The Examiner's Answers F1 - Financial Operations March 2014 Some of the answers that follow may be 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 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 D 1.3 $000 Tax on QR s profits (200 x 25%) = 50 Tax on dividends (75 x 20%) = 15 1.4 AU VAT due = (63,250 x 15/ 115) (44,050 x 15%) = 8,250 6,608 = 1,642 Answer $1,642 VAT due to be paid. 1.5 Original cost ($45,000+$5,000)= $50,000 Indexation ($50,000x1.35)= $67,500 Sales proceeds $110,000 Taxable gain $42,500 Tax @ 25% $10,625 Answer - A 1.6 D Financial Operations 1 March 2014
1.7 C 1.8 Any Two from: Comparability Verifiability Timeliness Understandability 1.9 A 1.10 C March 2014 2 Financial Operations
SECTION B Answers to Question Two (a) To test candidates understanding of the concept of control in the context of the preparation of consolidated financial statements. Tests learning outcome C1b. Define the meaning of a subsidiary and explain how control is achieved. Define the meaning of an associate and significant influence. A subsidiary entity is an entity, including an unincorporated entity such as a partnership, which is controlled by another entity (known as the parent). Control is the power to govern the financial and operating policies of an entity so as to obtain benefit from its activities. A controlling interest is usually obtained by acquiring more than 50% of the equity shares. An associated entity is an entity where another entity can exercise significant influence over the financial and operating policy decisions of that entity. Significant influence is not control over those policies. Significant influence is normally assumed to exist if an entity acquires 20% or more of another entity s equity share capital. Financial Operations 3 March 2014
(b) To test the candidates understanding of the treatment in consolidated financial statements of goodwill arising on acquisition and its impairment. Tests learning outcome C1d. Calculate goodwill arising on acquisition. Calculate the impairment of goodwill and the remaining balance at 31 December 2013. Calculate the group retained earnings at 31 December 2013. Goodwill: $000 Cost 1,136 Acquired: Equity shares 430 Share premium 86 Retained earnings 260 Fair value adjustment 110 886 250 Impairment at 31 December 2013 (20%) (50) Balance at 31 December 2013 200 Group retained earnings: Retained earnings (excluding subsidiary) 2,100 Retained earnings of SUB post-acquisition (324 260) 64 Fair value adjustment 3 years depreciation (110/11 x 3) (30) Goodwill impairment Balance at 31 December 2013 (50) 2,084 March 2014 4 Financial Operations
(c) To test candidates understanding of taxation of foreign entities. Tests learning outcome A2a. Calculate total foreign tax (withholding tax and underlying tax). Calculate the tax due in Country X. Apply the tax credit method and calculate any tax due, if any. (i) Withholding tax = $150,000 x 15% = $22,500 Underlying tax = 150,000 / 355,000 x 95,000 = $40,141 Total foreign tax $62,641 (ii) The tax credit method means that in the country where the dividend is received the recipient with be given credit for the tax already paid in the foreign country. Relief will usually be restricted to the lower of the foreign tax paid and the amount due in the country of residence. Dividend received $127,500 Withholding tax $22,500 Gross dividend $150,000 Underlying tax $40,141 $190,141 Country X tax due @ 25% $47,535 Total foreign tax $62,641 FP received a dividend having suffered withholding tax at 15% and underlying tax at 26.8%, a total of 41.8%. As a resident in Country X, FP is due to pay tax on the gross dividend plus underlying tax at 25%. Tax credit will therefore be restricted to $47,535 and no tax will be payable in Country X. Financial Operations 5 March 2014
(d) To test candidates knowledge of corporate income tax calculations. 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 ($56,000 + $94,000) x 20% = $30,000 Tax depreciation allowances for plant & equipment -: Allowance for plant and equipment purchased 1 January 2012 First year $56,000 x 50% = $28,000 Year to Dec 2013 writing down allowance (56,000 28,000) x 25% = $7,000 Year to Dec 2013 First year allowance for plant & equipment purchased 1 January 2013 94,000 x 50% = 47,000 Total tax depreciation for year ended 31 December 2013 = 7,000 + 47,000 = 54,000 FY Tax computation for year to 31 December 2013: $ Profit before tax 137,400 Add: Donations 6,120 Entertaining expenses 13,240 Accounting depreciation 30,000 Less: Tax depreciation plant & equipment (54,000) Taxable profit 132,760 Tax due at 25% = ($132,760 x 25%) = $33,190 March 2014 6 Financial Operations
(e) To test candidates understanding of deferred tax. Tests learning outcome A4a. Calculate carrying value of the asset. Calculate the tax written down value of the asset. Calculate the temporary difference at each year end. Calculate the deferred tax balance at 31 December 2013 and the change from the previous year. Accounting depreciation Tax depreciation Temporary difference $000 $000 $000 Cost 1 January 2012 600 600 First year 36 300 Balance 31 December 2012 564 300 264 x 25% = 66 Revaluation 50 614 Second year 39.6 75 Balance 31 December 2013 574.4 225 349.4 x 25% = 87.4 Change since 31 December 2012 85.4 x 25% = 21.4 Accounting depreciation: 2012 (600 60) / 15 = 36 2013 (614 60) / 14 = 39.6 Answer: (i) Deferred tax balance at 31 December 2013 = $87,400 (ii) Deferred tax increase during year ended 31 December 2013 = $21,400 $21,400 will be added to the tax charge in PQ s statement of profit or loss for the year ended 31 December 2013. Financial Operations 7 March 2014
(f) To test candidates knowledge of external audit processes. Tests learning outcome B1g. Briefly explain the main advantages to an entity of having an external audit. Briefly explain the main disadvantages to an entity of having an external audit. Advantages of an external audit include: Investors and other users of the financial statements will have more confidence in the financial statements and may be more willing to buy the entity s shares or trade with the entity. Applications to financial institutions for finance may be more viable. Auditor may be able to give constructive advice to management. An external audit may help to deter fraud. Disadvantages of an audit include: The cost of the audit. Disruption caused to management of the entity. The benefits may be limited if the entity is relatively small. March 2014 8 Financial Operations
SECTION C Question Three To test candidates ability to prepare a set of financial statements for a single entity, including the application of a number of IFRS/IAS. Tests learning outcome C1a. Prepare the non-current asset depreciation calculations. Prepare workings for cost of sales, administration and distribution. Prepare workings for the construction contract. Prepare all other required workings. Prepare the statement of profit or loss and other comprehensive income. Prepare the statement of financial position. Prepare the statement of changes in equity. LPO - Statement of profit or loss and other comprehensive income for the year ended 31 December 2013 $000 $000 Revenue W8 5,265 Cost of sales W9 (3,355) Gross Profit 1,910 Administrative expenses W3 (569) Distribution costs (230) (799) Profit from operations 1,111 Finance cost W4 (54) Profit before tax 1,057 Income tax expense W5 (191) Profit for the period 866 LPO Statement of changes in equity for the year ended 31 December 2013 Equity Share Retained Total Shares Premium earnings $000 $000 $000 $000 Balance at 1 January 2013 1,450 240 370 2,060 Profit for period 866 866 Share issue 50 10 60 Dividend paid (360) (360) Balance at 31 December 2013 1,500 250 876 2,626 Financial Operations 9 March 2014
LPO Statement of financial position as at 31 December 2013 $000 $000 Non-current assets Property, plant and equipment W1 2,682 Current Assets Inventory 562 Short term investments 135 Trade receivables (W10) 297 Construction contract amount due from customer (W7) 255 Cash and cash equivalents 215 Total Assets Equity and liabilities 1,464 4,146 Equity Share capital 1,500 Share premium 250 Retained earnings 876 Total equity 2,626 Non-current Liabilities Long term borrowings 900 Deferred tax (W6) 231 Total non-current liabilities 1,131 Current liabilities Trade payables 145 Tax payable (W5) 160 Provision for legal claim 30 Interest payable 54 Total current liabilities 389 Total equity and liabilities 4,146 Workings - All figures in $000 W1 Tangible Non-current Assets Cost/Valuation Land Buildings Plant & Equip. Total $000 $000 $000 $000 Balance 1/1/13 900 1,600 1,055 Disposal of assets (46) 1,009 Depreciation Balance 1/1/13 (225) (400) Disposal of assets 41 Charge for year (48) (195) Net book value at 31/12/13 900 1,327 455 2,682 Depreciation Buildings 2,500 900 = 1,600 x 3% = 48 Plant and equipment Reducing balance = (1,055-46) (400-41) = 650 x 30% = 195 W2 Loss on disposal of plant and equipment Carrying value 5 Selling price 3 Loss 2 March 2014 10 Financial Operations
W3 Cost of sales Administration Trial balance 455 Inventory 1/1/13 420 Purchases 1,425 1,845 Less inventory 31/12/13 (562) 1,283 Depreciation plant and equipment W1 195 Loss on disposal P&E (W2) 2 Buildings depreciation (W1) 48 Bad debt 36 Legal claim _ 30 Totals 1,480 569 W4 Finance charge Year s loan interest 900 x 6% = 54 Accrued interest @ 31 Dec 2013 54 W5 W6 Tax Current year 160 Increase in deferred tax 31 191 Deferred tax Per trial balance 200 Increase in year 31 231 W7 Construction Contract Contract revenue 5,500 Contract cost: Work in progress 1,875 Cost to complete 2,700 Profit % work complete 1,875/4,575 = 41% Recognise in statement of comprehensive income: Revenue (5,500 x 41%) = 2,255 Cost of sales 1,875 Profit 380 4,575 925 Recognise in statement of financial position - amount due from customer: Cost 1,875 Profit recognised 380 Cash received on account Due from customer (2,000) 255 W8 Revenue Sales revenue 3,010 Contract revenue 2,255 5,265 W9 Cost of sales Cost of sales (W3) 1,480 Contract cost 1,875 3,355 W10 Trade Receivables Balance b/f 330 Bad debt (36) Sale of plant & equipment 3 297 Financial Operations 11 March 2014
Question Four To test candidates understanding of Statement of cash flows. Tests learning outcome C1a. Explain the meaning of the direct and indirect method of preparing a statement of cash flows. Draft the outline headings for a statement of cash flows. Complete the cash generated from operations section. Calculate the tax and interest paid and put in statement of cash flows. Calculate the cash flows from movements in non-tangible assets and complete cash flows from investing activities. Calculate dividends paid and complete cash flows from financing activities. Complete the statement of cash flows. (a) IAS 7 Statement of cash flows terms direct method and indirect method refer to the way that cash flows from operating activities are calculated and shown in the statement of cash flows. Direct method Operating cash flows are calculated directly from the accounting records and are shown in the statement of cash flows. Items such as cash received from customers; cash paid to suppliers and cash paid to and on behalf of employees are examples of operating cash flows. Indirect method Starts with profit before tax taken from the statement of profit or loss and other comprehensive income and converts it from the accruals basis to a cash basis by adding back items that do not involve a movement of cash, for example depreciation. Adjustments are also made for items shown elsewhere in the statement of cash flows, for example finance costs. Adjustments also need to be made for changes in working capital; increases and decreases in receivables, payables and inventory. March 2014 12 Financial Operations
(b) Workings (All figures in $000) W1 Net carrying values Property, Plant & Equip Balance b/f 3,200 2,223 Less Disposal, carrying value (W2) - (11) Revaluation 450 - Depreciation for year (150) (290) 3,500 1,922 Acquired in year (to balance) 70 727 Balance c/f 3,570 2,649 W2 Gain on disposal of plant Cost 77 Depreciation (77*6/7) 66 Carrying value 11 Cash received Gain 20 9 W3 Non-current asset investments Balance b/f 137 Revaluation loss (21) 116 Balance c/f Acquired in year 123 7 W4 Interest paid Balance b/f 110 Finance cost in statement of profit or loss 133 243 Balance c/f (69) Interest paid in year 174 W5 Tax paid current tax balance b/f 93 Statement of profit or loss and other comprehensive income charge Current tax balance c/f Increase in deferred tax: Balance b/f 51 Balance c/f (72) Paid in year 92 185 (87) 98 (21) 77 W6 Proceeds from issue of equity share capital Equity shares (1,750-1,100) 650 Share premium (305-110) 195 845 W7 Dividends paid Retained earnings b/f 1,870 Profit for year 648 Retained earnings c/f Dividends paid 2,518 (1,968) 550 Financial Operations 13 March 2014
CX Statement of Cash Flows for the year ended 31 December 2013 $000 $000 Cash flows from operating activities Profit before taxation 740 Adjustments for: Depreciation 440 Finance cost 133 Loss on revaluation non-current asset investments 21 Gain on disposal of plant (W2) (9) Operating profit before working capital changes 1,325 Increase in inventory (40) Decrease in trade receivables 112 Decrease in trade payables (31) Cash generated from operations 1,366 Interest paid (W4) (174) Income taxes paid (W5) (77) Net cash from operating activities 1,115 Cash flows from investing activities Purchase of property, plant and equipment (W1) (797) Purchase of non-current asset investments(w3) (7) Proceeds from sale of equipment 20 Net cash used in investing activities (784) Cash flows from financing activities Proceeds from issue of share capital (W6) 845 Repayment of bank loans (800) Equity dividends paid*(w7) (550) Net cash used in financing activities (505) Net decrease in cash and cash equivalents (174) Cash and cash equivalents at 1 January 2013 60 Cash and cash equivalents at 31 December 2013 (114) * this could also be shown as an operating cash flow March 2014 14 Financial Operations