ATC F7_Rev Kit _june12

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2012 EDITION | Study Question Bank

ACC A CCA A Paper F7 | FINANCI FINANCIAL AL REPORT RE PORTII NG (INTERNATIONAL)

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ACCA

PAPER F7 FINANCIAL REPORTING (INTERNATIONAL)

STUDY QUESTION BANK

JUNE 2012

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(ii)


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) CONTENTS

Question

Page

Answer

Marks Date worked

1 2 3 4

1001 1003 1005 1007

18 22 17 26

6 6 6 6 7 7 7 8

1009 1010 1011 1012 1013 1014 1015 1016

6 8 8 5 16 12 20 8

8 9 10 11

1016 1018 1020 1022

15 12 14 20

11 11

1023 1025

12 8

12

1025

20

13

1027

25

14 15

1030 1033

14 15

15 16 17

1035 1037 1038

15 9 20

18 19

1039 1040

8 13

FINANCIAL STATEMENTS 1 2 3 4

Oscar Mercury Sulphur Cayman

ACCOUNTING CONCEPTS 5 6 7 8 9 10 11 12

Nette (ACCA J04) Limitations Framework Regulatory Framework Four Concepts (ACCA D98) IASB (ACCA J98) Objectives (ACCA Pilot Paper 97) Comparability (ACCA J04)

TANGIBLE ASSETS AND DEPRECIATION (IAS 16) 13 14 15 16

Adjustments Sponger Fam Stoat (ACCA D99)

ACCOUNTING FOR SUBSTANCE 17 18

Substance over form Hughes and Custom cars

ACCOUNTING POLICIES etc (IAS 8) 19

Perseus (ACCA J01)

REVENUE (IAS 18) 20

Jenson

ACCOUNTING FOR LEASES (IAS 17) 21 22

XYZ Snow

INTANGIBLE ASSETS (IAS 38) 23 24 25

Intellectual Individuals Rovers (ACCA J97) Lamond (ACCA D00)

INVENTORY (IAS 2) 26 27

Allrights Inc Sampi (ACCA J98)


(iii)

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK CONTENTS

Question

Page

Answer

20

1041

Marks Date worked

CONSTRUCTION CONTRACTS (IAS 11) 28

William

12

PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS (IAS 37) AND EVENTS AFTER THE BALANCE SHEET DATE (IAS 10) 29 30

Earley Accounting treatment

20 21

1043 1044

13 12

22 23 24 24 25

1045 1046 1047 1048 1048

15

26 28 29 31 32 33 34 35 36 37 38 39 40

1049 1053 1055 1057 1059 1061 1063 1065 1067 1069 1071 1073 1074

19 12 12 12 12 10 15 10 10 13 10 10 16

41

1076

15

41 42

1078 1081

20 20

44 45 46

1083 1085 1088

20 18 10

47

1089

14

INCOME TAXES (IAS 12) 31 32 33 34 35

Shep (I) Shep (II) Shep (III) Shep (IV) Broken dreams

GROUP ACCOUNTS 36 37 38 39 40 41 42 43 44 45 46 47 48

Consolidations Honey Hatton Haggis Hammer Hut Hat Humphrey High Happy Haley Hamish Hydrogen

PRINCIPLES OF PRICE LEVEL ACCOUNTING 49

Period of inflation

CASH FLOW STATEMENTS (IAS 7) 50 51

Standard Fallen

ANALYSIS AND INTERPRETATION 52 53 54

Witton Way Rapido Not-for-profit

EARNINGS PER SHARE (IAS 33) 55

(iv)

Earnings per share


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 1 OSCAR

A trial balance has been extracted from the books of account of Oscar as at 31 March 2012 as follows: Administrative expenses Share capital (ordinary shares of $1 fully paid) Receivables Bank overdraft Income tax (overprovision in 2011) Provision for pollution costs Distribution costs Listed financial asset investments Investment income Plant and machinery: Cost Accumulated depreciation (at 31 March 2012) Retained earnings (at 1 April 2011) Purchases Inventory (at 1 April 2011) Trade payables Sales revenue Interim dividend paid

$000 210

$000 600

470 80 25 180 420 560 75 750 220 180 960 140 260 2,010 120 ——— 3,630 ———

——— 3,630 ———

Additional information

(1)

Inventory at 31 March 2012 was valued at $150,000.

(2)

The following items are already included in the balances listed in the above trial balance:

Depreciation (for the year to 31 March 2012) Hire of plant and machinery Auditors’ remuneration Directors’ emoluments

Distribution costs $000 27 20 – –

Administrative expenses $000 5 15 30 45

(3)

The income tax rate is 33%.

(4)

The income tax charge based on the profits for the year is estimated to be $74,000.

(5)

The provision for pollution costs is to be increased by $16,000.

(6)

Authorised ordinary share capital consists of 1,000,000 ordinary shares of $1 each.

(7)

There were no purchases or disposals of fixed assets during the year.

(8)

The market value of the listed financial asset investments, which are classed as “fair value through profit or loss” as at 31 March 2012 was $580,000. There were no purchases or sales of such investments during the year.

Required: Insofar as the information permits, prepare the company’s statement of profit or loss for the year to 31 March 2011 and a statement of financial position as at that date in accordance with IAS 1 . (18 marks)


1

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 2 MERCURY

The trial balance of Mercury at 30 June 2012 was as follows: Dr $000

7% Preferred shares of $1 Ordinary shares of 50 cents Share premium account Retained earnings, at 1 July 2011 Inventory, 1 July 2011 Land at cost Buildings at cost Buildings, accumulated depreciation, 1 July 2011 Plant at cost Plant, accumulated depreciation, 1 July 2011 Trade payables Trade receivables Allowance for doubtful debts, at 1 July 2011 Purchases Administrative expenses Revenue Distribution costs Other expenses Bank balance Ordinary dividend paid 10% Loan notes

Cr $000 500 250 180 70

450 300 900 135 1,020 370 900 600 25 2,030 205 3,000 240 50 110 25 _____

500 _____

5,930 –––––

5,930 –––––

You are provided with the following additional information: (i)

Depreciation on buildings is to be provided at 5% per year on cost and allocated to administrative expenses.

(ii)

Plant is to be depreciated at 20% per year using the reducing balance method and included in distribution costs.

(iii)

Closing inventory is valued at $500,000.

(iv)

The allowance for doubtful debts is to be maintained at 5% of trade accounts receivable balances.

(v)

An accrual for distribution wages of $30,000 is required.

(vi)

Interest on the loan notes has not been paid during the year.

(vii)

During June, a bonus (or scrip) issue of two for five was made to ordinary shareholders. This has not been entered into the books. The bonus shares do not rank for dividend for the current financial year.

(viii)

Provisions are to be made for the following: − −

2

the preferred dividend for the year; an income tax charge of $55,000 for the year.


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Required: Prepare for Mercury for the year ended 30 June 2012, in accordance with IAS 1 Presentation of Financial Statements: (a) (b) (c)

(8 marks) (5 marks) (9 marks)

a statement of profit or loss; and a statement of changes in equity; and a statement of financial position.

Notes to the accounts are NOT required. (22 marks) Question 3 SULPHUR

The balances listed below were extracted from the records of Sulphur Co on 30 June 2012: $ 530,650 298,400 1,880 19,230 24,000 350,000 66,420 18,710 12,000 30,000 1,500 24,680 15,690 34,700 44,280 410 4,820 150,000 160,030

Revenue Purchases Returns (inwards) Delivery vehicles (carrying amount) Factory plant and equipment (carrying amount) Land and buildings (carrying amount) Factory overheads Administrative expenses Rent received Investments (unlisted) Investment income Inventory at 1 July 2011 Trade receivables Trade payables Distribution costs Cash in hand Bank overdraft Ordinary shares ($1 each) Retained earnings at 1 July 2011

The following transactions and events occurred on 30 June 2012, after the above balances had been extracted: (1)

Sulphur received $460 from a customer.

(2)

Inventory was valued at $29,170 at the close of business.

(3)

Sulphur received an electricity bill for $1,240 relating to the factory for the three months to 30 June 2012. The bill was paid in July 2012.

(4)

Sulphur paid $690 to a supplier in full settlement of an invoice for $700.

(5)

The company’s land and buildings were valued by a chartered surveyor at $390,000 and the new value is to be included in the statement of financial position.

(6)

Depreciation was provided on the reducing balance basis at the following annual rates: Delivery vehicles Factory plant and equipment

20% 10%

(7)

Bonus shares were issued on the basis of one for every two held on 29 June 2012.

(8)

Income tax for the financial year ended 30 June 2012 was estimated at $38,100.


3

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Required: Prepare for Sulphur for the year ended 30 June 2012, in accordance with IAS 1 Presentation of Financial Statements: (i)

a statement of total comprehensive income using the “cost of sales” (i.e. function of (7 marks) expense) method;

(ii)

a statement of changes in equity; and

(3 marks)

(iii)

a statement of financial position.

(7 marks)

Notes to the financial statements are NOT required. (17 marks) Question 4 CAYMAN

Cayman prepares annual financial statements to 30 September. At 30 September 2011, the company’s list of account balances was as follows: $000 Revenue Production costs Inventory at 1 October 2010 Distribution costs Administrative expenses Loan interest expense Land at valuation Buildings – cost

7,400 4,140 695 540 730 120 5,250 4,000

– accumulated depreciation at 1 October 2010 Plant and equipment – cost

1,065 6,400

– accumulated depreciation at 1 October 2010 Trade accounts receivable Trade accounts payable Bank overdraft Issued shares (50 cent ordinary) at 30 September 2011 Share premium account at 30 September 2011 Revaluation surplus Retained earnings 12% loan (payable 2018)

4

$000

1,240 2,060 1,120 40 7,000

______

2,000 1,500 1,570 1,000 ______

23,935 ––––––

23,935 ––––––


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) The following matters are relevant to the preparation of the financial statements for the year ended 30 September 2011: (1)

(2)

Inventory at 30 September 2011 amounted to $780,000 at cost before adjusting for the following: (i)

Items which had cost $40,000 and which would normally sell for $60,000 were found to be faulty. $10,000 needs to be spent on these items in order to sell them for $45,000.

(ii)

Goods sent to a customer on a sale or return basis have been omitted from inventory and included as sales in September 2011. The cost of these items was $8,000 and they were included in revenue at $12,000. The goods were returned by the customer in October 2011.

Depreciation is to be provided on cost as follows: Buildings: Plant and equipment:

2% per year 20% per year

80% of the depreciation is to be charged to cost of sales and 10% to each of distribution costs and administrative expenses. (3)

Land is to be revalued to $5,000,000.

(4)

Accrued expenses and prepayments were: Accrued expenses $000

Distribution costs Administrative expenses

95 35

Prepayments $000

60 30

(5)

During the year 4 million ordinary shares were issued at 75 cents each. The directors of Cayman declared an interim dividend of 2 cents per share in September 2011. No dividends were paid during the year.

(6)

Loan interest is paid annually, in arrears, on 30 September each year.

Required: Prepare for Cayman for the year ended 30 September 2011: (i) (ii) (iii)

a statement of total comprehensive income; a statement of financial position; and a statement of changes in equity,

(10 marks) (10 marks) (6 marks)

in accordance with IAS 1 Presentation of Financial Statements. Notes to the financial statements are NOT required. (26 marks)


5

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 5 NETTE

Nette, a public limited company, manufactures mining equipment and extracts natural gas. The directors are uncertain about the role of the IASB’s “Conceptual Framework for Financial Reporting” (the Framework) in corporate reporting. Their view is that accounting is based on the transactions carried out by the company and these transactions are allocated to the company’s accounting period by using the matching and prudence concepts. The argument put forward by the directors is that the Framework does not take into account the business and legal constraints within which companies operate. Required: Explain the importance of the “Framework” to the reporting of corporate performance and whether it takes into account the business and legal constraints placed upon companies. (6 marks) Question 6 LIMITATIONS

Financial statements identify position, performance and changes in position over a period of time. The main statements include Statement of Financial Position, Statement of Comprehensive Income and Statement of Cash Flows. These statements are intended to show how well a company has performed and give an indication of the value of the business. However, many accountants feel that the financial statements are limited in their value to the users of financial statements. Required: Identify and discuss the limitations of financial statements. (8 marks) Question 7 “THE FRAMEWORK” (a)

State the main purpose of the Conceptual Framework for Financial Reporting (“The Framework”) adopted by the International Accounting Standards Board (IASB). (4 marks)

(b)

Explain the status of “The Framework”.

(c)

State the underlying assumption of financial statements identified by The Framework . (2 marks)

(2 marks)

(8 marks) Question 8 REGULATORY FRAMEWORK Required: Briefly explain what a regulatory framework is and discuss the reasons why there is a need for a regulatory framework in financial reporting. (5 marks)

6


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 9 FOUR CONCEPTS Required: Define the following accounting concepts and explain for each their implications for the preparation of financial statements: (a) (b) (c) (d)

The entity concept Going concern Materiality Fair presentation (true and fair view)

(4 marks) (4 marks) (4 marks) (4 marks) (16 marks)

Question 10 IASB Required:

(4 marks)

(a)

State the objectives of the International Accounting Standards Board (IASB).

(b)

Explain how the IASB approaches the task of producing a standard, with particular reference to the way in which comment or feedback from interested parties is obtained. (8 marks) (12 marks)

Question 11 OBJECTIVES

The objective of financial statements is to provide information about financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. Required: (a)

State five potential users of company published financial statements, briefly explaining (10 marks) for each one their likely information needs from those statements.

(b)

Briefly discuss whether you think that the company published financial statements, prepared in accordance with IFRS, achieve the objective stated above, giving your reasons.

Include in your answer two ways in which you think the quality of the information disclosed in financial statements could be improved. (10 marks) (20 marks)


7

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 12 COMPARABILITY

Comparability is an enhancing qualitative characteristic which adds to the usefulness of financial statements. Required: (a)

Explain what is meant by the term “comparability” in financial statements, referring to (4 marks) TWO types of comparison that users of financial statements may make.

(b)

Explain TWO ways in which the IASB’s Conceptual Framework for Financial Reporting and the requirements of accounting standards aid the comparability of financial (4 marks) information. (8 marks)

Question 13 ADJUSTMENTS

Adjustments manufactures items for use in engineering products. You note that amongst its many tangible non-current assets it has the following: (a)

A lathe was purchased on 1 January 2005 for $150,000. The plant had an estimated useful life of twelve years, residual value of nil. Depreciation is charged on the straight line basis. On 1 January 2011, when the asset’s carrying amount is $75,000, the directors decide that the asset’s total useful life is only ten years.

(b)

A grinder was purchased on 1 January 2008 for $100,000. The plant had an estimated useful life of ten years and a residual value of Nil. Depreciation is charged on the straight line basis. On 1 January 2011, when the asset’s carrying amount is $70,000, the directors decide that it would be more appropriate to depreciate this asset using the sum of digits approach. The remaining useful life is unchanged.

(c)

The company purchased a fifty year lease some years ago for $1,000,000. This was being depreciated over its life on a straight line basis. On 1 January 2011, when the carrying amount is $480,000 and twenty-four years of the lease are remaining, the asset is revalued to $1,500,000. This revised value is being incorporated into the accounts.

Required: As the company’s financial accountant, prepare a memorandum for the attention of the board explaining the effects of these changes on the depreciation charge and indicating what additional disclosures need to be made in the accounts for the year to 31 December 2011. (15 marks)

8


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 14 SPONGER

Sponger has been having financial difficulties recently due to the economic climate in its industry sector. However, its financial director Mr Philip Tislid has discovered that there are a number of schemes by which he can obtain government financial assistance. Details of the assistance obtained are as follows: (a)

Sponger has received three grants of $10,000 each in the current year relating to on-going research and development projects. One grant relates to the Cuckoo project which involves research into the effect of various chemicals on the pitch of the human voice. No constructive conclusions have been reached yet. The second relates to the development of a new type of hairspray which is expected to be extremely popular. Commercial production will commence in 2013 and large profits are foreseen. The third relates to the purchase of high powered microscopes.

(b)

In 2010 Sponger’s premises were entirely isolated from the outside world for four months due to the renovation of roads by the local council. All production was lost in that period. Mr Tislid has been assured by the council’s officers that a $25,000 compensation grant will be paid on submission of the relevant triplicate form. Mr Tislid had not yet filled in the form by 31 December 2011.

(c)

Sponger entered into an agreement with the government that, in exchange for a grant of $60,000, it will provide “vocational experience” tours around its factory, for twelve young criminals per month over a five year period starting on 1 January 2011. The grant was to be paid on the date Sponger purchased a minibus (useful life three years) to take the inmates to the factory and back. The bus was bought and the grant received on 1 January 2011. The grant becomes repayable on a pro rata basis for every monthly visit not fulfilled. During 2011 five visits did not take place due to the pressure of work and this pattern is expected to be repeated over the next four years. No repayments have yet been made.

Mr Tislid is totally confused as to how to account for these grants. Required: Write a memorandum to Mr Tislid explaining to him how he should account for the above grants in the accounts for the year ended 31 December 2011. (12 marks)


9

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 15 FAM

Fam had the following tangible non-current assets at 31 December 2010: Cost $000 500 400 1,613 390 91 ——— 2,994 ———

Land Buildings Plant and machinery Fixtures and fittings Assets under construction

Depreciation $000 – 80 458 140 – —— 678 ——

Carrying amount $000 500 320 1,155 250 91 ——— 2,316 ———

In the year ended 31 December 2011 the following transactions occur: (1)

Further costs of $53,000 are incurred on buildings being constructed by the company. A building costing $100,000 is completed during the year.

(2)

A deposit of $20,000 is paid for a new computer system which is undelivered at the year end.

(3)

Additions to plant are $154,000.

(4)

Additions to fixtures, excluding the deposit on the new computer system, are $40,000.

(5)

The following assets are sold: Cost

Plant Fixtures

$000 277 41

Depreciation brought forward $000 195 31

Proceeds

$000 86 2

(6)

Land and buildings were revalued at 1 January 2011 to $1,500,000, of which land is worth $900,000. The revaluation was performed by Messrs Jackson & Co, Chartered Surveyors, on the basis of existing use value on the open market.

(7)

The useful economic life of the buildings is unchanged. The buildings were purchased ten years before the revaluation.

(8)

Depreciation is provided on all assets in use at the year end at the following rates: Buildings Plant Fixtures

2% per year straight line 20% per year straight line 25% per year reducing balance

Required: Show the disclosure under IAS 16 in relation to non-current assets in the notes to the published accounts for the year ended 31 December 2011. (14 marks)

10


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 16 STOAT

The directors of Stoat, a limited liability company, are reviewing the company’s draft financial statements for the year ended 30 June 2012. Two matters under discussion are depreciation and non-current asset valuation – several directors are of the opinion that the company’s depreciation methods and rates are unsatisfactory, and that the statement of financial position values of some of the non-current assets are unrealistic. Required: Draft a memorandum for the directors dealing with the following matters: (a)

The purpose of depreciation and the factors affecting the assessment of useful life (7 marks) according to IAS 16 “Property, Plant and Equipment”.

(b)

Three items of evidence obtainable from inside or outside the company, to check (3 marks) whether the company’s depreciation rates are in fact likely to be too low.

(c)

The disclosures, if any, which would be required in the financial statements if the (4 marks) company decided to change its depreciation methods.

(d)

The requirements of IAS 16 “Property, Plant and Equipment” regarding revaluation of (6 marks) non-current assets. (20 marks)

Question 17 SUBSTANCE OVER FORM

“The accounting treatment and disclosure of the vast majority of transactions will remain the same whether they are accounted for on the basis of ‘substance’ or ‘form’. However, some transactions will have a commercial effect not fully indicated by their legal form, and where this is the case, it will not be sufficient to account for them merely by recording that form.” Required: Discuss the proposal that accounts should always reflect the commercial substance of transactions. (12 marks) Question 18 HUGHES AND CUSTOM CARS (a)

On 10 December 2011, Hughes sold inventory with a production cost of $30 million to the Wodwo Bank for $36 million cash. Hughes has a call option (an option to repurchase) on the goods exercisable on 10 January 2012 at a price of $37.8 million. The Wodwo Bank has a put option (an option to resell to the seller) exercisable on 10 February 2012 at a price of $39.7 million. Required: Discuss how the transaction should be accounted for in the accounts of Hughes at 31 (4 marks) December 2011.


11

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (b)

Custom Cars customises standard sports cars purchased from a major manufacturer, Sigma, by fitting extras (spoilers, skirts, tinted windows, etc) at its workshop premises. It sells them from its showroom on the same site, which it owns. During the year, the showroom was renovated and enlarged by means of an extension to the existing building. Sigma contributed many of the interior fitments, such as display stands for the cars, free of charge and also made a cash payment toward the total costs. Required: Discuss whether or not the extension and fittings should be shown in the statement of (4 marks) financial position of Custom Cars. (8 marks)

Question 19 PERSEUS

The list of account balances of Perseus, a limited liability company, contains the following items at 31 December 2011: Dr Cr $ $ Opening inventory 3,850,000 Accounts receivable ledger balances 2,980,000 1,970 Accounts payable ledger balances 14,300 1,210,400 Prepayments 770,000 Cash at bank A 940,000 Overdraft at bank B 360,000 The closing inventory amounted to $4,190,000, before allowing for the adjustments required by items (2) and (3) below. In the course of preparing the financial statements at 31 December 2011, the need for a number of adjustments emerged, as detailed below: (1)

The opening inventory was found to have been overstated by $418,000 as a result of errors in calculations of values in the inventory sheets.

(2)

Some items included in closing inventory at cost of $16,000 were found to be defective and were sold after the end of the reporting period for $10,400. Selling costs amounted to $600.

(3)

Goods with a sales value of $88,000 were in the hands of customers at 31 December 2011 on a sale or return basis. The goods had been treated as sold in the records and the full sales value of $88,000 had been included in trade receivables. After the end of the reporting period, the goods were returned in good condition. The cost of the goods was $66,000.

(4)

Accounts receivable amounting to $92,000 are to be written off.

(5)

An allowance for doubtful debts is to be set up for 5% of the accounts receivable total.

(6)

The manager of the main selling outlet of Perseus is entitled, from 1 January 2011, to a commission of 2% of the company’s profit after charging that commission. The profit amounted to $1,101,600 before including the commission, and after adjusting for items (1) to (5) above. The manager has already received $25,000 on account of the commission due during the year ended 31 December 2011.

12


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Required: (a)

(b)

(i)

Explain how adjustment should be made for the error in the opening inventory, according to IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”. (Assume that it constitutes a material error.)

(ii)

State two disclosures required by IAS 8 in the financial statements at 31 (6 marks) December 2011 for the adjustment in (i) above.

Show how the final figures for current assets should be presented in the statement of (14 marks) financial position at 31 December 2011. (20 marks)

Question 20 JENSON

The timing of revenue (income) recognition has long been an area of debate and inconsistency in accounting. Industry practice in relation to revenue recognition varies widely; the following are examples of different points in the operating cycle of businesses that revenue and profit can be recognised:      

on the acquisition of goods; during the manufacture or production of goods; on delivery/acceptance of goods; when certain conditions have been satisfied after the goods have been delivered; receipt of payment for credit sales; on the expiry of a guarantee or warranty.

In the past the “critical event” approach has been used to determine the timing of revenue recognition. The International Accounting Standards Board in its “Conceptual Framework for Financial Reporting (Framework)” has defined the “elements” of financial statements, and it uses these to determine when a gain or loss occurs. Required: (a)

Explain what is meant by the critical event in relation to revenue recognition and discuss the criteria used in the Framework for determining when a gain or loss arises. (5 marks)

(b)

For each of the stages of the operating cycle identified above, explain why it may be an appropriate point to recognise revenue and, where possible, give a practical example of (12 marks) an industry where it occurs.

(c)

Jenson has entered into the following transactions/agreements in the year to 31 March 2012: (i)

Goods, which had cost of $20,000, were sold to Wholesaler for $35,000 on 1 June 2011. Jenson has an option to repurchase the goods from Wholesaler at any time within the next two years. The repurchase price will be $35,000 plus interest charged at 12% per year from the date of sale to the date of repurchase. It is expected that Jenson will repurchase the goods.


13

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (ii)

Jenson owns the rights to a fast food franchise. On 1 April 2011 it sold the right to open a new outlet to Mr Cody. The franchise is for five years. Jenson received an initial fee of $50,000 for the first year and will receive $5,000 per year thereafter. Jenson has continuing service obligations on its franchise for advertising and product development that amount to approximately $8,000 per year per franchised outlet. A reasonable profit margin on rendering the continuing services is deemed to be 20% of revenues received.

(iii)

On 1 September 2011 Jenson received total subscriptions in advance of $240,000. The subscriptions are for 24 monthly publications of a magazine produced by Jenson. At the year end Jenson had produced and despatched six of the 24 publications. The total cost of producing the magazine is estimated at $192,000 with each publication costing a broadly similar amount.

Required: Describe how Jenson should treat each of the above examples in its financial statements (8 marks) in the year to 31 March 2012. (25 marks) Question 21 XYZ

A lessor, ABC, leases an asset, which it purchased for $4,400, to XYZ under a finance lease. It estimates that its residual value after five years will be $400 and after seven years will be zero. The lease is for five years at a rental of $600 per half year in advance, with an option of two more years at nominal rental. The lease commences on 1 January 2011. The directors of XYZ consider that the asset has a useful life of seven years. The finance charge is to be allocated using the sum of digits (“rule of 78”) method. Title to the asset will pass to XYZ at the end of seven years if the option is exercised. It is likely that it will be. Required: (a)

Show the relevant extracts from the accounts of XYZ at the year-end 31 December 2011. (9 marks)

(b)

Show the allocation of the finance charge for XYZ using the actuarial before tax method (using the interest rate implicit in the lease). Compare this with the sum of the digits (5 marks) allocation in (a) above.

The rate of interest implicit in the lease is 7.68% per half year. (14 marks)

14


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 22 SNOW

On 1 January 2011, Snow entered into the following finance lease agreements: (a)

Snowplough

To lease a snowplough for 3 years from Ice. The machine had cost Ice $35,000. A deposit of $2,000 was payable on 1 January 2011 followed by 6 half yearly instalments of $6,500 payable in arrears, commencing on 30 June 2011. Finance charges are to be allocated on a sum of digits basis. (b)

Snow machine

To lease a snow machine for 5 years from Slush. The snow machine cost Slush $150,000 and is estimated to have a useful life of 5 years. Snow has agreed to make 5 annual instalments of $35,000, payable in advance, commencing on 1 January 2011. The interest rate implicit in the lease is 8.36%. Required: Show the relevant extracts from the accounts of Snow for year ended 31 December 2011. (15 marks) Question 23 INTELLECTUAL INDIVIDUALS

Intellectual Individuals is a company involved in a wide range of activities. At 31 December 2011 it provided you with details of the following projects: Project Rico

This is the idea of the company’s flamboyant chairman, Bobby Bobov. The aim is to try and convert lead into gold. During the year expenditure of $332,000 has been incurred on trying to set up such a process, with no success to date. Project Mounsey

The company has for the last few years been trying to devise a miniature radio transmitter for golf balls. This will enable golfers to locate their balls when they are mis-hit into the rough. The company had no success until the end of 2008, when a breakthrough was made, although costs of $120,000 had been incurred to that date. The product went on sale at the end of 2010 after a further $200,000 expenditure had been incurred on cosmetic changes. The advertising budget is $100,000 a year for the three years commencing 1 January 2011. The product has achieved spectacular sales and profits. The company anticipates sales continuing for between five and fifteen more years from the end of the current year.


15

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Project Wellington

The company had found that an existing product could be used as a petrol additive which would cut fuel consumption by 50%. Various oil companies had expressed support for the product, and it was clear that it would be very popular with the public. Up to the end of 2009 a total of $400,000 had been spent refining the product to ensure that it works in all types of engine. The product was estimated to have a shelf life of ten years and has been successful since 2011. However, legislation proposed by the government during the current year to control exhaust emissions means that the product will have to be withdrawn from the market. Required: (a)

Write a memorandum to the chairman justifying the accounting treatment which the company should have adopted for each of the projects assuming that the prime aim is to (8 marks) match revenues to costs.

(b)

Disclose the note to the financial statements in respect of research development. (An (7 marks) accounting policy note is not required.) (15 marks)

Question 24 ROVERS (IASs 10, 37 & 38)

The directors of Rovers are reviewing the company’s most recent draft financial statements and the following points have been raised for discussion: (a)

Research and development

This year the company has begun a substantial programme of research and development. To spread the cost fairly over the years, the draft financial statements have been prepared on the basis that all such costs are to be capitalised and written off on the straight-line basis over three years, beginning in the year in which the expenditure is incurred. (5 marks) (b)

Provision/Contingent liability

An ex-director of the company has commenced an action against the company claiming substantial damages for wrongful dismissal. The company lawyers have advised that the exdirector is unlikely to succeed with his claim. The lawyers’ potential liabilities are:

– legal costs (to be incurred whether the claim is successful or not) – settlement of claim if successful

$000 50 500 ____ 550 ——

At present there is no provision or note for this contingency. (4 marks) Required: State with reasons whether or not you consider the accounting treatments in draft financial statements, as described above, are acceptable. Include in your answer, where appropriate, an explanation of the relevant provisions of IFRS. (9 marks)

16


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 25 LAMOND

Lamond, a limited liability company, is engaged in a number of research and development projects. Its accounting policy as regards research and development is to capitalise expenditure as far as allowed by IAS 38 “Intangible Assets”. At 30 June 2011 the following balances existed in the company’s accounting records: Project A

Development completed 30 June 2009. Total expenditure $200,000. Being amortised over five years on the straight line basis in accordance with the company’s standard policy. Balance at 30 June 2011: $120,000.

Project B

A development project commenced 1 July 2009. Total expenditure in the years ended 30 June 2010 and 30 June 2011 totalled $175,000. During the year ended 30 June 2012, it became clear that a competitor had launched a superior product and the project was abandoned. Further development expenditure in the year ended 30 June 2012 amounted to $55,000.

Project C

Development commenced 1 October 2010. Expenditure to date: Year ended 30 June 2011 Year ended 30 June 2012

$85,000 $170,000

All expenditure on Project C meets the criteria for capitalisation in IAS 38. Project D

In addition, research project D commenced on 1 July 2011. Expenditure to date (all research): Year ended 30 June 2012

$80,000

Required: (a)

State the conditions which must be met if development expenditure is to be recognised as (6 marks) an intangible asset.

(b)

Calculate the amounts which should appear in the company’s statement of profit or loss and statement of financial position for research and development for the year ended 30 (7 marks) June 2012.

(c)

Prepare the notes which IAS 38 requires in the financial statements for the year giving supporting figures for the items in the statement of profit or loss and statement of (7 marks) financial position. (20 marks)


17

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 26 ALLRIGHTS

Allrights is an old established company operating in the highly competitive business of manufacturing and marketing radios and television sets. A new board of directors is considering the draft accounts, prepared under the historical cost convention, for the year ended 31 March 2012. The main executive directors involved in the policy discussions are – – –

Stevie Striver Charlie Chatty Gordon Gloome

(managing) (sales) (production)

You are in attendance to give advice. A standard model radio has the following disclosed costs: Direct labour and material Bought-in components Factory overhead costs Royalty on sale payable to the owner of a patent

$ 38 5 8 2

For 1,000 radio sets, the other overhead costs are $14,000 made up as follows: Salary and space costs of executive responsible for production planning General office administration Selling and distribution costs, including a fixed $4 per set commission payable to salesmen

$ 4,000 2,500 7,500

The advertised selling price of the model has recently been reduced to $60 because of intensive competition. The three directors have expressed the following views on the most appropriate method of valuing the company’s closing inventories: (1)

Stevie Striver

“A most prudent approach is necessary, particularly as the company has a cash flow problem which means that the amount locked up in inventory should be kept as low as possible. I propose a valuation of $43 per set.” (2)

Charlie Chatty

“All the functions of the company are directed towards the production and sale of a good finished product and therefore I think each set should be valued at the total cost involved, including the other overhead costs.” (3)

Gordon Gloome

“$47 per set, because that’s what the production cost would have been if we’d been more efficient and kept in line with budgets.” Required: Draft, for inclusion in a report, your opinions on the views expressed by each director, stating the principles involved. (8 marks)

18


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 27 SAMPI (IAS 2) (a)

IAS 2 “Inventories” requires inventories of raw materials and finished goods to be valued in financial statements at the lower of cost and of net realisable value. Required:

(b)

(i)

Describe three methods of arriving at cost of inventory which are acceptable (5 marks) under IAS 2 and explain how they are regarded as acceptable.

(ii)

Explain how the cost of an inventory of finished goods held by the manufacturer would normally be arrived at when obtaining the figure for the (3 marks) financial statements.

Sampi is a manufacturer of garden furniture. The company has consistently used FIFO (first in, first out) in valuing inventory, but it is interested to know the effect on its inventory valuation of using weighted average cost instead of FIFO At 28 February 2012 the company had inventory of 4,000 standard plastic tables, and has computed its value on each side of the two bases as: Basis

FIFO Weighted average

Unit cost $ 16 13

Total value $ 64,000 52,000

During March 2012 the movements on the inventory of tables were as follows: Received from factory:

Date

8 March 22 March Revenue:

12 March 18 March 24 March 28 March

Number of units

3,800 6,000

Production cost per unit $ 15 18 Number of units 5,000 2,000 3,000 2,000

On a FIFO basis the inventory at 31 March was $32,400. Required: Compute what the value of the inventory at 31 March 2012 would be using weighted (5 marks) average cost In arriving at the total inventory values you should make calculations to two decimal places (where necessary) and deal with each inventory movement in date order. (13 marks)


19

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 28 WILLIAM

William, a company which designs and builds racecourses, commenced a four year contract early in 2008. The price was initially agreed at $12,000,000. Profit, which was reasonably foreseeable from the year ended 31 December 2008, is to be taken on a costs basis, and revenue is to be taken on a consistent basis. Relevant figures are as follows:

Costs incurred in year Anticipated future costs Work certified and invoiced to date

2008 $000 2,750 7,750 3,000

2009 $000 3,000 7,750 5,000

2010 $000 4,200 1,550 11,000

2011 $000 1,150 – 12,500

Required: Show how the above would be disclosed in the statement of profit or loss and statement of financial position of William for each of the four years ended 31 December 2011. (12 marks) Question 29 EARLEY

Earley is finalising its accounts for the year ended 31 December 2011. The following events have arisen since the year end and the financial director has asked you to comment on the final accounts: (a)

At 31 December 2011 trade receivables included a figure of $250,000 in respect of Nedengy. On 8 March 2012, when the current debt was $200,000, Nedengy went into receivership. Recent correspondence with the receiver indicates that no dividend will be paid to unsecured creditors.

(b)

On 15 March 2011 Earley sold its former head office building, Whitley Wood, for $2.7 million. At the year end the building was unoccupied and carried at a value of $3.1 million.

(c)

Inventories at the year end included $650,000 of a new electric tricycle, the Opasney. In January 2012 the European Union declared the tricycle to be unsafe and prohibited it from sale. An alternative market, in Bongolia, is being investigated, although the current price is expected to be cost less 30%.

(d)

Stingy, a subsidiary in Outer Sonning, was nationalised in February 2012. The Outer Sonning authorities have refused to pay any compensation. The net assets of Stingy have been valued at $200,000 at the year end.

(e)

Freak floods caused $150,000 damage to the Southcote branch of Earley in January 2012. The branch was fully insured.

(f)

On 1 April 2012 Earley announced a 1 for 1 rights issue aiming to raise $15 million.

Required: Explain how you would respond to the matters listed above. (13 marks)

20


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 30 ACCOUNTING TREATMENT TREATMENT

You have been asked to advise on the appropriate accounting treatment for the following situations arising in the books of various companies. The year end in each each case can be taken as 31 December 2011 and you should assume that the amounts involved are material in each case. (a)

At the year end there was a debit balance in the books of a company for $15,000, representing an estimate of the amount amount receivable from an insurance company for an accident claim. In February 2012, before the directors had agreed the final draft of the published accounts, correspondence with lawyers indicated that $18,600 might be payable on certain conditions.

(b)

A company has an item of equipment which cost $400,000 in 2008 and was expected to last for ten years. At the beginning of the financial year 2011 the carrying amount amount was $280,000. It is now thought that the company will soon cease to make the product for which the equipment was specifically purchased. Its recoverable amount is only $80,000 at 31 December 2011.

(c)

On 30 November a company entered into a legal action defending a claim for supplying faulty machinery. The company’s solicitors advise that there is a 20% probability that the claim will succeed. The amount of the claim is $500,000.

(d)

An item has been produced at a manufacturing cost of $1,800 against a customer’s order at an agreed price of $2,300. The item was in inventory at the year end awaiting delivery instructions. In January 2012 the customer was declared bankrupt bankrupt and the most reasonable course of action seems to be to make a modification to the unit, costing approximately $300, which is expected to make it marketable with other customers at a price of about $1,900.

(e)

At 31 December a company has a total potential liability of $1,000,400 for warranty work on contracts. Past experience shows that 10% of this cost is likely to be incurred, that 30% may be incurred but that the remaining 60% is highly unlikely to be incurred.

Required: For each of the above situations outline the accounting treatment you would recommend and give the reasoning of of principles involved. involved. The accounting treatment should refer to entries in the books and/or the year-end financial statements as appropriate. (12 marks)

©2012 DeVry/Becker Educational Educational Development Corp. All rights reserved.

21

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Assume the following tax rules in respect of questions 31 – 35: 

Transactions are only deductible for tax purposes when they are “booked”, i.e. double entered into statutory accounting records. This means that there is often little difference between accounting profit under local GAAP and the taxable profit. However, it is common practice for large companies to maintain a parallel set of records and accounts for reporting according to IFRS rules. These are notably different to the rules in the domestic tax code and as a result the accounting profit under IFRS can be very different from the taxable profit.



The tax code allows for the general application of the accounting principles of prudence and accruals, but it does state the following; 

Tax allowable depreciation is computed according to rules set out in the tax code.



Allowance for doubtful debts are only deductible under very strict and limited circumstances.



Interest is taxable/allowable on a cash basis.



Development expenditure is allowable for tax in the period in which it is incurred.



The government operates a system of incentive through the tax system known as “Investment Relief”. Under this system a company is able to claim a proportion of the costs of qualifying fixed assets, as being deductible, in excess of the normal depreciation rates which would result from adoption of IFRSs.



The tax code defines finance leases but the criteria in the code are stricter than those in IAS 17 with the result that a company may well account for a leas e as a finance lease when it is deemed an operating lease for tax purposes. The tax treatment for operating leases is to expense the rentals on an accruals basis.

Question 31 SHEP (I)

Shep was incorporated on 1 January January 2011. In the year ended 31 December December 2011 the company made a profit before taxation of $121,000 This figure was after a depreciation charge of $11,000. During the period Shep made the following capital additions: Plant Motor vehicles

$ 48,000 12,000

Tax allowances for the current year are $15,000. Corporate tax is chargeable at the rate of 30%. Required: (a)

Calculate the corporate income tax liability for the year ended 31 December 2011.

(b)

Calculate the deferred tax balance that is required as at 31 December 2011.

(c)

Prepare a note showing the movement on the deferred tax account and thus calculate the deferred tax charge for the year ended 31 December 2011

(d)

Prepare the note which shows the compilation of the tax expense for the year ended 31 December 2011.

22

©2012 DeVry/Becker Educational Educational Development Corp. Corp. All rights reserved.

STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 32 SHEP (II)

Continuing from the previous year. The following information is relevant for the year ended 31 December 2012: (a)

Capital transactions

Depreciation charged Tax allowances (b)

$ 14,000 16,000

Interest payable

On 1 April 2012 the company issued $25,000 $25,000 of 8% convertible loan stock. Interest is paid in arrears on 30 September and 31 March. (c)

Interest receivable

On 1 April Shep purchased debentures debentures having a nominal value value of $4,000. Interest at 15% per year is receivable on 30 September September and 31 March. The investment is regarded as a financial asset valued at amortised cost. (d)

Provision for warranty

In preparing the financial statements for the year to 31 December 2012, Shep has recognised a provision for warranty payments in the amount of $1,200. This has been correctly recognised in accordance with IAS 37 and the amount has been expensed. Shep operates in a tax regime where warranty expense is deductible only when paid. (e)

Fine

During the period Shep has paid a fine of $6,000. The fine is not tax deductible. (f)

Further information

The accounting profit before tax for the year was $125,000. Required: (a)


(b)


(c)

Prepare a note showing the movement on the deferred tax account and thus calculate the deferred tax charge for the year ended 31 December 2012.


23

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 33 SHEP (III)

Continuing from the previous year. The following information is relevant for the year ended 31 December 2013: (a)

Interest payable/Interest receivable

Shep still has $25,000 of 8% convertible loan stack in issue and still retains its holding in the debentures purchased in 2012. (b)

Provision for warranty

During the year Shep had paid out $500 in warranty claims and provided for a further $2,000. (c)

Development costs

During 2013 Shep has capitalised development expenditure of $17,800 in accordance with the provisions of IAS 38 (d)

(e)

Further information

Profit before taxation Depreciation charged Tax allowable depreciation Entertainment

$ 175,000 18,500 24,700

Shep paid for a large office party during 2013 to celebrate a successful first two years of the business. This cost $20,000. This expenditure is not tax deductible. Required: (a)


(b)


(c)


Question 34 SHEP (IV)

Using the information provided in “Shep III” answer, assume that the government changed the rate of tax to 28% during 2013. Required: (a)


(b)


(c)


24


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 35 BROKEN DREAMS

Broken Dreams, a manufacturing company, has consistently adopted a progressive policy towards deferred taxation. The accountant is, however, unsure of his next move and has turned to you for advice. The poor demented man supplies you with the following information in respect of the year ended 30 June 2012: (a)

The company made an accounting profit of $900,000.

(b)

Freehold properties were revalued from $240,000 to $300,000 in the period. The company has no intention of disposing of the properties.

(c)

The remaining non-current assets comprised plant and machinery. On 1 July 2011 this amounted to Tax written down value Carrying amount

$ 500,000 1,300,000

During the year to 30 June 2012 depreciation amounted to $260,000 and capital allowances of $175,000 were claimed. (d)

The company entered into a five year lease on 1 July 2011 for an item of plant with a useful economic life of ten years. The lease rentals (which have all been paid on time to date) were to be as follows:

Initial payment (1 July 2011) Rentals (30 June 2012, 2013, 2014, 2015, 2016) (e)

$ 110,000 50,000 per rental

Broken Dreams now realises that a programme of research and development is essential to set itself apart from its competition, and has adopted a policy of deferring development expenditure. In the current year (the first year in which deferrals have occurred) expenditure of $80,000 was deferred.

Required: Prepare the note to the statement of financial position at 30 June 2012 for deferred taxation on the basis of IAS 12 Income Taxes. (15 marks)


25

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 36 CONSOLIDATIONS (a)

Statements of financial position at 31 December 2010

Investment in S Sundry net assets

Ordinary share capital ($1 shares) Retained earnings

P $ 65,000 115,000 ———– 180,000 ———–

S $ – 55,000 ——— 55,000 ———

140,000 40,000 ———– 180,000 ———–

30,000 25,000 ——— 55,000 ———

P acquired the whole of the issued share capital of S for $65,000 on 31 December 2010. Required: Prepare the consolidated statement of financial position at 31 December 2010. (b)

(3 marks)




P $ 65,000 129,000 ———– 194,000 ———–

S $ – 62,000 ——— 62,000 ———

140,000 54,000 ———– 194,000 ———–

30,000 32,000 ——— 62,000 ———

Same facts as in part (a) above. Goodwill has been impaired by $4,000 since acquisition. Required: Prepare the consolidated statement of financial position at 31 December 2011,

26

(4 marks)


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (c)

P acquired 80% of ordinary share capital of S for $52,000 on 31 December 2010

Non-controlling interest is valued at their proportionate share of the subsidiary’s identifiable net assets; it is not credited with its share of goodwill.



P $ 52,000 115,000 ———– 167,000 ———–

S $ – 55,000 ——— 55,000 ———

127,000 40,000 ———– 167,000 ———–

30,000 25,000 ——— 55,000 ———

Required: Prepare the consolidated statement of financial position at 31 December 2010. (d)

(4 marks)




P $ 52,000 129,000 ———– 181,000 ———–

S $ – 62,000 ——— 62,000 ———

127,000 54,000 ———– 181,000 ———–

30,000 32,000 ——— 62,000 ———

Same facts as in part (c) above regarding the acquisition.. Goodwill has been impaired by $3,200 since acquisition. Required: (i)

Prepare the consolidated statement of financial position at 31 December 2011. (4 marks)

(ii)

The market price of a share in S on the date of acquisition was $2.15. Re-calculate consolidated retained earnings, goodwill and non-controlling interest if P had chosen to value non-controlling interest on acquisition at fair (4 marks) value. (19 marks)


27

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 37 HONEY Statements of financial position as at 30 June 2012 Assets Non-current assets Tangible assets Investments: 2,000 ordinary shares in Sugar at cost

Current assets

Equity and liabilities Equity Equity shares of $1 each Share premium account Retained earnings

Non-current liabilities: 10% Debenture loan Current liabilities

Honey $

Sugar $

27,000 2,000 ——— 29,000 25,000 ——— 54,000 ———

12,500 ——— 12,500 12,000 ——— 24,500 ———

20,000 6,000 9,000 ——— 35,000 12,000 7,000 ——— 54,000 ———

3,000 – 14,000 ——— 17,000 – 7,500 ——— 24,500 ———

Honey acquired its shares in Sugar more than five years ago when the balance on the retained earnings was $nil. There was no goodwill arising on acquisition. Statements of profit or loss for the year ended 30 June 2012

Revenue Cost of sales Gross profit Distribution costs Administrative expenses Operating profit Interest payable and similar charges Profit before taxation Tax Profit for the financial year Extract from the statement of changes in equity: Retained earnings brought forward Profit for the financial year Retained earnings carried forward

28

Honey $ 24,000 (9,000) ——— 15,000 (2,300) (1,500) ——— 11,200 (1,200) ——— 10,000 (3,000) ——— 7,000 ———

Sugar $ 30,000 (11,000) ——— 19,000 (1,300) (2,700) ——— 15,000 – ——— 15,000 (5,000) ——— 10,000 ———

2,000 7,000 ——— 9,000 ———

4,000 10,000 ——— 14,000 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Required: Prepare the consolidated statement of profit or loss and the consolidated statement of financial position of Honey for the year ended 30 June 2012. (12 marks) Question 38 HATTON

The following are the statements of financial position of Hatton and its subsidiary Slap as at 31 December 2011: Hatton

$ Assets Non-current assets Tangible assets Investments

Current assets Inventory Trade receivables Slap current account Cash at bank and in hand

$

157,000 70,000

73,200 82,100 14,700 8,000 ———– 178,000 ———– 405,000 ———–

Equity and liabilities Equity Equity shares of $1 each Retained earnings

Current liabilities


250,000 32,000 ———– 282,000 123,000 ———– 405,000 ———–

29

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Slap

$ Assets Non-current assets Tangible assets

$

82,000

Current assets Inventory Trade receivables Cash at bank and in hand

35,200 46,900 25,150 ———– 107,250 ———– 189,250 ———–

Equity and liabilities Capital and reserves Equity shares of $1each Share premium account Revaluation surplus Retained earnings

50,000 6,250 15,000 40,000 ———– 111,250 20,000

Non-current liabilities: 6% debentures Current liabilities Trade payables Hatton current account

50,000 8,000 ———– 58,000 ———– 189,250 ———–

Notes (1)

Hatton acquired 40,000 shares in Slap on 1 January 2010 for a cost of $58,000 when the balances on Slap’s reserves were $ Share premium account 6,250 Revaluation surplus – Retained earnings 10,000 Hatton also acquired $12,000 of Slap’s debentures at par on the same date.

(2)

Non-controlling interest is valued at their proportionate share of the subsidiary’s identifiable net assets; it is not credited with its share of goodwill. Half of the goodwill on acquisition has been impaired by 31 December 2011.

(3)

The current account difference is due to cash in transit.

Required: Prepare the consolidated statement of financial position as at 31 December 2011 of Hatton. (12 marks)

30


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 39 HAGGIS Statements of financial position at 31 December 2011

Assets Non-current assets Tangible assets Investments: Shares in Stovies at cost

Current assets

Equity and liabilities Capital and reserves Equity shares of $1 each Share premium account Retained earnings

Non-current liabilities 8% Debenture loans Current liabilities

Haggis $

Stovies $

33,000 12,500

20,000 –

4,500 ——— 50,000 ———

16,000 ——— 36,000 ———

10,000 5,000 6,000 ——— 21,000

4,000 – 13,000 ——— 17,000

20,000

9,000

9,000 ——— 50,000 ———

10,000 ——— 36,000 ———

On 1 January 2009 Haggis acquired 3,000 shares in Stovies. At that date the balance on Stovies’ retained earnings was $8,000. Non-controlling interest are valued at fair value, the fair value of the noncontrolling interest on acquisition was $3,800. Goodwill has been impaired by $1,000 since acquisition. Required: Prepare the consolidated statement of financial position of Haggis as at 31 December 2011. (12 marks)


31

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 40 HAMMER

The summarised statements of financial position of Hammer and Sickle as at 31 December 2011 were as follows: Hammer Sickle $ $ Assets Non-current assets Tangible assets 110,000 58,200 Investments 54,000 – Current assets Inventory Trade receivables Investments Current account – Hammer Cash at bank

Equity and liabilities Equity shares of $1 each Share premium account Revaluation surplus on 1 January 2011 Retained earnings on 1 January 2011 Profit for 2011 Trade payables Current account – Sickle

18,000 12,000 62,700 21,100 – 2,500 – 3,200 10,000 3,000 ———– ———– 254,700 100,000 ———– ———–

120,000 60,000 18,000 – 23,000 16,000 40,000 8,000 16,000 5,000 35,000 11,000 2,700 – ———– ———– 254,700 100,000 ———– ———–

The following information is relevant: (1)

On 31 December 2010, Hammer acquired 48,000 shares in Sickle for $54,000 cash.

(2)

The inventory of Hammer includes $4,000 goods from Sickle invoiced to Hammer at cost plus 25%.

(3)

A cheque for $500 from Hammer to Sickle, sent before 31 December 2011, was not received by the latter company until January 2012.

(4)

Non-controlling interest is valued at the proportionate amount of the identifiable net assets.

(5)

There has been no movement in the revaluation surplus of either company since the beginning of the year.

Required: Prepare the consolidated statement of financial position of Hammer and its subsidiary Sickle as at 31 December 2011. Any gain on a bargain purchase is to be treated in accordance with IFRS 3. (12 marks)

32


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 41 HUT

On 1 July 2010 Hut acquired 128,000 $1 ordinary shares of Shed. financial position have been prepared as at 31 December 2011:

Land at cost Plant at cost Cost of shares in Shed Inventory at cost Receivables Bank balance

The following statements of Hut Shed $ $ 80,000 72,000 120,000 80,000 203,000 – 112,000 74,400 104,000 84,000 41,000 8,000 ———– ———– 660,000 318,400 ———– ———– Hut $

$1 ordinary share capital Retained earnings Plant depreciation at 31 December 2011 Payables

Shed $

400,000 160,000 160,000 112,000 48,000 22,400 52,000 24,000 ———– ———– 660,000 318,400 ———– ———–

The following information is available: (1)

At 1 July 2010 Shed had a debit balance of $11,000 on retained earnings.

(2)

In fixing the bid price for the shares of Shed, Hut valued the land at $90,000. All Shed’s plant was acquired since 1 July 2010.

(3)

The inventory of Shed includes goods purchased from Hut for $16,000. Hut invoiced those goods at cost plus 25%.

(4)

Non-controlling interest is valued at the proportionate share of the identifiable net assets on acquisition; it is not credited with its share of goodwill. Goodwill has been impaired by $27,760 since the acquisition occurred .

Required: Prepare the consolidated statement of financial position of Hut as at 31 December 2011. (10 marks)


33

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 42 HAT

On 30 June 2008, Hat acquired 60% of the ordinary share capital and 20% of the preferred share capital of Shoe for $95,000 and $8,000 respectively. At that date Shoe had a retained earnings balance of $50,000 and a share premium account balance of $9,000. The following statements of financial position have been prepared as at 30 June 2012:

Assets Non-current assets Tangible assets Investments: Shares in group undertaking

Current assets

Equity and liabilities Capital and reserves Ordinary shares of $1 each Share premium account Retained earnings

Preferred shares of $1 each Current liabilities

Hat $

Shoe $

227,000 103,000 ———– 330,000

170,000 ———– 170,000

270,000 ———– 600,000 ———–

186,000 ———– 356,000 ———–

200,000 25,000 150,000 ———– 375,000

90,000 9,000 80,000 ———– 179,000

– 225,000 ———– 600,000 ———–

40,000 137,000 ———– 356,000 ———–

During the year to 30 June 2012 Hat transferred a tangible asset to Shoe for $50,000. The asset originally cost $100,000 three years ago (in the year to 30 June 2009) and had a useful economic life of five years. Shoe’s depreciation policy is 25% per year based on cost. Both companies charge a full year’s depreciation in the year of acquisition and none in the year of disposal. Non-controlling interest is valued at the proportionate share o f the subsidiary’s identifiable net assets; it is not credited with its share of goodwill. Required: Prepare the consolidated statement of financial position of Hat and its subsidiary as at 30 June 2012. The value of goodwill at the 30 June 2012 is $2,520. (15 marks)

34


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 43 HUMPHREY

The following are the statements of profit or loss for the year ended 30 September 2011 of Humphrey and its subsidiary Stanley: Humphrey Stanley $000 $000 Sales 1,100 400 Cost of sales (600) (240) ——– —– Gross profit 500 160 Distribution costs (60) (50) Administration costs (65) (55) ——– —– Operating profit 375 55 Investment income 20 5 Interest (25) (6) ——– —– Profit before tax 370 54 Taxation (160) (24) ——– —– Profit for year 210 30 ——– —– Extract from the statement of changes in equity: Retained profit brought forward 90 30 Retained profit for year 210 30 Dividends paid (100) (20) ——– —– Retained profit carried forward 200 40 ——– —– The following information is relevant: (1)

Humphrey acquired 80% of Stanley many years ago, when the reserves of that company were $5,000.

(2)

Total intra-group sales in the year amounted to $100,000, Humphrey selling to Stanley.

(3)

At the year end the statement of financial position of Stanley included inventory purchased from Humphrey. Humphrey had taken a profit of $2,000 on this inventory.

(4)

The investment income of Humphrey includes $16,000 from Stanley.

(5)

Goodwill of $10,000 has been fully written off prior to the current period.

Required: Prepare a consolidated statement of profit or loss for the year ended 30 September 2011. (10 marks)


35

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 44 HIGH

High acquired its 80% interest in the ordinary capital of Speed many years ago when Speed’s retained earnings were $4,000, for $10,000. There were no other reserves at that date. The following are the draft statements of profit or loss of High and Speed for the year ended 31 March 2012 prepared by an inexperienced bookkeeper: High Speed $ $ $ $ Revenue 274,500 181,250 Less Cost of sales 126,480 86,520 Distribution costs 67,315 42,885 Administration costs 25,555 17,295 ——— ——— (219,350) (146,700) ———– ———– 55,150 34,550 Bank deposit interest Profit before tax Income tax Profit after tax

Retained earnings brought forward Profit for year Retained earnings carried forward

250 ———– 55,400 (29,000) ———– 26,400 ———–

100 ———– 34,650 (15,100) ———– 19,550 ———–

28,000 26,400 ———– 54,400 ———–

17,250 19,550 ———– 36,800 ———–

The following information is also available: (1)

The inventory of High at 31 March 2012 includes goods purchased from Speed at a profit to that company of $700. Total intra-group sales for the year amounted to $37,500.

(2)

In October 2011 High sold plant, with a carrying value of $7,000, to Speed for $10,000. Depreciation has been provided by Speed at 10% on the cost of $10,000 (with a full year’s charge in the year of acquisition and none in the year of sale) in line with group policy.

(3)

Included in Speed’s administration costs is an amount for $3,500 in respect of management charges invoiced and included in turnover by High.

(4)

Speed’s issued share capital comprises of 10,000 50 cent ordinary shares.

Required: Prepare the consolidated statement of profit or loss for the year ended 31 March 2012. Ignore goodwill. (10 marks)

36


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 45 HAPPY

The following statements of profit or loss were prepared for the year ended 31 March 2012: Happy

$ Revenue Cost of sales Gross profit Operating costs Operating profit Add: Dividends receivable from quoted investments Profit before tax Income tax Profit after tax Extract from the statement of changes in equity: Retained earnings brought forward Profit for year Retained earnings carried forward

Sleepy

$

$

$

303,600 (143,800) ———– 159,800 (71,200) ———– 88,600 2,800 ———– 91,400 (46,200) ———– 45,200 ———–

217,700 (102,200) ———– 115,500 (51,300) ———– 64,200 1,200 ———– 65,400 (32,600) ———– 32,800 ———–

79,300 45,200 ———– 124,500 ———–

38,650 32,800 ———– 71,450 ———–

On 30 November 2011 Happy acquired 75% of the issued ordinary capital of Sleepy. Profits of both companies are deemed to accrue evenly over the year. Required: (a)

Prepare the consolidated statement of profit or loss for the year ended 31 March 2012. (10 marks) Ignore goodwill.

(b)

Explain why only four months’ of Sleepy’s results are included in the consolidated (3 marks) statement of profit or loss. (13 marks)


37

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 46 HALEY

The draft statements of financial position as at 31 December 2011 of three companies are set out below:

Assets Non-current assets Tangible assets Investments at cost

18,000 shares in Socrates 18,000 shares in Aristotle

Current assets

Equity and liabilities Equity shares of $1 each Retained earnings Non-current loans

Haley $000

Socrates $000

Aristotle $000

300 75 30

100 – –

160 – –

345 —— 750 ——

160 —— 260 ——

80 —— 240 ——

250 400 100 —— 750 ——

30 180 50 —— 260 ——

60 100 80 —— 240 ——

The reserves of Socrates and Aristotle when the investments were acquired were $70,000 and $30,000 respectively. Assume the investments were acquired ten years ago and that goodwill has been fully written off. Required: Prepare the consolidated statement of financial position as at 31 December 2011. Notes are not required. (10 marks)

38


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 47 HAMISH

Hamish holds 80% of the ordinary share capital of Shug (acquired on 1 February 2012) and 30% of the ordinary share capital of Angus (acquired on 1 July 2011). A director of Hamish has been appointed to the board of Angus to take an active part in the management of that company. Hamish had no other investments, and none of the companies has any preferred capital. The draft statements of profit or loss for the year ended 30 June 2012 are set out below:

Revenue Operating expenses Operating profit Dividends received

Income tax Profit after taxation

Extract from the statement of changes in equity: Dividends paid

Hamish $000 12,614 (11,318) ——— 1,296 171 ——— 1,467 (621) ——— 846 ———

500

Shug $000 6,160 (5,524) ——– 636 – ——– 636 (275) ——– 361 ——–

120

Angus $000 8,640 (7,614) ——– 1,026 – ——– 1,026 (432) ——– 594 ——–

250

Included in the inventory of Shug at 30 June 2012 was $50,000 for goods purchased from Hamish in May 2012 which the latter company had invoiced at cost plus 25%. These were the only goods sold by Hamish to Shug but it did make sales of $180,000 to Angus during the year. None of these goods remained in Angus’s inventory at the year end. Required: Prepare a consolidated statement of profit or loss for Hamish for the year ended 30 June 2012. There was no impairment of goodwill during the year. Notes are not required. (10 marks)


39

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 48 HYDROGEN

The draft statements of financial position of three companies as on 30 September 2011 are as follows: Hydrogen $ $ Assets Non-current assets Tangible assets 697,210 Investments: 160,000 shares in Sodium 562,000 80,000 shares in Aluminium 184,000 ———

Sodium

$

648,010

349,400

– – ———

– – ———

1,443,210 Current assets Inventory Trade receivables Cash at bank and in hand

495,165 385,717 101,274 ———

648,010 388,619 320,540 95,010 ———

982,156 ———— 2,425,366 ———— Equity and liabilities Equity shares Retained earnings

Non-current liabilities: Debentures Current liabilities: Trade payables

$

Aluminium $ $

349,400 286,925 251,065 80,331 ———

804,169 ———— 1,452,179 ————

600,000 200,000 1,050,000 850,000 ———— 1,650,000 ————

1,050,000

618,321 ———– 967,721 ———– 200,000 478,000 ———–

678,000

400,000

150,000

100,000

375,366 ———— 2,425,366 ————

252,179 ———— 1,452,179 ————

189,721 ———– 967,721 ———–

You are given the following additional information: (1)

Hydrogen purchased the shares in Sodium on 13 October 2006 when the balance on retained earnings was $500,000.

(2)

The shares in Aluminium were acquired on 11 May 2006 when retained earnings stood at $242,000. Included in the inventory figure for Aluminium is inventory valued at $20,000 which had been purchased from Hydrogen at cost plus 25%.

(3) (4)

Non-controlling interest is valued at the proportionate share of the identifiable net assets acquired; it is not credited with its share of goodwill. Goodwill in respect of the acquisition of Sodium has been impaired by $1,500 since the acquisition. The recoverable amount of the investment in Aluminium exceeds its carrying value and therefore there is no impairment to account for .

(5)

40

Included in the current liabilities figure of Hydrogen is $18,000 payable to Aluminium, the amount receivable being recorded in the receivables figure of Aluminium.


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Required: Prepare the consolidated statement of financial position and notes for Hydrogen as on 30 September 2011, together with your consolidation schedules. (16 marks) Question 49 PERIOD OF INFLATION

During a period of inflation many accountants believe that financial reports prepared under the historical cost convention are subject to the following major limitations: (a) (b) (c) (d) (e)

Inventories are undervalued. Depreciation is understated. Gains and losses on net monetary assets are undisclosed. Asset and liability values are unrealistic. Meaningful periodic comparisons are difficult to make.

Required: Explain briefly the limitations of historical cost accounting in periods of inflation with reference to each of the items listed above. (15 marks) Question 50 STANDARD

The summarised statements of financial position of Standard at 31 December 2010 and 2011 are as follows: 2011 2010 $ $ Issued share capital 150,000 100,000 Share premium 35,000 15,000 Retained earnings 41,000 14,000 Non-current loans 30,000 70,000 Payables 63,000 41,500 Bank overdraft – 14,000 Tax payable 33,000 21,500 Depreciation Plant and machinery 54,000 45,000 Fixtures and fittings 15,000 13,000 ———— ———— 421,000 334,000 ———— ————

Freehold property at cost Plant and machinery at cost Fixtures and fittings at cost Inventories Trade receivables Long-term investments Cash at bank


2011 $ 130,000 151,000 29,000 51,000 44,000 4,600 11,400 ———— 421,000 ————

2010 $ 110,000 120,000 24,000 37,000 42,800 – 200 ———— 334,000 ————

41

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Extract from the statement of changes in equity: Dividends paid in year

7,500

5,000

The following information is relevant: (a)

There had been no disposal of freehold property in the year.

(b)

A machine tool which had cost $8,000 (in respect of which $6,000 depreciation had been provided) was sold for $3,000, and fixtures which had cost $5,000 (in respect of which depreciation of $2,000 had been provided) were sold for $1,000. Profits and losses on those transactions had been dealt with through the statement of profit or loss.

(c)

The statement of profit or loss charge in respect of tax was $22,000.

(d)

The premium paid on redemption of the non-current loan was $2,000, which has been written off to the statement of profit or loss.

(e)

Interest received during the year was $450. Interest charged in the statement of profit or loss for the year was $6,400. Accrued interest of $440 is included in payables at 31 December 2010 (nil at 31 December 2011).

(f)

The government stock is a long term investment.

Required: Prepare a statement of cash flows for the year ended 31 December 2011, together with notes as required by IAS 7 Statement of Cash flows. (20 marks) Question 51 FALLEN

Fallen has prepared the following rough draft accounts for the year ended 31 December 2011: Statement of profit or loss

Revenue Cost of sales Gross profit Distribution costs Administration expenses Interest payable Operating profit before tax Taxation (35%) including deferred tax Profit after tax Extract from the statement of changes in equity Dividends

42

$000 11,563 (5,502) ——— 6,061 (402) (882) (152) ——— 4,625 (1,531) ——— 3,094 ——— 700


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Statements of financial position

31 December

Leasehold premises (net) Plant, machinery and equipment (net) Investments at cost Inventories Receivables Bank

2011 $000 6,600 5,040 2,406 2,880 2,586 – ——— 19,512 ———

2010 $000 5,700 3,780 2,208 1,986 1,992 576 ——— 16,242 ——— 31 December

Share capital (25 cent ordinary) Share premium Retained earnings Deferred taxation Non-current loan (10%) Provision for deferred repairs Payables Overdraft Income tax

2011 $000 2,280 2,112 9,108 202 1,240 1,202 1,416 222 1,730 ——— 19,512 ———

2010 $000 1,800 1,800 6,714 138 1,800 1,016 936 – 2,038 ——— 16,242 ———

The following data is relevant: (1)

The 10% non-current loan was redeemed at par.

(2)

Plant and equipment with a written down value of $276,000 was sold for $168,000. New plant was purchased for $2,500,000.

(3)

Leasehold premises costing $1,300,000 were acquired during the year.

Required: Prepare the statement of cash flows and supporting notes in accordance with IAS 7 Statement of Cash Flows for Fallen for 2011. (20 marks)


43

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Question 52 WITTON WAY

The following information has been extracted from the accounts of Witton Way: Statements of profit or loss for the year to 30 April

Turnover (all credit sales) Less Cost of sales Gross profit Other expenses Loan interest Profit before taxation Taxation Profit after taxation Extract from the statement of changes in equity: Dividends Statements of financial position at 30 April Assets Non-current assets Tangible assets

Current assets Inventories Trade receivables Cash

Equity and liabilities Capital and reserves Called-up share capital Retained earnings

Non-current liabilities Current liabilities

2011 $000 7,650 (5,800) ——— 1,850 (150) (50) ——— 1,650 (600) ——— 1,050 ———

300

2012 $000 11,500 (9,430) ——— 2,070 (170) (350) ——— 1,550 (550) ——— 1,000 ———

300

2011 $000

2012 $000

10,050 ———

11,350 ———

1,500 1,200 900 ——— 3,600 ——— 13,650 ———

2,450 3,800 50 ——— 6,300 ——— 17,650 ———

5,900 5,000 ——— 10,900 350 2,400 ——— 13,650 ———

5,900 5,700 ——— 11,600 3,350 2,700 ——— 17,650 ———

Additional information

During the year to 30 April 2012 the company tried to stimulate sales by reducing the selling price of its products and by offering more generous credit terms to its customers.

44


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Required: (a)

Calculate six accounting ratios, specifying the basis of your calculations, for each of the two years to 30 April 2011 and 2012 which will enable you to examine the company’s (9 marks) progress during 2012.

(b)

From the information available to you, including the ratios calculated in part (a) of the question, comment upon the company’s results for the year to 30 April 2012 under the (11 marks) heads of “profitability”, “liquidity” and “efficiency”. (20 marks)

Question 53 RAPIDO

You are an independent financial advisor and have been given the following details relating to Rapido: Summary statements of financial position

Assets Non-current assets Tangible assets

Current assets Inventory Trade receivables Cash and bank balances

Total assets Equity and liabilities Capital and reserves Equity shares Share premium account Retained earnings

Non-current liabilities Secured loans Current liabilities Trade and other payables Bank overdraft

Total liabilities and equity


31 December 2010 2011 Actual Budget $000 $000

2011 Actual $000

957 ———

1,530 ———

1,620 ———

205 305 175 ——— 685 ——— 1,642 ———

290 720 – ——— 1,010 ——— 2,540 ———

325 810 – ——— 1,135 —— 2,755 ———

800 200 280 ——— 1,280

800 200 420 ——— 1,420

800 200 460 ——— 1,460

(360)

(360)

505 255 ——— 760 ——— 2,540 ———

545 390 ——— 935 ——— 2,755 ———

– 175 187 ——— 362 ——— 1,642 ———

45

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Statements of profit or loss

Revenue Cost of sales Gross profit Administration and distribution Operating profit Interest payable

Taxation

Extract from the statement of changes in equity: Dividends

31 December 2010 2011 Actual Budget $000 $000 2,560 4,500 (1,700) (3,150) ——— ——— 860 1,350 (655) (880) ——— ——— 205 470 – (20) ——— ——— 205 450 (86) (202) ——— ——— 119 248 ——— ———

82

108

2011 Actual $000 5,110 (3,580) ——— 1,530 (1,084) ——— 446 (35) ——— 411 (182) ——— 229 ———

49

The opening inventory figure was $135,000 2010 actual and $210,000 2011 budget. Required: Using the above information and appropriate ratios, prepare a report for the board of directors of Rapido assessing the profitability, liquidity and solvency of the company and briefly suggesting the necessary action to be taken. (18 marks) Question 54 NOT FOR PROFIT

Not-for-profit (NFP) organisations share many characteristics with those organisations whose main aim is to generate profits. NFPs include government bodies, bodies, museums and charities. Required:

(5 marks)

(a)

Explain the main aims of an NFP and those of a profit orientated entity.

(b)

Discuss the different approaches that may be required when assessing the performance (5 marks) of an NFP organisation. (10 marks)

46


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Question 55 EARNINGS PER SHARE (a)

Consolidated statements of profit or loss for the year

2010 $ 80,500 (3,500) (28,000) 6,500 (3,500) ——— 52,000 ———

Profit before finance costs Preference dividend Taxation Share of profit of associate Non-controlling interest

2011 $ 85,400 (3,500) (31,600) 8,900 (3,900) ——— 55,300 ———

Capital structure $ Ordinary shares of 50 cents

100,000

Required: Earnings per share for the year ended 31 December 2011 (with c omparative). (b)

(2 marks)

Bonus issues

Consolidated statements of profit or loss as in part (a). Capital structure as in part (a), except that a bonus issue (stock dividend) was made on 1 February 2011 of 1 new bonus share for every 4 shares already held. Required: Earnings per share for the year ended 31 December 2011 (with c omparative). (c)

(2 marks)

New shares to new shareholders

Issued capital to 30 September 2011 $100,000 – ordinary 50 cent shares On 1 October 2011 the company issued 200,000 ordinary shares in order to acquire 90% of the issued ordinary share capital of S. Year 2011

Profit after tax

P $63,000

S $20,000

Year 2010 P $50,000

Required: Earnings per share for the year ended 31 December 2011 (with c omparative).


(2 marks)

47

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (d)

Rights issue

Profit after tax Year ended 31 December 2010 Year ended 31 December 2011

$40,000 $50,000

Capital (before rights issue) 200,000 × 50 cent ordinary shares On 1 October 2011 a rights issue of 1 for 4 at $3 per share was made. The price quoted on the last day cum rights was $3.60. Required: Earnings per share for the year ended 31 December 2011 (with c omparative). (e)

(3 marks)

Convertible debentures/loan stock

Shares in issue throughout $100,000 – ordinary 25 cent shares The company issued (in 2011) $100,000 8% loan stock convertible into ordinary shares on the following alternative bases: 31 December 2015 31 December 2016

$100 stock for 140 shares $100 stock for 120 shares

Profit after loan interest and tax Year ended 31 December 2010 Year ended 31 December 2011

$40,000 $50,000

Assume a marginal rate of tax of 33%. Required: Basic and diluted earnings per share for the year ended 31 December 2011 (with (3 marks) comparatives). (f)

Options

Shares in issue $100,000 – ordinary 25 cent shares Options have been granted granted to directors and certain senior executives. These give the right to subscribe for ordinary shares between 2014 and 2016 at 80 cents per share. Options were available in respect of 50,000 shares during the year ended 31 December 2011. The average fair value of one ordinary share during the year was $1.00 per share. Profit after tax for 2011 was $50,000. Required: Basic and diluted earnings per share for the year ended 31 December 2011.

(2 marks) (14 marks)

48


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 1 OSCAR (a)

Profit or loss for the year ended 31 March 2012

$000 Sales Operating costs $(140 + 960 – 150 + 420 + 210 + 16)

2,010 (1,596) ——— 414 95 ——— 509 (49) ——— 460 ———

Operating profit before interest Income from investments $(75 + 20) Profit before taxation Income tax Profit for year

Notes

(2) (1) (3)

Extract from statement of changes in equity: (not required by question) Opening retained earnings 180 Profit for year 460 Dividends (120) —— Closing retained earnings 520 —— Statement of financial position as at 31 March 2012

$000 Assets Non-current assets Tangible assets Investments

$000

530 580 ——

Notes

(4) (5) 1,110

Current assets Inventory Receivables

150 470 —— 620 —— 1,730 ——

Equity and liabilities Capital and reserves Share capital Retained earnings

Non-current liabilities Provisions for liabilities and charges Current liabilities


600 520 ——

(8) 1,120 196

(7)

414 ——— 1,730 ———

(6)

1001

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK The following notes form part of these accounts: Notes to the accounts for the year to 31 March 2012 (1)

Included in operating profit are the following items:

$000 Depreciation $(27 + 5) Directors’ emoluments (2)

32 45

Income from financial asset investments

$000 Listed financial asset investments Gain in value of investment

(3)

75 20 ——

Income tax

$000 Income tax based on the profits for the year at a rate of 33% Over provision for tax in the previous year

(4)

74 (25) —— 49 ——

Tangible assets – plant and machinery

$000 Cost at 1 April 2011 and 31 March 2012 Accumulated depreciation At 31 March 2011 Charge for the year $(27 + 5)

188 32 —— 220 ——

At 31 March 2012

(5)

750 ——

Carrying amount at 31 March 2012

530 ——

Investments

$000

The financial asset investments are classed as “Fair Value though profit or loss”, their fair value at 31 March 2012 was $580,000. The gain in value of $20,000 has been credited to profit or loss. (6)

Current liabilities

$000 Trade payables Income tax Bank overdraft

1002

260 74 80 —— 414 ——


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (7)

Provisions for liabilities and charges

$000 Pollution costs At 1 April 2011 Provided in the year

180 16 —— 196 ——

At 31 March 2012

(8)

Called up share capital

Ordinary shares of $1 each

Authorised $000

Issued $000

1,000 ———

600 ——–

Answer 2 MERCURY (a)

Statement of comprehensive income for the year ended 30 June 2012

$000 Revenue Opening inventory Purchases

Less closing inventory

$000

$000 3,000

450 2,030 _____ 2,480 (500) _____

Cost of sales

1,980 _____

Gross profit

1,020

Distribution costs (240 + (20% × (1,020 – 370)) + 30) Administrative expenses (205 + (5% × 900)) Other expenses (50+ 5 (W1)) Profit before interest and tax Finance costs Loan note interest (10% × 500) Preference dividend (7% × 500)

400 250 55 ___ 315 50 35 (85) ___

Profit before tax Income tax

230 55 ___

Profit after tax

175 ___


1003


Statement of changes in equity for the year ended 30 June 2012

Share capital $000

Balance at 1 July 2011 Bonus issue Profit for the period Ordinary dividend Balance at 30 June 2012

(c)

Share premium $000

250 100

180 (100)

Retained earnings $000

Total $000

70

500

______

_____

175 (25) _____

350 ––––––

80 –––––

220 –––––

175 (25) _____ 650 –––––

Statement of financial position as at 30 June 2012

Cost Tangible non-current assets Land Buildings Plant

$000 300 900 1,020 _____

Accumulated depreciation $000

2,220 _____ Current assets Inventory Trade receivables (600 – 30) Bank

180 500 ___ 680 ___ 500 570 110 _____

Total assets

Net book value $000 300 720 520 _____

1,540

1,180 _____ 2,720 _____

Capital and reserves 50 cent ordinary shares (250 + ( 2/3 × 250)) Share premium account (180 – 100) Retained earnings

350 80 220 _____ 650

Non-current liabilities 10% Loan notes 7% Preferred shares of $1 Current liabilities Trade payables Income tax Accrued expenses (50 + 30) Dividends

Total equity and liabilities

1004

500 500

900 55 80 35 _____

1,070 _____ 2,720 _____


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) WORKING (1)

Allowance for doubtful debts

5% trade receivables (5% × 600) Brought forward

$000 30 (25) __

Expense

5 ___

Answer 3 SULPHUR (i)

Statement of total comprehensive income for the year ended 30 June 2012

Profit or loss $ Revenue (530,650 – 1,880) Cost of sales (W1)

528,770 (363,960) _______

* Gross profit Other operating income (1,500 + 12,000)

164,810 13,500 _______

Distribution costs (W1) Administrative expenses (W1)

178,310 (48,126) (18,710) _______

* Profit before tax Income tax expense

111,474 (38,100) ______

* Profit for year

73,374

Other Comprehensive income Revaluation surplus

40,000 ______

Total comprehensive income for year

(ii)

113,374 ––––––

Statement of changes in equity

Share capital $

Balance at 1 July 2011 Comprehensive income Bonus issue

150,000

Revaluation surplus $

75,000 _______

______

160,030 73,374 (75,000) _______

225,000 _______

40,000 ______

158,404 _______


– 40,000

Retained earnings $

Total $

310,030 113,374 – _______ 423,404 _______

1005

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (iii)

Statement of financial position as at 30 June 2012

$ * ASSETS * Non-current assets Land and buildings (at valuation) Delivery vehicles (carrying amount) ($19,230 – $3,846) Factory plant and equipment (carrying amount) ($24,000 – $2,400)

$

390,000 15,384 21,600 _______ 426,984 30,000

Investments * Current assets Inventories Trade receivables ($15,690 – $460) Cash

29,170 15,230 410 ______

* Total assets

44,810 _______ 501,794 –––––––

* EQUITY AND LIABILITIES * Capital and reserves Issued ordinary capital Revaluation surplus Retained earnings

225,000 40,000 158,404 _______ 423,404

* Current liabilities Trade payables ($34,700 – $700) Accrued expenses Bank overdraft ($4,820 + $690 – $460) Income tax

34,000 1,240 5,050 38,100 ______

* Total equity and liabilities

78,390 _______ 501,794 –––––––

WORKING (1)

Cost analysis

Cost of sales $

Opening inventory 24,680 Purchases 298,400 Discount received (10) Closing inventory (29,170) Factory overheads (66,420 + 1,240) 67,660 Per trial balance Depreciation (as calculated in (a)) 2,400 _______ 363,960 _______

1006

Distribution $

Administrative $

44,280 3,846 ______

18,710 ______

48,126 ______

18,710 ______


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 4 CAYMAN Statement of total comprehensive income for the year ended 30 September 2011 Profit or loss

$000 * Revenue (7,400 – 12) * Cost of sales (W1)

7,388 (5,140) _____

* Gross profit * Distribution costs (W2) * Administrative expenses (W2)

2,248 (711) (871) ____

* Profit from operations * Finance cost (12% × $1m)

666 (120) ___

* Profit for the year

546

Other comprehensive income Revaluation deficit

(250) ___

Total comprehensive income

296 –––

WORKINGS (1)

Cost of sales

$000 Opening inventory Production costs Depreciation 80% × ([2% × $4m] + [20% × $6.4m]) Less: Closing inventory (780k – 5k + 8k)

695 4,140 1,088 (783) _____ 5,140 –––––

(2)

Cost classification

Distribution $000

Per list of balances Prepayments Accrued expenses Depreciation – buildings (10% × 2% × $4m) – plant and equipment (10% × 20% × $6.4m)


Admin $000

540 (60) 95

730 (30) 35

8 128 ___

8 128 ___

711 –––

871 –––

1007

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Statement of financial position at 30 September 2011

$000

$000

*ASSETS

*Non-current assets Property, plant and equipment (W3)

11,735

*Current assets Inventory (W1) Trade receivables (2,060 – 12) Prepayments (60 + 30)

783 2,048 90 ___

*Total assets

2,921 ______ 14,656 ––––––

*EQUITY AND LIABILITIES

*Capital and reserves Issued capital Share premium account Revaluation surplus Retained earnings

7,000 2,000 1,250 1,836 ______ 12,086

*Non-current liabilities Interest bearing borrowings/12% Loan (2018) *Current liabilities Trade payables Operating overdraft Accrued expenses (95 + 35) Interim dividend (14m × 2c)

1,000

1,120 40 130 280 ___

1,570 ______ 14,656 ––––––

Statement of changes in equity for the year ended 30 September 2011

Share capital $000

Share premium $000

Balance at 1 October 2010 5,000 ( β) 1,000 (β) Comprehensive income Dividends (14m × 2c) Issue of share capital 2,000 1,000 _____ _____ (4m × 50c and 25c) Balance at 30 September 2011 7,000 2,000 ––––– –––––

1008

Revaluation surplus $000

Retained earnings $000

1,500 (250)

1,570 546 (280)

Total $000

_____

_____

9,070 296 (280) 3,000 ______

1,250 –––––

1,836 –––––

12,086 ––––––


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) WORKINGS (3)

Property, plant and equipment

$000 Land Buildings Plant and equipment

(4,000 – 1,065 – 80) (6,400 – 1,240 – 1,280)

5,000 2,855 3,880 ______ 11,735 ––––––

Answer 5 NETTE

The “Conceptual Framework for Financial Reporting” provides a conceptual underpinning for the International Financial Reporting Standards (IFRS). The framework is in the process of being updated by the IASB and as at 2011 it is a mixture of the “old” framework document plus two new chapters that have been issued by the IASB as a replacement for sections of the old framework. IFRS are based on the Framework and its aim is to provide a framework for the formulation of accounting standards. If accounting issues arise which are not covered by accounting standards then the “Framework” can provide a basis for the resolution of such issues. The Framework deals with several areas:       

the objective of financial statements the underlying assumption the qualitative characteristics of useful financial information the elements of financial statements recognition in financial statements measurement in financial statements concepts of capital and capital maintenance

The Framework adopts an approach which builds corporate reporting around the definitions of assets and liabilities and the criteria for recognising and measuring them in the s tatement of financial position. This approach views accounting in a different way to most companies. The notion that the measurement and recognition of assets and liabilities is the starting point for the determination of the profit of the business does not sit easily with most practising accountants who see the transactions of the company as the basis for accounting. The Framework provides a useful basis for discussion and is an aid to academic thought. However, it seems to ignore the many legal and business roles that financial statements play. In many jurisdictions, the financial statements form the basis of dividend payments, the starting point for the assessment of taxation, and often the basis for executive remuneration. A statement of financial position, fair value system which the IASB seems to favour would have a major impact on the above elements, and would not currently fit t he practice of accounting. Very few companies fit this practice of accounting. Very few companies take into account the principles embodied in the Framework unless those principles themselves are embodied in an accounting standard. Some International Financial Reporting Standards are inconsistent with the Framework primarily because they were issued earlier than the Framework. The Framework is a useful basis for financial reporting but a fundamental change in the current basis of financial reporting will be required for it to have any practical application. The IASB seems intent on ensuring that this change will take place.


1009

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors” makes reference to the use of the “Framework” where there is no IFRS or IFRIC in issue. The standard says ‘in making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: 

the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and



the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the framework.’

Answer 6 LIMITATIONS

The following list includes some of the limitations of financial statements: 

Nowadays, financial statements prepared under a financial reporting framework (e.g. IFRS) contain very complex and detailed information. Most users will not be able to fully understand what the financial statements are trying to communicate. For example, accounting for financial instruments encompasses detailed rules, which even accountants may struggle to understand.



Decision-making processes undertaken by management require timely information on matters that are not incorporated in financial statements. Therefore financial statements are of limited use to management.



The values used in financial statements are mixed in nature. Some transactions and balances are accounted for at historic cost whilst others are incorporated at fair value. Without detailed knowledge of how these figures have been determined, their meaning can be difficult to construe.



The financial statements are mainly historic in nature and summarise what has happened, not what is going to happen. They cannot be used to make predictions about the future.



Many items are excluded from the financial statements. For example, many internallygenerated intangible assets (e.g. a brand name) can never be recognised in the statement of financial position of the reporting entity. The only way in which such assets can be recognised is if the entity is acquired, but even then they are recognised only in the consolidated statement of financial position of the acquiring company.



Management may be very creative in how information is presented in the financial statements. Much of the information which is required to be disclosed is subjective in nature and management may interpret the accounting requirements to portray information in a particular light. Enron is the “classic” example of management being creative and, in doing so, the financial statements not showing a realistic picture.



How the financial market perceives an entity cannot be recognised in the financial statements. The market value of a company is very different to the carrying value presented in the financial statements because market value reflects, for example, shareholders’ expectations of future returns.



It can be quite difficult to judge at what point revenue should be recognised. When complex contractual agreements are made between parties it may also be difficult to specify an appropriate amount of revenue to be included. Therefore the statement of comprehensive income may be inadequate in reflecting the amount of profit made in a period.

1010


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) 

Financial statements are drawn up at a specified point in time. A cut-off therefore has to be established to be able to prepare the financial statements. The point of cut-off could be in the middle of a very detailed or complex transaction or related transactions which again the financial statements may not be able to reflect fully.



From the end of the reporting period to when the statements are authorised for publication is usually a minimum of three months. A lot can happen in that three-month period, so the statements become out of date very quickly.



Many transactions take place between related parties. Although certain dis closures should be made regarding related party transactions it is still difficult for the financial statements to fully reflect the impact of these transactions.

Answer 7 ”THE FRAMEWORK” (a)

(b)

Main purpose 

To assist the Board of IASCF in developing future International Financial Reporting Standards (IFRSs) and reviewing existing ones



To promote harmonisation of regulations by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs



To assist national standard-setting bodies in developing national standards



To assist preparers of accounts in applying IFRSs and in dealing with topics that have yet to be covered by an IFRS.



To assist auditors in forming an opinion on whether the accounts comply with IFRS.



To assist users of financial statements in the interpretation of information contained in those statements.



To provide those who are interested in the work of the IASB with information about its approach to the formulation of standards.

1 per point to max 4

Status  

1

The Framework is not an IFRS hence it does not define standards. Nothing in the framework overrides any specific IFRS.

1

In a limited number of cases where a conflict between the framework and an IFRS arises, the IFRS prevails.

1 ___

max 2 ___


1011

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (c)

Underlying assumption ½ ½

Going concern 



Financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Therefore is assumed that the enterprise has neither intention nor need to liquidate or curtail materially the scale of operations. If such an intention or need exist, the financial statements may have to be prepared on a different basis (and the basis used is disclosed).

1 1

1 ___

max 2 ___

8 ___

Answer 8 REGULATORY FRAMEWORK

A regulatory framework has been defined as “a system of regulations and the means to enforce them, usually established by a governing body to regulate a specific activity.” Without such a framework the system would fail to function properly and ad hoc rules and regulations would emerge which individuals and bodies would not be able to understand fully. There would be no direction or guidelines governing the content, or rules, that should be followed and parties would devise their own rules. A regulatory framework is needed for financial reporting to ensure that all relevant parties understand exactly what should be reported by the entity, and how. The framework may be a set of rules and regulations detailing exactly what and to whom an entity should report or it may be a less formal framework providing guidance for reporting. Company law and/or accounting standards can be issued to create Generally Accepted Accounting Practice (GAAP) for reporting entities to follow when preparing their financial statements. There is a need for some form of regulatory framework in financial reporting to ensure there is consistency in accounting treatments so that comparisons can be made between financial statements (e.g. year-on-year and between companies). Under IFRS the IASB has issued the “Conceptual Framework for Financial Reporting”. This is a conceptual framework which is used by the IASB to assist relevant parties in the needs and requirements of users of financial statements. It is used in conjunction with International Financial Reporting Standards to form a set of principles with which reporting entities should comply when preparing and presenting their financial statements. The conceptual framework is not in itself a regulatory framework as there is no formal means of enforcing the issued standards, and as they are principles-based they are open to interpretation. Other GAAPs have formed regulatory frameworks in order to regulate the financial reporting activities of their members. UK GAAP is formed of company law issued by the UK government and accounting standards issued by the Accounting Standards Board. The ASB has a body within it, the Financial Reporting Review Panel, whose function is to “police” the financial statements issued by UK companies. It aims to ensure that published financial statements are prepared in conformity with the UK regulatory framework.

1012


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 9 FOUR CONCEPTS (a)

Entity concept

In accounting, it is necessary to define the boundaries of the entity concerned. In the case of a limited liability company, only transactions of that company must be included. There must be no confusion between the transactions of the company and the transactions of its owners and managers. If the entity concept is not followed, the profit, financial position and cash flow may all be distorted to the point where they become meaningless. A limited liability company is therefore a separate entity which can sue and be sued in its own name. (b)

Going concern concept

The going concern is that financial statements are prepared on the basis that the entity will continue for the foreseeable future – that there is no intention or necessity to liquidate or curtail the scale of operations. If the going concern concept is followed when it is not appropriate, assets may be overstated, liabilities may continue to be shown as non-current when the collapse of the going concern status of the entity renders them current liabilities, and the profit is likely to be overstated. (c)

Materiality

Information is material if its omission from, or misstatement in, the financial statements could influence the economic decisions of users. Materiality cannot always be measured in monetary or percentage terms, but a commonly used measure is 5% of normal pre-tax profit. Above that level, for example, the transaction would need to be disclosed in the financial statements. Materiality is not solely related to the size of a transaction; it would also be necessary to consider the nature of the transaction and the fact that the nature would give rise to an item being treated as material and require disclosure. If the materiality concept is not followed, financial statements could become confused by the inclusion of unnecessary detail of trivial matters, or could be rendered misleading by the exclusion of reference to important matters. (d)

Fair presentation (true and fair view)

Fair presentation really means that all figures in financial statements have been arrived at accurately when accuracy is possible (true) and that when judgement or estimation is needed it has been exercised without bias (fair). Compliance with generally accepted concepts and principles will normally result in fair presentation. Failure to present information fairly will obviously mean that users may be misled by the financial statements.


1013

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Answer 10 IASB (a)

(b)

Objectives 

To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their world-wide acceptance and observance.



To work generally for the improvement and harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements.

Producing an IFRS 

A Steering Committee is set up, chaired by a Board representative, and usually including representatives of at least three other countries.



The Steering Committee identifies and reviews all the accounting issues associated with the topic. These will include: 





The application of the IASB “Conceptual Framework for Financial Reporting” Review of existing national and regional accounting requirements and practice.

The Steering Committee then submits a Point Outline to the Board.



After receiving comments from the Board, the Steering Committee prepares and publishes a Draft Statement of Principles. Comments are invited from all interested parties during an exposure period, usually between four and six months.



The next stage is the preparation of a final Statement of Principles, which is submitted to the Board by the Steering Committee. This final Statement is used as a basis for preparing an Exposure Draft of a proposed IFRS. The final Statement of Principles is available to the public on request, but is not formally published.



The Steering Committee prepares a draft Exposure Draft for approval by the Board. After revision, and with the approval of at least 9 members of the board, the Exposure Draft is published. Comments are invited from all interested parties during an exposure period, usually six months.



The Steering Committee reviews the comments and prepares a draft IFRS for review by the Board. After revision, and with the approval of at least 9 members of the board, the IFRS is published.

During the process, the Board may decide to issue a Discussion Paper for comment, or to issue more than one Exposure Draft.

1014


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 11 OBJECTIVES (a)

Users

Information needs

(1)

(2)

(3)

Investors and their advisers

Employees

Lenders





the risk inherent in the company’s operations.



stability and survival of the company;



ability of the company to provide remuneration, employment opportunities and retirement benefits.



the solvency of the company;





(b)

performance of management in achieving profit growth while ensuring the continued solvency of the company;

profitability, to ensure payment of interest when due; asset values.

(4)

Suppliers and other creditors



information as to the solvency of the company and its ability to pay, probably over a shorter period than lenders.

(5)

Customers



information about the continuance of the company, especially if they have a long term involvement with it.

Achieving objectives

Users of financial statements are interested in three main areas in their use of company financial statements:   

profitability; solvency/liquidity; the risk of the operation.

The statement of comprehensive income provides a measure of profitability. However, the use of historical cost accounting means that the profit is often overstated as depreciation is often based on historical cost of the assets and inventory tends to be valued at an historic cost which does not match itself to the current revenue figure. The statement of financial position details of current assets and liabilities enable users to form a reasonable assessment of a company’s solvency, because they are reasonably reliably valued. Lack of information about the dates of payments to sundry accounts payable or receipts from sundry accounts receivable could affect the position. Users would be very interested in seeing the age analysis of the accounts receivable balances in order that they may make a more informed judgement on the solvency of the business. The leverage ratio (percentage of total assets financed by debt) provides a reasonably reliable assessment of the financial risk of the company’s operation.


1015

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Two ways in which the quality of information disclosed in financial statements could be improved:  

requiring regular revaluation of non-current assets; reducing the number of alternative accounting treatments allowed by accounting standards.

Answer 12 COMPARABILITY (a)

Meaning and types

Comparability means that users are able to draw conclusions about the performance or financial position of a business by relating amounts for a particular period to other relevant amounts. Possible types of comparison are with:   

figures for the same business for earlier periods; figures for other businesses for the same period; budgets or forecasts.

Tutorial note: Two types only required for full marks. (b)

Aid to comparability

The IASB’s Framework and the requirements of accounting standards aid comparability by: 

requiring the disclosure of accounting policies (IAS 1 Presentation of Financial Statements) and the effect of changes in them (IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors);



reducing or eliminating the number of possible alternative treatments for similar items available to businesses;



requiring businesses to treat similar items in the same way in each period and from one period to the next (unless a change is required to comply with accounting standards or to ensure that a more appropriate presentation of events or transactions is provided).

Answer 13 ADJUSTMENTS Internal memorandum To From Date

Members of the Board S Bean, Financial Accountant 5 February 2012

Re

Adjustments to depreciation

At the board meeting on 1 January 2011 it was decided to modify the depreciation charge on a number of assets of the company. Set out below is the effect that these modifications will have on the accounts for the year to 31 December 2011. (a)

Lathe

The lathe was purchased in 2005 and was originally being written off over an estimated useful life of 12 years. As at 1 January 2011 six of the years have elapsed with a further six years remaining. It was decided that the machine will now only be usable for a further four years.

1016


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) IAS 16 Property, Plant and Equipment requires that where the original estimate of useful life is revised, adjustments should be made in current and future periods (not in prior periods). I therefore propose that the unamortised cost of the asset should be charged to revenue over the remaining useful life of the asset. The carrying amount of $75,000 should therefore be charged over the remaining four years of useful life, giving an annual depreciation charge of $18,750. The revision is not a change in accounting policy, or an error. It is merely a refinement of an existing policy to reflect changed circumstances. It is therefore not appropriate to deal with any excess depreciation by adjusting opening retained earnings. (b)

Grinder

The grinder was purchased in 2008 and was originally being depreciated on a straight line basis. It has now been decided to depreciate this on the sum of digits basis. IAS 16 requires that depreciation methods be reviewed annually and if there is a significant change in the expected pattern of economic benefits, the method should be changed. Depreciation adjustments should be made in current and future periods. This change might be appropriate if, for instance, usage of the machine is greater in the early years of an asset’s life when it is still new and consequently it is appropriate to have a higher depreciation charge. If the change is implemented, I propose that the unamortised cost (the carrying amount) of the asset should be written off over the remaining useful life commencing with the period in which the change is made. The depreciation charge for the remaining life of the asset will therefore be as follows: Year

2011 2012 2013 2014 2015 2016 2017 ½ × 7 (7 + 1)

No of digits

7 6 5 4 3 2 1 —— 28 ——

7/28 × $70,000 6/28 × $70,000

Depreciation $ 17,500 15,000 12,500 10,000 7,500 5,000 2,500 ———– 70,000 ———–

Disclosure will need to be made in the accounts of the details of the change, including the effect on the charge in the year. (c)

Leasehold land

The revaluation model in IAS 16 allows groups of assets to be subsequently valued at a revalued amount, which will normally be its fair value. Where any item of property plant or equipment is revalued, the entire class to which the asset belongs should be revalued. Revaluations must be kept up to date. Where there are volatile movements in fair value, the revaluation should be performed annually. Where there are no such movements, revaluations every three to five years may be appropriate.


1017

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Accumulated depreciation at the date of revaluation is either (i)

restated proportionately with the change in the gross carrying amount so that the carrying amount after the revaluation equals the revalued amount (e.g. where revaluations are made to depreciated replacement cost using indices)

(ii)

eliminated against the gross carrying amount of the assets and the net amount restated to the revalued amount of the asset (e.g. where buildings are revalued to their market value).

IAS 16 requires that the subsequent charge for depreciation should be based on the revalued amount. The annual depreciation will therefore be $62,500 (i.e. $1,500,000 divided by the 24 years of remaining life). There will then be a difference between the revalued depreciation charge and the historical depreciation charge. The resulting excess depreciation may be dealt with by a movement in reserves (i.e. by transferring from the revaluation surplus to retained earnings a figure equal to the depreciation charged on the revaluation surplus each year). Additional disclosures required under IAS 16 include the following: (i)

the basis used to revalue the assets (e.g. market value based on existing use)

(ii)

the date of the revaluation

(iii)

whether an independent valuer was involved

(iv)

the nature of any indices used

(v)

the carrying amount of each class of property plant and equipment that would have been included at historical cost

(vi)

the revaluation surplus, indicating movements for the period and any restrictions on the distribution of the balance to shareholders (many countries prohibit the distribution of revaluation surpluses to shareholders as they are “unrealised” profits).

Answer 14 SPONGER MEMORANDUM To From Date

Philip Tislid, Sponger Bill Smith, Accountant 27 January 2012

Subject Accounting for government assistance received by Sponger

IAS 20 Accounting for Government Grants and Disclosure of Government Assistance requires that no grant should be recognised until there is reasonable assurance that the entity will comply with the conditions attaching to them and that the grants will actually be received. The IAS covers forgivable loans and non-monetary grants.

1018


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (a)

Research and development grants

The general principle of IAS 20 is that grants should be matched in the statement of comprehensive income with the expenditure to which they are intended to contribute. They should not be credited directly to shareholders’ interests. Cuckoo project

The expenditure on the Cuckoo project is research and therefore is written off as incurred under IAS 38 Intangible Assets. Accordingly the grant of $10,000 should be credited to profit or loss in the years in which the expenditure to which it relates is incurred. Hairspray project

The Hairspray project appears to satisfy the criteria of IAS 38 for deferral of development expenditure, and thus may be carried forward as an intangible fixed asset until commercial production commences (2013). It will then be amortised to profit or loss over the period of successful production. Technological and economic obsolescence create uncertainties that restrict the time period over which development costs should be amortised. The grant of $10,000 relating to it will therefore also be carried forward as deferred income, and will be released to profit or loss in line with the amortisation of the development expenditure. The balance of $10,000 will appear in the statement of financial position at 31 December 2011 under current and non-current liabilities as appropriate. Grants relating to assets can either be:

(b)

–

set up as deferred income and recognised in profit or loss over the useful life of the asset (to match the depreciation charge), or

–

deducted from the carrying amount of the asset in the statement of financial position (i.e. being recognised over the useful life of the asset by means of a reduced depreciation charge).

Compensation grant

IAS 20 states that grants receivable as compensation for expenses or losses already incurred should be recognised as income when they become receivable. They cannot be taken back to prior periods, as their receipt does not constitute correction of a prior period error or a change in accounting policy. Disclosure may be appropriate. However, in order to apply the prudence concept, the standard requires grants not to be recognised until conditions for receipt have been satisfied and receipt is reasonably assured. In this situation the conditions for receipt, namely filling out the triplicate form, have not been fully satisfied and therefore the grant should not be recognised in the accounts at 31 December 2011.


1019


“Vocational experience” grant

(i)

General accounting

This grant relates not to specific expenditure but to a non-financial objective. The terms of the grant suggest that it is effectively earned at a rate of $1,000 per visit, and therefore it should be credited to income at that rate. In the year to 31 December 2011 the credit will be $7,000. Amounts to be recognised in future periods will be carried forward as deferred income. The grant is not spread over the life of the bus as it does not specifically contribute to its cost. (ii)

Repayments

A repayment of $5,000 is due relating to unfulfilled visits in the current year and should be provided for. However, as this is expected to recur in each of the next four years, provision also needs to be made in total for repayments relating to 20 further unfulfilled visits. A contingent liability should be disclosed relating to the potential repayment of the grant relevant to the visits in future periods which are expected to take place. (iii)

Amounts for the financial statements Profit or loss

Grants received (7

$ 7,000

× $1,000)

Statement of financial position

Current liabilities (1 × 7 × $1,000) Non-current liabilities (3 × 7 × $1,000) Provision for grant repayment (5 × 5 × $1,000)

$ 7,000 21,000 25,000

Note to the financial statements

There is a contingent liability in respect of potentially repayable government grants of $28,000. Answer 15 FAM Accounting policies

(a)

Property, plant and equipment is stated at historical cost less depreciation, or at valuation.

(b)

Depreciation is provided on all assets, except land, and is calculated to write down the cost or valuation over the estimated useful life of the asset. The principal rates are as follows: Buildings Plant and machinery Fixtures and fittings

1020

2% per year straight line 20% per year straight line 25% per year reducing balance


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Non-current asset movements

Cost/valuation

Cost at 1 January 2011 Revaluation adjustment Additions Reclassifications Disposals Cost at 31 December 2011 2011 valuation Depreciation At 1 January 2011 Revaluation adjustment Provisions for year (W2) Disposals

At 31 December 2011

Carrying amount At 31 December 2011

At 31 December 2010

Land Plant Fixtures, Payments on and and fittings, account and buildings machinery tools and assets in the equipment course of construction

$000

$000

Total

$000

$000

390 – 40 – (41) —— 389 ——

91 2,994 – 600 73 (W1) 267 (100) – – (318) —— ——— 64 2,043 1,500 —— ———

140 – 70 (31) —— 179 ——

– – – – —— – ——

678 (80) 385 (226) —— 757 ——

1,583 929 ——— ———

210 ——

64 ——

2,786 ———

820 1,155 ——— ———

250 ——

91 ——

2,316 ———

900 1,613 600 – – 154 100 – – (277) ——— ——— 100 1,490 1,500 ——— ——— 80 (80) 17 – —— 17 ——

458 – 298 (195) —— 561 ——

$000

Land and buildings have been revalued during the year by Messrs Jackson & Co on the basis of an existing use value on the open market. The corresponding historical cost information is as follows: Land and buildings $000 Cost Brought forward Reclassification

Carried forward Depreciation Brought forward Provided in year

Carried forward Carrying amount


900 100 ——— 1,000 ——— 80 10 ——— 90 ——— 910 ———

1021

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK WORKINGS (1)

$000 53 20 —— 73 ——

Additions to assets under construction Deposit on computer

$000 (2)

600

+ (100 × 2%) 17 40 2% straight line depreciation is equivalent to a 50-year life. The buildings are 10 years old at valuation and therefore have 40 years remaining.

Depreciation on buildings

Depreciation on plant (1,613 + 154 – 277)

× 20%

Depreciation on fixtures (390 + 40 – 41 – 140 + 31)

298

× 25%

70

Answer 16 STOAT To:

Directors of Stoat

From:

Financial adviser

Depreciation and non-current asset valuation

You asked me to explain certain aspects of the accounting regulations governing depreciation and noncurrent asset valuations, and I have set out the information you need below. (a)

Purpose of depreciation and factors affecting its assessment

The purpose of depreciation is to spread the cost of a non-current asset with a life of several years as fairly as possible over the periods expected to benefit from its use. The factors affecting the assessment of the useful life of an asset are:    

(b)

expected usage; expected physical wear and tear; technological obsolescence; legal or similar limits on the use of the asset, such as the expiry dates of related leases.

Evidence that depreciation rates might be too low

[Three from]     

1022

Substantial losses on sale of non-current assets; Frequent scrapping of assets before end of useful lives assessed; Advice from auditors; Information from other companies’ financial statements; Information from trade associations.



(d)

Disclosures if depreciation methods are changed 

The effect, if material, in the year of change;



The reason for the change.

Revaluation of non-current assets

IAS 16 “Property, Plant and Equipment” allows the revaluation of non-current assets other than goodwill if a policy of revaluation is adopted. IAS 16 requires that if any asset of a class is revalued, all assets of that class must be revalued. Once revaluation is adopted, values must be kept up to date. Any change in value will be recognised in equity as a revaluation surplus, after being included in other comprehensive income. Any surplus, or loss, cannot be reclassified when the asset is disposed, although a reserve transfer can be made from the revaluation surplus to retained earnings. There are extensive disclosure requirements, including the basis of valuation, whether an independent valuer was involved and the date and amounts of valuations. Answer 17 SUBSTANCE OVER FORM

Preparing accounts on a substance over form basis means that they should reflect the commercial effect of transactions rather than their legal form. The arguments for and against this treatment are discussed below. Framework The IASB’s Conceptual Framework for Financial Reporting notes that financial statements are frequently described as showing a “true and fair view” (as in the UK), or as “presenting fairly” the financial position (as in the US). Many other countries adopt similar requirements for financial statements, particularly in Europe where the requirements of directives state that all member states’ financial statements should give a true and fair view. This is, for example, translated as “donner une image fidele” in France. Some countries interpret this as meaning in accordance with their own legislation, particularly in Germany, but generally speaking, legislatures and accounting standard setters increasingly recognise an overriding notion of truth and fairness. One of the fundamental qualitative characteristics required by the Framework is that of “Faithful Representation”. To faithfully represent a transaction the entity must reflect the economic reality (substance) rather than its legal form, if there is a difference. It gives the example of an entity disposing of an asset in such a way that the documentation purports to pass legal ownership to a third party, but where agreements exist to ensure that the entity continues to enjoy the future economic benefits embodied in the assets. In such circumstances the reporting of a sale would not represent faithfully the transaction entered into.


1023

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Application of the principle

IAS 17 Leases requires that finance leases be capitalised in the statement of financial position where certain conditions are met. In such cases the legal form of the transaction is that the lessor retains the legal title to the assets. The economic substance of the transaction however is that the lessee is the true “owner” of the asset as the lease transfers substantially all the risks and rewards incident to the ownership of the asset. The lessee therefore includes it in its financial statements. Not to do so would distort gearing ratios. IFRS 10 Consolidated Financial Statements requires that group accounts be prepared to show information about the group as that of a single entity, without regard for the legal boundaries of the separate legal entities. IAS 32 Financial Instruments: Presentation recognises that some financial instruments take the legal form of equity, but are liabilities in substances and requires that classification of an instrument is made on the basis of an assessment of its substance when it is first recognised. IAS 1 Presentation of Financial Statements states the importance of prudence, substance over form and materiality in the selection and application of accounting policies and the preparation of financial statements. Other areas where the principle applies include the factoring of receivables and the sale and repurchase of inventories. Factored debts are “sold” to a third party in exchange for a proportion of the carrying amount of the debt. Such agreements vary considerably in their nature and some leave the entity with most of the risks associated with the collection of the receivables. In such circumstances it may be appropriate to keep the receivables on the face of the statement of financial position and recognise the cash received from the factor as a liability, rather than accounting for the transaction as a sale of the receivable. Consistency, comparability and subjectivity

Another argument put forward against the use of substance over form is that it introduces yet more subjectivity into accounts (the judgment of the true substance). It is argued that if transactions were accounted for on a legal basis, there would be greater certainty and objectivity in the preparation of accounts and hence more comparability. It may be true that the certainty of legal form would increase, but this does not mean the comparability. In fact most accountants would say that it is the substance over form principle which is designed to increase comparability by making transactions of a similar nature treated in similar ways. It may introduce another element of subjectivity, but accounts preparation inevitably does involve many judgmental decisions. It is these judgments that make accounts fair as well as true, and hence duly comparable. Accounting or extra disclosure

A further argument against the proposal is that it may not be essential to account on the basis of substance over form, but merely to provide additional disclosure. The argument here rests on whether any amount of disclosure can compensate for a transaction which is fundamentally misleadingly treated in the accounts. If additional disclosure is not so much addition as contradictory to the accounting treatment, then surely the result is confusing the user and hence still misleading and not true and fair.

1024


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Conclusion

Broadly speaking, the Anglo-Saxon world regards economic substance as being more important than legal form. This is at least in part due to the historical separation of fiscal and financial accounting. Countries with civil, as opposed to common law legal traditions place more emphasis on the fiscal correctness of financial statements. With increasing globalisation of capital markets the trend, at the moment seems to be away from legal form, and towards economic substance. However, the inherent uncertainties in the notion of economic substance mean that there is an ever increasing volume of accounting standards on what exactly is meant by “substance” as it is very easily abused. Answer 18 HUGHES AND CUSTOM CARS (a)

Hughes

The Conceptual Framework for Financial Reporting states that financial statements should show the economic substance of transactions over their legal form. Hughes has entered into a sale and repurchase agreement with the Wodwo Bank. Hughes has received $36 million now. If Hughes exercises its call option after one month, it will repurchase the inventory at a premium of $1.8 million which represents a finance charge of 5% for the month. If the Wodwo Bank exercises its put option after two months, Hughes will repurchase the inventory at a premium of $3.7 million which represents a finance charge of 5% for each of the two months. It is highly likely that one or other of the options will be exercised. Taking the transactions as a whole, the commercial substance is that of a short-term loan secured on the inventory. The inventory should remain in inventory at $30 million at year end. $36 million should be shown in current liabilities. The interest payable to 31 December 2011 of $1.2 million ($1.8m × 21/31) should be charged to profit or loss and added to the liability in the statement of financial position. (b)

Custom Cars

Unless Sigma’s cash contribution is very substantial (say 80% as opposed to 20% of the expenditure incurred by Custom Cars), there should be no doubt that Custom Cars owns the extension (and has the risks and rewards of ownership). The fittings supplied free of charge by Sigma could be excluded from the statement of financial position on the grounds that they are not owned by Custom Cars. Also their economic benefit is primarily to Sigma in promoting Sigma’s product. Answer 19 PERSEUS (a)

Adjustments to be made

(i)

For inventory



The opening balance of retained earnings should be adjusted in the s tatement of changes in equity.



Comparative information should be restated, unless it is impracticable to do so


1025


IAS 8 required disclosure



The nature of the error.





(b)

The amount of the correction for the current period and for each prior period presented. The fact that comparative information has been restated or that it is impracticable to do so.

Current assets

$ 4,249,800 2,674,300 773,400 940,000

Inventory (W1) Trade receivables (W2) Prepayments Cash at bank WORKINGS (1)

Inventory

$ As originally taken (i)

(ii)

Reduction to net realisable value Original cost Net realisable value (10,400 – 600) Goods on sale or return at cost

16,000 9,800

$ 4,190,000

(6,200) 66,000 _________ 4,249,800 _________

(2)

Trade receivables

As originally stated Accounts receivable ledger Goods on sale or return Less:

Less:

Debts written off

2,980,000 88,000 _________ 2,892,000 92,000 _________ 2,800,000

Less: Allowance for doubtful debts 5% × $2,800,000

Accounts payable ledger balances

140,000 _________ 2,660,000 14,300 _________ 2,674,300 _________

1026



Prepayments

$ As originally stated Payments on account Less: Commission due 2/102 × $1,101,600

$ 770,000

25,000 21,600 ______

3,400 _______ 773,400 _______

Answer 20 JENSON (a)

Critical event

Problems of revenue recognition in accounting arise from the requirement to produce financial statements for specific periods of reporting. Consequently accounting principles and practices have evolved which focus on when and at what value transactions should be recognised in financial statements. Annual reporting creates artificial periods that are not related to the natural operating cycle of an entity. A typical operating cycle (for a manufacturing company) would comprise of acquiring goods or raw materials from which a saleable product is manufactured, at some stage orders would be obtained for these goods and they would then be delivered to and accepted by customers. The collection of cash for these sales is often considered to be the end of this process, but it should be borne in mind that in some cases further risks can exist in relation to product warranties or other after-sale commitments. The critical event theory argues that there comes a stage in the operating cycle, beyond which there is either no further significant risks or uncertainties or that they can be estimated with sufficient accuracy to enable revenue to be recognised. The point at which there remain no further risks is referred to as the critical event. For most transactions the critical event is synonymous with full performance, but in theory, the critical event could occur at almost any point in the operating cycle. The traditional view of determining profit involves matching revenues earned with the related cost of earning those revenues. This involves the use of the accruals, matching and prudence concept, with prudence being closely related to the principle of realisation. Under this approach the statement of financial position is effectively a statement of unexpired costs and un-discharged liabilities. In its Framework, the IASB advocates a different approach; it takes a “balance sheet” approach to the process of revenue recognition. It chooses to define the elements of financial statements, principally assets and liabilities, and uses these to determine income (gains) and expenses (losses). Recognition of gains and losses takes place when there is an increase or decrease in equity other than from contributions to, or withdrawals of, equity. Thus increases in economic benefits in the form of enhancements of assets or decreases in liabilities result in income, and decreases in economic benefits in the form of outflows or depletions of assets or incurrences of liabilities results in losses (expenses). Recognition is the incorporation of an item in the financial statements. It involves the depiction of the item in words and at a monetary amount. For a transaction to be recognised as giving rise to a new asset or liability, or to add to an existing one, it must meet the following recognition criteria: (i)

it is probable that any future economic benefit associated with the item will flow to the entity; and

(ii)

the item has a cost or value that can be measured with reliability.


1027


Acquisition of goods or raw materials:

For most industries this event is a routine occurrence that could not be considered as critical. However where this is a very difficult task, perhaps due the rarity or scarcity of materials, then it may be critical. A rare practical example of this is in the extraction of precious metals e.g. gold mining. Because gold is a valuable and readily marketable commodity the real difficulty in deriving income from it is obtaining it, so this is the critical event. A logical progression of this point would be to say that any industry whose products are normally sold on a commodities market could consider the obtaining of the product to be the critical event. Such industries may include, for example, growing coffee beans. During the manufacture or production of goods:

Again for most industries this is not the critical event. Normally there would be far too many uncertainties remaining in the operating cycle. For example the manufacturing process could be flawed and therefore not produce saleable goods. Even if the goods are manufactured properly, it does not necessarily mean someone will buy them. It could be argued that where there is a firm order for the goods this would overcome some of the uncertainties, but it would still be imprudent to recognise firm orders as sales. There are however some industries where, due to a long production period, revenues are recognised during the production or manufacturing period. The most common example of this is the percentage of completion method of profit recognition for construction contracts under IAS 11 “Construction Contracts”. Where companies adopt this approach to revenue (and profit) recognition it is generally referred to as the “accretion approach”. Delivery/acceptance of the goods:

For the vast majority of businesses this is the point at which revenue is recognised, and it usually coincides with the transfer of the legal title to the goods and represents the point of full performance. Although there may be some uncertainties beyond this point (for example, the goods may prove to be faulty or the customer may not be able to pay for them), these can usually be quantified and provided for with reasonable accuracy based on past experience. When a condition has been satisfied after the goods have been delivered:

The most common occurrence of this type of sale is where the customer has the right to return goods and not incur a liability for them. In most cases the condition is the passage of time (e.g. goods may be returned within three months of delivery), but it may also occur in relation to some other event such as their subsequent resale to another party. Traditionally with this type of sale, its recognition is delayed until the condition has been met, however one could argue that the substance of these transactions should be considered. Although a customer may have the right to return goods, if it can be demonstrated that in practice this never actually occurs, then recognising the sale before the expiry of the return period could be justified. Another example of this type of condition is where the terms of a sale of say an item of equipment required the seller to install and test the equipment. If this involves significant expense or risk then recognition of this type of sale would be deferred until completion of the installation.

1028


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Collection of cash:

For most (credit) sales the risk of non-payment is relatively low. Revenue recognition would only be delayed to the point of receipt of cash if its collection was perceived to be particularly difficult or risky. Revenues (and profits) from high risk credit sale agreements may be examples of this. Another possibility is sales made to risky overseas countries/customers, particularly if they are in non-convertible currencies or the country has strict exchange controls. Expiry of guarantees/warranties:

This serves as a reminder that not all the risks and associated costs are resolved when cash is received. For some products such costs can be significant (e.g. with the supply of new motor vehicles or rectification work on construction contracts); however it is normally possible to reliably estimate these costs and provide for them at the time of the sale. It would be unrealistic, and may cause distortions, if revenues were not recognised until such obligations had elapsed. (c)

Transactions

(i)

Although this agreement may be worded as a sale, and even if the title to the goods passes to Wholesaler, it seems clear that this is not a sale – it is a secured loan. Therefore Jenson should not treat the income from Wholesaler as revenue, but instead as a loan in its statement of financial position. The goods should continue to be recognised as inventory, and accrued interest of $3,150 ($35,000 × 12% × 9/12) should be provided for against profit or loss.

(ii)

It appears that the on-going fees after the first initial payment are insufficient to cover Jenson’s servicing cost and provide a reasonable profit. In these circumstances IAS 18 “Revenue” requires part of the initial fee of $50,000 to be deferred and recognised in future periods as the servicing costs are incurred. As there is a requirement to earn a (reasonable) profit of 20% on revenues, with ongoing servicing costs of $8,000, revenues of $10,000 would need to be recognised in the next four years. The actual fees receivable are $5,000; therefore Jenson will have to defer $20,000 ($5,000 × four years) of the initial fee. Thus in the year to 31 March 2012 Jenson would recognise $30,000 ($50,000 – $20,000) of the initial franchise fee.

(iii)

An accruals/matching approach to this problem would be to say that the profit on each publication would be $2,000 (($240000 – $192,000)/24). In the year to 31 March 2012, as six of the 24 publications have been produced and delivered, the profit or loss would include:

Sales (6 × 240,000/24) Cost of sales (6 × 192,000/24) Profit

$ 60,000 (48,000) –––––– 12,000 ––––––

Deferred income on the statement of financial position would be $180,000 ($240,000 – $60,000).


1029

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK The problem with the above approach is that the deferred income does not seem to fit the definition of liability in the Framework and IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”. A liability is defined as “an obligation of an entity to transfer economic benefits as a result of past transactions or events”. The Framework effectively says that a statement of financial position comprises only of assets, liabilities and equity. Deferred income does not satisfy the definition of any of the elements. The liability of Jenson is to produce and deliver the next 18 publications. The cost of this liability is $144,000 ($192,000 × 18/24). Thus adopting the balance sheet approach to revenue recognition advocated in the Framework would mean recognising only $144,000 as a liability on the statement of financial position instead of $180,000 as deferred income under the accruals approach. The balance sheet approach would mean that Jenson would recognise all of the profit on the publications on receipt of the subscriptions. Many commentators have criticised the Framework for its lack of prudence in reporting profit and being contrary to existing accounting practice and, in some cases IFRS. A similar argument to the above could be applied to the deferred franchise fees in (ii) above. Answer 21 XYZ (a)

Extracts from the financial statements of XYZ at 31 December 2011 Statement of financial position

(i)

Tangible non-current assets held under finance leases Plant and machinery $

Cost At 1 January 2011 Additions At 31 December 2011 Accumulated depreciation At 1 January 2011 Charge for the year At 31 December 2011 Carrying amount At 31 December 2011

At 1 January 2011

1030

x 4,400 ——— 4,400 ——— x 629 ——— 629 ———

3,771 ——— x ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (ii)

Finance lease payables

Amounts payable: $ Within one to five years ($600 Less future finance charges

× 8 – $284)

4,516 996 ——— 3,520 ———

Accruals

$ Finance leases ($667 + $284)

951

Profit or loss Profit is stated after charging $ Finance charges Depreciation $4,400 ÷ 7 (b)

604 (W2) 629

Table

Period ended

30 June 2011 31 December 2011 30 June 2012 31 December 2012 30 June 2013 31 December 2013 30 June 2014 31 December 2014 30 June 2015 31 December 2015

Amount borrowed $ 4,400 4,092 3,760 3,403 3,018 2,604 2,158 1,677 1,160 600

Repaid

$ (600) (600) (600) (600) (600) (600) (600) (600) (600) (600)

Capital due 7.68% for period interest $ $ 3,800 292 3,492 268 3,160 243 2,803 215 2,418 186 2,004 154 1,558 119 1,077 83 560 40 – –

Amount due at period end $ 4,092 3,760 3,403 3,018 2,604 2,158 1,677 1,160 600 –

Comparison

Period

1 2 3 4 5 6 7 8 9 10

Sum of digits (W2) $ 320 284 249 213 178 142 107 71 36 – ——— 1,600 ———


Actuarial (as above) $ 292 268 243 215 186 154 119 83 40 – ——— 1,600 ———

1031


Calculation of finance charge

$ 6,000 (4,400) ——— 1,600 ———

Minimum lease payments 5 × $600 × 2 Fair value of asset Finance charge

(2)

Allocation of finance charge

Period ended

Digits

30 June 2011 31 December 2011

9 8

30 June 2012 31 December 2012 30 June 2013 31 December 2013 30 June 2014 31 December 2014 30 June 2015 31 December 2015 n (n + 1) 2

=

7 6 5 4 3 2 1 – ——

9(9 + 1)

9/45 × $1,600 8/45 × $1,600

7/45 × $1,600 6/45 × $1,600 5/45 × $1,600 4/45 × $1,600 3/45 × $1,600 2/45 × $1,600 1/45 × $1,600

———

45

2

1,600

—— (3)

Finance charge $ 320 284 ——— 604 249 213 178 142 107 71 36

———

Lease obligation

Period ended

Amount borrowed

Repaid

$ 4,400 4,120 3,804 3,453

$ (600) (600) (600) (600)

30 June 2011 31 December 2011 30 June 2012 31 December 2012

Capital due Interest for period

$ 3,800 3,520 3,204 2,853

$ 320 284 249 213

Amount due at period end $ 4,120 3,804 3,453 3,066

$3,804

Interest $284

Capital $3,520

During 2011 β $667

1032

End 2011 $2,853


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 22 SNOW Extracts from the financial statements of Snow for year ended 31 December 2011 Profit or loss

Profit is stated after charging Finance charges Depreciation

$(1,714 + 1,429 + 9,614) (W1 and 2)

$ 12,757 41,667

Statement of financial position Tangible non-current assets held under finance leases

Cost At 1 January 2011 Additions $(35,000 + 150,000)

At 31 December 2011 Accumulated depreciation At 1 January 2011  35,000 150,000  Charge for year $  +  5   3

At 31 December 2011 Carrying amount At 31 December 2011

At 1 January 2011

Plant and machinery $ – 185,000 ———— 185,000 ————

– 41,667 ——— 41,667 ——— 143,333 ——— – ———

Finance lease payables

Amounts payable: Within one to five years Less future finance charges

$ 166,000 ($6,500 × 4 + $35,000 × 4) 18,243 ($2,857 + $15,386 *) ——— 147,757 ———

* $35,000 × 5 = $175,000 – $150,000 – $9,614 = $15,386 Accruals

Finance leases


$ 46,000 ($11,000 + $35,000)

1033


Snowplough (a)

Calculation of finance charge

$ 2,000 39,000 (35,000) ——— 6,000 ———

Deposit MLP (6 × $6,500) Fair value of asset Finance charge (b)

Allocation of finance charge

Period ended

Digits

30 Jun 2011

6

6

Finance charge $

× $6,000

1,714

× $6,000

1,429

× $6,000

1,143

× $6,000

857

× $6,000

571

× $6,000

286

21

31 Dec 2011

5

5 21

30 Jun 2012

4

4 21

31 Dec 2012

3

3 21

30 Jun 2013

2

2 21

31 Dec 2013

1

1 21

—— 21 —— n(n + 1) 2 (c)

Period ended

30 Jun 2011 31 Dec 2011 30 Jun 2012 31 Dec 2012

1034

=

6(7) 2

——— 6,000 ———

= 21 Capital O/S at start $ 33,000 28,214 23,143 17,786

Interest

$ 1,714 1,429 1,143 857

Amount Repayment Capital O/S at end O/S at end $ $ $ 34,714 (6,500) 28,214 29,643 (6,500) 23,143 24,286 (6,500) 17,786 18,643 (6,500) 12,143


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) $23,143

Interest –

Capital $23,143

During 2011 β $11,000 (2)

End 2011 $12,143

Snow machine

Period Ended

Amount Repayment Capital O/s at start O/S at start $ $ $ 150,000 (35,000) 115,000 124,614 (35,000) 89,614

31 Dec 2011 31 Dec 2012

Interest at 8.36% $ 9,614 7,492

Amount O/S at end $ 124,614 97,106

$124,614

Capital $115,000

During 2011 β $25,386

Interest $9,614

End 2011 $89,614

Answer 23 INTELLECTUAL INDIVIDUALS (a)

Memorandum To From Date Subject

Bobby Bobov, Chairman, Intellectual Individuals Amelia Bobouka 22 February 2012 Accounting treatment of research projects

I would advise you of the means by which the accounting department is dealing with current research projects. (i)

Project Rico

This research falls within the IAS 38 Intangible Assets definition of research as being original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge. The work being performed is experimental in nature, and to date there are not indications that it will be successful. It would thus be imprudent to capitalise such expenditure, and accordingly it should be written off in the year incurred.


1035

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK

(ii)

Project Mounsey

The expenditure since 2008 has been classified as development expenditure which should be capitalised. IAS 38 requires that development costs be capitalised and amortised when all of the following criteria are met: – – – – – –

the costs can be separately identified and measured reliably the product or process is technically feasible the entity intends to produce, market or use the product/process the market or usefulness to the entity of the product or process can be demonstrated the entity can demonstrate how it can generate future economic benefits from the sale or use of the asset adequate resources are available to complete the project.

The amount capitalised should not exceed recoverable amounts net of production, selling and administrative costs directly incurred in marketing the product. Prior to 2008 there was insufficient certainty as to the recoverability of costs to warrant capitalisation. IAS 38 requires that development costs initially recognised as an expense should not be recognised as an asset in subsequent periods. Accordingly, the expenditure of $200,000 between 2008 and 2010 has been correctly classified as an intangible non-current asset. (iii)

Project Wellington

The costs incurred refining Project Wellington have been capitalised since Department S discovered its extra properties. These costs should have been prudently amortised over a period of five years. IAS 38 requires that capitalised development costs be reviewed for impairment if any factors occur that may lead to the asset being impaired. The recent legislation changes mean that the carrying value of the development costs capitalised should be written off immediately as they are no longer recoverable. If, however, the proposed legislation is not approved by Parliament, then the provision for write-down in value can be written back. (b)

Notes to the financial statements (6)

Intangible assets

Deferred development costs $

Cost 1 Jan 2011 and 31 Dec 2011

1036

600,000 ————


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) $ Amortisation 1 Jan 2011 (2 ×

200,000 5

) + (3 ×

400,000 5

For year Provision for diminution in value

320,000 40,000 160,000 ———— 520,000 ————

At 31 Dec 2011

(10)

)

Carrying amount 1 Jan 2011

280,000 ————

Carrying amount 31 Dec 2011

80,000 ————

Statement of profit or loss disclosures

$ Research and development Costs incurred in year Development costs amortised

$ 332,000 200,000 ——— 532,000

Answer 24 ROVERS (IASs 10, 37 & 38) (a)

Research and development

The company’s policy as regards research and development is contrary to the requirements of IAS 38. All research expenditure should be written off to profit or loss as it is incurred. The only exception is capital expenditure on research facilities. All development expenditure should also be written off immediately unless the criteria in IAS 38 can be demonstrated: 

technical feasibility;



intention to complete the product;



ability to use or sell the product;



confidence that the product will make a profit if it is sold, or will be useful if for internal purposes;





availability of technical, financial and other resources needed to complete the product; measurable expenditure.

If all of these conditions are met the company must capitalise the development costs, to be written off systematically in the periods during which the product is used or sold. As the “substantial program” has only been begun this year all these conditions may have still to be met. Even if the conditions for capitalisation are met it is too soon to amortise the costs (before there is a product to use of sell). In order to capitalise any costs as development Rover must have a costing system that distinguishes development expenditure from research.


1037


Provision/Contingent liability

IAS 37 defines a provision as a liability of uncertain timing or amount and a contingent liability as either a possible obligation which will be confirmed only by the occurrence or non-occurrence of a future event or a present obligation that is not recognised because it is unlikely that there will be an outflow of future economic benefits or the amount of the obligation cannot be measured reliably. As it is felt that the claim is unlikely to succeed this would seem to fall into the definition of a contingent liability and IAS 37 requires the estimated amount of damages to be disclosed by note. However, as the legal costs are to be incurred whatever the outcome of the case, IAS 37 requires that a provision should be made for them in the company’s financial statements. Answer 25 LAMOND (a)

Conditions to be met

An entity must be able to demonstrate all of the following: 

The technical feasibility of completing the project so that it will be available for use or sale.



The intention to complete the project and use or sell the result.



Its ability to use or sell the product.



The ability of the product to generate future economic benefits.



The availability of adequate technical, financial and other resources to use or sell the product.



The ability to measure the expenditure attributable to the project reliability during its development.

Tutorial note: These points are broadly worded as they appear in IAS 38. Answers using the candidates’ own words to express them are obviously accepta ble. (b)

Amounts to appear

Statement of Statement of Profit or loss financial position $ $

Project A Amortisation Statement of financial position Project B Expenditure written off Project C Development expenditure to date Project D Research expenditure

1038

40,000 80,000 230,000

– 255,000

80,000 _______

– _______

350,000 _______

335,000 _______



Disclosure requirements

(i)

Total research and development expenditure recognised as an expense was $350,000 analysed as follows:

Expenditure during the year Amortised or written off from deferred expenditure

$ 135,000 215,000 _______ 350,000 _______

(ii)

Movements on unamortised development costs

Balance at 1 July 2011 Expenditure recognised as an asset in current year

$ 380,000 225,000 _______

Amortised during year Expenditure on abandoned project written off

605,000 (40,000) (230,000) _______

Balance at 30 June 2012

335,000 _______

Answer 26 ALLRIGHTS Directors’ views on inventory valuation Striver. A prudent approach is necessary, but the concept of accruals is also important. It is not acceptable to undervalue inventories. Valuing inventories at low figures will not of itself help cash flow although, as profit will be reduced, the outgoings for bonuses, taxation and dividends may also be reduced. Chatty . It is not acceptable to include selling costs or costs not related to production in the cost calculation. Gloome. Budgeted cost is not acceptable. Opinion

Inventories should be valued at the lower of cost and net realisable value under IAS 2 Inventories. “Cost” means all costs of purchase, of conversions and other costs incurred in bringing inventories to their present location and condition. They include a systematic allocation of fixed and variable production overheads including depreciation and maintenence of factory buildings and the cost of factory management and administration. The allocation of these overheads must however be based on the normal capacity of production facilities such that the value of inventories is not increased as a result of inefficiencies. In this case, Gloom indicates that there may have been some inefficiencies and these should be noted carefully before any final decision is made.


1039

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Costs to be included are therefore as follows: Direct labour and materials Bought-in components Factory overheads Production planning ($4,000 ÷ 1,000)

$ 38 5 8 4 —— 55 ——

“Net realisable value” means the selling price to be obtained on sale in the normal course of business less any costs inevitably incurred on sale (i.e. $60 less royalty $2 and commission $4 = $54). Inventories therefore should be valued at $54. Answer 27 SAMPI (IAS 2) (a)

IAS 2 treatment

(i)

Three acceptable methods

(1)

Unit cost Inventory is priced at the actual amount paid for each individual item of inventory held

(2)

First in first out Inventory is assumed to be composed of the items most recently purchased, regardless of whether this is actually the case. Inventory is therefore valued according to the price paid for the most recent purchase. If this purchase is insufficient to cover the quantity in inventory, the price of the next most recent purchase is taken as necessary.

(3)

Average cost Inventory is priced at the moving weighted average price at which each inventory line was purchased during the accounting period, or brought forward from the previous period. All three of these methods are acceptable under IAS 2 because they are either the actual cost of the inventory (method 1) or a reasonably close approximation to that actual cost (methods 2 and 3).

(ii)

Finished goods valuation

The cost of the inventory of finished goods would normally be arrived at by taking the labour and materials consumed in manufacturing the items plus an allocation of overheads. The overhead allocation should be based on the normal level of production and should exclude selling expenses and general management expenses.

1040


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (b)

Computation of value of inventory

Value using weighted average basis Number of units

Weighted average cost $ 13.00 15.00

Opening inventory 8 March

4,000 3,800 _____

Balance 12 March

7,800 (5,000) _____

13.97

13.97

18 March

2,800 (2,000) _____

22 March

800 6,000 _____

13.97 18.00 17.53

24 March

6,800 (3,000) _____

17.53

28 March

3,800 (2,000) _____ 1,800 _____

17.53

Total value of closing inventory $

31,554 _____

Tutorial note: Or 31,558 without rounding differences. Answer 28 WILLIAM (a)

Statement of profit or loss (extracts)

Revenue(W3) Cost of sales Gross profit /(loss) (W1)


for the year ended 31 December 2008 2009 2010 2011 $000 $000 $000 $000 3,143 1,968 5,272 2,117 (2,750) (3,861) (3,339) (1,150) ——– ——– ——– ——– 393 (1,893) 1,933 967 ——– ——– ——– ——–

1041


Statement of financial position (extracts)

as at 31 December 2008 2009 2010 $000 $000 $000

2011 $000

3,143 ——

1,968 ——

5,272 ——

2,117 ——

3,143 ——

4,250 ——

10,383 —–

12,500 ——

143 ——

Nil ——

Nil ——

Nil ——

Nil ——

750 ——

617 —–

Nil ——

Contract revenue recognised as revenue in the period:

Contract costs incurred and recognised profits ( less recognised losses ) to date

Gross amounts due from customers for contract work (W2)

Gross amounts due to customers for contract work (W2)

WORKINGS (1)

Expected profit

2008 $000 Contract price 12,000 Less Costs to date (2,750) (2,750+3,000) Est. future costs (7,750) ——– 1,500 ——– Allocate on costs basis 393 (loss in full) (see W3 for fraction) Less prior periods – —— 393 —— (2)

2009 2010 2011 $000 $000 $000 12,000 12,000 12,500 (5,750) (5,750+4,200) (9,950)(9,950+1,150) (11,100) (7,750) (1,550) – ——– ——– ——– (1,500) 500 1,400 ——– ——– ——–

(1,500)

433

(393) ——– (1,893) ——–

1,500 ——– 1,933 ——–

1,400 (433) —— 967 ——

Disclosure workings

2008 Contract costs incurred 2,750 Profits /losses 393 ––––– 3,143

2009 2010 2011 5,750 9,950 11,100 (1500) 433 1,400 ––––– –––––– –––––– 4,250 10,383 12,500

Billings

(3000) (5,000) (11,000) (12,500) ––––– ––––– –––––– –––––– * 143 (750) (617) nil ––––– ––––– –––––– –––––– *Positive = a receivable; Negative = a payable.

1042



Revenue

Allocate on a costs basis 2008 $000 Costs to date Total costs % complete × tender value Revenue to date Less taken in prior periods Revenue in year

2,750 (2,750+7,750)

2009 $000

2010 $000

5,750 (5,750+7,750)

9,950 (9,950+1,550)

11,000 11,000

26% × 12,000

43% × 12,000

3,143

5,111

10,383

12,500

(3,143) ——– 1,968 ——–

(5,111) ——– 5,272 ——–

(10,383) ——– 2,117 ——–

– ——– 3,143 ——–

86% × 12,000

2011 $000

100% × Actual (12,500)

Answer 29 EARLEY (a)

IAS 10 Events After the Reporting Period states that assets and liabilities should be adjusted for events occurring after the end of the reporting period that provide additional evidence relating to conditions existing at the end of the reporting period . It specifically includes the example of bad debts, where evidence of bankruptcy of a debtor occurs after the year end. In this case, Nedengy appears to have recovered part of the debt and as such only $200,000 needs to be provided. It may be argued that the receivership has occurred as a result of events occurring after the end of the reporting period, as a result of a change in legislation for example, but this is unlikely. IAS 18 Revenue states that when uncertainty arises about the collectability of an amount already included in revenue, the amount should be recognised as an expense.

(b)

It is likely that the fall in the value of the property will fit the IAS 10 definition of adjusting events noted in (a) above, unless, again, it can be argued that the decline in the property market occurred after the year-end. IAS 36 Impairment of assets and IAS 16 Property, Plant and Equipment require that the carrying amount of property, plant and equipment should be reviewed periodically in order to assess whether the recoverable amount has fallen below the carrying amount. Where it has, the property, plant and equipment should be written down to the recoverable amount, through the statement of comprehensive income as an expense, or within the other comprehensive income section, if the asset had previously been revalued upwards and a surplus still exists for that asset.

(c)

IAS 2 Inventories requires that inventories be stated at the lower on cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.


1043

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Unless Earley was making a significant margin on the tricycles, it is likely that the reduction in selling price of 30% will necessitate a write- down to net realisable value, especially considering the transportation costs to Bongolia which must be included. If the Bongolia option is unlikely to proceed, it may be necessary to write the tricycles down to scrap value. (d)

Under IAS 10, the nationalisation is likely to be regarded as a non-adjusting event that merely requires disclosure in the financial statements. IAS 27 Separate Financial Statements, requires that an investment in a entity should be accounted for as an investment (under IFRS 9: Financial Instruments) from the date that it ceases to fall within the definition of a subsidiary and does not become an associate. It seems here that Earley has neither control nor significant influence, nor even an investment as the assets have been in fact, expropriated. The loss of the investment should be accounted for in the year in which it occurred, but disclosed in the current year. If the loss of the subsidiary results in Earley no longer being a going concern, then the event becomes an adjusting event.

(e) & (f) Both of the events described are non-adjusting event which should be disclosed, but not adjusted for in the current year financial statements. Answer 30 ACCOUNTING TREATMENTS (a)

IAS 37 Provisions contingent liabilities and contingent assets states that contingent gains should not be recognised as income in the financial statements. The company has a debit balance already in its books which indicates that it must be reasonably certain that at least part of the claim will be paid. This element of the claim then is probably not a contingency at all. The remaining part (the difference between the $15,000 and the $18,600) is, and should be disclosed and not accrued.

(b)

IAS 16 Property, Plant and Equipment requires that the carrying amount of property, plant and equipment should be reviewed periodically in order to assess whether the recoverable amount has fallen below the carrying amount. Where it has, the property, plant and equipment should be written down to the recoverable amount through the profit or loss as an expense. It may be the case that the amounts involved are so significant as to warrant separate disclosure under IAS 1 Presentation of Financial Statements.

(c)

IAS 37 states that contingent liabilities should not be recognised. Though a provision should be made for amounts where the company has an obligation to pay t hem. The question in this case is whether or there is an obligating event within the meaning of IAS 37. On balance it seems inappropriate to recognise a provision in respect of this amount but the possible liability should be disclosed as a contingent liability. (i) (ii) (iii)

(d)

the nature of the contingency the uncertainties surrounding the ultimate outcome the likely effect (i.e. $500,000 loss less likely tax relief).

IAS 2 Inventories requires that inventories be stated at the lower on cost and net realisable value. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. In this case, cost is $1,800 and net realisable value is $1,600

1044


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (e)

The company should set up a provision for $100,040 (i.e. should accrue for the 10% probable liability). It should disclose the possible liability under contingent liabilities. The disclosure is as noted in (c) except that the financial effect is $300,120 (30% × $1,000,400). The balance should be ignored as it is a remote contingent liability.

Tutorial note: In (c) above it is not appropriate to provide for 20% receivable $500,000 (i.e. $100,000). This would only be appropriate where the event is recurring many times over.

In (e) it is appropriate to use the percentages provided, as warranty work is provided for. Answer 31 SHEP (I) (a)

Corporate income tax liability – year ended 31 December 2011

$ Profit per accounts Add Depreciation

Less tax allowance Taxable profits Tax payable @ 30%

(b)

121,000 11,000 ———— 132,000 (15,000) ———— 117,000 ———— 35,100 ————

Deferred tax liability

$ Tax base Carrying amount (60,000 – 11,000) Temporary difference Deferred tax provision required @ 30% (c)

45,000 49,000 ——— (4,000) ——— (1,200) ———

Movement on the deferred tax liability

$ Balance b/f Profit or loss (balancing figure) Balance c/f

(d)

− 1,200 ——— 1,200 ———

Tax note

Current tax expense Deferred tax expense Tax expense


$ 35,100 1,200 ——— 36,300 ———

1045

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Answer 32 SHEP (II) (a)


$ Profit per accounts Add Depreciation Interest payable Provision Fine

125,000 14,000 500 1,200 6,000 ———— 146,700 (16,000) (150) ———— 130,550 ————

Less tax allowance (given) Interest receivable Taxable profits

Tax payable @ 30% (b)

39,165 ————


Carrying amount $

Tangible assets Carrying amount (49 bf – 14) Tax base (45bf – 16) Interest payable (25,000 × 8% × 3/12) Interest receivable (4,000 × 15% × 3/12) Provision

Deferred tax @30% (c)

Tax base $

Temporary difference $

29,000 − − − ——— 29,000 ———

6,000 (500) 150 (1,200) ——— 4,450 ———

35,000 (500) 150 (1,200) ——— 33,450 ———

1,335 ———



1046

1,200 135 ——— 1,335 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 33 SHEP (III) (a)


$ Profit per accounts Add Depreciation Interest payable (note) Provision Entertainment

175,000 18,500

− 1,500 20,000 ———— 215,000 (24,700)

Less tax allowance (given) Interest receivable (note) Development costs

− (17,800) ———— 172,500 ————

Taxable profits

Tax payable @ 30%

(b)

51,750 ————


Carrying amount $

Tangible assets Carrying amount (35 bf – 18.5) Tax base (29bf – 24.7) Interest payable Interest receivable Provision Development expenditure

Deferred tax @30% (c)

Tax base $

Temporary difference $

4,300 − − − − ——— 4,300 ———

12,200 (500) 150 (2,700) 17,800 ——— 26,950 ——— $8,085 ———

16,500 (500) 150 (2,700) 17,800 ——— 31,250 ———



1,335 6,750 ——— 8,085 ———

Note There is no adjustment to profit for the interest paid and the interest receivable. Consider the interest payable. The tax authority will disallow the closing accrual but will allow last year’s accrual (that has been paid in this year) as a deduction. These amounts are equal so there is no net effect. Similar comments can be made about the interest receivable.


1047

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Answer 34 SHEP (IV) (a)


$

(b)

Taxable profits (as before)

172,500 ————

Tax payable @ 28%

48,300 ————


$

(c)

Temporary difference (as before)

26,950 ———

Deferred tax @28%

7,546 ———


$ Balance b/f Adjustment due to change in rate

1,335 (89) ——— 1,246 6,300 ——— 7,546 ———

Opening balance restated to 28% (1,335 × 28/30) Profit or loss (balancing figure) Balance c/f Answer 35 BROKEN DREAMS Notes to the accounts

Amounts provided (a)

Provisions for liabilities and charges

$ Deferred taxation Relating to Tangible assets Other temporary differences

(b)

235,950 55,440 ———— 291,380 ————

Shareholders equity

$ Share capital Revaluation surplus Provision for deferred tax (60 @ 33%)

1048

x

60,000 (19,800) ______

40,200 ——— x ———



Standard deferred tax working

C/f Total $

(2)

Tangible assets (W2) Operating lease (W3) Deferred development expenditure

715,000 88,000 80,000 ———— 883,000 ————

Deferred tax @ 33%

291,390 ————

Provision at 30 June 2012

“Full” basis (800,000 – 260,000 + 175,000) = $715,000 (3)

Operating lease

$ At 30 June 2012 Profit or loss charge to date Rentals paid to date

72,000 160,000 ———— 88,000 ————

Temporary difference

Answer 36 CONSOLIDATIONS (a)

Consolidated statement of financial position at 31 December 2010

$ 10,000 170,000 ———— 180,000 ————

Goodwill Sundry net assets (115,000 + 55,000)

Equity capital Retained earnings

(1)

140,000 40,000 ———— 180,000 ————

Net assets S

Share capital Retained earnings


Reporting date $ 30,000 25,000 ——— 55,000 ———

Acquisition

$ 30,000 25,000 ——— 55,000 ———

Postacquisition $ – –

1049

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (2)

Goodwill

$ 65,000

Cost of shares Net assets acquired S (100% × 55,000) (W1)

(b)

(55,000) ——— 10,000 ———


$ 6,000 191,000 ———— 197,000 ————

Goodwill (10,000 – 4,000) Sundry net assets (129,000 + 62,000)


(1)

140,000 57,000 ———— 197,000 ————

Net assets S


(2)

1050

Acquisition

$ 30,000 25,000 ——— 55,000 ———

Postacquisition $ – 7,000

Goodwill


(3)

Reporting date $ 30,000 32,000 ——— 62,000 ———

Retained earnings P S (100% × 7,000 (W2)) Goodwill impaired

S $ 65,000

(55,000) ——— 10,000 ——— $ 54,000 7,000 (4,000) ——— 57,000 ———




$ 8,000 170,000 ———— 178,000 ————

Goodwill Sundry net assets (115,000 + 55,000)


127,000 40,000 ———— 167,000 11,000 ———— 178,000 ————

Non-controlling interest

(1)

Net assets S


(2)

Acquisition

$ 30,000 25,000 ——— 55,000 ———

Postacquisition $ – -

Goodwill


(3)

Reporting date $ 30,000 25,000 ——— 55,000 ———

Non-controlling interest S (20% × 55,000 (W1))


S $ 52,000

(44,000) ——— 8,000 ———

$ 11,000

1051

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK (d)


(i)

Non-controlling interest valued at proportionate share of idenftifiable net assets

$ 4,800 191,000 ———— 195,800 ————

Goodwill (8,000 – 3,200) Sundry net assets (129,000 + 62,000)


127,000 56,400 ———— 183,400 12,400 ———— 195,800 ————


(1)

Net assets of S


(2)

Acquisition

$ 30,000 25,000 ——— 55,000 ———

Postacquisition $ – 7,000

Goodwill


(3)

Non-controlling interest S (20% × 62,000 (W1))

(4)

Retained earnings P S (80% × 7,000 (W2)) Goodwill impaired

1052

Reporting date $ 30,000 32,000 ——— 62,000 ———

$ 52,000 (44,000) ——— 8,000 ——— $ 12,400 $ 54,000 5,600 (3,200) ——— 56,400 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (ii)

Non-controlling interest valued at fair value

(1)

Goodwill

Cost of shares Fair value of non-controlling interest (6,000 Net assets acquired (100%)

× $2.15)

$ 52,000 12,900 (55,000) ——— 9,900 ———

(2)

Non-controlling interest Fair value on acquisition Share of post-acquisition profits (7,000 × 20%) Share of goodwill impairment (3,200 × 20%)

$ 12,900 1,400 (640) ——— 13,660 ———

(4)

Retained earnings P S (80% × 7,000 (W2)) Goodwill impaired (3,200

$ 54,000 5,600 (2,560) ——— 57,040 ———

× 80%)

Answer 37 HONEY Consolidated statement of financial position as at 30 June 2012 Assets Non-current assets Tangible assets (27,000 + 12,500)

Current assets (25,000 + 12,000)

Equity and liabilities Shareholders’ equity Called up share capital Share premium account Retained earnings (9,000 + (⅔

$ 39,500 37,000 ——— 76,500 ———

× 14,000))

Non-controlling interest (⅓ × 17,000)

Non-current liabilities Current liabilities


20,000 6,000 18,333 ——— 44,333 5,667 ——— 50,000 12,000 14,500 ——— 76,500 ———

1053

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Consolidated statement of profit or loss for the year ended 30 June 2012

$ 54,000 (20,000) ——— 34,000 (3,600) (4,200) ——— 26,200 (1,200) ——— 25,000 (8,000) ——— 17,000 ———

Revenue (24,000 + 30,000) Cost of sales (9,000 + 11,000) Gross profit Distribution costs (2,300 + 1,300) Administrative expenses (1,500 + 2,700) Operating profit Interest payable and similar charges Profit before taxation Tax (3,000 + 5,000) Profit after taxation

Non-controlling interest (⅓ × 10,000) Profit for the financial year attributable to the members of Honey Profit for year Extract from statement of changes in equity: Retained earnings brought forward (2,000 + (⅔ × 4,000)) Profit for the financial year attributable to the members of Honey Retained earnings carried forward

1054

3,333 13,667 ——— 17,000 ——— 4,666 13,667 ——— 18,333 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 38 HATTON Consolidated statement of financial position as at 31 December 2011

$ Assets Non-current assets Tangible assets Goodwill (5,000 – 2,500)

Current assets Inventories Trade receivables Cash at bank and in hand

Equity and liabilities Capital and reserves Called up share capital – $1 ordinary shares, fully paid Revaluation surplus (W6) Retained earnings (W5)

Non-controlling interest (W4)

Non-current liabilities 6% Debenture loan (20,000 – 12,000) Current liabilities Trade payables

239,000 2,500 ———– 108,400 129,000 39,850 ———–

$

241,500

277,250 ———– 518,750 ———–

250,000 12,000 53,500 ———– 315,500 22,250 ———– 337,750 8,000

173,000 ———– 518,750 ———–

WORKINGS (1)

Group structure

Hatton

80%

Slap


1055


Net assets of Slap

Reporting Acquisition Post date date acquisition $ $ $ $ 50,000 50,000 – 6,250 6,250 – 15,000 – 15,000 40,000 10,000 30,000 ———– ——— 111,250 66,250 ———– ———

Share capital Share premium Revaluation surplus Retained earnings

(3)

Goodwill

$ 58,000 (53,000) ——— 5,000 ———

Cost of shares Net assets acquired (80% × 66,250) (W2)

Half of the goodwill has been impaired, therefore half remains at 31 December 2011. (4)

Non-controlling interest (20% × 111,250) (W2)

(5)

Retained earnings

Hatton Slap (80% × 30,000 (W2)) Goodwill impaired

(6)

$ 32,000 24,000 (2,500) ——— 53,500 ———

Revaluation surplus

Slap (80% × 15,000 (W2))

1056

22,250 ———

$12,000 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 39 HAGGIS Consolidated statement of financial position as at 31 December 2011

$ Assets Non-current assets Tangible assets (33,000 + 20,000) Intangible assets – goodwill

53,000 3,300 ——— 56,300 20,500 ——— 76,800 ———

Current assets (4,500 + 16,000)

Equity and liabilities Capital and reserves Called up share capital Share premium account Retained earnings (W5)

10,000 5,000 9,000 ——— 24,000 4,800 ———– 28,800


Non-current liabilities 8% Debenture loans (20,000 + 9,000)

29,000

Current liabilities (9,000 + 10,000)

19,000 ——— 76,800 ———

WORKINGS (1)

Group structure

Haggis

75%

Stovies (2)

Net assets of Stovies



Reporting date $ 4,000 13,000 ——— 17,000 ———

Acquisition

$ 4,000 8,000 ——— 12,000 ———

Post acquisition $ – 5,000

1057


Goodwill

Cost of shares Fair value of non-controlling interest on acquisition Less Fair value of net assets acquired (W2)

$ 12,500 3,800 (12,000) ——— 4,300 ———

Goodwill of $1,000 has been impaired since the acquisition occurred, therefore $3,300 remains and is included in the consolidated statement of financial position. Of the impairment loss 75% ($750) will be charged to retained earnings and 25% (250) will be charged to non-controlling interest. (4)

(5)

Non-controlling interest Fair value on acquisition Share of post-acquisition profits (5,000 Goodwill impaired (W3)

Retained earnings

Haggis Stovies (75% × 5,000 (W2)) Less: Goodwill (W3)

1058

× 25%)

3,800 1,250 (250) ——– 4,800 ——–

$ 6,000 3,750 (750) ——– 9,000 ——–


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 40 HAMMER Consolidated statement of financial position as at 31 December 2011

$ Assets Non-current assets Tangible assets

Current assets Inventory Receivables Investments Cash at bank and in hand

$

168,200 29,200 83,800 2,500 13,500 ———– 129,000 ———– 297,200 ———–

Equity and liabilities Capital and reserves Called up share capital – $1 ordinary shares, fully paid Share premium account Revaluation surplus Retained earnings (W5)


Current liabilities


120,000 18,000 23,000 72,560 ———– 233,560 17,640 ———– 251,200 46,000 ———– 297,200 ———–

1059


Group structure

Hammer

80%

Sickle (2)

Net assets of Sickle

Reporting date $ $

Share capital Revaluation surplus Retained earnings – Per Q (8,000 + 5,000) Provision for unrealised profit

(3)

Acquisition Post acquisition $ $

60,000 60,000 16,000 16,000 13,000 8,000 (800) ——— ——— 88,200 84,000 ——— ———

– – 5,000 (800)

Goodwill (negative)

Cost of shares Less Net assets acquired (80% × 84,000 (W2))

$ 54,000 (67,200) ——— (13,200) ———

Any gain on a bargain purchase is to be credited to consolidated profits immediately. (4)

(5)

Non-controlling interest Share of net assets (20% × 88,200 (W2))

Retained earnings

Hammer (40,000 + 16,000) Sickle (80% × 4,200 (W2)) Excess (W3)

1060

$17,640 ———

$ 56,000 3,360 13,200 ——— 72,560 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 41 HUT (a)

Consolidated statement of financial position as at 31 December 2011

$ Assets Non-current assets Tangible Land (80,000 + 72,000 + 18,000 (W2)) Plant at cost (120,000 + 80,000) Accumulated depreciation (48,000 + 22,400)

170,000 200,000 (70,400) ———– 129,600 41,640 ———– 341,240

Intangible goodwill

Current assets Inventory (112,000 + 74,400 – 3,200 (W6)) Receivables (104,000 + 84,000) Bank (41,000 + 8,000)

$

183,200 188,000 49,000 ———– 420,200 ———– 761,440 ———–

Equity and liabilities Capital and reserves Called up share capital Retained earnings


Current liabilities (52,000 + 24,000)

400,000 227,440 ———– 627,440 58,000 ———– 685,440 76,000 ———– 761,440 ———–

WORKINGS (1)

Group structure

Hut

128 160

= 80% ords

Shed


1061


Net assets of Shed

ReportingAcquisition Post date acquisition $ $ $ 160,000 160,000 –

Share capital Fair value adjustment on non-current assets (90,000 – 72,000) Retained earnings

(3)

18,000 18,000 – 112,000 (11,000) 123,000 ———– ———– 290,000 167,000 ———– ———–

Goodwill

Cost of shares Less Net assets acquired (80% × 167,000 (W2))

$ 203,000 (133,600) ———– 69,400 ———–

Goodwill to the extent of $27,760 has been impaired since acquisition; therefore $41,640 will be included in the consolidated statement of financial position. (4)

(5)

Non-controlling interest Share of net assets (20% × 290,000 (W2))

Retained earnings

Hut Less

Goodwill (W3) Provision for unrealised profit (W6)

Shed (80% × 123,000 (W2))

(6)

$ 160,000 (27,760) (3,200) ———– 129,040 98,400 ———– 227,440 ———–

Unrealised profits

SP Cost GP

1062

$58,000 ———

% $ 125 16,000 (100) (12,800) —— ——— 25 3,200 —— ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 42 HAT Consolidated statement of financial position as at 30 June 2012

$ Assets Non-current assets Tangible assets (227 + 170 – 17.5 (W6)) Intangible assets – goodwill

Current assets (270 + 186)

Equity and liabilities Shareholders’ equity Called up share capital Share premium account Retained earnings (W5)


Preference shares (40,000 – 8,000) Current liabilities

379,500 2,520 ———– 382,020 456,000 ———– 838,020 ———–

200,000 25,000 147,420 ———– 372,420 71,600 ———– 444,020 32,000 362,000 ———– 838,020 ———–

WORKINGS (1)

Group structure

Hat

60%

Shoe


1063


Net assets of Shoe

30 June 30 June 2012 2008 $ $ 90,000 90,000 9,000 9,000 80,000 50,000 ———– ———– 179,000 149,000 ———– ———–

Ordinary shares of $1 each Share premium account Retained earnings

(3)

$

Goodwill

Shares in Shoe Ordinary Net assets acquired Ordinary shareholders (60%

$ 95,000

× 149,000) (W2)

(89,400) ——— 5,600 ———

Goodwill is valued at $2,520 at the end of the reporting period, therefore $3,080 has been impaired since acquisition. (4)


NA at reporting date (40% × 179,000) (W2) (5)

Retained earnings

Hat Less

Profit on disposal (W6)

Shoe (60% × 30,000 (W2)) Goodwill Depreciation adjustment

1064

$ 71,600 $ 150,000 (10,000) ———– 140,000 18,000 (3,080) (7,500) ———– 147,420 ———–



Provision for unrealised profit on non-current assets

Hat’s books: $ Remove profit on disposal Proceeds carrying amount

Dr

Profit or loss Cr Non-current assets

Shoe’s books: Adjust depreciation Is Should be

Dr

Profit or loss Cr Non-current assets

50,000 (40,000) ——— 10,000 ——— 10,000 10,000

12,500 20,000 ——— 7,500 ——— 7,500 7,500

Answer 43 HUMPHREY Consolidated statement of profit or loss for the year ended 30 September 2011

Revenue Cost of sales Gross profit Distribution costs Administrative expenses Operating profit Investment income Interest Profit before tax Taxation Profit for the year

Non-controlling interest (W3) Shareholders of parent


$000 1,400 (742) ——– 658 (110) (120) ——– 428 9 (31) ——– 406 (184) ——– 222 ——– 6 216 ——– 222 ——–

1065

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Extract from statement of changes in equity: Retained earnings at 1 October 2010 (W4) Profit for year attributable to parent Dividends

100 216 (100) ——– 216 ——–

Retained earnings at 30 September 2011 WORKINGS (1)

Group structure

Hum hre

80%

Stanle

(2)

Consolidated statement of profit or loss

Revenue Cost of sales – per Q – Provision for unrealised profit Distribution Administration Investment income (20 – 16) Interest payable Tax Profit after tax

(3)

Humphrey Stanley Adjustment Consolidated $000 $000 $000 $000 1,100 400 (100) 1,400 (600) (240) 100 (2) – – (742) (60) (50) (110) (65) (55) (120) 4 5 9 (25) (6) (31) (160) (24) (184) —– 30 —–


20% × 30,000 (W2) or as per profit after tax in question

(4)

Reserves brought forward

Humphrey Stanley (80% × (30 – 5)) Goodwill impaired

1066

$000 6 ——

$000 90 20 (10) —— 100 ——



Inter-company dividend

Check consistency between companies. $000 20 —–

Payable by Stanley Receivable by Humphrey (80%

× 20)

16 —–

Answer 44 HIGH Consolidated statement of profit or loss for year ended 31 March 2012

Revenue Cost of sales Gross profit Distribution costs Administration costs Operating profit Investment income Profit before tax Taxation Profit after tax Attributable to: Non-controlling interest (W3) Shareholders of P

Extract from statement of changes in equity: Retained earnings at 1 April 2011 (W4) Profit attributable to P Retained earnings at 31 March 2012

$ 414,750 (178,900) ———– 235,850 (110,200) (39,350) ———– 86,300 350 ———– 86,650 (44,100) ———– 42,550 ———– 3,830 38,720 ———– 42,550 ———– 38,600 38,720 ———– 77,320 ———–

WORKINGS (1)

Group structure

High

80% ords

Speed


1067


Consolidation schedule

High $ 274,500

Sales revenue

Speed Adjustment Consolidated $ $ $ 181,250 (37,500) (3,500) 414,750

Cost of sales – Per Q (126,480) (86,520) Inventory provision for unrealised profit (700) Non-current asset provision for unrealised profit Depreciation (10% × 3,000) 300 Distribution Administration Investment income – interest Tax

(67,315) (42,885) (25,555) (17,295) 250 100 (29,000) (15,100) ——— 19,150 ———

Profit after tax

(3)

(3,000) (178,900) (110,200) 3,500 (39,350) 350 (44,100)


$ 19,150

Profits after tax (4)

37,500

% × 20%

$ 3,830

Retained profits brought forward

$ 28,000 10,600 ——— 38,600 ———

High Speed (80% (17,250 – 4,000))

Tutorial note:

Alternative calculation for profit after tax of Speed (W2): Per question Inventory provision for unrealised profit Depreciation adjustment

1068

$ 19,550 (700) 300 ——— 19,150 ———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 45 HAPPY (a)

Consolidated statement of profit or loss for the year ended 31 March 2012

Revenue Cost of sales Gross profit Operating costs Operating profit Investment income Profit before tax Income tax Profit after tax Attributable to: Non-controlling interest (W3) Shareholders of P Profit Extract from statement of changes in equity: Retained earnings at 1 April 2011 Retained profit for the year Retained earnings at 31 March 2012

(b)

$ 376,167 (177,867) ———– 198,300 (88,300) ———– 110,000 3,200 ———– 113,200 (57,067) ———– 56,133 ———– 2,733 53,400 ———– 56,133 ———– 79,300 53,400 ———– 132,700 ———–

Time apportionment

The results of a subsidiary are included in the consolidated accounts from the date control is achieved. Happy acquired 75% of the issued ordinary capital of Sleepy on 30 November 2011. This is the date on which control passed and hence the date from which the results of Sleepy should be reflected in the consolidated statement of profit or loss . All reserves earned by Sleepy in the four months since that date are post-acquisition reserves. The remaining previous eight months’ profit from 1 April 2011 to 30 November 2011 are all pre-acquisition reserves and will be included in the calculation of goodwill on consolidation.


1069


Group structure

Happy

75% (acq 30 November 2011

∴ 124 in )

Sleepy (2)


Happy

Sleepy Adjustment Consolidated 4 12

$ Sales revenue Cost of sales Operating costs Investment income Tax

303,600 72,567 (143,800) (34,067) (71,200) (17,100) 2,800 400 (46,200) (10,867) ——— 10,933 ———

Profit after tax

(3)

$

$

$

– –

376,167 (177,867) (88,300) 3,200 (57,067)


25% × 10,933

2,733 ——–

Tutorial note:

Alternative calculation for profit after tax of Sleepy (W1) Per question 32,800 ×

4

$10,933

12

1070

———


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 46 HALEY Consolidated statement of financial position as at 31 December 2011

$000

$000

Assets

Non-current assets Tangible assets Interest in associated undertaking

400 48 —— 448 505 —— 953 ——

Current assets Total assets Equity and liabilities

Capital and reserves Called up share capital – $1 ordinary shares Retained earnings (note 2)

250 469 —— 719 84 —— 803


Non-current liabilities

150 —— 953 ——

Total equity and liabilities

WORKINGS (1)

Group structure

Hale

60%

30% Aristotle

Socrates


1071


Net assets

Socrates


Reporting date $000 30 180 —— 210 ——

Acquisition $000 30 70 —— 100 ——

Postacquisition $000 – 110

Aristotle


(3)

Reporting date $000 60 100 —— 160 ——

Acquisition $000 60 30 —— 90 ——

Post acquisition $000 – 70

Goodwill

Cost of investment Share of net assets acquired (60% × 100 (W2))/(30% × 90 (W2))

Socrates $000 75 (60) —— 15 ——

Aristotle $000 30 (27) —— 3 ——

All fully written off to retained earnings. (4)


Socrates (40% × 210) (5)

Retained earnings

Haley Socrates (60% × 110 (W2)) Aristotle (30% × 70 (W2)) Goodwill (15 + 3)

(6)

$000 84 —— $000 400 66 21 (18) —— 469 ——

Investment in associate

Aristotle (30% × 160)

$000 48 ——

All goodwill in respect of Aristotle has been impaired; therefore the value of investment in the associate is based upon the net assets of the associate at the end of the reporting period.

1072


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 47 HAMISH Consolidated statement of profit or loss for the year ended 30 June 2012

$000 15,131 (13,580) ——— 1,551 178 (736) ——— 993 ———

Revenue Cost of sales and expenses Operating profit before tax Share of income from associated company Tax Profit after tax Attributable to: Non-controlling interest (W3) Shareholders of P

30 963 ——— 993 ———

Profit for the year Extract from statement of changes in equity: Dividends Only the dividend of the P will be included in the statement of changes in equity.

500

WORKINGS (1)

Group structure

Hamish 30% 80% Angus Shug (2)


Hamish

Shug 5

Angus Adjustment Consolidated

30%

12

Sales revenue Cost of sales per Q provision for unrealised profit (50 ×

25

)

$000 12,614

$000 2,567

(11,318)

(2,302)

$000

$000 (50)

$000 15,131

50

(10)

(13,580)

(621)

178 (736)

125

Income from associate (594 × 30%) Tax – group


(115) —— 150 ——

1073



$000 30 ——

Shug (20% × 150,000) (4)

Profit retained by

$000 346

Hamish Shug (80% × ((

5

× 361) – 120))

24

12

—— 370 (10) 103 —— 463 ——

Less Unrealised intra-group profit Angus (30% × 344)

Answer 48 HYDROGEN Consolidated statement of financial position as at 30 September 2011

$

$

Assets

Non-current assets Tangible assets (697,210 + 648,010) Goodwill (W3) Interest in associate (W5)

1,345,220 500 276,800 ————– 1,622,520

Current assets Inventory (495,165 + 388,619) Receivables (385,717 + 320,540 ) Cash at bank and in hand (101,274 + 95,010)

Total assets

883,784 706,257 196,284 ————– 1,786,325 ————– 3,408,845 ————– $ $

Equity and liabilities

Capital and reserves Called up share capital Retained earnings (W6)


Non-current liabilities Debenture loans (400,000 + 150,000) Current liabilities Trade payables (375,366 + 252,179) Total equity and liabilities

1074

600,000 1,421,300 ————– 2,021,300 210,000 ————– 2,231,300 550,000 627,545 ————– 3,408,845 ————–



Group structure

Hydrogen

80%

Sodium

(2)

40% Aluminium

Net assets Sodium

Original share capital Retained earnings

Reporting date $ $ 200,000 850,000 ————– 1,050,000 ————–

Acquisition $ $ 200,000 500,000 ———– 700,000 ———–

Post acquisition $

350,000

Aluminium

Share capital Retained earnings Unrealised profit

(3)

Reporting date Acquisition $ $ $ 200,000 200,000 478,000 242,000 (4,000) – ——— ——— 674,000 442,000 ——— ———

Post acquisition $ – 236,000 (4,000)

Goodwill Sodium

Cost of shares Share of net assets acquired (80% × 700,000) (W2)

$ 562,000 (560,000) ———– 2,000 ———–

Aluminium

Cost of shares Share of net assets acquired (40% × 442,000) (W2)

$ 184,000 (176,800) ———– 7,200 ———–

Goodwill of $1,500 is written off in respect of Sodium. The goodwill of Aluminium is included in the value of investment in associate in the consolidated statement of financial position.


1075



Share of net assets (20% × 1,050,000) (W2) (5)

$210,000 ———–

Investment in associate

$

$ 184,000 92,800 ————– 276,800 ————–

$

$ 1,050,000 (1,500) 280,000 92,800 ————– 1,421,300 ————–

Cost of investment Aluminium post-acquisition (40% × 232,000 (W2))

(6)

Retained earnings

Hydrogen Goodwill written off – Sodium Sodium (80% × 350,000 (W2)) Aluminium (40% × 232,000 (W2))

Answer 49 PERIOD OF INFLATION (a)

Inventories undervalued

Inventory is stated at historical cost (or net realisable value if lower). Historical cost is normally below the current value in times of general inflation. The major weakness of historical cost is the effect of charging the historical cost of inventory against sales. Cost of sales will be lower than if current values had been charged, leading to higher profits and higher dividend payments. There may be insufficient funds to purchase replacement inventory, the price of which will equate to current value of inventory. (b)

Depreciation understated

Depreciation is usually based on the historical cost of non-current assets. Replacements will normally increase in price during a period of inflation. The annual depreciation charge, therefore, may not reflect the amount needed to be able to replace the assets. Consequently, the accounting profit will be overstated, and this may mean that too much profit is withdrawn from the business. The cash resources may then prove insufficient to replace the assets at the end of their useful life and the business may not be able to operate at the same level of activity as it has previously experienced. (c)

Gains and losses on net monetary assets undisclosed

Net monetary assets are monetary assets less monetary liabilities. The term “monetary” refers to all liabilities of a business repayable in money and those assets which are stated in historical cost accounts at the amount of money expected to be received (e.g. receivables are stated at sales value less allowances for irrecoverable debts). In a time of inflation gains can arise on monetary liabilities and losses on monetary assets. For example, loans to or from a company are monetary items. A loan made to a company may produce a gain to the company as, although the amount originally borrowed will be repaid at its face value, its purchasing power will have been reduced.

1076


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) The person lending the money to the company will have charged interest to cover: (i) (ii)

the risk of making the loan, and compensation for the fall in the purchasing power of the investment.

The interest cost will thus be charged against profits of the company, but also there should be a “gain” recorded in the statement of profit or loss(that of eventually having to repay only the same monetary amount). (d)

Asset and liability values unrealistic

Values for inventory and non-current assets are stated at historical cost (i.e. below their current value). Many would argue that a statement of financial position should record not only the assets in the possession of a company at the end of the reporting period but also their current worth. To show the amount at which the company originally bought the asset is not useful information and would never be used for decision-making purposes. (e)

Difficulty of meaningful periodic comparisons

A meaningful comparison of financial reports prepared under historical cost accounting over several accounting periods may be misleading. Many figures disclosed in accounts are not comparable. For example, profits of $100,000 in 2007 are not equivalent to profits of $100,000 in 2012 if there has been inflation between the two dates. The worth of the 2012 profits is less than the worth of the 2007 profits. The comparison is just as meaningless as comparing financial reports prepared in Japanese yen with reports prepared in euros. In order to be able to make a meaningful comparison between financial reports prepared in different time periods, it is desirable therefore to translate them into the same currency (i.e. to use units of a constant purchasing power). The adjustments are similar in principle to that used in translating dollars into euros or euros into dollars. Figures are often adjusted for changes in a price index to achieve a measure of constant purchasing power. In many countries, government departments issue indices in accordance with which companies must adjust their financial statements, particularly where there is high inflation.


1077

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Answer 50 STANDARD Cash flows from operating activities

Profit before tax (W7) Adjustments for: Depreciation, loss on sale (W1-5) Interest receivable Interest and premium payable Operating profit Increase in inventories Increase in receivables Increase in payables (63,000 – (41,500 – 440)) Cash generated from operations Interest paid Tax paid (W6)

$ 56,500

$

20,000 (450) 8,400 ——— 84,450 (14,000) (1,200) 21,940 ——— 91,190 (6,840) (10,500) ———

Net cash from operating activities

73,850

Cash flows from investing activities

Acquisition of long-term investment Purchase of property plant and equipment Receipt from sale of NCA (3,000 + 1,000) Interest received

(4,600) (69,000) 4,000 450 ———

Net cash used in investing activities

(69,150)

Cash flows from financing activities

Proceeds from issuance of shares Redemption of loan Dividends paid

70,000 (42,000) (7,500) ———

Net cash used in financing activities

20,500 ——— 25,200 (13,800) ——— 11,400 ———

Net increase in cash and cash equivalents Opening cash and cash equivalents Closing cash and cash equivalents

Notes to statement of cash flows (1)


Cash payments of $69,000 were made to purchase property, plant and equipment

1078



Cash and cash equivalents as shown in the statement of financial position

Cash and cash equivalents consist of cash on hand and balances with banks. 2011

$ 11,400 – ——— 11,400 ———

Cash at bank Bank overdraft

2010

Change in year $ $ 200 11,200 (14,000) 14,000 ——— ——— (13,800) 25,200 ——— ———

WORKINGS (1)

Plant and machinery account – at cost

Balance b/d Additions

(2)

$ 120,000 39,000 ———— 159,000 ————

Disposals account Balance c/d

$ 8,000 151,000 ———— 159,000 ————

Fixtures and fittings account – at cost

Balance b/d Additions

$ 24,000 10,000 ——— 34,000 ———


$ 5,000 29,000 ——— 34,000 ———

Non-current assets – additions summary

$ 20,000 39,000 10,000 ——— 69,000 ———

Freehold property $(130,000 - 110,000) Plant and machinery Fixtures and fittings

(3)

Plant and machinery account – depreciation


$ 6,000 54,000 ——— 60,000 ———


Balance b/d Charge for year

$ 45,000 15,000 ——— 60,000 ———

1079


Fixtures and fittings account – depreciation


(5)

$ 2,000 15,000 ——— 17,000 ———

Balance b/d Charge for year

NCA disposals account

Plant cost Fittings cost

$ 8,000 5,000

Plant depreciation Fittings depreciation Cash proceeds Plant Fittings Depreciation underprovided (bal fig)

——— 13,000 ——— (6)

$ 6,000 2,000 3,000 1,000 1,000 ——— 13,000 ———

Tax account

Cash paid (bal fig) Balance c/f

(7)

$ 13,000 4,000 ——— 17,000 ———

$ 10,500 33,000 ——— 43,500 ———

Balance b/f Profit of loss

$ 21,500 22,000 ——— 43,500 ———

Net profit before tax

As profit before tax is required, reconstruct the statement of profit or loss up to this figure. $ Profit before tax 56,500 Taxation (22,000) ——— 34,500 Dividends (7,500) ——— Retained profit for year 27,000 Balance b/f 14,000 ——— Balance c/f 41,000 ———

Note:

1080


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Answer 51 FALLEN Cash flows from operating activities

Profit before tax Adjustments for: Depreciation, (W1-3) Interest payable Operating profit Increase in deferred repairs provision Increase in inventories Increase in receivables Increase in payables Cash generated from operations Interest paid Tax paid (W5)

$ 4,625

$

1,472 152 ——— 6,249 186 (894) (594) 480 ——— 5,427 (152) (1,775) ———

Net cash from operating activities

3,500

Cash flows from investing activities

Acquisition of long-term investment Purchase of property plant and equipment Receipt from sale of non-current assets

(198) (3,800) 168 ———

Net cash used in investing activities

(3,830)

Cash flows from financing activities

Proceeds from issuance of shares (W6, W7) Redemption of loan Dividends paid

792 (560) (700) ——

Net cash used in financing activities Net decrease in cash and cash equivalents Opening cash and cash equivalents Closing cash and cash equivalents

(468) —— (798) 576 –––––– (222) ––––––

Notes to the statement of cash flows (1)


Cash payments of $3,800 were made to purchase property, plant and equipment.


1081


Analysis of the balances of cash and cash equivalents

Cash and cash equivalents consist of cash on hand and balances with banks.

Cash at bank and in hand Bank overdrafts

2011

2010

$000 – (222) —— (222) ——

$000 576 – —— 576 ——

Change in year $000 576 (222) —— (798) ——

WORKINGS (1)

Leasehold premises (net)

Brought forward Additions

(2)

$000 5,700 1,300 ——— 7,000 ———

Depreciation (to balance) Carried forward

Plant (net)

Brought forward Additions

$000 3,780 2,500

Disposals Depreciation (to balance) Carried forward

——— 6,280 ——— (3)

$000 276 964 5,040 ——— 6,280 ———

Disposals

Plant

$000 276

Cash Loss on sale (to balance)

—–— 276 —–— (5)

$000 168 108 —–— 276 —–—

Taxation

Cash (to balance) Carried forward Deferred tax Current tax

$000 1,775 202 1,730

$000 Brought forward Deferred tax Current tax P&L account

——— 3,707 ———

1082

$000 400 6,600 ——— 7,000 ———

138 2,038 1,531 ——— 3,707 ———



Share capital

$000 Carried forward

Brought forward Cash (to balance)

2,280 ——— 2,280 ———

(7)

$000 1,800 480 ——— 2,280 ———

Share premium

$000 2,112

Carried forward

$000 1,800 312 ——— 2,112 ———

Brought forward Cash (to balance)

——— 2,112 ——— (8)

Non-current loan

Cash (to balance) Carried forward

$000 560 1,240 ——— 1,800 ———

$000 1,800

Brought forward

——— 1,800 ———

Answer 52 WITTON WAY (a)

Accounting ratios

2011

2012

Profitability

Gross profit : Sales

Gross profit Sales

1,850

× 100

7,650

2,070

× 100

11,500

= 24.2% ———

× 100

= 18.0% ———

Return on capital employed

Profit before interest + tax Share cap + reserves + LTL

× 100

1,650 + 50 (5,900 + 5,000 + 350) = 15.1% ———


× 100

1,550 + 350 (5,900 + 5,700 + 3,350)

× 100

= 12.7% ———

1083

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Liquidity

Current ratio Current assets

Current liabilities

3,600

6,300

2,400

2,700

= 1.5 :1 ——

= 2.3 : 1 ——

3,600 – 1,500 2,400

6,300 – 2,450 2,700

= 0.9 : 1 ——

= 1.4 : 1 ——

Acid test

Current assets – Inventories Current liabilities

Efficiency

Trade receivables collection period Trade receivables × 365 Credit sales

1,200 7,650

Inventory turnover Cost of sales

Year - end inventory

× 365

11,500

× 365

= 57 days ————

= 121 days ————

5,800

9,430

1,500

2,450

= 3.9 times per year ————————— (b)

3,800

= 3.8 times per year ————————

Comments on the company’s results Profitability

The trading profitability to sales has significantly decreased from 24% to 18%. Profitability to capital employed has also decreased from 15% to 12.7%. The decline in the first ratio is not surprising given the reduction in selling prices. Sales have significantly increased – a growth of 50%: 11,500 - 7,650 7,650 The overall effect is an actual increase in gross profitability from $1,850,000 to $2,070,000. However, loan interest has eliminated this favourable result. Presumably the additional finance was raised for the sales expansion, to date, therefore, the expansion policy has not been successful but the additional finance may not be invested efficiently as yet. A more favourable result may be forthcoming next year.

1084


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Liquidity

Due to the expansion cash balances have disappeared by the year-end. However, there has been a large increase in other elements of working capital. Provided that the increase in receivables simply represents the extended credit terms being offered to customers rather than problem payers, liquidity is healthy. Both ratios in fact show an increase from 2011 to 2012. Efficiency

There has been no change in the inventory turnover ratio. This may be a sign of inefficiency as, if the company is selling the same range of goods as before, the inventory turnover ratio should increase if sales volume has been increased due to lower prices. The receivables collection period, however, has been greatly extended from 57 days to 121 days. 57 days was a long period in the first place, and it may be that the more generous credit terms are being abused by customers. Payables have not increased in line with the expansion of sales volume (and the purchases volume), thus increasing the pressure on funding working capital. Answer 53 RAPIDO

To From Date

Directors, Rapido AN Advisor

(a)

Introduction

This report intends to conclude on the profitability, liquidity, and solvency of Rapido and to suggest any necessary action. The report has been based on statements of comprehensive income for 2011 and 2010 together with 2011 budgets. (b)

(c)

Summary of conclusions and recommendations 

The company has achieved expansion in the current year, and has improved profitability, although below that budgeted.



The expansion has been financed by increases in borrowings, a substantial proportion being short-term overdrafts.



To improve the liquidity and solvency position the company needs to raise further long-term finance and reduce overdrafts.



The level of overheads should be investigated to identify reasons for increases.

Trading performance

(i)

Overall 

The company aimed for, and has achieved, a large increase in both operations level and profitability.



The expansion in turnover was greater than budgeted but profitability has not matched expectations.


1085


(iii)

(d)

(e)

1086

Margins 

Expansion was budgeted to be achieved at the expense of margins. However, the net margin has fallen below the budgeted level.



The reason for this is a growth in overheads above that budgeted, which should be investigated.

Asset utilisation 

Improved asset turnover, also above budgeted levels, has partly compensated for the below-budget margins.



The primary areas of improvement are inventories and tangible assets.

Liquidity 

The liquidity position was budgeted to decrease in the year, but the position is slightly worse than anticipated.



The main reason is the level of the overdraft which is rather higher than budgeted.



The overdraft limit may present an obstacle to future activities.



The liquidity position has also been worsened by substantial extra credit being allowed to customers.



Cash balances have also deteriorated, and the company is in need of an injection of capital for liquidity purposes.



The poor liquidity position has resulted in a low dividend being paid in spite of good profits.

Gearing 

Gearing has increased dramatically in order to finance new equipment, but is still at acceptable levels.



A large amount of the debt is short-term, which does not help the long-term stability of the company and should be replaced by further raising of long-term capital.



The extra capital should be debt due to the low level of dividend cover, and also because of increased tangible assets available as security.


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) Appendix Ratios

(1)

Net operating assets

Net profit % Operating profit

Revenue

Asset turnover Revenue

Net operating assets

Gross profit Gross profit

Revenue

2011 Actual

205

470

446

1,280 + 187

1,420 + 255 + 360

1,460 + 390 + 360

= 14%

= 23%

= 20%

205

470

446

2,560

4,500

5,110

= 8%

= 10.4%

= 8.7%

2,560

4,50

5,110

1,280 + 187

1,420 + 255 + 360

1,460 + 390 + 360

= 1.75

= 2.21

= 2.31

860

1,350

1,530

2,560 = 33.6%

4,500 = 30%

5,110 = 30%

187

255 + 360

390 + 360

1,280 + 187

1,420 + 255 + 360

1,460 + 390 + 360

= 12.7%

= 30.2%

= 34%

720

810

760

935

= 0.95

= 0.87

Solvency

Gearing

(3)

2011 Budget

Profitability

ROCE Operating profit

(2)

2010

Liquidity

Quick ratio

Current assets less inventory 305 + 175 362 Current liabilitie s = 1.33 (4)

Working capital

Receivables days Receivables

Sales

× 365

Inventory turnover Cost of sales

Inventory

305 2,560

× 365

720 4,500

× 365

810 5,110

× 365

= 43

= 58

= 58

1,700 ½ (135 + 205)

3,150 ½ (210 + 290)

3,580 ½ (205 + 325)

= 10

= 12.6

= 13.5


1087

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK Answer 54 NOT FOR PROFIT (a)

Main aims

A profit-orientated entity will have a primary aim of increasing the wealth of its owners. The best way of increasing this wealth is to be profitable and thereby increase the entity’s share price and also distribute the profits to the owners by way of a dividend payment. In fulfilling this primary aim the entity will also have to consider other stakeholders of the entity, employees, the local environment and government bodies to name a few. The considerations of these other stakeholders may well have an impact on the entity’s primary aim, employees will want a satisfactory return for the labour they provide and governments will want a share of the entity’s profits by way of taxation. So as well as maximising profits an entity will have to consider, maybe as secondary objectives, the other stakeholders that have a say in the business. An entity will make profits by selling its goods or services to its customers and thereby earn revenues. An NFP does not have the primary objective of making profits; the main objective of an NFP will be to provide a service for the community it serves. A government body is responsible for providing a policing service in the local community; a museum will have one of its primary objectives to educate the people by allowing them to see the various exhibits. There are no specific owners of an NFP, so there is no need to make profits; that is not to say that an NFP can continually make losses. An NFP must work within a given budget and must recognise if it exceeds that budget there will be consequences to the future income and costs. Income for an NFP may be in the form of government funding or donations from sponsors or by asking the public to make a contribution to the running costs of the organisation. (b)

Assessing performance

Assessing the performance of a profit-orientated entity is generally done by analysing the financial statements of the entity. Calculating various ratios and comparing those ratios with budget, prior years or other similar entities will give the analyst an idea of how the entity has performed. The analyst will consider whether the entity has made adequate returns on funds invested, that the entity is able to meet its commitments and that the market perceives that the entity is meeting expectations through various stock market ratios. Some of the ratios used in assessing a profit based entity will still be useful in assessing a NFP organisation. However, as the main aim of an NFP is to provide a service, and not be profitable, then profit-based ratios may not be as relevant. One of the most critical ways of assessing an NFP is to ensure it has met its budget. The budget of an NFP is far more relevant is assessing performance than the budget of a profit based entity. The NFP must stay within budget and analysts of an NFP will be focusing more on this factor than its income statement. Assessment of an NFP tends to be based upon the “3 Es”:

1088

(i)

Efficiency is measured by considering what inputs have been used to generate the respective output, and managers should be trying to minimise the level of inputs to perform the task.

(ii)

Effectiveness considers whether the objectives and targets have been met. Management must give clear objectives to the workforce so that those objectives can be seen and attained.

(iii)

Economy is considered by looking at the cost of the resources consumed against the value of the output delivered. Economy is very much linked to the efficiency of the task.


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) An NFP must ensure that it can meet any obligations that it may have and so liquidity is just as important for an NFP as it is for a profit orientated entity. If an NFP has borrowed monies then it must be in a situation that will allow it to repay those funds on the due date. Cash is possible more important for an NFP than profit, so an assessment of the cash flow statement of an NFP will be extremely important when considering its performance. Considerations will include, have cash inflows met budgeted expectations, have funds been used for the correct purpose. For both types of entities it is very important to assess performance so that if the entity is not performing as expected then steps can be taken to ensure that in the future the entity is able to meet its objectives, whether they be making a profit or providing a service. Answer 55 EARNINGS PER SHARE (a)

Basic EPS

Earnings Number of shares

$100,000 $0.50

EPS

(b)

2010 $ 52,000 ———

2011 $ 55,300 ———

200,000

200,000

————

————

26.0c ———

27.7c ———

Bonus issue

Comparative EPS – original (as above) Restated 26c ×

200,000 250,000

Current EPS Earnings (as above) No of shares EPS


26.0c 20.8c

$55,300 ———— 250,000 ———— 22.1c ———

1089


2010 $ 50,000 – ——— 50,000 – ——— 50,000 ——— 200,000 ———

Takeover

Earnings S – post-acquisition only 3/12 × $20,000 Less Non-controlling interest 10% × $5,000

No of shares Weighted average (200,000 × 9/12) + (400,000 × 3/12) EPS (d)

25c ——

2011 $ 63,000 5,000 ——— 68,000 (500) ——— 67,500 ———

250,000 ———— 27c ——

Rights issue

Cents (i)

Compute theoretical ex rights price

4 shares quoted cum rights at 360c 1 share at rights price — 5 — 1740 , c TERP = 5 (ii)

1,440 300 ——— 1,740 ——— 348c

EPS

Comparative $40,000 Original 200 200,000 000 348c Restated 20c × 360c Current Earnings Date

1 January 1 October

EPS

1090

No

200,000 50,000 ———— 250,000

$50,000 217,672

20.0c 19.3c $50,000 Time

Rights

Weighted average

× 9/12 x 360/348

= 155,172

× 3/12

= 62,500 ———— 217,672 ———— 23.0c


STUDY QUESTION BANK – FINANCIAL REPORTING (F7) (e)

Diluted – Convertible debentures

$ Earnings Basic Add Interest on debentures Less Tax at 33%

8,000 (2,640) ———

Diluted No of shares Basic Convertible debentures –

$100,000 × 140

EPS Basic Diluted (f)

2010 $

2011 $

40,000

50,000

5,360 ——— 45,360 ———

5,360 ——— 55,360 ———

400,000 140,000 ——— 540,000 ———

400,000 140,000 ——— 540,000 ———

10.0c ———

12.5c ———

8.4c ———

10.3c ———

$

2011 $

Diluted – Options

Earnings Basic and diluted

50,000 ———

EPS Basic (50,000/400,000)

12.5c ———

Diluted (50,000/410,000)

12.19c ——— $

Number of shares under option Number of shares shares that would have been issued at fair value

Number of shares outstanding


50,000 (50,00 000 × 80c) 100c

(40,000) ———— 10,000 400,000 ———— 410,000 ————

1091

FINANCIAL REPORTING (F7) – STUDY QUESTION BANK

1092


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