Question
Piper Industrial (PI)
Piper Industrial (PI) manufactures pipe. The company is highly profitable and its corporate tax rate is 20 %. PI is forecasting major capital expenditure for 2019.
Table 1: Selected forecast financial information for the year ending 31 December 2019
Table 2: Annual cash flow forecast for the year ending 31 December 2019
a. Define the term capital expenditure.[2]
b. (b) Using Table 1, calculate for $P l$ :
(i) gross profit $(\mathbf{X})$;
(ii) $\operatorname{tax}(\mathbf{Y})$.
(c) Using Table 1 and your calculations in (i) and (ii), construct a profit and loss account for $P I$.
d. Using Table 2, calculate the net cash flow (Z) for PI for 2019 (show all your working).[2]
e. Explain the difference between profit and cash flow.[2]
▶️Answer/Explanation
Ans:
a. Capital expenditure refers to the purchase by a business of long-term assets (assets that have a useful life longer than one year).
Award [1] mark for partial understanding and knowledge and [2] for a complete definition as the above (though candidates do not have to use the precise wording above).
b. (b)(i) Gross profit is $\$ 10000000$. Candidate is not required to show workings.
Award [1] for the correct answer.
$\mathrm{b}$ (ii) Tax is $\$ 860000$.
Candidate is not required to show workings. Award [1] for the correct answer.
If a candidate provides NR or some other answer that appears incorrect but then calculates tax correctly in (c), award [1].
(c)
If the candidate has some idea what a profit and loss account is, award an additional [1] mark. If the candidate produces a profit and loss account that is correct and conforms to the IB format (as above), award [2].
Maximum award: [2].
N.B. The candidate must follow the IB format. However, be flexible if candidates use slightly different wording, such as “Pre-tax profit” rather than “Net profit before tax,” as long as the correct meaning is conveyed.
d. Net cash flow is $\$ 1500000$ calculated as follows:
$\$ 24000000$ total receipts
$\$ 22500000$ total payments
$\$ 1500000$ net cash flow
Award [1] for the correct answer and [1] for workings. Accept alternative methods provided they are correct methods.
e. Profit is typically calculated on an accrual basis (when revenue or expense actually accrues to the business) but does not reflect the actual movement of funds. Cash flow reflects the actual movement of funds – when a business receives payment and makes a payment. Thus, a timing difference can exist between the accrual of a revenue or an expense and the actual receipt of funds.
Award [1] for partial understanding and explanation and [2] marks for a complete understanding and explanation. A candidate does not have actually to use the word accrual, but they must convey understanding of a timing difference between the profit and loss account and the cash flow.
An alternative way that a candidate can earn [2] is by defining profit (revenue minus expenses) and then explaining that cash flow is the movement of funds such as external financing (an inflow) or debt service (an outflow) or some other specific examples of inflows and outflows.