The Examiner's Answers F1 - Financial Operations Some of the answers that follow are fuller and more comprehensive than would be expected from a well-prepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike. SECTION A Answer to Question One 1.1 B 1.2 A tax base is something that is liable to tax, e.g. income or consumption of goods 1.3 C 1.4 $000 Accounting profit 860 Add depreciation 42 Add amortisation 15 917 Less tax depreciation 51 Taxable profit 866 Tax @ 25% 216.5 Answer D 1.5 D 1.6 A 1.7 C Financial Operations 1
1.8 An operating segment is defined by IFRS 8 as a component of an entity whose operating results are regularly reviewed by the entity s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance. 1.9 Four from the following: Significant risks and rewards of ownership of the goods have been transferred to the buyer The seller does not retain any continuing influence or control over the goods Revenue can be measured reliably It is reasonably certain the buyer will pay for the goods The costs to the seller can be measured reliably 2 Financial Operations
SECTION B Answer to Question Two (a) Deferred tax balance at 31 December 2011: Carrying Value Tax base $000 $000 Cost 1 January 2010 440 440 Year to 31 December 2010 (55) (220) 385 220 Revaluation 1 Jan 2011 70 0 455 220 Year to 31 December 2011 (65) (55) 390 165 At 31 December 2010: $385,000 - $220,000 = $165,000 At 31 December 2011: $390,000 - $165,000 = $225,000 Change (Increase) $60,000 Tax at 25% = $15,000 Deferred tax movement in year to 31 December 2011: Debit to income statement of $15,000 Deferred tax balance at 31 December 2011: Credit balance $225,000 x 25% = $56,250 (b) (i) An item that is Zero rated means that no VAT is charged on sales but UYT can reclaim VAT paid on its inputs. An item exempted from VAT means that the revenue earned is exempt VAT, so no VAT is charged but UYT cannot reclaim the portion of input VAT that relates to the exempted goods. If an actual figure cannot be calculated it will be on a proportional basis. Excl VAT VAT 15% $ $ Inputs: Cost 400,000 60,000 Input VAT claim limited to 450/600 45,000 Outputs: Standard rate 450,000 67,500 Exempt 150,000 0 600,000 67,500 Net 22,500 (ii) Net Vat due to be paid is $22,500 Financial Operations 3
(c) Under the classical system of corporate income tax the entity s profit for the year is taxed and then when a dividend is paid the shareholder is taxed on the full amount received. In this case the dividends have been taxed twice. With an imputation system of corporate income tax the entity pays corporate income tax on all the profits before paying a dividend but then all or part of the underlying corporate income tax that relates to the distribution is imputed to the shareholders as a tax credit. Therefore avoiding the problem of double taxation of dividends. If the personal income tax rate of the shareholder is higher than the rate of tax credit the shareholder may have to apy additional tax on the dividend, however it will still only have been taxed once. With systems using the full imputation system all of the underlying corporate income tax is passed to the shareholder as a tax credit if a partial imputation system is used only part of the tax paid by the entity will be passed to the shareholder. YT has received a dividend from LKJ and will have received a tax credit for the proportion of tax paid by LKJ on the underlying profit. As LKJ is an entity resident in Country X it will have paid corporate income tax at 25% on its taxable profit for the year. This will be passed on to its shareholders as a tax credit as Country X uses the full imputation system.. YT will receive a tax credit and will be able to set this tax credit against any tax due on the dividend leaving additional tax to be paid if YT s personal tax rate is higher than 25%. YT is therefore incorrect in thinking that his dividend has been taxed twice. (d) The four main entities involved in developing and implementing IFRS are: IFRS Foundation (formerly known as the International Accounting Standards Committee Foundation (IASCF). Role governance and fund raising International Accounting Standards Board (IASB) Role responsibility for all technical matters including the preparation and publication of international financial reporting standards IFRS Advisory Council (formerly known as the Standards Advisory Council) Role to provide a forum for wider participation. Provides strategic advice to the IASB and informs the IASB of public views on major standard setting projects. IFRS Interpretations Committee (formerly known as the International Financial Reporting Interpretations Committee IFRIC) Role provides timely guidance on the application and interpretation of IFRSs 4 Financial Operations
(e) (i) According to the International Standard on Auditing (ISA) 200 Objective and General Principles Governing an Audit of Financial Statements the objective of an audit is to enable auditors to express an opinion as to whether the financial statements give a true and fair view of the affairs of the entity at the period end and of its profit or loss for the period then ended and have been properly prepared in accordance with the applicable reporting framework (e.g. relevant legislation and applicable accounting standards). (ii) Three key areas of content of the audit report as required by ISA 700 The Auditor s Report on Financial Statements include: Management s responsibility for the financial statements Report should state that management is responsible for the preparation and fair presentation of the financial statements. Auditor s responsibility Report should state that the responsibility of the auditor is to express an opinion on the financial statements based on the audit. Description of the audit work done Report should give an overview of the type of work done during the audit, such as obtaining audit evidence, risk assessment, procedures selected and the evaluation of the accounting policies used. Auditor s opinion Report should give the auditor s opinion on whether the financial statements give a true and fair view or are presented fairly in all material respects, in accordance with the applicable financial reporting framework. (f) The ethical problem that XQ faces is that a professional accountant in business should prepare or present information fairly, honestly and in accordance with relevant professional standards so that the information will be understood in its context. A professional accountant is expected to act with integrity and objectivity and not allow any undue influence from others to override his professional judgement. XQ is facing pressure from others to change the results and therefore break the CIMA Code. XQ is being asked to misrepresent the facts of the actual situation which would be contrary to the CIMA Code s fundamental principles of integrity and objectivity. XQ would also be breaking the due care requirement of the CIMA Code. XQ should apply safeguards to eliminate the threats or reduce them to an acceptable level. As other staff are offering incentives XQ will need to decline these and refuse to alter the accounting information. XQ should also consult with his line manager. XQ may also wish to get advice from the CIMA helpline. The situation is unlikely to require XQ to seek legal advice or resign. Financial Operations 5
SECTION C Answer to Question Three RTY - Statement of comprehensive income for the year ended 31 January 2012 $000 $000 Revenue 9,320 Cost of sales (6,059) Gross Profit 3,261 Administrative expenses (1,225) Distribution costs (679) (1,904) Profit from operations 1,357 Finance cost (137) Profit before tax 1,220 Income tax expense (755) Net profit for the period 465 Other Comprehensive Income Revaluation of property (W7) 1,240 1,705 RTY - Statement of Financial Position at 31 January 2012 $000 $000 Non-current assets Property, plant and equipment 14,877 Deferred development expenditure 272 15,149 Current assets Inventory 330 Trade receivables 1,428 Cash and cash equivalents 142 1,900 Total assets 17,049 Equity and liabilities Equity Share capital 1,375 Share premium 2,750 Retained earnings 3,912 Revaluation reserve 3,340 Total equity 11,377 Non-current liabilities Long term borrowings 2,740 Deferred tax 1,019 Total non-current liabilities 3,759 Current liabilities Trade payables 1,080 Tax payable 765 Interest payable 68 Total current liabilities Total equity and liabilities 1,913 17,049 6 Financial Operations
RTY Statement of changes in equity for year ended 31 January 2012 Equity Share Retained Revaluation Total Shares Premium Earnings Reserve $000 $000 $000 $000 $000 Balance at 1 February 2011 1,375 2,750 2,785 2,900 9,810 Statement of comprehensive 465 1,240 1,705 income for year Disposal of revalued property (W4) 800 (800) 0 Dividend paid (138) (138) Balance at 31 January 2012 1,375 2,750 3,912 3,340 11,377 Workings (All figures in $000) (W1) Depreciation Cost/revalued amount Land Buildings Plant & equipment Total Balance b/f 6,220 10,900 5,750 22,870 Revaluation adjustment 630 (2,000). (1,370) 6,850 8,900 5,750 21,500 Assets sold (1,800). (820) (2,620) 5,050 8,900 4,930 18,880 Depreciation Balance b/f 2,610 3,900 6,510 Assets sold. (800) (800) 2,610 3,100 5,710 Revaluation adjustment (2,610) (2,610) Depreciation for year 445 458 903. 445 3,558 4,003 Carrying value 31 Jan 2012 5,050 8,455 1,372 14,877 (W2) Deferred development expenditure Balance b/f 455 Expenditure in year 71 526 Year s amortisation (254) 272 Year s amortisation: Capitalised in previous years 1,199 Expenditure in 2011 71 1,270 Amortised at 20% 254 (W3) Cost of Administration Distribution sales Trial balance 4,939 1,225 679 Depreciation (W1) 903 Research 163 Bad debt 48 Development amortisation (W2) 254 Gain on disposal of non-current assets (248).. Totals 6,059 1,225 679 Financial Operations 7
(W4) Disposal of non-current assets Land Plant and equipment Land Carrying value 1,800 (820-800)= 20 Revalued amount 1,800 Selling price 2,060 8 Cost 1,000 Profit/(loss) 260 (12) Reversal of revaluation 800 (W5) Interest Years loan interest (2740 x 5%) 137 Paid 69 Current liability 68 (W6) Tax Balance b/f 35 Year 765 800 Decrease in deferred tax (45) Income statement 755 Statement of financial position Current liability tax 765 Provision deferred tax 1,019 (W7) Revaluation of Land and buildings Land (W1) 630 Buildings (W1) (2,610 2,000) 610 1,240 8 Financial Operations
Answer to Question Four Workings (All workings in $000) (i) Fair value of net assets of Branch at acquisition Equity Shares 790 Retained earnings 380 Fair value adjustment 240 1,410 (ii) Goodwill - Branch Cost 1,500 Fair value of net assets acquired: Goodwill 1,410 90 (iii) Investment in associate - Leaf Cost 550 Add group share of post acquisition profits (220-70) = 150 x 40% = 60 Investment at 31 January 2012 610 (iv) Intra-group trading Mark up on cost 50% = 50/150 or 33.3% margin on selling price. Selling price 180; profit = 180 x 33.3% = 60 2/3 remain in inventory - unrealised profit 60 x 2/3 = 40 Dr. Cr. Consolidated cost of sales 40 Consolidated current assets - inventory 40 Consolidated revenue 180 Consolidated cost of sales 180 Current accounts: Tree current account with Branch 123 Less cheque in transit 28 95 Cancels Branch current account with Tree 95 Cancels Loan interest Accrue interest receivable by Tree 30 Dr Cr Interest payable 30 Interest receivable 30 Consolidated interest payable = (102 + 59 30) = 131 Consolidated interest receivable (30 30) = 0 (v) Excess depreciation Fair value adjustment 240 Economic life 10 years, straight line basis Excess depreciation = 240/10 = 24 Financial Operations 9
(vi) Consolidated Retained Earnings Balance Tree at 1 Feb 2011 (665 620) 45 Add consolidated profit for year Balance 31 Jan 2012 Alternative calculation: (vi) Consolidated Retained Earnings Balance - Tree (665 + 30) 695 Branch - group share of post acquisition profits (495-380) = 115 Associate - Leaf, group share of post acquisition profits (iii) 60 Excess depreciation (24) Cancel unrealised profit in inventory (iv) (40) 806 (vii) Consolidated Property, plant and equipment Tree 1,535 Branch 1,155 Fair value adjustment 240 Excess depreciation (24) 2,906 761 806 Tree Group Consolidated Statement of Comprehensive Income for year ended 31 January 2012 $000 Revenue(2,200 + 777-180) 2,797 Cost of sales (1,112 + 456 180 + 24 + 40) (1,452) Gross profit 1,345 Expenses (221 + 115) (336) Profit from operations 1,009 Share of profit of associated entity 60 Finance cost (131) Profit before tax 938 Tax (145 + 32) Profit for the year (177) 761 Tree Group - Consolidated Statement of Financial Position as at 31 January 2012 $000 $000 Non-Current Assets Property, plant and equipment (vii) 2,906 Goodwill (ii) 90 Investment in associate (iii) 610 3,606 Current Assets Inventory (1,360 + 411-40) 1,731 Trade receivables (1,540 + 734) 2,274 Cash and cash equivalents (47 + 75 + 28) 150 4,155 Total assets 7,761 Equity and Liabilities Equity Shares 3,900 Retained Earnings (vi) 806 4,706 Current Liabilities Trade payables (2,690 + 365) 3,055 7,761 10 Financial Operations