Passport to Success

Level 2 Book-keeping and Accounts

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Passport to Success
Level 2 Book-keeping & Accounts
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© EDI 2008
First published in 2008
exclusively for EDI by
Hodder Education,
Part of Hachette Livre UK
338 Euston Road
London NW1 3BH

Impression number 5 4 3 2 1
Year 2012 2011 2010 2009 2008

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A catalogue record for this title is available from the British Library

ISBN: 978 1862 471122

Contents
Introduction 1

1 Advanced Aspects of Depreciation 2

2 Adjusting for Accruals and Prepayments 15

3 Bad Debts and Provision for Doubtful Debts 26

4 Introduction to Partnership Accounts 32

5 Admission and Retirement of Partners 43

6 Dissolution of a Partnership 60

7 Formation of a Company – Meaning, Purpose and Effect 74

8 Limited Companies – The Profit and Loss Account 82

9 Limited Companies – The Balance Sheet 90

10 Control Accounts 100

11 Incomplete Records 116

12 Stock Valuation 132

13 Manufacturing Accounts 144

14 Non-trading Organisations 162

15 Non-trading Organisations:
Subscriptions Account and Balance Sheet 173

16 Errors and the Use of a Suspense Account 188

17 Calculation and Interpretation of Ratios 204

18 Preparing Simple Financial Statements Using Ratios 225

Introduction
This workbook has been written specifically to help you prepare for the
LCCI IQ Level 2 Book-keeping and Accounts exam. The content is organised
and presented in chapters that map directly to the revised syllabus to ensure
that you cover all the topics for the exam. Concepts are introduced and
sequenced in a way that will help you to develop and build on your book-
keeping and accounting knowledge and skills. To help you bring together and
reinforce your learning, examples and exercises are provided with solutions
and notes to show how to apply the principles and make the necessary
calculations.
In addition, you will find the workbook language simple and easy to read.
The clear presentation and layout of the book will make it easy for you to find
specific concepts and identify key new terms, which are highlighted in blue.
To help you make the best of your learning experience the book has been
designed with the following features:

● Learning targets stated at the beginning of each chapter – these outline

what you should learn by the end of the chapter. You can use these as a
checklist to make sure that you have met all the learning outcomes for
the syllabus topic.
● Improve your grade – these are tips given by the Chief Examiner to
help you to do better in the exam. Tips may be given either on the
application of key accounting principles, how they are tested in the
exam or how you should respond to exam questions on the topic.
● Think about it – these are questions, posed throughout the workbook,
which are designed to broaden your knowledge beyond each chapter
content and link concepts in each chapter to other concepts in the
book. This will help you understand how the different topics relate to
each other. Answers are not given in the workbook but are available in
the Solutions Booklet.
● Chapter summary – highlights the key points covered in the chapter.
This provides you, at a glance, with the important points from the
chapter and gives you the opportunity to check your learning.
● Target practice – questions at the end of each chapter to help you
consolidate and apply the concepts learnt. These questions are similar
to the examination questions and are therefore important for practice
and revision purposes. Answers are not provided in the workbook but
can be found in the Solutions Booklet, available for download from the
qualification page of the LCCI website, www.lcci.org.uk.
Whether you attend classes or study on your own, this workbook is an ideal
learning resource.

1
 1 Advanced Aspects of
Depreciation

Introduction
This chapter covers advanced aspects of depreciation and builds on your
knowledge from Level 1 Book-keeping. You should make sure that you
understand all the areas covered in Level 1, including the calculation of
depreciation using the straight-line method and the reducing (or
diminishing) balance method.

Learning targets
By the end of this chapter you should be able to:
● explain the importance and purpose of depreciation
● prepare entries in the Depreciation Expense Account, including the
transfer to the Profit and Loss Account at the financial year-end, and
the Provision for Depreciation Account
● explain the effect of using different methods of depreciation on the
charge to the Profit and Loss Account and recognise the relationship
between the type of asset and the depreciation method chosen
● prepare an Asset Cost Account and an Asset Disposal Account
● calculate the profit or loss on disposal of an asset
● prepare entries for assets sold for cash, traded in or exchanged for a
replacement asset.

1.1 Preparing entries in the depreciation

expense account
As fixed assets are used or get older, their value decreases. This fall in value is
an expense to the business and is accounted for by using depreciation
techniques.

Think about it Depreciation is an accounting adjustment that measures the fall in value
What are some of the of a fixed asset over a period of time.
specific causes of
depreciation? A Depreciation Expense Account is used to record the annual depreciation
charge, before its transfer to the Profit and Loss Account. At level 1 Book-
keeping, you were introduced to the Provision for Depreciation Account,
which deals with the accumulated depreciation. Depreciation also appears in
the Balance Sheet, forming part of the Provision for Depreciation Account.
It is usual to calculate depreciation for a specific time period. This could be,
for example, monthly, quarterly or annually.

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 Chapter 1: Advanced Aspects of Depreciation

Depreciation is recorded in the accounting records using double entry

principles. It is an expense to the business and so the debit entry is made to the
Depreciation Expense Account. The credit entry is posted to the Provision for
Depreciation Account, as shown in Example 1. This account acts as a ‘holding
account’ for all the depreciation charged to date. The value on this account will
increase each year assuming that none of the assets have been disposed of. It is
sometimes referred to as the Accumulated Provision for Depreciation.

Example 1

Depreciation Expense
£ £
31/12/X6 Provision for Depreciation 8 500

Provision for Depreciation

£ £
31/12/X6 Depreciation Expense 8 500

At the end of the accounting period, the balance on the Depreciation Expense
Account is transferred to the Profit and Loss Account. Once this transfer has
been done, the balance on the Depreciation Expense Account will be zero
(Example 2).

Example 2

Depreciation Expense
£ £
31/12/X6 Provision for Depreciation 8 500 31/12/X6 Profit and Loss 8 500
——
8 500
—— 8 500
—— ——
At the end of the accounting period, the balance on the Provision for
Depreciation Account will be carried forward to the next period (Example 3).

Example 3

Provision for Depreciation

£ £
31/12/X6 Balance c/d 8 500 31/12/X6 Depreciation Expense 8 500
——
8 500
—— 8 500
—— 01/01/X7 Balance b/d
——
8 500

Exercise 1.1 below shows a comprehensive example including entries in the

Depreciation Expense Account, the Provision for Depreciation Accounts and
the Fixed Asset Cost Accounts.

Exercise 1.1
Kerry leases a small shop. On 1 July 20X4, she purchased fixtures and fittings
costing £25 000 and a van costing £12 000. She decided to depreciate the
fixtures and fittings at 20% per year on a straight-line basis and the van at 30%
per year on a reducing (or diminishing) balance basis.

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LCCI Book-keeping & Accounts 2

Kerry prepares her accounts annually to 30 June.

Required:
Record the transactions for the purchase and depreciation of the assets for the
years ended 30 June 20X5 and 20X6, balancing the ledger accounts at the end
of each year. Kerry maintains separate ledger accounts for the cost and
accumulated depreciation of each type of fixed asset but only one
depreciation expense account.

Solution:
Fixtures and Fittings Cost
£ £
01/07/X4 Bank 25 000 30/06/X5 Balance c/d 25 000
——
25 000
——25 000
01/07/X5 Balance b/d
——
25 000 30/06/X6 Balance c/d
——
25 000
——
25 000
——
25 000
01/07/X6 Balance b/d
——
25 000
——

Provision for Depreciation of Fixtures and Fittings

£ £
30/06/X5 Balance c/d 5 000 30/06/X5 Depreciation Expense 5 000
——5 000
—— 5 000
—— 01/07/X5 Balance b/d
——
5 000
30/06/X6 Balance c/d 10 000 30/06/X6 Depreciation Expense 5 000
——
10 000
——
10 000
—— 01/07/X6 Balance b/d
——
10 000

Van Cost
£ £
01/07/X4 Bank 12 000 30/06/X5 Balance c/d 12 000
——
12 000
——12 000
01/07/X5 Balance b/d
——
12 000 30/06/X6 Balance c/d
——
12 000
——
12 000
——
12 000
01/07/X6 Balance b/d
——
12 000
——
Provision for Depreciation of Van
£ £
30/06/X5 Balance c/d 3 600 30/06/X5 Depreciation Expense 3 600
——3 600
—— 3 600
—— 01/07/X5 Balance b/d
——
3 600
30/06/X6 Balance c/d 6 120 30/06/X6 Depreciation Expense 2 520
——6 120
——
6 120
—— 01/07/X6 Balance b/d
——
6 120

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 Chapter 1: Advanced Aspects of Depreciation

Depreciation Expense
£ £
30/06/X5 PFD Fixtures and Fittings 5 000
30/06/X5 PFD Van 3 600 30/06/X5 Profit and Loss 8 600
——8 600
——
8 600
30/06/X6 PFD Fixtures and Fittings
——
5 000
——
30/06/X6 PFD Van 2 520 30/06/X6 Profit and Loss 7 520
——
7 520
——
7 520
—— ——
Depreciation calculations:
Fixtures and Fittings Van
£ £
Purchase cost 25 000 12 000
Depreciation 30 June 20X5 £25 000  20% 5 000 £12,000  30% 3 600
——
20 000
—— 8 400
Depreciation 30 June 20X6 £25 000  20% 5 000 £8,400  30% 2 520
——
15 000
—— 5 880
—— ——
Improve your grade 1.2 Other methods of depreciation
Remember that only It is important to match the type of fixed asset with an appropriate method of
the value of the fixed depreciation so that its original cost is spread over its useful life. If an asset is
asset (and not expected to lose a lot of value in the early years of its life, then the reducing
depreciation) appears (or diminishing) balance method would be appropriate. If the asset is
in the Fixed Asset expected to lose value evenly throughout its life, then the straight-line method
Cost Account. would be used.
Businesses may decide to calculate depreciation using methods other than
straight-line or reducing balance. You need to know how to calculate
Think about it depreciation based on revaluation and on machine hours methods.
Identify three types The revaluation method is based on an estimate of the value of the asset
of fixed assets and say at the end of the accounting period. Example 4 shows how this method is
which method would applied.
be appropriate for
each.
Example 4
Thomas Smith bought some gardening tools for his landscaping business.
These tools cost £1750 on 1 January 20X7. He estimated that the tools were
worth £980 at 31 December 20X7. Therefore the depreciation charge for the
year will be £1750 – £980 = £770.
Depreciation on machinery can also be calculated using the expected
number of machine hours for the asset’s useful life. This means that the
charge for a year will be high when the machine is working a large number of
hours. The charge will be less for a year when the machine works fewer hours.
Example 5 shows how this method works.

Example 5
A machine has a useful life of three years or 30 000 working hours. The
machine works 12 000 hours in year 1, 13 500 hours in year 2 and 4500 hours
in year 3. If the machine cost £120 000, calculate the depreciation for each
year using the machine hour rate method.
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LCCI Book-keeping & Accounts 2

1.5 Preparing entries for assets traded-in or

exchanged for a replacement asset
Sometimes, a business will dispose of an asset but will not sell it for cash.
Instead, it may give the asset as a trade-in for another asset, or exchange one
asset for another.

When an asset is traded

Where an asset is traded-in (or part exchanged), the proceeds for the disposal
is the trade-in value. This value is credited to the Asset Disposal Account as
proceeds and debited to the Asset Cost Account as part of the cost of the new
asset, as shown in Example 11. Numbered notes are given to explain the
entries in the accounts.

Example 11

Motor Vehicles – Cost

£ £
01/01/X6 Balance b/d 30 000
01/09/X6 Bank (2) 12 000 01/09/X6 Asset Disposal (1) 15 000
01/09/X6 Asset Disposal (3) 4 000

Asset Disposal
£ £
01/09/X6 Motor Vehicles Cost (1) 15 000 01/09/X6 Motor Vehicles Cost (3) 4 000

Notes:
1. The original cost of £15 000 for the old asset is removed from the Cost
Account and posted to the Asset Disposal Account.
2. The business paid £12 000 towards the cost of the new asset after the
trade-in.
3. The trade-in value is posted to the Cost Account and to the Asset Disposal
Account. This means that the total cost of the new asset is £16 000.

When an asset is exchanged

Where a business exchanges one asset for another then the value of the new
asset is also the disposal proceeds for the old asset. The value of the new asset
is debited to the Asset Cost Account and credited to the Asset Disposal
Account, as in Example 12. Numbered notes are given to explain the entries in
the accounts.

Example 12

Motor Vehicles – Cost

£ £
01/01/X6 Balance b/d 30 000
01/09/X6 Asset Disposal (2) 10 000 01/09/X6 Asset Disposal (1) 15 000

Asset Disposal
£ £
01/09/X6 Motor Vehicles Cost (1) 15 000 01/09/X6 Motor Vehicles Cost (2) 10 000

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 Chapter 1: Advanced Aspects of Depreciation

Notes:
1. The original cost of £15 000 for the exchanged asset is removed from the
Cost Account and posted to the Asset Disposal Account.
2. The new asset has a value of £10 000. This is treated as the proceeds for
the disposal of the old asset.

Exercise 1.4 shows an Asset Disposal Account where assets are both traded in
and exchanged.

Exercise 1.4
Build-It is a manufacturing company that owns three machines. The cost and
accumulated depreciation of these machines at 1 January 20X6 is as follows:

Machine Machine Machine

1 2 3
£ £ £
Cost 1 January 20X6 45 000 62 500 58 000
Accumulated depreciation 1 January 20X6 22 000 34 000 27 000

On 1 April 20X6, Machine 1 was traded-in (part exchanged) for Machine 4.

The trade-in value was £20 000 and the company paid an additional £40 000 by
cheque.
On 31 October 20X6, Build-It exchanged Machine 3 for Machine 5, which
was valued at £38 500.
The year-end date is 31 October 20X6.

Required:
Prepare the Asset Disposal Account to calculate the profit or loss on disposal
for Machines 3 and 5. The company does not charge any depreciation in the
year of disposal.

Solution:
Asset Disposal
Date £ Date £
01/04/X6 Machine 1 Cost 45 000 01/04/X6 Machine 1 Provision for
Depreciation 22 000
31/10/X6 Machine 3 Cost 58 000 01/04/X6 Machine 4 Cost (trade-in) 20 000
31/10/X6 Profit on Disposal – Machine 3 7 500 01/04/X6 Loss on Disposal – Machine 1 3 000
31/10/X6 Machine 3 Provision for
Depreciation 27 000
31/10/X6 Machine 5 Cost (exchange) 38 500
——
110 500
——
110 500
—— ——
Improve your grade
The key to calculating depreciation accurately is in the application of the
depreciation policy. Examination questions will state the depreciation policy (e.g.
charging a full year’s depreciation in the year of purchase, charging no depreciation
in the year of disposal, depreciation charged on a monthly basis etc.). It is
important that you pay attention to such notes as they guide you on how to
calculate the depreciation.
Target practice

11
LCCI Book-keeping & Accounts 2

Chapter summary
Important points to remember from this chapter:

1 Fixed assets may also be depreciated using the revaluation and

machine hour methods.
2 A separate account should be maintained for the Accumulated
Provision for Depreciation and the Depreciation Expense Account.
3 The Provision for Depreciation Account acts as a ‘holding account’ for
all the depreciation charged to date.
4 The Depreciation Expense Account is used to record the annual
depreciation charge, prior to its transfer to the Profit and Loss
Account.
5 Asset Cost Accounts and accounts for the accumulated provision of
depreciation should be balanced at the end of each financial year as
these balances will be required for the trial balance and later for the
Balance Sheet.
6 An appropriate method of depreciation should be chosen for each
type of asset.
7 A separate Disposal Account should be used to calculate the profit or
loss on the disposal of an asset.
8 If an asset is sold, the proceeds are credited to the Disposal Account.
9 Where an asset is traded-in, then the trade-in value is used as the
disposal proceeds and credited to the Disposal Account.

Target Practice
1. Complete the missing words in these sentences:
(a) Depreciation is an accounting adjustment which _______________ the
fall in _____________ of a ___________ ______________.
(b) The charge for deprecation is posted to the ___________ side of the
Depreciation Expense Account and the ____________ side of the
Provision for Depreciation Account.

2. Denholm Ltd purchased a machine on 1 January 20X5 for £120 000 and
two motor vehicles costing £14 000 each. The company depreciates its
assets on the following bases:
Machinery – 10% straight-line
Motor vehicles – 25% reducing balance.

Required:
Record the relevant entries in the ledger accounts for Motor Vehicle Cost,
Accumulated Provision for Depreciation and Depreciation Expense for each of
the years ended 31 December 20X5 and 20X6. You may assume that the
company maintains separate accounts for Cost and Accumulated Depreciation
for each class of asset, but only one Depreciation Expense Account.

12
 Chapter 1: Advanced Aspects of Depreciation

3. Silas Ltd purchased four machines on 1 January 20X7,

Machine A £35 000
Machine B £42 000
Machine C £22 500
Machine D £50 000
The company depreciates its machines on an annual 12% straight-line
method basis. Depreciation is calculated monthly from the date of
acquisition to the date of disposal.
On 30 April 20X7, the company sold Machine C for £15 360 and on
31 October 20X7 Machine A was sold for £28 600.

Required:
Record the relevant entries in the Machinery Cost, Accumulated Provision
for Depreciation, Depreciation Expense and Asset Disposal Ledger
Accounts for the year ended 31 December 20X7.
N.B. It is customary that a business would keep its fixed assets for longer
than indicated in the question above. However, for ease of illustration, the
fixed assets, in this case, have been maintained for less than two years.
4. Thaw Ltd purchased four trucks on 1 April 20X5. The trucks are
depreciated at 25% based on the straight-line method on a monthly basis.
You have been supplied with the following information:

Truck 1 Truck 2 Truck 3 Truck 4

£ £ £ £

Cost 1 April 20X5 25 000 30 000 36 000 40 000

Accumulated depreciation
1 April 20X6 6 250 7 500 8 750 11 250
Sold 30 September 20X6 27 500
Sold 31 December 20X6 22 800

Required:
(a) Calculate the depreciation charge on each truck for the year ended
31 March 20X7.

Truck 1 Truck 2 Truck 3 Truck 4

£ £ £ £

Depreciation for year

ended 31 March 20X7

(b) Record the relevant entries in the ledger accounts for Truck Cost,
Accumulated Provision for Depreciation, Depreciation Expense and
Asset Disposal for the year ended 31 March 20X7.
5. Weber Industries started in business on 1 April 20X5 and purchased three
machines for £30 000 each. Depreciation is charged on the machines using
the reducing balance method at 35% per annum. On 1 April 20X6 the
accumulated depreciation for each machine was £10 500.
On 1 July 20X6, Weber Industries traded in one of the machines for a
truck. The trade-in value was £18 000 and the business paid an additional
£21 000 in cash. The truck is to be depreciated at 25% using the straight-
line method.

13
LCCI Book-keeping & Accounts 2

On 1 October 20X6, one of the machines was exchanged for a newer

model with a value of £25 000.
Depreciation is charged on an annual basis with a full year’s charge in
the year of purchase and none in the year of disposal.

Required:
Prepare the asset disposal account for the year ended 31 March 20X7.

14
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