Accounting (IAS)

Level 3

Model Answers
Series 4 2007 (Code 3901)

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Accounting (IAS) Level 3

Series 4 2007

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(3)

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Accounting (IAS) Level 3

Series 4 2007
QUESTION 1 Pang, Tile and Gore are in partnership sharing profits/losses in the ratio 3:2:1 respectively, after allowing for a salary of $5,000 per year to Tile. From 1 July 2006, Pang became entitled to a salary of $3,000 per year. After calculating the draft net profit for 2006, the following matters were discovered: (i) Closing inventory had been included in the accounts as $17,200, when it should have been recorded as $12,700

(ii) On 31 December 2006, Pang had taken over a vehicle (net book value $4,800) at an agreed valuation of $5,000. This had been recorded by increasing sales and receivables by $5,000. The partnership does not record accumulated depreciation separately (iii) No entries had been made in respect of accrued gas expense of $400 and prepaid rent expense of $720 (iv) In December 2006, a debt of $350, written off during 2006 as bad, was unexpectedly received in full. This had been recorded by debiting the bank and crediting the receivable, but no other entry had been made. AFTER adjusting for the matters above, the net profit of the partnership for 2006 was $84,500. REQUIRED Prepare: (a) journal entries, (without narratives), showing how matters (i) to (iv) above were corrected in the books of the partnership. (7 marks) (b) a statement showing the draft net profit of the partnership for 2006 BEFORE the corrections shown in (a) above. (5 marks) (c) the Appropriation Account of the partnership for the year ended 31 December 2006. (4 marks) Giving a salary to Pang will increase his motivation and increase the amount of profit available for Tile and Gore. REQUIRED (d) Briefly discuss the above statement. (4 marks) (Total 20 marks)

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MODEL ANSWER TO QUESTION 1 (a) (i) Cost of goods sold (17,200 12,700) Inventory (ii) Sales/Income Statement Receivables Pang Vehicles Income Statement/Profit on Disposal (iii) Income Statement/Gas Accruals Prepayments Income Statement/Rent (iv) Receivables Income Statement/Bad Debts (b) Draft net profit (R) (i) Inventory overvalued (ii) Sales reduction Profit on disposal (iii) Gas accrual Rent prepayment (iv) Bad debt recovered Adjusted net profit $ + 200 400 720 350 1,270 9,900 (8,630) 84,500 $ 4,500 5,000 5,000 5,000 4,800 200 400 400 720 720 350 350 $ 4,500 5,000 $ 93,130 $ 4,500

(c) Pang, Tile and Gore Appropriation Account for year ended 31 December 2006 $ Net profit Less salary: Balance: Pang (.5 x 3,000) Tile Pang (3/6) Tile (2/6) Gore (1/6) 1,500 5,000 39,000 26,000 13,000 $ 84,500 6,500 78,000 78,000

(d)

Partners salaries are supposed to reward the time spent by each partner running the business. The motivation should be provided by the profit shares, of which Pangs is the largest. Unless annual profits increase by more than $3,000, Tile and Gore will actually receive less.

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QUESTION 2 The Consolidated Balance Sheet of Didcott, a public company, for the year ended 31 December 2006, prepared by an inexperienced accountant, was as follows: $000 $000 NON CURRENT ASSETS Tangible Land and Buildings 2,000 Plant and Machinery 400 Intangible Goodwill 700 3,100 CURRENT ASSETS Inventory Receivables Bank 512 278 14

804 3,904 $000 1,500 1,820 3,320 324 3,644 260 3,904

CAPITAL AND RESERVES Share Capital in $1 Ordinary Shares Accumulated Profit MINORITY INTEREST CURRENT LIABILITIES Creditors and accruals

Didcott purchased 80% of the Ordinary Shares in Parkway, a private company, (its only subsidiary) on 1 January 2003. Goodwill arising on the consolidation was $1,000,000 and is being written off evenly over 10 years. The following matters require attention: (1) No goodwill on consolidation was written off in respect of 2006 (2) No depreciation has been provided in respect of plant and machinery for 2006. Depreciation of $30,000 is necessary in the accounts of Didcott and $20,000 in the accounts of Parkway (3) During 2006, Parkway sold goods to Didcott for $75,000. These goods were invoiced by Parkway at cost plus 25%. At 31 December 2006 two thirds (by value) of these goods were still in Didcott inventory valued at their cost to Didcott (4) It has now been decided to set up a provision for bad debts equal to 2% of Parkway receivables, which total $200,000 (5) It has been discovered that Didcott owed $3,000 for electricity at 31 December 2006 (6) Intercompany indebtedness of $8,000 has been included in both the consolidated receivables and the consolidated payables. REQUIRED (a) Calculate at 31st December 2006: (i) (ii) the corrected Consolidated Accumulated Profit balance the corrected Minority Interest balance. (10 marks) (10 marks) (Total 20 marks)

(b) Prepare the corrected Consolidated Balance Sheet of Didcott at 31 December 2006.

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MODEL ANSWER TO QUESTION 2 (a) (i) Corrected Consolidated Accumulated Profit Balance $000 1,820 (100) (30) (16) (8) (4) (3) 1,659

Balance per question Less Goodwill Depreciation Unrealised profit Bad debt provision Accrual

(.10 x 1,000) Didcott Parkway (.80 x 20) (.80 x [25/125] x [2/3] x 75) (.80 x 0.025 x 200)

(ii) Corrected Minority Interest Balance Balance per question Less Depreciation Unrealised profit Bad debt provision $000 324 (4) (2) (1) 317

(.20 x 20) (.20 x [25/125] x [2/3] x 75) (.20 x 0.025 x 200)

(b)

Consolidated Balance Sheet of Didcott plc at 31 December 2006 $000 NON CURRENT ASSETS Tangible: Land and Buildings Plant and Machinery(400 30 20) Intangible: Goodwill (700 100) CURRENT ASSETS Inventory (512 8 2) Receivables (278 4 1 8) Bank CURRENT LIABILITIES Creditor and Accruals (260 8 + 3) 502 265 14 781 3,731 255 3,731 $000 CAPITAL AND RESERVES Share Capital in $1 Ordinary Shares Accumulated Profits MINORITY INTEREST 1,500 1,659 3,159 317 3,476 $000 2,000 350 600 2,950

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QUESTION 3 Twyford, a private company, began trading on 1 April 2005, but decided to prepare its year end accounts at 31 December each year. The following information relates to the first 21 months of operation: Nine months ended 31 December 2005 $ 126,000 104,000 12,100 15,200 13,900 Year ended 31 December 2006 $ 137,000 110,000 12,300 19,600 14,600

Sales Cost of goods sold Closing inventory Closing trade receivables Closing trade payables

All sales and purchases were on credit. REQUIRED (a) Calculate, to the nearest whole day and in respect of EACH of the two accounting periods, the following ratios: (i) inventory turnover period (ii) receivables collection period (iii) payables settlement period.

(10 marks)

It is often stated that companies should minimise the time that they take to collect money from receivables and maximise the time that they take to pay their payables. REQUIRED (b) Give two advantages and two disadvantages of minimising the time taken to collect receivables. (c) Give two advantages and two disadvantages of maximising the time taken to pay payables. (5 marks) (5 marks)

(Total 20 marks)

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MODEL ANSWER TO QUESTION 3 (a) (i) 31 December 2005 INVENTORY TURNOVER 12,100 x 275 104,000 = 32 days (ii) RECEIVABLES COLLECTION PERIOD 15,200 x 275 126,000 = 33 days (iii) PAYABLES SETTLEMENT PERIOD 13,900 x 275 104,000 + 12,100 = 33 days 14,600 x 365 110,000 + 12,300 12,100 = 48 days 19,600 x 365 137,000 = 52 days 12,300 x 365 110,000 = 41 days 31 December 2006

(b) Minimising time taken to collect receivables Advantages improving cash flow reducing possibility of bad debts Disadvantages damaging relationship with customers may have to offer discounts (c) Maximising time taken to pay payables Advantages improving cash flow minimising interest charges Disadvantages damaging relationship with suppliers - missing out on discounts for prompt payment

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QUESTION 4 Reading, a private company, imports model trains from China, paints them and puts them in attractive boxes before selling them to retail shops. The company imports three different models, whose financial details are as follows: STEAM $ per train Purchase price before trade discount Import taxes Trade discount received Settlement discount received Painting Boxes Carriage outwards Carriage inwards Selling costs Selling price Trains in inventory at 30 June 2007 5.20 0.52 0.78 0.26 1.40 0.60 0.50 0.30 0.40 6.10 UNITS 340 DIESEL $ per train 5.90 0.59 0.89 0.30 1.20 0.70 0.55 0.20 0.35 11.30 UNITS 410 ELECTRIC $ per train 7.20 0.72 1.04 0.36 1.10 0.40 0.60 0.22 0.60 10.90 UNITS 380

All trains in inventory had been boxed, ready for dispatch. REQUIRED (a) Calculate the amount which should appear in Readings Balance Sheet at 30 June 2007 in respect of inventory. (10 marks) Reading purchased a new painting machine on 1 July 2006 for $10,000. This is expected to last 5 years and have a residual value of $2,000. REQUIRED (b) Calculate, to the nearest $, the depreciation charge for the painting machine for each of the 5 years ending 30 June 2007 to 2011, using each of the following methods: (i) straight line (ii) reducing balance at a rate of 50% per annum (iii) sum of the years digits. Most companies have their inventory counted at their year end. REQUIRED (c) Give three reasons why it may also be beneficial to inspect and record fixed assets at the year end. (3 marks) (Total 20 marks)

(7 marks)

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MODEL ANSWER TO QUESTION 4 (a) Reading Cost Purchase price Import taxes Trade discount received Painting Boxes Carriage inwards Excluding settlement discount Net realisable value Selling price Carriage outwards Selling costs Lower of cost and NRV 6.10 (0.50) (0.40) 5.20 5.20 Steam trains Diesel trains Electric trains 11.30 (0.55) (0.35) 10.40 7.70 (340 x 5.20) (410 x 7.70) (380 x 8.60) 10.90 (0.60) (0.60) 9.70 8.60 $ 1,768 3,157 3,268 8,193 Inventory value at 30 June 2007 STEAM $/unit 5.20 0.52 (0.78) 1.40 0.60 0.30 7.24 DIESEL $/unit 5.90 0.59 (0.89) 1.20 0.70 0.20 7.70 ELECTRIC $/unit 7.20 0.72 (1.04) 1.10 0.40 0.22 8.60

Inventory Value

(b) (i)

Straight line method each year $ 5,000 2,500 1,250 625 313 $ 2,667 2,133 1,600 1,067 533 $ 1,600

(10,000 2,000) / 5 (ii) Reducing balance method 2007 2008 2009 2010 2011 10,000 x 0.5 5,000 x .5 2,500 x .5 1,250 x .5 625 x .5

(iii) Sum of the years digits method 2007 2008 2009 2010 2011 (c) (5/15) x (4/15) x (3/15) x (2/15) x (1/15) x (10,000 2,000) (10,000 2,000) (10,000 2,000) (10,000 2,000) (10,000 2,000)

Reasons for inspecting fixed assets at the year end (i) to check that fixed assets recorded still exist (ii) to check that their condition is such that their estimated lifetime and residual value are appropriate (iii) to check that all fixed assets have been recorded

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QUESTION 5 The Balance Sheets of Cholsey, a private company, at 31 December 2005 and at 31 December 2006 were as follows: 2005 $ ASSETS Land and buildings Plant and machinery Fixtures and fittings CURRENT ASSETS Inventory Receivables Bank TOTAL ASSETS EQUITY AND LIABILITIES CAPITAL AND RESERVES Ordinary Shares $1 each Share premium Revaluation (related to land and buildings) General reserve Accumulated Profits EQUITY TOTAL ASSETS NON CURRENT LIABILITIES 10% Debentures (Issued 1 Jan 2006) CURRENT LIABILITIES Payables Bank Overdraft TOTAL EQUITY AND LIABILITIES The following information is also available: (1) The only sale of fixed assets during 2006 was of plant and machinery, with a net book value of $780, which was sold for $1,200 (2) Payables at 31 December 2006 include $1,200 owing for the purchase of fittings (3) Depreciation charged in respect of 2006 was: Land and buildings Plant and machinery Fixtures and fittings $ 380 2,300 3,230 31,200 31,200 89,983 12,327 12,417 4,176 28,920 89,983 $ 10,000 12,000 20,000 16,783 58,783 35,200 7,163 42,363 119,399 $ 28,400 18,927 13,736 61,063 17,986 15,812 33,798 119,399 $ 30,000 12,000 12,400 17,636 72,036 5,000 $ 2006 $ 42,300 31,200 12,101 85,601

(4) A bonus (capitalisation) issue of shares was made from the general reserve during 2006 (5) The net profit for the year ended 31 December 2006 was $4,800 and a dividend was proposed and paid during the year. REQUIRED (a) Prepare the Cash Flow Statement of Cholsey for the year ended 31 December 2006, in accordance with IAS 7. (Total 20 marks) 3901/4/07/MA Page 11 of 15

MODEL ANSWER TO QUESTION 5 (a) Operating activities $ Profit from operations (4,800 + [0.1 x 5,000]) 5,300 Adjustment for: Depreciation (380 + 2,300 + 3,230) 5,910 Profit on disposal (1,200 - 780) (420) Operating cash flow before movement in working capital Increase in inventories (17,986 12,327) (5,659) Increase in receivables (15,812 12,417) (3,395) Increase in payables (35,200 1,200 31,200) 2,800 Cash generated by operations Interest paid Net cash from operating activities Investing activities Purchases of fixed assets (1,880 + 15,353 + 395) Net cash inflow from investing activities Financing activities Dividends paid (16,783 + 4,800 17,636) Issue of debentures Net cash used in financing activities Net decrease in cash Cash at beginning of year Cash at end of year $

10,790 (6,254) 4,536 (500) 4,036

(17,628) 1,200 (16,428) (12,392) (3,947) 5,000 1,053 (11,339) 4,176 (7,163)

* Purchase of land and buildings ** Purchase of plant and machinery *** Purchase of fixtures and fittings

(42,300 + 380 28,400 12,400) = 1,880 (31,200 + 2,300 + 780 18,927) = 15,353 (12,101 + 3,230 13,736 1,200) = 395

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QUESTION 6 Banbury is a retailer of cabinets with a head office in Southam. On 1 January 2006, he opened a branch in Leamington. He set up the following system for the branch: 1. 2. 3. All double entry records would be kept in the head office books Cabinets, all purchased by head office, would be invoiced to Leamington at a selling price set to earn a gross profit on sales of 20% When purchase prices fell, the value of the existing inventory would be reduced to reflect this fall.

During the year ended 31 December 2006, the following occurred in relation to the Leamington branch: (1) Head office purchased 1,200 cabinets for $120 each in the first nine months, and sent 90% of them to the Leamington branch (2) Head office purchased 400 cabinets for $100 each in the last three months, and sent 80% of them to the Leamington branch (3) Branch sales were 1,000 cabinets in the first nine months and 240 cabinets in the last three months (4) Faulty cabinets returned to head office totalled 60 in the first nine months, and 40 in the last three months (5) Head office made the following payments on behalf of the Leamington branch: $4,200 rent for the first fifteen months $20 per week for sundry expenses $90 per week for staff salaries $1,750 per month for the Branch Managers salary 10% of salaries to a pension fund for staff and manager (6) Staff were entitled to a commission of 1% of sales revenue. The manager did not share in this (7) No inventory was lost or damaged during 2006. REQUIRED (a) Prepare the following Accounts, in respect of the Leamington branch of Banbury, for the year ended 31 December 2006, as they would appear in the head office books: (i) Branch Inventory (ii) Branch Inventory Adjustment (iii) Branch Income Statement .

(18 marks) (2 marks) (Total 20 marks)

(b) State two reservations that you might have about the arrangements for the commission.

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MODEL ANSWER TO QUESTION 6 (a) * (1000 x 30) + (240 x 25)

Goods sent to branch (1,200 x .90 x 120) Branch Inventory adjustment (1,200 x .90 x 30) Goods sent to branch (400 x .80 x 100) Branch inventory adjustment (400 x .80 x 25)

1 1 1 1

Branch Inventory Branch Inventory Branch Inventory Income Statement Closing balance (60 x 25)

Branch inventory adjustment account $ 1,800 Branch Inventory 1,000 Branch Inventory 100 36,000* 1,500 ______ 40,400

Branch Inventory account $ Receivables/Bank (1,000 x 150) 129,600 Receivables/Bank (240 x 125) 32,400 Goods sent to branch (60 x 120) 32,000 Branch inventory adjustment (60 x 30) 8,000 Goods sent to branch (40 x 100) Branch inventory adjustment (40 x 25) Income Statement (1,080 1,000 60)(120 100) Branch inventory adjustment (20 x 20 x .25) ______ Closing balance (1,080 + 320 1,240 100)(125) 202,000

$ 150,000 30,000 7,200 1,800 4,000 1,000 400 100 7,500 202,000 $ 32,400 8,000

______ 40,400

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QUESTION 6 CONTINUED Branch Income Statement Account $ Branch inventory written down Rent (4,200 x 12/15) Sundry expenses (20 x 52) Staff salaries (90 x 52) Managers salary (1,750 x 12) Pension fund (25,680 x .10) Commission (180,000 x .01) Net profit (b) Reservations about commission seems strange to exclude manager, who bears the most responsibility for the success, or otherwise, of the branch staff are rewarded, even if the net profit is poor (or even a loss) is 1% sufficient to motivate? 1 400 3,360 1,040 4,680 21,000 2,568 1,800 1,152 36,000 Branch inventory adjustment $ 36,000

36,000

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Education Development International plc 2007