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(1)

Mock 1

Financial

Reporting

F7FR-MK1-Z08-A

(2)

1 GOLD

(a) Calculation of goodwill on acquisition

Silver

$000 $000

Cost of Investment 5,020

Net assets on acquisition

Share capital 400

Share premium 900

Retained earnings 6,740

Fair value adjustment 60

_____ goodwill of $20,000 which will be charged as an expense in the current years statement of comprehensive income. The previous periods impairment, also $20,000, will be deducted in the calculation of the opening consolidated retained earnings.

The fair value adjustment relates to plant and equipment which has a remaining life of 4 years at the date of acquisition. This extra $60,000 in value will need to be depreciated in the consolidated financial statements, giving a charge to the current years statement of comprehensive income of $15,000 and an adjustment against the opening consolidated retained earnings of $15,000.

Bronze

$000 $000

Cost of Investment

Share for share exchange (400 × 30%) × $3 360

Cash payment ____ 83.4

443.4 Net assets on acquisition

Share capital 400

Share premium 150

Retained earnings 1 February 2008 656

Profit for year 96 × 412 32

As the recoverable amount of the investment in Bronze is greater than its year-end carrying value there is no impairment of the investment, and therefore goodwill, to charge

(3)

(b) Gold group consolidated statement of comprehensive income for the year ended 30 September 2008

$000

Revenue 5,302

Cost of sales ______ (4,233)

Gross profit 1,069

Operating expenses (404)

Dividend income 40

Income from associated companies ______ 17.7

Profit before tax 722.7

Tax ______ (215)

Profit after tax ______ 507.7

Non-controlling interest 88.4

Shareholders of Gold ______ 419.3

Profit for year ______ 507.7

Gross profit 1,069

Operating expenses (212) (168)

Goodwill (20)

Depreciation on fair value (15) (404)

Depreciation on inter company sale 11

Dividends from non group companies 30 10 40

Income from investment in associate 17.7 ______ 17.7

Profit before tax 722.7

Tax (125) ______ (90) ______ (215)

Profit after tax 221 507.7

Non-controlling interest 40% ______ (88.4)

(4)

WORKINGS

(1) Inter company sales

Reduce both revenue and cost of sales for inter company sales between Gold and Silver, $120,000 and $220,000. Do not adjust for transaction with Bronze, the associate, as we do not include their revenue or costs in the consolidated statement of comprehensive income.

(2) Unrealised profit

P sells to S

$120,000 × 25/125 = 24,000 × 1/3 = $8,000 Increase P cost of sales by $8,000

S sells to P, and P treats the goods as non current assets $220,000 × 25/125 = $44,000

Increase S cost of sales by $44,000

As P treats the goods as non current assets which are being depreciated over 4 years there is a need to reduce P operating expenses to the extent of one years depreciation of $11,000.

A sells goods to P

$25,000 × 25/125 = $5,000

Reduce the income from associate by unrealised profit.

(3) Income from associate

Profit after tax = $96,000 × 8/12 = 64,000

Unrealised profit ______ (5,000)

59,000

P % ______ 30%

17,700 ______

It could have been possible to include income from associate based upon profit before tax and include the associates share of the tax expense within the consolidated tax figure, IAS 28 does not specify the precise treatment and therefore either treatment would be correct.

(4) Dividend income

Subsidiary has paid a dividend of $150,000 during the year of which $90,000 would have been included in Gold’s statement of comprehensive income. This would leave dividend income from non group companies of $30,000, add this to the $10,000 income in Silvers’ statement of comprehensive income to give dividend income from non group companies to be included in the consolidated statement of comprehensive income of $40,000.

(5)

(c) Reconciliation of consolidated retained earnings

Opening consolidated retained earnings

$000

Gold 7,960

Silver (7,190 – 6,740 – 15) × 60% 261

Goodwill written off _____ (20)

8,201 _____ Movement on consolidated retained earnings

Opening retained earnings 8,201

Profit for year 413.3

(i) Telenorth statement of comprehensive income – Year to 30 September 2008

$000 $000

Sales revenue 283,460

Cost of sales (W1) (155,170) _______

Gross profit 128,290

Distribution expenses (22,300)

Administration expenses (42,200) ______ _______ (64,500)

Operating profit 63,790

Profit from operations

Financing cost (W4) (1,656)

Investment income ______ 1,500 _______ (156)

Profit before tax 63,634

Income tax (23,400 + 2,200) _______ (25,600)

Profit for the period _______ 38,034

(6)

(ii) Telenorth – Statement of financial position as at 30 September 2008

Assets

Tangible Non-current assets $000 $000

Property, plant and equipment 83,440

Investments _______ 34,500

117,940

Current Assets

Inventory (W5) 16,680

Trade accounts receivable (35,700 + 12,000) (W3) _______ 47,700 64,380 _______ 182,320 _______

Equity and Liabilities Capital and Reserves:

Ordinary shares of $1 each (20,000 + 4,000 + 6,000) (W7) 30,000

Reserves:

Revaluation surplus 3,400

Share premium (4,000 + 12,000) (W7) 16,000

8% Preference shares 12,000

Deferred tax (5,200 + 2,200) _______ 7,400 29,400

Current liabilities

Trade and other payables (W6) 18,070

Loan from Kwikfinance ((9,600 + 96) W3) 9,696

Provision for income tax 23,400

Proposed dividends (W6) 4,980

Overdraft _______ 1,680 57,826

_______

Total equity and liabilities _______ 182,320

(7)

WORKINGS (all figures in $000) These marks should not be double counted

(1) Cost of sales:

Opening inventory 12,400

Purchases 147,200

Depreciation (W2) _______ 12,250

171,850

Closing inventory (W5) _______ (16,680)

155,170 _______ Administration:

Per question 34,440

Incorrect factoring charge (W3) (2,400)

Depreciation of computer system (W2) _______ 10,160 42,200 _______

(2) Property, plant and equipment:

Cost Depreciation Carrying value

Leasehold 56,250 20,250 (18,000 + 2,250) 36,000 Plant and equipment 55,000 22,800 (12,800 + 10,000) 32,200 Computer system 35,000 19,760 (9,600 + 10,160) 15,240 ______ 83,440 ______ Depreciation for year:

Leasehold (56,250/25 years) 2,250

Plant (55,000 – 5,000)/ 5 year life) ______ 10,000

Charged to cost of sales ______ 12,250

Computer system charged to administration ((35,000 – 9,600) × 40%) ______ 10,160

(3) Accounts receivable/factoring:

As Telenorth still bears the risk of slow payment and bad debts, the substance of the factoring is that of a loan on which finance charges will be made. The amount receivable from the customer should not have been derecognised (removed from the statement of financial position) nor should all of the difference between the amount due from the customer and the amount received from the factor have been treated as an administration cost. The required adjustments can be summarised as follows:

Dr Cr

Accounts receivable 12,000

Loan from factor 9,600

Administration (12,000 – 9,600) 2,400

Finance costs: accrued interest ($9·6 million × 1·0%) 96

Accruals ______ ______ 96

12,096 12,096 ______ ______

(8)

There would also be loan note interest of $600,000 charged for the year ($300,000 paid + $300,000 accrued).

(4) Financing cost.

Factoring cost (W3) 96

Loan interest (10,000 × 6%) 600

Preference dividend (12,000 × 8%) ______ 960

1,656 ______

(5) Closing inventory:

As this was not counted at the year-end, the actual count needs to be adjusted for movements in the period between the year-end and the date of the count:

Balance on 4 October 2008 16,000

Add goods sold at cost: normal sales (1,400/140 × 100) 1,000

sale or return (650/130 × 100) 500

Less goods received at cost ______ (820)

Adjusted value ______ 16,680

(6) Current liabilities

Trade and other payables:

Accounts payable from question 17,770

Accrued loan note interest (W3) ______ 300

18,070 ______ Proposed dividends

(15 cents on 30 million shares + (12,000 × 8% × 6/

12)) ______ 4,980

(7) Share capital/retained earnings/suspense account:

The elimination of the suspense account is as follows: Dr Cr

Suspense account (per trial balance) 26,000

Director’s options: share capital (4 million at $1) 4,000

share premium (4 million at $1) 4,000

Rights issue: share capital ((20 million + 4 million)/4) 6,000 share premium (6 million at $2) ______ ______ 12,000 26,000 26,000 ______ ______ Retained earnings:

Balance 1 October 2007 14,160

Profit for the period 38,034

Ordinary dividend (2,000 + 4,500 interim + final) ______ (6,500)

Balance 30 September 2008 ______ 45,694

(9)

3 NEDBERG

Statement of Cash Flows of Nedberg for the Year to 30 September 2008:

Cash flows from operating activities $m $m

Profit before tax 870

Adjustments for:

Amortisation – development expenditure (W1) 130

Impairment – goodwill (200 – 180) 20 150

–––

Depreciation – property, plant and equipment 320

Amortisation of government grant (W2) (90)

Loss on sale of plant 50

Interest expense 30

Increase in inventory (1,420 – 940) (480)

Increase in accounts receivable (990 – 680) (310)

Increase in accounts payable (875 – 730) 145

––––

Cash generated from operations 685

Interest paid (30 – (15 – 5 accrual adjustments)) (20)

Income tax paid (W3) (130)

––––

Net cash from operating activities 535

Cash flows from investing activities

Purchase property, plant and equipment (W4) (250)

Capitalised development costs (W1) (500)

Receipt of government grant 50

Proceeds of sale of plant (W4) 20

Net cash from operating activities –––– (680)

Cash flows from financing activities

Issue of ordinary shares (W5) 450

Issue of loan notes (300 – 100) 200

Dividends paid (200 final for 2007 + 120 interim for 2008) (320) ––––

Net cash generated from financing activities 330

––––

Net increase in cash and cash equivalents 185

Cash and cash equivalents at beginning of period (115) ––––

Cash and cash equivalents at end of period 70

(10)

WORKINGS

(1) Development expenditure:

$m

Balance b/f 100

Amount capitalised 500

Amortisation – balancing figure (130)

––––

Difference cash paid 130

––––

(4) Property, plant and equipment:

Balance b/f 1,830

Revaluation surplus 200

Plant acquired 250

Depreciation (320)

Disposal at net book value – balancing figure (70)

–––––

Balance c/f 1,890

––––– Disposal of plant:

Net book value from above 70

Loss on sale (from question) (50)

–––

Difference is sale proceeds 20

–––

(5) Share capital:

Ordinary shares b/f (500)

Bonus issue 1 for 10 (from revaluation reserve) (50)

Ordinary shares c/f 750

––––

Difference issue for cash 200

Plus increase in share premium (350 – 100) 250

(11)

(6) Reconciliation of reserve movements

Revaluation reserve:

Balance b/f nil

Revaluation of buildings 200

Bonus issue (50)

Transfer to realised profits (10)

––––

Transfer from revaluation reserve 10

–––––

Balance c/f 1,610

–––––

(b)

The cash flows generated from operations of $685 million are relatively healthy and more than adequate to pay the interest costs and taxation, but not as large as the equivalent profit figure. For most companies the operating cash flows tend to be higher than the profit before interest and tax due to the effects of depreciation/amortisation charges (which are not cash flows). In the case of Nedberg the depreciation/amortisation effect has been more than offset by a much higher investment in working capital of $645 million. Inventory has increased by over 50% and accounts receivable by 45%. This may be an indication of expanding activity, but it could also be an indication of poor inventory management policy and poor credit control, or even the presence of some obsolete inventory or unprovided bad accounts receivables.

A cause of concern is the size of the dividends, at $400 million they represent 67% of the profit for the period and cash flows for dividends (last year’s final plus this year’s interim) are also high at $320 million. This is a very high distribution ratio, and it seems curious that the company is returning such large amounts to shareholders at the same time as they are raising finance. $450 million has been received from the issue of new shares and $200 million from a further issue of loan notes.

(12)

4 IMPAIRMENT LOSS

(a) IAS 36

Circumstances

„ In identifying whether an impairment of an asset may have occurred an enterprise

should consider the following indications:

„ there has been a significant decrease in the market value of the asset in excess of the

normal process of depreciation;

„ there has been a significant adverse change in either the business or the market in

which the asset is involved. This will include changes in the technological, economic or legal environment in which the enterprise operates;

„ there has been a significant adverse change in the manner in which the asset has

been used, evidence is available that indicates that the economic performance of the asset will be worse than expected;

„ the asset has suffered considerable physical change, or obsolescence or physical

damage;

„ there has been an accumulation of costs significantly in excess of those originally

expected in the acquisition or construction of an asset so that it may affect profitability;

„ the management is committed to a significant reorganisation programme;

„ where an asset is valued in terms of value in use and the actual cash flows are less

than the estimated cash flows before discounting;

„ market interest rates or other market rates of return on investments have increased

during the period and those increases are likely to decrease materially the asset’s recoverable amount.

(b) AB

Taxi business

AB will recognise the impairment losses relating to the taxi business in the following way. (Impairment losses should be recognised if the recoverable amount of the cash generating unit is less than the carrying value of the items of that unit.)

At 1 February 2008

(13)

An impairment loss of $30,000 is recognised first-for the stolen-vehicles and the balance ($15,000) is attributed to goodwill.

At 1 March 2008

1Feb 2008 Impairment 1 Mar 2008 Loss

$000 $000 $000

Goodwill 25 (25)

Intangible assets 30 (5) 25

Vehicles 90 90

Sundry net assets ___ 40 ___ ___ 40

185 (30) 155

___ ___ ___

Any impairment loss should usually be allocated in priority to those assets which have the most subjective valuations. Thus impairment identified in this way should usually be allocated firstly to goodwill and then to other assets on a pro-rata basis.

In this case the question has told us that the fair value less costs to sell of all assets except the licence have remained constant. The assets were originally measured at their fair value less costs to sell. IAS 36 says that any asset within the cash generating unit cannot be reduced below its fair value less costs to sell. Therefore it is only the licence that can be impaired. AB recognises a further impairment loss of $30,000 although the value in use of the business is lower ($150,000). The carrying amounts of the individual assets are not reduced below their fair value less costs to sell.

(14)

5 DEFERRED TAXATION

Charge to the statement of comprehensive income in respect of deferred tax

Carrying

value Base Tax Temporary difference

Non-current assets $ $

Oil rig 198,000 165,000 33,000

Buildings – those at revaluation 100,000 75,000 25,000

Plant and machinery 67,000 49,000 18,000

Assets held under finance lease 20,000 −

Finance lease obligation W1 (22,286) −

(2,286) − (2,286) Receivables:

Gross amounts owed by customer

W2 53,500 40,000 13,500

Trade receivables 53,000 60,000 (7,000)

Interest receivable 2,000 − 2,000

Payables

Zero coupon bond W3 108,450 100,000 (8,450)

Fine 70,000 70,000 −

Interest payable 1,000 − (1,000)

72,764

Temporary

differences tax @ 30% Deferred Deferred tax liabilities 91,500 27,450

Deferred tax assets 18,736 (5,621)

21,829

Deferred tax @ 30%

$

Deferred tax as at 1st October 2007 3.890

To other comprehensive income (30%(100 – 75)) 7,500

Profit or loss (Balancing figure) 10,329

Deferred tax as at 30th September

(15)

WORKINGS

(1) Finance lease liability

$ Original amount capitalised

NBV of asset 20,000

Add back depreciation (2 × 5,000) 10,000

––––––

∴ Amount recognised as loan 30,000

Add interest 6,286

Less repayments (14,000)

–––––– 22,286 ––––––

(2) Amounts owed by customers in respect of construction contracts

Contract account

$000

Costs incurred 40

Revenue recognised 45

––––– 85 –––––

$000

Costs recognised 31.5

Bal c/f 53.5

––––– 85 –––––

Revenue recognise $100 × 45% = 45 Costs recognised (40 + 30) × 45% = 31.5

The tax base will be equal to the actual costs incurred on the contract.

(3) Zero coupon bonds

(16)

Marking Scheme

Marks 1 GOLD

See solution

2 TELENORTH

See solution

3 NEDBERG

(a) See solution

(b) Comments

1 mark per relevant point to max 5

4 IMPAIRMENT LOSS

(a) Circumstances of impairment loss

1 mark per relevant and IAS 36 related comment max 7 on circumstances related to impairment loss -

(give credit if student has used own expressions

providing they lead to what IAS 36 says about impairment)

(b) Treatment of loss

presentation 1

identification of 45k of impairment loss and its attribution

to both vehicles and goodwill 2

identification of 30k of impairment loss for the whole company 1

allocation of impairment loss first to GW 1½

decrease of intangibles by 5k due to impair. Loss 1½

Statement regarding break up valuation __ 1

max __ 8

Total per question 15 __ 5 DEFERRED TAXATION

½ mark for each temporary difference identified in the question 4½

1 mark for each deferred tax asset/liability 2

identification of o/b of deferred tax (3,890) ½

establishing the other comprehensive income charge of deferred tax 1½

calculation of balancing figure 1

amount of deferred tax as at 30 September 2008 __ ½

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