Florad Industries Cpa Mock Evaluation

CPA MOCK Evaluation

Performance Management Elective

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ELECTIVE (PERFORMANCE MANAGEMENT): Elective examinations will be 3 hours in length. Candidates will be given 4 hours to complete the examination, providing an extra hour to formulate their responses. The intention is to reduce the time constraint. The Elective examinations will be made up of a mix of objective-format questions and cases. The split and length may vary somewhat across the Electives to adapt to learning outcomes required. Elective examinations use larger and more complex cases than those used for Core 1 and Core 2, requiring a minimum of 60 and a maximum of 120 minutes to complete. The assessment of professional professional skill will continue continue in a multi-competency multi-competency environment, environment, always always building building on prior learnings, however, greater than 50% of assessment opportunities will be related to the Elective area being examined. Elective cases require candidates to simulate the “roles” they will play in real life, and therefore access will be provided to the reference tools they would use, where practical to do so. Below is an example of an average-length case that is focused on the Performance Management competencies, but also draws on Core Finance, Strategy and Financial Reporting competencies. FLORAD INDUSTRIES Suggested time: 90 minutes (represents the time judged necessary to complete the question)

Florad Industries Inc. (Florad) in a publicly-traded corporation that operates with four autonomous operating divisions that receive support from a corporate office. Divisions A, B and D all manufacture and sell niche products where Florad has found ways to charge a premium price, because it differentiates its products from the competition. Division C is a mature operating division with an older product line that has had steady sales for the last five years. See Exhibit 1 for more information on each of the divisions. The corporate office houses the executive management group, the research and development (R&D) department, and a shared service group that includes human resources, legal, and centralized purchasing. The corporate office also makes all capital investment and financing decisions for the operating divisions. The projected financial results for fiscal 2014, which include the first quarter actual results, are found in Exhibit 2. It is June 2014 and you, CPA, are a financial analyst who joined Florad three months ago. You are being mentored by Ms. Little, the current Vice President of Finance and CFO, who is also fairly new to the company. There are three other vice-presidents (VP) at Florad, who are responsible for each of Sales, R&D, and Operations (Manufacturing and Logistics). The general managers of each operating division have dual reporting relationships to both the VP of Operations and VP of Sales. In addition, the divisional controllers each report to both the CFO and the general manager.

CHARTERED PROFESSIONAL ACCOUNTANTS OF CANADA, CPA CANADA, CPA. © 2013, Chartered Professional Accountants of Canada. All Rights Reserved.

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Florad’s board of directors has mandated that all divisions’ weighted average cost of capital (WACC) be sustainable. Divisions not meeting a set requirement must either develop a corrective action plan that shows how they can can become sustainable by earning a return on investment at or exceeding a WACC of 10%, or they will be discontinued. Discussion was raised at the last board meeting about the future of Division C, the Board questioned if it should be shut down. One long-time board member said, “ Maybe Division C has had its day. We need to focus on the future, and to me we are better off focusing on the products in Divisions A, B and D.” As part par t of your mentoring, Ms. Little asks you to assess, based on the information available to you, whether the proposed divestiture of Division C is the right course of action, or if it should be kept. You should perform whatever analysis you believe is appropriate to support your position and present your findings in a draft report for her. She shares with you that the Board’s and executive management have focused their attention almost entirely on the niche markets of Divisions A, B, and D. These three niche markets have, of late, required the vast majority of executive time and support from the corporate office, including the use of shared services. She estimates less than 10% of corporate office resources are used on Division C. Ms. Little also asks you to comment on the performance measurement methods currently employed by Florad and to comment on the proposed bonus plan (see Exhibit 3). She asks you to comment on the use of a return on investment (ROI) by Florad, particularly on how the executive management uses it as the primary way of assessing divisional and general manager performance. She wonders if there are different applications of ROI that should be considered. She notes that the new bonus calculations will be based on a return on investment calculation of some sort. In her opinion, Florad is not measuring the economic reality of each of the divisions accurately. She wonders if there is a way to reduce the bias the board has in looking at purely financial results for performance evaluation. She asks you to provide her with a brief and high-level list of key performance measures that could be tracked using a balanced scorecard, attributes that could be helpful to manage Florad and balance its long-term needs with short-term profits. She already has some ideas in this area, but is curious to see if you come up with other ideas. Then she goes back to discussing the performance evaluation currently being done by Florad, and reminds you that the financial component must still be the dominant attribute in evaluating the divisions and management based on directions from the board. She suggests it be 80% of the weighting for your purposes. Finally, she encourages you to raise any other issues of significance you identify through your analyses.


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Just before leaving for the day, the Ms. Little comes into your office and says, “One last thing, the Board really wants to maintain the company’s debt to equity ratio to keep WACC at its

current level. They believe that if a pre-tax free cash flow in 2015 of $1,600,000 is achievable, any debt financing needed for the proposed Division E can easily be arranged. Bear in mind that because Division C is mature, it has low UCC, so for the next few years CCA and depreciation will not be significantly different. Can you see if we are short of the $1,600,000 cash flow target? And, if so, maybe you you can identify identify a couple couple of ways ways to internally internally fund the potential potential shortfall.” shortfall.” See you on my return. Good luck, I have a lot of confidence in you!”


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EXHIBIT 1 Divisional Information

Divisions A, B and D are much newer operating divisions operating in growing market segments. The view of the Board is that these divisions are the key to the future success of Florad, as they are all earning an ROI above the required 10%, based on corporate o ffice’s calculations. To further support Florad’s future success, management has committed to maintaining sales, general and administrative costs at $4.77M until at least 2017. Division A has grown steadily by about 6% a year for the four years it has been existence. The forecasted growth in sales is 5% for 2015 and 4% for 2016 and 2017. Division B is 3.5 years old and has two plants that are currently running below capacity. Three years ago, one of these plants was once quite busy but during the latest first quarter, one segment of the Division B’s sales was discontinued since it was not proving to be successful (was reported as a discontinued operation in Quarter 1). Later this year, management is going to close one plant entirely and move its remaining operations over to the other plant. Division B’s sales are expected to grow about 3% even with the two plants being combined. This growth rate is expected to continue for two more years before levelling off in 2017. The remaining plant would have sufficient capacity to meet the production needs for at least the next three years. Some land and equipment will be disposed of as part of the closure. The equipment is fairly new. The land and equipment can be sold for an estimated $500,000. At this point, a buyer has been found for the equipment, but not for the land, and a tentative agreement has been signed to transfer the equipment within 30 days of closure. Division C is a mature operating division with an older product line that is currently only earning a return on investment (ROI) of 7.5% on an investment base of $1,900,000 based on Corporate Office’s calculations calculations . Division C has had essentially the same sales results year over year for the past five years, and this trend is expected to continue for at least the next three years. Division C’s general manager does not understand how they only have an ROI of 7.5%. While

Division C no longer requires R&D, the strong R&D of the past has positioned Division C as a low-cost producer and Florad virtually dominates market share with selling prices that would be uneconomic for most in the industry, but work for Florad, creating a successful barrier to entry for other companies. This division has been highly successful at producing defect-free products products that always arrive on time at their customers’ locations. Division D was spearheaded by Mr. Aizawa and the former CFO. When first launched, the division could not be financed from internally-generated cash flows, therefore long-term debt was taken on to get the division up and running. Accordingly, all of the interest on the debt has been charged directly to Division D.


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Division D has been in existence for six years and is much more volatile than the other divisions. Sales have varied by as much as 15% year to year. This past year, sales were up 10% from the prior year but down 5% from the year before last. Management is forecasting an average of 5% growth in sales up to 2017. All divisions are budgeting the same gross margin percent for the next three years. Stemming from R&D breakthroughs, Division D was able to consolidate two operations into one and now has some land that is sitting idle. Corporate Office is working on selling it. However, Florad is now considering the creation of a Division E that would allow Florad to enter yet another niche market so they will likely keep the land for the new division.


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EXHIBIT 2 Forecast for Fiscal 2014 First Quarter Actual Results - 3 Quarters Revised Budget May 15, 2014 (in ‘000s) Division A

Sales Cost of Goods Sold Gross Margin Selling, General and Administrative Administrative 1 Corporate office Allocation (% of sales) EBIT Interest Expense Net Income before Taxes Income Tax expense Net Income before Discontinued Operations Loss (after taxes) from Discontinued Operation Net Income Note: Depreciation 2

Division B

Division C

Division D

Corporate Office

$1,700 900 800 35 327 438 0 438 175 263

$2,500 1,400 1,100 360 481 259 0 259 104 155

$5,900 3,300 2,600 1,225 1,137 238 0 238 95 143

$3,400 1,850 1,550 550 655 345 56 289 116 173

2,600 (2,600) 0 0 0 0 0

70

100

190

110

60

Total

$13,500 7,450 6,050 4,770 0 1,280 56 1,224 490 734 (277) $457 530

1

R&D expense, included in the $2,600 Corporate Office SG&A, totals $700. Included in cost of goods sold for manufacturing equipment and in Selling, General, and Administrative for non-manufacturing assets. 2


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EXHIBIT 2 (continued) Supplementary Balance sheet information (in ‘000s):

Assets 2 Return on investment Shareholder’s Equity

Division A

Division B

Division C

Division D

Corporate Office

Total

$700 37.4%

$1,000 15.5%

$1,900 7.5%

$1,100 15.7%

$300

$5,000 $2,857

2

The assets of Division D include land of $400 that is being held for resale. Corporate office is working on the disposition.

Forecasted Capital Expenditures (in ‘000s):

Capital Expenditures – 2015 Capital Expenditures – 2016

Division A

Division B

Division C

Division D

Corporate Office

Total

$65 $50

$120 $110

$65 $60

$80 $75

$25 $20

$355 $315

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EXHIBIT 2 (continued) Supplementary Balance sheet information (in ‘000s):

Assets 2 Return on investment Shareholder’s Equity

Division A

Division B

Division C

Division D

Corporate Office

Total

$700 37.4%

$1,000 15.5%

$1,900 7.5%

$1,100 15.7%

$300

$5,000 $2,857

2

The assets of Division D include land of $400 that is being held for resale. Corporate office is working on the disposition.

Forecasted Capital Expenditures (in ‘000s):

Capital Expenditures – 2015 Capital Expenditures – 2016 Capital Expenditures – 2017

Division A

Division B

Division C

Division D

Corporate Office

Total

$65 $50 $65

$120 $110 $120

$65 $60 $75

$80 $75 $85

$25 $20 $20

$355 $315 $365


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EXHIBIT 3 The Proposed Bonus Plan

The newly proposed bonus plan is intended to reward the general managers and the executives based on the return on investment generated. Corporate Office suggested the following be used: 10% of base salary if their division earns the minimum required ROI set by the board of directors. 25% of base salary if the division earns an ROI of at least 2% more but less than 5% above the minimum required. 50% of base salary if the division earns 5% or more above the minimum required ROI. 





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EXHIBIT 3 The Proposed Bonus Plan

The newly proposed bonus plan is intended to reward the general managers and the executives based on the return on investment generated. Corporate Office suggested the following be used: 10% of base salary if their division earns the minimum required ROI set by the board of directors. 25% of base salary if the division earns an ROI of at least 2% more but less than 5% above the minimum required. 50% of base salary if the division earns 5% or more above the minimum required ROI. 






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MARKING GUIDE FLORAD INDUSTRIES

To: Ms. Little Little VP and CFO From: CPA Subject: Draft Report and other discussions requested for your return I have completed my preliminary report that addresses the following issues for us to review. I approached the assigned tasks as follows: 1. Determined how ROI is being calculated. Is it using operating income or net net income? And on the denominator is it Return on Equity or Return on Assets? 2. Assessed if the ROI as calculated calculated is relevant for the specific entities entities being assessed – for example managers, divisions, CEO and company overall. 3. Assessed whether Division Division C should be shut down using the point of view view from both ROI and cash flow. 4. Extrapolated ROI and cash flow into the foreseeable future to assess: i. if all divisions are in fact returning a sufficient sufficient ROI; ROI; ii. suggested areas for improvement; and iii. to see if sufficient internal cash flow from operations exist exist for the development of the proposed new Division E. 5. Commented on the introduction of the proposed proposed bonus plan and the possible use of a Balanced Scorecard. 6. Discussed strategic strategic and external external reporting considerations considerations with respect to discontinued operations – the implications if Division C is to be discontinued, if plants at a t Division B are rolled into one, and treatment of surplus land in Division D C P A M a p p i n g – T e c h n i c a l C o m p e t e n c i e s

2.1.1 Evaluates the entity’s governance structure in terms of the quality of information given to

the board. (Level B at Core and Level A in PM elective) 3.6.2 Evaluates performance of responsibility centres. (Level B at Core and Level A in PM Elective)


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Indicator #1: Candidates should demonstrate they understand a relevant ROI for the divisions, specifically the need to exclude interest and taxes in the numerator for operating divisions and use assets as the denominator since each division is an operating division with no decisionmaking power over capital investments. (i.e. suggest using ROA). The candidate should remove non-relevant corporate allocations to evaluate the individual divisional general manager’s performance as they have no control over these allocations – and also determine an appropriate estimate of a distribution of corporate costs that more closely reflects the cause and effect of economic reality to better assess the Division performance. Analysis of ROI

You asked me to comment on the use of ROI as a measure of performance and how it is being used at Florad. I believe that it is inappropriate to use the same measure to assess each of the managers, the divisions and the company. My view is that the components used in determining the “return” and the “investment” portion should be tailored to the company level being evaluated. The ROI calculation was reviewed to validate the appropriateness of the numerator and denominator to ensure it represented a good proxy for the economic reality of the situation, in particular with respect to Division C which is under scrutiny. It appears that the Board has calculated ROI by using assets as the denominator resulting in Division C is only earning 7.5% which which is below the required 10% WACC. However, the approach is not an entirely representative measurement. It is necessary to determine if operating or net income is used as the numerator and if the numerator needs to be adjusted to appropriately assess performance of the component in question (division on its own, the performance of the general manager of the division, and for the company as a whole). It is also necessary to determine if the denominator is 1) assets, and if so whether any assets should be excluded for the entity in question or 2) shareholders’ equity. Shareholders equity is appropriate in the case of assessing performance of the overall company from the point of view of shareholders and for the CEO and CFO who, with their ability to finance assets with a combination of debt and/or equity, elect to boost the return on assets generated from operating income or EBIT by using financial leverage. However, it is not appropriate to use shareholders’ equity to assess the di visions or the managers since they do do not have decision-making power over financing.


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Measuring each general manager’s performance:

In my view, using net income is not a suitable metric for evaluation of ROI for divisions and for their general managers. This is because the operating divisions have no authority over financing of operations so they should not be evaluated on items that are below the EBIT line as they are non-controllable. In addition, the general manager has no control over costs allocated from corporate office so these amounts ought to be removed from the numerator in assessing the general manager, independent of the division. Measuring each division’s performance:

From a divisional point of view, the denominator of assets is appropriate. However in the case of Division D the land held for resale that it is now the responsibility of corporate office and should be excluded. Accordingly, the table below recalculates the ROI that should be used to evaluate evaluate the divisional general managers and the divisions. It excludes allocations from corporate office in the numerator and removed land held for resale in the case of Division D from the denominator in this revised calculation. Div A

EBIT before Corporate Office allocation Sales Assets (less land held for resale) ROI

$765 $1,700 $700 109.3%

Div B

$740 $2,500 $1,000 74.0%

Div C

$1,375 $5,900 $1,900 72.4%

Div D

$1,000 $3,400 $700 142.9%

I will discuss corporate overhead allocation next. C P A M a p p i n g – T e c h n i c a l C o m p e t e n c i e s

3.6.1 Organizational Performance Measurement using accepted frameworks – Level B at core and moves to Level A in PM elective 5.2.1 Treasury Management – evaluates the entity’s cash flow – Level A at Core Indicator #2: Candidates should question how corporate office costs are being allocated and recommend a recalculated ROI to assess division performance. Discussion should continue on the notion of controllable versus non-controllable costs. Candidates should then discuss the implications of the revised ROI, particularly with respect to Division C.

To be able to assess whether Division C should be shut down d own or not, certain adjustments should be made, particularly to the corporate cost allocations to better reflect the “usage” of those costs. Then the performance of Division C can be assessed against the set WACC and ROI criterion set by the Board.


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Decision-making is impaired if the corporate charges are allocated in a manner that does not represent the economic reality of the situation. Currently corporate office executive staff and shared services devote a substantial amount of their resources to the niche divisions (A, B, and D) and not to the mature Division C, therefore the current allocation a llocation of corporate charges (which is based on a percentage of sales) does not represent economic reality. Based on our conversation, less than 10% of corporate office resources are used on Division C. Using 10% as a starting point, I have revised the allocation of corporate office costs assuming Divisions A, B and D use equal amounts. Div A

EBIT before Corporate Office allocation Revised Corporate Allocation Revised EBIT Assets (less land held for resale) ROI

$765 $780 ($15) $700 -2.1%

Div B

Div C

$740 $780 ($40) $1,000 -4.0%

$1,375 $260 $1,115 $1,900 58.7%

Div D

$1,000 $780 $220 $700 31.4%

We should review the appropriateness approp riateness of the 30%, 30%, 10%, and 30% estimate for Divisions A, B, C and D respectively respectively for future use, but for now now it will provide reasonable estimate. The allocation of R&D costs should also be considered since Division C is mature and likely does not require the same proportion of R&D as the other three divisions. This shows how the current allocation of corporate office charges is misleading. Division C is currently under consideration to be closed but is in fact earning the highest ROI at 58.7% while Divisions A and B are earning a negative return. Given that significant economic value is being added by Division C based on the fact that it is earning well above Florad’s WACC requirement, there is a compelling argument a gainst discontinuing the operations of this division. d ivision. In fact, Division C is generating the highest EBIT $1,115,000. C P A M a p p i n g – T e c h n i c a l C o m p e t e n c i e s

3.2.2 Prepares, analyzes, or evaluates operational plans, budgets, and forecasts - Level A Core 5.2.1 Treasury Management – Evaluated the entity’s cash flow – Level A at Core

Indicator #3: Candidates should determine if pre-tax free cash flow for 2015 will reach the targeted $1.6 million as well prepare a projected cash flow for 2-3 years since the information is provided in the case and it will provide better information as to the company’s company’s ability to fund a new division.


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Cash Flow

I have calculated the forecast free-cash flow for fo r 2015 as follows: 2015

Growth rates Sales Gross margin SG&A EBIT (pre-corp. allocation) Add: depreciation Less: capital allocation Free cash flow

Division

Division

Division

Division

Corp

A

B

C

D

Office

Total

5% $1,785 840 35

3% $2,575 1,133 360

0% $5,900 2,600 1,225

3% $3,502 1,597 550

2,600

$13,762 6,170 4,770

805

773

1,375

1,047

(2,600)

1,400

70 65 810

100 120 753

190 65 1,500

110 80 1,077

60 25 (2,565)

530 355 1,575

The Board has stated that Division E’s expansion could progress provided that cash flow from

operations is at least $1.6 million. We can see that cash flow f low will be approximately $1,575,000 leaving the firm $25,000 shy of o f this target. Selling off unnecessary assets from Division B (estimated proceeds of $500,000) will easily offset this small shortfall. The growth rates vary beyond 2015, so forecasts should be examined as follows: 2016


Division

Division

Division

Division

Corp

A

B

C

D

Office

4% $1,856 874 35 839 70 50 859

3% $2,652 1,167 360 807 100 110 797

0% $5,900 2,600 1,225 1,375 190 60 1,505

5% $3,749 1,709 550 1,159 110 75 1,194

2,600 (2,600) 60 20 (2,560)


Total

$14,157 6,349 4,770 1,579 530 315 1,794

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Division

Division

Division

Division

Corp

A

B

C

D

Office

4% $1,931 909 35 874 70 65 879

0% $2,652 1,167 360 807 100 120 787

0% $5,900 2,600 1,225 1,375 190 75 1,490

5% $3,936 1,794 550 1,244 110 85 1,269

2,600 (2,600) 60 20 (2,560)

Total

$14,419 6,470 4,770 1,700 530 365 1,865

Depreciation associated with capital spending could be included but there may be some assets that become fully depreciated in the th e next 3 years, so for the purposes of this forecast it has been ignored. One of the important items the above tables show is that Division C is actually a “cash cow” and

is expected to generate close to $1.5 million of cash for each of the next three years. This division clearly should not be shut down and should be sustained as it is a key to generating funds for future growth – it is a strong generator of cash and with an ROI well above WACC, it is adding value to Florad. Divisional Performance Going Forward

Looking ahead, the divisional performance for 2015 shows improvement for Division A, Division C continues to be the top performer and Division B is still negative ROI. 2015

EBIT (pre-corp. allocation) Less: revised corp. allocation EBIT Assets 2014 (less land held for resale) Plus: capital expenditures Return on Investment

Division

Division

Division

Division

A

B

C

D

$805

$773

$1,375

$1,078

$780 $25

$780 (7)

$260 $1,115

$780 $298

$700

$1,000

$1,900

$700

$65 $765 3.3%

$120 $1,120 -0.6%

$65 $1,965 56.7%

$80 $780 38.1%


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Divisional performance could also be measured me asured on operating efficiency, specifically return on assets. The table above shows that the sales to assets ratio is low at 2.3 and 2.33 for Divisions A and B versus 3.00 and 4.58 for Divisions Divisions C and D. Therefore A and B appear less efficient efficient at this point in time compared to C and D. We could have further discussion to break down the return on investment even further using DuPont analysis to develop more precise performance measures based on return on investment. C P A M a p p i n g – T e c h n i c a l C o m p e t e n c i e s

3.6.1 Evaluates performance using accepted frameworks – Core level B and PM Elective level A 3.7.1 Analyzes the implications of management ma nagement incentive schemes and employee compensation methods. Core level A – PM Elective A Indicator #4: Candidates are expected to comment on the benefits of using a balanced scorecard and suggest some measures that could be used as part of a scorecard. Candidates should also recognize that the proposed bonus plan is not ideal as it does not take into account any division differences. Bonus Plan and Balanced Scorecard

The revised ROI discussed earlier (page 3) show a more representative performance of the general managers, one that better reflects their financial performance. Since the ROI’s vary from -4% to 58%, these amounts need to be scrutinized by executive management to assess tailored bonus targets for each general manager based on their respective division as using the same bonus formula for everyone would not be fair. Consideration perhaps ought to be given to a “Residual Income” goal for each general manager

or a specific % increase year over year, or some other scheme that ties the results to progress. Possibilities for our initial balanced scorecard, to try to achieve a blend of non-financial measures to ensure both short and long term strategic and operational objectives are met, are outlined below.


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Financial

Deliver target EBIT Improve ROI in terms of profitability, asset turnover, or financial leverage Target reductions in Corporate Overhead Customer

100% on time delivery no defects/returns (must be no more than some threshold) Learning and Growth

selected professional development for all key managers identify and coach individuals for succession planning Internal Process

maintain R&D seek out specific cost improvement targets There is insufficient data to be able to do a thorough review of the bonus plan at the moment. However, the proposed new bonus plan should be reconsidered in light of my comments on the flaws of the current measures. Should the new bonus plan be implemented along with a revised ROI, the bonus payments would be:

Revised ROI Bonus (% of base salary)

Div A

Div B

Div C

Div D

-2.1% 0%

-4.0% 0%

58.7% 50%

31.4% 50%

While this would be more m ore than satisfactory to the general managers of divisions C and D, the general managers at divisions A and B would not be happy. C P A M a p p i n g – T e c h n i c a l C o m p e t e n c i e s

1.2.3 Financial Reporting –evaluates treatment of non-routine transactions-Core Level A 1.4.5 Analyzes and predicts the impact of strategic and operational decisions on financial results- Core Level B and moves to Level A in PM elective. Indicator #5: Candidates recognize that Florad is a public company that reports under IFRS and that the events that have occurred or are being contemplated will affect the quarterly reporting. Candidates should identify the fact that the Division B plant closure may be a discontinued operation/may require a reclassification to assets held for sale.


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Florad is a public company and therefore has quarterly reporting requirements to meet. You asked me to raise raise any other issues issues that I considered significant in my report. Some of the events that have transpired have financial reporting implications that should be taken into account in preparing our next quarterly report. Discontinued operations and assets held for sale

I have assumed that the discontinued assets that are included in the financial statements have been properly accounted for since we would have completed our first quarter reporting already. I assume these relate to the disposal of the sales segment in Division B. Note: My earlier analysis strongly suggests that there is no merit in closing down Division C as it would not make economic sense to discontinue the operations of this Division, so I have not discussed segregating the results of Division C as a discontinued operation nor discussed showing its assets as being held for sale. Management recently decided to close one of Divisions B’s plants permanently and to move its operations over to the other plant later this year. From Florad’s operational perspective th is not

a discontinued operation as the operations are simply being merged into one plant and production levels are being maintained. However, a plant is being shut down and as a result land and equipment are being disposed of. There are therefore accounting implications to these events. (See the discontinued operations details outlined in IFRS 5 just below.) Discontinued Operations According to Paragraph 30 of IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, an entity shall present and disclose information that enables users of the financial statements to evaluate the financial effects of discontinued operations and disposals of noncurrent assets (or disposal groups). This would include separate disclosure of any discontinued operations, if the conditions of IFRS 5, Paragraph 32 are met: “A discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale, and (a) represents a separate major line of business or geographical area of operations, (b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale.” A “component of an entity” comprises operations and cash flows that can be clearly

distinguished, operationally and for financial reporting purposes (IFRS 5, Paragraph 31). In other words, a component of an entity will have been a cash-generating unit or a group of cashgenerating units while being held for use.


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In order to be classified as held for sale, the conditions listed above must be satisfied. However, IFRS 5, Paragraph 13, states that while the non-current assets to be abandoned may not be classified as held for sale, the results and cash flows of a disposal group to be abandoned must be classified as a discontinued operation if it meets the criteria established in IFRS 5, Paragraph 32: “An entity shall not classify as held for sale a non -current asset (or disposal group) that is to be abandoned. This is because its carrying amount will be recovered principally through continuing use. H o w e v e r , i f t h e d i s p o s a l g r o u p t o b e a b an an d o n e d m e et et s t h e c r i t e r i a i n p a r a g r a p h

–( c ), 32(a) ), t h e en en t i t y s h a l l p r e s e n t t h e r e s u l t s a n d c a s h f l o w s o f t h e d i s p o s a l g r o u p a s d i s c o n t i n u e d o p e r at at i o n s i n a c c o r d a n c e w i t h p a r a g r a p h s 3 3 a n d 3 4 a t t h e d a t e o n w h i c h i t . Non-current assets (or disposal groups) to be abandoned include nonc e a s es es t o b e u s e d current assets (or disposal groups) that are to be used to the end of their economic life and noncurrent assets (or disposal groups) that are to be closed rather than sold.”

Assets held for sale According to IFRS 5, Non-current Assets Held for Sale, “An entity shall classify a non -current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use.” I n order for this classification to occur, the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups) and its sale must be highly probable. To be probable, the appropriate level of management must be committed to a plan to sell the asset (or disposal group), an active programme to locate a buyer and complete the plan must have been initiated and in addition the asset (or disposal group) must be actively marketed for sale at a price that is reasonable in relation to its current fair value. In addition, the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification. In this case, Florad has formal plans to dispose of the idle assets at Division B and has identified a buyer for the equipment (not the land) who has signed an agreement to take possession within 30 days of the closure of the plant later this year. Therefore the equipment should be classified as assets held for sale. Since the equipment value is not impaired, it would seem likely there would would be no need for a write write down. The land is available for sale, but no buyer has been found for it. If so, then the land should also be classified as assets held for sale. In terms of the land from Division D, it is ready for sale. However, it sounds like management may end up keeping the land for use in Division E rather than dispose of it. No buyer appears to have been identified for it. So no reclassification would be done for this asset.


Florad Industries Cpa Mock Evaluation

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