acca p2 int revision mock - answers jun 12

ACCA

Paper P2 (INT)

Corporate Reporting

June 2012

Revision Mock – Answers

To gain maximum benefit, do not refer to these answers until you have completed the revision mock questions and submitted them for marking.

ACCA P2 ( INT): CORPORATE REPORTING

2 KAPLAN PUBLISHING

© Kaplan Financial Limited, 2012

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REVIS ION MOCK: ANSWERS

KAPLAN PUBLISHING 3

ANSWER 1 – JOBS GROUP

(a) Consolidated statement of financial position at 31 May 2012

$000 $000 Marks Non-current assets PPE (117,250 + 55,125 + 40,000 + 3,000 – 150 (FVA (W2)) 215,225 1 Investments – all cancelled (W3) except 2,500 + 3,500 (FVTPL (W2)) 6,000 1 Financial Asset CF hedge (W10) 10,000 1 Intangible assets – Goodwill (84,000 + 22,625) (W3) 106,625 5 ––––––––

337,850 Current assets (109,750 + 96,000 + 56,000) less purp 650 (W2) 261,100 2 ––––––––

598,950 ––––––––

Equity and liabilities Share capital 120,000 1 Other Components of Equity (W6) 19,682 4 Retained earnings (W5) 81,028 8 Non-controlling interest (W4) 113,775 6 ––––––––

Total equity of the group 334,485 Non-current liabilities Long-term loans (100,000 + 26,000) less 2,160 (6% bonds adj (W8)) 123,840 2 Current liabilities (80,500 + 30,125 + 30,000) 140,625 1 –––––––– –––

598,950 32 ––––––––

Net assets marks per workings 3

–––

35

–––


4 KAPLAN PUBLISHING

Workings

(W1) Group structure

Jobs

Gates

60,000 ––––––– 100,000

60% 1/2/12 6,600 –––––– 22,000 30% 1/2/12 Zuckerberg

5,500 –––––– 22,000

25% 1/2/12

All the investments take place 4 months prior to the reporting date. The Jobs group (Jobs & Zuckerberg combined) controls Gates by virtue of holding either directly or indirectly 55% (30% + 25%) of the voting rights of Gates. Therefore Gates is a subsidiary of the Jobs group; however the Jobs's group effective interest in Gates's profits is

Direct 30% Indirect (60% × 25%) 15% 45%

–––– Gates: effective NCI (bal fig) 55%

(W2) Net assets workings

Zuckerberg At acquisition At rep date Marks $000 $000 Equity capital 100,000 100,000 Retained earnings 23,000 36,000 FVA – property (16,000 – 13,000) 3,000 3,000 0.5 FVA – Dep’n (1/20) (150) 0.5 Fin. assets at FV (6,000 – 2,500) 3,500 0.5 –––––––– –––––––– 126,000 142,350 –––––––– ––––––––

The post acquisition profit of Zuckerberg is ($142.35m – $126m =) $16.35m (W4)/(W5)

Gates At acquisition At rep date Marks $000 $000 Equity capital 22,000 22,000 Retained earnings 17,000 18,000* 0.5 Inventory URP (650)** 1 ––––––– ––––––– 39,000 39,350 ––––––– –––––––

The post acquisition profit of Gates is ($39.35m – $39m =) $0.35m (W4)/(W5)


KAPLAN PUBLISHING 5

*Retained earnings of Gates at 1 February 2012

$000 Retained earnings at 1 February 2012 (balance) 17,000 Post acquisition profit (4/12 × 3,000) 1,000 ––––––– Retained earnings at 31 May 2012 18,000 –––––––

**Unrealised profit in inventory

Gates is the seller and also a subsidiary, so the adjustment is made against Gates's post acquisition profits in (W2) at the year end to ensure that the adjustment will impact the NCI.

$3,900,000 × 20/120 = $650,000

An alternative presentation that achieves the same overall result would be to exclude this amount from the net assets working of Gates, and to split the purp between the retained earnings and the NCI on a 45% & 55% basis and include those amounts in (W5) and (W4) respectively.

(W3) Goodwill

Zuckerberg $000 MarksCost of investment 142,000 0.5 FV of NCI at acquisition ($1.95 x 40% x 100,000) (W4) 78,000 0.5 ––––––––– 220,000 Less: FV of NA at acquisition (W2) (126,000) ––––––––– Goodwill at acquisition 94,000 Less impairment loss (from review) (see below) (10,000) 1 Group share 60% = 6,000 (W5): NCI share 40% = 4,000 (W4) ––––––––– To the S of FP 84,000 Impairment review of Zuckerburg's goodwill Carrying value of Zuckerberg

$000 Net assets at the reporting date (W2) 142,350 Goodwill 94,000

––––––––– 236,350

Recoverable amount per question 226,350 –––––––––

Impairment loss 10,000 –––––––––

–––––––––


6 KAPLAN PUBLISHING

Gates $000 Marks Indirect investment incurred by Zuckerberg 12,500 0.5 Less: indirect holding adj (40% × 12,500) to NCI (W4) (5,000) 0.5 ––––––– (same as 60% x 12,500) 7,500 Cost incurred directly by Jobs 31,000 0.5 FV of NCI (direct and indirect) (W4) 31,125 0.5 ––––––– 69,625 Less: FV of NA at acquisition (W2) (39,000) ––––––– Goodwill at acquisition 30,625 Less impairment loss (W4)/(W5) (8,000) 1 Group share 45% = 3,600 (W5): NCI share 55% = 4,400 (W4)

––––––– To the S of FP 22,625 –––––––

(W4) Non-controlling interest

$000 Marks Zuckerberg: FV of NCI at acquisition (W3) 78,000 0.5 Plus NCI % of the post acq profits (40% × 16,350) (W2) 6,540 1 Less NCI % of the impairment loss (40% × 10,000) (W3) (4,000) 0.5 Plus the increase in NCI re sale of shares in Z’berg (W7) 11,318 1 Gates: FV of NCI at acquisition (W3) 31,125 0.5 Plus NCI % of the post acq profits (55% × 350) (W2) 192 1 less NCI % of the impairment loss (55% × 8,000) (W3) (4,400) 0.5 Less NCI % indirect holding adjustment regarding the cost of investment by Zuckerberg in Gates (40% × 12,500) (W3)

(5,000) 1

–––––––– ––– 113,775 6 ––––––––

(W5) Retained earnings $000 Marks Jobs 99,500 1 Less correction re sale proceeds of sale of shaes in Z’berg not a gain (W6)

(16,000) 1

Less the option – equity settled share based expense (W9) (5,000) 1 Plus correction re 6% bond (W8) 3,000 1 Less Correction re 6% bond (W8) (840) (same as plus 2,160) Zuckerberg (60% × 16,350) (W2) 9,810 1 Less impairment loss (60% × 10,000) (W3) (6,000) 1 Gates (45% × 350) W2 158 1 Less impairment loss (45% × 8,000) (W3) (3,600) 1 ––––––– ––– 81,028 8 –––––––


KAPLAN PUBLISHING 7

(W6) Other components of Equity

$000 Marks Difference arising on the increase in NCI of Zuckerberg

(W7) 4,682 2

Equity settled share based payments of Jobs (W9) 5,000 1 Gain on the cash flow hedge derivative (W10) 10,000 1 ––––––– 19,682 –––––––

(W7) Increase in the NCI of Zuckerberg

The sale of 5 million shares at the year-end will have the effect of increasing the NCI of Zuckerberg. Jobs will still retain control of Zuckerberg with a direct holding of 55% of the shares following the sale. A difference will arise that will be recognised directly in equity. The proceeds should not have been regarded as a gain.

$000 Proceeds 16,000 Increase in the NCI share of NA and goodwill 5% X (142,350 (W2) + 84,000 (W3)) 11,318 ––––––– Positive difference to other components of equity 4,682 –––––––

The adjustments necessary can be summarised as

$000 $000 To record the Dr Retained earnings (W5) 16,000 – correction of the sale proceeds

being recorded as a gain Cr NCI (W4) 11,318 – increase in the NCI Cr Other components of

equity (W6) 4,682 – balancing figure directly in equity

(W8) 6% Bond

When Jobs issued the 6% bond the liability it was initially recognised in the accounts at $20,000,000 and not $17,000,000 as it should have been. The retained earnings need to be credited with $3,000,000 to reverse out the incorrect treatment of the discount and issue costs.

The finance charge should be $2,040,000 and not $1,200,000 thus an additional charge to retained earnings of $840,000 is required. The liability needs to be reduced by $2,160,000 from $20,000,000 to the correct balance of $17,840,000.

$000 Nominal value raised 20,000 Less: Discount on nominal value ($20,000 x 10%)

(2,000)

Less the transaction costs (1,000) –––––– Initial recognition of the financial liability 17,000

––––––


8 KAPLAN PUBLISHING

Opening balance

Plus income statement finance charge @ 12% on

the opening balance

Less the cash paid (6% x

20,000)

Closing balance, being the liability on

the statement of financial position

Yr1 $17,000 $2,040 ($1,200) $17,840

The correction required can be summarised as

$000 $000 Dr NCL 3,000 Cr Retained Earnings (W5) 3,000 Dr Retained Earnings (W5) 840 Cr NCL 840

i.e. a net adjustment of $2,160,000 that increases retained earnings and decreases the NCL

(W9) Equity settled share based payments

The options have to be expensed based on the value at the grant date ($3) and spread over the qualifying period of 3 years of which only six months has lapsed – thus the 6/36. There is no suggestion that the director will resign, thus 100% of the options are expected to vest.

$3 x 10 million options x 100% x 6/36 = $5million

This will be charged to (debited) reducing W5 Retained earnings – it is after all part of remuneration (wages) and then taken to (credited) and increasing Other Components of Equity.

(W10) Cash flow hedge derivative

The derivative must be carried at fair value of $10 million as an asset (DR asset) and a gain recorded of $10 million. This is a cash flow hedge as it is covering the risk associated with future cash flows; so the gain is recognised in other comprehensive income and in other components of equity (CR equity) and NOT in income / retained earnings.

(b) The new standard sets out that there will be a single basis of control to determine whether consolidation of an entity is required. This definition should be subject to continuous assessment, and should be considered at least at each reporting date to determine that control continues to apply. In making these proposals it is hoped that areas of divergent practice which had developed will be removed. (1.5 marks)

Under the new standard, control will consist of three components:

The first is having power over the investee; this is normally exercised through the majority of voting rights, but could also arise through other contractual arrangements. The proposal identifies that there is normally a correlation between exposure or rights to variable returns and the exercise of power, although this may not be conclusive in itself to identify a control relationship. Power relates only to substantive, rather than protective rights. The former arises where there is practical ability to exercise rights of control at the time when relevant decisions are made. The latter will arise where control may only be exercised upon pre-determined circumstances arising at some later date. (1.5 marks)

The second component of control is the exposure or rights to variable returns (positive and/or negative) from involvement. (1.0 marks)


KAPLAN PUBLISHING 9

The last component of control is the ability to use power over the investee to affect the amount of investor returns. The ability to use power over an investee to affect returns is regarded as a crucial determinant in deciding whether or not control is exercised. (1.0 marks)

The new standard also considers whether a portion of an entity (referred to as a “silo”) can be considered as a separate entity for the purposes of consolidation. This may lead to the situation of consolidation of only that part of a separate entity over which control is exercised. For this to be the case, the definition of control as previously outlined must apply to distinguishable or ring-fenced assets and liabilities. (1.0 marks)

(c) To act ethically assumes that one acts with integrity i.e. with honesty, and that the principles of transparent reporting are wholly embraced. Ethical accounting embraces substance over form and is concerned with providing the user of the financial statements with a true and fair view and a complete picture of the performance and position of the reporting entity. (1.0 marks)

To act ethically also implies that one is professional and competent i.e. technically up to date and that any financial statements prepared are free from material error. (0.5 marks)

The investment in Berners-Lee on the face of it does appear to be an associate undertaking, as significant influence is assumed when the investor has in excess of 20% of the voting rights. As such it would be equity accounted – thus presenting the investment in Berners-Lee in a single line in the group statement of financial position. With Berners-Lee looking like a highly geared entity this means that its liabilities will not be consolidated into the group accounts, thus preserving the prima facie gearing (risk perception) of the group.

(1.0 marks)

However there also exist the options that are exercisable at any time. These options are exercisable for a nominal (small) sum of money at any time and will give Jobs control over the majority of the voting rights of Berners-Lee. Given that the options were not issued at fair value and the immateriality of the consideration required to exercise them, this is not a normal commercial arrangement. If the business is a success it seems inevitable that the options will be exercised and Jobs will gain simple control of Berners-Lee whenever it wants to. But the mere existence of these options is such that in substance Jobs will control Berners-Lee from the outset, as the board of Berners-Lee will surely comply with the wishes of Jobs, knowing that if it does not Jobs will exercise the options, achieve simple control and appoint its own board of directors. (1.5 marks)

The options also give Jobs access to the future economic benefits that Berners-Lee will generate. In conclusion Berners-Lee is in substance a subsidiary of Jobs from the start and should be fully consolidated from incorporation. (1.0 marks)

It can be observed that this unnecessarily complex arrangement of setting up Berners-Lee with the weighted voting rights and options and the proposal not to be consolidated using acquisition accounting amounts to a crude attempt of off balance sheet finance. It can be inferred that Jobs has a desire to control the cash raised by the issue of the bonds of Berners-Lee, to participate ultimately in the profits generated by Berners-Lee but not to consolidate its results in the group accounts as the liabilities of Berners-Lee would reduce the perceived gearing of the group. (1.0 marks)

Such an intention to deceive is surely unethical, (lacking in integrity) as is the incorrect accounting treatment proposed. (0.5 marks)


10 KAPLAN PUBLISHING

ACCA Marking Scheme Marks

35

7

6

2

–––

50

–––

(a) Group statement of financial position per marking scheme

(b) Professional & ethical issues

(c) Discussion re accounting issues

Professional marks

Total

ANSWER 2 – MAGNOLIA

(a) IT services package:

Per IAS 18 revenue on service contracts should only be recognised when the appropriate criteria have been complied with as follows:

• The revenue earned can be reliably measured, (0.5 mark)

• It is probable that the future economic benefits will be received, (0.5 mark)

• The stage of completion of the contract can be reliably measured and (0.5 mark)

• The costs incurred can be reliably measured. (0.5 mark)

If there are complaints regarding reliability and quality of the service provision, then not all revenue originally expected to be earned from the contracts may be earned and recovered. This leads on to the prospect that revenue earned, including any associated profit, cannot be reliably estimated for recognition in the financial statements for the year to 30 April 2012. (1 mark)

If the directors of Magnolia are confident that costs incurred to date can be reliably measured, then revenue can be recognised only to the extent that costs incurred to date are regarded as recoverable. (1 mark)

This will result in any profit earned on the contracts being recognised at a later stage, either when the outcome and revenue earned can be measured reliably, or upon completion of the contracts.

As an additional issue, Magnolia may need to consider the possible requirement for provisions in case there are any claims made by this group of customers arising from the quality and reliability problems experienced during the year. (0.5 mark)

It is also possible that the problems encountered have damaged the reputation of Magnolia. This could be regarded as a possible indicator of impairment and the directors should consider the need for an impairment review based upon these circumstances.

(0.5 mark)

(b) Hardware and software packages:

IAS 18 requires that, where a combined package of goods and/or services is provided, the components should be disaggregated and revenue recognition principles applied to each separate component. (0.5 mark)

In addition, where a package of goods and /or services is provided at a discounted price, the revenue earned by each component should be pro-rated based upon the respective selling price of each component. (0.5 mark)


KAPLAN PUBLISHING 11

The revenue earned by each component of the package sold should therefore be allocated as follows:

Hardware: 240 / (240 + 360) × $500,000 = $200,000 (1 mark)

Support services: 360 / (240 + 360) × $500,000 = $300,000 (1 mark)

The revenue on sale of the hardware can be recognised immediately as the risks and rewards of ownership were transferred to the customer at the point of delivery on 1 May 2011. For twelve packages sold, this amounts to revenue of $2,400,000 to be recognised in the financial statements for the year ended 30 April 2012. (1 mark)

The revenue earned on the provision of support services is earned over the period of service provision. By 30 April 2012, one half of the support services contract has been completed, which results in revenue per package of $300,000 × 12/24 months = $150,000 per contract. Total revenue for the year to 30 April 2012 on twelve contracts would therefore be $1,800,000. (1 mark)

The cost of selling the hardware should be recognised immediately upon sale to match with revenue recognition. The cost of providing the support services should be recognised at a constant rate the two year contract term. (1 mark)

(c) Licence:

The licence would be recognised in the year to 30 April 2011 as an intangible asset at a cost of $20 million in accordance with IAS 38. Normally, any intangible asset with a definite useful life should be amortised on a systematic basis. (1 mark)

However, in the specific circumstances of the year to 30 April 2011, the asset is not being used to generate revenues due to the regulatory and commercial problems, so no amortisation is possible during that year. (1 mark)

Additionally, as the asset is not helping to generate revenues as expected, IAS 36 requires that it should also be subject to an impairment review at that date. (1 mark)

For the year to 30 April 2012, there is a further indication of impairment in that revenues from this new market are lower than originally forecast. At the time the licence is brought into use during the current year, it has a remaining useful life of nine years, with eight years remaining after 30 April 2012. An impairment review should be performed as follows:

$000 Carrying value of licence at 30 April 2012: Cost less 1 year amortisation over 9 year useful life 20,000 × 8/9

17,778 (1.5 mark)

Recoverable amount – higher of: Either: fair value less cost to sell 17,000 (1 mark)Or: value in use: $3,000 × 5.746 (W1) 17,238 17,238 (1.5 mark) –––––Impairment taken to profit or loss 540 (1 mark) –––––

(W1) this is the annuity factor for a discount rate of 8% for eight years



(d) Investment in Gloss:

The arrangement with Undercoat and Matt to set up and jointly operate another entity is dealt with by IFRS 11 Joint Arrangements. In particular, the arrangement outlined provides Magnolia, Undercoat and Matt each with an interest in the net assets of a separate entity, Gloss. (1 mark)

In addition, they would appear to have an arrangement whereby there is unanimous decision-making by them as parties who jointly control Gloss. It would be expected that the arrangement to have unanimous decision-making in relation to the key operational and financial decisions would be formalised in a contract. (1 mark)

IFRS 11 defines this form of joint arrangement as a joint venture. It should be equity-accounted in the same way as an associate in accordance with IAS 28 (revised) Investments in Associates and Joint Ventures. (1 mark)

IFRS 12 Disclosure of Interests in Other Entities requires that the name, shareholding, nature of investment and additional relevant information is disclosed in relation to subsidiaries, associates and joint arrangements to enable users of financial statements to understand their nature and their impact upon the financial statements. (1 mark)

ACCA Marking Scheme

Marks 5 6 8 4 2

––– 25

–––

(a) IT services package (b) Hardware and software package (c) Licence (d) Gloss – joint arrangement

Professional marks

Total

ANSWER 3 – RANGERSTAX

(a) Non-current assets:

Per IAS 16 revaluation gains on land are taken to revaluation reserve. Land is a non-depreciable non-current asset and therefore the revaluation will have no impact on profit before tax. (0.5 mark)

Based upon application of IAS 12, the revaluation will create a taxable temporary difference which will give rise to a deferred tax liability on the increase from carrying value to the new revalued amount amounting to $200,000 ($800,000 to $1,000,000). There has been an increase in the carrying value of an asset, but without any change in the tax base of that asset. (1 mark)

For the items of plant and equipment, there is no adjustment to the draft profit before tax as the assets have already been subject to depreciation for the year. (0.5 mark)

However, there is a taxable temporary difference, giving rise to a deferred tax liability, as the assets have attracted more tax relief than the cumulative write-off of depreciation to date. This means that there will be increased tax liabilities in future years. The amount of the temporary difference is $1,400,000 ($5,000,000 – $3,600,000). (1 mark)



(b) Defined contribution scheme:

Per IAS 19 account for contributions on an accruals basis in the financial statements as follows:

Expense to recognise: 6% × $13,000,000 = $780,000 (0.5 mark)

Expense already recognised due to monthly payments made

12 × $60,000 $720,000 (0.5 mark)

Additional charge required $60,000 (0.5 mark)

For deferred tax purposes, tax relief is granted when pension contributions are paid. There is a deductable temporary difference on the year-end accrual of $60,000 which will create a deferred tax asset as tax relief will only be received on this amount when paid after the year-end. (1 mark)

(c) Lease payments:

The lease would appear to be an operating lease per IAS 17 as it accounts for only five years of the expected asset life of eight years. The cost of the lease should be charged in the statement of comprehensive income on a straight-line basis. (1 mark)

This is done as follows:

Total payments/Lease term

($30,000 + (4 × $10,000))/ 5 years = $14,000 annual charge (1 mark)

Therefore, there is a net reduction in the lease rental charge of $16,000, with a consequent increase in profit for the year, rather than expensing the full $30,000 paid in the year.

(1 mark)

As the lease payments are allowed for tax when they are paid, there will be tax relief on the payment of $30,000, but a charge of only $14,000 in the accounts, thus creating a deferred tax liability on the $16,000 temporary difference. (1 mark)

(d) Financial asset:

If the company is acknowledging that it will not get full recovery on the financial asset, it is an indication of impairment, which should therefore be reviewed as follows: (1 mark)

Impairment review:

Carrying value $20,000

Less: Recoverable amount in one year $15,000/1.08 $13,889 (1 mark)

Impairment charged to profit or loss $6,111

The recoverable amount is discounted using the original effective rate at the time the loan was made of 8%. The impairment loss creates a deductable temporary difference as the tax base remains unchanged. The impairment loss will not be eligible for tax relief until after the due date of the loan – i.e. after 31 March 2013 – there is a deferred tax asset to the extent that there is an expected tax benefit at a later date. (1 mark)

(e) Share option scheme:

Per IFRS 2 the accounting treatment is to determine the year-end equity reserve required. Any change in the equity reserve from one reporting date to the next is charged against income. (0.5 mark)

The share options are measured at each reporting date using the fair value of the options at the grant date, together with the number of options expected to be eligible to be exercised at the vesting date. The total expected cost is then spread over the vesting period.

(0.5 mark)



Year 1 Equity reserve at 31 March 2011:

(900 – 17 – 35 – 10) = 838 × 50 × $4 × 1/ 3 years = $55,867 (0.5 mark)

This is also the charge to profit or loss for the year.

Year 2 Equity reserve at 31 March 2012:

(900 – 17 – 32 – 10) = 841 × 50 × $4 × 2/3 years = $112,133 (0.5 mark)

Charge for the year = increase in other equity component = $56,266 (0.5 mark)

The charge against profit is not allowed for tax purposes until exercise of the share options. This will create a deferred tax asset as an expense is recognised each year but tax relief will be obtained at a later date if and when the options are exercised. (0.5 mark)

The intrinsic value of the option is the difference between the fair value (market price) of a share and the exercise price of the option.

The position at 31 March 2012 is:

Cumulative expense charged against income: $112,133

Deferred tax asset based upon intrinsic value of options expected to be eligible for exercise at the vesting date:

(900 – 17 – 32 – 10) = 841 × 50 × ($9.50 – $6.50) × 2/3 years $84,100 (0.5 mark)

For information only: the deferred tax asset brought forward was:

(900 – 17 – 35 – 10) = 838 × 50 × ($7.50 – $6.50) × 1/3 years $13,967

The deferred tax asset would therefore be increased by ($84,100 - $13,967) = $70,133

Finally, as the total remuneration expense to date is greater than eligible tax deduction, none of the deferred tax income relates to equity.

$ Draft profit before tax 5,000,000 (a) Non-current assets – no impact upon profit before tax n/a (b) Defined contribution scheme – additional charge required (60,000) (0.5 mark)(c) Operating lease rental – reduction in amount charged 16,000 (0.5 mark)(d) Impairment of financial asset (6,111) (0.5 mark)(e) Share option scheme – remuneration expense for the year (56,266) (0.5 mark) ––––––––– Revised profit before tax 4,893,623 –––––––––



Deferred tax – IFRS

DT Asset DT Liability $ $ (a) Non-current assets

– temp difference re revaluation of land

200,000 (0.5 mark)

– temp difference re plant and equip’t 1,400,000 (0.5 mark)(b) Defined contribution scheme re accrual 60,000 (1 mark)(c) Op lease payments re prepayment 16,000 (0.5 mark)(d) Financial asset re impairment in IS 6,111 (0.5 mark)(e) Share option scheme re later exercise 84,100 (1 mark) ––––––– –––––––– 150,211 1,616,000 (150,211) –––––––– Net temporary difference at 31 March 2012 1,465,789 (0.5 mark) –––––––– Deferred tax provision c’fwd 31 March 2012

@ (1,465,789 × 30%) 439,737

Deferred tax provision b’fwd 31 March 2011 535,000 ––––––– Reduction in deferred tax provision for the year accounted for as follows:

95,263 (0.5 mark)

––––––– Reduction in deferred tax provision 95,263 Reduction in OCI re revaluation of land 60,000 Reduction in income tax charge in PorL 155,263

This presumes that there are no other deferred tax issues to be dealt with. It also assumes that any deferred tax assets are regarded as recoverable and can therefore be offset against deferred tax liabilities for the net position to be included in the statement of financial position at 31 March 2012.

ACCA Marking Scheme Marks

4 5 5 4 5 2

––– 25

–––

(a) Revaluation of land (b) Defined contribution scheme (c) Leased assets (d) Financial asset (e) Share option scheme

Professional marks

Total



ANSWER 4 – IFRS 13

(a) The standard does not introduce new fair value measurements but simply explains how to measure fair value when it is required by other standards. The mixed measurement system of allowing assets and liabilities to be measured at value and cost on the same statement of financial position is retained.

The standard does not change the accounting treatment for transaction costs or any gains or losses that arise on the remeasurement to fair value. These remain regulated by the relevant existing standards. As such this standard will not introduce radical change.

(0.5 mark)

Before the introduction of the IFRS 13, there was no single source of authority or guidance on the complex issue of fair value measurement. As a result it was perceived there were inconsistencies between entities in the measurement of fair value. The standard should therefore bring about greater clarity, consistency and comparability. (0.5 mark)

Standards are sometimes introduced as a result of a backlash to creative accounting but this is not the case here. The main driver appears to have been the completion of a joint project between the IASB and the equivalent body in the US, the Financial Accounting Standards Board (FASB) to converge the definition of what constitutes a fair value measurement. (1 mark)

There are several reasons for the issue of IFRS 13 as follows:

• To overcome inconsistency in the way that fair value measurements required by a reporting standard are determined for inclusion in the financial statements of an entity. (1 mark)

• To overcome increasing complexity in how fair value measurements are currently determined by individual entities in different situations. There is currently guidance in several reporting standards, on a piecemeal basis, to help determine fair value measurements when required, which is not necessarily consistent or comprehensive for preparers of financial statements to apply. (1 mark)

• To form part of the response of the accountancy profession to the global financial crisis. (1 mark)

• To increase and converge the supporting disclosure requirements to provide information that is relevant to users of financial statements, so that they understand the basis upon which a fair value measurement has been determined and applied with a set of financial statements. (1 mark)

In these ways financial reporting will be (marginally) improved by the standard.

(b) Fair value is defined by IFRS 13 as “...the price that would be received to sell an asset (or paid to transfer a liability) in an orderly transaction between market participants at the measurement date”. (1 mark)

This means that it is the exit price in an orderly market, i.e. not a distress sale. It assumes that the price is measured in the entity's principal (or most advantageous) market. The principal market is normally regarded as that which has the greatest volume or level of activity for that asset or liability. If there is no principal market, the most advantageous market should be used and this is determined by choosing the market that maximises the amount that would be received upon sale of an asset. (1 mark)

The measure of fair value considers only the characteristics of the asset (or liability) e.g. the condition and location of the asset. (1 mark)



Therefore the measure of fair value should not be adjusted for transaction costs as these are not characteristics of the asset (or liability). This emphasises that fair value is different from the net realisable value and fair value less cost to sell which do take into account transactions costs. (1 mark)

The measure of fair value does not consider any entity specific factors, i.e. the ability or intention of the entity to transact is irrelevant. (0.5 mark)

Measurement of non-financial assets should be based on the highest and best use. Thus in determining the fair value of land currently being used as a car park, it should be taken into account that alternative uses for the land may exist, for example its development potential. (1 mark)

The objective of using a valuation technique is to determine the price at which an orderly transaction would take place between market participants at the measurement date.

The fair value hierarchy gives highest priority to level 1 inputs and the lowest priority to level 3 inputs in order to increase reliability. Level 1 inputs are quoted prices, unadjusted in active markets for identical assets. Level 2 inputs are relevant observable inputs e.g. quoted prices of similar assets. Level 3 inputs are not observable i.e. are not based on market data, they comprise the outcome of application of management judgments and estimates.

(1.5 mark)

IFRS 9 Financial Instruments requires that the financial asset must be initially recognised at fair value. Thus the asset has to be initially recorded at $120,000 despite that only $100,000 has been paid out. This transaction has therefore created a gain for the buyer of $20,000. Under IFRS 13 this gain is recognised immediately in the income statement. (1.5 mark)

Whilst such a "bargain" transaction may be regarded as unusual they could occur when the seller needed to raise the cash i.e. it was a forced sale, not one in an orderly market.

(1 mark)

Another plausible scenario where such a purchase at undervalue could take place is between related parties. Full disclosure of related party transactions is required in the notes to the accounts per IAS 24 Related Parties. (1.5 mark)

IFRS 9 Financial Instruments requires that the loan must be initially measured at fair value. There is no market value to such a loan. The best evidence is to measure it at the present value of the future cash flow i.e. using level 3 inputs. (1 mark)

The relevant rate of interest is 12% as it takes into account the company's own credit rating. The entity will receive $200,000 x 0.797 = $159,400 in cash on the issue of the loan.

(1 mark)

The finance cost in the first year charged to income will be 12% x $159,400 = $19,128 and this is charged to income. As it is a zero coupon bond no interest is paid so that at the first year end the carrying value of the loan first appears to be $178,528 (being $159,400 + $19,128). (1.5 mark)

However the liability is classified as fair value through profit or loss and so the carrying value at the year-end has to be remeasured to fair value. There is a new credit rating of the company at this time of 15% which is relevant to use as the discount factor in measuring the present value of the future cash flow. As the discount rate is higher due to the poorer credit rating then the liability will decrease and therefore again will arise on the remeasurement of the liability. (1 mark)



If this gain was recognised in the income statement it would be confusing for users (counter intuitive) since the company’s credit rating has deteriorated. Therefore IFRS 9 requires that this gain is recognised in equity and in Other Comprehensive Income rather than in profit or loss for the year. (0.5 mark)

Whereas the carrying value of the loan is $178,528, the fair value of loan is now $200,000 x 0.87 = $174,000, giving rise to a gain of $4,528. (1 mark)

ACCA Marking Scheme

Marks

6

7

4

6

2

–––

25

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(a) Introduction of IFRS 13

(b) How FV is measured

(c) Financial asset

(d) Financial liability

Professional marks

Total

acca p2 int revision mock - answers jun 12

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