LCCI International Qualifications

Accounting (IAS) Level 3

Model Answers
Series 3 2010 (3902)

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Accounting (IAS) Level 3

Series 3 2010

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) (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.

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QUESTION 1 The following balances have been extracted from the books of Eboue at 31 December 2008: Land and buildings (NBV) Plant and machinery (NBV) Payables Prepayments Motor vehicles (NBV) Receivables Accruals Inventory Long term loan received Bank overdraft REQUIRED (a) Calculate the balance on Eboues Capital Account at 31 December 2008. (5 marks) Eboues business suffered a major computer failure during the year ended 31 December 2009 and he has no double entry records from which to prepare his accounts. However, the following information is available: (1) (2) (3) (4) (5) Land at 31 December 2008 cost $50,000. During 2009, a new building was purchased for $5,000. Depreciation on buildings is charged at 2% on the book value at the end of the year. There were no disposals. During 2009, plant and machinery (cost $30,000, accumulated depreciation $9,000) was sold at a loss of $2,000. Plant and machinery costing $40,000 was purchased. Depreciation is charged at 10% on the book value of all plant and machinery held at the year end. Trade purchases were $370,000, with payments to payables of $357,750 and discounts received of $7,800. Prepayments at 31 December 2009 increased by 10% on prepayments at 31 December 2008. During 2009 vehicles costing $36,000 were purchased and vehicles with a net book value of $18,000 were sold for $13,700. Motor vehicles are depreciated at 15% on a reducing balance basis for vehicles held throughout the year and at 7.5% on a reducing balance basis for vehicles purchased during the year. Sales were $475,000, with receipts from receivables of $459,800, discounts allowed of $8,600 and bad debts written off of $6,100. In addition, unlike in previous years, Eboue wishes to create a provision for bad debts equal to 3% of year end receivables. Accruals at 31 December 2009 were 10% less than they had been at 31 December 2008. Inventory at 31 December 2009 cost $15,200 and had a net realisable value of $25,400. This included goods on sale or return, held by customers, costing $3,100 with a net realisable value of $4,300. The customers had still to decide whether or not to purchase these goods. Provision for obsolete inventory was to be made at 10% of the value of closing inventory. On 1 July 2009 a further $4,000 was borrowed long term. Interest for the period, at 10% per year, was also added to the long term loan at 31 December 2009. The bank account balance at 31 December 2009 was $8,200. Eboue introduced $50,000 in cash as additional capital during 2009 and his drawings were $3,000 per month. $ 175,000 81,200 12,400 3,100 47,100 15,200 2,900 12,100 36,000 475

(6) (7) (8)

(9) (10) (11)

REQUIRED (b) (c) Calculate the balance on Eboues Capital Account at 31 December 2009. (16 marks) Using Eboues Capital Account, calculate Eboues profit for the year ended 31 December 2009. (4 marks) (Total 25 marks) 3902/3/10/MA Page 2 of 12

MODEL ANSWEWR TO QUESTION 1 (a) Capital 31 December 2008 DR $ 175,000 81,200 3,100 47,100 15,200 2,900 12,100 333,700 (51,775) 281,925 36,000 475 51,775 (51,775) -. CR $

Land and buildings Plant and machinery Payables Prepayments Motor vehicles Receivables Accruals Inventory Long term loan Bank overdraft

12,400

Capital

(b)

Capital 31 December 2009 DR $ CR $

Land and buildings (175,000 + 5,000) [(180,000 50,000) x 0.02] Plant and machinery [81,200 (30,000 9,000) + 40,000 x 0.90] Payables (12,400 + 370,000 357,750 7,800) Prepayments (3,100 x 1.1) Motor vehicles [(47,100 18,000) x 0.85 + (36,000 x 0.925)] Receivables [(15,200 + 475,000 459,800 8,600 6,100) x 0.97] Accruals (2,900 x 0.9) Inventory (15,200 x 09) Long term loan [(36,000 x 1.1) + (4,000 x 1.05)] Bank Capital

177,400 90,180 16,850 3,410 58,035 15,229 2,610 13,680 8,200 366,134 (63,260) 302,874 43,800 ... 63,260 (63,260) - .

(c) Capital Account $ Bank (3,000 x 12) Closing balance 36,000 302,874 000 338,874 Opening balance Bank Profit (R) $ 281,925 50,000 6,949 338,874

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QUESTION 2 Kanu, a public company, has an authorised share capital of 300,000 ordinary shares of $2 each. The company initially issued 100,000 shares at $2.50 per share. More recently it made a capitalisation (bonus) issue of one share for every four held. At that time the market price per share was $1.80. REQUIRED Calculate: (a) (b) The number of shares in issue after the capitalisation (bonus) issue. (2 marks) The total amount received from the issue of shares. (2 marks) Kanu has now issued a further 50,000 shares at $3 each, payable as follows: $ Application 0.50 Allotment (including premium) 1.50 First and final call 1.00 3.00 Applications were received for 100,000 shares. Applications for 25,000 shares were rejected and the application money refunded. The 50,000 shares were then allotted to the remaining applicants on a prorata basis. The surplus application money was then transferred to the allotment account, reducing the amount due on allotment. All amounts due were received. REQUIRED (c) (d) Prepare Journal entries (without narratives) recording the latest share issue. (16 marks) State, giving a reason, whether or not you consider the latest share issue to have been underpriced. (2 marks) (e) State two reasons why Kanu may have decided to issue more shares. (3 marks) (Total 25 marks)

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MODEL ANSWER TO QUESTION 2 (a) Number of shares in issue Initial issue Bonus issue (100,000 x 0.25) Total amount received from share issue Initial issue (100,000 x 2.50) Bonus issue Journal entries $ DR 50,000 12,500 12,500 12,500 12,500 25,000 25,000 62,500 62,500 75,000 25,000 50,000 50,000 50,000 50,000 50,000 $ CR 50,000 100,000 25,000 125,000 250,000 250,000

(b)

(c)

Bank (100,000 x 0.50) Application Application (25,000 x 0.50) Bank Application [(75,000 50,000) x 0.50] Allotment Application (50,000 x 0.50) Ordinary share capital Bank [(50,000 x 1.50) 12,500] Allotment Allotment (50,000 x 1.50) Ordinary share capital (50,000 x 0.50) Share premium (50,000 x 1.0) Bank (50,000 x 1.00) First and final call First and final call Ordinary share capital

(d)

There were applications for 100,000 shares and only 50,000 shares were available. This suggests that the issue was underpriced.

(e)

Reasons for share issue Reduce gearing/pay off debt Purchase new non-current assets.

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QUESTION 3 The summarised Balance Sheets at 31 December 2009 of two public companies are as follows: Noca Cola $000 Net assets Ordinary shares of $1 each Share premium Accumulated profits 600 200 150 250 600 Super Steel $000 4,000 200 250 3,550 4,000

Barry, a public company, is considering investing in either (or both) of these companies and believes the fair value of the net assets shown above to be as follows: (1) (2) Noca Cola Super Steel - $900,000 - $1,500,000 less than book value.

Barry is prepared to pay $4,000,000 for 75% of the shares in Noca Cola and $2,700,000 for 80% of the shares in Super Steel. It would write off 20 % of the goodwill arising on the consolidation of Noca Cola by 31 December 2011 and 40% of the goodwill arising on the consolidation of Super Steel by 31 December 2011. REQUIRED (a) Calculate the goodwill that would appear in the Consolidated Balance Sheet of Barry at 31 December 2011, assuming acquisition takes place on 31 December 2009, of: (i) (ii) (iii) Noca Cola only Super Steel only both companies. (11 marks) Noca Cola is an internationally known company, producing fizzy drinks which have become famous. The company has made high profits in recent years, despite the drinks being regarded as unhealthy. Super Steel is the new name of a former state owned company. Profits in recent years have been low. Recently, many workers have been made redundant and the company is hopeful that profits will increase in the future. REQUIRED (b) Give, and discuss, two reasons why the value of goodwill in Noca Cola is likely to be higher than the value of goodwill in Super Steel. (6 marks)

Barry is proposing to purchase the shares in Noca Cola by issuing 1,000,000 of its own $1 ordinary shares at $1.50, paying $2,000,000 in cash with the balance in 10% Debentures issued at par. Barry is proposing to purchase the shares in Super Steel by issuing 1,000,000 of its own $1 ordinary shares at $1.50 with the balance in cash. Barry currently has an issued share capital of 4,000,000 ordinary shares of $1 each.

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QUESTION 3 CONTINUED REQUIRED (c) Prepare a Journal entry (including narrative) showing, in the books of Barry, the proposed acquisition of shares in Noca Cola. (5 marks) Calculate the percentage of shares in Barry that would be held by former shareholders of Super Steel, assuming: (i) (ii) both acquisitions take place only the acquisition of Super Steel takes place. (3 marks) (Total 25 marks)

(d)

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MODEL ANSWER TO QUESTION 3 Accounting for groups of companies (a) Goodwill (i) Noca Cola only: Purchase price Fair value acquired (0.75 x 900) Good will written off (0.20 x 3325) Goodwill at 31 December 2011 (ii) Super Steel only: Purchase price Fair value acquired [0.80 x (4,000 1.500)] Good will written off (0.40 x 700) Goodwill at 31 December 2011 $000 4,000 675 3,325 (665) 2,660 $000 2,700 2,000 700 (280) 420 $000 3,080

(iii) (b)

Noca Cola and Super Steel (2,660 + 420)

Reasons why goodwill is higher in Noca Cola (i) Noca Cola and its drinks are very well known internationally (brand name value) whereas Super Steel is a new name of a previously state owned company associated with redundancies. Noca Cola has produced high profits in recent years and seems likely to do so in the future. Super Steel has not and the future profits are uncertain. $000 DR 4,000 $000 CR 1,000 500 2,000 500

(ii)

(c)

Journal Entry Investment in Noca Cola Share Capital Share Premium Bank 10% Debentures (R)

Acquisition of 150,000 shares in Noca Cola

(d)

Shares held by former shareholders of Super Steel (i) If both acquisitions take place: 1,000,000 4,000,000 + 1,000,000 + 1,000,000 (ii) If Super Steel acquisition only takes place 1,000,000 4,000,000 + 1,000,000 .x 100 = 20.00% x 100 = 16.67%

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QUESTION 4 Owen is deciding whether or not to replace his machinery. The following table shows information relating to the machinery and Owens business: Old Machinery $000 80 30 51 5 10 12 25 85 New Machinery $000 100 41 14 10 8 92

Cost when new Book value (now) Material and labour costs (per year) Depreciation (per year) Administration (per year) Power and maintenance (per year) Residual value (now) Sales revenue (per year) REQUIRED (a)

Copy the above table into your answer books leaving out the figures. Indicate in your table whether each figure is relevant (R) or not relevant (NR) to the decision whether or not to replace the machinery. (9 marks)

Both the old machinery and the new machinery are expected to have a useful life of 5 years from now. The old machinery will have a residual value of nil after 5 years and the new machinery will have a residual value of $30,000 after 5 years. The working capital requirement will increase immediately from $20,000 to $50,000 if the new machinery is chosen. All working capital will be recovered at the end of the five years. REQUIRED (b) Calculate the net present value of Owens business, if the old machine is retained, assuming a 10% rate of interest. Discount factors are as follows: Year 1 2 3 4 5 Cumulative (c) Factor 0.909 0.826 0.751 0.683 0.621 3.790 (7 marks) Calculate the net present value of Owens business, if the old machine is replaced, assuming a 12% rate of interest. Discount factors are as follows: Year 1 2 3 4 5 Cumulative Factor 0.893 0.797 0.712 0.636 0.567 3.605 (7 marks) (d) State one reason why a higher rate of interest is used for calculating the net present value of Owens business with the new machine. (2 marks) (Total 25 marks) 3902/3/10/MA Page 9 of 12

MODEL ANSWER TO QUESTION 4 Net present value (a) Table Cost when new Book value Material and labour costs Depreciation Administration Power and maintenance Residual value Sales revenue Old Machinery NR NR R NR NR R R R New Machinery R R NR NR R R

(b)

NPV of Owens Business Old Machinery Initial investment (25 + 20) Annual cash flow (85 51 10 12) Residual value (0 + 20) NPV = (12 x 3.790) + (20 x 0.621) 45 = 45.480 + 12.420 $000 - 45.000 = + 12.900

$000 45 12 20

(c)

NPV of Owens business New Machinery Initial investment (100 + 50) Annual cash flow (92 41 10 8) Residual value (30 + 50) NPV = (33 x 3.605) + (80 x 0.567) - 150 = 118.965 + 45.360 $000 - 150.000 = + 14.325

$000 150 33 80

(d)

Reason for higher rate of interest The cash flows in relation to the new machinery are likely to be more uncertain.

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QUESTION 5 The annual stocktaking of Moore, a private company, took place on 30 June 2009, the companys year end. The inventory was counted by the young son of the Managing Director gaining some work experience. The inventory was valued at $59,200 and included in the year end accounts. The auditors discovered the following errors: (1) (2) (3) (4) One inventory sheet had been over-added by $3,000, another inventory sheet had been underadded by $700 and on a third inventory sheet an item valued at $800 had been included twice. 5,000 screws, costing $0.10 each, had been included at $1.00 each, and 10,000 nails, costing $0.20 per box of ten nails, had been included at $0.20 per nail. Goods belonging to a customer (cost price $800, selling price $1,000) had been included in inventory at $1,000. An inventory sheet total had been completely omitted. This showed 700 items costing $5.00 each. It was estimated that these had a sales value of $4.50 each.

REQUIRED (a) (b) (c) Calculate the corrected inventory value for Moore at 30 June 2009. (8 marks) Calculate the change in Moores profit as a result of the stocktaking errors. (3 marks) State two causes for concern regarding the stocktaking arrangements on 30 June 2009. (4 marks) Tevez, a public company, purchased a non-current asset on 1 January 2002 for $95,000. It was depreciated at 10% on a reducing balance basis for two years, then at 10% on a straight line basis for three years. On 1 January 2007 it was revalued at $70,000 and continued to be depreciated at 10% per year on a straight line basis. A zero residual value was assumed throughout. REQUIRED (d) Calculate the total depreciation charged for the eight years to 31 December 2009 and the net book value of the asset at that date. (8 marks) State which reserve should be used to record a surplus arising on revaluation and whether this reserve would be distributable or non-distributable. (2 marks) (Total 25 marks)

(e)

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MODEL ANSWER TO QUESTION 5 (a) Corrected inventory valuation Original valuation (1) Inventory sheet errors ( - 3,000 + 700 800) (2) Valuation errors: screws [5,000 (0.10 1.00)] nails [(10,000/10) x 0.20 (10,000 x 0.20)] (3) Customers goods (4) Missing inventory sheet (700 x 4.5) Corrected valuation $ 59,200 (3,100) (4,500) (1,800) (1,000) 3,150 51,950

(b)

Decrease in profit Original valuation 59,200 corrected valuation 51,950

= $7,250

(c)

Causes for concern Inexperienced inventory taker making many mistakes No supervision by more experienced employee No subsequent checks made, other than by auditor Total depreciation and net book value Net Book Value $ Cost 1 January 2001 Depreciation 2001 (95,000 x 0.10) Depreciation 2002 (85,500 x 0.10) Depreciation 2003, 2004, 2005 (76,950 x 0.10 x 3) Revaluation 1 January 2006 Depreciation 2006, 2007, 2008 (70,000 x 0.10 x 3) 95,000 9,500 85,500 8,550 76,950 23,085 53,865 70,000 21,000 49,000 Total Depreciation $ 9,500 8,550 23,085 21,000 62,135

(d)

(e)

Reserve Revaluation Reserve should be used, which is non-distributable.

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