Institute of Chartered Accountants Ghana (ICAG) Paper 3.1 Corporate Reporting

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1 Institute of Chartered Accountants Ghana (ICAG) Paper 3.1 Corporate Reporting Final Mock Exam 1 Question paper Time allowed 3 hours Instructions: All five questions in this exam are compulsory and must be attempted. DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER EXAMINATION CONDITIONS

2 Corporate Reporting The Institute of Chartered Accountants Ghana First edition 2015 ISBN All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BPP Learning Media Ltd. Published by BPP Learning Media Ltd BPP House, Aldine Place London W12 8AA The Institute of Chartered Accountants Ghana 2015

3 Final Mock Exam 1: Questions 1 ALL FIVE questions are compulsory and MUST be attempted Question 1 The following financial statements relate to MLT, a public limited company. MLT GROUP STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 SEPTEMBER 20X5 MLT NBT ONW PLP GHSm GHSm GHSm GHSm Revenue 1, Cost of sales (1,650) (328) (202) (121) Gross profit Other income Distribution costs (72) (50) (62) (28) Administrative costs (92) (70) (28) (16) Finance costs (21) (20) (19) (10) Profit before tax Income tax expense (50) (56) (24) (11) Profit for the year Other comprehensive income for the year (not reclassified to profit or loss), net of tax: Gains on available-for-sale financial assets Gains (net) on property revaluation Remeasurement losses on defined benefit (34) plan Other comprehensive income for the year, net of tax Total comprehensive income and expense for year The following information is relevant to the preparation of the group statement of profit or loss and other comprehensive income: (a) During 20X0, MLT acquired a 10% interest in NBT, a public limited company. This investment was measured at fair value with changes in value presented in other comprehensive income. At the reporting date of 30 September 20X4 its fair value was GHS9m and no further adjustment has yet been made in the financial statements of MLT in respect of this value. On 1 January 20X5, MLT acquired a further 50% of the equity interests of NBT. The purchase consideration comprised cash of GHS200m paid on the acquisition date with a further amount to be paid on 1 January 20X6. The amount payable is based on a multiple of NBT s profit before tax over the three years after the acquisition. The fair value of this amount was estimated to be GHS250m as at the acquisition date. This estimate was revised to GHS220m as at 30 September 20X5 because subsequent work carried out by MLT s group accountant identified errors in the profit projections used in the original estimate. The fair value of NBT s identifiable net assets at the acquisition date was GHS380m. The fair value of the non-controlling interest in NBT was GHS40m on 1 January 20X5. MLT wishes to use the full goodwill method for all acquisitions. The stated capital and income surplus of NBT were GHS100m and GHS160m respectively and other components of equity were GHS100m at the date of acquisition. The excess of the fair value of the identifiable net assets at acquisition is due to an increase in the value of plant, which is depreciated on the straight-line method and has a ten year remaining life at the date of acquisition. NBT s profits are deemed to accrue evenly over the year. The goodwill on the acquisition of NBT was reviewed for impairment at the reporting date and this indicated that it had suffered an impairment of 10% of its value.

4 2 Final Mock Exam 1: Questions (b) MLT acquired 75% of the equity interests of ONW, a public limited company, on 1 April 20X5. (c) (d) There was no significant difference between the fair values of ONW s net assets and their carrying values at the acquisition date. Since 20X2 ONW has owned a 25% interest in PLP, a public limited company and exercises significant influence over that company. ONW carries the investment in PLP at fair value with changes in value recognised in other comprehensive income. In the current year a gain of GHS6m has been recognised. Goodwill had been impairment tested and no impairment had occurred. Profits of both ONW and PLP are deemed to accrue evenly over the year. In August 20X5 NBT sold inventory to MLT. The sale price of the inventory was GHS72m. NBT sells goods at a mark-up of 20% to group companies and third parties. At the year end, half of the inventory sold to MLT remained unsold. NBT paid a dividend of GHS20m on 30 June 20X5. MLT recognised the amount it received on that date in other income. (e) Ignore any taxation effects of the above adjustments. Required Prepare a consolidated statement of profit or loss and other comprehensive income for the year ended 30 September 20X5 for the MLT Group. (Total = 20 marks)

5 Question 2 (a) (b) Final Mock Exam 1: Questions 3 On 1 October 20X4 MCN, a public limited company with a 30 September year end, granted to each of its senior management team either 6,500 shares in MCN or a cash equivalent equal to the market price of 6,000 shares. The right is conditional on the managers remaining in employment at MCN until 30 September 20X6. MCN reserves the right to choose whether to settle the scheme in cash or shares. However, in the past, MCN has always opted to settle similar schemes in cash. If the shares are issued, they must be held for two years from 30 September 20X6 before being sold. MCN's share price was GHS8.50 on the 1 October 20X4 and GHS9.00 on 30 September 20X5. It rose to GHS9.25 on 20 October 20X5, the date the financial statements were authorised for issue. The fair value of the shares alternative was calculated at GHS8.10, GHS8.60 and GHS8.85 at the same dates respectively. At 1 October 20X4, there were 30 members of the senior management team. As at 1 October 20X4 no members of the team were expected to leave during the vesting period. However, due to a buoyant job market, two managers left in September 20X5 and as at 30 September 20X5, a third manager was expected to leave within a few months of the year end. The new finance director is unsure how to account for the above scheme. He is also aware that because tax relief will be granted on exercise (based on the entity's share price at the date of exercise), there might be some deferred tax implications. Required Discuss, with suitable computations, the accounting treatment for the above scheme in the financial statements of MCN for the year ended 30 September 20X5, taking into account any deferred tax implications and the impact of events occurring after the end of the reporting period. Assume a tax rate of 30%. Pension costs (10 marks) MCN acquired a new subsidiary on 1 January 20X5. The subsidiary operated a defined benefit pension plan for its senior management. As part of the fair value exercise, an actuarial valuation was carried out on the defined benefit pension plan at that date. The plan assets had a fair value of GHS72,600 and the present value of the pension obligation was GHS116,500. The following information has been provided for nine months to 30 September 20X5: GHS Plan assets at 30 September 20X5 at fair value 102,100 Present value of obligation at 30 September 20X5 119,500 Current service cost 15,500 Contributions paid into the fund by MCN 48,200 Benefits paid to pensioners 10,600 Yield on high quality corporate bonds (per annum) 6% The group accountant of MCN is unfamiliar with accounting for defined benefit plans, as the other plans within MCN are defined contribution plans. She has been advised that the directors must account for the plan in accordance with IAS 19 Employee benefits as revised in Required Prepare the extracts from the consolidated statement of profit or loss and other comprehensive income and statement of financial position for the year ended 30 September 20X5. (10 marks) (Total = 20 marks)

6 4 Final Mock Exam 1: Questions Question 3 SVT is a company that operates a chain of large out-of-town supermarkets. It has expanded rapidly over the last ten years, opening new stores in its home country and overseas. It has also moved into a wide-range of non-food sales and the provision of services, such as opticians. The company is currently preparing its consolidated financial statements for the year ending 30 September 20X5. On 1 October 20X3 SVT purchased land and buildings in an overseas capital city in order to open a new store. The land and buildings cost GHS20m, of which GHS8m related to the cost of the land. The property is being depreciated over 20 years on the straight-line basis with zero residual value. On 30 September 20X4, it was revalued to GHS23m (including land valued at GHS10m) and on 30 September 20X5, the land and buildings were revalued to GHS15m. The whole of the revaluation loss had been posted to other comprehensive income and depreciation has been charged for the year. It is SVT s company policy to make all necessary transfers for excess depreciation following revaluation. The directors of SVT are concerned about the most recent valuation, as well as the disappointing results from the new store and the possibility of closing down this operation was discussed at the most recent board meeting. (7 marks) During the last year, SVT opened petrol stations at a number of its supermarkets as a pilot scheme. This has proved to be very popular with customers and the company wants to expand this operation. The finance director identified a key risk of volatility of petrol prices and has taken out a forward contract to hedge against this. On 1 August 20X5, SVT entered into a forward contract to hedge its expected fuel requirements for the second quarter of the next financial year for delivery of 10 million gallons of petrol on 31 December 20X5 at a price of GHS2.04 per gallon. The company intends to settle the contract net in cash and purchase the actual required quantity of petrol in the open market on 31 December 20X5. At the company's year end the forward price for delivery on 31 December 20X5 had risen to GHS2.16 per gallon of fuel. (6 marks) During the year, SVT has commenced a programme of building 20 new stores in its home country. Costs of GHS68m have been incurred in the current year in respect of site preparation and payments to contractors. No specific loans were taken out to fund the building as SVT was able to use funds available to it through its existing set of borrowings. One director has suggested that an amount of interest calculated at the highest interest rate currently being suffered by the company should be capitalised in order to improve reported profits. (4 marks) In overseas countries, SVT normally leases its supermarket buildings. A number of properties leased over two years ago are now surplus to requirements. Although every effort has been made to sub-let these premises in the current economic climate it is recognised that it may not be possible to do so immediately. Therefore there will be a shortfall arising from sublease rental income being lower than the lease costs being borne by SVT. (3 marks) Required Write a report to the directors of SVT explaining how each of these matters should be dealt with in the group financial statements for the year ending 30 September 20X5. (Total = 20 marks)

7 Question 4 Final Mock Exam 1: Questions 5 FMC is a group of companies listed in the EU reporting under IFRSs. The group develops and makes a large portfolio of pharmaceutical products, both for the health care and beauty markets. FMC's customers include hospitals, governments, pharmacies and retail parapharmacy and supermarket chains. The group has two divisions: Research & Development and Fabrication. In addition to working for the FMC group, the Research & Development division also conducts research and development on behalf of smaller pharmaceutical companies and for governments. (a) Due to the nature of its business, FMC undertakes a significant amount of new research and development expenditure each year. During the current financial reporting period, FMC started two new significant development projects and abandoned development on another project which was not generating the results expected in human trials, as well as causing some significant adverse side effects. One of the testers is suing FMC for hair loss suffered in one trial, although FMC's lawyers have advised that the chances of success are slim given that a legal contract outlining the risk was signed with the human testers. One of the drugs that had been being developed in recent years went into commercial production for the first time during the year and has been an instant success. (6 marks) (b) On 1 October 20X0 the government awarded FMC a 10-year licence to make a cancer treatment drug. The licence was recognised on that date at its fair value of GHS9.8m. As a result of the award of the licence, FMC purchased a division of a competitor making similar products in 20X1 and merged it with its own activities, within its Specialist Drug sub-division, which is a separate cashgenerating unit. Goodwill of GHS12m was recognised on the purchase. By 20X6/20X7 the part of the Specialist Drug division producing the cancer drug amounted to about 5% of the revenues of the Group. On 1 May 20X7, the government revoked the licence on the grounds that FMC had failed to meet some of the criteria of the licence. At the date of the decision, the net book value of the combined assets of the Specialist Drug division was GHS942m (including the goodwill on the purchase of the competitor's business). No impairment losses had previously been recognised. As a result of this FMC decided to sell the associated assets or redeploy them elsewhere within the Specialist Drug division. As part of an impairment test conducted after the decision to sell, fair value less costs to sell of the Specialist Drug division was estimated at GHS804m. Revised estimated net cash inflows for the Specialist Drug division at the end of each of the next five years (taking into account sale or redeployment of the assets making the cancer drug) were estimated at GHS112m for years 1 3, GHS130m for year 4 and GHS1,014m for year 5 assuming the disposal of the division after five years. An appropriate discount factor is 12%. Employees of the division were notified of the decision on 1 June and redundancy notices for those who could not be redeployed elsewhere were issued on that date. The estimated amount of redundancy payment was GHS400,000 which had not been paid by the year end as the division had not been shut down by that date. (11 marks) (c) During the period FMC set up a joint (50:50) arrangement with a competitor to market and distribute certain over the counter products in the EU market. The joint arrangement is set up as a separate company which will pay dividends to the investors. FMC transferred a portfolio of distribution assets and a significant amount of cash to the entity as part of the set-up arrangement. The investors do not have direct rights to or ownership of the assets of the joint arrangement once contributed unless the entity is wound up, when the proceeds from the sale of the assets less liabilities would be distributed 50:50. No guarantees were entered into for the liabilities of the joint arrangement. The joint arrangement has been loss making so far, mainly due to set-up costs and has paid no dividends, but is expected to be profitable in the future. (3 marks) Required Write a report to the directors advising them about the implications of the above information for the financial statements for the year ending 30 September 20X7. (Total = 20 marks)

8 6 Final Mock Exam 1: Questions Question 5 The draft consolidated financial statements of LGR Group for the year ended 31 May 20X7 are being finalised. The non-executive directors have asked for expert advice in relation to the accounting treatment of certain transactions, and in particular, whether a summary of financial indicators presented to them is reliable. SUMMARISED CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X7 GHS 000 Non-current assets Property, plant and equipment 27,480 Intangible assets 9,400 Investment in joint venture ,200 Current assets 41,900 79,100 Equity Stated capital 39,900 Income surplus 8,700 48,600 Non-current liabilities Long-term loans 21,100 Current liabilities 9,400 79,100 Key ratios Profit before interest and tax GHS8,360,000 Return on capital employed 12% Equity long term loans GHS69,700,000 Interest bearing debt GHS21,100,000 Gearing 43% Equity GHS48,600,000 (a) One of LGR s subsidiaries LCO, has opened up a new retail superstore selling climbing equipment. The building has been leased on the following terms: Start date: 1 June 20X6 Lease term: Five years Rentals: Eight six-monthly payments of GHS200,000 commencing on 1 June 20X7 No expense has been recognised in respect of this lease. A six-monthly market rate of interest for borrowing with a similar risk would be 4%. LCO also plans to sell goods over the internet. GHS350,000 of start-up costs been capitalised as an intangible non-current asset. (3 marks) (b) Another subsidiary, PSN, completed the construction of a new manufacturing facility on 28 February 20X7. The project was financed through the issue of a GHS4,000,000 6% four-year bond. This was issued on 1 June 20X6 at a discount of 3⅓%. The internal rate of return of the debt is 7%. Market interest rates on debt with the same risk profile were 7% during the accounting period, but increased to 8% at the year end. The bond has been accounted for at fair value though profit or loss (fair value measured as the present value of the future cash flows with fair value changes recognised as financing items) and the finance costs for the year have been capitalised as part of the building cost. The building is being depreciated over 30 years. (6 marks) (c) LGR owns 50% of the equity stated capital of ISL. The other 50% is owned by an unrelated company, ZCF. All of the equity shares carry the same votes and rights to dividends. ISL was incorporated on 1 June 20X6 and acquired 10 shops from LGR. A contractual agreement between LGR and ISL grants LGR the right to make key management decisions regarding the operation of the ten shops. During the year ISL raised loans from ZCF carrying interest at market rates to fund expansion of the business.

9 Final Mock Exam 1: Questions 7 (d) Required The loans have been guaranteed by LGR. The investment in ISL has been equity accounted as a joint venture under IAS 28 Investments in associates and joint ventures. The following information relates to ISL for the year ended 31 May 20X7. STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X7 GHS 000 Non-current assets Property, plant and equipment 2,600 Current assets 1,200 3,800 Equity Stated capital 800 Retained losses (160) 640 Non-current liabilities Long-term loans 2,200 Current liabilities 960 3,800 (4 marks) JEB, another subsidiary of LGR, runs a national chain of garden centres. In June 20X6 the company paid GHS2,000,000 to acquire two leasehold properties, on leases of 40 years. The accounting policy which has been adopted as it is believed to be followed by other companies in this sector is not to provide any depreciation until the last ten years of the lease from which point the depreciable amount will be written off over the remainder of the useful life of the lease. (2 marks) Prepare a report for the non-executive directors explaining the appropriate accounting treatment and/or disclosure under current requirements for each of the issues identified above. Your report should also contain a revised schedule of ratios in line with best current practice. (5 marks) Notes. Cumulative discount factors: 8 periods at 4% periods at 8% (Total = 20 marks)

10 8 Final Mock Exam 1: Questions

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Institute of Chartered Accountants Ghana (ICAG) Paper 3.1 Corporate Reporting

Institute of Chartered Accountants Ghana (ICAG) Paper 3.1 Corporate Reporting Final Mock Exam 1 Marking scheme and suggested solutions DO NOT TURN THIS PAGE UNTIL YOU HAVE COMPLETED THE MOCK EXAM Corporate