LCCI International Qualifications

Accounting Level 3

Model Answers
Series 3 2010 (3012)

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Accounting Level 3
Series 3 2010

How to use this booklet Model Answers have been developed by 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)

Helpful Hints

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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QUESTION 1 The following balances have been extracted from the books of Eboue at 31 December 2008: Land and buildings (NBV) Plant and machinery (NBV) Creditors Prepayments Motor vehicles (NBV) Debtors Accruals Stock Long term loan received Bank overdraft REQUIRED (a) Calculate the balance on Eboues Capital Account at 31 December 2008. (5 marks) Eboues business suffered a major computer failure during the year ended 31 December 2009 and he has no double entry records from which to prepare his accounts. However, the following information is available: (1) (2) (3) (4) (5) Land at 31 December 2008 cost 50,000. During 2009, a new building was purchased for 5,000. Depreciation on buildings is charged at 2% on the book value at the end of the year. There were no disposals. During 2009, plant and machinery (cost 30,000, accumulated depreciation 9,000) was sold at a loss of 2,000. Plant and machinery costing 40,000 was purchased. Depreciation is charged at 10% on the book value of all plant and machinery held at the year end. Trade purchases were 370,000, with payments to creditors of 357,750 and discounts received of 7,800. Prepayments at 31 December 2009 increased by 10% on prepayments at 31 December 2008. During 2009 vehicles costing 36,000 were purchased and vehicles with a net book value of 18,000 were sold for 13,700. Motor vehicles are depreciated at 15% on a reducing balance basis for vehicles held throughout the year and at 7.5% on a reducing balance basis for vehicles purchased during the year. Sales were 475,000, with receipts from debtors of 459,800, discounts allowed of 8,600 and bad debts written off of 6,100. In addition, unlike in previous years, Eboue wishes to create a provision for bad debts equal to 3% of year end debtors. Accruals at 31 December 2009 were 10% less than they had been at 31 December 2008. Stock at 31 December 2009 cost 15,200 and had a net realisable value of 25,400. This included goods on sale or return, held by customers, costing 3,100 with a net realisable value of 4,300. The customers had still to decide whether or not to purchase these goods. Provision for obsolete stock was to be made at 10% of the value of closing stock. On 1 July 2009 a further 4,000 was borrowed long term. Interest for the period, at 10% per year, was also added to the long term loan at 31 December 2009. The bank account balance at 31 December 2009 was 8,200 in hand. Eboue introduced 50,000 in cash as additional capital during 2009 and his drawings were 3,000 per month. 175,000 81,200 12,400 3,100 47,100 15,200 2,900 12,100 36,000 475

(6) (7) (8)

(9) (10) (11)

REQUIRED (b) (c) Calculate the balance on Eboues Capital Account at 31 December 2009. (16 marks) Using Eboues Capital Account, calculate Eboues profit for the year ended 31 December 2009. (4 marks) (Total 25 marks) 3012/3/10/MA Page 2 of 12

MODEL ANSWER TO QUESTION 1 (a) Capital 31 December 2008 DR 175,000 81,200 3,100 47,100 15,200 2,900 12,100 333,700 (51,775) 281,925 36,000 475 51,775 (51,775) -. CR 12,400

Land and buildings Plant and machinery Creditors Prepayments Motor vehicles Debtors Accruals Stock Long term loan Bank overdraft Capital (b) Capital 31 December 2009

DR Land and buildings (175,000 + 5,000) [(180,000 50,000) x 0.02] Plant and machinery [(81,200 (30,000 9,000) + 40,000) x 0.90] Creditors (12,400 + 370,000 357,750 7,800) Prepayments (3,100 x 1.1) Motor vehicles [(47,100 18,000) x 0.85 + (36,000 x 0.925)] Debtors [(15,200 + 475,000 459,800 8,600 6,100) x 0.97] Accruals (2,900 x 0.9) Stock (15,200 x 0.9) Long term loan [(36,000 x 1.1) + (4,000 x 1.05)] Bank Capital 177,400 90,180

CR

16,850 3,410 58,035 15,229 2,610 13,680 8,200 366,134 (63,260) 302,874 43,800 ... 63,260 (63,260) -.

(c) Capital Account 36,000 Opening balance 302,874 Bank .. Profit (R) 338,874 281,925 50,000 6,949 338,874

Bank (3,000 x 12) Closing balance

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QUESTION 2 Kanu plc has an authorised share capital of 300,000 ordinary shares of 2 each. The company initially issued 100,000 shares at 2.50 per share. More recently it made a capitalisation (bonus) issue of one share for every four held. At that time the market price per share was 1.80. REQUIRED Calculate: (a) (b) The number of shares in issue after the capitalisation (bonus) issue. (2 marks) The total amount received from the issue of shares. (2 marks) Kanu plc has now issued a further 50,000 shares at 3 each, payable as follows: Application Allotment (including premium) First and final call 0.50 1.50 1.00 3.00

Applications were received for 100,000 shares. Applications for 25,000 shares were rejected and the application money refunded. The 50,000 shares were then allotted to the remaining applicants on a prorata basis. The surplus application money was then transferred to the allotment account, reducing the amount due on allotment. All amounts due were received. REQUIRED (c) (d) Prepare Journal entries (without narratives) recording the latest share issue. (16 marks) State, giving a reason, whether or not you consider the latest share issue to have been underpriced. (2 marks) (e) State two reasons why Kanu plc may have decided to issue more shares. (3 marks) (Total 25 marks)

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MODEL ANSWER TO QUESTION 2 (a) Number of shares in issue Initial issue Bonus issue (100,000 x 0.25) Total amount received from share issue Initial issue (100,000 x 2.50) Bonus issue Journal entries DR 50,000 12,500 12,500 12,500 12,500 25,000 25,000 62,500 62,500 75,000 25,000 50,000 50,000 50,000 50,000 50,000 CR 50,000 100,000 25,000 125,000 250,000 250,000

(b)

(c)

Bank (100,000 x 0.50) Application Application (25,000 x 0.50) Bank Application [(75,000 50,000) x 0.50] Allotment Application (50,000 x 0.50) Ordinary share capital Bank [(50,000 x 1.50) 12,500] Allotment Allotment (50,000 x 1.50) Ordinary share capital (50,000 x 0.50) Share premium (50,000 x 1.0) Bank (50,000 x 1.00) First and final call First and final call Ordinary share capital

(d) (e)

There were applications for 100,000 shares and only 50,000 shares were available. This suggests that the issue was underpriced. Reasons for share issue Reduce gearing/pay off debt Purchase new fixed assets.

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QUESTION 3 The summarised Balance Sheets at 31 December 2009 of two companies are as follows: Noca Cola plc 000 Net assets Ordinary shares of 1 each Share premium Retained earnings 600 200 150 250 600 Super Steel plc 000 4,000 200 250 3,550 4,000

Barry plc is considering investing in either (or both) of these companies and believes the fair value of the net assets shown above to be as follows: (1) (2) Noca Cola plc - 900,000 Super Steel plc - 1,500,000 less than book value.

Barry plc is prepared to pay 4,000,000 for 75% of the shares in Noca Cola plc and 2,700,000 for 80% of the shares in Super Steel plc. It would amortise the goodwill arising on the consolidation of Noca Cola plc over ten years and the goodwill arising on the consolidation of Super Steel plc over five years. REQUIRED (a) Calculate the goodwill that would appear in the Consolidated Balance Sheet of Barry plc at 31 December 2011, assuming acquisition takes place on 31 December 2009, of: (i) (ii) (iii) Noca Cola plc only Super Steel plc only both companies. (11 marks) Noca Cola plc is an internationally known company, producing fizzy drinks which have become famous. The company has made high profits in recent years, despite the drinks being regarded as unhealthy. Super Steel plc is the new name of a former state owned company. Profits in recent years have been low. Recently, many workers have been made redundant and the company is hopeful that profits will increase in the future. REQUIRED (b) Give, and discuss, two reasons why the value of goodwill in Noca Cola plc is likely to be higher than the value of goodwill in Super Steel plc. (6 marks)

Barry plc is proposing to purchase the shares in Noca Cola plc by issuing 1,000,000 of its own 1 ordinary shares at 1.50, paying 2,000,000 in cash with the balance in 10% Debentures issued at par. Barry plc is proposing to purchase the shares in Super Steel plc by issuing 1,000,000 of its own 1 ordinary shares at 1.50 with the balance in cash. Barry plc currently has an issued share capital of 4,000,000 ordinary shares of 1 each.

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QUESTION 3 CONTINUED REQUIRED (c) Prepare a Journal entry (including narrative) showing, in the books of Barry plc, the proposed acquisition of shares in Noca Cola plc. (5 marks) Calculate the percentage of shares in Barry plc that would be held by former shareholders of Super Steel plc, assuming: (i) (ii) both acquisitions take place only the acquisition of Super Steel plc takes place. (3 marks) (Total 25 marks)

(d)

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MODEL ANSWER QUESTION 3 (a) Goodwill (i) Noca Cola plc only: Purchase price Fair value acquired (0.75 x 900) Amortisation (0.20 x 3325) Goodwill at 31 December 2011 (ii) Super Steel plc only: Purchase price Fair value acquired [0.80 x (4,000 1.500)] Amortisation (0.40 x 700) Goodwill at 31 December 2011 000 4,000 675 3,325 (665) 2,660 000 2,700 2,000 700 (280) 420 000 3,080

(iii) (b)

Noca Cola plc and Super Steel plc (2,660 + 420)

Reasons why goodwill is higher in Noca Cola Plc (i) Noca Cola and its drinks are very well known internationally (brand name value) whereas Super Steel plc is a new name of a previously state owned company associated with redundancies. Noca Cola plc has produced high profits in recent years and seems likely to do so in the future. Super Steel plc has not and the future profits are uncertain. 000 DR 4,000 000 CR 1,000 500 2,000 500

(ii)

(c)

Journal Entry Investment in Noca Cola plc Share Capital Share Premium Bank 10% Debentures (R)

Acquisition of 150,000 shares in Noca Cola plc (d) Shares held by former shareholders of Super Steel Plc (i) If both acquisitions take place: 1,000,000 4,000,000 + 1,000,000 + 1,000,000 (ii) If Super Steel plc acquisition only takes place 1,000,000 4,000,000 + 1,000,000 x 100 = 20.00% x 100 = 16.67%

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QUESTION 4 Owen is deciding whether or not to replace his machinery. The following table shows information relating to the machinery and Owens business: Old Machinery 000 80 30 51 5 10 12 25 85 New Machinery 000 100 41 14 10 8 92

Cost when new Book value (now) Material and labour costs (per year) Depreciation (per year) Administration (per year) Power and maintenance (per year) Residual value (now) Sales revenue (per year) REQUIRED (a)

Copy the above table into your answer books leaving out the figures. Indicate in your table whether each figure is relevant (R) or not relevant (NR) to the decision whether or not to replace the machinery. (9 marks)

Both the old machinery and the new machinery are expected to have a useful life of 5 years from now. The old machinery will have a residual value of nil after 5 years and the new machinery will have a residual value of 30,000 after 5 years. The working capital requirement will increase immediately from 20,000 to 50,000 if the new machinery is chosen. All working capital will be recovered at the end of the five years. REQUIRED (b) Calculate the net present value of Owens business, if the old machine is retained, assuming a 10% rate of interest. Discount factors are as follows: Year 1 2 3 4 5 Cumulative (c) Factor 0.909 0.826 0.751 0.683 0.621 3.790 (7 marks) Calculate the net present value of Owens business, if the old machine is replaced, assuming a 12% rate of interest. Discount factors are as follows: Year 1 2 3 4 5 Cumulative Factor 0.893 0.797 0.712 0.636 0.567 3.605 (7 marks) (d) State one reason why a higher rate of interest is used for calculating the net present value of Owens business with the new machine. (2 marks) (Total 25 marks) 3012/3/10/MA Page 9 of 12

MODEL ANSWER QUESTION 4 (a) Table Cost when new Book value Material and labour costs Depreciation Administration Power and maintenance Residual value Sales revenue (b) NPV of Owens Business Old Machinery Initial investment (25 + 20) Annual cash flow (85 51 10 12) Residual value (0 + 20) NPV = (12 x 3.790) + (20 x 0.621) 45 = 45.480 + 12.420 - 45.000 = 000 + 12.900 Old Machinery NR NR R NR NR R R R New Machinery R R NR NR R R 000 45 12 20

(c)

NPV of Owens business New Machinery Initial investment (100 + 50) Annual cash flow (92 41 10 8) Residual value (30 + 50) NPV = (33 x 3.605) + (80 x 0.567) - 150 = 118.965 + 45.360 000 - 150.000 = + 14.325

000 150 33 80

(d)

Reason for higher rate of interest The cash flows in relation to the new machinery are likely to be more uncertain.

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QUESTION 5 The annual stocktaking of Moore Ltd took place on 30 June 2009, the companys year end. The stock was counted by the young son of the Managing Director gaining some work experience. The stock was valued at 59,200 and included in the year end accounts. The auditors discovered the following errors: (1) (2) (3) (4) One stock sheet had been over-added by 3,000, another stock sheet had been under-added by 700 and on a third stock sheet an item valued at 800 had been included twice. 5,000 screws, costing 0.10 each, had been included at 1.00 each, and 10,000 nails, costing 0.20 per box of ten nails, had been included at 0.20 per nail. Goods belonging to a customer (cost price 800, selling price 1,000) had been included in stock at 1,000. A stock sheet total had been completely omitted. This showed 700 items costing 5.00 each. It was estimated that these had a sales value of 4.50 each.

REQUIRED (a) (b) (c) Calculate the corrected stock value for Moore Ltd at 30 June 2009. (8 marks) Calculate the change in Moore Ltds profit as a result of the stocktaking errors. (3 marks) State two causes for concern regarding the stocktaking arrangements on 30 June 2009. (4 marks) Tevez plc purchased a fixed asset on 1 January 2002 for 95,000. It was depreciated at 10% on a reducing balance basis for two years, then at 10% on a straight line basis for three years. On 1 January 2007 it was revalued at 70,000 and continued to be depreciated at 10% per year on a straight line basis. A zero residual value was assumed throughout. REQUIRED (d) Calculate the total depreciation charged for the eight years to 31 December 2009 and the net book value of the asset at that date. (8 marks) State which reserve should be used to record a surplus arising on revaluation and whether this reserve would be distributable or non-distributable. (2 marks) (Total 25 marks)

(e)

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MODEL ANSWER TO QUESTION 5 (a) Corrected stock valuation Original valuation (1) Stock sheet errors ( - 3,000 + 700 800) (2) Valuation errors: screws [5,000 (0.10 1.00)] nails [(10,000/10) x 0.20 (10,000 x 0.20)] (3) Customers goods (4) Missing stocksheet (700 x 4.5) Corrected valuation 59,200 (3,100) (4,500) (1,800) (1,000) 3,150 51,950

(b)

Decrease in profit Original valuation 59,200 corrected valuation 51,950

= 7,250

(c)

Causes for concern Inexperienced stocktaker making many mistakes No supervision by more experienced employee No subsequent checks made, other than by auditor Total depreciation and net book value Net Book Value Cost 1 January 2001 Depreciation 2001 (95,000 x 0.10) Depreciation 2002 (85,500 x 0.10) Depreciation 2003, 2004, 2005 (76,950 x 0.10 x 3) Revaluation 1 January 2006 Depreciation 2006, 2007, 2008 (70,000 x 0.10 x 3) 95,000 9,500 85,500 8,550 76,950 23,085 53,865 70,000 21,000 49,000 Total Depreciation 9,500 8,550 23,085 21,000 62,135

(d)

(e)

Reserve Revaluation Reserve should be used, which is non-distributable

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1517/2/10/MA

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