INSTRUCTIONS: Answer Question ONE and any other TWO

a) Explain the importance of ratio analysis to a business enterprise. (2 Marks)
b) Identify with reasons, one party who may be interested in each of the following
a. Current ratio (2 Marks)
b. Net profit margin (2 Marks)
c. Stock turnover (2 Marks)
c) Citing suitable examples, briefly explain of the following terms:
a. Accounting concepts (2 Marks)
b. Accounting policies (2 Marks)
c. Accounting standards (2 Marks)
d) Explain the accounting treatment that would be applicable in dealing with the
following transactions relating to the accounts of Mlachake Ltd. for the year ended 31
December 2004:
(i) A debtor who owed the company Sh.200,000 was declared bankrupt on 1
February 2005. 25% of the debt had been recovered when the accounts were
approved by the directors on 15 March 2005. (2 Marks)
(ii) Some items of inventory purchased for Sh.300,000 were damaged in the
warehouse during the year. These items were repaired at Sh.50,000 and sold to a
customer on 2 February 2005 at 75% of the normal selling price of Sh.400,000
(2 Marks)
(iii) On 10 December 2004, the company secured an order worth Sh.1.2 million from a
foreign based company. The goods were shipped on 10 January 2005 and
included in sales for December 2004. (2 Marks)

(a) Using suitable examples, explain the meaning of the following terms:
(i) Accounting standards. (2 Marks)
(ii) Accounting policies. (2 Marks)
(iii) Accounting bases (2 Marks)
(b) “Qualitative characteristics are the attributes that make information provided in
financial statements useful to users.”
Briefly explain the four main qualitative characteristics of financial statements
with reference to shareholders of a company. (6 Marks)
(c) While research and development costs of a project may meet the definition of an
asset, the cost may not meet the criteria used in recognizing an asset.
Define the term “asset” and explain the criteria used in recognizing an asset.
(3 Marks)
(d) Give five purposes of control accounts. (5 Marks)
a) Briefly explain why the following parties may be interested in the financial
statements of an organisation:
(i) Employees (2 Marks)
(ii) Financial analysis (2 Marks)
(iii) The Government. (2 Marks)
(iv) The public. (2 Marks)
b) State any two circumstances that may hinder a firm from improving on the usefulness
of its financial statements. (4 Marks)
c) Dickson Kimula is an electronic equipment dealer. He has sought your advice on
certain matters relating to his financial statements for the year ended 30 April
2006.Citing the relevant accounting principle, advise Dickson Kimula how to deal
with each of the following:
(i) All his electrical equipment is sold with a one year warranty for repair and
service, which on average costs Sh.480 per item. The value of equipment returned
annually average 1% of the sales. The sales of the year ended 30 April 2006 were
200,000units. (2 Marks)
(ii) Closing stock as at 30 April 2006 was valued at Sh.500,000. However, some
items of stock whose initial cost was Sh. 200,000 can only realise Sh.150,000
after major repairs costing Sh.40,000 (2 Marks)
(iv) Sales for the year include deposits from customers amounting to Sh.2,000,000.
The goods had not been delivered to the customers as at 30 April 2006
(2 Marks)
(v) The firms’ VAT returns for the month of April 2006 had not been filed with the
Revenue Authority. The penalty for late filing of VAT returns is Sh.10,000.
(2 Marks)
(a) Outline the extent to which a trial balance is an indicator of correct book-keeping by
an entity. (4 Marks)
(b) After preparation of the trial balance or Bakari Brothers Enterprises as at 31
September 2005, the firm’s accountant has been provided with the following
additional information for the purpose of preparation of the final accounts:
1 Due to an oversight, discount has been allowed to a credit customer on the gross `
invoiced amount of Sh.80,000 at the rate 10%. The firm should have used a rate if
2 Electricity accrued amounts to Sh.36,710 while insurance premiums of Sh. 22,450
have been prepaid.
3 In October 2005, the employees of the firm received a general salary increase,
backdated to 1 July 2005. Amounts totalling Sh.126,550 in salary arrears are
payable to former employees who left shortly before the salary award was
announced and who have not yet been traced. It has been decided that the salary
packets will be opened and the cash banked until the ex-employees are traced.
4 Wages due to casuals amounting to Sh. 464,120 for services rendered in the last
week of December 2005 were paid in January 2006 together with the salaries for
the month of December 2005 which amounted to Sh.301,700.
5 During the year, the exterior of the warehouse was repaired and repainted at a cost
of Sh.500,000. This”
amount was erroneously debited to office premises account. It is policy of Bakari
Brothers Enterprises to provide for depreciation on the closing balances of noncurrent assets and this has already been done. The annual rate of depreciation on
office premises is 2% calculated on the straight-line basis.
6 In December 2005 2005, Bakari Brothers Enterprises had bought goods on credit
from CB Ltd. for Sh. 452,100 and has also sold goods on credit to the same
company for Sh.163,040. These amounts were correctly posted to their respective
accounts. However, these accounts are to be offset as at 31 December 2005 and
the remaining balance settled by cheque in January 2006.
7 The provision for discounts allowed to debtors, which at present has a balance of
Sh.229,530 needs to be reduced to Sh. 157,400.
8 Debts totaling Sh.64,800 are irrecoverable and should be written off. However,
amount of Sh.21,440
written off as a bad debt in the previous year has now been recovered in full but
the cheque in settlement has not been banked or posted in the accounts.
Journal entries, including narrations, necessary to record the above transactions in the
books of Bakari Brothers Enterprises (16 Marks)
(a) State four purposes of ratio analysis
(b) The following information was extracted from the financial statements of Sunrise
Ltd. and Sunset Ltd. in respect of the year ended 30 September 2005:
Income statement extracts for the year ended 30 September
Sunrise Ltd. Sunset Ltd.
Shs. ‘000’ Shs. ‘000’
Sales 497,000 371,000
Cost of sales 258,000 153,000
Operating profit 138,000 79,000
Interest expense 19,000 –
Balance sheet extracts as at 30 September 2005:
Sunrise Ltd. Sunset Ltd.
Shs. ‘000’ Shs. ‘000’
Non-current assets 142,000 92,000
Current assets:
Inventory 100,000 87,000
Debtors 46,000 42,000
Cash at bank 40,000 44,000
Current liabilities 98,000 108,000
Long-term loan 33,000 –
Shareholders funds 197,000 157,000
For each company, compute the following ratios:
(i) Acid test ratio (2 Marks)
(ii) Inventory turnover (2 Marks)
(iii) Average collection period (2 Marks)
(iv) Return on capital employed (2 Marks)
(v) Debt equity ratio (2 Marks)
(c) (i) On the basis of the ratios computed in (b) above, comment on the overall
performance of Sunrise Ltd. and Sunset Ltd. and advise which of the two
companies would provide better investment. (3 Marks)
(ii) Explain the possible shortcomings of relying on your analysis in (b)
above. (3 Marks)

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