ADVANCED FINANCIAL ACCOUNTING

Transcription

1 ADVANCED FINANCIAL ACCOUNTING PROFESSIONAL 2 EXAMINATION - APRIL 2008 NOTES: Answer all questions. PRO-FORMA INCOME STATEMENT BY NATURE, INCOME STATEMENT BY FUNCTION AND BALANCE SHEET ARE PROVIDED TIME ALLOWED: 3.5 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

2 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND ADVANCED FINANCIAL ACCOUNTING PROFESSIONAL 2 EXAMINATION - APRIL 2008 TIME ALLOWED: 3.5 hours and 10 minutes to read the paper. Answer ALL questions. You are the Financial Accountant of UNITED plc (UNITED), an Irish public limited company, involved in the sports industry. In 2004, UNITED acquired 80% of CITY Limited (CITY), a company that manufacturers sports clothing, and entered into a joint venture with LIVERPOOL Limited (LIVERPOOL) to promote sports through a limited company called LEEDS Limited (LEEDS). On 1st January 2007, UNITED purchased all of the share capital of DIEGO Incorporated (DIEGO), a company registered in America which promotes European sports in America. The income statement for the year ended 31st December 2007, balance sheet as at 31st December 2007 and summarised statement of changes in equity as at that date for UNITED, CITY, LEEDS and DIEGO were as follows: Income Statement for the Year Ended 31st December 2007 UNITED CITY LEEDS DIEGO ʼ000 ʼ000 ʼ000 $ʼ000 Revenue 74,100 56,175 4,740 6,950 Cost of sales (29,310) (12,440) (1,100) (1,650) Gross profit 44,790 43,735 3,640 5,300 Distribution costs (5,400) (4,865) (400) (510) Administrative expenses (5,650) (2,170) (390) (570) Operating profit before tax 33,740 36,700 2,850 4,220 Taxation (13,500) (12,270) (880) (1,310) Profit after tax 20,240 24,430 1,970 2,910 Page 1

3 Balance Sheet as at 31st December 2007 UNITED CITY LEEDS DIEGO Note ʼ000 ʼ000 ʼ000 ʼ000 ʼ000 ʼ000 $ʼ000 $ʼ000 ASSETS Non Current Assets Property, plant and equipment 49,480 53,420 7,050 10,540 Investment in CITY 1 9,250 Investment in LEEDS 2 2,000 Investment in DIEGO 4 8,000 Loan to LEEDS Current Assets Inventory 1,400 2, ,280 Receivables 365 2, Bank 590 2, ,340 1,020 2,480 1,510 3,650 71,285 58,760 9,530 14,190 EQUITY AND LIABILITIES Capital and Reserves 1/$1 ordinary shares 13,250 7,000 4,000 2,850 Retained earnings 52,225 42,900 5,220 9,930 Non Current Liabilities Loan Loan from UNITED Current Liabilities Payables 5,790 8, Taxation 20 5, , ,285 58,760 9,530 14,190 Summarised Statement of Changes in Equity as at 31st December 2007 UNITED CITY LEEDS DIEGO ʼ000 ʼ000 ʼ000 $ʼ000 Retained earnings brought forward 31,985 18,470 3,250 7,020 Profit for the year 20,240 24,430 1,970 2,910 Retained earnings carried forward 52,225 42,900 5,220 9,930 Additional Information 1. UNITED acquired its interest in CITY on 1st January 2004, when the retained earnings of CITY were 3,235,000. At the date of acquisition the fair value of CITYʼs assets was equal to their book value, with the exception of land and buildings which had a fair value of 435,000 in excess of their book value at that date. This has not been reflected in the books and records of CITY. If the revaluation had been reflected in the books and records of CITY, additional depreciation of 5,000 per annum would need to have been charged in each of the four years 2004 to UNITED and LIVERPOOL entered into their joint venture arrangement in 2004 on the same date on which LEEDS was incorporated, with each party contributing 50% to the share capital of the new company. UNITED and LIVERPOOL share profits equally and neither party has control of LEEDS. UNITED uses proportionate consolidation on a line by line basis to account for joint ventures. 3. In 2006, UNITED gave a loan of 200,000 to LEEDS. Page 2

4 4. UNITED purchased 100% of the share capital of DIEGO on 1st January 2007 at a cost of 8,000,000. At the date of acquisition the fair value of DIEGOʼs assets was equal to their book value, with the exception of land which had a fair value of $1,500,000 in excess of its book value. This has not been reflected in the books and records of DIEGO. UNITED view the investment in DIEGO as long term, with DIEGO operating as an autonomous entity. 5. On 1st July 2007, DIEGO raised a loan of $850,000 in America. 6. The exchange rates for the year are as follows: Date 1=$ 1st January Average st July st December UNITEDʼs property, plant & equipment includes an office building which had cost 2,500,000 (including land valued at 1,000,000) when purchased on 1st January The building has been depreciated on a straight line basis over its useful life of 50 years, and a full yearʼs depreciation has been charged in The building was occupied by UNITED until 30th June 2007, when UNITED reduced its administrative workforce. While the building was deemed surplus to administrative requirements by UNITED, the company decided to retain the building for its rental income and capital appreciation potential. The building was let to a television company from 1st July The Directors of UNITED wish the building to be treated as an investment property in the financial statements of UNITED for the year to 31st December 2007 using the fair value model. The building was valued at 30th June 2007 at a fair value of 2,750,000, and at 31st December 2007 at a fair value of 2,900, During 2007, UNITED sold goods to the value of 750,000 to CITY, making a profit of 25% on these sales. At 31st December 2007, 125,000 of these goods was still held in inventory by CITY. 9. The receivables of UNITED include an amount due from CITY of 70,000. The records of CITY show a balance owed to UNITED of 40,000. A cheque for 30,000 was sent on 27th December 2007 by CITY but was not received by UNITED until the 2nd January REQUIREMENT: Prepare the consolidated income statement of UNITED group for the year ended 31st December 2007 and the consolidated balance sheet as at that date, together with a statement of changes in equity for the group and a reconciliation of consolidated reserves. [Total: 60 Marks] (Notes to the accounts are not required.) 2. You have been approached by a Director of UNITED who is confused about accounting for joint ventures and associated companies. REQUIREMENT: Prepare a report for the Board of Directors of UNITED which: a) Explains the requirements of IAS 28 Investments in Associates and IAS 31 Joint Ventures, including the alternative accounting treatments that are permitted. The report should also outline the characteristics of associates and joint ventures and how their results should be reported in group financial statements in accordance with IAS 28 and IAS 31; and (14 marks) b) Quantifies how UNITEDʼs investment in LEEDS would be presented using the alternative treatment available under IAS 31. (4 Marks) [Total: 18 marks] Page 3

5 3. IAS 40 Investment Property sets out the accounting treatment for investment properties. REQUIREMENT: Prepare a short report for the Directors of UNITED which: a) Explains the term investment property and the different accounting treatments allowable for investment properties under IAS 40 Investment Property; and (8 Marks) b) Calculates the amounts that would have been disclosed in the financial statements of UNITED if the alternative treatment allowed by IAS 40 had been adopted, assuming that there has been no change to the economic life of the building. (4 marks) [Total: 12 marks] 4. UNITEDʼs investment in DIEGO is its first investment in a foreign entity. One of the Directors has asked about the rates of exchange that are to be used in translating the results of DIEGO for inclusion in the group financial statements. REQUIREMENT: Write a memorandum to the Directors of UNITED explaining the requirements of IAS 21 The Effects of Changes in Foreign Exchange Rates. Your memorandum should include a brief explanation of the terms ʻpresentation currencyʼ and ʻfunctional currencyʼ, and the factors that should be taken into account when determining the functional currency of an entity. [Total: 10 Marks] [Total: 100 Marks] END OF PAPER Page 4

6 SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND ADVANCED FINANCIAL ACCOUNTING PROFESSIONAL 2 EXAMINATION - APRIL 2008 Soluton 1 UNITED Group Income Statement for the Year Ended 31st December 2007 Working Revenue ,238,750 Cost of sales 12 (42,612,500 Gross profit 93,626,250 Distribution costs 13 (10,783,750) Administrative expenses 14 (8,361,250) Other income 6 150,000 Profit for the period 74,631,250 Taxation (13, ,270 + (50% x 880) ) (27,028,750) Profit after taxation 47,602,500 Minority Interest 8 4,885,000 42,717,500 (Format & Presentation 3 Marks) UNITED Group Balance Sheet as at 31st December 2007 Working ASSETS Non Current Assets Property, plant and equipment 7 113,380,000 Intangible assets Goodwill ( ) 1 1,029,000 Loan to LIVERPOOL ,000 Current Assets Inventory (1,400+2,450+(50%x880) ) 9 4,898,750 Receivables (365+2,290+(50%x580) ) 15 3,305,000 Bank ( (50%x1,020) ) 2,485,000 10,688, ,197,750 EQUITY AND LIABILITIES Capital and Reserves 1 ordinary shares 13,250,000 Retained earnings 10 86,139,750 Revaluation reserve 6 355,000 Attributable to equity shareholders 99,744,750 Minority Interest 8 10,063, ,807,750 Non Current Liabilities Loan 425,000 Current Liabilities Trade payables(5,790+8,835+(50%x100) ) 15 14,890,000 Taxation (20+25+(50%x10)+25) 75,000 14,965, ,197,750 (Format & Presentation 3 Marks) Page 6

7 Statement of Changes in Equity as at 31st December 2007 Share Retained Revaluation Total Capital Earnings Reserve Balance at 1st January ,250,000 45,786,000 59,036,000 Profit 42,717,500 42,717,500 Revaluation (working 6) 355, ,000 Exchange loss (working 5) (2,363,750) (2,363,750) 13,250,000 86,139, ,000 99,744,750 WORKINGS: 1. Goodwill (a) CITY Limited Cost of Investment 9,250,000 Net Assets Share Capital 7,000,000 Pre-acquisition reserves 3,235,000 Revaluation non current assets 435,000 80% (8,536,000) Balance Sheet 31st December ,000 (b) DIEGO Limited $ $ Cost of Investment ( 8,000,000 x 1.5) 12,000,000 Net Assets Share capital 2,850,000 Pre-acquisition reserves 31st December ,020,000 Revaluation 1,500,000 11,370,000 (11,370,000) 630,000 Balance Sheet 31st December 2006 [630/ 1.5] 420,000 Balance Sheet 31st December 2007 [630/ 2] 315,000 (4 Marks) 2. Consolidated Reserves as at 31st December 2006 UNITED Retained earnings 31/12/06 31,985,000 CITY Retained earnings 31/12/06 18,470,000 Pre acquisition profits (3,235,000) Additional depreciation (3/4 x 200,000) (15,000) 80% 12,176,000 LEEDS 3,250,000 x 50% 1,625,000 45,786,000 Page 7

8 3. Translation of DIEGO to $ʼ000 Rate ʼ000 Tangible Non Current Assets 10, ,270 Current Assets Inventory 1, Receivables Bank 1, ,190 7,095 1/$1 ordinary shares 2, ,900 Retained earnings pre-acquisition 7, ,680 Retained earnings post-acquisition 2,910 Per IS 1, Exchange difference (2,008.75) 12, Non Current Liabilities Loan Current Liabilities Payables Taxation ,190 7,095 Revenue 6, , Cost of sales (1,650) 1.6 (1,031.25) Gross profit (5,300 3,312.5 Distribution costs (510) 1.6 (318.75) Administrative expenses (570) 1.6 (356.25) Operating profit 4,220 2,637.5 Taxation (1,310) 1.6 (818.75) Profit after tax 2,910 1, Consolidation Adjustments - DIEGO $ Revaluation 1,500,000 At date of 1,000,000 At 31st December 2 750, Reconciliation of Exchange Difference Profit for the year at average 1.6) 1,818,750 Profit for the year at closing rate 2.0) 1,455,000 (363,750) Opening Net Assets At opening rate 1.5) 6,580,000 At closing rate 2.0) 4,935,000 (1,645,000) (2,008,750) Exchange difference arising on goodwill (105,000) Exchange difference on revaluation [$1,500,000 x ( )] (250,000) (2,363,750) (5 Marks) Page 8

9 6. Investment Property Building owner occupied from 1/1/04 to 30/6/07 = 3.5 years Depreciation 1,500/50 30, ,000 pa 105,000 6 months depreciation charged in error 15,000 Cost 2,500,000 (105,000) 2,395,000 Fair value 30/6/07 2,750,000 Revaluation Reserve 355,000 Fair value 31/12/07 2,900,000 Carrying value 2,750,000 Income Statement 150,000 (5 Marks) 7. Non Current Assets UNITED 49,480,000 CITY 53,420,000 LEEDS (50% x 7,050,000) 3,525,000 DIEGO 5,270,000 Revaluation CITY 435,000 Depreciation revaluation CITY (20,000) Revaluation DIEGO 750,000 Fair value adjustment 30/06/07 355,000 Fair value adjustment 31/12/07 150,000 Depreciation adjustment Investment property 15, ,380, Minority Interest Income Statement for the Year Ended 31st December 2007: CITY Profit after tax 24,430,000 depreciation (5,000) 20% 4,885,000 Balance Sheet as at 31st December 2007: CITY Share capital 7,000,000 Retained profits 42,900,000 Revaluation non current assets 435,000 Depreciation revaluation (20,000) 20% 10,063,000 Page 9

10 9. Unrealised Profit UNITED makes a profit of 25% on all sales. Therefore 750,000 x 25% = profit Unrealised profit = 125,000 x 25% 31,250 Reduce sales and cost of sales by intercompany sales: Debit Credit Sales 750,000 Cost of sales 750,000 Reduce inventory and cost of sales by unrealised profit: Cost of sales 31,250 Inventory 31, Consolidated Reserves UNITED 52,225,000 Unrealised profit on sales to CITY (31,250) Adjustment re fair value of investment property 150,000 Add depreciation adjustment investment property 15,000 52,358,750 CITY-post acquisition reserves Per Balance Sheet 31/12/07 42,900,000 Pre acquisition (3,235,000) Additional Depreciation (20,000) 39,645,000 80% 31,716,000 LEEDS Profit to 31st December 2007 ( 1 /2 x 5,220,000) 2,610,000 DIEGO Profit for the year 1,818,750 Exchange Loss (2,363,750) (545,000) 86,139,750 (4 Marks) 11. Revenue UNITED 74,100,000 CITY 56,175,000 LEEDS ( 1 /2 x 4,740,000) 2,370,000 DIEGO 4,343,750 Less inter company sales UNITED to CITY (750,000) 136,238, Cost of Sales UNITED 29,310,000 CITY 12,440,000 LEEDS ( 1 /2 x 1,100,000) 550,000 DIEGO 1031,250 Less inter company sales UNITED to CITY (750,000) Unrealised profit 31,250 42,612,500 Page 10

11 13. Distribution Costs UNITED 5,400,000 CITY 4,865,000 LEEDS ( 1 /2 x 400,000) 200,000 DIEGO 318,750 10,783, Administrative Expenses UNITED 5,650,000 CITY 2,170,000 LEEDS ( 1 /2 x 390,000) 195,000 DIEGO 356,250 Depreciation on revaluation 5,000 Depreciation adjustment re investment property (15,000) 8,361, Intercompany Balances Payables 40,000 Bank 30,000 Receivables 70, Loan to LEEDS Only the amount owed by LIVERPOOL is shown. [Total : 60 Marks] Page 11

12 Solution 2 REPORT Date dd/mm/yy The Directors, Further to our recent conversation and based upon the information available, I have outlined below (Format & Presentation 1 Mark) (a) Associates: IAS 28 definition An associate is an entity (including an incorporated entity such as a partnership) over which another entity has significant interest and which is neither a subsidiary nor a joint venture; This type of investment is something less than a subsidiary but more than a simple investment; The key is significant influence; Where an investor holds 20% or more there is a presumption that there is a significant interest-unless it can be shown not to be the case; Significant influence means the investor is actively involved; Existence of significant influence evidenced by: Representation on the board of directors; Participation in the policy making process; Material transactions between investor and investee; Interchanges of management personnel; Provision of technical information. IAS 28 requires the Equity Method of accounting The investment is stated at cost plus group share of post acquisition profits less amounts written off for impairment of goodwill; If goodwill is fully written off the investment will be stated at the investing companyʼs share of the net assets of the associate; The group share of the following is brought in: Operating profit; Interest payable; Interest receivable; Taxation. Joint Ventures A joint venture is an entity in which the reporting entity holds a long term interest and is jointly controlled by the reporting entity and another under a contractual arrangement; A reporting entity jointly controls the venture if none of the entities alone can control that entity; They are limited by time and/or activity; The venturers usually carry on their principal businesses at the same time; Separate books for the venture are not usually maintained; The venturers usually agree to a profit/loss sharing ratio for the venture. Types of joint venture Jointly controlled operations; Jointly controlled assets; Jointly controlled entities. Jointly controlled operations No separate entity set up-such as a partnership; The venturers use their own assets and resources for the joint venture; Venturers incur their own expenses and liabilities; IAS 31 requires the venturers to recognise: all assets and liabilities it controls in its own accounts; the expenses it incurs and income it earns from the joint venture. Page 12

13 Jointly controlled assets Venturers have joint control and often joint ownership of the assets of the joint venture; IAS 31 requires each venturer to recognise the following in respect of its interest in the venture: Share of jointly owned assets; Its share of any liabilities; Any income or expenses. Jointly controlled entities Involves setting up a separate entity; IAS 31 requires the consolidated accounts of the venturer to account using either: Proportionate consolidation; or Equity accounting (same as associates). Proportionate consolidation Benchmark treatment; Only the group share of assets and liabilities, income and expenses are brought into account; There is no minority interest; Use either: Line by line consolidation; or Separate line items. (4 Marks) (b) Equity Accounting Balance Sheet Investment in joint venture 4,610,000 Working Cost plus group share of post acquisition profits 2,000,000 + (50% x 5,220,000) 4,610,000 Income Statement Operating profits ####### Group share of venture profits (50% x 2,850,000) 1,435,000 Taxation ####### Group share of venture taxation 50% (880,000) (4 Marks) [Total : 18 Marks] Page 13

14 Solution 3 REPORT Date dd/mm/yy The Investors, Further to our recent press coverage and based upon the information available, I have outlined below (Format & Presentation 1 Mark) (a) Definition: Land and/or building held as assets, to earn rentals or for capital appreciation or both; Not employed in normal activities. Does not include: Held for production or for sale in normal course of business; Being constructed for future use as investment property; Mineral rights. Accounting treatment: Recognition Investment property should be recognised when: a. It is probable that future economic benefits that are associated with the investment property will flow to the entity; and b. The cost of the property can be measured reliably. Initial Measurement Recognised initially at cost; When an owner occupied property becomes an investment property to be carried at fair value IAS 16 shall apply to the date of change and the change to fair value treated as a revaluation under IAS 16. (b) Subsequent Measurement Choice of model: Fair value model Recognise changes in Fair Value in Income Statement. Cost model Apply same principle as IAS 16; Disclose Fair Value as a note to accounts. Investment Property Stated at Cost ʼ000 Cost at 30th June ,500 Less accumulated depreciation (105) Cost of investment property 2,395 Depreciation 1/07/07 to 31/12/07 (15) Balance sheet at 31st December ,380 Income Statement year ended 31st December 2007 Depreciation on investment property 15 Disclosure note of fair value at 31st December ,900 (4 Marks) [Total : 12 Marks] Page 14

15 Solution 4 MEMO DATE: XX/YY/XX TO: Directors of UNITED FROM: A N Accountant SUBJECT: IAS 21 The effects of changes in foreign exchange rates Further to our recent conversation and based upon the information available, I have outlined below (Format & Presentation 1 Mark) Functional Currency Is the currency of the primary economic environment in which the entity operates? It is determined by reference to certain factors. The organisation cannot choose its functional currency. Presentation currency The presentation currency is the currency a reporting entity uses for its financial statements; The reporting entity is entitled to present its financial statement in any currency; In some cases the presentation currency may differ from the functional currency. In the case of UNITED the presentation currency is and the functional currency of DIEGO is $. Factors which determine functional currency What mainly influences sales prices for goods sold? What mainly influences labour material and other costs of providing goods and services? What currency are funds from financing activities generated? Are the activities of the foreign operation carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy? Are transactions with the reporting entity a high or low proportion of the foreign operationʼs activities? Do cash flows from the activities of the foreign operation directly affect the cash flows of the reporting entity and are they readily available for remittance to it? Are cash flows from the activities of the foreign operation sufficient to service existing and normally expected debt obligations without funds from the reporting entity? Where the foreign entity is considered to be an extension of the parent company transactions are converted using the rates of exchange in operation when the transaction took place, or an average where this is more practical for sales and purchases. All exchange gains or losses are taken to profit or loss for the year. Where the foreign entity operates as an autonomous unit the parentʼs interest is in the net cash flow of the business and results are translated using the exchange rate at the balance sheet date for the balance sheet and the average for the income statement. Exchange differences are taken straight to reserves, as there is no realisation of the exchange loss/gain in cash flows. The results of DIEGO are translated using the closing rate. (4 Marks) [Total : 10 Marks] [Total Paper: 100 Marks] Page 15