Test f7int 002

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Exam details (completed by BPP Professional Education)

Course Examination 2

ACCA PAPER F7 (INT)

Financial Reporting (International)

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RESULTS Question Maximum Score

1 25 2 25 3 25 4 15 5 10

Total 100

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ACCA

Fundamentals

Paper F7

Financial Reporting

(International)


Question Paper

Time allowed

Reading and Planning Writing

15 minutes 3 hours

ALL questions are compulsory and MUST be attempted

Instructions: Please attempt this exam under test conditions and attach the frontsheet complete with your name and address to your script. The completed package should be sent to BPP Professional Education.

Take a few moments to review the notes on the inside of this page titled, ‘Get into good exam habits now!’ before attempting this exam.

DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER EXAMINATION CONDITIONS


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Get into good exam habits now! Take a moment to focus on the right approach for this exam.

Effective time management • Watch the clock, allocate 1.8 minutes to each mark and move on if you get behind.

• Take a few moments to think what the requirements are asking for and how you are going to answer them.

• Remember one mark is usually allocated for each valid point you give in a discursive question.

Effective planning • This paper is in exactly the same format as the real exam. You should read through the paper

and plan the order in which you will tackle the questions. Always start with the one you feel most confident about.

• Read the requirements carefully: focus on mark allocation, question words (see below) and potential overlap between requirements.

• Identify and make sure you pick up the easy marks available in each question.

Effective layout • Present your numerical solutions using the standard layouts you have seen. Show and

reference your workings clearly.

• With written elements try and make a number of distinct points using headings and short paragraphs. You should aim to make a separate point for each mark.

• Ensure that you explain the points you are making ie why is the point a strength, criticism or opportunity?

• Give yourself plenty of space to add extra lines as necessary, it will also make it easier for the examiner to mark.

Common terminology Advise To counsel, inform or notify Analyse Examine in detail the structure of Calculate/compute To ascertain or reckon mathematically Compare and contrast Show the similarities and/or differences Define Give the exact meaning of Describe Communicate the key features of Discuss To examine in detail by argument Distinguish Highlight the differences between Evaluate To appraise or assess the value of Explain Make clear or intelligible/state the meaning of Identify Recognise, establish or select after consideration Interpret Process information to explain its meaning Justify To produce reasons in support of List State short pieces of information on separate lines Prepare To make or get ready for use Recommend To advise on a course of action Summarise To express the most important facts of


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1 Sahara Co As newly appointed chief accountant of Sahara Co, it is your responsibility to prepare a group statement of financial position as at 31 March 20X9.

The relevant statements of financial position as at that date are given below.

Sahara Co Gobi Co Angel Co $’000 $’000 $’000 Non-current assets Property, plant and equipment 98,000 87,750 52,470 Investments 146,000 – – 244,000 87,750 52,470 Current assets Inventories 24,250 14,550 36,360 Trade receivables 35,000 26,500 19,960 Cash 17,500 9,610 27,010 76,750 50,660 83,330

320,750 138,410 135,800 Equity Share capital - $1 ordinary shares 150,000 75,000 100,000 Retained earnings 137,650 61,100 17,040 287,650 136,100 117,040 Current liabilities Trade payables 33,100 2,310 18,760

320,750 138,410 135,800

The following information is also relevant.

(a) Sahara Co acquired 60 million of the ordinary $1 shares of Gobi Limited on 31 March 20X7 at a cost of $89 million. At 31 March 20X7 Gobi had a credit balance on its retained earnings of $9 million.

(b) During March 20X9 Gobi Co sold goods to Sahara Co for $12 million. On 31 March 20X9 half of these goods remain unsold. Gobi Co sells goods at a mark up of 25%.

(c) On 31 October 20X8, Sahara Co acquired 25 million of Angel Limited’s $1 ordinary shares at a cost of $57 million. Angel Co had a retained earnings credit balance of $16 million at this time.

(d) The fair values of Gobi Co and Angel Co were not materially different from their book values at the time of acquisition, with the following exceptions:

(i) Gobi Co held inventories with a fair value which was $2 million greater than book value. All of these inventories had been sold by 31 March 20X9.

(ii) Items of plant and equipment belonging to Gobi Co have a fair value of $5 million in excess of book value. The items were acquired by Gobi Co on 1 April 20X6 and are being depreciated over their useful life of five years.

No adjustment has been made by Gobi Co for either of the above items.

(e) An impairment test conducted as at 31 March 20X9 indicated that $7.2m of the recognised goodwill relating to the investment in Gobi should be eliminated. No impairment losses were necessary re the investment in Angel.


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(f) It is group policy to value non-controlling interests at fair value at date of acquisition. The directors valued the non-controlling interests at acquisition at $20m.

Required

(a) Prepare a consolidated statement of financial position for the Sahara group as at 31 March 20X9.

(20 marks)

(b) Your managing director has asked for an explanation of why it is necessary to invest staff time in preparing a set of consolidated financial statements as well as those of the individual companies of the group. Write a memo to her explaining the main advantages. (5 marks)

(Total = 25 marks)


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2 Hi Co Hi Co, listed on its local stock exchange, is a retail organisation operating several retail outlets countrywide. A reorganisation of the company was started in 20X2 because of a significant reduction in profits. This reorganisation was completed during the current financial year.

The trial balance for Hi Co at 30 September 20X3 was as follows:

$'000 $'000 10% debentures 20Y0 1,000 Administrative expenses 615 Bank and cash 159 Buildings at 30 September 20X2 11,200 Cash received on disposal of equipment 11 Cost of sales 3,591 Debenture interest paid – half year to 31 March 20X3 50 Trade receivables 852 Distribution costs 314 Furniture and fixtures at 30 September 20X2 2,625 Investment properties at market value 30 September 20X2 492 Dividends paid 1,600 Rental income received 37 Ordinary shares of $1 each, fully paid at 30 September 20X3 4,000 Retained earnings at 30 September 20X2 1,390 Deferred tax liability 256 Provision for reorganisation expenses at 30 September 20X2 1,010 Accumulated depreciation at 30 September 20X2: Buildings 1,404 Furniture and fixtures 1,741 Reorganisation expenses 900 Revaluation surplus 172 Sales 9,415 Share premium 2,388 Inventories at 30 September 20X3 822 Trade payables 396 23,220 23,220

Additional information provided:

(i) The reorganisation expenses relate to a comprehensive restructuring and reorganisation of the company that began in 20X2. Hi Co's financial statements for 20X2 include a provision for reorganisation expenses of $1,010,000. All costs had been incurred by the year end, but an invoice for $65,000, received on 2 October 20X3, remained unpaid and is not included in the trial balance figures. No further restructuring and reorganisation costs are expected to occur and the provision is no longer required.

(ii) Investment properties are carried in the financial statements under the fair value of IAS 40. The market value of the properties at 30 September 20X3 was $522,000. There were no additions or disposals of investment properties held during the year.

(iii) On 1 November 20X3, Hi Co was informed that one of its credit customers, X Co, had ceased trading. The liquidators advised Hi Co that it was very unlikely to receive payment of any of the $45,000 due from X Co at 30 September 20X3.


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(iv) One of Hi Co's customers is suing the company for damages as a consequence of a faulty product. Legal advisers are currently advising that the probability of Hi Co being found liable is 75%. The amount payable is estimated to be the full amount claimed of $100,000.

(v) The income tax charge for the year ended 30 September 20X3 is estimated at $1,180,000 and the deferred tax liability needs to be adjusted to $281,000 (all movement to profit or loss).

(vi) The directors paid dividends amounting to 40c per share during the period.

(vii) During the year, Hi Co disposed of old equipment for $11,000. The original cost of this equipment was $210,000 and accumulated depreciation at 30 September 20X2 was $205,000 Hi Co's accounting policy is to charge no depreciation in the year of disposal. There were no additions to property, plant and equipment in the year.

(viii) Depreciation is charged to cost of sales using the straight-line basis on property, plant and equipment as follows:

Buildings 3% Furniture and fixtures 20%

(ix) On 1 April 20X3, Hi Co made a rights issue of 1 new share for 4 existing shares, at a price of $3. The fair value immediately before the rights issue was $4.25 per share. All the rights were taken up and all money paid by 30 September 20X3.

(x) On 30 September 20X3, the buildings were revalued to $9.5m. Ignore deferred tax effects.

Required

(a) Prepare the statement of comprehensive income for Hi Co for the year to 30 September 20X3 and a statement of financial position at that date. (20 marks)

(b) Calculate Hi Co's earnings per share for the year ended 30 September 20X3. (5 marks)

(Total = 25 marks)


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3 Busiquip Co Busiquip Co commenced trading in 20X2 selling business equipment such as computers, printers, fax machines, photocopiers, shredders and so on.

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X7 20X7 20X6 $ $ Non-current assets Property, plant and equipment 285,785 129,805 Current assets Inventories 327,490 191,039 Trade and other receivables 901,143 323,678 Cash 358 113 1,228,991 514,830

1,514,776 644,635 Equity Share capital 1,200 1,200 Retained earnings 275,124 183,788 276,324 184,988 Non-current liabilities 99,025 52,486 Current liabilities 1,139,427 407,161

1,514,776 644,635

STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20X7

20X7 20X6 $ $ Revenue 4,306,533 2,027,310 Cost of sales (3,289,702) (1,503,999) Gross profit 1,016,831 523,311 Administrative expenses (857,330) (390,750) Finance income 55 113 Profit before tax 159,556 132,674 Income tax expense (68,220) (43,536) PROFIT/TOTAL COMPREHENSIVE INCOME FOR THE YEAR 91,336 89,138

Additional information:

(a) Included in administrative expenses for the two years are:

20X7 20X6 $ $ Wages costs 496,235 201,841 Directors' emoluments 115,335 45,344 Depreciation 56,997 28,796 Interest payable 14,903 5,572

(b) $141,000 of the increase in the net book value of property, plant and equipment represents leased motor vehicles. In total they represent 79% of the total net book value at 31 December 20X7.

(c) The trade receivables at 31 December 20X7 are $802,793 whilst they were $322,528 at 31 December 20X6.


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(d) Current liabilities include an overdraft of $252,101 at 31 December 20X7; $39,979 at 31 December 20X6 and finance lease liabilities of $87,123 at 31 December 20X7; $40,342 at 31 December 20X6.

(e) Non-current liabilities consist of finance lease liabilities.

Required

You have been requested by the bank to assess the company's current position in the light of the company's request for an increased overdraft facility of $400,000.

Write a covering letter and a report giving your findings. The report should include an initial conclusion based on the evidence available and indicate what further information would be useful.

(Total = 25 marks)


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4 Nihao Co Nihao Co is preparing its accounts for the year ended 30 September 20X6.

The following information is available from the previous year's statement of financial position:

At 30 September 20X5 there were credit balances on the share premium account of $1,065,000 the revaluation surplus of $3,000,000 and retained earnings of $980,000. Issued share capital was 1,000,000 shares of $1 each.

During 20X5-20X6 the following transactions occurred

(a) 400,000 shares of $1 each were issued in exchange for cash proceeds of $1,500,000.

(b) A factory property that had been revalued from $300,000 to $980,000 in 20X3 was sold for $1,640,000. No transfers of realised profit have been made to date.

(c) Some land which originally cost $50,000 was revalued from $95,000 to $40,000.

(d) A warehouse property was revalued from $642,000 to $933,000.

(e) An adjustment for a change in accounting policy that reduces the previous year's profit by $320,000 was required.

(f) The separate income statement for the year ended 30 September 20X6 showed a profit for the year of $490,000. Dividends paid were $185,000.

Required

(a) Explain briefly

(i) The purpose of the two sections of the statement of comprehensive income ('profit or loss' and 'other comprehensive income').

(ii) The extent to which a user of the accounts will be better able to make decisions by referring to a statement of comprehensive income rather than just the statement of changes in equity. (5 marks)

(b) (i) Draft a statement of comprehensive income for the year ended 30 September 20X6 (insofar as the information permits, beginning with profit for the year from the separate income statement).

(ii) Draft a statement of changes in equity for the year ended 30 September 20X6. (10 marks)

(Total = 15 marks)


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5 Jupiter Co Jupiter Co is a manufacturing company with interests in the manufacture of kitchen appliances for the retail market and heavy engineering. The draft financial statements for the year ended 31 March 20X0 are about to be finalised. Two items have been noted for discussion with the auditors to determine their treatment in the final accounts. The group financial accountant has asked you to write a report explaining the best accounting treatment for these items.

Jupiter Co made a profit for the year in the year under review of $34 million on total assets of $116 million.

(i) A small rented factory specialising in the production of electric tin openers was closed during the year at a cost of $1.7 million.

A reorganisation of the factory which produces microwaves to cut labour costs has resulted in redundancies costing $1 million during the year. The factory is owned by Jupiter Co and a report was received on 1 May 20X0 from a professional valuer indicating that the value of the factory had fallen $4 million below its current carrying value. (5 marks)

(ii) On 1 April 20W9, Jupiter Co issued 100 million $1 loan notes. The issue costs were $100,000. The loan notes carry no interest entitlement but are redeemable on 31 March 20Y9 at a price of $259.1 million. Your assistant has included the nominal value of the loan notes ($100 million) as part of equity since they represent long-term finance for the company. The issue costs of $100,000 have been charged to profit or loss for the year, and your assistant suggests that the difference between the issue price and the redemption price should be dealt with in 20X9 when the loan notes are redeemed. You have (correctly) calculated the internal rate of return of the bond to be 10%. (5 marks)

(Total = 10 marks)


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Student self-assessment Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use this as a basis to focus your future study on effectively improving your performance.

Common problems Future emphasis if you answer Yes

Timing and planning

Did you finish too early? Y/N Focus your planning time on generating more ideas. Use models to help develop breadth to your thinking.

Did you overrun? Y/N Focus on allocating your time better. Practise questions under strict timed conditions. If you get behind leave space and move on.

Did you waffle? Y/N Focus your planning time on developing a logical structure to your answer.

Layout

Was your answer difficult to follow? Y/N Use headings and subheadings. Use numbering sequences when identifying points. Leave space between each point.

Did you fail to explain each point clearly? Y/N Show why the point identified answers the question set.

Did you fail to show any workings or were your workings unclear? Y/N Give yourself time and space to make the marker's job easy.

Content

Did you struggle with:

Interpreting the questions? Y/N Learn the meaning of common terminology (inside front cover). Learn subject jargon (key terms in study text). Read questions carefully noting all the parts. Practise as many questions as possible.

Understanding the subject? Y/N Review your notes/text. Work through easier examples first. Classroom students please contact your tutor for further help. Home Study students please contact ACCA queries for further help ([email protected]).

Remembering the notes/text? Y/N Quiz yourself constantly as you study. You need to develop your memory as well as your understanding of a subject.


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ACF7CE08(D) INT

AC28 – F7 INT (2)

ACCA

Fundamentals

Paper F7

Financial Reporting (International)


Commentary, Marking scheme and Suggested solutions


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Commentary Tutor guidance on improving performance on the exam paper. Overall, this was a balanced paper testing important areas of the syllabus. The questions were all of a style and standard that you would expect to see on a real examination paper.

This paper was fairly time pressured so good time allocation was important.

Q1 Sahara Co This was a question requiring the preparation of a consolidated statement of financial position, including an associate, with non-controlling interests at fair value. The question was fairly time pressured so a logical approach was essential. You should have dealt with basic figures first before moving on to deal with the adjustments. Noting adjustments on the face of the question paper is a useful way of ensuring that you don’t forget to incorporate them into your solution. You should have referenced your solution back to any working to make it easier for the marker to follow.

Q2 Hi Co This question is very typical of what your examiner sets as question 2. To pass part (a) which required a statement of comprehensive income and statement of financial position you need to adopt a methodical approach:

(1) proforma (2) download trial balance (3) deal with additional information

Part (b) required you to calculate the earnings per share where there had been a rights issue – remember

you need to adjust for the bonus fraction (price rights ex lTheoretica

rights of exercise beforey immediatelFV ) to arrive at the weighted

average number of shares.

Q3 Busiquip Co When attempting an interpretation question like this one, you must recognise that the majority of marks are for the report rather than the calculation of ratios. For example, in this question only 5 marks could be obtained by calculating ratios. You must make sensible business orientated comments, not just state that a ratio has gone up or down.

Q4 Nihao Co

This question tested your knowledge of the disclosure requirements of IAS 1. It illustrates how important it is to learn these layouts in order to pick up marks for simply slotting figures into the right “boxes”. It is also essential to get used to discussing the usefulness of various accounting treatments


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Q5 Jupiter Co This question required you to write a report explaining the best accounting treatment for various items. You should have noted the mark allocation and allocated the appropriate time to each part of the question. In a question of this type you should refer to relevant accounting standards.


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1 Sahara Co

Top tips. Read this question through during your reading time and underline the important points. Then read it again before you start to answer it, so that you know exactly what you have to do. Points to note are that there is a movement to account for on the fair value adjustment, that the unrealised profit is in the subsidiary, and that non-controlling interests are at fair value. Note that the non-controlling interests bear 20% of the goodwill impairment, which means in this case that goodwill in the non-controlling interests has been fully written off.

Easy marks. If you dealt correctly with the goodwill calculations you could have scored 5 marks for the intangible assets and the associate. There were another 5 marks available for current assets and current liabilities and 5 marks for part (b). So you could have scored half marks just on these areas.

Marking scheme Marks

(a) Statement of financial position Non-current assets – Property, plant and equipment 2 – Goodwill 3 – Investment in associate 2 7 Current assets – Inventories 2 – Trade receivables ½ – Cash 1 3½ Equity – Share capital ½ – Retained earnings 5 – Non-controlling interests 3½ 9 Current liabilities – Trade payables ½ __ Maximum 20 (b) 1 mark for each valid point properly explained to maximum 5 Total 25


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Suggested solution (a) SAHARA GROUP CO – CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH

20X9

$’000 Non-current assets Property, plant and equipment (98,000 + 87,750 + (W3) 2,500) 188,250 Goodwill (W4) 10,800 Investment in associate (W5) 57,260 256,310 Current assets Inventories (24,250 + 14,550 – (W2) 1,200) 37,600 Trade receivables (35,000 + 26,500) 61,500 Cash (17,500 + 9,610) 27,110 126,210

382,520

Equity attributable to owners of the parent Share capital 150,000 Retained earnings (W7) 169,270 319,270 Non-controlling interests (W6) 27,840 347,110 Current liabilities Trade payables (33,100 + 2,310) 35,410 382,520

Workings

1 Group structure

Sahara Co

mil 75mil 60

= 80% mil 100mil 25

= 25%

Gobi Co Angel Co

2 Unrealised profit on inventories

$’000 (6,000 × 25/125) 1,200

3 Fair value table

At Acquisition Change At year end $'000 $'000 $'000 Inventories 2,000 (2,000) – Plant and equipment 5,000 (2,500)* 2,500 7,000 (4,500) 2,500

* $5m/(5 – 1 years) x 2 years


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4 Goodwill – Gobi Co

Group NCI $’000 $’000 $’000 Consideration transferred 89,000 Fair value of non-controlling interests 20,000

Fair value of net assets acquired:

Share capital 75,000

Retained earnings 9,000

FV adjustments (W3) 7,000 91,000

Group/NCI share (80%/20%) (72,800) (18,200)

Goodwill 16,200 1,800

Impairment losses to date (7,200 × 80%/20%) (5,760) (1,440) 10,440 360

10,800

5 Investment in associate

$’000 Cost of associate 57,000 Share of post-acquisition retained earnings ((17,040 – 16,000) × 25%) 260 57,260

6 Non-controlling interests at end of reporting period

$’000 Net assets 136,100 Fair value adjustments (W3) 2,500 PUP (W2) (1,200) 137,400 Non-controlling interest in identifiable net assets (× 20%) 27,480 Non-controlling interest in goodwill (W4) 360 27,840

7 Retained earnings Sahara Co Gobi Co Angel Co $’000 $’000 $’000 Per question 137,650 61,100 17,040 PUP (W2) (1,200) FV adjustment movement (W3) (4,500) Pre-acquisition (9,000) (16,000) 46,400 1,040 Gobi Co - share of post acquisition earnings ( 46,400 × 80%) 37,120 Angel Co - share of post acquisition earnings (1,040 × 25%) 260 Less: group impairment losses to date (W4) (5,760) 169,270


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(b) To: Managing Director From: Chief Accountant Date: 5 May 20X9 Subject: Consolidated financial statements

The idea behind consolidated financial statements is to show a group of companies as a single economic entity, which gives a more accurate representation of the performance of the whole group. This is for several reasons:

• The separate financial statements of the parent entity only show dividend income from the subsidiary and therefore do not accurately represent the profits made by the group which include all of the profits made by the subsidiary less amounts due to non-controlling shareholders

• Trading between group companies is reflected in the sales and purchases in each group company's profit or loss section of the statement of comprehensive income, but from the point of view of the whole group is artificial because it is within the group. This is eliminated on consolidation, therefore showing a true picture of trading with third parties.

• The separate financial statements of the parent normally show the investment made in the subsidiary at its cost rather than the true picture of the accounting valuation of assets and liabilities at the year end under the group's control.

• The group financial statements also show the amount of money paid attributable to purchased goodwill and whether this has subsequently fallen in value.

Without the consolidated financial statements, it is impossible for the shareholders of the parent entity to see the full picture of their investment in the whole group and make accurate investment decisions.

Additionally, it is a requirement of IAS 27 Consolidated and Separate Financial Statements that consolidated financial statements are prepared where appropriate for companies who wish to state that their financial statements are prepared in accordance with International Financial Reporting Standards.


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2 Hi Co

Top tips. You have a statement of comprehensive income and statement of financial position to do here so you need to work fast. Get down the pro-formas, noting that you will have a write-back of restructuring costs and a profit on disposal to include in the statement of comprehensive income. Then work through the information and make sure all items in the trial balance are accounted for.

Easy marks. The statement of comprehensive income and statement of financial position had no serious complexities, so there were lots of easy marks available. Part (b) required a bit of working out, so that was 5 not particularly easy marks.

Marking scheme Marks (a) Statement of comprehensive income

Revenue ½ Cost of sales 1 Distribution costs ½ Administrative expenses 1 Finance costs 1 Provision reversed unused ½ FV gain on investment properties ½ Profit on disposal of equipment ½ Rental income ½ Income tax expense 1

Gain on property revaluation ½

Statement of financial position

Property, plant and equipment 1½ Investment properties 1 Inventories ½ Trade receivables 1 Cash ½ Share capital ½ Share premium ½ Revaluation surplus 1 Retained earnings (including dividends) 1 10% debentures 20Y0 ½ Deferred tax liability ½ Provisions 1 Trade payables ½ Income tax payable 1 Interest payable ½ Other payables (restructuring invoice) 1 Maximum 20


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Marks (b) Correct profit figure (award follow through mark) 1 Calculation of number of shares at 1.10.X2 1 Calculation of bonus fraction 1 Calculation of weighted average number of shares 1 Calculation of earnings per share 1 Available/maximum 5

Total 25

Suggested solution (a)

HI CO – STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 SEPTEMBER 20X3

$'000 Revenue 9,415 Cost of sales (3,591 + 819) (4,410) Gross profit 5,005 Distribution costs (314) Administrative expenses (W1) (760) Finance costs (W3) (100) Restructuring provision reversed unused ((900 + 65) – 1,010) 45 Fair value gain on investment properties (W5) 30 Profit on disposal of equipment (W6) 6 Rental income 37 Profit before tax 3,949 Income tax expense (1,180 + 25) (1,205) PROFIT FOR THE YEAR 2,744 Other comprehensive income: Gain on property revaluation (W2) 40 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 2,784

STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X3 $'000 Non-current assets Property, plant and equipment (W2) 9,896 Investment properties (W5) 522 10,418 Current assets Inventories 822 Trade receivables (852 – 45) 807 Cash 159 1,788

12,206 Equity Share capital (3,200 + (W7) 800) 4,000 Share premium (788 + (W7) 1,600) 2,388 Retained earnings (1,390 + 2,744 – 1,600) 2,534 Revaluation surplus (172 + (W2) 40) 212 9,134


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Non-current liabilities 10% debentures 20Y0 1,000 Deferred tax liability (W4) 281 Provisions 100 1,381 Current liabilities Trade payables 396 Income tax payable 1,180 Interest payable (W3) 50 Other payables 65 1,691

12,206 Workings

1 Administrative expenses

$'000 As per TB 615 Bad debt written off – X Co * 45 Provision for legal claim re faulty product ** 100 760

* Adjusting event – provides additional evidence of conditions existing at the end of the reporting period.

** The obligation appears to be probable rather than possible. Hence treated as a provision rather than disclosed as a contingent liability.

2 Property, plant and equipment

Buildings Plant & Total equipment $'000 $'000 $'000 Cost b/d 11,200 2,625 13,825 Accumulated dep'n b/d (1,404) (1,741) (3,145) 9,796 884 10,860 Additions – – Disposals (NBV) (210 – 205) (5) (5) Dep'n charge for year • 11,200 × 3% (336) • (2,625 – 210) × 20% (483) 9,460 396 9,856 Revaluation β 40 – – Net book value 9,500 396 9,896

3 Debenture interest

$'000 Per TB – ½ year 50 Accruals – further ½ year 50 P/L charge for year 100

(819)


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4 Deferred tax liability

$'000 As per TB 256 increase for year 25 Amount required for statement of financial position 281

5 Investment properties

$'000 Opening valuation 492 Increase in value 30 Closing valuation 522

6 Disposals account

$'000 Cost of asset sold 210 Depreciation thereon (205) Book value 5 Proceeds 11 Profit on disposal 6

7 Share issue

* Factor Shares $'000 Opening balance 4 3,200 3,200 Rights issue – 1 for 4 1 800 800 Closing balance 5 4,000 4,000

* The opening balance is arrived at by working backwards. A 1 for 4 rights issue will give shareholders 5 shares, which corresponds to the $4 million share capital in the trial balance. Hence the opening balance is

$4 million × 4/5 = $3.2 million

(b) EPS

EPS = 700,3744,2 = 74.2 cents

Workings (cont'd)

8 Weighted average number of shares

Date Narrative No of shares Time Bonus fraction (see below)

Weighted average

01.10.X2 b/d 3,200 × 6/12

× 00.425.4

1,700

01.04.X3 Rights issue 800 4,000 × 6/12 2,000 3,700

Bonus fraction TERP 4 shares : $4.25 = $17 1 share : $3 = $ 3 $20 Per share $20/5 = $4.00


12

3 Busiquip Co

Top tips. Note that you have been asked for a covering letter and a report, so you must produce both of these. It is a good practice to present the ratios in an appendix at the end, so leave some blank pages for your report before you start calculating the ratios. You must start by considering the areas you will address in your report and then look at what ratios are relevant. So do a quick answer plan, making sure that you are addressing the issue of the overdraft.

Easy marks. Note that only 5 marks out of 25 are available for the ratios. The real marks are available for intelligent analysis and a lot of points could be made without referring to ratios, just by looking at the picture presented by the financial statements and thinking about what further information is required.


Covering letter – Intro – Aim and identification of your brief 2 – Tone: professional but friendly/tactful Profitability – Sales and margin movement 1 – Reasons for sales increases 1½ – Need for strategy 1 – Overhead problem 1 – Details required on overheads ½ Liquidity – Poor 1 – Inventories reasonable ½ – Stock-outs v tight controls 1 – Debtors movements 1 – Quantity v quality of customers 1 – Credit control procedures required 1 Capital structure – Leasing liabilities ½ – Level, reasonable gearing 1 – Interest cover good ½ Conclusions – Overtrading 1 – Overdraft v medium/long term finance 1 – Cash management, forecasting and internal controls 1½

– Capital structure: more equity 1 – Floating charge 1 20 Appendix – Selection of key ratios, correctly calculated 5 Total 25


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Suggested solution The Manager An Accountant ACCA Town and Country Bank Co 88 High Street 66 Creamery Crescent Brixham Torquay Devon Devon DH93 6BX DH36 2VJ

30 June 20X8

Dear Sir,

Report on Busiquip Co at 31 December 20X7

1 Introduction

I have reviewed the financial affairs of Busiquip Co based on the accounts you supplied to me. I understand that the company wishes to increase its overdraft limit to $400,000.

My review is of an initial nature designed to highlight areas for further discussion rather than provide definitive answers on the company's performance.

My report is structured into three areas: profitability, liquidity and gearing, before drawing my initial conclusions. Calculations have been reproduced in an appendix to this report.

2 Profitability

2.1 The company has traded i.e. bought and sold inventories, very successfully in 20X7 with a near doubling in turnover achieved with only a slight reduction in the gross margin. This reflects a very aggressive growth in sales.

2.2 As usual, it is important to identify how an increase in revenue is achieved and what is the trading strategy.

• Reduction of prices and margins • Search for new customers in new geographical areas etc • Selling to less creditworthy customers • Improved marketing and selling effort

2.3 As the company seeks to grow, it would be useful to ensure that it has a coherent business strategy that clearly demonstrates that it can sustain its course of development.

2.4 Overheads have increased from 20X6 to 20X7 by 119%, causing net margin to fall from 6.9% to 4.1%.

2.5 During the period mentioned, remuneration paid to directors and employees rose by 155% and 145% respectively.

2.6 Consideration should be given to whether company has adequate cost control procedures. Additional spending may be necessary to support the growth of the business but these need to carefully evaluated against the commercial benefits to be gained.

2.7 I would recommend that the company supply a detailed statement of comprehensive income so that a thorough analytical review of overheads can be undertaken.

3 Liquidity

3.1 Examination of the company's statement of financial position indicates that the company's liquidity is poor. It has a large overdraft and its working capital consists almost entirely of inventories and receivables.


14

3.2 The inventory turnover period has improved from 46 days in 20X6 to 36 days in 20X7. This may reflect better inventory control or that sales are going faster. The possibility of stock-outs and lost sales opportunities might need further investigation.

3.3 The company has almost $1m tied up in receivables. The collection period has increased from 58 days to 73 days. It would appear that the company has a weak credit control function which appears to be getting even weaker. The likelihood of taking on riskier customers in the drive to increase sales should be borne in mind. It is important that the quality of the customer base is maintained.

3.4 The company should provide detail on its credit control procedures both for vetting new customers and chasing up debts.

3.5 The possibility that irrecoverable debts exist must be discussed. You need to establish what is their policy regarding providing for doubtful debts.

3.6 The cash position is discussed further below.

4 Capital structure

4.1 The company's gearing level is 67% compared with 50% last year. All gearing consists of leasing obligations.

4.2 Interest cover is still high although it has fallen in the year.

4.3 The level of gearing is not unreasonable and the interest cover is quite good.

5 Conclusion

5.1 The company appears to have a good product range that sells well at a reasonable margin.

5.2 There is evidence, however, of over-trading. In other words the company may be trying to expand too rapidly and is therefore losing control over various areas. It appears to a small company which probably had very basic internal controls which are inadequate to cope with the increased scale of the operation.

5.3 Cash management is obviously weak and there is a dependence on short term financing, i.e. the overdraft.

5.4 It is likely that business is moving into a new phase of development where it needs stronger systems in terms of business planning, financial management and internal control. It must avoid the pitfall of believing that it can use bank overdraft money to support its medium to long term growth.

5.5 The company appears to have commendable entrepreneurial drive which is a valuable resource to be retained but also has to balance this with supporting internal controls. I would therefore recommend that the following should be seen before deciding on how much should be granted by way of overdraft facility.

(a) Auditor's management letter showing measures to improve internal control. (b) Business plan, including market share and market growth assumptions. (c) Cash flow forecast for the next three to five years.

5.6 The company should also be encouraged to seek long term stability in its financing by either a fresh injection of share capital or the conversion of the overdraft into a regulated medium to long tem loan. They must be discouraged from continuing to depend on overdraft financing for non-current assets and medium to long term funding.

5.7 There are no real non-current assets of worth. Therefore the bank should seek a floating charge over the business as a whole recognising that there are no major single assets on which to rely.


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Please do not hesitate to contact me with any queries you may have or would like to discuss any matter further.

Yours faithfully

An Accountant

APPENDIX: CALCULATION OF RATIOS

Profitability

20X7 20X6 Change Change $'000 $'000 $'000 % (i) Summary of statement of comprehensive income Revenue 4,037 2,027 +2,010 +99 Cost of sales 3,290 1,504 +1,786 +118 Overheads 857 391 +466 +119 PBIT 175 139 +36 +26 (ii) Analysis of selected overheads Wages 496 202 +294 +145 Directors' emoluments 115 45 +70 +155 (iii) Ratios – profitability 20X7 20X6 Gross margin

4,307

1,017

= 23.6%

2,027

523

= 25.8%

Net margin (based on PBIT)

4,307

175

= 4.1%

2,027

139

= 6.9%

(iv) Ratios – efficiency 20X7 20X6 Return on capital employed

992751.2175

++

= 46.6%

521841.2139

++

= 58.6%

Liquidity 20X7 20X6 Current ratio

1,139

1,229

= 1.07 407515

= 1.24

Inventory turnover period 3,290327

× 365 = 36.3 days 504,1191

× 365 = 46.3 days

Quick ratio 1,139

3271,229 −

= 0.79 407

191515 − = 0.80

Receivables collection period 4,307803 × 365 = 68.1 days

2,027323 × 365 days = 58.2 days

Cash position virtually nil

Longer term capital structure 20X7 20X6

= 67.4% = 49.7%

Gearing ratio (assuming finance leases are prior charge capital)

2768799 +

185

4052 +

Interest cover

15175

= 11.7 6

139 = 23.2


16

4 Nihao Co

Top tips. The problem with this question was not how to deal with the transactions, which were all fairly simple, but knowing the formats of the statements. These will be much less familiar to you than the statement of financial position and statement of comprehensive income formats, but should be learned .

Easy marks. Part (a) is easy in that you got a mark for each item that you posted in the right place and you should have been able to score a few marks on part (b).

Marking scheme Marks (a) (i) Intended to be all-inclusive statement ½ Profit includes trading and investment items ½ Other CI includes unrealised items such as revaluations on non-

investment assets

½

These can represent material amounts ½ Therefore IAS 1 requires disclosure ½ 2½ (ii) Dividends not shown in SOCI ½ Share issues not included in SOCI ½ SOCI only includes true income and expense - therefore has clearer purpose ½ Both are primary statements with equal importance ½ IASB may be moving towards further additional statements ½ 2½ 5

(b) (i) Statement of comprehensive income Inclusion of correct profit figure ½ Correct treatment of – gain on revaluation ½ – loss on land ½ – prior period adjustment not included ½ Additional mark if no other items included in error 1 Presentation ½ (ii) Statement of changes in equity Change in accounting policy 1 Share capital ½ Premium on issue 1 Dividends 1 Total comprehensive income (as one line) 1 Transfer of realised profit 1 Presentation 1 10 15


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Suggested solution (a) (i) The purpose of the statement of comprehensive income is to be an 'all inclusive' statement of

gains and losses occurring in an entity during a period.

The profit or loss section of the statement of comprehensive income shows trading and investment profits, i.e. realised profits and profits that may be unrealised, such as investments, but which are held for the specific purpose of making a profit, and their result during the period is therefore included.

The profit or loss section excludes items deemed to be unrealised that are not held for investment growth, such as revaluations of property used by the business, and these are reported in other comprehensive income. They can however represent very material amounts. IAS 1 therefore requires companies to provide this information to give increased prominence to these items, either in a single statement below profit or loss or as a separate statement beginning with profit or loss as shown in a separate income statement.

(ii) As illustrated in part (b) the two statements differ as dividends are not shown in the statement of comprehensive income. Dividends are a distribution of income earned, not an expense. The share capital and share premium accounts are also not included in the statement of comprehensive income as they result from transactions with owners of the business in their capacity as owners and therefore do not meet the definition of income.

By only including true income and expenses, not merely anything which changes net assets, the statement of comprehensive income has a clearer purpose than the statement of changes in equity.

The statement of comprehensive income and statement of changes in equity are both primary financial statements that must be presented and be given equal prominence within the financial statements. Total comprehensive income is shown as one line and not broken down in the statement of changes in equity to emphasis that the statement of comprehensive income is used for measuring the business' performance.

The efforts to improve the presentation of information in the accounts is designed to produce decision useful information. By advocating such additional information the IASB might be setting the scene for further primary statements that could be used to accommodate future developments e.g. value statements with a reconciliation to the historical cost profit.

(b) (i) The format follows that illustrated by IAS 1.

Nihao Co – Statement of comprehensive income for the year ended 30 September 20X6

$'000 Profit for the year 490 Other comprehensive income: Gain on property revaluation 291 Loss on land revaluation (45) Other comprehensive income for the year 246 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 736


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(ii) Nihao Co – Statement of changes in equity for the year ended 30 September 20X6

Share Share Ret'd Revaluation Total capital premium earnings surplus $000 $000 $000 $000 $000 Balance at 1 October 20X5 1,000 1,065 980 3,000 6,045 Change in accounting policy (320) (320) Restated balance 1,000 1,065 660 3,000 5,725 Changes in equity for 20X6 Issue of share capital 400 1,100 1,500 Dividends (185) (185) Total comprehensive income for the year

490

246

736

Transfer to retained earnings 680 (680) Balance at 30 September 20X6 1,400 2,165 1,645 2,566 6,776


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5 Jupiter Co

Top tips. This question gives you two scenarios to deal with, requiring you to apply the relevant accounting standard. Note that you are expected to write a report, so head your answer up as a report and you can then make a number of separate points – rather than two essays.

Easy marks. Part (i) was not particularly easy as you had to decide which standards applied. Part (ii) may have looked difficult but, if you had studied IAS 39 it was actually very straightforward.


(i) IFRS 5 treatment explained 1½ Treatment of reorg. costs 1 IAS 10 explained 1½ Treatment of devaluation 1 5 (ii) Requirements of IAS 39 1 Discuss gearing ½ Liability, not equity ½ Treatment of finance costs 1 Treatment of issue costs 1 Liability on B/S 1 5 Total 10

Suggested solution REPORT

To: Group Financial Accountant From: An Accountant Date: 30 June 20X0 Subject: Best accounting treatment for items in year end accounts.

The best accounting treatment for each of the items noted for discussion with the auditors is summarised below

(i) Factory closures and reorganisations

IFRS 5 requires that profit or loss line items and additional costs arising from a discontinued operation should be disclosed separately, either on the face of the statement of comprehensive income as a separate column or as a note. However, this only applies to 'major lines of business' which appears not to be the case here.

The reorganisation costs of $1 million are material and therefore would also be disclosed separately per IAS 1, as would the cost of closure of the tin opener factory.

A valuation which provides evidence of an impairment in the value of a property relating to the year would be an adjusting event after the reporting period per IAS 10. However, if the decline occurred after the year end the event would be non adjusting.

As the valuation report was received so soon after the year end, it seems likely that the decline occurred before the year end.

Therefore, the loss in value should be accounted for in the 20X0 accounts as an adjusting event after the reporting period.


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(ii) Loan notes

The requirements of IAS 39 Financial Instruments must be met in relation to the debenture. This is important because debt and equity must be distinguished so as not to distort gearing.

Loan notes are not classed as equity as they contain an obligation which will result in an outflow of resources embodying economic benefits and therefore should be reported as a liability.

The debt must be carried at amortised cost. Initially this will be:

$m Par value 100.0 Less issue costs (per IAS 39) (0.1) 99.9 The loan note is a form of 'deep discount' finance. No interest is payable over the term of the note but the total finance costs of $159.2 million (259.1 – 99.9) must be allocated to profit or loss over the ten year period of the loan. The finance costs are allocated using the effective interest rate of the loan note.

Hence, each year the carrying amount of the loan note is increased to reflect the fact that is one period closer to maturity using the effective interest rate.

$99.9m × 10% = $10.0m

Dr Finance costs $10.0m

Cr Financial liability $10.0m

∴ Financial liability at 31.3.20X0 = $99.9m + $10.0m = $109.9m

Signed

An Accountant


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