ICAG 2014 NOVEMBER PROFESSIONAL EXAMINATIONS MARKING SCHEME FOR ADVANCED FINANCIAL REPORTING

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1 ICAG 2014 NOVEMBER PROFESSIONAL EXAMINATIONS MARKING SCHEME FOR ADVANCED FINANCIAL REPORTING

2 Answer to Q2 Ogyam Group Consolidated Statement of comprehensive income for the year ended 31 December 2012 GH 000 Sales (136,800+74,100+68,400-1, ) 276,360 Less Cost of Sales (54,150+16,389+15, ) (83,745) Gross Profit 192,615 Distribution cost ( ) (22,086) Administration costs (10,425+2,850+5,700) (18,975) Impairment of goodwill (Current year) (778) Net Profit from operation before interest and tax 150,776 Finance costs (975) Profit before tax 149,801 Taxation (24,900+16,170+12,723) (53,793) - Profit after tax 96,008 Profit attributable to: NCI 11,142 Members of Parent 84,866 96,008 ===== Ogyam Ltd Group Consolidated Statement of Financial Position as at 31 December 2012 GH 000 PPE (106,449+72,819+39, ) 218,361 Goodwill 777 Current Assets (4,704+27,075+26,649-90) 58, Net Assets 277,476 ===== Financed by Stated Capital 24,000 Income Surplus 158,713 Shareholders Interest 182,713 NCI 25, ,074 Current liabilities 69, Equity and liabilities 277,476 ===== Page 1 of 14

3 Workings 1) Control Structure M K E Group: Direct 90% - Indirect - 90% of 80%= 72% Non-controlling interest: Direct 10% 20%] Indirect - 10% of 80% = 8% ] =28% All figures in 000 2(a) Elimination of intra-group sales from Revenue and Cost of sales 000 K 1,440 M 780 b) Elimination of intra-group unrealized profit on closing inventories 000 K 25/125 x 225, = 45 M ¼ x 180, = 45 3 Elimination of unrealized profit on non-current assets 000 Sale price to M 720 Cost price to O Unrealised profit 120 ======== 4 Adjustment for depreciation on intra group sales of fixed asset % of sales price % of Cost price Excess depreciation charge 24, 5 Cost of Control M K GH 000 GH 000 Cost of Investment to the group 19,950 10,260 (90% of GH 11,400) Representing Net assets acquired Stated Capital 8,100 4,320 Pre-acquisition. income surplus 3, ,949 6,372 Goodwill 8,001 3,888 Impaired previous years (8001) (2,333) Impaired in current year (778) Balance c/d ===== ==== Page 2 of 14

4 6 Non-controlling interest in Statement of Financial Position M K GH 000 GH 000 Stated Capital (10% of 9000) 900 1,680 (28% of 2000) Income Surplus [10% of (72, )] ,701 [28% of (59,694-45)] Minority portion of cost of investment (10% of 11,400) (1,140) ,980 18,381 ==== ==== 7 Non-controlling interest in Statement of comprehensive income GH 000 M 10% of (32, ) 3,226 K 28% of (28,317-45) 7, ,142 ==== 8 Consolidated Income Surplus for the year ended 31 December 2012 GH 000 GH 000 Balance b/f Ogyam 60,039 M 90% of (39, ) 32,103 K 72% of (31,377-2,850) 20, ,681 Less Goodwill impairment previously (10,334) ,347 Profit for the year 84, ,213 Dividend (28,500 ) Balance c/d 158,713 ====== Page 3 of 14

5 Answer to Question 3 Restated Statement of financial position as at 31 December 2013 Non-current assets 000 Intangible assets [240-40] 200 Land and buildings [2, ] 2,100 Plant and equipment [3, ] 3, ,940 Current assets 16, Total assets 22,640 ===== Equity: Ordinary shares 3,400 Preference shares 600 Revaluation reserve 100 Retained profit: [ ] 8, ,370 Non current liabilities Debenture stocks 2,100 Provisions for liabilities and charges 240+ Provision for de-commission [120+30] 150+ Provision for deferred tax [25% of 400] ,590 Current liabilities 7,680 - Equity and liabilities 22,640 ====== + These could be combined as Provisions for liabilities and charges 490 Workings Adjustment DR CR Profit 40 Intangible assets 40 Land and buildings 100 Revaluation reserve 100 Plant and machinery [234,375 x ] 120 Provision for de-commission 120 Profit-Depreciation [120/3] 40 Accumulated depreciation -Plant and Machinery 40 Profit :Finance cost-unwound discount [25% of 120] 30 Provision for de-commission 30 Profit Deferred tax [25% of 400,000] 100 Deferred tax provision 100 Page 4 of 14

6 Profit [Additional interest -Amortisation 100 Long-term liability Net Asset basis Value per share = Net assets/no of ordinary shares = [12,370, ,000]/3,400,000 shares = 3.46 ii) Price - Earnings Value of share = EPS X PE Ratio EPS Earnings = Earnings /No of ordinary shares = Revised earnings for 2013 Preference dividend = 2,000,000 [40,000-40,000-30, , ,000]-60,000 = 1,630,000 = =1630,000/3,400,000 = = That of similar listed company, appropriately adjusted EPS PE Ratio = 5 adjusted to say 4 Value of a share = X 4 = III Dividend Growth Method Value of a share = Do (1+g) ---- r-g Do = 1,488,000-60,000 = 1,428,000/3, shares = g = [1,428,000-1,360,000]/1,360,000 =5% r = That of similar listed entity = 15% or 0.15 Value of a business = (1.05) = /0.10 = = Comments The price per share ranges from about 2.00 to The PE Ratio provided the least valuation and the Dividend yield provided the highest. As prospective I00% takeover bidder, the earning based valuation seems more appropriate but it is unlikely that the shareholders of Old Timers would accept that price since the net assets basis [which provided the floor for a bargain) provided a higher valuation. It is also unlikely that the predator company would accept to pay a price based on the Dividend yield valuation of It is most likely that they would settle on a price close to the valuation produced by the net assets method [ since a great deal of work was done to fair value the net assets and more so net asset provided the median valuation. Page 5 of 14

7 Answer to Question 4 Resolutions reducing Capital, Shares, or liabilities (Section 75): Subject to confirmation by the Court, a company limited by shares may, by special resolution, Reduce its stated capital in any way; Extinguish or reduce the unpaid liability on any of its shares, Resolve to pay or return to its shareholders any of its assets which are in excess of the wants of the company; Alter the Regulations by canceling any of its shares Protection of payables (Section 79) If the company fails to pay any creditor the amount owed him, every member of the company shall be liable to contribute for the payment of that debt an amount not exceeding the amount which he would have been liable to contribute on the winding up of the company B REALISATION ACCOUNT Non-current assets 296,000 Payables discount 20,000 Inventories and WIP 182,000 PSTL: :Purchase Consideration 496,000 Receivables Bad Debts 18,000 Sundry Members: Loss on realization 54,120 Bank - Preference dividend 8,000 Winding up costs 4,000 Debenture holders (w1) 56,000 (premium on conversion) (256, ,000) PSTL - Service Charges : Debtor Collection 4,220 Creditor Payment 1, , ,120 ====== ====== SUNDRY MEMBERS ACCOUNT Income Surplus 60,000 Ordinary Shares 200,000 Loss on Realisation 54,120 Capital Surplus 140,000 Balance c/d 225, , ,000 ======= ====== Investment in PSTL shares 160,000 Balance c/d 225,880 Cash 65, , ,880 Page 6 of 14

8 CASH Balance b/f 42,000 Preference dividend 8,000 Net Cash received Winding up costs 4,000 Balance c/d 65, ,880 77,880 ====== ===== Balance c/d 65,880 Sundry Members (Settlement of Interest) 65,880 ======= ===== Cash received from PSTL Cash collected from receivables (440,000 18,000) 422,000 Less Cash paid to payables (400,000 20,000) 380,000 Service charge ( 4, ,900) 6, , Net Cash received 35,880 ====== PSTL Realisation : Purchasing Consideration 496,000 Preference Shareholders 80,000 12% Debentures 256,000 Investment in NOURISHING Ordinary shares 160, , ,000 ======= ======= b) Calculation of Goodwill on Acquisition Purchase Consideration 496,000 Net Assets Taken Over Non-current assets ( 296, ,000-40,000) 316,000 Inventory 160, , Goodwill 20,000 ======== Page 7 of 14

9 Calculation of Purchase Consideration Preference Shareholders 5/4 x 20,000 x ,000 Ordinary shareholder 1/2 x 100,000 x GHC ,000 Debenture holders 200,000 /200 X 80 X , ,000 ===== C)Initial Statement of Financial Position of PSTL Non-current assets 316,000 Goodwill 20, ,000 Inventories 160,000 Cash 64, Net Assets 560,000 ======= Financed by Stated Capital (80, , , ) 560,000 ======= Page 8 of 14

10 Answer to Question 5 A ACCOUNTING INCOME Accounting capital measures the total of the individual identifiable assets and liabilities of the business, Accounting capital measures the excess of total identifiable assets over liabilities of the business Accounting income is based on the actual transaction entered into by the firm It is based on the period postulate and refers to the financial performance of a form during a given period It is based on the revenue principle and requires a definition, measurement and recognition of revenues Accounting income requires the measurement of expenses in terms of the historical cost to the enterprise It requires that the realized revenues of the period be related to the appropriate or corresponding relevant cost ECONOMIC INCOME Economic capital measures the present value of the future cash flows. Income is used by an economist to mean profit as defined by an accountant Economic income should be viewed as a series of perceived events of psychic experiences called enjoyment. In the rational, utilitarian world of economic analysis, enjoyment is derived from the consumption of goods and services. Fisher therefore regards income as equivalent to the consumption of goods and services. He regards capital as the store of value which produces the flow of goods and services. Thus, in order to determine the income of a specific period, it is necessary to measure the value of a person s capital, both at the beginning and at the end of the period. If the capital has not changed in value, the person will have had no income; if it has increased in value, then income will have been earned. The increase may be withdrawn and consumed. In practice, the fund of capital may have given rise to goods, services or cash during the period and this must be taken into account in ascertaining the income of a person. If the value of the capital was identical at the beginning and at the end of the period, then the value consumed would equate the income of the period. HC Accounting The profit for the period is found by matching the income against the cost of items consumed in generating the revenue for the period (such items include non-current assets which depreciate through use, obsolescence or the passage of time). Items and events for which no monetary transaction has occurred are usually ignored altogether. The income for each period is normally taken into account only when the revenue is realised in the form of cash or in some form which will soon be converted into cash. In every case, a prudent view is taken of the value of assets, income and expenses. CCP Accounting CPP measures profits as the increase in the current purchasing power of equity. Profits are therefore stated after allowing for the declining purchasing power of money due to price inflation CPP accounts are prepared by adjusting all the amounts in the HC accounts to reflect the value of money at a point in time. Page 9 of 14

11 CPP accounts are prepared by updating all items in the statement of comprehensive income, and all non-monetary items in the Statement of Financial Position, by the CPP factor: Index at the Statement of Financial Position date CPP factor = Index at date of entry in accounts Depreciation is adjusted by reference to the date of acquisition of the related non-monetary asset item. Monetary items in the Statement of Financial Position are not adjusted, because their values in CPP units is their monetary amount. In the CPP accounts, it is necessary to compute a gain or loss from holding monetary items in times of inflation. In principle, this can be found by adjusting all entries in the accounts for each monetary item by the CPP factor, so that the difference between the CPP balance and the actual monetary balance represents the gain or loss on holding that item. CCA The current cost profit and loss is charged with the value to the business of assets consumed during the period. In particular, the charges for consuming inventories (cost of sales) and non-current assets (depreciation) are based on current rather than historical values. Current cost accounting is addressed to the concept of capital maintenance interpreted as maintaining the operating capacity of the firm. It involves: The current cost statement of comprehensive income is charged with the value to the business of assets consumed during the period. In particular, the charges for consuming inventory (cost of sales) and non-current assets (depreciation) are based on current rather than historical values. The current cost statement of financial position reflects the current value of inventory and non-current assets. - Calculating current operating profit by matching current revenues with the current cost of resources exhausted in earning those revenues. - Calculating holding gains and losses - Presenting the Statement of Financial Position in current value terms. Current cost accounting (CCA) is based on the deprival method of valuation of assets. In order to reflect deprival values, the Statement of Financial Position assets of inventory and noncurrent assets require revaluation. All other assets and all liabilities are monetary in nature (i.e. they are already stated at current value in HC accounts) and therefore do not need to be adjusted. Page 10 of 14

12 Answer to Question 5 B I Borrowing Cost The project is funded by a combination of three loans all specifically borrowed to finance the qualifying assets. Hence all the interest incurred [reduced only by interest income earned on temporarily investment of idle funds] on the specific loan up to the point of project completion would be capitalized as part of the initial recognised cost. Interest expense relating to 1 October -31 December will be expensed Interest expense to capitalize 15% of 4 million x 9/12 450,000 20% of 6 million x9/12 900,000 24% o 10 million 9/12 1,800, ,150,000* Less: Interest income 850,000 (W1) --- 2,300,000 ======== *An alternative is to calculate the weighted average rate and apply it on the total portfolio [15% of 4 million] +[ 20% of 6 million] + [25% of GH10 million] /20million 600,000+ 1,200, ,400,000/20 million 4,300,000/20,000,000 = 21% 21% of 20 million x 9/12 = 3,150,000 The building should be recognised as [20,000, ,000] = 22,300,000 Depreciation for the year should be 22,300,000/40 years x 3/12 = 139,375 Adjustment required Recognition of interest income and capitalization of interest expense DR Bank 850,000 DR Property 2,300,000 CR Interest expense 3,150,000 Adjustment to depreciation charge DR: Depreciation charge 14,375 CR Accumulated Depreciation 14,375 (w1)interest income 1 January -31 March 10% x 18,000,000 x 3/12 450,000 1 April - 30 June 10% x 13,000,000 X 3/12 325,000 1 July 30 September 10% x 3,000,000 x 3/12 75, ,000 ====== Page 11 of 14

13 Ii: Non-current assets held for sale On 1 January 2013, the land was revalued to GHC70,000. The revaluation gain of GHC10,000 [70,000 60,000] should be recognized in other comprehensive income [OCI] and held in equity under revaluation surplus. The land should then be reclassified as held for sale. The cost to sell of GHC2,000 should be recognized in income statement as an impairment loss. The carrying amount of the land (now classified as held for sale ) should now be GHC68,000. On the sale of the land on 1 July 2013, a further loss of GHC1.000 [68,000-67,000] should be recognized as a loss on sale because the sale proceeds are less than the carrying amount. Any balance on revaluation surplus is now realized and should be transferred to retained earnings [income surplus] through the statement of changes in equity. Relevant Journal entries are as below: DR CR GHC GHC 1 January 2013 DR Land PPE 10,000 CR Revaluation surplus 10,000 Being revaluation prior to reclassification DR Non current assets held for sale [70,000 2,000] 68,000 DR Income statement [ loss on reclassification] 2,000 CR Land PPE 70,000 Being reclassification of non current assets held for sale And remeasurement at fair value less costs to sell 1 July 2013 DR Cash 67,000 DR Income statement [loss on disposal] CR Non- current asset held for sale 68,000 De-recognition of non-current asset now sold and recognition Of loss on disposal DR Revaluation surplus 10,000 CR Retained earnings [income surplus] 10,000 Transfer of realized revaluation surplus to retained earnings Through statement of changes in equity. [4 marks] III: Financial liabilities When a financial liability is recognized initially in the statement of financial position, the liability is measured at fair value (plus transaction costs, f the FL is not fair valued through profit or loss). Since fair value is a market transaction price, on initial recognition fair value generally is assumed to equal the amount of consideration received for financial liability. Accordingly, IAS 39 specifies that the best evidence of the fair value of a financial instrument at initial recognition generally is the transaction price. Page 12 of 14

14 Transaction costs may arise in the acquisition, issuance, or disposal of a financial instrument. Transaction costs are incremental costs, such as fees and commissions paid to agents, advisers, brokers and dealers; levies by regulatory agencies and securities exchanges; and transfer taxes and duties. Except for financial liabilities at fair value through profit or loss, transaction costs that are directly attributable to the issue of a financial liability are capitalized. Fair value = 40,000 X 97.5% = 39,000 Recognition of transaction cost of 1,068 is DR Transaction cost 1,068, CR Cash 1,068. This transaction cost is capitalized by a transfer to the financial liability: DR Financial Liability 1,068 CR Transaction cost 1,068. The initial capitalized fair value of the financial liability is 39,000 1,068 = 37,932 The accountant should charge interest of 2,655 (7% of 37,932) and recognise a liability at amortised cost of 38,987 at the end of the year (37,932+2,655 1,600) The amortistion schedule is as follows[not required by the question] Int. Year AC[1/1/] Int(@7%) Pd(@4%) AC(31/12) ,932 2,655 (1,600) 38, ,987 2,729 (1,600) 40, ,116 2,808 (1,600) 41, ,324 2,893 (1,600) 42, ,617 2,983 (1,600) 44,000 Page 13 of 14