2007 AL P.I No. 1
1. Big Ltd acquired 3 000 000 ordinary shares of Small Ltd two years ago on 1 January 2005 for $3990 000.
The equity of Small Ltd as at the date consisted of:
$
$ 1 ordinary shares 5 000 000
General reserve 300 000
Retained profits 500 000
5 800 000
The fair values of all the assets at 1 January 2005 were the same as their carrying amounts at the date.
The financial statements ( for internal use) for the year ended 31 December 2006 are shown as follows:
Profit and loss account for the year ended 31 December 2006
Big Ltd Small Ltd
$ $
Turnover 9 450 000 6 400 000
Cost of sales(7 050 000) (3 140 000)
Gross profit 2 400 000 3 260 000
Gain on sale of machinery to small Ltd 60 000 —
Dividend income from Small Ltd 180 000 —
Rental income from Big Ltd — 200 000
2 640 000 3 460 000
Operating expenses (2 250 000) (2 280 000)
Profit before tax 390 000 1 180 000
Taxation (40 000) (150 000)
Profit after tax 350 000 1 030 000
Dividend paid — (300 000)
Retained profit for the year 350 000 730 000
Balance sheet as at December 2006
Big LtdSmall Ltd
$ $
Non current assets
Property (net) — 1 900 000
Machinery and equipment (net) 2 280 000 1 940 000
2 280 000 3840 000
Investment in Small Ltd 3 990 000 —
Current assets
Inventories 1 660 000 650 000
Accounts receivable 2 500 000 2 640 000
Bank 1 000 360 000 4 161 000 3 650 000
Current liabilities
Accounts payable (3 371 000) (420 000)
Net assets 7 060 000 7 070 000
Capital and reserve
Ordinary shares of $ 1 each 7 000 000 5 000 000
General reserve — 500 000
Retained profit 60 000 1 570 000
7 060 000 7 070 000
Other information:
(i)During 2006, Small Ltd sold goods to Big Ltd at the invoice price of $ 2 400 000, of which Small Ltd earned a mark up of 25%. One-third of these goods remained unsold at 31 December 2006. Any unrealized profit arising from this upstream sale of goods is to be eliminated against the group profit
(ii) On 1 July 2006, Big Ltd sold a machine to Small Ltd for $210 000 with an estimated remaining
useful life of 3 years. The machine was originally purchased by Big Ltd on 1 January 2004 for
$300 000 with an estimated useful life of 5 years. Any unrealized profit arising from this
downstream sale and the related depreciation adjustments are to be eliminated in full against the
group profit only.
(iii)Part of Small Ltd’s office had been let to Big Ltd for the whole year of 2006 at an annual rent of
$200 000. The amount was not yet settled at 31 December 2006.
(iv)Small Ltd’s property was revalued at $2 500 000 on 31 December 2006. No accounting entries had
been made in respect of this.
(v)Annual impairment tests of goodwill arising from consolidation revealed that it was impaired by
$100 000 in 2006 only.
(vi)The group provides depreciation on non-current assets using the straight line method.
You are required to:
(a) Prepare for the group of Big Ltd the consolidated income statement for the year ended 31 December
2006 (showing the profit attributable to equity holders of the parent and minority interest respectively), and the consolidated balance sheet as at that date. (20 marks)
(b)Big Ltd is applying for a bank loan of $ 500 000 and has submitted the financial statements for
2006 to the banker for consideration.
(i)Calculate (to two decimal places) the net profit (after tax) ratio and current ratio for Big
Ltd and the group as a whole. ( 4 marks)
(ii) Referring to your calculations in (i) above, advise how the banker would make the loan decision. ( 6 marks)
2007 AL P.I No. 1
2. John Lam is engaged in the trading of a product. A water leakage in December 2006 caused some
goods to be damaged and most of the accounting records destroyed. The following information
relating to 2006 was available.
(i)Assets and liabilities as at 1January 2006
$
Office equipment (net) 46 000
Stock 180 000
Trade debtors (net of estimated doubtful debts of $5000) 91 600
Accrued rent 6 000
Bank 130 000
Trade creditors 84 000
Petty cash imprest float 1 000
Rental deposit ( 2 months’ rental) 12 000
Deposit paid by a trade debtor (for goods to be delivered in February
2006)7 000
(ii)From 1 September 2006, the purchase cost increased abruptly. Purchases made before and after the
cost increase amounted to $ 576 000 and $429 000 respectively. To maintain competitiveness, the
mark-up of the goods purchased since 1 September 2006 was adjusted downward from 40% to
30%. All the goods at the old mark-up were sold by the end of October 2006, of which goods costing $151 200 were sold at discount of 15% off the normal selling price.
(iii) Goods costing $33 000 were damaged during the water leakage in December 2006. The insurance
company agreed to compensate $30 000 and the amount was received in January 2007. Physical
stock-taking revealed that stock at 31 December 2006 amounted to $291 060 at cost.
(iv) All receipts from customers and all payments to suppliers were in the form of cheques. The
following summarized amounts for 2006 were extracted from the bank statements:
$
Cheques received from customers 1 015 000
Cheques paid to suppliers 931 500
Returned cheque 25 200
The returned cheque was issued by a customer in full settlement of his debt. The customer, however,
was declared bankrupt on 26 December 2006 and John decided that the whole amount was to be
written off.
It was also discovered that (1) cheques in the amount of $19 800 drawn on the suppliers had not been presented and (2) cheques in the amount of $38 610 received from customers had not credited by
The bank.
(v) Discounts received from suppliers and discounts allowed to customers amounted to $4680 and $8400
respectively.
(vi) Doubtful debts at December 2006 were estimated at $9000.
You are required to:
(a) Based on the above, prepared the sales ledger control account and the purchases ledger control account for the year ended 31 December 2006.
(vii)Cash of $20 580, representing the amount net of a 2% cash discount, was received from a customer
during his visit at the office in early December 2006. $20 000 0f this amount was paid for John’s
personal investment while the $580 was used to pay off sundry expense of his business. No
accounting entries had been made in respect of these transactions.
(viii)The bank statement as at 31 December 2006 showed a credit balance of $6130 as at that date.
Further analysis of the bank statements in 2006 revealed the following summarized payments:
$
Salaries 46 000
Rent 74 000
Drawings by John Lam 40 000
Purchase of computers 12 000
Additional rental deposit ( due to an increase in monthly rent
to $7000 effective from 1 October 2006) 2 000
Amount drawn to restore petty cash to imprest 8 170
(ix)Petty cash was solely used to meet sundry expenses.
(x)Depreciation was calculated at an annual rate of 20% using the reducing balance method.
You are required to:
(b) Prepare for John Lam the trading and profit account for the year ended 31 December 2006
and the balance sheet as at that date. Present both statements in vertical form. (16 marks)
John Lam spent much effort in preparing the final accounts for year 2006. He complained: ‘ The purpose of
Accounting is to provide information to the investor. I myself run this firm and I know how well it runs. I
am also the only investor. It is pointless for me to keep all those accounting records and prepare the final account. ’
You are required to:
(c)Comment on what John Lam said with reference to the purposes of accounting that would facilitate
the management of his business. (6 marks)
3. Cheung and Lau had been in partnership for more than 10 years engaging in the trade of medical equipment.
The following are the terms of their partnership agreement:
(i)Cheung and Lau share profits and losses in the ratio of 3:2 respectively.
(ii)Interest is allowed on capital at 3% per annum.
(iii)Cheung and Lau were entitled to an annual salary of $70 000 and $80 000 respectively.
Heavy losses were incurred in 2006. Cheung and Lau finally decided to dissolve the partnership on 31 December 2006. A list if balances as at that date immediately before the dissolution is given below.
Dr Cr
$’000 $’000
Property (net) 7600
Motor vehicles(net) 400
Stock 7000
Debtors 2000
Bank 2400
Capital—Cheung 7000
—Lau 3000
9% Loan—Cheung 1800
—Lau 300
Creditors 4500
Net loss for the year 2000
19 000 19 000
Further information:
(i)The motor vehicles were taken over by Lau as full settlement of his loan.
(ii)On 1 January 2007, C&L Limited was set up with an authorized share capital of 7 000 000 ordinary shares of par value $2 each. Cheung and Lau would be actively involved in the management and operations of the new business. C&L Limited took over the partnership’s assets and liabilities as follows:
Items / TermsProperty / Fair value of $8 700 000
Stock / A mark up of 5% on the carrying amount
Debtors / 5% estimated to be collectible
Loan from Cheung / Whole amount completely replaced by a new loan agreement for
$1 600 000 at 6% interest per annum
Creditors / At book value
(iii)C&L Limited settled the purchase consideration by an issue of 4 000 000 ordinary shares at $3 each.
(iv)Lau paid the realization expense of $20 000 on behalf of the partnership.
(v)On 15 January 2007, C&L Limited issued the balance of authorized capital at $3.5 per share, payable in full on application. Issue cost of $100 000 was paid and all shares were allotted on 31 January 2007.
You are required to:
(a) Prepare the following accounts in the books of the partnership to record the above:
(i) realisation account (4 marks)
(ii) partners’ capital accounts ( in columnar form ) (5 marks)
(b) Prepare the necessary journal entries in the books of C&L Limited to record the above.
(c) Despite a heavy loss incurred by the partnership of Cheung and Lau, C&L Limited was paying a premium to take over the business. Suggest two possible reasons for this. (4 marks)
4. The draft financial statements of Wai Kuen Limited are as follows:
Income statement for the year ended 31 December 2006
$’000
Sales 18 133
Cost of good sold (10 470)
Gross profit 7 663
Depreciation (987)
Wages and salaries (1 729)
Administrative expenses (3 077)
Finance costs (121)
Profit before taxation 1 749
Taxation (306)
Retained profit for the year 1 443
Balance sheet as at December
20062005
$’000 $’000 $’000 $’000
Non-current Assets
Property 13 236 13 570
Accumulated depreciation (536) 12 700 (270) 13 300
Office equipment 6 308 2 500
Accumulated depreciation (1 096) 5 212 (375) 2 125
17 912 15 425
Current Assets
Inventories 4 326 1 264
Trade receivables 2 220 1 080
Bank 240 1 800
6 696 4 144
Current Liabilities
Trade payables (4 526) (872)
Interest payable (16) —
Tax payable (366) (240)
(4 908) (1 112)
Net current assets 1 788 3 032
19 700 18 457
Non-current Liabilities
6% Bank loan — (1 000)
8% Debentures (800) —
Total net assets 18 900 17 457
Capital and Reserves
Ordinary shares of $1 each 10 000 10 000
Share premium 4 800 4 800
Retained profits 4 100 2 657
18 900 17 457
Additional information relating to the year ended 31 December 2006 was given below:
(i)All sales and purchases for the year were in credit.
(ii)During the year, a property with a net book value of $1 941 000 was sold for $1 000 000. The loss had been included in administrative expenses. On the other hand, a property was acquired for cash.
(iii)Interest was payable yearly on 31 December on the 6% bank loan. On 1 April 2006, the loan was settled by an issue of $800 000 8%debentures at par to the banker and the balance in cash. Debenture interest is payable half yearly on 31 March and 30 September.
(iv)On 1 December 2006, office equipment costing $3 000 000 was purchased under a finance lease contract. The bookkeeper had debited the office equipment and credited the trade payables account for the amount. The contract stipulates monthly payments $58 000 each commencing on 31 December 2006 for 5 years at the interest rate of 6%per annum. Other office equipment was purchased for cash.
(v)Based on the number of shares held at 30 November 2006, shares were issued on 28 December 2006 as follows:
(1)bonus issue — 1 for every 10 shares held
(2)right issue — 1 for every 5 shares held at a price of $2 per share
No accounting entries had been made in respect of these issues.
(vi)The finance costs in the income statement consisted of the following:
$’000
Loan interest 15
Debenture interest 48
First finance lease payment 58
121
(vii)It is the company practice to classify interest paid as a financing activity.
You are required to:
(a) Prepare the cash flow statement for Wai Kuen Limited for the year ended 31 December 2006 using
the direct method. (12 marks)
(b)Prepare a statement to reconcile the profit before taxation to net cash from operating activities.
(4 marks)
(c)Explain the circumstances in which cash flows from operating activities offer a clearer picture of a
company’s operating performance than earnings.
5.(A) ‘The purpose of depreciation is to calculate the loss in the value of non-current assets. It follow
that depreciation is only required when the market value of a non-current asset is lower than its carrying amount.’
Explain whether the above viewpoint is correct or not. (4 marks)
(B) The following information relates to non-current assets of Dreamshop LTD at 1 January 2006:
Building Plant and machinery Motor vehicle
$ $ $
Cost / Valuation 2 160 000 900 000 200 000
Accumulated depreciation — (325 000) (140 000)
Carrying amount 2 160 000 575 000 60 000
(i) The company’s building was acquired on 1 January 2002 for $2 000 000. It had an expected
useful life of 40 years with no residual value. On 31 December 2005, it was revalued at
$2 160 000. It was disposed of for $1 720 000 on 31 December 2006.
(ii) On 1 September 2006, Dreamshop Ltd leased a specialized machine. The cash price of the
machine was $680 380. The lease agreement stipulates the following:
(1)There are four yearly lease payments of $200 000 each commencing on 1 September
2006. The implicit interest rate is 12% per annum.
(2)Dreamshop Ltd is responsible for all repairs and maintenance charges during the lease
period.
(3)Ownership of the machine will pass to Dreamshop Ltd when the last lease payment is
paid.
(iii) The only motor vehicle owned by Dreamshop Ltd was purchased on 1 January 2004. It was
no longer required and thus exchanged for an air-conditioning plant on 1 July 2006. The fair
values of the motor vehicle and the air-conditioning plant at that date were $65 000 and
$70 000 respectively, and the difference was settled by cash.
Dreamshop Ltd adopts the following depreciation policies for its non-current assets:
• Building — Straight line method
• Plant and machinery — 20% per annum using the straight line method
• Motor vehicle — sum of the years’ digit method with a useful life of 4 years
You are required to:
(a) Prepare the necessary journal entries for the above for the year 2006. (Note: Narration are not required. Assume that all amounts are material.) (12 marks)
(b)Prepare a statement to show the movements of the following items related to the non-current assets of
Dreamshop Ltd during the year 2006:
(1)cost/valuation
(2)accumulated depreciation
(3)carrying amount
(4 marks)
( Correct all amounts to the nearest dollar.)
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