QUESTIONS Q1) Sarah prepares a bank reconciliation statement for her business bank account at the end of each

month. At 31 May 2007 her cash book balance was Rs2,759 (credit) and her bank statement showed that she had funds of Rs131 at the bank. She has the following information: (i) The bank debited Sarahs account with charges of Rs129 during May. Sarah has not recorded the charges. (ii) Sarah arranged for Rs2,500 to be transferred from her personal bank account into the business bank account. The bank made the transfer on 30 May, but Sarah has not made any entry for it in her records. (iii) On 22 May Sarah withdrew Rs100 cash which she did not record. (iv) Cheque number 543987 which Sarah issued to a supplier appears on the bank statement as Rs650. Sarah incorrectly recorded the cheque as Rs560. (v) On 31 May, Sarah lodged Rs457. This amount appears on the bank statement dated 3 June. (vi) Sarah was advised by the bank that she earned Rs52 interest for the period in May that her account was in credit. Sarah recorded this in May, but the bank did not credit her account until June. (vii) Three of the cheques issued in May, with a total value of Rs942, were not debited on the bank statement until after 31 May. (viii) A cheque for Rs276, issued to a supplier was cancelled, but Sarah has not recorded the cancellation of the cheque. Required: (a) Show the bank account in Sarahs general ledger, including any adjusting entries required due to the information in (i) to (viii) above. (b) Prepare a reconciliation of the bank statement balance to the corrected balance on the Sarahs cash book. c) Amount to be reported in balance sheet

Q2 (a) Tony Dunlop restores and sells vintage motorcycles. At 30 November 2006 he had three motorcycles in inventory. Details of these were: Model Details Triumph This item cost Rs4,800, and at 30 November 2006 Tony had also spent Rs750 on repairs. He has not yet sold it but is confident that he will be able to sell it at a motorcycle event in January 2007 for at least Rs7,500. It will cost Tony Rs400 to transport the motorcycle to the event. Ducati Tony bought this item for Rs6,800. When he bought it, he estimated that repairs would cost Rs1,100. By 30November 2006 he had spent Rs1,800 on repairs, and he sold it on 2 December 2006 for Rs8,000. Norton Tony bought this item for Rs8,500. He estimates that he will have to spend Rs1,200 on repair, after which he will be able to sell it for Rs11,500. Required: For each of the three motorcycles, calculate the following values at 30 November 2006: (i) Cost; (ii) Net Realizable Value; and (iii) Inventory value

The general rule is that stock should be valued at lower of cost or NRV. Note: Stock is valued at COST using FIFO, LIFO and AVCO methods. Then calculated stock is compared with NRV and lower value is taken in closing stock
(b) Smart company prepared its annual financial statements dated 31 December, 2007. The company follows FIFO costing method and closing stock included in income statement below is at cost. The income statement is as follows: Sales Cost of Goods Sold: Opening stock Purchases Closing stock Cost of Goods Sold Gross Profit Operating expenses Profit 280,000 30,000 182,000 44,000 168,000 112,000 61,000 51,000

You have developed the following data relating to 2008 closing stock: Item A Quantity 3,000 Per Unit price 3 Total Value 9,000 Selling price 5

B C D Total

1,500 7,000 3,000

4 2 5

6,000 14,000 15,000 44,000

3 5 4

The company has received discount of 5% on purchases. Its effect has not been taken into the above income statement. Return inward of Rs. 5,500 also not included above. Required: Identify the errors in above income statement and prepare revised correct income statement. (Rs.1 will be incurred as necessary cost to sell each item). Q(3) The following facts relate to the business of Mr Ali, a client of yours who requires you to reconcile his bank statement balance with his cash book balance: Balance as per cash book ( in favor) Cr. Balance as per cash book ( overdrawn) Unpresented cheques Uncredited deposits Rs. 600 Cr. Rs. 800 Rs. 1,440 Rs. 260

In addition to the above, you also ascertain the following: (a) A cheque of Rs. 200 paid to M. Jamil has been entered in error in the cash book (b) Bank commission of Rs 80 has not been entered in the cash book (c) The debit side of the cash book has been understated by Rs. 500. Q(4) From the following particulars, ascertain the bank balance that would appear in the bank statement of the trader as at 31 December, 1991. (a) the bank overdraft as per cash book on 31 December 1991 was Rs. 6,000. (b) Interest on overdraft for the six months ending 31 December 1991 of Rs 200 is debited in the bank statement. (c) Bank charges for the above period also debited in the bank statement amounted to Rs 50 (d) Cheques issued but not cashed prior to 31 December 1991 amounted to Rs 1,500 (e) Cheques paid into bank but not cleared and credited before 31 December 1991 were of Rs 2,500. (f) Interest on investment collected by the bankers and credited in bank statement amounted to Rs 1,800. Relationship of ending inventory/ closing stock with profit Closing stock has direct relation with profit and inverse relation with cost of goods sold i.e increase in closing stock will result in an increase in profit and decrease in closing stock will result in decrease in profit. Likewise increase in closing stock will result in a decrease in cost of goods sold and decrease in closing stock will result in an increase in cost of goods sold.

Relation with COGS Opening stock + Purchases - closing stock = Cost of goods sold Overstated Relation with profit Closing stock and Overstated profit overstated understated

Relationship of opening inventory/ opening stock with profit and COGS Opening stock has inverse relation with profit i.e increase in opening stock will result in an decrease in profit and decrease in opening stock will result in increase in profit. Increase or decrease in inventory can result from errors i.e stock may be understated or overstated in a period Relation with COGS Opening stock + Purchases - closing stock = Cost of goods sold Overstated Relation with profit Opening stock and Overstated profit Understated Overstated

Q(5) Dell company prepared the following two income statements. Sales COGS Opening stock Purchases Goods available for sale Closing stock Cost of goods sold Gross profit Operating expenses First quarter 15,000 3,000 7,000 10,000 4,000 6,000 9,000 5,000 Second quarter 18,000 4,000 12,000 16,000 9,000 7,000 11,000 6,000

Pretax profit

4,000

5,000

During the third quarter it was discovered that the closing stock for the first quarter should have been 4,400. Required: Explain the effect of error on pretax profits and prepare the corrected income statement Q(6) Lunar company uses periodic inventory system. At the end of the accounting period 31 December 20B, the accounting records provided the following information for product 2: Transactions a. Opening stock April 11 purchases June 1 purchases May 1 sales ( 40 each ) July 3 sales ( 40 each ) Operating expenses Rs. 195,000 Units 3,000 9,000 8,000 5,000 6,000 Unit cost 12 10 13

Required: Prepare separate income statement that details cost of goods sold under FIFO, LIFO and AVCO. Price changes effect on stocks FIFO When FIFO method is used during a period of rising prices (inflation), FIFO method will show larger GP because the earlier unit costs are lower than the most recent unit costs. We know that in FIFO method we take last units and their value in the valuation. So in inflation, the last units cost will be high. As a result an increase in stock will result in an increase in profit. It will be reverse in case of decrease in prices i.e FIFO will show lower profits. LIFO When LIFO method is used during a period of rising prices (inflation), LIFO method will show lower GP because the earlier unit costs are lower than the most recent unit costs. We know that in LIFO method we take first units and their rate in the valuation. So in inflation, the earlier units cost will be low. As a result a decrease in stock will result in a decrease in profit. It will be reverse in case of decrease in prices i.e LIFO will show higher profits.

Q7 Income is to be evaluated under four different situations as follows: a. Prices are rising: i. Situation A: FIFO is used ii. Situation B: LIFO is used b. Prices are falling i. Situation C: FIFO is used ii. Situation D: LIFO is used The basic data common to all four situations are sales 500 units for Rs 12,500; opening stock 300 units; purchases 400 units and operating expense Rs 4,000. Use periodic inventory procedure. In Situation A and B Opening stock 300 units @ Rs 12 per unit; purchases 400 units @ Rs 13 per unit; In Situation C and D Opening stock 300 units @ Rs 13 per unit; purchases 400 units @ Rs 12 per unit Prices Rising Situation A Situation B FIFO LIFO 12,500 12,500 3,600 5,200 8,800 (2,600) 6,200 6,300 4,000 2,300 690 1,610 ? ? ? ? ? ? 4,000 ? ? ? Prices Falling Situation C Situation D FIFO LIFO 12,500 12,500 ? ? ? ? ? ? 4,000 ? ? ? ? ? ? ? ? ? 4,000 ? ? ?

Sales COGS: Opening stock Purchases Goods available for sale Closing stock Cost of goods sold Gross profit Operating expenses Pretax profit Tax @ 30% Profit after tax

Required: Complete the above table and analyze the effect of increase and decrease in prices

ANSWER - 1
Bank Account/Cash book Rs (ii) Transfer 2,500 (viii) Cancelled cheque 276 Balance (corrected) 302 3,078 Rs Balance as given (i) Charges (iii) Cash withdrawal (iv) Corrected cheque 2,759 129 100 90 3,078

(b) Bank reconciliation statement Balance per statement (v) Outstanding lodgement (vi) Interest (vii) Outstanding cheques Rs 131 457 52

(942) Adjusted balance (overdrawn) (302) (c) The bank balance should be reported on the balance sheet. The corrected ledger balance of $302 should be reported. As it is overdrawn, it should be reported as a current liability.

ANSWER 2 (a)
Triumph Cost Purchase price Completed repairs Cost at 30 November 2006 Net Realisable value Expected selling price Costs of selling Net realisable value Inventory value (lower) Ducati Cost Purchase price Actual cost of repairs Cost at 30 November 2006 Net realisable value Inventory value (lower) Norton Cost (purchase price) Net realisable value Expected selling price Repairs required Net realisable value 4,800 750 5,550 7,500 400 7,100 5,550

6,800 1,800 8,600 8,000 8,000 8,500 11,500 1,200 10,300

Inventory value (lower)

8,500

ANSWER 2 (b) Important point Closing stock should be stated at lower of cost or NRV. So check that calculation in question Revised Income Statement
Sales Less: Return inwards Cost of Goods Sold: Opening stock Purchases Less: Discount (W-2) Net purchases Closing stock (W-1) Cost of Goods Sold Gross Profit Operating expenses Profit 30,000 182,000 9,100 172,900 35,000 167,900 106,600 61,000 45,600 Rupees 280,000 5,500 274,500

(W-1) Closing stock in income statement should be included at lower of cost or NRV, So
Item (1) A B C D Total Quantity (2) 3,000 1,500 7,000 3,000 Per Unit price (3) 3 4 2 5 Total Cost 4=(2x3) 9,000 6,000 14,000 15,000 44,000 Selling price (5) 5 3 5 4 Selling expense (6) 1 1 1 1 Net selling price 7=5-6 4 2 4 3 NRV 8=2x7 12,000 3,000 28,000 9,000 Lower of cost or NRV 9,000 3,000 14,000 9,000 35,000

(W-2) Purchase discount = 182,000 x 5% = 9,100 ANSWER 3 Cash Book a/c Understatement Rs 500 Balance carried down Rs 580 enetered in cash book Brought forward cheques issued wrongly Rs.200 Commission Rs 800 Rs 80

1,080 Bank Reconciliation Statement Balance as per Cash book Add: un credited cheques Cr Rs 580 Rs 260 Rs 840 Rs 1,440 Rs 600

1,080

Less: un presented cheques Balance as per bank statement Cr ANSWER 4 Interest Balance c/d

Cash Book a/c 1,800 balance b/d 6,000 Interest 200 4,450 bank charges 50 6,250 6,250

Bank Reconciliation Statement Balance as per cash book Add: un credited deposits Cr Rs 4,450 Rs 2,500 Rs 6,950 Rs 1,500 Rs 5,450

Less: un presented cheques Balance as per bank statement ANSWER 5

Dr

NEW INCOME STATEMENT ( with correction ) First quarter Sales 15,000 COGS Opening stock 3,000 Purchases 7,000 Goods available for sale 10,000 Closing stock 4,400 Cost of goods sold 5,600 Gross profit 9,400 Operating expenses 5,000 Pretax profit 4,400 Important point to note

Second quarter 18,000 4,400 12,000 16,400 9,000 7,400 10,600 6,000 4,600

Two quarters are given in the question. Closing stock of first quarter will be the opening stock of the second quarter. So error will occur in both quarters 1 & 2. In first quarter closing stock is increased from 4,000 to 4,400. So closing stock of first quarter is increased by 400. As per rule closing stock has direct relation with profit. Increase in closing stock will result in increase in profit by 400 as shown above. In second quarter, closing stock of first quarter will be the opening stock of second quarter. Opening stock has inverse relation with profit. Increase in opening stock will result in a decrease in profit by 400 as shown above. ANSWER 6 INCOME STATEMENT FIFO Sales ( W-1 ) COGS: Opening stock Purchases ( W-2 ) Goods available for sale Less: Closing stock ( W-3 ) Cost of goods sold Gross profit Operating expenses Pre tax profit (W-1) Sales May 1 July 3 Qty Rate Value 5,000 x 40 = 200,000 6,000 x 40 = 240,000 440,000 440,000 36,000 194,000 230,000 114,000 116,000 324,000 195,000 129,000 LIFO 440,000 36,000 194,000 230,000 96,000 134,000 306,000 195,000 111,000 AVCO 440,000 36,000 194,000 230,000 103,500 126,500 313,500 195,000 118,500

(W-2) Purchases April 11 June 1 9,000 x 10 = 90,000 8,000 x 13 = 104,000 194,000

(W-3) Closing stock First calculate number of units in closing stock Sale Purchase May 1 5,000 April 11 9,000 July 3 6,000 June 1 8,000 11,000 17,000 During the year company purchased 17,000 units and sold 11,000 units. There are 3,000 units in opening stock. So units left unsold are (17,000 + 3,000) 11,000 = 9,000. So units in closing stock are 9,000. Now calculate the rate at which closing units should be valued Opening stock Purchase April 11 Purchase June 1 Qty Rate 3,000 12 9,000 10 8,000 13 20,000 Value 36,000 90,000 104,000 230,000

Under FIFO Method First units purchased are sold first so last purchased units should be in closing stock. We know that we have 9,000 units in closing stock. So the following should be in the closing stock. Purchases June 1 Purchase April 11 8,000 x 13 = 104,000 1,000 x 10 = 10,000 9,000 114,000

Under LIFO Method Last units purchased are sold first so first purchased units should be in closing stock. We know that we have 9,000 units in closing stock. So the following should be in the closing stock. Opening stock Purchase April 11 Closing stock 3,000 x 12 = 36,000 6,000 x 10 = 60,000 9,000 96,000

Under AVCO Method We simply take the average rate. Qty Rate Opening stock 3,000 12 Purchase April 11 9,000 10 Purchase June 1 8,000 13 Closing stock 20,000

Value 36,000 90,000 104,000 230,000

Average rate 230,000 / 20,000 = 11.50 Closing stock = 9,000 x 11.50 = 103,500 ANSWER 7: Note the following: a. See that all the information already put into the table is correct. b. See that you have all the information to complete the table. c. Dont get confused by so many ? because examiners wants that. d. Check which amount is missing in the question e. Determine carefully what examiner wants? Stock valuation and comment on price increase and decrease effect How to Solve? a. Note that all data in question is same except the closing stock under each situation b. In order to calculate the closing stock value we first need to determine the closing stock units and then the values under LIFO and FIFO c. Keep rising and falling situations in mind. Prices Rising Situation A Situation B FIFO LIFO 12,500 12,500 3,600 5,200 8,800 (2,600) 6,200 6,300 4,000 2,300 690 1,610 3,600 5,200 8,800 (2,400) 6,400 6,100 4,000 2,100 630 1,470 Prices Falling Situation C Situation D FIFO LIFO 12,500 12,500 3,600 5,200 8,800 (2,400) 6,400 6,100 4,000 2,100 630 1,470 3,600 5,200 8,800 (2,600) 6,200 6,300 4,000 2,300 690 1,610

Sales COGS: Opening stock Purchases Goods available for sale Closing stock ( W-1 ) Cost of goods sold Gross profit Operating expenses Pretax profit Tax @ 30% ( W-2 ) Profit after tax

Situation A and C When FIFO method is used during a period of rising prices (inflation), FIFO method will show larger profit because the earlier unit costs are lower than the most recent unit costs. We know that in FIFO method we take last units and their value in the valuation. So in inflation, the last units cost will be high. As a result an increase in stock will result in an increase in profit. So if we see the solution above, note that in situation A profit after tax is Rs 1,610 whereas in Situation C profit after tax is Rs 1,470. Situation B and D When LIFO method is used during a period of rising prices (inflation), LIFO method will show lower profit because the earlier unit costs are lower than the most recent unit costs. We know that in LIFO method we take first units and their rate in the valuation. So in

inflation, the earlier units cost will be low. As a result a decrease in stock will result in a decrease in profit. It will be reverse in case of decrease in prices i.e LIFO will show higher profits. In situation B profit after tax is lower i.e Rs 1,470 than profit after tax in situation D i.e Rs 1,670. WORKINGS (W-1) a. First calculate closing stock units b. Then value of closing stock c. First value closing stock in rising situation then in falling price situation Closing units Opening stock + Purchase = total units in hand during the year 300 + 400 = 700 Out of 700 units, 500 units have been sold. So units left in hand will be 700 500 = 200 units. Valuation under LIFO Method in Rising prices situation Opening stock Purchases Qty 300 400 700 Rate 12 13 Value 3,600 5,200 8,800

Under LIFO method first units will be in stock, so 200 x 12 = 2,400 Valuation under LIFO Method in falling prices situation Qty Rate Value Opening stock 300 13 3,600 Purchases 400 12 5,200 700 8,800 Under LIFO method first units will be in stock, so 200 x 13 = 2,600 Valuation under FIFO Method in falling prices situation Qty Rate Value Opening stock 300 13 3,600 Purchases 400 12 5,200 700 8,800 Under FIFO method last units will be in stock, so 200 x 12 = 2,400 ( W-2 ) Tax Simply apply %age of tax to the amount of profit before tax

= 2,100 x 30% = 630 = 2,300 x 30% = 690