Financial Reporting and Analysis June 2013

Transcription

1 Financial Reporting and Analysis June 2013 s and examiner s comments Important notice When reading these answers, please note that they are not intended to be viewed as a definitive model answer, as in many instances there are several possible answers/approaches to a question. These answers indicate a range of appropriate content that could have been provided in answer to the questions. They may be a different length or format to the answers expected from students in the examination. Examiner s general comments There were some excellent scripts produced for the June 2013 examination. The pass rate was comparable with the average achieved over the four previous examination sessions, indicating that the majority of candidates had prepared well. Candidates achieving the pass standard were well prepared across the whole syllabus and answered numerical, analytical and descriptive questions well. Performance in the compulsory Question 1 in Section A was excellent: similar creditable answers were produced in response to Question 2 (both questions were part numeric and part analysis). However, Questions 3, 4, 5 and 6 were not always answered well. Weaker answers to these questions were frequently incomplete and these partial answers appeared to be due to a lack of basic knowledge of the topics and insufficient preparation, rather than time pressures during the examination. Scripts that did not achieve a pass standard overall revealed that the candidates had not prepared well for questions across the whole syllabus. For example, Questions 4, 5 and 6 examine segmental statements, asset measurement bases and accounting concepts and aspects of international accounting and XBRL (extensible Business Reporting Language). These subject areas are key parts of the syllabus and should have been studied by all candidates aspiring to pass the examination. Some candidates may correctly believe they produced very good answers to one question (for example, Question 1) and yet be disappointed that their overall result for the examination was not at a pass standard. However, candidates are advised that one very good answer does not guarantee an overall pass grade. It is imperative that answers to the other three questions demonstrate a good knowledge across a range of syllabus topics. ICSA, 2013 Page 1 of 23

2 Lack of basic knowledge and preparation was evidenced by scripts that did not achieve the pass standard. However, that said, the candidates achieving the pass standard had prepared well and demonstrated a sound knowledge and application of the syllabus. Many candidates producing good answers also demonstrated good examination technique, for example, not wasting time during the examination by writing more than was required for the marks available, not straying from the question asked, and presenting their figures in a clear and understandable form. The poorer preparation and performance referred to above should not detract from the fact that, by and large, the performance of candidates is of a very good standard. Section A (Compulsory question) 1. Redbourne Ltd ( Redbourne ) is a company which manufactures and sells plastic furniture. The directors have pursued a policy of rapid expansion since April A number of new products have been developed and market share has increased. Redbourne s accounting department is finalising its accounting statements for the year ended 31 March These statements will be presented to the forthcoming meeting of the board of directors where the financial results for the year will be assessed. When reviewing the accounts, the directors will study four target ratios identified in loan covenants given to Redbourne s bankers. The target ratios set out in the contractual arrangements between Redbourne and the bank are as follows: Quick (liquidity) ratio 1.1:1 Current (working capital) ratio 1.5:1 Interest cover 9.5 times Gearing (debt:equity) ratio 0.5:1 The draft accounts are as follows: Income Statement for the year ended 31 March Revenue 102,600 86,700 Cost of sales -72,000-60,750 Gross profit 30,600 25,950 Distribution costs -5,000-3,200 Administration expenses -10,360-6,700 Finance costs -1,560-1,350 Profit before tax 13,680 14,700 Taxation -3,900 4,200 Profit for the period 9,780 10,500 ICSA, 2013 Page 2 of 23

3 Statement of Financial Position as at 31 March Assets Non-current assets Property, plant and equipment 77,790 53,640 Available-for-sale investments 18,600 16,200 96,390 69,840 Current assets Inventories 13,500 10,800 Trade receivables 12,900 15,600 Cash and cash equivalents ,400 26,760 Total assets 122,790 96,600 Equity and liabilities Share capital ( 1 ordinary shares) 30,000 30,000 Revaluation reserve 12,600 3,300 Other reserves 5,400 3,000 Retained earnings 22,380 12,600 Total equity 70,380 48,900 Non-current liabilities Loan repayable December ,200 15,600 Other loans 18,000 18,000 Total non-current liabilities 34,200 33,600 Current liabilities Trade and other payables 14,000 9,900 Bank overdraft Taxation 3,900 4,200 Total current liabilities 18,210 14,100 Total liabilities 52,410 47,700 Total equity and liabilities 122,790 96,600 The following additional information is provided: The movement on the revaluation reserve relates to property, plant and equipment revalued on 1 January The increase in the other reserves arose from increases in the market value of the available-for-sale investments. Required (a) Calculate the four ratios identified in the covenants given to the bank, and calculate four other ratios that are relevant when assessing the financial performance and position of Redbourne. The ratios should be calculated to one decimal place. (8 marks) ICSA, 2013 Page 3 of 23

4 Accounting ratios Workings Covenant Quick (liquidity) ratio 12,900:18, :1 1.1:1 15,960:14, :1 Current (working capital) ratio 26,400:18, :1 1.5:1 26,760:14, :1 Interest cover (13,680+1,560):1, times 9.5 times (14,700+1,350):1, times Gearing (debt:equity) ratio 34,200:70, :1 0.5:1 33,600:48, :1 Further indicative ratios* Gearing ratio (excluding 34,200:(70,380-9,300) 0.6:1 revaluation) Return on equity 13,680:70,380x % 14,700:48,900x % Gross profit margin 30, ,600x % 25,950 86,700x % Operating profit margin (13,680+1,560) 102,600x % (14,700+1,350) 86,700x100 18,5% * Note: There are other ratios which could have been calculated in order to provide an appropriate basis for discussion and analysis under part (b). (b) Prepare a report for the board of directors of Redbourne that explains the company s financial performance and position. The report should be based on the ratios calculated under part (a) and should include consideration of any other issues relevant to the future financing of Redbourne. (17 marks) To: The board of directors From: A. Student Date: June 2013 Subject: Report on the financial performance and position of Redbourne The following report is based on the financial statements of Redbourne and relevant accounting ratios. Financial performance Redbourne had invested heavily in property, plant and equipment and this had enabled turnover to be increased by 18% between and Expansion appears to have been achieved without significant price-cutting as the gross profit margin has remained steady at just under 30%. This ratio also indicates that direct costs have been kept under control. However, the operating profit margin has dropped significantly from 18.5% to 14.9%. This has happened because both the distribution costs and administrative expenses have each increased by over 50%. It is likely that the expansion policy has required a significant increase in marketing costs to achieve increased market share. The disproportionate rise in administration expenses also requires careful investigation. ICSA, 2013 Page 4 of 23

5 The interest cover has declined from 11.9 times to 9.8 times. The cover remains ahead of the 9.5 times specified in the loan covenant, but the margin is now slight. The return on equity has declined from 30.1% to 19.4%. There are two reasons for this. First, as noted above, net margins have declined due to the rise in running costs. Second, the decline has been exaggerated by the revaluation of property, plant and machinery during the year which means that the percentages are not strictly comparable. If the effect of the revaluation is stripped out, the return on equity for becomes 22.4% [13,680 (70,380-9,300)]. A decline in the return is still revealed but it could be restored to the earlier level if effective action can be taken to reduce running costs. Financial position Redbourne s gearing has improved significantly during the year with the debt:equity ratio declining from 0.7:1 to 0.5:1 which brings it in line with the target level specified in the loan covenant. However, much of the reduction is attributable to the revaluation of non-current assets. The debt:equity ratio, excluding the revaluation surplus arising during the year, remains above the target level at 0.6:1. The quick (liquidity) ratio specified in the loan covenant is 1.1:1 and this is exactly the figure at 31 March By the end of the accounting year , the ratio has declined to a highly unfavourable 0.7:1. Tight control has been exerted over the liquid assets with trade receivables down 2,700,000 despite the 18% increase in turnover. However, the trade payables have risen disproportionately during the year, which might signal the company s inability to make payments to suppliers as they fall due. The current (working capital) ratio was well above the target level of 1.5 on 31 March 2012 but, at the end of the following year, is exactly in line with that figure. Inventories have increased a little more than might have been expected but the real problem is, again, the disproportionate increase in current liabilities. Redbourne s liquidity problems are further reflected in the immediate cash position of the company. Whereas, one year earlier, the company held 360,000 in cash, there is an overdraft of 310,000 on 31 March Overall, there are signs that Redbourne is overtrading. The company has no cash, current liabilities are rising and receivables are falling. The latter observation reflects the possibility that customers are being pressed for payment to help alleviate the company s liquidity problems. Future financing Clearly it is important for the company to be able to convince the bank that the board has a strategy in place for easing the pressure on working capital and that the company is not expanding too quickly. The following two issues require particular consideration in that context: Working capital position. The current approach to managing working capital which relies on customers paying quickly and suppliers being forced to wait for payment cannot be sustained in the longer term as it is likely to damage relationships with each of these groups. Loans repayable December The repayment date is in just 18 months time. At present, the company has no cash and it seems unlikely that it will generate sufficient funds from operating activities to meet the obligation to repay 16,200,000 at the end of The directors need to explore strategies to improve cash flow both immediately and in the longer term. For these purposes cash flow projections need to be carefully examined to reveal whether cash generated from operations can be used to help improve the working capital position of the ICSA, 2013 Page 5 of 23

6 company. Sufficient cash might also be generated to make some contribution to future loan repayments. However, other available avenues need to be explored. Fortunately, the company has built up a significant balance of available-for-sale investments. These could be drawn upon, if necessary, both to alleviate short term cash difficulties and to help make the loan repayment at the end of Indeed, depending on the amount of cash generated from operations, proceeds from the sale of investments might also enable the directors to continue their expansion strategy should this be considered essential for the future viability and success of the company. Finally, the board also needs to carefully consider the advisability of further expansion, as this is likely to require further investment in current and non-current assets. Examiner s comments Performance in the compulsory Question 1 in Section A was generally very good and some excellent answers were prepared. Weaker answers indicated that the candidates had not prepared for questions relating to the analysis and interpretation of accounts. For example, many answers did not calculate basic accounting ratios and included very little commentary or inaccurate comments. This topic is discussed in three of the thirteen chapters in the Financial Reporting and Analysis study text and has a 45% weighting in the syllabus. Good answers provided workings to explain how candidates had calculated the accounting ratios. This approach of including relevant workings is recommended for answers to numerical questions as it allows the marker to reward correct methodology even if it contains arithmetic errors. An issue with examination technique was also illustrated in answers to this question. The question clearly asked for candidates to provide the four ratios identified in the question and four other relevant ratios of the candidate s choice, that is, eight ratios in total over the two accounting years. Some candidates provided more ratios than the eight asked for in the question. Candidates are advised that, in such cases, examiners will assess the first eight answers and any additional answers will not be awarded any marks. However, Question 1, which tested candidates ability to calculate, analyse and interpret financial data, key functions of a Chartered Secretary, was extremely well answered. ICSA, 2013 Page 6 of 23

7 Section B 2. The following accounting information is provided in respect of Andover plc ( Andover ): Income Statement for the year ended 31 March Revenue 86,884 78,694 Changes in inventories of finished goods and work in progress 2, ,264 79,184 Raw materials and consumables used 43,428 38,948 Employee benefits expense 8,526 8,624 Depreciation of plant and equipment less profit on sale of plant 2, Other expenses including impairment of goodwill 16,100 15,288 Finance charges 2,520 2,338 Profit before tax 16,562 13,496 Taxation 3,990 3,570 Profit for the period 12,572 9,926 Statement of Financial Position as at 31 March Assets Non-current assets Land and buildings at valuation (2012 at cost) 35,000 24,710 Plant and equipment at carrying value 30,240 15,400 Goodwill 3,024 3,500 Acquired brands at cost 39,200 35, ,464 78,610 Current assets Inventories 39,662 31,654 Trade receivables 23,660 18,872 Cash and cash equivalents 6,300 4,284 69,622 54,810 Total assets 177, ,420 Equity and liabilities Share capital 103,600 91,000 Share premium account 7,014 - Reserves 32,788 9,926 Total equity 143, ,926 Non-current liabilities Long-term borrowings 21,000 22,428 Current liabilities Trade and other payables 8,694 6,496 Taxation 3,990 3,570 Total current liabilities 12,684 10,066 Total equity and liabilities 177, ,420 During the financial year , Andover sold plant with a carrying value of 1,428,000 for 1,834,000. ICSA, 2013 Page 7 of 23

8 Required (a) Explain the usefulness of the Cash Flow Statement, describing its advantages compared with the Income Statement. (6 marks) As the Income Statement is prepared under the accruals basis of accounting, the revenues reported may not have been collected at the reporting date with outstanding receivables being reported in the Statement of Financial Position. Similarly, the expenses reported on the Income Statement might not have been paid with outstanding payables reported in the Statement of Financial Position. The Income Statement also includes expenses that are not paid in cash, for example, depreciation and increases in provisions. The Cash Flow Statement therefore facilitates an assessment of a company s liquidity as well as helping to determine the ability of a company to generate cash and to show how it has been used. The cash flow statement explains the difference between cash generated from operating activities and the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a high quality. If the cash from operating activities is less than net income, this raises issues as to why the reported net income is greater than cash flows generated. Typically investors believe that cash is king. The Cash Flow Statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its shares, reduce debt, or acquire another company/asset/investment. All of these are perceived to be good for shareholder value. Some financial models are based upon cash flow. While in the short-term a company s performance is measured on the basis of profitability, in the long-term, investors and stakeholders view the financial health of a company on the present value of all future cash flows. (b) Prepare a Cash Flow Statement for Andover covering the year to 31 March The statement should comply with standard accounting practice, so far as the available information permits. (13 marks) Cash Flow Statement for 2012/13 Cash flows from operating activities Operating profit 19,082 W1 Depreciation charge 2,534 W5 Amortisation of goodwill 476 W2 Profit on sale of plant -406 W3 Increase in inventories -8,008 Increase in accounts receivable -4,788 Increase in accounts payable 2,198 Cash generated from operations 11,088 Interest paid -2,520 Taxation -3,570 Net cash generated from operating activities 4,998 Cash flows from financing activities Issue of shares 19,614 W4 Redemption of long-term borrowing -1,428 18,186 ICSA, 2013 Page 8 of 23

9 Cash flows from investing activities Purchase of plant and machinery -18,802 W5 Purchase of brands -4,200 Sale of plant 1,834-21,168 Increase in cash 2,016 Cash at beginning of period 4,284 Cash at end of period 6,300 Workings 000 W1 Profit before tax 16,562 Finance charges 2,520 Operating profit 19,082 W2 Amortisation of goodwill, 3,500 3, W3 Carrying value of plant sold 1,428 Sales proceeds 1,834 Profit on sale 406 W4 Increase in nominal value of shares 12,600 Share premium 7,014 Proceeds from share issue 19,614 W5 Balance of plant and machinery at 31 March ,400 Sales at carrying value -1,428 Depreciation (2, ) -2,534 11,438 Balance at 31 March ,240 Purchases during the year, therefore 18,802 (c) Comment on Andover s performance based on an analysis of the information contained in the Cash Flow Statement prepared under part (b). (6 marks) The Cash Flow Statement shows that only a little more than half of the operating profit has in fact been converted into cash during the year; most of the balance has been used to finance an increased investment in inventories and receivables. A further 6,090,000 or 57% of cash generated from operations has been absorbed in paying interest and taxation. Andover has made a substantial share issue during the year, about 10% of which has been absorbed in repaying long-term borrowing. The company has made a major investment in new plant and machinery and in the acquisition of brands. This has been financed by the share issue and cash generated from operations. After all outflows, there has been a net inflow of cash of 2,016,000 which has increased the cash balance to 6,300,000. ICSA, 2013 Page 9 of 23

10 Examiner s comments Question 2 was a popular question and was generally well answered. This question required candidates to prepare and comment on a Cash Flow Statement. In general, candidates made some good attempts at preparing the Cash Flow Statement but some appeared to have struggled with how to record the purchase of plant, machinery and brands; also, the depreciation and amortisation were not always handled correctly. Candidates are advised to refer to the suggested answer above. The written answers to parts (a) and (c) were not always well answered and answers sometimes illustrated problems with examination technique. For example, part (a) expected candidates to explain the usefulness of the Cash Flow Statement, describing its advantages compared to the Income Statement. Many weaker answers merely listed the content of a Cash Flow Statement and made little or no reference to the Income Statement. Candidates are advised to be clear as to what the question is looking for. In this case, the verb explain is asking you to make the usefulness of the Cash Flow Statement clearer in order to display your comprehension of the topic. This is illustrated in the suggested answer and candidates are advised to always answer the question asked. In some instances, answers to part (c) were very limited and not sufficient for the 6 marks available. The comments were often very general and not applied to Andover. ICSA, 2013 Page 10 of 23

11 3. Beta plc ( Beta ) was incorporated on 31 March 2012, at which date it issued 170,000,000 shares with a nominal value of 1 each, for 1.40 each. Beta made the following cash investments at the same date: Company Number of voting equity Price paid shares acquired Gamma plc ( Gamma ) 3,060 85,000 Delta Ltd ( Delta ) 30,600 71,400 Epsilon Ltd ( Epsilon ) 20,400 64,600 The fair values of the assets and liabilities of Gamma, Delta and Epsilon were the same as their carrying values on 31 March The following are the summarised Statements of Financial Position of Gamma, Delta and Epsilon as at 31 March 2013: Gamma Delta Epsilon Non-current assets 51, ,800 44,200 Net current assets 33,490 62,900 23,800 84, ,700 68,000 Ordinary shares ( 1 each) 38, ,000 25,500 Retained profit at 1 April ,740 68,000 20,400 Profit for 2012/13 25,500 18,700 22,100 84, ,700 68,000 You are provided with the following additional information: (i) (ii) (iii) None of the companies issued or redeemed any shares during the year to 31 March Beta incurred administration expenses of 3,400,000 during the year to 31 March Beta, under a contractual arrangement, has the power to appoint two directors to the board of Delta to sit alongside three other directors. (iv) Gamma paid an interim dividend of 40 pence per share during October (v) The directors of Beta intend to sell the shares in Gamma during July 2013 to finance an expansion of the activities of Epsilon. (vi) The market value of each of the shares in Gamma at 31 March 2013 was 30. (vii) Beta had no cash inflows or outflows during the year to 31 March 2013 except as indicated above. Required Note: Assume no impairment of any goodwill that arises on consolidation. (a) Explain the appropriate accounting treatment by Beta of the investments it has made in Gamma, Delta and Epsilon. (6 marks) ICSA, 2013 Page 11 of 23

12 Gamma should be accounted for as an investment as the percentage of shares acquired is 8%, with at least 20% normally being the required threshold for treatment as an associated company. Neither is there evidence that Beta exerts significant influence over the affairs of Gamma. As there is an intention to sell the shares in Gamma in July 2013, they should be accounted for as available for sale investments and valued at market price. Delta should be treated as an associated company because Beta is in possession of more than 20% of the voting power (30%) and appears able to exercise a significant influence over Delta s financial and operating policies through representation on the board of directors. Epsilon should be treated as a subsidiary in view of the fact that Beta has acquired more than 50% of the equity voting share capital, that is, 80% in this case. It is therefore in a position to exert a dominant influence. (b) Prepare the legal entity-based Statement of Financial Position of Beta as at 31 March (5 marks) Statement of Financial Position as at 31 March Investments 227,800 W1 Cash 14, ,624 W2 Equity: Share capital 170,000 Share premium account 68,000 Retained earnings 4,624 W3 242,624 Workings 000 W1 Investments Gamma at market price: 3,060 x 30 91,800 Delta at cost 71,400 Epsilon at cost 64, ,800 W2 Cash Share issue 238,000 Investments -221,000 Administration expenses -3,400 Dividend received 1,224 14,824 W3 Profit Dividends received 1,224 Increase in fair value of shares in Gamma: 91,800 85,000 6,800 Administration expenses -3,400 4,624 ICSA, 2013 Page 12 of 23

13 (c) Prepare the consolidated Statement of Financial Position of Beta as at 31 March (14 marks) Consolidated Statement of Financial Position as at 31 March 2013 Assets Non-current assets 44,200 Goodwill 27,880 W4 Investment in associated company 77,010 W5 Available for sale investment 91,800 Net current assets Beta 14,824 Epsilon 23,800 38,624 Total assets 279,514 Equity and liabilities Parent company shareholders equity Share capital 170,000 Share premium account 68,000 Retained earnings Beta 4,624 Delta 5,610 Epsilon 17,680 27,914 W4 265,914 Minority interest 13,600 W4 Total equity 279,514 Workings W4 Epsilon subsidiary company (80%) Total equity At acquisition Since acquisition Minority interest Share capital 25,500 20,400 5,100 Retained profits: At acquisition 20,400 16,320 4,080 Since acquisition 22,100 17,680 4,420 68,000 36,720 13,600 Price paid 64,600 Goodwill 27,880 W5 Delta associated company 000 Cost 71,400 Profit share 18,700 x 30% 5,610 77,010 ICSA, 2013 Page 13 of 23

14 Examiner s comments Questions 3 was a popular question but only a minority provided good answers. The question required knowledge of the accounting treatment of investments, associated companies and subsidiaries to be demonstrated by the preparation of relevant financial statements. Candidates that achieved the pass standard for this question handled this task and produced professional answers. However, weaker answers did not draft the two Statements of Financial Position asked for in the question and so lost the opportunity for a majority of the 19 marks available for these parts of the question. Clear workings (as illustrated in the suggested answer) were not always presented to support the figures included in the statements. Frequently, no reference was made to key figures, including the minority interest, profits at and post acquisition and goodwill. ICSA, 2013 Page 14 of 23

15 4. Banchory Ltd ( Banchory ) is a supplier of soft furnishings. The three operating divisions involve the supply of curtains, carpets and bedding. The following financial information is provided: Income Statement for the year ended 31 March Revenue 6,660 Less: Cost of sales 3,444 Administration expenses 576 Distribution costs 852 Finance costs 60 4,932 Profit before tax 1,728 Statement of Financial Position as at 31 March 2013 Assets 000 Non-current assets at carrying value 14,658 Current assets Inventories 342 Receivables 264 Cash and cash equivalents 1,350 Total assets 16,614 Equity and liabilities Equity Share capital 6,000 Retained earnings 8,694 Total equity 14,694 Non-current liabilities Long-term borrowing 1,260 Current liabilities Payables 468 Short-term borrowing 192 Total equity and liabilities 16,614 The following table sets out a breakdown of resources allocated to Banchory s operating segments: Curtains Carpets Bedding Revenue 3,666 2, Cost of sales 2, Administration expenses Distribution costs Finance costs Non-current assets at carrying value 6,072 4,602 2,592 Inventories Receivables Cash and cash equivalents Payables Short-term borrowing Long-term borrowing 1, ICSA, 2013 Page 15 of 23

16 Required Note: Assume that each segment is of sufficient size to require separate disclosure of its activities. (a) Explain the rationale underlying IFRS 8 Operating Segments. (5 marks) The growth in the size of businesses in a global economy has resulted in the emergence of groups of companies that engage in a wide range of activities, where: there are significant variations in rates of profitability; the activities involve different degrees of risk, for example, different geographical areas raise problems of movements in exchange rate, political upheaval, expropriation of assets, and high inflation rates; and there are differential opportunities for growth. The objective of IFRS 8, therefore, is to establish principles for reporting financial information by segment to help users of financial statements: (b) better understand the enterprise s past performance; better assess the enterprise s risks and returns; and make more informed judgements about the enterprise as a whole. Prepare a segmental statement for Banchory complying, so far as the information permits, with the provisions of IFRS 8. (10 marks) s Income Statement for the year ended 31 March 2013 Curtains Carpets Bedding HO* Total Revenue 3,666 2, ,660 Less: Cost of sales 2, ,444 Administrative expenses Distribution costs Finance costs Net profit (-loss) 438 1, ,728 Statement of Financial Position as at 31 March 2013 Assets Curtains Carpets Bedding HO* Total Non-current assets at carrying value 6,072 4,602 2,592 1,392 14,658 Current assets Inventories Receivables Bank ,350 Total assets 7,284 5,034 2,904 1,392 16,614 ICSA, 2013 Page 16 of 23

17 Equities and liabilities Equity Share capital 6,000 6,000 Retained earnings 8,694 8,694 14,694 14,694 Non-current liabilities Long-term borrowing 1,260 1,260 Current Liabilities Payables Short-term borrowing Total equity and liabilities 1, ,802 16,614 * These amounts comprise values not allocated to operating segments. (c) Outline the accounting issues which need to be tackled when preparing segmental statements. Illustrate your comments by reference to the statements prepared in answer to part (b), above. (10 marks) The accounting problems which need to be tackled when preparing segmental statements are as follows: The treatment of common costs relating to more than one segment Entities often apportion some of their common costs for the purpose of internal reporting (perhaps based on sales) and, in such cases, it may be reasonable for such costs to be treated in the same way for external reporting purposes. However, if apportionment would be misleading, common costs should not be apportioned to the segments but should be deducted from the total segment result. Thus, in the case of Banchory, a proportion of the administration and finance costs remain unapportioned. Assets and liabilities which cannot be directly linked with the activities of individual segments The arbitrary allocations of such items would distort the financial information published, and undermine the usefulness of any accounting ratios that make use of figures for assets and/or liabilities, for example, rate of return on capital employed. Common assets and liabilities must also, therefore, remain unallocated and be reported at the level of the group. Thus, in the case of Banchory, some of the non-current assets, payables and short-term borrowing remain at head office level. At the same time, it must be realised that common costs, assets, and liabilities do benefit the individual segments and so their true segmental values will inevitably be understated. This bias in reported data should be borne in mind when comparing segmental results with other companies, particularly those entities undertaking no other activities with the consequence that their reported results will take account of all costs, assets, and liabilities. ICSA, 2013 Page 17 of 23

18 Examiner s comments Question 4 was a question requiring explanation, preparation of, and commentary on, segmental statements, which was competently answered by well prepared candidates. However, a majority of answers did not accurately prepare the segmental statement or provide relevant comments. In particular, candidates appeared to have struggled to identify the problems and solutions for dealing with common costs and/or assets and liabilities relating to more than one segment. Better answers were presented in a columnar form (as shown in the suggested answer) and so saved time by avoiding having to repeat details relating to the four segments. Clear workings were not always presented to support the figures included in the statements. One other issue relating to examination technique was also illustrated in some answers. The question is in three parts: part (a) worth 5 marks; part (b) worth 10 marks; and part (c) worth 10 marks. It is important to manage your time and produce answers of the depth and length that reflect the marks available. A three-hour examination of 100 marks means that each mark is worth 1.8 minutes. Thus, the 25 marks available for an individual question merits only 45 minutes which, for this question, translates into: part (a) 9 minutes; and parts (b) and (c) 18 minutes each. This might seem very precise but can help candidates to remember the need to attempt all parts of a question and not to spend too much/ too little time on one part of a question. In this instance, answers to part (c) were frequently too brief and contained insufficient comments to gain the 10 marks available. ICSA, 2013 Page 18 of 23

19 5. (a) Identify and discuss the four measurement bases for asset recognition as contained in the International Accounting Standard Board s (IASB s) conceptual framework document The Framework for the Preparation and Presentation of Financial Statements. (10 marks) Once it has been decided that a resource should be recognised in the Statement of Financial Position, a decision has to be made about how that resource is to be measured. To be included in financial statements, a monetary value must be attached to the resource. The Framework for the Preparation and Presentation of Financial Statements details the following acceptable bases: Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire them at the time of their acquisition. Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was currently acquired. Realisable value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. Present value. Assets are carried at the present value of the future net cash inflows that the item is expected to generate in the normal course of business. The measurement basis most commonly adopted by enterprises in preparing their financial statements is historical cost. This is usually combined with other measurement bases. For example, inventories are usually carried at the lower of cost and net realisable value and pension liabilities are carried at their present value. Furthermore, the current cost basis may be used as a response to the inability of the historical cost accounting model to deal with the effects of changing prices of non-monetary assets. (b) Critically discuss the relationship between the measurement bases identified under (a) and the accounting concepts of accruals and going concern, with particular reference to IAS 36 Impairment of Assets. (15 marks) The critical discussion of the relationship between the above measurement bases and the accounting concepts of accruals and going concern requires, first, a definition of the two latter terms. Accruals basis. In order to meet the objective for financial statements to provide useful information for decision making, it is appropriate to prepare them on the accruals basis. This means that transactions and events should be recognised when economic rights and obligations arise rather than when cash or its equivalent is received or paid. The result is that assets are reported in the financial statements of the periods to which they relate. Going concern. Financial statements are usually prepared on the assumption that the reporting entity is a going concern and is likely to operate for the foreseeable future. The assumption is that the reporting entity has no intention to liquidate or to adversely curtail its scale of activities. Where a company can no longer be considered a going concern, however, a different basis of reporting may be necessary and that basis disclosed. ICSA, 2013 Page 19 of 23

20 Each of the measurement bases identified under (a) broadly comply with each of the above accounting assumptions, though they can result in very different figures reported in the accounts. Historical cost has been the traditionally used basis for financial reports but there has been a significant move towards the adoption of current values under the leadership of the standard setters. Current or fair values must be used in certain circumstances which include when an impairment review is undertaken. Where there is a suspicion that impairment has occurred, the carrying value of an asset must be compared with its recoverable amount. For this purpose, IAS 36 Impairment of Assets defines recoverable amount as the higher of an asset s (or larger cash-generating units): fair value less cost to sell, that is, net selling price (NSP); or value in use (VIU), that is, present value of future cash flows. Clearly, value in use involves a classic application of the going concern principle; the assumption is that the company will remain in business over the entire future period that the cash generating unit is expected to produce future cash flows. The use of net selling price, on the other hand, assumes that the cash generating unit is to be disposed of by the reporting entity, in which circumstances a figure which approximates to liquidation value might be appropriate. The result of these arrangements and others, for example, the option to restate non-current assets at higher current values, produces what is known as the mixed measurement system or modified historical cost. In the view of some, such diversity is justified in order to ensure that the accounts show a true and fair view, that is, given different circumstances, alternative measurement systems are best suited to ensuring the accounts fairly portray underlying economic arrangements. However, there is little doubt that the standard setters have shied away from enforcing the widespread use of current values, in anticipation of resistance from the business community, but the consequence is continued inconsistency in the valuation basis adopted both within the company (for example, some classes of non-current assets may be stated on the basis of historical cost and others at current value) and between companies. Examiner s comments This was an essay/discursive question on the four measurement bases for asset recognition contained in the IASB s conceptual framework; this had to be related to the accruals and going concern concepts. The weaker answers did not demonstrate the ability to provide the required recall/discussion of basic knowledge. Some answers tended to describe the work of the IASB and how accounting standards are set; others wrote about the characteristics of accounting information, for example, timeliness, comparability and so on. The key point is that many answers did not actually answer the question set and candidates are advised to make points which relate directly to the question. ICSA, 2013 Page 20 of 23

21 6. (a) Identify and discuss how, historically, differences in legal systems and the way in which industry is financed have impacted on the nature of financial reporting systems in particular countries. (10 marks) The following are two reasons for differences in financial reporting systems between countries. (i) The character of the national legal system Whereas common law forms the basis for legal systems in operation in some countries in the world, in others it is Roman Law. The UK is an example of a country where the legal system is substantially based on common law and, as a result, it traditionally relies on the application of equity and fairness to specific cases rather than compliance with a set of detailed rules. The result was, in the UK, limited regulation of financial reporting practices until the implementation of the European Directives following that country s admission to the European Community, beginning with the Companies Acts 1980 and The UK common law tradition has been, to an extent, accommodated within the changing character of legislation being applied to member states by allowing a degree of flexibility where strict compliance with detailed rules causes accounts not to exhibit a true and fair view. A key concept enabling such flexibility to be achieved is the true and fair override. France and Germany are examples of countries where the legal system is based on Roman Law and this results in less flexibility in the preparation of published financial reports. From the second quarter of the twentieth century, financial statements in such countries were prepared in accordance with charts of accounts and this became general practice among member countries following implementation of the Fourth Company Law Directive on accounting standards. (ii) The way in which industry is financed The information requirements of different providers of company finance differ depending on the nature of the relationship between contracting parties. UK and US companies rely more heavily on shareholder finance than many European and Japanese companies do, where loan finance is more prominent. Where the capital market dominates, as in the UK and the US, there is greater evidence of attention to concepts such as accruals and substance over form as a means of improving the quality of information available for performance assessment purposes. Where the loan creditor is more prominent, there can tend to be a greater emphasis on prudence and conservatism. The result is that in countries such as Germany and Japan, understatement of financial position and, even, secret reserves have found favour on the grounds that creditors rarely suffer from an entity s financial position being stronger than indicated by the published financial reports. ICSA, 2013 Page 21 of 23

22 (b) Explain the nature of XBRL (extensible Business Reporting Language) and describe how it helps businesses to operate more efficient accounting systems. (15 marks) The purpose of International Financial Reporting Standards (IFRSs) in the business community is to pave the way for global reporting processes that are common across countries. To facilitate and strengthen this process, the International Accounting Standards Board (IASB) and XBRL entities are working together to develop a set of XBRL taxonomies that enables the creation and use of common set of reporting format throughout the world. Both IFRSs and XBRL are intended to standardise financial reporting in order to promote transparency and to improve the quality and comparability of business information, therefore, the two entities form a perfect partnership. The development of XBRL enabled the business community to electronically communicate economic and financial information in a manner that cut down costs, provides a greater level of efficiency of use, and improves reliability to users and suppliers of information. XBRL uses the XML (Extensible Markup Language) syntax and related XML technologies, which are the standard in communicating information between businesses and the Internet. Data can be converted to XBRL by appropriate mapping tools designed to convert electronic data to XBRL format, or data can be written directly in XBRL by suitable software. XBRL works on a system of TAGS. Instead of treating financial information as a block of text, as in a standard internet page or a printed document, XBRL provides an identifying tag for each individual item of data. This is computer readable. For example, company revenues and items of expenses and net profit have their own unique tag. This enables manipulation by users, through query forms, to generate data and information in the required format. The introduction of XBRL tags enables automated processing of business information by computer software, facilitating efficient re-use of data for comparison. Computers can treat XBRL data intelligently, enabling: Storage of data and information in XBRL format that enables selection, analysis, exchange and presentation in a variety of ways dependent on the end-users requirements. Speed XBRL greatly increases the speed of handling financial data, reduces the chance of error and permits automatic checking of information. Costs Companies can use XBRL to save costs and streamline their processes for collecting and reporting financial information. Retrieval Consumers of financial data, including investors, analysts, financial institutions and regulators and researchers, can locate, manipulate, compare and analyse data much more rapidly and efficiently in XBRL format than by other online facility. Data handling XBRL can handle data in different languages and accounting standards. It can flexibly be adapted to meet different requirements and uses. Examiner s comments This was an essay/discursive question, with part (a) asking candidates to identify and discuss how differences in legal systems and the way industry is financed have impacted on the nature of financial reporting. Candidates who demonstrated they were well prepared on the topic produced good answers but the weaker answers frequently did not focus on the question set ICSA, 2013 Page 22 of 23

23 and provided points that were not relevant to all aspects of financial reporting and the content of International Accounting Standards. Part (b) examined candidate s knowledge of XBRL and answers were clearly divided between those who had studied XBRL and those who had not. However, part (b) not only asked candidates to explain the nature of XBRL but also to describe how it helps businesses to operate more efficient accounting systems. Weaker answers emphasised the description but omitted the ways in which XBRL could promote efficiency. As ever, the advice is to answer the question set, in a focused and direct manner, rather than provide a general discussion of the topic. The scenarios included here are entirely fictional. Any resemblance of the information in the scenarios to real persons or organisations, actual or perceived, is purely coincidental. ICSA, 2013 Page 23 of 23