2025 Cambridge IAS-Level Accounting (9706) Practice Paper with Answers

**(a) Tariq - Statement of Profit or Loss for the year ended 31 December 2023**

| | $ | $ |
| :--- | :--- | :--- |
| **Revenue** | | 180,000 |
| **Cost of sales** | | |
| Opening inventory | 14,000 | |
| Purchases | 110,000 | |
| | 124,000 | |
| Less: Closing inventory | (16,500) | (107,500) |
| **Gross Profit** | | **72,500** |
| | | |
| **Expenses** | | |
| Rent and rates \((\$12,000 - \$1,500)\) | 10,500 | |
| General expenses | 9,500 | |
| Advertising \((\text{W1})\) | 5,000 | |
| Depreciation - Fixtures & fittings \((\text{W2})\) | 3,600 | (28,600) |
| **Profit for the year** | | **43,900** |

**Workings:**
* **W1: Advertising expense**
Prepayment portion: 3 months (January to March 2024) out of 6 months paid.
\(\text{Prepayment} = \$2,000 \times \frac{3}{6} = \$1,000\)
\(\text{Advertising expense for the year} = \$6,000 - \$1,000 = \$5,000\)

* **W2: Depreciation charge**
\(\text{Net Book Value (NBV)} = \$40,000 - \$16,000 = \$24,000\)
\(\text{Depreciation charge} = 15\% \times \$24,000 = \$3,600\)

***

**(b) Accruals (Matching) Concept Application:**
* The accruals concept states that revenue and expenses should be recognized and matched in the period to which they relate, rather than when the cash is paid or received.
* Out of the $6,000 paid for advertising, $2,000 relates to a 6-month campaign. Half of this campaign (3 months: October to December 2023) occurs in the current financial year, and the other half (3 months: January to March 2024) belongs to the next financial year.
* Therefore, $1,000 must be deducted from expenses as a prepayment (current asset) and deferred to the next period. This ensures only the expense incurred for the benefit of the current year’s sales ($5,000) is matched against the current year's revenue.

***

**(c) Evaluation of Premises Options:**

* **Leasing Option:**
* *Pros:* No major immediate capital outlay, preserving cash/working capital for inventory and operations. Flexibility to move or relocate easily if the expansion is unsuccessful. Repairs and maintenance may be the responsibility of the landlord.
* *Cons:* Lease payments of $15,000 are a continuous expense with no asset ownership at the end. Lease costs may increase upon renewal.

* **Purchasing Option:**
* *Pros:* Tariq gains a non-current asset that may appreciate in value. Security of tenure (no landlord can evict him). No future rental increases.
* *Cons:* Requires a large commitment ($150,000 loan). Interest cost in Year 1 would be \(6\% \times \$150,000 = \$9,000\) plus principal repayments, which creates high fixed cash outflows. The business is responsible for all maintenance costs.

* **Recommendation:**
Tariq should choose leasing in the short term to avoid over-gearing (high debt levels) and to preserve working capital for stock and operational scaling during the initial expansion phase. (Accept purchase if justified by stable cash flows and asset growth potential).

**(a) Statement of Profit or Loss [7 marks]**
* Revenue and Cost of Sales structure with correct Gross Profit of $72,500 [2] (1 mark for Cost of sales calculation, 1 mark for Gross Profit value)
* Rent and rates: $10,500 [1]
* General expenses: $9,500 [1]
* Advertising: $5,000 [1] (1 mark for working showing $1,000 prepayment deducted)
* Depreciation: $3,600 [1] (1 mark for calculating 15% on NBV of $24,000)
* Profit for the year: $43,900 [1] (1 mark for correct calculation based on previous figures - OF applies)

**(b) Accruals Concept [3 marks]**
* State the general definition of the accruals concept (matching revenue and expenses to the period they relate to, not cash flow) [1]
* Explain the specific adjustment: $1,000 relates to the next financial year (3/6 months prepaid) [1]
* State the impact: Including the full $6,000 would overstate expenses and understate profit for the year [1]

**(c) Evaluation and Recommendation [4 marks]**
* 1 mark for analyzing the leasing option (e.g., lower initial cash flow/flexibility)
* 1 mark for analyzing the purchasing option (e.g., asset ownership/capital appreciation vs interest cost)
* 1 mark for comparing the financial impact (e.g., loan interest of $9,000 vs rent of $15,000)
* 1 mark for a clear, reasoned recommendation based on the arguments presented

### **Liam**
#### **Statement of Financial Position (Extract) at 31 December 2023**

| **Current Assets** | **$** | **$** |
| :--- | :--- | :--- |
| Inventory (W1) | | 31,400 |
| Trade receivables (W2) | 14,400 | |
| Less: Provision for doubtful debts (W3) | (720) | 13,680 |
| Other receivables / Prepayments (W4) | | 650 |
| Cash at bank (W5) | | 2,100 |
| **Total Current Assets** | | **47,830** |

---

### **Workings:**

**W1: Inventory**
* Inventory should be valued at the lower of cost and net realisable value (IAS 2).
* Damaged items: Cost = $1,800; Net Realisable Value = $1,100.
* Adjustment / Write-down required = $1,800 - $1,100 = $700.
* Adjusted Inventory = $32,100 - $700 = **$31,400**.

**W2: Trade Receivables**
* Draft balance = $14,800
* Add: Dishonoured cheque (reinstating the debt) = $350
* Less: Irrecoverable debt write-off = ($750)
* Adjusted Trade Receivables = $14,800 + $350 - $750 = **$14,400**.

**W3: Provision for Doubtful Debts**
* Adjusted Trade Receivables = $14,400
* New Provision = $14,400 \times 5\% = **$720**.
* Net Trade Receivables = $14,400 - $720 = **$13,680**.

**W4: Other Receivables (Prepayments)**
* Prepaid advertising = $350
* Prepaid insurance = $300
* Total = $350 + $300 = **$650**.

**W5: Cash at Bank**
* Draft balance = $2,450
* Less: Dishonoured cheque = ($350)
* Adjusted Cash at bank = **$2,100**.

Marks are awarded as follows (Total: 7 marks):

* **Inventory (1 mark)**: $31,400 (Award 1 mark for calculating $32,100 - $700 write-down).
* **Cash at Bank (1 mark)**: $2,100 (Award 1 mark for adjusting $2,450 - $350 dishonoured cheque).
* **Trade Receivables Gross (1 mark)**: $14,400 (Award 1 mark for adding the dishonoured cheque of $350 and subtracting $750 bad debt write-off).
* **Provision for Doubtful Debts (1 mark)**: $720 (Award 1 mark for calculating 5% of adjusted trade receivables. Accept owner's figure [OF] of gross receivables \times 5%).
* **Net Trade Receivables (1 mark)**: $13,680 (Award 1 mark for subtracting the calculated provision from the gross receivables. Accept OF).
* **Other Receivables / Prepayments (1 mark)**: $650 (Award 1 mark for summing $350 and $300).
* **Total Current Assets (1 mark)**: $47,830 (Award 1 mark for total sum of all adjusted current asset components. Accept OF based on previous figures).

The accruals concept requires that revenue and expenses are recognized in the period to which they relate, rather than when cash is received or paid.

Applying this to prepaid rent receivable:
1. The prepaid rent received does not relate to the current financial year. It is deducted from the total cash received during the year, ensuring only the rent earned for the current accounting period is credited to the Income Statement.
2. The portion of rent received in advance represents a future obligation to provide the premises to the tenant, and is therefore recorded as a current liability (other payables) in the Statement of Financial Position.

1 mark for explaining the Income Statement adjustment (deducting the prepaid portion so only the current period's earned income is included).
1 mark for explaining the Statement of Financial Position treatment (classifying the prepaid rent as a current liability).

The cost of repainting existing office walls is classified as revenue expenditure.

- Treatment: It is debited to the repairs and maintenance expense account and shown in the Income Statement for the period.
- Reason: Repainting is a routine maintenance cost that maintains the non-current asset in its normal working condition. Unlike the new extension (which is capital expenditure), repainting does not increase the asset's original earning capacity or extend its useful life.

1 mark for identifying the treatment (classified as revenue expenditure / expensed to the income statement).
1 mark for the correct reasoning (it is maintenance/repair that maintains, rather than increases, the asset's earning capacity).

Arguments for purchasing the premises:
- Financial: The property becomes a non-current asset on the statement of financial position, which increases the total assets of the business and can appreciate in value over time.
- Financial: Loan repayments will eventually cease after 15 years, whereas rent is payable indefinitely and is likely to increase over time.
- Non-financial: Hamish gains security of tenure and full control over modifications, renovations, and usage of the property.

Arguments for continuing to rent the premises:
- Financial: Renting avoids a significant initial cash outflow (deposit) and the ongoing interest expenses of a bank loan, preserving working capital for day-to-day operations.
- Financial: The landlord is usually responsible for major external maintenance and building insurance, reducing Hamish's overhead risks.
- Non-financial: Renting offers greater flexibility to relocate or downsize/upsize at the end of the 5-year lease if market conditions change.

Conclusion/Recommendation:
Hamish should choose based on his business goals. If he has sufficient working capital and seeks long-term stability and asset growth, purchasing is recommended. If he prioritizes flexibility and wishes to avoid high debt obligations, renting is the better option.

Marking scheme (Max 5 marks):
- Up to 2 marks for discussing the advantages/disadvantages of purchasing the premises (1 mark per developed point).
- Up to 2 marks for discussing the advantages/disadvantages of renting the premises (1 mark per developed point).
- 1 mark for providing a clear recommendation that is consistent with the analysis.

Acceptable points include:
- Asset ownership / appreciation vs rent expense inflation (Financial)
- Debt burden / interest cost vs working capital preservation (Financial)
- Operational control vs flexibility to relocate (Non-financial)
- Maintenance responsibility (Financial/Non-financial)

1. Limited liability: In a partnership, partners have unlimited liability, meaning their personal assets are at risk to settle business debts. By converting to a private limited company, Amina and Ben will benefit from limited liability, meaning their liability is restricted to the amount they have invested or agreed to invest in shares.

2. Separate legal identity and continuity: A company has a separate legal personality from its owners. This ensures perpetual succession, meaning the company will continue to exist even if Amina or Ben leaves, retires, or dies. It also allows the company to own assets and enter into contracts in its own name.

Award up to 2 marks for each explained advantage (maximum 4 marks in total). For each advantage: 1 mark for identifying the advantage, and 1 mark for appropriate development/explanation.

Suggested points:
- Limited liability (1) + explanation that personal assets are protected / liability is limited to the amount invested in shares (1).
- Separate legal entity (1) + explanation that the company can contract, sue, or own property in its own name (1).
- Continuity of existence / perpetual succession (1) + explanation that the company continues to exist despite changes in ownership, retirement, or death of shareholders (1).
- Access to capital (1) + explanation that they can raise funds by issuing shares to new private investors (1).

1. Calculate the number of rights shares issued: \(800,000 \times \frac{1}{4} = 200,000\text{ shares}\). 2. Calculate the total number of shares in issue after the rights issue: \(800,000 + 200,000 = 1,000,000\text{ shares}\). 3. Calculate the first interim dividend paid on 1 October 2022: \(1,000,000 \times \$0.03 = \$30,000\). 4. Calculate the second interim dividend paid on 15 March 2023: \(1,000,000 \times \$0.04 = \$40,000\). 5. Calculate the total dividend paid: \(\$30,000 + \$40,000 = \$70,000\).

Award marks as follows: Calculate total shares in issue after rights issue (1,000,000 shares) (0.83 marks); Calculate first interim dividend of $30,000 (0.5 marks); Calculate second interim dividend of $40,000 (0.5 marks); State total dividend paid of $70,000 (0.5 marks).

1. Calculate the Profit for the Year: \(\text{Profit for the Year} = \text{Operating Profit} - \text{Finance Costs} - \text{Tax Expense} = \$92,000 - \$12,000 - \$18,000 = \$62,000\). 2. Prepare the movement in Retained Earnings: \(\text{Opening Retained Earnings } (\$145,000) + \text{ Profit for the Year } (\$62,000) - \text{ Dividend Paid } (\$25,000) - \text{ Transfer to General Reserve } (\$15,000)\). 3. Calculate the closing balance: \(\$145,000 + \$62,000 - \$25,000 - \$15,000 = \$167,000\).

Award marks as follows: Correct calculation of Profit for the Year of $62,000 (0.83 marks); Correct treatment of dividends paid ($25,000 deduction) and transfer to general reserve ($15,000 deduction) (1.0 mark); Correct closing balance of $167,000 (0.5 marks).

1. Calculate the corrected profit before interest and tax (Operating Profit): \(\$184,000 - \$6,200 = \$177,800\). 2. Calculate the total annual finance cost (debenture interest): \(6\% \times \$150,000 = \$9,000\). 3. Calculate the profit before tax: \(\$177,800 - \$9,000 = \$168,800\). 4. Deduct the tax expense to find the profit for the year: \(\$168,800 - \$34,000 = \$134,800\).

Award marks as follows: Adjustment for omitted distribution expense of $6,200 (0.5 marks); Calculation of debenture interest of $9,000 and deduction from profit (0.83 marks); Deduction of tax liability of $34,000 (0.5 marks); Correct final profit for the year of $134,800 (0.5 marks).

To prepare the Retained Earnings account, we start with the opening credit balance and add the profit for the year. We then deduct transactions that reduce retained earnings, such as dividends paid (both the previous year's final dividend and the current year's interim dividend) and transfers to other equity reserves.

Note: The proposed final ordinary dividend of $10,000 for 2023 is a non-adjusting event under IAS 10 and is not recognized as a liability or a debit in the Retained Earnings account for the year ended 31 December 2023.

**Retained Earnings Account**

$$\begin{array}{l r | l r}
\hline
\textbf{Details} & \textbf{\$} & \textbf{Details} & \textbf{\$}\\
\hline
\text{Dividends paid (final 2022)} & 8,000 & \text{Balance b/d} & 45,000 \\
\text{Dividends paid (interim 2023)} & 6,000 & \text{Profit for the year} & 32,000 \\
\text{Transfer to general reserve} & 5,000 & & \\
\text{Balance c/d} & 58,000 & & \\
\hline
& \mathbf{77,000} & & \mathbf{77,000} \\
\hline
& & \text{Balance b/d (1 Jan 2024)} & \mathbf{58,000} \\
\end{array}$$

Total 4 marks:
- 1 mark [1] for both credit entries: Opening balance ($45,000) and Profit for the year ($32,000).
- 1 mark [1] for debiting both dividends paid ($8,000 and $6,000) (Ignore the proposed dividend of $10,000).
- 1 mark [1] for debiting the transfer to general reserve ($5,000).
- 1 mark [1] for calculating the correct balance c/d and showing it brought down (b/d) as a credit balance of $58,000 on 1 January 2024.

The liquid (acid test) ratio measures a business's ability to meet its short-term liabilities using its most liquid current assets (excluding inventory, which takes longer to convert into cash). The formula is:

\(\text{Liquid Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}\)

Alternatively, it can be written as:
\(\frac{\text{Trade Receivables} + \text{Cash and Cash Equivalents}}{\text{Current Liabilities}}\)

[1 mark] for the correct formula: \(\frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}\).

Accept:
- Current assets less inventory divided by current liabilities
- (Trade receivables + Cash) / Current liabilities

Reject:
- Current assets / Current liabilities (this is the current ratio)

The rate of inventory turnover measures how many times a business sells and replaces its inventory over a given accounting period. The formula is:

\(\text{Rate of Inventory Turnover (times)} = \frac{\text{Cost of Sales}}{\text{Average Inventory}}\)

where Average Inventory is calculated as:
\(\frac{\text{Opening Inventory} + \text{Closing Inventory}}{2}\)

[1 mark] for the correct formula: \(\frac{\text{Cost of Sales}}{\text{Average Inventory}}\).

Accept:
- Cost of goods sold / Average inventory

Reject:
- Revenue / Average inventory
- Average inventory / Cost of sales * 365 (this calculates the turnover in days rather than times)

To analyze the decrease in gross profit margin despite a selling price increase, we consider factors that increase the Cost of Sales disproportionately to Revenue:
1. **Increase in purchase costs**: If the cost price from suppliers increased by more than 5%, the cost of sales would rise faster than revenue, reducing the overall margin.
2. **Change in sales mix**: If the retailer sold a higher proportion of alternative products with lower markups, the overall gross profit margin would decline.
3. **Inventory loss/write-down**: Higher inventory wastage, theft, or write-downs of obsolete stock directly increase the cost of sales without generating corresponding revenue.

1 mark for each valid reason explained, up to a maximum of 2 marks.
- Accept: higher purchase costs / carriage inwards (1 mark)
- Accept: change in sales mix to lower margin goods (1 mark)
- Accept: increased inventory theft / wastage / write-down (1 mark)
- Accept: increased trade discounts allowed (1 mark)
- Reject: cash discounts allowed / finance costs (this affects profit for the year, not gross profit) (0 marks)

1. **Excessive Inventory**: The significant difference between the current ratio (\(2.8:1\)) and the liquid ratio (\(0.5:1\)) indicates that a massive proportion of current assets is tied up in inventory (represented by \(2.3\) parts of the ratio). This suggests poor inventory management or obsolete stock.
2. **Liquidity Risk**: A liquid ratio of \(0.5:1\) is well below the industry benchmark of \(1.0:1\), meaning the company does not have enough liquid assets (cash and trade receivables) to meet its short-term obligations as they fall due if inventory cannot be sold quickly.

1 mark for identifying that a large volume of working capital is tied up in slow-moving or excessive inventory (1 mark).
1 mark for identifying that the company faces high liquidity risk/inability to meet short-term liabilities because the liquid ratio is far below the benchmark (1 mark).

### Part (a) Formulas
* \(\text{Gross Profit Margin} = \frac{\text{Gross Profit}}{\text{Revenue}} \times 100\)
* \(\text{Profit for the Year Margin} = \frac{\text{Profit for the Year}}{\text{Revenue}} \times 100\)

### Part (b) Analysis and Explanation
1. **Explanation of diverging trends:**
The Gross Profit Margin only considers direct trading factors (Revenue and Cost of Sales). An increase from 20% to 25% means the business is making more profit per dollar of sales before expenses. However, the Profit for the Year Margin accounts for all overheads/operating expenses. If these expenses increase disproportionately to revenue, they will erode the extra gross profit, leading to a decline in the bottom-line margin (from 10% to 6%).
2. **Possible cause for GP Margin increase:**
* Negotiating cheaper purchase prices from suppliers.
* Increasing selling prices without a corresponding increase in purchase costs.
3. **Possible cause for Profit for the Year Margin decrease:**
* A sharp rise in fixed overheads (e.g., warehouse rent, utility bills, or staff salaries).
* High marketing and promotional expenses to drive the sales volume.

Total: 4.5 Marks
- State Gross Profit Margin formula: 0.5 marks
- State Profit for the Year Margin formula: 0.5 marks
- Clear explanation that gross profit looks at trading costs while net profit includes overheads: 1.5 marks
- One valid reason for GP Margin increase (e.g., lower cost of sales, higher selling prices): 1.0 marks
- One valid reason for Profit Margin decrease (e.g., increase in operating overheads, high administrative costs): 1.0 marks

### Part (a) Formula
* \(\text{Liquid (Acid Test) Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}\)
*(Accept: \(\frac{\text{Trade Receivables} + \text{Cash and cash equivalents}}{\text{Current Liabilities}}\))*

### Part (b) Critical Evaluation
1. **Analysis of Current Ratio:**
LMN Ltd's Current Ratio (2.4:1) is well above the industry benchmark range of 1.5:1 to 2.0:1. Superficially, this suggests a safe liquid position with plenty of current assets to cover current liabilities.
2. **Analysis of Liquid (Acid Test) Ratio:**
However, LMN Ltd's Liquid Ratio (0.6:1) is significantly below the industry benchmark of 0.9:1 to 1.1:1. This is a critical concern, as a ratio below 1:1 implies the business does not have enough highly liquid assets (cash and receivables) to pay its immediate short-term liabilities if they fall due tomorrow.
3. **Working Capital Management implications:**
The substantial gap between the two ratios (\(2.4 - 0.6 = 1.8\)) reveals that a large portion of working capital is tied up in inventory.
* This indicates inefficient inventory control, potential overstocking, or slow-moving and obsolete inventory.
* This ties up cash resources that could otherwise be used to pay off short-term debts or invest in profitable areas, leading to severe cash-flow strain despite seeming 'solvent' on paper.

Total: 4.5 Marks
- Correct formula for Liquid (Acid Test) Ratio: 0.5 marks
- Evaluation of Current Ratio (above benchmark, seems safe but could mean inefficient resources): 1.0 marks
- Evaluation of Liquid Ratio (below benchmark, indicates short-term insolvency risk): 1.0 marks
- Identifying that the difference is due to high inventory levels: 1.0 marks
- Conclusion regarding poor working capital/inventory management: 1.0 marks

A stepped cost (or stepped-fixed cost) is a cost that remains constant in total within a specific range of activity. However, once the activity level exceeds a certain threshold, the cost increases by a lump sum to a new level, where it remains constant until the next threshold is reached. Examples include supervisor salaries when an additional supervisor must be hired for a new shift.

1 mark for a complete definition mentioning that the cost is constant/fixed within a range of activity and increases to a new level when a threshold/limit is exceeded. (Accept: costs that behave like fixed costs over a limited range of output, but increase in steps when capacity is reached).

Overhead apportionment is the process of dividing and sharing common indirect expenses (overheads) among different cost centres or departments on a reasonable and equitable basis (such as floor area for rent, or number of employees for canteen costs), because these costs cannot be directly traced to a single cost centre.

1 mark for explaining that it involves sharing/dividing common/indirect costs among departments/cost centres on a fair/equitable basis.

Contribution is defined as selling price per unit minus variable cost per unit (or total sales revenue minus total variable costs). It is the amount that contributes towards covering fixed overheads and, once fixed costs are covered, towards generating profit.

1 mark for stating that it is sales revenue minus variable costs (or contribution per unit is selling price minus variable cost per unit) OR that it is the amount available to cover fixed costs and generate profit.

### Step 1: Apportion Rent and Rates
Rent and Rates ($18,000) are apportioned based on floor area (Total = \(1,200 + 800 + 400 = 2,400\) sq m).
- **Machining**: \(\frac{1,200}{2,400} \times \$18,000 = \$9,000\)
- **Assembly**: \(\frac{800}{2,400} \times \$18,000 = \$6,000\)
- **Maintenance**: \(\frac{400}{2,400} \times \$18,000 = \$3,000\)

### Step 2: Apportion Power
Power ($10,000) is apportioned based on Kilowatt hours (Total = \(5,000 + 3,000 + 2,000 = 10,000\) kWh).
- **Machining**: \(\frac{5,000}{10,000} \times \$10,000 = \$5,000\)
- **Assembly**: \(\frac{3,000}{10,000} \times \$10,000 = \$3,000\)
- **Maintenance**: \(\frac{2,000}{10,000} \times \$10,000 = \$2,000\)

### Step 3: Calculate Subtotals before Reapportionment
- **Machining**: \(\$25,000 + \$9,000 + \$5,000 = \$39,000\)
- **Assembly**: \(\$15,000 + \$6,000 + \$3,000 = \$24,000\)
- **Maintenance**: \(\$8,000 + \$3,000 + \$2,000 = \$13,000\)

### Step 4: Reapportion Maintenance Department
Maintenance costs ($13,000) are reapportioned in a 7:3 ratio.
- **Machining**: \(70\% \times \$13,000 = \$9,100\)
- **Assembly**: \(30\% \times \$13,000 = \$3,900\)

### Step 5: Calculate Final Totals
- **Machining**: \(\$39,000 + \$9,100 = \$48,100\)
- **Assembly**: \(\$24,000 + \$3,900 = \$27,900\)

- **1 mark**: Rent and Rates correctly apportioned (Machining: $9,000; Assembly: $6,000; Maintenance: $3,000).
- **1 mark**: Power correctly apportioned (Machining: $5,000; Assembly: $3,000; Maintenance: $2,000).
- **1 mark**: Correct subtotal for Maintenance department of $13,000 (Allocated $8,000 + Rent $3,000 + Power $2,000).
- **1 mark**: Correct reapportionment of Maintenance department costs to Machining ($9,100) and Assembly ($3,900).
- **1 mark**: Correct final totals calculated (Machining: $48,100; Assembly: $27,900).

Step 1: Reapportion Maintenance overheads ($12,000). To Canteen: \(10\% \times \$12,000 = \$1,200\). To Assembly: \(60\% \times \$12,000 = \$7,200\). To Finishing: \(30\% \times \$12,000 = \$3,600\). Step 2: Calculate revised Canteen overheads. Original Canteen overheads ($8,000) + Share from Maintenance ($1,200) = $9,200. Step 3: Reapportion Canteen overheads ($9,200) to Assembly and Finishing in the ratio 3:2 (60% to Assembly and 40% to Finishing). To Assembly: \(60\% \times \$9,200 = \$5,520\). To Finishing: \(40\% \times \$9,200 = \$3,680\). Step 4: Calculate total Assembly overheads. Original Assembly ($45,000) + Share from Maintenance ($7,200) + Share from Canteen ($5,520) = $57,720.

1 mark for calculating correct share from Maintenance to Canteen ($1,200) and Assembly ($7,200). 1 mark for calculating revised Canteen total ($9,200) and its correct reapportionment to Assembly ($5,520). 1 mark for final correct Assembly total ($57,720).

1. Calculate Prime Cost: Direct materials = $350. Direct labour: Assembly = \(12 \text{ hours} \times \$15 = \$180\); Finishing = \(8 \text{ hours} \times \$18 = \$144\). Total Prime Cost = $350 + $180 + $144 = $674. 2. Calculate Overheads absorbed: Assembly = \(12 \text{ hours} \times \$8 = \$96\). Finishing = \(8 \text{ hours} \times \$12 = \$96\). Total Overheads = $96 + $96 = $192. 3. Calculate Total Cost: Total Cost = Prime Cost ($674) + Total Overheads ($192) = $866. 4. Calculate Selling Price: Selling Price = Total Cost \times 1.25 = $866 \times 1.25 = $1,082.50.

1 mark for calculating correct total Prime Cost of $674. 1 mark for calculating correct total overheads absorbed of $192 and total cost of $866. 1 mark for calculating correct selling price of $1,082.50 (with method mark for applying 25% markup on total cost).

1. Determine the fixed overhead absorption rate (OAR) per unit: Budgeted Fixed Overheads / Budgeted Production = $\frac{120,000}{12,000 \text{ units}} = $10 \text{ per unit}. 2. Determine closing inventory units: Opening inventory + Production - Sales = \(0 + 12,000 - 10,000 = 2,000 \text{ units}\). 3. Determine the difference in profit: The difference in profit is equal to the fixed overheads included in closing inventory: \(2,000 \text{ units} \times \$10 \text{ per unit} = \$20,000\). Since production (12,000 units) is greater than sales (10,000 units), inventory increased, so some fixed overhead is carried forward in inventory under absorption costing. Thus, absorption costing profit is higher than marginal costing profit by $20,000.

1 mark for calculating correct fixed overhead rate of $10 per unit. 1 mark for calculating closing inventory of 2,000 units. 1 mark for identifying that absorption costing profit is higher by $20,000 (with correct calculation of difference).

(a) Job Cost Card for Job 210: Direct Materials: $450.00. Direct Labor: Machining (8 hours * $12.00) = $96.00; Assembly (15 hours * $10.00) = $150.00. Total Direct Labor: $246.00. Prime Cost = $450.00 + $246.00 = $696.00. Overheads Absorbed: Machining Department (12 machine hours * $15.00 OAR) = $180.00; Assembly Department (15 labor hours * $8.50 OAR) = $127.50. Total Overheads = $307.50. Total Production Cost = Prime Cost ($696.00) + Total Overheads ($307.50) = $1,003.50. Administration Overheads (10% of $1,003.50) = $100.35. Total Cost of Job 210 = $1,103.85. (b) Reasons for using absorption costing for pricing: 1. It ensures all production overheads are fully recovered in the price charged to customers. 2. It recognizes that in the long run, all costs (both fixed and variable) must be covered to generate a net profit.

(a) Job Cost Card: [6 marks in total] - Prime Cost calculation: Direct materials ($450) and Direct labor ($246) correctly totaled to $696 [1 mark]. - Machining overhead: 12 hours * $15 = $180 [1 mark]. - Assembly overhead: 15 hours * $8.50 = $127.50 [1 mark]. - Total Production Cost: $1,003.50 [1 mark]. - Admin overhead: 10% * $1,003.50 = $100.35 [1 mark]. - Total Cost: $1,103.85 (allow OF based on previous errors) [1 mark]. (b) Reasons for absorption costing: [2 marks in total] - 1 mark for each valid point up to 2 marks (e.g., ensures recovery of all fixed overheads, more appropriate for long-run pricing decisions, avoids underpricing jobs).

1. Under marginal costing, fixed production overheads are treated as period costs and written off in the period they are incurred. Under absorption costing, fixed overheads are treated as product costs and absorbed into the valuation of inventory. 2. When inventory levels increase (production exceeds sales), absorption costing profit will be higher than marginal costing profit. This is because a portion of the fixed production overheads is carried forward in closing inventory to the next period. 3. When inventory levels decrease (sales exceed production), marginal costing profit will be higher than absorption costing profit. This is because fixed overheads deferred from the previous period in opening inventory are released and charged as an expense in the current period under absorption costing. The difference in profit can be expressed as: \( \text{Difference} = \text{Change in Inventory Units} \times \text{Fixed Overhead Absorption Rate} \). 4. For short-term decision-making (such as special pricing or make-or-buy), marginal costing is superior because it clearly shows the contribution of each product and prevents management from inflating profits through unnecessary overproduction. 5. However, absorption costing is essential for long-term pricing decisions to ensure all fixed overheads are recovered. It is also required for statutory financial statements under IAS 2. Therefore, Kestrel Limited should use marginal costing for internal monthly decision-making while maintaining reconciliation with absorption costing for long-term strategy and compliance.

1 mark: Explaining the different treatments of fixed production overheads (period costs in marginal costing vs product costs in absorption costing). 1 mark: Explaining that when inventory increases, absorption costing profit is higher due to deferral of fixed overheads. 1 mark: Explaining that when inventory decreases, marginal costing profit is higher because deferred fixed overheads are released under absorption costing. 1 mark: Identifying the benefit of marginal costing for short-term decision-making (contribution analysis, avoids overproduction profit distortion). 1 mark: Providing clear advice/recommendation that addresses long-term pricing (absorption costing) or IAS 2 compliance. (Maximum 5 marks)