ICAEW Financial Accounting Answers March 2015 to March 2016 {SPirate}

Financial Accounting and Reporting – March 2015

Copyright © ICAEW 2015. All rights reserved Page 1 of 16

MARK PLAN AND EXAMINER’S COMMENTARY

The mark plan set out below was that used to mark these questions. Markers are encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. More marks are available than could be awarded for each requirement, where indicated. This allows credit to be given for a variety of valid points, which are made by candidates.

Question 1 Total marks: 30 Overall marks for this question can be analysed as follows:

General comments This question presented a draft set of financial statements with some adjustments. Candidates were required to prepare the amended statement of profit or loss and statement of financial position. A number of adjustments were required to be made, including depreciation, revenue adjustments, provisions, treasury shares, a lease incentive and a prior year inventory adjustment. Part b) required candidates to explain the concepts of accruals basis of accounting and going concern, with reference to the scenario. Part c) required a discussion on the ethical issues arising from the scenario. Coghlan Ltd – Statement of financial position as at 30 September 2014

£ £ ASSETS Non-current assets Property, plant and equipment (600,000 + 138,260) (W3) 738,260 Current assets Inventories 98,000 Trade and other receivables 125,400 Tax asset 65,000 Cash and cash equivalents 1,200

289,600

Total assets 1,027,860

Equity Ordinary share capital (294,500 + 85,500) 380,000 Share premium 94,000 Treasury shares (45,000 x £1.90) (85,500) Retained earnings (W4) 52,910

Equity 441,410 Non-current liabilities Lease incentive 7,200 Current liabilities Trade and other payables 31,900 Deferred income (36,000 x 3/12) 9,000 Provision (W2) 538,350

579,250

Total equity and liabilities 1,027,860



Coghlan Ltd – Statement of profit or loss for the year ended 30 September 2014

£ Revenue (3,359,200 – (36,000 x 3/12)) 3,350,200 Cost of sales (W1) (2,744,950)

Gross profit 605,250 Administrative expenses (W1) (1,418,965)

Loss before tax (813,715) Income taxation (65,000 + 32,800) 97,800

Net profit for the period (715,915)

W1 Expenses

Cost of sales £

Administrative expenses

£ Brought forward 2,198,050 1,039,700 Opening inventories adj (114,550 – 79,000) (35,550) Closing inventories adj (142,100 – 98,000) 44,100 Provision (W2) 538,350 Lease incentive (1,200 x 6) 7,200 Impairment (W3) 293,750 Depreciation charge (43,750 + 34,565) (W3) 78,315

2,744,950 1,418,965

W2 Provision £ £ Brought forward 500,000 Lawsuits (50 x 350) 17,500 Warranties ((65,000 x 20%) + (157,000 x 5%)) 20,850

At 30 September 2014 38,350

538,350

W3 Plant and equipment Land

and buildings

Fixtures and

fittings

£ £ Carrying amount at 1 Oct 2013 (1,125,000 – 187,500) / (236,000 – 63,175)

937,500 172,825

Depreciation charge for the year (1,125,000 – 250,000) x 5% (43,750) 172,825 x 20% (34,565)

Carrying amount at 30 Sept 2014 893,750 138,260 Recoverable amount 600,000 170,000

Impairment 293,750 –

W4 Retained earnings £ Per draft 425,825 Add: draft loss 416,550 Less: revised profit and loss (715,915) Dividend paid (380,000 x 10p) (38,000) Prior year adjustment – inventories (35,550)

52,910

Presentation of the statement of profit or loss and statement of financial position was generally good. As indicated as acceptable at the tutor conference, most candidates omitted sub-totals on the statement of financial position, but were penalised if they omitted totals for total assets and total equity and liabilities. A minority missed out sub-totals on the statement of profit or loss – this is not considered acceptable and marks were lost for this. However, there were a number of very messy statements, usually the statement of profit or loss, where costs workings were shown on the face of the statement instead of in a recommended “costs



matrix” in the workings. Whereas in most recent sittings almost all candidates have used a costs matrix, this was not the case at this sitting. Performance on this question was good, with some high marks achieved. A significant number of candidates arrived at completely correct figures in respect of revenue, cost of sales, closing inventories and the provision. Most candidates also arrived at the correct figures for the two depreciation charges for the year, and correctly presented them in administrative expenses. However, a few candidates calculated depreciation based on the year end recoverable amounts instead of on the opening figures. It was also common to see the fixtures and fittings, which were not impaired, revalued, when no indication was given that the company wished to move to the revaluation model. Pleasingly, most candidates did provide relatively clear workings for their property, plant and equipment figure. The tax refund probably caused the most difficulties, with only a few candidates treating both this and the over-provision from the previous year correctly. A number of candidates showed only the tax refund in the statement of profit or loss, others reduced the tax refund by the over-provision from the previous year, instead of adding it. Many were so confused by the income tax position that they showed no figure for income tax at all in the statement of profit or loss. On the statement of financial position it was common to see the over-provision from the previous year reducing the tax asset. And whatever figure was arrived at this was presented more often as a “negative” current liability than (correctly) as a current asset. Other common errors included the following:

Errors in adjusting cost of sales for the incorrect inventory valuations – most commonly getting the net adjustment in the wrong direction against the cost of sales figure from the draft financial statements, or making careless errors in the calculations.

Calculating the dividend paid during the year on a figure other than the one shown in their own statement of financial position.

Total possible marks Maximum full marks

20½ 19

(b)

Accrual basis The accrual basis of accounting records transactions in the period in which they occur, rather than when the cash inflow or outflow arises. Under the accrual basis an entity recognises items as assets, liabilities, equity, income and expenses when they satisfy the definition and recognition criteria for those elements in the Framework An example of this is the treatment of the revenue generated from the magazine subscriptions. These were incorrectly recorded in revenue as the cash had been received, however part of the service delivery, ie the magazines being despatched, arose after the year end and therefore part of the revenue should have been deferred. The recognition of the provisions are another example of the accrual basis, as these are present obligations arising from past events and hence have been recognised as liabilities in the current period, although the cash will be paid out in future periods. Other examples include the charging of depreciation on the property, plant and equipment recognising that the entity is generating economic benefits from these assets over their useful lives and the charging of operating lease rental over the total period of the lease. Going concern basis The going concern basis of accounting assumes that the entity will continue operating in the foreseeable future as a going concern. To operate for the foreseeable future there must be no intention by management, or the need, to liquidate the entity by selling its assets and paying its liabilities. The going concern basis affects the valuation of the company’s assets. It is assumed that non-current assets, for example, will be used in the operation of the entity and therefore the use of historical cost is considered appropriate. However, if the entity ceases in operation then the historical cost basis would no longer be



appropriate and instead the assets would be valued based on their recoverable amount at that point in time, this valuation basis is known as the break-up basis. The concept of being “non-current” also would no longer be appropriate as all assets and liabilities would be “current” in nature as the entity would no longer be trading. Coghlan Ltd’s financial statements have been prepared using the going concern basis of accounting. If the break-up basis were appropriate due to the company no longer being a going concern, as a result of the adverse publicity, caused by the unsafe products, assets and liabilities might be different. For example, Coghlan Ltd has five years left on the office lease, if Coghlan Ltd ceased to trade the lease would become an onerous obligation and the full amount would need to be recognised. Coghlan Ltd traded at a large loss during the year, if this performance continues it is unlikely that the company would be a viable trading entity for long. In addition a dividend was paid, presumably to ensure shareholders remained happy, however as a result of this retained earnings and hence distributable profits are virtually zero, so no further dividends could be paid in the future without substantial profits being made. It is therefore questionable whether Coghlan Ltd will remain a going concern for much longer.

This part of the question was reasonably well answered although few candidates scored high marks. Most candidates could give a basic definition of the accruals concept, but the quality of explanation using the subscription revenue and the operating lease varied. Again, most candidates could give a basic definition of the going concern concept, and cite the break-up basis as an alternative, but less candidates went beyond this to explain how going concern financial statements differ from those prepared on a break-up basis. However, a majority of candidates made the point that Coghlan Ltd appeared to be in financial difficulties and that therefore the going concern basis may not be appropriate.


11 6

(c)

Professional accountants are expected to follow the guidance contained in the fundamental principles in all of their professional and business activities. The Code of Ethics has five fundamental principles. The financial statements should be prepared fairly, honestly and in accordance with relevant professional standards. Objectivity is one of the five fundamental principles in the ICAEW’s ethical Code, which means that I should not allow bias, conflict of interest or undue influence of others to override professional or business judgements. I should not let the managing director pressure me into completing the financial statements quickly and not making a satisfactory and thorough job. Intimidation threat exists. Professional behaviour is another principle and hence I should ensure that the relevant laws and regulations are complied with. I should ensure that I act with both professional competence and due care and therefore not be influenced by the pressure that management are putting on me. The financial statements should be prepared by someone who has the relevant expertise and that is unlikely to be someone who is undertaking work experience. I should not allow bias in any way, conflict of interest or undue influence of others override my professional judgement. It is unfair for the managing director to mention my performance appraisal and therefore I need to ensure that this does not affect any decisions I make as a self-interest threat exists. I should explain that the financial statements need additional work to the managing director and explain that they may take longer than he would have ideally liked to ensure that they provide a fair assessment of the facts. If he is unwilling to allow additional time then I should discuss the matter with the other directors and explain that I am being pressured by the managing director. I should keep a record of all discussions and I could discuss the matter confidentially with the ICAEW helpline for advice and support.



The answers to the “ethics” part were mixed, with a significant number of candidates putting themselves in the position of being the external auditor, as opposed to the financial controller, as specified in the question. Most candidates identified self-interest and possible intimidation threats, that the financial controller should uphold the values of professional competence and due care and professional behaviour, and refer continuing difficulties with the managing director to the other directors and then to the ICAEW ethics helpline. Weaker candidates missed the point that all discussions should be documented and spent some time discussing the ethics of the managing director, when we were not told whether he was an ICAEW Chartered Accountant or not.

Total possible marks Maximum Marks

8½ 5




General comments Part (a) of this question required candidates to explain the financial reporting treatment of four accounting issues, given in the scenario. The four issues covered borrowing costs, a compound financial instrument, an intangible asset and a joint venture. Journal entries were also required. Part (b) required candidates to recalculate consolidated profit for the year for the adjustments needed as a result of their answer to Part (a). Part (c) required a calculation of basic earnings per share following a rights issue and explanation of the accounting treatment was also required.

(1) Borrowing cost Under IAS 23 Borrowing costs, certain borrowing costs form part of the cost of the qualifying asset, and should therefore be capitalised. A qualifying asset is an asset which takes a substantial period of time to get ready for its intended use, or sale. The office block is therefore a qualifying asset as it is not ready for use. Borrowing costs are defined as interest and other costs that an entity incurs in connection with the borrowing of funds. Only borrowing costs that are directly attributable to the acquisition, construction or production of the qualifying asset should be capitalised. These are the borrowing costs which would have been avoided if the expenditure on the qualifying asset had not been incurred. As the loan was specifically taken out for the purpose of funding the construction of the office block use the actual interest rate of 6%. Capitalisation of borrowing costs should commence when the entity meets all three of the following conditions: (1) It incurs expenditure on the asset (the payment to acquire the land was made on

1 October 2013); (2) It incurs borrowing costs (the loan was taken out on 1 October 2013, from which date interest will

start to accrue); (3) It undertakes activities that are necessary to prepare the asset for its intended use (the land was

acquired on 1 October 2013 with planning permission which was needed for construction to take place).

Borrowing costs of £36,000 (600,000 x 6%) should therefore be capitalised from 1 October 2013. Where the borrowed funds are not required immediately, so instead are put on deposit, the borrowing costs capitalised should be reduced by the investment income received on the invested funds. Investment income: (600,000 – 200,000 = 400,000) (1 Oct 2013 – 28 Feb 2014) 400,000 x 3% x 5/12 = £5,000 (1 Mar – 31 Aug 2014) 300,000 x 3% x 6/12 = £4,500 (1 Sept – 30 Sept 2014) 100,000 x 3% x 1/12 = £250 £9,750 Total borrowing costs which should be capitalised are £26,250 (36,000 – 9,750). No depreciation should be recognised on the office block as it’s not ready for use.

Porcaro plc

(a) (i) IFRS accounting treatment



The journal entries required are: DR: Property, plant and equipment (SOFP)

£ 26,250

£

CR: Net interest (PorL) 26,250

(2) Convertible bonds The convertible bonds are compound financial instruments per IAS 32 Financial Instruments: Presentation. They have both an equity and a liability component which should be presented separately at the time of issue. IAS 32 requires that the substance of such an instrument be reflected, focusing on the economic reality that in effect two financial instruments have been issued. The liability component should be measured first at the present value of the capital and interest payments. The discount rate used should be the effective rate for an instrument with the same terms and conditions except without the ability to convert it into shares. Cash flow

£ Discount factor

@ 7% Present value

£ 1 October 2014 30,000 1/1.07 28,037 1 October 2015 30,000 1/1.07

2 26,203

1 October 2016 30,000 1/1.073 24,489

1 October 2017 (redemption) 630,000 1/1.074 480,624

Liability component 559,353 Equity component (bal fig) 40,647

Total 600,000

The liability should initially be measured at £559,353 and the equity component is the residual at £40,647. Once recognised the equity element remains unchanged. However, the liability element should be shown at amortised cost at the end of each year:

1 Oct 2013 Interest (7%) Payment (5%) 30 Sept 2014 £ £ £ £

559,353 39,155 (30,000) 568,508

At the year an adjustment should be made to non-current liabilities of £31,492 (600,000 – 568,508), and an additional £9,155 recognised as finance costs as part of profit or loss. The journal entries required are: DR: Non-current liabilities (SOFP)

£ 31,492

£

DR: Finance costs (PorL) 9,155 CR: Equity (SOFP)

40,647

(3) Intangible asset – licence The licence should be recognised as an intangible asset as it is an identifiable non-monetary asset without physical substance. The licence is identifiable as it arises from contractual or legal rights to use the microchip technology. The licence should initially be recognised at its cost of £72,000. Amortisation of £6,000 ((72,000 / 6yrs) x 6/12) should be recognised as part of profit or loss. The carrying amount of the licence at 30 September 2014 under historical cost accounting is £66,000 (72,000 – £6,000). The licence can continue to be held at cost or may be revalued if the directors can show that an active market exists for it. Although a competitor has offered to buy the licence which suggests that an active market exists, part of the definition also requires the items traded to be homogenous. As it states that the licence is unique it is unlikely that it will meet this definition and therefore should be held at historical cost. The revaluation gain of £18,000 (£90,000 - £72,000) at 30 September 2014 should be reversed.



The journal entries required are: £ £ DR: Equity – Revaluation surplus (SOFP) 18,000 DR: Amortisation (PorL) 6,000 CR: Non-current assets (SOFP) (18,000 + 6,000)

24,000

(4) Joint venture Porcaro plc should recognise its investment in Barbarossa Ltd as a joint venture. Four companies have joint control over Barbarossa Ltd and there is a contractual arrangement in place to share profits and losses equally. IFRS 11 Joint Arrangements requires the use of the equity method for joint ventures. The investment should therefore be recognised at cost of £25,000 plus the share of the joint venture’s post acquisition increase in net assets, £32,500 (£130,000 x 25%). The investment in Barbarossa Ltd will be shown as a non-current asset, rather than a current asset in the consolidated statement of financial position, so the £25,000 will need to be reclassified. The share of post-acquisition profit of £32,500 should be added to non-current assets, giving a carrying amount of £57,500 and the £32,500 recognised in consolidated profit or loss. The journal entries required are: £ £ DR: Non-current assets (SOFP) 57,500 CR: Current assets (SOFP) 25,000 CR: Share of joint venture profit (PorL)

32,500

Most candidates produced reasonably detailed narrative explanations, melded together with calculations although less went on to produce journal entries. Only the very weakest candidates restricted their answers to predominantly calculations, with little explanation. Answers to Issues (1), (2) and (4) were all reasonably well attempted, with Issue (3) causing some difficulties. Borrowing costs Most candidates set out the appropriate terminology, such as “directly attributable” and “qualifying asset”, and correctly concluded that the office block was a qualifying asset and that interest on the loan should be capitalised. However, a significant number of candidates were careless in their choice of words and stated that borrowing costs “could” be capitalised – implying a choice in the matter (even when in Part (d) they went on to clearly state that under IFRS borrowing costs must be capitalised). Most then listed the IAS 23 criteria for the commencement of capitalisation, but few applied these criteria to this scenario. Of those that did, many concluded, in error, that capitalisation could not commence until 31 December 2013, and hence only capitalised nine months of the annual interest. Almost all candidates stated that the borrowing costs should be reduced by the investment income on surplus funds. Calculations for the investment income often contained errors generally around the number of months. The 6% actual interest rate was used, although only a very small minority explained why this was appropriate. Almost all candidates then set out the correct journal entry for their net figure. Convertible bonds The majority of candidates explained that this was a compound financial instrument and that split accounting was appropriate, with fewer mentioning substance over form. Most of these candidates then produced correct calculations for the split of debt and equity and for the amortised cost of the debt, although less referred to “amortised cost” in their explanation. Journal entries were largely correct, although some candidates took a rather convoluted approach to arriving at the correct net journal. Intangible asset – licence This issue caused the most problems. Most candidates gave some basic definitions and calculated the initial carrying amount of the intangible at cost (although some used the incorrect number of months for the amortisation charge). Answers were then mixed, depending on whether candidates realised that the information in the scenario did not support the existence of an “active market”. Those that saw this quickly concluded their answer by reversing out the revaluation. The ones that did not then wasted time calculating



additional amortisation charges, and sometimes also transfers between the revaluation surplus and retained earnings. Others hedged their bets and set out both accounting treatments without a conclusion, which was time consuming. Joint venture There was a lot of confusion to this issue and candidates seem to struggle between the concept of an associate and a joint venture, with many candidates simply believing they are the same instrument. Although the majority of candidates identified that equity accounting should be applied and recognised the cost correctly, candidates often described the investment as an associate. Journal entries were usually correct, with the most common error being to credit cash instead of current assets. The only real error seen in the calculations was taking the appropriate share of only a fraction of the profit after tax, instead of the appropriate share of the whole figure, which was stated to be the profit for that period.


36 27

(b)

Porcaro plc – Group figures Profit for

the year £

£

As stated 483,150

Issue (1) 26,250

Issue (2) (9,155)

Issue (3) (6,000)

Issue (4) 32,500

Profit adjustment 43,595

526,745

Most candidates appeared to adopt the recommended approach of setting up a schedule as the first page of their answer starting with the draft profit from the question, and adjusted this as they wrote their explanation for each issue. Many candidates did therefore score the full two marks for this part, based sometimes on completely correct and sometimes on their “own” figures. Only the very weakest candidates failed to attempt this part of the question. Where marks were lost it was generally where candidates failed to replicate in this part the journal entries set out in their answers to Part (a).


2 2



(c)

Porcaro plc No. Of

shares Period in

issue Bonus

factor Weighted

average

1 Oct 2013 – 31 Jan 2014 270,000 4/12 210/200 94,500 Rights issue 1 for 3 90,000

1 Feb – 30 Sept 2014 360,000 8/12 240,000

334,500 Theoretical ex-rights price: £ 3 shares @ £2.10 6.30 1 share @ £1.70 1.70

8.00 Theoretical ex-rights price per share £8.00 / 4 = £2.00 Bonus fraction: 210 / 200 Basic EPS = 526,745 = £1.57 334,500

A rights issue is an issue of shares to current shareholders in proportion to their existing holdings at a discount to market price. Because the share issue is below market price, a rights issue is in effect a combination of an issue at full market value and a bonus issue. An adjustment therefore needs to be made to the earnings per share for the bonus element. This is calculated by comparing the pre-rights market value with the theoretical ex-rights price. The theoretical price is the price at which the shares would have traded after the rights issue in theory.

A good number of candidates arrived at the correct weighted average number of shares, and produced an EPS based on that and their own figure for revised profit for the year. However calculations often contained errors in the theoretical ex-rights price per share. Only the very best candidates could explain clearly why the rights issue had been scaled up by a bonus fraction, and many of these candidates achieved full marks for this part of the question. Weaker candidates merely described in words what they had done in their calculation. A minority of candidates described the accounting entries for the rights issue which gained no marks.


7½ 6

(d) UK GAAP differences

Borrowing costs Under UK GAAP Porcaro plc has the choice whether to capitalise borrowing costs. If a policy of capitalisation is chosen then this policy should be applied to the class of qualifying assets. Under IFRS borrowing costs which meet the definition of being directly attributable to the acquisition, construction or production of a qualifying asset must be capitalised.

Most candidates achieved the full one mark for this part, clearly stating that capitalisation is mandatory under IFRS, but optional under UK GAAP. Only the weakest candidates got this the wrong way round, or failed to give both the IFRS and UK GAAP treatments.


1½ 1




General comments This question was a mixed topic question, covering the completion of extracts from the statement of cash flows for adjustments to investing and financing activities. Part b) required the preparation of an extract from the consolidated statement of financial position, showing non-current and current assets.

Consolidated statement of cash flows (extract)

Cash flows from investing activities £ Purchase of property, plant and equipment (W2) (365,450) Proceeds from sale of property, plant and equipment (124,000 + 9,500) 133,500 Cash flows from financing activities Payment of finance lease (15,000 – 7,375) (W3) (7,625) Proceeds from issue of loan (450,000 – 290,000) 160,000

Workings

(1) Interest £ 290,000 x 5% x 6/12 7,250 450,000 x 5% x 6/12 11,250

18,500

Henrit plc

(a)

(2) PPE

£ £ B/d 729,400 Disposals 124,000 Additions – finance lease (W3) 105,350 Depreciation 113,000 Additions – cash (β) 365,450 C/d 963,200

1,200,200 1,200,200

(3) Finance lease

£ £ Cash 15,000 B/d – PPE addition (β) 105,350 C/d 97,725 Interest (25,875 – 18,500 (W1)) 7,375

112,725 112,725

Answers to this requirement were quite mixed, with a significant number of candidates achieving full marks. Most candidates successfully calculated the proceeds from the disposal of equipment and also attempted to produce a T-account for property, plant and equipment to identify the cost of additions. Within this working nearly all candidates correctly credited the depreciation charge for the year and the carrying amount of the equipment that had been sold. The majority of candidates also realised that they needed to debit the account with plant acquired under a finance lease but very few candidates calculated this figure correctly. Most simply used the closing balance on the finance lease account given in the question. It was clear that the majority of candidates either do not understand that payments under finance leases need to be split between interest and capital or cannot calculate the split. Many candidates merged the finance lease liability and the bank loan and as a result lost the easy mark available for showing the inflow of cash relating to the bank loan. Some candidates used the information given in the question to calculate the interest relating to the bank loan but then made no use of this information.



Statement of financial position at 30 September 2014 (extract) Non-current assets Property, plant and equipment (963,200 + 469,400 + 623,150 – 4,400 (W2)) 2,051,350 Goodwill (73,400 + 17,750 (W1)) 91,150 Current assets Inventory (46,980 + 18,900 + 31,300 – 1,500 (W3)) 95,680

Workings (1) Goodwill – Crago Ltd £ Consideration transferred (230,000 + (45,000 x 3.15)) 371,750 Non-controlling interest at acquisition at fair value 261,000 Less: Net assets at acquisition (615,000)

17,750 (2) Inter-company machine transfer £ Original carrying amount (95,000 – (95,000 x 3/5)) 38,000 Consideration less depreciation (53,000 – (53,000 x 6/30)) (42,400)

Unrealised profit 4,400 (3) PURP % £

SP 115 11,500 Cost (100) (10,000)

GP 15 1,500

With regards to presentation nearly all candidates did produce extracts as required and also entered figures under the appropriate headings, although totals were often not seen. As is always the case with questions on the statement of cash flows a significant number of candidates lost marks for failing to put brackets around outflows of cash.


8½ 6

(b)

Generally this was well answered with many candidates achieving full marks. A majority of candidates correctly calculated goodwill and the PURP relating to inventory and made the relevant adjustments to the figures given in the question. A minority of candidates used the nominal rather than the market value of the shares to calculate the consideration for the acquisition of the subsidiary and a similar number calculated the PURP using gross margin rather than a mark-up on cost. However only a small minority of candidates correctly calculated the PURP relating to the sale of the machine. Common errors were to calculate the profit on disposal or the difference in the subsequent depreciation and therefore only adjust for part of the difference. As with part (a) nearly all candidates produced extracts but again a number failed to add numbers across so could not be given full credit for presentation.


6 5




This question required the preparation of a consolidated statement of profit or loss and extracts from the consolidated statement of changes in equity (for retained earnings). The group had two subsidiaries, one of which was disposed of during the year. A fair value adjustment was required on acquisition of one of the companies. Inter-company trading took place during the year between one of the subsidiary’s and the parent. Part (b) required candidates to describe the UK GAAP differences for the acquisition and disposal of a subsidiary.

Mantia plc

(i) Consolidated statement of profit or loss for the year ended 30 September 2014 £ Continuing operations Revenue (W1) 3,722,000 Cost of sales (W1) (1,658,500)

Gross profit 2,063,500 Operating expenses (W1) (536,055)

Profit from operations (W1) 1,527,445 Investment income (W1) 17,000

Profit before tax 1,544,445 Income tax expense (W1) (327,000)

Profit for the year from continuing operations 1,217,445 Discontinued operations Profit for the year from discontinued operations (300,100 (W2) – 32,715 (W4)) 267,385

Profit for the period 1,484,830

Profit attributable to Owners of Mantia plc (β) 1,327,451 Non-controlling interest (W2) 157,379

1,484,830

(ii) Consolidated statement of changes in equity for the year ended 30 September 2014 (extract) Retained

earnings £

Balance at 1 October 2013 (W6) 227,249 Total comprehensive income for the year 1,327,451 Dividends (W6) (600,000)

Balance at 30 September 2014 (β) 954,700



Workings

(1) Consolidation schedule Mantia plc Appice Ltd Adj Consol £ £ £ £ Revenue 2,986,000 768,000 (32,000) 3,722,000 Cost of sales – per Q (1,343,700) (345,600) 32,000 (1,658,500) – PURP (W5) (1,200) Op expenses – per Q (419,575) (84,480) (536,055) – FV deprec (70,000/10yrs) (7,000) – Impairment of goodwill (25,000) Investment income 42,600 – Appice (80,000 x 40p x 80%) (25,600) 17,000 Tax (259,000) (68,000) (327,000)

261,720

(2) Non-controlling interest in year £ Appice Ltd (20% x 261,720 (W1)) 52,344 Starkey Ltd (35% x 300,100 (600,200 x 6/12)) 105,035

157,379

(3) Goodwill – Starkey Ltd £ Consideration transferred 230,000 Non-controlling interest at acquisition (302,000 x 35%) 105,700

335,700 Less: Net assets at acquisition Share capital (91,000 / 65%) 140,000 Retained earnings 162,000

(302,000)

Goodwill 33,700 Impairment brought forward (18,000)

Goodwill at date of disposal 15,700 (4) Group profit/loss on disposal of Starkey Ltd £ Sale proceeds 427,000 Less: carrying amount of goodwill at disposal (W3) (15,700) Carrying amount of net assets at disposal Share capital 140,000 Retained earnings (243,000 + (600,200 x 6/12)) 543,100

(683,100) Add back: Attributable to non-controlling interest (683,100 x 35%) 239,085

Loss on disposal (32,715) (5) PURP % £

SP 100 32,000 Cost (85) (27,200)

GP 15 4,800

X 1/4 1,200



(6) Retained earnings brought forward £ £ Mantia plc (596,300 – 1,006,325) (410,025) Add back dividend (500,000 x £1.20) 600,000 Appice Ltd – post acquisition change in net assets C/fwd retained earnings 384,200 Less: retained earnings at acquisition (136,000) Less: profit for the period (269,920) Add back dividend (80,000 x 40p) 32,000 Less: FV adjustment (70,000 / 10yrs) (7,000)

3,280 Appice Ltd – 3,280 x 80% 2,624 Starkey Ltd – post acquisition ((243,000 – 162,000) x 65%) 52,650 Less: impairment – Starkey Ltd (18,000)

227,249

Retained earnings carried forward (for proof only) £ Mantia plc 596,300 Appice Ltd – post acquisition (384,200 – 136,000 – 14,000 – 1,200) x 80% 186,400 Less: impairment – Appice Ltd (25,000) Profit on disposal of investment in Starkey Ltd (427,000 – 230,000) 197,000

954,700

Most candidates made a good attempt at preparing the consolidation schedule and correctly excluded the subsidiary held for sale. Many dealt with the relevant adjustments correctly obtaining all the available marks for this part of the question. Where candidates did make errors it was normally for the following:

deducting the inventory PURP from revenue rather than adding it to cost of sales or adding it to the cost of sales of the purchasing rather than the selling company.

calculating the cumulative adjustment to depreciation arising from the fair value adjustment rather than just the current year adjustment and/or entering this into the parent company rather than the subsidiary’s column.

adjusting the subsidiary’s profits for the goodwill impairment.

deducting 100% of the subsidiary’s dividend from investment income rather than just the parent company’s share of the dividend.

Virtually all candidates attempted to calculate the profit on disposal and a reasonable number arrived at the correct figure. One common error was using the incorrect share capital figure (the shares bought by the parent company rather than total share capital) or ignoring share capital altogether when calculating net assets. Other errors included:

failing to deduct the impairment from goodwill (many candidates deducted this from the profit on disposal instead).

failing to add 6/12 of current year profit to brought forward retained earnings or deducting it rather than adding it.

using retained earnings at acquisition rather than at the date of disposal when calculating net assets at disposal.

A number of candidates produced very disorganised workings for their retained earnings calculation and it was often difficult to understand where numbers had come from and whether they were increasing or decreasing the profit on disposal. Candidates are strongly advised to use the standard pro-forma given in the Learning Material to calculate this figure and label workings appropriately. Most candidates did prepare a consolidated statement of profit or loss and showed a separate figure for the profit from discontinued operations. However this figure often ignored the profit up to disposal or just took the parent company’s share of that profit. Candidates should note that if they only produce the consolidation schedule they will not get the presentation marks available for this statement. As expected the extract to the consolidated statement of changes in equity was not as well dealt with. Most candidates who attempted this statement did insert the “easy” figures ie the profit for the period and the dividends paid. However errors were frequently made even with these figures by taking total profit for the period rather than just the profit attributable to the owners of the parent company and/or also including the



subsidiary’s dividend as a deduction from retained earnings. Some candidates also showed dividends as an addition rather than a deduction to retained earnings. Relatively few candidates attempted to calculate retained earnings b/fwd or c/fwd. Where they did, workings were again often confused and difficult to follow. Few candidates appear to understand that they should take the same approach to calculate consolidated retained earnings as they do to calculate the consolidated retained earnings figure for consolidated statement of financial position questions.


21½ 20

(b) UK GAAP differences

Acquisition of Starkey Ltd The calculation for goodwill is the same under UK GAAP as per IFRS, however under IFRS the parent entity has a choice whether to measure the non-controlling interest at fair value or at the proportion of net assets. Under UK GAAP only the proportion of net assets method is permitted. UK GAAP requires goodwill to be amortised over its useful life and there is a rebuttable presumption that this should not exceed five years. Under IFRS amortisation is not permitted and instead annual impairment reviews take place. Disposal of Starkey Ltd UK GAAP requires that a detailed analysis of discontinued operations should be shown on the face of the profit and loss account. However, IFRS only requires a single line to be shown on the face of the statement of profit or loss.

The majority of candidates made a good attempt at this part of the question with many achieving full marks. However a significant number of candidates wasted time by including differences that were not relevant to the scenario such as the treatment of a discount on acquisition. A common misunderstanding is that under UK GAAP goodwill must be amortised over five years rather than it being a maximum useful life.


3½ 3

Financial Accounting and Reporting – Professional Level – June 2015


MARK PLAN AND EXAMINER’S COMMENTARY The marking plan set out below was that used to mark this question. Markers were encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. More marks were available than could be awarded for each requirement. This allowed credit to be given for a variety of valid points which were made by candidates.

Question 1 Total Marks: 33

General comments Part (a) of this question tested the preparation of a statement of profit or loss and a statement of financial position from a trial balance plus a number of adjustments. Adjustments included an asset held for sale which had previously been revalued, a finance lease, the receipt of a government grant, an adjusting event after the reporting period and an income tax refund. Part (b) tested the difference between the IFRS treatment of the government grant and that under UK GAAP. Part (c) tested the definitions of the elements of financial statements with application to the financial statements prepared in Part (a).

Antigua plc

(a) Financial statements Statement of profit or loss for the year ended 31 December 2014 £ Revenue 8,417,010 Cost of sales (W1) (4,799,960)

Gross profit 3,617,050 Operating expenses (W1) (2,044,050)

Profit from operations 1,573,000 Finance cost (W7) (1,750)

Profit before tax 1,571,250 Income tax expense (497,500 – 127,000) (370,500)

Profit for the year 1,200,750

Statement of financial position as at 31 December 2014 £ £ Assets Non-current assets Property, plant and equipment (1,271,600 + 283,090)

(W2) 1,554,690

Current assets Inventories (W6) 733,400 Trade and other receivables 578,700

1,312,100 Non-current asset held for sale (58,000 – 5,000) 53,000

1,365,100




Equity and liabilities £ £ Equity Ordinary share capital 50,000 Revaluation surplus (W5) 717,400 Retained earnings (W4) 1,185,740

1,953,140 Non-current liabilities Finance lease liabilities (W7) 33,500 Current liabilities Finance lease liabilities (W7) 9,250 Trade and other payables 325,100 Borrowings 101,300 Taxation 497,500

933,150


Workings (1) Allocation of expenses Cost of

sales Operating expenses

£ £ Per TB 4,741,400 2,017,500 Opening inventories 678,000 Closing inventories (W6) (733,400) Costs to sell held for sale asset 5,000 Loss on held for sale asset (W3) 800 Depreciation charge on buildings 30,000 Depreciation charges on plant and equipment (5,175 + 8,375 + 48,660 (W2))

62,210

Add back government grant (103,500 x 50%) 51,750 Lease payment wrongly included (9,250)

4,799,960 2,044,050

(2) PPE Land and

buildings Plant and

equipment

£ £ B/f Valuation/Cost 1,490,000 578,000 B/f Accumulated depreciation (90,000) (231,200)

1,400,000 346,800 Less: Held for sale asset (W3) (98,400) Depreciation on buildings ((1,490,000 – 140,000) ÷ 45) (30,000) Less government grant (W1) (51,750) Depreciation on equipment subject to grant (51,750 x 20% x 6/12)

(5,175)

Leased asset 50,250 Depreciation on leased asset (50,250 ÷ 6) (8,375) Depreciation on other plant and equipment ((346,800 – 103,500) x 20%)

(48,660)

1,271,600 283,090



(3) Asset held for sale

Asset

Revaluation

surplus

£ £ Cost on 1 January 2006 76,000 Depreciation to 31 December 2010 (76,000/50 x 5) (7,600)

Carrying amount at 31 December 2010 68,400

Revaluation on 1 January 2011 108,000 39,600 Depreciation to 31 December 2014 (108,000/45 x 4) (9,600)

Carrying amount at 31 December 2014 98,400 Fair value (58,000)

40,400 39,600 Charge to profit/revaluation surplus 800 (39,600)

(4) Retained earnings £ At 31 December 2013 (15,010) Profit for the year 1,200,750

At 31 December 2014 1,185,740

(5) Revaluation surplus £ At 31 December 2013 757,000 Loss on held for sale asset (W3) (39,600)

At 31 December 2014 717,400

(6) Closing inventories £ At cost 752,000 Less Write down to NRV ((142,000 x 70%) – 118,000) (18,600)

733,400

(7) Finance lease B/f Payment Capital Interest C/f £ £ £ £ £ 31 December 2014 50,250 (9,250) 41,000 (5/15 x 5,250) 1,750 42,750 31 December 2015 42,750 (9,250) 33,500 SOTD = (5 x 6)/2 = 15 Interest = (9,250 x 6) – 50,250 = 5,250



Generally candidates made a good attempt at this part of the question. However, presentation of the financial statements was often poor, and many scripts were messy and disorganised. It was noticeable that far less well-presented scripts than usual were seen. In particular it was often not possible to agree the figure taken to the statement of financial position for the carrying amount of property, plant and equipment to a single figure in the workings. Candidates should be aware that if such a figure cannot be seen in the workings then they will not gain the mark available for this figure on the face of the statement of financial position. In general, property, plant and equipment workings were often untidy and indicated that the approach to working out this figure was not methodical. The recommended approach is for candidates to use a property, plant and equipment “table” with supporting workings as needed. Generally, candidates arrived at the correct figures for closing inventories, the income tax charge in the statement of profit and loss and the figure for non-current assets held for sale on the statement of financial position (with many candidates gaining the additional marks available for putting this in the correct place at the bottom of current assets). Many candidates made a good attempt at the workings in relation to the impairment on the asset held for sale, the most common errors being:

a failure to revalue the asset to fair value first and therefore deal with the costs to sell separately

errors in depreciation calculations (usually charging depreciation for an incorrect number of years)

charging the whole of the impairment to the revaluation surplus, without first checking what the balance on the revaluation surplus in relation to the asset was

charging the impairment to the revaluation surplus and the same figure as an expense in the statement of profit and loss

having arrived at a figure for the carrying amount of the asset held for sale, failing to deduct this figure from property, plant and equipment, or deducting the fair value instead.

Surprisingly, the aspect of the question that caused the most problems was the finance lease. Usually, the majority of candidates would get the figures in relation to this completely correct, but, on this occasion, that was rare. Almost all candidates calculated a “sum of the digits” but this was often based on payments in arrears, rather than in advance, even where the candidate’s lease “table” clearly showed payments in advance. Furthermore, a worrying number of candidates were unable to calculate the correct figure for total finance costs. Having calculated their own sum of the digits, some candidates then went on to use this as an interest rate in their leasing table. Finally, only a small number of candidates were able to correctly split the year-end liability, per their own table, into current and non-current, with few appreciating that for a lease where payments are in advance, the current liability will always be the payment for the next year. Most candidates did use the recommended “costs matrix” when allocating costs for the statement of profit or loss, and entered the adjustments into the correct columns. Occasionally errors were made in terms of whether the adjustment was increasing or decreasing costs particularly with regard to the grant incorrectly credited to purchases. Candidates whose convention was to use figures in brackets for costs were generally the ones who got themselves into a muddle with the direction of their adjustments, as if they had reverted to the opposite convention part way through. A number of candidates failed to include all of their depreciation charges (on the leased asset, the asset subject to a grant, on the remaining plant and equipment, and on the building) in this matrix, even when they had calculated all of these elements in their property, plant and equipment workings. Once again, this indicated a disorganised approach. Other common errors included the following:

Showing the bank account (which was a credit balance in the trial balance) as a current asset, rather than as an overdraft in current liabilities.

Adding the retained earnings brought forward (which was a debit balance in the trial balance) to their profit for the year, instead of deducting it.

Reducing the income tax liability by the income tax refund when that refund had already been received (or showing the refund as a separate tax asset).

Adding the grant to property, plant and equipment rather than deducting it.

Charging a full year’s depreciation on the asset subject to the grant, instead of six months.

Using a useful life of seven years for the leased asset instead of the (shorter) lease term of six years.


27 25



(b) Differences between IFRS and UK GAAP re government grant

UK GAAP Grants are recognised under the performance model or the accrual model. This policy choice is to be made on a class-by-class basis. Under the performance model, where no specific performance-related conditions are imposed on the recipient (as here) then the grant is recognised in income when the grant proceeds are received or receivable. Hence, if the performance model had been chosen, then Antigua Ltd would have credited the whole £51,750 to income during the year. Under the accrual model grants relating to assets are recognised in income on a systematic basis over the expected useful life of the asset. However, this cannot be done by deducting the grant from the carrying amount of the asset, but by recognising deferred income.

IFRS No such requirement exists in IAS 20. This would not be possible under IFRS, where, under the chosen netting-off method, the grant is credited against the cost of the asset and so effectively released to profit or loss over the life of that asset, in line with the depreciation policy on that asset.

Most candidates made a reasonable attempt at this part of the question, with almost all stating that IFRS allows a choice of treatment, but that UK GAAP only allows the deferred income method. Most went on to clearly describe the mechanics of the two methods, although some wasted time providing calculations for the deferred income method, which were not required. Very few candidates gained full marks, and almost all candidates seemed unaware of the two models (performance and accrual) allowed by UK GAAP.


6 3

(c) Elements of the financial statements Asset – The finance lease is recognised as an asset because the machine is controlled by Antigua plc (has the risks and rewards), the control came about via the signing of the lease, which happened during the year, and the machine will be used in the business to generate future revenue. Liability – The overdraft is recognised as a liability because it existed at the year end and will lead to future outflows in the form of repayment and interest payments. Income – Revenue is a form of income as it brings cash inflows or enhancement of assets in the form of trade receivables. Expenses – Depreciation is an expense as it reduces the carrying amount of property, plant and equipment (ie depletes an asset). Equity – this equals Antigua plc’s ordinary share capital, retained earnings and revaluation surplus as the sum of these is equal to total assets minus total liabilities/is the residual interest in the assets of the entity after deducting all its liabilities.

There were some very good attempts at this part of the question, with all five elements clearly stated, an appropriate example given for each, and a clear explanation of why the given example met the definition. At the other end of the scale were answers which, although they gave the five elements and appropriate examples, merely copied out the definitions of the elements from the open book text, without any attempt to relate those definitions to their examples, and therefore scored very little for their explanations. A significant minority of candidates confused “elements” with the fundamental and enhancing qualitative characteristics, thereby scoring no marks.


8½ 5




General comments Part (a) of this question required candidates to explain the IFRS financial reporting treatment of the four issues given in the scenario. The issues covered a financial asset, the disposal of a subsidiary, a foreign exchange transaction and a related party transaction. Part (b) required a discussion of the ethical issues arising from the scenario and the action to be taken. Part (c) required candidates to describe any differences between IFRS and UK GAAP in respect of the financial reporting treatment of Issue (2).

Cuba Ltd

(a) IFRS financial reporting treatment (1) Financial asset The bond is a financial asset as defined by IAS 32, Financial Instruments: Presentation, because it represents a contractual right to receive cash from another entity. Per IAS 39, Financial Instruments: Recognition and Measurement, financial assets should be recognised when the contract is entered into and initially measured at its fair value, including transaction costs. Fair value is defined by IFRS 13, Fair Value Measurement, but is normally the transaction price. Hence Philippe was correct to recognise the asset on 1 January 2014, but should have recognised it at £97,000 (94,500 + 2,500), not £110,000. As this is a held-to-maturity financial asset, the asset should subsequently be measured at amortised cost using the effective interest method. At 31 December 2014 interest of £6,295 (97,000 x 6.49%) should be recognised as income in profit or loss so the income recognised of £15,500 will need to be reduced by £9,205 (15,500 – 6,295). The bond should be stated at £103,295 (97,000 + 6,295). Because the bond is redeemable on 31 December 2015, ie within one year, it should be presented in investments within current assets.

(2) Disposal of subsidiary In Cuba Ltd’s consolidated financial statements the profit on disposal of Honduras Ltd should be calculated by comparing the net assets at the date of disposal and non-controlling interest (NCI), less goodwill on consolidation not already written off, to the sale proceeds. The net assets at the date of disposal will be the net assets brought forwards on 1 January 2014, less the loss earned by Honduras Ltd to the date of disposal/(six months pro-rated).

£ £ Sale proceeds 256,600 Less: Carrying amount of goodwill at date of disposal: Consideration transferred at date of acquisition 147,800 Fair value of NCI at date of acquisition 40,100

187,900 Net assets as date of acquisition (157,500)

Goodwill at date of acquisition and disposal (30,400) Carrying amount of goodwill at date of disposal: Net assets on 31 December 2013 301,000 Loss for current year to date of disposal (16,600 ÷ 2) (8,300)

Carrying amount of net assets at date of disposal (292,700) Add: NCI in net assets at date of disposal (40,100 +

(292,700 – 157,500) x 20%)) 67,140

Profit on disposal 640



This figure should be recognised in the consolidated statement of profit or loss as discontinued operations. In the consolidated statement of profit or loss, Cuba Ltd should include the results of Honduras Ltd up to the date of disposal. At the year end of 31 December 2014 the Cuba Ltd group no longer controls any of the assets or liabilities of Honduras Ltd and so the consolidated statement of financial position should not recognise any of Honduras Ltd’s assets or liabilities. The non-controlling interest figure will similarly include their share (20%) of six-twelfths of Honduras Ltd’s loss for the year, being £1,660 (16,600 x 20% x 6/12). In the statement of changes of equity for the year the £67,140 above will be shown as a deduction in the non-controlling interest column. Because the investment in Honduras Ltd represented a separate major line of business of the Cuba Ltd group, in the consolidated statement of profit or loss, the results of Honduras Ltd for the year ended 31 December 2014 should be presented separately in accordance with IFRS 5, Non-current Assets Held for Sale and Discontinued Operations. A single net figure of a loss of £7,660 for the discontinued operation should be disclosed on the face of the consolidated statement of profit or loss, being the profit on disposal of £640, less the loss for the period to disposal of £8,300. A disclosure note should show the breakdown of this figure into revenue, costs and the profit on disposal. Honduras Ltd’s prior period results should be reclassified as discontinued in order to ensure comparability.

(3) Foreign exchange transaction IAS 21, The Effects of Changes in Foreign Exchange rates, states that a foreign currency transaction should be recorded, on initial recognition in the functional currency, by applying the exchange rate between the reporting currency and the foreign currency at the date of the transaction/historic rate. When the goods were received on 23 November 2014, Philippe was correct to record them in purchases and trade payables at the spot rate of €1:£0.85, ie at an amount of £134,300 (158,000 x 0.85). However, at the year end, IAS 21 requires that any foreign currency monetary items are retranslated using the closing rate. Monetary items are defined as “units of currency held and assets and liabilities to be received or paid in fixed or determinable number of units of currency”. The trade payable in respect of this purchase meets the definition of a monetary item and should have been retranslated at the closing rate. This would have given a trade payable of £142,200 (158,000 x 0.90). This exchange loss of £7,900 (142,200 – 134,300) should have been included in the consolidated statement of profit or loss for the year ended 31 December 2014. Furthermore, because inventory does not meet the definition of a monetary item, it should have been left as originally recorded, and not been restated. Closing inventory therefore should be reduced by the same amount (£7,900), further reducing the profit for the year.

(4) Related party transaction This appears to be a related party transaction per IAS 24, Related Party Disclosures. Grenada Ltd is a related party of Cuba Ltd because Grenada Ltd is owned by a close family member of Cuba Ltd’s key management personnel (ie it is owned by the wife of Cuba Ltd’s finance director). The following disclosures are therefore required, even if the purchases were indeed made on an arm’s length basis:

The nature of the related party relationship (ie that purchases have been made from a company owned by the finance director’s wife).

The amount of the transactions (£550,000).

The amount of any balances outstanding at the year-end (£75,000). Disclosure may be made of the fact that the transactions were made on an arm’s length basis if this can be substantiated.



This question was not answered as well as the numeric parts of the paper, and indeed the other written

parts. Candidates need to be aware that they can only score well on this type of question if they make a

reasonable attempt to provide explanations, in addition to calculations.

Issue (1): This was generally very poorly answered with many candidates assuming this was a liability.

Given that the bond was “purchased” as opposed to being “issued” it was clearly a financial asset, not a

financial liability. Others thought it was a compound financial instrument, with equity and liability

components. Some hedged their bets altogether by stating it was both an asset and a liability. A few

thought it was an intangible asset. Others provided figures (some sort of amortised cost table) without ever

stating what the transaction represented. Those candidates who did correctly identify the transaction as a

financial asset generally said that it needed to be recognised at an initial £97,000 (ie including the

transaction costs) and then amortised that figure at its effective interest rate, giving a closing carrying

amount, although the answer did not always describe that method in words.

Issue (2): Much better attempts were made at this part of the question. Almost all candidates recognised

this as a discontinued operation, although they didn’t always explicitly state this, and correctly stated that it

needed to be recognised as a single line in the statement of profit or loss. They then correctly combined

their own figure for profit or loss on disposal with the subsidiary’s loss for the year up to disposal. Most

recognised that the loss for the year was for six months only, but a significant number of candidates, as

usual, took only the group share of this figure. However, although almost all candidates attempted the

relevant calculations, many, once again, failed to also describe what needed to be done in words. Few

considered the impact of the disposal on the statement of financial position (ie the subsidiary would not be

consolidated as control had been lost). By far the most common error in the calculation of the profit or loss

on disposal was in respect of the non-controlling interest at disposal with very few calculating this using

the chosen fair value policy – most candidates calculated this using the proportionate method and

therefore simply took 20% of the net assets at disposal. Others made errors in the calculation of the latter

figure, most commonly adding, rather than deducting, the loss for the year from the opening net assets.

Issue (3): Once again, many candidates produced the correct relevant calculations (this time often

accompanied by journal entries, which were not required) without explaining why it was that the payable

needed to be restated but that the inventory should not have been (ie making reference to the treatment of

monetary, as opposed to non-monetary items). A minority of candidates said that the inventory had

correctly been restated and that the payables correctly left at the historic rate. A significant number of

candidates, whilst producing the three correct figures, seemed to be completely unclear as to which

figures should be shown at which amount, ie at the historic or closing rate.

Issue (4): Most candidates recognised that this was a related party transaction and were able to explain

why. However, most said that this was because Phillippe’s wife was a related party, as opposed to Cuba

Ltd being a related party. Almost all candidates listed the necessary disclosure requirements but fewer

illustrated how these requirements would be fulfilled by reference to the information in the scenario. Most

knew that the fact that the transaction had been made on an arm’s length basis did not negate the need

for disclosure.


33 21



(b) Ethical issues Philippe appears to have a self-interest threat, as he is due a bonus based on the profit for the year. The “errors” which José has discovered in the draft financial statements could be genuine mistakes due to a lack of knowledge, or could be a deliberate attempt by Philippe to overstate the profit for the year in order to increase his bonus. It may be that had it not been for his illness that these “errors” would not have been discovered. As an ICAEW Chartered Accountant Philippe has a duty of professional behaviour and due care and should be aware of the correct IFRS financial reporting treatment for all of these issues, none of which are at all controversial. His imminent retirement is no excuse.

Although the transaction with Grenada Ltd may all be above board, it does perhaps throw into doubt the integrity of Philippe if there is any question over whether the transactions were conducted on an arm’s length basis. In any case, even if they were, as an ICAEW Chartered Accountant Philippe should not only act with integrity but he should appear to act with integrity. The fact that he is suggesting that this transaction does not need to be disclosed also paints him in a poor light. Given Phillippe’s attitude about not amending the figures, José is subject to an intimidation threat. He should apply the ICAEW Code of Ethics, with the following programme of actions:

Explain to Philippe how each of these matters should be accounted for.

If Philippe refuses to correct the errors, discuss the matters with the other directors to explain the situation and obtain support. Consider also discussing the issues with the external auditors.

Obtain advice from the ICAEW helpline or local members responsible for ethics.

Keep a written record of all discussions, who else was involved and the decisions made.

This part of the question was well answered. Most candidates correctly identified that there was a self- interest threat for Phillippe (because of his profit-related bonus) and that there was an intimidation threat for José (due to Phillippe’s attitude in the telephone call). They also recognised that all of the “errors” had increased the profit for the year. Many then went on the discuss the actions that José should take, being the standard response of discussion with Phillippe, discussion with the other/managing director(s), seeking help from the ICAEW helpline, and documenting all discussions. As ever, many candidates were overly keen to resign and a number put themselves in an audit context, by suggesting that they should seek help from the ethics partner.


9 5



(c) IFRS v UK GAAP differences re disposal of subsidiary

IFRS UK GAAP

IFRS 5 requires the results of a discontinued operation to be shown as a single figure on the face of the statement of profit or loss.

FRS 102 shows the results of a discontinued operation as a separate column on the face of the income statement.

Under IFRS 3 non-controlling interest may be measured at fair value or on the proportionate basis. IFRS 3 goodwill is not amortised but is subject to annual impairment reviews.

FRS 102 only permits the proportionate (share of ownership) basis. FRS 102 requires goodwill to be amortised over its useful life. There is a rebuttable presumption that the useful life should not exceed five years.

Almost all candidates scored at least one mark in this part, with the most common answer being to describe the differences between the presentation of discontinued activities in the statement of profit or loss/income statement, which was understandable as this was the main focus of Issue (2). However, Issue (2) also covered the calculation of goodwill and candidates should have been guided by the fact that the requirement was for two marks and that therefore they needed to think more widely and look at the calculation itself. Some candidates did go on to do this and achieve a second mark by describing which methods of calculating goodwill and the non-controlling interest are available under IFRS and UK GAAP. It was less common to see the differences with reference to the impairment and amortisation of goodwill, although this was not needed to achieve full marks.


3½ 2




General comments This was a mixed topic question requiring the preparation of extracts from the financial statements. The question featured various transactions in property, plant and equipment, including a self-constructed asset, in addition to share issues during the year and dividends. In Part (a) candidates were required to explain their treatment of the self-constructed asset, which meant they could then use their calculated figures in Part (b).

Columbia plc

(a) IFRS financial reporting treatment of the manufacturing facility Per IAS 16, Property, Plant and Equipment, the cost of an item of property, plant and equipment (PPE) comprises:

Purchase price

Costs directly attributable to bringing the asset to its intended location and condition. The site preparation costs, materials and labour costs, professional fees, construction overheads and costs of the initial safety inspection are directly attributable costs and therefore can be capitalised, a total of £500,300 (100,000 + 358,300 + 10,000 + 21,000 + 11,000). The relocation costs of £45,600 and the general overhead costs of £32,500 cannot be capitalised/should be expensed because they are not directly attributable. So the total amount written off to profit or loss should be £78,100 (45,600 + 32,500). Capitalisation should cease when the asset becomes capable of operating in the manner intended /so on 30 November 2014.

Each significant part of an item of PPE should be depreciated separately so the calculation of the annual depreciation charge for the year will be: £ Safety inspection (21,000 ÷ 3) 7,000 Other ((500,300 – 21,000) ÷ 20) 23,965

30,965

Since the asset was available for use only from 30 November 2014, then only one month of this annual charge should be recognised in profit or loss for the year ended 31 December 2014, ie £2,580 (30,965 ÷ 12). The carrying amount of the facility on 31 December 2014 is therefore £497,720.

Answers to this part were mixed, although a reasonable number of candidates did obtain the maximum marks and, generally, the quality of explanations in this part was better than those in Part (a) of Question 2. However, a significant number of candidates wasted time by discussing irrelevant accounting standards, in particular IAS 38, Intangible Assets and IAS 23, Borrowing Costs. Most candidates made an attempt at justifying which costs should and shouldn’t be capitalised and virtually all candidates did conclude that a month’s worth of depreciation should be charged and attempted to calculate this figure. The most common errors were:

failing to justify the appropriate treatment for the costs by reference to IAS 16, Property, Plant and Equipment

treating the professional fees and/or the construction overheads and/or the initial safety inspection costs incorrectly

not separating out the initial safety inspection costs so that they could be depreciated over the shorter life of three years.


7½ 5



(b) (i) Revised profit for the year ended 31 December 2014 £ Draft profit for the year 52,600 Costs re self-constructed asset (a) (78,100) Depreciation on self-constructed asset (a) (2,580) Finance costs (50,000 x 4% x ½) (1,000)

(29,080)

(ii) Extracts from the financial statements for the year ended 31 December 2014

Statement of cash flows for the year ended 31 December 2014 £ Investing activities Purchase of property, plant and equipment (W1) (932,800) Proceeds from sale of property, plant and equipment (125,700 –

14,300) 111,400

Financing activities Issue of ordinary share capital (75,000 x 1.50) 112,500 Issue of irredeemable preference share capital 50,000 Ordinary dividends paid (W2)) (56,250) Statement of financial position as at 31 December 2014 £ Non-current assets Property, plant and equipment (W1) 2,025,620 Equity Ordinary share capital (W3) 468,750 Retained earnings (W2) 39,220 Non-current liabilities Irredeemable preference share capital 50,000 Current liabilities Preference dividend/finance costs payable 1,000 Workings (1) PPE

£ £ B/d 1,456,700 Disposal 125,700 Additions (432,500 + 500,300 (a)) 932,800 Depreciation (235,600 + 2,580 (a)) 238,180 C/d (β) 2,025,620

2,389,500 2,389,500

(2) Retained earnings

£ £ Loss for the year (i) 29,080 B/d 145,800 Bonus issue (93,750 – 72,500) (W3) 21,250

Ordinary dividend (15p x 375,000) 56,250 C/d (β) 39,220

145,800 145,800



(3) Ordinary share capital and share premium Share

capital Share

premium

£ £ At 31 December 2013 300,000 35,000 Issue on 1 February 2014 75,000 37,500

375,000 72,500 Bonus issue on 1 November 2014 (÷ 4) 93,750 (72,500)

At 31 December 2014 468,750 -

Generally answers to this part were good with most candidates calculating an adjusted profit figure and preparing extracts to both the statement of financial position and statement of cash flows. The quality of extracts produced was reasonable, but a minority of candidates produced a jumble of notes and workings. Many candidates correctly calculated the closing balance on the share capital account and showed in their workings that the share premium account would be reduced to zero. The figures for proceeds from disposals of property, plant and equipment, issue of shares and dividends paid were also dealt with well and nearly always shown under the correct heading in the statement of cash flows. However, as always with the statement of cash flows, many candidates lost marks for failing to show outflows of cash in brackets. This is an issue that has been flagged up repeatedly. Also, many candidates wasted time by duplicating workings; often doing a bracketed working for property, plant and equipment to calculate the figure for the statement of financial position then also producing a T-account working (which often included different numbers). Another common error with property, plant and equipment was to include the costs of the new manufacturing facility in the working but not in the figure on the face of the statement of cash flows. Other candidates wasted time by preparing a combined share capital and share premium T-account then had to repeat the working, showing these accounts separately, to allow for the preparation of statement of financial position extracts. A worrying minority of candidates calculated a weighted average number of ordinary shares, as would be needed for an earnings per share calculation. Other common errors included:

including a full year for the dividend on the irredeemable preference shares (rather than six months) and also treating it as a dividend paid on the statement of cash flows, or omitting this dividend entirely

making unnecessary adjustments to both profit and property, plant and equipment (when the question clearly stated that the depreciation on existing assets and the loss on the disposal had already been recognised)

deducting all of the bonus issue from retained earnings when as much of it as possible should have been taken to share premium (another reason why it was necessary to produce separate share capital and share premium workings)

calculating the ordinary dividend by reference to closing share capital (when the bonus issue had not been made until after the interim dividend was paid)

combining the liabilities for the preference dividend payable with the preference share capital in the statement of financial position, rather than showing these individually as current and non-current liabilities respectively.


14½ 14




General comments This question required the preparation of a consolidated statement of financial position from a draft version of the same, where figures for a subsidiary had been incompletely incorporated and figures for an associate not included at all. Fair value adjustments were required on acquisition for both companies as well as dealing with contingent consideration for the subsidiary. Intra-group trading and the transfer of a non-current asset had occurred during the year and also needed to be adjusted for.

Dominica plc

Consolidated statement of financial position as at 31 December 2014 £ £ Assets Non-current assets Property, plant and equipment (3,780,400 – 20,000

(W7)) 3,760,400

Investment in associate (W4) 160,060 Goodwill (W2) 108,830

4,029,290 Current assets Inventories (400,800 + 8,500 (W1) + 17,700 (W1)) 427,000 Trade and other receivables 182,400 Cash and cash equivalents 53,400

662,800


Equity and liabilities Equity Ordinary share capital (1,400,000 – 160,000) 1,240,000 Share premium (890,000 – 80,000) 810,000 Revaluation surplus (1,061,600 – 240,000 + (100,000 (W1) x 85%)) 906,600 Retained earnings (W5) 1,228,835

Attributable to the equity holders of Dominica plc 4,185,435 Non-controlling interest (W3) 103,155

4,288,590 Current liabilities Trade and other payables (320,000 – 200,000) 120,000 Contingent consideration 150,000 Taxation 133,500

403,500


Workings (1) Net assets – Tobago Ltd Year end Acquisition Post acq £ £ £ Ordinary share capital 160,000 160,000 - Share premium 80,000 80,000 - Revaluation surplus 240,000 140,000 100,000 Retained earnings 181,500 63,200 FV adj – inventories ((124,000 – 107,000)/2) 8,500 17,000 Inventory – sale or return (23,600 x 75%) 17,700 - 127,500

687,700 460,200 227,500



(2) Goodwill – Tobago Ltd £ Consideration transferred:

Cash 400,000 Contingent consideration 100,000

500,000 Net assets at acquisition (W1) (460,200) Non-controlling interest at acquisition (460,200 (W1) x 15%) 69,030

108,830

(3) Non-controlling interest – Tobago Ltd £ Share of net assets at acquisition (460,200 (W1) x 15%) 69,030 Share of post-acquisition profits (227,500 (W1) x 15%) 34,125

103,155

(4) Investment in associate – Anguilla Ltd £ Cost 156,000 Add: Share of post-acquisition profits ((168,100 – 104,500) x 35%) 22,260 Less: FV depreciation (100,000/20 years) x 35% x 10 years) (17,500) Less: PURP (W6) (700)

160,060

(5) Retained earnings £ Draft consolidated (1,367,900 – 181,500) 1,186,400 Additional contingent consideration (50,000) Tobago Ltd (127,500 (W1) x 85%) 108,375 Anguilla Ltd (W4) 22,260 Less: FV depreciation (W4) (17,500) Less: PURP (W6) (700) Less: PPE PURP (W7) (20,000)

1,228,835

(6) PURP Anguilla Ltd % £ SP 100 20,000 Cost (70) 14,000

GP 30 6,000

X 1/3 2,000

Anguilla Ltd x 35% 700

(7) PPE PURP £ Asset now in Tobago Ltd’s books at 180,000 x 5/6 years 150,000 Asset would have been in Dominica plc’s books at 156,000 x 5/6 years (130,000)

20,000



Answers to this question were generally good, with virtually all candidates recognising that the associate should not be consolidated and that the equity balances needed to be adjusted to remove the figures of the subsidiary that had been incorrectly added in. Most candidates produced the standard workings used in the learning materials which meant it was relatively straightforward to follow the workings and give credit where appropriate. The correct figure for the unrealised profit relating to the associate was frequently calculated correctly although, as always, some candidates failed to use only the parent’s share of this. Many candidates also seemed confused about what should be included in the associate working, often adding in fair value adjustments and not understanding that adjustments to the cost of the associate should also be included in retained earnings. A number of candidates calculated different figures for these two workings thereby wasting time and losing marks. The two adjustments that caused the most problems were the unrealised profit relating to the sale of a machine and the adjustment to inventory for goods sold on a sale or return basis. With regard to the former those candidates who calculated the adjustment by comparing the two different carrying amounts did well. However, those who calculated separate figures for profit on disposal and the adjustment to the subsequent depreciation charge rarely netted these off to come to the correct adjustment. Some candidates calculated the relevant figure but then failed to adjust property, plant and equipment for this. Few candidates calculated the correct adjustment for the goods on sale and return often adjusting for the profit element (which had not been recognised) rather than calculating the cost of the goods and adding it to net assets and inventories. The contingent consideration was also poorly dealt with. Many candidates used the wrong figure in the goodwill calculation and few made the appropriate corresponding adjustment to liabilities or dealt with the change in the value of the contingent consideration in retained earnings. As always, many candidates lost marks by failing to show an “audit trail” so figures appeared in workings without any evidence of how they had been calculated. It is not sufficient to say, for example, “85% x NA at acq”. The actual figure for net assets at acquisition (as calculated in the candidate’s own net assets table) must also clearly be shown alongside the percentage for the marks to be awarded. Other common errors included the following:

Deducting, rather than adding, the fair value increase relating to inventory and/or failing to recognise that half the inventory had been sold by the year end.

Adopting an inconsistent treatment in the net asset working and the adjustment to inventories in respect of the above (eg adding the figure to net assets but deducting it from inventories).

Not separating out the movement in net assets relating to the revaluation surplus and therefore including this in retained earnings.

Not adjusting the revaluation surplus to take into account only the parent’s share of the subsidiary’s post-acquisition movement on its revaluation surplus – many candidates added in 100% of this figure, others did not adjust for it at all.

Not knowing how to calculate and/or account for the post-acquisition depreciation on the fair value uplift in the associate. A significant number of candidates who were able to calculate the depreciation adjustment then only proceeded to account for one year’s worth of the adjustment instead of the required ten years’ worth.

Using 80% when calculating figures for the subsidiary, instead of the 85% given in the question.


22 20

Financial Accounting and Reporting - Professional Level – September 2015



Question 1 Total Marks:

General comments Part (a) of this question tested the preparation of a statement of profit or loss, a statement of financial position and a provisions note from a draft set of financial statements with a number of adjustments required. Adjustments included deferred revenue, foreign exchange difference, a provision with discounting and a convertible bond as well as adjustments to property, plant and equipment. Part (b) tested the difference between the presentation of financial statements prepared using IFRS and UK GAAP. Part (c) asked for explanations of the concepts of substance over form, present fairly and true and fair view with illustration to the financial statements prepared in Part (a).

(i) Gamow Ltd – Statement of financial position as at 31 March 2015

£

£

ASSETS Non-current assets Property, plant and equipment (W4) 1,207,020 Intangibles 160,000

1,367,020 Current assets Inventories 47,300 Trade and other receivables (121,240 – 880 (W3)) 120,360 Cash and cash equivalents 3,800

171,460


Equity Ordinary share capital 580,000 Other share reserve (share options / warrants) (W7) 22,782 Retained earnings (541,720 – 779,890 + 336,900) 98,730

Equity 701,512 Non-current liabilities Bond (W6) 284,168 Provisions (note) 112,150 Deferred income (250,000 x 3/24) (W2) 31,250

427,568 Current liabilities Trade and other payables (92,400 + 18,000 (W7)) 110,400 Deferred income (100,000 + (156,250 (W2) – 31,250)) 225,000 Taxation 74,000

409,400




(ii) Gamow Ltd – Statement of profit or loss for the year ended 31 March 2015

£ Revenue (1,896,200 – 156,250 (W2) – 100,000 (W2)) 1,639,950 Cost of sales (W1) (683,310)

Gross profit 956,640 Administrative expenses (337,360) Other operating costs (174,533)

Operating profit 444,747 Finance costs (1,560 + 7,337 (W6) + 24,950 (W7)) (33,847)

Profit before tax 410,900 Income tax (74,000)

Profit for the year 336,900

(iii) Provisions note £ At 1 April 2014 – Profit or loss charge (W6) 104,813 Unwinding of discount 7,337

At 31 March 2015 112,150

This provision is in relation to a legal claim which arose on 1 April 2015 due to the delivery of faulty goods to a customer. The incident was one-off in nature due to a fault with one of the machines. The provision has been discounted to a present value of 7%. The legal claim is likely to be settled in April 2016.

Workings

W1 Expenses Cost of

sales £

Admin expenses

£

Other operating

costs £

Draft 567,430 283,600 189,720 Exchange loss (W3) 880 Provision adjustment (120,000 – 104,813)

(15,187)

Research & development costs (W5) 115,000 Depreciation charge (W4) 51,360 Loss in disposal (W4) 2,400

683,310 337,360 174,533

W2 Revenue

Loyalty cards (200 x £1,250) = £250,000 £250,000 x 9/24 months = £93,750 revenue Deferred income (250,000 – 93,750) £156,250 Mendel pre-orders (2,000 x £50) = £100,000 W3 Foreign exchange £ Translation at 1 January 2015 (22,000 x 0.83) 18,260 Translation at 31 March 2015 (22,000 x 0.79) (17,380)

Exchange loss 880



W4 Property, plant & equipment Land &

buildings Plant &

machinery

£ £ Cost 1,080,000 384,900 Less: disposal (cost) (19,500)

365,400 Depreciation charge for the year 1,080,000 / 40yrs (27,000) 365,400 / 15yrs (24,360)

Disposal – carrying amount (19,500 – (19,500 / 15yrs) x 6yrs) = 11,700

PPE – carrying amount at 31 March 2015 £ At 1 April 2014 1,260,780 Less: depreciation (27,000 + 24,360) (51,360) Less: disposal adj (11,700 – 9,300) (2,400)

At 31 March 2015 1,207,020

W5 R&D Project – Mendel Intangible

asset £

Expense

£

Background investigation work 25,000 Initial development work 42,800 Second phase development work 160,000 Product launch costs 31,600 Staff training 15,600

160,000 115,000

W6 Provision 120,000 / 1.07

2 = 104,813

Unwinding of discount: 104,813 x 7% = 7,337 W7 Convertible bond Cash flow

£

Discount factor @ 9%

Present value

£ 31 March 2015 18,000 1/1.09 16,514 31 March 2016 18,000 1/1.09

2 15,150

31 March 2017 (redemption) 318,000 1/1.093 245,554

Liability component 277,218 Equity component (bal fig) 22,782

Total 300,000

1 April 2014 Interest (9%) Payment (6%) 31 Mar 2015 £ £ £ £

277,218 24,950 (18,000) 284,168

Presentation of the statement of profit or loss and statement of financial position varied. Although as indicated as acceptable at the tutor conference, most candidates omitted sub-totals on the statement of financial position, many also omitted totals for total assets and total equity and liabilities on this statement and/or sub-totals on the statement of profit or loss and were penalised accordingly. However, there were few very messy statements in terms of workings shown on the face of the statements. Most candidates did use the recommended “costs matrix” in their workings and fewer than usual lost marks by mixing up bracket conventions. However, a worrying number of candidates were let down by difficult to read handwriting.



Presentation of the provisions note was poor. Many candidates seemed to have little idea what this note should look like, with many notes looking more like a property, plant and equipment note, featuring “additions” for the year. In addition, a number of candidates gave an explanation for how they had arrived at the closing balance (rather like an answer to an “explain” type question), rather than the narrative that should accompany such a note. Although most candidates arrived at the correct closing balance of £112,150, this was mainly achieved by discounting the gross provision of £120,000 by 7% for one year, to the current year end. Even those who correctly discounted by two years, usually failed to show this correctly in the movement note. Others mixed up the unwinding charge with the correction of the error (from £120,000 to £104,813) with different figures shown either in the costs matrix and/or as a finance charge. However, many candidates did achieve high marks on this question with many arriving at completely correct figures in respect of revenue and the associated deferred income, the foreign exchange adjustment, the depreciation charges, and the loss on sale. A good number also arrived at the correct split for the convertible bond between equity and debt, and correctly amortised the latter. Where mistakes were made over the convertible bond they included failing to accrue for the £18,000 interest, taking the net of the true interest and the nominal interest to finance charges, adding the equity element to ordinary share capital when it should have been shown separately and failing to amortise the debt from its base figure. Fewer candidates than might have been anticipated arrived at the correct split between research and development costs to be capitalised and those to be expensed. The most common error was to capitalise the product launch costs instead of expensing them. Other common errors included arriving at an incorrect foreign exchange adjustment by using the rate at settlement, as opposed to the year-end rate, deducting the foreign exchange adjustment from revenue instead of adding it to costs, when calculating closing retained earnings adding the revised profit for the year but failing to take out the draft profit for the year and reducing the plant and machinery by the carrying amount of the disposed of asset instead of by the cost (the cash proceeds had already been credited there), before calculating the depreciation charge for the year. Candidates also need to be reminded that unless they show their workings then they will lose calculation marks unless the resultant figure is completely correct, this was particularly prevalent in the calculation of the depreciation charge on plant and machinery (ie what figure had been divided by how many years).


30 27



(b) UK GAAP – Presentation of financial statements

Under UK GAAP the presentation of financial statements is primarily dealt with by the Companies Act 2006 and FRS 102. The Companies Act sets out the balance sheet and profit and loss account formats, in general the requirements are similar to those of IAS 1. However, it should be noted that the formats in IAS 1 are only contained in the ‘Guidance on Implementation’ whereas the Companies Act formats are enshrined in law. Under UK GAAP the profit and loss account format requires less detail to be included than in IAS 1, although IAS 1 allows some of the additional detail to be presented in the notes rather than on the face of the statement. The Companies Act balance sheet format is less flexible than the equivalent IAS 1 statement of financial position. A UK balance sheet is usually prepared on a net assets basis.

Different terminology is used, as already described above the Companies Act uses a balance sheet and a profit and loss account as opposed to a statement of financial position and a statement of profit or loss. In addition, other terms are different for example, inventories are called stock, receivables are called debtors, property, plant and equipment is called tangible fixed assets. Different presentation is used between UK GAAP and IFRS. For example, for discontinued operations, UK GAAP requires a separate column to be presented on the face of the profit and loss account. However under IFRS a single line is required for profit or loss from such activities. Another relevant example is the presentation of held for sale assets as these will simply be included as part of tangible fixed assets under UK GAAP. However, a separate line is presented below current assets for such assets under IFRS.

This part of the question was poorly answered with many candidates setting out seemingly “random” differences between IFRS and UK GAAP accounting treatments, when the requirement asked for differences in presentation. Very few candidates referred to the fact that IFRS presentation is guided by IAS 1 and UK GAAP presentation dictated by the Companies Act 2006. The most common answer referred to differences in the names of the statements and gave a few examples of differences in terminology (eg inventories as opposed to stock). The better answers then set out the differences in presentation for held for sale assets and discontinued operations, both of which were relevant points.


8 4



(c)(i) Substance over form

Substance over form is the principle that transactions and other events are accounted for and presented in accordance with their broader substance and economic reality and not their legal form. Substance over form should be applied to all accounting areas in accordance with the IASB Conceptual Framework.

The main example of substance over form included in Gamow Ltd’s financial statements above is the treatment of the convertible debt.

Gamow Ltd has a convertible bond which is a hybrid financial instrument containing both a liability component and an equity component. The substance of the financial instrument is the same as issuing separately a non-convertible bond and an option to purchase shares. The substance of the instrument is followed and therefore separate liability and equity components are accounted for, rather than following its legal form of a financial liability.

Another example could be argued to include the process of recording deferred income rather than recognising the cash proceeds immediately, although this is more akin to the accruals concept. The capitalisation of development costs is another example with the link between their nature being that of an expense however in substance they may meet the definition of an asset, per the Conceptual Framework and hence capitalised.

(ii) Fair presentation and true and fair

IAS 1 Presentation of financial statements requires financial statements to ‘present fairly’ the financial performance and position of an entity. This means that the effects of transactions should be faithfully represented. This is generally achieved by presenting the financial information in accordance with International Accounting Standards. In the UK, the Companies Act 2006 requires that financial statements present a ‘true and fair view’ of the company’s financial position and of its profit or loss for the period. True and fair is usually defined in terms of generally accepted accounting practice, which in the UK means compliance with accounting standards and adherence to the Companies Act requirements. ‘True’ is generally interpreted as reflecting factual accuracy and ‘fairness’ as indicating that the view is unbiased (neutral) and objective.

Answers to this part of the question were varied and generally disappointing. Many candidates could only state that substance over form means “accounting for an item’s substance instead of its form”! Very few candidates referred to economic or commercial reality compared to legal form. Most candidates cited the convertible bonds as an example, but some then went on to say that their legal form was equity, and the substance a liability, even where they had treated the bonds as a compound financial instrument in their answer to Part (a). Other examples, such as leasing, which did not feature in Part (a) earned no marks. The concepts of “present fairly” and “true and fair view” were also poorly explained by the majority of candidates, with only a minority referring to such matters as faithful representation, accuracy and a lack of bias. A number of candidates believed that “present fairly” is concerned with the fair value of assets. Others couched their explanation of a “true and fair view” in the context of an audit report. It was very rare to see the basic fact that “present fairly” is an IFRS concept, and “true and fair view” the equivalent in UK GAAP, and even if this fact was presented few then went onto to say that these concepts could be achieved by compliance with accounting standards.


8 6




General comments Part (a) of this question required candidates to explain the IFRS financial reporting treatment of the four issues given in the scenario. The issues covered a government grant, a sale and leaseback, two possible held for sale assets with impairment issues and the purchase of own shares. Part (b) required the calculation of revised figures for profit before tax and equity.

(a)

(1) Government grant This is an income related grant and should therefore be recognised over the period to which the related expenditure is being incurred. For Meitner plc it is expected to employ local employees over a three year period, therefore it would be reasonable to assume that the grant should be recognised over the three years also. The grant should not be recognised unless there is reasonable assurance that the entity will comply with any conditions attached to the grant and the grant will be received. Meitner plc has already received the grant and has currently met the condition that the local workforce makes up a third of the total employees as it has 35% local employees and this is expected to rise. So both conditions have been met. However, the grant should not be recognised in the statement of profit or loss in full upon receipt regardless of whether it is assessed as being not likely to be repaid.

£125,000 (£375,000 / 3yrs) of income should be recognised for the year ended 31 March 2015. The remaining £250,000 should be reversed from other income and recognised as deferred income, as part of liabilities. The liability should be split equally between current and non-current. (2) Sale and operating leaseback Sale and leaseback transactions can result in either a finance or an operating lease. The length of the lease of five years in comparison to the life of the property of 30 years, so this is a sale and operating leaseback.

The substance of the transaction arising from the sale and immediate leaseback on a short-term lease of five years is that of a sale. The risks and rewards of ownership are not substantially reacquired when the leaseback is an operating lease and have passed instead to the lessor. Therefore, a profit or loss on disposal should be recognised. Meitner plc has correctly recognised the transaction as a disposal. The amount of profit to be recognised will depend on the amount of the sale proceeds in comparison with the property’s fair value. Here the sale proceeds are above the fair value of £7.3 million, and therefore the excess of £700,000 (£8m – 7.3m) should be deferred and amortised over the period which the asset is expected to be used (ie the length of the lease of 5 years). Profit on disposal is made up of two elements: £ £ Proceeds 8,000,000 Fair value (7,300,000)

Deferred profit 700,000 Fair value 7,300,000 Carrying amount (6,500,000)

Profit to be recognised immediately 800,000

Total profit 1,500,000



£700,000 of profit should therefore be removed from other income and instead recognised as deferred income as part of liabilities and recognised evenly over five years. At 31 March 2015, 9 months of deferred income should also be recognised as part of profit or loss, being £105,000 (£700,000 x 9/60). Deferred income at 31 March 2015 will be £595,000 (700,000 – 105,000). (3) Held for sale assets

IFRS 5 Non-current assets held for sale and discontinued operations requires that a non-current asset should be classified as held for sale when the entity intends to recover its carrying amount principally through sale rather than continuing use. In order for the properties to be classified as held for sale they must be available for immediate sale, both of which are and the sale must be highly probable. Highly probable is defined as:

Management must be committed to a plan to sell the properties, which they are at both locations by fulfilling the requirements below;

There must be an active programme to locate a buyer, which is the case as the properties are being advertised in the relevant trade press;

The assets must be marketed for sale at a price that is fair, in both cases a professional valuation was obtained;

The sale should be expected to take place within one year from the date of classification. The property at Ostwald is expected to be sold within this time frame however, the property at Dirac won’t be sold until the road restructure is finalised which is expected to take longer than a year, so it is unlikely to be sold within the year;

It is unlikely that significant changes to the plan will be made, or the decision reversed. This is unlikely to be the case as the operations have moved to the new central location.

It therefore seems reasonable to conclude that the property at Dirac should continue to be held as part of non-current assets and depreciated. It is possible that the Dirac property did meet the held for sale criteria at 1 December, however at some point prior to the year end it was decided that the property should not be sold until the uncertainty regarding the planning permission was resolved. As no specific information was provided regarding the date of this decision it seems reasonable to assume that the asset should not be treated as held for sale. Its’ treatment is therefore correct. However, the current valuation suggests that an impairment has taken place as the carrying amount exceeds its recoverable amount. Recoverable amount is higher of value in use and fair value less costs to sell. A value in use figure has not been provided, however it would be unlikely that this would be higher as the operations have been moved from the Dirac property. At 1 December 2014 an impairment of £164,997 (1,323,000 – (1,169,700 x 99%)) should be recognised. The property should then be depreciated based on its revised value of £1,158,003 over the property’s remaining life at 1 December 2014 of 21 years. Therefore reverse the excess depreciation charge of £2,619 (21,000 – 18,381): Based on cost: ((1,890,000 / 30yrs) x 4/12) = £21,000 Based on impaired amount: ((1,158,003 / 21yrs) x 4/12) = £18,381 However, the property at Ostwald does meet all of the conditions and should therefore be separately disclosed as a ‘held for sale’ asset. The property should no longer be depreciated from the date it meets the held for sale criteria, being 1 December 2014. So the depreciation from 1 December 2014 to 31 March 2015 needs to be reversed. So depreciation of £15,250 ((1,372,500 / 30yrs) x 4/12) needs to be removed from profit or loss and added back to non-current assets.



The property should be recognised at the lower of its carrying amount of £976,000 and its fair value less costs to sell of £1,280,500 (1,300,000 x 98.5%), so at £976,000. As the property will continue to be held at its current carrying amount there is no impairment to be recognised. The potential gain on the sale of the property should be recognised at the point of sale, when it is realised. (4) Purchase of own shares When an entity purchases its own shares, the shares should be recognised as treasury shares as a negative reserve within equity. The amount recognised is the amount that Meitner plc paid to reacquire the shares, being £210,000 (150,000 x £1.40). No gain or loss should be recognised on their repurchase or subsequent resale. The original share capital, and share premium if relevant, recognised when the shares were originally issued should remain unchanged. £210,000 should be removed from investments and instead recognised as part of equity.

This question was reasonably well answered with nearly all candidates attempting all four of the issues. As always some candidates lost easy marks by focusing on the calculations without sufficient accompanying explanations. (1) Government grant: This was generally well answered with nearly all candidates identifying that the recognition criteria for the grant had been met and that it should be spread over three years. Most candidates also correctly calculated the amount of the grant to be recognised in the current year and that the balance should be included as deferred income split equally between a current and non-current liability. Fewer candidates specifically stated that it was a grant related to income and in fact a significant number of candidates wasted time by discussing the alternative treatments available for grants relating to assets which was simply not relevant in this scenario. Other candidates wasted time by discussing what might happen in future years (particularly if the grant became repayable) when the requirement only asks for the accounting treatment in the current year. The most common error was to release the grant over two years rather than three. (2) Sale and operating leaseback: Answers to this were more mixed although a good majority of candidates did identify this as an operating leaseback and justified their decision using the information given in the scenario. Again most candidates realised that the fact that selling price was above fair value should have an impact on the amount and timing of the profit to be recognised. A pleasing number of candidates calculated the figures for the release of the deferred profit correctly reflecting the fact that the transaction took place three months into the year. However a number of candidates either suggested deferring the entire profit on disposal or mixed up the amount to be recognised immediately with the amount to be deferred. A minority of candidates decided that the transaction was a finance leaseback/secured loan despite the fact that they often also referred to the short period of the leaseback. Other candidates discussed the risks and rewards of ownership but made a conclusion the wrong way round. (3) Held for sale assets: This was probably the issue that was answered the least well by candidates with answers being quite mixed although pleasingly most candidates did identify the key issue – here non-current assets held for sale with a significant number also realising that only one of the assets met the relevant criteria. Again most candidates did refer to the criteria but to gain full marks candidates needed to apply the criteria to the scenario rather than just list them out. Having correctly identified the asset held for sale most candidates recognised that depreciation should have stopped and many calculated the correct adjustment to the depreciation charge for the year (although some failed to pro rate it for the correct number of months). Although most candidates realised that the asset needed to be transferred to non -current assets held for sale a significant number did this at the higher (rather than lower) of fair value less costs to sell and carrying amount. Many candidates seemed confused as to the different approaches for assets carried at cost (as was the case here) and those carried at revalued amount and therefore incorrectly recognised a revaluation surplus. With regard to the asset that did not meet the criteria answers were disappointing with relatively few candidates recognising that a “normal” IAS 36 impairment test was required comparing carrying amount to recoverable amount. Even where this was discussed relatively few candidates managed to calculate the impairment correctly. Even fewer then realised that the write down to recoverable amount should have reduced the subsequent depreciation charge and it was very unusual to see this amount calculated correctly.



A number of candidates wasted time by not reading the question carefully and in particular not recognising that the carrying amounts given were as at the time of the decision to close the manufacturing operations. Therefore they produced lengthy calculations to arrive at the carrying amount already given. Other candidates also seemed unsure as to whether depreciation for the year had already been charged although this was clearly stated in the question. A significant minority of candidates also treated the two separate operations as needing to be treated as one, so because Dirac did not meet the criteria neither could be. (4) Treasury shares: Generally this was reasonably well answered with nearly all candidates correctly recognising that these shares were treasury shares and that they should have been debited to equity rather than investments. Most candidates also calculated the correct amount. A minority of candidates calculated the amount using the nominal value of the shares only and/or seemed to think that the correct double entry was to debit share capital/share premium rather than a separate reserve. A significant number of answers were quite brief and therefore candidates lost some easy marks from saying for example, that there was no impact on share capital and premium.


34 23

(b)

Profit before tax

Equity

£ £ £ Draft 1,460,000 2,600,180 (1) Deferred income (250,000) (2) Deferred profit (700,000) (2) Release of profit in year 105,000 (3) Reversal of depreciation - Ostwald 15,250 (3) Impairment – Dirac (164,997) (3) Reversal of excess depreciation – Dirac 2,619 (4) Treasury shares – (210,000)

(992,128) (992,128)

467,872 1,398,052

Answers to part (b) were very mixed and a significant minority of candidates did not attempt this part of the question at all. For those who did, it was normally relatively easy to follow the adjustments relating to issues (1) and (4) but often difficult to see an audit trail for adjustments relating to issues (2) and (3). Candidates frequently put the adjustments in the wrong way round (ie added rather than subtracted and vice versa) and relatively few reflected the impact on equity for the cumulative adjustments made to profit. A small minority thought that the requirement was to calculate earnings per shares!


4 3




General comments This was a mixed topic question with three distinct elements. Part (a) covered the preparation of extracts from a consolidated statement of cash flows. Part (b) required a revised extract for consolidated gross profit and part (c) required a discussion of the ethical issues arising from a request to prepare a paper on financing opportunities.

(a)

Consolidated statement of cash flows for year ended 31 March 2015 (extract) Cash flows from investing activities Acquisition of subsidiary (135,000 – 3,150) (131,850) Dividend received from associate (W1) 20,080

Net cash used in investing activities (111,770) Cash flows from financing activities Proceeds from issue of ordinary shares (W2) 87,750 Dividends paid to non-controlling interest (W3) (41,065)

Net cash used in financing activities 46,685 Workings

Draft cash flows from operating activities £ £ Per question 386,480 Decrease in trade receivables ((112,400 – 61,400) – 83,100) 32,100 Increase in trade payables ((96,700 – 36,700) – 53,840) 6,160

Revised cash flows from operating activities 424,740

(1) Associate

£ £ B/d 176,300 Dividend received (β) 20,080 Share of profit 83,200 C/d 239,420

259,500 259,500

(2) Share capital and premium

£ £ B/d (460,000 + 320,000) 780,000 Non-cash issue

(70,000 x £1.90)

133,000 C/d (575,000 + 425,750) 1,000,750 Cash received (β) 87,750

1,000,750 1,000,750

(3) Non-controlling interest

£ £ Cash (β) 41,065 B/d 246,700 Acquisition (420,550 x

30%) 126,165

C/d 471,400 CPorL 139,600

512,465 512,465

Generally candidates made a good attempt at this part of the question with many achieving full marks. Candidates generally made some attempt at presenting reasonable extracts from the consolidated statement of cash flows, although only a minority went as far as including sub-totals. Most candidates calculated proceeds from the share issue, although the number of candidates who adjusted the opening and closing balances for the non-cash issue were significantly lower.



The dividend received from the associate was generally calculated correctly although candidates often showed this in the incorrect place in the statement. The calculation of the cash outflow from the acquisition of the subsidiary was disappointing with candidates preparing an extensive calculation when the cash consideration was simply given in the question. A number of candidates correctly calculated the dividend paid to the non-controlling interest although it was common for it to be shown as an inflow, under investing activities or no adjustment made for the acquisition during the year. A significant number of candidates correctly calculated the cash flows from operating activities, although the most common error was to add the newly acquired subsidiary’s amounts rather than deducting them.


8 7

(b)

Consolidated statement of profit or loss for year ended 31 March 2015 £ Revenue 2,879,950 Cost of sales (1,578,850)

Gross profit 1,301,100

Workings

(1) Consolidation schedule 7/12 Fermi Group Seyle Ltd Adj Consol £ £ £ £ Revenue 2,345,800 561,750 (27,600) 2,879,950 Cost of sales – per Q (1,290,200) (313,250) 27,600 (1,578,850) – PURP – Sub (W2) (2,300) – PURP – Associate (W2) (700) (2) PURP % £ £

SP 120 27,600 24,000 Cost (100) (23,000) (20,000)

GP 20 4,600 4,000

X 1/2 2,300 2,000

Boas Ltd £2,000 x 35% = £700

Again many candidates achieved full marks for this part of the question, with candidates generally even completing the revised extract with full narrative and a total, which gained presentation marks. Most candidates managed to calculate the unrealised profits figures, although not all went on to apportion by 35% for the inter-company sale to the associate. However, how the unrealised profits were then adjusted was more mixed, with a significant number of candidates adjusting revenue as well as other candidates subtracting from the cost of sales figure rather increasing it. Other common errors included not adjusting the subsidiary by seven months, or pro-rating it by the incorrect number of months and failing to adjust for intra-group sales and purchases when calculating consolidated totals.


5½ 5



(c) Ethical issues

Relevant key fundamental principles: Professional competence and due care – Elion should consider whether he has the necessary skills and experience to prepare such a proposal and deliver it to the board. If Elion concludes he does not possess such skills and experience he could request to attend a training course to gain such expertise. Even if he attends such a course will he still be able to gain the experience in time? It may be possible for Elion to instead assist another member of staff who does have the relevant experience. This would allow Elion to enhance his own skills and level of technical competence. Professional behaviour – How should Elion proceed so as not to discredit himself in any way? Producing a paper without the relevant knowledge could lead to the board relying on such information and making an inappropriate investment decision. Objectivity – Elion should remain objective at all times and not allow a possible self-interest threat to affect his professional judgement. Elion may want to impress the finance director and therefore may be tempted to try and prepare the paper. Integrity – the integrity of the finance director should be questioned as he would be expected to have some idea as to the level of experience that Elion has had and therefore you’d expect him to make the judgement that he doesn’t have the right level of expertise at this point in time. Elion could take the following actions:

He should speak to you as his senior in the first instance and see if you can come to an arrangement which will deliver the paper to the required standard.

If Elion is not happy with your advice then he should speak directly with the finance director and discuss the different options available and the suggested courses of action, for example assisting another more experienced member of staff.

If he still feels uncomfortable with the level of work he is being asked to prepare then speak to another director or human resources.

Finally, if Elion is still unable to resolve the situation to his satisfaction then he should contact the ICAEW Ethical Helpline for advice.

Elion should keep a detailed record of all discussions and the outcomes at each stage. Most candidates prepared a reasonable answer with enough content to score at least half marks. The better candidates dissected the answer looking at different key elements of the ethical code, such as professional competence and due care, and professional behaviour. Weaker candidates produced generic answers that encompassed a broad range of relevant and non-relevant comments in relation to the scenario.


8 4




General comments This question involved the preparation of a consolidated statement of financial position from individual company financial statements. The question included the acquisition of a subsidiary in the period, with a fair value adjustment and deferred consideration, along with an investment in a newly formed joint venture. Part (b) included an explanation and calculation of distributable profits for the parent entity.

(a) Huygens plc

(a) Consolidated statement of financial position as at 31 March 2015 £ £ Assets

Non-current assets

Property, plant and equipment (911,700 + 89,400 + 15,000 – 750) 1,015,350 Intangibles (W2) 47,000 Investments (116,250 – 85,000 (W2) – 25,000 + 3,750 (W4)) 10,000 Investment in joint venture (W6) 28,810

1,101,160 Current assets Inventories (43,700 + 32,000 – 1,440 (W5) 74,260 Trade and other receivables (71,000 + 17,900 – 12,800) 76,100 Cash and cash equivalents (5,600 + 3,100 + 6,400) 15,100

165,460


Equity and liabilities Equity attributable to owners of Huygens plc Ordinary share capital 300,000 Share premium account 105,000 Retained earnings (W4) 599,018

1,004,018 Non-controlling interest (W3) 29,202

Total equity 1,033,220 Current liabilities Trade and other payables (98,600 + 21,400 – 6,400) 113,600 Deferred consideration (40,000 + 1,000) (W4) 41,000 Taxation (65,000 + 13,800) 78,800

233,400




Workings

(1) Net assets – Planck Ltd Year end Acquisition Post acq £ £ £ Share capital 50,000 50,000 Retained earnings Per Question 57,200 39,000 Less: PURP (W5) (1,440) – Fair value adjustment 15,000 15,000 Depreciation thereon ((15,000 / 10) x 6/12) (750) –

120,010 104,000 16,010

(2) Goodwill – Planck Ltd £ Consideration transferred (85,000 + (42,000/1.05)) 125,000 Non-controlling interest at acquisition – FV 26,000

Net assets at acquisition (W1) (104,000)

47,000 (3) Non-controlling interest – Planck Ltd £ NCI at acquisition date (W2) 26,000 Share of post-acquisition reserves (16,010 (W2) x 20%) 3,202

29,202

(4) Retained earnings £ Huygens plc 579,650 Deferred consideration – unwinding (40,000 x 5% x 6/12) (1,000) Planck Ltd (16,010 (W1) x 80%) 12,808 Quimby Ltd (W6) 3,810 Quimby Ltd’s dividend (15,000 x 25%) 3,750

599,018

(5) Inventory PURP % £ SP 100 9,600 Cost (85) (8,160)

GP 15 1,440

(6) Investments in Joint Venture – Quimby Ltd

£ Cost 25,000 Add: Share of post acquisition profits (15,240 x 25%) 3,810

28,810

Candidates made a reasonable attempt at this question with almost all candidates producing a relatively well laid out consolidated statement of financial position. As mentioned earlier in the examination commentary candidates did lose marks where there was no audit trail as to how a figure on the face of the statement had been arrived at. Where there are no workings candidates gain no marks unless the correct figure is arrived at. Most candidates gained all the marks for adding the parent and subsidiary’s figures together, although a small minority pro-rated the subsidiary’s figures to reflect that it was acquired during the year.



Share capital and premium were almost always correct and the separately presented non-controlling interest was almost always present, although candidates do not seem to understand the significance of the sub-total before and after this figure. A significant number of candidates showed a deferred consideration figure although not always the correct figure was shown, the most common error again was to not pro-rate this figure. Pleasingly a number of candidates also then adjusted retained earnings for the unwinding of this deferred amount. It was pleasing to see that most candidates prepared a net assets table for Planck Ltd and that this was often completely correct. The most common error was to miscalculate the depreciation on the fair value adjustment, forgetting that it needed to be time apportioned. A significant number of candidates correctly calculated goodwill and the inventory PURP figure. The calculations for non-controlling interest and retained earnings were more mixed, although almost all candidates picked up some marks on these calculations. Adjustments to the figures on the face of the consolidated statement of financial position were generally mixed, although completely correct figures were prepared by a number of candidates. The most common errors were to only deduct half of the inter-company invoice from trade receivables and not to adjust the cash figure for the cash in transit. Consolidated retained earnings were only completely correct in a minority of cases with candidates generally confused over the treatment of the PURP and dividend. The figure which caused a problem to a majority of candidates was the calculation of the investment figure. A variety of calculations were presented, for example adding rather than subtracting the cost of investments and adding in the total dividend paid by Quimby Ltd rather than only Huygens plc’s share.


19 18

(b) Distributable profits

For entities within a group, distributable profits must be made for each individual entity, rather than the consolidated group. Therefore, Huygens plc’s distributable profits are those profits distributable by the parent company only. The basic rule is that distributable profits are measured as accumulated realised profits less accumulated realised losses, this is usually retained earnings of the individual company.

In the case of listed companies, here it is not clear whether Huygens plc is listed or not, the amount of distributable profits is further reduced by any excess of unrealised losses over unrealised profits. No such information is available in this question to determine this.

Huygens plc’s distributable profits are therefore calculated as:

The share of profits in the joint venture only affects the consolidated retained earnings, but Huygens plc’s own financial statements would include the dividend from Quimby Ltd of £3,750. This should have been recognised in the Huygens plc’s own statement of profit or loss, however was incorrectly deducted from Investments, thereby increasing retained earnings by £3,750.

The finance cost arising on the deferred consideration will be recognised by Huygens plc and therefore reduces retained earnings by £1,000.

Huygens plc’s distributable reserves are therefore £579,650 + 3,750 – 1,000 = £582,400.

This requirement was quite poorly answered by a majority of candidates. Most candidates didn’t go beyond mentioning the basic rule, that distributable profits are calculated on an individual company basis and that it is often simply retained earnings. However, a small minority of candidates did go on to make an adjustment for the joint venture dividend and the unwinding of the deferred consideration.


6½ 3

Financial Accounting and Reporting - Professional Level – December 2015




General comments Part (a) of this question tested the preparation of a statement of profit or loss and a statement of financial position from a trial balance plus a number of adjustments. Adjustments included property, plant and equipment depreciation, revaluation and impairment, borrowing costs, redeemable preference shares and dividends thereon, and the correction of a prior period error. Part (b) required an explanation of the treatment of the prior period error. Part (c) tested the four measurement bases set out in the IASB Conceptual Framework, with reference to figures provided in the question.

Darwin plc

(a) Financial statements

Statement of profit or loss for the year ended 30 June 2015 £ Revenue 6,558,550 Cost of sales (W1) (5,160,050)

Gross profit 1,398,500 Administrative expenses (W1) (1,018,300) Distribution costs (W1) (262,800)

Profit from operations 117,400 Finance cost (15,250 – 1,825 (W4) + 7,125 (W7)) (20,550)

Profit before tax 96,850 Income tax expense (18,600 + 1,500) (20,100)


Statement of financial position as at 30 June 2015 £ £ Assets Non-current assets Property, plant and equipment (W2) 915,050 Current assets Inventories 175,400

Trade and other receivables 403,375

578,775




£

£

Equity and liabilities Equity (W3) Ordinary share capital 500,000 Revaluation surplus (W6) 354,750 Retained earnings (W3) (13,900)

840,850 Non-current liabilities

Preference share capital (4% redeemable) (W7) 151,125 Current liabilities Trade and other payables 342,750 Borrowings (100,000 + 40,500) 140,500 Taxation 18,600

501,850


Workings (1) Costs matrix Cost of

sales Admin

expenses Distrib costs

£ £ £ Per TB 5,106,100 1,008,300 262,800 Opening inventories (266,175 – 100,000) 166,175 Closing inventories (175,400) Depreciation/impairment charges (8,900 + 3,950 + 50,325) (W2)

63,175 10,000

5,160,050 1,018,300 262,800

(2) PPE Land and

buildings Plant and machinery

£ £ Carrying amount b/f (382,000 – 159,100) 222,900 Valuation 600,000 Depreciation/impairment charges

Buildings (400,000/40) (10,000) Impairment of machine (W5) (8,900) Depreciation on impaired machine (2,700 (W5) +

(10,000 x 25% x 6/12)) (3,950)

Depreciation on other machines ((222,900 – 21,600 (OF)) x 25%)

(50,325)

Construction costs 163,500 Borrowing costs (W4) 1,825

590,000 325,050

Total PPE 915,050

(3) Retained earnings £ Per TB 148,100 Less: Issue of redeemable prefs (150,000) Prior period adjustment (100,000) Add: Interest paid on redeemable prefs (W7) 6,000 Profit for the year 76,750 Transfer from revaluation surplus (W6) 5,250

(13,900)



(4) Borrowing costs Cost of loan = (30,000 x 5% x 9/12) + (70,000 x 4% x 3/12) = 1,825

(5) Impairment of machine £ CA at 30 June 2014 (38,400 x 0.75

2) 21,600

Less: Depreciation to 31 December 2014 (21,600 x 25% x 6/12) (2,700)

CA at 31 December 2014 18,900 Less: Value in use (10,000)

8,900

(6) Revaluation surplus £ £ Valuation 600,000 CA per TB (400,000 – 160,000) (240,000)

360,000 Depreciation charge on revalued amount (W2) 10,000 Depreciation charge on historic cost ((240,000 – 50,000)/40) (4,750)

Transfer to retained earnings (5,250)

354,750

(7) Redeemable preference shares Opening

balance Interest

expense (4.75%)

Interest paid (4%)

Closing balance

Year £ £ £ £ 30 June 2015 150,000 7,125 (6,000) 151,125

Most candidates obtained all of the easier marks to gain a solid pass. Better candidates attempted the more challenging adjustments which increased their mark to a very good pass. A significant minority of candidates approached the question in a clear and structured fashion and scored all or almost all of the marks. Most candidates presented a well laid out statement of profit or loss and included the correct revenue figure. The adjustment to finance costs was often correct, the most common mistake being to add the interest actually paid on the preference shares rather than the interest expense (with a few candidates adjusting for both these figures). Others added the interest capitalised on the borrowing costs rather than deducting it. The majority of candidates also arrived at the correct income tax expense but a good number then went on to also use this figure in the statement of financial position. Almost all candidates produced a costs matrix working and included the correct figures from the trial balance. Candidates generally included the correct closing inventory and a majority also correctly adjusted opening inventory for the prior period error. Where candidates lost marks here was by using the incorrect bracket convention, for example adding closing inventory rather than deducting it. Most candidates charged depreciation in the costs matrix although a significant number omitted to include the charge for the impairment which they had calculated. A minority of candidates charged depreciation or impairment to the incorrect cost heading even though the question was explicit as to where these costs should be charged, and they lost marks as a result of this. Presentation of the statement of financial position was not quite as good as the statement of profit or loss. Generally candidates included the correct figures from the trial balance although where these were presented varied. For example, the bank loan repayable on 31 December 2015 was often included in non-current liabilities instead of in current liabilities, and the bank overdraft was often shown within current assets (sometimes as a positive, and sometimes as a negative figure) instead of in current liabilities. A few candidates incorrectly adjusted the inventories figure here for the prior period error.



The preference shares caused problems for many candidates. Most prepared a correct working for the closing balance but included the nominal figure of £150,000 on the face of the statement of financial position. Others presented the preference shares as part of equity. A significant minority of candidates prepared two years of calculations in their working table rather than one, and then included the balance at the end of next year instead of at the end of the current year in their statement of financial position. A majority of candidates made an attempt at the machine impairment calculation with the correct figure being seen more often than not. As mentioned above, although most candidates prepared this calculation many then failed to make the double entry adjustment for it by including it both in expenses and in their property, plant and equipment working. The most common errors were to calculate accumulated depreciation at the point of classification incorrectly, or to use the wrong figure for the “recoverable amount”, generally using the lower of the fair value less costs to sell as opposed to the higher figure as required by IAS 36. A significant number of candidates tried to do a weighted average working for the borrowing costs rather than a simple pro-rata calculation for the actual interest costs incurred on the specific loan. Almost all candidates did do some kind of calculation and made some adjustment to finance costs, although less then went on to include this figure as part of property, plant and equipment. The best candidates made the correct adjustment for both construction costs and the interest on the borrowings in their property, plant and equipment calculation. Most candidates prepared a retained earnings working although this was often squashed on the face of the statement of financial position which made it difficult to read. Candidates are encouraged to prepare a separate working where there are more than, say, three adjustments to a figure. The most common error here was to confuse the direction of the adjustments. A good number of candidates arrived at the correct figure for the initial revaluation surplus although the adjustment then made for the additional depreciation transfer was often incorrect. The most common error was to use the original cost of the property for the historic depreciation. Because the useful life of the property had been reassessed the carrying amount at that date should have been used instead. A minority of candidates transferred the whole of the balance on the revaluation surplus to retained earnings. Occasionally candidates wasted time by writing out an explanation of the accounting treatment followed, although this was seen less often than in many previous sittings. Where explanation is not explicitly asked for in the requirement there are no marks available for such explanations.


25½ 23



(b) Financial reporting treatment of prior period error Provided that the relevant information was available when the financial statements for the year ended 30 June 2014 were authorised for issue, this should be treated as a prior period error. Per IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, a material prior period error should be corrected retrospectively. Retrospective misstatement means correcting the recognition, measurement and disclosure of amounts as if the error had never occurred. For Darwin plc this means that the comparative amounts for the prior periods need to be restated. In the statement of profit or loss for the year ended 30 June 2015 the correct opening inventory figure of £166,175 should be recognised/opening inventory is overstated by £100,000. Therefore cost of sales for the current year is overstated/profit understated by £100,000. The corresponding debit to opening retained earnings will be shown as an in the statement of changes in equity for the year ended 30 June 2015.

A minority of candidates did not attempt this part of the question, and answers overall were disappointing. Although most candidates dealt correctly with this prior period error in Part (a) few were able to explain the accounting treatment here. A worrying number of candidates thought this was an event after the reporting period (when it fell way outside the definition of such an event per IAS 10), and a minority discussed how inventory should be valued at the lower of cost and net realisable value. Others were confused as to whether this was an error or simply an adjustment to an accounting policy. Of those candidates who did identify this as a prior period error there was a split as to those who believed it should be adjusted for retrospectively and those who chose prospective adjustment (with some hedging their bets by referring to both).


5 3



(c) The four measurement bases

Historical cost Assets are recorded at the amount of cash or cash equivalents paid (/amount paid/cost) or the fair value of the consideration given to acquire them at the time of their acquisition. At historical cost the machine was recorded at its price of £38,400. Current cost Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset at a similar age and level of use was acquired at the current date. If the machine was to be measured at its current cost it would have been restated to £23,625 (£56,000 depreciated for 3 years) on 31 December 2014 – representing an “aged” version of the (£56,000) current cost. Realisable (settlement) value Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal, ie at £9,500 (11,000 – 1,500). Present value Assets are measured at the current estimate of the present discounted value of the future cash flows in the normal course of business. Under this basis the machine would be measured at £10,000.

Most candidates made a good attempt at this conceptual part. A minority of candidates were clearly confused as to what the measurement bases were and discussed anything from the revaluation to the accrual and the cash bases, or even the qualitative characteristics. However, the vast majority of candidates did correctly identify the four measurement bases and provided reasonable explanations. A few candidates then went on to waste time by discussing which one was used in the question when calculating the impairment, or was the best to use generally. There were no marks available for these discussions. The most common omission from answers, which meant that only a small minority gained full marks on the question, was that current cost should be adjusted for the current age and condition of the asset rather than being simply the current price of a new machine. The most common error was to state that the realisable (settlement) value would be £11,000, rather than that figure less selling costs. A few candidates gave examples of the four bases other than by reference to the figures in Note (3) (as was specified in the requirement) and therefore gained no marks for these examples.


5½ 5




General comments Part (a) of this question required candidates to explain the financial reporting treatment of four accounting issues, given in the scenario. The issues covered goodwill arising on a business combination, share issues (treasury shares and a subsequent bonus issue), a related party transaction and the sale of a package of goods and services. Part (b) required the calculation of revised figures for profit for the year and number of ordinary shares and of earnings per share (plus comparative figure). Part (c) required an explanation of the ethical issues arising from the scenario and the action to be taken.

Girton plc

(a) IFRS accounting treatment

(1) Goodwill arising on a business combination Per IFRS 3, Business Combinations, goodwill should be calculated as the excess of the fair value of the consideration transferred plus any non-controlling interest less the fair value of the net assets acquired. When calculating goodwill Alan should therefore have included all three elements of the consideration not just the cash element. The fair value of any quoted equity investments (ie Girton plc’s ordinary shares) should have been taken as the market price at the acquisition date. The deferred consideration should have been accounted for as a liability at the present value of the amount payable. Consideration is therefore: £ Cash 375,000 Ordinary shares (100,000 x £1.20) 120,000 Deferred consideration (147,000/1.05) 140,000

635,000

The ordinary shares should be credited to ordinary share capital (£100,000) and share premium (£20,000). The discount on the deferred consideration should be unwound for the period 1 January 2015 to 30 June 2015. This would give a finance cost of £3,500 ((147,000 – 140,000) x 6/12). At 30 June 2015 the deferred consideration would be shown as a current liability of £143,500 (140,000 + 3,500). Per IFRS 3, the calculation of the fair value of net assets acquired should have included recognition of Downing Ltd’s contingent liability, in spite of the fact that this will not have been recognised in Downing Ltd’s statement of financial position. The liability existed at 1 January 2015 as the proceedings commenced on 15 December 2014. Once recognised, the contingent liability should be carried at the higher of the amount under IAS 37 (here £Nil) and the fair value at the acquisition date of £75,000, therefore £75,000 should be used. Fair value of net assets acquired is therefore: £ Share capital and retained earnings at 30 June 2015 (200,000 + 356,700) 556,700 Less: Profit 1 January 2015 to 30 June 2015 (6/12 x 245,600) (122,800) Contingent liability (75,000)

358,900

When calculating goodwill, Alan should have used the fair value method to value the non-controlling interest, as agreed by the board. Goodwill should therefore be calculated as:



£ Fair value of consideration 635,000 Fair value of non-controlling interest 115,000 Fair value of net assets acquired (358,900)

391,100

Intangible assets in the consolidated statement of financial positon as at 30 June 2015 will therefore increase by £341,525 (391,100 – 49,575). An impairment review in accordance with IAS 38, Intangible Assets, should be carried out on this goodwill at every year end. Non-controlling interest at 30 June 2015 will be stated at £145,700 (115,000 + (122,800 x 25%). (2) Share issues Equity instruments reacquired by the entity which issued them are known as treasury shares. Treasury shares should be deducted from equity, and shown as a separate (ie negative) reserve. The original share capital and share premium amounts remain unchanged. No gain or loss should be recognised on the issue, sale, purchase or cancellation of treasury shares. The bonus issue was based on the correct number of shares (ie 750,000 – see (b)) so 150,000 shares were issued, and ordinary share capital should be credited with this amount. Assuming that Girton plc wishes to maximise distributable profits, the premium should firstly be charged to the share premium account, with the balance going to retained earnings. Therefore £110,000 (90,000 + 20,000 (1)) of this should be debited to share premium and the remaining £40,000 to retained earnings. (3) Related party transaction Selwyn Ltd is wholly-owned by one of the close family members of a member of Girton plc’s key management personnel, so Selwyn Ltd is a related party of Girton plc. Alan and his son are also related parties of Girton plc. This transaction with Selwyn Ltd is therefore a related party transaction. Disclosure is required of all related parties and related party transactions, even if the transactions took place on an arm’s length basis. The fact that the transactions took place on an arm’s length basis may be disclosed, but only if such terms can be substantiated. Disclosure should be made of:

- The nature of the relationship (a company owned by the son of a director of Girton plc) - The amount of the transactions (£216,700) - The amount of any balances outstanding at the year end (£54,400) - Any provision against outstanding balances and the expense recognised for bad or doubtful debts

due from related parties (£20,000). There is no requirement to identify related parties by name. Since Selwyn Ltd is in financial difficulties, consideration should be given to making an allowance for the remainder of the debt, ie for an additional £34,400 (54,000 – 20,000). (4) Revenue recognition Per IAS 18, Revenue, where a package of goods and services is sold then the components of the package should be identified, measured and recognised as if sold separately. If the total of the fair values exceed the overall price of the contract the same discount percentage should be applied to each separate component, unless specific discount rates are known. In this case a package with a usual retail price of £225,000, has been sold for £191,250, ie at a discount of 15%. The two components of the package should be split out and accounted for as follows: Equipment: Revenue of £148,750 (175,000 x 85%) should be recognised in the year ended 30 June 2015 because the equipment was sold in the year and therefore the risks and rewards of ownership were transferred.



Support services: Revenue of £42,500 (50,000 x 85%) should be accounted for based on the stage of completion. In the absence of other information, on a straight-line basis over the period of the contract (12 months). In the year ended 30 June 2015 only 3/12 of the £42,500 should be recognised as revenue, ie £10,625. Alan has therefore overstated revenue (and profit for the year) by £31,875 (191,250 – 148,750 – 10,625) and understated liabilities (deferred income) by the same amount.

This part of the question was generally well answered with nearly all candidates discussing all four of the issues. As always weaker answers tended to focus on the figures without giving appropriate supporting explanations. Issue (1) This focused on goodwill and many candidates calculated the correct figure. Nearly all recognised that there were three components to the consideration, that shares should be included at their market price and that deferred cash consideration needed to be discounted to its present value. Relatively few candidates discussed the implications of discounting the consideration ie that this would have to be “unwound” between the acquisition and payment dates. Where candidates did address this they often included a full year, rather than six months, of finance cost. More errors were made with the calculation of net assets at acquisition with a number of candidates omitting share capital. Many struggled to back out six months of current year profit from the year-end retained earnings figure to determine retained earnings at acquisition. Although most candidates did realise that an adjustment was needed for the contingent liability this was sometimes added to net assets or deducted from the goodwill figure calculated. There was often no explanation provided as to why this adjustment needed to be made. Nearly all candidates included the non-controlling interest at fair value as required in the scenario, but few explained why they were using that figure. Where a reason was given it was often stated as being because “that method usually leads to a higher value of non-controlling interest”. Few candidates discussed the need to carry out an impairment review of goodwill and even fewer attempted to calculate a closing figure for the non-controlling interest Issue (2) Answers to this part were mixed with some candidates appearing unable to cope with the two different share transactions and often mixing them up. Many errors were made because candidates did not focus on the specific information given in the question – in particular the timing of the two issues and how, if at all, they had been accounted for. Most candidates did eventually suggest that the bonus issue should be debited to the share premium account then retained earnings and credited to share capital. However, the figures used were often wrong as many candidates failed to take into account the shares which had been issued on acquisition of the subsidiary. Most candidates identified that the second transaction related to treasury shares. Most then stated that treasury shares should appear as a debit balance in equity, although fewer suggested that the debit to share capital needed to be reversed out in full. Some candidates appeared to treat the treasury shares as a normal issue of shares. Others credited treasury shares, and split the debit between share capital and share premium. A minority of candidates wasted time explaining why the company might have chosen to make these share issues. Issue (3) Virtually all candidates correctly identified this as a related party transaction. Most attempted to justify their conclusion using the facts from the question and went on to set out the disclosure requirements, using the information from the scenario. A small minority concluded the transaction did not need to be disclosed as the sales had been made at an arm’s length price.



Many candidates lost marks by simply repeating definitions and a list of disclosure requirements straight from IAS 24, rather than using the specific information given in the question. Some candidates did discuss the potential need to write down receivables but those that did nearly always overlooked the fact that some of the outstanding balance was already covered by the closing allowance for doubtful debts. Issue (4) This was generally well answered and many candidates calculated all the relevant figures correctly. Nearly all candidates recognised that the sale needed to be split into separate components for the sale of goods and the provision of a service. Almost all candidates recognised that there was a discount to be allocated to both elements and that some of the revenue relating to the helpdesk support needed to be deferred until the following year. Even those candidates who did not realise there was a discount did usually defer the relevant proportion of the service revenue.


31½ 22

(b) Revised figures and EPS Weighted average number of ordinary shares Date Number

of shares Number

of months

Bonus fraction

Weighted average

Per extracts 450,000 Add back Treasury shares debited in error 200,000

B/f 650,000 6/12 6/5 390,000 1 January 2015 – on acq of Downing Ltd 100,000

750,000 1/12 6/5 75,000 1 February 2015 – bonus issue (750,000/5)

150,000

900,000 5/12 375,000

840,000

Profit

attributable to shareholders of Girton plc

£ Per question 574,500 (1) Unwinding of discount (3,500) (4) Package of products (31,875)

539,125

2015 EPS = 539,125/840,000 = 64.2p 2014 (comparative) EPS = 118.6p x 5/6 = 98.8p

Answers to this part of the question were disappointing as candidates have historically performed well when asked to calculate EPS. Although most candidates correctly adjusted the draft profit for the adjustment relating to the deferred revenue far fewer adjusted for the “unwinding” of the discount arising from Issue (1) (even where they had covered this in their answer to Part (a)). A number of candidates made unnecessary adjustments (such as relating to the contingent liability and change in value of goodwill from Issue (1) or adjusting for the receivable already provided for in Issue (2)). This indicates that such candidates lack an understanding of the double entry relating to these issues.



Most candidates (although by no means all) made an attempt at a weighted average share capital working although the timings of the share issues and subsequently the relevant number of months were usually incorrect. Most of these candidates took into account the impact of the bonus issue and correctly calculated and used the bonus fraction. Although most candidates did eventually calculate a current year EPS figure fewer correctly restated the prior year figure to reflect the bonus issue made in the current year.


6 4

(c) Ethical issues Alan’s financial accounting knowledge seems lacking, given that he failed to take the contingent liability and the deferred consideration into account when calculating goodwill. As an ICAEW Chartered Accountant Alan is obliged to comply with the ICAEW code of ethics, including the principle of professional competence and due care, and should keep his knowledge up to date. He makes other “errors”, all of which have the effect of either understating the number of ordinary shares in issue, or overstating the profit for the year, with the result that EPS for the current year, to which Alan’s bonus is linked, is massively overstated. There is a clear self-interest threat here for Alan as the directors’ bonuses are linked to profit. In accordance with the code of ethics, Alan should have ignored this self-interest threat and prepared the figures accurately, in accordance with the principles of objectivity, independence and professional behaviour. The fact that Alan has failed to disclose the related party relationship/transaction with his son’s company also points to a possible lack of integrity. More so, if Alan engineered the sale and knew that his son’s company was in financial difficulties. You should take the following action:

- Discuss each of the errors found with Alan, explaining the correct IFRS accounting treatment to him. - If Alan appears genuinely to be out of date tactfully suggest that he goes on an update course. - Ensure the financial statements are corrected. - If Alan refuses to amend the financial statements seek support from the managing director. - Document all discussions. - If you find yourself in a difficult situation, eg, caught between the FD and the MD, or subject to any

sort of intimidation threat, then consult the ICAEW helpline.

This part, covering ethics, was generally well answered with candidates reacting well to the “clues” provided in the scenario. Almost all candidates recognised the potential impact of the directors’ bonus being linked to EPS and there were some excellent answers discussing the impact of the errors from Part (a) of the question and questioning the integrity of the finance director. Most candidates also correctly identified a potential intimidation threat to the financial controller. As ever, weaker candidates placed themselves in an audit context and suggested a review of Alan’s work and referral to the ethics partner.


9½ 5




General comments This was a mixed topic question. Part (a) required candidates to calculate the correct closing inventory figure, after a valuation error had been made. Part (b) required the preparation of extracts from the statement of profit or loss and statement of financial position for a finance lease taken out during the year. Part (c) required candidates to redraft a single entity statement of cash flows, correcting for the above matters and other errors.

Peterhouse Ltd

(a) Calculation of closing inventories £ £ Original figure 135,800 Adjustments re Perro WIP at NRV (2,000 x ((25 x 70%) – 1 – 3)) 27,000 Less: WIP at cost (2,000 x £15) (30,000) FG at NRV (1,000 x ((25 x 70%) – 1) 16,500 Less: FG at cost (1,000 x £18) (18,000)

Total decrease to closing inventories (4,500)

131,300

Most candidates made some attempt at this part of the question, however answers were mixed. Most candidates were able to calculate the correct cost figures for both finished goods and work in progress but many struggled with the net realisable value calculations. Candidates often made a reasonable attempt at the net realisable value for finished goods but failed to perform any calculation for the net realisable value of the work in progress. Some candidates carried out various (sometimes seemingly random) calculations, but it was unclear how they impacted on the draft inventory figure. A worrying number of candidates actually arrived at a higher figure than the original one. Nonetheless, a good number of candidates did achieve full marks.


4½ 3

(b) Finance lease extracts Statement of profit or loss for the year ended 30 June 2015 (extracts) £ Cost of sales ((29,786 (W1) ÷ 3) – (8,000 x 2)) 6,071 Finance costs (W2) (1,089)

Statement of financial position as at 30 June 2015 (extracts) £ Non-current assets Property, plant and equipment (29,786 (W1) – 9,929) 19,857 Non-current liabilities Finance lease liabilities 7,619 Current liabilities Finance lease liabilities (14,875 – 7,619) (W2) 7,256



Workings (1) Present value of minimum lease payments Date of payment PV calculation £ 1 July 2014 8,000 8,000 30 June 2015 8,000 / 1.05 7,619 30 June 2016 8,000 / 1.05

2 7,256

30 June 2017 8,000 / 1.053 6,911

29,786

(2) Lease table Year ended B/f Interest @ 5% Payment C/f £ £ £ £

30 June 2015 (29,786 – 8,000) 21,786 1,089 (8,000) 14,875 30 June 2015 14,875 744 (8,000) 7,619

Almost all candidates who attempted this part of the question prepared a finance lease table working. Occasionally candidates failed to deduct the initial deposit from the opening balance or prepared the table based on payments in advance rather than in arrears. A smaller number of candidates were able to correctly transfer figures from their table into their financial statement extracts. Some presented figures the wrong way round between current and non-current, or showed the lease payment as a current liability rather than using the figure from their table. Others failed to use the same figure to calculate the carrying amount of property, plant and equipment as they had used in their table. However, it was pleasing to see that the majority of candidates had made a reasonable attempt at the financial statement extracts. The two most disappointing aspects of answers were that most candidates:

simply used the fair value of the asset as the opening balance in their finance lease table rather than calculating the present value of the minimum lease payments; and

depreciated the asset over four, rather than three, years. However, most candidates still achieved a good mark for this part of the question and a significant number of candidates achieved full marks.


7½ 6

(c) Revised statement of cash flows for the year ended 30 June 2015 £ £ Cash flows from operating activities Cash generated from operations (W) 991,600 Interest paid (2,100 + 1,089 – 1,500) (1,689) Income tax paid (195,500)

Net cash from operating activities 794,411 Cash flows from investing activities Purchase of property, plant and equipment (1,041,200

+ 15,600) (1,056,800)

Proceeds from sales of property, plant and equipment 17,200

Net cash from investing activities (1,039,600) Cash flows from financing activities Proceeds from issue of ordinary share capital (150,000

x £1.50) 225,000

Payment of finance lease liabilities (16,000 – 1,089 (b)) (14,911) Ordinary dividend paid (23,900 + (150,000 x 50p)) (98,900)

Net cash from financing activities 111,189

Net decrease in cash and cash equivalents (134,000) Cash and cash equivalents at 1 July 2014 49,150 Cash and cash equivalents at 30 June 2015 (150 – 85,000) (84,850)



Working Cash generated from operations £ Per draft 978,700 Decrease in cost of sales re lease (8,000 x 2) (b) 16,000 Less profit on sale of PPE (17,200 – 15,600) (1,600) Adjustment to movement in trade and other payables for accrued interest (1,500)

991,600

Answers were disappointing and a minority of candidates failed to attempt this part. Although some candidates did achieve good marks it was unusual to see full marks. Adjustments to cash generated from operations were frequently rather random with even those candidates who had the correct figures often making their adjustments in the wrong direction. A significant number of candidates hedged their bets (in this working or on the statement of cash flows) by including only one side of a bracket around figures, so it was unclear whether they intended it to be added or subtracted. The most common correct adjustment seen was the negative £1,500 in respect of the opening and closing interest accrual. The next was the removal of the profit on sale of property, plant and equipment. An adjustment for the lease payments wrongly debited to cost of sales was rarely seen. Many candidates adjusted for the change in inventory valuation from Part (a) failing to appreciate that this had no impact as it affected both operating profit and the movement in inventories for the year. Most candidates included the correct income tax paid figure, although a few did not show this in brackets (or included only one bracket). The calculations for interest paid were mixed although the most common figure seen was £600, which ignored the interest on the finance lease calculated in Part (b). Proceeds from the sale of property, plant and equipment was often included, and where they were, it was usually both the correct figure and shown as a positive. The most common error for the purchase of property, plant and equipment was to deduct the cash proceeds rather than add them. If a figure was included for the finance lease then it was generally only the payments made rather than that figure net of the interest. A figure for the proceeds from the share issue was usually given, although this was often the nominal figure rather than the total cash received. T-account workings were at best rather random and usually had figures on the wrong side or were incomplete. Candidates often failed to complete their statement of cash flows by not showing sub-totals or not completing the total for cash and cash equivalents at the end of the year. A significant number of candidates left the adjustment for the increase in the overdraft as part of financing activities rather than appreciating that this should have been shown as part of cash and cash equivalents at the end of the period.


10 8




General comments This was a consolidated statement of profit or loss question, featuring two subsidiaries (one acquired during the year) and one associate. The associate had made losses since acquisition, such that the share of the loss taken for the current year had to be restricted. Other adjustments included a fair value adjustment on acquisition, a gain on bargain purchase of the subsidiary acquired during the year, an intra-group sale of a non-current asset (with subsequent impact on the annual consolidated statement of profit or loss) and intra-group management charges. The non-controlling interest column from the consolidated statement of changes in equity was also required. Part (b) required a description of the differences between IFRS and UK GAAP in respect of the preparation of consolidated financial statements.

Pembroke Ltd

Consolidated statement of profit or loss for the year ended 30 June 2015 £ Revenue (W1) 2,146,000 Cost of sales (W1) (1,447,100)

Gross profit 698,900 Operating expenses (W1) (257,300)

Profit from operations 441,600 Share of loss of associate (W3) (3,000)

Profit before tax 438,600 Income tax expense (W1) (94,300)

Profit for the period 344,300

Profit attributable to Owners of Pembroke Ltd (β) 309,340

Non-controlling interest (W4) 34,960

344,300

Consolidated statement of changes in equity for the year ended 30 June 2015 (extract) Non-

controlling interest

£ Balance at 1 July 2014 (W4) 184,440 Total comprehensive income for the year 34,960 Added on acquisition of subsidiary ((400,000 + 175,000) x 30%)

172,500

Balance at 30 June 2015 (β) 391,900



Workings (1) Consolidation schedule Pembroke

Ltd Newnham

Ltd Trinity

Ltd (8/12)

Adj Consol

£ £ £ £ £ Revenue 945,200 754,800 470,000 (24,000) 2,146,000 Cost of sales – per Q (583,700) (573,600) (279,000) – PPE PURP (W5) (10,800) (1,447,100) Op expenses – per Q ((122,550 – 12,000) x 8/12)

(128,900) (116,400) (73,700) 24,000

– FV deprec (120,000/25 yrs)

(4,800)

– Gain on bargain purchase* (W6)

42,500 (257,300)

Tax (60,000) (13,000) (21,300) (94,300)

47,000 85,200

*Or show on face of consolidated statement of profit or loss

(2) Share of loss of associate (Wolfson Ltd)

£ Original cost 118,200 Share of post-acquisition change in NAs ((181,900 + (120,600 – 14,500)) x 40%) (115,200)

Carrying amount of associate at 30 June 2014 3,000

Share of loss in year = 14,500 x 40% = 5,800 – restricted to £3,000 (3) Non-controlling interest in year £ Newnham Ltd (20% x 47,000 (W1)) 9,400 Trinity Ltd (30% x 85,200 (W1)) 25,560

34,960

(4) Non-controlling interest brought forward (Newnham Ltd) £ At acquisition (20% x (500,000 + 301,000 + 120,000)) 184,200 Share of post-acquisition profits (20% x (363,600 – 51,800 – 301,000 – (4,800 (W1) x 2)))

240

184,440

(5) PPE PURP (Trinity Ltd) £ Asset now in Pembroke Ltd’s books at £51,000 x 4½/5 45,900 Asset would have been in Trinity Ltd’s books at £39,000 x 4½/5 (35,100)

10,800

(6) Gain on bargain purchase (Trinity Ltd) £ Consideration transferred 360,000 Net assets at acquisition (400,000 + 175,000) (575,000) Non-controlling interest at acquisition (575,000 x 30%) 172,500

(42,500)



(7) Non-controlling interest carried forward (for proof only) Newnham Ltd £ At acquisition (W4) 184,200 Share of post-acquisition profits (20% x (363,600 – 301,000 –

(4,800 (W1) x 3)) 9,640

193,840 Trinity Ltd At acquisition (SCE) 172,500

Share of post-acquisition profits (W3) 25,560

198,060

391,900

Answers were very disappointing. The majority of candidates did produce a consolidated statement of profit or loss with a supporting consolidation schedule. However, a minority chose to merge the consolidation schedule working into the consolidated statement of profit or loss, and as a result did not earn presentation marks. The majority of candidates did time apportion the new subsidiary’s results for the correct number of months. A minority consolidated for the full year or used an incorrect number of months. Common errors in the consolidation schedule included:

entering the contra for the management charges in the wrong column and/or to cost of sales rather than to operating expenses

adjusting for the proceeds from the intra-group sale of a machine as if those proceeds would have been treated as revenue

splitting the provision for unrealised profit on the intra-group sale of the machine between the parent and subsidiary columns (such that £12,000 appeared in one column and £1,200 in another, rather than the correct net £10,800 being shown in the subsidiary’s column)

incorrectly calculating the provision for unrealised profit on the machine or not realising that the profit on disposal should be reduced rather than increased by the subsequent difference in depreciation

including the cumulative increase to depreciation arising from the fair value adjustment rather than just adjusting for the current year’s depreciation

including a prior year impairment rather than the gain on bargain purchase on the current year acquisition

failing to deal correctly with the consultancy fees (which did not arise evenly over the year). Having arrived at the consolidated profit for the period, almost all candidates allocated the profit between the parent and the non-controlling interest. A minority of candidates used the figures from the question to perform this calculation instead of the adjusted figures from their consolidation schedule. Others failed to show what figure they had multiplied by what percentage to arrive at their non-controlling interest figure. Answers to the non-controlling interest column from the consolidated statement of changes in equity were even more disappointing. Frequently this was not attempted at all and where it was attempted presentation was poor. The most the majority of candidates managed to do was to enter the non-controlling interest share of the profit for the year. Some did attempt to calculate the non-controlling interest arising on the subsidiary acquired in the year but frequently made this much more complicated than the simple calculation required and often ended up with an incorrect figure. A minority attempted to calculate the non-controlling interest brought forward, but workings were often disorganised and difficult to follow. Many candidates wasted time preparing completely unnecessary workings and often failed to realise that this figure would not include anything for the subsidiary acquired in the year. However, a significant number of the better-prepared candidates did correctly calculate both this figure and that for the non-controlling interest arising on the subsidiary acquired in the year.



Although almost all candidates calculated a figure for the share of the associate’s losses this was frequently treated as a profit rather than a loss and some candidates seemed to be including some form of investment in the associate in their profit or loss account figure. Hardly any candidates understood the impact of a loss-making associate and the requirement to “cap” losses to prevent a “negative” investment in associate figure.


19½ 17

(b) IFRS v UK GAAP differences re preparation of consolidated financial statements

UK GAAP IFRS - Requires goodwill to be amortised over its useful life, with rebuttable presumption that this should not exceed five years

- Goodwill is subject to annual impairment review

- Impairment losses cannot be reversed

- Impairment losses re goodwill may be reversed - Acquisition related costs added to cost of acquisition - Negative goodwill presented on the statement of financial position directly under positive goodwill, as a negative asset

- Acquisition related costs are expensed - Negative goodwill recognised in profit or loss/retained earnings

- Non-controlling interest must be measured using the proportionate method - A subsidiary should be excluded from consolidation where severe long-term restrictions apply or where the interest is held exclusively for resale - Where a subsidiary is disposed of and meets the definition of a discontinued operation its results are shown in a separate column in the consolidated income statement - Recognises implicit goodwill on the acquisition of an associate or joint venture and requires it to be amortised

- Can use the proportionate method or the fair value method - No allowed exclusions from consolidation - The results of the subsidiary are shown as a single amount on the face of the consolidated statement of profit or loss - No separate goodwill recognised

As usual for parts of questions testing UK GAAP differences answers were mixed. Many candidates wasted time and gained no marks by just listing out random differences on a variety of topics rather than focusing, as required, on differences relating to consolidated financial statements. Those that did focus on differences relating to consolidated financial statements usually gained at least half of the available marks for the more obvious points on the different methods of calculating goodwill and amortisation versus annual impairment reviews. Well-prepared candidates achieved full marks on this part.


10 4

Financial Accounting and Reporting - Professional Level – March 2016




General comments Part 1.1 required the preparation of a statement of profit or loss and a statement of financial position from a trial balance plus a number of adjustments. Adjustments included property, plant and equipment depreciation, revenue adjustment, an asset partly funded by a government grant, an intangible asset which had been incorrectly revalued, a lease incentive, a rights issue and an inventory adjustment. Part 1.2 required a calculation of basic earnings per share. Part 1.3 required the preparation of a UK GAAP extract in relation to the government grant asset. Part 1.4 required an explanation of how the inherent limitations of financial statements reduce their usefulness to users and part 1.5 required an explanation of the ethical issues arising from the scenario.

1.1 Laderas plc – Statement of financial position as at 30 September 2015

£ £ ASSETS Non-current assets Property, plant and equipment (W3) 913,060 Intangibles (W4) 66,625

979,685 Current assets Inventories (42,600 + 6,600 (W2)) 49,200 Trade and other receivables 47,800 Cash and cash equivalents 15,600

112,600


Equity Ordinary share capital ((520,000 / 4) x 5) 650,000 Share premium account (307,500 – 130,000) 177,500 Retained earnings (70,690 + 107,295) 177,985

Equity 1,005,485 Current liabilities Trade and other payables 61,200 Lease accrual (12,000 / 3yrs) 4,000 Taxation 21,600

86,800


Laderas plc – Statement of profit or loss for the year ended 30 September 2015

£ Revenue (1,323,700 – 75,000) 1,248,700 Cost of sales (W1) (758,030)

Gross profit 490,670 Administrative expenses (W1) (237,400) Other operating costs (W1) (124,375)

Profit before tax 128,895 Income tax (21,600)




Workings

W1 Expenses Cost of

sales £

Admin expenses

£

Other operating

costs £

Draft 721,400 237,400 113,000 Opening inventory 52,690 Closing inventory (49,200) Depreciation charge (W3) 41,140 Amortisation 11,375 Lease liability (12,000 – 4,000) (8,000)

758,030 237,400 124,375

W2 Inventory £ Variable costs per unit ((14,800 + 4,200) / 3,800) 5.00 Fixed costs per unit (2,000 / 4,000) 0.50

5.50 Eros: 1,200 x £5.50 6,600 W3 Property, plant & equipment Land &

buildings Plant &

machinery

£ £ Cost 992,600 290,600 Less: government grant asset (125,000)

165,600 Less: Land (300,000) Less: New building (350,000)

342,600 Depreciation charge for the year 342,600 / 40yrs (8,565) (350,000 / 40yrs) x 6/12 (4,375) 165,600 / 8yrs (20,700) ((125,000 – 75,000) / 5yrs) x 9/12 (7,500)

12,940 28,200 PPE – carrying amount at 30 September 2015 £ Cost (290,600 + 992,600) 1,283,200 Less: acc depreciation b/fwd (176,000 + 78,000) (254,000) Less: government grant (75,000) Less: depreciation (12,940 + 28,200) (41,140)

At 30 September 2015 913,060

W4 Intangibles – brands £ Capitalised in TB 133,000 Arafo – internal brand – valuation (55,000)

78,000 Boca – amortisation (78,000 / 4yrs) x 7/12 (11,375)

66,625

Presentation of the statement of profit or loss and statement of financial position was better than usual. However there were few very messy statements in terms of workings shown on the face of the statements. Many candidates achieved very high marks on this part of the question with a good number achieving maximum marks. Almost all candidates gained the marks for the adjusted revenue and for the tax figure on the statement of profit or loss although a number failed to also show the tax as a liability on the statement of financial position.



On the statement of financial position completely correct figures were often seen for the intangible assets, share capital and share premium. Most candidates correctly showed no revaluation surplus, having removed this balance via their adjustment to the intangible asset, although candidates occasionally also showed the amount as an expense. It was also, on the high marking scripts, not unusual to see the correct figure for total property, plant and equipment. The most common errors on the face of the statement of financial position included the following:

Omitting the income tax liability.

Including an inventories figure which did not match the working for closing inventories.

Including an incorrect figure for the accrual in respect of the operating lease – although the correct figure was seen on many scripts, weaker candidates showed a wide variation of figures on the statement of financial position in respect of this lease.

Showing the correct figure for share capital, but the incorrect figure for share premium – ie failing to complete the double entry correctly between these two accounts.

Leaving the internally generated brand within the intangible asset figure and/or charging amortisation for the incorrect number of months.

Perhaps the most disappointing mistake was in the calculation of closing inventory. Although occasional errors were made in the valuation of this inventory, for example, allocating the variable costs over the planned production, rather than over the actual production, by far the most common error was to value this inventory at its selling price, often without even checking whether cost was lower. It was also not unusual to see one inventory figure on the statement of financial position and a different figure taken to the statement of profit or loss. Most candidates did use the recommended “costs matrix” in their workings, and generally the costs were allocated to the correct category. Where figures were deducted instead of added, or vice versa, this tended to be when the candidate had started their matrix with the base figures in brackets. There were some very neat property, plant and equipment “tables” which acted as a working for the final figure, in contrast to some candidates who produced a series of seemingly unrelated and unreferenced workings. What was seen far more often than usual at this session, however, was a large number of depreciation figures with no supporting workings. This meant that partial marks could not be awarded to these figures if they were not correct. Where workings were provided for these figures, the most common errors seen were to mix up useful lives and fractions of years between the different categories of property, plant and equipment.


21 19



1.2

Laderas plc

No. Of shares

Period in issue

Bonus factor

Weighted average

1 Oct – 30 June 520,000 9/12 1.85/1.72 419,477 Rights issue 1 for 4 (520,000 / 4 130,000

1 July – 30 Sept 650,000 3/12 – 162,500

581,977 Theoretical ex-rights price: £ 4 shares @ £1.85 7.40 1 share @ £1.20 1.20

8.60 Theoretical ex-rights price per share: 8.60 / 5 = £1.72 Bonus fraction: 1.85 / 1.72 Basic EPS = 107,295= £0.18 581,977

A large number of candidates arrived at the correct figure for weighted average share capital, even though this necessitated making an adjustment for a bonus factor. Weaker candidates failed to calculate a bonus factor, or calculated it incorrectly. Others calculated the correct theoretical ex-rights price, but then failed to use this in their calculations. Other errors included the following:

Using the incorrect fractions for the two parts of the year, eg treating the bonus issue as though it had happened half way through the year instead of after nine months.

Applying the fraction for the second part of the year (ie that after the bonus issue had taken place) to the bonus issue itself instead of to the cumulative number of shares in issue.

Using different numbers of shares in this calculation than they had shown in their answer to Part 1.1

Inverting the bonus fraction so that it reduced the number of shares instead of increasing them.


5 4

1.3 UK GAAP – Government grants

Fixed assets Tangible fixed assets (125,000 – 18,750)

£ 106,250

Creditors falling due within one year Deferred income (75,000 / 5yrs)

15,000

Creditors falling due after one year Deferred income (75,000 – 11,250 – 15,000)

48,750

Workings: Depreciation: 125,000/5yrs x 9/12 = £18,750 Deferred income release: (75,000 / 5yrs) x 9/12 = £11,250



Most candidates appeared to know that UK GAAP/FRS 102 specifies the deferral method with a significant number of candidates calculating the correct carrying amount for the machine and the correct current liability for the deferred income figure. However, what was most disappointing about these answers was that almost every single candidate presented these UK GAAP extracts using IFRS terminology. A few candidates wasted time writing about the differences between the UK GAAP and the IFRS treatment of government grants, which was not required.


5 3

1.4 Limitations of financial statements

Financial statements have a number of limitations as set out below:

Financial statements are prepared to a specific date. The information when published is therefore historic and backward looking. Although historic information is useful in assessing how a company has been performing it provides limited predicted value.

Financial statements are prepared in a standardised manner with much of the information aggregated. While this means that it is easier to compare information between companies because it is presented in a similar manner it also means that the content of standardised and aggregated information may be difficult to identify.

Financial statements only contain a limited amount of narrative information about the business which can provide valuable insight into the company’s future, for example, how it is operating, what the company’s plans are for the future, the risks facing the company, such as number of competitors in the market and the management structure.

Financial statements are based on estimates and judgements and hence figures are not an exact number. Management in different organisations may make slightly different assumptions and judgements and hence include slightly different figures.

Companies use different accounting policies which means that exact comparisons cannot always be made. However, disclosure of accounting policies means that users can identify differences.

Answers to this part of the question were varied. Those attempting the question could usually say that the financial statements were “historic” or “backward looking” and/or “prepared at a point in time” such that they may not be useful in predicting future performance. A few then went further and discussed the impact of different accounting policies in reducing comparability and considered the use of estimated figures/judgements, the aggregation of figures and the lack of narrative disclosures on matters that might be of use to a potential investor. A worrying number of candidates appeared to think that the financial statements included no narrative disclosures at all, presumably not realising that the notes are an integral part of the financial statements. Weaker candidates discussed the fact that the financial statements may contain errors, or be biased, which are not inherent limitations. Others went further down this road, discussing how an audit could never provide absolute assurance. A few candidates instead wrote about the enhancing qualitative characteristics.


9½ 4



1.5 Ethical issues

Professional competence and due care – As a professional accountant Parry has an obligation to maintain his professional knowledge and skills at the level required to ensure that his current employer receives competent professional services based on current developments in financial reporting and legislation. Does Parry have the necessary skills and experience to prepare the financial statements of Laderas plc following his career break? Should Parry instead have looked to refresh his professional knowledge following his career break and then have taken a less demanding, technically, role than that of covering a financial controller? The fact that Parry is an ICAEW Chartered Accountant means that he has met the first phase of attaining professional competence, however he now needs to maintain his professional competence. Professional behaviour – A profession accountant should comply with relevant laws and financial reporting standards. Parry has made a number of mistakes over the accounting treatment for items over the year, for example, the rights issue was incorrectly accounted for. This suggests that perhaps Parry is not acting as professionally as he should be, be it in error or deliberately. In addition to these two fundamental principles being questionable there is also a threat towards these being breached. The threat is that of self-interest for Parry. The finance director has suggested that the board are looking for a high reported profit this year and a strong financial position to secure additional funding for the future of the company. Parry may feel pressured, intimidation threat, to overstate profits as a result. Parry has over-stated profits by recognising the whole of the government grant in the current year even though some should have been deferred and the internally generated brand was revalued to a market valuation increasing the company’s financial position incorrectly. These may have been innocent mistakes as Parry may not be up to date due to his career break, but he may have incorrectly accounted for things to make the company’s results appear stronger than they were so that the board would believe that he was good at his job and offer him a full-time position. The assistant accountant should take the following action:

Discuss each of the errors found with Parry, explaining the correct IFRS accounting treatment to him.

Suggest that Parry attends an update course to ensure that he maintains appropriate continuing professional development as an ICAEW Chartered Accountant.

Ensure the financial statements are corrected.

If Parry refuses to amend the financial statements seek support from a director.

Keep a detailed record of all discussions and calculations.

If you find yourself in a difficult situation, or subject to intimidation threat, then consult the ICAEW helpline.

There were some excellent answers to this part of the question. Most candidates correctly recognised the self-interest and intimidation threats arising from the scenario, and the threat to professional competence and due care arising from Parry’s lengthy career break. However, only the very best candidates linked the latter back to the scenario to discuss the type of errors that had been made and whether they were likely to have been deliberate and/or might indicate a lack of professional competence. Most candidates produced the usual list of steps which needed to be taken: discussion with Parry, escalation to the other directors/audit committee, seeking help from the ICAEW, and documenting all discussions. As ever, a number placed themselves in an audit context and wished to consult “more senior members of the team” or “the ethics partner”.


12 5




General comments This question required candidates to explain the financial reporting treatment of four accounting issues, given in the scenario. The issues covered the construction of an asset, obligations and events after the reporting period, a provision and an impairment review for a revalued asset. Journal entries were also required.

(1) Construction of an asset The cost of an item of property, plant and equipment is initially recognised at cost. In the case of a specialised piece of plant which has been specifically constructed for the entity, cost will include its purchase cost and all directly attributable costs to bring the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. Directly attributable costs include:

Employee benefits arising directly from the construction of the machine; and

Site preparation, delivery, installation and assembly costs, costs of testing and professional fees. There are certain costs which should not be capitalised as they are not considered to be directly attributable to the item, for example the cost of introducing new products and administration and general overheads. Any proceeds from selling products generated during testing of new property, plant and equipment should be deducted from the cost capitalised. The following costs should therefore be capitalised as part of property, plant and equipment:

PPE Expense £ £ Materials cost (including cutters) 124,000 Internal allocated labour costs 31,500 10,000 Sale of by-products produced as part of testing process

(450)

Staff training 1,800 Consultancy fees re installation and assembly 1,150 Professional fees 1,300 Safety inspection 1,500 Overheads allocated 7,100 7,100

166,100 18,900

Capitalisation ceases when the item is capable of operating in the manner intended, this was on 1 July 2015 and this is the date on which depreciation should commence. Each significant part of an item of property, plant and equipment must be depreciated separately, although if component parts have the same useful lives and depreciation methods are the same they may be grouped together for practical purposes. Here the cutters should be recognised as a separate component as they have a useful life of five years compared with 15 years for the rest of the asset. Total depreciation of £3,235 (£700 + £2,535) should be recognised as part of profit or loss for the period and the carrying amount of the plant at 30 September 2015 is £162,865 (166,100 – 3,235).

Cutters: (14,000 / 5yrs) x 3/12 = £700 Remainder: ((166,100 – 14,000) / 15yrs) x 3/12 = £2,535



The journal entries required are:

£ £ DR: Expense (PorL) (18,900 + 3,235) 22,135 CR: Property, plant and equipment (SOFP) 22,135 (2) Obligations and events after the reporting date

A liability arises when there is a present obligation arising from past events, the settlement of which is expected to lead to the outflow from the entity of resources embodying economic benefits. An obligation implies that the entity is not free to avoid the outflow of resources. A management decision does not in itself create an obligation because it can be reversed. The obligation arises instead at the date of delivery, as cancellation is possible up to this date. Therefore, Equipment A and C should be accrued for at 30 September 2015 based on cost. Cost of Equipment A is £34,000, however the cost of Equipment C was finalised after the end of the reporting period. This is an adjusting event as it provides evidence of conditions that existed at the end of the reporting period, ie the subsequent determination of the purchase price purchased before 30 September 2015. Equipment C should therefore be accrued for at £38,000 rather than £40,000. As Equipment B was delivered after the year end, the cost should not have been accrued for at the year end as there was no firm commitment at that date and the order can be cancelled at any time for no cost. The new equipment will be depreciated once it is ready and available for use. As no useful life is provided no depreciation has been recognised, although even if a useful life was provided it is likely that the amount would be immaterial as the equipment was owned for less than a week. It is also highly likely that the equipment will take a day or two to be made available for use. The journal entries required are: DR: Accruals – current liabilities (27,000 + 2,000)

£ 29,000

£

CR: PPE (SOFP) 29,000 (3) Provision

As stated above, a liability exists when there is a present obligation arising from past events, the settlement of which is expected to lead to the outflow from the entity of resources embodying economic benefits. A present obligation exists here as a result of a past event which is independent of Chayofa Ltd’s future actions. The past event is the acquisition of the land and the obligation is the restoration of the recycling centre. Therefore, it was correct to recognise a provision at 30 September 2015. Where the obligation is in respect of an asset, the amount provided for at 30 September 2015 should have been recognised as part of property, plant and equipment rather than recognised as part of profit or loss for the period. The amount of the provision should not be reduced by the expected cost reduction from new technology as at the date of the obligation the new technology does not exist. In addition the provision should not be recognised at the full £450,000 and should instead be discounted as the time value of money is material. Hence the provision should be recognised at the present value f the expenditure required to settle the obligation. The provision should therefore have been recognised as follows:

1 Oct 2014 (450,000 / 1.06

15)

£ 187,769



At 1 October 2014 an asset should be recognised as part of property, plant and equipment for £187,769 and this should be depreciated over 15 years. A depreciation charge of £12,518 (187,769 / 15yrs) should be recognised as part of profit or loss for the period and the carrying amount of £175,251 (187,769 – 12,518) should be recognised at 30 September 2015. A finance cost of £11,266 (187,769 x 6%) should be recognised as part of profit or loss for the period and a provision for £199,035 (187,769 + 11,266) should be recognised at 30 September 2015. DR: PPE (SOFP)

£ 175,251

£

DR: Depreciation expense (PorL) 12,518 DR: Finance costs (PorL) 11,266 DR: Provision (SOFP) (450,000 – 199,035) 250,965 CR: Expenses (PorL) 450,000 (4) Impairment

The maintenance work may indicate that the machine has suffered an impairment and therefore an impairment review should be carried out. Assets should be carried at no more than their recoverable amount. Recoverable amount is the higher of value in use and fair value less costs to sell. Carrying amount at 30 September 2012:

Cost (1 Oct 2009)

£ 60,000

Less: acc dep (60,000 / 8yrs) x 3yrs (22,500)

37,500 Revalued amount 42,000

Revaluation surplus 4,500 Carrying amount at 30 September 2015: Revalued amount (1 Oct 2012)

£ 42,000

Less: acc dep (42,000 / 5yrs) x 3yrs (25,200)

16,800 FV less costs to sell (£10,500 – £500) £10,000 Value in use £11,000 Recoverable amount is therefore £11,000, which is lower than the current carrying amount and therefore the machine has suffered an impairment of £5,800 (£16,800 - £11,000). As the machine has been revalued, the loss should be treated as a revaluation decrease and charged to the revaluation surplus up to the amount held in the revaluation surplus in respect of that asset (£4,500). Any remaining balance should be recognised in profit or loss for the period, ie £1,300 (5,800 – 4,500). The journal entries required are:

DR: Impairment expense (PorL)

£ 1,300

£

DR: Revaluation surplus 4,500 CR: PPE (SOFP) 5,800

Virtually all candidates attempted all parts of the question producing both narrative explanations and supporting calculations and nearly all also attempted to include the relevant journals. Unfortunately, a significant number of candidates did not read the question carefully enough to determine what double entries had already been made and therefore struggled to arrive at the right correcting journals. Issue 1: This was well answered with most candidates starting their answer by mentioning general recognition criteria for non-current assets and then focusing on the specific costs given in the question.



Most costs were dealt with correctly but by far the most common error was to treat the sales of by-products as sundry revenue rather than deducting the proceeds from cost. Nearly all candidates realised that component parts with different useful lives should be depreciated separately and a majority also time apportioned the depreciation to start from the date the asset was ready for use. Issue 2: This was the issue that caused the most problems and many answers were brief. Candidates could have approached the question in two ways – either focusing on the criteria for recognition of assets (the approach most candidates took) or on the criteria for recognition of liabilities. Full credit was given for either approach. While many candidates did arrive at the correct decision as to which assets/liabilities should be recognised they often failed to justify why this was the case although a significant number did realise this was to do with the date of delivery. Fewer discussed the impact of IAS 10 and the fact that the subsequent determination of cost was an adjusting event, a significant minority of candidates thought that this meant that there was an unreliable estimate and that the cost should not be accrued. Issue 3: This was well answered with candidates discussing why the provision should be made and virtually all candidates successfully calculating the discounted balance. Most also discussed the subsequent recognition of a finance cost (although sometimes this was calculated on the “gross” liability rather than the discounted figure). Again the majority of candidates also recognised that the provision should be added to the asset and attempted to calculate the impact on depreciation (although here some candidates clearly hadn’t read the question carefully enough and assumed that the “gross” provision had been added to cost rather than expensed). Journals were often difficult to follow as they were spread throughout the answer with considerable repetition. Issue 4: This was well answered but many candidates wasted time by giving lengthy explanations and journals relating to what had occurred in previous years (rather than simply calculating the relevant numbers to determine the correct treatment in the current year) and/or discussing and calculating the transfers between reserves, which the question specifically stated were not made. Nearly all candidates discussed the need for an impairment review in the current year although relatively few explained why it was needed, linking it to the maintenance work. A majority of candidates calculated the correct impairment figure, with many understanding that it should be split between the revaluation surplus and as an expense in the statement of profit and loss. A significant minority of candidates described recoverable amount as being the lower of fair value less cost to sell and value in use and a common error was to recognise the excess impairment above the balance on the revaluation surplus to retained earnings rather than profit for the period.


43½ 28




General comments Part 3.1(a) required candidates to calculate the profit or loss from discontinued operations, with part (b) asking for the UK GAAP differences. Part 3.2 required extracts from the consolidated financial statements for an investment in an associate. Part 3.3 required an explanation of accounting treatment for a sale and repurchase and finally part 3.4 required extracts from the consolidated statement of cash flows.

3.1(a)

Group profit on disposal of Isora Ltd £ £

Sale proceeds 765,000 Less carrying amount at goodwill at disposal: Consideration transferred 495,000 NCI at acquisition (609,800 x 25%) 152,450 Less net assets at acquisition (609,800)

37,650 Less impairments to date (35,000)

(2,650) Less carrying amount of net assets at disposal: Net assets at 30 September 2014 898,700 Profit for 9 months to 30 June 2015 (108,000 x 9/12) 81,000

(979,700) Add back attributable to NCI (979,700 x 25%) 244,925

Profit on disposal 27,575 Profit for 9 months to 30 June 2015 81,000

Profit for the year from discontinued operations 108,575

A good number of candidates achieved the maximum marks on this question, by producing a completely correct calculation. By far the most common error made was not adding the profit for the year up to disposal to the profit on disposal to arrive at the required profit or loss from discontinued activities (or adding only the group share of that profit). Other common errors included the following:

Not reducing the goodwill at acquisition by the cumulative impairment losses.

Deducting the profit for the year up to disposal from the net assets at the beginning of the year in order to arrive at the net assets at disposal, instead of adding it.

Calculating net assets at disposal from various figures in the question (and making errors in doing so) instead of simply adding the profit for the year up to disposal to the figure given in the question for the net assets at the beginning of the year.


4 4

(b)

Under IFRS 5 the results of discontinued operations are presented as a one-line item in the statement of profit or loss. This amount comprises the post-tax profit or loss of the discontinued operation and the post-tax profit or loss on disposal. Under FRS 102 the results of discontinued operations are presented in full in a separate column of the income statement and comparatives restated.



Most candidates could state that IFRS showed a “single line” for the discontinued operations figure, and that UK GAAP showed this as a “separate column” but few candidates added any detail to this. Others wasted time by setting out other differences between IFRS and UK GAAP which they thought might be relevant (but which were not required).


2 2

3.2

Associate – Amparo Ltd Extract from consolidated statement of profit or loss for year ending 30 Sept 2015

£ Share of profit of associate 6,045 Extract from consolidated statement of financial position at 30 September 2015 Non-current assets £ Investment in associate 269,045

Working Investment in associate Cost 263,000 Add: post acquisition profits (51,300 x 6/12) 25,650 Less: FV depreciation ((450,000 – 285,000) / 15yrs) x 6/12) (5,500)

20,150 X 30% 6,045

269,045

A majority of candidates made some errors in these calculations. Presentation was varied, with only some candidates showing their investment in associate figure as part of non-current assets. A minority of candidates produced only calculations, with no extracts from the financial statements. Common errors included the following:

Taking 30% of the profit figure, or 30% of the depreciation adjustment, but not 30% of both.

Reducing the asset figure by the depreciation adjustment, but not also the figure for the statement of profit or loss.

Adding the fair value adjustment to the investment in the associate.

Adjusting by a whole year’s worth of depreciation, instead of only by six months.


4½ 4

3.3

In substance this is a secured loan rather than revenue and the £150,000 profit should be reversed. Hiedras plc has the continuing right to have access to the site it has retained the risks and rewards of ownership and should therefore continue to recognise the land as part of property, plant and equipment. As the sale proceeds and repurchase price are considerably lower than the lands fair value this is further evidence that this is in substance a two-year loan. The difference between the sale and repurchase values of £75,000 is interest.



At 1 October 2014 the land should be recognised as part of property, plant and equipment at its original carrying amounting amount of £350,000. The proceeds of £500,000 should be recognised as a liability, as it is assumed that the land will be repurchased on 30 September 2016. Finance costs of £36,250 (500,000 x 7.25%) should be recognised as part of profit or loss for the period and added to the loan giving a closing current liability of £536,250.

Answers to this part of the question were varied, with a number of non-attempts and zero marks. Almost all candidates thought that this was some sort of a “financing arrangement” but a significant majority went on to say that it was a finance (or occasionally an operating) leaseback, as opposed to a loan. Those who correctly identified that this should be treated as a loan usually went on to gain additional marks for explaining why this was and for their calculation of finance costs.


7 5

3.4

Consolidated statement of cash flows for year ended 30 September 2015 (extract) Cash flows from financing activities Proceeds from issue of ordinary shares (W1) 310,000 Dividends paid (W2) (127,500)

Net cash used in financing activities 182,500 Workings

(1) Share capital and premium

£ £ B/d (320,000 + 120,000) 440,000 Cash issue

(155,000 x £2.00)

310,000 C/d (570,000 + 275,000) 845,000 Non-cash issue (β) 95,000

845,000 845,000

(2) Retained earnings

£ £ Dividends paid (β) 127,500 B/d 375,600 Non-cash issue (W1) 95,000 C/d 594,200 CPorL 441,100

816,700 816,700

A significant number of candidates achieved full marks on this part of the question. Where the odd half mark was lost, it was most commonly from not including brackets on the face of the statement for the dividend paid. The most common error in the T-account workings was to omit the bonus issue from the debit of the retained earnings T-account, even where this had been calculated. However, on a number of occasions marks were lost in the T-account workings by failing to copy down numbers accurately from the question.


3 3




General comments This was a consolidation question, requiring the preparation of a consolidated statement of financial position, featuring two subsidiaries, one of which was acquired during the year. A draft consolidated statement of financial position was provided along with the new subsidiary’s separate figures. Adjustments included a fair value adjustment on acquisition, a gain on bargain purchase, intra-group sales of a non-current asset and inventories.

Gordo plc Consolidated statement of financial position as at 30 September 2015 £ £ Assets

Non-current assets

Property, plant and equipment (936,400 + 389,500 + 145,500 (W1) – 6,000 (W9))

1,465,400

Goodwill (W2) 29,350 Investments (667,800 – 442,000 (W2) – 220,000) 5,800

1,500,550 Current assets Inventories (46,170 + 21,500 – 1,400 (W8)) 66,270 Trade and other receivables (53,900 + 36,950 – 14,000) 76,850 Cash and cash equivalents (4,700 + 1,400) 6,100

149,220


Equity and liabilities Equity attributable to owners of Gordo plc Ordinary share capital 400,000 Share premium account 200,000 Retained earnings (W7) 661,670

1,261,670

Non-controlling interest (85,250 (W6) + 59,950 (W3)) 145,200

Total equity 1,406,870 Current liabilities Trade and other payables (67,400 + 37,800 – 14,000) 91,200 Taxation (112,300 + 39,400) 151,700

242,900


Workings

(1) Net assets – Orotava Ltd Year end Acquisition Post acq £ £ £ Share capital 150,000 150,000 Share premium account 75,000 75,000 Retained earnings Per Question 147,150 89,650 Fair value adjustment 150,000 150,000 Depreciation thereon ((150,000 / 25) x 9/12) (4,500) –

517,650 464,650 53,000



(2) Goodwill – Orotava Ltd £ Consideration transferred (340,000 + (85,000 x 1.20)) 442,000 Non-controlling interest at acquisition – FV 52,000

494,000


29,350 (3) Non-controlling interest – Orotava Ltd £ NCI at acquisition date (FV) 52,000 Share of post-acquisition reserves (53,000 (W2) x 15%) 7,950

59,950

(4) Net assets – Tixera Ltd Year end Acquisition Post acq £ £ £ Share capital 200,000 200,000 Share premium account 50,000 50,000 Retained earnings Per Question 98,400 61,200 Less: PURP (W8) (1,400) – Less: PPE PURP (W9) (6,000) –

341,000 311,200 29,800

(5) Goodwill –Tixera Ltd £ Consideration transferred 220,000 Non-controlling interest at acquisition (311,200 x 25%) 77,800

297,800


Gain on bargain purchase (13,400) (6) Non-controlling interest – Tixera Ltd £ NCI at acquisition date (W5) 77,800 Share of post-acquisition reserves (29,800 (W4) x 25%) 7,450

85,250

(7) Retained earnings £ Gordo plc 580,870 Orotava Ltd (53,000 (W1) x 85%) 45,050 Tixia Ltd (29,800 (W4) x 75%) 22,350 Gain on bargain purchase (W5) 13,400

661,670

(8) Inventory PURP % £ SP 125 14,000 Cost (100) (11,200)

GP 25 2,800

x ½ 1,400

(9) PPE PURP – Tixera Ltd

£ Asset in Gordo plc’s books at 30 Sept 2015 (45,000 x 4/5) 36,000 Asset would have been in Tixera Ltd’s books at 30 Sept 2015 (60,000 x 4/8) 30,000

6,000



This question was extremely well answered and candidates had obviously practiced this style of question at length. Virtually all candidates recognised that the draft consolidated statement of financial position excluded the new subsidiary which therefore had to be added in to their answer. Again nearly all produced the expected standard workings although sometimes there was no “audit trail” for the final figures on the face of the statement of financial position or for the shares of net assets/post acquisition profits included in the workings. By far the most common error (as always) related to the calculation of the PURP relating to the non-current asset transfer. Those candidates who calculated it by comparing the two carrying amounts more commonly arrived at the correct figure. Those who calculated separately the profit on disposal and impact on subsequent depreciation often then ignored the latter element (or added rather than subtracting it) to arrive at the net adjustment. Other relatively common errors included:

Failing to time apportion the additional depreciation relating to the fair value adjustment.

Calculating the goodwill and non-controlling interest figures using the same method (when one subsidiary used the proportionate method and one the fair value method).

Adjusting retained earnings for PURP’s that related to the subsidiaries.

Netting off the positive goodwill and gain on bargain purchase.

Deducting rather than adding the gain on bargain purchase, or ignoring it altogether, in retained earnings.

Failing to deduct the cost of the subsidiaries from the investments figure on the face of the consolidated statement of financial position.


20½ 19

Documents

ICAEW Financial Accounting Answers March 2015 to March 2016 {SPirate}