You are the management accountant of Prompt plc, a UK company which prepares financial statements…

You are the management accountant of Prompt plc, a UK company which prepares financial statements to 31 March each year. The financial statements for the year ended 31 March 1998 are due to be formally approved by the board of directors on 15 June 1998.

Your assistant has prepared a first draft of the financial statements. These show a turnover of £200 million and a profit before taxation of £18 million. Your assistant has identified a number of transactions [(a), (b) and (c) in Requirement, below] for which he is unsure of the correct accounting treatment. For each transaction, he has indicated the treatment followed in the draft financial statements. You have reviewed the transactions highlighted by your assistant.

Requirement

Draft a memorandum to your assistant which explains the correct accounting treatment for each transaction. Where the treatment adopted by your assistant in the draft financial statements is incorrect, your memorandum should indicate the reasons for this. For each transaction, your memorandum should refer to relevant provisions of company law and Accounting Standards.

Transaction (a)

During the year ended 31 March 1998, Prompt plc entered into an arrangement with a finance company to factor its debts. Each month 90% of the value of the debts arising from credit sales that month was sold to the factor, who assumed legal title and responsibility for collection of all debts. Upon receipt of the cash by the factor, the remaining 10% was paid to Prompt plc less a deduction for administration and finance costs. Any debtor who did not pay the factor within three months of the debt being factored was transferred back to Prompt plc and the amounts advanced by the factor recovered from Prompt plc. In preparing the draft financial statements, your assistant has removed the whole of the factored debts from trade debtors at the date the debts are factored. The net amount receivable from the factor has been shown as a sundry debtor. (5 marks)

Transaction (b)

On 15 March 1998, Prompt plc decided to close one of its three factories. This decision was taken because the product (called product X) which was manufactured at the factory was considered obsolete. A gradual run down of the operation commenced on 15 April 1998 and was expected to be complete by 15 June 1998. The factory produced monthly operating statements detailing turnover, profits and assets, and the turnover for the year ended 31 March 1998 was £35 million. Closure costs (including redundancy) were estimated to be £2.5 million. Your assistant has made no entries in the draft financial statements in respect of the closure since it took place in the year ending 31 March 1999. (12 marks)

Transaction (c)

On 30 June 1997, Prompt plc issued 100 million £1 debentures. The issue costs were £100 000. The debentures carry no interest entitlement but are redeemable on 30 June 2007 at a price of £259 million. Your assistant has included the nominal value of the debentures (£100 million) as part of shareholders’ funds since they represent long-term finance for the company. The issue costs of £100 000 have been charged to the profit and loss account for the year, and your assistant suggests that the difference between the issue price and the redemption price should be dealt with in 2007 when the debentures are redeemed. (8 marks)

CIMA, Financial Reporting, May 1998  (25 marks)

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