Accounting 4AC1 | Paper 2 Mock 01 | Written Paper 2

Shahnaz runs a mixed business: ticket takings are service income, while the kiosk buys tea and snacks for resale and therefore has inventory, purchases and a cost of sales. The question gives a single revenue figure of $147 200 covering both, so the gross profit calculated below is the combined result of carrying passengers and selling refreshments rather than a pure trading margin. Set out cost of sales for the kiosk goods only, since those are the only goods bought for resale.

The allowance is the deliberate trap. It is required at $365 and it already stands at $365, so there is no increase and no decrease and nothing at all appears in the income statement. Writing $365 as an expense would charge the same estimate for a second time. The allowance still shows in the statement of financial position, because trade receivables must be stated at the amount realistically expected to be collected.

The launches and the fittings are depreciated on different bases because they lose value differently: the launches are written off evenly at 8% of cost, giving the same $11 360 charge each year, while the fittings lose a fifth of a falling carrying amount. Whichever policy the business has adopted, the consistency concept requires it to be applied in the same way year after year so results can be compared.

(a) Income statement for the year ended 31 July 2024 [15]

Hull maintenance keeps the launches at their existing standard, so it is revenue expenditure charged in full this year. Had the money been spent on lengthening a launch or fitting a larger engine, that would be capital expenditure, added to the $142 000 cost and depreciated over the asset's remaining life instead.

(b) Statement of financial position at 31 July 2024 [10]

The two sides agree at $60 985. Drawings of $28 000 exceed the $20 980 profit, so capital has fallen by $7 020 over the year even though the business traded profitably. Net current assets of $7 545 against current liabilities of $9 730 gives a current ratio of about 1.8 to 1, which is adequate, but almost all of the launches' value is pledged against the $24 000 loan.

The two cafes have identical gross profits of $72,000, which is the trap in the question. Llan needs $240,000 of revenue to earn that $72,000 while Cwrt needs only $180,000, and it takes $94,000 of capital to do it against Cwrt's $65,000. Ratios are the tool that exposes that difference, because absolute figures alone would suggest the larger business is the better one.

The figures each ratio needs.

(a) The five measures, side by side [20]

Two points of method. Capital employed is capital plus the loan, as the question directs, because the profit is struck before any return to the long term lender is separated out, so the capital measured must be all the long term finance. And the loan is not a current liability: it is repayable in 2031, so it stays out of both liquidity ratios.

(b) Recommendation [5]

Dylan should buy Cwrt Cafe. Every one of the five ratios favours it.

1. Cwrt keeps 40.00% of each dollar of revenue as gross profit against Llan's 30.00%. Llan has to sell a third more to reach the same $72,000, which means either lower prices or higher food costs. That is a structural weakness in the way Llan trades, not a one off.
2. Cwrt turns 14.00% of revenue into profit against Llan's 11.00%. Llan's expenses are actually slightly lower in dollars, at $45,600 against $46,800, so the whole difference comes from the weaker margin.
3. Cwrt earns 38.77% on capital employed against 28.09%. This is the decisive figure for a buyer, because it answers the only question that matters to Dylan: how hard will my money work? Llan makes barely $1,200 more profit but needs $29,000 more capital to do it.
4. Llan's liquid ratio of 0.60:1 is a warning. Stripping out inventory, Llan holds $12,000 of receivables and bank against $20,000 owed to suppliers. It cannot pay its trade payables without first selling inventory, and it has only $2,400 in the bank. Cwrt stands at 1.40:1 with $9,500 in the bank.
5. Llan's only advantage is size. Revenue of $240,000 against $180,000 sounds impressive, but it has not converted into either profitability or safety. Buying revenue rather than return is the mistake this question is designed to test.

One qualification a full answer should note: these are one year's figures from the owners themselves, with no comparison to a previous year and no explanation of why Llan's margin is so much thinner. Before completing the purchase Dylan should ask whether Llan has cut prices to win business that could be re-priced, and whether Cwrt's premises are on a secure lease, since a single year's ratios cannot show either.