Accounting

Level 3

Model Answers
Series 2 2008 (Code 3012)
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Accounting Level 3
Series 2 2008

How to use this booklet

Model Answers have been developed by Education Development International plc (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.

© Education Development International plc 2008

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3012/2/08/MA Page 1 of 14
3012/2/08/MA Page 2 of 14
QUESTION 1

Dean Ltd does not have control accounts for debtors or creditors and does not have a cost of goods
sold account. The draft accounts for the year ended 31 March 2008 show a gross profit of £79,380
and a net profit of £51,270. The auditors have discovered the following errors:
(1) Closing stock valued at £21,700 had been recorded in the books at £27,100

(2) No entry had been made in respect of a cheque for £375, found in a drawer, representing a bad
debt recovered

(3) Selling expenses of £382 had been included in motor expenses

(4) A sales invoice for £742 had not been recorded, but had been sent to the debtor, who had yet to
pay

(5) Accrued light and heat of £237 had been recorded as a prepayment

(6) No entry had been made in respect of the sale of a car for £300. The car was included in the
books at cost, £6,700, and had a net book value of £340. The purchaser had yet to pay.

REQUIRED

(a) Prepare Journal entries (without narratives) correcting the above errors. (12 marks)

(b) Prepare a statement showing the adjustment of gross profit and a statement showing the
adjustment of net profit, as a result of the corrections made in (a) above.
(8 marks)

Bad Debts Account normally includes a transfer to the debit side of the Profit and Loss Account in
respect of bad debts expense.

REQUIRED

(c) Describe the circumstances in which there would be a transfer from the Bad Debts Account to the
credit side of the Profit and Loss Account.
(5 marks)

(Total 25 marks)

3012/2/08/MA Page 3 of 14
MODEL ANSWER TO QUESTION 1

(a)
£ £
(1) Stock (Trading Account) (27,100 – 21,700) 5,400
Stock (Balance Sheet) 5,400

(2) Debtor 375

Bad Debts 375
Cash 375
Debtor 375

(3) Selling Expenses 382

Motor Expenses 382

(4) Debtor 742

Sales 742

(5) Light and Heat 474

Accruals 237
Prepayments 237

(6) Debtor 300

Fixed Assets Disposal 300
Fixed Assets Disposal 6,700
Car – cost 6,700
Accumulated Depreciation on Car 6,360
Fixed Assets Disposal 6,360
Profit and Loss (340 – 300) 40
Fixed Assets Disposal 40

(b) £
Original Gross Profit 79,380
(1) Less Stock over-valued 5,400
73,980
(4) Add Sales omitted 742
Adjusted gross profit 74,722

(c) +£ -£ £
Original Net Profit 51,270
(1) Stock over-valued 5,400
(2) Bad debt recovered 375
(4) Sales omitted 742
(5) Light and heat 474
(6) Loss on disposal of car 40
1,117 5,914 -4,797
Adjusted net profit 46,473

(d) Bad Debts Account can include the increase or decrease in the provision for bad debts as well
as bad debts written off and bad debts recovered.

Where bad debts recovered/decrease in provision exceed bad debts written off/increase in provision
then there will be a transfer to the credit side of the Profit and Loss Account.

3012/2/08/MA Page 4 of 14
QUESTION 2

Yarm makes model trains in a small factory. Each train requires materials costing £8 and takes two
hours to make. Direct labour costs £6 per hour and variable overheads cost £1.50 per hour. The
fixed costs of operating the factory are £6,000 per month and the trains are sold to a single wholesaler
for £48 each.

REQUIRED

(a) Calculate Yarm’s monthly breakeven point in units and in sales revenue. (7 marks)

(b) Calculate the sales required, in units and in sales value, for Yarm to make a monthly profit of
£12,000.
(3 marks)

Yarm is considering using a higher grade of materials costing £10 per train. If he does this, each train
will only take one hour to make but direct labour cost will increase to £8 per hour and variable
overheads will be £2 per hour. The fixed costs of operating the factory will remain the same, but Yarm
will be able to charge the wholesaler £50 per train.

REQUIRED

(c) Calculate Yarm’s revised monthly breakeven point in units and in sales value. (8 marks)

(d) Calculate the revised sales required, in units and in sales value, for Yarm to make a monthly
profit of £12,000.
(3 marks)

Yarm currently sells all his model trains to a single wholesaler.

REQUIRED

(e) State one advantage and one disadvantage of this arrangement for Yarm. (4 marks)

(Total 25 marks)

3012/2/08/MA Page 5 of 14
MODEL ANSWER TO QUESTION 2

(a)
Contribution per unit = Selling price – variable cost per unit
£ £
Selling price 48
Materials 8
Direct labour (2 x 6) 12
Variable overhead (2 x 1.5) 3 23
25

Breakeven point (units) = Fixed costs ÷ Contribution per unit

6,000 = 240 units

25

240 x 48 = £11,520 revenue

(b) 6,000 + 12,000 = 720 units

25

720 x 48 = £34,560 revenue

(c) £ £
Selling price 50
Materials 10
Direct labour (1 x 8) 8
Variable overhead (1 x 2) 2 20
30

6,000 = 200 units

30

200 x 50 = £10,000 revenue

(d) 6,000 + 12,000 = 600 units

30

600 x 50 = £30,000 revenue

(e) Advantage - selling and administrative costs are minimised

Disadvantage - totally reliant on one customer

3012/2/08/MA Page 6 of 14
QUESTION 3

Frant Ltd is about to make an offer to the shareholders of Worle Ltd. The share capital of Worle Ltd
consists of 700,000 shares of £0.75 each. Frant Ltd wishes to take over the whole company and
considers it to be worth £1,400,000. Three methods of purchasing the shares are being considered:
METHOD A: making a cash offer of £2.00 per share in Worle Ltd

METHOD B: offering 5 shares in Frant Ltd (nominal value £1.25) for every 7 shares in Worle Ltd

METHOD C: offering 3 shares in Frant Ltd and £5.60 in secured 10% Debentures for every 7
shares in Worle Ltd.

Worle Ltd’s Balance Sheet comprises tangible fixed assets of £600,000, current assets of £260,000
and total liabilities of £80,000. Frant Ltd’s professional advisors value the tangible fixed assets at
£750,000 and the current assets at 80% of their balance sheet value. The 10% Debentures in Frant
Ltd would be secured on Frant Ltd’s land and buildings.

REQUIRED

(a) Prepare Journal entries, without narratives, in the books of Frant Ltd to record the purchase of
shares in Worle Ltd for each of the three methods being considered.
(9 marks)

(b) Calculate the amount of goodwill arising on the proposed acquisition of Worle Ltd for inclusion in
the consolidated Balance Sheet of Frant Ltd.
(4 marks)

(c) Briefly explain the significance to the debenture holders of the Debentures being secured on land
and buildings.
(4 marks)

Frant Ltd has forecast the group results for the two years following the year of acquisition. They show
debenture interest being paid in full and a dividend of £0.05 per share in the first year and a dividend
of £0.08 per share in the second year.

REQUIRED

(d) Calculate the expected total cash receipts that the former shareholders in Worle Ltd can expect to
receive from Frant Ltd for each of Methods A, B and C in each of the two years following the
takeover.
(8 marks)

(Total 25 marks)

3012/2/08/MA Page 7 of 14
MODEL ANSWER TO QUESTION 3

(a)
£ £
A Investment in Worle Ltd (2 x 700,000) 1,400,000
Bank 1,400,000
B Investment in Worle Ltd 1,400,000
Ordinary Shares [ (5 x 700,000 ÷ 7) (1.25) ] 625,000
Share Premium (R) 775,000
C Investment in Worle Ltd 1,400,000
10% Debentures (5.60 x 700,000 ÷ 7) 560,000
Ordinary Shares (625,000 x 3 ÷ 5) 375,000
Share Premium (R) 465,000

(b)
£ £
Cost of Investment in Worle Ltd 1,400,000
Less Value of Investment: Tangible fixed assets 750,000
Current assets (0.8 x 260,000) 208,000
958,000
Total liabilities 80,000 878,000
Goodwill 522,000

(c) When debentures are secured on land and buildings they cannot be sold without the consent of
the debenture holders. If the company defaults, on either interest payments or the repayment of
the loan, the debenture holders may appoint a receiver, who, if necessary will sell the land and
buildings to recover the outstanding interest/loan.

(d)
Year 1 Year 2
£ £
A Payment in cash NIL NIL
B (500,000 x .05) (500,000 x .08) 25,000 40,000
C (560,000 x .10) + (300,000 x .05) 71,000
(560,000 x .10) + (300,000 x .08) 80,000

3012/2/08/MA Page 8 of 14
QUESTION 4

On 1 January 2008 the balance on the Sales Ledger Control Account of Upway was equal to the total
of the following balances:
£
Frome 3,147
Bruton 563
Castle 2,142
Cary 516

During January 2008 the following occurred:

(1) Credit Sales: £
Cary 426
Bruton 1,526
Castle 516
Maiden 1,427

(2) Cash received from Debtors: £

Frome 257
Bruton 1,846
Maiden 917

(3) Cary was unable to pay his debt. A specific provision for bad debts of £300 in respect of his debt
had been made on 31 December 2007.

(4) Frome also sells goods to Upway and it was agreed the £747 of Upway’s debt to Frome be
settled by contra.

REQUIRED

(a) Prepare the Sales Ledger Control Account of Upway for January 2008. (7 marks)

(b) Calculate Upway’s bad debts expense for January 2008. (2 marks)

(c) Give one reason for concern about Upway’s credit control procedures. (2 marks)

Grays has been in business for many years. On 1 January 2008 he had 200 units of Y in stock,
valued at £5,600. During January 2008 the following transactions took place relating to Y:
Purchases January 8 200 units for a total cost of £6,000
January 12 150 units for a total cost of £4,950
January 15 100 units for a total cost of £3,400

Sales January 11 300 units for £54 each

January 24 200 units for £55 each

Grays values stock on a first in first out basis.

REQUIRED

(d) Calculate Grays’ gross profit on sales of Y for January 2008. (7 marks)

3012/2/08/MA Page 9 of 14
QUESTION 4 CONTINUED

(e) Calculate, to the nearest £, the value of Grays’ stock of Y at 31 January 2008, had he used the
periodic weighted average cost basis assuming a period of one month.
(3 marks)

(f) Name, and briefly explain, two other bases of stock valuation, acceptable under SSAP 9, which
might have been used by Grays for valuing Y.
(4 marks)

(Total 25 marks)

3012/2/08/MA Page 10 of 14
MODEL ANSWER TO QUESTION 4

(a)
Sales Ledger Control Account
£ £
Balance b/f 6,368 Cash 3,020
(3,147 + 563 + 2,142 + 516) (257 + 1,846 + 917)
Sales 3,895 Bad debts 942
(426 + 1,526 + 516 + 1,427) (516 + 426)
Contra 747
Balance c/f 5,554
10,263 10,263

(b)
£
Cary – Balance at 1 January 2008 516
Sales in January 2008 426
942
Less – Previous provision for bad debts 300
Bad debts expense for January 2008 642

(c) Despite there being an existing provision for bad debts in respect of Cary, further goods were
sold to him on credit in January 2008. (Any valid alternative acceptable)

(d)
£ £
Sales (300 x 54) + (200 x 55) 27,200
Less Cost of goods sold:
Opening stock 5,600
Purchases (6,000 + 4,950 + 3,400) 14,350
19,950
Closing stock* 5,050 14,900
∴ Gross profit 12,300
* units 200 + 200 + 150 + 100 – 300 – 200 = 150
last 150 purchased cost 3,400 + (1/3 x 4,950) = 5,050

(e)
5,600 + 6,000 + 4,950 + 3,400 = 19,950 = 30.69
200 + 200 + 150 + 100 650

∴ Stock value = 150 x 30.69 = £4,604

(f) Replacement cost – valued at the current cost of purchase

Standard cost – valued at a predetermined unit cost

Net realisable value – valued at estimated sales value less costs of disposal (used if less than
cost).

3012/2/08/MA Page 11 of 14
QUESTION 5

Following are the most recent Balance Sheets of Prees plc:

At 31 December 2006 At 31 December 2007
£000 £000 £000 £000 £000 £000
Fixed Assets (net book value) 800 1,100
Current Assets
Stock 231 174
Debtors 110 93
Bank 60 70

Creditors: Amount due within 401 337

one year
Creditors 80 58
Dividends 50 130 52 110
Net Current Assets 271 227
1,071 1,327
Creditors: Amounts due after
more than one year
10% Debentures 300 500
771 827

£000 £000
Capital and Reserves
Ordinary Shares of £1 each 400 550
Share Premium 150 -
General Reserve - 60
Profit and Loss 221 217
771 827

During 2007 fixed assets were purchased for £450,000 and fixed assets with a net book value of
£107,000 were sold for £81,000.

The financing transactions, reflected above, all took place on 1 January 2007. An interim dividend of
£14,000 was paid in 2007.

REQUIRED

(a) Calculate the operating profit for the year ended 31 December 2007.
(5 marks)

(b) Prepare a statement reconciling operating profit to net cash inflow/outflow from operating
activities.
(7 marks)

(c) Prepare the Cash Flow Statement of Prees plc for the year ended 31 December 2007 in
accordance with FRS 1 (revised).
(7 marks)

3012/2/08/MA Page 12 of 14
QUESTION 5 CONTINUED

The Managing Director of Prees plc has stated that the primary aims of the company in 2008 will be to
increase profits through higher sales and to improve the cash position.

REQUIRED

(d) Other than through increased profits, state six ways in which Prees plc could improve its cash
position during 2008.
(6 marks)

(Total 25 marks)

3012/2/08/MA Page 13 of 14
MODEL ANSWER TO QUESTION 5

(a)
Prees plc – Operating Profit 2007 £000
Change in Profit and Loss Account (217 – 221) (4)
Transfer to General Reserve Account 60
Interim dividend 14
Final dividend 52
Debenture interest (0.10 x 500) 50
172

(b)
Prees plc – Reconciliation of Operating Profit To Net Cash £000
Inflow/Outflow from Operating Activities
Operating profit (as in (a) above) 172
Loss on sale of fixed assets (107 – 81) 26
Depreciation of fixed assets [(800 + 450 – 107) – 1,100] 43
Decrease in stock (231 – 174) 57
Decrease in debtors (110 – 93) 17
Decrease in creditors (80 – 58) (22)
293

(c)
Prees plc – Cash Flow Statement for the year ended 31 December 2007
£000 £000
Net Cash Flow from Operating Activities 293
Returns on Investment and Servicing of Finance
Debenture interest (50)
Capital Expenditure and Financial Investment
Sale of fixed assets 81
Purchase of fixed assets (450) (369)
Equity Dividends Paid (50 + 14) (64)
Net Cash Outflow before Financing (190)
Financing
Issue of 10% Debentures (500 – 300) 200
Increase in Cash and Cash Equivalents (70 – 60) 10

(d) Ways of Improving Cash Position During 2008

Reduce stock
Reduce debtors
Delay payments to creditors
Reduce or don’t pay dividends
Sell fixed assets
Issue more debentures
Issue more shares
Lease fixed assets instead of buying

3012/2/08/MA Page 14 of 14 © Education Development International plc 2008