2002 (P1)

Part A

Answer any TWO questions from this section. Each question carries 20marks.

  1. Luen Fook Ltd commenced its business on 1 January 1999. The following trial balance was extracted from its books of accounts on 31 December 2001:

$ / $
Leasehold property - net book value at 1 January 2001 / 4 750 00
Manufacturing machinery - net book value at 1 January 2001 / 2 700 000
Office equipment - net book value at 1 January 2001 / 420 000
Stocks at 1 January 2001;
Raw materials (10 000 units@ $25 each) / 250 000
Work in progress / 480 000
Finished goods / 720 000
Sales / 16 960 000
Purchase of raw materials / 2 340 000
Returns of raw materials / 60 000
Returns inwards / 260 000
Direct wages / 1 940 000
Direct manufacturing expenses / 648 000
Indirect manufacturing expenses / 518 000
Patent / 1 000 000
Administrative staff salaries / 2 920 000
Bad debts / 100 000
Utilities expenses / 450 000
Carriage inwards / 156 000
Carriage outwards / 284 000
Repairing of products under warranty / 150 000
Other operating expenses / 1 886 000
Provision for unrealized profit / 120 000
Trade debtors and trade creditors / 2 540 000 / 1 760 000
Bank / 258 000
Issued share capital / 4 500 000
Profit and loss account at 1 January 2001 / 370 000
8% debentures / 1 000 000
24 770 000 / 24 770 000

You are also provided with the following information:

(i)All the fixed assets were purchased on 1 January 1999 and will have no residual value at the end of their respective useful lives.

(ii)80% of the floor area of the leasehold property is used for manufacturing purposes while 20% is used for the general office. The property is depreciated at 2.5% per annum using the straight line method.

(iii)Depreciation of the manufacturing machines is calculated on the basis of machine hours. The total estimated machine service hours were 2 000 000. The machine hours used in the years 1999, 2000 and 2001 were 300 000, 350 000 and 400 000 respectively.

(iv)Office equipment is depreciated at an annual rate of 25% using the reducing balance method.

(v)During 2001, Luen Fook Ltd paid carriage inwards at $2 per unit for all the raw materials purchased.

Two batches of raw materials were purchased during the year. The first batch of 30 000 units was purchased on 1 April 2001 at the unit cost of $28. The second batch of 50 000 units was purchased on 1 August 2001 at the unit cost of $30. On 1 September 2001, 2000 units of the second batch were returned to the supplier. The supplier issued a credit note to Luen Fook Ltd for the amount of raw materials returned plus the related carriage inwards incurred by Leun Fook Ltd. During the year, 72 000 units of raw materials were transferred to manufacturing. Luen Fook Ltd adopted the FIFO method for the valuation of the closing stock of raw materials.

(vi)The amount of work in progress at 31 December 2001 was 25% more than at 1 January 2001.

(vii)Factory supervisors’ salaries of $380 000 had been included in the administrative staff salaries.

(viii)Utilities expenses were to be allocated between the factory and the general office according to the floor area occupied.

(ix)In the year 2001, Luen Fook Ltd paid $1 000 000 to a US company for a patent. The terms of the patent allow production of 250 000 units of goods over a 4-year period. During the year 100 000 units of goods were produced.

(x)Manufactured goods were transferred to the trading account at a markup of 20%. At 31 December 2001, the value of stock of finished goods at transfer price was $1 020 000. However, a batch of this stock with a transfer price of $120 000 was found to be defective and the net realizable value was estimated to be 10% lower than the manufactured cost.

(xi)The following provisions were to be made:

(1)Commission payable to salesmen: at 1% of the net sales after bad debts

(2)Bonus payable to general manager : at 3% of the net profit after charging the bonus

(xii)In the year 2001, Luen Fook Ltd started to provide a warranty for any defective goods sold. The warranty period covers one year from the date of sale. Luen Fook estimated that the unexpired warranty liability for the year 2001 sales was $184 000.

(xiii)A clerk was injurned in the office. Luen Fook Ltd’s lawyer was certain that the compensation would amount to $50 000. 80% of the compensation payment would be covered by an insurance policy.

You are required to prepare:

(a) the manufacturing account for the year ended 31 December 2001, showing clearly the amount of prime cost; (10 marks)

(b) the trading and profit and loss account for the year ended 31 December 2001; and (12 marks)

(c)the balance sheet as at that date. (8 marks)

3. Dick Chung started his trading business on 1 January 2001. Dick has limited knowledge of accounting. However, he has prepared the following statements:

Trading and profit and loss account for the year ended 31 December 2001

$ / $
Sales / 1 134 000
Less: Cost of goods sold
Purchases / 1 100 000
Less: Closing stock / 240 000 / 860 000
Gross profit / 274 000
Discounts received / 6 600
Compensation received / 50 000
330 600
Less: Depreciation / 60 000
Cost of packing machine destroyed / 80 000
Provision for doubtful debts / 5 640
Rent / 350 000
Insurance / 18 000
Advertising / 100 000
Discounts allowed / 4 800
Transportation / 86 000
Repairs and maintenance / 25 00
Sundry expense / 39 600 / 769 040
Net loss for the year / (438 440)

Balance sheet as at 31 December 2001

$ / $
Machinery at cost / 160 000
Less: Provision for depreciation / 60 000 / 100 000
Stock / 240 000
Debtors / 188 000
Less: Provision for doubtful debts / 5 640 / 182 360
Preliminary expenses / 12 000
Petty cash / 320
Cash / 6 880
Bank / 100 000
641 560
Less: Creditors / 180 000
Bank loan / 400 000 / 580 000
61 560
Capital / 500 000
Less: Net loss for the year / 438 440
61 560

Dick Chung could not balance the accounts and the discrepancy was included in the ‘sundry expenses’.

Further information:

(i)During the year, 1000 units at the cost of $50 per unit were lost and had to be regarded as abnormal loss.

(ii)During the year, $100 000 was incurred for advertising. Dick Chung believed that the advertising helped promote the company’s image and wondered whether the advertising expenditure could be capitalized as an intangible asset. Any intangible assets were to be amortized over 5 years.

(iii)All machinery was purchased on 1 January 2001 at a cost of $240 000 and depreciated at an annual rate of 25% on cost. One packing machine was destroyed on 31 December 2001 and $50 000 was received as compensation from the insurance company.

$10 000 was paid for the delivery of a printing machine on 1 January 2001. $5000 was incurred for installation on the same day. After the machine had been put into use, $3000 was spent on repairs. The delivery charge has been included in ‘transportation’ while the other two amounts totaling $8000 has been accounted for as ‘ repairs and maintenance.’

(iv)From 1 January 2001, Dick Chung leased two buildings: one of business use and the other for family use. The business tenancy agreement required a deposit of $20 000 and a monthly rental payment of $10 000. The family tenancy agreement required a deposit of $30 000 and a monthly rental payment of $15000. The rent amount in the profit and loss account included the payments made for these two tenancy agreements.

(v)Insurance of $18 000 was paid for the period 1 January 2001 to 31 March 2002.

(vi)On 31 December 2001, Dick Chung transferred the title of his motor vehicle to the business. He purchased the motor vehicle three years ago for $120 000. The motor vehicle was valued on 31 December 2001 at $90 000. Dick Chung thought that as there was no money involved in the transaction, he did not have to record the motor vehicle in the accounts.

(vii)Preliminary expenses were to be written off in 2001.

(viii)The following items were discovered after further investigation:

(1)An imprest system was maintained so that the petty cash balance would be restored to $1000 at the end of each month.

(2)After checking the bank statement for the month of December 2001, it was found that two cheques amounting to $12 400 remained unpresented.

(3)The total of discounts received for the year, $4800, had been wrongly debited to the discounts allowed account; and the total of discounts allowed for the year, $6600, had been wrongly credited to the discounts received account.

(4)Dick Chung won $30 000 in a lucky draw in December 2001 and the amount had not been included in the business books.

(5)In calculating the creditors’ total shown in the balance sheet, a credit balance of $400 had been wrongly cast as $4000.

You are required to prepare:

(a) the journal entries necessary to correct the above items (i) to (viii). If no journal entry is required, you should state so. (Note: Compensating and contra entries are required.) (14 marks)

(b) a corrected trading and profit and loss account for the year ended 31 December 2001; and

(8 marks)

(c) a corrected balance sheet as at the same date. (8 marks)

Part B

Answer any TWO questions from this section. Each question carries 20 marks.

4. The following financial statements were prepared by David Wong, the accountant of Wise Ltd:

Trading and profit and loss account for the years ended 31 December

2001 / 2000
$ / $
Sales / 12 000 000 / 7 600 000
Opening stock / 460 000 / 420 000
Purchases / 7 580 000 / 3 350 000
Less: Closing stock / (1 140 000) / (460 000)
Cost of sales / 6 900 000 / 3 310 000
Gross profit / 5 100 000 / 4 290 000
Less : Operating expenses / (4 770 000) / (4 040 000)
Net profit for the year / 330 000 / 250 000
Retained profits brought forward / 350 000 / 10 000
Retained profits carried forward / 680 000 / 350 000

Balance sheet as at 31 December

2001 / 2000
$ / $
Fixed assets / 3 100 000 / 2 720 000
Current assets
Stock / 1 140 000 / 476 000
Debtors (net) / 2 116 800 / 640 000
Investment / 450 000 / -
Cash / 23 200 / 40 000
3 730 000 / 1 140 000
Less: Creditors / (1 650 000) / (510 000)
Working capital / 2 080 000 / 630 000
5 180 000 / 3 350 000
$1 ordinary shares / 3 000 000 / 3 000 000
Profit and loss / 680 000 / 350 000
3 680 000 / 3 350 000
12% bank loan / 1 500 000 / -
5 180 000 / 3 350 000

Based on the financial statements above, David Wong commented that the profitability of the company improved in 2001 and supported this with the following information:

-Compared with that of the year 2000, sales increased by 57.89%.

-The amount of gross profit and net profit also increased by $810 000 and $80 000 respectively.

-The return on average equity improved from 7.75% in 2000 to 9.39% in 2001.

You are required to:

(a)Critically evaluate the comments made by David Wong concerning the profitability of the company, calculating (to two decimal places) other ratios where appropriate. (6 marks)

David also commented that the liquidity position of the company improved in 2001. He remarked that the current ratio and the liquid ratio in 2001 were 2.26 and 1.57 respectively. The corresponding figures in 2000 were 2.24 and 1.33 respectively.

Additional information:

(i)The credit policy was revised in 2001, allowing a longer credit period to both old and new customers. The change successfully brought about an increase in sales. In 2001, provision for doubtful debts was provided at 2% of debtors, the same as in 2000. However, in view of the longer credit period allowed to customers, a provision of 4% was considered more appropriate.

(ii)Some of the stock at 31 December 2001, costing $250 000, become obsolete. The net realizable value was estimated to be $120 000.

(iii)The investment represented the holding of shares in a listed company. Wise Ltd intended to hold the shares for a long term.

(iv)A packing machine costing $600 000 was purchased on 31 December 2001 under a hire purchase agreement. A deposit of $100 000 was paid on 31 December 2001 and the balance was payable by 8 monthly instalments of $70 000 each commencing on 31 January 2002. As the ownership of the asset would only pass to the company when the final instalment was paid, the machine had not been recorded as an asset of the company. In the year 2001, only $100 000 had been charged to the profit and loss account as ‘hire of plant’ and included in the operating expenses.

(v)The bank loan of $1 500 000 was raised on 1 January 2001 to finance the working capital as well as the purchase of fixed assets. The loan was to be repaid in 2004.

You are required to:

(b) With the aid of the additional information given, prepare a statement to adjust the amounts of current assets and current liabilities as at 31 December 2001. (7 marks)

(c) Re-calculate (to two decimal places) the current ratio and the liquid ratio. Comment on the revised liquidity position of Wise Ltd as at 31 December 2001. (4 marks)

Suppose the bank loan agreement states that if the company’s current ratio fails below 1.80, the bank has the right to ask for immediate total repayment of the loan.

You are required to:

(d) Comment on how this would affect the liquidity position of Wise Ltd. (3 marks)

5. (A) With reference to the prudence and the matching concept, compare the purposes of making ‘provision for doubtful debts’ and ‘provision for depreciation’.

(B)Luen Tung Ltd is a trading company. Its accounting year end is 31 December. Its fixed assets consisted of three categories: motor cars, delivery vans and trailers, and machinery.

Motor cars

The company had only one motor car which was used by the company directors. The car was purchased on 1 January 1996 at a cost of $1 200 000. It was estimated to have no residual value and was depreciated at an annual rate of 12.5% on cost. In accordance with an independent valuation on 1 January 2001, the directors decided to adjust the value to $1 000 000 with a remaining useful life of 8 years. The car was subsequently sold on 31 December 2001 for $1 100 000.

Delivery vans and trailers

A van was purchased on 1 April 2000 with a trailer which was specially designed for it and could not be fitted onto any other van. The cost of the van and the trailer was $420 000 and $210 000 respectively and their useful lives were 6 years and 8 years respectively. They were to be depreciated by the sum of the years’ digits method, assuming no residual value at the end of their useful lives.

Machinery

The company had only one machine, which was purchased on 1 April 1998 for $150 000, with an estimated residual value of $30 000. The machine was depreciated over 5 years using the straight line method. On 1 January 2001, the company decided to replace this machine on 31 March 2003 and the residual value was revised to $39 000.

You are required to:

In respect of each of three categories of fixed assets, prepare the provision for depreciation account for reach of the two years ended 31 December 2000 and 31 December 2001. (11marks)

(C)Fat Tat Ltd provides two months’ credit to its customers. If the customers settle their accounts within one month, they will be entitled to a cash discount of 4%. The ageing analysis of debtors at 31 December 2001 was:

Outstanding / $
Within one month / 450 000
One to three months / 560 000
Over three months / 60 000
1 070 000

Additional information:

(i)Provision for doubtful debts and provision for discounts allowed at 31 December 2000 were $25 000 and $8000 respectively.

(ii)A debtor owing $20 000 for over three months was declared bankrupt.

(iii)The cheques issued by a debtor owing $10 000 for two months had been dishonoured three times. The company filed a petition to the court to recover the debt and estimated that 40% of the amount was recoverable

(iv)Provision for doubtful debts was to be made at the year end according to the duration of debts. The rates to be applied were: 1% for debts outstanding for less than one month, 2% for debts outstanding for one to three months and 4% for these longer than three months.

(v)A provision for discounts allowed was also to be made on 50% of the net collectible debts.

You are required to:

Prepare the provision for doubtful debts and the provision for discounts allowed accounts of Fat Tat Ltd for the year ended 31 December 2001. (5 marks)