The Examiner's Answers F1 - Financial Operations November 2014 Some of the answers that follow are fuller and more comprehensive than would be expected from a wellprepared 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 Question One consists of 10 objective test sub-questions. These are drawn from all sections of the syllabus. They are designed to examine breadth across the syllabus and thus cover many learning outcomes. 1.1 B 1.2 Output VAT (250 x $65 x 15%) = $2,437.5 Input VAT [(45+8) x 250 x 15%] = $1,987.5 VAT payable $450.0 Excise duty payable (8 x 250) = $2,000.0 $2,450.0 Answer = B 1.3 Tax evasion is the illegal manipulation of the tax system to avoid paying tax. Intentional disregard of the law to escape tax and can include falsifying tax returns and claiming fictitious enterprises. 1.4 Two from: Income Consumption Assets (capital) 1.5 C Financial Operations 1 November 2014
1.6 C 1.7 A 1.8 D 1.9 D 1.10 C November 2014 2 Financial Operations
SECTION B Answers to Question Two (a) To test candidates knowledge of the treatment of changes in non-current assets in the statement of cash flows. Tests learning outcome C2c. Calculate the proceeds from disposal of property, plant and equipment during the year. Calculate the amount invested in property, plant and equipment during the year. Calculate the deferred development expenditure capitalised during the year. (i) Proceeds from disposal of property, plant and equipment during the year Carrying value $95,000 Loss on disposal $23,000 Cash received $72,000 (ii) Property, plant and equipment Carrying value at 31 March 2013 $28,000,000 Revalued during the year $3,000,000 $31,000,000 Carrying value of assets sold during the year ($95,000) Annual depreciation ($4,055,000) $26,850,000 Carrying value at 31 March 2014 $27,660,000 Assets acquired during the year $810,000 (iii) Deferred development expenditure Carrying value at 31 March 2013 $290,000 Amortised in year ($73,000) $217,000 Carrying value at 31 March 2014 $370,000 Expenditure during the year $153,000 ALZ Statement of cash flows for the year ended 31 March 2014 (Extract) Investing activities: Purchase of Property, plant and equipment (ii) ($810,000) Proceeds from disposal of property, plant and equipment (i) $72,000 Deferred development expenditure incurred in year (iii) Net cash used in investing activities ($153,000) ($891,000) Financial Operations 3 November 2014
(b) To test the candidates understanding of the concept of residence and its impact on an international entity. Tests learning outcome A2a. Explain why residence is important for corporate income tax. Explain the OECD model tax convention s definition of residence and apply it to CXV. (i) (ii) In most countries corporate income tax is a residence-based tax. The residence, for tax purposes, of an entity determines where its worldwide profits will be subject to corporate income tax. It is therefore important to establish the residence of an entity for tax purposes. The key criterion for an entity s residence status, as long as it can be determined, is where an entity s effective management is located. CXV holds all its management board meetings in country X and its senior managers all live in country X. These two circumstances both imply effective management is in country X. CXV will therefore be deemed to be resident in country X for tax purposes as that is where its place of effective management is. November 2014 4 Financial Operations
(c) To test the candidates understanding of the CIMA code of ethics. Tests learning outcome B2c. Describe two of the five fundamental principles of ethical behaviour contained in the code. Explain how an accountant should resolve an ethical dilemma. (i) According to CIMA s code of ethics the five fundamental principles of ethical behaviour contained in the code are: Objectivity not allowing bias, conflict of interest or influence of others to override professional judgement. Professional competence and due care the need to maintain your level of knowledge and skill. Professional behaviour comply with relevant laws and regulations Integrity being straightforward honest and truthful. Confidentiality respecting the confidential nature of the information you acquire during your work. Briefly describe two of the above. (ii) First the ethical dilemma needs to be assessed to decide if it is significant. If the dilemma is significant action should be taken to remove or mitigate it. A significant ethical dilemma should be resolved by taking actions, these actions are referred to in the code as safeguards. A safeguard should eliminate a dilemma or reduce it to a level where it is no longer significant or of any consequence. An accountant should: Gather all relevant information to be sure of the facts and help decide if there is a significant problem. Raise concern internally and then escalate it if need be. Use any existing grievance procedure or whistle blowing procedure. Consider reporting externally, take legal advice and remember confidentiality. Finally if all else has failed consider removing yourself from the situation. Financial Operations 5 November 2014
(d) To test candidates understanding of the enhancing qualitative characteristics of financial information identified in the IASB s Conceptual Framework for Financial Reporting (2010). Tests learning outcome B1d. Explain each one of the four enhancing qualitative characteristics of financial information identified in the IASB s Conceptual Framework for Financial Reporting (2010). The four enhancing qualitative characteristics of financial information identified in the IASB s Conceptual Framework for Financial Reporting (2010) are comparability, verifiability, understandability and timeliness. (i) Comparability: being able to compare financial statements for an entity through time and being able to compare the financial statements of different entities. To achieve this requires similar items to be treated in a consistent way from one period to the next and from one entity to another. (ii) Verifiability: Information must be verifiable. Verification can be direct, e.g. physical check or indirect using formulae or computer models. (iii) Understandability: Information needs to be readily understandable by users. Users are assumed to have a reasonable knowledge of business and economic activities and be willing to put some effort into studying the information. (iv) Timeliness: The information needs to be available to the decision makers in time to influence their decisions. November 2014 6 Financial Operations
(e) To test candidates understanding of deferred tax. Tests learning outcome A4a. Explain why YT s revaluation of its assets would cause a temporary difference as defined by IAS 12 Income Taxes. Calculate the deferred tax provision for YT as at 30 September 2014. (i) Temporary differences arise as a result of different treatment of assets for tax purposes and for accounting purposes. This causes a difference between the carrying amount of an asset or liability in the statement of financial position and its tax base (value used for calculating tax). In YT the revaluation of assets changes accounting depreciation but has no effect on the tax base. The tax on the temporary difference is the amount of deferred tax, that is the tax that will need to be paid/refunded in the future as a result of the different treatments in the current period. (ii) Figures per accounts: $ Annual depreciation is (440,000 / 5) = 88,000 Cost 440,000 Depreciation 2012/13 88,000 352,000 Revaluation 1/10/13 100,000 452,000 Depreciation 2013/14(1/4) 113,000 Net book value at 30/9/14 339,000 Tax balances $ Cost 440,000 First year allowance 50% 220,000 220,000 Allowance 2013/14 25% 55,000 Tax base at 30/9/14 165,000 Temporary difference is the difference between the accounting net book value and the tax base. $ Accounting net book value 339,000 Tax base 165,000 Temporary difference 174,000 Total deferred tax provision required = $174,000 x 25%= $43,500 Financial Operations 7 November 2014
(f) To test candidates knowledge of the calculation of corporate income tax. Tests learning outcome A3a. Calculate the depreciation charged against profits. Calculate the tax depreciation allowance. Calculate the taxable profit for the year. Calculate the tax due for the year. Accounting depreciation: Plant and equipment ($112,000 + $188,000) x 20% = $60,000 Tax depreciation allowances for plant & equipment -: Allowance for plant and equipment purchased 1 October 2012 First year $112,000 x 50% = $56,000 Year to 30 September 2014 writing down allowance (112,000 56,000) x 25% = $14,000 Year to 30 September 2014 First year allowance for plant & equipment purchased 1 October 2013 $188,000 x 50% = $94,000 Total tax depreciation for year ended 30 September 2014 = $14,000 + $94,000 = $108,000 MX Tax computation for year to 30 September 2014: $ Profit before tax 291,100 Add: Donations 9,440 Entertaining expenses 22,120 Accounting depreciation 60,000 Less: Tax depreciation plant & equipment (108,000) Taxable profit 274,660 Tax due at 25% = ($274,660 x 25%) = $68,665 November 2014 8 Financial Operations
SECTION C Question Three To test candidates ability to prepare a set of financial statements for a single entity. Tests learning outcome C1a. Prepare the non-current assets and depreciation calculations. Prepare workings for cost of sales and administration. Prepare all other required workings. Prepare the statement of profit or loss. Prepare the statement of financial position. Prepare the statement of changes in equity. TYV - Statement of profit or loss for the year ended 30 September 2014 $000 $000 Revenue 19,460 Cost of sales (W2) (11,119) Gross Profit 8,341 Administrative expenses (W2) (1,954) Distribution costs (1,110) (3,064) Profit from operations 5,277 Finance cost (W4) (378) Profit before tax 4,899 Income tax expense (W5) (971) Profit for the period 3,928 TYV Statement of changes in equity for the year ended 30 September 2014 Equity Share Retained Total Shares Premium earnings $000 $000 $000 $000 Balance at 30 Sept 2013 6,000 850 491 7,341 Profit for period 3,928 3,928 Dividend paid (350) (350) Balance at 6,000 850 4,069 10,919 Financial Operations 9 November 2014
TYV Statement of financial position as at 30 September 2014 $000 $000 Non-current assets Property, plant and equipment (W1) 16,415 Current Assets Inventory 575 Trade receivables 2,250 Cash and cash equivalents 272 3,097 Non-current assets held for sale 1,420 Total Assets 20,932 Equity and liabilities Equity Share capital 6,000 Share premium 850 Retained earnings 4,069 Total equity 10,919 Non-current Liabilities 7% Loan 5,000 Deferred tax (W5) 576 Total non-current liabilities 5,576 Current liabilities Trade payables 1,880 Tax payable 940 Short term loan 1,500 Interest 117 Total current liabilities 4,437 Total equity and liabilities 20,932 Workings - All figures in $000 W1 Tangible Non-current Assets Cost/Valuation Land Buildings Plant & Equipment Total Balance 30/9/13 11,000 6,386 7,750 Disposal factory B (1,120) (325) Transfer factory A - held for sale (1,375) (455) Plant & equipment scrapped (175) New factory building. 1,099. 8,505 6,705 7,575 Depreciation Balance 30/9/13 1,700 4,510 Disposal factory B (286) Transfer factory A-held for sale (364) Plant & equipment scrapped (120) Charge for year 134 796 1,184 5,186 Net book value at 30/9/14 8,505 5,521 2,389 16,415 Depreciation Buildings 6,705 x 2% = 134 Plant and equipment Reducing balance = 7,575 (4,510-120) = 3,185 x 25% = 796 November 2014 10 Financial Operations
W2 Cost of sales Administrative Expenses $000 $000 Balance per trial balance 10,200 1,820 Depreciation buildings (W1) 134 Loss on factory closures Factory A (W3) 46 Loss on factory closures Factory B (W3) 29 Loss on plant and equipment (W3) 48 Depreciation plant & equipment (W1) 796 11,119 1,954 W3 Loss on factory closures Factory A Carrying value: Land 1,375 Buildings 455 1,830 Less depreciation (364) 1,466 Fair value 30/9/2014 1,420 Write down (46) Factory B Carrying value: Land 1,120 Buildings 325 1,445 Less depreciation (286) 1,159 Cash received 1,130 Loss on disposal (29) Plant and equipment Cost 175 Less depreciation (120) 55 Cash received 7 Loss (48) W4 Finance cost: Interest on long term loan: Balance t/b 233 Accrued ($5,000 x 7% x 4/12) 117 350 Finance charge on short term loan: 3 months 113 x 3/12 = 28 378 W5 Income tax expense: Income tax for year 940 Previous year balance 80 1,020 Deferred tax decrease (49) Income statement 971 Deferred tax b/f 625 Reduction (49) Deferred tax at 30 Sept 2014 576 W6 Cost of new factory Cost of new factory building 1,014 Finance charge on short term loan, 9 months added to cost of building (IAS 23). 113 x 9/12 = 84.75 85 1,099 Financial Operations 11 November 2014
Question Four To test candidates ability to prepare a journal entry to record a share issue. To test candidates ability to prepare a set of financial statements for a group of entities. Tests learning outcomes C2b and C1c and d. Prepare a journal entry to record the purchase of SU in HC s accounting records. Calculate goodwill arising on acquisition of SU. Calculate investment in associated entity AS. Prepare workings for intra-group activities. Calculate consolidated property, plant and equipment. Prepare the consolidated statement of profit or loss. Calculate consolidated retained earnings. Prepare consolidated statement of financial position. (a) Consideration for SU paid in shares: Cost $1,356,000; HC issued 600,000 shares therefore share premium was $756,000 (1,356,000 600,000). Journal Dr Cr $000 $000 Investment in SU 1,356 Equity shares 600 Share premium 756 (b) Investment of HC in SU HC purchased all 720,000 shares in SU on 1 October 2013. 100% shares purchased therefore treat SU as wholly owned subsidiary of HC from 1 October 2013. Investment of HC in AS HC purchased 96,000 of AS s 320,000 shares on 1 October 2013. This gave HC 30% of AS s equity. As HC has in excess of 20% of AS s equity and can exercise significant influence over all aspects of AS s financial and operating policies HC will treat AS as an associated entity from 1 October 2013. Workings (All workings in $000) (i) Fair value of net assets of SU at acquisition Equity Shares 720 Retained earnings 319 Fair value adjustment 231 1,270 (ii) Goodwill - SU Cost 1,356 Fair value of net assets acquired: 1,270 Goodwill 86 Impairment (13) Balance at 30 September 2014 73 November 2014 12 Financial Operations
(iii) Investment in associate - AS Cost 384 Add group share of post acquisition profits (229-132) = 97 x 30% = 29 Investment at 30 September 2014 413 (iv) Intra-group trading Mark up on cost 25% = 25/125 or 20% margin on selling price. Selling price 170; unrealised profit = 170 x 20% = 34 50% of goods remain in inventory, adjust inventory by (34 x 50%) 17. Dr. Cr. Consolidated cost of sales 17 Consolidated current assets - inventory 17 Consolidated revenue 170 Consolidated cost of sales 170 Consolidated trade payables 170 Consolidated trade receivables 170 (v) Cash transfer Consolidated cash and cash equivalents 90 Consolidated trade payables 90 (vi) Excess depreciation Fair value adjustment 231 Economic life 21 years, straight line basis Excess depreciation = 231/21 = 11 (vii) Consolidated Retained Earnings Balance HC at 1 October 2013 (796-(611-25)) 210 Add consolidated profit for year 712 Balance 30 September 2014 922 Alternative calculation: (viii) Consolidated Retained Earnings Balance HC 796 SU - group share of post acquisition profits (457-319) = 138 Associate - AS, group share of post acquisition profits (iii) 29 Excess depreciation (11) Goodwill impairment (13) Cancel unrealised profit in inventory (iv) (17) 922 (ix) Consolidated Property, plant and equipment HC 2,192 SU 920 Fair value adjustment 231 Excess depreciation (11) 3,332 HC Group Consolidated Statement of Profit or Loss for year ended 30 September 2014 $000 Revenue(1,925+480-170) 2,235 Cost of sales (925+230-170+11+17) (1,013) Gross profit 1,222 Expenses (240+54+13) (307) Profit from operations 915 Share of profit of associated entity (iii) 29 Finance cost (27+45-25) (47) Profit before tax 897 Tax (147+38) (185) Profit for the year 712 Financial Operations 13 November 2014
HC Group - Consolidated Statement of Financial Position as at 30 September 2014 $000 $000 Non-Current Assets Property, plant and equipment (ix) 3,332 Goodwill (ii) 73 Investment in associate (iii) 413 3,818 Current Assets Inventory (1,810+782-17) 2,575 Trade receivables (2,292+686-170) 2,808 Cash and cash equivalents (113+70+90) 273 5,656 Total assets 9,474 Equity and Liabilities Equity Shares (5,520+600) 6,120 Share premium [see part (a)] 756 Retained Earnings (viii) 922 7,798 Non-current Liabilities Long term loans (650-250) 400 Current Liabilities Trade payables (725+631-170+90) 1,276 9,474 November 2014 14 Financial Operations