Faculty of Economic and Management Sciences. Department Accounting. Examination period: 2 nd semester. Module code: FRK 300

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1 Copyright reserved Faculty of Economic and Management Sciences Department Accounting Examination period: 2 nd semester Module code: FK 300 Duration: 3 hours (180 minutes) Date: 18 November 2014 Total marks: 120 Details of perusal: EMS 1 3 Monday, 1 December 2014 from 9h00 11h00 and 13h30 15h30 Internal examiners: K B Leith / A Smit / W M Badenhorst External examiners: T Tomes/ von Well (University of Pretoria) DJ Deysel (University of Johannesburg) Instructions: Answer all of the questions. The question paper consists of 17 pages (excluding cover page). Only the four bound IFS textbooks are permitted in the examination venue. Important information 1. The results of examinations and supplementary examinations for first year students only will be displayed on the notice-boards next to the Human Sciences Building. The results for first, second and third year, as well as postgraduate students will be available on the MTN line ( ) and on the UP Student Portal. esults will be mailed to candidates after the examination period. LECTUES AND ADMINISTATIVE STAFF WILL NOT GIVE CANDIDATES THEI ESULTS PESONALLY O PE TELEPHONE. 2. Supplementary examinations are not granted automatically, but are subjected to current Departmental policy. 3. Supplementary examinations take place from 28 November 5 December Timetables to determine the date, time and place of supplementary examinations are available on: 3.1 Noticeboards at the main entrance to the Merensky Library; 3.2 UP Student Portal; or 3.3 MTN telephone nr

2 1 VEY IMPOTANT INFOMATION 1. SUPPLEMENTAY EXAMINATION Date: 3 December 2014 Time: 7H30 10H30 (3 hours) Venue: Centenary 1 and 2 2. CHANCELLO S / SPECIAL / ADMISSION EXAMINATION Date: 14 January 2015 Time: 14H00 17H00 (3 hours) Venue: EMS 4 150

3 2 QUESTION 1 (35 marks) OIL EXTACTION LIMITED (OEL), listed on the JSE Limited, has a reporting date of 31 December. The company manufactures and supplies machinery and equipment for use in the oil exploration industry and also does its own oil extraction off the coast of Mossel Bay, South Africa. The financial accountant is preparing the annual report for the year ended 31 December 20X14 and is in the process of calculating the deferred tax liability / (asset) to be presented in the statement of financial position on this date. He has been provided with the following information for the year ended 31 December 20X14: 1. Finance lease agreement entered into with Oil Drillers Limited (ODL) OEL entered into a finance lease agreement with ODL on 1 January 20X14 for the supply of oil drilling equipment to ODL. The fair value of this equipment on 1 January 20X14 was 5,2 million whilst its cost of manufacture was 4,3 million. The oil drilling equipment was manufactured by OEL and was completed on 1 January 20X14. OEL incurred costs of related to the negotiation and arrangement of this finance lease agreement that were paid for in cash on 1 January 20X14. ODL did not incur any such costs. The terms of the finance lease agreement are market-related. The following information has been extracted from this agreement: Term of finance lease agreement 4 years Annual payments payable in arrears, with the first payment on 31 December 20X Guaranteed residual value payable on 31 December 20X Unguaranteed residual value ODL uses the oil drilling equipment for a qualifying purpose. 2. Instalment sale agreement entered into with Seabed Oil Limited (SOL) OEL entered into an instalment sale agreement with SOL on 1 September 20X13 for the supply of a pump to be used in oil drilling operations. The fair value of this pump on 1 September 20X13 was 4,5 million and it cost OEL 3,825 million to manufacture. Neither of the parties to this agreement incurred any costs related to the negotiation and arrangement of this instalment sale agreement. The terms of this agreement are market-related. The following amortisation schedule has been prepared by the assistant accountant related to this agreement (assume correct):

4 3 Payment date Payment Finance income Capital Capital outstanding /09/20X /09/20X /09/20X Operating lease agreement entered into with City Investments Limited (CIL) OEL leases its office building from CIL in terms of an operating lease agreement. This agreement was entered into on 1 January 20X13 for an initial period of five years with an option to renew the lease agreement for a further five years at an annual rental of 1,65 million. On 1 January 20X13, there was no reasonable certainty that OEL would exercise this option. OEL incurred initial direct costs of related to this operating lease agreement. The annual operating lease payments are payable at the beginning of each year and are as follows: 1 January 20X January 20X January 20X January 20X January 20X Land and factory buildings OEL purchased the land and factory buildings on 1 January 20X9. The factory buildings were available for use as intended by management immediately. The land and factory buildings have been accounted for on the cost model up to and including the year ended 31 December 20X13. The factory buildings are depreciated in accordance with the straight-line method over an estimated useful life of 15 years, with no significant residual value. There have been no indicators of impairment of the land and factory buildings at any of the reporting dates. On 31 December 20X13, the carrying amount of the land and factory buildings comprised the following: Land Factory buildings Cost on 1 January 20X Accumulated depreciation on 31 December 20X13 - ( ) Carrying amount on 31 December 20X

5 4 On 1 January 20X14, OEL decided to change its accounting policy relating to the land and factory buildings and to account for them in accordance with the revaluation model. On the date of revaluation, the accumulated depreciation of the factory buildings is eliminated against the asset s gross carrying amount. Any surplus arising on the revaluation of the factory buildings is realised with use whilst any surplus related to the land is realised on sale. On 1 January 20X14, an independent property valuator estimated that the net replacement cost of the factory buildings was 15 million whilst the fair value of the land was 3,5 million. The total useful life of the factory buildings remained unchanged on this date. 5. Construction of own oil rig During the year ended 31 December 20X13, OEL commenced with the construction of a new oil rig off the coast of Mossel Bay. This new oil rig is a qualifying asset in terms of IAS 23, Borrowing Costs. It is the accounting policy of OEL to capitalise borrowing costs related to qualifying assets every six months. OEL s financing activities are arranged by the finance division and none of the financing arrangements can be specifically identified as relating to the construction of this new oil rig. The following weighted average capitalisation rates have been calculated by the finance division for the year ended 31 December 20X14: Six months interest rate for the six month period ended on 30 June 20X14 5,50% Six months interest rate for the six month period ended on 31 December 20X14 5,75% The total costs incurred by OEL related to this new oil rig as at 31 December 20X13 comprised the following: Costs of construction Borrowing costs capitalised The following costs were incurred by OEL during the year ended 31 December 20X14 related to the construction of this new oil rig: Costs incurred and paid for on 30 June 20X Costs incurred and paid for on 15 December 20X All of the activities necessary to prepare the oil rig for its intended use were substantially completed on 15 December 20X14. The oil rig was available for use as intended by management on this date, on which date management estimated that the total useful life of the oil rig would be 15 years. The extraction of the oil from the sea bed will only commence on 5 January 20X15 when the oil rig crew will report for duty.

6 5 In terms of environmental protection legislation relating to off-shore oil rigs, they must be dismantled and removed at the end of production and the sea bed must be restored. OEL estimated that the cost that will be incurred at the end of the 15 year period is 12 million. Of this 12 million, management estimates that 85% of these costs are attributable to the actual dismantling and removal of the oil rig structure and the rehabilitation of the sea bed relating to this, whilst 15% of these costs are attributable to the rehabilitation of the sea bed arising from damage related to the actual extraction of the oil. An appropriate discount rate before tax is 10% per annum compounded annually. An extract from the accounting policy of OEL indicates that all oil rigs are accounted for on the cost model and depreciated over their estimated useful life in accordance with the straight-line model. The residual values are considered to be insignificant. 6. Bonus obligation In terms of employment contracts with employees assigned to the oil rig crews, the employees are entitled to an annual bonus calculated at 2,5% of the profit before bonuses and tax. These bonuses are only payable in cash on 1 June of the following year, provided the employee is still employed by OEL on 30 April of that following year. The bonus payable to each employee is limited to what it would have been had there been no resignations. Based on past experience, OEL has established that 15% of these employees will resign before 30 April of the following year. The profit before bonuses and tax for the year ended 31 December 20X14 has been calculated as 150 million. 7. Income tax The tax rate has remained unchanged at 28%. There are no temporary differences other than those that arise from the information provided. There is evidence of sufficient taxable income in the future for the recognition of any deferred tax assets. The South African evenue Service (SAS) applies the following, inter alia, in determining the taxable profit of OEL: - an allowance of 20% per annum is granted on the oil drilling equipment; - rental income is taxed when it is received in cash; - the remaining capital allowances on 31 December 20X14 that will be granted on the factory buildings amount to 12,6 million; - any costs related to the dismantling of oil rigs and rehabilitation of the sea bed will be deductible when they are paid in cash; - oil rigs are written off in equal amounts over a 15 year period commencing on the date that they are taken into use for the first time; and - bonus expenses are deductible when they are paid in cash.

7 6 EQUIED: Prepare the deferred tax note of Oil Extraction Limited as at 31 December 20X14 in accordance with International Financial eporting Standards (IFS). Note: Comparative amounts are not required. ound calculated amounts to the nearest and. A detailed deferred tax calculation must be provided for all of the assets and liabilities arising from the information provided. ound interest rates calculated to five decimal places. Ignore Value Added Tax (VAT) and Capital Gains Tax (CGT). (35 marks)

8 7 QUESTION 2 (35 marks) SHELDON LIMITED is listed on the JSE Limited and has a reporting date of 28 February. The company provides contract research and development services to both the state as well as commercial clients for a wide variety of technical areas. In order for the company to maintain its diverse areas of specialist knowledge, Sheldon Limited holds investments in various other entities. The following summarised trial balances of all the companies in the Sheldon Limited Group for the year ended 28 February 20X14 are available: Sheldon Limited Leonard Limited ajesh Limited Howie Limited Ordinary share capital etained earnings: 1/3/20X Mark-to-market reserve: Balance 1/3/20X Movement during the year Profit for the year Deferred tax Bank overdraft Trade and other creditors Property, plant and equipment Intangible assets Investment in Leonard Limited Investment in ajesh Limited Investment in Howie Limited Other financial assets Non-current assets held for sale Inventories Trade debtors Bank Ordinary dividends Additional information 1.1 All of the companies in the Sheldon Limited Group have a 28 February reporting date and uniform accounting policies. 1.2 Each ordinary share of each of the companies in the Sheldon Limited Group has only one voting right and there have been no changes in the issued share capital of any of the companies since the acquisition of the various investments. 1.3 All of the investments in subsidiaries are accounted for at cost in the separate financial statements. Investments in associates and joint ventures are

9 8 accounted for at fair value through other comprehensive income in the separate financial statements. Mark-to-market reserves are only transferred to retained earnings when the underlying investment is disposed of. 1.4 All property, plant and equipment and intangible assets are accounted for in accordance with the cost model. The assets are written off over their estimated useful lives using the straight-line method. All residual values are insignificant. 1.5 The companies bank accounts are not held at the same financial institutions and the companies do not guarantee each other s bank overdraft accounts. 1.6 The tax rate for companies is 28%. Ignore Capital Gains Tax (CGT) and Dividend Withholding Tax (DWT). 2. Investment in Leonard Limited 2.1 On 1 March 20X10, Sheldon Limited acquired 80% of the issued ordinary share capital of Leonard Limited when the equity of Leonard Limited comprised the following: Ordinary share capital ( shares) etained earnings Mark-to-market reserve (see point 2.5)??? Since 1 March 20X10, Sheldon Limited has exercised control over Leonard Limited. 2.2 All of the assets and liabilities of Leonard Limited were considered to be fairly valued on the acquisition date, other than for an internally generated patent whose fair value was The patent was originally available for use as intended by management on 1 December 20X7 and the total development costs capitalised in terms of IAS 38, Intangible Assets, amounted to 1,2 million. On 1 December 20X7, it was estimated that the patent will have a useful life of ten years and this estimation has remained unchanged throughout. During the current year, Leonard Limited decided to dispose of the patent and on 1 March 20X13, all of the requirements of IFS 5, Non-current Assets Held for Sale and Discontinued Operations, were met for the classification of the patent as held for sale. The fair value less costs to sell of the patent was on 1 March 20X13. Due to unforeseen circumstances, the patent had still not been sold on 28 February 20X14 and the extension of the one year period was applicable. You can assume that the fair value less costs to sell remained unchanged on 28 February 20X Sheldon Limited chose to measure the non-controlling interest on the acquisition of Leonard Limited in accordance with the proportionate method.

10 9 2.4 During the year ended 28 February 20X11, Sheldon Limited recognised an impairment loss of on the investment in Leonard Limited in its separate financial statements. Assume that the impairment loss has no tax effect. 2.5 The Other financial assets of Leonard Limited comprise a non-controlling interest of shares in a listed company that were purchased on 31 May 20X9 at 5,00 per share. These shares were trading on the JSE Limited at 4,70 per share on 28 February 20X10 and at 7,50 per share on 28 February 20X14. Leonard Limited accounts for this investment at fair value through other comprehensive income. Leonard Limited has not accounted for the fair value adjustment related to this investment for the year ended 28 February 20X During the year ended 28 February 20X14, Leonard Limited sold technical manuals to Sheldon Limited for The technical manuals are classified as inventories in the financial statements of both companies. Leonard Limited sold the technical manuals to Sheldon Limited at a profit of 25% on cost. On 28 February 20X14, 40% of these manuals were still on hand in the records of Sheldon Limited. 3. Investment in ajesh Limited 3.1 On 1 March 20X9, Sheldon Limited acquired 60% of the issued ordinary share capital of ajesh Limited for 2,5 million when the equity of ajesh Limited comprised the following: Ordinary share capital ( shares) etained earnings Since 1 March 20X9, Sheldon Limited has exercised control over ajesh Limited. All of the assets and liabilities of ajesh Limited were considered to be fairly valued on acquisition date. Sheldon Limited chose to measure the non-controlling interest on the acquisition of ajesh Limited in accordance with the proportionate method. 3.2 On 1 April 20X11, ajesh Limited sold a copyright to Leonard Limited for The cost of the copyright was in the records of ajesh Limited and the copyright was available for use as intended by management on 30 November 20X10. On 30 November 20X10, it was estimated that the copyright had an indefinite useful life and this estimate was applicable throughout. Assume that the South African evenue Service does not grant any deduction in respect of the copyright.

11 10 4. Investment in Howie Limited 4.1 ajesh Limited acquired 30% of the issued ordinary share capital of Howie Limited on 1 March 20X11, and since this date, has exercised significant influence over the financial and operating policy decisions of Howie Limited. On the date of acquisition, all of the assets and liabilities of Howie Limited were considered to fairly valued. 4.2 The following analysis of the equity of Howie Limited on 28 February 20X14 (that you must assume is correct), is available: Total ajesh Limited (30%) At Since At acquisition Ordinary share capital etained earnings Total equity Consideration Gain on bargain purchase Since acquisition to the beginning of the current year etained earnings Current year Profit for the year Ordinary dividend ( ) (60 000) The above analysis does not take any intragroup transactions (if applicable) into account. 4.3 Since 1 March 20X11, Howie Limited purchases certain of its inventories from ajesh Limited at a gross profit percentage of 20%. Howie Limited has the following inventories on hand that had been purchased from ajesh Limited: 28 February 20X February 20X

12 11 EQUIED: a) Prepare only the Non-current assets section of the consolidated statement of financial position of the Sheldon Limited Group as at 28 February 20X14, in accordance with International Financial eporting Standards (IFS). Note: The Deferred tax line item is not required. Notes and comparative amounts are not required. ound all calculated amounts to the nearest and. (17½ marks) b) Calculate only the following amounts attributable to the owners of the parent company, as they would appear in the consolidated statement of changes in equity of the Sheldon Limited Group for the year ended 28 February 20X14: Opening balance of retained earnings Profit for the year. Note: Your answer must comply with International Financial eporting Standards (IFS). Both amounts must be calculated and may not be taken to be balancing amounts. Notes and comparative amounts are not required. ound all calculated amounts to the nearest and. (17½ marks)

13 12 QUESTION 3 (30 marks) On 1 December 20X3, the South African government awarded three of fifty new national television broadcasting licences in accordance with a tender process to TELEFANTASIC! HOLDINGS LIMITED (TFH), a company listed on the JSE Limited. The accountant of TFH calculated the profit for the year ended 30 November 20X9 as before taking into account the following transactions and events: 1. On 1 December 20X8, TFH had 112 million ordinary shares in issue. Selected closing prices for the company s shares according to the JSE Limited s database were as follows during the year ended 30 November 20X9: Date Price per share 30 November 20X8 1,60 1 April 20X9 1,75 30 June 20X9 2,35 30 November 20X9 1,80 2. The three national television broadcasting licences of TFH were acquired for a total amount of 57 million and are valid for a period of 25 years, after which they can be renewed for a further period of 25 years at 3 million. The expected economic benefits from renewal is estimated to be 100 billion. TFH plans to use the broadcasting licences for as long as possible. The broadcasting licences were available for use as intended by management on 1 December 20X3. Due to the large number of new national television broadcasting licences which were granted on 1 December 20X3, an active market for the broadcasting licences was created on this date. TFH accounts for broadcasting licences in accordance with the revaluation model and the broadcasting licences are revalued every three years with reference to the active market. On revaluation, any accumulated amortisation is eliminated against the gross carrying amount of the broadcasting licences. Amortisation is calculated on the latest revalued amount in accordance with the straight-line method. The first revaluation was performed on 30 November 20X6. A net replacement cost of 17 million per broadcasting licence on 30 November 20X6 and a net replacement cost of 18 million per broadcasting licence on 30 November 20X9 were used to perform the revaluations. The estimate of the useful life has remained unchanged throughout. 3. On 1 April 20X9, TFH issued 24 million ordinary shares at their fair value and the cash was received on this date. 4. On 1 July 20X9, TFH purchased 19 million ordinary shares in Best Adverts (Proprietary) Limited at 1,50 each in order to protect the company s revenue streams. Transfer fees of 1 million were paid in cash on this date. The company s internal legal advisor spent a month of his time on the negotiation of this transaction. The total cost to the company in respect of this legal advisor is

14 per month. The legal advisor was employed by the company for the full year ended 30 November 20X9. Due to the strategic nature of the investment, management designated the investment in Best Adverts (Proprietary) Limited as at fair value through other comprehensive income on 1 July 20X9. The ordinary shares of Best Adverts (Proprietary) Limited do not trade in the open market. On 30 November 20X9, management reports of Best Adverts (Proprietary) Limited showed a profit after tax for the past twelve months of 28 million. Management determined on 30 November 20X9 that a fair priceearnings-ratio for companies similar to Best Adverts (Proprietary) Limited was five. If TFH should sell the shares on this date, transfer fees of 1,2 million would be payable. Best Adverts (Proprietary) Limited has 100 million ordinary shares in issue. 5. In order to finance the purchase of the interest in Best Adverts (Proprietary) Limited (refer point 4), TFH had a rights issue. The rights issue allowed existing shareholders to take up one ordinary share for every eight shares previously held at 1,90 per share. The rights issue took place at the opening of the JSE Limited on 1 July 20X9 and was fully taken up. 6. On 31 August 20X9, TFH issued convertible debentures at their face value of 10 each (equal to fair value on this date) in order to finance expansion in Namibia. These debentures bear interest at 12% per annum on the face value, which is paid quarterly (i.e. four times per year) in arrears with the first payment on 30 November 20X9. On 31 August 20X19, these debentures will be converted into 3,5 million ordinary shares or be redeemed in cash at face value at the option of the entity. Market-related interest rates on similar debentures without conversion rights were 14% per annum on 31 August 20X9. By 30 November 20X9, these rates had increased to 15% per annum and it is expected that they will reach 16% per annum by 31 August 20X TFH accounts for investment property in accordance with the fair value model. On 30 November 20X8, the carrying amount of TFH s investment property was 4 million (1 million attributable to land). On 30 November 20X9, the fair value of the investment property was 4,5 million (1 million attributable to the land). On 30 November 20X9, TFH planned to use the investment property for another 20 years and then to sell it for an estimated 1,5 million (1,2 million attributable to the land).

15 14 8. The accountant was uncertain about the treatment of the leave obligation and obtained the following information: Category Number of employees Average basic salary per employee per year Average accumulated leave days outstanding per employee 30/11/20X8 30/11/20X9 - Broadcasting Technicians All employees must contribute 5% of their basic salary to a defined contribution plan, while the employer contributes a further 10%. No salary increases have been granted. All employees are entitled to 20 days vacation leave per year and the leave cycle falls with the financial year. Broadcasting personnel and technicians may take their leave in the next leave cycle. On 31 March of each year, accumulated leave in respect of the previous year which has not yet been taken is paid out in cash for the broadcasting personnel. For technicians, accumulated leave in respect of the previous year which has not yet been taken by 31 March, expires on this date. Historical experience shows that all personnel that may carry leave forward use 80% of this leave by 31 March of the next year. Assume 250 work days in a year. The leave pay accrual on 30 November 20X8 was The accountant has already accounted correctly for all other aspects in respect of these personnel (i.e. everything except for the leave pay accrual) for the year ended 30 November 20X9. No resignations or appointments of personnel are expected for the next financial year. (The equired is on the following page..)

16 15 EQUIED: a) Prepare the statement of profit or loss and other comprehensive income of Telefantasic! Holdings Limited for the year ended 30 November 20X9 in accordance with International Financial eporting Standards (IFS). Note: Ignore earnings per share. Ignore all tax consequences. ound calculated amounts to the nearest and. Notes and comparative amounts are not required. Start your answer with the subtotal Profit for the year. (23 marks) b) Calculate the weighted average number of ordinary shares in issue that Telefantasic! Holdings Limited must use in the calculation of basic earnings per share for the year ended 30 November 20X9. Your answer must meet the requirements of IAS 33, Earnings per Share. (7 marks)

17 16 QUESTION 4 (20 marks) EMALI LIMITED has a reporting date of 31 January. Emali Limited has a business model whose objective is to hold assets in order to collect their contractual cash flows. The company has not made any designations of financial instruments. The company s treasury department invests any surplus cash resources in various types of financial instruments in accordance with the entity s risk management and investment strategy. The financial accountant is aware that the accounting standards for financial instruments has undergone some significant changes recently and is uncertain about the classification and measurement of the following financial instrument: On 1 August 20X14, Nomali Limited issued a number of debentures to finance a capital project that would be very profitable in the future. Emali Limited purchased one of these debentures on this date at its fair value. This debenture has a nominal value of 1 million. In terms of the debenture deed, the debenture bears interest at 8,5% per annum that is payable six-monthly in arrears on 31 January and 31 July until its redemption at 105% on 31 July 20X24. On 1 August 20X14, the marketrelated effective interest rate for similar debentures was 9,25% per annum. Emali Limited incurred costs of that are directly related to this transaction. On 31 January 20X15, Emali Limited received its first interest payment from Nomali Limited based on the terms of the debenture on the date of issue. On 26 January 20X15, during a severe thunderstorm, the factory buildings of Nomali Limited were very badly damaged. This event was widely reported on in the press at the time and on 31 January 20X15, management of Nomali Limited entered into a compromise arrangement with its creditors as a result of the significant financial difficulties that the company found itself in. In terms of this arrangement, the coupon rate of the debentures issued on 1 August 20X14 was reduced to 7,5% per annum with effect from 1 February 20X15 but the redemption amount remained unchanged. On 1 February 20X15, the market-related interest rate for similar debentures was 9,5% per annum. (The equired is on the following page..)

18 17 EQUIED: a) Discuss, with reasons, whether the debenture purchased by Emali Limited would be classified as subsequently measured at amortised cost in accordance with IFS 9, Financial Instruments. Note: A discussion of definitions is not required. (6 marks) b) egardless of your answer to part (a) above, assume that the debenture can be classified as subsequently measured at amortised cost. Discuss, with reasons, how the debenture will be initially and subsequently measured by Emali Limited during the year ended 31 January 20X15 in accordance with IFS 9, Financial Instruments, and IAS 39, Financial Instruments: ecognition and Measurement. Note: Calculations must be included in your discussion. A discussion of definitions is not required. Do not discuss the impact that this debenture will have on profit or loss. ound interest rates calculated to the nearest 5 decimal points and and amounts to the nearest and. (14 marks)