LCCI International Qualifications

Accounting (IAS) Level 3

Model Answers
Series 2 2010 (3902)

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Accounting (IAS) Level 3

Series 2 2010

How to use this booklet Model Answers have been developed by EDI to offer additional information and guidance to Centres, teachers and candidates as they prepare for LCCI International Qualifications. The contents of this booklet are divided into 3 elements: (1) (2) Questions Model Answers reproduced from the printed examination paper summary of the main points that the Chief Examiner expected to see in the answers to each question in the examination paper, plus a fully worked example or sample answer (where applicable) where appropriate, additional guidance relating to individual questions or to examination technique

(3)

Helpful Hints

Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success. EDI provides Model Answers to help candidates gain a general understanding of the standard required. The general standard of model answers is one that would achieve a Distinction grade. EDI accepts that candidates may offer other answers that could be equally valid.

Education Development International plc 2010 All rights reserved; no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission of the Publisher. The book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover, other than that in which it is published, without the prior consent of the Publisher.

Page 1 of 15

QUESTION 1 Some categories of accounting error do not cause trial balance totals to disagree. REQUIRED (a) Name three categories of accounting error which do not affect the balancing of a trial balance, and give an example for each category. (6 marks)

Kuyt, a sole trader, has balanced his trial balance at 31 December 2009, after preparing his income statement for the year ended 31 December 2009. Extracts from this trial balance are as follows: $000 241 121 98 41 14

Capital (less drawings) Non-current assets (net book value) Trade receivables (less provision) Trade payables Inventory The following errors have now been discovered: (1) (2)

Kuyt paid himself a salary of $500 a month and charged it to wages. Closing inventory included an item costing $800 which Kuyt believes can now only be sold for $300. Selling costs of $20 would also have to be incurred. Bad debts of $5,000 should have been written off and the bad debt provision of 2% should have been provided at 5%. Motor expenses of $820 had been recorded as selling expenses. Non-current assets, with a net book value of $8,000, were taken by Kuyt for his personal use. This had not been recorded. Depreciation for the year had not been provided. Kuyts policy is to charge depreciation at 10% on the net book value of the non-current assets held at the year end.

(3)

(4) (5)

(6)

REQUIRED (b) Prepare Journal entries (without narratives) to record the correction of the above errors. (12 marks) (c) Calculate the change to net profit resulting from the correction of the errors. (4 marks) (d) Calculate the revised balance on Kuyts Capital Account resulting from the correction of the errors. (3 marks) (Total 25 marks)

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MODEL ANSWER TO QUESTION 1 (a) Error of omission e.g. forgetting to charge depreciation. Error of original entry e.g. sales of $1,000 recorded in the sales day book as $100. Error of commission e.g. sales on credit to D Jones recorded in A Jones Account. Error of principle e.g. recording $1,000 of non-current asset purchases in Repairs Account. Compensating errors e.g. recording wages to X at $100 too much and wages to Y at $100 too little.

(b) Journal Entries $ DR 6,000 520 520 5,000 5,000 2,750 2,750 820 820 8,000 8,000 11,300 11,300 $ CR 6,000

(1) (2) (3)

(4) (5) (6)

Capital (500 x 12) Wages expense Inventory (trading account)[800 (300 - 20)] Inventory Bad debts expense Receivables Bad debts expense (W1) Provision for bad debts Motor expenses Selling expenses Capital Non-current assets Depreciation expense [(121,000 - 8,000) 10] Non-current assets Receivables before bad debt and provision (98,000 x 100/98) Bad debt

W1

Increase in provision [(0.05 x 95,000) (100,000 98,000)] (c) Change in net profit Wages Inventory Bad debts Bad debts Depreciation

100,000 5,000 95,000 $2,750 $ 6,000 (520) (5,000) (2,750) (11,300) (13,570) $ 241,000 (13,570) (6,000) (8,000) 213,430

(d) Revised Capital Per trial balance Change in net profit Wages/drawings Non-current assets/drawings

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QUESTION 2 Basso and Carey are in partnership sharing profits/losses equally. At 31 December 2009 their Trial Balance was as follows: $000 DR Capital - Basso - Carey Land and buildings cost accumulated depreciation Plant and machinery cost accumulated depreciation Inventory Trade receivables Trade payables Bank overdraft $000 CR 242 191 60 120 65 90 140 50 42 650

300

650

The partnership sells toys and Orr has expressed an interest in joining Basso and Carey in business. Orr has extensive knowledge of the toy industry. It was agreed to dissolve the partnership and transfer the business to a new company BCO, a private company, on the following terms: (1) all assets and liabilities of the partnership to be taken over at book value except land and buildings, which would be re-valued at $400,000, and inventory, which would be written down by $32,000. the share capital of the company would be 2,000,000 Ordinary Shares of $0.50 each. Basso and Carey would take shares, issued at a premium of $0.25 each, in settlement of their capital accounts. Orr would spend $150,000 purchasing shares in the company, also issued at a premium of $0.25 each.

(2) (3)

(4)

REQUIRED (a) State what is meant by the term issued share capital. (2 marks) (b) Calculate the number of shares in BCO received by: (i) (ii) (iii) Basso Carey Orr (7 marks) (c) Calculate the number of shares in BCO remaining unissued. (2 marks) (d) Prepare the Balance Sheet of BCO on 1 January 2010, before trading commenced. (8 marks) Many small businesses find it advantageous to operate their businesses as private companies. REQUIRED (e) Give four reasons why the partners might have wished to incorporate as a private company. (6 marks) (Total 25 marks) 3902/2/10/MA Page 4 of 15

MODEL ANSWER TO QUESTION 2 (a) Issued Share Capital The number of shares a company has issued. (2 marks) (b) Number of shares received (i) Basso Capital account Surplus on land and buildings [(400 (300 60)) x 0.50] Loss on inventory (32 x 0.50) $000 242 (ii) Carey $000 191

80 (16) 306 306,000 0.75 = 408,000 shares

80 (16) 255 255,000 0.75 = 340,000 shares = 200,000 shares

(iii)

Orr

150,000 0.75

(c) Shares Remaining Unissued 2,000,000 408,000 340,000 200,000 =

1,052,000 shares

(d)

BCO Balance Sheet at 1 January 2010 $000 ASSETS Non-current assets Land and buildings Plant and machinery (120 65) $000

400 55 455

Current assets Inventory (96 32) Receivables Bank (150 42) Total assets EQUITY AND LIABILITIES Capital and reserves Ordinary shares of $0.50 [(408 + 340 + 200) x 0.50] Share premium (948 x 0.25) Equity Current liabilities Payables

58 140 108 306 761

474 237 711

50 761

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QUESTION 2 CONTINUED (e) Reasons for incorporation Limited liability Ease of raising finance Flexibility of ownership Taxation Prestige

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QUESTION 3 The Cash Flow Statement for Cole, a private company, for the year ended 31 December 2008 was as follows: Cash flows from operating activities Profit from operations Adjustments for: Depreciation Profit on disposal of non-current assets Operating cash flow before movements in working capital Increase in inventory Increase in receivables Increase in payables Cash generated from operations Interest paid Net cash from operating activities Cash flows from investing activities Purchase of non-current assets Sale of non-current assets Net cash from investing activities $ $ 10,600

11,820 (840) 10,980 21,580 (11,318) (6,790) 5,600 (12,508) 9,072 (1,000) 8,072

(35,256) 2,400 (32,856) (24,784)

Cash flows from financing activities Equity dividends paid Issue of debentures Net cash used in financing activities Net decrease in cash During the year ended 31 December 2009: (1) (2) (3)

(7,894) 10.000 2,106 (22,678)

The profit from operations increased by 15%, after allowing for writing down obsolete inventory. Non-current assets with a net book value of $4,800 were sold at a profit of $800. Non-current assets purchased had a net book value of $9,000 at 31 December 2009. Non-current assets are depreciated at 10% on cost with a full charge being made in the year of acquisition. The total depreciation charge was $400 higher than for 2008. Interest paid was the same as in 2008. Dividends paid were the final dividend for 2008 of $4,900 and an interim dividend for 2009 of $2,800. The final dividend proposed for 2009 was $5,100. No debentures were issued or redeemed, but a rights issue of shares raised $9,000. A capitalisation (bonus) issue of 5,000 $1 shares was made. Inventory at the year end cost $12,714, an increase of $1,157 on the previous year end. However, included in the inventory was obsolete inventory costing $1,200, which was expected to be sold for $900. The receivables total has increased. Receivables at 31 December 2008 were $12,750, which was 85% of the total receivables at 31 December 2009. The payables total has decreased. Payables at 31 December 2009 were $12,000, which is 20% lower than the total payables at 31 December 2008.

(4) (5) (6)

(7)

(8)

(9)

(10)

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QUESTION 3 CONTINUED REQUIRED (a) Prepare, in the format given, the Cash Flow Statement of Cole for the year ended 31 December 2009.

(21 marks)

Cash flow statements report cash inflows and cash outflows during an accounting period

REQUIRED (b) Give two advantages of a cash flow statement over the other accounting statements. (4 marks) (Total 25 marks)

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MODEL ANSWER TO QUESTION 3

(a) $000 Cash flows from operating activities Profit from operations (10,600 x 1.15) Adjustments for: Depreciation (11,820 + 400) Profit on disposal of non-current assets $000 12,190

12,220 (800) 11,420

Operating cash flow before movements in working capital Increase in inventory [1,157 (1,200 900)] Increase in receivables (12,750 x 15/85) Decrease in payables (12,000 x 20/80) Cash generated by operations Interest paid Net cash from operating activities Cash flows from investing activities Purchase of non-current assets (9,000 x 10/9) Sale of non-current assets (4,800 + 800) Net cash from investing activities

23,610 (857) (2,250) (3,000) (6,107) 17,503 (1,000) 16,503

(10,000) 5,600 (4,400) 12,103

Cash flows from Financing activities Equity dividends paid (4,900 + 2,800) Issue of shares Net cash used in financing activities Net increase in cash

(7,700) 9,000 1,300 13,403

Presentation (b) Advantages There is little scope for manipulating the figures. The figures are more objective. The figures are easier to compare with previous years/other firms.

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QUESTION 4 Obi is planning to start a business on 1 July 2010, making and selling umbrellas. He will provide $5,000, in cash, as his initial capital on 30 June 2010. Obi is going to budget on a quarterly basis, with each quarter consisting of 13 weeks. Production and sales are expected to be as follows: WEEKLY PRODUCTION UMBRELLAS Quarter 1 ending 30 September 2010 Quarter 2 ending 31 December 2010 Quarter 3 ending 31 March 2011 Quarter 4 ending 30 June 2011 70 90 90 40 WEEKLY SALES UMBRELLAS 60 86 94 16

There will not be any partly completed umbrellas at the end of each quarter, and materials are purchased as required. Each umbrella will be sold for $30. 75% of each quarters sales will be received in that quarter with the remaining 25% received in the following quarter. The materials for each umbrella will cost $12 up to 31 December 2010 and $14 subsequently. Payables for materials are expected to be $4,000 at 30 September 2010, rise by 2% at 31 December 2010, rise a further 10% on the 31 December 2010 figure at 31 March 2011, and fall to $4,200 at 30 June 2011. Obi will do most of the work himself in his garage. However, when production exceeds 70 units per week, he will employ Mikel to help him. Mikel will be paid a fixed wage of $60 per week, when he is required. On 1 July 2010, Obi will purchase manufacturing machinery costing $4,000. This will be depreciated at 2% per quarter on cost. Other variable costs (50% of which will relate to production) are expected to be $6 per umbrella and be paid weekly in cash. Obi intends to use the FIFO basis of inventory valuation, for the 442 umbrellas he expects to be in inventory at 30 June 2011. However, he is uncertain how to apply it, and decides to value them at $14 each.

REQUIRED (a) Prepare, a quarterly cash budget, in columnar form for each of the four quarters to 30 June 2011, showing the cash balance at the end of each quarter. (13 marks) (b) Prepare, a budgeted Income Statement for the year ended 30 June 2011. You should value closing inventory on the basis of the $14 decided by Obi. (10 marks) Give two reasons why Obis valuation of $14 per umbrella is unacceptable for external reporting purposes. (2 marks) (Total 25 marks)

(c)

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MODEL ANSWER TO QUESTION 4 (a) OBI cash budget for the year ending 30 June 2011 Q1 Q2 Q3 $ Receipts Sales (W1) Payments Materials (W2) Labour (13 x 60) Non-current assets Other variable costs (W3) Opening balance Receipts Payments Closing balance 6,920 4,000 5,460 16,380 5,000 17,550 22,550 16,380 6,170 13,960 780 7,020 21,760 6,170 31,005 37,175 21,760 15,415 15,972 780 7.020 23,772 15,415 35,880 51,295 23,772 27,523 7,568 3,120 10,688 27,523 13,845 41,368 10,688 30,680 17,550 31,005 35,880 13,845 $ $

Q4 $

(b) Sales

OBI Income Statement for the year ending 30 June 2011 $ (23,400 + 33,540 + 36,660 + 6,240) (W1) 48,620 1,560 320 $ 99,840

Less Cost of Sales: Opening inventory Materials (10,920 + 14,040 + 16,380 + 7,280) (W2) Labour (780 + 780) Depreciation (4,000 x 0.02 x 4) Other variable production costs [(5,460 + 7,020 + 7,020 + 3,120) x 0.50] Less Closing inventory (442 x 14) Gross profit Less Expenses Net profit 11,310 61,810 6,188 55,622 44,218 11,310 32,908

(c)

Obis inventory valuation is unacceptable because it should include: (1) $3 per unit of other variable cost a proportion of the depreciation charge.

3902/2/10/MA

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QUESTION 5 The following information relates to Hart, a public company, a car manufacturer, for 2009: Number of $1 Ordinary Shares in issue Market price per share (31 December) Price/earnings ratio Net profit percentage Gross profit percentage 1,000,000 $1.50 30 40% 65%

REQUIRED (a) Calculate the following amounts, in respect of Hart, for 2009: (i) (ii) (iii) (iv) earnings per share net profit cost of goods sold expenses (8 marks) The following information relates to Dunne, a public company, a supermarket chain, for 2009: Receivables collection period Sales Payables settlement period Purchases Current ratio (31 December) Bank (balance in hand at 31 December) Opening inventory was equal to closing inventory There were no current assets other than receivables, inventory and bank There were no current liabilities other than payables. 2 days $730,000,000 80 days $511,000,000 0.5 : 1 $40,000,000

REQUIRED (b) Calculate the following amounts in respect of Dunne plc at 31 December 2009: (i) (ii) (iii) receivables payables inventory (6 marks)

(c)

Calculate (to the nearest day) the inventory turnover ratio of Dunne for 2009. (2 marks)

Elano, an investor, is considering purchasing shares in either Hart or Dunne and has asked the following questions: (i) in difficult economic times is it safer to invest in Hart, which makes cars, or in Dunne, which sells mainly food?

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QUESTION 5 CONTINUED (ii) is Dunnes current ratio of 0.5 : 1 a concern, as I have heard that a safe current ratio should be at least 1 : 1? does Harts high price/earnings ratio of 30 mean that it will take a long time to get my money back in dividends? Does this ratio also mean that the company is not highly rated by the stock market?

(iii)

REQUIRED (d) Answer each of Elanos questions, in a way that a non-expert investor would understand. (9 marks) (Total 25 marks)

3902/2/10/MA

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MODEL ANSWER TO QUESTION 5

(a) Hart plc 2009 (i) Price/earnings ratio = Price per share Earnings per share 30 EPS = 1.50 30 = $0.05

1.50 Earnings per share (ii) Net profit

0.05 x 1,000,000

$50,000

(iii) Cost of goods sold 50,000 x 100 Sales = 125,000 COGS = 40 Sales = 50,000 x 100 40 = $43,750

125,000 (1.00 0.65) 125,000 (0.65 0.40)

(iv) Expenses

$31,250

(b) Dunne plc 31 December 2009 (i) Receivables 365 730,000,000 = 2 Receivables Receivables = 2 x 730,000,000 365 (ii) Payables 365 511,000,000 = 80 Payables Payables = 80 x 511,000,000 365 (iii) Inventory = $112,000,000 = $4,000,000

Inventory + 4,000,000 + 40,000,000 112,000,000

0.50

Inventory = 56,000,000 44,000,000 = $12,000,000

(c) Inventory turnover ratio 365 511,000,000 12,000,000 = 365 x 12,000,000 = 8.57 511,000,000 = 9 days

(d) (i)

In difficult economic times Dunne would be regarded as the safer investment. People are more likely to delay purchasing a car than they are to reduce their consumption of food.

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QUESTION 5 CONTINUED (ii) Dunnes current ratio is unlikely to be a concern because supermarkets have: (1) (2) (3) relatively low inventories, as food must turnover rapidly low receivables, as nearly all transactions are for cash high payables, as supermarkets have power over their suppliers, who are generally smaller.

(iii) It is possible that a high price/earnings ratio is an indication that it will take a long time to recover an investment. However, the share price is based on anticipated future earnings and dividends, which are likely to be higher than the current earnings upon which the ratio is based. For this reason, the higher the ratio the higher the company is rated by the stock market.

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Education Development International plc 2010

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