SUGGESTED ANSWERS AND EXAMINER S COMMENTARY Assignment 2 Diploma in IFRSs 30 April 2012 The suggested answers set out below were those used to mark this question. Markers were encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. More marks were available than could be awarded for each requirement. This allowed credit to be given for a variety of valid points or alternative calculations (based on valid assumptions) which were made by candidates. Short Answer Questions Question 1 Total Marks: 0 Examiner comments Candidates generally performed better in this question than in other parts of the paper. Parts 1(c), 1(f), 1(i) and 1(j) were answered very well with many candidates earning full marks on those parts. Nevertheless there were some areas of difficulty. In part 1(a) a number of candidates treated the change in depreciation method as a change in accounting policy rather than a revision of an estimate (which is applied prospectively). Few candidates answered the whole of part 1(e) correctly following the instructions in the question about how to allocate costs. Another common error was the incorrect treatment or incorrect calculation of the normal capacity re the fixed overheads. Performance on parts 1(h) and 1(k) was disappointing. Presentation is important to facilitate the marking process. In some scripts, it was hard to see where the answer to one part finished and the next one started. It is recommended to start each part of a question on a new sheet. On the other hand, the presentation of some scripts was excellent. Some candidates wrote at excessive length, particularly in parts 1(c) and 1(d). The suggested answers are indicative of what is expected in terms of length for a given number of marks. (a) Opening retained Profit earnings (1 Jan 2010) million million Profit using existing policies - 240 Depreciation method (change in estimate) Old depreciation 100 / years 20 Revised depreciation (100 x 3/) x 20% (12) Inventory valuation (change in policy) Adj to opening inventories (62 64)/(63 66) (2) 3 Adj to closing inventories (67 71) (4) Revenue (change in nature not policy, therefore apply from 1 Jan 2011) (88 90) x 20% (0.4) (2) 246.6 6 6 Copyright ICAEW 2012. All rights reserved. Page 1 of 13
(b) Carrying amount at 1 July 2011, after applying IAS 16: million Land and buildings 124 Equipment (0 (80/4 years x 6/12)) 40 Trade receivables 30 Inventories 20 Trade payables (26) 188 Any test for impairment will be based on the disposal group as a whole. As a disposal group, fair value less costs to sell (200 million) is higher than carrying amount (188 million) there is no impairment charge. The amount recognised as non-current assets held for sale is therefore: million Land and buildings 124 Equipment 40 164 Trade receivables and inventories are outside the scope of IFRS. 4 4 (c) Separate information is reported for operating segments that: (a) (b) meet the IFRS 8 definition of an operating segment, and exceed 10% of (in this case) group revenue, profit or assets. Holding Co is reported separately as it satisfies the revenue criteria. Sub A is also reported separately as it satisfies the revenue criteria. Its subsidiary Sub E does not meet the required criteria of results being reviewed by the chief operating decision maker and therefore is reported combined with Sub A. Although Sub B does not contribute more than 10% of group revenue, its significance to group profit is sufficient to be reported separately. Sub C is reported separately as its revenue is consolidated 100% and therefore meets the 10% cutoff criteria. Although an associate, Assoc F is sufficiently material at 12% of group profit to constitute a separate segment. However, disclosures are restricted to share of profit or loss and the amount of the investment accounted for using the equity method. Sub D does not meet any of the criteria and is reported as 'All other segments'. Practically however, as there are no other segments that fall into that category, its results are by default reported, albeit as 'all other segments'. Management can also choose to report a segment separately if they feel the information would be useful to users of the financial statements. 7 7 Copyright ICAEW 2012. All rights reserved. Page 2 of 13
(d) (1) Construction of rail tunnel Revenue recognition in respect of construction contracts is currently governed by IAS 11 Construction Contracts. It requires revenue to be recognised by reference to the stage of completion of the contract, ie as the contract progresses. The stage of completion can be measured in various ways including cost to date as a proportion of total estimated cost, work surveys and physical proportion completed. Under the proposed revisions to revenue recognition, revenue would be recognised when the performance obligation is satisfied, ie when control is passed to the customer. As control of a tunnel, by nature, cannot be passed in stages, revenue would be recognised at the end of the contract. (2) Mortgage loans The revenue associated with mortgage loan assets is the interest. Under IFRS 9, the variable element of the interest is accrued on a time basis and the fixed element is reduced to reflect any initial transactions costs and to reflect a constant return in the balance outstanding. Under IAS 39 (which continues to govern impairment of financial assets until IFRS 9 is complete), no reduction is made to the interest revenue to take account of expected credit losses; credit losses are only accounted for when there is objective evidence that they have occurred. IAS 18 provides that interest revenues should only be recognised when it is probable that the economic benefits will flow to the entity (and the amount can be measured reliably). Under revised proposals (ED/2009/12 Amortised Cost and Impairment Exposure Draft Supplement), the approach to recognition of interest would essentially be the same as at present. Expected credit losses would be spread over the period of the loan (subject to an impairment test where loan recoverability is in doubt), but recognised separately as a cost and an allowance rather than reducing revenue recognised. (e) Cost of cheese inventories: Milk (120,000 x 4/(13. + 18 + 4)) 6,27 Variable labour (44,000 x (4 x 4,620)/312,70 below) 2,601 Fixed overheads [48,000 x 4/((13. + 18 + 4) x 100%/90% normal)] 2,29 Specific costs (24,000 x 18,480/(18,480 + 189,420 below)) 2,133 13,268 6 6 Sales prices for the month: Bulk cream (13. x 1,860) 2,110 Butter (18 x 4,420) 79,60 Cheese (41 x 4,620) 189,420 Total product revenues for goods sold 294,090 Unsold cheese at same sales price (4 x 4,620) 18,480 312,70 Selling and marketing costs are not part of production cost. Net realisable value: Expected selling price (4 x 4,620) 18,480 Expected selling costs (44,000 x (4 x 4,620)/294,090)) (2,76) 1,71 The inventories are therefore held at their production cost of 13,268. Copyright ICAEW 2012. All rights reserved. Page 3 of 13
(f) Douglas Tipe is a related party as he both has significant influence over entity and is a member of key management. Mel Parker is treated as a close family member of Douglas Tipe, and is therefore a related party. The company Mel Parker has invested in is jointly controlled. It is considered a related party as there is joint control by a close family of key management of Ultra Designs. Both Apex Fabrics and Patten Designs are related parties as they are members of the same group as Ultra Designs. Dennis Small is a related party because he is a member of key management personnel at a group level. (Innovative Moda is not a related party of the group as it does not have significant influence at a group level). (g) million Cash on hand 8 Cash held in current accounts at Western Bank 34 Cash held in foreign bank accounts (translated at rate at 31 March 2012) Investments in % governments bonds greater than 3 month maturity at acquisition (IAS 7 para 7) - Investments in redeemable preferred shares (IAS 7 para 7) 6 Bank overdraft with Southern Bank repayable on demand (IAS 7 para 8) (1) 2 3 3 (h) Consolidated figures: Revenue (S 100,000 + (P 60,000 x 120%) 100,000 intragroup) 72,000 Cost of sales Opening inventories Purchases (S 100,000 x 7%) + P 100,000 7,000 100,000 intragroup) Closing inventories (P 40,000 PUP 40,000 x 2%) (30,000) (4,000) Gross profit 27,000 Current tax (P 60,000 x 20% x 30% + S 100,000 x 2% x 2%) (9,80) Deferred tax (40,000 x 2% PUP x 30% receiving company rate) 3,000 Profit for the year 20,10 3 3 Copyright ICAEW 2012. All rights reserved. Page 4 of 13
(i) (1) Enactment by the government of a revised tax rate affecting the amount of the settlement of the deferred tax liability included in the financial statements Non-adjusting event (IAS 10 para 22(h)) rates enacted after the year end do not meet the definition of a liability at the year end (2) A share split in respect of the earnings per share calculation Adjusting event in respect of the earnings per share calculation (IAS 33 para 64) although a non-adjusting event for the statement of financial position, if a share spit occurs before the financial statements are issued to shareholders, earnings per share is adjusted as it would otherwise be misleading as the shareholders' shareholdings have been diluted before they receive the financial statements (3) Criteria being met in order to classify non-current assets as held for sale Non-adjusting event (IAS 10 para 22(c)) IFRS requires the criteria to be met at any given point in time so if the criteria are not met at the year end, the assets cannot be classified as held for sale (4) A material, but not fundamental, error arising in the comparative figures Adjusting event all material errors are corrected retrospectively under IAS 8 (j) Provision is made for probable amount: 220,000 + 40,000 = 260,000 4 4 260,000 is charged to profit or loss. The insurance recovery, while disclosed, is not virtually certain (as the court case itself has not been lost) and therefore is disclosed as a contingent asset. (k) Goodwill: 000 Consideration transferred 32,100 Non-controlling interests (44.6 x 40%) 17,840 Fair value of identifiable assets and liabilities at acquisition (44,600),340 Amortisation to 31 December 2009 (,340 x 4/10) (2,136) Goodwill under previous GAAP at date of transition to IFRSs 3,204 Intangible asset derecognised under IFRSs: Capitalised research 2,400 Associated deferred tax liability (600) 1,800 Group share (60%) 1,080 Impairment test (0) Goodwill under IFRSs 4,284 3 3 Maximum for the question 4 4 0 Copyright ICAEW 2012. All rights reserved. Page of 13
Question 2 Total Marks: 16 Examiner comments Part (a) was well answered by most candidates although there were some mistakes relating to the timing of the cash payments and the allocation between non-current and current amounts. Part (b), which tested application of the Exposure Draft treatment, was less well answered. A few candidates simply said that the treatment would be the same under the revisions as before. The question asked candidates to prepare financial statement extracts (only). A few candidates turned the question into a written one and therefore did not answer the question set. (a) IAS 17 approach As the lessor transfers substantially all the risks and rewards incident to ownership of the asset, the lease is accounted for as a finance lease Profit or loss Profit on derecognition (62,000 0,000 2,000) 10,000 Finance income (W1) 33,130 Statement of financial position as at 31 December 2011 Non-current assets Net investment in finance lease (W1) 373,933 Current assets Net investment in finance lease (W1) (44,130 373,933) 71,197 Workings 1 IAS 17 net investment in the finance lease 1 January 2011 (34,41 + (40,000 x 1/1.064708 6 )) 62,000 Receipt (0,000) 12,000 Effective interest 1 Jan 2011 31 Dec 2011 (12,000 x 6.4708%) 33,130 At 31 December 2011 44,130 Effective interest 1 Jan 2012 31 Dec 2012 (44,130 x 6.4708%) 28,803 At 31 December 2012 (non-current asset) 373,933 The legal fees are 'initial direct costs' and are factored into the 6.4708% in IAS 17. Double entry on derecognition of asset/recognition of lease: DR Net investment in the lease 62,000 CR Asset at net book value 0,000 CR Cash (initial direct costs) 2,000 CR Profit or loss 10,000 7½ 7 Copyright ICAEW 2012. All rights reserved. Page 6 of 13
(b) Exposure Draft approach As the lessor does not retain exposure to significant risks or benefits associated with an underlying asset, the derecognition approach is appropriate Profit or loss Revenue: lease income (W2) 32,727 Cost of sales: lease expense (W1) (23,214) Gross profit 9,13 Finance income (W1) 31,818 Statement of financial position as at 31 December 2011 Non-current assets Right to receive lease payments (W1) 342,903 Residual asset ((60,000 (W2) 32,727)/60,000) x 0,000) 26,786 Current assets Right to receive lease payments (W1) (416,033 342,903) 73,130 Workings 1 Right to receive lease payments 1 January 2011 PVLP (W2) 32,727 Add: initial direct costs 2,000 34,727 Receipt (0,000) 484,727 Effective interest 1 Jan 2011 31 Dec 2011 (484,727 x (W3) 6.48%) 31,306 At 31 December 2011 416,033 Effective interest 1 Jan 2012 31 Dec 2012 (416,033 x 6.48%) 26,870 At 31 December 2012 (non-current asset) 342,903 For completeness (only) to demonstrate elimination of right to lease payments: Effective interest 1 Jan 2013 31 Dec 2013 (342,903 x 6.48%) 22,146 At 31 December 2013 26,049 Effective interest 1 Jan 2014 31 Dec 2014 (26,049 x 6.48%) 17,118 At 31 December 2014 182,167 Effective interest 1 Jan 201 31 Dec 201 (182,167 x 6.48%) 11,76 At 31 December 201 93,932 Effective interest 1 Jan 2016 31 Dec 2016 (93,932 x 6.48%) 6,067 At 31 December 2016 (ignoring rounding difference) 0 Double entries on derecognition of asset/recognition of lease: DR Right to receive lease payments 32,727 CR Profit or loss (Revenue: lease income) 32,727 Copyright ICAEW 2012. All rights reserved. Page 7 of 13
DR Right to receive lease payments (initial direct costs paid) 2,000 CR Cash 2,000 DR Profit or loss (Cost of sales: lease expense) 23,214 CR Underlying asset (32,727/60,000 x 0,000 carrying value) 23,214 2 Present value of lease payments Cash flows are discounted at the 'rate the lessor charges the lessee' per ED/2010/9 para B12-B13, i.e. 6.913% excluding the effect of initial direct costs given in question: 1 January 2011 0,000 1 0,000 31 December 2011 100,000 1/1.06913 93,816 31 December 2012 100,000 1/1.06913 2 88,01 31 December 2013 100,000 1/1.06913 3 82,72 31 December 2014 100,000 1/1.06913 4 77,466 31 December 201 100,000 1/1.06913 72,676 31 December 2016 100,000 1/1.06913 6 68,182 32,727 3 Effective interest rate A calculation of the effective rate of interest (i.e. internal rate of return, IRR) is required for amortised cost measurement per ED/2010/9 para 4 (can use a triangulation or linear interpolation method below, spreadsheet, or business analysis calculator): PV at 6.4% PV at 6.% 1 Jan 2011 (32,727 + 2,000-0,000) 484,727 (484,727) (484,727) 31 Dec 2011 100,000 93,98 93,897 31 Dec 2012 100,000 88,332 88,166 31 Dec 2013 100,000 83,019 82,78 31 Dec 2014 100,000 78,02 77,732 31 Dec 201 100,000 73,332 72,988 31 Dec 2016 100,000 68,921 68,33 887 (626) Effective interest rate (IRR) = A% + NPV A% x (B% A%) (NPV A% - NPV B% ) = 6.4% + 887 x (6.% - 6.4%) (887 + 626) = 6.486% (6.48% if calculated using a spreadsheet) Marking. The 6.4708% rate from part (a) was accepted as an approximation. Maximum for the question 10½ 9 16 Copyright ICAEW 2012. All rights reserved. Page 8 of 13
Question 3 Total Marks: 10 Examiner comments Performance on this question was disappointing as the majority of candidates missed the point for discussion that the 'higher of' option does not sit well with the current version of IAS 19. Most answers to part (a) simply listed the requirements of IAS 19, often at excessive length. While some credit was available for the IAS 19 requirements, full marks were only available where the issue of the classification of the pension plan was discussed. Similarly, in part (b), most answers focussed on listing as weaknesses the areas recently revised in IAS 19 rather than using the information given in the question to discuss the weaknesses of IAS 19 in respect of 'higher of' option pension plans. Again, credit was given, but full marks were only available where the 'higher of' issue was discussed. (a) Defined contribution pension plans are defined by IAS 19 as 'post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligations to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in current and prior periods.' Defined benefit plans are defined simply as 'post-employment benefit plans other than defined contribution plans'. In this plan, the plan takes the form of a final salary plan where the pension is determined as a proportion of final salary at retirement. However, in this case the directors receive a 'higher of' option of whereby they may receive the equivalent of a defined contribution pension if performance of the plan assets generates a defined contribution pension which exceeds the final salary-based one. The plan therefore has elements of both types of plan. As contributions into the plan by the company will vary based on performance of plan assets and actuarial assumptions of retirement date and life expectancy of the plan members, the plan cannot be accounted for as a defined contribution plan as contributions are not 'fixed'. It is therefore accounted for as a defined benefit plan. The net pension fund asset or liability will be shown in the company's statement of financial position. Current service cost, interest cost on the plan obligation and expected return on plan assets will be recorded in profit or loss. Actuarial gains and losses will be reported in other comprehensive income or profit or loss depending on the company's accounting policy. 6 (b) Under the current version of IAS 19, this plan is accounted for as solely as a defined benefit one. In reality it is a hybrid plan which has elements of both types of pension plan and this is not reflected in the financial statements under the current accounting treatment. The obligation to pay pensions will be measured using defined benefit plan principles. However, if stock market performance is better than expected, the directors will receive a higher pension than that determined using the defined benefit methodology. The risk is that the obligation to pay pensions recorded in the financial statements under the current version of IAS 19 will be understated. Net assets of the company may therefore be overstated. A possible solution would be to recognise a separate additional liability for the 'higher of' option whereby the expected additional payment above that recognised under the defined benefit basis would be recognised at its fair value. Copyright ICAEW 2012. All rights reserved. Page 9 of 13
Another possibility would be to develop a new type of accounting for hybrid schemes, which either has elements of both the current defined benefit and defined contribution accounting treatments, or brings all assets and liabilities onto the company's statements of financial position together, representing the fact that the hybrid scheme is a single plan. Maximum for the question 10 Copyright ICAEW 2012. All rights reserved. Page 10 of 13
Question 4 Total Marks: 24 Examiner comments This question was very well answered, with a number of candidates earning full marks. Areas of difficulty included the property, plant and equipment figure, deferred tax figures (and elimination of the deferred tax on the development costs) and the retained earnings brought forward figure. Some answers were very well laid out and easy to follow, while others were not. It is important that all calculations are shown and workings referenced. This is a particular issue where a spreadsheet is used and incorporated into the final answer: where a figure is incorrect, no partial credit can be awarded unless the breakdown of the figure can be seen and marked. Copper Statement of profit or loss and retained earnings for the year ended 31 December 2011 Revenue 2,48,200 Cost of sales (W1) (1,349,400) Gross profit 1,198,800 Other income (22,800 22,800) (shown for clarity) 0 Distribution costs (218,300) Administrative expenses (329,100) Finance costs (21,000) Remeasurement of pension plan assets (11,70) Investment income (2,000 44,000) 8,000 Profit before tax 626,60 Income tax expense (162,890 + (W3) 2,160) (16,00) PROFIT FOR THE YEAR 461,600 Retained earnings at 1 January 2011 (W4) 1,2,90 Dividends (108,000) Retained earnings at 31 December 2011 1,879,0 Copyright ICAEW 2012. All rights reserved. Page 11 of 13
Statement of financial position as at 31 December 2011 ASSETS Current assets Cash and cash equivalents 48,700 Trade receivables 220,200 Inventories 180,300 449,200 Non-current assets Investments in equity instruments 2,000 Development expenditure (shown for clarity) 0 Property, plant and equipment (W2) 4,634,000 4,686,000,13,200 EQUITY AND LIABILITIES Current liabilities Trade and other payables 230,800 Current tax payable 162,890 393,690 Non-current liabilities Deferred tax liability (W3) 12,210 Long-term borrowings 420,000 Net defined benefit pension plan obligation (90,20 80,00) 9,70 441,960 Equity Share capital 40,000 Share premium 1,880,000 Retained earnings (from SOP/L) 1,879,0 Revaluation surplus (106,87 142,00 + 3,62) (shown for clarity) 0 4,299,0,13,200 Zero lines need not be shown, but are shown here for clarity Workings 1 Cost of sales Per trial balance 1,404,600 Depreciation based on revalued amount (2,7,000/ 47. years) (8,000) Depreciation based on historical cost (2,800,000/0 years) 6,000 Amortisation of development expenditure, net of grant (380,000 x 70%/ years) (3,200) 1,349,400 Copyright ICAEW 2012. All rights reserved. Page 12 of 13
2 Property, plant and equipment Land Buildings Equipment Total Per trial balance: Revalued amount 2,047,00 2,7,000 120,000 Accumulated depreciation (8,000) (90,000) 2,047,00 2,697,000 30,000 4,774,00 Depreciation rev'd (W1) 8,000 8,000 Reverse revaluation (below) (47,00) (9,000) (142,00) Depreciation cost (W1) (6,000) (6,000) IFRS for SMEs 2,000,000 2,604,000 30,000 4,634,000 (cost basis as question asked for 'full retrospective application' so transitional exemptions were not relevant) Net book value at 31 December 2010: Cost 2,000,000 2,800,000 Accumulated dep'n (2,800 x 2./0) (140,000) 2,000,000 2,660,000 Revaluation (balancing figure) 47,00 9,000 Revalued amount 2,047,00 2,7,000 3 Deferred tax Deferred tax liability per trial balance 104,33 Revaluation gains ((142,00 2,000 below) 2%) (3,12) Development expenditure (380,000 3/ 2%) (7,000) 12,210 Deferred tax credit in profit or loss per trial balance (19,340) Revaluation depreciation ((W2) 9,000/ 47. years 2%) 00 Deferred tax on investments moved from OCI 2,000 Development expenditure not amortised (380,000 1/ 2%) 19,000 2,160 4 Retained earnings at 1 January 2011 Per trial balance 1,69,70 Write-off of development expenditure (380,000 4/) (304,000) Credit government grant (380,000 30% 4/) 91,200 Deferred tax re development expenditure (304,000 2%) 76,000 Gain on investments (44,000 40,000) 4,000 Deferred tax re investments moved ((44,000 40,000) 2%) (1,000) Restated balance 1,2,90 27 24 Copyright ICAEW 2012. All rights reserved. Page 13 of 13