30 April 2012 ASSIGNMENT 2 - DIPLOMA IN IFRSs This assignment consists of FOUR written test questions (100 marks). Attempt all parts of all four questions. 1. Answer the assignment questions in order. Each answer must begin on a new page and must be clearly numbered. 2. Files must be prepared in both Microsoft Word format (as a single A4 printable Word file with all pages numbered) and as a PDF file and you should submit both files via email by midnight GMT on 28 May 2012 to dipifrsassessments@icaew.com. It is the responsibility of each candidate to ensure that assignments, as submitted, are complete and presented in the appropriate format. 3. Ensure that your submission includes the title page, ASSIGNMENT 2 - DIPLOMA IN IFRSs, and your candidate number (but not your name). 4. Confirm that your submission is your own work by completing and attaching the Declaration of Ownership which you must email with your assignment (as a separate PDF file to your answers as it includes your name). 5. Retain the question paper and an electronic copy of your submitted answer for reference purposes. 6. Ensure you have read and complied with the full regulations as published. 7. Answers should be based on IFRSs issued at 1 January 2011 (ie, those in the 2011 IFRS 'red book') and, where required, examinable Exposure Drafts in accordance with the examinable documents list for this sitting. 8. You should spend approximately 3½ to 5 hours preparing your answers to this assignment. All workings must be shown and clearly referenced. 9. No correspondence will be entered into regarding assignment content. Copyright The Institute of Chartered Accountants in England and Wales 2012. ICAEW\DIPLOMA IN IFRSs\Apr12
1(a) Peckham, a company reporting under IFRSs, is considering making the following changes to its financial statements for the year ended 31 December 2011. Peckham presents one year of comparative information. (1) Changing the method of depreciation of its plant from straight line depreciation over five years (with a nil residual value) to reducing balance at 20% per annum with effect from 1 January 2011. The plant originally cost $100 million on 1 January 2009. (2) Changing the basis of valuation of certain non-seasonal inventories from first-in first-out (FIFO) to weighted average cost (WAC). Inventories were valued as follows under the two different methods: 31 December 2009 31 December 2010 31 December 2011 $ million $ million $ million FIFO 64 66 71 WAC 62 63 67 (3) Changing the revenue recognition basis for certain seasonal goods that were first sold in 2009 such that revenue is recognised on delivery to the customer rather than on shipment. This has arisen as a result of a change in delivery arrangements such that, with effect from 1 January 2011, risks are now borne by Peckham until delivery has been made to the customer. 2009 2010 2011 $ million $ million $ million Revenue based on shipment date 50 86 90 Revenue based on delivery date 46 84 88 The cost of the seasonal goods is consistently 80% of sales price. Profit (calculated using existing policies and accounting estimates) was $240 million for the year ended 31 December 2011. Calculate: the adjustment to opening retained earnings in the statement of changes in equity (including 2010 comparative figures) in the financial statements for the year ended 31 December 2011; and profit or loss for the year ended 31 December 2011. (6 marks) 1(b) Zoom made a decision to sell a business unit on 15 June 2011, and the criteria to classify the unit as held for sale were met on 1 July 2011. Zoom s accounting year end is 31 December. At 1 July 2011, the carrying amount of the assets and liabilities of the business unit (before any 2011 depreciation or revaluation adjustments) was as follows: $ million Land and buildings 120 Equipment 50 Trade receivables 30 Inventories 20 Trade payables (26) ICAEW\DIPLOMA IN IFRSs\Apr12 Page 2 of 12
The land and buildings are held under the revaluation model of IAS 16 and were last revalued on 31 December 2010 to $120 million. Their market valuation on 1 July 2011 was $124 million and selling costs were estimated at $2.5 million at that date. Residual value was, and continues to be, expected to be higher than cost. The equipment is held under the cost model of IAS 16. The equipment was purchased on 1 July 2009 for $80 million and is being depreciated straight line over a four-year period to a zero residual value. Its sales value at 1 July 2011 is $55 million. Selling costs are insignificant. The trade receivables are recorded at invoiced value, reduced by any allowances for credit losses recognised at 31 December 2010. No adjustment to these allowances was necessary at 1 July 2011. The receivables, if factored, would realise approximately $26 million, net of transaction costs at 1 July 2011. The inventories are merchandise purchased for resale and are held at cost. Their market value at 1 July 2011 was $28 million. Associated selling costs would amount to $1.4 million. It was anticipated at 1 July 2011 that the business unit will be sold for $200 million, net of selling costs, to a rival company in a single transaction. In respect of Zoom s year ended 31 December 2011, show, and briefly explain, the amount recognised as non-current assets held for sale under IFRS 5 at 1 July 2011. (4 marks) 1(c) A group reported under IFRSs, with shares quoted on the national stock exchange. It has the following group structure: Holding Co Sub A Sub B Sub C Sub D Assoc F Sub E The figures for Holding Co, Sub A, Sub B, Sub C, Sub D and Assoc F are each reported separately to group management for decision-making purposes. The following information relates to the consolidated financial statements of Holding Co for the year ended 31 March 2012: Holding Co generates the majority (51%) of the group's revenue. Sub A and Sub B are 100% owned by Holding Co. Sub A contributes 15% of group revenue. Sub B is highly profitable, contributing 8% of group revenue, but 20% of group profit. It represents only 5% of group assets. ICAEW\DIPLOMA IN IFRSs\Apr12 Page 3 of 12
Sub C is 70% owned by Holding Co and contributes 11% of group revenue, 5% of group profit and 4% of group assets. Sub D, which is 100% owned by Sub A, has recently been set up and contributes approximately 3% of group revenue, profit and assets. Sub E is 100% owned by Sub A and contributes 12% of group revenue. Its results are combined with those of Sub A's when reported to the management of Holding Co for decision-making purposes. Assoc F is 20% owned by Holding Co. The shareholding allows Holding Co two seats on Assoc F's board and significant influence is exercised. The group share of Assoc F's profit recognised in the consolidated financial statements represents 12% of group profit. None of the entities made losses during the year. State, with reasons, insofar as the information provided permits, whether each of the above entities would be classified as a reportable operating segment in the consolidated financial statements of Holding Co for the year ended 31 March 2012 under IFRS 8 Operating Segments. (7 marks) 1(d) Discuss how revenue relating to the following items would be accounted for under current IFRSs and under the proposals to revise the approach to revenue recognition. (6 marks) (1) Construx enters into a contract to build a rail tunnel under a river for $2.6 billion. Construction will take place over a 3-year period, and billing will take place in accordance with an agreed schedule. Contingency arrangements are incorporated into the contract whereby additional payments would be received by Construx if unexpected difficulties arise. At the commencement of the contract it is estimated that there is a 20% chance that difficulties will arise which would trigger the additional payments to be made to Construx. (2) A bank makes mortgage loans to clients. Interest charged to these clients is LIBOR (London Interbank Offer Rate) + 1%, reset monthly. The bank recognises that in its portfolio of clients there will be some clients who will experience financial difficulties in the future and will not be able to keep up mortgage payments. Under the mortgage agreement, the bank takes first legal charge over the mortgaged property, and in the event of a default where payments cannot be rescheduled, the property would be sold to cover unpaid debts. ICAEW\DIPLOMA IN IFRSs\Apr12 Page 4 of 12
1(e) Downtown Dairy incurred the following costs in producing its three products, cream, butter and cheese for the month of February 2012: $ Common costs before separation: Milk purchased from dairy farmers 120,000 Labour 44,000 Fixed dairy production overheads 48,000 Specific costs post separation (variable labour and direct production costs): bulk cream 10,000 butter 15,000 cheese 24,000 Selling and marketing costs (incurred in proportion to product revenues for goods sold) 44,000 Production for the month was: 13.5 tonnes of bulk cream, all sold at $1,860 per tonne 18 tonnes butter, all sold at $4,420 per tonne 45 tonnes cheese, 41 tonnes sold at $4,620 per tonne All cream and butter was sold in the month. However, 4 tonnes of cheese remained in inventories. Production was 10% lower (for each product) than normal production per month. Company policy is to allocate milk costs and overheads in proportion to production tonnage. Other costs are allocated in proportion to total sales revenues (also using selling values to allocate other costs to unsold production). Calculate the carrying amount of the cheese inventories at 28 February 2012. (5 marks) 1(f) Ultra Designs is the parent company of a small group. Its shares are stock market quoted, with many shareholders. Only one shareholder, Douglas Tipe has a holding over 5%. Douglas holds 20% of the shares and was the founder of the company. He still retains a seat on the board which is made up of four executive directors (including him) and two nonexecutive directors. Douglas' domestic live-in partner of ten years, Mel Parker recently set up a company, Fashionex, in the design business with a friend, Sally Valentine. Mel and Sally each own 50% of the shares of Fashionex, and decisions are made jointly under a contract that both parties signed. Ultra Designs has two subsidiaries, Apex Fabrics which is 100% owned and Patten which is 60% owned. The other 40% of Patten is owned by a single shareholder, Innovative Moda, which has two seats on Patten s five-member board. Dennis Small is the Finance Director of Apex Fabrics. He is also the person responsible for finance at a group level, but is not a member of the group board. ICAEW\DIPLOMA IN IFRSs\Apr12 Page 5 of 12
Identify the related parties of Ultra Designs in the above scenario, explaining why each is a related party. (5 marks) 1(g) A company held the following liquid investments as at 31 March 2012, its year end: $ million Cash on hand 8 Cash held in current accounts at Western Bank 34 Cash held in foreign bank accounts (translated at the exchange rate at 31 March 2012) 5 Investments in 5% governments bonds purchased on 1 February 2012 maturing on 31 May 2012 (fair value) 18 Investments in redeemable preference shares acquired on 1 March 2012, maturing on 31 May 2012 held at fair value through profit or loss (fair value) 6 Bank overdraft with Southern Bank repayable on demand (1) How much should be shown as 'cash and cash equivalents' in the company's statement of cash flows for the year ended 31 March 2012. (3 marks) 1(h) During 2011, a subsidiary sold goods to its parent for $100,000 at a profit margin on selling price of 25%. Of the goods received, the parent sold $60,000 (at transfer price) to external parties at a mark-up on cost of 20% and the rest remained in inventories at 31 December 2011, the group year end. Inventories are tax deductible when sold in the tax regime in which the two companies operate. The parent pays tax at 30% and the subsidiary pays tax at 25%. Neither tax rate will change in 2012. Calculate the profit recognised in respect of these transactions in consolidated profit or loss for the year ended 31 December 2011, clearly showing the consolidated gross profit, current tax and deferred tax figures. (3 marks) ICAEW\DIPLOMA IN IFRSs\Apr12 Page 6 of 12
1(i) The following events all occur after the year end, but before the financial statements have been authorised for issue. (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 (2) A share split in respect of the earnings per share calculation (3) Criteria being met in order to classify non-current assets as held for sale (4) A material, but not fundamental, error arising in the comparative figures. Explain whether each of the above is an adjusting or a non-adjusting event after the reporting period. (4 marks) 1(j) A company is being sued by a customer in respect of some products supplied which the customer claims are faulty. The customer is suing for $220,000 plus costs. Court costs are likely to amount to $40,000. The company's lawyer has advised that there is an 80% chance that the case will be lost and that the full amount claimed will be payable. If the case is lost, it is highly likely that costs would be awarded against the company. The company is fully insured and the lawyer has advised that it is probable that the insurance policy will cover the event. Explain and calculate the amount that should be recognised as a provision and the amount to be recognised in profit or loss in respect of the above items. (3 marks) 1(k) ZYX is switching to IFRSs from Ruritanian GAAP for the first time for the year ended 31 December 2011 (with one year's comparative data). On 1 January 2006, ZYX acquired 60% of an entity in a similar line of business for $32,100,000. The fair value of the identifiable net assets, as measured under Ruritanian GAAP was $44,600,000. Under Ruritanian GAAP, goodwill was amortised over ten years on a straight-line basis and non-controlling interests at the date of acquisition were measured at the proportionate share of the fair value of the identifiable net assets. Included in ZYX's subsidiary's financial statements at the date of transition to IFRSs was $2,400,000 of capitalised research, as well as a corresponding deferred tax liability of $600,000. Impairment tests conducted at the date of transition to IFRSs and at subsequent year ends did not reveal any impairment losses. Calculate the amount of the goodwill to be recognised in the consolidated financial statements of ZYX under IFRSs at 31 December 2011, assuming all applicable exemptions are followed. (4 marks) (50 marks) ICAEW\DIPLOMA IN IFRSs\Apr12 Page 7 of 12
2 A lessor leases an item of plant to a client on 1 January 2011. The terms of the lease are that the lessee makes an initial payment of $50,000 on 1 January 2011 and then pays $100,000 on each 31 December from 31 December 2011 to 31 December 2016 inclusive, on which date the plant will be returned to the lessor. Legal fees incurred by the lessor to set up the lease amounted to $2,000. The lessor expects the asset to be worth approximately $40,000 at the end of the lease, but this has not been guaranteed by any party. During the period of the lease, the lessee is required to insure and maintain the plant and is permitted to make any moderations necessary providing the modifications are removed when the plant is returned to the lessor. The annual interest rate implicit in the lease under IAS 17 is 6.4708%. The present value of the lease payments discounted at this rate is $534,541. The annual interest rate implicit in the lease excluding initial direct costs incurred by the lessor is 6.5913%. The fair value of the plant on 1 January 2011 is $560,000. Its carrying amount in the lessor's financial statements (before accounting for the lease transaction) at the same date is $550,000. The lessor did not manufacture the plant and is not a dealer lessor. The company uses the actuarial method of allocating finance charges. Prepare extracts from the profit or loss section of the statement of comprehensive income for the year ended 31 December 2011 for the lessor and the statement of financial position at that date (a) in accordance with IAS 17 Leases, and (7 marks) (b) under the proposals to revise IAS 17 contained in ED/2010/9 (insofar as the information provided permits). (9 marks) Disclosure notes are not required. (16 marks) ICAEW\DIPLOMA IN IFRSs\Apr12 Page 8 of 12
3 A company has set up a new pension plan for its directors. The plan is non-contributory and guarantees the directors an annual pension from retirement until death based on 2.5% of the average annual salary of the three years preceding retirement multiplied by the number of years (or fraction of years) employed by the company. Assets of the plan are invested in a stock market tracker fund and then switched into fixed rate bonds in the final three years preceding each director's retirement. If the performance of the contributions paid by the company from their initial investment until three years before retirement yields a higher annual pension (based on annuity rates available at the time of retirement) than that calculated based on years employed, then the directors receive the higher pension. s (a) (b) Explain how the above pension plan would be accounted for under IAS 19 Employee Benefits. (5 marks) Discuss weaknesses in the current financial reporting regulations under IAS 19 for the above plan and how the financial reporting recognition and measurement rules could be improved by making changes to IAS 19. (5 marks) (10 marks) ICAEW\DIPLOMA IN IFRSs\Apr12 Page 9 of 12
4 Copper is a private company reporting under local GAAP, which is the same in all material respects as IFRSs for quoted companies. Copper will be switching to the IFRS for Small and Medium-sized Entities for the year ended 31 December 2012 (with full retrospective application). The trial balance of Copper, after accounting for all items correctly in accordance with local GAAP as at 31 December 2011, showed the following balances: $ $ DR CR Land 2,047,500 Buildings 2,755,000 Buildings accumulated depreciation at 31 December 2011 58,000 Equipment cost 120,000 Equipment accumulated depreciation at 31 December 2011 90,000 Development expenditure 266,000 Development expenditure accumulated amortisation at 31 December 2011 106,400 Investments 52,000 Inventories at 31 December 2011 180,300 Trade receivables 220,200 Cash and cash equivalents 48,700 Ordinary share capital ($1 shares) 540,000 Share premium 1,880,000 Retained earnings at 1 January 2011 1,659,750 Revaluation surplus at 1 January 2011 106,875 Investment reserve at 1 January 2011 3,000 Long-term borrowings 420,000 Defined benefit pension plan assets (fair value at 31 December 2011) 80,500 Defined benefit pension plan obligation (at 31 December 2011) 90,250 Deferred tax liability at 31 December 2011 104,335 Trade and other payables 230,800 Current tax payable 162,890 Dividends paid 108,000 Sales 2,548,200 Cost of sales 1,404,600 Distribution costs 218,300 Administrative expenses 329,100 Finance costs 21,000 Current tax 162,890 Deferred tax for year ended 31 December 2011 (profit or loss) 19,340 Gain on investments 8,000 Remeasurement of pension plan assets 11,750 Deferred tax for year ended 31 December 2011 (other comprehensive income) 2,000 8,027,840 8,027,840 ICAEW\DIPLOMA IN IFRSs\Apr12 Page 10 of 12
The following information has been correctly accounted for in accordance with local GAAP in the above trial balance: (a) The land and buildings were purchased on 1 July 2008 for $4,800,000 (including $2,000,000 in respect of the land). The buildings are being depreciated straight line over 50 years to a zero residual value from that date and charged to cost of sales. On 31 December 2010, the land and buildings were revalued (for the first time) to $4,802,500 (including $2,047,500 in respect of the land). The useful life and residual value of the buildings did not require revision at that date. Company policy under local GAAP was to treat revaluation surpluses as realised and transfer them to retained earnings on disposal of the asset. No land or buildings were acquired or disposed of since 1 July 2008. A tax allowance on the buildings is permitted at 2.5% per annum on cost in the tax regime in which Copper operates. Revaluation gains and losses on land and buildings are taxable/tax deductible on disposal of the land and buildings. (b) The equipment was purchased on 1 January 2009 and is being depreciated straight line over four years to a zero residual value. The equipment is tax deductible at 30% per annum on a diminishing balance basis in the tax regime in which Copper operates. (c) The development expenditure was incurred in 2009. A total cost of $380,000 was incurred in 2009 developing a new product. A government grant was awarded of 30% of this value in 2009 and was netted against the development cost. The product being developed began commercial production on 1 January 2010, with an expected life of 5 years and a zero residual value. Amortisation of the development expenditure and associated grant over five years began on that date. Development expenditure is tax deductible as incurred in the tax regime in which Copper operates. Government grant income is not taxable. (d) The investments represent a 10% holding in the ordinary shares of a publicly traded company and are shown at their fair value. The investments cost $40,000. Their fair value at 31 December 2010 was $44,000. Under local GAAP, Copper elected to recognise gains and losses on these investments in other comprehensive income. Gains (or losses) on investments in shares are taxable (or tax deductible) on disposal in the tax regime in which Copper operates. (e) The inventories are held at their cost. ICAEW\DIPLOMA IN IFRSs\Apr12 Page 11 of 12
(f) Copper set up a defined benefit pension plan for its employees in 2011 and contributed $90,000 during the year. The fund is a separate legal entity administered by trustees of the fund who are independent from the directors of Copper. The following shows the actual performance of the investments in 2011: $ Contributions paid in 90,000 Interest, dividend and other income 2,000 Tax payable by the fund (500) Unrealised stock market losses (11,000) 80,500 The pension plan liability is treated the same way for tax as for accounting purposes in the tax regime in which Copper operates. Income and changes in the values of plan assets are taxable (or tax deductible) in the pension plan and no further tax arises in the Copper s financial statements. Current service cost is included in cost of sales in the above trial balance. Interest on the plan obligation (net of amounts recognised on plan assets) is included in finance costs. Under local GAAP, remeasurements of the plan obligation and plan assets are recognised directly in other comprehensive income. Copper wishes to recognise these in profit or loss under the IFRS for Small and Medium-sized Entities. The remeasurement of the pension plan asset of $11,750 in the trial balance differs to the unrealised stock market losses of $11,000 above as the amounts recognised in finance costs re the pension plan assets differ from actual returns in the year. (g) The deferred tax liability has been calculated at 25% which is the tax rate that applies to Copper's 2011 profits and is the rate enacted for 2012. The rate is unchanged from 2010. Current tax can be settled on a net basis with the single tax regime in which Copper operates. (h) Dividends of 20 cents per share were paid in 2011. Prepare for Copper in accordance with the IFRS for Small and Medium-sized Entities a combined statement of comprehensive income and retained earnings for the year ended 31 December 2011 and the statement of financial position at that date (insofar as the information provided permits). (24 marks) Work to the nearest $1 where necessary. ICAEW\DIPLOMA IN IFRSs\Apr12 Page 12 of 12