DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO. Financial Pillar. F1 Financial Operations. Monday 24 February 2014

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1 DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO. Instructions to candidates Financial Pillar F1 Financial Operations Monday 24 February 2014 You are allowed three hours to answer this question paper. You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, highlight and/or make notes on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time. You are strongly advised to carefully read ALL the question requirements before attempting the question concerned (that is all parts and/or subquestions). ALL answers must be written in the answer book. Answers written on the question paper will not be submitted for marking. You should show all workings as marks are available for the method you use. ALL QUESTIONS ARE COMPULSORY. Section A comprises 10 sub-questions and is on pages 3 to 6. Section B comprises 6 sub-questions and is on pages 8 to 11. Section C comprises 2 questions and is on pages 12 to 15. The country Tax Regime for the paper is provided on page 2. Maths tables and formulae are provided on pages 17 and 18. References to IFRS in this paper refer to International Financial Reporting Standards or International Accounting Standards as issued or adopted by the International Accounting Standards Board. The list of verbs as published in the syllabus is given for reference on page 19. Write your candidate number, the paper number and examination subject title in the spaces provided on the front of the answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close. Tick the appropriate boxes on the front of the answer book to indicate the questions you have answered. F1 Financial Operations TURN OVER The Chartered Institute of Management Accountants 2014

2 COUNTRY X - TAX REGIME FOR USE THROUGHOUT THE EXAMINATION PAPER Relevant Tax Rules for Years Ended 31 March 2007 to 2014 Corporate Profits Unless otherwise specified, only the following rules for taxation of corporate profits will be relevant, other taxes can be ignored: Accounting rules on recognition and measurement are followed for tax purposes. All expenses other than depreciation, amortisation, entertaining, taxes paid to other public bodies and donations to political parties are tax deductible. Tax depreciation is deductible as follows: o o o 50% of additions to property, plant and equipment in the accounting period in which they are recorded; 25% per year of the written-down value (i.e. cost minus previous allowances) in subsequent accounting periods except that in which the asset is disposed of; No tax depreciation is allowed on land. The corporate tax on profits is at a rate of 25%. No indexation is allowable on the sale of land. Tax losses can be carried forward to offset against future taxable profits from the same business. Value Added Tax Country X has a VAT system which allows entities to reclaim input tax paid. In country X the VAT rates are: Zero rated 0% Standard rated 15% Exempt goods 0% March Financial Operations

3 SECTION A 20 MARKS [You are advised to spend no longer than 36 minutes on this section] ANSWER ALL TEN SUB-QUESTIONS IN THIS SECTION Instructions for answering Section A: The answers to the ten sub-questions in Section A should ALL be written in your answer book. Your answers should be clearly numbered with the sub-question number and then ruled off, so that the markers know which sub-question you are answering. For multiple choice questions, you need only write the sub-question number and the letter of the answer option you have chosen. You do not need to start a new page for each sub-question. Question One 1.1 SB operates in Country X and is considering starting business activities in a foreign country. An entity may conduct a foreign operation through a branch or a subsidiary. Which ONE of the following is an advantage of SB operating its foreign operation as a subsidiary? A A loss made by the foreign operation will be available to the SB group. B SB will only pay tax on dividends received from its foreign operation. C All profits/losses overseas will be subject to tax in Country X. D SB can claim tax depreciation on its foreign operation s assets. 1.2 The government of Country X has estimated the following for the year ended 31 December 2014: Total income tax due $166 billion Total income tax expected to be collected $135 billion Income tax that will not be collected due to tax evasion $10 billion Income tax that will not be collected due to tax avoidance $15 billion The tax gap for the year to 31 December 2014 is expected to be: A B C D $6 billion $16 billion $21 billion $31 billion TURN OVER Financial Operations 3 March 2014

4 1.3 QR is resident in a country that uses the classical system for the taxation of entity profits paid to shareholders as dividends. QR made a profit (before tax) for the year to 31 December 2013 of $200,000 and paid a dividend of $75,000. The shareholders pay income tax of 20% on dividends received. Calculate the tax paid by QR on its profits and the tax paid by the shareholders in respect of the dividend of $75, AU is registered for VAT in Country X. AU sells two types of products, W and Y. Product W is standard rated for VAT purposes and product Y is zero rated. During the VAT period ended 31 December 2013, AU s sales and purchases were: Sales (inclusive of VAT where applicable) Product W $63,250 Product Y $23,000 Purchases (exclusive of VAT) Goods subject to VAT at standard rate $44,050 Goods subject to VAT at zero rate $20,700 Assume AU has no other transactions that require inclusion in its VAT return. Calculate the VAT that AU is due to pay for the period ended 31 December YZ, incorporated in Country X, purchased a non-depreciable asset for $45,000 on 1 January YZ incurred additional purchase costs of $5,000. The asset was eventually sold for $110,000 on 31 December The indexation factor from 1 January 2005 to 31 December 2013 was 35%. The capital gains tax that YZ is due to pay on the disposal of the asset is: A $10,625 B $16,250 C $42,500 D $60, Which ONE of the following is NOT a fundamental principle of the CIMA Code of Ethics? A B C D Objectivity Integrity Confidentiality Responsibility March Financial Operations

5 1.7 Which of the following are responsibilities of the IFRS Advisory Council? (i) Give advice to the IASB on agenda decisions and priorities in its work. (ii) Annually review the strategy of the IASB. (iii) Inform the IASB of the views of the members of the Council on proposed new standards. (iv) Appoint the members of the IASB. A B C D (i) and (ii) (ii) and (iv) (i) and (iii) (iii) and (iv) 1.8 The IASB s Conceptual Framework for Financial Reporting (2010) (Framework) identifies four enhancing qualitative characteristics of financial statements. List TWO enhancing qualitative characteristics identified in the Framework. 1.9 A customer of CDF went bankrupt on 15 January 2014 owing CDF $75,000. CDF s profit for the year ended 31 December 2013 was $750,000 and its statement of financial position at that date showed trade receivables of $300,000. CDF has not provided for any bad debts for the year ended 31 December This is material but not fundamental. Which ONE of the following types of audit report should the external auditor of CDF issue for the financial statements of CDF for the year ended 31 December 2013? A A modified report with a qualified opinion in respect of receivables. B A modified report with a disclaimer opinion. C A modified report with an adverse opinion. D A modified report with an emphasis of matter paragraph. Section A continues on the next page TURN OVER Financial Operations 5 March 2014

6 1.10 Which ONE of the following is NOT listed as an element of financial statements by the IASB Framework? A B C D Asset Equity Profit Expenses (Total for Section A = 20 marks) Reminder All answers to Section A must be written in your answer book. Answers or notes to Section A written on the question paper will not be submitted for marking. End of Section A Section B starts on page 8 March Financial Operations

7 Section B starts on the next page TURN OVER Financial Operations 7 March 2014

8 SECTION B 30 MARKS [You are advised to spend no longer than 9 minutes on each sub-question in this section.] ANSWER ALL SIX SUB-QUESTIONS IN THIS SECTION 5 MARKS EACH Question Two (a) Required: (i) Explain the meaning of a subsidiary entity according to IFRS 10 Consolidated Financial Statements. (ii) Explain the meaning of an associated entity according to IAS 28 Investments in Associates and Joint Ventures. (Total for sub-question (a) = 5 marks) March Financial Operations

9 (b) PRT acquired 100% of SUB s ordinary shares on 1 January 2011 for $1,136,000 when SUB s retained earnings were $260,000. At 1 January 2011 the fair value of the net assets of SUB exceeded their carrying value by $110,000. The remaining useful life of these assets was 11 years from acquisition. SUB has not issued any new shares since acquisition by PRT. SUB is PRT s only subsidiary. PRT calculated that goodwill in its subsidiary was impaired by 20% at 31 December The equity of SUB as at 31 December 2013: $000 Ordinary share capital 430 Share premium 86 Retained earnings The retained earnings of PRT were $2,100,000 at 31 December Required: Calculate the amount that PRT should include in its consolidated statement of financial position as at 31 December 2013 for: (i) (ii) Goodwill Group retained earnings (Total for sub-question (b) = 5 marks) Section B continues on the next page TURN OVER Financial Operations 9 March 2014

10 (c) FP, resident in Country X for tax purposes, owns 100% of shares in a foreign entity, SM. SM reported profits before tax of $450,000 for the year ended 31 December 2013 with corporate income tax of $95,000. SM paid FP a dividend for the year ended 31 December 2013 of $150,000 which was then subject to withholding tax of 15%. SM uses the same functional currency as FP. SM operates in a country that has a double taxation treaty with Country X, that provides for the use of the tax credit method of double taxation relief. Required: (i) Calculate the total foreign tax suffered on the dividend. (ii) Calculate the amount of tax that FP will be liable to pay on receipt of the dividend in Country X, applying the tax credit method of double taxation relief. (3 marks) (Total for sub-question (c) = 5 marks) (d) FY is resident in Country X for tax purposes. For the year ended 31 December 2013, FY s profit before tax was $137,400. FY s expenses included entertaining $13,240; staff travel and subsistence $17,200 and donations to political parties of $6,120. FY s statement of financial position at 31 December 2013 included plant and equipment with a carrying value of $108,800. Part of the plant and equipment was purchased on 1 January 2012 at a cost of $56,000 and the remainder was purchased on 1 January 2013 at a cost of $94,000. FY depreciates all its plant and equipment on the straight line basis at 20% per annum. Required: Calculate the tax payable by FY for the year ended 31 December (Total for sub-question (d) = 5 marks) March Financial Operations

11 (e) PQ, an entity operating in Country X purchased plant for $600,000 on 1 January PQ depreciates its plant using the straight line method over 15 years, assuming a residual value of 10% of original cost. PQ claims all available tax depreciation allowances. On 1 January 2013 PQ revalued the plant and increased its carrying value by $50,000. The asset s useful life was not affected. Assume there were no other temporary differences in the period. Required: (i) Calculate the amount of PQ s deferred tax balance at 31 December 2013 in accordance with IAS 12 Income Taxes. (ii) Calculate the change in PQ s deferred tax balance for the year ended 31 December 2013 AND explain how the change would be treated in PQ s statement of profit or loss for the year to 31 December 2013 in accordance with IAS 12 Income Taxes. (Total for sub-question (e) = 5 marks) (f) Required: Explain the main advantages and disadvantages to an entity of having an external audit. (Total for sub-question (f) = 5 marks) (Total for Section B = 30 marks) End of Section B Section C starts on the next page TURN OVER Financial Operations 11 March 2014

12 SECTION C 50 MARKS [You are advised to spend no longer than 45 minutes on each question in this section.] ANSWER BOTH QUESTIONS FROM THIS SECTION 25 MARKS EACH Question Three The trial balance for LPO at 31 December 2013 was as follows: Notes $000 $000 Long term loans (repayable 2020) (xi) 900 Administrative expenses 455 Cash received from construction contract client (vi) 2,000 Cash and cash equivalents 215 Construction contract work in progress (vi) 1,875 Distribution costs 230 Equity dividend paid (x) 360 Inventory purchases 1,425 Inventory at 1 January 2013 (i) 420 Land and buildings at cost (iv) 2,500 Equity shares $1 each, fully paid at 31 December 2013 (ix) 1,500 Plant and equipment at cost (ii) 1,055 Provision for deferred tax (iii) 200 Provision for buildings depreciation at 1 January 2013 (iv) 225 Provision for plant and equipment depreciation at 1 January 2013 (v) 400 Retained earnings at 1 January Sales revenue 3,010 Share premium at 31 December 2013 (ix) 250 Trade payables 145 Trade receivables (vii) 330 Short term investments 135 9,000 9,000 Notes: (i) Closing inventory at 31 December 2013 was $562,000. (ii) On 31 December 2013, LPO disposed of some obsolete plant and equipment for $3,000. The plant and equipment had originally cost $46,000 and had a carrying value of $5,000. The purchaser has not yet paid for the plant and equipment and LPO has not made any entries in its financial records for this disposal. (iii) The income tax due for the year ended 31 December 2013 is estimated at $160,000. The deferred tax provision is to be increased by $31,000. (iv) Depreciation is charged on buildings using the straight line method at 3% per annum. The cost of land included in land and buildings is $900,000. Buildings depreciation is treated as an administrative expense. (v) Plant and equipment is depreciated using the reducing balance method at 30%. Depreciation of plant and equipment is regarded as a cost of sales. March Financial Operations

13 (vi) At 31 December 2013, LPO had a construction contract in progress: Contract length 3 years Date commenced 1 January 2013 Fixed contract price $5,500,000 Contract detail for year ended 31 December 2013: $000 Construction contract work in progress 1,875 Estimated cost to complete 2,700 Cash received on account from construction contract client during the year 2,000 LPO uses the cost of work completed as a proportion of total cost to recognise attributable profit for the year. (vii) On 1 February 2014, LPO was informed that one of its customers, ZZ, had ceased trading. The liquidators advised LPO that it was very unlikely to receive payment of any of the $36,000 due from ZZ at 31 January (viii) On 1 July 2013 one of LPO s customers started litigation against LPO, claiming damages of $30,000. LPO has been advised that the claim will probably succeed. (ix) On 1 July 2013 LPO issued 50,000 new equity shares at a premium of 20%. All cash was received and is included in the trial balance. (x) During the year LPO paid a final dividend of $240,000 in respect of the year ended 31 December This was in addition to the interim dividend paid on 31 July 2013 for the year ended 31 December (xi) The long term loans incur interest at 6% a year and this was not paid until 6 January Required: Prepare LPO s statement of profit or loss and other comprehensive income and statement of changes in equity for the year to 31 December 2013 AND the statement of financial position at that date in accordance with the requirements of International Financial Reporting Standards. Notes to the financial statements are not required, but all workings must be clearly shown. Do not prepare a statement of accounting policies. (Total for Question Three = 25 marks) Section C continues on the next page 4 TURN OVER Financial Operations 13 March 2014

14 Question Four CX s financial statements for 2013 are as follows: CX Statement of profit or loss and other comprehensive income for the year ended 31 December 2013 Note $000 Revenue 3,345 Cost of sales (vii) (1,912) Gross profit 1,433 Administrative expenses (430) Distribution costs (130) Profit from operations 873 Finance cost (133) Profit before tax 740 Income tax expense (92) Profit for the period 648 Other comprehensive income items that will not be reclassified subsequently to profit or loss Revaluation gain on properties 450 1,098 CX Statements of financial position at 31 December Notes $000 $000 $000 $000 Non-current assets Property, plant and equipment (i)(ii)(iii) 6,219 5,423 Investments (iv) Current Assets Inventories Trade receivables Investments (iv) 0 20 Cash and cash equivalents Total Assets 6,785 6,135 Equity and liabilities Equity Equity shares (v) 1,750 1,100 Share premium Revaluation reserve Retained earnings (viii) 1,968 1,870 Total equity 4,473 3,080 Non-current Liabilities Bank loans 1,900 2,700 Deferred tax 72 1, ,751 6,445 5,831 Current liabilities (vi) Total equity and liabilities 6,785 6,135 Notes: (i) Property, plant and equipment are comprised of: $000 $000 Property 3,570 3,200 Plant and equipment 2,649 2,223 March Financial Operations

15 (ii) Plant and equipment sold during the year for $20,000 had originally cost $77,000 on 1 January The plant and equipment was being depreciated on the straight line basis over seven years. CX depreciation policy is to charge a full year s depreciation in the year of acquisition with no depreciation charged in the year of disposal. Any gain/loss on disposal is included in profit or loss. (iii) Properties were revalued on 31 December (iv) The non-current asset investments are measured at fair value. During the year they suffered a loss and were reduced in value by $21,000. The current asset investment, disposed of during the year, was a 30 day government bond. (v) CX issued equity shares at a premium on 31 December (vi) Current liabilities: $000 $000 Trade payables Interest payable Tax payable Bank overdraft Total current liabilities (vii) Depreciation charged during the year was $150,000 for property and $290,000 for plant and equipment. (viii) A final dividend for the year ended 31 December 2012 was paid during the year ended 31 December Required: (a) Explain, in accordance with IAS 7 Statement of Cash Flows, the difference between the direct method and the indirect method (4 marks) (b) Prepare a statement of cash flows, using the indirect method, for CX for the year ended 31 December 2013, in accordance with IAS 7 Statement of Cash Flows. (21 marks) Notes to the Statement of cash flows are not required, but all workings must be clearly shown. (Total for Question Four = 25 marks) (Total for Section C = 50 marks) End of Question Paper Maths Tables and Formulae are on Pages 17 and 18 Financial Operations 15 March 2014

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17 MATHS TABLES AND FORMULAE Present value table Present value of $1, that is (1 + r) -n where r = interest rate; n = number of periods until payment or receipt. Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Financial Operations 17 March 2014

18 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years n 1 (1+ r ) r Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Annuity FORMULAE Present value of an annuity of $1 per annum, receivable or payable for n years, commencing in one year, discounted at r% per annum: 1 1 PV = 1 n r [1 + r ] Perpetuity Present value of $1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum: 1 PV = r March Financial Operations

19 LIST OF VERBS USED IN THE QUESTION REQUIREMENTS A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for each question in this paper. It is important that you answer the question according to the definition of the verb. LEARNING OBJECTIVE VERBS USED DEFINITION Level 1 - KNOWLEDGE What you are expected to know. List Make a list of State Express, fully or clearly, the details/facts of Define Give the exact meaning of Level 2 - COMPREHENSION What you are expected to understand. Describe Communicate the key features Distinguish Highlight the differences between Explain Make clear or intelligible/state the meaning or purpose of Identify Recognise, establish or select after consideration Illustrate Use an example to describe or explain something Level 3 - APPLICATION How you are expected to apply your knowledge. Level 4 - ANALYSIS How are you expected to analyse the detail of what you have learned. Level 5 - EVALUATION How are you expected to use your learning to evaluate, make decisions or recommendations. Apply Calculate Demonstrate Prepare Reconcile Solve Tabulate Analyse Categorise Compare and contrast Construct Discuss Interpret Prioritise Produce Advise Evaluate Recommend Put to practical use Ascertain or reckon mathematically Prove with certainty or to exhibit by practical means Make or get ready for use Make or prove consistent/compatible Find an answer to Arrange in a table Examine in detail the structure of Place into a defined class or division Show the similarities and/or differences between Build up or compile Examine in detail by argument Translate into intelligible or familiar terms Place in order of priority or sequence for action Create or bring into existence Counsel, inform or notify Appraise or assess the value of Advise on a course of action Financial Operations 19 March 2014

20 Financial Pillar Operational Level Paper F1 Financial Operations March 2014 Monday March Financial Operations