=21.2% =13.1%

Transcription

1 SECTION A CASE QUESTIONS (Total: 75 marks) Question 1(a)(i) Computations GP GP margin = Revenue PBT PBT margin = Revenue =21.2% =13.1% =19.1% =9.3% To adjust for the non-recurring items: Adjusted PBT margin = PBT Non - recurring items Revenue = 10.8% 9.3% ROCE = Operating profit Capitalemployed = Total Operating profit assets - current liabilitie s 56 1, = 5.5% 3.9% Debt to equity ratio = Interest bearingdebts Equity = 45.5% 56.2% Current ratio = Current assets Current liabilitie s = Comments on the financial performance of LBH under the new management GP margin increased from 19.0% to 21.2%, indicating higher profitability due to effective direct cost control. Final Examination (June 2014 Session) Paper I 1 of 13

2 Adjusted PBT margin increased from 9.3% to 10.8%, indicating higher profitability. However, the increase in PBT margin was less than the increase in GP margin, which is possibly due to the increase in promotional and advertising expenses. ROCE increased from 3.9% to 5.5%, indicating a higher return on capital employed due to improvement in operating profit and better use of the assets / capital to generate revenue or profit. Also, since ROCE is higher than the borrowing cost, it indicates that it is making more efficient/productive use of its bank borrowings. Debt to equity ratio decreased from 56.2% to 45.5%, indicating lower financial leverage and thus financial risk, possibly due to the delay in capital expenditure plans. Current ratio increased from 1.1 to 1.2, indicating liquidity has improved, probably due to the increase in revenue and delay in capital expenditure plans. Revenue increased by 23.8% from HK$ 420 million to HK$ 520 million, reflecting the expansion of the business scale. Profit after tax rose from HK$ 33 million to HK$ 58 million, representing an increase of 75.8%. Taking into account the non-recurring item (and assuming no tax impact on net (58 12) 33 profit), adjusted profit after tax increased 39.4% ( ), indicating that profitability 33 grew healthily without squeezing the profit margin. Based on the above, the financial performance of LBH under the new management appears to have improved compared with that of the previous year. Question 1(a)(ii) Other financial benchmarks LBH can be compared against: other divisions of the KHH Group e.g. the luxury hotel or the boutique hotel division; the competitors of LBH e.g. the market leaders in budget hotel operations; and industry average of budget hotels. Question 1(b) The possible aspects (other than financial aspects) of a company that can be compared and measured in benchmarking include: products of the company offers; services of the company offers; significant business practices of the company; and processes by which the products / services are delivered. Final Examination (June 2014 Session) Paper I 2 of 13

3 Possible non-financial performance indicators include: number of complaints received from customers monthly or annually; rating or score of customer satisfaction in regular survey conducted; room occupancy rate; market share or ranking of the business; number of awards won; and employee productivity or turnover rate. Question 1(c) Typical means to align managers short-term interest with the company s long-term objectives: evaluate managers performance based on their contribution to long-term as well as short-term objectives; assign realistic short-term targets so that managers will not be forced to make tradeoffs with a negative impact on the long-term objectives; provide sufficient management information or reporting to allow managers to appraise what trade-offs (short-term versus long-term) they are making; set quality based targets as well as financial targets; and link managers rewards to share price which may also be an assessment of the company s future by the market. Answer 2(a)(i) Classification of hotel properties by nature Property class Owner-occupied property Investment property Hotel bedrooms / Office blocks / restaurant / bars Owner-occupied property held by owner for use in the production or supply of goods or services or for administrative purposes Investment property leased to KHH s fellow subsidiary to earn rentals the ancillary services provided are a significant component of the arrangement Shops leased to earn rentals Final Examination (June 2014 Session) Paper I 3 of 13

4 Classification of hotel properties by entities Entities Owner-occupied property Investment property Leases operating lease DSH - hotel bedrooms / restaurants / bars - shops WPH GHM - hotel bedrooms / restaurants / bars - shops XHL LBH KHH (consolidated) - hotel bedrooms / restaurants / bars - shops Answer 2(a)(ii) Guestroom renovation programme Hotels owned by DSH are regarded as owner-occupied property and the following requirements under HKFRSs would be relevant for consideration: DSH should differentiate items to be installed in the guest room from (i) major spare parts and stand-by equipment or (ii) spare parts, stand-by equipment and servicing equipment: Major spare parts and stand-by equipment that are expected to be used for more than one period or can be used only in connection with an item of property, plant and equipment would be accounted for as property, plant and equipment under HKAS 16. Spare parts, stand-by equipment and servicing equipment are generally classified as inventories under HKAS 2. Where an item of PPE can be separated into parts (components) when those parts are significant in relation to the total cost of them, component accounting is mandatory. Final Examination (June 2014 Session) Paper I 4 of 13

5 Major inspections or overhauls are identified and accounted for as a separate component if that component is used over more than one period. When an item of PPE comprises individual components for which different depreciation methods or rates are appropriate, each component is depreciated separately. Costs associated with routine repairs and maintenance are expensed as incurred. Directly attributable expenditure, such as guestroom design modification costs, labour costs incurred to renovate the guest room or to install major pieces of equipment would be capitalised as part of the cost of the PPE. As to replacement, DSH should recognise in the carrying amount of an item of PPE the cost of replacing part of such item when that cost is incurred if the recognition criteria under HKAS 16 are met. The carrying amount of those parts that are replaced by a new component (e.g. original hotel room design costs) is derecognised in accordance with HKAS 16. Answer 2(a)(iii) Replacement of interior wall of shopping mall in DS Bangkok The following matters would be relevant for consideration: The shopping mall in DS Bangkok would be classified as investment property under HKAS 40. Given that DSH accounts for its hotel properties, including shopping malls under cost model, the shopping mall in DS Bangkok would be accounted for in accordance with the cost model for PPE. The replacement of the interior wall of the hotel shopping mall in DS Bangkok is ahead of the negotiation and conclusion of the terms and conditions of a lease agreement with a potential lessee, whether to replace the interior wall of the hotel shopping mall in DS Bangkok is at the discretion of DS Bangkok. If DS Bangkok replaces the interior wall, it would be treated as a replacement of part of an investment property. Parts of investment property acquired through replacement are capitalised and included in the carrying amount of the investment property if the general asset recognition criteria are met. The carrying amount of the part replaced is derecognised. consistent with those in HKAS 16. These requirements are Final Examination (June 2014 Session) Paper I 5 of 13

6 Answer 2(b) Accounting for hotel properties in the consolidated financial statements of KHH: In determining the classification of a property in consolidated financial statements, the assessment is made from the point of view of the group as a single reporting entity. This means that a property might be classified differently in consolidated financial statements in KHH from any separate financial statements or consolidated financial statements of each of KHH s subsidiaries. Uniform accounting policy should be adopted and therefore all properties classified under PPE or IP would be stated at cost less accumulated depreciation and accumulated impairment (if any) in KHH s consolidated financial statements. As a result, the following consolidation adjustments would be made: Hotel properties owned by WPH hotel properties owned by WPH would no longer be classified as IP or stated at fair values; carrying amount of the properties and the consolidated retained earnings would be adjusted against the accumulated fair value changes and accumulated depreciation based on original cost of the properties for prior years; and consolidated profit or loss for current year and the carrying amount of the properties would be adjusted based on the difference between current year fair value changes and the depreciation based on original cost of the properties. Hotel properties owned by XHL no longer be stated at fair values on the statement of financial position; PPE revaluation reserve as recognised in other comprehensive income would be reversed by reducing the carrying amount of the properties and the additional depreciation charged to profit or loss based on revalued amount of the properties; and hotel properties should be recognised as owner-occupied property under HKAS 16 because XHL owns the hotel properties and operates the hotels by itself. As such, the retained earnings as at the beginning of the current year and prior years as well as the profit for the current year should be corrected retrospectively by reversing the amounts of fair value changes as previously recognised and adjusting the depreciation of the hotel properties based on the original cost of the properties. Final Examination (June 2014 Session) Paper I 6 of 13

7 Hotel properties leased by GHM intra-group transactions between WPH and GHM would be fully eliminated as if no lease arrangements between WPH and GHM exist; and fair value of shopping malls leased by GHM would be reversed retrospectively by adjusting the current year fair values changes in profit or loss and the accumulated fair value changes in retained earnings. Shopping malls included in hotel properties owned by DSH and WPH are leased to third parties and classified as IP and hence their fair values should be disclosed in the consolidated financial statements under HKAS 40.79(e). Under such situation, the requirements under HKFRS 13 should be adhere to for fair value measurement and comprehensive disclosures. Answer 2(c) The board of directors is the body of elected or appointed members who jointly oversee the activities of a corporate entity. In general, the board of directors is collectively responsible for the management and operations of the entity. In Hong Kong, the responsibilities and liabilities of directors derive from various sources, including the constitution of the entity, case law, statute and regulation such as listing rules. If a person does not comply with his duties as a director he may be liable to civil or criminal proceedings and may be disqualified from acting as a director. As such, a company director owes a duty to exercise reasonable skill and care to the company. The new Hong Kong Company Ordinance ( CO ) contains explicit requirements on the following financial reporting related matters: directors of a company must prepare annual financial statements that give a true and fair view of the company s financial position and financial performance for the financial year; financial statements must be approved and signed by directors; company must send copies of financial statements to members before annual general meeting; and a company s directors must, in respect of each financial year, lay financial statements before the company in annual general meeting. Final Examination (June 2014 Session) Paper I 7 of 13

8 Answer 3(a) Risk assessment of material misstatement in employee costs and related expenses The values of the staff costs and related expenses are significant to the financial statements as noted from the case, which might create a material misstatement should something go wrong. Furthermore, the internal controls around this area are minimal which might provide opportunities for manipulation or misappropriation. Moreover, given that management has received anonymous reports of frauds and the unusual amount of employee salaries identified by the auditor, it is likely that the staff costs and related expenses are misstated. Based on the above and from the case background, the risk of material misstatement is assessed to be high, in particular in relation to the occurrence of the expenses. Responding audit procedures if the assessed risk level is high The auditor shall vary the nature, timing and extent of audit procedures depending on the results of risks assessment. Nature The testing procedures for a normal risk in this area might typically include relying on control and substantive analytical procedures for a large group like KHH. However, if the area is of higher risk, the auditor may increase the vigour by changing the nature of the procedures to a test of details (e.g. select some staff costs and related expenses transactions to see if they agree with evidence at the source level) to increase the expected level of audit comfort to be obtained from the procedure. The auditor shall also cover specific procedures not originally planned should the higher risk assessment triggers be not there. For example, the auditor shall ask management their view and response to the anonymous complaints, and if a formal investigation has been carried out and, if so, the result. (Note: Other examples could include i) performing a physical check of the employees to test the integrity of the payroll listing, or ii) performing investigation on the unusual payment identified in the case. Timing For an area with a normal risk, the auditor might for efficiency or other reasons perform audit procedures before the year end, for example testing controls before the year end followed by some level of update testing only in the intervening period. However, if the area is of higher risk, the auditor may defer the procedure to the year end, so that the whole period is covered in the planned procedures in order to increase the audit comfort obtained from the procedures. Extent The auditor shall increase the extent of testing if there is a higher risk assessed. For example, the auditor might select more samples for test of details procedures, like physical checking of employee to payroll listing, if the risk is assessed to be high in order to gain more audit comfort from the procedure. Final Examination (June 2014 Session) Paper I 8 of 13

9 The auditor may also extend the inquiry with management to a broader base, for example including persons outside the financial function, persons with higher seniority as well as junior staff, and the internal audit team in the Group. Answer 3(b) In accordance with HKSA240 (Clarified) The Auditor s Responsibilities Relating to Fraud in an Audit of Financial Statements and HKSA250 (Clarified) Consideration of Laws and Regulations in an Audit of Financial Statements, the auditor shall communicate irregularities and non-compliance with laws and regulations, including fraud, identified with those charged with governance. If the auditor suspects that those charged with governance are involved, the auditor shall make the communication at the next higher level of authority. The auditor shall also consider implications of the auditor s report if the auditor believes that the matter has a material effect on the financial statements and has not been adequately reflected or the auditor is unable to draw a conclusion as to whether the matter is material to the financial statements. The auditor shall also determine whether the matter should be reported to other regulatory or enforcement authorities, though the auditor shall also consider his duty of confidentiality. Answer 3(c) Typical internal controls with regard to employee costs and related expenses include the following: The group may carry out random check of the attendance record by identifying physically the employee using the attendance record on that particular day. The group may perform analytical procedures to analyse the employee costs and related expenses by types, compare it across periods, and cross-match with their understanding of employee manpower demand and salary rates to identify an unusual or unexplainable trend. The group may avoid payment of employee remuneration by cash even for part-time employees, and ensure salaries are only paid to employees designated accounts with matching names and other details in employment records. The group shall assign different persons to (i) keep the payroll records and information; (ii) calculate the monthly payment for staff; and (iii) communicate with banks for payments to staff, etc., to ensure proper segregation of duties. Final Examination (June 2014 Session) Paper I 9 of 13

10 Answer 3(d) The following are the facts identified from the case which would affect the risk assessment of related parties and their transactions: The related parties, from the case, are group companies and their key management within the same ultimate group with related businesses. There is no other complex range of relationships or structure identified, therefore, reducing the risk of unidentified related parties. Though the various group companies have different related party transactions (e.g. royalty arrangement, interest income and expenses on loans and advance), the transactions appear to be in their respective normal course of business and at market terms, therefore, reducing the risk of manipulation through these parties and transactions. The companies have well established controls for identifying and reporting related parties and their transactions, therefore, reducing the risk of unidentified/unreported related parties and transactions. The potential significant one-off support in the form of discounted services and equipment from EMH to the Low Budget Hotel business might also increase the risks as it is one-off in nature and might not align with general market practices / terms. The following are the typical risk assessment procedures we would consider using in the area of auditing related parties and their transactions: Review the last year audit file to understand the list of related parties and transactions from last year to assess the risk and plan the audit procedures for this year. Ask management for information regarding new related party and transactions carried out in the year and understand the business rationale for the transactions. Understand from management the changes in controls around related parties and their transactions, and consider whether these management controls are adequate. Review significant contracts and minutes to identify new related parties and their transactions. * * * END OF SECTION A * * * Final Examination (June 2014 Session) Paper I 10 of 13

11 SECTION B ESSAY QUESTIONS (Total: 25 marks) Memo Date : 3 June 2014 To : Managing Director From: XXXXX, Manager, Goodman Tax Consulting Limited Re : Tax issues of the X Hotel Group Answer 4(a) The Assess First Audit Later after the submission of the Profits Tax Return refers to the practice that the Assessor will not examine the taxpayer s return and would issue the assessment (or statement of loss) based on the assessable profits (or adjusted loss) as stated in the tax return. Procedures to rectify the overstatement in tax return filed It is too late to lodge an objection against the said Notice of assessment, which should be lodged within one month after the issuance of notice of assessment. The Company should lodge a s.70a claim and state that there has been an error in the tax return, namely, the assessment profits were wrongly stated in the tax return submitted and that the correct assessable profits was HK$26,945,384. XHL has to lodge a s.70a claim within 6 years of assessment or within 6 months of the date on which the notice of assessment was received, whichever is later. Answer 4(b) The tax treatment and related procedure for the royalty are as follows: deductibility of royalty under s.16(1) requires that it is incurred in the production of XHL s assessable profits; for royalty payment falls within s.15(1)(b), IRD deems EMSH s royalty income as Hong Kong sourced trading receipt; XHL is required to withhold the tax required for the royalty payment under s.20b If no person carrying on a trade or business in Hong Kong has at any time wholly or partly owned the trademark in question, profits tax of 4.95% of the royalty sum (30% x 16.5%) is required to be withheld. Otherwise, the amount to be withheld is 100% x 16.5%, i.e. 16.5%; and XHL is required to file a non-resident tax return BIR54 on behalf of EMSH. Final Examination (June 2014 Session) Paper I 11 of 13

12 Answer 4(c)(i) Interest income assessment considerations include the following: interest income derived from deposits placed in Hong Kong with authorised institutions under the Banking Ordinance is exempted from Profits Tax under the Hong Kong Profits Tax (Interest income) Order; Swiss bank interest income offshore and non-taxable; loan to XML, a Macau fellow subsidiary assessment refers to provision of credit where to negotiate / sign the loan agreement is irrelevant when the loan is a simple loan of money; and as the fellow subsidiary in Macau obtained the loan fund outside Hong Kong it is not taxable since the provision of credit was outside Hong Kong. Answer 4(c)(ii) Interest expenses deductibility considerations include the following: s.16(1)(a) to be satisfied, i.e. the amount should be incurred in the production of assessable profits; interest paid to DEF bank is deductible as it is borrowed from a financial institution ( FI ), and it is not secured or pledged by any deposit and there is no arrangement for interest flow back stipulation [s.16(2)(d), s.16(2a), s.16(2b)]; interest paid to CEF bank is not deductible even it is borrowed from a FI as it is pledged by a deposit from which non-taxable interest income was generated. s.16(2a); and interest paid to a director is not deductible as the interest income is not taxable in the recipient s hands [s.16(2)(c)]. Final Examination (June 2014 Session) Paper I 12 of 13

13 Answer 4(d) The gain on the value of hotel properties should be non-taxable as it is related to the fair value change of a capital asset made in accordance with the accounting standards, which should be capital in nature. The tax treatment for the ELN is as follows: the gain should be revenue in nature as the period of ownership is short; and under DIPN 21, for determining source of gain derived from disposal of unlisted equity investment, one needs to look into where the sales and purchase agreement ( S&P ) was concluded and negotiated. Since both negotiation and conclusion should be conducted by DEF bank in Hong Kong, it should be taxable. Whether the underlying equity is listed in the US is not relevant. Signed XXXX Manager of Goodman Tax Consulting Limited * * * END OF EXAMINATION PAPER * * * Final Examination (June 2014 Session) Paper I 13 of 13