The correct answer is C.
EXPLANATION

Principal-agent problems arise when there is a conflict of interest between the principal, eg the shareholder and the agent, eg the manager. These conflicts can be reduced by incentives to encourage the managers to work in the interest of the shareholders, eg by executive share options and profit-related bonuses …
… and having written agreements setting out the roles and responsibilities of all stakeholders.
Performance-related pay would be a greater incentive for workers and managers to strive to increase profits than payment by the hour.

The correct answer is C.
EXPLANATION

The financial manager aims to maximize shareholder wealth (or the share price) by investing in projects that display a positive net present value when discounted at the (opportunity) cost of capital. They do not discount at the cost of borrowing, but at the weighted average rate that shareholders and debt holders could have received on equivalent alternative investments.

The correct answer is A.
EXPLANATION

Debtholders would want the company to invest in projects with minimum risk of return, make bare minimum profits (just enough to make interest payments). They would want the company to go for safe route of making profits, since their money is with the company.
Employees would not want to be replaced with efficient technologies, hence there would be a conflict of interest.
Local community would not want to be disturbed with loud noise, hence again there would be a conflict of interest.
Government would want the company to duly pay their taxes.

The correct answer is D.
EXPLANATION

Statement 1 is false. Companies do not have access to unlimited resources and so only those projects adding most value can be financed and this means rejecting some projects that may be profitable.

Statement 2 is true. In theory a company’s value is the sum of the NPVs of all the projects that company undertakes. Therefore it is true that, in theory, projects with positive NPVs add to the shareholders’ wealth.

The correct answer is A & D.
EXPLANATION

Control of the decisions within a company will usually lie with the managers, who are acting as agents of the shareholders (the company’s owners). If the interests of the shareholders and managers diverge, this could give rise to agency problems.

The interests of employees, regulators and auditors respectively may conflict with those of either the shareholders and/or the managers. However, employees, regulators and auditors neither own companies nor control their decisions.

The correct answer is C.
EXPLANATION

Statement 1 is true. For publicly quoted companies, maximising shareholder value is generally taken to mean maximising the share price.

Statement 2 is false. Share prices fall for many possible reasons, eg a market crash, and reflect the general industry and economic outlook, not just the performance of the directors of the particular company concerned. While a fall in the share price may indicate that shareholders believe the directors are underperforming, it is not necessarily evidence that this is the case.

The correct answer is C.
EXPLANATION

I is false. The directors retain ultimate responsible for the company’s financial affairs, but they are allowed to delegate that work to other, more qualified, people.

II is false. As a regulated professional, the accountant also has professional responsibilities, eg as set out by their professional body and accounting standards.

III is true. The directors retain legal responsibility for the company’s affairs, but they are entitled in turn to take action against the accountant in the event of fraud.

The correct answer is B & E.
EXPLANATION

The market value of a quoted company’s shares can be reviewed as the present value of the future expected returns it provides. This can be assessed as the present value of the future expected returns (ie profits not revenues) discounted at the shareholders’ required return on their investment.

The correct answer is C.
EXPLANATION

Managers are agents of the shareholders and so the managers should consider the shareholders’ ethical principles.

Ensuring the company complies with relevant regulations is part of the managers’ responsibilities, but their ethical responsibilities extend beyond this.

The managers’ ethical responsibilities also extend beyond their own personal views.
Membership of a professional body is likely to bring additional ethical responsibilities, but is not their only source.

The correct answer is B.
EXPLANATION

The UK Corporate Governance Code defines corporate governance as the system by which companies are directed and controlled.

The correct answer is B.
EXPLANATION

I is false. Milton Friedman argued that the social responsibility of business is to increase profits. His qualifiers to this view, eg that the ethics of a business be determined by its owners, and that companies should comply with the rules of society, still do not makel true.
II is true. Ethical standards apply wherever the firm conducts its operations.
III is false. Ethical investors may choose to sell their shares, but do not have to do so. In particular, they may decide it is more appropriate to maintain their investments and to try and influence companies’ future behaviour than to sell the shares to other investors who may be unconcerned with ethical behaviour.

The correct answer is C & D.
EXPLANATION

The objectives of corporate governance codes are more likely to include management of conflicts of interest, transparent reporting to shareholders and ensuring corporate actions are in line with long-term sustainable success.

While it may be true that disclosure may help managers in their salary negotiations, this is unlikely to be a motivation for corporate governance requiring such disclosure.

A lack of disclosure requirements may help private equity backed firms in their recruitment as they may be prepared to offer more attractive remuneration to top executives (without the potential adverse publicity) and executives may prefer their remuneration not to be publicly disclosed.

The correct answer is D.
EXPLANATION

The chair deciding the remuneration of all directors would be inappropriate as individuals should not be involved in deciding their own remuneration.

The AGM is typically the major regular opportunity for the shareholders and board to communicate.

A transparent and merit-based procedure for the appointment of new directors is required under the Code’s composition, succession and evaluation section.

Requiring all directors to undertake induction training should ensure they have the skills and knowledge to make an effective contribution, as required by the Code.

The correct answer is D.
EXPLANATION

Consistent minimum standards, and the investor confidence they provide, are an advantage of rules-based corporate governance codes.

The onus on boards and shareholders to form their own view (rather than.rely on potential tickbox that rules are being followed) is an advantage of a principles-based approach.

It is difficult to prescribe rules that would be appropriate for every imaginable situation, whereas a principles-based approach has the advantage of allowing for flexibility in unusual situations.

The correct answer is B.
EXPLANATION

Only a public limited company must have an issued share capital of at least $£ 50,000$.

The correct answer is A, D & E.
EXPLANATION

Bob would give some ownership rights to Camilla and Caspar and so would no longer own $100 \%$ of the company.

Bob and the other partners will be jointly and severally liable for $100 \%$ of any liabilities occurring from the business activity, so Bob could still be responsible for the full amount of a liability.

Camilla and Caspar could be sleeping partners, but there is no requirement that this be the case.
No documentation would be required as it is not a limited company, but a partnership agreement could be drawn up if desired.

Camilla and Caspar would indeed pay income tax on the share of partnership profits.
Neither a sole trader nor a partnership is a separate legal entity.

The correct answer is D.
EXPLANATION

A social enterprise is defined by its social or environmental purpose.
A social enterprise can accept donations provided that once established they make the majority of their income from trading.

A social enterprise cannot have profit maximisation as its primary objective, but it must make the majority of its income from trading.

An ethical business aims to make profits while minimising its negative impact on society or the environment. However, unlike a social enterprise it does not have to have its social or environmental mission as its primary focus.

The correct answer is A.
EXPLANATION

While all of the businesses may benefit from the potentially greater capital availability of a limited company, the general insurance business is very risky, and could incur a large, unexpected liability. As a result it is unlikely to survive as a partnership.

The correct answer is A.
EXPLANATION

I is true. There must be at least two members to form an LLP.
II is false. There is no upper limit on the number of members in an LLP.
III is false. The exposure of the members of an LLP to loss is limited, but it is not removed entirely.

The correct answer is A.
EXPLANATION

The costs of employing the managers are likely to be small in comparison to the costs incurred by bad decisions made by managers who pursue their own agenda rather than the aims of the owners.

The make-up of the Board is usually flexible, and may not change much when professional managers are employed.

There would be no change to the liability of the owners as the company remains a limited company.

The correct answer is D.
EXPLANATION

The discount is of less importance as it is a discount offered to all the existing shareholders.
If the issue is underwritten it is guaranteed to succeed, but that is more of an advantage to the managers and not the shareholders.

The risk of takeover is more linked to the share price in relation to other similar companies, which may not be materially changed by a rights issue.

If the economy is turning down, and the managers know more about the short-term prospects for the company, the fact that they have chosen to issue shares and not debt would be a worry for shareholders. If the prospects had been good, the managers might have issued debt instead to avoid diluting the ownership of the company before the profitable period. However, if the prospects are bad or uncertain, they would be more likely to issue shares.

The correct answer is A.
EXPLANATION

Capital gains tax will normally beassociated with a gain which has been crystallised and therefore be associated with a cashflow.

It is normally payable in arrears rather than deducted at source.
Capital gains are typically taxed when an asset is sold (and so the selling price is known), avoiding the need to regularly value the asset during the period it is held.

Capital gains tax rates may be higher for those with higher incomes, but capital gains tax will often affect more than just the highest earners.

The correct answer is A.
EXPLANATION

The country may lose employers (eg domestically based multinationals relocating their base overseas needing fewer staff in the domestic country or overseas companies closing their operations in the domestic market) with knock on consequences for the number of employed people and so for income tax revenue.

Double taxation treaties reduce the extent to which companies are taxed twice by offsetting tax paid overseas against the liability to domestic tax. As this can considerably reduce the tax that a company has to pay in its home country, withdrawing from the treaties may increase the government’s total tax revenue.

However, companies are free to domicile themselves in different countries, and many countries are competing via their low corporation tax rates to attract multinationals to be based there. If companies move their base overseas, then withdrawing from double tax treaties may result in the government losing more tax revenue than it gains.

If there is no double tax treaty with a foreign country, companies based in the overseas country may choose to close down operations in the home country because they are no longer tax effective or profitable. The government would lose out on the corporation tax these companies would have paid.

The correct answer is D.
EXPLANATION

The cost of measuring small gains, and then collecting the tax, would almost certainly be higher than the tax collected. So this is the most likely reason for a taxation system to have a capital gains allowance.

Capital gains are generally earned by the wealthy but this does not give a reason to suggest having an allowance to avoid taxing a portion of the gains. Indeed, it may be an argument in favour of increasing the amount of tax on gains.

Simply copying elements of other countries’ systems is unlikely to produce a good strategy for designing a taxation system

The existence of a capital gains allowance results in gains being favourably taxed relative to income, which may in turn encourage companies to retain more profits rather than pay them as dividends. However, this impact is not in itself a reason for a government to have such a tax system. The impact on dividends is, in any event, indirect, likely to be quite small and only a small number of companies may change their dividend behaviour.

The correct answer is D.
EXPLANATION

I is false. It is preferable to tax in arrears because the cash or profit have been earned and can be used to pay the tax. A tax in advance could often have no cashflow that allowed the taxpayer to pay the tax bill.

II is false. Non-financial rewards such as healthcare benefits (often called income in kind) are usually taxed, even though the taxpayer does not receive any cash directly.

III is true. Most countries aim to increase the marginal rate of taxation as a person’s income rises as this is deemed to be fairer.

The correct answer is C.
EXPLANATION

Statement 1 is true. A company’s published financial statements are primarily to show shareholders a true and fair view of the company’s prospects, not to calculate its legal obligation to pay tax. The pre-tax profit shown in these statements contains items that are not allowable in tax accounts, such as depreciation, and may contain expenses that are not allowable for tax.

Statement 2 is wrong because the published statements contain depreciation, which is replaced by a capital allowance when determining taxable profits.

The correct answer is B & E.
EXPLANATION

The offshore scheme is legal and there is no law making it illegal to invest offshore.
If the pension scheme is due to pay any taxes on income or gains, it would pay these to the UK authorities directly based on the dividends and the capital gains it makes on the offshore fund shares.

Schemes based in other jurisdictions will be governed by the rules in those jurisdictions, and cannot be required to pay UK taxes.

Most investors, including pension schemes, do invest overseas, and it is not generally seen as a moral duty to invest domestically, certainly not to invest entirely domestically.

If the pension scheme invested in a UK fund, the fund may be required to pay taxes that the pension scheme could avoid (for example, by investing directly in property). Therefore by using the offshore fund the pension scheme is simply avoiding these irrecoverable taxes in the UK.

The correct answer is B.
EXPLANATION

Double taxation treaties have the effect that if a company has paid tax on overseas profits to an overseas tax authority, it will reduce the home government’s taxes due by a significant amount, so the domestic government will receive less tax. (It may be that overseas companies with subsidiaries in the country pay taxes based on their subsidiaries’ operations, which can help make up for the shortfall, but this is not guaranteed.)

The correct answer is A.
EXPLANATION

If double tax treaties were cancelled, companies would pay overseas taxes and domestically on their overseas earnings, and so would be less keen to expand abroad. (They could set up a separate company based abroad to pursue the expansion, but this would incur costs so again make overseas expansion less attractive.)

The correct answer is B.
EXPLANATION

Companies have no incentive to ‘avoid’ double tax treaties as such treaties reduce the amount of tax companies pay.

The correct answer is B.
EXPLANATION

If companies in high corporation tax jurisdictions pay less tax in an overseas country; they would have to pay a balance of tax in the UK, so little tax would be saved by building up profits abroad.

The correct answer is B.
EXPLANATION

Marketability and credit risk are the key differences between government bonds and loan stock which are of concern to investors. The size of a bond issue affects its marketability. Tax is, however, paid on government bond interest and corporate bond interest in the same way.

The correct answer is B & E.
EXPLANATION

It is possible (although unlikely) that the loan will be issued at a price above par. It is likely that it will be issued at a price close to or a little below par.

The total repayment will be: $500 \times 0.05 \times 10+500=£ 750$
The repayment of the capital occurs at the end of the loan period. The loan is very likely to be fixed interest in nature.

The correct answer is B.
EXPLANATION

A floating charge offers more flexibility as a company with a fixed charge on an asset cannot sell that asset without agreement from the debenture holders.

Investors cannot choose to float the charge. The remaining options are incorrect as it is likely to be the value of the securing asset(s) that is the primary concern of investors.

The correct answer is A.
EXPLANATION

Institutions would prefer the top ranking tranche to back their liabilities due to its higher rating (and despite its lower yield). The lowest tranche is typically very small and thinly traded. The portfolio of $£ 1,000 \mathrm{~m}$ underlying loans would give diversified exposure to a new type of asset class that institutions cannot normally access.

Asset-backed securities are typically in one currency and offer no currency diversification. All tranches would likely be the same term, and there is no suggestion that the coupon is inflation linked.

The correct answer is C.
EXPLANATION

Conversion of a contingent convertible is a negative event, and conversion is not determined by the investor. It occurs automatically when a trigger event happens, such as during a banking crisis. At this point the bond investors would prefer to remain higher-ranking bondholders, but they will be converted to lower-ranking shareholders and suffer losses.

If the bank is acquired by another bank, the conversion would simply be legally changed to convert into the shares of the new merged entity.

The correct answer is A.
EXPLANATION

I is true as the lower default risk would suggest a lower required return and so a lower coupon rate all else being equal.

II is false as lower marketability would reduce the attractiveness to investors and so require a higher return to compensate.

III is false as, while this feature of debentures may increase security for investors, it reduces the flexibility of actions of the company.

The correct answer is B.
EXPLANATION

I is false. There is still default risk since if the company failed then the expected stream of payments from the debenture would not be received and, even if the value of the securing assets is sufficient to repay the amount outstanding, the investor still has to reinvest this amount to replace their original investment.
II is true. The real value of the debenture’s fixed nominal payments will be less if inflation is high.
III is false as, while the investor may be sure of a positive return if they held the debenture until maturity, they may make a loss if they sell before the debenture matures.

The correct answer is B.
EXPLANATION

Floating rate bond coupons move with the short-term interest rate set by central banks and are not tied to inflation (as index-linked bonds are). Although short-term rates could rise with rising inflation, it is not a certainty. Also, the central bank would determine the rate, not the company.

The correct answer is A.
EXPLANATION

Most companies that issue in the Eurobond markets are well known, have good credit ratings and issue large liquid tranches of bonds.

The correct answer is B.
EXPLANATION

Eurobonds are almost always unsecured, so no security would be required for either fixed or floating rate Eurobonds.

The correct answer is B.
EXPLANATION

US stock market authorisation would not be required as Eurobonds are issued through investment banks, and not in the markets of any country. The US stock market may choose to begin trade in the bond, but in most cases the bond will trade through investment banks.

The correct answer is D.
EXPLANATION

All four options are methods of obtaining a listing and so could broaden the pool of shareholders. However, an introduction would not involve issuing any new shares and so would not raise the desired additional finance.

The correct answer is B.
EXPLANATION

When evaluating the tender offers received, the company must determine a single strike price for all applicants. This is the highest price at which it can sell all of the shares on offer.

The company can sell only 250,000 at $£ 1.20$. In order to sell all 1 million shares it must sell its shares at $£ 1.10$. The company would then raise $£ 1.1$ million.

The correct answer is C.
EXPLANATION

Number of issued shares before the rights issue:
$
\frac{£ 8 \mathrm{~m}}{£ 0.50}=16 \mathrm{~m}
$

Current share price:
$
\frac{£ 60 \mathrm{~m}}{16 m}=£ 3.75
$

Rights issue price $=(1-20 \%) \times £ 3.75=£ 3.00$
Theoretical ex-rights share price:
$
\frac{4 \times £ 3.75+1 \times £ 3.00}{5}=£ 3.60
$

The correct answer is C & E.
EXPLANATION

The theoretical ex-rights share price:

$
\frac{10 \times £ 3.50+2 \times £ 2.50}{12}=£ 3.33
$

There will now be a further 2 million of issued shares.

There is no change to the amount of shares of the company is authorised to be allowed to sell. The company will raise $2 m \times 2.50=£ 5 m$. The expected market capitalisation will be $10 \mathrm{~m} \times \mathrm{£} 3.50+2 \mathrm{~m} \times 2.50=£ 40 \mathrm{~m}$.

The correct answer is C & E.
EXPLANATION

The main benefit of underwriting is that it removes the risk of the company being left with unsold shares, so the directors should assess how likely this risk is to occur and how bad are the consequences if it does.

Market confidence in the stock market generally, or this company in particular, reduces the risk of the issue being undersubscribed.

A small discount to the share price reduces the attractiveness of the rights issue and so would increase the perceived value of underwriting the issue.

If unsold shares resulted in modified plans rather than complete cancellation of plans this may be, seen as an acceptable risk.

The directors may see the risk of takeover after a failed rights issue as an unacceptable risk.

The correct answer is B.
EXPLANATION

It would not be legally permissible to cancel the issue after investors have sent in their binding offers. The company accepted the issuing house’s advice on the price, which seems to be too low, and so the company cannot have legal redress. The stock exchange has no power to prevent investors from applying in large numbers, and therefore could not prevent the incident.

The correct answer is B & C.
EXPLANATION

Corporate governance disclosure costs are extremely high for quoted companies but are less costly for private companies. Private equity investors are generally more focused on the long term.

The authorities that manage competition in the market have remained constant in their attempts to limit monopoly powers. In any case, this does not explain the trend in the question.

It is easier for quoted companies to raise further finance through equity rights issues, and harder for private companies. Similarly, quoted companies must meet the Stock Exchange’s quotation requirements, which can mean providers of debt finance are happier to lend to a quoted company.

Private equity markets are denominated in a currency and it is harder to raise private finance in a foreign currency.

The correct answer is B & D.
EXPLANATION

A bank has the right to recall the overdraft immediately.
An overdraft can be drawn up to its maximum size without notice by the customer, and can be paid down at any time, whereas a bank loan will have a fixed term and fixed repayment schedule.

There are no explicit arrangements for the repayment of overdrafts. Overdrafts are usually secured by a floating charge. Overdrafts often have a high interest rate compared to other forms of borrowing.

The correct answer is B.
EXPLANATION

The bank could seek to wind up the company if necessary to repay its loan, but the factoring loan is also recourse, which means that the repayment is a liability of the company, and must be made in the same way as the bank loan.

The correct answer is B.
EXPLANATION

The bank loan will normally be secured on some assets of the company, typically with a floating charge.

The correct answer is A.
EXPLANATION

If the company has a similar volume of customer invoices to cover the same loan, then there is no reason why the factor would not repeat the deal for the company.

The correct answer is B.
EXPLANATION

The bank loan payments float up and down based on short-term rates, and are therefore unknown.

The correct answer is D.
EXPLANATION

With an operating lease, the car leases would need to be renewed on a rolling basis. If the leasing companies prefers not to renew the lease then it will end and the cars will be returned, leaving the company in a difficult situation.

Cars leased with a finance lease would appear on the balance sheet as an asset, along with a liability equal to the value of the future lease payments, even though the company does not own the cars.

Fleet companies will be flexible, and will offer both forms of lease.
Whichever way the lease is structured, the payments will be an allowable expense against tax.

The correct answer is D.
EXPLANATION

Statement 1 is false. Many companies do use trade credit with their suppliers and offer it to their customers.
Statement 2 is however true. If a company chooses not to offer trade credit, their customers might move their business elsewhere, so commercial pressure is an important factor. Trade credit is a cost to the company that offers it, so it is unlikely to be offered if there is no pressure to do so.

The correct answer is B & E.
EXPLANATION

Commercial paper is unsecured.
Commercial paper would be cheaper because the commercial paper market is highly liquid and tradeable.

The commercial paper loan would be issued for a set period of days but could not be raised or lowered during that period and could only be repaid at the end.

The costs of the commercial paper issue would not include any stock exchange listing costs as the paper is not listed on the stock exchange. It trades on the money markets.

The bank would offer a variety of services to customers that it values, such as import export insurance, customer credit rating advice, foreign exchange transactions, etc.,

The correct answer is C.
EXPLANATION

I is false. An eligible bill of exchange is a two-named paper, the two names being the company that owes the money and the bank acting as a guarantor.
II is false. A bill of exchange is an example of a short-term finance instrument.
III is true. A bank will act as a guarantor, agreeing for a fee to meet the payment due on the bill if the company that owes the money is unable to pay.

The correct answer is A.
EXPLANATION

Shadow banks are useful to some customers, eg they may offer loans to customers that might not be provided by mainstream banks.

They are not necessarily based offshore and they are not guaranteed by a central bank.

The correct answer is A.
EXPLANATION

I is true. Project finance is almost always financed through the capital markets.
II is false. The finance is raised by a special purpose vehicle and will not show on ABC’s balance sheet.
III is false. The government will leave the financing and management of the project largely to the companies in the consortium, and will rarely get involved.

The correct answer is C.
EXPLANATION

I is false. There will likely be no cashflows for the project financers until the sewerage pipeline is constructed and rented back to the local government. This is the most risky period of the project for investors. So, III is true.

II is true. Government may give guarantees such as a guarantee to rent the pipeline for a minimum period, a guarantee to have access to the land required, etc. This will reduce the risks to the consortium and to investors.

The correct answer is D.
EXPLANATION

An individual looking to raise money for charity could use donation-based crowdfunding to do this.

The partnership running the food truck could raise the funds they need using either loan- or investment-based crowdfunding.

The company that’s invented a boardgame could use reward-based crowdfunding to raise the funds they need. Those who provide funds would then receive the game once it’s released.

A large company with an established reputation is unlikely to try to raise large amounts of money using crowdfunding. It is more likely to raise debt or equity finance via more traditional routes.

The correct answer is C.
EXPLANATION

The loan will be small in size, so the associated costs with issuing and managing the loan are large in comparison.

There is no interest charged on microloans and they often have flexibility on the time for repayment. Microloans are not available to all borrowers, they are commonly offered to individuals or small businesses who otherwise would be unable to raise funds using traditional loans.

The correct answer is B.
EXPLANATION

IFRSs help to improve and harmonise financial reporting internationally.
Many countries do adopt the IFRSs but the IFRSs do not prevent national accounting bodies issuing their own standards. The standards are technical rather than ethical in nature, ie they deal with the statements themselves, rather than the professional and ethical behaviour of those who produce them. The standards are sometimes quite general or allow alternative possible treatments of certain items.

The correct answer is C & D.
EXPLANATION

While the materiality concept can allow for the approximation of small items in the accounts, it is not true to say that any figure can be approximated. Using too many approximate figures in the financial statements could lead to material misstatements, which could mislead the users of the accounts.

Some transactions or adjustments that are small in size could be material to the users of the accounts by their nature. For example, if the company had to pay a regulatory fine or if a fraudulent transaction took place, these items would be of interest to the users of the accounts regardless of their size.

The correct answer is C.
EXPLANATION

I and II are true. III is false.
III is incorrect since a qualified audit opinion could indicate that the company is being managed poorly. This could result in the company’s other stakeholders responding with negative consequences. For example, creditors could be less willing to lend and customers and suppliers might be less likely to do business with the company.

The correct answer is A.
EXPLANATION

The directors’ depreciation treatment would reduce expenses and therefore increase the company’s reported profits and affects a key asset, which the auditor may feel prevents the statements from being fair and necessitates a qualification to the audit opinion. The auditor may therefore issue a qualified audit opinion that will state that the financial statements present fairly ‘except for’ the impact of the depreciation treatment of the particular asset.

The correct answer is C.
EXPLANATION

While sustainability reporting is a reasonably new practice, it is not true to say that there is no guidance available and plenty of companies (even oil companies) have reported on sustainability for some years now, so there are plenty of examples from similar companies. In addition, the Global Reporting Initiative provides some standards on sustainability reporting.

The correct answer is B.
EXPLANATION

I and II are true.
Statement III is false as producing useful, comprehensive sustainability reporting can be difficult and time-consuming. A company reviewing and reporting on its operations in this way may also be compelled to make some operational changes, eg by introducing vehicles powered by renewable energy.

The correct answer is D.
EXPLANATION

The statement of financial position (balance sheet) at the start of the year and at the end of the year will show the company’s cash balances.

The correct answer is B.
EXPLANATION

The company has an existing revaluation reserve in the equitypart of the statement of financial position. This will be reduced by the size of the loss and a similar reduction made to the value of the non-current assets (therefore following the dual aspect concept).

The correct answer is A.
EXPLANATION

An increase in trade payables, eg credit offered by trade suppliers, improves the company’s cash position. All the other options reduce cash.

The correct answer is A.
EXPLANATION

The company’s profit is equal to the change in equity.

$\begin{aligned}
\text { So, profit } \quad & =\text { (end year assets }- \text { end year liabilities })-(\text { start year assets }- \text { start year liabilities }) \\\\
& =(1,183,000-338,000)-(840,000-288,000) \\\\
& =845,000-552,000 \\\\
& =293,000
\end{aligned}$

343,000 is incorrect as it is the increase in assets only. 393,000 is incorrect as it is the increase in assets plus the increase in liabilities. 845,000 is incorrect as it is the company’s equity at the end of the year (rather than the change in equity).

The correct answer is B.
EXPLANATION

Dividends are a payment out of earnings and reduce the amount retained in the business. Equity includes share capital and reserves. Reserves include revaluation reserves and retained earnings.

The correct answer is C.
EXPLANATION

Intangible assets, eg patents, can be sold, and they do depreciate, Although they may be difficult and subjective to value, they do have a value.

Goodwill is an intangible asset that can be created on the consolidated statement of financial position when a parent company buys a subsidiary.

The correct answer is A.
EXPLANATION

I is true. A successful rights issue will increase cash and therefore assets.

II is false. The share premium account will probably increase (as shares are usually issued at a price above their nominal/value).

III is false. Investments will be unchanged.

The correct answer is B & C.
EXPLANATION

The realisation and accruals concept are designed to give an accurate representation of the income and expenses for a given reporting period, and therefore the company’s performance. However, note that these accounting concepts do not always give an accurate representation of the company’s overall financial position, eg a company could be profitable but still have liquidity issues.

The cashflow statement is not the only way to establish the amount of cash a company has as the company’s bank balance can be found on the statement of financial position. This should give the users of the financial statements an idea of the appropriateness of the size of the company’s bank balance relative to its size and scale of operations. The directors may also communicate with stakeholders in other ways, eg by explaining significant movements in cash in the directors’ report or notes to the accounts.

The correct answer is C.
EXPLANATION

Depreciation is calculated using the reducing balance method, the depreciation rate $r$ is:

$
r=1-(5,000 / 70,000)^{0.1}=23.195 \%
$

After one year, the value of machinery shown under ‘non-current assets’ will be:

$
=70,000 \times(1-0.23195)=£ 53,763
$

The correct answer is A.
EXPLANATION

The other options are incorrect as:
$\bullet$ $\quad$ the reducing balance method would give a higher deprecation cost in the early years
$\bullet$ $\quad$ wishing to reflect an asset’s higher productivity when new is a reason for choosing reducing balance rather than straight line depreciation
$\bullet$ $\quad$ both the straight line and the reducing balance methods are based on the age of an asset rather than its usage.

The correct answer is D.
EXPLANATION

I and III are true. II is false.
The asset has been depreciated by $\$ 5,000$ each year since purchase. Therefore. as it is now six years old its value will be $\$ 55,000-\$ 30,000=\$ 25,000$. With no change to the depreciation, the depreciation charge in years seven to ten would be $\$ 5,000$.

The change in the estimated useful life will result in a depreciation charge of \$2,000 each year in years seven to sixteen.

I is true as the year seven depreciation will be $\$ 2,000$ rather than $\$ 5,000$ as a result of the change.
II is not true as the total amount of depreciation charged is the difference between the initial cost $(\$ 55,000)$ and the residual value $(\$ 5,000)$ in either case.
III is true as the year ten depreciation will be $\$ 2,000$ rather than $\$ 5,000$ as a result of the change. Deducting a lower depreciation charge in that year will result in a higher reported profit.

The correct answer is A & E.
EXPLANATION

The depreciation charge each year is part of cost of sales deducted in arriving at operating profit. This changed operating profit would result in a changed profit for the year and so, as the company does not pay dividends, a changed in the earnings for the year that contribute to the retained earnings in the equity section of the statement of financial position.

Finance costs are independent of the depreciation charge.
Depreciation affects a company’s operating profit, but not ‘its taxable profit and so not its tax liability.

Depreciation is not a cashflow and so has no impact on cash.

The correct answer is C.
EXPLANATION

Statement 1 is true. Company law restricts dividends to a company’s distributable earnings, which are normally made up of the company’s accumulated retained earnings reserve.

Statement 2 is false. The company is likely to have used some proportion of its past earnings in the business, eg investing in more machinery, buying more stock. There is no reason this amount would be expected to all be held as cash.

Company law restricts dividends in order to protect the creditors of a failing company which might otherwise use its assets to pay a large dividend to shareholders.

The correct answer is C.
EXPLANATION

$\begin{aligned}
\text { Book value of property } & =\text { Cost }- \text { depreciation to date } \\\\
& = \,\text{€} 1.4 m-\text{€} 0.3 \mathrm{~m} \\\\
& = \,\text{€} 1.1 \mathrm{~m} \\\\
\text { Revaluation reserve } & =\text { Revalued value }- \text { book value } \\\\
& =\,\text{€} 2.4 m-\text{€} 1.1 \mathrm{~m} \\\\
& =\,\text{€} 1.3 \mathrm{~m}
\end{aligned}$

On revaluation, the depreciation to date is restated from $\text{€} 0.3 \mathrm{~m}$ to zero, but this is not the revaluation reserve. The revaluation reserve is the difference between the revalued property value and its book value.
$\text{€} 1.1 \mathrm{~m}$ is incorrect as it ignores the depreciation to date. The revaluation reserve is the difference between the revalued property value and its book value (rather than its original cost).
$\text{€} 2.1 \mathrm{~m}$ is incorrect as it applies the depreciation to date to the revalued property value.

The correct answer is B.
EXPLANATION

$\begin{aligned}
\text { Book value of building } & =\text { Cost }- \text { depreciation to date } \\
& =\,800,000-200,000 \\
& =\,600,000 \\\\
\text { Fair value of building } & =\text { Book value }+ \text { revaluation reserve } \\
& =600,000+350,000 \\
& =950,000
\end{aligned}$

600,000 is the book value of the building, As the revaluation reserve is the difference between the fair value and the book value, we need to add the revaluation reserve to the book value to obtain the fair value.
$1,000,000$ is incorrect as it has added the depreciation of the building to its original cost.
Subtracting the depreciation would give the book value of the building. Then adding the revaluation reserve would give the fair value as required.
$1,150,000$ is incorrect as it has ignored the depreciation to date.

The correct answer is C.
EXPLANATION

The revaluation of the factory will increase equity and non-current assets on the statement of financial position, it will not affect Sheldon’s profit for 20Y7. The amount of the revaluation (£ 100,000 in this case) will also be shown as ‘other comprehensive income’, which is below profit for the year on the statement of comprehensive income.

The correct answer is D.
EXPLANATION

In the draft statements, the full amount of the invoice has been included in the advertising expenses for the year to 30 June 20XX, when only a third of the expense relates to this financial year. The advertising expenses should therefore decrease by two thirds of the invoice amount, ie £ 10,000.

Since the invoice was paid before the year-end date, the full £ 15,000 will have come out of Z plc’s bank account, reducing cash. Since £ 10,000 of this expense relates to the next financial year, the company has prepaid an expense, meaning that a prepayment of £ 10,000 will be shown under current assets on the statement of financial position.

The correct answer is C.
EXPLANATION

An associate company is defined as one over which the parent has significant influence but not a controlling interest. Wam is therefore not an associate company, it is a subsidiary company.

A significant influence is often taken to mean a holding of between $20 \%$ and $50 \%$ of the company’s shares. However, a parent company can sometimes hold this proportion of shares but have little influence. On the other hand the parent company can hold less than $20 \%$ of the shares and yet still have a significant influence.

Both Wizz and Watt are associate companies. Although Techno only holds $18 \%$ of the shares of Watt, it has 1 of the 3 seats on the board and therefore exerts a significant influence.

The correct answer is B.
EXPLANATION

Alpha’s share of Jet’s earnings should be included in the consolidated statement of profit or loss, regardless of whether or not Alpha receives these as dividends. Including all of Jet’s assets and non-controlling interests in the consolidated statement of financial positionwould be correct if Jet was a subsidiary, but both are inappropriate as Jet is an associate.

The correct answer is D.
EXPLANATION

In theory, it would be possible for Z to NOT support Company B. Strictly, a group has no legal identity and so there is no legal requirement for $Z$ to settle Company B’s liabilities. However, there is also nothing forbidding Z from giving its support, even in the absence of contractual guarantees or 100\% ownership.

Z will presumably weigh the potential reputational damage of not supporting Company B against the cost of doing so in making its decision.

The correct answer is D.
EXPLANATION

It is not true to say that there is little guidance available to those preparing accounts for insurance companies. Insurance company accounts are subject to the same reporting regime as any other type of limited company, so the preparation of the accounts must follow the International Financial Reporting Standards (IFRSs). There is a specific accounting standard, IFRS 17 (Insurance Contracts) that provides guidance on the preparation of insurance company accounts. In addition to this, the insurance industry is heavily regulated.

The correct answer is B.
EXPLANATION

The CET1 capital ratio is the ratio of a bank’s equity capital to its total risk-weighted assets. Issuing new equity capital would increase the numerator while the denominator would be unchanged as the total risk-weighted assets is unchanged.

Switching from government to corporate bonds and replacing equity finance with debt finance would reduce the ratio (by increasing the risk-weightings of the assets and by reducing the amount of equity capital respectively). Making less use of wholesale money markets should not affect the ratio.

The correct answer is D.
EXPLANATION

If the bank achieves a higher return on equity, it has increased income or reduced costs to below other competitor banks, ie has a lower cost to income ratio.

If the bank is smaller, it would not have economies of scale to keep its costs down and would therefore by likely to show a high cost to income ratio. The bank’s business mix could well increase its costs, particularly if it operates in many niche markets. If the bank had experienced persistent losses in recent years, then its income would be depressed, and the cost to income would be higher.

The correct answer is B.
EXPLANATION

Profit before tax and interest is: $85+6+10=£ 101 \mathrm{~m}$.
Interest on ULS $=£ 10 \mathrm{~m}$, interest on prior ranking mortgage $=£ 6 \mathrm{~m}$. Total interest $=£ 16 \mathrm{~m}$.
Therefore interest cover on the ULS is $101 \div 16$.

The correct answer is C.
EXPLANATION

$\begin{array}{ll}
&& \text { Dividend yield }=\frac{\text { dividend per share }}{\text { share price }} \\\\
&& \text { Dividend cover }=\frac{\text { earnings per share }}{\text { dividend per share }} \\\\
& \text { Therefore, } &\text { Dividend yield }=\frac{\text { earnings per share }}{\text { share price }} \times \frac{1}{\text { dividend cover }}
\end{array}$

This expression can then be used to evaluate each of the options. For the first two the dividend yield halved and for the final one it remained the same.

The correct answer is A.
EXPLANATION

Earnings per share is, in, isolation, not particularly useful as the number of shares per company is somewhat arbitrary. Earnings per share becomes meaningful when compared with, for example, the share price (in the price earnings ratio) or the dividend per share (in the dividend cover or payout ratio).

The correct answer is A.
EXPLANATION

I is true. EBIDTA is higher than earnings as EBIDTA includes depreciation, interest payments, tax etc that are subtracted to reach the company’s earnings.

II is false. Company X ‘s lower price earnings ratio may be because its earnings are more risky as a result of it having more debt than Company Y , but this is not the only possible explanation so we cannot be sure that Company X has more debt.

III is false. The earnings per share would half and the share price would also be expected to fall to about half its previous level.

The correct answer is A.
EXPLANATION

A high price earnings ratio could indicate that a share is over-priced rather than under-priced, since a higher price earnings ratio indicates that the market is prepared to pay more for a given level of current earnings.

The correct answer is D.
EXPLANATION

Being more competitive means reducing product prices, which would likely decrease gross profit. The other options would tend to increase gross profit margin.

The correct answer is C.
EXPLANATION

As we are told to use $\$ 29.4 m$ for the capital employed, this includes both debt and equity on the denominator of our ROCE equation (since $\$ 29.4 m=\$ 12.0 m$ share capital $+\$ 8.4 m$ reserves + $\$ 9.0 \mathrm{~m}$ loans). Therefore, we must use the net profit before tax and interest in the numerator. For this company, that is the operating profit of $\$ 3.7 \mathrm{~m}$.

The correct answer is E.
EXPLANATION

Statement 1 is false. Company E could increase its selling price, but that might affect sales volumes. Since it currently has a high return on capital employed, increasing selling prices may not be sensible.

Statement 2 is false. Return on capital employed is the most important profitability ratio and this indicates that Company E is profitable. This is despite the low gross profit margin, ie low profit per unit sold.

The correct answer is D.
EXPLANATION

Statement 1 is false. It is not clear which investment is the best choice for the investor, since we do not know anything about the investor’s existing portfolio or investment preferences, eg their appetite for risk, or whether both companies have the same growth prospects.

Statement 2 is true. Company A’s return on capital employed is higher and this does suggest it is generating returns for its investors more effectively than Company B.

The return on capital employed calculations (using the return on all capital definition) are:
$$
\begin{aligned}
& \text { Company } A=\frac{420,000+75,000}{2,500,000+1,500,000}=12.4 \% \\\\
& \text { Company } B=\frac{320,000+30,000}{3,000,000+500,000}=10.0 \%
\end{aligned}
$$

Using the alternative definition based on just equity capital also results in a higher return for Company A.

The correct answer is A.
EXPLANATION

I-D, II-A, III-C, IV – B

The correct answer is C & D.
EXPLANATION

Profit can vary greatly from month to month for various reasons, eg seasonal sales volumes, estimated stock levels and delays in accounting for accruals due to late receipt of invoices from suppliers may all distort the accounts. This will affect the numerator of the ROCE calculation, resulting in significant fluctuations in ROCE from month tomonth.

Since ROCE can vary significantly from month to month in the normal course of business, it would be unwise to take drastic action as a result of a one-off decline in ROCE.

The directors should monitor ROCE to ensure that they are generating a satisfactory return for investors. This would make ROCE a very important measure for the directors as well as investors.

Share capital and long-term debt generally stay consistent from month to month. That is unless the company has undertaken some sort of financing activities, eg borrowing money or issuing shares. This is unlikely to be something that is done frequently.

On a month-by-month basis, monitoring profitability and asset utilisation ratios may be more useful than monitoring ROCE. Although these fluctuate too, managers will be aware of reasons for changes, and if these are well managed, a healthy ROCE should follow.

The correct answer is A.
EXPLANATION

$\mathrm{I}-\mathrm{C}, \mathrm{II}-\mathrm{B}, \mathrm{III}-\mathrm{A}$

The correct answer is D.
EXPLANATION

I is true. If F plc exceeds any agreed credit terms, suppliers may withdraw trade credit and insist on cash purchases only.

II is false. Trade credit does not attract interest – this cost is effectively factored into the original cost of goods. So, delaying making payments to suppliers can be seen as a cheap source of funding compared to, say, paying bills using a short-term loan from a bank.

III is true. F plc’s liquidity position may have worsened recently for a variety of reasons, eg inventories are spending longer in the warehouse. If this is managed solely by extending the time taken to pay suppliers, it may mask but not address some more serious issues that F plc faces.

The correct answer is D.
EXPLANATION

Statement 1 is false. Although the short-term assets have increased by more than the short-term liabilities, it is not true to say that T’s liquidity position has improved. The growth in short-term assets is largely due to the increase in trade receivables with a single company, U plc. This is quite a concentration of risk. Thas gone from a positive cash position to being overdrawn. This is an issue as it means the bank could demand immediate repayment of the overdraft, leaving $T$ with insufficient liquid funds and therefore facing insolvency.

Statement 2 is true as both the ratios have increased over the period.

The correct answer is B & E.
EXPLANATION

Inventory taking longer to leave the warehouse would cause the inventory turnover period to increase, however $T$ has not experienced this. Its inventory turnover period has shortened during the three months being reviewed.

The receivables turnover period has increased, which does appear to be at least partly due to the significant new customer, U plc.

The payables turnover period has shortened, which suggests less competitive terms with suppliers.

Stock turning over more quickly would reduce the period cash is tied up in inventory and we’re looking for reasons why it might have increased.

Making a higher proportion of sales on credit increases the receivables turnover period, which is what the figures show.

The correct answer is A.
EXPLANATION

$\mathrm{I}-\mathrm{A}, \mathrm{II}-\mathrm{C}, \mathrm{III}-\mathrm{B}, \mathrm{IV}-\mathrm{D}$

Statement I matches with A, Non-recourse factoring involves selling receivables to a third party who then collects from customers. This can be aggressive or impersonal, potentially harming customer relations.
Statement II matches with C, Suppliers may respond to late payments by withdrawing discounts or tightening credit terms.
Statement III matches with B, Overdrafts are repayable on demand, so relying too heavily on them carries the risk of a sudden liquidity crunch.
Statement IV matches with D, Lean inventory systems can lead to stockouts if demand surges unexpectedly.

The correct answer is A.
EXPLANATION

A future is an obligation and is traded on an exchange.
An option would give a different size of profit or loss depending on whether interest rates rose or fell. A call option on a bond would make a profit when rates fell, but the loss when rates rise would be limited to the price of the option.

Swaps and forwards are both over the counter (OTC) derivatives and would not be traded on an exchange.

The correct answer is D.
EXPLANATION

The contract will have moved in the favour of the French company, since it has agreed in the contract to provide a certain amount of Euros for one million dollars but the dollar is now worth more. The futures contract has therefore made a profit which will be deposited into the margin account.

As futures contracts are marked-to-market daily, this profit will be credited to the French company by the clearing house, increasing their margin account and enabling them to request a refund (if they choose) from the clearing house.

The correct answer is B.
EXPLANATION

The buyer of an option does not have an obligation and therefore cannot have a liability at expiry.
In the other cases the investor may have an obligation to settle:
$\bullet$ $\quad$ the seller of a futures contract may be obliged at expiry to sell an asset at a price that is below the then current market price
$\bullet$ $\quad$ the writer of a call may be obliged to sell stock at a price below the current market price
$\bullet$ $\quad$ the buyer of a futures contract may be obliged to buy an asset at a price that is then above the current market price.

The correct answer is A.
EXPLANATION

The $£ 0.15$ per share that the option holder paid for the option is known as the option premium.
The prices of $£ 1.35$ and $£ 1.40$ are previous and current market values respectively.
The price at which the shares can be purchased, ie $£ 1.50$ each, is the strike price.

The correct answer is C.
EXPLANATION

If the company generates foreign currency, the swap will pay it to the counterparty in return for a stream of domestic currency, which may be useful.

Swaps require the payment and involve the receipt of funds, and so would not produce ’emergency funds’ for a company. Speculation is relatively rare for most trading companies, being undertaken primarily by investment specialists. It is difficult to hedge option exposure with a swap as one is an option and the other an obligation.

The correct answer is D.
EXPLANATION

I is true. Depreciation of the domestic currency against the overseas currency would make a cost incurred in the overseas currency more expensive in domestic currency terms.

II is true. Buying currency futures or forwards would protect the company from a depreciation of the domestic currency because the higher project costs could be offset by profits on the futures.

III is true. Buying currency call options would also protect the company because, if the domestic currency depreciates, the company would exercise the option (and so profit from having the option to buy the overseas currency at the agreed better rate).

The correct answer is D.
EXPLANATION

Margin is required for default protection for the clearing house. If a customer of a clearing house sells a future, the position will become a liability for the customer (and an asset for the clearing house) if the asset rises, so the clearing house demands more margin.

There is no upfront fee for a future as futures have the same chance of making a profit as a loss. Margin is not posted to cover interest rate risk, as most futures (other than interest rate and bond futures) are not exposed to this risk. Nor is cash required for liquidity management.