Institute of Chartered Accountants Ghana (ICAG) Paper 2.1 Financial Reporting Final Mock Exam 1 Question paper Time allowed 3 hours Instructions: All five questions in this exam are compulsory and must be attempted. DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER EXAMINATION CONDITIONS
ii Financial Reporting The Institute of Chartered Accountants Ghana First edition 2015 ISBN 9781 4727 2837 1 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BPP Learning Media Ltd. Published by BPP Learning Media Ltd BPP House, Aldine Place London W12 8AA www.bpp.com/learningmedia The Institute of Chartered Accountants Ghana 2015
Final Mock Exam 1: Questions 1 ALL FIVE questions are compulsory and MUST be attempted Question 1 L The following trial balance relates to L, a listed company, at 31 December 20X4: GHS'000 GHS'000 Land and buildings at valuation 1 January 20X4 (Note (1)) 130,000 Plant at cost (Note (1)) 128,000 Accumulated depreciation of plant at 1 January 20X4 32,000 Financial assets at fair value through profit or loss (Note (2)) 26,500 Investment income 2,200 Cost of sales (Note (1)) 89,200 Distribution costs 11,000 Administrative expenses 12,500 Interest paid (on 2% loan note) 800 Inventories at 31 December 20X4 37,900 Income tax (Note (3)) 400 Trade receivables 35,100 Revenue (Note (5)) 180,400 Equity shares (120 million shares) 60,000 Income surplus at 1 January 20X4 40,500 Ordinary dividends paid 15,000 Capital surplus (arising from land and buildings) 14,000 2% loan note 20X9 (Note (4)) 80,000 Trade payables 34,700 Deferred tax 11,200 Suspense account (Note (6)) 24,000 Bank 6,600 486,000 486,000 Notes (1) L has a policy of revaluing its land and buildings at each year end. The valuation in the trial balance includes a land element of GHS30m. The estimated remaining life of the buildings at 1 January 20X4 was 20 years. On 31 December 20X4, a professional valuer valued the buildings at GHS92m with no change in the value of the land. Depreciation of buildings is charged to administrative expenses. During the year L manufactured an item of plant that it is using as part of its own operating capacity. The details of its cost, which is included in cost of sales in the trial balance, are: GHS'000 Materials cost 6,000 Direct labour cost 4,000 Machine time cost 8,000 Directly attributable overheads 6,000 The manufacture of the plant was completed on 1 July 20X4 and the plant was brought into immediate use, but its cost has not yet been capitalised. All plant is depreciated at 12½% per annum (time apportioned where relevant) using the reducing balance method and charged to cost of sales. No non-current assets were sold during the year. (2) The financial assets are investments in equity instruments held at fair value through profit or loss. Their fair value at 31 December 20X4 was GHS27.1m. (3) The balance of income tax in the trial balance represents the under/over provision of the previous year's estimate. The estimated current tax charge for the year ended 31 December 20X4 is GHS18.7m. At 31 December 20X4 there were GHS40m of taxable temporary differences. The
2 Final Mock Exam 1: Questions income tax rate is 25%. Note. You may assume that the movement in deferred tax should be taken to profit or loss. (4) The 2% loan note was issued on 1 July 20X4 under terms that provide for a large premium on redemption on 1 July 20X9. The finance department has calculated that the effect of this is that the loan note has an effective interest rate of 6% per annum. (5) Included in L's revenue is GHS3.9m of credit sales made on a 'sale or return' basis. L had applied a mark-up on cost of 30% on these sales and treated them as a normal credit sale. (6) The suspense account contains the credit entry for the proceeds of a rights issue of shares made on 1 October 20X4. The terms of the issue were one share for every four held at 80 Gp per share. L's share price immediately before the issue was GHS1. The issue was fully subscribed. Required Prepare for L: (a) A statement of profit or loss and other comprehensive income for the year ended 31 December 20X4 and a statement of financial position as at 31 December 20X4. (17 marks) (b) A calculation of the earnings per share for the year ended 31 December 20X4. (3 marks) (Total = 20 Marks) Question 2 S The finance director of S, a listed company is unsure how the following matters should be reflected in the financial statements to 31 December 20X4: (i) From 1 January 20X4, the directors have decided to reclassify research and amortised development costs as administrative expenses rather than its previous classification as cost of sales. They believe that the previous treatment unfairly distorted the company's gross profit margin. (ii) S has two potential liabilities to assess. The first is an outstanding court case concerning a customer claiming damages for losses due to faulty components supplied by S. The second is the provision required for product warranty claims against 200,000 units of retail goods supplied with a one-year warranty. The estimated outcomes of the two liabilities are: Court case Product warranty claims 10% chance of no damages awarded 70% of sales will have no claim 65% chance of damages of GHS4m 20% of sales will require a GHS25 repair 25% chance of damages of GHS6m 10% of sales will require a GHS120 repair (iii) On 1 January 20X4, S received a government grant of GHS8m towards the purchase of new plant with a gross cost of GHS64m. The plant has an estimated life of 10 years and is depreciated on a straight-line basis. One of the terms of the grant is that the sale of the plant before 31 December 20X7 would trigger a repayment on a sliding scale as follows: Sale in the year ended: Amount of repayment 31 December 20X4 100% 31 December 20X5 75% 31 December 20X6 50% 31 December 20X7 25% Accordingly, the directors propose to credit to the statement of profit or loss GHS2m (GHS8m 25%) being the amount of the grant they believe has been earned in the year to 31 December 20X4.
Final Mock Exam 1: Questions 3 (iv) S accounts for government grants as a separate item of deferred credit in its statement of financial position. S has no intention of selling the plant before the end of its economic life. On 1 January 20X4, S issued a 5% GHS5m convertible loan note at par. Interest is payable annually in arrears on 31 December each year. The loan note is redeemable at par or convertible into equity shares at the option of the loan note holders on 31 December 20X6. The interest on an equivalent loan note without the conversion rights would be 8% per annum. The present values of GHS1 receivable at the end of each year, based on discount rates of 5% and 8%, are: End of year 5% 8% 1 0.95 0.93 2 0.91 0.86 3 0.86 0.79 (v) S owns two properties at 1 January 20X4: Property A: An office building used by S for administrative purposes with a depreciated historical cost of GHS2m. At 1 January 20X4 it had a remaining life of 20 years. After a reorganisation on 1 July 20X4, the property was let to a third party and reclassified as an investment property applying the fair value model. An independent valuer assessed the property to have a fair value of GHS2.3m at 1 July 20X4, which had risen to GHS2.34m at 31 December 20X4. Property B: Another office building sub-let to a subsidiary of S. At 1 January 20X4, it had a fair value of GHS1.5m which had risen to GHS1.65m at 31 December 20X4. Note. Ignore deferred tax. Required Explain and quantify where possible, how the above items (i) to (v) should be treated in S's financial statements for the year ended 31 March 2014. The following mark allocation is provided as guidance for this question: (i) (3 marks) (ii) (4 marks) (iii) (3 marks) (iv) (5 marks) (v) (5 marks) (Total = 20 marks) Question 3 LB (a) On 1 January 20X4 LB, a listed company, signed two agreements with a leasing company: 1 For a machine with a fair value of GHS55,000. The terms of the agreement are that LB will make 4 annual payments of GHS15,775 starting on 1 January 20X4. Ownership of the machine will be transferred to LB when the final payment is received by the finance company. The machine has an expected useful life of 5 years. 2 For a machine with a fair value of GHS80,000. The terms of the agreement are that LB will pay a deposit of GHS12,000 on the day the agreement is signed and then make 4 annual payments of GHS12,000 starting on 31 December 20X4. The expected useful life of the machine is 8 years. The finance director has correctly calculated that where applicable, the effective rate of interest on lease agreements is 10%.
4 Final Mock Exam 1: Questions Required Prepare the journals to record these leases in the year ended 31 December 20X4 and state the amounts that would be included in the financial statements at that date. (8 marks) (b) The following definitions have been taken from the IASB's Conceptual Framework for Financial Reporting: '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.' 'A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.' IAS 17 Leases requires lessees to capitalise finance leases in their financial statements. Required Explain how IAS 17's treatment of finance leases applies the definitions of assets and liabilities. (7 marks) (c) LB intends to start production and sales in a second location and has been advised to record the activities of the new location by 'branch accounting'. Required Explain what branch accounting is, why LB might find it useful, and the possible disadvantages. (5 marks) (Total = 20 marks) Question 4 P On 1 May 20X4, P acquired 8 million of the 10 million shares issued by S. The consideration was as follows: An initial cash payment of GHS1.00 per share acquired. A share for share exchange on the basis of 1 share in P for every 2 shares acquired in S. The share for share exchange has not yet been recorded by P, but the cash payment was recorded. At the date of acquisition the market price of shares in P was GHS9.60 per share and the market price of the shares in S was GHS5.80 per share. S's income surplus and capital surplus stood at GHS32m and GHS5.3m respectively. On 1 July 20X4, P acquired 4 million of the 10million shares issued by A for a cash payment of GHS21.6m. Below are the summarised draft financial statements of the three companies. STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4 P S A GHS'000 GHS'000 GHS'000 Non-current assets Property, plant and equipment 122,000 54,000 43,000 Investments in equity instruments 29,600 151,600 54,000 43,000 Current assets 44,000 18,000 16,000 Total assets 195,600 72,000 59,000 Equity Ordinary shares 15,000 10,000 5,000 Income surplus 116,600 40,400 39,000 Capital surplus 12,000 6,500 3,000 143,600 56,900 47,000
Final Mock Exam 1: Questions 5 Non-current liabilities 5% loan notes 16,000 Current liabilities 36,000 15,100 12,000 Total equity and liabilities 195,600 72,000 59,000 STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME YEAR ENDED 31 DECEMBER 20X4 P S A GHS'000 GHS'000 GHS'000 Revenue 180,000 78,000 62,000 Cost of sales (108,000) (46,800) (37,200) Gross profit 72,000 31,200 24,800 Distribution costs (14,700) (6,600) (4,600) Administrative expenses (18,500) (7,800) (6,200) Finance costs (800) - - Profit before tax 38,000 16,800 14,000 Income tax expense (9,500) (4,200) (3,500) PROFIT FOR THE YEAR 28,500 12,600 10,500 Other comprehensive income: Gains on property revaluation 5,000 1,800 1,200 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 33,500 14,400 11,700 The following information is relevant: (i) (ii) (iii) (iv) (v) (vi) At the date of acquisition, the fair values of S's assets were equal to their carrying amounts with the exception of the following: Equipment (remaining useful life of 5 years) which had a fair value of GHS22,400,000 and a carrying value of GHS20,000,000. Depreciation on equipment is included in cost of sales. Inventories which had a fair value of GHS800,000 more than their carrying amount. The inventories were sold shortly after the acquisition. In addition, S was the defendant in a court case. It was estimated that the fair value of the potential liability at 1 May 20X4 was GHS500,000. The case was eventually settled out of court for GHS800,000 in December 20X4. S sold raw materials to P throughout the year ended 31 December 20X4 for GHS1m per month. S made a profit margin of 20% on the sales. GHS2m (at transfer price) of the raw materials supplied in the post-acquisition period by S remained in P's inventories at 31 December 20X4. P sold inventories to A during the final quarter of the year for GHS1,200,000. These were sold at a mark-up on cost of 20%. Half of these goods were still in A's inventories at the year end. At 31 December 20X4, P's trade payables included a balance of GHS1,000,000 owed to S. This agreed with the corresponding trade receivable in S's books. P elected to measure the non-controlling interests in S at fair value. S's share price at the date of acquisition can be deemed to be representative of the fair value of the shares held by the noncontrolling interest shareholders. All items of income and expense in the above statements of profit or loss and other comprehensive income are deemed to accrue evenly over the year unless otherwise stated. There has been no impairment of consolidated goodwill. Required (a) Prepare the consolidated statement of financial position for P as at 31 December 20X4. (15 marks) (b) Calculate the figures for consolidated revenue and investment in associate from the consolidated statement of profit or loss and other comprehensive income for P for the year ended 31 December 20X4. (2 marks)
6 Final Mock Exam 1: Questions (c) P is considering acquiring 60% of the ordinary shares in an entity over which they will have joint control. Explain how such an acquisition will be accounted for in the consolidated statement of financial position. (3 marks) (Total = 20 marks) Question 5 C C makes furniture and sells to various wholesalers and retailers. It has recently subscribed to an inter-firm comparison service. Members submit their own accounting ratios as specified by the operator of the service, and in return, receive the average figures for each of the specified ratios taken from all of the companies in the same sector that subscribe to the service. The specified ratios and the average figures for C's sector are shown below. Ratios of companies reporting a full year's results for periods ending between 1 July 20X4 and 31 December 20X4 Return on capital employed 22.1% Net asset turnover 1.8 times Gross profit margin 30% Net profit (before tax) margin 12.5% Current ratio 1.6:1 Quick ratio 0.9:1 Inventory holding period 46 days Trade receivables collection period 45 days Trade payables payment period 55 days Debt to equity 40% C's financial statements for the year to 31 December 20X4 are set out below: STATEMENT OF PROFIT OR LOSS GHS'000 Revenue 2,425 Cost of sales (1,870) Gross profit 555 Operating expenses (Note 1) (335) Interest payable (34) Profit before tax 186 Income tax expense (90) PROFIT FOR THE YEAR 96 EXTRACT FROM STATEMENT OF CHANGES IN EQUITY GHS'000 Income surplus 1 January 20X4 179 Profit for the year 96 Dividends paid (interim GHS60,000; final GHS30,000) (90) Income surplus 31 December 20X4 185 STATEMENT OF FINANCIAL POSITION GHS'000 Property, plant and equipment (Note (2)) 540 Current assets Inventories 275 Trade receivables 320 Bank Nil 595 1,135
Final Mock Exam 1: Questions 7 Equity and liabilities Equity Stated capital (600,000 shares) 150 Income Surplus 185 335 Non-current liabilities 8% loan notes 300 Current liabilities Bank overdraft 65 Trade payables 350 Tax 85 500 1,135 Notes (1) Operating expenses include GHS120,000 for the write off of obsolete inventory. (2) The details of property, plant and equipment are: Accumulated Carrying Cost depreciation value GHS'000 GHS'000 GHS'000 At 30 December 20X4 3,600 3,060 540 (3) The market price of C's shares throughout the year averaged GHS6.00 each. Required (a) The IASB's Conceptual Framework for Financial Reporting (the 'IASB Conceptual Framework') outlines the qualitative characteristics that useful financial information should possess. One such characteristic is faithful representation. Identify and explain the factors that contribute to the faithful representation of financial information. (5 marks) (b) (c) Calculate the ratios for C equivalent to those provided by the inter-firm comparison service. (5 marks) Analyse the financial performance of C in terms of profitability, short term solvency and liquidity and long term solvency and stability by comparing C with the sector averages. (10 marks) (Total = 20 marks)
8 Final Mock Exam 1: Questions
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