QUESTIONS
K APLAN P UBLI S H I N G
1
P AP E R F 7 : FINAN CIAL RE POR TIN G
A CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING
1
A COMPANY
Discuss what you understand by the terms:
(i)
current purchasing power accounting
(ii)
current cost accounting
(iii)
real terms system of accounting
and state what you consider to be the advantages and disadvantages of each.
(Total: 12 marks)
2
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
2
LIMITATIONS OF HISTORICAL COST
Even in times of inflation, published financial statements continue to be prepared under the
historical cost convention despite its alleged limitations.
Required:
Explain why historical cost accounting has been criticised and to explain some of the
advantages associated with its use.
(Total: 15 marks)
KAPLAN P UBLI S H I N G
3
P AP E R F 7 : FINAN CIAL RE POR TIN G
3
FOREST
The overriding requirement of a company’s financial statements is that they should
represent faithfully the underlying transactions and other events that have occurred. To
achieve this transactions have to be accounted for in terms of their ‘substance’ or economic
reality rather than their legal form. This principle is included in the IASB (International
Accounting Standards Board) Conceptual Framework for Financial Reporting, and is also
used in many Standards, in particular IAS 17 Leases and IAS 18 Revenue.
Required:
(a)
Describe why it is important that substance rather than legal form is used to
account for transactions, and describe how financial statements can be adversely
affected if the substance of transactions is not recorded.
(5 marks)
(b)
Describe, using an example, how the following features may indicate that the
substance of a transaction is different from its legal form:
(c)
(i)
separation of ownership from beneficial use
(ii)
the linking of transactions including the use of option clauses
(iii)
when an asset is sold at a price that differs to its fair value.
(10 marks)
On 1 April 20X0, Forest had an inventory of cut seasoning timber which had cost
$12 million two years ago. Due to shortages of this quality of timber its value at
1 April 20X0 had risen to $20 million. It will be a further three years before this
timber is sold to a manufacturer of high-class furniture. On 1 April 20X0, Forest
entered into an arrangement to sell Barret Bank the timber for $15 million. Forest
has an option to buy back the timber at any time within the next three years at a
cost of $15 million plus accumulated interest at 2% per annum above base rate.
This will be charged from the date of the original sale. The base rate for the period
of the transactions is expected to be 8%. Forest intends to buy back the timber on
31 March 20X3 and sell it the same day for an expected price of $25 million.
Note: Ignore any storage costs and capitalisation of interest that may relate to
inventories.
Assuming the above transactions take place as expected, prepare extracts to reflect
the transactions in the statement of profit or loss for the years to 31 March 20X1,
20X2 and 20X3 and the Statement of financial positions (ignore cash) at those year
ends:
(i)
if Forest treated the transactions in their legal form
(ii)
if the substance of the transactions is recorded.
Comment briefly on your answer to (c) above.
(10 marks)
(Total: 25 marks)
4
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
4
CREATIVE ACCOUNTING 1
In producing the Conceptual Framework for Financial Reporting (Framework) and some of
the current International Accounting Standards the International Accounting Standards
Board (IASB) has had to address the potential problem that the management of some
companies may choose to adopt inappropriate accounting policies. These could have the
effect of portraying an entity’s financial position in a favourable manner. In some countries
this is referred to as ‘creative accounting’. Included in the Framework, and a common
feature of many recent international accounting standards, is the application of the
principle of ‘substance over form’.
Required:
(a)
(c)
Explain the principle of substance over form and how it limits the above practice;
and for each of the following areas of accounting describe an example of the
application of substance over form:
(i)
group accounting
(ii)
financing non-current assets
(iii)
measurement and disclosure of current assets.
(8 marks)
Alpha, a public listed corporation, is considering how it should raise $10 million of
finance which is required for a major and vital long-term asset renewal scheme that
will be undertaken during the current year to 31 December 20X6. Alpha is
particularly concerned about how analysts are likely to react to its financial
statements for the year to 31 December 20X6. Present forecasts suggest that
Alpha’s earnings per share and its financial gearing ratios may be worse than
market expectations. Mr Wong, Alpha’s Finance Director, is in favour of raising the
finance by issuing a convertible loan. He has suggested that the coupon (interest)
rate on the loan should be 5%; this is below the current market rate of 9% for this
type of loan. In order to make the stock attractive to investors the terms of
conversion into equity would be very favourable to compensate for the low
interest rate.
(i)
Explain why the Finance Director believes the above scheme may favourably
improve Alpha’s earnings per share and gearing.
(ii)
Describe how the requirements of IAS 33 Earnings per Share and IAS 32
Financial Instruments: Presentation are intended to prevent the above
effects.
(7 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
5
P AP E R F 7 : FINAN CIAL RE POR TIN G
5
CREATIVE ACCOUNTING 2
The principle of recording the substance or economic reality of transactions rather than
their legal form lies at the heart of the Conceptual Framework for Financial Reporting
(Framework) and several International Accounting Standards. The development of this
principle was partly in reaction to a minority of public interest companies entering into
certain complex transactions. These transactions sometimes led to accusations that
company directors were involved in ‘creative accounting’.
Required:
(i)
Explain, with relevant examples, what is generally meant by the term ‘creative
accounting’.
(5 marks)
(ii)
Describe in broad terms common ways in which management can manipulate
financial statements to indulge in ‘creative accounting’ and why they would wish to
do so.
(5 marks)
(iii)
Explain why it is important to record the substance rather than just the legal form
of transactions and describe the features that may indicate that the substance of a
transaction is different from its legal form.
(5 marks)
(Total: 15 marks)
6
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
6
REVENUE RECOGNITION
The timing of revenue (income) recognition has long been an area of debate and
inconsistency in accounting. The operating cycle of enterprises may involve the following
stages:
•
obtaining an order for goods prior to manufacture
•
acquisition of goods or raw materials (including extraction)
•
production of goods
•
obtaining an order for goods in inventory
•
delivery of goods
•
collection of cash (re: credit sales);
•
provision of after sales service or warranties.
In many countries the 'critical event' approach has traditionally been used to determine the
timing of income recognition. The International Accounting Standards Board in its
Conceptual Framework for Financial Reporting (Framework) identifies 'elements' of
financial statements and uses these to determine when income or expenses occur. These
principles also form the basis of revenue recognition in IAS 18 Revenue.
Required:
(a)
In relation to each of the above stages in the operating cycle discuss, giving
practical examples where possible, the circumstances in which the critical event
may be deemed to have occurred at that stage.
(10 marks)
(b)
Discuss the criteria used in the Framework to determine when income and
expenses arise, and how they should be reported.
(5 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
7
P AP E R F 7 : FINAN CIAL RE POR TIN G
A REGULATORY FRAMEWORK FOR FINANCIAL REPORTING
7
INFLUENCES
One of your friends has recently decided to invest in some quoted securities. He is,
however, concerned that the companies in which he is interested may have inflated their
share prices by publishing misleading financial statements. He is aware that the
accountancy profession has established an international standard setting body, but has
read that this organisation is subject to a number of influences.
Required:
Explain how the International Accounting Standards Board goes about setting an
International Financial Reporting Standard. Explain how the process could be influenced
by the preparers of financial statements.
(Total: 10 marks)
8
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
FINANCIAL STATEMENTS
IAS 10, 37, 38, 40
8
PROBLEMS
D is a large paper manufacturing company. The company's finance director is working on
the published accounts for the year ended 31 March 20X3. The chief accountant has
prepared the following list of problems which will have to be resolved before the
statements can be finalised.
(a)
Events after the reporting date (IAS 10)
A fire broke out at the company's Westown factory on 4 April 20X3. This has
destroyed the factory's administration block. Many of the costs incurred as a result
of this fire are uninsured.
A major customer went into liquidation on 27 April 20X3. The customer's balance at
31 March 20X3 remains unpaid. The receiver has intimated that unsecured payables
will receive very little compensation, if any.
(3 marks)
(b)
Possible investment property (IAS 40)
The company decided to take advantage of depressed property prices and purchased
a new office building in the centre of Westville. This was purchased with the
intention of the building being resold at a profit within five years. In the meantime,
the company is using the property to house the administrative staff from the
Westown factory until such time as their own offices can be repaired. It is anticipated
that this will take at least nine months. The managing director has suggested that the
building should not be depreciated.
(3 marks)
(c)
Possible development expenditure (IAS 38)
The company paid the engineering department at Northtown University a large sum
of money to design a new pulping process which will enable the use of cheaper raw
materials. This process has been successfully tested in the University's laboratories
and is almost certain to be introduced at D's pulping plant within the next few
months.
The company paid a substantial amount to the University's biology department to
develop a new species of tree which could grow more quickly and therefore enable
the company's forests to generate more wood for paper manufacturing. The project
met with some success in that a new tree was developed. Unfortunately, it was
prone to disease and the cost of the chemical sprays needed to keep the wood
healthy rendered the tree uneconomic.
(4 marks)
(d)
Possible contingent liabilities (IAS 37)
One of the company's employees was injured during the year. He had been operating
a piece of machinery which had been known to have a faulty guard. The company's
lawyers have advised that the employee has a very strong case, but will be unable to
estimate likely financial damages until further medical evidence becomes available.
One of the company's customers is claiming compensation for losses sustained as a
result of a delayed delivery. The customer had ordered a batch of cut sheets with the
intention of producing leaflets to promote a special offer. There was a delay in
supplying the paper and the leaflets could not be prepared in time. The company's
lawyers have advised that there was no specific agreement to supply the goods in
time for this promotion and, furthermore, that it would be almost impossible to
attribute the failure of the special offer to the delay in the supply of the paper.
(5 marks)
KAPLAN P UBLI S H I N G
9
P AP E R F 7 : FINAN CIAL RE POR TIN G
Required:
Explain how each of these matters should be dealt with in the published accounts for the
year ended 31 March 20X3 in the light of the accounting standards referred to above. You
should assume that the amounts involved are material in every case.
(Total: 15 marks)
10
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
9
IAS 37
(a)
How does IAS 37 Provisions, Contingent Liabilities and Contingent Assets define
contingent assets and contingent liabilities?
(4 marks)
(b)
What information should be disclosed in financial statements with regard to
contingencies?
(5 marks)
(c)
State, with reasons, how you would account for the following items:
(i)
The directors of a company have discovered a painting in a cupboard and have
sent it to an auction house, which has confirmed that it should sell for $1
million in the following month's auction.
(2 marks)
(ii)
A claim has been made against a company for injury suffered by a pedestrian
in connection with building work by the company. Legal advisers have
confirmed that the company will probably have to pay damages of $200,000
but that a counter claim made against the building sub-contractors for
$100,000 would probably be successful.
(2 marks)
(iii)
The manufacturer of a snooker table has received a letter from a professional
snooker player who was defeated in the final of a major snooker competition,
threatening to sue the manufacturer for $1 million, being his estimate of his
loss of earnings through failing to win the competition, on the grounds that the
table was not level.
(2 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
11
P AP E R F 7 : FINAN CIAL RE POR TIN G
IFRS 15
10
CONTRACTS TO BE RECOGNISED OVER TIME
(a)
How should the financial effects of contracts for assets being constructed for others
be recognised and disclosed in the statement of profit or loss and statement of
financial position?
(7 marks)
(c)
Show how the following reliable information for two contracts should be disclosed in
the financial statements if progress is measured based on the work done to date
compared to the total value.
Value of work done
Total value of contract
Progress billings
Total costs to date
Costs to complete
Contract X
$000
500
1,000
525
600
300
Contract Y
$000
350
1,000
200
400
710
(8 marks)
(Total: 15 marks)
12
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
IAS 17
11
USER
User leased a specialised piece of equipment on 1 October 20X9. The lessor agreed to buy a
particular item to User's detailed specification from User's choice of supplier. The item has
an expected useful life of up to 10 years, but the lease agreement will terminate at the end
of 8 years, at which time the asset will be returned to the lessor.
The lease agreement makes User responsible for any damage to the equipment, either
accidental or through poor maintenance. The lessor will not be responsible for any loss of
use arising because of breakdowns.
User's Chief Accountant has declared that she does not need to see any detailed figures in
order to classify this lease. The broad description of the lease terms and conditions
indicates that it is almost certainly a finance lease.
Required:
(a)
Explain why it is necessary to distinguish between finance and operating leases.
(3 marks)
(b)
Explain how IAS 17 Leases distinguishes finance and operating leases and explain
whether you agree that User's lease appears to be a finance lease.
(8 marks)
(c)
When IAS 17 was first introduced, it was argued that forcing companies to
capitalise finance leases would be disastrous because it would raise gearing ratios,
reduce return on capital employed and generally make companies appear
unattractive to investors.
Explain whether accounting standard setters should avoid setting standards that
might deter investors from investing in certain companies.
(4 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
13
P AP E R F 7 : FINAN CIAL RE POR TIN G
IAS 38
12
CATEGORIES
IAS 38 Intangible Assets defines the difference between research expenditure and
development expenditure. IAS 38 also lays down rules which must be applied to the
capitalisation of research and development expenditure.
Required:
(a)
Explain the meaning of the terms research expenditure and development
expenditure.
(3 marks)
(b)
Explain the criteria applied to research and development expenditure, according to
IAS 38, to determine whether the cost should be capitalised.
(8 marks)
(c)
Discuss briefly why there was a need for an accounting standard relating to
research and development expenditure.
(4 marks)
(Total: 15 marks)
14
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
EARNINGS PER SHARE – IAS 33
13
RADAN
Extracts from the statement of financial position of Radan as at 1 April 20X6 are:
$000
Ordinary shares of 25 cents each
8% Irredeemable preference shares
Reserves:
Share premium
Capital reserve
Revaluation reserve
Retained earnings
$000
4,000
1,000
700
1,300
90
750
–––––
2,840
–––––
7,840
–––––
2,000
–––––
10% Convertible loan notes
Note: the above are extracts from the opening statement of financial position for the
current reporting year.
The following draft statement of profit or loss has been prepared for the year to 31 March
20X7, prior to the declaration of the final ordinary dividend for the year:
$000
Profit before interest and tax
Loan interest
Profit before tax
Taxation
− provision for 20X7
− deferred tax
$000
1,800
(200)
–––––
1,600
300
390
–––––
(690)
–––––
910
–––––
Dividends declared in the year – Ordinary
– Preference
320
80
–––––
400
–––––
KAPLAN P UBLI S H I N G
15
P AP E R F 7 : FINAN CIAL RE POR TIN G
The following information is relevant:
(i)
A bonus issue of one new share for every eight ordinary shares held was made on
7 September 20X6.
(ii)
A fully subscribed rights issue of one new share for every five ordinary shares held at
a price of 50 cents each was made on 1 January 20X7. Immediately prior to the issue
the market price of Radan’s ordinary shares was $1.40 each.
(iii)
The terms of conversion of the 10% loan notes are:
Year
20X9 to 20Y3
20Y4
Loan notes
$100
$100
Ordinary shares
100
120
Income tax is to be taken as 33%.
(iv)
The profit before interest and taxation includes stage profits of $150,000 relating to
construction contracts that have been calculated in accordance with IAS 11
Construction Contracts.
(v)
The statement of financial position includes an asset of deferred development
expenditure of $114,000. The directors are confident that the development project
will be a success.
(vi)
Plant and equipment was revalued on 1 April 20X4 giving a surplus of $150,000. At
that time it had a remaining life of five years. It is being depreciated, based on its
revalued amount, on a straight-line basis. The excess depreciations for the years to
31 March 20X5 and 20X6 have been transferred from the revaluation reserve to
retained earnings.
(vii)
The earnings per share (EPS) was correctly reported in last year’s accounts at 8 cents.
Required:
(a)
Calculate the earnings per share (EPS) for Radan for the year ended 31 March 20X7:
(i)
on a basic basis (including the comparative figure)
(ii)
on a diluted basis (ignore the comparative figure)
and state which figures need to be disclosed in the financial statements (ignore
comparatives).
(10 marks)
(b)
Explain why it is useful to disclose the EPS calculated on a diluted basis in addition
to the basic basis.
(5 marks)
(Total: 15 marks)
16
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
14
A
A is a listed company. Your client, Mr B, currently owns 300 shares in A. Mr B has recently
received the published financial statements of A for the year ended 30 September 20X8.
Extracts from these published financial statements, and other relevant information, are
given below. Mr B is confused by the statements. He is unsure how the performance of the
company during the year will affect the market value of his shares, but is aware that the
published earnings per share (EPS) is a statistic which is often used by analysts in assessing
the performance of listed companies.
Statements of profit or loss — year ended 30 September
Revenue
Cost of sales
Gross profit
Other operating expenses
Profit from operations
Finance costs
Profit before tax
Income tax expense
Profit for the year
20X8
$m
10,000
(6,300)
––––––
3,700
(1,900)
––––––
1,800
(300)
––––––
1,500
(470)
20X7
$m
8,500
(5,100)
––––––
3,400
(1,800)
––––––
1,600
(320)
––––––
1,280
(400)
––––––
1,030
––––––
––––––
880
––––––
Statements of financial position at 30 September
20X8
$m
Non-current assets:
Tangible assets
Intangible assets
20X7
$m
4,000
3,000
––––––
$m
3,700
−
––––––
7,000
Current assets:
Inventories
Receivables
Cash in hand and at bank
Equity:
Share capital
Share premium account
Retained earnings
KAPLAN P UBLI S H I N G
$m
1,300
1,500
100
––––––
3,700
1,000
1,200
90
––––––
2,900
––––––
9,900
––––––
2,290
––––––
5,990
––––––
1,500
2,700
900
––––––
5,100
500
500
670
––––––
1,670
17
P AP E R F 7 : FINAN CIAL RE POR TIN G
Non-current liabilities:
Loan notes
Current liabilities:
Trade payables
Taxation
Bank overdraft
2,000
1,700
500
600
––––––
2,000
1,200
420
700
––––––
2,800
––––––
9,900
––––––
2,320
––––––
5,990
––––––
Information regarding share capital:
The issued share capital of the company comprises $1 equity shares only. On 1 April 20X8,
the company made a rights issue to existing shareholders of two new shares for every one
share held, at a price of $3.30 per share, paying issue costs of $100,000. The market price of
the shares immediately before the rights issue was $3.50 per share. No changes took place
in the equity capital of A in the year ended 30 September 20X7.
Required:
(a)
Compute the EPS figures (current year plus comparative) that will be included in
the published financial statements of A for the year ended 30 September 20X8.
(3 marks)
(b)
Using the extracts with which you have been provided, write a short report to Mr B
which identifies the key factors which have led to the change in the EPS of A since
the year ended 30 September 20X7.
(9 marks)
(c)
Comment on the relevance of the EPS statistic to a shareholder like Mr B who is
concerned about the market value of his shares.
(3 marks)
(Total: 15 marks)
18
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
15
EARNIT
Earnit is a listed company. The issued share capital of the company at 1 April 20X9 was as
follows:
•
500 million equity shares of 50c each;
•
100 million $1 non-equity shares, redeemable at a premium on 31 March 20Y4. The
effective finance cost of these shares for Earnit is 10% per annum. The carrying value
of the non-equity shares in the financial statements at 31 March 20X9 was
$110 million.
Extracts from the draft consolidated statement of profit or loss of Earnit for the year ended
31 March 20Y0 showed:
Revenue
Cost of sales
Gross profit
Other operating expenses
Profit from operations
Exceptional gain
Finance costs
Profit before tax
Income tax expense
Profit for the year
$m
250
(130)
––––
120
(40)
––––
80
10
(36)
––––
54
(20)
––––
34
––––
The company has a share option scheme in operation. The terms of the options are that
option holders are permitted to subscribe for 1 equity share for every option held at a price
of $1.50 per share. At 1 April 20X9, 100 million share options were in issue. On 1 October
20X9, the holders of 50 million options exercised their option to purchase, and 70 million
new options were issued on the same terms as the existing options. During the year ended
31 March 20Y0, the average market price of an equity share in Earnit was $2.00.
There were no changes to the number of shares or share options outstanding during the
year ended 31 March 20Y0 other than as noted in the previous paragraph.
Required:
(a)
Compute the basic and diluted earnings per share of Earnit for the year ended
31 March 20Y0 Comparative figures are NOT required.
(5 marks)
(b)
Explain to a holder of equity shares in Earnit the usefulness of both the figures you
have calculated in part (a).
(5 marks)
(Total: 10 marks)
KAPLAN P UBLI S H I N G
19
P AP E R F 7 : FINAN CIAL RE POR TIN G
NON-CURRENT ASSETS
16
INFORMED
You are the management accountant of Informed, a private company. One of your directors
has recently attended a seminar which discussed the drawbacks in an environment of rising
prices of financial statements prepared under the historical cost convention. Your company
normally depreciates its plant and machinery on a straight-line basis over a period of eight
years, with no expectation of significant residual value. Your director is considering
recommending to the board that the company adopts a policy of revaluing non-current
assets every five years.
Assume that today's date is 1 May 20X8 and that the company prepares financial
statements to 30 April each year.
Required:
(a)
Write a report to your director which summarises the arguments for and against a
policy of carrying non-current assets at revalued amounts. Your director has a solid
general knowledge of business but she is not a qualified accountant, so any
technical terms you use in the report will need to be clearly explained.
(8 marks)
(b)
In respect of an item of plant purchased for $40,000 on 1 May 20X8 and under the
new accounting policy revalued to $18,000 on 30 April 20Y3:
(i)
set out the charges in the statement of profit or loss for each of the years
ending 30 April 20X9 to 30 April 20Y5;
(3 marks)
(ii)
explain how the revaluation will be treated in the financial statements for
the year ending 30 April 20Y3;
(2 marks)
(iii)
calculate the gain or loss on sale that will be taken to the statement of profit
or loss for the year ending 30 April 20Y6 assuming the plant is sold for $7,500
on 1 May 20Y5.
(2 marks)
Note: Your answer to part (b) should be fully justified by referring to IFRS as appropriate.
(Total: 15 marks)
20
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
17
LAND AND BUILDINGS
Required:
(a)
Compare the accounting treatment of land and buildings as laid down by IAS 16
Property, Plant and Equipment with the accounting treatment of investment
properties as laid down by IAS 40 Investment Property.
(6 marks)
(b)
Explain why a building owned for its investment potential should be accounted for
differently from one which is occupied by its owners.
(4 marks)
(c)
Explain whether the revaluation of land and buildings other than investment
properties is compatible with the underlying assumptions of the accrual basis and
going concern and provides relevant and reliable information.
(5 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
21
P AP E R F 7 : FINAN CIAL RE POR TIN G
18
HAMILTON
Hamilton owns a large 12 storey office block in the financial area of Metro City which it
purchased on 1 April 20X5 for $3 million. On that date it had an estimated life of 25 years.
It occupies the top two floors which are used for the company’s administration and as its
registered office. The remainder of the building is available for sub-letting on short term
leases. The building is currently classified in Hamilton’s statement of financial position as an
investment property under IAS 40 Investment Property and the fair value model is applied.
The office block has been revalued annually since acquisition by Platonic, a firm of
professional surveyors. The fair values have been:
Year ended 31 March
20X6
$3.2 million
20X7
$3.6 million
Included in the report on the valuation for the last year end (31 March 20X7) the surveyors
noted that over the next few years there was expected to be a surplus of rented property
space in Metro City and sub-lease rentals were expected to fall. This in turn was expected
to lead to a serious decline in the value of properties like Hamilton’s.
The directors of Hamilton wish to change the classification of the office block from an
investment property to a property accounted for under IAS 16 Property, Plant and
Equipment's cost model, the change coming into effect in the 20X8 financial statements.
The draft statement of profit or loss for the year to 31 March 20X8 before the directors’
proposed change shows only a small profit (after tax) of $180,000. In the unadjusted
financial statements for 20X7 the profit for the period was $300,000 with retained earnings
brought forward of $110,000. No dividends have been declared in either year.
Required:
(a)
Describe the circumstances in which companies are required to change their
accounting policies; and explain whether the change in the classification of
Hamilton’s office block would represent a change of accounting policy.
(4 marks)
(b)
Prepare Hamilton's statement of profit or loss and statement of financial position
for the year to 31 March 20X8 (including comparatives) to the extent the above
information allows:
(i)
assuming that the property remains classified as an investment property and
its value has fallen by 25% (to $2.7 million) in the year to 31 March 20X8;
(ii)
assuming that the property is reclassified as property, plant and equipment
accounted for under the cost model;
and identify the major differences in the information provided to users by the two
presentations.
(11 marks)
(Total: 15 marks)
22
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
IFRS 5
19
A
A, a company with a 31 December year end, sells processed products to retail shops and
has two operating divisions: the Beans division which specialises in the processing and sale
of canned beans and the Spaghetti division which does the same in respect of canned
spaghetti. The canned beans are processed from beans bought in directly from UK farmers.
The canned spaghetti is processed from pasta which is purchased from suppliers in Italy.
Each division operates in its own freehold factory and maintains separate financial records
in order to produce a monthly operating report for Head Office.
Once canned, the products are transferred to one of four freehold distribution centres (two
centres per factory) prior to onward sale to shops and supermarkets. The distribution
centres also maintain their own individual financial records.
Due to adverse exchange rate movements it was decided on 30 November 20X5 to close
the Spaghetti division down, with the majority of the personnel employed being made
redundant. The decision was announced to the workforce on 15 December 20X5, on which
date the factory and one of the associated distribution centres were put up for sale. It was
expected that the sale of the properties and the closure would be completed by 31 March
20X6.
On 30 November 20X5, A also decided to restructure its remaining distribution operations
for canned beans, redefining the areas covered by the three distribution centres and
reducing staffing levels. The timetable decided on was for the restructuring to commence
on 15 January 20X6 and be completed by 31 March 20X6). Apart from carrying out
extensive negotiations with workers representatives regarding redundancy packages, no
restructuring activities were to be commenced before 15 January 20X6.
You are the Chief Accountant of A, and one of the directors has recently visited you to
discuss the accounting treatment of the closure and restructuring programme. The director
is unsure as to whether the programme will have any impact on the financial statements for
the year ended 31 December 20X5. The director is aware that there is a financial reporting
standard which deals with the discontinued operations but is unaware of any relevant
details. The 20X5 financial statements are currently in the course of preparation and are
expected to be formally approved by the directors at the April 20X6 board meeting. For the
purposes of this question, you should assume that today's date is 29 February 20X6.
Required:
Write a memorandum for the Board of Directors which:
(a)
explains how a discontinued operation is defined in IFRS 5 Non-current Assets Held
for Sale and Discontinued Operations and when restructuring provisions are to be
recognised under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
(5 marks)
(b)
outlines the accounting treatment (if any) in the financial statements of A for the
year ended 31 December 20X5 of the decisions taken on 30 November 20X5.
Your explanation should encompass the treatment in the statement of financial position
and statement of profit or loss and any additional information which is required in the
notes to the financial statements.
(10 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
23
P AP E R F 7 : FINAN CIAL RE POR TIN G
CASH FLOW STATEMENTS
20
CASINO
(a)
Casino is a publicly listed company. Details of its statements of financial position as at
31 March 20X5 and 20X4 are shown below together with other relevant information:
Statement of financial position as at
Non-current assets (note (i))
Property, plant and equipment
Intangible assets
Current assets
Inventory
Trade receivables
Interest receivable
Short term deposits
Bank
31 March 20X5
$m
$m
880
400
31 March 20X4
$m
$m
760
510
––––––
––––––
1,280
1,270
350
808
5
32
15
––––––
Total assets
Share capital and reserves
Ordinary shares of $1 each
Reserves
Share premium
Revaluation reserve
Retained earnings
60
112
1,098
––––––
1,210
420
372
3
120
75
990
––––––
––––––
––––––
2,490
2,260
––––––
––––––
300
200
1,270
nil
45
1,165
1,210
––––––
––––––
––––––
1,570
Non-current liabilities
12% loan note
8% variable rate loan note
Deferred tax
Current liabilities
Trade payables
Bank overdraft
Taxation
Total equity and liabilities
24
nil
160
90
––––––
1,410
250
150
nil
75
225
––––––
––––––
––––––
530
125
15
515
nil
110
––––––
––––––
670
625
––––––
––––––
2,490
2,260
––––––
––––––
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
The following supporting information is available:
(i)
Details relating to the non-current assets are:
Property, plant and equipment at:
31 March 20X5
Cost/
Depreciation Carrying
value
Valuation
Land and
buildings
Plant
$m
600
$m
12
440
148
31 March 20X4
Cost/
Depreciation Carrying
Valuation
value
$m
588
$m
500
$m
80
292
445
105
$m
420
340
––––––
––––––
880
760
––––––
––––––
Casino revalued the carrying value of its land and buildings by an increase of
$70 million on 1 April 20X4. On 31 March 20X5 Casino transferred $3 million from the
revaluation reserve to retained earnings representing the realization 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 statement of profit or loss for the year to
31 March 20X5:
$m
Operating loss
Interest receivable
Finance costs
$m
(32)
12
(24)
––––––
Loss before tax
Income tax repayment claim
Deferred tax charge
(44)
14
(15)
––––––
Loss for the period
(1)
––––––
(45)
––––––
The finance costs are made up of:
Interest expenses
Penalty cost for early redemption of fixed rate loan
(18)
(6)
––––––
(24)
––––––
(iii)
The short-term deposits meet the definition of cash equivalents.
(iv)
Dividends of $25 million were paid during the year.
KAPLAN P UBLI S H I N G
25
P AP E R F 7 : FINAN CIAL RE POR TIN G
Required:
As far as the information permits, prepare a statement of cash flows for Casino for
the year to 31 March 20X5 in accordance with IAS 7 Statements 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’
statements of profit or loss and other comprehensive income.
Required:
Discuss the extent to which a company’s statement of cash flows may be more
useful and reliable than its statement of profit or loss and other comprehensive
income.
(5 marks)
(Total: 25 marks)
26
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
21
PLANTER
The following information relates to Planter, a small private company. It consists of an
opening statement of financial position as at 1 April 20X3 and a listing of the company’s
ledger accounts at 31 March 20X4 after the draft operating profit (of $15,600) had been
calculated.
Planter – Statement of financial position as at 1 April 20X3
$
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
44,200
47,500
16,900
–––––––
108,600
57,400
28,600
1,200
––––––
Total assets
Equity and liabilities
Capital and Reserves:
Ordinary shares of $1 each
Reserves:
Share premium
Revaluation reserve
Retained earnings
Non-current liabilities
8% Loan notes
Current liabilities
Trade payables
Taxation
Total equity and liabilities
KAPLAN P UBLI S H I N G
$
87,200
–––––––
195,800
–––––––
25,000
5,000
12,000
70,300
––––––
87,300
–––––––
112,300
43,200
31,400
8,900
––––––
40,300
–––––––
195,800
–––––––
27
P AP E R F 7 : FINAN CIAL RE POR TIN G
Ledger account listings at 31 March 20X4
Ordinary shares of $1 each
Share premium
Retained earnings – 1 April 20X3
Operating profit – year to 31 March 20X4
Revaluation reserve
8% Loan notes
Trade payables
Accrued loan interest
Taxation
Land and buildings at valuation
Plant at cost
Buildings – accumulated depreciation 31 March 20X4
Plant – accumulated depreciation 31 March 20X4
Investments at cost
Trade receivables
Inventory – 31 March 20X4
Bank
Investment income
Profit on sale of investments
Loan interest
Ordinary dividend
Dr
$
Cr
$
50,000
8,000
70,300
15,600
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
2,300
1,700
26,100
–––––––
277,700
–––––––
–––––––
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. There were
no further purchases of investments. These investments are all in unquoted
companies and therefore their fair value cannot be reliably estimated.
(iv)
On 10 October 20X3 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 20X3.
(v)
The balance on the taxation account is after settlement of the provision made for the
year to 31 March 20X3. 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 Statements of Cash flows for the year to 31 March
20X4.
(Total: 15 marks)
28
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
22
MNO PLC
The statement of financial position and statement of profit or loss for MNO for the year
ended 31 March 20X2 are as follows:
Statement of financial positions at 31 March
Non-current assets
Intangibles
Property, plant and equipment
Investments
Current assets
Inventories
Receivables
Investments
Cash at bank and in hand
Total assets
Shares of $1 each
Share premium
Revaluation reserve
Retained earnings
Equity
Non-current liabilities
Long-term loans
Current liabilities
Trade payables
Taxation
Bank overdraft
Total equity and liabilities
KAPLAN P UBLI S H I N G
20X2
$000
20X1
$000
300
3,450
400
200
1,600
200
––––––
––––––
4,150
2,000
––––––
––––––
3,200
2,400
−
32
2,000
2,000
100
480
––––––
––––––
5,632
4,580
––––––
––––––
9,782
6,580
––––––
––––––
3,000
858
1,000
1,110
2,000
600
−
554
––––––
––––––
5,968
3,154
––––––
––––––
1,580
1,960
––––––
––––––
1,200
520
514
1,000
466
−
––––––
––––––
2,234
1,466
––––––
––––––
9,782
6,580
––––––
––––––
29
P AP E R F 7 : FINAN CIAL RE POR TIN G
Statement of profit or loss for year ended 31 March 20X2
$000
Revenue
Change in inventories of finished goods and WIP
Own work capitalised
Other operating income
Raw materials and consumables
Other external charges
$000
10,000
1,000
300
100
(4,000)
(1,500)
––––––
(5,500)
(3,000)
(700)
(324)
Staff costs
Depreciation
Other operating charges
––––––
Profit before interest
Interest receivable
Interest payable
1,876
50
(320)
––––––
Profit before tax
Tax
1,606
(650)
––––––
Profit for the year
956
––––––
The following information may also be relevant:
(1)
Non-current assets
Intangibles
Property, plant and equipment
20X2
Cost
Depreciation
$000
$000
700
400
5,000
1,550
20X1
Cost
Depreciation
$000
$000
400
200
3,000
1,400
(2)
At 1 April 20X1, freehold land was revalued from $1,000,000 to $2,000,000. During
the year, plant and machinery which had cost $600,000 and had a carrying amount of
$100,000 was sold for $250,000. Book gains and losses are adjusted through the
depreciation charge.
(3)
Own work capitalised relates to development work carried forward as an intangible
fixed asset.
(4)
Dividends paid amounted to $400,000.
(5)
Non-current liabilities comprises loans with a nominal value of $1,600,000. Loans
with a nominal value of $400,000 (less unamortised discount of $20,000) were
redeemed at par during the year.
(6)
Current asset investments at 1 April 20X1 (not held as liquid resources) were sold
during the year for $94,000.
Required:
Prepare a cash flow statement with related notes for MNO plc for the year ended
31 March 20X2 which meets the requirements of IAS 7 Cash Flow Statements.
(Total: 15 marks)
30
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
23
LADWAY
The draft statement of financial positions as at 31 March 20X8 and 20X7 of Ladway are
shown below:
20X8
$m
Assets
Non-current assets
Property, plant and equipment
Goodwill
20X7
$m
2,480
450
$m
1,830
410
––––––
––––––
2,930
Current assets
Inventories
Trade receivables
Cash and cash equivalents
763
472
34
––––––
––––––
Equity and liabilities
Equity
Equity capital
10% preference capital
Reserves
Share premium
Revaluation reserve
Retained earnings
Non-current liabilities
8% Loan note
Government grants
Deferred tax
Environmental provision
2,240
920
642
−
Total assets
1,562
1,269
––––––
––––––
4,492
3,509
––––––
––––––
500
350
400
350
90
170
1,871
70
−
1,732
––––––
––––––
2,981
2,552
200
210
52
76
−
160
30
24
––––––
––––––
538
Current liabilities
Trade payables
Accrued interest
Operating overdraft
Taxation
Government grants
Total equity and liabilities
KAPLAN P UBLI S H I N G
$m
214
680
4
63
176
50
518
−
−
185
40
––––––
––––––
973
743
––––––
––––––
4,492
3,509
––––––
––––––
31
P AP E R F 7 : FINAN CIAL RE POR TIN G
The draft statement of profit or loss for Ladway for the year to 31 March 20X8 is as follows:
$m
Revenue
Cost of sales:
Depreciation of property, plant and equipment
Impairment of goodwill
Other costs
$m
3,655
366
36
2,522
––––––
(2,924)
––––––
Gross profit for period
Other operating income – government grant
731
50
––––––
781
Distribution costs
Administration
Environmental provision
75
56
67
––––––
(198)
––––––
Interest – loan stock
583
(12)
––––––
Profit before income tax
Income tax expense
571
(177)
––––––
Profit for the period after tax
394
––––––
The following information is relevant:
Tangible non-current assets:
(i)
These include land which was revalued giving a surplus of $170 million during the
period.
(ii)
The company’s motor vehicle haulage fleet was replaced during the year. The fleet
originally cost $42 million and had been written down to $11 million at the date of its
replacement. The gross cost of the fleet replacement was $180 million and a trade-in
allowance of $14 million was given for the old vehicles.
(iii)
The company acquired some new plant on 1 July 20X7 at a cost of $120 million from
Bromway. An arrangement was made on the same day for the liability for the plant
to be settled by Ladway issuing at par an 8% Loan note dated 20Y3 to Bromway. The
value by which the 8% Loan note exceeded the liability for the plant was received
from Bromway in cash.
Provision:
The provision represents an estimate of the cost of environmental improvements relating
to the company’s mining activities.
32
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
Equity share issues:
During the year Ladway made a bonus issue from the share premium reserve of one share
for every ten shares held. Later Ladway made a further share issue for cash.
Dividends:
During the year Ladway paid the preference dividend due, the final dividend from 20X7 of
$180m and an interim dividend for 20X8 of $40m.
Required:
(a)
A statement of cash flows for Ladway for the year to 31 March 20X8 prepared in
accordance with IAS 7 Statements of cash flows.
(20 marks)
(b)
IAS 7 Statements of cash flows encourages entities to disclose, usually in the notes,
additional information on:
(i)
aggregate cash flows relating to an expansion of operating capacity separate
to those required to maintain operating capacity; and
(ii)
cash flows arising from each reported industry and geographical segment.
Discuss the relevance and usefulness of the above information to users of accounts.
(5 marks)
(Total: 25 marks)
KAPLAN P UBLI S H I N G
33
P AP E R F 7 : FINAN CIAL RE POR TIN G
PUBLISHED FINANCIAL STATEMENTS
24
TADEON
The following trial balance relates to Tadeon, a publicly listed company, at 30 September
20X6:
$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 amortized cost
Accumulated depreciation at 1 October 20X5
– leasehold property
– plant and equipment
Equity shares of 20 cents each fully paid
Retained earnings at 1 October 20X5
2% Loan note (note (i))
Deferred tax balance 1 October 20X5 (note (iv))
Trade receivables
Inventories at 30 September 20X6
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
–––––––
48,000
–––––––
700,000
–––––––
700,000
–––––––
The following notes are relevant:
34
(i)
The loan note was issued on 1 October 20X5. It is redeemable on 30 September 2010
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
scrutinized 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 20X5 (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 used) at
1 October 20X5 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.
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
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 20X6 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 20X6 at $38 million. At 30 September 20X6 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 20X5. This was calculated to give a 5% yield on the
company’s share price of 80 cents as at 30 September 20X5.
The net receipt in March 20X6 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)
A statement of profit or loss and other comprehensive income for the year ended
30 September 20X6; and
(8 marks)
(b)
A statement of financial position as at 30 September 20X6.
(17 marks)
Note: A statement of changes in equity is not required. Disclosure notes are not required.
(Total: 25 marks)
KAPLAN P UBLI S H I N G
35
P AP E R F 7 : FINAN CIAL RE POR TIN G
25
CHAMBERLAIN
The following trial balance relates to Chamberlain, a publicly listed company, at
30 September 20X4:
$000
Ordinary share capital
Retained earnings at 1 October 20X3
6% Loan note (issued in 20X2)
Deferred tax (note (iv))
Land and buildings at cost (land element $163 million (note (i)))
Plant and equipment at cost (note (i))
Accumulated depreciation 1 October 20X3 – buildings
Accumulated depreciation 1 October 20X3 – plant and equipment
Trade receivables
Inventory – 1 October 20X3
Bank
Trade payables
Revenue
Purchases
Contract with customer balance (note (ii))
Operating expenses
Loan interest paid
Interim dividend
Research and development expenditure (note (iii))
$000
200,000
162,000
50,000
17,500
403,000
180,000
60,000
60,000
48,000
35,500
12,500
45,000
246,500
78,500
5,000
29,000
1,500
8,000
40,000
–––––––
841,000
–––––––
–––––––
841,000
–––––––
The following notes are relevant:
36
(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 contract with customer balance relates to a building being constructed for a
customer, with the revenue being recognised over time. The 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 20X3. The total
contract price has been agreed at $125 million and Chamberlain expects the total
contract cost to be $75 million. The progress is determined by the contract costs
used to date compared to the total estimated contract costs. At 30 September 20X4,
$5 million of the $35 million costs incurred to date related to unused inventory of
materials on site.
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
Other inventory at 30 September 20X4 amounted to $38.5 million at cost.
(iii)
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 20X5.
(iv)
The directors have estimated the provision for income tax for the year to
30 September 20X4 at $22 million. The deferred tax provision at 30 September 20X4
is to be adjusted to a credit balance of $14 million.
Required:
Prepare for Chamberlain:
(a)
a statement of profit or loss for the year to 30 September 20X4; and
(11 marks)
(b)
a statement of financial position as at 30 September 20X4 in accordance with
International Financial Reporting Standards as far as the information permits.
(14 marks)
Note: A statement of changes in equity is NOT required.
(Total: 25 marks)
KAPLAN P UBLI S H I N G
37
P AP E R F 7 : FINAN CIAL RE POR TIN G
26
J
J manufactures high-quality tinned soups and other food products. The company spends a
great deal of money advertising its products on television and in newspapers and
magazines. The company sells its products to major retailing organisations.
J’s trial balance at 30 September 20X5 is as follows:
Administration costs
Advertising costs
Bank
Income tax
Cost of new brand name
Deferred tax
Distribution costs
Dividend (declared 1 December 20X4)
Plant and machinery – cost at 30 September 20X4
Plant and machinery – depreciation at 30 September 20X4
Premises – cost at 30 September 20X4
Premises – depreciation at 30 September 20X4
Retained earnings
Purchases and other manufacturing costs
Revenue
Share capital
Inventories at 30 September 20X4
Trade payables
Trade receivables
Salaries – administration
Salaries – distribution
Salaries – manufacturing
38
$000
170
1,100
17
$000
24
1,600
330
240
500
1,200
520
3,300
794
461
1,900
9,700
1,000
32
230
850
980
470
700
––––––
––––––
13,059
13,059
––––––
––––––
(i)
Inventories were physically counted at 30 September 20X5 and were valued at
$39,000.
(ii)
Premises are to be depreciated at 2% of cost, and plant and machinery at 25% on the
reducing balance basis. All depreciation is to be treated as part of the cost of goods
sold. The company did not purchase or sell any tangible non-current assets during
the year.
(iii)
The balance on the income tax account represents the amount remaining after the
settlement of all tax liabilities up to and including those for the year ended
30 September 20X4.
(iv)
The balance on the deferred tax account is to be increased to $390,000.
(v)
The tax charge on the profits for the year ended 30 September 20X5 is estimated at
$940,000.
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
(vi)
During the year the company purchased an established brand name from and other
manufacturing company which was selling its food business. The Directors of J have
decided that the cost of this acquisition should be capitalised as a non-current
intangible asset. A full year’s amortisation is to be charged for the year ended 30
September 20X5. Amortisation of the brand name is to be treated as part of the cost
of goods sold. The useful life of the brand is estimated to be 10 years.
(vii)
A customer is suing the company for compensation of $200,000 for a serious injury
caused in June 20X5 by a sharp object which was accidentally packed in a can of
soup. J’s lawyers have warned the directors that that the court is likely to award
damages of approximately the amount claimed and that payment will probably be
due in December 20X7.
(viii) A final dividend of $700,000 is proposed by the directors.
Required:
Prepare J’s statement of profit or loss for the year ended 30 September 20X5 and its
statement of financial position at that date. These should be in a form suitable for
publication and should be accompanied by notes as far as you are able to prepare these
from the information provided.
Do NOT prepare a statement of accounting policies, a statement of changes in equity or
calculate earnings per share.
(Total: 30 marks)
KAPLAN P UBLI S H I N G
39
P AP E R F 7 : FINAN CIAL RE POR TIN G
27
T
T manufactures radar equipment for military and civil aircraft. The company’s trial balance
at 31 December 20X8 is as follows:
Administration costs
Bank overdraft
Receivables
Factory – cost
Factory – depreciation
Factory running costs
Loan interest
Long-term loans
Machinery – cost
Machinery – depreciation
Manufacturing wages
Opening inventory – parts and materials
Opening inventory – work-in-progress
Retained earnings
Purchases – parts and materials
Research and development
Revenue
Sales department salaries
Share capital
Trade payables
Trade fair
$000
800
700
2,000
18,000
1,800
1,200
1,680
12,000
13,000
8,000
1,300
400
900
380
2,300
5,300
10,000
600
15,000
600
1,000
–––––––
–––––––
48,480
48,480
–––––––
–––––––
(i)
Inventory was counted at 31 December 20X8. Closing inventories of parts and
materials were valued at $520,000 and closing inventories of work-in-progress were
valued at $710,000. There are no inventories of finished goods because all
production is for specific customer orders and goods are usually shipped as soon as
they are completed.
(ii)
No depreciation has been charged for the year ended 31 December 20X8. The
company depreciates the factory at 2% of cost per annum and all machinery at 25%
per annum on the reducing balance basis.
(iii)
The balance on the research and development account is made up as follows:
Opening balance (development costs brought forward)
Purchase of laboratory calibration equipment
Long-range radar project
Wide-angle microwave project
40
$000
$000
2,100,000
600,000
900,000
1,700,000
––––––––
5,300,000
––––––––
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
The opening balance comprises expenditure on new products which have just been
introduced to the market. The company has decided that these costs should be written off
over ten years, starting with the year ended 31 December 20X8.
The new calibrating equipment is used in the company’s research laboratory. It is used to
ensure that the measurement devices used during experiments are properly adjusted. The
long-range radar project is intended to adapt existing military radar technology for civilian
air traffic control purposes. The company has built a successful prototype and has had
strong expressions of interest from a number of potential customers. It is almost certain
that the company will start to sell this product early in the year 20Y0 and that it will make a
profit.
The wide-angle microwave project is an attempt to apply some theoretical concepts to
create a new radar system for use in military aircraft. Initial experiments have been
promising, but there is little immediate prospect of a saleable product because the
transmitter is far too large and heavy to install in an aeroplane.
(iv)
During the year the company spent $1,000,000 in order to exhibit its product range
at a major trade fair. This was the first time that T had attended such an event. No
orders have been received as a direct result of this fair, although the sales director
has argued that contacts were made which will generate sales over the next few
years.
(v)
T has made losses for tax purposes for several years. It does not expect any tax
charge for the year ended 31 December 20X8.
(vi)
The directors do not plan to propose any dividends for the year ended 31 December
20X8.
Required:
Prepare T’s statement of profit or loss for the year ended 31 December 20X8 and its
statement of financial position at that date. These should be in a form suitable for
publication and should be accompanied by notes as far as you are able to prepare these
from the information provided.
Do NOT prepare a statement of accounting policies, a statement of changes in equity or a
calculation of earnings per share.
(Total: 30 marks)
KAPLAN P UBLI S H I N G
41
P AP E R F 7 : FINAN CIAL RE POR TIN G
28
STILSON
The summarised list of account balances of Stilson, a publicly listed company, at 31 March
20X1 is as follows:
Land and building – at cost (land $2 million) (note 1)
Plant and equipment – at cost
Depreciation 1 April 20X0
– building
– plant
Trade receivables and prepayments
Inventory – 31 March 20X0
Cash and bank
Trade payables and accruals
Equity shares of 25c each
8% Loan Note (issued in 20W9)
Retained earnings 1 April 20X0
Sales revenues (note 2)
Purchases
Contract costs to 31 March 20X1 (note 3)
Contract progress billings received (note 3)
Property rental
Profit on sale of property (note 1)
Other operating costs
Interim dividend
Loan note interest paid
$000
10,000
4,480
$000
3,200
2,400
8,620
1,900
4,180
3,540
5,000
5,000
580
26,750
16,000
1,900
2,000
1,250
3,400
1,340
2,000
200
–––––––
51,870
–––––––
–––––––
51,870
–––––––
The following notes are relevant:
(1)
One of the company’s buildings was sold on 1 April 20X0. The disposal has been
recorded leaving a profit on sale of $3.4 million which is included in the balances
above. On the same date the company’s only remaining property was revalued at
$12 million ($3 million is attributable to the land). The building had an estimated life
of 25 years when it was acquired on 1 April 20W0 and this has not changed as a
result of the revaluation. The directors of Stilson wish to incorporate this value in the
financial statements for the year ended 31 March 20X1.
Plant is depreciated at 20% per annum on cost.
(2)
42
Included in the sales revenue is an amount of $3 million relating to sales made under
a special promotion in March 20X1. These goods were sold with an accompanying
voucher equal to the selling price. Five years after the sale, these vouchers will be
exchanged for goods of the customer’s choosing. The profit margin on these goods is
expected to be 30% of selling price, and market research estimates that 50% of the
vouchers will be redeemed. The present value (at 31 March 20X1) of $1 at the time
the vouchers will be exchanged can be taken as 60c.
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
(3)
The figures in respect of contract balances relate to a three-year contract entered
into on 1 July 20X0. Details relating to this contract are:
Contract price
Estimated total contract costs
Agreed value of work completed and billed at 31 March 20X1
$000
10,000
6,000
3,000
Stilson’s policy is to recognise revenue over time. Progress is measured based on the
agreed value of the work completed to date as a percentage of the total contract
price.
(4)
A provision for income tax for the year to 31 March 20X1 of $2,400,000 is required.
The directors declared a final dividend of 15c per share on 25 March 20X1.
(5)
Inventory, other than that relating to the construction contract, at 31 March 20X1
was valued at a cost of $2.8 million.
Required:
Prepare the statement of profit or loss and other comprehensive income, the statement
of changes in equity and statement of financial position for Stilson for the year to
31 March 20X1.
(Total: 15 marks)
KAPLAN P UBLI S H I N G
43
P AP E R F 7 : FINAN CIAL RE POR TIN G
29
LARCHER
The following list of account balances relates to Larcher, a public listed company, at
30 September 20X8:
$000
Equity shares of $1 each
11% Loan note
Retained earnings 1 October 20X7
Property, plant and equipment – cost (note (i))
Depreciation of property, plant and equipment
1 October 20X7
Trade receivables (note (ii))
Trade payables
Lease rentals (note (iii))
Sales revenue
Cost of sales
Distribution costs
Administration expenses (note (ii))
Income tax (note (iv))
Loan interest paid (note (v))
Inventories – 30 September 20X8
Cash
$000
100,000
30,000
23,440
216,740
50,740
25,500
8,390
800
247,450
165,050
13,400
12,300
400
1,650
16,240
7,940
–––––––
460,020
–––––––
–––––––
460,020
–––––––
The following notes are relevant:
(i)
Non-current assets
Property, plant and equipment, and its accumulated depreciation, is made up of the
following assets:
Cost
Depreciation 1 October 20X7
Land
$000
12,000
Nil
Buildings
$000
80,000
16,000
Plant
$000
124,740
34,740
All of Larcher’s land and buildings were revalued at open market value on 1 October
20X7 at $120 million in total. This was made up of $20 million attributed to the land
and $100 million to the buildings. The buildings’ original estimated life of 50 years
(with a nil residual value) has not changed. From the date of the revaluation there
were 40 years of life remaining. The directors wish to include the revalued amounts
(including the depreciation effects) in the financial statements for the year to
30 September 20X8.
Plant is depreciated at 15% of the reducing balance.
44
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
(ii)
Factoring of trade receivables
The trade receivables figure in the list of account balances of $25.5 million is a net
figure after $10 million of trade receivables were sold for $9.5 million to
Merchant Financing on 30 September 20X8. The $9.5 million was paid into the bank
on the same date. The difference of $500,000 has been charged to administration as
a financing cost. Larcher will have to refund Merchant Financing any amounts
relating to trade receivables that remain uncollected by Merchant Financing after a
period of six months.
(iii)
Lease rentals
A lease rental of $800,000 was paid on 30 September 20X8. It is the first of five
annual payments in arrears for the rental of an item of equipment that has a cash
purchase price of $3m. The auditors have advised that this is a finance lease and have
calculated that the implicit interest rate in the lease is 10% per annum.
(iv)
Income tax
A provision for income tax for the year to 30 September 20X8 of $9 million is
required. Income tax is paid 6 months after the company’s year end. A provision for
income tax of $6.8 million made for the year ended 30 September 20X7 was settled
on 31 March 20X8 for $7.2 million.
(v)
Interest payable
The company has paid half of the annual loan note interest. Ignore tax relating to
interest paid.
(vi)
An employee of Larcher is currently suing the company for damages in respect of
serious injuries sustained as a result of a breach of safety regulations.
Correspondence from Larcher’s legal representatives indicates one of two outcomes
to the court action is likely:
Outcome
Contributory negligence
Fully responsible
Probability
70%
30%
Damages against Larcher
$3 million
$6 million
In addition legal costs are estimated at $500,000.
Required:
(a)
an statement of profit or loss for Larcher for the year to 30 September 20X8
reflecting the adjustments required by notes (i) to (vi) above;
(10 marks)
(b)
a statement of changes in equity for the same period;
(c)
a statement of financial position as at 30 September 20X8.
(5 marks)
(15 marks)
Note: Ignore deferred tax and the notes to the financial statements.
(Total: 30 marks)
KAPLAN P UBLI S H I N G
45
P AP E R F 7 : FINAN CIAL RE POR TIN G
30
DAWES
The following problems and issues have arisen during the preparation of the draft financial
statements of Dawes for the year to 30 September 20X7:
(a)
The following schedule of the movement of plant has been drafted:
Cost
$m
At 1 October 20X6
(including leased assets)
Additions at cost excluding
leased assets (see (1) and (2) below)
Depreciation charge for year
Disposal (see (3) below)
Balance 30 September 20X7
Depreciation
$m
81.20
32.50
23.00
−
(5.00)
−
19.84
––––––
––––––
99.20
––––––
52.34
––––––
Notes:
(1)
The addition to plant is made up of:
Basic cost from supplier
Recoverable sales tax (see (4) below)
Installation costs
Pre-production testing
Annual insurance and maintenance contract
Less government grant (see (5) below)
$m
20.00
3.50
1.00
0.50
1.00
(3.00)
–––––
23.00
–––––
(2)
During the year some assets were acquired under finance leases. The fair value
of these assets is represented by the movement on finance lease liabilities.
These increased from $21.4 million at 1 October 20X6 to $29 million at 30
September 20X7 after capital repayments of lease liabilities during the year of
$8.4 million. All finance leases for plant are for five years and none are more
than three years old.
(3)
The disposal figure of $5 million is the proceeds from the sale of an item of
plant during the year which had cost $15 million on 1 October 20X3 and had
been correctly depreciated prior to disposal. Dawes charges depreciation of
20% per annum on the cost of plant held at the year end.
(4)
The recoverable sales tax paid on the acquisition of assets is recoverable from
the taxing authorities.
(5)
The company policy for government grants is to treat them as deferred income
in the statement of financial position.
Required:
Prepare a corrected schedule of the movements of the cost and depreciation of
plant, including leased assets.
(5 marks)
46
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
(b)
Dawes has a policy of capitalising borrowing costs in relation to ‘qualifying assets’ in
accordance with the allowed alternative treatment in IAS 23 Borrowing Costs. Details
relating to two such assets and their financing are:
Manufacturing plant
On 1 October 20X6 Dawes commenced construction of a manufacturing plant that is
expected to take four years to complete. It is being financed entirely by a four-year
term loan of $5 million (taken out at the start of the construction). The loan carries
fixed interest at 14% per annum and issue costs of 2% (of the loan value) were
incurred on the loan. During the year $72,000 had been earned from the temporary
investment of these borrowings.
Note: You may use the straight-line method to amortise issue costs.
Investment property
Due to the poor state of the property letting market, construction of this property
was halted for the first three months of the year. On 30 June 20X7, after a prolonged
construction period, the company completed the property. Despite attempts to let
the property it remained empty at the year end. The average carrying value of the
property before inclusion of the current year’s borrowing cost is $12 million. The
investment property has been financed out of funds borrowed generally for the
purpose of financing qualifying assets. The company’s weighted average cost of
capital is 11% including all borrowings, and 10% if the $5 million referred to above is
excluded.
Required:
Calculate, with explanations, the amount of borrowing costs that should be
capitalised in respect of each qualifying asset.
(3 marks)
(c)
On 20 September 20X7, Dawes sold its loss making engineering operation to
Manulite. Dawes accounts for its various operations on a divisional basis, but they
are not separate legal entities. The sale was completed at an agreed value of $30
million. Associated disposal costs were $2 million. The carrying amount of the
division’s net assets at the date of sale were $46 million. The revenues and operating
losses from the period from 1 October 20X6 to the date of sale were $22 million and
$4.5 million respectively.
The engineering division is currently being sued for damages relating to a faulty
product it manufactured. Independent engineering consultants have prepared a
report which confirms that the product was faulty, but this was partly due to the
failure of a component that was manufactured by Holroyd as a sub-assembly. The
damages and costs are estimated at $5 million and the level of contributory
negligence of Holroyd is considered to be 40%. The directors of Dawes believe that as
the division has been sold, there is no need to provide for the claim for damages.
Note: Dawes operates in a country where a limited liability company and its
shareholders are separate legal persons.
The above amounts are material in the context of the financial statements of Dawes.
Required:
Advise the Directors on the correct treatment of the disposal of the engineering
division and the claim for damages. Your answer should be supported by
appropriate calculations.
(3 marks)
KAPLAN P UBLI S H I N G
47
P AP E R F 7 : FINAN CIAL RE POR TIN G
(d)
On 1 October 20X1, Dawes purchased a 25-year lease on a new industrial storage
building for $4 million. Prior to the current year this property was being amortised
over its life. The directors are now questioning the necessity for this as a 20-year
lease on an almost identical building was sold on 1 October 20X6 by the builders for
$6 million. With effect from the same date (1 October 20X6) the directors wish to
value the lease at $6 million and cease depreciating it.
Note: The regulatory requirements applicable to Dawes permit revaluation of nonmonetary assets in accordance with the revaluation model in IAS 16 Property, Plant
and Equipment.
Required:
Critically comment on the Directors’ views in relation to revaluation and
depreciation of the leased property, and show the statement of profit or loss and
statement of financial position extracts for the year ended 30 September 20X7
assuming:
(i)
there is no revaluation of the property;
(ii)
the property is revalued to $6 million at 1 October 20X6.
(4 marks)
(Total: 15 marks)
48
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
31
DARIUS
The following trial balance relates to Darius at 31 March 20X6:
$000
Revenue
Cost of sales
Closing inventories – 31 March 20X6 (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))
Investment property – valuation 1 April 20X5 (note (iii))
Accumulated depreciation 1 April 20X5 – plant and equipment
Plant held for sale
Trade receivables
Bank
Trade payables
Ordinary shares of 25 cents each
10% Redeemable preference shares of $1 each
Deferred tax (note (v))
Revaluation reserve (note (iii))
Retained earnings 1 April 20X5
$000
213,800
143,800
10,500
22,400
1,200
5,000
63,000
36,000
16,000
16,800
8,000
13,500
–––––––
318,200
–––––––
900
11,800
20,000
10,000
5,200
21,000
17,500
–––––––
318,200
–––––––
The following notes are relevant:
(i)
An inventory count at 31 March 20X6 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 20X5.
(iii)
Non-current assets:
Land and building
The land and building were revalued at $15 million and $48 million respectively on 1 April
20X5 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 realized profits in
respect of excess depreciation.
KAPLAN P UBLI S H I N G
49
P AP E R F 7 : FINAN CIAL RE POR TIN G
Plant
All plant 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 20X6 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)
The plant held for sale is valued in the trial balance at its carrying value in the
statement of financial position. A broker has found a buyer for the plant for
$6 million and will charge a fee of 5% of the sales proceeds. The sale should take
place during April 20X6.
(v)
The directors have estimated the provision for income tax for the year ended
31 March 20X6 at $8 million. The deferred tax provision at 31 March 20X6 is to be
adjusted (through the statement of profit or loss) 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 profit or loss and other comprehensive income for Darius
for the year ended 31 March 20X6.
(12 marks)
(b)
Prepare the statement of financial position for Darius as at 31 March 20X6.
(13 marks)
Notes to the financial statements are NOT required.
50
(Total: 25 marks)
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
BUSINESS COMBINATIONS
32
HEDRA
Hedra, a public listed company, acquired the following investments:
(i)
On 1 October 20X4, 72 million shares in Salvador for an immediate cash payment of
$195 million. Hedra agreed to pay further consideration on 30 September 20X5 of
$54 million if the post acquisition profits of Salvador exceeded an agreed figure at
that date. Hedra has not accounted for this deferred payment (ignore discounting).
Salvador also received a $50 million 8% loan from Hedra at the date of its acquisition.
(ii)
On 1 April 20X5, 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 summarized statements of financial position of the three companies as at
30 September 20X5 are:
Non-current assets
Property, plant and equipment
Investments – in Salvador
– other
Current assets
Inventories
Trade receivables
Cash and bank
Equity and liabilities
Ordinary share capital ($1 each)
Reserves:
Share premium
Revaluation
Retained earnings
Non-current liabilities
8% loan note
Deferred tax
Current liabilities
Trade payables
Bank overdraft
Current tax payable
KAPLAN P UBLI S H I N G
Hedra
$m
$m
358
245
45
––––
648
130
142
nil
––––
272
––––
920
––––
Salvador
$m
$m
240
nil
nil
––––
240
80
97
4
––––
400
40
15
240
––––
Nil
45
––––
118
12
50
––––
295
––––
695
45
180
––––
920
––––
181
––––
421
––––
Aragon
$m
$m
270
nil
nil
––––
270
110
70
20
––––
120
50
nil
60
––––
50
Nil
––––
141
nil
nil
––––
110
––––
230
50
141
––––
421
––––
200
––––
470
––––
100
nil
nil
300
––––
Nil
Nil
––––
40
nil
30
––––
300
––––
400
Nil
70
––––
470
––––
51
P AP E R F 7 : FINAN CIAL RE POR TIN G
The following information is relevant:
(a)
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 20X5 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 20X5 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 utilized and accordingly they should be recognized
as a deferred tax asset. By 30 September 20X5 the group had not yet utilized
any of these losses. The income tax rate is 25%.
(b)
The retained earnings of Salvador and Aragon at 1 October 20X4, as reported in their
separate financial statements, were $20 million and $200 million respectively. All
profits are deemed to accrue evenly throughout the year.
(c)
Hedra’s policy is to value the non-controlling interest using the fair value at the date
of acquisition. On this date the fair value of the non-controlling interests was $132
million.
An impairment test on 30 September 20X5 showed that goodwill had impaired by
$30 million.
(d)
The investment in Aragon has not suffered any impairment.
Required:
Prepare the consolidated statement of financial position of Hedra as at 30 September
20X5.
(Total: 30 marks)
52
K A P LA N P UB L I S H I N G
L EC TURER RESO UR CE PAC K: Q U EST IO NS
33
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 20X4.
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 20X6 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 20X4 was $6 per share.
The summarised statement of profit or loss for the three companies for the year to
30 September 20X4 are:
Revenue
Cost of sales
Gross profit
Operating expenses
Operating profit
Finance cost
Profit before tax
Income tax expense
Profit for period
Holdrite
$000
75,000
(47,400)
–––––––
27,600
(10,480)
–––––––
17,120
(170)
–––––––
16,950
(4,800)
–––––––
12,150
–––––––
Staybrite
$000
40,700
(19,700)
–––––––
21,000
(9,000)
–––––––
12,000
–
–––––––
12,000
(3,000)
–––––––
9,000
–––––––
Allbrite
$000
31,000
(15,300)
–––––––
15,700
(9,700)
–––––––
6,000
–
–––––––
6,000
(2,000)
–––––––
4,000
–––––––
The following information is relevant:
(i)
A fair value exercise was carried out for Staybrite at the date of its acquisition with
the following results:
Land
Plant
Book value
$000
20,000
25,000
Fair value
$000
23,000
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 20X4.
Depreciation of plant is charged to cost of sales.
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(ii)
The details of each company’s share capital and reserves at 1 October 20X3 are:
Equity shares of $1 each
Share premium
Retained earnings
Holdrite
$000
20,000
5,000
18,000
Staybrite
$000
10,000
4,000
7,500
Allbrite
$000
5,000
2,000
6,000
(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 20X4.
(iv)
Holdrite’s policy is to value the non-controlling interest at fair value at the date of
acquisition. As a result, the goodwill attributable to the non-controlling interest was
$500,000.
An impairment test on the goodwill of Staybrite at 30 September 20X4 indicated it
was overstated by $1 million. The investment in Allbrite was not impaired.
(v)
Holdrite paid a dividend of $5 million on 20 September 20X4.
Required:
(a)
Calculate the goodwill arising on the purchase of the shares in both Staybrite and
Allbrite at 1 April 20X4.
(9 marks)
(b)
Prepare a consolidated statement of profit or loss for the Holdrite Group for the
year to 30 September 20X4.
(16 marks)
(c)
Show the movement on the consolidated retained earnings attributable to Holdrite
for the year to 30 September 20X4.
(5 marks)
(Total: 30 marks)
Note: The additional disclosures in IFRS 3 Business Combinations relating to a newly
acquired subsidiary are not required.
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34
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 20X2 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 market price of each Skeptik share at the date of acquisition was $6.00.
The summarized draft financial statements of both companies are:
Statements of profit or loss: Year to 31 March 20X3
Revenue
Cost of sales
Gross profit
Operating expenses
Loan interest received (paid)
Profit before tax
Taxation
Profit for the year
Hillusion
$000
60,000
(42,000)
––––––
18,000
(6,000)
75
––––––
12,075
(3,000)
––––––
9,075
––––––
Skeptik
$000
24,000
(20,000)
––––––
4,000
(200)
(200)
––––––
3,600
(600)
––––––
3,000
––––––
19,320
11,280
––––––
30,600
15,000
––––––
45,600
––––––
10,000
25,600
––––––
35,600
8,000
nil
––––––
8,000
8,000
––––––
16,000
––––––
2,000
8,400
––––––
10,400
Nil
10,000
––––––
45,600
––––––
2,000
3,600
––––––
16,000
––––––
Statements of financial position: as at 31 March 20X3
Property, plant and equipment
Investments
Current assets
Total assets
Ordinary shares of $1 each
Retained earnings
Non-current liabilities
10% loan notes
Current liabilities
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The following information is relevant:
(i)
The fair values of Skeptik assets were equal to their book values with the exception
of its plant, which had a fair value of $3.2 million in excess of its book 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.
(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)
Hillusion has a policy of valuing non-controlling interests at fair value at the date of
acquisition. For this purpose, the share price of Skeptik should be used.
(vii)
An impairment test on 31 March 20X3 showed that consolidated goodwill should be
written down by $400,000.
Required:
(a)
Prepare a consolidated statement of profit or loss and statement of financial
position for Hillusion for the year to 31 March 20X3.
(25 marks)
(b)
Explain why it is necessary to eliminate unrealized 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: 30 marks)
Note: Your answer should refer to the circumstances described in the question.
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ANALYSING AND INTERPRETING FINANCIAL STATEMENTS
35
NEEDS OF USERS OF ACCOUNTS
Several different categories of users are traditionally considered as having an interest in the
financial statements of a company. The importance of the financial statements to each
category will vary with the nature and size of the company and with the type of use made
of the company's accounts by that category.
Required:
Describe the ways in which the needs of users of the financial statements vary with the
size of the company, for each of the following categories of user:
(a)
Investors and their advisers;
(b)
Loan creditors;
(c)
Employees;
(d)
Customers, suppliers and other business contacts;
(e)
The Government;
(f)
The public.
(Total: 15 marks)
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36
SR
You are the management accountant of SR. PQ is a competitor in the same industry and it
has been operating for 20 years. Summaries of PQ’s statement of profit or loss and
statement of financial positions for the previous three years are given below:
Summarised statement of profit or loss for year ended 31 December
Revenue
Cost of sales
Gross profit
Selling, distribution and administration expenses
Profit before interest
Interest
Profit before tax
Tax
Profit for the year
20X1
$m
840
554
––––
286
186
––––
100
6
––––
94
45
––––
49
––––
20X2
$m
981
645
––––
336
214
––––
122
15
––––
107
52
––––
55
––––
20X3
$m
913
590
––––
323
219
––––
104
19
––––
85
45
––––
40
––––
20X1
$m
20X2
$m
20X3
$m
36
176
––––
212
40
206
––––
246
48
216
––––
264
––––
237
105
52
––––
394
––––
606
––––
100
299
––––
399
––––
303
141
58
––––
502
––––
748
––––
100
330
––––
430
––––
294
160
52
––––
506
––––
770
––––
100
346
––––
446
––––
74
138
138
––––
––––
––––
Summarised statement of financial positions at 31 December
Non-current assets:
Intangibles
Property, plant and equipment
Current assets:
Inventory
Receivables
Bank
Total assets
Ordinary shares
Retained earnings
Equity
Non-current liabilities:
Long-term loans
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Current liabilities:
Trade payables
Other payables
Total equity and liabilities
53
80
––––
133
––––
606
––––
75
105
––––
180
––––
748
––––
75
111
––––
186
––––
770
––––
Each year PQ has declared and paid an annual dividend of $24 million.
Required:
Write a report to the finance director of SR:
(a)
analysing the performance of PQ and showing any calculations in an appendix to
this report
(15 marks)
(b)
summarising five areas which require further investigation, including reference to
other pieces of information which would complement your analysis of the
performance of PQ.
(5 marks)
(Total: 20 marks)
KAPLAN P UBLI S H I N G
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P AP E R F 7 : FINAN CIAL RE POR TIN G
37
REGIS
The following information relates to the draft financial statements of Regis for the year to
31 March 20X1 together with the comparative figures for the year to 31 March 20X0:
Statement of profit or loss for the year to:
Revenue
Cost of sales
Gross profit
Research and development costs
Property rentals
Selling and distribution costs
Administration
Profit on sale of property
Interest expense
Taxation
– on income
– deferred tax
Profit for the year
Statement of financial position as at:
Non-current assets:
Property, plant and equipment
Goodwill
Development costs
31 March 20X1
$000
$000
2,400
(1,440)
–––––
960
(300)
(40)
(155)
(125)
(620)
–––––
–––––
340
50
(70)
–––––
320
(200)
190
(10)
–––––
–––––
310
–––––
31 March 20X0
$000
$000
2,500
(1,800)
–––––
700
(80)
Nil
(95)
(85)
(260)
–––––
–––––
440
Nil
(80)
–––––
360
(120)
(30)
(150)
–––––
–––––
210
–––––
31 March 20X1
$000
$000
31 March 20X0
$000
$000
950
200
Nil
–––––
1,250
200
280
–––––
200
–––––
1,150
Current assets:
Inventory
Accounts receivable
Bank
Total assets
60
450
190
210
–––––
480
–––––
1,730
800
470
Nil
–––––
850
–––––
2,000
–––––
1,270
–––––
3,000
–––––
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L EC TURER RESO UR CE PAC K: Q U EST IO NS
Equity and liabilities
Share capital and reserves:
Shares of $1 each
Reserves:
Retained earnings
Less dividends
31 March 20X1
$000
$000
31 March 20X0
$000
$000
600
600
410
(150)
–––––
180
(80)
–––––
260
–––––
860
Non-current liabilities
8% Convertible loan note
12% Debenture
Deferred tax
Provision for plant renovation
400
Nil
110
Nil
–––––
100
–––––
700
Nil
500
300
370
–––––
510
Current liabilities
Accounts payable
Dividends
Taxation
Overdraft
330
90
210
Nil
–––––
Total equity and liabilities
1,170
620
60
115
335
–––––
630
–––––
2,000
–––––
1,130
–––––
3,000
–––––
The convertible loan note was issued on 1 April 20X0 at par and will be redeemed at par or
exchanged for equity shares on the basis of one equity share for each $1 nominal value of
the loan note in 20X5 at the option of the holders. Assume an income tax rate of 30%.
The share price of Regis fell considerably in June 20X0 in reaction to adverse press
comment concerning the operating performance and financial position of the company as
revealed by the publication of the company’s consolidated financial statements for the year
ended 31 March 20X0. The main performance areas criticised were:
(i)
a gross profit ratio below that of the market sector
(ii)
a lack of expenditure on research and development
(iii)
a disappointing EPS
(iv)
low utilisation of the property, plant and equipment (there have been no acquisitions
of non-current assets in the year to 31 March 20X1)
(v)
poor control of accounts receivable
(vi)
inefficient inventory turnover
(vii)
long payment period for trade payables
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(viii) poor liquidity ratios
(ix)
statement of financial position gearing (debt/capital employed) too high.
In order to address these problems Regis commissioned consultants to recommend
possible strategic actions with a view to improving the statement of profit or loss and
statement of financial position.
The Board acted quickly on many of the consultants’ recommendations and is pleased with
the overall position revealed by the consolidated financial statements for the year to
31 March 20X1. Due to over-capacity in the industry the directors of Regis negotiated a
contract for an external company to manufacture one of its products that had previously
been manufactured internally. This allowed Regis to dispose of some inefficient furnaces
that were included in plant. These furnaces had required major renovation consisting of relining them with new material every five years. Regis had been providing for this on an
annual basis, but due to the sale of the furnaces, the provision was no longer required and
was released to cost of sales. Regis had also been engaged in a research and development
project to revise the design of this type of furnace in order to avoid the expensive re-lining
costs. This project was abandoned when the furnaces were sold. The sale of the property
was not related to the outsourcing decision.
Required:
Appraise the performance of Regis for the year to 31 March 20X1 in the specific areas
((i) to (ix) above) where its performance was criticised by the press in the previous year.
Note: Your answer should include an appendix of ratios (for both years) relevant to each
of the nine areas reviewed.
(Total: 15 marks)
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38
ACQUIRER AND TARGET
You are the accountant of Acquirer. Your company has the strategy of growth by
acquisition and your directors have identified an entity, Target, which they wish to
investigate with a view to launching a takeover bid. Your directors consider that the
directors of Target will contest any bid and will not be very co-operative in providing
background information on the entity. Therefore, relevant financial information is likely to
be restricted to the publicly available financial statements.
Your directors have asked you to compute key financial ratios from the latest financial
statements of Target (for the year ended 30 November 2002) and compare the ratios with
those for other entities in a similar sector. Accordingly, you have selected ten broadly
similar entities and have presented the directors with the following calculations:
Ratio
Basis of calculation
Gross profit
margin
Operating profit
margin
Return on total
capital
Interest cover
Gearing
Dividend cover
Inventory
turnover
Receivables
days
Gross profit
Revenue
Profit from operations
Revenue
Profit from operations
Total capital
Profit from operations
Finance cost
Debt capital
Total capital
Profit after tax
Dividend
Cost of sales
Closing inventory
Trade receivables
1 day' s sales revenue
Ratio for
target
Spread of ratios for comparative
entities
Highest
Average
Lowest
42%
44%
38%
33%
29%
37%
30%
26%
73%
92.5%
69%
52%
1.8 times
3.2 times
2.5 times
1.6 times
52%
56%
40%
28%
5.2 times
5 times
4 times
3 times
4.4 times
4.5 times
4 times
3.2 times
51 days
81 days
62 days
49 days
Assume that it is now November 20X3.
Required:
(a)
Using the ratios provided, write a report that compares the financial performance
and position of Target to the other entities in the survey. Where an issue arises that
reflects particularly favourably or unfavourably on Target, you should assess its
relevance to a potential acquirer.
(10 marks)
(b)
Identify any reservations you have regarding the extent to which the ratios
provided can contribute to an acquisition decision by the directors of Acquirer. You
should highlight the extent to which the financial statements themselves might
help you to overcome the reservations you have identified.
(5 marks)
(Total: 15 marks)
KAPLAN P UBLI S H I N G
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