cima f1 fin ops

Financial Operations November 2010 1

The Examiner's Answers – F1 - Financial Operations

Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike.

SECTION A

Answer to Question One 1.1 B 1.2 C 1.3 A 1.4 D 1.5 UF Output tax 2,875 x 15/115 = 375 Input tax 1,000 x 15% = VAT Payable

150 225

ZF Output tax 6,900 x 15/115 = 900 Input tax 2,875 x 15/115 = VAT Payable

375 525

1.6 B 1.7 D 1.8 C 1.9 C 1.10 A

November 2010 Financial Operations 2

SECTION B

Answer to Question Two

(a) The four methods that a Country can choose from when relieving trading losses of an entity are: (i) Carry forward against future trading profits

The effect on ZK would be: Year ended 31 August 2009 taxable profits, chargeable gains of $5,000 Year ended 31 August 2010 no tax payable ($10,000 - $10,000) Year ended 31 August 2011 taxable profits $30,000 ($50,000 – ($30,000 – $10,000))

(ii) Offset against other income and chargeable gains of the same period The effect on ZK would be: Year ended 31 August 2009 no tax payable ($5,000 - $5,000) Year ended 31 August 2010 no tax payable ($10,000 - $10,000) Year ended 31 August 2011 taxable profits $35,000 ($50,000 – ($30,000 – $10,000 - $5,000))

(iii) Offset against other income and chargeable gains of the previous period As ZK has traded profitably for a number of years it should be possible to offset at least some of the $30,000 loss against last years taxable profits this could result in a refund of tax previously paid.

(iv) Group relief As ZK is part of a group, group relief may be available. ZK would transfer its loss to another group entity so that entity could offset it against taxable profits. As a result the total group tax payable would be reduced for the year.

(b) (i) A withholding tax is a tax deducted from a payment at source, before it is made to the

recipient abroad. As a tax authority cannot tax individuals in foreign countries, a withholding tax ensures that the tax authority gains some tax revenues from the payment before it is sent out of the country.

(ii) Withholding Tax Receipt $3,375,000 = 90% Tax deducted at 10% = $3,375,000 x 10/90 = $375,000 Gross amount $3,375,000 x 100/90 = $3,750,000


Underlying Tax $1,875,000 x 3,750,000/(12,500,000-1,875,000) = $661,765 Total $375,000 + $661,765 = $1,036,765 Tax due in Country X $3,750,000 x 25% = $937,500 Tax to pay in Country X = $937,500 - $1,036,765 = $0

(c) The four qualitative characteristics are:

• Relevance • Reliability • Understandability • Comparability

Relevance Information must be relevant to the needs of the user, it is relevant if it influences the economic decisions of the user. Reliability Information must be reliable to be useful. To be reliable it must be free from material error and bias and be a faithful representation of the underlying transactions. Reliable information must be prepared using economic substance rather than legal form and be complete. Any estimates required must be made on a prudent basis. Understandability To be useful Information needs to be understood by users. Users can be assumed to have a reasonable knowledge of business and accounting. Comparability Comparability is essential, information should be able to be compared within the entity over time and with other entities. The inclusion of prior period comparative figures and disclosure of accounting policies helps comparability.

(d) (i) $000 $000 Cost of shares (180 x $2.50) 450 Acquired: Equity shares 180 Retained earnings 40 Share premium 60 Revaluation of land

70 350

Goodwill

100


(ii) IFRS 3 Business combinations requires that goodwill is calculated and recognised in the Statement of financial position as an intangible non-current asset. Goodwill is not amortised but must be subjected to impairment reviews at least once a year. HB should record goodwill as $100,000 in its intangible non-current assets and not provide for any amortisation. An impairment review should be carried out on or before 31 August 2010.

(e)

(i) The acquisition of 80,000 non-voting preferred shares will not give control or any influence over ABC, therefore this would be classified as a non-current asset investment in HI’s financial statements.

(ii) The preferred shares will be ignored as they do not add any influence to the equity shares. (½) The 40,000 equity shares would give a 40% holding. Without any further information, a 40% holding of equity shares would be assumed to give significant influence (½) over the entity and would be classified as an associated entity, according to IAS 28 Investments in Associates.

(iii) The 70,000 equity shares will give HI a 70% interest in ABC, this would be

sufficient to give control of ABC. As HI would gain control of ABC, ABC would be classified as a subsidiary, according to IAS 27 Consolidated and separate financial statements.

(f)

(i) IAS 37 Provisions, contingent liabilities and contingent assets requires that future costs of reinstatement be provided for as soon as they become an unavoidable commitment. The mine’s license requires the work to be done, so there is a commitment as soon as the mine starts operations. The present value of the full cost must be provided for. $3 million will be credited to provisions and added to the cost of the non-current asset.

(ii) The earthquake occurred after the end of the accounting period. Assets and liabilities

at 31 August 2010 were not affected. The earthquake is indicative of conditions that arose after the reporting period and does not give any further evidence in relation to assets and liabilities in existence at the reporting date. Therefore according to IAS 10 Events after the reporting period it will be classified as a non-adjusting event after the reporting period. The cost of the repairs will be charged to the Statement of comprehensive income in the period when it is incurred. Due to the impact on MN, i.e. closure and loss of earnings for 6 months, the earthquake and an estimate of its effect will need to be disclosed by way of a note in MN’s financial statements for the year ended 31 August 2010.


SECTION C Answer to Question Three

(b) XB – Statement of changes in equity for the year ended 31 October 2010 Equity

shares Share

premium Retained Earnings

Total

$000 $000 $000 $000

Balance at 1 November 2009 300 0 168 468 New share issue 330 99 429 Statement of Comprehensive Income

63 63

Dividend paid (50) (50) Balance at 31 October 2010 630 99 181 910

(a) XB - Statement of comprehensive income for the year ended 31 October 2010

$000 $000 Revenue 690 Cost of sales W3 323 Gross Profit 367 Administrative expenses W3 (202) Distribution costs W3 (62) (264) Profit from operations 103 Finance cost W9 (6) Profit before tax 97 Income tax expense W7 (34) Profit for the period 63


XB – Statement of Financial Position at 31 October 2010 $000 $000 Non-current assets

Land 730 Property, plant and equipment W2 152 882

Current assets Inventory 18 Trade receivables 109

Cash and cash equivalents 216 Total assets

343

1,225

Equity and liabilities Equity

Equity share capital 630 Share premium 99 Retained earnings 181

Total equity 910 Non-current liabilities

Long term borrowings 200 Deferred tax W8 7

Total non-current liabilities 207 Current liabilities

Trade payables (77-3) 74 Tax payable 31 Accrued interest 3

Total current liabilities Total equity and liabilities

108 1,225

Workings (All figures in $000) (W1) Property Plant and Equipment – Depreciation and Net Book Value Cost 320 Less depreciation to 31 Oct 2009 Net book value at 31 Oct 2009 128

192

Depreciation for year (20% x 320) 64 64

Purchased during year 110 Depreciation for year (20% x 110) 22 88Net book value at 31 Oct 2010

152

(W2) PPE Cost Depreciation NBV Balance per trial balance 320 192 128 Purchases 110 110 Depreciation charge for year (W1) (64 +22) . (86)

(86) Balance at 31 Oct 2010 430 278

152


(W3) Cost of sales Administration Distribution Trial balance 237 185 62 Donations 5 Entertaining 12 Depreciation (W1) 86 . . Total 323 202 62 (W4) PPE - Tax Written down Value Tax written down value at 31 Oct 2009 90 Tax allowance for year to 31 Oct 2010 - 25% (22.5) 67.5

Purchased during year 110 Tax allowance at 50% (55)

Tax written down value at 31 Oct 2010 55

122.5

(W5) Income Tax Expense Tax Calculation for year ended 31 October 2010 $000 Profit per Statement of Comprehensive Income 97 Add back: Entertaining 12 Donations 5 Depreciation (W2) 86 200

Less tax depreciation (W3) (22.5 + 55) (77.5)Taxable profit

122.5

TAX AT 25% 30.625

Provide for taxation of $31,000 for the year (W6) Deferred tax Temporary difference at 31 Oct 2009 (128-90) 38 @25% = 9.5 rounded to 10 Temporary difference at 31 Oct 2010 (152 (W1) - 122.5 (W4)) 29.5 @25% = 7.375 rounded to 7 Change in year (3) Decrease deferred tax by $3,000 See W8 for SoFP (W7) Income tax expense for year ended 31 Oct 10 Balance b/f 6 Income tax for year (W5) 31 Deferred tax reduction (W6) (3) 34


(W8) Deferred Tax – Statement of Financial Position Temporary difference at 31/10/10 (W6) 7.375 rounded to 7 Or Balance 1 September 2009 10 Reduction (3) Balance 31 October 2010 7 (W9) Finance cost Interest on long term borrowings 200 x 3% = 6 SoCI Half year 6 x 6/12 = 3 current liability SoFP


Answer to Question Four (a) YG - Statement of Cash Flows for the year ended 31 October 2010 $000 $000 Cash flows from operating activities Profit before taxation 266 Adjustments for: Redundancy cost provision (150) Depreciation 250 Development expenditure amortisation (W5) 145 Finance cost 16 Loss on disposal of non-current tangible asset (W1) 4 Operating profit before working capital changes 531 Increase in inventory (97) Increase in trade receivables (84) Increase in trade payables 115 (66) Cash generated from operations 465 Interest paid (W2)** (14) Income taxes paid (W3) (180) (194) Net cash from operating activities 271 Cash flows from investing activities Purchase of property, plant and equipment (W4) (448) Proceeds from sale of equipment 66 Development expenditure (W5) (68) Net cash used in investing activities (450) Cash flows from financing activities Proceeds from issue of share capital (W6) 2,400 Repayment of long term borrowings (355) Equity dividends paid* (82) Net cash used in financing activities 1,963 Net increase in cash and cash equivalents 1,784 Cash and cash equivalents at 1 November 2009 205 Cash and cash equivalents at 31 October 2010 1,989 * this could also be shown as an operating cash flow ** this could be shown as a financing cash flow Workings (All figures in $000)

W1 – Loss on disposal of property plant and equipment Net book value 70 Cash 66 Gain 4 W2 – Interest Paid Balance B/F 3 SoCI 16 19 Balance C/F 5 Paid 14


W3 – Income Taxes paid Balance b/f – corporate income tax 170 - deferred tax 170 340 Income statement 120 460 Balance c/f – corporate income tax 70 - deferred tax 210 280 Tax paid 180 Alternative Method: Balance b/f – corporate income tax 170 Income statement 80 250 Balance c/f – corporate income tax (70) Tax paid 180 W4 – Purchase of plant and equipment Balance b/f 4,248 Revaluation 300 Disposals (70) 4,478 Depreciation for year (250) 4,228 Balance c/f 4,676 Purchases 448 W5 – Development expenditure Balance b/f 494 Amortised in year (145) 349 Balance c/f 417 New expenditure 68 W6 – Proceeds from issue of share capital Shares 1,600 Share premium 800 Received 2,400 W7 – Dividend paid Retained earnings b/f 1,250 Add profit for the year 146 1,391 Less retained earnings c/f 1,314 Dividend paid in year 82


(b) Confidentiality is one of the fundamental principles of the CIMA Code of Ethics for Professional Accountants. A professional accountant should respect the confidentiality of information acquired as a result of business relationships and should not disclose any such information to third parties unless there is a legal or professional right or duty to disclose. If there is no right or duty to disclose, the principle of confidentiality requires the professional accountant to not disclose confidential information outside the employing entity without specific authority. In addition it is usually illegal to use this type of information for personal gain. In most countries this would be classified as insider trading. The CIMA Code requires that the professional accountant does not use confidential information to their personal advantage or the advantage of third parties. You would therefore have to respond by either not accepting the invitation or accepting the invitation but make it clear in advance that you are unable to discuss any confidential information relating to your employer and the employer’s activities.

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