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F2 Advanced Financial ReportingA: FINANCING CAPITAL PROJECTS 3

1. Financial Markets 32. Long–Term Finance 53. Weighted Average Cost of Capital (WACC) 9

B: FINANCIAL REPORTING STANDARDS 17

4. IFRS 15 Revenue 175. IFRS 16 Leases 236. IAS 37 Provisions, contingent assets and liabilities 257. IAS 32 and IFRS 9 Financial instruments 318. IAS 38 Intangible Assets 359. IAS 12 Income taxes 3710. IAS 21 Effect of changes in foreign currency rates 41

C: GROUP ACCOUNTS 43

11. Consolidated Statement of Financial Position 4312. Group Statement of Profit or Loss and Other Comprehensive Income 5513. Group Statement of Changes in Equity 6314. Associates 6515. Foreign subsidiaries 6916. Group statement of cash flows 7317. IAS 24 Related parties 7918. IAS 33 Earnings per Share 83

D: INTEGRATED REPORTING 87

19. Integrated Reporting <IR> 87

E: ANALYSING FINANCIAL STATEMENTS 91

20. Accounting ratios 91

ANSWERS TO EXAMPLES 99

2019 Syllabus – November 2019 Watch free CIMA F2 lectures 1

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A: FINANCING CAPITAL PROJECTS

Chapter 1FINANCIAL MARKETS

1. What are financial markets?Financial markets are generally where companies can raise finance either in the short-term or long-term. Short-term financial markets are referred to as the money markets, whilst long-term financial markets are referred to as the capital markets.

Typical finance sought on the financial markets are treasury bills, commercial paper and certificates of deposit, all of which have been discussed in CIMA F1.

Typical finance sought on the capital markets are issues of debt, equity and derivatives, which is the focus of CIMA F2. The main capital markets for UK companies are:

๏ London Stock Exchange (LSE)

๏ Alternative Investment Market (AIM)

๏ Eurobond Market

Capital markets operate through banks and stock exchanges (financial intermediaries) taking surplus funds from individuals, companies and governments. The banks use these funds to provide finance to individuals, companies and governments. Direct funding without the requirement of financial intermediaries is possible but it is more risky for the lending institution.

2. Primary and Secondary marketsThe primary market is whereby new finance is sought through new issues. The secondary market is whereby existing financial instruments (equity shares, debt and derivatives) are traded. Both the LSE and AIM serve a purpose as both primary and secondary markets.

3. AdvisorsIn order to seek a listing on the capital markets the following advisors would be required to ensure compliance with the rules and regulations of the market:

๏ Sponsor Advises the board and coordinates the process

๏ Bookrunner Finds investors and determines pricing

๏ Lawyer Due diligence and draft prospectus

๏ Reporting accountant Financial due diligence and tax advice

๏ Financial PR Communication strategy









Chapter 2LONG–TERM FINANCE

Incorporated entities use two primary sources of long-term finance;

๏ Equity - relates to money invested within a business by it shareholders

๏ Debt - relates to a business borrowing money from an investor or financial institution.

1. Equity Finance

1.1. Ordinary equity shares

๏ Owning a share confers part ownership.

๏ High risk investments offering higher returns.

Advantages (to the company) Disadvantages (for the company)No fixed interest payments An expensive form of raising finance (issue cost).No repayment required No tax relief on dividend paymentsShares can be easily disposed of if company is listed Dilution of ownership on issue of new shares

A high proportion of equity can increase the overall company cost of capital (see later)

1.2. Preference shares

Preference shares do not offer ownership or voting rights within a business.

The features of a preference share are as follows:

๏ Fixed dividend (coupon % x par value).

๏ Paid in preference to ordinary share dividends.





1.3. Unlisted companies

Unlisted companies find it more difficult to raise equity finance than a listed company, due to the following reasons:

๏ Lack of audited information.

๏ Marketability.

๏ Higher risk of unlisted companies.

1.4. Listed companies

An unlisted company will seek to become listed once it has grown enough to meet the requirements of the local stock exchange. Below are listed possible advantages of becoming listed and possible disadvantages.

Advantages DisadvantagesCreating a market for the company's shares. Increasing accountability to shareholders and

stakeholders. Enhanced status and financial standing of the company.

Need to maintain dividend and profit growth trends.

Increasing public awareness and public interest in the company and its products.

Strict rules and regulations of governing bodies.

Access to additional finance in the future (issue of new issues or other securities)

Increasing costs of compliance with reporting requirements.

Increased acquisition opportunities (share exchange).

Relinquishing some control of the company.

Exit route for existing shareholders. Increased media interest.Opportunity to implement share option schemes for employees.

Becoming more vulnerable to an unwelcome takeover.





1.5. Methods of obtaining a listing

๏ Fixed price offer for saleAn offer to the general public at a fixed price that has the potential to raise the highest possible price for the company as it is offered to the widest possible market.

If price is perceived to be too high then it may not be attractive to investors which creates a risk that the issue fails to raise the amount of finance required.

The risk can be mitigated by paying an underwriting fee, where the underwriter commits to buying unsubscribed shares.

๏ Offer for sale by tenderAn offer where investors are able to bid for shares and the shares are issued only to those investors who have bid at the strike price or above.

Investors are asked to subscribe to shares at one price in a given list.

If there are insufficient bidders at the top price, they are moved into the bracket at the lower price until either:

‣ A desired amount of capital has been raised, or ;‣ The maximum possible capital has been raised.There is more chance of a successful take up of the shares with the flexibility of a sale by tender which mitigates the risk of having to pay underwriting fees.

Example 1 - ABC

ABC receives the following bids for shares at different possible prices:

Price (cents) Number of bids400 2,000,000375 2,800,000350 3,800,000325 1,700,000300 500,000

Calculate the issue price at which ABC will raise $30 million.Calculate the price at which ABC will maximise proceeds from the public offer.

๏ Private placingShares are placed with / sold to institutional investors, keeping the cost of the issue to a minimum and thus making the share issue slightly cheaper.

๏ Stock exchange introductionNo capital is raised by the company but the shares become listed on the stock exchange. The company’s founders can dispose of those shares more easily and realise capital gain whilst retaining (should they so choose) a controlling interest in the company.





2. Debt Finance

2.1. There are two main points to consider when issuing debt;

๏ Debt interest it tax deductible, thus can be cheaper than equity finance

๏ Debt interest must be paid prior to dividends and irrespective of profit levels thus there is a risk of default if interest and principal payments are not met.

Other points to consider when opting for debt finance include the following:

๏ SecurityThe debt holder will normally require some form of security (fixed or floating) against which the funds are advanced. This means that in the event of default the lender will be able to take assets in exchange of the amounts owing.

๏ CovenantsA further means of limiting the risk to the lender is to restrict the actions of the directors through the means of covenants. These are specific requirements or limitations laid down as a condition of taking on debt financing. They may include:

‣ Dividend restrictions.‣ Financial ratios (e.g. gearing or interest cover).‣ Issue of further debt.

2.2. Types of debt finance

Debt may be raised from two general sources, banks or investors.

๏ Bank financeFor many companies bank borrowings are the primary form of debt finance. These could be the high street banks or more likely for larger companies the large number of merchant banks concentrating on ‘securitised lending’.

๏ Traded investments Traded debt instruments are sold by the company, through a broker, to investors.

Typical features may include:

‣ The debt is denominated in units of $100, this is called the nominal or par value.‣ Interest is paid at a fixed rate (coupon rate) on the nominal or par value.‣ The debt has a lower risk than ordinary shares and may be protected by the charges and

covenants.

Instruments could be:

๏ Redeemable - the amounts borrowed will need to be repaid at a particular point in the future.

๏ Irredeemable - the amount borrowed never needs to be repaid

๏ Convertible - the investor has the option to convert for cash or shares within the company.





Chapter 3WEIGHTED AVERAGE COST OF CAPITAL (WACC)

1. WACC formula

The weighted average cost of capital is the average cost of the company’s finance (equity, loan notes, bank loans, and preference shares) weighted according to the proportion each element bears to the total pool of funds.

WACC formula

WACC=

Ve

Ve +Vd

⎛⎝⎜

⎞⎠⎟

ke +Vd

Ve +Vd

⎛⎝⎜

⎞⎠⎟

kd(1–T)

Where,

ke - Cost of equitykd - Cost of debt (to the company)Ve - Market value of equity in the companyVd - Market value of debt in the company





2. Use of WACC as the discount rate in project appraisal

WACC can be used to evaluate the company’s investment projects if the following conditions apply:

๏ No change in financial riskThe company will maintain its existing capital structure. Using the existing market value mix of funds as weights in the calculation assumes that in the long run funds will be raised in this proportion (i.e. in the long run the capital structure of the company will remain unchanged). This implies that the current gearing ratio is thought to be optimal.

๏ No change in business riskThe cost of capital is only valid for the existing level of risk in the enterprise. The project must therefore have the same level of business risk as the company does currently and will cause no change in this risk.

๏ Small project

The project is small relative to the size of the company thus representing a marginal investment. This is because the costs of capital calculated refer to the minimum required return of marginal investors and therefore are only appropriate for the evaluation of marginal changes in the company’s total investment.

๏ ‘Pooled funds’No attempt is made to match a project with a particular source of funds. All funds are regarded as forming a pool out of which all projects are financed.

๏ Perfect capital marketsOnly under conditions of perfect capital markets will the costs of capital calculated represent the true opportunity cost of funds used.

3. Calculating market values of sources of finance

WACC is calculated based upon market values, therefore it is important to ensure that you convert book value of all sources of finance as follows:

๏ Ordinary shares Ex-div price per share x number of shares in issue๏ Preference shares Ex-div price per share x number of shares in issue๏ Debentures Book value x market value / 100๏ Bank loans Book value (market value does not exist)





4. Cost of Equity (ke)

The cost of equity for an incorporated entity can be calculated using the dividend valuation model. The dividend valuation model states that the current ex-div market value (P0 ex-div) is equal to the present value of future dividends (D0), discounted at the required rate of return of the equity shareholder (ke)

P0 ex-div =D0 (1 + g)

P0 ex-div =ke – g

We can then re-arrange the formula to find the cost of equity (ke) that shareholders must have used to arrive at the share value.

ke =D0 (1 + g)

+ gke =P0 ex-div

+ g

g = dividend growth rate (assumed constant)

D0 = current dividend

P0 ex-div = current ex-div market value of the share

Example 1 - Banks

Banks Ltd has an ex-div share price of $2.50 and has recently paid out a dividend of 10 cents. Dividends are expected to grow at an annual rate of 4%.

Calculate the cost of equity.

Note:

“ex-div” is the share price immediately after a dividend has been paid

“cum-div” is the price immediately before a dividend is paid

The difference between “ex-div” and “cum-div” is the value of the dividend, D0, so that the “cum-div” share price can be expressed as follows;

P0 cum-div = P0 ex-div + D0

Example 2 – Cohen

Cohen Ltd has a cum-dividend share price of $4.15 and is due to pay out a dividend of 35 cents per share. Dividends are expected to grow at an annual rate of 5%.






5. Estimating Growth

5.1. Historic growth method

g= D0

Dn

⎛

⎝⎜

⎞

⎠⎟ −1

Where;

D0 = current dividend

Dn = dividend n years ago

Example 3 - Wilson

Wilson paid a dividend of 25 cents per share 5 years ago, and the current dividend is 42 cents.

The current share price is $5.50 ex-div.

Calculate an estimate of the dividend growth rate.Calculate the cost of equity.

Example 4 - Stiles

Stiles paid a dividend of 10 cents per share 5 years ago, and the current dividend is 16 cents.

The current share price is $2.36 cum-div.






5.2. Gordon’s growth model

g = r x b

Where;

r = Return on reinvested funds

b = Proportion of funds retained

Example 5 - Charlton

The ordinary shares of Charlton are quoted at $4.45 cum div and a dividend of 45 cents is just about to be paid.

The company has a return on capital employed of 15% and each year pays out 25% of its profits after tax as dividends.


6. Cost of Preference shares (kp)

Preference shares carry a fixed rate charge to the company in the form of a dividend rather than in terms of interest.

Preference shares are normally treated as debt rather than equity but they are not tax deductible.

Their cost can be calculated using the dividend valuation model with no growth, giving the following formula;

kp =D0

kp =P0 ex-div

Example 6 - Moore

Moore’s 8% preference shares ($1) are currently trading at $1.10 ex-div.

Calculate the cost of the preference shares.





7. Cost of Debt (kd)

There is only one approach to calculate the cost of debt. We can’t call it “dividend” valuation model since debt doesn’t pay dividends but it follows the same principle of future cash flows related to current market value.

7.1. Non-tradable debt

Bank loans and other non-traded loans have a cost of debt equal to the coupon rate adjusted for tax. So we can use the following formula;

kd = Interest rate(%) x (1 – T)

Example 7 - Ball

Ball has a loan from the bank at 8% per annum.

Corporation tax is charged at 25%.

Calculate the cost of debt.

7.2. Traded debt

Traded debt is always quoted in $100 nominal units or blocks. Therefore all calculations are done by reference to $100, regardless of the total amount borrowed.

Interest paid on the debt is stated as a percentage of nominal value ($100 as stated). This is known as the ‘coupon rate’. It is not the same as the cost of debt.

Debt can be:

๏ Irredeemable.

๏ Redeemable (at par or at a premium)

๏ Convertible (investor has the choice of redeeming for cash or a specified number of shares in place of cash).





7.3. Irredeemable debt

To calculate the cost of debt we will need to calculate the IRR of the future cash flows, which gives the following formula:

kd =I (1 − T)

kd =P0 ex-int

Where;

I - Coupon interest rate

T - Tax rate

P0 ex-int - Ex-interest market value of debt

Example 8 - Bobby

Bobby has 10% irredeemable loan notes that are quoted at $120 ex-int.

Corporation tax is payable at 25%.


7.4. Redeemable debt

To calculate the cost of debt we will need to calculate the IRR of the future cash flows, which now includes the redemption value of the debt in n years’ time. The relevant cash flows would be:

Time Narrative Cash flow0 Market value of debt (P0)1 – n Annual coupon interest paid (net of tax) I (1 – T)n Redemption value of debt RV

To then calculate the IRR we need to use linear interpolation.

Example 9 - Peters

Peters has 10% loan notes quoted at $95 ex-interest redeemable in 5 years’ time at par.

Corporation tax is paid at 25%.






7.5. Convertible debt

In this situation the holder of the debt has the option to redeem for cash or for shares.

To calculate the cost of debt using IRR the redemption value is assumed to be the greater of either:

๏ The share value on conversion, or

๏ The cash redemption value if not converted.

Example 10 - Hunt

Hunt has convertible loan notes in issue that may be redeemed at a 10% premium to par value in 4 years. The coupon is 8% and the current market value is $110.

Alternatively the loan notes may be converted at that date into 25 ordinary shares.

The current value of the shares is $5 and they are expected to appreciate in value by 2% per annum.

The tax rate is 25%.

Calculate the cost of debt for the convertible loan notes.

8. WACC - Calculation

Example 11 - Ramsey

The following information is in the statement of financial position of Ramsey:

$000sOrdinary shares (25c) 4,0008% redeemable bonds 6,0005% bank loan 4,000

The current ex-div share price is $4.00 and a dividend of 25c has just been paid which is 10c higher than the dividend paid 5 years ago.

The 8% bonds are trading on an ex-interest basis at $94.00 per $100 bond and are redeemable in seven years’ time.

Corporation Tax is 25%

Calculate the weighted average cost of capital.





B: FINANCIAL REPORTING STANDARDS

Chapter 4IFRS 15 REVENUE

IFRS 15 has replaced the previous IFRS on revenue recognition, IAS 18 Revenue and IAS 11 Construction Contracts. It uses a principles-based 5-step approach to apply to contact with customers.

The five steps are as follows:

1. Identification of contracts

2. Identification of performance obligations (goods, services or a bundle of goods and services)

3. Determination of transaction price

4. Allocation of the price to performance obligations

5. Recognition of revenue when/as performance obligations are satisfied

1. Identification of contracts

The contract does not have to be a written one, it can be verbal or implied. In order for IFRS 15 to apply the following must all be met:

๏ The contract is approved by all parties

๏ The rights and payment terms can be identified

๏ The contract has commercial substance

๏ It is probable that revenue will be collected





2. Identification of performance obligations

If the goods or services that have agreed to be exchanged under the contract are distinct (i.e. could be sold alone) then they should be accounted for separately.

If a series of goods or services are substantially the same they are treated as a single performance obligation.

Illustration – Performance obligations

LiverTech is a computer business that primarily sells computer hardware. As well as selling computers, it also supplies and installs the software to its customers and provides a technical support package over a number of years. The business commonly sells the supply and installation, and technical support in a combined goods and services contract.

The combined goods and services contract has two separate performance obligations, which would need to be separated out and recognised separately.

The installation of software would be recognised once complete and the provision of technical services over the period of the support service.

3. Determination of transaction price

The amount the selling party expects to receive is the transaction price. This should consider the following:

๏ Significant financing components

๏ Variable consideration

๏ Refunds ad rebates (paid to the customer!)

Example 1 – Transaction price

Luckers Co. sells a car to a customer for $10,000, offering interest-free credit for a three-year period. The car is delivered to the customer immediately. The annual market rate of interest on the provision of consumer credit to similar customers is 5%.

What is the transaction price?





4. Allocation of the price

The price is allocated proportionately to the separate performance obligations based upon the stand-alone selling price.

Example 2 – Allocation of price

Richer Co. sells home entertainment systems including a two-year repair and maintenance package for $10,000. The price of a home entertainment system without the repair and maintenance contract is $9,000 and the price to renew a two-year maintenance package is $2,000.

How is the $10,000 contract price allocated to the separate performance obligations?Note: Ignore any discounting and time value of money.

5. Recognition of revenue

Once control of goods or services transfers to the customer, the performance obligation is satisfied and revenue is recognised. This may occur at a single point in time, or over a period of time.

If a performance obligation is satisfied at a single point in time, we should consider the following in assessing the transfer of control:

๏ Present right to payment for the asset

๏ Transferred legal title to the asset

๏ Transferred physical possession of the asset

๏ Transferred the risks and rewards of ownership to the customer

๏ Customer has accepted the asset.

Example 3 – IFRS 15 (1)

Telephonica sells mobile phones, selling them for “free” when a customer signs up for a 12 month contract. The contract costs the customer $45 per month.

Explain how the revenue should be recognised in Telephonica’s financial statementsNote: Vodaphone sells mobile phones without a monthly contract, selling the handset for $480. Call and data charges are $20 per month. Ignore discounting and the time value of money





Example 4 – IFRS 15 (2)

LiverTech is a computer business that primarily sells computer hardware. As well as selling computers, it also supplies and installs the software to its customers and provides a technical support package over two years. The business commonly sells the supply and installation, and technical support in a combined goods and services contract.

The combined goods and services contract sells for $1,600, but if sold separately the supply and installation is sold for $1,500 and the technical support for $500.

If LiverTech sold a combined contract on 1 July 20X7, demonstrate how the transaction would be presented in the financial statements for the year ended 31 December 20X7.

If a performance obligation is transferred over time, the completion of the performance obligation is measured using either of the following methods:

๏ Output method – revenue is recognised based upon the value to the customer, i.e. work certified.

Output method =Work certified to date

Output method =Total contract revenue

๏ Input method – revenue is recognised based upon the amounts the entity has used, i.e. costs incurred or labour hours.

Input method (cost based) =Costs to date

Input method (cost based) =Total estimated costs

Example 5 – Performance obligations over time and the statement of profit or loss (1)

Alex commenced a three year building contract during the year-ended 31 December 20X4 and continued the contract during 20X5. The details of the contract are as follows:

$mTotal contract value 45Costs incurred to date @ 20X5 20Estimated costs to completion 12Work certified as completed in 20X5 15Stage of completion @ 20X5 70%Profit recognised to date @ 20X4 3.3

Show how this contract would be dealt with in the statement of profit or loss for the year ended 31 December 20X5.Where not profit can be calculated if contracts spanning more than one accounting period, i.e. it is loss making, then the revenue is limited to the recoverable costs.





Example 6 – Performance obligations over time and the statement of profit or loss (2)

Evelyn commenced a building contract in 20X5 that has seen large increases in future costs to complete. The contract will still be completed on schedule in 20X6. The details from the year ended 31 December 20X5 are as follows:

$mTotal contract value 40Costs incurred to date 25Estimated costs to completion 20Stage of completion 45%

Show how this contract would be accounted for in the statement of profit or loss for the year ended 31 December 20X5.

As contracts that span more than one accounting period progress, the company is creating an asset for the customer that needs to be recognised in the statement of financial position. The amount to be recognised is as follows:

$Costs incurred to date X

Recognised profits X

Recognised losses (X)

Receivables (amounts invoiced) (X)

Contract asset/(liability) X/(X)

Example 7 – Performance obligations over time and the statement of financial position

Noah has a three year contract which commenced on 1 January 20X5. At 31 December 20X5 Noah extracted the following balances from its ledger relating to the contract:

$000 $000Total contract value 140,000Cost incurred up to 31 December 20X5:Attributable to work completed 52,000Inventory purchased for use in future years 8,000 60,000Progress billing to date 45,000Cash received 26,500Other information:Expected further costs to completion 48,000

At 31 December 20X5, the contract was certified as 40% complete.

Prepare extracts from the statement of profit or loss and statement of financial position for the year-ended 31 December 20X5.





6. Specifics

Principal vs agent - When a third party is involved in providing goods or services to a customer, the seller is required to determine whether the nature of its promise is a performance obligation to:

๏ Provide the specified goods or services itself (principal) or

๏ Arrange for a third party to provide those goods or services (agent)

Repurchase agreements - When a vendor sells an asset to a customer and is either required, or has an option, to repurchase the asset. The legal form here is always a sale followed by a purchase at a later date. The economic substance is more likely to be a loan secured against an asset that is never actually being sold.

Bill and hold arrangements - an entity bills a customer for a product but the entity retains physical possession of the product until it is transferred to the customer at a point in time in the future

Consignments – arises where a vendor delivers a product to another party, such as a dealer or retailer, for sale to end customers. The inventory is recognised in the books of the entity that bears the significant risk and reward of ownership (e.g. risk of damage, obsolescence, lack of demand for vehicles, no opportunity to return them, the showroom-owner must buy within a specified time if not sold to public)





Chapter 5IFRS 16 LEASES

1. Lessor accounting

1.1. Classification of the lease

Leases

Finance Operating

Finance lease if risks and rewards of ownership transferred to lessee.

๏ Ownership passes at end of the lease term

๏ Option to purchase asset at below fair value at end of lease and reasonably certain option will be exercised

๏ Lease term represents the major part of assets economic life

๏ PV of minimum lease payments represents substantially all of the asset’s fair value

๏ Leased asset is specialised in nature





1.2. Operating lease accounting

Operating lease income receipts are recognised as income through profit or loss on a straight line basis.

Depreciation on the asset continues over its useful life.

Example 1 – Operating leases

Banana leases out a machine to Mango under a four year operating lease. The terms of the lease are that the annual lease rentals are $2,000 payable in arrears. As an incentive, Banana grants Mango a rent free period in the first year.

Explain how both Banana would account for the lease in the financial statements.

1.3. Finance lease accounting

1. Derecognise asset and record a receivable (@ net investment in the lease”)

2. Record finance lease receipts as a reduction in the receivable

3. Record interest income on the receivable

Net investment in the lease = Gross investment in the lease discounted at the implicit rate of interest

Gross investment in the lease = Minimum lease payments receivable plus any unguaranteed residual value

Example 2 – Finance lease

Cherry leases out an item of property, plant and equipment under a 5 year finance lease. The lease commenced on 1 January 2015 and the rate implicit in the lease is 4%. The annual lease rentals of $5,000 are paid at the start of the lease period.

Cherry estimates that the estimated residual value of the item of property, plant and equipment is $2,000 and the guaranteed residual value is $1,600.

Calculate Cherry’s net investment in the lease, showing the guaranteed and the unguaranteed amounts.





Chapter 6IAS 37 PROVISIONS, CONTINGENT ASSETS AND LIABILITIES

Provision

Present obligation as a result of a past event

Measure the outcome reliably

Probable transfer/outflow of economic benefit

1. Measurement๏ Best estimate of expenditure

๏ Expected values (various different outcomes)

๏ Discount to present value if materially different

Illustration – Best estimate (single obligation)

Following the explosion of an oil rig in the North Sea that resulted in large amounts of environmental damage the company was taken to court by the local authority who were looking to recover the costs of the clean-up operation. The company has been informed by their lawyers that it was probable that they would be liable for the costs of the clean-up operation. The lawyers estimated that following financial settlements and their likelihood:

Settlement amount ($m) Likelihood of settlement25 20%40 45%65 35%

For a single obligation that is being measured, i.e. the payment to clean-up the environmental damage, the best estimate of the liability is the individual most likely outcome.

The most likely outcome is the settlement for $40 million and so this is the amount that would be provided for within the financial statements.





Illustration – Best estimate (large population)

A company sells second hand cars with a six-month warranty that promises to repair the cars if any faults occur following the sale. The company has estimated that 80% of the cars sold in the last six-months will require no repairs, however 15% will require minor repairs and the remaining 5% will require major repairs.

The company has estimated that if all the cars were to have minor repairs then this would cost $100,000 and if all the cars were to have major repairs then this would cost $500,000.

For a large population of items, the best estimate of the provision is based on an expected value of the possible outcomes. The expected value of the repair costs is $40,000 [(80% x $nil) + (15% x $100,000) + (5% x $500,000)] and so this is the amount that would be provided for within the financial statements.

Example 1 – Discounting and provisions

HR Co has a year end of 31 December 2018, and it was notified that on the 1 July 2018 a former employee brought about a legal claim for unfair dismissal. HR Co’s legal team have said that it is probable that that HR Co would lose the case, resulting in a payment of $495,000 on 30 June 2019.

HR Co has a cost of capital of 10% per annum. A one year discount factor at 10% is 0.9091.

Calculate the amounts to be recognised in the financial statements of HR Co for the year ended 31 December 2018

2. Subsequent treatment๏ Review the provision annually

๏ Only use the provision for expense originally created

Contingent liability

Possible obligation Present obligation

๏ Possible transfer, or

๏ Cannot measure reliably (rare)





Example 2 – Provisions and contingencies (1)

The following items have to be considered when finalising the financial statements of G-Star Co, a limited liability company:

The company gives warranties on its products. The company’s statistics show that about 5% of sales give rise to a warranty claim.

The company has guaranteed the overdraft of another company. The likelihood of a liability arising under the guarantee is assessed as possible.

What is the correct action to be taken in the financial statement for these items?

Item 1 Item 2A Create a provision Disclose by note onlyB Disclose by note only No actionC Create a provision Create a provisionD Disclose by note only Disclose by note only

Example 3 – Provisions and contingencies (2)

Justina supplies fish to a local restaurant. In August 2009 she supplied the restaurant with some shell-fish, and now she has heard that some of the restaurant’s customers have suffered attacks of food-poisoning. The restaurant has claimed that this is because of Justina’s shell-fish, and has commenced a legal action against her.

Algirdas, a local solicitor who specialises in food-poisoning cases, has advised Justina that she has a 42% chance of losing the case, and that, if she does lose, she will probably have to pay $300,000 to settle the liability.

What is the nature of Justina’s liability, if any, and how should it be treated in her financial statements for the year ended 31 August, 2009?





3. Specifics

Future operating losses

No provision can be made for anticipated losses as there is no obligation.

Onerous contracts

An onerous contract is whereby the cost of fulfilling the contract exceed the benefits received from the contract (e.g. non-cancellable operating lease).

A provision is recognised at the lower of:

๏ Present value of continuing under the contract, and

๏ Present value of exiting the contract

Example 4 – Onerous contract

Daiva has a contract to buy 900 metres of cloth each month for $7 per metre. From each 3 metres of cloth she can make a dress which she can sell for $30. She also incurs labour costs of $4 per dress. Alternatively she can sell the cloth immediately for $6.25 per metre.

If she decides to cancel the cloth purchase contract without notice she must pay a cancellation penalty of $700, for each of the next two months.

In December 2009 the market price of dresses fell to $22.

She is considering ceasing production since she believes that the market will not improve.

There is 2 months notice stated in the contract in case of breach of a contract.

(a) Is there a present obligation?(b) What will appear in respect of the contract in Daiva’s financial statements for the year

ending 31 December, 2009.





Restructuring๏ Sale or closure of a line of business

๏ Ceasing activities in a geographical location

๏ Relocating activities

๏ Re-organisation (management or focus of operations)

A provision is recognised if there is a detailed formal plan and the plan has been announced.

The provision only includes costs which are necessarily to be incurred and not associated with continuing activities.

Example 5 – Restructuring

On 18 August 2017 the directors of Paulius decided to close the Kaunas Factory.

(a) Assuming that no steps were taken to implement the decision and the decision was not communicated to any of those affected by the Statement of Financial Position date of 31 August, 2017 what is the appropriate accounting treatment?

(b) What would be the appropriate accounting treatment for the closure if a detailed plan had been agreed by the board on 26 August 2017, and letters sent to notify suppliers? The workforce in Kaunas has been sent redundancy notices.

Contingent asset

Remote/Possible Virtually certain

Recognise an asset

Probable

DiscloseIgnore

Illustration – Contingent asset

A business has a reporting date of 31 December and inventory worth $100,000 was stolen just prior to the reporting date. The business has made a claim on its insurance and has heard from the insurers who have said that it is probable that the full amount will be reimbursed, but no further confirmation of when any payment will be made has been received.

The business will disclose a contingent asset within the notes to the accounts as it is probable that the $100,000 will be received, however an asset cannot be recognised as it is not yet virtually certain as the final confirmation has not been received of when the payment will be received.









Chapter 7IAS 32 AND IFRS 9 FINANCIAL INSTRUMENTS

Company A Company B

Financial asset Financial liability, or equity

Purchase shares in co. B Issues shares

Purchase co. B debt Issues debt

Sells goods to B Buys good from A

1. Financial assets

1.1. Initial measurement

๏ Initially recognise at fair value including transaction costs, unless classified as fair value through profit or loss

1.2. Subsequent measurement

1.2.1 Equity instruments

Fair value through profit or loss (default)๏ Transaction costs are recognised immediately through profit or loss

๏ Re-measure to fair value at the reporting date, with gains or losses through profit or loss

Fair value through other comprehensive income

If there is a strategic intent to hold the asset the option to hold at fair value through other comprehensive income is available. Re-measure to fair value at reporting date, with gains or losses through other comprehensive income.

1.2.2 Debt instruments

Amortised cost

A financial asset is measured at amortised cost if it fulfils both of the following tests:

๏ Business model test – intent to hold the asset until its maturity date; and,

๏ Contractual cash flow test – contractual cash receipts on holding the asset.





Example 1 – Financial assets

Norman has the following financial assets during the financial year.

1. Norman bought 100,000 shares in a listed entity on 1 November 2015. Each share cost $5 to purchase and a fee of $0.25 per share was paid as commission to a broker. The fair value of each share at 31 December 2015 was $3.50.

2. Norman bought 200,000 shares in a listed entity on 1 March 2015 for $500,000, incurring transaction costs of £40,000. Norman acquired the shares as part of a long term strategy to realise the gains in the future. The fair value of the shares was £620,000 at 31 December. The shares were subsequently sold for $650,000 on 31 January 2016.

3. Norman bought 10,000 debentures at a 2% discount on the par value of $100. The debentures are redeemable in four years’ time at a premium of 5%. The coupon rate attached to the debentures is 4%. The effective rate of interest on the debenture is 5.73%.

Explain how each of the above financial assets will be accounted for in the financial statements.

4. Financial liabilities

4.1. Initial measurement

๏ Initially recognise at fair value less transaction costs (‘net proceeds’)

Subsequent measurement

๏ Amortised cost

๏ Fair value though profit or loss

Example 2 – Financial liabilities

Norma issues 20,000 redeemable debentures at their $100 par value, incurring issue costs of $100,000. The debentures are redeemable at a 5% premium in 4 years’ time and carry a coupon rate of 2%. The effective rate on the debenture is 4.58%.

Calculate the amounts to be shown in the statement of financial position and statement of profit or loss for each of the four years of the debenture.





5. Convertible debentures

If a convertible instrument is issued, the economic substance is a combination of equity and liability and is accounted for using split equity accounting.

The liability element is calculated by discounting back the maximum possible amount of cash that will be repaid assuming that the conversion doesn’t take place. The discount rate to be used is that of the interest rate on similar debt without and conversion option.

The equity element is the difference between the proceeds on issue and the initial liability element.

The liability element is subsequently measured at amortised cost, using the interest rate on similar debt without the conversion option as the effective rate. The equity element is not subsequently changed.

Example 3 – Convertible debentures

Alice issued one million 4% convertible debentures at the start of the accounting year at par value of $100 million.

The rate of interest on similar debt without the conversion option is 6%.

Explain how Alice should account for the convertible debenture in its financial statements for each of the three years.

6. Derivatives

A derivative financial instrument must have all three of the following characteristics:

1. Its value changes in response to the change in a specified interest or exchange rate, or in response to the change in a price, rating, index or other variable;

2. It requires no initial net investment;

3. It is settled at a future date.

Derivative financial instruments should be recognised as either assets (favourable) or liabilities (unfavourable). They should be measured at fair value both upon initial recognition and subsequently, with any movement in the value of the derivative going through profit or loss.

Example 4 – Derivates

On 1 February 2019, the directors of Wayne decided to enter into a forward foreign exchange contract to buy 12 million Dinar at a forward rate of $1 = 6 Dinar, on 31 May 2020. Wayne’s year end is 31 March.

Relevant forward exchange rates were as follows:

1 February 2019 $1 = 6 Dinar

31 March 2019 $1 = 5⋅8 Dinar

31 March 2020 $1 = 5⋅6 Dinar

Prepare relevant extracts from Wayne’s statement of profit or loss and statement of financial position to reflect the forward foreign exchange contract at 31 March 20X8, with comparatives. (Note: ignore discounting when measuring the derivative).









Chapter 8IAS 38 INTANGIBLE ASSETS

An identifiable, non-monetary asset with no physical substance but has value to the business.

๏ patents

๏ brand names

๏ licences

3 factors to consider

Identifiability

i.e. can sell separately

RecognitionControl

Framework

IAS 38

Separate acquisition

Capitalise at cost (purchase price, import duties and non-refundable purchase taxes less any trade discounts) plus any directly attributable costs (e.g. legal fees, testing costs). Amortisation is charged over the useful life of the asset, starting when it is available for use.

Research

Research expenditure is charged immediately to profit or loss in the year in which it is incurred.

Development

Development expenditure must be capitalised when it meets all the criteria.

๏ Sell/use

๏ Commercially viable

๏ Technically feasible

๏ Resources to complete

๏ Measure cost reliably (expense)

๏ Probable future economic benefits (overall)

Internally generated

Internally generate brands, mastheads cannot be capitalised as their cost cannot be separated from the overall cost of developing the business.





Revaluations

An intangible asset can only be revalued if there exists an active market.

An active market is one where the following conditions are all met:

๏ The items traded are homogenous

๏ Willing buyers and sellers can normally be found at any time

๏ Prices are available to the public

Amortisation

If an intangible has a finite life then it should be amortised over its useful economic life.

Residual value is normally assumed to be zero unless there is a commitment from a buyer or an active market exists.

An intangible could be considered to have an indefinite useful life if there is no foreseeable limit to the period over which the asset is expected to generate net cash flows for the entity. It will therefore be subject to annual impairment reviews.

Example 1 – Intangibles

GKS is a large pharmaceutical business involved in the research and development of viable new drugs. It commenced initial investigation into the viability of a new drug on 1 February 20X5 at a cost of $40,000 per month. On 1 August 20X5 GSK were able to demonstrate the commercial viability of the new drug and intend to sell it on the open market once fully complete.

Costs subsequent to 1 August 20X5 remained at $40,000 per month. At 31 December 20X5, GSK’s reporting date, the drug was not yet complete but it is believed that by mid-20X6 the drug will be available for sale.

The finance director is confident of the success of the drug’s sales that he wishes to revalue the intangible at the reporting date, using a discounted future cash flow model to establish the fair value.

Explain the treatment of the above costs in GSK’s financial statements for the year-ended 31 December 20X5.

Intangibles and business combinations

If an intangible asset is acquired in a business combination (i.e. acquisition of a subsidiary, that has a previously unrecognised internally generated brand), the cost of that intangible asset is recognised at fair value in the consolidated financial statements.

If a fair value cannot be established the intangible is not recognised separately and becomes part of the overall goodwill established on acquisition of the subsidiary..





Chapter 9IAS 12 INCOME TAXES

1. Deferred taxDeferred tax arises because;

Accounting profit (PFY) ≠ Taxable profit (PCTCT)

The reasons for this can be split into two categories:

๏ Permanent differencesItems that would have been used in calculating accounting profit but would NOT be used in calculating taxable profit e.g. some entertaining expenses

๏ Temporary differencesItems that would have been used in calculating accounting profit and taxable profit but in different accounting periods e.g. depreciation/tax allowances.

IAS 12 considers only temporary differences.

Example 1 – Tracy (ignoring deferred tax)

Tracy purchased an item of property, plant and equipment on 1 January 20X5 for $5 million. It was estimated that it had a useful economic life of 5 years but according to the tax authority had a 50% tax allowance in its first year and 20% reducing balance there after.

Tracy made an accounting profit of $2m for the year, which is expected to continue unchanged for the next two years.

Income tax rate 20%

Ignoring deferred tax calculate the profits after tax for Tracy for each of the three years ending 31 December 20X5 to 20X7.





2. Calculating deferred tax1. Calculate the the temporary difference, as being the difference between the carrying vale of

the asset or liability and its tax base.

$’000sCarrying value XTax base XTemporary difference X

2. Calculate the deferred tax position by multiplying the temporary difference by the income tax rate at which the asset or liability will be settled at.

X% x temporary difference = closing deferred tax provision

3. The closing deferred tax position is either a deferred tax asset or a liability.

A deferred tax liability arises if:

Carrying value > Tax base – taxable temporary difference

A deferred tax asset arises if:

Carrying value < Tax base – tax deductible temporary difference

4. The movement in the deferred tax position goes through profit or loss.

$’000sClosing position XOpening position XMovement X/(X)

Increase in deferred tax

Dr Income tax expense (SPL)

Cr Deferred tax provision

Decrease in deferred tax

Dr Deferred tax

Cr Incoime tax expense (SPL)





Example 2 – Tracy (incl. deferred tax)

Tracy purchased an item of property, plant and equipment on 1 January 20X5 for $5 million. It was estimated that it had a useful economic life of 5 years but according to the tax authority had a 50% tax allowance in its first year and 20% reducing balance there after.

Tracy made an accounting profit of $2m for the year, which is expected to continue unchanged for the next two years.

Income tax rate 20%

Calculate the profits after tax for Tracy for each of the three years ending 31 December 20X5 to 20X7.

20X5 20X6 20X7$’000s $’000s $’000s

Carrying valueTax baseTemporary difference

Closing deferred tax Opening deferred taxMovement

Statement of profit or loss (extracts)

20X5 20X6 20X7$’000s $’000s $’000s

Profit before taxIncome tax expenseCurrent taxDeferred tax movementProfit for the year

Statements of financial position (extracts)

20X5 20X6 20X7$’000s $’000s $’000s

Non-current liabilities Deferred tax

Current liabilities Tax payable









Chapter 10IAS 21 EFFECT OF CHANGES IN FOREIGN CURRENCY RATES

1. Functional Currency“The functional currency is the currency of the primary economic environment in which the entity operates.”

The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash. An entity’s management considers the following factors in determining its functional currency:

๏ The currency that dominates the determination of the sales prices๏ The currency that most influences operating costs๏ The currency in which an entity’s finances are denominated is also considered.

IAS 21 Foreign currency translation says that, when an individual company has transactions that are denominated in a foreign currency, they should translate them at the rate prevailing when the transactions occurred i.e. the historic rate (HR).

At the year end, the statement of financial position items need to be classified as either monetary or non-monetary items. The monetary items are then re-translated at the year-end using the closing rate (CR). Any exchange gains or losses that arise are taken directly to profit or loss.

The non-monetary items are not re-translated at the year-end.

Non-current asset investments, tangible non-current assets and inventory are deemed to be non-monetary and everything else is monetary.

Example 1 – Functional currency

Flower Inc. has its functional currency as the $USD. It trades with several suppliers overseas and bought goods costing 400,000 Dinar on 1 December 20X5. Flower paid for the goods on 10 January 20X6. Flower’s year-end is 31 December. The exchange rates were as follows:

1 December 20X5 4.1 Dinar : $1USD31 December 20X5 4.3 Dinar : $1USD10 January 20X6 4.4 Dinar : $1USD

Show how the transaction would be recorded in Flower’s financial statements.









C: GROUP ACCOUNTS

Chapter 11CONSOLIDATED STATEMENT OF FINANCIAL POSITION

1. Introduction to Group Accounts

P

100%

S

๏ P Ltd and S Ltd – separate legal entities

๏ P Group Ltd – one single entity, prepare accounts using substance

Control and ownership

๏ Control (power to direct activities) – 100%P + 100%S

๏ Ownership – Non-controlling interest (NCI%)

Basic principles

A parent is an entity that has one or more subsidiaries.

A subsidiary is an entity which is controlled by another entity (known as the parent).

The key concept in determining whether or not an investment constitutes a subsidiary is that of control.

Control is the power to govern the financial and operating policies of an entity so as to obtain benefit from its activities.

Control is usually achieved by the purchase of more than 50% of a company’s equity share capital.





2. Basic consolidation

2.1. Basic steps

100% P + 100% S assets and liabilities, ignoring the investments in subsidiary

100% P share capital and share premium only (reporting to parent’s shareholders)

Retained earnings (balancing figure)

Example 1 – Basic consolidation

Peter acquired 100% of the equity share capital of Steven on 31 December 20X4 for $1,000,000.

The financial statements of the two companies at that date were as follows:

Peter$000

Steven $000

Investment in Steven Co 1,000 -Other assets 1,500 1,200Total assets 2,500 1,200

Equity share capital 1,000 250Retained earnings 1,100 750

2,100 1,000Liabilities 400 200Total equity and liabilities 2,500 1,200

Prepare the consolidated statement of financial position for the Peter Group at 31 December 20X4.





Example 2 – Basic consolidation (continued)

Following Peter’s acquisition of the 100% of Steven’s equity share capital of Steven on 31 December 20X4, both companies continued to trade. The financial statements of the two companies at the end of the following year 31 December 20X5 were as follows:

Peter$000

Steven $000

Investment in Steven Co 1,000 -Other assets 1,900 1,450Total assets 2,900 1,450



Prepare the consolidated statement of financial position for the Peter Group at 31 December 20X5.

2.2. Non-controlling interest

Control is exerted through a shareholding of greater than 50%, so therefore it is not always necessary to fully own a subsidiary.

Shareholdings of 75% will still give the parent the power to direct the activities of the subsidiary and therefore it must prepare consolidated financial statements.

As the parent’s 75% holding still maintains control, the assets and liabilities of the subsidiary are consolidated 100% on a line-by-line basis.

It is necessary to account for 25% ownership interest in the subsidiary which is referred to as the non-controlling interest. It is shown in the equity section of the consolidated statement of financial position.

The non-controlling interest is measured using either of the following methods:

๏ Proportionate share of net assets

๏ Fair value





Example 3 – Non-controlling interest

Pierre acquired 80% of Stefan’s equity share capital on 31 December 20X4 when Stefan’s retained earnings were $750,000. The financial statements of the two companies at the end 31 December 20X5 were as follows:

Pierre$000

Stefan$000

Investment in Stefan Co 800 -Other assets 1,900 1,450Total assets 2,700 1,450



Prepare the consolidated statement of financial position for the Pierre Group at 31 December 20X5 assuming the non-controlling interest is measured using the proportionate share of net assets method

2.3. Goodwill

On acquisition of a subsidiary, the parent will usually pay more for the subsidiary than the value of the net assets (assets less liabilities). Why?

๏ Customer loyalty

๏ Good reputation

The difference between what the parent pays and what the net assets are truly worth is referred to as goodwill.

Example 4 - Goodwill

A parent company buys 75% of the equity shares in a subsidiary company for $156,000.

The remaining shares were valued at $56,000 and the net assets at acquisition were $170,000.

Calculate the goodwill arising on acquisition assuming that:1) Non-controlling interest is measured using the proportionate share of net assets method

2) Non-controlling interest is measured using the fair value method.





2.4. Other reserves (e.g. revaluation reserve)

Each reserve has a separate calculation still based on ownership so the calculation is the same as for group retained earnings

Group revaluation reserve

100% P XAdd: P’s % of S’s post acqn revaluation reserve X

X

Workings

W1) Group Structure

P

S

>50%

A

20-50%

W2) Net assets of subsidiary

At reporting date

At acquisition

Post acquisition

Equity shares X XSP X XRet. earnings X X

X X X

W3) Goodwill

FV of consideration (shares/cash) XNCI at acquisition X

XFV of net assets at acquisition (W2) (X)Goodwill at acquisition X

W4) Non-controlling interests

NCI @ acquisition (W3) XAdd: NCI% x S’s post-acqn profits (W2) X

X

W5) Group retained earnings

100% P XAdd: P’s % of S’s post acqn retained earnings (P’s% x (W2)) X

X





Example 5 - Workings

Matthews purchased 80% of Jones for $600,000 two years ago when Jones’s retained earnings showed a balance of $100,000.

Matthews$000

Jones$000

Non-current assets 1,000 500Investment in Jones 600 -Current assets 800 600Total assets 2,400 1,100

Equity share capital ($1) 500 200Retained earnings 800 400

1,300 600Liabilities 1,100 500Total equity and liabilities 2,400 1,100

Additional information:

Matthews measures the non-controlling interest using the fair value method.

The fair value of Jones’s equity shares was $200,000 at acquisition

Prepare the consolidated statement of financial position for the Matthews group for the year-ended 31 December 20X5.

2.5. Mid-year acquisition

If a subsidiary is acquired mid-year the issue revolves around calculating the retained earnings at the acquisition date. To calculate the retained earnings figure at the acquisition date we assume, unless told otherwise, that the profits for the year made by the subsidiary have accrued evenly and adjust either the opening or closing retained earnings figure.

Illustration – Mid-year acquisition

Richard acquired 80% of Andy’s equity share capital on 1 August 20X5. Both have a year end of 31 December 20X5.

Andy’s retained earnings at the end of the year were $600,000 and its profit for the year was $120,000.

Assuming the profit accrued evenly during the year then the Andy’s retained earnings figure at 1 August 20X5 is calculated as follows:

$600,000 − (5/12 x $120,000) = $540,000





3. Adjustments – Group

3.1. Intra-company balances

The intragroup receivable balance and intragroup payable balance should not be shown in the consolidated accounts as we treat the group as a single entity.

๏ Remove the payable

๏ Remove the receivable

3.2. Cash in transit

The intragroup receivable and intragroup payable balance should be equal. If they are not then it will be due to cash in transit.

Illustration – Cash in transit

P has an intra-company trade receivable of $1,500 at the year-end due form S. This does not agree with the corresponding $1,000 trade payable in S due to a cheque of $500 sent by S immediately prior to the year-end, which P did not receive until after the start of the new accounting year.

To account for the cash in transit and intra-company balances we need to:

1. Record the cash in transit in the group accounts

DR Bank $500

CR Receivables $500

2. Eliminate the equal intra-company balances

DR Payables $1,000

CR Receivables $1,000





3.3. Unrealised profits

Inventory PUP - Need to remove the intra-group profit included in inventory held @ year-end (cost structures)

Cr Inventory (CSFP) X

Dr Retained earnings (of seller) X

๏ If S is seller → Adjust (W2)

๏ If P is seller → Adjust (W5)

Illustration – Unrealised profits

P sells $100 goods to S at $125 and S has not sold the goods on by the end of the year.

Example 6 – Unrealised profits

Statements of financial position as at 31 December 20X5

James Molly$’000 $’000

Non-current assets PPE 900 500 Investment in Molly 800 -

Current Assets 700 600

2,400 1,100

Share Capital 500 200Retained earnings 800 400Current liabilities 1,100 500

2,400 1,100


1) James bought 80% of the equity shares in Molly for $800,000 when the retained earnings were $150,000.

2) Non-controlling interest is measured using the fair value method.

3) During the year Molly sold goods to James at $120,000 based on a mark-up of 20%. Half of the goods remain in inventory at the year-end.

Prepare the James Group consolidated statement of financial position as at 31 December 20X5.





3.4. Consideration

A parent may acquire a controlling interest in a subsidiary in other fashions as opposed to just a cash payment.

Other considerations are as follows:

๏ Share for share exchange

๏ Deferred cash consideration

๏ Contingent consideration

Share for share exchange

1. Calculate the number of subsidiary shares acquired

2. Calculate the number of P shares issued

3. Value the P shares issued

4. Record the journal entry

Example 7 – Share exchange

Harry acquired 80% of the 10 million ordinary $1 shares of Sally by offering a share exchange of one for every four shares acquired. The fair value of Harry’s shares is $3 per share.

Calculate the cost of investment for the acquisition and prepare the journal entry to record the share issue.





3.5. Deferred consideration

A parent may agree to pay cash in the future following the acquisition of the subsidiary. This deferred consideration is recorded on acquisition at present value.

Example 8 – Deferred consideration

Pony acquired 80% of the 30 million $1 equity shares of Star on 1 January 20X5. The consideration was through the offer of a share exchange of two shares issued for every three shares acquired and a cash payment of $1 per share payable on 31 December 20X5. The fair value of the Pany’s equity shares was $2 at 1 January 20X5.

The present value of $1 received in one year’s time is $0.91 at a rate of 10%.

Calculate the cost of the investment in Star at 1 January 20X5

The deferred consideration needs to be unwound to its final value and is done so using the interest rate originally applied to discount back the original entry and is recorded as follows:

Dr Finance cost

Cr Deferred consideration liability

NOTE: The adjustment does not impact the fair value of consideration.





4. Exam questions

Example 9 – Fair value adjustments

Statements of financial position at 31 December 20X5

AB XY$ $

Non-current assets PPE 12,000 5,000 Investment in XY 5,000 -

Current assets Inventory 7,000 3,500 Receivables 6,000 2,000 Bank 4,500 500

34,500 11,000

Equity shares ($1) 15,000 3,000Reserves 14,000 6,500Current liabilities 5,500 1,500

34,500 11,000

AB purchased 75% of XY two years ago, when the reserves of XY were $500.

At the date of acquisition, XY’s property, plant and equipment had a carrying value of $1,500 and a fair value of $3,500 and a remaining life of four years.

The group policy is to measure non-controlling interest at fair value at the acquisition date. The fair value of non-controlling interest in XY at acquisition was $2,600.

An impairment review performed on the 31 December 20X5 indicated that goodwill on the acquisition of XY had been impaired by 20% of its value.

Property, plant and equipment will be included in the consolidated statements of the AB group at 31 December 20X5 at a value of:$_________

The goodwill that is recorded in non-current assets of the AB group as at 31 December 20X5 is:$_________

The retained earnings of XY to be included in the consolidated retained earnings of the AB group at 31 December 20X5 will be:$_________





Example 10 – Unrealised profit

Statements of financial position as at 31 December 20X5

CD PQ$000 $000

Non-current assets PPE 11,000 6,000 Investments 6,000 -Current assets Inventory 5,000 1,500 Receivables 4,500 5,500 Bank 1,500 2,000

28,000 15,000

Equity shares ($1) 11,000 5,000Reserves 13,000 7,000Current liabilities 4,000 3,000

28,000 15,000

CD acquired 60% of the shares in PQ for $5m four years ago when PQ’s retained earnings were $1.5m. It is group policy to value the non-controlling interest at acquisition using the proportionate share of net assets method.

CD owed PQ $1m in respect of group trading that had occurred during the year. This balance is reflected in both companies statement of financial positions.

During the year PQ sold $1m goods to CD at a mark-up of 25% on cost. Half of these goods had been sold by CD by the year end.

Goodwill on acquisition has been impaired by $0.5m since the acquisition date.

Inventory will be included in the consolidated statements of the CD group at 31 December 20X5 at a value of:$_________

Receivables will be included in the consolidated statements of the CD group at 31 December 20X5 at a value of:$_________

Non-controlling interest in the consolidated statements of the CD group at 31 December 20X5 will be included at a value of:$_________





Chapter 12GROUP STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Consolidated statement of profit or loss and other comprehensive income for the year ended [date]

$Revenue XCost of sales (X)Gross profit XOther income XDistribution costs (X)Administrative expenses (X)Other expenses (X)Finance costs (X)Share of profit of associate XProfit before tax XIncome tax expense (X)PROFIT FOR THE YEAR XOther comprehensive income:Exchange differences on translating foreign operations XGains on property revaluation XActuarial gains/(losses) on defined benefit pension plans XGains/(losses) on fair value through other comprehensive investments XShare of other comprehensive income of associate X

Other comprehensive income for the year, net of tax X

TOTAL COMPREHENSIVE INCOME FOR THE YEAR XProfit attributable to: Owners of the parent (β) X Non-controlling interests (NCI% x S’s PFY) X

XTotal comprehensive income attributable to: Owners of the parent (β) X Non-controlling interests (NCI% x S’s TCI) X

X





X/12

P S Adj. GroupRevenue X X (X) XCOS (X) (X) X-PUP (Inventory ) (X) (X) (X)Gross profit XDist costs (X) (X) (X)Admin exp. (X) (X) (X)Finance cost (X) (X) X (X)Investment income X X (X) X-Dividend from S (X)Profit before tax XTaxation (X) (X) (X)PFY X X

Parent (β)Parent (β) XNCI = NCI% x S’s PFYNCI = NCI% x S’s PFY X

Example 1 – Basic consolidation

Statements of profit or loss for the year-ended 31 December 20X5

Vader$’000

Maul$’000

Revenue 1,645 1,280Cost of sales (1,205) (990)Gross profit 440 290Distribution costs (100) (70)Administrative expenses (90) (50)Profit before interest and tax 250 170Finance costs (55) (30)Investment income 10Profit before tax 205 140Taxation (35) (28)Profit for the year 170 112


1. On 1 July 20X5, Vader acquired 80% of the equity shares of Maul. It is the group policy to measure the non-controlling interest at acquisition at fair value.

2. Maul declared a dividend during the year of $10,000.

3. Assume that profits accrue evenly during the year.

Prepare a consolidated statement of profit or loss for the Vader group for the year-ended 31 December 20X5





1. Adjustments

1.1. Mid-year acquisition

If a subsidiary is acquired mid-year then the results can only be consolidated from the acquisition date as this is when the parent gained control. The results of the subsidiary will need to be pro-rated before being included in the consolidated financial statements

1.2. Intra-group sales

The group is treated as a single entity so any sales that have taken place between the parent and the subsidiary will need to be removed in full.

Dr Revenue (CSPL) XCr Cost of sales (CSPL) X

1.3. Provision for unrealised profits (PUP)

Any unrealised profit adjustment needs to be made in the seller’s financial statements within cost of sales as an increase to cost of sales.

1.4. Dividends

Dividends received by the parent from the subsidiary need to be removed from the group accounts to reflect the single entity concept. Any dividends shown in the group financial statements need to be those received from outside of the group only.

1.5. Fair value

Any change in the fair value of the assets or liabilities of the subsidiary is accounted for in S’s column in the consolidation schedule (e.g. extra depreciation or increase/decrease in contingent liability)





Example 2 - MYA

Statements of profit or loss for year ended 31 December 20X5

Edinburgh Glasgow Aberdeen$m $m $m

Revenue 200 240 120Cost of sales (120) (160) (50)Gross profit 80 80 70Operating expenses (30) (30) (32)

Operating profit 50 50 38Income tax expense (10) (10) (8)

Profit for the year 40 40 30

Edinburgh acquired 80% of the equity share capital of Glasgow on 1 July 20X5 and 75% of the equity share capital of Aberdeen several years ago.

Edinburgh sold goods to Aberdeen invoiced at $10m, including a mark-up of 25%, and all the goods remain in Aberdeen’s inventory at the year end.

Glasgow sold goods to Edinburgh invoiced at $5m, including a mark-up of 25%, and all of these sales occurred after the acquisition and half the goods remain in inventory at the year end.

Produce the consolidated statement of profit or loss for the Edinburgh group for the year ended 31 December 20X5.





Example 3 – Unrealised profits

Statement of profit or loss for the year ended 31 December 20X5

Gary Nick $000 $000Revenue 120,000 90,000Cost of sales (70,000) (40,000)Gross profit 50,000 50,000Operating expenses (20,000) (35,000)Profit from operations 30,000 15,000Finance cost (2,000) (500)Profit before tax 28,000 14,500Income tax expense (6,000) (3,000)Profit for the year 22,000 11,500

Additional information

1. Gary acquired 80% of Nick on 1 January 20X5. Goodwill on acquisition has been impaired by $1m during the year and should be charged to operating expenses. Full goodwill method

2. During the year Nick sold $10m goods to Gary at a mark-up of 25% on cost. One quarter of those goods are in inventory at the year end.

Prepare the Gary Group consolidated statement of profit or loss for the year to 31 December 20X5.





Example 4 – Pip

Statements of profit or loss for the year ended 31 December 20X5

Pip Posy$m $m

Revenue 250 280Cost of sales (100) (160)Gross profit 150 120Admin expenses (40) (30)Distribution costs (30) (20)Profit from operations 80 70Investment income 10 -Profit before tax 90 70Income tax expense (30) (20)Profit for the year 60 50

Pip acquired 80% of Posy on 1 July 20X5 when Posy’s PPE had a fair value of $2m more than their carrying value. The PPE had a remaining useful life of 5 years at the acquisition date. Depreciation is charged to cost of sales.

Following the acquisition Posy sold $10m goods to Pip at a mark-up of 25% on cost, half of these goods are in inventory at the year end.

Posy paid a dividend of $10m during the year.

The group revenue figure to be included in the Pip group statement of profit or loss for the year to 31 December 20X5 will be:$_________

The group cost of sales figure to be included in the Pip group statement of profit or loss for the year to 31 December 20X5 will be:$_________

The group investment income figure to be included in the Pip group statement of profit or loss for the year to 31 December 20X5 will be:$_________

The non-controlling interest figure to be included in the Pip group statement of profit or loss for the year to 30 December 20X5 will be:$_________





Example 5 – TJ (Group statement of profit or loss and other comprehensive income)

Statements of profit or loss and other comprehensive income for the year ended 31 December 20X5

TJ WM$’000 $’000

Revenue 16,500 13,800Cost of sales (12,800) (9,750)Gross profit 3,700 4,050Distribution costs (500) (600)Administrative expenses (850) (780)Profit before tax 2,350 2,670Income tax expense (600) (650)Profit for the year 1,750 2,020Other comprehensive income:Gains from revaluation (net of tax) 120 200Total comprehensive income (TCI) 1,870 2,220

TJ purchased 80% of the shares in WM on 1 January 20X5. It is group policy to measure the non-controlling interest using the fair value method.

TJ sold $2m of goods to WM at a mark-up of 25% and a quarter of these remained in inventory at the year end.

During the year the goodwill on acquisition had been impaired by $0.2m. Impairments are charged in administrative expenses.

Prepare the consolidated statement of comprehensive income of the TJ group for the year ended 31 December 20X5.

IFRS 10 Consolidated Financial Statements defines control and tells us how to consolidate.

A parent/subsidiary relationship can exist even where the parent owns less than 50% of the voting power of the subsidiary since the key to the relationship is control and the power to direct the activities.

The following instances are where control is exerted:

๏ power over more than half of the voting rights by virtue of an agreement with other investors;

๏ power to govern the financial and operating policies of the entity under a statute or agreement;

๏ power to appoint or remove the majority of the members of the board of directors or equivalent governing body and control of the entity is by that board or body; or

๏ power to cast the majority of votes at meetings of the board of directors or equivalent governing body and control of the entity is by that board or body.









Chapter 13GROUP STATEMENT OF CHANGES IN EQUITY

Consolidated statement of changes in equity for the year ended [date]

Attributable to equity holders of parent

Non-controlling Interest

Total

$000 $000 $000Balance at start X X XTotal comprehensive income for the period:Parent XNon-controlling interest X XDividends:Parent (X)Non-controlling interest (X) XBalance at close X X X

Example 1 – Group statement of changes in equity

Summarised statements of changes in equity for the year ended 31 December 20X5 for Penny and its only subsidiary, Sophie, are shown below:

Penny Sophie$000 $000

Balance at 1 January 20X5 280,250 85,100Profit for the year 51,200 10,000Dividends (10,000) (4,000)Balance at 31 December 20X5 321,450 91,100

Penny acquired 70% of the issued share capital of Sophie on 1 January 20X2, when Sophie’s total equity was $48.2 million. The first dividend Sophie has paid since acquisition is the amount of $4 million shown in the summarised statement above. The profit for the period of $51.2m in Penny’s summarised statement of changes in equity above does not include its share of the dividend paid by Sophie.

It is group policy to value NCI at its proportionate share of net assets at acquisition.

Prepare a summarised consolidated statement of changes in equity for the Penny Group for the year ended 31 December 20X5.









Chapter 14ASSOCIATES

1. DefinitionIf an investor holds, directly or indirectly, between 20 per cent of the voting rights of an entity then it is normally considered an associated entity and is accounted for in accordance with IAS 28 Investment in associates.

IAS 28 states that there is a presumption that the investor has significant influence over the entity, unless it can be clearly demonstrated that this is not the case.

The key concept in the definition is ‘significant influence’. IAS 28 explains that significant influence is the power to participate in the financial and operating policy decisions of the entity but is not control over those policies.

The existence of significant influence by an investor is usually evidenced in one or more of the following ways:

๏ representation on the board of directors;

๏ participation in policy-making processes;

๏ material transactions between the investor and the entity;

๏ interchange of managerial personnel;

A shareholding of between 20% and 50% is assumed to give the investing company significant influence over its investment. This means it is treated as an associate and equity accounting is used.

Using equity accounting results in a one line entry in both the group income statement and in the group statement of financial position, an associate is NOT CONSOLIDATED as a subsidiary.





2. Statement of Financial PositionAn investment in associate is shown in the statement of financial position under non-current assets. This additional line item is calculated using equity accounting as follows:

Cost of investment XAdd: % x post acquisition reserves (W5) XLess: impairment of associate to date (X)

X

Example 1 – PUP

LR owns 40% of the equity share capital of GH. During the year to 31 December 20X3 LR purchased goods with a sales value of $500,000 from GH. One quarter of these goods remained in inventories at the year ended 31 December 20X3. GH includes a mark-up of 25% on all sales.

Which of the following accounting adjustments would LR process in the preparation of its consolidated financial statements in relation to these goods?A Dr Cost of sales $10,000 Cr Inventories $10,000B Dr Share of profit of associate $25,000 Cr Inventories $25,000C Dr Share of profit of associate $10,000 Cr Inventories $10,000D Dr Investment in associate $25,000 Cr Cost of sales $25,000

3. Statement of Profit or Loss and Other Comprehensive Income

The share of the associates profit for the year is shown immediately before profit before tax and is calculated as:

๏ Share of profit of associate = group % x A’s profit for the year

๏ The share of the associates other comprehensive income is shown on one line in other comprehensive income of the group and is calculated as:

Share of other comprehensive income of associate = % x A’s other comprehensive income

4. AdjustmentsProvision for unrealised profits (PUP)

If there has been trading between the group and the associate, then any profit on inventory sold between the parties that is still held at the reporting date will need to be removed, however we adjust for the group share only.

If the parent sells to the associate:

Dr Group retained earnings/Cost of sales

Cr Investment in associate (reduce goods to cost to the group)

If the associate sells to the parent:

Dr Group retained earnings/Share of profit of associate

Cr Group inventory (reduce goods to cost to the group)





Example 2 – Equity accounting (SFP)

Statements of financial position at 31 December 20X5 are as follows:

Rey$m

Finn$m

Assets:Non-current assetsProperty, plant and equipment 1,560 1,250Investments 1,540

3,100 1,250Current assets:Inventory 450 580Receivables 380 390Cash 190 230

1,020 1,200Total assets 4,120 2,450

Equity and liabilities:Share capital 1,700 1,000Retained earning 1,450 800Total equity 3,150 1,800

Non-current liabilities 520 350

Current liabilitiesTrade payable 450 300

Total liabilities 970 650Total equity and liabilities 4,120 2,450

The following information is relevant to the preparation of the group financial statements:

1. On 1 January 20X4, Rey acquired 70% of the equity interest of Finn for a cash consideration of $1,340 million. At 1 January 20X4, the identifiable net assets of Finn had a fair value of $1,850 million, and retained earnings were $450 million. The excess in fair value is due to an item of property, plant and equipment that has a remaining useful life of 10 years.

2. It is the group policy to measure the non-controlling interest at acquisition at is proportionate share of the fair value of the subsidiary’s net assets.

3. On 1 July 20X5, Rey acquired 25% of the equity interest of Ben for a cash consideration of $200 million. Ben’s profits for the year were $80 million, out of which a dividend of $20 million was declared on 31 December 2015. The 25% holding gives Rey the power to participate in the operating and financing decisions of Ben.

Prepare the group consolidated statement of financial position of Rey as at 31 December 20X5.





Example 3 – Equity accounting (SPLOCI)

Statements of profit or loss and other comprehensive income for the year ended 31 December 20X5 are as follows:

Vader Maul$m $m

Revenue 1,645 1,280Cost of sales (1,205) (990)Gross profit 440 290Distribution costs (100) (70)Administrative expenses (90) (50)Profit before interest and tax 250 170Finance costs (55) (30)Profit before tax 195 140Taxation (35) (30)Profit for the year 160 110Revaluation gain 100 50Total comprehensive income 260 160

The following information is relevant in the preparation of the group financial statements:

1. On 1 July 20X5, Vader acquired 80% of the equity shares of Maul.

2. On 1 May 20X5 Vader acquired 25% of the equity shares of Sith and exerted significant influence through its representation on the board of directors. Sith’s profits for the year were $240 million.

3. During the year Vader also sold goods to Maul to the value of $80m at a mark-up of 25%. Maul had sold half of this inventory by the year end.

4. It is the group policy to measure the non-controlling interest at acquisition at fair value.

5. Goodwill has been impairment tested at year-end and found to have fallen in value by $5 million in Maul and $2 million in Sith. Goodwill impairments are recorded in administrative expenses.

6. Maul revalued its land and buildings at the year-end and recorded a revaluation surplus of $50 million through other comprehensive income.

7. No dividends were declared by any company during the year.

8. Assume that profits accrue evenly during the year.

Prepare a consolidated statement of profit or loss and other comprehensive income for the Vader group for the year-ended 31 December 20X5





Chapter 15FOREIGN SUBSIDIARIES

1. Group accountsIf a group has a subsidiary company that is located overseas, that subsidiary will have a different functional currency to the rest of the group. Before consolidation of the subsidiary its results will need to be correctly stated in its functional currency. Once this has been done the results can then be translated into the presentational currency of the group and consolidated.

Group SFP๏ Translate all the assets and liabilities of the subsidiary @ closing rate (CR)

๏ Net assets working in overseas currency

๏ Goodwill working in overseas currency and translate at the closing rate

๏ Non-controlling interest in overseas currency and translate at the closing rate

๏ Group retained earnings in presentational currency, translate S’s post acquisition profits at closing rate and calculate the gain/loss on translation of P’s investment in the overseas subsidiary.

Group P/L and OCI

Translate all the income and expenses of the subsidiary @ average rate (AR)

Example 1 – Overseas consolidation

Statements of profit or loss for the year-ended 31 December 20X5

Holly$m

IvyDinars m

Revenue 247 1,664Cost of sales (181) (1,288)Gross profit 66 376Expenses (29) (156)Profit before interest and tax 37 220Finance costs (8) (40)Profit before tax 31 180Taxation (5) (36)Profit for the year 26 144





Statements of financial position at 31 December 20X5

Holly$m

IvyDinars m

Non-current assets 200 500Investment in Ivy 200 -Current assets 90 390

Total assets 490 890

Share capital 250 350Retained earning 110 280Non-current liabilities 80 65Current liabilities 50 195

Total equity and liabilities 490 890

The following information is relevant to the preparation of the consolidated financial statements of Holly.

1. On 1 January 2015, Holly acquired 80% of the equity share capital of Ivy for a consideration of 760 million Dinars when the retained earnings were Dinars 150 million and the fair value of the net assets at that date were Dinars 600 million. Any difference between the fair value of the net assets and their book value is due to non-depreciable land.

2. The non-controlling interest is valued using the proportionate share on net assets method.

3. The following exchange rates are relevant to the preparation of the financial statements:

Dinars to $1 January 2015 3.831 December 2015 4.3Average rate for the year to 31 December 2015 4.0

The goodwill figure to be included in the Holly group statement of financial position for the year to 31 December 20X5 will be:$_________

The non-controlling interest figure to be included in the Holly group statement of financial position for the year to 31 December 20X5 will be:$_________

The group retained earnings figure to be included in the Holly group statement of financial position for the year to 31 December 20X5 will be:$_________

The property, plant and equipment figure to be included in the Holly group statement of financial position for the year to 31 December 20X5 will be:$_________





The inventory figure to be included in the Holly group statement of financial position for the year to 31 December 20X5 will be:$_________

Exchange gains and losses on consolidation of the overseas subsidiary

$Opening net assets@ OR X@ CR X

X

Profit for the year@ AR X@ CR X

XGoodwill@ OR X@ CR X

XX

Example 2 – Gain or loss on translation of the overseas subsidiary

Continuing from the previous example, calculate the gain or loss on translation of the overseas subsidiary.









Chapter 16GROUP STATEMENT OF CASH FLOWS

Consolidated statement of cash flows for the year ended [date]

$m $mOperating Activities Group Profit Before Tax X Depreciation X *Impairment X Gain/Loss on Disposal of Tangibles (X)/X *Gain/Loss on Sale of Subsidiary (X)/X *Share of Associates Profit (X) Finance costs X

Inventory (X)/X Receivables (X)/X Payables X/(X)

Cash generated from operations X Interest Paid (X) Tax Paid (X)

Cash generated from operating activities XInvesting Activities Sale Proceeds from Tangibles X Purchase of Tangibles (X) *Dividend Received from Associate X *Acquisition/Disposal of Sub (X)/X Dividends Received X

Cash generated from investing activities XFinancing Activities Proceeds from Share Issue X Loan Issue/Repayment X/(X) *Dividend paid to NCI (X) Dividend paid to parent shareholders (X)

Cash generated from financing activities XChange in cash and cash equivalents X/(X)Opening cash and cash equivalents X

Closing cash and cash equivalents X

* items relate specifically to group statement of cash flows.





1. Dividend paid to the non-controlling interest

Non-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestB/f X

Dividend paid (β) X Profit X

Disposal of sub. X Acquisition of sub. X

C/f X

X X

Example 1 - Dividend paid to non-controlling interest

Group statement of profit or loss for the year-ended 31 December 2015 (extract)

$mProfit before tax 91Taxation (31)Profit for the year 60

Attributable to:Ordinary shareholders of the parent 54Non-controlling interest 6

Group statement of financial position as at 31 December 2015 (extract)

2015$m

2014$m

EquityNon-controlling interests 115 110

Calculate the dividend paid to the non-controlling interests to appear in the group statement of cash flows for the year-ended 31 December 2015.





2. Dividend received from associate

AssociateAssociateAssociateAssociateAssociateAssociateAssociateAssociateB/f X

Profit X Dividend paid (β) X

C/f X

X X

Example 2 – Dividend received from associate

Group statement of profit or loss for the year-ended 31 December 2015 (extract)

$mOperating profit 83Finance costs (12)Share of profit of associate 20Profit before tax 91Taxation (31)Profit for the year 60

Attributable to:Ordinary shareholders of the parent 54Non-controlling interest 6

Group statement of financial position as at 31 December 2015 (extract)

2015$m

2014$m

AssetsNon-current assetsInvestment in associate 190 180

Calculate the dividend received from associate to appear in the group statement of cash flows for the year-ended 31 December 2015.





3. Acquisition/disposal of subsidiaryThe acquisition or disposal of a subsidiary during the year is shown as a net cash outflow or inflow within investing activities to show the net cash paid to acquire the subsidiary or net cash received on disposal of a subsidiary.

An indirect adjustment is also required to adjust for any other balances (e.g. PPE, inventory, receivables, and payables) consolidated as part of the acquisition or disposed of as part of the disposal.

Working capital movement

Inventory Receivables PayablesOpening X X XAcquisition/(disposal) X/(X) X/(X) X/(X)Expected X X XClosing (actual) X X XMovement ↑or ↓ ↑or ↓ ↑ or ↓

Example 3 – Acquisition of a subsidiary

Pablo Group statement of financial position as at 31 December 2015 (extract)

2015$m

2014$m

Non-current assetsProperty, plant and equipment 520 490Current assetsInventory 145 195Receivables 130 109Cash and cash equivalents 50 75

Current liabilitiesTrade payables 85 70

The following information relates to the financial statements of the Pablo Group:

On 1 June 2015, Pablo acquired all of the share capital of Juan for $50 million. The fair value of the identifiable net assets and liabilities at the date of acquisition that have been reflected in the year-end balances of the Pablo Group are as follows:

$mProperty, plant and equipment 15Inventory 8Receivables 6Cash and cash equivalents 5Payables (3)

Show how the above would be dealt with in the consolidated statement of cash flows for the year-ended 31 December 2015.





Example 4 – Group statement of cash flows

The following draft group financial statements relate to Dove, a public limited company.

Dove Group statement of financial position as at 31 December 20X5

20X5$m

20X4$m

Assets:Non-current assetsProperty, plant and equipment 1,745 1,250Goodwill 1,184 1,230Investment in associate 200 190

3,129 2,670Current assets:Inventory 530 580Receivables 456 390Cash and cash equivalents 190 230

1,176 1,200Total assets 4,305 3,870

Equity and liabilities:Share capital 1,700 1,500Retained earning 1,060 900

2,760 2,400Non-controlling interest 575 540

3,335 2,940

Non-current liabilitiesLong-term borrowings 300 200Deferred tax 220 190

Current liabilitiesTrade payable 300 430Current tax payable 150 110

450 540Total liabilities 970 930Total equity and liabilities 4,305 3,870





Dove group statement of profit or loss for the year-ended 31 December 20X5

$mRevenue 1,765Cost of sales (1,185)Gross profit 580Distribution costs (100)Administrative expenses (90)Profit before interest and tax 390Finance costs (55)Share of profit of associate 40Profit before tax 375Taxation (95)Profit for the year 280

Dove group statement of changes in equity for the year-ended 31 December 20X5

Equity shares

Retained earnings

Non-controlling

interest

Total

$m $m $m $mB/f 1,500 900 2,400 540 2,940Issue of share capital 200 200 200Dividends (65) (65) (20) (85)Total comprehensive income for the year 225 225 55 280

Transfer to retained earnings C/f 1,700 1,060 2,760 575 3,335

The following information relates to the financial statements of the Emilio Group:

1. On 1 June 20X5, Emilio acquired all of the share capital of Fred for $50 million. The fair value of the identifiable net assets and liabilities at the date of acquisition that have been reflected in the year-end balances of the Pablo Group are as follows:

$mProperty, plant and equipment 13Inventory 20Receivables 15Cash and cash equivalents 3Payables (9)

42

2. Dove owns 20% of an associate. The associate made a profit for the year of $200 million and paid a dividend of $150 million.

3. During the year Dove charged depreciation of $130 million on its property, plant and equipment. It sold property, plant and equipment with a carrying value of $43million for $50 million

Prepare the consolidated statement of cash flows for the year ended 31 December 20X5.





Chapter 17IAS 24 RELATED PARTIES

1. IntroductionRelated party relationships are a normal part of everyday business. Often groups of companies are formed based on their trading relationship.

This relationship can have a direct impact on the financial performance of an individual company. This is mainly due to the special terms and arrangements that could arise between related parties e.g. an entity sells its products to a subsidiary in the same group at a smaller mark-up than it would to an entity that wasn’t a related party. Obviously this would have a direct impact on profit margins.

When it comes to balances outstanding the same could be true e.g. an entity allows an extended credit period to its related parties so distorting is debt collection figures.

If the users of the financial statements are aware of these relationships, transactions and balances then they can take them into account when assessing the performance and position of the entity.

2. DefinitionsRelated party – A party is related to an entity if the party either:

๏ controls, is controlled by, or is under common control with, the entity

๏ has an interest in the entity that gives a significant influence over the entity

๏ has joint control over the entity

๏ is an associate (IAS 28 Investment in Associates)

๏ is a joint venture in which the entity is a venturer (IAS 31 Interests in joint ventures)

๏ is a member of the key management personnel of the entity or its parent

๏ is a close family member of any of the above

๏ is a post-employment benefit plan for the employees of the entity or of any entity that is a related party of the entity

Related party transaction – The transfer of resources, services or obligations between related parties, regardless of whether a price is charged.

Control – Is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

Joint control – Is the contractually agreed sharing of control over an economic activity.

Key management personnel – Those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director of that entity.

Significant influence – The power to participate in the financial and operating policy decisions of an entity but is not control over those policies. Significant influence may be gained by share ownership, statute or agreement.





Example 1 – CXZ (March 2012)

Which one of the following would be regarded as a related party of CXZ?A The wife of CXZ’s finance director

B CXZ’s main supplier, supplying approximately 35% of CXZ’s purchasesC CXZ’s biggest customer, providing 60% of CZ’s annual revenueD CXZ’s banker, providing CXZ with and overdraft facility and a short-term loan at market rates

3. DisclosuresRelationships between parents and subsidiaries shall be disclosed irrespective of whether there have been transactions between those related parties.

๏ Name of entity’s parent and;

๏ If different the ultimate controlling party

Disclosure of key management personnel compensation

Key management personnel compensation in total and for each of the following;

๏ Short-term employee benefits

๏ Post-employment benefits

๏ Other long term benefits

๏ Share based payments





Disclosure of transactions and balances generally

If there have been transactions between related parties, an entity should disclose the nature of the related party relationships as well as information about the types of transactions and the outstanding balances necessary for an understanding of the financial statements

Disclosure should be made irrespective of whether a price is charged.

At a minimum the disclosure should include:

๏ The amount of the transactions

๏ The amount of outstanding balances, including terms and conditions, whether they are secured and the nature of the consideration to be provided

๏ Provisions for doubtful debts based on the amount outstanding

๏ The expense recognised during the period in relation to bad and doubtful debts

The above should be made separately for each of the following

๏ The parent

๏ Entities with joint control or significant influence over the entity

๏ Subsidiaries

๏ Associates

๏ Joint ventures in which the entity is a venture

๏ Key management personnel

๏ Other related parties









Chapter 18IAS 33 EARNINGS PER SHARE

Earnings per share (EPS) is an important ratio as it is one of the component parts of the Price/Earnings ratio (P/E ratio). The P/E ratio is used by investors to help them identify the relative riskiness of investments and the potential future performance of a business. This then allows an investor to see if investments are over-valued or under-valued by the stock market.

EPS is also considered important by investors, analysts and others as a key measurement of performance and as a basis for making decisions. It is principally for these reasons that some accounting standard setters, amongst them the IASB, have produced accounting standards regulating its calculation.

1. Basic earnings per share

Basic EPS =profit attributable to the ordinary shareholder’s of the parent

Basic EPS =weighted average number of ordinary shares in issue during the year

Profit attributable to owners of the parent = (less irredeemable preference dividends).

The earnings per share figure is disclosed at the bottom of the statement of profit or loss.

1.1. Changes to Share Capital

Issue at Full Market Price

The cash received from the shareholder/investor has an impact on earnings and consequently a weighted average calculation needs to be done for the number of shares in issue during the year.

Bonus Issue

There is no cash received from the bonues issue so there is no impact on earnings and therefore no weighted average calculation needs to be done.

Comparatives will need restating.

Rights Issue

The cash received from the shareholder/investor has an impact on earnings and so a weighted average calculation needs to be done for the number of shares in issue during the year.

However as the shares are issued at below their market value there is a “free element” to the shares issued, so an adjustment will need to be made using a rights issue fraction.

Comparatives will need restating.





Example 1 – Basic EPS

Ruth makes up its accounts to 31 June each year. On 1 July 20X5 Ruth has 500 million ordinary shares in issue.

Profits for the year to 31 June 20X6 were $250m. There were no preference shares in issue.

Calculate the basic earnings per share assuming:1. Share capital has not changed during the year

2. An issue of 50 million new shares at full market price on 1 August 20X5.

3. A 1 for 4 bonus issue occurring on 1 November 20X5.

4. A 1 for 5 rights issue on 1 February 20X6 held at $1.25. The price of a share immediately before the rights issue was $1.40.

2. Diluted Earnings per ShareThis figure takes into account potential future changes to ordinary share capital that may occur as a result of commitments that exist at the year end.

Diluted EPS =profit attributable to owners of the parent

Diluted EPS =weighted average number of ordinary shares in issue during the year

IAS 33 requires both the basic and the fully diluted earnings per share figure to be disclosed in the financial statements, but only if the fully diluted figure is lower.

Future dilutions can occur if a company has issued convertible debt or share options.

Example 2 – Diluted EPS

Flanagan makes up his accounts to 31 December each year and has calculated the basic EPS based on actual shares of 1,000 million and earnings of $500m, for the year ended 31 Dec 20X5.

Convertible debentres

On 31 December 20X6 Flanagan had in issue of $10m of 5% convertible loan stock. The loan stock is convertible at the following dates with the following terms:

31 Dec 20X6 125 shares for every $100 of loan stock

31 Dec 20X7 120 shares for every $100 of loan stock

The tax rate is 20%

Share options

Flanagan also granted 100m options at the same date. The option price is $2.50 but the average fair value of a share is $4.00.

Calculate the fully diluted EPS for the year to 31 December 20X5.





3. Limitation of Earnings per Share๏ Historic - transactions and events those that have already taken place so is of limited use for

predictive purposes although it is used as an indicator of future performance.

๏ Share price - EPS is soon out of date whereas the P/E ratio calculation uses an up to date share price figure. If the price has been affected significantly by events after the statement of financial position date, the mixing of a current price with an old earnings figure may be meaningless.

๏ Post-tax earnings – earnings are calculated after tax figures and if entities are subject to significantly differing rates of tax because they are based in different countries, the comparison is unrealistic.

๏ Accounting standards - choice of accounting treatments. It is quite likely, therefore, that entities being compared with each other use different policies and/or bases for preparation of the financial statements. Where such policies and bases impact upon the profit figure, as will usually be the case, EPS figures are not strictly comparable.

๏ Accounting standards - The problem of comparability is made worse where the entities being compared are subject to different sets of accounting standards.









D: INTEGRATED REPORTING

Chapter 19INTEGRATED REPORTING <IR>

The International Integrated Reporting Council has issued a Framework that gives the principles and concepts that govern the content of an integrated report. It aims to communicate how an entity will create value over time and identify the key drivers of its value. To do this requires relevant financial and non-financial information.

1. Limitations of financial statements

Financial statements focus on the past financial performance of an entity and have not focused on non-financial objectives. It has become more important in the modern financial world to evaluate not just financial objectives but also the non-financial objectives within an entity.

๏ Human – Entity work force and retention of key staff, leads to better financial performance and there is less disruption in the workforce and a high degree of trust is built up between employees.

๏ Intellectual – Technology businesses generate ideas that are the intellectual property of that entity and therefore add value to the business. Although they may meet the generic definition of an intangible asset they cannot be recognised in the financial statements

๏ Natural – Businesses need to be more environmentally aware of the impact of their business practices on the environment. Financial statements have not shown this impact and need to evolve to ensure coverage is given to key environmental issues.

๏ Social and relationship – Better relationships between business and society can promote a better financial performance.

Example 1 – Non-financial objectives

Which of the following are examples of non-financial objectives?Select ALL that apply.

(a) A reduction in staff turnover of 10%(b) A growth in earnings per share of 4%(c) A reduction in the company’s carbon footprint by 25% over the next 5 years(d) An increase in share price of 5%(e) An increase in company charitable donations of 10%(f) A reduction in the number of staff sick days to below national average





2. Fundamental Concepts

‘An integrated report aims to provide insight about the resources and relationships used and affected by an organisation – these are collectively referred to as “the capitals”

The capitals are stocks of value that are increased, decreased or transformed through the activities and outputs of the organisation. They are categorised in this Framework as:

๏ Financial

๏ Manufactured

๏ Intellectual

๏ Human

๏ Natural

๏ Social and relationship

3. Guiding Principles

A key factor in the development of the framework is that previous attempts to highlight non-financial factors, notably the management commentary and the Operating and Financial Review (OFR), became too cluttered and focussed on the positives and not the negatives. The <IR> framework has therefore recommended Guiding Principles to aid the content of the report and how it is presented.

The Guiding Principles that underpin the preparation and presentation of an integrated report are:

๏ Strategic focus and orientation

๏ Connectivity and information

๏ Stakeholder relationships

๏ Materiality

๏ Conciseness

๏ Reliability and completeness

๏ Consistency and comparability

4. Content Elements

The key components of an integrated report are as follows:

๏ Organisational overview and the external environment under which it operates.

๏ Governance structure and how this supports its ability to create value.

๏ Business model.

๏ Risks and opportunities and how they are dealing with them and how they affect the company's ability to create value.

๏ Strategy and resource allocation.

๏ Performance and achievement of strategic objectives for the period and outcomes.

๏ Outlook and challenges facing the company and their implications.

๏ Basis of preparation and presentation





5. International Integrated Reporting Council

Until recently companies were free to report these objectives how they wished and there was limited guidance available to help them do so.

Given the importance of these non-financial objectives, particularly the social and environmental issues, guidance has now been developed via the two following frameworks:

via the Integrated Reporting <IR> Framework, developed by the International Integrated Reporting Council

6. International Integrated Reporting Council (IIRC)The International Integrated Reporting Council’s Framework outlines the principles and concepts that govern the content of an Integrated Report <IR>. It aims to communicate how an entity will create value over time and identify the key drivers of its value and its primary objective is:

‘To provide insight about the resources and relationships used and affected by an organization – these are collectively referred to as “the capitals”

The capitals are stocks of value that are increased, decreased or transformed through the activities and outputs of the organization. They are categorised by the Framework as:

๏ Financial

๏ Manufactured

๏ Intellectual

๏ Human

๏ Natural


6.1. The Framework

The purpose of this Framework is to establish Guiding Principles and Content Elements that govern the overall content of an integrated report, and to explain the fundamental concepts that underpin them.

Guiding Principles

A key factor in the development of the framework is that previous attempts to highlight non-financial factors, notably the management commentary and the Operating and Financial Review (OFR), became too cluttered and focussed on the positives and not the negatives. The <IR> framework has therefore recommended Guiding Principles to aid the content of the report and how it is presented.

The Guiding Principles that underpin the preparation and presentation of an integrated report are:

๏ Strategic focus and orientation

๏ Connectivity and information

๏ Stakeholder relationships

๏ Materiality

๏ Conciseness


๏ Consistency and comparability





Content Elements

The key components of an integrated report are as follows:

๏ Organisational overview and the external environment under which it operates.

๏ Governance structure and how this supports its ability to create value.

๏ Business model.

๏ Risks and opportunities and how they are dealing with them and how they affect the company's ability to create value.

๏ Strategy and resource allocation.

๏ Performance and achievement of strategic objectives for the period and outcomes.

๏ Outlook and challenges facing the company and their implications.

๏ Basis of preparation and presentation

Example 2 – The Capitals

The IIRC’s IR Framework defines the resources and relationships of an entity as the capitals.

Which of the following are defined by the IIRC’s IR Framework as capitals?Select ALL that apply๏ Materiality

๏ Human

๏ Sustainable

๏ Conciseness

๏ Intellectual

Example 3 – The Guiding Principles

The IIRC’s IR Framework establishes both guiding principles and content elements.

Which of the following are defined by the IIRC’s IR Framework as guiding principles?Select ALL that apply๏ Manufactured

๏ Materiality


๏ Conciseness


๏ Business model





E: ANALYSING FINANCIAL STATEMENTS

Chapter 20ACCOUNTING RATIOS

1. Profitability

Gross margin (%)Gross profit

x 100%Gross margin (%)Revenue

x 100%

Operating profit margin (%)Operating profit

x 100%Operating profit margin (%)Revenue

x 100%

Net margin (%)Profit for the year

x 100%Net margin (%)Revenue

x 100%

Asset turnover (# times)Revenue

Asset turnover (# times)Capital employed*

Return on capital employed (%)PBIT

x 100%Return on capital employed (%)Capital employed*

x 100%

* Capital employed = shareholders’ funds + interest bearing debt.





2. Liquidity

Current ratio (X:1)Current assets

Current ratio (X:1)Current liabilities

Quick ratio (X:1)Current assets (excl. inventory)

Quick ratio (X:1)Current liabilities

3. Efficiency (Working capital)

Inventory holding periodInventory

x 365 daysInventory holding periodCost of sales

x 365 days

Receivables collection periodTrade receivables

x 365 daysReceivables collection periodCredit sales1

x 365 days

1 Total sales may be used instead.

Payables payment periodTrade payables

x 365 daysPayables payment periodCredit purchases2

x 365 days

2 Total purchases or cost of sales may be used instead.





Example 1 – Past exam question – May’13

SAF has experienced a period of rapid expansion in the last 6 months following the launch of a new product on 1 July 20X2. The following information is available from the management accounts of SAF:

6 months to 31 December 20X2

6 months to 30 June 20X2

$000 $000Inventories at period end 1,220 460Receivables at period end 1,715 790Cash and cash equivalents at period end - 150Trade payables at period end 1,190 580Short-term borrowing at period end 250 -Revenue for the period 3,100 2,000Cost of sales for the period 2,420 1,450

Analyse the financial performance and working capital position of SAF, including the calculation of five relevant ratios.

4. Solvency/Gearing/Risk

Gearing ratio =Debt

x 100%Gearing ratio =Capital employed

x 100%

Or,

Gearing ratio =Debt

x 100%Gearing ratio = Equity (shareholders’ funds) x 100%

If questions do not specify, either one of these may be used.

Interest cover (# times)PBIT

Interest cover (# times) Interest payable





5. Investor Ratios

Dividend Cover =Profit for the year

(# times)Dividend Cover = Dividends (# times)

Dividend Yield =Dividends

(%)Dividend Yield = Share price (%)

Price/earnings ratio =Price per share

Price/earnings ratio = Earnings per share

Note: EPS can also be calculated but that is dealt with in a previous chapter because it is a ratio with its own accounting standard.

Example 2 – Investor ratios

Morgan Co is a listed company and has 50c equity share capital of $20m in issue.

The company paid a dividend per share of 10.5c in its most recent financial year and the share price at the reporting date was $1.20. The additional financial information is also available to investors:

Statement of profit and loss Statement of profit and loss 2019

$’000sProfit before tax 28,350Income tax expense (4,600)Profit for the year 22,680

Calculate each of the following investor ratios for Morgan Co:Dividend cover

Dividend yield

P/E ratio

EPS





6. Evaluation of ratios

Example 3 – DFG (March’11)

A friend has approached you looking for some advice. He has been offered the position of Sales Director within an entity, DFG, which supplies the building trade. He commented that he had reviewed the information on DFG’s website and there were lots of positive messages about the entity’s future, including how it had secured a new supplier relationship in 2010 resulting in a significant improvement in margins.

He has been offered a lucrative remuneration package to implement a new aggressive sales strategy, but has been with his current employer for six years and wants to ensure his future would be secure. He has provided you with the finalised financial statements for DFG for the year ended 31 December 2010, with comparatives.

The financial statements for DFG are provided below:

Statement of comprehensive income for the year ended 31 December

2010 2009$m $m

Revenue 252 248Cost of sales (203) (223)Gross profit 49 25Distribution costs (18) (13)Administrative expenses (16) (11)Share of profit of associate 7 -Finance Cost (12) (8)Profit before tax 10 (7)Tax (3) 2Profit for the year 7 (5)Other comprehensive income:Revaluation gain on PPE 40 -Total comprehensive income 47 (5)





Statement of financial position at 31 December

2010 2009$m $m

Non-current assets Tangibles 254 198 Investment in associate 24 -

Current assets Inventory 106 89 Receivables 72 48 Cash/Bank - 6

456 341

Share capital 45 45Retained earnings 146 139Revaluation reserve 40 -Non-current liabilities 91 91Current liabilities 134 66

456 341


1. Long term borrowings

The long term borrowings are repayable in 2012.

2. Contingent liability

The notes to the financial statements include details of a contingent liability of $30 million. A major customer, a house builder, is suing DFG, claiming that it supplied faulty goods. The customer had to rectify some of its building work when investigations discovered that a building material, which had recently been supplied by DFG, was found to contain a hazardous substance. The initial assessment from the lawyer is that DFG is likely to lose the case although the amount of potential damages could not be measured with sufficient reliability at the year-end date.

3. Revaluation

DFG decided on a change of accounting policy in the year and now includes its land and buildings at their revalued amount. The valuation was performed by an employee of DFG who is a qualified valuer.

4. Current liabilities

2010 2009$m $m

Trade and other payables 95 66Short term borrowings 39 -

134 66





Analyse the financial performance of DFG for the year to 31 December 2010 and its financial position at that date AND briefly discuss DFG’s suitability as a secure employer for your friend (8 marks are available for the calculation of relevant ratios).

5. Limitations of ratio analysis๏ Historic – financial information has only very limited relevance when applied to future

decisions.

๏ Detail – Lack of detailed information - no breakdown of costs.

๏ Non-financial performance – largely ignored.

๏ Accounting figures – may be subject to manipulation by using creative accounting techniques and estimation.

๏ Accounting policies – two different company’s figures may well be distorted by different accounting practices and policies.

๏ Accounting standards – comparisons may be difficult if competitor using different accounting standards (e.g. US GAAP)









ANSWERS TO EXAMPLES

A: Financing capital projects

Chapter 1FINANCIAL MARKETS

No examples

Chapter 2LONG–TERM FINANCE

Answer 1 – ABC

(a) An issue price of 350 cents would raise $30 million.

(b) An issue price of 325 cents would maximise the proceeds from the offer.

Price (cents) xNumber of bids

(cumulative)=

Proceeds($)

400 2,000,000 8,000,000

375 4,800,000 18,000,000

350 8,600,000 30,100,000

325 10,300,000 33,475,000

300 10,800,000 32,400,000

Chapter 3WEIGHTED AVERAGE COST OF CAPITAL (WACC)

Answer 1 – Banks

ke = $0.10 (1 + 0.04) + 0.04ke = $2.50 + 0.04

ke = 8.16%

Answer 2 – Cohen

ke =$0.35 (1 + 0.05)

+ 0.05ke =$4.15 - $0.35

+ 0.05

ke = 14.67%





Answer 3 – Wilson

(a) g = 42¢

25¢⎛⎝⎜

⎞⎠⎟5 −1

g = 10.93%

(b) ke =$0.42 (1 + 0.1093)

+ 0.1093(b) ke =$5.50

+ 0.1093

ke = 19.40%

Answer 4 – Stiles

ke =$0.16 (1 + 0.0986)

+ 0.0986ke =$2.36 - $0.16

+ 0.0986

ke = 17.84%

Where,

g = 16¢

10¢⎛⎝⎜

⎞⎠⎟5 −1

g = 9.86%

Answer 5 – Charlton

ke =$0.45 (1 + 0.1125)

+ 0.1125ke =$4.45 - $0.45

+ 0.1125

ke = 23.77%

Where,

g = 0.15 x (1 – 0.25)

g = 0.1125 ≡ 11.25%

Answer 6 – Moore

kp =8% x $1

kp =$1.10

kp= 6.15%

Answer 7 – Ball

kd = 8% x (1 – 0.25)

kd = 6%





Answer 8 – Bobby

kd =$10 (1 − 0.25)

kd =$120

kd = 5.45%

Answer 9 – Peters

T Narrative CFDF

(5%)PV

DF (10%)

PV

0 (MV) (95) 1 (95) 1 (95)

1 – 5 I (1 – T)10 x (1 – 0.25)= 7.5 4.329 32.5 3.791 28.4

n RV 100 0.784 78.4 0.621 62.115.9 (4.5)

kd =15.9

x (0.10 – 0.05) + 0.05kd =(15.9 – (–4.5))

x (0.10 – 0.05) + 0.05

kd = 8.90%

Answer 10 – Hunt

T Narrative CFDF

(10%)PV

DF (12%)

PV

0 (MV) (110) 1 (110) 1 (110)

1 – 4 I (1 – T)= 8 x (1 – 0.25) 6 3.170 19.0 3.037 18.2

4 RV* 135.30 0.683 92.4 0.636 86.11.4 (5.7)

kd =1.4

x (0.12 – 0.10) + 0.10kd = (1.4 – (–5.7))

x (0.12 – 0.10) + 0.10

kd = 10.39%

RV (debt) = (1 + 0.1) x $100 = $110

*RV (shares) = $5 x 25 shares x (1 + 0.02)4 = $135.30 = HIGHER





Answer 11 – Ramsey

Financek

(%)MV

($000s)k x MV

Equity 0.177 64,000 11,328

Redeemable bonds 0.0733 5,640 413

Bank loan 0.0375 4,000 150

73,640 11,891WACC = 11,891/73,640 = 16.1%

WorkingsEquity

MVe ($000s) = (4,000/0.25) x $4.00 = $64,000

ke =$0.25 (1 + 0.1076)

+ 0.1076ke =$4.00

+ 0.1076

ke = 17.68%

Where,

g = 25¢

15¢⎛⎝⎜

⎞⎠⎟5 −1

g = 10.76%

Redeemable bonds

MVd ($000s) = (6,000/100) x $94.00 = $5,640

T Narrative CFDF

(5%)PV

DF (10%)

PV

0 (MV) (94) 1 (94) 1 (94)

1 – 7 I (1 – T) 8 x (1 – 0.25)= 6 5.786 34.7 4.868 29.2

n RV 100 0.711 71.1 0.513 51.3

11.8 (13.5)

kd =11.8

x (0.10 – 0.05) + 0.05kd =(11.8 – (–13.5))

x (0.10 – 0.05) + 0.05

kd = 7.33%

Bank loan

kd = 5% x (1 – 0.25) = 3.75%





B: Financial reporting standards

Chapter 4REVENUE (IFRS 15)

Answer 1 – Transaction price

The three-year interest-free credit period suggests that the $10,000 selling price includes a significant financing component.

The selling price is therefore discounted to present value based on a discount rate that reflects the credit characteristics of the party (customer) receiving the financing i.e. 5%.

Therefore the transaction price is $10,000/(1.05)3 = $10,000 x 0.8638 = $8,638.

Answer 2 – Allocation of price

The performance obligations and allocation of total price are as follows:

Provision of home cinema system (9,000/11,000 × $10,000) = $8,182

Provision of maintenance contract (2,000/11,000 × $10,000) = $1,818

Answer 3 – IFRS 15 (1)

Identify the contract

๏ Signed agreement

Identify the separate performance obligations

๏ Sale of handset

๏ Provision of calls and data service

Determine the transaction price

๏ $540 = $45 x 12 months

Allocate transaction price to performance obligations

๏ Standalone prices (using Vodaphone)

๏ $720 (= $480 + (12 months x $20)

๏ Handset = 480/720 x 540 = $360

๏ Calls and data = 240/720 x 540 = $180

Recognise revenue as each performance obligation is satisfied

๏ Handset (goods) = at

๏ Calls and data (services) = over 12 months





Answer 4 – IFRS 15 (2)

Identify the contract

๏ Signed agreement

Identify the separate performance obligations

๏ Supply and installation service

๏ Technical support

Determine the transaction price

๏ Combined contract price = $1,600

Allocate transaction price to performance obligations

๏ Standalone price(supply and installation) = $1,500

๏ Standalone price (technical support) = $500

๏ Supply and installation = 1,500/2,000 x 1,600 = $1,200

๏ Technical support = 500/2,000 x 540 = $400

Recognise revenue as each performance obligation is satisfied

๏ Supply and installation = on installation (1 July 20X7)

๏ Technical support = over two years (1 July 20X7 to 30 June 20X9)

SFP (extract) SPL (extract)$ $

Non-current liabilities Revenue 1,300Deferred income 100 = 1,200 + (6/24 x 400)

Current liabilitiesDeferred income 200

= 12/24 x 400

Answer 5 – Performance obligations over time and the statement of profit or loss (1)

$mRevenue (= work certified in year) 15.0Cost (β) (9.2)Profit (9.1 (W) – 3.3) 5.8

Workings$m

Total revenue 45.0Total costs (20.0 + 12.0) (32.0)Profit 13.0

@ 70% 9.1





Answer 6 – Performance obligations over time and the statement of profit or loss (2)

$mRevenue (45% x 40) 18.0Cost (β) (23.0)Loss (100%) (5.0)

Workings$m

Total revenue 40.0Total costs (25.0 + 20.0) (45.0)Loss (5.0)

Answer 7 – Performance obligations over time and the statement of financial positionStatement of profit or loss (extract)

$000Revenue (40% x 140,000) 56,000Cost (β) (43,200)Profit 12,800Statement of financial position (extract)

Current assets$

Costs incurred to date 52,000Recognised profits 12,800Recognised losses (-)Progress billings to date (45,000)Gross amount due from/(to) customers 19,800

Receivables (45,000 – 26,500) 18,500

Workings$000s

Total revenue 140,000

Total costs (60,000 + 48,000)) (108,000)

Profit 32,000

@ 40% 12,800





Chapter 5LEASES (IFRS 16)

Answer 1 - Lessor accounting

Income of $1,500 would be recognised through profit or loss for each of the four year lease. At the end of year one, accrued income of $1,500 would be recognised on the statement of financial position of which $500 would be released over the remaining three years of the lease.

Answer 2 – Lessor accounting

Unguaranteed residual value = $2,000 - $1,600 = $400

Gross investment in the lease = ($5,000 x 5 years) + $400 = $25,400

Net investment in the lease = $23,484 (W)

Year DF 4% PV0 5,000 1 5,000

1 5,000 0.962 4,810

2 5,000 0.925 4,625

3 5,000 0.889 4,445

4 5,000 0.855 4,275

5 400 0.822 329

23,484

Chapter 6PROVISIONS (IAS 37)

Answer to example 1 – Discounting and provisions

The provision is initially recognised at its present value on 1 July 2018 of $450,000 (= $495,000 x 0.9091 (rounded to nearest $000)).

The provision is then unwound at 10% for six months to calculate the finance cost of $22,500 ($450,000 x 10% x 6/12)

SFPSFPSFP SPLSPLSPL$ $

Provision 472,500 Finance cost 22,500

Answer to example 2 – Provisions and contingencies (1)

Answer A





Answer to example 3 – Provisions and contingencies (2)

If she has a 42% chance of losing, then she must have a 58% chance of winning. It is, therefore, not probable that she has an obligation. No provision would be appropriate.

However, there is a possible obligation, arising from some past event, which may involve the outflow of economic resource.

The appropriate treatment in Justina’s financial statements for the year ended 31 August, 2009 would therefore seem to be to treat the matter as a contingent liability.

This involves:

๏ a disclosure note of the past event,

๏ the legal action outstanding,

๏ an explanation of the uncertainties upon which the outcome depends, and

๏ an estimate of the costs, were she to lose the case

Answer to example 4 – Onerous contract

(a) Yes, a legal obligation under the purchase contract

(b) Give notice, and buy the cloth for 2 more months and produce

Give notice, buy the cloth, and sell immediately

Cancel the contract without notice

Cost 2 × 900 × $7 12,600 2 × 900 × $7 12,600 2 × $700 1,400Labour cost 2 ×900/3 × $4 2,400

15,000Sell 2 × 300 dresses × $22 13,200 Sell 2 × 900 × $6.25 11,250Loss (1,800

)Loss (1,350

)Loss (1,400

)

There is therefore an unavoidable loss of $1,350. This should be provided for in the Statement of Financial Position and expensed through the Statement of Profit or Loss and Other Comprehensive Income. In the Notes to the Financial Statements, there should be an explanation of the circumstances and the uncertainties concerning timings, amounts and assumptions

Answer to example 5 – Restructuring

(a) There is neither a legal nor constructive obligation, because no obligating event has yet occurred. The directors could change their minds, and decide to keep the Kaunas factory open. Therefore, no provision is appropriate.

(b) There is a detailed plan, the impact of which has been communicated to suppliers and the workforce. Paulius has therefore raised the valid expectation in the minds of those affected. Although not a legal obligation, there is a constructive obligation arising from some past event, involving the probable outflow of economic resource. A provision is therefore appropriate in the amount which represents the best estimate of the costs of closing the Kaunas factory.





Chapter 7FINANCIAL INSTRUMENTS (IAS 32 AND IFRS 9)

Answer 1 – Financial assets

1. The investment in shares is initially recognised at $500,000 on the statement of financial position as an asset.The transaction costs are recognised immediately through profit or loss as the shares are classified as fair value through profit or loss.

At the reporting date the shares are re-measured to their fair value of $350,000 on the statement of financial position.

A loss on the investment is recognised through profit or loss of $150,000.

2. The investment in shares is initially recognised at $540,000 on the statement of financial position as an asset.The transaction costs are included in the value of the asset as it is held strategically for the long-term and therefore classified as fair value through other comprehensive income.

At the reporting date the shares are re-measured to fair value of $620,000 on the statement of financial position.

The gain on the investment of $80,000 is shown through other comprehensive income.

On disposal of the shares a gain of $30,000 is recognised through profit or loss and the $80,000 held in other comprehensive income is transferred to retained earnings through the statement of changes in equity as a reserve transfer.

3. The investment in debt is classified as amortised cost as there are contractual coupon interest receipts each year and the intent is to hold the asset until all the cash has been collected.The investment in debt is initially measured at $980,000 on the statement of financial position.

The effective rate of interest is used to calculate the interest income each year. In the first year the interest income is $56,154 ($980,000 x 5.73%) and is recognised through profit or loss.

The cash receipts of $40,000 are used to reduce the value of the investment on the statement of financial position.

The investment in debt is held at $996,451 at the reporting date on the statement of financial position.

Answer 2 – Financial liabilities

SPLYear 1 Year 2 Year 3 Year 4

Finance cost 87 89 91 93

SFPYear 1 Year 2 Year 3 Year 4

2% debentures (W) 1,947 1,996 2,047 -





Working

Year B/fInterest(4.58%)

Cash C/f

1 1,900 87 (40) 1,9472 1,947 89 (40) 1,9963 1,996 91 (40) 2,0474 2,047 93 (2,140) -

Answer 3 – Convertible Debentures

Alice is required to account for the convertible debentures on initial recognition based on substance and using split equity accounting.

The liability is calculated on the assumption that there is no conversion option on the debt, so essentially treated as a 100% loan redeem for cash. The initial liability is recognised at the present value of the future cash flows, discounted at the rate of interest on similar debt without the conversion option.

This gives a figure of $94.7 million (see working below).

The difference between the liability and the net proceeds is recognised within equity at $5.3 million.

The subsequent accounting treatment of the debt is at amortised cost, whilst the equity balance is not adjusted until conversion takes place in the future.

Working

Year Cash flow($m)

DF(@

6%)

PV($m)

1 4(4% coupon x $100 million (par))

0.943 3.772

2 4 0.890 3.563 104

($4m plus $100 million (par at redemption)

0.840 87.36

94.692 =$94.7 million

Answer 4 – Derivates

The forward contract is a derivative because:

1. Its value changs as the exchange rates change

2. It has no initial cost

3. It is setteld on 31 May 2020 (future date)

The forward contract is initially measured at its fair value of nil on 1 February 2019, but it has a nil value as a contract for this amount can only be entered into at the $1 = 6 Dinar forward exchenge rate.

At the reporting date, 31 March 2019, it is remeasured to its fair value with gains/losses through profit or loss:





$With the contract have to pay(12,000,000 Dinar / 6 Dinar = $1) 2,000,000

Without the contract would have to pay(12,000,000 Dinar / 5.8 Dinar = $1) 2,068,966

Gain (cheaper with contract) 68,966

Statement of profit or loss (extract) for the year ended 31 March 2019

2019$

Gain on derivative 68,966

Statement of financial position (extract) at 31 March 2019

2019$

Derivative asset 68,966

At the reporting date, 31 March 2020, it is remeasured to its fair value with gains/losses through profit or loss:

$With the contract have to pay(12,000,000 Dinar / 6 Dinar = $1) 2,000,000

Without the contract would have to pay(12,000,000 Dinar / 5.6 Dinar = $1) 2,142,857

Gain (cheaper with contract) 142,857

Statement of profit or loss (extract) for the year ended 31 March 2020

2020$

Gain on derivative (142,857 – 68,966 73,891

Statement of financial position (extract) at 31 March 2020

2020$

Derivative asset 142,857





Chapter 8IAS 38 Intangible Assets

Answer 1 – Intangibles

The purchase of the patent should be capitalised at $15 million and amortised over its useful life.

The $6 million spent on the investigative phase is essentially research and should be expensed through profit or loss as incurred.

The $8 million subsequently spent after completion of the research phase is development expenditure and is capitalised as an intangible non-current asset on the statement of financial position.

It is not yet amortised as the project is not yet complete but an impairment review should be carried out to see if the asset has lost value.

The $1.5 million spent on marketing and training should both be expensed through profit or loss immediately.

Chapter 9IAS 12 INCOME TAXES

Answer 1 – Tracy (ignoring deferred tax)

20X5($000s)

20X6($000s)

20X7($000s)

Profit before tax 2,000 2,000 2,000Income tax expense (100) (500) (520)Profit after tax 1,900 1,500 1,480

Workings20X5

($000s)20X6

($000s)20X7

($000s)Profit before tax 2,000 2,000 2,000Add: depreciation 1,000 1,000 1,000Less: tax depreciation (2,500) (500) (400)PCTCT 500 2,500 2,600Tax @ 20% 100 500 520

$000sCost 5,000Tax allowance X5 (50%) (2,500)

2,500Tax allowance X6 (20%) (500)

2,000Tax allowance X7 (20%) (400)

1,600





Answer 2 – Tracy (incl. deferred tax)

20X5($000s)

20X6($000s)

20X7($000s)

Profit before tax 2,000 2,000 2,000Income tax expensecurrent tax (100) (500) (520)- deferred tax movement (300) 100 120Profit after tax 1,500 1,600 1,600

20X5($000s)

20X6($000s)

20X7($000s)

Carrying value 4,000 3,000 2,000Tax base 2,500 2,000 1,600

Temporary difference 1,500 1,000 400

@ 20% 300 200 80DT liab DT liab DT liab

Closing DT 300 200 80Opening DT 0 300 200Movement 300 100 120

increase decrease decrease





Chapter 10IAS 21 EFFECT OF CHANGES IN FOREIGN CURRENCY RATES

Answer 1 – Functional currency

1 December 20X5

DR Purchases $97,561

CR Payables $97,561

=400,000 Dinar

= $97,561=4.1

= $97,561

31 December 20X5

Retranslate the monetary balance (payable) at the closing rate (4.3 Dinar:$1)

=400,000 Dinar

= $93,023=4.3

= $93,023

Reduction in payables = $97,561 - $93,023 = $4,538

DR Payables $4,538

CR Profit or loss $4,538Do not retranslate the non-monetary balance (inventory), and leave it at $97,561 at the reporting date.

10 January 20X6

Translate the payment at the exchange rate on the day of the transaction

=400,000 Dinar

= $90,909=4.4

= $90,909

DR Payables $93,023

CR Bank $90,909

CR Profit or loss $2,114





Chapter 11CONSOLIDATED STATEMENT OF FINANCIAL POSITION

Answer 1 – Basic consolidation

Peter Group$000

Other assets(1,500 + 1,200) 2,700

Total assets 2,700

Equity share capital 1,000Retained earnings 1,100

2,100Liabilities(400 + 200) 600

Total equity and liabilities 2,700

Answer 2 – Basic consolidation (continued)

Peter Group$000

Other assets(1,900 + 1,450) 3,350

Total assets 3,350

Equity share capital 1,000Retained earnings(=1,400 + (100% x (900 – 750)) 1,550

2,550Liabilities(500 + 300) 800






Answer 3 – Non-controlling interest

Pierre Group$000

Other assets(1,900 + 1,450) 3,350

Total assets 3,350

Equity share capital 1,000Retained earnings(1,200 + (80% x (900 – 750)) 1,320

2,320Non-controlling interest(25% x (250 + 750)) + (25% x (900 – 750)) 230

2,550Liabilities(500 + 300) 800


Answer 4 – Goodwill

(i) Proportionate share of net assets method

$FV of consideration 156,000NCI at acquisition(25% x 170,000) 42,500

FV of net assets at acquisition (170,000)Goodwill at acquisition 28,500

(ii) Fair value method

$FV of consideration 156,000NCI at acquisition 36,000FV of net assets at acquisition (W2) (170,000)Goodwill at acquisition 22,000





Answer 5 – Workings

Matthews Group$000

Non-current assets(1,000 + 500) 1,500

Goodwill (W3) 500Current assets(800 + 600) 1,400

Total assets 3,400

Equity share capital ($1) 500Retained earnings (W5) 1,040

1,540Non-controlling interest (W4) 260

1,800Liabilities(1,100 + 500) 1,600


Workings

W1) Group Structure

Matthews

Jones

80%


At reporting date

At acquisition

Post acquisition

Equity shares 200 200Ret. earnings 400 100

600 300 300

W3) Goodwill

FV of consideration (shares/cash) 600NCI at acquisition (FV) 200

800FV of net assets at acquisition (W2) (300)Goodwill at acquisition 500






NCI @ acqn (W3) 200

Add: 20% x 300 (W2) 60

260


100% P 800

Add: 80% x 300 (W2) 240

1,040

Answer 6 – Unrealised profits

JamesGroup$’000

Non-current assets PPE(900 + 500) 1,400

Goodwill (W3) 650

Current Assets(700 + 600 – 10 (PUP)) 1,290

3,340

Share Capital 500Retained earnings (W5) 992Non-controlling interest (W4) 248

Current liabilities(1,100 + 500) 1,600

3,340





Workings

W1) Group Structure

James

Molly

80%


At reporting date

At acquisition

Post acquisition

Equity shares 200 200Ret. earnings 400 150PUP(20/120 x 120 x ½) (10)

590 350 240

W3) Goodwill

FV of consideration (shares/cash) 800NCI at acquisition (FV) 200

1,000FV of net assets at acquisition (W2) (350)Goodwill at acquisition 650


NCI @ acqn (W3) 200

Add: 20% x 240 (W2) 48

248


100% P 800

Add: 80% x 240 (W2) 192

992





Answer 7 – Share exchange

1. No. S shares acquired = 80% x 10,000,000 = 8,000,000

2. No. P shares issued = 8,000,000 x 1 / 4 = 2,000,000

3. Value of P shares issued = 2,000,000 x $3 = $6,000,000 (cost of investment)

4. Journal entry

Dr Investment $6,000,000

Cr Share capital $2,000,000

Cr Share premium (β) $4,000,000

Answer 8 – Deferred consideration

Share exchange

1. No. S shares acquired = 80% x 30,000,000 = 24,000,000

2. No. P shares issued = 24,000,000 x 2 / 3 = 16,000,000

3. Value of P shares issued = 16,000,000 x $2 = $32,000,000 (cost of investment)

Deferred consideration

PV of consideration = 24,000,000 x $1 x 0.91 = 21,840,000

Total consideration

= 32,000,000 + 21,840,000 = $53,840,000





Chapter 12GROUP STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

Answer 1 – Basic consolidation

Vader$’000

Revenue(1,645 + (6/12 x 1,280)) 2,285

Cost of sales(1,205 + (6/12 x 990)) (1,403)

Gross profit 882Distribution costs(100 + (6/12 x 70)) (135)

Administrative expenses(90 + (6/12 x 50)) (115)

Profit before interest and tax 632Finance costs(55 x (6/12 x 30)) (70)

Investment income(10 – (80% x 10)) 2

Profit before tax 564Taxation(35 + (6/12 x 28)) (49)

Profit for the year 515

Profit attributable to:Equity shareholders (β) 503.8Non-controlling interest(20% x (6/12 x 112) 11.2





Answer 2 – MYA

Edinburgh Group Statement of Profit or Loss for year ended 31 December 20X5

EdiGla

6/12Abe Adj. $m

Revenue 200 120 120 (10 + 5) 425Cost of sales (120) (80) (50) 10 + 5 (237.5) - PUP (2) - PUP (0.5)Gross profit 187.5Operating expenses (30) (15) (32) (77)Operating profit 110.5Tax (10) (5) (8) (23)Profit for the year 19.5 30 87.5

20% 25%Attributable to:Group (β) 76.1Non-controlling interest 3.9 7.5 11.4

WorkingsLeeds - no PUP as there is no unsold inventory

Manchester - 1m x25

= 0.2mManchester - 1m x125

= 0.2m

Answer 3 – Unrealised profits

P S Adj. GroupRevenue 120,000 90,000 (10,000) 200,000COS (70,000) (40,000) 10,000 (100,500)PUP

(25/125 x 10,000 x ¼)(500)

Gross profit 99,500Op exp. (20,000) (35,000)

(56,000)-Impairment (1,000)

(56,000)

Finance cost (2,000) (500) (2,500)Profit before tax 41,000Taxation (6,000) (3,000) (9,000)PFY 10,000 32,000

Parent (β)Parent (β) 30,000NCI = 20% x 10,000NCI = 20% x 10,000 2,000





Answer 4 – Pip

Revenue $380million

(250 + (280 x 6/12) – 10 (i/co sales))

Cost of sales $171.2million

(100 + (160 x 6/12) – 10 (i/co sales) + 0.2 (FV depn) + 1 (PUP))

Dividends $3million

(10 – (70% x 10)

Non-controlling interest $1.76million

(10 – 0.2 (FV depn) – 1 (PUP)) x 20%

WorkingsPUP

= $10m x 1 X 25 = $1m= $10m x 2 X 125 = $1m

FV Depn

$2m/5 x 6/12 = 0.2m

Answer 5 – TJ (Group statement of profit or loss and other comprehensive income)

Consolidated statement of profit or loss and other comprehensive income

TJ WM Adj $’000Revenue 16,500 13,800 (2,000) 28,300Cost of sales (12,800) (9,750) 500 (22,650)- PUP (100)Gross profit 5,650Distribution costs (500) (600) (1,100)Administrative expenses (850) (780) (1,830)- Impairment (200)Profit before tax 2,720Income tax expense (600) (650) (1,250)Profit for the period 2,020 1,470Other comprehensive income:Gain from revaluations 120 200 320Total comprehensive income 2,220 1,790Profit attributable to: Equity holders of the parent (β) 1,066 Non-controlling interest (20% x 2,020) 404

TCI attributable to: Equity holders of the parent (β) 1,346 Non-controlling interest (20% x 2,220) 444

WorkingsPUP Adj

2,000 x 25/125 x 25% = 100





Chapter 13GROUP STATEMENT OF CHANGES IN EQUITY

Answer 1 – Group statement of changes in equity

Penny Group consolidated statement of changes in equity for the year ended 31 December 20X5

Attributable to equity holders

of parent

Non controlling

interestTotal

$000 $000 $0001 January 20X5 (W1) 306,080 25,530 331,610Profit for the period: 58,200Parent (W2)Non-controlling interest (W3) 3,000 61,200Dividends:Parent (10,000)Non-controlling interest (4,000 x 30%) (1,200) (11,200)

31 December 20X5 (β) 354,280 27,330 381,610

Workings(W1) Opening reserves

100% P 280,250Add 80% x S’s post-acqn

(85,100 – 48,200) x 70% 25,830

Total 306,080

NCI (85,100 x 30%) 25,530Total 331,610

(W2) Group profit

100% P 51,200Add (70% x 10,000) 7,000

58,200

(W3) NCI profit10,000 x 30% 3,000

Total 61,200





Chapter 14ASSOCIATES

Answer 1 – PUP

C

Answer 2 – Equity accounting (SFP)

Rey$m

Assets:Non-current assetsProperty, plant and equipment(1,560 + 1,250 + (400 – 80) (W2)) 3,130

Goodwill (W3) 45Investment in associate (W6) 205

3,380Current assets:Inventory (450 + 580) 1,030

Receivables(380 + 390) 770

Cash(190 + 230) 420

Total assets 5,600

Equity and liabilities:Share capital 1,700Retained earnings (W5) 1,644Non-controlling interest (W4) 636Total equity 3,980

Non-current liabilities(520 + 350) 870

Current liabilitiesTrade payable (450 + 300)

750

Total liabilities 1,620Total equity and liabilities 5,600





WorkingsW1) Group Structure

P

S

>50%

A

20-50%


At reporting date At acquisition Post

acquisitionEquity shares 1,000 1,000SPRet. earnings 800 450FV – PPE 400 400Depreciation (80) -

2,120 1,850 270

W3) Goodwill

FV of consideration 1,340NCI at acquisition(30% x 1,850) 555

FV of net assets at acquisition (W2) (1,850)Goodwill at acquisition 45


NCI @ acqn (W3) 555Add: NCI% x S’s post-acqn profits (W2)(30% x 270) 81

636


100% P 1,450Add: P’s % of S’s post acqn retained earnings (70% x 1,270(W2)) 189

Add: P’s % of A’s post acqn retained earnings (W6) 10Less: Dividend (W6) (5)

1,644





W6) Investment in associate

Cost 200Add: P% x A’s post-acqn profits(25% x 80 x 6/12) 10

Less: Dividend(25% x 20) (5)

205

Answer 3 – Equity accounting (SPLOCI)

6/12P S Adj. Group

Revenue 1,645 640 (80) 2,205COS (1,205) (495) 80 (1,628)- PUP (8)Gross profit 577Dist costs (100) (35) (135)Admin exp. (90) (25) (120)- Impt (year) (5)Finance cost (55) (15) (70)Associate (25% x 200 x 8/12) - 2 38

Profit before tax 290Taxation (35) (15) (50)PFY 50 240Revaluation gain 100 50 150Total comp. inc. 100 390

Parent (β)Parent (β) 370NCI = 20% x 100NCI = 20% x 100 20

Workings

– PUP Adj

80 x 25/125 x 50% = 8





Chapter 15

Answer 1 – Overseas consolidation

Holly$m

IvyDinars m

@4.0Ivy$m

Group

Revenue 247 1,664 416 663Cost of sales (181) (1,288) (322) (503)

160Expenses (29) (156) (39) (68)

92Finance costs (8) (40) (10) (18)

74Taxation (5) (36) (9) (14)Profit for the year 26 146 36 60

Attributable to:Parent 52.8NCI (20% x 36) 7.2

Holly$m

Non-current assets(200 + 500/4.3 + 100(W2)/4.3 339.5

Goodwill (W3) 65.1Current assets(90 + 390/4.3 180.7

Total assets 585

Share capital 250Retained earnings (W5) 190.7Non-controlling interest (W4) 34.0

Non-current liabilities(80 + 65/4.3) 15.1

Current liabilities(50 + 195/4.3) 95.3

Total equity and liabilities 585





WorkingsW2) Net assets of Ivy (Dinars m)

At reporting date At acquisition Post

acquisitionEquity shares 350 350Ret. earnings 280 150 130FV - land 100 100

730 600 130

W3) Goodwill (Dinars m)

FV of consideration 760

NCI at acquisition (20% x 600) 120

FV of net assets at acquisition (W2) (600)

Goodwill at acquisition 280

W4) NCI (Dinars m)

NCI @ acqn (W3) 120Add: 20% x 130 (W2) 26

146

W5) Group retained earnings ($ million)

100% P 110

Add: 80% x 130 (W2) 104

Less: exchange loss (W6) (23.3)190.7

W6) Exchange difference on investment

$ million

Initially Dinars 760 million @ 3.8 = 200

Year-end Dinars 760 million @ 4.1 = 176.7

Loss = 23.3





Answer 2 – gain or loss on translation of overseas subsidiary

$mOpening net assets = 600 million Dinars@ OR (3.8) 157.9@ CR (4.3) 139.5

(18.4)

Profit for the year = 146 million Dinars@ AR (4.0) 36.5@ CR (4.3) 34.0

(2.5)Goodwill = 280 million Dinars@ OR (3.8) 73.7@ CR (4.3) 65.1

(8.6)

Translation loss (29.5)Any gains or losses on translation of the overseas subsidiary are recognised in other comprehensive income.

Chapter 16

Answer 1 – Dividend paid to the non-controlling interest

Non-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interestNon-controlling interest

B/f 110

Dividend paid (β) 1 Profit 6

C/f 115

116 116

Answer 2 – Dividend received from associate

AssociateAssociateAssociateAssociateAssociateAssociateAssociateAssociate

B/f 180

Profit 20 Dividend paid (β) 10

C/f 190

200 200





Answer 3 – Acquisition of subsidiary

2015$m

Operating activitiesIncrease in inventory (W) 58Increase in receivables (W) (15)Increase in payables (W) 20Investing activitiesAcquisition of subsidiary, net of cash(50 – 5) (45)

Working capital movement

Inventory Receivables PayablesOpening 195 109 67Acquisition/(disposal) 8 6 3Expected 203 115 70Closing (actual) 145 130 90Movement 58↓ 15 ↑ 20 ↑





Answer 4 – Group statement of cash flows

Consolidated statement of cash flows for the year ended [date]

$m $mOperating Activities Group Profit Before Tax 375 Finance cost 55 Depreciation 130 Impairment 54 Profit on disposal of PPE (7) Share of Associates Profit (40) Inventory 70 Receivables (51) Payables (139)Cash generated from operations 447 Interest Paid (55) Tax Paid (25)Cash generated from operating activities 367Investing Activities Sale Proceeds from Tangibles 50 Purchase of Tangibles (655) Dividend Received from Associate 30 Acquisition of Sub (50 – 3) (47)Cash generated from investing activities (622)Financing Activities Proceeds from Share Issue (1,700 – 1,500) 200 Loan Issue (300 – 200) 100 Dividend paid to NCI (20) Dividend paid to parent shareholders (65)Cash generated from financing activities 215

Change in cash and cash equivalents (40)Opening cash and cash equivalents 230Closing cash and cash equivalents 190





WorkingsWorking capital movement

Inventory Receivables Payables

Opening 580 390 430

Acquisition 20 15 9

Expected 600 405 439

Closing (actual) 530 456 300

Movement 70↓ 51↑ 139↓

TaxationTaxationTaxationTaxationTaxationTaxationTaxationTaxationB/f(190 + 110) 300

Tax paid (β) 25 SPL - Tax 95C/f(220 + 150) 370

395 395

PPEPPEPPEPPEPPEPPEPPEPPE

B/f 1,250

Depreciation 130

Purchase 155

Acquisition 13 Disposal 43

Revaluation 500

C/f 1,745

1,918 1,918

Goodwill on acquisition = 50 -42 = 8

Impairment = 1,230 + 8 = 1,238 -1,184 = 54

AssociateAssociateAssociateAssociateAssociateAssociateAssociateAssociate

B/f 190

Profit 40 Dividend paid (β) 30

C/f 200

200 200





Chapter 17RELATED PARTIES (IAS 24)

Answer 1 – CXZ

A

Chapter 18EARNINGS PER SHARE (IAS 33)

Answer 1 – Basic EPS

a) Basic EPS = 250m = 50c per sharea) Basic EPS = 500m = 50c per share

b) Basic EPS =250m

= 45.8c per shareb) Basic EPS =546m (W)

= 45.8c per share

Date No. shares in issue

Weighting (# months)

Weighted average no.

shares1 July X5 500m 1/12 42m

1 August X5 550m 11/12 504m

WANS = 546m

New number of shares

Original number 500

New issue 50New number 550

c) Basic EPS = 250m = 40c per sharec) Basic EPS = 625m = 40c per share


Original number 500New issue 125New number 625

d) Basic EPS = 250m = 45.8c per shared) Basic EPS = 546m = 45.8c per share

Date No. shares in issue

Weighting (# months)

Fraction Weighted average no. shares

1 July X5 500m 7/12 1.40/1.38 296m1 Feb X6 600m 5/12 250m

WANS = 546m


500m × 1 ÷ 8 = 63m extra shares

New number of shares = 500m + 63m = 563m





Theoretical ex-rights price

$ $5 shares at 1.40 7.001 share at 1.25 1.256 shares 8.25

TERP = 8.25/6 = $1.375

Therefore rights issue fraction = 1.40 / 1.38

Answer 2 – Diluted EPS

i) Convertible loan stock

Diluted EPS =500m + 400k

= 49.4c per shareDiluted EPS =1,000m + 12.5m

= 49.4c per share

(W1) Extra earnings = $500,000 x (1 – 0.2) = $400,000

(W2) Extra Shares = $10m x 125 shares / $100 = 12.5m

ii) Share options

Diluted EPS =500m

= 48.2c per shareDiluted EPS =1,000m + 37.5m

= 48.2c per share

No. shares under the option 100mNo. shares at full market value100 x $2.50/$4.00 62.5m

37.5m

Fully diluted EPS

Earnings($m)

Shares(m)

Basic 500 1,000Options - 37.5Convertibles 0.04 12.5

500.04 1,050 47.6c

Both the basic EPS of 50c and the fully diluted EPS of 48.1c are to be disclosed.





D: Integrated reporting

Chapter 19SUSTAINABILITY AND INTEGRATED REPORTING

Answer 1 – Non-financial objectives

Non-financial objectives are a reduction in staff turnover of 10%, a reduction in the company’s carbon footprint, an increase in company charitable donations, and a reduction in the number of staff sick days below national average.

Answer 2 – Global Reporting Initiative (1)

The general standard disclosures are:

๏ Strategy and analysis

๏ Organisational profile

๏ Identified material aspects and boundaries

๏ Stakeholder engagement

๏ Report profile

๏ Governance

๏ Ethics and integrity

Therefore the management approach is not part of the general standard disclosures.

Answer 3 – Global Reporting Initiative (2)

All of the answers except the management approach are part of the general standard disclosures.

Answer 4 – The Capitals

Human and intellectual are part of the six capitals.

The other five capitals are social and relationship, natural, financial and manufactured.

Answer 5 – The Guiding Principles

Materiality, conciseness, and reliability and completeness are part of the guiding principles. The other ones are strategic focus and orientation, connectivity and information, stakeholder relationships, and consistency and comparability.





E: Analysing financial statements

Chapter 20ANALYSIS OF RATIOS

Answer 1 – Past exam question – May’13

The expansion of operations has resulted in more than a 50% increase in revenue, however this has been at the expense of gross profit margin which has reduced from 27.5% to 21.9%. This is a significant decrease in the period, however it is likely that this is as a result of a strategic decision to sell a lower margin product as costs would not be expected to increase that dramatically in a 6 month period. Alternatively, it could be the result of a strategic decision to sell the new product at a discount in order to boost the volume of sales.

There has been a significant increase in inventories held, increasing from 58 days to 92 days. This is not surprising in a period of expansion and it is most likely needed in order to meet the increased demand.

More concerning is the position on receivables and payables, as it appears that SAF is overtrading with an increase in receivable days from 72 to 101 days in the last six months. It could be as a result of more favourable credit terms being offered to new customers, however since receivables days have increased beyond payable days the result will be increased pressure on the entity’s liquidity.

It could be the case that the credit control department has struggled to cope with the increased level of activity and could be addressed simply by dedicating additional resources to credit control.

The current ratio has fallen. However the quick ratio is more of a concern as it has decreased from 1.6 to 1.2 and this together with the entity having moved from a positive cash position to having short term borrowings, makes it clear that the expansion has caused problems with the management of working capital. The entity should ensure that an overdraft facility is in place until procedures can be imposed to improve the management of working capital.

Appendix

All Workings in $000’s 6 months to 31 December 2012 6 months to 30 June 2012

Inventory days 1,220/2,420 x 182.5 = 92 days 460/1,450 x 182.5 = 58 days

Payable days 1,190/2,420 x 182.5 = 90 days 580/1,450 x 182.5 = 73 days

Receivable days 1,715/3,100 x 182.5 = 101 days 790/2,000 x 182.5 = 72 days

Current ratio 2,935/1,440 = 2.0 1,400/580 = 2.4

Quick ratio 1,715/1,440 = 1.2 940/580 = 1.6

Gross profit margin 680/3,100 x 100 = 21.9% 550/2,000 x 100 = 27.5%





Answer to example 2 – Investor ratios

EPS 56.7c = Earnings/No. shares in issue = 22,680/40,000

Dividend cover 5.4 times = EPS/DPS = 56.6c/10.5c

Dividend yield 8.75% = DPS/Price per share = 10.5c/$1.20 x 100%

P/E ratio 2.12 = Share price/EPS = $1.20/56.6c

NOTE: No. shares in issue = $20m/50c = 40m shares

Answer 3 – DFG (March’11)

To friend

Report on financial performance and position

The revenue has only marginally increased in the year by 1.6%, however, profit margins have all increased significantly. In particular the gross profit margin has increased from 10% to 19%, which is likely to be as a result of reduced purchase prices from the new supplier contract that was secured in the year. Whilst this is a very positive and important step for DFG (given its low margin in the previous year) it will be important to establish whether this reduced cost also means a reduced level of quality. If quality is being compromised then this increase in margin maybe short-lived as customers may be driven away in the longer term.

In addition, the switch in supplier may be responsible for the lawsuit. It is a risky strategy to pursue aggressive revenue and margin targets at the expense of supplying good quality products. Although a contingent liability of $30 million is included in the notes, the lawyer’s assessment is that DFG is likely to lose the court case and the payout may be more. There is already serious pressure on the entity’s finances and the entity may not survive if the payout is any more or if other customers decide to sue. There is a potential issue of going concern that would need clarification before you arrive at a final decision concerning employment.

Both administration and distribution costs have increased significantly when compared to a 1.6% increase in revenue. Whilst these costs are not that large in relation to revenues, it will be important to establish that management have good control over expenses for the long term.

The increase in TCI is largely due to the revaluation gain reported within other comprehensive income. The valuation was performed by an internal member of staff, which is perhaps not as ideal as someone external, however you noted that these financial statements were finalised and so I assume they have been audited and that the valuations are fair. One note of caution though is why the directors have chosen this year to change the policy - could it be an attempt to boost income and reduce gearing to make further borrowing easier, especially as the long term borrowings will need to be repaid or re-negotiated relatively soon. However, it maybe shows good commercial sense to ensure that assets that are to be used as security for finance are at the most up-to-date valuation.

The overall liquidity of DFG is on the low side at 1.3:1 and has fallen significantly from 2009. One contributing factor to the worsening liquidity is the significant increase in inventories in the year. This could be as a result of bad publicity about below standard goods and customer orders being cancelled. There is then an increased risk of obsolete inventories. This is reinforced by the





inventories days which have increased from 146 days to 191 days. Receivables days have also increased from 71 days to 104 days, and this be could be as a result of disputed invoices. DFG may then have a problem with slow/non-payment of these debts. Payables days have increased from 108 days to 171 days and this could be resulting from a deliberate attempt by DFG to improve the cash flow by delaying payment or extended credit terms given by the new supplier to attract DFG’s business.

The cash position of DFG is clearly a concern as the cash has moved from a positive balance to an overdraft and the long term borrowings are soon to be repaid or re-negotiated. This coupled with the poor working capital management would indicate that DFG must raise some additional funding if it is to survive. The gearing ratio shows deterioration on the previous year, despite an increase in equity from the revaluation. However, it is likely to be the lack of interest cover that would put lenders off. It is unlikely that DFG could afford to pay interest on any additional funding.

I would recommend investigating DFG in more detail before making your decision. Losing the court case and having a large settlement to pay could result in the entity collapsing and despite the fact that details of this are only in the notes, the seriousness of this should not be overlooked. The entity may struggle to survive anyway as there is a lack of cash and funding options (and it should be noted that DFG did not pay a dividend in 2010). The increases in profitability are not enough of an indicator of a stable/growing entity – especially an entity involved in the building trade which is known for its sensitivity to the economy around it.

Appendix

2010 2009

(Workings in $m)Gross profit margin 49/252 x 100 = 19.4% 25/248 x 100 = 10.1%Operating profit margin (49 – 18 – 16)/252 x 100 = 6.0% (25 – 13 – 11)/248 x 100 = 0.4%Net profit margin 7/252 x 100 = 2.8% (5)/248 x 100 = (2.0)%Gearing (91 + 39)/231 x 100 = 56.3% 91/184 x 100 = 49.5%Current ratio 178/134 = 1.3:1 143/66 = 2.2:1Quick ratio (178 – 106)/134 = 0.5:1 (143 – 89)/66 = 0.8:1Receivable days 72/252 x 365 = 104 days 48/248 x 365 = 71 daysPayable days 95/203 x 365 = 171 days 66/223 x 365 = 108 daysInventory days 106/203 x 365 = 191 days 89/223 x 365 = 146 days

Return on capital employed (49 – 18 – 16)/(231 + 91) x 100 = 4.7%

(25 – 13 – 11)/(184 + 91) x 100 = 0.4%

Non-current asset turnover 252/254 = 0.99 times 248/198 = 1.3 timesInterest cover (10 + 12)/12 = 1.8 times ((7) + 8)/8 = 1.0 times




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