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Examiner’s Report and

Model Answers for

Accounting

THIRD LEVEL Series 2 (Code 3001) 2000

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Accounting Third Level 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 – 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.

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Accounting Third Level Series 2 2000

GENERAL The overall standard was lower than expected although the level of presentation had in general improved. There was some evidence that candidates were entering for the examination without making adequate preparation, and in some cases indicating a lack of knowledge which they should possess at Second Level. Although the percentage passing is probably about average the number of Distinctions is definitely fewer than normal. Once again the main problem was that candidates omitted either sections of questions or complete questions resulting in the need to attain a higher percentage in those parts tried.

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5 CONTINUED

Accounting Third Level Series 2 2000 QUESTION 1 Carriers Ltd is a small private company making deliveries. Its Trial Balance as at 31 December Year 9 was as follows: All figures in the Trial Balance are in £000. Sales 195 Motor expenses 30 Debtors and creditors 15 5 Delivery vehicles 90 Depreciation on delivery vehicles 54 General expenses 52 Wages 48 Rent of property 8 Directors' salaries 24 Office equipment 30 Depreciation on office equipment 6 Retained profits 5 Bank overdraft 2 Ordinary Share Capital ___ 30 297 297 Notes (1) The three delivery vehicles are depreciated at 20% per annum on cost.

(2) Office equipment is depreciated at 3331 % per annum using the reducing balance method.

REQUIRED (a) Prepare for Carriers Ltd, using vertical layout, the Profit & Loss Account for the year ended

31 December Year 9 and the Balance Sheet as at 31 December Year 9. (12 marks)

Stewarts plc is a manufacturing concern that uses Carriers Ltd both to collect its raw materials and deliver its finished goods. The Trial Balance of Stewarts plc at 1 January Year 10 was as follows: £000 £000 Leasehold buildings at cost 320 Accumulated depreciation on leasehold buildings 60 Machinery at cost 450 Accumulated depreciation on machinery 130 Office equipment at cost 110 Accumulated depreciation on office equipment 40 Motor vehicles at cost 90 Accumulated depreciation on motor vehicles 30 Stock raw material 40 Stock work in progress 45 Stock finished goods 55 Debtors and creditors 90 125 Bank 15 Share Capital £1 Ordinary Shares 600 Retained profit ____ 230 1,215 1,215

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QUESTION 1 CONTINUED

On 1 January Year 10 Stewarts plc purchased all the shares in Carriers Ltd for £50,000. All the assets and liabilities were taken over at their net book value except the office equipment which was valued at £15,000. One of the three identical vehicles was immediately sold for £4,000 cash, which was immediately banked and Carriers Ltd's bank overdraft was paid off. At the time of the takeover Stewarts plc owed Carriers Ltd £10,000. REQUIRED (b) Prepare, in vertical format, the Consolidated Balance Sheet of Stewarts plc on 1 January

Year 10 immediately after the above transactions were completed. Note the loss on disposal of the delivery vehicle is to be added to goodwill and the goodwill is to be immediately written off against retained earnings.

(18 marks) Before taking over Carriers Ltd the directors of Stewarts plc made the following calculations in respect of Year 10: (1) The cost of delivery services provided by Carriers Ltd to Stewarts plc would have risen by 5% on

the Year 9 figure of £120,000. (2) The sale of one delivery vehicle would reduce the drivers' wage bill by one-third. The wages

expenses for Carriers Ltd in Year 9 included £6,000 for office staff who would now have to be paid £7,100 each year. The remaining wages in Year 9 were all for the vehicle drivers.

(3) The cost of Carriers Ltd's motor expenses would be reduced by 25% and Stewarts plc would not

carry goods for any other company. (4) The rent expense would cease as Stewarts plc already had the necessary office and garage

space. General expenses would be reduced by £10,000 and the directors' salaries would cease. (5) Both the delivery vehicles and the office equipment would be depreciated on the same basis and

at the same percentages as that used by Carriers Ltd. REQUIRED (c) Calculate the estimated net cost savings to Stewarts plc in Year 10 from taking over

Carriers Ltd. (10 marks)

(d) Calculate Stewarts plc return on its investment in the first year.

(2 marks) (e) Assuming Stewarts plc aim for a minimum return of 20% on its initial investment, mention

any two factors which might have influenced the decision other than the return on investment.

(7 marks)

(Total 49 marks)

7 CONTINUED

Model Answer to Question 1 (a)

Trading Profit & Loss Account for Carriers Ltd Year ending 31 December Year 9

£000 £000 Sales 195 Less Petrol and parts 30 General expenses 52 Wages 48 Directors' emoluments 24 Rent 8 Depreciation vehicles (9 x 2) 18 Depreciation office equipment (30 - 6)/3 8 188 Net profit 7 Brought forward 5 Carried forward 12

Balance Sheet of Carriers Ltd as at 31 December Year 9 Tangible Fixed Assets £000 £000 £000 Vehicles 90 (54 + 18) 72 18 Office equipment 30 (6 + 8) 14 16 120 86 34 Current assets Debtors 15 Liabilities due within 1 year Creditors 5 Bank overdraft 2 7 8 42 Financed by Capital 30 Retained profit 12 42

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Model Answer to Question 1 continued (b)

Stewarts plc Consolidated Balance Sheet as at 31 December Year 9

£000 £000 £000 Tangible fixed assets Cost Depreciation Net or valuation Leasehold and buildings 320 60 260 Machinery 450 130 320 Office equipment (110 + 15) 125 40 85 Vehicles (90 + (2/3 x 18)) 102 30 72 997 260 737 Current assets Stock raw material 40 Stock work-in-progress 45 Stock finished goods 55 Debtors (90 + 15 - 10) 95 235 Liabilities due within one year Bank overdraft (15 - 50 + 4 - 2) 33 Creditors (125 + 5 - 10) 120 153 82 819 Issued capital Ordinary Shares £1 600 Profit & Loss Account (230 - 11) 219 819 Calculations Goodwill (50,000 - 42,000 + (16,000 - 15,000)) = 9,000 Add loss on vehicle (18,000/3 - 4,000) = 2,000 11,000 (c) Net cost savings in Year 10 £000 £000 Cost saved on delivery service (120 x 1.05) 126 Less Drivers' wages 2/3 (48 – 6) 28 Office wages 7.1 Petrol and repairs (30 x .75) 22.5 General expenses (52 – 10) 42 Depreciation vehicles (2/3 x 18 x 0.2) 2.4 Office equipment 1/3 x 15 5 107 Net savings 19 (d) Return on investment 19/50 x 100 = 38%. (e) It gives Stewarts plc control of carriage operations and costs. There will be quicker delivery and collection The 2 old vehicles will need replacement soon so further capital costs involved.

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Examiner’s Report on Question 1 Part (a) was a standard Trading, Profit & Loss Account and Balance Sheet. In general there were few problems but a significant number of scripts showed a lack of awareness of the term ‘profits brought forward’ and endeavoured to make the current years profits equal to the balance for previous years. Layout was in general good, though there were scripts where the candidates ignored the requirement for vertical presentation. Part (b) required a Consolidated Balance sheet and only a minority managed to get this correct. The calculation of Goodwill often missed the revaluation of office equipment, and some candidates calculated a minority interest even though Stewart’s owned all the shares. Less than half the candidates were able to deal with the inter company debt correctly and a number made errors on the number of shares issued, adding the capital of the subsidiary to that of the parent. Finally some 20% of candidates produced a Balance Sheet for Stewarts with no attempt at Consolidation at all. Part (c) was for the most part omitted as were parts (d) and (e). Those that did attempt part (c), in general made the error of adding revenue and cost together rather than looking at the net cost incurred. About half of those that tried part (c) also tried part (d) and using their figures in general calculated the return on investment, however some candidates confused the investment in Carriers Ltd with the share holding of the parent company and in consequence lost marks they really should have had. Finally the answers to part (e) ranged from excellent to non existent. The main fault among those attempting this part lay in giving reasons that were linked to the return on investment, rather than other factors. One point of possible significance was that failure to answer this part seemed to run in centres. At other centres no candidate made any attempt which could indicate that candidates from those centres had not been properly prepared in the area of written comment.

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QUESTION 2 Ardvak plc had the following information in the "Share Capital and Reserves" section of its most recent Balance Sheet: £ Authorised Capital 5,100,000 £0.50 Ordinary Shares 2,550,000 200,000 9% £2 Preference Shares 400,000 2,950,000 Issued Capital 3,750,000 £0.50 Ordinary Shares 1,875,000 100,000 9% £2 Preference Shares 200,000 2,075,000 Reserves Share Premium Account 100,000 Revaluation Reserve 100,000 General Reserve 350,000 Retained Earnings 400,000 950,000 Ardvak plc also had £300,000 of 10% Debentures. The Directors of Ardvak plc have now made the following decisions: (1) To issue the remaining Preference Shares at par, £1.20 per share payable on application and

£0.80 per share payable subsequently on allotment. (2) To redeem the Debentures at a premium of 5%. (3) To make a rights issue of two Ordinary Shares for every fifteen Ordinary Shares held at a

premium of £0.25 each. All money to be paid on application. (4) To make a capitalisation issue of one Ordinary Share for every five Ordinary Shares held

(including those issued under (3) above). The Directors also decided to make maximum use of the non-distributable reserves when recording the above transactions. Applications were received for 150,000 Preference Shares, so each applicant was allotted two-thirds of the shares they had requested. The additional money received on application was set against the amount payable on allotment. All Ordinary shareholders took up their rights. REQUIRED Prepare Journal entries without narratives to record all the above transactions for Ardvak plc.

(17 marks)

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Model Answer to Question 2 – Ardvak plc

Journal Entries £000 £000 Dr bank (150,000 x 1.2) 180 Cr Application Account (100,000 x 1.2) 120 Cr Allotment Account (50,000 x 1.2) 60 Dr Bank (100,000 x 0.8) - 60,000 20 Cr Allotment Account 20 Dr Application Account 120 Dr Allotment Account 80 Cr Preference Share Capital 200 Dr Debentures 300 Dr Share Premium Account (300,000 x .05) 15 Cr Bank 315 Dr Bank (3,750,000 x 2/15 x (0.50 + 0.25) 375 Cr Ordinary Share Capital (3,750,000/15) x 2 x .5 250 Cr Share Premium Account 125 Dr Share Premium (100,000 - 15,000 + 125,000) 210 Dr Revaluation reserve 100 Dr General reserve 115 Cr Ordinary Share Capital (3,750,000 + 500)/5 x 0.5 425 Examiner’s Report on Question 2 Journal entries relating to issue of shares and redemption of a debenture. In general well handled although a few candidates made the entries in the ledger and not in the Journal, and a few confused debits and credits. The only real problem lay in the last section in the calculation of the bonus shares and the use of non distributable reserves. Overall reasonably well handled.

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QUESTION 3 The Vanguard Sports Club started on 1 January Year 8 with eighty members. During its first three years of operation no new members were accepted and no members resigned. Any member paying the following year's subscription before 30 September in the current year was allowed to pay at the current year's rate. Any member not paying the year's subscription by 31 January in the year following that when it was due was excluded from membership. Such subscriptions were written off as bad debts. During Year 8 the subscription rate was £80 per member. Seventy-five members paid this amount and another two members paid for Year 8 and in advance for Year 9 before 30 September. During Year 9 the subscription rate was £90 per member. Two members paid in respect of Year 8 and also paid their Year 9 subscription before 31 January. Seventy-two members paid £90, and another two members paid for Year 9 and in advance for Year 10 before 30 September. The loss of subscription income in respect of the two members who had paid in advance for Year 9 was treated as a discount in the subscription account. This policy was to continue for future years. During Year 10 the subscription rate was £95 per member and all members paid all subscriptions due so that at 31 December there were neither subscriptions in arrears nor subscriptions in advance. REQUIRED Show the Subscription Account of the Vanguard Sports Club for each of Years 8, 9 and 10. You should show clearly the annual transfers to Income and Expenditure Account and the balances both prepaid and accrued at the end of each year.

(17 marks)

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Model Answer to Question 3 – Vanguard Sports Club

Subscriptions Account Year 8 Income & expenditure (80 x 80) 6,400 Bank (75 + 4) x 80 6,320 Prepaid (2 x 80) 160 due (3 x 80) 240 6,560 6,560 Year 9 Balance 240 Balance 160 Income & expenditure (79 x 90) 7,110 Bank (2 x 80) + (2 x 90) 340 Income & expenditure (bad debt) 80 Bank (72 x 90) 6,480 Bank (4 x 90) 360 Income & expenditure (discount) 20 Prepaid (2 x 90) 180 Due (1 x 90) 90 7,530 7,530 Year 10 Balance 90 Balance 180 Income & expenditure (79 x 95) 7,505 Bank 90 Bank (77 x 95) 7,315 _____ Income & expenditure (discount) 10 7,595 7,595 Examiner’s Report on Question 3 This required the entries in the subscription account over a period of three years. Apart from several candidates who had the entries on the wrong side, the main problem lay in the calculation of the prepaid and accrued subscriptions with the balances often being inaccurate, and even more often being entered on the wrong side of the account. It was apparent that too many candidates had leant by rote that prepayments are debit balances and could not adjust to the fact that on an income account they are credit balances. The bad debt was also frequently put on the wrong side of the account as was the discount when it was included at all. Entries were also made in the incorrect year. However on the plus side a significant number obtained full marks.

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QUESTION 4 John intends setting up in business as a retailer and has provided you with the following information. (1) He has arranged a loan with the bank of £4,000 at 10% interest per year which is to be repaid at

the rate of £1,000 per year at the end of each year. (2) He will introduce his own car as capital. The car is worth £6,000 and will last the business for a

further four years and then be sold for £1,000. It will be depreciated on a straight line basis. (3) He can rent premises for £150 per month but must maintain a deposit of £450 with his landlord. (4) Shop fittings will cost £2,500 and will last the business ten years and then be sold for £250.

These will also be depreciated on a straight line basis. (5) The first year's sales revenue all received in cash is expected to be £91,000. His prices will be

based on a mark up on cost of 40%. Revenue is expected to be spread evenly over the year. (6) He will purchase an initial stock of £4,000 and aims to maintain it at this level by regular

purchases. These will be made on a credit of 1.5 months. (7) Power and other expenses are expected to amount to £580 each month. (8) He intends to take £900 per month out of the business for his own use. REQUIRED Prepare for John in relation to his first year of operating: (a) a budgeted Trading, Profit & Loss Account

(6 marks) (b) a budgeted Bank Account

(6 marks) (c) a budgeted Balance Sheet as at the end of the year.

(5 marks)

(Total 17 marks)

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Model Answer to Question 4 (a)

Budgeted Trading, Profit & Loss Account for John £ £ Sales 91,000 Less cost of sales (100/140 x 91,000) 65,000 Gross profit (40/140 x 91,000) 26,000 Less Rent (12 x 150) 1,800 Power, etc (12 x 580) 6,960 Loan interest (4,000 x 0.1) 400 Depreciation Fittings (2,500 - 250)/10 225 Car (6,000 - 1,000)/4 1,250 10,635 Net profit 15,365

(b) Budgeted Bank Account Bank balance Loan 4,000 Sales 91,000 95,000 Less rent (1,800 + 450) 2,250 Fittings 2,500 Purchases (65,000/12 x 10.5 + 4,000) 60,875 Power, etc 6,960 Drawings (12 x 900) 10,800 Loan interest 400 Loan repayment 1,000 84,785 Balance at year end 10,215

(c) Budgeted Balance Sheet at end of first year £ £ £ Tangible Fixed Assets Cost Depreciation Net Car 6,000 1,250 4,750 Fittings 2,500 225 2,275 8,500 1,475 7,025 Current Assets Stock 4,000 Prepaid rent 450 Bank 10,215 14,665 Less Liabilities due within one year Creditors (65,000 ÷ 12 x 1.5) 8,125 Bank loan 1,000 9,125 5,540 12,565 Less bank loan 2,000 10,565 Capital 6,000 Plus retained profit 15,365 21,365 Less Drawings 10,800 10,565

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Examiner’s Report on Question 4 In general a reasonable standard was obtained for most candidates with the major problem being the allocation of the loan into current and long term liabilities, but there were a significant number of papers where the bank figures replicated the Profit and Loss account, making no adjustment for creditors, nor for the deposit on the rent. In too many cases depreciation was included as an expense on the bank account as well as in the profit and loss. Most candidates passed on this question but very few obtained full marks.

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QUESTION 5 The trial balances of Peters plc were as follows: 31 December Year 5 31 December Year 6 £000 £000 £000 £000 Freehold land and buildings 300 400 Machinery at cost 500 565 Accumulated depreciation on machinery 235 280 Stock at cost 75 80 Debtors 90 86 Creditors 60 58 Proposed dividend 10 13 Bank 15 20 Share capital 600 670 Retained earnings ___ 75 ____ 90 980 980 1,131 1,131 The summarised Trading, Profit & Loss and Appropriation Account of Peters plc for the year ended 31 December Year 6 was as follows: £000 £000 Sales 1,320 Cost of sales 950 Selling expenses 10 General expenses 152 Depreciation on machinery 75 Profit on sale of machine* (5) Salaries 110 Proposed dividend 13 1,305 Addition to retained earnings 15 * Note: the machine sold cost originally £65,000 REQUIRED (a) Prepare for Peters plc for Year 6 a reconciliation of operating profit to net cash flow from

operating activities. (5 marks)

(b) Prepare for Peters plc a cash flow statement in the format laid down in Financial Reporting

Standard (FRS) 1 as revised. (12 marks)

(Total 17 marks)

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Model Answer to Question 5 – Peters plc (a) Reconciliation of Operating Profit to Net Cash Flow from operating activities for Year 6 £000 Operating profit (15 + 13) 28 Add back depreciation 75 Less profit on sale (5) 98 Increase in stocks (75 - 80) (5) Decrease in debtors (90 - 86) 4 Decrease in creditors (60 - 58) (2) Net cash inflow from operating activities 95 (b) Peters plc Cash Flow Statement for Year 6 £000 £000 Net cash inflow from operating activities 95 Net cash outflow from returns on investment and servicing of finance - Dividend paid (10) Investing activities Purchase of machinery (565 - 500 + 65) 130 Purchase of land and building (400 - 300) 100 Receipt from sale of machine* (40) Net cash outflow from investing activities 190 Net cash outflow before financing (105) Net cash inflow from financing Ordinary Shares issued 70 Decrease in cash and equivalents (15 + 20) 35 * Cost of machine sold 65 * Depreciation (235 + 75 - 280) 30 35 Profit on sale 5 Sale proceeds 40 Examiner’s Report on Question 5 Rather surprisingly this was the question with the best overall level of answers. Though layout was at times not totally clear the underlying principles appeared to be understood, and the majority of papers were Credit to Distinction level on this question. The major error was in the calculation of the amount received from sale of assets, and the amount spent on new fixed assets, but overall well handled.