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Accounting Level 3

Model Answers Series 2 2007 (Code 3001)

3001/2/07/MA 2 OVER

Accounting Level 3 Series 2 2007

How to use this booklet

Model Answers have been developed by Education Development International plc (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) Questions – reproduced from the printed examination paper (2) Model Answers – 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)

(3) Helpful Hints – where appropriate, additional guidance relating to individual

questions or to examination technique 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 2007 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.

3001/2/07/MA 3

SECTION A (Answer Questions 1 and 2 in Section A − Compulsory) QUESTION 1 The accountant of Acton plc, who is unqualified, has prepared a Trial Balance at 31 December 2006 containing a Suspense Account balance of £7,400 Dr. The company’s auditors have so far discovered the following errors: (1) No record had been made of the disposal of a fixed asset for £500. This fixed asset cost £1,400 and had a net book value of £200. The cash received was found in a drawer. (2) The total of the Sales Day Book for December had been over added by £400. The accounts of

individual debtors are treated as memorandum records only. (3) The proceeds of an issue of 5,000 £1 Ordinary Shares at £2 each had been debited to Suspense Account and credited to Share Capital Account. (4) Stock, valued at cost £4,800, which was part of the closing stock, had been omitted from the

stock records. The balances on the Cost of Goods Sold Account and the Closing Stock Account appeared in the Trial Balance.

(5) A payment for electricity of £78 had been credited in the Bank Account, no further entry had been

made. Following the correction of these errors a balance remained on the Suspense Account. REQUIRED (a) Prepare Journal entries, including narratives, to correct the above errors.

(13 marks) (b) Prepare the Suspense Account, starting with the current balance of £7,400 DR and showing the revised balance as a result of the relevant entries from (a) above.

(3 marks)

(c) State two reasons for concern regarding the errors made by Acton plc’s accountant. (4 marks)

(Total 20 marks)

3001/2/07/MA CONTINUED ON NEXT PAGE 4

MODEL ANSWER TO QUESTION 1 (a) (1) Dr

£ Cr £

Fixed Asset Disposal 1,400 Fixed Asset at cost 1,400 Being transfer of cost of fixed asset sold to disposal account Accumulated Depreciation – Fixed Asset 1,200 Fixed Asset Disposal 1,200 Being transfer of accumulated depreciation on fixed asset sold to disposal account

Cash 500 Fixed Asset Disposal 500 Being the recording of the proceeds of sale of a fixed asset Fixed Asset Disposal 300 Profit and Loss 300 Being the recording of the profit on disposal of a fixed asset (2) Sales 400 Debtors Control 400 Being the correction of an error in the recording of sales (3) Ordinary Share Capital 5,000 Share Premium 5,000 Being the correction of the recording of a share issue Bank 10,000 Suspense 10,000 Being the proceeds of a share issue transferred from suspense (4) Stock 4,800 Cost of Goods Sold 4,800 Being the correction of an error in stock recording (5) Electricity 78 Suspense 78 Being the correction of an error in the recording of electricity

3001/2/07/MA 5

MODEL ANSWER TO QUESTION 1 CONTINUED (b)

SUSPENSE ACCOUNT £ £ Balance per Trial Balance 7,400 Bank 10,000Closing Balance 2,678 Electricity 78 10,078 10,078

(c) The accountant (unqualified) was unable to record

(i) Fixed asset disposal (ii) A share issue He was also careless: (i) Left out part of the stock (ii) Failed to complete the double entry for electricity (iii) Wrongly added the sales day book

3001/2/07/MA 6

SECTION A CONTINUED QUESTION 2 Below are ratios calculated from the accounting statements of Ealing plc at 31 December 2005: Gross profit to sales {(12 million / 200 million) x 100} = 6.00% Net profit to sales {(3 million / 200 million) x 100} = 1.50% Debtors’ collection {(23 million / 200 million) x 365} = 42 days Creditors’ settlement {(18 million / 187 million) x 365} = 35 days Current (60 million / 18 million) = 3.33 times The bank balance at 31 December 2005 was £10 million and at 31 December 2006 it was £12 million. Between 31 December 2005 and 31 December 2006 debtors increased by £7 million, creditors fell by £2 million and stock increased by £3 million. During the year ended 31 December 2006 sales increased by 25%, gross profit increased by 20% and expenses fell from £9 million to £8 million. REQUIRED (a) Calculate the stock value of Ealing plc at 31 December 2005.

(3 marks)

(b) Calculate, with the same degree of accuracy, the ratios shown above, in respect of the accounting statements of Ealing plc for 2006.

(11 marks)

Typically supermarkets have stock turnover rates of around 7 days, debtors’ collection periods averaging around 2 days but creditors’ settlement periods of around 90 days. REQUIRED (c) Briefly explain why, for supermarkets, stock turnover rates and debtors’ collection periods are so

short and creditors’ settlement periods are so long. (6 marks)

(Total 20 marks)

3001/2/07/MA 7

MODEL ANSWER TO QUESTION 2 (a) £ £ Stock at 31 December 2005 Current assets 60M Less: Debtors 23M Bank 10M 33M 27M (b) Gross profit to sales 12M x 1.2 x 100 = 5.76% 200M x 1.25 Net profit to sales (12M x 1.2) – 8M = 2.56% 200M x 1.25 Debtors’ collection (23M + 7M) x 365 = 44 days 200M x 1.25 Creditors’ settlement (18M – 2M) x 365 = 24 days 238.6M* Current (27M + 3M) + (23M + 7M) + 12M = 4.50 times 18M – 2M *Purchases 250M – 14.4M + 3M (c) Stock turnover – supermarkets sell perishables which must be sold quickly; supermarkets rely on low margins and high turnover; supermarkets have “just in time” stock delivery systems. Debtors’ collection – supermarkets sell almost exclusively for cash or credit card. Creditors’ settlement – supermarkets have a high degree of buyer power with which to negotiate payment terms.

3001/2/07/MA 8

SECTION B (Answer any THREE questions from Section B)

QUESTION 3 Hanwell started in business on 1 January 2007. He immediately rented some premises and paid £50,000 for machinery. He decided to depreciate this on a unit cost basis. The following additional information is available: (1) Budgeted sales were:

UNITS TOTAL VALUE £ January 4,200 90,000 February 4,000 84,000 March 4,400 102,000 April 5,000 110,000 May 5,200 124,000

40% of each month’s sales are expected to be received within that month and qualify for a 10% cash discount. 98% of the remainder are expected to be received in the month following the month of sale. The remainder are expected to be bad debts. (2) Production cost per unit was expected to be: £ Direct materials 4 Direct wages 1 Production overheads 4 Other overheads 5 14 (3) Hanwell intended to keep in stock direct materials sufficient to make 500 units and finished goods

sufficient to satisfy 25% of the following month’s sales requirements. Raw materials are paid for in the month acquired.

(4) 90% of direct wages are paid in the month incurred and the remainder in the following month. (5) Production overheads include machinery depreciation of £1 per unit. Payment is made in the

month incurred. (6) Other overheads are paid 50% in the month incurred and 50% the following month. (7) Selling expenses were expected to be £5,000 per month and paid in the month incurred. REQUIRED (a) Calculate for Hanwell how many units of finished goods need to be produced for each of the four

months January, February, March and April 2007. (3 marks)

(b) Prepare for Hanwell a cash budget for each of the four months January, February, March and

April 2007. This must be in columnar form and show the cumulative balance at the end of each month. Interest may be ignored.

(17 marks)

(Total 20 marks)

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MODEL ANSWER TO QUESTION 3 (a) Production Budget (units) January February March April £ £ £ £ Opening stock ( - ) (1,000) (1,100) (1,250)Sales 4,200 4,000 4,400 5,000Closing stock (25% x next month’s sales) 1,000 1,100 1,250 1,300 5,200 4,100 4,550 5,050 (b) Cash Budget January February March April £ £ £ £ RECEIPTS: Debtors 32,400 83,160 86,112 99,576PAYMENTS: Machinery 50,000 - - - Direct materials 22,800 16,400 18,200 20,200 Direct wages 4,680 4,210 4,505 5,000 Production overheads 15,600 12,300 13,650 15,150 Other overheads 13,000 23,250 21,625 24,000 Selling expenses 5,000 5,000 5,000 5,000 111,080 61,160 62,980 69,350OPENING BALANCE - (78,680) (56,680) (33,548)NET INFLOW / (OUTFLOW) (78,680) 22,000 23,132 30,226CLOSING BALANCE (78,680) (56,680) (33,548) (3,322) Presentation 2

WORKINGS [1] January February March April Receipts from debtors £ £ £ £ 40% x 90,000 x 90% 32,400 60% x 90,000 x 98% 52,920 40% x 84,000 x 90% 30,240 60% x 84,000 x 98% 49,392 40% x 102,000 x 90% 36,720 60% x 102,000 x 98% 59,97640% x 110,000 x 90% 39,600 32,400 83,160 86,112 99,576 [2] January February March AprilPayments for direct materials Units Units Units UnitsMinimum stock 500 - - -Production (a) 5,200 4,100 4,550 5,050 5,700 4,100 4,550 5,050X cost per unit £4 £22,800 £16,400 £18,200 £20,200

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MODEL ANSWER TO QUESTION 3 CONTINUED [3] January February March April Payments for direct wages £ £ £ £ 5,200 x .9 4,680 5,200 x .1 520 4,100 x .9 3,690 4,100 x .1 410 4,550 x .9 4,095 4,550 x .1 4555,050 x .9 4,545 4,680 4,210 4,505 5,000[4] Payments for production overheads £ £ £ £ 5,200 x (4-1) 15,600 4,100 x (4-1) 12,300 4,550 x (4-1) 13,650 5,050 x (4-1) 15,150 [5] Payments for other overheads £ £ £ £ 5,200 x 5 x 50% 13,000 13,000 4,100 x 5 x 50% 10,250 10,250 4,550 x 5 x 50% 11,375 11,3755,050 x 5 x 50% 12,625 13,000 23,250 21,625 24,000

3001/2/07/MA 11

QUESTION 4

The following relates to the Holborn Social Club for 2006:

SUBSCRIPTION ACCOUNT £ £Balance brought down 200 Balance brought down 180Income & Expenditure 18,200 Bank 18,320 Income & Expenditure – bad debts 20Balance carried down 220 Balance carried down 100 18,620 18,620 The annual subscription is £20 REQUIRED (a) Calculate for Holborn Social Club, in respect of 2006, how many members:

(i) there were (ii) were in arrears at the end of the period (iii) had paid in advance at the beginning of the period (iv) had their membership terminated for non-payment of subscription

(4 marks)

Many non-trading organisation use a cash basis, rather than accruals basis, for accounting for subscriptions. REQUIRED (b) Give two reasons why the cash basis is regularly used for accounting for subscriptions.

(3 marks)

On 31 March 2007 Moorgate’s bank account in his cash book showed that he had an overdraft of £400 on his current account. The statement provided by his bank at that date showed an overdraft of £408. When comparing the cash book and the bank statement the following were discovered: (1) Cheques totalling £480, entered in the cash book, had not been presented at the bank. (2) £60 transferred from Moorgate’s deposit account to his current account had been debited to his

deposit account and credited to his current account in his cash book. (3) Bank charges of £18 had not been entered in his cash book. (4) Cheques received totalling £290 had been entered in his cash book but not yet recorded by the

bank. (5) The payments side of the cash book had been under added by £300. (6) A cheque for £30 payable to a supplier was replaced when out of date. Both cheques were

entered in the cash book. The second cheque has been cleared by the bank and the first cheque has been listed as an unpresented cheque.

REQUIRED (c) Show the adjustments necessary in Moorgate’s bank account in his cash book, as a result of the

above discoveries, and the revised closing balance. (5 marks)

(d) Reconcile the balance shown in the bank statement with the revised cash book balance. (5 marks)

(e) Explain: (i) the difference between bank interest and bank charges (ii) why an overdraft is shown as a debit balance on a bank statement

(3 marks)

(Total 20 marks)

3001/2/07/MA 12

MODEL ANSWER TO QUESTION 4 (a) (i) Number of members (18,200/20) 910

(ii) Members in arrears at the end (100/20) 5 (iii) Members paid in advance at the beginning (180/20) 9 (iv) Members having membership terminated (20/20) 1

(b)

(i) Non-trading organisations rarely have qualified accountants keeping the records and accrual accounting is more complicated.

(ii) Non-trading organisations are voluntary and despite the rules members rarely give notification of resignation, records are therefore likely to be inaccurate.

(iii) Cash accounting is more prudent as unpaid subscriptions are most likely to become bad debts.

(c)

BANK ACCOUNT £ £ Deposit (2 x 60) 1 120 Balance brought down 400 1 Cancelled cheque 1 30 Bank charges 18 1 Balance carried down 568 Addition error 300 1 718 718 (d) BANK RECONCILIATION STATEMENT £ Balance per Bank Statement (408) Add unpresented cheques (480 – 30) (450) (858) Less unrecorded deposit 290 Balance per Bank Account (568)

(e)

(i) Bank interest is charged on overdrawn accounts and is a charge for the borrowing of money. Bank charges are charges by the bank for administering an account.

(ii) The bank statement is a copy of the bank’s account with its customer in the bank’s books.

An overdraft (money owed to the bank) is therefore an asset and as such has a debit balance.

3001/2/07/MA 13

SECTION B CONTINUED QUESTION 5 Iver, Langley and Slough are in partnership sharing profits/losses in the ratio 3:2:1 respectively. Their year end is 31 December and sales and net profits for the last five years have been as follows:

Sales Net Profits £000 £000 2002 320 54 2003 360 44 2004 380 46 2005 360 36 2006 480 64

The partners are about to change their profit/loss sharing ratio to 15:6:10 respectively and are discussing two possible ways of valuing goodwill: (1) Taking twice the sales of 2006. (2) Taking the total net profits of the last five years but giving a weighting of 1 for 2002 and

increasing the weighting by 1 for each subsequent year. Iver prefers the first method, because it gives a higher figure and relies entirely on the most recent results. Langley prefers the second method, because he feels that goodwill valuation should be more a function of profit than sales. Slough is indifferent, as he believes goodwill value is entirely dependent on what someone would be prepared to pay for it. REQUIRED (a) Calculate the total value of goodwill under each of the two methods.

(4 marks)

(b) Briefly discuss the views of each of the three partners. (8 marks)

(c) Assuming that goodwill is to remain unrecorded and that the second valuation method is adopted,

calculate the adjustments necessary (+/-) to each of the three partners’ capital account balances. (3 marks)

The partners are considering admitting Burnham as a partner from 1 January 2008. It has been proposed that Burnham is given either: (1) 10% of the partnership net profits with no salary, or (2) 5% of the partnership net profits with a salary of £6,000 per year. REQUIRED (d) Assuming that the partnership net profit for 2008 is expected to be £76,000, calculate Burnham’s

share of the net profit under each the two alternatives and state which method would be preferable for the existing partners.

(5 marks)

(Total 20 marks)

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MODEL ANSWER TO QUESTION 5 (a) Goodwill value method (1) £ 2006 2 x 480,000 960,000 Goodwill value method (2) 2002 1 x 54,000 54,000 2003 2 x 44,000 88,000 2004 3 x 46,000 138,000 2005 4 x 36,000 144,000 2006 5 x 64,000 320,000 744,000 (b) Iver The sales method does give a higher figure and concentrates entirely on the most recent information. However sales fluctuate and profits are not solely a function of sales. Langley The profit method is more closely related to goodwill than the sales method. However profits are less objective as they are dependent on valuation methods (e.g. depreciation) and judgement (e.g. bad debts). Slough Goodwill is indeed dependent on what someone is prepared to pay for it, but some estimate has to be made when profit/loss sharing ratios change or when a partner retires.

(c) Goodwill adjustments in Capital Accounts Iver Langley Slough £ £ £ 744,000 3:2:1 + 372,000 + 248,000 + 124,000 744,000 15:6:10 - 360,000 - 144,000 - 240,000 + 12,000 + 104,000 - 116,000

(d) Burnham’s profit share method (1) £ Profit 76,000 x 10% 7,600 Burnham’s profit share method (2) £ Profit (76,000 – 6,000) x 5% 3,500 Salary 6,000 9,500 Preference of existing partners Method (1)

3001/2/07/MA 15

SECTION B CONTINUED QUESTION 6 On 1 January 2004 Taplow Ltd paid £120,000 to acquire 80% of the share capital of Maidenhead Ltd. On that date Maidenhead Ltd had a debit balance of £40,000 on its Profit and Loss Account. The summarised Balance Sheets of the two companies on 31 December 2006 were as follows: TAPLOW LTD MAIDENHEAD LTD £000 £000FIXED ASSETS Tangible 520 180Investment: 80,000 shares in Maidenhead Ltd 120 - 640 180NET CURRENT ASSETS 30 65 670 245 £000 £000CAPITAL AND RESERVES Ordinary shares of £1 each 500 100Profit and Loss 170 145 670 245 Additional information: (1) Goodwill arising on consolidation is amortised on a straight-line basis over 5 years. (2) During the year to 31 December 2006 Maidenhead Ltd sold goods to Taplow Ltd for £45,000.

These goods were invoiced at cost plus 25% and Taplow Ltd had sold half the value of these goods by 31 December 2006.

(3) Included in Maidenhead Ltd’s creditors is £10,000 relating to a dividend proposed by the

company prior to the year end. Taplow Ltd has not made any entries in its books to record the dividend receivable from Maidenhead Ltd.

REQUIRED (a) Calculate the following balances for the Consolidated Balance Sheet of Taplow Ltd at 31 December 2006:

(i) goodwill on consolidation (ii) minority interest (iii) consolidated profit and loss

(15 marks)

(b) Prepare the summarised Consolidated Balance Sheet of Taplow Ltd at 31 December 2006. (5 marks)

(Total 20 marks)

3001/2/07/MA © Education Development International plc 2007 16

MODEL ANSWER TO QUESTION 6 (a) (i) Goodwill £ £ Cost of Investment 120,000Less: Share capital 100,000 Profit and loss 40,000 Group share .8 x 60,000 48,000 72,000Less: Written off {(3/5) x 72,000} 43,200 28,800 (ii) Minority Interest £ Share capital and reserves (.20 x 245,000) 49,000Less: Unrealised profit (.20 x .20 x .50 x 45,000) 900 48,100 (iii) Profit and Loss £ £ Taplow Ltd 170,000Maidenhead Ltd – post acquisition share {(145,000 + 40,000) x .80} 148,000 318,000Less: Goodwill written off 43,200 Unrealised profit (.80 x .20 x .50 x 45,000) 3,600 46,800 271,200Dividend receivable (10,000 x .80) 8,000 279,200

(b)

TAPLOW LTD CONSOLIDATED BALANCE SHEET AT 31 DECEMBER 2006

FIXED ASSETS £ Tangible (520,000 + 180,000) 700,000 Intangible - Goodwill 28,800 728,800 NET CURRENT ASSETS (30,000 + 65,000 – 4,500 + 8,000) 98,500 827,300 CAPITAL AND RESERVES £ Ordinary Shares of £1 each 500,000 Profit and loss 279,200 779,200 MINORITY INTEREST 48,100 827,300