THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS

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DECEMBER 2006 Time allowed 3 hours Section A 10 short questions (compulsory) Section B 5 long

1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG FINANCIAL ACCOUNTING DECEMBER 2006 Time allowed 3 hours Section A 10 short questions (compulsory) Section B 5 long questions (attempt any 3) DO NOT OPEN THIS PAPER UNTIL INSTRUCTED TO DO SO BY THE INVIGILATOR Page 1 of 14

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3 SUBJECT NO 15M HONG KONG FINANCIAL ACCOUNTING DECEMBER 2006 The examination paper is divided into TWO Sections. Section A is compulsory and carries 40 marks. Candidates should attempt THREE questions from Section B, all of which carry 20 marks each. You should allow yourself approximately 70 minutes in total to answer the questions in Section A, and 35 minutes for each of the questions attempted in Section B. $ denotes Hong Kong dollars. Tuesday morning 5 December 2006 Time allowed: 3 hours SECTION A (Compulsory answer ALL questions in this section) 1. (a) Rainbow Company operates in three different locations, each of which is appropriately regarded as an operating segment. Segment 1 contributed 60% of Rainbow s total sales in Sales for Segment 1 were $900,000 and traceable expenses were $400,000 in Rainbow s total nontraceable expenses for 2005 were $600,000. Rainbow allocates nontraceable expenses based on the ratio of a segment s sales to total sales, an appropriate method of allocation. Determine the segment profit or loss for Rainbow Company s Segment 1 for (b) HKAS 23 Borrowing Costs specifies a benchmark treatment and an allowed alternative treatment for the borrowing costs incurred by business entities. Explain the terms benchmark treatment and allowed alternative treatment for borrowing costs incurred in a particular period. Page 3 of 14

4 (c) A travel agency makes an airplane reservation for a customer, collects $1,000 from the customer, delivers the ticket to the customer, remits $930 to the airline and retains $70 as commission. The travel agency acts purely as an agent for the airline, assuming no responsibility for the flight. Based on the definition and recognition criteria for revenue in the HKICPA s Framework for Preparation and Presentation of Financial Statements, calculate how much the travel agency should recognise as its revenue (provide justification for your answer). (d) Specify the major features of two inventory accounting systems, i.e., a perpetual inventory system and a periodic inventory system, and explain their advantages and disadvantages. (e) How should the following changes be accounted for in terms of HKAS 8 Accounting Policies, Changes in Estimates and Errors retrospectively or prospectively? (i) A change in accounting policy made voluntarily (ii) A change in accounting policy required by an new accounting standard or interpretation (iii) A change in accounting estimate (iv) A material accounting error discovered in the current year, relating to a transaction recorded two years ago (f) Singdong Ltd s share capital currently consists of 40,000 ordinary shares issued with a par value of $5 per share, and 20,000 10% preference shares issued at $10 each. No dividend has been paid for the past two years. The company plans to pay out $100,000 in dividends in the current year, meeting all past obligations (where applicable) to shareholders. Determine how much dividend each class of shares should receive under the following situations: (i) the preference shares are cumulative and non participating; and (ii) the preference shares are cumulative and participating. (Assume that the participation agreement requires that the ordinary shareholders receive the same percentage of dividends as the preference shareholders, and that any balance of dividends to be paid is shared in proportion to the issued share capital of each class.) Page 4 of 14

5 (g) A wholly owned foreign subsidiary of Nippon Company has selected expense accounts stated in foreign currency units (FCU) for the fiscal year ended 30 November 2006 as follows: Doubtful accounts expense FCU 60,000 Patent amortisation expense (patent acquired in 1 December 2003) 40,000 Rent expense 100,000 The functional currency of the foreign subsidiary is Hong Kong dollars. The exchange rates for the FCU for various dates or periods were as follows: HK$ 1 December November Average for year ended 30 November Determine the total Hong Kong dollar amount to be included in the remeasured income statement for Nippon Co s foreign subsidiary for the year ended 30 November 2006 for the foregoing expense accounts. (h) Cheng Ltd and Wong Ltd own 80% and 20% respectively of the ordinary shares that carry voting rights at a general meeting of shareholders of Ng Ltd. Cheng Ltd sells one half of its interest to Lam Ltd and buys call options from Lam Ltd that are exercisable at any time at a premium to the market price when issued, and which, if exercised, would give Cheng Ltd its original 80% ownership interest and voting rights. At 30 June 2006 the options are out of the money. Explain whether Cheng Ltd is the parent of Ng Ltd. (i) Company A is a listed diversified retail company. Its stores are located mainly in China. It has three main types of stores general department stores, liquor stores and specialist toy stores. Each of these stores has different products, customer types and distribution processes. In accordance with HKAS 14, Segment Reporting, Company A has identified three business segments general department stores, liquor stores and specialist toy stores. All three business units earn a majority of their revenues from external customers. The total consolidated revenue of Company A is $600 million. General Department Stores $ m Liquor Stores $ m Toy Stores $ m All Segments $ m Revenue Segment result (profit) Assets ,200 Identify Company A s reportable segments and explain your answer in terms of HKAS 14 Segment Reporting. Page 5 of 14

6 (j) A customer filed a lawsuit against Company A in June 2006 for costs and damages allegedly incurred as a result of the failure of one of Company A s electrical products. The amount claimed was $3 million. Company A s lawyers have advised that the amount claimed is extortionate and that Company A has a good chance of winning the case. However, the lawyers have also advised that if Company A loses the case its expected costs and damages would be about $500,000. How should Company A disclose this event in its financial statements as at 30 June 2006? (Total: 40 marks) Page 6 of 14

7 SECTION B (Answer THREE questions from this section) 2. A summarised comparative balance sheet of Hardcord Company is presented below: 30 June June 2006 $ $ Cash 20,000 91,000 Trade accounts receivables 65,000 90,000 Inventory 58,000 62,000 Prepayments 10,000 12,000 Land 80,000 90,000 Plant 280, ,000 Accumulated depreciation (60,000) (92,000) 453, ,000 Accounts payable 45,000 48,000 Borrowings 160, ,000 Share capital 200, ,000 Retained earnings 48,000 95, , ,000 Additional information: There were no disposals of land and plant during the year. A $30,000 loan was settled through the issue of ordinary shares. There were no other repayments of loans. Profit for the year was $120,000, interest expense was $14,000, and income tax expense was $41,000. A $73,000 dividend was paid during the year. REQUIRED: Using the indirect method of presenting cash flows from operating activities, prepare a cash flow statement in accordance with HKAS 7 Cash Flow Statements for the year ended 30 June (Total: 20 marks) Page 7 of 14

8 3. Mountain Ltd has two divisions, Abes and Buel. Each of these is regarded as a separate cash-generating unit. At 31 December 2005, the carrying amounts of the assets of the two divisions were : Abes Buel $ 000 $ 000 Plant 1,500 1,200 Accumulated depreciation (650) (375) Patent Inventory Receivables Goodwill The receivables were regarded as collectible, while the inventory s fair value less costs to sell was equal to its carrying amount. The patent had a fair value less costs to sell of $220,000. The plant at Abes was depreciated at $300,000 per annum, while that at Buel was depreciated at $250,000 per annum. Mountain Ltd undertook impairment testing at 31 December 2005, and determined the value in use of the two divisions to be as follows: Abes Buel $ 000 $ 000 Value in use 1, As a result, management increased the depreciation of the Abes plant from $300,000 to $350,000 per annum. REQUIRED: (a) Determine how Mountain Ltd should account for the results of the impairment tests at 31 December 2005 and list the carrying amounts of the assets of the two divisions at 31 December (13 marks) (b) If the performance in both divisions improved in 2006, and the recoverable amounts of the assets of both divisions are higher than the carrying amount, what will the maximum amount of reversal of the impairment in relation to plant and patent in the two divisions be? (7 marks) (Total: 20 marks) Page 8 of 14

9 4. On 1 July 2003, Company X leased a photocopier from Company Y, a company that manufactures, retails and leases copiers. The photocopier had cost Company Y $30,000 to make but had a fair value on 1 July 2003 of $35,080. The lease agreement contained the following provisions: Lease term 3 years Annual payment, payable in advance on 1 July each year $14,500 Economic life of the copier 4 years Estimated residual value at the end of the lease term when the copier is returned to Company Y $3,000 Residual value guaranteed by Company X $1,500 Interest rate implicit in the lease 10% The lease is cancellable, provided another lease is immediately entered into. The annual payment included an amount of $2,500 per annum to reimburse Company Y for the cost of paper and toner supplied to Company X. Company Y s solicitor prepared the lease agreement for a fee of $1,365. At the end of the lease term on 30 June 2006, Company X returned the copier to Company Y, who sold the copier for $3,000. The present value factors at discount rate of 10% for years 1 to 3 are , , and respectively. REQUIRED: (a) Classify the lease for both the lessor and the lessee. Justify your answer. (b) Prepare the following: (i) For the lessee: the lease payment schedule and the journal entries for the year ended 30 June 2006 only. (8 marks) (ii) For the lessor: the lease receipts schedule and the journal entries for the year ended 30 June 2004 only. (8 marks) (Total: 20 marks) Page 9 of 14

10 5. First Co owns all the share capital of Second Co. For each of the following intragroup transactions, assume that the consolidation process is being undertaken at 30 June 2006, and that an income tax rate of 30% applies. REQUIRED: Prepare the consolidation worksheet adjustment entries for these intragroup transactions. All parts are independent unless otherwise specified. (a) On 1 January 2006, First Co sold an item of plant to Second Co for $1,000. Immediately before the sale, First Co had the item of plant on its accounts for $1,500. First Co depreciates items at 5% per annum on the reducing balance basis and Second Co uses the straight-line method over ten years. (b) A non-current asset with a carrying amount of $1,000 was sold by First Co to Second Co for $800 on 1 January Second Co intended to use this item as inventory, being a seller of second-hand goods. Both entities charge depreciation at the rate of 10% per annum on the reducing balance basis. The item was still on hand at 30 June (2 marks) (c) On 1 May 2006, Second Co sold inventory costing $200 to First Co for $400 on credit. On 30 June 2006, only half of these goods had been sold by First Co, but First Co had paid $300 back to Second Co. (3.5 marks) (d) During March 2006, Second Co declared a $3,000 dividend. The dividend was paid in August (2 marks) (e) In December 2005, Second Co paid a $1,500 interim dividend. (2 marks) (f) In February 2005, First Co sold inventory to Second Co for $6,000, at a mark-up of 20% on cost. One-quarter of this inventory was unsold by Second Co at 30 June (1.5 marks) (g) On 1 January 2005, Second Co sold a new tractor to First Co for $20,000. This had cost Second Co $16,000 on that day. Both entities charged depreciation at the rate of 10% per annum on the reducing balance basis. (3.5 marks) (h) Second Co rented a spare warehouse to First Co and also to Third Co during The total charge for the rental was $300; First Co and Third Co both agreed to pay half of this amount each to Second Co. (1.5 marks) (Total: 20 marks) Page 10 of 14

11 6. Nanshan Ltd purchased 75% of the capital of Futing Ltd for $250,000 on 1 July At this date the equity of Futing Ltd was: $ Share capital 100,000 General reserve 60,000 Retained earnings 40,000 At this date, Futing Ltd had not recorded any goodwill, and all identifiable assets and liabilities were recorded at fair value except for the following assets: Carrying Fair amount value $ $ Inventory 70, ,000 Plant (cost $170,000) 150, ,000 Land 50, ,000 The plant has a remaining useful life of ten years. As a result of an impairment test, all goodwill was written off in All the inventory on hand at 1 July 2000 was sold by 30 June Differences between carrying amounts and fair values are recognised on consolidation. The tax rate is 30%. Assume a profit for Futing Ltd for the period of $40,000. The trial balances of Nanshan Ltd and Futing Ltd at 30 June 2006 are: Nanshan Ltd Futing Ltd $ $ Shares in Futing Ltd 250, Plant 425, ,000 Land 110,000 50,000 Current assets 162,000 84,000 Cost of sales 225,000 35,000 Other expenses 65,000 7,000 Income tax expense 50,000 5,000 1,287, ,000 Share capital 400, ,000 General reserve 60,000 80,000 Retained earnings (1 July 2005) 120,000 75,000 Sales revenue 510,600 80,000 Payables 72,900 12,000 Accumulated depreciation (plant) 124,000 24,000 1,287, ,000 REQUIRED: (a) Determine the goodwill to be recognised by Nanshan Ltd with the acquisition of Futing Ltd on 1 July (5 marks) Page 11 of 14

12 (b) Prepare the consolidated income statement for the fiscal year ended 30 June (5.5 marks) (c) Prepare the consolidated balance sheet as at 30 June (9.5 marks) (Total: 20 marks) End of Examination Paper Page 12 of 14

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THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS

THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG FINANCIAL ACCOUNTING PILOT PAPER Time allowed