FINANCIAL ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2013 NOTES: You are required to answer Question 1. You are also required to answer any three out of Questions 2 to 5. (If you provide answers to all of Questions 2 to 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first three answers to hand for Questions 2 to 5 will be marked.) Note: Students have optional use of the Extended Trial Balance, which if used, must be included in the answer booklet. Provided are pro-forma: a) Statement of Comprehensive Income By Nature, Statement of Comprehensive Income By Function, and Statement of Financial Position. IAS 1 Presentation of Financial Statements permits the use of these for annual periods commencing prior to, or on, 30 June 2012. AND b) Statements of Profit or Loss and Other Comprehensive Income By Expense, Statements of Profit or Loss and Other Comprehensive Income By Function, and Statements of Financial Position. These incorporate the June 2011 amendments to IAS 1 and are effective for annual periods commencing on, or after, 1 July 2012. You may opt to answer questions to which these are relevant using either a) the formats permissible up to 30 June 2012 or b) those that are effective for annual periods commencing on, or after, 1 July 2012. TIME ALLOWED: 3.5 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded to pay particular attention to your communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of your answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.
THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND FINANCIAL ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2013 Time allowed: 3.5 hours plus 10 minutes to read the paper. Answer Question 1 and three of the remaining four questions. Note: Students have optional use of the Extended Trial Balance, which if used, must be included in the answer booklet. 1. (a) (b) Outline the main stages of the standard setting process by the International Accounting Standards Board (IASB) in relation to International Financial Reporting Standards (IFRS). (10 Marks) The following trial balance was extracted from the books of Dulemn Limited, a company involved in the construction industry as at 31 December 2012: Debit Credit Bank 20,000 Retained Earnings at 31.12.2011 87,100 Land 300,000 Revenue 940,640 Buildings Accumulated Depreciation at 31.12.2011 160,000 Stationery 1,650 Share Capital 200,000 shares at 1 each 200,000 Buildings 400,000 Revaluation Reserve 14,000 Trade Receivables/Trade Payables 80,000 56,000 Debentures 160,000 Repairs 4,000 Advertising 26,400 Purchases 634,200 Sales Returns/Purchases Returns 2,600 1,900 Opening Inventory at 01.01.2012 83,000 Light & Heat 16,400 Motor Expenses 2,650 Long-Term Bank Loan 126,500 Rent 17,000 Telephone 3,670 Insurance 18,000 Wages 136,570 Vehicles Accumulated Depreciation at 31.12.2011 25,000 Vehicles 75,000 Allowance for Bad Debts 4,000 Other Reserves 6,000 1,801,140 1,801,140 The following additional information, based on your investigations, has also come to your attention: (i) Dulemn Limited s year-end inventory amounted to 91,000 valued at cost. This amount includes 4,800 of slow moving inventories. The review of the sale of inventory after the year-end revealed that this slow moving inventory was sold on 6 January 2013 at 65% of the original cost price. (ii) Included in Revenue is 7,000 from the sale of a vehicle which was purchased in 2010 for 20,000. Page1
(iii) Depreciation is to be charged as follows: Buildings Motor Vehicles 2% Straight Line on Cost 25% Straight Line on Cost Depreciation is charged in full in year of purchase and none in year of sale. Depreciation for 2012 has not been included in the above trial balance (iv) (v) (vi) (vii) (viii) Land and buildings were revalued at 31 December 2012 to 250,000 and 200,000 respectively. All of the relevant expenses in the trial balance are split 50:50 between Administrative Expenses and Distribution Costs. At the year-end, Dulemn Limited owed its workforce of fourteen people a week s wages of 600 each for work completed. A dividend of 5 cent per share was paid by cheque on 30 December 2012. This transaction has not been recorded in the above trial balance. The Corporation tax bill for the 2012 year is estimated at 16,200 and this has not been provided for in the above trial balance. (ix) The Rent amount in the above trial balance covers 16 months from 1 January 2012. (x) (xi) Dulemn Limited issued 60,000 shares and lodged 90,000 from the proceeds of the share issue to the bank account on 31 December 2012. This transaction is not reflected in the above trial balance. The allowance for Bad Debts should be changed to 6% of Trade Receivables. REQUIREMENT: Prepare, in a form suitable for publication, a Statement of Profit or Loss and Other Comprehensive Income and Statement of Financial Position for Dulemn Limited for the financial year-ending 31 December 2012. Note: All workings should be shown. Where appropriate, adjustments should be in the form of a double entry or journal (there is no need for a narrative). (30 Marks) [Total: 40 Marks] Page 2
2. Kirany Limited issued 100,000 1.00 shares at 1.40 per share. Monies due were as follows: On Application 0.80 including premium On Allotment 0.40 Call 0.20 Applications were received for 130,000 shares with the excess applications returned on application. At the call stage, 1,500 shares were forfeited. These were subsequently reissued for 1.10 cash. REQUIREMENT: (a) Write up the relevant ledger (T) accounts for the above issue of shares. (15 Marks) (b) Explain what TWO of the following terms mean in relation to the issue of shares. (i) Application (ii) Allotment (iii) Call (iv) Forfeiture (5 Marks) [Total: 20 Marks] 3. Michael King, a client who owns hardware shops, has asked you for advice in relation to IAS 37, Provisions: Contingent Liabilities and Contingent Assets. REQUIREMENT: Michael has asked you to prepare a report which addresses the following: (a) (b) Explain the recognition criteria for recognising a Provision in accordance with IAS 37, Provisions: Contingent Liabilities and Contingent Assets. (3 Marks) In relation to obligations, define (i) A Legal Obligation; and (ii) A Constructive Obligation. (4 Marks) (c) Explain how a Provision is measured. (3 Marks) (d) Michael has a policy of refunding purchases to dissatisfied customers even though he is under no legal obligation to do so. His policy of issuing refunds is generally well known, as he always reinforces the point in any advertising he does and normally 4% of goods are returned. REQUIREMENT: Explain, in relation to this refund policy, whether a recognition of a provision is necessary. (5 Marks) (e) Michael sells washing machines under a warranty whereby the costs of repairs for any manufacturing defects discovered within six months of sale are covered. If minor defects are detected in all washing machines sold, then repair costs of 200,000 would be incurred. If there are major defects detected in all washing machines sold, then repair costs of 500,000 would be incurred. His experience and future expectations indicate that in the next six months, 85% of washing machines will have no defects, 10% will have minor defects and 5% will have major defects. REQUIREMENT: Discuss whether a provision should be recognised in relation to washing machines and calculate the amount, if any, of the provision. (5 Marks) [Total: 20 Marks] Page 3
4. Mr. Martin Neville is a retailer in Tralee with a branch in Killarney. The following trial balances have been extracted from his books as at 31 December 2012. Tralee Killarney Dr. Cr. Dr. Cr. 000 000 000 000 Accumulated Depreciation 125 50 Administration Expenses 60 30 Bank 125 76 Capital 1,343 Current Accounts 500 378 Distribution Expenses 120 26 Drawings 45 Inventory 40 24 Inventory sent to branch 822 780 Non-Current Assets 1,000 260 Allowance for doubtful debts 6 2 Provision for unrealised profit 4 Purchases/Sales 2,400 2,000 926 Receivables/Payables 200 190 160 4,490 4,490 1,356 1,356 Additional Information: 1) At 31 December 2012, there was 80,000 cash in transit from Killarney to Tralee. 2) Goods invoiced at 42,000 were in transit from Tralee to Killarney. 3) All goods are purchased by Tralee. Good sent to Killarney are invoiced at cost plus 20%. 4) Closing inventory was valued at 31 December 2012 at cost of 48,000 in Tralee and at invoice price of 30,000 in Killarney. 5) The allowance for Doubtful Debts is to be maintained at a rate of 2%. 6) Depreciation is to be provided for the year on non-current assets at the rate of 15% straight line. REQUIREMENT: Prepare: (a) In adjacent columns the Statement of Profit or Loss for the year ended 31 December 2012 for Mr. Neville for: (i) (ii) The Tralee Shop; The Killarney Shop; and (iii) The combined entity. (12 Marks) (b) A combined Statement of Financial Position for Mr. Neville as at 31 December 2012. (8 Marks) [Total: 20 Marks] Page 4
5. REQUIREMENT: (a) Explain the importance of ratios to parties inside and outside a company. (5 Marks) (b) VentureC limited is considering possible investment in only one of the following companies: Mido Limited or Kyera Limited. Extracts from the financial statements of both companies are on page 6. The managing director of VentureC Limited has asked you to prepare a report for him in which you calculate the following ratios, (i) to (v) below, and provide an overall assessment and recommendation as regards which company VentureC Limited should invest in. (i) the Net Profit % (ii) the Current Ratio (iii) the Debt to Equity Ratio (iv) Trade Receivable Days (v) Interest Cover Your assessment may include other relevant ratios and commentry thereon. (14 Marks) Format & Presentation (1 Mark) Note: Equal marks will go for the analysis as well as the calculation of the above ratios. [Total: 20 Marks] (Question 5 continued on page opposite) Page 5
(Question 5 continued) Statement of Profit or Loss for Year Ended 31st December 2012 Mido Limited Kyera Limited 2012 2012 000 000 Sales 20,000 18,000 Cost of Sales (12,000) (12,000) Gross Profit 8,000 6,000 Administrative Expenses (1,600) (1,200) Finance Costs (2,000) (800) Profit before Tax 4,400 4,000 Income Tax Expense (600) (500) PROFIT FOR THE YEAR 3,800 3,500 Statement of Financial Position as at 31st December 2012 Mido Limited Kyera Limited 2012 2012 Non-Current Assets 000 000 Property, Plant & Equipment 30,000 15,000 Total Non-Current Assets 30,000 15,000 Current Assets Inventory 2,000 300 Trade Receivables 1,400 300 Cash & Cash Equivalents 600 900 Total Current Assets 4,000 1,500 Total Assets 34,000 16,500 Equity & Liabilities Equity Share Capital 4,000 3,000 Retained Earnings 7,600 4,300 Total Equity 11,600 7,300 Non-Current Liabilities LoaN 20,000 7,200 Total Non-Current Liabilities 20,000 7,200 Current Liabilities Trade Payables 1,600 1,300 Taxation 600 500 Accrued Expenses 200 200 Total Current Liabilities 2,400 2,000 Total Equity & Liabilities 34,000 16,500 END OF PAPER Page 6
SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND FINANCIAL ACCOUNTING FORMATION 2 EXAMINATION - AUGUST 2013 SOLUTION 1 a) The Standard Setting Process International Financial Reporting Standards (IFRSs) are developed through an international consultation process, the "due process", which involves interested individuals and organisations from around the world. The due process comprises six stages, with the Trustees of the IFRS Foundation having the opportunity to ensure compliance at various points throughout: 1. Setting the agenda 2. Planning the project 3. Developing and publishing the discussion paper 4. Developing and publishing the exposure draft 5. Developing and publishing the standard 6. After the standard is issued 1. Setting the agenda The International Accounting Standards Board (IASB) seeks to address a demand for better quality information that is of value to those users of financial reports. When deciding whether an item will address users needs the IASB considers: The relevance to users of the information and the reliability of information that could be provided, Existing guidance available, The possibility of increasing convergence, The quality of the IFRS to be developed, Resource constraints. To help the IASB in considering its future agenda, its staff is asked to identify, review and raise issues that might warrant the IASB s attention as well as receiving comments from other standard setters and various interested parties. New issues may also arise from a change in the IASB s Conceptual Framework for Financial Reporting. 2. Planning the project When considering whether to add an item to its active agenda, the IASB assesses the issue against criteria such as Clarifying, Correcting, Well defined and sufficiently narrow in scope that the consequences of the proposed change have been considered, Completed on a timely basis, All criteria must be met to qualify for inclusion. After considering the nature of the issues and the level of interest among constituents, the IASB may establish a working group at this stage and a project team for the project will be selected. 3. Developing and publishing the discussion paper A discussion paper is not a mandatory step in the IASB s due process. If the IASB decides to omit this step, it will state its reasons. The discussion paper acts as a vehicle to explain an issue and solicit early comment from interested parties. Page 7
Typically, a discussion paper includes a comprehensive overview of the issue, possible approaches in addressing the issue, the preliminary views of its authors or the IASB, and an invitation to comment. The IASB develops the paper and all discussions of technical issues related to the draft paper take place in public sessions. When the draft is completed and the IASB has approved it for publication the discussion paper is published to invite public comment which the IASB normally allows for a period of 120 days but can be longer. After the comment period has ended the project team analyses and summarises the comment letters for the IASB s consideration. If the IASB decides to explore the issues further, it may seek additional comment and suggestions by conducting field visits, or by arranging public hearings and round-table meetings. 4. Developing and publishing the exposure draft Publication of an exposure draft is a mandatory step. An exposure draft is the IASB s main vehicle for consulting the public. Unlike a discussion paper, an exposure draft sets out a specific proposal in the form of a proposed IFRS (or amendment to an IFRS). After resolving issues at its meetings, the IASB instructs the staff to draft the exposure draft. When the draft has been completed, and the IASB has balloted on it, with a minimum of nine votes necessary to publish an exposure draft, the IASB publishes it for public comment. The draft may also include mandatory application guidance and implementation guidance, and will be accompanied by a basis for conclusions on the proposals and the alternative views of dissenting IASB members (if any). The project team collects, summarises and analyses the comments received for the IASB s deliberation which can solicit further comments and suggestions. 5. Developing and publishing the standard The development of an IFRS is carried out during IASB meetings, when the IASB considers the comments received on the exposure draft. Changes from the exposure draft are posted on the website. After resolving issues arising from the exposure draft, the IASB considers whether it should expose its revised proposals for public comment, for example by publishing a second exposure draft. As it moves towards completing a new IFRS or major amendment to an IFRS, the IASB prepares a project summary and feedback statement to provide feedback to interested parties. At the same time, the IASB prepares an analysis of the likely effects of the forthcoming IFRS or major amendment. When the IASB is satisfied that it has reached a conclusion on the issues arising from the exposure draft, it instructs the staff to draft the IFRS. The IASB members ballot in favour or against publication of the IFRS and if in favour, the IFRS is issued, followed by publication of any project summary and feedback statement and any effect analysis. 6. After the standard is issued After an IFRS is issued, IASB members and staff hold regular meetings with interested parties to help understand unanticipated issues related to the practical implementation and potential impact of its provisions. The IASB carries out a post-implementation review of each new IFRS or major amendment. This is normally carried out two years after the new requirements have become mandatory and been implemented. Such reviews are normally limited to important issues identified as contentious during the development of the pronouncement and consideration of any unexpected costs or implementation problems encountered. The review may lead to items being added to the IASB s agenda. The IASB may also continue informal consultations throughout the implementation of the IFRS or amendment. [Total: 10 Marks] Page 8
(b) Dulemn Limited Statement of Profit or Loss and Other Comprehensive Income for the year-ended 31st December 2012 Revenue W2 931,040 Cost of Sales Total W3 625,980 Gross Profit 305,060 Other Operating Income - Distribution Costs 126,520 Administrative Expenses 126,520 Finance Costs - Loss on Sale of Vehicles W1.ii 3,000 Revaluation Loss on Land & Buildings W4 68,000 324,040 Profit/(Loss) before Tax - 18,980 Income Tax Expense W1.viii - 16,200 PROFIT/(LOSS) FOR THE YEAR - 35,180 Other Comprehensive Income Revaluation Loss on Land & Buildings W1.ii - 14,000 Other Comprehensive Income for the year, net of tax - 14,000 TOTAL COMPREHENSIVE INCOME FOR THE YEAR - 49,180 Dulemn Limited Statement of Financial Position as at 31st December 2012 Non-Current Assets Property, Plant & Equipment W4 476,250 Total Non-Current Assets 476,250 Current Assets Inventories W1.i 89,320 Trade Receivables W1.xi 75,200 Prepayments W1.ix 4,250 Cash & Cash Equivalents W1.vii - 20,000-10,000 90,000 60,000 Total Current Assets 228,770 TOTAL ASSETS 705,020 Equity & Liabilities Equity Share Capital W1.x 200,000 60,000 260,000 Share Premium W1.x 30,000 Retained Earnings W1.vii 87,100-10,000-35,180 41,920 Revaluation Surplus W4 14,000-14,000 - Other Reserves 6,000 Total Equity 337,920 Non-Current Liabilities Debentures 160,000 Long-term Bank Loan 126,500 Total Non-Current Liabilities 286,500 Current Liabilities Trade Payables 56,000 Corporation Tax W1.viii 16,200 Accruals W1.vi 8,400 Total Current Liabilities 80,600 TOTAL EQUITY & LIABILITIES 705,020 TOTAL MARKS 8.00 Page 9
Working - Journal Entries Working - Closing Inventory Total Inventories at Cost per Inventory Count 91,000 Slow Moving Inventories - Cost 4,800 NRV - Selling Price - 65% of Cost - 3,120 Inventory Write Down 1,680 Value of Closing Inventories 89,320 '000 '000 1.i Dr. Inventory + Current Assets SOFP 89,320 Cr. Closing Inventory - Cost of Sales SOCI 89,320 1.ii Dr. Revenue - Revenue SOCI 7,000 Cr. Disposal Account - Vehicles 7,000 Dr. Disposal Account - Vehicles 20,000 Cr. Property, Plant & Equipment (PPE) - Non-Current Assets SOFP 20,000 Dr. Accumulated Depreciation - PPE + Non-Current Assets SOFP 10,000 Cr. Disposal Account - Vehicles 10,000 Dr. Loss on Disposal + Expenses SOCI 3,000 Cr. Disposal Account - Vehicles 3,000 1.vi Dr. Wages + Expenses SOCI 8,400 Cr. Accruals + Current Liabilities SOFP 8,400 1.vii Dr. Retained Earnings - Equity SOFP 10,000 Cr. Bank - Current Asset SOFP 10,000 1.viii Dr. Income Tax + Expenses SOCI 16,200 Cr. Current Tax Payable + Current Liabilities SOFP 16,200 1.ix Dr. Prepayments + Current Assets SOFP 4,250 Cr. Rent + Expenses SOCI 4,250 1.x Dr. Bank + Current Assets SOFP 90,000 Dr. Share Capital + Equity SOFP 60,000 Cr. Share Premium + Equity SOFP 30,000 1.xi Dr. Allowance for Bad Debts + Expenses SOCI 800 Cr. Trade Receivables - Current Assets SOFP 800 Trade Receivables Balance per TB 80,000 - Allowance for Bad Debts - 6% 4,800 Revised Trade Receivable 75,200 Current Allowance for Bad Debts TB 4,000 New Allowance Bad Debts See Above 4,800 Increase in Allowance for Bad Debts 800 Page 10
Working 2 - Revenue Revenue Per TB 940,640 Revenue Returns Per TB - 2,600 Proceeds on Sale of Vehicle W1.ii - 7,000 Revised Revenue 931,040 Cost of Distribution Administration Working 3 - Expenses Sales Costs Expenses Opening Inventory Per TB 83,000 - - Purchases Per TB 634,200 - - Purchase Returns Per TB - 1,900 - - Closing Inventory W1.i - 89,320 - - Stationery Per TB - 825 825 Repairs Per TB - 2,000 2,000 Advertising Per TB - 13,200 13,200 Light & Heat Per TB - 8,200 8,200 Motor Expenses Per TB - 1,325 1,325 Rent Per TB+W1.ix - 6,375 6,375 Telephone Per TB - 1,835 1,835 Insurance Per TB - 9,000 9,000 Wages Per TB+W1.vi - 72,485 72,485 Allowance for Bad Debts W1.xi - 400 400 Depreciation - Buildings W4-4,000 4,000 Depreciation - Equipment W4-6,875 6,875 Total 625,980 126,520 126,520 Working 4 - Property, Plant & Equipment Land Buildings Vehicles Total Cost 300,000 400,000 75,000 775,000 - Accumulated Depreciation b/d - - 160,000-25,000-185,000 Carrying Value b/d at 1st January 2012 300,000 240,000 50,000 590,000 Disposal - Cost Note 1 - - - 20,000-20,000 Disposal - Accumulated Depreciation Note 1 - - 10,000 10,000 Carrying Value 300,000 240,000 40,000 580,000 Depreciation - Buildings - 2% Straight Line - - 8,000 - - 8,000 Depreciation - Vehicles - 25% Straight Line - - - 13,750-13,750 300,000 232,000 26,250 558,250 Revaluation Loss Note 2-50,000-32,000 - - 82,000 Carrying Value c/d at 31st December 2012 250,000 200,000 26,250 476,250 Note 1 - Disposal of Equipment Cost 20,000 Accumulated Depreciation - 25% straight line per annum Depreciation 2010 5,000 Depreciation 2011 5,000 10,000-10,000 Carrying Value of Equipment disposed 10,000 Disposal Account Cost 20,000 Accumulated Depreciation 10,000 Disposal Proceeds 7,000 Loss on Disposal 3,000 20,000 20,000 Note 2 - Revaluation Loss Dr. Revaluation Surplus - Other Comprehensive Income SOCI 14,000 Dr. Expenses - Expenses SOCI 68,000 Cr. Property, Plant & Equipment - Non-Current Assets SOFP 82,000 TOTAL MARKS 22.00 Page 11
Adjustment Statement of Profit or Loss and Statement of Financial Position Other Comprehensive Income Debit Credit Debit Credit Debit Credit Debit Credit Bank 20,000 90,000 10,000 60,000 Retained Earnings at 31.12.2011 87,100 10,000 35,180 41,920 Land 300,000 50,000 250,000 Revenue 940,640 7,000 933,640 Buildings Accumulated Depreciation at 31.12.2011 160,000 8,000 8,000 8,000 168,000 Stationery 1,650 1,650 Share Capital 200,000 shares at 1 each 200,000 60,000 260,000 Buildings 400,000 32,000 368,000 Revaluation Surplus 14,000 14,000 - Trade Receivable/Trade Payable 80,000 56,000 80,000 56,000 Debentures 160,000 160,000 Repairs 4,000 4,000 Advertising 26,400 26,400 Purchases 634,200 634,200 Revenue Return/Purchases Returns 2,600 1,900 2,600 1,900 Inventory 83,000 83,000 89,320 89,320 Light & Heat 16,400 16,400 Motor Expenses 2,650 2,650 Long term Bank Loan 126,500 126,500 Rent 17,000 4,250 12,750 Telephone 3,670 3,670 Insurance 18,000 18,000 Wages 136,570 8,400 144,970 Vehicles Accumulated Depreciation at 31.12.2011 25,000 23,750 13,750 13,750 28,750 Vehicles 75,000 20,000 55,000 Allowance for Bad Debts 4,000 800 800 800 4,800 Other Reserves 6,000 6,000 Share Premium 30,000 30,000 Disposal Account - Vehicles 20,000 17,000 3,000 Accruals 8,400 8,400 Income Tax 16,200 16,200 16,200 16,200 Prepayments 4,250 4,250 Revaluation Loss - Expenses 82,000 14,000 68,000 Revaluation Loss - Other Comprehensive Income 14,000 14,000 1,801,140 1,801,140 284,400 284,400 1,074,040 1,074,040 906,570 906,570 Page 12
SOLUTION 2 Page 13
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SOLUTION 3 REPORT To: Mr. Michael King From: Financial Accountant Re: IAS 37 Provisions: Contingent Liabilities and Contingent Assets Date: September 2013 (a) Per paragraph 14 of IAS 37, a provision shall be recognised when: (a) (b) (c) An entity has a present obligation (legal or constructive) as a result of a past event; It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and A reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognised (3 Marks) (b) i) Per paragraph 10 of IAS 37, a legal obligation is a obligation that derives from (a) A contract (through its explicit or implicit terms); (b) Legislation; or (c) Other operation of law. (3 Marks) ii) Per paragraph 10 of IAS 37, a constructive obligation is a obligation that derives from an entity s actions where: (a) (b) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. (3 Marks) c) Per paragraph 36 and 37 of IAS 37, the amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. The best estimate is the amount that an entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. (3 Marks) d) The obligating event is the sale of the product, which gives rise to a constructive obligation because the conduct of the shops has created a valid expectation on the part of its customers that the store will refund purchases. There is a probable expectation that a proportion of the goods will be returned for refund which will lead to an outflow of resources. The provision should be for 4% of the sales as this is the best estimate that is available in relation to the obligation. ( 4 Marks) e) A present obligation exists at the end of the reporting period based on historical evidence of items being repaired under the guarantee agreement. A large population of items is involved and therefore, a provision is made for the expected value of the outflow: Provision Amount: 80% of Nil + 10% of 200,000 + 5% of 500,000 0 + 20,000 + 25,000 = 45,000 (4 Marks) I hope that the above responses clarify and answer your queries. If you have any further queries, please do not hesitate to contact me. Yours sincerely, Financial Accountant Page 14 [Total: 20 Marks]
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SOLUTION 5 Please note that different variations of ratio formulae will be accepted provided that they are correct. a) Internal parties including management need to assess whether profits have been maximised and capital has been utilised efficiently as well as identifying areas where performance issues occurred. External parties include debt and equity investors as well as financial institutions that have provided funding. Banks and long-term trade payables will be interested in the gearing ratios and interest cover of the company to ensure that interest and capital can be repaid. Shareholders will have a greater interest in dividend cover and earnings per share ratios to see that they are getting a return on their investment and that there is an exit option for them. b) To: Managing Director of VentureC Limited From:Financial Accountant Re: Evaluation of potential purchase of either Mido Limited or Kyera Limited Date: September 2013 (5 Marks) Please find attached the results of a review of certain key ratios of the above companies for the year ended 31st December 2012. Mido Ltd. Kyera Ltd. 2012-000 2012-000 Net Profit Ratio 3,800/20,000 = 19.00% 3,500/18,000 = 19.44% Current Ratio 4,000/2,400 = 1.67:1 1,500/2,000 = 0.75:1 Debt to Equity Ratio 20,000/11,600*100 = 172.41% 7,200/7,300*100 = 98.63% Trade Receivable Days 1,400/20,000*365 = 26 Days 300/18,000*365 = 6 Days Interest Cover 6,400/2,000 = 3.2 Times 4,800/800 = 6 Times Calculation of, Commentary on & Presentation of Results (14 Marks) Net Profit Ratio The net profit ratio for both companies is broadly similar 19% for Mido versus 19.44% for Kyera. Kyera sales are 10% less than Mido Limited and a review of results for prior years would be beneficial before making a definitive decision. Mido s gross profit for 2012 is 40% versus Kyera s 33.33%. Therefore, Mido has a more profitable business on their sales but leaks margin with higher administrative costs 8% versus 6.67% and extra finance costs - 10% versus 4.44% due to their significant borrowings. Current Ratio Mido s current ratio is significantly better than Kyera s i.e. 1.67:1 versus 0.75:1. However, a significant proportion of Mido s current ratio is due to the inventory on hand at the year-end and when this is stripped out, Mido s acid ratio would be 0.83:1 versus Kyera s 0.60:1. Both ratios are under the norm of 2:1. Kyera carry 300,000 more cash than Mido which may be due to delayed payment to trade payables and it appears as if Kyera operate tight credit and inventory control which is a positive. Debt to Equity Ratio Both companies have a high debt to equity ratio with Mido s in particular being at a dangerously high level. Are the high levels due to significant increases in non-current assets which may drive growth in the future this needs to be investigated as well as review of the loan agreements to ensure that both companies can adequately cover repayments. Management at Mido should be asked whether an injection of capital/funds is needed to ensure its survival. Given the amount of debt in each company, it would appear that Mido is making repayments at a lower interest rate than Kyera. Trade Receivable Days Kyera s result is significantly better than Mido but both results are within 30 days which is quite good provided both companies are not in an industry with lower normal receivable days than 30 days. Inquiries should be made to Kyera s management as regards how they manage to keep their trade receivables as low because there may be an opportunity with other companies managed by VentureC limited to capitalise on their approach. Page 17
Interest Cover Kyera s interest cover is nearly twice Mido s level 6 times versus 3.2 times and is at a comfortable level to satisfy banks. Mido s level is at an acceptable level but it would need to be monitored closely for any signs of deterioration given the level of debt the company currently holds. Recommendation The most worrying aspect for both companies is the debt levels they currently hold and before purchase significantly questions need to be asked of management of companies re the sustainability of the debt levels and impact on future growth and profitability. Both companies have strong net profit margins. Mido has slightly better sales and excluding debt repayments has better profit margins and liquidity in its acid test ratio. Kyera appears to have strong working capital management and interest cover. Therefore, provided Kyera liquidity from a short and long term view is adequately managed, I would recommend it over Mido whose debts levels are very significant for VentureC to accept as an investment proposition. I would urge that further due diligence be undertaken on both companies before investment proceeds. I hope that the above responses clarify and answer your queries. If you have any further queries, please do not hesitate to ask. Yours sincerely, Financial Accountant Presentation & Format (1 Mark) [Total: 20 Marks] Page 18
MARKING SCHEME Q1 a) 6 x 1.5 Marks each 9 Presentation 1 b) Workings 22 Statement of Profit or Loss and Other Comprehensive Income + 8 Statement of Financial Position Total Marks Q1 40 Q2 Ledger (T) Accounts 15 Explanation of terms 5 Total Marks Q2 20 Q3 a) Recognition criteria of a Provision 3 x 1 Mark each 3 b) Definition of Legal Obligation 3 x 1 Mark each 3 Definition of Constructive Obligation 3 x 1 Mark each 3 c) Measurement of Provision 3 d) Refund Policy Provision Recognition 2 Points x 2 marks each 4 e) Reason for recognising Provision 2 Calculation of Provision 2 Total Marks Q3 20 Q4 Statement of Profit or Loss 12 Statement of Financial Position 8 Total Marks Q4 20 Q5 a) Inside Parties 2.5 Outside Parties 2.5 b) Calculation and Analysis of Ratios 5 x 2 marks each 10 Recommendation 4 Format & Presentation of Report 1 Total Marks Q5 20 Page 19