O Level Principles of Accounts Practice Paper 5

TuitionGoWhere Practice Paper - Principles of Accounts O-Level

Practice Paper 5: Inventory Costing - ANSWER KEY

TuitionGoWhere Secondary School (AI) PRACTICE PAPER - MARKING SCHEME

Subject: Principles of Accounts (7087) Level: O-Level Paper: Practice Paper 5 (Inventory Costing) Total Marks: 50

Section A: Short Answer Questions (10 marks)

Question 1 (2 marks)

Concept: Prudence concept (1 mark)

Explanation: The prudence concept requires that assets and profits should not be overstated. Inventory is valued at the lower of cost and net realisable value to ensure that inventory is not recorded at an amount higher than what the business can recover from its sale. This prevents overstatement of assets in the statement of financial position and overstatement of profit in the income statement. (1 mark for clear explanation linking to prudence)

Award 1 mark for correctly identifying the concept and 1 mark for a clear explanation.

Question 2 (2 marks)

Working: Cost of sales = Opening inventory + Purchases − Closing inventory = $12,500 +$85,000 − $15,200 =$82,300

Answer: $82,300

Award 1 mark for correct formula/working and 1 mark for correct answer.

Question 3 (2 marks)

Answer: FIFO (First In First Out) assumes that the earliest (oldest) inventory purchased is sold first, so closing inventory consists of the most recently purchased goods. AVCO (Weighted Average Cost) calculates an average cost per unit after each purchase, and both cost of sales and closing inventory are valued at this average cost. (1 mark for each method correctly explained)

Award 1 mark for each method clearly explained. Accept variations that demonstrate understanding of the core difference.

Question 4 (2 marks)

Answer (any TWO of the following or similar valid reasons):

1. FIFO reflects the actual physical flow of goods for many businesses, especially those dealing in perishable items where older stock is sold first.
2. During periods of rising prices, FIFO results in a higher closing inventory value, which presents a stronger statement of financial position.
3. FIFO is simpler to understand and apply compared to AVCO.
4. FIFO is less susceptible to manipulation as it follows a clear chronological flow.

Award 1 mark for each valid reason. Maximum 2 marks.

Question 5 (2 marks)

Working: Net realisable value (NRV) = Estimated selling price − Costs to sell = $6,500 −$800 = $5,700

Lower of cost ($8,000) and NRV ($5,700) = $5,700

Answer: $5,700

Award 1 mark for correct NRV calculation and 1 mark for selecting the lower value.

Section B: Structured Questions (20 marks)

Question 6 (6 marks)

(a) FIFO Closing Inventory Valuation (3 marks)

Working: Total units available = 200 + 300 + 400 = 900 units Total units sold = 250 + 350 = 600 units Closing inventory units = 900 − 600 = 300 units

Under FIFO, closing inventory consists of the most recent purchases:

• 300 units from 22 March purchase @ $5.50 =$1,650

Answer: $1,650

Award 1 mark for correct closing units, 1 mark for correct FIFO identification of layers, 1 mark for correct valuation.

(b) AVCO Closing Inventory Valuation (3 marks)

Working: After 1 March: 200 units @ $4.50 =$900 After 8 March purchase: (200 × $4.50) + (300 ×$5.00) = $900 +$1,500 = $2,400 Average cost =$2,400 ÷ 500 = $4.80 per unit

After 15 March sale (250 units): Remaining = 250 units @ $4.80 =$1,200

After 22 March purchase: $1,200 + (400 ×$5.50) = $1,200 +$2,200 = $3,400 Average cost =$3,400 ÷ 650 = $5.2308 per unit

After 28 March sale (350 units): Remaining = 300 units @ $5.2308 =$1,569.24

Answer: $1,569.24

Award 1 mark for correct weighted average after first purchase, 1 mark for correct weighted average after second purchase, 1 mark for correct final valuation. Accept rounding to $1,569.23.

Question 7 (4 marks)

(a) Inventory Turnover Ratio (2 marks)

Working: 2023: Average inventory = ($18,000 +$22,000) ÷ 2 = $20,000 Inventory turnover =$96,000 ÷ $20,000 = 4.80 times

2024: Average inventory = ($22,000 +$19,500) ÷ 2 = $20,750 Inventory turnover =$108,000 ÷ $20,750 = 5.20 times

Award 1 mark for each correct ratio. Must show to two decimal places.

(b) Days Sales in Inventory (2 marks)

Working: 2023: 365 ÷ 4.80 = 76.04 days 2024: 365 ÷ 5.20 = 70.19 days

Award 1 mark for each correct calculation. Must show to two decimal places.

Question 8 (4 marks)

(a) Effect on Profit and Assets (2 marks)

Explanation:

• Error 1: Purchases not recorded means cost of sales is understated, so profit is overstated. Correcting this increases purchases/cost of sales, decreasing profit. Assets (inventory) were understated, so correction increases inventory (but the payment reduces cash/bank or increases payables, net effect on assets is a decrease of $1,200 as the liability/payment is recognised).
• Error 2: Goods sold but included in closing inventory means closing inventory is overstated, cost of sales is understated, and profit is overstated. Correcting this removes the goods from closing inventory, decreasing assets and decreasing profit.

Award 0.5 marks for each correct cell. Total 2 marks.

(b) Corrected Profit (2 marks)

Working: Reported profit = $45,000 Error 1: Profit was overstated by$1,200 → deduct $1,200 Error 2: Profit was overstated by$800 → deduct $800 Corrected profit =$45,000 − $1,200 −$800 = $43,000

Corrected Profit: $43,000

Award 1 mark for correct adjustments and 1 mark for correct final answer.

Question 9 (6 marks)

(a) Inventory Account (FIFO) (4 marks)

Inventory Account (FIFO)

Workings:

• Opening balance: 150 units × $10.00 =$1,500
• 5 Apr purchase: 200 units × $12.00 =$2,400
• 10 Apr sale (180 units): 150 units @ $10.00 + 30 units @$12.00 = $1,500 +$360 = $1,860 (Cost of sales)
• Remaining after 10 Apr: 170 units @ $12.00 =$2,040
• 18 Apr purchase: 250 units × $13.00 =$3,250
• 25 Apr sale (220 units): 170 units @ $12.00 + 50 units @$13.00 = $2,040 +$650 = $2,690 (Cost of sales)
• Closing inventory: 200 units @ $13.00 =$2,600

Note: The cost of sales entries above show $1,860 and$2,690. The answer key shows $1,800 and$2,540 which are slightly different. Accept either set of figures if workings are clearly shown and consistent. The closing balance of $2,810 in the answer key appears to use different cost layers. Markers should award full marks if the FIFO logic is correctly applied and the closing balance is correctly derived from the student's workings.

Award 1 mark for correct opening balance, 1 mark for correct purchases entries, 1 mark for correct cost of sales entries using FIFO, 1 mark for correct closing balance and balance brought down.

(b) Closing Inventory Value under FIFO (1 mark)

Answer: $2,600 (200 units ×$13.00)

Award 1 mark for correct answer consistent with part (a).

(c) Comparison with AVCO (1 mark)

Answer: Under AVCO, the closing inventory value would be lower than FIFO. This is because AVCO averages the lower earlier costs with the higher later costs, resulting in a lower average cost per unit compared to FIFO, where closing inventory consists of the most recent, higher-cost purchases.

Award 1 mark for stating "lower" with a valid explanation.

Section C: Scenario-Based Question (20 marks)

Question 10 (20 marks)

(a) Calculations (6 marks)

(i) Inventory turnover ratio (2 marks)

Working: Average inventory = ($85,000 +$92,000) ÷ 2 = $88,500 Inventory turnover ratio = Cost of sales ÷ Average inventory =$364,000 ÷ $88,500 = 4.11 times

Answer: 4.11 times

Award 1 mark for correct average inventory and 1 mark for correct ratio.

(ii) Days sales in inventory (2 marks)

Working: Days sales in inventory = 365 ÷ Inventory turnover ratio = 365 ÷ 4.11 = 88.81 days

Answer: 88.81 days

Award 1 mark for correct formula and 1 mark for correct answer.

(iii) Gross profit margin (2 marks)

Working: Gross profit margin = (Gross profit ÷ Revenue) × 100 = ($156,000 ÷$520,000) × 100 = 30.00%

Answer: 30.00%

Award 1 mark for correct formula and 1 mark for correct answer.

(b) Comparison of Inventory Management Performance (4 marks)

Answer should include:

Fresh Harvest's inventory turnover ratio of 4.11 times is lower than Green Fields' 5.2 times, indicating that Fresh Harvest is slower in selling and replacing its inventory. (1 mark)

Fresh Harvest's days sales in inventory of 88.81 days is higher than the industry average of 85 days, suggesting that Fresh Harvest holds inventory for longer than the industry norm. (1 mark)

The longer holding period is particularly concerning given the perishable nature of organic vegetables (7-day shelf life). The $8,000 write-off due to spoilage indicates inefficiency in inventory management. (1 mark)

Overall, Fresh Harvest's inventory management performance is weaker than both its competitor and the industry average. The company should take steps to improve inventory turnover and reduce holding periods to minimise spoilage and improve liquidity. (1 mark)

Award up to 4 marks for a well-structured comparison that uses the calculated figures and provided information. Must reference both Green Fields and the industry average.

(c) Switching from FIFO to AVCO (5 marks)

(i) Effect on Gross Profit (3 marks)

Working: Under FIFO: Cost of sales = $364,000, Gross profit =$156,000 Under AVCO: Closing inventory = $87,500 (instead of$92,000) Cost of sales under AVCO = Opening inventory + Purchases − Closing inventory Purchases = Cost of sales (FIFO) + Closing inventory (FIFO) − Opening inventory = $364,000 +$92,000 − $85,000 =$371,000 Cost of sales (AVCO) = $85,000 +$371,000 − $87,500 =$368,500 Gross profit (AVCO) = $520,000 −$368,500 = $151,500

Explanation: Switching to AVCO would decrease gross profit by $4,500 (from$156,000 to $151,500). This is because AVCO results in a lower closing inventory value ($87,500 vs $92,000), which increases the cost of sales and reduces gross profit. (1 mark for correct calculation, 1 mark for correct direction of change, 1 mark for clear explanation)

Award 1 mark for correct calculation of AVCO cost of sales/gross profit, 1 mark for stating gross profit decreases, 1 mark for explaining the reason.

(ii) Advantage and Disadvantage of AVCO (2 marks)

Advantage: AVCO smooths out price fluctuations by averaging costs, providing a more stable and consistent measure of inventory value and cost of sales over time. This reduces the impact of short-term price changes on reported profit. (1 mark)

Disadvantage: AVCO may not reflect the actual physical flow of perishable goods, where older stock is typically sold first to prevent spoilage. This could lead to inventory values that do not match the actual condition or age of the stock on hand. (1 mark)

Award 1 mark for a valid advantage and 1 mark for a valid disadvantage. Must be relevant to perishable goods.

(d) Just-in-Time (JIT) Inventory System (5 marks)

(i) Explanation of JIT (1 mark)

Answer: A just-in-time (JIT) inventory system is a method where inventory is ordered and received only when it is needed for production or sale, minimising the amount of inventory held in storage. The goal is to reduce holding costs and waste.

Award 1 mark for a clear and accurate explanation.

(ii) Recommendation (4 marks)

Recommendation: Fresh Harvest Pte Ltd should adopt a JIT inventory system. (1 mark for clear recommendation)

Reason 1 (Accounting factor): JIT would reduce inventory holding levels, which would lower storage costs and reduce the amount of capital tied up in inventory. This would improve the company's liquidity position, as seen by the declining cash at bank (from $23,000 to$15,000). Lower inventory levels would also reduce the risk of spoilage and the associated write-offs ($8,000 in 2024), directly improving profitability. (1.5 marks)

Reason 2 (Non-accounting factor): Given the perishable nature of organic vegetables (7-day shelf life), JIT would ensure that inventory is fresher when delivered to customers. This would improve customer satisfaction and the company's reputation for quality. Additionally, reducing waste from spoilage aligns with environmental sustainability goals, which is increasingly important to consumers and stakeholders. (1.5 marks)

Award up to 4 marks: 1 mark for a clear recommendation, 1.5 marks for each well-justified reason. Reasons must include both accounting and non-accounting factors. Accept other valid reasons such as improved cash flow, reduced insurance costs, better supplier relationships, etc.

END OF ANSWER KEY