Examination Technique Seminar (Essay) for Module A on Financial Reporting. Speaker Ms. Minnie Leung

Transcription

1 Examination Technique Seminar (Essay) for Module A on Financial Reporting Speaker Ms. Minnie Leung 28 May 2014

2 1. Exam Techniques Before the exam 1. Understand the important and new topics (e.g. new accounting standards and interpretations, topics discussed in seminars) 2. Practise past papers 3. Read the examination panelists reports 4. Index your notes for examination by topics Part A: Legal environment Part B: Financial reporting framework Part C: Accounting standards for transactions - Non-current assets - Lease - Provision Part D: Group financial statements In the exam 1. Read the requirement carefully a) Explain/discuss/advise/comment No calculation b) Calculate No detailed explanation c) Explain/discuss/advise/comment with detailed calculation 2. Consider marks allocated 3. Draw diagram or timeline to assist your understanding of the question and the relationship between different parties 4. Plan your answer i) Principles (Accounting standards and/or interpretation) ii) Analyse the case (Apply the principles) iii) Conclusion iv) Recommendation 5. New page for new question (or part) 6. Time management Leave question unanswered Spend too much time on finding reference Spend too much time on copying the material 7. Use correct format required E.g. Letter, memo or report June

3 2. Review Past papers and Examination panelist s report Page Non-current assets Q1 Ralland Corp Investment properties, PPE Dec 2013 B3 4 Q2 Winner Sports Ltd Impairment of CGU, bottom up and top down approach Jun 2013 B3 12 Provision, Contingent liabilities and contingent assets Q3 Xprint Ltd Discount coupon, warranty, litigation Dec 2013 B4 20 Construction contract Q4 Newtop Construction Co Ltd Construction contract, stage of completion Jun 2013 B2 27 Income tax Q5 Rider Games Inc Deferred tax calculation, director's duties Dec 2013 B2 34 Financial Instruments Q6 Canyo Co Ltd Financial liabilities, terms modification Jun 2013 B4 39 June

4 Q1 Ralland Corp (Dec 2013 B3) Ralland Corp (RLC), a property development and investment company, has the following properties at 31 December 2012, the end of the previous financial year: Carrying amount Original cost HKD'M HKD'M Investment property Tower A Investment property under construction Tower B Office building Tower C Office building Tower D The company adopts the cost model for owned used property and the fair value model for investment property. All four properties were acquired in 2010 with an expected useful life of 50 years. Depreciation, if applicable, is calculated on a monthly basis and commenced on 1 July To enhance the profitability of the property portfolio, RLC carried out the following activities: (a) (b) (c) (d) Moved its headquarter from Tower C to Tower A upon the expiry of the lease with the tenant at the end of March 2013; Refurnished Tower C at a cost of HKD1.8 million in April and May 2013 and then rented it out to earn rental income since 1 June 2013; Completed the construction of Tower B by end of May 2013 with additional expenditure of HKD3.8 million; and Sold Tower D at HKD30 million to an independent third party and entered into a lease of the premises for 2 years at a market rental of HKD80,000 per month on 1 May An external valuer has been engaged to perform a valuation for all the properties except Tower D and the estimated fair values at 31 March 2013 and 30 June 2013 are as follows: 31 March June 2013 HKD'M HKD'M Tower A Tower B Tower C June

5 Required: (a) Explain the implication of the activities occurred during the six months ended 30 June 2013 on the classification and the effective date for each of the properties of RLC. (6 marks) (b) Determine the carrying amount at 30 June 2013 for each of the properties owned by RLC. (5 marks) (c) Identify the nature and quantify the amount of each income and expenses item to be recognised in the statement of comprehensive income for the six months ended 30 June 2013 of RLC in relation to each of these properties. (12 marks) Note: Ignore tax effect and rental income from investment properties. Examiner s comment Question (a) Performance: Satisfactorily Common mistake: not able to clearly express the change from one category to another just stated the classification as at the end of the financial period Question (b) Performance: Satisfactorily Common mistake: The challenging part was that one of the properties was reclassified from investment property at fair value model to owner occupied property at cost model made mistake in determination of the remaining useful life for the calculation of deprecation and resulted for an incorrect carrying amount. Question (c) Performance: Only the outstanding candidates could manage part (c). Most of the candidates are able to identify deprecation charge, fair value gain on revaluation of investment properties, gain or loss on disposal of owneroccupied properties and rental expenses. Common mistake: made mistakes in their calculations, therefore they could not score a high mark not realised that the revaluation gain on the reclassification of an owner-occupied property to an investment property should be recognised in the other comprehensive income. June

6 Key concept for Q1 Ralland Corp (Dec 2013 B3) Source: HKICPA Module A Learning pack p June

7 Key concept for Q1 Ralland Corp (Dec 2013 B3) Source: HKICPA Module A Learning pack p June

8 Key concept for Q1 Ralland Corp (Dec 2013 B3) Source: HKICPA Module A Learning pack p June

9 Answer to Q1 Ralland Corp (Dec 2013 B3) Answer (a) Tower A is reclassified from an investment property under HKAS 40 to an owner-occupied property under HKAS16 upon commencement of occupation for own use at end of March 2013 (or since April 2013). Tower B is treated as an investment property continuously, but transferred from under construction to completed property upon completion of the construction by end of May 2013(or since June 2013). Tower C is reclassified from owner-occupied property to investment property upon the end of the owner-occupation from 1 April Tower D is derecognised as an asset from 1 May 2013 under the sales and operating lease back arrangement. June

10 Answer (b) Carrying amount at 30 June 2013: Tower A Owner-occupied property stated at cost model Deemed cost at 31 March 2013: fair value of HKD26.4 million Depreciation for 3 months ended 30 June 2013: HKD 26.4 million x (0.25 year / years) = HKD 0.14 million Cost less accumulated depreciation: HKD26.4 million 0.14 million = HKD26.26 million Tower B investment property stated at fair value of HKD19.2 million Tower C investment property stated at fair value of HKD40.0 million June

11 Answer (c) Amounts recognised in the income statement for the six months ended 30 June 2013: Fair value gain on investment properties = HKD2 million Tower A: HKD26.4 million 25.8 million = HKD0.6 million Tower B: HKD19.2 million (14.2 million million) = HKD1.2 million Tower C: HKD40.0 million (38.0 million million) = HKD0.2 million Depreciation of owner-occupied properties = HKD0.41 million Tower A: HKD0.14 million Tower C: HKD30 million x (0.25/50) or (3mths/ 600mths)= HKD0.15 million Tower D: HKD18 million / 50 x 4/12 or HKD18 million / 600 mths x 4mths = HKD0.12 million Gain on disposal of owner-occupied property = HKD13.02 million Tower D: HKD30 million (17.1 million million) = HKD13.02 million Operating lease expense of Tower D = HKD0.16 million (HKD0.08 million x 2) Amount recognised in the other comprehensive income for the six months ended 30 June 2013: Revaluation gain on reclassification of owner-occupied property to investment property Tower C: HKD38.0 million (28.5 million million) = HKD9.65 million June

12 Q2 Winner Sports Ltd (Jun 2013 B3) Winner Sports Limited (WSL) is a sports shoe manufacturer and it sells its products under two different brands, Run Pro and Jog Pro, which were acquired in Both units have been established for the research and development, design, manufacturing, and marketing the products of individual brands with their own production plant and sales teams. In the past two years, the sales performance for Run Pro has deteriorated significantly due to the keen competition in the market and the lack of new designs and models introduced, while Jog Pro has achieved a double digit growth of sales. The management is considering to re-allocate resources to enhance the profitability of the entity. The statement of financial position showed the following assets at 30 June 2012: Run Pro Joy Pro Total $'000 $'000 $'000 Brand 25,000 5,000 30,000 Plant and equipment 40,000 25,000 65,000 Development cost capitalised 6,000 3,000 9,000 Inventories 12,000 8,000 20,000 83,000 41, ,000 Both brands are determined to be of indefinite life. No impairment has been recognised since acquisition. The above are the only assets that are directly attributable to the brands. Corporate assets are negligible. For the purpose of preparation of the annual financial statements, the management has carried out the following estimation: Run Pro Joy Pro Total $'000 $'000 $'000 Value in use 64,000 60, ,000 Fair value less cost to sell - Unit as a whole 60,000 58, ,000 - Plant and equipment 36,000 22,000 58,000 - Development cost capitalised nil nil nil Inventories are excluded from the cash generating unit (CGU) carrying value and the impact has been properly incorporated in determining the value in use. Impact of other working capital is minimal. The fair value less costs to sell of individual items under plant and equipment are indeterminable. Inventories are with net realisable value / fair value less costs to sell higher than their carrying amount. June

13 Required: (a) (b) (c) Briefly discuss and advise whether WSL is required to conduct asset impairment review at 30 June (3 marks) The total of value in use of both brands is higher than their total net assets, there is no impairment issue. Comment on this statement with reasons. (5 marks) Determine the impairment of assets with detail calculation, if any, to be recognised by WSL at 30 June (9 marks) Examiner s comment Question (a) Performance: Average Common mistake: answered with detailed explanations of internal and external indicators of impairment set out in the standard which did not address the circumstances given in the question spent too much time providing answers which scored few marks. Question (b) Performance: Average Common mistake: failed to discuss the subject matter and failed to take into account that each brand is to be considered as a CGU. Question (c) Performance: Average Common mistake: had difficulties to correctly allocate the impairment loss on a pro-rata basis to individual assets within a CGU June

14 Key concept for Q2 Winner Sports Ltd (Jun 2013 B3a) Source: HKICPA Module A Learning pack p June

15 Key concept for Q2 Winner Sports Ltd (Jun 2013 B3b) Source: HKICPA Module A Learning pack p June

16 Answer to Q2 Winner Sports Ltd (Jun 2013 B3) Answer (a) Based on the information provided in the question, the significant deterioration of Run Pro s sales performance is an impairment indicator. When such an indication exists, the entity shall estimate the recoverable amount of the asset of Run Pro. The brand, being an intangible asset with indefinite useful life, and therefore no amortisation is recognised, is required to be tested for impairment at least annually, irrespective of whether there is any indication of impairment. Accordingly, WSL is required to perform an asset impairment review in both Run Pro and Jog Pro at 30 June June

17 Answer (b) An asset or cash generating unit (CGU) is considered to be impaired when its recoverable amount declines below its carrying amount. The recoverable amount of an asset or a CGU is the higher of its fair value less costs to sell and its value in use. The recoverable amount is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. If that is the case, the recoverable amount is determined for the CGU to which the asset belongs, unless either: The asset s fair value less costs to sell is higher than its carrying amount; or The asset s value in use can be estimated to be close to its fair value less costs to sell and fair value less costs to sell can be determined. A CGU is the smallest group of assets that generates largely independent cash inflows. This may be a single asset or group of assets. Based on the information provided, each brand is considered as a cash generating unit. The value in use of the group of assets (i.e. the intangible asset, plant and equipment, developed cost capitalised and inventories) under individual brands and fair value less costs to sell of each of the two brands and individual categories of assets are determinable. HKAS 36 has a bottom-up approach to impairment testing. It is incorrect to compare the aggregate value in use with the total net assets of both brands to determine whether an individual brand or other asset is impaired. June

18 Answer (c) Run Pro Jog Pro $000 $000 Net assets of the CGU, other than inventories (a) 71,000 33,000 Value in use of the CGU (b) 64,000 60,000 Fair value less cost to sell of the CGU (c) 60,000 58,000 The recoverable amount (d) (The higher of (b) and (c)) 64,000 60,000 Recoverable amount > Carrying amount of assets under the CGU NO YES Impairment issue YES NO Excess of net assets over the recoverable amount (d) (a) = (e) (7,000) According to the result above, the brand "Run Pro" is considered impaired and the impairment loss, HK$7 million, should be first allocated pro-rata on the basis of the carrying amount of each individual assets. Allocation of impairment loss on pro-rata basis: Carrying Impairment After value Pro-rated allocation $000 $000 $000 Brand 25,000 (7,000 x 25/71) 2,465 22,535 Plant and equipment 40,000 (7,000 x 40/71) 3,944 36,056 (note 1) Development cost 6,000 (7,000 x 6/71) 591 5,409 (note 2) 71,000 7,000 64,000 When allocating an impairment loss to individual assets within a CGU, the carrying amount of an individual asset should not be reduced below the highest of (i) its fair value less costs to sell (if determinable); (ii) its value in use (if determinable); and (iii) zero. If this results in an amount being allocated to an asset which is less than its pro rata share of the impairment loss, the excess is allocated to the remaining assets within the CGU on a pro rated basis. June

19 Note 1: Plant and Equipment Fair value less cost to sell (f) 36,000 Carrying amount (g) 40,000 (f) (g) = (h) (4,000) Note 2: Development cost Capitalized without determinable fair value 6,000 Less costs to sell nor value in use (i) Both development cost and plant & equipment fulfilled the requirement above and no excess impairment loss should reallocate to other assets. June

20 Q3 Xprint Ltd (Dec 2013 B4) XPrint Limited (XP), a printer manufacturer, had the following balances under current liabilities as presented in its annual management accounts as at 31 March 2013: HKD 000 Provision for discount coupon 750 Warranty provision 5,640 Litigation provision 8,000 XP has developed a new printers model and targets to promote it to its old customers. A letter was issued to 1,500 old customers to offer them a HKD500 discount to exchange the old model for the new one on or before 30 April It is expected that a profit will still be made at a discounted selling price. XP provides a one year warranty provision for all the printers it sells. Customers can request a free of charge repair service during the warranty period. A provision of HKD400,000 was made per month. Total expenditure incurred for this service, mainly costs for labour and parts replacement, was HKD3,160,000 during the year, which represented around 0.8% of the sales in the previous year. The ratio for the past five years ranged from 0.64% to 1%. Total sales for the current year amounted to HKD437 million. XP was named as a defendant in a writ of summons with a statement of claim by another printer producer in relation to the alleged infringement of patent of design, claiming for a sum of HKD9.6 million. XP intended to settle with the plaintiff out of court. An offer letter of HKD3.8 million in compensation was given to the plaintiff in January 2013 and a counteroffer of HKD5 million payable within one month was received in early March The Board of XP approved to accept the counter-offer of the plaintiff and made the payment on 20 April The lawyer issued a fee note of HKD650,000 to XP on 1 May 2013 for the relevant legal service provided during the year. Other than the existing HKD8 million provision relating to this case, XP had no other provision. June

21 Required: (a) (b) Explain and comment the appropriateness of the amount of the provisions recognised in the management accounts at 31 March (14 marks) The marketing director wrote the following to the chief financial officer on 29 March 2013: We just concluded the contract terms of a television advertisement for the new products to be launched in the coming May with a cost of HKD1.8 million. As there was still an un-utilised budget of HKD1.2 million for marketing expenses for this year, I suggest making a partial provision for this expenditure first, please approve. Do you agree the recognition of the provision at 31 March 2013? (3 marks) Examiner s comment Question (a) Common mistake: either stated the three conceptual recognition criteria of the standard or repeated the facts given in the case background could not link up the two together to explain why a provision is needed or not needed and what range of provision is considered appropriate if a provision is justified. No full or high marks could be gained without an organized answer with logical reasons. Question (b) Common mistake: could not identify it is a future obligation and thus no provision, no matter partially or fully, could be recognised at 31 March June

22 Key concept for Q3 Xprint Ltd (Dec 2013 B4) Source: HKICPA Module A Learning pack p June

23 Answer to Q3 Xprint Ltd (Dec 2013 B4) Answer (a) A provision should be recognised when and only when: An entity has a present obligation (legal or constructive) as a result of a past event; It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and A reliable estimate can be made of the amount of the obligation. Provision for discount coupon XP had the obligation to give the discount upon issue of the letter and before the expiry date. As XP is still able to make a profit, after the deduction of HKD500, for the sales of the new printer, there are no outflow of resources nor transfer of economic benefits. It may be possible for XP to make an estimate of number of new sales with the usage of the discount coupon should there have been a similar scheme in the past. Conclusion: A provision should only be recognised when all the conditions under HKAS are met. No provision should be recognised at 31 March Accordingly, the provision for the discount coupon of HKD750,000 should be reversed. June

24 Warranty provision XP has a contractual obligation to provide the free of charge repair service. XP needs to incur and has incurred the cost for labour and parts replacement for the repair service, there will be a transfer of economic benefits It is presumed that XP can make an estimate of the amount to be incurred for the provision of the repair service in respect of the product sales made in the year based on the historical performance Conclusion: A provision should be recognised at 31 March The amount recognised should be the best estimate of the expenditure recognised to settle the present obligation at the end of the reporting period. With the presumption that the ratio of expenditure incurred to the sales of the past five years is a reliable estimate of the amount to be incurred for repair services, XP should adjust downward the provision to an amount ranging from HKD2.80 million (HKD437 million x 0.64%) to HKD4.37 million (HKD437 million x 1%). OR Assuming 0.8% of the sales is considered to be the best estimate of the amount to be incurred for the repair service, XP can adjust downward to approximately HKD3.5 million (437 million x 0.8%). June

25 Litigation provision XP is considered to have an obligation to compensate the plaintiff that arises from a past sales transaction. The compensation of cash payment represents a transfer of economic benefits for XP. It is presumed that XP could make an estimate of the compensation amount taking into consideration the offer given by XP and counter-offer from the plaintiff approved by the Board. The payment made in April is an adjusting event after the reporting period. Conclusion: The provision should be adjusted downward to HKD5,650,000, i.e. HKD5 million compensation to plaintiff and HKD650,000 legal fee for provided services. June

26 Answer (b) Disagree with the comment. No provision should be recognised at 31 March 2013 for the cost of television advertising to be launched after the end of the reporting period because: The agreement is executory and XP had no present obligation (or XP had future obligation only) for the future services to be received from the counter-party. HKAS 37 does not allow artificial smoothing of results by early recognition in the profit or loss before the costs are actually incurred. June

27 Q4 Newtop Construction Co Ltd. (Jun 2013 B2) Newtop Construction Company Limited is a construction company and has two contracts underway as at 30 September 2012: Contract A Contract B $'000 $'000 Total agreed contract sum 42,000 65,000 Estimated total costs (original budget) 36,000 63,000 Costs incurred to date 25,600 30,000 Contract sum certified and billed to date 28,000 26,000 Total billing received to date 22,800 23,500 Revenue recognised up to 30 September ,200 N/A Costs recognised up to 30 September ,600 N/A Management has reassessed the cost budget and considered that the original budget of contract A is reasonable while the budgeted total costs for contract B should be revised upward by 5%. The stage of completion is determined based on the survey of work performed by external architects at each month end. June

28 Required: (a) Calculate the amounts to be recognised in profit or loss in the year ended 30 September (10 marks) (b) Show the amounts to be disclosed and presented under HKAS 11 Construction Contracts for Contacts in Progress as at 30 September (9 marks) Examiner s comment Question (a) Performance: Diverse A relatively large number of high scores and low scores as a result of the correct or incorrect application of the stage of completion. Common mistake: missed the fact given in the question that the stage of completion was determined based on the survey of work performed by external architects determined the percentage of completion with reference to costs incurred to date as compared with estimated total costs incorrect calculation of the revenue and profit to be recognized Question (b) Performance: Diverse Common mistake: gave their answers contract by contract. Total amounts for the two contracts should be calculated and presented. failed to consider that the recognised profits (loss) of the contracts in progress at a particular date is an accumulated figure only took account the profit recognised for the current year as quantified in part (a). June

29 Key concept for Q4 Newtop Construction Co Ltd. (Jun 2013 B2) Source: HKICPA Module A Learning pack p June

30 Key concept for Q4 Newtop Construction Co Ltd. (Jun 2013 B2) The stage of completion of a contract is normally measured using: (a) Cost basis The proportion that contract costs incurred for work performed to date bear to the estimated total contract costs: (b) Sales bases or physical completion basis Surveys of work performed, or physical proportion of the contract work completed: Disclose: Revenue recognised in period Methods to determine revenue recognised Methods to determine stage of completion Costs incurred + recognised profits (less recognised losses) to date Advances received Retentions Amounts due from/to customers: Contract A Contact B Total Costs incurred x x xx Recognised profits/losses x/(x) x/(x) x/(x) Progress billings x x xx Amounts due from/to customer x/(x) x/(x) x/(x) June

31 Answer to Q4 Newtop Construction Co Ltd. (Jun 2013 B2) Answer (a) Amounts recognised in profit or loss for the year ended 30 September 2012: Contract A Contract B Total $000 $000 $000 Revenue W1 9,800 26,000 35,800 Cost of services recognised W2 (8,400) (27,150) (35,550) Profits (loss) recognised 1,400 (1,150) 250 Working: 1 Revenue: Contract A Contract B $000 $000 Contract sum certified and billed to date 28,000 26,000 Less: Revenue previously recognised up to 30 Sept 2011 (18,200) --- 9,800 26,000 2 Cost of service recognised: Contract A Contract B $000 $000 Total agreed contract sum 42,000 65,000 % of completion 28,000 / 42,000 x 100% 26,000 / 65,000 x 10% =66.67% =40% Revised estimated total 36,000 x 100% 63,000 x 105% contract cost =36,000 =66,150 Cost to recognised 36,000 x 66.67% 66,150 x 40% = 24,000 = 26,460 Less: Cost recognised up to 30 September 2011 (15,600) -- Sub-total [A] =8,400 = 26,460 June

32 Foreseeable loss recognised for Contract B: $000 Estimated contract sum 65,000 Revised estimated total contract cost (66,150) Foreseeable loss (1,150) Less: Loss recognised 460 (26,000 26,460) Additional loss to recognise[b] (690) Total cost of service recognised [A]+[B] 8,400 27,150 Alternative for Contract B: Contract B $000 Revised estimated total contract cost (63,000 x 105%) 66,150 Less: Total contract sum (65,000) Total loss to be recognised, including foreseeable loss 1,150 Revenue recognised 26,000 Add: Total lost to be recognised 1,150 Total cost of service recognised 27,150 June

33 Answer (b) The amounts to be disclosed and presented under HKAS 11 at 30 September 2012: Contract A Contract B Total $000 $000 $000 Costs incurred 25,600 30,000 55,600 Recognised profits (loss) W1 4,000 (1,150) 2,850 Progress billings (28,000) (26,000) (54,000) Amount due from customers for contract works 1,600 2,850 4,450 Receivable W2 5,200 2,500 7,700 Working: 1. Recognised profits for contract A: Alternative 1 = $28,000,000 x (42,000,000 36,000,000) /42,000,000 = $4,000,000 Alternative 2 = $18,200,000 15,600, ,400,000 = $4,000,000 Alternative 3 = (42,000,000 36,000,000 x 66.67% = 4,000, Receivable: Contract A: ($28,000,000 22,800,000 = $5,200,000) Contract B: ($26,000,000 23,500,000 = $2,500,000) June

34 Q5 Rider Games Inc (Dec 2013 B2) Rider Games Inc. (RGI) acquired a patented technology that expires in 10 years and a licence to use a custom made software for 5 years at consideration of HKD4.5 million and HKD2.4 million respectively on 1 October Amortisation is calculated on an annual basis over a 5-year estimated useful life for both intangible assets. For tax purposes, the cost of a patent is a non-deductible expenditure and the software licence is fully deductible in the year of acquisition. Tax rate applicable to RGI is 30%. Required: (a) Calculate the temporary differences and deferred tax asset / liability of RGI at the year end date of 30 September (6 marks) (b) The director of the company asked the financial controller the following question. If the company can get full tax deduction for the software licence, why don t we state the whole HKD6.9 million as the cost of acquisition for the software licence in our financial statements? Besides, as software is an intangible item, we can use our own computer and printer to create more agreements and invoices in order to record more acquisitions of software in the financial statements. Being the financial controller of RGI, explain to the director his duties and responsibilities in connection with the subject matter and the preparation of the financial statements. (4 marks) Examiner s comment Question (a) Performance: Average Candidate could correctly calculate the carrying amount, tax base and temporary differences for the software licence. Common mistake: failed to consider the fact that the cost of the patent is non-deductible and therefore no deferred tax liability should be recognised. Question (b) Performance: Average Most of the answers had a general discussion of the true and fair preparation of financial statements Common mistake: did not address the behaviour issues by the directors mentioned in the question. mis-interpreted this as a question in relation to HKAS 38 Intangible Assets and gave an explanation about the recognition and measurement requirements of that standard. June

35 Key concept for Q5 Rider Games Inc (Dec 2013 B2a) Source: HKICPA Module A Learning pack p June

36 Key concept for Q5 Rider Games Inc (Dec 2013 B2b) Source: HKICPA Module A Learning pack p. 20. June

37 Answer to Q5 Rider Games Inc (Dec 2013 B2) Answer (a) Temporary differences at 30 September 2013 = Carrying amount less tax base Where tax base of asset = Carrying amount taxable amount + deductible amount Patent: Carrying amount = HKD4.5 million x 1/5 = HKD0.9 million Tax base = HKD( ) = 0 Temporary difference is HKD0.9 million. Deferred tax at 30 September 2013: Patent being a non-tax deductible expenditure and the initial recognition is not part of a business combination and does not affect either accounting profit or taxable profit, therefore no deferred tax liability should be recognised. Software licence: Carrying amount = HKD2.4 million x 1/5 = HKD0.48 million Tax base = HKD( ) = 0 Temporary difference is HKD0.48 million. Deferred tax at 30 September 2013: Deferred tax liability: HKD0.48 million x 30% = HKD144,000 June

38 Answer (b) Directors have statutory duties laid down in the Companies Ordinance, common law duties of reasonable care and skill, fiduciary duties in equity, and must act honestly and in good faith for the benefit of the company. Directors must act for a proper purpose. Directors are responsible for the preparation of financial statements in accordance with the financial reporting framework required by the law or jurisdiction, and for such internal control as the directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. It is improper to state all the cost of acquisition of the patent as a software licence in the financial statements in order to mislead the tax authority for the calculation of the tax deductible expenditure. The creation of fictitious agreements or invoices for recording assets is improper/ a fraud. To make any false statement in connection with a claim for any deduction for tax purposes, or to prepare or maintain or authorise the preparation or maintenance of any false books of account or other records, or/and make use of any fraud for tax purposes may constitute an offence under the relevant tax law. June

39 Q6 Canyo Co Ltd (Jun 2013 B4) Canyo Company Limited (CCL) has two bank loans at 31 December 2012 with the following terms: Bank loan A Bank loan B Principal $10,000,000 $8,000,000 Interest rate in arrears Fixed at 7 per cent per annum Prime rate plus 1.5 per cent per annum Borrowing date 1 July October 2012 Maturity date 30 June instalments of $2,000,000 repayable at 1 April and 1 October 2013 and 2014 Repayment on demand No Yes clause Penalty for early repayment Nil 1 per cent of the early repayment balance Effective interest rate for both loans approximated to the contractual rate. Prime rate at 1 October 2012 was 5.25%. On 1 February 2013, CCL signed an agreement to extend the maturity date of bank loan A to 31 January 2015 with an increase in the interest rate to 8 per cent per annum payable at the end of the maturity date. A transaction fee of $500,000 is required to be paid to the bank for this arrangement. On 1 April 2013, CCL obtained a new bank loan of $10,000,000 (bank loan C) from another bank, which carries a fixed interest rate of 7.5 per cent per annum and is payable at 31 December 2014 without repayment on demand clause. The proceeds have been used to repay bank loan B early in full on the same day. June

40 Required: (a) Explain how to present these two bank loans on the statement of financial position at 31 December 2012 with current / non-current presentation of financial liabilities. (3 marks) (b) Explain how to account for the extension of bank loan A on 1 February (6 marks) (c) Explain how to account for the early settlement of bank loan B on 1 April 2013 supported with detail calculation. (Assuming the prime rate remains at 5.25%). (5 marks) Examiner s comment Question (a) Common mistake: failed to identify the loan that contains a repayment on demand should be classified as a current liability. Question (b) Common mistake: Calculation of the net present value of the cash flows under the modified terms based on the original effective interest rate was a challenge for most candidates Question (c) Performance: Poor or not attempted Common mistakes: failed to identify the correct principle amount which will be subject to penalty for early repayment arrived at an incorrect penalty amount June

41 Key concept for Q6 Canyo Co Ltd (Jun 2013 B4a) HK Interpretation 5 was issued in November It sets out the conclusions of the HKICPA in relation to whether a term loan subject to a repayment on demand clause should be classified as current or non-current. HKICPA concludes that the classification depends on the rights and obligations of the lender and borrower as contractually agreed and in force at the reporting date. Where a lender has an unconditional right to call the loan at any time, it must be classified by the borrower as current, regardless of the probability of the lender exercising their right within 12 months. June

42 Key concept for Q6 Canyo Co Ltd (Jun 2013 B4b) Source: HKICPA Module A Learning pack p June

43 Answer to Q6 Canyo Co Ltd (Jun 2013 B4) Answer (a) Bank loan A of $10,000,000 is classified as a current liability as it is due to be settled within twelve months after 31 December Bank loan B of $8,000,000 is classified as a current liability as there is a clause in the loan agreement that gives the bank the unconditional right to call the loan at any time. CCL does not have an unconditional right to defer settlement of the liability for at least twelve months after 31 December June

44 Answer (b) Modification of the terms of a liability is accounted for as an extinguishment of the original liability and recognition of a new liability where the modification is substantial. The terms are deemed to be substantially different if the net present value of the cash flows under the modified terms, including any fees paid and received, differs by at least 10 per cent from the net present value of the remaining cash flows of the existing liability, both discounted at the original effective interest rate of the original liability. The interest for the original loan of $408,333 ($10,000,000 x 7% x 7/12) should be settled before the extension of the maturity date. Accordingly, the carrying amount of the bank loan for modification assessment is $10,000,000. Total amount to be repaid on 31 January 2015 = $10,000,000 x 1.08 x 1.08 = $11,664,000. Present value calculated based on the original effective interest rate = $11,664,000 / (1.07 x1.07) = $10,187,789. ($10,187,789 + $500,000 - $10,000,000) / $10,000,000 = 6.88%. Because the difference is within the 10 per cent test, the existing bank loan A will not be derecognised. $500,000 transaction cost will be adjusted to the carrying amount of the bank loan and amortised over two years up to 31 January June

45 Answer (c) Bank loan B is accounted for as an extinguishment of liability. Carrying amount of principal at 1 April 2013 = $8,000,000 Interest accrual: $8,000,000 x 6.75% x 0.5 year = $270,000 Early repayment penalty: $6,000,000 x 1% = $60,000 Total amount to be paid for early settlement = $8,330,000 June

46 Practice Makes Perfect! Good luck! End of Seminar June