 80, but why have they not included the 1000 spent on raw materials in cost of sales? I see this has gone into inventories on the balance sheet (which makes sense) but I thought cost of sales was inventory at start + purchases (surely these are the raw materials) - closing stock - depreciation for year. The only change they have made is to alter for depreciation??


Buying inventory is simply a change from cash account on the B/S to inventory. the income statement "cost of sales" only includes "raw materials consumed". Since these raw materials were bought but not used, they dont affect the income statement. Another way to look at it is Raw materials consumed = Purchases of raw material + stock opening - stock closing. If you buy stock but dont use it, your purchases goes up, but so does your closing stock. So no change. (Depreciation is a separate item in the cost of sales, and as you mention is also affected).


Some of the balance sheet also makes no sense to me:
Why has this interest payment of 80 gone into current liabilities? I thought interest payments never went into a balance sheet? And why a liability? since we have deducted it from profit in the income statement?


In most CT2 income statements, interest is not accrued. they simply assume that its paid on 30 June and 31 December. At end of year there is no interest "accrued but not yet paid". In this example, because the dates were spelled out in the question and were clearly important, the examiner decided to put a liability to pay the interest that had been accrued to the end of the year. Since it will have to be paid Sept 2011, it is a current liability due to its short term. Many things that we deduct from profit but havent paid end up as current liabilities. Another example would be the tax accrued - if we hadnt paid it, it would become an outstanding liability in current liabilities.


Really sorry about the length...


No problems - means I can understand the issue more clearly

 

[Nicole890]

Ah, wow, that definitely is a nasty one.

Brilliant, thanks Colin. Everything you've said makes sense...certainly wouldn't have thought of it myself though!

Cheers

 

[Piddox]

Hello,

I have a follow-up question about question ii), about the ROCE.

It is stated in the answer key (as well as in the core reading) that:
\[ ROCE=\frac{NetProfitBeforeTax\&Interest}{Share Capital + Reserves + LongTerm Debt} \]

Since we have:
\[ TotalEquity=ShareCapital+Reserves+RetainedEarnings, \] I simply interpret ROCE as (correct me if I'm wrong here):
\[ ROCE=\frac{EBIT}{TotalEquity-RetainedEarnings + LongTerm Debt} \]

Filling this formula in for the "before" situation, would give me:
\[ ROCE=\frac{6400}{10000+0+6000}=\frac{6400}{14677-4677+6000}=40\%\]

The answer key however, gives the following answer:
\[ Return On All Capital=\frac{6400}{14677+6000}=31\%\]

They sneakily changed ROCE to Return On All Capital as well. Why do they do this? Why not simply apply the formula for ROCE?

Thanks.