f7fr revision question bank sample j15

REVISION QUESTION BANK

June 2015 Edition

ACCAPaper F7 | FINANCIAL REPORTING

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©2014 DeVry/Becker Educational Development Corp. All rights reserved. (i)

ACCA

PAPER F7

FINANCIAL REPORTING

REVISION QUESTION BANK

For Examinations to June 2015

®

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REVISION QUESTION BANK – FINANCIAL REPORTING (F7)

©2014 DeVry/Becker Educational Development Corp. All rights reserved. (iii)

CONTENTS Question Page Answer Marks Date worked MULTIPLE CHOICE QUESTIONS

1 International Financial Reporting Standards 1 1001 14 2 Conceptual Framework 2 1001 18 3 Substance over Form 4 1002 10 4 IAS 1 Presentation of Financial Statements 6 1002 18 5 Accounting Policies 8 1003 12 6 IAS 18 Revenue 10 1003 10 7 Inventory and Biological Assets 11 1003 28 8 IAS 11 Construction Contracts 15 1004 10 9 IAS 16 Property, Plant and Equipment 17 1006 18 10 IAS 23 Borrowing Costs 19 1007 12 11 Government Grants 21 1007 12 12 IAS 40 Investment Properties 22 1008 10 13 IAS 38 Intangible Assets 23 1008 20 14 Non-current Assets Held for Sale and Discontinued Operations 26 1009 10 15 IAS 36 Impairment of Assets 27 1009 10 16 IAS 17 Leases 29 1010 10 17 IAS 37 Provisions, Contingent Liabilities and Contingent Assets 31 1011 16 18 IAS 10 Events after the Reporting Period 33 1011 12 19 IAS 12 Income Taxes 35 1012 12 20 Financial Instruments 37 1013 18 21 Regulatory Framework 39 1014 10 22 Consolidated Statement of Financial Position 41 1014 10 23 Consolidation Adjustments 42 1015 18 24 Further Consolidation Adjustments 45 1016 18 25 Consolidated Statement of Comprehensive Income 48 1017 22 26 Investments in Associates 51 1019 12 27 Analysis and Interpretation 53 1019 14 28 IAS 7 Statement of Cash Flows 55 1021 22 29 IAS 33 Earnings per Share 58 1022 22

Section B of the Examination will include two 15 mark questions and one 30 mark question as shown in the Specimen Exam reproduced in this Revision Question Bank. Questions with different mark allocations are not current exam style but provided for additional syllabus coverage.

INTERNATIONAL FINANCIAL REPORTING STANDARDS

1 Standard setting process (ACCA D04 adapted) 63 1025 15 CONCEPTUAL FRAMEWORK

2 Period of inflation 63 1026 15 3 Rebound (ACCA J11) 63 1027 15 SUBSTANCE OVER FORM

4 Wardle (ACCA J10) 65 1029 15

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FINANCIAL REPORTING (F7) – REVISION QUESTION BANK

(iv) ©2014 DeVry/Becker Educational Development Corp. All rights reserved.

Question Page Answer Marks Date worked IAS 1 PRESENTATION OF FINANCIAL STATEMENTS

5 Dexon (ACCA J08 adapted) 66 1031 15 6 Pricewell (ACCA J09 adapted) 68 1032 30 7 Sandown (ACCA D09 adapted) 70 1036 30 8 Cavern (ACCA D10 adapted) 72 1040 30 9 Highwood (ACCA J11 adapted) 74 1043 30 ACCOUNTING POLICIES

10 Emerald (ACCA D07 adapted) 76 1047 15 11 Tunshill (ACCA D10) 77 1048 15 IAS 18 REVENUE

12 Derringdo (ACCA J03 adapted) 78 1050 15 IAS 11 CONSTRUCTION CONTRACTS

13 Linnet (ACCA J04) 79 1052 15 14 Mocca (ACCA J11) 80 1054 10 IAS 16 PROPERTY, PLANT AND EQUIPMENT

15 Dearing (ACCA D08) 81 1055 10 16 Flightline(ACCA J09) 81 1056 10 IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS

17 Baxen (ACCA J12 adapted) 82 1057 15

IAS 23 BORROWING COSTS 18 Apex (ACCA J10 adapted) 83 1059 15 IAS 38 INTANGIBLE ASSETS

19 Dexterity (ACCA J04 adapted) 84 1060 15 20 Darby (ACCA D09) 85 1062 15 IFRS 5 DISCONTINUED OPERATIONS

21 Manco (ACCA D10) 86 1063 10 IAS 36 IMPAIRMENT OF ASSETS

22 Wilderness (ACCA D05 adapted) 86 1064 15 IAS 17 LEASES

23 Fino (ACCA D07) 87 1066 15

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©2014 DeVry/Becker Educational Development Corp. All rights reserved. (v)

Question Page Answer Marks Date worked IAS 37 PROVISIONS

24 Promoil (ACCA D08) 88 1068 15 25 Borough (ACCA D11) 88 1069 15 IAS 10 EVENTS AFTER THE REPORTING PERIOD 26 Waxwork (ACCA J09) 89 1070 15 FINANCIAL INSTRUMENTS

27 Pingway (ACCA J08 adapted) 90 1071 15 28 Bertrand (ACCA D11) 91 1073 10 GROUP ACCOUNTS

29 Parentis (ACCA J07 adapted) 91 1074 30 30 Patronic (ACCA J08 adapted) 93 1077 15 31 Pedantic (ACCA D08) 95 1079 30 32 Pacemaker (ACCA J09 adapted) 97 1082 30 33 Pandar (ACCA D09 adapted) 99 1085 25 34 Premier (ACCA D10 adapted) 101 1087 30 35 Prodigal (ACCA J11 adapted) 103 1091 20 36 Paladin (ACCA D11) 104 1093 25 ANALYSIS AND INTERPRETATION

37 Harbin (ACCA D07 adapted) 106 1095 30 38 Victular (ACCA D08 adapted) 109 1098 20 39 Hardy (ACCA D10) 111 1100 25 IAS 7 STATEMENT OF CASH FLOWS

40 Crosswire (ACCA D09 adapted) 114 1102 15 41 Deltoid (ACCA J10 adapted) 116 1104 15 IAS 33 EARNINGS PER SHARE

42 Savoir (ACCA J06) 118 1106 15 43 Barstead (ACCA D09) 119 1107 10 COMPOSITE IFRS QUESTIONS

44 Toogood (ACCA J07 adapted) 120 1108 15 45 Errsea I (ACCA J07 adapted) 121 1110 15 46 Errsea II (ACCA J07 adapted) 122 1112 15 SAMPLE


(vi) ©2014 DeVry/Becker Educational Development Corp. All rights reserved.

Question Page Answer Marks Date worked RECENT EXAMS June 2012 1 Pyramid (see Specimen Exam) 2 Fresco (adapted) 123 1114 30 3 Tangier (adapted) 125 1118 15 4 Telepath 127 1120 15 December 2012 1 Viagem (adapted) 129 1122 15 2 Quincy (see Specimen Exam) 3 Quartile (adapted) 130 1123 15 4 Lobden (adapted) 131 1124 15 5 Shawler 133 1126 15 June 2013 1 Paradigm (adapted) 135 1128 15 2 Atlas (adapted) 136 1130 30 3A Monty I (adapted) 138 1134 15 3B Monty II (adapted) 140 1135 15 4 Radar 142 1136 15 5 Not reproduced December 2013 1 Polestar (adapted) 143 1138 30 2 Moby (adapted) 145 1141 15 3A Kingdom I (adapted) 146 1144 15 3B Kingdom II (adapted) 148 1145 15 4 Laidlaw (adapted) 150 1148 15 5 Fundo 151 1149 15 SPECIMEN EXAMINATION Section A Multiple Choice Questions 2 17 40 Section B 1 Tangier 8 19 15 2 Pyramid 10 20 15 3 Quincy 12 21 30 SAMPLE

REVISION QUESTION BANK MCQ – FINANCIAL REPORTING (F7)

©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1

1 INTERNATIONAL FINANCIAL REPORTING STANDARDS

1.1 Which ONE of the following is NOT a function of the IASB?

A Responsibility for all IFRS technical matters B Publication of IFRSs C Overall supervisory body of the IFRS organisations D Final approval of interpretations by the IFRS Interpretations Committee

1.2 Which ONE of the following is NOT part of the process of developing a new International Financial Reporting Standard?

A Issuing a discussion paper that sets out the possible options for a new standard B Publishing clarification of an IFRS where conflicting interpretations have developed C Drafting an IFRS for public comment D Analysing the feedback received on a discussion paper

1.3 Whose needs are general purpose financial statements intended to meet?

A Shareholders of incorporated entities B The general public C Users of financial statements D Regulatory authorities

1.4 Which body develops International Financial Reporting Standards?

A IASB B IFRS Foundation C IFRS IC D IFRS Advisory Council

1.5 According to the International Accounting Standards Board, in whose interests are financial reporting standards issued?

A Company directors B The public C Company auditors D The government

1.6 The issue of a new IFRS means that:

(1) An existing standard may be partially or completely withdrawn. (2) Issues that are not in the scope of an existing standard are covered. (3) Issues raised by users of existing standards are explained and clarified. (4) Current financial reporting practice is modified. Which combination of the above will most likely be the result of issuing a new IFRS?

A 1, 2 and 3 only B 2, 3 and 4 only C 1, 3 and 4 only D 1, 2 and 4 only

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FINANCIAL REPORTING (F7) – REVISION QUESTION BANK MCQ

2 ©2014 DeVry/Becker Educational Development Corp. All rights reserved.

1.7 Which ONE of the following is one of the “3Es” in the “value for money” concept?

A Earnings B Equity C Evaluation D Effectiveness

(14 marks)

2 CONCEPTUAL FRAMEWORK

2.1 Which ONE of the following is stated as an underlying assumption according to the IASB’s Conceptual Framework for Financial Reporting?

A Neutrality B Accruals C Relevance D Going concern

2.2 The International Accounting Standards Board’s uses the Conceptual Framework for Financial Reporting (Framework) to assist in developing new standards.

Which one of the following is NOT covered by the Framework?

A The format of financial statements B The objective of financial statements C Concepts of capital maintenance D The elements of financial statements

2.3 An item meets the definition of an element in accordance with the Conceptual Framework for Financial Reporting.

Which of the following criteria must be met for item to be recognised in the financial statements?

(1) It is probable that any future economic benefit associated with the item will flow to or from the entity.

(2) The item has a cost or value that can be measured with reliability.

(3) The rights or obligations associated with the item are controlled by the reporting entity.

A 1 only B 2 only C 1 and 2 only D 1, 2 and 3

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2.4 Which of the following statements about the characteristics of financial information is correct?

(1) Faithful representation means that the legal form of a transaction must be reflected in financial statements, regardless of the economic substance.

(2) Under the recognition concept only items capable of being measured in monetary terms can be recognised in financial statements.

(3) It may sometimes be necessary to exclude information that is relevant and reliable from financial statements because it is too difficult for some users to understand.

A 1 only B 2 only C 3 only D None of these statements

2.5 Which of the following statements are correct?

(1) The money measurement concept requires all assets and liabilities to be accounted for at original (historical) cost.

(2) Faithful representation means that the economic substance of a transaction should be reflected in the financial statements, not necessarily its legal form.

(3) The realisation concept means that profits or gains cannot normally be recognised in the statement of profit or loss until cash has been received.

A 1 and 2 only B 1 and 3 only C 2 and 3 only D All three statements

2.6 IFRS 13 Fair Value Measurement sets out a fair value hierarchy that categorises inputs into three levels.

Which of the following inputs would have the highest authority?

A Unobservable inputs B Directly observable inputs other than quoted prices C Quoted prices in active markets at the measurement date D Market-corroborated inputs

2.7 The following are possible methods of measuring assets and liabilities other than historical cost:

(1) Current cost (2) Realisable value (3) Present value (4) Replacement cost According to the IASB’s Conceptual Framework for Financial Reporting which of the measurement bases above can be used by an entity for measuring assets and liabilities shown in its statement of financial position?

A 1 and 2 only B 1, 2 and 3 only C 2 and 3 only D All four

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2.8 The IASB’s Conceptual Framework for Financial Reporting identifies qualitative characteristics of financial statements.

Which TWO of the following characteristics are fundamental qualitative characteristics according to the IASB’s Framework?

(1) Relevance (2) Understandability (3) Faithful representation (4) Comparability A 1 and 2 only B 1 and 3 only C 2 and 4 only D 3 and 4 only

2.9 Which of the following is the underlying assumption in the International Accounting Standards Board’s Conceptual Framework for Financial Reporting?

A Accruals B Reliability C Going concern D Relevance

(18 marks)

3 SUBSTANCE OVER FORM

3.1 In which of the following accounting treatments is the qualitative characteristic of faithful representation being applied?

A An asset is depreciated on the straight-line basis B The costs of a patent are capitalised C An asset acquired through a finance lease is capitalised by the buyer D An allowance is made for irrecoverable trade receivables

3.2 Which of the following are examples of transactions which could be used to create “off-balance sheet finance”?

(1) Sale and repurchase arrangements (2) Factoring of debts (3) Warranty provisions (4) Consignment inventories A 1, 2 and 3 B 2, 3 and 4 C 1, 3 and 4 D 1, 2 and 4

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3.3 Which one of the following descriptions most accurately describes “creative accounting”?

A Using loop-holes in the requirements of International Financial Reporting Standards so that the financial statements are biased in a required direction

B Creating fictitious assets in the statement of financial position to show a stronger financial position

C Not applying the requirements of International Financial Reporting Standards in order to show a better year-end position

D Deliberately falsifying the financial statements to show a stronger financial position

3.4 Soco revalues its properties to market value each year. One of Soco’s warehouses, is valued at its market value of $1,200,000 in its statements of financial position as at September 20X3.. This building is sold on 29 September 20X4 for $900,000 with an option to repurchase after four years at $1,093,956 ($900,000 plus compound interest for four years at 5% per annum).

The warehouse’s market value at 29 September 20X4 was $1,380,000.

How should Soco treat this transaction in its financial statements for the year ended 30 September 20X4?

A As a sale of the warehouse recording a loss on disposal of $300,000

B Leave the warehouse in its statement of financial position at $1,200,000 and record $900,000 as a loan received

C Revalue the warehouse to $1,380,000 and record a loss on disposal of $480,000

D Revalue the warehouse to $1,380,000 and record $900,000 as a loan received

3.5 On 31 December 20X3 Tenby sold $100,000 of trade receivables to a factoring company, for $90,000. If the factor has not collected the debt by 28 February 20X4 they can return the debt to Tenby.

In respect of the above transaction what value should be placed on the receivables as at 31 December 20X3?

A Nil B $10,000 C $90,000 D $100,000

(10 marks)

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4 IAS 1 PRESENTATION OF FINANCIAL STATEMENTS

4.1 XYZ decided to change its reporting date which will result in a 15-month reporting period.

Which of the following two items must be disclosed in accordance with IAS 1 Presentation of Financial Statements?

(1) The reason for the period being longer than 12 months.

(2) A statement that similar entities have also changed their accounting period.

(3) A statement that comparative amounts used in the financial statements are not entirely comparable.

(4) Whether the change is just for the current period or for the foreseeable future.

A 1 and 2 only B 1 and 3 only C 2 and 4 only D 3 and 4 only

4.2 Which of the following disclosures are specifically required by IAS 1 Presentation of Financial Statements?

(1) The name of the reporting entity or other means of identification. (2) The names of all major shareholders. (3) The level of rounding used in presenting amounts in the financial statements. (4) Whether the financial statements cover the individual entity or a group of entities.

A 2, 3and 4 only B 1, 3 and 4 only C 1, 2 and 4 only D 1, 2 and 3 only

4.3 Which item must be shown as a line item in the statement of financial position?

A Intangible assets B Work in progress C Trade receivables D Taxation

4.4 Balances under the following headings are extracted from the books of Ego.

(1) Staff costs – wages and salaries (2) Raw materials and consumables (3) Own work capitalised The accountant wishes to use a classification of expenses within profit by nature format.

Which of the above balances may be included without further analysis in the statement of profit or loss?

A 1 and 2 only B 1 and 3 only C 2 and 3 only D All three

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4.5 During the year ended 31 March 20X3 Woolf sold a leasehold building for $1,550,000. The 20-year lease was purchased on 1 July 20W0 for $100,000 but had been revalued to $1,900,000 on 31 March 20X0. Woolf depreciates leasehold buildings on a straight line basis over the life of the lease, with a full year’s amortisation in the year of acquisition and none in the year of disposal.

Woolf revalues another leasehold building to $2,000,000 on 31 March 20X3. Its historical cost was $1,000,000 and accumulated amortisation on the lease was $350,000.

How are these transactions reflected in other comprehensive income and profit or loss?

Other comprehensive income Profit or loss

A $1,350,000 gain $1,510,000 profit B $500,000 loss $1,510,000 profit C $1,350,000 gain $30,000 profit D $500,000 loss $30,000 profit

4.6 Bell made a profit of $183,000 for the year ended 30 June 20X7 and paid a dividend during the year of $18,000. During the year the company wrote off development costs of $45,000 directly to retained earnings as a prior period adjustment and revalued a property with a carrying amount of $60,000 to $135,000.

What was total comprehensive income for period ended 30 June 20X7?

A $195,000 B $240,000 C $258,000 D $318,000

4.7 IAS 1 Presentation of Financial Statements encourages an analysis of expenses to be presented in the statement of profit or loss. This analysis must use a classification based on either the nature of expense, or its function, such as:

(1) Raw materials and consumables used (2) Distribution costs (3) Employee benefit costs (4) Cost of sales (5) Depreciation and amortisation expense Which of the above should be disclosed in the statement profit or loss if a manufacturing entity uses analysis based on function?

A 1, 3 and 4 only B 2 and 4 only C 1 and 5 only D 2, 3 and 5 only

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4.8 DT’s final dividend for the year ended 31 October 20X5 of $150,000 was declared on 1 February 20X6 and paid in cash on 1 April 20X6. The financial statements were approved on 31 March 20X6.

Which of the following statements reflect the correct treatment of the dividend in the financial statements of DT?

(1) The payment settles an accrued liability in the statement of financial position as at 31 October 20X5.

(2) The dividend is shown as a deduction in the statement of profit or loss for the year ended 31 October 20X6.

(3) The dividend is shown as an accrued liability in the statement of financial position as at 31 October 20X6.

(4) The $150,000 dividend was shown in the notes to the financial statements at 31 October 20X5.

(5) The dividend is shown as a deduction in the statement of changes in equity for the year ended 31 October 20X6.


4.9 Which of the following items are required be disclosed in the notes to the financial statements?

(1) Useful lives of assets or depreciation rates used. (2) Increases in asset values as a result of revaluations in the period. (3) Depreciation expense for the period. (4) Reconciliation of carrying amounts of non-current assets at the beginning and end

of period.

A All four B 1 and 2 only C 1 and 3 only D 2, 3 and 4 only

(18 marks)

5 ACCOUNTING POLICIES

5.1 According to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, which ONE of the following is a change in accounting policy that requires retrospective application?

A The depreciation of the production facility has been reclassified from administration expenses to cost of sales in the current and future years

B The depreciation method of vehicles was changed from straight line depreciation to reducing balance

C The provision for warranty claims was changed from 10% of sales revenue to 5%

D Based on information that became available in the current period a provision was made for an injury compensation claim relating to an incident in a previous year

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5.2 Which ONE of the following would require retrospective application in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors?

A An entity changes its method of depreciation of machinery from straight line to reducing balance

B An entity has started capitalising borrowing costs for assets in accordance with IAS 23 Borrowing Costs. The borrowing costs previously had been charged to profit or loss

C An entity changes its method of calculating the provision for warranty claims on its products sold

D An entity disclosed a contingent liability for a legal claim in the previous year’s financial statements. In the current year, a provision has been made for the same legal claim

5.3 During its 20X6 accounting year, DL made the following changes.

Which ONE of these changes would be classified as “a change in accounting policy” as determined by IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors?

A Increased the allowance for irrecoverable trade receivables for 20X6 from 5% to 10% of outstanding balances

B Changed the depreciation of plant and equipment from straight line depreciation to reducing balance depreciation

C Changed the valuation method of inventory from FIFO to weighted average

D Changed the useful economic life of its motor vehicles from six years to four years

5.4 The draft 20X5 statement of financial position of Vale reported retained earnings of $1,644,900 and net assets of $6,957,300. Following the completion of the draft 20X5 statement of financial position it was discovered that several items of inventory had been valued at selling price at the 20X4 year end. This meant that the opening inventory value for 20X5 was overstated by $300,000. The closing inventory had been correctly valued in the draft 20X5 statement of financial position.

If the error is corrected before the 20X5 financial statements are finalised, what figures will be reported for retained earnings and net assets in the statement of financial position?

Retained earnings Net assets A $1,644,900 $6,657,300 B $1,644,900 $6,957,300 C $1,944,900 $6,657,300 D $1,944,900 $6,957,300

5.5 In 20X3 Falkirk identified that a fraud had been perpetrated by an employee who had been making payments to himself amounting to $6,200,000. $1,400,000 million were payments made in 20X3, $1,800,000 in 20X2 and $3,000,000 prior to 20X2; the double entry to the payments had created false assets.

How much of the fraud should be recognised as an expense in 20X3 profit or loss?

A Nil B $1,400,000 C $3,200,000 D $6,200,000

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5.6 IAS 8 Accounting Policies, Changes in Accounting Estimate and Errors specifies the definition and treatment of a number of different items.

Which of the following is NOT specified by IAS 8?

A The notification that a credit customer has just gone bankrupt owing debts of $250,000 B Identification of fraud relating to the current and prior years C Moving from FIFO to weighted average valuation model for inventory D The recognition of a decommissioning provision

(12 marks)

6 IAS 18 REVENUE

6.1 IAS 18 Revenue sets out criteria for the recognition of revenue from the sale of goods.

Which ONE of the following is NOT a criterion specified by IAS 18 for recognising revenue from the sale of goods?

A The seller no longer retains any influence or control over the goods B The cost to the seller can be measured reliably C The buyer has paid for the goods D The significant risks and rewards of ownership have been transferred to the buyer

6.2 OC signed a contract to provide office cleaning services for an entity for a period of one year from 1 October 20X8 for a fee of $500 per month.

The contract required the entity to make one payment to OC covering all twelve months’ service in advance. The contract cost to OC was estimated at $300 per month for wages, materials and administration costs.

OC received $6,000 on 1 October 20X8.

What profit or loss on the contract should OC recognise in its statement of profit or loss for the year ended 31 March 20X9?

A $600 loss B $1,200 profit C $2,400 profit D $4,200 profit

6.3 LP received an order to supply 10,000 units of product A every month for two years. The customer had negotiated a low price of $200 per 1,000 units and agreed to pay $12,000 in advance every 6 months.

The customer made the first payment on 1 July 20X2 and LP supplied the goods each month from 1 July 20X2.

LP’s year end is 30 September.

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In addition to recording the cash received, how should LP record this order, in its financial statements for the year ended 30 September 20X2, in accordance with IAS 18 Revenue?

A Include $6,000 in revenue for the year and create a trade receivable for $36,000 B Include $6,000 in revenue for the year and create a current liability for $6,000 C Include $12,000 in revenue for the year and create a trade receivable for $36,000 D Include $12,000 in revenue for the year but do not create a trade receivable or

current liability

6.4 On 31 March, DT received an order from a new customer, XX, for products with a sales value of $900,000. XX enclosed a deposit with the order of $90,000.

On 31 March, DT had not completed credit referencing of XX and had not despatched any goods. DT is considering the following possible entries for this transaction in its financial statements for the year ended 31 March:

(1) Include $900,000 as revenue for the year; (2) Include $90,000 as revenue for the year; (3) Do not include anything as revenue for the year; (4) Create a trade receivable for $810,000; (5) Create a trade payable for $90,000. According to IAS 18 Revenue, how should DT record this transaction in its financial statements for the year ended 31 March?


6.5 Which of the following statements correctly describes the accounting treatment when there are goods in transit with free on board shipping?

A If an entity is the buyer, inventory is recognised in its financial statements when it receives the goods from a common carrier

B If an entity is the buyer, inventory cannot be recognised in its financial statements

C If an entity is the buyer, inventory is recognised in its financial statements upon shipment

D If an entity is the seller, inventory is recognised in its financial statement until delivery is completed

(10 marks)

7 INVENTORY AND BIOLOGICAL ASSETS

7.1 At 30 September 20X1 the closing inventory of a company amounted to $386,400. The following items were included in this total at cost:

(1) 1,000 items which had cost $18 each. These items were all sold in October 20X1 for $15 each, with selling expenses of $800.

(2) Five items which had been purchased for $100 each eight years ago. These items were sold in October 20X1 for $1,000 each, net of selling expenses.

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What figure should appear in the company’s statement of financial position at 30 September 20X1 for inventory?

A $382,600 B $384,200 C $387,100 D $400,600

7.2 The inventory value for the financial statements of Q for the year ended 31 December 20X1 was based on an inventory count on 4 January 20X2, which gave a total inventory value of $836,200.

Between 31 December and 4 January 20X2, the following transactions took place:

$ Purchases of goods 8,600 Sales of goods (profit margin 30% on sales) 14,000 Goods returned by Q to supplier 700 What adjusted figure should be included in the financial statements for inventories at 31 December 20X1?

A $818,500 B $834,300 C $838,100 D $853,900

7.3 According to IAS 2 Inventories, which of the following costs should be included in valuing the inventories of a manufacturing company?

(1) Carriage inwards (2) Carriage outwards (3) Depreciation of factory plant (4) General administrative overheads

A 1 and 3 only B 1, 2 and 4 only C 2 and 3 only D 2, 3 and 4 only

7.4 IAS 2 Inventories defines the extent to which overheads are included in the cost of inventories of finished goods.

Which of the following statements about the IAS 2 requirements relating to overheads are true?

(1) Finished goods inventories may be valued on the basis of labour and materials cost only, without including overheads.

(2) Factory management costs should be included in fixed overheads allocated to inventories of finished goods.

A 1 only B 2 only C Both 1 and 2 D Neither 1 nor 2

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7.5 Which of the following are correct?

(1) The carrying amount of inventory should be as close as possible to net realisable value.

(2) The valuation of finished goods inventory must include production overheads.

(3) Production overheads included in valuing inventory should be calculated by reference to the company’s normal level of production during the period.

(4) In assessing net realisable value, inventory items must be considered separately, or in groups of similar items, not by taking the inventory value as a whole.

A 1 and 2 only B 1 and 3 only C 2, 3 and 4 D 3 and 4 only

7.6 The net realisable value of inventory is defined as the actual or estimated selling price less all costs to be incurred in marketing, selling and distribution.

Which of all the following additional items should be deducted in calculating the net realisable value of inventory?

Trade Settlement Costs to discounts discounts completion A No Yes Yes B Yes No Yes C Yes Yes No D Yes Yes Yes

7.7 Which of the following costing methods for inventory valuation purposes is permissible under both IAS 2 Inventories?

A Absorption costing B Direct costing C Marginal costing D Variable costing

7.8 IAS 2 Inventories allows a number of methods for determining purchase price or production of finished goods inventory.

Which of the following valuation methods is also allowed by IAS 2?

A both LIFO and weighted average B only LIFO C only weighted average D neither LIFO nor weighted average

SAMPLE



7.9 During the year ended 31 December 20X6 Grasmere purchased the following items for resale.

Date Number of items Cost price per item March 20 $11 June 20 $13 This was a new product line and by 31 December 20X6 twenty items were left unsold. At that date they were being sold at $12 an item and it would have cost Grasmere $10 an item to buy further supplies. Grasmere determines cost of inventory under the FIFO method.

At what amount should finished goods inventory be shown in the statement of financial position on 31 December 20X6?

A $200 B $220 C $240 D $260

7.10 Toulouse makes three different products. The following table shows the inventory valuation for each of the products under different bases.

First-in- Last-in- Net realisable first-out first-out value $ $ $ Product I 10 11 12 Product II 13 15 14 Product III 9 5 7 —— —— —— 32 31 33 —— —— —— At what value should Toulouse ’s inventory be stated in accordance with IAS 2 Inventories?

A $28 B $30 C $31 D $32

7.11 Which of the following is NOT dealt with by IAS 41 Agriculture?

A Sheep B Wool C Wine D Vines

7.12 XYZ Farm purchased 100 turkeys for $10,000 on 17 November 20X1. At the year end of XYZ , 31 December 20X1, the estimated sales price of the 100 turkeys was measured at $10,500. In addition, the following costs are expected to be incurred in respect to the sale of the turkeys. $ Transportation cost 700 Finance cost 300 Income taxes related to this sale 1,000

SAMPLE



What amount should be recognised for the biological assets in XYZ’s statement of financial position as at 31 December 20X1?

A $8,500 B $9,800 C $10,000 D $10,500

7.13 IAS 41 Agriculture is applied to all of the following items except one.

Which item does IAS 41 not apply to?

A Biological assets B Land related to agricultural activity C Agricultural produce at the point of harvest D Government grants related to agricultural activity

7.14 Which of the following is NOT an example of agricultural activity, as defined in IAS 41 Agriculture?

A Cultivating orchards B Floriculture C Fish farming D Sale of harvested crops

(28 marks)

8 IAS 11 CONSTRUCTION CONTRACTS

8.1 Digger commenced a construction contract, X47, on 1 July 20X3 and details for the first year of the contract were as follows: $

Amounts invoiced 2,400 Costs to date of last certificate 1,800 Costs since last certificate 200 Amounts received 2,100 Total contract price 4,200 Estimated costs to complete 1,200 Work certified 2,625

The company invoices the customer immediately it receives a certificate of the value of the work done.

What should Digger include as cost of sales for the X47 contract for the year ended 30 June 20X4, assuming profit is calculated on a cost basis?. (To the nearest $)

A $1,938,000 B $1,971,000 C $1,875,000 D $2,000,000

SAMPLE



8.2 Augustus is involved in a number of construction contracts at 30 September 20X3. The company calculates profit on a sales basis.

At that date the following information is available with respect to contract ZX45.

$ Contract price 225 Costs incurred to date 115 Estimated further costs to completion 65 Work certified 125 Amounts invoiced 145 What amount should be included in the statement of financial position of Augustus in respect of contract ZX45 as at 30 September 20X3?

A Nil B $5,000 due to customer C $5,000 due from customer D $20,000 due to customer

8.3 B entered into a three-year contract to build a leisure centre for an entity. The contract value was $6 million. B recognises profit on the basis of certified work completed.

At the end of the first year, the following figures were extracted from B's accounting records:

$000 Certified value of work completed (progress payments billed) 2,000 Cost of work certified as complete 1,650 Cost of work-in-progress (not included in completed work) 550 Estimated cost of remaining work required to complete the contract 2,750 Progress payments billed and received from entity 1,600 Cash paid to suppliers for work on the contract 1,300 What values should B record for this contract as “gross amounts due from customers” and “current liabilities – trade and other payables”?

Gross amounts due from Current liabilities – trade and customers other payables A $950,000 $350,000 B $950,000 $900,000 C $1,250,000 $350,000 D $2,550,000 $900,000

8.4 C started work on a four-year contract on 24 October 20X1. C recognises profit on the basis of the certified percentage of work completed. The contract price is $10 million.

An analysis of C’s records provided the following information for the year to 30 September 20X3:

Percentage of work completed and certified in year 25% Total cost incurred during the year $1,700,000 Estimated cost of remaining work to complete contract $3,900,000 Total payments made for the cost incurred during the year $2,000,000 In the year ended 30 September 20X2 costs of $2,900,000 had been incurred, the contract was 30% complete and a profit of $330,000 had been recognised.

SAMPLE



How much profit should C recognise in its statement of profit or loss for the year ended 30 September 20X3?

A $330,000 B $375,000 C $495,000 D $825,000

8.5 Under what circumstances is it appropriate to immediately recognise a loss on a construction contract?

A After work has commenced on the contract B After 50% stage of completion of contract activity C When it is probable that total contract costs will exceed total contract revenues D All of the above

(10 marks)

9 IAS 16 PROPERTY, PLANT AND EQUIPMENT

9.1 On 1 January 20X1 a company purchased some plant. The invoice showed:

$ Cost of plant 48,000 Delivery to factory 400 One year warranty covering breakdown during 20X1 800 –––––– 49,200 ——— Modifications to the factory building costing $2,200 were necessary to enable the plant to be installed.

What amount should be capitalised for the plant in the company’s records in accordance with IAS 16 Property, Plant and Equipment?

A $48,000 B $48,400 C $50,600 D $51,400

9.2 At 31 December 2014 Cutie owned a building that had cost $800,000 on 1 January 2005. It was being depreciated at 2% per year.

On 31 December 2014 a revaluation to $1,000,000 was recognised. At this date the building had a remaining useful life of 40 years.

Which of the following pairs of figures correctly reflects the effects of the revaluation?

Depreciation charge for Revaluation surplus year ending 31 December 2015 as at 31 December 2014 $ $ A 25,000 200,000 B 25,000 360,000 C 20,000 200,000 D 20,000 360,000

SAMPLE



9.3 Which of the following statements are correct?

(1) All non-current assets must be depreciated.

(2) If goodwill is revalued, the revaluation surplus appears in the statement of changes in equity.

(3) If a tangible non-current asset is revalued, all tangible assets of the same class should be revalued.

(4) In a company’s published statement of financial position, tangible assets and intangible assets must be shown separately.


9.4 ABC has revalued its property for the first time this year. It is proposing a policy whereby depreciation based on the original historic cost is charged as an expense to profit or loss and the depreciation based on the revalued amount is charged directly to revaluation surplus, this policy is known as split depreciation.

Under IAS 16 Property, Plant and Equipment is this policy of split depreciation permitted?

A Yes, it is required B Yes, it is allowed but not required C Yes, it is allowed only in prescribed circumstances D No it is not allowed

9.5 Thames depreciates non-current assets at 20% per annum on a reducing balance basis. All non-current assets were purchased on 1 April 20X3. The carrying amount on 31 March 20X6 is $20,000.

What is the accumulated depreciation (to the nearest $000) as at that date?

A $15,000 B $19,000 C $30,000 D $39,000

9.6 The following information relates to the disposal of two machines by Halwell:

Machine 1 Machine 2 $ $

Cost 120,000 100,000 Selling price 90,000 40,000 Profit/(loss) on sale 30,000 (20,000)

What was the total accumulated depreciation on both machines sold?

A $80,000 B $100,000 C $120,000 D $140,000

SAMPLE



9.7 Lydd purchased production machinery costing $100,000, having an estimated useful life of twenty years and a residual value of $2,000. After being in use for six years the remaining useful life of the machinery is revised and estimated to be twenty-five years, with an unchanged residual value.

What is the annual depreciation charge on the machinery in year 7?

A $3,226 B $3,161 C $2,824 D $2,744

9.8 Upton makes up its financial statements to 31 December each year. On 1 January 20X0 it bought a machine with a useful life of 10 years for $200,000 and started to depreciate it at 15% per annum on the reducing balance basis. On 31 December 20X3 the accumulated depreciation was $95,600 and the carrying amount $104,400. During 20X4 the company changed the basis of depreciation to straight line.

What is the correct accounting treatment to be adopted in the financial statements of Upton for the year ended 31 December 20X4?

A Depreciation charge ($10,440) Prior period adjustment Nil B Depreciation charge ($17,400) Prior period adjustment Nil C Depreciation charge ($17,400) Prior period adjustment $15,600 D Depreciation charge ($20,000) Extraordinary item $15,600

9.9 Which ONE of the following items would CM recognise as subsequent expenditure on a non-current asset and capitalise it as required by IAS 16 Property, Plant and Equipment?

A When CM purchased a furnace five years ago, the furnace lining was separately identified in the accounting records. The furnace now requires relining at a cost of $200,000. Once relined the furnace will be usable for a further five years

B CM’s office building has been badly damaged by a fire. CM intends to restore the building to its original condition at a cost of $250,000

C CM’s delivery vehicle broke down. When it was inspected by the garage it was found to be in need of a new engine. The engine and associated labour costs are estimated to be $5,000

D CM closes its factory for two weeks every year. During this time, all plant and equipment has an annual maintenance check and any necessary repairs are carried out. The cost of the current year’s maintenance check and repairs was $75,000

(18 marks)

10 IAS 23 BORROWING COSTS

10.1 Under what conditions can an entity capitalise borrowing costs?

A The borrowing costs are incurred for purchases of inventory items

B The borrowing costs are directly attributable to the acquisition, construction, or production of a qualifying asset

C The borrowing costs are directly attributable to the acquisition, construction, or production of routinely manufactured assets

D The borrowing costs are incurred for purchases of property, plant and equipment

SAMPLE



10.2 Which of the following would qualify as a borrowing cost as defined in IAS 23 Borrowing Costs?

(1) Premium on redemption of preference share capital. (2) Discount on the issue of convertible debt. (3) Interest expense calculated using the effective interest rate. (4) Finance charges related to finance leases. A 1, 2 and 3 only B 2, 3 and 4 only C 1 and 4 only D All four

10.3 Borrowing costs from which category of borrowed funds may be capitalised (to the extent they are directly attributable to qualifying assets)?

A Funds borrowed specifically to construct a qualifying asset B Funds borrowed in advance of expenditure on qualifying assets C General borrowed funds used to finance a qualifying asset D All of the above

10.4 Which of the following is an example of an asset that would never qualify for capitalisation of borrowing costs under IAS 23 Borrowing Costs?

A Intangible assets B Financial assets C Manufacturing plants D Power generation facilities

10.5 Which qualitative characteristic is applied by IAS 23 Borrowing Costs to the capitalisation of borrowing costs?

A Consistency B Timeliness C Materiality D Understandability

10.6 QI in incurring expenditure on project 275 which meets the definition of a qualifying asset, in accordance with IAS 23 Borrowing Costs. The company has the following debt components:

(1) 6% $100,000 debt used specifically to finance project 274. (2) 7% $500,000 preference share capital. (3) 10% $80,000 short-term loan. (4) 4% $200,000 convertible debt.

What capitalisation rate would QI apply to expenditure incurred on project 275?

A 7% B 6.75% C 6.54% D 4%

(12 marks)

SAMPLE



11 GOVERNMENT GRANTS

11.1 Which of the following accounting policies for grants related to assets is allowed under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance?

(1) Deduct from the cost of related asset in the statement of financial position. (2) Include in liabilities in the statement of financial position. (3) Credit profit and loss immediately with cash received. A All three B 1 and 2 only C 1 and 3 only D 2 and 3 only

11.2 Under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, what is the correct term for a loan which the lender undertakes to waive repayment of under certain conditions?

A A forgivable loan B A non-payable loan C A non-recourse loan D A recourse loan

11.3 Under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, how are government grants related to depreciable assets treated in the profit or loss?

A The government grant is recognised over the period and in the proportions in which depreciation expense on those assets is recognised

B The government grant must be recognised in the year in which the depreciable asset is received and the following year only

C The government grant must be recognised over a period of five years

D The government grant must be recognised over a period of no more than 10 years

11.4 IAS 20 Accounting for Government Grants and Disclosure of Government Assistance defines government assistance as an action by government designed to provide an economic benefit specific to an entity qualifying under certain criteria.

Which of the following is an example of government assistance?

A Free technical or marketing advice B Provision of infrastructure by improvement to the general transportation network C Supply of improved facilities such as irrigation D A cash grant to buy a new item of plant

SAMPLE



11.5 Which of the following disclosures for government grants is required under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance?

(1) The accounting policy adopted for government grants.

(2) The nature and extent of government grants recognised in the financial statements.

(3) Unfulfilled conditions and other contingencies attached to government assistance that have been recognised.

A 1 only B 1 and 2 only C 1 and 3 only D 1, 2, and 3

11.6 On 1 January 20X1 Emex received a government grant of $100,000 to assist in the purchase of new machinery costing $1,000,000 with a useful life of five years. The grant is repayable on a sliding scale if the machine is sold within five year; that is the full amount if sold in the first year, 80% if sold in the second year and so on. The management of Emex intends to use the machine for five years.

The accounting policy is to offset the grant against the cost of the asset.

What will be the depreciation expense for the year ended 31 December 20X2 and what provision will be required for the repayment of the grant as at 31 December 20X2?

Depreciation charge Provision $000 $000 A 180 60 B 180 Nil C 200 60 D 200 Nil

(12 marks)

12 IAS 40 INVESTMENT PROPERTIES

12.1 What is the definition of an investment property according to IAS 40 Investment Property?

A An investment in land and or buildings whether let to third parties or occupied by an entity within the group

B A property owned and occupied by an entity for its own purposes

C A property which is held to earn rentals or for capital appreciation

D An investment in land and or buildings other than leased property

12.2 IAS 40 Investment Property gives examples of investment properties, which include some of the following:

(1) Property held for long-term capital appreciation (2) Property leased to another entity on a finance lease (3) Property leased out under one or more operating leases (4) Owner-occupied property (5) Land held for an undetermined future use (6) Property occupied by employees

SAMPLE



Which of the above are listed by IAS 40 as examples of an investment property?

A 1, 5 and 6 only B 1, 3 and 5 only C 2, 3 and 4 only D 2, 4 and 6 only

12.3 Which of the following qualifies as investment property under IAS 40 Investment Property?

A A building that is vacant but is held to be leased out under an operating lease B Property being constructed on behalf of third parties C Property that is leased to another entity under a finance lease D Owner-occupied property

12.4 Under IAS 40 Investment Property, which of the following transfers would result in a change from the cost measurement basis before transfer to the fair value measurement basis after transfer?

A A transfer from investment property to owner-occupied property

B A transfer from inventories to investment property at the commencement of an operating lease to another party

C A transfer from investment property to inventories, when the property is intended for sale

D None of the above

12.5 Under IAS 40 Investment Property, which of the following is correct?

A Investment property is property held for administrative purposes B Investment property is property held for use in the supply of services C Investment property is property held for use in the production of goods D Investment property is property held by owner to earn rental income or for capital

appreciation (10 marks)

13 IAS 38 INTANGIBLE ASSETS

13.1 Which one of the following could be classified as deferred development expenditure in M’s statement of financial position as at 31 March 20X1 according to IAS 38 Intangible Assets?

A $120,000 spent on developing a prototype and testing a new type of propulsion system for trains. The project needs further work on it as the propulsion system is currently not viable

B A payment of $50,000 to a local university’s engineering faculty to research new environmentally friendly building techniques

C $35,000 spent on consumer testing a new type of electric bicycle. The project is near completion and the product will probably be launched in the next twelve months. M is not yet certain that there is going to be a viable market for the finished product

D $65,000 spent on developing a special type of new packaging for a new energy efficient light bulb. The packaging is expected to be used by M for many years and is expected to reduce M’s distribution costs by $35,000 a year

SAMPLE



13.2 Which ONE of the following would most likely result in the recognition of an asset in KJH’s statement of financial position at 31 January 20X2?

A KJH spent $50,000 on an advertising campaign in January 20X2. KJH expects the advertising to generate additional sales of $100,000 over the period February to April 20X2

B KJH is taking legal action against a contractor for faulty work. Advice from its legal team is that it is probable that KJH may receive $250,000 in settlement of its claim within the next 12 months

C KJH purchased the copyright and film rights to the next book to be written by a famous author for $75,000 on 1 March 20X1. A first manuscript has already been received and advance orders suggest that the book will be a best seller

D KJH has developed a new brand name internally. The directors value the brand name at $150,000

13.3 IAS 38 Intangible Assets governs the accounting treatment of expenditure on research and

development.

Which of the following statements are correct?

(1) Capitalised development expenditure must be amortised over a period not exceeding five years.

(2) If all the conditions specified in IAS 38 are met, development expenditure may be capitalised if the directors decide to do so.

(3) Capitalised development costs are shown in the statement of financial position under the heading of Intangible Assets.

(4) Amortisation of capitalised development expenditure will appear as an item in a company’s statement of changes in equity.

A 1 and 3 only B 1 and 4 only C 2 and 3 only D 3 only

13.4 Which of the following is NOT an intangible asset?

A Patents B Development costs C Short leaseholds D Licences

13.5 Which of the following may be included in a company’s statement of financial position as an intangible asset under IAS 38 Intangible Assets?

A Payment on account of patents B Expenditure on completed research C Start-up costs D Internally-generated goodwill

SAMPLE



13.6 Henna was incorporated on 1 January 20X6. At 31 December 20X6 the following costs had been incurred:

$ (1) Legal fees incurred in establishing the entity 80,000 (2) Customer lists purchased from a company that has gone out of business 100,000 (3) Goodwill created by the company 80,000 (4) Patents purchased for valuable consideration 70,000 (5) Costs incurred by the company in developing patents 60,000 What is the total cost of intangible assets to be recognised in the statement of financial position of Henna at 31 December 20X6 in accordance with IAS 38 Intangible Assets?

A $310,000 B $250,000 C $230,000 D $170,000

13.7 Which of the following conditions would preclude any part of the development expenditure to which it relates from being capitalised?

A The development is incomplete

B The benefits flowing from the completed development are expected to be greater than its cost

C Funds are unlikely to be available to complete the development

D The development is expected to give rise to more than one product

13.8 Which of the following types of expenditure must be recognised as an expense when it is incurred?

A Tangible non-current assets acquired in order to provide facilities for research and development activities

B Legal costs in connection with registration of a patent

C Costs of searching for possible alternative products

D Costs of research work which are to be reimbursed by a customer

13.9 On 1 October 20X1 Hyena paid $500,000 deposit towards the cost of a laboratory for research and development. On 31 December 20X1, Hyena ’s financial year end, the laboratory had still not been completed.

Where should the payment of $500,000 appear in Hyena’s statement of financial position on 31 December 20X1?

A Development costs under intangible assets B Payments on account under intangible assets C Payments on account under tangible non-current assets D Payments on account under current assets

SAMPLE



13.10 RD ’s figures for research and development are as follows:

Research $267,000 Development expenditure in the year $215,000 Brought forward deferred development expenditure $305,000 Written off deferred expenditure in the year **

** To be calculated.

At 31 December 20X4 the balance carried forward for development expenditure was $375,000.

What amount will RD charge to profit or loss for research and development for 20X4?

A $267,000 B $412,000 C $482,000 D $787,000

(20 marks)

14 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

14.1 PQ has ceased operations overseas in the current accounting period. This resulted in the closure of a number of small retail outlets.

Which one of the following costs would be excluded from the loss on discontinued operations?

A Loss on the disposal of the retail outlets B Redundancy costs for overseas staff C Cost of restructuring head office as a result of closing the overseas operations D Trading losses of the overseas retail outlets up to the date of closure

14.2 BN has an asset that was classified as held for sale at 31 March 20X2. The asset had a carrying amount of $900 and a fair value of $800. The cost of disposal was estimated to be $50.

According to IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, which ONE of the following values should be used for the asset in BN’s statement of financial position as at 31 March 20X2?

A $750 B $800 C $850 D $900

14.3 During the year to 30 April 20X9 two companies carried out major re-organisations of their activities. The re-organisations were as follows:

Maynard closed down its manufacturing division on 1 January 20X9. This division accounted for 30% of Maynard’s revenue, Maynard will now focus all of their efforts on its retail division.

Grant purchased a group of companies in February 20X9. One of the subsidiaries within the group, Lytton, did not meet the profile required by Grant and therefore the intention of Grant is to sell this subsidiary as soon as possible, and no later than 30 September 20X9.

SAMPLE



Which of these re-organisations would be classified as discontinued operations for the year ended 30 April 20X9?

A Maynard B Lytton C Both Maynard and Lytton D Neither Maynard or Lytton

14.4 On 1 January 20X0 Beech purchased an asset for $500,000, the asset had a useful life of eight years and nil residual value.

On 1 July 20X3 the asset was classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinuing Activities. On that date the fair value less cost of disposing of the asset were assessed as $254,000.

What is the total expense should be recognised in respect of this asset in the statement of profit or loss for 20X3?

A $31,250 B $56,650 C $58,500 D $62,500

14.5 In order for an asset to be classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinuing Activities the sale of the asset must be highly probable.

Which TWO of the following are indicators that the sale of the asset is highly probable?

(1) The asset has been advertised for sale in a trade journal.

(2) A contract with a buyer has been signed.

(3) The market value of similar assets is $50,000 and management hopes to sell the asset for a profit of $30,000.

(4) Necessary repairs to the asset will be carried out when management has signed a contract for the sale.


(10 marks)

15 IAS 36 IMPAIRMENT OF ASSETS

15.1 The following information relates to three assets held by a company:

Asset A B C $000 $000 $000 Carrying amount 100 50 40 Fair value less costs of disposal 80 60 35 Value in use 90 70 30

SAMPLE



What is the total impairment loss?

A $Nil B $10,000 C $15,000 D $20,000

15.2 Dodgy has a property which is currently stated at a revalued carrying amount of $253,000.

Due to a slump in property prices the value of the property is currently only $180,000.

The historical cost carrying amount of the property is $207,000.

How should the above impairment in value be reflected in the financial statements in accordance with IAS 36 Impairment of Assets?

Profit or loss Other account Comprehensive Income A Dr $73,000 Cr $46,000 B Dr $27,000 Dr $46,000 C Dr $73,000 – D – Dr $73,000

15.3 Noddy has an item of equipment included in its statement of financial position at a carrying amount of $2,750. The asset had been revalued several years ago. If the asset had not been revalued its carrying amount would only have been $1,250.

An impairment review of the asset has been undertaken and it is estimated that the recoverable amount of the asset is only $1,000.

Noddy has not made any annual transfers from the revaluation surplus to retained earnings.

How much of the impairment loss should be charged to other comprehensive income in accordance with IAS 36 Impairment of Assets?

A $1,750 B $1,500 C $nil D $250

15.4 In 20X3 Angry revalued at $360,000 a plot of land which had been purchased in 20X1 for $300,000 and recognised a revaluation gain of $60,000.

In 20X4 Angry revalued to $130,000 a second plot of land which had been purchased for $100,000 in 20X2 and recognised a further revaluation gain of $30,000.

In 20X5 Angry wishes to write down the value of the first plot of land from $360,000 to $260,000 because of an impairment in its value due to changes in market prices.

There have been no other movements on the revaluation surplus.

SAMPLE



What amounts should be recognised in the financial statements for 20X5 for the impairment loss?

Profit or loss Other Comprehensive Income A $100,000 Nil B $40,000 $60,000 C $10,000 $90,000 D Nil $100,000

15.5 The following measures relate to a non-current asset:

(1) Carrying amount $20,000 (2) Net realisable value $18,000 (3) Value in use $22,000 (4) Replacement cost $50,000 What is the recoverable amount of the asset?

A $18,000 B $20,000 C $22,000 D $50,000

(10 marks)

16 IAS 17 LEASES

16.1 On 1 January 20X7 Melon bought a machine by way of a finance lease. The terms of the contract were as follows: $

Cash price 18,000 Deposit (6,000)

——— 12,000

Interest (9% for two years) 2,160 ———

Balance 14,160 ——— The balance is payable in two annual instalments commencing 31 December 20X7.

The rate of interest implicit in the contract is approximately 12%.

Applying the requirements of IAS 17 Leases what is the finance charge to profit or loss for the year ended 31 December 20X7?

A $1,080 B $1,440 C $1,620 D $2,160

SAMPLE



16.2 IAS 17 Leases requires a lessee to capitalise a finance lease at which of the following amounts?

A Fair value of the leased asset B Present value of the minimum lease payments C Lower of fair value of the leased asset and present value of the minimum lease payments D Lower of minimum lease payments and fair value of leased asset

16.3 Alpha enters into a lease with Omega of an aircraft which had a fair value of $240,000 at the inception of the lease. The terms of the lease require Alpha to pay 10 annual rentals of $36,000 in arrears. Alpha is totally responsible for the maintenance of the aircraft which has a useful life of approximately fifteen years.

The present value of the 10 annual rentals of $36,000 discounted at the interest rate implicit in the lease is $220,000.

Applying the requirements of IAS 17 Leases to this lease what is the increase in Alpha’s non-current assets?

A Nil B $220,000 C $240,000 D $360,000

16.4 Acor is planning to acquire a new machine, which would cost $1,750,000. The acquisition will be financed through a finance lease agreement, which has an implicit interest rate of 13% per annum. The lease is for four years and Acor is required to make four annual payments of $520,000, with the first payment due on commencement of the lease agreement.

There is uncertainty regarding title of the asset at the end of the lease period.

Acor’s usual policy is to depreciate similar machinery over five years on the straight line basis.

What is the correct total charge to profit or loss for the first year of the lease?

A $509,900 B $577,500 C $597,400 D $665,000

16.5 Z entered into a finance lease agreement on 1 November 20X2. The lease was for five years, the fair value of the asset acquired was $45,000 and the interest rate implicit in the lease was 7%. The annual payment was $10,975 in arrears.

What is the total amount owing under the lease at 31 October 20X4?

A $27,212 B $28,802 C $29,350 D $40,108

(10 marks)

SAMPLE



17 IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

17.1 TY is the main contractor employing sub-contractors to assist it when required.

TY has recently completed a contract replacing a roof on the local school. Despite this, the roof has been leaking and some sections are now unsafe. The school is suing TY for $20,000 to repair the roof.

TY used a sub-contractor to install the roof and regards the sub-contractor’s work as faulty. TY has raised a court action against the sub-contractor claiming the cost of the school’s action plus legal fees, a total of $22,000.

TY has been informed by legal advisers that it will probably lose the case brought against it by the school and will probably win the case against the sub-contractor.

How should these items be treated in TY’s financial statements?

A A provision should be made for the $20,000 liability and the case against the sub- contractor ignored

B A provision should be made for the $20,000 liability and the probable receipt of cash from the case against the sub-contractor disclosed as a note

C No provisions should be made but the $20,000 liability should be disclosed as a note

D A provision should be made for the $20,000 liability and the probable receipt of cash from the case against the sub-contractor recognised as a current asset

17.2 MN obtained a government licence to operate a mine from 1 April 20X1. The licence

requires that at the end of the mine’s useful life, all buildings must be removed from the site and the site landscaped. MN estimates that the cost of this decommissioning work will be $1,000,000 in 10 years’ time using a discount factor of 8%, a 10 year discount factor at 8% is 0.463.

According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets how much should MN include in provisions in its statement of financial position as at 31 March 20X2?

A $100,000 B $463,000 C $500,000 D $1,000,000

17.3 Which of the following statements about provisions, contingencies and events after the reporting period is correct?

A A company expecting future operating losses should make provision for those losses as soon as it becomes probable that they will be incurred

B Details of all adjusting events after the reporting period must be disclosed by note in a company’s financial statements

C A contingent asset must be recognised as an asset in the statement of financial position if it is probable that it will arise

D Contingent liabilities must be treated as actual liabilities and provided for when it is probable that they will arise, if they can be measured with reliability

SAMPLE



17.4 Which of the following statements about contingent assets and contingent liabilities is true?

(1) A contingent asset should be disclosed by note if an inflow of economic benefits is probable.

(2) A contingent liability should be disclosed by note if it is probable that a transfer of economic benefits to settle it will be required, with no provision being made.

(3) No disclosure is required for a contingent liability if it is less than probable that a transfer of economic benefits to settle it will be required.

A 1 only B 2 only C 3 only D None of these statements

17.5 IAS 37 Provisions, Contingent Liabilities and Contingent Assets deals with accounting for contingencies. An entity has a present obligation that probably requires the outflow of economic resources and a contingent asset where the inflow of economic benefits is probable.

How should the entity treat the present obligation and contingent asset?

Present obligation Contingent asset A Provided for Disclosed B Provided for Not disclosed C Disclosed, but not provided for Disclosed D Disclosed, but not provided for Not disclosed

17.6 The following describe potential provisions.

(1) A provision to cover refunds. The company is in the retail sector and has a reputation for a “no questions asked” policy on refunds.

(2) A provision to cover an onerous contract on an operating lease. The lease was on a building which the company has subsequently vacated. The lease cannot be terminated and cannot be re-let.

In accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets in which of the above situations would a company be allowed to recognise a provision in its financial statements?

A Neither situation B Both situations C Situation 1 only D Situation 2 only

17.7 Porter is finalising its financial statements for the year ended 30 September 20X3.

A former employee of Porter has initiated legal action for damages against the company after being summarily dismissed in October 20X3. Porter ’s legal advisors feel that the employee will probably win the case and have given the company a reasonably accurate estimate of the damages which would be awarded. Porter has not decided whether to contest the case.

SAMPLE



How should this item be classified in the financial statements of Porter for the year ended 30 September 20X3?

A A non-adjusting event B An adjusting event C A contingent liability disclosed by way of note D A provision

17.8 Which ONE of the following would require a provision to be created by BW at its reporting date of 31 October 20X5?

A The government introduced new laws on data protection which come into force on 1 January 20X6. BW’s directors have agreed that this will require a large number of staff to be retrained. At 31 October 20X5, the directors were waiting on a report they had commissioned that would identify the actual training requirements

B At the reporting date, BW is negotiating with its insurance provider about the amount of an insurance claim that it had filed. On 20 November 20X5, the insurance provider agreed to pay $200,000

C BW makes refunds to customers for any goods returned within 30 days of sale, and has done so for many years

D A customer is suing BW for damages alleged to have been caused by BW’s product. BW is contesting the claim and, at 31 October 20X5, the directors have been advised by BW’s legal advisers it is very unlikely to lose the case

(16 marks)

18 IAS 10 EVENTS AFTER THE REPORTING PERIOD

18.1 WDC’s year end is 30 September 20X1.

Which ONE of the following should be classified by WDC as a non-adjusting event according to IAS 10 Events After The Reporting Period?

A WDC was notified on 5 November 20X1 that one of its customers was insolvent and was unlikely to repay any of its debts. The balance outstanding at 30 September 20X1 was $42,000

B On 30 September WDC had an outstanding court action against it. WDC had made a provision in its financial statements for the year ended 30 September 20X1 for damages awarded against it of $22,000. On 29 October 20X1 the court awarded damages of $18,000

C On 5 October 20X1 a serious fire occurred in WDC’s main production centre and severely damaged the production facility

D The year end inventory balance included $50,000 of goods from a discontinued product line. On 1 November 20X1 these goods were sold for a net total of $20,000

SAMPLE



18.2 IAS 10 Events After the Reporting Period distinguishes between adjusting and non-adjusting events.

Which ONE of the following gives rise to an adjusting event?

A A dispute with workers caused all production to cease six weeks after the year end

B A month after the year end the directors decided to cease production of one of three product lines and to close the production facility

C One month after the year end a court awarded damages of $50,000 to one of the reporting entity’s customers. The entity had expected to lose the case and made a provision of $30,000 at the year end

D Three weeks after the year end a fire destroyed the reporting entity’s main warehouse facility and most of its inventory

18.3 The draft financial statements of a limited liability company are under consideration. The

accounting treatment of the following material events after the reporting period needs to be determined:

(1) The bankruptcy of a major customer, with a substantial debt outstanding at the end of the reporting period.

(2) A fire destroying some of the company’s inventory (the company’s going concern status is not affected).

(3) An issue of shares to finance expansion.

(4) Sale for less than cost of some inventory held at the end of the reporting period.

According to IAS 10 Events After the Reporting Period, which of the above events require an adjustment to the figures in the draft financial statements?

A 1 and 4 only B 1, 2 and 3 only C 2 and 3 only D 2 and 4 only

18.4 Which of the following events between the end of the reporting period and the date the financial statements are authorised for issue must be adjusted in the financial statements?

(1) Declaration of equity dividends. (2) Decline in market value of investments. (3) The announcement of changes in tax rates. (4) The announcement of a major restructuring. A 1 and 2 only B 2 and 4 only C 3 and 4 only D None of them

18.5 Which of the following events occurring after the year end is classified as a non-adjusting event in accordance with IAS 10 Events After the Reporting Period?

A A property valuation which provides evidence of a permanent diminution in value B The renegotiation of amounts owing by credit customers C The determination of the amount of bonus payments to be made to employees D Government announcing a change in tax rates

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18.6 The financial statements of an entity for the year ended 31 March 20X4 were approved by the directors on 31 August 20X4.

Which of the following would be classified as an adjusting event in accordance with IAS 10 Events after the Reporting Period/

A A reorganisation of the entity proposed by a director on 31 January 20X4 was agreed by the Board on 10 July 20X4

B A strike by the workforce which started on 1 May 20X4 stopped all production for 10 weeks before working terms and conditions were settled

C An insurance claim for damage caused by a fire in a warehouse on 1 January 20X4 for $2.5 million was settled with a receipt of $1.5 million on 1 June 20X4

D On 3 September 20X4 the entity sold some inventory for $100,000 which had a carrying amount at 31 March 20X4 of $122,000

(12 marks)

19 IAS 12 INCOME TAXES

19.1 At 1 October 20X1 DX had the following balances in respect of property, plant and equipment:

$ Cost $220,000 Tax written down value $82,500 Statement of financial position: Carrying amount $132,000

DX depreciates all property, plant and equipment over five years using the straight line method and no residual value. All assets were less than five years old at 1 October 20X1. No assets were purchased or sold during the year ended 30 September 20X2.

The local tax regime allows tax depreciation of 50% on additions to property, plant and equipment in the accounting period in which they are purchased. In subsequent accounting periods tax depreciation of 25% per year of the tax written down value is allowed. Income tax on profits is at a rate of 25%.

What should be the amount for deferred tax in DX’s statement of financial position as at 30 September 20X2 in accordance with IAS 12 Income Taxes?

A $5,843 B $6,531 C $12,375 D $23,375

19.2 DF purchased its only item of plant on 1 October 20X1 for $200,000. DF charges depreciation on a straight line basis over five years.

Tax depreciation is allowed as follows:

50% of additions to property, plant and equipment in the accounting period in which they are recorded;

25% per year of the written down value in subsequent accounting periods except that in which the asset is disposed of;

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Income tax on profits is at a rate of 25%.

What would be the amount for deferred tax in DM’s statement of financial position as at 30 September 20X3, in accordance with IAS 12 Income Taxes?

A $3,750 B $11,250 C $18,750 D $45,000

19.3 The following information relating to taxation appears in the records of Stapley.

$ Balance on income tax account on 1 January 20X2 187,500 Income tax paid in 20X2 in full settlement for the year ended 31 December 20X1 194,300 Estimated income tax for the year ended 31 December 20X2 137,600 What will the corporation tax liability be in Stapley’s statement of financial position on 31 December 20X2?

A $194,300 B $144,400 C $137,600 D $130,800

19.4 DZ recognised a tax liability of $290,000 in its financial statements for the year ended 30 September 20X5. This was subsequently agreed with and paid to the tax authorities as $280,000 on 1 March 20X6. The directors of DZ estimate that the tax due on the profits for the year to 30 September 20X6 will be $320,000. DZ has no deferred tax liability.

What is DZ’s profit or loss tax charge for the year ended 30 September 20X6?

A $310,000 B $320,000 C $330,000 D $600,000

19.5 At 30 April 20X3 the non-current assets of Shades have a carrying amount of $365,700 and a

tax written down value of $220,000. The balance brought forward on the deferred tax account at 1 May 20X2 was $33,000. The tax rate is 25%.

What is the balance on the deferred tax account at 30 April 20X3?

A $33,000 B $36,425 C $55,000 D $91,425

19.6 At 30 April 20X6, the carrying amount of the non-current assets of Bahno was $80,000 greater than the tax written down value, and the balance brought forward on the deferred tax account was $24,800. The company accountant calculated that the corporation tax charge on the reported profit for the year to 30 April 20X6 would be $53,960, based on the tax rate of 24%.

SAMPLE



What is the total charge for taxation in the statement of profit and loss for the year to 30 April 20X6?

A $48,360 B $59,560 C $73,160 D $78,760

(12 marks)

20 FINANCIAL INSTRUMENTS

20.1 TS purchased 100,000 of its own equity shares in the market and classified them as treasury shares. At the end of the accounting period TS still held the treasury shares.

Which ONE of the following is the correct presentation of the treasury shares in TS’s closing statement of financial position in accordance with IAS 32 Financial Instruments: Presentation?

A As a current asset investment B As a non-current liability C As a non-current asset D As a deduction from equity

20.2 IAS 32 Financial Instruments: Presentation classifies issued shares as either equity instruments or financial liabilities. An entity has the following categories of funding on its statement of financial position:

(1) A preference share that is redeemable for cash at a 10% premium on 30 May 20X5.

(2) An ordinary share which is not redeemable and has no restrictions on receiving dividends.

(3) A loan note that is redeemable at par in 2020.

(4) An irredeemable loan note that pays interest at 7% a year.

Applying IAS 32, how would each of the above be categorised in the statement of financial position?

As an equity As a financial instrument liability A 1 and 2 only 3 and 4 only B 2 and 3 only 1 and 4 only C 2 only 1, 3 and 4 only D 1, 2 and 3 only 4 only

20.3 How should convertible debt be classified in accordance with IAS 32 Financial Instruments: Presentation?

A As either a liability or equity based on an evaluation of the substance of the contractual arrangement

B As separate liability and equity components , basing the liability element on the present value of future cash flows

C As equity in its entirety, on the presumption that all options to convert the debt into equity will be exercised in the future

D As a liability in its entirety, until it is converted into equity

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20.4 How should the proceeds from issuing a compound instrument be allocated between liability and equity components in accordance with IAS 32 Financial Instruments: Presentation?

A The liability component is measured at fair value and the remainder is allocated to the equity component

B The equity component is measured at fair value and the remainder is allocated to the liability component

C The fair values of both the components are estimated and the proceeds allocated proportionately

D The equity component is measured at its intrinsic value and the remainder is allocated to the liability component

20.5 In the current financial year, Natamo has raised a loan for $3m. The loan is repayable in 10 equal half-yearly instalments. The first instalment is due six months after the loan was raised.

How should the loan be reported in Natamo’s next financial statements?

A As a current liability B As a non-current liability C As equity D As both a current and a non-current liability

20.6 On 1 January 20X2 LMN issued $2,000,000 8% convertible debt at par. The debt is repayable, or convertible, at a premium of 10% four years after issue. The effective interest rate for the debt is 14%. The present values $1 receivable at the end of each year, based on discount rates of 8%, 10% and 14% are: 8% 10% 14% End of year 1 0.926 0.909 0.877 2 0.857 0.826 0.769 3 0.794 0.751 0.675 4 0.735 0.683 0.592

What is the finance charge to LMN’s profit or loss for the year ended 31 December 20X3?

A $160,000 B $248,000 C $260,000 D $274,000

20.7 On 1 March 20X2 PQR purchased a debt instrument from the market for $105,000, the par value of the instrument was $100,000. At 31 December 20X2 the fair value of the instrument is $112,000 and the amortised cost has been calculated to be $104,000.

PQR does not hold this type of asset for contractual cash flows.

At what amount should the investment be included in PQR’s statement of financial position as at 31 December 20X2?

A $100,000 B $104,000 C $105,000 D $112,000

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20.8 On 1 January 20X2 XYZ issued $1,000,000 4% convertible loan notes, at a discount of 95. The loan notes are redeemable in five years at a premium of 10%.

What are the total finance costs that should be charged to profit or loss over the five-year term of the convertible loan notes?

A $350,000 B $345,000 C $250,000 D $200,000

20.9 In accordance with IFRS 9 Financial Instruments, under what circumstances, can an entity classify financial assets that meet the amortised cost criteria as at fair value through profit or loss?

A Where the instrument is held to maturity B If doing so eliminates an accounting mismatch C Where the financial asset passes the contractual cash flow characteristics test D Where the business model approach is adopted

(18 marks)

21 REGULATORY FRAMEWORK

21.1 Harwich holds 70,000 $1 “B” shares in Sall. These shares carry one vote each.

Felixstowe holds 18,000 $1 “A” shares in Sall. These shares carry 10 votes each.

The share capital of Sall is made up of the following: $ 100,000 “B” shares of $1 each 100,000 20,000 “A” shares of $1 each 20,000 ———— 120,000 ————

Of which of the following reporting entities is Sall a subsidiary undertaking?

A Both Harwich and Felixstowe B Harwich C Felixstowe D Neither Harwich nor Felixstowe

21.2 Sam has a share capital of $10,000 split into 2,000 A ordinary shares of $1 each and 8,000 B ordinary shares of $1 each. Each A ordinary share has 10 votes and each B ordinary share has one vote. Both classes of shares have the same rights to dividends and on liquidations. Tom owns 1,500 A ordinary shares in Sam. Dick owns 6,000 B ordinary shares in Sam.

All three companies conduct similar activities and there is no special relationship between the companies other than that already stated. The shareholdings in Sam are held as long-term investments and are the only shareholdings of Tom and Dick.

Which companies must prepare consolidated financial statements?

A Neither Tom nor Dick B Tom only C Dick only D Both Tom and Dick

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Answer 1 STANDARD SETTING PROCESS

(a) IASB’s Standard Setting Process

The IASB is ultimately responsible for setting International Financial Reporting Standards (IFRS). The Board (advised by the Advisory Council) identifies a subject and appoints an Advisory Committee to advise on the issues relevant to the given topic. Depending on the complexity and importance of the subject matter the IASB may develop and publish Discussion Papers for public comment. Following the receipt and review of comments the IASB then develops and publishes an Exposure Draft for public comment. The usual comment period for both of these is between 90 and 120 days. Finally, and again after a review of any further comments, an IFRS is issued. The IASB also publishes a Basis for Conclusions which explains how it reached its conclusions and gives information to help users to apply the Standard in practice. In addition to the above the IASB will sometimes conduct public hearings where proposed standards are openly discussed and occasionally field tests are conducted to ensure that proposals are practical and workable around the world.

The authority of IFRS is a rather difficult area. The IASB has no power to enforce IFRS within those countries/entities that choose to adopt them. This means that enforcement is in the hands of the regulatory systems of the individual adopting countries. There is no doubt the regulatory systems in different parts of the world differ from each other considerably in their effectiveness. For example in the UK the Financial Reporting Review Panel (FRRP) was a body that investigated departures from the UK’s regulatory system (which requires the use of IFRS for listed companies). The FRRP had wide and effective powers of enforcement, these powers have now been subsumed into other UK bodies. However, not all countries have equivalent bodies, thus it can be argued that IFRS is not enforced in a consistent manner throughout the world. Complementary to IFRSs, there also exist International Auditing Standards (ISAs) and part of the rigour and transparency that the use of IFRSs brings is that those companies adopting IFRS are also likely to be audited in accordance with ISAs. (This auditing aspect is part of IOSCO’s requirements for financial statements to be used for cross-border listing purposes.)

Where it becomes apparent (often through press reports) that there is widespread inconsistency in the interpretation of an IFRS, or where it is perceived that a standard is not clear enough in a particular area, the IFRS Interpretation Committee (IFRS IC) may act to remedy the issue by issuing an Interpretation. This adds to the body of pronouncements and will usually (eventually) be incorporated on revision of the relevant IFRS. However, where it becomes apparent (perhaps through a modified audit report) that a company has departed from IFRSs there is little that the IASB can do directly to enforce their application.

All new standards are now reviewed after a two-year period, to ensure that the standard is fulfilling its stated objective and that there are no undue concerns in the application of the standard. An annual improvements cycle looks at making minor improvements relating to all standards.

(b) Success of the process

Any measure of success is really a matter of opinion. There is no doubt that the growing acceptance of IFRSs through IOSCO’s endorsement, the European Union requirement for their use by listed companies and the ever increasing number of countries that are either adopting IFRS outright or basing their domestic standards very closely on IFRSs is a measure of the success of the IASB. Equally there is widespread recognition that in recent years the quality of IFRS has improved enormously due to the improvements project and subsequent continuing improvements.

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However the IASB is not without criticism. Some countries that have developed sophisticated regulatory systems feel that IFRSs are not as rigorous as the local standards and this may give cross-border listing companies an advantage over domestic companies. Some requirements of IFRS are regarded as quite controversial (e.g. deferred tax (in IAS 12) and financial instruments). Many IFRSs are complex and the benefits of applying them to smaller entities may be outweighed by the costs. The IASB has therefore issued a standard on financial reporting issues for small and medium sized entities. Also some securities exchanges that are part of IOSCO require non-domestic companies that are listing by filing financial statements prepared under IFRSs to produce a reconciliation to local GAAP. This involves reconciling the IFRS statement of profit or loss and other comprehensive income and statement of financial position, to what they would be if local GAAP had been used (e.g. in the US). Critics argue that this requirement negates many of the benefits of being able to use a single set of financial statements to list on different security exchanges. This is because to produce reconciliation to local GAAP is almost as much work and expense as preparing financial statements in the local GAAP which was usually the previous requirement.

Despite these criticisms there is no doubt that the work of IASB has already led, and in the future will lead, to further improvement in financial reporting throughout the world.

Answer 2 PERIOD OF INFLATION

(a) Inventories undervalued

Inventory is stated at historical cost (or net realisable value if lower). Historical cost is normally below the current value in times of general inflation.

The major weakness of historical cost is the effect of charging the historical cost of inventory against sales. Cost of sales will be lower than if current values had been charged, leading to higher profits and higher dividend payments. There may be insufficient funds to purchase replacement inventory, the price of which will equate to current value of inventory.

(b) Depreciation understated

Depreciation is usually based on the historical cost of non-current assets. Replacements will normally increase in price during a period of inflation. The annual depreciation charge, therefore, may not reflect the amount needed to be able to replace the assets. Consequently, the accounting profit will be overstated, and this may mean that too much profit is withdrawn from the business. The cash resources may then prove insufficient to replace the assets at the end of their useful life and the business may not be able to operate at the same level of activity as it has previously experienced.

(c) Gains and losses on net monetary assets undisclosed

Net monetary assets are monetary assets less monetary liabilities. The term “monetary” refers to all liabilities of a business repayable in money and those assets which are stated in historical cost accounts at the amount of money expected to be received (e.g. receivables are stated at sales value less allowances for irrecoverable debts).

In a time of inflation gains can arise on monetary liabilities and losses on monetary assets. For example, loans to or from a company are monetary items. A loan made to a company may produce a gain to the company as, although the amount originally borrowed will be repaid at its face value, its purchasing power will have been reduced.

The person lending the money to the company will have charged interest to cover:

(i) the risk of making the loan; and (ii) compensation for the fall in the purchasing power of the investment.

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The interest cost will thus be charged against profits of the company, but also there should be a “gain” recorded in the statement of profit or loss (that of eventually having to repay only the same monetary amount).

(d) Asset values unrealistic

Values for inventory and non-current assets are stated at historical cost (i.e. below their current value). Many would argue that a statement of financial position should record not only the assets in the possession of a company at the end of the reporting period but also their current worth. To show the amount at which the company originally bought the asset is not useful information and would never be used for decision-making purposes.

(e) Difficulty of meaningful periodic comparisons

A meaningful comparison of financial reports prepared under historical cost accounting over several accounting periods may be misleading.

Many figures disclosed in accounts are not comparable. For example, profits of $100,000 in 2008 are not equivalent to profits of $100,000 in 2013 if there has been inflation between the two dates. The worth of the 2013 profits is less than the worth of the 2008 profits. The comparison is just as meaningless as comparing financial reports prepared in Japanese yen with reports prepared in euros.

In order to be able to make a meaningful comparison between financial reports prepared in different time periods, it is desirable therefore to translate them into the same currency (i.e. to use units of a constant purchasing power). The adjustments are similar in principle to that used in translating dollars into euros or euros into dollars. Figures are often adjusted for changes in a price index to achieve a measure of constant purchasing power. In many countries, government departments issue indices in accordance with which companies must adjust their financial statements, particularly where there is high inflation.

Answer 3 REBOUND

(a) Conceptual Framework and Relevance

Two important and inter-related aspects of relevance are its confirmatory and predictive roles. The Framework specifically states that to have predictive value, information need not be in the form of an explicit forecast. The serious drawback of forecast information is that it does not have (strong) confirmatory value; essentially it will be an educated guess.

IFRS examples of enhancing the predictive value of historical financial statements are:

The disclosure of continuing and discontinued operations. This allows users to focus on those areas of an entity’s operations that will generate its future results. Alternatively it could be thought of as identifying those operations which will not yield profits or, perhaps more importantly, losses in the future.

The separate disclosure of non-current assets held for sale. This informs users that these assets do not form part of an entity’s long-term operating assets.

The separate disclosure of material items of income or expense (e.g. a gain on the disposal of a property). These are often “one off” items that may not be repeated in future periods. They are sometimes called “exceptional” items or described in the Framework as “unusual, abnormal and infrequent” items.

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The presentation of comparative information (and the requirement for the consistency of its presentation such as retrospective application of changes in accounting policies) allows for a degree of trend analysis. Recent trends may help predict future performance.

The requirement to disclose diluted earnings per share (EPS) is often described as a “warning” to shareholders of what EPS would have been if any potential (future) equity shares such as convertibles and options had already been exercised.

The Framework’s definitions of assets (resources from which future economic benefits should flow) and liabilities (obligations which will result in a future outflow of economic benefits) are based on an entity’s future prospects rather than its past costs.

Tutorial note: Other relevant examples would be given credit.

(b) Calculations

(i) Estimated profit after tax for the year ending 31 March 2015

$000 Existing operations (continuing only) ($2 million × 1·06) 2,120 Newly acquired operations ($450,000 × 12/8 months × 1·08) 729 ––––– 2,849 –––––

Tutorial note: The profit from newly acquired operations in 2014 was for only eight months; in 2015 it will be for a full year.

(ii) Diluted EPS on continuing operations

2014 Comparative 2013

(W2) 14,600,000

(W1) $2,730,000 × 100 18·7 cents

(W2) 14,000,000

(W1) $2,030,000× 100 14·5 cents

WORKINGS (figures in brackets are in 000 or $000)

(1) Earnings 2014 Comparative 2013 $000 $000 Continuing operations: Existing operations 2,000 1,750 Newly acquired operations 450 nil Convertible loan stock (W3) 280 280 ––––– ––––– 2,730 2,030 ––––– –––––

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(2) Weighted average number of shares (000)

At 1 April 2012 (3,000 × 4 (i.e. shares of 25 cents each)) 12,000 12,000 Convertible loan stock (W3) 2,000 2,000 Share options (W4) 600 (six months) nil –––––– –––––– 14,600 14,000 –––––– –––––– (3) Convertible loan stock

On an assumed conversion there would be an increase in income of $280,000 ($5,000 × 8% × 0·7 after tax).

There would be an increase in the number of shares of 2 million ($5,000/$100 × 40)

These adjustments would apply fully to both years.

(4) Share options

Exercising the options would create proceeds of $2 million (2,000 × $1). At the market price of $2·50 each this would buy 800,000 shares ($2,000/$2·50) thus the diluting number of shares is 1·2 million (2,000 – 800).

This would be weighted for 6/12 in 2014 as the grant was half way through the year.

Answer 3 WARDLE

(a) Underlying substance and legal form

The two fundamental qualitative characteristics of useful information are faithful representation and relevance. Faithful representation means that financial information represents the substance of an economic phenomenon rather than merely representing its legal form. Representing a legal form that differs from the economic substance of the underlying economic phenomenon could not result in a faithful representation. For example, if an entity “sold” an asset to a third party, but continued to enjoy the future benefits embodied in that asset, then this transaction would not be represented faithfully by recording it as a sale (in all probability this would be a financing transaction).

Particular attention needs to be given to underlying substance and economic reality and not merely legal form in assessing whether an item meets the definition of an asset, liability or equity. Taking the previous example, recognition of a sale would result in failure to recognised an asset.

Indications that substance and economic reality may differ from legal form:

control of an asset differs from the ownership of the asset; assets are “sold” at prices that are greater or less than their fair values; options are provided for under the terms of a contractual agreement; a series of transactions are “linked”; a “sale” to a financial institution is not a normal transaction for this type of

institution.

Tutorial note: None of these necessarily mean there is a difference.

SAMPLE



(b) Profit or loss (Extracts)

(i) Reflecting legal form

Year ended 31 March 31 March 31 March Total 2014 2015 2016 $000 $000 $000 $000 Revenue 6,000 nil 10,000 16,000 Cost of sales (5,000) nil (7,986) (12,986) ––––––– ––––––– ––––––– ––––––– Gross profit 1,000 nil 2,014 3,014 Finance costs nil nil nil nil ––––––– ––––––– ––––––– ––––––– Profit for the year 1,000 nil 2,014 3,014 ––––––– ––––––– ––––––– ––––––– (ii) Reflecting underlying substance

Year ended 31 March 31 March 31 March Total 2014 2015 2016 $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 5,000 Finance costs (600) (660) (726) (1,986) ––––––– ––––––– ––––––– ––––––– Profit for the year (600) (660) 4,274 3,014 ––––––– ––––––– ––––––– –––––––

(c) Effect on financial statements

It can be seen from the above that the two treatments have no effect on the overall profit for the year reported in the statements of profit or loss, however, the profit is reported in different periods and the classification of costs is different. In effect the legal form creates some element of profit smoothing and completely hides the financing cost. Although not shown, the effect on the statements of financial position is that recording the legal form of the transaction does not show the inventory, nor does it show what is, in substance, a loan. Thus recording the legal form would be an example of off balance sheet (statement of financial position) financing. The effect of this on an assessment of Wardle using ratio analysis would be that interest cover and inventory turnover would be higher and gearing lower. All of which may be considered as reporting a more favourable performance.

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Answer 5 DEXON

(a) Redraft profit or loss for the year

$000 $000 Retained profit for period per question 96,700 Dividends paid (W1) 15,500 ––––––– Draft profit for year ended 31 March 2014 112,200 Discovery of fraud (W2) (2,500) Goods on sale or return (W3) (600) Depreciation (W4) – buildings (165,000/15 years) 11,000 – plant (180,500 × 20%) 36,100 (47,100) ––––––– Increase in investments ((12,500 × 1,296/1,200) – 12,500) 1,000 Provision for income tax (11,400) Increase in deferred tax (W5) (800) ––––––– Recalculated profit for year ended 31 March 2014 50,800 –––––––

(b) Statement of changes in equity for the year ended 31 March 2014

Ordinary Share Revaluation Retained Total shares premium reserve earnings $000 $000 $000 $000 $000 At 1 April 2013 200,000 30,000 18,000 12,300 260,300 Prior period adjustment (W2) (1,500) (1,500) –––––– Restated earnings at 1 April 2013 10,800 Rights issue (see below) 50,000 10,000 60,000 Total comprehensive income (from (a) and (W4) 4,800 50,800 55,600 Dividends paid (W1) (15,500) (15,500) –––––– –––––– –––––– –––––– –––––– At 31 March 2014 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 would mean that 50 million shares were issued (250,000 × 1/5). As the issue price was $1·20, this would create $50 million of share capital and $10 million of share premium.

WORKINGS (figures in brackets in $000)

(1) Dividends paid

The dividend in May 2013 would be $8 million (200 million shares at 4 cents) and in November 2013 would be $7·5 million (250 million shares × 3 cents). Total dividends would therefore have been $15·5 million.

(2) Fraud

The discovery of the fraud means that $4 million should be written off trade receivables. $1·5 million debited to retained earnings as a prior period adjustment (in the statement of changes in equity) and $2·5 written off in the profit or loss for the year ended 31 March 2014.

SAMPLE



(3) Goods on sale or return

The sales over which customers still have the right of return should not be included in Dexon’s recognised revenue. The reversing effect is to reduce the relevant trade receivables by $2·6 million, increase inventory by $2 million (the cost of the goods (2,600 × 100/130)) and reduce the profit for the year by $600,000.

(4) Property

The carrying amount of the property (after the year’s depreciation) is $174 million (185,000 – 11,000). A valuation of $180 million would create a revaluation surplus of $6 million of which $1·2 million (6,000 × 20%) would be transferred to deferred tax.

(5) Deferred tax

An increase in the taxable temporary differences of $10 million would create a transfer (credit) to deferred tax of $2 million (10,000 × 20%). Of this $1·2 million relates to the revaluation of the property and is debited to the revaluation reserve. The balance, $800,000, is charged to profit or loss.

Answer 6 PRICEWELL

(a) Statement of profit or loss for the year ended 31 March 2014

$000 Revenue (310,000 + 22,000 (W1) – 6,400 (W2)) 325,600 Cost of sales (W3) (255,100) ––––––– Gross profit 70,500 Distribution costs (19,500) Administrative expenses (27,500) Finance costs (4,160 (W5) + 1,248 (W6)) (5,408) ––––––– Profit before tax 18,092 Income tax expense (4,500 +700 – (8,400 – 5,600 deferred tax) (2,400) ––––––– Profit for the year 15,692 –––––––

SAMPLE



(b) Statement of financial position as at 31 March 2014

Assets $000 $000 Non-current assets Property, plant and equipment (24,900 + 41,500 (W4)) 66,400 Current assets Inventory 28,200 Amount due from customer (W1) 17,100 Trade receivables 33,100 Bank 5,500 83,900 ––––––– ––––––– Total assets 150,300 ––––––– Equity and liabilities: Equity shares of 50 cents each 40,000 Retained earnings (4,900 + 15,692 per (a) – 8,000) 12,592 ––––––– 52,592 Non-current liabilities Deferred tax 5,600 Finance lease obligation (W6) 5,716 6% Redeemable preference shares (41,600 + 1,760 (W5)) 43,360 54,676 ––––––– Current liabilities Trade payables 33,400 Finance lease obligation (10,848 – 5,716) (W6)) 5,132 Current tax payable 4,500 43,032 ––––––– ––––––– Total equity and liabilities 150,300 –––––––


(1) Construction contract

Selling price 50,000 Estimated cost: To 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 22,000 Cost of sales (= balance) (13,200) –––––– Profit to date (44% × 20,000) 8,800 –––––– Cost incurred to date materials and labour 12,000 Plant depreciation (8,000 × 6/24 months) 2,000 Profit to date 8,800 –––––– 22,800 Cash received (5,700) –––––– Amount due from customer 17,100 ––––––

SAMPLE



(2) Revenue

Pricewell is acting as an agent (not the principal) for the sales on behalf of Trilby. Therefore profit or loss 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 to show agency sales (of $1·6 million) separately as other income.

(3) Cost of sales

Per question 234,500 Contract (W1) 13,200 Agency cost of sales (W2) (6,400) Depreciation (W4) – leasehold property 1,800 – owned plant ((46,800 – 12,800) × 25%) 8,500 – leased plant (20,000 × 25%) 5,000 Surplus on revaluation of leasehold property (W4) (1,500) ––––––– 255,100 –––––––

(4) Non-current assets

Leasehold property Valuation at 31 March 2013 25,200 Depreciation for year (14 year life remaining) (1,800) –––––– Carrying amount at date of revaluation 23,400 Valuation at 31 March 2014 (24,900) –––––– Revaluation surplus (to profit or loss – see below) 1,500 ––––––

The $1·5 million revaluation surplus is credited to profit or loss this is the partial reversal of the $2·8 million impairment loss recognised in profit or loss in the previous period (i.e. year ended 31 March 2013).

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 (W1)) 6,000 ––––––– Carrying amount at 31 March 2014 41,500 –––––––

(5) Preference shares

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 2013. The accrual 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. As these shares are redeemable they are treated as debt and their dividend is treated as a finance cost.

SAMPLE



(6) Finance lease liability

Balance at 31 March 2013 15,600 Interest for year at 8% 1,248 Lease rental paid 31 March 2014 (6,000) –––––– Total liability at 31 March 2014 10,848 Interest next year at 8% 868 Lease rental due 31 March 2015 (6,000) –––––– Total liability at 31 March 2015 5,716 ––––––

(c) Financial instruments

IAS 32 Financial Instruments: Presentation defines a financial liability as a liability that is a contractual obligation:

to deliver cash or another financial asset to another entity; or to exchange financial assets or liabilities with another entity under conditions that

are potentially unfavourable to the entity.

The essence of a financial liability is that there is a present obligation. The entity is going to have to settle this either with a cash payment or by delivering a financial asset.

An equity instrument is defined as any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities.

For an equity instrument there is no obligation to make a payment. The difference between assets and liabilities (i.e. net assets) is therefore equal to equity as presented in the statement of financial position.

Examples of financial liabilities

Trade payables Redeemable preference shares Loan notes (also called bonds or debentures) Any debt which matures in the future (whether on a specific date or open ended).

Examples of equity instruments

Ordinary share capital Share options Irredeemable preference shares

Tutorial note: Only two examples of each were required. SAMPLE



Answer 7 SANDOWN

(a) Statement of profit or loss and other comprehensive income for the year ended 30 September 2014

$000 Revenue (380,000 – 4,000 (W1)) 376,000 Cost of sales (W2) (265,300) ––––––– Gross profit 110,700 Distribution costs (17,400) Administrative expenses (50,500 – 12,000 (W3)) (38,500) Investment income 1,300 Finance costs (W5) (1,475) ––––––– Profit before tax 54,625 Income tax expense (16,200 + 2,100 – 1,500 (W6)) (16,800) ––––––– Profit for the year 37,825 ––––––– Other comprehensive income Gain on fair value though other comprehensive income investments (W4) 4,700 ––––––– Total comprehensive income 42,525 –––––––

SAMPLE



(b) Statement of financial position as at 30 September 2014

Assets $000 $000 Non-current assets Property, plant and equipment (W7) 67,500 Intangible – brand (15,000 – 2,500 (W2)) 12,500 Financial asset investments (at fair value) 29,000 ––––––– 109,000 Current assets Inventory 38,000 Trade receivables 44,500 Bank 8,000 90,500 ––––––– ––––––– Total assets 199,500 ––––––– Equity and liabilities Equity shares of 20 cents each 50,000 Equity option 2,000 Other reserve (W9) 5,700 Retained earnings (W8) 55,885 ––––––– 113,585 Non-current liabilities Deferred tax (W6) 3,900 Deferred income (W1) 2,000 5% convertible loan note (W5) 18,915 24,815 ––––––– Current liabilities Trade payables 42,900 Deferred income (W1) 2,000 Current tax payable 16,200 61,100 ––––––– ––––––– Total equity and liabilities 199,500 –––––––


(1) Servicing element

IAS 18 Revenue requires that where sales revenue includes an amount for after sales servicing and support costs then a proportion of the revenue should be deferred. The amount deferred should cover the cost and a reasonable profit (in this case a gross profit of 40%) on the services. As the servicing and support is for three years and the date of the sale was 1 October 2013, revenue relating to two years’ servicing and support provision must be deferred: ($1·2 million × 2/0·6) = $4 million. This is shown as $2 million in both current and non-current liabilities. SAMPLE



(2) Cost of sales

Per question 246,800 Depreciation – building (50,000 ÷ 50 years – see below) 1,000 – plant and equipment (42,200 – 19,700) × 40%)) 9,000 Amortisation – brand (1,500 + 2,500 – see below) 4,000 Impairment of brand (see below) 4,500 ––––––– 265,300 –––––––

The cost of the building of $50 million (63,000 – 13,000 land) has accumulated depreciation of $8 million at 30 September 2013 which is eight years 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 × 6/12) is required for the second-half of the year giving total amortisation of $4 million for the full year.

(3) Dividend

A dividend of 4·8 cents per share would amount to $12 million (50 million × 5 (i.e. shares are 20 cents each) × 4·8 cents). This is not an administrative expense but a distribution of profits that should be accounted for through equity.

(4) Fair value through other comprehensive income financial assets

gain on disposal (11,000 proceeds – 8,800 carrying amount) 2,200 Increase in fair value of remaining investments: (29,000 – 26,500) 2,500 ––––––– Included in other comprehensive income 4,700 –––––––

The gain on the investments disposed of $4,000 (11,000 – 7,000) has now been realised and can be transferred to retained earnings from other equity reserve.

(5) Convertible loan note

The finance cost of the convertible loan note is based on its effective rate of 8% applied to $18,440,000 carrying amount at 1 October 2013 = $1,475,000 (rounded). The accrual of $475,000 (1,475 – 1,000 interest paid) is added to the 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 2014.

(6) Deferred tax

Credit balance required at 30 September 2014 (13,000 × 30%) 3,900 Balance at 1 October 2013 (5,400) ––––––– Credit (reduction in balance) to profit or loss 1,500 –––––––

SAMPLE



(7) Non-current assets

Freehold property (63,000 – (8,000 + 1,000)) (W2) 54,000 Plant and equipment (42,200 – (19,700 + 9,000)) (W2) 13,500 ––––––– Property, plant and equipment 67,500 –––––––

(8) Retained earnings

At 1 October 2013 26,060 Profit for year 37,825 Transfer from other equity reserve ((W4) 4,000 Dividend paid (W3) (12,000) –––––– 55,885 ––––––

(9) Other reserve (re financial asset investments)

At 1 October 2013 5,000 Other comprehensive income for year (W4) 4,700 Transfer to retained earnings ((W4) (4,000) –––––– 5,700 ––––––

(c) Accounting for dividends

IAS 10 Events After the Reporting Period prescribes the accounting for proposed dividends. It states that dividends declared after the end of the reporting period cannot be recognised as a liability in that reporting period.

For the year ended 30 September 2014 Sandown can only disclose the proposed dividend in the notes to the financial statements.

When the dividend is paid in the following period it cannot be recognised as an expense in profit or loss as it is a “distribution to equity participants”. The Conceptual Framework for Financial Reporting specifically excludes incurrences of liabilities relating to such distributions from its definition of expenses. The dividend is not an expense but an appropriation of profits that should be deducted from retained earnings in the statement of changes in equity.

The managing director’s suggested treatment is not allowed under IFRS. He is also incorrect in his assertion that the income tax expense will be reduced. As dividends are not deductible for tax purposes it has no effect on the amount of tax payable.

SAMPLE



Answer 8 CAVERN

(a) Statement of profit or loss and other comprehensive income for the year ended 30 September 2014

$000 Revenue 182,500 Cost of sales (W1) (137,400) ––––––– Gross profit 45,100 Distribution costs (8,500) Administrative expenses (25,000 – 18,500 dividends (W3)) (6,500) Investment income 700 Finance costs (300 + 400 (w (ii)) + 3,060 (W4)) (3,760) –––––– Profit before tax 27,040 Income tax expense (5,600 + 900 – 250 (W5)) (6,250) –––––– Profit for the year 20,790 –––––– Other comprehensive income Loss on fair value through other comprehensive income investments (15,800 – 13,500) (2,300) Gain on revaluation of land and buildings (W2) 800 –––––– Total other comprehensive losses for the year (1,500) –––––– Total comprehensive income 19,290 ––––––

(b) Statement of changes in equity for the year ended 30 September 2014

Share Share Other Revaluation Retained Total capital premium equity reserve earnings equity $000 $000 $000 $000 $000 $000 Balance at 1 October 2013 40,000 nil 3,000 7,000 12,100 62,100 Rights issue (W3) 10,000 11,000 21,000 Dividends (W3) (18,500) (18,500) Comprehensive income (2,300) 800 20,790 19,290 –––––– –––––– –––––– –––––– ––––––– –––––– Balance at 30 September 2014 50,000 11,000 700 7,800 14,390 83,890 –––––– –––––– –––––– –––––– ––––––– –––––– SAMPLE



(c) Statement of financial position as at 30 September 2014

Assets $000 $000 Non-current assets Property, plant and equipment (41,800 + 51,100 (W2)) 92,900 Fair value through other comprehensive income investments 13,500 ––––––– 106,400 Current assets Inventory 19,800 Trade receivables 29,000 ––––––– 48,800 ––––––– Total assets 155,200 ––––––– Equity and liabilities Equity (see (b) above) Equity shares of 20 cents each 50,000 Share premium 11,000 Other equity reserve 700 Revaluation reserve 7,800 Retained earnings 14,390 ––––––– 33,890 –––––– 83,890 Non-current liabilities Provision for decontamination costs (4,000 + 400 (W2)) 4,400 8% loan note (W4) 31,260 Deferred tax (W5) 3,750 ––––––– 39,410 –––––– Current liabilities Trade payables 21,700 Bank overdraft 4,600 Current tax payable 5,600 ––––––– 31,900 ––––––– Total equity and liabilities 155,200 –––––––

WORKINGS (monetary figures in brackets in $000)

(1) Cost of sales

Per trial balance 128,500 Depreciation of building (36,000 ÷ 18 years) 2,000 Depreciation of new plant (14,000 ÷ 10 years) 1,400 Depreciation of existing plant and equipment ((67,400 – 10,000 – 13,400) × 12·5%) 5,500 ––––––– 137,400 –––––––

SAMPLE



(2) Property, plant and equipment

The new plant of $10 million should be grossed up by the provision for the present value of the estimated future decontamination costs of $4 million to give a gross cost of $14 million. The “unwinding” of the provision will give rise to a finance cost in the current year of $400,000 (4,000 × 10%) to give a closing provision of $4·4 million.

The gain on revaluation and carrying amount of the land and building will be:

Valuation – 30 September 2013 43,000 Building depreciation (W1) (2,000) –––––– Carrying amount before revaluation 41,000 Revaluation – 30 September 2014 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 ––––––

(3) Rights issue/dividends paid

Based on 250 million (50 million × 5 – as shares are 20 cents each) shares in issue at 30 September 2014, a rights issue of 1 for 4 on 1 April 2014 would have resulted in the issue of 50 million new shares (250 million – (250 million × 4/5)). This would be recorded as share capital of $10 million (50,000 × 20 cents) and share premium of $11 million (50,000 × (42 cents – 20 cents)).

The dividend of 3 cents per share paid on 30 November 2013 would have been based on 200 million shares and been $6 million. The dividend of 5 cents per share paid on 31 May 2014 would have been based on 250 million shares and been $12·5 million. Therefore the total dividends paid, incorrectly included in administrative expenses, were $18·5 million.

(4) Loan note

The finance cost of the loan note, at the effective rate of 10% applied to the carrying amount of the loan note of $30·6 million, is $3·06 million. The interest actually paid is $2·4 million. The difference between these amounts of $660,000 (3,060 – 2,400) is added to the carrying amount of the loan note to give $31·26 million (30,600 + 660) for inclusion as a non-current liability in the statement of financial position.

(5) Deferred tax

Provision required at 30 September 2014 (15,000 × 25%) 3,750 Provision at 1 October 2013 (4,000) ––––– Credit (reduction in provision) to profit or loss 250 –––––

SAMPLE



(d) Financial assets

IFRS 9 requires that all financial assets be placed into one of three categories:

Fair value through profit or loss Fair value through other comprehensive income Amortised cost

Fair value through profit or loss is the default category, with the other two exceptions to the default. As the title implies the financial asset is measured at fair value at each reporting date, reference should be made to IFRS 13 Fair Value Measurement to find fair value, with any change in fair value being recognised as income or expense in the profit or loss.

For an asset to be classed as fair value through other comprehensive income the whole instrument must be an equity instrument of another entity, the asset is being held for the long term and the entity must have designated, documented, the asset at fair value through other comprehensive income. The asset is again measured at fair value and any change in fair value is this time taken to other comprehensive income.

For the asset to be classified at amortised cost the asset must be held within a business model whose objective is to hold assets in order to collect contractual cash flows, in other words it is a debt asset; and the contractual terms of the asset gives rise to cash flows that are solely payments of principal and interest on the principal outstanding, it must be “simple” debt.

The amortised cost model takes the initial amount of the asset adds to that the interest income based on the effective interest rate and then deducts any cash interest received.

Answer 9 HIGHWOOD

(a) Statement of profit or loss and other comprehensive income for the year ended 31 March 2014

$000 Revenue 339,650 Cost of sales (W1) (216,950) ––––––– Gross profit 122,700 Distribution costs (27,500) Administrative expenses (30,700 – 1,300 + 600 (W4)) (30,000) Finance costs (W5) (2,848) ––––––– Profit before tax 62,352 Income tax expense (19,400 – 800 + 400 (W6)) (19,000) ––––––– Profit for the year 43,352 Other comprehensive income: Gain on revaluation of property (W2) 15,000 Deferred tax on revaluation (W2) (3,750) ––––––– Total comprehensive income 54,602 –––––––

SAMPLE



(b) Statement of changes in equity for the year ended 31 March 2014

Share Equity Revaluation Retained Total capital option reserve earnings equity $000 $000 $000 $000 $000 Balance at 1 April 2013 (see below) 56,000 nil nil 7,000 63,000 8% Loan note issue (W5) 1,524 1,524 Dividend paid (W7) (5,600) (5,600) Comprehensive income 11,250 43,352 54,602 ––––––– ––––––– ––––––– ––––––– ––––––– Balance at 31 March 2014 56,000 1,524 11,250 44,752 113,526 ––––––– ––––––– ––––––– ––––––– ––––––– Tutorial note: The retained earnings of $1·4 million in the trial balance is after deducting the dividend paid of $5·6 million, therefore the retained earnings at 1 April 2013 amounted to $7 million.

(c) Statement of financial position as at 31 March 2014

Assets $000 $000 Non-current assets Property, plant and equipment (77,500 + 40,000) (W1) 117,500 Current assets Inventory (36,000 – 2,700 + 6,000) (W1) 39,300 Trade receivables (47,100 + 10,000 – 600 (W4)) 56,500 95,800 –––––– ––––––– Total assets 213,300 ––––––– Equity and liabilities Equity (see (ii)) Equity shares of 50 cents each 56,000 Other component of equity – equity option 1,524 Revaluation reserve 11,250 Retained earnings 44,752 ––––––– 113,526 Non-current liabilities Deferred tax (W6) 6,750 8% Convertible loan note (28,476 + 448) (W5) 28,924 35,674 –––––– Current liabilities Trade payables 24,500 Liability to Easyfinance (W4) 8,700 Bank overdraft 11,500 Current tax payable 19,400 64,100 –––––– ––––––– Total equity and liabilities 213,300 ––––––– SAMPLE




(1) Cost of sales and non-current assets

$000 Cost of sales (given) 207,750 Depreciation – building (W2) 2,500 – plant and equipment (W2) 10,000 Adjustment/increase to closing inventory (W3) (3,300) ––––––– 216,950 ––––––– (2) Depreciation

Freehold property

The revaluation of the property will create an initial revaluation reserve of $15 million (80,000 – (75,000 – 10,000)).

$3·75 million of this (25%) will be transferred to deferred tax leaving a net revaluation reserve of $11·25 million. The building valued at $50 million will require a depreciation charge of $2·5 million (50,000/20 years remaining) for the current year. This will leave a carrying amount in the statement of financial position of $77·5 million (80,000 – 2,500).

Plant and equipment Cost Accumulated depreciation $000 $000 1 April 2013 74,500 24,500 Charge for year ((74,500 – 24,500) × 20%) 10,000 –––––– –––––– 31 March 2014 74,500 34,500 –––––– –––––– The carrying amount in the statement of financial position is $40 million.

(3) Inventory adjustment

Goods delivered (deduct from closing inventory) (2,700) Cost of goods sold (7,800 × 100/130) (add to closing inventory) 6,000 ––––– Net increase in closing inventory 3,300 ––––– (4) Factored receivables

As Highwood still bears the risk of the non-payment of the receivables, the substance of this transaction is a loan. Thus the receivables must remain on Highwood’s statement of financial position and the proceeds of the “sale” treated as a current liability. The difference between the factored receivables (10,000) and the loan received (8,700) of $1·3 million, which has been charged to administrative expenses, should be reversed except for $600,000 which should be treated as an allowance for uncollectible receivables. SAMPLE



(5) 8% convertible loan note

This is a compound financial instrument having a debt (liability) and an equity component. These must be quantified and accounted for separately:

Year ended 31 March Outflow 10% Present value $000 $000 2014 2,400 0·91 2,184 2015 2,400 0·83 1,992 2016 32,400 0·75 24,300 ––––––– Liability component 28,476 Equity component (balance) 1,524 ––––––– Proceeds of issue 30,000 ––––––– The finance cost for the year will be $2,848,000 (28,476 × 10% rounded). Thus $448,000 (2,848 – 2,400 interest paid) will be added to the carrying amount of the loan note in the statement of financial position.

The equity component of $1,524 could have been reduced and retained earnings increased by a transfer of the difference between the interest expense of $2,848 and the interest cash paid of $2,400.

(6) Deferred tax

Credit balance required at 31 March 2014 (27,000 × 25%) 6,750 Revaluation of property (W1) (3,750) Balance at 1 April 2013 (2,600) ––––– Charge to profit or loss 400 ––––– (7) Dividend

The dividend paid in November 2013 was $5·6 million. This is based on 112 million shares in issue (56,000 × 2 – the shares are 50 cents each) times 5 cents.

(d) Impact of revaluation

The marketing director’s statements are both incorrect.

Depreciation must be charged on all depreciable assets; land is the only non-depreciable asset. Depreciation is “the systematic allocation of the depreciable amount of an asset over its useful life”. Depreciable amount is “the cost of an asset, or other amount substituted for cost, less its residual value”.

So if an asset is revalued this will increase its depreciable amount which, in turn, will increase the depreciation expense for the year. Revaluation does not negate the requirement to depreciate depreciable assets and IA8 Property. Plant and Equipment does not allow non-depreciation in the event of revaluation.

IAS 33 Earnings per Share states that the earnings figure to be used in the calculation is “profit or loss attributable to ordinary equity holders” (i.e. after tax).

SAMPLE



Any revaluation gain is recognised in other comprehensive income which is presented below profit or loss in the statement of total comprehensive income. A revaluation gain is not part of the profit for the period and therefore does not inflate profits. Hence EPS will not improve as a result of the revaluation.

Answer 10 EMERALD

(a) Asset definition

The Framework defines an asset as a resource controlled by an entity as a result of past transactions or events from which future economic benefits (normally net cash inflows) are expected to flow to the entity. However assets can only be recognised (on the statement of financial position) when those expected benefits are probable and can be measured reliably. The Framework recognises that there is a close relationship between incurring expenditure and generating assets, but they do not necessarily coincide. Development expenditure, perhaps more than any other form of expenditure, is a classic example of the relationship between expenditure and creating an asset. Clearly entities commit to expenditure on both research and development in the hope 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 not even be probable) that the project will be successful. Relating this to accounting concepts, if there is doubt that a project will be successful the application of faithful representation would dictate that the expenditure is charged (expensed) to profit or loss.

At the stage where management becomes confident that the project will be successful, it meets the definition of an asset and the accruals/matching concept would mean that it should be capitalised (treated as an asset) and amortised over the period of the expected benefits. IAS 38 Intangible Assets interprets this as writing off all research expenditure and only capitalising development costs from the point in time where they meet strict conditions which effectively mean the expenditure meets the definition of an asset.

(b) Accounting entries

30 September 2014 30 September 2013 Statement of profit or loss $000 $000 Amortisation of development expenditure 335 (W2) 135 (W1) Statement of financial position Development expenditure 1,195 (W4) 1,130 (W3) Statement of changes in equity Prior period adjustment (credit required to restate retained earnings at 1 October 2012) (cumulative carrying amount at 2012 of 300 + 165) 465 WORKINGS (All figures in $000)

Year ended Cumulative Cumulative 2011 2012 2013 2013 2014 2014 Expenditure 300 240 800 1,340 400 1,740 ––––– ––––– ––––– ––––– ––––– ––––– Amortisation (25%) nil (75) (75) (150) (75) (225) nil nil (60) (60) (60) (120) nil nil nil nil (200) (200) ––––– ––––– ––––– ––––– ––––– ––––– Total amortisation nil (75) (W1) (135) (210) (W2) (335) (545) ––––– ––––– ––––– ––––– ––––– ––––– Carrying amount 300 165 665 (W3) 1,130 65 (W4) 1,195 ––––– ––––– ––––– ––––– ––––– –––––

SAMPLE



(c) Extracts from financial statements for the year ended 31 March 2014

(Figures in brackets in $000) $000 Statement of profit or loss and other comprehensive income

Depreciation of office building (A) (2,000 ÷ 20 years × 6/12) (50) Gain on investment properties: A (2,340 – 2,300) 40 B (1,650 – 1,500) 150 Other comprehensive income (A see below) 350

Statement of financial position

Non-current assets Investment properties (A and B) (2,340 + 1,650) 3,990

Equity Revaluation reserve (A) (2,300 – (2,000 – 50)) 350 In Speculate’s consolidated financial statements property B would be accounted for under IAS 16 Property, Plant and Equipment and classified as owner-occupied. Further information is required to determine the depreciation charge.

Answer 11 TUNSHILL

(a) Choice of accounting policy

Management’s choices of which accounting policies they may adopt are not as wide as generally thought. Where an International Financial Reporting Standard, IAS or IFRS (or an Interpretation) specifically applies to a transaction (or event) the accounting policy used must be as prescribed in that Standard (taking in to account any Implementation Guidance within the Standard). In the absence of a Standard, or where a Standard contains a choice of policies, management must use its judgement in applying accounting policies that result in information that is relevant and faithfully represents the circumstances of the transactions and events. In making such judgements, management should refer to guidance in the Standards related to similar issues and the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the IASB’s Conceptual Framework for Financial Reporting. 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 or rule being applied by an entity. Accounting estimates are used to measure the carrying amounts of assets and liabilities, or related expenses and income. A change 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 estimated useful life would be a change of accounting policy. To change the estimate of its useful life would be a change in an accounting estimate. SAMPLE



(b) Transactions

(i) Useful life of non-current asset

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 the depreciation charge. Like most estimates, an annual review of their appropriateness is required and it is not unusual, as in this case, to revise the estimate of the remaining useful life of plant. It appears, from the information in the question, that the increase in the estimated remaining useful life of the plant is based on a genuine reassessment by the production manager. This appears to be an acceptable reason for a revision of the plant’s life, whereas it would be unacceptable to increase the estimate simply to improve the company’s reported profit. That said, the assistant accountant’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 a non-current asset, its carrying amount (at the time of the revision) is allocated over the new remaining life (after allowing for any estimated residual value). The carrying amount at 1 October 2013 is $12 million ($20 million – $8 million accumulated depreciation) and this should be written off over the estimated remaining life of six years (eight years in total less two already elapsed). Thus a charge for depreciation of $2 million would be required in the year ended 30 September 2014 leaving a carrying amount of $10 million ($12 million – $2 million) in the statement of financial position at that date. A depreciation charge for the current year cannot be avoided and there will be no credit to profit or loss as suggested by the assistant accountant. The incremental effect of the revision to the estimated life of the plant would be to improve the reported profit by $2 million being the difference between the depreciation based on the old life ($4 million) and the new life ($2 million).

(ii) Inventory valuation

The appropriateness of the proposed change to the method of valuing inventory is more dubious than the previous example. Whilst both methods (FIFO and AVCO) are acceptable methods of valuing inventory under IAS 2 Inventories, changing an accounting policy to be consistent with that of competitors is not a convincing reason. Generally changes in accounting policies should be avoided unless a change is required by a new or revised International Financial Reporting Standard or the new policy provides more reliable and relevant information regarding the entity’s position. In any event the assistant accountant’s calculations are again incorrect and would not meet the intention of improving reported profit. The most obvious error is that changing from FIFO to AVCO will cause a reduction in the value of the closing inventory at 30 September 2014 effectively reducing, rather than increasing, both the valuation of inventory and reported profit. A change in accounting policy must be accounted for as if the new policy had always been in place (retrospective application). In this case, for the year ended 30 September 2014, both the opening and closing inventories would need to be measured at AVCO which would reduce reported profit by $400,000 (($20 million – $18 million) – ($15 million – $13·4 million) – i.e. the movement in the values of the opening and closing inventories). The other effect of the change will be on the retained earnings brought forward at 1 October 2013. These will be restated (reduced) by the effect of the reduced inventory value at 30 September 2013 i.e. $1·6 million ($15 million – $13·4 million). This adjustment would be shown in the statement of changes in equity. SAMPLE



Answer 12 DERRINGDO

(a) Income recognition

Under the Framework revenue recognition issues are approached from the definitions of assets and liabilities. Income and expenses are defined as increases or decreases in net assets other than those resulting from transactions with owners. The Framework can therefore be said to take a “balance sheet approach” to income recognition. In effect a recognisable increase in an asset results in a gain.

The more traditional view, which is largely the basis used in IAS 18 Revenue, is that (net) revenue recognition is part of a transactions-based accruals or matching process with the statement of financial position recording any residual assets or liabilities such as receivables and payables. The issue of revenue recognition arises out of the need to report company performance for specific periods.

The Framework identifies three stages in the recognition of assets (and liabilities):

(1) initial recognition, when an item first meets the definition of an asset;

(2) subsequent measurement, which may involve changing the value (with a corresponding effect on income) of a recognised item; and

(3) possible derecognition, where an item no longer meets the definition of an asset.

For many simple transactions both the Framework’s approach and the traditional approach (IAS 18) 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 increase would be reported as a profit. The same figure would be reported under the traditional transactions based reporting (sales of $150 less cost of sales of $100). However, in more complex areas the two approaches can produce different results. 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 deferred income (on the statement of financial position) and “release” it to income as the tuition is provided and matched with the cost of providing the tuition. Thus the profit would be spread (accrued) over the period of the course. If an asset/liability approach were taken, then the only liability the company would have after the receipt of the fee would be for the cost of providing the course. If only this liability is recognised in the statement of financial position, the whole of the profit on the course would be recognised on receipt of the income.

This is not a prudent approach and has led to criticism of the Framework for this very reason. Arguably the treatment of government grants under IAS 20 (as deferred income) does not comply with the Framework as deferred income does not meet the definition of a liability. Other standards that may be in conflict with the Framework are the use of the accretion approach in IAS 11 Construction Contracts and a deferred tax liability in IAS 12 Income Tax may not fully meet the Framework’s definition of a liability.

(b) Sale of goods

Sales made by Derringdo of goods from Gungho must be treated under two separate categories. Sales of the A grade goods are made by Derringdo acting as an agent of Gungho. For these sales Derringdo must only record in profit or loss the amount of commission (12·5%) it is entitled to under the sales agreement. There may also be a receivable or payable for Gungho in the statement of financial position. Sales of the B grade goods are made by Derringdo acting as a principal, not an agent. Thus they will be included in sales with their cost included in cost of sales.

SAMPLE



$000 Sales revenue (4,600 (W1) + 11,400 (W2)) 16,000 Cost of sales (W2) (8,550) ––––––– Gross profit 7,450 WORKINGS: (all figures in $000) A grade (1) Opening inventory 2,400 Transfers/purchases 18,000 ––––––– 20,400 Closing inventory (2,000) ––––––– Cost of sales 18,400 Selling price (to give 50% gross profit) 36,800 ––––––– Gross profit 18,400 Commission (12·5% × 36,800) 4,600 B grade (2) Opening inventory 1,000 Transfers/purchases 8,800 ––––––– 9,800 Closing inventory (1,250) ––––––– Cost of sales 8,550 Selling price (8,550 × 4/3 see below) 11,400 –––––––

A gross profit margin of 25% is equivalent to a mark-up on cost of 1/3. Thus if cost of sale is multiplied by 4/3 this will give the relevant selling price.

(c) Accounting policies

On first impression, it appears that the company has changed its accounting policy from recognising carpet sales at the point of fitting to recognising them at the point when they are ordered and paid for. If this were the case then the new accounting policy should be applied as if it had always been in place and the income recognised in the year to 31 March 2014 would be $23 million. Without the change in policy, sales would have been $22·6 million (23m + 1·2m – 1·6m). Sales made from the retail premises during the current year, but not yet fitted ($1·6 million) will not be recognised until the following period. A corresponding adjustment is made recognising the equivalent figure ($1·2 million) from the previous year. The difference between the $23 million and $22·6 million would be a prior year adjustment (less the cost of sales relating to this amount). This analysis assumes that the figures are material.

Despite first impressions, the above is not a change of accounting policy. This is because a change of accounting policy only occurs where the same circumstances are treated differently. In this case there are different circumstances. Derringdo has changed its method of trading; it is no longer responsible for any errors that may occur during the fitting of the carpets. An accounting policy that is applied to circumstances that differ from previous circumstances is not a change of accounting policy. Thus the amount to be recognised in income for the year to 31 March 2014 would be $24·2 million (23m + 1·2m). Whilst this appears to boost the current year’s income it would be mitigated by the payments to the sub-contractors for the carpet fitting.

SAMPLE



Answer 13 LINNET

(a) Recognition principles

Construction contracts tend to span more than one accounting period. This leads to the problem of determining how the uncompleted transactions should be dealt with over the life of the contract. Normal sales are not recognised until the production and sales cycle is complete. Where the outcome of a construction contract cannot be reasonably foreseen due to inherent uncertainty, the completed contracts basis should be applied. The effect of this is that sales revenue earned to date is matched to the cost of sales and no profit is taken nor loss recognised. This lack of bias (i.e. neutrality) is one of the three characteristics that contributes to faithful representation.

The problem with the above is that for say a three-year contract it can lead to a situation where no profits are recognised, possibly for two years, and in the year of completion the whole of the profit is recognised (assuming the contract is profitable). This seems consistent with the principle that only realised profits should be recognised in the statement of profit or loss. The problem is that the overriding requirement is for financial statements to show a faithful representation of the events and transactions occurring in the period and there is an implication that financial statements should reflect the economic reality of these events. In the above case it can be argued that the company has been involved in a profitable contract for a three-year period, but its financial statements over the three years show a profit in only one period. This also leads to volatility of profits which many companies feel is undesirable and not favoured by analysts. An alternative approach is to apply the matching/accruals concept which underlies the percentage of completion method. This approach requires the percentage of completion of a contract to be assessed (there are several methods of doing this) and then recognising in the statement of profit or loss that percentage of the total estimated profit on the contract. This method has the advantage of more stable profit recognition and can be argued shows a more faithful representation of the events than the completed contract method. A contrary view is that this method can be criticised as being a form of profit smoothing which, in other circumstances, is considered to be an (undesirable) example of creative accounting. IAS 11 Construction Contracts requires the use of the percentage of completion method where the outcome of the contract is reasonably foreseeable. Where a contract is expected to produce a loss, the whole of the loss must be recognised as soon as it is anticipated.

(b) Statement of profit or loss (extract) for the year to 31 March 2014

$m Sales revenue 70 Cost of sales (64 +17) (81) ––– Loss for period (11) ––– Linnet – statement of financial position extracts – as at 31 March 2014

Current assets Gross amounts due from customers for contract work (W3) 59 SAMPLE



WORKINGS Cumulative Cumulative Amounts 1 April 2013 31 March 2014 for year $m $m $m Sales 150 (W1) 220 70 Cost of sales (112) (W2) (176) (64) Rectification costs nil (17) (17) –––– –––– –––– Profit/(loss) 38 (W2) 27 (11) –––– –––– ––––

(1) Contract sales

Progress payments received are $180 million. This is 90% of the work certified (at 28 February 2014); therefore the work certified at that date was $200 million. The value of the further work completed in March 2014 is given as $20 million, giving a total value of contract sales at 31 March 2014 of $220 million.

(2) Total estimated profit (excluding rectification costs)

$m Contract price 300 Cost to date (195) Estimated cost to complete (45) –––– Estimated total profit 60 ––––

The degree of completion (by the method given in the question) is 220/300.

Costs recognised to date are based on total expected cost of $240 million × 220/300 = $176 million less costs recognised in prior period of $112 million to arrive at costs recognised this period of $64 million. However, the rectification costs, of $17 million, are an abnormal cost and they must be charged against profits in the year they are incurred, they cannot be spread over the term of the contract. Therefore costs to be recognised this period are $81 million (64 + 17), leading to a loss recognised for this period of $11 million.

(3) Gross amount due from customers

The gross amounts due from customers is actual costs incurred to date ($195 million + $17 million) plus cumulative profit ($27 million) less progress billings ($180 million) = $59 million. Of this $59 million $20 million (200 – 180) would be recognised as a receivable asset under IFRS 9 Financial Instruments and the remaining $39 million would be the gross amount due from customers under IAS 11. SAMPLE



Answer 14 MOCCA

Statement of profit or loss year ended 31 March 2014 (extracts)

$000 Revenue recognised ((65% (W1) × 12,500) – 3,500 in 2013) 4,625 Contract expenses recognised ((65% × 9,500) – 2,660 in 2013) (3,515) ––––– Profit recognised 1,110 –––––

Statement of financial position as at 31 March 2014 (extracts)

Non-current assets Plant (8,000 – 2,500 (W3)) 5,500 Current assets Receivables (8,125 – 7,725) 400 Amounts due from customers (Note) 1,125 Disclosure Note – Amounts due from customers

Contract costs incurred (W3) 7,300 Recognised profits (840 + 1,110) 1,950 ––––– 9,250 Progress billings (8,125) ––––– Amounts due from customers 1,125 –––––

WORKINGS (in $000)

(1) Percentage complete

Agreed value of work completed at year end 8,125 –––––– Contract price 12,500 Percentage completed (8,125/12,500 × 100) 65%

(2) Estimated total costs

$000 Plant depreciation (8,000 × 24/48 months) 4,000 Other costs 5,500 ––––– Total costs 9,500 –––––

(3) Contract costs incurred

Plant depreciation (8,000 × 15/48 months) 2,500 Other costs 4,800 ––––– 7,300 –––––

SAMPLE



Answer 15 DEARING

Extracts from the financial statements

Year ended 30 September 2012 2013 2014 Statement of profit or loss $000 $000 $000 Depreciation (see workings) 180 270 119 Maintenance (60,000 ÷ 3 years) 20 20 20 Discount received (840,000 × 5%) (42) Staff training 40 –––– –––– –––– 198 290 139 –––– –––– –––– Statement of financial position Property, plant and equipment Cost 920 920 670 Accumulated depreciation (180) (450) (119) –––– –––– –––– Carrying amount 740 470 551 –––– –––– –––– WORKINGS $000 Manufacturer’s base price 1,050 Less: Trade discount (20%) (210) –––– Base cost 840 Freight charges 30 Electrical installation cost 28 Pre-production testing 22 –––– Initial capitalised cost 920 –––– The depreciable amount is $900,000 (920,000 – 20,000 residual value) and, based on an estimated machine life of 6,000 hours, this gives depreciation of $150 per machine hour. Therefore depreciation for the year ended 30 September 2012 is $180,000 ($150 × 1,200 hours) and for the year ended 30 September 2013 is $270,000 ($150 × 1,800 hours).

Tutorial note: Early settlement discount, staff training in use of machine and maintenance are all revenue items and cannot be part of capitalised costs.

$000 Carrying amount at 1 October 2013 470 Subsequent expenditure 200 –––– Revised “cost” 670 –––– The revised depreciable amount is $630,000 (670,000 – 40,000 residual value) and with a revised remaining life of 4,500 hours, this gives a depreciation charge of $140 per machine hour. Therefore depreciation for the year ended 30 September 2014 is $119,000 ($140 × 850 hours).

SAMPLE



Answer 16 FLIGHTLINE

Statement of profit or loss for the year ended 31 March 2014

$000 Depreciation (W1) 13,800 Loss on write off of engine (W3) 6,000 Repairs – engine 3,000 – exterior painting 2,000

Statement of financial position as at 31 March 2014

Non-current asset – Aircraft Cost Accumulated Carrying depreciation amount $000 $000 $000 Exterior (W1) 120,000 84,000 36,000 Cabin fittings (W2) 29,500 21,500 8,000 Engines (W3) 19,800 3,700 16,100 ––––––– ––––––– ––––––– 169,300 109,200 60,100 ––––––– ––––––– –––––––


(1) Depreciation

The exterior of the aircraft is depreciated at $6 million per annum (120,000 ÷ 20 years). The cabin is depreciated at $5 million per annum (25,000 ÷ 5 years). The engines would be depreciated by $500 ($18 million/36,000 hours) i.e. $250 each, per flying hour.

Carrying amount of aircraft at 1 April 2013 Cost Accumulated Carrying depreciation amount $000 $000 $000 Exterior (13 years old) 120,000 78,000 42,000 Cabin (3 years old) 25,000 15,000 10,000 Engines (used 10,800 hours) 18,000 5,400 12,600 ––––––– ––––––– ––––––– 163,000 98,400 64,600 ––––––– ––––––– ––––––– Depreciation for year to 31 March 2014: $000 Exterior (no change) 6,000 Cabin fittings – six months to 30 September 2013(5,000 × 6/12) 2,500 – six months to 31 March 2014(W2) 4,000 Engines – six months to 30 September 2013(500 × 1,200 hours) 600 – six months to 31 March 2014 ((400 + 300) W3) 700 ––––––– 13,800 –––––––

(2) Cabin fittings

Cabin fittings – at 1 October 2013 the carrying amount of the cabin fittings is $7·5 million (10,000 – 2,500). The cost of improving the cabin facilities of $4·5 million should be capitalised as it led to enhanced future economic benefits in the form of substantially higher fares. The cabin fittings would then have a carrying amount of $12 million (7,500 + 4,500) and an unchanged remaining life of 18 months. Thus depreciation for the six months to 31 March 2014 is $4 million (12,000 × 6/18).

SAMPLE



(3) Engines

Engines – before the accident the engines (in combination) were being depreciated at a rate of $500 per flying hour. At the date of the accident each engine had a carrying amount of $6 million ((12,600 – 600)/2). This represents the loss on disposal of the written off engine. The repaired engine’s remaining life was 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 the six months to 31 March 2014. The new engine with a cost of $10·8 million and a life of 36,000 hours will be depreciated by $300 per flying hour, resulting in a depreciation charge of $300,000 for the six months to 31 March 2014. Summarising both engines: Cost Accumulated Carrying depreciation amount $000 $000 $000 Old engine 9,000 3,400 5,600 New engine 10,800 300 10,500 ––––––– ––––––– ––––––– 19,800 3,700 16,100 ––––––– ––––––– –––––––

Tutorial note: Marks are awarded for clear calculations rather than for detailed explanations. Full explanations are given for tutorial purposes.

Answer 17 BAXEN

(a) Advantages of adopting IFRS

There are several aspects of Baxen’s business strategy where adopting IFRS would be advantageous.

It is unclear how sophisticated or developed the “local” standards which it currently uses are, however, it is widely accepted that IFRS are a set of high quality and transparent global standards that are intended to achieve consistency and comparability across the world. They have been produced in co-operation with other internationally renowned standard setters, with the aspiration of achieving consensus and global convergence. Thus if Baxen does adopt IFRS it is likely that its status and reputation (e.g. an improved credit rating) in the eyes of other entities would be enhanced.

Other more specific advantages

Its own financial statements would be comparable with other companies that use IFRS. This would help the company to better assess and rank prospective investments in its foreign trading partners.

Should Baxen acquire (as a subsidiary) any foreign companies, it would make the task of consolidation much simpler as there would be no need to reconcile its foreign subsidiary’s financial statements to the local generally accepted accounting principles (GAAP) that Baxen currently uses. The use of IFRSs may make the audit fee less expensive.

If Baxen needs to raise finance in the future (highly likely because of its ambitions), it will find it easier to get a listing on any security exchange that is a member of the International Organisation of Securities Commissions (IOSCO) as they recognise IFRS for listing purposes. This flexibility to raise funding also means that Baxen’s financing costs should be lower.

SAMPLE



(b) Government grants

(i) Policy

The IASB’s Framework defines liabilities as obligations to transfer economic benefits as a result of past transactions. Such transfers of economic benefits are to third parties and normally as cash payments. Traditionally and in compliance with IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, capital based government grants are treated as deferred credits and spread over the life of the related assets. This is the application of the matching concept. A strict interpretation of the Framework would not normally allow deferred credits to be treated as liabilities as there is usually no obligation to transfer economic benefits. In this particular example the only liability that may occur in respect of the grant would be if Baxen were to sell the related asset within four years of its purchase. A possible argument would be that the grant should be treated as a reducing liability (in relation to a potential repayment) over the four-year claw back period. On closer consideration this would not be appropriate. The repayment would only occur if the asset were sold, thus it is potentially a contingent liability. As Baxen has no intention to sell the asset there is no reason to believe that the repayment will occur, thus it is not a reportable contingent liability. The implication of this is that the company’s policy for the government grant does not comply with the definition of a liability in the Framework. Applying the guidance in the Framework would require the whole of the grant to be included in income as it is “earned” (i.e. in the year of receipt).

(ii) Accounting treatment – applying the company’s policy

Statement of profit or loss extract year to 31 March 2014 $ Depreciation – plant ((800,000 – 120,000 estimated residual value)/10 years × 6/12) Dr 34,000 Government grant ((800,000 × 30%)/10 years × 6/12) Cr 12,000

Statement of financial position extracts as at 31 March 2014 Non-current assets: Plant at cost 800,000 Accumulated depreciation (34,000) –––––––– 766,000 –––––––– Current liabilities: Government grant (240,000 ÷ 10 years) 24,000

Non-current liabilities: Government grant (240,000 – 12,000 – 24,000) 204,000 Accounting treatment – applying the Framework

Statement of profit or loss extract year to 31 March 2014 Depreciation – plant ((800,000 – 120,000 estimated residual value)/10 years × 6/12) Dr 34,000 Government grant (whole amount) Cr 240,000 Statement of financial position extracts as at 31 March 2014 Non-current assets: Plant at cost 800,000 Accumulated depreciation (34,000) –––––––– 766,000 ––––––––

SAMPLE



Answer 18 APEX

(a) Intangibles

Where an intangible asset other than goodwill is acquired as a separate transaction, the treatment is relatively straightforward. It should be capitalised at cost and amortised over its estimated useful economic life. The fair value of the purchase consideration paid to acquire an intangible is deemed to be its cost. If the asset has an indefinite useful life then it is not amortised, but is tested annually for impairment. IAS 38 does allow the subsequent revaluation of intangible assets as long as there is an active market for that class of intangibles.

Intangibles purchased as part of the acquisition of a business should be recognised separately to goodwill if the fair value of the intangible can be measured reliably. Reliable measurement does not have to be at market value, techniques such as valuations based on multiples of turnover or notional royalties are acceptable. This test is not meant to be overly restrictive and is likely to be met in valuing intangibles such as brands, publishing titles, patents etc. Any intangible not capable of reliable measurement will be subsumed within goodwill. The impact of IFRS 3 and the revised IAS 38 has been to recognise far more separate intangibles than the previous standard; this has had the effect of reducing the amount of goodwill identified in the business combination.

Recognition of internally developed intangibles is much more restrictive. IAS 38 states that internally generated goodwill, brands, mastheads, publishing titles, customer lists and similar items should not be recognised as intangible assets as these items cannot be distinguished from the cost of developing the business as a whole. The Standard does require development costs to be capitalised if they meet detailed recognition criteria. Those criteria being:

the technical feasibility of completing the intangible asset so that it will be available for use or sale;

its intention to complete the intangible asset and use it or sell it;

its ability to use or sell the intangible asset;

how the intangible asset will generate probable future economic benefits;

the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset; and

its ability to measure the expenditure attributable to the intangible asset during its development reliability.

(b) Capitalising borrowing costs

Where borrowing costs are directly incurred on a “qualifying asset”, they must be capitalised as part of the cost of that asset. A qualifying asset may be a tangible or an intangible asset that takes a substantial period of time to get ready for its intended 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 incorporates the amortisation of discounts, premiums and certain expenses) on overdrafts, loans and (some) other financial instruments and finance charges on finance leased assets. They may be based on specifically borrowed funds or on the weighted average cost of a pool of funds. Any income earned from the temporary investment of specifically borrowed funds would normally be deducted from the amount to be capitalised.

SAMPLE



Capitalisation should commence when expenditure is being incurred on the asset, which is not necessarily from the date funds are borrowed. Capitalisation should cease when the asset is ready for its intended use, even though the funds may still be incurring borrowing costs. Also capitalisation should be suspended if 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.

(c) Calculation of borrowing costs

The finance cost of the loan must be calculated using the effective rate of 7·5%, so the total finance cost for the year ended 31 March 2014 is $750,000 ($10 million × 7·5%). As the loan relates to a qualifying asset, the finance cost (or part of it in this case) must be capitalised under IAS 23 Borrowing Costs.

The Standard says that capitalisation commences from when expenditure is being incurred (1 May 2013) and must cease when the asset is ready for its intended use (28 February 2014); in this case a 10-month period. However, interest cannot be capitalised during a period where development activity is suspended; in this case the two months of July and August 2013. Thus only eight months of the year’s finance cost can be capitalised = $500,000 ($750,000 × 8/12). The remaining four months’ finance costs of $250,000 must be expensed. IAS 23 also says that interest earned from the temporary investment of specific loans should 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 $40,000 would be credited to profit or loss and not to the capitalised finance costs.

In summary $000 Profit or loss for the year ended 31 March 2014

Finance cost (debit) (250) Investment income (credit) 40

Statement of financial position as at 31 March 2014

Property, plant and equipment (finance cost element only) 500

Answer 19 DEXTERITY

(a) Allocation of purchase consideration $m Net tangible assets 15 Work in progress 2 Patent 10 Goodwill 8 ––– 35 ––– The difficulty here is the potential value of the patent if the trials are successful. In effect this is a contingent asset and on an acquisition contingencies have to be valued at their fair value. There is insufficient information to make a judgment of the fair value of the contingent asset and in these circumstances it would be prudent to value the patent at $10 million. The additional $5 million is an example of where an intangible cannot be measured reliably and thus it should be subsumed within goodwill. The other issue is that although research cannot normally be treated as an asset, in this case the research is being done for another company and is in fact work in progress and should be recognised as such.

SAMPLE



(b) New drug

This is an example of an internally developed intangible asset and although the circumstances of its valuation are similar to the patent acquired above it cannot be recognised at Leadbrand’s valuation. Internally generated intangibles can only be recognised if they meet the definition of development costs in IAS 38. Internally generated intangibles are permitted to be carried at a revalued amount (under the revaluation model) but only where there is an active market of homogeneous assets with prices that are available to the public. By their very nature drug patents are unique (even for similar types of drugs) therefore they cannot be part of a homogeneous population. Therefore the drug would be recorded at its development cost of $12 million, as long as the 6 recognition criteria mentioned in part (a) have been met..

(c) Operating license

This is an example of a “granted” asset. It is neither an internally developed asset nor a purchased asset. In one sense it is recognition of the standing of the company that is part of the company’s goodwill. IAS 38’s general requirement requires intangible assets to be initially recorded at cost and specifically mentions granted assets. IAS 38 also refers to IAS 20 Accounting for Government Grants and Disclosure of Government Assistance in this situation. This standard says that both the asset and the grant can be recognised at fair value initially (in this case they would be at the same amount). If fair values are not used for the asset it should be valued at the amount of any directly attributable expenditure (in this case this is zero). It is unclear whether IAS 38’s general restrictive requirements on the revaluation of intangibles are intended to cover granted assets under IAS 20.

(d) Skilled workforce

There is no doubt that a skilled workforce is of great benefit to a company. In this case there is an enhancement of revenues and a reduction in costs and if resources had been spent on a tangible non-current asset that resulted in similar benefits they would be eligible for capitalisation. However the Standard specifically excludes this type of expenditure from being recognised as an intangible asset and it describes highly trained staff as “pseudo-assets”. The main reason is the issue of control (through custody or legal rights).

Part of the definition of any asset is the ability to control it. In the case of employees (or, as in this case, training costs of employees) the company cannot claim to control them, as it is quite possible that employees may leave the company and work elsewhere.

(e) Advertising campaign

The benefits of effective advertising are often given as an example of goodwill (or an enhancement of it). If this view is accepted then such expenditures are really internally generated goodwill which cannot be recognised. In this particular case it would be reasonable to treat the unexpired element of the expenditure as a prepayment (in current assets) this would amount to 3/6 of $5 million i.e. $2·5 million. This represents the cost of the advertising that has been paid for, but not yet taken place. In the past some companies have treated anticipated continued benefits as deferred revenue expenditure, but this is no longer permitted as it does not meet the Standard’s recognition criteria for an asset. SAMPLE



Answer 20 DARBY

(a) Non-current assets definition

There are four elements to the assistant’s definition of a non-current asset and he is substantially incorrect in respect of all of them.

The term non-current assets will normally include intangible assets and certain investments; the use of the term “physical asset” would be specific to tangible assets only.

Whilst it is usually the case that non-current assets are of relatively high value this is not a defining aspect. A waste paper bin may exhibit the characteristics of a non-current asset, but on the grounds of materiality it is unlikely to be treated as such. Furthermore the past cost of an asset may be irrelevant; no matter how much an asset has cost, it is the expectation of future economic benefits flowing from a resource (normally in the form of future cash inflows) that defines an asset according to the IASB’s Conceptual Framework for Financial Reporting.

The concept of ownership is no longer a critical aspect of the definition of an asset. It is probably the case that most non-current assets in an entity’s statement of 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 a defining feature. For example: this is an important characteristic in treating a finance 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 than one year and a part of the definition of property, plant and equipment in IAS 16 Property, Plant and Equipment refers to an expectation of use in more than one period, but this is not necessarily always the case. It may be that a non-current asset is acquired which proves unsuitable for the entity’s intended use or is damaged in an accident. In these circumstances assets may not have been used for longer than a year, but nevertheless they were reported as non-current during the time they were in use. A non-current asset may be within a year of the end 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 be reported as a non-current asset if it was still giving economic benefits. Another defining aspect of non-current assets is their intended use (i.e. held for continuing use in the production, supply of goods or services, for rental to others or for administrative purposes).

(b) Issues

(i) Training course

The expenditure on the training courses may exhibit the characteristics of an 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 the statement of financial position and must be charged as an expense as the cost is incurred. The main reason for this lies with the issue of “control”; it is Darby’s employees that have the “skills” provided by the courses, but the employees can leave the company and take their skills with them or, through accident or injury, may be deprived of those skills. Also the capitalisation of staff training costs is specifically prohibited under International Financial Reporting Standards (specifically IAS 38 Intangible Assets).

(ii) Research and development expenditure

The question specifically states that the costs incurred to date on the development of the new processor chip are research costs. IAS 38 states that research costs must be expensed. This is mainly because research is the relatively early stage of a new project and any future benefits are so far in the future that they cannot be considered to meet the definition of an asset (probable future economic benefits), despite the good record of success in the past with similar projects.

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Although the work on the automatic vehicle braking system is still at the research stage, this is different in nature from the previous example as the work has been commissioned by a customer, As such, from the perspective of Darby, it is work in progress (a current asset) and should not be written off as an expense. A note of caution should be added here in that the question says that the success of the project is uncertain which presumably means it may not be completed. This does not mean that Darby will not receive payment for the work it has carried out, but it should be checked to the 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 that only $2 million would be allowed for research costs, this would place a limit on how much Darby could treat as work in progress. If this were the case then, for this example, Darby would have to expense $400,000 and treat only $2 million as work in progress.

(iii) Installation contract

The question suggests the correct treatment for this kind of contract is to treat 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 until the next financial year/reporting period and no depreciation needs to be provided at 30 September 2014.

The capitalised costs to date of $58,000 should only be written down if there is evidence that the asset has been impaired. This occurs where the recoverable amount of an asset is less than its carrying amount. The assistant appears to believe that the recoverable amount is the future profit, whereas (in this case) it is the future (net) cash inflows. Thus any impairment test at 30 September 2014 should compare the carrying amount of $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 completion the installation of $52,000 (see note below)). As the future net cash flows are in 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) at cost of $58,000.

Tutorial 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 this leaves completion costs of $52,000.

Answer 21 MANCO

From the information in the question, the closure of the furniture making operation is a restructuring as defined in IAS 37 Provisions, Contingent Liabilities and Contingent Assets and, due to the timing of the decision, a provision for the closure costs will be required in the year ended 30 September 2013. Although the Standard says that a Board of directors’ decision to close an operation is alone not sufficient to trigger a provision the other actions of the management, informing employees, customers and a press announcement indicate that this is an irreversible decision and that therefore there is an obligating event.

(i) Factory and plant

At 30 September 2013 – these assets cannot be classed as “held-for-sale” as they are 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 carrying amount of $2·8 million, an impairment charge of $2·3 million ($2·8 million – $0·5 million) would be required (subject to any further depreciation for the three months from July to September 2013). The expected gain on the sale of the factory cannot be recognised or used to offset the impairment charge on the plant. The impairment charge is not part of the restructuring provision, but should be reported with the depreciation charge for the year.

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This ACCA Revision Question Bank has been reviewed by ACCA's examining team and includes:

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• Tutorial notes

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