AAT Level 4 - Professional Diploma in Accounting Drafting Financial Statements Questions and Answers — Questions and Answers
Question 1: A UK limited company is preparing its Statement of Cash Flows for the year ended 31 December under FRS 102, using the indirect method. Which of the following items should be added back to profit before tax when calculating net cash flow from operating activities?
- Increase in inventories
- Depreciation charge for the year (Correct answer)
- Profit on disposal of a non-current asset
- Decrease in trade payables
Correct answer: Depreciation charge for the year
When using the indirect method to calculate net cash flow from operating activities, the starting point is profit before tax. This figure must be adjusted for non-cash items. Depreciation is an expense in the statement of profit or loss but does not involve a movement of cash, so it must be added back. An increase in inventories, a profit on disposal, and a decrease in trade payables all represent uses of cash or non-operating cash inflows and would be deducted (or adjusted for accordingly).
Question 2: Under FRS 102, a company revalues a piece of property, plant, and equipment upwards for the first time, resulting in a gain. Where should this revaluation gain be recognised in the financial statements?
- As a separate line item in the profit and loss account
- Directly in retained earnings
- In other comprehensive income and credited to a revaluation reserve (Correct answer)
- As a deferred income liability on the statement of financial position
Correct answer: In other comprehensive income and credited to a revaluation reserve
FRS 102, Section 17 'Property, Plant and Equipment' requires that revaluation gains are recognised in other comprehensive income and accumulated in equity within a separate revaluation reserve. The gain is not recognised in the profit and loss account unless it reverses a previous revaluation decrease recognised in profit or loss. It does not go directly to retained earnings as it is an unrealised gain.
Question 3: Which of the following statements is a mandatory component of a complete set of financial statements for a UK company that is NOT eligible for small or micro-entity reporting exemptions, according to the Companies Act 2006 and FRS 102?
- Statement of Director's Remuneration
- Statement of Changes in Equity (Correct answer)
- Environmental Impact Report
- Five-Year Financial Summary
Correct answer: Statement of Changes in Equity
According to FRS 102, a complete set of financial statements includes a Statement of Financial Position, a Statement of Comprehensive Income (or an Income Statement and a separate Statement of Comprehensive Income), a Statement of Changes in Equity, a Statement of Cash Flows, and related notes. The Statement of Changes in Equity is a required primary statement. While information on director's remuneration is required in the notes or a separate report, it's not a primary statement itself. Environmental reports and five-year summaries are not mandatory components for all companies.
Question 4: A company acquires a new machine on the first day of its financial year for £100,000. The company's accounting policy is to depreciate machinery over 10 years on a straight-line basis. For tax purposes, the company can claim a 100% first-year capital allowance. The corporation tax rate is 25%. What is the deferred tax implication at the year-end?
- A deferred tax asset of £2,500
- A deferred tax liability of £25,000
- A deferred tax liability of £22,500 (Correct answer)
- No deferred tax implication arises
Correct answer: A deferred tax liability of £22,500
A timing difference arises because the asset is written off for tax purposes immediately, but only depreciated by £10,000 for accounting purposes (£100,000 / 10 years). The carrying amount in the accounts is £90,000, while the tax base is £0. This results in a taxable temporary difference of £90,000. The deferred tax liability is calculated as £90,000 * 25% = £22,500. This represents the tax that will be payable in future periods when the accounting depreciation is charged but no further tax relief is available.
Question 5: According to the Companies Act 2006, who has the primary legal responsibility for the preparation of a company's financial statements and ensuring they give a true and fair view?
- The external auditors
- The company secretary
- The shareholders
- The directors of the company (Correct answer)
Correct answer: The directors of the company
The Companies Act 2006 places the legal duty to prepare annual accounts on the directors of the company. The directors must not approve the accounts unless they are satisfied that they give a 'true and fair view' of the company's financial position and performance. Auditors provide an opinion on the accounts, but the preparation is the responsibility of the directors.
Question 6: A UK parent company is preparing consolidated financial statements. It owns 80% of a subsidiary. During the year, the subsidiary sold goods to the parent company for £50,000, which had cost the subsidiary £30,000. At the year-end, all of these goods remained in the parent company's inventory. What is the correct consolidation adjustment for the unrealised profit?
- Debit Group Cost of Sales £20,000, Credit Group Inventory £20,000 (Correct answer)
- Debit Group Revenue £50,000, Credit Group Cost of Sales £50,000
- Debit Non-controlling Interest £4,000, Credit Group Inventory £4,000
- Debit Group Retained Earnings £16,000, Credit Group Inventory £16,000
Correct answer: Debit Group Cost of Sales £20,000, Credit Group Inventory £20,000
From the group's perspective, no sale has occurred to an external party, so the profit included in the inventory value is unrealised. The unrealised profit is £50,000 - £30,000 = £20,000. To eliminate this, group inventory must be reduced by £20,000. The corresponding debit is to group cost of sales (or retained earnings, depending on the method, but adjusting cost of sales is standard practice) to remove the profit element from the group's results. The adjustment is: Debit Group Cost of Sales £20,000, Credit Group Inventory £20,000.
AAT Level 4 - Professional Diploma in Accounting Drafting Financial Statements Questions and Answers
A UK limited company is preparing its Statement of Cash Flows for the year ended 31 December under FRS 102, using the indirect method.
Which of the following items should be added back to profit before tax when calculating net cash flow from operating activities?