Mark Scheme GCE A Level Accounting (6002) June 2006

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Mark Scheme

ACCOUNTING 6002, MARK SCHEME

Question 1 (a) Larnaca Limited

Profit and loss account for year ended 31 March 2006 Working Working Turnover 900000 W1

Cost of sales* 560751 Admin Exps

Gross profit 339249 OF R of Auditors 800

Administrative expenses* W1 OF 145100 R of Directors 32000

Selling and distribution costs 68000 213100 Office Exps 74800 126149 Depr on Prem 12000 Interest payable* W2 OF 2800 Depr on Mach 25500 Profit on ordinary activities before tax OF 123349 145100 Corporation tax 11000 W2 Profit on ordinary activities after tax OF 112349 Interest payable Dividends 10000 Int on Loan S 800 Retained profit for the year OF 102349 Int on Debs 2000

2800 Retained earnings brought forward 19000 Retained earnings for the year 102349 Retained earnings carried forward OF 121349 20x =10 marks

Balance Sheet at 31 March 2006 W3 Shop at cost 180000

Fixed Assets -prov for depr 72000

OF

Tangible 108000 Leasehold workshop* W3 OF 108000 W4

Machinery* W4 OF 117500 225500 Machinery 160000

+additions 10000 Current Assets -prov for depr -52500 Stock 86000 117500 Prepaid expenses 700 Debtors 95200 W5 Cash at bank 25789 207689 OF Creditors 50500 Accruals 5340 Creditors -amounts falling due within 1 year Corp Tax 11000 Creditors W5 OF 76840 Prop Dividend 10000 Net current assets OF 130849 76840

Total assets less current liabilities OF 356349

(no if incorrect headings for cl and ltl)

Creditors -amounts falling due after more than 1 year 8% Debenture stock 25000 8% Loan stock 10000 35000 321349

Financed by: Capital and reserves: Share capital 200000 Retained earnings OF 121349 20x=10 marks 321349

(b) Assess the value to Larnaca Limited of retaining profits at the end of its financial year.

Up to 12 available in total. Award up to 6 for reasons for retaining profits Award up to 4 for reasons for alternatives to retaining profits (share dividend) Award up to 2 for conclusion Reasons for retaining profits To provide funds for the growth of the company To provide for the replacement of fixed assets To provide for dividends in the future if in a given period there are not enough profits Can be used to issue bonus shares Award up to 2 for a relevant pointmax 3 points and max 6 Reasons for alternative...i.e. paying share dividend To reward shareholders for investing in firm To encourage further investment by shareholders Award up to 2 for a relevant pointmax 2 points and max 4 Conclusion Award up to 2 for an appropriate conclusionmust be related to Larnaca Ltd Example Larnaca Ltd is in a position both to retain profits for the reasons given above and to distribute dividend . I would advise taking a middle line between the two so that the shareholders are satisfied with both the present (in terms of dividend) and the future (in terms of investment from retained profits) Total 12 = 6 marks Total 26 marks

Total 14

(a) + (b)

Question 2 (a) In the books of Sun Ltd

Realisation Account Jan 1 Buildings 70000 c Creditors 4600 c

Machinery 20000 c SunLand Ltd (PP) 148000 OF

Stock 2300 c Debtors 1500 c Bank 18800 c

Sundry Shareholders (Pr on Rls) 40000 0F

15260

0 152600

Sundry Shareholders Account Jan 1 SunLand Ltd

148000 Share Capital 100000 c

Profit/loss 8000 c

Realisation (Profit) 40000 OF

14800

0 148000

Calculation of Purchase Price

Sun Ltd Land Ltd

Goodwill 20000 14000 c Buildings 90000 Machinery 20000 80000 c Vehicles (40 000 - 3 800) 36200 c Stock 2300 21000 c Debtors 1500 14050 c Bank (12 000 + 3 000) 18800 15000 c 152600 180250 Less Creditors 4600 3450 c PURCHASE PRICE 148000 176800 0F

Shares issued at 50p each 296000 353600 OF

10 x = 5 marks Double PP

Total shares 649600

(c)

Total 16

(d) Sunland Limited intends to raise 200 000 for investment. The intention is to issue 160 000 ordinary shares at a premium of 75p per share or issue 200 000 1 6% Redeemable Debentures. Evaluate the relative strengths of each method and recommend an appropriate course of action. Up to 12 available in total Award max 6 for relative strengths of ordinary shares Award max 6 for relative strengths of debentures Overall max 10 Award up to 2 for conclusion Relative strengths of Ordinary shares In comparison to debentures there is no necessary charge on the firm since ordinary dividend is an appropriation of profit (and need not be made) rather than a charge like debentures There is no need to repay the share holders (unlike debenture holders) at some time in the future Relative strengths of Debentures Since debentures do not carry a vote ..there is no possible loss of control for the Directors (unlike with ordinary shares) Debentures can be considered more secure than ordinary shares because debenture holders will be repaid before ordinary shareholders Debentures may be secured on the fixed assets again giving greater security in the event of winding up Conclusion Up to 2 for an appropriate conclusion selecting and justifying a course of action. 12 = 6 marks Total 26 marks

Balance Sheet of SunLand Limited at 1 January 2006 Fixed Assets of(nc) Buildings 90000 c Machinery 100000 c Vehicles 36200 c Goodwill 34000c 260200 OF Current Assets of(nc) Stock 23300 c Debtors 15550 c

Bank 33800 c 72650 OF

Less Current Liabilitiesof(nc) Creditors 8050 c Net Current Assets 64600 OF 324800 Financed by Share Capital 649 600 shares of 50 p each 324800 OF

Question 3

(a)

Application and Allotment Account Apr 15 Ord Sh Cap 37500 Apr 15 Bank 50000 Apr 20 Bank 5000 Apr 30 Bank 67500 Apr 30 Ord Sh Cap 75000 117500 117500

Ordinary Share Capital Mar 31 Balance c/d 595000 Apr 1 Balance b/d 100000 Apr 15 Applic/Allotm 37500 combine Apr 30 Applic/Allotm 75000 is OK May 1 First & F Call 37500 Nov 14 Bank 250000

Dec 1 Bonus dividend 95000 OF

595000 595000 Apr 1 Balance b/d 595000 OF

Share Premium Dec 1 Bonus Shares 95000 OF Apr 1 Balance b/d 20000 cash/bank OK May 1 First & F Call 75000 95000 95000

First and Final Call May 1 Ord Sh Cap 37500 May 31 Bank 112500 May 1 Share Prem 75000 112500 112500

Bonus Shares Account

Dec 1 Ord Sh Cap 95000 Dec 1 Share Prem 95000

OF 2 for all dates correct OF

28 =14 marks

(b) Show your calculation of the dividend payable on the ordinary shares for year ended 31 March 2006. 10% of ord share capital held for 1 Yr % Divi Dividend Ordinary share capital held for one Year 250000 0.1 25000

Rights and Bonus shares 345000 0.05 17250 OF

T O T A L 42250 OF

6 = 3 marks

(c) Give the entries required (in journal form) Dr Cr Mar 31 P/L Appropriation 42250 OF Ord Share Divi 42250 OF Being provision of Ordinary share dividend Mar 31 Ord Share Divi 42250 OF Bank 42250 OF Being payment of ordinary share dividend 6 = 3 marks

(d) Assess the value to Paphos Limited of issuing bonus shares Up to 12 available here in total Award up to 3 for each strengths of bonus shares (max 2 points and 5) Award up to 3 for each limitations of bonus shares (max 2 points and 5) Award up to 2 for conclusion ...overall statement on value to Paphos Some acceptable points are given below Issuing bonus shares capitalises (turns into permanent capital) reserves that may have built up but no extra cash flows into the company ..so the shareholders are no better off Indeed the market value of the shares may fall because the companys net assets are now spread among a greater number of shares. Issuing bonus shares can be a useful way of utilising capital reserves which cannot be used to fund dividend payments. Conclusion In a rapid growth situation Paphos may have a compelling need to receive and use cash to finance expansion. At this time a bonus issue probably has limited value 12 = 6 marks Total marks 26

(b) Plan 1 ..Sales needed to maintain profits at 540 000 Selling price reduced to 27, so contribution reduced to 15 OF To maintain profits, total contribution needs to stay at 900 000 So 900 000 divided by 15 gives the number of units that must be sold

900 000 is 60 000 OF 15 OF

(b) Plan 2 ..Sales needed to maintain profits at 540 000 Selling price increased to 33, so contribution increased to 21 OF To maintain profits, total contribution needs to stay at 900 000 So 900 000 divided by 21 gives the number of units that must be sold

900 000 is 42 857 OF 21 OF

(b) Plan 3 ..Sales needed to maintain profits at 540 000 Fixed Costs reduced by 160 000 OF means contribution now needs to be 740 000 OF But variable costs increased by 6 per unit ..so new contribution is 12 OF per unit So 740 000 divided by 10 gives the number of units that must be sold

740 000 is 61 667 OF 12 OF

14 x = 7 marks

Question 4 (a) BEP

= Fixed Cost Contribution

BEP = 360 000 30 - 12 360 000 18

BEP = 20,000 OF Calculation of Profit Total Contribution 50 000 x 18 900 000 OF less Fixed Costs 360 000 PROFIT 540 000 OF 6 x = 3 marks

(c) BEP for Plan 3

BEP = Fixed Costs Contribution

BEP = 200 000 30 - 18 200 000 12

BEP = 16,667 OF The BEP for Plan 3 is lower than the original situation OF 6 x = 3 marks

(d) Explain, giving one limitation, which plan Georgio should follow to maintain current profit level Up to 6 available here in total Award up to 3 for clear reason why a named plan should be followed Award up to 3 for a well argued limitation Example Plan 2 would be the easiest to achieve because less items need to be sold to reach the required profit level The most telling limitation is the reliance on actually selling this quantity at the raised price. Break even analysis assumes this and this may not be realistic. I really would need to know about the demand for the product before proceeding 6 x = 3 marks Total 16 marks

Question 5

Sylett Supplies Cash Budget for 2 months Ended 30 September 2006 August September Receipts Sales 21000 15250 Dividend from investment 2000 Total Receipts 21000 17250 Payments Purchases 17000 13000 Wages 3600 3500 Expenses 2800 3200 Interim dividend 5000 Total 23400 24700 Balance b/d 1000 -1400 Receipts less Payment -2400 -7450

Balance c/d -1400 OF -8850 0F

14 = 7 marks

(b) Using the cash budget, indicate whether Sylett Supplies Ltd will be in a position to pay the interim dividend. Sylett supplies will not OF be in a position to pay the interim dividend because if it does so it will be overdrawn on cash by 8850 according to the cash budget given above OF 2 x = 1 mark

(c) Forecast Profit for 2 months ended 30 September 2006 Sales (15000 + 7000) 32000 less expenses Purchases (12000 + 14000) 26000 Wages (3200 + 3600) 6800 Expenses (2800 + 3200) 6000 38800 add dividend from investment 2000 Net Loss -4800 of(nc) 10 x = 5 marks

(d) Assess the value of cash budgets as a decision making aid Up to 6 available here in total Award up to 2 for point in favour of cash budgets Award up to 2 for limitation Award up to 2 for conclusion Example Cash budget is an organised way to estimate cash to be received and spent, it gives a definite and clear indication of the availability of cash at monthly stages in the future Of course the quality of the information is dependent on the quality of the estimates and this is the downside of any budget it is not a crystal ball Overall I feel the cash budget is an excellent tool providing great care is taken over estimates and its limitations are understood 6 x = 3 marks Total 16 marks

Question 6 (i) Calculate the earnings per share Earnings per share = Net profit attributable to ordinary shareholders Number of ordinary shares issued

1136 - 360 16 000

4.85p of

(ii) Calculate the price earnings ratio Price earnings ratio = Market price Earnings per share

64p 4.85p (OF)

13.2 of

(iii) Calculate the dividend yield Dividend yield = Dividend per share Market price per share

800/16 000 (or 5p) 64p 7.8% must be percentage

(iv) Calculate gearing Gearing = Prior charge capital Total capital

9 000 x 100

19 060 of

47.2% of

(Also accept Equity: fixed interest .fixed interest/Equity and reserves)

16 = 8 marks

(b) Commenting on the price earning ratio, dividend policies, and gearing advise Andreas in which company to invest. Up to 4 for each appropriate comment made on each of the 3 elements max 12 Award 1 for decision based on comments Award up to 3 for summarising giving a conclusion Total 16 = 8 marks Example P/E Ratio The p/e ratio shows that investors have more confidence in the management and prospects of Athena plc The chances are, therefore, that this confidence will translate into more improvement in the price of shares in Athena plc Dividend policy Athena plc is pursuing a more prudent and sustainable dividend policy. While earning 6.4p per share, it is paying a dividend of only 4.5 p per share. As the dividend cover ratio shows, it will be able to maintain this level of dividend. Thessaloniki plc on the other hand is earning 4.85p per share and paying a dividend of 5p per share. Even at current levels of earnings its dividend policy is not sustainable Gearing Athena plc is not geared at all. Thessaloniki plc is significantly geared (though not highly geared). Any downturn in performance will, therefore, have a more than proportionate impact on the amounts available to ordinary shareholders in Thessaloniki plc. Total 12 = 6 marks Decision and Conclusion My comments indicate that on the basis of these three ratios Andreas should invest in Athena plc The p/e ratio is higher, the dividend per share, although lower, is sustainable and the gearing protects the ordinary shareholder against a downturn in profits Total 4 = 2 marks Question total 16 marks

Question 7 (a) Distinguish between each of the following investment appraisal methods: (i) payback period; (ii) accounting rate of return. Award up to 3for acceptable definition Example (i) payback period is the amount of time it takes to recover or receive the income in cash required to match the amount spent on the investment (ii) accounting rate of return is the average profit expressed as a percentage of the capital invested in the project 6 x = 3 marks

(c) Calculate the net present value of the replacement machine Net cash flow Disc Factor Present Value Yr 0 -100000 1 -100000 2007 30000 0.926 27780 2008 54000 0.857 46278 2009 51000 0.794 40494

Net Present Value 14552

c ..of(nc) ()

6 x = 3 marks

(b) Calculate the net cash flows of the replacement machine Cash inflow Cash outflow Net Cash Flow 2007 105000 75000 30000 of 2008 144000 90000 54000 of 2009 153000 102000 51000 of 8 x = 4 marks

(d) Evaluate whether Singh Limited should purchase the machine Up to 6 available here in total Award up to 2 for point in favour of investment Award up to 2 for limitation Award up to 2 for conclusion Example From the financial point of view the net present value indicates a return on investment significantly in excess of the 8% cost of capital faced by Singh Ltd. There may be non financial factors to take into account e.g. displacement of labour Overall it would depend on the policy of Singh Limited and how this decision fitted in with its overall strategy (e) (i) State how the net present value could be used to find the internal rate of return of purchasing the cutting machine. If the net present value were 0 instead of 14 552then the exact return on the investment would have equalled the chosen discount rate (8%) The exact rate is known as IRR. Since NPV is higher than 0 the IRR must be higher than 8% . It is possible to estimate the IRR by deciding how much above 0 the return is and expressing this as a percentage (ii) Why would the internal rate of return be more valuable to Singh Limited than the net present value? It is more precise 6 x = 3 marks Acceptable definitions for Accounting Rate of Return Main one Average Annual profit Average investment (Op +Closing/2)

Others Estimated total profit Estimated initial investment

Gearing = Estimated Average Profit Estimated initial investment

It is key that Accounting rate of return is about profit not cash