financial reporting (fr) sept / dec 2020 examiner’s report

Examiner’s report – FR September/December 2020 1

Financial Reporting

(FR)

Sept / Dec 2020

Examiner’s report

The examining team share their observations from the

marking process to highlight strengths and

weaknesses in candidates’ performance, and to offer

constructive advice for those sitting the exam in the

future.

Contents General comments .............................................................. 2

Section A ............................................................................. 3

Question 1 ........................................................................ 3

Question 2 ........................................................................ 4

Question 3 ........................................................................ 5

Question 4 ........................................................................ 6

Section B ............................................................................. 8

Question 1 ........................................................................ 9

Question 2 ........................................................................ 9

Question 3 ...................................................................... 10

Question 4 ...................................................................... 11

Question 5 ...................................................................... 12

Section C ........................................................................... 13

Karl Co ........................................................................... 13

Requirement (a) – 4 marks ......................................... 14

Part (b) – 13 marks ..................................................... 15

Part (c) – 3 marks ....................................................... 16

Loudon Co ...................................................................... 17


General comments

This examiner’s report should be used in conjunction with the published

September/December 2020 sample exam which can be found on the ACCA Practice

Platform.

In this report, the examining team provide constructive guidance on how to answer

the questions whilst sharing their observations from the marking process,

highlighting the strengths and weaknesses of candidates who attempted these

questions. Future candidates can use this examiner’s report as part of their exam

preparation, attempting question practice on the ACCA Practice Platform, reviewing

the published answers alongside this report.

The Financial Reporting (FR) exam is offered as a computer-based exam (CBE). The model of delivery for the CBE exam means that candidates do not all receive the same set of questions.

• Section A objective test questions – we focus on four specific questions that

caused difficulty in this sitting of the exam.

• Section B objective test case questions – here we look at one specific question

that was challenging for candidates.

• Section C constructed response questions – here we provide detailed

commentary around two constructed response questions and identify some of

the main issue that have affected candidates’ performance in this section of the

exam, identifying common knowledge gaps and offering guidance on where

exam technique could be improved, including in the use of the CBE functionality

in answering this question.

https://cbept.accaglobal.com/sso/acca




Section A Here we look at FOUR Section A questions which proved to be particularly challenging for candidates.

Question 1

Pater Co acquired 80% of the issued equity share capital of Sono Co on 1 May 20X1, when the balance on Sono Co's retained earnings was $520,000.

On 15 November 20X8, Sono Co made $240,000 sales of goods to Pater Co, on which Sono Co made a mark-up (on cost) of 20%. Pater Co subsequently sold one-quarter of these goods to external parties prior to 31 December 20X8.

At 31 December 20X8, the retained earnings of Pater Co and Sono Co were $4m and $3.4m respectively.

What retained earnings should be reported in Pater Co's consolidated statement of financial position as at 31 December 20X8 (to the nearest $'000)?

$ ____________ ,000

What does this test? This question tests learning outcome D2(a) where candidates should be able to prepare a consolidated statement of financial position for a simple group. It is important to note this area of the syllabus can be tested anywhere in the Financial Reporting exam and is not restricted to section C. As this is a fill in the blank, candidates should take care to read all the information given to ensure their calculation is accurate and has taken account of all the details provided. Unfortunately, most candidates made one error by not reading the question scenario carefully enough. The three most common errors were:

(i) calculating the PUP adjustment using margin rather than mark-up; (ii) not reflecting the 80% ownership; or (iii) not taking into account the retained earnings figure in Sono Co at the date of

acquisition. It is worth pointing out that most candidates who did not arrive at the correct figure only made one of these errors which suggests they are not methodically working through the information given. What is the correct answer? The correct answer is $6,280,000 calculated as follows: PUP on sales made by Sono Co to Pater Co $240,000 x 20/120 x ¾ unsold = $30,000

Consolidated retained earnings at 31 December 20X8 are:

For Pater Co $4,000,000


For Sono Co (3,400,000 – 520,000 pre-acquisition (given in question) – 30,000 PUP) x 80% share = $2,280,000

This gives a total of $4,000,000 + $2,280,000 = $6,280,000

Where did candidates go wrong? As indicated above the common errors were:

(i) Using margin – so calculating PUP as $240,000 x 20% x ¾ unsold = $36,000 so arrived at $4,000,000 + (3,400,000 – 520,000 – 36,000 PUP) x 80% share = $6,275,200

Or

(ii) Not adjusting for 80% so $4,000,000 + (3,400,000 – 520,000 – 30,000 PUP) = $6,850,000

Or

(iii) Not adjusting for pre-acquisition retained earnings so $4,000,000 + (3,400,000 – 30,000 PUP) x 80% = $6,696,000

Question 2

What does this test? This question tests learning outcome B4(a) where candidates should be able to account for inventories applying the requirement that inventory be measured at the lower of cost and net realisable value (NRV). What is the correct answer? The correct answer is calculated as follows: Cost (given in question) $14,900

At 31 December 20X4, Litch Co had, in inventory, 100 items of work in progress which had cost $14,900 to produce. It estimated that the work in progress would cost $13 per unit to complete, and that each unit would then sell for $166. Direct selling costs are estimated at 2% of revenue. In accordance with IAS 2 Inventories, what is the correct value of Litch Co’s inventory as at 31 December 20X4? Options:

A. $14,900

B. $16,268

C. $16,200

D. $14,968


NRV = Realisable value (selling price) less costs of completion less costs to make the sale 100 units x ($166 - $13 - ($166 x 2% = $3.32)) = $14,968 Therefore, cost is lower and the correct answer is A. $14,900

Where did candidates go wrong? The most common error was to add the costs to complete (100 x $13) to the cost to produce and therefore chose C, $16,200. This demonstrated a lack of understanding of the basic principles of valuing inventories and suggests that candidates might focus practice and learning on more complex areas of the syllabus but they should not ignore the more straightforward learning outcomes, especially if they build on prior learning and knowledge.

Question 3 What does this test? This question tests learning outcome C2(a) where candidates should be able to calculate accounting ratios and know what and how an accounting adjustment might impact these ratios. This tests more deeply whether the candidate understands the components of a ratio calculation. It is important to note this area of the syllabus can be tested anywhere in the Financial Reporting exam and is not restricted to section C. What is the correct answer? The correct answer is A. as the revaluation of a significant asset will cause all 4 ratios to decrease. The revaluation is at the beginning of the year and will affect the depreciation for the year and therefore operating profit: ROCE – increased depreciation will reduce profit and capital employed will increase due to the revaluation surplus but the denominator (including the revaluation surplus) will increase more.

Which of the following ratios are likely to DECREASE due to a significant revaluation gain on a depreciating asset at the start of the year?

(1) Return on capital employed (ROCE)

(2) Gearing (debt/equity)

(3) Operating profit margin

(4) Net asset turnover

Options:

A. 1, 2, 3 and 4

B. 1, 2 and 3 only

C. 2, 3 and 4 only

D. 1 and 4 only


Gearing – increase in equity due to the revaluation surplus will decrease the ratio as debt will not be affected Operating profit margin – reduction in profit due to increased depreciation Asset turnover – increase in assets (PPE) due to revaluation even if the asset has one year’s worth of depreciation. Where did candidates go wrong? A significant number of candidates focussed on the impact of the revaluation surplus without considering the impact of increased depreciation on the operating profit and therefore chose D. It is important that candidates have a deep understanding of how ratios are calculated and how adjustments to the financial statements can impact the numerator and/or the denominator. Rote learning ratios is not useful for section C where they need to interpret these ratios.

Question 4

Identify TWO associate companies of Zuckal Co (one from each group of three)

What does this test? This question tests learning outcome A4(j) where candidates should be able to define an associate and explain the principles and reasoning for the use of equity accounting.


It is important to note that associate companies and equity accounting can be tested anywhere in the Financial Reporting exam and is not restricted to section C where the computational approach to equity accounting may be examined. Candidates need to carefully read all the information as the details are very important for them to differentiate. It is also important to read the instructions – they must select one from each group of three to gain the 2 marks as partial marks are not awarded. What is the correct answer? Group 1 The 50% owned in Castur Co will give significant influence as Zuckai Co will not have the power to direct operating decisions but will be able to have significant influence over Castur Co through being able to participate in the financial and operating decisions. Group 2 The 15% owned in Fumitt Co will also give significant influence as no individual party will have control or the ability to appoint 2 board members. It is important that candidates understand the 20% holding is a rebuttable presumption and candidates need to read all of the information provided and not merely concentrate on the % holdings given. Where did candidates go wrong? Artles Co should be treated as a trade investment as there is neither significant influence nor control – most candidates correctly identified this was not an associate Bandoka Co should be accounted for as a subsidiary as Zuckai Co controls the majority of the voting rights in the company – this was a common error as the candidates were only considering the shares owned (40%) Dunnatonn Co should be treated as a trade investment as despite owning 21%, the other 79% is owned by Yentee Co which gives them control. Again, candidates often got this incorrect as they were focussing on the 21% rather than considering the wider information. Eahnn Co will be accounted for as a subsidiary and most candidates identified this correctly.


Section B

Section B tests candidates’ knowledge on a number of IFRS standards in more depth than section A, with three case questions containing five two-mark objective test questions. The range of topics tested in the September and December 2020 examination included:

• Tangibles and Intangibles, impairment, held for sale and government grants

• Earnings per share and discontinued operations

• Foreign currency transactions

• IFRS 16 leases

• Revenue recognition (contracts for goods and service, contracts over time)

We have selected one of the cases that examined IFRS 15 Revenue from Contracts with Customers as these continue to challenge candidates. You should note a case will be a mixture of narrative and calculation questions and can also include different styles of OT questions similar to those used in section A. Candidates should also read the case scenario and its requirements carefully. As these questions score either 2 marks or zero marks, it is important that they do not misread or miss any information in the scenario. Close reading of the requirements is also important to identify specific instructions such as rounding. Section B – Case question

The following details relate to three of Campbell Co's contracts:

Contract 1 has a total price of $9m and commenced in 20X7. Total costs are expected to be $7m. The progress towards completion is assessed at 90% at 31 December 20X8. Progress was measured at 20% for the year ended 31 December 20X7.

Contract 2 commenced in December 20X8 and is expected to generate a profit of $3m. It is too early in the contract to assess progress towards completion. Campbell Co has spent $0.2m so far, all of which is expected to be recoverable from the customer when Campbell Co sends its first invoice in 20X9.

Contract 3 relates to the sale of equipment to a customer for $2.36m on 1 July 20X8. The sale included $0.4m for installation of the equipment and $0.2m relating to 12 months after-sales support. The equipment was installed on 1 July 20X8.


Question 1

Which of the following correctly reflects how revenue should be recognised in accordance with IFRS 15 Revenue from Contracts with Customers?

Options:

(1) Revenue should be recognised as an entity satisfies a performance obligation

Correct Not correct

(2) Progress towards completion on a contract should be measured solely on an input basis

Correct Not correct

What is the correct answer? Statement (1) is correct but statement (2) is not correct as progress can be measured using input or output methods Where did candidates go wrong? Most candidates got the correct answer but many thought statement (2) was also correct. We suspect they saw the term ‘input method’ and recognised it as relating to IFRS 15 without reading carefully the whole statement. The crucial point was ‘solely’ – they should have known there were alternative acceptable methods.

Question 2

What revenue should be recognised in respect of Contract 1 in Campbell Co's statement of profit or loss for the year ended 31 December 20X8?

$________________m

What is the correct answer? $6.3m As the contract is 90% complete (given in question), cumulative revenue of $8.1m (90% x $9m) should be recognised by 31 December 20X8. However, $1.8m (20% x $9m) will have been recognised in 20X7 so only $6.3m can be recognised in the current year ($8.1 – 1.8m)

Where did candidates go wrong? Although the majority of candidates got this correct, a significant number made common errors. The most common errors were to calculate:


(i) $1.4m – these candidates had taken 70% of the contract profit ($9m - $7m). These candidates had not read the question carefully to identify it was revenue that was required

(ii) $8.1m – these candidates had not taken account of the fact that this contract was in its second year and that they needed to deduct the revenue already recognised in the prior year

Question 3 Which of the following items would NOT be recorded in the financial statements for 20X8 of Campbell Co in respect of Contract 2?

Options: A. Revenue $0.2m

B. Cost of sales $0.2m

C. Contract asset $0.2m

D. Contract liability $0.2m

What is the correct answer? D – the candidates were asked what will NOT be recorded. Revenue will be recognised to the level of recoverable costs where the progress cannot be measured (IFRS 15 para 45). Therefore $0.2m should be recognised as Revenue and cost of sales. As no invoice has yet been issues a contract asset will be recognised for $0.2m. Where did candidates go wrong? This was the question within the case that candidates found most challenging with a range of options although the most common option chosen was A – which would be not to recognise revenue. This suggests candidates again were not reading the requirement and instead calculated the revenue to be recognised, saw the option and chose it rather than reflecting on what they should actually have been selecting.


Question 4

What revenue should be recognised in respect of Contract 3 in Campbell Co’s statement of profit or loss for the year ended 31 December 20X8?

Options: A. $2.06m

B. $2.16m

C. $2.26m

D. $2.36m

What is the correct answer? C – The after sales support will be recognised over the 12-month period. As Campbell Co has already provided 6 months of support, $0.1m can be recognised meaning that $2.26m can be recognised overall ($2.36m - $0.1m).

Where did candidates go wrong? We felt that two fill in the blanks on the calculation questions within this case would have potentially made it too challenging and in fact the candidates performed very well in this question, perhaps because MCQ styles tend to perform better. The most common errors were either to remove all the after sales support or not adjusting for it (perhaps not reading the dates carefully).


Question 5

Campbell Co offers its customers an accessory for the equipment that it sells in contract 3. Campbell Co does not manufacture the accessory itself, but has an agreement with the manufacturer to sell the accessory on the manufacturer's behalf. Campbell Co places the order with the manufacturer and the manufacturer delivers the accessory direct to the customer. The customer pays Campbell Co for the accessory and Campbell Co then deducts 3% commission before paying the manufacturer.

An accessory is delivered to one of Campbell Co's customers on 10 December 20X8, which the customer has accepted and will pay $50,000.

Which of the following correctly describes how Campbell Co should recognise this transaction?

Options: A. $50,000 should be recognised as revenue by Campbell Co when the accessory has been delivered and accepted by the customer

B. $1,500 should be recognised as revenue by Campbell Co when the accessory has been paid for by the customer

C. $1,500 should be recognised as revenue by Campbell Co when the accessory has been delivered and accepted by the customer

D. $50,000 should be recognised as revenue by Campbell Co when the accessory has been paid for by the customer

What is the correct answer? C – Campbell Co is acting as an agent as the equipment accessory is delivered directly to the customer from the manufacturer. Only the 3% commission should be recognised as revenue (3% x $50,000 = $1,500). As the customer has taken delivery and accepted the price of $50,000, the revenue can be recognised at that point.

Where did candidates go wrong? We were pleased that candidates understood how IFRS 15 applies to principal/agent relationships and the majority got this correct. The most common error was delaying recognition of the revenue until payment would have taken place (B).


Section C We have selected two constructed response questions, Karl Co and Loudon Co, that

are available on the ACCA Practice Platform. Karl Co is a financial statements

analysis and interpretation question for a group entity, while Louden Co is a financial

statements preparation question for a single entity. When using the following detailed

commentary it would be helpful to consult the questions and answers available to

you here.

Karl Co

Karl Co shares similarities with recent questions examined on the syllabus area of

analysis and interpretation of the financial statements (syllabus section C). The

question had both numerical information and additional information relating to a

subsidiary that was sold at the end of the financial year and candidates were asked to

complete a variety of tasks using this information.

The analysis and interpretation of a group is an important area of the syllabus and will

continue to be examined. As in previous examination sessions, most candidates failed

to score high marks on this question. The reason for this seemed to be poor exam

technique by not addressing the requirement or adequately using the information in

the scenario. The focus for this detailed commentary will be on getting the most out of

the question, rather than simply recreating the suggested solution and will highlight

the importance of using the scenario when constructing an answer to an interpretation

question.

From an exam technique point of view, time management is crucial in performing well

in any exam. Typically, in a 3 hour exam, you would allocate 1.8 minutes per mark

(180 minutes/100 marks = 1.8 minutes per mark). The maximum amount of your exam

time that you should spend on Karl Co is 36 minutes.

There is a lot of information contained within the question itself that you will need to

become familiar with. It is important that you take the time to read through the

information in the question and use the onscreen tools available to highlight important



information, use your scratch pad to make any key notes etc. On this basis, it may be

better to allocate 1.5 minutes per mark in each of the three requirements which will

allow you six minutes to read (and make sense of) the scenario and allow some time

at the end for checking your answer.

Requirement (a) – 4 marks

The calculation is only worth four marks and based on the discussion above, you would

have approximately six minutes to answer this requirement (1.5 minutes per mark x 4

marks). It is vital that you do not overrun on the allocated time on this task as this will

be detrimental to the analysis that you are able to provide in the next requirement. In

the time taken to read the scenario, you will have noted that all the information required

to answer this part of the question is included in the opening paragraphs, before the

extracts of the financial statements.

You should take the time here to consider how a gain or loss on disposal to be included

in the consolidated accounts should be calculated. A common error noted by the

marking teams on this question was candidates providing a calculation that would be

included in the single entity financial statements of Karl Co.

You are advised to lay out the working for the disposal in the workspace first, for

example:

£ Proceeds X Less: net assets (X) Less: carrying amount of goodwill

(X)

Gain/loss on disposal X

You should have already noted that the subsidiary that was sold was wholly owned,

so you did not need to consider non-controlling interests. Once you have the structure

for the working in place, you can include information from the question requirement.

For example, the disposal proceeds and the net assets at disposal are given and can

be transferred directly into your working. The goodwill at the disposal date will need to

be calculated and you can either show this working separately and reference it to your

disposal calculation or you can include it directly within the cell area of the

spreadsheet. From a marker’s perspective, showing the calculation of goodwill

separately is preferable because it will be easier for the marker to determine how

figures have been arrived at and therefore potentially award marks under the own

figure rule, even if there are mistakes in some of the calculations.


Part (b) – 13 marks

The guidance given in the following commentary is not intended to reproduce the

suggested solution, but should give a candidate an idea on how to approach this part

of the answer.

When calculating the ratios, you must ensure that you show your workings, it is also

advised that you note the formula that you are using e.g. current ratio = current

assets/current liabilities. Accounting ratios are a key part of the financial reporting

syllabus and it is essential that you are familiar with these. The question requirement

informs you that there will be a maximum of five marks available for the calculation of

ratios and therefore you should spend approximately 7.5 minutes on these

calculations.

You may be provided with a pre-formatted table in these types of questions, but not

always. However, it would be helpful if you constructed a table that will allow you to

demonstrate your workings and make the analysis more ordered. For example:

Working 20X8 Working 20X7

Gross profit margin

If there is a ratio that you cannot remember how to calculate, it is a good idea to have

a go anyway as you may be partially correct. This not only means that you may be

able to earn part of the marks that would be available for the calculation, but also you

will have some results that will allow discussion in the commentary part of your answer.

The remaining eight marks available are allocated to the discussion of the

performance and position of the Karl group year on year. Many candidate

commentaries provided to these analysis style questions remain vague and generic.

This limits the number of marks that can be awarded. We do not need you to describe

what a ratio means or what an ‘acceptable’ ratio might be as they are not comments

that directly address the specific scenario you have been given.

You should ensure that you use the scenario in order to make the most of the question

and score as many marks as possible when analysing a company.

This question had many clues that could help to form your discussion. A disposal of a

subsidiary took place on the very last day of the accounting year. What is the impact

of this? Well, the consolidated profit or loss would contain a full year’s results for Sinker


Co, whereas, the statement of financial position, which is a snapshot at a point in time,

would not include any assets or liabilities of Sinker Co as control was lost at the

reporting date. This would lead to a massive distortion in comparing ratios such as

ROCE and gearing year on year. Many candidates failed to address this point at all.

The one-off redundancy costs would distort current year profitability and is a cost that

will not be repeated in subsequent years. This point could be supported further by

recalculating operating profit margin without this one-off cost to determine the impact

on this year’s profitability.

Even without the redundancy costs it can be noted that Sinker Co was already in a

loss making position ($17 million operating loss in total minus the $15 million

redundancy costs reflects a $2 million operating loss). This was likely due to the fact

that Sinker Co had lost a significant contract three months into the financial year.

Again, this needed to be referred to in the analysis as it would have had a detrimental

impact on the group revenue during the last nine months.

A point many candidates did not refer to was the loss on disposal that had been

calculated in part (a). Again, this is a one-off transaction within the consolidated

financial statements and will not be part of the results in the following years.

Candidates needed to refer to the fact that this was causing group profitability to fall in

the current year, but would not impact the performance in the future.

By referring to this information in your analysis and using it as potential justification for

the changes in the ratios year on year, you should be able to provide the marking team

with a commentary that attracts marks available in the marking scheme.

A final point to note is that a conclusion to your analysis should always be provided.

This conclusion does not need to be overly comprehensive, but should state your final

opinion on the performance and position of the Karl group year on year. It is always

worth re-reading the scenario before you write your conclusion, and make sure you

have used each separate point of information provided.

Part (c) – 3 marks

This part of the question was often overlooked by candidates which demonstrated a

lack of time management. This was a standalone requirement for three marks

(approximately 4.5 minutes) which could have been attempted first to ensure that it

was covered.

The main factors affecting the comparability of the financial statements are points that

will be addressed in part (b) such as the one-off costs and the disposal resulting in a

full year’s results in the consolidated statement of profit or loss but only the assets and

liabilities of Karl and its other subsidiary in the consolidated statement of financial

position.


It is important to note that you are not expected to recreate the analysis from part (b)

and use these points to explain the performance, rather provide them as justification

as to why comparability has been impaired. The rule of thumb you should use, is that

one well explained point will be worth 1 mark so you were expected to make 3

reasonable points.

Loudon Co

Loudon Co is a typical example of a published financial statements preparation

question from section C of the exam, covering syllabus areas D and B. In this type of

question, you will be provided with a trial balance (or an extract from a trial balance)

and some additional information that will require adjustment in accordance with

relevant IFRS Standards and accounting principles.

Question requirements will vary, but you can expect to be asked to prepare a mixture

of a statement of profit or loss and other comprehensive income, a schedule of

adjustments to profit, a statement of changes in equity, a statement of financial

position, or a specific extract from the financial statements such as, ‘financing

activities’ from the statement of cash flow.

Before you attempt this question, make sure you are clear on what the requirement is

asking for. There is no point in, for example, preparing a statement of changes in equity

when the requirement has asked for a schedule of adjustments to retained earnings

and a statement of financial position. Providing additional statements that are not

required wastes valuable time and will not attract any marks.


Overall, this question is worth 20 marks. For 20 marks you would allocate 36 minutes

of your exam time to answering this question (180 minutes/100 marks = 1.8 minutes

per mark x 20 marks). For many questions, it will be advised that you further sub-divide

this time between the separate tasks e.g. part (a) is worth 8 marks and therefore 14.4

minutes could be spent on this (and similarly 21.6 minutes could be spent on part (b)).

However this approach is not advised for this type of question. Why? Well some of the

adjustments required to the trial balance will impact both the adjustment to retained

earnings and the statement of financial position and so it makes more sense to deal

with these separate tasks together. This approach will be further explained below.

From an exam technique perspective, it is advised that you set up the proforma for the

requirements first. For example, for Loudon Co, layout the working for the adjusted

profit calculation and the statement of financial position within the workspace. Perhaps

leave an extra row between each heading in case you need to insert a new heading

on the statement. This will give you focus when dealing with the additional information

and will enable you to update the required statements accordingly.

As a general comment, you must ensure that all trial balance items are included either

in the relevant working or within the financial statements themselves. It is often noted

by the marking team that some balances are not transferred from the trial balance into

the answer and therefore, what are considered to be easy marks, are lost. In this

question, equity shares, current assets and current liabilities did not require adjustment

as a result of the additional information and needed to be transferred directly to the

statement of financial position. Including these balances in this statement attracted

marks from the marking scheme.

It is important to note that you do not have to deal with the adjustments in the order

presented in the question, although this is a logical approach and will ensure you do

not miss out any required adjustments. However, for example, in this question you

may be most confident with adjusting the environmental provision in note (3) and less

confident with the loan note in note (1). Dealing with the adjustments that you are most

familiar with first will ease you into the question and stop panic setting in.

The following discussion will look at each of the adjustments in more detail and may

help when you work through the question as a practice question.

(1) Loan note

In this question, Loudon Co had incorrectly expensed the direct issue costs. Per IFRS

9 Financial Instruments, such costs should be deducted from the proceeds of the loan

and not expensed. This adjustment was often incorrectly treated in the exam, with


many candidates only adjusting one side of the transaction, or omitting the adjustment

all together. To fix this error, the issue costs need to be added back to profit in part (a)

and deducted from the loan note proceeds of $5 million.

The adjusted loan amount (net proceeds of $4,875,000) then needed to be accounted

for using the amortised cost method. This was often done well and attracted own figure

marks even where the issue costs had not been dealt with correctly but the effective

interest rate was used correctly. There was some confusion with the finance cost

though as the trial balance has recorded the interest paid separately to retained

earnings and therefore, once calculated, the effective rate of interest needed to be

deducted from retained earnings in full as it had not been adjusted yet. A common

error was where candidates took the difference between the effective rate of interest

and the cash paid as an expense in part (a).

This adjustment demonstrates the benefit of already preparing proformas for both part

(a) and (b) before starting your detailed workings. You can use your working to

immediately adjust the TB profit figure (part (a)) by the effective interest rate finance

cost you have just calculated (deduct $390,000) and include the closing balance for

the loan note under non-current liabilities in the statement of financial position

($5,015,000).

(2) Non-current assets

This note contains information for both the office building and factories and requires

knowledge of both IAS 16 Property, Plant and Equipment and IAS 36 Impairment. It is

advisable to deal with each asset category separately. Again, you can choose which

adjustment you wish to deal with first.

You need to be very clear on the dates in this part of the question to deal with the

adjustment to the office building correctly. Not taking the time to look at the dates and

determine what they mean may lead to incorrect workings taking place. You may find

it useful to consider a timeline of events as part of your workings. For example, the

financial year for Loudon Co begins on 1 October 20X7 and ends on 30 September

20X8. Mid-way (six months) through this year (1 April 20X8) the office was deemed to

be impaired. These dates should now form the structure for this part of the working.

Initially a six-month depreciation charge for the building (based on the original life of

25 years) is required between 1 October 20X7 and the date of impairment. On 1 April

20X8, the building should be reviewed for impairment by comparing the carrying

amount of the building at that date (cost b/f minus accumulated depreciation b/f minus

six months depreciation calculated to 1 April 20X8) to the fair value. Once the

impairment expense is identified and accounted for as both a reduction in the retained

earnings and the carrying amount of the asset, the final six months depreciation can

be calculated. Following the impairment, depreciation will be calculated by spreading

the impaired carrying amount over the remaining life of the asset (estimated at the

date of impairment). Don’t forget to only take six months of this final depreciation

calculation. At this point, include the impairments and the depreciation to your adjusted

retained earnings (part (a))


The factory that was sold at the beginning of the financial year has not yet been

accounted for correctly. This disposal will need to be dealt with first before the annual

depreciation charge is calculated. When there is a disposal of a non-current asset, the

carrying amount of the asset should be removed from the statement of financial

position and compared with the proceeds to determine if there is a gain or loss that

should be recorded in the statement of profit or loss. Many candidates correctly

calculated the gain on the disposal, but failed to remove the asset on the statement of

financial position. Another common error noted was the deduction of the gain on

disposal from the adjustment to retained earnings in part (a).

The depreciation charge for the remaining nine factories can be calculated once the

disposal has been adjusted for. Depreciation for this category of asset uses the

reducing balance method. The 15% depreciation rate will be applied to the carrying

amount of the factories left after the disposal. The depreciation charge is an expense

and once again should be treated as a deduction against retained earnings.

The main issue with the adjustments required by this note was not providing adequate

workings. Again, another useful rule of thumb is that if you are using your calculator to

find a figure, you should be replicating that in a working for the marker to see.

(3) Environmental provision

This should have been a relatively straightforward adjustment requiring knowledge of

IAS 37 Provisions, Contingent Assets & Contingent Liabilities. The information given

in the question informs us that the environmental provision has already been correctly

accounted for in the previous accounting period and that it relates to a liability at the

end of the factory’s useful life. The time value of money would have been taken into

account and the provision would have been discounted to present value in the

previous accounting period. Therefore, the only adjustment required here is to unwind

the discount for the year using the cost of capital of 5%. This will then need to be

treated as both a finance cost in part (a) and an increase in the provision in part (b).

Another rule of thumb is that if you are given a cost of capital or discount rate you are

expected to use it.

There was a tendency to overcomplicate this adjustment, by further discounting the

trial balance amount and then unwinding. This may have been due to a lack of

understanding of the required treatment or, most likely, was due to not taking the time

to read the information in the question thoroughly. It is important that you review the

information you are given carefully and consider what accounting has already been

done (sometimes nothing) and what is left to do.

(4) Deferred tax

This adjustment was not done well by the majority of candidates. It was considered

that this was as a result of not reading the information in the question properly, rather

than there being a lack of working knowledge of the calculation for deferred tax. The

information in this note provided you with a tax written down value. Most candidates

mistook this for a temporary difference and incorrectly multiplied the $25 million by the

tax rate of 20%.


The question actually required you to calculate a temporary difference by comparing

the tax written down value to the total carrying amount of non-current assets

(calculated following the adjustments made from note (2)). Candidates were given

credit for calculating the temporary difference under the own figure rule so even if the

property, plant and equipment figure was not correct, credit was given for

demonstrating understanding of the deferred tax calculation. This temporary

difference should then be multiplied by the tax rate to arrive at the closing deferred tax

liability for the statement of financial position. Finally, the opening and closing amounts

should be compared and the increase in deferred tax reported as a reduction in

retained earnings. This adjustment is something that candidates are encouraged to

have an awareness of for future examination sessions.

Once you have worked through all the notes, check that you have transferred all the

figures from the trial balance.

One last observation is that it is disappointing that candidates do not appear to be

practising these type of questions using a spreadsheet. It is worthwhile doing so and

then standing back and considering whether you could follow the workings and see

clearly how all the figures have been arrived at if you were the marker? Familiarity with

the CBE environment and the available functionality is vital to success in the exam

and we would always recommend looking at the CBE specimen exam and using the

practice platform when using past exam questions.

financial reporting (fr) sept / dec 2020 examiner’s report

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