LCCI Examinations Board

Examiner’s Report and

Model Answers for

Accounting

THIRD LEVEL Series 2 (Code 3501) 2000 Hong Kong

1

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

2

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.

CONTINUED ON NEXT PAGE 3

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.

4

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)

CONTINUED ON NEXT PAGE 5

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

CONTINUED ON NEXT PAGE 6

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

7

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

8

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%.

9

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)

10

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

11

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.

12

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)

13

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

14

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.

15

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)

16

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

17

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.

CONTINUED ON NEXT PAGE 18

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.

19

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)

20

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

21

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.