FAR360
PART A 1. If capital expenditure (on depreciable assets) is incorrectly treated as revenue expenditure, the total expenses in the year the error is made will be overstated√. This will mean that profit will be understated by the difference between the cost of the asset(s) purchased and the amount of depreciation which should have been charged√.
This will lead to net assets being understated√ by the same amount as profit. In the following year, profit will be overstated√ as the charge which should be made for depreciation will not be made, leading to an understatement of expenses. If the capital expenditure was in relation to assets which do not require being depreciated (e.g. land), the profit and net assets in the year the error is made will be understated by the cost of the asset(s). In the following year, the profit is unaffected as there will be no depreciation charge.
(4 marks)
2. Three benefits of a budgeting system: (other reasonable benefits are acceptable)
Able to set targets, to give direction to operations, to anticipate problems and to be ready for changes
Able to transmit information about plans to all affected by them and to receive feedback from subordinates
Able to co-ordinate between different operations, departments, and individual plans so that the objectives of the company can be achieved
(2 marks x 3 benefits= 6 marks)
3. Capital budgeting is a decision-making process of selecting and evaluating long term investment√. Non-discounted cash flow method means that the cash flows will not be discounted, that is, the present value concept is not applied√. Timing of the cash flows does not make any difference to the evaluation√. Discounted cash flow means that cash inflows and cash outflows will be discounted according to the time value of money concept√. Different timing of returns will give different values. Two examples:
Non-discounted cash flow; Payback period and ARR√√
Discounted cash flows; NPV, IRR discounted payback
This will lead to net assets being understated√ by the same amount as profit. In the following year, profit will be overstated√ as the charge which should be made for depreciation will not be made, leading to an understatement of expenses. If the capital expenditure was in relation to assets which do not require being depreciated (e.g. land), the profit and net assets in the year the error is made will be understated by the cost of the asset(s). In the following year, the profit is unaffected as there will be no depreciation charge.
(4 marks)
2. Three benefits of a budgeting system: (other reasonable benefits are acceptable)
Able to set targets, to give direction to operations, to anticipate problems and to be ready for changes
Able to transmit information about plans to all affected by them and to receive feedback from subordinates
Able to co-ordinate between different operations, departments, and individual plans so that the objectives of the company can be achieved
(2 marks x 3 benefits= 6 marks)
3. Capital budgeting is a decision-making process of selecting and evaluating long term investment√. Non-discounted cash flow method means that the cash flows will not be discounted, that is, the present value concept is not applied√. Timing of the cash flows does not make any difference to the evaluation√. Discounted cash flow means that cash inflows and cash outflows will be discounted according to the time value of money concept√. Different timing of returns will give different values. Two examples:
Non-discounted cash flow; Payback period and ARR√√
Discounted cash flows; NPV, IRR discounted payback