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Mark Scheme

GCE A Level Accounting (6002)

June 2006
delivered locally, recognised globally

Mark Scheme

ACCOUNTING 6002, MARK SCHEME


Question 1
(a)

Larnaca Limited
Profit and loss account for year ended 31 March 2006
Working

Turnover

900000

Cost of sales*

560751

Gross profit

339249

213100

Administrative expenses*

W1

OF

Selling and distribution costs

145100
68000

Working

Admin Exps

W2

Profit on ordinary activities before tax

R of Directors

32000

Office Exps

74800

Depr on Prem

12000

Depr on Mach

25500

2800

OF

123349

11000

W2

112349

Interest payable

10000

Int on Loan S

102349

Int on Debs

OF

Dividends
Retained profit for the year

R of Auditors

OF

Corporation tax
Profit on ordinary activities after tax

800

OF

126149
Interest payable*

W1

OF

145100

800

2000

2800
Retained earnings brought forward

19000

Retained earnings for the year

102349

Retained earnings carried forward

OF

121349

W3
Shop at cost

Balance Sheet at 31 March 2006

Fixed Assets
Tangible
Leasehold workshop*

W3

OF

108000

Machinery*

W4

OF

117500

-prov for depr

Current Assets
Stock
Prepaid expenses
Debtors

86000
700
95200

Cash at bank

25789

207689

225500

OF

W5

Net current assets

Total assets less current liabilities

OF

76840

OF

OF

Creditors -amounts falling due after more than 1 year


8% Debenture stock

356349

25000
10000

8% Loan stock

W4
Machinery

160000

+additions
-prov for depr

10000
-52500
117500

Creditors

50500

Accruals
Corp Tax
Prop Dividend

5340
11000
10000

76840

(no if incorrect
headings for cl and
ltl)

20x=10 marks

35000
321349

Financed by:
Capital and reserves:
Share capital
Retained earnings

OF

200000
121349
321349

72000
108000

O
F

W5

130849

180000

Creditors -amounts falling due within 1 year


Creditors

20x =10 marks

(b) Assess the value to Larnaca Limited of retaining profits at the end of its
financial year.
Up to 12 available in total.
Award up to 6 for reasons for retaining profits
Award up to 4 for reasons for alternatives to retaining profits (share dividend)
Award up to 2 for conclusion
Reasons for retaining profits
To provide funds for the growth of the company
To provide for the replacement of fixed assets
To provide for dividends in the future if in a given period there are not enough
profits
Can be used to issue bonus shares
Award up to 2 for a relevant pointmax 3 points and max 6
Reasons for alternative...i.e. paying share dividend
To reward shareholders for investing in firm
To encourage further investment by shareholders
Award up to 2 for a relevant pointmax 2 points and max 4
Conclusion
Award up to 2 for an appropriate conclusionmust be related to Larnaca Ltd
Example
Larnaca Ltd is in a position both to retain profits for the reasons given above and to
distribute dividend . I would advise taking a middle line between the two so that
the shareholders are satisfied with both the present (in terms of dividend) and the
future (in terms of investment from retained profits)
Total 12 = 6 marks
Total 26 marks

Question 2
(a) In the books of Sun Ltd
Realisation Account

Jan
1
Buildings

Machinery
Stock
Debtors
Bank
Sundry Shareholders (Pr on
Rls)

Jan
1
SunLand Ltd

70000

20000
2300
1500
18800

Creditors
SunLand Ltd
(PP)

4600
148000

c
c
0F

152600

Sundry Shareholders Account


14800
0
Share Capital
Profit/loss
Realisation
(Profit)
14800
0

100000
8000
40000
148000

Total 14
(a) + (b)
Calculation of Purchase Price
Goodwill
Buildings
Machinery
Vehicles (40 000 - 3
800)
Stock
Debtors
Bank (12 000 + 3 000)
Less Creditors
PURCHASE PRICE

2300
1500
18800
152600
4600
148000

Shares issued at 50p each

296000

Total shares

OF

40000
15260
0

Sun Ltd
20000
90000
20000

Land
Ltd
14000 c
80000 c
36200
21000
14050
15000
180250
3450
176800

c
c
c
c
c
0F

353600 OF
Double
10 x = 5 marks
PP
649600

c
c
OF

(c)
Balance Sheet of SunLand Limited at 1 January 2006
Fixed Assets of(nc)
Buildings
90000
Machinery
100000
Vehicles
36200
Goodwill
34000c 260200

OF

Current Assets of(nc)


Stock
Debtors

c
c

Bank
Less Current Liabilitiesof(nc)
Creditors
Net Current Assets

23300
15550
33800
c

72650

c
c
c

OF

8050 c

Financed by
Share Capital
649 600 shares of 50 p each

64600 OF
324800

324800 OF
Total 16

(d) Sunland Limited intends to raise 200 000 for investment. The intention is to
issue 160 000 ordinary shares at a premium of 75p per share or issue 200 000 1 6%
Redeemable Debentures. Evaluate the relative strengths of each method and
recommend an appropriate course of action.
Up to 12 available in total
Award max 6 for relative strengths of ordinary shares
Award max 6 for relative strengths of debentures
Overall max 10
Award up to 2 for conclusion
Relative strengths of Ordinary shares
In comparison to debentures there is no necessary charge on the firm since
ordinary dividend is an appropriation of profit (and need not be made) rather than
a charge like debentures
There is no need to repay the share holders (unlike debenture holders) at some
time in the future
Relative strengths of Debentures
Since debentures do not carry a vote ..there is no possible loss of control for the
Directors (unlike with ordinary shares)
Debentures can be considered more secure than ordinary shares because debenture
holders will be repaid before ordinary shareholders
Debentures may be secured on the fixed assets again giving greater security in
the event of winding up
Conclusion
Up to 2 for an appropriate conclusion selecting and justifying a course of action.
12 = 6 marks
Total 26 marks

Question 3
(a)
Apr 15
Apr 20
Apr 30

Mar 31

Dec 1

May 1
May 1

Application and Allotment Account


37500
Apr 15 Bank
5000 Apr 30 Bank
75000
117500

Ord Sh Cap
Bank
Ord Sh Cap

Ordinary Share Capital


595000 Apr 1
Balance b/d
Apr 15
Applic/Allotm
Apr 30
Applic/Allotm
May 1
First & F Call
Nov 14
Bank
Bonus
Dec 1
dividend
595000
Apr 1
Balance b/d
Share Premium
95000 OF Apr 1
Balance b/d
May 1
First & F Call
95000

Balance c/d

Bonus Shares

First and Final Call


37500
May 31 Bank
75000
112500

Ord Sh Cap
Share Prem

50000
67500
117500

100000
37500
75000
37500
250000

combine
is OK

95000 OF
595000
595000 OF
20000 cash/bank OK
75000
95000

112500
112500

Bonus Shares Account


Dec 1

Ord Sh Cap

95000
OF

Dec 1

Share Prem
95000
2 for all dates correct OF
28 =14 marks

(b) Show your calculation of the dividend payable on the ordinary shares
for year ended 31 March 2006.
10% of ord share capital held for 1 Yr
% Divi
Dividend
Ordinary share capital held for
one Year
250000
0.1
25000
Rights and Bonus shares
TOTAL

345000

0.05

17250 OF

42250 OF

6 = 3 marks

(c) Give the entries required (in journal form)


Mar 31

P/L Appropriation
Ord Share Divi
Being provision of Ordinary share dividend
Mar 31

Ord Share Divi


Bank
Being payment of ordinary share dividend

Dr
42250 OF

Cr

42250 OF

42250 OF

42250 OF

6 = 3 marks

(d) Assess the value to Paphos Limited of issuing bonus shares


Up to 12 available here in total
Award up to 3 for each strengths of bonus shares (max 2 points and 5)
Award up to 3 for each limitations of bonus shares (max 2 points and 5)
Award up to 2 for conclusion ...overall statement on value to Paphos
Some acceptable points are given below
Issuing bonus shares capitalises (turns into permanent capital) reserves that may
have built up but no extra cash flows into the company ..so the shareholders
are no better off Indeed the market value of the shares may fall because the
companys net assets are now spread among a greater number of shares.
Issuing bonus shares can be a useful way of utilising capital reserves
which cannot be used to fund dividend payments.
Conclusion
In a rapid growth situation Paphos may have a compelling need to receive and use
cash to finance expansion. At this time a bonus issue probably has limited
value
12 = 6 marks
Total marks 26

Question 4
(a)
BEP
=
BEP =

Fixed Cost
Contribution
360 000
30 - 12

360 000
18
BEP =

20,000

Calculation of Profit
Total
Contribution
50 000 x 18
less Fixed
Costs
PROFIT

OF

900 000 OF
360 000
540 000 OF
6 x = 3 marks

(b) Plan 1 ..Sales needed to maintain profits at 540 000


Selling price reduced to 27, so contribution reduced to 15 OF
To maintain profits, total contribution needs to stay at 900 000
So 900 000 divided by 15 gives the number of units that must be sold
900 000
is
60 000 OF
15
OF

(b) Plan 2 ..Sales needed to maintain profits at 540 000


Selling price increased to 33, so contribution increased to 21 OF
To maintain profits, total contribution needs to stay at 900 000
So 900 000 divided by 21 gives the number of units that must be sold
900 000
is
42 857 OF
21
OF
(b) Plan 3 ..Sales needed to maintain profits at 540 000
Fixed Costs reduced by 160 000 OF means contribution now needs to be
740 000 OF
But variable costs increased by 6 per unit ..so new contribution is 12
OF per unit
So 740 000 divided by 10 gives the number of units that must be sold
740 000
is
61 667 OF
12
OF
14 x = 7 marks

(c) BEP for Plan 3


BEP =
Fixed Costs
Contribution
BEP =

200 000
30 - 18

200 000
12
BEP =

16,667

OF

The BEP for Plan 3 is lower than the original situation OF


6 x = 3 marks
(d) Explain, giving one limitation, which plan Georgio should follow to maintain
current profit level
Up to 6 available here in total
Award up to 3 for clear reason why a named plan should be followed
Award up to 3 for a well argued limitation
Example
Plan 2 would be the easiest to achieve because less items need to be sold to
reach the required profit level
The most telling limitation is the reliance on actually selling this quantity at the
raised price. Break even analysis assumes this and this may not be realistic. I
really would need to know about the demand for the product before proceeding
6 x = 3 marks
Total 16 marks

Question 5
Sylett Supplies
Cash Budget for 2 months Ended 30 September 2006
August
September
Receipts
Sales
21000
15250
Dividend from investment
2000
Total Receipts
21000
17250
Payments
Purchases
17000
13000
Wages
3600
3500
Expenses
2800
3200
Interim dividend
5000
Total
23400
24700
Balance b/d
Receipts less Payment

1000
-2400

-1400
-7450

Balance c/d

-1400 OF

-8850 0F

14 = 7 marks

(b) Using the cash budget, indicate whether Sylett Supplies Ltd will be in a
position to pay the interim dividend.
Sylett supplies will not OF be in a position to pay the interim dividend because if it
does so it will be overdrawn on cash by 8850 according to the cash budget given
above OF
2 x = 1 mark
(c)
Forecast Profit for 2 months ended
Sales (15000 + 7000)
less expenses
Purchases (12000 + 14000)
Wages (3200 + 3600)
Expenses (2800 + 3200)
add dividend from investment
Net Loss

30 September 2006
32000
26000
6800
6000

38800
2000
-4800
10 x = 5 marks

of(nc)

(d) Assess the value of cash budgets as a decision making aid


Up to 6 available here in total
Award up to 2 for point in favour of cash budgets
Award up to 2 for limitation
Award up to 2 for conclusion
Example
Cash budget is an organised way to estimate cash to be received and spent, it gives
a definite and clear indication of the availability of cash at monthly stages in the
future
Of course the quality of the information is dependent on the quality of the
estimates and this is the downside of any budget it is not a crystal ball
Overall I feel the cash budget is an excellent tool providing great care is taken over
estimates and its limitations are understood
6 x = 3 marks

Total 16 marks

Question 6
(i) Calculate the earnings per share
Earnings per share =

Net profit attributable to ordinary shareholders


Number of ordinary shares issued

1136 - 360
16 000

of

4.85p
(ii) Calculate the price earnings ratio
Price earnings ratio =

Market price
Earnings per share

64p
4.85p (OF)

of

13.2
(iii) Calculate the dividend yield
Dividend yield =

Dividend per share


Market price per share

800/16 000 (or 5p)


64p

7.8% must be percentage

Prior charge capital


Total capital

(iv) Calculate gearing


Gearing =

9 000

x 100

19 060

of

of

47.2%

(Also accept Equity: fixed interest .fixed interest/Equity and reserves)


16 = 8 marks

(b) Commenting on the price earning ratio, dividend policies, and gearing advise
Andreas in which company to invest.
Up to 4 for each appropriate comment made on each of the 3 elements max 12
Award 1 for decision based on comments
Award up to 3 for summarising giving a conclusion
Total 16 = 8 marks

Example
P/E Ratio
The p/e ratio shows that investors have more confidence in the management and
prospects of Athena plc The chances are, therefore, that this confidence will
translate into more improvement in the price of shares in Athena plc
Dividend policy
Athena plc is pursuing a more prudent and sustainable dividend policy. While
earning 6.4p per share, it is paying a dividend of only 4.5 p per share. As the
dividend cover ratio shows, it will be able to maintain this level of dividend.
Thessaloniki plc on the other hand is earning 4.85p per share and paying a dividend
of 5p per share. Even at current levels of earnings its dividend policy is not
sustainable
Gearing
Athena plc is not geared at all. Thessaloniki plc is significantly geared (though not
highly geared). Any downturn in performance will, therefore, have a more
than proportionate impact on the amounts available to ordinary shareholders in
Thessaloniki plc.
Total 12 = 6 marks
Decision and Conclusion
My comments indicate that on the basis of these three ratios Andreas should invest
in Athena plc
The p/e ratio is higher, the dividend per share, although lower, is sustainable
and the gearing protects the ordinary shareholder against a downturn in profits
Total 4 = 2 marks

Question total 16 marks

Question 7
(a) Distinguish between each of the following investment appraisal methods:
(i)
payback period;
(ii)
accounting rate of return.
Award up to 3for acceptable definition
Example
(i) payback period is the amount of time it takes to recover or receive the
income in cash required to match the amount spent on the investment
(ii) accounting rate of return is the average profit expressed as a percentage
of the capital invested in the project
6 x = 3 marks
(b) Calculate the net cash flows of the
machine
Cash inflow
Cash outflow
2007
105000
75000
2008
144000
90000
2009
153000
102000

replacement

Net Cash Flow


30000 of
54000 of
51000 of

8 x = 4 marks

(c) Calculate the net present value of the replacement machine


Net cash flow
Disc Factor
Present Value
Yr 0
-100000
1
-100000
2007
30000
0.926
27780
2008
54000
0.857
46278
2009
51000
0.794
40494
Net Present
Value
6 x = 3 marks

14552

( )

c ..of(nc)

(d) Evaluate whether Singh Limited should purchase the machine


Up to 6 available here in total
Award up to 2 for point in favour of investment
Award up to 2 for limitation
Award up to 2 for conclusion
Example
From the financial point of view the net present value indicates a return on
investment significantly in excess of the 8% cost of capital faced by Singh Ltd.
There may be non financial factors to take into account e.g. displacement of
labour
Overall it would depend on the policy of Singh Limited and how this decision fitted
in with its overall strategy
(e) (i) State how the net present value could be used to find the internal rate of
return of purchasing the cutting machine.
If the net present value were 0 instead of 14 552then the exact return on the
investment would have equalled the chosen discount rate (8%)
The exact rate is known as IRR. Since NPV is higher than 0 the IRR must be
higher than 8% . It is possible to estimate the IRR by deciding how much above
0 the return is and expressing this as a percentage
(ii) Why would the internal rate of return be more valuable to Singh Limited than
the net present value?
It is more precise
6 x = 3 marks

Acceptable definitions for Accounting Rate of Return


Main one

Average Annual profit


Average investment (Op +Closing/2)

Others
Estimated total profit
Estimated initial investment

Gearing =

Estimated Average Profit


Estimated initial investment

It is key that Accounting rate of return is about profit not cash