Accounting

Level 3

Model Answers
Series 3 2007 (Code 3001)

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Accounting Level 3
Series 3 2007

How to use this booklet Model Answers have been developed by Education Development International plc (EDI) to offer additional information and guidance to Centres, teachers and candidates as they prepare for LCCI International Qualifications. The contents of this booklet are divided into 3 elements: (1) (2) Questions Model Answers – reproduced from the printed examination paper – summary of the main points that the Chief Examiner expected to see in the answers to each question in the examination paper, plus a fully worked example or sample answer (where applicable) – where appropriate, additional guidance relating to individual questions or to examination technique

(3)

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.

© Education Development International plc 2007 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.

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SECTION A (Answer Questions 1 and 2 in Section A − Compulsory) QUESTION 1 Paddington, a sole trader, has the following list of balances at 31 December 2006: £ 192,500 28,000 140,000 18,560 2,000 247,000 120,000 5,000 42,000 4,400 10,800 52,010 32,000 15,130

Capital Drawings Fixed assets (NBV at 1 January 2006) Bank (in hand) Cash Sales Purchases Stock (at 1 January 2006) Debtors Provision for doubtful debts (at 1 January 2006) Creditors Wages Rent Sundry expenses

Despite the trial balance agreeing, the following errors were subsequently discovered: (1) Paddington had paid himself a salary of £1,000 per month and included this in wages (2) Contras of £3,000 between debtors and creditors had been recorded by increasing both debtors and creditors by that amount (3) Closing stock had been valued at £16,000, but included an item costing £750 which Paddington believes could only be sold for £300. Selling costs of £50 would be incurred. (4) No entries had been made in respect of a bad debt recovered of £600: a cheque for this amount was discovered in a drawer. In addition, bad debts of £1,000 needed to be written off and the provision for doubtful debts adjusted to 10% of the revised debtors figure (5) Fixed assets with a net book value of £5,000 have been sold for £3,000. This had been recorded by debiting bank and crediting sales with £3,000. It is Paddington’s policy to calculate depreciation each year by taking 15% of the net book value of assets held at the end of the year (6) No provision had been made for the accountant’s fee of £1,000.

REQUIRED (a) Prepare the Trading and Profit and Loss Account of Paddington for the year ended 31 December 2006 and his Balance Sheet at that date. (b) Give three reasons why, despite a Trial Balance balancing, there can still be errors in the underlying book-keeping.

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MODEL ANSWER TO QUESTION 1 Paddington Trading and Profit and Loss Account for the Year Ended 31 December 2006 £ £ Sales (247,000 – 3,000) 244,000 Less: Cost of goods sold: Opening stock 5,000 Purchases 120,000 125,000 Closing stock (16,000 – (750 – (300 – 50)) 15,500 109,500 Gross profit 134,500 Add: Bad debts recovered 600 900* Reduction in doubtful debts provision* 136,000 Less: Expenses Wages (52,010 – (1,000 x 12)) Bad debts Loss on disposal (5,000 – 3,000) Accountant’s fee Rent Sundry expenses Depreciation (.15 (140,000 – 5,000)) Net profit (a)

40,010 1,000 2,000 1,000 32,000 15,130 20,250 111,390 24,610

*

Debtors per TB Less contra (3,000 x 2) Less Bad debt (10 x 35,000) – 4,400 = 900

42,000 6,000 36,000 1,000 35,000

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CONTINUED ON THE NEXT PAGE

MODEL ANSWER TO QUESTION 1 CONTINUED Paddington Balance Sheet at 31 December 2006 £ Fixed Assets (140,000 – 5,000 – 20,250) Current Assets Stock Debtors (35,000 – 3,500) Bank (18,560 + 600) Cash Current Liabilities Creditors (10,800 – (3,000 x 2)) Accrued fee Net Current Assets

£

£ 114,750

15,500 31,500 19,160 2,000 68,160 4,800 1,000

5,800 62,360 177,110 £ 192,500 24,610 217,110 40,000 177,110

Capital Account Opening Balance Add Profit Less Drawings (28,000 + (1,000 x 12))

(b) (i) (ii) (iii) (iv)

Transaction completely omitted The entry for a transaction has been reversed An entry has been made in the wrong account but on the correct side The wrong amount has been recorded for the transaction

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SECTION A CONTINUED QUESTION 2 Upminster plc depreciates freehold property at 2% per year on cost, calculations being done on a monthly basis. On 1 January 2006 the books showed freehold property costing £200,000, with a net book value of £80,000. On 1 July 2006 the freehold property was revalued by a qualified independent valuer at £260,000. The directors of Upminster plc have decided to incorporate this value in its books. Upminster plc depreciates motor vehicles at 25% per year on cost. A full year’s depreciation is charged in the year of purchase but none in the year of sale. On 1 January 2006 the books showed vehicles costing £80,000, with a net book value of £52,000. On 1 July 2006 Upminster plc acquired an entire fleet of new vehicles costing £210,000. The supplier accepted the old vehicles in part exchange, at a value of £46,000, and the balance was paid by cheque.

REQUIRED (a) Prepare the necessary ledger accounts of Upminster plc (excluding Bank and Profit and Loss) to record the above transactions for the year ended 31 December 2006. (b) Show extracts from Upminster plc’s Cash Flow Statement (and Reconciliation of Net Operating Profit to Net Cash flow from Operating Activities) for the year ended 31 December 2006, resulting from the above transactions.

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MODEL ANSWER TO QUESTION 2 (a) Freehold Property at Cost/Valuation Account £ Opening balance 200,000 Accumulated depreciation Revaluation reserve (R) 182,000 Closing balance 382,000 Accumulated Depreciation on Freehold Property Account £ Freehold property at cost 122,000 Opening balance (200,000 – 80,000) Profit and loss (.02 x .5 x 200,000) Profit and loss Closing balance 6,667 128,667 *(260,000 ÷ 19.5 years) x 6 months 12 months Revaluation Reserve Account £ Freehold property at cost Closing balance 182,000 182,000 Motor Vehicles at Cost Account £ 80,000 Disposal 46,000 164,000 Closing balance 290,000 £ 122,000 260,000 382,000

£ 120,000 2,000 6,667 * 128,667

£ 182,000 182,000

Opening balance Disposal Bank (210,000 – 46,000)

£ 80,000 210,000 290,000

Disposal Closing balance

Accumulated Depreciation on Motor Vehicles Account £ 28,000 Opening balance (80,000 – 52,000) 52,500 Profit and loss (.25 x 210,000) 80,500 Motor Vehicle Disposal Account £ 80,000 Motor vehicles at cost Acc. Depn. on motor vehicles Profit and loss - loss 80,000

£ 28,000 52,500 80,500

Motor vehicles at cost

£ 46,000 28,000 6,000 80,000

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CONTINUED ON THE NEXT PAGE

MODEL ANSWER TO QUESTION 2 CONTINUED (b) Extracts from Upminster plc’s Cash Flow Statement for Year Ended 31 December 2006 £ Capital Expenditure and Financial Investment Sale of fixed assets Purchase of fixed assets 46,000 (210,000) £ Reconciliation of Net Operating Profit to Net Cash Flow from Operating Activities Add: Depreciation (2000 + 6,667 + 52,500) Loss on sale of fixed assets

61,167 6,000

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SECTION B (Answer any THREE questions from Section B) QUESTION 3 Circle Ltd keeps a Purchase Ledger Control Account, which is part of its double entry book-keeping system. The underlying individual creditors accounts are for memorandum purposes only. The following information is available in relation to creditors for December 2006: £ 14,516 2,174 1,762 2,142 3,426 3,716 1,296 486 1,201 4,163 1,437 912 307 621 2,100 711 1,428 1,511 1,296 200 120 100

Opening balances:

Purchase Ledger Control Account Bayswater Account Victoria Account Westminster Account Embankment Account Temple Account Blackfriars Account Bayswater Account Victoria Account Temple Account Monument Account Aldgate Account Temple Account Aldgate Account Victoria Account Westminster Account Embankment Account Temple Account Blackfriars Account Aldgate Account Victoria Account Westminster Account

Purchases:

Purchase returns:

Bank (payments):

Discounts received:

REQUIRED (a) Write up the Purchase Ledger Control Account of Circle Ltd for December 2006, showing clearly the opening and closing balances. (b) Write up the individual Purchase Ledger Accounts of Circle Ltd for December 2006, showing clearly the opening and closing balances on each account. (c) Reconcile the total of the list of Purchase Ledger balances at 31 December 2006 with the balance on the Purchase Ledger Control Account at that date. (d) Give three reasons why the Purchase Ledger Control Account balance might not agree with the total of the individual Purchase Ledger balances.

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MODEL ANSWER TO QUESTION 3 (a) Purchase Ledger Control Account £ 928 Opening balance 7,246 Purchases 220 14,321 22,715 £ 14,516 8,199

Purchase returns Bank Discount received Closing balance (R)

22,715

(b) Bayswater Account £ 2,660 Bal. b/d Purchases 2,660 £ 2,174 486 2,660 Victoria Account £ 2,100 Bal. b/d 120 Purchases 743 2,963 Embankment Account £ 1,428 Bal. b/d 1,998 3,426 £ 1,762 1,201 2,963

Bal. c/d

Bank Disc. rec. Bal. c/d

Bank Disc. rec. Bal. c/d

Westminster Account £ 711 Bal. b/d 100 1,331 2,142 Temple Account £ 307 Bal. b/d 1,511 Purchases 6,061 7,879 Monument Account £ Bal. b/d 1,437 Purchases 1,437

£ 2,142

Bank Bal. c/d

£ 3,426 3,426

2,142 Blackfriars Account £ 1,296 Bal. b/d 1,296

Purc. ret. Bank Bal. c/d

£ 3,716 4,163 7,879

Bank

£ 1,296 1,296

£ 0 1,437 1,437 Purc. ret. Bank Bal. c/d

Bal. c/d

Aldgate Account £ 621 Bal. b/d 200 Purchases 91 912

£ 0 912 912

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CONTINUED ON THE NEXT PAGE

MODEL ANSWER TO QUESTION 3 CONTINUED (c) Reconciliation £ Purchase Ledger Account balances: Bayswater Victoria Westminster Embankment Temple Blackfriars Monument Aldgate Purchase Ledger Control Account balance 2,660 743 1,331 1,998 6,061 1,437 91 14,321

(d) Incorrect additions:

list of purchase ledger balances books of prime entry individual accounts individual accounts control accounts wrong (different) figures Items on wrong side of accounts etc.

Items omitted:

Incorrect entries:

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SECTION B CONTINUED QUESTION 4 Southall and Hayes entered into a joint venture on 1 June 2006. The joint venture was to run for three months and the agreement stated that profits would then be divided between Southall and Hayes in the ratio 2 : 1 respectively. At the end of the three month period Southall prepared the following memorandum account: Southall and Harlington Memorandum Joint Venture Account for the Year Ended 30 September 2006 £ Purchases Purchases Purchase returns Purchases Goods sent from Hayes to Southall Transport costs Transport costs Stock taken over by Southall Loss: Southall Hayes 6,250 31,200 400 14,000 850 300 200 1,220 3,045 3,045 60,510 Hayes is convinced that this memorandum account is incorrect. 60,510 Sales Sales Sales returns Goods sent from Southall to Hayes Storage costs Allowance to Hayes for use of car on Joint Venture business Sales £ 12,600 21,200 280 510 220 600 25,100

REQUIRED (a) Redraft the Memorandum Joint Venture Account, in good style, showing the division of the correct profit/loss between the venturers. You may assume that Southall’s figures (other than the loss) are correct. (b) State whether or not the Memorandum Joint Venture Account is part of the double entry book-keeping system of: (i) (ii) Southall Hayes

(c) State why it is necessary for each venturer to keep a separate Joint Venture Account in his/her books and state what it contains.

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MODEL ANSWER TO QUESTION 4 (a) Southall and Hayes . Memorandum Joint Venture Three Months Ended 31 August 2006 . £ £ Purchases (6,250 + 31,200 + 14,000 Sales (12,600 + - 400) 51,050 21,200 + 25,100 – 280) Storage costs 220 Stock taken over Transport costs (300 + 200) 500 Allowance for car use 600 52,370 Profit: Southall (2/3) 4,980 Hayes (1/3) 2,490 _7,470 59,840

£ 58,620 1,220

59,840

(b) (i) (ii)

No No

(c) It is necessary for each venturer to maintain an account in which to record the financial relationship with the other venturer (who will be either a debtor or a creditor). The profit/loss on the venture will also be recorded in this account. The account will be closed by the final cash settlement between the venturers.

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SECTION B CONTINUED QUESTION 5 Barbican plc has an authorised share capital of 6,000,000 £1 ordinary shares. The issued share capital at 31 December 2006 was 2,000,000 £1 ordinary shares, issued at par and fully paid. On 1 January 2007 a further 2,000,000 ordinary shares were offered for sale at £1.20, payable as follows: £ On application (including premium) 0.55 On allotment 0.15 On first and final call on 1 April 2007 0.50 1.20 The following applications were received: Category A - 200 applicants for 10,000 shares each Category B - 100 applicants for 5,000 shares each Category C - 100 applicants for 1,000 shares each. The Directors of Barbican plc decided to allocate the shares as follows: Category A - each applicant to receive 7,500 shares Category B - each applicant to receive 4,000 shares Category C - each applicant to receive 1,000 shares. Any balance of money received on application was to be applied to the amounts due on allotment. All outstanding money was received on both application and allotment and Barbican plc repaid the excess money received. All monies were received in respect of the call, except for one shareholder who failed to pay the call on 1,000 shares allotted to him. These shares were forfeited and reissued at £1.80 per share. REQUIRED (a) Explain the difference between the authorised share capital and the issued share capital of a company. State whether or not it is possible for the issued share capital of a company to be higher than its authorised share capital. (b) (i) (ii) Calculate the total amount payable on allotment by two applicants in Category C Calculate the amount refundable on allotment to three applicants in Category A.

(c) Calculate the total amount that will be credited to the Share Premium Account as a result of the forfeiture and reissue of the 1,000 shares. Setting a price for a new issue of existing shares is always difficult. REQUIRED (d) On the evidence provided by the question, suggest whether the issue price should have been higher or lower than £1.20, giving your reasons. The Balance Sheet of Farrington plc at 31 March 2007 included 100,000 redeemable shares of £1 each and retained earnings of £250,000. On that date it was decided to redeem 80,000 redeemable shares at par. REQUIRED (e) Record the above transaction using journal entries. No narratives are required.

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MODEL ANSWER TO QUESTION 5 (a) The authorised share capital is the maximum number of shares a company is permitted to issue. The issued share capital is the number of shares that have been issued. The number issued cannot exceed the number authorised.

(b) (i) Amount payable on allotment by two Category C Applicants: 2 x 1,000 x .15 =

£ 300 £ (ii) Amount refundable on allotment to three Category A Applicants: Amount paid (3 x 10,000 x .55) Amount due (3 x 10,000 x .75 x (.55 + .15)) = 16,500 = 15,750 750

(c) Amount credited to share premium account: Amount received on original issue (1,000 x .7) Amount received on reissue (1,000 x 1.8) Amount due (1,000 x 1.2)

£ 700 1,800 2,500 1,200 1,300

(d) The issue price should have been higher because: (i) it was oversubscribed (ii) the reissued shares received £1.80 each

(e) Share capital Share redemption Share redemption Bank Retained earnings Capital redemption reserve

Dr Dr Dr

80,000 Cr 80,000 Cr 80,000 Cr 80,000 80,000 80,000

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QUESTION 6 On 1 January 2004 Amersham Ltd paid £320,000 to acquire 70% of the share capital of Chesham Ltd. On that date Chesham Ltd had a credit balance of £30,000 in its Profit and Loss Account. Group policy is to amortise goodwill over a period of 10 years. The summarised Balance Sheets of the two companies at 31 December 2006 were as follows: Amersham Ltd £ 200,000 320,000 40,000 33,000 4,000 (21,000) 576,000 £ 400,000 176,000 576,000 Chesham Ltd £ 160,000 50,000 13,000 2,000 (9,000 ) 216,000 £ 240,000 (24,000 ) 216,000

Tangible fixed assets Investment: Shares in Chesham Stock Debtors Bank Creditors

Ordinary Share Capital Profit and Loss

At 31 December 2006 Chesham Ltd had in stock goods transferred to it from Amersham Ltd valued at £10,000. These had been charged to Chesham Ltd at 10 times their cost to Amersham Ltd. No dividends have been paid by either company since 2003. REQUIRED (a) Prepare the Consolidated Balance Sheet of the Amersham Group at 31 December 2006. Several shareholders in Amersham Ltd and the minority shareholders of Chesham Ltd are unhappy with the performance of the group. Comments made include the following: (i) (ii) “Chesham Ltd has made losses since acquisition. This indicates bad management.” “By transferring goods from Amersham Ltd to Chesham Ltd at 10 times their cost, the directors of Amersham Ltd are treating Chesham Ltd unfairly and possibly defrauding the minority shareholders in Chesham Ltd.”

(iii) “We have had no dividends for three years. Dividends should be paid immediately.” (iv) “Dividends cannot be paid unless there is cash available, but neither company has much in the bank.” REQUIRED (b) Critically discuss each of the above comments.

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MODEL ANSWER TO QUESTION 6 (a) Preliminary calculations: Goodwill Cost of investment Less Share of net assets: Share capital Profit and loss £ £ 320,000

240,000 30,000 270,000

Written off 3 years x 10%

189,000 131,000 39,300 91,700

Profit and Loss Amersham Ltd Chesham Ltd

£ (.7 (30,000 + 24,000)) 39,300 9,000

£ 176,000 (37,800) 138,200 48,300 89,900

Less Goodwill Unrealised profit (9/10 x 10,000)

Minority Interest (216,000 x .3)

£

£ 64,800

Consolidated Balance Sheet of the Amersham Group at 31 December 2006 Fixed Assets Tangible (200,000 + 160,000) Intangible - goodwill Current Assets Stock (40,000 + 50,000 – 9,000) Debtors (33,000 + 13,000) Bank (4,000 + 2,000) Liabilities: Amounts Payable within 1 year: Creditors (21,000 + 9,000) £ £ 360,000 91,700 451,700

81,000 46,000 6,000 133,000 30,000 103,000 554,700 £ 400,000 89,900 489,900 64,800 554,700

Capital and Reserves Ordinary share capital Profit and loss Minority Interest

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CONTINUED ON THE NEXT PAGE

MODEL ANSWER TO QUESTION 6 CONTINUED (b) (i) Chesham Ltd has indeed made losses since it was acquired (£30,000 + £24,000 = £54,000). However, this is not necessarily due to bad management. If significant, the transfers from Amersham Ltd to Chesham Ltd at ten times cost is likely to have transferred profits from Chesham Ltd to Amersham Ltd. The transfer of profits referred to in (i) above will adversely affect the minority shareholders in Chesham Ltd i.e. reduce their prospect of dividends and therefore the value of their shares. It is unlikely however to be fraudulent. As Chesham Ltd has no distributable profits no dividend can be paid. As far as Amersham Ltd is concerned dividends can be paid. Dividends can be paid out of distributable reserves, even if it is necessary to borrow in order to make the payment. Borrowing would increase Amersham’s expenses.

(ii)

(iii)

(iv)

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