Publishing
2013
ACCA F7 (INT)
Financial
Reporting
Exam Kit
emilewoolfpublishing.com
KIT
ACCA
EXAM
Paper
F7 (INT)
Financial Reporting
(International)
Publishing
Sixth edition published by
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© Emile Woolf Publishing Limited, January 2013
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Notice
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ISBN: 978‐1‐84843‐289‐5
Printed and bound in Great Britain.
Acknowledgements
The syllabus, study guide, exam questions and answers (where indicated) are
reproduced by kind permission of the Association of Chartered Certified Accountants.
ii
© Emile Woolf Publishing Limited
Paper F7 (INT)
Financial Reporting
c
Contents
Page
Questions and answers index
v
Syllabus and study guide
ix
Exam techniques
xxi
Section
1 Practice questions
1
A conceptual framework and a regulatory framework for financial reporting
1
Financial statements – Statements of cash flows
7
Financial statements – Preparation of accounts from a trial balance
25
Financial statements – Amendment of draft financial statements
46
Financial statements – Application of accounting standards
63
Business combinations – Statements of financial position
79
Business combinations – Statements of financial performance
100
Business combinations – Statements of financial position and performance
111
Analysing and interpreting financial statements
118
2 Answers to practice questions
131
A conceptual framework and a regulatory framework for financial reporting
131
Financial statements – Statements of cash flows
145
Financial statements – Preparation of accounts from a trial balance
169
Financial statements – Amendment of draft financial statements
203
Financial statements – Application of accounting standards
226
© Emile Woolf Publishing Limited
iii
iv
Business combinations – Statements of financial position
255
Business combinations – Statements of financial performance
287
Business combinations – Statements of financial position and performance
301
Analysing and interpreting financial statements
311
3
Mock exam questions
329
4
Answers to mock exam questions
335
© Emile Woolf Publishing Limited
Paper F7 (INT)
Financial Reporting
i
Questions and
answers index
Question
page
Answer
page
Exam
A conceptual framework and regulatory framework for financial reporting
1
Recost
1
131
2
Worthright
1
133
3
Revenue recognition
2
135
4
Angelino
3
137
5
Emerald
4
140
F7 D07
6
Conceptual Framework
5
141
F7 J08
7
Promoil (IAS 37)
5
143
F7 D08
8
Wardle
6
144
F7 J10
Financial statements – Statements of cash flows
9
Tabba
7
145
10
Boston
9
149
11
Planter
10
152
12
Casino
12
153
13
Minster
14
156
F7 J07 (amended)
14
Pinto
16
159
F7 J08
15
Coaltown
18
162
F7 J09
16
Crosswire
20
165
F7 D09
17
Deltoid
22
167
F7 J10
Financial statements – Preparation of accounts from a trial balance
18
Petra
25
169
19
Darius
26
172
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v
Paper F7: Financial Reporting (International)
Question
page
Answer
page
Exam
20
Danzig
28
175
21
Allgone
30
178
22
Tourmalet
32
181
23
Chamberlain
34
183
24
Tadeon
35
185
25
Llama
36
188
26
Candel
38
191
F7 D08
27
Sandown
39
193
F7 D09
28
Pricewell
41
196
F7 J09
29
Dune
43
198
F7 J10
30
Cavern
45
200
F7 D10
Financial statements – Amendment of draft financial statements
31
Deltoid
46
203
32
Tintagel
48
206
33
Harrington
50
209
34
Wellmay
53
211
35
Dexon
55
214
36
Bodyline (IAS 37)
57
216
37
Niagara (IAS 33)
57
217
38
Taxes (IAS 12)
58
218
39
Broadoak (IAS 16)
59
220
40
Merryview (IAS 16 and IAS 36)
60
222
41
Impairment and Wilderness (IAS 36)
61
223
F7 J08
Financial statements – Application of accounting standards
42
Torrent and Savoir (IAS 11, IAS 33 and IAS 32)
63
226
43
Elite Leisure and Hideaway (IAS 16 and IAS 24)
64
228
44
Triangle (IASs 37, 10, 18)
66
231
45
Construction (IAS 11)
67
233
46
Bowtock (IAS 10, 2 and 11)
67
234
47
Multiplex and Simpkins (IAS 32)
68
235
48
Convertibles (IAS 32)
69
237
49
Errsea (IAS 16, 20 and 10)
70
238
50
Partway (IFRS 5 and IAS 8)
71
240
51
Pingway (IAS 32)
73
243
F7 J08
52
Dearing (IAS 16)
73
244
F7 D08
53
Waxwork (IAS 10)
74
245
F7 J09
54
Flightline (Non‐current assets)
74
247
F7 J09
vi
© Emile Woolf Publishing Limited
Index to questions and answers
Question
page
Answer
page
Exam
248
F7 D09
55
Darby (Non‐current assets)
75
56
Barstead (IAS 33)
76
256
F7 D09
57
Apex (IAS 23)
77
251
F7 J10
58
Tunshill (IAS 8)
77
252
F7 D10
59
Manco (IFRS 5 and IAS 37)
78
253
F7 D10
Business combinations – Statements of financial position
60
Hydrox
79
255
61
Hedra
80
257
62
Harden
82
260
63
Halogen
84
263
64
Horsefield
86
265
65
Highmoor
87
267
66
Hapsburg
89
270
67
Highveldt
90
273
68
Hark, Spark and Ark
92
275
69
Parentis
94
279
70
Plateau
95
280
F7 D07
71
Pacemaker
96
283
F7 J09
72
Picant
98
285
F7 J10
Business combinations – Statements of financial performance
73
Hydan
100
287
74
Holdrite, Staybrite and Allbrite
102
290
75
Python, Snake and Adder
103
292
76
Hosterling
105
294
77
Patronic
106
295
F7 J08
78
Pandar
107
297
F7 D09
79
Premier
109
299
F7 D10
Business combinations – Statements of financial position and performance
80
Hepburn
111
301
81
Hydrate
113
304
82
Hillusion
114
306
83
Pedantic
116
309
F7 D08
Analysing and interpreting financial statements
84
Comparator
118
311
85
Ryetrend
120
315
86
Greenwood
121
318
© Emile Woolf Publishing Limited
vii
Paper F7: Financial Reporting (International)
Question
page
Answer
page
Exam
87
Harbin
123
320
F7 D07
88
Victular
125
323
F7 D08
89
Hardy
127
326
F7 D10
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Paper F7 (INT)
Financial Reporting
S
Syllabus and study guide
Aim
To develop knowledge and skills in understanding and applying accounting
standards and the theoretical framework in the preparation of financial statements
of entities, including groups and how to analyse and interpret those financial
statements.
Main capabilities
On successful completion of this paper candidates should be able to:
A
Discuss and apply a conceptual framework for financial reporting
B
Discuss a regulatory framework for financial reporting
C
Prepare and present financial statements which conform with International
accounting standards
D
Account for business combinations in accordance with International
accounting standards
E
Analyse and interpret financial statements
© Emile Woolf Publishing Limited
ix
Paper F7: Financial Reporting (International)
Rationale
The financial reporting syllabus assumes knowledge acquired in Paper F3, Financial
Accounting, and develops and applies this further and in greater depth.
The syllabus begins with the conceptual framework of accounting with reference to
the qualitative characteristics of useful information and the fundamental bases of
accounting introduced in the Paper F3 syllabus within the Knowledge module. It
then moves into a detailed examination of the regulatory framework of accounting
and how this informs the standard setting process.
The main areas of the syllabus cover the reporting of financial information for single
companies and for groups in accordance with generally accepted accounting
principles and relevant accounting standards.
Finally, the syllabus covers the analysis and interpretation of information from
financial reports.
Detailed Syllabus
A
B
C
x
A conceptual framework for financial reporting
1.
The need for a conceptual framework
2.
The fundamental concepts of relevance and faithful representation (‘true
and fair view’)
3.
The enhancing characteristics of comparability, verifiability, timeliness
and understandability
4.
Recognition and measurement
5.
The legal versus the commercial view of accounting
6.
Alternative models and practices
A regulatory framework for financial reporting
1.
Reasons for the existence of a regulatory framework
2.
The standard setting process
3.
Specialised, not-for-profit, and public sector
entities
Financial statements
1.
Statements of cash flows
2.
Tangible non-current assets
3.
Intangible assets
4.
Inventory
5.
Financial assets and financial liabilities
6.
Leases
© Emile Woolf Publishing Limited
Syllabus and study guide
D
E
7.
Provisions, contingent liabilities, and contingent assets
8.
Impairment of assets
9.
Taxation
10.
Regulatory requirements relating to the preparation of financial
statements
11.
Reporting financial performance
Business combinations
1.
The concept and principles of a group
2.
The concept of consolidated financial statements
3.
Preparation of consolidated financial statements including an associate
Analysing and interpreting financial statements
1.
Limitations of financial statements
2.
Calculation and interpretation of accounting ratios
address users’ and stakeholders’ needs
3.
Limitations of interpretation techniques
4.
Specialised, not-for-profit, and public sector
and
trends
to
entities
Approach to examining the syllabus
The syllabus is assessed by a three-hour paper-based examination.
All questions are compulsory. It will contain both computational and discursive
elements.
Some questions will adopt a scenario/case study approach.
Question 1 will be a 25 mark question on the preparation of group financial
statements and/or extracts thereof, and may include a small discussion element.
Computations will be designed to test an understanding of principles.
Question 2, for 25 marks, will test the reporting of non-group financial statements.
This may be from information in a trial balance or by restating draft financial
statements.
Question 3, for 25 marks, is likely to be an appraisal of an entity’s performance and
may involve statements of cash flows.
Questions 4 and 5 will cover the remainder of the syllabus and will be worth 15 and
10 marks respectively.
© Emile Woolf Publishing Limited
xi
Paper F7: Financial Reporting (International)
An individual question may often involve elements that relate to different subject
areas of the syllabus. For example the preparation of an entity’s financial statements
could include matters relating to several accounting standards.
Questions may ask candidates to comment on the appropriateness or acceptability
of management’s opinion or chosen accounting treatment. An understanding of
accounting principles and concepts and how these are applied to practical examples
will be tested.
Questions on topic areas that are also included in Paper F3 will be examined at an
appropriately greater depth in this paper.
Candidates will be expected to have an appreciation of the need for specified
accounting standards and why they have been issued. For detailed or complex
standards, candidates need to be aware of their principles and key elements.
xii
© Emile Woolf Publishing Limited
Syllabus and study guide
Study guide
This study guide provides more detailed guidance on the syllabus. You should use
this as the basis of your studies.
A
A conceptual framework for Financial Reporting
1
The need for a conceptual framework
a)
b)
2
The fundamental concepts of relevance and faithful representation
(‘true and fair view’)
a)
b)
c)
3
Discuss what is meant by relevance and faithful representation
and describe the qualities that enhance these characteristics.
Discuss whether faithful representation constitutes more than
compliance with accounting standards.
Indicate the circumstances and required disclosures where a ‘true
and fair’ override may apply.
The enhancing characteristics
timeliness and understandability
a)
b)
c)
d)
4
Describe what is meant by a conceptual framework of accounting.
Discuss whether a conceptual framework is necessary and what an
alternative system might be.
of
comparability,
verifiability,
Discuss what is meant by understandability and verifiability in
relation to the provision of financial information.
Discuss the importance of comparability and timeliness to users of
financial statements.
Distinguish between changes in accounting policies and changes
in accounting estimates and describe how accounting standards
apply the principle of comparability where an entity changes its
accounting policies.
Recognise and account for changes in accounting policies and the
correction of prior period errors.
Recognition and measurement
a)
b)
c)
d)
e)
© Emile Woolf Publishing Limited
Define what is meant by ‘recognition’ in financial statements and
discuss the recognition criteria.
Apply the recognition criteria to:
i)
assets and liabilities.
ii)
income and expenses
Discuss revenue recognition issues; indicate when income and
expense recognition should occur.
Demonstrate the role of the principle of substance over form in
relation to recognising sales revenue.
Explain the following measures and compute amounts using:
i)
historical cost
xiii
Paper F7: Financial Reporting (International)
ii)
iii)
iv)
5
The legal versus the commercial view of accounting
a)
b)
c)
d)
6
b)
c)
Describe the advantages and disadvantages of the use of historical
cost accounting.
Discuss whether the use of current value accounting overcomes
the problems of historical cost accounting.
Describe the concept of financial and physical capital maintenance
and how this affects the determination of profits.
A regulatory framework for financial reporting
1
Reasons for the existence of a regulatory framework
a)
b)
c)
2
Explain why a regulatory framework is needed also including the
advantages and disadvantages of IFRS over a national regulatory
framework.
Explain why accounting standards on their own are not a
complete regulatory framework.
Distinguish between a principles based and a rules based
framework and discuss whether they can be complementary.
The standard setting process
a)
b)
xiv
Explain the importance of recording the commercial substance
rather than the legal form of transactions – give examples where
recording the legal form of transactions may be misleading.
Describe the features which may indicate that the substance of
transactions differs from their legal form.
Apply the principle of substance over form to the recognition and
derecognition of assets and liabilities.
Recognise the substance of transactions in general, and specifically
account for the following types of transaction:
i)
goods sold on sale or return/consignment inventory
ii)
sale and repurchase/leaseback agreements
iii) factoring of receivables.
Alternative models and practices
a)
B
fair value/current cost
net realisable value
present value of future cash flows.
Describe the structure and objectives of the IFRS Foundation, the
International Accounting Standards Board (IASB), the IFRS
Advisory Council (IFRS AC) and the IFRS Interpretations
Committee (IFRS IC).
Describe the IASB’s Standard setting process including revisions
to and interpretations of Standards.
© Emile Woolf Publishing Limited
Syllabus and study guide
c)
3
Specialised, not-for-profit and public sector entities
a)
b)
C
Explain the relationship of national standard setters to the IASB in
respect of the standard setting process.
Distinguish between the primary aims of not-for profit and public
sector entities and those of profit oriented entities.
Discuss the extent to which International Financial Reporting
Standards (IFRSs) are relevant to specialised, not-for-profit and
public sector entities.
Financial statements
1
Statements of Cash flows
a)
b)
c)
2
Tangible non-current assets
a)
b)
c)
d)
e)
f)
g)
h)
3
Prepare a statement of cash flows for a single entity (not a group)
in accordance with relevant accounting standards using the direct
and the indirect method .
Compare the usefulness of cash flow information with that of a
statement of profit or loss or a statement of profit or loss and other
comprehensive income.
Interpret a statement of cash flows (together with other financial
information) to assess the performance and financial position of an
entity.
Define and compute the initial measurement of a non-current
(including a self-constructed and borrowing costs) asset.
Identify subsequent expenditure that may be capitalised,
distinguishing between capital and revenue items.
Discuss the requirements of relevant accounting standards in
relation to the revaluation of non-current assets.
Account for revaluation and disposal gains and losses for noncurrent assets.
Compute depreciation based on the cost and revaluation models
and on assets that have two or more significant parts (complex
assets).
Apply the provisions of relevant accounting standards in relation
to accounting for government grants.
Discuss why the treatment of investment properties should differ
from other properties.
Apply the requirements of relevant accounting standards for
investment property.
Intangible assets
a)
© Emile Woolf Publishing Limited
Discuss the nature and accounting treatment of internally
generated and purchased intangibles.
xv
Paper F7: Financial Reporting (International)
b)
c)
d)
e)
f)
4
Inventory
a)
b)
c)
d)
5
b)
c)
d)
e)
Explain the need for an accounting standard on financial
instruments.
Define financial instruments in terms of financial assets and
financial liabilities.
Indicate for the following categories of financial instruments how
they should be measured and how any gains and losses from
subsequent measurement should be treated in the financial
statements:
i)
amortised cost
ii)
fair value ( including option to elect to present gains and
losses on equity instruments in other comprehensive
income)
Distinguish between debt and equity capital.
Apply the requirements of relevant accounting standards to the
issue and finance costs of:
i)
equity
ii)
redeemable preference shares and debt instruments with no
conversion rights (principle of amortised cost)
iii) convertible debt
Leases
a)
b)
xvi
Describe and apply the principles of inventory valuation.
Define a construction contract and discuss the role of accounting
concepts in the recognition of profit.
Describe the acceptable methods of determining the stage
(percentage) of completion of a contract.
Prepare financial statement extracts for construction contracts.
Financial assets and financial liabilities
a)
6
Distinguish between goodwill and other intangible assets.
Describe the criteria for the initial recognition and measurement of
intangible assets.
Describe the subsequent accounting treatment, including the
principle of impairment tests in relation to goodwill.
Indicate why the value of purchase consideration for an
investment may be less than the value of the acquired identifiable
net assets and how the difference should be accounted for.
Describe and apply the requirements of relevant accounting
standards to research and development expenditure.
Explain why recording the legal form of a finance lease can be
misleading to users (referring to the commercial substance of such
leases).
Describe and apply the method of determining a lease type (i.e. an
operating or finance lease).
© Emile Woolf Publishing Limited
Syllabus and study guide
c)
d)
e)
7
Provisions, contingent liabilities and contingent assets
a)
b)
c)
d)
e)
f)
8
c)
d)
Define an impairment loss.
Identify the circumstances that may indicate impairments to
assets.
Describe what is meant by a cash generating unit.
State the basis on which impairment losses should be allocated,
and allocate an impairment loss to the assets of a cash generating
unit.
Taxation
a)
b)
c)
d)
10
Explain why an accounting standard on provisions is necessary.
Distinguish between legal and constructive obligations.
State when provisions may and may not be made and demonstrate
how they should be accounted for.
Explain how provisions should be measured.
Define contingent assets and liabilities and describe their
accounting treatment.
Identify and account for:
i)
warranties/guarantees
ii)
onerous contracts
iii) environmental and similar provisions
iv) provisions for future repairs or refurbishments.
Impairment of assets
a)
b)
9
Discuss the effect on the financial statements of a finance lease
being incorrectly treated as an operating lease.
Account for assets financed by finance leases in the records of the
lessee.
Account for operating leases in the records of the lessee.
Account for current taxation in accordance with relevant
accounting standards.
Record entries relating to income tax in the accounting records.
Explain the effect of taxable temporary differences on accounting
and taxable profits.
Compute and record deferred tax amounts in the financial
statements.
Regulatory requirements relating to the preparation of financial
statements
a)
b)
© Emile Woolf Publishing Limited
Describe the structure (format) and content of financial statements
presented under IFRS.
Prepare an entity’s financial statements in accordance with the
prescribed structure and content.
xvii
Paper F7: Financial Reporting (International)
11
Reporting financial performance
a)
b)
c)
d)
e)
f)
g)
D
Business combinations
1
The concept and principles of a group
a)
b)
c)
d)
e)
f)
xviii
Discuss the importance of identifying and reporting the results of
discontinued operations.
Define and account for non-current assets held for sale and
discontinued operations.
Indicate the circumstances where separate disclosure of material
items of income and expense is required.
Prepare and explain the contents and purpose of the statement of
changes in equity.
Describe and prepare a statement of changes in equity.
Earnings per share (eps)
i)
calculate the eps in accordance with relevant accounting
standards (dealing with bonus issues, full market value
issues and rights issues)
ii)
explain the relevance of the diluted eps and calculate the
diluted eps involving convertible debt and share options
(warrants)
iii) explain why the trend of eps may be a more accurate
indicator of performance than a company’s profit trend and
the importance of eps as a stock market indicator
iv) discuss the limitations of using eps as a performance
measure.
Events after the reporting date
i)
distinguish between and account for adjusting and nonadjusting events after the reporting date
ii)
Identify items requiring separate disclosure, including their
accounting treatment and required disclosures
Describe the concept of a group as a single economic unit.
Explain and apply the definition of a subsidiary within relevant
accounting standards.
Identify and outline using accounting standards and other
applicable regulation the circumstances in which a group is
required to prepare consolidated financial statements.
Describe the circumstances when a group may claim exemption
from the preparation of consolidated financial statements. .
Explain why directors may not wish to consolidate a subsidiary
and outline using accounting standards and other applicable
regulation the circumstances where this is permitted.[2
Explain the need for using coterminous year ends and uniform
accounting polices when preparing consolidated financial
statements.
© Emile Woolf Publishing Limited
Syllabus and study guide
g)
2
The concept of consolidated financial statements
a)
b)
c)
d)
3
Explain why it is necessary to eliminate intra-group transactions.
Explain the objective of consolidated financial statements.
Indicate the effect that the related party relationship between a
parent and subsidiary may have on the subsidiary’s entity
statements and the consolidated financial statements.
Explain why it is necessary to use fair values for the consideration
for an investment in a subsidiary together with the fair values of a
subsidiary’s identifiable assets and liabilities when preparing
consolidated financial statements.
Describe and apply the required accounting treatment of
consolidated goodwill.
Preparation of consolidated financial statements including an
associate
a)
b)
c)
d)
e)
f)
g)
h)
© Emile Woolf Publishing Limited
Prepare a consolidated statement of financial position for a simple
group (parent and one subsidiary) dealing with pre and post
acquisition profits, non-controlling interests and consolidated
goodwill.
Prepare a consolidated statement of profit or loss and consolidated
statement of profit or loss and other comprehensive income for a
simple group dealing with an acquisition in the period and noncontrolling interest.
Explain and account for other reserves (e.g. share premium and
revaluation reserves).
Account for the effects in the financial statements of intra-group
trading.
Account for the effects of fair value adjustments (including their
effect on consolidated goodwill) to:
i)
depreciating and non-depreciating non-current assets
ii)
inventory
iii) monetary liabilities
iv) assets and liabilities not included in the subsidiary’s own
statement of financial position, including contingent assets
and liabilities
Account for goodwill impairment.
Define an associate and explain the principles and reasoning for
the use of equity accounting.
Prepare consolidated financial statements to include a single
subsidiary and an associate.
xix
Paper F7: Financial Reporting (International)
E
Analysing and interpreting financial statements
1
Limitations of financial statements
a)
b)
c)
d)
2
Calculation and interpretation of accounting ratios and trends to
address users’ and stakeholders’ needs
a)
b)
c)
d)
e)
3
b)
c)
Discuss the limitations in the use of ratio analysis for assessing
corporate performance.
Discuss the effect that changes in accounting policies or the use of
different accounting polices between entities can have on the
ability to interpret performance.
Indicate other information, including non-financial information,
that may be of relevance to the assessment of an entity’s
performance.
Specialised, not-for-profit and public sector entities
a)
xx
Define and compute relevant financial ratios.
Explain what aspects of performance specific ratios are intended to
assess.
Analyse and interpret ratios to give an assessment of an entity’s
performance and financial position in comparison with:
i)
an entity’s previous period’s financial statements
ii)
another similar entity for the same reporting period
iii) industry average ratios.
Interpret an entity’s financial statements to give advice from the
perspectives of different stakeholders.
Discuss how the interpretation of current value based financial
statements would differ from those using historical cost based
accounts.
Limitations of interpretation techniques
a)
4
Indicate the problems of using historic information to predict
future performance and trends.
Discuss how financial statements may be manipulated to produce
a desired effect (creative accounting, window dressing).
Recognise how related party relationships have the potential to
mislead users.
Explain why figures in a statement of financial position may not be
representative of average values throughout the period for
example, due to:
i)
seasonal trading
ii)
major asset acquisitions near the end of the accounting
period.
Discuss the different approaches that may be required when
assessing the performance of specialised, not-for-profit and public
sector organisations.
© Emile Woolf Publishing Limited
Paper F7 (INT)
Financial Reporting
e
Exam techniques
Five steps to exam success
1
Know your subject
It sounds obvious, but you really need to know all topics in the syllabus – ACCA can
test you on any area of the syllabus so even those topics you think might ‘never come
up’ could be on your next exam. Whatever the format, questions require that you have
learnt definitions, know key words and their meanings and understand concepts,
theories and rules.
2
Know your exam structure
Do you know how many questions you need to attempt? Do you know how long you
exam is? What type of questions come up? Knowing this is essential!
The F7 exam is three hours long (plus an additional 15 minutes reading time) and has
five compulsory questions. Question 1 will be on group financial statements, Question
2 will be on non‐group financial statements, Question 3 may involve cash flow
statements and Questions 4 and 5 cover the rest of the syllabus.
3
Practice makes perfect
One of the best ways to prepare for your actual exam is to try lots of examination‐
standard questions under timed conditions.
Attempt ALL of the questions in this exam kit and compare your answers with the
answers to see what you need to improve on and the areas you need to go back and
revise! Go back and revise and then attempt questions again if you get any wrong.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
4
Time yourself
If you are sitting an exam worth 100 marks in three hours, you should aim to spend 1.8
minutes on each mark. Make sure that you have double‐checked your strategy of how
you are going to allocate your time before you go into the exam and that you are
comfortable answering five questions in three hours.
Since you don’t need to attempt the questions in order, a good strategy could be to
attempt the ‘easy’ questions (such as those you either know or you don’t) at the
beginning and save those that involve calculations or a bit more thought to the end.
5
Reading and planning time in the exam
You have been given an extra 15 minutes ‘reading and planning’ time in the exam. Use
it wisely! You are allowed to read the questions, begin to plan your answers and use
your calculator to make some preliminary numerical calculations. You’re allowed to
write on your exam paper, so try going through and highlighting the key points and
requirements in the questions, or jot down some ideas as to how you are going to
structure your answers.
xxii
© Emile Woolf Publishing Limited
SECTION 1
Paper F7 (INT)
Financial Reporting
Q&A
Practice questions
1
Recost
For over 20 years the accounting profession in many countries has attempted to
formulate a method of preparing financial statements that takes account of the effects
of price increases (inflation). It seems that no proposed method of reflecting the effects
of changing prices has gained international acceptance. The decision of the IASB, and
the accounting standard setters in many countries, is that no form of accounting for
price changes should be made compulsory, but enterprises are encouraged to present
such information.
There have been two main methods put forward by various accounting standard
bodies for reporting the effects of price
changes. One method is based on the
movements in general price inflation and is referred to as a General (or Current)
Purchasing Power Approach, the other method is based on specific price changes of
goods and assets and is generally referred to as a Current Cost Approach. Some bodies
have also suggested an approach which combines features of each method.
Required:
(a)
Explain the limitations of (pure) historical cost accounts when used as a basis for
assessing the performance of an enterprise. You should give an example of how
each of three different user groups may be misled by such information.
(10 marks)
(b)
Describe the advantages and criticisms of Current Cost Accounting.
(5 marks)
(Total: 15 marks)
2
Worthright
Although it may come as a surprise to many non-accountants, the accounting
profession internationally has encountered a great deal of problems in arriving at
robust definitions for the ‘elements’ of financial statements. Defining assets, liabilities,
and gains and losses (income and expenditure) has been particularly problematical.
These definitions form the core of any conceptual framework that is to be used as a
basis for preparing financial statements. It is also in this area that the International
Accounting Standards Board’s original conceptual framework, Framework for the
Preparation and Presentation of Financial Statements (Framework) has come in for
© Emile Woolf Publishing Limited
1
Paper F7: Financial Reporting (International)
some criticism. It seems that the current accounting treatment of certain items does not
(fully) agree with definitions in the Framework. A major objective of the Framework is
to exclude from the statement of financial position items that are neither assets nor
liabilities; and to make ‘off balance sheet’ assets and liabilities more visible by putting
them on the statement of financial position whenever practicable. This is one of the
reasons that the IASB has been engaged on a project to develop a new framework. This
project has resulted in amendment to the original document and is ongoing.
Required:
(a)
Critically discuss the definition of assets and liabilities contained in the
Conceptual Framework.
Your answer should explain the importance of the definitions and the relevance
of each component of the definitions.
(10 marks)
(b)
Worthright undertakes a considerable amount of research and development
work. Most of this work is done on its own behalf, but occasionally it undertakes
this type of work for other companies. Before any of its own projects progress to
the development stage they are assessed by an internal committee, which
carefully analyses all information relating to the project. This process has led to a
very good record of development projects delivering profitable results. Despite
this, Worthright deems it prudent to write off immediately all research and
development work, including that which it does for other companies. (5 marks)
Required:
Discuss whether the above transactions and events give rise to assets; and describe
how they should be recognised and measured under current International Accounting
Standards and conventionally accepted practice.
(Total: 15 marks)
3
Revenue recognition
Revenue recognition is the process by which companies decide when and how much
income should be included in the income statement. It is a topical area of great debate
in the accounting profession. The IASB looks at revenue recognition from conceptual
and substance points of view. There are occasions where a more traditional approach
to revenue recognition does not entirely conform to the IASB guidance; indeed neither
do some International Accounting Standards.
Required:
2
(a)
Explain the implications that the IASB’s Conceptual Framework and the
application of substance over form have on the recognition of income. Give
examples of how this may conflict with traditional practice and some accounting
standards.
(6 marks)
(b)
Derringdo acquired an item of plant at a gross cost of $800,000 on 1 October 2011.
The plant has an estimated life of 10 years with a residual value equal to 15% of
its gross cost. Derringdo uses straight-line depreciation on a time-apportioned
basis. The company received a government grant of 30% of its cost price at the
time of its purchase. The terms of the grant are that if the company retains the
asset for four years or more, then no repayment liability will be incurred. If the
plant is sold within four years a repayment on a sliding scale would be
applicable. The repayment is 75% if sold within the first year of purchase and this
amount decreases by 25% per annum. Derringdo has no intention to sell the plant
within the first four years. Derringdo’s accounting policy for capital based
© Emile Woolf Publishing Limited
Section 1: Practice questions
government grants is to treat them as deferred credits and release them to
income over the life of the asset to which they relate.
Required:
(i)
Discuss whether the company’s policy for the treatment of government grants
meets the definition of a liability in the IASB Conceptual Framework. (3 marks)
(ii)
Prepare extracts of Derringdo’s financial statements for the year to 31 March 2012
in respect of the plant and the related grant:
„
applying the company’s policy;
„
in compliance with the definition of a liability in the Conceptual
Framework. Your answer should consider whether the sliding scale
repayment should be used in determining the deferred credit for the grant.
(6 marks)
(Total: 15 marks)
4
Angelino
(a)
Recording the substance of transactions, rather than their legal form, is an
important principle in financial accounting. Abuse of this principle can lead to
profit manipulation, non-recognition of assets and substantial debt not being
recorded on the statement of financial position.
Required:
Describe how the use of off statement of financial position financing can mislead
users of financial statements.
Note: your answer should refer to specific user groups and include examples
where recording the legal form of transactions may mislead them.
(9 marks)
(b)
Angelino has entered into the following transactions during the year ended 30
September 2012:
(i)
In September 2012 Angelino sold (factored) some of its trade receivables to
Omar, a finance house. On selected account balances Omar paid Angelino
80% of their book value. The agreement was that Omar would administer
the collection of the receivables and remit a residual amount to Angelino
depending upon how quickly individual customers paid. Any balance
uncollected by Omar after six months will be refunded to Omar by
Angelino.
(5 marks)
(ii)
On 1 October 2011 Angelino owned a freehold building that had a carrying
amount of $7·5 million and had an estimated remaining life of 20 years. On
this date it sold the building to Finaid for a price of $12 million and entered
into an agreement with Finaid to rent back the building for an annual rental
of $1·3 million for a period of five years. The auditors of Angelino have
commented that in their opinion the building had a market value of only
$10 million at the date of its sale and to rent an equivalent building under
similar terms to the agreement between Angelino and Finaid would only
cost $800,000 per annum. Assume any finance costs are 10% per annum.
(6 marks)
(iii)
Angelino is a motor car dealer selling vehicles to the public. Most of its new
vehicles are supplied on consignment by two manufacturers, Monza and
Capri, who trade on different terms.
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Paper F7: Financial Reporting (International)
Monza supplies cars on terms that allow Angelino to display the vehicles
for a period of three months from the date of delivery or when Angelino
sells the cars on to a retail customer if this is less than three months. Within
this period Angelino can return the cars to Monza or can be asked by
Monza to transfer the cars to another dealership (both at no cost to
Angelino). Angelino pays the manufacturer’s list price at the end of the
three month period (or at the date of sale if sooner). In recent years
Angelino has returned several cars to Monza that were not selling very
well and has also been required to transfer cars to other dealerships at
Monza’s request.
Capri’s terms of supply are that Angelino pays 10% of the manufacturer’s
price at the date of delivery and 1% of the outstanding balance per month
as a display charge. After six months (or sooner if Angelino chooses),
Angelino must pay the balance of the purchase price or return the cars to
Capri. If the cars are returned to the manufacturer, Angelino has to pay for
the transportation costs and forfeits the 10% deposit. Because of this
Angelino has only returned vehicles to Capri once in the last three years.
(5 marks)
Required:
Describe how the above transactions and events should be treated in the
financial statements of Angelino for the year ended 30 September 2012.
Your answer should explain, where relevant, the difference between the
legal form of the transactions and their substance.
Note: The mark allocation is shown against each of the three transactions
above.
(Total: 25 marks)
5
Emerald
Product development costs are a material cost for many companies. They are either
written off as an expense or capitalised as an asset.
Required:
(a)
Discuss the conceptual issues involved and the definition of an asset that may be
applied in determining whether development expenditure should be treated as
an expense or an asset.
(4 marks)
(b)
Emerald has had a policy of writing off development expenditure to the income
statement as it was incurred. In preparing its financial statements for the year
ended 30 September 2012 it has become aware that, under IFRS rules, qualifying
development expenditure should be treated as an intangible asset. Below is the
qualifying development expenditure for Emerald:
$’000
Year ended 30 September 2009
300
Year ended 30 September 2010
240
Year ended 30 September 2011
800
Year ended 30 September 2012
400
All capitalised development expenditure is deemed to have a four year life.
Assume amortisation commences at the beginning of the accounting period
following capitalisation. Emerald had no development expenditure before that
for the year ended 30 September 2009.
4
© Emile Woolf Publishing Limited
Section 1: Practice questions
Required:
Treating the above as the correction of an error in applying an accounting policy,
calculate the amounts which should appear in the income statement and
statement of financial position (including comparative figures), and statement of
changes in equity of Emerald in respect of the development expenditure for the
year ended 30 September 2012.
Note: ignore taxation.
(6 marks)
(Total: 10 marks)
6
Conceptual Framework
(a)
The IASB’s Conceptual Framework requires financial statements to be prepared
on the basis that they comply with certain accounting concepts, underlying
assumptions and (qualitative) characteristics. Five of these are:
Matching/accruals
Substance over form
Prudence
Comparability
Materiality
Required:
Briefly explain the meaning of each of the above concepts/assumptions. (5 marks)
(b)
For most entities, applying the appropriate concepts/assumptions in accounting
for inventories is an important element in preparing their financial statements.
Required:
Illustrate with examples how each of the concepts/assumptions in (a) may be
(10 marks)
applied to accounting for inventory.
(Total: 15 marks)
7
Promoil
(a)
The definition of a liability forms an important element of the IASB’s Conceptual
Framework which, in turn, forms the basis for IAS 37 Provisions, Contingent
Liabilities and Contingent Assets.
Required:
Define a liability and describe the circumstances under which provisions should
be recognised. Give two examples of how the definition of liabilities enhances the
(5 marks)
reliability of financial statements.
(b)
On 1 October 2011, Promoil acquired a newly constructed oil platform at a cost of
$30 million together with the right to extract oil from an offshore oilfield under a
government licence. The terms of the licence are that Promoil will have to
remove the platform (which will then have no value) and restore the sea bed to
an environmentally satisfactory condition in 10 years’ time when the oil reserves
have been exhausted. The estimated cost of this on 30 September 2021 will be $15
million. The present value of $1 receivable in 10 years at the appropriate discount
rate for Promoil of 8% is $0·46.
© Emile Woolf Publishing Limited
5
Paper F7: Financial Reporting (International)
Required:
(i)
Explain and quantify how the oil platform should be treated in the financial
statements of Promoil for the year ended 30 September 2012;
(7 marks)
(ii)
Describe how your answer to (b)(i) would change if the government licence
did not require an environmental clean-up.
(3 marks)
(Total: 15 marks)
8
Wardle
(a)
An important aspect of the International Accounting Standards Board’s
Framework for the preparation and presentation of financial statements is that
transactions should be recorded on the basis of their substance over their form.
Required:
Explain why it is important that financial statements should reflect the substance
of the underlying transactions and describe the features that may indicate that
(5 marks)
the substance of a transaction may be different from its legal form.
(b)
Wardle’s activities include the production of maturing products which take a
long time before they are ready to retail. Details of one such product are that on 1
April 2009 it had a cost of $5 million and a fair value of $7 million.
The product would not be ready for retail sale until 31 March 2012.
On 1 April 2009 Wardle entered into an agreement to sell the product to
Easyfinance for $6 million. The agreement gave Wardle the right to repurchase
the product at any time up to 31 March 2012 at a fixed price of $7,986,000, at
which date Wardle expected the product to retail for $10 million. The compound
interest Wardle would have to pay on a three-year loan of $6 million would be:
$
Year 1
600,000
Year 2
660,000
Year 3
726,000
This interest is equivalent to the return required by Easyfinance.
Required:
Assuming the above figures prove to be accurate, prepare extracts from the
income statement of Wardle for the three years to 31 March 2012 in respect of the
above transaction:
(i)
Reflecting the legal form of the transaction;
(ii)
Reflecting the substance of the transaction.
Note: statement of financial position extracts are NOT required.
The following mark allocation is provided as guidance for this requirement:
(c)
(i)
2 marks
(ii)
3 marks
(5 marks)
Comment on the effect the two treatments have on the income statements and
the statements of financial position and how this may affect an assessment of
(5 marks)
Wardle’s performance.
(Total: 15 marks)
6
© Emile Woolf Publishing Limited
Section 1: Practice questions
Financial statements – Statements of cash flows
9
Tabba
The following draft financial statements relate to Tabba, a private company.
Statements of financial position
(balance sheets) as at:
30 September 2012
$000
Tangible non-current assets (note (ii))
Current assets
Inventories
Trade receivables
Insurance claim (note (iii))
Cash and bank
Non-current liabilities
Finance lease obligations (note (ii))
6% loan notes
10% loan notes
Deferred tax
Government grants (note (ii))
Current liabilities
Bank overdraft
Trade payables
Government grants (note (ii))
Finance lease obligations (note (ii))
Current tax payable
2,550
3,100
1,500
850
――――
15,800
8,000
――――
――――
――――
――――
6,000
6,000
nil
2,550
2,550
2,450
――――
――――
8,550
8,450
1,700
nil
4,000
500
900
4,400
nil
4,050
600
900
100
――――
21,450
1,600
850
2,000
800
nil
200
1,400
――――
5,650
――――
18,600
――――
$000
1,850
2,600
1,200
nil
――――
7,100
550
2,950
400
800
1,200
5,650
――――
5,900
――――
――――
――――
――――
18,600
© Emile Woolf Publishing Limited
$000
10,600
Total assets
Equity and liabilities
Share capital ($1 each)
Reserves:
Revaluation (note (ii))
Retained earnings
$000
30 September 2011
21,450
7
Paper F7: Financial Reporting (International)
The following information is relevant:
(i)
Income statement extract for the year ended 30 September 2012:
$000
Operating profit before interest and tax
Interest expense
270
(260)
Interest receivable
40
Profit before tax
50
Net income tax credit
50
Profit for the period
100
Note: the interest expense includes finance lease interest.
(ii)
The details of the tangible non-current assets are:
Cost
At 30 September 2011
At 30 September 2012
$000
20,200
16,000
Accumulated
depreciation
$000
4,400
5,400
Carrying
value
$000
15,800
10,600
During the year Tabba sold its factory for its fair value $12 million and agreed to
rent it back, under an operating lease, for a period of five years at $1 million per
annum. At the date of sale it had a carrying value of $7.4 million based on a
previous revaluation of $8.6 million less depreciation of $1.2 million since the
revaluation. The profit on the sale of the factory has been included in operating
profit. The surplus on the revaluation reserve related entirely to the factory. No
other disposals of non-current assets were made during the year.
Plant acquired under finance leases during the year was $1.5 million. Other
purchases of plant during the year qualified for government grants of $950,000.
Amortisation of government grants has been credited to cost of sales.
(iii)
The insurance claim relates to flood damage to the company’s inventories which
occurred in September 2011. The original estimate has been revised during the
year after negotiations with the insurance company. The claim is expected to be
settled in the near future.
Required:
(a)
Prepare a statement of cash flows using the indirect method for Tabba in
accordance with IAS 7 Statement of Cash Flows for the year ended 30
September 2012.
(17 marks)
(b)
Using the information in the question and your statement of cash flows,
comment on the change in the financial position of Tabba during the year
ended 30 September 2012.
(8 marks)
Note: You are not required to calculate any ratios.
8
(Total: 25 marks)
© Emile Woolf Publishing Limited
Section 1: Practice questions
10
Boston
Shown below are the summarised financial statements for Boston, a publicly listed
company, for the years ended 31 March 2011 and 2012, together with some segment
information analysed by class of business for the year ended 31 March 2012 only:
Income statements
Carpeting
Revenue
Cost of sales (note (i))
Gross profit
Operating expenses
Segment result
Unallocated corporate expense
$m
90
(30)
Hotels
$m
130
(95)
$m
280
(168)
Total
31 March
2012
$m
500
(293)
Total
31 March
2011
$m
450
(260)
112
(32)
207
(72)
190
(60)
Housebuilding
―――
―――
―――
―――
―――
―――
60
(25)
35
(15)
35
20
―――
80
Unallocated bank balance
―――
―――
―――
―――
―――
―――
―――
―――
65
(25)
Profit for the period
Segment assets
―――
75
(10)
Profit before tax
Income tax expense
Tangible non-current
assets
Current assets
―――
135
(60)
Profit from operations
Finance costs
40
40
40
140
40
200
75
―――
―――
―――
―――
―――
―――
80
180
275
Consolidated total assets
380
155
535
Consolidated equity and total liabilities
9
51
12
53
75
(30)
45
332
462
15
nil
―――
―――
―――
―――
―――
―――
462
100
20
232
4
4
80
(5)
―――
80
nil
192
352
Segment current liabilities
– tax
– other
Unallocated loans
Unallocated bank
overdraft
130
(50)
130
―――
550
Ordinary share capital
Share premium
Retained earnings
―――
108
65
nil
272
25
30
115
40
5
―――
―――
―――
―――
550
462
The following notes are relevant:
(i)
Depreciation for the year to 31 March 2012 was $35 million. During the year a
hotel with a carrying amount of $40 million was sold at a loss of $12 million.
Depreciation and the loss on the sale of non-current assets are charged to cost of
sales. There were no other non-current asset disposals. As part of the company’s
overall acquisition of new non-current assets, the hotel segment acquired $104
million of new hotels during the year.
© Emile Woolf Publishing Limited
9
Paper F7: Financial Reporting (International)
(ii)
The above figures are based on historical cost values. The fair values of the
segment net assets are:
At 31 March 2011
At 31 March 2012
(iii)
Hotels
$m
150
240
House building
$m
250
265
The following ratios (which can be taken to be correct) have been calculated
based on the overall group results:
Year ended
Return on capital employed
Gross profit margin
Operating profit margin
Net assets turnover
Current ratio
Gearing
(iv)
Carpeting
$m
80
97
31 March 2012
18.0%
41.4%
15.0%
1.2 times
1.3:1
15.6%
31 March 2011
25.6%
42.2%
17.8%
1.4 times
0.9:1
12.8%
The following segment ratios (which can be taken to be correct) have been
calculated for the year ended 31 March 2012 only:
Segment return on net assets
Segment asset turnover (times)
Gross profit margin
Net profit margin
Current ratio (excluding bank)
Carpeting
48.6%
1.3
66.7%
38.9%
5:1
Hotels
16.7%
1.1
26.9%
15.4%
0.7:1
House building
38.1%
1.3
40.0%
28.6%
1.2:1
Required:
(a)
Prepare a statement of cash flows for Boston for the year ended 31 March 2012.
(10 marks)
Note: You are not required to show separate segmental cash flows or any disclosure
notes.
(b)
Using the ratios provided, write a report to the Board of Boston analysing the
company’s financial performance and position for the year ended 31 March 2012.
(15 marks)
Your answer should make reference to your statement of cash flows and the segmental
information and consider the implication of the fair value information.
(Total: 25 marks)
11
Planter
The following information relates to Planter, a small private company. It consists of an
opening statement of financial position as at 1 April 2011 and a listing of the company’s
ledger accounts at 31 March 2012 after the draft operating profit before interest and
taxation (of $17,900) had been calculated.
10
© Emile Woolf Publishing Limited
Section 1: Practice questions
Planter – Statement of financial position as at 1 April 2011
$
Non-current assets
Land and buildings
(at valuation $49,200 less accumulated depreciation of $5,000)
Plant (at cost of $70,000 less accumulated depreciation of $22,500)
Investments at cost
Current assets
Inventory
Trade receivables
Bank
Total assets
Equity and liabilities
Capital and reserves:
Ordinary shares of $1 each
Reserves:
Share premium
Revaluation reserve
Retained earnings
$
44,200
47,500
16,900
108,600
57,400
28,600
1,200
87,200
195,800
25,000
5,000
12,000
70,300
87,300
112,300
Non-current liabilities
8% Loan notes
Current liabilities
Trade payables
Taxation
43,200
31,400
8,900
40,300
195,800
Total equity and liabilities
Ledger account listings at 31 March 2012
Ordinary shares of $1 each
Share premium
Retained earnings – 1 April 2011
Profit before interest and tax – year to 31 March 2012
Revaluation reserve
8% Loan notes
Trade payables
Accrued loan interest
Taxation
Land and buildings at valuation
Plant at cost
Buildings – accumulated depreciation 31 March 2012
Plant – accumulated depreciation 31 March 2012
Investments at cost
Trade receivables
Inventory – 31 March 2012
Bank
Investment income
Loan interest
© Emile Woolf Publishing Limited
Dr
$
Cr
$
50,000
8,000
70,300
17,900
18,000
39,800
26,700
300
1,100
62,300
84,600
6,800
37,600
8,200
50,400
43,300
1,900
400
1,700
11
Paper F7: Financial Reporting (International)
Ledger account listings at 31 March 2012
Dr
$
26,100
277,700
Ordinary dividend
Cr
$
277,700
Notes
(i)
There were no disposals of land and buildings during the year. The increase in
the revaluation reserve was entirely due to the revaluation of the company’s
land.
(ii)
Plant with a net book value of $12,000 (cost $23,500) was sold during the year for
$7,800. The loss on sale has been included in the profit before interest and tax.
(iii)
Investments with a cost of $8,700 were sold during the year for $11,000. The
profit has been included in the profit before interest and tax. There were no
further purchases of investments.
(iv)
On 10 October 2011 a bonus issue of 1 for 10 ordinary shares was made utilising
the share premium account. The remainder of the increase in ordinary shares was
due to an issue for cash on 30 October 2011.
(v)
The balance on the taxation account is after settlement of the provision made for
the year to 31 March 2011. A provision for the current year has not yet been
made.
Required:
From the above information, prepare a statement of cash flows using the indirect
method for Planter in accordance with IAS 7 Statement of Cash Flows for the year to 31
March 2012.
(Total: 25 marks)
12
Casino
(a)
Casino is a publicly listed company. Details of its statements of financial position
as at 31 March 2012 and 2011 are shown below together with other relevant
information:
Statement of financial position as at
31 March 2012
$m
$m
31 March 2011
$m
$m
880
400
1,280
760
510
1,270
Non-current assets (note (i))
Property, plant and equipment
Intangible assets
Current assets
Inventory
Trade receivables
Interest receivable
Short term deposits
Bank
Total assets
Share capital and reserves
Ordinary shares of $1 each
12
350
808
5
32
15
420
372
3
120
75
1,210
2,490
990
2,260
300
200
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position as at
Reserves
Share premium
Revaluation reserve
Retained earnings
31 March 2012
$m
$m
31 March 2011
$m
$m
60
112
1,098
nil
45
1,165
1,270
1,570
Non-current liabilities
12% loan note
8% variable rate loan note
Deferred tax
1,210
1,410
nil
160
90
150
nil
75
250
Current liabilities
Trade payables
Bank overdraft
Taxation
225
530
125
15
515
nil
110
670
2,490
Total equity and liabilities
625
2,260
The following supporting information is available:
(i)
Details relating to the non-current assets are:
Property, plant and equipment at:
Cost/
Valuation
$m
Land and buildings
600
Plant
440
31 March 2012
Depreciation Carrying
value
$m
$m
12
588
148
292
880
Cost/
Valuation
$m
500
445
31 March 2011
Depreciation Carrying
value
$m
$m
80
420
105
340
760
Casino revalued the carrying value of its land and buildings by an increase
of $70 million on 1 April 2011. On 31 March 2012 Casino transferred $3
million from the revaluation reserve to retained earnings representing the
realisation of the revaluation reserve due to the depreciation of buildings.
During the year Casino acquired new plant at a cost of $60 million and sold
some old plant for $15 million at a loss of $12 million.
There were no acquisitions or disposals of intangible assets.
(ii)
The following extract is from the draft income statement for the year to 31
March 2012:
$m
Operating loss
Interest receivable
Finance costs
Loss before tax
Income tax repayment claim
Deferred tax charge
Loss for the period
© Emile Woolf Publishing Limited
$m
(32)
12
(24)
(44)
14
(15)
(1)
(45)
13
Paper F7: Financial Reporting (International)
$m
The finance costs are made up of:
Interest expenses
Penalty cost for early redemption of fixed rate loan
Issue costs of variable rate loan
$m
(16)
(6)
(2)
(24)
iii)
The short-term deposits meet the definition of cash equivalents.
(iv)
Dividends of $25 million were paid during the year.
Required:
As far as the information permits, prepare a statement of cash flows for Casino
for the year to 31 March 2012 in accordance with IAS 7 Statement of Cash Flows.
(20 marks)
(b)
In recent years many analysts have commented on a growing disillusionment
with the usefulness and reliability of the information contained in some
companies’ income statements.
Required:
Discuss the extent to which a company’s statement of cash flows may be more
(5 marks)
useful and reliable than its income statement.
(Total: 25 marks)
13
Minster
Minster is a publicly listed company. Details of its financial statements for the year
ended 30 September 2012, together with a comparative statement of financial position,
are:
Statement of financial position at
30 September 2012 30 September 2011
$000
$000
$000
$000
Non-current assets (note (i))
Property, plant and equipment
Software
Investments at fair value through profit and loss
Current assets
Inventories
Trade receivables
Amounts due from construction contracts
Bank
Total assets
Equity and liabilities
Equity shares of 25 cents each
Reserves
Share premium (note (ii))
Revaluation reserve
Retained earnings
14
1,280
135
150
⎯⎯⎯
1,565
480
270
80
nil
⎯⎯⎯
830
⎯⎯⎯
2,395
⎯⎯⎯
940
nil
125
⎯⎯⎯
1,065
510
380
55
35
⎯⎯⎯
500
150
60
950
⎯⎯⎯
1,160
⎯⎯⎯
1,660
980
⎯⎯⎯
2,045
⎯⎯⎯
300
85
25
965
⎯⎯⎯
1,075
⎯⎯⎯
1,375
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position at
Non-current liabilities
9% loan note
Environmental provision
Deferred tax
Current liabilities
Trade payables
Bank overdraft
Current tax payable
Total equity and liabilities
30 September 2012 30 September 2011
$000
$000
$000
$000
120
162
18
⎯⎯⎯
350
25
60
⎯⎯⎯
Income statement for the year ended 30 September 2012
Revenue
Cost of sales
300
435
⎯⎯⎯
2,395
⎯⎯⎯
Gross profit
Operating expenses
Finance costs (note (i))
Investment income and gain on investments
Profit before tax
Income tax expense
Profit for the year
The following supporting information is available:
(i)
nil
nil
25
⎯⎯⎯
555
40
50
⎯⎯⎯
25
645
⎯⎯⎯
2,045
⎯⎯⎯
1,397
(1,110)
⎯⎯⎯
287
(125)
⎯⎯⎯
162
(40)
20
⎯⎯⎯
142
(57)
⎯⎯⎯
85
⎯⎯⎯
Included in property, plant and equipment is a coal mine and related plant that
Minster purchased on 1 October 2011. Legislation requires that in ten years’ time
(the estimated life of the mine) Minster will have to landscape the area affected
by the mining. The future cost of this has been estimated and discounted at a rate
of 8% to a present value of $150,000. This cost has been included in the carrying
amount of the mine and, together with the unwinding of the discount, has also
been treated as a provision. The unwinding of the discount is included within
finance costs in the income statement.
Other land was revalued (upward) by $35,000 during the year.
Depreciation of property, plant and equipment for the year was $255,000.
There were no disposals of property, plant and equipment during the year.
The software was purchased on 1 April 2012 for $180,000.
The market value of the investments had increased during the year by $15,000.
There have been no sales of these investments during the year.
(ii)
On 1 April 2012 there was a bonus (scrip) issue of equity shares of one for every
four held utilising the share premium reserve. A further cash share issue was
made on 1 June 2012. No shares were redeemed during the year.
(iii)
A dividend of 5 cents per share was paid on 1 July 2012.
© Emile Woolf Publishing Limited
15
Paper F7: Financial Reporting (International)
Required:
(a)
Prepare a statement of cash flows for Minster for the year to 30 September 2012 in
accordance with IAS 7 Statement of cash flows.
(15 marks)
(b)
Comment on the financial performance and position of Minster as revealed by
the above financial statements and your Statement of cash flows.
(10 marks)
(Total: 25 marks)
14
Pinto
Pinto is a publicly listed company. The following financial statements of Pinto are
available:
Statement of comprehensive income for the year ended 31 March 2012
Revenue
Cost of sales
Gross profit
Income from and gains on investment property
Distribution costs
Administrative expenses (note (ii))
Finance costs
Profit before tax
Income tax expense
Profit for the year
Other comprehensive income
Gains on property revaluation
100
––––––
380
––––––
Total comprehensive income
Statements of financial position as at
31 March 2012
$’000
$’000
31 March 2011
$’000
$’000
2,880
420
––––––
3,300
1,860
400
––––––
2,260
Assets
Non-current assets (note (i))
Property, plant and equipment
Investment property
Current assets
Inventory
Trade receivables
Income tax asset
Bank
Total assets
16
$’000
5,740
(4,840)
––––––
900
60
(120)
(350)
(50)
––––––
440
(160)
––––––
280
––––––
1,210
480
nil
10
–––––
1,700
––––––
5,000
––––––
810
540
50
nil
––––––
1,400
––––––
3,660
––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of comprehensive income for the year ended 31 March 2012
Equity and liabilities
Equity shares of 20 cents each (note (iii))
1,000
Share premium
600
nil
Revaluation reserve
150
50
Retained earnings
1,440
2,190
1,310
–––––
––––––
––––––
3,190
Non-current liabilities
6% loan notes (note (ii))
nil
400
Deferred tax
50
50
30
–––––
––––––
Current liabilities
Trade payables
1,410
1,050
Bank overdraft
nil
120
Warranty provision (note (iv))
200
100
Current tax payable
150
1,760
nil
–––––
––––––
––––––
Total equity and liabilities
5,000
––––––
$’000
600
1,360
––––––
1,960
430
1,270
––––––
3,660
––––––
The following supporting information is available:
(i)
An item of plant with a carrying amount of $240,000 was sold at a loss of $90,000
during the year. Depreciation of $280,000 was charged (to cost of sales) for
property, plant and equipment in the year ended 31 March 2012.
Pinto uses the fair value model in IAS 40 Investment Property. There were no
purchases or sales of investment property during the year.
(ii)
The 6% loan notes were redeemed early incurring a penalty payment of $20,000
which has been charged as an administrative expense in the income statement.
(iii)
There was an issue of shares for cash on 1 October 2011. There were no bonus
issues of shares during the year.
(iv)
Pinto gives a 12 month warranty on some of the products it sells. The amounts
shown in current liabilities as warranty provision are an accurate assessment,
based on past experience, of the amount of claims likely to be made in respect of
warranties outstanding at each year end. Warranty costs are included in cost of
sales.
(v)
A dividend of 3 cents per share was paid on 1 January 2012.
Required:
(a)
Prepare a statement of cash flows for Pinto for the year to 31 March 2012 in
accordance with IAS 7 Statement of cash flows.
(15 marks)
(b)
Comment on the cash flow management of Pinto as revealed by the statement of
cash flows and the information provided by the above financial statements.
Note: ratio analysis is not required, and will not be awarded any marks.
(10 marks)
(Total: 25 marks)
© Emile Woolf Publishing Limited
17
Paper F7: Financial Reporting (International)
15
Coaltown
Coaltown is a wholesaler and retailer of office furniture. Extracts from the company’s
financial statements are set out below:
Statements of comprehensive income for the year ended:
Revenue
– cash
– credit
Cost of sales
Gross profit
Operating expenses
Finance costs
– loan notes
– overdraft
Profit before tax
Income tax expense
Profit for period
Other comprehensive income
Gain on property revaluation
31 March 2012
$’000
$’000
12,800
53,000
65,800
–––––––
(43,800)
–––––––
22,000
(11,200)
(380)
(220)
(600)
–––––––
–––––––
10,200
(3,200)
–––––––
7,000
31 March 2011
$’000
$’000
26,500
28,500
55,000
–––––––
(33,000)
–––––––
22,000
(6,920)
(180)
nil
(180)
–––––––
–––––––
14,900
(4,400)
–––––––
10,500
5,000
–––––––
12,000
–––––––
1,200
–––––––
11,700
–––––––
Total comprehensive income for the year
Statement of changes in equity for the year ended 31 March 2012:
Balances b/f
Share issue
Comprehensive income
Dividends paid
$’000
Equity
shares
$’000
Share
premium
$’000
Revaluation
reserve
$’000
Retained
earnings
8,000
8,600
500
4,300
2,500
15,800
5,000
7,000
(4,000)
–––––––
18,800
–––––––
–––––––
––––––
16,600
4,800
–––––––
––––––
Statements of financial position as at 31 March:
Balances c/f
2012
$’000
Assets
Non-current assets (see note)
Cost
Accumulated depreciation
Current assets
Inventory
Trade receivables
Bank
Total assets
18
––––––
7,500
––––––
$’000
$’000
93,500
(43,000)
–––––––
50,500
5,200
7,800
nil
–––––––
$’000
Total
26,800
12,900
12,000
(4,000)
–––––––
47,700
–––––––
2011
$’000
80,000
(48,000)
––––––––
32,000
4,400
2,800
13,000
––––––––
63,500
–––––––
700
–––––––
7,900
––––––––
39,900
––––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
2012
$’000
Equity and liabilities
Equity shares of $1 each
Share premium
Revaluation reserve
Retained earnings
Non-current liabilities
10% loan notes
Current liabilities
Bank overdraft
Trade payables
Taxation
Warranty provision
Total equity and liabilities
3,600
4,200
3,000
1,000
–––––––
$’000
$’000
2011
$’000
16,600
4,800
7,500
18,800
–––––––
47,700
–––––––
8,000
500
2,500
15,800
––––––––
26,800
––––––––
4,000
3,000
11,800
––––––––
63,500
–––––––
nil
4,500
5,300
300
–––––––
10,100
––––––––
39,900
––––––––
Note
Non-current assets
During the year the company redesigned its display areas in all of its outlets. The
previous displays had cost $10 million and had been written down by $9 million. There
was an unexpected cost of $500,000 for the removal and disposal of the old display
areas. Also during the year the company revalued the carrying amount of its property
upwards by $5 million, the accumulated depreciation on these properties of $2 million
was reset to zero.
All depreciation is charged to operating expenses.
Required:
(a)
Prepare a statement of cash flows for Coaltown for the year ended 31 March 2012
in accordance with IAS 7 Statement of Cash Flows by the indirect method.
(15 marks)
(b)
The directors of Coaltown are concerned at the deterioration in its bank balance
and are surprised that the amount of gross profit has not increased for the year
ended 31 March 2012. At the beginning of the current accounting period (i.e. on 1
April 2011), the company changed to importing its purchases from a foreign
supplier because the trade prices quoted by the new supplier were consistently
10% below those of its previous supplier. However, the new supplier offered a
shorter period of credit than the previous supplier (all purchases are on credit).
In order to encourage higher sales, Coaltown increased its credit period to its
customers, and some of the cost savings (on trade purchases) were passed on to
customers by reducing selling prices on both cash and credit sales by 5% across
all products.
Required:
(i)
Calculate the gross profit margin that you would have expected Coaltown
to achieve for the year ended 31 March 2012 based on the selling and
purchase price changes described by the directors;
(2 marks)
© Emile Woolf Publishing Limited
19
Paper F7: Financial Reporting (International)
(ii)
Comment on the directors’ surprise at the unchanged gross profit and
suggest what other factors may have affected gross profit for the year
ended 31 March 2012;
(4 marks)
(iii)
Applying the trade receivables and payables credit periods for the year
ended 31 March 2011 to the credit sales and purchases of the year ended 31
March 2012, calculate the effect this would have had on the company’s
bank balance at 31 March 2012 assuming sales and purchases would have
remained unchanged.
(4 marks)
Note: the inventory at 31 March 2011 was unchanged from that at 31 March 2010;
assume 365 trading days.
(Total: 25 marks)
16
Crosswire
(a)
The following information relates to Crosswire a publicly listed company.
Summarised statements of financial position as at:
30 September
2012
$’000
$’000
30 September
2011
$’000
$’000
32,500
1,000
––––––
33,500
8,200
––––––
41,700
––––––
13,100
2,500
––––––
15,600
6,800
––––––
22,400
––––––
5,000
4,000
Assets
Non-current assets
Property, plant and equipment (note (i))
Development costs (note (ii))
Current assets
Total assets
Equity and liabilities
Equity
Equity shares of $1 each
Share premium
Other equity reserve
Revaluation reserve
Retained earnings
Non-current liabilities
10% convertible loan notes (note (iii))
Environmental provision
Finance lease obligations
Deferred tax
Current liabilities
Finance lease obligations
Trade payables
Total equity and liabilities
20
6,000
500
2,000
5,700
––––––
1,000
3,300
5,040
3,360
––––––
1,760
8,040
––––––
14,200
––––––
19,200
12,700
9,800
––––––
41,700
––––––
2,000
500
nil
3,200
––––––
5,000
nil
nil
1,200
––––––
nil
6,500
––––––
5,700
––––––
9,700
6,200
6,500
––––––
22,400
––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
Information from the income statements for the year ended:
Revenue
Finance costs (note (iv))
Income tax expense
Profit for the year (after tax)
30 September
2012
$’000
52,000
1,050
1,000
4,000
30 September
2011
$’000
42,000
500
800
3,000
The following information is available:
(i)
During the year to 30 September 2012, Crosswire embarked on a
replacement and expansion programme for its non-current assets. The
details of this programme are:
On 1 October 2011 Crosswire acquired a platinum mine at a cost of $5
million. A condition of mining the platinum is a requirement to landscape
the mining site at the end of its estimated life of ten years. The present
value of this cost at the date of the purchase was calculated at $3 million (in
addition to the purchase price of the mine of $5 million).
Also on 1 October 2011 Crosswire revalued its freehold land for the first
time. The credit in the revaluation reserve is the net amount of the
revaluation after a transfer to deferred tax on the gain. The tax rate
applicable to Crosswire for deferred tax is 20% per annum.
On 1 April 2012 Crosswire took out a finance lease for some new plant. The
fair value of the plant was $10 million. The lease agreement provided for an
initial payment on 1 April 2012 of $2·4 million followed by eight sixmonthly payments of $1·2 million commencing 30 September 2012.
Plant disposed of during the year had a carrying amount of $500,000 and
was sold for $1·2 million. The remaining movement on the property, plant
and equipment, after charging depreciation of $3 million, was the cost of
replacing plant.
(ii)
From 1 October 2011 to 31 March 2012 a further $500,000 was spent
completing the development project at which date marketing and
production started. The sales of the new product proved disappointing and
on 30 September 2012 the development costs were written down to $1
million via an impairment charge.
(iii)
During the year ended 30 September 2012, $4 million of the 10% convertible
loan notes matured. The loan note holders had the option of redemption at
par in cash or to exchange them for equity shares on the basis of 20 new
shares for each $100 of loan notes. 75% of the loan-note holders chose the
equity option. Ignore any effect of this on the other equity reserve.
All the above items have been treated correctly according to International
Financial Reporting Standards.
© Emile Woolf Publishing Limited
21
Paper F7: Financial Reporting (International)
(iv)
The finance costs are made up of:
For year ended:
finance lease charges
unwinding of environmental provision
loan-note interest
Required:
(i)
30 September
2012
$’000
400
300
350
––––––
1,050
––––––
30 September
2011
$’000
nil
nil
500
––––
500
––––
Prepare a statement of the movements in the carrying amount of
Crosswire’s non-current assets for the year ended 30 September 2012;
(9 marks)
(ii)
Calculate the amounts that would appear under the headings of ‘cash flows
from investing activities’ and ‘cash flows from financing activities’ in the
statement of cash flows for Crosswire for the year ended 30 September
2012.
Note: Crosswire includes finance costs paid as a financing activity.
(8 marks)
(b)
A substantial shareholder has written to the directors of Crosswire expressing
particular concern over the deterioration of the company’s return on capital
employed (ROCE)
Required:
Calculate Crosswire’s ROCE for the two years ended 30 September 2011 and 2012
and comment on the apparent cause of its deterioration.
Note: ROCE should be taken as profit before interest on long-term borrowings
and tax as a percentage of equity plus loan notes and finance lease obligations (at
the year-end).
(8 marks)
(Total: 25 marks)
17
Deltoid
(a)
The following information relates to the draft financial statements of Deltoid.
Summarised statements of financial position as at:
Assets
Non-current assets
Property, plant and equipment (note (i))
Current assets
Inventory
Trade receivables
Tax refund due
Bank
Total assets
22
31 March 2010
$’000
$’000
31 March 2009
$’000
$’000
19,000
25,500
12,500
4,500
500
nil
–––––––
36,500
–––––––
4,600
2,000
nil
1,500
–––––––
33,600
–––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
Equity and liabilities
Equity
Equity shares of $1 each (note (ii))
Share premium (note (ii))
Retained earnings
Non-current liabilities
10% loan note (note (iii))
Finance lease obligations
Deferred tax
Current liabilities
10% loan note (note (iii))
Tax
Bank overdraft
Finance lease obligations
Trade payables
31 March 2010
$’000
$’000
31 March 2009
$’000
$’000
10,000
3,200
4,500
––––––
nil
4,800
1,200
–––––––
5,000
nil
1,400
1,700
4,700
––––––
7,700
–––––––
17,700
6,000
8,000
4,000
6,300
––––––
5,000
2,000
800
–––––––
10,300
–––––––
18,300
7,800
nil
2,500
nil
800
4,200
––––––
12,800
7,500
–––––––
–––––––
Total equity and liabilities
36,500
33,600
–––––––
–––––––
Summarised income statements for the years ended:
31 March 2010
31 March 2009
$’000
$’000
Revenue
55,000
40,000
Cost of sales
(43,800)
(25,000)
–––––––
–––––––
Gross profit
11,200
15,000
Operating expenses
(12,000)
(6,000)
Finance costs (note (iv))
(1,000)
(600)
–––––––
–––––––
Profit (loss) before tax
(1,800)
8,400
Income tax relief (expense)
700
(2,800)
–––––––
–––––––
Profit (loss) for the year
(1,100)
5,600
–––––––
–––––––
The following additional information is available:
(i)
Property, plant and equipment is made up of:
As at:
31 March 2010
31 March 2009
$’000
$’000
Leasehold property
nil
8,800
Owned plant
12,500
14,200
Leased plant
6,500
2,500
–––––––
–––––––
19,000
25,500
–––––––
–––––––
During the year Deltoid sold its leasehold property for $8·5 million and entered
into an arrangement to rent it back from the purchaser. There were no additions
to or disposals of owned plant during the year. The depreciation charges (to cost
of sales) for the year ended 31 March 2010 were:
© Emile Woolf Publishing Limited
23
Paper F7: Financial Reporting (International)
$’000
200
1,700
1,800
–––––––
3,700
–––––––
On 1 July 2009 there was a bonus issue of shares from share premium of one new
share for every 10 held.
Leasehold property
Owned plant
Leased plant
(ii)
On 1 October 2009 there was a fully subscribed cash issue of shares at par.
(iii)
The 10% loan note is due for repayment on 30 June 2010. Deltoid is in
negotiations with the loan provider to refinance the same amount for another
five years.
(iv)
The finance costs are made up of:
For year ended:
Finance lease charges
Overdraft interest
Loan note interest
31 March 2010
$’000
300
200
500
––––––
1,000
––––––
31 March 2009
$’000
100
nil
500
––––
600
––––
Required:
(b)
(i)
Prepare a statement of cash flows for Deltoid for the year ended 31 March
2010 in accordance with IAS 7 Statement of cash flows, using the indirect
method;
(12 marks)
(ii)
Based on the information available, advise the loan provider on the matters
you would take into consideration when deciding whether to grant Deltoid
a renewal of its maturing loan note.
(8 marks)
On a separate matter, you have been asked to advise on an application for a loan
to build an extension to a sports club which is a not-for-profit organisation. You
have been provided with the audited financial statements of the sports club for
the last four years.
Required:
Identify and explain the ratios that you would calculate to assist in determining
whether you would advise that the loan should be granted.
(5 marks)
(Total: 25 marks)
24
© Emile Woolf Publishing Limited
Section 1: Practice questions
Financial statements – Preparation of accounts from trial
balance
18
Petra
The following trial balance relates to Petra, a public listed company, at 30 September
2012:
$000
Revenue (note (i))
Cost of sales (note (i))
Distribution costs
Administration expenses
Loan interest paid
Ordinary shares of 25 cents each fully paid
Share premium
Retained earnings 1 October 2011
6% Redeemable loan note (issued in 2010)
Land and buildings at cost
((land element $40 million) note (ii))
Plant and equipment at cost (note (iii))
Deferred development expenditure (note (iv))
Accumulated depreciation at 1 October 2011:
– buildings
– plant and equipment
Accumulated amortisation of development expenditure
at 1 October 2011
Income tax (note (v))
Deferred tax (note (v))
Trade receivables
Inventories – 30 September 2012
Cash and bank
Trade payables
$000
197,800
114,000
17,000
18,000
1,500
40,000
12,000
34,000
50,000
100,000
66,000
40,000
16,000
26,000
8,000
1,000
15,000
24,000
21,300
11,000
413,800
15,000
413,800
The following notes are relevant:
(i)
Included in revenue is $12 million for receipts that the company’s auditors have
advised are commission sales. The costs of these sales, paid for by Petra, were $8
million. $3 million of the profit of $4 million was attributable to and remitted to
Sharma (the auditors have advised that Sharma is the principal for these
transactions). Both the $8 million cost of sales and the $3 million paid to Sharma
have been included in cost of sales.
(ii)
The buildings had an estimated life of 30 years when they were acquired and are
being depreciated on the straight-line basis.
(iii)
Included in the trial balance figures for plant and equipment is plant that had
cost $16 million and had accumulated depreciation of $6 million. Following a
© Emile Woolf Publishing Limited
25
Paper F7: Financial Reporting (International)
review of the company’s operations this plant was made available for sale during
the year. Negotiations with a broker have concluded that a realistic selling price
of this plant will be $7.5 million and the broker will charge a commission of 8% of
the selling price. The plant had not been sold by the year end. Plant is
depreciated at 20% per annum using the reducing balance method. Depreciation
of buildings and plant is charged to cost of sales.
(iv)
The development expenditure relates to the capitalised cost of developing a
product called the Topaz. It had an original estimated life of five years.
Production and sales of the Topaz started in October 2010. A review of the sales
of the Topaz in late September 2012, showed them to be below forecast and an
impairment test concluded that the fair value of the development costs at 30
September 2012 was only $18 million and the expected period of future sales
(from this date) was only a further two years.
(v)
The balance on the income tax account in the trial balance is the under-provision
in respect of the income tax liability for the year ended 30 September 2011. The
directors have estimated the provision for income tax for the year ended 30
September 2012 to be $4 million and the required balance sheet provision for
deferred tax at 30 September 2012 is $17.6 million.
Required:
Prepare for Petra:
(a)
An income statement for the year ended 30 September 2012
(10 marks)
(b) A statement of financial position as at 30 September 2012.
(10 marks)
Note: A statement of changes in equity and a statement of comprehensive income are
NOT required. Disclosure notes are also NOT required.
(c)
The directors hold options to purchase 24 million shares for a total of $7.2
million. The options were granted two years ago and have been correctly
accounted for. The options do not affect your answer to (a) and (b) above. The
average stock market value of Petra’s shares for the year ended 30 September
2012 can be taken as 90 cents per share.
Required:
A calculation of the basic and diluted earnings per share for the year ended 30
(5 marks)
September 2012 (comparatives are not required).
(Total: 25 marks)
19
Darius
The following trial balance relates to Darius at 31 March 2012:
$000
Revenue
Cost of sales
Closing inventories – 31 March 2012 (note (i))
Operating expenses
Rental income from investment property
Finance costs (note (ii))
Land and building – at valuation (note (iii))
Plant and equipment – cost (note (iii))
26
$000
213,800
143,800
10,500
22,400
1,200
5,000
63,000
36,000
© Emile Woolf Publishing Limited
Section 1: Practice questions
$000
Investment property – valuation 1 April 2011 (note (iii))
Accumulated depreciation 1 April 2011 – plant and equipment
Joint venture (note (iv))
Trade receivables
Bank
Trade payables
Ordinary shares of 25c each
10% Redeemable preference shares of $1 each
Deferred tax (note (v))
Revaluation reserve (note (iii))
Retained earnings – 1 April 2011
$000
16,000
16,800
8,000
13,500
900
11,800
20,000
10,000
5,200
21,000
17,500
318,200
318,200
The following notes are relevant:
(i)
An inventory count at 31 March 2012 listed goods with a cost of $10.5 million.
This includes some damaged goods that had cost $800,000. These would require
remedial work costing $450,000 before they could be sold for an estimated
$950,000.
(ii)
Finance costs include overdraft charges, the full year’s preference dividend and
an ordinary dividend of 4c per share that was paid in September 2011.
(iii)
Non-current assets:
Land and building
The land and building were revalued at $15 million and $48 million respectively
on 1 April 2011 creating a $21 million revaluation reserve. At this date the
building had a remaining life of 15 years.
Depreciation is on a straight-line basis. Darius does not make a transfer to
realised profits in respect of excess depreciation.
Plant
All plant, including that of the joint venture (note (iv)), is depreciated at 12·5% on
the reducing balance basis.
Depreciation on both the building and the plant should be charged to cost of
sales.
Investment property
On 31 March 2012 a qualified surveyor valued the investment property at $13.5
million. Darius uses the fair value model in IAS 40 Investment property to value
its investment property.
(iv)
On 1 April 2011 Darius entered into a joint venture with two other entities. Each
venturer contributes their own assets and is responsible for their own expenses
including depreciation on joint venture assets. Darius is entitled to 40% of the
joint venture’s total revenues. The joint venture is not a separate entity.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Details of Darius’s joint venture transactions are:
$000
Plant and equipment at cost
12,000
Share of joint venture revenue (40% of total sales revenue)
(8,000)
Related joint venture cost of sales excluding depreciation
5,000
Trade receivables
1,500
Trade payables
(2,500)
Net balance included in the above list of balances
(v)
8,000
The directors have estimated the provision for income tax for the year ended 31
March 2012 at $8 million. The deferred tax provision at 31 March 2012 is to be
adjusted (through the income statement) to reflect that the tax base of the
company’s net assets is $12 million less than their carrying amounts. The rate of
income tax is 30%.
Required:
(a)
Prepare the statement of comprehensive for Darius for the year ended 31 March
(12 marks)
2012.
(c)
Prepare the statement of financial position for Darius as at 31 March 2012.
(13 marks)
Notes to the financial statements are not required.
20
(Total: 25 marks)
Danzig
The following trial balance relates to Danzig, a public listed company, at 30 September
2012.
$000
Cost of sales
Operating expenses
Loan interest paid (see note (1))
Rental of vehicles (see note (2))
Revenue
Investment income
Leasehold property at cost (see note (4))
Plant and equipment at cost
Accumulated depreciation at 1 October 2011:
- leasehold property
- plant and equipment
Investments at amortised cost
Equity shares of $0.50 each, fully paid
Retained earnings at 1 October 2011
3% loan notes (see note (1))
Deferred tax balance at 1 October 2011 (see note (5))
Inventory at 30 September 2012
Trade receivables
28
$000
134,000
35,000
1,500
8,600
295,300
2,000
250,000
197,000
40,000
47,000
92,400
180,000
19,300
50,000
20,000
23,700
76,400
© Emile Woolf Publishing Limited
Section 1: Practice questions
$000
Trade payables
Bank
Suspense account (see note (6))
$000
14,100
12,100
830,700
163,000
830,700
The following notes are relevant:
(1)
The loan notes were issued on 1 October 2011 and are redeemable on 30
September 2016. They are redeemable at a large premium to nominal value
because of the low nominal interest rate payable. It has been calculated that the
effective interest rate on these loan notes is 6% per year.
(2)
There are two separate contracts for rental of vehicles. A recent review by the
finance department of these contracts has reached the conclusion that of the total
rental cost of vehicles, $7 million relates to a finance lease rather than an
operating lease or rental arrangement. The finance lease was entered into on 1
October 2011 which was when the $7 million was paid: the lease agreement is for
a four-year period in total, and there will be three more annual payments in
advance of $7 million, payable on 1 October in each year. The vehicles in the
finance lease agreement had a fair value of $24 million at 1 October 2011 and they
should be depreciated using the straight line method to a nil residual value. The
interest rate implicit in the lease is 10% per year. The other contract for vehicle
rental is an operating lease and the rental payment should be charged to
operating expenses. (Note: You are not required to calculate the present value of
the minimum lease payments for the finance lease.)
(3)
Other plant and equipment is depreciated at 20% per year by the reducing
balance method.
All depreciation of property, plant and equipment should be charged to cost of
sales.
(4)
The leasehold property has a 25-year life and is amortised at a straight-line rate.
On 30 September 2012 the leasehold property was re-valued to $220 million and
the directors wish to incorporate this re-valuation in the financial statements.
(5)
The provision for income tax for the year ended 30 September 2012 has been
estimated at $18 million. At 30 September 2012 there are taxable temporary
differences of $92 million. Of these $20 million is related to the revaluation of the
leasehold property (see note (2) above). The rate of income tax on profits is 25%.
(6)
The suspense account balance can be reconciled from the following transactions.
The payment of a dividend in October 2011. This was calculated to give a 5%
yield on the company’s share price as at 30 September 2011. The share price as at
this date was $2.00.
The net receipts from a rights issue of shares in March 2012. The issue was of one
new share for every three held at a price of $1.70 per share. The issue was fully
subscribed. The expenses of the share issue were $5 million. These should be
charged against share premium.
Note that the cash entries for these transactions have already been fully
accounted for.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Required:
(a)
Prepare an income statement for Danzig for the year to 30 September 2012
(8 marks)
(b)
Prepare a statement of financial position for Danzig as at 30 September 2012.
(17 marks)
Note: A statement of changes in equity is not required.
21
(Total: 25 marks)
Allgone
The following trial balance relates to Allgone at 31 March 2012:
$000
Sales revenue (note (i))
Purchases
Operating expenses
Loan note interest paid
Preference dividend
Land and buildings – at valuation (note (ii))
Plant and equipment – cost
Software – cost 1 April 2009
Stock market investments – valuation 1 April 2011 (note
(iii))
Depreciation 1 April 2011 – plant and equipment
Depreciation 1 April 2011 – software
Extraordinary item (note (iv))
Trade receivables
Inventory – 1 April 2011
Bank
Trade payables
Ordinary shares of 25c each
10% Redeemable preference shares
12% Loan note (issued 1 July 2011)
Deferred tax
Revaluation reserve
(relating to land and buildings and the investments)
Retained earnings – 1 April 2011
$000
236,200
127,850
12,400
2,400
1,000
130,000
84,300
10,000
12,000
24,300
6,000
32,000
23,000
19,450
350
15,200
60,000
20,000
40,000
3,000
454,400
45,000
4,350
454,400
The following notes are relevant:
(i)
Sales revenue includes $8 million for goods sold in March 2012 for cash to
Funders, a merchant bank. The cost of these goods was $6 million. Funders has
the option to require Allgone to repurchase these goods within one month of the
year-end at their original selling price plus a facilitating fee of $250,000.
The inventory at 31 March 2012 was counted at a cost value of $8.5 million. This
includes $500,000 of slow moving inventory that is expected to be sold for a net
$300,000.
30
© Emile Woolf Publishing Limited
Section 1: Practice questions
(ii)
Non-current assets:
On 1 April 2011 Allgone re-valued its land and buildings. The details are:
Cost 1 April 2006
Valuation 1 April 2011
$000
$000
Land
20,000
25,000
Building
80,000
105,000
The building had an estimated life of 40 years when it was acquired and this has
not changed as a result of the revaluation. Depreciation is on a straight-line basis.
The surplus on the revaluation has been added to the revaluation reserve, but no
other movements on the revaluation reserve have been recorded.
Plant and equipment is depreciated at 20% per annum on the reducing balance
basis.
Software is depreciated by the sum of the digits method over a five-year life.
(iii)
The investment represents 7.5% of the ordinary share capital of Wondaworld.
Allgone has a policy of revaluing its investments at their market price at each
year-end. The auditors have agreed that changes in value can be taken to the
revaluation reserve which at 1 April 2011 contained a surplus of $5 million for
previous revaluations of the investments. The stock market price of Wondaworld
ordinary shares was $2.50 each on 1 April 2011 and by 31 March 2012 this had
fallen to $2.25.
(iv)
The extraordinary item is a loss incurred due to a fraud relating to the company’s
investments. A senior employee of the company, who left in January 2011, had
diverted investment funds into his private bank account. The fraud was
discovered by the employee’s replacement in April 2011. It is unlikely that any of
the funds will be recovered. Allgone has now implemented tighter procedures to
prevent such a fraud recurring. The company has been advised that this loss will
not qualify for any tax relief.
(v)
The directors have estimated the provision for income tax for the year to 31
March 2012 at $11.3 million. The deferred tax provision at 31 March 2012 is to be
adjusted to reflect the tax base of the company’s net assets being $16 million less
than carrying values. The rate of income tax is 30%. The movement on deferred
tax should be charged to the income statement.
Required:
In accordance with International Accounting Standards and International Financial
Reporting Standards as far as the information permits, prepare:
(a)
the income statement of Allgone for the year to 31 March 2012; and
(7 marks)
(b)
the statement of changes in equity for the year to 31 March 2012; and
(5 marks)
(c)
a statement of financial position as at 31 March 2012.
Notes to the financial statements are not required.
© Emile Woolf Publishing Limited
(13 marks)
(Total: 25 marks)
31
Paper F7: Financial Reporting (International)
22
Tourmalet
The following extracted balances relate to Tourmalet at 30 September 2012:
$000
Ordinary shares of 20 cents each
Retained earnings at 1 October 2011
Revaluation reserve at 1 October 2011
6% Redeemable preference shares 2014
Trade accounts payable
Tax
Land and buildings – at valuation (note (iii))
Plant and equipment – cost (note (v))
Investment property – valuation at 1 October 2011 (note
(iv))
Depreciation 1 October 2011 – land and buildings
Depreciation 1 October 2011 – plant and equipment
Trade accounts receivable
Inventory – 1 October 2011
Bank
Sales revenue (note (i))
Investment income (from properties)
Purchases
Distribution expenses
Administration expenses
Interim preference dividend
Ordinary dividend paid
$000
50,000
47,800
18,500
30,000
35,300
2,100
150,000
98,600
10,000
9,000
24,600
31,200
26,550
3,700
313,000
1,200
158,450
26,400
23,200
900
2,500
531,500
531,500
The following notes are relevant:
32
(i)
Sales revenue includes $50 million for an item of plant sold on 1 June 2012. The
plant had a book value of $40 million at the date of its sale, which was charged to
cost of sales. On the same date, Tourmalet entered into an agreement to lease
back the plant for the next five years (being the estimated remaining life of the
plant) at a cost of $14 million per annum payable annually in arrears. An
arrangement of this type is deemed to have a financing cost of 12% per annum.
No depreciation has been charged on the item of plant in the current year.
(ii)
The inventory at 30 September 2012 was valued at cost of $28.5 million. This
includes $4.5 million of slow moving goods. Tourmalet is trying to sell these to
another retailer but has not been successful in obtaining a reasonable offer. The
best price it has been offered is $2 million.
(iii)
On 1 October 2008 Tourmalet had its land and buildings revalued by a firm of
surveyors at $150 million, with $30 million of this attributed to the land. At that
date the remaining life of the building was estimated to be 40 years. These figures
were incorporated into the company’s books. There has been no significant
change in property values since the revaluation. $500,000 of the revaluation
reserve will be realised in the current year as a result of the depreciation of the
buildings.
© Emile Woolf Publishing Limited
Section 1: Practice questions
(iv)
Details of the investment property are:
Value – 1 October 2011
$10 million
Value – 30 September 2012
$9.8 million
The company adopts the fair value method in IAS 40 Investment Property of
valuing its investment property.
(v)
Plant and equipment (other than that referred to in note (i) above) is depreciated
at 20% per annum on the reducing balance basis. All depreciation is to be
charged to cost of sales.
(vi)
The above balances contain the results of Tourmalet’s car retailing operations
which ceased on 31 December 2011 due to mounting losses. The results of the car
retailing operation, which is to be treated as a discontinued operation, for the
year to 30 September 2012 are:
$000
Sales
15,200
Cost of sales
16,000
Operating expenses
3,200
The operating expenses are included in administration expenses in the trial
balance.
Tourmalet is still paying rentals for the lease of its car showrooms. The rentals
are included in operating expenses. Tourmalet is hoping to use the premises as
an expansion of its administration offices. This is dependent on obtaining
planning permission from the local authority for the change of use, however this
is very difficult to obtain. Failing this, the best option would be early termination
of the lease which will cost $1.5 million in penalties. This amount has not been
provided for.
(vii) The balance on the taxation account in the trial balance is the result of the
settlement of the previous year’s tax charge. The directors have estimated the
provision for income tax for the year to 30 September 2012 at $9.2 million.
Required:
(a)
Comment on the substance of the sale of the plant and the directors’ treatment of
it.
(5 marks)
(b)
Prepare the income statement; and
(c)
Prepare a statement of changes in equity for Tourmalet for the year to 30
September 2012 in accordance with current International Accounting Standards.
(17 marks)
(3 marks)
Note: A statement of financial position is NOT required. Disclosure notes are NOT
required.
(Total: 25 marks)
© Emile Woolf Publishing Limited
33
Paper F7: Financial Reporting (International)
23
Chamberlain
The following trial balance relates to Chamberlain, a publicly listed company, at 30
September 2012:
$000
$000
Ordinary share capital
200,000
Retained profits at 1 October 2011
162,000
6% Loan note (issued in 2010)
50,000
Deferred tax (note (iv))
17,500
Land and buildings at cost (land element $163 million (note (i)))
403,000
Plant and equipment at cost (note (i))
180,000
Accumulated depreciation 1 October 2011
– buildings
60,000
Accumulated depreciation 1 October 2011
– plant & equipment
60,000
Trade receivables
48,000
Inventory – 1 October 2011
35,500
Bank
12,500
Trade payables
45,000
Revenue
Purchases
Construction contract balance (note (ii))
Operating expenses
246,500
78,500
5,000
29,000
Loan interest paid
1,500
Interim dividend
8,000
Research and development expenditure (note (iii))
40,000
841,000
841,000
The following notes are relevant:
(i)
The building had an estimated life of 40 years when it was acquired and is being
depreciated on a straight-line basis. Plant and equipment is depreciated at 12.5%
per annum using the reducing balance basis. Depreciation of buildings and plant
and equipment is charged to cost of sales.
(ii)
The construction contract balance represents costs incurred to date of $35 million
less progress billings received of $30 million on a two-year construction contract
that commenced on 1 October 2011. The total contract price has been agreed at
$125 million and Chamberlain expects the total contract cost to be $75 million.
The company policy is to accrue for profit on uncompleted contracts by applying
the percentage of completion to the total estimated profit. The percentage of
completion is determined by the proportion of the contract costs to date
compared to the total estimated contract costs. At 30 September 2012, $5 million
of the $35 million costs incurred to date related to unused inventory of materials
on site.
Other inventory at 30 September 2012 amounted to $38.5 million at cost.
(iii)
34
The research and development expenditure is made up of $25 million of research,
the remainder being development expenditure. The directors are confident of the
success of this project which is likely to be completed in March 2013.
© Emile Woolf Publishing Limited
Section 1: Practice questions
(iv)
The directors have estimated the provision for income tax for the year to 30
September 2012 at $22 million. The deferred tax provision at 30 September 2012 is
to be adjusted to a credit balance of $14 million.
Required:
Prepare for Chamberlain:
(a)
an income statement for the year to 30 September 2012; and
(b)
a statement of financial position as at 30 September 2012 in accordance with
International Financial Reporting Standards as far as the information permits.
(11 marks)
(14 marks)
Note: A statement of changes in equity is NOT required.
24
(Total: 25 marks)
Tadeon
The following trial balance relates to Tadeon, a publicly listed company, at 30
September 2012:
$’000
Revenue
Cost of sales
Operating expenses
Loan interest paid (note (i))
Rental of vehicles (note (ii))
Investment income
25 year leasehold property at cost (note (iii))
Plant and equipment at cost
Investments at amortised cost
Accumulated depreciation at 1 October 2011:
– leasehold property
– plant and equipment
Equity shares of 20 cents each fully paid
Retained earnings at 1 October 2011
2% Loan note (note (i))
Deferred tax balance 1 October 2011 (note (iv))
Trade receivables
Inventories at 30 September 2012
Bank
Trade payables
Suspense account (note (v))
$’000
277,800
118,000
40,000
1,000
6,200
2,000
225,000
181,000
42,000
36,000
85,000
150,000
18,600
50,000
12,000
53,500
33,300
1,900
18,700
700,000
48,000
700,000
The following notes are relevant:
(i)
The loan note was issued on 1 October 2011. It is redeemable on 30 September
2012 at a large premium (in order to compensate for the low nominal interest
rate). The finance department has calculated that the effective interest rate on the
loan is 5·5% per annum.
(ii)
The rental of the vehicles relates to two separate contracts. These have been
scrutinised by the finance department and they have come to the conclusion that
$5 million of the rentals relate to a finance lease. The finance lease was entered
into on 1 October 2011 (the date the $5 million was paid) for a four year period.
The vehicles had a fair value of $20 million (straight-line depreciation should be
© Emile Woolf Publishing Limited
35
Paper F7: Financial Reporting (International)
used) at 1 October 2011 and the lease agreement requires three further annual
payments of $6 million each on the anniversary of the lease. The interest rate
implicit in the lease is to be taken as 10% per annum. (Note: you are not required
to calculate the present value of the minimum lease payments.) The other
contract is an operating lease and should be charged to operating expenses.
Other plant and equipment is depreciated at 121/2% per annum on the reducing
balance basis.
All depreciation of property, plant and equipment is charged to cost of sales.
(iii)
On 30 September 2012 the leasehold property was revalued to $200 million. The
directors wish to incorporate this valuation into the financial statements.
(iv)
The directors have estimated the provision for income tax for the year ended 30
September 2012 at $38 million. At 30 September 2012 there were $74 million of
taxable temporary differences, of which $20 million related to the revaluation of
the leasehold property (see (iii) above). The income tax rate is 20%.
(v)
The suspense account balance can be reconciled from the following transactions:
The payment of a dividend in October 2011. This was calculated to give a 5%
yield on the company’s share price of 80 cents as at 30 September 2011.
The net receipt in March 2012 of a fully subscribed rights issue of one new share
for every three held at a price of 32 cents each. The expenses of the share issue
were $2 million and should be charged to share premium.
Note: the cash entries for these transactions have been correctly accounted for.
Required:
Prepare for Tadeon:
(a)
An income statement for the year ended 30 September 2012; and
(b)
A statement of financial position as at 30 September 2012.
(8 marks)
(17 marks)
Note: A statement of changes in equity is not required. Disclosure notes are not
required.
(25 marks)
25
Llama
The following trial balance relates to Llama, a listed company, at 30 September 2012:
$’000
Land and buildings – at valuation 1 October 2011 (note (i))
Plant – at cost (note (i))
Accumulated depreciation of plant at 1 October 2011
Investments – at fair value through profit and loss (note (i))
Investment income
Cost of sales (note (i))
Distribution costs
Administrative expenses
Loan interest paid
Inventory at 30 September 2012
Income tax (note (ii))
Trade receivables
Revenue
Equity shares of 50 cents each fully paid
Retained earnings at 1 October 2011
36
$’000
130,000
128,000
32,000
26,500
2,200
89,200
11,000
12,500
800
37,900
400
35,100
180,400
60,000
25,500
© Emile Woolf Publishing Limited
Section 1: Practice questions
$’000
$’000
471,000
80,000
34,700
14,000
11,200
24,000
6,600
471,000
2% loan note 2014 (note (iii))
Trade payables
Revaluation reserve (arising from land and buildings)
Deferred tax
Suspense account (note (iv))
Bank
The following notes are relevant:
(i)
Llama has a policy of revaluing its land and buildings at each year end. The
valuation in the trial balance includes a land element of $30 million. The
estimated remaining life of the buildings at that date (1 October 2011) was 20
years. On 30 September 2012, a professional valuer valued the buildings at $92
million with no change in the value of the land. Depreciation of buildings is
charged 60% to cost of sales and 20% each to distribution costs and
administrative expenses.
During the year Llama manufactured an item of plant that it is using as part of its
own operating capacity. The details of its cost, which is included in cost of sales
in the trial balance, are:
$’000
Materials cost
6,000
Direct labour cost
4,000
Machine time cost
8,000
Directly attributable overheads
6,000
The manufacture of the plant was completed on 31 March 2012 and the plant was
brought into immediate use, but its cost has not yet been capitalised.
All plant is depreciated at 121/2% per annum (time apportioned where relevant)
using the reducing balance method and charged to cost of sales. No non-current
assets were sold during the year.
The fair value of the investments held at fair value through profit and loss at 30
September 2012 was $27·1 million.
(ii)
The balance of income tax in the trial balance represents the under/over
provision of the previous year’s estimate. The estimated income tax liability for
the year ended 30 September 2012 is $18·7 million. At 30 September 2012 there
were $40 million of taxable temporary differences. The income tax rate is 25%.
Note: you may assume that the movement in deferred tax should be taken to the
income statement.
(iii)
The 2% loan note was issued on 1 April 2012 under terms that provide for a large
premium on redemption in 2014. The finance department has calculated that the
effect of this is that the loan note has an effective interest rate of 6% per annum.
(iv)
The suspense account contains the corresponding credit entry for the proceeds of
a rights issue of shares made on 1 July 2012. The terms of the issue were one
share for every four held at 80 cents per share. Llama’s share price immediately
before the issue was $1. The issue was fully subscribed.
© Emile Woolf Publishing Limited
37
Paper F7: Financial Reporting (International)
Required:
Prepare for Llama:
(a)
An income statement for the year ended 30 September 2012.
(b)
A statement of financial position as at 30 September 2012.
(c)
A calculation of the earnings per share for the year ended 30 September 2012.
(9 marks)
(13 marks)
(3 marks)
Note: a statement of changes in equity is not required.
26
(Total: 25 marks)
Candel
The following trial balance relates to Candel at 30 September 2012:
Leasehold property – at valuation 1 October 2011 (note (i))
Plant and equipment – at cost (note (i))
Plant and equipment – accumulated depreciation at 1 October
2011
Capitalised development expenditure – at 1 October 2011
(note (ii))
Development expenditure – accumulated amortisation at 1
October 2011
Closing inventory at 30 September 2012
Trade receivables
Bank
Trade payables and provisions (note (iii))
Revenue (note (i))
Cost of sales
Distribution costs
Administrative expenses (note (iii))
Preference dividend paid
Interest on bank borrowings
Equity dividend paid
Research and development costs (note (ii))
Equity shares of 25 cents each
8% redeemable preference shares of $1 each (note (iv))
Retained earnings at 1 October 2011
Deferred tax (note (v))
Leasehold property revaluation reserve
The following notes are relevant:
(i)
$’000
50,000
76,600
$’000
24,600
20,000
6,000
20,000
43,100
1,300
23,800
300,000
204,000
14,500
22,200
800
200
6,000
8,600
–––––––
466,000
–––––––
50,000
20,000
24,500
5,800
10,000
––––––––
466,000
––––––––
Non-current assets – tangible:
The leasehold property had a remaining life of 20 years at 1 October 2011. The
company’s policy is to revalue its property at each year end and at 30 September
2012 it was valued at $43 million. Ignore deferred tax on the revaluation.
On 1 October 2011 an item of plant was disposed of for $2·5 million cash. The
proceeds have been treated as sales revenue by Candel. The plant is still included
in the above trial balance figures at its cost of $8 million and accumulated
depreciation of $4 million (to the date of disposal).
38
© Emile Woolf Publishing Limited
Section 1: Practice questions
All plant is depreciated at 20% per annum using the reducing balance method.
Depreciation and amortisation of all non-current assets is charged to cost of sales.
(ii)
Non-current assets – intangible:
In addition to the capitalised development expenditure (of $20 million), further
research and development costs were incurred on a new project which
commenced on 1 October 2011. The research stage of the new project lasted until
31 December 2011 and incurred $1·4 million of costs. From that date the project
incurred development costs of $800,000 per month. On 1 April 2012 the directors
became confident that the project would be successful and yield a profit well in
excess of its costs. The project is still in development at 30 September 2012.
Capitalised development expenditure is amortised at 20% per annum using the
straight-line method. All expensed research and development is charged to cost
of sales.
(iii)
Candel is being sued by a customer for $2 million for breach of contract over a
cancelled order. Candel has obtained legal opinion that there is a 20% chance that
Candel will lose the case. Accordingly Candel has provided $400,000 ($2 million
x 20%) included in administrative expenses in respect of the claim. The
unrecoverable legal costs of defending the action are estimated at $100,000. These
have not been provided for as the legal action will not go to court until next year.
(iv)
The preference shares were issued on 1 April 2012 at par. They are redeemable at
a large premium which gives them an effective finance cost of 12% per annum.
(v)
The directors have estimated the provision for income tax for the year ended 30
September 2012 at $11·4 million. The required deferred tax provision at 30
September 2012 is $6 million.
Required:
(a)
Prepare the statement of comprehensive income for the year ended 30 September
2012.
(12 marks)
(b)
Prepare the statement of changes in equity for the year ended 30 September 2012.
(3 marks)
(c)
Prepare the statement of financial position as at 30 September 2012.
Note: notes to the financial statements are not required.
27
(10 marks)
(Total: 25 marks)
Sandown
The following trial balance relates to Sandown at 30 September 2011:
$’000
Revenue (note (i))
Cost of sales
Distribution costs
Administrative expenses (note (ii))
Loan interest paid (note (iii))
Investment income
Profit on sale of investments (note (iv))
Current tax (note (v))
Freehold property – at cost 1 October 2002 (note (vi))
Plant and equipment – at cost (note (vi))
Brand – at cost 1 October 2007 (note (vi))
© Emile Woolf Publishing Limited
$’000
380,000
246,800
17,400
50,500
1,000
1,300
2,200
2,100
63,000
42,200
30,000
39
Paper F7: Financial Reporting (International)
Accumulated depreciation – 1 October 2010 – building
– plant and equipment
Accumulated amortisation – 1 October 2010 – brand
Equity investments (note (iv))
Inventory at 30 September 2011
Trade receivables
Bank
Trade payables
Equity shares of 20 cents each
Equity option
Other reserve (note (iv))
5% convertible loan note 2014 (note (iii))
Retained earnings at 1 October 2010
Deferred tax (note (v))
The following notes are relevant:
(i)
(ii)
(iii)
(iv)
(v)
(vi)
40
$’000
$’000
8,000
19,700
9,000
26,500
38,000
44,500
8,000
–––––––––
570,000
–––––––––
42,900
50,000
2,000
5,000
18,440
26,060
5,400
–––––––––
570,000
–––––––––
Sandown’s revenue includes $16 million for goods sold to Pending on 1 October
2010. The terms of the sale are that Sandown will incur ongoing service and
support costs of $1·2 million per annum for three years after the sale. Sandown
normally makes a gross profit of 40% on such servicing and support work. Ignore
the time value of money.
Administrative expenses include an equity dividend of 4·8 cents per share paid
during the year.
The 5% convertible loan note was issued for proceeds of $20 million on 1 October
2009. It has an effective interest rate of 8% due to the value of its conversion
option.
Sandown invests in quoted equity instruments but never takes a holding of more
than 5% in any company. During the year Sandown sold an investment for $11
million. At the date of sale it had a carrying amount of $8·8 million and had
originally cost $7 million. Sandown has recorded the disposal of the investment.
The remaining investments (the $26·5 million in the trial balance) have a fair
value of $29 million at 30 September 2011. The other reserve in the trial balance
represents the net increase in the value of the available-for-sale investments as at
1 October 2010. Ignore deferred tax on these transactions.
The balance on current tax represents the under/over provision of the tax
liability for the year ended 30 September 2010. The directors have estimated the
provision for income tax for the year ended 30 September 2011 at $16·2 million.
At 30 September 2011 the carrying amounts of Sandown’s net assets were $13
million in excess of their tax base. The income tax rate of Sandown is 30%.
Non-current assets:
The freehold property has a land element of $13 million. The building element is
being depreciated on a straight-line basis. Plant and equipment is depreciated at
40% per annum using the reducing balance method.
Sandown’s brand in the trial balance relates to a product line that received bad
publicity during the year which led to falling sales revenues. An impairment
review was conducted on 1 April 2011 which concluded that, based on estimated
future sales, the brand had a value in use of $12 million and a remaining life of
only three years.
© Emile Woolf Publishing Limited
Section 1: Practice questions
However, on the same date as the impairment review, Sandown received an offer
to purchase the brand for $15 million. Prior to the impairment review, it was
being depreciated using the straight-line method over a 10-year life.
No depreciation/amortisation has yet been charged on any non-current asset for
the year ended 30 September 2011. Depreciation, amortisation and impairment
charges are all charged to cost of sales.
Required:
(a)
Prepare the statement of comprehensive income for Sandown for the year ended
30 September 2011.
(13 marks)
(b)
Prepare the statement of financial position of Sandown as at 30 September 2011.
(12 marks)
Notes to the financial statements are not required.
A statement of changes in equity is not required.
28
(Total: 25 marks)
Pricewell
The following trial balance relates to Pricewell at 31 March 2011:
Leasehold property – at valuation 31 March 2010 (note (i))
Plant and equipment (owned) – at cost (note (i))
Plant and equipment (leased) – at cost (note (i))
Accumulated depreciation at 31 March 2010
Owned plant and equipment
Leased plant and equipment
Finance lease payment (paid on 31 March 2011) (note (i))
Obligations under finance lease at 1 April 2010 (note (i))
Construction contract (note (ii))
Inventory at 31 March 2011
Trade receivables
Bank
Trade payables
Revenue (note (iii))
Cost of sales (note (iii))
Distribution costs
Administrative expenses
Preference dividend paid (note (iv))
Equity dividend paid
Equity shares of 50 cents each
6% redeemable preference shares at 31 March 2010 (note (iv))
Retained earnings at 31 March 2010
Current tax (note (v))
Deferred tax (note (v))
The following notes are relevant:
(i)
Non-current assets:
$’000
25,200
46,800
20,000
$’000
12,800
5,000
6,000
15,600
14,300
28,200
33,100
5,500
33,400
310,000
234,500
19,500
27,500
2,400
8,000
40,000
41,600
4,900
700
–––––––
471,700
–––––––
8,400
––––––––
471,700
––––––––
The 15 year leasehold property was acquired on 1 April 2009 at cost $30 million.
The company policy is to revalue the property at market value at each year end.
© Emile Woolf Publishing Limited
41
Paper F7: Financial Reporting (International)
The valuation in the trial balance of $25·2 million as at 31 March 2010 led to an
impairment charge of $2·8 million which was reported in the income statement of
the previous year (i.e. year ended 31 March 2010). At 31 March 2011 the property
was valued at $24·9 million.
Owned plant is depreciated at 25% per annum using the reducing balance
method.
The leased plant was acquired on 1 April 2009. The rentals are $6 million per
annum for four years payable in arrears on 31 March each year. The interest rate
implicit in the lease is 8% per annum. Leased plant is depreciated at 25% per
annum using the straight-line method.
No depreciation has yet been charged on any non-current assets for the year
ended 31 March 2011. All depreciation is charged to cost of sales.
(ii)
On 1 October 2010 Pricewell entered into a contract to construct a bridge over a
river. The agreed price of the bridge is $50 million and construction was expected
to be completed on 30 September 2012. The $14·3 million in the trial balance is:
$’000
materials, labour and overheads
12,000
specialist plant acquired 1 October 2010
8,000
payment from customer
(5,700)
–––––––
14,300
–––––––
The sales value of the work done at 31 March 2011 has been agreed at $22 million
and the estimated cost to complete (excluding plant depreciation) is $10 million.
The specialist plant will have no residual value at the end of the contract and
should be depreciated on a monthly basis. Pricewell recognises profits on
uncompleted contracts on the percentage of completion basis as determined by
the agreed work to date compared to the total contract price.
(iii)
Pricewell’s revenue includes $8 million for goods it sold acting as an agent for
Trilby. Pricewell earned a commission of 20% on these sales and remitted the
difference of $6·4 million (included in cost of sales) to Trilby.
(iv)
The 6% preference shares were issued on 1 April 2009 at par for $40 million. They
have an effective finance cost of 10% per annum due to a premium payable on
their redemption.
(v)
The directors have estimated the provision for income tax for the year ended 31
March 2011 at $4·5 million. The required deferred tax provision at 31 March 2011
is $5·6 million; all adjustments to deferred tax should be taken to the income
statement. The balance of current tax in the trial balance represents the
under/over provision of the income tax liability for the year ended 31 March
2010.
Required:
(a)
Prepare the statement of comprehensive income for the year ended 31 March
2011.
(12 marks)
(b)
Prepare the statement of financial position as at 31 March 2011.
(13 marks)
Note: a statement of changes in equity and notes to the financial statements are
not required.
(Total: 25 marks)
42
© Emile Woolf Publishing Limited
Section 1: Practice questions
29
Dune
The following trial balance relates to Dune at 31 March 2010:
$’000
Equity shares of $1 each
5% loan note (note (i))
Retained earnings at 1 April 2009
Leasehold (15 years) property – at cost (note (ii))
45,000
Plant and equipment – at cost (note (ii))
67,500
Accumulated depreciation – 1 April 2009 – leasehold property
– plant and equipment
Investments at fair value through profi t or loss (note (iii))
26,500
Inventory at 31 March 2010
48,000
Trade receivables
40,700
Bank
Deferred tax (note (v))
Trade payables
Revenue (note (iv))
Cost of sales
294,000
Construction contract (note (vi))
20,000
Distribution costs
26,400
Administrative expenses (note (i))
34,200
Dividend paid
10,000
Loan note interest paid (six months)
500
Bank interest
200
Investment income
Current tax (note (v))
––––––––
613,000
––––––––
The following notes are relevant:
$’000
60,000
20,000
38,400
6,000
23,500
4,500
6,000
52,000
400,000
1,200
1,400
––––––––
613,000
––––––––
(i)
The 5% loan note was issued on 1 April 2009 at its nominal (face) value of $20
million. The direct costs of the issue were $500,000 and these have been charged
to administrative expenses. The loan note will be redeemed on 31 March 2012 at a
substantial premium. The effective finance cost of the loan note is 10% per
annum.
(ii)
Non-current assets:
In order to fund a new project, on 1 October 2009 the company decided to sell its
leasehold property. From that date it commenced a short-term rental of an
equivalent property. The leasehold property is being marketed by a property
agent at a price of $40 million, which was considered a reasonably achievable
price at that date. The expected costs to sell have been agreed at $500,000. Recent
market transactions suggest that actual selling prices achieved for this type of
property in the current market conditions are 15% less than the value at which
they are marketed. At 31 March 2010 the property had not been sold.
Plant and equipment is depreciated at 15% per annum using the reducing
balance method.
No depreciation/amortisation has yet been charged on any non-current asset for
the year ended 31 March 2010. Depreciation, amortisation and impairment
charges are all charged to cost of sales.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(iii)
The investments at fair value through profit or loss had a fair value of $28 million
on 31 March 2010. There were no purchases or disposals of any of these
investments during the year.
(iv)
It has been discovered that goods with a cost of $6 million, which had been
correctly included in the count of the inventory at 31 March 2010, had been
invoiced in April 2010 to customers at a gross profit of 25% on sales, but included
in the revenue (and receivables) of the year ended 31 March 2010.
(v)
A provision for income tax for the year ended 31 March 2010 of $12 million is
required. The balance on current tax represents the under/over provision of the
tax liability for the year ended 31 March 2009. At 31 March 2010 the tax base of
Dune’s net assets was $14 million less than their carrying amounts. The income
tax rate of Dune is 30%.
(vi)
The details of the construction contract are:
costs to
further costs
31 March 2010
to complete
$’000
$’000
materials
5,000
8,000
labour and other direct costs
3,000
7,000
–––––––
–––––––
8,000
15,000
–––––––
plant acquired at cost
12,000
–––––––
per trial balance
20,000
–––––––
The contract commenced on 1 October 2009 and is scheduled to take 18 months
to complete. The agreed contract price is fi xed at $40 million. Specialised plant
was purchased at the start of the contract for $12 million. It is expected to have a
residual value of $3 million at the end of the contract and should be depreciated
using the straight-line method on a monthly basis. An independent surveyor has
assessed that the contract is 30% complete at 31 March 2010. The customer has
not been invoiced for any progress payments. The outcome of the contract is
deemed to be reasonably certain as at the year end.
Required:
(a)
Prepare the income statement for Dune for the year ended 31 March 2010.
(b)
Prepare the statement of financial position for Dune as at 31 March 2010.
Notes to the financial statements are not required.
A statement of changes in equity is not required.
The following mark allocation is provided as guidance for this question:
44
(a)
13 marks
(b)
12 marks
(25 marks)
© Emile Woolf Publishing Limited
Section 1: Practice questions
30
Cavern
The following trial balance relates to Cavern as at 30 September 2010:
$’000
$’000
50,000
30,600
12,100
3,000
7,000
11,000
Equity shares of 20 cents each (note (i))
8% loan note (note (ii))
Retained earnings – 30 September 2009
Other equity reserve
Revaluation reserve
Share premium
Land and buildings at valuation – 30 September 2009:
Land ($7 million) and building ($36 million) (note (iii))
43,000
Plant and equipment at cost (note (iii))
67,400
Accumulated depreciation plant and equipment – 30 September 2009
13,400
Available-for-sale investments (note (iv))
15,800
Inventory at 30 September 2010
19,800
Trade receivables
29,000
Bank
4,600
Deferred tax (note (v))
4,000
Trade payables
21,700
Revenue
182,500
Cost of sales
128,500
Administrative expenses (note (i))
25,000
Distribution costs
8,500
Loan note interest paid
2,400
Bank interest
300
Investment income
700
Current tax (note (v))
900
–––––––– ––––––––
340,600
340,600
–––––––– ––––––––
The following notes are relevant:
(i)
Cavern has accounted for a fully subscribed rights issue of equity shares made on
1 April 2010 of one new share for every four in issue at 42 cents each. The
company paid ordinary dividends of 3 cents per share on 30 November 2009 and
5 cents per share on 31 May 2010. The dividend payments are included in
administrative expenses in the trial balance.
(ii)
The 8% loan note was issued on 1 October 2008 at its nominal (face) value of $30
million. The loan note will be redeemed on 30 September 2012 at a premium
which gives the loan note an effective finance cost of 10% per annum.
(iii)
Non-current assets:
Cavern revalues its land and building at the end of each accounting year. At 30
September 2010 the relevant value to be incorporated into the financial
statements is $41·8 million. The building’s remaining life at the beginning of the
current year (1 October 2009) was 18 years. Cavern does not make an annual
transfer from the revaluation reserve to retained earnings in respect of the
realisation of the revaluation surplus. Ignore deferred tax on the revaluation
surplus.
Plant and equipment includes an item of plant bought for $10 million on 1
October 2009 that will have a 10-year life (using straight-line depreciation with
no residual value). Production using this plant involves toxic chemicals which
© Emile Woolf Publishing Limited
45
Paper F7: Financial Reporting (International)
will cause decontamination costs to be incurred at the end of its life. The present
value of these costs using a discount rate of 10% at 1 October 2009 was $4 million.
Cavern has not provided any amount for this future decontamination cost. All
other plant and equipment is depreciated at 12·5% per annum using the reducing
balance method.
No depreciation has yet been charged on any non-current asset for the year
ended 30 September 2010. All depreciation is charged to cost of sales.
(iv)
The available-for-sale investments held at 30 September 2010 had a fair value of
$13·5 million. There were no acquisitions or disposals of these investments
during the year ended 30 September 2010.
(v)
A provision for income tax for the year ended 30 September 2010 of $5·6 million
is required. The balance on current tax represents the under/over provision of
the tax liability for the year ended 30 September 2009. At 30 September 2010 the
tax base of Cavern’s net assets was $15 million less than their carrying amounts.
The movement on deferred tax should be taken to the income statement. The
income tax rate of Cavern is 25%.
Required:
(a)
Prepare the statement of comprehensive income for Cavern for the year ended 30
September 2010.
(b)
Prepare the statement of changes in equity for Cavern for the year ended 30
September 2010.
(c)
Prepare the statement of financial position of Cavern as at 30 September 2010.
Notes to the financial statements are not required.
The following mark allocation is provided as guidance for this question:
(a)
11 marks
(b)
5 marks
(c)
9 marks
(25 marks)
Financial statements – Amendments of draft financial
statements
31
Deltoid
The following balance sheet has been extracted from the draft financial statements of
Deltoid for the year to 31 March 2012:
Statement of financial position as at 31 March 2012
$000
Non-current assets
Property, plant and equipment
Current assets
Inventory
Trade accounts receivable
Bank
Total assets
46
$000
12,110
3,850
2,450
250
6,550
18,660
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position as at 31 March 2012
$000
Equity and liabilities
Equity:
Ordinary shares of 50 cents each
Reserves
Share premium
Revaluation reserve
Retained earnings b/f at 1 April 2011
Profit after tax for year to 31 March 2012
$000
2,000
1,000
3,000
2,500
2,000
4,500
10,500
Non-current liabilities
Environmental provision (note 4)
6% Convertible loan note (note 3)
1,200
3,000
4,200
Current liabilities
Trade accounts payable
Taxation
2,820
1,140
3,960
18,660
Total equity and liabilities
The following additional information is available:
(1)
The financial statements include an item of plant based on its treatment in the
company’s management accounts where plant is depreciated on a machine hour
use basis. The details of this item of plant are:
Cost (1 April 2010)
$250,000
Estimated residual value
$50,000
Estimated machine hour life
8,000 hours
Measured usage in year to:
31 March 2011
2,000 hours
31 March 2012
800 hours
In the financial statements the company policy is that plant and machinery
should be written off at 20% per annum on the reducing balance basis.
(2)
The income statement includes a charge of $150,000 being the first two of ten
payments of $75,000 each in respect of a five-year lease of an item of plant. The
payments were made on 1 April 2011 and 1 October 2011.
The fair value of this plant at the date it was leased was $600,000. Information
obtained from the finance department confirms that this is a finance lease and an
appropriate periodic rate of interest is 10% per annum.
Deltoid has treated the lease as an operating lease in the above financial
statements. The company depreciates plant used under finance leases on a
straight-line basis over the life of the lease.
(3)
On 1 April 2011 Deltoid issued a $3 million 6% convertible loan note at par. The
loan note is redeemable at a premium of 10% on 31 March 2015 or it may be
converted into ordinary shares on the basis of 50 shares for each $100 of loan note
at the option of the holder. The interest (coupon) rate for an equivalent loan note
without the conversion rights would have been 10%. In the draft financial
© Emile Woolf Publishing Limited
47
Paper F7: Financial Reporting (International)
statements Deltoid has paid and charged interest of $180,000 and shown the loan
note at $3 million on the statement of financial position.
The present value of $1 receivable at the end of each year, based on discount
rates of 6% and 10% can be taken as:
(4)
End of year
6%
10%
1
0.94
0.91
2
0.89
0.83
3
0.84
0.75
4
0.79
0.68
The draft financial statements contain an accumulating provision for the cost of
restoring (landscaping) the site of a quarry that is being operated by Deltoid. The
result of an environmental audit has concluded that the provision has been
calculated on the wrong basis and is materially underprovided. A firm of
environmental consultants has summarised the required revision:
Income statement charge – year to 31 March 2012
Balance sheet liability – at 31 March 2012
Current
provision
Required
provision
$000
$000
180
245
1,200
2,150
The directors consider that the incorrect original estimate constitutes a material
error.
(5)
Deltoid made a 1 for 4 bonus issue of shares on 1 March 2012 utilising the
revaluation reserve. This has not yet been recorded in the above financial
statements.
Required:
(a)
Redraft the statement of financial position of Deltoid as at 31 March 2012 making
appropriate adjustments for the items in (1) to (5) above.
(20 marks)
Note: Work to the nearest $000 and show separately your working for the
retained earnings included in the statement of financial position.
(b)
Calculate the basic and diluted earnings per share for Deltoid for the year to 31
March 2012. Assume a tax rate of 25% and that only the actual loan interest paid
is available for tax relief.
Ignore deferred tax.
(5 marks)
(Total: 25 marks)
32
Tintagel
Reproduced below is the draft statement of financial position of Tintagel as at 31
March 2012.
$000
Non-current assets (note (i))
Freehold property
Plant
48
$000
126,000
110,000
© Emile Woolf Publishing Limited
Section 1: Practice questions
$000
Investment property at 1 April 2011 (note (ii))
Current assets
Inventory (note (iii))
Trade receivables and prepayments
Bank
15,000
251,000
60,400
31,200
13,800
105,400
356,400
Total assets
Equity and liabilities
Ordinary shares of 25c each
Reserves:
Share premium
Retained earnings – 1 April 2011
Retained earnings – Year to 31 March 2012
$000
150,000
10,000
52,500
47,500
110,000
260,000
Non-current liabilities
Deferred tax – at 1 April 2011 (note (v))
Trade payables (note (iii))
Provision for plant overhaul (note (iv))
Taxation
Suspense account (note (vi))
Total equity and liabilities
18,700
47,400
12,000
4,200
63,600
14,100
356,400
Notes:
(i)
The income statement has been charged with $3.2 million being the first of four
equal annual rental payments for an item of excavating plant. This first payment
was made on 1 April 2011. Tintagel has been advised that this is a finance lease
with an implicit interest rate of 10% per annum. The plant had a fair value of
$11.2 million at the inception of the lease.
None of the non-current assets have been depreciated for the current year. The
freehold property should be depreciated at 2% on its cost of $130 million, the
leased plant is depreciated at 25% per annum on a straight-line basis and the
non-leased plant is depreciated at 20% on the reducing balance basis.
(ii)
Tintagel adopts the fair value model for its investment property. Its value at 31
March 2012 has been assessed by a qualified surveyor at $12.4 million.
(iii)
During an inventory count on 31 March 2012 items that had cost $6 million were
identified as being either damaged or slow moving. It is estimated that they will
only realise $4 million in total, on which sales commission of 10% will be
payable. An invoice for materials delivered on 12 March 2012 for $500,000 has
been discovered. It has not been recorded in Tintagel’s bookkeeping system,
although the materials were included in the inventory count.
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Paper F7: Financial Reporting (International)
(iv)
Tintagel operates some heavy excavating plant which requires a major overhaul
every three years. The overhaul is estimated to cost $18 million and is due to be
carried out in April 2013. The provision of $12 million represents two annual
amounts of $6 million made in the years to 31 March 2011 and 2012.
(v)
The deferred tax provision required at 31 March 2012 has been calculated at $22.5
million.
(vi)
The suspense account contains the credit entry relating to the issue on 1 October
2011 of a $15 million 8% loan note. It was issued at a discount of 5% and incurred
direct issue costs of $150,000. It is redeemable after four years at a premium of
10%. Interest is payable six months in arrears. The first payment of interest has
not been accrued and is due on 1 April 2012. Apportionment of issue costs,
discounts and premiums can be made on a straight-line basis.
Required:
(a)
Commencing with the retained earnings figures in the above balance sheet ($52.5
million and $47.5 million), prepare a schedule of adjustments required to these
figures taking into account any adjustments required by notes (i) to (vi) above.
(11 marks)
(b)
Redraft the statement of financial position of Tintagel as at 31 March 2012 taking
(14 marks)
into account the adjustments required in notes (i) to (vi) above.
(Total: 25 marks)
33
Harrington
Reproduced below are the draft financial statements of Harrington, a public company,
for the year to 31 March 2012:
Income statement – Year to 31 March 2012
Sales revenue (note (i))
Cost of sales (note (ii))
Gross profit
Operating expenses
Loan note interest paid (refer to balance sheet)
Profit before tax
Income tax expense (note (vi))
Profit for the period
$000
13,700
(9,200)
4,500
(2,400)
(25)
2,075
(55)
2,020
Statement of financial position as at 31 March 2012
$000
Property, plant and equipment (note (iii))
Investments (note (iv))
Current assets
Inventory
Trade receivables
Bank
$000
6,270
1,200
7,470
1,750
2,450
350
4,550
50
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position as at 31 March 2012
$000
Total assets
Equity and liabilities:
Ordinary shares of 25c each (note (v))
Reserves:
Share premium
Retained earnings – 1 April 2011
– Year to 31 March 2012
– dividends paid
$000
12,020
2,000
600
2,990
2,020
(500)
4,510
7,110
Non-current liabilities
10% loan note (issued 2009)
Deferred tax (note (vi))
500
280
780
Current liabilities
Trade payables
4,130
12,020
The company policy for ALL depreciation is that it is charged to cost of sales and a full
year’s charge is made in the year of acquisition or completion and none in the year of
disposal.
The following matters are relevant:
(i)
Included in sales revenue is $300,000 being the sale proceeds of an item of plant
that was sold in January 2012. The plant had originally cost $900,000 and had
been depreciated by $630,000 at the date of its sale. Other than recording the
proceeds in sales and cash, no other accounting entries for the disposal of the
plant have been made. All plant is depreciated at 25% per annum on the
reducing balance basis.
(ii)
On 31 December 2011 the company completed the construction of a new
warehouse. The construction was achieved using the company’s own resources
as follows:
Purchased materials
Direct labour
Supervision
Design and planning costs
$000
150
800
65
20
Included in the above figures are $10,000 for materials and $25,000 for labour
costs that were effectively lost due to the foundations being too close to a
neighbouring property. All the above costs are included in cost of sales. The
building was brought into immediate use on completion and has an estimated
life of 20 years (straight-line depreciation).
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Paper F7: Financial Reporting (International)
(iii)
Details of the other property, plant and equipment at 31 March 2012 are:
$000
Land at cost
Buildings at cost
Less accumulated depreciation at 31 March 2008
$000
1,000
4,000
(800)
3,200
Plant at cost
Less accumulated depreciation at 31 March 2008
5,200
(3,130)
2,070
6,270
At the beginning of the current year (1 April 2011), Harrington had an open
market basis valuation of its properties (excluding the warehouse in note (ii)
above). Land was valued at $1.2 million and the property at $4.8 million. The
directors wish these values to be incorporated into the financial statements. The
properties had an estimated remaining life of 20 years at the date of the valuation
(straight-line depreciation is used). Harrington makes a transfer to realised
profits in respect of the excess depreciation on revalued assets.
Note: Depreciation for the year to 31 March 2012 has not yet been accounted for
in the draft financial statements.
(iv)
The investments are in quoted companies that are carried at their stock market
values with any gains and losses recorded in the income statement. The value
shown in the statement of financial position is that at 31 March 2011 and during
the year to 31 March 2012 the investments have risen in value by an average of
10%. Harrington has not reflected this increase in its financial statements.
(v)
On 1 October 2011 there had been a fully subscribed rights issue of 1 for 4 at 60c.
This has been recorded in the above statement of financial position.
(vi)
Income tax on the profits for the year to 31 March 2012 is estimated at $260,000.
The figure in the income statement is the under-provision for income tax for the
year to 31 March 2011. The carrying value of Harrington’s net assets is $1.4
million more than their tax base at 31 March 2012. The income tax rate is 25%.
Required:
(a)
Prepare a re-stated income statement for the year to 31 March 2012 reflecting the
information in notes (i) to (vi) above.
(9 marks)
(b)
Prepare a statement of changes in equity for the year to 31 March 2012.
(6 marks)
(c)
Prepare a re-stated statement of financial position at 31 March 2012 reflecting the
information in notes (i) to (vi) above.
(10 marks)
(Total: 25 marks)
52
© Emile Woolf Publishing Limited
Section 1: Practice questions
34
Wellmay
The summarised draft financial statements of Wellmay are shown below.
Income statement year ended 31 March 2012:
$’000
4,200
(2,700)
———
1,500
(470)
20
(55)
———
995
(360)
———
635
———
Revenue (note (i))
Cost of sales (note (ii))
Gross profit
Operating expenses
Investment property rental income
Finance costs
Profit before tax
Income tax
Profit for the period
Statement of financial position as at 31 March 2012:
$’000
Assets
Non-current assets
Property, plant and equipment (note (iii))
Investment property (note (iii))
4,200
400
———
4,600
1,400
———
6,000
———
Current assets
Total assets
Equity and liabilities
Equity
Equity shares of 50 cents each (note (vii))
Reserves:
Revaluation reserve
Retained earnings (note (iv))
Non-current liabilities
8% Convertible loan note (2015) (note (v))
Deferred tax (note (vi))
Current liabilities
Total equity and liabilities
$’000
1,200
350
2,850 3,200
——— ———
4,400
600
180
———
780
820
———
6,000
———
The following information is relevant to the draft financial statements:
(i)
Revenue includes $500,000 for the sale on 1 April 2011 of maturing goods to
Westwood. The goods had a cost of $200,000 at the date of sale. Wellmay can
repurchase the goods on 31 March 2013 for $605,000 (based on achieving a
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Paper F7: Financial Reporting (International)
lender’s return of 10% per annum) at which time the goods are estimated to have
a value of $750,000.
(ii)
Past experience shows that in the period after the reporting date the company
often receives unrecorded invoices for materials relating to the previous year. As
a result of this an accrued charge of $75,000 for contingent costs has been
included in cost of sales and as a current liability.
(iii)
Non-current assets:
Wellmay owns two properties. One is a factory (with office accommodation)
used by Wellmay as a production facility and the other is an investment property
that is leased to a third party under an operating lease. Wellmay revalues all its
properties to current value at the end of each year and uses the fair value model
in IAS 40 Investment property. Relevant details of the fair values of the
properties are:
Factory
Investment property
$’000
$’000
Valuation 31 March 2011
1,200
400
Valuation 31 March 2012
1,350
375
The valuations at 31 March 2012 have not yet been incorporated into the financial
statements. Factory depreciation for the year ended 31 March 2012 of $40,000 was
charged to cost of sales. As the factory includes some office accommodation, 20%
of this depreciation should have been charged to operating expenses.
(iv)
The balance of retained earnings is made up of:
balance b/f 1 April 2011
profit for the period
dividends paid during year ended 31 March 2012
(v)
8% Convertible loan note (2015)
$’000
2,615
635
(400)
———
2,850
———
On 1 April 2011 an 8% convertible loan note with a nominal value of $600,000
was issued at par. It is redeemable on 31 March 2015 at par or it may be
converted into equity shares of Wellmay on the basis of 100 new shares for each
$200 of loan note. An equivalent loan note without the conversion option would
have carried an interest rate of 10%. Interest of $48,000 has been paid on the loan
and charged as a finance cost.
The present value of $1 receivable at the end of each year, based on discount
rates of 8% and 10% are:
8%
10%
1
0·93
0·91
2
0·86
0·83
3
0·79
0·75
4
0·73
0·68
The carrying amounts of Wellmay’s net assets at 31 March 2012 are $600,000
higher than their tax base. The rate of taxation is 35%. The income tax charge of
$360,000 does not include the adjustment required to the deferred tax provision
which should be charged in full to the income statement.
End of year
(vi)
54
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Section 1: Practice questions
(vii) Bonus/scrip issue:
On 15 March 2012, Wellmay made a bonus issue from retained earnings of one
share for every four held. The issue has not been recorded in the draft financial
statements.
Required:
Redraft the financial statements of Wellmay, including a statement of changes in
equity, for the year ended 31 March 2012 reflecting the adjustments required by notes
(i) to (vii) above.
Note: Calculations should be made to the nearest $’000.
35
(25 marks)
Dexon
Below is the summarised draft statement of financial position of Dexon, a publicly
listed company, as at 31 March 2012.
$’000
$’000
Assets
Non-current assets
Property at valuation (land $20,000; buildings
$165,000 (note (ii))
Plant (note (ii))
Investments at fair value through profit and loss at 1
April 2011 (note (iii))
185,000
180,500
12,500
–––––––
378,000
Current assets
Inventory
Trade receivables (note (iv))
Bank
84,000
52,200
3,800
–––––––
Total assets
Equity and liabilities
Equity
Ordinary shares of $1 each
Share premium
Revaluation reserve
Retained earnings – at 1 April 2011
– for the year ended 31 March 2012
Non-current liabilities
Deferred tax – at 1 April 2011 (note (v))
Current liabilities
Total equity and liabilities
$’000
140,000
–––––––
518,000
–––––––
250,000
40,000
18,000
12,300
96,700
–––––––
109,000
–––––––
167,000
–––––––
417,000
19,200
81,800
–––––––
518,000
–––––––
The following information is relevant:
(i)
Dexon’s income statement includes $8 million of revenue for credit sales made on
a ‘sale or return’ basis. At 31 March 2012, customers who had not paid for the
goods, had the right to return $2·6 million of them. Dexon applied a mark up on
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Paper F7: Financial Reporting (International)
cost of 30% on all these sales. In the past, Dexon’s customers have sometimes
returned goods under this type of agreement.
(ii)
The non-current assets have not been depreciated for the year ended 31 March
2012.
Dexon has a policy of revaluing its land and buildings at the end of each
accounting year. The values in the above statement of financial position are as at
1 April 2011 when the buildings had a remaining life of fifteen years. A qualified
surveyor has valued the land and buildings at 31 March 2012 at $180 million.
Plant is depreciated at 20% on the reducing balance basis.
(iii)
The investments at fair value through profit and loss are held in a fund whose
value changes directly in proportion to a specified market index. At 1 April 2011
the relevant index was 1,200 and at 31 March 2012 it was 1,296.
(iv)
In late March 2012 the directors of Dexon discovered a material fraud
perpetrated by the company’s credit controller that had been continuing for some
time. Investigations revealed that a total of $4 million of the trade receivables as
shown in the statement of financial position at 31 March 2012 had in fact been
paid and the money had been stolen by the credit controller. An analysis
revealed that $1·5 million had been stolen in the year to 31 March 2011 with the
rest being stolen in the current year. Dexon is not insured for this loss and it
cannot be recovered from the credit controller, nor is it deductible for tax
purposes.
(v)
During the year the company’s taxable temporary differences increased by $10
million of which $6 million related to the revaluation of the property. The
deferred tax relating to the remainder of the increase in the temporary differences
should be taken to the income statement. The applicable income tax rate is 20%.
(vi)
The above figures do not include the estimated provision for income tax on the
profit for the year ended 31 March 2012. After allowing for any adjustments
required in items (i) to (iv), the directors have estimated the provision at $11·4
million (this is in addition to the deferred tax effects of item (v)).
(vii) On 1 September 2011 there was a fully subscribed rights issue of one new share
for every four held at a price of $1·20 each. The proceeds of the issue have been
received and the issue of the shares has been correctly accounted for in the above
statement of financial position.
(viii) In May 2011 a dividend of 4 cents per share was paid. In November 2011 (after
the rights issue in item (vii) above) a further dividend of 3 cents per share was
paid. Both dividends have been correctly accounted for in the above statement of
financial position.
Required:
Taking into account any adjustments required by items (i) to (viii) above
(a)
Prepare a statement showing the recalculation of Dexon’s profit for the year
ended 31 March 2012.
(8 marks)
(b)
Prepare the statement of changes in equity of Dexon for the year ended 31 March
2012.
(8 marks)
(c)
Redraft the statement of financial position of Dexon as at 31 March 2012.
(9 marks)
Note: notes to the financial statements are NOT required.
56
(Total: 25 marks)
© Emile Woolf Publishing Limited
Section 1: Practice questions
36
Bodyline
IAS 37 Provisions, Contingent Liabilities and Contingent Assets sets out the principles
of accounting for these items and clarifies when provisions should and should not be
made. Prior to its issue, the inappropriate use of provisions had been an area where
companies had been accused of manipulating the financial statements and of creative
accounting.
Required:
(a)
Briefly describe the nature of provisions and the accounting requirements for
them contained in IAS 37.
(5 marks)
(b)
Briefly explain why there is a need for an accounting standard in this area.
Illustrate your answer with three practical examples of how the standard
addresses controversial issues.
(5 marks)
(c)
Rockbuster has recently purchased an item of earth moving plant at a total cost of
$24 million. The plant has an estimated life of 10 years with no residual value,
however its engine will need replacing after every 5,000 hours of use at an
estimated cost of $7.5 million. The directors of Rockbuster intend to depreciate
the plant at $2.4 million ($24 million/10 years) per annum and make a provision
of $1,500 ($7.5 million/5,000 hours) per hour of use for the replacement of the
engine.
Required:
Explain how the plant should be treated in accordance with International Accounting
Standards and comment on the directors’ proposed treatment.
(5 marks)
(Total: 15 marks)
37
Niagara
Extracts of Niagara’s consolidated income statement for the year to 31 March 2012 are
as follows:
Sales
Cost of sales
Gross profit
Other operating expenses
Finance costs
Impairment of non-current assets
Income from associates
Profit before tax
Taxation
Profit for the period
Attributable to:
Equity shareholders of the parent
Non controlling interests
© Emile Woolf Publishing Limited
$000
36,000
(21,000)
15,000
(6,200)
(800)
(4,000)
1,500
5,500
(2,800)
2,700
2,585
115
2,700
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Paper F7: Financial Reporting (International)
The impairment of non-current assets attracted tax relief of $1 million which has been
included in the tax charge.
Niagara paid an interim ordinary dividend of 3c per share in June 2011 and declared a
final dividend on 25 March 2012 of 6c per share.
The issued share capital of Niagara on 1 April 2011 was:
Ordinary shares of 25c each
$3 million
8% Preference shares
$1 million
The preference shares are non-redeemable.
The company also had in issue $2 million 7% convertible loan stock dated 2014. The
loan stock will be redeemed at par in 2014 or converted to ordinary shares on the basis
of 40 new shares for each $100 of loan stock at the option of the stockholders. Niagara’s
income tax rate is 30%.
There are also in existence directors’ share warrants (issued in 2010) which entitle the
directors to receive 750,000 new shares in total in 2014 at no cost to the directors.
The following share issues took place during the year to 31 March 2012:
„
1 July 2011: a rights issue of 1 new share at $1.50 for every 5 shares held. The
market price of Niagara’s shares the day before the rights was $2.40.
„
1 October 2011: an issue of $1 million 6% non‐redeemable preference shares at
par.
Both issues were fully subscribed.
Niagara’s basic earnings per share in the year to 31 March 2011 was correctly disclosed
as 24c.
Required:
Calculate for Niagara for the year to 31 March 2012:
(a)
the basic earnings per share including the comparative
(b)
the fully diluted earnings per share (ignore comparative); and advise a
prospective investor of the significance of the diluted earnings per share figure.
(3 marks)
(7 marks)
(Total: 10 marks)
38
Taxes
(a)
(i)
IAS 12 Income Taxes details the requirements relating to the accounting
treatment of deferred tax.
Required:
Explain why it is considered necessary to provide for deferred tax and
briefly outline the principles of accounting for deferred tax contained in
IAS 12 Income Taxes.
(5 marks)
(ii)
58
Bowtock purchased an item of plant for $2,000,000 on 1 October 2009. It
had an estimated life of eight years and an estimated residual value of
$400,000. The plant is depreciated on a straight‐line basis. The tax
authorities do not allow depreciation as a deductible expense. Instead a tax
expense of 40% of the cost of this type of asset can be claimed against
income tax in the year of purchase and 20% per annum (on a reducing
© Emile Woolf Publishing Limited
Section 1: Practice questions
balance basis) of its tax base thereafter. The rate of income tax can be taken
as 25%.
Required:
In respect of the above item of plant, calculate the deferred tax
charge/credit in Bowtock’s income statement for the year to 30 September
2012 and the deferred tax balance in the statement of financial position at
that date.
(5 marks)
Note: Work to the nearest $000.
(b)
The tax charge for a company called Stepper is $5 million on profits before tax of
$35 million. This is an effective rate of tax of 14.3%. Another company Jenni has
an income tax charge of $10 million on profit before tax of $30 million. This is an
effective rate of tax of 33.3%. However both companies state the rate of income
tax applicable to them is 25%. The statements of cash flows show that each
company has paid the same amount of tax of $8 million.
Required:
Explain the possible reasons why the income tax charge in the financial
statements as a percentage of the profit before tax may not be the same as the
applicable income tax rate, and why the tax paid in the statement of cash flows
may not be the same as the tax charge in the income statement.
(5 marks)
(Total: 15 marks)
39
Broadoak
The broad principles of accounting for tangible non-current assets involve
distinguishing between capital and revenue expenditure, measuring the cost of assets,
determining how they should be depreciated and dealing with the problems of
subsequent measurement and subsequent expenditure. IAS 16 Property, Plant and
Equipment has the intention of improving consistency in these areas.
Required:
(a)
Briefly explain:
(i)
how the initial cost of tangible non-current assets should be measured; and
(3 marks)
(b)
(ii)
the circumstances in which subsequent expenditure on those assets should
be capitalised.
(2 marks)
(i)
Broadoak has recently purchased an item of plant from Plantco, the details
of this are:
$
Basic list price of plant
trade discount applicable to Broadoak
Ancillary costs:
shipping and handling costs
estimated pre-production testing
maintenance contract for three years
site preparation costs
© Emile Woolf Publishing Limited
$
240,000
12.5% on list price
2,750
12,500
24,000
59
Paper F7: Financial Reporting (International)
electrical cable installation
concrete reinforcement
own labour costs
$
14,000
4,500
7,500
$
26,000
Broadoak paid for the plant (excluding the ancillary costs) within four
weeks of order, thereby obtaining an early settlement discount of 3%.
Broadoak had incorrectly specified the power loading of the original
electrical cable to be installed by the contractor. The cost of correcting this
error of $6,000 is included in the above figure of $14,000.
The plant is expected to last for 10 years. At the end of this period there
will be compulsory costs of $15,000 to dismantle the plant and $3,000 to
restore the site to its original use condition.
Required:
Calculate the amount at which the initial cost of the plant should be
(5 marks)
measured. (Ignore discounting.)
(Total: 10 marks)
40
Merryview
Merryview conducts its activities from two properties, a head office in the city centre
and a property in the countryside where staff training is conducted. Both properties
were acquired on 1 April 2009 and had estimated lives of 25 years with no residual
value. The company has a policy of carrying its land and buildings at current values.
However, until recently property prices had not changed for some years. On 1 October
2011 the properties were revalued by a firm of surveyors. Details of this and the
original costs are:
Head office
Training premises
Land
Buildings
$
$
– cost 1 April 2009
500,000
1,200,000
– revalued 1 October 2011
700,000
1,350,000
– cost 1 April 2009
300,000
900,000
– revalued 1 October 2011
350,000
600,000
The fall in the value of the training premises is due mainly to damage done by the use
of heavy equipment during training. The surveyors have also reported that the
expected life of the training property in its current use will only be a further 10 years
from the date of valuation. The estimated life of the head office remained unaltered.
Note: Merryview treats its land and its buildings as separate assets. Depreciation is
based on the straight-line method from the date of purchase or subsequent revaluation.
Required:
Prepare extracts of the financial statements of Merryview in respect of the above
properties for the year to 31 March 2012.
(Total: 10 marks)
60
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Section 1: Practice questions
41
Impairment and Wilderness
(a)
The main objective of IAS 36 Impairment of Assets is to prescribe the procedures
that should ensure that an entity’s assets are included in its statement of financial
position at no more than their recoverable amounts. Where an asset is carried at
an amount in excess of its recoverable amount, it is said to be impaired and IAS
36 requires an impairment loss to be recognised.
Required:
(i)
Define an impairment loss explaining the relevance of fair value less costs
to sell and value in use; and state how frequently assets should be tested
for impairment.
(6 marks)
Note: Your answer should NOT describe the possible indicators of an
impairment.
(ii)
(b)
Explain how an impairment loss is accounted for after it has been
(5 marks)
calculated.
The assistant financial controller of the Wilderness group, a public listed
company, has identified the matters below which she believes may indicate an
impairment to one or more assets:
(i)
Wilderness owns and operates an item of plant that cost $640,000 and had
accumulated depreciation of $400,000 at 1 October 2011. It is being
depreciated at 12½% on cost. On 1 April 2012 (exactly half way through the
year) the plant was damaged when a factory vehicle collided into it. Due to
the unavailability of replacement parts, it is not possible to repair the plant,
but it still operates, albeit at a reduced capacity. Also it is expected that as a
result of the damage the remaining life of the plant from the date of the
damage will be only two years. Based on its reduced capacity, the
estimated present value of the plant in use is $150,000. The plant has a
current disposal value of $20,000 (which will be nil in two years’ time), but
Wilderness has been offered a trade-in value of $180,000 against a
replacement machine which has a cost of $1 million (there would be no
disposal costs for the replaced plant). Wilderness is reluctant to replace the
plant as it is worried about the long-term demand for the product
produced by the plant. The trade-in value is only available if the plant is
replaced.
Required:
Prepare extracts from the statement of financial position and income
statement of Wilderness in respect of the plant for the year ended 30
September 2012. Your answer should explain how you arrived at your
figures.
(7 marks)
(ii)
On 1 April 2011 Wilderness acquired 100% of the share capital of Mossel,
whose only activity is the extraction and sale of spa water. Mossel had been
profitable since its acquisition, but bad publicity resulting from several
consumers becoming ill due to a contamination of the spa water supply in
April 2012 has led to unexpected losses in the last six months. The carrying
amounts of Mossel’s assets at 30 September 2012 are:
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Paper F7: Financial Reporting (International)
Brand (Quencher – see below)
Land containing spa
Purifying and bottling plant
Inventories
$000
7,000
12,000
8,000
5,000
32,000
The source of the contamination was found and it has now ceased.
The company originally sold the bottled water under the brand name of
‘Quencher’, but because of the contamination it has re-branded its bottled
water as ‘Phoenix’. After a large advertising campaign, sales are now
starting to recover and are approaching previous levels. The value of the
brand in the balance sheet is the depreciated amount of the original brand
name of ‘Quencher’.
The directors have acknowledged that $1.5 million will have to be spent in
the first three months of the next accounting period to upgrade the
purifying and bottling plant.
Inventories contain some old ‘Quencher’ bottled water at a cost of $2
million; the remaining inventories are labelled with the new brand
‘Phoenix’. Samples of all the bottled water have been tested by the health
authority and have been passed as fit to sell. The old bottled water will
have to be relabelled at a cost of $250,000, but is then expected to be sold at
the normal selling price of (normal) cost plus 50%.
Based on the estimated future cash flows, the directors have estimated that
the value in use of Mossel at 30 September 2012, calculated according to the
guidance in IAS 36, is $20 million. There is no reliable estimate of the fair
value less costs to sell of Mossel.
Required:
Calculate the amounts at which the assets of Mossel should appear in the
consolidated statement of financial position of Wilderness at 30 September
2012. Your answer should explain how you arrived at your figures.
(7 marks)
(Total: 25 marks)
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Section 1: Practice questions
Financial statements – Application of accounting standards
42
Torrent contracts and Savoir EPS
(a)
Torrent is a large publicly listed company whose main activity involves
construction contracts. Details of three of its contracts for the year ended 31
March 2012 are:
Contract
Alfa
Beta
Ceta
Date commenced
1 April
2010
1 October
2011
1 October
2011
Estimated duration
3 years
18 months
2 years
$m
$m
$m
Fixed contract price
20
6
12
Estimated costs at start of contract
15
7.5 (note
(iii))
10
at 31 March 2011
5
nil
nil
at 31 March 2012
12.5
(note (ii)
2
4
Estimated costs at 31 March 2012 to complete
3.5
5.5 (note
(iii))
6
Progress payments received at 31 March 2011:
(note (i))
5.4
nil
nil
Progress payments received at 31 March 2012:
(note (i))
Notes
12.6
1.8
nil
Cost to date:
(i)
The company’s normal policy for determining the percentage completion
of contracts is based on the value of work invoiced to date compared to the
contract price. Progress payments received represent 90% of the work
invoiced. However, no progress payments will be invoiced or received
from contract Ceta until it is completed, so the percentage completion of
this contract is to be based on the cost to date compared to the estimated
total contract costs.
(ii)
The cost to date of $12.5 million at 31 March 2012 for contract Alfa includes
$1 million relating to unplanned rectification costs incurred during the
current year (ended 31 March 2012) due to subsidence occurring on site.
(iii)
Since negotiating the price of contract Beta, Torrent has discovered the land
that it purchased for the project is contaminated by toxic pollutants. The
estimated cost at the start of the contract and the estimated costs to
complete the contract include the unexpected costs of decontaminating the
site before construction could commence.
Required:
Prepare extracts of the income statement and statement of financial position for
Torrent in respect of the above construction contracts for the year ended 31
March 2012.
(12 marks)
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Paper F7: Financial Reporting (International)
(b)
(i)
The issued share capital of Savoir, a publicly listed company, at 31 March
2009 was $10 million. Its shares are denominated at 25 cents each. Savoir’s
earnings attributable to its ordinary shareholders for the year ended 31
March 2009 were also $10 million, giving an earnings per share of 25 cents.
Year ended 31 March 2010
On 1 July 2009 Savoir issued eight million ordinary shares at full market
value. On 1 January 2010 a bonus issue of one new ordinary share for every
four ordinary shares held was made. Earnings attributable to ordinary
shareholders for the year ended 31 March 2010 were $13,800,000.
Year ended 31 March 2011
On 1 October 2010 Savoir made a rights issue of shares of two new
ordinary shares at a price of $1.00 each for every five ordinary shares held.
The offer was fully subscribed. The market price of Savoir’s ordinary shares
immediately prior to the offer was $2.40 each. Earnings attributable to
ordinary shareholders for the year ended 31 March 2011 were $19,500,000.
Required:
Calculate Savoir’s earnings per share for the years ended 31 March 2010
and 2011 including comparative figures.
(9 marks)
(ii)
On 1 April 2011 Savoir issued $20 million 8% convertible loan stock at par.
The terms of conversion (on 1 April 2014) are that for every $100 of loan
stock, 50 ordinary shares will be issued at the option of loan stockholders.
Alternatively the loan stock will be redeemed at par for cash. Also on 1
April 2011 the directors of Savoir were awarded share options on 12 million
ordinary shares exercisable from 1 April 2014 at $1.50 per share. The
average market value of Savoir’s ordinary shares for the year ended 31
March 2012 was $2.50 each. The income tax rate is 25%. Earnings
attributable to ordinary shareholders for the year ended 31 March 2012
were $25,200,000. The share options have been correctly recorded in the
income statement.
Required:
Calculate Savoir’s basic and diluted earnings per share for the year ended
31 March 2012 (comparative figures are not required).
You may assume that both the convertible loan stock and the directors’
options are dilutive.
(4 marks)
(Total: 25 marks)
43
Elite Leisure and Hideaway
(a)
Assume that ‘now’ is the end of September 2012.
Elite Leisure is a private limited liability company that operates a single cruise
ship. The ship was acquired on 1 October 2003. Details of the cost of the ship’s
components and their estimated useful lives are:
Component
Ship’s fabric (hull, decks etc)
Cabins and entertainment area fittings
Propulsion system
64
Original cost
($ million)
300
150
100
Depreciation basis
25 years straight-line
12 years straight-line
Useful life of 40,000 hours
© Emile Woolf Publishing Limited
Section 1: Practice questions
At 30 September 2011 no further capital expenditure had been incurred on the
ship.
In the year ended 30 September 2011 the ship had experienced a high level of
engine trouble which had cost the company considerable lost revenue and
compensation costs. The measured expired life of the propulsion system at 30
September 2011 was 30,000 hours. Due to the unreliability of the engines, a
decision was taken in early October 2011 to replace the whole of the propulsion
system at a cost of $140 million. The expected life of the new propulsion system
was 50,000 hours and in the year ended 30 September 2012 the ship had used its
engines for 5,000 hours.
At the same time as the propulsion system replacement, the company took the
opportunity to do a limited upgrade to the cabin and entertainment facilities at a
cost of $60 million and repaint the ship’s fabric at a cost of $20 million. After the
upgrade of the cabin and entertainment area fittings it was estimated that their
remaining life was five years (from the date of the upgrade). For the purpose of
calculating depreciation, all the work on the ship can be assumed to have been
completed on 1 October 2011. All residual values can be taken as nil.
Required:
Calculate the carrying amount of Elite Leisure’s cruise ship at 30 September 2012
and its related expenditure in the income statement for the year ended 30
September 2012. Your answer should explain the treatment of each item.
(12 marks)
(b)
Related party relationships are a common feature of commercial life. The
objective of IAS 24 Related party disclosures is to ensure that financial statements
contain the necessary disclosures to make users aware of the possibility that
financial statements may have been affected by the existence of related parties.
Required:
(i)
Describe the main circumstances that give rise to related parties.
(ii)
Explain why the disclosure of related party relationships and transactions
may be important.
(3 marks)
(iii)
Assume that ‘now’ is the end of September 2012.
(4 marks)
Hideaway is a public listed company that owns two subsidiary company
investments. It owns 100% of the equity shares of Benedict and 55% of the
equity shares of Depret. During the year ended 30 September 2012 Depret
made several sales of goods to Benedict. These sales totalled $15 million
and had cost Depret $14 million to manufacture. Depret made these sales
on the instruction of the Board of Hideaway. It is known that one of the
directors of Depret, who is not a director of Hideaway, is unhappy with the
parent company’s instruction as he believes the goods could have been sold
to other companies outside the group at the far higher price of $20 million.
All directors within the group benefit from a profit sharing scheme.
Required:
Describe the financial effect that Hideaway’s instruction may have on the
financial statements of the companies within the group and the
implications this may have for other interested parties.
(6 marks)
(Total: 25 marks)
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44
Triangle
Assume that ‘now’ is June 2012
Triangle, a public listed company, is in the process of preparing its draft financial
statements for the year to 31 March 2012. The following matters have been brought to
your attention:
(i)
On 1 April 2011 the company brought into use a new processing plant that had
cost $15 million to construct and had an estimated life of ten years. The plant
uses hazardous chemicals which are put in containers and shipped abroad for
safe disposal after processing. The chemicals have also contaminated the plant
itself which occurred as soon as the plant was used. It is a legal requirement that
the plant is decontaminated at the end of its life. The estimated present value of
this decontamination, using a discount rate of 8% per annum, is $5 million. The
financial statements have been charged with $1.5 million ($15 million/10 years)
for plant depreciation and a provision of $500,000 ($5 million/10 years) has been
made towards the cost of the decontamination.
(8 marks)
(ii)
On 15 May 2012 the company’s auditors discovered a fraud in the material
requisitions department. A senior member of staff who took up employment
with Triangle in August 2011 had been authorising payments for goods that had
never been received. The payments were made to a fictitious company that
cannot be traced. The member of staff was immediately dismissed. Calculations
show that the total amount of the fraud to the date of its discovery was $240,000
of which $210,000 related to the year to 31 March 2012. (Assume the fraud is
material).
(5 marks)
(iii)
The company has contacted its insurers in respect of the above fraud. Triangle is
insured for theft, but the insurance company maintains that this is a commercial
fraud and is not covered by the theft clause in the insurance policy. Triangle has
not yet had an opinion from its lawyers.
(4 marks)
(iv)
On 1 April 2011 Triangle sold maturing inventory that had a carrying value of $3
million (at cost) to Factorall, a finance house, for $5 million. Its estimated market
value at this date was in excess of $5 million. The inventory will not be ready for
sale until 31 March 2012 and will remain on Triangle’s premises until this date.
The sale contract includes a clause allowing Triangle to repurchase the inventory
at any time up to 31 March 2015 at a price of $5 million plus interest at 10% per
annum compounded from 1 April 2011. The inventory will incur storage costs
until maturity. The cost of storage for the current year of $300,000 has been
included in trade receivables (in the name of Factorall). If Triangle chooses not to
repurchase the inventory, Factorall will pay the accumulated storage costs on 31
March 2012. The proceeds of the sale have been debited to the bank and the sale
has been included in Triangle’s sales revenue.
(8 marks)
Required:
Explain how the items in (i) to (iv) above should be treated in Triangle’s financial
statements for the year to 31 March 2012 in accordance with current international
accounting standards. Your answer should quantify the amounts where possible.
The mark allocation is shown against each of the four matters above.
66
(Total: 25 marks)
© Emile Woolf Publishing Limited
Section 1: Practice questions
45
Construction
Magpie specialises in construction contracts. It is “now” the end of March 2012. One of
its contracts, with Better Homes, is to build a complex of luxury flats. The price agreed
for the contract is $40 million and its scheduled date of completion is 31 December
2012. Details of the contract to 31 March 2012 are:
Commencement date
1 July 2010
Contract costs:
$000
Architects’ and surveyors’ fees
Materials delivered to site
Direct labour costs
Overheads are apportioned at 40% of direct labour costs
Estimated cost to complete (excluding depreciation – see below)
500
3,100
3,500
14,800
Plant and machinery used exclusively on the contract cost $3,600,000 on 1 July 2010. At
the end of the contract it is expected to be transferred to a different contract at a value
of $600,000. Depreciation is to be based on a time apportioned basis.
Inventory of materials on site at 31 March 2011 is $300,000.
Better Homes paid a progress payment of $12,800,000 to Magpie on 31 March 2011.
At 31 March 2012 the details for the construction contract have been summarised as:
$000
Contract costs to date (i.e. since the start of the contract) excluding all
depreciation
20,400
Estimated cost to complete (excluding depreciation)
6,600
A further progress payment of $16,200,000 was received on 31 March 2012.
Magpie accrues profit on its construction contracts using the percentage of completion
basis as measured by the percentage of the cost to date compared to the total estimated
contract cost.
Required:
Prepare extracts of the financial statements of Magpie for the construction contract
with Better Homes for:
(a)
the year to 31 March 2011
(8 marks)
(b)
the year to 31 March 2012.
(7 marks)
(Total: 15 marks)
46
Bowtock
(a)
Explain why events occurring after the reporting date may be relevant to the
financial statements of the previous period.
(4 marks)
(b)
At 30 September 2007 Bowtock had included in its draft statement of financial
position inventory of $250,000 valued at cost. Up to 5 November 2012, Bowtock
had sold $100,000 of this inventory for $150,000. On this date new government
legislation (enacted after the year end) came into force which meant that the
unsold inventory could no longer be marketed and was worthless.
Bowtock is part way through the construction of a housing development. It has
prepared its financial statements to 30 September 2012 in accordance with IAS 11
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Paper F7: Financial Reporting (International)
Construction Contracts and included a proportionate amount of the total
estimated profit on this contract. The same legislation referred to above (in force
from 5 November 2012) now requires modifications to the way the houses within
this development have to be built. The cost of these modifications will be
$500,000 and will reduce the estimated total profit on the contract by that
amount, although the contract is still expected to be profitable.
Required:
Assuming the amounts are material, state how the information above should be
reflected in the financial statements of Bowtock for the year ended 30 September
2012.
(6 marks)
(Total: 10 marks)
47
Multiplex and Simpkins
The following transactions and events have arisen during the preparation of the draft
financial statements of Multiplex for the year to 31 March 2012:
(a)
On 1 April 2011 Multiplex issued $80 million 8% convertible loan stock at par.
The stock is convertible into equity shares, or redeemable at par, on 31 March
2016, at the option of the stockholders. The terms of conversion are that each
$100 of loan stock will be convertible into 50 equity shares of Multiplex. A
finance consultant has advised that if the option to convert to equity had not
been included in the terms of the issue, then a coupon (interest) rate of 12%
would have been required to attract subscribers for the stock.
The value of $1 receivable at the end of each year at a discount rate of 12% can be
taken as:
Year
1
2
3
4
5
$
0.89
0.80
0.71
0.64
0.57
Required:
Calculate the income statement finance charge for the year to 31 March 2012 and
the extracts from the statement of financial position at 31 March 2012 in respect of
the issue of the convertible loan stock.
(5 marks)
(b)
On 1 October 2011 Simpkins issued $10 million 6% Convertible Loan Stock on the
following terms:
The issue price was at par.
The loan stock is convertible into the company’s equity shares at the option of the
stockholders four years after the date of its issue (30 September 2015) on the basis
of 20 shares for each $100 of loan stock. Alternatively it will be redeemed at par.
Merchant Financial Services had advised that if Simpkins had issued similar loan
stock without the conversion rights, then it would have had to pay an interest
(coupon) rate of 10% on the loan stock. This is because the terms of conversion to
equity shares are favourable.
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Section 1: Practice questions
Merchant Financial Services further advised that because it is almost certain that
the loan stock holders will exercise their right to convert to equity shares, the
loan stock has the substance of equity and can be included as such on the
statement of financial position. This has the added advantage of
improving/reducing the company’s gearing (debt/equity) in comparison to what
would be the case with the issue of ‘straight’ loan stock.
The present value of $1 receivable at the end of each year, based on discount
rates of 6% and 10% can be taken as:
End of year
1
2
3
4
6%
0.94
0.89
0.84
0.79
10%
0.91
0.83
0.75
0.68
Required:
In relation to the 6% Convertible Loan Stock, calculate the finance cost to be
shown in the income statement and the extracts from the statement of financial
position for the year to 30 September 2012; and comment on Merchant Financial
Services’ advice.
(5 marks)
(Total: 10 marks)
48
Convertibles
Torpid issued $10 million of 4% convertible loan notes on 1 October 2011, on which
interest is paid annually in arrears on 30 September. The loan notes are convertible into
equity shares of Torpid on 30 September 2014 at the rate of 20 shares in Torpid for
every $100 of notes. Alternatively the notes can be redeemed on that date for cash at
par, at the option of the note holder.
If Torpid had issued straight loan notes, redeemable at par after 3 years, it would have
had to pay interest at the rate of 7% in order to persuade investors to subscribe for
them.
The directors of Torpid chose to issue convertible loan notes, rather than straight loan
notes, because annual profits would be higher due to the lower interest charge, and the
company’s gearing, currently at a high level, would be reduced.
The present value of $1 receivable at the end of the year, at discount rates of 4% and 7%
are as follows:
End of year 1
End of year 2
End of year 3
4%
$
0.96
0.92
0.89
7%
$
0.93
0.87
0.81
Required
(a)
Show how the convertible loan notes would be accounted for in the financial
statements of Torpid for the year to 30 September 2012.
(7 marks)
(b)
Comment on the validity of the reasons of the directors for choosing to issue
convertible loan notes.
(3 marks)
(Total: 10 marks)
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49
Errsea
(a)
The following is an extract of Errsea’s balances of property, plant and equipment
and related government grants at 1 April 2011.
Property, plant and equipment
Non-current liabilities
Government grants
Current liabilities
Government grants
cost
$’000
240
accumulated
depreciation
$’000
180
carrying
amount
$’000
60
30
10
Details including purchases and disposals of plant and related government
grants during the year are:
(i)
Included in the above figures is an item of plant that was disposed of on 1
April 2011 for $12,000 which had cost $90,000 on 1 April 2008. The plant
was being depreciated on a straight-line basis over four years assuming a
residual value of $10,000. A government grant was received on its purchase
and was being recognised in the income statement in equal amounts over
four years. In accordance with the terms of the grant, Errsea repaid $3,000
of the grant on the disposal of the related plant.
(ii)
An item of plant was acquired on 1 July 2011 with the following costs:
Base cost
Modifications specified by Errsea
Transport and installation
$
192,000
12,000
6,000
The plant qualified for a government grant of 25% of the base cost of the
plant, but it had not been received by 31 March 2012. The plant is to be
depreciated on a straight-line basis over three years with a nil estimated
residual value.
(iii)
All other plant is depreciated by 15% per annum on cost
(iv)
$11,000 of the $30,000 non-current liability for government grants at 1 April
2011 should be reclassified as a current liability as at 31 March 2012.
(v)
Depreciation is calculated on a time apportioned basis.
Required:
Prepare extracts of Errsea’s income statement and statement of financial position
in respect of the property, plant and equipment and government grants for the
year ended 31 March 2012.
Note: Disclosure notes are not required.
(b)
After the reporting date, prior to authorising for issue the financial statements of
Tentacle for the year ended 31 March 2012, the following material information
has arisen.
(i)
70
(10 marks)
The notification of the bankruptcy of a customer. The balance of the trade
receivable due from the customer at 31 March 2012 was $23,000 and at the
© Emile Woolf Publishing Limited
Section 1: Practice questions
date of the notification it was $25,000. No payment is expected from the
bankruptcy proceedings. (3 marks)
(ii)
Sales of some items of product W32 were made at a price of $5·40 each in
April and May 2012. Sales staff receive a commission of 15% of the sales
price on this product. At 31 March 2012 Tentacle had 12,000 units of
product W32 in inventory included at cost of $6 each. (4 marks)
(iii)
Tentacle is being sued by an employee who lost a limb in an accident while
at work on 15 March 2012. The company is contesting the claim as the
employee was not following the safety procedures that he had been
instructed to use. Accordingly the financial statements include a note of a
contingent liability of $500,000 for personal injury damages. In a recently
decided case where a similar injury was sustained, a settlement figure of
$750,000 was awarded by the court. Although the injury was similar, the
circumstances of the accident in the decided case are different from those of
Tentacle’s case.
(4 marks)
(iv)
Tentacle is involved in the construction of a residential apartment building.
It is being accounted for using the percentage of completion basis in IAS 11
Construction contracts. The recognised profit at 31 March 2012 was $1·2
million based on costs to date of $3 million as a percentage of the total
estimated costs of $6 million. Early in May 2012 Tentacle was informed that
due to very recent industry shortages, building materials will cost $1·5
million more than the estimate of total cost used in the calculation of the
percentage of completion. Tentacle cannot pass on any additional costs to
the customer.
(4 marks)
Required:
State and quantify how items (i) to (iv) above should be treated when finalising
the financial statements of Tentacle for the year ended 31 March 2012.
Note: The mark allocation is shown against each of the four items above.
(Total: 25 marks)
50
Partway
(a)
(i)
State the definition of both non-current assets held for sale and
discontinued operations and explain the usefulness of information for
discontinued operations.
(4 marks)
Partway is in the process of preparing its financial statements for the year
ended 31 October 2012. The company’s main activity is in the travel
industry mainly selling package holidays (flights and accommodation) to
the general public through the Internet and retail travel agencies. During
the current year the number of holidays sold by travel agencies declined
dramatically and the directors decided at a board meeting on 15 October
2012 to cease marketing holidays through its chain of travel agents and sell
off the related high-street premises. Immediately after the meeting the
travel agencies’ staff and suppliers were notified of the situation and an
announcement was made in the press. The directors wish to show the
travel agencies’ results as a discontinued operation in the financial
statements to 31 October 2012. Due to the declining business of the travel
agents, on 1 August 2012 (three months before the year end) Partway
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Paper F7: Financial Reporting (International)
expanded its Internet operations to offer car hire facilities to purchasers of
its Internet holidays.
The following are Partway’s summarised income statement results – years
ended:
31 October 2012
31 October 2011
travel
Internet
car hire
total
total
agencies
$’000
$’000
$’000
$’000
$’000
Revenue
23,000
14,000
2,000
39,000
40,000
Cost of sales
(18,000)
(16,500)
(1,500)
(36,000)
(32,000)
⎯⎯⎯⎯ ⎯⎯⎯⎯
⎯⎯⎯⎯ ⎯⎯⎯⎯
⎯⎯⎯⎯
Gross profit/(loss)
5,000
(2,500)
500
3,000
8,000
(1,500)
(100)
(2,600)
(2,000)
Operating expenses
(1,000)
⎯⎯⎯⎯ ⎯⎯⎯⎯
⎯⎯⎯⎯ ⎯⎯⎯⎯
⎯⎯⎯⎯
Profit/(loss) before tax
4,000
(4,000)
400
400
6,000
⎯⎯⎯⎯ ⎯⎯⎯⎯
⎯⎯⎯⎯ ⎯⎯⎯⎯
⎯⎯⎯⎯
The results for the travel agencies for the year ended 31 October 2011 were:
revenue $18 million, cost of sales $15 million and operating expenses of
$1·5 million.
Required:
(ii)
Discuss whether the directors’ wish to show the travel agencies’ results as a
(4 marks)
discontinued operation is justifiable.
(iii)
Assuming the closure of the travel agencies is a discontinued operation,
prepare the (summarised) income statement of Partway for the year ended
31 October 2012 together with its comparatives.
Note: Partway discloses the analysis of its discontinued operations on the
face of its income statement.
(6 marks)
(b)
(i)
Describe the circumstances in which an entity may change its accounting
policies and how a change should be applied.
(5 marks)
The terms under which Partway sells its holidays are that a 10% deposit is
required on booking and the balance of the holiday must be paid six weeks
before the travel date. In previous years Partway has recognised revenue
(and profit) from the sale of its holidays at the date the holiday is actually
taken. From the beginning of November 2011, Partway has made it a
condition of booking that all customers must have holiday cancellation
insurance and as a result it is unlikely that the outstanding balance of any
holidays will be unpaid due to cancellation. In preparing its financial
statements to 31 October 2012, the directors are proposing to change to
recognising revenue (and related estimated costs) at the date when a
booking is made. The directors also feel that this change will help to negate
the adverse effect of comparison with last year’s results (year ended 31
October 2011) which were better than the current year’s.
Required:
(ii)
Comment on whether Partway’s proposal to change the timing of its
recognition of its revenue is acceptable and whether this would be a change
of accounting policy.
(6 marks)
(Total: 25 marks)
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Section 1: Practice questions
51
Pingway
Pingway issued a $10 million 3% convertible loan note at par on 1 April 2011 with
interest payable annually in arrears. Three years later, on 31 March 2015, the loan note
is convertible into equity shares on the basis of $100 of loan note for 25 equity shares or
it may be redeemed at par in cash at the option of the loan note holder. One of the
company’s financial assistants observed that the use of a convertible loan note was
preferable to a non-convertible loan note as the latter would have required an interest
rate of 8% in order to make it attractive to investors. The assistant has also commented
that the use of a convertible loan note will improve the profit as a result of lower
interest costs and, as it is likely that the loan note holders will choose the equity option,
the loan note can be classified as equity which will improve the company’s high
gearing position.
The present value of $1 receivable at the end of the year, based on discount rates of
3% and 8% can be taken as:
End of year
1
2
3
3%
$
0·97
0·94
0·92
8%
$
0·93
0·86
0·79
Required:
Comment on the financial assistant’s observations and show how the convertible loan
note should be accounted for in Pingway’s income statement for the year ended 31
March 2012 and statement of financial position as at that date.
(Total: 10 marks)
52
Dearing
On 1 October 2009 Dearing acquired a machine under the following terms:
Hours
Manufacturer’s base price
Trade discount (applying to base price only)
Early settlement discount taken (on the payable amount of the
base cost only)
Freight charges
Electrical installation cost
Staff training in use of machine
Pre-production testing
Purchase of a three-year maintenance contract
Estimated residual value
Estimated life in machine hours
Hours used – year ended 30 September 2010
– year ended 30 September 2011
– year ended 30 September 2012 (see below)
$
1,050,000
20%
5%
30,000
28,000
40,000
22,000
60,000
20,000
6,000
1,200
1,800
850
On 1 October 2011 Dearing decided to upgrade the machine by adding new
components at a cost of $200,000. This upgrade led to a reduction in the production
time per unit of the goods being manufactured using the machine. The upgrade also
increased the estimated remaining life of the machine at 1 October 2011 to 4,500
machine hours and its estimated residual value was revised to $40,000.
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Paper F7: Financial Reporting (International)
Required:
Prepare extracts from the income statement and statement of financial position for the
above machine for each of the three years to 30 September 2012.
(Total: 10 marks)
53
Waxwork (IAS 10)
(a)
The objective of IAS 10 Events after the Reporting Period is to prescribe the
treatment of events that occur after an entity’s reporting period has ended.
Required:
Define the period to which IAS 10 relates and distinguish between adjusting and
(5 marks)
non-adjusting events.
(b)
Waxwork’s current year end is 31 March 2012. Its financial statements were
authorised for issue by its directors on 6 May 2012 and the AGM (annual general
meeting) will be held on 3 June 2012. The following matters have been brought to
your attention:
(i)
On 12 April 2012 a fire completely destroyed the company’s largest
warehouse and the inventory it contained. The carrying amounts of the
warehouse and the inventory were $10 million and $6 million respectively.
It appears that the company has not updated the value of its insurance
cover and only expects to be able to recover a maximum of $9 million from
its insurers. Waxwork’s trading operations have been severely disrupted
since the fire and it expects large trading losses for some time to come.
(4 marks)
(ii)
A single class of inventory held at another warehouse was valued at its cost
of $460,000 at 31 March 2012. In April 2012 70% of this inventory was sold
for $280,000 on which Waxworks’ sales staff earned a commission of 15% of
the selling price.
(3 marks)
(iii)
On 18 May 2012 the government announced tax changes which have the
effect of increasing Waxwork’s deferred tax liability by $650,000 as at 31
March 2012.
(3 marks)
Required:
Explain the required treatment of the items (i) to (iii) by Waxwork in its financial
statements for the year ended 31 March 2012.
Note: assume all items are material and are independent of each other.
(10 marks as indicated)
(Total: 15 marks)
54
Flightline
Flightline is an airline which treats its aircraft as complex non-current assets. The cost
and other details of one of its aircraft are:
$’000 estimated life
Exterior structure – purchase date 1 April 1998
120,000 20 years
Interior cabin fittings – replaced 1 April 2008
25,000 5 years
Engines (2 at $9 million each) – replaced 1 April 2008
18,000 36,000 flying hours
No residual values are attributed to any of the component parts.
74
© Emile Woolf Publishing Limited
Section 1: Practice questions
At 1 April 2011 the aircraft log showed it had flown 10,800 hours since 1 April 2008. In
the year ended 31 March 2012, the aircraft flew for 1,200 hours for the six months to 30
September 2011 and a further 1,000 hours in the six months to 31 March 2012.
On 1 October 2011 the aircraft suffered a ‘bird strike’ accident which damaged one of
the engines beyond repair. This was replaced by a new engine with a life of 36,000
hours at cost of $10·8 million. The other engine was also damaged, but was repaired at
a cost of $3 million; however, its remaining estimated life was shortened to 15,000
hours. The accident also caused cosmetic damage to the exterior of the aircraft which
required repainting at a cost of $2 million. As the aircraft was out of service for some
weeks due to the accident, Flightline took the opportunity to upgrade its cabin facilities
at a cost of $4·5 million. This did not increase the estimated remaining life of the cabin
fittings, but the improved facilities enabled Flightline to substantially increase the air
fares on this aircraft.
Required:
Calculate the charges to the income statement in respect of the aircraft for the year
ended 31 March 2012 and its carrying amount in the statement of financial position as
at that date.
Note: the post accident changes are deemed effective from 1 October 2011.
(Total: 10 marks)
55
Darby
(a)
An assistant of yours has been criticised over a piece of assessed work that he
produced for his study course for giving the definition of a non-current asset as
‘a physical asset of substantial cost, owned by the company, which will last
longer than one year’.
Required:
Provide an explanation to your assistant of the weaknesses in his definition of
non-current assets when compared to the International Accounting Standards
Board’s (IASB) view of assets.
(4 marks)
(b)
The same assistant has encountered the following matters during the preparation
of the draft financial statements of Darby for the year ending 30 September 2011.
He has given an explanation of his treatment of them.
(i)
Darby spent $200,000 sending its staff on training courses during the year.
This has already led to an improvement in the company’s efficiency and
resulted in cost savings. The organiser of the course has stated that the
benefits from the training should last for a minimum of four years. The
assistant has therefore treated the cost of the training as an intangible asset
and charged six months’ amortisation based on the average date during the
year on which the training courses were completed.
(3 marks)
(ii)
During the year the company started research work with a view to the
eventual development of a new processor chip. By 30 September 2011 it
had spent $1·6 million on this project. Darby has a past history of being
particularly successful in bringing similar projects to a profitable
conclusion. As a consequence the assistant has treated the expenditure to
date on this project as an asset in the statement of financial position.
Darby was also commissioned by a customer to research and, if feasible,
produce a computer system to install in motor vehicles that can
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Paper F7: Financial Reporting (International)
automatically stop the vehicle if it is about to be involved in a collision. At
30 September 2011, Darby had spent $2·4 million on this project, but at this
date it was uncertain as to whether the project would be successful. As a
consequence the assistant has treated the $2·4 million as an expense in the
income statement.
(4 marks)
(iii)
Darby signed a contract (for an initial three years) in August 2011 with a
company called Media Today to install a satellite dish and cabling system
to a newly built group of residential apartments. Media Today will
provide telephone and television services to the residents of the apartments
via the satellite system and pay Darby $50,000 per annum commencing in
December 2011. Work on the installation commenced on 1 September 2011
and the expenditure to 30 September 2011 was $58,000. The installation is
expected to be completed by 31 October 2011. Previous experience with
similar contracts indicates that Darby will make a total profit of $40,000
over the three years on this initial contract. The assistant correctly recorded
the costs to 30 September 2011 of $58,000 as a non-current asset, but then
wrote this amount down to $40,000 (the expected total profit) because he
believed the asset to be impaired.
The contract is not a finance lease. Ignore discounting.
(4 marks)
Required:
For each of the above items (i) to (iii) comment on the assistant’s treatment of
them in the financial statements for the year ended 30 September 2011 and advise
him how they should be treated under International Financial Reporting
Standards.
Note: the mark allocation is shown against each of the three items above.
(Total: 15 marks)
56
Barstead
(a)
The following figures have been calculated from the financial statements
(including comparatives) of Barstead for the year ended 30 September 2012:
increase in profit after taxation
increase in (basic) earnings per share
increase in diluted earnings per share
Required:
80%
5%
2%
Explain why the three measures of earnings (profit) growth for the same
company over the same period can give apparently differing impressions.
(4 marks)
(b)
The profit after tax for Barstead for the year ended 30 September 2012 was $15
million. At 1 October 2011 the company had in issue 36 million equity shares and
a $10 million 8% convertible loan note. The loan note will mature in 2012 and will
be redeemed at par or converted to equity shares on the basis of 25 shares for
each $100 of loan note at the loan-note holders’ option. On 1 January 2012
Barstead made a fully subscribed rights issue of one new share for every four
shares held at a price of $2·80 each. The market price of the equity shares of
Barstead immediately before the issue was $3·80. The earnings per share (EPS)
reported for the year ended 30 September 2011 was 35 cents.
Barstead’s income tax rate is 25%.
76
© Emile Woolf Publishing Limited
Section 1: Practice questions
Required:
Calculate the (basic) EPS figure for Barstead (including comparatives) and the
diluted EPS (comparatives not required) that would be disclosed for the year
ended 30 September 2012.
(6 marks)
(Total: 10 marks)
57
Apex
(a)
Apex is a publicly listed supermarket chain. During the current year it started the
building of a new store. The directors are aware that in accordance with IAS 23
Borrowing costs certain borrowing costs have to be capitalised.
Required:
Explain the circumstances when, and the amount at which, borrowing costs
should be capitalised in accordance with IAS 23.
(5 marks)
(b)
Details relating to construction of Apex’s new store:
Apex issued a $10 million unsecured loan with a coupon (nominal) interest rate
of 6% on 1 April 2009. The loan is redeemable at a premium which means the
loan has an effective finance cost of 7·5% per annum. The loan was specifically
issued to finance the building of the new store which meets the definition of a
qualifying asset in IAS 23. Construction of the store commenced on 1 May 2009
and it was completed and ready for use on 28 February 2010, but did not open
for trading until 1 April 2010. During the year trading at Apex’s other stores was
below expectations so Apex suspended the construction of the new store for a
two-month period during July and August 2009. The proceeds of the loan were
temporarily invested for the month of April 2009 and earned interest of $40,000.
Required:
Calculate the net borrowing cost that should be capitalised as part of the cost of
the new store and the finance cost that should be reported in the income
statement for the year ended 31 March 2010.
(5 marks)
(Total: 10 marks)
58
Tunshill
(a)
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors contains
guidance on the use of accounting policies and accounting estimates.
Required:
Explain the basis on which the management of an entity must select its
accounting policies and distinguish, with an example, between changes in
accounting policies and changes in accounting estimates. (5 marks)
(b)
The directors of Tunshill are disappointed by the draft profit for the year ended
30 September 2010. The company’s assistant accountant has suggested two areas
where she believes the reported profit may be improved:
(i)
A major item of plant that cost $20 million to purchase and install on 1
October 2007 is being depreciated on a straight-line basis over a five-year
period (assuming no residual value). The plant is wearing well and at the
beginning of the current year (1 October 2009) the production manager
believed that the plant was likely to last eight years in total (i.e. from the
date of its purchase). The assistant accountant has calculated that, based on
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Paper F7: Financial Reporting (International)
an eight-year life (and no residual value) the accumulated depreciation of
the plant at 30 September 2010 would be $7·5 million ($20 million/8 years x
3). In the financial statements for the year ended 30 September 2009, the
accumulated depreciation was $8 million ($20 million/5 years x 2).
Therefore, by adopting an eight-year life, Tunshill can avoid a depreciation
charge in the current year and instead credit $0·5 million ($8 million – $7·5
million) to the income statement in the current year to improve the
reported profit.
(5 marks)
(ii)
Most of Tunshill’s competitors value their inventory using the average cost
(AVCO) basis, whereas Tunshill uses the first in first out (FIFO) basis. The
value of Tunshill’s inventory at 30 September 2010 (on the FIFO basis) is
$20 million, however on the AVCO basis it would be valued at $18 million.
By adopting the same method (AVCO) as its competitors, the assistant
accountant says the company would improve its profit for the year ended
30 September 2010 by $2 million. Tunshill’s inventory at 30 September 2009
was reported as $15 million, however on the AVCO basis it would have
been reported as $13·4 million.
(5 marks)
Required:
Comment on the acceptability of the assistant accountant’s suggestions and
quantify how they would affect the financial statements if they were
implemented under IFRS. Ignore taxation.
Note: the mark allocation is shown against each of the two items above.
(15 marks)
59
Manco
Manco has been experiencing substantial losses at its furniture making operation
which is treated as a separate operating segment. The company’s year end is 30
September. At a meeting on 1 July 2010 the directors decided to close down the
furniture making operation on 31 January 2011 and then dispose of its non-current
assets on a piecemeal basis. Affected employees and customers were informed of the
decision and a press announcement was made immediately after the meeting. The
directors have obtained the following information in relation to the closure of the
operation:
(i)
On 1 July 2010, the factory had a carrying amount of $3·6 million and is expected
to be sold for net proceeds of $5 million. On the same date the plant had a
carrying amount of $2·8 million, but it is anticipated that it will only realise net
proceeds of $500,000.
(ii)
Of the employees affected by the closure, the majority will be made redundant at
cost of $750,000, the remainder will be retrained at a cost of $200,000 and given
work in one of the company’s other operations.
(iii)
Trading losses from 1 July to 30 September 2010 are expected to be $600,000 and
from this date to the closure on 31 January 2011 a further $1 million of trading
losses are expected.
Required:
Explain how the decision to close the furniture making operation should be treated in
Manco’s financial statements for the years ending 30 September 2010 and 2011. Your
answer should quantify the amounts involved.
(10 marks)
78
© Emile Woolf Publishing Limited
Section 1: Practice questions
Business combinations – Statements of financial position
60
Hydrox
Hydrox acquired 90% of Syntax’s equity shares on 1 April 2010 for $30 million when
Syntax’s retained earnings were $15 million. The statements of financial position of the
two companies at 31 March 2012 are shown below:
Statement of financial position
Hydrox
$000
$000
Non-current assets:
Property, plant and equipment at depreciated historic
cost
Investment in Syntax
Other quoted investments at cost
Current assets:
Inventory
Accounts receivable
Bank
Non-current liabilities:
12% Debenture
Bank loan
Current liabilities:
Accounts payable
Provision for taxation
Dividends payable (announced before the year
end)
Overdraft
26,400
16,200
30,000
1,000
57,400
6,000
22,200
9,500
7,200
300
Total assets:
Equity and liabilities
Share capital and reserves:
Equity shares of $1 each
Reserves:
Retained earnings
Syntax
$000
$000
4,000
1,500
nil
17,000
74,400
5,500
27,700
10,000
5,000
48,600
58,600
6,300
11,300
4,000
6,000
6,700
4,100
1,000
5,200
700
nil
nil
4,500
11,800
74,400
Total equity and liabilities:
10,400
27,700
The following information is relevant:
(i)
The movements on the retained earnings of Syntax since the date of acquisition
have been:
Balance at acquisition, 1 April 2010
Year to 31 March 2011
Year to 31 March 2012
© Emile Woolf Publishing Limited
Loss after
tax
$000
Dividends
paid
$000
(3,000)
(1,700)
nil
(4,000)
$000
15,000
(3,000)
(5,700)
――――
6,300
――――
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Paper F7: Financial Reporting (International)
Hydrox accounted for its share of Syntax’s dividend as a credit to its income
statement. The group policy is that only dividends paid out of post-acquisition
profits are credited to income.
(ii)
At the date of acquisition the fair values of Syntax’s net assets were
approximately equal to their book values with the exception of two items.
„
Specialised plant of Syntax had a net replacement cost of $6 million in
excess of its book value; it had an estimated remaining life of five years.
„
The stock market value of Syntax’s investments was $8 million
There have been no acquisitions or disposals of non-current assets since the date
of acquisition.
(iii)
An impairment test at 31 March 2012 on the consolidated goodwill concluded
that it should be written down by $400,000. No other assets were impaired.
(iv)
Three days before the current year-end Hydrox processed the accounting entries
in respect of a credit sale of goods to Syntax at a selling price of $600,000.
Hydrox charges a standard mark-up on cost of 20% on all its sales. Syntax had
not received the goods and had therefore not included them in inventories, nor
had it received the invoice for them by the year-end. The agreed balance on
Syntax’s purchase ledger account with Hydrox prior to this transaction was $1.4
million.
Required:
Prepare the consolidated statement of financial position of Hydrox as at 31 March 2012.
(Total: 25 marks)
61
Hedra
Hedra, a public listed company, acquired the following investments:
(i)
On 1 October 2011, 72 million shares in Salvador for an immediate cash payment
of $195 million. Hedra agreed to pay further consideration on 30 September 2012
of $49 million if the post-acquisition profits of Salvador exceeded an agreed
figure at that date. Hedra has not accounted for this deferred payment as it did
not believe it would be payable, however Salvador’s profits have now exceeded
the agreed amount (ignore discounting). Salvador also accepted a $50 million 8%
loan from Hedra at the date of its acquisition.
(ii)
On 1 April 2012, 40 million shares in Aragon by way of a share exchange of two
shares in Hedra for each acquired share in Aragon. The stock market value of
Hedra’s shares at the date of this share exchange was $2.50. Hedra has not yet
recorded the acquisition of the investment in Aragon.
The summarised statements of financial position of the three companies as at 30
September 2012 are:
Statement of financial position
Hedra
$m
$m
Non-current assets
Property, plant and equipment
Investments – in Salvador
– other
Current assets
Inventories
80
Salvador
$m
$m
358
245
45
648
130
Aragon
$m
$m
240
nil
nil
240
80
270
nil
nil
270
110
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position
Trade receivables
Cash and bank
Total assets
Equity and liabilities
Ordinary share capital ($1each)
Reserves
Share premium
Revaluation
Retained earnings
Hedra
Salvador
Aragon
$m
$m
$m
$m
$m
$m
142
97
70
nil
4
20
272
181
200
920
421
470
400
40
15
240
120
50
nil
60
295
695
Non-current liabilities
8% loan note
Deferred tax
Total equity and liabilities
nil
nil
300
110
230
300
400
50
nil
50
nil
nil
45
45
Current liabilities
Trade payables
Bank overdraft
Current tax payable
100
118
12
50
141
nil
nil
180
920
40
nil
30
141
421
70
470
The following information is relevant:
(a)
(b)
Fair value adjustments and revaluations:
(i)
Hedra’s accounting policy for land and buildings is that they should be
carried at their fair values. The fair value of Salvador’s land at the date of
acquisition was $20 million in excess of its carrying value. By 30 September
2012 this excess had increased by a further $5 million. Salvador’s buildings
did not require any fair value adjustments. The fair value of Hedra’s own
land and buildings at 30 September 2012 was $12 million in excess of its
carrying value in the above statement of financial position.
(ii)
The fair value of some of Salvador’s plant at the date of acquisition was $20
million in excess of its carrying value and had a remaining life of four years
(straight-line depreciation is used).
(iii)
At the date of acquisition Salvador had unrelieved tax losses of $40 million
from previous years. Salvador had not accounted for these as a deferred tax
asset as its directors did not believe the company would be sufficiently
profitable in the near future. However, the directors of Hedra were
confident that these losses would be utilised and accordingly they should
be recognised as a deferred tax asset. By 30 September 2012 the group had
not yet utilised any of these losses. The income tax rate is 25%.
The retained earnings of Salvador and Aragon at 1 October 2011, as reported in
their separate financial statements, were $20 million and $200 million
respectively. All profits are deemed to accrue evenly throughout the year.
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Paper F7: Financial Reporting (International)
(c)
An impairment test on 30 September 2012 showed that consolidated goodwill
should be written down by $20 million. Hedra has applied IFRS 3 Business
Combinations since the acquisition of Salvador.
(d)
The investment in Aragon has not suffered any impairment.
Required:
Prepare the consolidated statement of financial position of Hedra as at 30 September
2012.
(Total: 25 marks)
62
Harden
Harden acquired 800,000 of Solder’s $1 equity shares on 1 October 2010 for $2.5million.
One year later, on 1 October 2011, Harden acquired 200,000 $1 equity shares in Active
for $800,000. The statements of financial position of the three companies at 30
September 2012 are shown below:
Non-current assets
Property, plant and
equipment
Patents
Investments – in Solder
– in Active
– in others
Current assets
Inventories
Trade receivables
Bank
Harden
$000
$000
Solder
$000
$000
Active
$000
$000
3,980
2,300
1,340
250
420
nil
3,450
7,680
200
2,920
60
1,400
2,500
800
150
570
420
nil
Total assets
Equity and liabilities
Capital and reserves:
Equity shares of $1 each
Reserves:
Share premium
Retained earnings
Total equity and liabilities
82
300
400
120
990
8,670
930
3,850
820
2,220
2,000
1,000
500
1,000
4,500
Non-current liabilities
Deferred tax
Current liabilities
Trade payables
Taxation
Overdraft
400
380
150
500
1,900
100
1,200
5,500
7,500
2,400
3,400
1,300
1,800
200
nil
80
750
140
80
450
nil
nil
970
8,670
280
60
nil
450
3,850
340
2,220
© Emile Woolf Publishing Limited
Section 1: Practice questions
The following information is relevant:
(i)
The balances of the retained earnings of the three companies were:
Harden
Solder
Active
$000
$000
$000
at 1 October 2010
2,000
1,200
500
at 1 October 2011
3,000
1,500
800
(ii)
At the date of its acquisition the fair values of Solder’s net assets were equal to
their book values with the exception of a plot of land that had a fair value of
$200,000 in excess of its book value.
(iii)
On 26 September 2012 Harden processed an invoice for $50,000 in respect of an
agreed allocation of central overhead expenses to Solder. At 30 September 2012
Solder had not accounted for this transaction. Prior to this the current accounts
between the two companies had been agreed at Solder owing $70,000 to Harden
(included in trade receivables and trade payables respectively).
(iv)
During the year Active sold goods to Harden at a selling price of $140,000 which
gave Active a profit of 40% on cost. Harden had half of these goods in inventory
at 30 September 2012.
(v)
An impairment test at 31 March 2012 on the consolidated goodwill concluded
that there was no write down necessary. No other assets were impaired.
Required:
(a)
Prepare the consolidated statement of financial position of Harden as at 30
September 2012.
(20 marks)
(b)
At the beginning of the following year, on 1 October 2012, the shareholders of
Deployed accepted a bid from Harden to purchase the whole of its equity share
capital. Harden is currently considering whether and at what value certain of
Deployed’s assets and liabilities should be recognised in the consolidated
financial statements. The details are:
(i)
Deployed has made an accounting and taxable loss of $200,000 in the year
to 30 September 2012. This loss will be allowable for tax purposes for relief
against any future trading profit that Deployed may make. Deployed has
not recognised the loss as a deferred tax asset because the directors are not
confident that the company will make sufficient profits in the near future to
absorb the loss. The directors of Harden are firmly of the opinion that the
profitability of the group is such that Deployed’s tax losses can be utilised
on a group basis. Assume a tax rate of 30%.
(ii)
Deployed is in dispute over an insurance claim relating to one of its
buildings that has been damaged in a fire. The insurance company is
disputing the claim on the basis that the use of the building was not
properly disclosed when it was insured. A copy of the insurance proposal
form has been obtained and sent to Deployed’s lawyers. The lawyers have
said that in their opinion the use of the building was adequately disclosed
and in any event its use was not the cause of the fire and therefore they
believe the claim is valid. The cost of the damage caused by the fire has
been provided for, but as the claim is a contingent asset, the directors of
Deployed have not recognised it in the financial statements.
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Paper F7: Financial Reporting (International)
Required:
Discuss how the directors of Harden should treat the above items when
preparing consolidated financial statements to reflect the acquisition of
Deployed.
(5 marks)
(Total: 25 marks)
63
Halogen
On 1 April 2011 Halogen acquired a controlling interest of 75% of Stimulus, a
previously wholly owned subsidiary of Exowner. At this date Halogen issued one
new ordinary share valued at $5 and paid $1.40 in cash, for every two shares it
acquired in Stimulus. The reserves of Stimulus at the time of the date of the acquisition
were:
Retained earnings
$180 million
Revaluation reserve
$40 million
The statements of financial position of Halogen and Stimulus at 31 March 2012 are:
Halogen
$m
$m
Assets
Non-current assets
Property, plant and equipment
Development expenditure
Investments (including that in Stimulus)
Current assets
Inventory
Trade receivables
Bank
910
100
700
1,710
224
264
nil
Total assets
Equity and liabilities
Equity:
Equity shares of $1 each
Reserves:
Share premium
Retained earnings
Revaluation reserve
Non-current liabilities
10% Debenture
Current liabilities
Trade payables
Taxation
Bank overdraft
Total equity and liabilities
84
Stimulus
$m
$m
330
nil
60
390
120
84
25
488
2,198
229
619
1,000
200
300
530
60
nil
260
40
890
1,890
300
500
nil
60
128
94
86
24
35
nil
308
2,198
59
59
619
© Emile Woolf Publishing Limited
Section 1: Practice questions
The following information is relevant:
(i)
At the date of acquisition the statement of financial position of Stimulus included
an intangible non-current asset of $8 million in respect of the development of a
new medical drug. On this date an independent specialist assessed the fair value
of this intangible asset at $28 million. Halogen had been developing a similar
drug and shortly after the acquisition it was decided to combine the two
development projects. All information and development work on Stimulus’s
project was transferred to Halogen in return for a payment of $36 million. The
carrying value of Stimulus’s development expenditure at the date of transfer was
still $8 million. Stimulus has taken the profit on this transaction to its income
statement. Approval to market the drug is expected in September 2012.
(ii)
Both companies have a policy of keeping their land (included in property, plant
and equipment) at current value. The balances on the revaluation reserves
represent the revaluation surpluses at 1 April 2011. Neither company has yet
recorded further increases of $10 million and $8 million for Halogen and
Stimulus respectively for the year to 31 March 2012.
(iii)
During the year to 31 March 2012 Halogen sold goods at a price of $26 million to
Stimulus at a mark-up on cost of 30%. Half of these goods were still in inventory
at the year-end.
(iv)
On 28 March 2012 Stimulus recorded a payment of $12 million to settle its
current account balance with Halogen. Halogen had not received this by the
year-end. Inter company current account balances are included in trade
payables/receivables as appropriate.
(v)
An impairment test at 31 March 2012 on the consolidated goodwill concluded
that it should be written down by $30,000. No other assets were impaired.
Required:
(a)
Prepare the consolidated statement of financial position of Halogen as at 31
March 2012.
(20 marks)
(b)
Included within the investments of Halogen is an investment in a wholly owned
private limited company called Lockstart. Prior to the current year Halogen has
consolidated the results of Lockstart. In recent years the profits of Lockstart have
been declining and in the year to 31 March 2012 it made significant losses. In
January of 2012 the management of Halogen held a Board meeting where it was
decided that the investment in Lockstart would be sold as soon as possible. No
buyer had been found by 31 March 2012.
The directors of Halogen are aware that shareholders often use a company’s
published financial statements to predict future performance, and this is one of
the reasons why IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations requires the results of discontinued operations to be separately
identified. Shareholders are thus made aware of those parts of the business that
will not contribute to future profits or losses.
In the spirit of the above, the management of Halogen have decided not to
consolidate the results of Lockstart for the current year (to 31 March 2012),
believing that if they were consolidated, it would give a misleading basis for
predicting the group’s future performance.
© Emile Woolf Publishing Limited
85
Paper F7: Financial Reporting (International)
Required:
Comment on the suitability of the Directors’ treatment of Lockstart; and state
how you believe Lockstart should be treated in the group financial statements of
Halogen.
(5 marks)
Note: You are not required to amend your answer to (a) in respect of this information.
(Total: 25 marks)
64
Horsefield
Horsefield, a public company, acquired 90% of Sandfly’s $1 ordinary shares on 1 April
2010 paying $3.00 per share. The balance on Sandfly’s retained earnings at this date
was $800,000. On 1 October 2011, Horsefield acquired 30% of Anthill’s $1 ordinary
shares for $3.50 per share. The statements of financial position of the three companies
at 31 March 2012 are shown below:
Horsefield
$000
$000
Non-current assets
Property, plant and
equipment
Investments
Current assets
Inventory
Accounts receivable
Bank
Equity and liabilities
Equity:
Ordinary shares of $1 each
Reserves:
Retained earnings b/f
Profit year to 31 March 2012
Non-current liabilities
10% Loan notes
Current liabilities
Accounts payable
Taxation
Overdraft
Total equity and liabilities
86
Sandfly
$000
$000
Anthill
$000
8,050
3,600
1,650
4,000
12,050
910
4,510
nil
1,650
830
520
240
Total assets
$000
340
290
nil
250
350
100
1,590
13,640
630
5,140
700
2,350
5,000
1,200
600
6,000
1,500
1,400
900
800
600
7,500
12,500
2,300
3,500
1,400
2,000
500
240
nil
420
220
nil
960
250
190
640
13,640
200
150
nil
1,400
5,140
350
2,350
© Emile Woolf Publishing Limited
Section 1: Practice questions
The following information is relevant:
(i)
Fair value adjustments:
On 1 April 2010 Sandfly owned an investment property that had a fair value of
$120,000 in excess of its carrying value (book value). The value of this property
has not changed since acquisition. This property is included within investments
in the balance sheet.
Just prior to its acquisition, Sandfly was successful in applying for a six-year
licence to dispose of hazardous waste. The licence was granted by the
government at no cost, however Horsefield estimated that the licence was worth
$180,000 at the date of acquisition.
(ii)
In January 2012 Horsefield sold goods to Anthill for $65,000. These were
transferred at a mark up of 30% on cost. Two thirds of these goods were still in
the inventory of Anthill at 31 March 2012.
(iii)
To facilitate the consolidation procedures the group insists that all inter company
current account balances are settled prior to the year-end. However a cheque for
$40,000 from Sandfly to Horsefield was not received until early April 2012. Inter
company balances are included in accounts receivable and payable as
appropriate.
(iv)
Anthill is to be treated as an associated company of Horsefield.
(v)
An impairment test at 31 March 2012 on the consolidated goodwill of Sandfly
and Anthill concluded that it should be written down by $468,000 and $12,000
respectively. No other assets were impaired.
Required:
(a)
(b)
Prepare the consolidated statement of financial position of Horsefield as at 31
(20 marks)
March 2012.
Discuss the matters to consider in determining whether an investment in another
company constitutes associated company status.
(5 marks)
(Total: 25 marks)
65
Highmoor
Highmoor, a public listed company, acquired 80% of Slowmoor’s ordinary shares on 1
October 2011. Highmoor paid an immediate $2 per share in cash and agreed to pay a
further $1.20 per share if Slowmoor made a profit within two years of its acquisition.
Highmoor has not recorded the contingent consideration.
The statements of financial position of the two companies at 30 September 2012 are
shown below:
Tangible non-current assets
Investments (note (ii))
Software (note (iii))
Current assets
Inventory
Accounts receivable
Tax asset 1
© Emile Woolf Publishing Limited
Highmoor
$ million $ million
585
225
nil
――――
810
85
95
nil
Slowmoor
$ million $ million
172
13
40
――――
225
42
36
80
87
Paper F7: Financial Reporting (International)
Bank
Total assets
Equity and liabilities
Equity:
Ordinary shares of $1 each
Retained earnings – 1 October 2011
– profit/loss for year
Non-current liabilities
12% loan note
8% Inter company loan (note (ii))
Current liabilities
Accounts payable
Taxation
Overdraft
Highmoor
Slowmoor
$ million $ million $ million $ million
20,
nil
――――
――――
200
158
――――
――――
1,010
383
――――
――――
400
230
100
――――
nil
nil
――――
210
70
nil
――――
Total equity and liabilities
The following information is relevant:
330
――――
730
nil
280
――――
1,010
――――
100
150
(35)
――――
135
45
――――
71
nil
17
――――
115
――――
215
80
88
――――
383
――――
(i)
At the date of acquisition the fair values of Slowmoor’s net assets were
approximately equal to their carrying values (book values).
(ii)
Included in Highmoor’s investments is a loan of $50 million made to Slowmoor.
On 28 September 2012, Slowmoor paid $9 million to Highmoor. This represented
interest of $4 million for the year and the balance was a capital repayment.
Highmoor had not received nor accounted for the payment, but it had accrued
for the loan interest receivable as part of its accounts receivable figure. There are
no other intra group balances.
(iii)
The software was developed by Highmoor during 2011 at a total cost of $30
million. It was sold to Slowmoor for $50 million immediately after its acquisition.
The software had an estimated life of five years and is being amortised by
Slowmoor on a straight-line basis.
(iv)
Due to the losses of Slowmoor since its acquisition, the directors of Highmoor are
not confident it will return to profitability in the short term.
(v)
It is the accounting policy of Highmoor that the non-controlling interests in its
subsidiary should be valued at a proportionate share of net assets.
Required:
(a)
Prepare the consolidated statement of financial position of Highmoor as at 30
September 2012, explaining your treatment of the contingent consideration.
(20 marks)
88
© Emile Woolf Publishing Limited
Section 1: Practice questions
(b)
Describe the circumstances in which negative goodwill may arise. Your answer
should refer to the particular issues of the above acquisition.
(5 marks)
(Total: 25 marks)
66
Hapsburg
(a)
Hapsburg, a public listed company, acquired the following investments:
„
On 1 April 2011, 24 million shares in Sundial. This was by way of an
immediate share exchange of two shares in Hapsburg for every three
shares in Sundial plus a cash payment of $1 per Sundial share payable on 1
April 2014. The market price of Hapsburg’s shares on 1 April 2011 was $2
each.
„
On 1 October 2011, 6 million shares in Aspen paying an immediate $2.50 in
cash for each share.
Based on Hapsburg’s cost of capital (taken as 10% per annum), $1 receivable in
three years’ time can be taken to have a present value of $0.75.
Hapsburg has not yet recorded the acquisition of Sundial but it has recorded the
investment in Aspen. The summarised statements of financial position at 31
March 2012 are:
Hapsburg
$000
$000
Sundial
$000
$000
Aspen
$000
$000
41,000
15,000
56,000
34,800
3,000
37,800
37,700
nil
37,700
Non-current assets
Property, plant and equipment
Investments
Current assets
Inventory
Trade and other receivables
Cash
Total assets
Equity and liabilities
Capital and reserves
Ordinary shares $1 each
Reserves:
Share premium
Retained earnings
Non-current liabilities
10% loan note
Current liabilities
Trade and other payables
Bank overdraft
Taxation
Total equity and liabilities
© Emile Woolf Publishing Limited
9,900
13,600
1,200
4,800
8,600
3,800
7,900
14,400
nil
24,700
80,700
17,200
55,000
22,300
60,000
20,000
30,000
20,000
8,000
10,600
2,000
8,500
nil
8,000
18,600
38,600
10,500
40,500
8,000
28,000
16,000
4,200
12,000
16,500
nil
9,600
6,900
nil
3,400
26,100
80,700
13,600
4,500
1,900
10,300
55,000
20,000
60,000
89
Paper F7: Financial Reporting (International)
The following information is relevant:
(i)
Below is a summary of the results of a fair value exercise for Sundial
carried out at the date of acquisition:
Asset
Plant
Carrying
value at
acquisition
Fair value at Notes
acquisition
$000
$000
10,000
15,000
remaining life at
acquisition = four years
no change in value since
acquisition
The carrying values (book values) of the net assets of Aspen at the date of
acquisition were considered to be a reasonable approximation to their fair
values.
Investments
3,000
4,500
(ii)
The profits of Sundial and Aspen for the year to 31 March 2012, as reported
in their entity financial statements, were $4.5 million and $6 million
respectively. No dividends have been paid by any of the companies during
the year. All profits are deemed to accrue evenly throughout the year.
(iii)
In January 2012 Aspen sold goods to Hapsburg at a selling price of $4
million. These goods had cost Aspen $2.4 million. Hapsburg had $2.5
million (at cost to Hapsburg) of these goods still in inventory at 31 March
2012.
(iv)
All depreciation is charged on a straight-line basis.
(v)
It is the accounting policy of Hapsburg that the non-controlling interests in
its subsidiary should be valued at a proportionate share of net assets.
(vi)
An impairment test at 31 March 2012 on the consolidated goodwill for
Sundial and Aspen concluded that it should be written down by $3,200,000
and $750,000 and treated as an operating expense. No other assets were
impaired.
Required:
Prepare the consolidated statement of financial position of Hapsburg as at 31
March 2012.
(20 marks)
(b)
Some commentators have criticised the use of equity accounting on the basis that
it can be used as a form of ‘off balance sheet’ financing.
Required:
Explain the reasoning behind the use of equity accounting and discuss the above
(5 marks)
comment.
(Total: 25 marks)
67
Highveldt
Assume that ‘now’ is June 2012
Highveldt, a public listed company, acquired 75% of Samson’s ordinary shares on 1
April 2011. Highveldt paid an immediate $3.50 per share in cash and agreed to pay a
further amount of $108 million on 1 April 2012. Highveldt’s cost of capital is 8% per
annum. Highveldt has only recorded the cash consideration of $3.50 per share.
90
© Emile Woolf Publishing Limited
Section 1: Practice questions
The summarised statements of financial position of the two companies at 31 March
2012 are shown below:
Highveldt
$m
Tangible non-current assets (note (i))
Samson
$m
$m
$m
420
320
nil
40
300
20
720
380
Current assets
133
91
Total assets
853
471
270
80
Share premium
80
40
Revaluation reserve
45
nil
Development costs (note (iv))
Investments (note (ii))
Equity and liabilities
Ordinary share capital ($1each)
Reserves
Retained earnings: 1 April 2011
- Year to 31 March 2012
160
134
190
76
350
210
745
330
nil
60
Current liabilities
108
81
Total equity and liabilities
853
471
Non-current liabilities
10% inter company loan (note (ii))
The following information is relevant:
(i)
Highveldt has a policy of revaluing land and buildings to fair value. At the date
of acquisition Samson’s land and buildings had a fair value $20 million higher
than their carrying value (book value) and at 31 March 2012 this had increased by
a further $4 million (ignore any additional depreciation).
(ii)
Included in Highveldt’s investments is a loan of $60 million made to Samson at
the date of acquisition. Interest is payable annually in arrears. Samson paid the
interest due for the year on 31 March 2012, but Highveldt did not receive this
until after the year end. Highveldt has not accounted for the accrued interest
from Samson.
(iii)
Samson had established a line of products under the brand name of Titanware.
Acting on behalf of Highveldt, a firm of specialists, had valued the brand name at
a value of $40 million with an estimated life of 10 years as at 1 April 2011. The
brand is not included in Samson’s statement of financial position.
(iv)
Samson’s development project was completed on 30 September 2011 at a cost of
$50 million. $10 million of this had been amortised by 31 March 2012.
Development costs capitalised by Samson at the date of acquisition were $18
million. Highveldt’s directors are of the opinion that Samson’s development costs
do not meet the criteria in IAS 38 ‘Intangible Assets’ for recognition as an asset.
© Emile Woolf Publishing Limited
91
Paper F7: Financial Reporting (International)
(v)
Samson sold goods to Highveldt during the year at a profit of $6 million, onethird of these goods were still in the inventory of Highveldt at 31 March 2012.
(vi)
It is the accounting policy of Highveldt that the non-controlling interests in its
subsidiary should be valued at a proportionate share of net assets.
An impairment test at 31 March 2012 on the consolidated goodwill concluded
that it should be written down by $22 million. No other assets were impaired.
Required:
(a)
Calculate the following figures as they would appear in the consolidated
statement of financial position of Highveldt at 31 March 2012:
(i)
goodwill
(8 marks)
(ii)
non-controlling interest
(4 marks)
(iii)
the following consolidated reserves: share premium, revaluation reserve
(8 marks)
and retained earnings.
Note: Show your workings
(b)
Explain why consolidated financial statements are useful to the users of financial
statements (as opposed to just the parent company’s separate (entity) financial
(5 marks)
statements).
(Total: 25 marks)
68
Hark, Spark and Ark
Hark acquired the following non-current investments on 1 April 2011:
(1)
4 million equity shares in Spark, by means of an exchange of one share in Handel
for every one share in Spark, plus $6.05 million in cash for each Spark share
acquired. The professional fees associated with the acquisition amounted to $1
million. The market price of shares in Hark at the date of the acquisition was $9
per share. The market price of Spark shares just before the acquisition was $7.
The cash part of the consideration is deferred and will not be paid until two years
after the acquisition.
(2)
25% of the equity shares in Ark, at a cost of $6 per share. The money to make this
payment was obtained by issuing one million new shares in Hark at $9 per share.
None of these transactions has yet been recorded in the summary statements of
financial position that are shown below.
The summarised draft statements of financial position of the three companies at 31
March 2012 are as follows.
Statement of financial position
Assets
Non-current assets
Property, plant and equipment
Other equity investments
Current assets
Total assets
92
Hark
$
million
60.0
0.8
60.8
18.2
79.0
Spark
$
million
Ark
$
million
31.0
nil
31.0
8.0
39.0
16.0
nil
16.0
9.0
25.0
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position
Equity and liabilities
Equity shares of $1 each
Share premium
Retained earnings: at 1 April 2011
- for year ended 31 March 2012
Non-current liabilities
6% loan notes
7% loan notes
Current liabilities
Total equity and liabilities
Hark
$
million
Spark
$
million
Ark
$
million
16.0
2.0
36.0
8.0
62.0
5.0
4.0
16.0
3.0
28.0
6.0
4.0
8.0
2.0
20.0
10.0
7.0
79.0
6.0
5.0
39.0
3.0
2.0
25.0
The following information is relevant:
(1)
Hark has chosen to value the non-controlling interest in Spark using the fair
value method permitted by IFRS 3 (revised). The fair value of the non-controlling
interests at the acquisition date is estimated to be the market value of the shares
before the acquisition.
(2)
At the date of acquisition of Spark, the fair values of its assets were equal to their
carrying amounts.
(3)
The cost of capital of Hark is 10% per year.
(4)
During the year ended 31 March 2012, Spark sold goods to Hark for $3.6 million,
at a mark-up of 50% on cost. Hark had 75% of these goods in its inventory at 31
March 2012.
(5)
There were no intra-group receivables and payables at 31 March 2012.
(6)
On 1 April 2011, Hark sold a group of machines to Spark at their agreed fair
value of $3 million. At the time of the sale, the carrying amount of the machines
was $2 million. The estimated remaining useful life of the plant at the date of the
sale was four years. Plant and machinery is depreciated to a residual value of nil
using straight-line depreciation and at 1 April 2011 the machines had an
estimated remaining life of five years.
(7)
“Other equity investments” are included in the summary statement of financial
position of Hark at their fair value on 1April 2011. Their fair value at 31 March
2012 is $0.65 million.
(8)
Impairment tests were carried out on 31 March 2012. These show that there is no
impairment of the value of the investment in Ark or in the consolidated goodwill.
(9)
No dividends were paid during the year by any of the three companies.
Required
Prepare the consolidated statement of financial position for Hark as at 31 March 2012.
(Total: 25 marks)
© Emile Woolf Publishing Limited
93
Paper F7: Financial Reporting (International)
69
Parentis
Parentis, a public listed company, acquired 600 million equity shares in Offspring on 1
April 2011. The purchase consideration was made up of:
a share exchange of one share in Parentis for two shares in Offspring
the issue of $100 10% loan note for every 500 shares acquired; and a
deferred cash payment of 11 cents per share acquired payable on 1
April 2012.
Parentis has only recorded the issue of the loan notes. The value of each Parentis share
at the date of acquisition was 75 cents and Parentis has a cost of capital of 10% per
annum.
The statements of financial position of the two companies at 31 March 2012 are shown
below:
Assets
Property, plant and equipment (note (i))
Investments
Intellectual property (note (ii))
Current assets
Inventory (note (iii))
Trade receivables (note (iii))
Bank
Total assets
Equity and liabilities
Equity shares of 25 cents each
Retained earnings – 1 April 2011
– year ended 31 March 2012
Parentis
$ million $ million
640
120
nil
———
760
76
84
nil
———
Total equity and liabilities
The following information is relevant:
94
160
———
920
———
340
nil
30
———
370
22
44
4
———
300
210
90
———
Non-current liabilities
10% loan notes
Current liabilities
Trade payables (note (iii))
Current tax payable
Overdraft
Offspring
$ million $ million
200
300
———
600
120
20
———
120
130
45
25
———
70
———
440
———
140
———
340
20
200
———
920
———
57
23
nil
———
80
———
440
———
(i)
At the date of acquisition the fair values of Offspring’s net assets were
approximately equal to their carrying amounts with the exception of its
properties. These properties had a fair value of $40 million in excess of their
carrying amounts which would create additional depreciation of $2 million in the
post acquisition period to 31 March 2012. The fair values have not been reflected
in Offspring’s statement of financial position.
(ii)
The intellectual property is a system of encryption designed for internet use.
Offspring has been advised that government legislation (passed since
© Emile Woolf Publishing Limited
Section 1: Practice questions
acquisition) has now made this type of encryption illegal. Offspring will receive
$10 million in compensation from the government.
(iii)
Offspring sold Parentis goods for $15 million in the post acquisition period. $5
million of these goods are included in the inventory of Parentis at 31 March 2012.
The profit made by Offspring on these sales was $6 million. Offspring’s trade
payable account (in the records of Parentis) of $7 million does not agree with
Parentis’s trade receivable account (in the records of Offspring) due to cash in
transit of $4 million paid by Parentis.
(iv)
Due to the impact of the above legislation, Parentis has concluded that the
consolidated goodwill has been impaired by $27 million.
Required:
Prepare the consolidated statement of financial position of Parentis as at 31 March
(Total: 25 marks)
2012.
70
Plateau
On 1 October 2011 Plateau acquired the following non-current investments:
–
3 million equity shares in Savannah by an exchange of one share in Plateau for
every two shares in Savannah plus $1 per acquired Savannah share in cash. The
market price of each Plateau share at the date of acquisition was $6.
–
30% of the equity shares of Axle at a cost of $7·50 per share in cash.
Only the cash consideration of the above investments has been recorded by Plateau.
The summarised draft statements of financial position of the three companies at 30
September 2012 are:
Assets
Non-current assets
Property, plant and equipment
Investments in Savannah and Axle
Other equity investments
Current assets
Inventory
Trade receivables
Total assets
Equity and liabilities Equity shares of $1 each
Retained earnings – at 30 September 2011
– for year ended 30 September 2012
Non-current liabilities
7% Loan notes
Current liabilities
Total equity and liabilities
© Emile Woolf Publishing Limited
Plateau
$’000
Savannah
$’000
Axle
$’000
18,400
12,000
6,500
–––––––
36,900
10,400
nil
nil
–––––––
10,400
18,000
nil
nil
–––––––
18,000
6,900
3,200
–––––––
6,200
1,500
–––––––
3,600
2,400
–––––––
47,000
–––––––
10,000
16,000
8,000
–––––––
34,000
18,100
–––––––
4,000
6,500
2,400
–––––––
12,900
24,000
–––––––
4,000
11,000
5,000
–––––––
20,000
5,000
8,000
–––––––
47,000
–––––––
1,000
4,200
–––––––
18,100
–––––––
1,000
3,000
–––––––
24,000
–––––––
95
Paper F7: Financial Reporting (International)
The following information is relevant:
(i)
At the date of acquisition the fair values of Savannah’s assets were equal to their
carrying amounts with the exception of Savannah’s land which had a fair value
of $500,000 below its carrying amount; it was written down by this amount
shortly after acquisition and has not changed in value since then.
(ii)
On 1 October 2011, Plateau sold an item of plant to Savannah at its agreed fair
value of $2·5 million. Its carrying amount prior to the sale was $2 million. The
estimated remaining life of the plant at the date of sale was five years (straightline depreciation).
(iii)
During the year ended 30 September 2012 Savannah sold goods to Plateau for
$2·7 million. Savannah had marked up these goods by 50% on cost. Plateau had a
third of the goods still in its inventory at 30 September 2012. There were no intragroup payables/receivables at 30 September 2012.
(iv)
Impairment tests on 30 September 2012 concluded that the value of the
investment in Axle was not impaired, but consolidated goodwill was impaired
by $900,000.
(v)
“Other equity investments” are included in Plateau’s statement of financial
position (above) at their fair value on 1 October 2011, but they have a fair value of
$9 million at 30 September 2012
(vi)
No dividends were paid during the year by any of the companies.
Required:
(a)
Prepare the consolidated statement of financial position for Plateau as at 30
September 2012.
(20 marks)
(b)
A financial assistant has observed that the fair value exercise means that a
subsidiary’s net assets are included at acquisition at their fair (current) values in
the consolidated statement of financial position. The assistant believes that it is
inconsistent to aggregate the subsidiary’s net assets with those of the parent
because most of the parent’s assets are carried at historical cost.
Required:
Comment on the assistant’s observation and explain why the net assets of acquired
subsidiaries are consolidated at acquisition at their fair values.
(5 marks)
(25 marks)
71
Pacemaker
Below are the summarised statements of financial position for three companies as at 31
March 2012:
Pacemaker
$
$
million million
Assets
Non-current assets
Property, plant and
equipment
Investments
96
Syclop
$
$
million million
Vardine
$
$
million million
520
280
240
345
––––––
865
40
––––
320
nil
––––
240
© Emile Woolf Publishing Limited
Section 1: Practice questions
Current assets
Inventory
Trade receivables
Cash and bank
Pacemaker
$
$
million million
Total assets
Equity and liabilities
Equity shares of $1each
Share premium
Retained earnings
Non-current liabilities
10% loan notes
Current liabilities
Total equity and
liabilities
142
95
8
––––
245
––––––
1,110
––––––
Syclop
$
$
million million
160
88
22
––––
500
100
130
––––
230
––––––
730
270
––––
590
––––
Vardine
$
$
million million
120
50
10
––––
145
nil
260
––––
260
––––
405
180
––––
420
––––
100
nil
240
––––
240
––––
340
180
200
––––––
20
165
––––
nil
80
––––
1,110
––––––
590
––––
420
––––
Notes:
Pacemaker is a public listed company that acquired the following investments:
(i)
Investment in Syclop
On 1 April 2010 Pacemaker acquired 116 million shares in Syclop for an
immediate cash payment of $210 million and issued at par one 10% $100 loan
note for every 200 shares acquired. Syclop’s retained earnings at the date of
acquisition were $120 million.
(ii)
Investment in Vardine
On 1 October 2011 Pacemaker acquired 30 million shares in Vardine in exchange
for 75 million of its own shares. The stock market value of Pacemaker’s shares at
the date of this share exchange was $1·60 each.
Pacemaker has not yet recorded the investment in Vardine.
(iii)
Pacemaker’s other investments, and those of Syclop, are equity investments
which are carried at their fair values as at 31 March 2011. The fair value of these
investments at 31 March 2012 is $82 million and $37 million respectively. Each of
these investments is no bigger than a 10% holding.
Other relevant information:
(iv) Pacemaker’s policy is to value non-controlling interests at their fair values. The
directors of Pacemaker assessed the fair value of the non-controlling interest in
Syclop at the date of acquisition to be $65 million.
There has been no impairment to goodwill or the value of the investment in
Vardine.
(v)
At the date of acquisition of Syclop owned a recently built property that was
carried at its (depreciated) construction cost of $62 million. The fair value of this
property at the date of acquisition was $82 million and it had an estimated
remaining life of 20 years.
For many years Syclop has been selling some of its products under the brand
name of ‘Kyklop’. At the date of acquisition the directors of Pacemaker valued
© Emile Woolf Publishing Limited
97
Paper F7: Financial Reporting (International)
this brand at $25 million with a remaining life of 10 years. The brand is not
included in Syclop’s statement of financial position.
The fair value of all other identifiable assets and liabilities of Syclop were equal
to their carrying values at the date of its acquisition.
(vi)
The inventory of Syclop at 31 March 2012 includes goods supplied by Pacemaker
for $56 million (at selling price from Pacemaker). Pacemaker adds a mark-up of
40% on cost when selling goods to Syclop. There are no intra-group receivables
or payables at 31 March 2012.
(vii) Vardine’s profit is subject to seasonal variation. Its profit for the year ended 31
March 2012 was $100 million.
$20 million of this profit was made from 1 April 2011 to 30 September 2011.
(viii) None of the companies have paid any dividends for many years.
Required:
Prepare the consolidated statement of financial position of Pacemaker as at 31 March
2012.
(Total: 25 marks)
72
Picant
On 1 April 2009 Picant acquired 75% of Sander’s equity shares in a share exchange of
three shares in Picant for every two shares in Sander. The market prices of Picant’s and
Sander’s shares at the date of acquisition were $3·20 and $4·50 respectively.
In addition to this Picant agreed to pay a further amount on 1 April 2010 that was
contingent upon the post-acquisition performance of Sander. At the date of acquisition
Picant assessed the fair value of this contingent consideration at $4·2 million, but by 31
March 2010 it was clear that the actual amount to be paid would be only $2·7 million
(ignore discounting). Picant has recorded the share exchange and provided for the
initial estimate of $4·2 million for the contingent consideration.
On 1 October 2009 Picant also acquired 40% of the equity shares of Adler paying $4 in
cash per acquired share and issuing at par one $100 7% loan note for every 50 shares
acquired in Adler. This consideration has also been recorded by Picant.
Picant has no other investments.
The summarised statements of financial position of the three companies at 31 March
2010 are:
Assets
Non-current assets
Property, plant and equipment
Investments
Current assets
Inventory
Trade receivables
Total assets
98
Picant
$’000
Sander
$’000
Adler
$’000
37,500
45,000
–––––––
82,500
24,500
nil
–––––––
24,500
21,000
nil
–––––––
21,000
10,000
6,500
–––––––
99,000
–––––––
9,000
1,500
–––––––
35,000
–––––––
5,000
3,000
–––––––
29,000
–––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
Equity and liabilities
Equity
Equity shares of $1 each
Share premium
Retained earnings – at 1 April 2009
– for the year ended 31 March 2010
Non-current liabilities
7% loan notes
Current liabilities
Contingent consideration
Other current liabilities
Total equity and liabilities
The following information is relevant:
(i)
Picant
$’000
Sander
$’000
Adler
$’000
25,000
19,800
16,200
11,000
–––––––
72,000
8,000
nil
16,500
1,000
–––––––
25,500
5,000
nil
15,000
6,000
–––––––
26,000
14,500
2,000
nil
4,200
8,300
–––––––
99,000
–––––––
nil
7,500
–––––––
35,000
–––––––
nil
3,000
–––––––
29,000
–––––––
At the date of acquisition the fair values of Sander’s property, plant and
equipment was equal to its carrying amount with the exception of Sander’s
factory which had a fair value of $2 million above its carrying amount. Sander
has not adjusted the carrying amount of the factory as a result of the fair value
exercise. This requires additional annual depreciation of $100,000 in the
consolidated financial statements in the post-acquisition period.
Also at the date of acquisition, Sander had an intangible asset of $500,000 for
software in its statement of financial position. Picant’s directors believed the
software to have no recoverable value at the date of acquisition and Sander wrote
it off shortly after its acquisition.
(ii)
At 31 March 2010 Picant’s current account with Sander was $3·4 million (debit).
This did not agree with the equivalent balance in Sander’s books due to some
goods-in-transit invoiced at $1·8 million that were sent by Picant on 28 March
2010, but had not been received by Sander until after the year end. Picant sold all
these goods at cost plus 50%.
(iii)
Picant’s policy is to value the non-controlling interest at fair value at the date of
acquisition. For this purpose Sander’s share price at that date can be deemed to
be representative of the fair value of the shares held by the non-controlling
interest.
(iv)
Impairment tests were carried out on 31 March 2010 which concluded that the
value of the investment in Adler was not impaired but, due to poor trading
performance, consolidated goodwill was impaired by $3·8 million.
(v)
Assume all profits accrue evenly through the year.
Required:
(a)
Prepare the consolidated statement of financial position for Picant as at 31 March
2010.
(21 marks)
(b)
Picant has been approached by a potential new customer, Trilby, to supply it
with a substantial quantity of goods on three months credit terms. Picant is
concerned at the risk that such a large order represents in the current difficult
economic climate, especially as Picant’s normal credit terms are only one month’s
credit. To support its application for credit, Trilby has sent Picant a copy of
© Emile Woolf Publishing Limited
99
Paper F7: Financial Reporting (International)
Tradhat’s most recent audited consolidated financial statements. Trilby is a
wholly-owned subsidiary within the Tradhat group. Tradhat’s consolidated
financial statements show a strong statement of financial position including
healthy liquidity ratios.
Required:
Comment on the importance that Picant should attach to Tradhat’s consolidated
financial statements when deciding on whether to grant credit terms to Trilby.
(4 marks)
(Total: 25 marks)
Business combinations – Statements of financial
performance
73
Hydan
On 1 October 2011 Hydan, a publicly listed company, acquired a 60% controlling
interest in Systan paying $9 per share in cash. Prior to the acquisition Hydan had been
experiencing difficulties with the supply of components that it used in its
manufacturing process. Systan is one of Hydan’s main suppliers and the acquisition
was motivated by the need to secure supplies. In order to finance an increase in the
production capacity of Systan, Hydan made a non-dated loan at the date of acquisition
of $4 million to Systan that carried an actual and effective interest rate of 10% per
annum. The interest to 31 March 2012 on this loan has been paid by Systan and
accounted for by both companies. The summarised draft financial statements of the
companies are:
Income statements for the year ended 31 March 2012
Hydan
$000
Revenue
Cost of sales
Gross profit
Operating expenses
Interest income
Finance costs
Profit/(loss) before tax
Income tax (expense)/relief
Profit/(loss) for the period
100
Systan
Preacquisition
Postacquisition
$000
$000
98,000
24,000
35,200
(76,000)
―――――
22,000
(18,000)
―――――
6,000
(31,000)
―――――
4,200
(11,800)
(1,200)
(8,000)
350
nil
nil
(420)
―――――
10,130
nil
―――――
4,800
(200)
―――――
(4,000)
(4,200)
―――――
5,930
―――――
(1,200)
―――――
3,600
―――――
1,000
―――――
(3,000)
―――――
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statements of financial position as at 31 March 2012
Non-current assets
Property, plant and equipment
Investments (including loan to Systan)
Current assets
Total assets
Equity and liabilities
Ordinary shares of $1 each
Share premium
Retained earnings
Non-current liabilities
7% Bank loan
10% loan from Hydan
Current liabilities
Total equity and liabilities
Hydan
$000
Systan
$000
18,400
16,000
―――――
34,400
18,000
―――――
52,400
―――――
9,500
nil
―――――
9,500
7,200
―――――
16,700
―――――
10,000
5,000
20,000
―――――
35,000
2,000
500
6,300
―――――
8,800
6,000
nil
11,400
―――――
52,400
―――――
nil
4,000
3,900
―――――
16,700
―――――
The following information is relevant:
(i)
At the date of acquisition, the fair values of Systan’s property, plant and
equipment were $1.2 million in excess of their carrying amounts. This will have
the effect of creating an additional depreciation charge (to cost of sales) of
$300,000 in the consolidated financial statements for the year ended 31 March
2012. Systan has not adjusted its assets to fair value.
(ii)
In the post acquisition period Systan’s sales to Hydan were $30 million on which
Systan had made a consistent profit of 5% of the selling price. Of these goods, $4
million (at selling price to Hydan) were still in the inventory of Hydan at 31
March 2012. Prior to its acquisition Systan made all its sales at a uniform gross
profit margin.
(iii)
Included in Hydan’s current liabilities is $1 million owing to Systan. This agreed
with Systan’s receivables ledger balance for Hydan at the year end.
(iv)
An impairment review of the consolidated goodwill at 31 March 2012 revealed
that its current value was 12.5% less than its carrying amount.
(v)
Neither company paid a dividend in the year to 31 March 2012.
Required:
(a)
Prepare the consolidated income statement for the year ended 31 March 2012 and
the consolidated balance sheet at that date.
(20 marks)
(b)
Discuss the effect that the acquisition of Systan appears to have had on Systan’s
operating performance.
(5 marks)
(Total: 25 marks)
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
74
Holdrite, Staybrite and Allbrite
Holdrite purchased 75% of the issued share capital of Staybrite and 40% of the issued
share capital of Allbrite on 1 April 2012.
Details of the purchase consideration given at the date of purchase are:
Staybrite:
A share exchange of 2 shares in Holdrite for every 3 shares in Staybrite
plus an issue to the shareholders of Staybrite of 8% loan notes
redeemable at par on 30 June 2014 on the basis of $100 loan note for
every 250 shares held in Staybrite.
Allbrite:
A share exchange of 3 shares in Holdrite for every 4 shares in Allbrite
plus $1 per share acquired in cash.
The market price of Holdrite’s shares at 1 April 2012 was $6 per share.
The summarised income statements for the three companies for the year to 30
September 2012 are:
Holdrite
Staybrite
Allbrite
$000
$000
$000
Revenue
Cost of sales
75,000
(47,400)
––––––––
Gross profit
27,600
Operating expenses
(10,480)
––––––––
Operating profit
17,120
Finance cost
(170)
––––––––
Profit before tax
16,950
Income tax expense
(4,800)
––––––––
Profit for period
12,150
––––––––
The following information is relevant:
(i)
40,700
(19,700)
––––––––
21,000
(9,000)
––––––––
12,000
–
––––––––
12,000
(3,000)
––––––––
9,000
––––––––
31,000
(15,300)
––––––––
15,700
(9,700)
––––––––
6,000
–
––––––––
6,000
(2,000)
––––––––
4,000
––––––––
A fair value exercise was carried out for Staybrite at the date of its acquisition
with the following results:
Book value
Fair value
$000
$000
Land
20,000
23,000
Plant
25,000
30,000
The fair values have not been reflected in Staybrite’s financial statements. The
increase in the fair value of the plant would create additional depreciation of
$500,000 in the post acquisition period in the consolidated financial statements to
30 September 2012.
Depreciation of plant is charged to cost of sales.
102
© Emile Woolf Publishing Limited
Section 1: Practice questions
(ii)
The details of each company’s share capital and reserves at 1 October 2011 are:
Holdrite
Staybrite
Allbrite
$000
$000
$000
20,000
10,000
5,000
Share premium
5,000
4,000
2,000
Retained profits
18,000
7,500
6,000
Equity shares of $1 each
(iii)
In the post acquisition period Holdrite sold goods to Staybrite for $10 million.
Holdrite made a profit of $4 million on these sales. One-quarter of these goods
were still in the inventory of Staybrite at 30 September 2012.
(iv)
Impairment tests on the goodwill of Staybrite at 30 September 2012 resulted in
the need to write down Staybrite’s goodwill by $750,000. Non-controlling
interests are valued at their proportionate share of net assets.
(v)
Holdrite paid a dividend of $5 million on 20 September 2012.
Required:
(a)
Calculate the goodwill arising on the purchase of the shares in both Staybrite and
Allbrite at 1 April 2012.
(8 marks)
(b)
Prepare a consolidated income statement for the Holdrite Group for the year to
30 September 2012.
(15 marks)
(c)
Show the movement on the consolidated retained profits attributable to Holdrite
for the year to 30 September 2012.
(2 marks)
(Total: 25 marks)
Note: The additional disclosures in IFRS 3 Business Combinations relating to a newly
acquired subsidiary are not required.
75
Python, Snake and Adder
On 1 October 2011, Python acquired 24 million of the 32 million issued equity shares of
Snake. The purchase consideration was two shares in Python for every three shares in
Snake. The market price of Python’s shares at 1 October 2011 was $4.80 per share. In
addition, Python will make a cash payment of $1.21 for each share in Snake that it has
acquired: this is payable on 30 September 2013, two years after the acquisition.
Python’s cost of capital is 10%. The reserves of Snake at 1 July 2011 were $67 million.
The shares of Python and of Snake have a nominal value of $1 each.
Python has held an investment of 25% of the shares of Adder for many years.
The summarised income statements of the three companies for the year ended 30 June
2012 are as follows.
Income statements
Python
Snake
Adder
$000
$000
$000
Revenue
160,000
72,000
72,000
Cost of sales
(99,000)
(42,000)
(50,000)
Gross profit
61,000
30,000
22,000
Distribution costs
(7,900)
(4,000)
(5,000)
(13,200)
(6,000)
(7,000)
Administrative expenses
© Emile Woolf Publishing Limited
103
Paper F7: Financial Reporting (International)
Income statements
Python
Snake
Adder
$000
$000
$000
Finance costs (see note 2)
(2,500)
(1,000)
nil
Profit before tax
37,400
19,000
10,000
Income tax expense
(12,300)
(2,600)
(2,000)
Profit for the period
25,100
16,400
8,000
The following information is relevant:
(1)
The carrying amounts of the assets and liabilities of Snake at the date of
acquisition were equal to their fair values, with the exception of some property
and plant. Property had a fair value $2.5 million in excess of its carrying value,
and the plant had a fair value $2.4 million in excess of carrying value. The fair
values are not reflected in the financial statements of Snake.
The plant had a remaining useful life of four years from the date of acquisition
and is depreciated by the straight line method. The increase in the fair value of
the property creates additional depreciation of $50,000 for the post-acquisition
period to 30 June 2012.
All depreciation should be treated as part of the cost of sales.
No fair value adjustments were required on the acquisition of Adder.
(2)
The finance costs in the income statement of Python do not include the finance
cost of the deferred consideration.
(3)
Python’s accounting policy is to value non-controlling interests at a
proportionate share of the identifiable net assets of the subsidiary.
(4)
Snake has been a regular buyer of goods from Python, both before and after the
acquisition. Throughout the year to 30 June 2012, Snake purchased goods at a
price of $1 million per month. Python makes a profit of 25% on cost on these
sales. At 30 June 2012, Snake held $2 million (at cost to Snake) in inventory of
goods purchased from Python in the post-acquisition period.
(5)
A test for impairment on 30 June 2012 found that goodwill should be written
down by $1.5 million.
(6)
It should be assumed that all items in the income statement accrue at an even rate
through the year. Deferred tax should be ignored.
Required
(a)
Calculate the goodwill arising on the acquisition of Snake on 1 October 2011.
(6 marks)
104
(b)
Prepare the consolidated income statement of Python for the year ended 30 June
2012. You should assume that the investment in Adder has been accounted for by
the equity method since the investment was originally acquired.
(15 marks)
(c)
Until 30 June 2012, the other equity shares in Adder (75%) were held by a large
number of investors, but shortly after this date, 70% of the shares in Adder were
acquired by a single investor, Mamba Company. A director of Python, who had
been serving as a director of Adder, resigned from his position on the Adder
board of directors.
© Emile Woolf Publishing Limited
Section 1: Practice questions
Explain how the accounting treatment of the investment in Adder would be
affected for the year ended 30 June 2013 by this event.
(4 marks)
(Total: 25 marks)
76
Hosterling
Hosterling purchased the following equity investments:
On 1 October 2011: 80% of the issued share capital of Sunlee. The acquisition was
through a share exchange of three shares in Hosterling for every five shares in
Sunlee. The market price of Hosterling’s shares at 1 October 2011 was $5 per
share.
On 1 July 2012: 6 million shares in Amber paying $3 per share in cash and issuing
to Amber’s shareholders 6% (actual and effective rate) loan notes on the basis of
$100 loan note for every 100 shares acquired.
The summarised income statements for the three companies for the year ended 30
September 2012 are:
Hosterling
$’000
Revenue
105,000
Cost of sales
(68,000)
––––––––
Gross profit/(loss)
37,000
Other income (note (i))
400
Distribution costs
(4,000)
Administrative expenses
(7,500)
Finance costs
(1,200)
––––––––
Profit/(loss) before tax
24,700
Income tax (expense)/credit
(8,700)
––––––––
Profit/(loss) for the period
16,000
––––––––
The following information is relevant:
Sunlee
$’000
62,000
(36,500)
––––––––
25,500
nil
(2,000)
(7,000)
(900)
––––––––
15,600
(2,600)
––––––––
13,000
––––––––
Amber
$’000
50,000
(61,000)
––––––––
(11,000)
nil
(4,500)
(8,500)
nil
––––––––
(24,000)
4,000
––––––––
(20,000)
––––––––
(i)
The other income is a dividend received from Sunlee on 31 March 2012.
(ii)
The details of Sunlee’s and Amber’s share capital and reserves at 1 October 2011
were:
Equity shares of $1 each
Retained earnings
(iii)
Amber
$’000
15,000
35,000
Sunlee
$’000
20,000
18,000
A fair value exercise was carried out at the date of acquisition of Sunlee with the
following results:
Intellectual property
Land
Plant
© Emile Woolf Publishing Limited
carrying
amount
$’000
18,000
17,000
30,000
fair
value
$’000
22,000
20,000
35,000
remaining life
(straight line)
still in development
not applicable
five years
105
Paper F7: Financial Reporting (International)
The fair values have not been reflected in Sunlee’s financial statements.
Plant depreciation is included in cost of sales.
No fair value adjustments were required on the acquisition of Amber.
(iv)
In the year ended 30 September 2012 Hosterling sold goods to Sunlee at a selling
price of $18 million. Hosterling made a profit of cost plus 25% on these sales. $7·5
million (at cost to Sunlee) of these goods were still in the inventories of Sunlee at
30 September 2012.
(v)
Impairment tests for both Sunlee and Amber were conducted on 30 September
2012. They concluded that the goodwill of Sunlee should be written down by $1·6
million and, due to its losses since acquisition, the investment in Amber was
worth $21·5 million.
(vi)
All trading profits and losses are deemed to accrue evenly throughout the year.
Required:
(a)
Calculate the goodwill arising on the acquisition of Sunlee at 1 October 2011.
(5 marks)
(b)
Calculate the carrying amount of the investment in Amber at 30 September 2012
under the equity method prior to the impairment test.
(4 marks)
(c)
Prepare the consolidated income statement for the Hosterling Group for the year
ended 30 September 2012.
(16 marks)
(Total: 25 marks)
77
Patronic
On 1 August 2010 Patronic purchased 18 million of a total of 24 million equity shares in
Sardonic. The acquisition was through a share exchange of two shares in Patronic for
every three shares in Sardonic. Both companies have shares with a par value of $1
each. The market price of Patronic’s shares at 1 August 2010 was $5·75 per share.
Patronic will also pay in cash on 31 July 2012 (two years after acquisition) $2·42 per
acquired share of Sardonic. Patronic’s cost of capital is 10% per annum. The reserves of
Sardonic on 1 April 2010 were $69 million.
Patronic has held an investment of 30% of the equity shares in Acerbic for many years.
The summarised income statements for the three companies for the year ended 31
March 2011 are:
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance costs (note (ii))
Profit before tax
Income tax expense
Profit for the period
106
Patronic
$’000
150,000
(94,000)
––––––––
56,000
(7,400)
(12,500)
Sardonic
$’000
78,000
(51,000)
–––––––
27,000
(3,000)
(6,000)
Acerbic
$’000
80,000
(60,000)
–––––––
20,000
(3,500)
(6,500)
(2,000)
––––––––
34,100
(10,400)
––––––––
23,700
––––––––
(900)
–––––––
17,100
(3,600)
–––––––
13,500
–––––––
nil
–––––––
10,000
(4,000)
–––––––
6,000
–––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
The following information is relevant:
(i)
The fair values of the net assets of Sardonic at the date of acquisition were equal
to their carrying amounts with the exception of property and plant. Property and
plant had fair values of $4·1 million and $2·4 million respectively in excess of
their carrying amounts. The increase in the fair value of the property would
create additional depreciation of $200,000 in the consolidated financial statements
in the post acquisition period to 31 March 2011 and the plant had a remaining life
of four years (straight-line depreciation) at the date of acquisition of Sardonic. All
depreciation is treated as part of cost of sales.
The fair values have not been reflected in Sardonic’s financial statements.
No fair value adjustments were required on the acquisition of Acerbic.
(ii)
The finance costs of Patronic do not include the finance cost on the deferred
consideration.
(iii)
Prior to its acquisition, Sardonic had been a good customer of Patronic. In the
year to 31 March 2011, Patronic sold goods at a selling price of $1·25 million per
month to Sardonic both before and after its acquisition. Patronic made a profit of
20% on the cost of these sales. At 31 March 2011 Sardonic still held inventory of
$3 million (at cost to Sardonic) of goods purchased in the post acquisition period
from Patronic.
(iv)
An impairment test on the goodwill of Sardonic conducted on 31 March 2011
concluded that it should be written down by $2 million. The value of the
investment in Acerbic was not impaired.
(v)
All items in the above income statements are deemed to accrue evenly over the
year.
(vi)
Ignore deferred tax.
Required:
(a)
Calculate the goodwill arising on the acquisition of Sardonic at 1 August 2010.
(6 marks)
(b)
Prepare the consolidated income statement for the Patronic Group for the year
ended 31 March 2011.
Note: assume that the investment in Acerbic has been accounted for using the
(15 marks)
equity method since its acquisition.
(c)
At 31 March 2011 the other equity shares (70%) in Acerbic were owned by many
separate investors. Shortly after this date Spekulate (a company unrelated to
Patronic) accumulated a 60% interest in Acerbic by buying shares from the other
shareholders. In May 2011 a meeting of the board of directors of Acerbic was
held at which Patronic lost its seat on Acerbic’s board.
Required:
Explain, with reasons, the accounting treatment Patronic should adopt for its
investment in Acerbic when it prepares its financial statements for the year
ending 31 March 2012.
(4 marks)
(Total: 25 marks)
78
Pandar
On 1 April 2012 Pandar purchased 80% of the equity shares in Salva. The acquisition
was through a share exchange of three shares in Pandar for every five shares in Salva.
© Emile Woolf Publishing Limited
107
Paper F7: Financial Reporting (International)
The market prices of Pandar’s and Salva’s shares at 1 April 2012 were $6 per share and
$3.20 respectively.
On the same date Pandar acquired 40% of the equity shares in Ambra paying $2 per
share.
The summarised income statements for the three companies for the year ended 30
September 2012 are:
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Investment income (interest and dividends)
Finance costs
Profit (loss) before tax
Income tax (expense) relief
Profit (loss) for the year
Pandar
$’000
210,000
(126,000)
–––––––––
84,000
(11,200)
(18,300)
9,500
(1,800)
–––––––––
62,200
(15,000)
–––––––––
47,200
–––––––––
Salva
$’000
150,000
(100,000)
–––––––––
50,000
(7,000)
(9,000)
Ambra
$’000
50,000
(40,000)
––––––––
10,000
(5,000)
(11,000)
(3,000)
–––––––––
31,000
(10,000)
–––––––––
21,000
–––––––––
nil
––––––––
(6,000)
1,000
––––––––
(5,000)
––––––––
The following information for the equity of the companies at 30 September 2012 is
available:
Equity shares of $1 each
Share premium
Retained earnings 1 October 2011
Profit (loss) for the year ended 30 September 2012
Dividends paid (26 September 2012)
200,000
300,000
40,000
47,200
nil
120,000
nil
152,000
21,000
(8,000)
40,000
nil
15,000
(5,000)
nil
The following information is relevant:
(i)
The fair values of the net assets of Salva at the date of acquisition were equal to
their carrying amounts with the exception of an item of plant which had a
carrying amount of $12 million and a fair value of $17 million. This plant had a
remaining life of five years (straight-line depreciation) at the date of acquisition
of Salva. All depreciation is charged to cost of sales.
In addition Salva owns the registration of a popular internet domain name. The
registration, which had a negligible cost, has a five year remaining life (at the
date of acquisition); however, it is renewable indefinitely at a nominal cost. At
the date of acquisition the domain name was valued by a specialist company at
$20 million.
The fair values of the plant and the domain name have not been reflected in
Salva’s financial statements.
No fair value adjustments were required on the acquisition of the investment in
Ambra.
(ii)
108
Immediately after its acquisition of Salva, Pandar invested $50 million in an 8%
loan note from Salva. All interest accruing to 30 September 2012 had been
accounted for by both companies. Salva also has other loans in issue at 30
September 2012.
© Emile Woolf Publishing Limited
Section 1: Practice questions
(iii)
Pandar has credited the whole of the dividend it received from Salva to
investment income.
(iv)
After the acquisition, Pandar sold goods to Salva for $15 million on which Pandar
made a gross profit of 20%. Salva had one third of these goods still in its
inventory at 30 September 2012. There are no intra-group current account
balances at 30 September 2012.
(v)
The non-controlling interest in Salva is to be valued at its (full) fair value at the
date of acquisition. For this purpose Salva’s share price at that date can be taken
to be indicative of the fair value of the shareholding of the non-controlling
interest.
(vi)
The goodwill of Salva has not suffered any impairment; however, due to its
losses, the value of Pandar’s investment in Ambra has been impaired by $3
million at 30 September 2012.
(vii) All items in the above income statements are deemed to accrue evenly over the
year unless otherwise indicated.
Required:
(a)
(i)
Calculate the goodwill arising on the acquisition of Salva at 1 April 2012;
(6 marks)
(ii)
(b)
Calculate the carrying amount of the investment in Ambra to be included
within the consolidated statement of financial position as at 30 September
2012.
(3 marks)
Prepare the consolidated income statement for the Pandar Group for the year
ended 30 September 2012.
(16 marks)
(Total: 25 marks)
79
Premier
On 1 June 2010, Premier acquired 80% of the equity share capital of Sanford. The
consideration consisted of two elements: a share exchange of three shares in Premier
for every five acquired shares in Sanford and the issue of a $100 6% loan note for every
500 shares acquired in Sanford. The share issue has not yet been recorded by Premier,
but the issue of the loan notes has been recorded. At the date of acquisition shares in
Premier had a market value of $5 each and the shares of Sanford had a stock market
price of $3·50 each. Below are the summarised draft financial statements of both
companies.
Statements of comprehensive income for the year ended 30 September 2010
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the year
© Emile Woolf Publishing Limited
Premier
$’000
92,500
(70,500)
–––––––
22,000
(2,500)
(5,500)
(100)
–––––––
13,900
(3,900)
–––––––
10,000
Sanford
$’000
45,000
(36,000)
–––––––
9,000
(1,200)
(2,400)
nil
–––––––
5,400
(1,500)
–––––––
3,900
109
Paper F7: Financial Reporting (International)
Other comprehensive income:
Gain on revaluation of land (note (i))
Total comprehensive income
Statements of financial position as at 30 September 2010
Assets
Non-current assets
Property, plant and equipment
Investments
Current assets
Total assets
Equity and liabilities
Equity
Equity shares of $1 each
Land revaluation reserve – 30 September 2010 (note (i))
Other equity reserve – 30 September 2009 (note (iv))
Retained earnings
Non-current liabilities
6% loan notes
Current liabilities
Total equity and liabilities
The following information is relevant:
(i)
Premier
$’000
Sanford
$’000
500
–––––––
10,500
–––––––
nil
–––––––
3,900
–––––––
25,500
1,800
–––––––
27,300
12,500
–––––––
39,800
–––––––
13,900
nil
–––––––
13,900
2,400
–––––––
16,300
–––––––
12,000
2,000
500
12,300
–––––––
26,800
5,000
nil
nil
4,500
–––––––
9,500
3,000
10,000
–––––––
39,800
–––––––
nil
6,800
–––––––
16,300
–––––––
At the date of acquisition, the fair values of Sanford’s assets were equal to their
carrying amounts with the exception of its property. This had a fair value of $1.2
million below its carrying amount. This would lead to a reduction of the
depreciation charge (in cost of sales) of $50,000 in the post-acquisition period.
Sanford has not incorporated this value change into its entity financial
statements.
Premier’s group policy is to revalue all properties to current value at each year
end. On 30 September 2010, the value of Sanford’s property was unchanged from
its value at acquisition, but the land element of Premier’s property had increased
in value by $500,000 as shown in other comprehensive income.
110
(ii)
Sales from Sanford to Premier throughout the year ended 30 September 2010 had
consistently been $1 million per month. Sanford made a mark-up on cost of 25%
on these sales. Premier had $2 million (at cost to Premier) of inventory that had
been supplied in the post-acquisition period by Sanford as at 30 September 2010.
(iii)
Premier had a trade payable balance owing to Sanford of $350,000 as at 30
September 2010. This agreed with the corresponding receivable in Sanford’s
books.
(iv)
Premier’s investments include some available-for-sale investments that have
increased in value by $300,000 during the year. The other equity reserve relates to
these investments and is based on their value as at 30 September 2009. There
© Emile Woolf Publishing Limited
Section 1: Practice questions
were no acquisitions or disposals of any of these investments during the year
ended 30 September 2010.
(v)
Premier’s policy is to value the non-controlling interest at fair value at the date of
acquisition. For this purpose Sanford’s share price at that date can be deemed to
be representative of the fair value of the shares held by the non-controlling
interest.
(vi)
There has been no impairment of consolidated goodwill.
Required:
(a)
Prepare the consolidated statement of comprehensive income for Premier for the
year ended 30 September 2010.
(b)
Prepare the consolidated statement of financial position for Premier as at 30
September 2010.
The following mark allocation is provided as guidance for this question:
(a)
9 marks
(b)
16 marks
(25 marks)
Business combinations – Statements of financial position
and performance
80
Hepburn
(a)
On 1 October 2011 Hepburn acquired 80% of the equity share capital of Salter by
way of a share exchange. Hepburn issued five of its own shares for every two
shares it acquired in Salter. The market value of Hepburn’s shares on 1 October
2011 was $3 each. The share issue has not yet been recorded in Hepburn’s books.
The summarised financial statements of both companies are:
Income statements: Year to 31 March 2012
Revenue
Cost of sales
Gross profit
Operating expenses
Financial costs
Profit before tax
Income tax expense
Profit for the period
Hepburn
$000
1,200
(650)
550
(120)
nil
430
(100)
330
Salter
$000
1,000
(660)
340
(88)
(12)
240
(40)
200
Statements of financial position: as at 31 March 2012
Hepburn
Non-current assets
Property, plant and
equipment
Investments
© Emile Woolf Publishing Limited
Salter
620
660
20
640
10
670
111
Paper F7: Financial Reporting (International)
Hepburn
Current assets
Inventory
Accounts receivable
Bank
240
170
20
Total assets
Equity and liabilities
Equity shares of $1 each
Retained earnings
Non-current liabilities
8% Debentures
Current liabilities
Trade accounts payable
Taxation
Salter
280
210
40
430
1,070
530
1,200
400
410
810
150
700
850
nil
150
210
50
155
45
260
1,070
Total equity and liabilities
200
1,200
The following information is relevant:
(i)
The fair values of Salter’s assets were equal to their carrying values (book
values) with the exception of its land, which had fair value of $125,000 in
excess of its carrying value at the date of acquisition.
(ii)
In the post acquisition period Hepburn sold goods to Salter at a price of
$100,000, this was calculated to give a mark-up on cost of 25% to Hepburn.
Salter had half of these goods in inventory at the year end.
(iii)
Consolidated goodwill is to be written off as an operating expense. An
impairment test at 31 March 2012 on the consolidated goodwill concluded
that it should be written down by $20,000. No other assets were impaired.
(iv)
The current accounts of the two companies disagreed due to a cash
remittance of $20,000 to Hepburn on 26 March 2012 not being received
until after the year end. Before adjusting for this, Salter’s debit balance in
Hepburn’s books was $56,000.
Required:
Prepare a consolidated income statement and consolidated statement of financial
position for Hepburn for the year to 31 March 2012.
(20 marks)
(b)
At the same date as Hepburn made the share exchange for Salter’s shares, it also
acquired 6,000 ‘A’ shares in Woodbridge for a cash payment of $20,000. The
share capital of Woodbridge is made up of:
Equity voting A shares
10,000
Equity non-voting B shares
14,000
All of Woodbridge’s equity shares are entitled to the same dividend rights;
however during the year to 31 March 2012 Woodbridge made substantial losses
and did not pay any dividends.
Hepburn has treated its investment in Woodbridge as an ordinary long-term
investment on the basis that:
112
© Emile Woolf Publishing Limited
Section 1: Practice questions
„
it is only entitled to 25% of any dividends that Woodbridge may pay
„
it does not any have directors on the Board of Woodbridge; and
„
it does not exert any influence over the operating policies or management
of Woodbridge.
Required:
Comment on the accounting treatment of Woodbridge by Hepburn’s directors
and state how you believe the investment should be accounted for.
(5 marks)
Note: You are not required to amend your answer to part (a) in respect of the
information in part (b).
(Total: 25 marks)
81
Hydrate
Hydrate is a public company operating in the industrial chemical sector. In order to
achieve economies of scale, it has been advised to enter into business combinations
with compatible partner companies. As a first step in this strategy Hydrate acquired
80% of the ordinary share capital of Sulphate by way of a share exchange on 1 April
2012. Hydrate issued five of its own shares for every four shares in Sulphate. The
market value of Hydrate’s shares on 1 April 2012 was $6 each. The share issue has not
yet been recorded in Hydrate’s books. The summarised financial statements of both
companies for the year to 30 September 2012 are:
Income statement – year to 30 September 2012
Revenue
Cost of sales
Gross profit
Operating expenses
Profit before tax
Taxation
Profit after tax
Hydrate
$000
24,000
(16,600)
7,400
(1,600)
5,800
(2,000)
3,800
Sulphate
$000
20,000
(11,800)
8,200
(1,000)
7,200
(3,000)
4,200
Statement of financial position as at 30 September 2012
Non-current assets
Property, plant and equipment
Investment
Current assets
Inventory
Accounts receivable
Bank
Total assets
© Emile Woolf Publishing Limited
Hydrate
$000
$000
64,000
nil
64,000
22,800
16,400
500
Sulphate
$000
$000
35,000
12,800
47,800
23,600
24,200
200
39,700
103,700
48,000
95,800
113
Paper F7: Financial Reporting (International)
Statement of financial position as at 30 September 2012
Hydrate
Equity and liabilities
Ordinary shares of $1 each
Reserves:
Share premium
Retained earnings
Non-current liabilities
8% Loan note
Current liabilities
Accounts payable
Taxation
Sulphate
20,000
12,000
2,400
42,700
4,000
57,200
61,200
81,200
45,100
57,100
Hydrate
$000
$000
Sulphate
$000
$000
5,000
18,000
15,300
2,200
17,700
3,000
17,500
103,700
20,700
95,800
The following information is relevant:
(i)
The fair value of an item of plant of Sulphate’s was $5 million in excess of its
book value at the date of acquisition. The asset has a remaining life of five years.
The fair values of Sulphate’s other net assets were equal to their book values.
(ii)
An impairment test at 30 September 2012 on the consolidated goodwill
concluded that it should be written down by $1,000,000 and treated as an
operating expense. No other assets were impaired.
(iii)
In the post acquisition period Hydrate sold goods to Sulphate at a price of
$100,000, this was calculated to give a mark-up on cost of 25% to Hydrate.
Sulphate had half of these goods in inventory at the year end.
(iv)
It is the accounting policy of Hydrate that the non-controlling interests in its
subsidiary should be valued at a proportionate share of net assets.
Required:
Prepare the consolidated income statement and consolidated statement of financial
(25 marks)
position of Hydrate for the year to 30 September 2012
82
Hillusion
In recent years Hillusion has acquired a reputation for buying modestly performing
businesses and selling them at a substantial profit within a period of two to three years
of their acquisition. On 1 July 2011 Hillusion acquired 80% of the ordinary share capital
of Skeptik at a cost of $10,280,000. On the same date it also acquired 50% of Skeptik
10% loan notes at par. The summarised draft financial statements of both companies
are:
114
© Emile Woolf Publishing Limited
Section 1: Practice questions
Income statements: Year to 31 March 2012
Revenue
Cost of sales
Gross profit
Operating expenses
Loan interest received (paid)
Profit before tax
Taxation
Profit for the year
Retained earnings brought forward
Retained earnings per balance sheet
Hillusion
$000
60,000
(42,000)
18,000
(6,000)
75
12,075
(3,000)
9,075
16,525
25,600
Skeptik
$000
24,000
(20,000)
4,000
(200)
(200)
3,600
(600)
3,000
5,400
8,400
Statements of financial position: as at 31 March 2012
Hillusion
Skeptik
$000
$000
19,320
8,000
11,280
――――
30,600
nil
――――
8,000
Current assets
15,000
8,000
Total assets
45,600
16,000
10,000
2,000
25,600
――――
35,600
8,400
――――
10,400
nil
2,000
10,000
――――
45,600
――――
3,600
――――
16,000
――――
Tangible non-current assets
Investments
Equity and liabilities
Ordinary shares of $1 each
Retained earnings
Non-current liabilities
10% loan notes
Current liabilities
The following information is relevant:
(i)
The fair values of Skeptik assets were equal to their carrying values (book values)
with the exception of its plant, which had a fair value of $3.2 million in excess of
its carrying value at the date of acquisition. The remaining life of all of Skeptik’s
plant at the date of its acquisition was four years and this period has not changed
as a result of the acquisition. Depreciation of plant is on a straight-line basis and
charged to cost of sales. Skeptik has not adjusted the value of its plant as a result
of the fair value exercise.
(ii)
In the post acquisition period Hillusion sold goods to Skeptik at a price of $12
million. These goods had cost Hillusion $9 million. During the year Skeptik had
sold $10 million (at cost to Skeptik) of these goods for $15 million.
© Emile Woolf Publishing Limited
115
Paper F7: Financial Reporting (International)
(iii)
Hillusion bears almost all of the administration costs incurred on behalf of the
group (invoicing, credit control, etc). It does not charge Skeptik for this service as
to do so would not have a material effect on the group profit.
(iv)
Revenues and profits should be deemed to accrue evenly throughout the year.
(v)
The current accounts of the two companies were reconciled at the year-end with
Skeptik owing Hillusion $750,000.
(vi)
It is the accounting policy of Hillusion that the non-controlling interests in its
subsidiary should be valued at a proportionate share of net assets.
(vii) An impairment test at 31 March 2012 on the consolidated goodwill concluded
that it should be written down by $300,000 and treated as an operating expense.
No other assets were impaired.
Required:
(a)
Prepare a consolidated income statement and consolidated statement of financial
(20 marks)
position for Hillusion for the year to 31 March 2012.
(b)
Explain why it is necessary to eliminate unrealised profits when preparing group
financial statements; and how reliance on the entity financial statements of
Skeptik may mislead a potential purchaser of the company.
(5 marks)
(Total: 25 marks)
Note: Your answer should refer to the circumstances described in the question.
83
Pedantic
On 1 April 2012, Pedantic acquired 60% of the equity share capital of Sophistic in a
share exchange of two shares in Pedantic for three shares in Sophistic. The issue of
shares has not yet been recorded by Pedantic. At the date of acquisition shares in
Pedantic had a market value of $6 each. Below are the summarised draft financial
statements of both companies.
Income statements for the year ended 30 September 2012
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the year
Statements of financial position as at 30 September 2012
Assets
Non-current assets
Property, plant and equipment
Current assets
Total assets
116
Pedantic
$’000
85,000
(63,000)
––––––––
22,000
(2,000)
(6,000)
(300)
––––––––
13,700
(4,700)
––––––––
9,000
––––––––
Sophistic
$’000
42,000
(32,000)
––––––––
10,000
(2,000)
(3,200)
(400)
––––––––
4,400
(1,400)
––––––––
3,000
––––––––
40,600
16,000
––––––––
56,600
––––––––
12,600
6,600
––––––––
19,200
––––––––
© Emile Woolf Publishing Limited
Section 1: Practice questions
Equity and liabilities
Equity shares of $1 each
Retained earnings
Non-current liabilities
10% loan notes
Current liabilities
Total equity and liabilities
The following information is relevant:
Pedantic
$’000
Sophistic
$’000
10,000
35,400
––––––––
45,400
4,000
6,500
––––––––
10,500
3,000
8,200
––––––––
56,600
––––––––
4,000
4,700
––––––––
19,200
––––––––
(i)
At the date of acquisition, the fair values of Sophistic’s assets were equal to their
carrying amounts with the exception of an item of plant, which had a fair value
of $2 million in excess of its carrying amount. It had a remaining life of five years
at that date [straight-line depreciation is used]. Sophistic has not adjusted the
carrying amount of its plant as a result of the fair value exercise.
(ii)
Sales from Sophistic to Pedantic in the post acquisition period were $8 million.
Sophistic made a mark up on cost of 40% on these sales. Pedantic had sold $5·2
million (at cost to Pedantic) of these goods by 30 September 2012.
(iii)
Other than where indicated, income statement items are deemed to accrue evenly
on a time basis.
(iv)
Sophistic’s trade receivables at 30 September 2012 include $600,000 due from
Pedantic which did not agree with Pedantic’s corresponding trade payable. This
was due to cash in transit of $200,000 from Pedantic to Sophistic. Both companies
have positive bank balances.
(v)
Pedantic has a policy of accounting for any non-controlling interest at fair value.
For this purpose the fair value of the goodwill attributable to the non-controlling
interest in Sophistic is $1·5 million. Consolidated goodwill was not impaired at
30 September 2012.
Required:
(a)
Prepare the consolidated income statement for Pedantic for the year ended 30
(9 marks)
September 2012.
(b)
Prepare the consolidated statement of financial position for Pedantic as at 30
(16 marks)
September 2012.
Note: a statement of changes in equity is not required.
© Emile Woolf Publishing Limited
(Total: 25 marks)
117
Paper F7: Financial Reporting (International)
Analysing and interpreting financial statements
84
Comparator
Comparator assembles computer equipment from bought in components and
distributes them to various wholesalers and retailers. It has recently subscribed to an
interfirm comparison service. Members submit accounting ratios as specified by the
operator of the service, and in return, members receive the average figures for each of
the specified ratios taken from all of the companies in the same sector that subscribe to
the service. The specified ratios and the average figures for Comparator’s sector are
shown below.
Ratios of companies reporting a full year’s results for periods ending between 1 July
2012 and 30 September 2012
Return on capital employed
Net assets turnover
Gross profit margin
Net profit (before tax) margin
Current ratio
Quick ratio
Inventory holding period
Accounts receivable collection period
Accounts payable payment period
Debt to equity
Dividend yield
Dividend cover
22.1%
1.8 times
30%
12.5%
1.6:1
0.9:1
46 days
45 days
55 days
40%
6%
3 times
Comparator’s financial statements for the year to 30 September 2012 are set out below:
Income statement
Revenue
Cost of sales
Gross profit
Other operating expenses
Profit from operations
Finance costs
Exceptional item (note (ii))
Profit before taxation
Income tax
Profit for the period
$000
2,425
(1,870)
555
(215)
340
(34)
(120)
186
(90)
96
$000
Extracts of changes in equity
Retained earnings – 1 October 2011
Net profit for the period
Dividends paid (interim $60,000; final $30,000)
Retained earnings – 30 September 2012
118
179
96
(90)
185
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statement of financial position
Non-current assets (note (i))
Current assets
Inventory
Accounts receivable
Bank
$000
$000
540
275
320
nil
595
1,135
Equity
Ordinary shares (25 cents each)
Retained earnings
150
185
335
Non-current liabilities
8% loan notes
Current liabilities
Bank overdraft
Trade accounts payable
Taxation
300
65
350
85
500
1,135
Notes
(i)
The details of the non-current assets are:
Cost
At 30 September 2007
$000
3,600
Accumulated
depreciation
$000
3,060
Net book
value
$000
540
(ii)
The exceptional item relates to losses on the sale of a batch of computers that had
become worthless due to improvements in microchip design.
(iii)
The market price of Comparator’s shares throughout the year averaged $6.00
each.
Required:
(a)
Explain the problems that are inherent when ratios are used to assess a
company’s financial performance.
Your answer should consider any additional problems that may be encountered
when using interfirm comparison services such as that used by Comparator.
(7 marks)
(b)
Calculate the ratios for Comparator equivalent to those provided by the interfirm
comparison service.
(6 marks)
(c)
Write a report analysing the financial performance of Comparator based on a
comparison with the sector averages.
(12 marks)
(Total: 25 marks)
© Emile Woolf Publishing Limited
119
Paper F7: Financial Reporting (International)
85
Rytetrend
Rytetrend is a retailer of electrical goods. Extracts from the company’s financial
statements are set out below:
Income statement for the year ended 31 March:
2012
$000
Revenue
Cost of sales
Gross profit
Other operating expenses
Operating profit
Interest payable – loan notes
Interest payable – overdraft
$000
31,800
(22,500)
9,300
(5,440)
3,860
(260)
(200)
(460)
3,400
(1,000)
2,400
Profit before taxation
Taxation
Profit for the period
2011
$000
$000
23,500
(16,000)
7,500
(4,600)
2,900
(500)
nil
(500)
2,400
(800)
1,600
Statements of financial position as at 31 March:
2012
$000
Non-current assets (note (i))
Current assets
Inventory
Receivables
Bank
Equity and liabilities
Ordinary capital ($1 shares)
Share premium
Retained earnings
Total equity and liabilities
120
$000
24,500
2,650
1,100
nil
Total assets
Non-current liabilities
10% loan notes
6% loan notes
Current liabilities
Bank overdraft
Trade payables
Taxation
Warranty provision (note (ii))
2011
$000
$000
17,300
3,270
1,950
400
3,750
28,250
5,620
22,920
11,500
1,500
8,130
21,130
10,000
nil
6,160
16,160
nil
2,000
4,000
nil
1,050
2,850
720
500
nil
1,980
630
150
5,120
28,250
2,760
22,920
© Emile Woolf Publishing Limited
Section 1: Practice questions
Notes
(i)
The details of the non-current assets are:
Cost
Accumulated
depreciation
Net book
value
$000
$000
$000
At 31 March 2011
27,500
10,200
17,300
At 31 March 2012
37,250
12,750
24,500
During the year there was a major refurbishment of display equipment. Old
equipment that had cost $6 million in September 2008 was replaced with new
equipment at a gross cost of $8 million. The equipment manufacturer had
allowed Rytetrend a trade in allowance of $500,000 on the old display equipment.
In addition to this Rytetrend used its own staff to install the new equipment. The
value of staff time spent on the installation has been costed at $300,000, but this
has not been included in the cost of the asset. All staff costs have been included
in operating expenses. All display equipment held at the end of the financial year
is depreciated at 20% on its cost. No equipment is more than five years old.
(ii)
Operating expenses contain a charge of $580,000 for the cost of warranties on the
goods sold by Rytetrend. The company makes a warranty provision when it sells
its products and cash payments for warranty claims are deducted from the
provision as they are settled.
Required:
(a)
Prepare a statement of cash flows for Rytetrend for the year ended 31 March 2012.
(12 marks)
(b)
Write a report briefly analysing the operating performance and financial position
of Rytetrend for the years ended 31 March 2011 and 2012.
(13 marks)
Your report should be supported by appropriate ratios.
86
(Total: 25 marks)
Greenwood
Greenwood is a public listed company. During the year ended 31 March 2012 the
directors decided to cease operations of one of its activities and put the assets of the
operation up for sale (the discontinued activity has no associated liabilities). The
directors have been advised that the cessation qualifies as a discontinued operation
and has been accounted for accordingly.
Extracts from Greenwood’s financial statements are set out below.
Note: the income statement figures down to the profit for the period from continuing
operations are those of the continuing operations only.
Income statements for the year ended 31 March:
Revenue
Cost of sales
Gross profit
Operating expenses
© Emile Woolf Publishing Limited
2012
$’000
27,500
(19,500)
––––––––
8,000
(2,900)
––––––––
5,100
2011
$’000
21,200
(15,000)
––––––––
6,200
(2,450)
––––––––
3,750
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Income statements for the year ended 31 March:
Finance costs
Profit before taxation
Income tax expense
Profit for the period from continuing operations
Profit/(Loss) from discontinued operations
Profit for the period
2012
$’000
(600)
––––––––
4,500
(1,000)
––––––––
3,500
(1,500)
––––––––
2,000
––––––––
2011
$’000
(250)
––––––––
3,500
(800)
––––––––
2,700
320
––––––––
3,020
––––––––
7,500
(8,500)
––––––––
(1,000)
(400)
––––––––
(1,400)
300
––––––––
(1,100)
(500)
100
––––––––
(1,500)
––––––––
9,000
(8,000)
––––––––
1,000
(550)
––––––––
450
(130)
––––––––
320
–
–
––––––––
320
––––––––
Analysis of discontinued operations:
Revenue
Cost of sales
Gross profit/(loss)
Operating expenses
Profit/(loss) before tax
Tax (expense)/relief
Loss on measurement to fair value of disposal group
Tax relief on disposal group
Profit/(Loss) from discontinued operations
Statements of financial position as at 31 March
$’000
Non-current assets
Current assets
Inventory
1,500
Trade receivables
2,000
Bank
nil
Assets held for sale (at fair value)
6,000
––––––
Total assets
Equity and liabilities
Equity shares of $1 each
Retained earnings
Non-current liabilities
5% loan notes
Current liabilities
122
2012
$’000
17,500
9,500
–––––––
27,000
–––––––
10,000
4,500
–––––––
14,500
8,000
$’000
1,350
2,300
50
nil
––––––
2011
$’000
17,600
3,700
–––––––
21,300
–––––––
10,000
2,500
–––––––
12,500
5,000
© Emile Woolf Publishing Limited
Section 1: Practice questions
Statements of financial position as at 31 March
$’000
Bank overdraft
1,150
Trade payables
2,400
Current tax payable
950
––––––
Total equity and liabilities
2012
$’000
4,500
–––––––
27,000
–––––––
$’000
nil
2,800
1,000
––––––
2011
$’000
3,800
–––––––
21,300
–––––––
Note: the carrying amount of the assets of the discontinued operation at 31 March 2011
was $6·3 million.
Required:
Analyse the financial performance and position of Greenwood for the two years ended
31 March 2012.
Note: Your analysis should be supported by appropriate ratios (up to 10 marks
(25 marks)
available) and refer to the effects of the discontinued operation.
87
Harbin
Shown below are the recently issued (summarised) financial statements of Harbin, a
listed company, for the year ended 30 September 2012, together with comparatives for
2011 and extracts from the Chief Executive’s report that accompanied their issue.
Income statement
Revenue
Cost of sales
Gross profit
Operating expenses
Finance costs
Profit before tax
Income tax expense (at 25%)
Profit for the period
Statement of financial position
Non-current assets
Property, plant and equipment
Goodwill
Current assets
Inventory
Trade receivables
Bank
Total assets
Equity and liabilities
Equity shares of $1 each
© Emile Woolf Publishing Limited
2012
2011
$’000
250,000
(200,000)
50,000
(26,000)
(8,000)
16,000
(4,000)
12,000
$’000
180,000
(150,000)
30,000
(22,000)
(nil)
8,000
(2,000)
6,000
210,000
90,000
10,000
220,000
nil
90,000
25,000
13,000
15,000
8,000
nil
38,000
258,000
14,000
37,000
127,000
100,000
100,000
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Paper F7: Financial Reporting (International)
Income statement
Retained earnings
Non-current liabilities
8% loan notes
Current liabilities
Bank overdraft
Trade payables
Current tax payable
Total equity and liabilities
2012
2011
$’000
$’000
14,000
114,000
12,000
112,000
100,000
nil
17,000
23,000
nil
13,000
4,000
44,000
258,000
2,000
15,000
127,000
Extracts from the Chief Executive’s report:
‘Highlights of Harbin’s performance for the year ended 30 September 2012:
an increase in sales revenue of 39%
gross profit margin up from 16·7% to 20%
a doubling of the profit for the period.
In response to the improved position the Board paid a dividend of 10 cents per share in
September 2012 an increase of 25% on the previous year.’
You have also been provided with the following further information.
On 1 October 2011 Harbin purchased the whole of the net assets of Fatima (previously
a privately owned entity) for $100 million. The contribution of the purchase to Harbin’s
results for the year ended 30 September 2012 was:
$’000
Revenue
70,000
Cost of sales
(40,000)
–––––––
Gross profit
30,000
Operating expenses
(8,000)
–––––––
Profit before tax
22,000
–––––––
There were no disposals of non-current assets during the year.
The following ratios have been calculated for Harbin for the year ended 30 September
2011:
Return on year-end capital employed
(profit before interest and tax over total assets less current liabilities)
Net asset (equal to capital employed) turnover
1·6
Net profit (before tax) margin
124
7·1%
4·4%
Current ratio
2·5
Closing inventory holding period (in days)
37
Trade receivables’ collection period (in days)
16
Trade payables’ payment period (based on cost of sales) (in days)
32
Gearing (debt over debt plus equity)
nil
© Emile Woolf Publishing Limited
Section 1: Practice questions
Required:
(a)
Calculate ratios for Harbin for the year ended 30 September 2012 equivalent to
those calculated for the year ended 30 September 2011 (showing your workings).
(8 marks)
(b)
Assess the financial performance and position of Harbin for the year ended 30
September 2012 compared to the previous year. Your answer should refer to the
information in the Chief Executive’s report and the impact of the purchase of the
net assets of Fatima.
(17 marks)
(Total: 25 marks)
88
Victular
Victular is a public company that would like to acquire (100% of) a suitable private
company. It has obtained the following draft financial statements for two companies,
Grappa and Merlot. They operate in the same industry and their managements have
indicated that they would be receptive to a takeover.
Income statements for the year ended 30 September 2012
$’000
Revenue
Cost of sales
Gross profit
Operating expenses
Finance costs – loan
– overdraft
– lease
Profit before tax
Income tax expense
Grappa
$’000
12,000
(10,500)
––––––––
1,500
(240)
(210)
nil
nil
––––––––
1,050
(150)
––––––––
Profit for the year
900
––––––––
Note: dividends paid during the year
250
––––––––
Statements of financial position as at 30 September 2012
Assets
Non-current assets
Freehold factory (note (i))
4,400
Owned plant (note (ii))
5,000
Leased plant (note (ii))
nil
––––––––
9,400
Current assets
Inventory
2,000
Trade receivables
2,400
Bank
600
5,000
––––––––
––––––––
Total assets
14,400
––––––––
© Emile Woolf Publishing Limited
$’000
Merlot
$’000
20,500
(18,000)
––––––––
2,500
(500)
(300)
(10)
(290)
––––––––
1,400
(400)
––––––––
1,000
––––––––
700
––––––––
nil
2,200
5,300
––––––––
7,500
3,600
3,700
nil
––––––––
7,300
––––––––
14,800
––––––––
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Paper F7: Financial Reporting (International)
$’000
Grappa
$’000
Merlot
$’000
$’000
Equity and liabilities
Equity shares of $1 each
Property revaluation reserve
Retained earnings
Non-current liabilities
Finance lease obligations
(note (iii))
7% loan notes
10% loan notes
Deferred tax
Government grants
Current liabilities
Bank overdraft
Trade payables
Government grants
Finance lease obligations
(note (iii))
Taxation
2,000
900
2,600
––––––––
3,500
––––––––
5,500
nil
3,000
nil
600
1,200
––––––––
4,800
2,000
nil
800
––––––––
3,200
nil
3,000
100
nil
––––––––
nil
3,100
400
1,200
3,800
nil
nil
600
––––––––
500
200
––––––––
Total equity and liabilities
4,100
––––––––
14,400
––––––––
800
––––––––
2,800
6,300
5,700
––––––––
14,800
––––––––
Notes
(i)
Both companies operate from similar premises.
(ii)
Additional details of the two companies’ plant are:
Owned plant – cost
Leased plant – original fair value
Grappa
Merlot
$’000
$’000
8,000
10,000
nil
7,500
There were no disposals of plant during the year by either company.
(iii)
The interest rate implicit within Merlot’s finance leases is 7·5% per annum. For
the purpose of calculating ROCE and gearing, all finance lease obligations are
treated as long-term interest bearing borrowings.
(iv)
The following ratios have been calculated for Grappa and can be taken to be
correct:
Return on year end capital employed (ROCE)
14·8%
(capital employed taken as shareholders’ funds plus long-term interest bearing
borrowings – see note (iii) above)
Pre-tax return on equity (ROE)
126
19·1%
© Emile Woolf Publishing Limited
Section 1: Practice questions
Net asset (total assets less current liabilities) turnover
1·2 times
Gross profit margin
12·5%
Operating profit margin
10·5%
Current ratio
1·2:1
Closing inventory holding period
70 days
Trade receivables’ collection period
73 days
Trade payables’ payment period (using cost of sales)
108 days
Gearing (see note (iii) above)
35·3%
Interest cover
6 times
Dividend cover
3·6 times
Required:
(a)
Calculate for Merlot the ratios equivalent to all those given for Grappa above.
(8 marks)
(b)
Assess the relative performance and financial position of Grappa and Merlot for
the year ended 30 September 2012 to inform the directors of Victular in their
acquisition decision.
(12 marks)
(c)
Explain the limitations of ratio analysis and any further information that may be
useful to the directors of Victular when making an acquisition decision. (5 marks)
(Total: 25 marks)
89
Hardy
Hardy is a public listed manufacturing company. Its summarised financial statements
for the year ended 30 September 2010 (and 2009 comparatives) are:
Income statements for the year ended 30 September:
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Investment income
Finance costs
Profit (loss) before taxation
Income tax (expense) relief
Profit (loss) for the year
© Emile Woolf Publishing Limited
2010
$’000
29,500
(25,500)
–––––––
4,000
(1,050)
(4,900)
50
(600)
–––––––
(2,500)
400
–––––––
(2,100)
–––––––
2009
$’000
36,000
(26,000)
–––––––
10,000
(800)
(3,900)
200
(500)
–––––––
5,000
(1,500)
–––––––
3,500
–––––––
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Paper F7: Financial Reporting (International)
Statements of financial position as at 30 September:
Assets
Non-current assets
Property, plant and equipment
Investments at fair value through profit or loss
Current assets
Inventory and work-in-progress
Trade receivables
Tax asset
Bank
Total assets
Equity and liabilities
Equity
Equity shares of $1 each
Share premium
Revaluation reserve
Retained earnings
Non-current liabilities
Bank loan
Deferred tax
Current liabilities
Trade payables
Current tax payable
$’000
2010
$’000
$’000
17,600
2,400
–––––––
20,000
2009
$’000
24,500
4,000
–––––––
28,500
2,200
1,900
2,200
2,800
600
nil
1,200
6,200
100
4,800
–––––– ––––––– –––––– –––––––
26,200
33,300
–––––––
–––––––
13,000
1,000
nil
3,600
–––––––
17,600
12,000
nil
4,500
6,500
–––––––
23,000
4,000
1,200
5,000
700
3,400
2,800
nil
3,400
1,800
4,600
–––––– ––––––– –––––– –––––––
Total equity and liabilities
26,200
33,300
–––––––
–––––––
The following information has been obtained from the Chairman’s Statement and the
notes to the financial statements:
‘Market conditions during the year ended 30 September 2010 proved very challenging
due largely to difficulties in the global economy as a result of a sharp recession which
has led to steep falls in share prices and property values.
Hardy has not been immune from these effects and our properties have suffered
impairment losses of $6 million in the year.’
The excess of these losses over previous surpluses has led to a charge to cost of sales of
$1·5 million in addition to the normal depreciation charge.
‘Our portfolio of investments at fair value through profit or loss has been ‘marked to
market’ (fair valued) resulting in a loss of $1·6 million (included in administrative
expenses).’
There were no additions to or disposals of non-current assets during the year.
‘In response to the downturn the company has unfortunately had to make a number of
employees redundant incurring severance costs of $1·3million (included in cost of
sales) and undertaken cost savings in advertising and other administrative expenses.’
128
© Emile Woolf Publishing Limited
Section 1: Practice questions
‘The difficulty in the credit markets has meant that the finance cost of our variable rate
bank loan has increased from 4·5% to 8%. In order to help cash flows, the company
made a rights issue during the year and reduced the dividend per share by 50%.’
‘Despite the above events and associated costs, the Board believes the company’s
underlying performance has been quite resilient in these difficult times.’
Required:
Analyse and discuss the financial performance and position of Hardy as portrayed by
the above financial statements and the additional information provided.
Your analysis should be supported by profitability, liquidity and gearing and other
appropriate ratios (up to 10 marks available).
(25 marks)
© Emile Woolf Publishing Limited
129
Paper F7: Financial Reporting (International)
130
© Emile Woolf Publishing Limited
SECTION 2
Paper F7 (INT)
Financial Reporting
Q&A
Answers to practice
questions
A conceptual framework and regulatory framework for
financial reporting
1
Recost
(a)
The main drawback of the use of historical cost accounts for assessing the
performance of a business is that they do not take into account the current values
of assets and, to a lesser extent, liabilities. This can become a serious problem
and give misleading information when either specific or general price inflation
rates are considered to be high. The effect is that many of the values of the assets
in the statement of financial position are understated, and, partly because of
related depreciation, profits tend to be overstated. More detailed criticisms of
historical cost accounts during a period of rising prices are:
Effects on the statement of financial position
(i)
Most non-current assets can be considerably understated in terms of their
current worth. The most affected assets tend to be land and buildings,
investments and some plant.
(ii)
In general net current assets tend not to be affected by inflation mainly
because they are monetary in nature. The possible exception is trading
inventories.
(iii)
Liabilities tend to be ignored when current values are discussed. This may
be an error because, for example, a long term loan carrying a fixed rate of
interest, may have a current value that is considerably different to when it
was taken out (ignoring the possibility of any repayments). This is because
current interest rates may have changed (often as a reaction to levels of
inflation) since the loan was originally taken out.
(iv)
If the net assets are understated, then so too are shareholders’ funds.
© Emile Woolf Publishing Limited
131
Paper F7: Financial Reporting (International)
Effects on the income statement
Many costs tend to be understated in terms of their current value. Where this
occurs it means the profit is overstated in as much as the use of lower costs leads
to a higher profit. Many commentators argue that pure historical cost profits are
made up of a current operating profit (see below) plus inflationary gains relating
to the:
„
costs of goods sold (both purchased and manufactured). This can be
mitigated, but not completely removed, by the use of LIFO, however this is
not common practice in many countries and is now prohibited by IAS
2Inventories.
„
depreciation charges for non-current assets. In historic cost accounts these
are based on historical values rather than current values, and therefore
understate the values of the assets that have been used (consumed) during
the period.
„
some methods of accounting for inflation include monetary working capital
and/or ‘gearing’ adjustments to historical cost profits. These are intended
to reflect the inflation effects of holding net monetary working capital and
debt.
The above combined effects lead to the following criticisms and limitations of the
use of historic cost accounts to assess a business’s performance:
Lack of comparability
It may be invalid to compare the results of two companies. One company may
have assets that are relatively old (and of lower cost) whereas another company
may have similar, but more recently purchased (and of higher cost) assets. In
effect such companies would have a similar operating capacity, but it would be
recorded at different values. This situation can also be found within a single
company that has operating divisions with similar characteristics to the above
scenario. Management may assess their relative performance using historical
costs (which would be an invalid basis) to make decisions relating to future
investment or even closure.
There is also a lack of comparability between a company’s current year’s results
and those of previous years i.e. trend analysis may be distorted.
Conceptual inconsistency
Accounting theorists sometimes argue that historical cost accounts are not
internally consistent because they are in fact ‘mixed value’ accounts. This means
that some historical costs are at current values, whereas other historical costs are
at out-of-date values. Thus current values, of say sales revenues, are being
matched with out-of-date values such as depreciation relating to older assets.
Many important ratios which are calculated as a basis for interpreting and
assessing company performance can be distorted by inflation. Important
examples are: return on capital employed, profit margins, many asset turnover
ratios, gearing levels and earnings per share.
The misleading effects of the above on different users
Investors may find it difficult to compare the results of different companies as a
basis for investment decisions. A shareholder may be tempted to accept a low
bid for his shares if weight is given to the asset backing, based on carrying
values, of the shares. Dividends may seem low in relation to reported profits,
132
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Section 2: Answers to practice questions
this may be because management is recommending dividends based on a current
operating profit.
Employees may make high wage demands based on reported profit rather than
current operating profits.
Governments generally tax reported profits which means companies pay tax on
higher, inflation boosted, profits.
(b)
The advantages and criticisms of Current Cost Accounting are set out below:
Current cost accounting principles, from a conceptual point of view, are more
soundly based and therefore more difficult to criticise than GPP accounts. They
correct most of the limitations (that are due to increased price changes) of
historical cost accounts. They reflect the current values (which is not necessarily
the current costs) of a company’s specific assets. The reported current operating
profit is considered to be more relevant to many decisions such as dividend
distribution, employee wage claims and even as a basis for taxation.
The problems of CCA lie in their preparation and understanding. In practical
terms it can be very difficult to determine the current value of assets, and many
alternative forms of current value exist e.g. replacement cost, realisable value and
value in use. Methods of determining current costs include the use of
manufacturers’ price lists for plant and inventory, professional revaluation of
assets e.g. land and buildings and the use of specific price indexes published by
government agencies. Whatever method is used it is often subjective and
sometimes complex. This makes the cost of the preparation and audit of current
cost accounts expensive.
2
Worthright
(a)
Importance of the definitions:
The definitions of assets and liabilities are fundamental to the IASB’s Conceptual
Framework. Apart from forming the obvious basis for the preparation of a
statement of financial position, they are also the two elements of financial
statements that are used to derive the other elements. Equity (ownership)
interest is the residue of assets less liabilities. Gains and losses are changes in
ownership interests, other than contributions from, and distributions to, the
owners. In effect, a gain is an increase in an asset or a reduction of a liability
whereas a loss is the reverse of this. Transactions with owners are defined in a
straightforward manner in order to exclude them from the definitions of gains
and losses.
Assets:
The IASB Conceptual Framework defines assets as ‘a resource controlled by an
entity as a result of past events and from which future economic benefits are
expected to flow to the entity’. The first part of the definition ‘a resource
controlled by an entity’ is a refinement of the principle that an asset must be
owned by the entity. This refinement allows assets that are not legally owned by
an entity, but over which the entity has the rights that are normally conveyed by
ownership, such as the right to use or occupy an asset, to be recognised as an
asset of the entity. The essence of this approach is that an asset is not the physical
item that one might expect it to be such as a machine or a building, but it is the
right to enjoy the future economic benefits that the asset will produce (normally
future cash flows). Perhaps the best known example of this type of arrangement
© Emile Woolf Publishing Limited
133
Paper F7: Financial Reporting (International)
is a finance lease or asset being bought under a hire purchase agreement.
Control not only allows the entity to obtain the economic benefits of assets but
also to restrict the access of others to them. Where an entity develops an
alternative manufacturing process that reduces future cash outflows in terms of
lower cost of production, this too can be an asset. Assets can also arise where
there is no legal control. The Conceptual Framework cites the example of ‘knowhow’ derived from a development activity. Where an entity has the capacity to
keep this a secret, the entity controls the benefits that are expected to flow from
it.
Other definitions of an asset refer to future economic benefits being ‘probable’.
This wording recognises that all future economic benefits are subject to some
degree of risk or uncertainty. The IASB deals with the ‘probable’ issue by saying
that future economic benefits are only ‘expected’ and therefore need not be
certain.
The reference to past events makes it clear that transactions arising after the
reporting period that may lead to economic benefits cannot be treated as assets.
The use of the word ‘events’ in this part of the definition recognises that it is not
only transactions that can create assets or liabilities (see below), but other events
such as ‘legal wrongs’ which may lead to damages claims. This aspect of the
definition does cause some problems. For example, it could be argued that
signing a profitable contract before the end of the reporting period is an ‘event’
that gives rise to a future economic benefit. It is widely held that the justification
for not recognising future profitable contracts as assets is that the rights and
obligations under these contracts are equal (which is unlikely to be true) and also
that the historical cost of ‘signing’ them is zero.
Liabilities:
The IASB defines liabilities as ‘a present obligation of the entity arising from past
events which is expected to result in an outflow from the entity of resources
embodying economic benefits’. The IASB stress that the essential characteristic is
the ‘present obligation’. Although the definition is complementary to that of
assets, it is perceived as less controversial. Most components of the definition
have the same meaning e.g. the terms ‘economic benefits’ and ‘past events’. Most
liabilities are legal or contractual obligations to transfer known amounts of cash
e.g. trade payables and loans. Occasionally they may be settled other than for
cash such as in a barter transaction, but this still constitutes transferring
economic benefits. It is necessary to consider the principles and definitions in
The Conceptual Framework alongside those of IAS 37 Provisions, Contingent
Liabilities and Contingent Assets. Within the Conceptual Framework the IASB
introduces the concept of obligations arising from ‘normal business practice’
being liabilities. One such example is rectifying faults in goods sold even when
the warranty period has expired. IAS 37 explores this principle more fully and
refers to them as ‘constructive’ obligations. These occur where an entity creates a
valid expectation that it will discharge responsibilities that it is not legally
obliged to. This is usually as a result of past behaviour, or by commitments
given in a published statement (e.g. voluntarily incurring environmental costs).
Where the exact amount of a liability is uncertain it is usually referred to as a
provision.
Obligations may exist that are not expected to require ‘transfers of economic
benefits’. These again are described in IAS 37 and are more generally known as
134
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Section 2: Answers to practice questions
contingent liabilities. For example, where a holding company guarantees a
subsidiary’s loan.
Similar to assets, costs to be incurred in the future do not represent liabilities.
This is because either the entity has the ability to avoid the costs, or if it cannot
(e.g. where a contract exists), then incurring the cost would be matched by
receiving an asset of equal value.
(b)
An issue with research and development costs is whether they are an asset or an
expense. If they result in future economic benefits, they are assets; if not, they are
expenses. Unfortunately the resolution to the question whether development
costs are an asset lies in the future and is therefore unknown. Since most
development projects do not result in a profitable project, , most research and
development costs are not an asset.
In the case of the development expenditure of Worthright it appears that it may
satisfy the criteria in IAS 38 Intangible Assets to be treated as an intangible asset,
particularly in view of its impressive track record on development projects. More
details would have to be obtained in order to determine whether the expenditure
does qualify as an asset. If it does the company’s existing policy would not be
permitted under IAS 38, as this says that if the recognition criteria are met, the
expenditure should be capitalised. It does not offer a choice.
The above only applies to Worthright’s own development costs. The company
also performs research and development for clients and here the case is different.
Although it is conducting research and development, it is in fact work in
progress. The costs of this research and development should be matched with
the revenues it will bring. To the extent it has been invoiced to clients, it will
appear as cost of sales in the income statement (not as research and
development). Any unbilled costs should appear as a current asset under work
in progress.
3
Revenue recognition
(a)
The IASB Conceptual Framework advocates that revenue recognition issues are
resolved within the definition of assets (gains) and liabilities (losses). Gains
include all forms of income and revenue as well as gains on non-revenue items.
Gains and losses are defined as increases or decreases in net assets other than
those resulting from transactions with owners. Thus in its Conceptual
Framework, the IASB takes a ‘statement of financial position approach’ to
defining revenue (i.e. an approach based on the statement of financial position)..
In effect a recognisable increase in an asset results in a gain. The more traditional
view, which is largely the basis used in IAS 18 Revenue, is that (net) revenue
recognition is part of a transactions based accruals or matching process with the
statement of financial position recording any residual assets or liabilities such as
receivables and payables. The issue of revenue recognition arises out of the need
to report company performance for specific periods. The Conceptual Framework
identifies three stages in the recognition of assets (and liabilities): initial
recognition, when an item first meets the definition of an asset; subsequent remeasurement, which may involve changing the value (with a corresponding
effect on income) of a recognised item; and possible derecognition, where an
item no longer meets the definition of an asset. For many simple transactions
both the Conceptual Framework’s approach and the traditional approach (IAS
18) will result in the same profit (net income). If an item of inventory is bought
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for $100 and sold for $150, net assets have increased by $50 and the increase
would be reported as a profit. The same figure would be reported under the
traditional transactions based reporting (sales of $150 less cost of sales of $100).
However, in more complex areas the two approaches can produce different
results. An example of this would be deferred income. If a company received a
fee for a 12 month tuition course in advance, IAS 18 would treat this as deferred
income (in the statement of financial position) and release it to income as the
tuition is provided and matched with the cost of providing the tuition. Thus the
profit would be spread (accrued) over the period of the course. If an
asset/liability approach were taken, then the only liability the company would
have after the receipt of the fee would be for the cost of providing the course. If
only this liability is recognised in the statement of financial position, the whole of
the profit on the course would be recognised on receipt of the income. This is not
a prudent approach and has led to criticism of the IASB Conceptual Framework
for this very reason. Other standards that may be in conflict with the Conceptual
Framework are the use of the accretion approach in IAS 11 Construction Contracts
and a deferred tax liability in IAS 12 Income Taxes may not fully meet the
Conceptual Framework’s definition of a liability.
The principle of substance over form should also be applied to revenue
recognition. An example of where this can impact on reporting practice is on sale
and repurchase agreements. Companies sometimes ‘sell’ assets to another
company with the right to buy them back on predetermined terms that will
almost certainly mean that they will be repurchased in the future. In substance
this type of arrangement is a secured loan and the ‘sale’ should not be treated as
revenue. A less controversial area of the application of substance in relation to
revenue recognition is with agency sales. IAS 18 says, where a company sells
goods acting as an agent, those sales should not be treated as sales of the agent,
instead only the commission from the sales is income of the agent.
(b)
136
(i)
The IASB Conceptual Framework defines liabilities as obligations to
transfer economic benefits as a result of past transactions. Such transfers of
economic benefits are to third parties and normally as cash payments.
Traditionally and in compliance with IAS 20, capital-based government
grants are treated as deferred credits and spread over the life of the related
assets. This is the application of the matching concept. A strict
interpretation of the Conceptual Framework would not normally allow
deferred credits to be treated as liabilities as there is usually no obligation
to transfer economic benefits. In this particular example the only liability
that may occur in respect of the grant would be if Derringdo were to sell
the related asset within four years of its purchase. A possible argument
would be that the grant should be treated as a reducing liability (in relation
to a potential repayment) over the four-year claw back period. On closer
consideration this would not be appropriate. The repayment would only
occur if the asset were sold, thus it is potentially a contingent liability. As
Derringdo has no intention to sell the asset there is no reason to believe that
the repayment will occur, thus it is not a reportable contingent liability. The
implication of this is that the company’s policy for the government grant
does not comply with the definition of a liability in the Conceptual
Framework. Applying the guidance in the Conceptual Framework would
require the whole of the grant to be included in income as it is ‘earned’ i.e.
in the year of receipt.
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(ii)
Treatment under the company’s policy
Income statement extract year to 31 March 2012
Depreciation – plant ((800,000 – 120,000 estimated
residual value)/10 years × 6/12)
Government grant ((800,000 × 30%)/10 years × 6/12)
$
Dr 34,000
Cr 12,000
Statement of financial position extracts as at 31 March 2012
Non-current assets:
$
Plant at cost
800,000
Accumulated depreciation
(34,000)
――――
766,000
――――
Current liabilities:
Government grant (240,000/10 years)
24,000
Non-current liabilities:
Government grant (240,000 – 12,000 – 24,000)
204,000
Treatment under the IASB Conceptual Framework
Income statement extract year to 31 March 2012
Depreciation – plant
((800,000 – 120,000 estimated residual value) /10 years × 6/12)
Government grant (whole amount)
$
Dr 34,000
Cr 240,000
Statement of financial position extracts as at 31 March 2012
Non-current assets:
$
Plant at cost
800,000
Accumulated depreciation
(34,000)
766,000
4
Angelino
(a)
Most forms of off statement of financial position financing have the effect of what
is, in substance, debt finance either not appearing on the statement of financial
position at all or being netted off against related assets such that it is not
classified as debt. Common examples would be structuring a lease such that it
fell to be treated as an operating lease when it has the characteristics of a finance
lease, complex financial instruments classified as equity when they may have, at
least in part, the substance of debt and ‘controlled’ entities having large
borrowings (used to benefit the group as a whole), that are not consolidated
because the financial structure avoids the entities meeting the definition of a
subsidiary.
The main problem of off statement of financial position finance is that it results in
financial statements that do not faithfully represent the transactions and events
that have taken place. Faithful representation is an important qualitative
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characteristic of useful information (as described in the Conceptual Framework).
Financial statements that do not faithfully represent that which they purport to
lack reliability. A lack of reliability may mean that any decisions made on the
basis of the information contained in financial statements are likely to be
incorrect or, at best, suboptimal.
The level of debt on a statement of financial position is a direct contributor to the
calculation of an entity’s statement of financial position gearing, which is
considered as one of the most important financial ratios. It should be understood
that, to a point, the use of debt financing is perfectly acceptable. Where statement
of financial position gearing is considered low, borrowing is relatively
inexpensive, often tax efficient and can lead to higher returns to shareholders.
However, when the level of borrowings becomes high, it increases risk in many
ways. Off statement of financial position financing may lead to a breach of loan
covenants (a serious situation) if such debt were to be recognised on the
statement of financial position in accordance with its substance.
High gearing is a particular issue to equity investors. Equity (ordinary shares) is
sometimes described as residual return capital. This description identifies the
dangers (to equity holders) when an entity has high gearing. The dividend that
the equity shareholders might expect is often based on the level of reported
profits. The finance cost of debt acts as a reduction of the profits available for
dividends. As the level of debt increases, higher interest rates are also usually
payable to reflect the additional risk borne by the lender, thus the higher the debt
the greater the finance charges and the lower the profit. Many off statement of
financial position finance schemes also disguise or hide the true finance cost
which makes it difficult for equity investors to assess the amount of profits that
will be needed to finance the debt and consequently how much profit will be
available to equity investors. Furthermore, if the market believes or suspects an
entity is involved in ‘creative accounting’ (and off statement of financial position
finance is a common example of this) it may adversely affect the entity’s share
price.
An entity’s level of gearing will also influence any decision to provide further
debt finance (loans) to the entity. Lenders will consider the nature and value of
the assets that an entity owns which may be provided as security for the
borrowings. The presence of existing debt will generally increase the risk of
default of interest and capital repayments (on further borrowings) and existing
lenders may have a prior charge on assets available as security. In simple terms if
an entity has high borrowings, additional borrowing is more risky and
consequently more expensive. A prospective lender to an entity that already has
high borrowings, but which do not appear on the statement of financial position
is likely to make the wrong decision. If the correct level of borrowings were
apparent, either the lender would not make the loan at all (too high a lending
risk) or, if it did make the loan, it would be on substantially different terms (e.g.
charge a higher interest rate) so as to reflect the real risk of the loan.
Some forms of off statement of financial position financing may specifically
mislead suppliers that offer credit. It is a natural precaution that a prospective
supplier will consider the statement of financial position strength and liquidity
ratios of the prospective customer. The existence of consignment inventories may
be particularly relevant to trade suppliers. Sometimes consignment inventories
and their related current liabilities are not recorded on the statement of financial
position as the wording of the purchase agreement may be such that the legal
138
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Section 2: Answers to practice questions
ownership of the goods remains with the supplier until specified events occur
(often the onward sale of the goods). This means that other suppliers cannot
accurately assess an entity’s true level of trade payables and consequently the
average payment period to suppliers, both of which are important determinants
in deciding whether to grant credit.
(b)
(i)
Debt factoring is a common method of entities releasing the liquidity of
their trade receivables. The accounting issue that needs to be decided is
whether the trade receivables have been sold, or whether the income from
the finance house for their ‘sale’ should be treated as a short term loan. The
main substance issue with this type of transaction is to identify which party
bears the risks (i.e. of slow and non-payment by the customer) relating to
the asset. If the risk lies with the finance house (Omar), the trade
receivables should be removed from the statement of financial position
(derecognised in accordance with IAS 39). In this case it is clear that
Angelino still bears the risk relating to slow and non-payment. The residual
payment by Omar depends on how quickly the receivables are collected;
the longer it takes, the less the residual payment (this imputes a finance
cost). Any balance uncollected by Omar after six months will be refunded
by Angelino which reflects the non-payment risk.
Thus the correct accounting treatment for this transaction is that the cash
received from Omar (80% of the selected receivables) should be treated as a
current liability (a short term loan) and the difference between the gross
trade receivables and the amount ultimately received from Omar (plus any
amounts directly from the credit customers themselves) should be charged
to the income statement. The classification of the charge is likely to be a
mixture of administrative expenses (for Omar collecting receivables),
finance expenses (reflecting the time taken to collect the receivables) and
the impairment of trade receivables (bad debts).
(ii)
This is an example of a sale and leaseback of a property. Such transactions
are part of normal commercial activity, often being used as a way to
improve cash flow and liquidity. However, if an asset is sold at an amount
that is different to its fair value there is likely to be an underlying reason for
this. In this case it appears (based on the opinion of the auditor) that Finaid
has paid Angelino $2 million more than the building is worth. No
(unconnected) company would do this knowingly without there being
some form of ‘compensating’ transaction. This sale is ‘linked’ to the five
year rental agreement. The question indicates the rent too is not at a fair
value, being $500,000 per annum ($1,300,000 – $800,000) above what a
commercial rent for a similar building would be.
It now becomes clear that the excess purchase consideration of $2 million is
an ‘in substance’ loan (rather than sales proceeds – the legal form) which is
being repaid through the excess ($500,000 per annum) of the rentals.
Although this is a sale and leaseback transaction, as the building is freehold
and has an estimated remaining life (20 years) that is much longer than the
five year leaseback period, the lease is not a finance lease and the building
should be treated as sold and thus derecognised.
The correct treatment for this item is that the sale of the building should be
recorded at its fair value of $10 million, thus the profit on disposal would
be $2·5 million ($10 million – $7·5 million). The ‘excess’ of $2 million ($12
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Paper F7: Financial Reporting (International)
million – $10 million) should be treated as a loan (non-current liability).
The rental payment of $1·3 million should be split into three elements;
$800,000 building rental cost, $200,000 finance cost (10% of $2 million) and
the remaining$300,000 is a capital repayment of the loan.
(iii)
The treatment of consignment inventory depends on the substance of the
arrangements between the manufacturer and the dealer (Angelino). The
main issue is to determine if and at what point in time the cars are ’sold’.
The substance is determined by analysing which parties bear the risks (e.g.
slow moving/obsolete inventories, finance costs) and receive the benefits
(e.g. use of inventories, potential for higher sales, protection from price
increases) associated with the transaction.
Supplies from Monza
Angelino has, and has actually exercised, the right to return the cars
without penalty (or been required by Monza to transfer them to another
dealer), which would indicate that it has not ‘bought’ the cars. There are no
finance costs incurred by Angelino, however Angelino would suffer from
any price increases that occurred during the three month holding/display
period. These factors seem to indicate that the substance of this
arrangement is the same as its legal form i.e. Monza should include the cars
in its statement of financial position as inventory and therefore Angelino
will not record a purchase transaction until it becomes obliged to pay for
the cars (three months after delivery or until sold to customers if sooner).
Supplies from Capri
Although this arrangement seems similar to the above, there are several
important differences. Angelino is bearing the finance costs of 1% per
month (calling it a display charge is a distraction). The option to return the
cars should be ignored because it is not likely to be exercised due to
commercial penalties (payment of transport costs and loss of deposit).
Finally the purchase price is fixed at the date of delivery rather than at the
end of six months. These factors strongly indicate that Angelino bears the
risks and rewards associated with ownership and should recognise the
inventory and the associated liability in its financial statements at the date
of delivery.
5
Emerald
(a)
140
The Conceptual Framework defines an asset as a resource controlled by an entity
as a result of past transactions or events from which future economic benefits
(normally net cash inflows) are expected to flow to the entity. However assets
can only be recognised (on the statement of financial position) when those
expected benefits are probable and can be measured reliably. The Conceptual
Framework recognises that there is a close relationship between incurring
expenditure and generating assets, but they do not necessarily coincide.
Development expenditure, perhaps more than any other form of expenditure, is a
classic example of the relationship between expenditure and creating an asset.
Clearly entities commit to expenditure on both research and development in the
hope that it will lead to a profitable product, process or service, but at the time
that the expenditure is being incurred, entities cannot be certain (or it may not
even be probable) that the project will be successful. Relating this to accounting
concepts would mean that if there is doubt that a project will be successful the
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
application of prudence would dictate that the expenditure is charged (expensed)
to the income statement. At the stage where management becomes confident that
the project will be successful, it meets the definition of an asset and the
accruals/matching concept would mean that it should be capitalised (treated as
an asset) and amortised over the period of the expected benefits. Accounting
Standards (IAS 38 Intangible Assets) interpret this as writing off all research
expenditure and only capitalising development costs from the point in time
where they meet strict conditions which effectively mean the expenditure meets
the definition of an asset.
(b)
Emerald Income statement:
Amortisation of development expenditure
Statement of financial position
Development expenditure
30 September
2012
$’000
335 (w (ii))
30 September
2011
$’000
135
(w (i))
1,195 (w (iv))
1,130
(w (iii))
Statement of changes in equity
Prior period adjustment (credit required to restate retained earnings at 1 October
2010) (cumulative carrying amount at 2010 of 300 + 165)
465
Workings (All figures in $’000. Note: references to 2009, 2010 etc should be taken
as for the year ended 30 September
Year
Expenditure
Amortisation
(25%)
Total amortisation
Carrying amount
6
2009
300
––––
2010
240
––––
2011 cumulative 2011
1,340
800
––––
––––––
2012 cumulative 2012
400
1,740
––––
––––––
nil
nil
nil
––––
(75)
nil
nil
––––
(75)
(60)
nil
––––
(150)
(60)
nil
––––––
(75)
(60)
(200)
––––
(225)
(120)
(200)
––––––
nil
––––
300
––––
(75) (w (i))
––––
165
––––
(135)
––––
665 (w (iii))
––––
(210) (w (ii))
––––––
1,130
––––––
(335)
––––
65 (w (iv))
––––
(545)
––––––
1,195
––––––
Conceptual Framework
(a)
The accruals basis requires transactions (or events) to be recognised when they
occur (rather than on a cash flow basis). Revenue is recognised when it is earned
(rather than when it is received) and expenses are recognised when they are
incurred (i.e. when the entity has received the benefit from them), rather than
when they are paid.
Recording the substance of transactions (and other events) requires them to be
treated in accordance with economic reality or their commercial intent rather
than in accordance with the way they may be legally constructed. This is an
important element of faithful representation.
Prudence is used where there are elements of uncertainty surrounding
transactions or events. Prudence requires the exercise of a degree of caution
when making judgements or estimates under conditions of uncertainty. Thus
when estimating the expected life of a newly acquired asset, if we have past
experience of the use of similar assets and they had had lives of (say) between
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five and eight years, it would be prudent to use an estimated life of five years for
the new asset.
Comparability is fundamental to assessing the performance of an entity by using
its financial statements. Assessing the performance of an entity over time (trend
analysis) requires that the financial statements used have been prepared on a
comparable (consistent) basis. Generally this can be interpreted as using
consistent accounting policies (unless a change is required to show a fairer
presentation). A similar principle is relevant to comparing one entity with
another; however it is more difficult to achieve consistent accounting policies
across entities.
Information is material if its omission or misstatement could influence
(economic) decisions of users based on the reported financial statements. Clearly
an important aspect of materiality is the (monetary) size of a transaction, but in
addition the nature of the item can also determine that it is material. For example
the monetary results of a new activity may be small, but reporting them could be
material to any assessment of what it may achieve in the future. Materiality is
considered to be a threshold quality, meaning that information should only be
reported if it is considered material. Too much detailed (and implicitly
immaterial) reporting of (small) items may confuse or distract users.
(b)
Accounting for inventory, by adjusting purchases for opening and closing
inventories is a classic example of the application of the accruals principle
whereby revenues earned are matched with costs incurred. Closing inventory is
by definition an example of goods that have been purchased, but not yet
consumed. In other words the entity has not yet had the ‘benefit’ (i.e. the sales
revenue they will generate) from the closing inventory; therefore the cost of the
closing inventory should not be charged to the current year’s income statement.
Consignment inventory is where goods are supplied (usually by a manufacturer)
to a retailer under terms which mean the legal title to the goods remains with the
supplier until a specified event (say payment in three months time). Once the
goods have been transferred to the retailer, normally the risks and rewards
relating to those goods then lie with the retailer. Where this is the case then (in
substance) the consignment inventory meets the definition of an asset and the
goods should appear as such (inventory) on the retailer’s statement of financial
position (along with the associated liability to pay for them) rather than on the
statement of financial position of the manufacturer.
At the year end, the value of an entity’s closing inventory is, by its nature,
uncertain. In the next accounting period it may be sold at a profit or a loss.
Accounting standards require inventory to be valued at the lower of cost and net
realisable value. This is the application of prudence. If the inventory is expected
to sell at a profit, the profit is deferred (by valuing inventory at cost) until it is
actually sold. However, if the goods are expected to sell for a (net) loss, then that
loss must be recognised immediately by valuing the inventory at its net realisable
value.
There are many acceptable ways of valuing inventory (e.g. average cost or FIFO).
In order to meet the requirement of comparability, an entity should decide on the
most appropriate valuation method for its inventory and then be consistent in the
use of that method. Any change in the method of valuing (or accounting for)
inventory would break the principle of comparability.
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For most businesses inventories are a material item. An error (omission or
misstatement) in the value or treatment of inventory has the potential to affect
decisions users may make in relation to financial statements. Therefore
(correctly) accounting for inventory is a material event. Conversely there are
occasions where on the grounds of immateriality certain ‘inventories’ are not
(strictly) accounted for correctly. For example, at the year end a company may
have an unused supply of stationery. Technically this is inventory, but in most
cases companies would charge this ‘inventory’ of stationery to the income
statement of the year in which it was purchased rather than show it as an asset.
Note: other suitable examples would be acceptable.
7
Promoil
(a)
A liability is a present obligation of an entity arising from past events, the
settlement of which is expected to result in an outflow of economic benefits
(normally cash). Provisions are defined as liabilities of uncertain timing or
amount, i.e. they are normally estimates. In essence provisions should be
recognised if they meet the definition of a liability. Equally they should not be
recognised if they do not meet the definition. A statement of financial position
would not give a ‘fair representation’ if it did not include all of an entity’s
liabilities (or if it did include, as liabilities, items that were not liabilities). These
definitions benefit the reliability of financial statements by preventing profits
from being ‘smoothed’ by making a provision to reduce profit in years when they
are high and releasing those provisions to increase profit in years when they are
low. It also means that the statement of financial position cannot avoid the
immediate recognition of long-term liabilities (such as environmental provisions)
on the basis that those liabilities have not matured.
(b)
(i)
Future costs associated with the acquisition/construction and use of noncurrent assets, such as the environmental costs in this case, should be
treated as a liability as soon as they become unavoidable. For Promoil this
would be at the same time as the platform is acquired and brought into use.
The provision is for the present value of the expected costs and this same
amount is treated as part of the cost of the asset. The provision is
‘unwound’ by charging a finance cost to the income statement each year
and increasing the provision by the finance cost. Annual depreciation of the
asset effectively allocates the (discounted) environmental costs over the life
of the asset.
Income statement for the year ended 30 September 2012
Depreciation (see below)
Finance costs ($6·9 million x 8%)
Statement of financial position as at 30 September 2012
Non-current assets
Cost ($30 million + $6·9 million ($15 million x 0·46))
Depreciation (over 10 years)
Non-current liabilities
$’000
3,690
552
36,900
(3,690)
–––––––
33,210
–––––––
Environmental provision ($6·9 million x 1·08) 7,452
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(ii)
If there was no legal requirement to incur the environmental costs, then
Promoil should not provide for them as they do not meet the definition of a
liability. Thus the oil platform would be recorded at $30 million with $3
million depreciation and there would be no finance costs.
However, if Promoil has a published policy that it will voluntarily incur
environmental clean up costs of this type (or if this may be implied by its
past practice), then this would be evidence of a ‘constructive’ obligation
under IAS 37 and the required treatment of the costs would be the same as
in part (i) above.
8
Wardle
(a)
For financial statements to be of value to their users they must possess certain
characteristics; reliability is one such important characteristic. In order for
financial statements to be reliable, they must faithfully represent an entity’s
underlying transactions and other events. For financial statements to achieve
faithful representation, transactions must be accounted for and presented in
accordance with their substance and economic reality where this differs from
their legal form. For example, if an entity ‘sold’ an asset to a third party, but
continued to enjoy the future benefits embodied in that asset, then this
transaction would not be represented faithfully by recording it as a sale (in all
probability this would be a financing transaction).
The features that may indicate that the substance of a transaction is different
from its legal form are:
– where the control of an asset differs from the ownership of the asset
– where assets are ‘sold’ at prices that are greater or less than their fair values
– the use of options as part of an agreement
– where there are a series of ‘linked’ transactions.
It should be noted that none of the above necessarily mean there is a difference
between substance and legal form.
(b)
Extracts from the income statements
(i)
reflecting the legal form:
Year ended:
Revenue
Cost of sales
Gross profit
Finance costs
Net profit
144
31 March 2010
31 March 2011 31 March 2012 Total
$’000
$’000
$’000
$’000
6,000
nil
10,000
16,000
(5,000)
––––––
1,000
nil
–––
nil
(7,986)
–––––––
2,014
(12,986)
–––––––
3,014
nil
––––––
1,000
––––––
nil
–––
nil
–––
nil
–––––––
2,014
–––––––
nil
–––––––
3,014
–––––––
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Section 2: Answers to practice questions
(ii)
reflecting the substance:
Year ended:
Revenue
Cost of sales
Gross profit
31 March 2010
31 March 2011 31 March 2012 Total
$’000
$’000
$’000
$’000
nil
nil
10,000
10,000
(nil)
––––––
nil
nil
–––
nil
(5,000)
–––––––
5,000
(5,000)
–––––––
5,000
Finance costs
(c)
(600)
(660)
(726)
(1,986)
––––––
–––
–––––––
–––––––
Net profit
(600)
(660)
4,274
3,014
––––––
–––
–––––––
–––––––
It can be seen from the above that the two treatments have no effect on the total
net profit reported in the income statements, however, the profit is reported in
different periods and the classification of costs is different. In effect the legal form
creates some element of profit smoothing and completely hides the financing
cost. Although not shown, the effect on the statements of financial position is that
recording the legal form of the transaction does not show the inventory, nor does
it show the in-substance loan. Thus recording the legal form would be an
example of off balance sheet (statement of financial position) financing. The effect
on an assessment of Wardle using ratio analysis may be that recording the legal
form rather than the substance of the transaction would be that interest cover and
inventory turnover would be higher and gearing lower. All of which may be
considered as reporting a more favourable performance.
Financial statements – Statements of cash flow
9
Tabba
(a)
Tabba: Statement of cash flows for the year ended 30 September 2012
$000
Cash flows from operating activities
Profit before tax
50
Adjustments for:
Depreciation (w (i))
2,200
Amortisation of government grant (w (iii))
(250)
Profit on sale of factory (w (i))
(4,600)
Increase in insurance claim provision (1,500 – 1,200)
(300)
Interest receivable
(40)
Interest expense
260
(2,680)
Working capital adjustments:
Increase in inventories (2,550 – 1,850)
(700)
Increase in trade receivables (3,100 – 2,600)
(500)
Increase in trade payables (4,050 – 2,950)
1,100
Cash outflow from operations
(2,780)
Interest paid
(260)
© Emile Woolf Publishing Limited
$000
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Paper F7: Financial Reporting (International)
Tabba: Statement of cash flows for the year ended 30 September 2012
$000
$000
Cash flows from operating activities
Income taxes paid (w (iv))
(1,350)
Net cash outflow from operating activities
(4,390)
Cash flows from investing activities
Sale of factory
Purchase of non-current assets (w (i))
Receipt of government grant (from question)
Interest received
Net cash from investing activities
Cash flows from financing activities
Issue of 6% loan notes
Redemption of 10% loan notes
Repayment of finance leases (w (ii))
Net cash from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
12,000
(2,900)
950
40
10,090
800
(4,000)
(1,100)
(4,300)
1,400
(550)
850
Tutorial note: Interest paid may also be presented as a financing activity and
interest received may be presented as an operating cash flow.
Workings (figures in $000)
(i)
Non-current assets
Cost/valuation at beginning of the year
New finance leases (from question)
Disposals in the year
20,200
1,500
(8,600)
––––––
13,100
Cost/valuation at end of the year
Therefore acquisitions during the year
Accumulated depreciation at beginning of the year
Accumulated depreciation on disposals
16,000
––––––
2,900
––––––
4,400
(1,200)
––––––
3,200
Accumulated depreciation at end of the year
Therefore depreciation charge for the year
5,400
––––––
2,200
––––––
Sale of factory
Proceeds (from question)
12,000
Net book value
(7,400)
Profit on sale
146
––––––
4,600
––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(ii)
Finance lease obligations
Balance brought forward: current
800
Balance brought forward: over 1 year
1,700
––––––
2,500
New leases (from question)
1,500
––––––
4,000
Balance carried forward: current
Balance carried forward: over 1 year
900
2,000
––––––
(2,900)
––––––
Cash repayments – balancing figure
(iii)
1,100
––––––
Government grant
Balance brought forward: current
400
Balance brought forward: over 1 year
900
––––––
1,300
Grants received in year (from question)
950
––––––
2,250
Balance carried forward: current
Balance carried forward: over 1 year
600
1,400
––––––
––––––
Difference – amortisation credited to income statement
(iv)
(2,000)
250
––––––
Taxation
Current provision brought forward
Deferred tax brought forward
1,200
500
––––––
1,700
(50)
Tax credit in income statement
––––––
1,650
Current provision carried forward
Deferred tax carried forward
Tax paid – balancing figure
(v)
––––––
(300)
––––––
1,350
––––––
Reconciliation of retained earnings
Balance b/f
Transfer from revaluation reserve
Profit for period
Balance c/f
(b)
100
200
850
1,600
100
––––––
2,550
––––––
Consideration of the statement of cash flows reveals some important information
in assessing the change in the financial position of Tabba during the year. There
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
is a huge net cash outflow from operating activities of $4,390,000 despite Tabba
reporting a small operating profit of $270,000. More detailed analysis of this
difference reveals some worrying concerns for the future.
Many companies have higher operating cash flows than their underlying
operating profit, mainly due to depreciation charges being added back to profits
to arrive at the cash flows. In Tabba’s case, operating profits have been
‘improved’ by $2.2 million during the year in terms of the underlying cash flows.
However, the major reconciling difference is the profit on the sale of Tabba’s
factory of $4.6 million. This amount has been credited in the income statement
and has dramatically distorted the operating profit. If the sale and lease back of
the factory had not taken place, Tabba’s operating profits would show losses of
$4.33 million (ignoring any possible tax effects). When Tabba publishes its
financial statements this profit will almost certainly require separate disclosure
which should make the effects of the transaction more transparent to the users of
the financial statements.
A further indication of poor operating profits is that they have been boosted by
$300,000 due to an increase in the insurance claim provision (again this is not a
cash flow) and $250,000 amortisation of government grants.
Many commentators believe that the net cash flow from operating activities is the
most important figure in the statement of cash flows. This is because it is a
measure of expected or maintainable future cash flows. In Tabba’s case this
highlights a very important point; although Tabba has increased its cash position
during the year by $1.4 million, $12 million has come from the sale of its factory.
Clearly this is a one-off transaction that cannot be repeated in future years. If the
drain on the operating cash flows continues at the current rates, the company
will not survive for very long.
The tax position: there is a small tax credit in the income statement, perhaps due
to current year trading losses, whereas the cash flow statement shows that tax of
$1.35 million has been paid during the year. This payment of tax is on what must
have been a substantial profit for the previous year. This seems to confirm the
deteriorating position of the company.
There has been a very small increase in working capital of $100,000. However,
underlying this is the fact that both inventories and trade receivables are showing
substantial increases (despite the profit deterioration), which may indicate the
presence of bad debts or obsolete inventories, and trade payables have also
increased substantially (by $1.1 million) which may be a symptom of liquidity
problems prior to the sale of the factory.
On the positive side there has been substantial investment in non-current assets
(after allowing for the sale of the factory), but even this is partly due to leasing
assets of $1.5 million (companies often lease assets when they do not have the
resources to purchase them outright) and finance from a government grant of
$950,000.
The company appears to have taken advantage of the proceeds from the sale of
the factory to redeem the expensive 10% $4 million loan note. (This has partly
been replaced by a less expensive 6% $800,000 loan note).
In conclusion the statement of cash flows reveals some interesting and worrying
issues that may indicate a worrying future for Tabba and serves as an illustration
of the importance of a statement of cash flows to the users of financial statements.
148
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
10
Boston
(a)
Boston: Statement of cash flows for the year ended 31 March 2012
$000
65
Cash flows from operating activities
Profit before tax
Adjustments for:
Depreciation of non-current assets
Loss on sale of hotel
Interest expense
$000
35
12
10
122
Working capital adjustments:
Increase in current assets (155 – 130)
Decrease in other current liabilities (115 – 108)
Cash generated from operations
Interest paid (see note)
Income tax paid
Net cash outflow from operating activities
Cash flows from investing activities
Purchase of non-current assets (see below)
Sale of non-current assets: 40 – 12
Net cash used in investing activities
Cash flows from financing activities
Issue of ordinary shares (20 + 20)
Issue of loans (65 – 40)
Net cash from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period:
Cash and cash equivalents at end of period
(25)
(7)
90
(10)
(30)
50
(123)
28
(95)
40
25
65
20
(5)
15
Tutorial note: Interest paid may also be presented as a cash flow from financing
activities.
Workings (figures in $000)
Non-current assets: carrying amount
$m
Balance b/f
332
Disposal
(40)
Depreciation for the year
(35)
257
Balance c/f
380
Cash purchases (balancing figure)
123
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(b)
Report on the financial performance of Boston for the year ended
31 March 2012
To: The Board of Boston
From:
Date:
Profitability
The most striking feature of the current year’s performance is the deterioration in
the ROCE, down from 25.6% to only 18.0%.
This represents an overall fall in profitability of 30% (= (25.6 – 18·.0)/25.6). An
examination of the other ratios shows that this is due to a decline in both profit
margins and asset utilisation. A closer look at the profit margins shows that the
decline in gross margin is relatively small (42.2% down to 41.4%), whereas the
fall in the operating profit margin is down by 2.8%, this represents a 15.7%
decline in profitability (i.e. 2.8% on 17.8%). This has been caused by increases in
operating expenses of $12m and unallocated corporate expenses of $10m. These
increases represent more than half of the net profit for the period and further
investigation into the cause of these increases should be made. The company is
generating only $1.20 of sales per $1 of net assets this year compared to a figure
of $1.40 in the previous year. This decline in asset utilisation represents a fall of
14.3% (= (1.4 – 1.2)/1.4).
Liquidity/solvency
From the limited information provided a poor current ratio of 0·9:1 in 2011 has
improved to 1·3:1 in the current year. Despite the improvement, it is still below
the accepted norm. At the same time gearing has increased from 12.8% to 15.6%.
Information from the statement of cash flows shows the company raised $65
million in new capital ($40m in equity and $25m in loans). The disproportionate
increase in the loans is the cause of the increase in gearing. However, at 15.6%
this is still not a highly-geared company. The increase in finance has been used
mainly to purchase new non-current assets, but it has also improved liquidity,
mainly by reversing an overdraft of $5 million to a bank balance in hand of $15
million.
A common feature of new investment is that there is often a delay between
making the investment and benefiting from the returns. This may be the case
with Boston, and it may be that in future years the increased investment will be
rewarded with higher returns. Another aspect of the investment that may have
caused the lower return on assets is that the investment is likely to have occurred
part way through the year (maybe even near the year end). This means that the
income statement may not include returns for a full year, whereas in future years
it will.
Segment issues
Segment information is intended to help the users to better assess the
performance of an enterprise by looking at the detailed contribution made by the
differing activities that comprise the enterprise as a whole. Referring to the
segment ratios it appears that the carpeting segment is giving the greatest
contribution to overall profitability achieving a 48.6% return on its segment
assets, whereas the equivalent return for house building is 38.1% and for hotels it
is only 16.7%. The main reason for the better return from carpeting is due to its
150
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
higher segment net profit margin of 38.9% compared to hotels at 15·4% and
house building at 28·6%. Carpeting’s higher segment net profit is in turn a
reflection of its underlying very high gross margin (66.7%). The segment net asset
turnover of the hotels (1.1 times) is also very much lower than the other two
segments (1.3 times). It seems that the hotel segment is also responsible for the
group’s fairly poor liquidity ratios (ignoring the bank balances) the segment
current liabilities are 50% greater than its current assets ($60m compared to
$40m). The opposite of this would be a more acceptable current ratio.
These figures are based on historical values. Most commentators argue that the
use of fair values is more consistent and thus provides more reliable information
on which to base assessments (they are less misleading than the use of historical
values).
If fair values are used all segments understandably show lower returns and
poorer performance (as fair values are higher than historical values), but the
figures for the hotels are proportionately much worse, falling by a half of the
historic values (as the fair values of the hotel segment are exactly double the
historical values). Fair value adjusted figures may even lead one to question the
future of the hotel activities. However, before making any conclusions an
important issue should be considered. Although the reported profit of the hotels
is poor, the market values of its segment assets have increased by a net $90
million. New net investment in hotel capital expenditure is $64 million ($104m –
$40m disposal); this leaves an increase in value of $26 million. The majority of
this appears to be from market value increases. Whilst this is not a realised profit,
it is nevertheless a significant and valuable gain (equivalent to 65% of the group
reported net profit).
Conclusion
Although the company’s overall performance has deteriorated in the current
year, it is clear that at least some areas of the business have had considerable new
investment which may take some time to produce returns. This applies to the
hotel segment in particular and may explain its poor performance, which is also
partly offset by the strong increase in the market value of its assets.
Appendix
Further segment ratios
Return on net assets at fair values (35/97 × 100%)
Asset turnover on fair values (times) (90/97)
Carpeting
Hotels
36.1%
0.9
8.3%
0.5
House
building
30.2%
1.1
Note: Workings have been shown for the figures for the carpeting segment only, the
figures for the other segments are based on similar calculations.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
11
Planter
Planter: Statement of cash flows for the year to 31 March 2012
$
Cash flows from operating activities
Net profit before interest and tax (per question)
Adjustments:
Depreciation – buildings (W1)
– plant (W2)
17,900
1,800
26,600
28,400
4,200
(2,300)
48,200
14,100
(21,800)
(4,700)
35,800
(1,400)
(10,000)
24,400
Loss on sale of plant (W1)
Profit on sale of investments (11,000 – 8,700)
Decrease in inventory (57,400 – 43,300)
Increase in receivables (50,400 – 28,600)
Decrease in payables (31,400 – 26,700)
Cash generated from operations
Interest paid (1,700 – 300 accrued)
Income tax paid (8,900 + 1,100)
Net cash from operating activities
Cash flows from investing activities
Purchase of plant (W1)
Purchase of land and buildings (W1)
Investment income
Sale of plant (W1)
Sale of investments
Net cash used in investing activities
Cash flows from financing activities
Issue of ordinary shares (W2)
Redemption of 8% loan notes
Ordinary dividend paid
Net cash used in financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at 1 April 2011
Cash and cash equivalents at 31 March 2012
$
(38,100)
(7,100)
400
7,800
11,000
(26,000)
28,000
(3,400)
(26,100)
(1,500)
(3,100)
1,200
(1,900)
Workings
(W1) Non-current assets
$
Land and buildings
Opening balance
Revaluation surplus (18,000 – 12,000)
49,200
6,000
55,200
Closing balance
Acquisitions – balancing figure
152
62,300
7,100
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$
Accumulated depreciation: opening balance
5,000
Accumulated depreciation: closing balance
6,800
Depreciation charge for year – balancing figure
1,800
$
Plant
Opening balance at cost
Disposals at cost
70,000
(23,500)
46,500
84,600
38,100
Closing balance at cost
Acquisitions – balancing figure
Accumulated depreciation: opening balance
Accumulated depreciation: disposals
22,500
(11,500)
11,000
37,600
26,600
$
12,000
(7,800)
4,200
Accumulated depreciation: closing balance
Depreciation charge for year – balancing figure
Disposal of plant:
Disposal at net book value
Sale proceeds (given in the question)
Loss on sale
(W2) Share capital and share premium
$m
25,000
2,500
27,500
50,000
22,500
Opening balance, ordinary shares
Bonus issue 1 for 10 (from share premium)
Closing balance, ordinary shares
Difference: shares issued for cash (nominal value)
Opening balance, share premium
Bonus issue
Closing balance, share premium
Increase in premium on cash issue of shares
Total cash proceeds of share issue
12
5,000
(2,500)
2,500
8,000
5,500
28,000
Casino
(a)
Casino
Statement of cash flows for the Year to 31 March 2012
$m
Cash flows from operating activities
Operating loss
Adjustments for:
© Emile Woolf Publishing Limited
$m
(32)
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Paper F7: Financial Reporting (International)
Casino
Statement of cash flows for the Year to 31 March 2012
Depreciation
– buildings (W1)
– plant (W2)
– intangibles (510 – 400)
Loss on disposal of plant (from question)
$m
12
81
110
12
215
183
70
(436)
15
(168)
(16)
(81)
(265)
Operating profit before working capital changes
Decrease in inventory (420 – 350)
Increase in trade receivables (808 – 372)
Increase in trade payables (530 – 515)
Cash generated from operations
Interest paid
Income tax paid (W3)
Net cash used in operating activities
Cash flows from investing activities
Purchase of
– land and buildings (W1)
– plant (W2)
Sale of plant (W2)
Interest received (12 – 5 + 3)
Net cash used in investing activities
Cash flows from financing activities
Issue of ordinary shares (100 + 60)
Issue of 8% variable rate loan (160 – 2 issue costs)
Repayments of 12% loan (150 + 6 penalty)
Dividends paid
Net cash from financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period (120 + 75)
Cash and cash equivalents at end of period (125 – (32 + 15))
$m
(110)
(60)
15
10
(145)
160
158
(156)
(25)
137
(273)
195
(78)
Interest and dividends received and paid may be shown as operating cash flows
or as investing or financing activities as appropriate.
Workings (in $ million)
(W1) Land and buildings
Net book value b/f
420
Revaluation gains
70
Depreciation for year
154
(12)
Net book value c/f
(588)
Difference is cash purchases
(110)
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(W2) Plant:
Cost b/f
Additions from question
Balance c/f
Difference is cost of disposal
Loss on disposal
Proceeds
Difference accumulated depreciation of plant disposed of
445
60
(440)
65
(12)
(15)
38
Depreciation b/f
Less – disposal (above)
Depreciation c/f
Charge for year
105
(38)
(148)
(81)
(W3) Taxation:
Tax provision b/f
(110)
Deferred tax b/f
(75)
Income statement net charge
(1)
Tax provision c/f
15
Deferred tax c/f
90
Difference is cash paid
(81)
(W4) Revaluation reserve:
Balance b/f
45
Revaluation gains
70
Transfer to retained earnings
(3)
Balance c/f
112
(W5) Retained earnings:
Balance b/f
Loss for period
(45)
Dividends paid
(25)
Transfer from revaluation reserve
Balance c/f
(b)
1,165
3
1,098
The accruals/matching concept applied in preparing an income statement has
the effect of smoothing cash flows for reporting purposes. This practice arose
because interpreting ‘raw’ cash flows can be very difficult and the accruals
process has the advantage of helping users to understand the underlying
performance of a company. For example if an item of plant with an estimated life
of five years is purchased for $100,000, then in the statement of cash flows for the
five year period there would be an outflow in year 1 of the full $100,000 and no
further outflows for the next four years. Contrast this with the income statement
where by applying the accruals principle, depreciation of the plant would give a
charge of $20,000 per annum (assuming straight-line depreciation). Many would
see this example as an advantage of an income statement, however it is important
to realise that profit is affected by many subjective items. This has led to
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
accusations of profit manipulation or creative accounting,
disillusionment of the usefulness of the income statement.
hence
the
Another example of the difficulty in interpreting cash flows is that counterintuitively a decrease in overall cash flows is not always a bad thing (it may
represent an investment in extra productive capacity). Nor is an increase in cash
flows necessarily a good thing, since this may be from the sale of non-current
assets because of the need to raise cash urgently.
The advantages of cash flows are:
13
„
it is difficult to manipulate cash flows, they are real and possess the
qualitative characteristic of objectivity (as opposed to subjective profits).
„
cash flows are an easy concept for users to understand, indeed many users
misinterpret income statement items as being cash flows.
„
cash flows help to assess a company’s liquidity, solvency and financial
adaptability. Healthy liquidity is vital to a company’s going concern.
„
many business investment decisions and company valuations are based on
projected cash flows.
„
the ‘quality’ of a company’s operating profit is said to be confirmed by
closely correlated cash flows. Some analysts take the view that if a
company shows a healthy operating profit, but has low or negative
operating cash flows, there is a suspicion of profit manipulation or creative
accounting.
Minster
(a)
Statement of cash flows of Minster for the Year ended 30 September 2012:
$000
Cash flows from operating activities
Profit before tax
Adjustments for:
Depreciation of property, plant and equipment
Amortisation of software (180 – 135)
142
255
45
⎯⎯⎯
Investment income
Finance costs
⎯⎯⎯
Working capital adjustments
Decrease in trade receivables (380 – 270)
110
$000
(25)
30
(90)
⎯⎯⎯
Increase in amounts due from construction contracts (80 – 55)
Decrease in inventories (510 – 480)
Decrease in trade payables (555 – 350) (205)
Cash generated from operations
Interest paid (40 – 12 re unwinding of environmental provision)
Income taxes paid (w (ii))
Net cash from operating activities
Cash flows from investing activities
156
$000
300
⎯⎯⎯
(20)
40
⎯⎯⎯
462
$000
⎯⎯⎯
372
(28)
(54)
⎯⎯⎯
290
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Purchase of – property, plant and equipment (w (i))
– software
– investments (150 – (15 + 125))
Investment income received (20 – 15 gain on investments)
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of equity shares (w (iii))
Proceeds from issue of 9% loan note
Dividends paid (500 x 4 x 5 cents)
Net cash from financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period (40 – 35)
Cash and cash equivalents at end of period
$000
(410)
(180)
(10)
5
⎯⎯⎯
$000
(595)
265
120
(100)
⎯⎯⎯
285
⎯⎯⎯
(20)
(5)
⎯⎯⎯
(25)
⎯⎯⎯
Note: interest paid may be presented under financing activities and dividends
paid may be presented under operating activities.
Workings (in $’000)
(i)
Property, plant and equipment:
carrying amount b/f
non-cash environmental provision
revaluation
depreciation for period
carrying amount c/f
difference is cash acquisitions
(ii)
Taxation:
tax provision b/f
deferred tax b/f
income statement charge
tax provision c/f
deferred tax c/f
difference is cash paid
(iii)
Equity shares
balance b/f
bonus issue (1 for 4)
balance c/f
difference is cash issue
Share premium
balance b/f
bonus issue (1 for 4)
balance c/f
940
150
35
(255)
(1,280)
⎯⎯⎯
(410)
⎯⎯⎯
(50)
(25)
(57)
60
18
⎯⎯⎯
(54)
⎯⎯⎯
(300)
(75)
500
⎯⎯⎯
125
⎯⎯⎯
(85)
75
150
⎯⎯⎯
difference is cash issue
140
⎯⎯⎯
Therefore the total proceeds of cash issue of shares are $265,000 (125 + 140).
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(b)
Report on the financial position of Minster for the year ended 30 September 2012
To:
From:
Date:
Minster shows healthy operating cash inflows of $372,000 (prior to finance costs
and taxation). This is considered by many commentators as a very important
figure as it is often used as the basis for estimating the company’s future
maintainable cash flows. Subject to (inevitable) annual expected variations and
allowing for any changes in the company’s structure this figure is more likely to
be repeated in the future than most other figures in the statement of cash flows
which are often ‘one-off’ cash flows such as raising loans or purchasing noncurrent assets. The operating cash inflow compares well with the underlying
profit before tax $142,000. This is mainly due to depreciation charges of $300,000
being added back to the profit as they are a non-cash expense. The cash inflow
generated from operations of $372,000 together with the reduction in net working
capital of $90,000 is more than sufficient to cover the company’s taxation
payments of $54,000, interest payments of $28,000 and the dividend of $100,000
and leaves an amount to contribute to the funding of the increase in non-current
assets. It is important that these short term costs are funded from operating cash
flows; it would be of serious concern if, for example, interest or income tax
payments were having to be funded by loan capital or the sale of non-current
assets.
There are a number of points of concern. The dividend of $100,000 gives a
dividend cover of less than one (85/100 = 0·85) which means the company has
distributed previous year’s profits. This is not a tenable situation in the longterm. The size of the dividend has also contributed to the lower cash balances
(see below). There is less investment in both inventory levels and trade
receivables. This may be the result of more efficient inventory control and better
collection of receivables, but it may also indicate that trading volumes may be
falling. Also of note is a large reduction in trade payable balances of $205,000.
This too may be indicative of lower trading (i.e. less inventory purchased on
credit) or pressure from suppliers to pay earlier. Without more detailed
information it is difficult to come to a conclusion in this matter.
Investing activities:
The statement of cash flows shows considerable investment in non-current assets,
in particular $410,000 in property, plant and equipment. These acquisitions
represent an increase of 44% of the carrying amount of the property, plant and
equipment as at the beginning of the year. As there are no disposals, the increase
in investment must represent an increase in capacity rather than the replacement
of old assets. Assuming that this investment has been made wisely, this should
bode well for the future (most analysts would prefer to see increased investment
rather than contraction in operating assets). An unusual feature of the required
treatment of environmental provisions is that the investment in non-current
assets as portrayed by the statement of cash flows appears less than if statement
of financial position figures are used. The statement of financial position at 30
September 2012 includes $150,000 of non-current assets (the discounted cost of
the environmental provision), which does not appear in the cash flow figures as
it is not a cash ‘cost’. A further consequence is that the ‘unwinding’ of the
discounting of the provision causes a financing expense in the income statement
158
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Section 2: Answers to practice questions
which is not matched in the statement of cash flows as the unwinding is not a
cash flow. Many commentators have criticised the required treatment of
environmental provisions because they cause financing expenses which are not
(immediate) cash costs and no ‘loans’ have been taken out. Viewed in this light, it
may be that the information in the statement of cash flows is more useful than
that in the income statement and statement of financial position.
Financing activities:
The increase in investing activities (before investment income) of $600,000 has
been largely funded by an issue of shares at $265,000 and raising a 9% $120,000
loan note. This indicates that the company’s shareholders appear reasonably
pleased with the company's past performance (or they would not be very willing
to purchase further shares). The interest rate of the loan at 9% seems quite high,
and virtually equal to the company’s overall return on capital employed of 9·1%
(162/(1,660 + 120)). Provided current profit levels are maintained, it should not
reduce overall returns to shareholders.
Cash position:
The overall effect of the year’s cash flows has worsened the company’s cash
position by an increased net cash liability of $20,000. Although the company’s
short term borrowings have reduced by $15,000, the cash at bank of $35,000 at the
beginning of the year has now gone. In comparison to the cash generation ability
of the company and considering its large investment in non-current assets, this
$20,000 is a relatively small amount and should be relieved by operating cash
inflows in the near future.
Summary
The above analysis shows that Minster has invested substantially in new noncurrent assets suggesting expansion. To finance this, the company appears to
have no difficulty in attracting further long-term funding. At the same time there
are indications of reduced inventories, trade receivables and payables which may
suggest the opposite i.e. contraction. It may be that the new investment is a
change in the nature of the company’s activities (e.g. mining) which has different
working capital characteristics. The company has good operating cash flow
generation and the slight deterioration in short term net cash balance should only
be temporary.
Yours …………………..
14
Pinto
(a)
Statement of cash flows of Pinto for the Year to 31 March 2012:
Cash flows from operating activities
Profit before tax
Adjustments for:
Depreciation of property, plant and equipment
Loss on sale of property, plant and equipment
$’000
280
90
–––––––
Increase in warranty provision (200 – 100)
Investment income
Finance costs
Redemption penalty costs included in administrative expenses
© Emile Woolf Publishing Limited
$’000
440
370
100
(60)
50
20
–––––––
920
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Paper F7: Financial Reporting (International)
Working capital adjustments
Increase in inventories (1,210 – 810)
Decrease in trade receivables (540 – 480)
Increase in trade payables (1,410 – 1,050)
Cash generated from operations
Finance costs paid
Income tax refund (w (ii))
Net cash from operating activities
Cash flows from investing activities
Purchase of property, plant and equipment (w (i))
Sale of property, plant and equipment (240 – 90)
Investment income received
(60 – 20 gain on investment property)
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of equity shares (400 + 600)
Redemption of loan notes (400 plus 20 penalty)
Dividends paid (1,000 x 5 x 3 cents)
Net cash from financing activities
$’000
(400)
60
360
–––––––
$’000
20
–––––––
940
(50)
60
–––––––
950
(1,440)
150
40
–––––––
(1,250)
1,000
(420)
(150)
–––––––
430
–––––––
Net increase in cash and cash equivalents
130
Cash and cash equivalents at beginning of period
(120)
–––––––
Cash and cash equivalents at end of period
10
–––––––
Note: investment income received and dividends paid may alternatively be
shown in operating activities.
Workings (in $’000)
(i)
Property, plant and equipment:
carrying amount b/f
revaluation
depreciation for period
disposal
carrying amount c/f
difference is cash acquisitions
(ii)
Income tax:
tax asset b/f
deferred tax b/f
income statement charge
tax provision c/f
deferred tax c/f
difference is cash received
(b)
Comments on the cash management of Pinto
1,860
100
(280)
(240)
(2,880)
–––––––
(1,440)
–––––––
50
(30)
(160)
150
50
–––––––
60
–––––––
Operating cash flows:
Pinto’s operating cash inflows at $940,000 (prior to investment income, finance
costs and taxation) are considerably higher than the equivalent profit before
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Section 2: Answers to practice questions
investment income, finance costs and tax of $430,000. This shows a satisfactory
cash generating ability and is more than sufficient to cover finance costs, taxation
(see later) and dividends. The major reasons for the cash flows being higher than
the operating profit are due to the (non-cash) increases in the depreciation and
warranty provisions. Working capital changes are relatively neutral; a large
increase in inventory appears to be being financed by a substantial increase in
trade payables and a modest reduction in trade receivables. The reduction in
trade receivables is perhaps surprising as other indicators point to an increase in
operating capacity which has not been matched with an increase in trade
receivables. This could be indicative of good control over the cash management
of the trade receivables (or a disappointing sales performance).
An unusual feature of the cash flow is that Pinto has received a tax refund of
$60,000 during the current year. This would indicate that in the previous year
Pinto was making losses (hence obtaining tax relief). Whilst the current year’s
profit performance is an obvious improvement, it should be noted that next
year’s cash flows are likely to suffer a tax payment (estimated at $150,000 in
current liabilities at 31 March 2012) as a consequence. In any forward planning,
Pinto should be aware that the tax reversal position will create an estimated total
incremental outflow of $210,000 in the next period.
Investing activities:
There has been a dramatic investment/increase in property, plant and
equipment. The carrying value at 31 March 2012 is substantially higher than a
year earlier (admittedly $100,000 is due to revaluation rather than a purchase). It
is difficult to be sure whether this represents an increase in operating capacity or
is the replacement of the plant disposed of. (The voluntary disclosure encouraged
by IAS 7 Statement of cash flows would help to assess this issue more accurately).
However, judging by the level of the increase and the (apparent) overall
improvement in profit position, it seems likely that there has been a successful
increase in capacity. It is not unusual for there to be a time lag before increased
investment reaches its full beneficial effect and in this context it could be
speculated that the investment occurred early in the accounting year (because its
effect is already making an impact) and that future periods may show even
greater improvements.
The investment property is showing a good return which is composed of rental
income (presumably) of $40,000 and a valuation gain of $20,000.
Financing activities:
It would appear that Pinto’s financial structure has changed during the year.
Debt of $400,000 has been redeemed (for $420,000) and there has been a share
issue raising $1 million. The company is now nil geared compared to modest
gearing at the end of the previous year. The share issue has covered the cost of
redemption and contributed to the investment in property, plant and equipment.
The remainder of the finance for the property, plant and equipment has come
from the very healthy operating cash flows. If ROCE is higher than the finance
cost of the loan note at 6% (nominal) it may call into question the wisdom of the
early redemption especially given the penalty cost (which has been classified
within financing activities) of the redemption.
Cash position:
The overall effect of the year’s cash flows is that they have improved the
company’s cash position dramatically. A sizeable overdraft of $120,000, which
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Paper F7: Financial Reporting (International)
may have been a consequence of the (likely) losses in the previous year, has been
reversed to a modest bank balance of $10,000 even after the payment of a
$150,000 dividend.
Summary
The above analysis indicates that Pinto has invested substantially in renewing
and/or increasing its property, plant and equipment. This has been financed
largely by operating cash flows, and appears to have brought a dramatic
turnaround in the company’s fortunes. All the indications are that the future
financial position and performance will continue to improve.
15
Coaltown
(a)
Coaltown – Statement of cash flows for the year ended 31 March 2012:
Cash flows from operating activities
Profit before tax
Adjustments for:
depreciation of non-current assets (w (i))
loss on disposal of displays (w (i))
interest expense
increase in warranty provision (1,000 – 300)
increase in inventory (5,200 – 4,400)
increase in receivables (7,800 – 2,800)
decrease in payables (4,500 – 4,200)
$’000
10,200
6,000
1,500
––––––––
Cash generated from operations
Interest paid
Income tax paid (w (ii))
Net cash from operating activities
Cash flows from investing activities (w (i))
Purchase of non-current assets
Disposal cost of non-current assets
Net cash used in investing activities
Cash flows from financing activities:
Issue of equity shares (8,600 capital + 4,300 premium)
Issue of 10% loan notes
Equity dividends paid
Net cash from financing activities
(20,500)
(500)
––––––––
600
700
(800)
(5,000)
(300)
––––––––
12,900
(600)
(5,500)
––––––––
6,800
(21,000)
––––––––
(14,200)
9,900
––––––––
(4,300)
700
––––––––
(3,600)
––––––––
Cash and cash equivalents at end of period
162
7,500
12,900
1,000
(4,000)
––––––––
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Workings
(i)
Non-current assets
Cost
Balance b/f
$’000
$’000
80,000
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Section 2: Answers to practice questions
Revaluation (5,000 – 2,000 depreciation)
Disposal
Balance c/f
Cash flow for acquisitions
Depreciation
Balance b/f
Revaluation
Disposal
Balance c/f
Difference – charge for year
Disposal of displays
Cost
Depreciation
Cost of disposal
Loss on disposal
(ii)
Income tax paid:
Provision b/f
Income statement tax charge
Provision c/f
Difference cash paid
(b)
(i)
$’000
3,000
(10,000)
(93,500)
––––––––
20,500
––––––––
$’000
48,000
(2,000)
(9,000)
(43,000)
––––––––
6,000
––––––––
10,000
(9,000)
500
––––––––
1,500
––––––––
$’000
(5,300)
(3,200)
3,000
––––––––
(5,500)
––––––––
Workings – all monetary figures in $’000
(note: references to 2011 and 2012 should be taken as to the years ended 31
March 2011 and 2012)
The effect of a reduction in purchase costs of 10% combined with a
reduction in selling prices of 5%, based on the figures from 2011, would be:
Sales (55,000 x 95%)
Cost of sales (33,000 x 90%)
52,250
(29,700)
–––––––
Expected gross profit
22,550
–––––––
This represents an expected gross profit margin of 43·2% (22,550/52,250 x
100)
The actual gross profit margin for 2012 is 33·4% (22,000/65,800 x 100)
(ii)
The directors’ expression of surprise that the gross profit in 2012 has not
increased seems misconceived.
A change in the gross profit margin does not necessarily mean there will be
an equivalent change in the absolute gross profit. This is because the gross
profit figure is the product of the gross profit margin and the volume of
sales and these may vary independently of each other. That said, in this
case the expected gross profit margin in 2012 shows an increase over that
earned in 2011 (to 43·2% from 40·0% (22,000/55,000 x100)) and the sales
have also increased, so it is understandable that the directors expected a
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Paper F7: Financial Reporting (International)
higher gross profit. As the actual gross profit margin in 2012 is only 33·4%,
something other than the changes described by the directors must have
occurred. Possible reasons for the reduction are:
The opening inventory being at old (higher) cost and the closing inventory
is at the new (lower) cost will have caused slight distortion.
Inventory write downs due to damage/obsolescence.
A change in the sales mix (i.e. from higher margin sales to lower margin
sales).
New (lower margin) products may have been introduced from other new
suppliers.
Some selling prices may have been discounted because of sales promotions.
Import duties (perhaps not allowed for by the directors) or exchange rate
fluctuations may have caused the actual purchase cost to be higher than the
trade prices quoted by the new supplier.
Change in cost classification: some costs included as operating expenses in
2011 may have been classified as cost of sales in 2012 (if intentional and
material this should be treated as a change in accounting policy) – for
example it may be worth checking that depreciation has been properly
charged to operating expenses in 2012.
The new supplier may have put his prices up during the year due to
market conditions. Coaltown may have felt it could not pass these increases
on to its customers.
(iii)
Note – all monetary figures in $’000
Trade receivables collection period in 2011:
2,800/28,500 x 365 = 35·9 days
Applying the 35·9 days collection period to the credit sales made in 2012:
53,000 x 35·9/365 = 5,213, the actual receivables are 7,800 thus
potentially increasing the bank balance by 2,587.
A similar exercise with the trade payables period in 2011:
4,500/33,000 x 365 = 49·8 days
Note the 33,000 above is the cost of sales for 2011. This was the same as the
credit purchases as there was no change in the value of inventory.
However, in 2012 the credit purchases will be 44,600 (43,800 + 5,200 closing
inventory – 4,400 opening inventory).
Applying the 49·8 days payment period to purchases made in 2012 gives:
44,600 x 49·8/365 = 6,085, the actual payables are 4,200 thus
potentially increasing the bank balance by 1,885.
Inevitably a shortening of the period of credit offered by suppliers and
lengthening the credit offered to customers will put a strain on cash
resources. For Coaltown the combination of maintaining the same credit
periods for both trade receivables and payables would have led to a
reduction in cash outflows of 4,472 (2,587 + 1,885), which would have
eliminated the overdraft of 3,600 leaving a balance in hand of 872.
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Section 2: Answers to practice questions
16
Crosswire
(a)
(i)
Non-current assets
Property, plant and equipment
Carrying amount b/f
Mine (5,000 + 3,000 environmental cost)
Revaluation (2,000/0·8 allowing for effect of deferred tax transfer)
Fair value of leased plant
Plant disposal
Depreciation
Replacement plant (balance)
Carrying amount c/f
Development costs
Carrying amount b/f
Additions during year
Amortisation and impairment (balance)
Carrying amount c/f
(ii)
Cash flows from investing activities
Purchase of property, plant and equipment (w (i))
Disposal proceeds of plant
Development costs
Net cash used in investing activities
Cash flows from financing activities:
Issue of equity shares (w (ii))
Redemption of convertible loan notes ((5,000 – 1,000) x 25%)
Lease obligations (w (iii))
Interest paid (400 + 350)
Net cash used in financing activities
$’000
13,100
8,000
2,500
10,000
(500)
(3,000)
2,400
––––––––
32,500
––––––––
2,500
500
(2,000)
––––––––
1,000
––––––––
(7,400)
1,200
(500)
––––––––
(6,700)
––––––––
2,000
(1,000)
(3,200)
(750)
––––––––
(2,950)
––––––––
Workings (figures in brackets in $’000)
(i)
The cash elements of the increase in property, plant and equipment are $5
million for the mine (the capitalised environmental provision is not a cash
flow) and $2·4 million for the replacement plant making a total of $7·4
million.
(ii)
Of the $4 million convertible loan notes (5,000 – 1,000) that were redeemed
during the year, 75% ($3 million) of these were exchanged for equity shares
on the basis of 20 new shares for each $100 in loan notes. This would create
600,000 (3,000/100 x 20) new shares of $1 each and share premium of $2·4
million (3,000 – 600). As 1 million (5,000 – 4,000) new shares were issued in
total, 400,000 must have been for cash. The remaining increase (after the
effect of the conversion) in the share premium of $1·6 million (6,000 – 2,000
b/f – 2,400 conversion) must relate to the cash issue of shares, thus cash
proceeds from the issue of shares is $2 million (400 nominal value + 1,600
premium).
(iii) The initial lease obligation is $10 million (the fair value of the plant). At 30
September 2012 total lease obligations are $6·8 million (5,040 + 1,760), thus
repayments in the year were $3·2 million (10,000 – 6,800).
© Emile Woolf Publishing Limited
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(b)
Taking the definition of ROCE from the question:
Year ended 30 September 2012
$’000
Profit before tax and interest on long-term borrowings
(4,000 + 1,000 + 400 + 350)
5,750
Equity plus loan notes and finance lease obligations
(19,200 + 1,000 + 5,040 + 1,760)
27,000
ROCE
21·3%
Equivalent for year ended 30 September 2011
(3,000 + 800 + 500)
4,300
(9,700 + 5,000)
14,700
ROCE
29·3%
To help explain the deterioration it is useful to calculate the components of ROCE
i.e. operating margin and net asset turnover (utilisation):
2012
Operating margin (5,750/52,000 x 100)
Net asset turnover (52,000/27,000)
2011
11·1%
(4,300/42,000)
1·93 times
(42,000/14,700)
10·2%
2·86 times
From the above it can be clearly seen that the 2012 operating margin has
improved by nearly 1% point, despite the $2 million impairment charge on the
write down of the development project. This means the deterioration in the
ROCE is due to poorer asset turnover. This implies there has been a decrease in
the efficiency in the use of the company’s assets this year compared to last year.
Looking at the movement in the non-current assets during the year reveals some
mitigating points:
The land revaluation has increased the carrying amount of property, plant and
equipment without any physical increase in capacity. This unfavourably distorts
the current year’s asset turnover and ROCE figures.
The acquisition of the platinum mine appears to be a new area of operation for
Crosswire which may have a different (perhaps lower) ROCE to other previous
activities or it may be that it will take some time for the mine to come to full
production capacity.
The substantial acquisition of the leased plant was half-way through the year and
can only have contributed to the year’s results for six months at best. In future
periods a full year’s contribution can be expected from this new investment in
plant and this should improve both asset turnover and ROCE.
In summary, the fall in the ROCE may be due largely to the above factors
(effectively the replacement and expansion programme), rather than to poor
operating performance, and in future periods this may be reversed.
It should also be noted that had the ROCE been calculated on the average capital
employed during the year (rather than the year end capital employed), which is
arguably more correct, then the deterioration in the ROCE would not have been
as pronounced.
166
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
17
Deltoid
(a)
(i)
Deltoid – Statement of cash flows for the year ended 31 March 2010:
(Note: figures in brackets are in $’000)
$’000
Cash flows from operating activities:
Loss before tax
Adjustments for:
depreciation of non-current assets
3,700
loss on sale of leasehold property (8,800 – 200 – 8,500)
interest expense
increase in inventory (12,500 – 4,600)
increase in trade receivables (4,500 – 2,000)
increase in trade payables (4,700 – 4,200)
Cash deficit from operations
Interest paid
Income tax paid (w (i))
Net cash deficit from operating activities
Cash flows from investing activities:
Disposal of leasehold property
Cash flows from financing activities:
Shares issued
(10,000 – 8,000 – 800 bonus issue)
1,200
Payment of finance lease obligations (w (ii)) (2,100)
Equity dividends paid (w (iii))
(700)
––––––
Net cash from financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Workings
(i)
Income tax paid:
Provision b/f
– current
– deferred
Income statement tax relief
Provision c/f
– current
– deferred
Difference – cash paid
(ii)
Leased plant:
Balance b/f
Depreciation
Leased during year (balance)
Balance c/f
Lease obligations:
Balance b/f
– current
– non-current
© Emile Woolf Publishing Limited
$’000
(1,800)
100
1,000
(7,900)
(2,500)
500
––––––
(6,900)
(1,000)
(1,900)
––––––
(9,800)
8,500
(1,600)
––––––
(2,900)
1,500
––––––
(1,400)
––––––
$’000
(2,500)
(800)
700
(500)
1,200
––––––
(1,900)
––––––
2,500
(1,800)
5,800
––––––
6,500
––––––
(800)
(2,000)
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New leases (from above)
Balance c/f
– current
– non-current
Difference – repayment during year
(iii) Equity dividends paid:
(5,800)
1,700
4,800
––––––
(2,100)
––––––
Retained earnings b/f
Loss for period
Dividends paid (balance)
(ii)
6,300
(1,100)
(700)
––––––
Retained earnings c/f
4,500
––––––
The main concerns of a loan provider would be whether Deltoid would be
able to pay the servicing costs (interest) of the loan and the eventual
repayment of the principal amount. Another important aspect of granting
the loan would be the availability of any security that Deltoid can offer.
Interest cover is a useful measure of the risk of non-payment of interest.
Deltoid’s interest cover has fallen from a healthy 15 times (9,000/600) to be
negative in 2010. Although interest cover is useful, it is based on profit
whereas interest is actually paid in cash. It is usual to expect interest
payments to be covered by operating cash flows (it is a bad sign when
interest has to be paid from long-term sources of funding such as from the
sale of non-current assets or a share issue).
Deltoid’s position in this light is very worrying; there is a cash deficit from
operations of $6·9 million and after interest and tax payments the deficit
has risen to $9·8 million.
When looking at the prospect of the ability to repay the loan, Deltoid’s
position is deteriorating as measured by its gearing (debt including finance
lease obligations/equity) which has increased to 65% (5,000 + 6,500/17,700)
from 43% (5,000 + 2,800/18,300). What may also be indicative of a
deteriorating liquidity position is that Deltoid has sold its leasehold
property and rented it back. This has been treated as a disposal, but,
depending on the length of the rental agreement and other conditions of
the tenancy agreement (which are not specified in the question) it may be
that the substance of the sale is a loan/finance leaseback (e.g. if the period
of the rental agreement was substantially the same as the remaining life of
the property). If this were the case the company’s gearing would increase
even further. Furthermore, there is less value in terms of ownership of noncurrent assets which may be used as security (in the form of a charge on
assets) for the loan. It is also noteworthy that, in a similar vein, the increase
in other non-current assets is due to finance leased plant. Whilst it is correct
to include finance leased plant on the statement of financial position
(applying substance over form), the legal position is that this plant is not
owned by Deltoid and offers no security to any prospective lender to
Deltoid.
Therefore, in view of Deltoid’s deteriorating operating and cash generation
performance, it may be advisable not to renew the loan for a further five
years.
168
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Section 2: Answers to practice questions
(b)
Although the sports club is a not-for-profit organisation, the request for a loan is
a commercial activity that should be decided on according to similar criteria as
would be used for other profit-orientated entities.
The main aspect of granting a loan is how secure the loan would be. To this
extent a form of capital gearing ratio should be calculated; say existing long-term
borrowings to net assets (i.e. total assets less current liabilities). Clearly if this
ratio is high, further borrowing would be at an increased risk. The secondary
aspect is to measure the sports club’s ability to repay the interest (and ultimately
the principal) on the loan. This may be determined from information in the
income statement. A form of interest cover should be calculated; say the excess of
income over expenditure (broadly the equivalent of profit) compared to (the
forecast) interest payments. The higher this ratio the less risk of interest default.
The calculations would be made for all four years to ascertain any trends that
may indicate a deterioration or improvement in these ratios. As with other profitoriented entities the nature and trend of the income should be investigated: for
example, are the club’s sources of income increasing or decreasing, does the
reported income contain ‘one-off’ donations (which may not be recurring) etc?
Also matters such as the market value of, and existing prior charges against, any
assets intended to be used as security for the loan would be relevant to the
lender’s decision-making process. It may also be possible that the sports club’s
governing body (perhaps the trustees) may be willing to give a personal
guarantee for the loan.
Financial statements – Preparation of accounts from a trial
balance
18
Petra
(a)
Petra – Income statement for the year ended 30 September 2012
$000
$000
Revenue: 197,800 – 12,000 (w (i))
185,800
Cost of sales (w (ii))
(128,100)
―――――
Gross profit
Other income – commission received (w (i))
57,700
1,000
―――――
58,700
Distribution costs
Administration expenses
Interest expense: 1,500 + 1,500
Profit before tax
Income tax expense: 4,000 +1,000 + (17,600 – 15,000)
Profit for the period
© Emile Woolf Publishing Limited
17,000
18,000
3,000
――――
(38,000)
―――――
20,700
(7,600)
―――――
13,100
―――――
169
Paper F7: Financial Reporting (International)
(b)
Petra – Statement of financial position as at 30 September 2012
Cost
Accumulated
Carrying
depreciation
amount
Non-current assets (w (iii))
$000
$000
$000
44,000
106,000
Property, plant and equipment
150,000
Development costs
40,000
22,000
18,000
――――
――――
――――
190,000
66,000
124,000
――――
――――
Current assets
Inventories
21,300
Trade receivables
24,000
Bank
11,000
Held for sale asset – plant (w (iii))
6,900
――――
63,200
――――
Total assets
187,200
――――
Equity and liabilities
Ordinary shares of 25c each
40,000
Reserves:
Share premium
12,000
Retained earnings: 34,000+ 13,100
47,100
――――
59,100
――――
99,100
Non-current liabilities
6% loan note
50,000
Deferred tax
17,600
――――
67,600
Current liabilities
Trade payables
15,000
Accrued interest
1,500
Current tax payable
4,000
――――
20,500
――――
Total equity and liabilities
187,200
――――
(c)
Basic EPS
Nominal value per share: 25 cents
Therefore number of shares: $40 million/25c per share = 160 million shares
EPS = $13,100,000/16 million = 8.2 cents.
Diluted EPS
The existence of the directors’ share options to buy 24 million shares requires the
disclosure of a diluted EPS. The dilution effect of the options is as follows:
Proceeds from options when exercised $7.2 million.
This is equivalent to buying 8 million shares at full market value (= $7.2
million/90c per share).
170
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Thus the dilutive number of shares is 16 million (- 24 million – 8 million).
Diluted EPS = $13,100,000/ (160 million + 16 million) = 7.4 cents.
Workings (figures are in $000)
(i)
Agency sales
Petra has treated the sales it made on behalf of Sharma as its own sales. The
advice from the auditors is that these are agency sales. Thus $12 million
should be removed from revenue and the cost of the sales of $8 million and
the $3 million ‘share’ of profit to Sharma should also be removed from cost
of sales. Petra should only recognise the commission of $1 million as
income.
(The answer has included this as other income, but it would also be
acceptable to include the commission in revenue.)
(ii)
Cost of sales
$000
Cost of sales in trial balance
Remove agency sales and Sharma profit ($8m + $3m)
Charge annual depreciation/amortisation
Buildings (w (iii))
Plant (w (iii))
Deferred development expenditure (w (iii))
Impairment of development expenditure (w (iii))
Impairment of plant held for sale (w (iii))
2,000
6,000
8,000
6,000
3,100
――――
Adjusted cost of sales
(iii)
Non-current assets and depreciation
$000
114,000
(11,000)
103,000
25,100
――――
128,100
――――
The cost of the buildings = $60 million (= $100 million – $40 million for the
land).
Annual depreciation of buildings = $60 million/30 years = $2 million.
IFRS 5 Non-current assets held for sale and discontinued operations requires
plant whose carrying amount will be recovered principally through sale
(rather than use) to be classified as ‘held for sale’. It must be shown
separately in the statement of financial position and carried at the lower of
its carrying amount (when classified as for continuing use) and its fair
value less estimated costs to sell. Assets classified as held for sale should
not be depreciated.
Figures in $millions
Cost at start of year
Less: held for sale
Cost at end of year
Accumulated depreciation
Start of year
© Emile Woolf Publishing Limited
Land
40
-
Buildings
60
-
40
60
――――
Plant
66
(16)
Total
166
(16)
――――
――――
――――
――――
――――
――――
――――
-
16
26
42
50
150
171
Paper F7: Financial Reporting (International)
Figures in $millions
Less: Plant held for sale
Land
Buildings
Plant
(6)
Total
(6)
――――
20
Depreciation charge: buildings
Depreciation charge: plant:
20% × (50 – 20)
End of year
Carrying amount: end of year
2
2
6
6
――――
――――
――――
――――
――――
――――
――――
――――
-
40
――――
18
42
――――
26
44
24
106
――――
――――
Plant held for sale must be valued at $6.9 million (7,500 selling price less
commission of 600 (7,500 × 8%)) as this is lower than its carrying amount of $10
million. Thus an impairment charge of $3.1 million ($10 million – $6.9 million) is
required for the plant held for sale and this is a charge in the income statement.
Development expenditure
This has suffered impairment as a result of disappointing sales. The asset should be
written down to $18 million in the statement of financial position.
The impairment loss should be calculated after charging amortisation of $8 million
(40,000/5 years) for the current year.
$m
Cost of development expenditure in the statement of financial position
Amortisation to beginning of year
Amortisation charge in the year
$m
40
8
8
16
24
18
6
Carrying amount before revaluation
Carrying amount after revaluation
Impairment loss: charge to income statement
The carrying amount of $18 million will then be written off over the next two years.
19
Darius
(a)
Darius
Statement of comprehensive income for the year ended 31 March 2012
Revenue (w (i))
Cost of sales (w (i))
Gross profit
Operating expenses
Investment income
Loss on investment property (16,000 – 13,500 w (ii))
Financing cost (5,000 – 3,200 ordinary dividend (w (v))
Profit before tax
Income tax expense (w (iii))
Profit for the period
Other comprehensive income
172
$000
221,800
(156,200)
65,600
(22,400)
1,200
(2,500)
(1,800)
40,100
(6,400)
33,700
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Darius
Statement of comprehensive income for the year ended 31 March 2012
Unrealised surplus on land and building
Total comprehensive income for the year
$000
21,000
54,700
(b)
Darius statement of financial position as at 31 March 2012
Non-current assets
Property, plant and equipment (w (iv))
Investment property (w (ii))
Current assets
Inventories (10,500 – 300 (w (i)))
Trade receivables (13,500 + 1,500 joint venture)
Total assets
Equity and liabilities
Ordinary shares of 25c each
Reserves:
Revaluation reserve
Retained earnings (w (v))
$000
$000
87,100
13,500
100,600
10,200
15,000
25,200
125,800
20,000
21,000
48,000
69,000
89,000
Non-current liabilities
Deferred tax (w (iii))
Redeemable preference shares of $1 each
3,600
10,000
13,600
Current liabilities
Trade payables (11,800 + 2,500 joint venture)
Bank overdraft
Current tax payable
Total equity and liabilities
Workings (figures in $000)
(i)
Revenue
As stated in the question
Joint venture revenue
Cost of sales
As stated in the question
Closing inventories adjustment (see below)
Joint venture costs
Depreciation (w (iv)) – building
– plant
© Emile Woolf Publishing Limited
14,300
900
8,000
23,200
125,800
213,800
8,000
221,800
143,800
300
5,000
3,200
3,900
156,200
173
Paper F7: Financial Reporting (International)
Note on closing inventories adjustment. The damaged inventories will
require expenditure of $450,000 to repair them and then have an expected
selling price of $950,000. This gives a net realisable value of $500,000: as
their cost was $800,000, a write down of $300,000 is required.
(ii)
The fair value model in IAS 40 Investment property requires investment
properties to be included in the statement of financial position at their fair
value (in this case taken to be the open market value). Any surplus or
deficit is recorded in income.
(iii)
$000
8,000
(1,600)
6,400
Taxation
Provision for the year
Deferred tax (see below)
Taxable temporary differences are $12 million. At a rate of 30% this would
require a statement of financial position provision for deferred tax of $3.6
million. The opening provision is $5.2 million, thus a credit of $1.6 million
will be made for deferred tax in the income statement.
(iv)
$000
Non-current assets
Land and building
Depreciation of the building for the year ended
31 March 2012 will be (48,000/15 years)
Plant and equipment
As stated in the trial balance
Joint venture plant
3,200
36,000
12,000
48,000
(16,800)
31,200
(3,900)
27,300
Accumulated depreciation 1 April 2011
Carrying amount prior to depreciation for the year
Depreciation year ended 31 March 2012 at 12.5%
Carrying amount at 31 March 2012
Cost/valuation
Land and building
Plant and equipment
Property, plant and equipment
(v)
63,000
48,000
――――
Accumulated
depreciation
3,200
20,700
――――
Carrying
amount
59,800
27,300
――――
111,000
23,900
87,100
――――
――――
――――
Retained earnings
$000
Balance b/f
17,500
Profit for period
33,700
Ordinary dividends paid (20,000 × 4 × 4c)
(3,200)
48,000
174
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
20
Danzig
(a)
Danzig
Income statement for the year ended 30 September 2012
$000
Revenue
Cost of sales: see working (1)
Gross profit
Operating expenses: see working (2)
Investment income
Finance costs: Loan notes – see working (3)
Finance lease – see working (2)
$000
295,300
(180,000)
105,300
(36,600)
2,000
(3,000)
(1,700)
(4,700)
76,000
(16,000)
60,000
Profit before tax
Income tax expense: see working (4)
Profit for the period
(b)
Danzig
Statement of financial position as at 30 September 2012
$000
Non-current assets
Property, plant and equipment: see working (5)
Investments at amortised cost
Current assets
Inventory
Trade receivables
Bank
Total assets
Equity and liabilities
Capital and reserves
Equity shares of $0.50 each fully paid : see working (6)
Share premium: see working (6)
Revaluation reserve: see working (7)
Retained earnings: see working (8)
$000
358,000
92,400
450,400
23,700
76,400
12,100
112,200
562,600
240,000
139,000
15,000
43,300
197,300
437,300
Non-current liabilities
3% loan notes: see working (3)
Deferred tax: see working (4)
Finance lease obligation: see working (2)
51,500
23,000
11,700
86,200
© Emile Woolf Publishing Limited
175
Paper F7: Financial Reporting (International)
Danzig
Statement of financial position as at 30 September 2012
$000
Current liabilities
Trade payables
Accrued lease finance costs: see working (2)
Finance lease obligation: see working (2)
Income tax payable
$000
14,100
1,700
5,300
18,000
39,100
562,600
Total equity and liabilities
Workings
(1)
Cost of sales
$000
As given in the trial balance
134,000
Depreciation of plant and equipment: 20% × (197,000 – 47,000)
30,000
Depreciation of leased vehicles: 24,000/4 years
6,000
Amortisation of leasehold property: 250,000/25 years
10,000
180,000
(2)
Vehicle rentals and finance lease. Operating expenses
$000
Rental costs given in the trial balance
8,600
Relating to finance lease
(7,000)
Balance: relating to operating lease – operating expense
(3)
1,600
Other operating expenses (trial balance in question)
35,000
Total operating expenses
36,600
Finance lease
$000
$000
Fair value of leased assets
24,000
Less: First rental payment, paid in advance 1 October 2011
(7,000)
Remaining obligation, 1 October 2011
17,000
Interest at 10% to 30 September 2012 (current liability)
1,700
Lease payment due 1 October 2012
7,000
Capital repayment due (= balance, current liability)
(5,300)
Remaining lease obligation = non-current liability
11,700
Loan notes
Although the nominal interest rate on the loan notes is 3%, the effective
interest rate is 6%. The finance charge in the income statement should be
based on the effective interest rate (= 6% × $50 million) = $3 million. Actual
interest paid was $1,500,000 (in trial balance); therefore the balancing
$1,500,000 should be added to the loan notes obligation, to make the total
loan notes liability $50 million + $1,500,000 = $51.5 million.
176
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(4)
Taxation
$000
$000
Deferred tax on taxable temporary differences (92,000 × 25%)
23,000
(= liability in the statement of financial position)
Taxable temporary differences relating to revaluation
20,000
Credit to deferred tax, debit to revaluation reserve (at 25%)
5,000
18,000
Deferred tax liability in the trial balance
20,000
Deferred tax: credit in the income statement
2,000
$000
(5)
Income tax on profits for the year
18,000
Deferred tax movement
(2,000)
Tax charge in the income statement
16,000
Non-current assets and depreciation
$000
Leasehold property
Carrying value in the trial balance (250,000 – 40,000)
210,000
Amortisation charge for the year to 30 September 2012
(10,000)
200,000
Re-valued amount
220,000
Transfer to revaluation reserve
20,000
The annual depreciation charges for plant and equipment and the leased
vehicles are shown in workings (1)
Accumulated
depreciation
Carrying
amount
$000
$000
$000
Leasehold property
220,000
0
220,000
Plant and equipment (non-leased)
197,000
77,000
120,000
Leased vehicles
(6)
Cost or
valuation
24,000
6,000
18,000
――――
――――
――――
441,000
83,000
358,000
――――
――――
――――
Suspense account
Shares in issue at 1 October 2011 = $180,000,000/$0.50 per share = 360
million.
Value at 30 September 2011 = (× $2 per share) = $720,000,000.
Dividend to give a 5% yield = 5% × = $36,000,000 = dividend paid.
Rights issue
Number of shares issued (360 million × 1/3) = 120 million
Nominal value of shares at 1 October 2011
Rights issue: nominal value (120 million × $0.50)
Nominal value of shares at 30 September 2012
© Emile Woolf Publishing Limited
$000
180,000
60,000
240,000
177
Paper F7: Financial Reporting (International)
$000
204,000
(60,000)
144,000
(5,000)
139,000
Rights issue
Cash raised from rights issue (120 million × $1.70)
Nominal value of shares issued
Therefore share premium before deducting issue costs
Less issue costs
Share premium
(7)
Revaluation reserve
Revaluation of leasehold property
Associated deferred tax
Revaluation reserve in the statement of financial position
(8)
Retained profits
$000
19,300
60,000
(36,000)
43,300
At 1 October 2011 (trial balance)
Profit for the year
Dividends paid (working (6))
Retained profits at 30 September 2012
21
$000
20,000
(5,000)
15,000
Allgone
(a)
Allgone: Income statement – Year to 31 March 2012
Revenue (236,200 – 8,000 (see below))
Cost of sales (W1)
Gross profit
Operating expenses
Finance costs (W2)
Profit before tax
Taxation (W3)
Net profit for the period
$000
228,200
(150,000)
78,200
(12,400)
(5,850)
59,950
(13,100)
46,850
The sale of goods to Funders is an attempt to ‘window dress’ the statement of
financial position by improving its liquidity position. It is in substance a (short
term) loan with a finance cost of $250,000.
(b)
Allgone – Statement of changes in equity – Year to 31 March 2012
Balance at 1 April 2011
Material error (see below)
Surplus on revaluation of land
and buildings (W4)
178
Share Revaluation
reserve
capital
$000
$000
60,000
5,000
―――
60,000
―――
5,000
40,000
Retained
earnings
Total
$000
4,350
(32,000)
―――
(27,650)
$000
89,350
(32,000)
―――
57,350
40,000
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Share Revaluation
reserve
capital
$000
$000
Transferred to realised profits re
building: (35,000/35 years)
Deficit on value of investments
Net profit for the period
(1,000)
(1,200)
Retained
earnings
Total
$000
$000
1,000
(1,200)
46,850
46,850
―――
―――
―――
――――
Balance at 31 March 2012
60,000
42,800
20,200
123,000
―――
―――
―――
――――
The discovery of the major fraud is not an extraordinary item. As it occurred in
previous years and is material it should be treated as a prior period adjustment.
(c)
Allgone – Statement of financial position as at 31 March 2012
$000
$000
Assets
Non-current assets
2,000
Software (W4)
Property, plant and equipment (W4)
175,000
Investments (12,000 – 1,200 (W4))
10,800
187,800
Current assets
Inventory (W1)
14,300
Trade receivables
23,000
37,300
Total assets
225,100
Equity and liabilities:
Ordinary shares of 25c each
60,000
Reserves:
Retained earnings
20,200
Revaluation reserve (W4)
42,800
63,000
123,000
Non-current liabilities (W5)
64,800
Current liabilities
Trade payables
15,200
Bank overdraft
350
In substance loan from Funders
8,000
Accrued finance costs (1,200 + 250 (W2))
1,450
Taxation
11,300
Preference dividend
1,000
37,300
Total equity and liabilities
225,100
Workings
(W1) Cost of sales:
Opening inventory
Purchases
© Emile Woolf Publishing Limited
$000
19,450
127,850
179
Paper F7: Financial Reporting (International)
$000
2,000
3,000
12,000
(14,300)
150,000
Depreciation (W4) – software
Depreciation (w (iv)) – building
Depreciation (w (iv)) – plant
Closing inventory (8,500 – 200 + 6,000 see below)
The slow moving inventory requires a write down of $200,000 to net
realisable value of $300,000 ($500,000 – $200,000). The cost of the goods of
the sale and repurchase agreement ($6 million) should be treated as
inventory.
(W2) Finance costs:
Per question
Accrued loan note interest (see below)
Accrued facilitating fee for in substance a loan (see below)
Preference dividend (10% x 20,000)
$000
2,400
1,200
250
2,000
5,850
The loan notes have been in issue for nine months, but only six months’
interest has been paid. Accrued interest of $1,200,000 is required.
The substance of the sale and repurchase agreement is that it is a loan with
effective interest of $250,000, the facilitating fee. Therefore this has been
treated as a finance cost.
(W3) Taxation:
Provision for year
Deferred tax (see below)
$000
11,300
1,800
13,100
The difference between the tax base of the assets and their carrying value of
$16 million would require a provision in the statement of financial position
for deferred tax of $4.8 million (at 30%). The opening provision is $3
million, thus an additional charge of $1·8 million is required.
(W4) Non-current assets/depreciation/revaluation:
The software was purchased on 1 April 2009 with a five year life. The
depreciation for the year to 31 March 2012 will be for the third year of its
life. Using the sum of the digits method this will be 3/15 of the cost i.e. $2
million. This will give accumulated depreciation of $8 million ($6m brought
forward+ $2m).
Land and buildings
Cost 1 April 2004
Five years’ depreciation (80,000 × 5/40)
Carrying value prior to revaluation
Valuation 1 April 2011
180
Buildings
Land
$000
$000
80,000
20,000
(10,000)
―――
70,000
105,000
―――
25,000
―――
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Land and buildings
Buildings
Land
$000
$000
Revaluation surplus
35,000
―――
Depreciation year to 31 March 2012 (105,000/35 years)
5,000
―――
3,000
Plant depreciation ((84,300 – 24,300) × 20%)
12,000
Summarising:
Cost/
valuation
Land and building (25 + 105)
Plant and equipment
Property, plant and equipment
Software
Accumulated
depreciation
Net book
value
$000
$000
$000
130,000
3,000
127,000
84,300
36,300
48,000
214,300
―――
10,000
―――
39,300
175,000
―――
―――
8,000
2,000
―――
―――
Revaluation reserve:
Given in the trial balance
45,000
Loss of value of investments (12,000 – (12,000 × 2.25/2.50))
(1,200)
Transfer to realised profits re building (35,000/35 years)
(1,000)
Balance at 31 March 2005
42,800
(W5) Non-current liabilities:
Deferred tax (3,000 + 1,800) (W3)
4,800
12% loan note
40,000
10% Irredeemable preference shares
20,000
64,800
22
Tourmalet
(a)
The sale of the plant has been incorrectly treated on two counts. Firstly even if it
were a genuine sale it should not have been included in sales and cost of sales,
rather it should have been treated as the disposal of a non-current asset. Only the
profit or loss on the disposal would be included in the income statement
(requiring separate disclosure if material). However even this treatment would
be incorrect. As Tourmalet will continue to use the plant for the remainder of its
useful life, the substance of this transaction is a secured loan. Thus the receipt of
$50 million for the ‘sale’ of the plant should be treated as a loan. The rentals,
when they are eventually paid, will be applied partly as interest (at 12% per
annum) and the remainder will be a capital repayment of the loan. In the income
statement an accrual for loan interest of 12% per annum on $50 million for four
months ($2 million) is required.
© Emile Woolf Publishing Limited
181
Paper F7: Financial Reporting (International)
(b)
Tourmalet – Income statement for the year ending 30 September 2012
$000
Continuing operations
Revenue (313,000 – 50,000 – 15,200 (discontinued)
Cost of sales (W1)
Gross profit
Distribution costs
Administrative expenses (W2)
Finance costs (W3)
Loss on investment properties ($10 million – $9.8 million)
Investment income
Profit before tax
Income tax expense (9,200 – 2,100)
Profit for the period from continuing operations
Discontinued operations
Loss for the period from discontinued operations
(15,200 – 16,000 – 3,200 – 1,500) (W4)
Profit for the period
(c)
247,800
(128,800)
119,000
(26,400)
(20,000)
(3,800)
(200)
1,200
69,800
(7,100)
62,700
(5,500)
57,200
Tourmalet: Statement of changes in equity – Year to 30 September 2012
Balance at 1 October 2011
Share
Revaluation
$000
$000
50,000
18,500
Retained
i
$000
Profit for the period
Transferred to realised profit
(500)
Ordinary dividends paid
Balance at 31 March 2012
―――
50,000
―――
―――
18,000
―――
Total
$000
47,800
116,300
57,200
57,200
500
-
(2,500)
(2,500)
―――― ――――
103,000
171,000
―――― ――――
Note: IAS 32 Financial Instruments: Presentation says redeemable preference shares
have the substance of debt and should be treated as non-current liabilities and
not as equity. This also means that preference dividends are treated as a finance
cost in the income statement.
Workings
(W1) Cost of sales
Opening inventory
Purchases
Transfer to plant (see (a))
Depreciation (W2)
Closing inventory (28.5 million – 2.5 million see below)
182
$000
26,550
158,450
(40,000)
25,800
(26,000)
144,800
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
The slow-moving inventory should be written down to its estimated
realisable value. Despite the optimism of the Directors, it would seem
prudent to base the realisable value on the best offer so far received (i.e. $2
million).
(W2) Depreciation
$000
3,000
14,800
8,000
25,800
Buildings 120/40 years
Plant – per trial balance ((98,600 – 24,600) × 20%)
Plant – plant treated as sold (40,000/5 years)
Note: Investment properties do not require depreciating under the fair
value model in IAS 40. Instead they are revalued each year with the surplus
or deficit being taken to income.
For information only:
In the statement of financial
position
Land and buildings
Plant – per trial balance
Plant incorrectly treated as sold
Cost/
valuation
$000
150,000
98,600
40,000
Accumulated
depreciation
$000
12,000
39,400
8,000
Net
book
value
$000
138,000
59,200
32,000
229,200
(W3) Finance costs: income statement
Accrued interest on in-substance loan (see (a))
Preference dividends (30,000 × 6%)
$000
2,000
1,800
3,800
(W4) The penalty on the lease has been accrued for as it would appear to be
unlikely that the permission for change of use will be granted. The $1.5m
has therefore been included in the loss from discontinuing operations.
23
Chamberlain
(a)
Chamberlain – Income statement – Year to 30 September 2012
Revenue (246,500 + 50,000 (W1)
Cost of sales (W2)
Gross profit
Operating expenses
Profit before interest and tax
Interest expense (1,500 + 1,500 accrued)
© Emile Woolf Publishing Limited
$000
296,500
(151,500)
–––––––––
145,000
(29,000)
–––––––––
116,000
(3,000)
–––––––––
183
Paper F7: Financial Reporting (International)
Chamberlain – Income statement – Year to 30 September 2012
$000
113,000
(18,500)
–––––––––
94,500
–––––––––
Profit before tax
Income tax (22,000 – (17,500 – 14,000))
Profit for the period
(b)
Chamberlain – Statement of financial position as at 30 September 2012
Non-current assets
$000
$000
Property, plant and equipment (W3)
442,000
Development costs (40,000 – 25,000)
15,000
––––––––
457,000
Current assets
Inventory
38,500
Amounts due from construction contracts (W1)
25,000
Trade receivables
48,000
Bank
12,500
–––––––
124,000
––––––––
Total assets
581,000
––––––––
Equity and liabilities
Capital and reserves:
Ordinary share capital
200,000
Retained profits – 1 October 2011
162,000
– Year to 30 September 2012 (less dividends paid)
86,500
––––––––
248,500
––––––––
448,500
Non-current liabilities (W4)
64,000
Current liabilities
Trade payables
45,000
Accrued finance costs
1,500
Taxation
22,000
–––––––
68,500
––––––––
Total equity and liabilities
581,000
––––––––
Workings (all figures in $000)
(W1) Construction contract:
$000
125,000
(75,000)
50,000
Contract price
Estimated cost
Estimated total profit
Contract cost for year (35,000 – 5,000 inventory on site)
Estimated cost
Percentage complete (30,000/75,000)
184
30,000
75,000
40%
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$000
Year to 30 September 2012
Contract revenue – included in sales (125,000 × 40%)
Contract costs – included in cost of sales (35,000 – 5,000)
Amounts due from customers:
Cost to date plus profit taken (35,000 + 20,000)
Less progress billings received
50,000
(30,000)
55,000
(30,000)
25,000
(W2) Cost of sales:
Opening inventory
Purchases
Contract costs (W1)
Research costs
Depreciation (W3) – buildings
– plant
Closing inventory
35,500
78,500
30,000
25,000
6,000
15,000
(38,500)
151,500
(W3) Non-current assets/depreciation
Buildings
A cost of $240,000 ($403,000 – $163,000 for the land) over a 40 year life gives
annual depreciation of $6,000 per annum.
This gives accumulated depreciation at 30 September 2012 of $66,000
($60,000 + $6,000) and a carrying value of $337,000 ($403,000 – $66,000).
Plant
The carrying value prior to the current year’s depreciation is $120,000
($180,000 – $60,000). Depreciation at 12.5% on the reducing balance basis
gives an annual charge of $15,000. This gives a carrying value at 30
September 2012 of $105,000 ($120,000 – $15,000). Therefore the carrying
value of property, plant and equipment at 30 September 2012 is $442,000
($337,000 + $105,000).
(W4) Non-current liabilities
6% loan note
Deferred tax
24
50,000
14,000
64,000
Tadeon
(a)
Tadeon – Income statement – Year to 30 September 2012
Revenue
Cost of sales (w (i))
Gross profit
Operating expenses (40,000 + 1,200 (w (ii)))
Investment income
© Emile Woolf Publishing Limited
$’000
$’000
277,800
(144,000)
⎯⎯⎯⎯
133,800
(41,200)
2,000
185
Paper F7: Financial Reporting (International)
Finance costs – finance lease (w (ii))
– loan (w (iii))
Profit before tax
Income tax expense (w (iv))
$’000
(1,500)
(2,750)
⎯⎯⎯⎯
(4,250)
⎯⎯⎯⎯
90,350
(36,800)
⎯⎯⎯⎯
Profit for the period
(b)
$’000
53,550
Tadeon – Statement of financial position as at 30
September 2012
Non-current assets
Property, plant and equipment (w (v))
Investments at amortised cost
⎯⎯⎯⎯
$’000
$’000
299,000
42,000
⎯⎯⎯⎯
341,000
Current assets
Inventories
Trade receivables
Total assets
Equity and liabilities
Capital and reserves:
Equity shares of 20 cents each fully paid (w
(vi)) Reserves
Share premium (w (vi))
Revaluation reserve (w (v)) Retained
earnings (w (vii))
Non-current liabilities
2% Loan note (w (iii)) Deferred tax (w (iv))
Finance lease obligation (w (ii))
Current liabilities
Trade payables
Accrued lease finance costs (w (ii))
Finance lease obligation (w (ii))
Bank overdraft
Income tax payable (w (iv))
Total equity and liabilities
Workings (note figures in brackets are in $’000)
(i)
Cost of sales:
Per trial balance
Depreciation (12,000 + 5,000 + 9,000 w (v))
(ii)
186
33,300
53,500
⎯⎯⎯⎯
86,800
⎯⎯⎯⎯
427,800
⎯⎯⎯⎯
200,000
28,000
16,000
42,150
86,150
⎯⎯⎯⎯
⎯⎯⎯⎯
51,750
14,800
10,500
77,050
⎯⎯⎯⎯
18,700
1,500
4,500
1,900
38,000
⎯⎯⎯⎯
286,150
64,600
⎯⎯⎯⎯
427,800
⎯⎯⎯⎯
$’000
118,000
26,000
––––––––
144,000
––––––––
Vehicle rentals/finance lease: The total amount of vehicle rentals is $6·2 million
of which $1·2 million are operating lease rentals and $5 million is identified as
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
finance lease rentals. The operating rentals have been included in operating
expenses.
Finance lease
$’000
Fair value of vehicles
20,000
First rental payment – 1 October 2011
(5,000)
––––––––
Capital outstanding to 30 September 2012
15,000
Accrued interest 10% (current liability)
1,500
––––––––
Total outstanding 30 September 2012
16,500
––––––––
In the year to 30 September 2013 (i.e. on 1 October 2012) the second rental
payment of $6 million will be made, of this $1·5 million is for the accrued interest
for the previous year, thus $4·5 million will be a capital repayment. The
remaining $10·5 million (16,500 – (4,500 + 1,500)) will be shown as a non-current
liability.
(iii)
Although the loan has a nominal (coupon) rate of only 2%, amortisation of the
large premium on redemption, gives an effective interest rate of 5·5% (from
question). This means the finance charge to the income statement will be a total
of $2·75 million (50,000 x 5·5%). As the actual interest paid is $1 million an
accrual of $1·75 million is required. This amount is added to the carrying amount
of the loan in the statement of financial position.
(iv)
Income tax and deferred tax
The income statement charge is made up as follows:
Current year’s provision
Deferred tax (see below)
$'000
38,000
(1,200)
36,800
There are $74 million of taxable temporary differences at 30 September 2012.
With an income tax rate of 20%, this would require a deferred tax liability of
$14·8 million (74,000 x 20%). $4 million ($20m x 20%) is transferred to deferred
tax in respect of the revaluation of the leasehold property (and debited to the
revaluation reserve), thus the effect of deferred tax on the income statement is a
credit of $1·2 million (14,800 – 4,000 – 12,000 b/f).
(v)
Non-current assets/depreciation:
Non-leased plant
This has a carrying amount of $96 million (181,000 – 85,000) prior to depreciation
of $12 million at 121/2% reducing balance to give a carrying amount of $84
million at 30 September 2012.
The leased vehicles will be included in non-current assets at their fair value of
$20 million and depreciated by $5 million (four years straight-line) for the year
ended 30 September 2012 giving a carrying amount of $15 million at that date.
The 25 year leasehold property is being depreciated at $9 million per annum
(225,000/25 years). Prior to its revaluation on 30 September 2012 there would be
a further year’s depreciation charge of $9 million giving a carrying amount of
$180 million (225,000 – (36,000 + 9,000)) prior to its revaluation to $200 million.
Thus $20 million would be transferred to a revaluation reserve. The question says
the revaluation gives rise to $20 million of the deductible temporary differences,
at a tax rate of 20%, this would give a credit to deferred tax of $4 million which is
© Emile Woolf Publishing Limited
187
Paper F7: Financial Reporting (International)
debited to the revaluation reserve to give a net balance of $16 million.
Summarising:
25 year leasehold property
Non-leased plant
Leased vehicles
(vi)
Cost/
Accumulated
valuation depreciation
$,000
$,000
200,000
nil
181,000
97,000
20,000
5,000
401,000
102,000
Carrying
amount
$,000
200,000
84,000
15,000
299,000
Suspense account
The called up share capital of $150 million in the trial balance represents 750
million shares (150m/0·2) which have a market value at 1 October 2011 of $600
million (750m x 80 cents). A yield of 5% on this amount would require a $30
million dividend to be paid.
A fully subscribed rights issue of one new share for every three shares held at a
price of 32c each would lead to an issue of 250 million (150m/0·2 x 1/3). This
would yield a gross amount of $80 million, and after issue costs of $2 million,
would give a net receipt of $78 million. This should be accounted for as $50
million (250m x 20 cents) to equity share capital and the balance of $28 million to
share premium.
The receipt from the share issue of $78 million less the payment of dividends of
$30 million reconciles the suspense account balance of $48 million.
(vii) Retained earnings
$,000
At 1 October 2011
18,600
Year to 30 September 2012
53,550
less dividends paid (w (vi))
25
(30,000)
–––––––
42,150
–––––––
Llama
(a)
Llama – Income statement – Year ended 30 September 2012
$’000
Revenue
Cost of sales (w (i))
Gross profit
Distribution costs (11,000 + 1,000 depreciation)
Administrative expenses (12,500 + 1,000 depreciation)
(12,000)
(13,500)
–––––––
2,200
600
–––––––
Investment income
Gain on fair value of investments (27,100 – 26,500)
Finance costs (w (ii))
Profit before tax
Income tax expense (18,700 – 400 – (11,200 – 10,000) deferred tax)
Profit for the period
188
$’000
180,400
(81,700)
98,700
–––––––
(25,500)
2,800
(2,400)
–––––––
73,600
(17,100)
–––––––
56,500
–––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(b)
Llama – Statement of financial position as at 30 September 2012
Assets
Non-current assets
Property, plant and equipment (w (iv))
Investments at fair value through profit and loss
Current assets
Inventory
Trade receivables
Total assets
Equity and liabilities
Equity
Equity shares of 50 cents each ((60,000 + 15,000) w (iii))
Share premium (w (iii))
Revaluation reserve (14,000 – 3,000 (w (iv)))
Retained earnings (56,500 + 25,500)
Non-current liabilities
2% loan note (80,000 + 1,600 (w (ii)))
Deferred tax (40,000 x 25%)
Current liabilities
Trade payables
Bank overdraft
Current tax payable
Total equity and liabilities
$’000
$’000
228,500
27,100
–––––––
255,600
37,900
35,100
73,000
––––––– –––––––
328,600
–––––––
75,000
9,000
11,000
82,000 102,000
––––––– –––––––
177,000
81,600
10,000
–––––––
91,600
34,700
6,600
18,700
60,000
––––––– –––––––
328,600
–––––––
Workings (monetary figures in brackets are in $’000)
(i)
Cost of sales:
Per question
Plant capitalised (w (iv))
Depreciation (w (iv)) – buildings
– plant
(ii)
$’000
89,200
(24,000)
3,000
13,500
––––––
81,700
––––––
The loan has been in issue for six months. The total finance charge should
be based on the effective interest rate of 6%.
This gives a charge of $2·4 million (80,000 x 6% x 6/12). As the actual
interest paid is $800,000 an accrual (added to the carrying amount of the
loan) of $1·6 million is required.
(iii)
The rights issue was 30 million shares (60 million/50 cents is 120 million
shares at 1 for 4) at a price of 80 cents this would increase share capital by
$15 million (30 million x 50 cents) and share premium by $9 million (30
million x 30 cents).
© Emile Woolf Publishing Limited
189
Paper F7: Financial Reporting (International)
(iv)
Non-current assets/depreciation:
Land and buildings:
On 1 October 2011 the value of the buildings was $100 million (130,000 –
30,000 land). The remaining life at this date was 20 years, thus the annual
depreciation charge will be $5 million (3,000 to cost of sales and 1,000 each
to distribution and administration). Prior to the revaluation at 30
September 2012 the carrying amount of the building was $95 million
(100,000 – 5,000). With a revalued amount of $92 million, this gives a
revaluation deficit of $3 million which should be debited to the revaluation
reserve. The carrying amount of land and buildings at 30 September 2012
will be $122 million (92,000 buildings + 30,000 land (unchanged)).
Plant
The existing plant will be depreciated by $12 million ((128,000 – 32,000) x
121/2%) and have a carrying amount of $84 million at 30 September 2012.
The plant manufactured for internal use should be capitalised at $24
million (6,000 + 4,000 + 8,000 + 6,000).
Depreciation on this will be $1·5 million (24,000 x 121/2% x 6/12). This will
give a carrying amount of $22·5 million at 30 September 2012. Thus total
depreciation for plant is $13·5 million with a carrying amount of $106·5
million (84,000 + 22,500)
Summarising the carrying amounts:
Land and buildings
Plant
$’000
122,000
106,500
–––––––
228,500
–––––––
Property, plant and equipment
(c)
Earnings per share (eps) for the year ended 30 September 2012
Theoretical ex rights value
Holding (say)
Issue (1 for 4)
$
100
at $1
100
at 80 cents
20
25
––––
––––
120
New holding
125 ex rights price is 96 cents
––––
––––
Weighted average number of shares
120,000,000
x 9/12 x 100/96
93,750,000
150,000,000
(120 x 5/4) x 3/12
37,500,000
––––––––––
131,250,000
––––––––––
Earnings per share ($56,500,000/131,250,000) 43 cents
190
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
26
Candel
(a)
Candel – Statement of comprehensive income for the year ended 30 September
2012
$’000
297,500
(225,400)
–––––––––
72,100
(14,500)
(21,900)
(1,400)
–––––––––
34,300
(11,600)
–––––––––
22,700
Revenue (300,000 – 2,500)
Cost of sales (w (i))
Gross profit
Distribution costs
Administrative expenses (22,200 – 400 + 100 see note below)
Finance costs (200 + 1,200 (w (ii)))
Profit before tax
(Income tax expense (11,400 + (6,000 – 5,800 deferred tax))
Profit for the year
Other comprehensive income
Loss on leasehold property revaluation (w (iii))
(4,500)
–––––––––
Total comprehensive income for the year
18,200
–––––––––
Note: as it is considered that the outcome of the legal action against Candel is
unlikely to succeed (only a 20% chance) it is inappropriate to provide for any
damages. The potential damages are an example of a contingent liability which
should be disclosed (at $2 million) as a note to the financial statements. The
unrecoverable legal costs are a liability (the start of the legal action is a past
event) and should be provided for in full.
(b)
Candel – Statement of changes in equity for the year ended 30 September 2012
Balances at 1 October 2011
Dividend
Comprehensive income
Balances at 30 September 2012
(c)
Equity
shares
$’000
50,000
Revaluation
reserve
$’000
10,000
–––––––
50,000
–––––––
(4,500)
––––––
5,500
––––––
Retained
earnings
$’000
24,500
(6,000)
22,700
–––––––
41,200
–––––––
Total
equity
$’000
84,500
(6,000)
18,200
–––––––
96,700
–––––––
Candel – Statement of financial position as at 30 September 2012
Assets
Non-current assets (w (iii))
Property, plant and equipment (43,000 + 38,400)
Development costs
Current assets
Inventory
Trade receivables
Total assets
© Emile Woolf Publishing Limited
$’000
$’000
81,400
14,800
––––––––
96,200
20,000
43,100
–––––––
63,100
––––––––
159,300
––––––––
191
Paper F7: Financial Reporting (International)
$’000
Equity and liabilities:
Equity (from (b))
Equity shares of 25 cents each
Revaluation reserve
Retained earnings
Non-current liabilities
Deferred tax
8% redeemable preference shares (20,000 + 400 (w (ii)))
Current liabilities
Trade payables (23,800 – 400 + 100 – re legal action)
Bank overdraft
Current tax payable
Total equity and liabilities
$’000
50,000
5,500
41,200
–––––––
6,000
20,400
–––––––
23,500
1,300
11,400
–––––––
46,700
––––––––
96,700
26,400
36,200
––––––––
159,300
––––––––
Workings (figures in brackets in $’000)
(i)
Cost of sales: $’000
Per trial balance
Depreciation (w (iii)) – leasehold property
– plant and equipment
Loss on disposal of plant (4,000 – 2,500)
Amortisation of development costs (w (iii))
Research and development expensed (1,400 + 2,400 (w (iii)))
(ii)
(iii)
204,000
2,500
9,600
1,500
4,000
3,800
––––––––
225,400
––––––––
The finance cost of $1·2 million for the preference shares is based on the
effective rate of 12% applied to $20 million issue proceeds of the shares for
the six months they have been in issue (20m x 12% x 6/12). The dividend
paid of $800,000 is based on the nominal rate of 8%. The additional $400,000
(accrual) is added to the carrying amount of the preference shares in the
statement of financial position. As these shares are redeemable they are
treated as debt and their dividend is treated as a finance cost.
Non-current assets:
Leasehold property
Valuation at 1 October 2011
Depreciation for year (20 year life)
Carrying amount at date of revaluation
Valuation at 30 September 2012
Revaluation deficit
192
50,000
(2,500)
––––––––
47,500
(43,000)
––––––––
4,500
––––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Plant and equipment per trial balance (76,600 – 24,600)
Disposal (8,000 – 4,000)
Depreciation for year (20%)
Carrying amount at 30 September 2012
Capitalised/deferred development costs
Carrying amount at 1 October 2011 (20,000 – 6,000)
Amortised for year (20,000 x 20%)
Capitalised during year (800 x 6 months)
Carrying amount at 30 September 2012
$’000
52,000
(4,000)
––––––––
48,000
(9,600)
––––––––
38,400
––––––––
14,000
(4,000)
4,800
––––––––
14,800
––––––––
Note: development costs can only be treated as an asset from the point
where they meet the recognition criteria in IAS 38 Intangible assets. Thus
development costs from 1 April to 30 September 2012 of $4·8 million (800 x
6 months) can be capitalised. These will not be amortised as the project is
still in development. The research costs of $1·4 million plus three months’
development costs of $2·4 million (800 x 3 months) (i.e. those incurred
before 1 April 2012) are treated as an expense.
27
Sandown
(a)
Sandown –
Statement of comprehensive income for the year ended 30 September 2011
$’000
Revenue (380,000 – 4,000 (w (i)))
376,000
Cost of sales (w (ii))
(265,300)
––––––––
Gross profit
110,700
Distribution costs
(17,400)
Administrative expenses (50,500 – 12,000 (w (iii)))
(38,500)
Investment income
1,300
Profit on sale of investments (w (iv))
2,200
Finance costs (w (v))
(1,475)
––––––––
Profit before tax
56,825
Income tax expense (16,200 + 2,100 – 1,500 (w (vi)))
(16,800)
––––––––
Profit for the year
40,025
––––––––
Other comprehensive income
Gain on available-for-sale investments (w (iv))
2,500
––––––––
Total other comprehensive income
2,500
––––––––
Total comprehensive income
42,525
––––––––
© Emile Woolf Publishing Limited
193
Paper F7: Financial Reporting (International)
(b)
Sandown – Statement of financial position as at 30 September 2011
Assets
Non-current assets
Property, plant and equipment (w (vii))
Intangible – brand (15,000 – 2,500 (w (ii)))
Equity investments (at fair value)
Current assets
Inventory
Trade receivables
Bank
Total assets
$’000
67,500
12,500
29,000
––––––––
109,000
38,000
44,500
8,000
––––––––
Equity and liabilities
Equity
Equity shares of 20 cents each
Equity option
Other reserve (w (viii))
Retained earnings (26,060 + 40,025 + 1,800 – 12,000 dividend (w (iii))
Non-current liabilities
Deferred tax (w (vi))
Deferred income (w (i))
5% convertible loan note (w (v))
Current liabilities
Trade payables
Deferred income (w (i))
Current tax payable 16,200
Total equity and liabilities
$’000
3,900
2,000
18,915
––––––––
42,900
2,000
61,100
––––––––
90,500
––––––––
199,500
––––––––
50,000
2,000
5,700
55,885
––––––––
113,585
24,815
––––––––
199,500
––––––––
Workings (figures in brackets in $’000)
(i)
IAS 18 Revenue requires that where sales revenue includes an amount for
after sales servicing and support costs then a proportion of the revenue
should be deferred. The amount deferred should cover the cost and a
reasonable profit (in this case a gross profit of 40%) on the services. As the
servicing and support is for three years and the date of the sale was 1
October 2010, revenue relating to two years’ servicing and support
provision must be deferred: ($1·2 million x 2/0·6) = $4 million. This is
shown as $2 million in both current and non-current liabilities.
(ii)
Cost of sales
Per question
Depreciation – building (50,000/50 years – see below)
– plant and equipment (42,200 – 19,700) x 40%))
Amortisation – brand (1,500 + 2,500 – see below)
Impairment of brand (see below)
194
246,800
1,000
9,000
4,000
4,500
––––––––
265,300
––––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
The cost of the building of $50 million (63,000 – 13,000 land) has
accumulated depreciation of $8 million at 30 September 2010 which is eight
years after its acquisition. Thus the life of the building must be 50 years.
The brand is being amortised at $3 million per annum (30,000/10 years).
The impairment occurred half way through the year, thus amortisation of
$1·5 million should be charged prior to calculation of the impairment loss.
At the date of the impairment review the brand had a carrying amount of
$19·5 million (30,000 – (9,000 + 1,500)). The recoverable amount of the
brand is its fair value of $15 million (as this is higher than its value in use of
$12 million) giving an impairment loss of $4·5 million (19,500 – 15,000).
Amortisation of $2·5 million (15,000/3 years x 6/12) is required for the
second-half of the year giving total amortisation of $4 million for the full
year.
(iii)
A dividend of 4·8 cents per share would amount to $12 million (50 million x
5 (i.e. shares are 20 cents each) x 4·8 cents). This is not an administrative
expense but a distribution of profits that should be accounted for through
equity.
(iv)
Profit on the sale of the investments has already been recorded at 2,200
(11,000 proceeds – 8,800 carrying amount)
The previous cumulative net gain on this investment is included in an
equity reserve. It should be transferred to retained earnings as a movement
in the statement of changes in equity(not through OCI). The transfer is:
(8,800 carrying amount – 7,000 original cost) = 1,800
The remaining investments of $26·5 million have a fair value of $29 million
at 30 September 2011 which gives a fair value increase (credited to other
reserve) of $2·5 million.
(v)
The finance cost of the convertible loan note is based on its effective rate of
8% applied to $18,440,000 carrying amount at 1 October 2010 = $1,475,000
(rounded). The accrual of $475,000 (1,475 – 1,000 interest paid) is added to
the carrying amount of the loan note giving a figure of $18,915,000 (18,440 +
475) in the statement of financial position at 30 September 2011.
(vi)
Deferred tax
credit balance required at 30 September 2011 (13,000 x 30%)
balance at 1 October 2010
credit (reduction in balance) to income statement
(vii) Non-current assets
Freehold property (63,000 – (8,000 + 1,000)) (w (ii))
Plant and equipment (42,200 – (19,700 + 9,000)) (w (ii))
Property, plant and equipment
(viii) Other reserve (re investments in equity)
At 1 October 2010
Transferred to retained earnings (w (iv))
Increase in year ((w (iv))
© Emile Woolf Publishing Limited
3,900
(5,400)
––––––––
1,500
––––––––
54,000
13,500
––––––––
67,500
––––––––
5,000
(1,800)
2,500
––––––––
5,700
––––––––
195
Paper F7: Financial Reporting (International)
28
Pricewell
(a)
Pricewell –
Statement of comprehensive income for the year ended 31 March 2011:
Revenue (310,000 + 22,000 (w (i)) – 6,400 (w (ii)))
Cost of sales (w (iii))
Gross profit
Distribution costs
Administrative expenses
Finance costs (4,160 (w (v)) + 1,248 (w (vi)))
Profit before tax
Income tax expense (4,500 +700 – (8,400 – 5,600 deferred tax)
Profit for the year
(b)
Pricewell – Statement of financial position as at 31 March 2011:
Assets
Non-current assets
Property, plant and equipment (24,900 + 41,500 w (iv))
Current assets
Inventory
Amount due from customer (w (i))
Trade receivables
Bank
Total assets
$’000
Current liabilities
Trade payables
Finance lease obligation (10,848 – 5,716) (w (vi)))
Current tax payable
Total equity and liabilities
Workings (figures in brackets in $’000)
(i)
Construction contract:
Selling price
Estimated cost
To date
To complete
Plant
Estimated profit
196
$’000
66,400
28,200
17,100
33,100
5,500
–––––––
Equity shares of 50 cents each
Retained earnings (w (vii))
Non-current liabilities
Deferred tax
Finance lease obligation (w (vi))
6% Redeemable preference shares (41,600 + 1,760 (w (v)))
$’000
325,600
(255,100)
–––––––––
70,500
(19,500)
(27,500)
(5,408)
–––––––––
18,092
(2,400)
–––––––––
15,692
–––––––––
5,600
5,716
43,360
–––––––
33,400
5,132
4,500
–––––––
83,900
––––––––
150,300
––––––––
40,000
12,592
––––––––
52,592
54,676
43,032
––––––––
150,300
––––––––
$'000
50,000
(12,000)
(10,000)
(8,000)
–––––––––
20,000
–––––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Work done is agreed at $22 million so the contract is 44% complete
(22,000/50,000).
Revenue
Cost of sales (= balance)
(ii)
(iii)
22,000
(13,200)
–––––––––
Profit to date (44% x 20,000)
8,800
–––––––––
Cost incurred to date materials and labour
12,000
Plant depreciation (8,000 x 6/24 months)
2,000
Profit to date
8,800
–––––––––
22,800
Cash received
(5,700)
–––––––––
Amount due from customer
17,100
–––––––––
Pricewell is acting as an agent (not the principal) for the sales on behalf of
Trilby. Therefore the income statement should only include $1·6 million
(20% of the sales of $8 million). Therefore $6·4 million (8,000 – 1,600) should
be deducted from revenue and cost of sales. It would also be acceptable to
show agency sales (of $1·6 million) separately as other income.
Cost of sales
Per question
Contract (w (i))
Agency cost of sales (w (ii))
Depreciation (w (iv)) – leasehold property
– owned plant ((46,800 – 12,800) x 25%)
– leased plant (20,000 x 25%)
Surplus on revaluation of leasehold property (w (iv))
(iv)
Non-current assets
$'000
234,500
13,200
(6,400)
1,800
8,500
5,000
(1,500)
–––––––––
255,100
–––––––––
Leasehold property
valuation at 31 March 2010
depreciation for year (14 year life remaining)
25,200
(1,800)
–––––––
carrying amount at date of revaluation
23,400
valuation at 31 March 2011
(24,900)
–––––––
revaluation surplus (to income statement – see below)
1,500
–––––––
The $1·5 million revaluation surplus is credited to the income statement as
this is the partial reversal of the $2·8 million impairment loss recognised in
the income statement in the previous period (i.e. year ended 31 March
2010).
Plant and equipment
– owned (46,800 – 12,800 – 8,500)
– leased (20,000 – 5,000 – 5,000)
– contract (8,000 – 2,000 (w (i)))
(v)
25,500
10,000
6,000
–––––––
Carrying amount at 31 March 2011
41,500
–––––––
The finance cost of $4,160,000 for the preference shares is based on the
effective rate of 10% applied to $41·6 million balance at 1 April 2010. The
accrual of $1,760,000 (4,160 – 2,400 dividend paid) is added to the carrying
© Emile Woolf Publishing Limited
197
Paper F7: Financial Reporting (International)
amount of the preference shares in the statement of financial position. As
these shares are redeemable they are treated as debt and their dividend is
treated as a finance cost.
(vi)
Finance lease liability
balance at 31 March 2010
interest for year at 8%
lease rental paid 31 March 2011
15,600
1,248
(6,000)
–––––––
10,848
868
(6,000)
–––––––
5,716
–––––––
total liability at 31 March 2011
interest next year at 8%
lease rental due 31 March 2012
total liability at 31 March 2012
(vii) Retained earnings
balance at 1 April 2010
profit for year
equity dividend paid
4,900
15,692
(8,000)
–––––––
12,592
–––––––
balance at 31 March 2011
29
Dune
(a)
Dune – Income statement for the year ended 31 March 2010
Revenue (400,000 – 8,000 + 12,000 (w (i) and (ii)))
Cost of sales (w (iii))
Gross profit
Distribution costs
Administrative expenses (34,200 – 500 loan note issue costs)
Investment income
Profit (gain) on investments at fair value through profit or loss
(28,000 – 26,500)
Finance costs (200 + 1,950 (w (iv)))
Profit before tax
Income tax expense (12,000 – 1,400 – 1,800 (w (v)))
Profit for the year
(b)
Dune – Statement of financial position as at 31 March 2010
Assets
Non-current assets
Property, plant and equipment (w (vi))
Investments at fair value through profit or loss
Current assets
Inventory
Construction contract –
amounts due from customer (w (ii))
Trade receivables (40,700 – 8,000 (w (i)))
198
$’000
$’000
404,000
(315,700)
–––––––
88,300
(26,400)
(33,700)
1,200
1,500
(2,150)
–––––––
28,750
(8,800)
–––––––
19,950
–––––––
$’000
46,400
28,000
–––––––
74,400
48,000
13,400
32,700
–––––––
94,100
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Non-current assets held for sale (w (iii))
$’000
Total assets
Equity and liabilities
Equity
Equity shares of $1 each
Retained earnings (38,400 + 19,950 – 10,000 dividend paid)
Non-current liabilities
Deferred tax (w (v))
5% loan notes (2012) (w (iv))
Current liabilities
Trade payables
Bank overdraft
Accrued loan note interest (w (iv))
Current tax payable
Total equity and liabilities
4,200
20,450
–––––––
52,000
4,500
500
12,000
–––––––
$’000
33,500
–––––––
202,000
–––––––
60,000
48,350
–––––––
108,350
24,650
69,000
––––––––
202,000
–––––––
Workings (figures in brackets in $’000)
(i)
This appears to be a ‘cut off’ error in that Dune has invoiced goods that are
still in inventory. The required adjustment is to remove the sale of $8
million (6,000 x 100/75) from revenue and trade receivables. No adjustment
is required to cost of sales or closing inventory.
(ii)
Construction contract:
Agreed selling price
Costs to date
Costs to complete
Plant (12,000 – 3,000)
Total estimated profit
$’000
8,000
15,000
9,000
–––––––
Amounts for inclusion in the
income statement for the year ended 31 March 2010
Revenue (40,000 x 30%)
Cost of sales (balance)
Gross profit (8,000 x 30%)
Amounts for inclusion in the statement of
financial position as at 31 March 2010
Cost to date – materials, labour and other direct costs
Plant depreciation ((12,000 – 3,000) x 6/18)
Profit to date
Payments received
Amounts due from customer
© Emile Woolf Publishing Limited
$’000
40,000
(32,000)
––––––––
8,000
––––––––
12,000
(9,600)
––––––––
2,400
––––––––
8,000
3,000
––––––––
11,000
2,400
––––––––
13,400
(nil)
––––––––
13,400
––––––––
199
Paper F7: Financial Reporting (International)
(iii)
Cost of sales
$’000
Per question
294,000
Construction contract (w (ii))
9,600
Depreciation of leasehold property (see below)
1,500
Impairment of leasehold property (see below)
4,000
Depreciation of plant and equipment ((67,500 – 23,500) x 15%) 6,600
––––––
315,700
––––––
The leasehold property must be classed as a non-current asset held for sale
from 1 October 2009 at its fair value less costs to sell. It must be depreciated
for six months up to this date (after which depreciation ceases). This is
calculated at $1·5 million (45,000/15 years x 6/12). Its carrying amount at 1
October 2009 is therefore $37·5 million (45,000 – (6,000 + 1,500)).
Its fair value less cost to sell at this date is $33·5 million ((40,000 x 85%) –
500). It is therefore impaired by $4 million (37,500 – 33,500).
(iv)
The finance cost of the loan note, at the effective rate of 10% applied to the
correct carrying amount of the loan note of $19·5 million is, $1·95 million
(the issue costs must be deducted from the proceeds of the loan note; they
are not an administrative expense). The interest actually paid is $500,000
(20,000 x 5% x 6/12); however, a further $500,000 needs to be accrued as a
current liability (as it will be paid soon). The difference between the total
finance cost of $1·95 million and the $1 million interest payable is added to
the carrying amount of the loan note to give $20·45 million (19,500 + 950)
for inclusion as a non-current liability in the statement of financial position.
(v)
Deferred tax
Provision required at 31 March 2010 (14,000 x 30%)
Provision at 1 April 2009
Credit (reduction in provision) to income statement
(vi) Property, plant and equipment
Property, plant and equipment (67,500 – 23,500 – 6,600)
Construction plant (12,000 – 3,000)
30
37,400
9,000
––––––––
46,400
––––––––
Cavern
(a)
Cavern – Statement of comprehensive income for the year ended 30 September
2010
Revenue
Cost of sales (w (i))
Gross profit
Distribution costs
Administrative expenses (25,000 – 18,500 dividends (w (iii)))
Investment income
Finance costs (300 + 400 (w (ii)) + 3,060 (w (iv)))
200
4,200
(6,000)
––––––––
1,800
––––––––
$’000
182,500
(137,400)
–––––––
45,100
(8,500)
(6,500)
700
(3,760)
–––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$’000
27,040
(6,250)
–––––––
20,790
–––––––
Profit before tax
Income tax expense (5,600 + 900 – 250 (w (v)))
Profit for the year
Other comprehensive income
Loss on available-for-sale investments (15,800 – 13,500)
Gain on revaluation of land and buildings (w (ii))
(b)
(2,300)
800
–––––––
Total other comprehensive losses for the year
(1,500)
–––––––
Total comprehensive income
19,290
–––––––
Craven – Statement of changes in equity for the year ended 30 September 2010
Share
capital
Balance at
1 October 2009
Rights issue (w (iii))
Dividends (w (iii))
Comprehensive
income
Share
premium
$’000
$’000
40,000
10,000
nil
11,000
Other Revaluation Retained
equity
reserve
earnings
reserve
$’000
$’000
$’000
(18,500)
20,790
–––––––
19,290
–––––––
50,000
11,000
700
7,800
14,390
––––––– –––––––
––––––
–––––– –––––––
Cavern – Statement of financial position as at 30 September 2010
83,890
–––––––
–––––––
(2,300)
––––––
7,000
800
––––––
12,100
Balance at
30 September 2010
(c)
$’000
62,100
21,000
(18,500)
–––––––
3,000
Total
equity
Assets
Non-current assets
Property, plant and equipment (41,800 + 51,100 (w (ii)))
Available-for-sale investments
Current assets
Inventory
Trade receivables
Total assets
Equity and liabilities
Equity (see (b) above)
Equity shares of 20 cents each
Share premium
Other equity reserve
Revaluation reserve
Retained earnings
© Emile Woolf Publishing Limited
$’000
19,800
29,000
–––––––
11,000
700
7,800
14,390
–––––––
$’000
92,900
13,500
––––––––
106,400
48,800
––––––––
155,200
––––––––
50,000
33,890
––––––––
83,890
201
Paper F7: Financial Reporting (International)
$’000
Non-current liabilities
Provision for decontamination costs (4,000 + 400 (w (ii))) 4,400
8% loan note (w (iv))
31,260
Deferred tax (w (v))
3,750
–––––––
Current liabilities
Trade payables
21,700
Bank overdraft
4,600
Current tax payable
5,600
–––––––
Total equity and liabilities
Workings (monetary figures in brackets in $’000)
(i)
Cost of sales
Per trial balance 128,500
Depreciation of building (36,000/18 years)
Depreciation of new plant (14,000/10 years)
Depreciation of existing plant and equipment
((67,400 – 10,000 – 13,400) x 12·5%)
(ii)
Property, plant and equipment
$’000
39,410
31,900
––––––––
155,200
––––––––
2,000
1,400
5,500
––––––––
137,400
––––––––
The new plant of $10 million should be grossed up by the provision for the
present value of the estimated future decontamination costs of $4 million to
give a gross cost of $14 million. The ‘unwinding’ of the provision will give
rise to a finance cost in the current year of $400,000 (4,000 x 10%) to give a
closing provision of $4·4 million.
The gain on revaluation and carrying amount of the land and building will
be:
Valuation – 30 September 2009
Building depreciation (w (i))
(iii)
43,000
(2,000)
–––––––
Carrying amount before revaluation
41,000
Revaluation – 30 September 2010
41,800
–––––––
Gain on revaluation
800
–––––––
The carrying amount of the plant and equipment will be:
New plant (14,000 – 1,400)
12,600
Existing plant and equipment
(67,400 – 10,000 – 13,400 – 5,500)
38,500
–––––––
51,100
–––––––
Rights issue/dividends paid
Based on 250 million (50 million x 5 – as shares are 20 cents each) shares in
issue at 30 September 2010, a rights issue of 1 for 4 on 1 April 2010 would
have resulted in the issue of 50 million new shares (250 million – (250
million x 4/5)). This would be recorded as share capital of $10 million
(50,000 x 20 cents) and share premium of $11 million (50,000 x (42 cents – 20
cents)).
The dividend of 3 cents per share paid on 30 November 2009 would have
been based on 200 million shares and been $6 million. The dividend of 5
202
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
cents per share paid on 31 May 2010 would have been based on 250 million
shares and been $12·5 million. Therefore the total dividends paid,
incorrectly included in administrative expenses, were $18·5 million.
(iv)
Loan note
The finance cost of the loan note, at the effective rate of 10% applied to the
carrying amount of the loan note of $30·6 million, is $3·06 million. The
interest actually paid is $2·4 million. The difference between these amounts
of $660,000 (3,060 – 2,400) is added to the carrying amount of the loan note
to give $31·26 million (30,600 + 660) for inclusion as a non-current liability
in the statement of financial position.
(v)
Deferred tax
Provision required at 30 September 2010
(15,000 x 25%)
Provision at 1 October 2009
Credit (reduction in provision)
to income statement
3,750
(4,000)
–––––
250
–––––
Financial statements – Amendment of draft financial
statements
31
Deltoid
(a)
Statement of financial position of Deltoid as at 31 March 2012
$000
$000
Non-current assets
Property, plant and equipment
(12,110 + 600 – 20 (W1) – 120 (W3))
12,570
Current assets
Inventory
3,850
Trade accounts receivable
2,450
Bank
250
6,550
Total assets
Equity and liabilities:
Equity
Ordinary shares of 50c each (2,000 + 500 bonus issue)
Conversion rights (equity element of convertible loan note (W4)
© Emile Woolf Publishing Limited
19,120
2,500
186
2,686
203
Paper F7: Financial Reporting (International)
Statement of financial position of Deltoid as at 31 March 2012
$000
Reserves
Share premium
Revaluation reserve (3,000 – 500 bonus issue)
Retained earnings (W1)
$000
1,000
2,500
3,409
6,909
9,595
Non-current liabilities
Environmental provision – revised amount
Finance lease (W3)
6% Convertible loan note (2,814 + 101 accrued interest (W4))
2,150
371
2,915
5,436
Current liabilities
Trade accounts payable
Accrued interest (W3)
Finance lease (W3)
Taxation
2,820
24
105
1,140
4,089
19,120
Total equity and liabilities
Workings (figures in $000):
(W1) Recalculation of retained earnings
Retained profit for year to 31 March 2012 from question
2,000
Additional depreciation of: plant (W2)
(20)
leased plant (W3)
(120)
(140)
150
Add back: lease rentals (W3)
Addition finance costs:
for loan notes (281 – 180) (W4)
(101)
for leased plant (W3)
(50)
Additional environmental provision (245 – 180)
(151)
(65)
Restated retained profit for year
1,794
Retained profit b/f at 1 April 2011 from question
2,500
Prior year effect of error in environmental provision:
(2,150 – 1,200 – 65)
(885)
Retained earnings in statement of financial position
3,409
(W2) Change of depreciation policy
Management
accounts
204
Financial
accounts
Year to 31 March 2011
((250 – 50) × 2,000/8,000)
50
(250 × 20%)
50
Year to 31 March 2012
((250 –50) × 800/8,000)
20
(200 × 20%)
40
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
The net effect of this is an increase in the depreciation charge of $20,000 for
the current year only.
(W3) Leased plant – This has been treated as an operating lease whereas it
should be treated as a finance lease:
Fair value/cost
1st payment 1 April 2011
Interest to 30 September 2011 (10% for 6 months)
2nd payment 1 October 2011
Capital outstanding at 31 March 2012
Accrued interest to 31 March 2012 (10% for 6 months)
Total outstanding at 31 March 2012
3rd payment due 1 April 2012
Interest to 30 September 2012 (10% for 6 months)
4th payment 1 October 2012
Capital outstanding at 31 March 2013
$000
600
(75)
525
26
551
(75)
476
24
500
(75)
425
21
446
(75)
371
Summarising:
„
The lease payments of $150,000 should be eliminated from expenses
and replaced with a depreciation charge of $120,000 ($600,000 × 20%
p.a.)
„
Interest of $50,000 ($26,000 paid, $24,000 accrued) should be included
as a finance cost.
„
Current liabilities are $24,000 for accrued interest and $105,000
($476,000 – $371,000) for the capital element of the finance lease.
„
Non-current liabilities are $371,000 for the capital element of the
finance lease.
(W4) The convertible loan note is a compound financial instrument and IAS 32
Financial Instruments: Presentation requires that the debt element and the
equity element of such instruments are accounted for separately. The
amount of the issue proceeds attributable to the conversion rights is classed
as equity. This amount is normally calculated as the ‘residue’ after the value
of the debt has been calculated:
Cash
flows
Year 1 interest
Year 2 interest
Year 3 interest
Year 4 interest, redemption premium and
capital
© Emile Woolf Publishing Limited
$000
180
180
180
3,480
Factor
at 10%
0.91
0.83
0.75
0.68
Present
value
$000
164
149
135
2,366
–––––
205
Paper F7: Financial Reporting (International)
Cash
flows
Factor
at 10%
Present
value
$000
$000
2,814
3,000
–––––
186
–––––
Total value of debt component
Proceeds of the issue
Equity component (residual amount)
The interest cost in the income statement should be increased from $180 to
$281 (10% of 2,814) by accruing $101, and this accrual should be added to
the carrying value of the debt.
(b)
Basic earnings per share
Profit attributable to ordinary shareholders (W1)
Number of shares in issue (2.5 million × 2)
Earnings per share
$1,794,000
5 million
35.9 cents
Diluted earnings per share
The potential dilution of the convertible loan note must be assessed. On an
assumed conversion to ordinary shares there would be an increase in shares of
1.5 million (3 million × 50/100). The effect on earnings is that there will also be an
increase based on the after tax finance costs saved. Although the finance costs are
$281,000, only the actual interest paid of $180,000 is available for tax relief, thus
the after tax increase in earnings will be $281,000 – ($180,000 × 25%) = $236,000.
The diluted earnings per share is:
Earnings (1,794 basic earnings + 236 above)
$2,030,000
Number of shares (5 million + 1.5 million)
6.5 million
Diluted earnings per share
32
31.2 cents
Tintagel
(a)
$000
Accumulated profits at 1 April 2011
Reversal of provision plant overhaul (W4)
Profit for the year to 31 March 2012
Lease rental charge added back (W1)
Lease interest (W1)
Depreciation (W2) – building
– owned plant
– leased plant
Loss on investment property (15,000 – 12,400)
Write down of inventory (W3)
Unrecorded trade payable
206
$000
52,500
6,000
58,500
47,500
3,200
(800)
2,600
22,000
2,800
(27,400)
(2,600)
(2,400)
(500)
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$000
6,000
(3,800)
(900)
Reversal of provision for plant overhaul (W4)
Increase in deferred tax (22.5 − 18.7)
Loan note interest (0.6 + 0.3 (W5))
$000
18,300
76,800
Accumulated profits at 31 March 2012
(b)
Tintagel – Statement of financial position as at 31 March 2012
$000
$000
Non-current assets
Freehold property (126,000 – 2,600 (W2))
123,400
Plant – owned (110,000 – 22,000 (W2))
88,000
– leased (11,200 – 2,800 (W2))
8,400
12,400
Investment property
232,200
Current assets
Inventory (60,400 – 2,400 (W3))
58,000
Trade receivables and prepayments
31,200
Bank
13,800
103,000
Total assets
335,200
Equity and liabilities
Capital and Reserves:
Ordinary shares of 25c each
Reserves:
Share premium
Accumulated profits – 31 March 2012 (part (a))
150,000
10,000
76,800
86,800
236,800
Non-current liabilities
Deferred tax
Finance lease obligations (W1)
8% Loan note (14,100 + 300 (W5))
22,500
5,600
14,400
42,500
Current liabilities
Trade payables (47,400 + 500)
Accrued lease finance interest (W1)
Accrued loan note interest (W5)
Finance lease obligation (W1)
Taxation
Total equity and liabilities
© Emile Woolf Publishing Limited
47,900
800
600
2,400
4,200
55,900
335,200
207
Paper F7: Financial Reporting (International)
Workings
(W1) Finance lease:
The lease has been incorrectly treated as an operating lease. Treating it as a
finance lease gives the following figures:
Cash price/recorded cost
First instalment (reversed in income statement)
Capital outstanding at 1 April 2011
$000
11,200
(3,200)
8,000
Interest at 10% p.a. to 31 March 2012 (current liability)
800
The capital outstanding of $8 million must be split between current and
non-current liabilities. The second instalment payable on 1 April 2012 will
contain $800,000 of interest (8,000 × 10%), therefore the capital element in
this payment will be $2.4 million and this is a current liability. This leaves
$5.6 million (8,000 – 2,400) as a non-current liability.
(W2) Depreciation
$000
Buildings (130,000 × 2%)
2,600
Non-leased plant (110,000 × 20%)
22,000
Leased plant (11,200 × 25%)
2,800
(W3) The damaged and slow moving inventory should be written down to its
estimated realisable value. This is $3.6 million ($4 million less sales
commission at 10%). Therefore the required write down is $2.4 million ($6
million – $3.6 million).
The unrecorded invoice would be an addition to purchases therefore a
deduction from profit.
(W4) A provision for a future major overhaul does not meet the definition of a
liability in IAS 37 Provisions, Contingent Liabilities and Contingent Assets and
must be reversed; this will increase the current year’s profit and the
previous year’s profit by $6 million each.
(W5) International accounting standards require issue costs, discounts on issue
and premiums on redemptions of loan instruments to be included as part
of the finance costs:
$000
Issue proceeds (15,000 × 95%)
Issue costs
Initial carrying value (as per suspense account)
208
$000
14,250
(150)
14,100
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$000
$000
Less
Payable on redemption (15,000 × 110%)
16,500
Total interest payments (15,000 × 8% × 4 years)
4,800
(21,300)
Total finance costs
(7,200)
The question states that these may be apportioned on a straight-line basis at
$1.8 million pa. The loan stock was issued on 1 October 2011 therefore an
interest charge of $900,000 is required for the current year. Of this $600,000
is represented by the accrual to be paid on 1 April 2012 and the remainder
is also accrued, but added to the carrying value of the loan stock in the
statement of financial position.
33
Harrington
(a)
Harrington:
$000
Restated income statement – Year to 31 March 2012
Sales revenues (13,700 – 300 plant sale proceeds)
13,400
Cost of sales (W1)
(8,910)
Gross profit
4,490
Operating expenses
(b)
(2,400)
Investment income (1,320 – 1,200 increase in market value)
120
Loan interest (25 + 25)
(50)
Profit before tax
2,160
Income tax expense (55 + 260 + (350 – 280) deferred tax)
(385)
Profit for the period
1,775
Statement of changes in equity – Year to 31 March 2012
Balance at 1 April 2011
Rights issue (see below)
Profit for the period (see (a))
Revaluation of property (W2)
Ordinary dividends paid
Transferred to realised profits
Balance at 31 March 2012
Retained
profits
$000
2,990
Revaluation
reserve
$000
nil
Ordinary
shares
$000
1,600
400
Share
premium
$000
40
560
–––––––
2,000
–––––––
–––––––
600
–––––––
1,775
1,800
(500)
80
–––––––
4,345
–––––––
(80)
–––––––
1,720
–––––––
The number of 25c ordinary shares at the year end is 8 million ($2 million × 4).
This is after a rights issue of 1 for 4. Thus the number of shares prior to the issue
would be 6.4 million (8 million × 4/5) and the rights issue would have been for
1.6 million shares. The rights issue price is 60c each which would be recorded as
© Emile Woolf Publishing Limited
209
Total
$000
4,630
960
1,775
1,800
(500)
––––––
8,665
––––––
Paper F7: Financial Reporting (International)
an increase in share capital of $400,000 (1.6 million × 25c) and an increase in share
premium of $560,000 (1.6 million × 35c).
(c)
Statement of financial position as at 31 March 2012
Non-current assets
Property, plant and equipment (6,710 + 1,350 (W2)
Investments (1,200 × 110%)
Current assets
Inventory
Trade receivables
Bank
$000
$000
8,060
1,320
9,380
1,750
2,450
350
4,550
13,930
Total assets
Equity and liabilities:
Ordinary shares of 25c each
Reserves (see (b)):
Share premium
Revaluation reserve (W2)
Retained earnings (from (b))
2,000
600
1,720
4,345
6,665
8,665
Non-current liabilities
10% loan note (issued 2004)
Deferred tax (1,400 × 25%)
500
350
850
Current liabilities
Trade payables
Accrued loan interest ((500 × 10%) – 25 paid)
Current tax payable
4,130
25
260
4,415
13,930
Total equity and liabilities
Workings (all figures in $000):
(W1) Cost of sales
As given in the question
Profit on sale of plant ((900 – 630) – 300)
Depreciation – plant (W3)
– buildings (W2)
Capitalised expenses net of error (W2)
9,200
(30)
450
290
(1,000)
8,910
(W2) Land and buildings: cost/revaluation depreciation
Cost/revaluation
Self constructed (see below)
Re-valued
210
1,000
Depreciation
50
6,000
240
―――
―――
7,000
290
―――
―――
(20-year life)
(see below)
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
The carrying value of the land and buildings at 31 March 2012 is $6,710,000
(7,000 – 290).
Depreciation on the building element will be $240 (4,800/20 years). The
revaluation of the land and buildings will create a revaluation reserve
initially of $1,800 (6,000 – (1,000 + (4,000 – 800)). However a transfer of $80
(1,600/20 building element of the revaluation) to realised profit is required.
Self-constructed asset:
Purchased materials
Direct labour
Supervision
Design and planning costs
Error in construction (10 + 25)
150
800
65
20
(35)
1,000
Note: The cost of the error cannot be capitalised; it must therefore be
written off.
(W3) Plant
Cost
Per SofFP
Disposal
5,200
(900)
―――
Depreciation
31 March 2011
Carrying value
3,130
(630)
―――
4,300
2,500
―――
―――
1,800
Depreciation for the current year will be $450,000 (25% reducing balance),
giving a carrying value at 31 March 2012 of $1,350,000.
34
Wellmay
Wellmay Income Statement year ended 31 March 2012:
Revenue (4,200 – 500 (w (i)))
Cost of sales (w (ii))
Gross profit
Operating expenses (470 + 8 depreciation)
Investment property – rental income
– fair value loss (400 – 375)
Finance costs (w (iii))
Profit before tax
Income tax (360 + 30 (w (v)))
Profit for the period
© Emile Woolf Publishing Limited
$’000
20
(25)
$’000
3,700
(2,417)
1,283
(478)
(5)
(113)
687
(390)
297
211
Paper F7: Financial Reporting (International)
Statement of changes in equity – year ended 31 March 2012
Balances at 1 April 2011
Equity conversion option (W4)
Bonus issue (1 for 4)
Revaluation of factory (W4)
Profit for the period
Dividends
Balances at 31 March 2012
Equity
shares
$’000
1,200
Equity
option
$’000
Revaluation
reserve
$’000
350
40
300
Total
$’000
4,165
40
(300)
190
1,500
40
540
Statement of financial position as at 31 March 2012:
Assets
Non-current assets
Property, plant and equipment (W6)
Investment property (W4)
4,390
375
4,765
1,600
6,365
Equity and liabilities (see statement of changes in equity above)
Equity shares of 50 cents each
Equity option (W4)
Reserves:
Revaluation reserve
Retained earnings
Non-current liabilities
Deferred tax (W5)
8% Convertible loan note ((560 + 8) (W4)
Current liabilities (820 – 75 (W2)
Loan from Westwood (500 + 50 accrued interest (W1)
297
(400)
2,212
190
297
(400)
4,292
$’000
Current assets (1,400 + 200 inventory (W1)
Total assets
Total equity and liabilities
Retained
earnings
$’000
2,615
1,500
40
1,540
540
2,212
4,292
210
568
778
745
550
1,295
6,365
Workings (note: all figures in $’000)
(1)
Secured loan:
The ‘sale’ to Westwood is, in substance, a secured loan. The repurchase price is
the cost of sale plus compound interest at 10% for two years. The correct
accounting treatment is to reverse the sale with the goods going back into
inventory and the ‘proceeds’ treated as a loan with accrued interest of 10%
($50,000) for the current year.
212
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Section 2: Answers to practice questions
(2)
Cost of sales:
From draft financial statements
Sale of goods added back to inventory (see above)
Reversal of contingency provision (see below)
Depreciation transferred to operating costs (40 x 20%)
2,700
(200)
(75)
(8)
2,417
General or non-specific provisions do not meet the definition of a liability in IAS
37 Provisions, contingent liabilities and contingent assets and must therefore be
reversed.
(3)
Finance costs:
From draft financial statements
Additional accrued interest on convertible loan (w (iv))
Finance cost on in-substance loan (500 x 10%)
(4)
55
8
50
113
Convertible Loan:
This is a compound financial instrument that contains an element of debt and an
element of equity (the option to convert). IAS 32 Financial instruments:
disclosure and presentation requires that the substance of such instruments
should be applied to the reporting of them. The value of the debt element is
calculated by discounting the future cash flows (at 10%). The residue of the issue
proceeds is recorded as the value of the equity option:
Cash
flows
48
48
48
Discount
factor at 10%
0·91
0·83
0·75
Present
value $’000
43·6
39·8
36·0
Year 1 interest
Year 2 interest
Year 3 interest
Year 4 interest, redemption premium
and capital
648
0·68
440·6
Total value of debt component
560·0
Proceeds of the issue
600·0
Equity component (residual amount)
40·0
For the year ended 31 March 2012, the interest cost for the convertible loan in the
income statement should be increased from $48,000 to $56,000 (10% x 560) by
accruing $8,000, which should be added to the carrying value of the debt.
(5)
Taxation:
The required deferred tax balance is $210,000 (600 x 35%), the current balance is
$180,000, and thus a further transfer of $30,000 (via the income statement) is
required.
(6)
Properties:
The fair value model in IAS 40 Investment property requires the loss of $25,000
on the fair value of investment properties to be reported in the income statement.
This differs from revaluations of other properties. IAS 16 Property, plant and
equipment requires surpluses and deficits to be recorded as movements in equity
(a revaluation reserve). After depreciation of $40,000 for the year ended 31 March
2012, the factory (used by Wellmay) would have a carrying amount of $1,160,000
(1,200 – 40). The valuation of $1,350,000 at 31 March 2012 would give a further
© Emile Woolf Publishing Limited
213
Paper F7: Financial Reporting (International)
revaluation surplus of $190,000 (1,350 – 1,160) and a carrying amount of
property, plant and equipment of $4,390,000 (4,200 + 190) at that date.
35
Dexon
(a)
$’000
Retained profit for period per question
Dividends paid (w (i))
Draft profit for year ended 31 March 2012
Discovery of fraud (w (ii))
Goods on sale or return (w (iii))
Depreciation (w (iv)) – buildings (165,000/15 years)
– plant (180,500 x 20%)
Increase in investments ((12,500 x 1,296/1,200) – 12,500)
Provision for income tax
Increase in deferred tax (w (v))
11,000
36,100
–––––––
Recalculated profit for year ended 31 March 2012
(b)
$’000
96,700
15,500
–––––––
112,200
(2,500)
(600)
(47,100)
1,000
(11,400)
(800)
–––––––
50,800
–––––––
Dexon – Statement of Changes in Equity – Year ended 31 March 2012
At 1 April 2011
Prior period adjustment (w (ii))
Restated earnings at 1 April 2011
Rights issue (see below)
Total comprehensive income
(from (a) and (w (iv))
Dividends paid (w (i))
At 31 March 2012
Ordinary
shares
$’000
200,000
50,000
Share
premium
$’000
30,000
10,000
Revaluation Retained
reserve
earnings
$’000
$’000
18,000
12,300
(1,500)
––––––––
10,800
4,800
––––––––
250,000
––––––––
–––––––
40,000
–––––––
–––––––
22,800
–––––––
50,800
(15,500)
––––––––
46,100
––––––––
Total
$’000
260,300
(1,500)
60,000
55,600
(15,500)
––––––––
358,900
––––––––
Rights issue: 250 million shares in issue after a rights issue of one for four would
mean that 50 million shares were issued (250,000 x 1/5). As the issue price was
$1·20, this would create $50 million of share capital and $10 million of share
premium.
(c)
Dexon – Statement of financial position as at 31 March 2012:
Non-current assets
Property (w (iv))
Plant (180,500 – 36,100 depreciation see (a))
Investments at fair value through profit and loss
(12,500 + 1,000 see (a))
Current assets
Inventory (84,000 + 2,000 (w (iii)))
214
$’000
$’000
180,000
144,400
13,500
–––––––
337,900
86,000
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$’000
Trade receivables (52,200 – 4,000 – 2,600 (w (ii) and (iii))) 45,600
Bank
3,800
–––––––
Total assets
Equity and liabilities
Equity (from (b))
Ordinary shares of $1 each
Share premium
Revaluation reserve
Retained earnings
Non-current liabilities
Deferred tax (19,200 + 2,000 (w (v)))
Current liabilities (81,800 + 11,400 income tax)
Total equity and liabilities
$’000
135,400
–––––––
473,300
–––––––
250,000
40,000
22,800
46,100
–––––––
108,900
–––––––
358,900
21,200
93,200
–––––––
473,300
–––––––
Workings (figures in brackets in $’000)
(i)
Dividends paid
The dividend in May 2011 would be $8 million (200 million shares at 4
cents) and in November 2011 would be $7·5 million (250 million shares x 3
cents). Total dividends would therefore have been $15·5 million.
(ii)
The discovery of the fraud means that $4 million should be written off
trade receivables. $1·5 million debited to retained earnings as a prior period
adjustment (in the statement of changes in equity) and $2·5 written off in
the income statement for the year ended 31 March 2012.
(iii)
Goods on sale or return
The sales over which customers still have the right of return should not be
included in Dexon’s recognised revenue. The reversing effect is to reduce
the relevant trade receivables by $2·6 million, increase inventory by $2
million (the cost of the goods (2,600 x 100/130)) and reduce the profit for
the year by $600,000.
(iv)
Property
The carrying amount of the property (after the year’s depreciation) is $174
million (185,000 – 11,000). A valuation of $180 million would create a
revaluation surplus of $6 million of which $1·2 million (6,000 x 20%) would
be transferred to deferred tax.
(v)
Deferred tax
An increase in the taxable temporary differences of $10 million would
create a transfer (credit) to deferred tax of $2 million (10,000 x 20%). Of this
$1·2 million relates to the revaluation of the property and is debited to the
revaluation reserve. The balance, $800,000, is charged to the income
statement.
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Paper F7: Financial Reporting (International)
36
Bodyline
(a)
IAS 37 Provisions, Contingent Liabilities and Contingent Assets defines a provision
as a liability of uncertain timing or amount. There is clearly an overlap between
provisions and contingencies. Because of the ‘uncertainty’ aspects of the
definition, it can be argued that to some extent all provisions have an element of
contingency. The IASB distinguishes between the two by stating that a
contingency is not recognised as a liability if it is either:
(i)
only possible and therefore yet to be confirmed as a liability, or
(ii)
where there is a liability but it cannot be measured with sufficient
reliability (although this situation should be rare).
IAS 37 requires provisions to satisfy all of the following three recognition criteria:
„
There is a present obligation (legal or constructive) as a result of a past
event.
„
It is probable that a transfer of economic benefits will be required to settle
the obligation.
„
The obligation can be estimated reliably.
A provision is triggered by an obligating event. This must have already occurred,
future events cannot create current liabilities. The first of the three criteria refers
to legal or constructive obligations. A legal obligation is straightforward and
uncontroversial in nature. Constructive obligations arise where a company
creates an expectation that it will meet certain obligations that it is not legally
bound to meet. These may arise due to a published statement or even by a
pattern of past practice. In reality constructive obligations are usually accepted
because the alternative action is unattractive or may damage the reputation of the
company. An example is a commitment to pay for environmental damage caused
by the company, even where there is no legal obligation to do so.
To summarise: a company must provide for a liability where the three defining
criteria of a provision are met, but conversely a company cannot provide for a
liability where these criteria are not met.
(b)
The main need for an accounting standard in this area was to clarify and regulate
when provisions should and should not be made. In the past, it was fairly
common to ‘abuse’ the use of provisions by creating a provision when the IAS37
criteria did not exist. One of the most common yet controversial examples of
provisioning was in relation to future restructuring or reorganisation costs (often
as part of an acquisition). This was sometimes extended to making provisions for
future operating losses. The attraction of providing for this type of expense/loss
was that once the provision had been made, the future actual costs were then
charged to the provision and did not get reported in the income statement as
they occurred. Such provisions could be described by management as
‘exceptional items’, which analysts were expected to disregard when assessing
the company’s future prospects. IAS 37 now prevents this practice as future costs
and operating losses (unless they are for an onerous contract) do not constitute
past events, and so a provision cannot be created in these circumstances.
Another important change initiated by IAS 37 was the way in which
environmental provisions are treated. IAS 37 requires that if the environmental
costs are a liability (legal or constructive), then the whole of the costs must be
216
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Section 2: Answers to practice questions
provided for immediately. That has led to large liabilities appearing in the
statements of financial position of some companies.
A third example of bad practice prior to IAS37 was the use of ‘big bath’
provisions and over-provisioning. In its simplest form this occurred when a
company made a large provision, often for non-specific future expenses, or as
part of an overall restructuring package. If the provision was deliberately overprovided (i.e. too large), then its later release improved future profits.
Alternatively the company could charge to the provision a different cost than the
one it was originally created for. IAS 37 prevents this practice in two ways: by
not allowing provisions to be created if they do not meet the definition of an
obligation; and specifically preventing a provision made for one expense to be
used for a different expense. Under IAS 37 the original provision would have to
be reversed and a new one would be created with appropriate disclosures. Whilst
this treatment does not affect overall profits, it does enhance transparency.
(c)
The directors’ proposed treatment is incorrect. The replacement of the engine is
an example of what has been described as cyclic repairs or replacement. Whilst it
may seem logical and prudent to accrue for the cost of a replacement engine as
the old one is being worn out, such practice leads to double counting. Under the
directors’ proposals the cost of the engine is being depreciated as part of the cost
of the asset, albeit over an incorrect time period. The solution to this problem lies
in IAS 16 Property, Plant and Equipment. The plant constitutes a ‘complex’ asset i.e.
one that may be thought of as having separate components within a single asset.
Thus part of the plant $16.5 million (total cost of $24 million less $7.5 assumed
cost of the engine) should be depreciated at $1.65 million per annum over a 10year life and the engine should be depreciated at $1,500 per hour of use
(assuming machine hour depreciation is the most appropriate method). If a
further provision of $1,500 per machine hour is made, there would be a double
charge against profit for the cost of the engine.
IAS 37 also refers to this type of provision and says that the future replacement of
the engine is not a liability. The reasoning is that the replacement could be
avoided if, for example, the company chose to sell the asset before replacement
was due. If an item does not meet the definition of a liability it cannot be
provided for.
37
Niagara
(a)
All items in arriving at the profit for the financial year are included in the
calculation of the earnings per share.
Earnings attributable to the ordinary shares are after the deduction of the
following dividends on the non-redeemable preference shares:
8% on $1 million for full year
New issue 6% on $1 million for six months
Preference dividends
Earnings attributable to ordinary shares
(2,585,000 – 110,000)
© Emile Woolf Publishing Limited
$
80,000
30,000
110,000
$2,475,000
217
Paper F7: Financial Reporting (International)
Calculation of theoretical ex-rights price:
100 current shares at $2.40 are worth
Rights to 20 shares at $1.50 each cost
120 shares are theoretically worth
$
240
30
270
Theoretical ex-rights price = $270/120 shares = $2.25 per share.
Weighted average number of shares in issue
12,000,000 × $2.4/$2.25 × 3/12
14,400,000 (12 million × 1.2) × 9/12
Weighted average number
3,200,000
10,800,000
14,000,000
Earnings per share = 17.7c ($2,475,000/14,000,000 × 100)
Restated earnings per share for the year to 31 March 2011 is 22.5c (= 24 ×
2.25/2.40)
(b)
Fully diluted earnings per share
On conversion the loan stock would create an extra 800,000 new shares ($2
million × 40/$100). The effect on earnings would be a saving of interest of
$140,000 ($2 million × 7%) before tax and $98,000 after tax (140,000 × (100% –
30%))
The directors’ warrants would create an additional 750,000 new shares without
any effect on earnings. Fully diluted earnings per share is 16.5c ((2,475,000 +
98,000)/(14,000,000 + 800,000 + 750,000)).
The basic earnings per share is a measure of past performance. The diluted
earnings per share figure is more forward looking and is intended to act as a
warning to existing and prospective shareholders. Although it is still based on
past performance, it does give effect to potential ordinary shares outstanding
during the period. Its disclosure is required where circumstances exist that
would cause the EPS to be lower if those circumstances had crystallised. It is not
a prediction of the future earnings per share figures, as these will be based on the
future profits and the number of shares in issue in the future.
The diluted EPS is more a ‘theoretical’ value, as it is unlikely that the profit in the
period when the circumstances crystallise will be the same as the current year’s
profit. The convertible loan stock in the question is a good example of diluting
circumstance. On conversion the share entitlement will cause the number of
shares in issue in the future to be greater than the present (assuming loan
stockholders opt for conversion). There will be a compensating increase in profit
as a result of the non-payment of interest but overall the expected conversion will
cause a dilution.
38
Taxes
(a)
218
(i)
The need to provide for deferred tax arises from the fact that accounting
profit (as reported in a company’s financial statements) differs from the
profit figure used by the tax authorities to calculate a company’s income
tax liability for a given period. If deferred tax were ignored then a
company’s tax charge for a particular period may not be proportional to the
reported profit.
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
For example if a company makes a large profit in a particular period, but,
perhaps because of high levels of capital expenditure, it is entitled to claim
large tax allowances for that period, this would reduce the amount of tax it
has to pay. The result of this would be that the company would report a
large profit, but very little, if any, tax charge. This situation is usually
‘reversed’ in subsequent periods such that tax charges appear to be much
higher than the reported profit would suggest that they should be.
Such a reporting system is misleading in that the profit after tax, which is
used for calculating the company’s earnings per share, may bear very little
resemblance to the pre-tax profit. This can mean that a government’s tax
rules may distort a company’s profit trends. Providing for deferred tax
goes some way towards relieving this anomaly, although it can never be
entirely corrected. This is because of the fact that some items of expense in
the income statement are not allowed for tax purposes.
Where tax depreciation is different from the related accounting
depreciation charges this leads to the tax base of an asset being different to
its carrying value on the statement of financial position (these differences
are called temporary differences) and a provision for deferred tax is made.
This ‘statement of financial position liability’ approach is the general
principle on which IAS 12 bases the calculation of deferred tax. The effect
of this is that it usually brings the total tax charge (i.e. the provision for the
current year’s income tax plus the deferred tax) in proportion to the profit
reported to shareholders.
(ii)
IAS 12 Income Taxes requires the temporary difference to be calculated and
the rate of income tax applied to this difference to give the deferred tax
asset or liability. Temporary differences are the differences between the
carrying amount of an asset and its tax base.
$000
$000
Carrying value at 30 September 2012
Cost of plant
2,000
Accumulated depreciation at 30 September 2012
(2,000 – 400)/8 years for 3 years
(600)
Carrying value
1,400
Tax base at 30 September 2012
Initial tax base (original cost)
2,000
Tax depreciation
Year to 30 September 2010 (2,000 × 40%)
800
Year to 30 September 2011 (1,200 × 20%)
240
Year to 30 September 2012 (960 × 20%)
192
(1,232)
Tax base 30 September 2012
© Emile Woolf Publishing Limited
768
219
Paper F7: Financial Reporting (International)
Temporary differences at 30 September 2012: (1,400 – 768)
632
Deferred tax liability at 30 September 2012: (632 × 25% tax rate)
158
Income statement credit – year to 30 September 2012:
((200 – 192) × 25%)
(b)
2
There are two main reasons why the income tax charge in the financial
statements is not at the same rate as the stated percentage. The first reason is that
tax is payable on the taxable profits of a company, which may differ considerably
from the accounting profit. Such differences may be because some items of
income or expenditure included in the financial statements may be disallowable
for tax purposes (or allowed in a different accounting period) and some taxation
allowances (e.g. tax depreciation allowances) are not included in the accounting
profit. These differences may be mitigated by deferred tax on temporary
differences.
The second reason for differences is that the income tax charge does not usually
consist solely of the charge on the current year’s profit. Commonly the tax charge
also includes an element of deferred tax (this may be a debit or credit) and
possibly an adjustment to the previous year’s tax provision (due to it being
settled at an amount different to the provision). Other more complex items such
as withholding taxes on income and double (dual) taxation relief may also be
included in the tax charge.
The main reason why the income tax charge in the income statement differs to
the amount for income tax in the statement of cash flows is that the tax charge in
the financial statements is a provision for tax that is normally settled in the
following period. This means that the cash flow figure for tax actually paid is the
amount needed to settle the previous year’s tax liability. Other differences may
be due to items referred to above such as deferred tax movements that are not
cash flows.
39
Broadoak
(a)
(i)
Although the broad principles of accounting for non-current assets are well
understood by the accounting profession, applying these principles to
practical situations has resulted in complications and inconsistency. For
the most part, IAS 16 codified existing good practice, but it does include
specific rules which were intended to achieve improved consistency and
more transparency.
Cost
The cost of an item of property, plant and equipment comprises its
purchase price and any other costs directly attributable to bringing the
asset into a working condition for its intended use. This is expanded upon
as follows:
„
220
Purchase price is after the deduction of any trade discounts or rebates
(but not early settlement discounts), but it does include any transport
and handling costs (delivery, packing and insurance), non-refundable
taxes (e.g. sales taxes such as VAT or GST, stamp duty, import duty).
If the payment is deferred beyond normal credit terms this should be
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
taken into account either by the use of discounting or substituting a
cash equivalent price.
„
Directly attributable costs are the incremental costs that would have
been avoided had the assets not been acquired. For self-constructed
assets this includes labour costs of own employees. Abnormal costs
such as wastage and errors are excluded.
„
Installation costs and site preparation costs.
„
Professional fees (e.g. legal fees, architects fees).
In addition to the ‘traditional’ costs above two further groups of cost may
be capitalised:
IAS 23 Borrowing Costs allows (under the allowed alternative method)
directly attributable borrowing costs to be capitalised. Directly attributable
borrowing costs are those that would have been avoided had there been no
expenditure on the asset.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets says that if the
estimated costs of removing and dismantling an asset and restoring its site
qualify as a liability, they should be provided for and added to the cost of
the relevant asset.
Finally, the carrying amount of an asset may be reduced by any applicable
government grants under IAS 20 Accounting for Government Grants and
Disclosure of Government Assistance.
(ii)
Subsequent expenditure
Traditionally the appropriate accounting treatment of subsequent expenditure
on non-current assets revolved around whether it represented a revenue
expense, in effect maintenance or a repair, or whether it represented an
improvement that should be capitalised. IAS 16 bases the question of
capitalisation of subsequent expenditure on whether it results in a probable
future economic benefit in excess of the amount originally assessed for the
asset and on whether the cost of the item can be measured reliably. All other
subsequent expenditure should be recognised in the income statement as it is
incurred. Examples of circumstances where subsequent expenditure should
be capitalised are where it:
„
represents a modification that enhances the economic benefits of an
asset (in excess of its previously assessed standard of performance).
This could be an increase in its life or production capacity;
„
upgrades an asset with the effect of improving the quality of output;
or
„
is on a new production process that reduces operating costs.
In addition to the above, the Standard says it is important to take into
account the circumstances of the expenditure. For example, normal
servicing and overhaul of plant is a revenue cost but, if the expenditure
represents a major overhaul of an asset that restores its previous life, and
the consumption of the previous economic benefits has been reflected by
past depreciation charges, then the expenditure should be capitalised
(subject to not exceeding its recoverable amount). A further example of
where subsequent expenditure should be capitalised is where a major
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
component of an asset that has been treated separately (for depreciation
purposes) is replaced or restored (e.g. new engines for an aircraft).
(b)
(i)
The initial measurement of the cost at which the plant would be capitalised
is calculated as follows:
$
Basic list price of plant
Less trade discount of 12.5% on list price
Shipping and handling costs
Estimated pre-production testing
Site preparation costs
Electrical cable installation (14,000 – 6,000)
Concrete reinforcement
Own labour costs
$
240,000
(30,000)
――――
210,000
――――
2,750
12,500
8,000
4,500
7,500
―――
20,000
Dismantling and restoration costs (15,000 + 3,000)
18,000
――――
Initial cost of plant
263,250
――――
Note: The early settlement discount is a revenue item (probably deducted
from administration costs). The maintenance cost is also a revenue item,
although a proportion of it would be a prepayment at the end of the year of
acquisition (the amount would be dependent on the date of acquisition).
The cost of the specification error must be charged to the income statement.
40
Merryview
Merryview income statement (extracts) – year to 31 March 2012
Note: workings in brackets are in $000
Depreciation: head office – 6 months to 1 October 2011
(1,200/25 × 6/12)
– 6 months to 31 March 2012
(1,350/22.5 (W1) × 6/12)
$
$
24,000
30,000
–––––––
54,000
–––––––
Depreciation: training premises – 6 months to 1 October 2012
(900/25 × 6/12)
– 6 months to 31 March 2012
(600/10 × 6/12)
Impairment loss (W2)
18,000
30,000
––––––––
48,000
––––––––
210,000
––––––––
258,000
––––––––
222
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Statement of financial position (extracts) as at 31 March 2012
$
$
Non-current assets
Land and buildings – head office (700 + 1,350 – 30)
2,020,000
– training premises (350 + 600 – 30)
920,000
––––––––––
2,940,000
––––––––––
Revaluation reserve
Head office land (700 – 500)
200,000
Building (1,350 – 1,080 (W1))
270,000
Training premises land (350 – 300)
50,000
––––––––
520,000
Transfer to realised profit (270/22.5 (W1) × 6/12 re
depreciation of buildings)
Workings
(6,000)
––––––––
514,000
––––––––
(W1) The date of the revaluation is two and a half years after acquisition. This means
the remaining life of the head office would be 22.5 years. The carrying value of
the head office building at the date of revaluation is $1,080,000 i.e. its cost less
two and a half years at $48,000 per annum ($1,200,000 – $120,000).
(W2) Impairment loss: the carrying value of training premises at date of revaluation is
$810,000 i.e. its cost less two and a half years at $36,000 per annum ($900,000 –
$90,000). It is revalued down to $600,000 giving a loss of $210,000. As the land and
the buildings are treated as separate assets the gain on the land cannot be used to
offset the loss on the buildings.
41
Impairment and Wilderness
(a)
(i)
An impairment loss arises where the carrying amount of an asset is higher
than its recoverable amount. The recoverable amount of an asset is defined
in IAS 36 Impairment of Assets as the higher of its fair value less costs to sell
and its value in use (fair value less cost to sell was previously referred to as
net selling price). Thus an impairment loss is simply the difference between
the carrying amount of an asset and the higher of its fair value less costs to
sell and its value in use.
Fair value
The fair value could be based on the amount of a binding sale agreement or
the market price where there is an active market. However many (used)
assets do not have active markets and in these circumstances the fair value
is based on a ‘best estimate’ approach to an arm’s length transaction. It
would not normally be based on the value of a forced sale. In each case the
costs to sell would be the incremental costs directly attributable to the
disposal of the asset.
Value in use
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Paper F7: Financial Reporting (International)
The value in use of an asset is the estimated future net cash flows expected
to be derived from the asset discounted to a present value. The estimates
should allow for variations in the amount, timing and inherent risk of the
cash flows. A major problem with this approach in practice is that most
assets do not produce independent cash flows i.e. cash flows are usually
produced in conjunction with other assets. For this reason IAS 36
introduces the concept of a cash-generating unit (CGU) which is the
smallest identifiable group of assets, which may include goodwill, that
generates (largely) independent cash flows.
Frequency of testing for impairment
Goodwill and any intangible asset that is deemed to have an indefinite
useful life should be tested for impairment at least annually, as too should
any intangible asset that has not yet been brought into use. In addition, at
the end of each reporting period an entity must consider if there has been
any indication that other assets may have become impaired and, if so, an
impairment test should be done. If there are no indications of impairment,
testing is not required.
(b)
(ii)
Once an impairment loss for an individual asset has been identified and
calculated it is applied to reduce the carrying amount of the asset, which
will then be the base for future depreciation charges. The impairment loss
should be charged to income immediately. However, if the asset has
previously been revalued upwards, the impairment loss should first be
charged to the revaluation surplus. The application of impairment losses to
a CGU is more complex. They should first be applied to eliminate any
goodwill and then to the other assets on a pro rata basis to their carrying
amounts. However, an entity should not reduce the carrying amount of an
asset (other than goodwill) to below the higher of its fair value less costs to
sell and its value in use if these are determinable.
(i)
The plant had a carrying amount of $240,000 on 1 October 2011. The
accident that may have caused impairment occurred on 1 April 2012 and an
impairment test would be done at this date. The depreciation on the plant
from 1 October 2011 to 1 April 2012 would be $40,000 (640,000 x 121/2% x
6/12) giving a carrying amount of $200,000 at the date of impairment. An
impairment test requires the plant’s carrying amount to be compared with
its recoverable amount. The recoverable amount of the plant is the higher
of its value in use of $150,000 or its fair value less costs to sell. If Wilderness
trades in the plant it would receive $180,000 by way of a part exchange, but
this is conditional on buying new plant which Wilderness is reluctant to do.
A more realistic amount of the fair value of the plant is its current disposal
value of only $20,000. Thus the recoverable amount would be its value in
use of $150,000 giving an impairment loss of $50,000 ($200,000 – $150,000).
The remaining effect on income would be that a depreciation charge for the
last six months of the year would be required. As the damage has reduced
the remaining life to only two years (from the date of the impairment) the
remaining depreciation would be $37,500 ($150,000/ 2 years × 6/12).Thus
extracts from the financial statements for the year ended 30 September 2012
would be:
224
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Section 2: Answers to practice questions
Statement of financial position
Non-current assets
Plant (150,000 – 37,500)
Income statement
Plant depreciation (40,000 + 37,500)
Plant impairment loss
$
112,500
77,500
50,000
There are a number of issues relating to the carrying amount of the assets
of Mossel that have to be considered. It appears the value of the brand is
based on the original purchase of the ‘Quencher’ brand. The company no
longer uses this brand name; it has been renamed ‘Phoenix’. Thus it would
appear the purchased brand of ‘Quencher’ is now worthless. Mossel cannot
transfer the value of the old brand to the new brand, because this would be
the recognition of an internally developed intangible asset and the brand of
‘Phoenix’ does not appear to meet the recognition criteria in IAS 38. Thus
prior to the allocation of the impairment loss the value of the brand should
be written off as it no longer exists.
The inventories are valued at cost and contain $2 million worth of old
bottled water (Quencher) that can be sold, but will have to be relabelled at
a cost of $250,000. However, as the expected selling price of these bottles
will be $3 million ($2 million × 150%), their net realisable value is
$2,750,000. Thus it is correct to carry them at cost i.e. they are not impaired.
The future expenditure on the plant is a matter for the following year’s
financial statements.
Applying this, the revised carrying amount of the net assets of Mossel’s
cash-generating unit (CGU) would be $25 million ($32 million – $7 million
re the brand). The CGU has a recoverable amount of $20 million, thus there
is an impairment loss of $5 million. This would be applied first to goodwill
(of which there is none) then to the remaining assets pro rata. However
under IAS2 the inventories should not be reduced as their net realisable
value is in excess of their cost. This would give revised carrying amounts at
30 September 2012 of:
Brand
Land containing spa: 12,000 – [(12,000/20,000) × 5,000]
Purifying and bottling plant: 8,000 – [(8,000/20,000) × 5,000]
Inventories
© Emile Woolf Publishing Limited
$000
nil
9,000
6,000
5,000
21,000
225
Paper F7: Financial Reporting (International)
Financial statements – Application of accounting standards
42
Torrent contracts and Savoir EPS
(a)
Income statement for the year ended 31 March 2012
Alfa
Beta
$m
$m
Revenue
8.0
2.0
Cost of sales
(7.0)
(3.5)
――― ―――
Profit/(loss)
1.0
(1.5)
――― ―――
Statement of financial position as at 31 March 2012
2.4
Gross amounts due from customers (see
below)
Gross amounts due to customers (see
below)
Gross amounts from and to customers:
Contract cost incurred
Recognised profits less (losses)
Provision for losses to date
Payments received
Due from customers
12.5
2.5
(12.6)
―――
2.4
―――
Due to customers (contract liability)
Ceta
Total
$m
$m
4.8
14.8
(4.0)
14.5
――― ―――
0.8
0.3
――― ―――
4.8
(1.3)
3.5
(1.5)
(1.5)
(1.8)
―――
―――
(1.3)
―――
7.2
(1.3)
4.0
0.8
nil
―――
4.8
―――
20.0
1.8
(1.5)
(14.4)
―――
7.2
―――
(1.3)
―――
Workings (in $m)
Alfa
(5.4/90%)
Work
invoiced
Cost of sales
(balancing figure)
Profit (see below)
Percentage
(6/20 ×
complete
100%)
Attributable
($5m ×
profit
30%)
226
At
31 March 2011
At
31 March
2012
14.0
Year
ended
31 March
2012
8.0
(4.5)
(11.5)
(7.0)
1.5
30%
2.5
70%
1.0
6.0
1.5
(12.6/90%)
(14/20 × 100%)
(($5m × 70%)
– $1m
rectification)
2.5
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Section 2: Answers to practice questions
Prior to the rectification costs (which must be charged to the year in which they
are incurred), the estimated total profit on the contract is $5 million ($20m –
$15m).
Beta
Due to the increase in the estimated cost Beta is a loss-making contract and the
whole of the loss must be provided for as soon as it is can be anticipated. The loss
is expected to be $1.5 million ($7.5m – $6m). The sales value of the contract at 31
March 2012 is $2 million ($1.8/90%), thus the cost of sales must be recorded as
$3.5 million. As costs to date are $2 million, this means a provision of $1.5 million
is required.
Ceta
Based on the costs to date at 31 March 2012 of $4 million and the total estimated
costs of $10 million, this contract is 40% complete. The estimated profit is $2
million ($12m – $10m); therefore the profit at 31 March 2012 is $0.8 million ($2m
× 40%). This gives an imputed sales (and receivable) value of $4.8 million.
(b)
(i)
Savoir: EPS year ended 31 March 2010
The share issue on 1 July 2009 at full market value needs to be weighted:
New shares
40m
8m
48m
× 3/12 =
10m
× 9/12 =
36m
46m
Without the bonus issue this would give an EPS of 30c ($13.8m/46m).
The bonus issue of one for four would result in 12 million new shares
giving a total number of ordinary shares of 60 million. The dilutive effect of
the bonus issue would reduce the EPS to 24c (30c × 48m/60m).
The comparative EPS (for 2009) would be restated at 20c (25c × 48m/60m).
EPS year ended 31 March 2011
The rights issue of two for five on 1 October 2010 is half way through the
year. The theoretical ex rights value is calculated as follows:
Holder of
subscribes for
Theoretical value of
100 shares
40 shares
140 shares
worth $2.40
at $1
=
$
240
40
280
Theoretical ex-rights price = $280/140 = $2 per share.
Weighting
Rights issue (2 for 5)
New total
Weighted average
60m × 6/12 × 2.40/2.00 =
24m
84m × 6/12 =
36m
42m
78m
EPS is therefore 25c (= $19.5m/78m).
The comparative (for 2010) would be restated at 20c (24c × 2.00/2.40).
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Paper F7: Financial Reporting (International)
(ii)
The basic EPS for the year ended 31 March 2012 is 30c ($25.2m/84m × 100).
Dilution
Convertible loan stock
On conversion loan interest of $1.2 million after tax would be saved ($20
million × 8% × (100% – 25%)) and a further 10 million shares would be
issued ($20m/$100 × 50).
Directors’ options
Options for 12 million shares at $1.50 each would yield proceeds of $18
million. At the average market price of $2.50 per share this would purchase
7.2 million shares ($18m/$2.50). Therefore the ‘bonus’ element of the
options is 4.8 million shares (12m – 7.2m).
Using the above figures the diluted EPS for the year ended 31 March 2012
is 26.7c ($25.2m + $1.2m)/(84m + 10m + 4.8m)).
43
Elite Leisure and Hideaway
(a)
The cruise ship is an example of what can be called a complex asset. This is a
single asset that should be treated as if it was a collection of separate assets, each
of which may require a different depreciation method/life. In this case the
question identifies three components to the cruise ship. The carrying amount of
the asset at 30 September 2011 (eight years after acquisition) would be:
Component
Ship’s fabric
Cabins and
entertainment area
fittings
Propulsion system
Cost
$m
300
150
100
―――
550
―――
Depreciation
$m
96
100
75
―――
271
―――
(300/25) × 8)
Carrying value
$m
204
(150/12) × 8)
(100/40,000) × 30,000
50
25
―――
279
―――
Ship’s fabric
This is the most straightforward component. It is being depreciated over a 25
year life and depreciation of $12 million (300/25 years) would be required in the
year ended 30 September 2012. The repainting of the ship’s fabric does not meet
the recognition criteria of an asset and should be treated as repairs and
maintenance.
Cabins and entertainment area and fittings
During the year these have had a limited upgrade at a cost of $60 million. This
has extended the remaining useful life from four to five years. The costs of the
upgrade meet the criteria for recognition as an asset. The original fittings have
not been replaced thus the additional $60 million would be added to the cost of
the fittings and the new carrying amount of $110 million will be depreciated over
the remaining life of five years to give a charge for the year of $22 million.
228
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Propulsion system
This has been replaced by a new system so the carrying value of the system ($25
million) must be written off and depreciation of the new system for the year
ended 30 September 2012 (based on use) would be $14 million (140
million/50,000 × 5,000).
Elite Leisure – income statement extract: year ended 30 September 2012
Depreciation
– ship’s fabric
– cabin and entertainment fittings
– propulsion system
Disposal loss – propulsion system
Repainting ship’s fabric
$m
12
22
14
25
20
93
Elite Leisure – statement of financial position extract as at 30 September 2012
Cruise ship (see working): $406m
Working (in $ million)
Component
Cost
Depreciation
$m
$m
Ship’s fabric
300
108
Cabins and entertainment
area fittings
210
122
Propulsion system
140
―――
650
―――
(b)
(i)
(ii)
14
―――
244
―――
Carrying value
$m
(300/25) × 9)
(110/5) + 100)
(100/50,000) × 5,000
192
88
126
―――
406
―――
IAS 24 Related party disclosures states that a party is related to an entity in
the following circumstances:
–
The party, directly or indirectly, controls, is controlled by or is under
common control with the entity (e.g. parent/subsidiary or
subsidiaries of the same group)
–
One party has an interest in another entity that gives it significant
influence over the entity (e.g. an associate) or has joint control over
the entity (e.g. joint venturers are related parties).
–
In addition members of key management and close family members
of related parties are also themselves related parties.
In the absence of related party disclosures, users of financial statements
would assume that an entity has acted independently and in its own best
interests. Principally within this assumption is that all transactions have
been entered into willingly and at arm’s length (i.e. on normal commercial
terms at fair value).
Where related party relationships and transactions exist, this assumption
may not be justified. These relationships and transactions lead to the
danger that financial statements may have been distorted or manipulated,
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both favourably and unfavourably. The most obvious example of this type
of transaction would be the sale of goods or rendering of services from one
party to another on non-commercial terms (this may relate to the price
charged or the credit terms given). Other examples of disclosable
transactions are agency, licensing and leasing arrangements, transfer of
research and development and the provision of finance, guarantees and
collateral. Collectively this would mean there is hardly an area of financial
reporting that could not be affected by related party transactions.
It is a common misapprehension that related party transactions need only
be disclosed if they are not at arm’s length. This is not the case. For
example, a parent may instruct all members of its group to buy certain
products or services (on commercial terms) from one of its subsidiaries. In
the absence of the related party relationships, these transactions may not
have occurred. If the parent were to sell the subsidiary, it would be
important for the prospective buyer to be aware that the related party
transactions would probably not occur in the future. Indeed even where
there are no related party transactions, the disclosure of the related party
relationship is still important as a subsidiary may obtain custom, receive
favourable credit ratings, and benefit from a superior management team
simply by being a part of a well respected group.
(iii)
The subsidiaries of Hideaway are related parties to each other and to
Hideaway itself as they are under common control. One of the important
aspects of related party relationships is that one of the parties may have its
interests subordinated, i.e. it may not be able to act in its own best interest.
This appears to be the case in this situation. Depret (or at least one of its
directors) believes that the price it is charging Benedict is less than it could
have achieved by selling the goods to non-connected parties. In effect these
sales have not been made at an arm’s length fair value. The obvious
implication of this is that the transactions have moved profits from Depret
to Benedict. If the director’s figures are accurate Depret would have made a
profit on these transactions of $6 million (20 – 14) rather than the $1 million
it has actually made.
The transactions will also affect reported revenue and cost of sales and
working capital in the individual financial statements of Benedict and
Depret. Some might argue that as the profit remains within the group,
there is no real overall effect as, in the consolidated financial statements,
intra-group transactions are eliminated. This is not entirely true. The
implications of these related party sales are serious:
230
–
Depret has a non controlling interest of 45% and they have been
deprived of their share of the $5 million transferred profit. This could
be construed as oppression of the non controlling interest and is
probably illegal.
–
There is a similar effect on the profit share that the directors of Depret
might be entitled to under the group profit sharing scheme as
Depret’s profits are effectively $5 million lower than they should be.
–
Shareholders, independent analysts or even the (independent)
managers of Depret would find it difficult to appraise the true
performance of Depret. The related party transaction gives the
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
impression that Depret is under-performing. This may lead to the
non controlling interest selling their shares for a low price (because of
poor returns) or calls for the company’s closure or some form of
rationalisation which may not be necessary.
44
–
The tax authorities may wish to investigate the transactions under
transfer pricing rules. The profit may have been moved to Benedict’s
financial statements to avoid paying tax in Depret’s tax jurisdiction
which may have high levels of taxation.
–
In the same way as Depret’s results appear poorer due to the effect of
the related party transactions, Benedict’s results would look better.
This may have been done deliberately. Hideaway may intend to
dispose of Benedict in the near future and thus its more favourable
results may allow Hideaway to obtain a higher sale price for
Benedict.
Triangle
Item (i)
Future decontamination costs must be provided for in full at the time they become
unavoidable. Where they are based on future values, they should be discounted to
their present value. Instead of being immediately written off as a charge in the income
statement, the decontamination costs are added to the cost of the related asset and
amortised over the expected life of the asset.
The current treatment of these costs by Triangle is incorrect. The depreciation charge
must be based on the full cost of the plant which must include the decontamination
costs.
In addition an imputed finance cost must be applied to the provision (often referred to
as unwinding).
Applying this to the financial statements of Triangle at 31 March 2012:
Statement of financial position extracts
Non-current assets
Plant at cost ($15 million + $5 million)
Depreciation at 10% per annum
Non-current liabilities
Provision
Accrued finance costs
Income statement extracts
Depreciation
Accrued finance costs ($5 million × 8%)
$m
20.0
(2.0)
18.0
5.0
0.4
5.4
$m
2.0
0.4
Item (ii)
This is an example of an adjusting event after the reporting period. To some extent the
figures in the draft financial statements already reflect the effects of the fraud (up to the
amount at the year end i.e. $210,000) in that presumably the cost of the materials paid
© Emile Woolf Publishing Limited
231
Paper F7: Financial Reporting (International)
for are included in cost of sales. However, the financial statements are incorrect in their
presentation.
As the fraud is considered material, $210,000 should be removed from the cost of sales
and included as an income statement operating expense (perhaps with separate
disclosure). This will affect the gross profit and other ratios, though it will not affect the
net profit.
The further costs beyond the year end of $30,000 should be disclosed in a note as a nonadjusting event (if these costs are material in their own right).
Item (iii)
Triangle is of the opinion that the cost of the fraud may be covered by an insurance
claim. However the insurance company is disputing the claim.
This appears to be a contingent asset. If the contingent asset is ‘probable’ it should be
disclosed in a note in the financial statements. However if it is only ‘possible’, it should
be ignored. As this claim is at an early stage and the company has not yet sought a
legal opinion, it would be premature to consider the claim probable. In these
circumstances the contingent asset should be ignored and the financial statements will
be unaffected.
Item (iv)
Although this transaction has been treated as a sale, this is probably not its substance.
The clause in the agreement that allows Triangle to repurchase the inventory makes
this a sale and repurchase agreement. Assuming Triangle acts rationally it will
repurchase the inventory if its retail value at 31 March 2012 is more than $7,320,500 ($5
million plus compound interest at 10% for four years) plus the accumulated storage
costs (as these can be recovered from Factorall in the event that the inventory is not
repurchased).
There is no indication in the question as to what the inventory is likely to be worth on
31 March 2012. However it is unlikely that a finance company will really want to
acquire this inventory (it is not its normal line of business) and thus it would not have
entered into the contract unless it believed Triangle would repurchase the inventory. If
the above is correct the substance of the transaction is that it is a secured loan rather
than a sale.
The required adjustments would therefore be as follows:
232
–
Remove $5 million from sales (debit) and treat this as a long term (4 year) loan.
–
Remove $3 million from cost of sales and treat this as inventory.
–
The receivable for the storage cost should be removed from trade receivables and
added to the cost of the inventory.
–
Accrued interest of $500,000 ($5 million × 10%) should be charged to the income
statement and added to the carrying value of the loan.
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
45
Construction
(a)
2011
$000
Magpie – Income statement (extracts) – year to 31 March 2011
Sales revenue (40,000 × 35% (W1))
14,000
Cost of sales (W1)
(9,100)
–––––––
4,900
–––––––
Profit on contract
(b)
Statement of financial position (extracts) as at 31 March 2011
Non-current assets
Plant and machinery (3,600 – 900 (W2))
2,700
Current assets
Amount due from customer (W3)
1,500
2012
$000
Income statement (extracts) – year to 31 March 2012
Sales revenue (40,000 × 75% – 14,000 (W1))
16,000
Cost of sales (22,500 – 9,100 (W1))
(13,400)
––––––
2,600
––––––
Profit on contract
Statement of financial position (extracts) as at 31 March 2012
Non-current assets
Plant and machinery (3,600 – 900 – 1,200 (W2))
1,500
Current assets
Amount due from customer (W3)
1,000
Workings (all figures $000):
(W1) Contract costs as at 31 March 2011:
Architects’ and surveyors’ fees
Materials used (3,100 – 300 inventory)
Direct labour costs
Overheads (40% of 3,500)
Plant depreciation (9 months (W2))
500
2,800
3,500
1,400
900
––––––
Cost at 31 March 2011
9,100
––––––
Cost at 31 March 2011 (see above)
9,100
Estimated cost to complete:
Excluding depreciation
Plant depreciation (3,600 – 600 – 900)
14,800
2,100
––––––
16,900
–––––––
Estimated total costs on completion
© Emile Woolf Publishing Limited
26,000
–––––––
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Paper F7: Financial Reporting (International)
Percentage of completion at 31 March 2011 (9,100/26,000)
= 35%
Contract costs as at 31 March 2012:
Summarised costs excluding depreciation
20,400
Plant depreciation (21 months at $100 per month)
2,100
–––––––
Cost to date
22,500
Estimated cost to complete: Excluding depreciation
6,600
Plant depreciation (9 months)
900
––––––
7,500
–––––––
Estimated total costs on completion
30,000
–––––––
Percentage of completion at 31 March 2012 (22,500/30,000)
= 75%
(W2) The plant has a depreciable amount of $3,000 (3,600 – 600 residual value).
Its estimated life on this contract is 30 months (1 July 2010 to 31 December
2012). Depreciation would be $100 per month i.e. $900 for the period to 31
March 2011; $1,200 for the period to 31 March 2012; and a further $900 to
completion.
(W3) Amount due from customer at 31 March 2011:
Contract costs incurred (9,100 + 300 material inventory)
9,400
Recognised profit
4,900
––––––––
14,300
Cash received at 31 March 2011
(12,800)
––––––––
Amount due at 31 March 2011
1,500
––––––––
Amount due from customer at 31 March 2012:
Contract costs incurred
22,500
Recognised profit (4,900 + 2,600)
7,500
––––––––
30,000
Cash received
– 31 March 2011
– 31 March 2012
(12,800)
(16,200)
––––––––
(29,000)
––––––––
Amount due at 31 March 2012
46
Bowtock
(a)
234
1,000
––––––––
Most events occurring after the reporting period should be properly reflected in
the following year’s financial statements. There are two circumstances where
events occurring after the reporting period are relevant to the current year’s
financial statements. The first category, known as adjusting events, provides
additional evidence of conditions that existed at the end of the reporting period.
This usually means that they help to determine the value of an item that may
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
have been uncertain at the year-end. Common examples of this are receipts from
accounts receivable and sales of inventory after the end of the reporting period..
These receipts help to confirm the bad debt and inventory write down
allowances. The second category is non-adjusting events. These do not affect the
amounts contained in the financial statements, but are considered of such
importance that unless they are disclosed, users of financial statements would
not be properly able to assess the financial position of the company. Common
examples of these are the loss of a major asset (say due to a fire) after the
reporting period and the sale of an investment (often a subsidiary) after the
reporting period.
(b)
Inventory
Sales of goods after the reporting period are normally a reflection of
circumstances that existed prior to the year end. They are usually interpreted as a
confirmation of the value of inventory as it existed at the year end, and are thus
adjusting events. In this case the sale of the goods after the year-end confirmed
that the value of the inventory was correctly stated as it was sold at a profit.
Goods remaining unsold at the date the new legislation was enacted are
worthless. Whilst this may imply that they should be written off in preparing the
financial statements to 30 September 2012, this is not the case. What it is
important to realise is that the event that caused the inventory to become
worthless did not exist at the year end and its consequent losses should be
reflected in the following accounting period. Thus there should be no adjustment
to the value of inventory in the draft financial statements, but given that it is
material, it should be disclosed as a non-adjusting event.
Construction contract
On first appearance this new legislation appears similar to the previous example,
but there is a major difference. Profits on an uncompleted long term construction
contract are based on assessment of the overall eventual profit that the contract is
expected to make. This new legislation will mean the overall profit is $500,000
less than originally thought. This information must be taken into account when
calculating the profit at 30 September 2012. This is an adjusting event.
47
Multiplex and Simpkins
(a)
Income statement extracts:
Loan stock interest paid ($80 million × 8%)
Required accrual of finance cost
Total finance cost for loan stock ($68,704,000 × 12%)
Statement of financial position extracts:
Non-current liabilities
8% loan stock 2014
Accrual of finance costs
Equity and liabilities
Share options
© Emile Woolf Publishing Limited
$000
6,400
1,844
––––––
8,244
––––––
68,704
1,844
–––––––
70,548
–––––––
11,296
–––––––
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Paper F7: Financial Reporting (International)
Workings
IAS 32 and 39, dealing with financial instruments, require compound or hybrid
financial instruments such as convertible loan stock to be treated under the
substance of the contractual agreement. For this type of instrument this means
that its equity element and liability (debt) element must be separately identified
and presented as such in the statement of financial position. In practice there are
several methods of calculating the split between the two elements. For example
there are several option pricing models. However, given the limited information
in the question, the split can only be calculated by a ‘residual value of equity’
approach. This involves calculating the present value of the cash flows
attributable to a ‘pure’ debt instrument and treating the difference between this
and the issue proceeds (the residue) as the equity component.
Year 1 interest
Year 2 interest
Year 3 interest
Year 4 interest
Year 5 interest and capital
Cash
flow
$m
6.4
6.4
6.4
6.4
86.4
Factor at
12%
× 0.89
× 0.80
× 0.71
× 0.64
× 0.57
Discounted
cash flow
$000
5,696
5,120
4,544
4,096
49,248
68,704
(b)
Residual equity element (share
options)
11,296
Proceeds of issue
80,000
IAS 32 Financial Instruments: Disclosure and Presentation says that the issuer of a
compound (hybrid) instrument (i.e. one that contains both a liability debt and an
equity element) should classify the instrument’s components separately. Thus the
advice of Merchant Financial Services is wrong; convertible loan stock cannot be
classified as pure equity. The proceeds of the issue have to be split between the
amount attributable to the conversion rights, which is then classed as equity, and
the balance of the proceeds being classed a liability/debt. There are several
methods of obtaining these amounts, but from the information given in the
question these can only be calculated on a ‘residual value of equity’ basis:
Year 1 interest
Year 2 interest
Year 3 interest
Year 4 interest and capital
Total value of debt component
Proceeds of the issue
Equity component (residual amount)
236
Cash
flows
$000
600
600
600
10,600
Factor at
10%
0.91
0.83
0.75
0.68
Present
value
$000
546
498
450
7,208
––––––
8,702
10,000
––––––
1,298
––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
$
600,000
270,000
870,000
Income statement:
Interest paid (6% of $10 million)
Provision for additional finance costs
((10% × 8.702m) – 0.6m)
Statement of financial position:
Non-current liabilities:
6% Convertible Loan Stock (from above)
Provision for additional finance costs
8,702,000
270,000
8,972,000
Capital and reserves:
Option to convert to equity (from above)
48
1,298,000
Convertibles
Workings
Year
1
2
3
$10 million of loan notes
Annual
cash flow
$000
400
400
10,400
Interest
Interest
Interest + Redemption
Value as straight loan notes
Issue price
Equity component (residual amount)
Discount
factor at
7%
Present
value
$000
372
348
8,424
9,144
10,000
856
0.93
0.87
0.81
Finance cost: year to 30 September 2012
$000
Total finance cost: 9,144 × 7%
Interest payable on 30 September 2012 ($10 million × 4%)
Accrual to add to carrying value of debt
640
400
240
Carrying value of loan notes: 30 September 2012
$000
Initial valuation of debt element
Add accrued interest
Carrying amount at 30 September 2012
(a)
9,144
240
9,384
In the financial statements of Torpid for the year to 30 September 2012.
In the income statement, the finance cost relating to the loan notes is $640,000.
In the statement of financial position:
Non-current liability for the loan notes = $9,384,000
Equity component of loan notes = $856,000.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(b)
The directors are not fully correct in their views. If the company had issued
straight convertible loan notes, the interest cost would be 7% per year or $700,000.
By issuing convertible loan notes, the total finance cost is not much lower in the
first year ($640,000) and it will increase in the next two years as the liability for the
loan notes increases.
The company’s gearing will be reduced after three years if the loan note holders
exercise their option to convert their notes into equity shares. In the short term
however, the issue of the convertible loan notes will add to debt capital and only a
small amount to equity (the residual amount); therefore it seems likely that gearing
will increase in the short term and will not fall.
49
Errsea
(a)
Errsea – income statement extracts year ended 31 March 2012
Loss on disposal of plant – see note below ((90,000 – 60,000) – 12,000)
Depreciation for year (wkg (i))
Government grants (a credit item) – see note below and (wkg (iv))
$
18,000
75,000
(19,000)
Note: the repayment of government grant of $3,000 may instead have been
included as an increase of the loss on disposal of the plant.
Errsea – statement of financial position extracts as at 31 March 2012
cost
Property, plant and equipment (wkg (v))
Non-current liabilities
Government grants (wkg (iv))
Current liabilities
Government grants (wkg (iv))
$
360,000
––––––––
accumulated
depreciation
$
195,000
––––––––
carrying
amount
$
165,000
––––––––
39,000
27,000
Workings
238
(i)
Depreciation for year ended 31 March 2012
On acquired plant (wkg (ii))
Other plant (wkg (iii))
(ii)
The cost of the acquired plant is recorded at $210,000 being its base cost
plus the costs of modification and transport and installation. Annual
depreciation over three years will be $70,000. Time apportioned for year
ended 31 March 2012 by 9/12 = $52,500.
(iii)
The other remaining plant is depreciated at 15% on cost
(b/f 240,000 – 90,000 (disposed of) x 15%)
$
52,500
22,500
–––––––
75,000
–––––––
$
22,500
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(iv)
Government grants
Transferred to income for the year ended 31 March 2012:
From current liability in 2011 (10,000 – 3,000 (repaid))
From acquired plant (see below):
Non-current liability
b/f
transferred to current
on acquired plant (see below)
$
7,000
12,000
–––––––
19,000
–––––––
$
30,000
(11,000)
20,000
–––––––
39,000
–––––––
Grant on acquired plant is 25% of base cost only = $48,000
This will be treated as:
To income in year ended 31 March 2012 (48,000/3 x 9/12)
Classified as current liability (48,000/3)
Classified as a non-current liability (balance)
12,000
16,000
20,000
–––––––
48,000
–––––––
Note: government grants are accounted for from the date they are receivable (i.e.
when the qualifying conditions for the grant have been met).
Current liability
Transferred from non-current (per question)
On acquired plant (see above)
11,000
16,000
–––––––
27,000
–––––––
(v)
cost
(b)
accumulated
depreciation
carrying
amount
$
$
$
Property, plant and equipment
Balances b/f
240,000
180,000
60,000
Disposal
(90,000)
(60,000)
(30,000)
Addition (w (ii))
210,000
52,500
157,500
Other plant depreciation for year (wkg (iii))
22,500
(22,500)
–––––––
–––––––– ––––––––
Balances at 31 March 2012
360,000
195,000
165,000
–––––––
–––––––– ––––––––
(i)
This is an example of an adjusting event within IAS 10 Events after the
reporting date. This means that an impairment of trade receivables of
$23,000 must be recognised (and charged to income). The increase in the
receivable after the year end should be written off in the following year’s
financial statements.
(ii)
Sales of the year-end inventory in the following accounting period may
provide evidence that the inventory’s net realisable value has fallen below
its cost. This appears to be the case for product W32 and is another example
© Emile Woolf Publishing Limited
239
Paper F7: Financial Reporting (International)
of an adjusting event. With a selling price of $5·40 and after paying a 15%
commission, the net realisable value of W32 is $4·59 each. Assuming that
the fall in selling price is not due to circumstances that occurred after the
year end and that the selling price is typical of what the remainder of the
product will sell for, inventory should be written down (via a charge to the
income statement) by $16,920 ((6·00 – 4·59) x 12,000 units).
50
(iii)
Tentacle has correctly treated the outstanding litigation as a contingent
liability. The settlement of a court case after the reporting date may confirm
(or otherwise) the existence of an obligation at the year end and would be
an example of an adjusting event. This would then require that either the
disclosure note of the contingency is removed or the obligation should be
provided for dependent on the outcome of the litigation. However, this is
not quite the case in Tentacle’s example. The circumstances of the claim
against Tentacle are different from those of the recently settled case. So this
settlement does not appear to have any effect on the likelihood of Tentacle
losing the case. What it does (potentially) affect is the estimated amount of
the liability. IAS 10 refers to this situation as an updating disclosure. The
only required change to the financial statements would be to update the
disclosure note on the contingent liability to reflect that the potential
liability has increased from $500,000 to $750,000.
(iv)
Normally the effect of price increases of materials after the reporting date
would be a matter for the following year’s financial statements as such
increases do not affect the costs as they existed at the reporting date (i.e.
they would not be an adjusting event). However, Tentacle’s method of
recognising profit (using a cost basis to determine the percentage of
completion) requires an estimate (at 31 March 2012) of the future costs of
the contract. This estimate directly determines the amount of profit
recognised at 31 March 2012. Therefore the information indicating that the
total estimated costs of the contract have increased should be taken as
providing additional evidence of conditions that existed at the year end.
Thus this is an adjusting event which requires the recognised profit to be
recalculated. The original estimate of the recognised profit at 31 March 2012
of $1·2 million would be half of the estimated total profit of $2·4 million
(percentage of completion is 50% i.e. $3 million/$6 million). The increase in
the costs of $1·5 million means the revised estimated total profit is only
$900,000 (2·4m – 1·5m). The revised total costs are $7·5 million (6m + 1·5m).
Thus the recognised profit on the contract should be recalculated as
$360,000 (900,000 x 3m/7·5m) with appropriate amendments to the income
statement and statement of financial position figures.
Partway
(a)
(i)
IFRS 5 Non-current assets held for sale and discontinued operations defines
non-current assets held for sale as those assets (or a group of assets) whose
carrying amounts will be recovered principally through a sale transaction
rather than through continuing use. A discontinued operation is a
component of an entity that has either been disposed of, or is classified as
‘held for sale’ and:
(i)
240
represents a separate major line of business or geographical area of
operations
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(ii) is part of a single co-ordinated plan to dispose of such, or
(iii) is a subsidiary acquired exclusively for sale.
IFRS 5 says that a ‘component of an entity’ must have operations and cash
flows that can be clearly distinguished from the rest of the entity and will
in all probability have been a cash-generating unit (or group of such units)
whilst held for use. This definition also means that a discontinued
operation will also fall to be treated as a ‘disposal group’ as defined in IFRS
5. A disposal group is a group of assets (possibly with associated liabilities)
that it is intended will be disposed of in a single transaction by sale or
otherwise (closure or abandonment). Assets held for disposal (but not those
being abandoned) must be presented separately (at the lower of cost or fair
value less costs to sell) from other assets and included as current assets
(rather than as non-current assets) and any associated liabilities must be
separately presented under liabilities. The results of a discontinued
operation should be disclosed separately as a single figure (as a minimum)
on the face of the income statement with more detailed figures disclosed
either also on the face of the income statement or in the notes.
The intention of this requirement is to improve the usefulness of the
financial statements by improving the predictive value of the (historical)
income statement. Clearly the results from discontinued operations should
have little impact on future operating results. Thus users can focus on the
continuing activities in any assessment of future income and profit. (ii) The
timing of the board meeting and consequent actions and notifications is
within the accounting period ended 31 October 2012. The notification of
staff, suppliers and the press seems to indicate that the sale will be highly
probable and the directors are committed to a plan to sell the assets and are
actively locating a buyer. From the financial and other information given in
the question it appears that the travel agencies’ operations and cash flows
can be clearly distinguished from its other operations. The assets of the
travel agencies appear to meet the definition of non-current assets held for
sale; however the main difficulty is whether their sale and closure also
represent a discontinued operation. The main issue is with the wording of
‘a separate major line of business’ in part (i) of the above definition of a
discontinued operation. The company is still operating in the holiday
business, but only through Internet selling. The selling of holidays through
the Internet compared with through high-street travel agencies requires
very different assets, staff knowledge and training and has a different cost
structure. It could therefore be argued that although the company is still
selling holidays the travel agencies do represent a separate line of business.
If this is the case, it seems the announced closure of the travel agencies
appears to meet the definition of a discontinued operation.
(iii)
Partway income statement year ended:
Continuing operations
Revenue
Cost of sales
Gross profit
Operating expenses
© Emile Woolf Publishing Limited
31 October 2012
$’000
31 October 2011
$’000
25,000
(19,500)
⎯⎯⎯
5,500
(1,100)
⎯⎯⎯
22,000
(17,000)
⎯⎯⎯
5,000
(500)
⎯⎯⎯
241
Paper F7: Financial Reporting (International)
Profit/(loss) from continuing operations
Discontinued operations
Profit/(loss) from discontinued operations
31 October 2012
$’000
4,400
31 October 2011
$’000
4,500
(4,000)
⎯⎯⎯
400
⎯⎯⎯
1,500
⎯⎯⎯
6,000
⎯⎯⎯
14,000
(16,500)
⎯⎯⎯
(2,500)
(1,500)
⎯⎯⎯
(4,000)
⎯⎯⎯
18,000
(15,000)
⎯⎯⎯
3,000
(1,500)
⎯⎯⎯
1,500
⎯⎯⎯
Profit for the period
Analysis of discontinued operations
Revenue
Cost of sales
Gross profit/(loss)
Operating expenses
Profit/(loss) from discontinued operations
Note: other presentations may be acceptable.
(b)
(i)
Comparability is one of the four principal qualitative characteristics of
useful financial information. It is a vital attribute when assessing the
performance of an entity over time (trend analysis) and to some extent with
other similar entities. For information to be comparable it should be based
on the consistent treatment of transactions and events. In effect a change in
an accounting policy breaks the principle of consistency and should
generally be avoided. That said there are circumstances where it becomes
necessary to change an accounting policy. These are mainly where it is
required by a new or revised accounting standard, interpretation or
applicable legislation or where the change would result in financial
statements giving a more reliable and relevant representation of the entity’s
transactions and events.
It is important to note that the application of a different accounting policy
to transactions or events that are substantially different to existing
transactions or events or to transactions or events that an entity had not
previously experienced does NOT represent a change in an accounting
policy. It is also necessary to distinguish between a change in an accounting
policy and a change in an estimation technique.
In an attempt to limit the problem of reduced comparability caused by a
change in an accounting policy, the general principle is that the financial
statements should be prepared as if the new accounting policy had always
been in place. This is known as retrospective application. The main effect of
this is that comparative financial statements should be restated by applying
the new policy to them and adjusting the opening balance of each
component of equity affected in the earliest prior period presented. IAS 8
Accounting policies, changes in accounting estimates and errors says that a
change in accounting policy required by a specific Standard or
Interpretation should be dealt with under the transitional provisions (if
any) of that Standard or Interpretation (normally these apply the general
rule of retrospective application). There are some limited exemptions
(mainly on the grounds of impracticality) to the general principle of
retrospective application in IAS 8.
(ii)
242
This issue is one of the timing of when revenue should be recognised in the
income statement. This can be a complex issue which involves identifying
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
the transfer of significant risks, reliable measurement, the probability of
receiving economic benefits, relevant accounting standards and legislation
and generally accepted practice. Applying the general guidance in IAS 18
Revenue, the previous policy, applied before cancellation insurance was
made a condition of booking, seemed appropriate. At the time the holiday
is taken it can no longer be cancelled, all monies would have been received
and the flights and accommodation have been provided. There may be
some compensation costs involved if there are problems with the holiday,
but this is akin to product warranties on normal sales of goods which may
be immaterial or provided for based on previous experience of such costs.
The appendix to IAS 18 specifically refers to payments in advance of the
‘delivery’ of goods and says that revenue should be recognised when the
goods are delivered. Interpreting this for Partway’s transaction would seem
to confirm the appropriateness of its previous policy.
The directors of Partway wish to change the timing of recognition of sales
because of the change in circumstances relating to the compulsory
cancellation insurance. The directors are apparently arguing that the new
‘transactions and events’ are substantially different to previous transactions
therefore the old policy should not apply. Even if this does justify revising
the timing of the recognition of revenue, it is not a change of accounting
policy because of the reasons outlined in (i) above.
An issue to consider is whether compulsory cancellation insurance
represents a substantial change to the risks that Partway experiences. An
analysis of past experience of losses caused by uninsured cancellations may
help to assess this, but even if the past losses were material (and in future
they won’t be), it is unlikely that this would override the general guidance
in the appendix to IAS 18 relating to payments made in advance of
delivery. It seems the main motivation for the proposed change is to
improve the profit for the year ended 31 October 2012 so that it compares
more favourably with that of the previous period.
To summarise, it is unlikely that the imposition of compulsory cancellation
insurance justifies recognising sales at the date of booking when a deposit
is received, and, even if it did, it would not be a change in accounting
policy. This means that comparatives would not be restated (which is
something that would actually suit the suspected objectives of the
directors).
51
Pingway
Accounting correctly for the convertible loan note in accordance with IAS 32 Financial
Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement
would mean that virtually all the financial assistant’s observations are incorrect. The
convertible loan note is a compound financial instrument containing a (largely) debt
component and an equity component – the value of the option to receive equity shares.
These components must be calculated using the residual equity method and
appropriately classified (as debt and equity) on the statement of financial position. As
some of the proceeds of the instrument will be equity, the gearing will not be quite as
high as if a non-convertible loan was issued, but gearing will be increased. However, if
the loan note is converted to equity in March 2012, gearing will be reduced. The
interest rate that would be applicable to a non-convertible loan (8%) is representative
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
of the true finance cost and should be applied to the carrying amount of the debt to
calculate the finance cost to be charged to the income statement thus giving a much
higher charge than the assistant believes.
Accounting treatment: financial statements year ended 31 March 2012
Income statement:
Finance costs (see working)
Statement of financial position:
Non-current liabilities
3% convertible loan note (8,674 + 393·92)
Equity
Option to convert
Working (figures in brackets in $’000)
cash flows
year 1 interest
300
year 2 interest
300
year 3 interest and capital
10,300
$693,920
$9,067,920
$1,326,000
present value $’000
279
258
8,137
–––––––
total value of debt component
8,674
proceeds of the issue
10,000
–––––––
equity component (residual amount)
1,326
–––––––
The interest cost in the income statement should be $693,920 (8,674 x 8%), requiring an
accrual of $393,920 (693·92 – 300 i.e. 10,000 x 3%). This accrual should be added to the
carrying value of the debt.
52
Dearing
Year ended/as at:
Income statement
Depreciation (see workings)
Maintenance (60,000/3 years)
Discount received (840,000 x 5%)
Staff training
Statement of financial position (see
below)
Property, plant and equipment
Cost
Accumulated depreciation
Carrying amount
244
factor at 8%
0·93
0·86
0·79
30
September
2010
$
180,000
20,000
(42,000)
40,000
––––––––
198,000
––––––––
30
September
2011
$
270,000
20,000
30
September
2012
$
119,000
20,000
––––––––
290,000
––––––––
––––––––
139,000
––––––––
920,000
(180,000)
––––––––
740,000
––––––––
920,000
(450,000)
––––––––
470,000
––––––––
670,000
(119,000)
––––––––
551,000
––––––––
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Workings
Manufacturer’s base price
Less trade discount (20%)
Base cost
Freight charges
Electrical installation cost
Pre-production testing
Initial capitalised cost
$
1,050,000
(210,000)
––––––––
840,000
30,000
28,000
22,000
––––––––
920,000
––––––––
The depreciable amount is $900,000 (920,000 – 20,000 residual value) and, based on an
estimated machine life of 6,000 hours, this gives depreciation of $150 per machine hour.
Therefore depreciation for the year ended 30 September 2010 is $180,000 ($150 x 1,200
hours) and for the year ended 30 September 2011 is $270,000 ($150 x 1,800 hours).
Note: early settlement discount, staff training in use of machine and maintenance are
all revenue items and cannot be part of capitalised costs.
Carrying amount at 1 October 2011
Subsequent expenditure
470,000
200,000
––––––––
Revised ‘cost’
670,000
––––––––
The revised depreciable amount is $630,000 (670,000 – 40,000 residual value) and with a
revised remaining life of 4,500 hours, this gives a depreciation charge of $140 per
machine hour. Therefore depreciation for the year ended 30 September 2012 is $119,000
($140 x 850 hours).
53
Waxwork (IAS 10)
(a)
Events after the reporting period are defined by IAS 10 Events after the
Reporting Period as those events, both favourable and unfavourable, that occur
between the end of the reporting period and the date that the financial
statements are authorised for issue (normally by the Board of directors).
An adjusting event is one that provides further evidence of conditions that
existed at the end of the reporting period, including an event that indicates that
the going concern assumption in relation to the whole or part of the entity is not
appropriate. Normally trading results occurring after the end of the reporting
period are a matter for the next reporting period, however, if there is an event
which would normally be treated as non-adjusting that causes a dramatic
downturn in trading (and profitability) such that it is likely that the entity will no
longer be a going concern, this should be treated as an adjusting event.
A non-adjusting event is an event after the end of the reporting period that is
indicative of a condition that arose after the end of the reporting period and,
subject to the exception noted above, the financial statements would not be
adjusted to reflect such events.
The outcome (and values) of many items in the financial statements have a
degree of uncertainty at the end of the reporting period. IAS 10 effectively says
that where events occurring after the end of the reporting period help to
determine what those values were at the end of the reporting period, they should
be taken in account (i.e. adjusted for) in preparing the financial statements.
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Paper F7: Financial Reporting (International)
If non-adjusting events, whilst not affecting the financial statements of the
current year, are of such importance (i.e. material) that without disclosure of their
nature and estimated financial effect, users’ ability to make proper evaluations
and decisions about the future of the entity would be affected, then they should
be disclosed in the notes to the financial statements.
(b)
(i)
This is normally classified as a non-adjusting event as there was no reason
to doubt that the value of warehouse and the inventory it contained was
worth less than its carrying amount at 31 March 2012 (the last day of the
reporting period). The total loss suffered as a result of the fire is $16
million. The company expects that $9 million of this loss will be recovered
from an insurance policy. Recoveries from third parties should be assessed
separately from the related loss. As this event has caused serious
disruption to trading, IAS 10 would require the details of this nonadjusting event to be disclosed as a note to the financial statements for the
year ended 31 March 2012 as a total loss of $16 million and the effect of the
insurance recovery to be disclosed separately.
The severe disruption in Waxwork’s trading operations since the fire,
together with the expectation of large trading losses for some time to come,
may call in to question the going concern status of the company. If it is
judged that Waxwork is no longer a going concern, then the fire and its
consequences become an adjusting event requiring the financial statements
for the year ended 31 March 2012 to be redrafted on the basis that the
company is no longer a going concern (i.e. they would be prepared on a
liquidation basis).
(ii)
70% of the inventory amounts to $322,000 (460,000 x 70%) and this was sold
for a net amount of $238,000 (280,000 x 85%). Thus a large proportion of a
class of inventory was sold at a loss after the reporting period. This would
appear to give evidence of conditions that existed at 31 March 2012 i.e. that
the net realisable value of that class of inventory was below its cost.
Inventory is required to be valued at the lower of cost and net realisable
value, thus this is an adjusting event. If it is assumed that the remaining
inventory will be sold at similar prices and terms as that already sold, the
net realisable value of the whole of the class of inventory would be
calculated as:
$280,000/70% = $400,000, less commission of 15% = $340,000.
Thus the carrying amount of the inventory of $460,000 should be written
down by $120,000 to its net realisable value of $340,000.
In the unlikely event that the fall in the value of the inventory could be
attributed to a specific event that occurred after the date of the statement of
financial position then this would be a non-adjusting event.
(iii)
246
The date of the government announcement of the tax change is beyond the
period of consideration in IAS 10. Thus this would be neither an adjusting
nor a non-adjusting event. The increase in the deferred tax liability will be
provided for in the year to 31 March 2012. Had the announcement been
before 6 May 2012, it would have been treated as a non-adjusting event
requiring disclosure of the nature of the event and an estimate of its
financial effect in the notes to the financial statements.
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
54
Flightline
Flightline – Income statement for the year ended 31 March 2012:
$’000
Depreciation (w (i))
13,800
Loss on write off of engine (w (iii))
6,000
Repairs
– engine
3,000
– exterior painting
2,000
Statement of financial position as at 31 March 2012
Non-current asset – Aircraft
Exterior (w (i))
Cabin fittings (w (ii))
Engines (w (iii))
cost
$’000
120,000
29,500
19,800
––––––––
169,300
––––––––
accumulated
depreciation
$’000
84,000
21,500
3,700
––––––––
109,200
––––––––
carrying
amount
$’000
36,000
8,000
16,100
–––––––
60,100
–––––––
Workings (figures in brackets in $’000)
(i)
The exterior of the aircraft is depreciated at $6 million per annum (120,000/20
years). The cabin is depreciated at $5 million per annum (25,000/5 years). The
engines would be depreciated by $500 ($18 million/36,000 hours) i.e. $250 each,
per flying hour.
The carrying amount of the aircraft at 1 April 2011 is:
cost
(ii)
carrying
amount
$’000
$’000
Exterior (13 years old)
120,000
42,000
Cabin (3 years old)
25,000
10,000
Engines (used 10,800 hours)
18,000
12,600
––––––––
–––––––
163,000
64,600
––––––––
–––––––
Depreciation for year to 31 March 2012:
$’000
Exterior (no change)
6,000
Cabin fittings – six months to 30 September 2011 (5,000 x 6/12)
2,500
– six months to 31 March 2012 (w (ii))
4,000
Engines
– six months to 30 September 2011 (500 x 1,200 hours)
600
– six months to 31 March 2012 ((400 + 300) w (iii))
700
–––––––
13,800
–––––––
Cabin fittings – at 1 October 2011 the carrying amount of the cabin fittings is $7·5
million (10,000 – 2,500). The cost of improving the cabin facilities of $4·5 million
should be capitalised as it led to enhanced future economic benefits in the form
of substantially higher fares. The cabin fittings would then have a carrying
amount of $12 million (7,500 + 4,500) and an unchanged remaining life of 18
months. Thus depreciation for the six months to 31 March 2012 is $4 million
(12,000 x 6/18).
© Emile Woolf Publishing Limited
accumulated
depreciation
$’000
78,000
15,000
5,400
––––––––
98,400
––––––––
247
Paper F7: Financial Reporting (International)
(iii)
Engines – before the accident the engines (in combination) were being
depreciated at a rate of $500 per flying hour. At the date of the accident each
engine had a carrying amount of $6 million ((12,600 – 600)/2). This represents the
loss on disposal of the written off engine. The repaired engine’s remaining life
was reduced to 15,000 hours. Thus future depreciation on the repaired engine
will be $400 per flying hour, resulting in a depreciation charge of $400,000 for the
six months to 31 March 2012. The new engine with a cost of $10·8 million and a
life of 36,000 hours will be depreciated by $300 per flying hour, resulting in a
depreciation charge of $300,000 for the six months to 31 March 2012.
Summarising both engines:
Cost
$’000
9,000
10,800
––––––––
19,800
––––––––
Note: marks are awarded for clear calculations rather
Full explanations are given for tutorial purposes.
Old engine
New engine
55
accumulated
carrying
depreciation
amount
$’000
$’000
3,400
5,600
300
10,500
––––––––
–––––––
3,700
16,100
––––––––
–––––––
than for detailed explanations.
Darby
(a)
There are four elements to the assistant’s definition of a non-current asset and he
is substantially incorrect in respect of all of them.
The term non-current assets will normally include intangible assets and certain
investments; the use of the term ‘physical asset’ would be specific to tangible
assets only.
Whilst it is usually the case that non-current assets are of relatively high value
this is not a defining aspect. A waste paper bin may exhibit the characteristics of
a non-current asset, but on the grounds of materiality it is unlikely to be treated
as such. Furthermore the past cost of an asset may be irrelevant; no matter how
much an asset has cost, it is the expectation of future economic benefits flowing
from a resource (normally in the form of future cash inflows) that defines an
asset according to the IASB’s Conceptual Framework for the preparation and
presentation of financial statements.
The concept of ownership is no longer a critical aspect of the definition of an
asset. It is probably the case that most noncurrent assets in an entity’s statement
of financial position are owned by the entity; however, it is the ability to ‘control’
assets (including preventing others from having access to them) that is now a
defining feature. For example: this is an important characteristic in treating a
finance lease as an asset of the lessee rather than the lessor.
It is also true that most non-current assets will be used by an entity for more than
one year and a part of the definition of property, plant and equipment in IAS 16
Property, plant and equipment refers to an expectation of use in more than one
period, but this is not necessarily always the case. It may be that a non-current
asset is acquired which proves unsuitable for the entity’s intended use or is
damaged in an accident. In these circumstances assets may not have been used
for longer than a year, but nevertheless they were reported as non-currents
during the time they were in use. A non-current asset may be within a year of the
end of its useful life but (unless a sale agreement has been reached under IFRS 5
248
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Non-current assets held for sale and discontinued operations) would still be
reported as a non-current asset if it was still giving economic benefits. Another
defining aspect of non-current assets is their intended use i.e. held for continuing
use in the production, supply of goods or services, for rental to others or for
administrative purposes.
(b)
(i)
The expenditure on the training courses may exhibit the characteristics of
an asset in that they have and will continue to bring future economic
benefits by way of increased efficiency and cost savings to Darby.
However, the expenditure cannot be recognised as an asset on the
statement of financial position and must be charged as an expense as the
cost is incurred. The main reason for this lies with the issue of ’control’; it is
Darby’s employees that have the ‘skills’ provided by the courses, but the
employees can leave the company and take their skills with them or,
through accident or injury, may be deprived of those skills. Also the
capitalisation of staff training costs is specifically prohibited under
International Financial Reporting Standards (specifically IAS 38 Intangible
assets).
(ii)
The question specifically states that the costs incurred to date on the
development of the new processor chip are research costs. IAS 38 states
that research costs must be expensed. This is mainly because research is the
relatively early stage of a new project and any future benefits are so far in
the future that they cannot be considered to meet the definition of an asset
(probable future economic benefits), despite the good record of success in
the past with similar projects.
Although the work on the automatic vehicle braking system is still at the
research stage, this is different in nature from the previous example as the
work has been commissioned by a customer, As such, from the perspective
of Darby, it is work in progress (a current asset) and should not be written
off as an expense. A note of caution should be added here in that the
question says that the success of the project is uncertain which presumably
means it may not be completed. This does not mean that Darby will not
receive payment for the work it has carried out, but it should be checked to
the contract to ensure that the amount it has spent to date ($2·4 million) will
be recoverable. In the event that say, for example, the contract stated that
only $2 million would be allowed for research costs, this would place a
limit on how much Darby could treat as work in progress. If this were the
case then, for this example, Darby would have to expense $400,000 and
treat only $2 million as work in progress.
(iii)
The question suggests the correct treatment for this kind of contract is to
treat the costs of the installation as a non-current asset and (presumably)
depreciate it over its expected life of (at least) three years from when it
becomes available for use. In this case the asset will not come into use until
the next financial year/reporting period and no depreciation needs to be
provided at 30 September 2012.
The capitalised costs to date of $58,000 should only be written down if
there is evidence that the asset has become impaired. Impairment occurs
where the recoverable amount of an asset is less than its carrying amount.
The assistant appears to believe that the recoverable amount is the future
profit, whereas (in this case) it is the future (net) cash inflows. Thus any
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
impairment test at 30 September 2012 should compare the carrying amount
of $58,000 with the expected net cash flow from the system of $98,000
($50,000 per annum for three years less future cash outflows to completion
the installation of $52,000 (see note below)). As the future net cash flows are
in excess of the carrying amount, the asset is not impaired and it should not
be written down but shown as a non-current asset (under construction) at
cost of $58,000.
Note: as the contract is expected to make a profit of $40,000 on income of
$150,000, the total costs must be $110,000, with costs to date at $58,000 this
leaves completion costs of $52,000.
56
Barstead
(a)
Whilst profit after tax (and its growth) is a useful measure, it may not give a fair
representation of the true underlying earnings performance. In this example,
users could interpret the large annual increase in profit after tax of 80% as being
indicative of an underlying improvement in profitability (rather than what it
really is: an increase in absolute profit). It is possible, even probable, that (some
of) the profit growth has been achieved through the acquisition of other
companies (acquisitive growth). Where companies are acquired from the
proceeds of a new issue of shares, or where they have been acquired through
share exchanges, this will result in a greater number of equity shares of the
acquiring company being in issue. This is what appears to have happened in the
case of Barstead as the improvement indicated by its earnings per share (EPS) is
only 5% per annum. This explains why the EPS (and the trend of EPS) is
considered a more reliable indicator of performance because the additional
profits which could be expected from the greater resources (proceeds from the
shares issued) is matched with the increase in the number of shares. Simply
looking at the growth in a company’s profit after tax does not take into account
any increases in the resources used to earn them. Any increase in growth
financed by borrowings (debt) would not have the same impact on profit (as
being financed by equity shares) because the finance costs of the debt would act
to reduce profit.
The calculation of a diluted EPS takes into account any potential equity shares in
issue. Potential ordinary shares arise from financial instruments (e.g. convertible
loan notes and options) that may entitle their holders to equity shares in the
future. The diluted EPS is useful as it alerts existing shareholders to the fact that
future EPS may be reduced as a result of share capital changes; in a sense it is a
warning sign. In this case the lower increase in the diluted EPS is evidence that
the (higher) increase in the basic EPS has, in part, been achieved through the
increased use of diluting financial instruments. The finance cost of these
instruments is less than the earnings their proceeds have generated leading to an
increase in current profits (and basic EPS); however, in the future they will cause
more shares to be issued. This causes a dilution where the finance cost per
potential new share is less than the basic EPS.
(b)
250
(Basic) EPS for the year ended 30 September 2012
($15 million/43·25 million x 100)
34·7 cents
Comparative (basic) EPS (35 x 3·60/3·80)
33·2 cents
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Effect of rights issue (at below market price)
100 shares at $3·80
25 shares at $2·80
–––
125 shares at $3·60 (calculated theoretical ex-rights value)
–––
Weighted average number of shares
36 million x 3/12 x $3·80/$3·60
45 million x 9/12
Diluted EPS for the year ended 30 September 2012
($15·6 million/45·75 million x 100)
380
70
––––
450
––––
9·50 million
33·75 million
––––––
43·25 million
––––––
34·1 cents
Adjusted earnings
15 million + (10 million x 8% x 75%)
$15·6 million
Adjusted number of shares
43·25 million + (10 million x 25/100)
57
45·75 million
Apex
(a)
Where borrowing costs are directly incurred on a ‘qualifying asset’, they must be
capitalised as part of the cost of that asset. A qualifying asset may be a tangible or
an intangible asset that takes a substantial period of time to get ready for its
intended use or eventual sale. Property construction would be a typical example,
but it can also be applied to intangible assets during their development period.
Borrowing costs include interest based on its effective rate (which incorporates
the amortisation of discounts, premiums and certain expenses) on overdrafts,
loans and (some) other financial instruments and finance charges on finance
leased assets. They may be based on specifically borrowed funds or on the
weighted average cost of a pool of funds.
Any income earned from the temporary investment of specifically borrowed
funds would normally be deducted from the amount to be capitalised.
Capitalisation should commence when expenditure is being incurred on the
asset, which is not necessarily from the date funds are borrowed. Capitalisation
should cease when the asset is ready for its intended use, even though the funds
may still be incurring borrowing costs. Also capitalisation should be suspended
if there is a suspension of active development of the asset.
Any borrowing costs that are not eligible for capitalisation must be expensed.
Borrowing costs cannot be capitalised for assets measured at fair value.
(b)
The finance cost of the loan must be calculated using the effective rate of 7·5%, so
the total finance cost for the year ended 31 March 2010 is $750,000 ($10 million x
7·5%). As the loan relates to a qualifying asset, the finance cost (or part of it in
this case) can be capitalised under IAS 23.
The Standard says that capitalisation commences from when expenditure is
being incurred (1 May 2009) and must cease when the asset is ready for its
intended use (28 February 2010); in this case a 10-month period. However,
interest cannot be capitalised during a period where development activity is
suspended; in this case the two months of July and August 2009. Thus only eight
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
months of the year’s finance cost can be capitalised = $500,000 ($750,000 x 8/12).
The remaining four-months finance costs of $250,000 must be expensed. IAS 23
also says that interest earned from the temporary investment of specific loans
should be deducted from the amount of finance costs that can be capitalised.
However, in this case, the interest was earned during a period in which the
finance costs were NOT being capitalised, thus the interest received of $40,000
would be credited to the income statement and not to the capitalised finance
costs.
In summary:
$
Income statement for the year ended 31 March 2010:
Finance cost (debit)
Investment income (credit)
Statement of financial position as at 31 March 2010:
Property, plant and equipment (finance cost element only)
58
(250,000)
40,000
500,000
Tunshill
(a)
Management’s choices of which accounting policies they may adopt are not as
wide as generally thought. Where an International Accounting Standard, IAS or
IFRS (or an Interpretation) specifically applies to a transaction or event the
accounting policy used must be as prescribed in that Standard (taking in to
account any Implementation Guidance within the Standard). In the absence of a
Standard, or where a Standard contains a choice of policies, management must
use its judgement in applying accounting policies that result in information that
is relevant and reliable given the circumstances of the transactions and events. In
making such judgements, management should refer to guidance in the Standards
related to similar issues and the definitions, recognition criteria and
measurement concepts for assets, liabilities, income and expenses in the IASB’s
Framework for the preparation and presentation of financial statements.
Management may also consider pronouncements of other standard-setting
bodies that use a similar conceptual framework to the IASB.
A change in an accounting policy usually relates to a change of principle, basis or
rule being applied by an entity. Accounting estimates are used to measure the
carrying amounts of assets and liabilities, or related expenses and income. A
change in an accounting estimate is a reassessment of the expected future
benefits and obligations associated with an asset or a liability. Thus, for example,
a change from non-depreciation of a building to depreciating it over its estimated
useful life would be a change of accounting policy. To change the estimate of its
useful life would be a change in an accounting estimate.
(b)
252
(i)
The main issue here is the estimate of the useful life of a non-current asset.
Such estimates form an important part of the accounting estimate of the
depreciation charge. Like most estimates, an annual review of their
appropriateness is required and it is not unusual, as in this case, to revise
the estimate of the remaining useful life of plant. It appears, from the
information in the question, that the increase in the estimated remaining
useful life of the plant is based on a genuine reassessment by the
production manager. This appears to be an acceptable reason for a revision
of the plant’s life, whereas it would be unacceptable to increase the estimate
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
simply to improve the company’s reported profit. That said, the assistant
accountant’s calculation of the financial effect of the revised life is incorrect.
Where there is an increase (or decrease) in the estimated remaining life of a
non-current asset, its carrying amount (at the time of the revision) is
allocated over the new remaining life (after allowing for any estimated
residual value). The carrying amount at 1 October 2009 is $12 million ($20
million – $8 million accumulated depreciation) and this should be written
off over the estimated remaining life of six years (eight years in total less
two already elapsed). Thus a charge for depreciation of $2 million would be
required in the year ended 30 September 2010 leaving a carrying amount of
$10 million ($12 million – $2 million) in the statement of financial position
at that date. A depreciation charge for the current year cannot be avoided
and there will be no credit to the income statement as suggested by the
assistant accountant. It should be noted that the incremental effect of the
revision to the estimated life of the plant would be to improve the reported
profit by $2 million being the difference between the depreciation based on
the old life ($4 million) and the new life ($2 million).
(ii)
59
The appropriateness of the proposed change to the method of valuing
inventory is more dubious than the previous example. Whilst both
methods (FIFO and AVCO) are acceptable methods of valuing inventory
under IAS 2 Inventories, changing an accounting policy to be consistent
with that of competitors is not a convincing reason. Generally changes in
accounting policies should be avoided unless a change is required by a new
or revised accounting standard or the new policy provides more reliable
and relevant information regarding the entity’s position. In any event the
assistant accountant’s calculations are again incorrect and would not meet
the intention of improving reported profit. The most obvious error is that
changing from FIFO to AVCO will cause a reduction in the value of the
closing inventory at 30 September 2010 effectively reducing, rather than
increasing, both the valuation of inventory and reported profit. A change in
accounting policy must be accounted for as if the new policy had always
been in place (retrospective application). In this case, for the year ended 30
September 2010, both the opening and closing inventories would need to be
measured at AVCO which would reduce reported profit by $400,000 (($20
million – $18 million) – ($15 million – $13·4 million) – i.e. the movement in
the values of the opening and closing inventories). The other effect of the
change will be on the retained earnings brought forward at 1 October 2009.
These will be restated (reduced) by the effect of the reduced inventory
value at 30 September 2009 i.e. $1·6 million ($15 million – $13·4 million).
This adjustment would be shown in the statement of changes in equity.
Manco
From the information in the question, the closure of the furniture making operation is a
restructuring as defined in IAS 37 Provisions, contingent liabilities and contingent
assets and, due to the timing of the decision, a provision for the closure costs will be
required in the year ended 30 September 2010. Although the Standard says that a
Board of directors’ decision to close an operation is alone not sufficient to trigger a
provision the other actions of the management, informing employees, customers and a
press announcement indicate that this is an irreversible decision and that therefore
there is an obligating event.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Commenting on each element in turn for both years:
(i)
Factory and plant
At 30 September 2010 – these assets cannot be classed as ‘held-for-sale’ as they
are still in use (i.e. generating revenue) and therefore are not available for sale.
Both assets will therefore continue to be depreciated.
Despite this, it does appear that the plant is impaired. Based on its carrying
amount of $2·8 million an impairment charge of $2·3 million ($2·8 million – $0·5
million) would be required (subject to any further depreciation for the three
months from July to September 2010). The expected gain on the sale of the factory
cannot be recognised or used to offset the impairment charge on the plant. The
impairment charge is not part of the restructuring provision, but should be
reported with the depreciation charge for the year.
At 30 September 2011 – the realised profit on the disposal of the factory and any
further loss on the disposal of the plant will both be reported in the income
statement.
(ii)
Redundancy and retraining costs
At 30 September 2010 – a provision for the redundancy costs of $750,000 should
be made, but the retraining costs relate to the ongoing actives of Manco and
cannot be provided for.
At 30 September 2011 – the redundancy costs incurred during the year will be
offset against the provision created last year. Any under- or over-provision will
be reported in the income statement. The retraining costs will be written off as
they are incurred.
(iii)
Trading losses
The losses to 30 September 2010 will be reported as part of the results for the year
ended 30 September 2010. The expected losses from 1 October 2010 to the closure
on 31 January 2011 cannot be provided in the year ended 30 September 2010 as
they relate to ongoing activities and will therefore be reported as part of the
results for the year ended 30 September 2011 as they are incurred.
It should also be considered whether the closure fulfils the definition of a discontinued
operation in accordance with IFRS 5 Non-current assets held for sale and discontinued
operations. As there is a co-ordinated plan to dispose of a separate major line of
business (the furniture making operation is treated as an operating segment) this
probably is a discontinued operation. However, the timing of the closure means that it
is not a discontinued operation in the year ended 30 September 2010; rather it is likely
that it will be such in the year ended 30 September 2011. Some commentators believe
that this creates an anomalous situation in that most of the closure costs are reported in
the year ended 30 September 2010 (as described above), but the closure itself is only
identified and reported as a discontinued operation in the year ended 30 September
2011 (although the comparative figures for 2010 would then restate this as a
discontinued operation).
254
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Business combinations – Statements of financial position
60
Hydrox
Hydrox
Consolidated statement of financial position of Hydrox as at 31 March 2012
$000
$000
Assets
Non-current assets
Property, plant and equipment (W1)
45,840
800
Goodwill (1,200 − 400)
Investments (W1)
8,800
55,440
Current assets
Inventory (W2)
14,000
Trade accounts receivable (7,200 + 1,500 - 2,000)
6,700
Cash and bank
300
21,000
Total assets
76,440
Equity and liabilities
Share capital and reserves:
Equity shares $1 each
Reserves: Retained earnings (W3)
10,000
34,510
44,510
1,130
45,640
Non-controlling interest (W5)
Non-current liabilities
12% Debenture
Bank loan
4,000
6,000
10,000
Current liabilities
Trade accounts payable (6,700 + 5,200 − 1,400)
Operating overdraft
Income tax liability (4,100 + 700)
Dividends payable – Hydrox
10,500
4,500
4,800
1,000
20,800
76,440
Total equity and liabilities
Workings (Note: all figures in $000)
(W1) Property, plant and equipment
Balance from question
– Hydrox
26,400
– Syntax
16,200
Fair value adjustment on acquisition
Depreciation on fair value adjustment (5,400/5 × 2)
5,400
(2,160)
45,840
© Emile Woolf Publishing Limited
255
Paper F7: Financial Reporting (International)
Investments
Investments
Balance from question
– Hydrox
1,000
– Syntax
6,000
Fair value adjustment on acquisition (90% × (8,000 − 6,000))
1,800
8,800
(W2) Inventory
Amounts per question (9,500 + 4,000)
13,500
Add back ‘in transit’ goods at cost (600 × 100/120)
500
14,000
Note: A mark-up of 20% (1/5) on cost is equivalent to a gross profit on selling
price of 1/6. Therefore the cost of the inventory is $500,000 and there is an
unrealised profit of $100,000.
(W3) Retained earnings
Unrealised profit (W2)
Additional depreciation
(W1)
Pre acq. dividend to cost
of control (90% × 4,000)
(W8)
Non-controlling interest
(10% × 6,300)
Pre-acquisition profit
(90% × 15,000)
Post acquisition loss
(90% × (15,000 − 6,300))
Goodwill impairment
Balance c/f
Hydrox
100
Hydrox
48,600
B/f
Syntax
6,300
2,160
3,600
630
13,500
Post acquisition loss
(7,830)
(7,830)
400
34,510
――――
(W4) Cost of control
Syntax
――――
40,770
6,300
――――
――――
――――
―――
40,770
6,300
――――
―――
Investments at cost
30,000
Equity shares (90% × 5,000)
4,500
Pre acquisition dividend (W3)
(3,600)
Pre acquisition profit (W3)
13,500
Fair value adjustments (W1)
(plant 5,400, investments 1,800)
7,200
Goodwill
1,200
26,400
26,400
(W5) Non-controlling interest
Balance c/f
1,130
1,130
256
Equity shares (10% × 5,000)
500
Retained earnings (W4)
630
1,130
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(W6) Elimination of current accounts
The current accounts of Hydrox and Syntax were agreed at $1,400,000 before the
‘in transit’ sale. When Hydrox processed this transaction it would have debited
the sale to Syntax’s current account. In effect, this must be reversed to eliminate
intra-group balances. A summary of the ‘reversal’, including the effect of the
unrealised profit is:
Dr
Accounts payable (elimination of Hydrox’s credit balance)
1,400
Inventory at cost (W2)
Income statement of Hydrox (unrealised profit)
Cr
500
100
Accounts receivable (elimination of Syntax’s debit balance)
2,000
2,000
2,000
(W7) Hydrox’s treatment of the dividend received from Syntax is incorrect and must
be adjusted for on consolidation. As Syntax has not made any profits since
acquisition, and seems unlikely to in the future, the dividend must be considered
as being paid out of pre-acquisition profits and should be treated as a partial
return of the cost of the investment. It should not be treated as income in the
consolidated financial statements.
61
Hedra
Hedra: Consolidated statement of financial position as at 30 September 2012
$000
$000
Non-current assets
Property, plant and equipment: 358 + 240 + 12 + 20 + 5 +15 (w (iv))
650
Goodwill: 100 – 20 (w (i))
80
Investment in associate (w (v))
220
Other investments
45
995
Current assets
Inventories: 130 + 80
210
Trade receivables: 142 + 97
239
Cash and bank
4
453
Total assets
1,448
Equity and liabilities
Equity attributable to the parent
Ordinary share capital: 400 + 80 (w (v))
Reserves:
Share premium: 40 + 120 (w (v))
Revaluation: 15 + 12 + (5 × 60%) (w (iv))
Retained earnings (w (ii))
480
160
30
261
451
931
© Emile Woolf Publishing Limited
257
Paper F7: Financial Reporting (International)
Hedra: Consolidated statement of financial position as at 30 September 2012
$000
$000
Non-controlling interest (w (iii))
112
1,043
Non-current liabilities
Deferred tax: 45 – 10
35
Current liabilities
Bank overdraft
12
Trade payables: 118 + 141
259
Deferred consideration (w (i))
49
Current tax payable
50
370
Total equity and liabilities
1,448
Workings
The investment in Salvador represents 60% (72/120) of its equity and is likely to give
Hedra control thus Salvador should be consolidated as a subsidiary. The investment in
Aragon represents 40% (40/100) of its equity. Normally this would give Hedra
significant influence and Aragon would be classed as an associate that should be
equity accounted.
(i)
Cost of control
$000
$000
Cost of acquisition
Immediate
Deferred
Acquired
Share capital
Share premium of Salvador (60% × 50)
Pre-acquisition profit of Salvador (60% × 20)
Fair value adjustments:
Land
Plant
Deferred tax asset (40 × 25% tax rate)
$000
195
49
244
72
30
12
20
20
10
50
Group share (60%)
30
144
100
Goodwill (balancing figure)
The deferred contingent consideration has now become payable and has to be
accounted for. Goodwill must be adjusted accordingly.
(ii)
Retained earnings
$000
Hedra: per statement of financial position at end of year
$000
240
Salvador
Retained profits in year-end statement of financial position
258
60
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Section 2: Answers to practice questions
$000
Less: Additional plant depreciation (w(iv))
$000
(5)
55
Non controlling interest share (40%)
22
Group share
33
Pre-acquisition profit (60% × 20)
(12)
21
Impairment of goodwill
(20)
Share of Aragon profits (6 months)
6/12 × (300 – 200) × 40%
20
Consolidated retained earnings
(iii)
261
Non-controlling interest
Salvador:
$000
$000
Share capital
120
Share premium
50
Retained profit as in statement of financial position
60
Less: Additional plant depreciation (w(iv))
(5)
55
225
Non-controlling interest share (40%
90
Non-controlling interest share in:
Fair value adjustments (see w(i)) 40% × 50
Post-acquisition revaluation of land: 40% × 5
Non-controlling interest
(iv)
20
2
112
Fair value adjustments/revaluation
There are fair value adjustments of $50,000, see working (i).
Group share (60%) = 30
Non-controlling interest share (40%) = 20
The increase in the fair value of the land at the date of acquisition is accounted
for as a fair value adjustment. The increase of a further $5 million in the year
ended 30 September 2012 is a revaluation increase (accounted for as 60% to the
group revaluation reserve and 40% to non controlling interest).
The fair value adjustment of $20 million to plant will be realised evenly over the
next four years in the form of additional depreciation at $5 million per annum. In
the year ended 30 September 2012 the effect on the consolidated financial
statements is that $5 million will be charged to Salvador’s profit (as additional
depreciation); and a net $15 million added to the carrying value of the plant.
© Emile Woolf Publishing Limited
259
Paper F7: Financial Reporting (International)
(v)
Investment in associate
Investment at cost: 80 million share of Hedra × $2.50 per share
Share of post acquisition profit: 6/12 × (300 – 200) × 40%
$000
200
20
220
The purchase consideration by way of a share exchange (80 million in Hedra for
40 million in Aragon) would be recorded in the accounts of Hedra as an increase
in share capital of $80 million ($1 nominal value) and an increase in share
premium of $120 million (80 × $1.50).
As shown in the statement of financial position of Hedra
Acquisition of shares in Aragon
In the consolidated statement of financial position
62
Share
capital
$000
400
80
―――
480
―――
Share
premium
$000
40
120
―――
160
―――
Harden
(a)
Harden
Consolidated statement of financial position as at 30 September 2012
$000
$000
Non-current assets
Property, plant and equipment (W1)
6,480
Patents (250 + 420)
670
Consolidated goodwill (W4)
180
850
Investments
Associate (W7)
960
Others (150 + 200)
350
1,310
8,640
Current assets
Inventories (W2)
962
Trade receivables (420 + 380 – 70 – 50) (W6)
680
Bank
150
1,792
Total assets
10,432
Equity attributable to equity holders of the parent
Equity shares of $1 each
2,000
Reserves
Share premium
1,000
Retained earnings (W3)
5,172
6,172
8,172
Non-controlling interest (W5)
710
8,882
260
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Section 2: Answers to practice questions
Harden
Consolidated statement of financial position as at 30 September 2012
$000
Non-current liabilities
Deferred tax
Current liabilities
Trade payables (750 + 450 – 70) (W6)
Taxation
Overdraft
$000
200
1,130
140
80
1,350
10,432
Total equity and liabilities
Workings ($000)
(W1) Tangible non-current assets
Balance from question – Harden
– Solder
Land fair value increase
3,980
2,300
200
6,480
(W2) Inventories
Amounts per question (570 + 400)
Group share of unrealised profit (140 × 40/140 × ½ × 40%)
970
(8)
962
(W3) Retained earnings
Unrealised profit (W2)
Management charge (W6)
Non-controlling interest
(20% × (1,900 – 50))
Pre-acq profit (80% × 1,200)
Post acq profit
(80% × (1,900 – 50 – 1,200))
Balance c/f
(W4) Goodwill
Investments at cost
Harden
8
Solder
50
370
960
Solder
1,900
―――
520
5,172
―――
―――
―――
5,180
1,900
5,180
1,900
―――
―――
―――
―――
2,500
2,500
© Emile Woolf Publishing Limited
Harden
B/f
4,500
Post acq profit – Solder
520
Post acq profit – Active
160
(W7)
Equity shares (80% × 1,000) 800
800
Share premium (80% × 500)
400
Pre acq profit (80% x 1,200))
960
Fair value adjustments (80% × 200)
160
Goodwill
180
2,500
261
Paper F7: Financial Reporting (International)
(W5) Non-controlling interest
Balance c/f
710
Equity shares (20% × 1,000)
200
Share premium (20% × 500)
100
Fair value adjustments (20% × 200)
Retained earnings (W3)
40
370
710
710
(W6) Elimination of current accounts
The current accounts of Harden and Solder were agreed at $70,000 before
the charge for the allocation of central overheads. When Harden processed
this transaction it would have debited Solder’s current account to give a
balance of $120,000 which must be eliminated. The corresponding
adjustments are to eliminate $70,000 from Solder’s trade payables and debit
$50,000 to the retained earnings of Solder.
In summary:
Dr
70
50
Trade payables (elimination of intra-group creditor)
Retained earnings of Solder reflecting the charge
Trade receivables (elimination of intra-group debtor)
120
Cr
120
120
(W7) Associate
Investment at cost
Post-acquisition profits (40% × (1,200 – 800))
800
160
960
(b)
262
IFRS 3 Business Combinations states the assets and liabilities that should be
recognised on the acquisition of an acquired entity are those that existed at the
date of acquisition. Whilst this sounds relatively obvious, it does raise some
issues. It may be that an entity has in existence some assets and liabilities that are
not (and in some cases cannot be) recognised on the entity’s own statement of
financial position. Applying this guidance to items (i) and (ii):
(i)
Trading losses available for future tax relief can represent a deferred tax
asset, but only where their recovery can be assured with a high degree of
certainty. Prior to the acquisition it is clear that this degree of certainty did
not exist and the directors of Deployed are correct in not recognising a
deferred tax asset in respect of the losses. However when Deployed
becomes a member of the Harden group, deferred tax has to be determined
on a group basis and the directors of Harden are confident that the tax
losses of Deployed can be utilised on a group basis. IFRS 3 says that any
benefit to the group of an acquired entity’s tax losses should be recognised
on acquisition. Therefore it would appear that a deferred tax asset of
$60,000 ($200,000 × 30%) should be recognised as part of the fair value
exercise. This would be either as a reduction of the group deferred tax
liability or as a deferred tax asset, provided it meets the recognition criteria
in IAS 12 Income Taxes.
(ii)
Again the management of Deployed are correct in not recognising the
disputed insurance claim as it is probably not ‘virtually certain’ which is
the recognition criterion required under IAS 37 Provisions, Contingent
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Liabilities and Contingent Assets. Despite this IFRS 3 says that identifiable
assets, liabilities and contingent liabilities of the acquired entity have to be
recognised in the consolidated financial statements even if they were not
recognised, or did not qualify for recognition, in the acquired entity’s own
financial statements. If an acquired entity has a contingent asset it is
possible that future economic benefits will flow to the acquirer, although it
could be disputed that there is the required reliable measure of their fair
value. There is a case for recognising this asset as part of the fair value
exercise at the best estimate of its likely outcome. However, IFRS 3 does not
state that contingent assets should be recognised and therefore the
insurance claim should not be recognised.
63
Halogen
(a)
Halogen
Consolidated statement of financial position as at 31 March 2012
$m
Assets
Non-current assets
Property, plant and equipment (910 + 330 + 10 + 8)
Goodwill (150 – 30)(W2)
Development expenditure (100 – 8 )
Investments ((700 – 480 (W3))) + 60)
$m
1,258
120
92
280
1,750
Current assets
Inventory (224 +120 – 3)
Trade receivables (264 + 84 – 12 (W4))
Bank
Total assets
Equity and liabilities
Equity shares $1 each
Share premium
Retained earnings (W6)
Revaluation reserve: 70 + 75% × (48 – 40))
Non-controlling interest (W5)
Equity
Non-current liabilities
10% Debenture
Current liabilities
Trade payables (128 + 24)
Taxation (94 + 35)
Overdraft (86 – 12 (W4))
Total equity and liabilities
© Emile Woolf Publishing Limited
341
336
25
702
2,452
1,000
300
536
76
912
1,912
125
2,037
60
152
129
74
355
2,452
263
Paper F7: Financial Reporting (International)
Workings
(W1) Net assets in subsidiary
At acquisition
At end of
reporting period
$m
200
48
260
20
528
$m
200
40
180
20
440
Share capital
Revaluation reserve
Retained earnings
Fair value adjustments – dev exp (28 – 8)
(W2) Goodwill
Cost of investment
75 million (200m/2 × 75%) x $5
Cash paid (200m/2 × 75%) × $1.40
Net assets acquired 75% × 440 (W1)
Goodwill
Less impairment
$m
480
375
105
480
330
150
(30)
120
(W3) Unrealised profit adjustments
Unrealised profit in inventory (26 × 30/130 × 1/2) = (3)
Parent sells to subsidiary so no NCI adjustment
(W5) Non-controlling interest
25% × (528 – 28) (W1) =
$125,000
(W6) Retained earnings
Halogen
Less: unrealised profit in inventory (W4)
Stimulus: group share post acquisition
75% × ((260 – 28) – 180)
Less impairment
(b)
$m
530
(3)
39
(30)
536
There is a view that an income statement prepared under the concept of ‘current
operating income’ has some merit. The principal advantage of this method of
reporting is said to be that it reports the results of those parts of a business that
can be expected to be operating in the future and this forms a useful basis from
which to predict the future profit and income streams of the entity. Whilst this
view may have some benefits, the accounting profession has rejected it mainly
because it would lead to incomplete reporting and the introduction of greater
subjectivity. It would give management scope to report selectively certain
aspects of performance.
The directors of Halogen are partly correct in interpreting the usefulness of IFRS
5, in that by identifying and separately reporting discontinued operations and
assets and subsidiaries held for sale this does help the predictive/forecasting
process. However, it is important to realise that IFRS 5 does not permit the
264
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
omission of the results of those parts of the business that have been (or are about
to be) discontinued, which is what the directors of Halogen are proposing.
IFRS 10 Consolidated Financial Statements does not allow any subsidiary to be
excluded from the consolidation process. The Standard prevents managers from
selectively excluding the results of subsidiaries that have made losses or have a
poor liquidity position. Subsidiaries must continue to be consolidated up to the
date of their disposal. It seems the directors of Halogen may be attempting to
avoid reporting the losses of Lockstart. This they cannot do. There is however
some value in ascertaining those parts of a business that will not affect group
profits in the future. Provided the future disposal meets the criteria in IFRS 5 to
be reported as a discontinued operation, this information need would be
satisfied. (Although the sale has not yet taken place, it is possible that Lockstart
meets the definition of a disposal group held for sale, in which case it might be
possible to classify it as a discontinued operation.) Thus the directors’ current
treatment of excluding Lockstart from the consolidated financial statements is
incorrect and they should be advised to redraft the group financial statements to
include its results, possibly as part of discontinued operations, and there may
need to be further provisions for some of the future costs associated with the
disposal and for impairment losses.
64
Horsefield
(a)
Horsefield
Consolidated statement of financial position as at 31 March 2012
$000
Non-current assets
Property, plant and equipment (8,050 + 3,600)
Goodwill (W2)
Licence (180 – 60) (W3)
Investments
Associate (W5)
Others (4,000 + 910 – 3,240 – 630 + 120 FV)
$000
11,650
702
120
12,472
705
1,160
1,865
14,337
Current assets
Inventory (830 + 340)
Accounts receivable (520 + 290 – 40)
Bank (240 + 40)
Total assets
Equity and liabilities
Equity attributable to equity holders of the parent:
Ordinary shares of $1 each
Retained earnings (W4)
Non-controlling interest (W3)
© Emile Woolf Publishing Limited
1,170
770
280
2,220
16,557
5,000
8,403
13,403
374
13,757
265
Paper F7: Financial Reporting (International)
Horsefield
Consolidated statement of financial position as at 31 March 2012
$000
Non-current liabilities
10% Loan notes (500 + 240)
Current liabilities
Accounts payable (420 + 960)
Taxation (220 + 250)
Overdraft
$000
740
1,380
470
190
2,040
16,557
Total equity and liabilities
Workings
(W1) Net assets in subsidiary
Share capital
Retained earnings
Fair value adjustment:
Investment property
Licence
Amortisation of licence 180/6 x 2yrs
At
acquisition
$000
1,200
800
120
180
120
180
(60)
―――
―――
―――
―――
2,300
(W2) Goodwill
At end of
reporting period
$000
1,200
2,300
Cost of investment ($3 × 1,200 × 90%)
Net assets acquired (90% × 2,300) (W1)
Goodwill
Less impairment
3,740
$000
3,240
2,070
1,170
(468)
702
(W3) Unrealised profit in inventory
((2/3 × 65,000) × 30/130) × 30% = $3,000
Parent sells to associate, therefore reduce group retained earnings and
Investment in associate
(W3) Non-controlling interest
10% × 3,740 = $374,000
(W4) Retained earnings
Horsefield
Sandfly – group share post acquisition
90% × (3,740 – 2,300)
Anthill – group share post acquisition
30% × (600 × 6/12)
Unrealised profit (W3)
Less impairment (468 + 12)
266
$000
7,500
1,296
90
(3)
(480)
8,403
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(W5) Investment in associate
$000
Investment at cost
Post acquisition profit (30% × (600 × 1/2))
Less impairment
630
90
(12)
718
Unrealised profit in inventory
(3)
705
(b)
IAS 28 Investments in Associates and Joint Ventures defines associates. In order for
an investment to be classified as an investment in an associate the investor must
have ‘significant influence’ over the investee. Significant influence is presumed to
exist where there is a holding of 20% or more of the voting power unless the
investor can clearly demonstrate that this is not the case. Conversely a holding of
less than 20% is presumed not to be an associate, unless it can be clearly
demonstrated that the investor can exercise significant influence. The voting
rights can be held directly or through subsidiaries.
IAS 28 says that a majority holding by one investor does not preclude another
investor having significant influence. An investing company owning a majority
holding in another company normally has control over the investee and would
thus class it as a subsidiary. In normal circumstances it is difficult to see how a
company could be controlled by one entity and be significantly influenced by a
different entity unless ‘control’ was passive. The 20% test is not definitive and the
following other evidence should be considered.
Does the investing company:
65
„
have representation on the Board of the investee?
„
participate in the policy making processes (operational and financial); have
material transactions with the investee?
„
interchange managerial personnel with the investee; or provide technical
expertise to the investee?
Highmoor
(a)
Highmoor
Consolidated statement of financial position as at 30 September 2012
$m
$m
Assets
Non-current assets
Tangible (585 + 172)
757
Intangible:
Software (W7) 1
24
Investments (225 – 160 shares – 50 loan (W6) + 13)
28
809
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Highmoor
Consolidated statement of financial position as at 30 September 2012
$m
$m
Current assets
Inventory (85 + 42)
127
Accounts receivable (95 – 4 in transit (W6) + 36)
127
Tax asset
80
Bank (20 + 9 in transit (W6))
29
363
Total assets
1,172
Equity and liabilities
Equity attributable to equity holders of the parent
Ordinary shares $1 each
Retained earnings (W4)
400
326
726
43
769
Non-controlling interest (W3)
Non-current liabilities
12% loan notes
Current liabilities
Accounts payable (210 + 71)
Overdraft
Taxation
35
281
17
70
368
1,172
Total equity and liabilities
Workings (Note: all figures in $ million)
(W1) Net assets in subsidiary
At acquisition
Share capital
Retained earnings
$000
100
150
250
At end of
reporting period
$000
100
115
215
(W2) Goodwill
$000
Cost of investment
160
Net assets acquired (80% × 250) (W1)
200
Negative goodwill
Transfer to income statement immediately
40
(40)
‐
The contingent consideration has not been included in the above
calculation.
268
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Section 2: Answers to practice questions
IFRS 3 Business Combinations only requires contingent consideration to be
included in the cost of an acquisition if it is probable that the amount will
be paid and it can be measured reliably.
The additional $96 million (i.e. $1.20 per share) is only payable if Slowmoor
makes a profit within two years of acquisition. In the year since acquisition
the company made a loss of $35 million and the directors of Highmoor are
now less confident of the future prospects of Slowmoor. This seems to
indicate that it is unlikely that any further consideration will be paid and
the above treatment is justified.
(W3) Non-controlling interest
20% × 215 (W1) = $43,000
(W4) Retained earnings
Highmoor
Slowmoor – group share of post-acquisition losses
= 80% × 35
Negative goodwill
Unrealised profit (W6)
$000
330
(28)
40
(16)
326
(W5) Elimination of loan and accrued interest
The investments of Highmoor will show an unadjusted amount of $50
million as a loan to Slowmoor. The cash in transit of $9 million from
Slowmoor should be applied $4 million to cancel the accrued interest
receivable and the balance of $5 million to the investment (loan). When this
adjustment is made the investment and the loan will cancel each other out.
(W6) The carrying value of the software in Slowmoor’s books is $40 million. If
the software had been depreciated on its original cost of $30 million it
would have a carrying value of $24 million ($30 less $6 million depreciation
at 20% per annum). Thus there is an unrealised profit on the transfer of the
software of $16 million ($40 million – $24 million).
(b)
Negative goodwill arises in book-keeping where the consideration given for a
business is less than the fair value of the net assets acquired. Intuitively it does
not make sense for a vendor to sell net assets for less than they are worth. This
view is reflected by the IASB which requires that where an acquisition appears to
create negative goodwill, a careful check of the value of the assets acquired and
whether any liabilities have been omitted is required.
Negative goodwill may arise for several reasons; the most obvious is that there
has been a bargain purchase. This may occur through the vendor being in a poor
financial position and needing to realise assets quickly, or it may be due to good
negotiating skills on the part of the acquirer, or the vendor may not realise how
much the assets are really worth.
A more controversial occasion where negative goodwill arises is where a
company, in determining the amount of consideration it is willing to pay for a
business, will take into account the cost of anticipated future losses and postacquisition reorganisation expenditure that it believes will be required. The effect
of this is that it would reduce the consideration offered/paid. As these costs
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
cannot generally be recognised as a liability at the date of purchase, this can lead
to the consideration being lower than the recognisable net assets.
In relation to the acquisition of Slowmoor the following are questionable issues:
66
„
Highmoor may be trying to deliberately create losses at Slowmoor to avoid
paying the further consideration. An example of this may be the transfer
price of the software.
„
The additional consideration of $96 million, if payable, would change the
negative goodwill into positive goodwill of $56 million.
„
The tax asset of Slowmoor may be questionable. Accounting standards are
quite restrictive over the recognition of tax assets.
Hapsburg
(a)
Hapsburg
Consolidated statement of financial position as at 31 March 2012
$000
Non-current assets
Goodwill (w (i))
Property, plant and equipment (41,000 + 34,800 + 3,750 (w (i)))
Investments:
– in associate (w (iv))
15,150
– ordinary (3,000 + 1,500 (fair value increase))
4,500
$000
12,800
79,550
19,650
112,000
Current assets
Inventory (9,900 + 4,800 – 300 (w (v)))
Trade receivables (13,600 + 8,600)
Cash (1,200 + 3,800)
14,400
22,200
5,000
41,600
153,600
Total assets
Equity and liabilities
Ordinary share capital (20,000 + 16,000 (w (i)))
Reserves:
Share premium (8,000 + 16,000 (w (i)))
Retained earnings(w (ii))
36,000
24,000
8,050
32,050
68,050
9,150
77,200
Non-controlling interests (w (iii))
Non-current liabilities
10% Loan note (16,000 + 4,200)
Deferred consideration (18,000 + 1,800) W2
20,200
19,800
40,000
270
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Hapsburg
Consolidated statement of financial position as at 31 March 2012
$000
Current liabilities:
Trade payables (16,500 + 6,900)
23,400
Taxation (9,600 + 3,400)
13,000
$000
36,400
153,600
Total equity and liabilities
Workings – Note: all working figures in $000.
(W1) Net assets in subsidiary
At
acquisition
At end of
reporting
period
$000
$000
30,000
30,000
Share premium
2,000
2,000
Retained earnings (8,500 – 4,500)
4,000
8,500
5,000
5,000
Share capital
Fair value adjustment
Plant (15 – 10)
Depreciation 5,000 × 1/4
Investment (4.5 – 3)
(1,250)
1,500
1,500
42,500
45,750
(W2) Goodwill
$000
Investment at cost
Shares (24m x 2/3 x $2)
32,000
Cash (24m x$1) x 0.75
18,000
50,000
Net assets at acquisition (80% × 42,500) (W2)
(34,000)
Goodwill on consolidation
16,000
Less impairment
(3,200)
In consolidated statement of financial position
12,800
In Hapsburgs books
Dr Cost of investment
50,000
Cr Share capital (24m × 2/3)
16,000
Cr Share premium (32 – 16)
16,000
Cr Deferred consideration
18,000
Unwind the discount: 10% × 18,000 = 1,800
Dr Group finance cost (Group RE)
Cr Deferred consideration
© Emile Woolf Publishing Limited
1,800
1,800
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Paper F7: Financial Reporting (International)
(W3) Unrealised profit
2.5m × (4m – 2.4m/4m) × 30% = 300,000
Associate sells to Parent, therefore reduce the group retained earnings and
group inventory by the full unrealised profit
(W4) Non-controlling interest
Statement of financial position
20% × 45,750 (W1) = 9,150
(W5) Consolidated retained earnings
Hapsburg reserves
10,600
Sundial post acquisition
80% × (45,750 – 42,500) (W1))
2,600
Aspen post acquisition
30% × (8,000 – 5,000)
Unrealised profit inventory (W3)
900
(300)
Less impairment
(3,950)
Less unwinding of discount
(1,800)
8,050
(W6) Investment in associate
Investment at cost
Share of post acquisition profit (W5)
15,000
900
15,900
Less impairment
(750)
15,150
(b)
272
In recent years many companies have conducted large parts of their business by
acquiring substantial non-controlling interests in other companies. There are
broadly three levels of investment. Below 20% of the equity shares of an
investee would normally be classed as an ordinary investment and shown at cost
(it is permissible to revalue them to market value) with only the dividends paid
by the investee being included in the income of the investor. A holding above
50% normally gives control and would create subsidiary company status and
consolidation is required. Between these two, in the range of over 20% up to
50%, the investment would normally be deemed to be an associate). The
relevance of this level of shareholding is that it is presumed to give significant
influence over the operating and financial policies of the investee (but this
presumption can be rebutted). If such an investment were treated as an ordinary
investment, the investing company would have the opportunity to manipulate its
profit. The most obvious example of this would be by exercising influence over
the size of the dividend the associate paid. This would directly affect the reported
profit of the investing company. Also, as companies tend not to distribute all of
their earnings as dividends, over time the cost of the investment in the statement
of financial position may give very little indication of its underlying value.
Equity accounting for associates is an attempt to remedy these problems. In the
income statement any dividends received from an associate are replaced by the
investor’s share of the associate’s results. In the statement of financial position
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
the investment is initially recorded at cost and subsequently increased by the
investor’s share of the retained profits of the associate (any other gains such as
the revaluation of the associate’s assets would also be included in this process).
This treatment means that the investor would show the same profit irrespective
of the size of the dividend paid by the associate and the statement of financial
position more closely reflects the worth of the investment.
The problem of ‘off balance sheet’ finance relates to the fact that it is the net
assets that are shown in the investor’s statement of financial position. Any share
of the associate’s liabilities is effectively hidden because they have been offset
against the associate’s assets. As a simple example, say a holding company
owned 100% of another company that had assets of $100 million and debt of $80
million, both the assets and the debt would appear in the consolidated statement
of financial position. Whereas if this single investment was replaced by owning
50% each of two companies that had the same statements of financial position
(i.e. $100 million assets and $80 million debt), then under equity accounting only
$20 million ((100 – 80) × 50% × 2) of net assets would appear in the statement of
financial position thus hiding the $80 million of debt. Because of this problem, it
has been suggested that proportionate consolidation is a better method of
accounting for associates, as both assets and debts would be included in the
investor’s statement of financial position. IAS 28 does not permit the use of
proportionate consolidation.
67
Highveldt
(a)
(i)
The deferred consideration of $108 million must be discounted for one year
at a cost of capital of 8% to $100 million (= $108 million/(1.08)1. The $8
million difference is a finance charge in the year to 31 March 2012.
Goodwill calculation
$m
$m
Investments at cost
Cash consideration (80 × 75% × $3.50)
210
Deferred consideration (see above)
100
310
Less:
Ordinary shares (75% × 80)
60
Share premium (75% × 40)
30
Pre-acquisition profit (see working)
87
Fair value adjustments: brand (75% × 40)
30
- land and buildings (75% × 20)
15
(222)
Goodwill on acquisition
Impairment at 31 March 2012 (from question)
Goodwill at 31 March 2012
88
(22)
66
Although the internally-generated brand cannot be recognised in Samson’s
own financial statements, it should be recognised in the consolidated
statement of financial position on the acquisition of Samson. This is because
the method given in the question is an acceptable method of valuation and
thus the brand can be ‘reliably measured’.
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Paper F7: Financial Reporting (International)
The fair value adjustment for Samson’s land and buildings on acquisition is
$20 million. (The subsequent increase in value of $4 million in the year to 31
March 2012 is treated as a revaluation in that year.).
The non-controlling interest in the fair value adjustments and revaluation is
$16 million (= 25% of $(20 + 4 + 40) million).
(ii)
$m
20
10
41
16
87
Non-controlling interest
Ordinary shares (25% × 80)
Share premium (25% × 40)
Retained earnings (see working)
Share of fair value adjustments (see above)
(iii)
Consolidated reserves
Share premium: Highveldt only
Revaluation reserve: 45 + (75% × 4)
Retained earnings:
Highveldt – from question
Post-acquisition profit of Samson (see working)
Interest receivable (see below)
Finance cost on deferred consideration (see (i) above)
Impairment of goodwill
$m
$m
80
48
350
36
6
392
8
22
(30)
362
Consolidated retained earnings
Note on interest receivable: The intra-group interest has not been recorded
by Highveldt. To do so it would credit interest receivable (which increases
the profit for the year) and debit cash (in transit).
Working (Note: All figures in $million)
The pre and post acquisition profits of Samson are calculated as follows:
Preacquisitio
n
Postacquisitio
n
As in the question
134
76
Apportionment of development costs
(18)
(22)
Unrealised profit in inventory (= 6/3)
At 31
March
2012
(2)
Amortisation of brand (= 40/10 years)
(4)
―――
―――
116
48
―――
―――
―――
164
―――
Therefore non-controlling interest is 25% × 164 = 41
Pre-acquisition earnings are 75% × 116 = 87
Post-acquisition earnings are 75% × 48 = 36
274
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(b)
The objective of consolidated financial statements is to show the financial
performance and position of the group as if it was a single economic entity. There
is a view that, as the entity financial statements of the parent company contain
the investments in subsidiaries as non-current assets, they reflect the assets of the
group as a whole. The more traditional view is that entity financial statements do
not provide users with sufficient information about subsidiaries for them to
make a reliable assessment of the performance of the group as a whole. The
following are benefits of consolidated financial statements:
–
They identify the nature and classification of the subsidiary’s assets. For
example, the investment in a subsidiary may be almost entirely in
intangible assets or conversely they may be substantially land and
buildings. Such a distinction is of obvious importance to users.
–
The amount of the subsidiary’s debt could not be assessed from the
parent’s entity financial statements. In effect the subsidiary’s assets and
liabilities are netted off when it is shown as an investment. This means
group liquidity and gearing cannot be properly assessed.
–
The cost of the investment in the parent company statement of financial
position does not reflect the size of a company. For example a parent
company may show an investment in a subsidiary at a cost of $10 million.
This may represent the purchase of a subsidiary that has $10 million of
assets and no liabilities. Alternatively this could be a subsidiary that has
$100 million in assets and $90 million of liabilities.
–
The cost of the investment may be a fair representation of its value at the
date of purchase, but with the passage of time (assuming the subsidiary is
profitable), its value will increase. This increase would not be reflected in
the original cost, but it would be reflected in the consolidated net assets of
the subsidiary (and the increase in group reserves).
–
The cost of the investment might represent all of the ownership of the
subsidiary or only just over half of it, i.e. there would be no indication of
the non-controlling interest.
To summarise, in the absence of a consolidated statement of financial position,
users would have no information on the current value of a subsidiary, its size, the
composition of its net assets and how much of it was owned by the group.
68
Hark, Spark and Ark
Hark Group
Consolidated statement of financial position as at 31 March 2012
$000
$000
Non‐current assets
Property, plant and equipment (working 1)
90,200
Goodwill (working 4)
23,000
Investment in associate (working 6)
Other investments
9,500
650
123,350
Current assets (working 5)
Total assets
© Emile Woolf Publishing Limited
24,300
147,650
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Paper F7: Financial Reporting (International)
Hark Group
Consolidated statement of financial position as at 31 March 2012
$000
$000
Equity and liabilities
Equity shares of $1 each (working 3)
21,000
Share premium (working 3)
42,000
Retained earnings (working 8)
43,730
85,730
106,730
Non‐controlling interests (working 7)
7,420
Total equity
114,150
Non‐current liabilities
Deferred consideration for Spark shares
5,500
6% loan notes
10,000
7% loan notes
6,000
21,500
Current liabilities: 7,000 + 5,000
Total equity and liabilities
12,000
147,650
Workings
1
Property, plant and equipment (PPE)
$000
Hark
Spark
Profit on transfer of machines (3 million – 2 million)
Less: Depreciation on this amount in accounts of Spark
(1,000/5 years)
Unrealised profit in machines
PPE in consolidated statement of financial position
2
$000
60,000
31,000
1,000
(200)
(800)
90,200
Deferred consideration
The present value of the deferred consideration at 1 April 2011 is $6.05
million × 1/(1.10)2 = $5 million.
During the year to 31 March 2012 there is a finance charge of 10% (=
$500,000) on this amount, reducing the parent’s share of the consolidated
profit.
The deferred consideration at 31 March 2012 is $5 million + $500,000 =
$5,500,000. This is payable in just over 12 months and is included in the
consolidated statement of financial position as a non-current liability.
3
Share issues
The share issues to acquire the shares in Spark and Ark are not recorded in
the summary statement of financial position of Hark (as stated in the
question).
276
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Section 2: Answers to practice questions
Total
Share
capital
Share
premium
$000
$000
$000
36,000
4,000
32,000
9,000
1,000
8,000
5,000
40,000
In summary statement of financial position
16,000
2,000
In consolidated statement of financial position
21,000
42,000
To acquire the shares in Spark
Hark shares issued: (4 million at $9)
To acquire the shares in Ark
Hark shares issued: (1 million at $9)
Increase in share capital and share premium of
Hark
4
Goodwill
Hark has acquired 4 million/5 million = 80% of the shares of Spark.
At 1 April 2011 the fair value of the net assets of Spark was (share capital
plus reserves) = $(5 + 4 + 16) million = $25 million
$000
Purchase consideration paid by the parent company
Issue of 4 million shares at $9
Deferred consideration
36,000
5,000
41,000
Fair value of parent company share of net assets (80% × $25 million)
20,000
Purchased goodwill attributable to parent
21,000
$000
Fair value of NCI at acquisition date (1 million shares × $7)
7,000
NCI share of net assets at this date (20% × $25 million)
5,000
Purchased goodwill attributable to NCI
2,000
There has been no impairment of goodwill during the year.
$000
Purchased goodwill attributable to parent
Goodwill attributable to NCI
Total goodwill in consolidated statement of financial position
21,000
2,000
23,000
Alternatively, total goodwill could be calculated as follows:
$000
Purchase consideration paid by the parent company (see above)
Fair value of NCI at acquisition date
41,000
7,000
48,000
5
Net assets of the subsidiary at the acquisition date (at fair value)
25,000
Total goodwill (parent and NCI)
23,000
Current assets
The cost of the goods sold by Spark to Hark was $3,600,000 × 100/150 =
$2,400,000 and the profit was $1,200,000.
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Paper F7: Financial Reporting (International)
Since 75% of these goods are in closing inventory, the unrealised profit on
intra-group sales is 75% × $1,200,000 = $900,000. Current assets in the
consolidated statement of financial position (inventory) should be reduced
by this amount.
The question states that the transaction costs of the acquisition of Spark
have not yet been recorded. These costs reduce the consolidated profit, and
also (presumably) reduce the current assets of Hark.
Current assets on consolidation
Hark
Spark
Less: unrealised profit in closing inventory
Less: expenses of acquisition of Spark
Current assets in consolidated statement of financial position
6
$000
18,200
8,000
(900)
(1,000)
24,300
Investment in associate (Ark)
Since Hark owns 25% of the equity of Ark, it is assumed that Ark is an
associated entity.
Cost of investment: 25% × 6 million shares × $6
Share of post-acquisition retained profit: 25% × $2 million
$000
9,000
500
9,500
7
Non-controlling interests
$000
Share of net assets of Spark at 31 March 2012 (20% × $28 million)
5,600
Goodwill attributable to NCI (working 4)
2,000
7,600
8
NCI share of unrealised profit in inventory (20% × $900,000)
(180)
NCI at 31 March 2012: fair value method
7,420
Consolidated retained earnings
$000
Hark retained earnings (36,000 + 8,000)
$000
44,000
Spark
Profit for year ended 31 March 2012
3,000
Unrealised profit in closing inventory
(900)
2,100
Parent company share (80%)
1,680
Share of post-acquisition retained profits of Ark (25% × $2 million)
Costs of acquisition of Spark (expensed)
(1,000)
Additional finance costs: deferred consideration
(500)
Unrealised profit in machines (working 1)
(800)
Loss on other (800 – 650)
(150)
Consolidated retained earnings at 31 March 2012
278
500
43,730
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Section 2: Answers to practice questions
69
Parentis
Consolidated statement of financial position of Parentis as at 31 March 2012:
Assets
Non-current assets
Property, plant and equipment (640 + 340 + 40 – 2)
Intangible
Consolidated goodwill (135 (w (i)) – 27 impairment)
Current assets
Inventory (76 + 22 – 2 URP)
Trade receivables (84 + 44 – 11 intra-group)
Receivable re intellectual property
Bank
Total assets
Equity and liabilities
Equity attributable to equity holders of the parent
Equity shares 25c each (w (i))
Reserves:
Share Premium (w (i))
Retained earnings (w (ii))
$ million
1,018
108
––––––
1,126
96
117
10
4
––––
150
264
––––
Workings (Note: all figures in $ million)
(i)
414
––––––
789
89
––––––
878
Total equity
Total equity and liabilities
227
––––––
1,353
––––––
375
Non controlling interest (w (iii))
Non-current liabilities
10% loan notes (120 + 20)
Current liabilities
Trade payables (130 + 57 – 7 intra-group)
Cash consideration due 1 April 2012 (60 + 6 interest)
Overdraft (25 – 4 CIT)
Taxation (45 + 23)
$ million
140
180
66
21
68
––––
335
––––––
1,353
––––––
Goodwill:
The acquisition of 600 million shares represents 75% of Offspring’s 800 million
shares ($200m/25c). The share exchange of 300 million (i.e. 1 for 2) at $0·75 each
will result in an increase in equity share capital of $75 million (the nominal value)
and create a share premium balance of $150 million (i.e. $0·50 premium on 300
million shares).
Consideration:
Equity shares (600/2 x $0·75)
10% loan notes (see below)
Cash (600 x $0·11/1·1 i.e. discounted at 10%)
© Emile Woolf Publishing Limited
225
120
60
––––
405
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Paper F7: Financial Reporting (International)
Acquired:
Equity shares (600m x 25c)
Pre acquisition retained earnings (120 x 75%)
Fair value adjustment to properties (40 x 75%)
150
90
30
––––
(270)
––––
Goodwill
135
––––
The issue of the 10% loan notes is calculated as 600 million/500 x $100 = $120
million.
(ii)
Retained earnings:
Parentis
Interest on deferred consideration (60 x 10%)
Goodwill impairment (from question)
Offspring
URP in inventory (see below)
Additional depreciation (from question)
Write down intellectual property (30 – 10)
Pre acquisition
300
(6)
(27)
140
(2)
(2)
(20)
(120)
––––
(4) x 75%
(3)
––––
264
––––
The unrealised profit in inventory (URP) is $5m/$15m of the profit of $6 million
made by Offspring.
(iii)
Non controlling interest
Offspring net assets at 31 March 2012
Fair value adjustment
URP in inventory
Additional depreciation
Write down intellectual property (30 – 10)
70
340
40
(2)
(2)
(20)
––––
356 x 25%
––––
Plateau
(a)
Consolidated statement of financial position of Plateau as at 30 September 2012
Assets
Non-current assets:
Property, plant and equipment (18,400 + 10,400 – 400 (w (i)))
Goodwill (w (ii))
Investments – associate (w (iii))
Other equity investments
Current assets
Inventory (6,900 + 6,200 – 300 URP (w (iv)))
Trade receivables (3,200 + 1,500)
Total assets
280
89
–––
$’000
$’000
28,400
3,600
10,500
9,000
––––––
51,500
12,800
4,700 17,500
–––––– ––––––
69,000
––––––
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Section 2: Answers to practice questions
$’000
Equity and liabilities
Equity shares of $1 each (w (v))
Reserves:
Share premium (w (v))
Retained earnings (w (vi))
Non controlling interest (w (vii))
Total equity
Non-current liabilities
7% Loan notes (5,000 + 1,000)
Current liabilities (8,000 + 4,200)
$’000
11,500
7,500
28,650 36,150
–––––– ––––––
47,650
3,150
––––––
50,800
6,000
12,200
––––––
69,000
––––––
Total equity and liabilities
Workings (figures in brackets are in $’000)
(i)
Property, plant and equipment
The transfer of the plant creates an initial unrealised profit (URP) of
$500,000. This is reduced by $100,000 for each year (straight-line
depreciation over five years) of depreciation in the post-acquisition period.
Thus at 30 September 2012 the net unrealised profit is $400,000. This should
be eliminated from Plateau’s retained profits and from the carrying amount
of the plant. The fall in the fair value of the land has already been taken into
account in Savannah’s statement of financial position.
(ii) Goodwill in Savannah:
Goodwill in Savannah:
Investment at cost:
Shares issued (3,000/2 x $6)
Cash (3,000 x $1)
Less – equity shares of Savannah
– pre-acquisition reserves (6,000 x 75% (see below))
$’000
$’000
9,000
3,000
––––––
12,000
(3,000)
(4,500)
––––––
(7,500)
––––––
Goodwill on consolidation
4,500
––––––
Goodwill is impaired by $900,000 thus has a carrying amount at 30
September 2012 of $3·6 million.
Savannah’s pre-acquisition reserves of $6·5 million require an adjustment
for a write down of $500,000 in respect of the fair value of its land being
below its carrying amount. Thus the adjusted pre-acquisition reserves of
Savannah are $6 million. A consequent effect is that the post-acquisition
reserves which are reported as $2·4 million in Savannah’s statement of
financial position will become $2·9 million. This is because the fall in the
value of the land has effectively been treated by Savannah as a postacquisition loss.
(iii)
Carrying amount of Axle at 30 September 2012
Cost (4,000 x 30% x $7·50)
Share post-acquisition profit (5,000 x 30%)
© Emile Woolf Publishing Limited
$’000
9,000
1,500
––––––
10,500
––––––
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(iv)
The unrealised profit (URP) in inventory is calculated as:
Intra-group sales are $2·7 million on which Savannah made a profit of
$900,000 (2,700 x 50/150). One third of these are still in the inventory of
Plateau, thus there is an unrealised profit of $300,000.
(v)
The 1·5 million shares issued by Plateau in the share exchange at a value of
$6 each would be recorded as $1 per share as capital and $5 per share as
share premium giving an increase in share capital of $1·5 million and a
share premium of $7·5 million.
(vi)
Consolidated retained earnings: $’000
Plateau’s retained earnings
Savannah’s post-acquisition ((2,900 – 300 URP) x 75%)
Axle’s post-acquisition profits (5,000 x 30%)
URP in plant (see (i))
Gain on other equity investments (9,000 – 6,500)
Impairment of goodwill
(vii) Non controlling interest
Adjusted equity at 30 September 2012: (12,900 – 300 URP) =
12,600 x 25%
(b)
$’000
24,000
1,950
1,500
(400)
2,500
(900)
––––––
28,650
––––––
3,150
––––––
IFRS 3 Business Combinations requires the purchase consideration for an acquired
entity to be allocated to the fair value of the assets, liabilities and contingent
liabilities acquired (henceforth referred to as net assets and ignoring contingent
liabilities) with any residue being allocated to goodwill. This also means that
those net assets will be recorded at fair value in the consolidated statement of
financial position. This is entirely consistent with the way other net assets are
recorded when first transacted (i.e. the initial cost of an asset is normally its fair
value). The purpose of this process is that it ensures that individual assets and
liabilities are correctly classified (and valued) in the consolidated statement of
financial position. Whilst this may sound obvious, consider what would happen
if say a property had a carrying amount of $5 million, but a fair value of $7
million at the date it was acquired. If the carrying amount rather than the fair
value was used in the consolidation it would mean that tangible assets (property,
plant and equipment) would be understated by $2 million and intangible assets
(goodwill) would be overstated by the same amount (note: in the consolidated
statement of financial position of Plateau the opposite effect would occur as the
fair value of Savannah’s land is below its carrying amount at the date of
acquisition). There could also be a ‘knock on’ effect with incorrect depreciation
charges in the years following an acquisition and incorrect calculation of any
goodwill impairment. Thus the use of carrying amounts rather than fair values
would not give a ‘faithful representation’ as required by the Conceptual
Framework.
The assistant’s comment regarding the inconsistency of value models in the
consolidated statement of financial position is a fair point, but it is really a
deficiency of the historical cost concept rather than a flawed consolidation
technique. Indeed the fair values of the subsidiary’s net assets are the historical
282
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Section 2: Answers to practice questions
costs to the parent. To overcome much of the inconsistency, there would be
nothing to prevent the parent company from applying the revaluation model to
its property, plant and equipment.
71
Pacemaker
Consolidated statement of financial position of Pacemaker as at 31 March 2012:
Non-current assets
Tangible
Property, plant and equipment (w (i))
Intangible
Goodwill (w (ii))
Brand (25 – 5 (25/10 x 2 years post acq
amortisation))
Investments
Investment in associate (w (iii))
Other equity investments (82 + 37)
Current assets
Inventory (142 + 160 – 16 URP (w (iv)))
Trade receivables (95 + 88)
Cash and bank (8 + 22)
Total assets
Equity and liabilities
Equity attributable to the parent
Equity shares (500 + 75 (w (iii)))
Share premium (100 + 45 (w (iii))
Retained earnings (w (iv))
Non-controlling interest (w (v))
Total equity
Non-current liabilities
10% loan notes (180 + 20)
Current liabilities (200 + 165)
Total equity and liabilities
$million
$million
818
23
20
144
119
––––––
1,124
286
183
30
–––––
499
––––––
1,623
––––––
575
145
247
–––––
392
––––––
967
91
––––––
1,058
200
365
––––––
1,623
––––––
Workings (all figures in $ million)
The investment in Syclop represents 80% (116/145) of its equity and is likely to give
Pacemaker control thus Syclop should be consolidated as a subsidiary. The investment
in Vardine represents 30% (30/100) of its equity and is normally treated as an associate
that should be equity accounted.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(i)
Property, plant and equipment
Pacemaker
Syclop
Fair value property (82 – 62)
Post-acquisition depreciation (2 years) (20 x 2/20 years)
(ii)
520
280
20
(2)
––––
818
––––
Goodwill in Syclop:
Investment at cost – cash
– loan note (116/200 x $100)
210
58
––––
268
65
Cost of the controlling interest
Fair value of non-controlling interest (from question)
Equity shares
Pre-acquisition profit
Fair value adjustments – property (w (i))
– brand
145
120
20
25
––––
Fair value of net assets at acquisition
Goodwill
(iii)
Investment in associate:
(310)
––––
23
––––
$million
Investment at cost (75 x $1·60)
120
Share of post-acquisition profit (100 – 20) x 30%
24
––––
144
––––
The purchase consideration by way of a share exchange (75 million shares in
Pacemaker for 30 million shares in Vardine) would be recorded as an increase in
share capital of $75 million ($1 nominal value) and an increase in share premium
of $45 million (75 million x $0·60).
(iv)
Consolidated retained earnings:
Pacemaker’s retained earnings
Syclop’s post-acquisition profits (130 x 80% see below)
Gain on investments – Pacemaker (see below)
Vardine’s post-acquisition profits (w (iii))
URP in Inventories (56 x 40/140)
130
104
5
24
(16)
––––
247
––––
Syclop’s retained earnings:
Post-acquisition (260 – 120)
Additional depreciation/amortisation (2 + 5)
Loss on other equity investments (40 – 37)
Adjusted post-acquisition profits
Gain on the value of Pacemaker’s available-for-sale investments:
Carrying amount at 31 March 2011 (345 – 210 cash – 58 loan note)
Carrying amount at 31 March 2012
Gain to retained earnings (or other components of equity)
284
140
(7)
(3)
––––
130
––––
77
82
––––
5
––––
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Section 2: Answers to practice questions
(v)
72
Non-controlling interest
Fair value on acquisition (from question)
Share of adjusted post acquisition profit (130 x 20% (w (iv)))
65
26
––––
91
––––
Picant
(a)
Consolidated statement of financial position of Picant as at 31 March 2010
$’000
Assets
Non-current assets:
Property, plant and equipment
(37,500 + 24,500 + 2,000 – 100)
Goodwill (16,000 – 3,800 (w (i)))
Investment in associate (w (ii))
Current assets
Inventory
(10,000 + 9,000 + 1,800 GIT – 600 URP (w (iii)))
Trade receivables
(6,500 + 1,500 – 3,400 intra-group (w (iii)))
Total assets
Equity and liabilities
Equity attributable to owners of the parent
Equity shares of $1 each
Share premium
Retained earnings (w (iv))
63,900
12,200
13,200
––––––––
89,300
20,200
4,600
–––––––
Total equity and liabilities
2,700
14,200
–––––––
16,900
––––––––
114,100
––––––––
$’000
$’000
Controlling interest
Share exchange (8,000 x 75% x 3/2 x $3·20)
Contingent consideration
Non-controlling interest (8,000 x 25% x $4·50)
© Emile Woolf Publishing Limited
47,300
––––––––
72,300
8,400
––––––––
80,700
16,500
Workings (figures in brackets are in $’000)
(i)
Goodwill in Sander
Equity shares
24,800
––––––––
114,100
––––––––
25,000
19,800
27,500
–––––––
Non-controlling interest (w (v))
Total equity
Non-current liabilities
7% loan notes (14,500 + 2,000)
Current liabilities
Contingent consideration
Other current liabilities
(8,300 + 7,500 – 1,600 intra-group (w (iii)))
$’000
28,800
4,200
9,000
–––––––
42,000
8,000
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Pre-acquisition reserves:
At 1 April 2009
Fair value adjustments – factory
– software (see below)
16,500
2,000
(500)
–––––––
(26,000)
––––––––
Goodwill arising on acquisition
16,000
––––––––
Goodwill is impaired by $3·8 million and therefore has a carrying amount
at 31 March 2010 of $12·2 million. The goodwill impairment is charged
against Sander’s retained earnings (see working (iv)), thus ensuring it is
allocated between the controlling and non-controlling interests in
proportion to their share ownership in Sander.
The effect of the software having no recoverable amount is that its write-off
in the post-acquisition period should be treated as a fair value adjustment
at the date of acquisition for consolidation purposes. The consequent effect
is that this will increase the post-acquisition profit for consolidation
purposes by $500,000.
(ii)
Carrying amount of Adler at 31 March 2010
Cash consideration (5,000 x 40% x $4)
7% loan notes (5,000 x 40% x $100/50)
Share of post-acquisition profits (6,000 x 6/12 x 40%)
$’000
8,000
4,000
1,200
–––––––
13,200
–––––––
(iii) Goods in transit and unrealised profit (URP)
The intra-group current accounts differ by the goods-in-transit sales of $1·8
million on which Picant made a profit of $600,000 (1,800 x 50/150). Thus
inventory must be increased by $1·2 million (its cost), $600,000 is
eliminated from Picant’s profit, $3·4 million is deducted from trade
receivables and $1·6 million (3,400 – 1,800) is deducted from trade payables
(other current liabilities).
(iv) Consolidated retained earnings
$’000
Picant’s retained earnings
27,200
Sander’s post-acquisition losses (2,400 x 75% see below)
(1,800)
Gain from reduction of contingent consideration
(4,200 – 2,700 see below)
1,500
URP in inventory (w (iii))
(600)
Adler’s post-acquisition profits (6,000 x 6/12 x 40%) 1,200
–––––––
27,500
–––––––
The adjustment to the provision for contingent consideration due to events
occurring after the acquisition is reported in income (goodwill is not
recalculated).
Post-acquisition adjusted losses of Sander are:
Profit as reported
1,000
Add back write off software
(treated as a pre-acquisition fair value adjustment)
500
Additional depreciation on factory
(100)
Goodwill written off (w (i))
(3,800)
–––––––
(2,400)
–––––––
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(v)
Non-controlling interest
Fair value on acquisition (w (i))
Post-acquisition losses (2,400 x 25% (w (iv)))
(b)
9,000
(600)
–––––––
8,400
–––––––
Although the concept behind the preparation of consolidated financial
statements is to treat all the members of the group as if they were a single
economic entity, it must be understood that the legal position is that each
member is a separate legal entity and therefore the group itself does not exist as a
separate legal entity. This focuses on a criticism of group financial statements in
that they aggregate the assets and liabilities of all the members of the group. This
can give the impression that all of the group’s assets would be available to
discharge all of the group’s liabilities. This is not the case.
Applying this to the situation in the question, it would mean that any liability of
Trilby to Picant would not be a liability of any other member of the Tradhat
group. Thus the fact that the consolidated statement of financial position of
Tradhat shows a strong position with healthy liquidity is not necessarily of any
reassurance to Picant. Any decision on granting credit to Trilby must be based on
Trilby’s own (entity) financial statements (which Picant should obtain), not the
group financial statements. The other possibility, which would take advantage of
the strength of the group’s statement of financial position, is that Picant could ask
Tradhat if it would act as a guarantor to Trilby’s (potential) liability to Picant. In
this case Tradhat would be liable for the debt to Picant in the event of a default
by Trilby.
Business combinations – Statements of financial
performance
73
Hydan
(a)
Hydan: Consolidated income statement year ended 31 March 2012
Revenue (98,000 + 35,200 – 30,000 intra-group sales)
Cost of sales (w (i))
Gross profit
Operating expenses: 11,800 + 8,000 + 375 goodwill (w (ii))
Interest receivable: 350 – 200 intra-group (= 4,000 × 10% × 6/12))
Finance costs
Income tax expense (4,200 – 1,000 tax relief)
Profit for the period
Attributable to:
Equity holders of the parent
Non-controlling interest (w (iv))
© Emile Woolf Publishing Limited
$000
103,200
(77,500)
25,700
(20,175)
150
(420)
5,255
(3,200)
2,055
3,455
(1,400)
2,055
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Paper F7: Financial Reporting (International)
Hydan: Consolidated statement of financial position as at 31 March 2012
$000
Non-current assets
Property, plant and equipment (18,400 + 9,500 + 1,200 – 300
depreciation adjustment)
Goodwill: 3,000 – 375 (w (ii))
Investment (16,000 – 10,800 – 4,000 loan)
28,800
2,625
1,200
32,625
24,000
56,625
Current assets (w (v))
Total assets
Equity attributable to holders of the parent
Ordinary shares of $1 each
Share premium
Retained earnings (w (iii))
10,000
5,000
17,525
32,525
3,800
36,325
Non-controlling interest (w (iv))
Total equity
Non-current liabilities
7% bank loan
Current liabilities (w (v))
6,000
14,300
56,625
Workings: All figures in $000
(i)
Cost of sales
Hydan
Systan
Intra-group sales
Unrealised profit in inventories
Additional depreciation re fair values
76,000
31,000
(30,000)
200
300
77,500
(ii)
Goodwill/Cost of control in Systan
Investment at cost (2,000 × 60% × $9)
Less:
Ordinary shares of Systan
Share premium
Pre-acquisition reserves
(= 6,300 + 3,000 post acquisition loss)
Fair value adjustment
10,800
2,000
500
9,300
1,200
13,000
× 60%
Goodwill on consolidation
(7,800)
3,000
Goodwill is impaired by 12.5% of its carrying amount = 375
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Section 2: Answers to practice questions
(iii)
Consolidated reserves
Hydan’s reserves
20,000
Systan’s post-acquisition losses (see below) (3,500 × 60%)
(2,100)
Goodwill impairment (w (ii))
(375)
17,525
6,300
The adjusted profits of Systan are:
Profit as stated in the question
Adjustments:
Unrealised profit in inventories (4,000 × 5%)
Additional depreciation
(200)
(300)
(500)
5,800
(iv)
Non-controlling interest in income statement
Systan’s post acquisition loss after tax
Adjustments from (w (iii))
Adjusted losses
NCI in statement of financial position
Ordinary shares and premium of Systan
Adjusted profits (w (iii))
Fair value adjustments
3,000
500
3,500
× 40% =
1,400
2,500
5,800
1,200
9,500
× 40% =
3,800
(v)
Current assets and liabilities
Current assets:
Hydan
18,000
Systan
7,200
Unrealised profit in inventories
(200)
Intra-group balance
(1,000)
24,000
Current liabilities:
Hydan
11,400
Systan
3,900
Intra-group balance
(1,000)
14,300
(b)
Although Systan’s revenue has increased since its acquisition by Hydan, its
operating performance appears to have deteriorated markedly. Its gross profit
margin has fallen from 25% (6m/24m) in the six months prior to the acquisition
to only 11.9% (4.2m/35.2m) in the post-acquisition period. The decline in gross
profit is made worse by a huge increase in operating expenses in the postacquisition period. These have gone from $1.2 million pre-acquisition to $8
million post-acquisition.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Taking into account the effects of interest and tax, a $3.6 million first half profit
(pre-acquisition) has turned into a $3 million second half loss (post-acquisition).
Whilst it is possible that some of the worsening performance may be due to
market conditions, the major cause is probably due to the effects of the
acquisition.
Hydan has acquired a controlling interest in Systan and thus the two companies
are related parties. Since the acquisition most of Systan’s sales have been to
Hydan. This is not surprising as Systan was acquired to secure supplies to
Hydan. The terms under which the sales are made are now determined by the
management of Hydan, whereas they were previously determined by the
management of Systan. The question says sales to Hydan yield a consistent gross
profit of only 5%. This is very low and much lower than the profit margin on
sales to Hydan prior to the acquisition and also much lower than the few sales
that were made to third parties in the post acquisition period. It may also be that
Hydan has shifted the burden of some of the group operating expenses to Systan
– this may explain the large increase in Systan’s post-acquisition operating
expenses. The effect of these (transfer pricing) actions would move profits from
Systan’s books into those of Hydan.
The implications of this are quite significant. Initially there may be a tendency to
think the effect is not important as on consolidation both companies’ results are
added together, but other parties are affected by these actions. The most obvious
is the significant (40%) non-controlling interests. The NCI in Systan are
effectively having some of their share of Systan’s profit and net asset value taken
from them.
74
Holdrite, Staybrite and Allbrite
(a)
Cost of control in Staybrite
Consideration
Shares (10,000 × 75% × 2/3) × $6
8% loan notes (10,000 × 75%) × $100/250
75% of net assets at acquisition (W1) (75% × 34,000)
Goodwill on the purchase of Staybrite
Goodwill on the purchase of Allbrite
Consideration
Shares (40% x 5,000 × 3/4) × $6
Cash (40% × 5,000) × $1
40% of net assets at acquisition (W1) (40% × 15,000)
Goodwill
290
$000
30,000
3,000
33,000
(25,500)
7,500
9,000
2,000
11,000
(6,000)
5,000
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(b)
Holdrite Group
Consolidated income statement for the year ended 30 September 2012
$000
Revenue 75,000 + (40,700 × 6/12) – 10,000
Cost of sales 47,400 +(6/12 × 19,700) – 10,000 + 500 +1,000
Gross profit
Operating expenses 10,480 +(6/12 × 9,000) +750
Profit from operations
Income from associate 40% × (6/12 × 6,000)
Interest expense
Profit before tax
Income tax expense
– Group (4,800 + (3,000 × 6/12))
– Associate (w (iii))
$000
85,350
(48,750)
36,600
(15,730)
20,870
1,200
22,070
(170)
21,900
(6,300)
(400)
(6,700)
15,200
Profit for the period
Attributable to:
Equity holders of the parent
Non-controlling interest (W3)
14,200
1,000
15,200
(c)
Movement on consolidated retained profits
$000
14,200
(5,000)
9,200
18,000
27,200
Net profit for period (group only)
Dividend paid
Retained profits b/f
Retained profits c/f
Workings
(W1)
Net assets in subsidiary
Acquisition
$000
Share capital
Share premium
Retained earnings (7,500 + 6/12 × 9,000)
10,000
4,000
12,000
Fair value adjustment
Land
3,000
Plant
5,000
34,000
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Net assets in associate
Acquisition
$000
Share capital
Share premium
Retained earnings (6,000 + 6/12 × 4,000)
5,000
2,000
8,000
15,000
(W2) Unrealised profit
4m × 1/4 = 1m
Parent selling to subsidiary, reduce group retained earnings and increase
group cost of sales
(W3) Non-controlling interest
Subsidiary post acquisition profit after tax(9,000 × 6/12)
4,500
Less: Depreciation adjustment on FV
(500)
4,000
Non controlling interest share 25% × 4,000
75
1,000
Python, Snake and Adder
(a)
Goodwill on acquisition
Purchase consideration
$000
$000
Issue of new shares in Python: 24 million × 2/3 × $4.80
76,800
Deferred consideration: working 1
24,000
Total purchase consideration
100,800
Equity shares
32,000
Pre-acquisition reserves at 1July 2011
67,000
Pre-acquisition reserves from
1 July – 1 Oct 2011: 16,400 × 3/12
4,100
Fair value adjustments ($2.5 million + $2.4 million)
4,900
Total net assets at fair value, 1 October 2011
108,000
Share acquired by Python: 75%
(81,000)
Goodwill on acquisition
19,800
(b)
Python Group
Consolidated income statement for the year ended 30 June 2012
$000
$000
Revenue: 160,000 + (72,000 × 9/12) – (1,000 × 9 months)
205,000
Cost of sales: working 3
(122,400)
Gross profit
Distribution costs: 7,900 + (4,000 × 9/12)
292
82,600
(10,900)
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Python Group
Consolidated income statement for the year ended 30 June 2012
$000
Administrative expenses: 13,200 + (6,000 × 9/12)
$000
(17,700)
Finance costs: working 2
(5,050)
Impairment of goodwill
(1,500)
Share of profits of associate: 8,000 × 25%
2,000
(33,150)
Profit before tax
49,450
Income tax expense: 12,300 + (2,600 × 9/12)
(14,250)
Profit for the year after tax
35,200
Attributable to:
Equity shareholders of parent company: 35,200 – 2,950
32,250
Non-controlling interests (working 4)
2,950
35,200
Workings
(1)
Deferred consideration per share = $1.21 per share × 1/(1.10)2 = $1.
Total deferred consideration = 24 million shares × $1 = $24 million.
(2)
Finance costs
$000
Python (as given in income statement)
2,500
Finance cost of deferred consideration: $24 million × 10% × 9/12
1,800
Snake: 1,000 × 9/12
750
5,050
(3)
Cost of sales
Python (as given in income statement)
Snake: 42,000 × 9/12
Less: Post-acquisition purchases from Python by Snake: 1,000 × 9
months
Additional depreciation: property
Additional depreciation: plant ($2.4 million/4 years) × 9/12
Unrealised profit in inventory: $2 million × 25/125
$000
99,000
31,500
(9,000)
50
450
400
122,400
Note: Only post-acquisition intra-group sales are removed from revenue and
the cost of sales.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(4)
NCI share of consolidated profit
$000
Snake post-acquisition profit: 16,400 × 9/12
12,300
Less: Additional post-acquisition depreciation on snake assets: 50 + 450
(500)
11,800
NCI share = 25%
2,950
The parent company share is the difference between the total consolidated
profit and the profit attributable to the NCI. The unrealised profit on
inventory is attributable to Python (sales by Python). Similarly the impairment
of goodwill is attributable to the parent company shareholders, since there is
no goodwill attributable to the NCI.
(c)
Python has accounted for its investment in Adder using the equity method on
the basis that it has been able to exert significant influence even though it has
not been able to exercise control. Significant influence was evident from the
shareholding of 25% in Adder’s equity (in excess of the 20% minimum where
significant influence is presumed to exist) and from the fact that a director of
Python was also a director of Adder.
Following the purchase of shares in Adder by Mambo, Mambo has acquired
control and will account for Snake as a subsidiary. Python has lost its position
on the Adder board. It seems clear that Python no longer has significant
influence over Adder, and should therefore no longer account for its
investment in Adder by the equity method. The investment should be carried
in the financial statements of Python at fair value, in accordance with IAS 39.
76
Hosterling
(a)
Cost of control in Sunlee:
Consideration
Shares (20,000 x 80% x 3/5 x $5)
Less
Equity shares
Pre acq reserves
Fair value adjustments (4,000 + 3,000 + 5,000)
Goodwill
(b)
294
$’000
$’000
48,000
20,000
18,000
12,000
50,000 x 80%
(40,000)
8,000
Carrying amount of Amber 30 September 2012 (prior to impairment loss):
At cost
$’000
Cash (6,000 x $3)
18,000
6% loan notes (6,000 x $100/100)
6,000
24,000
Less
Post acquisition losses (20,000 x 40% x 3/12)
(2,000)
22,000
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(c)
Hosterling Group
Consolidated income statement for the year ended 30 September 2012
$’000
149,000
(89,000)
60,000
(6,000)
(14,500)
(2,100)
Revenue (105,000 + 62,000 – 18,000 intra group)
Cost of sales (see working)
Gross profit
Distribution costs (4,000 + 2,000)
Administrative expenses (7,500 + 7,000)
Finance costs (1,200 + 900)
Impairment losses:
Goodwill
Investment in associate (22,000 – 21,500)
Share of loss from associate (20,000 x 40% x 3/12)
Profit before tax
Income tax expense (8,700 + 2,600)
Profit for the period
(1,600)
(500)
(2,000)
33,300
(11,300)
22,000
Attributable to:
Equity holders of the parent
Non controling interest
((13,000 – 1,000 depreciation adjustment) x 20%)
19,600
2,400
22,000
Note: the dividend from Sunlee is eliminated on consolidation.
Working
Cost of sales
Hosterling
Sunlee
Intra group purchases
Additional depreciation of plant (5,000/5 years)
Unrealised profit in inventories (7,500 x 25%/125%)
77
$’000
68,000
36,500
(18,000)
1,000
1,500
89,000
Patronic
(a)
Cost of control in Sardonic: $’000 $’000
Cost of control in Sardonic:
Consideration
Shares (18,000 x 2/3 x $5·75)
Deferred payment (18,000 x 2·42/1·21 (see below))
Less
Equity shares
Pre-acquisition reserves:
At 1 April 2010
To date of acquisition (13,500 x 4/12)
Fair value adjustments (4,100 + 2,400)
Goodwill
© Emile Woolf Publishing Limited
$’000
24,000
69,000
4,500
6,500
––––––––
104,000 x 75%
$’000
69,000
36,000
––––––––
105,000
(78,000)
––––––––
27,000
––––––––
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$1 compounded for two years at 10% would be worth $1·21.
The acquisition of 18 million out of a total of 24 million equity shares is a 75%
interest.
(b)
Patronic Group
Consolidated income statement for the year ended 31 March 2011
Revenue (150,000 + (78,000 x 8/12) – (1,250 x 8 months intra group))
Cost of sales (w (i))
Gross profit
Distribution costs (7,400 + (3,000 x 8/12))
Administrative expenses (12,500 + (6,000 x 8/12))
Finance costs (w (ii))
Impairment of goodwill
Share of profit from associate (6,000 x 30%)
Profit before tax
Income tax expense (10,400 + (3,600 x 8/12))
Profit for the year
Attributable to:
Equity holders of the parent
Minority interest (w (iii))
(c)
$’000
192,000
(119,100)
–––––––––
72,900
(9,400)
(16,500)
(5,000)
(2,000)
1,800
–––––––––
41,800
(12,800)
–––––––––
29,000
–––––––––
26,900
2,100
–––––––––
29,000
–––––––––
An associate is defined by IAS 28 Investments in Associates and Joint Ventures as an
investment over which an investor has significant influence. There are several
indicators of significant influence, but the most important are usually considered
to be a holding of 20% or more of the voting shares and board representation.
Therefore it was reasonable to assume that the investment in Acerbic (at 31
March 2011) represented an associate and was correctly accounted for under the
equity accounting method.
The current position (from May 2011) is that although Patronic still owns 30% of
Acerbic’s shares, Acerbic has become a subsidiary of Spekulate as it has acquired
60% of Acerbic’s shares. Acerbic is now under the control of Spekulate (part of
the definition of being a subsidiary), therefore it is difficult to see how Patronic
can now exert significant influence over Acerbic. The fact that Patronic has lost
its seat on Acerbic’s board seems to reinforce this point. In these circumstances
the investment in Acerbic falls to be treated under IAS 39 Financial Instruments:
Recognition and Measurement. It will cease to be equity accounted from the date of
loss of significant influence. Its carrying amount at that date will be its initial
recognition value under IAS 39 and thereafter it will be carried at fair value.
Workings
(i)
Cost of sales
Cost of sales
Patronic
Sardonic (51,000 x 8/12)
Intra group purchases (1,250 x 8 months)
Additional depreciation: plant
(2,400/ 4 years x 8/12)
296
$’000
$’000
94,000
34,000
(10,000)
400
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
property (per question)
Unrealised profit in inventories (3,000 x 20/120)
$’000
200
––––
$’000
600
500
–––––––––
119,100
–––––––––
Note: for both sales revenues and cost of sales, only the post acquisition
intra group trading should be eliminated.
(ii)
(iii)
Finance costs
$’000
Patronic per question
Unwinding interest – deferred consideration
(36,000 x 10% x 8/12)
Sardonic (900 x 8/12)
2,000
Non-controlling interest
Sardonic’s post acquisition profit (13,500 x 8/12)
Less post acquisition additional depreciation (w (i))
78
2,400
600
––––––
5,000
––––––
9,000
(600)
––––––
8,400
x 25% = 2,100
Pandar
(a)
(i)
Goodwill in Salva at 1 April 2012:
Controlling interest
Shares issued (120 million x 80% x 3/5 x $6)
Non-controlling interest (120 million x 20% x $3·20)
Equity shares
Pre-acquisition reserves:
At 1 October 2011
To date of acquisition (see below)
Fair value adjustments (5,000 + 20,000)
$’000
$’000
345,600
76,800
––––––––
422,400
120,000
152,000
11,500
25,000
––––––––
308,500
––––––––
Goodwill arising on acquisition
113,900
––––––––
The interest on the 8% loan note is $2 million ($50 million x 8% x 6/12).
This is included in Salva’s income statement in the post-acquisition period.
Thus Salva’s profit for the year of $21 million has a split of $11·5 million
pre-acquisition ((21 million + 2 million interest) x 6/12) and $9·5 million
post-acquisition.
(ii)
Carrying amount of investment in Ambra at 30 September 2012
Cost (40 million x 40% x $2)
Share of post-acquisition losses (5,000 x 40% x 6/12)
Impairment charge (3,000)
© Emile Woolf Publishing Limited
$’000
32,000
(1,000)
––––––––
28,000
––––––––
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(b)
Pandar Group
Consolidated income statement for the year ended 30 September 2012
$’000
$’000
Revenue
(210,000 + (150,000 x 6/12) – 15,000 intra-group sales)
270,000
Cost of sales (w (i))
(162,500)
––––––––
Gross profit
107,500
Distribution costs (11,200 + (7,000 x 6/12))
(14,700)
Administrative expenses (18,300 + (9,000 x 6/12))
(22,800)
Investment income (w (ii))
1,100
Finance costs (w (iii))
(2,300)
Share of loss from associate (5,000 x 40% x 6/12)
(1,000)
Impairment of investment in associate
(3,000)
(4,000)
––––––––
––––––––
Profit before tax
64,800
Income tax expense (15,000 + (10,000 x 6/12))
(20,000)
––––––––
Profit for the year
44,800
––––––––
Attributable to:
Owners of the parent
43,000
Non-controlling interest (w (iv))
1,800
––––––––
44,800
––––––––
Workings (figures in brackets in $’000)
(i)
Cost of sales
$’000
Pandar
126,000
Salva (100,000 x 6/12)
50,000
Intra-group purchases
(15,000)
Additional depreciation: plant (5,000/5 years x 6/12)
500
Unrealised profit in inventories (15,000/3 x 20%)
1,000
––––––––
162,500
––––––––
As the registration of the domain name is renewable indefinitely (at only a
nominal cost) it will not be amortised.
(ii) Investment income
Per income statement
9,500
Intra-group interest (50,000 x 8% x 6/12)
(2,000)
Intra-group dividend (8,000 x 80%)
(6,400)
––––––––
1,100
––––––––
(iii) Finance costs
$’000
$’000
Pandar
1,800
Salva post-acquisition ((3,000 – 2,000) x 6/12 + 2,000)
2,500
Intra-group interest (w (ii))
(2,000)
––––––––
2,300
––––––––
(iv) Non-controlling interest
Salva’s post-acquisition profit (see (i) above)
9,500
Less: post-acquisition additional depreciation (w (i))
(500)
––––––––
9,000
x 20% = 1,800
298
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Section 2: Answers to practice questions
79
Premier
(a)
Premier
Consolidated statement of comprehensive income for the year ended 30
September 2010
Revenue (92,500 + (45,000 x 4/12) – 4,000 intra-group sales)
Cost of sales (w (i))
Gross profit
Distribution costs (2,500 + (1,200 x 4/12))
Administrative expenses (5,500 + (2,400 x 4/12))
Finance costs
Profit before tax
Income tax expense (3,900 + (1,500 x 4/12))
Profit for the year
Other comprehensive income:
Gain on available-for-sale investments
Gain on revaluation of property
Total other comprehensive income for the year
Total comprehensive income
Profit for year attributable to:
Equity holders of the parent
Non-controlling interest
((1,300 see below – 400 URP + 50 reduced depreciation) x 20%)
Total comprehensive income attributable to:
Equity holders of the parent (10,760 + 300 + 500)
Non-controlling interest
$’000
103,500
(78,850)
––––––––
24,650
(2,900)
(6,300)
(100)
––––––––
15,350
(4,400)
––––––––
10,950
––––––––
300
500
––––––––
800
––––––––
11,750
––––––––
10,760
190
––––––––
10,950
––––––––
11,560
190
––––––––
11,750
––––––––
Sanford’s profits for the year ended 30 September 2010 of $3·9 million are $2·6
million (3,900 x 8/12) pre-acquisition and $1·3 million (3,900 x 4/12) postacquisition.
(b)
Consolidated statement of financial position as at 30 September 2010.
$’000
Assets
Non-current assets
Property, plant and equipment (w (ii))
38,250
Goodwill (w (iii))
9,300
Available-for-sale investments (1,800 – 800 consideration + 300 gain) 1,300
–––––
48,850
Current assets (w (iv))
14,150
–––––
Total assets
63,000
–––––
© Emile Woolf Publishing Limited
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$’000
Equity and liabilities
Equity attributable to owners of the parent
Equity shares of $1 each ((12,000 + 2,400) w (iii))
Share premium (w (iii))
Land revaluation reserve
Other equity reserve (500 + 300)
Retained earnings (w (v))
Non-controlling interest (w (vi))
Total equity
Non-current liabilities
6% loan notes
Current liabilities (10,000 + 6,800 – 350 intra group balance)
Total equity and liabilities
Workings in
(i)
Cost of sales
Premier
Sanford (36,000 x 4/12)
Intra-group purchases
URP in inventory
Reduction of depreciation charge
14,400
9,600
2,000
800
13,060
–––––
39,860
3,690
–––––
43,550
3,000
16,450
–––––
63,000
–––––
$’000
70,500
12,000
(4,000)
400
(50)
–––––
78,850
–––––
The unrealised profit (URP) in inventory is calculated as $2 million x
25/125 = $400,000.
(ii) Non-current assets
Premier
25,500
Sanford
13,900
Fair value reduction at acquisition
(1,200)
Reduced depreciation
50
–––––
38,250
–––––
(iii) Goodwill in Sanford
Investment at cost
Shares (5,000 x 80% x 3/5 x $5)
12,000
6% loan notes (5,000 x 80% x 100/500)
800
Non-controlling interest (5,000 x 20% x $3·50)
3,500
–––––
16,300
Net assets (equity) of Sanford at 30 September 2010
(9,500)
Less: post-acquisition profits (see above)
1,300
Less: fair value adjustment for property
1,200
–––––
Net assets at date of acquisition
(7,000)
–––––
Goodwill
9,300
–––––
The 2·4 million shares (5,000 x 80% x 3/5) issued by Premier at $5 each would be
recorded as share capital of $2·4 million and share premium of $9·6 million.
300
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Section 2: Answers to practice questions
(iv)
(v)
Current assets
Premier 12,500
Sanford 2,400
URP in inventory (400 )
Intra-group balance (350 )
Retained earnings
Premier 12,300
Sanford’s post-acquisition adjusted profit
((1,300 – 400 URP + 50 reduced depreciation) x 80%) 760
(vi) Non-controlling interest in statement of financial position
At date of acquisition 3,500
Post-acquisition profit from income statement 190
–––––
14,150
–––––
–––––
13,060
–––––
–––––
3,690
–––––
Business combinations – Statements of financial position
and performance
80
Hepburn
(a)
Hepburn
Consolidated income statement year to 31 March 2012
$000
Sale revenues (1,200 + 500 − 100 intra-group sales)
Cost of sales (W1)
Gross profit
Operating expenses (120 + 44)
Finance costs (12 × 6/12)
Profit before tax
Income tax expense (100 + 20)
Profit for the period
Attributable to:
Equity holders of the parent
Non-controlling interests (200 × 20% × 6/12)
Consolidated statement of financial position at 31 March 2012
$000
Non-current assets
Tangible
Property, plant and equipment (620 + 660 + 125)
Intangible: Goodwill (W2)
© Emile Woolf Publishing Limited
$000
1,600
(890)
710
(164)
(6)
540
(120)
420
400
20
420
$000
1,405
200
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Consolidated statement of financial position at 31 March 2012
$000
Investments (20 + 10)
Current assets
Inventory (240 + 280 − 10)
Accounts receivable (170 + 210 − 56)
Bank (20 + 40 + 20)
$000
30
1,635
510
324
80
914
2,549
Total assets
Equity and liabilities:
Equity shares of $1 each (400 + 300 (W2))
Reserves:
Share premium (W2)
Retained earnings (W3)
700
600
480
1,080
1,780
195
1,975
Non-controlling interest (W4)
Non-current liabilities
8% Debentures
Current liabilities
Trade payables (170 + 155 − 36)
Taxation (50 + 45)
Dividends
150
289
95
40
424
2,549
Workings
(W1) Goodwill
$000
Investment at cost (((150,000/2 × 5) × 80%) × $3)
Less – equity shares of Salter (150 × 80%)
– pre-acquisition profits ((700 − 100) × 80%)
– fair value adjustment of land (125 × 80%)
302
(120)
(480)
(100)
(700)
200
(40)
160
Goodwill on consolidation
Less impairment
In Hepburn’s books
Dr Cost of investment
$000
900
900,000
Cr Share Capital
300,000
Cr Share premium
600,000
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(W2) Unrealised profit
($100,000 × 50%) × 25/125 = $10,000
Parent sells to subsidiary so no non controlling interest adjustment
(W3) Non-controlling interest
Equity shares of Salter (150 × 20%)
30
Fair value adjustment of land (125 × 20%)
25
Retained earnings (700 × 20%)
140
195
(W4) Consolidated reserves
$000
Hepburn’s reserves
Share of Salter’s post acquisition profits (200 × 6/12 × 80%)
Unrealised profit in inventory
410
80
(10)
480
(W5) Cost of sales
Hepburn
Salter (660 × 6/12)
Intra-group sales
Unrealised profit in inventory
(b)
$000
650
330
(100)
10
890
It seems that the directors of Hepburn are basing their arguments on the
possibility that the investment in Woodbridge may be an associated company.
The ownership of the total equity is 25%, giving Hepburn the right to 25% of any
dividends Woodbridge may pay. If this were the basis on which the assessment
of associate status is made, it may be that given the lack of involvement in the
operating policies of Woodbridge, the directors may be able to rebut the normal
presumption that Woodbridge is an associate by virtue of its 25% holding.
The directors do however appear to be misunderstanding the basis of
determining subsidiary company status. IFRS 10 Consolidated Financial Statements
bases its definition of a subsidiary on control rather than ownership. In the case
of Woodbridge, Hepburn in fact owns 6,000 of the 10,000 voting shares, and, in
the absence of any other information, this would constitute control of
Woodbridge by virtue of its 60% of voting rights. Thus, far from being an
associate of Hepburn, Woodbridge is in fact a subsidiary, irrespective of the fact
that control may be passive. Therefore Woodbridge’s results should be
consolidated by Hepburn from the date of its acquisition.
It may be that the motive for the directors’ position is that they wish to improve
group profits by avoiding consolidation of Woodbridge’s losses. This raises the
further point that these losses may indicate that the value of the investment in the
subsidiary has been impaired under IAS 36 Impairment of Assets. If so, it will be
necessary to perform an impairment test, which involves calculating the
recoverable amount of the investment. If this is less than $20,000 the directors
© Emile Woolf Publishing Limited
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will have to write down the value of the investment (in Hepburn’s own (entity)
financial statements) to its recoverable amount, and also write down the
consolidated assets of Woodbridge.
81
Hydrate
Hydrate
Consolidated income statement – year to 30 September 2012
Sales revenue (24,000 + (6 /12 × 20,000)) – 100
Cost of sales (16,600 + (6 /12 × 11,800)) – 100 + 500 +10
Gross profit
Operating expenses (1,600 + ( 6 /12 × 1,000) + 1,000
Taxation (2,000 + (6 /12 × 3,000))
Profit for the year
Attributable to
Group
Non-controlling interest (W4)
$000
33,900
(22,910)
10,990
(3,100)
7,890
(3,500)
4,390
4,070
320
Consolidated statement of financial position at 30 September 2012
$000
$000
Non-current assets
Property, plant and equipment
(64,000 + 35,000 + 5,000 – 500)
103,500
Investments
12,800
Goodwill (W2)
23,000
139,300
Current assets
Inventory (22,800 + 23,600) – 10
46,390
Accounts receivable (16,400 + 24,200)
40,600
Bank (500 + 200)
700
87,690
Total assets
226,990
Equity and liabilities:
Ordinary shares of $1 each (20,000 + 12,000 (W2))
32,000
Reserves:
Share premium (4,000 + 60,000 (W2))
64,000
Retained earnings (W5)
57,470
121,470
153,470
Non-controlling interest (W4)
12,320
165,790
Non-current liabilities
8% Loan notes (5,000 + 18,000)
304
23,000
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Consolidated statement of financial position at 30 September 2012
$000
$000
Current liabilities
Accounts payable (15,300 + 17,700)
33,000
Taxation (2,200 + 3,000)
5,200
38,200
226,990
Workings
(W1) Net assets in subsidiary
At
acquisition
Share capital
Share premium
Retained earnings 42,700 – (6/12 × 4,200)
At end of
reporting
period
$000
$000
12,000
12,000
2,400
2,400
40,600
42,700
5,000
5,000
Fair value adjustment
Plant
Depreciation 5,000 × 1/5 x 6/12
(500)
60,000
61,600
(W2) Goodwill
$000
Investment at cost ((80% × 12,000) × 5/4) × $6
72,000
Net assets at acquisition (80% × 60,000) (W2)
(48,000)
Goodwill at acquisition
24,000
Less impairment
(1,000)
In consolidated statement of financial position
23,000
Dr Cost of investment
72,000
Cr Share capital (80% × 12,000) 05/4
12,000
Cr Share premium
60,000
(W3) Unrealised profit
($100,000 × 50%) × 25/125 = $10,000
Parent sells to subsidiary so no NCI adjustment
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
(W4) Non-controlling interest
Statement of financial position
20% × 61,600 (W1) = 12,320
Income statement
Subsidiary post acquisition profit after tax (4,200 ×
6/12)
2,100
Less depreciation adjustment on fair value
(500)
1,600
NCI share: 20% × 1,600
320
(W5) Consolidated retained earnings:
Hydrate reserves
57,200
Skeptik post acquisition
(80% × 61,600 – 60,000 (W1))
Unrealised profit in inventory (W3)
Less impairment
1,280
(10)
(1,000)
57,470
82
Hillusion
(a)
Hillusion
Consolidated income statement for the year to 31 March 2012
$000
Sales revenue (60,000 + (24,000 ×9/12)) – 12,000
Cost of sales
(42,000 + (20,000 × 9/12)) – 12,000 + 500 + 600
Gross profit
Operating expenses (6,000 + (200 × 9/12)) + 300
Loan interest (200 × 9/12) – 75
Profit before tax
Taxation (3,000 + (600 × 9/12))
Profit for the period
Attributable to:
Equity holders of the parent
Non-controlling interest (W4)
306
$000
66,000
(46,100)
19,900
(6,450)
(75)
(6,225)
13,375
(3,450)
9,925
9,595
330
9,925
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
Consolidated statement of financial position at 31 March 2012
$000
Tangible non-current assets (19,320 + 8,000 + 3,200 – 600)
Goodwill (W3)
Current assets (15,000 + 8,000 – 500 – 750)
Total assets
Equity and liabilities
Equity attributable to equity holders of the parent
Ordinary shares of $1 each
Retained earnings (W5)
$000
29,920
900
30,820
21,750
52,570
10,000
26,120
36,120
2,600
38,720
Non-controlling interest (W4)
Non-current liabilities
10% Loan notes (2,000 – 1,000 intra-group)
Current liabilities (10,000 + 3,600 – 750)
Total equity and liabilities
1,000
12,850
52,570
Workings in $000
(W1) Net assets in subsidiary
At
acquisition
Share capital
Retained earnings (5,400 + 3/12 × 3,000)
Fair value adjustment
Plant
Depreciation 3,600 × 9/48
At end of
reporting
period
$000
$000
2,000
6,150
2,000
8,400
3,200
(600)
3,200
11,350
13,000
(W2) Goodwill
$000
Investment at cost
Net assets at acquisition (80% × 11,350 (W2))
Goodwill on consolidation
Less impairment
In consolidated statement of financial position
10,280
(9,080)
1,200
(300)
900
(W3) Unrealised profit
[(12m – 10m) × 12] – 9/12 = 500,000
Parent sells to subsidiary; therefore no non-controlling interest in this
unrealised profit
© Emile Woolf Publishing Limited
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(W4) Non-controlling interest
Statement of financial position
20% × 13,000 (W1) = 2,600
Income statement
Subsidiary post acq profit after tax (3,000 × 9/12)
2,250
Less depreciation adjustment to fair value
(600)
1,650
Non-controlling interest share: 20% x 1,650
330
(W5) Consolidated retained earnings:
Hillusion’s reserves
25,600
Skeptik’s post acquisition
(80% × 13,000 – 11,350 (W1))
1,320
Unrealised profit inventory (W3)
(500)
Less impairment
(300)
26,120
(b)
The main reason why intra-group unrealised profits must be eliminated on
consolidation is to achieve the main objective of group financial statements
which is to show the position of the group as if it were a single economic entity.
As such, a group cannot trade with itself, nor can it make a profit out of itself. In
a similar way it cannot increase its sales or its net assets by transferring assets
and liabilities between members of the group. As a simple illustrative example,
but for the requirement to eliminate intra-group profits, a group could buy an
item of inventory; sell it to another member of the group (at a profit), who in turn
could sell it to another member of the group and so on. The result would be that
each member of the group would make a profit which would then be combined
to form a large group profit. This would be ‘balanced’ by an over-inflated
inventory value in the statement of financial position (in practice this effect
would be limited by the application of the lower of cost and net realisable value
principle of valuing inventory). Such accounting would not give a fair
presentation of the results and position.
The main problem with using Skeptik entity financial statements to assess its
performance is that it is a related party of its parent, Hillusion. Related party
transactions can distort the true economic performance and financial position of a
company. In this case, the related party relationship extends to complete control
of Skeptik by Hillusion.
From the information in the question, it can be seen that most of Skeptik’s
trading is from goods it buys from Hillusion. Sales of non-group sourced goods
are only $9 million (out of $24 million). It may be that these have been transferred
at a favourable price allowing Skeptik to achieve a higher level of sales and make
a higher than normal profit. Ultimately this course of action is no real detriment
to the group as a whole as most of Skeptik’s profits (and all of them if it were
100% owned) are consolidated into the group profit. In a similar manner the fact
that Hillusion does not make any charge for Skeptik’s administration costs acts to
308
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Section 2: Answers to practice questions
increase Skeptik’s profit. If Skeptik was to be purchased by an external party, all
these beneficial effects would cease and Skeptik’s profit would then be much
lower. It could be observed that Hillusion may be ‘massaging’ Skeptik’s financial
statements with a view to obtaining a favourable price on its future sale.
Hillusion’s past record of success in selling previous businesses at a considerable
profit after only a short period of ownership supports this view.
83
Pedantic
(a)
Pedantic
Consolidated income statement for the year ended 30 September 2012
Revenue (85,000 + (42,000 x 6/12) – 8,000 intra-group sales)
Cost of sales (w (i))
Gross profit
Distribution costs (2,000 + (2,000 x 6/12))
Administrative expenses (6,000 + (3,200 x 6/12))
Finance costs (300 + (400 x 6/12))
Profit before tax
Income tax expense (4,700 + (1,400 x 6/12))
Profit for the year
Attributable to:
Equity holders of the parent
Non-controlling interest (((3,000 x 6/12) – (800 URP + 200
depreciation)) x 40%)
(b)
Consolidated statement of financial position as at 30 September 2012
Assets
Non-current assets
Property, plant and equipment (40,600 + 12,600 + 2,000 – 200
depreciation adjustment (w (i)))
Goodwill (w (ii))
Current assets (w (iii))
Total assets
Equity and liabilities
Equity attributable to owners of the parent
Equity shares of $1 each ((10, 000 + 1,600) w (ii))
Share premium (w (ii))
Retained earnings (w (iv))
Non-controlling interest (w (v))
Total equity
© Emile Woolf Publishing Limited
$’000
98,000
(72,000)
–––––––
26,000
(3,000)
(7,600)
(500)
–––––––
14,900
(5,400)
–––––––
9,500
–––––––
9,300
200
–––––––
9,500
–––––––
$’000
55,000
4,500
–––––––
59,500
21,400
–––––––
80,900
–––––––
11,600
8,000
35,700
–––––––
55,300
6,100
–––––––
61,400
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Paper F7: Financial Reporting (International)
$’000
Non-current liabilities
10% loan notes (4,000 + 3,000)
Current liabilities (8,200 + 4,700 – 400 intra-group balance)
7,000
12,500
–––––––
80,900
–––––––
Total equity and liabilities
Workings (figures in brackets in $’000)
(i)
Cost of sales
$’000
Pedantic
Sophistic (32,000 x 6/12)
Intra-group sales
URP in inventory
Additional depreciation (2,000/5 years x 6/12)
63,000
16,000
(8,000)
800
200
–––––––
72,000
–––––––
The unrealised profit (URP) in inventory is calculated as ($8 million – $5·2
million) x 40/140 = $800,000.
(ii)
Goodwill in Sophistic
Investment at cost
Shares (4,000 x 60% x 2/3 x $6)
Less – Equity shares of Sophistic (4,000 x 60%)
– pre-acquisition reserves (5,000 x 60% see below)
– fair value adjustment (2,000 x 60%)
$’000
(2,400)
(3,000)
(1,200)
––––––
Parent’s goodwill
Non-controlling interest’s goodwill (per question)
Total goodwill
The pre-acquisition reserves are:
At 30 September 2012
Earned in the post acquisition period (3,000 x 6/12)
$’000
9,600
(6,600)
––––––
3,000
1,500
––––––
4,500
––––––
6,500
(1,500)
––––––
5,000
––––––
Alternative calculation for goodwill in Sophistic
Investment at cost (as above)
Fair value of non-controlling interest (see below)
Cost of the controlling interest
Less fair value of net assets at acquisition (4,000 + 5,000 + 2,000)
Total goodwill
Fair value of non-controlling interest (at acquisition)
Share of fair value of net assets (11,000 x 40%)
Attributable goodwill per question
9,600
5,900
––––––
15,500
(11,000)
––––––
4,500
––––––
4,400
1,500
––––––
5,900
––––––
The 1·6 million shares (4,000 x 60% x 2/3) issued by Pedantic would be
recorded as share capital of $1·6 million and share premium of $8 million
(1,600 x $5).
310
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Section 2: Answers to practice questions
(iii)
Current assets
Pedantic
Sophistic
URP in inventory
Cash in transit
Intra-group balance
$’000
16,000
6,600
(800)
200
(600)
––––––
21,400
––––––
(iv)
Retained earnings
(v)
Pedantic per statement of financial position
35,400
Sophistic’s post acquisition profit
(((3,000 x 6/12) – (800 URP + 200 depreciation)) x 60%) 300
––––––
35,700
––––––
Non-controlling interest (in statement of financial position)
Net assets per statement of financial position
URP in inventory
Net fair value adjustment (2,000 – 200)
Share of goodwill (per question)
$’000
10,500
(800)
1,800
––––––
11,500 x 40% = 4,600
––––––
1,500
––––––
6,100
––––––
Analysing and interpreting financial statements
84
Comparator
(a)
Ratios are used to assess the financial performance of a company by comparing
the calculated figures to various other sources. This may be to previous years’
ratios of the same company, it may be to the ratios of a similar rival company, to
accepted norms (say of liquidity ratios) or, as in this example, to industry
averages. The problems inherent in these processes are several. Probably the
most important aspect of using ratios is to realise that they do not give the
answers to the assessment of how well a company has performed, they merely
raise the questions and direct the analyst into trying to determine what has
caused favourable or unfavourable indicators. In many ways it can be said that
ratios are only as useful as the skills of the person using them. It is also true that
any assessment should also consider other information that may be available
including non-financial information.
More specific problem areas are:
„
Accounting policies: if two companies have different accounting policies, it
can invalidate any comparison between their ratios. For example return on
capital employed is materially affected by revaluations of assets.
Comparing this ratio for two companies where one has revalued its assets
and the other carries them at depreciated historical cost would not be very
meaningful. Similar examples may involve depreciation methods,
inventory valuation policies, etc.
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„
Accounting practices: this is similar to differing accounting policies in its
effects. An example of this would be the use of factoring of trade
receivables. If one company collects its accounts receivable in the normal
way, then the calculation of the accounts receivable collection period would
be a reasonable indication of the efficiency of its credit control department.
However if a company chose to factor its accounts receivable (i.e. ‘sell’
them to a finance company) then the calculation of its collection period
would be meaningless. A more controversial example would be the
engineering of a lease such that it fell to be treated as an operating lease
rather than a finance lease.
„
Statement of financial position averages: Many ratios are based on
comparing income statement items with items in the statement of financial
position. The ratio of accounts receivable collection period is a good
example of this. For such ratios to have any meaning, there is an
assumption that the year-end figures in the statement of financial position
are representative of annual norms. Seasonal trading and other factors may
invalidate this assumption. For example the level of accounts receivable
and inventory of a toy manufacturer could vary largely due to the nature of
its seasonal trading.
„
Inflation can distort comparisons over time.
„
The definition of an accounting ratio. If a ratio is calculated by two
companies using different definitions, then there is an obvious problem.
Common examples of this are gearing ratios (some use debt/equity, others
may use debt/debt + equity). Also where a ratio is partly based on a profit
figure, there can be differences as to what is included and what is excluded
from the profit figure. Problems of this type include the treatment of
finance costs.
„
The use of norms can be misleading. A desirable range for the current
ratio may be say between 1.5 and 2 : 1, but all businesses are different. This
would be a very high ratio for a supermarket (with few accounts
receivable), but a low figure for a construction company (with high levels
of work in progress).
„
Looking at a single ratio in isolation is rarely useful. It is necessary to
form a view when considering ratios in combination with other ratios.
A more controversial aspect of ratio analysis is that management have sometimes
indulged in creative accounting techniques in order that the ratios calculated
from published financial statements will show a more favourable picture than
the true underlying position. Examples of this are sale and repurchase
agreements, which manipulate liquidity figures, and ‘off balance sheet finance’
which distorts return on capital employed.
Inter firm comparisons:
Of particular concern with this method of using ratios is:
312
„
They are themselves averages and may incorporate large variations in their
composition. Some inter firm comparison agencies produce the ratios
analysed into quartiles to attempt to overcome this problem.
„
It may be that the sector in which a company is included may not be
sufficiently similar to the exact type of trade of the specific company. The
type of products or markets may be different.
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(b)
„
Companies of different sizes operate under different economies of scale,
this may not be reflected in the industry average figures.
„
The year end accounting dates of the companies included in the averages
are not going to be all the same. Some companies try to minimise this by
grouping companies with approximately similar year-ends together as in
the example of this question, but this is not a complete solution.
Calculation of specified ratios:
Comparator Sector
average
Return on capital employed (186 + 34 loan interest/635)
34.6%
22.1%
3.8 times
1.8 times
Gross profit margin (555/2,425 × 100)
22.9%
30%
Net profit (before tax) margin (186/2,425 × 100)
7.7%
12.5%
Current ratio (595/500)
1.19 : 1
1.6 : 1
Quick ratio (320/500)
0.64 : 1
0.9 : 1
Inventory holding period (275/1,870 × 365)
54 days
46 days
Accounts receivable collection period (320/2,425 × 365)
48 days
45 days
Creditor payment period (350/1,870 × 365)
(based on cost of sales)
68 days
55 days
Debt to equity (300/335 × 100)
90%
40%
Dividend yield (see below)
2.5%
6%
1.07 times
3 times
Net asset turnover (2,425/635)
Dividend cover (96/90)
The workings are in $000 (unless otherwise stated) and are for Comparator’s
ratios.
The dividend yield is calculated from a dividend per share figure of 15c
($90,000/150,000 × 4) and a share price of $6.00.
Thus the yield is 2.5% (15c/$6.00 × 100%).
(c)
Analysis of Comparator’s financial performance compared to sector average
for the year to 30 September 2012:
To:
From:
Date:
Operating performance
The return on capital employed of Comparator is impressive being more than
50% higher than the sector average. The components of the return on capital
employed are the asset turnover and profit margins. In these areas Comparator’s
asset turnover is much higher (nearly double) than the average, but the net profit
margin after exceptionals is considerably below the sector average. However, if
the exceptionals are treated as one off costs and excluded, Comparator’s margins
are very similar to the sector average.
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This short analysis seems to imply that Comparator’s superior return on capital
employed is due entirely to an efficient asset turnover i.e. Comparator is making
its assets work twice as efficiently as its competitors. A closer inspection of the
underlying figures may explain why its asset turnover is so high. It can be seen
from the note to the statement of financial position that Comparator’s noncurrent assets appear quite old. Their carrying amount is only 15% of their
original cost. This has at least two implications; they will need replacing in the
near future and the company is already struggling for funding; and their low
carrying value gives a high figure for asset turnover. Unless Comparator has
underestimated the life of its assets in its depreciation calculations, its noncurrent assets will need replacing in the near future. When this occurs its asset
turnover and return on capital employed figures will be much lower.
This aspect of ratio analysis often causes problems and to counter this anomaly
some companies calculate the asset turnover using the cost of non-current assets
rather than their carrying amount as this gives a more reliable trend. It is also
possible that Comparator is using assets that are not in its statement of financial
position. It may be leasing assets that do not meet the definition of finance leases
and thus the assets and corresponding obligations are not recognised in the
statement of financial position.
A further issue is which of the two calculated margins should be compared to the
sector average (i.e. including or excluding the effects of the exceptionals). The
gross profit margin of Comparator is much lower than the sector average. If the
exceptional losses were taken in at trading account level, which they should be as
they relate to obsolete inventory, Comparator’s gross margin would be even
worse. As Comparator’s net margin is similar to the sector average, it would
appear that Comparator has better control over its operating costs. This is
especially true as the other element of the net profit calculation is finance costs
and as Comparator has much higher gearing than the sector average, one would
expect Comparator’s interest to be higher than the sector average.
Liquidity
Here Comparator shows real cause for concern. Its current ratio and quick ratio
are much worse than the sector average, and indeed far below expected norms.
Current liquidity problems appear due to high levels of accounts payable and a
high bank overdraft. The high levels of inventory contribute to the poor quick
ratio and may be indicative of further obsolete inventory (the exceptional item is
due to obsolete inventory). The accounts receivable collection figure is
reasonable, but at 68 days, Comparator takes longer to pay its accounts payable
than do its competitors. Whilst this is a source of ‘free’ finance, it can damage
relations with suppliers and may lead to a curtailment of further credit.
Gearing
As referred to above, gearing (as measured by debt/equity) is more than twice
the level of the sector average. Whilst this may be an uncomfortable level, it is
currently beneficial for shareholders. The company is making an overall return of
34.6%, but only paying 8% interest on its loan notes. The gearing level may
become a serious issue if Comparator becomes unable to maintain the finance
costs. The company already has an overdraft and the ability to make further
interest payments could be in doubt.
314
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Section 2: Answers to practice questions
Investment ratios
Despite reasonable profitability figures, Comparator’s dividend yield is poor
compared to the sector average. From the extracts of the changes in equity it can
be seen that total dividends are $90,000 out of available profit for the year of only
$96,000 (hence the very low dividend cover). It is worthy of note that the interim
dividend was $60,000 and the final dividend only $30,000. Perhaps this indicates
a worsening performance during the year, as normally final dividends are higher
than interim dividends. Considering these factors it is surprising the company’s
share price is holding up so well.
Summary
The company compares favourably with the sector average figures for
profitability, however the company’s liquidity and gearing position is quite poor
and gives cause for concern. If it is to replace its old assets in the near future, it
will need to raise further finance. With already high levels of borrowing and poor
dividend yields, this may be a serious problem for Comparator.
85
Rytetrend
(a)
Rytetrend – Statement of cash flows for the year to 31 March 2012
$000
$000
Cash flows from operating activities
Operating profit per question
3,860
Capitalisation of installation costs
240
less depreciation (300 – 20%) (W1)
Adjustments:
Depreciation of non-current assets (W1)
Loss on disposal of plant (W1)
7,410
700
8,110
Increase in warranty provision (500 – 150)
350
Decrease in inventory (3,270 – 2,650)
620
Decrease in receivables (1,950 – 1,100)
850
Increase in payables (2,850 – 1,980)
870
Cash generated from operations
14,900
Interest paid
(460)
Income taxes paid (W2)
(910)
Net cash from operating activities
13,530
Net cash used in investing activities
Purchase of non-current assets (W1)
© Emile Woolf Publishing Limited
(15,550)
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Paper F7: Financial Reporting (International)
Rytetrend – Statement of cash flows for the year to 31 March 2012
$000
$000
Cash flows from financing activities
Issue of ordinary shares (1,500 + 1,500)
3,000
Issue of 6% loan notes
2,000
Repayment of 10% loan notes
(4,000)
Ordinary dividends paid (280 + (600 – 450) interim)
(430)
Net cash from financing activities
570
Net decrease in cash and cash equivalents
(1,450)
Cash and cash equivalents at beginning of period
400
Cash and cash equivalents at end of period
(1,050)
Workings
(W1) Non-current assets
Non-current assets at cost
Balance b/f
Disposal
Balance c/f (37,250 + 300 re installation)
$000
27,500
(6,000)
(37,550)
Cost of assets acquired
Trade in allowance
Cash flow for acquisitions
Depreciation
Balance b/f
Disposal (6,000 × 20% × 4 years)
Balance c/f (12,750 + (300 × 20%))
Difference – charge for year
(16,050)
500
(15,550)
Disposal
Cost
Depreciation
Net book value
Trade in allowance
Loss on sale
(10,200)
4,800
12,810
7,410
6,000
(4,800)
1,200
(500)
700
(W2) Tax paid
Tax provision b/f
Income statement tax charge
Tax provision c/f
Difference – cash paid
316
(630)
(1,000)
720
(910)
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
(b)
Report on the financial performance of Rytetrend for the year ended 31 March
2012
To:
From:
Date:
Operating performance
(i)
Revenue up $8.3 million representing an increase of 35% on 2011 figures.
(ii)
Costs of sales up by $6.5 million (40% increase on 2011).
Overall the increase in activity has led to an increase in gross profit of $1.8
million. However the gross profit margin has eased slightly from 31.9% in
2011 to 29.2% in 2012. Perhaps the slight reduction in margins gave a boost
to sales.
(iii)
Operating expenses have increased by $840,000, an increase of 18% on 2011
figures.
(iv)
Interest costs reduced by $40,000. It is worth noting that the composition of
them has changed. It appears that Rytetrend has taken advantage of a
cyclic reduction in borrowing cost and redeemed its 10% loan notes and
(partly) replaced these with lower cost 6% loan notes. From the interest cost
figure, this appears to have taken place half way through the year.
Although borrowing costs on long-term finance have decreased, other
factors have led to a substantial overdraft which has led to further interest
of $200,000.
(v)
The accumulated effect is an increase in profit before tax of $1 million (up
41.6% on 2011) which is reflected by an increase in dividends of $200,000.
(vi)
The company has invested heavily in acquiring new non-current assets
(over $15 million – see cash flow statement). The refurbishment of the
equipment may be responsible for the increase in the company’s sales and
operating performance.
Analysis of financial position
(vii) Inventory and receivables have both decreased markedly. Inventory is now
at 43 days from 75 days, this may be due to new arrangements with
suppliers or that the different range of equipment that Rytetrend now sells
may offer less choice requiring lower inventory. Receivables are only 13
days (from 30 days). This low figure is probably a reflection of a retailing
business.
(viii) Although payables have increased significantly, they still represent only 46
days (based on cost of sales) which is almost the same as in 2011.
(ix)
A very worrying factor is that the company has gone from net current
assets of $2,580,000 to net current liabilities of $1,820,000. This is mainly
due to a combination of the above mentioned item: decreased inventory
and receivables and increased trade payables leading to a fall in cash
balances of $1,450,000. That said, traditionally acceptable norms for
liquidity ratios are not really appropriate to a mainly retailing business.
© Emile Woolf Publishing Limited
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(x)
Long-term borrowing has fallen by $2 million; this has lowered gearing
from 20% (4,000,000/19,880,000) to only 9% (2,000,000/22,680,000). This is a
very modest level of gearing.
The statement of cash flows
This indicates very healthy cash flows generated from operations of $14,900,000,
more than sufficient to pay interest costs, taxation and dividends. The main
reason why the overall cash balance has fallen is that new non-current assets
(costing over $15 million) have largely been financed from operating cash flows
(only $1 million net of new capital has been raised). If Rytetrend continues to
generate operating cash flows in the order of the current year, its liquidity will
soon get back to healthy levels.
86
Greenwood
Note IFRS 5 uses the term discontinued operation. The answer below also uses this
term, but it should be realised that the assets of the discontinued operation are classed
as held for sale and not yet sold.
Profitability/utilisation of assets
An important feature of the company’s performance in the year to 31 March 2012 is to
evaluate the effect of the discontinued operation. When using an entity’s recent results
as a basis for assessing how the entity may perform in the future, emphasis should be
placed on the results from continuing operations as it is these that will form the basis of
future results. For this reason most of the ratios calculated in the appendix are based
on the results from continuing operations and ratio calculations involving net
assets/capital employed generally exclude the value of the assets held for sale.
On this basis, it can be seen that the overall efficiency of Greenwood (measured by its
ROCE) has declined considerably from 33·5% to 29·7% (a fall of 11·3%). The fall in the
asset turnover (from 1·89 to 1·67 times) appears to be mostly responsible for the overall
decline in efficiency. In effect the company’s assets are generating less sales per $
invested in them. The other contributing factors to overall profitability are the
company’s profit margins. Greenwood has achieved an impressive increase in headline
sales revenues of nearly 30% (6·3m on 21·2m) whilst being able to maintain its gross
profit margin at around 29% (no significant change from 2011). This has led to a
substantial increase in gross profit, but this has been eroded by an increase in operating
expenses. As a percentage of sales, operating expenses were 10·5% in 2012 compared to
11·6% in 2011 (they appear to be more of a variable than a fixed cost). This has led to a
modest improvement in the profit before interest and tax margin which has partially
offset the deteriorating asset utilisation.
The decision to sell the activities which are classified as a discontinued operation is
likely to improve the overall profitability of the company. In the year ended 31 March
2011 the discontinued operation made a modest pre tax profit of $450,000 (this would
represent a return of around 7% on the activity’s assets of $6·3 million).This poor return
acted to reduce the company’s overall profitability (the continuing operations yielded a
return of 33·5%). The performance of the discontinued operation continued to
deteriorate in the year ended 31 March 2012 making a pre tax operating loss of $1·4
million which creates a negative return on the relevant assets. Despite incurring losses
on the measurement to fair value of the discontinued operation’s assets, it seems the
318
© Emile Woolf Publishing Limited
Section 2: Answers to practice questions
decision will benefit the company in the future as the discontinued operation showed
no sign of recovery.
Liquidity and solvency
Superficially the current ratio of 2·11 in 2012 seems reasonable, but the improvement
from the alarming current ratio in 2011 of 0·97 is more illusory than real. The ratio in
the year ended 31 March 2012 has been distorted (improved) by the inclusion of assets
of the discontinued operation under the heading of ‘held for sale’. These have been
included at fair value less cost to sell (being lower than their cost – a requirement of
IFRS 5). Thus the carrying amount should be a realistic expectation of the net sale
proceeds, but it is not clear whether the sale will be cash (they may be exchanged for
shares or other assets) or how Greenwood intends to use the disposal proceeds. What
can be deduced is that without the assets held for sale being classified as current, the
company’s liquidity ratio would be much worse than at present (at below 1 for both
years). Against an expected norm of 1, quick ratios (acid test) calculated on the normal
basis of excluding inventory (and in this case the assets held for sale) show an alarming
position; a poor figure of 0·62 in 2011 has further deteriorated in 2012 to 0·44. Without
the proceeds from the sale of the discontinued operation (assuming they will be for
cash) it is difficult to see how Greenwood would pay its creditors (and tax liability),
given a year end overdraft of $1,150,000.
Further analysis of the current ratios shows some interesting changes during the year.
Despite its large overdraft Greenwood appears to be settling its trade payables quicker
than in 2011. At 68 days in 2011 this was rather a long time and the reduction in credit
period may be at the insistence of suppliers – not a good sign. Perhaps to relieve
liquidity pressure, the company appears to be pushing its customers to settle early. It
may be that this has been achieved by the offer of early settlement discounts, if so the
cost of this would have impacted on profit. Despite holding a higher amount of
inventory at 31 March 2012 (than in 2011), the company has increased its inventory
turnover; given that margins have been held, this reflects an improved performance.
Gearing
The additional borrowing of $3 million in loan notes (perhaps due to liquidity
pressure) has resulted in an increase in gearing from 28·6% to 35·6% and a consequent
increase in finance costs. Despite the increase in finance costs the borrowing is acting in
the shareholders’ favour as the overall return on capital employed (at 29·7%) is well in
excess of the 5% interest cost.
Summary
Overall the company’s performance has deteriorated in the year ended 31 March 2012.
Management’s action in respect of the discontinued operation is a welcome measure to
try to halt the decline, but more needs to be done. The company’s liquidity position is
giving cause for serious concern and without the prospect of realising $6 million from
the assets held for sale it would be difficult to envisage any easing of the company’s
liquidity pressures.
Appendix
ROCE: continuing operations
(4,500 + 400)/(14,500 + 8,000 – 6,000)
2012
29·7%
(3,500 + 250)/
(12,500 + 5,000 – 6,300)
2011
33·5%
The return has been taken as the profit before interest (on loan notes only) and tax from
continuing operations. The capital employed is the normal equity plus loan capital (as at the
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
year end), but less the value of the assets held for sale. This is because the assets held for sale
have not contributed to the return from continuing operations.
Gross profit percentage (8,000/27,500)
Operating expense percentage of sales
revenue (2,900/27,500)
Profit before interest and tax margin
(5,100/27,500)
Asset turnover (27,500/16,500)
Current ratio (9,500:4,500)
Current ratio (excluding held for sale)
(3,500:4,500)
29·1%
(6,200/21,200)
29·2%
10·5%
(2,450/21,200)
11·6%
18·5%
1·67
2·11
(3,750/21,200)
(21,200/11,200)
(3,700:3,800)
17·7%
1·89
0·97
0·77
not applicable
0·44
(2,350:3,800)
Quick ratio (excluding held for sale)
(2,000:4,500)
0·62
Inventory (closing) turnover (19,500/1,500)
11·1
13·0
Receivables (in days) (2,000/27,500) x 365
26·5
Payables/cost of sales (in days)
(2,400/19,500) x 365
Gearing (8,000/8,000 + 14,500)
87
44·9
35·6%
(2,300/21,200) x 365
39·6
(2,800/15,000) x 365
(5,000/5,000 + 12,500)
68·1
28·6%
Harbin
(a)
Note: figures in the calculations of the ratios are in $million
2012
2011
2012 re
Fatima (b)
11·2 %
7·1%
18·9%
1·2 x
20%
1·6x
16·7%
0·6x
42·9%
Net profit (before tax) margin
16/250
6·4%
4·4%
31·4%
Current ratio
38/44
0·9:1
2·5
Closing inventory holding period
25/200 x 365
46 days
37 days
Trade receivables’ collection period
13/250 x 365
19 days
16 days
Trade payables’ payment period
23/200 x 365
42 days
32 days
46·7%
nil
Return on year end capital employed
24/(114 + 100) x 100
Net asset turnover
250/214
Gross profit margin (given in question)
Gearing
100/214 x 100
The gross profit margins and relevant ratios for 2011 are given in the question,
and some additional ratios for Fatima are included above to enable a clearer
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Section 2: Answers to practice questions
analysis in answering part (b) (references to Fatima should be taken to mean
Fatima’s net assets).
(b)
Analysis of the comparative financial performance and position of Harbin for the
year ended 30 September 2012. Note: references to 2012 and 2011 should be taken
as the years ended 30 September 2012 and 2011.
Introduction
The figures relating to the comparative performance of Harbin ‘highlighted’ in
the Chief Executive’s report may be factually correct, but they take a rather
biased and one dimensional view. They focus entirely on the performance as
reflected in the income statement without reference to other measures of
performance (notably the ROCE); nor is there any reference to the purchase of
Fatima at the beginning of the year which has had a favourable effect on profit
for 2012. Due to this purchase, it is not consistent to compare Harbin’s income
statement results in 2012 directly with those of 2011 because it does not match
like with like. Immediately before the $100 million purchase of Fatima, the
carrying amount of the net assets of Harbin was $112 million. Thus the
investment represented an increase of nearly 90% of Harbin’s existing capital
employed. The following analysis of performance will consider the position as
shown in the reported financial statements (based on the ratios required by part
(a) of the question) and then go on to consider the impact the purchase has had
on this analysis.
Profitability
The ROCE is often considered to be the primary measure of operating
performance, because it relates the profit made by an entity (return) to the capital
(or net assets) invested in generating those profits. On this basis the ROCE in
2012 of 11·2% represents a 58% improvement (i.e. 4·1% on 7·1%) on the ROCE of
7·1% in 2011. Given there were no disposals of non-current assets, the ROCE on
Fatima’s net assets is 18·9% (22m/100m + 16·5m). Note: the net assets of Fatima
at the year end would have increased by profit after tax of $16·5 million (i.e. 22m
x 75% (at a tax rate of 25%)). Put another way, without the contribution of $22
million to profit before tax, Harbin’s ‘underlying’ profit would have been a loss
of $6 million which would give a negative ROCE. The principal reasons for the
beneficial impact of Fatima’s purchase is that its profit margins at 42·9% gross
and 31·4% net (before tax) are far superior to the profit margins of the combined
business at 20% and 6·4% respectively. It should be observed that the other
contributing factor to the ROCE is the net asset turnover and in this respect
Fatima’s is actually inferior at 0·6 times (70m/116·5m) to that of the combined
business of 1·2 times.
It could be argued that the finance costs should be allocated against Fatima’s
results as the proceeds of the loan note appear to be the funding for the purchase
of Fatima. Even if this is accepted, Fatima’s results still far exceed those of the
existing business.
Thus the Chief Executive’s report, already criticised for focussing on the income
statement alone, is still highly misleading. Without the purchase of Fatima,
underlying sales revenue would be flat at $180 million and the gross margin
would be down to 11·1% (20m/180m) from 16·7% resulting in a loss before tax of
$6 million. This sales performance is particularly poor given it is likely that there
must have been an increase in spending on property plant and equipment
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Paper F7: Financial Reporting (International)
beyond that related to the purchase of Fatima’s net assets as the increase in
property, plant and equipment is $120 million (after depreciation).
Liquidity
The company’s liquidity position as measured by the current ratio has
deteriorated dramatically during the period. A relatively healthy 2·5:1 is now
only 0·9:1 which is rather less than what one would expect from the quick ratio
(which excludes inventory) and is a matter of serious concern. A consideration of
the component elements of the current ratio suggests that increases in the
inventory holding period and trade payables payment period have largely offset
each other. There is a small increase in the collection period for trade receivables
(up from 16 days to 19 days) which would actually improve the current ratio.
This ratio appears unrealistically low, it is very difficult to collect credit sales so
quickly and may be indicative of factoring some of the receivables, or a
proportion of the sales being cash sales. Factoring is sometimes seen as a
consequence of declining liquidity, although if this assumption is correct it does
also appear to have been present in the previous year. The changes in the above
three ratios do not explain the dramatic deterioration in the current ratio, the real
culprit is the cash position, Harbin has gone from having a bank balance of $14
million in 2011 to showing short-term bank borrowings of $17 million in 2012.
A cash flow statement would give a better appreciation of the movement in the
bank/short term borrowing position.
It is not possible to assess, in isolation, the impact of the purchase of Fatima on
the liquidity of the company.
Dividends
A dividend of 10 cents per share in 2012 amounts to $10 million (100m x 10
cents), thus the dividend in 2011 would have been $8 million (the dividend in
2012 is 25% up on 2011). It may be that the increase in the reported profits led the
Board to pay a 25% increased dividend, but the dividend cover is only 1·2 times
(12m/10m) in 2012 which is very low. In 2011 the cover was only 0·75 times
(6m/8m) meaning previous years’ reserves were used to facilitate the dividend.
The low retained earnings indicate that Harbin has historically paid a high
proportion of its profits as dividends, however in times of declining liquidity, it
is difficult to justify such high dividends.
Gearing
The company has gone from a position of nil gearing (i.e. no long-term
borrowings) in 2011 to a relatively high gearing of 46·7% in 2012. This has been
caused by the issue of the $100 million 8% loan note which would appear to be
the source of the funding for the $100 million purchase of Fatima’s net assets. At
the time the loan note was issued, Harbin’s ROCE was 7·1%, slightly less than the
finance cost of the loan note. In 2012 the ROCE has increased to 11·2%, thus the
manner of the funding has had a beneficial effect on the returns to the equity
holders of Harbin. However, it should be noted that high gearing does not come
without risk; any future downturn in the results of Harbin would expose the
equity holders to much lower proportionate returns and continued poor liquidity
may mean payment of the loan interest could present a problem. Harbin’s
gearing and liquidity position would have looked far better had some of the
acquisition been funded by an issue of equity shares.
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Section 2: Answers to practice questions
Conclusion
There is no doubt that the purchase of Fatima has been a great success and
appears to have been a wise move on the part of the management of Harbin.
However, it has disguised a serious deterioration of the underlying performance
and position of Harbin’s existing activities which the Chief Executive’s report
may be trying to hide. It may be that the acquisition was part of an overall plan
to diversify out of what has become existing loss making activities. If such a
transition can continue, then the worrying aspects of poor liquidity and high
gearing may be overcome.
88
Victular
(a)
Equivalent ratios from the financial statements of Merlot (workings in $’000)
Return on year end capital employed
(ROCE)
20·9%
Pre tax return on equity (ROE)
Net asset turnover
Gross profit margin
50%
2·3 times
(1,400 + 590)/
(2,800 + 3,200 + 500 + 3,000) x 100
1,400/2,800 x 100
20,500/(14,800 – 5,700)
12·2%
2,500/20,500 x 100
Operating profit margin
9·8%
2,000/20,500 x 100
Current ratio
1·3:1
7,300/5,700
Closing inventory holding period
73 days
3,600/18,000 x 365
Trade receivables’ collection period 66 days
3,700/20,500 x 365
Trade payables’ payment period
3,800/18,000 x 365
Gearing
77 days
71%
(3,200 + 500 + 3,000)/9,500 x 100
Interest cover
3·3 times
2,000/600
Dividend cover
1·4 times
1,000/700
As per the question, Merlot’s obligations under finance leases (3,200 + 500) have
been treated as debt when calculating the ROCE and gearing ratios.
(b)
Assessment of the relative performance and financial position of Grappa and
Merlot for the year ended 30 September 2012
Introduction
This report is based on the draft financial statements supplied and the ratios
shown in (a) above. Although covering many aspects of performance and
financial position, the report has been approached from the point of view of a
prospective acquisition of the entire equity of one of the two companies.
Profitability
The ROCE of 20·9% of Merlot is far superior to the 14·8% return achieved by
Grappa. ROCE is traditionally seen as a measure of management’s overall
efficiency in the use of the finance/assets at its disposal. More detailed analysis
reveals that Merlot’s superior performance is due to its efficiency in the use of its
net assets; it achieved a net asset turnover of 2·3 times compared to only 1·2 times
for Grappa. Put another way, Merlot makes sales of $2·30 per $1 invested in net
assets compared to sales of only $1·20 per $1 invested for Grappa. The other
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element contributing to the ROCE is profit margins. In this area Merlot’s overall
performance is slightly inferior to that of Grappa, gross profit margins are almost
identical, but Grappa’s operating profit margin is 10·5% compared to Merlot’s
9·8%. In this situation, where one company’s ROCE is superior to another’s it is
useful to look behind the figures and consider possible reasons for the
superiority other than the obvious one of greater efficiency on Merlot’s part.
A major component of the ROCE is normally the carrying amount of the noncurrent assets. Consideration of these in this case reveals some interesting issues.
Merlot does not own its premises whereas Grappa does. Such a situation would
not necessarily give a ROCE advantage to either company as the increase in
capital employed of a company owning its factory would be compensated by a
higher return due to not having a rental expense (and vice versa). If Merlot’s
rental cost, as a percentage of the value of the related factory, was less than its
overall ROCE, then it would be contributing to its higher ROCE. There is
insufficient information to determine this. Another relevant point may be that
Merlot’s owned plant is nearing the end of its useful life (carrying amount is only
22% of its cost) and the company seems to be replacing owned plant with leased
plant. Again this does not necessarily give Merlot an advantage, but the finance
cost of the leased assets at only 7·5% is much lower than the overall ROCE (of
either company) and therefore this does help to improve Merlot’s ROCE. The
other important issue within the composition of the ROCE is the valuation basis
of the companies’ non-current assets. From the question, it appears that Grappa’s
factory is at current value (there is a property revaluation reserve) and note (ii) of
the question indicates the use of historical cost for plant. The use of current value
for the factory (as opposed to historical cost) will be adversely impacting on
Grappa’s ROCE. Merlot does not suffer this deterioration as it does not own its
factory.
The ROCE measures the overall efficiency of management; however, as Victular
is considering buying the equity of one of the two companies, it would be useful
to consider the return on equity (ROE) – as this is what Victular is buying. The
ratios calculated are based on pre-tax profits; this takes into account finance
costs, but does not cause taxation issues to distort the comparison. Clearly
Merlot’s ROE at 50% is far superior to Grappa’s 19·1%. Again the issue of the
revaluation of Grappa’s factory is making this ratio appear comparatively worse
(than it would be if there had not been a revaluation). In these circumstances it
would be more meaningful if the ROE was calculated based on the asking price
of each company (which has not been disclosed) as this would effectively be the
carrying amount of the relevant equity for Victular.
Gearing
From the gearing ratio it can be seen that 71% of Merlot’s assets are financed by
borrowings (39% is attributable to Merlot’s policy of leasing its plant). This is
very high in absolute terms and double Grappa’s level of gearing. The effect of
gearing means that all of the profit after finance costs is attributable to the equity
even though (in Merlot’s case) the equity represents only 29% of the financing of
the net assets. Whilst this may seem advantageous to the equity shareholders of
Merlot, it does not come without risk. The interest cover of Merlot is only 3·3
times whereas that of Grappa is 6 times. Merlot’s low interest cover is a direct
consequence of its high gearing and it makes profits vulnerable to relatively
small changes in operating activity. For example, small reductions in sales, profit
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Section 2: Answers to practice questions
margins or small increases in operating expenses could result in losses and mean
that interest charges would not be covered.
Another observation is that Grappa has been able to take advantage of the receipt
of government grants; Merlot has not. This may be due to Grappa purchasing its
plant (which may then be eligible for grants) whereas Merlot leases its plant. It
may be that the lessor has received any grants available on the purchase of the
plant and passed some of this benefit on to Merlot via lower lease finance costs
(at 7·5% per annum, this is considerably lower than Merlot has to pay on its 10%
loan notes).
Liquidity
Both companies have relatively low liquid ratios of 1·2 and 1·3 for Grappa and
Merlot respectively, although at least Grappa has $600,000 in the bank whereas
Merlot has a $1·2 million overdraft. In this respect Merlot’s policy of high
dividend payouts (leading to a low dividend cover and low retained earnings) is
very questionable. Looking in more depth, both companies have similar
inventory days; Merlot collects its receivables one week earlier than Grappa
(perhaps its credit control procedures are more active due to its large overdraft),
and of notable difference is that Grappa receives (or takes) a lot longer credit
period from its suppliers (108 days compared to 77 days). This may be a
reflection of Grappa being able to negotiate better credit terms because it has a
higher credit rating.
Summary
Although both companies may operate in a similar industry and have similar
profits after tax, they would represent very different purchases. Merlot’s sales
revenues are over 70% more than those of Grappa, it is financed by high levels of
debt, it rents rather than owns property and it chooses to lease rather than buy its
replacement plant. Also its remaining owned plant is nearing the end of its life.
Its replacement will either require a cash injection if it is to be purchased
(Merlot’s overdraft of $1·2 million already requires serious attention) or create
even higher levels of gearing if it continues its policy of leasing. In short although
Merlot’s overall return seems more attractive than that of Grappa, it would
represent a much more risky investment. Ultimately the investment decision may
be determined by Victular’s attitude to risk, possible synergies with its existing
business activities, and not least, by the asking price for each investment (which
has not been disclosed to us).
(c)
The generally recognised potential problems of using ratios for comparison
purposes are:
–
inconsistent definitions of ratios
–
financial statements may have been deliberately manipulated (creative
accounting)
–
different companies may adopt different accounting policies (e.g. use of
historical costs compared to current values)
–
different managerial policies (e.g. different companies offer customers
different payment terms)
–
statement of financial position figures may not be representative of average
values throughout the year (this can be caused by seasonal trading or a
large acquisition of non-current assets near the year end)
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Paper F7: Financial Reporting (International)
–
the impact of price changes over time/distortion caused by inflation
When deciding whether to purchase a company, Victular should consider the
following additional useful information:
89
–
in this case the analysis has been made on the draft financial statements;
these may be unreliable or change when being finalised. Audited financial
statements would add credibility and reliance to the analysis (assuming
they receive an unmodified Auditors’ Report).
–
forward looking information such as profit and financial position forecasts,
capital expenditure and cash budgets and the level of orders on the books.
–
the current (fair) values of assets being acquired.
–
the level of risk within a business. Highly profitable companies may also be
highly risky, whereas a less profitable company may have more stable
‘quality’ earnings
–
not least would be the expected price to acquire a company. It may be that
a poorer performing business may be a more attractive purchase because it
is relatively cheaper and may offer more opportunity for improving
efficiencies and profit growth.
Hardy
Note: references to 2009 and 2010 should be taken as being to the years ended 30
September 2009 and 2010 respectively.
Profitability:
Income statement performance:
Hardy’s income statement results dramatically show the effects of the downturn in the
global economy; revenues are down by 18% (6,500/36,000 x 100), gross profit has fallen
by 60% and a healthy after tax profit of $3·5 million has reversed to a loss of $2·1
million. These are reflected in the profit (loss) margin ratios shown in the appendix (the
‘as reported’ figures for 2010). This in turn has led to a 15·2% return on equity being
reversed to a negative return of 11·9%. However, a closer analysis shows that the
results are not quite as bad as they seem. The downturn has directly caused several
additional costs in 2010: employee severance, property impairments and losses on
investments (as quantified in the appendix). These are probably all non-recurring costs
and could therefore justifiably be excluded from the 2010 results to assess the
company’s ‘underlying’ performance. If this is done the results of Hardy for 2010
appear to be much better than on first sight, although still not as good as those
reported for 2009. A gross margin of 27·8% in 2009 has fallen to only 23·1% (rather than
the reported margin of 13·6%) and the profit for period has fallen from $3·5 million
(9·7%) to only $2·3 million (7·8%). It should also be noted that as well as the fall in the
value of the investments, the related investment income has also shown a sharp decline
which has contributed to lower profits in 2010.
Given the economic climate in 2010 these are probably reasonably good results and
may justify the Chairman’s comments. It should be noted that the cost saving measures
which have helped to mitigate the impact of the downturn could have some
unwelcome effects should trading conditions improve; it may not be easy to re-hire
employees and a lack of advertising may cause a loss of market share.
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Section 2: Answers to practice questions
Statement of financial position:
Perhaps the most obvious aspect of the statement of financial position is the fall in
value ($8·5 million) of the non-current assets, most of which is accounted for by losses
of $6 million and $1·6 million respectively on the properties and investments.
Ironically, because these falls are reflected in equity, this has mitigated the fall in the
return of the equity (from 15·2% to 13·1% underlying) and contributed to a perhaps
unexpected improvement in asset turnover from 1·6 times to 1·7 times.
Liquidity:
Despite the downturn, Hardy’s liquidity ratios now seem at acceptable levels (though
they should be compared to manufacturing industry norms) compared to the low
ratios in 2009. The bank balance has improved by $1·1 million. This has been helped by
a successful rights issue (this is in itself a sign of shareholder support and confidence in
the future) raising $2 million and keeping customer’s credit period under control. Some
of the proceeds of the rights issue appear to have been used to reduce the bank loan
which is sensible as its financing costs have increased considerably in 2010. Looking at
the movement on retained earnings (6,500 – 2,100 – 3,600) it can be seen that the
company paid a dividend of $800,000 during 2010. Although this is only half the
dividend per share paid in 2009, it may seem unwise given the losses and the need for
the rights issue. A counter view is that the payment of the dividend may be seen as a
sign of confidence of a future recovery. It should also be mentioned that the worst of
the costs caused by the downturn (specifically the property and investments losses) are
not cash costs and have therefore not affected liquidity.
The increase in the inventory and work-in-progress holding period and the trade
receivables collection period being almost unchanged appear to contradict the
declining sales activity and should be investigated. Although there is insufficient
information to calculate the trade payables credit period as there is no analysis of the
cost of sales figures, it appears that Hardy has received extended credit which, unless it
had been agreed with the suppliers, has the potential to lead to problems obtaining
future supplies of goods on credit.
Gearing:
On the reported figures debt to equity shows a modest increase due to income
statement losses and the reduction of the revaluation reserve, but this has been
mitigated by the repayment of part of the loan and the rights issue.
Conclusion:
Although Hardy’s results have been adversely affected by the global economic
situation, its underlying performance is not as bad as first impressions might suggest
and supports the Chairman’s comments. The company still retains a relatively strong
statement of financial position and liquidity position which will help significantly
should market conditions improve. Indeed the impairment of property and
investments may well reverse in future. It would be a useful exercise to compare
Hardy’s performance during this difficult time to that of its competitors – it may well
be that its 2010 results were relatively very good by comparison.
Appendix:
An important aspect of assessing the performance of Hardy for 2010 (especially in
comparison with 2009) is to identify the impact that several ‘one off’ charges have had
on the results of 2010. These charges are $1·3 million redundancy costs and a $1·5
million (6,000 – 4,500 previous surplus) property impairment, both included in cost of
sales and a $1·6 million loss on the market value of investments, included in
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Paper F7: Financial Reporting (International)
administrative expenses. Thus in calculating the ‘underlying’ figures for 2010 (below)
the adjusted cost of sales is $22·7 million (25,500 – 1,300 – 1,500) and the administrative
expenses are $3·3 million (4,900 – 1,600). These adjustments feed through to give an
underlying gross profit of $6·8 million (4,000 + 1,300 + 1,500) and an underlying profit
for the year of $2·3 million (–2,100 + 1,300 + 1,500 + 1,600).
Note: it is not appropriate to revise Hardy’s equity (upwards) for the one-off losses
when calculating equity based underlying figures, as the losses will be a continuing
part of equity (unless they reverse) even if/when future earnings recover.
Gross profit % (6,800/29,500 x 100)
2010
underlying
as reported
23·1%
13·6%
Profit (loss) for period % (2,300/29,500 x 100) 7·8%
2009
27·8%
(7·1)%
9·7%
13·1%
(11·9)%
15·2%
Net asset (taken as equity) turnover
(29,500/17,600)
1·7 times same
1·6 times
Return on equity (2,300/17,600 x 100)
Debt to equity (4,000/17,600)
22·7%
same
21·7%
Current ratio (6,200:3,400)
1·8:1
same
1·0:1
Quick ratio (4,000:3,400)
1·2:1
same
0·6:1
Receivables collection (in days)
(2,200/29,500 x 365)
27 days
same
28 days
Inventory and work-in-progress holding
period (2,200/22,700 x 365)
35 days
31 days
27 days
Note: the figures for the calculation of the 2010 ‘underlying’ ratios have been given;
those of 2010 ‘as reported’ and 2009 are based on equivalent figures from the
summarised financial statements provided.
Alternative ratios/calculations are acceptable, for example net asset turnover could be
calculated using total assets less current liabilities.
328
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SECTION 3
Paper F7 (INT)
Financial Reporting
Q&A
Mock exam questions
This mock exam is the pilot paper produced for the new syllabus and is © The Association of Chartered Certified
Accountants.
ALL FIVE questions are compulsory and MUST be attempted
1
On 1 October 2011 Pumice acquired the following non-current investments:
„
80% of the equity share capital of Silverton at a cost of $13.6 million
„
50% of Silverton’s 10% loan notes at par
„
1.6 million equity shares in Amok at a cost of $6.25 each.
The summarised draft statements of financial position of the three companies at 31
March 2012 are:
Non-current assets
Property, plant and equipment
Investments
Current assets
Total assets
Equity and liabilities
Equity
Equity shares of $1 each
Retained earnings
Non-current liabilities
8% loan note
10% loan note
Current liabilities
Total equity and liabilities
© Emile Woolf Publishing Limited
Pumice
$000
Silverton
$000
Amok
$000
20,000
26,000
‒‒‒‒‒‒‒
46,000
15,000
‒‒‒‒‒‒‒
61,000
‒‒‒‒‒‒‒
8,500
nil
‒‒‒‒‒‒‒
8,500
8,000
‒‒‒‒‒‒‒
16,500
‒‒‒‒‒‒‒
16,500
1,500
‒‒‒‒‒‒‒
18,000
11,000
‒‒‒‒‒‒‒
29,000
‒‒‒‒‒‒‒
10,000
37,000
‒‒‒‒‒‒‒
47,000
3,000
8,000
‒‒‒‒‒‒‒
11,000
4,000
20,000
‒‒‒‒‒‒‒
24,000
4,000
nil
10,000
‒‒‒‒‒‒‒
61,000
‒‒‒‒‒‒‒
nil
2,000
3,500
‒‒‒‒‒‒‒
16,500
‒‒‒‒‒‒‒
Nil
Nil
5,000
‒‒‒‒‒‒‒
29,000
‒‒‒‒‒‒‒
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Paper F7: Financial Reporting (International)
The following information is relevant:
(i)
The fair values of Silverton’s assets were equal to their carrying amounts with the
exception of land and plant. Silverton’s land had a fair value of $400,000 in excess
of its carrying amount and plant had a fair value of $1.6 million in excess of its
carrying amount. The plant had a remaining life of four years (straight-line
depreciation) at the date of acquisition.
(ii)
In the post acquisition period Pumice sold goods to Silverton at a price of $6
million. These goods had cost Pumice $4 million. Half of these goods were still in
the inventory of Silverton at 31 March 2012. Silverton had a balance of $1.5
million owing to Pumice at 31 March 2012 which agreed with Pumice’s records.
(iii)
The net profit after tax for the year ended 31 March 2012 was $2 million for
Silverton and $8 million for Amok. Assume profits accrued evenly throughout
the year.
(iv)
An impairment test at 31 March 2012 concluded that consolidated goodwill was
impaired by $400,000 and the investment in Amok was impaired by $200,000.
(v)
No dividends were paid during the year by any of the companies.
Required:
(a)
Discuss how the investments purchased by Pumice on 1 October 2011 should be
treated in its consolidated financial statements.
(5 marks)
(b)
Prepare the consolidated statement of financial position for Pumice as at 31
(20 marks)
March 2012.
(Total: 25 marks)
2
The following trial balance relates to Kala, a publicly listed company, at 31 March 2012:
Land and buildings at cost (note (i))
Plant – at cost (note (i))
Investment properties
– valuation at 1 April 2011 (note (i))
Purchases
Operating expenses
Loan interest paid
Rental of leased plant (note (ii))
Dividends paid
Inventory at 1 April 2011
Trade receivables
Revenue
Income from investment property
Equity shares of $1 each fully paid
Retained earnings at 1 April 2011
8% (actual and effective) loan note (note (iii))
Accumulated depreciation at 1 April 2011 – buildings
– plant
330
$000
270,000
156,000
$000
90,000
78,200
15,500
2,000
22,000
15,000
37,800
53,200
278,400
4,500
150,000
119,500
50,000
60,000
26,000
© Emile Woolf Publishing Limited
Section 3: Mock exam questions
$000
Trade payables
Deferred tax
Bank
The following notes are relevant:
(i)
$000
33,400
12,500
5,400
‒‒‒‒‒‒‒‒
739,700
‒‒‒‒‒‒‒‒
‒‒‒‒‒‒‒‒
739,700
‒‒‒‒‒‒‒‒
The land and buildings were purchased on 1 April 1990. The cost of the land was
$70 million. No land and buildings have been purchased by Kala since that date.
On 1 April 2011 Kala had its land and buildings professionally valued at $80
million and $175 million respectively. The directors wish to incorporate these
values into the financial statements. The estimated life of the buildings was
originally 50 years and the remaining life has not changed as a result of the
valuation.
Later, the valuers informed Kala that investment properties of the type Kala
owned had increased in value by 7% in the year to 31 March 2012.
Plant, other than leased plant (see below), is depreciated at 15% per annum using
the reducing balance method. Depreciation of buildings and plant is charged to
cost of sales.
(ii)
On 1 April 2011 Kala entered into a lease for an item of plant which had an
estimated life of five years. The lease period is also five years with annual rentals
of $22 million payable in advance from 1 April 2011. The plant is expected to
have a nil residual value at the end of its life. If purchased this plant would have
a cost of $92 million and be depreciated on a straight-line basis. The lessor
includes a finance cost of 10% per annum when calculating annual rentals. (Note:
you are not required to calculate the present value of the minimum lease
payments.)
(iii)
The loan note was issued on 1 July 2011 with interest payable six monthly in
arrears.
(iv)
The provision for income tax for the year to 31 March 2012 has been estimated at
$28.3 million. The deferred tax provision at 31 March 2012 is to be adjusted to a
credit balance of $14.1 million.
(v)
The inventory at 31 March 2012 was valued at $43.2 million.
Required:
Prepare for Kala:
(a)
An income statement for the year ended 31 March 2012.
(b)
A statement of changes in equity for the year ended 31 March 2012.
(c)
A statement of financial position as at 31 March 2012.
(10 marks)
(4 marks)
(11 marks)
(Total: 25 marks)
3
Reactive is a publicly listed company that assembles domestic electrical goods which it
then sells to both wholesale and retail customers. Reactive’s management were
disappointed in the company’s results for the year ended 31 March 2011. In an attempt
to improve performance the following measures were taken early in the year ended 31
March 2012:
© Emile Woolf Publishing Limited
331
Paper F7: Financial Reporting (International)
„
a national advertising campaign was undertaken,
„
rebates to all wholesale customers purchasing goods above set quantity levels
were introduced,
„
the assembly of certain lines ceased and was replaced by bought in completed
products. This allowed Reactive to dispose of surplus plant.
„
Reactive’s summarised financial statements for the year ended 31 March 2012 are
set out below:
Income statement
Revenue (25% cash sales)
Cost of sales
Gross profit
Operating expenses
Profit on disposal of plant (note (i))
Finance charges
Profit before tax
Income tax expense
Profit for the period
Statement of financial position
$ million
4,000
(3,450)
‒‒‒‒‒‒‒
550
(370)
‒‒‒‒‒‒‒
180
40
(20)
‒‒‒‒‒‒‒
200
(50)
‒‒‒‒‒‒‒
150
‒‒‒‒‒‒‒
$ million
Non-current assets
Property, plant and equipment (note (i))
Current assets
Inventory
Trade receivables
Bank
550
250
360
nil
‒‒‒‒‒‒‒
Total assets
Equity and liabilities
Equity shares of 25 cents each
Retained earnings
Non-current liabilities
8% loan notes
Current liabilities
Bank overdraft
Trade payables
Current tax payable
Total equity and liabilities
332
$ million
610
‒‒‒‒‒‒‒
1,160
‒‒‒‒‒‒‒
100
380
‒‒‒‒‒‒‒
480
200
10
430
40
‒‒‒‒‒‒‒
480
‒‒‒‒‒‒‒
1,160
‒‒‒‒‒‒‒
© Emile Woolf Publishing Limited
Section 3: Mock exam questions
Below are ratios calculated for the year ended 31 March 2011.
Return on year end capital employed
(profit before interest and tax over total assets less current liabilities)
28.1%
Net asset (equal to capital employed) turnover
4 times
Gross profit margin
17%
Net profit (before tax) margin
6.3%
Current ratio
1.6:1
Closing inventory holding period
46 days
Trade receivables’ collection period
45 days
Trade payables’ payment period
55 days
Dividend yield
3.75%
Dividend cover
2 times
Notes:
(i)
Reactive received $120 million from the sale of plant that had a carrying
amount of $80 million at the date of its sale.
(ii)
the market price of Reactive’s shares throughout the year averaged $3.75
each.
(iii)
there were no issues or redemption of shares or loans during the year.
(iv)
dividends paid during the year ended 31 March 2012 amounted to $90
million, maintaining the same dividend paid in the year ended 31 March
2011.
Required:
(a)
Calculate ratios for the year ended 31 March 2012 (showing your workings)
for Reactive, equivalent to those provided above.
(10 marks)
(b)
Analyse the financial performance and position of Reactive for the year
ended 31 March 2012 compared to the previous year.
(10 marks)
(c)
Explain in what ways your approach to performance appraisal would
differ if you were asked to assess the performance of a not-for-profit
organisation.
(5 marks)
(Total: 25 marks)
4
(a)
Chapter 3 of the IASB’s Conceptual Framework states that in order to be useful
for decision making purposes information must have certain characteristics. It
goes on to describe both fundamental and enhancing qualitative characteristics of
financial information.
Fundamental qualitative characteristics are relevance and faithful representation.
Enhancing qualitative characteristics include comparability.
Required:
Explain what is meant by relevance, faithful representation and comparability
and how they make financial information useful.
(9 marks)
© Emile Woolf Publishing Limited
333
Paper F7: Financial reporting (International)
(b)
During the year ended 31 March 2012, Porto experienced the following
transactions or events:
(i)
entered into a finance lease to rent an asset for substantially the whole of its
useful economic life.
(ii)
a decision was made by the Board to change the company’s accounting
policy from one of expensing the finance costs on building new retail
outlets to one of capitalising such costs.
(iii)
the company’s income statement prepared using historical costs showed a
loss from operating its hotels, but the company is aware that the increase in
the value of its properties during the period far outweighed the operating
loss.
Required:
Explain how you would treat the items in (i) to (iii) above in Porto’s financial
statements and indicate on which of the Framework’s qualitative characteristics
your treatment is based.
(6 marks)
(Total: 15 marks)
5
(a)
IAS 11 Construction contracts deals with accounting requirements for construction
contracts whose durations usually span at least two accounting periods.
Required:
Describe the issues of revenue and profit recognition relating to construction
(4 marks)
contracts.
(b)
Beetie is a construction company that prepares its financial statements to 31
March each year. During the year ended 31 March 2012 the company commenced
two construction contracts that are expected to take more than one year to
complete. The position of each contract at 31 March 2012 is as follows:
Contract
1
2
$’000
$’000
Agreed contract price
5,500
1,200
Estimated total cost of contract at commencement
4,000
900
Estimated total cost at 31 March 2012
4,000
1,250
Agreed value of work completed at 31 March 2012
3,300
840
Progress billings invoiced and received at 31 March 2012
3,000
880
Contract costs incurred to 31 March 2012
3,900
720
The agreed value of the work completed at 31 March 2012 is considered to be
equal to the revenue earned in the year ended 31 March 2012. The percentage of
completion is calculated as the agreed value of work completed to the agreed
contract price.
Required:
Calculate the amounts which should appear in the income statement and
statement of financial position of Beetie at 31 March 2012 in respect of the above
contracts.
(6 marks)
(Total: 10 marks)
334
© Emile Woolf Publishing Limited
SECTION 4
Paper F7 (INT)
Financial Reporting
Q&A
Answers to mock exam
questions
1
(a)
As the investment in shares represents 80% of Silverton’s equity, it is likely to
give Pumice control of that company. Control is the ability to direct the operating
and financial policies of an entity. This would make Silverton a subsidiary of
Pumice and require Pumice to prepare group financial statements which would
require the consolidation of the results of Silverton from the date of acquisition (1
October 2011). Consolidated financial statements are prepared on the basis that
the group is a single economic entity.
The investment of 50% ($1 million) of the 10% loan note in Silverton is effectively
a loan from a parent to a subsidiary. On consolidation Pumice’s asset of the loan
($1 million) is cancelled out with $1 million of Silverton’s total loan note liability
of $2 million. This would leave a net liability of $1 million in the consolidated
statement of financial position.
The investment in Amok of 1.6 million shares represents 40% of that company’s
equity shares. This is generally regarded as not being sufficient to give Pumice
control of Amok, but is likely to give it significant influence over Amok’s policy
decisions (e.g. determining the level of dividends paid by Amok). Such
investments are generally classified as associates and IAS 28 Investments in
associates requires the investment to be included in the consolidated financial
statements using equity accounting.
(b)
Consolidated statement of financial position of Pumice at 31 March 2012
$000
$000
Non-current assets:
Plant, property and equipment (w (i))
30,300
Goodwill (4,000 (w (ii)) – 400 impairment)
3,600
Investments – associate (w (iii))
11,400
– other ((26,000 – 13,600 – 10,000
– 1,000 intra-group loan note))
1,400
‒‒‒‒‒‒
46,700
© Emile Woolf Publishing Limited
335
Paper F7: Financial Reporting (International)
Current assets
(15,000 + 8,000 - 1,000 (w (iv)) – 1,500 current account)
20,500
‒‒‒‒‒‒
67,200
‒‒‒‒‒‒
Total assets
Equity and liabilities
Equity attributable to equity holders of the parent
Equity shares of $1 each
Reserves:
Retained earnings (w (v))
Non controlling interest (w (vi)) 2,560
Total equity 50,200
Non-current liabilities
8% Loan note
10% Loan note (2,000 – 1,000 intra-group)
10,000
37,640
‒‒‒‒‒‒
47,640
4,000
1,000
‒‒‒‒‒‒
Current liabilities
(10,000 + 3,500 – 1,500 current account)
12,000
‒‒‒‒‒‒
67,200
‒‒‒‒‒‒
Workings in $’000
(i)
Property, plant and equipment
Pumice
Silverton
Fair value – land
– plant
5,000
20,000
8,500
400
1,600
‒‒‒‒‒‒
Additional depreciation (see below)
2,000
(200)
‒‒‒‒‒‒
30,300
‒‒‒‒‒‒
The fair value adjustment to plant will create additional
depreciation of $400,000 per annum (1,600/4 years) and in the
post acquisition period of six months this will be $200,000.
(ii)
Goodwill in Silverton:
Investment at cost
Less – equity shares of Silverton (3,000 × 80%)
(2,400)
– pre-acquisition reserves(7,000 × 80% (see below)) (5,600)
– fair value adjustments (2,000 (w (i)) × 80%)
(1,600)
Goodwill on consolidation
The pre-acquisition reserves are:
At 31 March 2012
Post acquisition (2,000 × 6/12)
336
13,600
(9,600)
‒‒‒‒‒‒
4,000
‒‒‒‒‒‒
8,000
(1,000)
‒‒‒‒‒‒
7,000
‒‒‒‒‒‒
© Emile Woolf Publishing Limited
Section 4: Answers to mock exam questions
(iii)
Carrying amount of Amok at 31 March 2012
Cost (1,600 × $6.25)
Share post acquisition profit (8,000 × 6/12 × 40%)
10,000
1,600
‒‒‒‒‒‒
11,600
(200)
‒‒‒‒‒‒
11,400
‒‒‒‒‒‒
Impairment loss per question
(iv)
The unrealised profit (URP) in inventory is calculated as:
Intra-group sales are $6 million of which Pumice made a profit
of $2 million. Half of these are still in inventory, thus there is
an unrealised profit of $1 million.
(v)
Consolidated reserves:
Pumice’s reserves
Silverton’s post acquisition
(((2,000 × 6/12) - 200 depreciation) × 80%)
Amok’s post acquisition profits (8,000 × 6/12 × 40%)
URP in inventory (see (iv))
Impairment of goodwill – Silverton
– Amok
(vi)
2
(a)
Non controlling interest
Equity shares of Silverton (3,000 × 20%)
Retained earnings ((8,000 – 200 depreciation) × 20%)
Fair value adjustments (2,000 × 20%)
37,000
640
1,600
(1,000)
(400)
(200)
‒‒‒‒‒‒
37,640
‒‒‒‒‒‒
600
1,560
400
‒‒‒‒‒‒
2,560
‒‒‒‒‒‒
Kala – Income statement – Year ended 31 March 2012
$000
Revenue
Cost of sales (w (i))
Gross profit
Operating expenses
Investment income – property rental
– valuation gain (90,000 × 7%)
Finance costs – loan (w (ii))
– lease (w (iii))
Profit before tax
Income tax expense (28,300 + (14,100 – 12,500))
Profit for the period
© Emile Woolf Publishing Limited
4,500
6,300
‒‒‒‒‒‒‒
(3,000)
(7,000)
‒‒‒‒‒‒‒
$000
278,400
(115,700)
‒‒‒‒‒‒‒
162,700
(15,500)
‒‒‒‒‒‒‒
147,200
‒‒‒‒‒‒‒
10,800
(10,000)
‒‒‒‒‒‒‒
148,000
(29,900)
‒‒‒‒‒‒‒
118,100
‒‒‒‒‒‒‒
337
Paper F7: Financial Reporting (International)
(b)
Kala – Statement of changes in equity – Year ended 31 March 2012
Equity
shares
At 1 April 2011
Revaluation
reserve
Equity dividends paid
At 31 March 2012
(c)
$000
$000
$000
150,000
nil
119,500
269,500
118,100
118,100
45,000
‒‒‒‒‒‒‒
150,000
‒‒‒‒‒‒‒
45,000
(15,000)
‒‒‒‒‒‒‒‒
222,600
‒‒‒‒‒‒‒‒
‒‒‒‒‒‒‒
45,000
‒‒‒‒‒‒‒
(15,000)
‒‒‒‒‒‒‒‒
417,600
‒‒‒‒‒‒‒‒
Kala – Statement of financial position as at 31 March 2012
Non-current assets
Property, plant and equipment (w (iv))
Investment property (90,000 + 6,300)
Current assets
Inventory
Trade receivables
$’000
43,200
53,200
‒‒‒‒‒‒‒
Total assets
Equity and liabilities
Equity (see (b) above)
Equity shares of $1 each
Reserves:
Revaluation
Retained earnings
Non-current liabilities
8% loan note
Deferred tax
Lease obligation (w (iii))
Current liabilities
Trade payables
Accrued loan interest (w (ii))
Bank overdraft
Lease obligation (w (iii)) – accrued interest
– capital
Current tax payable
Total equity and liabilities
338
Total
$000
Profit for period (see (a))
Revaluation of property (w (iv))
Retained
earnings
$’000
434,100
96,300
‒‒‒‒‒‒‒
530,400
96,400
‒‒‒‒‒‒‒
626,800
‒‒‒‒‒‒‒
150,000
45,000
222,600
‒‒‒‒‒‒‒
50,000
14,100
55,000
33,400
1,000
5,400
7,000
15,000
28,300
‒‒‒‒‒‒‒
267,600
‒‒‒‒‒‒‒
417,600
119,100
‒‒‒‒‒‒‒
90,100
‒‒‒‒‒‒‒‒
626,800
‒‒‒‒‒‒‒‒
© Emile Woolf Publishing Limited
Section 4: Answers to mock exam questions
Workings in brackets in $’000
(i)
Cost of sales:
Opening inventory
Purchases
Depreciation (w (iv)) – buildings
– plant: owned
– plant: leased
Closing inventory
(ii)
(iii)
37,800
78,200
5,000
19,500
18,400
(43,200)
‒‒‒‒‒‒‒
115,700
‒‒‒‒‒‒‒
The loan has been in issue for nine months. The total finance cost for this
period will be $3 million (50,000 x 8% x 9/12). Kala has paid six months
interest of $2 million, thus accrued interest of $1 million should be
provided for.
Finance lease:
$000
Net obligation at inception of lease (92,000 – 22,000)
70,000
Accrued interest 10% (current liability)
7,000
Total outstanding at 31 March 2012
77,000
The second payment in the year to 31 March 2007 (made on 1 April 2012) of
$22 million will be $7 million for the accrued interest (at 31 March 2012)
and $15 million paid of the capital outstanding. Thus the amount
outstanding as an obligation over one year is $55 million (77,000 – 22,000).
(iv)
Non-current assets/depreciation:
Land and buildings:
At the date of the revaluation the land and buildings have a carrying
amount of $210 million (270,000 – 60,000). With a valuation of $255 million
this gives a revaluation surplus (to reserves) of $45 million. The
accumulated depreciation of $60 million represents 15 years at $4 million
per annum (200,000/50 years) and means the remaining life at the date of
the revaluation is 35 years. The amount of the revalued building is $175
million, thus depreciation for the year to 31 March 2012 will be $5 million
(175,000/35 years). The carrying amount of the land and buildings at 31
March 2012 is $250 million (255,000 – 5,000).
Plant: owned
The carrying amount prior to the current year’s depreciation is $130 million
(156,000 – 26,000). Depreciation at 15% on the reducing balance basis gives
an annual charge of $19.5 million. This gives a carrying amount at 31 March
2012 of $110.5 million (130,000 – 19,500).
Plant: leased
The fair value of the leased plant is $92 million. Depreciation on a straightline basis over five years would give a depreciation charge of $18.4 million
and a carrying amount of $73.6 million.
© Emile Woolf Publishing Limited
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Paper F7: Financial Reporting (International)
Summarising the carrying amounts:
Land and buildings
Plant (110,500 + 73,600)
Property, plant and equipment
3
(a)
250,000
184,100
‒‒‒‒‒‒‒‒
434,100
‒‒‒‒‒‒‒‒
Note: figures in the calculations are in $million
Return on year end capital employed
32.3 %
220/(1,160 – 480) × 100
Net asset turnover
5.9 times
4,000/680
Gross profit margin
13.8 %
(550/4,000) × 100
Net profit (before tax) margin
5.0 %
(200/4,000) × 100
Current ratio
1.3 :1
610:480
Closing inventory holding period
26 days
250/3,450 × 365
Trade receivables’ collection period
44 days
360/(4,000 – 1,000) × 365
Trade payables’ payment period
(based on cost of sales)
45 days
(430/3,450) × 365
Dividend yield
6.0%
(see below)
Dividend cover
1.67 times
150/90
The dividend per share is 22.5 cents (90,000/(100,000 × 4 i.e. 25 cents shares). This
is a yield of 6.0% on a share price of $3.75.
(b)
Analysis of the comparative financial performance and position of Reactive for
the year ended 31 March 2012
Profitability
The measures taken by management appear to have been successful as the
overall ROCE (considered as a primary measure of performance) has improved
by 15% (32.3 -28.1)/28.1). Looking in more detail at the composition of the ROCE,
the reason for the improved profitability is due to increased efficiency in the use
of the company’s assets (asset turnover), increasing from 4 to 5.9 times (an
improvement of 48%). The improvement in the asset turnover has been offset by
lower profit margins at both the gross and net level. On the surface, this
performance appears to be due both to the company’s strategy of offering rebates
to wholesale customers if they achieve a set level of orders and also the beneficial
impact on sales revenue of the advertising campaign. The rebate would explain
the lower gross profit margin, and the cost of the advertising has reduced the net
profit margin (presumably management expected an increase in sales volume as
a compensating factor). The decision to buy complete products rather than
assemble them in house has enabled the disposal of some plant which has
reduced the asset base. Thus possible increased sales and a lower asset base are
the cause of the improvement in the asset turnover which in turn, as stated
above, is responsible for the improvement in the ROCE.
The effect of the disposal needs careful consideration. The profit (before tax)
includes a profit of $40 million from the disposal. As this is a ‘one-off’ profit,
recalculating the ROCE without its inclusion gives a figure of only 23.7%
340
© Emile Woolf Publishing Limited
Section 4: Answers to mock exam questions
(180m/(1,160 - 480m + 80m (the 80m is the carrying amount of plant)) and the fall
in the net profit percentage (before tax) would be down even more to only 4.0%
(160m/4,000m). On this basis the current year performance is worse than that of
the previous year and the reported figures tend to flatter the company’s
underlying performance.
Liquidity
The company’s liquidity position has deteriorated during the period. An
acceptable current ratio of 1.6 has fallen to a worrying 1.3 (1.5 is usually
considered as a safe minimum). With the trade receivables period at virtually a
constant (45/44 days), the change in liquidity appears to be due to the levels of
inventory and trade payables. These give a contradictory picture. The closing
inventory holding period has decreased markedly (from 46 to 26 days) indicating
more efficient inventory holding. This is perhaps due to short lead times when
ordering bought in products. The change in this ratio has reduced the current
ratio, however the trade payables payment period has decreased from 55 to 45
days which has increased the current ratio. This may be due to different terms
offered by suppliers of bought in products.
Importantly, the effect of the plant disposal has generated a cash inflow of $120
million, and without this the company’s liquidity would look far worse.
Investment ratios
The current year’s dividend yield of 6.0% looks impressive when compared with
that of the previous year’s yield of 3.75%, but as the company has maintained the
same dividend (and dividend per share as there is no change in share capital) ,
the ‘improvement’ in the yield is due to a falling share price. Last year the share
price must have been $6.00 to give a yield of 3.75% on a dividend per share of
22.5 cents. It is worth noting that maintaining the dividend at $90 million from
profits of $150 million gives a cover of only 1.67 times whereas on the same
dividend last year the cover was 2 times (meaning last year’s profit (after tax)
was $180 million).
Conclusion
Although superficially the company’s profitability seems to have improved as a
result of the directors’ actions at the start of the current year, much, if not all, of
the apparent improvement is due to the change in supply policy and the
consequent beneficial effects of the disposal of plant. The company’s liquidity is
now below acceptable levels and would have been even worse had the disposal
not occurred. It appears that investors have understood the underlying
deterioration in performance as there has been a marked fall in the company’s
share price.
(c)
It is generally assumed that the objective of stock market listed companies is to
maximise the wealth of their shareholders. This in turn places an emphasis on
profitability and other factors that influence a company’s share price. It is true
that some companies have other (secondary) aims such as only engaging in
ethical activities (e.g. not producing armaments) or have strong environmental
considerations. Clearly by definition not-for-profit organisations are not
motivated by the need to produce profits for shareholders, but that does not
mean that they should be inefficient. Many areas of assessment of profit oriented
companies are perfectly valid for not-for-profit organisations; efficient inventory
© Emile Woolf Publishing Limited
341
Paper F7: Financial Reporting (International)
holdings, tight budgetary constraints, use of key performance indicators,
prevention of fraud etc.
There are a great variety of not-for-profit organisations; e.g. public sector health,
education, policing and charities. It is difficult to be specific about how to assess
the performance of a not-for-profit organisation without knowing what type of
organisation it is. In general terms an assessment of performance must be made
in the light of the stated objectives of the organisation. Thus for example in a
public health service one could look at measures such as treatment waiting times,
increasing life expectancy etc, and although such organisations don’t have a
profit motive requiring efficient operation, they should nonetheless be
accountable for the resources they use. Techniques such as ‘value for money’ and
the three Es (economy, efficiency and effectiveness) have been developed and can
help to assess the performance of such organisations.
4
(a)
Relevance
Information must be relevant to the decision-making needs of users. Information
is relevant if it can be used for predictive and/or confirmatory purposes.
•
It has predictive value if it helps users to predict what might happen in the
future.
•
It has confirmatory value if it helps users to confirm the assessments and
predictions they have made in the past.
The relevance of information is affected by its materiality.
•
Information is material if omitting it or misstating it could influence
decisions that users make on the basis of financial information about a
specific reporting entity.
•
Materiality is an entity-specific aspect of relevance based on the nature or
magnitude (or both) of the items to which the information relates in the
context of an individual entity’s financial report.
Therefore, it is not possible for the IASB to specify a uniform quantitative
threshold for materiality or predetermine what could be material in a particular
situation.
Faithful representation
Financial reports represent economic phenomena (economic resources, claims
against the reporting entity and the effects of transactions and other events and
conditions that change those resources and claims) by depicting them in words
and numbers.
To be useful, financial information must not only represent relevant phenomena,
but it must also faithfully represent the phenomena that it purports to represent.
A perfectly faithful representation would have three characteristics. It would be:
342
•
complete – the depiction includes all information necessary for a user to
understand the phenomenon being depicted, including all necessary
descriptions and explanations.
•
neutral – the depiction is without bias in the selection or presentation of
financial information; and
© Emile Woolf Publishing Limited
Section 4: Answers to mock exam questions
•
free from error – where there are no errors or omissions in the description
of the phenomenon, and the process used to produce the reported
information has been selected and applied with no errors in the process.
Comparability is the qualitative characteristic that enables users to identify and
understand similarities in, and differences among, items
Information about a reporting entity is more useful if it can be compared with
similar information about other entities and with similar information about the
same entity for another period or another date.
Consistency is related to comparability but is not the same. Consistency refers to
the use of the same methods for the same items, either from period to period
within a reporting entity or in a single period across entities. Consistency helps to
achieve the goal of comparability.
(b)
(i)
This item involves the characteristic of faithful representation, specifically
reporting the substance of transactions. As the lease agreement is for
substantially the whole of the asset’s useful economic life, Porto will
experience the same risks and rewards as if it owned the asset. Although
the legal form of this transaction is a rental, its substance is the equivalent
to acquiring the asset and raising a loan. Thus, in order for the financial
statements to be provide a faithful representation (and comparable to
those where an asset is bought from the proceeds of a loan), the transaction
should be shown as an asset on Porto’s statement of financial position with
a corresponding liability for the future lease rental payments. The income
statement should be charged with depreciation on the asset and a finance
charge on the ‘loan’.
(ii)
This item involves the characteristic of comparability. Changes in
accounting policies should generally be avoided in order to preserve
comparability. Presumably the directors have good reason to be believe the
new policy presents a more reliable and relevant view. In order to minimise
the adverse effect a change in accounting policy has on comparability, the
financial statements (including the corresponding amounts) should be
prepared on the basis that the new policy had always been in place
(retrospective application). Thus the assets (retail outlets) should include
the previously expensed finance costs and income statements will no
longer show a finance cost (in relation to these assets whilst under
construction). Any finance costs relating to periods prior to the policy
change (i.e. for two or more years ago) should be adjusted for by increasing
retained earnings brought forward in the statement of changes in equity.
(iii)
This item involves the characteristic of relevance. This situation questions
whether historical cost accounting is more relevant to users than current
value information. Porto’s current method of reporting these events using
purely historical cost based information (i.e. showing an operating loss, but
not reporting the increases in property values) is perfectly acceptable.
However, the company could choose to revalue its hotel properties (which
would subject it to other requirements). This option would still report an
operating loss (probably an even larger loss than under historical cost if
there are increased depreciation charges on the hotels), but the increases in
value would also be reported (in equity) arguably giving a more complete
picture of performance.
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Paper F7: Financial Reporting (International)
5
(a)
The correct timing of when revenue (and profit) should be recognised is an
important aspect of an income statement showing a faithful presentation. It is
generally accepted that only realised profits should be included in the income
statement. For most types of supply and sale of goods it is generally understood
that a profit is realised when the goods have been manufactured (or obtained) by
the supplier and satisfactorily delivered to the customer. The issue with
construction contracts is that the process of completing the project takes a
relatively long time and, in particular, will spread across at least one accounting
period-end. If such contracts are treated like most sales of goods, it would mean
that revenue and profit would not be recognised until the contract is completed
(the “completed contracts” basis). This is often described as following the
prudence concept. The problem with this approach is that it may not show a
faithful presentation as all the profit on a contract is included in the period of
completion, whereas in reality (a faithful representation), it is being earned, but
not reported, throughout the duration of the contract. IAS 11 remedies this by
recognising profit on uncompleted contracts in proportion to some measure of
the percentage of completion applied to the estimated total contract profit. This is
sometimes said to reflect the accruals concept, but it should only be applied
where the outcome of the contract is reasonably foreseeable. In the event that a
loss on a contract is foreseen, the whole of the loss must be recognised
immediately, thereby ensuring the continuing application of prudence.
(b)
Beetie
Income statement
Revenue recognised
Contract 1
Contract 2
Total
$’000
$’000
$’000
3,300
840
4,140
(2,400)
(720)
(3,120)
(170)
‒‒‒‒‒‒
(50)
‒‒‒‒‒‒
(170)
‒‒‒‒‒‒
850
‒‒‒‒‒‒
Contract expenses recognised
(balancing figure contract 1)
Expected loss recognised (contract 2)
Attributable profit/(loss) (see working)
‒‒‒‒‒‒
900
‒‒‒‒‒‒
Statement of financial position
Contact costs incurred
3,900
Recognised profit/(losses)
900
‒‒‒‒‒
4,800
(50)
‒‒‒‒‒‒
670
850
‒‒‒‒‒‒
5,470
(3,000)
‒‒‒‒‒‒
1,800
(880)
‒‒‒‒‒‒
(3,880)
‒‒‒‒‒‒
1,800
(210)
(210)
Progress billings
Amounts due from customers
Amounts due to customers
344
720
4,620
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Section 4: Answers to mock exam questions
Workings (in $’000)
Estimated total profit:
Agreed contract price
Estimated contract cost
Estimated total profit/(loss)
5,500
1,200
(4,000)
‒‒‒‒‒‒
1,500
‒‒‒‒‒‒
(1,250)
‒‒‒‒‒‒
(50)
‒‒‒‒‒‒
Percentage complete:
Agreed value of work completed at 31 March 2012
Contract price
Percentage complete at 31 March 2012 (3,300/5,500 × 100)
Profit to 31 March 2012 (60% × 1,500)
3,300
5,500
60%
900
At 31 March 2012 the increase in the expected total costs of contract 2 mean that a
loss of $50,000 is expected on this contract. In these circumstances, regardless of
the percentage completed, the whole of this loss should be recognised
immediately.
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Paper F7: Financial Reporting (International)
346
© Emile Woolf Publishing Limited
2013
ACCA F7 (INT)
Financial
Reporting
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