Financial Pillar. F2 Financial Management. 22 May 2014 Thursday Afternoon Session

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1 DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO. Financial Pillar F2 Financial Management 22 May 2014 Thursday Afternoon Session Instructions to candidates 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 5 questions and is on pages 2 to 7. Section B comprises 2 questions and is on pages 8 to 12. Maths tables and formulae are provided on pages 15 to 17. 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. F2 Financial Management TURN OVER The Chartered Institute of Management Accountants 2014

2 SECTION A 50 MARKS [You are advised to spend no longer than 18 minutes on each question in this section.] ANSWER ALL FIVE QUESTIONS IN THIS SECTION Question One MR operates a defined benefit pension plan for its employees. At 1 January 2013 the fair value of the pension plan assets was $3,700,000 and the present value of the pension plan liabilities was $3,900,000. The actuary estimated that the service cost for the year to 31 December 2013 was $1,100,000. The pension plan paid $340,000 to retired members and MR paid $760,000 in contributions to the pension plan in the year to 31 December The actuary estimated that the relevant discount rate for the year to 31 December 2013 was 5%. At 31 December 2013 the fair value of the pension plan assets was $4,400,000 and the present value of the pension plan liabilities was $4,700,000. Required: In accordance with IAS 19 Employee Benefits: (a) (i) Calculate the expense that will be charged to MR s profit for the year ended 31 December 2013 in respect of this pension plan.. (ii) Calculate the net actuarial gain or loss on pension plan assets and liabilities that will be included in MR s other comprehensive income for the year ended 31 December Your answer should clearly state whether it is a net gain or a net loss. (5 marks) Financial Management 2 May 2014

3 Asset sale On 31 December 2013 MR sold a piece of undeveloped land to CW and recorded the following entry: Dr Bank $6,000,000 Cr Land (Cost) $4,200,000 Cr Gain on sale $1,800,000 The sale agreement specifies that MR has the option to repurchase this land within the next two years for between $6,400,000 and $6,700,000 depending on the date of the transaction. MR is required to repurchase the land on 31 December 2015 for $6,700,000 if the option is not exercised before this date. CW must gain MR s approval before it can use the land for any purpose. The land had a market value of $8,000,000 on 31 December Required: (b) Discuss how MR should have accounted for this transaction in its financial statements for the year to 31 December 2013, in accordance with IAS 1(revised) Presentation of Financial Statements. (5 marks) Total for Question One = 10 marks TURN OVER May Financial Management

4 Question Two ER acquired 80% of the 1 million $1 equity shares of MW on 1 January 2012 when MW s retained earnings were $1,050,000. The consideration for the acquisition consisted of $400,000 cash paid on the acquisition date and the transfer of 500,000 $1 equity shares in ER with a fair value of $4.00 each at the acquisition date. The non-controlling interest in MW was measured at its fair value of $560,000 at the date of acquisition. On 1 January 2012 the carrying value of MW s net assets was considered to be the same as their fair value with the following exceptions: Leasehold property with a carrying value of $1,200,000 had a fair value of $1,320,000 and an estimated useful life of 5 years from the date of acquisition. ER depreciates property, plant and equipment on a straight line basis. A contingent liability, which had a fair value of $180,000 at the date of acquisition, had a fair value of $60,000 at 31 December This contingent liability is not reflected in the individual financial statements of MW. The retained earnings reported in the financial statements of ER and MW as at 31 December 2013 were $7,900,000 and $1,400,000 respectively. An impairment of 10% was recorded in ER s group financial statements as at 31 December An impairment review performed on 31 December 2013 indicated that goodwill on the acquisition of MW had been further impaired by 20% of its carrying value at that date. ER has no other subsidiaries. Required: Calculate the amounts that will be included in the consolidated statement of financial position of the ER group as at 31 December 2013 for: (a) goodwill; (b) retained earnings; and (c) non-controlling interest. Total for Question Two = 10 marks Financial Management 4 May 2014

5 Question Three The following information is available for entity QW: Share price as at 31 December $9.05 $5.12 Earnings per share for the year to 31 December $0.65 $0.38 Dividend per share for the year to 31 December $0.17 $0.30 Required: (a) (i) Calculate the P/E ratio and the dividend yield for QW at 31 December 2013 and comparative figures for (ii) Analyse the financial information for QW from the viewpoint of an investor. (6 marks) (b) Explain the limitations that would exist if you were to compare these ratios and market information for QW with that of an entity whose shares were listed on a stock exchange in a different country. (4 marks) Total for Question Three = 10 marks TURN OVER May Financial Management

6 Question Four ABC acquired 1 million $1 equity shares in XY on 14 June 2013 for $1.85 per share and classified this investment as available for sale. ABC paid a 1% transaction fee to its broker on this transaction. XY s shares were trading at $1.98 on 31 December On 2 October 2013 ABC acquired 200,000 $0.50 equity shares in LM for $0.70 per share and classified this investment as held for trading. ABC paid a 0.5% transaction fee to its broker on this transaction. LM s shares were trading at $1.15 on 31 December ABC prepares its financial statements in accordance with the provisions of IAS 32 Financial instruments: presentation and IAS 39 Financial instruments: Recognition and Measurement. Required: (a) Prepare the journal entries to record the initial measurement AND the subsequent measurement of the investments in XY and LM in the financial statements of ABC for the year to 31 December (6 marks) IFRS 13 Fair Value Measurement sets out a framework for the measurement of fair value. It has established a hierarchy that categorises the inputs used in valuation techniques. Required: (b) Explain, in accordance with IFRS 13 Fair Value Measurement, the level of input that is being used to value ABC s investment in XY and the different techniques and levels of input that could be used if XY was an unlisted entity. (4 marks) Total for Question Four = 10 marks Financial Management 6 May 2014

7 Question Five VB operates internationally and the directors have announced that they are to commission a sustainability project that is expected to significantly decrease the entity s adverse impact on the environment. The project will include adopting more environmentally-sound distribution options and relocating to properties with solar energy sources. The directors believe that while other competitors are likely to follow its example, VB will be the first in the sector to pursue this initiative. The announcement also mentions that VB will be applying for available government assistance to help with the funding of the project. Required: (a) Discuss the potential benefits to VB of including details of this project in the voluntary disclosures of its annual report. (6 marks) (b) Discuss the limitations of the voluntary information provided by VB in its annual report for investors making investment decisions about VB. (4 marks) Total for Question Five = 10 marks Total for Section A = 50 marks End of Section A Section B starts on page 8 TURN OVER May Financial Management

8 SECTION B 50 MARKS [You are advised to spend no longer than 45 minutes on each question in this section.] ANSWER BOTH QUESTIONS IN THIS SECTION 25 MARKS EACH Question Six The statement of financial position for the FB Group as at 31 December 2013 and its comparative are shown below: ASSETS $000 $000 Non-current assets Property, plant and equipment 38,000 32,000 Goodwill 2,000 - Investment in associate 11,000 9,000 51,000 41,000 Current assets Inventories 28,000 26,000 Receivables 22,000 25,000 Cash and cash equivalents 13,000 1,500 63,000 52,500 Total assets 114,000 93,500 EQUITY AND LIABILITIES Equity attributable to owners of the parent Share capital ($1 ordinary shares) 30,000 20,000 Share premium 5,000 - Retained earnings 18,350 14,300 53,350 34,300 Non-controlling interests Total equity 54,000 34,300 Non-current liabilities Long-term borrowings 36,000 42,000 Current liabilities Payables 20,000 14,000 Income tax 4,000 3,200 24,000 17,200 Total liabilities 60,000 59,200 Total equity and liabilities 114,000 93,500 Financial Management 8 May 2014

9 The statement of profit or loss for the FB Group for the year ended 31 December 2013 is shown below: $000 Revenue 38,000 Cost of sales (26,000) Gross profit 12,000 Distribution costs (1,800) Administrative expenses (2,000) Finance costs (1,900) Share of profit of associate 2,900 Profit before tax 9,200 Income tax expense (2,500) Profit for the year 6,700 Profit for the year attributable to: Owners of the parent 6,200 Non-controlling interests 500 6,700 Additional information 1. Depreciation charged in arriving at profit before tax was $4,000,000. There were no disposals of property, plant and equipment in the year to 31 December FB acquired a controlling interest in SM during the year for $6,350,000. The consideration consisted of $350,000 in cash and the transfer of 4,000,000 of FB s equity shares with a deemed value of $1.50 per share at the acquisition date. The non-controlling interest was measured at its fair value of $450,000 at the acquisition date. FB made no other purchases or sales of investments in the year and had no investments at the start of the year. 3. The fair value of the net assets of SM as at the acquisition date were as follows: $000 Property, plant and equipment 2,400 Inventories 3,600 Receivables 2,000 Cash and cash equivalents 200 Payables (3,800) 4, Finance costs relate solely to the long term borrowing. The effective interest rate of 4.524% was charged on the opening balance of the liability and interest of $1,200,000 was paid in December 2013, together with the capital repayment. 5. An impairment review conducted at 31 December 2013 resulted in goodwill being written down and an amount being charged to profit before tax. Required: Prepare the consolidated statement of cash flows for the FB Group for the year ended 31 December 2013, in accordance with IAS 7 Statement of Cash Flows. Total for Question Six = 25 marks TURN OVER May Financial Management

10 Question Seven VEG is an entity that started trading in January 2013 manufacturing and selling vegetable smoothie drinks. The entity uses innovative technology that pasteurises fresh drinks and gives them a shelf life of 8 weeks. VEG currently operates solely in Country X and is the only producer to use this technology to date. The two directors of VEG each initially invested $50,000 of equity capital to start the business. The long-term borrowings were secured in January 2013 under a business start-up initiative, and will be repaid over 4 years commencing January The directors also negotiated a short term bank overdraft facility of $75,000, which is intended to cover the working capital requirement. This is due for review on 1 April VEG has performed well in its first year of trading, selling to three large supermarkets and securing a contract with another supermarket to produce an own-brand product. This contract was signed in October The directors believe that VEG could exploit similar opportunities in both domestic and overseas markets if they expanded further. However, any further expansion would require significant capital investment in property, plant and equipment. You are a financial advisor and have a cash-rich client who is looking to make a private investment in an entity in return for equity shares. Your client is particularly interested in the technology that VEG is currently using. He is enthusiastic about VEG s potential, although he has not as yet looked at the financial performance and position of the entity. You have so far approached the directors of VEG who have confirmed that they would be interested in such an investment into their business as it would potentially allow them to undertake the capital investment required to expand. The directors have ed you the following financial information about VEG: Statement of financial position as at 31 December 2013 ASSETS $000 Non-current assets Property, plant and equipment 350 Intangible assets Current assets Inventories 40 Receivables Total assets 582 EQUITY AND LIABILITIES Share capital 100 Retained earnings 30 Total equity 130 Non-current liabilities Long-term borrowings 350 Current liabilities Payables 50 Income tax 12 Short-term borrowings 40 Total liabilities Total equity and liabilities Financial Management 10 May 2014

11 Statement of profit or loss for the year ended 31 December 2014 FORECAST 2013 ACTUAL $000 $000 Revenue 1, Cost of sales (620) (520) Gross profit Distribution costs (90) (70) Administrative expenses (100) (140) Finance costs (25) (20) Profit before tax Income tax expense (30) (20) Profit for the year Additional information 1. The forecast statement of profit or loss for the year ended 31 December 2014 is based upon VEG s existing contracts as at 31 December 2013 and does not take account of any potential new contracts from expansion. 2. The directors have estimated that forecast revenue can be achieved with the current levels of property, plant and equipment. 3. The directors are forecasting the following balances as at 31 December 2014: $000 Inventories 30 Receivables 290 No further forecast information is available at this time. 4. Administrative expenses for the year ended 31 December 2013 includes professional fees of $30,000 incurred in the business set-up, $40,000 in marketing and $20,000 for the cost of training staff in the production processes. Required: Write an to your client in which you: (a) analyse the actual and forecast financial performance and position of VEG using the information provided (6 marks are available for the calculation of relevant ratios); (18 marks) (b) explain the additional information that you would recommend he obtains before making an investment decision; and (4 marks) (c) explain, briefly, the limitations of using ratio analysis as a means of deciding on this potential investment. (3 marks) Total for Question Seven = 25 marks Total for Section B = 50 marks May Financial Management

12 End of Question Paper Maths Tables and formulae are on pages 15 to 17 Financial Management 12 May 2014

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15 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% May Financial Management

16 Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years 1 (1+ r ) r n Periods (n) Interest rates (r) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Periods (n) Interest rates (r) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Financial Management 16 May 2014

17 FORMULAE Annuity Present value of an annuity of $1 per annum receivable or payable for n years, commencing in one year, discounted at r% per annum: PV = r [1 + r ] n Perpetuity Present value of $1 per annum receivable or payable in perpetuity, commencing in one year, discounted at r% per annum: PV = r 1 Growing Perpetuity Present value of $1 per annum, receivable or payable, commencing in one year, growing in perpetuity at a constant rate of g% per annum, discounted at r% per annum: PV = 1 r g May Financial Management

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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 May Financial Management

20 Financial Pillar Management Level Paper F2 Financial Management May 2014 Thursday Afternoon Session Financial Management 20 May 2014