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LCCI International Qualifications

Accounting
Level 3

Model Answers
Series 4 2008 (3012)

For further Tel. +44 (0) 8707 202909


information Email. enquiries@ediplc.com
contact us: www.lcci.org.uk
Accounting Level 3
Series 4 2008

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) Questions – reproduced from the printed examination paper

(2) Model Answers – 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)

(3) 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.

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.

© EDI 2009

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.
QUESTION 1

Extracts from the draft financial statements of Dore, at 31 December 2007 and for the year ended
31 December 2007, were as follows:

£
Gross profit 27,901
Net profit 7,302
Net current assets 24,216
Current liabilities 17,246
Fixed assets 58,146

Dore uses a periodic stock recording system.

REQUIRED

(a) Calculate for Dore, the following amounts based on the draft financial statements:

(i) Total assets at 31 December 2007


(ii) Expenses other than cost of goods sold for the year ended 31 December 2007.
(4 marks)

The following matters still needed to be taken into consideration when completing the accounts:

(1) Bad debts of £736


(2) Closing stock included £137 of unsaleable stock
(3) Depreciation of £2,100 for 2007
(4) Prepaid administrative expenses of £274 and accrued distribution costs of £73
(5) During 2007 Dore took for his own use goods for resale costing £600
(6) Purchase invoices totalling £4,250 for the week ending 31 December 2007. The goods relating to
which have been included in closing stock.
(7) Sales invoices totalling £5,175 for the week ending 31 December 2007. The goods relating to
which have not been included in closing stock.

REQUIRED

(b) Calculate for Dore, at 31 December 2007 or for the year ended 31 December 2007, revised
figures for each of the following amounts:

(i) gross profit


(ii) net profit
(iii) net current assets
(iv) current liabilities
(v) fixed assets.
(15 marks)

Dore finds accrued expenses and prepaid expenses very confusing. He cannot understand why such
adjustments are necessary and how they affect profit.

REQUIRED

(c) Give a brief explanation of the need for accrued expenses and prepaid expenses and the effect of
such adjustments on profit.
(6 marks)

(Total 25 marks)

3012/4/08/MA Page 1 of 10
MODEL ANSWER TO QUESTION 1

(a)
TOTAL ASSETS £
Fixed assets 58,146
Current assets (24,216 + 17,246) 41,462
99,608

Expenses (27,901 – 7,302) 20,599

(b) (i) (ii)


Gross Profit £ Net Profit £
Pre adjustments 27,901 Pre adjustments 7,302
Unsaleable stock (2) (137) Bad debts (1) (736)
Drawings (5) 600 Unsaleable stock (2) (137)
Purchases (6) (4,250) Depreciation (3) (2,100)
Sales (7) 5,175 Prepayment (4) 274
Accrual (4) (73)
Drawings (5) 600
Purchases (6) (4,250)
_____ Sales (7) 5,175
29,289 6,055

(iii) (iv)
Net Current Assets £ Current Liabilities £
Pre adjustments 24,216 Pre adjustments 17,246
Bad debts (1) (736) Accrual (4) 73
Unsaleable stock (2) (137) Purchases (6) 4,250
Prepayment (4) 274
Accrual (4) (73)
Purchases (6) (4,250)
Sales (7) 5,175 ______
24,469 21,569

(v)
Fixed Assets £
Pre adjustments 58,146
Depreciation (3) 2,100
56,046

(c) Profit is measured for a period, in this case the year ended 31 December 2007. Expenses
represent the cost of resources consumed in the period. These are calculated by matching
with the revenue of the period (e.g. sales commissions) or with the period itself (e.g. rent). An
accrued expense is a consumption of resources for which payment has not yet been made. A
prepaid expense is a payment made in respect of a resource which has not yet been
consumed.

Recording an accrued expense reduces current profit but recording a prepaid expense
increases current profit. They will have the opposite effects on the profit of the following period.

3012/4/08/MA Page 2 of 10
QUESTION 2

Diss Ltd is about to add a product to its range. Machinery costing £100,000 will be purchased
immediately. This will be used for 5 years and then sold for £10,000. Additional working capital of
£50,000 will be required immediately, but will be released at the end of Year 5.

Sales of the new product for the next five years are expected to be as follows:

Year £
1 150,000
2 200,000
3 250,000
4 200,000
5 200,000

Units of the product will sell for £100 each, with variable costs of manufacture and sale being £80
each. The only additional fixed cost will be the depreciation of the machine, which will be calculated
on a straight line basis.

All cash flows are assumed to occur at the end of each year, “immediately” being Year 0.

REQUIRED

(a) Calculate, to the nearest 1%, the accounting rate of return on the investment in the new product.
(10 marks)

(b) Calculate the net present value of the investment in the new product, when discounted at 10%
and when discounted at 20%. Discount factors are as follows:

Year 10% 20%


1 0.909 0.833
2 0.826 0.694
3 0.751 0.579
4 0.683 0.482
5 0.621 0.402

(9 marks)

(c) Give one advantage and one disadvantage of each of the following methods of investment
appraisal:

(i) Accounting rate of return


(ii) Net present value.
(6 marks)

(Total 25 marks)

3012/4/08/MA Page 3 of 10
MODEL ANSWER TO QUESTION 2

(a) Accounting Rate of Return


Contribution – depreciation = profit £
Year 1 (150,000 x 0.20) – [(100,000 – 10,000) ÷ 5] = 12,000
Year 2 (200,000 x 0.20) – 18,000 = 22,000
Year 3 (250,000 x 0.20) – 18,000 = 32,000
Year 4 (200,000 x 0.20) – 18,000 = 22,000
Year 5 (200,000 x 0.20) – 18,000 = 22,000
110,000
∴ Average profit [110,000 ÷ 5] 22,000

Initial investment (100,000 + 50,000) = 150,000

∴ Return = 22,000 x 100 = 14.67 = 15%


150,000

(b) Net Present Value

Year 10% 20%


1 Contribution 30,000 x 0.909 27,270 30,000. x 0.833 24,990
2 Contribution 40,000 x 0.826 33,040 40,000 x 0.694 27,760
3 Contribution 50,000 x 0.751 37,550 50,000 x 0.579 28,950
4 Contribution 40,000 x 0.683 27,320 40,000 x 0.482 19,280
5 Contribution 40,000 40,000
Machinery 10,000 x 0.621 62,100 10,000. x 0.402 40,200
Working capital 50,000 ______ 50,000 _______
187,280 141,180
0 Initial investment 150,000 150,000
∴ NPV 37,280 (8,820)

(c) (i) Accounting Rate of Return

Advantage - easy to calculate


can be compared directly with cost of capital.

Disadvantage - ignores time value of money


can calculate several different versions
(e.g. return on initial investment v return on average investment).

(ii) Net Present Value

Advantage - takes into consideration time value of money


relies exclusively on cash flows.

Disadvantage - more complex


dependent on estimate of appropriate cost of capital.

3012/4/08/MA Page 4 of 10
QUESTION 3

Following are the summarised Balance Sheets of Dean plc and its subsidiary Lye Ltd at
31 December 2007:

Dean plc Lye Ltd


£ £ £
Fixed assets 280,000 173,000
Investment in Lye Ltd
70,000 £1 ordinary shares at cost 96,000
£10,000 loan stock at nominal value 10,000 106,000 -
Current assets 90,000 96,000
Lye Ltd - current account 8,000 -
Creditors: Amounts due within one year (58,000) (27,000)
Dean plc - current account - (6,000)
Creditors: Amounts due after one year
Loan stock - (15,000)
426,000 221,000
£ £
Capital and reserves
£1 Ordinary shares 200,000 100,000
£1 Preference shares 100,000 -
Revaluation reserve - 20,000
Profit and loss 126,000 101,000
426,000 221,000

NOTES:

(1) Dean plc made the investment in Lye Ltd on 1 January 2004, when Lye Ltd had a credit balance
on the profit and loss account of £29,000.

(2) The revaluation reserve is the result of a revaluation of fixed assets on 31 December 2006.

(3) On 31 December 2007, Lye Ltd recorded, and sent, a cheque for £2,000 to Dean plc. The
cheque was not received and recorded by Dean plc until 3 January 2008.

(4) Included in the current liabilities of Lye Ltd is a proposed ordinary dividend of £10,000. Dean
plc’s proportion of this had not been recorded in Dean plc’s books at 31 December 2007.

(5) On 1 December 2007, Lye Ltd sold goods to Dean plc for £8,000. Lye Ltd prices its goods at cost
plus 25%. Of the £8,000 of goods, £5,000 remained in Dean plc’s stock at 31 December 2007.

(6) Goodwill arising on consolidation is being written off over five years on a straight line basis.

REQUIRED

Prepare the Consolidated Balance Sheet of Dean plc and its subsidiary Lye Ltd at 31 December 2007.

(Total 25 marks)

3012/4/08/MA Page 5 of 10
MODEL ANSWER TO QUESTION 3
Dean plc
Consolidated Balance Sheet at 31 December 2007
£ £ £
Fixed Assets
Tangible (280,000 + 173,000) 453,000
Intangible – Goodwill [W1] 1,140
454,140
Current Assets
Sundry [W2] 187,000
Creditors: Amounts due within one year
Sundry (58,000 + 27,000 – 10,000) 75,000
Dividend payable to MI (0.30 x 10,000) 3,000 78,000
Net Current Assets 109,000
563,140
Creditors: Amounts due after one year
Loan stock (15,000 – 10,000) 5,000
558,140

£
Capital and reserves
£1 Ordinary shares 200,000
£1 Preference shares 100,000
Revaluation reserve (0.70 x 20,000) 14,000
Profit and loss [W3] 178,140
492,140
Minority Interest [W4] 66,000
558,140

Workings:

[1] Goodwill £ £
Acquisition cost 96,000
Less: Share capital 100,000
Profit and loss 29,000
0.70 x 129,000 90,300
5,700
Less: (0.80 x 5,700) 4,560
1,140

[2] Sundry Current Assets £


Dean plc 90,000
Lye Ltd 96,000
Cash in transit 2,000
Unrealised profit in stock 0(.20 x 5,000) (1,000)
187,000

[3] Profit and Loss £


Dean plc 126,000
Lye Ltd [.70 (101,000 – 29,000)] 50,400
Share of unrealised profit (0.70 x 1,000) (700)
Goodwill written off (4,560)
Dividend receivable (0.70 x 10,000) 7,000
178,140

[4] Minority Interest £


Share capital and reserves (0.30 x 221,000) 66,300
Share of unrealised profit (0.30 x 1,000) (300)
66,000

3012/4/08/MA Page 6 of 10
QUESTION 4

The following information has been extracted from the books of Par Ltd in respect of 2007:

£000 £000
Profit before interest 210
Interest 20
Profit after interest 190
Preference dividend 8
Ordinary dividend 24 32
Retained earnings for the year 158

Par Ltd has 100,000 £1.00 preference shares and 250,000 £0.20 ordinary shares. The market value
of the ordinary shares at 31 December 2007 was £4.80 each.

REQUIRED

(a) Calculate, to two decimal places, the following:

(i) Interest cover


(ii) Dividend cover for ordinary shares
(iii) Preference dividend per share
(iv) Ordinary dividend per share
(v) Total market value of ordinary shares at 31 December 2007
(vi) Earnings per ordinary share
(vii) Price earnings ratio.
(9 marks)

(b) Show the amounts that will appear in Par Ltd’s Balance Sheet in respect of preference share
capital and in respect of ordinary share capital.
(2 marks)

The following information has been extracted from the books of Hayle Ltd at 31 December 2007, or
was calculated on the basis of this information:

Creditors £174,000
Debtors £258,000
Stock of goods for resale £180,000
Debtors turnover 40 days
Stock turnover 36 days

Note: all sales and all purchases were on credit.

REQUIRED

(c) Calculate for 2007, to two decimal places, the following:

(i) Sales
(ii) Cost of goods sold
(iii) Gross profit margin.
(6 marks)

Companies normally wish to reduce the time they hold stock and maximise the time they take to pay
creditors.

REQUIRED

(d)
(i) State two ways companies may reduce the time they hold stock
(ii) State two dangers to companies of maximising the time they take to pay creditors.
(8 marks)

(Total 25 marks)
3012/4/08/MA Page 7 of 10
MODEL ANSWER TO QUESTION 4

(a) (i) Interest cover 210 = 10.50 times


20

(ii) Ordinary dividend cover 190 – 8 = 7.58 times


24

(iii) Preference dividend per share 8_ = £0.08


100

(iv) Ordinary dividend per share 24 = £0.10


250

(v) Market value of ordinary shares 250,000 x 4.8 = £1,200,000

(vi) Earnings per ordinary share 190 – 8 = £0.73


250

(vii) Price earnings ratio 4.80 = 6.58


0.73

(b) Share Capital £


100,000 Preference shares of £1.00 each 100,000
250,000 Ordinary shares of £0.20 each 50,000

(c) (i) 365 Sales = Debtor days


Debtors

365 Sales = 40 ∴ Sales = £2,354,250


258,000

(ii) 365 COGS = 36 ∴ COGS = £1,825,000


180,000

(iii) Gross profit margin = (2,354,250 – 1,825,000) x 100 = 22.48%


2,354,250

(d) (i) Ways Introduce JIT ordering; offer discounts on slow moving stock, etc.

(ii) Dangers Suppliers refusing to supply; loss of discounts received, etc.

3012/4/08/MA Page 8 of 10
QUESTION 5

The Balance Sheet of Torre Ltd at 31 December 2006 included the following:

Capital and reserves £000


Ordinary shares of £0.50 each 200
10% Preference shares of £0.10 each 100
Share premium 50
Profit and loss 160

During the year ended 31 December 2007 the following transactions in relation to share and loan
capital took place:

March 31 - a bonus issue of 1 for 5 was made in respect of the ordinary shares
June 30 - the 6 months’ preference dividend was paid; a dividend of £0.04 per ordinary share
was paid
July 31 - a rights issue of 1 for 4 at £0.60 per share was made to, and taken up by, ordinary
shareholders
October 31 - a dividend of £0.05 per ordinary share was paid
November 30 - 50,000 ordinary shares were issued to the public at £0.70 per share; £30,000 12%
Debentures were issued for £33,000

December 31 - the 6 months’ preference dividend was paid, a dividend of £0.01 per ordinary share
was paid.

The company’s policy is to make maximum use of the Share Premium Account.

REQUIRED

Calculate in respect of Torre Ltd:

(a) The accrued debenture interest at 31 December 2007 (2 marks)

(b) The number of ordinary shares in issue at 31 December 2007 (4 marks)

(c) The balance on the Share Premium Account at 31 December 2007 (5 marks)

(d) The total of all dividends paid in 2007. (6 marks)

Share issues and debenture issues are both ways in which a company can raise finance.

REQUIRED

(e) State two differences between shares and debentures. (4 marks)

March plc’s provision for doubtful debts at 31 December 2006 was £12,800. In the year ended
31 December 2007, £6,000 of debts were written off. At 31 December 2007 when debtors totalled
£498,000 it was decided to write off a further £8,000 and adjust the provision for doubtful debts to 3%
of the remainder.

REQUIRED

(f) Calculate the total charge in March plc’s Profit and Loss Account for the year ended
31 December 2007 in respect of bad and doubtful debts.
(4 marks)

(Total 25 marks)

3012/4/08/MA Page 9 of 10
MODEL ANSWER TO QUESTION 5

(a) Accrued debenture interest (30,000 x 0.12 x 1/12) = £300

(b) Ordinary shares in issue - 000’s


At 31 December 2006 (2 x 200) 400
Bonus issue (0.20 x 400) 80
480
Rights issue (0.25 x 480) 120
600
Public issue 50
650

(c) Balance on Share Premium Account - £000


At 31 December 2006 50
Bonus issue (0.5 x 80) (40)
10
Rights issue {(0.60 - 0.50) x 120} 12
Public issue {(0.70 - 0.50) x 50} 10
32

(d) Total dividends paid - £000


Preference dividends (0.10 x 100) 10.0
Ordinary dividends: (1) (0.04 x 480) 19.2
(2) (0.05 x 600) 30.0
(3) (0.01 x 650) 6.5
65.7

(e) Differences – Dividends paid on shares; Interest paid on debentures


Shareholders normally have votes; Debenture holders normally do
not have votes
Shareholders are owners; Debenture holders are creditors.

(f) Bad and doubtful debts expense - £


Bad debts (6,000 + 8,000) 14,000
Increase in provision
{0.03 (498,000 – 8,000) – 12,800} 1,900
15,900

3012/4/08/MA Page 10 of 10 © Education Development International plc 2009


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