ACCA Paper P2
(International)
Corporate Reporting
Class Notes
© The Accountancy College Ltd, July 2009
PAGE
INTRODUCTION TO THE PAPER 5
CHAPTER 1: BASIC GROUPS 15
CHAPTER 2: COMPLEX GROUPS 29
CHAPTER 3: FOREIGN CURRENCY TRANSLATION 35
CHAPTER 3: GROUP CASH FLOW STATEMENTS 45
CHAPTER 5: CORPORATE SOCIAL RESPONSIBILITY AND CURRENT ISSUES 57
CHAPTER 6: PERFORMANCE REPORTING 73
CHAPTER 7: PROVISIONS ETC. 81
CHAPTER 8: NON CURRENT ASSETS 87
CHAPTER 9: LEASES 95
CHAPTER 10: EMPLOYEE BENEFITS 101
CHAPTER 11: SHARE BASED PAYMENTS 107
CHAPTER 12: FINANCIAL INSTRUMENTS 113
CHAPTER 13: TAX 121
AIM OF THE PAPER
The aim of the paper is to test your understanding of financial reporting and probably more importantly to test your ability to solve problems in accounting scenarios that are every bit as messy as real life.
FORMAT OF THE EXAM PAPER
The syllabus is assessed by a three hour paper-based examination. The paper has 15 minutes reading time. There are four questions of which you must do three as follows:
Section A (Compulsory Case Study)
(q1) The case will be based around a group scenario. There will be 35 marks of numbers and 15 marks of narrative.
(50 marks)
Section B (Choice of 2 from 3 questions)
(q2) Focus. Typically the second question in the exam focuses on a single technical subject, such as pensions, financial instruments or deferred tax. Often these questions require thorough technical knowledge.
(25 marks)
(q3) Mix. Usually there are roughly 5 mini scenarios, each valued at 5 marks and covering a wide range of financial reporting issues. These questions require problem solving and usually far less technical knowledge than question two.
(25 marks)
(q4) Current Issues and CSR. Whether you call this question ―Corporate Social Responsibly‖, ―pure narrative‖ or another less polite phrase, there is no getting away from the very low technical content and the very high potential for letting your pen wander across a whole range of ideas. These questions have to be seen to be believed. So look at the chapter on Corporate Social Responsibility to get a feel for their style.
(25 marks)
INTERNATIONAL EXAMINABLE DOCUMENTS (JUNE 2009)
Knowledge of new examinable regulations will not be required until at least six calendar months after the last day of the month in which the document
was issued, or the legislation passed. Documents may be examinable even if
the effective date is in the future.
The documents listed as being examinable are the latest that were issued prior to 31 May of the same year for the December examinations, and 30 November of the previous year for the June examinations. The study guide offers more detailed guidance on the depth and level at which the
examinable documents will be examined. The study guide should be read in conjunction with the examinable documents list.
International Accounting Standards (IASs)/International Financial Reporting Standards (IFRSs)
IAS 1 Presentation of Financial Statements IAS 2 Inventories
IAS 7 Statement of Cash Flows
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events after the Reporting Period
IAS 11 Construction Contracts IAS 12 Income Taxes
IAS 16 Property, Plant and Equipment IAS 17 Leases
IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates
IAS 29 Financial Reporting in Hyperinflationary Economies IAS 31 Interests in Joint Ventures
IAS 32 Financial Instruments: Presentation IAS 33 Earnings per Share
IAS 34 Interim Financial Reporting IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement IAS 40 Investment Property
IAS 41 Agriculture
IFRS 1 First-time Adoption of International Financial Reporting Standards IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations IFRS 7 Financial Instruments: Disclosures
Other Statements
Framework for the Preparation and Presentation of Financial Statements
Interpretations of the International Financial Reporting Interpretations Committee (IFRIC)
SIC-12 Consolidation – Special Purpose Entities
SIC-13 Jointly Controlled Entities – Non monetary Contributions by Venturers
SIC-15 Operating Leases – Incentives
SIC-21 Income Taxes – Recovery of Revalued Non-depreciable Assets SIC-27 Evaluating the Substance of Transactions in the Legal Form of a Lease
SIC-32 Intangible Assets – Website Costs
IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities
IFRIC 4 Determining Whether an Arrangement Contains a Lease IFRIC 5 Rights to Interests from Decommissioning Restoration and Environmental Rehabilitation Funds
IFRIC 7 Applying the Restatement Approach under IAS 29, Financial Reporting in Hyperinflationary Economies
IFRIC 8 Scope of IFRS 2
IFRIC 9 Reassessment of Embedded Derivatives IFRIC 10 Interim Financial Reporting and Impairment IFRIC 11 IFRS 2: Group and Treasury Share Transactions IFRIC 12 Service Concession Arrangements
IFRIC 13 Customer Loyalty Programmes
EDs, Discussion Papers and Other Documents
ED IFRS for Small and Medium-sized Entities DP Management Commentary
DP Fair Value Measurements
DP Preliminary Views on an Improved Conceptual Framework for Financial Reporting - The Objective of Financial Reporting and Qualitative
UK EXAMINABLE DOCUMENTS (JUNE 2009)
FOR REFERENCE ONLY
Knowledge of new examinable regulations will not be required until at least six calendar months after the last day of the month in which the document
was issued, or the legislation passed. Documents may be examinable even if
the effective date is in the future.
The documents listed as being examinable are the latest that were issued prior to 31 May of the same year for the December examinations, and 30 November of the previous year for the June examinations. The study guide offers more detailed guidance on the depth and level at which the
examinable documents will be examined. The study guide should be read in conjunction with the examinable documents list.
Statements of Standard Accounting Practice (SSAPs)
SSAP 4 Accounting for government grants SSAP 5 Accounting for Value Added Tax SSAP 9 Stocks and long-term contracts
SSAP 13 Accounting for research and development SSAP19 Accounting for investment properties
SSAP 21 Accounting for leases and hire purchase contracts SSAP 25 Segmental reporting
Financial Reporting Standards (FRSs)
FRS 1 Cash Flow Statements
FRS 2 Accounting for Subsidiary Undertakings FRS 3 Reporting Financial Performance
FRS 5 Reporting the Substance of Transactions FRS 6 Acquisitions and Mergers
FRS 7 Fair Values in Acquisition Accounting FRS 8 Related Party Disclosures
FRS 9 Associates and Joint Ventures FRS 10 Goodwill and Intangible Assets
FRS 11 Impairment of Non current assets and Goodwill
FRS 12 Provisions, Contingent Liabilities and Contingent Assets FRS 15 Tangible Non current assets
FRS 16 Current Tax
FRS 17 Retirement Benefits FRS 18 Accounting Policies FRS 19 Deferred Tax
FRS 20 Share-based Payment
FRS 21 Events After the Statement of financial position Date FRS 22 Earnings per share
FRS 23 The Effect of Changes in Foreign Exchange Rates FRS 24 Financial Reporting in Hyperinflationary Economies FRS 25 Financial Instruments: Disclosure and Presentation FRS 26 Financial Instruments: Recognition and Measurement FRS 28 Corresponding Amount
Reporting Statement
Operating and Financial Review (OFR)
Other Statements
Statement of Principles for Financial Reporting
FRSSE Financial Reporting Standard for Smaller Entities
Urgent Issues Task Force (UITF) Abstracts
Foreword to UITF Abstracts
UITF Abstract 4 Presentation of long-term receivables in current assets UITF Abstract 5 Transfers from current assets to non current assets UITF Abstract 24 Accounting for start-up costs
UITF Abstract 27 Revision to estimates of the useful economic life of goodwill and intangible assets
UITF Abstract 28 Operating lease incentives UITF Abstract 29 Website development costs
UITF Abstract 31 Exchanges of businesses or other non-monetary assets for an interest in a subsidiary, joint venture or associate
UITF Abstract 34 Pre-contract costs
UITF Abstract 36 Contracts for sales of capacity
UITF Abstract 40 Revenue recognition and service contracts UITF Abstract 41 Scope of FRS 20
UITF Abstract 42 Reassessment of embedded derivatives
UITF Abstract 44 FRS 20 (IFRS 2) Group and Treasury Share Transactions
Discussion Papers and Other Documents
STREAM SELECTION
All students, regardless of circumstances should be switching to the international stream for P2 Corporate Reporting. Because GBR stream students are effectively required to understand both UK GAAP and International GAAP, GBR stream has become unbearable. International students only have to know International GAAP.
The differences in the exam questions
There is very little difference between the dominant International stream and the GBR variant. This is both technically and in terms of the exam. UK financial reporting has long been converging with International Financial Reporting Standards and so the UK FRS are largely copies of the International FRS. But more importantly, the GBR exam is a copy of the International examination. As the examiner explained at a conference in February 2007; the examiner first writes the international examination, checks it, rethinks it, and checks it again; then he converts it to the GBR exam by changing the $ to £, reformatting and adjusting for minor differences.
So there is really no difference between the International Stream examination questions and the GBR variant.
The differences in the exam answers
Often the exam answers are also the same for both streams. However, where there is a difference, it is always the International students who have the easier ride. The international Deferred Tax is much easier than the UK equivalent. The same is true for cash flow statements, associates and goodwill depreciation.
Sometimes the differences between the knowledge a GBR student is required to understand and the equivalent knowledge required by an international student can be come quite extreme. For business combinations for example, an international student is required to know the new rules, which are quite substantial. A GBR student would be required to know the old rules and the new rules. So giving an even more specific example, a GBR student would be required to be able to do a step acquisition two different ways; the old way and the new way. That‘s one heck of a challenge.
Course Structure
The weekend and evening courses for P2 Corporate Reporting are delivered in 10 sessions; that is 10 evening classes or 5 days at the weekend. The course will lean heavily towards the International stream. This is after all, the way in which the examiner sees the exam; International is the principal exam and GBR is a variant. But, I will use the language of the International stream and the GBR variant interchangeably; so some times I‘ll use the word ―stock‖ sometimes ―inventory‖.
Super Sunday
Stream Selection Frequently Asked Questions
Which stream should I select?
International. Regardless of your circumstances, you should be doing P2 Corporate Reporting International. The examiner is focussed on the International stream and so the questions make the most sense in the International exam. All the listed UK companies use International FRS already and International FRS will very soon apply to absolutely all companies in the UK. UK FRS are walking dead. Get out of the GBR variant now.
I did my F7 Financial Reporting using the GBR stream. Should I really change?
Absolutely, change now. Well done, you are through FR. Now to get through CR. The easiest stream is the International stream. The most useful stream is the International stream. So change stream. All the stuff you learnt from F7 GBR will help you with P2 International. You will hardly notice the difference. All that basic knowledge regarding P&L report, Balance Sheet, Cash Flow Statement, leases, fixed assets, grants, tax etc still applies.
I learnt a load of FRS numbers at F7 GBR. Will they help at P2 International?
If you learnt a whole load of UK FRS numbers for F7, well those FRS numbers are useless, it is true. But so are International FRS numbers, because the P2 examiner does not focus on FRS numbers. An FRS number is never the answer to the question at P2. If the examiner sets out a scenario describing provisions, discontinued and pensions; then he wants to hear about accounting for provisions, discontinued and pensions. He does not want a list of FRS numbers; either International or UK FRS numbers.
I want to change to International stream. Is it easy?
Very easy. I have not done it myself of course, but the students who have changed stream over the last two years have had no problem. Most simply send an email requesting a change of stream for P2 and have received a new exam docket showing P2 International shortly after. Others have used the phone, which seems to work fine as well. But the downside is that you often have to wait a long time to get through to the ACCA on the phone.
What happens if I accidentally use a GBR phrase in my International exam?
Nothing. The examiner does not care if you use language interchangeably. He himself is constantly switching between UK and International language in his answers, which I think is fair enough. This is an advanced financial reporting exam looking at the substance of a highly political communication science. Not a test of rote learning a load of formats.
I am still a little uncertain as to which stream to use. Can I talk it through?
INTERACTIVE STUDENT ADVICE
The following is advice aimed at students using the on line media to do battle with P2.
Firstly, I would advise that you treat this course as if it were a classroom course. Set an evening each week (or a half day each weekend) to study the subject. Sit yourself in front of your computer with paper, pen, calculator and these notes and copy what I am doing as if you and I were in class together.
Then rework the questions from the recorded lectures until you are happy with them. Any parts you are unsure about, review the relevant recording and rework the problem a couple of times.
Once you are satisfied with your understanding of the essentials as recorded to video, then provided time allows work the supplementary questions that have not been recorded. There are answers to all the questions in the back, but obviously it‘s the answers to the unrecorded questions that will interest you most.
If you are really stuck, then post your problem to the discussion board. See if you can help others with their problems posted to the discussion board. I will review the boards when I can and point you and others in the right direction. My advice is that the little things with which you struggle are often so minor as to be near irrelevant. Concentrate on the big picture, make sure you can do all the basics and when you come back to the same question for the third or fourth time, the tricky issues that seemed hard then will resolve themselves.
Emails. Really I should not be corresponding through email as this denies other students the opportunity to see our correspondence. I can see that email is very tempting, but it is against the spirit of Interactive. You guys are supposed to interact with one another as well as with me. This is why the discussion board is the way to communicate.
Chapter 1
CHAPTER CONTENTS
RELATIONSHIPS --- 17
SUBSIDIARY 17
ASSOCIATE 17
INVESTMENT 17
THE DEVELOPMENT OF ACCOUNTING FOR GOODWILL 19
PROCESS OF DEVELOPMENT 19
GOODWILL IMPAIRMENT --- 20
IMPAIRMENT 20
RECOVERABLE VALUE 20
IMPAIRMENT OF SUBSIDIARY 20
RELATIONSHIPS
This chapter covers the process of consolidation required in a group containing parent, subsidiary and associate.
The process is determined by the relationships between the entities. There are three relationships between entities:
● control
● influence
● passive.
Subsidiary
When a parent has control of another entity, then that entity is know as a subsidiary and is consolidated using acquisition accounting.
This means the subsidiary assets and liabilities are added to those of the parent.
Associate
When a parent has influence over another entity, then that entity is known as an associate and is brought into the group fs using equity accounting.
This means the group fs include a share of the profit on the income statement and a share of the net assets on the statement of financial position (in the UK we show three lines on the P&L, share of operating profit, finance and tax).
A joint venture is an entity over which the parent has joint control. Despite its name, joint control is taken to mean very significant influence. So a JV is accounted for as a 50% associate. There has never been a question in which students were required to consolidate a joint venture.
Investment
Question: Peddle
The following are the summarised accounts of Peddle (P), Saddle (S) and Andlebar (A) for the year.
Income Statements (Profit and loss accounts)
P S A
$‘000 $‘000 $‘000
Revenue 500 400 300
Operating Costs (200) (210) (100)
___________ __________ __________
Operating profit 300 190 200
Interest Expense (50) (20) (10)
___________ __________ __________
Profit before tax 250 170 190
Tax (80) (60) (50)
___________ __________ __________
Profit for the financial year 170 110 140
Retained profit brought forward 500 200 300
___________ __________ __________
Retained profit carried forward 670 310 440
___________ __________ __________
Statements of financial position (Balance Sheets)
P S A
___________ __________ __________
Share Capital (nominal $1 each) 100 50 30
Reserves 670 310 440
___________ ___________ __________
770 360 470
___________ __________ __________
The shares in Saddle and the shares in Andlebar were acquired on the first day of the year. Goodwill has an infinite life and has suffered no impairment.
It is the group‘s policy to value the non-controlling interest fair value. The fair value of the non-controlling interest is $60,000.
Required
The development of accounting for goodwill
Until 2009, Goodwill disclosed on the statement of financial position was ‗our‘ goodwill (that is until recently goodwill has shown ownership). This is often called ‗partial goodwill‘ (or ‗net goodwill‘). There is a newly reissued IFRS (IFRS3(2008revised)) that recommends goodwill disclosed be changed to the entire goodwill of the entity (so that goodwill would then show control). This is in order to make goodwill consistent with the rest of the statement of financial position where we already use control. This recommendation is usually called ‗full goodwill‘. However, the new IFRS continues to allow net goodwill, making the whole situation very confused.
Process of development
The process of development is undertaken by the International Accounting Standards Board (IASB). There are three phases ending with an IFRS. The three phases are as follows:-
DP Discussion Paper
ED Exposure draft
GOODWILL IMPAIRMENT
Some groups questions require students to conduct an impairment review on the subsidiaries at the year end. This results in a goodwill impairment.
Impairment
An impairment occurs if the recoverable value of an asset falls below the carrying value.
Recoverable value
This is the higher of VIU and NRV. ● VIV = Value in use
● NRV = Net realisable value.
Impairment of subsidiary
Question: Fakenstock
A parent, Fakenstock, bought 100% of the equity of a sub at the year start for $900m. Share capital was $100m, reserves were $400m and retained profits for the year were $200m.
Goodwill has in infinite life and an impairment review of the sub at the first year end revealed a value in use (VIU) of $780m and net realisable value (NRV) of $350m.
Required
Goodwill.
Question: Terra
A parent, Terra, buys 70% of a sub for $800m at the year start, when the share capital is $50m, reserves are $350m and a fair value adjustment (FVA) of $100m is required on machines with a life of five years. The fair value of the non-controlling interest is $317m
During the year the sub made profits retained of $50m and sold goods valued at $12m to the parent with a margin of 25%; one third of which is still in inventory in the parent.
Goodwill has an infinite life and a year end review reveals a value in use (VIU) of $360m and net realisable value (NRV) of $666m.
It is the group‘s policy to value the non-controlling interest at fair value (full goodwill).
Required
CHANGES IN OWNERSHIP
A parent may simply buy or sell shares. However, the group viewpoint is quite different. A group only acquires a sub when it gets control and only sells a sub when it loses control. Other share exchanges are simply changes in ownership and result in transfers. The examiner has written an article on this element of IFRS3. It is available at accaglobal.com within the P2 section under ―Technical Articles‖. It was published in February 2009. The following illustrative questions take their non-controlling interest from valuation at fair value of identifiable net assets (partial goodwill) to valuing at fair value as indicated by market price at acquisition (full identifiable net assets of Boy at the point of acquisition was $180m. The fair value of the NCI was $80m. The group has the policy of recognising the non-controlling interest fair value.
Required
(a) Goodwill.
At the year end, Toy acquires a further 5% of Boy for $24m. Boy has made profits and grown by $20m over the year and therefore the carrying value of Boy is $200m at the year end.
Required
Question: Love
At the year start, Love acquired 90% of Rat for $450m. The fair value of the identifiable net assets of Rat at the point of acquisition was $380m. The fair value of the NCI was $45m. The group has the policy of recognising the non-controlling interest fair value.
Required
(a) Goodwill.
At the year end, Love disposes of 10% of the equity of Rat for $55m and so reduces its ownership to 80%. Rat has made profits and grown by $20m over the year and therefore the carrying value of Rat is $400m at the year end.
Required
(b) Transfer to NCI and increase in controlling interest.
Question: Rock
At the year start, Rock acquired 60% of Star for $360m. Star had identifiable net assets with a fair value of $400m at acquisition and the fair value of the NCI was $200m. Rage has the policy of valuing NCI at the fair value of identifiable net assets, but on this occasion it chooses to recognise NCI at fair value.
At the year end, Rock sells 15% of Star for $150m and loses control, but retains influence through its remaining 45% ownership. The fair value of the associate retained is measured at $420m.
At the year end Star had identifiable net assets of $430m. The growth of $30m had been reported through the income statement.
Required
Supplementary Question: Freddie
On 1 January four years ago, Freddie acquired 80% of the shares of Mercury for $500,000. Mercury had share capital of $100,000 (nominal $1 each) and had reserves of $200,000. No shares have been issued since acquisition. At acquisition, the fair value of the net assets was $320,000. The fair value adjustment related to inventory, that was sold immediately after the acquisition. Goodwill has been tested for impairment at each year end since acquisition. No goodwill has been impaired since then. It is the group‘s policy to value the non -controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
The income statements for the year ended 31 December in the current year are as follows:
Operating profits 400 140
Dividend income 80 -
Opening retained earnings at the current year start 5,000 340
Freddie sold half of its holding in Mercury on 1 July in the current year. Freddie received cash proceeds of $430,000, but this has been recorded in a suspense account on the statement of financial position. The group accounts of Freddie group have been prepared and are presented above. However, the accounts of Mercury have not yet been consolidated because of the mid year disposal.
Freddie retains influence over Mercury via its remaining shareholding. The fair value of the associate retained is measured at $420,000 at disposal.
Mercury paid the interim dividend in cash on 17 April in the current year prior to the disposal.
Required
Classic question: Hebrides (parent sub associate with goodwill
impairment)
Exactly half way through the year, Hebrides acquired 80% of the share capital of Skye and 30% of the share capital of Aran. Hebrides acquired Skye by way of share for share exchange. Hebrides issued five of its own shares for two Skye shares. The market value of Hebrides‘ shares was $5 on that day. The share issue has not yet been recorded. Aran shares were acquired for $500,000 cash consideration.
It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
The summarised draft financial statements are as follows:
Income Statement or Profit and loss account for the year ended 31 March
Hebrides Skye Aran
Operating expenses (2,500) (420) (220)
_____ _____ ___
Operating profit 2,500 580 200
Interest (700) (280) (70)
Dividends received from Skye 32
_____ ___ ___
Retained profit brought forward 9,000 600 400
_____ ___ ___
Retained profit carried forward 9,600 760 500
Statement of financial position as at 31 March
Hebrides Skye Aran
$‘000 $‘000 $‘000 $‘000 $‘000 $‘000
Non current assets
Land & building 9,000 2,000 800
Plant & machinery 4,000 1,500 700
Investment in Aran 500
The following information is relevant:
(1) At acquisition the fair value of all Aran‘s assets was reasonably represented by the book value. The same was true of Skye with the exception of some land and plant. These had fair values of $400,000 and $300,000 above book values. The plant had a remaining life of five years. Depreciation is charged to cost of sales.
(2) In the post acquisition period Skye sold goods to Hebrides at $120,000. Transfer transactions were calculated to give a margin of 20% (mark up of 25%). Skye held five sixths of these goods in inventory at the year end. (3) Goodwill related to the Skye acquisition was subject to a brief impairment
review and this was sufficient to confirm that there was no impairment. However, a similar review of the goodwill related to Aran revealed that there may be an impairment. So a more detailed review was conducted which revealed a value in use of $790,000 and a net realisable value of $560,000. Goodwill impairment is separately discloseable on the face of the income statement.
(4) The current account between Hebrides and Skye did not agree due to cash in transit from subsidiary to parent of $4,000. Hebrides recorded a receivable of $25,000 at the year end. Dividends were paid in the last month before the year end.
Required
Chapter 2
CHAPTER CONTENTS
VERTICAL GROUP STRUCTURE
This occurs when a sub buys a sub-sub. Vertical group structure can often lead to a non-controlling interest greater than 50%. The examiner has written an article on this element of IFRS3. It is available at accaglobal.com within the P2 section under ―Technical Articles‖. It was published in April 2009. the following illustrative questions take their inspiration from that article.
Question: ACR
Parent A buys 60% of entity C which in turn buys 60% of entity R.
Required
Calculate the non-controlling interest in the group.
Question: PDQ
P buys 75% of entity D which buys 64% of Q.
Required
Calculate the non-controlling interest in the group.
Question: Hendrix
Hendrix (H) acquired shares in Seventy (S), which in turn acquired shares in Super Seventy (SS) many years ago. At acquisition reserves in S and SS were $60,000 and $30,000 respectively. Goodwill has been subject to an impairment review at each year end since acquisition. However, no impairment has occurred.
It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets (partial goodwill).
The Statements of financial position are as follows:
H S SS
$‗000 $‗000 $‗000
Investment in S (14,000 shares) 60
Investment in SS (6,000 shares) 50
Net assets 300 200 100
Question: Dee (slight return)
At the year start, on 1 January Mersey (M) bought 40% of Irwell (I). On 1 July Dee acquired 75% of M and 25% of I.
Goodwill has not been impaired. It is the group‘s policy to value the non-controlling interest at fair value. Fair value of the nci and reserves where as follows:
Fair value of nci Reserves
1 Jan 1 July 1 Jan 1 July
M 49 62 90 100
I 72 83 135 150
The Statements of financial position at 31 December are as follows:
D M I
$‗000 $‗000 $‗000
Investment in M 200
Investment in I 70 80
Net assets 600 112 180
___ ___ ___
870 192 180
___ ___ ___
Share capital ($1 each) 100 20 10
Reserves 770 172 170
___ ___ ___
870 192 180
___ ___ ___
Required
Exam question: Rodney
The following draft statements of financial positions relate to Rodney, a public limited company, Del, a public limited company, and Trigger, a public limited company, as at 30 November:
Rodney Del Trigger
Non-current liabilities 135 25 20
Current liabilities _____ 100 ____ 70 ____ 50 Total equity and liabilities 2,660 _____ ____ 895 ____ 450
It is the group‘s policy to value the non-controlling interest at fair value.
The following information is relevant to the preparation of the group financial statements:
(i) Rodney had acquired eighty per cent of the ordinary share capital of Del on 1 December three years ago, when the retained earnings of Del were $100 million. The fair value of the non-controlling interest was $154m at acquisition. The fair value of the net assets of Del was $710 million at that date. Any fair value adjustment related to inventory and these had been realised by the current year end. There had been no new issues of shares in the group since the current group structure was created.
(iii) The group operates in the pharmaceutical industry and incurs a significant amount of expenditure on the development of products. These costs were formerly written off to the income statement as incurred but then reinstated when the related products were brought into commercial use. The reinstated costs are shown as ‗Development Inventory‘. The costs do not meet the development criteria in IAS 38 Intangible Assets for classification as intangibles and it is unlikely that the net cash inflows from these products will be in excess of the development costs. In the current year, Del has included $20 million of these costs in inventory.
(iv) Del had purchased a significant amount of new production equipment early in the year. The cost before trade discount of this equipment was $50 million. The trade discount of $6 million was taken to the income statement. Depreciation is charged on the straight line basis over a six year period. (v) The policy of the group is now to state tangible non-current assets at
depreciated historical cost. The group changed from the revaluation model to the cost model under IAS 16 Property, Plant and Equipment at the current year start and restated all of its tangible non-current assets to historical cost in that year except for the tangible non-current assets of Trigger. These had been revalued by the directors of Trigger on the first day of the current year. The values were incorporated in the financial records creating a revaluation reserve of $70 million. The tangible non-current assets of Trigger were originally purchased on 1 December two years before the current year end, at a cost of $300 million. The assets are depreciated over six years on the straight line basis. The group does not make an annual transfer from revaluation reserves to the retained earnings in respect of the excess depreciation charged on revalued tangible non-current assets. There were no additions or disposals of the tangible non-current assets of Trigger for the two years to the current year end.
(vi) The goodwill resultant from the Del acquisition was impairment tested at the first and second year end after acquisition and again at the current year end. The first and second impairment reviews revealed no problems. However, the current review identified a recoverable value of $809m for Del. There has been no impairment in Trigger goodwill since acquisition.
Required
Prepare a consolidated statement of financial position of the Rodney Group as at 30 November.
(35 marks)
Chapter 3
CHAPTER CONTENTS
INTRODUCTION TO FOREIGN CURRENCY TRANSLATION --- 37
FOREIGN TRANSACTIONS --- 37
INTRODUCTION TO FOREIGN CURRENCY TRANSLATION
This chapter addresses the process of translating foreign currency information into the home currency (IAS 21 and FRS 23).
This chapter answers two questions: (1) Foreign transactions
‗How do I account for my foreign transactions?‘
(2) Foreign subsidiaries
‗How do I account for my foreign subsidiaries?‘
FOREIGN TRANSACTIONS
The process of translating individual foreign transactions is referred to by the rather clumsy expression ―the individual company stage‖ within the FRSs.
Foreign transactions are translated into the home currency and foreign monetary items on the statement of financial position are re-translated at the year end. This can be shown using the old UK style of statement of financial position presentation:
Non current assets x Non-monetary Translate
Current assets items and leave
Inventory x
Receivables x
Bank x Monetary Translate and
Creditors < 1 year (x) items retranslate
Question: Furtive
A company buys a machine on three months credit from France for €50,000 just before the year end of 31.12. It takes delivery on 15.12. The rates are as follows:
Date Rate
Delivery (15.12) $1: €1.25
Y/e (31.12) $1: €1.30
Required
Journals.
Question: Feature
A company buys a fixed asset on three months credit two weeks before the year end for 90,000 Roubles. Rates are as follows:
Date Rate
Delivery $1: 10 Roubles
Y/e $1: 9 Roubles
Required
Journals.
Question: Feature (continued)
The company pays the creditor on schedule in the new year.
Date Rate
Year start $1: 9 Roubles
Payment $1: 9.2 Roubles
Required
FOREIGN SUBSIDIARIES
Group stage
A foreign subsidiary needs translation before consolidation:
Statement Rate
Statement of financial position Closing rate
Profit and loss Average rate
Goodwill
Question: Kenya
Kenya owns 90% of the ordinary shares of a foreign subsidiary, Malawi, which has the functional currency of the kwacha. The subsidiary was acquired at the start of the current accounting period for 1,200,000 kwachas, when its reserves were 700,000 kwachas.
At the date of the acquisition the fair value of the net assets of the subsidiary were 1,000,000 kwachas. This included a fair value adjustment in respect of land. The land has not been sold.
Goodwill is estimated to have an infinite life, but has not been impaired. It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
Statement of financial position Kenya
Shillings ‗000
Malawi
Kwachas ‗000
Investment in Malawi 500
Other Net Assets 17,500 1,100
Operating Costs (22,500) (1,160)
Profit before tax 5,500 540
Tax (1,900) (190)
Profit after tax 3,600 350
Relevant exchange rates are:
Date Exchange rate (Kwachas to 1 Shilling)
Year start 2.4
Year end 2.1
Weighted average for year 2.2
Required
Prepare a consolidated statement of financial position, consolidated income statement and a consolidated movement on reserves.
Note: round figures to the nearest 1,000.
Note to students
Exam question: Xenon
Xenon (X) owns 60% of Gallium (G), a company situated in a foreign country. The currency of this country is the Kram (Kr). X acquired G at the beginning of the year, on 1 January.
It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
Income statement for current year ended 31 December
X G
Operating expenses (500) (1,000)
_____ _____
Operating profit 1,000 3,000
Dividends received 60
Interest expense (100) (300)
Interest income 40 100
Profit transferred 700 1,600
_____ _____
Reserve Movement
Accumulated profits brought forward 1,140 1,200
Dividends paid (100) (800)
Profit transferred 700 1,600
_____ _____
Accumulated profits carried forward 1,740 2,000
Statement of financial position as at 31 December
Current assets 2,000 2,200
Current liabilities (1,000) (1,000)
Non current liabilities (1,200) (700)
_____ _____ (2) G has applied local GAAP, but has made some attempt to adapt to IFRS (UK
FRS). As a result, the subsidiary has written off research previously capitalised as an extraordinary item prior period adjustment in the sum of Kr100 million. The remainder of the extraordinary item is the recognition of a fall in value of some plant that was damaged during the year.
(3) The fair value of the net assets of G at acquisition was Kr2,000 million after taking into account the removal of capitalised research discussed above. Goodwill is unimpaired. The increase in the fair value of G over carrying value is attributable to machines which are depreciated over five years on the straight line basis.
(4) During the year, X sold $30 million in goods to G at a margin of 20%. All of the goods had been utilised in production by the year end, but only one half of the relevant finished goods have been sold. G received the goods on 16 June and paid on 17 July. The foreign exchange difference remains in current liabilities.
(5) X made a loan of $50 million to G immediately after the acquisition on 1 January. This is still outstanding at the year end. The parent has recorded the asset in current assets. The subsidiary has recorded the liability in non current liabilities at the rate ruling at the year start.
(6) The following exchange rates are relevant:
Kram to $1
1 January 5
16 June 6
17 July 6.5
31 December 8
Required
(a) Prepare the income statement and statement of financial position for the
group for the current year. (30 marks)
(b) Prepare a movement in consolidated reserves for the current year. (5 marks)
(Total 35 marks)
(ACCA June 1998)
(Note: round to the nearest million)
Note to students
Chapter 4
CHAPTER CONTENTS
INTRODUCTORY QUESTIONS --- 47
INTRODUCTORY QUESTIONS
Here are a few introductory questions to remind you how to calculate the cash flow from incomplete records:
Example 1 Non current assets
The following information was extracted from the financial statements of an entity:
Current Comparative
Non current assets 900 700
Revaluation gain 70
Impairment 30
Depreciation 60
Disposal at net book value 40
Finance lease additions 10
Required
Calculate the cash flow additions.
Example 2 Tax
The following information was extracted from the financial statements of an entity:
Current Comparative
Corporation tax 400 350
Deferred tax 110 120
Income statement charge 410
Tax liability in sub disposal 20
Required
Calculate the cash flow payment to the tax authorities.
Example 3 Associate
The following information was extracted from the financial statements of an entity:
Current Comparative
Investment in associate 900 670
Share of associate profits in P&L 430
Forex gain on foreign associate 40
Required
EXAM QUESTIONS
Now all that is required is to do some exam questions to practice the techniques.
Exam question: Squire
The following draft financial statements relate to Squire, a public limited company:
Draft group statement of financial position at 31 May
Current Comparative
Non-current assets $m $m
Intangible 80 65
Tangible 2,630 2,010
Investment in associate 535 550
Retirement benefit asset _____ 22 _____ 16
3,267 2,641
_____ _____
Current assets
Inventories 1,300 1,160
Trade receivables 1,220 1,060
Cash at bank and in hand _____ 90 _____ 280
2,610 2,500
_____ _____
Total assets _____ 5,877 _____ 5,141
Capital and reserves
Nominal share capital 200 170
Share premium 60 30
Revaluation reserve 92 286
Accumulated profits _____ 508 _____ 505
860 991
Non-controlling interest 522 345
Non-current liabilities 1,675 1,320
Provisions for deferred tax 200 175
Current liabilities _____ 2,620 _____ 2,310
Draft group income statement for the year ended 31 May
$m
Revenue 8,774
Cost of sales (7,310) _____
1,464
Distribution and administrative expenses (1,030) _____
Profit from operations 434
Share of operating profit in associate 65
Interest expense _____ (84)
Profit before tax 415
Income tax expense (including tax on associate $20million) _____ (225)
Profit for the period 190
_____ Attributable to:
Equity holders of the parent 98
Minority interest _____ 92
Profit for the period _____ 190
Draft statement of changes in controlling interest equity for the year ended 31 May
$m
Opening Shareholders' Funds 991
Profit for period 98
Dividends paid (85)
Foreign exchange difference of associate (10)
Reversal of revaluation surplus (194)
New shares issued ____ 60
Closing Shareholders' Funds ____ 860
The following information relates to Squire:
(i) Squire acquired a seventy per cent holding in Hunsten Holdings, a public limited company, during the year. The fair values of the net assets acquired were as follows:
$m
Tangible non-current assets 250
Inventories and work in progress 70
Receivables 100
Payables (90)
Provisions for onerous contracts ____ (30)
300 ____
impairment loss has been recognised during the year in respect of goodwill and charged to the income statement within cost of sales. It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
(ii) There had been no disposals of tangible non-current assets during the year. Depreciation for the period charged in cost of sales was $129 million.
(iii) Current liabilities comprised the following items:
Current Comparative
$m $m
Trade payables 2,355 2,105
Interest payable 65 45
Taxation _____ 200 _____ 160
2,620 _____ 2,310 _____
(iv) Non-current liabilities comprised the following:
Current Comparative
$m $m
Deferred consideration - purchase of Hunsten
50 -
Liability for the purchase of non-current assets
355 -
Loans 1,270 _____ 1,320 _____
1,675 _____ 1,320 _____
(v) The retirement benefit asset increased due to a substantial cash investment during the year. The only other retirement benefit issue was a charge of $20m to the income statement.
Required
Prepare a group cash flow statement using the indirect method for Squire group for the year ended 31 May.
The note regarding the acquisition of the subsidiary is not required.
Exam question: Ducky Group
The following draft financial statements relate to the Ducky Group:
Draft group statement of financial position at 31 May
Current Comparative
Share premium account 185 75
Revaluation reserves 90 10
Retained earnings 1,218 ____ ____ 725
1,593 870
Non-controlling interest ____ 157 ____ 107
1,750 977
Non-current liabilities
Deferred Tax 390 417
Redeemable preference shares 200 230
Loans 1,005 ____ ____ 570
1,595 1,217
Current liabilities 1,231 ____ 1,124 ____
Draft group income statement for the year ended 31 May
$m
Revenue 9,425
Cost of sales (7,878) ____
Gross profit 1,547
Distribution and administrative expenses ____ (757)
Profit from operations 790
Income from associates 98
Interest income 23
Interest expense ___(45)
Profit before taxation 866
Tax (213) ___
Profit for the period 653
___ Attributable to:
Equity holders of the parent 584
Minority interests ___69
Profit for the period 653 ___
Draft statement of changes in controlling interest equity for the year ended 31 May
Surplus on revaluation 80 80
Net profit for members 584 584
The following information is relevant to the Ducky Group:
(i) Ducky acquired a 90% per cent holding in Prince during the year. The fair values of the assets of Prince on that day were as follows:
$m
Non-current assets (tangible) 172
Inventories 33
Trade receivables 27
Cash and cash equivalents 3
Trade payables (22)
Taxation ___(13)
200 ___
An impairment loss has been recognised on the goodwill arising on this acquisition and is included in cost of sales. It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
(ii) The remainder of the shares issued during the year were issued for cash during a rights issue. Ducky had allotted 20 million ordinary shares for cash during this issue.
(iii) The tangible non-current asset movement for the period included the following amounts at net book value.
$m
Disposals 40
Depreciation 51
The disposal resulted in a profit on disposal of $7million, included in cost of sales.
(iv) Current liabilities comprised the following items:
Current comparative
(vii) The preference share dividends are always paid in full on 31 May each year and are included in interest in the income statement. Part of the preference capital was redeemed during the year.
Required:
Prepare a group cash flow statement using the indirect method for the Ducky Group for the year ended 31 May.
The notes to the cash flow statement are not required.
Exam question: Duke Group
The following draft financial statements relate to the Duke Group:
Draft group statement of financial position at 31 May
Current Comparative
Revaluation reserves 30 10
Retained earnings ____ 200 ____ 103
415 198
Non-controlling interest 250 150
Non-current liabilities
Deferred Tax 200 230
Redeemable preference shares 100 130
Interest-bearing borrowings 1,098 ____ ____ 700
1,398 1,060
Current liabilities 1,501 ____ 1,213 ____
Draft group income statement for the year ended 31 May
$m $m
Revenue 7,310
Cost of sales (5,920) ____
Gross profit 1,390
Distribution and administrative expenses ____ (757)
Profit from operations 633
Income from associates 98
Interest income 34
Interest expense ___ (37) ___(3)
Profit before taxation 728
Tax (including tax on associates $15 million) (213) ___
Profit for the period 515
___ Attributable to:
Equity holders of the parent 418
Minority interests ___97
Profit for the period 515 ___
Draft statement of changes in controlling interest equity for the year ended 31 May
Surplus on revaluation 20 20
Net profit for period 418 418
The following information is relevant to the Duke Group:
(i) Duke acquired an eighty per cent holding in Regent during the year. The fair values of the assets of Regent on that day were as follows:
$m
Non-current assets (tangible) 60
Inventories 30
Trade receivables 25
Cash and cash equivalents 35
Trade payables (20)
Taxation ___(30)
100 ___
impairment loss has been recognised on the goodwill arising on this acquisition and is included in cost of sales. It is the group‘s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary‘s net assets.
(ii) The remainder of the shares issued were issued for cash during a rights issue. Duke had allotted 10 million ordinary shares for cash during this issue.
(iii) The tangible non-current asset movement for the period included the following amounts at net book value.
$m
Disposals 30
Depreciation 39
The disposal resulted in a profit on disposal of $15million, included in cost of sales.
(iv) Current liabilities comprised the following items:
Current Comparative supplier on the purchase of non current tangible assets and which is payable on in five years.
(vi) The exchange differences included in the statement of changes in equity relate to the foreign associate. There was no dividend income from the associate during the year. Instead, a huge cash injection was required to support the associate.
(vii) The preference share dividends are always paid in full on 31 May each year and are included in interest in the income statement. Part of the preference capital was redeemed during the year.
Required:
Prepare a group cash flow statement using the indirect method for the Duke Group for the year ended 31 May.
The notes to the cash flow statement are not required.
Chapter 5
CHAPTER CONTENTS
REORGANISATION --- 59
CORPORATE SOCIAL RESPONSIBILTY --- 60
THE FRAMEWORK FOR FINANCIAL REPORTING --- 60
FAIR VALUE --- 60
PROFESSIONAL AND ETHICAL BEHAVIOUR --- 61
ENVIRONMENTAL AND SOCIAL REPORTING --- 61
OPERATING AND FINANCIAL REVIEW --- 61
NOT-FOR-PROFIT ENTITIES --- 62
SMALL AND MEDIUM ENTITIES --- 62
REORGANISATION
CORPORATE SOCIAL RESPONSIBILTY
Corporate Social Responsibility (CSR) and Current Issues are phrases used by the examiner and other commentators to address the broad subjects of corporate governance, the reporting of information to users within that framework of corporate governance and the development of standards to ensure that communication is clear and understandable.
The subject of CSR is examined in question 4 of the exam, which requires a pure narrative answer. Whilst the examiner himself does not distinguish particularly between the subcomponents of CSR, the syllabus does. So this chapter looks at each in order:-
The framework for financial reporting Fair value
Professional and ethical behaviour Environmental and social reporting
Operating and Financial Review (Management Commentary) Not-for-profit entities
Small and medium entities Convergence
THE FRAMEWORK FOR FINANCIAL REPORTING
The framework for financial reporting (referred to as The Statement of Principles in the United Kingdom) requires that financial statements communicate performance, position and cash flow for an entity to user. So of course, the framework requires an income statement, statement of financial position and cash flow statement. However, the framework leans heavily towards the statement of financial position and so the key concept in financial reporting is the definition of an asset/liability.
FAIR VALUE
However, as we all know, the values of assets and liabilities as represented on the statement of financial position are rarely a reflection of the true worth. This is because accounting is coming from a system of financial reporting called ―Historical Cost Accounting‖ (HCA), which as the name suggests, is based on historical costs being used on the statement of financial position. Financial reporting is moving towards a system called ―Fair Value Accounting‖ (FVA). As the name suggests, this uses the real economic value of assets and liabilities on the statement of financial position in order to better reflect a true and fair view of financial position.
PROFESSIONAL AND ETHICAL BEHAVIOUR
Clearly, financial reporting requires that the directors present financial statements that show a true and fair view. This in turn requires that the directors adopt a professional and ethical behaviour. This area of corporate social responsibility is widely referred to as ―corporate governance‖ and whilst it is regularly examined in passing, the examiner does not require detailed knowledge of regulation.
ENVIRONMENTAL AND SOCIAL REPORTING
Most companies present environmental and social reports (ESR) to their shareholders as part of their annual report. Usually the finance team become involved in creating this report. The two issues that the examiner addresses when considering this subject is the difficulties of measuring environmental and social performance and the challenge of communicating these sensitive issues.
OPERATING AND FINANCIAL REVIEW (MANAGEMENT
COMMENTARY)
The operating and financial review (OFR) is presented along with the financial statements to make up the annual report. Essentially, it repeats the information within the fs, but makes that information more accessible for users.
Recently, it has swallowed up the environmental and social reporting and so now it includes sections on green performance and human resource management. More recently still, the report has begun to look forward as well as back and so now has large sections on future risks to the company and the strategies used to address those risks.
NOT-FOR-PROFIT ENTITIES
Essentially, charities and government agencies present financial statements that are little different from private sector entities. The not-for-profit financial statements use the same financial reporting standards and the same style of presentation. The only minor difference is in the income statement. These entities do not make a profit, so they present a performance statement simply listing their income and expenditure.
SMALL AND MEDIUM ENTITIES
It is widely accepted that IFRS are bulky and the presentation of fs using IFRS is a substantial bureaucratic burden. Large companies are big enough to shoulder this burden, but small and medium companies feel this expense disproportionately because of their size.
So many countries have utilised a two tier accounting system widely called ―big GAAP little GAAP‖ (generally accepted accounting principles). Each country has set a threshold above which companies are required to produce full fs using full IFRS (or equivalent) and below which companies are required to produce reduced fs with less disclosure. This makes SME accounting much cheaper in these countries. The IASB have until recently ignored this issue. However, following extreme pressure, they have reviewed the problem and a Discussion Paper has resulted. It proposes that all companies should be able to produce reduced fs, provided they are not public interest companies (that is, not quoted or offering financial services). So unless your company is quoted or offering financial services, then it is an SME and can produce reduced fs.
However, the proposals have been widely criticised because the reduced fs are very little reduced from the full fs. This means that even if your company qualifies as SME, you will produce fs just as bulky as would have been required had your company failed to qualify.
CONVERGENCE
Companies and counties are increasingly adopting international financial reporting standards (IFRS). This process is called ―convergence‖. It is widely accepted that it is a good thing for companies and the users of the financial statements because of the increased global consistency that results.
RELEVANT RECENT ARTICLES
Great and Small
The move towards convergence and the effects on small and medium entities
Shariq Barmaky and Soh Lin Leng consider plans to introduce differential reporting for SMEs in Singapore
In May 2008, the Accounting Standards Council (ASC) in Singapore published a consultation paper on a proposed differential reporting framework for SMEs, indicating a positive direction towards exempting SMEs from the full-scope Singapore Financial Reporting Standards (FRS).
FRS is modelled after the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). IFRS is a comprehensive set of standards aimed at producing high-quality financial reporting that facilitates cross-border transactions and capital-raising. However, due to its complexity, its benefits are better understood and appreciated by the more sophisticated users in the marketplace.
There is no doubt that enterprises with high levels of public accountability, such as listed companies and financial institutions, should continue to comply with full-scope FRS in their general-purpose financial statements. However, applying the complex and constantly evolving standards often requires significant investments in time and resources. The question is whether such costs are necessary for smaller private entities, whose financial statements have limited and potentially less demanding users.
The study presented in the ASC consultation paper indicated that several countries, including Australia, Canada, Hong Kong, Malaysia, New Zealand and the United Kingdom, plus the European Union, have already adopted differential reporting for SMEs. The IASB has also acknowledged the need for an internationally acceptable set of financial reporting standards for SMEs, with its active project on IFRS for SMEs (now retitled, IFRS for Private Entities).
Despite a dissenting view that a second set of financial reporting standards could cause more confusion, there appears to be general consensus that it is acceptable for SMEs to use a simpler, less complicated set of financial reporting standards. Cost-benefit considerations are noted to be the fundamental reason for this emerging trend of differential reporting for SMEs.
With experience to be gained from SME reporting practices worldwide, and an active IASB project on IFRS for Private Entities, it is an appropriate time to explore the possibilities of implementing similar differential reporting for SMEs in Singapore. The top-most benefit is definitely cost savings to SMEs. As SMEs form an important part of our growing economy, such a measure would add to the attractiveness of this business segment.
