2026 Cambridge IAL Accounting (9706) 模擬試題連答案詳解

1. Initial number of ordinary shares = $\frac{400\,000}{0.50} = 800\,000\text{ shares}$.
2. Bonus issue: $800\,000 \times \frac{1}{4} = 200\,000\text{ shares}$.
Nominal value of bonus issue = $200\,000 \times $0.50 = $100\,000$.
Share premium balance after bonus issue = $$120\,000 - \$100\,000 = \$20\,000\$.
3. Total shares held after bonus issue = \$800\,000 + 200\,000 = 1\,000\,000\text{ shares}\$.
Rights issue: \$1\,000\,000 \times \frac{1}{5} = 200\,000\text{ shares}\$.
Premium per share on rights issue = $$0.80 - $0.50 = $0.30$.
Total premium from rights issue = $200\,000 \times $0.30 = $60\,000$.
4. Final share premium balance = $$20\,000 + $60\,000 = $80\,000$.

B is correct [1 mark].
Calculation:
Bonus issue cost = 200 000 * $0.50 = $100 000 (deducted from share premium).
Remaining share premium = $120 000 - $100 000 = $20 000.
Rights shares = 1 000 000 / 5 = 200 000 shares.
Premium received = 200 000 * ($0.80 - $0.50) = $60 000.
Ending balance = $20 000 + $60 000 = $80 000.

Adjustments to draft profit ($52 400):
1. Rent error: remove incorrect expense (+ $1 200) and record income (+ $1 200) = + $2 400.
2. Repairs error: charge repairs expense (- $750) and remove excess depreciation charged ($750 \times 20\% = + $150$) = - $600.
3. Discount allowed error: correct credit entry by debiting twice ($380 \times 2$) = - $760.
4. Undervalued closing inventory: increases gross profit and profit for the year = + $1 800.

Corrected profit = $$52\,400 + $2\,400 - $600 - $760 + $1\,800 = $55\,240$.

C is correct [1 mark].
Adjustments: 52 400 + 2 400 (rent) - 600 (repairs net of depreciation) - 760 (discount allowed correction) + 1 800 (inventory correction) = $55 240.

Calculate contribution per unit and contribution per kg of limiting factor (direct material):

1. Product X:
- Total variable cost = $$16 + \$15 + \$5 = \$36\$
- Contribution per unit = $$60 - $36 = $24$
- Material usage = $\frac{$16}{$4} = 4\text{ kg}$
- Contribution per kg = $\frac{$24}{4\text{ kg}} = $6.00$

2. Product Y:
- Total variable cost = $$24 + \$30 + \$6 = \$60\$
- Contribution per unit = $$80 - $60 = $20$
- Material usage = $\frac{$24}{$4} = 6\text{ kg}$
- Contribution per kg = $\frac{$20}{6\text{ kg}} = $3.33$

3. Product Z:
- Total variable cost = $$20 + \$45 + \$10 = \$75\$
- Contribution per unit = $$100 - $75 = $25$
- Material usage = $\frac{$20}{$4} = 5\text{ kg}$
- Contribution per kg = $\frac{$25}{5\text{ kg}} = $5.00$

Ranking by contribution per kg of direct material: 1st X ($6.00), 2nd Z ($5.00), 3rd Y ($3.33).

B is correct [1 mark].
Ranking must be based on contribution per kg of direct material:
X = $6.00/kg (1st)
Z = $5.00/kg (2nd)
Y = $3.33/kg (3rd)
Priority order: X, Z, Y.

1. Depreciation charges:
- Year ended 31 Dec 2021: $20\% \times $36\,000 = $7\,200$; Carrying amount = $$36\,000 - \$7\,200 = \$28\,800\$.
- Year ended 31 Dec 2022: \$20\% \times \$28\,800 = \$5\,760\$; Carrying amount = $$28\,800 - $5\,760 = $23\,040$.
- Year ended 31 Dec 2023: $20\% \times $23\,040 = $4\,608$; Carrying amount = $$23\,040 - \$4\,608 = \$18\,432\$.
- Year ended 31 Dec 2024: \$0 (no depreciation in the year of disposal).

2. Carrying amount at disposal = \$18 432.
3. Proceeds (part-exchange allowance) = \$16 500.
4. Loss on disposal = $$18\,432 - $16\,500 = $1\,932$.

A is correct [1 mark].
Carrying amount at disposal: 36 000 * 0.8 * 0.8 * 0.8 = $18 432.
Proceeds = $16 500.
Loss on disposal = $18 432 - $16 500 = $1 932.

1. Calculate total units available for sale and total cost:
- 1 April: $200 \times $12 = $2\,400$
- 8 April: $300 \times $14 = $4\,200$
- 22 April: $250 \times $15 = $3\,750$
- Total units available = $200 + 300 + 250 = 750\text{ units}$
- Total cost = $$2\,400 + $4\,200 + $3\,750 = $10\,350$

2. Weighted average cost per unit = $\frac{$10\,350}{750\text{ units}} = $13.80$

3. Closing inventory units = $750 - (350 + 200) = 200\text{ units}$

4. Value of closing inventory = $200 \times $13.80 = $2\,760$.

A is correct [1 mark].
Periodic AVCO unit cost = ($2 400 + $4 200 + $3 750) / 750 = $13.80 per unit.
Closing inventory = 200 units * $13.80 = $2 760.

1. Trade receivables at 31 December 2024:
$$84\,000 + \$420\,000 - \$395\,000 - \$3\,500 = \$105\,500\$.

2. Required allowance at 31 December 2024:
\$5\% \times \$105\,500 = \$5\,275\$.

3. Increase in allowance for irrecoverable debts:
$$5\,275 - $4\,200 = $1\,075$ (expense).

4. Net charge in the statement of profit or loss:
- Debts written off: + $3 500
- Increase in allowance: + $1 075
- Debt recovered: - $600
Total net expense = $$3\,500 + $1\,075 - $600 = $3\,975$.

A is correct [1 mark].
Receivables at year end = 84 000 + 420 000 - 395 000 - 3 500 = $105 500.
Closing allowance = 5% of 105 500 = $5 275.
Increase in allowance = 5 275 - 4 200 = $1 075.
Net charge = 3 500 (written off) + 1 075 (allowance increase) - 600 (recovered) = $3 975.

1. Predetermined overhead absorption rate (OAR):
$$\text{OAR} = \frac{\text{Budgeted overheads}}{\text{Budgeted labour hours}} = \frac{\$384\,000}{48\,000} = \$8.00\text{ per direct labour hour}$$

2. Overheads absorbed:
$$\text{Overheads absorbed} = 51\,000\text{ actual hours} \times \$8.00 = \$408\,000$$

3. Over/under absorption:
$$\text{Absorbed (\$408 000)} - \text{Actual (\$402 500)} = \$5\,500\text{ over-absorbed}$$

A is correct [1 mark].
OAR = $384 000 / 48 000 = $8.00/hour.
Absorbed overheads = 51 000 * $8.00 = $408 000.
Actual overheads = $402 500.
Difference = $408 000 - $402 500 = $5 500 over-absorbed.

1. Cost of sales = $\text{Revenue} \times (1 - \text{Gross profit margin}) = $600\,000 \times (1 - 0.30) = $420\,000$.

2. Calculate credit purchases:
$$\text{Purchases} = \text{Cost of sales} + \text{Closing inventory} - \text{Opening inventory}$$
$$\text{Purchases} = \$420\,000 + \$56\,000 - \$48\,000 = \$428\,000$$

3. Trade payables turnover (days):
$$\text{Trade payables turnover} = \frac{\text{Trade payables}}{\text{Credit purchases}} \times 365 = \frac{\$38\,000}{\$428\,000} \times 365 = 32.41 \approx 32\text{ days}$$

C is correct [1 mark].
Cost of sales = $600 000 * 0.70 = $420 000.
Purchases = $420 000 + $56 000 - $48 000 = $428 000.
Trade payables turnover = ($38 000 / $428 000) * 365 = 32.41 days -> 32 days.

Using the accounting equation for opening and closing equity:

$$\text{Closing Net Assets} = \text{Opening Net Assets} + \text{Capital Introduced} + \text{Profit} - \text{Total Drawings}$$

$$\text{Total Drawings} = \text{Cash Drawings} (\$6 000) + \text{Goods for Personal Use} (\$3 800) = \$9 800$$

$$\$98 500 = \$74 000 + \$15 000 + \text{Profit} - \$9 800$$

$$\$98 500 = \$79 200 + \text{Profit}$$

$$\text{Profit} = \$98 500 - \$79 200 = \$19 300$$

C is correct [1].

- Option A ($11 700) incorrectly adds cash drawings but subtracts goods drawings.
- Option B ($15 500) omits the drawings of goods ($3 800).
- Option D ($23 100) incorrectly adds drawings of goods to opening capital instead of deducting.

1. Cost on 1 January 2022 = $48 000
2. Depreciation for year ended 31 December 2022 = \(20\% \times \$48 000 = \$9 600\)
Carrying amount at 31 December 2022 = \(\$48 000 - \$9 600 = \$38 400\)
3. Depreciation for year ended 31 December 2023 = \(20\% \times \$38 400 = \$7 680\)
Carrying amount at 31 December 2023 = \(\$38 400 - \$7 680 = \$30 720\)
4. No depreciation is charged in 2024 (year of disposal).
Carrying amount at date of disposal = $30 720
5. Profit/(loss) on disposal = \(\text{Part-exchange allowance} - \text{Carrying amount} = \$28 000 - \$30 720 = -\$2 720\) (Loss of $2 720).

B is correct [1].

- Option A ($800 loss) arises if straight-line depreciation is used ($48 000 - 2 years \(\times\) $9 600 = $28 800 carrying amount).
- Option C ($2 720 profit) reverses the direction of the disposal result.
- Option D ($3 424 profit) incorrectly charges a 3rd year of depreciation in 2024.

Only errors affecting the individual sales ledger accounts or the schedule of sales ledger balances require adjustments to the sales ledger total:

- Initial sales ledger balances total = $86 450
- Error 1: Overcast in sales journal affects the control account total only (no effect on individual customer accounts).
- Error 2: The customer was credited with $540 instead of $450 (understating their balance by $90). To correct, add $90 ($540 - $450).
- Error 3: Entered in the customer's account correctly; only omitted from the control account (no adjustment to individual balance).
- Error 4: Debit balance omitted from the list of balances; add $320.

$$\text{Correct sales ledger total} = \$86 450 + \$90 + \$320 = \$86 860$$

D is correct [1].

- Option A incorrectly deducts the sales journal overcast ($1 200).
- Option B incorrectly deducts the contra entry ($680).
- Option C incorrectly subtracts the $90 correction instead of adding it.

1. Initial number of ordinary shares = \(\frac{\$400 000}{\$0.50} = 800 000\) shares.
2. Rights issue:
- Number of rights shares = \(\frac{800 000}{4} = 200 000\) shares.
- Premium per share = \(\text{Issue price } (\$0.80) - \text{Nominal value } (\$0.50) = \$0.30\).
- Increase in share premium = \(200 000 \times \$0.30 = \$60 000\).
- Share premium before bonus issue = \(\$120 000 + \$60 000 = \$180 000\).
3. Bonus issue:
- Total shares after rights issue = \(800 000 + 200 000 = 1 000 000\) shares.
- Bonus shares issued = \(\frac{1 000 000}{5} = 200 000\) shares.
- Total nominal value of bonus shares = \(200 000 \times \$0.50 = \$100 000\).
- Maintaining reserves in their most flexible form requires utilising non-distributable capital reserves (share premium) before revenue reserves (retained earnings).
- Share premium utilised = $100 000.
4. Closing share premium balance = \(\$180 000 - \$100 000 = \$80 000\).

B is correct [1].

- Option A ($20 000) omits the share premium created on the rights issue ($120 000 - $100 000).
- Option C ($100 000) incorrectly calculates bonus shares on pre-rights issue shares (800 000 / 5 = 160 000 shares \(\times\) $0.50 = $80 000; $180 000 - $80 000).
- Option D ($180 000) assumes the bonus issue was funded entirely from retained earnings.

1. Profit for the year = $75 000
2. Add interest on drawings:
- Faye: \(6\% \times \$15 000 = \$900\)
- George: \(6\% \times \$10 000 = \$600\)
- Total interest on drawings = $1 500
- Profit available = \(\$75 000 + \$1 500 = \$76 500\)
3. Less interest on capital:
- Faye: \(5\% \times \$80 000 = \$4 000\)
- George: \(5\% \times \$50 000 = \$2 500\)
- Total interest on capital = $6 500
4. Less partner salary:
- George: $12 000
5. Residual profit = \(\$76 500 - \$6 500 - \$12 000 = \$58 000\)
6. George's share of residual profit = \(\frac{2}{5} \times \$58 000 = \$23 200\).

B is correct [1].

- Option A ($22 000) incorrectly deducts interest on drawings instead of adding it ($55 000 \(\times\) 2/5).
- Option C ($34 800) is Faye's share of residual profit ($58 000 \(\times\) 3/5).
- Option D ($37 700) is George's total income appropriation (Salary $12 000 + Interest on capital $2 500 + Profit share $23 200).

1. Gross profit margin is 25%, so Cost of sales is \(75\% \times \$480 000 = \$360 000\).
2. Calculate credit purchases:
$$\text{Cost of sales} = \text{Opening inventory} + \text{Purchases} - \text{Closing inventory}$$
$$\$360 000 = \$35 000 + \text{Purchases} - \$40 000$$
$$\text{Purchases} = \$360 000 + \$5 000 = \$365 000$$
3. Calculate trade payables turnover:
$$\text{Trade payables turnover (days)} = \left(\frac{\text{Trade payables}}{\text{Credit purchases}}\right) \times 365$$
$$\text{Trade payables turnover} = \left(\frac{\$42 000}{\$365 000}\right) \times 365 = 42.0\text{ days}$$

B is correct [1].

- Option A (31.9 days) incorrectly uses Revenue in the denominator ($42 000 / $480 000 \(\times\) 365).
- Option C (42.6 days) incorrectly uses Cost of sales in the denominator ($42 000 / $360 000 \(\times\) 365).
- Option D (43.2 days) incorrectly subtracts closing inventory change ($360 000 - $5 000 = $355 000 purchases; $42 000 / $355 000 \(\times\) 365).

Perpetual AVCO calculation:

1. 1 March: 200 units @ $15.00 = $3 000
2. 8 March purchase: 300 units @ $18.00 = $5 400
Total before sale: 500 units = $8 400
Weighted average cost per unit = \(\frac{\$8 400}{500} = \$16.80\)
3. 15 March sale: 350 units @ $16.80 = $5 880
Remaining inventory: 150 units @ $16.80 = $2 520
4. 22 March purchase: 250 units @ $20.00 = $5 000
Total after purchase: \(150 + 250 = 400\) units
Total value = \(\$2 520 + \$5 000 = \$7 520\)
New weighted average cost per unit = \(\frac{\$7 520}{400} = \$18.80\)
5. 28 March sale: 200 units @ $18.80 = $3 760
Closing inventory at 31 March = \(400 - 200 = 200\) units @ $18.80 = $3 760.

B is correct [1].

- Option A ($3 573) uses periodic weighted average cost across all purchases ($13 400 / 750 units = $17.867; 200 units \(\times\) $17.867).
- Option C ($4 000) uses FIFO (200 units \(\times\) $20.00).
- Option D ($5 000) represents the cost of the last batch purchased on 22 March.

1. Calculate contribution per unit:
- Product X: \(\$55 - (\$16 + \$15 + \$8) = \$55 - \$39 = \$16\)
- Product Y: \(\$72 - (\$24 + \$18 + \$12) = \$72 - \$54 = \$18\)
- Product Z: \(\$85 - (\$20 + \$22 + \$13) = \$85 - \$55 = \$30\)

2. Direct material (kg) required per unit (at $4 per kg):
- Product X: \(\frac{\$16}{\$4} = 4\text{ kg}\)
- Product Y: \(\frac{\$24}{\$4} = 6\text{ kg}\)
- Product Z: \(\frac{\$20}{\$4} = 5\text{ kg}\)

3. Contribution per kg of direct material:
- Product X: \(\frac{\$16}{4\text{ kg}} = \$4.00\text{ per kg} \rightarrow \text{2nd}\)
- Product Y: \(\frac{\$18}{6\text{ kg}} = \$3.00\text{ per kg} \rightarrow \text{3rd}\)
- Product Z: \(\frac{\$30}{5\text{ kg}} = \$6.00\text{ per kg} \rightarrow \text{1st}\)

4. Allocate 17 000 kg according to ranking:
- 1st (Product Z): 1 000 units \(\times 5\text{ kg} = 5 000\text{ kg}\) (12 000 kg remaining)
- 2nd (Product X): 1 500 units \(\times 4\text{ kg} = 6 000\text{ kg}\) (6 000 kg remaining)
- 3rd (Product Y): \(\frac{6 000\text{ kg}}{6\text{ kg per unit}} = 1 000\text{ units}\)

Optimal production: X = 1 500 units; Y = 1 000 units; Z = 1 000 units.

B is correct [1].

- Option A ranks by contribution per unit (Z 1st, Y 2nd, X 3rd), resulting in Z = 1 000, Y = 1 400 (8 400 kg), X = (3 600 / 4) = 900 units.
- Option C produces X and Y first and allocates remaining material to Z.
- Option D produces arbitrary rounded quantities without optimal ranking.

1. Calculate annual depreciation charge:
\(\text{Annual depreciation} = \frac{\text{Cost} - \text{Residual value}}{\text{Useful life}} = \frac{\$48\,000 - \$8\,000}{5} = \$8\,000\text{ per year}\)

2. Calculate total accumulated depreciation up to 30 September 2024 (2 years and 9 months = 33 months):
- Year 2022 (12 months): \(\$8\,000\)
- Year 2023 (12 months): \(\$8\,000\)
- Year 2024 (9 months): \(\frac{9}{12} \times \$8\,000 = \$6\,000\)
\(\text{Total accumulated depreciation} = \$8\,000 + \$8\,000 + \$6\,000 = \$22\,000\)

3. Calculate the carrying amount at the date of disposal:
\(\text{Carrying amount} = \$48\,000 - \$22\,000 = \$26\,000\)

4. Calculate profit or loss on disposal:
\(\text{Profit/(Loss) on disposal} = \text{Disposal proceeds} - \text{Carrying amount} = \$24\,500 - \$26\,000 = -\$1\,500\) (Loss of \(\$1\,500\)).

A is correct [1 mark].
B is incorrect (treated the difference as a profit).
C is incorrect (omitted the residual value when calculating depreciation: carrying amount \(\$21\,600\), profit \(\$2\,900\)).
D is incorrect (omitted depreciation for 2024: carrying amount \(\$32\,000\), loss \(\$7\,500\)).

Sales ledger control account corrections:
- Draft debit balance: \(\$54\,200\)
- Error 1: Sales day book overcast (reduce balance): \(-\$1\,400\)
- Error 2: Irrecoverable debt not recorded (credit control account): \(-\$850\)
- Error 3: Contra entered on debit instead of credit (correct with \(2 \times \$620\)): \(-\$1\,240\)
- Error 4: Cash under-credited by \(\$310 - \$130 = \$180\) (credit control account): \(-\$180\)

\(\text{Corrected balance} = \$54\,200 - \$1\,400 - \$850 - \$1\,240 - \$180 = \$50\,530\).

A is correct [1 mark].
B is incorrect (only corrected the contra by \(\$620\) once instead of \(\$1\,240\)).
C is incorrect (added back the under-credited cash of \(\$180\) and corrected contra by single amount).
D is incorrect (omitted the contra adjustment entirely).

1. Existing number of shares = \(\frac{\$200\,000}{\$0.50} = 400\,000\text{ shares}\).

2. Rights issue:
- Shares issued = \(\frac{400\,000}{4} = 100\,000\text{ shares}\).
- Premium per share = \(\$0.80 - \$0.50 = \$0.30\).
- Premium received = \(100\,000 \times \$0.30 = \$30\,000\).
- Share premium before bonus issue = \(\$60\,000 + \$30\,000 = \$90\,000\).

3. Bonus issue:
- Total shares held after rights issue = \(400\,000 + 100\,000 = 500\,000\text{ shares}\).
- Bonus shares issued = \(\frac{500\,000}{5} = 100\,000\text{ shares}\).
- Nominal value of bonus issue = \(100\,000 \times \$0.50 = \$50\,000\).
- To maintain reserves in their most flexible form, the capital reserve (share premium) is utilised before revenue reserves.

4. Share premium balance at 30 June 2025 = \(\$90\,000 - \$50\,000 = \$40\,000\).

B is correct [1 mark].
A is incorrect (calculated bonus issue on nominal value of \(\$0.80\) per share).
C is incorrect (omitted the additional premium from the rights issue, \(\$60\,000 - \$50\,000 = \$10\,000\), or subtracted bonus from rights premium only).
D is incorrect (did not deduct the bonus issue from the share premium account).

1. Appropriation of profit:
- Profit for the year: \(\$68\,000\)
- Add: Interest on drawings (\(\$600 + \$400\)): \(+\$1\,000\)
- Less: Partner salary to Y: \(-\$12\,000\)
- Less: Interest on capital (X: \(5\% \times 80\,000 = 4\,000\); Y: \(5\% \times 50\,000 = 2\,500\)): \(-\$6\,500\)
\(\text{Residual profit} = \$68\,000 + \$1\,000 - \$12\,000 - \$6\,500 = \$50\,500\)

2. Y's share of residual profit = \(\frac{2}{5} \times \$50\,500 = \$20\,200\).

3. Y's Current Account:
- Opening debit balance: \(-\$3\,400\)
- Salary: \(+\$12\,000\)
- Interest on capital: \(+\$2\,500\)
- Share of residual profit: \(+\$20\,200\)
- Drawings: \(-\$18\,000\)
- Interest on drawings: \(-\$400\)
\(\text{Closing balance} = -\$3\,400 + \$12\,000 + \$2\,500 + \$20\,200 - \$18\,000 - \$400 = +\$12\,900\) (Credit).

A is correct [1 mark].
B is incorrect (added the interest on drawings to the current account instead of deducting it).
C is incorrect (treated the opening current account balance as a credit balance instead of a debit balance).
D is incorrect (omitted drawings from the current account calculation).

1. Calculate average inventory:
\(\text{Average inventory} = \frac{\$42\,000 + \$54\,000}{2} = \$48\,000\)

2. Calculate cost of sales:
\(\text{Rate of inventory turnover} = \frac{\text{Cost of sales}}{\text{Average inventory}} = 6\)
\(\text{Cost of sales} = 6 \times \$48\,000 = \$288\,000\)

3. Calculate revenue:
\(\text{Gross profit margin} = 25\% \implies \text{Cost of sales} = 100\% - 25\% = 75\%\text{ of revenue}\)
\(\text{Revenue} = \frac{\text{Cost of sales}}{0.75} = \frac{\$288\,000}{0.75} = \$384\,000\).

C is correct [1 mark].
A is incorrect (applied \(75\%\) directly as a multiplier on cost of sales).
B is incorrect (treated the \(25\%\) margin as a mark-up: \(\$288\,000 \times 1.25 = \$360\,000\)).
D is incorrect (calculated cost of sales using closing inventory instead of average inventory: \(54\,000 \times 6 = 324\,000 / 0.75 = 432\,000\)).

1. Total units available for sale during the period:
\(200 + 300 + 500 = 1\,000\text{ units}\)

2. Total cost of units available for sale:
- 1 Jan: \(200 \times \$12.00 = \$2\,400\)
- 8 Jan: \(300 \times \$14.00 = \$4\,200\)
- 22 Jan: \(500 \times \$15.00 = \$7\,500\)
\(\text{Total cost} = \$2\,400 + \$4\,200 + \$7\,500 = \$14\,100\)

3. Periodic weighted average cost per unit:
\(\text{Weighted average cost per unit} = \frac{\$14\,100}{1\,000} = \$14.10\)

4. Units in closing inventory:
\(1\,000 - (350 + 250) = 400\text{ units}\)

5. Value of closing inventory:
\(400 \times \$14.10 = \$5\,640\).

B is correct [1 mark].
A is incorrect (valued closing units using simple average of purchase prices: \(\frac{12+14+15}{3} \times 400 = \$5\,600\)).
C is incorrect (used perpetual moving average cost).
D is incorrect (used FIFO valuation: \(400 \times \$15.00 = \$6\,000\)).

1. Calculate the predetermined overhead absorption rate (OAR):
\(\text{OAR} = \frac{\text{Budgeted overheads}}{\text{Budgeted direct labour hours}} = \frac{\$360\,000}{45\,000} = \$8.00\text{ per direct labour hour}\)

2. Calculate overhead absorbed during the period:
\(\text{Overhead absorbed} = \text{Actual hours} \times \text{OAR} = 48\,500 \times \$8.00 = \$388\,000\)

3. Calculate under- or over-absorption:
\(\text{Over-absorption} = \text{Overhead absorbed} - \text{Actual overhead incurred} = \$388\,000 - \$378\,000 = \$10\,000\text{ (Over-absorbed)}\).

A is correct [1 mark].
B is incorrect (calculated the amount correctly but stated under-absorbed).
C is incorrect (calculated the expenditure variance \(\$378\,000 - \$360\,000 = \$18\,000\)).
D is incorrect (calculated volume variance \(48\,500 - 45\,000 = 3\,500 \times \$8 = \$28\,000\)).

1. Contribution per unit:
- Alpha: \(\$52 - (\$16 + \$14 + \$6) = \$52 - \$36 = \$16\)
- Beta: \(\$68 - (\$24 + \$18 + \$8) = \$68 - \$50 = \$18\)

2. Material required per unit (at \(\$4\) per kg):
- Alpha: \(\frac{\$16}{\$4} = 4\text{ kg}\)
- Beta: \(\frac{\$24}{\$4} = 6\text{ kg}\)

3. Contribution per kg of limiting factor:
- Alpha: \(\frac{\$16}{4\text{ kg}} = \$4.00\text{ per kg}\) (Rank 1)
- Beta: \(\frac{\$18}{6\text{ kg}} = \$3.00\text{ per kg}\) (Rank 2)

4. Optimal production plan:
- Produce all 1 500 units of Alpha: Material used = \(1\,500 \times 4\text{ kg} = 6\,000\text{ kg}\).
Contribution from Alpha = \(1\,500 \times \$16 = \$24\,000\).
- Remaining material for Beta = \(9\,000\text{ kg} - 6\,000\text{ kg} = 3\,000\text{ kg}\).
Units of Beta produced = \(\frac{3\,000\text{ kg}}{6\text{ kg}} = 500\text{ units}\).
Contribution from Beta = \(500 \times \$18 = \$9\,000\).

5. Total contribution = \(\$24\,000 + \$9\,000 = \$33\,000\).

B is correct [1 mark].
A is incorrect (produced Beta first instead of Alpha: 1 200 units Beta = 7 200 kg, 450 units Alpha = 1 800 kg; contribution \(1\,200 \times 18 + 450 \times 16 = \$28\,800\), or only producing Beta: \(9\,000 / 6 \times 18 = \$27\,000\)).
C is incorrect (calculated contribution assuming 9 000 kg all used for Alpha at \(\$4\) per kg = \(\$36\,000\) ignoring demand cap of 1 500 units).
D is incorrect (calculated total unconstrained contribution if all demand could be satisfied: \(1\,500 \times 16 + 1\,200 \times 18 = \$45\,600\)).

1. Bonus issue:
- Existing shares = $400\,000$
- Bonus shares issued = $\frac{400\,000}{4} = 100\,000$ shares
- Nominal value of bonus issue = $100\,000 \times $0.50 = $50\,000$
- To keep reserves in their most flexible form (preserving distributable retained earnings), the bonus issue is fully funded from the share premium account.
- Share premium balance after bonus issue = $$50\,000 - \$50\,000 = \$0\$

2. Rights issue:
- Total shares in issue after bonus issue = \$400\,000 + 100\,000 = 500\,000\$ shares
- Rights shares issued = \$\frac{500\,000}{5} = 100\,000\$ shares
- Premium per share = $$0.80 - $0.50 = $0.30$
- Premium received = $100\,000 \times $0.30 = $30\,000$

Balance on share premium account = $$0 + $30\,000 = $30\,000$.

B is correct [1 mark].
A is incorrect ($100\,000 \times 0.20$).
C is incorrect (original balance unchanged).
D is incorrect ($50\,000 + 30\,000$, failing to deduct bonus issue).

1. Contribution per unit:
$$\text{Selling price} - \text{Total variable cost per unit} = \$45 - (\$16 + \$11 + \$3) = \$45 - \$30 = \$15$$

2. Total fixed costs:
$$\$140\,000 + \$70\,000 = \$210\,000$$

3. Required units for target profit:
$$\text{Required units} = \frac{\text{Total fixed costs} + \text{Target profit}}{\text{Contribution per unit}} = \frac{\$210\,000 + \$60\,000}{\$15} = \frac{\$270\,000}{\$15} = 18\,000\text{ units}$$.

C is correct [1 mark].
A is incorrect (break-even units = $210\,000 / 15 = 14\,000$).
B is incorrect (omits variable selling costs: $270\,000 / 18 = 15\,000$ or miscalculation).
D is incorrect (uses $300\,000 / 15 = 20\,000$).

1. Depreciation calculation:
- Cost (1 Jan 2022) = $80 000
- Year ended 31 Dec 2022 depreciation = $20\% \times $80\,000 = $16\,000$
- Carrying amount at 31 Dec 2022 = $$80\,000 - \$16\,000 = \$64\,000\$
- Year ended 31 Dec 2023 depreciation = \$20\% \times \$64\,000 = \$12\,800\$
- Carrying amount at 31 Dec 2023 = $$64\,000 - $12\,800 = $51\,200$
- Year of disposal (2024) depreciation = $0 (per business policy)

2. Profit or loss on disposal:
$$\text{Disposal proceeds} - \text{Carrying amount} = \$42\,500 - \$51\,200 = -\$8\,700$$

Therefore, there is a loss on disposal of $8 700.

A is correct [1 mark].
B is incorrect (treated as profit instead of loss).
C is incorrect (calculated by incorrectly charging depreciation in 2024).
D is incorrect (calculated using straight line depreciation).

1. Draft profit = $$148\,200\$

2. Adjustment for Error 1:
- The error was only made in the sales ledger (subsidiary ledger). The sales account in the general ledger was correctly credited from the sales journal. Profit is unaffected = $$0$.

3. Adjustment for Error 2:
- Repairs of $$1\,600\$ should be debited as an expense \$\rightarrow\$ reduces profit by $$1\,600$.
- Overcharged depreciation of $25\% \times $1\,600 = $400$ should be reversed $\rightarrow$ increases profit by $$400\$.
- Net impact = \$-\$1\,600 + \$400 = -\$1\,200\$.

4. Adjustment for Error 3:
- Discount received was debited instead of credited by $$850$. Correcting it requires a credit entry of $2 \times $850 = $1\,700$ to discount received $\rightarrow$ increases profit by $$1\,700\$.

$$\text{Corrected profit} = \$148\,200 - \$1\,200 + \$1\,700 = \$148\,700$$.

C is correct [1 mark].
A is incorrect ($148\,200 - 1\,200$).
B is incorrect ($148\,200 - 1\,200 + 850$).
D is incorrect ($148\,200 + 1\,400$ or miscalculating Error 1).

1. Predetermined overhead absorption rate (OAR):
$$\text{OAR} = \frac{\text{Budgeted overheads}}{\text{Budgeted direct labour hours}} = \frac{\$360\,000}{45\,000\text{ hours}} = \$8.00\text{ per direct labour hour}$$

2. Overheads absorbed:
$$\text{Overheads absorbed} = \text{Actual direct labour hours} \times \text{OAR} = 48\,500 \times \$8.00 = \$388\,000$$

3. Under/over-absorption:
$$\text{Overheads absorbed} - \text{Actual overheads incurred} = \$388\,000 - \$378\,000 = +\$10\,000$$

Because absorbed overheads exceeded actual overheads incurred, overheads were over-absorbed by $10 000.

A is correct [1 mark].
B is incorrect (labelled as under-absorbed).
C is incorrect (actual overheads minus budgeted overheads: $378\,000 - 360\,000 = 18\,000$).
D is incorrect ($18\,000$ expenditure difference labelled as under-absorbed).

1. Average inventory:
$$\text{Average inventory} = \frac{\$38\,000 + \$42\,000}{2} = \$40\,000$$

2. Cost of sales:
$$\text{Cost of sales} = \text{Rate of inventory turnover} \times \text{Average inventory} = 6 \times \$40\,000 = \$240\,000$$

3. Revenue:
$$\text{Gross profit margin} = 20\% \implies \text{Cost of sales} = 100\% - 20\% = 80\%\text{ of Revenue}$$
$$\text{Revenue} = \frac{\text{Cost of sales}}{0.80} = \frac{\$240\,000}{0.80} = \$300\,000$$.

B is correct [1 mark].
A is incorrect ($240\,000 \times 1.20 = 288\,000$, using mark-up instead of margin).
C is incorrect ($240\,000 / 0.75 = 320\,000$).
D is incorrect ($300\,000 / 0.80$ or misapplying formulas).

### (a) Updated Cash Book (Bank columns only)

$$
\begin{array}{llr|llr}
\textbf{Date} & \textbf{Details} & \textbf{\$} & \textbf{Date} & \textbf{Details} & \textbf{\$}\\ \hline
\text{2025} & & & \text{2025} & & \\
\text{Mar 31} & \text{Balance b/d} & 4\,280 & \text{Mar 31} & \text{Bank charges} & 85 \\
\text{Mar 31} & \text{A. Patel (Direct credit)} & 620 & \text{Mar 31} & \text{Insurance (Standing order)} & 340 \\
\text{Mar 31} & \text{Trade supplier (Error correction: } 840 - 480) & 360 & \text{Mar 31} & \text{J. Evans (Dishonoured cheque)} & 215 \\
& & & \text{Mar 31} & \text{Balance c/d} & 4\,620 \\
\hline
& & \mathbf{5\,260} & & & \mathbf{5\,260} \\
\hline
\text{Apr 1} & \text{Balance b/d} & 4\,620 & & & \\
\end{array}
$$

---

### (b) Bank Reconciliation Statement as at 31 March 2025

$$
\begin{array}{lrr}
\textbf{Bank Reconciliation Statement as at 31 March 2025} & \textbf{\$} & \textbf{\$} \\
\hline
\text{Balance as per bank statement (credit)} & & 4\,395 \\
\text{Add: Uncredited deposits} & 1\,190 & \\
\text{Add: Bank error (cheque incorrectly debited)} & 310 & 1\,500 \\
\hline
& & 5\,895 \\
\text{Less: Unpresented cheques} & & (1\,275) \\
\hline
\textbf{Balance as per updated cash book} & & \mathbf{4\,620} \\
\hline
\end{array}
$$

*(Note: Alternative starting from updated cash book balance $4 620 to arrive at bank statement balance $4 395 is equally acceptable).*

---

### (c) Differences between a timing difference and an accounting error

1. Resolution / Correction: Timing differences arise due to the time lag between when a transaction is processed by the business and when it is cleared by the bank (e.g., unpresented cheques, uncredited deposits); they resolve themselves automatically over time. Errors (e.g., entering incorrect amounts or wrong accounts) do not resolve automatically and require deliberate corrective entries.
2. Accounting Treatment: Timing differences are adjusted only in the bank reconciliation statement and do not affect ledger accounts. Errors in the business's own records must be corrected directly in the cash book/ledger accounts.

---

### (d) Advice on Monthly Bank Reconciliations

Advantages of monthly reconciliation:
- Errors made by the business or the bank (such as incorrect debits) are detected and rectified promptly.
- Increases internal control and reduces the risk of undetected fraud or misappropriation of funds.
- Ensures the business has an accurate, up-to-date knowledge of available cash balances, preventing overdraft charges or bounced cheques.
- Dishonoured cheques from customers are identified quickly, enabling prompt recovery action.

Disadvantages of monthly reconciliation:
- Requires extra management time and administrative cost.
- For very small businesses with low transaction volumes, the perceived administrative burden may be higher.

Conclusion/Advice:
Tariq should perform reconciliations on a monthly basis because the benefits of improved internal control, accurate cash management, and early fraud/error detection significantly outweigh the modest time required.

(a) Updated Cash Book (Max 5 marks):
- Opening balance $4 280 (Dr) (1)
- Direct credit $620 (Dr) (1)
- Error correction $360 (Dr) (1)
- Bank charges $85 and standing order $340 (Cr) (1 for both)
- Dishonoured cheque $215 (Cr) AND closing balance $4 620 (1OF - both required)

**(b) Bank Reconciliation Statement** (Max 4 marks):
- Opening balance $4 395 (1)
- Uncredited deposits $1 190 (1)
- Bank error $310 added (1)
- Unpresented cheques ($1 275) AND reconciled to cash book $4 620 (1OF)

(c) Differences (Max 2 marks):
- 1 mark for each valid difference explained (Max 2).

(d) Evaluative Advice (Max 4 marks):
- Max 2 marks for benefits of monthly reconciliation (e.g. early error/fraud detection, accurate cash visibility).
- Max 1 mark for drawbacks (e.g. extra time/workload).
- 1 mark for clear recommendation/decision justified by the arguments.

(a) General Journal entries:

1.
- Debit: Office equipment $1 800
- Credit: Office expenses $1 800

2.
- Debit: Maya (Trade receivables) $180
- Credit: Suspense $180
*(Working: $640 - $460 = $180)*

3.
- Debit: Suspense $520
- Credit: Purchases returns $520

4.
- Debit: Motor vehicle repairs $350
- Debit: Suspense $180
- Credit: Motor vehicles (cost) $530

5.
- Debit: Suspense $1 520
- Credit: Commission received $1 520
*(Working: $760 \times 2 = $1 520)*

---

(b) Suspense Account:

| Date | Details | $ | Date | Details | $ |
| :--- | :--- | :--- | :--- | :--- | :--- |
| 2025 | | | 2025 | | |
| Dec 31 | Purchases returns | 520 | Dec 31 | Difference on trial balance | 2 040 |
| Dec 31 | Motor vehicles / Repairs | 180 | Dec 31 | Maya | 180 |
| Dec 31 | Commission received | 1 520 | | | |
| | Total | 2 220 | | Total | 2 220 |

---

(c) Statement of Corrected Profit for the year ended 31 December 2025:

| Details | $ | $ |
| :--- | :--- | :--- |
| Draft profit for the year | | 42 800 |
| Add: | | |
| Office expenses overstated (Error 1) | 1 800 | |
| Purchases returns omitted (Error 3) | 520 | |
| Commission received correction (Error 5) | 1 520 | 3 840 |
| | | 46 640 |
| Less: | | |
| Motor vehicle repairs unrecorded (Error 4) | | (350) |
| Corrected profit for the year | | 46 290 |

(a) Journal entries [7 marks total]:
- Error 1: Debit Office equipment $1 800 and Credit Office expenses $1 800 (1)
- Error 2: Debit Maya / Trade receivables $180 and Credit Suspense $180 (1)
- Error 3: Debit Suspense $520 and Credit Purchases returns $520 (1)
- Error 4: Debit Motor vehicle repairs $350 (1), Debit Suspense $180 (1), Credit Motor vehicles (cost) $530 (1)
- Error 5: Debit Suspense $1 520 and Credit Commission received $1 520 (1)

**(b) Suspense Account [4 marks total]:**
- Opening balance (Difference on trial balance) $2 040 on credit side (1)
- Maya $180 on credit side (1)OF
- Purchases returns $520 on debit side (1)OF
- Motor vehicles / Repairs $180 AND Commission received $1 520 on debit side (1)OF

(c) Statement of corrected profit [4 marks total]:
- Draft profit $42 800 with addition of Office expenses $1 800 (1)
- Addition of Purchases returns $520 (1)
- Deduction of Motor vehicle repairs $350 (1)
- Addition of Commission received $1 520 and final corrected profit $46 290 (1)OF

(a) Contribution per unit:

$$\begin{array}{lrrr}
\hline
& \text{Product X} & \text{Product Y} & \text{Product Z} \\
& \$ & \$ & \$ \\
\hline
\text{Selling price} & 85 & 110 & 140 \\
\text{Less Variable costs:} & & & \\
\text{Direct material} & (20) & (32) & (44) \\
\text{Direct labour} & (24) & (36) & (48) \\
\text{Variable overheads} & (10) & (15) & (20) \\
\hline
\text{Total variable cost} & 54 & 83 & 112 \\
\hline
\textbf{Contribution per unit} & \mathbf{31} & \mathbf{27} & \mathbf{28} \\
\hline
\end{array}$$

---

(b)(i) Total direct labour hours required:

$$\begin{array}{lllr}
\text{Direct labour hours per unit:} & & & \\
\text{Product X} & = \$24 / \$12 & = & 2.0\text{ hours} \\
\text{Product Y} & = \$36 / \$12 & = & 3.0\text{ hours} \\
\text{Product Z} & = \$48 / \$12 & = & 4.0\text{ hours} \\
\end{array}$$

$$\begin{array}{lrr}
\text{Total hours required:} & & \\
\text{Product X: } 1\,200\text{ units} \times 2.0\text{ hours} & = & 2\,400\text{ hours} \\
\text{Product Y: } 1\,500\text{ units} \times 3.0\text{ hours} & = & 4\,500\text{ hours} \\
\text{Product Z: } 1\,000\text{ units} \times 4.0\text{ hours} & = & 4\,000\text{ hours} \\
\hline
\textbf{Total labour hours required} & = & \mathbf{10\,900\text{ \textbf{hours}}} \\
\hline
\end{array}$$

(b)(ii) Limiting factor:
Direct labour hours represent a limiting factor (bottleneck) because the total hours required to satisfy full market demand (10 900 hours) exceed the available supply of direct labour hours (8 500 hours) by 2 400 hours.

---

(c)(i) Ranking based on limiting factor:

$$\begin{array}{lrrr}
\hline
& \text{Product X} & \text{Product Y} & \text{Product Z} \\
\hline
\text{Contribution per unit} & \$31.00 & \$27.00 & \$28.00 \\
\text{Direct labour hours per unit} & 2.0\text{ hrs} & 3.0\text{ hrs} & 4.0\text{ hrs} \\
\text{Contribution per direct labour hour} & \$15.50 & \$9.00 & \$7.00 \\
\hline
\textbf{Ranking} & \mathbf{1^{\text{st}}} & \mathbf{2^{\text{nd}}} & \mathbf{3^{\text{rd}}} \\
\hline
\end{array}$$

(c)(ii) Optimum production schedule and monthly profit:

$$\begin{array}{lrrrr}
\hline
\text{Product} & \text{Units} & \text{Hours used} & \text{Unit Contribution} & \text{Total Contribution} \\
& & & \$ & \$ \\
\hline
\text{Product X } (1^{\text{st}}) & 1\,200 & 2\,400 & 31 & 37\,200 \\
\text{Product Y } (2^{\text{nd}}) & 1\,500 & 4\,500 & 27 & 40\,500 \\
\text{Product Z } (3^{\text{rd}}) & 400 & 1\,600 & 28 & 11\,200 \\
\hline
\textbf{Total} & & \mathbf{8\,500} & & \mathbf{88\,900} \\
\text{Less Fixed overheads} & & & & (75\,000) \\
\hline
\textbf{Budgeted profit} & & & & \mathbf{13\,900} \\
\hline
\end{array}$$

Working for Product Z units:
Hours remaining $= 8\,500 - (2\,400 + 4\,500) = 1\,600\text{ hours}$
Units produced $= 1\,600 / 4.0 = 400\text{ units}$

---

(d) Financial impact of buying in 600 units of Product Z:

$$\begin{array}{lrr}
\hline
\text{Selling price per unit} & & \$140 \\
\text{Less: Purchase cost per unit} & \$125 & \\
\quad\text{Additional packaging/handling cost} & \$3 & (128) \\
\hline
\textbf{Contribution per bought-in unit} & & \mathbf{\$12} \\
\hline
\end{array}$$

$$\begin{array}{lrr}
\text{Additional contribution from 600 units } (600 \times \$12) & = & \$7\,200 \\
\text{Original budgeted profit} & = & \$13\,900 \\
\hline
\textbf{Revised monthly profit } (\$13\,900 + \$7\,200) & = & \mathbf{\$21\,100} \\
\hline
\end{array}$$

*(Alternatively: Total Contribution $= $88\,900 + $7\,200 = $96\,100$; Profit $= $96\,100 - $75\,000 = $21\,100$)*

---

(e) Limitations of CVP analysis / marginal costing:
1. Constant selling price and variable cost assumption: CVP assumes selling prices and variable costs per unit remain constant regardless of output volume, ignoring potential economies of scale, bulk purchase discounts, or price reductions needed to sell higher volumes.
2. Linear cost behaviour / classification difficulty: It assumes costs can be split cleanly into purely fixed and variable elements, ignoring semi-variable costs, stepped fixed costs, and productivity changes (overtime rates or learning curve effects).

---

(f) Advice to directors:

Financial factors:
- Purchasing the 600 units yields a positive contribution of $12 per unit, generating an extra $7\,200 monthly profit (increasing profit from $13\,900 to $21\,100).
- Fixed costs remain unchanged and are fully covered.
- The contribution margin on bought-in units is $12/unit compared to $28/unit if made internally, but internal capacity is exhausted so no direct internal profit is sacrificed.

Non-financial factors:
- Quality control: The external supplier's quality must match Kestrel Ltd's standards; poor quality could damage the brand reputation.
- Reliability of delivery: Late deliveries could cause customer dissatisfaction and loss of repeat business.
- Customer satisfaction: Meeting the full market demand of 1 000 units ensures customers do not turn to competitors.
- Supplier dependency: The contractor might raise prices in subsequent periods once Kestrel becomes reliant on them.
- Confidentiality / IP: Sharing proprietary specifications with an outside supplier carries risks of imitation.

Conclusion/Recommendation:
The directors should accept the offer in the short term provided quality and delivery schedules are guaranteed via contract, as it increases profit by $7\,200 and protects market share while the company seeks to expand its own labour workforce.

(a) [3 marks]
- 1 mark for Product X contribution ($31)
- 1 mark for Product Y contribution ($27)
- 1 mark for Product Z contribution ($28)

**(b)(i)** [2 marks]
- 1 mark for calculating hours per unit: X = 2 hrs, Y = 3 hrs, Z = 4 hrs
- 1 mark for total demand hours = 10 900 hours

**(b)(ii)** [1 mark]
- 1 mark for explaining that hours required (10 900) exceed hours available (8 500) / resource is in shortage.

**(c)(i)** [3 marks]
- 1 mark for calculating contribution per DLH: X = $15.50, Y = $9.00, Z = $7.00
- 1 mark for correct ranking (1st X, 2nd Y, 3rd Z) based on contribution per DLH
- 1 mark for method / supporting division

(c)(ii) [5 marks]
- 1 mark for 1 200 units of Product X
- 1 mark for 1 500 units of Product Y
- 1 mark for 400 units of Product Z (OF)
- 1 mark for total contribution = $88 900 (OF)
- 1 mark for deducting fixed costs to get profit = $13 900 (OF)

(d) [5 marks]
- 1 mark for unit purchase + handling cost ($125 + $3 = $128)
- 1 mark for contribution per bought-in unit ($140 - $128 = $12)
- 1 mark for total extra contribution ($12 * 600 = $7 200)
- 1 mark for adding to original profit (or recalculating total contribution)
- 1 mark for final revised profit of $21 100 (OF)

**(e)** [4 marks]
- 2 marks for first limitation explained (1 mark for identification + 1 mark for development)
- 2 marks for second limitation explained (1 mark for identification + 1 mark for development)
*(Max 4 marks)*

**(f)** [7 marks]
- Up to 3 marks for financial arguments (positive contribution of $12/unit, increase in profit of $7 200, no fixed cost impact, comparisons).
- Up to 3 marks for non-financial arguments (quality control, delivery reliability, brand reputation, customer retention, dependency on external contractor).
- 1 mark for a clear, justified recommendation based on arguments presented.
(Max 7 marks)

(a) Manufacturing Account of Varnex Ltd for the year ended 31 December 2025

$$\begin{array}{lrr}
\text{\textbf{Raw materials:}} & & \\
\text{Opening inventory of raw materials} & 36\,400 & \\
\text{Add: Purchases of raw materials} & 215\,600 & \\
\text{Add: Carriage inwards} & 6\,800 & \\
\hline
& 258\,800 & \\
\text{Less: Closing inventory of raw materials} & (41\,800) & \\
\hline
\text{Cost of raw materials consumed} & & 217\,000 \\
\text{Direct factory wages} & & 148\,200 \\
\text{Royalties} & & 15\,000 \\
\hline
\textbf{Prime Cost} & & \mathbf{380\,200} \\
\text{\textbf{Factory Overheads:}} & & \\
\text{Indirect factory wages} & 42\,500 & \\
\text{Factory supervisor salary} & 31\,000 & \\
\text{Factory power and lighting} & 28\,400 & \\
\text{Rent and rates } (75\% \times \$40\,000) & 30\,000 & \\
\text{Depreciation of factory machinery} & 24\,000 & 155\,900 \\
\hline
& & 536\,100 \\
\text{Add: Opening work in progress} & & 18\,200 \\
\hline
& & 554\,300 \\
\text{Less: Closing work in progress} & & (21\,600) \\
\hline
\textbf{Cost of production} & & \mathbf{532\,700} \\
\text{Factory profit } (25\% \times \$532\,700) & & 133\,175 \\
\hline
\textbf{Transfer value to trading account} & & \mathbf{665\,875} \\
\hline
\end{array}$$

---

(b) Provision for Unrealised Profit Account

Workings:
- Opening unrealised profit in finished goods: $62\,500 \times \frac{25}{125} = $12\,500
- Closing unrealised profit in finished goods: $75\,000 \times \frac{25}{125} = $15\,000
- Increase in provision charged to profit or loss: $15\,000 - $12\,500 = $2\,500

$$\begin{array}{llr|llr}
\textbf{Date} & \textbf{Details} & \textbf{\$} & \textbf{Date} & \textbf{Details} & \textbf{\$}
\hline
2025 & & & 2025 & & \\
\text{Dec 31} & \text{Balance c/d} & 15\,000 & \text{Jan 1} & \text{Balance b/d} & 12\,500 \\
& & & \text{Dec 31} & \text{Income statement} & 2\,500 \\
\hline
& & 15\,000 & & & 15\,000 \\
\hline
& & & 2026 & & \\
& & & \text{Jan 1} & \text{Balance b/d} & 15\,000 \\
\end{array}$$

---

**(c) Statement of Profit or Loss for the year ended 31 December 2025**

$$\begin{array}{lrr}
\text{Revenue} & & 780\,000 \\
\text{\textbf{Cost of sales:}} & & \\
\text{Opening inventory of finished goods} & 62\,500 & \\
\text{Add: Transfer value from manufacturing account} & 665\,875 & \\
\hline
& 728\,375 & \\
\text{Less: Closing inventory of finished goods} & (75\,000) & (653\,375) \\
\hline
\textbf{Gross Profit} & & 126\,625 \\
\text{Factory profit} & 133\,175 & \\
\text{Less: Increase in provision for unrealised profit} & (2\,500) & 130\,675 \\
\hline
& & 257\,300 \\
\text{\textbf{Expenses:}} & & \\
\text{Administrative salaries} & 54\,000 & \\
\text{Office electricity} & 9\,600 & \\
\text{Rent and rates } (25\% \times \$40\,000) & 10\,000 & \\
\text{Office administrative expenses} & 16\,200 & \\
\text{Selling and distribution expenses} & 38\,900 & \\
\text{Depreciation of office equipment} & 6\,500 & (135\,200) \\
\hline
\textbf{Profit for the year} & & \mathbf{122\,100} \\
\hline
\end{array}$$

---

**(d) Reasons for adding factory profit:**
1. **Performance evaluation:** It enables management to evaluate the efficiency and profitability of the manufacturing department independently by treating it as a distinct profit centre.
2. **Commercial comparability:** It allows comparison between internal production costs and the market price at which the finished goods could be purchased from external suppliers to verify if internal manufacturing remains economically viable.

---

**(e) Advice on outsourcing:**

*Financial analysis:*
- Current internal cost of production = $532 700.
- External supplier purchase price = $600 000.
- Purchasing from the external supplier would increase costs by $67 300 per year ($600 000 - $532 700), thereby reducing annual profit by $67 300.
- Even if factory overheads contain some fixed costs that would continue, outsourcing currently shows an immediate adverse cost variance.

*Non-financial considerations:*
- **Quality control:** Varnex Ltd produces specialized valves; relying on an external supplier could jeopardize product standards and technical specifications.
- **Delivery and reliability:** Risk of production downtime if the supplier encounters delays or supply chain disruptions.
- **Staff redundancies:** Closing the factory could lead to redundancy payments and loss of skilled labour.

*Recommendation:* Varnex Ltd should **not** outsource manufacturing, as it is cheaper to manufacture internally by $67 300 per year and internal production retains full control over valve quality and delivery schedules.

(a) Manufacturing Account [10 marks]:
- Raw materials consumed: opening inventory + purchases + carriage inwards - closing inventory = $217 000 (1)
- Direct wages ($148 200) + Royalties ($15 000) (1)
- Prime Cost = $380 200 (1 OF)
- Indirect wages ($42 500) + Supervisor salary ($31 000) (1)
- Factory power ($28 400) + Factory rent ($30 000) (1)
- Depreciation of factory machinery ($24 000) (1)
- Total factory overheads = $155 900 (1 OF)
- Adjustment for WIP (+$18 200 - $21 600) to arrive at Cost of production $532 700 (1 OF)
- Factory profit calculated at 25% = $133 175 (1 OF)
- Transfer value = $665 875 (1 OF)

**(b) Provision for Unrealised Profit Account [3 marks]:**
- Opening balance b/d = $12 500 ($62 500 x 25/125) (1)
- Income statement transfer / increase = $2 500 (1 OF)
- Closing balance c/d = $15 000 ($75 000 x 25/125) (1 OF)

(c) Statement of Profit or Loss [5 marks]:
- Cost of sales correctly calculated ($653 375) and Gross Profit = $126 625 (1 OF)
- Factory profit ($133 175) less increase in provision ($2 500) = $130 675 (1 OF)
- Administrative expenses correctly totalled ($96 300) [salaries $54k + electricity $9.6k + rent $10k + admin exp $16.2k + dep $6.5k] (1)
- Selling and distribution expenses = $38 900 (1)
- Profit for the year = $122 100 (1 OF)

**(d) Reasons for factory profit [3 marks]:**
- 1 mark per valid reason explained up to 2 reasons (Max 2)
- 1 mark for clear reference to profit centre / market price comparability / prudence concepts (Max 1)

**(e) Evaluative Advice [4 marks]:**
- Financial comparison: internal cost $532 700 vs external $600 000 = extra cost $67 300 (1)
- Non-financial factors (e.g. quality risks, reliance on supplier, redundancy) (Max 2)
- Clear advice with justified conclusion (1)

(a) Calculations for the year ended 31 December 2025:

(i) Gearing ratio:
$$\text{Gearing} = \left( \frac{\text{Non-current liabilities}}{\text{Total capital employed}} \right) \times 100$$
$$\text{Gearing} = \left( \frac{\$300\,000}{\$1\,800\,000} \right) \times 100 = 16.67\%$$

(ii) Interest cover:
$$\text{Interest cover} = \frac{\text{Profit from operations}}{\text{Finance costs}} = \frac{\$318\,000}{\$18\,000} = 17.67\text{ times}$$

(iii) Earnings per share (EPS):
$$\text{EPS} = \frac{\text{Profit for the year}}{\text{Number of issued ordinary shares}} = \frac{\$300\,000}{800\,000} = \$0.375\text{ (or }\$0.38\text{)}$$

(iv) Price/earnings (P/E) ratio:
$$\text{P/E ratio} = \frac{\text{Market price per share}}{\text{EPS}} = \frac{\$2.40}{\$0.375} = 6.40\text{ times}$$

(v) Dividend cover:
$$\text{Dividend cover} = \frac{\text{Profit for the year}}{\text{Annual ordinary dividend}} = \frac{\text{\$300 000}}{\text{\$120 000}} = 2.50\text{ times}$$

---

(b) Forecasts under Option 1 (Share Issue):

- New profit from operations = $318 000 + $110 000 = $428 000
- Finance costs = $18 000
- Profit for the year = $428 000 - $18 000 = $410 000
- Total number of shares = 800 000 + 300 000 = 1 100 000 shares
- Total capital employed = $1 800 000 + $600 000 = $2 400 000
- Non-current liabilities = $300 000

(i) **Earnings per share (EPS):**
$$\text{EPS} = \frac{\$410\,000}{1\,100\,000} = \$0.3727\text{ (or }\$0.37\text{)}$$

(ii) **Gearing ratio:**
$$\text{Gearing} = \left( \frac{\$300\,000}{\$2\,400\,000} \right) \times 100 = 12.50\%$$

---

**(c) Forecasts under Option 2 (Debenture Issue):**

- New profit from operations = $318 000 + $110 000 = $428 000
- New finance costs = $18 000 + (8% \times $600 000) = $18 000 + $48 000 = $66 000
- Profit for the year = $428 000 - $66 000 = $362 000
- Total number of shares = 800 000 shares
- Total capital employed = $1 800 000 + $600 000 = $2 400 000
- Non-current liabilities = $300 000 + $600 000 = $900 000

(i) **Earnings per share (EPS):**
$$\text{EPS} = \frac{\$362\,000}{800\,000} = \$0.4525\text{ (or }\$0.45\text{)}$$

(ii) **Gearing ratio:**
$$\text{Gearing} = \left( \frac{\$900\,000}{\$2\,400\,000} \right) \times 100 = 37.50\%$$

---

**(d) Recommendation and Justification:**

**Option 1 (Share Issue):**
- *Advantages:* Lowers the gearing ratio from 16.67% to 12.50%, reducing financial risk; no fixed interest charge, which protects cash flow during downturns; no obligation to repay the capital.
- *Disadvantages:* Causes slight dilution of EPS (from $0.375 to $0.373); dilutes voting control and ownership rights of existing shareholders if not taken up proportionally; issue costs and underwriting fees may be high.

**Option 2 (Debenture Issue):**
- *Advantages:* Increases EPS significantly from $0.375 to $0.453 due to favourable financial leverage; does not dilute ownership or control of existing shareholders; debenture interest is tax-deductible (if corporation tax applies).
- *Disadvantages:* Increases gearing ratio significantly to 37.50%, increasing financial risk; incurs a fixed annual finance cost of $48 000 regardless of profitability; debentures must be repaid in 2035; debentures may require security/charge over company assets.

Decision/Advice:
Option 2 is recommended if the directors are confident in the stability of future operating cash flows and wish to maximize shareholder return (EPS rising to $0.45) without diluting control, provided gearing of 37.50% remains acceptable to lenders. Alternatively, Option 1 is recommended if the board prioritises financial stability and risk minimization over return.

(a) Ratios for year ended 31 December 2025 [10 marks]:
(i) Gearing = $\frac{300\,000}{1\,800\,000} \times 100$ (1) = 16.67% (1)
(ii) Interest cover = $\frac{318\,000}{18\,000}$ (1) = 17.67 times (1)
(iii) EPS = $\frac{300\,000}{800\,000}$ (1) = $0.375 or $0.38 (1)
(iv) P/E ratio = $\frac{2.40}{0.375\text{ OF}}$ (1) = 6.40 times (1OF)
(v) Dividend cover = $\frac{300\,000}{120\,000}$ (1) = 2.50 times (1)

(b) Option 1 forecasts [5 marks]:
(i) Profit for the year = $318 000 + $110 000 - $18 000 = $410 000 (1)
New number of shares = 1 100 000 (1)
EPS = $\frac{410\,000}{1\,100\,000} = $0.37$ (or 37.27c) (1OF)
(ii) Gearing = $\frac{300\,000}{2\,400\,000} \times 100$ (1) = 12.50% (1OF)

**(c) Option 2 forecasts [5 marks]:**
(i) Total interest = $18 000 + $48 000 = $66 000 (1)
Profit for the year = $428 000 - $66 000 = $362 000
EPS = $\frac{362\,000}{800\,000}$ (1) = $0.45$ (or 45.25c) (1OF)
(ii) Gearing = $\frac{900\,000}{2\,400\,000} \times 100$ (1) = 37.50% (1OF)

(d) Recommendation and Justification [5 marks]:
- Max 2 marks for discussion of Option 1 (dilution of control, reduction of gearing/risk, slight EPS drop).
- Max 2 marks for discussion of Option 2 (higher EPS, fixed interest burden, higher gearing of 37.50%, security over assets, no dilution of voting power).
- 1 mark for clear, justified advice/recommendation consistent with the analysis.

### (a) Explanation of Accounting Treatments

#### (i) Research and Development & Impairment (IAS 38 & IAS 36)
- Research costs: Under IAS 38, research expenditure of $45 000 cannot be capitalised and must be recognised as an expense in profit or loss in the period incurred.
- **Development costs & amortisation:** The $95 000 incurred from 1 May 2025 meets the criteria and is correctly capitalised. Correct amortisation for the 6-month period (1 July 2025 to 31 December 2025) is \(\frac{\$95\,000}{5} \times \frac{6}{12} = \$9\,500\). The draft amortisation charged was \(\frac{\$140\,000}{5} \times \frac{6}{12} = \$14\,000\). Amortisation was therefore overcharged by \(\$14\,000 - \$9\,500 = \$4\,500\), which must be credited back to profit or loss.
- Impairment (IAS 36): The recoverable amount is the higher of fair value less costs of disposal ($30 000) and value in use ($36 000), which is $36 000. An impairment loss of \(\$55\,000 - \$36\,000 = \$19\,000\) must be recognised as an expense in profit or loss.

#### (ii) Legal Claim (IAS 37)
- Under IAS 37, a provision must be recognised when:
1. There is a present obligation as a result of a past event (goods damaged in transit in September 2025);
2. It is probable that an outflow of resources embodying economic benefits will be required (75% probability); and
3. A reliable estimate can be made of the amount of the obligation ($80 000).
- Therefore, a provision of $80 000 must be recognised in the statement of profit or loss and presented as a current liability in the statement of financial position. Mere disclosure in the notes is incorrect.

#### (iii) Post-Reporting Period Events (IAS 10 & IAS 2)
- Flood damage to inventory: This is a non-adjusting event under IAS 10 because the flood occurred on 15 January 2026 and does not reflect conditions existing at the reporting date (31 December 2025). The inventory must remain valued at cost ($50 000) at 31 December 2025. If material, it should be disclosed by note.
- **Customer liquidation:** This is an adjusting event under IAS 10 because the customer's financial difficulties existed prior to 31 December 2025. An irrecoverable debt expense of $28 000 must be recognised in profit or loss and trade receivables reduced by $28 000.

---

### (b) Statement of Revised Profit for the Year Ended 31 December 2025

$$
\begin{array}{|l|r|}
\hline
\textbf{Item} & \textbf{\$} \\
\hline
\text{Draft profit for the year} & 480\,000 \\
\text{Less: Research expenditure expensed} & (45\,000) \\
\text{Add: Overcharged amortisation on development costs } (\$14\,000 - \$9\,500) & 4\,500 \\
\text{Less: Impairment loss on software licence } (\$55\,000 - \$36\,000) & (19\,000) \\
\text{Less: Provision for legal claim} & (80\,000) \\
\text{Less: Irrecoverable debt (customer insolvency)} & (28\,000) \\
\hline
\textbf{Revised profit for the year} & \mathbf{312\,500} \\
\hline
\end{array}
$$

*Workings:*
1. Development amortisation reversal: Draft = \(\$140\,000 / 5 \times 6/12 = \$14\,000\); Correct = \(\$95\,000 / 5 \times 6/12 = \$9\,500\); Difference = \(\$4\,500\).
2. Impairment: Carrying amount $55 000 less recoverable amount $36 000 (higher of $30 000 and $36 000) = $19 000.

---

### (c) Fundamental Principles of Ethics
Any three of the following:
1. Integrity: Being straightforward, honest, and truthful in all professional and business relationships.
2. Objectivity: Not allowing bias, conflict of interest, or undue influence of others to override professional judgments.
3. Professional competence and due care: Maintaining professional knowledge and skill at the required level and acting diligently in accordance with applicable standards.
4. Confidentiality: Respecting the confidentiality of information acquired as a result of professional relationships.
5. Professional behaviour: Complying with relevant laws and regulations and avoiding any conduct that discredits the profession.

---

### (d) Ethical Advice to the Financial Controller

- Evaluation of situation / Threats identified:
- The Financial Controller faces a self-interest threat (cash bonus) and an intimidation/undue pressure threat from the Managing Director.
- Accepting the Managing Director's request would violate the fundamental principle of integrity (producing false/misleading financial statements) and objectivity (subordinating judgment to financial self-interest).
- Failing to account for mandatory standards (IAS 38, IAS 36, IAS 37, IAS 10) produces misleading accounts that misstate profit, conceal covenant breaches from lenders, and mislead shareholders.

- Course of Action:
- The Financial Controller must refuse the cash bonus offer.
- The Financial Controller must insist on making all necessary adjustments to ensure the financial statements show a true and fair view in compliance with IAS.
- If the Managing Director continues to exert pressure, the matter should be escalated to the Audit Committee, the Board of Directors, or external auditors.
- If no corrective action is taken, legal/professional advice should be sought and resignation considered as a last resort.

- Final Advice: The Financial Controller must not accept the Managing Director's offer and must include all necessary adjustments in the financial statements.

(a) (i)
- 1 mark for stating research costs ($45 000) must be expensed in profit or loss under IAS 38 (1)
- 1 mark for stating development costs ($95 000) are capitalised and amortisation overcharged by $4 500 (1)
- 1 mark for identifying recoverable amount as higher of FV less costs to sell and value in use ($36 000) (1)
- 1 mark for calculating and stating impairment loss of $19 000 recognised in profit or loss under IAS 36 (1)
*(Max 4 marks)*

**(a) (ii)**
- 1 mark for stating criteria for provision: present legal/constructive obligation from past event (1)
- 1 mark for stating probable outflow of economic benefits (75% probability) and reliable estimate (1)
- 1 mark for concluding that provision of $80 000 must be recognised in profit or loss and as a current liability under IAS 37 (1)
(Max 3 marks)

(a) (iii)
- 1 mark for identifying flood damage as a non-adjusting event because condition arose after reporting date (1)
- 1 mark for stating inventory remains valued at cost ($50 000) at 31 Dec 2025 / note disclosure only (1)
- 1 mark for identifying customer liquidation as an adjusting event because financial difficulties existed before year-end (1)
- 1 mark for stating irrecoverable debt of $28 000 must be written off against profit and receivables reduced (1)
(Max 4 marks)

(b)
- Draft profit: $480 000 (1)
- Deduct research expenditure: ($45 000) (1)
- Add excess amortisation reversal: +$4 500 (1OF)
- Deduct software impairment: ($19 000) (1OF)
- Deduct legal provision: ($80 000) (1)
- Deduct irrecoverable debt: ($28 000) (1)
- Revised profit: $312 500 (1OF if at least 3 adjustments correct)
(Max 6 marks)

(c)
- 1 mark for each stated fundamental principle (Max 3 marks):
- Integrity (1)
- Objectivity (1)
- Professional competence and due care (1)
- Confidentiality (1)
- Professional behaviour (1)
(Max 3 marks)

(d)
- Discussion of threats (self-interest threat, intimidation threat) / breach of ethical principles (Max 2 marks)
- Discussion of impact on financial statements / misleading lenders and shareholders (Max 2 marks)
- Clear advice and recommended steps (refuse bonus, adjust accounts, escalate to audit committee/board) (1 mark)
(Max 5 marks)

(a) Cost driver definition:
A cost driver is any factor or activity that causes a change in the cost of an activity / causes overhead costs to be incurred (e.g. number of set-ups, orders processed).

---

(b) Traditional absorption costing:

(i) Direct labour hours:
* Valve X: \(4\,000 \times 1.5\text{ hours} = 6\,000\text{ hours}\)
* Valve Y: \(1\,000 \times 3.0\text{ hours} = 3\,000\text{ hours}\)
* Total direct labour hours = \(6\,000 + 3\,000 = 9\,000\text{ hours}\)

$$\text{Overhead Absorption Rate (OAR)} = \frac{\$270\,000}{9\,000\text{ hours}} = \$30\text{ per direct labour hour}$$

(ii) Total cost per unit and selling price per unit:

* Direct labour cost per unit:
* Valve X: \(1.5\text{ hours} \times \$12 = \$18\)
* Valve Y: \(3.0\text{ hours} \times \$12 = \$36\)

* Overhead per unit:
* Valve X: \(1.5\text{ hours} \times \$30 = \$45\)
* Valve Y: \(3.0\text{ hours} \times \$30 = \$90\)

* Unit cost and selling price schedule:

| | Valve X ($) | Valve Y ($) |
|---|---|---|
| Direct materials | 35.00 | 60.00 |
| Direct labour | 18.00 | 36.00 |
| Production overhead | 45.00 | 90.00 |
| Total unit cost | 98.00 | 186.00 |
| Mark-up (25%) | 24.50 | 46.50 |
| Selling price | 122.50 | 232.50 |

---

(c) Activity Based Costing (ABC):

(i) Cost driver rates:
* Machine set-ups: \(\frac{\$108\,000}{30 + 60} = \frac{\$108\,000}{90} = \$1\,200\text{ per set-up}\)
* Quality inspections: \(\frac{\$72\,000}{40 + 80} = \frac{\$72\,000}{120} = \$600\text{ per inspection}\)
* Material ordering: \(\frac{\$90\,000}{50 + 100} = \frac{\$90\,000}{150} = \$600\text{ per order}\)

(ii) Overhead allocation:

* Valve X:
* Set-ups: \(30 \times \$1\,200 = \$36\,000\)
* Inspections: \(40 \times \$600 = \$24\,000\)
* Material ordering: \(50 \times \$600 = \$30\,000\)
* Total overhead = \(\$90\,000\)
* Overhead per unit = \(\frac{\$90\,000}{4\,000\text{ units}} = \$22.50\)

* Valve Y:
* Set-ups: \(60 \times \$1\,200 = \$72\,000\)
* Inspections: \(80 \times \$600 = \$48\,000\)
* Material ordering: \(100 \times \$600 = \$60\,000\)
* Total overhead = \(\$180\,000\)
* Overhead per unit = \(\frac{\$180\,000}{1\,000\text{ units}} = \$180.00\)

* Total unit cost and selling price under ABC:

| | Valve X ($) | Valve Y ($) |
|---|---|---|
| Direct materials | 35.00 | 60.00 |
| Direct labour | 18.00 | 36.00 |
| Production overhead | 22.50 | 180.00 |
| Total unit cost | 75.50 | 276.00 |
| Mark-up (25%) | 18.88 | 69.00 |
| Selling price | 94.38 | 345.00 |
*(Note: Exact mark-up on Valve X is $18.875 leading to $94.375 or rounded to $94.38)*

---

**(d) Reasons for higher cost of Valve Y under ABC:**
1. **Batch size / Volume disparity:** Valve Y is produced in lower volume (1 000 units vs 4 000 units) but consumes a substantially higher proportion of batch-level activities (e.g. 66.7% of set-ups, 66.7% of inspections, and 66.7% of purchase orders). Under ABC, these support costs are spread over fewer units.
2. **Arbitrary volume-based distortion under traditional absorption:** Traditional absorption assumes overheads are driven solely by direct labour hours. Because Valve X accounts for \(\frac{6\,000}{9\,000}\) (66.7%) of direct labour hours, it was heavily subsidising the support costs incurred by Valve Y.

---

**(e) Recommendation and justification:**
* **Adoption benefits:** ABC gives more realistic and accurate product costing, eliminating cross-subsidisation. It reveals that Valve X was overpriced ($122.50 vs $94.38), causing uncompetitiveness, while Valve Y was severely underpriced ($232.50 vs $345.00), explaining the low profitability despite strong sales. Pricing decisions and cost control will be significantly improved.
* Drawbacks/Limitations: Implementing and operating ABC requires significant administrative time, complex data collection, and software costs. Identifying cost pools and drivers can still involve subjective judgement.
* Conclusion: The company should adopt ABC (or use ABC pricing data) to re-price Valve X competitively to regain market share and increase the price of Valve Y to reflect its true consumption of support resources.

(a) [2 marks]
* A factor / activity that causes or drives the incurrence of overhead costs (2).
(Partial: 1 mark for mentioning volume/basis without explicit causal relationship).

(b)(i) [2 marks]
* Total DLH = 9 000 (1)
* OAR = $30 per direct labour hour (1)

**(b)(ii)** [4 marks]
* Valve X Total Cost = $98.00 (1)
* Valve X Selling Price = $122.50 (1)OF
* Valve Y Total Cost = $186.00 (1)
* Valve Y Selling Price = $232.50 (1)OF

**(c)(i)** [3 marks]
* Machine set-ups = $1 200 per set-up (1)
* Quality inspections = $600 per inspection (1)
* Material ordering = $600 per order (1)

(c)(ii) [6 marks]
* Valve X total overhead = $90 000 / $22.50 per unit (1)
* Valve Y total overhead = $180 000 / $180.00 per unit (1)
* Valve X total cost = $75.50 (1)OF
* Valve X selling price = $94.38 or $94.375 (1)OF
* Valve Y total cost = $276.00 (1)OF
* Valve Y selling price = $345.00 (1)OF

(d) [4 marks]
* 1 mark for identifying each reason (max 2) + 1 mark for development/computational link (max 2):
* Valve Y consumes the majority (66.7%) of driver activities despite lower production volume (1) so support overheads are spread over fewer units (1).
* Traditional costing distorted costs / cross-subsidised Valve Y because direct labour hours allocated 66.7% of overheads to high-volume Valve X (1), ignoring the non-volume related drivers of overheads (1).

(e) [4 marks]
* Max 2 marks for benefits of adopting ABC (e.g. realistic cost/pricing, explains why Valve X is losing sales and Valve Y is underpriced).
* Max 2 marks for drawbacks/limitations (e.g. implementation cost, complexity, time-consuming data collection).
* 1 mark for clear advice supported by reasoned evaluation/computations (must be supported to gain final mark).

### (a) Calculations for Project Alpha

Net Annual Cash Flows:
- Year 1: $180 000 - $50 000 = $130 000
- Year 2: $220 000 - $70 000 = $150 000
- Year 3: $250 000 - $90 000 = $160 000
- Year 4: $200 000 - $80 000 = $120 000

---

#### (i) Payback Period
$$\begin{array}{|l|c|c|}
\hline
\textbf{Year} & \textbf{Net Cash Flow (\$)} & \textbf{Cumulative Cash Flow (\$)} \\
\hline
0 & (400\,000) & (400\,000) \\
1 & 130\,000 & (270\,000) \\
2 & 150\,000 & (120\,000) \\
3 & 160\,000 & 40\,000 \\
\hline
\end{array}$$

$$\text{Payback} = 2 \text{ years} + \left(\frac{120\,000}{160\,000} \times 12\right) \text{ months} = 2 \text{ years and } 9 \text{ months}$$

---

#### (ii) Accounting Rate of Return (ARR)
$$\text{Total Cash Inflows} = 130\,000 + 150\,000 + 160\,000 + 120\,000 = \$560\,000$$
$$\text{Total Depreciation} = \$400\,000$$
$$\text{Total Accounting Profit over 4 years} = \$560\,000 - \$400\,000 = \$160\,000$$
$$\text{Average Annual Profit} = \frac{\$160\,000}{4} = \$40\,000$$
$$\text{Average Investment} = \frac{\text{Initial Outlay} + \text{Residual Value}}{2} = \frac{\$400\,000 + \$0}{2} = \$200\,000$$
$$\text{ARR} = \left(\frac{\$40\,000}{\$200\,000}\right) \times 100 = 20.00\%$$

---

#### (iii) Net Present Value (NPV) at 10%
$$\begin{array}{|l|c|c|r|}
\hline
\textbf{Year} & \textbf{Net Cash Flow (\$)} & \textbf{Discount Factor (10\%)} & \textbf{Present Value (\$)} \\
\hline
0 & (400\,000) & 1.000 & (400\,000) \\
1 & 130\,000 & 0.909 & 118\,170 \\
2 & 150\,000 & 0.826 & 123\,900 \\
3 & 160\,000 & 0.751 & 120\,160 \\
4 & 120\,000 & 0.683 & 81\,960 \\
\hline
\textbf{Net Present Value} & & & \mathbf{+44\,190} \\
\hline
\end{array}$$

---

#### (iv) Internal Rate of Return (IRR)
Calculate NPV at 18%:
$$\begin{array}{|l|c|c|r|}
\hline
\textbf{Year} & \textbf{Net Cash Flow (\$)} & \textbf{Discount Factor (18\%)} & \textbf{Present Value (\$)} \\
\hline
0 & (400\,000) & 1.000 & (400\,000) \\
1 & 130\,000 & 0.847 & 110\,110 \\
2 & 150\,000 & 0.718 & 107\,700 \\
3 & 160\,000 & 0.609 & 97\,440 \\
4 & 120\,000 & 0.516 & 61\,920 \\
\hline
\textbf{Net Present Value} & & & \mathbf{(22\,830)} \\
\hline
\end{array}$$

$$\text{IRR} = a + \left[ \frac{N_a}{N_a - N_b} \right] \times (b - a)$$
$$\text{IRR} = 10\% + \left[ \frac{44\,190}{44\,190 - (-22\,830)} \right] \times (18\% - 10\%)$$
$$\text{IRR} = 10\% + \left[ \frac{44\,190}{67\,020} \right] \times 8\% = 10\% + (0.659355 \times 8\%) = 10\% + 5.27\% = 15.27\%$$

---

### (b) Advantages and Disadvantages of NPV compared to Payback

Advantages of NPV:
1. Time value of money: NPV discounts future cash flows, recognising that money received earlier is worth more than money received later, whereas Payback ignores the timing of cash flows within the payback period.
2. Total profitability / whole life: NPV considers all cash flows over the entire project lifespan, whereas Payback ignores all cash inflows occurring after the cut-off payback point.

Disadvantages of NPV:
1. Complexity: NPV is more difficult to understand and calculate than the simple Payback method.
2. Estimation of cost of capital: NPV relies heavily on choosing an accurate discount rate (cost of capital), which may fluctuate or be difficult to determine reliably.

---

### (c) Advice to Directors

Financial Factors in favour:
- The NPV is positive at +$44 190, which adds shareholder value.
- The IRR of 15.27% exceeds the company's cost of capital (10%) by 5.27 percentage points.
- ARR is 20.00%, representing a strong return on capital.
- The payback period is 2 years and 9 months, recovering the initial $400 000 well within the 4-year project life.

Non-Financial / Strategic Factors:
- Market demand & reputation: Biodegradable packaging aligns with increasing consumer demand and corporate sustainability targets, potentially enhancing brand image.
- Risk of obsolescence / technological failure: Automated technology carries risks of teething problems, maintenance downtime, and staff training requirements.
- Reliability of estimates: Forecasts of cash inflows may be overly optimistic given market competition.

Conclusion:
The directors should proceed with Project Alpha because it is financially viable across all appraisal metrics and positions the company strategically in a growing eco-friendly market.

(a)(i) Payback Period [3 marks]
- Annual net cash flows: $130k, $150k, $160k, $120k (1)
- Fraction of year 3: $120 000 / $160 000 (1)
- Correct payback: 2 years 9 months (or 2.75 years) (1)

(a)(ii) ARR [4 marks]
- Total profit: $160 000 (1)
- Average annual profit: $40 000 (1)OF
- Average investment: $200 000 (1)
- ARR = 20.00% (1)OF

**(a)(iii) NPV [4 marks]**
- Correct application of discount factors to net cash flows (1)
- Correct present values: $118 170, $123 900, $120 160, $81 960 (1)
- Total present value of inflows: $444 190 (1)OF
- Net Present Value: +$44 190 (1)OF

**(a)(iv) IRR [4 marks]**
- PV of cash flows at 18%: $377 170 (1)
- NPV at 18%: -$22 830 (1)
- Correct IRR formula substitution (1)OF
- Final IRR: 15.27% (1)OF

(b) NPV vs Payback [4 marks]
- 1 mark for each valid advantage explained (Max 2)
- 1 mark for each valid disadvantage explained (Max 2)

(c) Evaluative Advice [6 marks]
- Discussion of financial evidence (NPV, IRR, ARR, Payback) (Max 2)
- Discussion of non-financial/strategic factors (sustainability, training, reliability of estimates) (Max 2)
- Clear advice/recommendation supported by balanced justification (2)