SUGGESTED ANSWERS AND EXAMINER S COMMENTARY Final exam Diploma in IFRSs 15 July 2013 The suggested answers set out below were used to mark this question. Markers were encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. In some questions, more marks were available than could be awarded for each requirement. This allowed credit to be given for a variety of valid points or alternative calculations (based on valid assumptions) which were made by candidates. Question 1 Total Marks: 40 Examiner comments This question was well answered overall. The deferred tax and the gain on the loan restructuring were the areas that were not so well answered. Some candidates followed an approach to the deferred tax of taking the deferred tax liability b/d and calculating the changes, rather than the approach in the suggested solution. This generated the same answer for the provision and loan, but normally resulted in an incorrect figure for the deferred tax on the property, plant and equipment and licence which had deferred tax brought down associated with them. The deferred tax on the revaluation was sometimes omitted. Many candidates correctly calculated the revised loan value, but few arrived at the correct figure for the resulting gain. A number of candidates proved the loan figure in the trial balance in the question, by working forwards from the date the original loan was advanced, which was not necessary. The losses carried back represented a current tax asset. Some candidates incorrectly treated these as a deferred tax asset or as a reduction in the deferred tax liability. The cash flow part of the question was generally very well done. Full credit was given for following through the relevant effects of the candidates' figures from part (a). (a) Centra Statement of financial position as at 30 June 2013 ASSETS Non-current assets Property, plant and equipment (178,400 + (W6) 6,000) 184,400 Intangible assets - licence (4,000 (W4) 4,000) (shown for clarity) 0 184,400 Current assets Inventories (54,200 (W5) 2,200) 52,000 Current tax asset (W7) 4,800 Trade and other receivables 75,600 Cash and cash equivalents 3,400 135,800 320,200 EQUITY AND LIABILITIES Equity Share capital 40,000 Share premium 46,500 Retained earnings (W9) 74,269 Other components of equity (15,000 + (W6) 6,000 (W8) 1,500) 19,500 180,269 Non-current liabilities Long-term borrowings (36,532 (W2) 2,111) 34,421 Deferred tax liability (W8) 12,630 47,051 Current liabilities Trade and other payables 88,200 Provision for redundancy costs (W3) 4,680 92,880 320,200 Copyright ICAEW 2013. All rights reserved Page 1 of 11
Statement of profit or loss and other comprehensive income for the year ended 30 June 2013 Revenue 561,700 Cost of sales (W1) (410,400) Gross profit 151,300 Distribution costs and administrative expenses (W1) (171,780) Finance income (W2) 3,236 Finance costs (W2) (1,125) Loss before tax (18,369) Income tax expenses ((W7) 4,800 (W8) 230) 4,570 LOSS FOR THE YEAR (13,799) Other comprehensive income Items that will not be reclassified to profit or loss Gains on property revaluation (W6) 6,000 Income tax relating to items that will not be reclassified (W8) (1,500) Other comprehensive income, net of tax 4,500 TOTAL COMPREHENSIVE INCOME FOR THE YEAR (9,299) (b) Centra Statement of cash flows for the year ended 30 June 2013 Cash flows from operating activities Loss before taxation (18,369) Adjustments for: Depreciation 12,000 Provision (W3) 4,680 Impairment of licence (W4) 4,000 Finance income (per SPLOCI) (W2) (3,236) Interest expense (per SPLOCI) (W2) 1,125 200 Increase in trade receivables (75,600 70,300) (5,300) Decrease in inventories (52,000 per SOFP 54,000) 2,000 Increase in trade payables (88,200 84,800) 3,400 Cash generated from operations 300 Interest paid Income taxes paid (400) Net cash used in operating activities (100) Workings 1 Expenses Cost of sales Distrib costs and admin expenses Per question 404,200 167,100 Provision for redundancies (W3) 4,680 Impairment of licence (W4) 4,000 Impairment of inventories (W5) 2,200 410,400 171,780 Copyright ICAEW 2013. All rights reserved Page 2 of 11
2 Loan restructuring Carrying amount of old loan per question at 1/7/2012 (36,532 10,000) 26,532 Interest accrued at 4.24% to 30 June 2013 1,125 27,657 Additional cash advanced 10,000 Total owed to bank as at 30 June 2013 37,657 Renegotiated loan payments at amortised cost (see below) (34,421) Gain 3,236 Renegotiated loan at 30 June 2013: 6 instalments discounted at 6% (7,000 x 4.9173) 34,421 DR Finance costs 1,125 DR Loan 2,111 CR Profit or loss (Finance income) 3,236 3 Provision A provision cannot be made for the retraining costs as they benefit the ongoing activities of the entity. (IAS 37 paragraph 81). DR Administrative expenses (P/L) (4,600 + 80) 4,680 CR Provision for redundancy costs 4,680 4 Licence The licence has a zero recoverable amount at 30 June 2013 and should be written off. DR Profit or loss 4,000 CR Licence 4,000 5 Inventories Cost 2,200 Net realisable value 0 Loss 2,200 DR Cost of sales 2,200 CR Inventories 2,200 The cost of disposal and re-use will be accounted for when it is incurred. A net realisable value cannot be negative. 6 Revaluation DR Property, plant and equipment (116,000 110,000) 6,000 CR Other comprehensive income 6,000 7 Current tax Current tax credit: DR Current tax asset (19,200 x 25%) 4,800 CR Income tax (P/L) 4,800 Copyright ICAEW 2013. All rights reserved Page 3 of 11
8 Deferred tax Deferred tax liability: Accounting Tax Temporary carrying base difference amount Property, plant and equipment 184,400 125,400 59,000 Provision for redundancy costs (W3) (4,680) 0 (4,680) Licence (W4)/(4,000 (4,000 x 3/5)) 0 1,600 (1,600) Inventories (W5) 52,000 54,200 (2,200) 50,520 Deferred tax liability 25% Calculation of deferred tax in profit or loss: 12,630 Net deferred tax liability b/d 10,900 Charge to other comprehensive income ((W6) 6,000 25%) 1,500 Charge to profit or loss (balancing figure) 230 Net deferred tax liability c/d (from above) 12,630 9 Retained earnings (proof) Per draft SOFP 78,468 Loss per draft SPLOCI 9,600 Loss per revised SPLOCI (13,799) Closing balance per SOFP 74,269 Maximum for the question 41 40 40 Copyright ICAEW 2013. All rights reserved Page 4 of 11
Question 2 Total Marks: 24 Examiner comments In part (1) few candidates identified that a control relationship was the issue here. Answers were often at a very basic level stating that the 40% holding represented significant influence and how the investment should therefore be accounted for. Analysis was lacking from many answers. Part (2) was generally very well done, although the effect of the increase in value of the patent was sometimes not dealt with correctly. In part (3) a number of candidates covered the accounting treatment in the separate, rather than consolidated, financial statements, which was not asked for and earned no marks. The treatment of the transaction costs caused problems for some candidates. (1) The key issue here is whether Twenkin has significant influence or control over Biorka and therefore whether the investment should be accounted for as an associate or as a subsidiary. A subsidiary is defined by IFRS 10 Consolidated Financial Statements as 'an entity that is controlled by another entity'. An investor controls an investee when 'the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.' Through its shareholding in Biorka, it is clear that Twenkin is exposed to variable returns dependent on the performance of Biorka. The key question is whether Biorka has the power to affect those returns, rather than just influence decisions. At the acquisition date and at the year end, Twenkin can only vote with 40% of the ordinary shares. If it were to exercise its option it would be able to vote with 60% of the ordinary shares and practise control, however it cannot do that at the year end. IFRS 10 paragraph 12 states that 'An investor with the current ability to direct the relevant activities has power even if its rights have yet to be exercised'. IFRS 10 paragraph B47 also requires an investor to consider potential voting rights in considering whether it has control and (paragraph B22) whether they are substantive, ie whether the holder has the practical ability to exercise the right. Based on the information provided, the options appear to be 'in the money' as Biorka has been making profits since acquisition, and a 5% premium per share over price paid for the 40% shareholding price per share does not seem unreasonable as a premium for obtaining control given the company's performance. Consequently, Twenkin does have a 'current' ability to direct the activities of Biorka: it only requires the options to be exercised to do so. Consequently, Biorka should be accounted for as a subsidiary in the consolidated financial statements. Goodwill will be calculated at 1 October 2012. Income and expenses will be consolidated for the 6 months to 31 March 2013. Assets and liabilities will be consolidated at 31 March 2013. A 60% non-controlling interest will be shown. 10 8 Copyright ICAEW 2013. All rights reserved Page 5 of 11
(2) The contingent consideration was recognised in the financial statements for the year ended 31 March 2012 as a liability at its fair value of $4.2 million. At 31 March 2013, it must be remeasured to its fair value of $3.7 million on that date. As the change relates to events that arose after the date of acquisition the change is recognised in profit or loss: DR Liability for contingent consideration 0.5 CR Profit or loss 0.5 Goodwill was initially calculated for the 31 March 2012 financial statements as follows: Consideration transferred (103.8 + 4.2) 108 Non-controlling interests (120 x 20%) 24 Less: fair value of identifiable net assets (120) 12 As the valuation of the patents was received during the 'measurement period' (within one year of the acquisition date), the value of the patent can be remeasured with a corresponding adjustment to goodwill as follows: DR Patent intangible assets 2 CR Goodwill (2 x 80%) 1.6 CR Non-controlling interests (2 x 20%) 0.4 Goodwill becomes $12 million $1.6 million = $10.4 million. Additional amortisation for the year ended 31 March 2013 on consolidation is therefore $2 million/10 years, i.e. $0.2 million: DR Consolidated profit or loss 0.2 CR Patent intangible assets 0.2 The non-controlling interest effect of this is 20% ($0.04 million): DR Non-controlling interests (SOFP) 0.04 CR Non-controlling interests (P/L) 0.04 10½ 10 Copyright ICAEW 2013. All rights reserved Page 6 of 11
(3) The treatment of transaction costs is different in the financial statements of the parent and the consolidated financial statements. In the consolidated financial statements all transaction costs are charged to profit or loss. This requires an adjustment as follows: DR Profit or loss 0.42 CR Cost of investment in subsidiary 0.42 Goodwill on consolidation is calculated as follows: Consideration transferred (85.02 0.42) 84.6 Non-controlling interests 0 Less: fair value of identifiable net assets (84.9) (0.3) As the result is negative, Twenkin is required to reassess each of the figures in the goodwill calculation to ensure all available information as of the acquisition date is reflected. Missing liabilities, particularly contingent ones not recognised in the investee's own financial statements can cause negative figures to arise before correction. Assuming the figures are correct, the negative figure is treated as a bargain purchase and credited directly to profit or loss, attributable to the parent. Maximum for the question 6 6 24 Copyright ICAEW 2013. All rights reserved Page 7 of 11
Question 3 Total Marks: 18 Examiner comments Answers to part (a) were very good. A minority of candidates summarised the IFRS 2 requirements rather than explaining why an expense is recognised. Part (b) asked candidates to discuss the accounting treatment. Answers consisting solely of calculations did not therefore earn full marks. The calculations in part (b)(i) were generally well done. Answers to part (b)(ii) were more mixed. The calculation of the number of options was sometimes done incorrectly. A minority of candidates performed a diluted earnings per share calculation rather than recognising that the situation was equity-settled share-based payment. (a) Share options issued to employees are issued in return for services. The consumption of those services meets the Conceptual Framework definition of an expense and should be recognised in the financial statements. Similarly, where assets are acquired by way of share-based payment, these assets need to be recorded in the financial statements as they meet the definition of an asset. Recognising an expense for share-based payment makes financial statements more comparable between companies that remunerate their staff only by salaries and those that remunerate their staff with salaries and share-based payment. Omission of share-based payment expenses can cause economic distortions and corporate governance concerns. 5 4 (b)(i) The directors' scheme The directors' scheme is an equity-settled share-based payment scheme with a grant date of 1 July 2009. The fair value of the share options at the grant is spread over the 5 year vesting period to 30 June 2014, based on the expected options that will vest at 30 June 2014. At 1 July 2012 (the beginning of the current accounting period) the equity brought forward in respect of the scheme is: 300,000 share options x $8.30 x 3/5 = $1,494,000. The share options are re-priced on 30 June 2012, which, despite the fall in price of the original share options, creates a new benefit to the directors which must be accounted for over the remaining vesting period in addition to the fair value of the original option. The vesting period is of the original issue is not revised when there is a variation in terms. The original options therefore continue to be recognised over the remainder of the original vesting period. (IFRS 2 para B43(a)). The additional benefit is calculated as: $ Fair value of modified equity instrument at 30 June 2012 7.20 Fair value of original equity instrument at 30 June 2012 (1.20) 6.00 Copyright ICAEW 2013. All rights reserved Page 8 of 11
The charge for the year ended 30 June 2013 is thus calculated as follows: $ Equity b/d (from above) 1,494,000 Profit or loss charge (balancing figure) 1,398,000 Equity c/d at 30 June 2013 ((300,000 x $8.30 x 4/5) + (300,000 x $6.00 x 1/2)) 2,892,000 $ DR Profit or loss 1,398,000 CR Equity 1,398,000 8 8 (b)(ii) The employees' share ownership programme This is equity-settled, share-based payment because the employees can buy shares at what is expected to be less than market price. The expected benefit to the employee needs to be spread over the 3 year vesting period. In the year ended 30 June 2013, the following amount will be charged to profit or loss and recognised in equity: (2,000 30 50) x ($3,600/$25) options x $3.90 x 1/3 = $359,424 The double entry is: $ DR Profit or loss 359,424 CR Equity 359,424 A liability will need to be shown for the 30 employees who have left the company for any amounts not refunded. Maximum for the question 6 6 18 Copyright ICAEW 2013. All rights reserved Page 9 of 11
Question 4 Total Marks: 18 Examiner comments Part (a) was answered very well. Indeed it was the best answered part of a question on the paper. A minority of candidates did not give the practical examples asked for however. Answers to part (b) were mixed. Many candidates correctly calculated the fair value less costs to sell of the herd at the end of the period. The deferred tax part was not very well answered, with a number of candidates calculating the deferred tax as simply the fair value less costs to sell multiplied by the tax rate rather than fair value less costs to sell minus the tax base multiplied by the tax rate. (a) Biological assets are measured at fair value less costs to sell unless the fair value cannot be measured reliably. IFRS 13 relates to the determination of fair value for a biological asset. Fair value is 'the price that would be received to sell an asset in orderly transaction between market participants at the measurement date'. Fair value is determined by reference to the principal market for the asset and, given that biological assets are non-financial assets, a price for the asset in its highest and best use. IFRS 13 classifies inputs into a 3 level fair value hierarchy based on their reliability and subjectivity: Level 1 inputs Unadjusted quoted prices in active markets. An example would be a quoted price for 2 year old cattle Level 2 inputs Observable inputs other than quoted prices included within Level 1 that are observable, either directly or indirectly. An example would be a quoted price for similar cattle in another market. Adjustment would need to be made for the location of the other market. Level 3 inputs Unobservable inputs where there is little, if any, market activity for the asset at the measurement date. An example would be using discounted cash flow techniques to determine the value of trees used for making paper. 9 8 Copyright ICAEW 2013. All rights reserved Page 10 of 11
(b) Carrying amount at 31 December 2012 4 year olds (1,400 100 = 1,300 $900) 1,170 3 year olds (purchased when 2 years old: 150 $940) 141 Calves (200 100 = 100 $320) 32 1,343 Deferred tax Accounting Tax Temporary carrying amount base difference 31 December 2012 (Tax base: (1,300 $840) + 0 + (150 $1,000)) 1,343 1,242 101 Deferred tax liability 25% 25 31 December 2011 (1,400 $840) 1,260 1,176 84 Deferred tax liability 25% 21 Calculation of deferred tax profit or loss charge: Deferred tax liability at 1 January 2012 21 Charge to profit or loss (balancing figure) 4 Deferred tax liability at 31 December 2012 25 Maximum for the question 10 10 18 Copyright ICAEW 2013. All rights reserved Page 11 of 11