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Accounting

Level 3

Model Answers
Series 2 2007 (Code 3001)

1 3001/2/06

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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) (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)

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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.

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3001/2/07/MA

OVER

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 companys 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 plcs accountant. (4 marks) (Total 20 marks)

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MODEL ANSWER TO QUESTION 1 (a) (1) Fixed Asset Disposal Fixed Asset at cost Being transfer of cost of fixed asset sold to disposal account Accumulated Depreciation Fixed Asset Fixed Asset Disposal Being transfer of accumulated depreciation on fixed asset sold to disposal account Cash Fixed Asset Disposal Being the recording of the proceeds of sale of a fixed asset Fixed Asset Disposal Profit and Loss Being the recording of the profit on disposal of a fixed asset (2) Sales Debtors Control Being the correction of an error in the recording of sales (3) Ordinary Share Capital Share Premium Being the correction of the recording of a share issue Bank Suspense Being the proceeds of a share issue transferred from suspense (4) Stock Cost of Goods Sold Being the correction of an error in stock recording (5) Electricity Suspense Being the correction of an error in the recording of electricity 300 300

Dr 1,400

Cr 1,400

1,200 1,200

500 500

400 400

5,000 5,000

10,000 10,000

4,800 4,800

78 78

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CONTINUED ON NEXT PAGE

MODEL ANSWER TO QUESTION 1 CONTINUED (b) SUSPENSE ACCOUNT 7,400 Bank 2,678 Electricity 10,078 10,000 78 10,078

Balance per Trial Balance Closing Balance

(c) The accountant (unqualified) was unable to record (i) (ii) Fixed asset disposal 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

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SECTION A CONTINUED QUESTION 2 Below are ratios calculated from the accounting statements of Ealing plc at 31 December 2005: Gross profit to sales Net profit to sales Debtors collection Creditors settlement Current {(12 million / 200 million) x 100} {(3 million / 200 million) x 100} {(23 million / 200 million) x 365} {(18 million / 187 million) x 365} (60 million / 18 million) = 6.00% = 1.50% = 42 days = 35 days = 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)

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MODEL ANSWER TO QUESTION 2 (a) Stock at 31 December 2005 Current assets Less: Debtors Bank 60M 23M 10M

33M 27M

(b) Gross profit to sales

12M x 1.2 x 100 200M x 1.25 (12M x 1.2) 8M 200M x 1.25 (23M + 7M) x 365 200M x 1.25 (18M 2M) x 365 238.6M* (27M + 3M) + (23M + 7M) + 12M 18M 2M

= 5.76%

Net profit to sales

= 2.56%

Debtors collection

= 44 days

Creditors settlement

= 24 days

Current

= 4.50 times

*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.

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

40% of each months 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 Direct wages Production overheads Other overheads 4 1 4 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 months 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) Opening stock Sales Closing stock (25% x next months sales)

January ( - ) 4,200 1,000 5,200

February (1,000) 4,000 1,100 4,100

March (1,100) 4,400 1,250 4,550

April (1,250) 5,000 1,300 5,050

(b) Cash Budget RECEIPTS: Debtors PAYMENTS: Machinery Direct materials Direct wages Production overheads Other overheads Selling expenses OPENING BALANCE NET INFLOW / (OUTFLOW) CLOSING BALANCE Presentation 2

January 32,400 50,000 22,800 4,680 15,600 13,000 5,000 111,080 (78,680) (78,680)

February 83,160 16,400 4,210 12,300 23,250 5,000 61,160 (78,680) 22,000 (56,680)

March 86,112 18,200 4,505 13,650 21,625 5,000 62,980 (56,680) 23,132 (33,548)

April 99,576 20,200 5,000 15,150 24,000 5,000 69,350 (33,548) 30,226 (3,322)

WORKINGS [1] Receipts from debtors 40% x 90,000 x 90% 60% x 90,000 x 98% 40% x 84,000 x 90% 60% x 84,000 x 98% 40% x 102,000 x 90% 60% x 102,000 x 98% 40% x 110,000 x 90% January 32,400 February 52,920 30,240 49,392 36,720 59,976 39,600 99,576 April Units 5,050 5,050 20,200 March April

32,400 [2] Payments for direct materials Minimum stock Production (a) X cost per unit 4 January Units 500 5,200 5,700 22,800

83,160 February Units 4,100 4,100 16,400

86,112 March Units 4,550 4,550 18,200

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CONTINUED ON NEXT PAGE

MODEL ANSWER TO QUESTION 3 CONTINUED [3] Payments for direct wages 5,200 x .9 5,200 x .1 4,100 x .9 4,100 x .1 4,550 x .9 4,550 x .1 5,050 x .9 [4] Payments for production overheads 5,200 x (4-1) 4,100 x (4-1) 4,550 x (4-1) 5,050 x (4-1) [5] Payments for other overheads 5,200 x 5 x 50% 4,100 x 5 x 50% 4,550 x 5 x 50% 5,050 x 5 x 50% January 4,680 February 520 3,690 410 4,095 455 4,545 5,000 March April

4,680 15,600

4,210 12,300

4,505

13,650 15,150

13,000

13,000 10,250

10,250 11,375 21,625

13,000

23,250

11,375 12,625 24,000

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QUESTION 4 The following relates to the Holborn Social Club for 2006: SUBSCRIPTION ACCOUNT 200 Balance brought down 18,200 Bank Income & Expenditure bad debts 220 Balance carried down 18,620

Balance brought down Income & Expenditure Balance carried down

180 18,320 20 100 18,620

The annual subscription is 20 REQUIRED (a) Calculate for Holborn Social Club, in respect of 2006, how many members: (i) (ii) (iii) (iv) there were were in arrears at the end of the period had paid in advance at the beginning of the period 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 Moorgates 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 Moorgates 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 Moorgates 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)

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MODEL ANSWER TO QUESTION 4 (a) (i) (ii) Number of members (18,200/20) Members in arrears at the end (100/20) 910 5 9 1

(iii) Members paid in advance at the beginning (180/20) (iv) Members having membership terminated (20/20)

(b) (i) Non-trading organisations rarely have qualified accountants keeping the records and accrual accounting is more complicated. Non-trading organisations are voluntary and despite the rules members rarely give notification of resignation, records are therefore likely to be inaccurate.

(ii)

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

(c) BANK ACCOUNT 120 Balance brought down 30 Bank charges 568 Addition error 718 400 18 300 718

Deposit (2 x 60) Cancelled cheque Balance carried down

1 1

1 1 1

(d) BANK RECONCILIATION STATEMENT Balance per Bank Statement Add unpresented cheques (480 30) Less unrecorded deposit Balance per Bank Account (408) (450) (858) 290 (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. The bank statement is a copy of the banks account with its customer in the banks books. An overdraft (money owed to the bank) is therefore an asset and as such has a debit balance.

(ii)

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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 000 320 360 380 360 480 Net Profits 000 54 44 46 36 64

2002 2003 2004 2005 2006

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 Burnhams 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 960,000

2 x 480,000

Goodwill value method (2) 2002 2003 2004 2005 2006

1 x 54,000 2 x 44,000 3 x 46,000 4 x 36,000 5 x 64,000

54,000 88,000 138,000 144,000 320,000 744,000

(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 372,000 360,000 12,000 Langley 248,000 144,000 104,000 Slough 124,000 240,000 116,000

744,000 744,000

3:2:1 15:6:10

+ +

+ +

+ -

(d) Burnhams profit share method (1) Profit 76,000 x 10% 7,600

Burnhams profit share method (2) 3,500 6,000 9,500 Method (1)

Profit Salary

(76,000 6,000) x 5%

Preference of existing partners

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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 000 FIXED ASSETS Tangible Investment: 80,000 shares in Maidenhead Ltd NET CURRENT ASSETS 520 120 640 30 670 000 CAPITAL AND RESERVES Ordinary shares of 1 each Profit and Loss 500 170 670 MAIDENHEAD LTD 000 180 180 65 245 000 100 145 245

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 Ltds 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)

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MODEL ANSWER TO QUESTION 6 (a) (i) Goodwill Cost of Investment Less: Share capital Profit and loss Group share Less: Written off {(3/5) x 72,000}

100,000 40,000 .8 x 60,000

120,000

48,000 72,000 43,200 28,800

(ii) Minority Interest Share capital and reserves (.20 x 245,000) Less: Unrealised profit (.20 x .20 x .50 x 45,000)

49,000 900 48,100

(iii) Profit and Loss Taplow Ltd Maidenhead Ltd post acquisition share {(145,000 + 40,000) x .80} Less: Goodwill written off Unrealised profit (.80 x .20 x .50 x 45,000)

170,000 148,000 318,000

43,200 3,600

Dividend receivable (10,000 x .80)

46,800 271,200 8,000 279,200

(b) TAPLOW LTD CONSOLIDATED BALANCE SHEET AT 31 DECEMBER 2006 FIXED ASSETS Tangible (520,000 + 180,000) Intangible - Goodwill NET CURRENT ASSETS (30,000 + 65,000 4,500 + 8,000) 700,000 28,800 728,800 98,500 827,300 CAPITAL AND RESERVES Ordinary Shares of 1 each Profit and loss MINORITY INTEREST 500,000 279,200 779,200 48,100 827,300

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