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 Answers to Question One 1.1 D 1.2 B 1.3 C 1.4 Tax evasion is the illegal manipulation of the tax system to avoid paying tax. 1.5 C 1.6 B 1.7 2,400,000 / 6 = 400,000 new shares 400,000 x $1 = $400,000 Less issue costs $45,000 Total share premium = $355,000 1.8 Fair value adjustment = 350-325 = 25 Cost 342 Value Acquired: Equity shares 200 Share premium 40 Retained earnings 62 Fair value adjustment 25 327 Goodwill 15 Financial Operations 1 September 2011
1.9 Original investment 70 Share of profit for year 45.5 Less share of dividend paid (28) Value of investment in SX 87.5 1.10 C Financial Operations 2 September 2011
SECTION B Answers to Question Two Answer to (a) (i) Single stage sales tax is payable on sales at a specific part of the trade cycle, e.g. retail sales. There is no credit given to an entity for sales tax paid on purchases. VAT is a multi-stage tax, taxing sales at every stage of the transaction cycle. However most VAT paid by an entity is reimbursed by the tax authorities, usually by deducting from VAT collected. (ii) Output tax product Z = $207,000 x 15 / 115 = $27,000 Input tax on purchases = $200,000 x 15% = $30,000 Tax reimbursable by tax authorities $3,000 Answer to (b) (i) A temporary difference arises when an expense is allowed for both accounting and tax purposes, but there is a difference in the timing of the allowance. A temporary difference is the difference between the carrying amount of an asset in the statement of financial position and its tax base. The temporary difference times the tax rate is the amount of deferred tax required to be recognised by IAS12 Income Taxes. (ii) A deferred tax debit balance can arise from the following: deductible temporary difference, unused tax losses, unused tax credits. A deductible temporary difference is a temporary difference that will result in a deduction from future taxable profits when sold or realised. Some tax authorities may permit the tax effect of losses to be carried forward and offset against future taxable profits. IAS 12 requires that these unused tax losses be recognised as assets, where it is probable that the entity will make future profits against which these losses can be offset. Deferred tax debit balances should be recognised in the financial statements provided that it is probable that future taxable profits will be available for the asset to be utilised, that is future tax payable can be reduced. Answer to (c) (i) (ii) The worldwide approach is where a country claims the right to tax income earned outside its border if that income is received by an entity deemed resident for tax purposes within the country. The problem with the worldwide approach is that it leads to double taxation as income will usually be taxed in the country where it is earned and again in the country where the holding entity is resident. Double tax relief exists to reduce the total amount of tax payable on tax income earned in other countries. The effect of double tax relief is to reduce the total tax payable to the higher of the two, the home country or overseas tax rate. Most countries applying the worldwide approach grant some form of relief from double taxation. Double tax relief is given according to double tax agreements that a country has entered into. Financial Operations 3 September 2011
Answer to (d) The main factors that may influence accounting regulations in a country are: The legal system and tax legislation Taxable profits are based on accounting profit but the number and type of adjustments required to compute taxable profits varies from country to country. Part of this variation is due to the differences in the tax regulations but part of them is due to the different approaches to the calculation of accounting profit. In some countries taxable income is closely linked to the accounting profit and accounting rules are largely driven by taxation laws. These countries are usually known as code law countries; countries where the legal system originated in Roman law. Accounting regulation in these countries is usually in the hands of the government and financial reporting is a matter of complying with a set of legal rules. In other countries the common law system is used. Common law is based on case law and tends to have less detailed regulations. In countries with common law systems the accounting regulation within the legal system is usually kept to a minimum; with detailed accounting regulations produced by professional organisations or other private sector accounting standard setting bodies. Sources of finance and capital markets There is more demand for financial information and disclosure where a higher proportion of capital is raised from external shareholders rather than from banks or family members. Banks and family members are usually in a position to be able to demand information directly from the entity, whereas stock market and shareholders have to rely on published financial information. The political system The nature of regulation and control exerted on accounting will reflect political philosophies and objectives of the ruling party. Entity ownership The need for public accountability and disclosure will be greater where there is a broad ownership of shares as opposed to family or government ownership. Cultural differences The culture within a country can influence societal and national values which can influence accounting regulations. Answer to (e) (i) Asset - An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Liability - A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow of resources from the entity. (ii) To be recognised the item must meet the definition of an element and the two criteria set by the Framework. The criteria are: 1. it is probable that any future economic benefit associated with the item will flow to or from the entity; and 2. the item has a cost or value that can be measured with reliability. Financial Operations 4 September 2011
Answer to (f) According to CIMA s Code of ethics for professional accountants WZ is in a position where he may be compromising his integrity and objectivity. Integrity This principle imposes an obligation to be truthful and honest on the accountant. A professional accountant should not be associated with reports and other information where she/he believes that the information contains misleading statements. This seems to be the case with the revised treatment of the property, WZ believes that the revised financial statements will not follow IFRS 5 and may not show a true and fair view of the situation. Objectivity A professional accountant should not allow conflict of interest or undue influence of others to override professional or business judgements or to compromise her/his professional judgements. The management board is overriding WZ s professional and business judgement as it is imposing its business judgement over the professional accountant s (WZ) professional judgement. If WZ were to accept the change outsiders may interpret this as a lack of professional judgement by WZ as IFRS5 will not be applied correctly. The possible options for WZ in this situation would be: (i) To try and persuade the management board that IFRS 5 must be followed and the property treated correctly in the financial statements. (ii) To refuse to remain associated with the financial statements if IFRS 5 is not followed and to disassociate himself from them as much as possible. (iii) To consider reporting the situation to the external auditors or other appropriate authorities possibly after taking legal advice. (iv) To consider resignation from his post as a professional accountant. Financial Operations 5 September 2011
SECTION C Answer to Question Three ZY - Statement of comprehensive income for the year ended 30 June 2011 Revenue (2,084 30) 2,054 Cost of sales W3 1,136 Gross Profit 918 Administrative expenses W3 386 Distribution costs 221 607 Profit from operations 311 Finance cost W8 29 Profit before tax 282 Income tax expense W5 64 Profit for the period from continuing operations 218 ZY Statement of Financial Position at 30 June 2011 Non-current assets Property, plant and equipment W1 1,385 Current assets Inventory W9 385 Trade receivables W6 202 Cash and cash equivalents 229 816 Total assets 2,201 Equity and liabilities Equity Share capital 500 Other components of equity 490 Retained earnings 416 Total equity 1,406 Non-current liabilities Long term borrowings 320 4% Cumulative, Redeemable Preferred shares 150 Finance lease W7 78 Deferred tax 38 Total non-current liabilities 586 Current liabilities Trade payables 120 Tax payable 56 Finance lease W7 22 Interest payable W8 11 Total current liabilities 209 Total equity and liabilities 2,201 Financial Operations 6 September 2011
ZY Statement of changes in equity for the year ended 30 June 2011 Equity Share Revaluation Retained Total shares premium reserve earnings Balance at 1 July 2010 500 270 220 288 1,278 New share issue Profit for period 218 218 Dividend paid (90) (90) Balance at 30 June 2011 500 270 220 416 1,406 Workings (All figures in ) (W1) Depreciation Property Cost Depreciation NBV Balance b/fwd 844 8 Year depreciation @ 1%. 8 Balance c/fwd 844 16 828 Plant and equipment Balance b/fwd 864 249 Less disposal (95) (95) 769 154 Finance lease 120 889 Depreciation charge for year @ 20% 178 889 332 557 1,385 (W2) (W3) Gain on disposal Cost less depreciation 0 Cash received 10 Gain on disposal 10 Cost of sales Administration Trial balance 338 Inventory b/f 358 Purchases 987 Closing inventory (W9) (385) Gain on disposal NCA (10) Bad debt 48 Depreciation (178+8) 186 1136 386 (W5) Tax Balance b/f 15 Year 56 Decrease in deferred tax (45-38) 7 64 (W6) Trade Receivables Trial balance 280 Less bad debt 48 232 Less goods on sale or return 30 202 Financial Operations 7 September 2011
(W7) Finance Lease Cost 120 Interest @ 7.93%= 9.5 ~ 10 130 Rental payment (30) 100 Interest @ 7.93%= 7.9 ~ 8 108 Rental payment (30) 78 Current liability 22 Non-Current liability 78 (W8) Interest SoCI SoFP Interest on long term borrowings 16 8 Finance charge on lease 10 0 Dividend on Preferred shares 3 3 29 11 (W9) Inventory @ 30 June 2011 Balance @ 30 June 2011 390 Inventory write down (100 (110-30) (20) Sale or return goods 15 Adjusted balance 30 June 2011 385 Financial Operations 8 September 2011
Answer to Question Four (a) UV Tangible Non-current Asset note Property Plant Equipment Total Non-current assets Cost or valuation At 30 June 2010 4,150 2,350 985 7,485 Additions 0 215 275 490 Disposals 0 (90) 0 (90) Adjustment on revaluation 350 0 0 350 At 30 June 2011 4,500 2,475 1,260 8,235 Depreciation At 30 June 2010 (450) (1,350) (900) (2,700) Disposals 0 60 0 60 Charge for year (50) (280) (40) (370) Adjustment on revaluation 450 0 0 450 At 30 June 2011 (50) (1,570) (940) (2,560) Net book value at 30 June 2011 4,450 905 320 5,675 Net book value at 30 June 2010 3,700 1,000 85 4,785 (b) UV Statement of Cash flows for the year ended 30 June 2011 Cash flows from operating activities Profit before taxation 1,540 Adjustments for: Increase in legal claim provision 30 Depreciation (part a) 370 Amortisation of development expenditure (W4) 13 Restructuring provision (W6) (100) Finance cost 95 Loss on disposal of non-current tangible asset 15 423 Operating profit before working capital changes 1,963 Increase in inventory (15) Increase in trade receivables (45) Decrease in trade payables (25) (85) Cash generated from operations 1,878 Interest paid (W5) (122) Income taxes paid (W1) (229) Net cash from operating activities (351) 1,527 Cash flows from investing activities Purchase of property, plant and equipment (part a) (490) Proceeds from sale of equipment 15 Development expenditure (114) Net cash used in investing activities (589) 938 Cash flows from financing activities Proceeds from issue of share capital (W3) 415 Repayment of long term borrowings (1,250) Equity dividends paid* (W2) (168) Net cash used in financing activities (1,003) Net decrease in cash and cash equivalents (65) Cash and cash equivalents at 1July 2010 160 Cash and cash equivalents at 30 June 2011 95 Financial Operations 9 September 2011
Workings W1 Income Taxes paid Balance b/f corporate income tax 305 Income statement 455 Other comprehensive income deferred tax 200 960 Balance c/f corporate income tax (321) - Deferred tax (410) (731) Tax paid 229 W2 Dividends Paid Retained earnings Balance b/f 1,982 Profit for year 1,085 3,067 Retained earnings Balance c/f 2,899 Dividends paid 168 W3 Proceeds from issue of share capital Shares 150 Share premium 265 Received 415 W4 Deferred development expenses Balance b/f 69 Additions 114 183 Balance c/f 170 Amortised in year 13 W5 Interest paid Balance b/f 32 Income Statement 95 127 Less balance c/f (5) 122 W6 Restructuring costs Provision balance at 30 June 2010 100 Paid during year 160 Net charge to income statement Cos 60 Additional charge to cash flow 100 Financial Operations 10 September 2011