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Accounting Level 3

Model Answers Series 2 2006 (Code 3001)

3001/2/06/MA 2 OVER

Accounting Level 3 Series 2 2006

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 2006 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.

3001/2/06/MA 3 OVER

SECTION A (Answer Questions 1 and 2 in Section A − Compulsory) QUESTION 1 The Sales Ledger Control Account of Brodsworth showed a debit balance of £ 78,784 on 31 January 2006. On that date, the list of balances extracted from the Sales Ledger had a net total of £ 79,200 debit. Neither the Sales Ledger Accounts nor the Purchase Ledger Accounts are treated as part of Brodsworth’s double entry records. The auditors discovered the following errors: (1) An invoice for £ 60 recorded in the Sales Day Book had not been posted to the customer’s account in the Sales Ledger (2) A page in the Sales Day Book had been under-added by £ 1,000 (3) A sales invoice for £ 926 had been completely omitted from the books (4) A debit balance of £ 300 in the list of Sales Ledger balances had been wrongly listed as a credit

balance (5) Contras of £ 400 had been correctly recorded in the Purchase Ledger and Sales Ledger

Accounts but no entries had been made in either Control Account (6) The discount allowed column in the Cash Book had been over-added by £26 (7) A cheque for £ 1,500 received from a customer had been entered in the customer’s account as

£1,050 REQUIRED (a) Prepare Journal entries (without narratives) showing the corrections necessary to the

double entry records. (8 marks)

(b) Calculate: (i) the corrected Sales Ledger Control Account balance (ii) the corrected net total of the balances extracted from the Sales Ledger

(9 marks)

(c) Calculate the change to Brodsworth’s net profit as a result of the auditor’s discoveries (3 marks)

(Total 20 marks)

3001/2/06/MA 4 OVER

MODEL ANSWER TO QUESTION 1 SECTION A Questions 1 and 2 MUST be answered (a) Journal £ £ Sales Ledger Control 1,000 Sales 1,000 Sales Ledger Control 926 Sales 926 Purchase Ledger Control 400 Sales Ledger Control 400 Sales Ledger Control 26 Discounts Allowed 26

£ (b) (i) Sales Ledger Control Account balance per question 78,784 ADD Sales 1,000 Sales 926 Discounts Allowed 26 LESS Purchase Ledger Control Account (400) Corrected Sales Ledger Control Account balance 80,336 £ (ii) Net Sales Ledger Account balances per question 79,200 ADD Invoice omitted 60 Invoice omitted 926 Wrongly extracted balance (2 x 300) 600 LESS Wrongly entered cheque (1,500 – 1,050) (450) Corrected net total of Sales Ledger balances 80,336

£ (c) Change in net profit Sales under added +1,000 Sales invoice omitted +926 Discounts Allowed over-added +26 Increase in net profit 1,952

3001/2/06/MA 5 CONTINUED ON THE NEXT PAGE

SECTION A CONTINUED QUESTION 2 The accountant of Buxton received the following print out of the Product X Stock Account for the year ended 31 December 2005. All the figures printed were correct, as were all the calculations. However, most of the figures (indicated by *’s) were missing. Buxton uses the weighted average cost method for valuing stock.

DATE UNITS PRICE PER UNIT

£

VALUE £

2005

1 Jan Balance b/d * 4.00 24,000

4 Feb Creditors 6,000 * *

* 4.50 *

20 Mar Cost of goods sold * * 1,350

* * *

15 Apr Creditors *

4.50 *

12,000 * *

18 May Creditors * 4.80 *

* * 65,520

25 June Cost of goods sold 2,400 * *

* * 54,600

3 July Creditors 3,000 * *

* 5.00 *

10 Aug Cost of goods sold 3,000 * *

* * *

19 Sept Cost of goods sold * * 1,000

* * *

2 Oct Creditors * 5.30 *

* 5.06 *

5 Nov Cost of goods sold * * 6,072

31 Dec Balance c/d * * *

3001/2/06/MA CONTINUED ON THE NEXT PAGE 6

SECTION A CONTINUED QUESTION 2 CONTINUED REQUIRED (a) Copy the Product X Stock Account into your answer book, replacing the *’s with the

appropriate figures for units, price and value. (11 marks)

You are given the following ratios relating to the most recent accounts of three companies:

HALLAM plc

SHEFFIELD plc GLAPWELL plc

Net profit to sales

10% 5% 4%

Return on capital employed

15% 35% 36%

Stock turnover

19 times 26 times 32 times

Debtors’ collection

0 days 6 days 0 days

Creditors’ settlement

51 days 22 days 29 days

REQUIRED (b) Using the ratios given above and the background information given below, identify which

company is Company A, which company is Company B and which company is Company C.

Give reasons for each of your choices. (9 marks)

Company A is a food supermarket, operating from rented stores and selling only for cash. Company B is a food supermarket, which also sells a small range of clothes, (which offer a higher mark up than food). It offers some credit and operates from rented premises. Company C is a food supermarket, which also sells a large range of clothes. It sells only for cash and owns its own premises. It is currently experiencing cash flow difficulties.

(Total 20 marks)

3001/2/06/MA CONTINUED ON THE NEXT PAGE 7

MODEL ANSWER TO QUESTION 2 (a)

Product X Stock Account

Year Ended 31 December 2005

DATE UNITS PRICE PER UNIT

£

VALUE

£ 2005 Jan 1 Balance b/d 6,000 4.00 24,000 Feb 4 Creditors 6,000 5.00 30,000 12,000 4.50 54,000 Mar 20 Cost of goods sold 300 4.50 1,350 11,700 4.50 52,650 Apr 15 Creditors 300 4.50 1,350 12,000 4.50 54,000 May 18 Creditors 2,400 4.80 11,520 14,400 4.55 65,520 June 25 Cost of goods sold 2,400 4.55 10,920 12,000 4.55 54,600 July 3 Creditors 3,000 6.80 20,400 15,000 5.00 75,000 Aug 10 Cost of goods sold 3,000 5.00 15,000 12,000 5.00 60,000 Sept 19 Cost of goods sold 200 5.00 1,000 11,800 5.00 59,000 Oct 2 Creditors 2,950 5.30 15,635 14,750 5.06 74,635 Nov 5 Cost of goods sold 1,200 5.06 6,072 Dec 31 Balance c/d 13,550 5.06 68,563

(b) Company A = Glapwell Ltd

• Selling food only would lead to highest stock turnover

• Selling food only would give lowest net profit to sales

• Rented stores could give high return on capital employed

• Cash sales gives 0 days debt collection

3001/2/06/MA 8 OVER

SECTION A CONTINUED MODEL ANSWER TO QUESTION 2 CONTINUED (b) Company B = Sheffield plc

• The only company offering credit and therefore has a debt collection period

• As it sells only a few clothes it has the middle stock turnover ratio

• As it sells only a few clothes it has the middle net profit to sales ratio

• Selling from rented stores has generated a relatively high return on capital employed Company C = Hallam plc • The only company with cash flow problems. It has the longest creditors’ settlement period • Selling a lot of clothes leads to the lowest stock turnover ratio • The only company owning its own stores. It has the lowest return on capital employed • Selling a lot of clothes gives the highest net profit to sales ratio

3001/2/06/MA 9 OVER

SECTION B (Answer any THREE questions from Section B)

QUESTION 3 The following are extracts from the Balance Sheet of Selby plc at 31 December 2005:

£ 000 CAPITAL AND RESERVES 20,000,000 Ordinary Shares of £ 0.25 each 5,000 1,200,000 10% Preference Shares of £ 1.00 each 1,200 Share Premium 1,400 Retained Earnings 700 8,300 CREDITORS: AMOUNTS FALLING DUE AFTER ONE YEAR 15% Debentures 1,000 On 1 January 2006, the directors of Selby plc intend to raise £ 1,800,000 and invest it in a project which they believe will increase operating profit by £ 400,000 per year for the foreseeable future. They are considering three possible methods of raising the £ 1,800,000: (1) A rights issue of ordinary shares at £ 0.45 each

(2) Issuing more 10% preference shares at £ 1.20 each

(3) Issuing 15% Debentures at £ 0.90 for £ 1.00 nominal REQUIRED (a) Prepare Journal entries (including narratives) showing the effect of each of the three

possible ways of raising finance (10 marks) (b) Calculate the increase in earnings per ordinary share resulting from implementing

methods (2) and (3) (6 marks) The Managing Director of Selby plc has suggested two additional ways of raising the finance: (1) Making a bonus (capitalisation) issue of ordinary shares (2) Arranging a bank overdraft with a current rate of interest of 12% per year REQUIRED (c) Briefly discuss the Managing Director’s suggestions

(4 marks)

(Total 20 marks)

3001/2/06/MA 10 OVER

MODEL ANSWER TO QUESTION 3 (a) £ 000 £ 000

(i) Bank 1,800 Ordinary Share Capital 1,000 (1,800 ÷ 0.45 x 0.25) Share Premium (1,800 – 1,000) 800 Issue of Ordinary Shares at £0.45

(ii) Bank 1,800 10% Preference Share Capital 1,500 (1,800 ÷ 1.2) Share Premium (1,800 – 1,500) 300 Issue of Preference Shares at £1.20 (iii) Bank 1,800 Share Premium (2,000 – 1,800) 200 15% Debentures (1,800/.90) 2,000 Issue of Debentures at £0.90

(b) Increase in earnings per share: (i) (400,000 – 150,000) / 20,000,000 = £ 0.013 (ii) (400,000 – 300,000) / 20,000,000 = £ 0.005

(c) (i) Converting reserves into share capital does not result in the receipt of cash, so the suggestion is inappropriate. (ii) A bank overdraft is currently cheaper than the debentures though this could change. A bank

overdraft is repayable on demand so it could be dangerous to use an overdraft to finance a long term project.

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SECTION B CONTINUED QUESTION 4 Following are the two most recent Balance Sheets of Thackley Ltd together with the most recent Income Statement:

Thackley Ltd Balance Sheet as at 31 March

2005 2006 £ £ £ £ FIXED ASSETS Tangible at cost 78,000 71,700 Accumulated depreciation 24,200 24,600 53,800 47,100 Investments at cost 112,500 125,100 166,300 172,200CURRENT ASSETS Stock 55,080 161,187 Debtors 71,420 146,703 Bank 39,580 72,150 166,080 380,040 CREDITORS: AMOUNTS FALLING DUE WITHIN ONE YEAR

Creditors 79,280 96,140 Proposed dividend 13,000 16,000 92,280 112,140 NET CURRENT ASSETS 73,800 267,900 240,100 440,100 CREDITORS: AMOUNTS FALLING DUE AFTER ONE YEAR

Debentures 100,000 86,000 140,100 354,100 FINANCED BY: £ £ Ordinary Shares of £ 1.00 each 50,000 62,000 Share Premium 12,000 22,000 Retained earnings 78,100 270,100 140,100 354,100

3001/2/06/MA 12

SECTION B CONTINUED QUESTION 4 CONTINUED

Income Statement for Thackley Ltd Year Ended 31 March 2006

£ £ Sales 490,000 Cost of sales 170,000 Gross profit 320,000 Distribution expenses 64,000 Administrative expenses 37,000 101,000 Net operating profit 219,000 Debenture interest 7,000 212,000 Dividends paid and proposed 20,000 Retained profit 192,000 NOTES RELATING TO THE YEAR ENDED 31 MARCH 2006: (1) Tangible fixed assets costing £ 30,000 (accumulated depreciation £ 21,000) were sold for

£ 5,000. The loss on disposal was included in administrative expenses.

(2) A bonus (capitalisation) issue of 2,000 shares was made, utilising the share premium account and further shares were issued for cash.

(3) Fixed asset investments costing £ 6,000 were sold for £ 7,000. The profit on disposal was

deducted from administrative expenses.

(4) Debentures were redeemed at par.

REQUIRED (a) Prepare a statement reconciling the net operating profit for the year with the net cash

inflow from operating activities (8 marks)

(b) Prepare the Cash Flow Statement of Thackley Ltd for the year ended 31 March 2006

(12 marks)

(Total 20 marks)

3001/2/06/MA 13

MODEL ANSWER TO QUESTION 4

(a) Reconciliation: £

Net operating profit 219,000

Loss on disposal of tangible fixed assets (30,000 – 21,000) – 5,000 4,000

Profit on disposal of investments (7,000 – 6,000) (1,000)

Depreciation (24,600 – 24,200 + 21,000) 21,400

Increase in stock (161,187 – 55,080) (106,107)

Increase in debtors (146,703 – 71,420) (75,283)

Increase in creditors (96,140 – 79,280) 16,860

NET CASH FLOW FROM OPERATIONS 78,870

(b) Thackley Ltd Cash Flow Statement year ended 31 March 2006

£ £

Net cash flow from operating activities (as above) OF 78,870

Returns on investment and servicing of finance

Debenture interest paid (7,000)

Capital expenditure and financial investment

Sale of investments 7,000

Sale of tangible fixed assets 5,000

Purchase of investments (125,100 – 112,500 + 6,000) (18,600)

Purchase of tangible fixed assets (71,700 – 78,000 + 30,000) (23,700)

Net cash outflow (30,300)

Equity dividends paid (13,000 + 20,000 – 16,000) (17,000)

Net cash inflow before financing 24,570

Financing

Issue of shares (62,000 – 50,000 – 2,000) + (22,000 – 12,000 + 2,000) 22,000

Repayment of debentures (100,000 – 86,000) (14,000)

Net cash inflow 8,000

Net increase in cash (72,150 – 39,580) 32,570

3001/2/06/MA 14

SECTION B CONTINUED QUESTION 5 Following is the summarised Consolidated Balance Sheet of Pickering Ltd and its subsidiary Goole Ltd at 31 December 2004: £ Tangible fixed assets 170,100 Goodwill on consolidation 18,000 Net current assets 112,200 300,300 £ Share Capital 100,000 Retained earnings 176,300 Minority interest 24,000 300,300 Pickering Ltd acquired 80% of Goole Ltd’s ordinary shares on 1 January 2001. Pickering Ltd’s policy is to write goodwill off evenly over five years. Goole Ltd has an issued ordinary share capital of 20,000 £1.00 ordinary shares. Its retained earnings on 1 January 2001 were £36,000. No dividends have been paid or proposed by either Pickering Ltd or Goole Ltd since Goole Ltd became a subsidiary company. REQUIRED Calculate: (a) The goodwill arising on the acquisition of Goole Ltd (3 marks) (b) The total net profit made by Goole Ltd in the four years to 31 December 2004 (4 marks) (c) The retained earnings of Pickering Ltd (alone) at 31 December 2004 (3 marks) On 1 January 2005, Pickering Ltd acquired 70% of Maltby Ltd’s ordinary shares. Maltby Ltd has an issued ordinary share capital of 4,000 £1 ordinary shares. Its retained earnings at 1 January 2005 were £ 16,000. Following is the summarised Consolidated Balance Sheet of Pickering Ltd and its subsidiaries Goole Ltd and Maltby Ltd at 31 December 2005: £ Tangible fixed assets 248,100 Goodwill on consolidation 46,000 Net current assets 146,300 440,400 £ Share capital 100,000 Retained earnings 302,600 Minority interest 37,800 440,400

3001/2/06/MA 15

SECTION B CONTINUED QUESTION 5 CONTINUED No dividends were paid or proposed by any group company in the year ended 31 December 2005. Goole Ltd’s net profit for the year was £10,500. REQUIRED Calculate: (d) The goodwill arising on the acquisition of Maltby Ltd (3 marks) (e) The net profit made by Maltby Ltd in the year ended 31 December 2005 (7 marks)

(Total 20 marks)

3001/2/06/MA 16

MODEL ANSWER TO QUESTION 5 (a) Goodwill on the acquisition of Goole Ltd £ Goodwill at 31 December 2004 (1/5) 18,000 Goodwill written off (4 x 18,000) 72,000 ∴ Goodwill on acquisition 90,000 (b) Total net profit of Goole Ltd since acquisition £ Minority interest - Share capital (20% x 20,000) 4,000 Retained earnings (R) 20,000 24,000 Retained earnings at 31 December 2004 (5 x 20,000) 100,000 Retained earnings at 1 January 2001 36,000 ∴ Total net profits since acquisition 64,000 (c) Retained earnings of Pickering Ltd at 31 December 2004 £ Retained earnings as per Balance Sheet 176,300 LESS: Group share of Goole Ltd’s profits (0.80 x 64,000) 51,200 125,100 ADD: Goodwill written off 72,000 ∴ Retained earnings of Pickering Ltd 197,100 (d) Goodwill on the acquisition of Maltby Ltd £ Goodwill attributable to Goole Ltd NIL ∴ Goodwill attributable to Maltby Ltd (4/5) 46,000 Goodwill written off (0.25 x 46,000) 11,500 ∴Goodwill on acquisition 57,500 (e) Net profit of Maltby Ltd since acquisition £ Minority interest - Share Capital Goole Ltd (20% x 20,000) 4,000 Share Capital Maltby Ltd (30% x 4,000) 1,200 Retained earnings Goole Ltd [20,000 + (20% x 10,500)] 22,100 Retained earnings Maltby Ltd (R) 10,500 37,800 Retained earnings at 31 December 2005 (10,500 x 10/3) 35,000 Retained earnings at 1 January 2005 16,000 ∴ Net profit of Maltby Ltd - year to 31 December 2005 19,000

3001/2/06/MA 17

QUESTION 6 Blackpool has sold tables for many years. On 1 January 2005 he opened his first branch in Fleetwood. All double entry records are kept at the head office. All tables are purchased by head office and invoiced to Fleetwood at selling prices fixed to give a gross profit of 30% on sales revenue. All sales are for cash. In the year ended 31 December 2005, the following occurred: (1) Head office sent 480 wooden tables costing £ 91 each and 125 metal tables costing £ 63 each to

the Fleetwood branch. (2) The Fleetwood branch returned 60 wooden tables and 5 metal tables to head office as they were

the wrong colour. (3) At 31 December 2005, 50 wooden tables and 6 metal tables remained in stock at the Fleetwood

branch. (4) Head office made the following payments on behalf of the Fleetwood branch:

£ 5,000 rent for the fifteen month period to 31 March 2006; £ 50 per month for sundry expenses; £ 20 per week for the wages of part time staff; £ 300 per month for the manager’s salary. At 31 December 2005 it was discovered that no stock had been damaged, lost or stolen. The part time staff were entitled to a commission equal to 5% of sales revenue. The manager was entitled to a bonus equal to 4% of the branch net profit before charging the bonus. REQUIRED

(a) Prepare the following accounts for the year ended 31 December 2005, as they would

appear in the head office books of Blackpool:

(i) Branch Stock (ii) Branch Stock Adjustment (iii) Branch Profit and Loss

(18 marks) It is unusual for a retail outlet to have no stock losses. REQUIRED (b) Suggest one reason why no stock losses occurred at the Fleetwood branch. (2 marks)

(Total 20 marks)

3001/2/06/MA © Education Development International plc 2006 18

MODEL ANSWER TO QUESTION 6 (a) (i) Branch Stock Account

£ £ Goods sent to branch (480 x 91) ½ 43,680 Goods sent to branch (60 x 91) ½ 5,460Branch stock adj. (480 x 39) ½ 18,720 Branch stock adj. (60 x 39) ½ 2,340Goods sent to branch (125 x 63) ½ 7,875 Goods sent to branch (5 x 63) ½ 315Branch stock adj. (125 x 27) ½ 3,375 Branch stock adj. (5 x 27) ½ 135 Bank (370* x 130) 2 48,100 Bank (114** x 90) 2 10,260 Balance c/d (50 x 130) ½ 6,500 Balance c/d (6 x 90) ½ 540 73,650 73,650 * 480-60-50 = 370 ** 125-5-6 = 114

(ii) Branch Stock Adjustment Account £ £ Branch stock ½ 2,340 Branch stock ½ 18,720Branch stock ½ 135 Branch stock ½ 3,375Profit and loss (R) 1 17,508 Balance c/d (50 x 39) 1 1,950 Balance c/d (6 x 27) 1 162 22,095 22,095 (iii) Branch Profit and Loss Account £ £ Rent (5,000 x 12/15) 1 4,000 Branch stock adjustment ½ 17,508Sundry (50 x 12) ½ 600 Wages (20 x 52) ½ 1,040 Salary (300 x 12) ½ 3,600 Comm. (0.05 x 58,360) ½ 2,918 Profit before bonus 5,350 17,508 17,508Bonus (0.04 x 5,350) ½ 214 Profit before bonus 5,350Net profit 5,136 5,350 5,350 (18 marks) (b) Large items like tables are easy to count and difficult to lose or steal.