Examiner’s Report and

Model Answers for

Accounting

THIRD LEVEL
Series 2 (Code 3501) 2000
Hong Kong

LCCI Examinations Board

Accounting Third Level (Hong Kong)
Series 2 2000

How to use this booklet

Examiners’ Reports and Model Answers have been developed by LCCIEB to offer additional
information and guidance to Centres, teachers and candidates as they prepare for LCCIEB
examinations. The contents of this booklet are divided into 5 elements:

(1) General Comments – assessment of overall candidate performance in this examination,

providing general guidance where it applies across the
examination as a whole

(2) Questions – reproduced from the printed examination paper

(3) Model Answers – summary of the main points that the Chief Examiner expected to
see in the answers to each question in the examination paper

(4) Examiner’s Report – constructive analysis of candidate error, areas of weakness and
other comments that apply to each question in the examination
paper

(5) 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.

The London Chamber of Commerce and Industry Examinations Board provides Model Answers to
help candidates gain a general understanding of the standard required. The Board accepts that
candidates may offer other answers that could be equally valid.

Note

LCCIEB reserves the right not to produce an Examiner’s Report, either for an examination paper as a
whole or for individual questions, if too few candidates were involved to make an Examiner’s Report
meaningful.

© LCCI CET 2000

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system or
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published, without the prior consent of the Publisher.

Typeset, printed and bound by the London Chamber of Commerce and Industry Examinations Board.

1
Accounting Third Level (Hong Kong)
Series 2 2000
GENERAL COMMENTS

The overall performance at this examination was good with many candidates producing excellent
scripts. Unfortunately, it was apparent that some candidates had neglected to build upon the
knowledge gained at First and Second Levels and, as a result, they struggled with questions requiring
a more in-depth understanding of topics originally studied at these levels.

HELPFUL HINTS

In case study type questions it is extremely important that candidates work methodically

Workings should be structured and clearly linked to the part of the question to which they refer

An attempt should be made to answer all parts of the question and thus accumulate as many
marks as possible

Do not forget knowledge acquired at earlier levels as such knowledge will often be required at
Third Level

Please read any information given in a question very carefully and thus avoid unnecessary
problems caused by the failure to do so

Be sure to remember the order in which figures should be placed in a manufacturing account

Understand the mathematical relationship between margin and mark-up

Tutors and candidates alike must be fully conversant with the structure of balance sheets and the
impact that various transactions would have upon such structure

Remember that each transaction will have a twofold impact

Be sure to understand accounting concepts and how their application will impact upon the financial
results of a business

Be fully conversant with everyday accounting terminology eg working capital.

2
Accounting Third Level (Hong Kong)
Series 2 2000

QUESTION 1 Compulsory

Peter Ball has decided to start a retail business, Ball Specialists, from 1 January Year 20 when he will
pay £100,000 into a business bank account. He has purchased some business premises which will
require the payment of £60,000 in February Year 20 and a subsequent and final payment of £15,000 in
September of the same year. Peter has also acquired a van costing £8,000 and some office
equipment costing £5,000, both of which will be paid for in January Year 20.

His suppliers have informed him that the purchase price of the one product he intends selling,
Widget 1999, will remain fixed at £10 per unit until 1 July Year 20 at which time it will rise to
£12 per unit. Peter has decided upon a mark-up of 100% to establish his selling price and any rise in
selling price will operate from the same date as the purchase price rise.

The following budgeted information is provided by Peter Ball in respect of the year to 31 December
Year 20:

(1) Purchases and sales, in units for:

Purchases Sales

Three months ending

31 March 900 850
30 June 1,200 1,100
30 September 1,700 1,600
31 December 1,800 1,750

Suppliers are offering three months' credit and Peter is extending the same terms to his credit
customers. Thus, for example, payment for goods purchased or sold during the three months ending
31 March Year 20 will not be made or received until the three months ending 30 June Year 20.

Cash sales will represent 25% of total sales.

(2) Three members of staff will be employed from 1 January Year 20 at a salary cost of £450 per
month each. An additional member of staff will be employed from 1 July Year 20 at a salary cost
of £400 per month. All salaries will be payable at the end of the month in which they are
incurred.

(3) General expenses are expected to be £200 per month payable in the month following that in
which they are incurred.

(4) Part of the business premises will be sub-let from 1 July Year 20 at an annual rent of £4,008.
The rent will be payable three months in advance (on the first day of the three months to which
it relates) and the tenant will be required to pay a security deposit of £2,004 together with the
payment for the first three months' rent.

(5) Legal fees of £2,500, relating to the purchase of the business premises, will be paid in October
Year 20.

(6) Peter Ball will make cash drawings of £300 per month for the first six months of the year and
£400 per month thereafter.

3 CONTINUED ON NEXT PAGE

Question 1 continued

REQUIRED

(a) Prepare a cash budget in columnar form for the three month periods ending 31 March,
30 June, 30 September and 31 December:

Note: Show clearly the cash balance at the end of each three month period

(20 marks)

Peter has decided that the FIFO basis will be used to value closing stock and that depreciation will be
provided on fixed assets as follows:

Van - 25% per annum on cost

Office Equipment – 10% per annum on cost
Premises – 1% per annum on cost

REQUIRED

(b) Prepare a budgeted Trading, Profit & Loss Account for the year ending 31 December
Year 20.
(12 marks)

(c) Prepare a budgeted Balance Sheet at 31 December Year 20 showing clearly the working
capital position.
(10 marks)

Peter is investigating the possibility of extending his product range from 1 January Year 21 by offering
for sale a powerful new Widget known as WD10 which will serve a particular overseas market. The
purchase price of WD10 will be 125% of the purchase price prevailing at the end of Year 20 in respect
of the Widget 1999, and will remain fixed for the entire year. Peter anticipates that 5175 units of WD10
will be assembled in Year 21 and has used this figure to calculate the additional cost per unit.

Interest on money borrowed to finance the new project 1.00

Warehousing 1.00
Depreciation 2.75
Salary of the assembly line manager 3.25
Wages of assembly line operatives 4.50
Royalty payable to owner of patent 0.50
13.00

The costs relating to interest, warehousing, depreciation and assembly line manager are not affected
by the number of units assembled.

The selling price of WD10 is to be calculated by adding 100% to the unit cost of buying and
assembling 5175 units.

REQUIRED

(d) Prepare a detailed calculation of the number of units of WD10 which must be assembled
and sold in the year ending 31 December Year 21 in order that Ball Specialists might break
even on this product.

(7 marks)

(Total 49 marks)

4
Model Answer to Question 1

(a)
Cash Budget for Year 20

Three Months Ending 31 March 30 June 30 September 31 December

£ £ £ £
RECEIPTS

Capital Introduced 100,000

Sales
JFM (20 x 850 x .25)…. x 3 4,250 12,750

AMJ (20 x 1,100 x .25)…. x 3 5,500 16,500

JAS (24 x 1,600 x .25)…. x 3 9,600 28,800

OND (24 x 1,750 x .25)….x 3 10,500

Rent [ (.25 x 4,008) + 2,004]

(.25 x 4,008) 3,006 1,002
104,250 18,250 29,106 40,302

PAYMENTS

Premises 60,000 15,000 2,500

Van 8,000
Office equipment 5,000

Purchases
(10 x 900) 9,000
(10 x 1,200) 12,000
(12 x 1,700) 20,400

Salaries
(450 x 3 x 3) 4,050 4,050
+ (400 x 3) 5,250 5,250

General expenses (2 x 200) 400

(3 x 200) 600 600 600

Drawings (3 x 300) 900 900

(3 x 400) 1,200 1,200
Total Expenditure 78,350 14,550 34,050 29,950

Excess Receipts (Payments) 25,900 3,700 (4,944) 10,352

Balance Brought Forward — 25,900 29,600 24,656

Balance Carried Forward 25,900 29,600 24,656 35,008

5 CONTINUED ON NEXT PAGE

Model Answer to Question 1 continued

(b)

Ball Specialists

Budgeted Trading and Profit & Loss Account

Year ending 31 December Year 20

£ £

Sales [(1,950 x 20) + (3,350 x 24)] 119,400

Less Cost of Sales

Purchases [(2,100 x 10) + (3,500 x 12)] 63,000
Less Closing Stock [12(5,600-5,300)] 3,600
59,400
Gross Profit 60,000
Add Rental Income (2 x £1,002) 2,004
62,004
Less Salaries {(4,050 x 2) + (5,250 x 2)] 18,600
Expenses (200 x 12) 2,400
Depreciation Premises (77,500 x .01) 775
Office equipment (5,000 x .10) 500
Van (8,000 x .25) 2,000 24,275
Net Profit 37,729

(c)

Ball Specialists

Balance Sheet at 31 December Year 20

Tangible Fixed Assets Cost Depr`n NBV

£ £ £

Premises (75,000 + 2,500) 77,500 775 76,725

Van 8,000 2,000 6,000

Office Equipment 5,000 500 4,500

90,500 3,275 87,225

Current Assets

Stock 3,600
Trade Debtors (3 x 10,500) 31,500
Bank 35,008
70,108

Creditors – Amounts Payable within 1 Year

Trade Creditors (12 x 1,800) 21,600

Rent Deposit 2,004
Accrual – Overheads 200
23,804

Working Capital 46,304

133,529

6 CONTINUED ON NEXT PAGE

Model Answer to Question 1 continued

Financed by
£
Capital Introduced 100,000

Net Profit for year 37,729

137,729

Less Drawings (1,800 + 2,400) 4,200

133,529

(d)

Break-even Sales units of WD 10

£
Fixed Costs 5,175 ( 1.00 + 1.00 + 2.75 + 3.25 ) = 5,175 x 8 = 41,400

Variable unit cost ( 12 x 1.25 ) + 4.50 + 0.50 = 20

Selling price per unit ( 20 + 8 ) 2 = 56

Break-even in units = 41 400 = 1,150 units

56 - 20

7
Examiner’s Report on Question 1

This question was, in the main, well answered by the majority of candidates.

Common errors made by candidates were:

(a) Cash Budget

• Presenting the cash budget as a Trading and Profit & Loss Account.
• Presenting the cash budget in total form only, ie failing to show the required three monthly
analysis.
• Showing receipts and payments in the wrong period. Sales receipts and purchases
payments, for example, were often shown in the period the sales or purchases were made
rather than the period in which the cash was actually received or paid.
• Omitting to multiply the three monthly value of salaries by the number of people being paid.

(b) Budgeted Trading and Profit & Loss Account

• Mistakes made in the calculation of figures for inclusion in the cash budget were frequently
carried over into this part of the question.
• Some candidates did not understand how to value closing stock using the FIFO basis of
calculation.
• The vast majority of candidates treated the legal fees incurred in the purchase of the
business premises as a revenue expense rather than a part of the capital cost necessary to
ensure the building was ready for use.
• A surprising number of candidates treated the rental income as an expense despite
correctly showing it as income in the cash budget.

(c) Balance Sheet

• Most candidates made a reasonable attempt at the balance sheet.

• Some candidates are still producing balance sheets using the horizontal format. At Third
Level candidates are expected to use the vertical format, which enables the value of
working capital/net current assets to be calculated and displayed.

(d) Break-even calculation

• Candidates often failed to attempt this section.

• Of those candidates making an attempt, many did not recognise that costs “not affected by
the number of units assembled” must therefore be fixed costs.
• A large minority of candidates omitted to multiply the total unit value of fixed costs by the
number of units being assembled.
• The question required candidates to increase the existing purchase price of Widget 1999 by
25%.

8
QUESTION 2

After preparing the draft Trading, Profit & Loss Account for the year ended 30 June Year 20 and the
draft Balance Sheet as at that date, the assistant accountant of Pinkerton Enterprises received the
firm’s Bank Statement for the four weeks up to 30 June Year 20. This showed a debit balance of
£5,670 in the bank’s records. Pinkerton Enterprises Cash Book showed a credit balance of £6,086. An
investigation was carried out which revealed the following:

(1) The firm had entered into an equipment leasing agreement in February Year 20. This
agreement required £200 to be paid every month over a five year period with the first payment
becoming due on 1 March Year 20. Pinkerton Enterprises had entered the required amounts in
the Cash Book but the bank had inadvertently debited another company.

(2) A deposit made by Pinkerton Enterprises of £3,002 on 29 June Year 20, had been entered in
the Cash Book but did not yet appear on the Bank Statement.

(3) Bank charges of £125 appeared on the Bank Statement but had been omitted from the Cash
Book.

(4) A page of debit entries in the Cash Book had been overcast by £200 and the incorrect total
carried forward.

(5) A standing order of £210 relating to a magazine subscription, had been paid by the bank but not
entered in the firm’s Cash Book.

(6) Cheques totalling £2,768 had been issued by the firm and entered in the Cash Book but none of
these had as yet been presented to the bank.

(7) The Bank Statement showed the receipt of a credit transfer for £713 which did not relate to
Pinkerton Enterprises.

(8) A cheque received from a customer, and amounting to £538, had been dishonoured. This was
shown on the Bank Statement but no entry had been made in the Cash Book.

(9) A dividend cheque received for £400 had been credited twice in the Cash Book but treated
correctly in the General Ledger.

(10) A cheque for £90, issued to a supplier on 30 May Year 20, had been debited in the Cash Book
as £900 but treated correctly in the supplier's personal account.

REQUIRED

(a) Prepare statements showing the correction of the balance:

(i) in the bank's records

(ii) in Pinkerton Enterprises’ Cash Book.
(10 marks)

(b) A bank reconciliation at 30 June Year 20.

(3 marks)

(c) Calculate the balance that would have been entered in the Suspense Account to enable the
Trial Balance at 30 June Year 20 to agree.

Note: You may assume that there were no other recording errors.
(4 marks)

(Total 17 marks)

9
Model Answer to Question 2

(a) (i) Correction of Bank`s records £

Balance shown in Bank Statement (O/D) 5,670

Add: Leasing Agreement payments (4 x £200) 800

Credit Transfer 713

7,183

(ii) Correction of Pinkerton Enterprises records £

Balance shown in cash book (O/D) 6,086

Add Bank charges 125

Addition error 200
Magazine subscription 210
Dishonoured cheque 538
7,159
Less Dividend cheque error (400 x 3) 1,200
5,959
Add Supplier cheque errors (900 + 90) 990
6,949

(b) Bank reconciliation £

Balance per bank records (see (a) (i) above) 7,183 O/D

Less Deposit 3,002

4,181
Add Unpresented cheques 2,768
Balance per cash book (see (a) (ii) above) 6,949 O/D

(c) Balance on Suspense Account £

Addition error Suspense Dr 200

Dividend cheque error Suspense Cr 1,200
Supplier's cheque error Suspense Dr 990
Dr 10

10
Examiner’s Report on Question 2

It was clear from the answers produced to this question that many candidates had forgotten much of
what they had learned at First Level. As a consequence, they were often not prepared to deal with the
greater complexity required by the question.

Common errors made by candidates were:

(a) (i) Correction of Bank’s records

• Treating the leasing agreement payments as income or, alternatively, omitting to

multiply a month’s payment of £200 by the number of months for which the payment
was debited to another company.
• Ignoring the effect of the incorrect treatment of the credit transfer of £713.

(ii) Correction of Pinkerton Enterprises records

• A disturbingly high number of candidates failed to appreciate that the balance at bank
in the company’s records was an overdraft. As a result, all of the corrections, with the
exception of the divided cheque error, should have been added to the opening
balance of £6,086 rather than deducted.

(b) Bank reconciliation

• Candidates did not recognise that the adjusted cash book balance represented a credit
balance at bank.
• Those candidates who did not appreciate the implications of the bank balance being
overdrawn.

(c) Balance on Suspense Account

• Less than ten per cent of candidates answering this part of the question obtained full marks.
• The most common mistake made by candidates was in thinking of the entries required to
clear the Suspense Account rather than the way in which the errors would have originally
been reflected.

11
QUESTION 3

The following incomplete list of balances was extracted from the books of Northern Manufacturing Ltd
on 31 December Year 20:
£ £

Stocks 1 January Year 20

Raw Materials 24,900
Work in progress 61,029
Finished Goods (valued at manufacturing transfer price) 60,060
Purchases of raw materials 985,330
Manufacturing wages 290,135
Factory maintenance wages 45,915
Sales 1,761,408
Debtors 180,500
Provision for doubtful debts 2,650
Debenture interest 1,500
Rates and Insurance 7,030
General office expenses 101,228
Selling expenses 82,055
Distribution costs 55,890
10% Debentures Year 25 (issued Year 18) 30,000
Factory machinery at cost 160,000
Office equipment at cost 10,000
Delivery vehicles at cost 100,000

Additional information

(1) Stocks at cost on 31 December Year 20:

Raw materials £32,500

Work in progress £40,330

The company has always transferred finished goods from the Manufacturing Account to the Trading
Account at cost plus 10%.

(2) The company sells its manufactured products at a mark up of 20% on the manufacturing transfer
price.

(3) Rates and Insurance are apportioned between the Manufacturing and General Office Expenses
in the ratio of 7:3 respectively.

(4) The provision for doubtful debts is to be 4% of the total of Debtors at the year end.

(5) Depreciation is to be provided for as follows:

Factory machinery – 10% on cost

Office equipment – 25% on cost
Delivery vehicles – 20% on cost.

REQUIRED

(a) Calculate the provision for unrealised profit at 1 January Year 20.
(2 marks)

(b) Prepare the Manufacturing, Trading, Profit & Loss Account of Northern Manufacturing Ltd
for the year ended 31 December Year 20.
(15 marks)

(Total 17 marks)

12
Model Answer to Question 3

(a) Provision for unrealised profit at 1 January Year 20 - £60,060 x 10 = £5,460

110

(b)
Northern Manufacturing Ltd
Manufacturing Trading and Profit & Loss Account
for the year ending 31 December Year 20

£ £
Raw Materials
Stock 1 January Year 20 24,900
Purchases 985,330
1,010,230
Less Stock 31 December Year 20 32,500
Cost of raw materials used 977,730

Wages 290,135
Prime Cost 1,267,865

Manufacturing Overheads £
Factory maintenance 45,915
Rates & Insurance (7,030 x 70%) 4,921
Depreciation (160,000 x 10%) 16,000 66,836
1,334,701
Work-in-progress 1 January Year 20 61,029
1,395,730
Less Work-in-progress 31 December Year 20 40,330
Production cost of finished output 1,355,400

Profit and Loss - Manufacturing Profit (0.10 x 1,355,400) 135,540

Transfer to Trading Account 1,490,940

Sales 1,761,408
Cost of Sales of Goods Sold
Opening stock 60,060
Manufacturing 1,490,940
1,551,000
Closing stock 83,160 1,467,840
Gross profit ( 1,761,408 ÷ 6) 293,568
General office expenses 101,228
Rates & Insurance (0.3 x 7,030) 2,109
Depreciation of office equipment (0.25 x 10,000) 2,500
Selling expenses 82,055
Increase in provision for doubtful debts
[ (0.04 x 180,500) – 2,650] 4,570
Distribution expenses 55,890
Depreciation of Delivery Vehicles (0.20 x 100,000) 20,000
Debenture Interest (0.10 x 30,000) 3,000 271,352
22,216
Manufacturing Profit 135,540
157,756
Provision for unrealised profit [(83,160 ÷ 11) – 5,460] 2,100
Net Profit 155,656

13
Examiner’s Report on Question 3

The majority of candidates attempting this question gained good marks.

Common errors made by candidates were:

(a) Provision for unrealised profit

• The majority of candidates recognised that the closing stock value for finished goods of
£60,060 included unrealised profit. Unfortunately, it was common to find candidates
multiplying this figure by 10% to establish the value of unrealised profit. The correct
approach, of course, would have been to divide £60,060 by 110 and then multiply by 10.

(b) Manufacturing, Trading and Profit & Loss Account

• Including sales in the manufacturing account

• Failure to separate prime costs from other overheads
• Reversing the two work-in-progress figures
• Failing to recognise that the closing stock of finished goods in the trading account was the
missing figure in the cost of goods sold calculation. It was first necessary to calculate the
value of gross profit (one sixth of the given sales figure) and then work backwards.
• Charging the whole of the revised value for both the provision for doubtful debts and the
provision for unrealised profit in the Profit & Loss Account, rather than the difference
between the respective opening and closing balances
• Not spotting that an accrual of six months interest was required in respect of the 10%
debentures.

14
QUESTION 4

The directors of Sherwood Ltd prepared the following draft Balance Sheet at 30 June Year 20:

Cost Depreciation NBV

£ £ £

Machinery 100,000 75,000 25,000

Stock 35,000
Debtors 68,250
Bank 88,700
191,950

Creditors 15,770
Accruals 6,530

22,300
169,650
194,650

Authorised Share Capital – 200,000 Ordinary Shares of £1 each 200,000

Issued and Fully Paid Share Capital – 50,000 Ordinary Shares of £1 each 50,000
Share Premium 25,000
Retained earnings 119,650
194,650

Following the preparation of the draft Balance Sheet it was discovered that no entries had been made
in the books in respect of the following transactions:

(1) On 1 January Year 20, a bonus (capitalisation) issue of shares had been made on the basis of
one bonus share for every existing ordinary share held. The issue was made in such a way as to
retain the greatest flexibility possible in terms of future dividend declarations.

(2) On I May Year 20, and as part of an expansion programme, a rights issue was undertaken on the
basis of one new ordinary share for every 4 shares then held. The issue, which was priced at
£1.50 per share, was fully taken up by the shareholders and all moneys duly received with the
exception of one shareholder that still owed the company £200. The directors accepted the
shareholder’s assurance that payment would be forthcoming by 31 July Year 20. All receipts from
the rights issue had been deposited in a separate bank account.

(3) On 1 June Year 20, the company completed the financing of its expansion programme by taking
out a 10-year loan for £100,000, at an annual interest rate of 6%. This loan is repayable in
10 equal annual instalments starting on 1 June Year 21. The proceeds were paid into the same
bank account as the receipts from the rights issue and on 15 June Year 20, £80,000 of this money
was spent acquiring further machinery. All assets of the company are depreciated at 25% on cost
and a full year's depreciation is charged in the year of purchase.

REQUIRED

Prepare the revised Balance Sheet of Sherwood Ltd at 30 June Year 20 after the above
transactions have been fully reflected in the books. All workings must be clearly shown.
(17 marks)

15
Model Answer to Question 4

Sherwood Ltd
Balance Sheet at 30 June Year 20

£ £

Tangible Fixed Assets

Machinery at cost (100,000 + 80,000) 180,000

Less Accumulated Depreciation [75,000 + (0.25 x 80,000)] 95,000
85,000

Current Assets

Stock 35,000
Debtors 68,250
Unpaid on share issue 200
Bank [88,700 + (0.25 x 100,000 x 1.5) – 200 + 100,000 – 80,000] 146,000
249,450

Creditors – Amounts Payable Within 1 Year

£
Creditors 15,770
Accruals [6,530 + ( 1/12 x .06 x 100,000) 7,030
Loan Instalment (.10 x 100,000) 10,000
32,800

Net Current Assets 216,650

301,650
Creditors – Amounts Payable After 1 Year
Loan (.90 x 100,000) 90,000
211,650

Capital and Reserves

Ordinary Share Capital 125,000 (50,000 + 50,000 + 25,000) Shares of £1 each 125,000
Share Premium [25,000 – 25,000 + (25,000 x .5)] 12,500
Retained Earnings (119,650 – 25,000 – 500 – 20,000) 74,150
211,650

16
Examiner’s Report on Question 4

It was obvious from the answers to this question that the majority of candidates had little knowledge of
the way transactions impact upon a company’s balance sheet.

Common errors made by candidates were:

• Assuming that a bonus issue of shares results in the introduction of further cash into the company,
whereas it is simply a paper transaction and no money actually changes hands.
• Failure to understand that retaining “the greatest flexibility in terms of the future dividend
declarations” means making use of capital reserves for the issue of bonus shares in preference to
revenue reserves. Capital reserves cannot legally be used for the payment of dividends whereas
it is entirely legal to make use of revenue reserves for the purpose.
• Not understanding that fifty pence of the rights issue price of £1.50 per share represented a
premium and should therefore have been credited to the share premium account. The correct
balance sheet adjustments would have been to increase share capital by £25,000 and also to
increase the value of share premium account, this time by £12,500. Many candidates increased
the value of share capital by £37,500 and ignored the required adjustment to share premium.

• A long-term loan appears in 2 places within a balance sheet. That element which is repayable
within the next 12 months is allocated to Creditors – amounts payable within one year and the
remainder appears under, either Creditors – amounts payable after one year, or Capital and
Reserves.

17
QUESTION 5

Alan Clark, the owner of a local engineering firm Kingston Mechanics, has been asked by the firm’s
bankers to provide details of his working capital at the year end date of 30 November Year 20. He has
very little knowledge of accounting and has therefore asked for your assistance. In an attempt to be
helpful, he has extracted the following list of balances from his books:

Creditors 15,750
Debtors 32,000
Fixed Assets - at cost 125,000
Fixed Assets - Provision for Depreciation 92,250
Stocks 12,300
Alan Clark - Capital 25,000
- Drawings 5,000
10% Loan – being repaid 10 years at £3000 per annum 21,000
Provision for Doubtful Debts 1,600
Bank Overdraft 17,500
Accruals 1,750
Prepayments 550

His office manager subsequently provided the following additional information, which had not been
reflected in the above figures:

(1) The stock figure of £12,300 included the following two items;

Item 23 - valued at original cost of £230 but now considered to be worth £300
Item 56 - valued at original cost of £500 but can only be sold for £300 if repairs costing £50 are
carried out.

(2) Depreciation had not been charged for the year ended 30 November Year 20. There were no
purchases or sales of fixed assets during the year other than one new vehicle costing £15,000. All
assets have a full year's depreciation charged in the year of purchase. Depreciation is charged at
25% on cost.

(3) The bank reconciliation for 30 November Year revealed unrecorded bank charges of £500. In
addition the bank had returned a cheque for £10,000 as it had not been signed by an authorised
signatory of Kingston Mechanics. No entries had been made in the books to record this.

(4) The same reconciliation showed that a cheque received from a debtor for the sum of £600 had
been dishonoured. On the day the reconciliation was undertaken, notification was received that
the debtor had become bankrupt and that no further payments would be forthcoming. It was
therefore decided to immediately write off the balance on the account which, at 29 November
Year 6, was in the books at £1,250.

(5) The Provision for Doubtful Debts was to be adjusted to 4% of Debtors after allowing for any
known bad debts.

(6) As the result of an oversight, interest payments amounting to £2,100 had not been made on the
Loan Account during the year ended 30 November Year 20.

18 CONTINUED ON NEXT PAGE

Question 5 continued

REQUIRED

(a) Prepare for Kingston Mechanics a schedule showing details of its Working Capital at
30 November Year 20 showing clearly any adjustments considered necessary to the
relevant balances supplied by Alan Clark as a result of the information provided by his
office manager.
(11 marks)

(b) Describe three ways in which Kingston Mechanics might improve its Working Capital
position.
(6 marks)

(Total 17 marks)

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Model Answer to Question 5

(a) Kingston Mechanics – Working Capital at 30 November Year 20

Current Assets £ £

Stock {12,300 – (500 – [300-50] } 12,050

Debtors {32,000 + 600 – (1,250 + 600)} 30,750

Less Provision (.04 x 30,750) 1,230 29,520
Prepayment 550
42,120

Creditors – Amounts Payable Within 1 Year

Creditors (15,750 + 10,000) 25,750

Loan instalment 3,000
Accruals (1,750 + 2,100) 3,850
Bank (17,500 + 500 – 10,000 + 600) 8,600 41,200
920

(b) Ways to improve working capital position

Suggestions
Profitable trading
Sale of fixed assets
Introduce more capital (in cash)
Convert overdraft into long term loan
Obtain long term loan/ reschedule existing loan repayments

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Examiner’s Report on Question 5

Most candidates chose to omit this question although some very good answers were produced.

Common errors made by candidates were:

(a) Working Capital calculation at 30 November Year 20

• Ignoring the concept that stock should be valued at the lower of cost or net realisable value
and including stock item 23 at its perceived higher value of £300.
• Misreading the question and assuming that the returned cheque for £10,000 was in respect
of a debtor rather than a creditor.
• Failing to reduce debtors by the value of the additional bad debt write-off of £1,250 before
calculating the revised provision for doubtful debts.
• Treating the unpaid interest of £2,100 as an increase in the bank overdraft rather than
increasing the value of accruals.

(b) Three ways of improving working capital

• Encouraging debtors to pay early or paying creditors late does not improve working capital.
The three accounts in such an equation are bank, debtors and creditors. As all three are
component parts of working capital, the net effect would be nil ie neither an increase nor a
decrease in working capital.

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