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2013ACCA F7(INT)FinancialReporting

Publishing

Exam Kit



EXAM A C C APaper

F7 (INT)K I T

Financial Reporting(International)

Publishing



ii © Emile Woolf Publishing Limited

Sixth edition published by

Emile Woolf Publishing Limited

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© Emile Woolf Publishing Limited, January 2013

All rights reserved. No part of this publication may be reproduced, stored in a retrieval

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You must not circulate this book in any other binding or cover and you must impose

the same condition on any acquirer.

Notice

Emile Woolf Publishing Limited has made every effort to ensure that at the time of

writing the contents of this study text are accurate, but neither Emile Woolf Publishing

Limited nor its directors or employees shall be under any liability whatsoever for any

inaccurate or misleading information this work could contain.

British Library Cataloguing in Publications Data

A catalogue record for this book is available from the British Library.

ISBN: 978‐1‐84843‐289‐5

Printed and bound in Great Britain.

Acknowledgements

The syllabus, study guide, exam ques tions and answers (where indicated) are

reproduced by kind permission of the Association of Chartered Certified Accountants.



© Emile Woolf Publishing Limited iii

Paper F7 (INT)Financial Reporting

c

Contents

Page

Questions and answers index v

Syllabus and study guide ix

Exam techniques xxi

ection

1 Practice questions 1 A conceptual framework and a regulatory framework for financial reporting 1

Financial statements – Statements of cash flows 7

Financial statements – Preparation of accounts from a trial balance 25

Financial statements – Amendment of draft financial statements 46

Financial statements – Application of accounting standards 63

Business combinations – Statements of financial position 79

Business combinations – Statements of financial performance 100

Business combinations

– Statements

of

financial

position

and

performance

111

Analysing and interpreting financial statements 118

2 Answers to practice questions 131

A conceptual framework and a regulatory framework for financial reporting 131

Financial statements – Statements of cash flows 145

Financial statements – Preparation of accounts from a trial balance 169

Financial statements – Amendment of draft financial statements 203

Financial statements

– Application

of

accounting

standards

226



iv © Emile Woolf Publishing Limited

Business combinations – Statements of financial position 255

Business combinations – Statements of financial performance 287

Business combinations – Statements of financial position and performance 301

Analysing and interpreting financial statements 311

3 Mock exam questions 329

4 Answers to mock exam questions 335



© Emile Woolf Publishing Limited v


i

Questions andanswers index

Questionpage

Answerpage

Exam

A conceptual framework and regulatory framework for financial reporting

1 Recost 1 131

2 Worthright 1 133

3 Revenue recognition 2 135

4 Angelino 3 137 5 Emerald 4 140 F7 D07

6 Conceptual Framework 5 141 F7 J08

7 Promoil (IAS 37) 5 143 F7 D08

8 Wardle 6 144 F7 J10

Financial statements – Statements of cash flows

9 Tabba 7 145

10 Boston 9 149

11 Planter 10 152 12 Casino 12 153

13 Minster 14 156 F7 J07 (amended)

14 Pinto 16 159 F7 J08

15 Coaltown 18 162 F7 J09

16 Crosswire 20 165 F7 D09

17 Deltoid 22 167 F7 J10

Financial statements – Preparation of accounts from a trial balance

18 Petra

25

169

19 Darius 26 172



Paper F7: Financial Reporting (International)

vi © Emile Woolf Publishing Limited

Questionpage

Answerpage

Exam

20 Danzig 28 175

21 Allgone 30 178

22 Tourmalet 32 181 23 Chamberlain 34 183

24 Tadeon 35 185

25 Llama 36 188

26 Candel 38 191 F7 D08

27 Sandown 39 193 F7 D09

28 Pricewell 41 196 F7 J09

29 Dune 43 198 F7 J10

30 Cavern 45 200 F7 D10

Financial statements – Amendment of draft financial statements

31 Deltoid 46 203

32 Tintagel 48 206

33 Harrington 50 209

34 Wellmay 53 211

35 Dexon 55 214 F7 J08

36 Bodyline (IAS 37) 57 216

37 Niagara (IAS 33) 57 217

38 Taxes (IAS 12) 58 218

39 Broadoak (IAS 16) 59 220

40 Merryview (IAS 16 and IAS 36) 60 222

41 Impairment and Wilderness (IAS 36) 61 223

Financial statements – Application of accounting standards

42 Torrent and Savoir (IAS 11, IAS 33 and IAS 32) 63 226

43 Elite Leisure and Hideaway (IAS 16 and IAS 24) 64 228

44 Triangle (IASs 37, 10, 18) 66 231

45 Construction (IAS 11) 67 233

46 Bowtock (IAS 10, 2 and 11) 67 234

47 Multiplex and Simpkins (IAS 32) 68 235

48 Convertibles (IAS 32) 69 237

49 Errsea (IAS 16, 20 and 10) 70 238

50 Partway (IFRS 5 and IAS 8) 71 240

51 Pingway (IAS 32) 73 243 F7 J08

52 Dearing (IAS 16) 73 244 F7 D08

53 Waxwork (IAS 10) 74 245 F7 J09 54 Flightline (Non ‐current assets) 74 247 F7 J09



Index to questions and answers

© Emile Woolf Publishing Limited vii

Questionpage

Answerpage

Exam

55 Darby (Non ‐current assets) 75 248 F7 D09

56 Barstead (IAS 33) 76 256 F7 D09

57 Apex (IAS 23) 77 251 F7 J10 58 Tunshill (IAS 8) 77 252 F7 D10

59 Manco (IFRS 5 and IAS 37) 78 253 F7 D10

Business combinations – Statements of financial position

60 Hydrox 79 255

61 Hedra 80 257

62 Harden 82 260

63 Halogen 84 263

64 Horsefield 86 265 65 Highmoor 87 267

66 Hapsburg 89 270

67 Highveldt 90 273

68 Hark, Spark and Ark 92 275

69 Parentis 94 279

70 Plateau 95 280 F7 D07

71 Pacemaker 96 283 F7 J09

72 Picant 98 285 F7 J10

Business combinations – Statements of financial performance

73 Hydan 100 287

74 Holdrite, Staybrite and Allbrite 102 290

75 Python, Snake and Adder 103 292

76 Hosterling 105 294

77 Patronic 106 295 F7 J08

78 Pandar 107 297 F7 D09

79 Premier 109 299 F7 D10

Business combinations – Statements of financial position and performance

80 Hepburn 111 301

81 Hydrate 113 304

82 Hillusion 114 306

83 Pedantic 116 309 F7 D08

Analysing and interpreting financial statements

84 Comparator 118 311

85 Ryetrend

120

315

86 Greenwood 121 318




viii © Emile Woolf Publishing Limited

Questionpage

Answerpage

Exam

87 Harbin 123 320 F7 D07

88 Victular 125 323 F7 D08

89 Hardy 127 326 F7 D10



© Emile Woolf Publishing Limited ix


S

Syllabus and study guide

Aim

To develop knowledge and skills in understanding and applying accountingstandards and the theoretical framework in the preparation of financial statementsof entities, including groups and how to analyse and interpret those financialstatements.

Main capabilities On successful completion of this paper candidates should be able to:

A Discuss and apply a conceptual framework for financial reportingB Discuss a regulatory framework for financial reportingC Prepare and present financial statements which conform with International

accounting standardsD Account for business combinations in accordance with International

accounting standards

E Analyse and interpret financial statements




x © Emile Woolf Publishing Limited

Rationale

The financial reporting syllabus assumes knowledge acquired in Paper F3, Financial Accounting , and develops and applies this further and in greater depth.

The syllabus begins with the conceptual framework of accounting with reference tothe qualitative characteristics of useful information and the fundamental bases ofaccounting introduced in the Paper F3 syllabus within the Knowledge module. Itthen moves into a detailed examination of the regulatory framework of accountingand how this informs the standard setting process.

The main areas of the syllabus cover the reporting of financial information for singlecompanies and for groups in accordance with generally accepted accountingprinciples and relevant accounting standards.

Finally, the syllabus covers the analysis and interpretation of information fromfinancial reports.

Detailed Syllabus

A A conceptual framework for financial reporting

1. The need for a conceptual framework2. The fundamental concepts of relevance and faithful representation (‘true

and fair view’)3. The enhancing characteristics of comparability, verifiability, timeliness

and understandability4. Recognition and measurement5. The legal versus the commercial view of accounting6. Alternative models and practices

B A regulatory framework for financial reporting

1. Reasons for the existence of a regulatory framework2. The standard setting process

3. Specialised, not-for-profit, and public sector entities

C Financial statements

1. Statements of cash flows2. Tangible non-current assets3. Intangible assets4. Inventory5. Financial assets and financial liabilities6. Leases




© Emile Woolf Publishing Limited xi

7. Provisions, contingent liabilities, and contingent assets8. Impairment of assets9. Taxation10. Regulatory requirements relating to the preparation of financial

statements11. Reporting financial performance

D Business combinations

1. The concept and principles of a group2. The concept of consolidated financial statements3. Preparation of consolidated financial statements including an associate

E Analysing and interpreting financial statements

1. Limitations of financial statements2. Calculation and interpretation of accounting ratios and trends to

address users’ and stakeholders’ needs3. Limitations of interpretation techniques4. Specialised, not-for-profit, and public sector entities

Approach to examining the syllabus The syllabus is assessed by a three-hour paper-based examination.

All questions are compulsory. It will contain both computational and discursiveelements.Some questions will adopt a scenario/case study approach.

Question 1 will be a 25 mark question on the preparation of group financialstatements and/or extracts thereof, and may include a small discussion element.Computations will be designed to test an understanding of principles.

Question 2, for 25 marks, will test the reporting of non-group financial statements.This may be from information in a trial balance or by restating draft financialstatements.

Question 3, for 25 marks, is likely to be an appraisal of an entity’s performance andmay involve statements of cash flows.

Questions 4 and 5 will cover the remainder of the syllabus and will be worth 15 and10 marks respectively.




xii © Emile Woolf Publishing Limited

An individual question may often involve elements that relate to different subjectareas of the syllabus. For example the preparation of an entity’s financial statementscould include matters relating to several accounting standards.

Questions may ask candidates to comment on the appropriateness or acceptability

of management’s opinion or chosen accounting treatment. An understanding ofaccounting principles and concepts and how these are applied to practical exampleswill be tested.

Questions on topic areas that are also included in Paper F3 will be examined at anappropriately greater depth in this paper.

Candidates will be expected to have an appreciation of the need for specifiedaccounting standards and why they have been issued. For detailed or complexstandards, candidates need to be aware of their principles and key elements.




© Emile Woolf Publishing Limited xiii

Study guide

This study guide provides more detailed guidance on the syllabus. You should usethis as the basis of your studies.

A A conceptual framework for Financial Reporting

1 The need for a conceptual framework

a) Describe what is meant by a conceptual framework of accounting.

b) Discuss whether a conceptual framework is necessary and what analternative system might be.

2 The fundamental concepts of relevance and faithful representation(‘true and fair view’)

a) Discuss what is meant by relevance and faithful representationand describe the qualities that enhance these characteristics.

b) Discuss whether faithful representation constitutes more thancompliance with accounting standards.

c) Indicate the circumstances and required disclosures where a ‘trueand fair’ override may apply.

3 The enhancing characteristics of comparability, verifiability,timeliness and understandability

a) Discuss what is meant by understandability and verifiability in

relation to the provision of financial information.

b) Discuss the importance of comparability and timeliness to users offinancial statements.

c) Distinguish between changes in accounting policies and changesin accounting estimates and describe how accounting standardsapply the principle of comparability where an entity changes itsaccounting policies.

d) Recognise and account for changes in accounting policies and thecorrection of prior period errors.

4 Recognition and measurement

a) Define what is meant by ‘recognition’ in financial statements anddiscuss the recognition criteria.

b) Apply the recognition criteria to:

i) assets and liabilities.

ii) income and expensesc) Discuss revenue recognition issues; indicate when income and

expense recognition should occur.

d) Demonstrate the role of the principle of substance over form inrelation to recognising sales revenue.

e) Explain the following measures and compute amounts using:

i) historical cost




xiv © Emile Woolf Publishing Limited

ii) fair value/current costiii) net realisable valueiv) present value of future cash flows.

5 The legal versus the commercial view of accounting

a) Explain the importance of recording the commercial substancerather than the legal form of transactions – give examples whererecording the legal form of transactions may be misleading.

b) Describe the features which may indicate that the substance oftransactions differs from their legal form.

c) Apply the principle of substance over form to the recognition andderecognition of assets and liabilities.

d) Recognise the substance of transactions in general, and specificallyaccount for the following types of transaction:

i) goods sold on sale or return/consignment inventoryii) sale and repurchase/leaseback agreementsiii) factoring of receivables.

6 Alternative models and practices

a) Describe the advantages and disadvantages of the use of historicalcost accounting.

b) Discuss whether the use of current value accounting overcomesthe problems of historical cost accounting.

c) Describe the concept of financial and physical capital maintenance

and how this affects the determination of profits.

B A regulatory framework for financial reporting

1 Reasons for the existence of a regulatory framework

a) Explain why a regulatory framework is needed also including theadvantages and disadvantages of IFRS over a national regulatoryframework.

b) Explain why accounting standards on their own are not acomplete regulatory framework.

c) Distinguish between a principles based and a rules basedframework and discuss whether they can be complementary.

2 The standard setting process

a) Describe the structure and objectives of the IFRS Foundation, theInternational Accounting Standards Board (IASB), the IFRSAdvisory Council (IFRS AC) and the IFRS InterpretationsCommittee (IFRS IC).

b) Describe the IASB’s Standard setting process including revisionsto and interpretations of Standards.




© Emile Woolf Publishing Limited xv

c) Explain the relationship of national standard setters to the IASB inrespect of the standard setting process.

3 Specialised, not-for-profit and public sector entities

a) Distinguish between the primary aims of not-for profit and publicsector entities and those of profit oriented entities.

b) Discuss the extent to which International Financial ReportingStandards (IFRSs) are relevant to specialised, not-for-profit andpublic sector entities.

C Financial statements

1 Statements of Cash flows

a) Prepare a statement of cash flows for a single entity (not a group)in accordance with relevant accounting standards using the directand the indirect method .

b) Compare the usefulness of cash flow information with that of astatement of profit or loss or a statement of profit or loss and othercomprehensive income.

c) Interpret a statement of cash flows (together with other financialinformation) to assess the performance and financial position of anentity.

2 Tangible non-current assets

a) Define and compute the initial measurement of a non-current(including a self-constructed and borrowing costs) asset.

b) Identify subsequent expenditure that may be capitalised,distinguishing between capital and revenue items.

c) Discuss the requirements of relevant accounting standards inrelation to the revaluation of non-current assets.

d) Account for revaluation and disposal gains and losses for non-current assets.

e) Compute depreciation based on the cost and revaluation modelsand on assets that have two or more significant parts (complexassets).

f) Apply the provisions of relevant accounting standards in relationto accounting for government grants.

g) Discuss why the treatment of investment properties should differfrom other properties.

h) Apply the requirements of relevant accounting standards forinvestment property.

3 Intangible assets

a) Discuss the nature and accounting treatment of internallygenerated and purchased intangibles.




xvi © Emile Woolf Publishing Limited

b) Distinguish between goodwill and other intangible assets.

c) Describe the criteria for the initial recognition and measurement ofintangible assets.

d) Describe the subsequent accounting treatment, including theprinciple of impairment tests in relation to goodwill.

e) Indicate why the value of purchase consideration for aninvestment may be less than the value of the acquired identifiablenet assets and how the difference should be accounted for.

f) Describe and apply the requirements of relevant accountingstandards to research and development expenditure.

4 Inventory

a) Describe and apply the principles of inventory valuation.

b) Define a construction contract and discuss the role of accountingconcepts in the recognition of profit.

c) Describe the acceptable methods of determining the stage(percentage) of completion of a contract.

d) Prepare financial statement extracts for construction contracts.

5 Financial assets and financial liabilities

a) Explain the need for an accounting standard on financialinstruments.

b) Define financial instruments in terms of financial assets andfinancial liabilities.

c) Indicate for the following categories of financial instruments howthey should be measured and how any gains and losses fromsubsequent measurement should be treated in the financialstatements:

i) amortised costii) fair value ( including option to elect to present gains and

losses on equity instruments in other comprehensiveincome)

d) Distinguish between debt and equity capital.

e) Apply the requirements of relevant accounting standards to theissue and finance costs of:

i) equityii) redeemable preference shares and debt instruments with no

conversion rights (principle of amortised cost)iii) convertible debt

6 Leases

a) Explain why recording the legal form of a finance lease can bemisleading to users (referring to the commercial substance of suchleases).

b) Describe and apply the method of determining a lease type (i.e. anoperating or finance lease).




© Emile Woolf Publishing Limited xvii

c) Discuss the effect on the financial statements of a finance lease being incorrectly treated as an operating lease.

d) Account for assets financed by finance leases in the records of thelessee.

e) Account for operating leases in the records of the lessee.

7 Provisions, contingent liabilities and contingent assets

a) Explain why an accounting standard on provisions is necessary.

b) Distinguish between legal and constructive obligations.

c) State when provisions may and may not be made and demonstratehow they should be accounted for.

d) Explain how provisions should be measured.

e) Define contingent assets and liabilities and describe theiraccounting treatment.

f) Identify and account for:

i) warranties/guaranteesii) onerous contractsiii) environmental and similar provisionsiv) provisions for future repairs or refurbishments.

8 Impairment of assets

a) Define an impairment loss.

b) Identify the circumstances that may indicate impairments toassets.

c) Describe what is meant by a cash generating unit.

d) State the basis on which impairment losses should be allocated,and allocate an impairment loss to the assets of a cash generatingunit.

9 Taxation

a) Account for current taxation in accordance with relevantaccounting standards.

b) Record entries relating to income tax in the accounting records.

c) Explain the effect of taxable temporary differences on accountingand taxable profits.

d) Compute and record deferred tax amounts in the financialstatements.

10 Regulatory requirements relating to the preparation of financialstatements

a) Describe the structure (format) and content of financial statementspresented under IFRS.

b) Prepare an entity’s financial statements in accordance with theprescribed structure and content.




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11 Reporting financial performance

a) Discuss the importance of identifying and reporting the results ofdiscontinued operations.

b) Define and account for non-current assets held for sale anddiscontinued operations.

c) Indicate the circumstances where separate disclosure of materialitems of income and expense is required.

d) Prepare and explain the contents and purpose of the statement ofchanges in equity.

e) Describe and prepare a statement of changes in equity.

f) Earnings per share (eps)i) calculate the eps in accordance with relevant accounting

standards (dealing with bonus issues, full market valueissues and rights issues)

ii) explain the relevance of the diluted eps and calculate thediluted eps involving convertible debt and share options(warrants)

iii) explain why the trend of eps may be a more accurateindicator of performance than a company’s profit trend andthe importance of eps as a stock market indicatoriv) discuss the limitations of using eps as a performancemeasure.

g) Events after the reporting datei) distinguish between and account for adjusting and non-

adjusting events after the reporting dateii) Identify items requiring separate disclosure, including their

accounting treatment and required disclosures

D Business combinations

1 The concept and principles of a group

a) Describe the concept of a group as a single economic unit.

b) Explain and apply the definition of a subsidiary within relevantaccounting standards.

c) Identify and outline using accounting standards and otherapplicable regulation the circumstances in which a group isrequired to prepare consolidated financial statements.

d) Describe the circumstances when a group may claim exemptionfrom the preparation of consolidated financial statements. .

e) Explain why directors may not wish to consolidate a subsidiaryand outline using accounting standards and other applicableregulation the circumstances where this is permitted. [2

f) Explain the need for using coterminous year ends and uniformaccounting polices when preparing consolidated financial

statements.




© Emile Woolf Publishing Limited xix

g) Explain why it is necessary to eliminate intra-group transactions.

2 The concept of consolidated financial statements

a) Explain the objective of consolidated financial statements.

b) Indicate the effect that the related party relationship between aparent and subsidiary may have on the subsidiary’s entitystatements and the consolidated financial statements.

c) Explain why it is necessary to use fair values for the considerationfor an investment in a subsidiary together with the fair values of asubsidiary’s identifiable assets and liabilities when preparingconsolidated financial statements.

d) Describe and apply the required accounting treatment ofconsolidated goodwill.

3 Preparation of consolidated financial statements including anassociatea) Prepare a consolidated statement of financial position for a simple

group (parent and one subsidiary) dealing with pre and postacquisition profits, non-controlling interests and consolidatedgoodwill.

b) Prepare a consolidated statement of profit or loss and consolidatedstatement of profit or loss and other comprehensive income for asimple group dealing with an acquisition in the period and non-controlling interest.

c) Explain and account for other reserves (e.g. share premium and

revaluation reserves).

d) Account for the effects in the financial statements of intra-grouptrading.

e) Account for the effects of fair value adjustments (including theireffect on consolidated goodwill) to:

i) depreciating and non-depreciating non-current assetsii) inventoryiii) monetary liabilitiesiv) assets and liabilities not included in the subsidiary’s own

statement of financial position, including contingent assets

and liabilitiesf) Account for goodwill impairment.

g) Define an associate and explain the principles and reasoning forthe use of equity accounting.

h) Prepare consolidated financial statements to include a singlesubsidiary and an associate.




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E Analysing and interpreting financial statements

1 Limitations of financial statements

a) Indicate the problems of using historic information to predictfuture performance and trends.

b) Discuss how financial statements may be manipulated to producea desired effect (creative accounting, window dressing).

c) Recognise how related party relationships have the potential tomislead users.

d) Explain why figures in a statement of financial position may not berepresentative of average values throughout the period forexample, due to:

i) seasonal tradingii) major asset acquisitions near the end of the accounting

period.

2 Calculation and interpretation of accounting ratios and trends toaddress users’ and stakeholders’ needs

a) Define and compute relevant financial ratios.

b) Explain what aspects of performance specific ratios are intended toassess.

c) Analyse and interpret ratios to give an assessment of an entity’sperformance and financial position in comparison with:

i) an entity’s previous period’s financial statementsii) another similar entity for the same reporting period

iii) industry average ratios.d) Interpret an entity’s financial statements to give advice from the

perspectives of different stakeholders.

e) Discuss how the interpretation of current value based financialstatements would differ from those using historical cost basedaccounts.

3 Limitations of interpretation techniques

a) Discuss the limitations in the use of ratio analysis for assessingcorporate performance.

b) Discuss the effect that changes in accounting policies or the use ofdifferent accounting polices between entities can have on theability to interpret performance.

c) Indicate other information, including non-financial information,that may be of relevance to the assessment of an entity’sperformance.

4 Specialised, not-for-profit and public sector entities

a) Discuss the different approaches that may be required whenassessing the performance of specialised, not-for-profit and public

sector organisations.



© Emile Woolf Publishing Limited xxi


e

Exam techniques

Five steps to exam success

1 Know your subject

It sounds obvious, but you really need to know all topics in the syllabus – ACCA can

test you on any area of the syllabus so even those topics you think might ‘never come

up’ could be on your next exam. Whatever the format, questions require that you have

learnt definitions, know key words and their meanings and understand concepts,

theories and rules.

2 Know your exam structure

Do you know how many questions you need to attempt? Do you know how long you

exam is? What type of questions come up? Knowing this is essential!

The F7 exam is three hours long (plus an additional 15 minutes reading time) and has

five compulsory questions. Question 1 will be on group financial statements, Question

2 will be on non ‐group financial statements, Question 3 may involve cash flow

statements and Questions 4 and 5 cover the rest of the syllabus.

3 Practice makes perfect

One of the best ways to prepare for your actual exam is to try lots of examination ‐

standard questions under timed conditions.

Attempt ALL of the questions in this exam kit and compare your answers with the

answers to see what you need to improve on and the areas you need to go back and

revise! Go back and revise and then attempt questions again if you get any wrong.




xxii © Emile Woolf Publishing Limited

4 Time yourself

If you are sitting an exam worth 100 marks in three hours, you should aim to spend 1.8

minutes on each mark. Make sure that you have double ‐checked your strategy of how

you are going to allocate your time before you go into the exam and that you are

comfortable answering five questions in three hours.

Since you don’t need to attempt the questions in order, a good strategy could be to

attempt the ‘easy’ questions (such as those you either know or you don’t) at the

beginning and save those that involve calculations or a bit more thought to the end.

5 Reading and planning time in the exam

You have been given an extra 15 minutes ‘reading and planning’ time in the exam. Use

it wisely! You are allowed to read the questions, begin to plan your answers and use

your calculator to make some preliminary numerical calculations. You’re allowed to write on your exam paper, so try going through and highlighting the key points and

requirements in the questions, or jot down some ideas as to how you are going to

structure your answers.



© Emile Woolf Publishing Limited 1


S E C T I O N 1

Q &A

Practice questions

1 Recost

For over 20 years the accounting profession in many countries has attempted toformulate a method of preparing financial statements that takes account of the effectsof price increases (inflation). It seems that no proposed method of reflecting the effectsof changing prices has gained international acceptance. The decision of the IASB, andthe accounting standard setters in many countries, is that no form of accounting forprice changes should be made compulsory, but enterprises are encouraged to presentsuch information.

There have been two main methods put forward by various accounting standard bodies for reporting the effects of price changes. One method is based on themovements in general price inflation and is referred to as a General (or Current)Purchasing Power Approach, the other method is based on specific price changes ofgoods and assets and is generally referred to as a Current Cost Approach. Some bodieshave also suggested an approach which combines features of each method.Required:

(a) Explain the limitations of (pure) historical cost accounts when used as a basis forassessing the performance of an enterprise. You should give an example of howeach of three different user groups may be misled by such information.

(10 marks) (b) Describe the advantages and criticisms of Current Cost Accounting. (5 marks)

(Total: 15 marks)

2 Worthright

Although it may come as a surprise to many non-accountants, the accountingprofession internationally has encountered a great deal of problems in arriving atrobust definitions for the ‘elements ’ of financial statements. Defining assets, liabilities,and gains and losses (income and expenditure) has been particularly problematical.These definitions form the core of any conceptual framework that is to be used as a basis for preparing financial statements. It is also in this area that the InternationalAccounting Standards Board ’s original conceptual framework, Framework for thePreparation and Presentation of Financial Statements (Framework) has come in for




2 © Emile Woolf Publishing Limited

some criticism. It seems that the current accounting treatment of certain items does not(fully) agree with definitions in the Framework. A major objective of the Framework isto exclude from the statement of financial position items that are neither assets norliabilities; and to make ‘off balance sheet ’ assets and liabilities more visible by puttingthem on the statement of financial position whenever practicable. This is one of the

reasons that the IASB has been engaged on a project to develop a new framework. Thisproject has resulted in amendment to the original document and is ongoing.Required: (a) Critically discuss the definition of assets and liabilities contained in the

Conceptual Framework.Your answer should explain the importance of the definitions and the relevanceof each component of the definitions. (10 marks)

(b) Worthright undertakes a considerable amount of research and developmentwork. Most of this work is done on its own behalf, but occasionally it undertakesthis type of work for other companies. Before any of its own projects progress tothe development stage they are assessed by an internal committee, whichcarefully analyses all information relating to the project. This process has led to avery good record of development projects delivering profitable results. Despitethis, Worthright deems it prudent to write off immediately all research anddevelopment work, including that which it does for other companies. (5 marks)

Required: Discuss whether the above transactions and events give rise to assets; and describehow they should be recognised and measured under current International AccountingStandards and conventionally accepted practice. (Total: 15 marks)

3 Revenue recognitionRevenue recognition is the process by which companies decide when and how muchincome should be included in the income statement. It is a topical area of great debatein the accounting profession. The IASB looks at revenue recognition from conceptualand substance points of view. There are occasions where a more traditional approachto revenue recognition does not entirely conform to the IASB guidance; indeed neitherdo some International Accounting Standards.Required: (a) Explain the implications that the IASB ’s Conceptual Framework and the

application of substance over form have on the recognition of income. Giveexamples of how this may conflict with traditional practice and some accountingstandards. (6 marks)

(b) Derringdo acquired an item of plant at a gross cost of $800,000 on 1 October 2011.The plant has an estimated life of 10 years with a residual value equal to 15% ofits gross cost. Derringdo uses straight-line depreciation on a time-apportioned basis. The company received a government grant of 30% of its cost price at thetime of its purchase. The terms of the grant are that if the company retains theasset for four years or more, then no repayment liability will be incurred. If theplant is sold within four years a repayment on a sliding scale would beapplicable. The repayment is 75% if sold within the first year of purchase and this

amount decreases by 25% per annum. Derringdo has no intention to sell the plantwithin the first four years. Derringdo ’s accounting policy for capital based



Section 1: Practice questions


government grants is to treat them as deferred credits and release them toincome over the life of the asset to which they relate.

Required:

(i) Discuss whether the company ’s policy for the treatment of government grantsmeets the definition of a liability in the IASB Conceptual Framework. (3 marks)

(ii) Prepare extracts of Derringdo ’s financial statements for the year to 31 March 2012in respect of the plant and the related grant:

applying the company’s policy; in compliance with the definition of a liability in the Conceptual

Framework. Your answer should consider whether the sliding scalerepayment should be used in determining the deferred credit for the grant.

(6 marks)

(Total: 15 marks)

4 Angelino

(a) Recording the substance of transactions, rather than their legal form, is animportant principle in financial accounting. Abuse of this principle can lead toprofit manipulation, non-recognition of assets and substantial debt not beingrecorded on the statement of financial position.Required: Describe how the use of off statement of financial position financing can misleadusers of financial statements.Note: your answer should refer to specific user groups and include exampleswhere recording the legal form of transactions may mislead them. (9 marks)

(b) Angelino has entered into the following transactions during the year ended 30September 2012:(i) In September 2012 Angelino sold (factored) some of its trade receivables to

Omar, a finance house. On selected account balances Omar paid Angelino80% of their book value. The agreement was that Omar would administerthe collection of the receivables and remit a residual amount to Angelinodepending upon how quickly individual customers paid. Any balanceuncollected by Omar after six months will be refunded to Omar byAngelino. (5 marks)

(ii) On 1 October 2011 Angelino owned a freehold building that had a carrying

amount of $7 ·5 million and had an estimated remaining life of 20 years. Onthis date it sold the building to Finaid for a price of $12 million and enteredinto an agreement with Finaid to rent back the building for an annual rentalof $1·3 million for a period of five years. The auditors of Angelino havecommented that in their opinion the building had a market value of only$10 million at the date of its sale and to rent an equivalent building undersimilar terms to the agreement between Angelino and Finaid would onlycost $800,000 per annum. Assume any finance costs are 10% per annum.

(6 marks) (iii) Angelino is a motor car dealer selling vehicles to the public. Most of its new

vehicles are supplied on consignment by two manufacturers, Monza and

Capri, who trade on different terms.





Monza supplies cars on terms that allow Angelino to display the vehiclesfor a period of three months from the date of delivery or when Angelinosells the cars on to a retail customer if this is less than three months. Withinthis period Angelino can return the cars to Monza or can be asked byMonza to transfer the cars to another dealership (both at no cost to

Angelino). Angelino pays the manufacturer ’s list price at the end of thethree month period (or at the date of sale if sooner). In recent yearsAngelino has returned several cars to Monza that were not selling verywell and has also been required to transfer cars to other dealerships atMonza ’s request.Capri ’s terms of supply are that Angelino pays 10% of the manufacturer ’sprice at the date of delivery and 1% of the outstanding balance per monthas a display charge. After six months (or sooner if Angelino chooses),Angelino must pay the balance of the purchase price or return the cars toCapri. If the cars are returned to the manufacturer, Angelino has to pay forthe transportation costs and forfeits the 10% deposit. Because of thisAngelino has only returned vehicles to Capri once in the last three years.

(5 marks) Required: Describe how the above transactions and events should be treated in thefinancial statements of Angelino for the year ended 30 September 2012.Your answer should explain, where relevant, the difference between thelegal form of the transactions and their substance.Note: The mark allocation is shown against each of the three transactionsabove. (Total: 25 marks)

5 Emerald

Product development costs are a material cost for many companies. They are eitherwritten off as an expense or capitalised as an asset.Required: (a) Discuss the conceptual issues involved and the definition of an asset that may be

applied in determining whether development expenditure should be treated asan expense or an asset. (4 marks)

(b) Emerald has had a policy of writing off development expenditure to the incomestatement as it was incurred. In preparing its financial statements for the year

ended 30 September 2012 it has become aware that, under IFRS rules, qualifyingdevelopment expenditure should be treated as an intangible asset. Below is thequalifying development expenditure for Emerald:

$’000Year ended 30 September 2009 300Year ended 30 September 2010 240Year ended 30 September 2011 800Year ended 30 September 2012 400All capitalised development expenditure is deemed to have a four year life.Assume amortisation commences at the beginning of the accounting period

following capitalisation. Emerald had no development expenditure before thatfor the year ended 30 September 2009.





Required: Treating the above as the correction of an error in applying an accounting policy,calculate the amounts which should appear in the income statement andstatement of financial position (including comparative figures), and statement ofchanges in equity of Emerald in respect of the development expenditure for theyear ended 30 September 2012.Note: ignore taxation. (6 marks)

(Total: 10 marks)

6 Conceptual Framework

(a) The IASB’s Conceptual Framework requires financial statements to be preparedon the basis that they comply with certain accounting concepts, underlyingassumptions and (qualitative) characteristics. Five of these are:Matching/accruals

Substance over formPrudenceComparabilityMaterialityRequired: Briefly explain the meaning of each of the above concepts/assumptions. (5 marks)

(b) For most entities, applying the appropriate concepts/assumptions in accountingfor inventories is an important element in preparing their financial statements.Required: Illustrate with examples how each of the concepts/assumptions in (a) may beapplied to accounting for inventory. (10 marks)

(Total: 15 marks)

7 Promoil

(a) The definition of a liability forms an important element of the IASB ’s ConceptualFramework which, in turn, forms the basis for IAS 37 Provisions, ContingentLiabilities and Contingent Assets.Required:

Define a liability and describe the circumstances under which provisions should be recognised. Give two examples of how the definition of liabilities enhances thereliability of financial statements. (5 marks)

(b) On 1 October 2011, Promoil acquired a newly constructed oil platform at a cost of$30 million together with the right to extract oil from an offshore oilfield under agovernment licence. The terms of the licence are that Promoil will have toremove the platform (which will then have no value) and restore the sea bed toan environmentally satisfactory condition in 10 years’ time when the oil reserveshave been exhausted. The estimated cost of this on 30 September 2021 will be $15million. The present value of $1 receivable in 10 years at the appropriate discount

rate for Promoil of 8% is $0·46.





Required:(i) Explain and quantify how the oil platform should be treated in the financial

statements of Promoil for the year ended 30 September 2012; (7 marks)

(ii) Describe how your answer to (b)(i) would change if the government licencedid not require an environmental clean-up. (3 marks)

(Total: 15 marks)

8 Wardle

(a) An important aspect of the International Accounting Standards Board ’sFramework for the preparation and presentation of financial statements is thattransactions should be recorded on the basis of their substance over their form.Required:

Explain why it is important that financial statements should reflect the substanceof the underlying transactions and describe the features that may indicate that

the substance of a transaction may be different from its legal form. (5 marks) (b) Wardle ’s activities include the production of maturing products which take a

long time before they are ready to retail. Details of one such product are that on 1April 2009 it had a cost of $5 million and a fair value of $7 million.The product would not be ready for retail sale until 31 March 2012.On 1 April 2009 Wardle entered into an agreement to sell the product toEasyfinance for $6 million. The agreement gave Wardle the right to repurchasethe product at any time up to 31 March 2012 at a fixed price of $7,986,000, atwhich date Wardle expected the product to retail for $10 million. The compoundinterest Wardle would have to pay on a three-year loan of $6 million would be:

$Year 1 600,000Year 2 660,000Year 3 726,000This interest is equivalent to the return required by Easyfinance.Required:

Assuming the above figures prove to be accurate, prepare extracts from theincome statement of Wardle for the three years to 31 March 2012 in respect of theabove transaction:(i) Reflecting the legal form of the transaction;(ii) Reflecting the substance of the transaction.Note: statement of financial position extracts are NOT required.The following mark allocation is provided as guidance for this requirement:(i) 2 marks(ii) 3 marks (5 marks)

(c) Comment on the effect the two treatments have on the income statements andthe statements of financial position and how this may affect an assessment ofWardle ’s performance. (5 marks)

(Total: 15 marks)





Financial statements – Statements of cash flows

9 Tabba

The following draft financial statements relate to Tabba, a private company.

Statements of financial position(balance sheets) as at:

30 September 2012 30 September 2011

$000 $000 $000 $000Tangible non-current assets (note (ii)) 10,600 15,800Current assetsInventories 2,550 1,850Trade receivables 3,100 2,600Insurance claim (note (iii)) 1,500 1,200Cash and bank 850 nil

――――

8,000

――――

5,650―――― ―――― Total assets 18,600 21,450

―――― ―――― Equity and liabilitiesShare capital ($1 each) 6,000 6,000Reserves:Revaluation (note (ii)) nil 1,600Retained earnings 2,550 850

―――― 2,550 2,450

―――― ―――― 8,550 8,450

Non-current liabilitiesFinance lease obligations (note (ii)) 2,000 1,7006% loan notes 800 nil10% loan notes nil 4,000Deferred tax 200 500Government grants (note (ii)) 1,400 900――――

4,400――――

7,100Current liabilitiesBank overdraft nil 550Trade payables 4,050 2,950

Government grants (note (ii)) 600 400Finance lease obligations (note (ii)) 900 800Current tax payable 100 1,200

―――― 5,650

―――― 5,900

―――― ―――― 18,600 21,450

―――― ――――





10 Boston

Shown below are the summarised financial statements for Boston, a publicly listedcompany, for the years ended 31 March 2011 and 2012, together with some segmentinformation analysed by class of business for the year ended 31 March 2012 only:

Income statements Carpeting Hotels House-building Total31 March2012

Total31 March2011

$m $m $m $m $mRevenue 90 130 280 500 450Cost of sales (note (i)) (30) (95) (168) (293) (260)――― ――― ――― ――― ――― Gross profit 60 35 112 207 190Operating expenses (25) (15) (32) (72) (60)――― ――― ――― ――― ――― Segment result 35 20 80 135 130Unallocated corporate expense (60) (50)――― ――― Profit from operations 75 80Finance costs (10) (5)――― ――― Profit before tax 65 75Income tax expense (25) (30)――― ――― Profit for the period 40 45――― ――― Tangible non-currentassets

40 140 200 380 332

Current assets 40 40 75 155 130――― ――― ――― ――― ――― Segment assets 80 180 275 535 462――― ――― ――― Unallocated bank balance 15 nil――― ――― Consolidated total assets 550 462――― ――― Ordinary share capital 100 80Share premium 20 nilRetained earnings 232 192――― ―――

352 272Segment current liabilities

– tax 4 9 12 25 30– other 4 51 53 108 115

Unallocated loans 65 40Unallocated bankoverdraft nil 5

――― ――― Consolidated equity and total liabilities 550 462――― ――― The following notes are relevant:

(i) Depreciation for the year to 31 March 2012 was $35 million. During the year ahotel with a carrying amount of $40 million was sold at a loss of $12 million.Depreciation and the loss on the sale of non-current assets are charged to cost ofsales. There were no other non-current asset disposals. As part of the company’soverall acquisition of new non-current assets, the hotel segment acquired $104million of new hotels during the year.





(ii) The above figures are based on historical cost values. The fair values of thesegment net assets are:

Carpeting Hotels House building$m $m $m

At 31 March 2011 80 150 250At 31 March 2012 97 240 265

(iii) The following ratios (which can be taken to be correct) have been calculated based on the overall group results:

Year ended 31 March 2012 31 March 2011Return on capital employed 18.0% 25.6%Gross profit margin 41.4% 42.2%Operating profit margin 15.0% 17.8%Net assets turnover 1.2 times 1.4 timesCurrent ratio 1.3:1 0.9:1

Gearing 15.6% 12.8%(iv) The following segment ratios (which can be taken to be correct) have been

calculated for the year ended 31 March 2012 only:Carpeting Hotels House building

Segment return on net assets 48.6% 16.7% 38.1%Segment asset turnover (times) 1.3 1.1 1.3Gross profit margin 66.7% 26.9% 40.0%Net profit margin 38.9% 15.4% 28.6%Current ratio (excluding bank) 5:1 0.7:1 1.2:1

Required:

(a) Prepare a statement of cash flows for Boston for the year ended 31 March 2012.(10 marks)

Note: You are not required to show separate segmental cash flows or any disclosurenotes.(b) Using the ratios provided, write a report to the Board of Boston analysing the

company ’s financial performance and position for the year ended 31 March 2012.(15 marks)

Your answer should make reference to your statement of cash flows and the segmentalinformation and consider the implication of the fair value information.

(Total: 25 marks)

11 Planter

The following information relates to Planter, a small private company. It consists of anopening statement of financial position as at 1 April 2011 and a listing of the company ’sledger accounts at 31 March 2012 after the draft operating profit before interest andtaxation (of $17,900) had been calculated.





Planter – Statement of financial position as at 1 April 2011 $ $

Non-current assetsLand and buildings(at valuation $49,200 less accumulated depreciation of $5,000) 44,200

Plant (at cost of $70,000 less accumulated depreciation of $22,500) 47,500Investments at cost 16,900108,600

Current assetsInventory 57,400Trade receivables 28,600Bank 1,200

87,200Total assets 195,800Equity and liabilitiesCapital and reserves:

Ordinary shares of $1 each 25,000Reserves:Share premium 5,000Revaluation reserve 12,000Retained earnings 70,300

87,300112,300

Non-current liabilities8% Loan notes 43,200Current liabilitiesTrade payables 31,400

Taxation 8,90040,300

Total equity and liabilities 195,800

Ledger account listings at 31 March 2012 Dr Cr$ $

Ordinary shares of $1 each 50,000Share premium 8,000Retained earnings – 1 April 2011 70,300Profit before interest and tax – year to 31 March 2012 17,900Revaluation reserve 18,0008% Loan notes 39,800Trade payables 26,700Accrued loan interest 300Taxation 1,100Land and buildings at valuation 62,300Plant at cost 84,600Buildings – accumulated depreciation 31 March 2012 6,800Plant – accumulated depreciation 31 March 2012 37,600Investments at cost 8,200Trade receivables 50,400Inventory – 31 March 2012 43,300Bank 1,900Investment income 400Loan interest 1,700





Ledger account listings at 31 March 2012 Dr Cr$ $

Ordinary dividend 26,100277,700 277,700

Notes

(i) There were no disposals of land and buildings during the year. The increase inthe revaluation reserve was entirely due to the revaluation of the company ’sland.

(ii) Plant with a net book value of $12,000 (cost $23,500) was sold during the year for$7,800. The loss on sale has been included in the profit before interest and tax.

(iii) Investments with a cost of $8,700 were sold during the year for $11,000. Theprofit has been included in the profit before interest and tax. There were nofurther purchases of investments.

(iv) On 10 October 2011 a bonus issue of 1 for 10 ordinary shares was made utilisingthe share premium account. The remainder of the increase in ordinary shares wasdue to an issue for cash on 30 October 2011.

(v) The balance on the taxation account is after settlement of the provision made forthe year to 31 March 2011. A provision for the current year has not yet beenmade.

Required: From the above information, prepare a statement of cash flows using the indirectmethod for Planter in accordance with IAS 7 Statement of Cash Flows for the year to 31March 2012. (Total: 25 marks)

12 Casino

(a) Casino is a publicly listed company. Details of its statements of financial positionas at 31 March 2012 and 2011 are shown below together with other relevantinformation:Statement of financial position as at 31 March 2012 31 March 2011

$m $m $m $mNon-current assets (note (i))Property, plant and equipment 880 760Intangible assets 400 510

1,280 1,270Current assetsInventory 350 420Trade receivables 808 372Interest receivable 5 3Short term deposits 32 120Bank 15 75

1,210 990Total assets 2,490 2,260Share capital and reservesOrdinary shares of $1 each 300 200





Statement of financial position as at 31 March 2012 31 March 2011$m $m $m $m

ReservesShare premium 60 nilRevaluation reserve 112 45

Retained earnings 1,098 1,1651,270 1,2101,570 1,410

Non-current liabilities12% loan note nil 1508% variable rate loan note 160 nilDeferred tax 90 75

250 225Current liabilitiesTrade payables 530 515Bank overdraft 125 nil

Taxation 15 110670 625Total equity and liabilities 2,490 2,260

The following supporting information is available:(i) Details relating to the non-current assets are:

Property, plant and equipment at:31 March 2012 31 March 2011

Cost/Valuation

Depreciation Carryingvalue

Cost/Valuation

Depreciation Carryingvalue

$m $m $m $m $m $m

Land and buildings 600 12 588 500 80 420Plant 440 148 292 445 105 340

880 760

Casino revalued the carrying value of its land and buildings by an increaseof $70 million on 1 April 2011. On 31 March 2012 Casino transferred $3million from the revaluation reserve to retained earnings representing therealisation of the revaluation reserve due to the depreciation of buildings.During the year Casino acquired new plant at a cost of $60 million and soldsome old plant for $15 million at a loss of $12 million.There were no acquisitions or disposals of intangible assets.

(ii) The following extract is from the draft income statement for the year to 31March 2012:

$m $mOperating loss (32)Interest receivable 12Finance costs (24)Loss before tax (44)

Income tax repayment claim 14Deferred tax charge (15)

(1)Loss for the period (45)





$m $mThe finance costs are made up of:Interest expenses (16)Penalty cost for early redemption of fixed rate loan (6)Issue costs of variable rate loan (2)

(24)iii) The short-term deposits meet the definition of cash equivalents.(iv) Dividends of $25 million were paid during the year.Required: As far as the information permits, prepare a statement of cash flows for Casinofor the year to 31 March 2012 in accordance with IAS 7 Statement of Cash Flows.

(20 marks)

(b) In recent years many analysts have commented on a growing disillusionmentwith the usefulness and reliability of the information contained in somecompanies ’ income statements.Required: Discuss the extent to which a company ’s statement of cash flows may be moreuseful and reliable than its income statement. (5 marks)

(Total: 25 marks)

13 Minster

Minster is a publicly listed company. Details of its financial statements for the yearended 30 September 2012, together with a comparative statement of financial position,are:Statement of financial position at 30 September 2012 30 September 2011

$000 $000 $000 $000Non-current assets (note (i))Property, plant and equipment 1,280 940Software 135 nilInvestments at fair value through profit and loss 150 125

1,565 1,065Current assetsInventories 480 510Trade receivables 270 380Amounts due from construction contracts 80 55

Bank nil 830 35 980 Total assets 2,395 2,045 Equity and liabilitiesEquity shares of 25 cents each 500 300ReservesShare premium (note (ii)) 150 85Revaluation reserve 60 25Retained earnings 950 1,160 965 1,075

1,660 1,375





Statement of financial position at 30 September 2012 30 September 2011 $000 $000 $000 $000

Non-current liabilities9% loan note 120 nilEnvironmental provision 162 nil

Deferred tax 18 300 25 25 Current liabilitiesTrade payables 350 555Bank overdraft 25 40Current tax payable 60 435 50 645 Total equity and liabilities 2,395 2,045 Income statement for the year ended 30 September 2012Revenue 1,397Cost of sales (1,110) Gross profit 287Operating expenses (125)

162Finance costs (note (i)) (40)Investment income and gain on investments 20 Profit before tax 142Income tax expense (57) Profit for the year 85 The following supporting information is available:

(i) Included in property, plant and equipment is a coal mine and related plant thatMinster purchased on 1 October 2011. Legislation requires that in ten years ’ time(the estimated life of the mine) Minster will have to landscape the area affected by the mining. The future cost of this has been estimated and discounted at a rateof 8% to a present value of $150,000. This cost has been included in the carryingamount of the mine and, together with the unwinding of the discount, has also been treated as a provision. The unwinding of the discount is included withinfinance costs in the income statement.

Other land was revalued (upward) by $35,000 during the year.

Depreciation of property, plant and equipment for the year was $255,000.There were no disposals of property, plant and equipment during the year.

The software was purchased on 1 April 2012 for $180,000.

The market value of the investments had increased during the year by $15,000.There have been no sales of these investments during the year.

(ii) On 1 April 2012 there was a bonus (scrip) issue of equity shares of one for everyfour held utilising the share premium reserve. A further cash share issue wasmade on 1 June 2012. No shares were redeemed during the year.

(iii) A dividend of 5 cents per share was paid on 1 July 2012.





Required:

(a) Prepare a statement of cash flows for Minster for the year to 30 September 2012 inaccordance with IAS 7 Statement of cash flows. (15 marks)

(b) Comment on the financial performance and position of Minster as revealed by

the above financial statements and your Statement of cash flows. (10 marks)

(Total: 25 marks)

14 Pinto

Pinto is a publicly listed company. The following financial statements of Pinto areavailable:Statement of comprehensive income for the year ended 31 March 2012 $’000Revenue 5,740Cost of sales (4,840)

––––––Gross profit 900Income from and gains on investment property 60Distribution costs (120)Administrative expenses (note (ii)) (350)Finance costs (50)

––––––Profit before tax 440Income tax expense (160)

––––––Profit for the year 280

––––––Other comprehensive income

Gains on property revaluation 100––––––Total comprehensive income 380

––––––Statements of financial position as at 31 March 2012 31 March 2011

$’000 $’000 $’000 $’000AssetsNon-current assets (note (i))Property, plant and equipment 2,880 1,860Investment property 420 400

–––––– ––––––3,300 2,260

Current assetsInventory 1,210 810Trade receivables 480 540Income tax asset nil 50Bank 10 1,700 nil 1,400

––––– –––––– –––––– ––––––Total assets 5,000 3,660

–––––– ––––––





Statement of comprehensive income for the year ended 31 March 2012 $’000Equity and liabilitiesEquity shares of 20 cents each (note (iii)) 1,000 600Share premium 600 nilRevaluation reserve 150 50Retained earnings 1,440 2,190 1,310 1,360––––– –––––– –––––– ––––––

3,190 1,960Non-current liabilities6% loan notes (note (ii)) nil 400Deferred tax 50 50 30 430

––––– ––––––Current liabilitiesTrade payables 1,410 1,050Bank overdraft nil 120Warranty provision (note (iv)) 200 100Current tax payable 150 1,760 nil 1,270

––––– –––––– –––––– ––––––Total equity and liabilities 5,000 3,660–––––– ––––––

The following supporting information is available:(i) An item of plant with a carrying amount of $240,000 was sold at a loss of $90,000

during the year. Depreciation of $280,000 was charged (to cost of sales) forproperty, plant and equipment in the year ended 31 March 2012.Pinto uses the fair value model in IAS 40 Investment Property . There were nopurchases or sales of investment property during the year.

(ii) The 6% loan notes were redeemed early incurring a penalty payment of $20,000which has been charged as an administrative expense in the income statement.

(iii) There was an issue of shares for cash on 1 October 2011. There were no bonusissues of shares during the year.

(iv) Pinto gives a 12 month warranty on some of the products it sells. The amountsshown in current liabilities as warranty provision are an accurate assessment, based on past experience, of the amount of claims likely to be made in respect ofwarranties outstanding at each year end. Warranty costs are included in cost ofsales.

(v) A dividend of 3 cents per share was paid on 1 January 2012.

Required: (a) Prepare a statement of cash flows for Pinto for the year to 31 March 2012 in

accordance with IAS 7 Statement of cash flows. (15 marks)

(b) Comment on the cash flow management of Pinto as revealed by the statement ofcash flows and the information provided by the above financial statements.Note: ratio analysis is not required, and will not be awarded any marks.

(10 marks)

(Total: 25 marks)





15 Coaltown

Coaltown is a wholesaler and retailer of office furniture. Extracts from the company’sfinancial statements are set out below:Statements of comprehensive income for the year ended:

31 March 2012 31 March 2011$’000 $’000 $’000 $’000

Revenue – cash 12,800 26,500– credit 53,000 65,800 28,500 55,000

––––––– –––––––Cost of sales (43,800) (33,000)

––––––– –––––––Gross profit 22,000 22,000Operating expenses (11,200) (6,920)Finance costs – loan notes (380) (180)

– overdraft (220) (600) nil (180)––––––– ––––––– ––––––– –––––––

Profit before tax 10,200 14,900Income tax expense (3,200) (4,400)

––––––– –––––––Profit for period 7,000 10,500Other comprehensive incomeGain on property revaluation 5,000 1,200

––––––– –––––––Total comprehensive income for the year 12,000 11,700

––––––– –––––––

Statement of changes in equity for the year ended 31 March 2012:

$’000 $’000 $’000 $’000 $’000

Equity Share Revaluation Retained Totalshares premium reserve earnings

Balances b/f 8,000 500 2,500 15,800 26,800Share issue 8,600 4,300 12,900Comprehensive income 5,000 7,000 12,000Dividends paid (4,000) (4,000)

––––––– –––––– –––––– ––––––– –––––––Balances c/f 16,600 4,800 7,500 18,800 47,700

––––––– –––––– –––––– ––––––– –––––––Statements of financial position as at 31 March:

2012 2011

$’000 $’000 $’000 $’000AssetsNon-current assets (see note)Cost 93,500 80,000Accumulated depreciation (43,000) (48,000)

––––––– ––––––––50,500 32,000

Current assetsInventory 5,200 4,400Trade receivables 7,800 2,800Bank nil 13,000 700 7,900

––––––– –––––––– ––––––– ––––––––Total assets 63,500 39,900––––––– ––––––––





2012 2011$’000 $’000 $’000 $’000

Equity and liabilitiesEquity shares of $1 each 16,600 8,000Share premium 4,800 500

Revaluation reserve 7,500 2,500Retained earnings 18,800 15,800––––––– ––––––––

47,700 26,800––––––– ––––––––

Non-current liabilities10% loan notes 4,000 3,000Current liabilitiesBank overdraft 3,600 nilTrade payables 4,200 4,500Taxation 3,000 5,300Warranty provision 1,000 11,800 300 10,100

––––––– –––––––– ––––––– ––––––––Total equity and liabilities 63,500 39,900

––––––– –––––––– Note

Non-current assets

During the year the company redesigned its display areas in all of its outlets. Theprevious displays had cost $10 million and had been written down by $9 million. Therewas an unexpected cost of $500,000 for the removal and disposal of the old displayareas. Also during the year the company revalued the carrying amount of its propertyupwards by $5 million, the accumulated depreciation on these properties of $2 million

was reset to zero.All depreciation is charged to operating expenses.

Required:

(a) Prepare a statement of cash flows for Coaltown for the year ended 31 March 2012in accordance with IAS 7 Statement of Cash Flows by the indirect method.

(15 marks)

(b) The directors of Coaltown are concerned at the deterioration in its bank balanceand are surprised that the amount of gross profit has not increased for the yearended 31 March 2012. At the beginning of the current accounting period (i.e. on 1

April 2011), the company changed to importing its purchases from a foreignsupplier because the trade prices quoted by the new supplier were consistently10% below those of its previous supplier. However, the new supplier offered ashorter period of credit than the previous supplier (all purchases are on credit).In order to encourage higher sales, Coaltown increased its credit period to itscustomers, and some of the cost savings (on trade purchases) were passed on tocustomers by reducing selling prices on both cash and credit sales by 5% acrossall products.

Required:

(i) Calculate the gross profit margin that you would have expected Coaltownto achieve for the year ended 31 March 2012 based on the selling andpurchase price changes described by the directors; (2 marks)





(ii) Comment on the directors’ surprise at the unchanged gross profit andsuggest what other factors may have affected gross profit for the yearended 31 March 2012; (4 marks)

(iii) Applying the trade receivables and payables credit periods for the yearended 31 March 2011 to the credit sales and purchases of the year ended 31March 2012, calculate the effect this would have had on the company’s bank balance at 31 March 2012 assuming sales and purchases would haveremained unchanged. (4 marks)

Note: the inventory at 31 March 2011 was unchanged from that at 31 March 2010;assume 365 trading days. (Total: 25 marks)

16 Crosswire

(a) The following information relates to Crosswire a publicly listed company.Summarised statements of financial position as at:

30 September2012 30 September2011$’000 $’000 $’000 $’000

AssetsNon-current assetsProperty, plant and equipment (note (i)) 32,500 13,100Development costs (note (ii)) 1,000 2,500

–––––– ––––––33,500 15,600

Current assets 8,200 6,800–––––– ––––––

Total assets 41,700 22,400

–––––– ––––––Equity and liabilitiesEquityEquity shares of $1 each 5,000 4,000Share premium 6,000 2,000Other equity reserve 500 500Revaluation reserve 2,000 nilRetained earnings 5,700 14,200 3,200 5,700

–––––– –––––– –––––– ––––––19,200 9,700

Non-current liabilities10% convertible loan notes (note (iii)) 1,000 5,000Environmental provision 3,300 nilFinance lease obligations 5,040 nilDeferred tax 3,360 12,700 1,200 6,200

–––––– ––––––Current liabilitiesFinance lease obligations 1,760 nilTrade payables 8,040 9,800 6,500 6,500

–––––– –––––– –––––– ––––––Total equity and liabilities 41,700 22,400

–––––– ––––––





Information from the income statements for the year ended:30 September

2012 30 September

2011 $’000 $’000

Revenue 52,000 42,000Finance costs (note (iv)) 1,050 500Income tax expense 1,000 800Profit for the year (after tax) 4,000 3,000

The following information is available:(i) During the year to 30 September 2012, Crosswire embarked on a

replacement and expansion programme for its non-current assets. Thedetails of this programme are:On 1 October 2011 Crosswire acquired a platinum mine at a cost of $5million. A condition of mining the platinum is a requirement to landscapethe mining site at the end of its estimated life of ten years. The presentvalue of this cost at the date of the purchase was calculated at $3 million (inaddition to the purchase price of the mine of $5 million).Also on 1 October 2011 Crosswire revalued its freehold land for the firsttime. The credit in the revaluation reserve is the net amount of therevaluation after a transfer to deferred tax on the gain. The tax rateapplicable to Crosswire for deferred tax is 20% per annum.On 1 April 2012 Crosswire took out a finance lease for some new plant. Thefair value of the plant was $10 million. The lease agreement provided for aninitial payment on 1 April 2012 of $2·4 million followed by eight six-

monthly payments of $1·2 million commencing 30 September 2012.Plant disposed of during the year had a carrying amount of $500,000 andwas sold for $1·2 million. The remaining movement on the property, plantand equipment, after charging depreciation of $3 million, was the cost ofreplacing plant.

(ii) From 1 October 2011 to 31 March 2012 a further $500,000 was spentcompleting the development project at which date marketing andproduction started. The sales of the new product proved disappointing andon 30 September 2012 the development costs were written down to $1million via an impairment charge.

(iii) During the year ended 30 September 2012, $4 million of the 10% convertibleloan notes matured. The loan note holders had the option of redemption atpar in cash or to exchange them for equity shares on the basis of 20 newshares for each $100 of loan notes. 75% of the loan-note holders chose theequity option. Ignore any effect of this on the other equity reserve.All the above items have been treated correctly according to InternationalFinancial Reporting Standards.





(iv) The finance costs are made up of:For year ended: 30 September

201230 September

2011$’000 $’000

finance lease charges 400 nilunwinding of environmental provision 300 nilloan-note interest 350 500

–––––– ––––1,050 500

–––––– ––––Required: (i) Prepare a statement of the movements in the carrying amount of

Crosswire’s non-current assets for the year ended 30 September 2012;(9 marks)

(ii) Calculate the amounts that would appear under the headings of ‘cash flowsfrom investing activities’ and ‘cash flows from financing activities’ in the

statement of cash flows for Crosswire for the year ended 30 September2012.Note: Crosswire includes finance costs paid as a financing activity.

(8 marks)

(b) A substantial shareholder has written to the directors of Crosswire expressingparticular concern over the deterioration of the company’s return on capitalemployed (ROCE)Required: Calculate Crosswire’s ROCE for the two years ended 30 September 2011 and 2012and comment on the apparent cause of its deterioration.

Note: ROCE should be taken as profit before interest on long-term borrowingsand tax as a percentage of equity plus loan notes and finance lease obligations (atthe year-end). (8 marks)

(Total: 25 marks)

17 Deltoid

(a) The following information relates to the draft financial statements of Deltoid.Summarised statements of financial position as at:

31 March 2010 31 March 2009

$’000 $’000 $’000 $’000AssetsNon-current assetsProperty, plant and equipment (note (i)) 19,000 25,500Current assetsInventory 12,500 4,600Trade receivables 4,500 2,000Tax refund due 500 nilBank nil 1,500

––––––– ––––––– Total assets 36,500 33,600

––––––– –––––––





31 March 2010 31 March 2009$’000 $’000 $’000 $’000

Equity and liabilitiesEquityEquity shares of $1 each (note (ii)) 10,000 8,000

Share premium (note (ii)) 3,200 4,000Retained earnings 4,500 7,700 6,300 10,300–––––– ––––––– –––––– –––––––

17,700 18,300Non-current liabilities10% loan note (note (iii)) nil 5,000Finance lease obligations 4,800 2,000Deferred tax 1,200 6,000 800 7,800

––––––– ––––––– Current liabilities10% loan note (note (iii)) 5,000 nilTax nil 2,500

Bank overdraft 1,400 nilFinance lease obligations 1,700 800Trade payables 4,700 12,800 4,200 7,500

–––––– ––––––– –––––– ––––––– Total equity and liabilities 36,500 33,600

––––––– ––––––– Summarised income statements for the years ended:

31 March 2010 31 March 2009$’000 $’000

Revenue 55,000 40,000Cost of sales (43,800) (25,000)

––––––– ––––––– Gross profit 11,200 15,000Operating expenses (12,000) (6,000)Finance costs (note (iv)) (1,000) (600)

––––––– ––––––– Profit (loss) before tax (1,800) 8,400Income tax relief (expense) 700 (2,800)

––––––– ––––––– Profit (loss) for the year (1,100) 5,600

––––––– –––––––

The following additional information is available:(i) Property, plant and equipment is made up of:

As at: 31 March 2010 31 March 2009

$’000 $’000Leasehold property nil 8,800Owned plant 12,500 14,200Leased plant 6,500 2,500

––––––– ––––––– 19,000 25,500

––––––– ––––––– During the year Deltoid sold its leasehold property for $8 ·5 million and enteredinto an arrangement to rent it back from the purchaser. There were no additionsto or disposals of owned plant during the year. The depreciation charges (to costof sales) for the year ended 31 March 2010 were:





$’000Leasehold property 200Owned plant 1,700Leased plant 1,800

–––––––

3,700––––––– (ii) On 1 July 2009 there was a bonus issue of shares from share premium of one new

share for every 10 held.On 1 October 2009 there was a fully subscribed cash issue of shares at par.

(iii) The 10% loan note is due for repayment on 30 June 2010. Deltoid is innegotiations with the loan provider to refinance the same amount for anotherfive years.

(iv) The finance costs are made up of:For year ended:

31 March 2010 31 March 2009$’000 $’000Finance lease charges 300 100Overdraft interest 200 nilLoan note interest 500 500

–––––– –––– 1,000 600

–––––– –––– Required:(i) Prepare a statement of cash flows for Deltoid for the year ended 31 March

2010 in accordance with IAS 7 Statement of cash flows, using the indirect

method; (12 marks)(ii) Based on the information available, advise the loan provider on the matters

you would take into consideration when deciding whether to grant Deltoida renewal of its maturing loan note. (8 marks)

(b) On a separate matter, you have been asked to advise on an application for a loanto build an extension to a sports club which is a not-for-profit organisation. Youhave been provided with the audited financial statements of the sports club forthe last four years.Required:

Identify and explain the ratios that you would calculate to assist in determiningwhether you would advise that the loan should be granted. (5 marks)

(Total: 25 marks)





Financial statements – Preparation of accounts from trialbalance

18 Petra

The following trial balance relates to Petra, a public listed company, at 30 September2012:

$000 $000Revenue (note (i)) 197,800Cost of sales (note (i)) 114,000Distribution costs 17,000Administration expenses 18,000Loan interest paid 1,500Ordinary shares of 25 cents each fully paid 40,000

Share premium 12,000Retained earnings 1 October 2011 34,0006% Redeemable loan note (issued in 2010) 50,000Land and buildings at cost((land element $40 million) note (ii))

100,000

Plant and equipment at cost (note (iii)) 66,000Deferred development expenditure (note (iv)) 40,000Accumulated depreciation at 1 October 2011:

– buildings 16,000– plant and equipment 26,000

Accumulated amortisation of development expenditureat 1 October 2011 8,000Income tax (note (v)) 1,000Deferred tax (note (v)) 15,000Trade receivables 24,000Inventories – 30 September 2012 21,300Cash and bank 11,000Trade payables 15,000

413,800 413,800

The following notes are relevant:(i) Included in revenue is $12 million for receipts that the company’s auditors have

advised are commission sales. The costs of these sales, paid for by Petra, were $8million. $3 million of the profit of $4 million was attributable to and remitted toSharma (the auditors have advised that Sharma is the principal for thesetransactions). Both the $8 million cost of sales and the $3 million paid to Sharmahave been included in cost of sales.

(ii) The buildings had an estimated life of 30 years when they were acquired and are being depreciated on the straight-line basis.

(iii) Included in the trial balance figures for plant and equipment is plant that hadcost $16 million and had accumulated depreciation of $6 million. Following a





review of the company’s operations this plant was made available for sale duringthe year. Negotiations with a broker have concluded that a realistic selling priceof this plant will be $7.5 million and the broker will charge a commission of 8% ofthe selling price. The plant had not been sold by the year end. Plant isdepreciated at 20% per annum using the reducing balance method. Depreciation

of buildings and plant is charged to cost of sales.(iv) The development expenditure relates to the capitalised cost of developing a

product called the Topaz. It had an original estimated life of five years.Production and sales of the Topaz started in October 2010. A review of the salesof the Topaz in late September 2012, showed them to be below forecast and animpairment test concluded that the fair value of the development costs at 30September 2012 was only $18 million and the expected period of future sales(from this date) was only a further two years.

(v) The balance on the income tax account in the trial balance is the under-provisionin respect of the income tax liability for the year ended 30 September 2011. The

directors have estimated the provision for income tax for the year ended 30September 2012 to be $4 million and the required balance sheet provision fordeferred tax at 30 September 2012 is $17.6 million.

Required: Prepare for Petra:(a) An income statement for the year ended 30 September 2012 (10 marks)

(b) A statement of financial position as at 30 September 2012. (10 marks) Note: A statement of changes in equity and a statement of comprehensive income areNOT required. Disclosure notes are also NOT required.(c) The directors hold options to purchase 24 million shares for a total of $7.2

million. The options were granted two years ago and have been correctlyaccounted for. The options do not affect your answer to (a) and (b) above. Theaverage stock market value of Petra’s shares for the year ended 30 September2012 can be taken as 90 cents per share.Required:

A calculation of the basic and diluted earnings per share for the year ended 30September 2012 (comparatives are not required). (5 marks)

(Total: 25 marks)

19 Darius

The following trial balance relates to Darius at 31 March 2012:$000 $000

Revenue 213,800Cost of sales 143,800Closing inventories – 31 March 2012 (note (i)) 10,500Operating expenses 22,400Rental income from investment property 1,200Finance costs (note (ii)) 5,000Land and building – at valuation (note (iii)) 63,000Plant and equipment – cost (note (iii)) 36,000





$000 $000

Investment property – valuation 1 April 2011 (note (iii)) 16,000Accumulated depreciation 1 April 2011 – plant and equipment 16,800 Joint venture (note (iv)) 8,000

Trade receivables 13,500Bank 900Trade payables 11,800Ordinary shares of 25c each 20,00010% Redeemable preference shares of $1 each 10,000Deferred tax (note (v)) 5,200Revaluation reserve (note (iii)) 21,000Retained earnings – 1 April 2011 17,500

318,200 318,200The following notes are relevant:(i) An inventory count at 31 March 2012 listed goods with a cost of $10.5 million.

This includes some damaged goods that had cost $800,000. These would requireremedial work costing $450,000 before they could be sold for an estimated$950,000.

(ii) Finance costs include overdraft charges, the full year’s preference dividend andan ordinary dividend of 4c per share that was paid in September 2011.

(iii) Non-current assets:Land and building

The land and building were revalued at $15 million and $48 million respectively

on 1 April 2011 creating a $21 million revaluation reserve. At this date the building had a remaining life of 15 years.Depreciation is on a straight-line basis. Darius does not make a transfer torealised profits in respect of excess depreciation.Plant

All plant, including that of the joint venture (note (iv)), is depreciated at 12·5% onthe reducing balance basis.Depreciation on both the building and the plant should be charged to cost ofsales.

Investment property

On 31 March 2012 a qualified surveyor valued the investment property at $13.5million. Darius uses the fair value model in IAS 40 Investment property to valueits investment property.

(iv) On 1 April 2011 Darius entered into a joint venture with two other entities. Eachventurer contributes their own assets and is responsible for their own expensesincluding depreciation on joint venture assets. Darius is entitled to 40% of the joint venture’s total revenues. The joint venture is not a separate entity.





Details of Darius’s joint venture transactions are:

$000

Plant and equipment at cost 12,000Share of joint venture revenue (40% of total sales revenue) (8,000)

Related joint venture cost of sales excluding depreciation 5,000Trade receivables 1,500Trade payables (2,500)Net balance included in the above list of balances 8,000

(v) The directors have estimated the provision for income tax for the year ended 31March 2012 at $8 million. The deferred tax provision at 31 March 2012 is to beadjusted (through the income statement) to reflect that the tax base of thecompany’s net assets is $12 million less than their carrying amounts. The rate ofincome tax is 30%.

Required:

(a) Prepare the statement of comprehensive for Darius for the year ended 31 March2012. (12 marks)

(c) Prepare the statement of financial position for Darius as at 31 March 2012.(13 marks)

Notes to the financial statements are not required. (Total: 25 marks)

20 Danzig

The following trial balance relates to Danzig, a public listed company, at 30 September

2012.$000 $000

Cost of sales 134,000Operating expenses 35,000Loan interest paid (see note (1)) 1,500Rental of vehicles (see note (2)) 8,600Revenue 295,300Investment income 2,000Leasehold property at cost (see note (4)) 250,000

Plant and equipment at cost 197,000Accumulated depreciation at 1 October 2011:

- leasehold property 40,000- plant and equipment 47,000

Investments at amortised cost 92,400Equity shares of $0.50 each, fully paid 180,000Retained earnings at 1 October 2011 19,3003% loan notes (see note (1)) 50,000Deferred tax balance at 1 October 2011 (see note (5)) 20,000Inventory at 30 September 2012 23,700Trade receivables 76,400





$000 $000Trade payables 14,100Bank 12,100Suspense account (see note (6)) 163,000

830,700 830,700The following notes are relevant:(1) The loan notes were issued on 1 October 2011 and are redeemable on 30

September 2016. They are redeemable at a large premium to nominal value because of the low nominal interest rate payable. It has been calculated that theeffective interest rate on these loan notes is 6% per year.

(2) There are two separate contracts for rental of vehicles. A recent review by thefinance department of these contracts has reached the conclusion that of the totalrental cost of vehicles, $7 million relates to a finance lease rather than anoperating lease or rental arrangement. The finance lease was entered into on 1October 2011 which was when the $7 million was paid: the lease agreement is fora four-year period in total, and there will be three more annual payments inadvance of $7 million, payable on 1 October in each year. The vehicles in thefinance lease agreement had a fair value of $24 million at 1 October 2011 and theyshould be depreciated using the straight line method to a nil residual value. Theinterest rate implicit in the lease is 10% per year. The other contract for vehiclerental is an operating lease and the rental payment should be charged tooperating expenses. (Note: You are not required to calculate the present value ofthe minimum lease payments for the finance lease.)

(3) Other plant and equipment is depreciated at 20% per year by the reducing

balance method.All depreciation of property, plant and equipment should be charged to cost ofsales.

(4) The leasehold property has a 25-year life and is amortised at a straight-line rate.On 30 September 2012 the leasehold property was re-valued to $220 million andthe directors wish to incorporate this re-valuation in the financial statements.

(5) The provision for income tax for the year ended 30 September 2012 has beenestimated at $18 million. At 30 September 2012 there are taxable temporarydifferences of $92 million. Of these $20 million is related to the revaluation of theleasehold property (see note (2) above). The rate of income tax on profits is 25%.

(6) The suspense account balance can be reconciled from the following transactions.The payment of a dividend in October 2011. This was calculated to give a 5%yield on the company’s share price as at 30 September 2011. The share price as atthis date was $2.00.The net receipts from a rights issue of shares in March 2012. The issue was of onenew share for every three held at a price of $1.70 per share. The issue was fullysubscribed. The expenses of the share issue were $5 million. These should becharged against share premium.Note that the cash entries for these transactions have already been fullyaccounted for.





Required:

(a) Prepare an income statement for Danzig for the year to 30 September 2012(8 marks)

(b) Prepare a statement of financial position for Danzig as at 30 September 2012.(17 marks)

Note : A statement of changes in equity is not required. (Total: 25 marks)

21 Allgone

The following trial balance relates to Allgone at 31 March 2012:

$000 $000Sales revenue (note (i)) 236,200Purchases 127,850Operating expenses 12,400Loan note interest paid 2,400Preference dividend 1,000Land and buildings – at valuation (note (ii)) 130,000Plant and equipment – cost 84,300Software – cost 1 April 2009 10,000Stock market investments – valuation 1 April 2011 (note(iii))

12,000

Depreciation 1 April 2011 – plant and equipment 24,300Depreciation 1 April 2011 – software 6,000Extraordinary item (note (iv)) 32,000Trade receivables 23,000

Inventory – 1 April 2011 19,450Bank 350Trade payables 15,200Ordinary shares of 25c each 60,00010% Redeemable preference shares 20,00012% Loan note (issued 1 July 2011) 40,000Deferred tax 3,000Revaluation reserve(relating to land and buildings and the investments) 45,000Retained earnings – 1 April 2011 4,350

454,400 454,400The following notes are relevant:(i) Sales revenue includes $8 million for goods sold in March 2012 for cash to

Funders, a merchant bank. The cost of these goods was $6 million. Funders hasthe option to require Allgone to repurchase these goods within one month of theyear-end at their original selling price plus a facilitating fee of $250,000.The inventory at 31 March 2012 was counted at a cost value of $8.5 million. Thisincludes $500,000 of slow moving inventory that is expected to be sold for a net$300,000.





(ii) Non-current assets:On 1 April 2011 Allgone re-valued its land and buildings. The details are:

Cost 1 April 2006 Valuation 1 April 2011

$000 $000

Land 20,000 25,000Building 80,000 105,000

The building had an estimated life of 40 years when it was acquired and this hasnot changed as a result of the revaluation. Depreciation is on a straight-line basis.The surplus on the revaluation has been added to the revaluation reserve, but noother movements on the revaluation reserve have been recorded.Plant and equipment is depreciated at 20% per annum on the reducing balance basis.Software is depreciated by the sum of the digits method over a five-year life.

(iii) The investment represents 7.5% of the ordinary share capital of Wondaworld.Allgone has a policy of revaluing its investments at their market price at eachyear-end. The auditors have agreed that changes in value can be taken to therevaluation reserve which at 1 April 2011 contained a surplus of $5 million forprevious revaluations of the investments. The stock market price of Wondaworldordinary shares was $2.50 each on 1 April 2011 and by 31 March 2012 this hadfallen to $2.25.

(iv) The extraordinary item is a loss incurred due to a fraud relating to the company ’sinvestments. A senior employee of the company, who left in January 2011, haddiverted investment funds into his private bank account. The fraud wasdiscovered by the employee ’s replacement in April 2011. It is unlikely that any ofthe funds will be recovered. Allgone has now implemented tighter procedures toprevent such a fraud recurring. The company has been advised that this loss willnot qualify for any tax relief.

(v) The directors have estimated the provision for income tax for the year to 31March 2012 at $11.3 million. The deferred tax provision at 31 March 2012 is to beadjusted to reflect the tax base of the company ’s net assets being $16 million lessthan carrying values. The rate of income tax is 30%. The movement on deferredtax should be charged to the income statement.

Required: In accordance with International Accounting Standards and International FinancialReporting Standards as far as the information permits, prepare:(a) the income statement of Allgone for the year to 31 March 2012; and (7 marks)

(b) the statement of changes in equity for the year to 31 March 2012; and (5 marks)

(c) a statement of financial position as at 31 March 2012. (13 marks)

Notes to the financial statements are not required. (Total: 25 marks)





22 Tourmalet

The following extracted balances relate to Tourmalet at 30 September 2012:

$000 $000Ordinary shares of 20 cents each 50,000Retained earnings at 1 October 2011 47,800Revaluation reserve at 1 October 2011 18,5006% Redeemable preference shares 2014 30,000Trade accounts payable 35,300Tax 2,100Land and buildings – at valuation (note (iii)) 150,000Plant and equipment – cost (note (v)) 98,600Investment property – valuation at 1 October 2011 (note(iv))

10,000

Depreciation 1 October 2011 – land and buildings 9,000

Depreciation 1 October 2011 – plant and equipment 24,600Trade accounts receivable 31,200Inventory – 1 October 2011 26,550Bank 3,700Sales revenue (note (i)) 313,000Investment income (from properties) 1,200Purchases 158,450Distribution expenses 26,400Administration expenses 23,200Interim preference dividend 900

Ordinary dividend paid 2,500531,500 531,500

The following notes are relevant:(i) Sales revenue includes $50 million for an item of plant sold on 1 June 2012. The

plant had a book value of $40 million at the date of its sale, which was charged tocost of sales. On the same date, Tourmalet entered into an agreement to lease back the plant for the next five years (being the estimated remaining life of theplant) at a cost of $14 million per annum payable annually in arrears. Anarrangement of this type is deemed to have a financing cost of 12% per annum.No depreciation has been charged on the item of plant in the current year.

(ii) The inventory at 30 September 2012 was valued at cost of $28.5 million. Thisincludes $4.5 million of slow moving goods. Tourmalet is trying to sell these toanother retailer but has not been successful in obtaining a reasonable offer. The best price it has been offered is $2 million.

(iii) On 1 October 2008 Tourmalet had its land and buildings revalued by a firm ofsurveyors at $150 million, with $30 million of this attributed to the land. At thatdate the remaining life of the building was estimated to be 40 years. These figureswere incorporated into the company ’s books. There has been no significantchange in property values since the revaluation. $500,000 of the revaluationreserve will be realised in the current year as a result of the depreciation of the buildings.





(iv) Details of the investment property are:Value – 1 October 2011 $10 millionValue – 30 September 2012 $9.8 million

The company adopts the fair value method in IAS 40 Investment Property of

valuing its investment property.(v) Plant and equipment (other than that referred to in note (i) above) is depreciated

at 20% per annum on the reducing balance basis. All depreciation is to becharged to cost of sales.

(vi) The above balances contain the results of Tourmalet ’s car retailing operationswhich ceased on 31 December 2011 due to mounting losses. The results of the carretailing operation, which is to be treated as a discontinued operation, for theyear to 30 September 2012 are:

$000

Sales 15,200Cost of sales 16,000Operating expenses 3,200

The operating expenses are included in administration expenses in the trial balance.Tourmalet is still paying rentals for the lease of its car showrooms. The rentalsare included in operating expenses. Tourmalet is hoping to use the premises asan expansion of its administration offices. This is dependent on obtainingplanning permission from the local authority for the change of use, however this

is very difficult to obtain. Failing this, the best option would be early terminationof the lease which will cost $1.5 million in penalties. This amount has not beenprovided for.

(vii) The balance on the taxation account in the trial balance is the result of thesettlement of the previous year ’s tax charge. The directors have estimated theprovision for income tax for the year to 30 September 2012 at $9.2 million.

Required: (a) Comment on the substance of the sale of the plant and the directors ’ treatment of

it. (5 marks)

(b) Prepare the income statement; and (17 marks)

(c) Prepare a statement of changes in equity for Tourmalet for the year to 30September 2012 in accordance with current International Accounting Standards.

(3 marks)

Note: A statement of financial position is NOT required. Disclosure notes are NOTrequired. (Total: 25 marks)





(iv) The directors have estimated the provision for income tax for the year to 30September 2012 at $22 million. The deferred tax provision at 30 September 2012 isto be adjusted to a credit balance of $14 million.

Required:

Prepare for Chamberlain:(a) an income statement for the year to 30 September 2012; and (11 marks)

(b) a statement of financial position as at 30 September 2012 in accordance withInternational Financial Reporting Standards as far as the information permits.

(14 marks)

Note: A statement of changes in equity is NOT required. (Total: 25 marks)

24 Tadeon

The following trial balance relates to Tadeon, a publicly listed company, at 30September 2012:

$’000 $’000Revenue 277,800Cost of sales 118,000Operating expenses 40,000Loan interest paid (note (i)) 1,000Rental of vehicles (note (ii)) 6,200Investment income 2,00025 year leasehold property at cost (note (iii)) 225,000Plant and equipment at cost 181,000Investments at amortised cost 42,000

Accumulated depreciation at 1 October 2011:– leasehold property 36,000– plant and equipment 85,000

Equity shares of 20 cents each fully paid 150,000Retained earnings at 1 October 2011 18,6002% Loan note (note (i)) 50,000Deferred tax balance 1 October 2011 (note (iv)) 12,000Trade receivables 53,500Inventories at 30 September 2012 33,300Bank 1,900Trade payables 18,700

Suspense account (note (v)) 48,000700,000 700,000

The following notes are relevant:(i) The loan note was issued on 1 October 2011. It is redeemable on 30 September

2012 at a large premium (in order to compensate for the low nominal interestrate). The finance department has calculated that the effective interest rate on theloan is 5 ·5% per annum.

(ii) The rental of the vehicles relates to two separate contracts. These have beenscrutinised by the finance department and they have come to the conclusion that$5 million of the rentals relate to a finance lease. The finance lease was enteredinto on 1 October 2011 (the date the $5 million was paid) for a four year period.The vehicles had a fair value of $20 million (straight-line depreciation should be





used) at 1 October 2011 and the lease agreement requires three further annualpayments of $6 million each on the anniversary of the lease. The interest rateimplicit in the lease is to be taken as 10% per annum. (Note: you are not requiredto calculate the present value of the minimum lease payments.) The othercontract is an operating lease and should be charged to operating expenses.

Other plant and equipment is depreciated at 121/2% per annum on the reducing balance basis.All depreciation of property, plant and equipment is charged to cost of sales.

(iii) On 30 September 2012 the leasehold property was revalued to $200 million. Thedirectors wish to incorporate this valuation into the financial statements.

(iv) The directors have estimated the provision for income tax for the year ended 30September 2012 at $38 million. At 30 September 2012 there were $74 million oftaxable temporary differences, of which $20 million related to the revaluation ofthe leasehold property (see (iii) above). The income tax rate is 20%.

(v) The suspense account balance can be reconciled from the following transactions:The payment of a dividend in October 2011. This was calculated to give a 5%yield on the company ’s share price of 80 cents as at 30 September 2011.The net receipt in March 2012 of a fully subscribed rights issue of one new sharefor every three held at a price of 32 cents each. The expenses of the share issuewere $2 million and should be charged to share premium.Note: the cash entries for these transactions have been correctly accounted for.

Required: Prepare for Tadeon:(a) An income statement for the year ended 30 September 2012; and (8 marks)

(b) A statement of financial position as at 30 September 2012. (17 marks)

Note: A statement of changes in equity is not required. Disclosure notes are notrequired. (25 marks)

25 Llama

The following trial balance relates to Llama, a listed company, at 30 September 2012:$’000 $’000

Land and buildings – at valuation 1 October 2011 (note (i)) 130,000Plant – at cost (note (i)) 128,000Accumulated depreciation of plant at 1 October 2011 32,000Investments – at fair value through profit and loss (note (i)) 26,500Investment income 2,200Cost of sales (note (i)) 89,200Distribution costs 11,000Administrative expenses 12,500Loan interest paid 800Inventory at 30 September 2012 37,900Income tax (note (ii)) 400Trade receivables 35,100Revenue 180,400Equity shares of 50 cents each fully paid 60,000Retained earnings at 1 October 2011 25,500





$’000 $’0002% loan note 2014 (note (iii)) 80,000Trade payables 34,700Revaluation reserve (arising from land and buildings) 14,000Deferred tax 11,200Suspense account (note (iv)) 24,000Bank 6,600

471,000 471,000The following notes are relevant:(i) Llama has a policy of revaluing its land and buildings at each year end. The

valuation in the trial balance includes a land element of $30 million. Theestimated remaining life of the buildings at that date (1 October 2011) was 20years. On 30 September 2012, a professional valuer valued the buildings at $92million with no change in the value of the land. Depreciation of buildings ischarged 60% to cost of sales and 20% each to distribution costs and

administrative expenses.During the year Llama manufactured an item of plant that it is using as part of itsown operating capacity. The details of its cost, which is included in cost of salesin the trial balance, are:

$’000Materials cost 6,000Direct labour cost 4,000Machine time cost 8,000Directly attributable overheads 6,000

The manufacture of the plant was completed on 31 March 2012 and the plant was brought into immediate use, but its cost has not yet been capitalised.All plant is depreciated at 121/2% per annum (time apportioned where relevant)using the reducing balance method and charged to cost of sales. No non-currentassets were sold during the year.The fair value of the investments held at fair value through profit and loss at 30September 2012 was $27·1 million.

(ii) The balance of income tax in the trial balance represents the under/overprovision of the previous year’s estimate. The estimated income tax liability forthe year ended 30 September 2012 is $18·7 million. At 30 September 2012 there

were $40 million of taxable temporary differences. The income tax rate is 25%.Note: you may assume that the movement in deferred tax should be taken to theincome statement.

(iii) The 2% loan note was issued on 1 April 2012 under terms that provide for a largepremium on redemption in 2014. The finance department has calculated that theeffect of this is that the loan note has an effective interest rate of 6% per annum.

(iv) The suspense account contains the corresponding credit entry for the proceeds ofa rights issue of shares made on 1 July 2012. The terms of the issue were oneshare for every four held at 80 cents per share. Llama’s share price immediately before the issue was $1. The issue was fully subscribed.





Required: Prepare for Llama:(a) An income statement for the year ended 30 September 2012. (9 marks) (b) A statement of financial position as at 30 September 2012. (13 marks)

(c) A calculation of the earnings per share for the year ended 30 September 2012.(3 marks)

Note: a statement of changes in equity is not required. (Total: 25 marks)

26 Candel

The following trial balance relates to Candel at 30 September 2012:

$’000 $’000 Leasehold property – at valuation 1 October 2011 (note (i)) 50,000Plant and equipment – at cost (note (i)) 76,600Plant and equipment – accumulated depreciation at 1 October2011 24,600Capitalised development expenditure – at 1 October 2011(note (ii)) 20,000Development expenditure – accumulated amortisation at 1October 2011 6,000Closing inventory at 30 September 2012 20,000Trade receivables 43,100Bank 1,300Trade payables and provisions (note (iii)) 23,800Revenue (note (i)) 300,000Cost of sales 204,000Distribution costs 14,500Administrative expenses (note (iii)) 22,200Preference dividend paid 800Interest on bank borrowings 200Equity dividend paid 6,000Research and development costs (note (ii)) 8,600Equity shares of 25 cents each 50,0008% redeemable preference shares of $1 each (note (iv)) 20,000Retained earnings at 1 October 2011 24,500

Deferred tax (note (v)) 5,800Leasehold property revaluation reserve 10,000––––––– ––––––––466,000 466,000––––––– ––––––––

The following notes are relevant:(i) Non-current assets – tangible:

The leasehold property had a remaining life of 20 years at 1 October 2011. Thecompany ’s policy is to revalue its property at each year end and at 30 September2012 it was valued at $43 million. Ignore deferred tax on the revaluation.On 1 October 2011 an item of plant was disposed of for $2 ·5 million cash. Theproceeds have been treated as sales revenue by Candel. The plant is still includedin the above trial balance figures at its cost of $8 million and accumulateddepreciation of $4 million (to the date of disposal).





All plant is depreciated at 20% per annum using the reducing balance method.Depreciation and amortisation of all non-current assets is charged to cost of sales.

(ii) Non-current assets – intangible:In addition to the capitalised development expenditure (of $20 million), further

research and development costs were incurred on a new project whichcommenced on 1 October 2011. The research stage of the new project lasted until31 December 2011 and incurred $1·4 million of costs. From that date the projectincurred development costs of $800,000 per month. On 1 April 2012 the directors became confident that the project would be successful and yield a profit well inexcess of its costs. The project is still in development at 30 September 2012.Capitalised development expenditure is amortised at 20% per annum using thestraight-line method. All expensed research and development is charged to costof sales.

(iii) Candel is being sued by a customer for $2 million for breach of contract over acancelled order. Candel has obtained legal opinion that there is a 20% chance thatCandel will lose the case. Accordingly Candel has provided $400,000 ($2 millionx 20%) included in administrative expenses in respect of the claim. Theunrecoverable legal costs of defending the action are estimated at $100,000. Thesehave not been provided for as the legal action will not go to court until next year.

(iv) The preference shares were issued on 1 April 2012 at par. They are redeemable ata large premium which gives them an effective finance cost of 12% per annum.

(v) The directors have estimated the provision for income tax for the year ended 30September 2012 at $11 ·4 million. The required deferred tax provision at 30September 2012 is $6 million.

Required: (a) Prepare the statement of comprehensive income for the year ended 30 September

2012. (12 marks)

(b) Prepare the statement of changes in equity for the year ended 30 September 2012.(3 marks)

(c) Prepare the statement of financial position as at 30 September 2012. (10 marks)

Note: notes to the financial statements are not required. (Total: 25 marks)

27 Sandown

The following trial balance relates to Sandown at 30 September 2011:$’000 $’000

Revenue (note (i)) 380,000Cost of sales 246,800Distribution costs 17,400Administrative expenses (note (ii)) 50,500Loan interest paid (note (iii)) 1,000Investment income 1,300Profit on sale of investments (note (iv)) 2,200Current tax (note (v)) 2,100Freehold property – at cost 1 October 2002 (note (vi)) 63,000

Plant and equipment – at cost (note (vi)) 42,200Brand – at cost 1 October 2007 (note (vi)) 30,000





$’000 $’000Accumulated depreciation – 1 October 2010 – building 8,000– plant and equipment 19,700Accumulated amortisation – 1 October 2010 – brand 9,000Equity investments (note (iv)) 26,500

Inventory at 30 September 2011 38,000Trade receivables 44,500Bank 8,000Trade payables 42,900Equity shares of 20 cents each 50,000Equity option 2,000Other reserve (note (iv)) 5,0005% convertible loan note 2014 (note (iii)) 18,440Retained earnings at 1 October 2010 26,060Deferred tax (note (v)) 5,400

––––––––– –––––––––570,000 570,000

––––––––– –––––––––The following notes are relevant:(i) Sandown’s revenue includes $16 million for goods sold to Pending on 1 October

2010. The terms of the sale are that Sandown will incur ongoing service andsupport costs of $1·2 million per annum for three years after the sale. Sandownnormally makes a gross profit of 40% on such servicing and support work. Ignorethe time value of money.

(ii) Administrative expenses include an equity dividend of 4·8 cents per share paidduring the year.

(iii) The 5% convertible loan note was issued for proceeds of $20 million on 1 October2009. It has an effective interest rate of 8% due to the value of its conversionoption.

(iv) Sandown invests in quoted equity instruments but never takes a holding of morethan 5% in any company. During the year Sandown sold an investment for $11million. At the date of sale it had a carrying amount of $8·8 million and hadoriginally cost $7 million. Sandown has recorded the disposal of the investment.The remaining investments (the $26·5 million in the trial balance) have a fairvalue of $29 million at 30 September 2011. The other reserve in the trial balancerepresents the net increase in the value of the available-for-sale investments as at1 October 2010. Ignore deferred tax on these transactions.

(v) The balance on current tax represents the under/over provision of the tax

liability for the year ended 30 September 2010. The directors have estimated theprovision for income tax for the year ended 30 September 2011 at $16·2 million.At 30 September 2011 the carrying amounts of Sandown’s net assets were $13million in excess of their tax base. The income tax rate of Sandown is 30%.

(vi) Non-current assets:The freehold property has a land element of $13 million. The building element is

being depreciated on a straight-line basis. Plant and equipment is depreciated at40% per annum using the reducing balance method.Sandown’s brand in the trial balance relates to a product line that received badpublicity during the year which led to falling sales revenues. An impairmentreview was conducted on 1 April 2011 which concluded that, based on estimatedfuture sales, the brand had a value in use of $12 million and a remaining life ofonly three years.





However, on the same date as the impairment review, Sandown received an offerto purchase the brand for $15 million. Prior to the impairment review, it was being depreciated using the straight-line method over a 10-year life.No depreciation/amortisation has yet been charged on any non-current asset forthe year ended 30 September 2011. Depreciation, amortisation and impairment

charges are all charged to cost of sales.Required:

(a) Prepare the statement of comprehensive income for Sandown for the year ended30 September 2011. (13 marks)

(b) Prepare the statement of financial position of Sandown as at 30 September 2011.(12 marks)

Notes to the financial statements are not required.A statement of changes in equity is not required. (Total: 25 marks)

28 PricewellThe following trial balance relates to Pricewell at 31 March 2011:

$’000 $’000Leasehold ro ert – at valuation 31 March 2010 (note (i)) 25,200Plant and equipment (owned) – at cost (note (i)) 46,800Plant and equipment (leased) – at cost (note (i)) 20,000Accumulated depreciation at 31 March 2010Owned plant and equipment 12,800Leased plant and equipment 5,000Finance lease payment (paid on 31 March 2011) (note (i)) 6,000

Obligations under finance lease at 1 April 2010 (note (i)) 15,600Construction contract (note (ii)) 14,300Inventory at 31 March 2011 28,200Trade receivables 33,100Bank 5,500Trade payables 33,400Revenue (note (iii)) 310,000Cost of sales (note (iii)) 234,500Distribution costs 19,500Administrative expenses 27,500Preference dividend paid (note (iv)) 2,400Equity dividend paid 8,000Equity shares of 50 cents each 40,0006% redeemable preference shares at 31 March 2010 (note (iv)) 41,600Retained earnings at 31 March 2010 4,900Current tax (note (v)) 700Deferred tax (note (v)) 8,400

––––––– ––––––––471,700 471,700––––––– ––––––––

The following notes are relevant:(i) Non-current assets:

The 15 year leasehold property was acquired on 1 April 2009 at cost $30 million.The company policy is to revalue the property at market value at each year end.





The valuation in the trial balance of $25·2 million as at 31 March 2010 led to animpairment charge of $2·8 million which was reported in the income statement ofthe previous year (i.e. year ended 31 March 2010). At 31 March 2011 the propertywas valued at $24·9 million.Owned plant is depreciated at 25% per annum using the reducing balancemethod.The leased plant was acquired on 1 April 2009. The rentals are $6 million perannum for four years payable in arrears on 31 March each year. The interest rateimplicit in the lease is 8% per annum. Leased plant is depreciated at 25% perannum using the straight-line method.No depreciation has yet been charged on any non-current assets for the yearended 31 March 2011. All depreciation is charged to cost of sales.

(ii) On 1 October 2010 Pricewell entered into a contract to construct a bridge over ariver. The agreed price of the bridge is $50 million and construction was expectedto be completed on 30 September 2012. The $14·3 million in the trial balance is:

$’000materials, labour and overheads 12,000specialist plant acquired 1 October 2010 8,000payment from customer (5,700)

–––––––14,300

–––––––The sales value of the work done at 31 March 2011 has been agreed at $22 millionand the estimated cost to complete (excluding plant depreciation) is $10 million.The specialist plant will have no residual value at the end of the contract andshould be depreciated on a monthly basis. Pricewell recognises profits onuncompleted contracts on the percentage of completion basis as determined bythe agreed work to date compared to the total contract price.

(iii) Pricewell’s revenue includes $8 million for goods it sold acting as an agent forTrilby. Pricewell earned a commission of 20% on these sales and remitted thedifference of $6·4 million (included in cost of sales) to Trilby.

(iv) The 6% preference shares were issued on 1 April 2009 at par for $40 million. Theyhave an effective finance cost of 10% per annum due to a premium payable ontheir redemption.

(v) The directors have estimated the provision for income tax for the year ended 31March 2011 at $4·5 million. The required deferred tax provision at 31 March 2011is $5·6 million; all adjustments to deferred tax should be taken to the incomestatement. The balance of current tax in the trial balance represents theunder/over provision of the income tax liability for the year ended 31 March2010.

Required:

(a) Prepare the statement of comprehensive income for the year ended 31 March2011. (12 marks)

(b) Prepare the statement of financial position as at 31 March 2011. (13 marks)

Note: a statement of changes in equity and notes to the financial statements arenot required. (Total: 25 marks)





29 Dune

The following trial balance relates to Dune at 31 March 2010:$’000 $’000

Equity shares of $1 each 60,000

5% loan note (note (i)) 20,000Retained earnings at 1 April 2009 38,400Leasehold (15 years) property – at cost (note (ii)) 45,000Plant and equipment – at cost (note (ii)) 67,500Accumulated depreciation – 1 April 2009 – leasehold property 6,000– plant and equipment 23,500Investments at fair value through profi t or loss (note (iii)) 26,500Inventory at 31 March 2010 48,000Trade receivables 40,700Bank 4,500Deferred tax (note (v)) 6,000

Trade payables 52,000Revenue (note (iv)) 400,000Cost of sales 294,000Construction contract (note (vi)) 20,000Distribution costs 26,400Administrative expenses (note (i)) 34,200Dividend paid 10,000Loan note interest paid (six months) 500Bank interest 200Investment income 1,200Current tax (note (v)) 1,400

–––––––– –––––––– 613,000 613,000–––––––– ––––––––

The following notes are relevant:(i) The 5% loan note was issued on 1 April 2009 at its nominal (face) value of $20

million. The direct costs of the issue were $500,000 and these have been chargedto administrative expenses. The loan note will be redeemed on 31 March 2012 at asubstantial premium. The effective finance cost of the loan note is 10% perannum.

(ii) Non-current assets:

In order to fund a new project, on 1 October 2009 the company decided to sell itsleasehold property. From that date it commenced a short-term rental of anequivalent property. The leasehold property is being marketed by a propertyagent at a price of $40 million, which was considered a reasonably achievableprice at that date. The expected costs to sell have been agreed at $500,000. Recentmarket transactions suggest that actual selling prices achieved for this type ofproperty in the current market conditions are 15% less than the value at whichthey are marketed. At 31 March 2010 the property had not been sold.Plant and equipment is depreciated at 15% per annum using the reducing balance method.No depreciation/amortisation has yet been charged on any non-current asset forthe year ended 31 March 2010. Depreciation, amortisation and impairmentcharges are all charged to cost of sales.





(iii) The investments at fair value through profit or loss had a fair value of $28 millionon 31 March 2010. There were no purchases or disposals of any of theseinvestments during the year.

(iv) It has been discovered that goods with a cost of $6 million, which had beencorrectly included in the count of the inventory at 31 March 2010, had beeninvoiced in April 2010 to customers at a gross profit of 25% on sales, but includedin the revenue (and receivables) of the year ended 31 March 2010.

(v) A provision for income tax for the year ended 31 March 2010 of $12 million isrequired. The balance on current tax represents the under/over provision of thetax liability for the year ended 31 March 2009. At 31 March 2010 the tax base ofDune ’s net assets was $14 million less than their carrying amounts. The incometax rate of Dune is 30%.

(vi) The details of the construction contract are:costs to further costs

31 March 2010 to complete$’000 $’000

materials 5,000 8,000labour and other direct costs 3,000 7,000

––––––– ––––––– 8,000 15,000

––––––– plant acquired at cost 12,000

––––––– per trial balance 20,000

––––––– The contract commenced on 1 October 2009 and is scheduled to take 18 months

to complete. The agreed contract price is fi xed at $40 million. Specialised plantwas purchased at the start of the contract for $12 million. It is expected to have aresidual value of $3 million at the end of the contract and should be depreciatedusing the straight-line method on a monthly basis. An independent surveyor hasassessed that the contract is 30% complete at 31 March 2010. The customer hasnot been invoiced for any progress payments. The outcome of the contract isdeemed to be reasonably certain as at the year end.

Required:

(a) Prepare the income statement for Dune for the year ended 31 March 2010.(b) Prepare the statement of financial position for Dune as at 31 March 2010.

Notes to the financial statements are not required.A statement of changes in equity is not required.The following mark allocation is provided as guidance for this question:(a) 13 marks(b) 12 marks (25 marks)





30 Cavern

The following trial balance relates to Cavern as at 30 September 2010:$’000 $’000

Equity shares of 20 cents each (note (i)) 50,000

8% loan note (note (ii)) 30,600Retained earnings – 30 September 2009 12,100Other equity reserve 3,000Revaluation reserve 7,000Share premium 11,000Land and buildings at valuation – 30 September 2009:Land ($7 million) and building ($36 million) (note (iii)) 43,000Plant and equipment at cost (note (iii)) 67,400Accumulated depreciation plant and equipment – 30 September 2009 13,400Available-for-sale investments (note (iv)) 15,800Inventory at 30 September 2010 19,800

Trade receivables 29,000Bank 4,600Deferred tax (note (v)) 4,000Trade payables 21,700Revenue 182,500Cost of sales 128,500Administrative expenses (note (i)) 25,000Distribution costs 8,500Loan note interest paid 2,400Bank interest 300Investment income 700

Current tax (note (v)) 900–––––––– –––––––– 340,600 340,600

–––––––– –––––––– The following notes are relevant:(i) Cavern has accounted for a fully subscribed rights issue of equity shares made on

1 April 2010 of one new share for every four in issue at 42 cents each. Thecompany paid ordinary dividends of 3 cents per share on 30 November 2009 and5 cents per share on 31 May 2010. The dividend payments are included inadministrative expenses in the trial balance.

(ii) The 8% loan note was issued on 1 October 2008 at its nominal (face) value of $30million. The loan note will be redeemed on 30 September 2012 at a premiumwhich gives the loan note an effective finance cost of 10% per annum.

(iii) Non-current assets:Cavern revalues its land and building at the end of each accounting year. At 30September 2010 the relevant value to be incorporated into the financialstatements is $41 ·8 million. The building ’s remaining life at the beginning of thecurrent year (1 October 2009) was 18 years. Cavern does not make an annualtransfer from the revaluation reserve to retained earnings in respect of therealisation of the revaluation surplus. Ignore deferred tax on the revaluationsurplus.Plant and equipment includes an item of plant bought for $10 million on 1October 2009 that will have a 10-year life (using straight-line depreciation withno residual value). Production using this plant involves toxic chemicals which





will cause decontamination costs to be incurred at the end of its life. The presentvalue of these costs using a discount rate of 10% at 1 October 2009 was $4 million.Cavern has not provided any amount for this future decontamination cost. Allother plant and equipment is depreciated at 12 ·5% per annum using the reducing balance method.

No depreciation has yet been charged on any non-current asset for the yearended 30 September 2010. All depreciation is charged to cost of sales.

(iv) The available-for-sale investments held at 30 September 2010 had a fair value of$13·5 million. There were no acquisitions or disposals of these investmentsduring the year ended 30 September 2010.

(v) A provision for income tax for the year ended 30 September 2010 of $5 ·6 millionis required. The balance on current tax represents the under/over provision ofthe tax liability for the year ended 30 September 2009. At 30 September 2010 thetax base of Cavern ’s net assets was $15 million less than their carrying amounts.The movement on deferred tax should be taken to the income statement. The

income tax rate of Cavern is 25%.Required:

(a) Prepare the statement of comprehensive income for Cavern for the year ended 30September 2010.

(b) Prepare the statement of changes in equity for Cavern for the year ended 30September 2010.

(c) Prepare the statement of financial position of Cavern as at 30 September 2010.Notes to the financial statements are not required.The following mark allocation is provided as guidance for this question:

(a) 11 marks(b) 5 marks(c) 9 marks (25 marks)

Financial statements – Amendments of draft financialstatements

31 Deltoid

The following balance sheet has been extracted from the draft financial statements ofDeltoid for the year to 31 March 2012:

Statement of financial position as at 31 March 2012 $000 $000

Non-current assetsProperty, plant and equipment 12,110Current assetsInventory 3,850Trade accounts receivable 2,450Bank 250

6,550Total assets 18,660






Equity and liabilitiesEquity:Ordinary shares of 50 cents each 2,000

ReservesShare premium 1,000Revaluation reserve 3,000Retained earnings b/f at 1 April 2011 2,500Profit after tax for year to 31 March 2012 2,000

4,50010,500

Non-current liabilitiesEnvironmental provision (note 4) 1,2006% Convertible loan note (note 3) 3,000

4,200Current liabilitiesTrade accounts payable 2,820Taxation 1,140

3,960Total equity and liabilities 18,660

The following additional information is available:(1) The financial statements include an item of plant based on its treatment in the

company ’s management accounts where plant is depreciated on a machine houruse basis. The details of this item of plant are:Cost (1 April 2010) $250,000Estimated residual value $50,000Estimated machine hour life 8,000 hoursMeasured usage in year to: 31 March 2011 2,000 hours

31 March 2012 800 hoursIn the financial statements the company policy is that plant and machineryshould be written off at 20% per annum on the reducing balance basis.

(2) The income statement includes a charge of $150,000 being the first two of tenpayments of $75,000 each in respect of a five-year lease of an item of plant. Thepayments were made on 1 April 2011 and 1 October 2011.The fair value of this plant at the date it was leased was $600,000. Informationobtained from the finance department confirms that this is a finance lease and anappropriate periodic rate of interest is 10% per annum.Deltoid has treated the lease as an operating lease in the above financialstatements. The company depreciates plant used under finance leases on astraight-line basis over the life of the lease.

(3) On 1 April 2011 Deltoid issued a $3 million 6% convertible loan note at par. Theloan note is redeemable at a premium of 10% on 31 March 2015 or it may beconverted into ordinary shares on the basis of 50 shares for each $100 of loan noteat the option of the holder. The interest (coupon) rate for an equivalent loan notewithout the conversion rights would have been 10%. In the draft financial





statements Deltoid has paid and charged interest of $180,000 and shown the loannote at $3 million on the statement of financial position.The present value of $1 receivable at the end of each year, based on discountrates of 6% and 10% can be taken as:

End of year 6% 10%1 0.94 0.912 0.89 0.833 0.84 0.754 0.79 0.68

(4) The draft financial statements contain an accumulating provision for the cost ofrestoring (landscaping) the site of a quarry that is being operated by Deltoid. Theresult of an environmental audit has concluded that the provision has beencalculated on the wrong basis and is materially underprovided. A firm of

environmental consultants has summarised the required revision:Current

provisionRequiredprovision

$000 $000Income statement charge – year to 31 March 2012 180 245Balance sheet liability – at 31 March 2012 1,200 2,150

The directors consider that the incorrect original estimate constitutes a materialerror.

(5) Deltoid made a 1 for 4 bonus issue of shares on 1 March 2012 utilising the

revaluation reserve. This has not yet been recorded in the above financialstatements.Required: (a) Redraft the statement of financial position of Deltoid as at 31 March 2012 making

appropriate adjustments for the items in (1) to (5) above. (20 marks) Note: Work to the nearest $000 and show separately your working for theretained earnings included in the statement of financial position.

(b) Calculate the basic and diluted earnings per share for Deltoid for the year to 31March 2012. Assume a tax rate of 25% and that only the actual loan interest paidis available for tax relief.

Ignore deferred tax. (5 marks)(Total: 25 marks)

32 Tintagel

Reproduced below is the draft statement of financial position of Tintagel as at 31March 2012.

$000 $000Non-current assets (note (i))Freehold property 126,000Plant 110,000





$000 $000Investment property at 1 April 2011 (note (ii)) 15,000

251,000Current assets

Inventory (note (iii)) 60,400Trade receivables and prepayments 31,200Bank 13,800


Equity and liabilitiesOrdinary shares of 25c each 150,000Reserves:Share premium 10,000Retained earnings – 1 April 2011 52,500Retained earnings – Year to 31 March 2012 47,500

110,000260,000

Non-current liabilitiesDeferred tax – at 1 April 2011 (note (v)) 18,700Trade payables (note (iii)) 47,400Provision for plant overhaul (note (iv)) 12,000Taxation 4,200

63,600Suspense account (note (vi)) 14,100Total equity and liabilities 356,400

Notes:(i) The income statement has been charged with $3.2 million being the first of four

equal annual rental payments for an item of excavating plant. This first paymentwas made on 1 April 2011. Tintagel has been advised that this is a finance leasewith an implicit interest rate of 10% per annum. The plant had a fair value of$11.2 million at the inception of the lease.None of the non-current assets have been depreciated for the current year. Thefreehold property should be depreciated at 2% on its cost of $130 million, theleased plant is depreciated at 25% per annum on a straight-line basis and thenon-leased plant is depreciated at 20% on the reducing balance basis.

(ii) Tintagel adopts the fair value model for its investment property. Its value at 31March 2012 has been assessed by a qualified surveyor at $12.4 million.

(iii) During an inventory count on 31 March 2012 items that had cost $6 million wereidentified as being either damaged or slow moving. It is estimated that they willonly realise $4 million in total, on which sales commission of 10% will bepayable. An invoice for materials delivered on 12 March 2012 for $500,000 has been discovered. It has not been recorded in Tintagel ’s bookkeeping system,although the materials were included in the inventory count.





(iv) Tintagel operates some heavy excavating plant which requires a major overhaulevery three years. The overhaul is estimated to cost $18 million and is due to becarried out in April 2013. The provision of $12 million represents two annualamounts of $6 million made in the years to 31 March 2011 and 2012.

(v) The deferred tax provision required at 31 March 2012 has been calculated at $22.5million.

(vi) The suspense account contains the credit entry relating to the issue on 1 October2011 of a $15 million 8% loan note. It was issued at a discount of 5% and incurreddirect issue costs of $150,000. It is redeemable after four years at a premium of10%. Interest is payable six months in arrears. The first payment of interest hasnot been accrued and is due on 1 April 2012. Apportionment of issue costs,discounts and premiums can be made on a straight-line basis.

Required: (a) Commencing with the retained earnings figures in the above balance sheet ($52.5

million and $47.5 million), prepare a schedule of adjustments required to thesefigures taking into account any adjustments required by notes (i) to (vi) above.

(11 marks)

(b) Redraft the statement of financial position of Tintagel as at 31 March 2012 takinginto account the adjustments required in notes (i) to (vi) above. (14 marks)

(Total: 25 marks)

33 Harrington

Reproduced below are the draft financial statements of Harrington, a public company,for the year to 31 March 2012:

Income statement – Year to 31 March 2012 $000Sales revenue (note (i)) 13,700Cost of sales (note (ii)) (9,200)Gross profit 4,500Operating expenses (2,400)Loan note interest paid (refer to balance sheet) (25)Profit before tax 2,075Income tax expense (note (vi)) (55)Profit for the period 2,020


Property, plant and equipment (note (iii)) 6,270Investments (note (iv)) 1,200

7,470Current assetsInventory 1,750Trade receivables 2,450

Bank 350 4,550






Total assets 12,020

Equity and liabilities:Ordinary shares of 25c each (note (v)) 2,000Reserves:Share premium 600Retained earnings – 1 April 2011 2,990

– Year to 31 March 2012 2,020– dividends paid (500)

4,5107,110

Non-current liabilities10% loan note (issued 2009) 500Deferred tax (note (vi)) 280

780Current liabilitiesTrade payables 4,130

12,020

The company policy for ALL depreciation is that it is charged to cost of sales and a fullyear ’s charge is made in the year of acquisition or completion and none in the year ofdisposal.

The following matters are relevant:(i) Included in sales revenue is $300,000 being the sale proceeds of an item of plant

that was sold in January 2012. The plant had originally cost $900,000 and had been depreciated by $630,000 at the date of its sale. Other than recording theproceeds in sales and cash, no other accounting entries for the disposal of theplant have been made. All plant is depreciated at 25% per annum on thereducing balance basis.

(ii) On 31 December 2011 the company completed the construction of a newwarehouse. The construction was achieved using the company ’s own resourcesas follows:

$000Purchased materials 150Direct labour 800Supervision 65Design and planning costs 20

Included in the above figures are $10,000 for materials and $25,000 for labourcosts that were effectively lost due to the foundations being too close to aneighbouring property. All the above costs are included in cost of sales. The building was brought into immediate use on completion and has an estimatedlife of 20 years (straight-line depreciation).





(iii) Details of the other property, plant and equipment at 31 March 2012 are:

$000 $000Land at cost 1,000Buildings at cost 4,000

Less accumulated depreciation at 31 March 2008 (800) 3,200Plant at cost 5,200Less accumulated depreciation at 31 March 2008 (3,130)

2,0706,270

At the beginning of the current year (1 April 2011), Harrington had an openmarket basis valuation of its properties (excluding the warehouse in note (ii)above). Land was valued at $1.2 million and the property at $4.8 million. The

directors wish these values to be incorporated into the financial statements. Theproperties had an estimated remaining life of 20 years at the date of the valuation(straight-line depreciation is used). Harrington makes a transfer to realisedprofits in respect of the excess depreciation on revalued assets.Note: Depreciation for the year to 31 March 2012 has not yet been accounted forin the draft financial statements.

(iv) The investments are in quoted companies that are carried at their stock marketvalues with any gains and losses recorded in the income statement. The valueshown in the statement of financial position is that at 31 March 2011 and duringthe year to 31 March 2012 the investments have risen in value by an average of10%. Harrington has not reflected this increase in its financial statements.

(v) On 1 October 2011 there had been a fully subscribed rights issue of 1 for 4 at 60c.This has been recorded in the above statement of financial position.

(vi) Income tax on the profits for the year to 31 March 2012 is estimated at $260,000.The figure in the income statement is the under-provision for income tax for theyear to 31 March 2011. The carrying value of Harrington ’s net assets is $1.4million more than their tax base at 31 March 2012. The income tax rate is 25%.

Required: (a) Prepare a re-stated income statement for the year to 31 March 2012 reflecting the

information in notes (i) to (vi) above. (9 marks)

(b) Prepare a statement of changes in equity for the year to 31 March 2012.(6 marks)

(c) Prepare a re-stated statement of financial position at 31 March 2012 reflecting theinformation in notes (i) to (vi) above. (10 marks)

(Total: 25 marks)





34 Wellmay

The summarised draft financial statements of Wellmay are shown below.Income statement year ended 31 March 2012:

$’000

Revenue (note (i)) 4,200Cost of sales (note (ii)) (2,700)

———Gross profit 1,500Operating expenses (470)Investment property rental income 20Finance costs (55)

———Profit before tax 995Income tax (360)

———Profit for the period 635

———

Statement of financial position as at 31 March 2012:$’000 $’000

AssetsNon-current assetsProperty, plant and equipment (note (iii)) 4,200Investment property (note (iii)) 400

———4,600

Current assets 1,400———

Total assets 6,000———

Equity and liabilitiesEquityEquity shares of 50 cents each (note (vii)) 1,200Reserves:Revaluation reserve 350Retained earnings (note (iv)) 2,850 3,200

——— ———4,400

Non-current liabilities8% Convertible loan note (2015) (note (v)) 600Deferred tax (note (vi)) 180 780

———Current liabilities 820

———Total equity and liabilities 6,000

———

The following information is relevant to the draft financial statements:(i) Revenue includes $500,000 for the sale on 1 April 2011 of maturing goods to

Westwood. The goods had a cost of $200,000 at the date of sale. Wellmay canrepurchase the goods on 31 March 2013 for $605,000 (based on achieving a





lender ’s return of 10% per annum) at which time the goods are estimated to havea value of $750,000.

(ii) Past experience shows that in the period after the reporting date the companyoften receives unrecorded invoices for materials relating to the previous year. Asa result of this an accrued charge of $75,000 for contingent costs has beenincluded in cost of sales and as a current liability.

(iii) Non-current assets:Wellmay owns two properties. One is a factory (with office accommodation)used by Wellmay as a production facility and the other is an investment propertythat is leased to a third party under an operating lease. Wellmay revalues all itsproperties to current value at the end of each year and uses the fair value modelin IAS 40 Investment property. Relevant details of the fair values of theproperties are:

Factory Investment property$’000 $’000

Valuation 31 March 2011 1,200 400Valuation 31 March 2012 1,350 375The valuations at 31 March 2012 have not yet been incorporated into the financialstatements. Factory depreciation for the year ended 31 March 2012 of $40,000 wascharged to cost of sales. As the factory includes some office accommodation, 20%of this depreciation should have been charged to operating expenses.

(iv) The balance of retained earnings is made up of:$’000

balance b/f 1 April 2011 2,615profit for the period 635

dividends paid during year ended 31 March 2012 (400)———2,850

———(v) 8% Convertible loan note (2015)

On 1 April 2011 an 8% convertible loan note with a nominal value of $600,000was issued at par. It is redeemable on 31 March 2015 at par or it may beconverted into equity shares of Wellmay on the basis of 100 new shares for each$200 of loan note. An equivalent loan note without the conversion option wouldhave carried an interest rate of 10%. Interest of $48,000 has been paid on the loanand charged as a finance cost.The present value of $1 receivable at the end of each year, based on discountrates of 8% and 10% are:

8% 10%End of year 1 0 ·93 0·91

2 0·86 0·833 0·79 0·754 0·73 0·68

(vi) The carrying amounts of Wellmay ’s net assets at 31 March 2012 are $600,000higher than their tax base. The rate of taxation is 35%. The income tax charge of$360,000 does not include the adjustment required to the deferred tax provisionwhich should be charged in full to the income statement.





(vii) Bonus/scrip issue:On 15 March 2012, Wellmay made a bonus issue from retained earnings of oneshare for every four held. The issue has not been recorded in the draft financialstatements.

Required: Redraft the financial statements of Wellmay, including a statement of changes inequity, for the year ended 31 March 2012 reflecting the adjustments required by notes(i) to (vii) above.Note: Calculations should be made to the nearest $ ’000. (25 marks)

35 Dexon

Below is the summarised draft statement of financial position of Dexon, a publiclylisted company, as at 31 March 2012.

$’000 $’000 $’000 AssetsNon-current assetsProperty at valuation (land $20,000; buildings$165,000 (note (ii)) 185,000

Plant (note (ii)) 180,500Investments at fair value through profit and loss at 1April 2011 (note (iii))

12,500

–––––––378,000

Current assetsInventory 84,000

Trade receivables (note (iv)) 52,200Bank 3,800 140,000

––––––– –––––––Total assets 518,000

–––––––Equity and liabilitiesEquityOrdinary shares of $1 each 250,000Share premium 40,000Revaluation reserve 18,000Retained earnings – at 1 April 2011 12,300– for the year ended 31 March 2012 96,700 109,000 167,000

––––––– ––––––– –––––––417,000

Non-current liabilitiesDeferred tax – at 1 April 2011 (note (v)) 19,200Current liabilities 81,800

–––––––Total equity and liabilities 518,000

–––––––

The following information is relevant:(i) Dexon ’s income statement includes $8 million of revenue for credit sales made on

a ‘sale or return ’ basis. At 31 March 2012, customers who had not paid for thegoods, had the right to return $2·6 million of them. Dexon applied a mark up on





cost of 30% on all these sales. In the past, Dexon’s customers have sometimesreturned goods under this type of agreement.

(ii) The non-current assets have not been depreciated for the year ended 31 March2012.Dexon has a policy of revaluing its land and buildings at the end of eachaccounting year. The values in the above statement of financial position are as at1 April 2011 when the buildings had a remaining life of fifteen years. A qualifiedsurveyor has valued the land and buildings at 31 March 2012 at $180 million.Plant is depreciated at 20% on the reducing balance basis.

(iii) The investments at fair value through profit and loss are held in a fund whosevalue changes directly in proportion to a specified market index. At 1 April 2011the relevant index was 1,200 and at 31 March 2012 it was 1,296.

(iv) In late March 2012 the directors of Dexon discovered a material fraudperpetrated by the company ’s credit controller that had been continuing for sometime. Investigations revealed that a total of $4 million of the trade receivables asshown in the statement of financial position at 31 March 2012 had in fact beenpaid and the money had been stolen by the credit controller. An analysisrevealed that $1·5 million had been stolen in the year to 31 March 2011 with therest being stolen in the current year. Dexon is not insured for this loss and itcannot be recovered from the credit controller, nor is it deductible for taxpurposes.

(v) During the year the company ’s taxable temporary differences increased by $10million of which $6 million related to the revaluation of the property. Thedeferred tax relating to the remainder of the increase in the temporary differencesshould be taken to the income statement. The applicable income tax rate is 20%.

(vi) The above figures do not include the estimated provision for income tax on theprofit for the year ended 31 March 2012. After allowing for any adjustmentsrequired in items (i) to (iv), the directors have estimated the provision at $11·4million (this is in addition to the deferred tax effects of item (v)).

(vii) On 1 September 2011 there was a fully subscribed rights issue of one new sharefor every four held at a price of $1·20 each. The proceeds of the issue have beenreceived and the issue of the shares has been correctly accounted for in the abovestatement of financial position.

(viii) In May 2011 a dividend of 4 cents per share was paid. In November 2011 (afterthe rights issue in item (vii) above) a further dividend of 3 cents per share was

paid. Both dividends have been correctly accounted for in the above statement offinancial position.Required:

Taking into account any adjustments required by items (i) to (viii) above(a) Prepare a statement showing the recalculation of Dexon ’s profit for the year

ended 31 March 2012. (8 marks)

(b) Prepare the statement of changes in equity of Dexon for the year ended 31 March2012. (8 marks)

(c) Redraft the statement of financial position of Dexon as at 31 March 2012.(9 marks)

Note: notes to the financial statements are NOT required. (Total: 25 marks)





36 Bodyline

IAS 37 Provisions, Contingent Liabilities and Contingent Assets sets out the principlesof accounting for these items and clarifies when provisions should and should not bemade. Prior to its issue, the inappropriate use of provisions had been an area wherecompanies had been accused of manipulating the financial statements and of creativeaccounting.

Required:

(a) Briefly describe the nature of provisions and the accounting requirements forthem contained in IAS 37. (5 marks)

(b) Briefly explain why there is a need for an accounting standard in this area.Illustrate your answer with three practical examples of how the standardaddresses controversial issues. (5 marks)

(c) Rockbuster has recently purchased an item of earth moving plant at a total cost of

$24 million. The plant has an estimated life of 10 years with no residual value,however its engine will need replacing after every 5,000 hours of use at anestimated cost of $7.5 million. The directors of Rockbuster intend to depreciatethe plant at $2.4 million ($24 million/10 years) per annum and make a provisionof $1,500 ($7.5 million/5,000 hours) per hour of use for the replacement of theengine.

Required:

Explain how the plant should be treated in accordance with International AccountingStandards and comment on the directors ’ proposed treatment. (5 marks)

(Total: 15 marks)

37 Niagara

Extracts of Niagara ’s consolidated income statement for the year to 31 March 2012 areas follows:

$000Sales 36,000Cost of sales (21,000)Gross profit 15,000Other operating expenses (6,200)Finance costs (800)Impairment of non-current assets (4,000)Income from associates 1,500Profit before tax 5,500Taxation (2,800)Profit for the period 2,700

Attributable to:Equity shareholders of the parent 2,585

Non controlling interests 1152,700





The impairment of non-current assets attracted tax relief of $1 million which has beenincluded in the tax charge.Niagara paid an interim ordinary dividend of 3c per share in June 2011 and declared afinal dividend on 25 March 2012 of 6c per share.The issued share capital of Niagara on 1 April 2011 was:

Ordinary shares of 25c each $3 million8% Preference shares $1 million

The preference shares are non-redeemable.The company also had in issue $2 million 7% convertible loan stock dated 2014. Theloan stock will be redeemed at par in 2014 or converted to ordinary shares on the basisof 40 new shares for each $100 of loan stock at the option of the stockholders. Niagara ’sincome tax rate is 30%.There are also in existence directors ’ share warrants (issued in 2010) which entitle thedirectors to receive 750,000 new shares in total in 2014 at no cost to the directors.

The following share issues took place during the year to 31 March 2012: 1 July 2011: a rights issue of 1 new share at $1.50 for every 5 shares held. The

market price of Niagara’s shares the day before the rights was $2.40.

1 October 2011: an issue of $1 million 6% non ‐redeemable preference shares at par.

Both issues were fully subscribed.Niagara ’s basic earnings per share in the year to 31 March 2011 was correctly disclosedas 24c.Required: Calculate for Niagara for the year to 31 March 2012:(a) the basic earnings per share including the comparative (3 marks)

(b) the fully diluted earnings per share (ignore comparative); and advise aprospective investor of the significance of the diluted earnings per share figure.

(7 marks)

(Total: 10 marks)

38 Taxes

(a) (i) IAS 12 Income Taxes details the requirements relating to the accounting

treatment of deferred tax. Required:

Explain why it is considered necessary to provide for deferred tax and

briefly outline the principles of accounting for deferred tax contained in

IAS 12 Income Taxes. (5 marks)

(ii) Bowtock purchased an item of plant for $2,000,000 on 1 October 2009. It had an estimated life of eight years and an estimated residual value of $400,000. The plant is depreciated on a straight ‐line basis. The tax

authorities do not allow depreciation as a deductible expense. Instead a tax

expense of 40% of the cost of this type of asset can be claimed against income tax in the year of purchase and 20% per annum (on a reducing





balance basis) of its tax base thereafter. The rate of income tax can be taken

as 25%.

Required:

In respect of the above item of plant, calculate the deferred tax

charge/credit in Bowtock’s income statement for the year to 30 September 2012 and the deferred tax balance in the statement of financial position at that date. (5 marks)

Note: Work to the nearest $000.

(b) The tax charge for a company called Stepper is $5 million on profits before tax of $35 million. This is an effective rate of tax of 14.3%. Another company Jenni has

an income tax charge of $10 million on profit before tax of $30 million. This is an

effective rate of tax of 33.3%. However both companies state the rate of income

tax applicable to them is 25%. The statements of cash flows show that each

company has paid the same amount of tax of $8 million.

Required:

Explain the possible reasons why the income tax charge in the financial

statements as a percentage of the profit before tax may not be the same as the

applicable income tax rate, and why the tax paid in the statement of cash flows

may not be the same as the tax charge in the income statement. (5 marks)

(Total: 15 marks)

39 Broadoak

The broad principles of accounting for tangible non-current assets involvedistinguishing between capital and revenue expenditure, measuring the cost of assets,determining how they should be depreciated and dealing with the problems ofsubsequent measurement and subsequent expenditure. IAS 16 Property, Plant andEquipment has the intention of improving consistency in these areas.Required: (a) Briefly explain:

(i) how the initial cost of tangible non-current assets should be measured; and(3 marks)

(ii) the circumstances in which subsequent expenditure on those assets should

be capitalised.(2 marks)

(b) (i) Broadoak has recently purchased an item of plant from Plantco, the detailsof this are:

$ $Basic list price of plant 240,000

trade discount applicable to Broadoak 12.5% on list priceAncillary costs:

shipping and handling costs 2,750estimated pre-production testing 12,500maintenance contract for three years 24,000site preparation costs





$ $electrical cable installation 14,000concrete reinforcement 4,500own labour costs 7,500

26,000Broadoak paid for the plant (excluding the ancillary costs) within fourweeks of order, thereby obtaining an early settlement discount of 3%.Broadoak had incorrectly specified the power loading of the originalelectrical cable to be installed by the contractor. The cost of correcting thiserror of $6,000 is included in the above figure of $14,000.The plant is expected to last for 10 years. At the end of this period therewill be compulsory costs of $15,000 to dismantle the plant and $3,000 torestore the site to its original use condition.Required:

Calculate the amount at which the initial cost of the plant should bemeasured. (Ignore discounting.) (5 marks)

(Total: 10 marks)

40 Merryview

Merryview conducts its activities from two properties, a head office in the city centreand a property in the countryside where staff training is conducted. Both propertieswere acquired on 1 April 2009 and had estimated lives of 25 years with no residualvalue. The company has a policy of carrying its land and buildings at current values.However, until recently property prices had not changed for some years. On 1 October

2011 the properties were revalued by a firm of surveyors. Details of this and theoriginal costs are:

Land Buildings

$ $Head office – cost 1 April 2009 500,000 1,200,000

– revalued 1 October 2011 700,000 1,350,000Training premises – cost 1 April 2009 300,000 900,000

– revalued 1 October 2011 350,000 600,000

The fall in the value of the training premises is due mainly to damage done by the useof heavy equipment during training. The surveyors have also reported that theexpected life of the training property in its current use will only be a further 10 yearsfrom the date of valuation. The estimated life of the head office remained unaltered.Note: Merryview treats its land and its buildings as separate assets. Depreciation is based on the straight-line method from the date of purchase or subsequent revaluation.Required: Prepare extracts of the financial statements of Merryview in respect of the aboveproperties for the year to 31 March 2012. (Total: 10 marks)





41 Impairment and Wilderness

(a) The main objective of IAS 36 Impairment of Assets is to prescribe the proceduresthat should ensure that an entity’s assets are included in its statement of financialposition at no more than their recoverable amounts. Where an asset is carried atan amount in excess of its recoverable amount, it is said to be impaired and IAS36 requires an impairment loss to be recognised.Required: (i) Define an impairment loss explaining the relevance of fair value less costs

to sell and value in use; and state how frequently assets should be testedfor impairment. (6 marks)

Note: Your answer should NOT describe the possible indicators of animpairment.(ii) Explain how an impairment loss is accounted for after it has been

calculated. (5 marks)

(b) The assistant financial controller of the Wilderness group, a public listedcompany, has identified the matters below which she believes may indicate animpairment to one or more assets:(i) Wilderness owns and operates an item of plant that cost $640,000 and had

accumulated depreciation of $400,000 at 1 October 2011. It is beingdepreciated at 12½% on cost. On 1 April 2012 (exactly half way through theyear) the plant was damaged when a factory vehicle collided into it. Due tothe unavailability of replacement parts, it is not possible to repair the plant, but it still operates, albeit at a reduced capacity. Also it is expected that as aresult of the damage the remaining life of the plant from the date of thedamage will be only two years. Based on its reduced capacity, theestimated present value of the plant in use is $150,000. The plant has acurrent disposal value of $20,000 (which will be nil in two years’ time), butWilderness has been offered a trade-in value of $180,000 against areplacement machine which has a cost of $1 million (there would be nodisposal costs for the replaced plant). Wilderness is reluctant to replace theplant as it is worried about the long-term demand for the productproduced by the plant. The trade-in value is only available if the plant isreplaced.Required:

Prepare extracts from the statement of financial position and incomestatement of Wilderness in respect of the plant for the year ended 30September 2012. Your answer should explain how you arrived at yourfigures. (7 marks)

(ii) On 1 April 2011 Wilderness acquired 100% of the share capital of Mossel,whose only activity is the extraction and sale of spa water. Mossel had beenprofitable since its acquisition, but bad publicity resulting from severalconsumers becoming ill due to a contamination of the spa water supply inApril 2012 has led to unexpected losses in the last six months. The carryingamounts of Mossel’s assets at 30 September 2012 are:





$000Brand (Quencher – see below) 7,000Land containing spa 12,000Purifying and bottling plant 8,000

Inventories 5,00032,000

The source of the contamination was found and it has now ceased.The company originally sold the bottled water under the brand name of‘Quencher’, but because of the contamination it has re-branded its bottledwater as ‘Phoenix’. After a large advertising campaign, sales are nowstarting to recover and are approaching previous levels. The value of the brand in the balance sheet is the depreciated amount of the original brandname of ‘Quencher’.The directors have acknowledged that $1.5 million will have to be spent in

the first three months of the next accounting period to upgrade thepurifying and bottling plant.Inventories contain some old ‘Quencher’ bottled water at a cost of $2million; the remaining inventories are labelled with the new brand‘Phoenix’. Samples of all the bottled water have been tested by the healthauthority and have been passed as fit to sell. The old bottled water willhave to be relabelled at a cost of $250,000, but is then expected to be sold atthe normal selling price of (normal) cost plus 50%.Based on the estimated future cash flows, the directors have estimated thatthe value in use of Mossel at 30 September 2012, calculated according to theguidance in IAS 36, is $20 million. There is no reliable estimate of the fairvalue less costs to sell of Mossel.Required:

Calculate the amounts at which the assets of Mossel should appear in theconsolidated statement of financial position of Wilderness at 30 September2012. Your answer should explain how you arrived at your figures.

(7 marks)

(Total: 25 marks)






42 Torrent contracts and Savoir EPS

(a) Torrent is a large publicly listed company whose main activity involvesconstruction contracts. Details of three of its contracts for the year ended 31March 2012 are:

Contract Alfa Beta Ceta

Date commenced 1 April2010

1 October2011

1 October2011

Estimated duration 3 years 18 months 2 years

$m $m $mFixed contract price 20 6 12Estimated costs at start of contract 15 7.5 (note

(iii))10

Cost to date:at 31 March 2011 5 nil nilat 31 March 2012 12.5

(note (ii)2 4

Estimated costs at 31 March 2012 to complete 3.5 5.5 (note(iii))

6

Progress payments received at 31 March 2011:(note (i))

5.4 nil nil

Progress payments received at 31 March 2012:(note (i))

12.6 1.8 nil

Notes

(i) The company’s normal policy for determining the percentage completionof contracts is based on the value of work invoiced to date compared to thecontract price. Progress payments received represent 90% of the workinvoiced. However, no progress payments will be invoiced or receivedfrom contract Ceta until it is completed, so the percentage completion ofthis contract is to be based on the cost to date compared to the estimatedtotal contract costs.

(ii) The cost to date of $12.5 million at 31 March 2012 for contract Alfa includes$1 million relating to unplanned rectification costs incurred during thecurrent year (ended 31 March 2012) due to subsidence occurring on site.

(iii) Since negotiating the price of contract Beta, Torrent has discovered the landthat it purchased for the project is contaminated by toxic pollutants. Theestimated cost at the start of the contract and the estimated costs tocomplete the contract include the unexpected costs of decontaminating thesite before construction could commence.

Required:

Prepare extracts of the income statement and statement of financial position forTorrent in respect of the above construction contracts for the year ended 31March 2012. (12 marks)





(b) (i) The issued share capital of Savoir, a publicly listed company, at 31 March2009 was $10 million. Its shares are denominated at 25 cents each. Savoir ’searnings attributable to its ordinary shareholders for the year ended 31March 2009 were also $10 million, giving an earnings per share of 25 cents.Year ended 31 March 2010

On 1 July 2009 Savoir issued eight million ordinary shares at full marketvalue. On 1 January 2010 a bonus issue of one new ordinary share for everyfour ordinary shares held was made. Earnings attributable to ordinaryshareholders for the year ended 31 March 2010 were $13,800,000.Year ended 31 March 2011

On 1 October 2010 Savoir made a rights issue of shares of two newordinary shares at a price of $1.00 each for every five ordinary shares held.The offer was fully subscribed. The market price of Savoir’s ordinary sharesimmediately prior to the offer was $2.40 each. Earnings attributable toordinary shareholders for the year ended 31 March 2011 were $19,500,000.Required:

Calculate Savoir’s earnings per share for the years ended 31 March 2010and 2011 including comparative figures. (9 marks)

(ii) On 1 April 2011 Savoir issued $20 million 8% convertible loan stock at par.The terms of conversion (on 1 April 2014) are that for every $100 of loanstock, 50 ordinary shares will be issued at the option of loan stockholders.Alternatively the loan stock will be redeemed at par for cash. Also on 1April 2011 the directors of Savoir were awarded share options on 12 millionordinary shares exercisable from 1 April 2014 at $1.50 per share. Theaverage market value of Savoir’s ordinary shares for the year ended 31March 2012 was $2.50 each. The income tax rate is 25%. Earningsattributable to ordinary shareholders for the year ended 31 March 2012were $25,200,000. The share options have been correctly recorded in theincome statement.Required:

Calculate Savoir’s basic and diluted earnings per share for the year ended31 March 2012 (comparative figures are not required).You may assume that both the convertible loan stock and the directors’options are dilutive. (4 marks)

(Total: 25 marks)

43 Elite Leisure and Hideaway

(a) Assume that ‘now’ is the end of September 2012.Elite Leisure is a private limited liability company that operates a single cruiseship. The ship was acquired on 1 October 2003. Details of the cost of the ship’scomponents and their estimated useful lives are:

Component Original cost Depreciation basis($ million)

Ship’s fabric (hull, decks etc) 300 25 years straight-line

Cabins and entertainment area fittings 150 12 years straight-linePropulsion system 100 Useful life of 40,000 hours





At 30 September 2011 no further capital expenditure had been incurred on theship.In the year ended 30 September 2011 the ship had experienced a high level ofengine trouble which had cost the company considerable lost revenue andcompensation costs. The measured expired life of the propulsion system at 30September 2011 was 30,000 hours. Due to the unreliability of the engines, adecision was taken in early October 2011 to replace the whole of the propulsionsystem at a cost of $140 million. The expected life of the new propulsion systemwas 50,000 hours and in the year ended 30 September 2012 the ship had used itsengines for 5,000 hours.At the same time as the propulsion system replacement, the company took theopportunity to do a limited upgrade to the cabin and entertainment facilities at acost of $60 million and repaint the ship’s fabric at a cost of $20 million. After theupgrade of the cabin and entertainment area fittings it was estimated that theirremaining life was five years (from the date of the upgrade). For the purpose of

calculating depreciation, all the work on the ship can be assumed to have beencompleted on 1 October 2011. All residual values can be taken as nil.Required: Calculate the carrying amount of Elite Leisure’s cruise ship at 30 September 2012and its related expenditure in the income statement for the year ended 30September 2012. Your answer should explain the treatment of each item.

(12 marks)

(b) Related party relationships are a common feature of commercial life. Theobjective of IAS 24 Related party disclosures is to ensure that financial statementscontain the necessary disclosures to make users aware of the possibility thatfinancial statements may have been affected by the existence of related parties.Required: (i) Describe the main circumstances that give rise to related parties. (4 marks)

(ii) Explain why the disclosure of related party relationships and transactionsmay be important. (3 marks)

(iii) Assume that ‘now’ is the end of September 2012.

Hideaway is a public listed company that owns two subsidiary companyinvestments. It owns 100% of the equity shares of Benedict and 55% of theequity shares of Depret. During the year ended 30 September 2012 Depretmade several sales of goods to Benedict. These sales totalled $15 million

and had cost Depret $14 million to manufacture. Depret made these saleson the instruction of the Board of Hideaway. It is known that one of thedirectors of Depret, who is not a director of Hideaway, is unhappy with theparent company’s instruction as he believes the goods could have been soldto other companies outside the group at the far higher price of $20 million.All directors within the group benefit from a profit sharing scheme.Required:

Describe the financial effect that Hideaway’s instruction may have on thefinancial statements of the companies within the group and theimplications this may have for other interested parties. (6 marks)

(Total: 25 marks)





44 Triangle

Assume that ‘now’ is June 2012

Triangle, a public listed company, is in the process of preparing its draft financialstatements for the year to 31 March 2012. The following matters have been brought to

your attention:(i) On 1 April 2011 the company brought into use a new processing plant that had

cost $15 million to construct and had an estimated life of ten years. The plantuses hazardous chemicals which are put in containers and shipped abroad forsafe disposal after processing. The chemicals have also contaminated the plantitself which occurred as soon as the plant was used. It is a legal requirement thatthe plant is decontaminated at the end of its life. The estimated present value ofthis decontamination, using a discount rate of 8% per annum, is $5 million. Thefinancial statements have been charged with $1.5 million ($15 million/10 years)for plant depreciation and a provision of $500,000 ($5 million/10 years) has beenmade towards the cost of the decontamination. (8 marks)

(ii) On 15 May 2012 the company ’s auditors discovered a fraud in the materialrequisitions department. A senior member of staff who took up employmentwith Triangle in August 2011 had been authorising payments for goods that hadnever been received. The payments were made to a fictitious company thatcannot be traced. The member of staff was immediately dismissed. Calculationsshow that the total amount of the fraud to the date of its discovery was $240,000of which $210,000 related to the year to 31 March 2012. (Assume the fraud ismaterial). (5 marks)

(iii) The company has contacted its insurers in respect of the above fraud. Triangle isinsured for theft, but the insurance company maintains that this is a commercial

fraud and is not covered by the theft clause in the insurance policy. Triangle hasnot yet had an opinion from its lawyers. (4 marks)

(iv) On 1 April 2011 Triangle sold maturing inventory that had a carrying value of $3million (at cost) to Factorall, a finance house, for $5 million. Its estimated marketvalue at this date was in excess of $5 million. The inventory will not be ready forsale until 31 March 2012 and will remain on Triangle ’s premises until this date.The sale contract includes a clause allowing Triangle to repurchase the inventoryat any time up to 31 March 2015 at a price of $5 million plus interest at 10% perannum compounded from 1 April 2011. The inventory will incur storage costsuntil maturity. The cost of storage for the current year of $300,000 has beenincluded in trade receivables (in the name of Factorall). If Triangle chooses not torepurchase the inventory, Factorall will pay the accumulated storage costs on 31March 2012. The proceeds of the sale have been debited to the bank and the salehas been included in Triangle ’s sales revenue. (8 marks)

Required:

Explain how the items in (i) to (iv) above should be treated in Triangle’s financialstatements for the year to 31 March 2012 in accordance with current internationalaccounting standards. Your answer should quantify the amounts where possible.

The mark allocation is shown against each of the four matters above. (Total: 25 marks)





45 Construction

Magpie specialises in construction contracts. It is “now ” the end of March 2012. One ofits contracts, with Better Homes, is to build a complex of luxury flats. The price agreedfor the contract is $40 million and its scheduled date of completion is 31 December2012. Details of the contract to 31 March 2012 are:

Commencement date 1 July 2010

Contract costs: $000Architects’ and surveyors’ fees 500Materials delivered to site 3,100Direct labour costs 3,500Overheads are apportioned at 40% of direct labour costsEstimated cost to complete (excluding depreciation – see below) 14,800

Plant and machinery used exclusively on the contract cost $3,600,000 on 1 July 2010. Atthe end of the contract it is expected to be transferred to a different contract at a valueof $600,000. Depreciation is to be based on a time apportioned basis.Inventory of materials on site at 31 March 2011 is $300,000.Better Homes paid a progress payment of $12,800,000 to Magpie on 31 March 2011.At 31 March 2012 the details for the construction contract have been summarised as:

$000

Contract costs to date (i.e. since the start of the contract) excluding alldepreciation

20,400

Estimated cost to complete (excluding depreciation) 6,600

A further progress payment of $16,200,000 was received on 31 March 2012.Magpie accrues profit on its construction contracts using the percentage of completion basis as measured by the percentage of the cost to date compared to the total estimatedcontract cost.Required: Prepare extracts of the financial statements of Magpie for the construction contractwith Better Homes for:(a) the year to 31 March 2011 (8 marks)

(b) the year to 31 March 2012. (7 marks)

(Total: 15 marks)

46 Bowtock

(a) Explain why events occurring after the reporting date may be relevant to thefinancial statements of the previous period. (4 marks)

(b) At 30 September 2007 Bowtock had included in its draft statement of financialposition inventory of $250,000 valued at cost. Up to 5 November 2012, Bowtockhad sold $100,000 of this inventory for $150,000. On this date new governmentlegislation (enacted after the year end) came into force which meant that theunsold inventory could no longer be marketed and was worthless.

Bowtock is part way through the construction of a housing development. It hasprepared its financial statements to 30 September 2012 in accordance with IAS 11





Construction Contracts and included a proportionate amount of the totalestimated profit on this contract. The same legislation referred to above (in forcefrom 5 November 2012) now requires modifications to the way the houses withinthis development have to be built. The cost of these modifications will be$500,000 and will reduce the estimated total profit on the contract by that

amount, although the contract is still expected to be profitable.Required: Assuming the amounts are material, state how the information above should bereflected in the financial statements of Bowtock for the year ended 30 September2012. (6 marks)

(Total: 10 marks)

47 Multiplex and Simpkins

The following transactions and events have arisen during the preparation of the draftfinancial statements of Multiplex for the year to 31 March 2012:(a) On 1 April 2011 Multiplex issued $80 million 8% convertible loan stock at par.

The stock is convertible into equity shares, or redeemable at par, on 31 March2016, at the option of the stockholders. The terms of conversion are that each$100 of loan stock will be convertible into 50 equity shares of Multiplex. Afinance consultant has advised that if the option to convert to equity had not been included in the terms of the issue, then a coupon (interest) rate of 12%would have been required to attract subscribers for the stock.The value of $1 receivable at the end of each year at a discount rate of 12% can betaken as:

Year $1 0.892 0.803 0.714 0.645 0.57

Required: Calculate the income statement finance charge for the year to 31 March 2012 andthe extracts from the statement of financial position at 31 March 2012 in respect ofthe issue of the convertible loan stock. (5 marks)

(b) On 1 October 2011 Simpkins issued $10 million 6% Convertible Loan Stock on thefollowing terms:The issue price was at par.The loan stock is convertible into the company ’s equity shares at the option of thestockholders four years after the date of its issue (30 September 2015) on the basisof 20 shares for each $100 of loan stock. Alternatively it will be redeemed at par.Merchant Financial Services had advised that if Simpkins had issued similar loanstock without the conversion rights, then it would have had to pay an interest(coupon) rate of 10% on the loan stock. This is because the terms of conversion toequity shares are favourable.





Merchant Financial Services further advised that because it is almost certain thatthe loan stock holders will exercise their right to convert to equity shares, theloan stock has the substance of equity and can be included as such on thestatement of financial position. This has the added advantage ofimproving/reducing the company ’s gearing (debt/equity) in comparison to what

would be the case with the issue of ‘straight ’ loan stock.The present value of $1 receivable at the end of each year, based on discountrates of 6% and 10% can be taken as:

6% 10%End of year 1 0.94 0.91

2 0.89 0.833 0.84 0.754 0.79 0.68

Required: In relation to the 6% Convertible Loan Stock, calculate the finance cost to beshown in the income statement and the extracts from the statement of financialposition for the year to 30 September 2012; and comment on Merchant FinancialServices ’ advice. (5 marks)

(Total: 10 marks)

48 Convertibles

Torpid issued $10 million of 4% convertible loan notes on 1 October 2011, on whichinterest is paid annually in arrears on 30 September. The loan notes are convertible intoequity shares of Torpid on 30 September 2014 at the rate of 20 shares in Torpid forevery $100 of notes. Alternatively the notes can be redeemed on that date for cash atpar, at the option of the note holder.If Torpid had issued straight loan notes, redeemable at par after 3 years, it would havehad to pay interest at the rate of 7% in order to persuade investors to subscribe forthem.The directors of Torpid chose to issue convertible loan notes, rather than straight loannotes, because annual profits would be higher due to the lower interest charge, and thecompany’s gearing, currently at a high level, would be reduced.The present value of $1 receivable at the end of the year, at discount rates of 4% and 7%are as follows:

4% 7%$ $End of year 1 0.96 0.93End of year 2 0.92 0.87End of year 3 0.89 0.81

Required

(a) Show how the convertible loan notes would be accounted for in the financial

statements of Torpid for the year to 30 September 2012. (7 marks)

(b) Comment on the validity of the reasons of the directors for choosing to issue

convertible loan notes. (3 marks)(Total: 10 marks)





49 Errsea

(a) The following is an extract of Errsea ’s balances of property, plant and equipmentand related government grants at 1 April 2011.

accumulated carrying

cost depreciation amount$’000 $’000 $’000

Property, plant and equipment 240 180 60Non-current liabilitiesGovernment grants 30Current liabilitiesGovernment grants 10

Details including purchases and disposals of plant and related governmentgrants during the year are:

(i) Included in the above figures is an item of plant that was disposed of on 1April 2011 for $12,000 which had cost $90,000 on 1 April 2008. The plantwas being depreciated on a straight-line basis over four years assuming aresidual value of $10,000. A government grant was received on its purchaseand was being recognised in the income statement in equal amounts overfour years. In accordance with the terms of the grant, Errsea repaid $3,000of the grant on the disposal of the related plant.

(ii) An item of plant was acquired on 1 July 2011 with the following costs:

$Base cost 192,000Modifications specified by Errsea 12,000Transport and installation 6,000

The plant qualified for a government grant of 25% of the base cost of theplant, but it had not been received by 31 March 2012. The plant is to bedepreciated on a straight-line basis over three years with a nil estimatedresidual value.

(iii) All other plant is depreciated by 15% per annum on cost(iv) $11,000 of the $30,000 non-current liability for government grants at 1 April

2011 should be reclassified as a current liability as at 31 March 2012.

(v) Depreciation is calculated on a time apportioned basis.Required: Prepare extracts of Errsea ’s income statement and statement of financial positionin respect of the property, plant and equipment and government grants for theyear ended 31 March 2012.Note: Disclosure notes are not required. (10 marks)

(b) After the reporting date, prior to authorising for issue the financial statements ofTentacle for the year ended 31 March 2012, the following material informationhas arisen.

(i) The notification of the bankruptcy of a customer. The balance of the tradereceivable due from the customer at 31 March 2012 was $23,000 and at the





expanded its Internet operations to offer car hire facilities to purchasers ofits Internet holidays.The following are Partway ’s summarised income statement results – yearsended:

31 October 2012 31 October 2011

Internet travelagencies car hire total total

$’000 $’000 $’000 $’000 $’000 Revenue 23,000 14,000 2,000 39,000 40,000Cost of sales (18,000) (16,500) (1,500) (36,000) (32,000) Gross profit/(loss) 5,000 (2,500) 500 3,000 8,000Operating expenses (1,000) (1,500) (100) (2,600) (2,000) Profit/(loss) before tax 4,000 (4,000) 400 400 6,000 The results for the travel agencies for the year ended 31 October 2011 were:

revenue $18 million, cost of sales $15 million and operating expenses of$1·5 million.Required:

(ii) Discuss whether the directors ’ wish to show the travel agencies ’ results as adiscontinued operation is justifiable. (4 marks)

(iii) Assuming the closure of the travel agencies is a discontinued operation,prepare the (summarised) income statement of Partway for the year ended31 October 2012 together with its comparatives.Note: Partway discloses the analysis of its discontinued operations on theface of its income statement. (6 marks)

(b) (i) Describe the circumstances in which an entity may change its accountingpolicies and how a change should be applied. (5 marks) The terms under which Partway sells its holidays are that a 10% deposit isrequired on booking and the balance of the holiday must be paid six weeks before the travel date. In previous years Partway has recognised revenue(and profit) from the sale of its holidays at the date the holiday is actuallytaken. From the beginning of November 2011, Partway has made it acondition of booking that all customers must have holiday cancellationinsurance and as a result it is unlikely that the outstanding balance of anyholidays will be unpaid due to cancellation. In preparing its financial

statements to 31 October 2012, the directors are proposing to change torecognising revenue (and related estimated costs) at the date when a booking is made. The directors also feel that this change will help to negatethe adverse effect of comparison with last year ’s results (year ended 31October 2011) which were better than the current year ’s.

Required: (ii) Comment on whether Partway ’s proposal to change the timing of its

recognition of its revenue is acceptable and whether this would be a changeof accounting policy. (6 marks)

(Total: 25 marks)





51 Pingway

Pingway issued a $10 million 3% convertible loan note at par on 1 April 2011 withinterest payable annually in arrears. Three years later, on 31 March 2015, the loan noteis convertible into equity shares on the basis of $100 of loan note for 25 equity shares orit may be redeemed at par in cash at the option of the loan note holder. One of thecompany’s financial assistants observed that the use of a convertible loan note waspreferable to a non-convertible loan note as the latter would have required an interestrate of 8% in order to make it attractive to investors. The assistant has also commentedthat the use of a convertible loan note will improve the profit as a result of lowerinterest costs and, as it is likely that the loan note holders will choose the equity option,the loan note can be classified as equity which will improve the company’s highgearing position.The present value of $1 receivable at the end of the year, based on discount rates of3% and 8% can be taken as:

3% 8%$ $End of year 1 0·97 0·93

2 0·94 0·863 0·92 0·79

Required: Comment on the financial assistant’s observations and show how the convertible loannote should be accounted for in Pingway’s income statement for the year ended 31March 2012 and statement of financial position as at that date. (Total: 10 marks)

52 DearingOn 1 October 2009 Dearing acquired a machine under the following terms:

Hours $Manufacturer’s base price 1,050,000Trade discount (applying to base price only) 20%Early settlement discount taken (on the payable amount of the base cost only)

5%

Freight charges 30,000Electrical installation cost 28,000Staff training in use of machine 40,000Pre-production testing 22,000Purchase of a three-year maintenance contract 60,000Estimated residual value 20,000Estimated life in machine hours 6,000Hours used – year ended 30 September 2010 1,200

– year ended 30 September 2011 1,800– year ended 30 September 2012 (see below) 850

On 1 October 2011 Dearing decided to upgrade the machine by adding newcomponents at a cost of $200,000. This upgrade led to a reduction in the productiontime per unit of the goods being manufactured using the machine. The upgrade alsoincreased the estimated remaining life of the machine at 1 October 2011 to 4,500machine hours and its estimated residual value was revised to $40,000.





Required: Prepare extracts from the income statement and statement of financial position for theabove machine for each of the three years to 30 September 2012. (Total: 10 marks)

53 Waxwork (IAS 10)

(a) The objective of IAS 10 Events after the Reporting Period is to prescribe thetreatment of events that occur after an entity’s reporting period has ended.Required: Define the period to which IAS 10 relates and distinguish between adjusting andnon-adjusting events. (5 marks)

(b) Waxwork’s current year end is 31 March 2012. Its financial statements wereauthorised for issue by its directors on 6 May 2012 and the AGM (annual generalmeeting) will be held on 3 June 2012. The following matters have been brought toyour attention:

(i) On 12 April 2012 a fire completely destroyed the company’s largestwarehouse and the inventory it contained. The carrying amounts of thewarehouse and the inventory were $10 million and $6 million respectively.It appears that the company has not updated the value of its insurancecover and only expects to be able to recover a maximum of $9 million fromits insurers. Waxwork’s trading operations have been severely disruptedsince the fire and it expects large trading losses for some time to come.

(4 marks)

(ii) A single class of inventory held at another warehouse was valued at its costof $460,000 at 31 March 2012. In April 2012 70% of this inventory was soldfor $280,000 on which Waxworks’ sales staff earned a commission of 15% ofthe selling price. (3 marks)

(iii) On 18 May 2012 the government announced tax changes which have theeffect of increasing Waxwork’s deferred tax liability by $650,000 as at 31March 2012. (3 marks)

Required:

Explain the required treatment of the items (i) to (iii) by Waxwork in its financialstatements for the year ended 31 March 2012.Note: assume all items are material and are independent of each other.

(10 marks as indicated)

(Total: 15 marks)

54 Flightline

Flightline is an airline which treats its aircraft as complex non-current assets. The costand other details of one of its aircraft are:

$’000 estimated life Exterior structure – purchase date 1 April 1998 120,000 20 yearsInterior cabin fittings – replaced 1 April 2008 25,000 5 yearsEngines (2 at $9 million each) – replaced 1 April 2008 18,000 36,000 flying hours

No residual values are attributed to any of the component parts.





At 1 April 2011 the aircraft log showed it had flown 10,800 hours since 1 April 2008. Inthe year ended 31 March 2012, the aircraft flew for 1,200 hours for the six months to 30September 2011 and a further 1,000 hours in the six months to 31 March 2012.On 1 October 2011 the aircraft suffered a ‘bird strike’ accident which damaged one ofthe engines beyond repair. This was replaced by a new engine with a life of 36,000hours at cost of $10·8 million. The other engine was also damaged, but was repaired ata cost of $3 million; however, its remaining estimated life was shortened to 15,000hours. The accident also caused cosmetic damage to the exterior of the aircraft whichrequired repainting at a cost of $2 million. As the aircraft was out of service for someweeks due to the accident, Flightline took the opportunity to upgrade its cabin facilitiesat a cost of $4·5 million. This did not increase the estimated remaining life of the cabinfittings, but the improved facilities enabled Flightline to substantially increase the airfares on this aircraft.Required:

Calculate the charges to the income statement in respect of the aircraft for the year

ended 31 March 2012 and its carrying amount in the statement of financial position asat that date.Note: the post accident changes are deemed effective from 1 October 2011.

(Total: 10 marks)

55 Darby

(a) An assistant of yours has been criticised over a piece of assessed work that heproduced for his study course for giving the definition of a non-current asset as‘a physical asset of substantial cost, owned by the company, which will lastlonger than one year’.

Required: Provide an explanation to your assistant of the weaknesses in his definition ofnon-current assets when compared to the International Accounting StandardsBoard’s (IASB) view of assets. (4 marks)

(b) The same assistant has encountered the following matters during the preparationof the draft financial statements of Darby for the year ending 30 September 2011.He has given an explanation of his treatment of them.(i) Darby spent $200,000 sending its staff on training courses during the year.

This has already led to an improvement in the company’s efficiency andresulted in cost savings. The organiser of the course has stated that the benefits from the training should last for a minimum of four years. Theassistant has therefore treated the cost of the training as an intangible assetand charged six months’ amortisation based on the average date during theyear on which the training courses were completed. (3 marks)

(ii) During the year the company started research work with a view to theeventual development of a new processor chip. By 30 September 2011 ithad spent $1·6 million on this project. Darby has a past history of beingparticularly successful in bringing similar projects to a profitableconclusion. As a consequence the assistant has treated the expenditure todate on this project as an asset in the statement of financial position.

Darby was also commissioned by a customer to research and, if feasible,produce a computer system to install in motor vehicles that can





automatically stop the vehicle if it is about to be involved in a collision. At30 September 2011, Darby had spent $2·4 million on this project, but at thisdate it was uncertain as to whether the project would be successful. As aconsequence the assistant has treated the $2·4 million as an expense in theincome statement. (4 marks)

(iii) Darby signed a contract (for an initial three years) in August 2011 with acompany called Media Today to install a satellite dish and cabling systemto a newly built group of residential apartments. Media Today willprovide telephone and television services to the residents of the apartmentsvia the satellite system and pay Darby $50,000 per annum commencing inDecember 2011. Work on the installation commenced on 1 September 2011and the expenditure to 30 September 2011 was $58,000. The installation isexpected to be completed by 31 October 2011. Previous experience withsimilar contracts indicates that Darby will make a total profit of $40,000over the three years on this initial contract. The assistant correctly recorded

the costs to 30 September 2011 of $58,000 as a non-current asset, but thenwrote this amount down to $40,000 (the expected total profit) because he believed the asset to be impaired.The contract is not a finance lease. Ignore discounting. (4 marks)

Required:

For each of the above items (i) to (iii) comment on the assistant’s treatment ofthem in the financial statements for the year ended 30 September 2011 and advisehim how they should be treated under International Financial ReportingStandards.Note: the mark allocation is shown against each of the three items above.

(Total: 15 marks)

56 Barstead

(a) The following figures have been calculated from the financial statements(including comparatives) of Barstead for the year ended 30 September 2012:increase in profit after taxation 80%increase in (basic) earnings per share 5%increase in diluted earnings per share 2%Required:

Explain why the three measures of earnings (profit) growth for the samecompany over the same period can give apparently differing impressions.

(4 marks)

(b) The profit after tax for Barstead for the year ended 30 September 2012 was $15million. At 1 October 2011 the company had in issue 36 million equity shares anda $10 million 8% convertible loan note. The loan note will mature in 2012 and will be redeemed at par or converted to equity shares on the basis of 25 shares foreach $100 of loan note at the loan-note holders’ option. On 1 January 2012Barstead made a fully subscribed rights issue of one new share for every fourshares held at a price of $2·80 each. The market price of the equity shares ofBarstead immediately before the issue was $3·80. The earnings per share (EPS)

reported for the year ended 30 September 2011 was 35 cents.Barstead’s income tax rate is 25%.





Required:

Calculate the (basic) EPS figure for Barstead (including comparatives) and thediluted EPS (comparatives not required) that would be disclosed for the yearended 30 September 2012. (6 marks)

(Total: 10 marks)

57 Apex

(a) Apex is a publicly listed supermarket chain. During the current year it started the building of a new store. The directors are aware that in accordance with IAS 23Borrowing costs certain borrowing costs have to be capitalised.Required:

Explain the circumstances when, and the amount at which, borrowing costsshould be capitalised in accordance with IAS 23. (5 marks)

(b) Details relating to construction of Apex ’s new store:Apex issued a $10 million unsecured loan with a coupon (nominal) interest rateof 6% on 1 April 2009. The loan is redeemable at a premium which means theloan has an effective finance cost of 7 ·5% per annum. The loan was specificallyissued to finance the building of the new store which meets the definition of aqualifying asset in IAS 23. Construction of the store commenced on 1 May 2009and it was completed and ready for use on 28 February 2010, but did not openfor trading until 1 April 2010. During the year trading at Apex ’s other stores was below expectations so Apex suspended the construction of the new store for atwo-month period during July and August 2009. The proceeds of the loan weretemporarily invested for the month of April 2009 and earned interest of $40,000.

Required:Calculate the net borrowing cost that should be capitalised as part of the cost ofthe new store and the finance cost that should be reported in the incomestatement for the year ended 31 March 2010. (5 marks)

(Total: 10 marks)

58 Tunshill

(a) IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors containsguidance on the use of accounting policies and accounting estimates.Required:

Explain the basis on which the management of an entity must select itsaccounting policies and distinguish, with an example, between changes inaccounting policies and changes in accounting estimates. (5 marks)

(b) The directors of Tunshill are disappointed by the draft profit for the year ended30 September 2010. The company ’s assistant accountant has suggested two areaswhere she believes the reported profit may be improved:(i) A major item of plant that cost $20 million to purchase and install on 1

October 2007 is being depreciated on a straight-line basis over a five-yearperiod (assuming no residual value). The plant is wearing well and at the beginning of the current year (1 October 2009) the production manager believed that the plant was likely to last eight years in total (i.e. from thedate of its purchase). The assistant accountant has calculated that, based on





an eight-year life (and no residual value) the accumulated depreciation ofthe plant at 30 September 2010 would be $7 ·5 million ($20 million/8 years x3). In the financial statements for the year ended 30 September 2009, theaccumulated depreciation was $8 million ($20 million/5 years x 2).Therefore, by adopting an eight-year life, Tunshill can avoid a depreciation

charge in the current year and instead credit $0 ·5 million ($8 million – $7·5million) to the income statement in the current year to improve thereported profit. (5 marks)

(ii) Most of Tunshill ’s competitors value their inventory using the average cost(AVCO) basis, whereas Tunshill uses the first in first out (FIFO) basis. Thevalue of Tunshill ’s inventory at 30 September 2010 (on the FIFO basis) is$20 million, however on the AVCO basis it would be valued at $18 million.By adopting the same method (AVCO) as its competitors, the assistantaccountant says the company would improve its profit for the year ended30 September 2010 by $2 million. Tunshill ’s inventory at 30 September 2009was reported as $15 million, however on the AVCO basis it would have been reported as $13 ·4 million. (5 marks)

Required:

Comment on the acceptability of the assistant accountant ’s suggestions andquantify how they would affect the financial statements if they wereimplemented under IFRS. Ignore taxation.Note: the mark allocation is shown against each of the two items above.

(15 marks)

59 Manco

Manco has been experiencing substantial losses at its furniture making operationwhich is treated as a separate operating segment. The company ’s year end is 30September. At a meeting on 1 July 2010 the directors decided to close down thefurniture making operation on 31 January 2011 and then dispose of its non-currentassets on a piecemeal basis. Affected employees and customers were informed of thedecision and a press announcement was made immediately after the meeting. Thedirectors have obtained the following information in relation to the closure of theoperation:(i) On 1 July 2010, the factory had a carrying amount of $3 ·6 million and is expected

to be sold for net proceeds of $5 million. On the same date the plant had acarrying amount of $2 ·8 million, but it is anticipated that it will only realise netproceeds of $500,000.

(ii) Of the employees affected by the closure, the majority will be made redundant atcost of $750,000, the remainder will be retrained at a cost of $200,000 and givenwork in one of the company ’s other operations.

(iii) Trading losses from 1 July to 30 September 2010 are expected to be $600,000 andfrom this date to the closure on 31 January 2011 a further $1 million of tradinglosses are expected.

Required:

Explain how the decision to close the furniture making operation should be treated in

Manco ’s financial statements for the years ending 30 September 2010 and 2011. Youranswer should quantify the amounts involved. (10 marks)






60 Hydrox

Hydrox acquired 90% of Syntax ’s equity shares on 1 April 2010 for $30 million whenSyntax ’s retained earnings were $15 million. The statements of financial position of thetwo companies at 31 March 2012 are shown below:Statement of financial position Hydrox Syntax

$000 $000 $000 $000Non-current assets:Property, plant and equipment at depreciated historiccost

26,400 16,200

Investment in Syntax 30,000Other quoted investments at cost 1,000 6,000

57,400 22,200Current assets:Inventory 9,500 4,000Accounts receivable 7,200 1,500Bank 300 nil

17,000 5,500Total assets: 74,400 27,700Equity and liabilitiesShare capital and reserves:Equity shares of $1 each 10,000 5,000Reserves:Retained earnings 48,600 6,300

58,600 11,300Non-current liabilities:12% Debenture 4,000Bank loan 6,000Current liabilities:Accounts payable 6,700 5,200Provision for taxation 4,100 700Dividends payable (announced before the yearend)

1,000 nil

Overdraft nil 4,50011,800 10,400

Total equity and liabilities: 74,400 27,700The following information is relevant:(i) The movements on the retained earnings of Syntax since the date of acquisition

have been:Loss after

taxDividends

paid$000 $000 $000

Balance at acquisition, 1 April 2010 15,000Year to 31 March 2011 (3,000) nil (3,000)Year to 31 March 2012 (1,700) (4,000) (5,700)

―――― 6,300――――





Hydrox accounted for its share of Syntax ’s dividend as a credit to its incomestatement. The group policy is that only dividends paid out of post-acquisitionprofits are credited to income.

(ii) At the date of acquisition the fair values of Syntax ’s net assets wereapproximately equal to their book values with the exception of two items.

Specialised plant of Syntax had a net replacement cost of $6 million in excess of its book value; it had an estimated remaining life of five years.

The stock market value of Syntax’s investments was $8 million

There have been no acquisitions or disposals of non-current assets since the dateof acquisition.

(iii) An impairment test at 31 March 2012 on the consolidated goodwill concludedthat it should be written down by $400,000. No other assets were impaired.

(iv) Three days before the current year-end Hydrox processed the accounting entriesin respect of a credit sale of goods to Syntax at a selling price of $600,000.

Hydrox charges a standard mark-up on cost of 20% on all its sales. Syntax hadnot received the goods and had therefore not included them in inventories, norhad it received the invoice for them by the year-end. The agreed balance onSyntax ’s purchase ledger account with Hydrox prior to this transaction was $1.4million.

Required: Prepare the consolidated statement of financial position of Hydrox as at 31 March 2012.

(Total: 25 marks)

61 Hedra

Hedra, a public listed company, acquired the following investments:(i) On 1 October 2011, 72 million shares in Salvador for an immediate cash payment

of $195 million. Hedra agreed to pay further consideration on 30 September 2012of $49 million if the post-acquisition profits of Salvador exceeded an agreedfigure at that date. Hedra has not accounted for this deferred payment as it didnot believe it would be payable, however Salvador’s profits have now exceededthe agreed amount (ignore discounting). Salvador also accepted a $50 million 8%loan from Hedra at the date of its acquisition.

(ii) On 1 April 2012, 40 million shares in Aragon by way of a share exchange of twoshares in Hedra for each acquired share in Aragon. The stock market value ofHedra’s shares at the date of this share exchange was $2.50. Hedra has not yetrecorded the acquisition of the investment in Aragon.

The summarised statements of financial position of the three companies as at 30September 2012 are:

Statement of financial position Hedra Salvador Aragon$m $m $m $m $m $m

Non-current assetsProperty, plant and equipment 358 240 270Investments – in Salvador 245 nil nil

– other 45 nil nil648 240 270

Current assetsInventories 130 80 110





Statement of financial position Hedra Salvador Aragon$m $m $m $m $m $m

Trade receivables 142 97 70Cash and bank nil 4 20

272 181 200

Total assets 920 421 470Equity and liabilitiesOrdinary share capital ($1each) 400 120 100ReservesShare premium 40 50 nilRevaluation 15 nil nilRetained earnings 240 60 300

295 110 300695 230 400

Non-current liabilities8% loan note nil 50Deferred tax 45 nil

45 50 nilCurrent liabilitiesTrade payables 118 141 40Bank overdraft 12 nil nilCurrent tax payable 50 nil 30

180 141 70Total equity and liabilities 920 421 470

The following information is relevant:

(a) Fair value adjustments and revaluations :(i) Hedra ’s accounting policy for land and buildings is that they should be

carried at their fair values. The fair value of Salvador ’s land at the date ofacquisition was $20 million in excess of its carrying value. By 30 September2012 this excess had increased by a further $5 million. Salvador ’s buildingsdid not require any fair value adjustments. The fair value of Hedra ’s ownland and buildings at 30 September 2012 was $12 million in excess of itscarrying value in the above statement of financial position.

(ii) The fair value of some of Salvador ’s plant at the date of acquisition was $20million in excess of its carrying value and had a remaining life of four years

(straight-line depreciation is used).(iii) At the date of acquisition Salvador had unrelieved tax losses of $40 million

from previous years. Salvador had not accounted for these as a deferred taxasset as its directors did not believe the company would be sufficientlyprofitable in the near future. However, the directors of Hedra wereconfident that these losses would be utilised and accordingly they should be recognised as a deferred tax asset. By 30 September 2012 the group hadnot yet utilised any of these losses. The income tax rate is 25%.

(b) The retained earnings of Salvador and Aragon at 1 October 2011, as reported intheir separate financial statements, were $20 million and $200 millionrespectively. All profits are deemed to accrue evenly throughout the year.





The following information is relevant:(i) The balances of the retained earnings of the three companies were:

Harden Solder Active

$000 $000 $000

at 1 October 2010 2,000 1,200 500at 1 October 2011 3,000 1,500 800

(ii) At the date of its acquisition the fair values of Solder ’s net assets were equal totheir book values with the exception of a plot of land that had a fair value of$200,000 in excess of its book value.

(iii) On 26 September 2012 Harden processed an invoice for $50,000 in respect of anagreed allocation of central overhead expenses to Solder. At 30 September 2012Solder had not accounted for this transaction. Prior to this the current accounts between the two companies had been agreed at Solder owing $70,000 to Harden(included in trade receivables and trade payables respectively).

(iv) During the year Active sold goods to Harden at a selling price of $140,000 whichgave Active a profit of 40% on cost. Harden had half of these goods in inventoryat 30 September 2012.

(v) An impairment test at 31 March 2012 on the consolidated goodwill concludedthat there was no write down necessary. No other assets were impaired.

Required: (a) Prepare the consolidated statement of financial position of Harden as at 30

September 2012. (20 marks)

(b) At the beginning of the following year, on 1 October 2012, the shareholders of

Deployed accepted a bid from Harden to purchase the whole of its equity sharecapital. Harden is currently considering whether and at what value certain ofDeployed ’s assets and liabilities should be recognised in the consolidatedfinancial statements. The details are:(i) Deployed has made an accounting and taxable loss of $200,000 in the year

to 30 September 2012. This loss will be allowable for tax purposes for reliefagainst any future trading profit that Deployed may make. Deployed hasnot recognised the loss as a deferred tax asset because the directors are notconfident that the company will make sufficient profits in the near future toabsorb the loss. The directors of Harden are firmly of the opinion that theprofitability of the group is such that Deployed ’s tax losses can be utilisedon a group basis. Assume a tax rate of 30%.

(ii) Deployed is in dispute over an insurance claim relating to one of its buildings that has been damaged in a fire. The insurance company isdisputing the claim on the basis that the use of the building was notproperly disclosed when it was insured. A copy of the insurance proposalform has been obtained and sent to Deployed ’s lawyers. The lawyers havesaid that in their opinion the use of the building was adequately disclosedand in any event its use was not the cause of the fire and therefore they believe the claim is valid. The cost of the damage caused by the fire has been provided for, but as the claim is a contingent asset, the directors of

Deployed have not recognised it in the financial statements.





Required: Discuss how the directors of Harden should treat the above items whenpreparing consolidated financial statements to reflect the acquisition ofDeployed. (5 marks)

(Total: 25 marks)

63 Halogen

On 1 April 2011 Halogen acquired a controlling interest of 75% of Stimulus, apreviously wholly owned subsidiary of Exowner. At this date Halogen issued onenew ordinary share valued at $5 and paid $1.40 in cash, for every two shares itacquired in Stimulus. The reserves of Stimulus at the time of the date of the acquisitionwere:

Retained earnings $180 millionRevaluation reserve $40 million

The statements of financial position of Halogen and Stimulus at 31 March 2012 are:Halogen Stimulus

$m $m $m $mAssetsNon-current assetsProperty, plant and equipment 910 330Development expenditure 100 nilInvestments (including that in Stimulus) 700 60

1,710 390Current assetsInventory 224 120Trade receivables 264 84Bank nil 25

488 229Total assets 2,198 619

Equity and liabilitiesEquity:Equity shares of $1 each 1,000 200Reserves:Share premium 300 nil

Retained earnings 530 260Revaluation reserve 60 40

890 3001,890 500

Non-current liabilities10% Debenture nil 60Current liabilitiesTrade payables 128 24Taxation 94 35Bank overdraft 86 nil 59

308 59Total equity and liabilities 2,198 619





The following information is relevant:(i) At the date of acquisition the statement of financial position of Stimulus included

an intangible non-current asset of $8 million in respect of the development of anew medical drug. On this date an independent specialist assessed the fair valueof this intangible asset at $28 million. Halogen had been developing a similardrug and shortly after the acquisition it was decided to combine the twodevelopment projects. All information and development work on Stimulus ’sproject was transferred to Halogen in return for a payment of $36 million. Thecarrying value of Stimulus ’s development expenditure at the date of transfer wasstill $8 million. Stimulus has taken the profit on this transaction to its incomestatement. Approval to market the drug is expected in September 2012.

(ii) Both companies have a policy of keeping their land (included in property, plantand equipment) at current value. The balances on the revaluation reservesrepresent the revaluation surpluses at 1 April 2011. Neither company has yetrecorded further increases of $10 million and $8 million for Halogen and

Stimulus respectively for the year to 31 March 2012.(iii) During the year to 31 March 2012 Halogen sold goods at a price of $26 million toStimulus at a mark-up on cost of 30%. Half of these goods were still in inventoryat the year-end.

(iv) On 28 March 2012 Stimulus recorded a payment of $12 million to settle itscurrent account balance with Halogen. Halogen had not received this by theyear-end. Inter company current account balances are included in tradepayables/receivables as appropriate.

(v) An impairment test at 31 March 2012 on the consolidated goodwill concludedthat it should be written down by $30,000. No other assets were impaired.

Required: (a) Prepare the consolidated statement of financial position of Halogen as at 31

March 2012. (20 marks)

(b) Included within the investments of Halogen is an investment in a wholly ownedprivate limited company called Lockstart. Prior to the current year Halogen hasconsolidated the results of Lockstart. In recent years the profits of Lockstart have been declining and in the year to 31 March 2012 it made significant losses. In January of 2012 the management of Halogen held a Board meeting where it wasdecided that the investment in Lockstart would be sold as soon as possible. No buyer had been found by 31 March 2012.

The directors of Halogen are aware that shareholders often use a company ’spublished financial statements to predict future performance, and this is one ofthe reasons why IFRS 5 Non-current Assets Held for Sale and DiscontinuedOperations requires the results of discontinued operations to be separatelyidentified. Shareholders are thus made aware of those parts of the business thatwill not contribute to future profits or losses.In the spirit of the above, the management of Halogen have decided not toconsolidate the results of Lockstart for the current year (to 31 March 2012), believing that if they were consolidated, it would give a misleading basis forpredicting the group ’s future performance.





Required: Comment on the suitability of the Directors ’ treatment of Lockstart; and statehow you believe Lockstart should be treated in the group financial statements ofHalogen. (5 marks)

Note: You are not required to amend your answer to (a) in respect of this information.(Total: 25 marks)

64 Horsefield

Horsefield, a public company, acquired 90% of Sandfly ’s $1 ordinary shares on 1 April2010 paying $3.00 per share. The balance on Sandfly ’s retained earnings at this datewas $800,000. On 1 October 2011, Horsefield acquired 30% of Anthill ’s $1 ordinaryshares for $3.50 per share. The statements of financial position of the three companiesat 31 March 2012 are shown below:

Horsefield Sandfly Anthill

$000 $000 $000 $000 $000 $000Non-current assetsProperty, plant andequipment

8,050 3,600 1,650

Investments 4,000 910 nil12,050 4,510 1,650

Current assetsInventory 830 340 250Accounts receivable 520 290 350Bank 240 nil 100

1,590 630 700Total assets 13,640 5,140 2,350

Equity and liabilitiesEquity:Ordinary shares of $1 each 5,000 1,200 600Reserves:Retained earnings b/f 6,000 1,400 800Profit year to 31 March 2012 1,500 900 600

7,500 2,300 1,400

12,500 3,500 2,000Non-current liabilities10% Loan notes 500 240 nilCurrent liabilitiesAccounts payable 420 960 200Taxation 220 250 150Overdraft nil 190 nil

640 1,400 350Total equity and liabilities 13,640 5,140 2,350





The following information is relevant:(i) Fair value adjustments:

On 1 April 2010 Sandfly owned an investment property that had a fair value of$120,000 in excess of its carrying value (book value). The value of this propertyhas not changed since acquisition. This property is included within investmentsin the balance sheet. Just prior to its acquisition, Sandfly was successful in applying for a six-yearlicence to dispose of hazardous waste. The licence was granted by thegovernment at no cost, however Horsefield estimated that the licence was worth$180,000 at the date of acquisition.

(ii) In January 2012 Horsefield sold goods to Anthill for $65,000. These weretransferred at a mark up of 30% on cost. Two thirds of these goods were still inthe inventory of Anthill at 31 March 2012.

(iii) To facilitate the consolidation procedures the group insists that all inter companycurrent account balances are settled prior to the year-end. However a cheque for$40,000 from Sandfly to Horsefield was not received until early April 2012. Intercompany balances are included in accounts receivable and payable asappropriate.

(iv) Anthill is to be treated as an associated company of Horsefield.(v) An impairment test at 31 March 2012 on the consolidated goodwill of Sandfly

and Anthill concluded that it should be written down by $468,000 and $12,000respectively. No other assets were impaired.

Required: (a) Prepare the consolidated statement of financial position of Horsefield as at 31

March 2012. (20 marks) (b) Discuss the matters to consider in determining whether an investment in anothercompany constitutes associated company status. (5 marks)

(Total: 25 marks)

65 Highmoor

Highmoor, a public listed company, acquired 80% of Slowmoor ’s ordinary shares on 1October 2011. Highmoor paid an immediate $2 per share in cash and agreed to pay afurther $1.20 per share if Slowmoor made a profit within two years of its acquisition.Highmoor has not recorded the contingent consideration.

The statements of financial position of the two companies at 30 September 2012 areshown below:

Highmoor Slowmoor$ million $ million $ million $ million

Tangible non-current assets 585 172Investments (note (ii)) 225 13Software (note (iii)) nil 40―――― ――――

810 225Current assetsInventory 85 42Accounts receivable 95 36Tax asset 1 nil 80





Highmoor Slowmoor$ million $ million $ million $ million

Bank 20, nil―――― ―――― 200 158―――― ――――

Total assets 1,010 383―――― ―――― Equity and liabilitiesEquity:Ordinary shares of $1 each 400 100Retained earnings – 1 October 2011 230 150– profit/loss for year 100 (35)―――― ――――

330 115―――― ―――― 730 215

Non-current liabilities12% loan note nil 1358% Inter company loan (note (ii)) nil 45―――― ――――

nil 80Current liabilitiesAccounts payable 210 71Taxation 70 nilOverdraft nil 17―――― ――――

280 88―――― ―――― Total equity and liabilities 1,010 383―――― ―――― The following information is relevant:(i) At the date of acquisition the fair values of Slowmoor ’s net assets were

approximately equal to their carrying values (book values).(ii) Included in Highmoor ’s investments is a loan of $50 million made to Slowmoor.

On 28 September 2012, Slowmoor paid $9 million to Highmoor. This representedinterest of $4 million for the year and the balance was a capital repayment.Highmoor had not received nor accounted for the payment, but it had accruedfor the loan interest receivable as part of its accounts receivable figure. There areno other intra group balances.

(iii) The software was developed by Highmoor during 2011 at a total cost of $30million. It was sold to Slowmoor for $50 million immediately after its acquisition.The software had an estimated life of five years and is being amortised bySlowmoor on a straight-line basis.

(iv) Due to the losses of Slowmoor since its acquisition, the directors of Highmoor arenot confident it will return to profitability in the short term.

(v) It is the accounting policy of Highmoor that the non-controlling interests in itssubsidiary should be valued at a proportionate share of net assets.

Required: (a) Prepare the consolidated statement of financial position of Highmoor as at 30

September 2012, explaining your treatment of the contingent consideration.(20 marks)





(b) Describe the circumstances in which negative goodwill may arise. Your answershould refer to the particular issues of the above acquisition. (5 marks)

(Total: 25 marks)

66 Hapsburg

(a) Hapsburg, a public listed company, acquired the following investments: On 1 April 2011, 24 million shares in Sundial. This was by way of an

immediate share exchange of two shares in Hapsburg for every three

shares in Sundial plus a cash payment of $1 per Sundial share payable on 1

April 2014. The market price of Hapsburg’s shares on 1 April 2011 was $2

each.

On 1 October 2011, 6 million shares in Aspen paying an immediate $2.50 in

cash for each share.

Based on Hapsburg ’s cost of capital (taken as 10% per annum), $1 receivable inthree years ’ time can be taken to have a present value of $0.75.Hapsburg has not yet recorded the acquisition of Sundial but it has recorded theinvestment in Aspen. The summarised statements of financial position at 31March 2012 are:

Hapsburg Sundial Aspen$000 $000 $000 $000 $000 $000

Non-current assetsProperty, plant and equipment 41,000 34,800 37,700Investments 15,000 3,000 nil

56,000 37,800 37,700Current assetsInventory 9,900 4,800 7,900Trade and other receivables 13,600 8,600 14,400Cash 1,200 3,800 nil

24,700 17,200 22,300Total assets 80,700 55,000 60,000Equity and liabilitiesCapital and reservesOrdinary shares $1 each 20,000 30,000 20,000Reserves:Share premium 8,000 2,000 nilRetained earnings 10,600 8,500 8,000

18,600 10,500 8,00038,600 40,500 28,000

Non-current liabilities10% loan note 16,000 4,200 12,000Current liabilitiesTrade and other payables 16,500 6,900 13,600Bank overdraft nil nil 4,500Taxation 9,600 3,400 1,900

26,100 10,300 20,000Total equity and liabilities 80,700 55,000 60,000





The summarised statements of financial position of the two companies at 31 March2012 are shown below:

Highveldt Samson

$m $m $m $m

Tangible non-current assets (note (i)) 420 320Development costs (note (iv)) nil 40Investments (note (ii)) 300 20

720 380Current assets 133 91Total assets 853 471Equity and liabilitiesOrdinary share capital ($1each) 270 80ReservesShare premium 80 40Revaluation reserve 45 nilRetained earnings: 1 April 2011 160 134

- Year to 31 March 2012 190 76350 210745 330

Non-current liabilities10% inter company loan (note (ii)) nil 60

Current liabilities 108 81Total equity and liabilities 853 471


(i) Highveldt has a policy of revaluing land and buildings to fair value. At the dateof acquisition Samson’s land and buildings had a fair value $20 million higherthan their carrying value (book value) and at 31 March 2012 this had increased bya further $4 million (ignore any additional depreciation).

(ii) Included in Highveldt’s investments is a loan of $60 million made to Samson at

the date of acquisition. Interest is payable annually in arrears. Samson paid theinterest due for the year on 31 March 2012, but Highveldt did not receive thisuntil after the year end. Highveldt has not accounted for the accrued interestfrom Samson.

(iii) Samson had established a line of products under the brand name of Titanware.Acting on behalf of Highveldt, a firm of specialists, had valued the brand name ata value of $40 million with an estimated life of 10 years as at 1 April 2011. The brand is not included in Samson’s statement of financial position.

(iv) Samson’s development project was completed on 30 September 2011 at a cost of$50 million. $10 million of this had been amortised by 31 March 2012.Development costs capitalised by Samson at the date of acquisition were $18million. Highveldt’s directors are of the opinion that Samson’s development costsdo not meet the criteria in IAS 38 ‘Intangible Assets’ for recognition as an asset.





(v) Samson sold goods to Highveldt during the year at a profit of $6 million, one-third of these goods were still in the inventory of Highveldt at 31 March 2012.

(vi) It is the accounting policy of Highveldt that the non-controlling interests in itssubsidiary should be valued at a proportionate share of net assets.An impairment test at 31 March 2012 on the consolidated goodwill concludedthat it should be written down by $22 million. No other assets were impaired.

Required:

(a) Calculate the following figures as they would appear in the consolidatedstatement of financial position of Highveldt at 31 March 2012:(i) goodwill (8 marks)

(ii) non-controlling interest (4 marks)

(iii) the following consolidated reserves: share premium, revaluation reserveand retained earnings. (8 marks)

Note: Show your workings(b) Explain why consolidated financial statements are useful to the users of financial

statements (as opposed to just the parent company ’s separate (entity) financialstatements). (5 marks)

(Total: 25 marks)

68 Hark, Spark and Ark

Hark acquired the following non-current investments on 1 April 2011:(1) 4 million equity shares in Spark, by means of an exchange of one share in Handel

for every one share in Spark, plus $6.05 million in cash for each Spark share

acquired. The professional fees associated with the acquisition amounted to $1million. The market price of shares in Hark at the date of the acquisition was $9per share. The market price of Spark shares just before the acquisition was $7.The cash part of the consideration is deferred and will not be paid until two yearsafter the acquisition.

(2) 25% of the equity shares in Ark, at a cost of $6 per share. The money to make thispayment was obtained by issuing one million new shares in Hark at $9 per share.

None of these transactions has yet been recorded in the summary statements of financial position that are shown below.

The summarised draft statements of financial position of the three companies at 31

March 2012 are as follows. Statement of financial position Hark Spark Ark

$million

$million

$million

AssetsNon-current assetsProperty, plant and equipment 60.0 31.0 16.0Other equity investments 0.8 nil nil

60.8 31.0 16.0

Current assets 18.2 8.0 9.0Total assets 79.0 39.0 25.0





Statement of financial position Hark Spark Ark$

million$

million$

millionEquity and liabilitiesEquity shares of $1 each 16.0 5.0 6.0Share premium 2.0 4.0 4.0Retained earnings: at 1 April 2011 36.0 16.0 8.0

- for year ended 31 March 2012 8.0 3.0 2.062.0 28.0 20.0

Non-current liabilities6% loan notes 10.0 - -7% loan notes - 6.0 3.0

Current liabilities 7.0 5.0 2.0Total equity and liabilities 79.0 39.0 25.0


(1) Hark has chosen to value the non-controlling interest in Spark using the fairvalue method permitted by IFRS 3 (revised). The fair value of the non-controllinginterests at the acquisition date is estimated to be the market value of the shares before the acquisition.

(2) At the date of acquisition of Spark, the fair values of its assets were equal to theircarrying amounts.

(3) The cost of capital of Hark is 10% per year.(4) During the year ended 31 March 2012, Spark sold goods to Hark for $3.6 million,

at a mark-up of 50% on cost. Hark had 75% of these goods in its inventory at 31March 2012.

(5) There were no intra-group receivables and payables at 31 March 2012.(6) On 1 April 2011, Hark sold a group of machines to Spark at their agreed fair

value of $3 million. At the time of the sale, the carrying amount of the machineswas $2 million. The estimated remaining useful life of the plant at the date of thesale was four years. Plant and machinery is depreciated to a residual value of nilusing straight-line depreciation and at 1 April 2011 the machines had anestimated remaining life of five years.

(7) “Other equity investments ” are included in the summary statement of financial

position of Hark at their fair value on 1April 2011. Their fair value at 31 March2012 is $0.65 million.

(8) Impairment tests were carried out on 31 March 2012. These show that there is noimpairment of the value of the investment in Ark or in the consolidated goodwill.

(9) No dividends were paid during the year by any of the three companies.

Required

Prepare the consolidated statement of financial position for Hark as at 31 March 2012.(Total: 25 marks)





69 Parentis

Parentis, a public listed company, acquired 600 million equity shares in Offspring on 1April 2011. The purchase consideration was made up of:

a share exchange of one share in Parentis for two shares in Offspring

the issue of $100 10% loan note for every 500 shares acquired; and adeferred cash payment of 11 cents per share acquired payable on 1April 2012.

Parentis has only recorded the issue of the loan notes. The value of each Parentis shareat the date of acquisition was 75 cents and Parentis has a cost of capital of 10% perannum.The statements of financial position of the two companies at 31 March 2012 are shown below:

Parentis Offspring$ million $ million $ million $ million

AssetsProperty, plant and equipment (note (i)) 640 340Investments 120 nilIntellectual property (note (ii)) nil 30

——— ———760 370

Current assetsInventory (note (iii)) 76 22Trade receivables (note (iii)) 84 44Bank nil 160 4 70

——— ——— ——— ———Total assets 920 440

——— ———Equity and liabilitiesEquity shares of 25 cents each 300 200Retained earnings – 1 April 2011 210 120– year ended 31 March 2012 90 300 20 140

——— ——— ——— ———600 340

Non-current liabilities10% loan notes 120 20

Current liabilitiesTrade payables (note (iii)) 130 57Current tax payable 45 23Overdraft 25 200 nil 80

——— ——— ——— ———Total equity and liabilities 920 440

——— ———The following information is relevant:(i) At the date of acquisition the fair values of Offspring ’s net assets were

approximately equal to their carrying amounts with the exception of itsproperties. These properties had a fair value of $40 million in excess of theircarrying amounts which would create additional depreciation of $2 million in thepost acquisition period to 31 March 2012. The fair values have not been reflectedin Offspring ’s statement of financial position.

(ii) The intellectual property is a system of encryption designed for internet use.Offspring has been advised that government legislation (passed since





acquisition) has now made this type of encryption illegal. Offspring will receive$10 million in compensation from the government.

(iii) Offspring sold Parentis goods for $15 million in the post acquisition period. $5million of these goods are included in the inventory of Parentis at 31 March 2012.The profit made by Offspring on these sales was $6 million. Offspring ’s tradepayable account (in the records of Parentis) of $7 million does not agree withParentis ’s trade receivable account (in the records of Offspring) due to cash intransit of $4 million paid by Parentis.

(iv) Due to the impact of the above legislation, Parentis has concluded that theconsolidated goodwill has been impaired by $27 million.

Required: Prepare the consolidated statement of financial position of Parentis as at 31 March2012. (Total: 25 marks)

70 Plateau

On 1 October 2011 Plateau acquired the following non-current investments:– 3 million equity shares in Savannah by an exchange of one share in Plateau for

every two shares in Savannah plus $1 per acquired Savannah share in cash. Themarket price of each Plateau share at the date of acquisition was $6.

– 30% of the equity shares of Axle at a cost of $7·50 per share in cash.Only the cash consideration of the above investments has been recorded by Plateau.The summarised draft statements of financial position of the three companies at 30September 2012 are:

Plateau Savannah Axle $’000 $’000 $’000

AssetsNon-current assetsProperty, plant and equipment 18,400 10,400 18,000Investments in Savannah and Axle 12,000 nil nilOther equity investments 6,500 nil nil

––––––– ––––––– –––––––36,900 10,400 18,000

Current assetsInventory 6,900 6,200 3,600Trade receivables 3,200 1,500 2,400

––––––– ––––––– –––––––Total assets 47,000 18,100 24,000––––––– ––––––– –––––––

Equity and liabilities Equity shares of $1 each 10,000 4,000 4,000Retained earnings – at 30 September 2011 16,000 6,500 11,000– for year ended 30 September 2012 8,000 2,400 5,000

––––––– ––––––– –––––––34,000 12,900 20,000

Non-current liabilities7% Loan notes 5,000 1,000 1,000Current liabilities 8,000 4,200 3,000

––––––– ––––––– –––––––Total equity and liabilities 47,000 18,100 24,000––––––– ––––––– –––––––





The following information is relevant:(i) At the date of acquisition the fair values of Savannah’s assets were equal to their

carrying amounts with the exception of Savannah’s land which had a fair valueof $500,000 below its carrying amount; it was written down by this amountshortly after acquisition and has not changed in value since then.

(ii) On 1 October 2011, Plateau sold an item of plant to Savannah at its agreed fairvalue of $2·5 million. Its carrying amount prior to the sale was $2 million. Theestimated remaining life of the plant at the date of sale was five years (straight-line depreciation).

(iii) During the year ended 30 September 2012 Savannah sold goods to Plateau for$2·7 million. Savannah had marked up these goods by 50% on cost. Plateau had athird of the goods still in its inventory at 30 September 2012. There were no intra-group payables/receivables at 30 September 2012.

(iv) Impairment tests on 30 September 2012 concluded that the value of theinvestment in Axle was not impaired, but consolidated goodwill was impaired by $900,000.

(v) “Other equity investments ” are included in Plateau’s statement of financialposition (above) at their fair value on 1 October 2011, but they have a fair value of$9 million at 30 September 2012

(vi) No dividends were paid during the year by any of the companies.Required: (a) Prepare the consolidated statement of financial position for Plateau as at 30

September 2012. (20 marks) (b) A financial assistant has observed that the fair value exercise means that a

subsidiary’s net assets are included at acquisition at their fair (current) values inthe consolidated statement of financial position. The assistant believes that it isinconsistent to aggregate the subsidiary’s net assets with those of the parent because most of the parent’s assets are carried at historical cost.

Required: Comment on the assistant’s observation and explain why the net assets of acquiredsubsidiaries are consolidated at acquisition at their fair values. (5 marks)

(25 marks)

71 Pacemaker

Below are the summarised statements of financial position for three companies as at 31March 2012:

Pacemaker Syclop Vardine $

million $

million $

million $

million $

million $

million AssetsNon-current assetsProperty, plant andequipment 520 280 240

Investments 345 40 nil–––––– –––– ––––

865 320 240





Pacemaker Syclop Vardine $

million $

million $

million $

million $

million $

million Current assetsInventory 142 160 120

Trade receivables 95 88 50Cash and bank 8 245 22 270 10 180

–––– –––––– –––– –––– –––– ––––Total assets 1,110 590 420

–––––– –––– ––––Equity and liabilitiesEquity shares of $1each 500 145 100Share premium 100 nil nilRetained earnings 130 230 260 260 240 240

–––– –––––– –––– –––– –––– ––––730 405 340

Non-current liabilities

10% loan notes 180 20 nilCurrent liabilities 200 165 80–––––– –––– ––––

Total equity andliabilities 1,110 590 420

–––––– –––– ––––Notes:Pacemaker is a public listed company that acquired the following investments:(i) Investment in Syclop

On 1 April 2010 Pacemaker acquired 116 million shares in Syclop for animmediate cash payment of $210 million and issued at par one 10% $100 loannote for every 200 shares acquired. Syclop’s retained earnings at the date of

acquisition were $120 million.(ii) Investment in Vardine

On 1 October 2011 Pacemaker acquired 30 million shares in Vardine in exchangefor 75 million of its own shares. The stock market value of Pacemaker’s shares atthe date of this share exchange was $1·60 each.Pacemaker has not yet recorded the investment in Vardine.

(iii) Pacemaker’s other investments, and those of Syclop, are equity investmentswhich are carried at their fair values as at 31 March 2011. The fair value of theseinvestments at 31 March 2012 is $82 million and $37 million respectively. Each ofthese investments is no bigger than a 10% holding.

Other relevant information:(iv) Pacemaker’s policy is to value non-controlling interests at their fair values. The

directors of Pacemaker assessed the fair value of the non-controlling interest inSyclop at the date of acquisition to be $65 million.There has been no impairment to goodwill or the value of the investment inVardine.

(v) At the date of acquisition of Syclop owned a recently built property that wascarried at its (depreciated) construction cost of $62 million. The fair value of thisproperty at the date of acquisition was $82 million and it had an estimatedremaining life of 20 years.

For many years Syclop has been selling some of its products under the brandname of ‘Kyklop’. At the date of acquisition the directors of Pacemaker valued





this brand at $25 million with a remaining life of 10 years. The brand is notincluded in Syclop’s statement of financial position.The fair value of all other identifiable assets and liabilities of Syclop were equalto their carrying values at the date of its acquisition.

(vi) The inventory of Syclop at 31 March 2012 includes goods supplied by Pacemakerfor $56 million (at selling price from Pacemaker). Pacemaker adds a mark-up of40% on cost when selling goods to Syclop. There are no intra-group receivablesor payables at 31 March 2012.

(vii) Vardine’s profit is subject to seasonal variation. Its profit for the year ended 31March 2012 was $100 million.$20 million of this profit was made from 1 April 2011 to 30 September 2011.

(viii) None of the companies have paid any dividends for many years.Required:

Prepare the consolidated statement of financial position of Pacemaker as at 31 March

2012.(Total: 25 marks)

72 Picant

On 1 April 2009 Picant acquired 75% of Sander ’s equity shares in a share exchange ofthree shares in Picant for every two shares in Sander. The market prices of Picant ’s andSander ’s shares at the date of acquisition were $3 ·20 and $4 ·50 respectively.In addition to this Picant agreed to pay a further amount on 1 April 2010 that wascontingent upon the post-acquisition performance of Sander. At the date of acquisitionPicant assessed the fair value of this contingent consideration at $4 ·2 million, but by 31March 2010 it was clear that the actual amount to be paid would be only $2 ·7 million

(ignore discounting). Picant has recorded the share exchange and provided for theinitial estimate of $4 ·2 million for the contingent consideration.On 1 October 2009 Picant also acquired 40% of the equity shares of Adler paying $4 incash per acquired share and issuing at par one $100 7% loan note for every 50 sharesacquired in Adler. This consideration has also been recorded by Picant.Picant has no other investments.The summarised statements of financial position of the three companies at 31 March2010 are:

Picant Sander Adler$’000 $’000 $’000

AssetsNon-current assetsProperty, plant and equipment 37,500 24,500 21,000Investments 45,000 nil nil

––––––– ––––––– ––––––– 82,500 24,500 21,000

Current assetsInventory 10,000 9,000 5,000Trade receivables 6,500 1,500 3,000

––––––– ––––––– ––––––– Total assets 99,000 35,000 29,000

––––––– ––––––– –––––––





Picant Sander Adler$’000 $’000 $’000

Equity and liabilitiesEquityEquity shares of $1 each 25,000 8,000 5,000

Share premium 19,800 nil nilRetained earnings – at 1 April 2009 16,200 16,500 15,000– for the year ended 31 March 2010 11,000 1,000 6,000

––––––– ––––––– ––––––– 72,000 25,500 26,000

Non-current liabilities7% loan notes 14,500 2,000 nilCurrent liabilitiesContingent consideration 4,200 nil nilOther current liabilities 8,300 7,500 3,000

––––––– ––––––– ––––––– Total equity and liabilities 99,000 35,000 29,000

––––––– ––––––– ––––––– The following information is relevant:(i) At the date of acquisition the fair values of Sander ’s property, plant and

equipment was equal to its carrying amount with the exception of Sander ’sfactory which had a fair value of $2 million above its carrying amount. Sanderhas not adjusted the carrying amount of the factory as a result of the fair valueexercise. This requires additional annual depreciation of $100,000 in theconsolidated financial statements in the post-acquisition period.Also at the date of acquisition, Sander had an intangible asset of $500,000 forsoftware in its statement of financial position. Picant ’s directors believed thesoftware to have no recoverable value at the date of acquisition and Sander wrote

it off shortly after its acquisition.(ii) At 31 March 2010 Picant ’s current account with Sander was $3 ·4 million (debit).

This did not agree with the equivalent balance in Sander ’s books due to somegoods-in-transit invoiced at $1 ·8 million that were sent by Picant on 28 March2010, but had not been received by Sander until after the year end. Picant sold allthese goods at cost plus 50%.

(iii) Picant ’s policy is to value the non-controlling interest at fair value at the date ofacquisition. For this purpose Sander ’s share price at that date can be deemed to be representative of the fair value of the shares held by the non-controllinginterest.

(iv) Impairment tests were carried out on 31 March 2010 which concluded that thevalue of the investment in Adler was not impaired but, due to poor tradingperformance, consolidated goodwill was impaired by $3 ·8 million.

(v) Assume all profits accrue evenly through the year.Required:

(a) Prepare the consolidated statement of financial position for Picant as at 31 March2010. (21 marks)

(b) Picant has been approached by a potential new customer, Trilby, to supply itwith a substantial quantity of goods on three months credit terms. Picant isconcerned at the risk that such a large order represents in the current difficulteconomic climate, especially as Picant ’s normal credit terms are only one month ’scredit. To support its application for credit, Trilby has sent Picant a copy of





Tradhat ’s most recent audited consolidated financial statements. Trilby is awholly-owned subsidiary within the Tradhat group. Tradhat ’s consolidatedfinancial statements show a strong statement of financial position includinghealthy liquidity ratios.Required:

Comment on the importance that Picant should attach to Tradhat ’s consolidatedfinancial statements when deciding on whether to grant credit terms to Trilby.

(4 marks)

(Total: 25 marks)

Business combinations – Statements of financialperformance

73 Hydan

On 1 October 2011 Hydan, a publicly listed company, acquired a 60% controllinginterest in Systan paying $9 per share in cash. Prior to the acquisition Hydan had beenexperiencing difficulties with the supply of components that it used in itsmanufacturing process. Systan is one of Hydan’s main suppliers and the acquisitionwas motivated by the need to secure supplies. In order to finance an increase in theproduction capacity of Systan, Hydan made a non-dated loan at the date of acquisitionof $4 million to Systan that carried an actual and effective interest rate of 10% perannum. The interest to 31 March 2012 on this loan has been paid by Systan andaccounted for by both companies. The summarised draft financial statements of thecompanies are:

Income statements for the year ended 31 March 2012Hydan Systan

Pre-acquisition

Post-acquisition

$000 $000 $000Revenue 98,000 24,000 35,200Cost of sales (76,000) (18,000) (31,000)

――――― ――――― ――――― Gross profit 22,000 6,000 4,200

Operating expenses (11,800) (1,200) (8,000)Interest income 350 nil nilFinance costs (420) nil (200)

――――― ――――― ――――― Profit/(loss) before tax 10,130 4,800 (4,000)Income tax (expense)/relief (4,200) (1,200) 1,000

――――― ――――― ――――― Profit/(loss) for the period 5,930 3,600 (3,000)

――――― ――――― ―――――





Statements of financial position as at 31 March 2012

Hydan Systan$000 $000

Non-current assets

Property, plant and equipment 18,400 9,500Investments (including loan to Systan) 16,000 nil――――― ――――― 34,400 9,500

Current assets 18,000 7,200――――― ――――― Total assets 52,400 16,700――――― ――――― Equity and liabilitiesOrdinary shares of $1 each 10,000 2,000Share premium 5,000 500Retained earnings 20,000 6,300

――――― ――――― 35,000 8,800Non-current liabilities7% Bank loan 6,000 nil10% loan from Hydan nil 4,000Current liabilities 11,400 3,900――――― ――――― Total equity and liabilities 52,400 16,700――――― ―――――


(i) At the date of acquisition, the fair values of Systan’s property, plant andequipment were $1.2 million in excess of their carrying amounts. This will havethe effect of creating an additional depreciation charge (to cost of sales) of$300,000 in the consolidated financial statements for the year ended 31 March2012. Systan has not adjusted its assets to fair value.

(ii) In the post acquisition period Systan’s sales to Hydan were $30 million on whichSystan had made a consistent profit of 5% of the selling price. Of these goods, $4million (at selling price to Hydan) were still in the inventory of Hydan at 31March 2012. Prior to its acquisition Systan made all its sales at a uniform grossprofit margin.

(iii) Included in Hydan’s current liabilities is $1 million owing to Systan. This agreedwith Systan’s receivables ledger balance for Hydan at the year end.

(iv) An impairment review of the consolidated goodwill at 31 March 2012 revealedthat its current value was 12.5% less than its carrying amount.

(v) Neither company paid a dividend in the year to 31 March 2012.

Required:

(a) Prepare the consolidated income statement for the year ended 31 March 2012 andthe consolidated balance sheet at that date. (20 marks)

(b) Discuss the effect that the acquisition of Systan appears to have had on Systan’soperating performance. (5 marks)

(Total: 25 marks)





74 Holdrite, Staybrite and Allbrite

Holdrite purchased 75% of the issued share capital of Staybrite and 40% of the issuedshare capital of Allbrite on 1 April 2012.Details of the purchase consideration given at the date of purchase are:

Staybrite: A share exchange of 2 shares in Holdrite for every 3 shares in Staybriteplus an issue to the shareholders of Staybrite of 8% loan notesredeemable at par on 30 June 2014 on the basis of $100 loan note forevery 250 shares held in Staybrite.

Allbrite: A share exchange of 3 shares in Holdrite for every 4 shares in Allbriteplus $1 per share acquired in cash.

The market price of Holdrite ’s shares at 1 April 2012 was $6 per share.The summarised income statements for the three companies for the year to 30September 2012 are:

Holdrite Staybrite Allbrite

$000 $000 $000Revenue 75,000 40,700 31,000Cost of sales (47,400) (19,700) (15,300)

–––––––– –––––––– ––––––––Gross profit 27,600 21,000 15,700Operating expenses (10,480) (9,000) (9,700)

–––––––– –––––––– ––––––––Operating profit 17,120 12,000 6,000Finance cost (170) – –

–––––––– –––––––– ––––––––Profit before tax 16,950 12,000 6,000Income tax expense (4,800) (3,000) (2,000)

–––––––– –––––––– ––––––––Profit for period 12,150 9,000 4,000

–––––––– –––––––– ––––––––The following information is relevant:(i) A fair value exercise was carried out for Staybrite at the date of its acquisition

with the following results:

Book value Fair value

$000 $000Land 20,000 23,000Plant 25,000 30,000The fair values have not been reflected in Staybrite ’s financial statements. Theincrease in the fair value of the plant would create additional depreciation of$500,000 in the post acquisition period in the consolidated financial statements to30 September 2012.Depreciation of plant is charged to cost of sales.





(ii) The details of each company ’s share capital and reserves at 1 October 2011 are:

Holdrite Staybrite Allbrite

$000 $000 $000Equity shares of $1 each 20,000 10,000 5,000

Share premium 5,000 4,000 2,000Retained profits 18,000 7,500 6,000

(iii) In the post acquisition period Holdrite sold goods to Staybrite for $10 million.Holdrite made a profit of $4 million on these sales. One-quarter of these goodswere still in the inventory of Staybrite at 30 September 2012.

(iv) Impairment tests on the goodwill of Staybrite at 30 September 2012 resulted inthe need to write down Staybrite ’s goodwill by $750,000. Non-controllinginterests are valued at their proportionate share of net assets.

(v) Holdrite paid a dividend of $5 million on 20 September 2012.

Required: (a) Calculate the goodwill arising on the purchase of the shares in both Staybrite and

Allbrite at 1 April 2012. (8 marks)

(b) Prepare a consolidated income statement for the Holdrite Group for the year to30 September 2012. (15 marks)

(c) Show the movement on the consolidated retained profits attributable to Holdritefor the year to 30 September 2012. (2 marks)

(Total: 25 marks)

Note: The additional disclosures in IFRS 3 Business Combinations relating to a newlyacquired subsidiary are not required.

75 Python, Snake and Adder

On 1 October 2011, Python acquired 24 million of the 32 million issued equity shares of Snake. The purchase consideration was two shares in Python for every three shares in

Snake. The market price of Python’s shares at 1 October 2011 was $4.80 per share. In

addition, Python will make a cash payment of $1.21 for each share in Snake that it has

acquired: this is payable on 30 September 2013, two years after the acquisition.

Python’s cost of capital is 10%. The reserves of Snake at 1 July 2011 were $67 million.

The shares of Python and of Snake have a nominal value of $1 each.

Python has held an investment of 25% of the shares of Adder for many years.

The summarised income statements of the three companies for the year ended 30 June

2012 are as follows.

Income statements Python Snake Adder

$000 $000 $000

Revenue 160,000 72,000 72,000Cost of sales (99,000) (42,000) (50,000)Gross profit 61,000 30,000 22,000

Distribution costs (7,900) (4,000) (5,000)Administrative expenses (13,200) (6,000) (7,000)





Income statements Python Snake Adder

$000 $000 $000

Finance costs (see note 2) (2,500) (1,000) nilProfit before tax 37,400 19,000 10,000

Income tax expense (12,300) (2,600) (2,000)Profit for the period 25,100 16,400 8,000


(1) The carrying amounts of the assets and liabilities of Snake at the date ofacquisition were equal to their fair values, with the exception of some propertyand plant. Property had a fair value $2.5 million in excess of its carrying value,and the plant had a fair value $2.4 million in excess of carrying value. The fairvalues are not reflected in the financial statements of Snake.

The plant had a remaining useful life of four years from the date of acquisitionand is depreciated by the straight line method. The increase in the fair value ofthe property creates additional depreciation of $50,000 for the post-acquisitionperiod to 30 June 2012.All depreciation should be treated as part of the cost of sales.No fair value adjustments were required on the acquisition of Adder.

(2) The finance costs in the income statement of Python do not include the financecost of the deferred consideration.

(3) Python’s accounting policy is to value non-controlling interests at aproportionate share of the identifiable net assets of the subsidiary.

(4) Snake has been a regular buyer of goods from Python, both before and after theacquisition. Throughout the year to 30 June 2012, Snake purchased goods at aprice of $1 million per month. Python makes a profit of 25% on cost on thesesales. At 30 June 2012, Snake held $2 million (at cost to Snake) in inventory ofgoods purchased from Python in the post-acquisition period.

(5) A test for impairment on 30 June 2012 found that goodwill should be writtendown by $1.5 million.

(6) It should be assumed that all items in the income statement accrue at an even ratethrough the year. Deferred tax should be ignored.

Required

(a) Calculate the goodwill arising on the acquisition of Snake on 1 October 2011.(6 marks)

(b) Prepare the consolidated income statement of Python for the year ended 30 June2012. You should assume that the investment in Adder has been accounted for bythe equity method since the investment was originally acquired. (15 marks)

(c) Until 30 June 2012, the other equity shares in Adder (75%) were held by a largenumber of investors, but shortly after this date, 70% of the shares in Adder wereacquired by a single investor, Mamba Company. A director of Python, who had been serving as a director of Adder, resigned from his position on the Adder board of directors.





Explain how the accounting treatment of the investment in Adder would beaffected for the year ended 30 June 2013 by this event. (4 marks)

(Total: 25 marks)

76 Hosterling

Hosterling purchased the following equity investments:On 1 October 2011: 80% of the issued share capital of Sunlee. The acquisition wasthrough a share exchange of three shares in Hosterling for every five shares inSunlee. The market price of Hosterling ’s shares at 1 October 2011 was $5 pershare.On 1 July 2012: 6 million shares in Amber paying $3 per share in cash and issuingto Amber ’s shareholders 6% (actual and effective rate) loan notes on the basis of$100 loan note for every 100 shares acquired.

The summarised income statements for the three companies for the year ended 30

September 2012 are:Hosterling Sunlee Amber

$’000 $’000 $’000Revenue 105,000 62,000 50,000Cost of sales (68,000) (36,500) (61,000)

–––––––– –––––––– ––––––––Gross profit/(loss) 37,000 25,500 (11,000)Other income (note (i)) 400 nil nilDistribution costs (4,000) (2,000) (4,500)Administrative expenses (7,500) (7,000) (8,500)Finance costs (1,200) (900) nil

–––––––– –––––––– ––––––––Profit/(loss) before tax 24,700 15,600 (24,000)Income tax (expense)/credit (8,700) (2,600) 4,000

–––––––– –––––––– ––––––––Profit/(loss) for the period 16,000 13,000 (20,000)

–––––––– –––––––– ––––––––The following information is relevant:(i) The other income is a dividend received from Sunlee on 31 March 2012.(ii) The details of Sunlee ’s and Amber ’s share capital and reserves at 1 October 2011

were:Sunlee Amber

$’000 $’000Equity shares of $1 each 20,000 15,000Retained earnings 18,000 35,000

(iii) A fair value exercise was carried out at the date of acquisition of Sunlee with thefollowing results:

carryingamount

fairvalue

remaining life(straight line)

$’000 $’000Intellectual property 18,000 22,000 still in developmentLand 17,000 20,000 not applicable

Plant 30,000 35,000 five years





The fair values have not been reflected in Sunlee ’s financial statements.Plant depreciation is included in cost of sales.No fair value adjustments were required on the acquisition of Amber.

(iv) In the year ended 30 September 2012 Hosterling sold goods to Sunlee at a selling

price of $18 million. Hosterling made a profit of cost plus 25% on these sales. $7 ·5million (at cost to Sunlee) of these goods were still in the inventories of Sunlee at30 September 2012.

(v) Impairment tests for both Sunlee and Amber were conducted on 30 September2012. They concluded that the goodwill of Sunlee should be written down by $1 ·6million and, due to its losses since acquisition, the investment in Amber wasworth $21 ·5 million.

(vi) All trading profits and losses are deemed to accrue evenly throughout the year.

Required:

(a) Calculate the goodwill arising on the acquisition of Sunlee at 1 October 2011.(5 marks)

(b) Calculate the carrying amount of the investment in Amber at 30 September 2012under the equity method prior to the impairment test. (4 marks)

(c) Prepare the consolidated income statement for the Hosterling Group for the yearended 30 September 2012. (16 marks)

(Total: 25 marks)

77 Patronic

On 1 August 2010 Patronic purchased 18 million of a total of 24 million equity shares inSardonic. The acquisition was through a share exchange of two shares in Patronic forevery three shares in Sardonic. Both companies have shares with a par value of $1each. The market price of Patronic’s shares at 1 August 2010 was $5·75 per share.Patronic will also pay in cash on 31 July 2012 (two years after acquisition) $2·42 peracquired share of Sardonic. Patronic’s cost of capital is 10% per annum. The reserves ofSardonic on 1 April 2010 were $69 million.Patronic has held an investment of 30% of the equity shares in Acerbic for many years.The summarised income statements for the three companies for the year ended 31March 2011 are:

Patronic Sardonic Acerbic $’000 $’000 $’000 Revenue 150,000 78,000 80,000Cost of sales (94,000) (51,000) (60,000)

–––––––– ––––––– –––––––Gross profit 56,000 27,000 20,000Distribution costs (7,400) (3,000) (3,500)Administrative expenses (12,500) (6,000) (6,500)Finance costs (note (ii)) (2,000) (900) nil

–––––––– ––––––– –––––––Profit before tax 34,100 17,100 10,000Income tax expense (10,400) (3,600) (4,000)

–––––––– ––––––– –––––––Profit for the period 23,700 13,500 6,000–––––––– ––––––– –––––––






(i) The fair values of the net assets of Sardonic at the date of acquisition were equalto their carrying amounts with the exception of property and plant. Property andplant had fair values of $4·1 million and $2·4 million respectively in excess oftheir carrying amounts. The increase in the fair value of the property wouldcreate additional depreciation of $200,000 in the consolidated financial statementsin the post acquisition period to 31 March 2011 and the plant had a remaining lifeof four years (straight-line depreciation) at the date of acquisition of Sardonic. Alldepreciation is treated as part of cost of sales.The fair values have not been reflected in Sardonic ’s financial statements.No fair value adjustments were required on the acquisition of Acerbic.

(ii) The finance costs of Patronic do not include the finance cost on the deferredconsideration.

(iii) Prior to its acquisition, Sardonic had been a good customer of Patronic. In theyear to 31 March 2011, Patronic sold goods at a selling price of $1·25 million permonth to Sardonic both before and after its acquisition. Patronic made a profit of20% on the cost of these sales. At 31 March 2011 Sardonic still held inventory of$3 million (at cost to Sardonic) of goods purchased in the post acquisition periodfrom Patronic.

(iv) An impairment test on the goodwill of Sardonic conducted on 31 March 2011concluded that it should be written down by $2 million. The value of theinvestment in Acerbic was not impaired.

(v) All items in the above income statements are deemed to accrue evenly over theyear.

(vi) Ignore deferred tax.Required: (a) Calculate the goodwill arising on the acquisition of Sardonic at 1 August 2010.

(6 marks)

(b) Prepare the consolidated income statement for the Patronic Group for the yearended 31 March 2011.Note: assume that the investment in Acerbic has been accounted for using theequity method since its acquisition. (15 marks)

(c) At 31 March 2011 the other equity shares (70%) in Acerbic were owned by manyseparate investors. Shortly after this date Spekulate (a company unrelated to

Patronic) accumulated a 60% interest in Acerbic by buying shares from the othershareholders. In May 2011 a meeting of the board of directors of Acerbic washeld at which Patronic lost its seat on Acerbic’s board.Required: Explain, with reasons, the accounting treatment Patronic should adopt for itsinvestment in Acerbic when it prepares its financial statements for the yearending 31 March 2012. (4 marks)

(Total: 25 marks)

78 Pandar

On 1 April 2012 Pandar purchased 80% of the equity shares in Salva. The acquisitionwas through a share exchange of three shares in Pandar for every five shares in Salva.





(iii) Pandar has credited the whole of the dividend it received from Salva toinvestment income.

(iv) After the acquisition, Pandar sold goods to Salva for $15 million on which Pandarmade a gross profit of 20%. Salva had one third of these goods still in itsinventory at 30 September 2012. There are no intra-group current account balances at 30 September 2012.

(v) The non-controlling interest in Salva is to be valued at its (full) fair value at thedate of acquisition. For this purpose Salva’s share price at that date can be takento be indicative of the fair value of the shareholding of the non-controllinginterest.

(vi) The goodwill of Salva has not suffered any impairment; however, due to itslosses, the value of Pandar’s investment in Ambra has been impaired by $3million at 30 September 2012.

(vii) All items in the above income statements are deemed to accrue evenly over theyear unless otherwise indicated.

Required:

(a) (i) Calculate the goodwill arising on the acquisition of Salva at 1 April 2012;(6 marks)

(ii) Calculate the carrying amount of the investment in Ambra to be includedwithin the consolidated statement of financial position as at 30 September2012. (3 marks)

(b) Prepare the consolidated income statement for the Pandar Group for the yearended 30 September 2012. (16 marks)

(Total: 25 marks)

79 Premier

On 1 June 2010, Premier acquired 80% of the equity share capital of Sanford. Theconsideration consisted of two elements: a share exchange of three shares in Premierfor every five acquired shares in Sanford and the issue of a $100 6% loan note for every500 shares acquired in Sanford. The share issue has not yet been recorded by Premier, but the issue of the loan notes has been recorded. At the date of acquisition shares inPremier had a market value of $5 each and the shares of Sanford had a stock marketprice of $3 ·50 each. Below are the summarised draft financial statements of bothcompanies.

Statements of comprehensive income for the year ended 30 September 2010Premier Sanford

$’000 $’000Revenue 92,500 45,000Cost of sales (70,500) (36,000)

––––––– ––––––– Gross profit 22,000 9,000Distribution costs (2,500) (1,200)Administrative expenses (5,500) (2,400)Finance costs (100) nil

––––––– ––––––– Profit before tax 13,900 5,400

Income tax expense (3,900) (1,500)––––––– ––––––– Profit for the year 10,000 3,900





Premier Sanford$’000 $’000

Other comprehensive income:Gain on revaluation of land (note (i)) 500 nil

––––––– ––––––– Total comprehensive income 10,500 3,900

––––––– ––––––– Statements of financial position as at 30 September 2010AssetsNon-current assetsProperty, plant and equipment 25,500 13,900Investments 1,800 nil

––––––– ––––––– 27,300 13,900

Current assets 12,500 2,400––––––– –––––––

Total assets 39,800 16,300––––––– –––––––

Equity and liabilitiesEquityEquity shares of $1 each 12,000 5,000Land revaluation reserve – 30 September 2010 (note (i)) 2,000 nilOther equity reserve – 30 September 2009 (note (iv)) 500 nilRetained earnings 12,300 4,500

––––––– ––––––– 26,800 9,500

Non-current liabilities6% loan notes 3,000 nilCurrent liabilities 10,000 6,800

––––––– ––––––– Total equity and liabilities 39,800 16,300

––––––– ––––––– The following information is relevant:(i) At the date of acquisition, the fair values of Sanford ’s assets were equal to their

carrying amounts with the exception of its property. This had a fair value of $1.2million below its carrying amount. This would lead to a reduction of thedepreciation charge (in cost of sales) of $50,000 in the post-acquisition period.Sanford has not incorporated this value change into its entity financialstatements.Premier ’s group policy is to revalue all properties to current value at each yearend. On 30 September 2010, the value of Sanford ’s property was unchanged fromits value at acquisition, but the land element of Premier ’s property had increasedin value by $500,000 as shown in other comprehensive income.

(ii) Sales from Sanford to Premier throughout the year ended 30 September 2010 hadconsistently been $1 million per month. Sanford made a mark-up on cost of 25%on these sales. Premier had $2 million (at cost to Premier) of inventory that had been supplied in the post-acquisition period by Sanford as at 30 September 2010.

(iii) Premier had a trade payable balance owing to Sanford of $350,000 as at 30September 2010. This agreed with the corresponding receivable in Sanford ’s books.

(iv) Premier ’s investments include some available-for-sale investments that haveincreased in value by $300,000 during the year. The other equity reserve relates tothese investments and is based on their value as at 30 September 2009. There





were no acquisitions or disposals of any of these investments during the yearended 30 September 2010.

(v) Premier ’s policy is to value the non-controlling interest at fair value at the date ofacquisition. For this purpose Sanford ’s share price at that date can be deemed to be representative of the fair value of the shares held by the non-controllinginterest.

(vi) There has been no impairment of consolidated goodwill.Required:

(a) Prepare the consolidated statement of comprehensive income for Premier for theyear ended 30 September 2010.

(b) Prepare the consolidated statement of financial position for Premier as at 30September 2010.

The following mark allocation is provided as guidance for this question:(a) 9 marks

(b) 16 marks (25 marks)

Business combinations – Statements of financial positionand performance

80 Hepburn

(a) On 1 October 2011 Hepburn acquired 80% of the equity share capital of Salter byway of a share exchange. Hepburn issued five of its own shares for every twoshares it acquired in Salter. The market value of Hepburn ’s shares on 1 October2011 was $3 each. The share issue has not yet been recorded in Hepburn ’s books.The summarised financial statements of both companies are:Income statements: Year to 31 March 2012

Hepburn Salter$000 $000

Revenue 1,200 1,000Cost of sales (650) (660)Gross profit 550 340Operating expenses (120) (88)

Financial costs nil (12)Profit before tax 430 240Income tax expense (100) (40)Profit for the period 330 200

Statements of financial position: as at 31 March 2012

Hepburn Salter

Non-current assetsProperty, plant andequipment

620 660

Investments 20 10640 670





Hepburn SalterCurrent assetsInventory 240 280Accounts receivable 170 210Bank 20 40

430 530Total assets 1,070 1,200

Equity and liabilitiesEquity shares of $1 each 400 150Retained earnings 410 700

810 850Non-current liabilities8% Debentures nil 150Current liabilitiesTrade accounts payable 210 155Taxation 50 45

260 200Total equity and liabilities 1,070 1,200The following information is relevant:(i) The fair values of Salter ’s assets were equal to their carrying values (book

values) with the exception of its land, which had fair value of $125,000 inexcess of its carrying value at the date of acquisition.

(ii) In the post acquisition period Hepburn sold goods to Salter at a price of$100,000, this was calculated to give a mark-up on cost of 25% to Hepburn.Salter had half of these goods in inventory at the year end.

(iii) Consolidated goodwill is to be written off as an operating expense. Animpairment test at 31 March 2012 on the consolidated goodwill concludedthat it should be written down by $20,000. No other assets were impaired.

(iv) The current accounts of the two companies disagreed due to a cashremittance of $20,000 to Hepburn on 26 March 2012 not being receiveduntil after the year end. Before adjusting for this, Salter ’s debit balance inHepburn ’s books was $56,000.

Required: Prepare a consolidated income statement and consolidated statement of financial

position for Hepburn for the year to 31 March 2012. (20 marks)(b) At the same date as Hepburn made the share exchange for Salter ’s shares, it also

acquired 6,000 ‘A’ shares in Woodbridge for a cash payment of $20,000. Theshare capital of Woodbridge is made up of:

Equity voting A shares 10,000Equity non-voting B shares 14,000

All of Woodbridge ’s equity shares are entitled to the same dividend rights;however during the year to 31 March 2012 Woodbridge made substantial lossesand did not pay any dividends.Hepburn has treated its investment in Woodbridge as an ordinary long-terminvestment on the basis that:





it is only entitled to 25% of any dividends that Woodbridge may pay

it does not any have directors on the Board of Woodbridge; and

it does not exert any influence over the operating policies or management

of Woodbridge.

Required: Comment on the accounting treatment of Woodbridge by Hepburn ’s directorsand state how you believe the investment should be accounted for. (5 marks)

Note: You are not required to amend your answer to part (a) in respect of theinformation in part (b). (Total: 25 marks)

81 Hydrate

Hydrate is a public company operating in the industrial chemical sector. In order toachieve economies of scale, it has been advised to enter into business combinations

with compatible partner companies. As a first step in this strategy Hydrate acquired80% of the ordinary share capital of Sulphate by way of a share exchange on 1 April2012. Hydrate issued five of its own shares for every four shares in Sulphate. Themarket value of Hydrate ’s shares on 1 April 2012 was $6 each. The share issue has notyet been recorded in Hydrate ’s books. The summarised financial statements of bothcompanies for the year to 30 September 2012 are:

Income statement – year to 30 September 2012

Hydrate Sulphate$000 $000

Revenue 24,000 20,000Cost of sales (16,600) (11,800)Gross profit 7,400 8,200Operating expenses (1,600) (1,000)Profit before tax 5,800 7,200Taxation (2,000) (3,000)Profit after tax 3,800 4,200

Statement of financial position as at 30 September 2012

Hydrate SulphateNon-current assets $000 $000 $000 $000Property, plant and equipment 64,000 35,000Investment nil 12,800

64,000 47,800Current assetsInventory 22,800 23,600Accounts receivable 16,400 24,200Bank 500 200

39,700 48,000Total assets 103,700 95,800





Income statements: Year to 31 March 2012

Hillusion Skeptik$000 $000

Revenue 60,000 24,000

Cost of sales (42,000) (20,000)Gross profit 18,000 4,000Operating expenses (6,000) (200)Loan interest received (paid) 75 (200)Profit before tax 12,075 3,600Taxation (3,000) (600)Profit for the year 9,075 3,000Retained earnings brought forward 16,525 5,400Retained earnings per balance sheet 25,600 8,400

Statements of financial position: as at 31 March 2012

Hillusion Skeptik$000 $000

Tangible non-current assets 19,320 8,000Investments 11,280 nil―――― ――――

30,600 8,000Current assets 15,000 8,000Total assets 45,600 16,000Equity and liabilitiesOrdinary shares of $1 each 10,000 2,000Retained earnings 25,600 8,400―――― ――――

35,600 10,400Non-current liabilities10% loan notes nil 2,000Current liabilities 10,000 3,600―――― ――――

45,600 16,000―――― ―――― The following information is relevant:(i) The fair values of Skeptik assets were equal to their carrying values (book values)

with the exception of its plant, which had a fair value of $3.2 million in excess ofits carrying value at the date of acquisition. The remaining life of all of Skeptik ’splant at the date of its acquisition was four years and this period has not changedas a result of the acquisition. Depreciation of plant is on a straight-line basis andcharged to cost of sales. Skeptik has not adjusted the value of its plant as a resultof the fair value exercise.

(ii) In the post acquisition period Hillusion sold goods to Skeptik at a price of $12million. These goods had cost Hillusion $9 million. During the year Skeptik hadsold $10 million (at cost to Skeptik) of these goods for $15 million.





(iii) Hillusion bears almost all of the administration costs incurred on behalf of thegroup (invoicing, credit control, etc). It does not charge Skeptik for this service asto do so would not have a material effect on the group profit.

(iv) Revenues and profits should be deemed to accrue evenly throughout the year.(v) The current accounts of the two companies were reconciled at the year-end with

Skeptik owing Hillusion $750,000.(vi) It is the accounting policy of Hillusion that the non-controlling interests in its

subsidiary should be valued at a proportionate share of net assets.(vii) An impairment test at 31 March 2012 on the consolidated goodwill concluded

that it should be written down by $300,000 and treated as an operating expense.No other assets were impaired.

Required: (a) Prepare a consolidated income statement and consolidated statement of financial

position for Hillusion for the year to 31 March 2012. (20 marks)

(b) Explain why it is necessary to eliminate unrealised profits when preparing groupfinancial statements; and how reliance on the entity financial statements ofSkeptik may mislead a potential purchaser of the company. (5 marks)

(Total: 25 marks)

Note: Your answer should refer to the circumstances described in the question.

83 Pedantic

On 1 April 2012, Pedantic acquired 60% of the equity share capital of Sophistic in ashare exchange of two shares in Pedantic for three shares in Sophistic. The issue ofshares has not yet been recorded by Pedantic. At the date of acquisition shares in

Pedantic had a market value of $6 each. Below are the summarised draft financialstatements of both companies.Income statements for the year ended 30 September 2012

Pedantic$’000

Sophistic$’000


–––––––– ––––––––Gross profit 22,000 10,000Distribution costs (2,000) (2,000)Administrative expenses (6,000) (3,200)Finance costs (300) (400)–––––––– ––––––––Profit before tax 13,700 4,400Income tax expense (4,700) (1,400)

–––––––– ––––––––Profit for the year 9,000 3,000

–––––––– ––––––––Statements of financial position as at 30 September 2012AssetsNon-current assetsProperty, plant and equipment 40,600 12,600Current assets 16,000 6,600

–––––––– ––––––––Total assets 56,600 19,200–––––––– ––––––––





Pedantic$’000

Sophistic$’000

Equity and liabilitiesEquity shares of $1 each 10,000 4,000Retained earnings 35,400 6,500

–––––––– ––––––––45,400 10,500Non-current liabilities10% loan notes 3,000 4,000Current liabilities 8,200 4,700

–––––––– ––––––––Total equity and liabilities 56,600 19,200

–––––––– ––––––––The following information is relevant:(i) At the date of acquisition, the fair values of Sophistic ’s assets were equal to their

carrying amounts with the exception of an item of plant, which had a fair valueof $2 million in excess of its carrying amount. It had a remaining life of five years

at that date [straight-line depreciation is used]. Sophistic has not adjusted thecarrying amount of its plant as a result of the fair value exercise.(ii) Sales from Sophistic to Pedantic in the post acquisition period were $8 million.

Sophistic made a mark up on cost of 40% on these sales. Pedantic had sold $5 ·2million (at cost to Pedantic) of these goods by 30 September 2012.

(iii) Other than where indicated, income statement items are deemed to accrue evenlyon a time basis.

(iv) Sophistic ’s trade receivables at 30 September 2012 include $600,000 due fromPedantic which did not agree with Pedantic ’s corresponding trade payable. Thiswas due to cash in transit of $200,000 from Pedantic to Sophistic. Both companies

have positive bank balances.(v) Pedantic has a policy of accounting for any non-controlling interest at fair value.

For this purpose the fair value of the goodwill attributable to the non-controllinginterest in Sophistic is $1 ·5 million. Consolidated goodwill was not impaired at30 September 2012.

Required: (a) Prepare the consolidated income statement for Pedantic for the year ended 30

September 2012. (9 marks) (b) Prepare the consolidated statement of financial position for Pedantic as at 30

September 2012. (16 marks)

Note: a statement of changes in equity is not required. (Total: 25 marks)






84 Comparator

Comparator assembles computer equipment from bought in components anddistributes them to various wholesalers and retailers. It has recently subscribed to aninterfirm comparison service. Members submit accounting ratios as specified by theoperator of the service, and in return, members receive the average figures for each ofthe specified ratios taken from all of the companies in the same sector that subscribe tothe service. The specified ratios and the average figures for Comparator ’s sector areshown below.Ratios of companies reporting a full year ’s results for periods ending between 1 July2012 and 30 September 2012

Return on capital employed 22.1%Net assets turnover 1.8 times

Gross profit margin 30%Net profit (before tax) margin 12.5%Current ratio 1.6:1Quick ratio 0.9:1Inventory holding period 46 daysAccounts receivable collection period 45 daysAccounts payable payment period 55 daysDebt to equity 40%Dividend yield 6%Dividend cover 3 times

Comparator ’s financial statements for the year to 30 September 2012 are set out below:Income statement $000Revenue 2,425Cost of sales (1,870)Gross profit 555Other operating expenses (215)Profit from operations 340Finance costs (34)Exceptional item (note (ii)) (120)Profit before taxation 186Income tax (90)Profit for the period 96

$000Extracts of changes in equityRetained earnings – 1 October 2011 179Net profit for the period 96Dividends paid (interim $60,000; final $30,000) (90)Retained earnings – 30 September 2012 185





Statement of financial position $000 $000Non-current assets (note (i)) 540Current assetsInventory 275Accounts receivable 320Bank nil

5951,135

EquityOrdinary shares (25 cents each) 150Retained earnings 185

335Non-current liabilities8% loan notes 300Current liabilitiesBank overdraft 65Trade accounts payable 350Taxation 85

5001,135

Notes

(i) The details of the non-current assets are:Cost Accumulated

depreciationNet book

value$000 $000 $000

At 30 September 2007 3,600 3,060 540

(ii) The exceptional item relates to losses on the sale of a batch of computers that had become worthless due to improvements in microchip design.

(iii) The market price of Comparator ’s shares throughout the year averaged $6.00each.

Required: (a) Explain the problems that are inherent when ratios are used to assess a

company ’s financial performance.

Your answer should consider any additional problems that may be encounteredwhen using interfirm comparison services such as that used by Comparator.

(7 marks)

(b) Calculate the ratios for Comparator equivalent to those provided by the interfirmcomparison service. (6 marks)

(c) Write a report analysing the financial performance of Comparator based on acomparison with the sector averages. (12 marks)

(Total: 25 marks)





85 Rytetrend

Rytetrend is a retailer of electrical goods. Extracts from the company ’s financialstatements are set out below:Income statement for the year ended 31 March:

2012 2011$000 $000 $000 $000

Revenue 31,800 23,500Cost of sales (22,500) (16,000)Gross profit 9,300 7,500Other operating expenses (5,440) (4,600)Operating profit 3,860 2,900Interest payable – loan notes (260) (500)Interest payable – overdraft (200) nil

(460) (500)Profit before taxation 3,400 2,400Taxation (1,000) (800)Profit for the period 2,400 1,600

Statements of financial position as at 31 March:

2012 2011$000 $000 $000 $000

Non-current assets (note (i)) 24,500 17,300Current assetsInventory 2,650 3,270Receivables 1,100 1,950Bank nil 400

3,750 5,620Total assets 28,250 22,920

Equity and liabilitiesOrdinary capital ($1 shares) 11,500 10,000Share premium 1,500 nilRetained earnings 8,130 6,160

21,130 16,160Non-current liabilities10% loan notes nil 4,0006% loan notes 2,000 nilCurrent liabilitiesBank overdraft 1,050 nilTrade payables 2,850 1,980Taxation 720 630Warranty provision (note (ii)) 500 150

5,120 2,760

Total equity and liabilities 28,250 22,920





Notes (i) The details of the non-current assets are:

Cost Accumulateddepreciation

Net bookvalue

$000 $000 $000At 31 March 2011 27,500 10,200 17,300At 31 March 2012 37,250 12,750 24,500

During the year there was a major refurbishment of display equipment. Oldequipment that had cost $6 million in September 2008 was replaced with newequipment at a gross cost of $8 million. The equipment manufacturer hadallowed Rytetrend a trade in allowance of $500,000 on the old display equipment.In addition to this Rytetrend used its own staff to install the new equipment. Thevalue of staff time spent on the installation has been costed at $300,000, but thishas not been included in the cost of the asset. All staff costs have been included

in operating expenses. All display equipment held at the end of the financial yearis depreciated at 20% on its cost. No equipment is more than five years old.(ii) Operating expenses contain a charge of $580,000 for the cost of warranties on the

goods sold by Rytetrend. The company makes a warranty provision when it sellsits products and cash payments for warranty claims are deducted from theprovision as they are settled.

Required: (a) Prepare a statement of cash flows for Rytetrend for the year ended 31 March 2012.

(12 marks)

(b) Write a report briefly analysing the operating performance and financial position

of Rytetrend for the years ended 31 March 2011 and 2012. (13 marks)Your report should be supported by appropriate ratios. (Total: 25 marks)

86 Greenwood

Greenwood is a public listed company. During the year ended 31 March 2012 thedirectors decided to cease operations of one of its activities and put the assets of theoperation up for sale (the discontinued activity has no associated liabilities). Thedirectors have been advised that the cessation qualifies as a discontinued operationand has been accounted for accordingly.Extracts from Greenwood ’s financial statements are set out below.Note: the income statement figures down to the profit for the period from continuingoperations are those of the continuing operations only.Income statements for the year ended 31 March: 2012 2011

$’000 $’000 Revenue 27,500 21,200Cost of sales (19,500) (15,000)

–––––––– ––––––––Gross profit 8,000 6,200Operating expenses (2,900) (2,450)

–––––––– ––––––––5,100 3,750





Income statements for the year ended 31 March: 2012 2011 $’000 $’000

Finance costs (600) (250)–––––––– ––––––––

Profit before taxation 4,500 3,500

Income tax expense (1,000) (800)–––––––– ––––––––Profit for the period from continuing operations 3,500 2,700Profit/(Loss) from discontinued operations (1,500) 320

–––––––– ––––––––Profit for the period 2,000 3,020

–––––––– ––––––––Analysis of discontinued operations:Revenue 7,500 9,000Cost of sales (8,500) (8,000)

–––––––– ––––––––Gross profit/(loss) (1,000) 1,000Operating expenses (400) (550)

–––––––– ––––––––Profit/(loss) before tax (1,400) 450Tax (expense)/relief 300 (130)

–––––––– ––––––––(1,100) 320

Loss on measurement to fair value of disposal group (500) –Tax relief on disposal group 100 –

–––––––– ––––––––

Profit/(Loss) from discontinued operations (1,500) 320–––––––– ––––––––

Statements of financial position as at 31 March 2012 2011$’000 $’000 $’000 $’000

Non-current assets 17,500 17,600Current assetsInventory 1,500 1,350Trade receivables 2,000 2,300Bank nil 50

Assets held for sale (at fair value) 6,000 9,500 nil 3,700–––––– ––––––– –––––– –––––––Total assets 27,000 21,300

––––––– –––––––Equity and liabilitiesEquity shares of $1 each 10,000 10,000Retained earnings 4,500 2,500

––––––– –––––––14,500 12,500

Non-current liabilities5% loan notes 8,000 5,000Current liabilities





Statements of financial position as at 31 March 2012 2011$’000 $’000 $’000 $’000

Bank overdraft 1,150 nilTrade payables 2,400 2,800Current tax payable 950 4,500 1,000 3,800

–––––– ––––––– –––––– –––––––Total equity and liabilities 27,000 21,300

––––––– –––––––

Note: the carrying amount of the assets of the discontinued operation at 31 March 2011was $6 ·3 million.Required: Analyse the financial performance and position of Greenwood for the two years ended31 March 2012.Note: Your analysis should be supported by appropriate ratios (up to 10 marksavailable) and refer to the effects of the discontinued operation. (25 marks)

87 Harbin

Shown below are the recently issued (summarised) financial statements of Harbin, alisted company, for the year ended 30 September 2012, together with comparatives for2011 and extracts from the Chief Executive’s report that accompanied their issue.

Income statement 2012 2011$’000 $’000

Revenue 250,000 180,000Cost of sales (200,000) (150,000)Gross profit 50,000 30,000Operating expenses (26,000) (22,000)Finance costs (8,000) (nil)Profit before tax 16,000 8,000Income tax expense (at 25%) (4,000) (2,000)Profit for the period 12,000 6,000Statement of financial positionNon-current assets

Property, plant and equipment 210,000 90,000Goodwill 10,000 nil

220,000 90,000Current assetsInventory 25,000 15,000Trade receivables 13,000 8,000Bank nil 14,000

38,000 37,000Total assets 258,000 127,000Equity and liabilitiesEquity shares of $1 each 100,000 100,000





Income statement 2012 2011$’000 $’000

Retained earnings 14,000 12,000114,000 112,000

Non-current liabilities8% loan notes 100,000 nilCurrent liabilitiesBank overdraft 17,000 nilTrade payables 23,000 13,000Current tax payable 4,000 2,000

44,000 15,000Total equity and liabilities 258,000 127,000

Extracts from the Chief Executive ’s report: ‘Highlights of Harbin’s performance for the year ended 30 September 2012:an increase in sales revenue of 39%gross profit margin up from 16·7% to 20%a doubling of the profit for the period.In response to the improved position the Board paid a dividend of 10 cents per share inSeptember 2012 an increase of 25% on the previous year.’You have also been provided with the following further information.On 1 October 2011 Harbin purchased the whole of the net assets of Fatima (previouslya privately owned entity) for $100 million. The contribution of the purchase to Harbin’sresults for the year ended 30 September 2012 was:

$’000Revenue 70,000Cost of sales (40,000)

–––––––Gross profit 30,000Operating expenses (8,000)

–––––––Profit before tax 22,000

–––––––There were no disposals of non-current assets during the year.The following ratios have been calculated for Harbin for the year ended 30 September

2011:Return on year-end capital employed 7·1%(profit before interest and tax over total assets less current liabilities)Net asset (equal to capital employed) turnover 1·6Net profit (before tax) margin 4·4%Current ratio 2·5Closing inventory holding period (in days) 37Trade receivables’ collection period (in days) 16Trade payables’ payment period (based on cost of sales) (in days) 32Gearing (debt over debt plus equity) nil





Required: (a) Calculate ratios for Harbin for the year ended 30 September 2012 equivalent to

those calculated for the year ended 30 September 2011 (showing your workings).(8 marks)

(b) Assess the financial performance and position of Harbin for the year ended 30September 2012 compared to the previous year. Your answer should refer to theinformation in the Chief Executive’s report and the impact of the purchase of thenet assets of Fatima. (17 marks)

(Total: 25 marks)

88 Victular

Victular is a public company that would like to acquire (100% of) a suitable privatecompany. It has obtained the following draft financial statements for two companies,Grappa and Merlot. They operate in the same industry and their managements haveindicated that they would be receptive to a takeover.

Income statements for the year ended 30 September 2012Grappa Merlot

$’000 $’000 $’000 $’000Revenue 12,000 20,500Cost of sales (10,500) (18,000)

–––––––– ––––––––Gross profit 1,500 2,500Operating expenses (240) (500)Finance costs – loan (210) (300)– overdraft nil (10)– lease nil (290)

–––––––– ––––––––Profit before tax 1,050 1,400Income tax expense (150) (400)

–––––––– ––––––––Profit for the year 900 1,000

–––––––– ––––––––Note: dividends paid during the year 250 700

–––––––– ––––––––Statements of financial position as at 30 September 2012Assets

Non-current assetsFreehold factory (note (i)) 4,400 nilOwned plant (note (ii)) 5,000 2,200Leased plant (note (ii)) nil 5,300

–––––––– ––––––––9,400 7,500

Current assetsInventory 2,000 3,600Trade receivables 2,400 3,700Bank 600 5,000 nil 7,300

–––––––– –––––––– –––––––– ––––––––Total assets 14,400 14,800

–––––––– ––––––––





Grappa Merlot$’000 $’000 $’000 $’000

Equity and liabilitiesEquity shares of $1 each 2,000 2,000

Property revaluation reserve 900 nilRetained earnings 2,600 3,500 800 800–––––––– –––––––– –––––––– ––––––––

5,500 2,800Non-current liabilitiesFinance lease obligations(note (iii)) nil 3,2007% loan notes 3,000 nil10% loan notes nil 3,000Deferred tax 600 100

Government grants 1,200 4,800 nil 6,300–––––––– ––––––––Current liabilitiesBank overdraft nil 1,200Trade payables 3,100 3,800Government grants 400 nilFinance lease obligations(note (iii)) nil 500Taxation 600 4,100 200 5,700

–––––––– –––––––– –––––––– ––––––––Total equity and liabilities 14,400 14,800

–––––––– ––––––––

Notes(i) Both companies operate from similar premises.(ii) Additional details of the two companies’ plant are:

Grappa Merlot$’000 $’000

Owned plant – cost 8,000 10,000Leased plant – original fair value nil 7,500There were no disposals of plant during the year by either company.

(iii) The interest rate implicit within Merlot ’s finance leases is 7 ·5% per annum. Forthe purpose of calculating ROCE and gearing, all finance lease obligations aretreated as long-term interest bearing borrowings.

(iv) The following ratios have been calculated for Grappa and can be taken to becorrect:Return on year end capital employed (ROCE) 14·8%(capital employed taken as shareholders’ funds plus long-term interest bearing borrowings – see note (iii) above)

Pre-tax return on equity (ROE) 19·1%





Net asset (total assets less current liabilities) turnover 1·2 timesGross profit margin 12·5%Operating profit margin 10·5%Current ratio 1·2:1

Closing inventory holding period 70 daysTrade receivables’ collection period 73 daysTrade payables’ payment period (using cost of sales) 108 daysGearing (see note (iii) above) 35·3%Interest cover 6 timesDividend cover 3·6 times

Required: (a) Calculate for Merlot the ratios equivalent to all those given for Grappa above.

(8 marks)

(b) Assess the relative performance and financial position of Grappa and Merlot forthe year ended 30 September 2012 to inform the directors of Victular in theiracquisition decision. (12 marks)

(c) Explain the limitations of ratio analysis and any further information that may beuseful to the directors of Victular when making an acquisition decision. (5 marks)

(Total: 25 marks)

89 Hardy

Hardy is a public listed manufacturing company. Its summarised financial statements

for the year ended 30 September 2010 (and 2009 comparatives) are:Income statements for the year ended 30 September:

2010 2009$’000 $’000


––––––– ––––––– Gross profit 4,000 10,000Distribution costs (1,050) (800)Administrative expenses (4,900) (3,900)Investment income 50 200Finance costs (600) (500)

––––––– ––––––– Profit (loss) before taxation (2,500) 5,000Income tax (expense) relief 400 (1,500)

––––––– ––––––– Profit (loss) for the year (2,100) 3,500

––––––– –––––––





Statements of financial position as at 30 September:2010 2009

$’000 $’000 $’000 $’000AssetsNon-current assets

Property, plant and equipment 17,600 24,500Investments at fair value through profit or loss 2,400 4,000––––––– –––––––

20,000 28,500Current assetsInventory and work-in-progress 2,200 1,900Trade receivables 2,200 2,800Tax asset 600 nilBank 1,200 6,200 100 4,800

–––––– ––––––– –––––– ––––––– Total assets 26,200 33,300

––––––– ––––––– Equity and liabilitiesEquityEquity shares of $1 each 13,000 12,000Share premium 1,000 nilRevaluation reserve nil 4,500Retained earnings 3,600 6,500

––––––– ––––––– 17,600 23,000

Non-current liabilitiesBank loan 4,000 5,000Deferred tax 1,200 700Current liabilities

Trade payables 3,400 2,800Current tax payable nil 3,400 1,800 4,600–––––– ––––––– –––––– –––––––

Total equity and liabilities 26,200 33,300––––––– –––––––

The following information has been obtained from the Chairman ’s Statement and thenotes to the financial statements:‘Market conditions during the year ended 30 September 2010 proved very challengingdue largely to difficulties in the global economy as a result of a sharp recession whichhas led to steep falls in share prices and property values.Hardy has not been immune from these effects and our properties have sufferedimpairment losses of $6 million in the year. ’ The excess of these losses over previous surpluses has led to a charge to cost of sales of$1·5 million in addition to the normal depreciation charge.‘Our portfolio of investments at fair value through profit or loss has been ‘marked tomarket ’ (fair valued) resulting in a loss of $1 ·6 million (included in administrativeexpenses). ’ There were no additions to or disposals of non-current assets during the year.‘In response to the downturn the company has unfortunately had to make a number ofemployees redundant incurring severance costs of $1 ·3million (included in cost ofsales) and undertaken cost savings in advertising and other administrative expenses. ’





‘The difficulty in the credit markets has meant that the finance cost of our variable rate bank loan has increased from 4 ·5% to 8%. In order to help cash flows, the companymade a rights issue during the year and reduced the dividend per share by 50%. ’ ‘Despite the above events and associated costs, the Board believes the company ’sunderlying performance has been quite resilient in these difficult times. ’ Required:

Analyse and discuss the financial performance and position of Hardy as portrayed bythe above financial statements and the additional information provided.Your analysis should be supported by profitability, liquidity and gearing and otherappropriate ratios (up to 10 marks available). (25 marks)





S E C

T I O N 2

Q &A

Answers to practicequestions

A conceptual framework and regulatory framework forfinancial reporting

1 Recost

(a) The main drawback of the use of historical cost accounts for assessing the

performance of a business is that they do not take into account the current valuesof assets and, to a lesser extent, liabilities. This can become a serious problemand give misleading information when either specific or general price inflationrates are considered to be high. The effect is that many of the values of the assetsin the statement of financial position are understated, and, partly because ofrelated depreciation, profits tend to be overstated. More detailed criticisms ofhistorical cost accounts during a period of rising prices are:Effects on the statement of financial position

(i) Most non-current assets can be considerably understated in terms of theircurrent worth. The most affected assets tend to be land and buildings,investments and some plant.

(ii) In general net current assets tend not to be affected by inflation mainly because they are monetary in nature. The possible exception is tradinginventories.

(iii) Liabilities tend to be ignored when current values are discussed. This may be an error because, for example, a long term loan carrying a fixed rate ofinterest, may have a current value that is considerably different to when itwas taken out (ignoring the possibility of any repayments). This is becausecurrent interest rates may have changed (often as a reaction to levels ofinflation) since the loan was originally taken out.

(iv) If the net assets are understated, then so too are shareholders’ funds.



Section 2: Answers to practice questions


this may be because management is recommending dividends based on a currentoperating profit.Employees may make high wage demands based on reported profit rather thancurrent operating profits.Governments generally tax reported profits which means companies pay tax onhigher, inflation boosted, profits.

(b) The advantages and criticisms of Current Cost Accounting are set out below:Current cost accounting principles, from a conceptual point of view, are moresoundly based and therefore more difficult to criticise than GPP accounts. Theycorrect most of the limitations (that are due to increased price changes) ofhistorical cost accounts. They reflect the current values (which is not necessarilythe current costs) of a company’s specific assets. The reported current operatingprofit is considered to be more relevant to many decisions such as dividenddistribution, employee wage claims and even as a basis for taxation.The problems of CCA lie in their preparation and understanding. In practicalterms it can be very difficult to determine the current value of assets, and manyalternative forms of current value exist e.g. replacement cost, realisable value andvalue in use. Methods of determining current costs include the use ofmanufacturers’ price lists for plant and inventory, professional revaluation ofassets e.g. land and buildings and the use of specific price indexes published bygovernment agencies. Whatever method is used it is often subjective andsometimes complex. This makes the cost of the preparation and audit of currentcost accounts expensive.

2 Worthright

(a) Importance of the definitions:

The definitions of assets and liabilities are fundamental to the IASB’s ConceptualFramework. Apart from forming the obvious basis for the preparation of astatement of financial position, they are also the two elements of financialstatements that are used to derive the other elements. Equity (ownership)interest is the residue of assets less liabilities. Gains and losses are changes inownership interests, other than contributions from, and distributions to, theowners. In effect, a gain is an increase in an asset or a reduction of a liabilitywhereas a loss is the reverse of this. Transactions with owners are defined in astraightforward manner in order to exclude them from the definitions of gains

and losses.Assets:

The IASB Conceptual Framework defines assets as ‘a resource controlled by anentity as a result of past events and from which future economic benefits areexpected to flow to the entity’. The first part of the definition ‘a resourcecontrolled by an entity’ is a refinement of the principle that an asset must beowned by the entity. This refinement allows assets that are not legally owned byan entity, but over which the entity has the rights that are normally conveyed byownership, such as the right to use or occupy an asset, to be recognised as anasset of the entity. The essence of this approach is that an asset is not the physicalitem that one might expect it to be such as a machine or a building, but it is theright to enjoy the future economic benefits that the asset will produce (normallyfuture cash flows). Perhaps the best known example of this type of arrangement





is a finance lease or asset being bought under a hire purchase agreement.Control not only allows the entity to obtain the economic benefits of assets butalso to restrict the access of others to them. Where an entity develops analternative manufacturing process that reduces future cash outflows in terms oflower cost of production, this too can be an asset. Assets can also arise where

there is no legal control. The Conceptual Framework cites the example of ‘know-how’ derived from a development activity. Where an entity has the capacity tokeep this a secret, the entity controls the benefits that are expected to flow fromit.Other definitions of an asset refer to future economic benefits being ‘probable’.This wording recognises that all future economic benefits are subject to somedegree of risk or uncertainty. The IASB deals with the ‘probable’ issue by sayingthat future economic benefits are only ‘expected’ and therefore need not becertain.The reference to past events makes it clear that transactions arising after the

reporting period that may lead to economic benefits cannot be treated as assets.The use of the word ‘events’ in this part of the definition recognises that it is notonly transactions that can create assets or liabilities (see below), but other eventssuch as ‘legal wrongs’ which may lead to damages claims. This aspect of thedefinition does cause some problems. For example, it could be argued thatsigning a profitable contract before the end of the reporting period is an ‘event’that gives rise to a future economic benefit. It is widely held that the justificationfor not recognising future profitable contracts as assets is that the rights andobligations under these contracts are equal (which is unlikely to be true) and alsothat the historical cost of ‘signing’ them is zero.Liabilities:

The IASB defines liabilities as ‘a present obligation of the entity arising from pastevents which is expected to result in an outflow from the entity of resourcesembodying economic benefits’. The IASB stress that the essential characteristic isthe ‘present obligation’. Although the definition is complementary to that ofassets, it is perceived as less controversial. Most components of the definitionhave the same meaning e.g. the terms ‘economic benefits’ and ‘past events’. Mostliabilities are legal or contractual obligations to transfer known amounts of cashe.g. trade payables and loans. Occasionally they may be settled other than forcash such as in a barter transaction, but this still constitutes transferringeconomic benefits. It is necessary to consider the principles and definitions inThe Conceptual Framework alongside those of IAS 37 Provisions, ContingentLiabilities and Contingent Assets. Within the Conceptual Framework the IASBintroduces the concept of obligations arising from ‘normal business practice’ being liabilities. One such example is rectifying faults in goods sold even whenthe warranty period has expired. IAS 37 explores this principle more fully andrefers to them as ‘constructive’ obligations. These occur where an entity creates avalid expectation that it will discharge responsibilities that it is not legallyobliged to. This is usually as a result of past behaviour, or by commitmentsgiven in a published statement (e.g. voluntarily incurring environmental costs).Where the exact amount of a liability is uncertain it is usually referred to as aprovision.

Obligations may exist that are not expected to require ‘transfers of economic benefits’. These again are described in IAS 37 and are more generally known as





contingent liabilities . For example, where a holding company guarantees asubsidiary’s loan.Similar to assets, costs to be incurred in the future do not represent liabilities.This is because either the entity has the ability to avoid the costs, or if it cannot(e.g. where a contract exists), then incurring the cost would be matched byreceiving an asset of equal value.

(b) An issue with research and development costs is whether they are an asset or anexpense. If they result in future economic benefits, they are assets; if not, they areexpenses. Unfortunately the resolution to the question whether developmentcosts are an asset lies in the future and is therefore unknown. Since mostdevelopment projects do not result in a profitable project, , most research anddevelopment costs are not an asset.In the case of the development expenditure of Worthright it appears that it maysatisfy the criteria in IAS 38 Intangible Assets to be treated as an intangible asset,particularly in view of its impressive track record on development projects. More

details would have to be obtained in order to determine whether the expendituredoes qualify as an asset. If it does the company’s existing policy would not bepermitted under IAS 38, as this says that if the recognition criteria are met, theexpenditure should be capitalised. It does not offer a choice.The above only applies to Worthright’s own development costs. The companyalso performs research and development for clients and here the case is different.Although it is conducting research and development, it is in fact work inprogress. The costs of this research and development should be matched withthe revenues it will bring. To the extent it has been invoiced to clients, it willappear as cost of sales in the income statement (not as research anddevelopment). Any unbilled costs should appear as a current asset under workin progress.

3 Revenue recognition

(a) The IASB Conceptual Framework advocates that revenue recognition issues areresolved within the definition of assets (gains) and liabilities (losses). Gainsinclude all forms of income and revenue as well as gains on non-revenue items.Gains and losses are defined as increases or decreases in net assets other thanthose resulting from transactions with owners. Thus in its ConceptualFramework, the IASB takes a ‘statement of financial position approach’ todefining revenue (i.e. an approach based on the statement of financial position)..In effect a recognisable increase in an asset results in a gain. The more traditionalview, which is largely the basis used in IAS 18 Revenue, is that (net) revenuerecognition is part of a transactions based accruals or matching process with thestatement of financial position recording any residual assets or liabilities such asreceivables and payables. The issue of revenue recognition arises out of the needto report company performance for specific periods. The Conceptual Frameworkidentifies three stages in the recognition of assets (and liabilities): initialrecognition , when an item first meets the definition of an asset; subsequent re-measurement , which may involve changing the value (with a correspondingeffect on income) of a recognised item; and possible derecognition , where anitem no longer meets the definition of an asset. For many simple transactions both the Conceptual Framework’s approach and the traditional approach (IAS18) will result in the same profit (net income). If an item of inventory is bought





for $100 and sold for $150, net assets have increased by $50 and the increasewould be reported as a profit. The same figure would be reported under thetraditional transactions based reporting (sales of $150 less cost of sales of $100).However, in more complex areas the two approaches can produce differentresults. An example of this would be deferred income. If a company received a

fee for a 12 month tuition course in advance, IAS 18 would treat this as deferredincome (in the statement of financial position) and release it to income as thetuition is provided and matched with the cost of providing the tuition. Thus theprofit would be spread (accrued) over the period of the course. If anasset/liability approach were taken, then the only liability the company wouldhave after the receipt of the fee would be for the cost of providing the course. Ifonly this liability is recognised in the statement of financial position, the whole ofthe profit on the course would be recognised on receipt of the income. This is nota prudent approach and has led to criticism of the IASB Conceptual Frameworkfor this very reason. Other standards that may be in conflict with the ConceptualFramework are the use of the accretion approach in IAS 11 Construction Contracts

and a deferred tax liability in IAS 12 Income Taxes may not fully meet theConceptual Framework’s definition of a liability.The principle of substance over form should also be applied to revenuerecognition. An example of where this can impact on reporting practice is on saleand repurchase agreements. Companies sometimes ‘sell’ assets to anothercompany with the right to buy them back on predetermined terms that willalmost certainly mean that they will be repurchased in the future. In substancethis type of arrangement is a secured loan and the ‘sale’ should not be treated asrevenue. A less controversial area of the application of substance in relation torevenue recognition is with agency sales. IAS 18 says, where a company sellsgoods acting as an agent, those sales should not be treated as sales of the agent,instead only the commission from the sales is income of the agent.

(b) (i) The IASB Conceptual Framework defines liabilities as obligations totransfer economic benefits as a result of past transactions. Such transfers ofeconomic benefits are to third parties and normally as cash payments.Traditionally and in compliance with IAS 20, capital-based governmentgrants are treated as deferred credits and spread over the life of the relatedassets. This is the application of the matching concept. A strictinterpretation of the Conceptual Framework would not normally allowdeferred credits to be treated as liabilities as there is usually no obligationto transfer economic benefits. In this particular example the only liability

that may occur in respect of the grant would be if Derringdo were to sellthe related asset within four years of its purchase. A possible argumentwould be that the grant should be treated as a reducing liability (in relationto a potential repayment) over the four-year claw back period. On closerconsideration this would not be appropriate. The repayment would onlyoccur if the asset were sold, thus it is potentially a contingent liability. AsDerringdo has no intention to sell the asset there is no reason to believe thatthe repayment will occur, thus it is not a reportable contingent liability. Theimplication of this is that the company’s policy for the government grantdoes not comply with the definition of a liability in the ConceptualFramework. Applying the guidance in the Conceptual Framework would

require the whole of the grant to be included in income as it is ‘earned’ i.e.in the year of receipt.





ownership of the goods remains with the supplier until specified events occur(often the onward sale of the goods). This means that other suppliers cannotaccurately assess an entity ’s true level of trade payables and consequently theaverage payment period to suppliers, both of which are important determinantsin deciding whether to grant credit.

(b) (i) Debt factoring is a common method of entities releasing the liquidity oftheir trade receivables. The accounting issue that needs to be decided iswhether the trade receivables have been sold, or whether the income fromthe finance house for their ‘sale’ should be treated as a short term loan. Themain substance issue with this type of transaction is to identify which party bears the risks (i.e. of slow and non-payment by the customer) relating tothe asset. If the risk lies with the finance house (Omar), the tradereceivables should be removed from the statement of financial position(derecognised in accordance with IAS 39). In this case it is clear thatAngelino still bears the risk relating to slow and non-payment. The residualpayment by Omar depends on how quickly the receivables are collected;the longer it takes, the less the residual payment (this imputes a financecost). Any balance uncollected by Omar after six months will be refunded by Angelino which reflects the non-payment risk.Thus the correct accounting treatment for this transaction is that the cashreceived from Omar (80% of the selected receivables) should be treated as acurrent liability (a short term loan) and the difference between the grosstrade receivables and the amount ultimately received from Omar (plus anyamounts directly from the credit customers themselves) should be chargedto the income statement. The classification of the charge is likely to be amixture of administrative expenses (for Omar collecting receivables),

finance expenses (reflecting the time taken to collect the receivables) andthe impairment of trade receivables (bad debts).(ii) This is an example of a sale and leaseback of a property. Such transactions

are part of normal commercial activity, often being used as a way toimprove cash flow and liquidity. However, if an asset is sold at an amountthat is different to its fair value there is likely to be an underlying reason forthis. In this case it appears (based on the opinion of the auditor) that Finaidhas paid Angelino $2 million more than the building is worth. No(unconnected) company would do this knowingly without there beingsome form of ‘compensating ’ transaction. This sale is ‘linked ’ to the fiveyear rental agreement. The question indicates the rent too is not at a fairvalue, being $500,000 per annum ($1,300,000 – $800,000) above what acommercial rent for a similar building would be.It now becomes clear that the excess purchase consideration of $2 million isan ‘in substance ’ loan (rather than sales proceeds – the legal form) which is being repaid through the excess ($500,000 per annum) of the rentals.Although this is a sale and leaseback transaction, as the building is freeholdand has an estimated remaining life (20 years) that is much longer than thefive year leaseback period, the lease is not a finance lease and the buildingshould be treated as sold and thus derecognised.The correct treatment for this item is that the sale of the building should be

recorded at its fair value of $10 million, thus the profit on disposal would be $2·5 million ($10 million – $7·5 million). The ‘excess’ of $2 million ($12





million – $10 million) should be treated as a loan (non-current liability).The rental payment of $1 ·3 million should be split into three elements;$800,000 building rental cost, $200,000 finance cost (10% of $2 million) andthe remaining$300,000 is a capital repayment of the loan.

(iii) The treatment of consignment inventory depends on the substance of thearrangements between the manufacturer and the dealer (Angelino). Themain issue is to determine if and at what point in time the cars are ’sold ’.The substance is determined by analysing which parties bear the risks (e.g.slow moving/obsolete inventories, finance costs) and receive the benefits(e.g. use of inventories, potential for higher sales, protection from priceincreases) associated with the transaction.Supplies from MonzaAngelino has, and has actually exercised, the right to return the carswithout penalty (or been required by Monza to transfer them to anotherdealer), which would indicate that it has not ‘ bought ’ the cars. There are no

finance costs incurred by Angelino, however Angelino would suffer fromany price increases that occurred during the three month holding/displayperiod. These factors seem to indicate that the substance of thisarrangement is the same as its legal form i.e. Monza should include the carsin its statement of financial position as inventory and therefore Angelinowill not record a purchase transaction until it becomes obliged to pay forthe cars (three months after delivery or until sold to customers if sooner).Supplies from CapriAlthough this arrangement seems similar to the above, there are severalimportant differences. Angelino is bearing the finance costs of 1% permonth (calling it a display charge is a distraction). The option to return thecars should be ignored because it is not likely to be exercised due tocommercial penalties (payment of transport costs and loss of deposit).Finally the purchase price is fixed at the date of delivery rather than at theend of six months. These factors strongly indicate that Angelino bears therisks and rewards associated with ownership and should recognise theinventory and the associated liability in its financial statements at the dateof delivery.

5 Emerald

(a) The Conceptual Framework defines an asset as a resource controlled by an entityas a result of past transactions or events from which future economic benefits(normally net cash inflows) are expected to flow to the entity. However assetscan only be recognised (on the statement of financial position) when thoseexpected benefits are probable and can be measured reliably. The ConceptualFramework recognises that there is a close relationship between incurringexpenditure and generating assets, but they do not necessarily coincide.Development expenditure, perhaps more than any other form of expenditure, is aclassic example of the relationship between expenditure and creating an asset.Clearly entities commit to expenditure on both research and development in thehope that it will lead to a profitable product, process or service, but at the time

that the expenditure is being incurred, entities cannot be certain (or it may noteven be probable) that the project will be successful. Relating this to accountingconcepts would mean that if there is doubt that a project will be successful the





five and eight years, it would be prudent to use an estimated life of five years forthe new asset.Comparability is fundamental to assessing the performance of an entity by usingits financial statements. Assessing the performance of an entity over time (trendanalysis) requires that the financial statements used have been prepared on acomparable (consistent) basis. Generally this can be interpreted as usingconsistent accounting policies (unless a change is required to show a fairerpresentation). A similar principle is relevant to comparing one entity withanother; however it is more difficult to achieve consistent accounting policiesacross entities.Information is material if its omission or misstatement could influence(economic) decisions of users based on the reported financial statements. Clearlyan important aspect of materiality is the (monetary) size of a transaction, but inaddition the nature of the item can also determine that it is material. For examplethe monetary results of a new activity may be small, but reporting them could be

material to any assessment of what it may achieve in the future. Materiality isconsidered to be a threshold quality, meaning that information should only bereported if it is considered material. Too much detailed (and implicitlyimmaterial) reporting of (small) items may confuse or distract users.

(b) Accounting for inventory, by adjusting purchases for opening and closinginventories is a classic example of the application of the accruals principlewhereby revenues earned are matched with costs incurred. Closing inventory is by definition an example of goods that have been purchased, but not yetconsumed. In other words the entity has not yet had the ‘benefit’ (i.e. the salesrevenue they will generate) from the closing inventory; therefore the cost of theclosing inventory should not be charged to the current year’s income statement.

Consignment inventory is where goods are supplied (usually by a manufacturer)to a retailer under terms which mean the legal title to the goods remains with thesupplier until a specified event (say payment in three months time). Once thegoods have been transferred to the retailer, normally the risks and rewardsrelating to those goods then lie with the retailer. Where this is the case then (insubstance) the consignment inventory meets the definition of an asset and thegoods should appear as such (inventory) on the retailer’s statement of financialposition (along with the associated liability to pay for them) rather than on thestatement of financial position of the manufacturer.At the year end, the value of an entity’s closing inventory is, by its nature,

uncertain. In the next accounting period it may be sold at a profit or a loss.Accounting standards require inventory to be valued at the lower of cost and netrealisable value. This is the application of prudence. If the inventory is expectedto sell at a profit, the profit is deferred (by valuing inventory at cost) until it isactually sold. However, if the goods are expected to sell for a (net) loss, then thatloss must be recognised immediately by valuing the inventory at its net realisablevalue.There are many acceptable ways of valuing inventory (e.g. average cost or FIFO).In order to meet the requirement of comparability, an entity should decide on themost appropriate valuation method for its inventory and then be consistent in theuse of that method. Any change in the method of valuing (or accounting for)inventory would break the principle of comparability.





For most businesses inventories are a material item. An error (omission ormisstatement) in the value or treatment of inventory has the potential to affectdecisions users may make in relation to financial statements. Therefore(correctly) accounting for inventory is a material event. Conversely there areoccasions where on the grounds of immateriality certain ‘inventories’ are not

(strictly) accounted for correctly. For example, at the year end a company mayhave an unused supply of stationery. Technically this is inventory, but in mostcases companies would charge this ‘inventory’ of stationery to the incomestatement of the year in which it was purchased rather than show it as an asset.Note: other suitable examples would be acceptable.

7 Promoil

(a) A liability is a present obligation of an entity arising from past events, thesettlement of which is expected to result in an outflow of economic benefits(normally cash). Provisions are defined as liabilities of uncertain timing oramount, i.e. they are normally estimates. In essence provisions should berecognised if they meet the definition of a liability. Equally they should not berecognised if they do not meet the definition. A statement of financial positionwould not give a ‘fair representation’ if it did not include all of an entity’sliabilities (or if it did include, as liabilities, items that were not liabilities). Thesedefinitions benefit the reliability of financial statements by preventing profitsfrom being ‘smoothed’ by making a provision to reduce profit in years when theyare high and releasing those provisions to increase profit in years when they arelow. It also means that the statement of financial position cannot avoid theimmediate recognition of long-term liabilities (such as environmental provisions)on the basis that those liabilities have not matured.

(b) (i) Future costs associated with the acquisition/construction and use of non-current assets, such as the environmental costs in this case, should betreated as a liability as soon as they become unavoidable. For Promoil thiswould be at the same time as the platform is acquired and brought into use.The provision is for the present value of the expected costs and this sameamount is treated as part of the cost of the asset. The provision is‘unwound’ by charging a finance cost to the income statement each yearand increasing the provision by the finance cost. Annual depreciation of theasset effectively allocates the (discounted) environmental costs over the lifeof the asset.

Income statement for the year ended 30 September 2012 $’000Depreciation (see below) 3,690Finance costs ($6·9 million x 8%) 552Statement of financial position as at 30 September 2012Non-current assetsCost ($30 million + $6·9 million ($15 million x 0·46)) 36,900Depreciation (over 10 years) (3,690)

–––––––33,210

–––––––Non-current liabilities

Environmental provision ($6·9 million x 1·08) 7,452





(ii) If there was no legal requirement to incur the environmental costs, thenPromoil should not provide for them as they do not meet the definition of aliability. Thus the oil platform would be recorded at $30 million with $3million depreciation and there would be no finance costs.However, if Promoil has a published policy that it will voluntarily incurenvironmental clean up costs of this type (or if this may be implied by itspast practice), then this would be evidence of a ‘constructive ’ obligationunder IAS 37 and the required treatment of the costs would be the same asin part (i) above.

8 Wardle

(a) For financial statements to be of value to their users they must possess certaincharacteristics; reliability is one such important characteristic. In order forfinancial statements to be reliable, they must faithfully represent an entity ’sunderlying transactions and other events. For financial statements to achievefaithful representation, transactions must be accounted for and presented inaccordance with their substance and economic reality where this differs fromtheir legal form. For example, if an entity ‘sold ’ an asset to a third party, butcontinued to enjoy the future benefits embodied in that asset, then thistransaction would not be represented faithfully by recording it as a sale (in allprobability this would be a financing transaction).The features that may indicate that the substance of a transaction is differentfrom its legal form are:– where the control of an asset differs from the ownership of the asset– where assets are ‘sold ’ at prices that are greater or less than their fair values– the use of options as part of an agreement– where there are a series of ‘linked ’ transactions.It should be noted that none of the above necessarily mean there is a difference between substance and legal form.

(b) Extracts from the income statements(i) reflecting the legal form:

Year ended: 31 March 2010 31 March 2011 31 March 2012 Total$’000 $’000 $’000 $’000

Revenue 6,000 nil 10,000 16,000Cost of sales (5,000) nil (7,986) (12,986)

–––––– ––– ––––––– ––––––– Gross profit 1,000 nil 2,014 3,014Finance costs nil nil nil nil

–––––– ––– ––––––– ––––––– Net profit 1,000 nil 2,014 3,014

–––––– ––– ––––––– –––––––





(ii) reflecting the substance:Year ended: 31 March 2010 31 March 2011 31 March 2012 Total

$’000 $’000 $’000 $’000

Revenue nil nil 10,000 10,000

Cost of sales (nil) nil (5,000) (5,000)–––––– ––– ––––––– ––––––– Gross profit nil nil 5,000 5,000Finance costs (600) (660) (726) (1,986)

–––––– ––– ––––––– ––––––– Net profit (600) (660) 4,274 3,014

–––––– ––– ––––––– ––––––– (c) It can be seen from the above that the two treatments have no effect on the total

net profit reported in the income statements, however, the profit is reported indifferent periods and the classification of costs is different. In effect the legal formcreates some element of profit smoothing and completely hides the financing

cost. Although not shown, the effect on the statements of financial position is thatrecording the legal form of the transaction does not show the inventory, nor doesit show the in-substance loan. Thus recording the legal form would be anexample of off balance sheet (statement of financial position) financing. The effecton an assessment of Wardle using ratio analysis may be that recording the legalform rather than the substance of the transaction would be that interest cover andinventory turnover would be higher and gearing lower. All of which may beconsidered as reporting a more favourable performance.

Financial statements – Statements of cash flow

9 Tabba

(a)

Tabba: Statement of cash flows for the year ended 30 September 2012Cash flows from operating activities $000 $000Profit before tax 50Adjustments for:Depreciation (w (i)) 2,200Amortisation of government grant (w (iii)) (250)

Profit on sale of factory (w (i)) (4,600)Increase in insurance claim provision (1,500 – 1,200) (300)Interest receivable (40)Interest expense 260

(2,680)Working capital adjustments:Increase in inventories (2,550 – 1,850) (700)Increase in trade receivables (3,100 – 2,600) (500)Increase in trade payables (4,050 – 2,950) 1,100Cash outflow from operations (2,780)Interest paid (260)





Tabba: Statement of cash flows for the year ended 30 September 2012Cash flows from operating activities $000 $000Income taxes paid (w (iv)) (1,350)Net cash outflow from operating activities (4,390)

Cash flows from investing activities Sale of factory 12,000Purchase of non-current assets (w (i)) (2,900)Receipt of government grant (from question) 950Interest received 40Net cash from investing activities 10,090Cash flows from financing activities Issue of 6% loan notes 800Redemption of 10% loan notes (4,000)Repayment of finance leases (w (ii)) (1,100)Net cash from financing activities (4,300)Net increase in cash and cash equivalents 1,400Cash and cash equivalents at beginning of period (550)Cash and cash equivalents at end of period 850

Tutorial note : Interest paid may also be presented as a financing activity andinterest received may be presented as an operating cash flow.

Workings (figures in $000)

(i) Non-current assets

Cost/valuation at beginning of the year 20,200New finance leases (from question) 1,500Disposals in the year (8,600)

–––––– 13,100

Cost/valuation at end of the year 16,000––––––

Therefore acquisitions during the year 2,900––––––

Accumulated depreciation at beginning of the year 4,400Accumulated depreciation on disposals (1,200)

–––––– 3,200

Accumulated depreciation at end of the year 5,400––––––

Therefore depreciation charge for the year 2,200––––––

Sale of factory

Proceeds (from question) 12,000Net book value (7,400)

–––––– Profit on sale 4,600

––––––





(ii) Finance lease obligations

Balance brought forward: current 800Balance brought forward: over 1 year 1,700

–––––– 2,500

New leases (from question) 1,500–––––– 4,000

Balance carried forward: current 900Balance carried forward: over 1 year 2,000

–––––– (2,900)––––––

Cash repayments – balancing figure 1,100––––––

(iii) Government grant

Balance brought forward: current 400Balance brought forward: over 1 year 900

–––––– 1,300

Grants received in year (from question) 950–––––– 2,250

Balance carried forward: current 600Balance carried forward: over 1 year 1,400

–––––– (2,000)––––––

Difference – amortisation credited to income statement 250–––––– (iv) Taxation

Current provision brought forward 1,200Deferred tax brought forward 500

–––––– 1,700

Tax credit in income statement (50)–––––– 1,650

Current provision carried forward 100Deferred tax carried forward 200

–––––– (300)

–––––– Tax paid – balancing figure 1,350

–––––– (v) Reconciliation of retained earnings

Balance b/f 850Transfer from revaluation reserve 1,600Profit for period 100

–––––– Balance c/f 2,550

––––––

(b) Consideration of the statement of cash flows reveals some important informationin assessing the change in the financial position of Tabba during the year. There





is a huge net cash outflow from operating activities of $4,390,000 despite Tabbareporting a small operating profit of $270,000. More detailed analysis of thisdifference reveals some worrying concerns for the future.Many companies have higher operating cash flows than their underlyingoperating profit, mainly due to depreciation charges being added back to profitsto arrive at the cash flows. In Tabba’s case, operating profits have been‘improved’ by $2.2 million during the year in terms of the underlying cash flows.However, the major reconciling difference is the profit on the sale of Tabba’sfactory of $4.6 million. This amount has been credited in the income statementand has dramatically distorted the operating profit. If the sale and lease back ofthe factory had not taken place, Tabba’s operating profits would show losses of$4.33 million (ignoring any possible tax effects). When Tabba publishes itsfinancial statements this profit will almost certainly require separate disclosurewhich should make the effects of the transaction more transparent to the users ofthe financial statements.

A further indication of poor operating profits is that they have been boosted by$300,000 due to an increase in the insurance claim provision (again this is not acash flow) and $250,000 amortisation of government grants.Many commentators believe that the net cash flow from operating activities is themost important figure in the statement of cash flows. This is because it is ameasure of expected or maintainable future cash flows. In Tabba’s case thishighlights a very important point; although Tabba has increased its cash positionduring the year by $1.4 million, $12 million has come from the sale of its factory.Clearly this is a one-off transaction that cannot be repeated in future years. If thedrain on the operating cash flows continues at the current rates, the companywill not survive for very long.The tax position: there is a small tax credit in the income statement, perhaps dueto current year trading losses, whereas the cash flow statement shows that tax of$1.35 million has been paid during the year. This payment of tax is on what musthave been a substantial profit for the previous year. This seems to confirm thedeteriorating position of the company.There has been a very small increase in working capital of $100,000. However,underlying this is the fact that both inventories and trade receivables are showingsubstantial increases (despite the profit deterioration), which may indicate thepresence of bad debts or obsolete inventories, and trade payables have alsoincreased substantially (by $1.1 million) which may be a symptom of liquidity

problems prior to the sale of the factory.On the positive side there has been substantial investment in non-current assets(after allowing for the sale of the factory), but even this is partly due to leasingassets of $1.5 million (companies often lease assets when they do not have theresources to purchase them outright) and finance from a government grant of$950,000.The company appears to have taken advantage of the proceeds from the sale ofthe factory to redeem the expensive 10% $4 million loan note. (This has partly been replaced by a less expensive 6% $800,000 loan note).In conclusion the statement of cash flows reveals some interesting and worrying

issues that may indicate a worrying future for Tabba and serves as an illustrationof the importance of a statement of cash flows to the users of financial statements.





(b) Report on the financial performance of Boston for the year ended31 March 2012

To: The Board of BostonFrom:

Date:Profitability

The most striking feature of the current year’s performance is the deterioration inthe ROCE, down from 25.6% to only 18.0%.This represents an overall fall in profitability of 30% (= (25.6 – 18·.0)/25.6). Anexamination of the other ratios shows that this is due to a decline in both profitmargins and asset utilisation. A closer look at the profit margins shows that thedecline in gross margin is relatively small (42.2% down to 41.4%), whereas thefall in the operating profit margin is down by 2.8%, this represents a 15.7%decline in profitability (i.e. 2.8% on 17.8%). This has been caused by increases in

operating expenses of $12m and unallocated corporate expenses of $10m. Theseincreases represent more than half of the net profit for the period and furtherinvestigation into the cause of these increases should be made. The company isgenerating only $1.20 of sales per $1 of net assets this year compared to a figureof $1.40 in the previous year. This decline in asset utilisation represents a fall of14.3% (= (1.4 – 1.2)/1.4).Liquidity/solvency

From the limited information provided a poor current ratio of 0·9:1 in 2011 hasimproved to 1·3:1 in the current year. Despite the improvement, it is still belowthe accepted norm. At the same time gearing has increased from 12.8% to 15.6%.

Information from the statement of cash flows shows the company raised $65million in new capital ($40m in equity and $25m in loans). The disproportionateincrease in the loans is the cause of the increase in gearing. However, at 15.6%this is still not a highly-geared company. The increase in finance has been usedmainly to purchase new non-current assets, but it has also improved liquidity,mainly by reversing an overdraft of $5 million to a bank balance in hand of $15million.A common feature of new investment is that there is often a delay betweenmaking the investment and benefiting from the returns. This may be the casewith Boston, and it may be that in future years the increased investment will berewarded with higher returns. Another aspect of the investment that may havecaused the lower return on assets is that the investment is likely to have occurredpart way through the year (maybe even near the year end). This means that theincome statement may not include returns for a full year, whereas in future yearsit will.Segment issues

Segment information is intended to help the users to better assess theperformance of an enterprise by looking at the detailed contribution made by thediffering activities that comprise the enterprise as a whole. Referring to thesegment ratios it appears that the carpeting segment is giving the greatestcontribution to overall profitability achieving a 48.6% return on its segment

assets, whereas the equivalent return for house building is 38.1% and for hotels itis only 16.7%. The main reason for the better return from carpeting is due to its





higher segment net profit margin of 38.9% compared to hotels at 15·4% andhouse building at 28·6%. Carpeting’s higher segment net profit is in turn areflection of its underlying very high gross margin (66.7%). The segment net assetturnover of the hotels (1.1 times) is also very much lower than the other twosegments (1.3 times). It seems that the hotel segment is also responsible for the

group’s fairly poor liquidity ratios (ignoring the bank balances) the segmentcurrent liabilities are 50% greater than its current assets ($60m compared to$40m). The opposite of this would be a more acceptable current ratio.These figures are based on historical values. Most commentators argue that theuse of fair values is more consistent and thus provides more reliable informationon which to base assessments (they are less misleading than the use of historicalvalues).If fair values are used all segments understandably show lower returns andpoorer performance (as fair values are higher than historical values), but thefigures for the hotels are proportionately much worse, falling by a half of the

historic values (as the fair values of the hotel segment are exactly double thehistorical values). Fair value adjusted figures may even lead one to question thefuture of the hotel activities. However, before making any conclusions animportant issue should be considered. Although the reported profit of the hotelsis poor, the market values of its segment assets have increased by a net $90million. New net investment in hotel capital expenditure is $64 million ($104m –$40m disposal); this leaves an increase in value of $26 million. The majority ofthis appears to be from market value increases. Whilst this is not a realised profit,it is nevertheless a significant and valuable gain (equivalent to 65% of the groupreported net profit).

ConclusionAlthough the company’s overall performance has deteriorated in the currentyear, it is clear that at least some areas of the business have had considerable newinvestment which may take some time to produce returns. This applies to thehotel segment in particular and may explain its poor performance, which is alsopartly offset by the strong increase in the market value of its assets.

Appendix

Further segment ratios Carpeting Hotels House

buildingReturn on net assets at fair values (35/97 × 100%) 36.1% 8.3% 30.2%Asset turnover on fair values (times) (90/97) 0.9 0.5 1.1

Note : Workings have been shown for the figures for the carpeting segment only, thefigures for the other segments are based on similar calculations.





11 Planter

Planter: Statement of cash flows for the year to 31 March 2012$ $

Cash flows from operating activities

Net profit before interest and tax (per question) 17,900Adjustments:Depreciation – buildings (W1) 1,800

– plant (W2) 26,60028,400

Loss on sale of plant (W1) 4,200Profit on sale of investments (11,000 – 8,700) (2,300)

48,200Decrease in inventory (57,400 – 43,300) 14,100Increase in receivables (50,400 – 28,600) (21,800)Decrease in payables (31,400 – 26,700) (4,700)Cash generated from operations 35,800Interest paid (1,700 – 300 accrued) (1,400)Income tax paid (8,900 + 1,100) (10,000)Net cash from operating activities 24,400Cash flows from investing activitiesPurchase of plant (W1) (38,100)Purchase of land and buildings (W1) (7,100)Investment income 400

Sale of plant (W1) 7,800Sale of investments 11,000Net cash used in investing activities (26,000)Cash flows from financing activitiesIssue of ordinary shares (W2) 28,000Redemption of 8% loan notes (3,400)Ordinary dividend paid (26,100)Net cash used in financing activities (1,500)Net decrease in cash and cash equivalents (3,100)

Cash and cash equivalents at 1 April 2011 1,200Cash and cash equivalents at 31 March 2012 (1,900)

Workings

(W1) Non-current assets

$Land and buildingsOpening balance 49,200Revaluation surplus (18,000 – 12,000) 6,000

55,200

Closing balance 62,300Acquisitions – balancing figure 7,100





$Accumulated depreciation: opening balance 5,000Accumulated depreciation: closing balance 6,800

Depreciation charge for year – balancing figure 1,800

$PlantOpening balance at cost 70,000Disposals at cost (23,500)

46,500Closing balance at cost 84,600Acquisitions – balancing figure 38,100

Accumulated depreciation: opening balance 22,500

Accumulated depreciation: disposals (11,500)11,000

Accumulated depreciation: closing balance 37,600Depreciation charge for year – balancing figure 26,600Disposal of plant: $Disposal at net book value 12,000Sale proceeds (given in the question) (7,800)Loss on sale 4,200

(W2) Share capital and share premium$m

Opening balance, ordinary shares 25,000Bonus issue 1 for 10 (from share premium) 2,500

27,500Closing balance, ordinary shares 50,000Difference: shares issued for cash (nominal value) 22,500Opening balance, share premium 5,000Bonus issue (2,500)

2,500Closing balance, share premium 8,000Increase in premium on cash issue of shares 5,500

Total cash proceeds of share issue 28,000

12 Casino

(a)CasinoStatement of cash flows for the Year to 31 March 2012

$m $mCash flows from operating activitiesOperating loss (32)

Adjustments for:





CasinoStatement of cash flows for the Year to 31 March 2012

$m $mDepreciation – buildings (W1) 12

– plant (W2) 81– intangibles (510 – 400) 110

Loss on disposal of plant (from question) 12215

Operating profit before working capital changes 183Decrease in inventory (420 – 350) 70Increase in trade receivables (808 – 372) (436)Increase in trade payables (530 – 515) 15Cash generated from operations (168)Interest paid (16)Income tax paid (W3) (81)

Net cash used in operating activities (265)

Cash flows from investing activitiesPurchase of – land and buildings (W1) (110)

– plant (W2) (60)Sale of plant (W2) 15Interest received (12 – 5 + 3) 10Net cash used in investing activities (145)

Cash flows from financing activities

Issue of ordinary shares (100 + 60) 160Issue of 8% variable rate loan (160 – 2 issue costs) 158Repayments of 12% loan (150 + 6 penalty) (156)Dividends paid (25)Net cash from financing activities 137Net decrease in cash and cash equivalents (273)Cash and cash equivalents at beginning of period (120 + 75) 195Cash and cash equivalents at end of period (125 – (32 + 15)) (78)

Interest and dividends received and paid may be shown as operating cash flowsor as investing or financing activities as appropriate.

Workings (in $ million)(W1) Land and buildings

Net book value b/f 420Revaluation gains 70Depreciation for year (12)Net book value c/f (588)

Difference is cash purchases (110)





(W2) Plant:Cost b/f 445Additions from question 60Balance c/f (440)Difference is cost of disposal 65Loss on disposal (12)Proceeds (15)Difference accumulated depreciation of plant disposed of 38

Depreciation b/f 105Less – disposal (above) (38)Depreciation c/f (148)Charge for year (81)

(W3) Taxation:

Tax provision b/f (110)Deferred tax b/f (75)Income statement net charge (1)Tax provision c/f 15Deferred tax c/f 90

Difference is cash paid (81)

(W4) Revaluation reserve:

Balance b/f 45Revaluation gains 70

Transfer to retained earnings (3)Balance c/f 112

(W5) Retained earnings:

Balance b/f 1,165Loss for period (45)Dividends paid (25)Transfer from revaluation reserve 3

Balance c/f 1,098

(b) The accruals/matching concept applied in preparing an income statement hasthe effect of smoothing cash flows for reporting purposes. This practice arose because interpreting ‘raw’ cash flows can be very difficult and the accrualsprocess has the advantage of helping users to understand the underlyingperformance of a company. For example if an item of plant with an estimated lifeof five years is purchased for $100,000, then in the statement of cash flows for thefive year period there would be an outflow in year 1 of the full $100,000 and nofurther outflows for the next four years. Contrast this with the income statementwhere by applying the accruals principle, depreciation of the plant would give acharge of $20,000 per annum (assuming straight-line depreciation). Many would

see this example as an advantage of an income statement, however it is importantto realise that profit is affected by many subjective items. This has led to





accusations of profit manipulation or creative accounting, hence thedisillusionment of the usefulness of the income statement.Another example of the difficulty in interpreting cash flows is that counter-intuitively a decrease in overall cash flows is not always a bad thing (it mayrepresent an investment in extra productive capacity). Nor is an increase in cashflows necessarily a good thing, since this may be from the sale of non-currentassets because of the need to raise cash urgently.The advantages of cash flows are:

it is difficult to manipulate cash flows, they are real and possess thequalitative characteristic of objectivity (as opposed to subjective profits).

cash flows are an easy concept for users to understand, indeed many usersmisinterpret income statement items as being cash flows.

cash flows help to assess a company’s liquidity, solvency and financialadaptability. Healthy liquidity is vital to a company’s going concern.

many business investment decisions and company valuations are based onprojected cash flows.

the ‘quality’ of a company’s operating profit is said to be confirmed byclosely correlated cash flows. Some analysts take the view that if acompany shows a healthy operating profit, but has low or negativeoperating cash flows, there is a suspicion of profit manipulation or creativeaccounting.

13 Minster

(a) Statement of cash flows of Minster for the Year ended 30 September 2012:

$000 $000Cash flows from operating activitiesProfit before tax 142Adjustments for:Depreciation of property, plant and equipment 255Amortisation of software (180 – 135) 45 300

Investment income (20)Finance costs 40

462

Working capital adjustmentsDecrease in trade receivables (380 – 270) 110

$000 $000Increase in amounts due from construction contracts (80 – 55) (25)Decrease in inventories (510 – 480) 30Decrease in trade payables (555 – 350) (205) (90)

Cash generated from operations 372Interest paid (40 – 12 re unwinding of environmental provision) (28)Income taxes paid (w (ii)) (54)

Net cash from operating activities 290Cash flows from investing activities





$000 $000Purchase of – property, plant and equipment (w (i)) (410)– software (180)– investments (150 – (15 + 125)) (10)Investment income received (20 – 15 gain on investments) 5

Net cash used in investing activities (595)Cash flows from financing activitiesProceeds from issue of equity shares (w (iii)) 265Proceeds from issue of 9% loan note 120Dividends paid (500 x 4 x 5 cents) (100)

Net cash from financing activities 285

Net decrease in cash and cash equivalents (20)Cash and cash equivalents at beginning of period (40 – 35) (5)

Cash and cash equivalents at end of period (25)

Note: interest paid may be presented under financing activities and dividendspaid may be presented under operating activities.Workings (in $’000)(i) Property, plant and equipment:

carrying amount b/f 940non-cash environmental provision 150revaluation 35depreciation for period (255)carrying amount c/f (1,280)

difference is cash acquisitions (410)

(ii) Taxation:tax provision b/f (50)deferred tax b/f (25)income statement charge (57)tax provision c/f 60deferred tax c/f 18

difference is cash paid (54)

(iii) Equity shares balance b/f (300)

bonus issue (1 for 4) (75) balance c/f 500

difference is cash issue 125

Share premium balance b/f (85) bonus issue (1 for 4) 75 balance c/f 150

difference is cash issue 140

Therefore the total proceeds of cash issue of shares are $265,000 (125 + 140).





(b) Report on the financial position of Minster for the year ended 30 September 2012To:From:Date:

Minster shows healthy operating cash inflows of $372,000 (prior to finance costsand taxation). This is considered by many commentators as a very importantfigure as it is often used as the basis for estimating the company ’s futuremaintainable cash flows. Subject to (inevitable) annual expected variations andallowing for any changes in the company ’s structure this figure is more likely to be repeated in the future than most other figures in the statement of cash flowswhich are often ‘one-off ’ cash flows such as raising loans or purchasing non-current assets. The operating cash inflow compares well with the underlyingprofit before tax $142,000. This is mainly due to depreciation charges of $300,000 being added back to the profit as they are a non-cash expense. The cash inflowgenerated from operations of $372,000 together with the reduction in net workingcapital of $90,000 is more than sufficient to cover the company ’s taxationpayments of $54,000, interest payments of $28,000 and the dividend of $100,000and leaves an amount to contribute to the funding of the increase in non-currentassets. It is important that these short term costs are funded from operating cashflows; it would be of serious concern if, for example, interest or income taxpayments were having to be funded by loan capital or the sale of non-currentassets.There are a number of points of concern. The dividend of $100,000 gives adividend cover of less than one (85/100 = 0 ·85) which means the company hasdistributed previous year ’s profits. This is not a tenable situation in the long-term. The size of the dividend has also contributed to the lower cash balances(see below). There is less investment in both inventory levels and tradereceivables. This may be the result of more efficient inventory control and bettercollection of receivables, but it may also indicate that trading volumes may befalling. Also of note is a large reduction in trade payable balances of $205,000.This too may be indicative of lower trading (i.e. less inventory purchased oncredit) or pressure from suppliers to pay earlier. Without more detailedinformation it is difficult to come to a conclusion in this matter.Investing activities:

The statement of cash flows shows considerable investment in non-current assets,in particular $410,000 in property, plant and equipment. These acquisitionsrepresent an increase of 44% of the carrying amount of the property, plant andequipment as at the beginning of the year. As there are no disposals, the increasein investment must represent an increase in capacity rather than the replacementof old assets. Assuming that this investment has been made wisely, this should bode well for the future (most analysts would prefer to see increased investmentrather than contraction in operating assets). An unusual feature of the requiredtreatment of environmental provisions is that the investment in non-currentassets as portrayed by the statement of cash flows appears less than if statementof financial position figures are used. The statement of financial position at 30September 2012 includes $150,000 of non-current assets (the discounted cost ofthe environmental provision), which does not appear in the cash flow figures asit is not a cash ‘cost’. A further consequence is that the ‘unwinding ’ of thediscounting of the provision causes a financing expense in the income statement





which is not matched in the statement of cash flows as the unwinding is not acash flow. Many commentators have criticised the required treatment ofenvironmental provisions because they cause financing expenses which are not(immediate) cash costs and no ‘loans ’ have been taken out. Viewed in this light, itmay be that the information in the statement of cash flows is more useful than

that in the income statement and statement of financial position.Financing activities:

The increase in investing activities (before investment income) of $600,000 has been largely funded by an issue of shares at $265,000 and raising a 9% $120,000loan note. This indicates that the company ’s shareholders appear reasonablypleased with the company's past performance (or they would not be very willingto purchase further shares). The interest rate of the loan at 9% seems quite high,and virtually equal to the company ’s overall return on capital employed of 9 ·1%(162/(1,660 + 120)). Provided current profit levels are maintained, it should notreduce overall returns to shareholders.

Cash position:The overall effect of the year ’s cash flows has worsened the company ’s cashposition by an increased net cash liability of $20,000. Although the company ’sshort term borrowings have reduced by $15,000, the cash at bank of $35,000 at the beginning of the year has now gone. In comparison to the cash generation abilityof the company and considering its large investment in non-current assets, this$20,000 is a relatively small amount and should be relieved by operating cashinflows in the near future.Summary

The above analysis shows that Minster has invested substantially in new non-

current assets suggesting expansion. To finance this, the company appears tohave no difficulty in attracting further long-term funding. At the same time thereare indications of reduced inventories, trade receivables and payables which maysuggest the opposite i.e. contraction. It may be that the new investment is achange in the nature of the company ’s activities (e.g. mining) which has differentworking capital characteristics. The company has good operating cash flowgeneration and the slight deterioration in short term net cash balance should only be temporary.Yours ………………… ..

14 Pinto(a) Statement of cash flows of Pinto for the Year to 31 March 2012:

Cash flows from operating activities $’000 $’000Profit before tax 440Adjustments for:Depreciation of property, plant and equipment 280Loss on sale of property, plant and equipment 90 370

–––––––Increase in warranty provision (200 – 100) 100Investment income (60)Finance costs 50

Redemption penalty costs included in administrative expenses 20–––––––920





$’000 $’000Working capital adjustmentsIncrease in inventories (1,210 – 810) (400)Decrease in trade receivables (540 – 480) 60Increase in trade payables (1,410 – 1,050) 360 20

––––––– –––––––Cash generated from operations 940Finance costs paid (50)Income tax refund (w (ii)) 60

–––––––Net cash from operating activities 950Cash flows from investing activitiesPurchase of property, plant and equipment (w (i)) (1,440)Sale of property, plant and equipment (240 – 90) 150Investment income received

(60 – 20 gain on investment property) 40–––––––

Net cash used in investing activities (1,250)Cash flows from financing activitiesProceeds from issue of equity shares (400 + 600) 1,000Redemption of loan notes (400 plus 20 penalty) (420)Dividends paid (1,000 x 5 x 3 cents) (150)

–––––––Net cash from financing activities 430

–––––––Net increase in cash and cash equivalents 130Cash and cash equivalents at beginning of period (120)

–––––––Cash and cash equivalents at end of period 10

–––––––Note: investment income received and dividends paid may alternatively beshown in operating activities.

Workings (in $’000)(i) Property, plant and equipment:

carrying amount b/f 1,860revaluation 100depreciation for period (280)disposal (240)carrying amount c/f (2,880)

–––––––difference is cash acquisitions (1,440)

–––––––(ii) Income tax:tax asset b/f 50deferred tax b/f (30)income statement charge (160)tax provision c/f 150deferred tax c/f 50

–––––––difference is cash received 60

–––––––(b) Comments on the cash management of Pinto

Operating cash flows:

Pinto’s operating cash inflows at $940,000 (prior to investment income, financecosts and taxation) are considerably higher than the equivalent profit before





investment income, finance costs and tax of $430,000. This shows a satisfactorycash generating ability and is more than sufficient to cover finance costs, taxation(see later) and dividends. The major reasons for the cash flows being higher thanthe operating profit are due to the (non-cash) increases in the depreciation andwarranty provisions. Working capital changes are relatively neutral; a large

increase in inventory appears to be being financed by a substantial increase intrade payables and a modest reduction in trade receivables. The reduction intrade receivables is perhaps surprising as other indicators point to an increase inoperating capacity which has not been matched with an increase in tradereceivables. This could be indicative of good control over the cash managementof the trade receivables (or a disappointing sales performance).An unusual feature of the cash flow is that Pinto has received a tax refund of$60,000 during the current year. This would indicate that in the previous yearPinto was making losses (hence obtaining tax relief). Whilst the current year’sprofit performance is an obvious improvement, it should be noted that nextyear’s cash flows are likely to suffer a tax payment (estimated at $150,000 incurrent liabilities at 31 March 2012) as a consequence. In any forward planning,Pinto should be aware that the tax reversal position will create an estimated totalincremental outflow of $210,000 in the next period.Investing activities:

There has been a dramatic investment/increase in property, plant andequipment. The carrying value at 31 March 2012 is substantially higher than ayear earlier (admittedly $100,000 is due to revaluation rather than a purchase). Itis difficult to be sure whether this represents an increase in operating capacity oris the replacement of the plant disposed of. (The voluntary disclosure encouraged by IAS 7 Statement of cash flowswould help to assess this issue more accurately).

However, judging by the level of the increase and the (apparent) overallimprovement in profit position, it seems likely that there has been a successfulincrease in capacity. It is not unusual for there to be a time lag before increasedinvestment reaches its full beneficial effect and in this context it could bespeculated that the investment occurred early in the accounting year (because itseffect is already making an impact) and that future periods may show evengreater improvements.The investment property is showing a good return which is composed of rentalincome (presumably) of $40,000 and a valuation gain of $20,000.Financing activities:It would appear that Pinto’s financial structure has changed during the year.Debt of $400,000 has been redeemed (for $420,000) and there has been a shareissue raising $1 million. The company is now nil geared compared to modestgearing at the end of the previous year. The share issue has covered the cost ofredemption and contributed to the investment in property, plant and equipment.The remainder of the finance for the property, plant and equipment has comefrom the very healthy operating cash flows. If ROCE is higher than the financecost of the loan note at 6% (nominal) it may call into question the wisdom of theearly redemption especially given the penalty cost (which has been classifiedwithin financing activities) of the redemption.Cash position:

The overall effect of the year’s cash flows is that they have improved thecompany’s cash position dramatically. A sizeable overdraft of $120,000, which





may have been a consequence of the (likely) losses in the previous year, has beenreversed to a modest bank balance of $10,000 even after the payment of a$150,000 dividend.SummaryThe above analysis indicates that Pinto has invested substantially in renewingand/or increasing its property, plant and equipment. This has been financedlargely by operating cash flows, and appears to have brought a dramaticturnaround in the company’s fortunes. All the indications are that the futurefinancial position and performance will continue to improve.

15 Coaltown

(a) Coaltown – Statement of cash flows for the year ended 31 March 2012:

$’000 $’000Cash flows from operating activitiesProfit before tax 10,200Adjustments for:depreciation of non-current assets (w (i)) 6,000loss on disposal of displays (w (i)) 1,500 7,500

––––––––interest expense 600increase in warranty provision (1,000 – 300) 700increase in inventory (5,200 – 4,400) (800)increase in receivables (7,800 – 2,800) (5,000)decrease in payables (4,500 – 4,200) (300)

––––––––Cash generated from operations 12,900Interest paid (600)Income tax paid (w (ii)) (5,500)

––––––––Net cash from operating activities 6,800Cash flows from investing activities (w (i))Purchase of non-current assets (20,500)Disposal cost of non-current assets (500)

––––––––Net cash used in investing activities (21,000)

––––––––(14,200)

Cash flows from financing activities:Issue of equity shares (8,600 capital + 4,300 premium) 12,900

Issue of 10% loan notes 1,000Equity dividends paid (4,000)

––––––––Net cash from financing activities 9,900

––––––––Net decrease in cash and cash equivalents (4,300)Cash and cash equivalents at beginning of period 700

––––––––Cash and cash equivalents at end of period (3,600)

––––––––Workings $’000(i) Non-current assets

CostBalance b/f 80,000





$’000 $’000Revaluation (5,000 – 2,000 depreciation) 3,000Disposal (10,000)Balance c/f (93,500)

––––––––Cash flow for acquisitions 20,500

––––––––DepreciationBalance b/f 48,000Revaluation (2,000)Disposal (9,000)Balance c/f (43,000)

––––––––Difference – charge for year 6,000

––––––––Disposal of displaysCost 10,000

Depreciation (9,000)Cost of disposal 500––––––––

Loss on disposal 1,500––––––––

(ii) Income tax paid: $’000Provision b/f (5,300)Income statement tax charge (3,200)Provision c/f 3,000

––––––––Difference cash paid (5,500)

––––––––

(b) (i) Workings – all monetary figures in $’000(note: references to 2011 and 2012 should be taken as to the years ended 31March 2011 and 2012)The effect of a reduction in purchase costs of 10% combined with areduction in selling prices of 5%, based on the figures from 2011, would be:Sales (55,000 x 95%) 52,250Cost of sales (33,000 x 90%) (29,700)

–––––––Expected gross profit 22,550

–––––––

This represents an expected gross profit margin of 43·2% (22,550/52,250 x100)The actual gross profit margin for 2012 is 33·4% (22,000/65,800 x 100)

(ii) The directors’ expression of surprise that the gross profit in 2012 has notincreased seems misconceived.A change in the gross profit margin does not necessarily mean there will bean equivalent change in the absolute gross profit. This is because the grossprofit figure is the product of the gross profit margin and the volume ofsales and these may vary independently of each other. That said, in thiscase the expected gross profit margin in 2012 shows an increase over that

earned in 2011 (to 43·2% from 40·0% (22,000/55,000 x100)) and the saleshave also increased, so it is understandable that the directors expected a





higher gross profit. As the actual gross profit margin in 2012 is only 33·4%,something other than the changes described by the directors must haveoccurred. Possible reasons for the reduction are:The opening inventory being at old (higher) cost and the closing inventoryis at the new (lower) cost will have caused slight distortion.Inventory write downs due to damage/obsolescence.A change in the sales mix (i.e. from higher margin sales to lower marginsales).New (lower margin) products may have been introduced from other newsuppliers.Some selling prices may have been discounted because of sales promotions.Import duties (perhaps not allowed for by the directors) or exchange ratefluctuations may have caused the actual purchase cost to be higher than thetrade prices quoted by the new supplier.

Change in cost classification: some costs included as operating expenses in2011 may have been classified as cost of sales in 2012 (if intentional andmaterial this should be treated as a change in accounting policy) – forexample it may be worth checking that depreciation has been properlycharged to operating expenses in 2012.The new supplier may have put his prices up during the year due tomarket conditions. Coaltown may have felt it could not pass these increaseson to its customers.

(iii) Note – all monetary figures in $’000Trade receivables collection period in 2011:

2,800/28,500 x 365 = 35·9 daysApplying the 35·9 days collection period to the credit sales made in 2012:

53,000 x 35·9/365 = 5,213, the actual receivables are 7,800 thuspotentially increasing the bank balance by 2,587.

A similar exercise with the trade payables period in 2011:4,500/33,000 x 365 = 49·8 days

Note the 33,000 above is the cost of sales for 2011. This was the same as thecredit purchases as there was no change in the value of inventory.However, in 2012 the credit purchases will be 44,600 (43,800 + 5,200 closing

inventory – 4,400 opening inventory).Applying the 49·8 days payment period to purchases made in 2012 gives:

44,600 x 49·8/365 = 6,085, the actual payables are 4,200 thuspotentially increasing the bank balance by 1,885.

Inevitably a shortening of the period of credit offered by suppliers andlengthening the credit offered to customers will put a strain on cashresources. For Coaltown the combination of maintaining the same creditperiods for both trade receivables and payables would have led to areduction in cash outflows of 4,472 (2,587 + 1,885), which would haveeliminated the overdraft of 3,600 leaving a balance in hand of 872.





16 Crosswire

(a) (i) Non-current assetsProperty, plant and equipment $’000Carrying amount b/f 13,100

Mine (5,000 + 3,000 environmental cost) 8,000Revaluation (2,000/0·8 allowing for effect of deferred tax transfer) 2,500Fair value of leased plant 10,000Plant disposal (500)Depreciation (3,000)Replacement plant (balance) 2,400

––––––––Carrying amount c/f 32,500

––––––––Development costsCarrying amount b/f 2,500Additions during year 500

Amortisation and impairment (balance) (2,000)––––––––Carrying amount c/f 1,000

––––––––(ii) Cash flows from investing activities

Purchase of property, plant and equipment (w (i)) (7,400)Disposal proceeds of plant 1,200Development costs (500)

––––––––Net cash used in investing activities (6,700)

––––––––Cash flows from financing activities:Issue of equity shares (w (ii)) 2,000

Redemption of convertible loan notes ((5,000 – 1,000) x 25%) (1,000)Lease obligations (w (iii)) (3,200)Interest paid (400 + 350) (750)

––––––––Net cash used in financing activities (2,950)

––––––––Workings (figures in brackets in $’000)(i) The cash elements of the increase in property, plant and equipment are $5

million for the mine (the capitalised environmental provision is not a cashflow) and $2·4 million for the replacement plant making a total of $7·4million.

(ii) Of the $4 million convertible loan notes (5,000 – 1,000) that were redeemedduring the year, 75% ($3 million) of these were exchanged for equity shareson the basis of 20 new shares for each $100 in loan notes. This would create600,000 (3,000/100 x 20) new shares of $1 each and share premium of $2·4million (3,000 – 600). As 1 million (5,000 – 4,000) new shares were issued intotal, 400,000 must have been for cash. The remaining increase (after theeffect of the conversion) in the share premium of $1·6 million (6,000 – 2,000 b/f – 2,400 conversion) must relate to the cash issue of shares, thus cashproceeds from the issue of shares is $2 million (400 nominal value + 1,600premium).

(iii) The initial lease obligation is $10 million (the fair value of the plant). At 30September 2012 total lease obligations are $6·8 million (5,040 + 1,760), thusrepayments in the year were $3·2 million (10,000 – 6,800).





(b) Taking the definition of ROCE from the question:Year ended 30 September 2012 $’000

Profit before tax and interest on long-term borrowings(4,000 + 1,000 + 400 + 350) 5,750Equity plus loan notes and finance lease obligations(19,200 + 1,000 + 5,040 + 1,760) 27,000ROCE 21·3%Equivalent for year ended 30 September 2011(3,000 + 800 + 500) 4,300(9,700 + 5,000) 14,700ROCE 29·3%To help explain the deterioration it is useful to calculate the components of ROCEi.e. operating margin and net asset turnover (utilisation):

2012 2011Operating margin (5,750/52,000 x 100) 11·1% (4,300/42,000) 10·2%Net asset turnover (52,000/27,000) 1·93 times (42,000/14,700) 2·86 timesFrom the above it can be clearly seen that the 2012 operating margin hasimproved by nearly 1% point, despite the $2 million impairment charge on thewrite down of the development project. This means the deterioration in theROCE is due to poorer asset turnover. This implies there has been a decrease inthe efficiency in the use of the company’s assets this year compared to last year.Looking at the movement in the non-current assets during the year reveals somemitigating points:The land revaluation has increased the carrying amount of property, plant andequipment without any physical increase in capacity. This unfavourably distortsthe current year’s asset turnover and ROCE figures.The acquisition of the platinum mine appears to be a new area of operation forCrosswire which may have a different (perhaps lower) ROCE to other previousactivities or it may be that it will take some time for the mine to come to fullproduction capacity.The substantial acquisition of the leased plant was half-way through the year andcan only have contributed to the year’s results for six months at best. In futureperiods a full year’s contribution can be expected from this new investment inplant and this should improve both asset turnover and ROCE.In summary, the fall in the ROCE may be due largely to the above factors(effectively the replacement and expansion programme), rather than to pooroperating performance, and in future periods this may be reversed.It should also be noted that had the ROCE been calculated on the average capitalemployed during the year (rather than the year end capital employed), which isarguably more correct, then the deterioration in the ROCE would not have beenas pronounced.





17 Deltoid

(a) (i) Deltoid – Statement of cash flows for the year ended 31 March 2010:(Note: figures in brackets are in $ ’000)

$’000 $’000

Cash flows from operating activities:Loss before tax (1,800)Adjustments for:

depreciation of non-current assets 3,700loss on sale of leasehold property (8,800 – 200 – 8,500) 100interest expense 1,000increase in inventory (12,500 – 4,600) (7,900)increase in trade receivables (4,500 – 2,000) (2,500)increase in trade payables (4,700 – 4,200) 500

–––––– Cash deficit from operations (6,900)Interest paid (1,000)Income tax paid (w (i)) (1,900)

–––––– Net cash deficit from operating activities (9,800)Cash flows from investing activities:Disposal of leasehold property 8,500Cash flows from financing activities:Shares issued(10,000 – 8,000 – 800 bonus issue) 1,200Payment of finance lease obligations (w (ii)) (2,100)Equity dividends paid (w (iii)) (700)

–––––– Net cash from financing activities (1,600)

–––––– Net decrease in cash and cash equivalents (2,900)Cash and cash equivalents at beginning of period 1,500

–––––– Cash and cash equivalents at end of period (1,400)

–––––– Workings(i) Income tax paid:

$’000Provision b/f – current (2,500)

– deferred (800)Income statement tax relief 700

Provision c/f – current (500)– deferred 1,200––––––

Difference – cash paid (1,900)––––––

(ii) Leased plant:Balance b/f 2,500Depreciation (1,800)Leased during year (balance) 5,800

–––––– Balance c/f 6,500

–––––– Lease obligations:

Balance b/f – current (800)– non-current (2,000)





New leases (from above) (5,800)Balance c/f – current 1,700

– non-current 4,800––––––

Difference – repayment during year (2,100)––––––

(iii) Equity dividends paid:Retained earnings b/f 6,300Loss for period (1,100)Dividends paid (balance) (700)

–––––– Retained earnings c/f 4,500

–––––– (ii) The main concerns of a loan provider would be whether Deltoid would be

able to pay the servicing costs (interest) of the loan and the eventualrepayment of the principal amount. Another important aspect of grantingthe loan would be the availability of any security that Deltoid can offer.Interest cover is a useful measure of the risk of non-payment of interest.Deltoid ’s interest cover has fallen from a healthy 15 times (9,000/600) to benegative in 2010. Although interest cover is useful, it is based on profitwhereas interest is actually paid in cash. It is usual to expect interestpayments to be covered by operating cash flows (it is a bad sign wheninterest has to be paid from long-term sources of funding such as from thesale of non-current assets or a share issue).Deltoid ’s position in this light is very worrying; there is a cash deficit fromoperations of $6 ·9 million and after interest and tax payments the deficithas risen to $9 ·8 million.When looking at the prospect of the ability to repay the loan, Deltoid ’s

position is deteriorating as measured by its gearing (debt including financelease obligations/equity) which has increased to 65% (5,000 + 6,500/17,700)from 43% (5,000 + 2,800/18,300). What may also be indicative of adeteriorating liquidity position is that Deltoid has sold its leaseholdproperty and rented it back. This has been treated as a disposal, but,depending on the length of the rental agreement and other conditions ofthe tenancy agreement (which are not specified in the question) it may bethat the substance of the sale is a loan/finance leaseback (e.g. if the periodof the rental agreement was substantially the same as the remaining life ofthe property). If this were the case the company ’s gearing would increaseeven further. Furthermore, there is less value in terms of ownership of non-current assets which may be used as security (in the form of a charge onassets) for the loan. It is also noteworthy that, in a similar vein, the increasein other non-current assets is due to finance leased plant. Whilst it is correctto include finance leased plant on the statement of financial position(applying substance over form), the legal position is that this plant is notowned by Deltoid and offers no security to any prospective lender toDeltoid.Therefore, in view of Deltoid ’s deteriorating operating and cash generationperformance, it may be advisable not to renew the loan for a further fiveyears.





(b) Although the sports club is a not-for-profit organisation, the request for a loan isa commercial activity that should be decided on according to similar criteria aswould be used for other profit-orientated entities.The main aspect of granting a loan is how secure the loan would be. To thisextent a form of capital gearing ratio should be calculated; say existing long-term borrowings to net assets (i.e. total assets less current liabilities). Clearly if thisratio is high, further borrowing would be at an increased risk. The secondaryaspect is to measure the sports club ’s ability to repay the interest (and ultimatelythe principal) on the loan. This may be determined from information in theincome statement. A form of interest cover should be calculated; say the excess ofincome over expenditure (broadly the equivalent of profit) compared to (theforecast) interest payments. The higher this ratio the less risk of interest default.The calculations would be made for all four years to ascertain any trends thatmay indicate a deterioration or improvement in these ratios. As with other profit-oriented entities the nature and trend of the income should be investigated: forexample, are the club ’s sources of income increasing or decreasing, does thereported income contain ‘one-off ’ donations (which may not be recurring) etc?Also matters such as the market value of, and existing prior charges against, anyassets intended to be used as security for the loan would be relevant to thelender ’s decision-making process. It may also be possible that the sports club ’sgoverning body (perhaps the trustees) may be willing to give a personalguarantee for the loan.

Financial statements – Preparation of accounts from a trial

balance18 Petra

(a)Petra – Income statement for the year ended 30 September 2012

$000 $000Revenue: 197,800 – 12,000 (w (i)) 185,800Cost of sales (w (ii)) (128,100)――――― Gross profit 57,700

Other income – commission received (w (i)) 1,000――――― 58,700

Distribution costs 17,000Administration expenses 18,000Interest expense: 1,500 + 1,500 3,000――――

(38,000)――――― Profit before tax 20,700Income tax expense: 4,000 +1,000 + (17,600 – 15,000) (7,600)――――― Profit for the period 13,100―――――





(b)

Petra – Statement of financial position as at 30 September 2012Cost Accumulated

depreciationCarryingamount

Non-current assets (w (iii)) $000 $000 $000Property, plant and equipment 150,000 44,000 106,000Development costs 40,000 22,000 18,000―――― ―――― ――――

190,000 66,000 124,000―――― ―――― Current assetsInventories 21,300Trade receivables 24,000Bank 11,000Held for sale asset – plant (w (iii)) 6,900――――

63,200―――― Total assets 187,200―――― Equity and liabilitiesOrdinary shares of 25c each 40,000Reserves:Share premium 12,000Retained earnings: 34,000+ 13,100 47,100――――

59,100―――― 99,100

Non-current liabilities

6% loan note 50,000Deferred tax 17,600―――― 67,600

Current liabilitiesTrade payables 15,000Accrued interest 1,500Current tax payable 4,000――――

20,500―――― Total equity and liabilities 187,200――――

(c) Basic EPS

Nominal value per share: 25 centsTherefore number of shares: $40 million/25c per share = 160 million sharesEPS = $13,100,000/16 million = 8.2 cents.Diluted EPS

The existence of the directors’ share options to buy 24 million shares requires thedisclosure of a diluted EPS. The dilution effect of the options is as follows:Proceeds from options when exercised $7.2 million.

This is equivalent to buying 8 million shares at full market value (= $7.2million/90c per share).





Thus the dilutive number of shares is 16 million (- 24 million – 8 million).Diluted EPS = $13,100,000/ (160 million + 16 million) = 7.4 cents.Workings (figures are in $000)(i) Agency sales

Petra has treated the sales it made on behalf of Sharma as its own sales. Theadvice from the auditors is that these are agency sales. Thus $12 millionshould be removed from revenue and the cost of the sales of $8 million andthe $3 million ‘share’ of profit to Sharma should also be removed from costof sales. Petra should only recognise the commission of $1 million asincome.(The answer has included this as other income, but it would also beacceptable to include the commission in revenue.)

(ii) Cost of sales

$000 $000Cost of sales in trial balance 114,000Remove agency sales and Sharma profit ($8m + $3m) (11,000)

103,000Charge annual depreciation/amortisationBuildings (w (iii)) 2,000Plant (w (iii)) 6,000Deferred development expenditure (w (iii)) 8,000Impairment of development expenditure (w (iii)) 6,000Impairment of plant held for sale (w (iii)) 3,100――――

25,100――――Adjusted cost of sales 128,100――――

(iii) Non-current assets and depreciation The cost of the buildings = $60 million (= $100 million – $40 million for theland).Annual depreciation of buildings = $60 million/30 years = $2 million.IFRS 5 Non-current assets held for sale and discontinued operations requiresplant whose carrying amount will be recovered principally through sale(rather than use) to be classified as ‘held for sale’. It must be shownseparately in the statement of financial position and carried at the lower ofits carrying amount (when classified as for continuing use) and its fairvalue less estimated costs to sell. Assets classified as held for sale shouldnot be depreciated.Figures in $millions Land Buildings Plant TotalCost at start of year 40 60 66 166Less: held for sale - - (16) (16)

―――― ―――― ―――― ―――― Cost at end of year 40 60 50 150

―――― ―――― ―――― ―――― Accumulated depreciation

Start of year - 16 26 42





Figures in $millions Land Buildings Plant TotalLess: Plant held for sale (6) (6)

―――― 20

Depreciation charge: buildings 2 2Depreciation charge: plant:20% × (50 – 20) 6 6

―――― ―――― ―――― ―――― End of year - 18 26 44

―――― ―――― ―――― ――――

Carrying amount: end of year 40 42 24 106―――― ―――― ―――― ――――

Plant held for sale must be valued at $6.9 million (7,500 selling price lesscommission of 600 (7,500 × 8%)) as this is lower than its carrying amount of $10million. Thus an impairment charge of $3.1 million ($10 million – $6.9 million) isrequired for the plant held for sale and this is a charge in the income statement.

Development expenditureThis has suffered impairment as a result of disappointing sales. The asset should bewritten down to $18 million in the statement of financial position .The impairment loss should be calculated after charging amortisation of $8 million(40,000/5 years) for the current year.

$m $mCost of development expenditure in the statement of financial position 40Amortisation to beginning of year 8Amortisation charge in the year 8

16Carrying amount before revaluation 24Carrying amount after revaluation 18Impairment loss: charge to income statement 6

The carrying amount of $18 million will then be written off over the next two years.

19 Darius

(a)DariusStatement of comprehensive income for the year ended 31 March 2012

$000Revenue (w (i)) 221,800Cost of sales (w (i)) (156,200)Gross profit 65,600Operating expenses (22,400)Investment income 1,200Loss on investment property (16,000 – 13,500 w (ii)) (2,500)Financing cost (5,000 – 3,200 ordinary dividend (w (v)) (1,800)Profit before tax 40,100Income tax expense (w (iii)) (6,400)

Profit for the period 33,700Other comprehensive income





DariusStatement of comprehensive income for the year ended 31 March 2012

$000Unrealised surplus on land and building 21,000Total comprehensive income for the year 54,700

(b)Darius statement of financial position as at 31 March 2012 Non-current assets $000 $000Property, plant and equipment (w (iv)) 87,100Investment property (w (ii)) 13,500

100,600Current assetsInventories (10,500 – 300 (w (i))) 10,200Trade receivables (13,500 + 1,500 joint venture) 15,000

25,200Total assets 125,800Equity and liabilitiesOrdinary shares of 25c each 20,000Reserves:Revaluation reserve 21,000Retained earnings (w (v)) 48,000

69,00089,000

Non-current liabilitiesDeferred tax (w (iii)) 3,600

Redeemable preference shares of $1 each 10,000 13,600Current liabilitiesTrade payables (11,800 + 2,500 joint venture) 14,300Bank overdraft 900Current tax payable 8,000

23,200Total equity and liabilities 125,800Workings (figures in $000)(i)

RevenueAs stated in the question 213,800 Joint venture revenue 8,000

221,800

Cost of salesAs stated in the question 143,800Closing inventories adjustment (see below) 300 Joint venture costs 5,000Depreciation (w (iv)) – building 3,200

– plant 3,900

156,200





Note on closing inventories adjustment . The damaged inventories willrequire expenditure of $450,000 to repair them and then have an expectedselling price of $950,000. This gives a net realisable value of $500,000: astheir cost was $800,000, a write down of $300,000 is required.

(ii) The fair value model in IAS 40 Investment property requires investmentproperties to be included in the statement of financial position at their fairvalue (in this case taken to be the open market value). Any surplus ordeficit is recorded in income.

(iii)Taxation $000Provision for the year 8,000Deferred tax (see below) (1,600)

6,400

Taxable temporary differences are $12 million. At a rate of 30% this wouldrequire a statement of financial position provision for deferred tax of $3.6million. The opening provision is $5.2 million, thus a credit of $1.6 millionwill be made for deferred tax in the income statement.

(iv)Non-current assets $000Land and buildingDepreciation of the building for the year ended31 March 2012 will be (48,000/15 years)

3,200

Plant and equipmentAs stated in the trial balance 36,000 Joint venture plant 12,000

48,000Accumulated depreciation 1 April 2011 (16,800)Carrying amount prior to depreciation for the year 31,200Depreciation year ended 31 March 2012 at 12.5% (3,900)Carrying amount at 31 March 2012 27,300

Cost/valuation Accumulateddepreciation

Carryingamount

Land and building 63,000 3,200 59,800Plant and equipment 48,000 20,700 27,300

―――― ―――― ―――― Property, plant and equipment 111,000 23,900 87,100―――― ―――― ――――

(v)Retained earnings $000Balance b/f 17,500Profit for period 33,700

Ordinary dividends paid (20,000 × 4 × 4c) (3,200)

48,000





20 Danzig

(a)

DanzigIncome statement for the year ended 30 September 2012

$000 $000Revenue 295,300Cost of sales: see working (1) (180,000)Gross profit 105,300Operating expenses: see working (2) (36,600)Investment income 2,000Finance costs: Loan notes – see working (3) (3,000)

Finance lease – see working (2) (1,700)(4,700)

Profit before tax 76,000Income tax expense: see working (4) (16,000)Profit for the period 60,000

(b)

DanzigStatement of financial position as at 30 September 2012

$000 $000Non-current assetsProperty, plant and equipment: see working (5) 358,000Investments at amortised cost 92,400

450,400Current assetsInventory 23,700Trade receivables 76,400Bank 12,100

112,200Total assets 562,600Equity and liabilitiesCapital and reserves

Equity shares of $0.50 each fully paid : see working (6) 240,000Share premium: see working (6) 139,000Revaluation reserve: see working (7) 15,000Retained earnings: see working (8) 43,300

197,300437,300

Non-current liabilities3% loan notes: see working (3) 51,500Deferred tax: see working (4) 23,000Finance lease obligation: see working (2) 11,700

86,200





DanzigStatement of financial position as at 30 September 2012

$000 $000Current liabilitiesTrade payables 14,100Accrued lease finance costs: see working (2) 1,700Finance lease obligation: see working (2) 5,300Income tax payable 18,000


Workings

(1) Cost of sales $000

As given in the trial balance 134,000

Depreciation of plant and equipment: 20% × (197,000 – 47,000) 30,000

Depreciation of leased vehicles: 24,000/4 years 6,000Amortisation of leasehold property: 250,000/25 years 10,000

180,000(2) Vehicle rentals and finance lease. Operating expenses

$000Rental costs given in the trial balance 8,600Relating to finance lease (7,000)

Balance: relating to operating lease – operating expense 1,600Other operating expenses (trial balance in question) 35,000

Total operating expenses 36,600

Finance lease $000 $000Fair value of leased assets 24,000Less: First rental payment, paid in advance 1 October 2011 (7,000)

Remaining obligation, 1 October 2011 17,000Interest at 10% to 30 September 2012 (current liability) 1,700Lease payment due 1 October 2012 7,000

Capital repayment due (= balance, current liability) (5,300)Remaining lease obligation = non-current liability 11,700

(3) Loan notes Although the nominal interest rate on the loan notes is 3%, the effectiveinterest rate is 6%. The finance charge in the income statement should be based on the effective interest rate (= 6% × $50 million) = $3 million. Actualinterest paid was $1,500,000 (in trial balance); therefore the balancing$1,500,000 should be added to the loan notes obligation, to make the totalloan notes liability $50 million + $1,500,000 = $51.5 million.





(4) Taxation $000 $000

Deferred tax on taxable temporary differences (92,000 × 25%) 23,000

(= liability in the statement of financial position)

Taxable temporary differences relating to revaluation 20,000Credit to deferred tax, debit to revaluation reserve (at 25%) 5,000

18,000Deferred tax liability in the trial balance 20,000

Deferred tax: credit in the income statement 2,000

$000Income tax on profits for the year 18,000Deferred tax movement (2,000)

Tax charge in the income statement 16,000

(5) Non-current assets and depreciation

Leasehold property $000Carrying value in the trial balance (250,000 – 40,000) 210,000Amortisation charge for the year to 30 September 2012 (10,000)

200,000Re-valued amount 220,000

Transfer to revaluation reserve 20,000

The annual depreciation charges for plant and equipment and the leasedvehicles are shown in workings (1)

Cost orvaluation

Accumulateddepreciation

Carryingamount

$000 $000 $000Leasehold property 220,000 0 220,000Plant and equipment (non-leased) 197,000 77,000 120,000Leased vehicles 24,000 6,000 18,000

―――― ―――― ―――― 441,000 83,000 358,000

―――― ―――― ――――

(6) Suspense account Shares in issue at 1 October 2011 = $180,000,000/$0.50 per share = 360million.Value at 30 September 2011 = ( × $2 per share) = $720,000,000.Dividend to give a 5% yield = 5% × = $36,000,000 = dividend paid.Rights issue $000Number of shares issued (360 million × 1/3) = 120 millionNominal value of shares at 1 October 2011 180,000Rights issue: nominal value (120 million × $0.50) 60,000Nominal value of shares at 30 September 2012 240,000





Rights issue $000Cash raised from rights issue (120 million × $1.70) 204,000Nominal value of shares issued (60,000)Therefore share premium before deducting issue costs 144,000Less issue costs (5,000)Share premium 139,000

(7) Revaluation reserve $000

Revaluation of leasehold property 20,000Associated deferred tax (5,000)Revaluation reserve in the statement of financial position 15,000

(8) Retained profits $000

At 1 October 2011 (trial balance) 19,300Profit for the year 60,000Dividends paid (working (6)) (36,000)Retained profits at 30 September 2012 43,300

21 Allgone

(a)

Allgone: Income statement – Year to 31 March 2012 $000

Revenue (236,200 – 8,000 (see below)) 228,200Cost of sales (W1) (150,000)Gross profit 78,200Operating expenses (12,400)Finance costs (W2) (5,850)Profit before tax 59,950Taxation (W3) (13,100)Net profit for the period 46,850

The sale of goods to Funders is an attempt to ‘window dress’ the statement offinancial position by improving its liquidity position. It is in substance a (shortterm) loan with a finance cost of $250,000.

(b) Allgone – Statement of changes in equity – Year to 31 March 2012

Sharecapital

Revaluationreserve

Retainedearnings

Total

$000 $000 $000 $000Balance at 1 April 2011 60,000 5,000 4,350 89,350Material error (see below) (32,000) (32,000)――― ――― ――― ―――

60,000 5,000 (27,650) 57,350

Surplus on revaluation of landand buildings (W4) 40,000 40,000





Sharecapital

Revaluationreserve

Retainedearnings

Total

$000 $000 $000 $000Transferred to realised profits re building: (35,000/35 years) (1,000) 1,000 -Deficit on value of investments (1,200) (1,200)Net profit for the period 46,850 46,850――― ――― ――― ―――― Balance at 31 March 2012 60,000 42,800 20,200 123,000――― ――― ――― ―――― The discovery of the major fraud is not an extraordinary item. As it occurred inprevious years and is material it should be treated as a prior period adjustment.

(c) Allgone – Statement of financial position as at 31 March 2012 Assets $000 $000Non-current assetsSoftware (W4) 2,000Property, plant and equipment (W4) 175,000Investments (12,000 – 1,200 (W4)) 10,800

187,800Current assetsInventory (W1) 14,300Trade receivables 23,000

37,300Total assets 225,100Equity and liabilities:Ordinary shares of 25c each 60,000Reserves:Retained earnings 20,200Revaluation reserve (W4) 42,800

63,000123,000

Non-current liabilities (W5) 64,800Current liabilitiesTrade payables 15,200Bank overdraft 350In substance loan from Funders 8,000Accrued finance costs (1,200 + 250 (W2)) 1,450Taxation 11,300Preference dividend 1,000


Workings(W1) Cost of sales:

$000

Opening inventory 19,450Purchases 127,850





$000Depreciation (W4) – software 2,000Depreciation (w (iv)) – building 3,000Depreciation (w (iv)) – plant 12,000Closing inventory (8,500 – 200 + 6,000 see below) (14,300)

150,000The slow moving inventory requires a write down of $200,000 to netrealisable value of $300,000 ($500,000 – $200,000). The cost of the goods ofthe sale and repurchase agreement ($6 million) should be treated asinventory.

(W2) Finance costs: $000

Per question 2,400Accrued loan note interest (see below) 1,200

Accrued facilitating fee for in substance a loan (see below) 250Preference dividend (10% x 20,000) 2,0005,850

The loan notes have been in issue for nine months, but only six months’interest has been paid. Accrued interest of $1,200,000 is required.The substance of the sale and repurchase agreement is that it is a loan witheffective interest of $250,000, the facilitating fee. Therefore this has beentreated as a finance cost.

(W3) Taxation: $000

Provision for year 11,300Deferred tax (see below) 1,800

13,100

The difference between the tax base of the assets and their carrying value of$16 million would require a provision in the statement of financial positionfor deferred tax of $4.8 million (at 30%). The opening provision is $3million, thus an additional charge of $1·8 million is required.

(W4) Non-current assets/depreciation/revaluation: The software was purchased on 1 April 2009 with a five year life. The

depreciation for the year to 31 March 2012 will be for the third year of itslife. Using the sum of the digits method this will be 3/ 15 of the cost i.e. $2million. This will give accumulated depreciation of $8 million ($6m broughtforward+ $2m).

Land and buildings Buildings Land

$000 $000Cost 1 April 2004 80,000 20,000Five years’ depreciation (80,000 × 5/40) (10,000)――― Carrying value prior to revaluation 70,000

Valuation 1 April 2011 105,000 25,000――― ―――





Land and buildings Buildings Land

$000 $000Revaluation surplus 35,000 5,000――― ――― Depreciation year to 31 March 2012 (105,000/35 years) 3,000

Plant depreciation ((84,300 – 24,300) × 20%) 12,000

Summarising:

Cost/valuation


Net bookvalue

$000 $000 $000Land and building (25 + 105) 130,000 3,000 127,000Plant and equipment 84,300 36,300 48,000Property, plant and equipment 214,300 39,300 175,000――― ――― ――― Software 10,000 8,000 2,000――― ――― ―――

Revaluation reserve :Given in the trial balance 45,000Loss of value of investments (12,000 – (12,000 × 2.25/2.50)) (1,200)Transfer to realised profits re building (35,000/35 years) (1,000)

Balance at 31 March 2005 42,800

(W5) Non-current liabilities: Deferred tax (3,000 + 1,800) (W3) 4,80012% loan note 40,00010% Irredeemable preference shares 20,000

64,800

22 Tourmalet

(a) The sale of the plant has been incorrectly treated on two counts. Firstly even if itwere a genuine sale it should not have been included in sales and cost of sales,

rather it should have been treated as the disposal of a non-current asset. Only theprofit or loss on the disposal would be included in the income statement(requiring separate disclosure if material). However even this treatment would be incorrect. As Tourmalet will continue to use the plant for the remainder of itsuseful life, the substance of this transaction is a secured loan. Thus the receipt of$50 million for the ‘sale’ of the plant should be treated as a loan. The rentals,when they are eventually paid, will be applied partly as interest (at 12% perannum) and the remainder will be a capital repayment of the loan. In the incomestatement an accrual for loan interest of 12% per annum on $50 million for fourmonths ($2 million) is required.





(b)

Tourmalet – Income statement for the year ending 30 September 2012 $000

Continuing operations

Revenue (313,000 – 50,000 – 15,200 (discontinued) 247,800Cost of sales (W1) (128,800)Gross profit 119,000Distribution costs (26,400)Administrative expenses (W2) (20,000)Finance costs (W3) (3,800)Loss on investment properties ($10 million – $9.8 million) (200)Investment income 1,200Profit before tax 69,800Income tax expense (9,200 – 2,100) (7,100)Profit for the period from continuing operations 62,700Discontinued operationsLoss for the period from discontinued operations(15,200 – 16,000 – 3,200 – 1,500) (W4) (5,500)Profit for the period 57,200

(c) Tourmalet: Statement of changes in equity – Year to 30 September 2012 Share Revaluation Retained Total

$000 $000 $000 $000Balance at 1 October 2011 50,000 18,500 47,800 116,300

Profit for the period 57,200 57,200

Transferred to realised profit (500) 500 -

Ordinary dividends paid (2,500) (2,500)――― ――― ―――― ――――

Balance at 31 March 2012 50,000 18,000 103,000 171,000――― ――― ―――― ――――

Note : IAS 32 Financial Instruments: Presentation says redeemable preference shareshave the substance of debt and should be treated as non-current liabilities and

not as equity. This also means that preference dividends are treated as a financecost in the income statement.

Workings

(W1) Cost of sales

$000Opening inventory 26,550Purchases 158,450Transfer to plant (see (a)) (40,000)Depreciation (W2) 25,800

Closing inventory (28.5 million – 2.5 million see below) (26,000)144,800





The slow-moving inventory should be written down to its estimatedrealisable value. Despite the optimism of the Directors, it would seemprudent to base the realisable value on the best offer so far received (i.e. $2million).

(W2) Depreciation

$000Buildings 120/40 years 3,000Plant – per trial balance ((98,600 – 24,600) × 20%) 14,800Plant – plant treated as sold (40,000/5 years) 8,000

25,800

Note: Investment properties do not require depreciating under the fairvalue model in IAS 40. Instead they are revalued each year with the surplusor deficit being taken to income.For information only:

In the statement of financialposition

Cost/valuation


Netbookvalue

$000 $000 $000Land and buildings 150,000 12,000 138,000Plant – per trial balance 98,600 39,400 59,200Plant incorrectly treated as sold 40,000 8,000 32,000

229,200

(W3) Finance costs: income statement

$000Accrued interest on in-substance loan (see (a)) 2,000Preference dividends (30,000 × 6%) 1,800

3,800

(W4) The penalty on the lease has been accrued for as it would appear to beunlikely that the permission for change of use will be granted. The $1.5mhas therefore been included in the loss from discontinuing operations.

23 Chamberlain(a)

Chamberlain – Income statement – Year to 30 September 2012 $000

Revenue (246,500 + 50,000 (W1) 296,500Cost of sales (W2) (151,500)

–––––––––Gross profit 145,000Operating expenses (29,000)

–––––––––Profit before interest and tax 116,000

Interest expense (1,500 + 1,500 accrued) (3,000)–––––––––





$000Year to 30 September 2012Contract revenue – included in sales (125,000 × 40%) 50,000Contract costs – included in cost of sales (35,000 – 5,000) (30,000)

Amounts due from customers:Cost to date plus profit taken (35,000 + 20,000) 55,000Less progress billings received (30,000)

25,000

(W2) Cost of sales:Opening inventory 35,500Purchases 78,500Contract costs (W1) 30,000Research costs 25,000Depreciation (W3) – buildings 6,000

– plant 15,000Closing inventory (38,500)151,500

(W3) Non-current assets/depreciation

Buildings

A cost of $240,000 ($403,000 – $163,000 for the land) over a 40 year life givesannual depreciation of $6,000 per annum.This gives accumulated depreciation at 30 September 2012 of $66,000($60,000 + $6,000) and a carrying value of $337,000 ($403,000 – $66,000).Plant

The carrying value prior to the current year’s depreciation is $120,000($180,000 – $60,000). Depreciation at 12.5% on the reducing balance basisgives an annual charge of $15,000. This gives a carrying value at 30September 2012 of $105,000 ($120,000 – $15,000). Therefore the carryingvalue of property, plant and equipment at 30 September 2012 is $442,000($337,000 + $105,000).

(W4) Non-current liabilities 6% loan note 50,000Deferred tax 14,000

64,000

24 Tadeon

(a) Tadeon – Income statement – Year to 30 September 2012

$’000 $’000 Revenue 277,800Cost of sales (w (i)) (144,000)

Gross profit 133,800

Operating expenses (40,000 + 1,200 (w (ii))) (41,200)Investment income 2,000





$’000 $’000 Finance costs – finance lease (w (ii)) (1,500)– loan (w (iii)) (2,750) (4,250)

Profit before tax 90,350Income tax expense (w (iv)) (36,800)

Profit for the period 53,550

(b) Tadeon – Statement of financial position as at 30September 2012Non-current assets $’000 $’000Property, plant and equipment (w (v)) 299,000Investments at amortised cost 42,000

341,000

Current assetsInventories 33,300Trade receivables 53,500 86,800

Total assets 427,800

Equity and liabilitiesCapital and reserves:Equity shares of 20 cents each fully paid (w(vi)) Reserves

200,000

Share premium (w (vi)) 28,000Revaluation reserve (w (v)) Retainedearnings (w (vii))

16,00042,150 86,150

286,150

Non-current liabilities2% Loan note (w (iii)) Deferred tax (w (iv)) 51,750

14,800Finance lease obligation (w (ii)) 10,500 77,050

Current liabilitiesTrade payables 18,700Accrued lease finance costs (w (ii)) 1,500Finance lease obligation (w (ii)) 4,500Bank overdraft 1,900Income tax payable (w (iv)) 38,000 64,600


Workings (note figures in brackets are in $’000)(i) Cost of sales: $’000

Per trial balance 118,000Depreciation (12,000 + 5,000 + 9,000 w (v)) 26,000

–––––––– 144,000

––––––––

(ii) Vehicle rentals/finance lease: The total amount of vehicle rentals is $6·2 millionof which $1·2 million are operating lease rentals and $5 million is identified as





finance lease rentals. The operating rentals have been included in operatingexpenses.

Finance lease $’000Fair value of vehicles 20,000First rental payment – 1 October 2011 (5,000)

––––––––Capital outstanding to 30 September 2012 15,000Accrued interest 10% (current liability) 1,500

––––––––Total outstanding 30 September 2012 16,500

––––––––

In the year to 30 September 2013 (i.e. on 1 October 2012) the second rentalpayment of $6 million will be made, of this $1 ·5 million is for the accrued interestfor the previous year, thus $4 ·5 million will be a capital repayment. Theremaining $10 ·5 million (16,500 – (4,500 + 1,500)) will be shown as a non-currentliability.

(iii) Although the loan has a nominal (coupon) rate of only 2%, amortisation of thelarge premium on redemption, gives an effective interest rate of 5 ·5% (fromquestion). This means the finance charge to the income statement will be a totalof $2·75 million (50,000 x 5·5%). As the actual interest paid is $1 million anaccrual of $1 ·75 million is required. This amount is added to the carrying amountof the loan in the statement of financial position.

(iv) Income tax and deferred taxThe income statement charge is made up as follows: $'000 Current year’s provision 38,000Deferred tax (see below) (1,200)

36,800There are $74 million of taxable temporary differences at 30 September 2012.With an income tax rate of 20%, this would require a deferred tax liability of$14·8 million (74,000 x 20%). $4 million ($20m x 20%) is transferred to deferredtax in respect of the revaluation of the leasehold property (and debited to therevaluation reserve), thus the effect of deferred tax on the income statement is acredit of $1 ·2 million (14,800 – 4,000 – 12,000 b/f).

(v) Non-current assets/depreciation:Non-leased plantThis has a carrying amount of $96 million (181,000 – 85,000) prior to depreciationof $12 million at 121/2% reducing balance to give a carrying amount of $84million at 30 September 2012.The leased vehicles will be included in non-current assets at their fair value of$20 million and depreciated by $5 million (four years straight-line) for the yearended 30 September 2012 giving a carrying amount of $15 million at that date.The 25 year leasehold property is being depreciated at $9 million per annum(225,000/25 years). Prior to its revaluation on 30 September 2012 there would bea further year ’s depreciation charge of $9 million giving a carrying amount of$180 million (225,000 – (36,000 + 9,000)) prior to its revaluation to $200 million.Thus $20 million would be transferred to a revaluation reserve. The question saysthe revaluation gives rise to $20 million of the deductible temporary differences,at a tax rate of 20%, this would give a credit to deferred tax of $4 million which is





debited to the revaluation reserve to give a net balance of $16 million.Summarising:

Cost/valuation


Carryingamount

$,000 $,000 $,00025 year leasehold property 200,000 nil 200,000Non-leased plant 181,000 97,000 84,000Leased vehicles 20,000 5,000 15,000

401,000 102,000 299,000(vi) Suspense account

The called up share capital of $150 million in the trial balance represents 750million shares (150m/0 ·2) which have a market value at 1 October 2011 of $600million (750m x 80 cents). A yield of 5% on this amount would require a $30million dividend to be paid.A fully subscribed rights issue of one new share for every three shares held at aprice of 32c each would lead to an issue of 250 million (150m/0 ·2 x 1/3). Thiswould yield a gross amount of $80 million, and after issue costs of $2 million,would give a net receipt of $78 million. This should be accounted for as $50million (250m x 20 cents) to equity share capital and the balance of $28 million toshare premium.The receipt from the share issue of $78 million less the payment of dividends of$30 million reconciles the suspense account balance of $48 million.

(vii) Retained earnings $,000 At 1 October 2011 18,600Year to 30 September 2012 53,550less dividends paid (w (vi)) (30,000)

––––––– 42,150

–––––––

25 Llama

(a) Llama – Income statement – Year ended 30 September 2012$’000 $’000

Revenue 180,400Cost of sales (w (i)) (81,700)Gross profit 98,700–––––––

Distribution costs (11,000 + 1,000 depreciation) (12,000)Administrative expenses (12,500 + 1,000 depreciation) (13,500) (25,500)

–––––––Investment income 2,200Gain on fair value of investments (27,100 – 26,500) 600 2,800

–––––––Finance costs (w (ii)) (2,400)

–––––––Profit before tax 73,600Income tax expense (18,700 – 400 – (11,200 – 10,000) deferred tax)

(17,100)–––––––Profit for the period 56,500

–––––––





(b) Llama – Statement of financial position as at 30 September 2012$’000 $’000

AssetsNon-current assetsProperty, plant and equipment (w (iv)) 228,500Investments at fair value through profit and loss 27,100–––––––

255,600Current assetsInventory 37,900Trade receivables 35,100 73,000

––––––– –––––––Total assets 328,600

–––––––Equity and liabilitiesEquityEquity shares of 50 cents each ((60,000 + 15,000) w (iii)) 75,000

Share premium (w (iii)) 9,000Revaluation reserve (14,000 – 3,000 (w (iv))) 11,000Retained earnings (56,500 + 25,500) 82,000 102,000

––––––– –––––––177,000

Non-current liabilities2% loan note (80,000 + 1,600 (w (ii))) 81,600Deferred tax (40,000 x 25%) 10,000 91,600

–––––––Current liabilitiesTrade payables 34,700Bank overdraft 6,600Current tax payable 18,700 60,000––––––– –––––––Total equity and liabilities 328,600

–––––––

Workings (monetary figures in brackets are in $’000)(i)

Cost of sales: $’000Per question 89,200Plant capitalised (w (iv)) (24,000)Depreciation (w (iv)) – buildings 3,000

– plant 13,500––––––81,700 ––––––

(ii) The loan has been in issue for six months. The total finance charge should be based on the effective interest rate of 6%.This gives a charge of $2·4 million (80,000 x 6% x 6/12). As the actualinterest paid is $800,000 an accrual (added to the carrying amount of theloan) of $1·6 million is required.

(iii) The rights issue was 30 million shares (60 million/50 cents is 120 millionshares at 1 for 4) at a price of 80 cents this would increase share capital by

$15 million (30 million x 50 cents) and share premium by $9 million (30million x 30 cents).





(iv) Non-current assets/depreciation:Land and buildings:On 1 October 2011 the value of the buildings was $100 million (130,000 –30,000 land). The remaining life at this date was 20 years, thus the annualdepreciation charge will be $5 million (3,000 to cost of sales and 1,000 eachto distribution and administration). Prior to the revaluation at 30September 2012 the carrying amount of the building was $95 million(100,000 – 5,000). With a revalued amount of $92 million, this gives arevaluation deficit of $3 million which should be debited to the revaluationreserve. The carrying amount of land and buildings at 30 September 2012will be $122 million (92,000 buildings + 30,000 land (unchanged)).PlantThe existing plant will be depreciated by $12 million ((128,000 – 32,000) x121/2%) and have a carrying amount of $84 million at 30 September 2012.The plant manufactured for internal use should be capitalised at $24million (6,000 + 4,000 + 8,000 + 6,000).Depreciation on this will be $1·5 million (24,000 x 121/2% x 6/12). This willgive a carrying amount of $22·5 million at 30 September 2012. Thus totaldepreciation for plant is $13·5 million with a carrying amount of $106·5million (84,000 + 22,500)Summarising the carrying amounts: $’000Land and buildings 122,000Plant 106,500

–––––––Property, plant and equipment 228,500

–––––––

(c) Earnings per share (eps) for the year ended 30 September 2012Theoretical ex rights value $Holding (say) 100 at $1 100Issue (1 for 4) 25 at 80 cents 20

–––– ––––New holding 125 ex rights price is 96 cents 120

–––– ––––Weighted average number of shares120,000,000 x 9/12 x 100/96 93,750,000150,000,000 (120 x 5/4) x 3/12 37,500,000

––––––––––131,250,000––––––––––

Earnings per share ($56,500,000/131,250,000) 43 cents





26 Candel

(a) Candel – Statement of comprehensive income for the year ended 30 September2012

$’000

Revenue (300,000 – 2,500) 297,500Cost of sales (w (i)) (225,400)–––––––––

Gross profit 72,100Distribution costs (14,500)Administrative expenses (22,200 – 400 + 100 see note below) (21,900)Finance costs (200 + 1,200 (w (ii))) (1,400)

–––––––––Profit before tax 34,300(Income tax expense (11,400 + (6,000 – 5,800 deferred tax)) (11,600)

–––––––––Profit for the year 22,700Other comprehensive incomeLoss on leasehold property revaluation (w (iii)) (4,500)

–––––––––Total comprehensive income for the year 18,200

–––––––––Note: as it is considered that the outcome of the legal action against Candel isunlikely to succeed (only a 20% chance) it is inappropriate to provide for anydamages. The potential damages are an example of a contingent liability whichshould be disclosed (at $2 million) as a note to the financial statements. Theunrecoverable legal costs are a liability (the start of the legal action is a pastevent) and should be provided for in full.

(b) Candel – Statement of changes in equity for the year ended 30 September 2012

Equity Revaluation Retained Totalshares reserve earnings equity$’000 $’000 $’000 $’000

Balances at 1 October 2011 50,000 10,000 24,500 84,500Dividend (6,000) (6,000)Comprehensive income (4,500) 22,700 18,200

––––––– –––––– ––––––– –––––––Balances at 30 September 2012 50,000 5,500 41,200 96,700

––––––– –––––– ––––––– –––––––

(c) Candel – Statement of financial position as at 30 September 2012$’000 $’000

AssetsNon-current assets (w (iii))Property, plant and equipment (43,000 + 38,400) 81,400Development costs 14,800

––––––––96,200

Current assetsInventory 20,000Trade receivables 43,100 63,100

––––––– ––––––––Total assets 159,300––––––––





$’000 $’000 Equity and liabilities:Equity (from (b))Equity shares of 25 cents each 50,000Revaluation reserve 5,500

Retained earnings 41,200 46,700––––––– ––––––––96,700

Non-current liabilitiesDeferred tax 6,0008% redeemable preference shares (20,000 + 400 (w (ii))) 20,400 26,400

–––––––Current liabilitiesTrade payables (23,800 – 400 + 100 – re legal action) 23,500Bank overdraft 1,300Current tax payable 11,400 36,200

––––––– ––––––––

Total equity and liabilities 159,300––––––––

Workings (figures in brackets in $’000)

(i) Cost of sales: $’000Per trial balance 204,000Depreciation (w (iii)) – leasehold property 2,500– plant and equipment 9,600Loss on disposal of plant (4,000 – 2,500) 1,500Amortisation of development costs (w (iii)) 4,000

Research and development expensed (1,400 + 2,400 (w (iii))) 3,800––––––––225,400

––––––––(ii) The finance cost of $1 ·2 million for the preference shares is based on the

effective rate of 12% applied to $20 million issue proceeds of the shares forthe six months they have been in issue (20m x 12% x 6/12). The dividendpaid of $800,000 is based on the nominal rate of 8%. The additional $400,000(accrual) is added to the carrying amount of the preference shares in thestatement of financial position. As these shares are redeemable they aretreated as debt and their dividend is treated as a finance cost.

(iii) Non-current assets:Leasehold propertyValuation at 1 October 2011 50,000Depreciation for year (20 year life) (2,500)

––––––––Carrying amount at date of revaluation 47,500Valuation at 30 September 2012 (43,000)

––––––––Revaluation deficit 4,500

––––––––





The cost of the building of $50 million (63,000 – 13,000 land) hasaccumulated depreciation of $8 million at 30 September 2010 which is eightyears after its acquisition. Thus the life of the building must be 50 years.The brand is being amortised at $3 million per annum (30,000/10 years).The impairment occurred half way through the year, thus amortisation of$1·5 million should be charged prior to calculation of the impairment loss.At the date of the impairment review the brand had a carrying amount of$19·5 million (30,000 – (9,000 + 1,500)). The recoverable amount of the brand is its fair value of $15 million (as this is higher than its value in use of$12 million) giving an impairment loss of $4·5 million (19,500 – 15,000).Amortisation of $2·5 million (15,000/3 years x 6/12) is required for thesecond-half of the year giving total amortisation of $4 million for the fullyear.

(iii) A dividend of 4·8 cents per share would amount to $12 million (50 million x5 (i.e. shares are 20 cents each) x 4·8 cents). This is not an administrative

expense but a distribution of profits that should be accounted for throughequity.(iv) Profit on the sale of the investments has already been recorded at 2,200

(11,000 proceeds – 8,800 carrying amount)The previous cumulative net gain on this investment is included in anequity reserve. It should be transferred to retained earnings as a movementin the statement of changes in equity(not through OCI). The transfer is:(8,800 carrying amount – 7,000 original cost) = 1,800The remaining investments of $26·5 million have a fair value of $29 millionat 30 September 2011 which gives a fair value increase (credited to otherreserve) of $2·5 million.

(v) The finance cost of the convertible loan note is based on its effective rate of8% applied to $18,440,000 carrying amount at 1 October 2010 = $1,475,000(rounded). The accrual of $475,000 (1,475 – 1,000 interest paid) is added tothe carrying amount of the loan note giving a figure of $18,915,000 (18,440 +475) in the statement of financial position at 30 September 2011.

(vi) Deferred taxcredit balance required at 30 September 2011 (13,000 x 30%) 3,900 balance at 1 October 2010 (5,400)

––––––––credit (reduction in balance) to income statement 1,500

––––––––(vii) Non-current assets

Freehold property (63,000 – (8,000 + 1,000)) (w (ii)) 54,000Plant and equipment (42,200 – (19,700 + 9,000)) (w (ii)) 13,500

––––––––Property, plant and equipment 67,500

––––––––(viii) Other reserve (re investments in equity)

At 1 October 2010 5,000Transferred to retained earnings (w (iv)) (1,800)Increase in year ((w (iv)) 2,500

––––––––5,700

––––––––





28 Pricewell

(a) Pricewell –Statement of comprehensive income for the year ended 31 March 2011:

$’000

Revenue (310,000 + 22,000 (w (i)) – 6,400 (w (ii))) 325,600Cost of sales (w (iii)) (255,100)–––––––––

Gross profit 70,500Distribution costs (19,500)Administrative expenses (27,500)Finance costs (4,160 (w (v)) + 1,248 (w (vi))) (5,408)

–––––––––Profit before tax 18,092Income tax expense (4,500 +700 – (8,400 – 5,600 deferred tax) (2,400)

–––––––––Profit for the year 15,692

–––––––––(b) Pricewell – Statement of financial position as at 31 March 2011:

Assets $’000 $’000Non-current assetsProperty, plant and equipment (24,900 + 41,500 w (iv)) 66,400Current assetsInventory 28,200Amount due from customer (w (i)) 17,100Trade receivables 33,100Bank 5,500 83,900

––––––– ––––––––Total assets 150,300

––––––––Equity shares of 50 cents each 40,000Retained earnings (w (vii)) 12,592

––––––––52,592

Non-current liabilitiesDeferred tax 5,600Finance lease obligation (w (vi)) 5,7166% Redeemable preference shares (41,600 + 1,760 (w (v))) 43,360 54,676

–––––––Current liabilitiesTrade payables 33,400Finance lease obligation (10,848 – 5,716) (w (vi))) 5,132Current tax payable 4,500 43,032

––––––– ––––––––Total equity and liabilities 150,300

––––––––Workings (figures in brackets in $’000)(i) Construction contract: $'000

Selling price 50,000Estimated costTo date (12,000)To complete (10,000)Plant (8,000)

–––––––––Estimated profit 20,000–––––––––





Work done is agreed at $22 million so the contract is 44% complete(22,000/50,000).Revenue 22,000Cost of sales (= balance) (13,200)

–––––––––

Profit to date (44% x 20,000) 8,800–––––––––Cost incurred to date materials and labour 12,000Plant depreciation (8,000 x 6/24 months) 2,000Profit to date 8,800

–––––––––22,800

Cash received (5,700)–––––––––

Amount due from customer 17,100–––––––––

(ii) Pricewell is acting as an agent (not the principal) for the sales on behalf ofTrilby. Therefore the income statement should only include $1·6 million(20% of the sales of $8 million). Therefore $6·4 million (8,000 – 1,600) should be deducted from revenue and cost of sales. It would also be acceptable toshow agency sales (of $1·6 million) separately as other income.

(iii) Cost of sales $'000

Per question 234,500Contract (w (i)) 13,200Agency cost of sales (w (ii)) (6,400)Depreciation (w (iv)) – leasehold property 1,800– owned plant ((46,800 – 12,800) x 25%) 8,500– leased plant (20,000 x 25%) 5,000Surplus on revaluation of leasehold property (w (iv)) (1,500)

–––––––––255,100–––––––––

(iv) Non-current assetsLeasehold propertyvaluation at 31 March 2010 25,200depreciation for year (14 year life remaining) (1,800)

–––––––carrying amount at date of revaluation 23,400valuation at 31 March 2011 (24,900)

–––––––revaluation surplus (to income statement – see below) 1,500

–––––––

The $1·5 million revaluation surplus is credited to the income statement asthis is the partial reversal of the $2·8 million impairment loss recognised inthe income statement in the previous period (i.e. year ended 31 March2010).Plant and equipment– owned (46,800 – 12,800 – 8,500) 25,500– leased (20,000 – 5,000 – 5,000) 10,000– contract (8,000 – 2,000 (w (i))) 6,000

–––––––Carrying amount at 31 March 2011 41,500

–––––––(v) The finance cost of $4,160,000 for the preference shares is based on the

effective rate of 10% applied to $41·6 million balance at 1 April 2010. Theaccrual of $1,760,000 (4,160 – 2,400 dividend paid) is added to the carrying





amount of the preference shares in the statement of financial position. Asthese shares are redeemable they are treated as debt and their dividend istreated as a finance cost.

(vi) Finance lease liability balance at 31 March 2010 15,600interest for year at 8% 1,248lease rental paid 31 March 2011 (6,000)

–––––––total liability at 31 March 2011 10,848interest next year at 8% 868lease rental due 31 March 2012 (6,000)

–––––––total liability at 31 March 2012 5,716

–––––––(vii) Retained earnings

balance at 1 April 2010 4,900profit for year 15,692equity dividend paid (8,000)––––––– balance at 31 March 2011 12,592

–––––––

29 Dune

(a) Dune – Income statement for the year ended 31 March 2010 $’000

Revenue (400,000 – 8,000 + 12,000 (w (i) and (ii))) 404,000Cost of sales (w (iii)) (315,700)

–––––––

Gross profit 88,300Distribution costs (26,400)Administrative expenses (34,200 – 500 loan note issue costs) (33,700)Investment income 1,200Profit (gain) on investments at fair value through profit or loss

(28,000 – 26,500) 1,500Finance costs (200 + 1,950 (w (iv))) (2,150)

––––––– Profit before tax 28,750Income tax expense (12,000 – 1,400 – 1,800 (w (v))) (8,800)

––––––– Profit for the year 19,950

––––––– (b) Dune – Statement of financial position as at 31 March 2010

$’000 $’000AssetsNon-current assetsProperty, plant and equipment (w (vi)) 46,400Investments at fair value through profit or loss 28,000

––––––– 74,400

Current assetsInventory 48,000Construction contract –

amounts due from customer (w (ii)) 13,400Trade receivables (40,700 – 8,000 (w (i))) 32,700 94,100

–––––––





$’000 $’000Non-current assets held for sale (w (iii)) 33,500

––––––– Total assets 202,000

––––––– Equity and liabilities

EquityEquity shares of $1 each 60,000Retained earnings (38,400 + 19,950 – 10,000 dividend paid) 48,350

––––––– 108,350

Non-current liabilitiesDeferred tax (w (v)) 4,2005% loan notes (2012) (w (iv)) 20,450 24,650

––––––– Current liabilitiesTrade payables 52,000Bank overdraft 4,500

Accrued loan note interest (w (iv)) 500Current tax payable 12,000 69,000––––––– ––––––––

Total equity and liabilities 202,000–––––––

Workings (figures in brackets in $ ’000)(i) This appears to be a ‘cut off ’ error in that Dune has invoiced goods that are

still in inventory. The required adjustment is to remove the sale of $8million (6,000 x 100/75) from revenue and trade receivables. No adjustmentis required to cost of sales or closing inventory.

(ii) Construction contract:$’000 $’000

Agreed selling price 40,000Costs to date 8,000Costs to complete 15,000Plant (12,000 – 3,000) 9,000 (32,000)

––––––– –––––––– Total estimated profit 8,000

–––––––– Amounts for inclusion in theincome statement for the year ended 31 March 2010Revenue (40,000 x 30%) 12,000Cost of sales (balance) (9,600)

––––––––

Gross profit (8,000 x 30%) 2,400–––––––– Amounts for inclusion in the statement offinancial position as at 31 March 2010Cost to date – materials, labour and other direct costs 8,000Plant depreciation ((12,000 – 3,000) x 6/18) 3,000

–––––––– 11,000

Profit to date 2,400––––––––

13,400Payments received (nil)

––––––––

Amounts due from customer 13,400––––––––





(iii) Cost of sales$’000

Per question 294,000Construction contract (w (ii)) 9,600Depreciation of leasehold property (see below) 1,500Impairment of leasehold property (see below) 4,000Depreciation of plant and equipment ((67,500 – 23,500) x 15%) 6,600

–––––– 315,700––––––

The leasehold property must be classed as a non-current asset held for salefrom 1 October 2009 at its fair value less costs to sell. It must be depreciatedfor six months up to this date (after which depreciation ceases). This iscalculated at $1 ·5 million (45,000/15 years x 6/12). Its carrying amount at 1October 2009 is therefore $37 ·5 million (45,000 – (6,000 + 1,500)).Its fair value less cost to sell at this date is $33 ·5 million ((40,000 x 85%) – 500). It is therefore impaired by $4 million (37,500 – 33,500).

(iv) The finance cost of the loan note, at the effective rate of 10% applied to thecorrect carrying amount of the loan note of $19 ·5 million is, $1 ·95 million(the issue costs must be deducted from the proceeds of the loan note; theyare not an administrative expense). The interest actually paid is $500,000(20,000 x 5% x 6/12); however, a further $500,000 needs to be accrued as acurrent liability (as it will be paid soon). The difference between the totalfinance cost of $1 ·95 million and the $1 million interest payable is added tothe carrying amount of the loan note to give $20 ·45 million (19,500 + 950)for inclusion as a non-current liability in the statement of financial position.

(v) Deferred taxProvision required at 31 March 2010 (14,000 x 30%) 4,200Provision at 1 April 2009 (6,000)

–––––––– Credit (reduction in provision) to income statement 1,800

–––––––– (vi) Property, plant and equipment

Property, plant and equipment (67,500 – 23,500 – 6,600) 37,400Construction plant (12,000 – 3,000) 9,000

–––––––– 46,400

––––––––

30 Cavern(a) Cavern – Statement of comprehensive income for the year ended 30 September

2010$’000

Revenue 182,500Cost of sales (w (i)) (137,400)

––––––– Gross profit 45,100Distribution costs (8,500)Administrative expenses (25,000 – 18,500 dividends (w (iii))) (6,500)Investment income 700Finance costs (300 + 400 (w (ii)) + 3,060 (w (iv))) (3,760)–––––––





$’000 $’000Non-current liabilitiesProvision for decontamination costs (4,000 + 400 (w (ii))) 4,4008% loan note (w (iv)) 31,260Deferred tax (w (v)) 3,750 39,410

––––––– Current liabilitiesTrade payables 21,700Bank overdraft 4,600Current tax payable 5,600 31,900

––––––– –––––––– Total equity and liabilities 155,200

–––––––– Workings (monetary figures in brackets in $ ’000)(i) Cost of sales

Per trial balance 128,500Depreciation of building (36,000/18 years) 2,000Depreciation of new plant (14,000/10 years) 1,400Depreciation of existing plant and equipment((67,400 – 10,000 – 13,400) x 12·5%) 5,500

–––––––– 137,400

–––––––– (ii) Property, plant and equipment

The new plant of $10 million should be grossed up by the provision for thepresent value of the estimated future decontamination costs of $4 million togive a gross cost of $14 million. The ‘unwinding ’ of the provision will giverise to a finance cost in the current year of $400,000 (4,000 x 10%) to give aclosing provision of $4 ·4 million.

The gain on revaluation and carrying amount of the land and building will be:Valuation – 30 September 2009 43,000Building depreciation (w (i)) (2,000)

––––––– Carrying amount before revaluation 41,000Revaluation – 30 September 2010 41,800

––––––– Gain on revaluation 800

––––––– The carrying amount of the plant and equipment will be:New plant (14,000 – 1,400) 12,600

Existing plant and equipment(67,400 – 10,000 – 13,400 – 5,500) 38,500–––––––

51,100–––––––

(iii) Rights issue/dividends paidBased on 250 million (50 million x 5 – as shares are 20 cents each) shares inissue at 30 September 2010, a rights issue of 1 for 4 on 1 April 2010 wouldhave resulted in the issue of 50 million new shares (250 million – (250million x 4/5)). This would be recorded as share capital of $10 million(50,000 x 20 cents) and share premium of $11 million (50,000 x (42 cents – 20cents)).

The dividend of 3 cents per share paid on 30 November 2009 would have been based on 200 million shares and been $6 million. The dividend of 5





cents per share paid on 31 May 2010 would have been based on 250 millionshares and been $12 ·5 million. Therefore the total dividends paid,incorrectly included in administrative expenses, were $18 ·5 million.

(iv) Loan noteThe finance cost of the loan note, at the effective rate of 10% applied to thecarrying amount of the loan note of $30 ·6 million, is $3 ·06 million. Theinterest actually paid is $2 ·4 million. The difference between these amountsof $660,000 (3,060– 2,400) is added to the carrying amount of the loan noteto give $31 ·26 million (30,600 + 660) for inclusion as a non-current liabilityin the statement of financial position.

(v) Deferred taxProvision required at 30 September 2010(15,000 x 25%) 3,750Provision at 1 October 2009 (4,000)

–––––

Credit (reduction in provision)to income statement 250–––––

Financial statements – Amendment of draft financialstatements

31 Deltoid

(a)

Statement of financial position of Deltoid as at 31 March 2012$000 $000

Non-current assetsProperty, plant and equipment(12,110 + 600 – 20 (W1) – 120 (W3))

12,570

Current assetsInventory 3,850Trade accounts receivable 2,450Bank 250


Equity and liabilities:EquityOrdinary shares of 50c each (2,000 + 500 bonus issue) 2,500Conversion rights (equity element of convertible loan note (W4) 186

2,686





Statement of financial position of Deltoid as at 31 March 2012

$000 $000ReservesShare premium 1,000

Revaluation reserve (3,000 – 500 bonus issue) 2,500Retained earnings (W1) 3,409

6,9099,595

Non-current liabilitiesEnvironmental provision – revised amount 2,150Finance lease (W3) 3716% Convertible loan note (2,814 + 101 accrued interest (W4)) 2,915

5,436Current liabilitiesTrade accounts payable 2,820Accrued interest (W3) 24Finance lease (W3) 105Taxation 1,140


Workings (figures in $000):

(W1) Recalculation of retained earnings

Retained profit for year to 31 March 2012 from question 2,000Additional depreciation of: plant (W2) (20)

leased plant (W3) (120)

(140)Add back: lease rentals (W3) 150Addition finance costs: for loan notes (281 – 180) (W4) (101)

for leased plant (W3) (50)

(151)Additional environmental provision (245 – 180) (65)

Restated retained profit for year 1,794Retained profit b/f at 1 April 2011 from question 2,500Prior year effect of error in environmental provision:(2,150 – 1,200 – 65) (885)

Retained earnings in statement of financial position 3,409

(W2) Change of depreciation policy

Managementaccounts

Financialaccounts

Year to 31 March 2011((250 – 50) × 2,000/8,000) 50 (250 × 20%) 50Year to 31 March 2012((250 –50) × 800/8,000) 20 (200 × 20%) 40





The net effect of this is an increase in the depreciation charge of $20,000 forthe current year only.

(W3) Leased plant – This has been treated as an operating lease whereas itshould be treated as a finance lease:

$000Fair value/cost 6001st payment 1 April 2011 (75)

525Interest to 30 September 2011 (10% for 6 months) 26

5512nd payment 1 October 2011 (75)Capital outstanding at 31 March 2012 476Accrued interest to 31 March 2012 (10% for 6 months) 24Total outstanding at 31 March 2012 5003rd payment due 1 April 2012 (75)

425Interest to 30 September 2012 (10% for 6 months) 21

4464th payment 1 October 2012 (75)Capital outstanding at 31 March 2013 371

Summarising: The lease payments of $150,000 should be eliminated from expenses

and replaced with a depreciation charge of $120,000 ($600,000 × 20%p.a.)

Interest of $50,000 ($26,000 paid, $24,000 accrued) should be includedas a finance cost.

Current liabilities are $24,000 for accrued interest and $105,000($476,000 – $371,000) for the capital element of the finance lease.

Non-current liabilities are $371,000 for the capital element of thefinance lease.

(W4) The convertible loan note is a compound financial instrument and IAS 32Financial Instruments: Presentation requires that the debt element and theequity element of such instruments are accounted for separately. Theamount of the issue proceeds attributable to the conversion rights is classedas equity. This amount is normally calculated as the ‘residue ’ after the valueof the debt has been calculated:

Cashflows

Factorat 10%

Presentvalue

$000 $000Year 1 interest 180 0.91 164Year 2 interest 180 0.83 149Year 3 interest 180 0.75 135Year 4 interest, redemption premium andcapital 3,480 0.68 2,366

–––––





Cashflows

Factorat 10%

Presentvalue

$000 $000Total value of debt component 2,814

Proceeds of the issue 3,000–––––Equity component (residual amount) 186

–––––

The interest cost in the income statement should be increased from $180 to$281 (10% of 2,814) by accruing $101, and this accrual should be added tothe carrying value of the debt.

(b) Basic earnings per share

Profit attributable to ordinary shareholders (W1) $1,794,000Number of shares in issue (2.5 million × 2) 5 millionEarnings per share 35.9 cents

Diluted earnings per share

The potential dilution of the convertible loan note must be assessed. On anassumed conversion to ordinary shares there would be an increase in shares of1.5 million (3 million × 50/100). The effect on earnings is that there will also be anincrease based on the after tax finance costs saved. Although the finance costs are$281,000, only the actual interest paid of $180,000 is available for tax relief, thusthe after tax increase in earnings will be $281,000 – ($180,000 × 25%) = $236,000.The diluted earnings per share is:

Earnings (1,794 basic earnings + 236 above) $2,030,000

Number of shares (5 million + 1.5 million) 6.5 millionDiluted earnings per share 31.2 cents

32 Tintagel

(a)

$000 $000Accumulated profits at 1 April 2011 52,500Reversal of provision plant overhaul (W4) 6,000

58,500Profit for the year to 31 March 2012 47,500Lease rental charge added back (W1) 3,200Lease interest (W1) (800)Depreciation (W2) – building 2,600

– owned plant 22,000– leased plant 2,800

(27,400)Loss on investment property (15,000 – 12,400) (2,600)

Write down of inventory (W3) (2,400)Unrecorded trade payable (500)





$000 $000Reversal of provision for plant overhaul (W4) 6,000Increase in deferred tax (22.5 − 18.7) (3,800)Loan note interest (0.6 + 0.3 (W5)) (900)

18,300Accumulated profits at 31 March 2012 76,800

(b)

Tintagel – Statement of financial position as at 31 March 2012 $000 $000

Non-current assetsFreehold property (126,000 – 2,600 (W2)) 123,400Plant – owned (110,000 – 22,000 (W2)) 88,000– leased (11,200 – 2,800 (W2)) 8,400Investment property 12,400

232,200Current assetsInventory (60,400 – 2,400 (W3)) 58,000Trade receivables and prepayments 31,200Bank 13,800


Equity and liabilitiesCapital and Reserves:Ordinary shares of 25c each 150,000Reserves:Share premium 10,000Accumulated profits – 31 March 2012 (part (a)) 76,800

86,800236,800

Non-current liabilitiesDeferred tax 22,500Finance lease obligations (W1) 5,6008% Loan note (14,100 + 300 (W5)) 14,400

42,500Current liabilitiesTrade payables (47,400 + 500) 47,900Accrued lease finance interest (W1) 800Accrued loan note interest (W5) 600Finance lease obligation (W1) 2,400Taxation 4,200






Workings

(W1) Finance lease: The lease has been incorrectly treated as an operating lease. Treating it as afinance lease gives the following figures:

$000Cash price/recorded cost 11,200First instalment (reversed in income statement) (3,200)Capital outstanding at 1 April 2011 8,000

Interest at 10% p.a. to 31 March 2012 (current liability) 800The capital outstanding of $8 million must be split between current andnon-current liabilities. The second instalment payable on 1 April 2012 willcontain $800,000 of interest (8,000 × 10%), therefore the capital element inthis payment will be $2.4 million and this is a current liability. This leaves$5.6 million (8,000 – 2,400) as a non-current liability.

(W2) Depreciation

$000Buildings (130,000 × 2%) 2,600Non-leased plant (110,000 × 20%) 22,000Leased plant (11,200 × 25%) 2,800

(W3) The damaged and slow moving inventory should be written down to itsestimated realisable value. This is $3.6 million ($4 million less salescommission at 10%). Therefore the required write down is $2.4 million ($6million – $3.6 million).The unrecorded invoice would be an addition to purchases therefore adeduction from profit.

(W4) A provision for a future major overhaul does not meet the definition of aliability in IAS 37 Provisions, Contingent Liabilities and Contingent Assets andmust be reversed; this will increase the current year’s profit and theprevious year’s profit by $6 million each.

(W5) International accounting standards require issue costs, discounts on issueand premiums on redemptions of loan instruments to be included as partof the finance costs:

$000 $000

Issue proceeds (15,000 × 95%) 14,250Issue costs (150)

Initial carrying value (as per suspense account) 14,100





The carrying value of the land and buildings at 31 March 2012 is $6,710,000(7,000 – 290).Depreciation on the building element will be $240 (4,800/20 years). Therevaluation of the land and buildings will create a revaluation reserveinitially of $1,800 (6,000 – (1,000 + (4,000 – 800)). However a transfer of $80(1,600/20 building element of the revaluation) to realised profit is required.Self-constructed asset :Purchased materials 150Direct labour 800Supervision 65Design and planning costs 20Error in construction (10 + 25) (35)

1,000

Note: The cost of the error cannot be capitalised; it must therefore be

written off.(W3) Plant

Cost Depreciation31 March 2011

Carrying value

Per SofFP 5,200 3,130Disposal (900) (630)

――― ――― 4,300 2,500 1,800

――― ―――

Depreciation for the current year will be $450,000 (25% reducing balance),

giving a carrying value at 31 March 2012 of $1,350,000.

34 Wellmay

Wellmay Income Statement year ended 31 March 2012:$’000 $’000

Revenue (4,200 – 500 (w (i))) 3,700Cost of sales (w (ii)) (2,417)Gross profit 1,283Operating expenses (470 + 8 depreciation) (478)Investment property – rental income 20

– fair value loss (400 – 375) (25) (5)Finance costs (w (iii)) (113)Profit before tax 687Income tax (360 + 30 (w (v))) (390)Profit for the period 297





Statement of changes in equity – year ended 31 March 2012Equityshares

Equityoption

Revaluationreserve

Retainedearnings

Total

$’000 $’000 $’000 $’000 $’000Balances at 1 April 2011 1,200 350 2,615 4,165Equity conversion option (W4) 40 40Bonus issue (1 for 4) 300 (300)Revaluation of factory (W4) 190 190Profit for the period 297 297Dividends (400) (400)Balances at 31 March 2012 1,500 40 540 2,212 4,292

Statement of financial position as at 31 March 2012:Assets $’000Non-current assetsProperty, plant and equipment (W6) 4,390Investment property (W4) 375

4,765Current assets (1,400 + 200 inventory (W1) 1,600Total assets 6,365

Equity and liabilities (see statement of changes in equity above)Equity shares of 50 cents each 1,500Equity option (W4) 40

1,540

Reserves:Revaluation reserve 540Retained earnings 2,212

4,292Non-current liabilitiesDeferred tax (W5) 2108% Convertible loan note ((560 + 8) (W4) 568

778Current liabilities (820 – 75 (W2) 745Loan from Westwood (500 + 50 accrued interest (W1) 550


Workings (note: all figures in $ ’000) (1) Secured loan:

The ‘sale’ to Westwood is, in substance, a secured loan. The repurchase price isthe cost of sale plus compound interest at 10% for two years. The correctaccounting treatment is to reverse the sale with the goods going back intoinventory and the ‘proceeds ’ treated as a loan with accrued interest of 10%($50,000) for the current year.





(2) Cost of sales:From draft financial statements 2,700 Sale of goods added back to inventory (see above) (200) Reversal of contingency provision (see below) (75) Depreciation transferred to operating costs (40 x 20%) (8)

2,417

General or non-specific provisions do not meet the definition of a liability in IAS37 Provisions, contingent liabilities and contingent assets and must therefore bereversed.

(3) Finance costs:From draft financial statements 55 Additional accrued interest on convertible loan (w (iv)) 8 Finance cost on in-substance loan (500 x 10%) 50

113

(4) Convertible Loan:This is a compound financial instrument that contains an element of debt and anelement of equity (the option to convert). IAS 32 Financial instruments:disclosure and presentation requires that the substance of such instrumentsshould be applied to the reporting of them. The value of the debt element iscalculated by discounting the future cash flows (at 10%). The residue of the issueproceeds is recorded as the value of the equity option:

Cashflows

Discountfactor at 10%

Presentvalue $’000

Year 1 interest 48 0·91 43·6

Year 2 interest 48 0·83 39·8 Year 3 interest 48 0·75 36·0 Year 4 interest, redemption premiumand capital 648 0·68 440·6 Total value of debt component 560·0Proceeds of the issue 600·0Equity component (residual amount) 40·0For the year ended 31 March 2012, the interest cost for the convertible loan in theincome statement should be increased from $48,000 to $56,000 (10% x 560) byaccruing $8,000, which should be added to the carrying value of the debt.

(5) Taxation:The required deferred tax balance is $210,000 (600 x 35%), the current balance is$180,000, and thus a further transfer of $30,000 (via the income statement) isrequired.

(6) Properties:The fair value model in IAS 40 Investment property requires the loss of $25,000on the fair value of investment properties to be reported in the income statement.This differs from revaluations of other properties. IAS 16 Property, plant andequipment requires surpluses and deficits to be recorded as movements in equity(a revaluation reserve). After depreciation of $40,000 for the year ended 31 March

2012, the factory (used by Wellmay) would have a carrying amount of $1,160,000(1,200 – 40). The valuation of $1,350,000 at 31 March 2012 would give a further





revaluation surplus of $190,000 (1,350 – 1,160) and a carrying amount ofproperty, plant and equipment of $4,390,000 (4,200 + 190) at that date.

35 Dexon

(a)

$’000 $

’000Retained profit for period per question 96,700

Dividends paid (w (i)) 15,500–––––––

Draft profit for year ended 31 March 2012 112,200Discovery of fraud (w (ii)) (2,500)Goods on sale or return (w (iii)) (600)Depreciation (w (iv)) – buildings (165,000/15 years) 11,000– plant (180,500 x 20%) 36,100 (47,100)

–––––––Increase in investments ((12,500 x 1,296/1,200) – 12,500) 1,000Provision for income tax (11,400)Increase in deferred tax (w (v)) (800)

–––––––Recalculated profit for year ended 31 March 2012 50,800

–––––––

(b) Dexon – Statement of Changes in Equity – Year ended 31 March 2012Ordinary Share Revaluation Retained Total

shares premium reserve earnings$’000 $’000 $’000 $’000 $’000

At 1 April 2011 200,000 30,000 18,000 12,300 260,300Prior period adjustment (w (ii)) (1,500) (1,500)

––––––––Restated earnings at 1 April 2011 10,800Rights issue (see below) 50,000 10,000 60,000Total comprehensive income(from (a) and (w (iv)) 4,800 50,800 55,600Dividends paid (w (i)) (15,500) (15,500)

–––––––– ––––––– ––––––– –––––––– ––––––––At 31 March 2012 250,000 40,000 22,800 46,100 358,900

–––––––– ––––––– ––––––– –––––––– ––––––––

Rights issue: 250 million shares in issue after a rights issue of one for four wouldmean that 50 million shares were issued (250,000 x 1/5). As the issue price was$1·20, this would create $50 million of share capital and $10 million of sharepremium.

(c) Dexon – Statement of financial position as at 31 March 2012:

$’000 $’000Non-current assetsProperty (w (iv)) 180,000Plant (180,500 – 36,100 depreciation see (a)) 144,400Investments at fair value through profit and loss

(12,500 + 1,000 see (a)) 13,500–––––––337,900

Current assetsInventory (84,000 + 2,000 (w (iii))) 86,000





$’000 $’000Trade receivables (52,200 – 4,000 – 2,600 (w (ii) and (iii))) 45,600Bank 3,800 135,400

––––––– –––––––Total assets 473,300

–––––––

Equity and liabilitiesEquity (from (b))Ordinary shares of $1 each 250,000Share premium 40,000Revaluation reserve 22,800Retained earnings 46,100 108,900

––––––– –––––––358,900

Non-current liabilitiesDeferred tax (19,200 + 2,000 (w (v))) 21,200Current liabilities (81,800 + 11,400 income tax) 93,200

–––––––

Total equity and liabilities 473,300–––––––


(i) Dividends paidThe dividend in May 2011 would be $8 million (200 million shares at 4cents) and in November 2011 would be $7·5 million (250 million shares x 3cents). Total dividends would therefore have been $15·5 million.

(ii) The discovery of the fraud means that $4 million should be written offtrade receivables. $1·5 million debited to retained earnings as a prior periodadjustment (in the statement of changes in equity) and $2·5 written off inthe income statement for the year ended 31 March 2012.

(iii) Goods on sale or returnThe sales over which customers still have the right of return should not beincluded in Dexon’s recognised revenue. The reversing effect is to reducethe relevant trade receivables by $2·6 million, increase inventory by $2million (the cost of the goods (2,600 x 100/130)) and reduce the profit forthe year by $600,000.

(iv) PropertyThe carrying amount of the property (after the year’s depreciation) is $174

million (185,000 – 11,000). A valuation of $180 million would create arevaluation surplus of $6 million of which $1·2 million (6,000 x 20%) would be transferred to deferred tax.

(v) Deferred taxAn increase in the taxable temporary differences of $10 million wouldcreate a transfer (credit) to deferred tax of $2 million (10,000 x 20%). Of this$1·2 million relates to the revaluation of the property and is debited to therevaluation reserve. The balance, $800,000, is charged to the incomestatement.





36 Bodyline

(a) IAS 37 Provisions, Contingent Liabilities and Contingent Assets defines a provisionas a liability of uncertain timing or amount. There is clearly an overlap betweenprovisions and contingencies. Because of the ‘uncertainty’ aspects of thedefinition, it can be argued that to some extent all provisions have an element ofcontingency. The IASB distinguishes between the two by stating that acontingency is not recognised as a liability if it is either:(i) only possible and therefore yet to be confirmed as a liability, or(ii) where there is a liability but it cannot be measured with sufficient

reliability (although this situation should be rare).IAS 37 requires provisions to satisfy all of the following three recognition criteria:

There is a present obligation (legal or constructive) as a result of a pastevent.

It is probable that a transfer of economic benefits will be required to settle

the obligation. The obligation can be estimated reliably.

A provision is triggered by an obligating event. This must have already occurred,future events cannot create current liabilities. The first of the three criteria refersto legal or constructive obligations. A legal obligation is straightforward anduncontroversial in nature. Constructive obligations arise where a companycreates an expectation that it will meet certain obligations that it is not legally bound to meet. These may arise due to a published statement or even by apattern of past practice. In reality constructive obligations are usually accepted because the alternative action is unattractive or may damage the reputation of the

company. An example is a commitment to pay for environmental damage caused by the company, even where there is no legal obligation to do so.To summarise: a company must provide for a liability where the three definingcriteria of a provision are met, but conversely a company cannot provide for aliability where these criteria are not met.

(b) The main need for an accounting standard in this area was to clarify and regulatewhen provisions should and should not be made. In the past, it was fairlycommon to ‘abuse’ the use of provisions by creating a provision when the IAS37criteria did not exist. One of the most common yet controversial examples ofprovisioning was in relation to future restructuring or reorganisation costs (oftenas part of an acquisition). This was sometimes extended to making provisions forfuture operating losses. The attraction of providing for this type of expense/losswas that once the provision had been made, the future actual costs were thencharged to the provision and did not get reported in the income statement asthey occurred. Such provisions could be described by management as‘exceptional items’, which analysts were expected to disregard when assessingthe company’s future prospects. IAS 37 now prevents this practice as future costsand operating losses (unless they are for an onerous contract) do not constitutepast events, and so a provision cannot be created in these circumstances.Another important change initiated by IAS 37 was the way in whichenvironmental provisions are treated. IAS 37 requires that if the environmental

costs are a liability (legal or constructive), then the whole of the costs must be





provided for immediately. That has led to large liabilities appearing in thestatements of financial position of some companies.A third example of bad practice prior to IAS37 was the use of ‘big bath’provisions and over-provisioning. In its simplest form this occurred when acompany made a large provision, often for non-specific future expenses, or aspart of an overall restructuring package. If the provision was deliberately over-provided (i.e. too large), then its later release improved future profits.Alternatively the company could charge to the provision a different cost than theone it was originally created for. IAS 37 prevents this practice in two ways: bynot allowing provisions to be created if they do not meet the definition of anobligation; and specifically preventing a provision made for one expense to beused for a different expense. Under IAS 37 the original provision would have to be reversed and a new one would be created with appropriate disclosures. Whilstthis treatment does not affect overall profits, it does enhance transparency.

(c) The directors’ proposed treatment is incorrect. The replacement of the engine is

an example of what has been described as cyclic repairs or replacement. Whilst itmay seem logical and prudent to accrue for the cost of a replacement engine asthe old one is being worn out, such practice leads to double counting. Under thedirectors’ proposals the cost of the engine is being depreciated as part of the costof the asset, albeit over an incorrect time period. The solution to this problem liesin IAS 16 Property, Plant and Equipment . The plant constitutes a ‘complex’ asset i.e.one that may be thought of as having separate components within a single asset.Thus part of the plant $16.5 million (total cost of $24 million less $7.5 assumedcost of the engine) should be depreciated at $1.65 million per annum over a 10-year life and the engine should be depreciated at $1,500 per hour of use(assuming machine hour depreciation is the most appropriate method). If a

further provision of $1,500 per machine hour is made, there would be a doublecharge against profit for the cost of the engine.IAS 37 also refers to this type of provision and says that the future replacement ofthe engine is not a liability. The reasoning is that the replacement could beavoided if, for example, the company chose to sell the asset before replacementwas due. If an item does not meet the definition of a liability it cannot beprovided for.

37 Niagara

(a) All items in arriving at the profit for the financial year are included in the

calculation of the earnings per share.Earnings attributable to the ordinary shares are after the deduction of thefollowing dividends on the non-redeemable preference shares:

$8% on $1 million for full year 80,000New issue 6% on $1 million for six months 30,000Preference dividends 110,000

Earnings attributable to ordinary shares(2,585,000 – 110,000) $2,475,000





For example if a company makes a large profit in a particular period, but,perhaps because of high levels of capital expenditure, it is entitled to claimlarge tax allowances for that period, this would reduce the amount of tax ithas to pay. The result of this would be that the company would report alarge profit, but very little, if any, tax charge. This situation is usually

‘reversed’ in subsequent periods such that tax charges appear to be muchhigher than the reported profit would suggest that they should be.Such a reporting system is misleading in that the profit after tax, which isused for calculating the company’s earnings per share, may bear very littleresemblance to the pre-tax profit. This can mean that a government’s taxrules may distort a company’s profit trends. Providing for deferred taxgoes some way towards relieving this anomaly, although it can never beentirely corrected. This is because of the fact that some items of expense inthe income statement are not allowed for tax purposes.Where tax depreciation is different from the related accounting

depreciation charges this leads to the tax base of an asset being different toits carrying value on the statement of financial position (these differencesare called temporary differences) and a provision for deferred tax is made.This ‘statement of financial position liability’ approach is the generalprinciple on which IAS 12 bases the calculation of deferred tax. The effectof this is that it usually brings the total tax charge (i.e. the provision for thecurrent year’s income tax plus the deferred tax) in proportion to the profitreported to shareholders.

(ii) IAS 12 Income Taxes requires the temporary difference to be calculated andthe rate of income tax applied to this difference to give the deferred taxasset or liability. Temporary differences are the differences between thecarrying amount of an asset and its tax base.

$000 $000

Carrying value at 30 September 2012Cost of plant 2,000Accumulated depreciation at 30 September 2012(2,000 – 400)/8 years for 3 years

(600)

Carrying value 1,400

Tax base at 30 September 2012Initial tax base (original cost) 2,000Tax depreciationYear to 30 September 2010 (2,000 × 40%) 800Year to 30 September 2011 (1,200 × 20%) 240Year to 30 September 2012 (960 × 20%) 192

(1,232)Tax base 30 September 2012 768





Temporary differences at 30 September 2012: (1,400 – 768) 632Deferred tax liability at 30 September 2012: (632 × 25% tax rate) 158Income statement credit – year to 30 September 2012:((200 – 192) × 25%)

2

(b) There are two main reasons why the income tax charge in the financialstatements is not at the same rate as the stated percentage. The first reason is thattax is payable on the taxable profits of a company, which may differ considerablyfrom the accounting profit. Such differences may be because some items ofincome or expenditure included in the financial statements may be disallowablefor tax purposes (or allowed in a different accounting period) and some taxationallowances (e.g. tax depreciation allowances) are not included in the accountingprofit. These differences may be mitigated by deferred tax on temporarydifferences.

The second reason for differences is that the income tax charge does not usuallyconsist solely of the charge on the current year’s profit. Commonly the tax chargealso includes an element of deferred tax (this may be a debit or credit) andpossibly an adjustment to the previous year’s tax provision (due to it beingsettled at an amount different to the provision). Other more complex items suchas withholding taxes on income and double (dual) taxation relief may also beincluded in the tax charge.The main reason why the income tax charge in the income statement differs tothe amount for income tax in the statement of cash flows is that the tax charge inthe financial statements is a provision for tax that is normally settled in thefollowing period. This means that the cash flow figure for tax actually paid is the

amount needed to settle the previous year’s tax liability. Other differences may be due to items referred to above such as deferred tax movements that are notcash flows.

39 Broadoak

(a) (i) Although the broad principles of accounting for non-current assets are wellunderstood by the accounting profession, applying these principles topractical situations has resulted in complications and inconsistency. Forthe most part, IAS 16 codified existing good practice, but it does includespecific rules which were intended to achieve improved consistency and

more transparency.Cost

The cost of an item of property, plant and equipment comprises itspurchase price and any other costs directly attributable to bringing theasset into a working condition for its intended use. This is expanded uponas follows:

Purchase price is after the deduction of any trade discounts or rebates(but not early settlement discounts), but it does include any transportand handling costs (delivery, packing and insurance), non-refundabletaxes (e.g. sales taxes such as VAT or GST, stamp duty, import duty).

If the payment is deferred beyond normal credit terms this should be





taken into account either by the use of discounting or substituting acash equivalent price.

Directly attributable costs are the incremental costs that would have been avoided had the assets not been acquired. For self-constructedassets this includes labour costs of own employees. Abnormal costssuch as wastage and errors are excluded.

Installation costs and site preparation costs. Professional fees (e.g. legal fees, architects fees).

In addition to the ‘traditional’ costs above two further groups of cost may be capitalised:IAS 23 Borrowing Costs allows (under the allowed alternative method)directly attributable borrowing costs to be capitalised. Directly attributable borrowing costs are those that would have been avoided had there been noexpenditure on the asset.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets says that if theestimated costs of removing and dismantling an asset and restoring its sitequalify as a liability, they should be provided for and added to the cost ofthe relevant asset.Finally, the carrying amount of an asset may be reduced by any applicablegovernment grants under IAS 20 Accounting for Government Grants andDisclosure of Government Assistance.

(ii) Subsequent expenditure Traditionally the appropriate accounting treatment of subsequent expenditureon non-current assets revolved around whether it represented a revenue

expense, in effect maintenance or a repair, or whether it represented animprovement that should be capitalised. IAS 16 bases the question ofcapitalisation of subsequent expenditure on whether it results in a probablefuture economic benefit in excess of the amount originally assessed for theasset and on whether the cost of the item can be measured reliably. All othersubsequent expenditure should be recognised in the income statement as it isincurred. Examples of circumstances where subsequent expenditure should be capitalised are where it:

represents a modification that enhances the economic benefits of anasset (in excess of its previously assessed standard of performance).This could be an increase in its life or production capacity;

upgrades an asset with the effect of improving the quality of output;or

is on a new production process that reduces operating costs.In addition to the above, the Standard says it is important to take intoaccount the circumstances of the expenditure. For example, normalservicing and overhaul of plant is a revenue cost but, if the expenditurerepresents a major overhaul of an asset that restores its previous life, andthe consumption of the previous economic benefits has been reflected bypast depreciation charges, then the expenditure should be capitalised(subject to not exceeding its recoverable amount). A further example ofwhere subsequent expenditure should be capitalised is where a major





component of an asset that has been treated separately (for depreciationpurposes) is replaced or restored (e.g. new engines for an aircraft).

(b) (i) The initial measurement of the cost at which the plant would be capitalisedis calculated as follows:

$ $Basic list price of plant 240,000Less trade discount of 12.5% on list price (30,000)――――

210,000―――― Shipping and handling costs 2,750Estimated pre-production testing 12,500Site preparation costs

Electrical cable installation (14,000 – 6,000) 8,000Concrete reinforcement 4,500

Own labour costs 7,500――― 20,000

Dismantling and restoration costs (15,000 + 3,000) 18,000―――― Initial cost of plant 263,250―――― Note: The early settlement discount is a revenue item (probably deductedfrom administration costs). The maintenance cost is also a revenue item,although a proportion of it would be a prepayment at the end of the year ofacquisition (the amount would be dependent on the date of acquisition).The cost of the specification error must be charged to the income statement.

40 Merryview

Merryview income statement (extracts) – year to 31 March 2012

Note: workings in brackets are in $000 $ $Depreciation: head office – 6 months to 1 October 2011

(1,200/25 × 6/12) 24,000– 6 months to 31 March 2012

(1,350/22.5 (W1) × 6/12) 30,000

––––––– 54,000–––––––

Depreciation: training premises – 6 months to 1 October 2012(900/25 × 6/12) 18,000

– 6 months to 31 March 2012(600/10 × 6/12) 30,000

––––––––48,000

––––––––Impairment loss (W2) 210,000

––––––––258,000––––––––





Statement of financial position (extracts) as at 31 March 2012 $ $Non-current assetsLand and buildings – head office (700 + 1,350 – 30) 2,020,000

– training premises (350 + 600 – 30) 920,000

––––––––––2,940,000––––––––––

Revaluation reserveHead office land (700 – 500) 200,000Building (1,350 – 1,080 (W1)) 270,000Training premises land (350 – 300) 50,000

––––––––520,000

Transfer to realised profit (270/22.5 (W1) × 6/12 redepreciation of buildings) (6,000)

––––––––514,000––––––––

Workings

(W1) The date of the revaluation is two and a half years after acquisition. This meansthe remaining life of the head office would be 22.5 years. The carrying value ofthe head office building at the date of revaluation is $1,080,000 i.e. its cost lesstwo and a half years at $48,000 per annum ($1,200,000 – $120,000).

(W2) Impairment loss: the carrying value of training premises at date of revaluation is$810,000 i.e. its cost less two and a half years at $36,000 per annum ($900,000 –$90,000). It is revalued down to $600,000 giving a loss of $210,000. As the land andthe buildings are treated as separate assets the gain on the land cannot be used tooffset the loss on the buildings.

41 Impairment and Wilderness

(a) (i) An impairment loss arises where the carrying amount of an asset is higherthan its recoverable amount. The recoverable amount of an asset is definedin IAS 36 Impairment of Assets as the higher of its fair value less costs to selland its value in use (fair value less cost to sell was previously referred to asnet selling price). Thus an impairment loss is simply the difference betweenthe carrying amount of an asset and the higher of its fair value less costs tosell and its value in use.Fair value

The fair value could be based on the amount of a binding sale agreement orthe market price where there is an active market. However many (used)assets do not have active markets and in these circumstances the fair valueis based on a ‘best estimate’ approach to an arm’s length transaction. Itwould not normally be based on the value of a forced sale. In each case thecosts to sell would be the incremental costs directly attributable to thedisposal of the asset.Value in use





The value in use of an asset is the estimated future net cash flows expectedto be derived from the asset discounted to a present value. The estimatesshould allow for variations in the amount, timing and inherent risk of thecash flows. A major problem with this approach in practice is that mostassets do not produce independent cash flows i.e. cash flows are usually

produced in conjunction with other assets. For this reason IAS 36introduces the concept of a cash-generating unit (CGU) which is thesmallest identifiable group of assets, which may include goodwill, thatgenerates (largely) independent cash flows.Frequency of testing for impairment

Goodwill and any intangible asset that is deemed to have an indefiniteuseful life should be tested for impairment at least annually, as too shouldany intangible asset that has not yet been brought into use. In addition, atthe end of each reporting period an entity must consider if there has beenany indication that other assets may have become impaired and, if so, an

impairment test should be done. If there are no indications of impairment,testing is not required.(ii) Once an impairment loss for an individual asset has been identified and

calculated it is applied to reduce the carrying amount of the asset, whichwill then be the base for future depreciation charges. The impairment lossshould be charged to income immediately. However, if the asset haspreviously been revalued upwards, the impairment loss should first becharged to the revaluation surplus. The application of impairment losses toa CGU is more complex. They should first be applied to eliminate anygoodwill and then to the other assets on a pro rata basis to their carryingamounts. However, an entity should not reduce the carrying amount of an

asset (other than goodwill) to below the higher of its fair value less costs tosell and its value in use if these are determinable.

(b) (i) The plant had a carrying amount of $240,000 on 1 October 2011. Theaccident that may have caused impairment occurred on 1 April 2012 and animpairment test would be done at this date. The depreciation on the plantfrom 1 October 2011 to 1 April 2012 would be $40,000 (640,000 x 121/2% x6/12) giving a carrying amount of $200,000 at the date of impairment. Animpairment test requires the plant’s carrying amount to be compared withits recoverable amount. The recoverable amount of the plant is the higherof its value in use of $150,000 or its fair value less costs to sell. If Wildernesstrades in the plant it would receive $180,000 by way of a part exchange, butthis is conditional on buying new plant which Wilderness is reluctant to do.A more realistic amount of the fair value of the plant is its current disposalvalue of only $20,000. Thus the recoverable amount would be its value inuse of $150,000 giving an impairment loss of $50,000 ($200,000 – $150,000).The remaining effect on income would be that a depreciation charge for thelast six months of the year would be required. As the damage has reducedthe remaining life to only two years (from the date of the impairment) theremaining depreciation would be $37,500 ($150,000/ 2 years × 6/12).Thusextracts from the financial statements for the year ended 30 September 2012would be:





Statement of financial positionNon-current assets $Plant (150,000 – 37,500) 112,500

Income statement

Plant depreciation (40,000 + 37,500) 77,500Plant impairment loss 50,000

There are a number of issues relating to the carrying amount of the assetsof Mossel that have to be considered. It appears the value of the brand is based on the original purchase of the ‘Quencher’ brand. The company nolonger uses this brand name; it has been renamed ‘Phoenix’. Thus it wouldappear the purchased brand of ‘Quencher’ is now worthless. Mossel cannottransfer the value of the old brand to the new brand, because this would bethe recognition of an internally developed intangible asset and the brand of‘Phoenix’ does not appear to meet the recognition criteria in IAS 38. Thusprior to the allocation of the impairment loss the value of the brand should be written off as it no longer exists.The inventories are valued at cost and contain $2 million worth of old bottled water (Quencher) that can be sold, but will have to be relabelled ata cost of $250,000. However, as the expected selling price of these bottleswill be $3 million ($2 million × 150%), their net realisable value is$2,750,000. Thus it is correct to carry them at cost i.e. they are not impaired.The future expenditure on the plant is a matter for the following year’sfinancial statements.Applying this, the revised carrying amount of the net assets of Mossel’s

cash-generating unit (CGU) would be $25 million ($32 million – $7 millionre the brand). The CGU has a recoverable amount of $20 million, thus thereis an impairment loss of $5 million. This would be applied first to goodwill(of which there is none) then to the remaining assets pro rata. Howeverunder IAS2 the inventories should not be reduced as their net realisablevalue is in excess of their cost. This would give revised carrying amounts at30 September 2012 of:

$000Brand nil Land containing spa: 12,000 – [(12,000/20,000) × 5,000] 9,000Purifying and bottling plant: 8,000 – [(8,000/20,000) × 5,000] 6,000Inventories 5,000

21,000






42 Torrent contracts and Savoir EPS

(a)

Income statement for the year ended 31 March 2012Alfa Beta Ceta Total$m $m $m $m

Revenue 8.0 2.0 4.8 14.8Cost of sales (7.0) (3.5) (4.0) 14.5――― ――― ――― ――― Profit/(loss) 1.0 (1.5) 0.8 0.3――― ――― ――― ―――

Statement of financial position as at 31 March 2012

Gross amounts due from customers (see below) 2.4 4.8 7.2

Gross amounts due to customers (see below)

(1.3) (1.3)

Gross amounts from and to customers:Contract cost incurred 12.5 3.5 4.0 20.0Recognised profits less (losses) 2.5 (1.5) 0.8 1.8Provision for losses to date (1.5) (1.5)Payments received (12.6) (1.8) nil (14.4)―――

―――

―――

―――

Due from customers 2.4 4.8 7.2――― ――― ――― ――― Due to customers (contract liability) (1.3) (1.3)――― ―――

Workings (in $m)

Alfa At31 March 2011

At31 March

2012

Yearended

31 March2012

Workinvoiced

(5.4/90%) 6.0 (12.6/90%) 14.0 8.0

Cost of sales(balancing figure)

(4.5) (11.5) (7.0)

Profit (see below) 1.5 2.5 1.0Percentagecomplete

(6/20 × 100%)

30% (14/20 × 100%) 70%

Attributableprofit

($5m × 30%)

1.5 (($5m × 70%)– $1m

rectification)

2.5





Prior to the rectification costs (which must be charged to the year in which theyare incurred), the estimated total profit on the contract is $5 million ($20m –$15m).Beta

Due to the increase in the estimated cost Beta is a loss-making contract and thewhole of the loss must be provided for as soon as it is can be anticipated. The lossis expected to be $1.5 million ($7.5m – $6m). The sales value of the contract at 31March 2012 is $2 million ($1.8/90%), thus the cost of sales must be recorded as$3.5 million. As costs to date are $2 million, this means a provision of $1.5 millionis required.Ceta

Based on the costs to date at 31 March 2012 of $4 million and the total estimatedcosts of $10 million, this contract is 40% complete. The estimated profit is $2million ($12m – $10m); therefore the profit at 31 March 2012 is $0.8 million ($2m× 40%). This gives an imputed sales (and receivable) value of $4.8 million.

(b) (i) Savoir: EPS year ended 31 March 2010

The share issue on 1 July 2009 at full market value needs to be weighted:40m × 3/12 = 10m

New shares 8m48m × 9/12 = 36m

46mWithout the bonus issue this would give an EPS of 30c ($13.8m/46m).The bonus issue of one for four would result in 12 million new shares

giving a total number of ordinary shares of 60 million. The dilutive effect ofthe bonus issue would reduce the EPS to 24c (30c × 48m/60m).The comparative EPS (for 2009) would be restated at 20c (25c × 48m/60m).

EPS year ended 31 March 2011

The rights issue of two for five on 1 October 2010 is half way through theyear. The theoretical ex rights value is calculated as follows:

$Holder of 100 shares worth $2.40 240

subscribes for 40 shares at $1 40Theoretical value of 140 shares = 280

Theoretical ex-rights price = $280/140 = $2 per share.

Weighting60m × 6/12 × 2.40/2.00 = 36m

Rights issue (2 for 5) 24mNew total 84m × 6/12 = 42mWeighted average 78m

EPS is therefore 25c (= $19.5m/78m).

The comparative (for 2010) would be restated at 20c (24c × 2.00/2.40).





(ii) The basic EPS for the year ended 31 March 2012 is 30c ($25.2m/84m × 100).

Dilution

Convertible loan stock

On conversion loan interest of $1.2 million after tax would be saved ($20million × 8% × (100% – 25%)) and a further 10 million shares would beissued ($20m/$100 × 50).

Directors’ options

Options for 12 million shares at $1.50 each would yield proceeds of $18million. At the average market price of $2.50 per share this would purchase7.2 million shares ($18m/$2.50). Therefore the ‘bonus’ element of theoptions is 4.8 million shares (12m – 7.2m).

Using the above figures the diluted EPS for the year ended 31 March 2012

is 26.7c ($25.2m + $1.2m)/(84m + 10m + 4.8m)).

43 Elite Leisure and Hideaway

(a) The cruise ship is an example of what can be called a complex asset. This is asingle asset that should be treated as if it was a collection of separate assets, eachof which may require a different depreciation method/life. In this case thequestion identifies three components to the cruise ship. The carrying amount ofthe asset at 30 September 2011 (eight years after acquisition) would be:

Component Cost Depreciation Carrying value

$m $m $mShip’s fabric 300 96 (300/25) × 8) 204Cabins andentertainment areafittings 150 100 (150/12) × 8) 50Propulsion system 100 75 (100/40,000) × 30,000 25――― ――― ―――

550 271 279――― ――― ―――

Ship’s fabric

This is the most straightforward component. It is being depreciated over a 25year life and depreciation of $12 million (300/25 years) would be required in theyear ended 30 September 2012. The repainting of the ship’s fabric does not meetthe recognition criteria of an asset and should be treated as repairs andmaintenance.

Cabins and entertainment area and fittings

During the year these have had a limited upgrade at a cost of $60 million. Thishas extended the remaining useful life from four to five years. The costs of theupgrade meet the criteria for recognition as an asset. The original fittings havenot been replaced thus the additional $60 million would be added to the cost of

the fittings and the new carrying amount of $110 million will be depreciated overthe remaining life of five years to give a charge for the year of $22 million.





Propulsion system

This has been replaced by a new system so the carrying value of the system ($25million) must be written off and depreciation of the new system for the yearended 30 September 2012 (based on use) would be $14 million (140million/50,000 × 5,000).

Elite Leisure – income statement extract: year ended 30 September 2012

$mDepreciation – ship’s fabric 12

– cabin and entertainment fittings 22– propulsion system 14

Disposal loss – propulsion system 25Repainting ship’s fabric 20

93

Elite Leisure – statement of financial position extract as at 30 September 2012Cruise ship (see working): $406mWorking (in $ million)

Component Cost Depreciation Carrying value

$m $m $mShip’s fabric 300 108 (300/25) × 9) 192

Cabins and entertainmentarea fittings 210 122 (110/5) + 100) 88

Propulsion system 140 14 (100/50,000) × 5,000 126

――― ――― ――― 650 244 406――― ――― ―――

(b) (i) IAS 24 Related party disclosures states that a party is related to an entity inthe following circumstances:– The party, directly or indirectly, controls, is controlled by or is under

common control with the entity (e.g. parent/subsidiary orsubsidiaries of the same group)

– One party has an interest in another entity that gives it significantinfluence over the entity (e.g. an associate) or has joint control overthe entity (e.g. joint venturers are related parties).

– In addition members of key management and close family membersof related parties are also themselves related parties.

(ii) In the absence of related party disclosures, users of financial statementswould assume that an entity has acted independently and in its own bestinterests. Principally within this assumption is that all transactions have been entered into willingly and at arm’s length (i.e. on normal commercialterms at fair value).Where related party relationships and transactions exist, this assumption

may not be justified. These relationships and transactions lead to thedanger that financial statements may have been distorted or manipulated,





impression that Depret is under-performing. This may lead to thenon controlling interest selling their shares for a low price (because ofpoor returns) or calls for the company’s closure or some form ofrationalisation which may not be necessary.

– The tax authorities may wish to investigate the transactions undertransfer pricing rules. The profit may have been moved to Benedict’sfinancial statements to avoid paying tax in Depret’s tax jurisdictionwhich may have high levels of taxation.

– In the same way as Depret’s results appear poorer due to the effect ofthe related party transactions, Benedict’s results would look better.This may have been done deliberately. Hideaway may intend todispose of Benedict in the near future and thus its more favourableresults may allow Hideaway to obtain a higher sale price forBenedict.

44 TriangleItem (i)

Future decontamination costs must be provided for in full at the time they becomeunavoidable. Where they are based on future values, they should be discounted totheir present value. Instead of being immediately written off as a charge in the incomestatement, the decontamination costs are added to the cost of the related asset andamortised over the expected life of the asset.The current treatment of these costs by Triangle is incorrect. The depreciation chargemust be based on the full cost of the plant which must include the decontaminationcosts.In addition an imputed finance cost must be applied to the provision (often referred toas unwinding).Applying this to the financial statements of Triangle at 31 March 2012:

Statement of financial position extracts $mNon-current assets 20.0Plant at cost ($15 million + $5 million) (2.0)Depreciation at 10% per annum 18.0

Non-current liabilitiesProvision 5.0Accrued finance costs 0.4

5.4

Income statement extracts $mDepreciation 2.0Accrued finance costs ($5 million × 8%) 0.4

Item (ii)This is an example of an adjusting event after the reporting period. To some extent the

figures in the draft financial statements already reflect the effects of the fraud (up to theamount at the year end i.e. $210,000) in that presumably the cost of the materials paid





for are included in cost of sales. However, the financial statements are incorrect in theirpresentation.As the fraud is considered material, $210,000 should be removed from the cost of salesand included as an income statement operating expense (perhaps with separatedisclosure). This will affect the gross profit and other ratios, though it will not affect thenet profit.The further costs beyond the year end of $30,000 should be disclosed in a note as a non-adjusting event (if these costs are material in their own right).

Item (iii)

Triangle is of the opinion that the cost of the fraud may be covered by an insuranceclaim. However the insurance company is disputing the claim.This appears to be a contingent asset. If the contingent asset is ‘probable’ it should bedisclosed in a note in the financial statements. However if it is only ‘possible’, it should be ignored. As this claim is at an early stage and the company has not yet sought alegal opinion, it would be premature to consider the claim probable. In thesecircumstances the contingent asset should be ignored and the financial statements will be unaffected.

Item (iv)

Although this transaction has been treated as a sale, this is probably not its substance.The clause in the agreement that allows Triangle to repurchase the inventory makesthis a sale and repurchase agreement. Assuming Triangle acts rationally it willrepurchase the inventory if its retail value at 31 March 2012 is more than $7,320,500 ($5million plus compound interest at 10% for four years) plus the accumulated storagecosts (as these can be recovered from Factorall in the event that the inventory is notrepurchased).There is no indication in the question as to what the inventory is likely to be worth on31 March 2012. However it is unlikely that a finance company will really want toacquire this inventory (it is not its normal line of business) and thus it would not haveentered into the contract unless it believed Triangle would repurchase the inventory. Ifthe above is correct the substance of the transaction is that it is a secured loan ratherthan a sale.The required adjustments would therefore be as follows:– Remove $5 million from sales (debit) and treat this as a long term (4 year) loan.– Remove $3 million from cost of sales and treat this as inventory.– The receivable for the storage cost should be removed from trade receivables and

added to the cost of the inventory.– Accrued interest of $500,000 ($5 million × 10%) should be charged to the income

statement and added to the carrying value of the loan.





45 Construction

(a) 2011

Magpie – Income statement (extracts) – year to 31 March 2011 $000Sales revenue (40,000 × 35% (W1)) 14,000Cost of sales (W1) (9,100)

–––––––Profit on contract 4,900

–––––––Statement of financial position (extracts) as at 31 March 2011Non-current assetsPlant and machinery (3,600 – 900 (W2)) 2,700Current assetsAmount due from customer (W3) 1,500

(b) 2012 Income statement (extracts) – year to 31 March 2012 $000 Sales revenue (40,000 × 75% – 14,000 (W1)) 16,000Cost of sales (22,500 – 9,100 (W1)) (13,400)

––––––Profit on contract 2,600

––––––Statement of financial position (extracts) as at 31 March 2012Non-current assetsPlant and machinery (3,600 – 900 – 1,200 (W2)) 1,500Current assetsAmount due from customer (W3) 1,000

Workings (all figures $000):(W1) Contract costs as at 31 March 2011:

Architects’ and surveyors’ fees 500Materials used (3,100 – 300 inventory) 2,800Direct labour costs 3,500Overheads (40% of 3,500) 1,400Plant depreciation (9 months (W2)) 900

–––––– Cost at 31 March 2011 9,100––––––

Cost at 31 March 2011 (see above) 9,100Estimated cost to complete:Excluding depreciation 14,800Plant depreciation (3,600 – 600 – 900) 2,100

––––––16,900

–––––––Estimated total costs on completion 26,000

–––––––





Percentage of completion at 31 March 2011 (9,100/26,000) = 35%Contract costs as at 31 March 2012:Summarised costs excluding depreciation 20,400Plant depreciation (21 months at $100 per month) 2,100

–––––––Cost to date 22,500Estimated cost to complete: Excluding depreciation 6,600Plant depreciation (9 months) 900

––––––7,500

–––––––Estimated total costs on completion 30,000

–––––––

Percentage of completion at 31 March 2012 (22,500/30,000) = 75%

(W2) The plant has a depreciable amount of $3,000 (3,600 – 600 residual value).Its estimated life on this contract is 30 months (1 July 2010 to 31 December2012). Depreciation would be $100 per month i.e. $900 for the period to 31March 2011; $1,200 for the period to 31 March 2012; and a further $900 tocompletion.

(W3) Amount due from customer at 31 March 2011:

Contract costs incurred (9,100 + 300 material inventory) 9,400Recognised profit 4,900

––––––––14,300

Cash received at 31 March 2011 (12,800)––––––––

Amount due at 31 March 2011 1,500––––––––

Amount due from customer at 31 March 2012:Contract costs incurred 22,500Recognised profit (4,900 + 2,600) 7,500

––––––––30,000

Cash received – 31 March 2011 (12,800)– 31 March 2012 (16,200)

––––––––(29,000)

––––––––Amount due at 31 March 2012 1,000

––––––––

46 Bowtock

(a) Most events occurring after the reporting period should be properly reflected inthe following year’s financial statements. There are two circumstances whereevents occurring after the reporting period are relevant to the current year’sfinancial statements. The first category, known as adjusting events, providesadditional evidence of conditions that existed at the end of the reporting period.This usually means that they help to determine the value of an item that may





have been uncertain at the year-end. Common examples of this are receipts fromaccounts receivable and sales of inventory after the end of the reporting period..These receipts help to confirm the bad debt and inventory write downallowances. The second category is non-adjusting events. These do not affect theamounts contained in the financial statements, but are considered of such

importance that unless they are disclosed, users of financial statements wouldnot be properly able to assess the financial position of the company. Commonexamples of these are the loss of a major asset (say due to a fire) after thereporting period and the sale of an investment (often a subsidiary) after thereporting period.

(b) Inventory Sales of goods after the reporting period are normally a reflection ofcircumstances that existed prior to the year end. They are usually interpreted as aconfirmation of the value of inventory as it existed at the year end, and are thusadjusting events. In this case the sale of the goods after the year-end confirmed

that the value of the inventory was correctly stated as it was sold at a profit.Goods remaining unsold at the date the new legislation was enacted areworthless. Whilst this may imply that they should be written off in preparing thefinancial statements to 30 September 2012, this is not the case. What it isimportant to realise is that the event that caused the inventory to becomeworthless did not exist at the year end and its consequent losses should bereflected in the following accounting period. Thus there should be no adjustmentto the value of inventory in the draft financial statements, but given that it ismaterial, it should be disclosed as a non-adjusting event.Construction contract

On first appearance this new legislation appears similar to the previous example, but there is a major difference. Profits on an uncompleted long term constructioncontract are based on assessment of the overall eventual profit that the contract isexpected to make. This new legislation will mean the overall profit is $500,000less than originally thought. This information must be taken into account whencalculating the profit at 30 September 2012. This is an adjusting event.

47 Multiplex and Simpkins

(a)

Income statement extracts: $000

Loan stock interest paid ($80 million×

8%) 6,400Required accrual of finance cost 1,844––––––

Total finance cost for loan stock ($68,704,000 × 12%) 8,244––––––

Statement of financial position extracts :Non-current liabilities8% loan stock 2014 68,704Accrual of finance costs 1,844

–––––––70,548–––––––

Equity and liabilitiesShare options 11,296

–––––––





Workings

IAS 32 and 39, dealing with financial instruments, require compound or hybridfinancial instruments such as convertible loan stock to be treated under thesubstance of the contractual agreement. For this type of instrument this meansthat its equity element and liability (debt) element must be separately identifiedand presented as such in the statement of financial position. In practice there areseveral methods of calculating the split between the two elements. For examplethere are several option pricing models. However, given the limited informationin the question, the split can only be calculated by a ‘residual value of equity’approach. This involves calculating the present value of the cash flowsattributable to a ‘pure’ debt instrument and treating the difference between thisand the issue proceeds (the residue) as the equity component.

Cashflow

Factor at12%

Discountedcash flow

$m $000

Year 1 interest 6.4×

0.89 5,696Year 2 interest 6.4 × 0.80 5,120Year 3 interest 6.4 × 0.71 4,544Year 4 interest 6.4 × 0.64 4,096Year 5 interest and capital 86.4 × 0.57 49,248

68,704Residual equity element (shareoptions)

11,296

Proceeds of issue 80,000

(b) IAS 32 Financial Instruments: Disclosure and Presentation says that the issuer of acompound (hybrid) instrument (i.e. one that contains both a liability debt and anequity element) should classify the instrument’s components separately. Thus theadvice of Merchant Financial Services is wrong; convertible loan stock cannot beclassified as pure equity. The proceeds of the issue have to be split between theamount attributable to the conversion rights, which is then classed as equity, andthe balance of the proceeds being classed a liability/debt. There are severalmethods of obtaining these amounts, but from the information given in thequestion these can only be calculated on a ‘residual value of equity’ basis:

Cashflows

Factor at10%

Presentvalue

$000 $000Year 1 interest 600 0.91 546Year 2 interest 600 0.83 498Year 3 interest 600 0.75 450Year 4 interest and capital 10,600 0.68 7,208

––––––Total value of debt component 8,702Proceeds of the issue 10,000

––––––Equity component (residual amount) 1,298

––––––





(b) The directors are not fully correct in their views. If the company had issuedstraight convertible loan notes, the interest cost would be 7% per year or $700,000.By issuing convertible loan notes, the total finance cost is not much lower in thefirst year ($640,000) and it will increase in the next two years as the liability for theloan notes increases.

The company’s gearing will be reduced after three years if the loan note holdersexercise their option to convert their notes into equity shares. In the short termhowever, the issue of the convertible loan notes will add to debt capital and only asmall amount to equity (the residual amount); therefore it seems likely that gearingwill increase in the short term and will not fall.

49 Errsea

(a) Errsea – income statement extracts year ended 31 March 2012$

Loss on disposal of plant – see note below ((90,000 – 60,000) – 12,000) 18,000Depreciation for year (wkg (i)) 75,000Government grants (a credit item) – see note below and (wkg (iv)) (19,000)Note: the repayment of government grant of $3,000 may instead have beenincluded as an increase of the loss on disposal of the plant.Errsea – statement of financial position extracts as at 31 March 2012

cost accumulateddepreciation

carryingamount

$ $ $Property, plant and equipment (wkg (v)) 360,000 195,000 165,000

–––––––– –––––––– ––––––––Non-current liabilitiesGovernment grants (wkg (iv)) 39,000Current liabilitiesGovernment grants (wkg (iv)) 27,000

Workings

(i) Depreciation for year ended 31 March 2012 $On acquired plant (wkg (ii)) 52,500Other plant (wkg (iii)) 22,500

–––––––75,000

–––––––(ii) The cost of the acquired plant is recorded at $210,000 being its base cost

plus the costs of modification and transport and installation. Annualdepreciation over three years will be $70,000. Time apportioned for yearended 31 March 2012 by 9/12 = $52,500.

(iii) The other remaining plant is depreciated at 15% on cost $(b/f 240,000 – 90,000 (disposed of) x 15%) 22,500





(iv) Government grants Transferred to income for the year ended 31 March 2012: $ From current liability in 2011 (10,000 – 3,000 (repaid)) 7,000From acquired plant (see below): 12,000

–––––––

19,000–––––––

Non-current liability $ b/f 30,000transferred to current (11,000)on acquired plant (see below) 20,000

–––––––39,000

–––––––

Grant on acquired plant is 25% of base cost only = $48,000This will be treated as:To income in year ended 31 March 2012 (48,000/3 x 9/12) 12,000Classified as current liability (48,000/3) 16,000Classified as a non-current liability (balance) 20,000

–––––––48,000

–––––––Note: government grants are accounted for from the date they are receivable (i.e.when the qualifying conditions for the grant have been met).

Current liabilityTransferred from non-current (per question) 11,000On acquired plant (see above) 16,000

–––––––27,000

–––––––(v)

cost accumulateddepreciation

carryingamount

$ $ $Property, plant and equipmentBalances b/f 240,000 180,000 60,000Disposal (90,000) (60,000) (30,000)Addition (w (ii)) 210,000 52,500 157,500Other plant depreciation for year (wkg (iii)) 22,500 (22,500)

––––––– –––––––– ––––––––Balances at 31 March 2012 360,000 195,000 165,000

––––––– –––––––– ––––––––(b) (i) This is an example of an adjusting event within IAS 10 Events after the

reporting date. This means that an impairment of trade receivables of$23,000 must be recognised (and charged to income). The increase in thereceivable after the year end should be written off in the following year ’sfinancial statements.

(ii) Sales of the year-end inventory in the following accounting period may

provide evidence that the inventory ’s net realisable value has fallen belowits cost. This appears to be the case for product W32 and is another example





of an adjusting event. With a selling price of $5 ·40 and after paying a 15%commission, the net realisable value of W32 is $4 ·59 each. Assuming thatthe fall in selling price is not due to circumstances that occurred after theyear end and that the selling price is typical of what the remainder of theproduct will sell for, inventory should be written down (via a charge to the

income statement) by $16,920 ((6 ·00 – 4·59) x 12,000 units).(iii) Tentacle has correctly treated the outstanding litigation as a contingent

liability. The settlement of a court case after the reporting date may confirm(or otherwise) the existence of an obligation at the year end and would bean example of an adjusting event. This would then require that either thedisclosure note of the contingency is removed or the obligation should beprovided for dependent on the outcome of the litigation. However, this isnot quite the case in Tentacle ’s example. The circumstances of the claimagainst Tentacle are different from those of the recently settled case. So thissettlement does not appear to have any effect on the likelihood of Tentaclelosing the case. What it does (potentially) affect is the estimated amount ofthe liability. IAS 10 refers to this situation as an updating disclosure. Theonly required change to the financial statements would be to update thedisclosure note on the contingent liability to reflect that the potentialliability has increased from $500,000 to $750,000.

(iv) Normally the effect of price increases of materials after the reporting datewould be a matter for the following year ’s financial statements as suchincreases do not affect the costs as they existed at the reporting date (i.e.they would not be an adjusting event). However, Tentacle ’s method ofrecognising profit (using a cost basis to determine the percentage ofcompletion) requires an estimate (at 31 March 2012) of the future costs of

the contract. This estimate directly determines the amount of profitrecognised at 31 March 2012. Therefore the information indicating that thetotal estimated costs of the contract have increased should be taken asproviding additional evidence of conditions that existed at the year end.Thus this is an adjusting event which requires the recognised profit to berecalculated. The original estimate of the recognised profit at 31 March 2012of $1·2 million would be half of the estimated total profit of $2 ·4 million(percentage of completion is 50% i.e. $3 million/$6 million). The increase inthe costs of $1 ·5 million means the revised estimated total profit is only$900,000 (2·4m – 1·5m). The revised total costs are $7 ·5 million (6m + 1 ·5m).Thus the recognised profit on the contract should be recalculated as

$360,000 (900,000 x 3m/7 ·5m) with appropriate amendments to the incomestatement and statement of financial position figures.

50 Partway

(a) (i) IFRS 5 Non-current assets held for sale and discontinued operations definesnon-current assets held for sale as those assets (or a group of assets) whosecarrying amounts will be recovered principally through a sale transactionrather than through continuing use. A discontinued operation is acomponent of an entity that has either been disposed of, or is classified as‘held for sale ’ and:

(i) represents a separate major line of business or geographical area ofoperations





31 October 2012 31 October 2011$’000 $’000

Profit/(loss) from continuing operations 4,400 4,500Discontinued operationsProfit/(loss) from discontinued operations (4,000) 1,500

Profit for the period 400 6,000

Analysis of discontinued operationsRevenue 14,000 18,000Cost of sales (16,500) (15,000)

Gross profit/(loss) (2,500) 3,000Operating expenses (1,500) (1,500)

Profit/(loss) from discontinued operations (4,000) 1,500

Note: other presentations may be acceptable.

(b) (i) Comparability is one of the four principal qualitative characteristics ofuseful financial information. It is a vital attribute when assessing theperformance of an entity over time (trend analysis) and to some extent withother similar entities. For information to be comparable it should be basedon the consistent treatment of transactions and events. In effect a change inan accounting policy breaks the principle of consistency and shouldgenerally be avoided. That said there are circumstances where it becomesnecessary to change an accounting policy. These are mainly where it isrequired by a new or revised accounting standard, interpretation orapplicable legislation or where the change would result in financialstatements giving a more reliable and relevant representation of the entity ’s

transactions and events.It is important to note that the application of a different accounting policyto transactions or events that are substantially different to existingtransactions or events or to transactions or events that an entity had notpreviously experienced does NOT represent a change in an accountingpolicy. It is also necessary to distinguish between a change in an accountingpolicy and a change in an estimation technique.In an attempt to limit the problem of reduced comparability caused by achange in an accounting policy, the general principle is that the financialstatements should be prepared as if the new accounting policy had always

been in place. This is known as retrospective application. The main effect ofthis is that comparative financial statements should be restated by applyingthe new policy to them and adjusting the opening balance of eachcomponent of equity affected in the earliest prior period presented. IAS 8Accounting policies, changes in accounting estimates and errors says that achange in accounting policy required by a specific Standard orInterpretation should be dealt with under the transitional provisions (ifany) of that Standard or Interpretation (normally these apply the generalrule of retrospective application). There are some limited exemptions(mainly on the grounds of impracticality) to the general principle ofretrospective application in IAS 8.

(ii) This issue is one of the timing of when revenue should be recognised in theincome statement. This can be a complex issue which involves identifying





the transfer of significant risks, reliable measurement, the probability ofreceiving economic benefits, relevant accounting standards and legislationand generally accepted practice. Applying the general guidance in IAS 18Revenue, the previous policy, applied before cancellation insurance wasmade a condition of booking, seemed appropriate. At the time the holiday

is taken it can no longer be cancelled, all monies would have been receivedand the flights and accommodation have been provided. There may besome compensation costs involved if there are problems with the holiday, but this is akin to product warranties on normal sales of goods which may be immaterial or provided for based on previous experience of such costs.The appendix to IAS 18 specifically refers to payments in advance of the‘delivery ’ of goods and says that revenue should be recognised when thegoods are delivered. Interpreting this for Partway ’s transaction would seemto confirm the appropriateness of its previous policy.The directors of Partway wish to change the timing of recognition of sales because of the change in circumstances relating to the compulsorycancellation insurance. The directors are apparently arguing that the new‘transactions and events ’ are substantially different to previous transactionstherefore the old policy should not apply. Even if this does justify revisingthe timing of the recognition of revenue, it is not a change of accountingpolicy because of the reasons outlined in (i) above.An issue to consider is whether compulsory cancellation insurancerepresents a substantial change to the risks that Partway experiences. Ananalysis of past experience of losses caused by uninsured cancellations mayhelp to assess this, but even if the past losses were material (and in futurethey won ’t be), it is unlikely that this would override the general guidance

in the appendix to IAS 18 relating to payments made in advance ofdelivery. It seems the main motivation for the proposed change is toimprove the profit for the year ended 31 October 2012 so that it comparesmore favourably with that of the previous period.To summarise, it is unlikely that the imposition of compulsory cancellationinsurance justifies recognising sales at the date of booking when a depositis received, and, even if it did, it would not be a change in accountingpolicy. This means that comparatives would not be restated (which issomething that would actually suit the suspected objectives of thedirectors).

51 Pingway

Accounting correctly for the convertible loan note in accordance with IAS 32 FinancialInstruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurementwould mean that virtually all the financial assistant’s observations are incorrect. Theconvertible loan note is a compound financial instrument containing a (largely) debtcomponent and an equity component – the value of the option to receive equity shares.These components must be calculated using the residual equity method andappropriately classified (as debt and equity) on the statement of financial position. Assome of the proceeds of the instrument will be equity, the gearing will not be quite ashigh as if a non-convertible loan was issued, but gearing will be increased. However, if

the loan note is converted to equity in March 2012, gearing will be reduced. Theinterest rate that would be applicable to a non-convertible loan (8%) is representative





of the true finance cost and should be applied to the carrying amount of the debt tocalculate the finance cost to be charged to the income statement thus giving a muchhigher charge than the assistant believes.Accounting treatment: financial statements year ended 31 March 2012Income statement:Finance costs (see working) $693,920Statement of financial position:Non-current liabilities3% convertible loan note (8,674 + 393·92) $9,067,920EquityOption to convert $1,326,000

Working (figures in brackets in $’000)cash flows factor at 8% present value $’000

year 1 interest 300 0·93 279year 2 interest 300 0·86 258year 3 interest and capital 10,300 0·79 8,137

–––––––total value of debt component 8,674proceeds of the issue 10,000

–––––––equity component (residual amount) 1,326

–––––––The interest cost in the income statement should be $693,920 (8,674 x 8%), requiring anaccrual of $393,920 (693·92 – 300 i.e. 10,000 x 3%). This accrual should be added to thecarrying value of the debt.

52 Dearing

Year ended/as at: 30September

2010

30September

2011

30September

2012Income statement $ $ $ Depreciation (see workings ) 180,000 270,000 119,000Maintenance (60,000/3 years) 20,000 20,000 20,000Discount received (840,000 x 5%) (42,000)Staff training 40,000

–––––––– –––––––– ––––––––198,000 290,000 139,000

–––––––– –––––––– ––––––––Statement of financial position (seebelow)Property, plant and equipmentCost 920,000 920,000 670,000Accumulated depreciation (180,000) (450,000) (119,000)

–––––––– –––––––– ––––––––Carrying amount 740,000 470,000 551,000

–––––––– –––––––– ––––––––





Workings $Manufacturer’s base price 1,050,000Less trade discount (20%) (210,000)

––––––––Base cost 840,000Freight charges 30,000Electrical installation cost 28,000Pre-production testing 22,000

––––––––Initial capitalised cost 920,000

––––––––

The depreciable amount is $900,000 (920,000 – 20,000 residual value) and, based on anestimated machine life of 6,000 hours, this gives depreciation of $150 per machine hour.Therefore depreciation for the year ended 30 September 2010 is $180,000 ($150 x 1,200hours) and for the year ended 30 September 2011 is $270,000 ($150 x 1,800 hours).Note: early settlement discount, staff training in use of machine and maintenance are

all revenue items and cannot be part of capitalised costs.Carrying amount at 1 October 2011 470,000Subsequent expenditure 200,000

––––––––Revised ‘cost’ 670,000

––––––––The revised depreciable amount is $630,000 (670,000 – 40,000 residual value) and with arevised remaining life of 4,500 hours, this gives a depreciation charge of $140 permachine hour. Therefore depreciation for the year ended 30 September 2012 is $119,000($140 x 850 hours).

53 Waxwork (IAS 10)

(a) Events after the reporting period are defined by IAS 10 Events after theReporting Period as those events, both favourable and unfavourable, that occur between the end of the reporting period and the date that the financialstatements are authorised for issue (normally by the Board of directors).An adjusting event is one that provides further evidence of conditions thatexisted at the end of the reporting period, including an event that indicates thatthe going concern assumption in relation to the whole or part of the entity is notappropriate. Normally trading results occurring after the end of the reportingperiod are a matter for the next reporting period, however, if there is an eventwhich would normally be treated as non-adjusting that causes a dramaticdownturn in trading (and profitability) such that it is likely that the entity will nolonger be a going concern, this should be treated as an adjusting event.A non-adjusting event is an event after the end of the reporting period that isindicative of a condition that arose after the end of the reporting period and,subject to the exception noted above, the financial statements would not beadjusted to reflect such events.The outcome (and values) of many items in the financial statements have adegree of uncertainty at the end of the reporting period. IAS 10 effectively saysthat where events occurring after the end of the reporting period help todetermine what those values were at the end of the reporting period, they should

be taken in account (i.e. adjusted for) in preparing the financial statements.





If non-adjusting events, whilst not affecting the financial statements of thecurrent year, are of such importance (i.e. material) that without disclosure of theirnature and estimated financial effect, users’ ability to make proper evaluationsand decisions about the future of the entity would be affected, then they should be disclosed in the notes to the financial statements.

(b) (i) This is normally classified as a non-adjusting event as there was no reasonto doubt that the value of warehouse and the inventory it contained wasworth less than its carrying amount at 31 March 2012 (the last day of thereporting period). The total loss suffered as a result of the fire is $16million. The company expects that $9 million of this loss will be recoveredfrom an insurance policy. Recoveries from third parties should be assessedseparately from the related loss. As this event has caused seriousdisruption to trading, IAS 10 would require the details of this non-adjusting event to be disclosed as a note to the financial statements for theyear ended 31 March 2012 as a total loss of $16 million and the effect of theinsurance recovery to be disclosed separately.The severe disruption in Waxwork’s trading operations since the fire,together with the expectation of large trading losses for some time to come,may call in to question the going concern status of the company. If it is judged that Waxwork is no longer a going concern, then the fire and itsconsequences become an adjusting event requiring the financial statementsfor the year ended 31 March 2012 to be redrafted on the basis that thecompany is no longer a going concern (i.e. they would be prepared on aliquidation basis).

(ii) 70% of the inventory amounts to $322,000 (460,000 x 70%) and this was soldfor a net amount of $238,000 (280,000 x 85%). Thus a large proportion of a

class of inventory was sold at a loss after the reporting period. This wouldappear to give evidence of conditions that existed at 31 March 2012 i.e. thatthe net realisable value of that class of inventory was below its cost.Inventory is required to be valued at the lower of cost and net realisablevalue, thus this is an adjusting event. If it is assumed that the remaininginventory will be sold at similar prices and terms as that already sold, thenet realisable value of the whole of the class of inventory would becalculated as:$280,000/70% = $400,000, less commission of 15% = $340,000.Thus the carrying amount of the inventory of $460,000 should be written

down by $120,000 to its net realisable value of $340,000.In the unlikely event that the fall in the value of the inventory could beattributed to a specific event that occurred after the date of the statement offinancial position then this would be a non-adjusting event.

(iii) The date of the government announcement of the tax change is beyond theperiod of consideration in IAS 10. Thus this would be neither an adjustingnor a non-adjusting event. The increase in the deferred tax liability will beprovided for in the year to 31 March 2012. Had the announcement been before 6 May 2012, it would have been treated as a non-adjusting eventrequiring disclosure of the nature of the event and an estimate of itsfinancial effect in the notes to the financial statements.





(iii) Engines – before the accident the engines (in combination) were beingdepreciated at a rate of $500 per flying hour. At the date of the accident eachengine had a carrying amount of $6 million ((12,600 – 600)/2). This represents theloss on disposal of the written off engine. The repaired engine’s remaining lifewas reduced to 15,000 hours. Thus future depreciation on the repaired engine

will be $400 per flying hour, resulting in a depreciation charge of $400,000 for thesix months to 31 March 2012. The new engine with a cost of $10·8 million and alife of 36,000 hours will be depreciated by $300 per flying hour, resulting in adepreciation charge of $300,000 for the six months to 31 March 2012.Summarising both engines:

Cost accumulated carryingdepreciation amount

$’000 $’000 $’000Old engine 9,000 3,400 5,600New engine 10,800 300 10,500

–––––––– –––––––– –––––––

19,800 3,700 16,100–––––––– –––––––– –––––––Note: marks are awarded for clear calculations rather than for detailed explanations.Full explanations are given for tutorial purposes.

55 Darby

(a) There are four elements to the assistant’s definition of a non-current asset and heis substantially incorrect in respect of all of them.The term non-current assets will normally include intangible assets and certaininvestments; the use of the term ‘physical asset’ would be specific to tangibleassets only.Whilst it is usually the case that non-current assets are of relatively high valuethis is not a defining aspect. A waste paper bin may exhibit the characteristics ofa non-current asset, but on the grounds of materiality it is unlikely to be treatedas such. Furthermore the past cost of an asset may be irrelevant; no matter howmuch an asset has cost, it is the expectation of future economic benefits flowingfrom a resource (normally in the form of future cash inflows) that defines anasset according to the IASB’s Conceptual Framework for the preparation andpresentation of financial statements.The concept of ownership is no longer a critical aspect of the definition of anasset. It is probably the case that most noncurrent assets in an entity’s statementof financial position are owned by the entity; however, it is the ability to ‘control’assets (including preventing others from having access to them) that is now adefining feature. For example: this is an important characteristic in treating afinance lease as an asset of the lessee rather than the lessor.It is also true that most non-current assets will be used by an entity for more thanone year and a part of the definition of property, plant and equipment in IAS 16Property, plant and equipment refers to an expectation of use in more than oneperiod, but this is not necessarily always the case. It may be that a non-currentasset is acquired which proves unsuitable for the entity’s intended use or isdamaged in an accident. In these circumstances assets may not have been usedfor longer than a year, but nevertheless they were reported as non-currentsduring the time they were in use. A non-current asset may be within a year of theend of its useful life but (unless a sale agreement has been reached under IFRS 5





Non-current assets held for sale and discontinued operations) would still bereported as a non-current asset if it was still giving economic benefits. Anotherdefining aspect of non-current assets is their intended use i.e. held for continuinguse in the production, supply of goods or services, for rental to others or foradministrative purposes.

(b) (i) The expenditure on the training courses may exhibit the characteristics ofan asset in that they have and will continue to bring future economic benefits by way of increased efficiency and cost savings to Darby.However, the expenditure cannot be recognised as an asset on thestatement of financial position and must be charged as an expense as thecost is incurred. The main reason for this lies with the issue of ’control’; it isDarby’s employees that have the ‘skills’ provided by the courses, but theemployees can leave the company and take their skills with them or,through accident or injury, may be deprived of those skills. Also thecapitalisation of staff training costs is specifically prohibited underInternational Financial Reporting Standards (specifically IAS 38 Intangibleassets).

(ii) The question specifically states that the costs incurred to date on thedevelopment of the new processor chip are research costs. IAS 38 statesthat research costs must be expensed. This is mainly because research is therelatively early stage of a new project and any future benefits are so far inthe future that they cannot be considered to meet the definition of an asset(probable future economic benefits), despite the good record of success inthe past with similar projects.Although the work on the automatic vehicle braking system is still at theresearch stage, this is different in nature from the previous example as the

work has been commissioned by a customer, As such, from the perspectiveof Darby, it is work in progress (a current asset) and should not be writtenoff as an expense. A note of caution should be added here in that thequestion says that the success of the project is uncertain which presumablymeans it may not be completed. This does not mean that Darby will notreceive payment for the work it has carried out, but it should be checked tothe contract to ensure that the amount it has spent to date ($2·4 million) will be recoverable. In the event that say, for example, the contract stated thatonly $2 million would be allowed for research costs, this would place alimit on how much Darby could treat as work in progress. If this were thecase then, for this example, Darby would have to expense $400,000 andtreat only $2 million as work in progress.

(iii) The question suggests the correct treatment for this kind of contract is totreat the costs of the installation as a non-current asset and (presumably)depreciate it over its expected life of (at least) three years from when it becomes available for use. In this case the asset will not come into use untilthe next financial year/reporting period and no depreciation needs to beprovided at 30 September 2012.The capitalised costs to date of $58,000 should only be written down ifthere is evidence that the asset has become impaired. Impairment occurswhere the recoverable amount of an asset is less than its carrying amount.

The assistant appears to believe that the recoverable amount is the futureprofit, whereas (in this case) it is the future (net) cash inflows. Thus any





impairment test at 30 September 2012 should compare the carrying amountof $58,000 with the expected net cash flow from the system of $98,000($50,000 per annum for three years less future cash outflows to completionthe installation of $52,000 (see note below)). As the future net cash flows arein excess of the carrying amount, the asset is not impaired and it should not

be written down but shown as a non-current asset (under construction) atcost of $58,000.Note: as the contract is expected to make a profit of $40,000 on income of$150,000, the total costs must be $110,000, with costs to date at $58,000 thisleaves completion costs of $52,000.

56 Barstead

(a) Whilst profit after tax (and its growth) is a useful measure, it may not give a fairrepresentation of the true underlying earnings performance. In this example,users could interpret the large annual increase in profit after tax of 80% as beingindicative of an underlying improvement in profitability (rather than what itreally is: an increase in absolute profit). It is possible, even probable, that (someof) the profit growth has been achieved through the acquisition of othercompanies (acquisitive growth). Where companies are acquired from theproceeds of a new issue of shares, or where they have been acquired throughshare exchanges, this will result in a greater number of equity shares of theacquiring company being in issue. This is what appears to have happened in thecase of Barstead as the improvement indicated by its earnings per share (EPS) isonly 5% per annum. This explains why the EPS (and the trend of EPS) isconsidered a more reliable indicator of performance because the additionalprofits which could be expected from the greater resources (proceeds from theshares issued) is matched with the increase in the number of shares. Simplylooking at the growth in a company’s profit after tax does not take into accountany increases in the resources used to earn them. Any increase in growthfinanced by borrowings (debt) would not have the same impact on profit (as being financed by equity shares) because the finance costs of the debt would actto reduce profit.The calculation of a diluted EPS takes into account any potential equity shares inissue. Potential ordinary shares arise from financial instruments (e.g. convertibleloan notes and options) that may entitle their holders to equity shares in thefuture. The diluted EPS is useful as it alerts existing shareholders to the fact that

future EPS may be reduced as a result of share capital changes; in a sense it is awarning sign. In this case the lower increase in the diluted EPS is evidence thatthe (higher) increase in the basic EPS has, in part, been achieved through theincreased use of diluting financial instruments. The finance cost of theseinstruments is less than the earnings their proceeds have generated leading to anincrease in current profits (and basic EPS); however, in the future they will causemore shares to be issued. This causes a dilution where the finance cost perpotential new share is less than the basic EPS.

(b) (Basic) EPS for the year ended 30 September 2012($15 million/43·25 million x 100) 34·7 centsComparative (basic) EPS (35 x 3·60/3·80) 33·2 cents





Effect of rights issue (at below market price)100 shares at $3·80 38025 shares at $2·80 70

––– ––––125 shares at $3·60 (calculated theoretical ex-rights value) 450––– ––––

Weighted average number of shares36 million x 3/12 x $3·80/$3·60 9·50 million45 million x 9/12 33·75 million

––––––43·25 million

––––––Diluted EPS for the year ended 30 September 2012($15·6 million/45·75 million x 100) 34·1 cents

Adjusted earnings15 million + (10 million x 8% x 75%) $15·6 millionAdjusted number of shares43·25 million + (10 million x 25/100) 45·75 million

57 Apex

(a) Where borrowing costs are directly incurred on a ‘qualifying asset ’, they must becapitalised as part of the cost of that asset. A qualifying asset may be a tangible oran intangible asset that takes a substantial period of time to get ready for itsintended use or eventual sale. Property construction would be a typical example, but it can also be applied to intangible assets during their development period.

Borrowing costs include interest based on its effective rate (which incorporatesthe amortisation of discounts, premiums and certain expenses) on overdrafts,loans and (some) other financial instruments and finance charges on financeleased assets. They may be based on specifically borrowed funds or on theweighted average cost of a pool of funds.Any income earned from the temporary investment of specifically borrowedfunds would normally be deducted from the amount to be capitalised.Capitalisation should commence when expenditure is being incurred on theasset, which is not necessarily from the date funds are borrowed. Capitalisationshould cease when the asset is ready for its intended use, even though the fundsmay still be incurring borrowing costs. Also capitalisation should be suspendedif there is a suspension of active development of the asset.Any borrowing costs that are not eligible for capitalisation must be expensed.Borrowing costs cannot be capitalised for assets measured at fair value.

(b) The finance cost of the loan must be calculated using the effective rate of 7 ·5%, sothe total finance cost for the year ended 31 March 2010 is $750,000 ($10 million x7·5%). As the loan relates to a qualifying asset, the finance cost (or part of it inthis case) can be capitalised under IAS 23.The Standard says that capitalisation commences from when expenditure is being incurred (1 May 2009) and must cease when the asset is ready for itsintended use (28 February 2010); in this case a 10-month period. However,interest cannot be capitalised during a period where development activity issuspended; in this case the two months of July and August 2009. Thus only eight





months of the year ’s finance cost can be capitalised = $500,000 ($750,000 x 8/12).The remaining four-months finance costs of $250,000 must be expensed. IAS 23also says that interest earned from the temporary investment of specific loansshould be deducted from the amount of finance costs that can be capitalised.However, in this case, the interest was earned during a period in which the

finance costs were NOT being capitalised, thus the interest received of $40,000would be credited to the income statement and not to the capitalised financecosts.In summary:

$

Income statement for the year ended 31 March 2010:Finance cost (debit) (250,000)Investment income (credit) 40,000Statement of financial position as at 31 March 2010:Property, plant and equipment (finance cost element only) 500,000

58 Tunshill

(a) Management ’s choices of which accounting policies they may adopt are not aswide as generally thought. Where an International Accounting Standard, IAS orIFRS (or an Interpretation) specifically applies to a transaction or event theaccounting policy used must be as prescribed in that Standard (taking in toaccount any Implementation Guidance within the Standard). In the absence of aStandard, or where a Standard contains a choice of policies, management mustuse its judgement in applying accounting policies that result in information thatis relevant and reliable given the circumstances of the transactions and events. Inmaking such judgements, management should refer to guidance in the Standardsrelated to similar issues and the definitions, recognition criteria andmeasurement concepts for assets, liabilities, income and expenses in the IASB ’sFramework for the preparation and presentation of financial statements.Management may also consider pronouncements of other standard-setting bodies that use a similar conceptual framework to the IASB.A change in an accounting policy usually relates to a change of principle, basis orrule being applied by an entity. Accounting estimates are used to measure thecarrying amounts of assets and liabilities, or related expenses and income. Achange in an accounting estimate is a reassessment of the expected future benefits and obligations associated with an asset or a liability. Thus, for example,a change from non-depreciation of a building to depreciating it over its estimateduseful life would be a change of accounting policy. To change the estimate of itsuseful life would be a change in an accounting estimate.

(b) (i) The main issue here is the estimate of the useful life of a non-current asset.Such estimates form an important part of the accounting estimate of thedepreciation charge. Like most estimates, an annual review of theirappropriateness is required and it is not unusual, as in this case, to revisethe estimate of the remaining useful life of plant. It appears, from theinformation in the question, that the increase in the estimated remaininguseful life of the plant is based on a genuine reassessment by the

production manager. This appears to be an acceptable reason for a revisionof the plant ’s life, whereas it would be unacceptable to increase the estimate





simply to improve the company ’s reported profit. That said, the assistantaccountant ’s calculation of the financial effect of the revised life is incorrect.Where there is an increase (or decrease) in the estimated remaining life of anon-current asset, its carrying amount (at the time of the revision) isallocated over the new remaining life (after allowing for any estimated

residual value). The carrying amount at 1 October 2009 is $12 million ($20million – $8 million accumulated depreciation) and this should be writtenoff over the estimated remaining life of six years (eight years in total lesstwo already elapsed). Thus a charge for depreciation of $2 million would berequired in the year ended 30 September 2010 leaving a carrying amount of$10 million ($12 million – $2 million) in the statement of financial positionat that date. A depreciation charge for the current year cannot be avoidedand there will be no credit to the income statement as suggested by theassistant accountant. It should be noted that the incremental effect of therevision to the estimated life of the plant would be to improve the reportedprofit by $2 million being the difference between the depreciation based on

the old life ($4 million) and the new life ($2 million).(ii) The appropriateness of the proposed change to the method of valuing

inventory is more dubious than the previous example. Whilst bothmethods (FIFO and AVCO) are acceptable methods of valuing inventoryunder IAS 2 Inventories, changing an accounting policy to be consistentwith that of competitors is not a convincing reason. Generally changes inaccounting policies should be avoided unless a change is required by a newor revised accounting standard or the new policy provides more reliableand relevant information regarding the entity ’s position. In any event theassistant accountant ’s calculations are again incorrect and would not meetthe intention of improving reported profit. The most obvious error is thatchanging from FIFO to AVCO will cause a reduction in the value of theclosing inventory at 30 September 2010 effectively reducing, rather thanincreasing, both the valuation of inventory and reported profit. A change inaccounting policy must be accounted for as if the new policy had always been in place (retrospective application). In this case, for the year ended 30September 2010, both the opening and closing inventories would need to bemeasured at AVCO which would reduce reported profit by $400,000 (($20million – $18 million) – ($15 million – $13·4 million) – i.e. the movement inthe values of the opening and closing inventories). The other effect of thechange will be on the retained earnings brought forward at 1 October 2009.These will be restated (reduced) by the effect of the reduced inventoryvalue at 30 September 2009 i.e. $1 ·6 million ($15 million – $13·4 million).This adjustment would be shown in the statement of changes in equity.

59 Manco

From the information in the question, the closure of the furniture making operation is arestructuring as defined in IAS 37 Provisions, contingent liabilities and contingentassets and, due to the timing of the decision, a provision for the closure costs will berequired in the year ended 30 September 2010. Although the Standard says that aBoard of directors ’ decision to close an operation is alone not sufficient to trigger aprovision the other actions of the management, informing employees, customers and apress announcement indicate that this is an irreversible decision and that thereforethere is an obligating event.





Commenting on each element in turn for both years:(i) Factory and plant

At 30 September 2010 – these assets cannot be classed as ‘held-for-sale ’ as theyare still in use (i.e. generating revenue) and therefore are not available for sale.Both assets will therefore continue to be depreciated.Despite this, it does appear that the plant is impaired. Based on its carryingamount of $2 ·8 million an impairment charge of $2 ·3 million ($2 ·8 million – $0·5million) would be required (subject to any further depreciation for the threemonths from July to September 2010). The expected gain on the sale of the factorycannot be recognised or used to offset the impairment charge on the plant. Theimpairment charge is not part of the restructuring provision, but should bereported with the depreciation charge for the year.At 30 September 2011 – the realised profit on the disposal of the factory and anyfurther loss on the disposal of the plant will both be reported in the incomestatement.

(ii) Redundancy and retraining costsAt 30 September 2010 – a provision for the redundancy costs of $750,000 should be made, but the retraining costs relate to the ongoing actives of Manco andcannot be provided for.At 30 September 2011 – the redundancy costs incurred during the year will beoffset against the provision created last year. Any under- or over-provision will be reported in the income statement. The retraining costs will be written off asthey are incurred.

(iii) Trading losses

The losses to 30 September 2010 will be reported as part of the results for the yearended 30 September 2010. The expected losses from 1 October 2010 to the closureon 31 January 2011 cannot be provided in the year ended 30 September 2010 asthey relate to ongoing activities and will therefore be reported as part of theresults for the year ended 30 September 2011 as they are incurred.

It should also be considered whether the closure fulfils the definition of a discontinuedoperation in accordance with IFRS 5 Non-current assets held for sale and discontinuedoperations. As there is a co-ordinated plan to dispose of a separate major line of business (the furniture making operation is treated as an operating segment) thisprobably is a discontinued operation. However, the timing of the closure means that itis not a discontinued operation in the year ended 30 September 2010; rather it is likelythat it will be such in the year ended 30 September 2011. Some commentators believethat this creates an anomalous situation in that most of the closure costs are reported inthe year ended 30 September 2010 (as described above), but the closure itself is onlyidentified and reported as a discontinued operation in the year ended 30 September2011 (although the comparative figures for 2010 would then restate this as adiscontinued operation).






60 Hydrox

Hydrox

Consolidated statement of financial position of Hydrox as at 31 March 2012 $000 $000

AssetsNon-current assetsProperty, plant and equipment (W1) 45,840Goodwill (1,200 − 400) 800Investments (W1) 8,800

55,440Current assetsInventory (W2) 14,000

Trade accounts receivable (7,200 + 1,500 - 2,000) 6,700Cash and bank 300


Equity and liabilitiesShare capital and reserves:Equity shares $1 each 10,000Reserves: Retained earnings (W3) 34,510

44,510

Non-controlling interest (W5) 1,13045,640Non-current liabilities12% Debenture 4,000Bank loan 6,000

10,000Current liabilitiesTrade accounts payable (6,700 + 5,200 − 1,400) 10,500Operating overdraft 4,500Income tax liability (4,100 + 700) 4,800Dividends payable – Hydrox 1,000


Workings (Note: all figures in $000)(W1) Property, plant and equipment

Balance from question – Hydrox 26,400– Syntax 16,200

Fair value adjustment on acquisition 5,400

Depreciation on fair value adjustment (5,400/5 × 2) (2,160)

45,840





Investments

InvestmentsBalance from question – Hydrox 1,000

– Syntax 6,000

Fair value adjustment on acquisition (90% × (8,000 − 6,000)) 1,8008,800

(W2) Inventory

Amounts per question (9,500 + 4,000) 13,500

Add back ‘in transit’ goods at cost (600 × 100/120) 500

14,000

Note: A mark-up of 20% (1/5) on cost is equivalent to a gross profit on sellingprice of 1/6. Therefore the cost of the inventory is $500,000 and there is anunrealised profit of $100,000.

(W3) Retained earnings Hydrox Syntax Hydrox Syntax

Unrealised profit (W2) 100 B/f 48,600 6,300Additional depreciation(W1) 2,160

Pre acq. dividend to costof control (90% × 4,000)(W8)

3,600

Non-controlling interest(10% × 6,300) 630

Pre-acquisition profit(90% × 15,000) 13,500Post acquisition loss(90% × (15,000 − 6,300)) (7,830)

Post acquisition loss(7,830)

Goodwill impairment 400Balance c/f 34,510

―――― ―――― ―――― ――― 40,770 6,300 40,770 6,300

―――― ―――― ―――― ――― (W4) Cost of control

Investments at cost 30,000 Equity shares (90% × 5,000) 4,500

Pre acquisition dividend (W3) (3,600) Pre acquisition profit (W3) 13,500Fair value adjustments (W1)(plant 5,400, investments 1,800) 7,200Goodwill 1,200

26,400 26,400(W5) Non-controlling interest

Balance c/f 1,130 Equity shares (10% × 5,000) 500

Retained earnings (W4) 630

1,130 1,130





(W6) Elimination of current accounts The current accounts of Hydrox and Syntax were agreed at $1,400,000 before the‘in transit’ sale. When Hydrox processed this transaction it would have debitedthe sale to Syntax’s current account. In effect, this must be reversed to eliminateintra-group balances. A summary of the ‘reversal’, including the effect of theunrealised profit is:

Dr Cr

Accounts payable (elimination of Hydrox’s credit balance) 1,400Inventory at cost (W2) 500Income statement of Hydrox (unrealised profit) 100Accounts receivable (elimination of Syntax’s debit balance) 2,000

2,000 2,000

(W7) Hydrox’s treatment of the dividend received from Syntax is incorrect and must

be adjusted for on consolidation. As Syntax has not made any profits sinceacquisition, and seems unlikely to in the future, the dividend must be consideredas being paid out of pre-acquisition profits and should be treated as a partialreturn of the cost of the investment. It should not be treated as income in theconsolidated financial statements.

61 Hedra

Hedra: Consolidated statement of financial position as at 30 September 2012$000 $000

Non-current assets

Property, plant and equipment: 358 + 240 + 12 + 20 + 5 +15 (w (iv)) 650Goodwill: 100 – 20 (w (i)) 80Investment in associate (w (v)) 220Other investments 45

995Current assetsInventories: 130 + 80 210Trade receivables: 142 + 97 239Cash and bank 4

453

Total assets 1,448

Equity and liabilitiesEquity attributable to the parent 480

Ordinary share capital: 400 + 80 (w (v))Reserves:

Share premium: 40 + 120 (w (v)) 160Revaluation: 15 + 12 + (5 × 60%) (w (iv)) 30Retained earnings (w (ii)) 261

451

931





Hedra: Consolidated statement of financial position as at 30 September 2012$000 $000

Non-controlling interest (w (iii)) 1121,043

Non-current liabilitiesDeferred tax: 45 – 10 35Current liabilitiesBank overdraft 12Trade payables: 118 + 141 259Deferred consideration (w (i)) 49Current tax payable 50

370Total equity and liabilities 1,448Workings The investment in Salvador represents 60% (72/120) of its equity and is likely to giveHedra control thus Salvador should be consolidated as a subsidiary. The investment inAragon represents 40% (40/100) of its equity. Normally this would give Hedrasignificant influence and Aragon would be classed as an associate that should beequity accounted.(i) Cost of control

$000 $000 $000Cost of acquisition

Immediate 195Deferred 49

244AcquiredShare capital 72Share premium of Salvador (60% × 50) 30Pre-acquisition profit of Salvador (60% × 20) 12Fair value adjustments:

Land 20Plant 20Deferred tax asset (40 × 25% tax rate) 10

50Group share (60%) 30

144Goodwill (balancing figure) 100

The deferred contingent consideration has now become payable and has to beaccounted for. Goodwill must be adjusted accordingly.

(ii) Retained earnings

$000 $000Hedra: per statement of financial position at end of year 240

SalvadorRetained profits in year-end statement of financial position 60





$000 $000Less: Additional plant depreciation (w(iv)) (5)

55Non controlling interest share (40%) 22

Group share 33Pre-acquisition profit (60% × 20) (12)

21Impairment of goodwill (20)Share of Aragon profits (6 months)

6/12 × (300 – 200) × 40% 20

Consolidated retained earnings 261

(iii) Non-controlling interest

Salvador: $000 $000

Share capital 120Share premium 50Retained profit as in statement of financial position 60Less: Additional plant depreciation (w(iv)) (5)

55

225

Non-controlling interest share (40% 90

Non-controlling interest share in:Fair value adjustments (see w(i)) 40% × 50 20

Post-acquisition revaluation of land: 40% × 5 2

Non-controlling interest 112

(iv) Fair value adjustments/revaluation

There are fair value adjustments of $50,000, see working (i).Group share (60%) = 30Non-controlling interest share (40%) = 20

The increase in the fair value of the land at the date of acquisition is accountedfor as a fair value adjustment. The increase of a further $5 million in the yearended 30 September 2012 is a revaluation increase (accounted for as 60% to thegroup revaluation reserve and 40% to non controlling interest).The fair value adjustment of $20 million to plant will be realised evenly over thenext four years in the form of additional depreciation at $5 million per annum. Inthe year ended 30 September 2012 the effect on the consolidated financialstatements is that $5 million will be charged to Salvador’s profit (as additionaldepreciation); and a net $15 million added to the carrying value of the plant.





(v) Investment in associate

$000Investment at cost: 80 million share of Hedra × $2.50 per share 200Share of post acquisition profit: 6/12 × (300 – 200) × 40% 20

220The purchase consideration by way of a share exchange (80 million in Hedra for40 million in Aragon) would be recorded in the accounts of Hedra as an increasein share capital of $80 million ($1 nominal value) and an increase in sharepremium of $120 million (80 × $1.50).

Sharecapital

Sharepremium

$000 $000As shown in the statement of financial position of Hedra 400 40Acquisition of shares in Aragon 80 120――― ――― In the consolidated statement of financial position 480 160――― ―――

62 Harden

(a)Harden Consolidated statement of financial position as at 30 September 2012

$000 $000Non-current assetsProperty, plant and equipment (W1) 6,480Patents (250 + 420) 670Consolidated goodwill (W4) 180

850InvestmentsAssociate (W7) 960Others (150 + 200) 350

1,3108,640

Current assetsInventories (W2) 962Trade receivables (420 + 380 – 70 – 50) (W6) 680Bank 150

1,792Total assets 10,432Equity attributable to equity holders of the parentEquity shares of $1 each 2,000ReservesShare premium 1,000Retained earnings (W3) 5,172

6,1728,172

Non-controlling interest (W5) 7108,882





Harden Consolidated statement of financial position as at 30 September 2012

$000 $000Non-current liabilitiesDeferred tax 200

Current liabilitiesTrade payables (750 + 450 – 70) (W6) 1,130Taxation 140Overdraft 80


Workings ($000)(W1) Tangible non-current assets

Balance from question – Harden 3,980– Solder 2,300Land fair value increase 200

6,480(W2) Inventories

Amounts per question (570 + 400) 970Group share of unrealised profit (140 × 40/140 × ½ × 40%) (8)

962(W3) Retained earnings

Harden Solder Harden Solder

Unrealised profit (W2) 8 B/f 4,500 1,900Management charge (W6) 50 Post acq profit – Solder 520Non-controlling interest(20% × (1,900 – 50)) 370

Post acq profit – Active(W7)

160

Pre-acq profit (80% × 1,200) 960Post acq profit(80% × (1,900 – 50 – 1,200)) 520Balance c/f 5,172

――― ――― ――― ――― 5,180 1,900 5,180 1,900

――― ――― ――― ――― (W4) Goodwill

Investments at cost 2,500 Equity shares (80% × 1,000) 800 800

Share premium (80% × 500) 400

Pre acq profit (80% x 1,200)) 960

Fair value adjustments (80% × 200) 160

Goodwill 180

2,500 2,500





(W5) Non-controlling interest

Balance c/f 710 Equity shares (20% × 1,000) 200

Share premium (20% × 500) 100

Fair value adjustments (20% × 200) 40

Retained earnings (W3) 370710 710

(W6) Elimination of current accounts

The current accounts of Harden and Solder were agreed at $70,000 beforethe charge for the allocation of central overheads. When Harden processedthis transaction it would have debited Solder’s current account to give a balance of $120,000 which must be eliminated. The correspondingadjustments are to eliminate $70,000 from Solder’s trade payables and debit$50,000 to the retained earnings of Solder.

In summary:Dr Cr

Trade payables (elimination of intra-group creditor) 70Retained earnings of Solder reflecting the charge 50Trade receivables (elimination of intra-group debtor) 120

120 120(W7) Associate

Investment at cost 800Post-acquisition profits (40% × (1,200 – 800)) 160

960

(b) IFRS 3 Business Combinations states the assets and liabilities that should berecognised on the acquisition of an acquired entity are those that existed at thedate of acquisition. Whilst this sounds relatively obvious, it does raise someissues. It may be that an entity has in existence some assets and liabilities that arenot (and in some cases cannot be) recognised on the entity’s own statement offinancial position. Applying this guidance to items (i) and (ii):(i) Trading losses available for future tax relief can represent a deferred tax

asset, but only where their recovery can be assured with a high degree ofcertainty. Prior to the acquisition it is clear that this degree of certainty didnot exist and the directors of Deployed are correct in not recognising adeferred tax asset in respect of the losses. However when Deployed becomes a member of the Harden group, deferred tax has to be determinedon a group basis and the directors of Harden are confident that the taxlosses of Deployed can be utilised on a group basis. IFRS 3 says that any benefit to the group of an acquired entity’s tax losses should be recognisedon acquisition. Therefore it would appear that a deferred tax asset of$60,000 ($200,000 × 30%) should be recognised as part of the fair valueexercise. This would be either as a reduction of the group deferred taxliability or as a deferred tax asset, provided it meets the recognition criteriain IAS 12 Income Taxes.

(ii) Again the management of Deployed are correct in not recognising the

disputed insurance claim as it is probably not ‘virtually certain’ which isthe recognition criterion required under IAS 37 Provisions, Contingent





Liabilities and Contingent Assets. Despite this IFRS 3 says that identifiableassets, liabilities and contingent liabilities of the acquired entity have to berecognised in the consolidated financial statements even if they were notrecognised, or did not qualify for recognition, in the acquired entity’s ownfinancial statements. If an acquired entity has a contingent asset it is

possible that future economic benefits will flow to the acquirer, although itcould be disputed that there is the required reliable measure of their fairvalue. There is a case for recognising this asset as part of the fair valueexercise at the best estimate of its likely outcome. However, IFRS 3 does notstate that contingent assets should be recognised and therefore theinsurance claim should not be recognised.

63 Halogen

(a)Halogen

Consolidated statement of financial position as at 31 March 2012

$m $mAssetsNon-current assetsProperty, plant and equipment (910 + 330 + 10 + 8) 1,258Goodwill (150 – 30)(W2) 120Development expenditure (100 – 8 ) 92Investments ((700 – 480 (W3))) + 60) 280

1,750Current assetsInventory (224 +120 – 3) 341Trade receivables (264 + 84 – 12 (W4)) 336Bank 25

702Total assets 2,452Equity and liabilitiesEquity shares $1 each 1,000Share premium 300Retained earnings (W6) 536Revaluation reserve: 70 + 75% × (48 – 40)) 76

9121,912

Non-controlling interest (W5) 125Equity 2,037Non-current liabilities10% Debenture 60Current liabilitiesTrade payables (128 + 24) 152Taxation (94 + 35) 129Overdraft (86 – 12 (W4)) 74

355Total equity and liabilities 2,452





Workings (W1) Net assets in subsidiary

At acquisition At end ofreporting period

$m $mShare capital 200 200Revaluation reserve 40 48Retained earnings 180 260Fair value adjustments – dev exp (28 – 8) 20 20

440 528(W2) Goodwill

$mCost of investment 48075 million (200m/2 × 75%) x $5 375Cash paid (200m/2 × 75%) × $1.40 105

480Net assets acquired 75% × 440 (W1) 330Goodwill 150Less impairment (30)

120(W3) Unrealised profit adjustments

Unrealised profit in inventory (26 × 30/130 × 1/2) = (3)Parent sells to subsidiary so no NCI adjustment


25%×

(528 – 28) (W1) = $125,000(W6) Retained earnings

$mHalogen 530Less: unrealised profit in inventory (W4) (3)Stimulus: group share post acquisition75% × ((260 – 28) – 180) 39Less impairment (30)

536

(b) There is a view that an income statement prepared under the concept of ‘currentoperating income’ has some merit. The principal advantage of this method ofreporting is said to be that it reports the results of those parts of a business thatcan be expected to be operating in the future and this forms a useful basis fromwhich to predict the future profit and income streams of the entity. Whilst thisview may have some benefits, the accounting profession has rejected it mainly because it would lead to incomplete reporting and the introduction of greatersubjectivity. It would give management scope to report selectively certainaspects of performance.The directors of Halogen are partly correct in interpreting the usefulness of IFRS5, in that by identifying and separately reporting discontinued operations andassets and subsidiaries held for sale this does help the predictive/forecastingprocess. However, it is important to realise that IFRS 5 does not permit the





HorsefieldConsolidated statement of financial position as at 31 March 2012

$000 $000Non-current liabilities10% Loan notes (500 + 240) 740

Current liabilitiesAccounts payable (420 + 960) 1,380Taxation (220 + 250) 470Overdraft 190

2,040Total equity and liabilities 16,557Workings

(W1) Net assets in subsidiaryAt

acquisitionAt end of

reporting period

$000 $000Share capital 1,200 1,200Retained earnings 800 2,300

Fair value adjustment:Investment property 120 120Licence 180 180Amortisation of licence 180/6 x 2yrs (60)

――― ――― 2,300 3,740

――― ――― (W2) Goodwill

$000Cost of investment ($3 × 1,200 × 90%) 3,240Net assets acquired (90% × 2,300) (W1) 2,070Goodwill 1,170Less impairment (468)

702(W3) Unrealised profit in inventory

((2/3 × 65,000) × 30/130) × 30% = $3,000Parent sells to associate, therefore reduce group retained earnings andInvestment in associate

(W3) Non-controlling interest10% × 3,740 = $374,000

(W4) Retained earnings$000

Horsefield 7,500Sandfly – group share post acquisition90% × (3,740 – 2,300) 1,296Anthill – group share post acquisition30% × (600 × 6/12) 90Unrealised profit (W3) (3)

Less impairment (468 + 12) (480)8,403





(W5) Investment in associate

$000Investment at cost 630

Post acquisition profit (30% × (600 × 1/2)) 90

Less impairment (12)718

Unrealised profit in inventory (3)

705

(b) IAS 28 Investments in Associates and Joint Ventures defines associates. In order foran investment to be classified as an investment in an associate the investor musthave ‘significant influence ’ over the investee. Significant influence is presumed toexist where there is a holding of 20% or more of the voting power unless theinvestor can clearly demonstrate that this is not the case. Conversely a holding ofless than 20% is presumed not to be an associate, unless it can be clearlydemonstrated that the investor can exercise significant influence. The votingrights can be held directly or through subsidiaries.IAS 28 says that a majority holding by one investor does not preclude anotherinvestor having significant influence. An investing company owning a majorityholding in another company normally has control over the investee and wouldthus class it as a subsidiary. In normal circumstances it is difficult to see how acompany could be controlled by one entity and be significantly influenced by adifferent entity unless ‘control’ was passive. The 20% test is not definitive and thefollowing other evidence should be considered.

Does the investing company: have representation on the Board of the investee? participate in the policy making processes (operational and financial); have

material transactions with the investee? interchange managerial personnel with the investee; or provide technical

expertise to the investee?

65 Highmoor

(a)

HighmoorConsolidated statement of financial position as at 30 September 2012

$m $mAssetsNon-current assetsTangible (585 + 172) 757Intangible:Software (W7) 1 24Investments (225 – 160 shares – 50 loan (W6) + 13) 28

809





HighmoorConsolidated statement of financial position as at 30 September 2012

$m $mCurrent assetsInventory (85 + 42) 127Accounts receivable (95 – 4 in transit (W6) + 36) 127Tax asset 80Bank (20 + 9 in transit (W6)) 29

363Total assets 1,172

Equity and liabilitiesEquity attributable to equity holders of the parentOrdinary shares $1 each 400Retained earnings (W4) 326

726Non-controlling interest (W3) 43

769Non-current liabilities12% loan notes 35Current liabilitiesAccounts payable (210 + 71) 281Overdraft 17Taxation 70

368Total equity and liabilities 1,172

Workings (Note: all figures in $ million)

(W1) Net assets in subsidiary

At acquisition At end ofreporting period

$000 $000Share capital 100 100Retained earnings 150 115

250 215(W2) Goodwill

$000Cost of investment 160

Net assets acquired (80% × 250) (W1) 200

Negative goodwill 40

Transfer to income statement immediately (40) ‐

The contingent consideration has not been included in the abovecalculation.





IFRS 3 Business Combinations only requires contingent consideration to beincluded in the cost of an acquisition if it is probable that the amount will be paid and it can be measured reliably.The additional $96 million (i.e. $1.20 per share) is only payable if Slowmoormakes a profit within two years of acquisition. In the year since acquisitionthe company made a loss of $35 million and the directors of Highmoor arenow less confident of the future prospects of Slowmoor. This seems toindicate that it is unlikely that any further consideration will be paid andthe above treatment is justified.


20% × 215 (W1) = $43,000(W4) Retained earnings

$000Highmoor 330

Slowmoor – group share of post-acquisition losses= 80% × 35 (28)Negative goodwill 40Unrealised profit (W6) (16)

326(W5) Elimination of loan and accrued interest

The investments of Highmoor will show an unadjusted amount of $50million as a loan to Slowmoor. The cash in transit of $9 million fromSlowmoor should be applied $4 million to cancel the accrued interestreceivable and the balance of $5 million to the investment (loan). When thisadjustment is made the investment and the loan will cancel each other out.

(W6) The carrying value of the software in Slowmoor’s books is $40 million. Ifthe software had been depreciated on its original cost of $30 million itwould have a carrying value of $24 million ($30 less $6 million depreciationat 20% per annum). Thus there is an unrealised profit on the transfer of thesoftware of $16 million ($40 million – $24 million).

(b) Negative goodwill arises in book-keeping where the consideration given for a business is less than the fair value of the net assets acquired. Intuitively it doesnot make sense for a vendor to sell net assets for less than they are worth. Thisview is reflected by the IASB which requires that where an acquisition appears tocreate negative goodwill, a careful check of the value of the assets acquired andwhether any liabilities have been omitted is required.Negative goodwill may arise for several reasons; the most obvious is that therehas been a bargain purchase. This may occur through the vendor being in a poorfinancial position and needing to realise assets quickly, or it may be due to goodnegotiating skills on the part of the acquirer, or the vendor may not realise howmuch the assets are really worth.A more controversial occasion where negative goodwill arises is where acompany, in determining the amount of consideration it is willing to pay for a business, will take into account the cost of anticipated future losses and post-acquisition reorganisation expenditure that it believes will be required. The effectof this is that it would reduce the consideration offered/paid. As these costs





cannot generally be recognised as a liability at the date of purchase, this can leadto the consideration being lower than the recognisable net assets.In relation to the acquisition of Slowmoor the following are questionable issues:

Highmoor may be trying to deliberately create losses at Slowmoor to avoidpaying the further consideration. An example of this may be the transferprice of the software.

The additional consideration of $96 million, if payable, would change thenegative goodwill into positive goodwill of $56 million.

The tax asset of Slowmoor may be questionable. Accounting standards arequite restrictive over the recognition of tax assets.

66 Hapsburg

(a)

HapsburgConsolidated statement of financial position as at 31 March 2012

$000 $000Non-current assetsGoodwill (w (i)) 12,800Property, plant and equipment (41,000 + 34,800 + 3,750 (w (i))) 79,550Investments:

– in associate (w (iv)) 15,150– ordinary (3,000 + 1,500 (fair value increase)) 4,500

19,650

112,000Current assetsInventory (9,900 + 4,800 – 300 (w (v))) 14,400Trade receivables (13,600 + 8,600) 22,200Cash (1,200 + 3,800) 5,000


Equity and liabilitiesOrdinary share capital (20,000 + 16,000 (w (i))) 36,000Reserves:Share premium (8,000 + 16,000 (w (i))) 24,000Retained earnings(w (ii)) 8,050

32,05068,050

Non-controlling interests (w (iii)) 9,15077,200

Non-current liabilities10% Loan note (16,000 + 4,200) 20,200Deferred consideration (18,000 + 1,800) W2 19,800

40,000





HapsburgConsolidated statement of financial position as at 31 March 2012

$000 $000Current liabilities:

Trade payables (16,500 + 6,900) 23,400Taxation (9,600 + 3,400) 13,00036,400


Workings – Note: all working figures in $000.


Atacquisition

At end ofreporting

period$000 $000

Share capital 30,000 30,000Share premium 2,000 2,000Retained earnings (8,500 – 4,500) 4,000 8,500Fair value adjustmentPlant (15 – 10) 5,000 5,000

Depreciation 5,000 × 1/4 (1,250)

Investment (4.5 – 3) 1,500 1,500

42,500 45,750(W2) Goodwill

$000Investment at costShares (24m x 2/3 x $2) 32,000Cash (24m x$1) x 0.75 18,000

50,000Net assets at acquisition (80% × 42,500) (W2) (34,000)

Goodwill on consolidation 16,000Less impairment (3,200)

In consolidated statement of financial position 12,800

In Hapsburgs booksDr Cost of investment 50,000

Cr Share capital (24m × 2/3) 16,000Cr Share premium (32 – 16) 16,000Cr Deferred consideration 18,000

Unwind the discount: 10% × 18,000 = 1,800Dr Group finance cost (Group RE) 1,800

Cr Deferred consideration 1,800





the investment is initially recorded at cost and subsequently increased by theinvestor’s share of the retained profits of the associate (any other gains such asthe revaluation of the associate’s assets would also be included in this process).This treatment means that the investor would show the same profit irrespectiveof the size of the dividend paid by the associate and the statement of financial

position more closely reflects the worth of the investment.The problem of ‘off balance sheet’ finance relates to the fact that it is the netassets that are shown in the investor’s statement of financial position. Any shareof the associate’s liabilities is effectively hidden because they have been offsetagainst the associate’s assets. As a simple example, say a holding companyowned 100% of another company that had assets of $100 million and debt of $80million, both the assets and the debt would appear in the consolidated statementof financial position. Whereas if this single investment was replaced by owning50% each of two companies that had the same statements of financial position(i.e. $100 million assets and $80 million debt), then under equity accounting only$20 million ((100 – 80) × 50% × 2) of net assets would appear in the statement offinancial position thus hiding the $80 million of debt. Because of this problem, ithas been suggested that proportionate consolidation is a better method ofaccounting for associates, as both assets and debts would be included in theinvestor’s statement of financial position. IAS 28 does not permit the use ofproportionate consolidation.

67 Highveldt

(a) (i) The deferred consideration of $108 million must be discounted for one yearat a cost of capital of 8% to $100 million (= $108 million/(1.08) 1. The $8million difference is a finance charge in the year to 31 March 2012.

Goodwill calculation $m $mInvestments at costCash consideration (80 × 75% × $3.50) 210Deferred consideration (see above) 100

310Less:Ordinary shares (75% × 80) 60Share premium (75% × 40) 30Pre-acquisition profit (see working) 87Fair value adjustments: brand (75% × 40) 30

- land and buildings (75% × 20) 15(222)

Goodwill on acquisition 88Impairment at 31 March 2012 (from question) (22)Goodwill at 31 March 2012 66Although the internally-generated brand cannot be recognised in Samson’sown financial statements, it should be recognised in the consolidatedstatement of financial position on the acquisition of Samson. This is becausethe method given in the question is an acceptable method of valuation andthus the brand can be ‘reliably measured’.





(b) The objective of consolidated financial statements is to show the financialperformance and position of the group as if it was a single economic entity. Thereis a view that, as the entity financial statements of the parent company containthe investments in subsidiaries as non-current assets, they reflect the assets of thegroup as a whole. The more traditional view is that entity financial statements do

not provide users with sufficient information about subsidiaries for them tomake a reliable assessment of the performance of the group as a whole. Thefollowing are benefits of consolidated financial statements:– They identify the nature and classification of the subsidiary’s assets. For

example, the investment in a subsidiary may be almost entirely inintangible assets or conversely they may be substantially land and buildings. Such a distinction is of obvious importance to users.

– The amount of the subsidiary’s debt could not be assessed from theparent’s entity financial statements. In effect the subsidiary’s assets andliabilities are netted off when it is shown as an investment. This means

group liquidity and gearing cannot be properly assessed.– The cost of the investment in the parent company statement of financial

position does not reflect the size of a company. For example a parentcompany may show an investment in a subsidiary at a cost of $10 million.This may represent the purchase of a subsidiary that has $10 million ofassets and no liabilities. Alternatively this could be a subsidiary that has$100 million in assets and $90 million of liabilities.

– The cost of the investment may be a fair representation of its value at thedate of purchase, but with the passage of time (assuming the subsidiary isprofitable), its value will increase. This increase would not be reflected inthe original cost, but it would be reflected in the consolidated net assets ofthe subsidiary (and the increase in group reserves).

– The cost of the investment might represent all of the ownership of thesubsidiary or only just over half of it, i.e. there would be no indication ofthe non-controlling interest.

To summarise, in the absence of a consolidated statement of financial position,users would have no information on the current value of a subsidiary, its size, thecomposition of its net assets and how much of it was owned by the group.

68 Hark, Spark and Ark

Hark Group Consolidated statement of financial position as at 31 March 2012

$000 $000

Non ‐current assets

Property, plant and equipment (working 1) 90,200

Goodwill (working 4) 23,000

Investment in associate (working 6) 9,500

Other investments 650

123,350

Current assets (working 5) 24,300

Total assets 147,650





Hark Group

Consolidated statement of financial position as at 31 March 2012

$000 $000

Equity and liabilities

Equity shares of $1 each (working 3) 21,000

Share premium (working 3) 42,000

Retained earnings (working 8) 43,730

85,730

106,730

Non ‐controlling interests (working 7) 7,420

Total equity 114,150

Non ‐current liabilities

Deferred consideration for Spark shares 5,500

6% loan notes 10,000

7% loan notes 6,000 21,500

Current liabilities: 7,000 + 5,000 12,000


Workings

1 Property, plant and equipment (PPE)

$000 $000Hark 60,000Spark 31,000

Profit on transfer of machines (3 million – 2 million) 1,000Less: Depreciation on this amount in accounts of Spark(1,000/5 years)

(200)

Unrealised profit in machines (800)PPE in consolidated statement of financial position 90,200

2 Deferred consideration

The present value of the deferred consideration at 1 April 2011 is $6.05million × 1/(1.10) 2 = $5 million.During the year to 31 March 2012 there is a finance charge of 10% (=

$500,000) on this amount, reducing the parent’s share of the consolidatedprofit.The deferred consideration at 31 March 2012 is $5 million + $500,000 =$5,500,000. This is payable in just over 12 months and is included in theconsolidated statement of financial position as a non-current liability.

3 Share issues

The share issues to acquire the shares in Spark and Ark are not recorded inthe summary statement of financial position of Hark (as stated in thequestion).





Total Sharecapital

Sharepremium

To acquire the shares in Spark $000 $000 $000Hark shares issued: (4 million at $9) 36,000 4,000 32,000

To acquire the shares in Ark Hark shares issued: (1 million at $9) 9,000 1,000 8,000

Increase in share capital and share premium ofHark

5,000 40,000

In summary statement of financial position 16,000 2,000

In consolidated statement of financial position 21,000 42,000

4 Goodwill

Hark has acquired 4 million/5 million = 80% of the shares of Spark.At 1 April 2011 the fair value of the net assets of Spark was (share capital

plus reserves) = $(5 + 4 + 16) million = $25 million$000

Purchase consideration paid by the parent companyIssue of 4 million shares at $9 36,000Deferred consideration 5,000

41,000

Fair value of parent company share of net assets (80% × $25 million) 20,000

Purchased goodwill attributable to parent 21,000

$000

Fair value of NCI at acquisition date (1 million shares × $7) 7,000NCI share of net assets at this date (20% × $25 million) 5,000

Purchased goodwill attributable to NCI 2,000 There has been no impairment of goodwill during the year.

$000

Purchased goodwill attributable to parent 21,000Goodwill attributable to NCI 2,000

Total goodwill in consolidated statement of financial position 23,000

Alternatively, total goodwill could be calculated as follows:$000

Purchase consideration paid by the parent company (see above) 41,000Fair value of NCI at acquisition date 7,000

48,000Net assets of the subsidiary at the acquisition date (at fair value) 25,000

Total goodwill (parent and NCI) 23,000

5 Current assets

The cost of the goods sold by Spark to Hark was $3,600,000 × 100/150 =$2,400,000 and the profit was $1,200,000.





Since 75% of these goods are in closing inventory, the unrealised profit onintra-group sales is 75% × $1,200,000 = $900,000. Current assets in theconsolidated statement of financial position (inventory) should be reduced by this amount.The question states that the transaction costs of the acquisition of Sparkhave not yet been recorded. These costs reduce the consolidated profit, andalso (presumably) reduce the current assets of Hark.Current assets on consolidation $000Hark 18,200Spark 8,000Less: unrealised profit in closing inventory (900)Less: expenses of acquisition of Spark (1,000)Current assets in consolidated statement of financial position 24,300

6 Investment in associate (Ark)

Since Hark owns 25% of the equity of Ark, it is assumed that Ark is anassociated entity.$000

Cost of investment: 25% × 6 million shares × $6 9,000Share of post-acquisition retained profit: 25% × $2 million 500

9,500

7 Non-controlling interests

$000

Share of net assets of Spark at 31 March 2012 (20% × $28 million) 5,600

Goodwill attributable to NCI (working 4) 2,0007,600

NCI share of unrealised profit in inventory (20% × $900,000) (180)

NCI at 31 March 2012: fair value method 7,420

8 Consolidated retained earnings

$000 $000Hark retained earnings (36,000 + 8,000) 44,000Spark

Profit for year ended 31 March 2012 3,000Unrealised profit in closing inventory (900)

2,100

Parent company share (80%) 1,680

Share of post-acquisition retained profits of Ark (25% × $2 million) 500

Costs of acquisition of Spark (expensed) (1,000)Additional finance costs: deferred consideration (500)Unrealised profit in machines (working 1) (800)Loss on other (800 – 650) (150)

Consolidated retained earnings at 31 March 2012 43,730





69 Parentis

Consolidated statement of financial position of Parentis as at 31 March 2012:$ million $ million

AssetsNon-current assetsProperty, plant and equipment (640 + 340 + 40 – 2) 1,018IntangibleConsolidated goodwill (135 (w (i)) – 27 impairment) 108

––––––1,126

Current assetsInventory (76 + 22 – 2 URP) 96Trade receivables (84 + 44 – 11 intra-group) 117Receivable re intellectual property 10Bank 4 227

–––– ––––––Total assets 1,353

––––––Equity and liabilitiesEquity attributable to equity holders of the parentEquity shares 25c each (w (i)) 375Reserves:Share Premium (w (i)) 150Retained earnings (w (ii)) 264 414

–––– ––––––789

Non controlling interest (w (iii)) 89––––––

Total equity 878Non-current liabilities

10% loan notes (120 + 20) 140Current liabilitiesTrade payables (130 + 57 – 7 intra-group) 180Cash consideration due 1 April 2012 (60 + 6 interest) 66Overdraft (25 – 4 CIT) 21Taxation (45 + 23) 68 335

–––– ––––––Total equity and liabilities 1,353

––––––Workings (Note: all figures in $ million)(i) Goodwill:

The acquisition of 600 million shares represents 75% of Offspring ’s 800 millionshares ($200m/25c). The share exchange of 300 million (i.e. 1 for 2) at $0 ·75 eachwill result in an increase in equity share capital of $75 million (the nominal value)and create a share premium balance of $150 million (i.e. $0 ·50 premium on 300million shares).Consideration:

Equity shares (600/2 x $0 ·75) 22510% loan notes (see below) 120Cash (600 x $0 ·11/1 ·1 i.e. discounted at 10%) 60

–––– 405





Acquired:Equity shares (600m x 25c) 150Pre acquisition retained earnings (120 x 75%) 90Fair value adjustment to properties (40 x 75%) 30 (270)

–––– ––––

Goodwill 135–––– The issue of the 10% loan notes is calculated as 600 million/500 x $100 = $120million.

(ii) Retained earnings:Parentis 300Interest on deferred consideration (60 x 10%) (6)Goodwill impairment (from question) (27)Offspring 140URP in inventory (see below) (2)Additional depreciation (from question) (2)

Write down intellectual property (30 – 10) (20)Pre acquisition (120)––––

(4) x 75% (3)––––

264––––

The unrealised profit in inventory (URP) is $5m/$15m of the profit of $6 millionmade by Offspring.

(iii) Non controlling interestOffspring net assets at 31 March 2012 340Fair value adjustment 40URP in inventory (2)Additional depreciation (2)Write down intellectual property (30 – 10) (20)

–––– 356 x 25% 89

–––– –––

70 Plateau

(a) Consolidated statement of financial position of Plateau as at 30 September 2012$’000 $’000

AssetsNon-current assets:Property, plant and equipment (18,400 + 10,400 – 400 (w (i))) 28,400Goodwill (w (ii)) 3,600Investments – associate (w (iii)) 10,500Other equity investments 9,000

––––––51,500

Current assetsInventory (6,900 + 6,200 – 300 URP (w (iv))) 12,800Trade receivables (3,200 + 1,500) 4,700 17,500

–––––– ––––––Total assets

69,000––––––





$’000 $’000Equity and liabilitiesEquity shares of $1 each (w (v)) 11,500Reserves:Share premium (w (v)) 7,500

Retained earnings (w (vi)) 28,650 36,150–––––– ––––––47,650

Non controlling interest (w (vii)) 3,150––––––

Total equity 50,800Non-current liabilities7% Loan notes (5,000 + 1,000) 6,000Current liabilities (8,000 + 4,200) 12,200

––––––Total equity and liabilities 69,000

––––––Workings (figures in brackets are in $’000)(i) Property, plant and equipment

The transfer of the plant creates an initial unrealised profit (URP) of$500,000. This is reduced by $100,000 for each year (straight-linedepreciation over five years) of depreciation in the post-acquisition period.Thus at 30 September 2012 the net unrealised profit is $400,000. This should be eliminated from Plateau’s retained profits and from the carrying amountof the plant. The fall in the fair value of the land has already been taken intoaccount in Savannah’s statement of financial position.

(ii) Goodwill in Savannah:Goodwill in Savannah:

Investment at cost: $’000 $’000Shares issued (3,000/2 x $6) 9,000Cash (3,000 x $1) 3,000

––––––12,000

Less – equity shares of Savannah (3,000)– pre-acquisition reserves (6,000 x 75% (see below)) (4,500) (7,500)

–––––– ––––––Goodwill on consolidation 4,500

––––––Goodwill is impaired by $900,000 thus has a carrying amount at 30September 2012 of $3·6 million.Savannah’s pre-acquisition reserves of $6·5 million require an adjustmentfor a write down of $500,000 in respect of the fair value of its land being below its carrying amount. Thus the adjusted pre-acquisition reserves ofSavannah are $6 million. A consequent effect is that the post-acquisitionreserves which are reported as $2·4 million in Savannah’s statement offinancial position will become $2·9 million. This is because the fall in thevalue of the land has effectively been treated by Savannah as a post-acquisition loss.

(iii)Carrying amount of Axle at 30 September 2012 $’000Cost (4,000 x 30% x $7·50) 9,000

Share post-acquisition profit (5,000 x 30%) 1,500––––––10,500––––––





(iv) The unrealised profit (URP) in inventory is calculated as:Intra-group sales are $2·7 million on which Savannah made a profit of$900,000 (2,700 x 50/150). One third of these are still in the inventory ofPlateau, thus there is an unrealised profit of $300,000.

(v) The 1·5 million shares issued by Plateau in the share exchange at a value of$6 each would be recorded as $1 per share as capital and $5 per share asshare premium giving an increase in share capital of $1·5 million and ashare premium of $7·5 million.

(vi)Consolidated retained earnings: $’000 $’000Plateau’s retained earnings 24,000Savannah’s post-acquisition ((2,900 – 300 URP) x 75%) 1,950Axle’s post-acquisition profits (5,000 x 30%) 1,500URP in plant (see (i)) (400)Gain on other equity investments (9,000 – 6,500) 2,500Impairment of goodwill (900)––––––

28,650––––––

(vii) Non controlling interestAdjusted equity at 30 September 2012: (12,900 – 300 URP) =12,600 x 25% 3,150

––––––

(b) IFRS 3 Business Combinations requires the purchase consideration for an acquiredentity to be allocated to the fair value of the assets, liabilities and contingentliabilities acquired (henceforth referred to as net assets and ignoring contingentliabilities) with any residue being allocated to goodwill. This also means thatthose net assets will be recorded at fair value in the consolidated statement offinancial position. This is entirely consistent with the way other net assets arerecorded when first transacted (i.e. the initial cost of an asset is normally its fairvalue). The purpose of this process is that it ensures that individual assets andliabilities are correctly classified (and valued) in the consolidated statement offinancial position. Whilst this may sound obvious, consider what would happenif say a property had a carrying amount of $5 million, but a fair value of $7million at the date it was acquired. If the carrying amount rather than the fairvalue was used in the consolidation it would mean that tangible assets (property,plant and equipment) would be understated by $2 million and intangible assets(goodwill) would be overstated by the same amount (note: in the consolidatedstatement of financial position of Plateau the opposite effect would occur as thefair value of Savannah’s land is below its carrying amount at the date ofacquisition). There could also be a ‘knock on’ effect with incorrect depreciationcharges in the years following an acquisition and incorrect calculation of anygoodwill impairment. Thus the use of carrying amounts rather than fair valueswould not give a ‘faithful representation’ as required by the ConceptualFramework.The assistant’s comment regarding the inconsistency of value models in theconsolidated statement of financial position is a fair point, but it is really a

deficiency of the historical cost concept rather than a flawed consolidationtechnique. Indeed the fair values of the subsidiary’s net assets are the historical





costs to the parent. To overcome much of the inconsistency, there would benothing to prevent the parent company from applying the revaluation model toits property, plant and equipment.

71 Pacemaker

Consolidated statement of financial position of Pacemaker as at 31 March 2012:$million $million

Non-current assetsTangibleProperty, plant and equipment (w (i)) 818IntangibleGoodwill (w (ii)) 23Brand (25 – 5 (25/10 x 2 years post acqamortisation))

20

InvestmentsInvestment in associate (w (iii)) 144Other equity investments (82 + 37) 119

––––––1,124

Current assetsInventory (142 + 160 – 16 URP (w (iv))) 286Trade receivables (95 + 88) 183Cash and bank (8 + 22) 30 499

––––– ––––––Total assets 1,623

––––––Equity and liabilities

Equity attributable to the parentEquity shares (500 + 75 (w (iii))) 575Share premium (100 + 45 (w (iii)) 145Retained earnings (w (iv)) 247 392

––––– ––––––967

Non-controlling interest (w (v)) 91––––––

Total equity 1,058Non-current liabilities10% loan notes (180 + 20) 200Current liabilities (200 + 165) 365

––––––Total equity and liabilities 1,623––––––

Workings (all figures in $ million)The investment in Syclop represents 80% (116/145) of its equity and is likely to givePacemaker control thus Syclop should be consolidated as a subsidiary. The investmentin Vardine represents 30% (30/100) of its equity and is normally treated as an associatethat should be equity accounted.





(i) Property, plant and equipmentPacemaker 520Syclop 280Fair value property (82 – 62) 20Post-acquisition depreciation (2 years) (20 x 2/20 years) (2)

––––818––––

(ii) Goodwill in Syclop:Investment at cost – cash 210– loan note (116/200 x $100) 58

––––Cost of the controlling interest 268Fair value of non-controlling interest (from question) 65Equity shares 145Pre-acquisition profit 120Fair value adjustments – property (w (i)) 20

– brand 25––––Fair value of net assets at acquisition (310)

––––Goodwill 23

––––(iii) Investment in associate:

$millionInvestment at cost (75 x $1·60) 120Share of post-acquisition profit (100 – 20) x 30% 24

––––144

––––The purchase consideration by way of a share exchange (75 million shares inPacemaker for 30 million shares in Vardine) would be recorded as an increase inshare capital of $75 million ($1 nominal value) and an increase in share premiumof $45 million (75 million x $0·60).

(iv) Consolidated retained earnings:Pacemaker’s retained earnings 130Syclop’s post-acquisition profits (130 x 80% see below) 104Gain on investments – Pacemaker (see below) 5Vardine’s post-acquisition profits (w (iii)) 24URP in Inventories (56 x 40/140) (16)

––––247

––––Syclop’s retained earnings:Post-acquisition (260 – 120) 140Additional depreciation/amortisation (2 + 5) (7)Loss on other equity investments (40 – 37) (3)

––––Adjusted post-acquisition profits 130

––––Gain on the value of Pacemaker’s available-for-sale investments:Carrying amount at 31 March 2011 (345 – 210 cash – 58 loan note) 77Carrying amount at 31 March 2012 82

––––Gain to retained earnings (or other components of equity) 5

––––





(v) Non-controlling interestFair value on acquisition (from question) 65Share of adjusted post acquisition profit (130 x 20% (w (iv))) 26

––––91

––––

72 Picant(a) Consolidated statement of financial position of Picant as at 31 March 2010

$’000 $’000AssetsNon-current assets:Property, plant and equipment(37,500 + 24,500 + 2,000– 100) 63,900Goodwill (16,000 – 3,800 (w (i))) 12,200Investment in associate (w (ii)) 13,200

–––––––– 89,300

Current assetsInventory(10,000 + 9,000 + 1,800 GIT– 600 URP (w (iii))) 20,200Trade receivables(6,500 + 1,500– 3,400 intra-group (w (iii))) 4,600 24,800

––––––– –––––––– Total assets 114,100

–––––––– Equity and liabilitiesEquity attributable to owners of the parentEquity shares of $1 each 25,000Share premium 19,800Retained earnings (w (iv)) 27,500 47,300

––––––– –––––––– 72,300

Non-controlling interest (w (v)) 8,400––––––––

Total equity 80,700Non-current liabilities7% loan notes (14,500 + 2,000) 16,500Current liabilitiesContingent consideration 2,700Other current liabilities(8,300 + 7,500– 1,600 intra-group (w (iii))) 14,200 16,900

––––––– –––––––– Total equity and liabilities 114,100

–––––––– Workings (figures in brackets are in $ ’000)(i) Goodwill in Sander

$’000 $’000Controlling interestShare exchange (8,000 x 75% x 3/2 x $3 ·20) 28,800Contingent consideration 4,200Non-controlling interest (8,000 x 25% x $4 ·50) 9,000

––––––– 42,000

Equity shares 8,000





(v) Non-controlling interestFair value on acquisition (w (i)) 9,000Post-acquisition losses (2,400 x 25% (w (iv))) (600)

––––––– 8,400

––––––– (b) Although the concept behind the preparation of consolidated financial

statements is to treat all the members of the group as if they were a singleeconomic entity, it must be understood that the legal position is that eachmember is a separate legal entity and therefore the group itself does not exist as aseparate legal entity. This focuses on a criticism of group financial statements inthat they aggregate the assets and liabilities of all the members of the group. Thiscan give the impression that all of the group ’s assets would be available todischarge all of the group ’s liabilities. This is not the case.Applying this to the situation in the question, it would mean that any liability ofTrilby to Picant would not be a liability of any other member of the Tradhatgroup. Thus the fact that the consolidated statement of financial position ofTradhat shows a strong position with healthy liquidity is not necessarily of anyreassurance to Picant. Any decision on granting credit to Trilby must be based onTrilby ’s own (entity) financial statements (which Picant should obtain), not thegroup financial statements. The other possibility, which would take advantage ofthe strength of the group ’s statement of financial position, is that Picant could askTradhat if it would act as a guarantor to Trilby ’s (potential) liability to Picant. Inthis case Tradhat would be liable for the debt to Picant in the event of a default by Trilby.

Business combinations – Statements of financialperformance

73 Hydan(a)

Hydan: Consolidated income statement year ended 31 March 2012$000

Revenue (98,000 + 35,200 – 30,000 intra-group sales) 103,200Cost of sales (w (i)) (77,500)Gross profit 25,700

Operating expenses: 11,800 + 8,000 + 375 goodwill (w (ii)) (20,175)Interest receivable: 350 – 200 intra-group (= 4,000 × 10% × 6/12)) 150Finance costs (420)

5,255Income tax expense (4,200 – 1,000 tax relief) (3,200)Profit for the period 2,055Attributable to:Equity holders of the parent 3,455Non-controlling interest (w (iv)) (1,400)

2,055





Hydan: Consolidated statement of financial position as at 31 March 2012

$000Non-current assetsProperty, plant and equipment (18,400 + 9,500 + 1,200 – 300depreciation adjustment)

28,800

Goodwill: 3,000 – 375 (w (ii)) 2,625Investment (16,000 – 10,800 – 4,000 loan) 1,200

32,625Current assets (w (v)) 24,000Total assets 56,625

Equity attributable to holders of the parentOrdinary shares of $1 each 10,000Share premium 5,000Retained earnings (w (iii)) 17,525

32,525Non-controlling interest (w (iv)) 3,800Total equity 36,325Non-current liabilities7% bank loan 6,000Current liabilities (w (v)) 14,300

56,625

Workings : All figures in $000(i)

Cost of salesHydan 76,000Systan 31,000Intra-group sales (30,000)Unrealised profit in inventories 200Additional depreciation re fair values 300

77,500(ii)

Goodwill/Cost of control in Systan

Investment at cost (2,000 × 60% × $9) 10,800Less:Ordinary shares of Systan 2,000Share premium 500Pre-acquisition reserves(= 6,300 + 3,000 post acquisition loss) 9,300Fair value adjustment 1,200

13,000 × 60% (7,800)Goodwill on consolidation 3,000Goodwill is impaired by 12.5% of its carrying amount = 375





(iii)

Consolidated reserves

Hydan’s reserves 20,000

Systan’s post-acquisition losses (see below) (3,500 × 60%) (2,100)

Goodwill impairment (w (ii)) (375)17,525

The adjusted profits of Systan are: 6,300Profit as stated in the questionAdjustments:

Unrealised profit in inventories (4,000 × 5%) (200)Additional depreciation (300)

(500)5,800

(iv)Non-controlling interest in income statementSystan’s post acquisition loss after tax 3,000Adjustments from (w (iii)) 500Adjusted losses 3,500 × 40% = 1,400NCI in statement of financial positionOrdinary shares and premium of Systan 2,500Adjusted profits (w (iii)) 5,800Fair value adjustments 1,200

9,500 × 40% = 3,800

(v)Current assets and liabilities

Current assets:Hydan 18,000Systan 7,200Unrealised profit in inventories (200)Intra-group balance (1,000)

24,000

Current liabilities:

Hydan 11,400Systan 3,900Intra-group balance (1,000)

14,300(b) Although Systan’s revenue has increased since its acquisition by Hydan, its

operating performance appears to have deteriorated markedly. Its gross profitmargin has fallen from 25% (6m/24m) in the six months prior to the acquisitionto only 11.9% (4.2m/35.2m) in the post-acquisition period. The decline in grossprofit is made worse by a huge increase in operating expenses in the post-acquisition period. These have gone from $1.2 million pre-acquisition to $8million post-acquisition.





Taking into account the effects of interest and tax, a $3.6 million first half profit(pre-acquisition) has turned into a $3 million second half loss (post-acquisition).Whilst it is possible that some of the worsening performance may be due tomarket conditions, the major cause is probably due to the effects of theacquisition.

Hydan has acquired a controlling interest in Systan and thus the two companiesare related parties. Since the acquisition most of Systan’s sales have been toHydan. This is not surprising as Systan was acquired to secure supplies toHydan. The terms under which the sales are made are now determined by themanagement of Hydan, whereas they were previously determined by themanagement of Systan. The question says sales to Hydan yield a consistent grossprofit of only 5%. This is very low and much lower than the profit margin onsales to Hydan prior to the acquisition and also much lower than the few salesthat were made to third parties in the post acquisition period. It may also be thatHydan has shifted the burden of some of the group operating expenses to Systan– this may explain the large increase in Systan’s post-acquisition operatingexpenses. The effect of these (transfer pricing) actions would move profits fromSystan’s books into those of Hydan.The implications of this are quite significant. Initially there may be a tendency tothink the effect is not important as on consolidation both companies’ results areadded together, but other parties are affected by these actions. The most obviousis the significant (40%) non-controlling interests. The NCI in Systan areeffectively having some of their share of Systan’s profit and net asset value takenfrom them.

74 Holdrite, Staybrite and Allbrite

(a)

Cost of control in Staybrite $000ConsiderationShares (10,000 × 75% × 2/3) × $6 30,0008% loan notes (10,000 × 75%) × $100/250 3,000

33,00075% of net assets at acquisition (W1) (75% × 34,000) (25,500)Goodwill on the purchase of Staybrite 7,500

Goodwill on the purchase of AllbriteConsiderationShares (40% x 5,000 × 3/4) × $6 9,000Cash (40% × 5,000) × $1 2,000

11,00040% of net assets at acquisition (W1) (40% × 15,000) (6,000)Goodwill 5,000





(b)

Holdrite Group Consolidated income statement for the year ended 30 September 2012

$000 $000

Revenue 75,000 + (40,700×

6/12) – 10,000 85,350Cost of sales 47,400 +(6/12 × 19,700) – 10,000 + 500 +1,000 (48,750)Gross profit 36,600Operating expenses 10,480 +(6/12 × 9,000) +750 (15,730)Profit from operations 20,870Income from associate 40% × (6/12 × 6,000) 1,200

22,070Interest expense (170)Profit before tax 21,900Income tax expense– Group (4,800 + (3,000 × 6/12)) (6,300)– Associate (w (iii)) (400)

(6,700)Profit for the period 15,200

Attributable to:Equity holders of the parent 14,200Non-controlling interest (W3) 1,000

15,200

(c) Movement on consolidated retained profits

$000Net profit for period (group only) 14,200Dividend paid (5,000)

9,200Retained profits b/f 18,000Retained profits c/f 27,200

Workings

(W1)

Net assets in subsidiary Acquisition$000

Share capital 10,000Share premium 4,000Retained earnings (7,500 + 6/12 × 9,000) 12,000Fair value adjustmentLand 3,000Plant 5,000

34,000





Net assets in associate Acquisition$000

Share capital 5,000Share premium 2,000Retained earnings (6,000 + 6/12 × 4,000) 8,000

15,000

(W2) Unrealised profit 4m × 1/4 = 1mParent selling to subsidiary, reduce group retained earnings and increasegroup cost of sales


Subsidiary post acquisition profit after tax(9,000 × 6/12) 4,500

Less: Depreciation adjustment on FV (500)4,000

Non controlling interest share 25% × 4,000 1,000

75 Python, Snake and Adder

(a)Goodwill on acquisitionPurchase consideration $000 $000Issue of new shares in Python: 24 million × 2/3 × $4.80 76,800

Deferred consideration: working 1 24,000Total purchase consideration 100,800Equity shares 32,000Pre-acquisition reserves at 1July 2011 67,000Pre-acquisition reserves from1 July – 1 Oct 2011: 16,400 × 3/12

4,100

Fair value adjustments ($2.5 million + $2.4 million) 4,900Total net assets at fair value, 1 October 2011 108,000

Share acquired by Python: 75% (81,000)Goodwill on acquisition 19,800

(b)Python GroupConsolidated income statement for the year ended 30 June 2012

$000 $000Revenue: 160,000 + (72,000 × 9/12) – (1,000 × 9 months) 205,000Cost of sales: working 3 (122,400)

Gross profit 82,600Distribution costs: 7,900 + (4,000 × 9/12) (10,900)





Python GroupConsolidated income statement for the year ended 30 June 2012

$000 $000Administrative expenses: 13,200 + (6,000 × 9/12) (17,700)

Finance costs: working 2 (5,050)Impairment of goodwill (1,500)Share of profits of associate: 8,000 × 25% 2,000

(33,150)Profit before tax 49,450Income tax expense: 12,300 + (2,600 × 9/12) (14,250)

Profit for the year after tax 35,200

Attributable to:Equity shareholders of parent company: 35,200 – 2,950 32,250Non-controlling interests (working 4) 2,950

35,200Workings

(1) Deferred consideration per share = $1.21 per share × 1/(1.10)2 = $1.Total deferred consideration = 24 million shares × $1 = $24 million.

(2)Finance costs

$000Python (as given in income statement) 2,500

Finance cost of deferred consideration: $24 million × 10% × 9/12 1,800

Snake: 1,000 × 9/12 750

5,050(3)

Cost of sales$000

Python (as given in income statement) 99,000Snake: 42,000 × 9/12 31,500Less: Post-acquisition purchases from Python by Snake: 1,000 × 9months

(9,000)

Additional depreciation: property 50Additional depreciation: plant ($2.4 million/4 years) × 9/12 450Unrealised profit in inventory: $2 million × 25/125 400

122,400Note: Only post-acquisition intra-group sales are removed from revenue andthe cost of sales.





(4)NCI share of consolidated profit

$000

Snake post-acquisition profit: 16,400 × 9/12 12,300

Less: Additional post-acquisition depreciation on snake assets: 50 + 450 (500)11,800

NCI share = 25% 2,950The parent company share is the difference between the total consolidatedprofit and the profit attributable to the NCI. The unrealised profit oninventory is attributable to Python (sales by Python). Similarly the impairmentof goodwill is attributable to the parent company shareholders, since there isno goodwill attributable to the NCI.

(c) Python has accounted for its investment in Adder using the equity method onthe basis that it has been able to exert significant influence even though it hasnot been able to exercise control. Significant influence was evident from theshareholding of 25% in Adder’s equity (in excess of the 20% minimum wheresignificant influence is presumed to exist) and from the fact that a director ofPython was also a director of Adder.Following the purchase of shares in Adder by Mambo, Mambo has acquiredcontrol and will account for Snake as a subsidiary. Python has lost its positionon the Adder board. It seems clear that Python no longer has significantinfluence over Adder, and should therefore no longer account for itsinvestment in Adder by the equity method. The investment should be carried

in the financial statements of Python at fair value, in accordance with IAS 39.

76 Hosterling

(a) Cost of control in Sunlee: $’000 $’000ConsiderationShares (20,000 x 80% x 3/5 x $5) 48,000LessEquity shares 20,000Pre acq reserves 18,000Fair value adjustments (4,000 + 3,000 + 5,000) 12,000

50,000 x 80% (40,000)Goodwill 8,000

(b) Carrying amount of Amber 30 September 2012 (prior to impairment loss):At cost $’000Cash (6,000 x $3) 18,0006% loan notes (6,000 x $100/100) 6,000

24,000LessPost acquisition losses (20,000 x 40% x 3/12) (2,000)

22,000





(c) Hosterling GroupConsolidated income statement for the year ended 30 September 2012

$’000Revenue (105,000 + 62,000 – 18,000 intra group) 149,000Cost of sales (see working) (89,000)Gross profit 60,000Distribution costs (4,000 + 2,000) (6,000)Administrative expenses (7,500 + 7,000) (14,500)Finance costs (1,200 + 900) (2,100)Impairment losses:Goodwill (1,600)Investment in associate (22,000 – 21,500) (500)Share of loss from associate (20,000 x 40% x 3/12) (2,000)Profit before tax 33,300Income tax expense (8,700 + 2,600) (11,300)Profit for the period 22,000Attributable to:Equity holders of the parent 19,600Non controling interest((13,000 – 1,000 depreciation adjustment) x 20%) 2,400

22,000Note: the dividend from Sunlee is eliminated on consolidation.Working $’000Cost of salesHosterling 68,000Sunlee 36,500Intra group purchases (18,000)Additional depreciation of plant (5,000/5 years) 1,000Unrealised profit in inventories (7,500 x 25%/125%) 1,500

89,000

77 Patronic

(a) Cost of control in Sardonic: $ ’000 $’000Cost of control in Sardonic: $’000 $’000 ConsiderationShares (18,000 x 2/3 x $5·75) 69,000Deferred payment (18,000 x 2·42/1·21 (see below)) 36,000

––––––––Less 105,000Equity shares 24,000Pre-acquisition reserves:At 1 April 2010 69,000To date of acquisition (13,500 x 4/12) 4,500Fair value adjustments (4,100 + 2,400) 6,500

––––––––104,000 x 75% (78,000)

––––––––Goodwill 27,000––––––––





$1 compounded for two years at 10% would be worth $1 ·21.The acquisition of 18 million out of a total of 24 million equity shares is a 75%interest.

(b) Patronic Group

Consolidated income statement for the year ended 31 March 2011 $’000Revenue (150,000 + (78,000 x 8/12) – (1,250 x 8 months intra group)) 192,000Cost of sales (w (i)) (119,100)

–––––––––Gross profit 72,900Distribution costs (7,400 + (3,000 x 8/12)) (9,400)Administrative expenses (12,500 + (6,000 x 8/12)) (16,500)Finance costs (w (ii)) (5,000)Impairment of goodwill (2,000)Share of profit from associate (6,000 x 30%) 1,800

–––––––––Profit before tax 41,800

Income tax expense (10,400 + (3,600 x 8/12)) (12,800)–––––––––Profit for the year 29,000

–––––––––Attributable to:Equity holders of the parent 26,900Minority interest (w (iii)) 2,100

–––––––––29,000

–––––––––(c) An associate is defined by IAS 28 Investments in Associates and Joint Ventures as an

investment over which an investor has significant influence. There are severalindicators of significant influence, but the most important are usually considered

to be a holding of 20% or more of the voting shares and board representation.Therefore it was reasonable to assume that the investment in Acerbic (at 31March 2011) represented an associate and was correctly accounted for under theequity accounting method.The current position (from May 2011) is that although Patronic still owns 30% ofAcerbic’s shares, Acerbic has become a subsidiary of Spekulate as it has acquired60% of Acerbic’s shares. Acerbic is now under the control of Spekulate (part ofthe definition of being a subsidiary), therefore it is difficult to see how Patroniccan now exert significant influence over Acerbic. The fact that Patronic has lostits seat on Acerbic’s board seems to reinforce this point. In these circumstancesthe investment in Acerbic falls to be treated under IAS 39 Financial Instruments:Recognition and Measurement. It will cease to be equity accounted from the date ofloss of significant influence. Its carrying amount at that date will be its initialrecognition value under IAS 39 and thereafter it will be carried at fair value.Workings

(i) Cost of sales$’000 $’000

Cost of salesPatronic 94,000Sardonic (51,000 x 8/12) 34,000Intra group purchases (1,250 x 8 months) (10,000)Additional depreciation: plant(2,400/ 4 years x 8/12) 400





$’000 $’000property (per question) 200 600

––––Unrealised profit in inventories (3,000 x 20/120) 500

–––––––––119,100

–––––––––Note: for both sales revenues and cost of sales, only the post acquisitionintra group trading should be eliminated.

(ii) Finance costs $’000 Patronic per question 2,000Unwinding interest – deferred consideration(36,000 x 10% x 8/12) 2,400Sardonic (900 x 8/12) 600

––––––5,000

––––––(iii) Non-controlling interest

Sardonic’s post acquisition profit (13,500 x 8/12) 9,000Less post acquisition additional depreciation (w (i)) (600)

––––––8,400x 25% = 2,100

78 Pandar

(a) (i) Goodwill in Salva at 1 April 2012: $’000 $’000 Controlling interestShares issued (120 million x 80% x 3/5 x $6) 345,600

Non-controlling interest (120 million x 20% x $3·20) 76,800––––––––422,400

Equity shares 120,000Pre-acquisition reserves:At 1 October 2011 152,000To date of acquisition (see below) 11,500Fair value adjustments (5,000 + 20,000) 25,000 308,500

–––––––– ––––––––Goodwill arising on acquisition 113,900

––––––––The interest on the 8% loan note is $2 million ($50 million x 8% x 6/12).This is included in Salva’s income statement in the post-acquisition period.Thus Salva’s profit for the year of $21 million has a split of $11·5 millionpre-acquisition ((21 million + 2 million interest) x 6/12) and $9·5 millionpost-acquisition.

(ii) Carrying amount of investment in Ambra at 30 September 2012 $’000Cost (40 million x 40% x $2) 32,000Share of post-acquisition losses (5,000 x 40% x 6/12) (1,000)Impairment charge (3,000)

––––––––28,000

––––––––





(b) Pandar Group Consolidated income statement for the year ended 30 September 2012

$’000 $’000Revenue(210,000 + (150,000 x 6/12) – 15,000 intra-group sales) 270,000Cost of sales (w (i)) (162,500)––––––––Gross profit 107,500Distribution costs (11,200 + (7,000 x 6/12)) (14,700)Administrative expenses (18,300 + (9,000 x 6/12)) (22,800)Investment income (w (ii)) 1,100Finance costs (w (iii)) (2,300)Share of loss from associate (5,000 x 40% x 6/12) (1,000)Impairment of investment in associate (3,000) (4,000)

–––––––– ––––––––Profit before tax 64,800Income tax expense (15,000 + (10,000 x 6/12)) (20,000)

––––––––Profit for the year 44,800––––––––

Attributable to:Owners of the parent 43,000Non-controlling interest (w (iv)) 1,800

––––––––44,800

––––––––Workings (figures in brackets in $’000)(i) Cost of sales $’000

Pandar 126,000Salva (100,000 x 6/12) 50,000

Intra-group purchases (15,000)Additional depreciation: plant (5,000/5 years x 6/12) 500Unrealised profit in inventories (15,000/3 x 20%) 1,000

––––––––162,500

––––––––As the registration of the domain name is renewable indefinitely (at only anominal cost) it will not be amortised.

(ii) Investment incomePer income statement 9,500Intra-group interest (50,000 x 8% x 6/12) (2,000)Intra-group dividend (8,000 x 80%) (6,400)

––––––––1,100––––––––

(iii) Finance costs $’000 $’000 Pandar 1,800Salva post-acquisition ((3,000 – 2,000) x 6/12 + 2,000) 2,500Intra-group interest (w (ii)) (2,000)

––––––––2,300

––––––––(iv) Non-controlling interest

Salva’s post-acquisition profit (see (i) above) 9,500Less: post-acquisition additional depreciation (w (i)) (500)

––––––––9,000x 20% = 1,800





79 Premier

(a) Premier Consolidated statement of comprehensive income for the year ended 30September 2010

$’000Revenue (92,500 + (45,000 x 4/12) – 4,000 intra-group sales) 103,500Cost of sales (w (i)) (78,850)

–––––––– Gross profit 24,650Distribution costs (2,500 + (1,200 x 4/12)) (2,900)Administrative expenses (5,500 + (2,400 x 4/12)) (6,300)Finance costs (100)

–––––––– Profit before tax 15,350Income tax expense (3,900 + (1,500 x 4/12)) (4,400)

–––––––– Profit for the year 10,950

–––––––– Other comprehensive income:Gain on available-for-sale investments 300Gain on revaluation of property 500

–––––––– Total other comprehensive income for the year 800

–––––––– Total comprehensive income 11,750

–––––––– Profit for year attributable to:Equity holders of the parent 10,760Non-controlling interest((1,300 see below – 400 URP + 50 reduced depreciation) x 20%) 190

–––––––– 10,950––––––––

Total comprehensive income attributable to:Equity holders of the parent (10,760 + 300 + 500) 11,560Non-controlling interest 190

–––––––– 11,750

–––––––– Sanford ’s profits for the year ended 30 September 2010 of $3 ·9 million are $2 ·6million (3,900 x 8/12) pre-acquisition and $1 ·3 million (3,900 x 4/12) post-acquisition.

(b) Consolidated statement of financial position as at 30 September 2010.

$’000AssetsNon-current assetsProperty, plant and equipment (w (ii)) 38,250Goodwill (w (iii)) 9,300Available-for-sale investments (1,800 – 800 consideration + 300 gain) 1,300

––––– 48,850

Current assets (w (iv)) 14,150–––––

Total assets 63,000–––––





$’000Equity and liabilitiesEquity attributable to owners of the parentEquity shares of $1 each ((12,000 + 2,400) w (iii)) 14,400Share premium (w (iii)) 9,600

Land revaluation reserve 2,000Other equity reserve (500 + 300) 800Retained earnings (w (v)) 13,060

––––– 39,860

Non-controlling interest (w (vi)) 3,690–––––

Total equity 43,550Non-current liabilities6% loan notes 3,000Current liabilities (10,000 + 6,800 – 350 intra group balance) 16,450

––––– Total equity and liabilities 63,000

––––– Workings in $ ’000(i) Cost of sales

Premier 70,500Sanford (36,000 x 4/12) 12,000Intra-group purchases (4,000)URP in inventory 400Reduction of depreciation charge (50)

––––– 78,850–––––

The unrealised profit (URP) in inventory is calculated as $2 million x

25/125 = $400,000.(ii) Non-current assetsPremier 25,500Sanford 13,900Fair value reduction at acquisition (1,200)Reduced depreciation 50

––––– 38,250–––––

(iii) Goodwill in SanfordInvestment at costShares (5,000 x 80% x 3/5 x $5) 12,000

6% loan notes (5,000 x 80% x 100/500) 800Non-controlling interest (5,000 x 20% x $3 ·50) 3,500––––– 16,300

Net assets (equity) of Sanford at 30 September 2010 (9,500)Less: post-acquisition profits (see above) 1,300Less: fair value adjustment for property 1,200

––––– Net assets at date of acquisition (7,000)

––––– Goodwill 9,300

––––– The 2·4 million shares (5,000 x 80% x 3/5) issued by Premier at $5 each would be

recorded as share capital of $2·4 million and share premium of $9

·6 million.





(iv) Current assetsPremier 12,500Sanford 2,400URP in inventory (400 )Intra-group balance (350 )

––––– 14,150–––––

(v) Retained earningsPremier 12,300Sanford ’s post-acquisition adjusted profit((1,300 – 400 URP + 50 reduced depreciation) x 80%) 760

––––– 13,060–––––

(vi) Non-controlling interest in statement of financial positionAt date of acquisition 3,500Post-acquisition profit from income statement 190

––––– 3,690–––––

Business combinations – Statements of financial positionand performance

80 Hepburn

(a)

HepburnConsolidated income statement year to 31 March 2012

$000 $000Sale revenues (1,200 + 500 − 100 intra-group sales) 1,600Cost of sales (W1) (890) Gross profit 710Operating expenses (120 + 44) (164)Finance costs (12 × 6/12) (6)Profit before tax 540Income tax expense (100 + 20) (120)Profit for the period 420Attributable to:Equity holders of the parent 400Non-controlling interests (200 × 20% × 6/12) 20

420

Consolidated statement of financial position at 31 March 2012 $000 $000

Non-current assetsTangible

Property, plant and equipment (620 + 660 + 125) 1,405Intangible: Goodwill (W2) 200






Investments (20 + 10) 301,635

Current assetsInventory (240 + 280 − 10) 510Accounts receivable (170 + 210 − 56) 324Bank (20 + 40 + 20) 80

914Total assets 2,549

Equity and liabilities:Equity shares of $1 each (400 + 300 (W2)) 700Reserves:Share premium (W2) 600Retained earnings (W3) 480

1,0801,780

Non-controlling interest (W4) 1951,975

Non-current liabilities8% Debentures 150Current liabilitiesTrade payables (170 + 155 − 36) 289Taxation (50 + 45) 95Dividends 40

4242,549

Workings

(W1) Goodwill $000 $000

Investment at cost (((150,000/2 × 5) × 80%) × $3) 900Less – equity shares of Salter (150 × 80%) (120)

– pre-acquisition profits ((700−

100)×

80%) (480)– fair value adjustment of land (125 × 80%) (100)(700)

Goodwill on consolidation 200Less impairment (40)In Hepburn’s books 160Dr Cost of investment 900,000

Cr Share Capital 300,000Cr Share premium 600,000





(W2) Unrealised profit

($100,000 × 50%) × 25/125 = $10,000Parent sells to subsidiary so no non controlling interest adjustment

(W3) Non-controlling interest Equity shares of Salter (150 × 20%) 30

Fair value adjustment of land (125 × 20%) 25

Retained earnings (700 × 20%) 140

195(W4) Consolidated reserves

$000Hepburn’s reserves 410

Share of Salter’s post acquisition profits (200 × 6/12 × 80%) 80

Unrealised profit in inventory (10)

480(W5) Cost of sales

$000Hepburn 650Salter (660 × 6/12) 330Intra-group sales (100)Unrealised profit in inventory 10

890

(b) It seems that the directors of Hepburn are basing their arguments on thepossibility that the investment in Woodbridge may be an associated company.The ownership of the total equity is 25%, giving Hepburn the right to 25% of anydividends Woodbridge may pay. If this were the basis on which the assessmentof associate status is made, it may be that given the lack of involvement in theoperating policies of Woodbridge, the directors may be able to rebut the normalpresumption that Woodbridge is an associate by virtue of its 25% holding.The directors do however appear to be misunderstanding the basis ofdetermining subsidiary company status. IFRS 10 Consolidated Financial Statements bases its definition of a subsidiary on control rather than ownership. In the caseof Woodbridge, Hepburn in fact owns 6,000 of the 10,000 voting shares, and, inthe absence of any other information, this would constitute control ofWoodbridge by virtue of its 60% of voting rights. Thus, far from being anassociate of Hepburn, Woodbridge is in fact a subsidiary, irrespective of the factthat control may be passive. Therefore Woodbridge’s results should beconsolidated by Hepburn from the date of its acquisition.It may be that the motive for the directors’ position is that they wish to improvegroup profits by avoiding consolidation of Woodbridge’s losses. This raises thefurther point that these losses may indicate that the value of the investment in thesubsidiary has been impaired under IAS 36 Impairment of Assets. If so, it will be

necessary to perform an impairment test, which involves calculating therecoverable amount of the investment. If this is less than $20,000 the directors





will have to write down the value of the investment (in Hepburn’s own (entity)financial statements) to its recoverable amount, and also write down theconsolidated assets of Woodbridge.

81 Hydrate

HydrateConsolidated income statement – year to 30 September 2012

$000Sales revenue (24,000 + (6 /12 × 20,000)) – 100 33,900Cost of sales (16,600 + (6 /12 × 11,800)) – 100 + 500 +10 (22,910)Gross profit 10,990Operating expenses (1,600 + ( 6 /12 × 1,000) + 1,000 (3,100)

7,890Taxation (2,000 + (6 /12 × 3,000)) (3,500)Profit for the year 4,390Attributable toGroup 4,070Non-controlling interest (W4) 320

Consolidated statement of financial position at 30 September 2012 $000 $000

Non-current assetsProperty, plant and equipment(64,000 + 35,000 + 5,000 – 500) 103,500

Investments 12,800Goodwill (W2) 23,000

139,300Current assetsInventory (22,800 + 23,600) – 10 46,390Accounts receivable (16,400 + 24,200) 40,600Bank (500 + 200) 700


Equity and liabilities:Ordinary shares of $1 each (20,000 + 12,000 (W2)) 32,000Reserves:Share premium (4,000 + 60,000 (W2)) 64,000Retained earnings (W5) 57,470

121,470153,470

Non-controlling interest (W4) 12,320165,790

Non-current liabilities8% Loan notes (5,000 + 18,000) 23,000





Consolidated statement of financial position at 30 September 2012 $000 $000

Current liabilitiesAccounts payable (15,300 + 17,700) 33,000Taxation (2,200 + 3,000) 5,200

38,200226,990

Workings


Atacquisition

At end ofreporting

period

$000 $000Share capital 12,000 12,000

Share premium 2,400 2,400Retained earnings 42,700 – (6/12 × 4,200) 40,600 42,700Fair value adjustmentPlant 5,000 5,000

Depreciation 5,000 × 1/5 x 6/12 (500)

60,000 61,600

(W2) Goodwill

$000

Investment at cost ((80% × 12,000) × 5/4) × $6 72,000Net assets at acquisition (80% × 60,000) (W2) (48,000)

Goodwill at acquisition 24,000Less impairment (1,000)

In consolidated statement of financial position 23,000

Dr Cost of investment 72,000Cr Share capital (80% × 12,000) 05/4 12,000Cr Share premium 60,000

(W3) Unrealised profit($100,000 × 50%) × 25/125 = $10,000Parent sells to subsidiary so no NCI adjustment






Statement of financial position

20% × 61,600 (W1) = 12,320 Income statement

Subsidiary post acquisition profit after tax (4,200 ×6/12)

2,100

Less depreciation adjustment on fair value (500)

1,600

NCI share: 20% × 1,600 320

(W5) Consolidated retained earnings :

Hydrate reserves 57,200

Skeptik post acquisition(80% × 61,600 – 60,000 (W1)) 1,280

Unrealised profit in inventory (W3) (10)Less impairment (1,000)

57,470

82 Hillusion

(a)

Hillusion

Consolidated income statement for the year to 31 March 2012 $000 $000

Sales revenue (60,000 + (24,000 ×9/12)) – 12,000 66,000Cost of sales(42,000 + (20,000 × 9/12)) – 12,000 + 500 + 600 (46,100)Gross profit 19,900Operating expenses (6,000 + (200 × 9/12)) + 300 (6,450)Loan interest (200 × 9/12) – 75 (75)

(6,225)

Profit before tax 13,375Taxation (3,000 + (600 × 9/12)) (3,450)Profit for the period 9,925

Attributable to:Equity holders of the parent 9,595Non-controlling interest (W4) 330

9,925






Tangible non-current assets (19,320 + 8,000 + 3,200 – 600) 29,920Goodwill (W3) 900

30,820Current assets (15,000 + 8,000 – 500 – 750) 21,750Total assets 52,570

Equity and liabilitiesEquity attributable to equity holders of the parentOrdinary shares of $1 each 10,000Retained earnings (W5) 26,120

36,120Non-controlling interest (W4) 2,600

38,720Non-current liabilities10% Loan notes (2,000 – 1,000 intra-group) 1,000Current liabilities (10,000 + 3,600 – 750) 12,850Total equity and liabilities 52,570

Workings in $000


Atacquisition

At end ofreporting

period

$000 $000Share capital 2,000 2,000Retained earnings (5,400 + 3/12 × 3,000) 6,150 8,400Fair value adjustmentPlant 3,200 3,200Depreciation 3,600 × 9/48 (600)

11,350 13,000(W2) Goodwill

$000Investment at cost 10,280Net assets at acquisition (80% × 11,350 (W2)) (9,080)Goodwill on consolidation 1,200Less impairment (300)In consolidated statement of financial position 900

(W3) Unrealised profit

[(12m – 10m) × 12] – 9/12 = 500,000Parent sells to subsidiary; therefore no non-controlling interest in thisunrealised profit






Statement of financial position

20% × 13,000 (W1) = 2,600 Income statement

Subsidiary post acq profit after tax (3,000 × 9/12) 2,250Less depreciation adjustment to fair value (600)

1,650

Non-controlling interest share: 20% x 1,650 330

(W5) Consolidated retained earnings :

Hillusion’s reserves 25,600Skeptik’s post acquisition

(80% × 13,000 – 11,350 (W1)) 1,320

Unrealised profit inventory (W3) (500)Less impairment (300)

26,120

(b) The main reason why intra-group unrealised profits must be eliminated onconsolidation is to achieve the main objective of group financial statementswhich is to show the position of the group as if it were a single economic entity.As such, a group cannot trade with itself, nor can it make a profit out of itself. In

a similar way it cannot increase its sales or its net assets by transferring assetsand liabilities between members of the group. As a simple illustrative example, but for the requirement to eliminate intra-group profits, a group could buy anitem of inventory; sell it to another member of the group (at a profit), who in turncould sell it to another member of the group and so on. The result would be thateach member of the group would make a profit which would then be combinedto form a large group profit. This would be ‘balanced’ by an over-inflatedinventory value in the statement of financial position (in practice this effectwould be limited by the application of the lower of cost and net realisable valueprinciple of valuing inventory). Such accounting would not give a fairpresentation of the results and position.

The main problem with using Skeptik entity financial statements to assess itsperformance is that it is a related party of its parent, Hillusion. Related partytransactions can distort the true economic performance and financial position of acompany. In this case, the related party relationship extends to complete controlof Skeptik by Hillusion.From the information in the question, it can be seen that most of Skeptik’strading is from goods it buys from Hillusion. Sales of non-group sourced goodsare only $9 million (out of $24 million). It may be that these have been transferredat a favourable price allowing Skeptik to achieve a higher level of sales and makea higher than normal profit. Ultimately this course of action is no real detrimentto the group as a whole as most of Skeptik’s profits (and all of them if it were100% owned) are consolidated into the group profit. In a similar manner the factthat Hillusion does not make any charge for Skeptik’s administration costs acts to





increase Skeptik’s profit. If Skeptik was to be purchased by an external party, allthese beneficial effects would cease and Skeptik’s profit would then be muchlower. It could be observed that Hillusion may be ‘massaging’ Skeptik’s financialstatements with a view to obtaining a favourable price on its future sale.Hillusion’s past record of success in selling previous businesses at a considerable

profit after only a short period of ownership supports this view.

83 Pedantic

(a) PedanticConsolidated income statement for the year ended 30 September 2012

$’000Revenue (85,000 + (42,000 x 6/12) – 8,000 intra-group sales) 98,000Cost of sales (w (i)) (72,000)

–––––––Gross profit 26,000

Distribution costs (2,000 + (2,000 x 6/12)) (3,000)Administrative expenses (6,000 + (3,200 x 6/12)) (7,600)Finance costs (300 + (400 x 6/12)) (500)

–––––––Profit before tax 14,900Income tax expense (4,700 + (1,400 x 6/12)) (5,400)

–––––––Profit for the year 9,500

–––––––Attributable to:Equity holders of the parent 9,300Non-controlling interest (((3,000 x 6/12) – (800 URP + 200

depreciation)) x 40%) 200–––––––9,500

–––––––(b) Consolidated statement of financial position as at 30 September 2012

$’000 AssetsNon-current assetsProperty, plant and equipment (40,600 + 12,600 + 2,000 – 200depreciation adjustment (w (i))) 55,000

Goodwill (w (ii)) 4,500–––––––

59,500Current assets (w (iii)) 21,400–––––––

Total assets 80,900–––––––

Equity and liabilitiesEquity attributable to owners of the parentEquity shares of $1 each ((10, 000 + 1,600) w (ii)) 11,600Share premium (w (ii)) 8,000Retained earnings (w (iv)) 35,700

–––––––55,300

Non-controlling interest (w (v)) 6,100–––––––Total equity 61,400





$’000 Non-current liabilities10% loan notes (4,000 + 3,000) 7,000Current liabilities (8,200 + 4,700 – 400 intra-group balance) 12,500

–––––––Total equity and liabilities 80,900

–––––––


(i) Cost of sales $’000Pedantic 63,000Sophistic (32,000 x 6/12) 16,000Intra-group sales (8,000)URP in inventory 800Additional depreciation (2,000/5 years x 6/12) 200

–––––––72,000

–––––––

The unrealised profit (URP) in inventory is calculated as ($8 million – $5·2million) x 40/140 = $800,000.

(ii) Goodwill in SophisticInvestment at cost $’000 $’000Shares (4,000 x 60% x 2/3 x $6) 9,600Less – Equity shares of Sophistic (4,000 x 60%) (2,400)– pre-acquisition reserves (5,000 x 60% see below) (3,000)– fair value adjustment (2,000 x 60%) (1,200) (6,600)

–––––– ––––––Parent’s goodwill 3,000Non-controlling interest’s goodwill (per question) 1,500

––––––Total goodwill 4,500

––––––The pre-acquisition reserves are:At 30 September 2012 6,500Earned in the post acquisition period (3,000 x 6/12) (1,500)

––––––5,000

––––––Alternative calculation for goodwill in SophisticInvestment at cost (as above) 9,600

Fair value of non-controlling interest (see below) 5,900––––––Cost of the controlling interest 15,500Less fair value of net assets at acquisition (4,000 + 5,000 + 2,000) (11,000)

––––––Total goodwill 4,500

––––––Fair value of non-controlling interest (at acquisition)Share of fair value of net assets (11,000 x 40%) 4,400Attributable goodwill per question 1,500

––––––5,900

––––––The 1·6 million shares (4,000 x 60% x 2/3) issued by Pedantic would berecorded as share capital of $1·6 million and share premium of $8 million(1,600 x $5).





$’000 $’000(iii) Current assets

Pedantic 16,000Sophistic 6,600URP in inventory (800)

Cash in transit 200Intra-group balance (600)––––––21,400

––––––(iv) Retained earnings

Pedantic per statement of financial position 35,400Sophistic’s post acquisition profit(((3,000 x 6/12) – (800 URP + 200 depreciation)) x 60%) 300

––––––35,700

––––––(v) Non-controlling interest (in statement of financial position)

Net assets per statement of financial position 10,500URP in inventory (800)Net fair value adjustment (2,000 – 200) 1,800

––––––11,500 x 40% = 4,600

––––––Share of goodwill (per question) 1,500

––––––6,100

––––––


84 Comparator

(a) Ratios are used to assess the financial performance of a company by comparingthe calculated figures to various other sources. This may be to previous years’ratios of the same company, it may be to the ratios of a similar rival company, toaccepted norms (say of liquidity ratios) or, as in this example, to industryaverages. The problems inherent in these processes are several. Probably themost important aspect of using ratios is to realise that they do not give theanswers to the assessment of how well a company has performed, they merelyraise the questions and direct the analyst into trying to determine what has

caused favourable or unfavourable indicators. In many ways it can be said thatratios are only as useful as the skills of the person using them. It is also true thatany assessment should also consider other information that may be availableincluding non-financial information.More specific problem areas are:

Accounting policies : if two companies have different accounting policies, itcan invalidate any comparison between their ratios. For example return oncapital employed is materially affected by revaluations of assets.Comparing this ratio for two companies where one has revalued its assetsand the other carries them at depreciated historical cost would not be very

meaningful. Similar examples may involve depreciation methods,inventory valuation policies, etc.





Accounting practices : this is similar to differing accounting policies in itseffects. An example of this would be the use of factoring of tradereceivables. If one company collects its accounts receivable in the normalway, then the calculation of the accounts receivable collection period would be a reasonable indication of the efficiency of its credit control department.

However if a company chose to factor its accounts receivable (i.e. ‘sell’them to a finance company) then the calculation of its collection periodwould be meaningless. A more controversial example would be theengineering of a lease such that it fell to be treated as an operating leaserather than a finance lease.

Statement of financial position averages : Many ratios are based oncomparing income statement items with items in the statement of financial

position . The ratio of accounts receivable collection period is a goodexample of this. For such ratios to have any meaning, there is anassumption that the year-end figures in the statement of financial position

are representative of annual norms. Seasonal trading and other factors mayinvalidate this assumption. For example the level of accounts receivableand inventory of a toy manufacturer could vary largely due to the nature ofits seasonal trading.

Inflation can distort comparisons over time. The definition of an accounting ratio . If a ratio is calculated by two

companies using different definitions, then there is an obvious problem.Common examples of this are gearing ratios (some use debt/equity, othersmay use debt/debt + equity). Also where a ratio is partly based on a profitfigure, there can be differences as to what is included and what is excludedfrom the profit figure. Problems of this type include the treatment offinance costs.

The use of norms can be misleading . A desirable range for the currentratio may be say between 1.5 and 2 : 1, but all businesses are different. Thiswould be a very high ratio for a supermarket (with few accountsreceivable), but a low figure for a construction company (with high levelsof work in progress).

Looking at a single ratio in isolation is rarely useful. It is necessary toform a view when considering ratios in combination with other ratios.

A more controversial aspect of ratio analysis is that management have sometimesindulged in creative accounting techniques in order that the ratios calculatedfrom published financial statements will show a more favourable picture thanthe true underlying position. Examples of this are sale and repurchaseagreements, which manipulate liquidity figures, and ‘off balance sheet finance’which distorts return on capital employed.Inter firm comparisons:

Of particular concern with this method of using ratios is: They are themselves averages and may incorporate large variations in their

composition. Some inter firm comparison agencies produce the ratiosanalysed into quartiles to attempt to overcome this problem.

It may be that the sector in which a company is included may not besufficiently similar to the exact type of trade of the specific company. Thetype of products or markets may be different.





Companies of different sizes operate under different economies of scale,this may not be reflected in the industry average figures.

The year end accounting dates of the companies included in the averagesare not going to be all the same. Some companies try to minimise this bygrouping companies with approximately similar year-ends together as inthe example of this question, but this is not a complete solution.

(b) Calculation of specified ratios:

Comparator Sectoraverage

Return on capital employed (186 + 34 loan interest/635) 34.6% 22.1%Net asset turnover (2,425/635) 3.8 times 1.8 timesGross profit margin (555/2,425 × 100) 22.9% 30%

Net profit (before tax) margin (186/2,425 × 100) 7.7% 12.5%Current ratio (595/500) 1.19 : 1 1.6 : 1Quick ratio (320/500) 0.64 : 1 0.9 : 1Inventory holding period (275/1,870 × 365) 54 days 46 daysAccounts receivable collection period (320/2,425 × 365) 48 days 45 daysCreditor payment period (350/1,870 × 365)(based on cost of sales)

68 days 55 days

Debt to equity (300/335 × 100) 90% 40%Dividend yield (see below) 2.5% 6%

Dividend cover (96/90) 1.07 times 3 timesThe workings are in $000 (unless otherwise stated) and are for Comparator’sratios.The dividend yield is calculated from a dividend per share figure of 15c($90,000/150,000 × 4) and a share price of $6.00.Thus the yield is 2.5% (15c/$6.00 × 100%).

(c) Analysis of Comparator’s financial performance compared to sector averagefor the year to 30 September 2012 :To:

From:

Date:Operating performance

The return on capital employed of Comparator is impressive being more than50% higher than the sector average. The components of the return on capitalemployed are the asset turnover and profit margins. In these areas Comparator’sasset turnover is much higher (nearly double) than the average, but the net profitmargin after exceptionals is considerably below the sector average. However, if

the exceptionals are treated as one off costs and excluded, Comparator’s marginsare very similar to the sector average.





This short analysis seems to imply that Comparator’s superior return on capitalemployed is due entirely to an efficient asset turnover i.e. Comparator is makingits assets work twice as efficiently as its competitors. A closer inspection of theunderlying figures may explain why its asset turnover is so high. It can be seenfrom the note to the statement of financial position that Comparator’s non-

current assets appear quite old. Their carrying amount is only 15% of theiroriginal cost. This has at least two implications; they will need replacing in thenear future and the company is already struggling for funding; and their lowcarrying value gives a high figure for asset turnover. Unless Comparator hasunderestimated the life of its assets in its depreciation calculations, its non-current assets will need replacing in the near future. When this occurs its assetturnover and return on capital employed figures will be much lower.This aspect of ratio analysis often causes problems and to counter this anomalysome companies calculate the asset turnover using the cost of non-current assetsrather than their carrying amount as this gives a more reliable trend. It is alsopossible that Comparator is using assets that are not in its statement of financialposition. It may be leasing assets that do not meet the definition of finance leasesand thus the assets and corresponding obligations are not recognised in thestatement of financial position.A further issue is which of the two calculated margins should be compared to thesector average (i.e. including or excluding the effects of the exceptionals). Thegross profit margin of Comparator is much lower than the sector average. If theexceptional losses were taken in at trading account level, which they should be asthey relate to obsolete inventory, Comparator’s gross margin would be evenworse. As Comparator’s net margin is similar to the sector average, it wouldappear that Comparator has better control over its operating costs. This is

especially true as the other element of the net profit calculation is finance costsand as Comparator has much higher gearing than the sector average, one wouldexpect Comparator’s interest to be higher than the sector average.

Liquidity

Here Comparator shows real cause for concern. Its current ratio and quick ratioare much worse than the sector average, and indeed far below expected norms.Current liquidity problems appear due to high levels of accounts payable and ahigh bank overdraft. The high levels of inventory contribute to the poor quickratio and may be indicative of further obsolete inventory (the exceptional item isdue to obsolete inventory). The accounts receivable collection figure isreasonable, but at 68 days, Comparator takes longer to pay its accounts payablethan do its competitors. Whilst this is a source of ‘free’ finance, it can damagerelations with suppliers and may lead to a curtailment of further credit.

Gearing

As referred to above, gearing (as measured by debt/equity) is more than twicethe level of the sector average. Whilst this may be an uncomfortable level, it iscurrently beneficial for shareholders. The company is making an overall return of34.6%, but only paying 8% interest on its loan notes. The gearing level may become a serious issue if Comparator becomes unable to maintain the finance

costs. The company already has an overdraft and the ability to make furtherinterest payments could be in doubt.





Investment ratios

Despite reasonable profitability figures, Comparator’s dividend yield is poorcompared to the sector average. From the extracts of the changes in equity it can be seen that total dividends are $90,000 out of available profit for the year of only$96,000 (hence the very low dividend cover). It is worthy of note that the interimdividend was $60,000 and the final dividend only $30,000. Perhaps this indicatesa worsening performance during the year, as normally final dividends are higherthan interim dividends. Considering these factors it is surprising the company’sshare price is holding up so well.

Summary

The company compares favourably with the sector average figures forprofitability, however the company’s liquidity and gearing position is quite poorand gives cause for concern. If it is to replace its old assets in the near future, itwill need to raise further finance. With already high levels of borrowing and poor

dividend yields, this may be a serious problem for Comparator.

85 Rytetrend

(a)

Rytetrend – Statement of cash flows for the year to 31 March 2012 $000 $000

Cash flows from operating activities Operating profit per question 3,860Capitalisation of installation costsless depreciation (300 – 20%) (W1) 240Adjustments:

Depreciation of non-current assets (W1) 7,410Loss on disposal of plant (W1) 700

8,110Increase in warranty provision (500 – 150) 350Decrease in inventory (3,270 – 2,650) 620Decrease in receivables (1,950 – 1,100) 850

Increase in payables (2,850 – 1,980) 870Cash generated from operations 14,900Interest paid (460)Income taxes paid (W2) (910)Net cash from operating activities 13,530Net cash used in investing activities

Purchase of non-current assets (W1) (15,550)





Rytetrend – Statement of cash flows for the year to 31 March 2012 $000 $000

Cash flows from financing activities Issue of ordinary shares (1,500 + 1,500) 3,000

Issue of 6% loan notes 2,000Repayment of 10% loan notes (4,000)Ordinary dividends paid (280 + (600 – 450) interim) (430)Net cash from financing activities 570Net decrease in cash and cash equivalents (1,450)Cash and cash equivalents at beginning of period 400Cash and cash equivalents at end of period (1,050)

Workings

(W1) Non-current assetsNon-current assets at cost $000Balance b/f 27,500Disposal (6,000)Balance c/f (37,250 + 300 re installation) (37,550)

Cost of assets acquired (16,050)Trade in allowance 500Cash flow for acquisitions (15,550)

DepreciationBalance b/f (10,200)Disposal (6,000 × 20% × 4 years) 4,800Balance c/f (12,750 + (300 × 20%)) 12,810Difference – charge for year 7,410

DisposalCost 6,000Depreciation (4,800)Net book value 1,200Trade in allowance (500)Loss on sale 700

(W2) Tax paid

Tax provision b/f (630)Income statement tax charge (1,000)Tax provision c/f 720Difference – cash paid (910)





(b) Report on the financial performance of Rytetrend for the year ended 31 March2012 To:

From:

Date :Operating performance

(i) Revenue up $8.3 million representing an increase of 35% on 2011 figures.(ii) Costs of sales up by $6.5 million (40% increase on 2011).

Overall the increase in activity has led to an increase in gross profit of $1.8million. However the gross profit margin has eased slightly from 31.9% in2011 to 29.2% in 2012. Perhaps the slight reduction in margins gave a boostto sales.

(iii) Operating expenses have increased by $840,000, an increase of 18% on 2011figures.

(iv) Interest costs reduced by $40,000. It is worth noting that the composition ofthem has changed. It appears that Rytetrend has taken advantage of acyclic reduction in borrowing cost and redeemed its 10% loan notes and(partly) replaced these with lower cost 6% loan notes. From the interest costfigure, this appears to have taken place half way through the year.Although borrowing costs on long-term finance have decreased, otherfactors have led to a substantial overdraft which has led to further interestof $200,000.

(v) The accumulated effect is an increase in profit before tax of $1 million (up41.6% on 2011) which is reflected by an increase in dividends of $200,000.

(vi) The company has invested heavily in acquiring new non-current assets(over $15 million – see cash flow statement). The refurbishment of theequipment may be responsible for the increase in the company’s sales andoperating performance.

Analysis of financial position

(vii) Inventory and receivables have both decreased markedly. Inventory is nowat 43 days from 75 days, this may be due to new arrangements withsuppliers or that the different range of equipment that Rytetrend now sellsmay offer less choice requiring lower inventory. Receivables are only 13days (from 30 days). This low figure is probably a reflection of a retailing business.

(viii) Although payables have increased significantly, they still represent only 46days (based on cost of sales) which is almost the same as in 2011.

(ix) A very worrying factor is that the company has gone from net currentassets of $2,580,000 to net current liabilities of $1,820,000. This is mainlydue to a combination of the above mentioned item: decreased inventoryand receivables and increased trade payables leading to a fall in cash balances of $1,450,000. That said, traditionally acceptable norms forliquidity ratios are not really appropriate to a mainly retailing business.





(x) Long-term borrowing has fallen by $2 million; this has lowered gearingfrom 20% (4,000,000/19,880,000) to only 9% (2,000,000/22,680,000). This is avery modest level of gearing.

The statement of cash flows

This indicates very healthy cash flows generated from operations of $14,900,000,more than sufficient to pay interest costs, taxation and dividends. The mainreason why the overall cash balance has fallen is that new non-current assets(costing over $15 million) have largely been financed from operating cash flows(only $1 million net of new capital has been raised). If Rytetrend continues togenerate operating cash flows in the order of the current year, its liquidity willsoon get back to healthy levels.

86 Greenwood

Note IFRS 5 uses the term discontinued operation. The answer below also uses thisterm, but it should be realised that the assets of the discontinued operation are classedas held for sale and not yet sold.Profitability/utilisation of assets

An important feature of the company ’s performance in the year to 31 March 2012 is toevaluate the effect of the discontinued operation. When using an entity ’s recent resultsas a basis for assessing how the entity may perform in the future, emphasis should beplaced on the results from continuing operations as it is these that will form the basis offuture results. For this reason most of the ratios calculated in the appendix are basedon the results from continuing operations and ratio calculations involving netassets/capital employed generally exclude the value of the assets held for sale.On this basis, it can be seen that the overall efficiency of Greenwood (measured by itsROCE) has declined considerably from 33 ·5% to 29·7% (a fall of 11·3%). The fall in theasset turnover (from 1 ·89 to 1·67 times) appears to be mostly responsible for the overalldecline in efficiency. In effect the company ’s assets are generating less sales per $invested in them. The other contributing factors to overall profitability are thecompany ’s profit margins. Greenwood has achieved an impressive increase in headlinesales revenues of nearly 30% (6 ·3m on 21 ·2m) whilst being able to maintain its grossprofit margin at around 29% (no significant change from 2011). This has led to asubstantial increase in gross profit, but this has been eroded by an increase in operatingexpenses. As a percentage of sales, operating expenses were 10 ·5% in 2012 compared to

11·6% in 2011 (they appear to be more of a variable than a fixed cost). This has led to amodest improvement in the profit before interest and tax margin which has partiallyoffset the deteriorating asset utilisation.The decision to sell the activities which are classified as a discontinued operation islikely to improve the overall profitability of the company. In the year ended 31 March2011 the discontinued operation made a modest pre tax profit of $450,000 (this wouldrepresent a return of around 7% on the activity ’s assets of $6 ·3 million).This poor returnacted to reduce the company ’s overall profitability (the continuing operations yielded areturn of 33 ·5%). The performance of the discontinued operation continued todeteriorate in the year ended 31 March 2012 making a pre tax operating loss of $1 ·4million which creates a negative return on the relevant assets. Despite incurring losseson the measurement to fair value of the discontinued operation ’s assets, it seems the





year end), but less the value of the assets held for sale. This is because the assets held for salehave not contributed to the return from continuing operations.

Gross profit percentage (8,000/27,500) 29·1% (6,200/21,200) 29·2%Operating expense percentage of salesrevenue (2,900/27,500) 10·5% (2,450/21,200) 11·6%Profit before interest and tax margin(5,100/27,500) 18·5% (3,750/21,200) 17·7%Asset turnover (27,500/16,500) 1·67 (21,200/11,200) 1·89Current ratio (9,500:4,500) 2·11 (3,700:3,800) 0·97Current ratio (excluding held for sale)(3,500:4,500) 0·77 not applicableQuick ratio (excluding held for sale)(2,000:4,500) 0·44 (2,350:3,800) 0·62Inventory (closing) turnover (19,500/1,500)

13·0 11·1

Receivables (in days) (2,000/27,500) x 36526·5 (2,300/21,200) x 365 39·6

Payables/cost of sales (in days)(2,400/19,500) x 365 44·9 (2,800/15,000) x 365 68·1Gearing (8,000/8,000 + 14,500) 35·6% (5,000/5,000 + 12,500) 28·6%

87 Harbin

(a) Note: figures in the calculations of the ratios are in $million

2012 20112012 re

Fatima (b)Return on year end capital employed

24/(114 + 100) x 100 11·2 % 7·1% 18·9%

Net asset turnover250/214 1·2 x 1·6x 0·6x

Gross profit margin (given in question) 20% 16·7% 42·9%

Net profit (before tax) margin16/250 6·4% 4·4% 31·4%

Current ratio38/44 0·9:1 2·5

Closing inventory holding period25/200 x 365 46 days 37 days

Trade receivables’ collection period13/250 x 365 19 days 16 days

Trade payables’ payment period23/200 x 365 42 days 32 days

Gearing100/214 x 100 46·7% nil

The gross profit margins and relevant ratios for 2011 are given in the question,and some additional ratios for Fatima are included above to enable a clearer





analysis in answering part (b) (references to Fatima should be taken to meanFatima’s net assets).

(b) Analysis of the comparative financial performance and position of Harbin for theyear ended 30 September 2012. Note: references to 2012 and 2011 should be takenas the years ended 30 September 2012 and 2011.Introduction

The figures relating to the comparative performance of Harbin ‘highlighted’ inthe Chief Executive’s report may be factually correct, but they take a rather biased and one dimensional view. They focus entirely on the performance asreflected in the income statement without reference to other measures ofperformance (notably the ROCE); nor is there any reference to the purchase ofFatima at the beginning of the year which has had a favourable effect on profitfor 2012. Due to this purchase, it is not consistent to compare Harbin’s incomestatement results in 2012 directly with those of 2011 because it does not matchlike with like. Immediately before the $100 million purchase of Fatima, the

carrying amount of the net assets of Harbin was $112 million. Thus theinvestment represented an increase of nearly 90% of Harbin’s existing capitalemployed. The following analysis of performance will consider the position asshown in the reported financial statements (based on the ratios required by part(a) of the question) and then go on to consider the impact the purchase has hadon this analysis.Profitability

The ROCE is often considered to be the primary measure of operatingperformance, because it relates the profit made by an entity (return) to the capital(or net assets) invested in generating those profits. On this basis the ROCE in2012 of 11·2% represents a 58% improvement (i.e. 4·1% on 7·1%) on the ROCE of7·1% in 2011. Given there were no disposals of non-current assets, the ROCE onFatima’s net assets is 18·9% (22m/100m + 16·5m). Note: the net assets of Fatimaat the year end would have increased by profit after tax of $16·5 million (i.e. 22mx 75% (at a tax rate of 25%)). Put another way, without the contribution of $22million to profit before tax, Harbin’s ‘underlying’ profit would have been a lossof $6 million which would give a negative ROCE. The principal reasons for the beneficial impact of Fatima’s purchase is that its profit margins at 42·9% grossand 31·4% net (before tax) are far superior to the profit margins of the combined business at 20% and 6·4% respectively. It should be observed that the othercontributing factor to the ROCE is the net asset turnover and in this respect

Fatima’s is actually inferior at 0·6 times (70m/116·5m) to that of the combined business of 1·2 times.It could be argued that the finance costs should be allocated against Fatima’sresults as the proceeds of the loan note appear to be the funding for the purchaseof Fatima. Even if this is accepted, Fatima’s results still far exceed those of theexisting business.Thus the Chief Executive’s report, already criticised for focussing on the incomestatement alone, is still highly misleading. Without the purchase of Fatima,underlying sales revenue would be flat at $180 million and the gross marginwould be down to 11·1% (20m/180m) from 16·7% resulting in a loss before tax of$6 million. This sales performance is particularly poor given it is likely that theremust have been an increase in spending on property plant and equipment





beyond that related to the purchase of Fatima’s net assets as the increase inproperty, plant and equipment is $120 million (after depreciation).Liquidity

The company’s liquidity position as measured by the current ratio hasdeteriorated dramatically during the period. A relatively healthy 2·5:1 is nowonly 0·9:1 which is rather less than what one would expect from the quick ratio(which excludes inventory) and is a matter of serious concern. A consideration ofthe component elements of the current ratio suggests that increases in theinventory holding period and trade payables payment period have largely offseteach other. There is a small increase in the collection period for trade receivables(up from 16 days to 19 days) which would actually improve the current ratio.This ratio appears unrealistically low, it is very difficult to collect credit sales soquickly and may be indicative of factoring some of the receivables, or aproportion of the sales being cash sales. Factoring is sometimes seen as aconsequence of declining liquidity, although if this assumption is correct it does

also appear to have been present in the previous year. The changes in the abovethree ratios do not explain the dramatic deterioration in the current ratio, the realculprit is the cash position, Harbin has gone from having a bank balance of $14million in 2011 to showing short-term bank borrowings of $17 million in 2012.A cash flow statement would give a better appreciation of the movement in the bank/short term borrowing position.It is not possible to assess, in isolation, the impact of the purchase of Fatima onthe liquidity of the company.Dividends

A dividend of 10 cents per share in 2012 amounts to $10 million (100m x 10

cents), thus the dividend in 2011 would have been $8 million (the dividend in2012 is 25% up on 2011). It may be that the increase in the reported profits led theBoard to pay a 25% increased dividend, but the dividend cover is only 1·2 times(12m/10m) in 2012 which is very low. In 2011 the cover was only 0·75 times(6m/8m) meaning previous years’ reserves were used to facilitate the dividend.The low retained earnings indicate that Harbin has historically paid a highproportion of its profits as dividends, however in times of declining liquidity, itis difficult to justify such high dividends.Gearing

The company has gone from a position of nil gearing (i.e. no long-term borrowings) in 2011 to a relatively high gearing of 46·7% in 2012. This has beencaused by the issue of the $100 million 8% loan note which would appear to bethe source of the funding for the $100 million purchase of Fatima’s net assets. Atthe time the loan note was issued, Harbin’s ROCE was 7·1%, slightly less than thefinance cost of the loan note. In 2012 the ROCE has increased to 11·2%, thus themanner of the funding has had a beneficial effect on the returns to the equityholders of Harbin. However, it should be noted that high gearing does not comewithout risk; any future downturn in the results of Harbin would expose theequity holders to much lower proportionate returns and continued poor liquiditymay mean payment of the loan interest could present a problem. Harbin’sgearing and liquidity position would have looked far better had some of the

acquisition been funded by an issue of equity shares.





Conclusion

There is no doubt that the purchase of Fatima has been a great success andappears to have been a wise move on the part of the management of Harbin.However, it has disguised a serious deterioration of the underlying performanceand position of Harbin’s existing activities which the Chief Executive’s reportmay be trying to hide. It may be that the acquisition was part of an overall planto diversify out of what has become existing loss making activities. If such atransition can continue, then the worrying aspects of poor liquidity and highgearing may be overcome.

88 Victular

(a) Equivalent ratios from the financial statements of Merlot (workings in $ ’000)

Return on year end capital employed(ROCE) 20·9% (1,400 + 590)/

(2,800 + 3,200 + 500 + 3,000) x 100Pre tax return on equity (ROE) 50% 1,400/2,800 x 100Net asset turnover 2·3 times 20,500/(14,800 – 5,700)Gross profit margin 12·2% 2,500/20,500 x 100Operating profit margin 9·8% 2,000/20,500 x 100Current ratio 1·3:1 7,300/5,700Closing inventory holding period 73 days 3,600/18,000 x 365Trade receivables’ collection period 66 days 3,700/20,500 x 365Trade payables’ payment period 77 days 3,800/18,000 x 365

Gearing 71% (3,200 + 500 + 3,000)/9,500 x 100Interest cover 3·3 times 2,000/600Dividend cover 1·4 times 1,000/700As per the question, Merlot ’s obligations under finance leases (3,200 + 500) have been treated as debt when calculating the ROCE and gearing ratios.

(b) Assessment of the relative performance and financial position of Grappa andMerlot for the year ended 30 September 2012

Introduction

This report is based on the draft financial statements supplied and the ratiosshown in (a) above. Although covering many aspects of performance andfinancial position, the report has been approached from the point of view of aprospective acquisition of the entire equity of one of the two companies.ProfitabilityThe ROCE of 20·9% of Merlot is far superior to the 14·8% return achieved byGrappa. ROCE is traditionally seen as a measure of management’s overallefficiency in the use of the finance/assets at its disposal. More detailed analysisreveals that Merlot’s superior performance is due to its efficiency in the use of itsnet assets; it achieved a net asset turnover of 2·3 times compared to only 1·2 times

for Grappa. Put another way, Merlot makes sales of $2·30 per $1 invested in netassets compared to sales of only $1·20 per $1 invested for Grappa. The other





element contributing to the ROCE is profit margins. In this area Merlot’s overallperformance is slightly inferior to that of Grappa, gross profit margins are almostidentical, but Grappa’s operating profit margin is 10·5% compared to Merlot’s9·8%. In this situation, where one company’s ROCE is superior to another’s it isuseful to look behind the figures and consider possible reasons for the

superiority other than the obvious one of greater efficiency on Merlot’s part.A major component of the ROCE is normally the carrying amount of the non-current assets. Consideration of these in this case reveals some interesting issues.Merlot does not own its premises whereas Grappa does. Such a situation wouldnot necessarily give a ROCE advantage to either company as the increase incapital employed of a company owning its factory would be compensated by ahigher return due to not having a rental expense (and vice versa). If Merlot’srental cost, as a percentage of the value of the related factory, was less than itsoverall ROCE, then it would be contributing to its higher ROCE. There isinsufficient information to determine this. Another relevant point may be thatMerlot’s owned plant is nearing the end of its useful life (carrying amount is only22% of its cost) and the company seems to be replacing owned plant with leasedplant. Again this does not necessarily give Merlot an advantage, but the financecost of the leased assets at only 7·5% is much lower than the overall ROCE (ofeither company) and therefore this does help to improve Merlot’s ROCE. Theother important issue within the composition of the ROCE is the valuation basisof the companies’ non-current assets. From the question, it appears that Grappa’sfactory is at current value (there is a property revaluation reserve) and note (ii) ofthe question indicates the use of historical cost for plant. The use of current valuefor the factory (as opposed to historical cost) will be adversely impacting onGrappa’s ROCE. Merlot does not suffer this deterioration as it does not own itsfactory.The ROCE measures the overall efficiency of management; however, as Victularis considering buying the equity of one of the two companies, it would be usefulto consider the return on equity (ROE) – as this is what Victular is buying. Theratios calculated are based on pre-tax profits; this takes into account financecosts, but does not cause taxation issues to distort the comparison. ClearlyMerlot’s ROE at 50% is far superior to Grappa’s 19·1%. Again the issue of therevaluation of Grappa’s factory is making this ratio appear comparatively worse(than it would be if there had not been a revaluation). In these circumstances itwould be more meaningful if the ROE was calculated based on the asking priceof each company (which has not been disclosed) as this would effectively be the

carrying amount of the relevant equity for Victular.GearingFrom the gearing ratio it can be seen that 71% of Merlot’s assets are financed by borrowings (39% is attributable to Merlot’s policy of leasing its plant). This isvery high in absolute terms and double Grappa’s level of gearing. The effect ofgearing means that all of the profit after finance costs is attributable to the equityeven though (in Merlot’s case) the equity represents only 29% of the financing ofthe net assets. Whilst this may seem advantageous to the equity shareholders ofMerlot, it does not come without risk. The interest cover of Merlot is only 3·3times whereas that of Grappa is 6 times. Merlot’s low interest cover is a directconsequence of its high gearing and it makes profits vulnerable to relativelysmall changes in operating activity. For example, small reductions in sales, profit





margins or small increases in operating expenses could result in losses and meanthat interest charges would not be covered.Another observation is that Grappa has been able to take advantage of the receiptof government grants; Merlot has not. This may be due to Grappa purchasing itsplant (which may then be eligible for grants) whereas Merlot leases its plant. Itmay be that the lessor has received any grants available on the purchase of theplant and passed some of this benefit on to Merlot via lower lease finance costs(at 7·5% per annum, this is considerably lower than Merlot has to pay on its 10%loan notes).LiquidityBoth companies have relatively low liquid ratios of 1·2 and 1·3 for Grappa andMerlot respectively, although at least Grappa has $600,000 in the bank whereasMerlot has a $1·2 million overdraft. In this respect Merlot’s policy of highdividend payouts (leading to a low dividend cover and low retained earnings) isvery questionable. Looking in more depth, both companies have similar

inventory days; Merlot collects its receivables one week earlier than Grappa(perhaps its credit control procedures are more active due to its large overdraft),and of notable difference is that Grappa receives (or takes) a lot longer creditperiod from its suppliers (108 days compared to 77 days). This may be areflection of Grappa being able to negotiate better credit terms because it has ahigher credit rating.SummaryAlthough both companies may operate in a similar industry and have similarprofits after tax, they would represent very different purchases. Merlot’s salesrevenues are over 70% more than those of Grappa, it is financed by high levels ofdebt, it rents rather than owns property and it chooses to lease rather than buy itsreplacement plant. Also its remaining owned plant is nearing the end of its life.Its replacement will either require a cash injection if it is to be purchased(Merlot’s overdraft of $1·2 million already requires serious attention) or createeven higher levels of gearing if it continues its policy of leasing. In short althoughMerlot’s overall return seems more attractive than that of Grappa, it wouldrepresent a much more risky investment. Ultimately the investment decision may be determined by Victular’s attitude to risk, possible synergies with its existing business activities, and not least, by the asking price for each investment (whichhas not been disclosed to us).

(c) The generally recognised potential problems of using ratios for comparison

purposes are:– inconsistent definitions of ratios– financial statements may have been deliberately manipulated (creative

accounting)– different companies may adopt different accounting policies (e.g. use of

historical costs compared to current values)– different managerial policies (e.g. different companies offer customers

different payment terms)– statement of financial position figures may not be representative of average

values throughout the year (this can be caused by seasonal trading or alarge acquisition of non-current assets near the year end)





– the impact of price changes over time/distortion caused by inflationWhen deciding whether to purchase a company, Victular should consider thefollowing additional useful information:– in this case the analysis has been made on the draft financial statements;

these may be unreliable or change when being finalised. Audited financialstatements would add credibility and reliance to the analysis (assumingthey receive an unmodified Auditors’ Report).

– forward looking information such as profit and financial position forecasts,capital expenditure and cash budgets and the level of orders on the books.

– the current (fair) values of assets being acquired.– the level of risk within a business. Highly profitable companies may also be

highly risky, whereas a less profitable company may have more stable‘quality’ earnings

– not least would be the expected price to acquire a company. It may be that

a poorer performing business may be a more attractive purchase because itis relatively cheaper and may offer more opportunity for improvingefficiencies and profit growth.

89 Hardy

Note: references to 2009 and 2010 should be taken as being to the years ended 30September 2009 and 2010 respectively.Profitability:

Income statement performance:

Hardy ’s income statement results dramatically show the effects of the downturn in theglobal economy; revenues are down by 18% (6,500/36,000 x 100), gross profit has fallen by 60% and a healthy after tax profit of $3 ·5 million has reversed to a loss of $2 ·1million. These are reflected in the profit (loss) margin ratios shown in the appendix (the‘as reported ’ figures for 2010). This in turn has led to a 15 ·2% return on equity beingreversed to a negative return of 11 ·9%. However, a closer analysis shows that theresults are not quite as bad as they seem. The downturn has directly caused severaladditional costs in 2010: employee severance, property impairments and losses oninvestments (as quantified in the appendix). These are probably all non-recurring costsand could therefore justifiably be excluded from the 2010 results to assess thecompany ’s ‘underlying ’ performance. If this is done the results of Hardy for 2010

appear to be much better than on first sight, although still not as good as thosereported for 2009. A gross margin of 27 ·8% in 2009 has fallen to only 23 ·1% (rather thanthe reported margin of 13 ·6%) and the profit for period has fallen from $3 ·5 million(9·7%) to only $2 ·3 million (7 ·8%). It should also be noted that as well as the fall in thevalue of the investments, the related investment income has also shown a sharp declinewhich has contributed to lower profits in 2010.Given the economic climate in 2010 these are probably reasonably good results andmay justify the Chairman ’s comments. It should be noted that the cost saving measureswhich have helped to mitigate the impact of the downturn could have someunwelcome effects should trading conditions improve; it may not be easy to re-hireemployees and a lack of advertising may cause a loss of market share.





Statement of financial position:

Perhaps the most obvious aspect of the statement of financial position is the fall invalue ($8 ·5 million) of the non-current assets, most of which is accounted for by lossesof $6 million and $1 ·6 million respectively on the properties and investments.Ironically, because these falls are reflected in equity, this has mitigated the fall in thereturn of the equity (from 15 ·2% to 13·1% underlying) and contributed to a perhapsunexpected improvement in asset turnover from 1 ·6 times to 1 ·7 times.Liquidity:

Despite the downturn, Hardy ’s liquidity ratios now seem at acceptable levels (thoughthey should be compared to manufacturing industry norms) compared to the lowratios in 2009. The bank balance has improved by $1 ·1 million. This has been helped bya successful rights issue (this is in itself a sign of shareholder support and confidence inthe future) raising $2 million and keeping customer ’s credit period under control. Someof the proceeds of the rights issue appear to have been used to reduce the bank loanwhich is sensible as its financing costs have increased considerably in 2010. Looking at

the movement on retained earnings (6,500 – 2,100 – 3,600) it can be seen that thecompany paid a dividend of $800,000 during 2010. Although this is only half thedividend per share paid in 2009, it may seem unwise given the losses and the need forthe rights issue. A counter view is that the payment of the dividend may be seen as asign of confidence of a future recovery. It should also be mentioned that the worst ofthe costs caused by the downturn (specifically the property and investments losses) arenot cash costs and have therefore not affected liquidity.The increase in the inventory and work-in-progress holding period and the tradereceivables collection period being almost unchanged appear to contradict thedeclining sales activity and should be investigated. Although there is insufficientinformation to calculate the trade payables credit period as there is no analysis of thecost of sales figures, it appears that Hardy has received extended credit which, unless ithad been agreed with the suppliers, has the potential to lead to problems obtainingfuture supplies of goods on credit.Gearing:

On the reported figures debt to equity shows a modest increase due to incomestatement losses and the reduction of the revaluation reserve, but this has beenmitigated by the repayment of part of the loan and the rights issue.Conclusion:

Although Hardy ’s results have been adversely affected by the global economicsituation, its underlying performance is not as bad as first impressions might suggestand supports the Chairman ’s comments. The company still retains a relatively strongstatement of financial position and liquidity position which will help significantlyshould market conditions improve. Indeed the impairment of property andinvestments may well reverse in future. It would be a useful exercise to compareHardy ’s performance during this difficult time to that of its competitors – it may well be that its 2010 results were relatively very good by comparison.Appendix:

An important aspect of assessing the performance of Hardy for 2010 (especially incomparison with 2009) is to identify the impact that several ‘one off ’ charges have hadon the results of 2010. These charges are $1 ·3 million redundancy costs and a $1 ·5million (6,000 – 4,500 previous surplus) property impairment, both included in cost ofsales and a $1 ·6 million loss on the market value of investments, included in





administrative expenses. Thus in calculating the ‘underlying ’ figures for 2010 (below)the adjusted cost of sales is $22 ·7 million (25,500 – 1,300 – 1,500) and the administrativeexpenses are $3 ·3 million (4,900 – 1,600). These adjustments feed through to give anunderlying gross profit of $6 ·8 million (4,000 + 1,300 + 1,500) and an underlying profitfor the year of $2 ·3 million ( –2,100 + 1,300 + 1,500 + 1,600).

Note: it is not appropriate to revise Hardy ’s equity (upwards) for the one-off losseswhen calculating equity based underlying figures, as the losses will be a continuingpart of equity (unless they reverse) even if/when future earnings recover.

2010 2009underlying as reported

Gross profit % (6,800/29,500 x 100) 23 ·1% 13·6% 27·8%Profit (loss) for period % (2,300/29,500 x 100) 7 ·8% (7·1)% 9·7%Return on equity (2,300/17,600 x 100) 13 ·1% (11·9)% 15·2%Net asset (taken as equity) turnover

(29,500/17,600) 1 ·7 times same 1 ·6 timesDebt to equity (4,000/17,600) 22 ·7% same 21 ·7%Current ratio (6,200:3,400) 1 ·8:1 same 1 ·0:1Quick ratio (4,000:3,400) 1 ·2:1 same 0 ·6:1Receivables collection (in days)

(2,200/29,500 x 365) 27 days same 28 daysInventory and work-in-progress holding

period (2,200/22,700 x 365) 35 days 31 days 27 daysNote: the figures for the calculation of the 2010 ‘underlying ’ ratios have been given;those of 2010 ‘as reported ’ and 2009 are based on equivalent figures from thesummarised financial statements provided.Alternative ratios/calculations are acceptable, for example net asset turnover could becalculated using total assets less current liabilities.





S E C T I O N 3

Q &A

Mock exam questions

This mock exam is the pilot paper produced for the new syllabus and is © The Association of Chartered Certified Accountants.

ALL FIVE questions are compulsory and MUST be attempted

1 On 1 October 2011 Pumice acquired the following non-current investments: 80% of the equity share capital of Silverton at a cost of $13.6 million

50% of Silverton’s 10% loan notes at par

1.6 million equity shares in Amok at a cost of $6.25 each.

The summarised draft statements of financial position of the three companies at 31

March 2012 are:

Pumice Silverton Amok$000 $000 $000

Non-current assetsProperty, plant and equipment 20,000 8,500 16,500Investments 26,000 nil 1,500

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ 46,000 8,500 18,000

Current assets 15,000 8,000 11,000‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ Total assets 61,000 16,500 29,000‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒

Equity and liabilitiesEquityEquity shares of $1 each 10,000 3,000 4,000Retained earnings 37,000 8,000 20,000

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ 47,000 11,000 24,000

Non-current liabilities8% loan note 4,000 nil Nil10% loan note nil 2,000 NilCurrent liabilities 10,000 3,500 5,000

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ Total equity and liabilities 61,000 16,500 29,000‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒





The following information is relevant:(i) The fair values of Silverton ’s assets were equal to their carrying amounts with the

exception of land and plant. Silverton ’s land had a fair value of $400,000 in excessof its carrying amount and plant had a fair value of $1.6 million in excess of itscarrying amount. The plant had a remaining life of four years (straight-linedepreciation) at the date of acquisition.

(ii) In the post acquisition period Pumice sold goods to Silverton at a price of $6million. These goods had cost Pumice $4 million. Half of these goods were still inthe inventory of Silverton at 31 March 2012. Silverton had a balance of $1.5million owing to Pumice at 31 March 2012 which agreed with Pumice ’s records.

(iii) The net profit after tax for the year ended 31 March 2012 was $2 million forSilverton and $8 million for Amok. Assume profits accrued evenly throughoutthe year.

(iv) An impairment test at 31 March 2012 concluded that consolidated goodwill wasimpaired by $400,000 and the investment in Amok was impaired by $200,000.

(v) No dividends were paid during the year by any of the companies.

Required:

(a) Discuss how the investments purchased by Pumice on 1 October 2011 should betreated in its consolidated financial statements. (5 marks)

(b) Prepare the consolidated statement of financial position for Pumice as at 31March 2012. (20 marks)

(Total: 25 marks)

2 The following trial balance relates to Kala, a publicly listed company, at 31 March 2012:$000 $000

Land and buildings at cost (note (i)) 270,000Plant – at cost (note (i)) 156,000Investment properties

– valuation at 1 April 2011 (note (i)) 90,000Purchases 78,200Operating expenses 15,500Loan interest paid 2,000Rental of leased plant (note (ii)) 22,000

Dividends paid 15,000Inventory at 1 April 2011 37,800Trade receivables 53,200Revenue 278,400Income from investment property 4,500Equity shares of $1 each fully paid 150,000Retained earnings at 1 April 2011 119,5008% (actual and effective) loan note (note (iii)) 50,000Accumulated depreciation at 1 April 2011 – buildings 60,000

– plant 26,000



Section 3: Mock exam questions


$000 $000Trade payables 33,400Deferred tax 12,500Bank 5,400

‒‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒

739,700 739,700‒‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒ The following notes are relevant:(i) The land and buildings were purchased on 1 April 1990. The cost of the land was

$70 million. No land and buildings have been purchased by Kala since that date.On 1 April 2011 Kala had its land and buildings professionally valued at $80million and $175 million respectively. The directors wish to incorporate thesevalues into the financial statements. The estimated life of the buildings wasoriginally 50 years and the remaining life has not changed as a result of thevaluation.Later, the valuers informed Kala that investment properties of the type Kalaowned had increased in value by 7% in the year to 31 March 2012.Plant, other than leased plant (see below), is depreciated at 15% per annum usingthe reducing balance method. Depreciation of buildings and plant is charged tocost of sales.

(ii) On 1 April 2011 Kala entered into a lease for an item of plant which had anestimated life of five years. The lease period is also five years with annual rentalsof $22 million payable in advance from 1 April 2011. The plant is expected tohave a nil residual value at the end of its life. If purchased this plant would havea cost of $92 million and be depreciated on a straight-line basis. The lessorincludes a finance cost of 10% per annum when calculating annual rentals. (Note:

you are not required to calculate the present value of the minimum leasepayments.)

(iii) The loan note was issued on 1 July 2011 with interest payable six monthly inarrears.

(iv) The provision for income tax for the year to 31 March 2012 has been estimated at$28.3 million. The deferred tax provision at 31 March 2012 is to be adjusted to acredit balance of $14.1 million.

(v) The inventory at 31 March 2012 was valued at $43.2 million.

Required:

Prepare for Kala:(a) An income statement for the year ended 31 March 2012. (10 marks)

(b) A statement of changes in equity for the year ended 31 March 2012. (4 marks)

(c) A statement of financial position as at 31 March 2012. (11 marks)

(Total: 25 marks)

3 Reactive is a publicly listed company that assembles domestic electrical goods which itthen sells to both wholesale and retail customers. Reactive ’s management weredisappointed in the company ’s results for the year ended 31 March 2011. In an attemptto improve performance the following measures were taken early in the year ended 31March 2012:





a national advertising campaign was undertaken, rebates to all wholesale customers purchasing goods above set quantity levels

were introduced, the assembly of certain lines ceased and was replaced by bought in completed

products. This allowed Reactive to dispose of surplus plant. Reactive’s summarised financial statements for the year ended 31 March 2012 are

set out below:Income statement

$ millionRevenue (25% cash sales) 4,000Cost of sales (3,450)

‒‒‒‒‒‒‒ Gross profit 550Operating expenses (370)

‒‒‒‒‒‒‒ 180

Profit on disposal of plant (note (i)) 40Finance charges (20)

‒‒‒‒‒‒‒ Profit before tax 200Income tax expense (50)

‒‒‒‒‒‒‒ Profit for the period 150

‒‒‒‒‒‒‒ Statement of financial position

$ million $ million

Non-current assetsProperty, plant and equipment (note (i)) 550Current assetsInventory 250Trade receivables 360Bank nil 610

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ Total assets 1,160

‒‒‒‒‒‒‒ Equity and liabilities

Equity shares of 25 cents each 100Retained earnings 380

‒‒‒‒‒‒‒ 480

Non-current liabilities8% loan notes 200Current liabilitiesBank overdraft 10Trade payables 430Current tax payable 40 480

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ Total equity and liabilities 1,160

‒‒‒‒‒‒‒



Paper F7: Financial reporting (International)


(b) During the year ended 31 March 2012, Porto experienced the followingtransactions or events:(i) entered into a finance lease to rent an asset for substantially the whole of its

useful economic life.(ii) a decision was made by the Board to change the company ’s accounting

policy from one of expensing the finance costs on building new retailoutlets to one of capitalising such costs.

(iii) the company ’s income statement prepared using historical costs showed aloss from operating its hotels, but the company is aware that the increase inthe value of its properties during the period far outweighed the operatingloss.

Required:

Explain how you would treat the items in (i) to (iii) above in Porto ’s financialstatements and indicate on which of the Framework ’s qualitative characteristicsyour treatment is based. (6 marks)

(Total: 15 marks)

5 (a) IAS 11 Construction contracts deals with accounting requirements for constructioncontracts whose durations usually span at least two accounting periods.Required:Describe the issues of revenue and profit recognition relating to constructioncontracts. (4 marks)

(b) Beetie is a construction company that prepares its financial statements to 31March each year. During the year ended 31 March 2012 the company commencedtwo construction contracts that are expected to take more than one year tocomplete. The position of each contract at 31 March 2012 is as follows:

Contract 1 2

$’000 $’000Agreed contract price 5,500 1,200Estimated total cost of contract at commencement 4,000 900Estimated total cost at 31 March 2012 4,000 1,250Agreed value of work completed at 31 March 2012 3,300 840Progress billings invoiced and received at 31 March 2012 3,000 880Contract costs incurred to 31 March 2012 3,900 720

The agreed value of the work completed at 31 March 2012 is considered to beequal to the revenue earned in the year ended 31 March 2012. The percentage ofcompletion is calculated as the agreed value of work completed to the agreedcontract price.Required:

Calculate the amounts which should appear in the income statement andstatement of financial position of Beetie at 31 March 2012 in respect of the above

contracts. (6 marks)(Total: 10 marks)





S E C

T I O N 4

Q &A

Answers to mock examquestions

1 (a) As the investment in shares represents 80% of Silverton’s equity, it is likely togive Pumice control of that company. Control is the ability to direct the operatingand financial policies of an entity. This would make Silverton a subsidiary ofPumice and require Pumice to prepare group financial statements which wouldrequire the consolidation of the results of Silverton from the date of acquisition (1October 2011). Consolidated financial statements are prepared on the basis thatthe group is a single economic entity.The investment of 50% ($1 million) of the 10% loan note in Silverton is effectivelya loan from a parent to a subsidiary. On consolidation Pumice ’s asset of the loan($1 million) is cancelled out with $1 million of Silverton ’s total loan note liabilityof $2 million. This would leave a net liability of $1 million in the consolidatedstatement of financial position.The investment in Amok of 1.6 million shares represents 40% of that company ’sequity shares. This is generally regarded as not being sufficient to give Pumicecontrol of Amok, but is likely to give it significant influence over Amok ’s policydecisions (e.g. determining the level of dividends paid by Amok). Suchinvestments are generally classified as associates and IAS 28 Investments in

associates requires the investment to be included in the consolidated financial

statements using equity accounting.(b) Consolidated statement of financial position of Pumice at 31 March 2012

$000 $000Non-current assets:Plant, property and equipment (w (i)) 30,300Goodwill (4,000 (w (ii)) – 400 impairment) 3,600Investments – associate (w (iii)) 11,400

– other ((26,000 – 13,600 – 10,000– 1,000 intra-group loan note)) 1,400

‒‒‒‒‒‒ 46,700





Current assets(15,000 + 8,000 - 1,000 (w (iv)) – 1,500 current account) 20,500

‒‒‒‒‒‒ Total assets 67,200

‒‒‒‒‒‒ Equity and liabilitiesEquity attributable to equity holders of the parentEquity shares of $1 each 10,000Reserves:Retained earnings (w (v)) 37,640

‒‒‒‒‒‒ 47,640

Non controlling interest (w (vi)) 2,560Total equity 50,200Non-current liabilities8% Loan note 4,000

10% Loan note (2,000 – 1,000 intra-group) 1,000 5,000‒‒‒‒‒‒

Current liabilities(10,000 + 3,500 – 1,500 current account) 12,000

‒‒‒‒‒‒ 67,200‒‒‒‒‒‒

Workings in $’000(i) Property, plant and equipment

Pumice 20,000Silverton 8,500

Fair value – land 400– plant 1,600 2,000

‒‒‒‒‒‒ Additional depreciation (see below) (200)

‒‒‒‒‒‒ 30,300‒‒‒‒‒‒

The fair value adjustment to plant will create additionaldepreciation of $400,000 per annum (1,600/4 years) and in thepost acquisition period of six months this will be $200,000.

(ii) Goodwill in Silverton:Investment at cost 13,600Less – equity shares of Silverton (3,000 × 80%) (2,400)

– pre-acquisition reserves(7,000 × 80% (see below)) (5,600)– fair value adjustments (2,000 (w (i)) × 80%) (1,600) (9,600)

‒‒‒‒‒‒ Goodwill on consolidation 4,000

‒‒‒‒‒‒ The pre-acquisition reserves are:At 31 March 2012 8,000Post acquisition (2,000 × 6/12) (1,000)

‒‒‒‒‒‒ 7,000

‒‒‒‒‒‒



Section 4: Answers to mock exam questions


(iii) Carrying amount of Amok at 31 March 2012Cost (1,600 × $6.25) 10,000Share post acquisition profit (8,000 × 6/12 × 40%) 1,600

‒‒‒‒‒‒ 11,600

Impairment loss per question (200)‒‒‒‒‒‒ 11,400‒‒‒‒‒‒

(iv) The unrealised profit (URP) in inventory is calculated as:Intra-group sales are $6 million of which Pumice made a profitof $2 million. Half of these are still in inventory, thus there isan unrealised profit of $1 million.

(v) Consolidated reserves:Pumice’s reserves 37,000Silverton’s post acquisition(((2,000 × 6/12) - 200 depreciation) × 80%) 640Amok’s post acquisition profits (8,000 × 6/12 × 40%) 1,600URP in inventory (see (iv)) (1,000)Impairment of goodwill – Silverton (400)

– Amok (200)‒‒‒‒‒‒ 37,640‒‒‒‒‒‒

(vi) Non controlling interestEquity shares of Silverton (3,000 × 20%) 600Retained earnings ((8,000 – 200 depreciation) × 20%) 1,560

Fair value adjustments (2,000 × 20%) 400‒‒‒‒‒‒ 2,560

‒‒‒‒‒‒

2 (a) Kala – Income statement – Year ended 31 March 2012

$000 $000Revenue 278,400Cost of sales (w (i)) (115,700)

‒‒‒‒‒‒‒ Gross profit 162,700

Operating expenses (15,500)‒‒‒‒‒‒‒ 147,200‒‒‒‒‒‒‒

Investment income – property rental 4,500– valuation gain (90,000 × 7%) 6,300 10,800

‒‒‒‒‒‒‒ Finance costs – loan (w (ii)) (3,000)– lease (w (iii)) (7,000) (10,000)

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ Profit before tax 148,000Income tax expense (28,300 + (14,100 – 12,500)) (29,900)

‒‒‒‒‒‒‒ Profit for the period 118,100

‒‒‒‒‒‒‒





(b) Kala – Statement of changes in equity – Year ended 31 March 2012

Equityshares

Revaluationreserve

Retainedearnings Total

$000 $000 $000 $000

At 1 April 2011 150,000 nil 119,500 269,500Profit for period (see (a)) 118,100 118,100Revaluation of property (w (iv)) 45,000 45,000Equity dividends paid (15,000) (15,000)

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒ At 31 March 2012 150,000 45,000 222,600 417,600

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒

(c) Kala – Statement of financial position as at 31 March 2012 Non-current assets $’000 $’000

Property, plant and equipment (w (iv)) 434,100Investment property (90,000 + 6,300) 96,300‒‒‒‒‒‒‒ 530,400

Current assetsInventory 43,200Trade receivables 53,200 96,400

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ Total assets 626,800

‒‒‒‒‒‒‒ Equity and liabilitiesEquity (see (b) above)Equity shares of $1 each 150,000Reserves:Revaluation 45,000Retained earnings 222,600 267,600

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒ 417,600

Non-current liabilities8% loan note 50,000Deferred tax 14,100Lease obligation (w (iii)) 55,000 119,100

‒‒‒‒‒‒‒

Current liabilitiesTrade payables 33,400Accrued loan interest (w (ii)) 1,000Bank overdraft 5,400Lease obligation (w (iii)) – accrued interest 7,000

– capital 15,000Current tax payable 28,300 90,100

‒‒‒‒‒‒‒ ‒‒‒‒‒‒‒‒ Total equity and liabilities 626,800

‒‒‒‒‒‒‒‒





Workings in brackets in $ ’000(i) Cost of sales:

Opening inventory 37,800Purchases 78,200

Depreciation (w (iv)) – buildings 5,000– plant: owned 19,500– plant: leased 18,400

Closing inventory (43,200)‒‒‒‒‒‒‒ 115,700‒‒‒‒‒‒‒

(ii) The loan has been in issue for nine months. The total finance cost for thisperiod will be $3 million (50,000 x 8% x 9/12). Kala has paid six monthsinterest of $2 million, thus accrued interest of $1 million should beprovided for.

(iii) Finance lease:$000

Net obligation at inception of lease (92,000 – 22,000) 70,000Accrued interest 10% (current liability) 7,000Total outstanding at 31 March 2012 77,000The second payment in the year to 31 March 2007 (made on 1 April 2012) of$22 million will be $7 million for the accrued interest (at 31 March 2012)and $15 million paid of the capital outstanding. Thus the amountoutstanding as an obligation over one year is $55 million (77,000 – 22,000).

(iv) Non-current assets/depreciation:

Land and buildings:At the date of the revaluation the land and buildings have a carryingamount of $210 million (270,000 – 60,000). With a valuation of $255 millionthis gives a revaluation surplus (to reserves) of $45 million. Theaccumulated depreciation of $60 million represents 15 years at $4 millionper annum (200,000/50 years) and means the remaining life at the date ofthe revaluation is 35 years. The amount of the revalued building is $175million, thus depreciation for the year to 31 March 2012 will be $5 million(175,000/35 years). The carrying amount of the land and buildings at 31March 2012 is $250 million (255,000 – 5,000).

Plant: ownedThe carrying amount prior to the current year ’s depreciation is $130 million(156,000 – 26,000). Depreciation at 15% on the reducing balance basis givesan annual charge of $19.5 million. This gives a carrying amount at 31 March2012 of $110.5 million (130,000 – 19,500).Plant: leased

The fair value of the leased plant is $92 million. Depreciation on a straight-line basis over five years would give a depreciation charge of $18.4 millionand a carrying amount of $73.6 million.





Summarising the carrying amounts:Land and buildings 250,000Plant (110,500 + 73,600) 184,100

‒‒‒‒‒‒‒‒ Property, plant and equipment 434,100

‒‒‒‒‒‒‒‒

3 (a) Note: figures in the calculations are in $million

Return on year end capital employed 32.3 % 220/(1,160 – 480) × 100

Net asset turnover 5.9 times 4,000/680

Gross profit margin 13.8 % (550/4,000) × 100

Net profit (before tax) margin 5.0 % (200/4,000) × 100

Current ratio 1.3 :1 610:480

Closing inventory holding period 26 days 250/3,450 × 365

Trade receivables’ collection period 44 days 360/(4,000 – 1,000) × 365

Trade payables’ payment period(based on cost of sales) 45 days (430/3,450) × 365

Dividend yield 6.0% (see below)

Dividend cover 1.67 times 150/90

The dividend per share is 22.5 cents (90,000/(100,000 × 4 i.e. 25 cents shares). Thisis a yield of 6.0% on a share price of $3.75.

(b) Analysis of the comparative financial performance and position of Reactive forthe year ended 31 March 2012Profitability

The measures taken by management appear to have been successful as theoverall ROCE (considered as a primary measure of performance) has improved by 15% (32.3 -28.1)/28.1). Looking in more detail at the composition of the ROCE,the reason for the improved profitability is due to increased efficiency in the useof the company ’s assets (asset turnover), increasing from 4 to 5.9 times (animprovement of 48%). The improvement in the asset turnover has been offset bylower profit margins at both the gross and net level. On the surface, this

performance appears to be due both to the company’s strategy of offering rebatesto wholesale customers if they achieve a set level of orders and also the beneficial

impact on sales revenue of the advertising campaign. The rebate would explainthe lower gross profit margin, and the cost of the advertising has reduced the netprofit margin (presumably management expected an increase in sales volume asa compensating factor). The decision to buy complete products rather thanassemble them in house has enabled the disposal of some plant which hasreduced the asset base. Thus possible increased sales and a lower asset base arethe cause of the improvement in the asset turnover which in turn, as statedabove, is responsible for the improvement in the ROCE.The effect of the disposal needs careful consideration. The profit (before tax)

includes a profit of $40 million from the disposal. As this is a ‘one-off ’ profit,recalculating the ROCE without its inclusion gives a figure of only 23.7%





(180m/(1,160 - 480m + 80m (the 80m is the carrying amount of plant)) and the fallin the net profit percentage (before tax) would be down even more to only 4.0%(160m/4,000m). On this basis the current year performance is worse than that ofthe previous year and the reported figures tend to flatter the company ’sunderlying performance.

LiquidityThe company ’s liquidity position has deteriorated during the period. Anacceptable current ratio of 1.6 has fallen to a worrying 1.3 (1.5 is usuallyconsidered as a safe minimum). With the trade receivables period at virtually aconstant (45/44 days), the change in liquidity appears to be due to the levels ofinventory and trade payables. These give a contradictory picture. The closinginventory holding period has decreased markedly (from 46 to 26 days) indicatingmore efficient inventory holding. This is perhaps due to short lead times whenordering bought in products. The change in this ratio has reduced the currentratio, however the trade payables payment period has decreased from 55 to 45

days which has increased the current ratio. This may be due to different termsoffered by suppliers of bought in products.Importantly, the effect of the plant disposal has generated a cash inflow of $120million, and without this the company ’s liquidity would look far worse.Investment ratios

The current year ’s dividend yield of 6.0% looks impressive when compared withthat of the previous year ’s yield of 3.75%, but as the company has maintained thesame dividend (and dividend per share as there is no change in share capital) ,the ‘improvement ’ in the yield is due to a falling share price. Last year the shareprice must have been $6.00 to give a yield of 3.75% on a dividend per share of22.5 cents. It is worth noting that maintaining the dividend at $90 million fromprofits of $150 million gives a cover of only 1.67 times whereas on the samedividend last year the cover was 2 times (meaning last year ’s profit (after tax)was $180 million).Conclusion

Although superficially the company ’s profitability seems to have improved as aresult of the directors ’ actions at the start of the current year, much, if not all, ofthe apparent improvement is due to the change in supply policy and theconsequent beneficial effects of the disposal of plant. The company ’s liquidity isnow below acceptable levels and would have been even worse had the disposalnot occurred. It appears that investors have understood the underlyingdeterioration in performance as there has been a marked fall in the company ’sshare price.

(c) It is generally assumed that the objective of stock market listed companies is tomaximise the wealth of their shareholders. This in turn places an emphasis onprofitability and other factors that influence a company ’s share price. It is truethat some companies have other (secondary) aims such as only engaging inethical activities (e.g. not producing armaments) or have strong environmentalconsiderations. Clearly by definition not-for-profit organisations are notmotivated by the need to produce profits for shareholders, but that does notmean that they should be inefficient. Many areas of assessment of profit oriented

companies are perfectly valid for not-for-profit organisations; efficient inventory





holdings, tight budgetary constraints, use of key performance indicators,prevention of fraud etc.There are a great variety of not-for-profit organisations; e.g. public sector health,education, policing and charities. It is difficult to be specific about how to assessthe performance of a not-for-profit organisation without knowing what type oforganisation it is. In general terms an assessment of performance must be madein the light of the stated objectives of the organisation. Thus for example in apublic health service one could look at measures such as treatment waiting times,increasing life expectancy etc, and although such organisations don ’t have aprofit motive requiring efficient operation, they should nonetheless beaccountable for the resources they use. Techniques such as ‘value for money ’ andthe three Es (economy, efficiency and effectiveness) have been developed and canhelp to assess the performance of such organisations.

4 (a) Relevance

Information must be relevant to the decision-making needs of users. Informationis relevant if it can be used for predictive and/or confirmatory purposes.• It has predictive value if it helps users to predict what might happen in the

future.• It has confirmatory value if it helps users to confirm the assessments and

predictions they have made in the past.The relevance of information is affected by its materiality.• Information is material if omitting it or misstating it could influence

decisions that users make on the basis of financial information about aspecific reporting entity.

• Materiality is an entity-specific aspect of relevance based on the nature ormagnitude (or both) of the items to which the information relates in thecontext of an individual entity ’s financial report.

Therefore, it is not possible for the IASB to specify a uniform quantitativethreshold for materiality or predetermine what could be material in a particularsituation.Faithful representation

Financial reports represent economic phenomena (economic resources, claimsagainst the reporting entity and the effects of transactions and other events and

conditions that change those resources and claims) by depicting them in wordsand numbers.To be useful, financial information must not only represent relevant phenomena, but it must also faithfully represent the phenomena that it purports to represent.A perfectly faithful representation would have three characteristics. It would be:• complete – the depiction includes all information necessary for a user to

understand the phenomenon being depicted, including all necessarydescriptions and explanations.

• neutral – the depiction is without bias in the selection or presentation offinancial information; and





• free from error – where there are no errors or omissions in the descriptionof the phenomenon, and the process used to produce the reportedinformation has been selected and applied with no errors in the process.

Comparability is the qualitative characteristic that enables users to identify andunderstand similarities in, and differences among, itemsInformation about a reporting entity is more useful if it can be compared withsimilar information about other entities and with similar information about thesame entity for another period or another date.Consistency is related to comparability but is not the same. Consistency refers tothe use of the same methods for the same items, either from period to periodwithin a reporting entity or in a single period across entities. Consistency helps toachieve the goal of comparability.

(b) (i) This item involves the characteristic of faithful representation, specificallyreporting the substance of transactions. As the lease agreement is forsubstantially the whole of the asset ’s useful economic life, Porto willexperience the same risks and rewards as if it owned the asset. Althoughthe legal form of this transaction is a rental, its substance is the equivalentto acquiring the asset and raising a loan. Thus, in order for the financialstatements to be provide a faithful representation (and comparable tothose where an asset is bought from the proceeds of a loan), the transactionshould be shown as an asset on Porto ’s statement of financial position witha corresponding liability for the future lease rental payments. The incomestatement should be charged with depreciation on the asset and a financecharge on the ‘loan ’.

(ii) This item involves the characteristic of comparability. Changes inaccounting policies should generally be avoided in order to preservecomparability. Presumably the directors have good reason to be believe thenew policy presents a more reliable and relevant view. In order to minimisethe adverse effect a change in accounting policy has on comparability, thefinancial statements (including the corresponding amounts) should beprepared on the basis that the new policy had always been in place(retrospective application). Thus the assets (retail outlets) should includethe previously expensed finance costs and income statements will nolonger show a finance cost (in relation to these assets whilst underconstruction). Any finance costs relating to periods prior to the policy

change (i.e. for two or more years ago) should be adjusted for by increasingretained earnings brought forward in the statement of changes in equity.

(iii) This item involves the characteristic of relevance. This situation questionswhether historical cost accounting is more relevant to users than currentvalue information. Porto ’s current method of reporting these events usingpurely historical cost based information (i.e. showing an operating loss, butnot reporting the increases in property values) is perfectly acceptable.However, the company could choose to revalue its hotel properties (whichwould subject it to other requirements). This option would still report anoperating loss (probably an even larger loss than under historical cost ifthere are increased depreciation charges on the hotels), but the increases invalue would also be reported (in equity) arguably giving a more completepicture of performance.





5 (a) The correct timing of when revenue (and profit) should be recognised is animportant aspect of an income statement showing a faithful presentation. It isgenerally accepted that only realised profits should be included in the incomestatement. For most types of supply and sale of goods it is generally understoodthat a profit is realised when the goods have been manufactured (or obtained) by

the supplier and satisfactorily delivered to the customer. The issue withconstruction contracts is that the process of completing the project takes arelatively long time and, in particular, will spread across at least one accountingperiod-end. If such contracts are treated like most sales of goods, it would meanthat revenue and profit would not be recognised until the contract is completed(the “completed contracts” basis). This is often described as following theprudence concept. The problem with this approach is that it may not show afaithful presentation as all the profit on a contract is included in the period ofcompletion, whereas in reality (a faithful representation), it is being earned, butnot reported, throughout the duration of the contract. IAS 11 remedies this byrecognising profit on uncompleted contracts in proportion to some measure of

the percentage of completion applied to the estimated total contract profit. This issometimes said to reflect the accruals concept, but it should only be appliedwhere the outcome of the contract is reasonably foreseeable. In the event that aloss on a contract is foreseen, the whole of the loss must be recognisedimmediately, thereby ensuring the continuing application of prudence.

(b) Beetie

Income statement Contract 1 Contract 2 Total

$’000 $’000 $’000Revenue recognised 3,300 840 4,140

Contract expenses recognised(balancing figure contract 1) (2,400) (720) (3,120)Expected loss recognised (contract 2) (170) (170)

‒‒‒‒‒‒ ‒‒‒‒‒‒ ‒‒‒‒‒‒ Attributable profit/(loss) (see working) 900 (50) 850

‒‒‒‒‒‒ ‒‒‒‒‒‒ ‒‒‒‒‒‒ Statement of financial position

Contact costs incurred 3,900 720 4,620Recognised profit/(losses) 900 (50) 850

‒‒‒‒‒ ‒‒‒‒‒‒ ‒‒‒‒‒‒

4,800 670 5,470Progress billings (3,000) (880) (3,880)

‒‒‒‒‒‒ ‒‒‒‒‒‒ ‒‒‒‒‒‒ Amounts due from customers 1,800 1,800Amounts due to customers (210) (210)





Workings (in $’000)Estimated total profit:Agreed contract price 5,500 1,200Estimated contract cost (4,000) (1,250)

‒‒‒‒‒‒

‒‒‒‒‒‒

Estimated total profit/(loss) 1,500 (50)‒‒‒‒‒‒ ‒‒‒‒‒‒

Percentage complete:Agreed value of work completed at 31 March 2012 3,300Contract price 5,500Percentage complete at 31 March 2012 (3,300/5,500 × 100) 60%Profit to 31 March 2012 (60% × 1,500) 900

At 31 March 2012 the increase in the expected total costs of contract 2 mean that a

loss of $50,000 is expected on this contract. In these circumstances, regardless ofthe percentage completed, the whole of this loss should be recognisedimmediately.

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