LCCI International Qualifications

Accounting (IAS)
Level 3

Model Answers
Series 2 2010 (3902)

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Accounting (IAS) Level 3
Series 2 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) 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 2010

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system or
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Page 1 of 15
QUESTION 1

Some categories of accounting error do not cause trial balance totals to disagree.

REQUIRED

(a) Name three categories of accounting error which do not affect the balancing of a trial balance, and
give an example for each category.
(6 marks)

Kuyt, a sole trader, has balanced his trial balance at 31 December 2009, after preparing his income
statement for the year ended 31 December 2009. Extracts from this trial balance are as follows:

$000
Capital (less drawings) 241
Non-current assets (net book value) 121
Trade receivables (less provision) 98
Trade payables 41
Inventory 14

The following errors have now been discovered:

(1) Kuyt paid himself a salary of $500 a month and charged it to wages.

(2) Closing inventory included an item costing $800 which Kuyt believes can now only be sold for
$300. Selling costs of $20 would also have to be incurred.

(3) Bad debts of $5,000 should have been written off and the bad debt provision of 2% should have
been provided at 5%.

(4) Motor expenses of $820 had been recorded as selling expenses.

(5) Non-current assets, with a net book value of $8,000, were taken by Kuyt for his personal use. This
had not been recorded.

(6) Depreciation for the year had not been provided. Kuyt’s policy is to charge depreciation at 10%
on the net book value of the non-current assets held at the year end.

REQUIRED

(b) Prepare Journal entries (without narratives) to record the correction of the above errors.
(12 marks)

(c) Calculate the change to net profit resulting from the correction of the errors.
(4 marks)

(d) Calculate the revised balance on Kuyt’s Capital Account resulting from the correction of
the errors.

(3 marks)

(Total 25 marks)

3902/2/10/MA Page 2 of 15
MODEL ANSWER TO QUESTION 1

(a) Error of omission e.g. forgetting to charge depreciation.

Error of original entry e.g. sales of $1,000 recorded in the sales day book as $100.
Error of commission e.g. sales on credit to D Jones recorded in A Jones Account.
Error of principle e.g. recording $1,000 of non-current asset purchases in Repairs Account.
Compensating errors e.g. recording wages to X at $100 too much and wages to Y at
$100 too little.

(b) Journal Entries

$ $
DR CR
(1) Capital (500 x 12) 6,000
Wages expense 6,000
(2) Inventory (trading account)[800 – (300 - 20)] 520
Inventory 520
(3) Bad debts expense 5,000
Receivables 5,000
Bad debts expense (W1) 2,750
Provision for bad debts 2,750
(4) Motor expenses 820
Selling expenses 820
(5) Capital 8,000
Non-current assets 8,000
(6) Depreciation expense [(121,000 - 8,000) ÷10] 11,300
Non-current assets 11,300

W1 Receivables before bad debt and provision

(98,000 x 100/98) 100,000
Bad debt 5,000
95,000
Increase in provision [(0.05 x 95,000) – (100,000 – 98,000)] $2,750

(c) Change in net profit $

Wages 6,000
Inventory (520)
Bad debts (5,000)
Bad debts (2,750)
Depreciation (11,300)
(13,570)

(d) Revised Capital $

Per trial balance 241,000
Change in net profit (13,570)
Wages/drawings (6,000)
Non-current assets/drawings (8,000)
213,430

3902/2/10/MA Page 3 of 15
QUESTION 2

Basso and Carey are in partnership sharing profits/losses equally. At 31 December 2009 their
Trial Balance was as follows:

$000 $000
DR CR
Capital - Basso 242
- Carey 191
Land and buildings – cost 300
– accumulated depreciation 60
Plant and machinery – cost 120
– accumulated depreciation 65
Inventory 90
Trade receivables 140
Trade payables 50
Bank overdraft 42
650 650

The partnership sells toys and Orr has expressed an interest in joining Basso and Carey in business.
Orr has extensive knowledge of the toy industry.

It was agreed to dissolve the partnership and transfer the business to a new company BCO, a private
company, on the following terms:

(1) all assets and liabilities of the partnership to be taken over at book value except land and
buildings, which would be re-valued at $400,000, and inventory, which would be written down by
$32,000.

(2) the share capital of the company would be 2,000,000 Ordinary Shares of $0.50 each.

(3) Basso and Carey would take shares, issued at a premium of $0.25 each, in settlement of their
capital accounts.

(4) Orr would spend $150,000 purchasing shares in the company, also issued at a premium of $0.25
each.

REQUIRED

(a) State what is meant by the term “issued share capital”.

(2 marks)

(b) Calculate the number of shares in BCO received by:

(i) Basso
(ii) Carey
(iii) Orr
(7 marks)

(c) Calculate the number of shares in BCO remaining unissued.

(2 marks)

(d) Prepare the Balance Sheet of BCO on 1 January 2010, before trading commenced.
(8 marks)

Many small businesses find it advantageous to operate their businesses as private companies.

REQUIRED

(e) Give four reasons why the partners might have wished to incorporate as a private company.

(6 marks)

(Total 25 marks)

3902/2/10/MA Page 4 of 15
MODEL ANSWER TO QUESTION 2

(a) Issued Share Capital

The number of shares a company has issued.
(2 marks)

(b) Number of shares received

(i) Basso (ii) Carey

$000 $000
Capital account 242 191
Surplus on land and buildings

[(400 – (300 – 60)) x 0.50] 80 80

Loss on inventory (32 x 0.50) (16) (16)

306 255

306,000 255,000
0.75 0.75
= 408,000 shares = 340,000 shares

(iii) Orr 150,000 = 200,000 shares

0.75

(c) Shares Remaining Unissued

2,000,000 – 408,000 – 340,000 – 200,000 = 1,052,000 shares

(d) BCO Balance Sheet at 1 January 2010

$000 $000
ASSETS

Non-current assets
Land and buildings 400
Plant and machinery (120 – 65) 55
455

Current assets
Inventory (96 – 32) 58
Receivables 140
Bank (150 – 42) 108
306
Total assets 761

EQUITY AND LIABILITIES

Capital and reserves

Ordinary shares of $0.50
[(408 + 340 + 200) x 0.50] 474

Share premium (948 x 0.25) 237

711
Equity
Current liabilities
Payables 50
761

3902/2/10/MA Page 5 of 15
QUESTION 2 CONTINUED

(e) Reasons for incorporation

Limited liability
Ease of raising finance
Flexibility of ownership
Taxation
Prestige

3902/2/10/MA Page 6 of 15
QUESTION 3

The Cash Flow Statement for Cole, a private company, for the year ended 31 December 2008 was as
follows:

Cash flows from operating activities $ $

Profit from operations 10,600

Adjustments for:
Depreciation 11,820
Profit on disposal of non-current assets (840)
10,980
Operating cash flow before movements in working capital 21,580
Increase in inventory (11,318)
Increase in receivables (6,790)
Increase in payables 5,600
(12,508)
Cash generated from operations 9,072

Interest paid (1,000)

Net cash from operating activities 8,072

Cash flows from investing activities

Purchase of non-current assets (35,256)
Sale of non-current assets 2,400
Net cash from investing activities (32,856)
(24,784)

Cash flows from financing activities

Equity dividends paid (7,894)
Issue of debentures 10.000
Net cash used in financing activities 2,106
Net decrease in cash (22,678)

During the year ended 31 December 2009:

(1) The profit from operations increased by 15%, after allowing for writing down obsolete inventory.

(2) Non-current assets with a net book value of $4,800 were sold at a profit of $800.

(3) Non-current assets purchased had a net book value of $9,000 at 31 December 2009. Non-current
assets are depreciated at 10% on cost with a full charge being made in the year of acquisition.

(4) The total depreciation charge was $400 higher than for 2008.

(5) Interest paid was the same as in 2008.

(6) Dividends paid were the final dividend for 2008 of $4,900 and an interim dividend for 2009
of $2,800. The final dividend proposed for 2009 was $5,100.

(7) No debentures were issued or redeemed, but a rights issue of shares raised $9,000. A
capitalisation (bonus) issue of 5,000 $1 shares was made.

(8) Inventory at the year end cost $12,714, an increase of $1,157 on the previous year end. However,
included in the inventory was obsolete inventory costing $1,200, which was expected to be sold for
$900.

(9) The receivables’ total has increased. Receivables at 31 December 2008 were $12,750, which was
85% of the total receivables at 31 December 2009.

(10) The payables’ total has decreased. Payables at 31 December 2009 were $12,000, which is 20%
lower than the total payables at 31 December 2008.

3902/2/10/MA Page 7 of 15
QUESTION 3 CONTINUED

REQUIRED

(a) Prepare, in the format given, the Cash Flow Statement of Cole for the year ended
31 December 2009. (21 marks)

Cash flow statements report cash inflows and cash outflows during an accounting period

REQUIRED

(b) Give two advantages of a cash flow statement over the other accounting statements.
(4 marks)

(Total 25 marks)

3902/2/10/MA Page 8 of 15
MODEL ANSWER TO QUESTION 3

(a)
$000 $000
Cash flows from operating activities
Profit from operations (10,600 x 1.15) 12,190

Adjustments for:
Depreciation (11,820 + 400) 12,220
Profit on disposal of non-current assets (800)
11,420

Operating cash flow before movements

in working capital 23,610
Increase in inventory [1,157 – (1,200 – 900)] (857)
Increase in receivables (12,750 x 15/85) (2,250)
Decrease in payables (12,000 x 20/80) (3,000)
(6,107)
Cash generated by operations 17,503

Interest paid (1,000)

Net cash from operating activities 16,503

Cash flows from investing activities

Purchase of non-current assets (9,000 x 10/9) (10,000)
Sale of non-current assets (4,800 + 800) 5,600
Net cash from investing activities (4,400)
12,103

Cash flows from Financing activities

Equity dividends paid (4,900 + 2,800) (7,700)
Issue of shares 9,000
Net cash used in financing activities 1,300
Net increase in cash 13,403

Presentation

(b) Advantages
There is little scope for manipulating the figures.
The figures are more objective.
The figures are easier to compare with previous years/other firms.

3902/2/10/MA Page 9 of 15
QUESTION 4

Obi is planning to start a business on 1 July 2010, making and selling umbrellas. He will provide
$5,000, in cash, as his initial capital on 30 June 2010.

Obi is going to budget on a quarterly basis, with each quarter consisting of 13 weeks. Production and
sales are expected to be as follows:

WEEKLY PRODUCTION WEEKLY SALES

UMBRELLAS UMBRELLAS
Quarter 1 – ending 30 September 2010 70 60
Quarter 2 – ending 31 December 2010 90 86
Quarter 3 – ending 31 March 2011 90 94
Quarter 4 – ending 30 June 2011 40 16

There will not be any partly completed umbrellas at the end of each quarter, and materials are
purchased as required.

Each umbrella will be sold for $30. 75% of each quarter’s sales will be received in that quarter with the
remaining 25% received in the following quarter.

The materials for each umbrella will cost $12 up to 31 December 2010 and $14 subsequently.
Payables for materials are expected to be $4,000 at 30 September 2010, rise by 2% at 31 December
2010, rise a further 10% on the 31 December 2010 figure at 31 March 2011, and fall to $4,200 at 30
June 2011.

Obi will do most of the work himself in his garage. However, when production exceeds 70 units per
week, he will employ Mikel to help him. Mikel will be paid a fixed wage of $60 per week, when he is
required.

On 1 July 2010, Obi will purchase manufacturing machinery costing $4,000. This will be depreciated at
2% per quarter on cost.

Other variable costs (50% of which will relate to production) are expected to be $6 per umbrella and
be paid weekly in cash.

Obi intends to use the FIFO basis of inventory valuation, for the 442 umbrellas he expects to be in
inventory at 30 June 2011. However, he is uncertain how to apply it, and decides to value them at $14
each.

REQUIRED

(a) Prepare, a quarterly cash budget, in columnar form for each of the four quarters to
30 June 2011, showing the cash balance at the end of each quarter.
(13 marks)

(b) Prepare, a budgeted Income Statement for the year ended 30 June 2011. You should value
closing inventory on the basis of the $14 decided by Obi.
(10 marks)

(c) Give two reasons why Obi’s valuation of $14 per umbrella is unacceptable for external reporting
purposes.
(2 marks)

(Total 25 marks)

3902/2/10/MA Page 10 of 15
MODEL ANSWER TO QUESTION 4

(a) OBI cash budget for the year ending 30 June 2011
Q1 Q2 Q3 Q4
$ $ $ $
Receipts
Sales (W1) 17,550 31,005 35,880 13,845
Payments
Materials (W2) 6,920 13,960 15,972 7,568
Labour (13 x 60) - 780 780 -
Non-current assets 4,000 - - -
Other variable costs (W3) 5,460 7,020 7.020 3,120
16,380 21,760 23,772 10,688
Opening balance 5,000 6,170 15,415 27,523
Receipts 17,550 31,005 35,880 13,845
22,550 37,175 51,295 41,368
Payments 16,380 21,760 23,772 10,688
Closing balance 6,170 15,415 27,523 30,680

(b) OBI Income Statement for the year ending 30 June 2011
$ $
Sales (23,400 + 33,540 + 36,660 + 6,240) (W1) 99,840
Less Cost of Sales:
Opening inventory -
Materials (10,920 + 14,040 + 16,380 + 7,280) (W2) 48,620
Labour (780 + 780) 1,560
Depreciation (4,000 x 0.02 x 4) 320
Other variable production costs

[(5,460 + 7,020 + 7,020 + 3,120) x 0.50] 11,310

61,810
Less Closing inventory (442 x 14) 6,188 55,622
Gross profit 44,218
Less Expenses 11,310
Net profit 32,908

(c) Obi’s inventory valuation is unacceptable because it should include:

(1) $3 per unit of other variable cost

a proportion of the depreciation charge.

3902/2/10/MA Page 11 of 15
QUESTION 5

The following information relates to Hart, a public company, a car manufacturer, for 2009:

Number of $1 Ordinary Shares in issue 1,000,000

Market price per share (31 December) $1.50
Price/earnings ratio 30
Net profit percentage 40%
Gross profit percentage 65%

REQUIRED

(a) Calculate the following amounts, in respect of Hart, for 2009:

(i) earnings per share

(ii) net profit
(iii) cost of goods sold
(iv) expenses
(8 marks)

The following information relates to Dunne, a public company, a supermarket chain, for 2009:

Receivables’ collection period 2 days

Sales $730,000,000
Payables’ settlement period 80 days
Purchases $511,000,000
Current ratio (31 December) 0.5 : 1
Bank (balance in hand at 31 December) $40,000,000
Opening inventory was equal to closing inventory
There were no current assets other than receivables, inventory and bank
There were no current liabilities other than payables.

REQUIRED

(b) Calculate the following amounts in respect of Dunne plc at 31 December 2009:

(i) receivables
(ii) payables
(iii) inventory
(6 marks)

(c) Calculate (to the nearest day) the inventory turnover ratio of Dunne for 2009.
(2 marks)

Elano, an investor, is considering purchasing shares in either Hart or Dunne and has asked the following
questions:

(i) in difficult economic times is it safer to invest in Hart, which makes cars, or in Dunne, which
sells mainly food?

3902/2/10/MA Page 12 of 15
QUESTION 5 CONTINUED

(ii) is Dunne’s current ratio of 0.5 : 1 a concern, as I have heard that a safe current ratio
should be at least 1 : 1?

(iii) does Hart’s high price/earnings ratio of 30 mean that it will take a long time to get my
money back in dividends? Does this ratio also mean that the company is not highly rated
by the stock market?

REQUIRED

(d) Answer each of Elano’s questions, in a way that a non-expert investor would understand.
(9 marks)

(Total 25 marks)

3902/2/10/MA Page 13 of 15
MODEL ANSWER TO QUESTION 5

(a) Hart plc 2009

(i) Price/earnings ratio = Price per share

Earnings per share

1.50 = 30 EPS = 1.50 = $0.05

Earnings per share 30

(ii) Net profit = 0.05 x 1,000,000 = $50,000

(iii) Cost of goods sold

50,000 x 100 = 40 Sales = 50,000 x 100

Sales 40

= 125,000 COGS = 125,000 (1.00 – 0.65) = $43,750

(iv) Expenses = 125,000 (0.65 – 0.40) = $31,250

(b) Dunne plc 31 December 2009

(i) Receivables 365 730,000,000 = 2

Receivables

Receivables = 2 x 730,000,000 = $4,000,000

365

(ii) Payables 365 511,000,000 = 80

Payables

Payables = 80 x 511,000,000 = $112,000,000

365

(iii) Inventory Inventory + 4,000,000 + 40,000,000 = 0.50

112,000,000

Inventory = 56,000,000 – 44,000,000 = $12,000,000

(c) Inventory turnover ratio

365 511,000,000 = 365 x 12,000,000 = 8.57 = 9 days

12,000,000 511,000,000

(d) (i) In difficult economic times Dunne would be regarded as the safer investment. People are
more likely to delay purchasing a car than they are to reduce their consumption of food.

3902/2/10/MA Page 14 of 15
QUESTION 5 CONTINUED

(ii) Dunne’s current ratio is unlikely to be a concern because supermarkets have:

(1) relatively low inventories, as food must turnover rapidly

(2) low receivables, as nearly all transactions are for cash
(3) high payables, as supermarkets have power over their suppliers, who are generally
smaller.

(iii) It is possible that a high price/earnings ratio is an indication that it will take a long
time to recover an investment.

However, the share price is based on anticipated future earnings and dividends, which are
likely to be higher than the current earnings upon which the ratio is based. For this reason,
the higher the ratio the higher the company is rated by the stock market.

3902/2/10/MA Page 15 of 15 © Education Development International plc 2010

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