CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION - AUGUST 2013 NOTES: You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5. (If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for Question 4 or 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. Please read each Question carefully. 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 CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION AUGUST 2013 Time allowed 3.5 hours, plus 10 minutes to read the paper. You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5. (If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for Question 4 or 5 will be marked.) You are required to answer Questions 1, 2 and 3. 1. The following Statements of Comprehensive Income relate to Rooster plc (Rooster) and its investee companies, Houseton plc (Houseton) and Kelson plc (Kelson). Kelson is based in New Jersey, USA. It produces, sells and is managed autonomously in the USA. Accordingly, its financial statements are presented in dollars. Statements of Profit or Loss and Other Comprehensive Income for year ended 31 July 2013 Rooster plc Houseton plc Kelson plc million million US$ million Revenue 2,640 450 600 Cost of Sales (1,230) (120) (270) Gross profit 1,410 330 330 Operating expenses (270) (120) (180) Finance costs (60) (30) (20) Other income 20 Investment income 40 - - Profit before taxation 1,140 180 130 Taxation (275) (24) (40) Profit for the year 865 156 90 Other comprehensive income: Gains on revaluation of property 290 45 10 Total comprehensive income for the year 1,155 201 100 The following additional information is provided: (i) Rooster purchased a 60% holding in Kelson on 1 August 2012 for an immediate cash payment of US$510 million. On that date, the fair values of the net assets of Kelson totalled US$750 million, which was the same as their carrying values in the books of Kelson. The 40% non-controlling interest had a fair value of US$300 million on 1 August 2012. No impairment of goodwill had occurred by 31 July 2013. (ii) Rooster purchased a 70% holding in the equity of Houseton on 1 December 2012. The purchase price was 650 million paid in cash. Goodwill arising on acquisition was calculated at 140 million using the fair value method. On 31 July 2013, impairment losses against consolidated goodwill amounting to 20 million needed to be recognised. (iii) On 1 December 2012, the fair value of certain plant & equipment held by Houseton was 24 million in excess of its carrying value. This plant & equipment had a useful economic life of 4 years from the date of acquisition. The revised values have not been incorporated into the books of Houseton and depreciation was accounted for based on the carrying values. (iv) During the three months ended 31 July 2013, Houseton sold goods to Rooster for 24 million. These goods were sold at a mark-up on cost of 60%. One third of the goods remained in the inventory of Rooster at 31 July 2013. (v) Houseton declared a dividend of 50 million during the year from post-acquisition profits. Rooster has recognised its share of this dividend within investment income. (vi) The US$ / exchange rate was as follows during the relevant period: Date US$ per 1 1 August 2012 1.35 31 July 2013 1.25 Average for period 1.28 Page 1
REQUIREMENT: (a) Calculate (i) the goodwill arising on the acquisition of Kelson for inclusion in the group accounts at the date of acquisition; and (ii) the goodwill figure to be reported in the group accounts at 31 July 2013. Explain clearly the accounting treatment of any difference between the two figures. (4 marks) Prepare a consolidated Statement of Profit or Loss and Other Comprehensive Income for the Rooster Group for year ended 31 July 2013 in accordance with IFRS. Your answer should show clearly the amount of any exchange gains or losses recognised during the period. (20 marks) Format & Presentation (1 mark) Explain what is meant by the functional currency of an entity? Discuss briefly the guidance offered by IAS 21 to assist in determining an entity s functional currency. (5 marks) [Total: 30 MARKS] Page 2
2. The following trial balance was extracted from the books of Knightsfield plc on 31 May 2013. Note Dr Cr million million Revenue 60.2 Cost of sales 19.2 Distribution costs 6.1 Administration expenses (i) 3 Land and buildings at cost (including land 6 million) (ii) 40 Accumulated depreciation 1 June 2012 land & buildings (ii) 2 Plant and equipment at cost (iii) 65 Accumulated depreciation 1 June 2012 - plant and equipment (iii) 31 Investment property (iv) 32 Equity investments (v) 8.4 Trade receivables 6.9 Inventory at 31 May 2013 6.2 Cash and bank 8.8 Trade payables 4.6 Provision for warranty claim (i) 3 Corporation tax (vi) 0.4 Equity shares of 10c each (viii) 20 Share premium account (viii) 35 Revaluation surplus (ii) 6 Equity investment reserve (v) 1.4 12% Debenture (issued on 1 March 2013) (vii) 20 Retained earnings reserve 1 June 2012 12.8 196.0 196.0 The following notes are relevant to your answer: (i) Knightsfield maintains a provision for warranty claims expected to arise in the future on goods sold. At the reporting date this provision was carried at 3 million. This amount was arrived at following an increase of 1 million recognised during the year, which was taken to administration expenses. The auditors have indicated that they believe this provision overestimated the expected cost of the warranty. Their calculations, accepted by the directors of Knightsfield, suggest the provision should instead be set at 2.4 million. (ii) Land and buildings are carried under the revaluation model, as permitted by IAS 16. The most recent valuation recorded in the books, took place on 31 May 2011 resulting in the values included in the trial balance above. The revaluation surplus of 6 million resulted solely from the land and buildings. The buildings were estimated to have a useful economic life of 17 years. On 1 June 2012, the land was revalued to 5 million. There was no change to the value or useful life estimates of the buildings. All depreciation is recognised in cost of sales, and no depreciation has yet been charged for the year ended 31 May 2013. (iii) Plant & equipment is being depreciated at 20% per annum on a reducing balance basis. On 31 May 2013, a piece of plant which cost 10 million on 1 June 2011 was sold for 5 million. The only entries made to record this transaction were to debit cash and credit sales revenue with 5 million. (iv) Investment properties are accounted for under the fair value model of IAS 40 Investment Property. The figure included in the trial balance above represents the fair value of these properties at 1 June 2012. The fair value of these properties at 31 May 2013 was 29 million. (v) The figure for investments represents the fair value of equities held at 1 June 2012 plus the cost of equities purchased during the year. As permitted by IFRS 9 Financial Instruments, an election was made at the date of purchase to account for any fair value gains and losses on all these equity investments through other comprehensive income. Knightsfield takes such gains and losses to a separate component of equity. The fair value of the equity investments at 31 May 2013 was 9.5 million. (vi) Corporation tax for the year was estimated at 1.3 million. The balance in the trial balance is a residual amount following the payment of corporation tax for year ended 31 May 2012. (vii) The debentures were issued during the year. Interest is payable annually in arrears. No interest has been provided for or paid as at 31 May 2013. (viii) 10 million was raised towards the end of the year through the issue of equity shares. This was correctly accounted for by crediting 4 million to equity share capital and 6 million to share premium. The directors, prior to the reporting date, proposed a final ordinary dividend of 1.2c per share which was subsequently approved by the financial year-end. However, the new shares did not rank for this dividend. As of yet, no account has been made of the proposed dividend. Page 3
REQUIREMENT: Prepare, in a form suitable for publication to the shareholders of Knightsfield plc: (a) a Statement of Profit or Loss and Other Comprehensive Income of Knightsfield plc for the year to 31 May 2013; (12 marks) Format & Presentation (1 mark) a Statement of Changes in Equity for year ended 31 May 2013; (5 marks) a Statement of Financial Position as at 31 May 2013. (11 marks) Format & Presentation (1 mark) [Total: 30 MARKS] 3. The following multiple-choice question contains eight sections, each of which is followed by a choice of answers. Only one of each set of answers is strictly correct. Each question carries equal marks. REQUIREMENT: Record your answer to each section on the answer sheet provided. [Total: 20 MARKS] 1. A company s research & development department incurred the following items of expenditure during the year to 30 June 2013: (i) Wages & salaries 350,000. (ii) New equipment with a 6 year useful economic life 750,000 (bought on 1 July 2012). (iii) Overheads specific to the R&D department 140,000. These are allocated in proportion to the activity of the department. (iv) Materials for laboratory use 420,000. There was a closing inventory of these materials amounting to 60,000. No opening inventory existed. The R&D department is working on several projects. The directors estimate the department s time and resources can be allocated reasonably as follows: Research activities 30%; Development activities (projects not meeting the IAS 38 criteria for capitalisation) 25%; Development activities (projects meeting the IAS 38 criteria for capitalisation) 45%. How much of the above expenditure should be capitalised under IAS 38 to intangible assets (development costs) in the year ended 30 June 2013? (a) 438,750 465,750 720,000 (d) 747,000. 2. Pat plc has owned 70% of the issued share capital of Joe Ltd for several years. Joe Ltd s profit for the year ended 30 June 2013 was 42m. During that year, Joe Ltd sold goods to Pat plc for 18m at cost plus 25%. At the end of the year 40% of these goods are still held by Pat plc. What will be the amount of profit for the year attributable to the non-controlling interest in Joe Ltd for the year ended 30 June 2013? (a) 10,440,000 12,060,000 12,168,000 (d) 12,600,000. Page 4
3. Under the IASB s revised conceptual framework, issued in 2010, which of the following best describes the primary objective of general-purpose financial statements? (a) (d) Report on the performance of the entity Provide information to assist economic decision makers allocate resources Assist in the calculation of tax liability Help predict future performance. 4. Flyrest plc disclosed the following ratios in a presentation to potential investors: Gross margin 2012 55% Gross margin 2011 40% Which of the following statements must be true if the above information is correct? (a) Gross profit was higher in 2012 than in 2011 Sales prices increased in 2012 over 2011 Both (a) and above (d) None of the above. 5. Phantom plc purchased a 10% 30 million bond on 1 July 2012 at a 10% premium to par value. Expenses of purchase were 500,000. The bond is due for redemption on 30 June 2027 at par. The effective annual interest rate to maturity can be assumed to be 8.6%. How much should be recognised as finance income in the statement of profit or loss and other comprehensive income for year ended 30 June 2013? (a) 3,000,000 2,881,000 2,795,000 (d) 2,338,000. 6. The following events occurred after the reporting date but prior to the date the directors signed the annual report: (i) A flood took place in one of the company s premises, causing 100,000 worth of irrecoverable damage. (ii) A customer declared bankruptcy, causing the company to write off 56,000 in bad debts. Of this, 48,000 was outstanding at the reporting date. How much of the above losses should be recognised at the reporting date in compliance with IAS 10 Events After the Reporting Date? (a) 156,000 148,000 56,000 (d) 48,000. 7. On 1 July 2012, Murrin plc had a property in its books carried under the fair value model of IAS 16 Property, Plant & Equipment at an amount of 400,000. It was being used by Murrin plc as an office building. The property is estimated on 1 July 2012 to have a 20-year useful economic life with no residual value. On 1 January 2013, it was decided to vacate the property and rent it out immediately to an unconnected party. The sole purpose of holding the property became, at that date, the collection of rental income and accrual of capital gains. The fair value of the property was 425,000 at 1 January 2013 and 440,000 on 30 June 2013. What is the effect of the above events on profit or loss and on other comprehensive income for the year ended 30 June 2013? Profit or Loss Other Comprehensive Income (a) 15,000 gain 25,000 gain 25,000 gain 15,000 gain 5,000 gain 35,000 gain (d) 15,000 gain 35,000 gain Page 5
8. On 1 July 2012 trade and other payables stood at 45,000 including an amount of 2,000 in respect of the purchase of plant. The equivalent figure on 30 June 2013 was 47,000 including 6,000 in respect of the purchase of a motor vehicle. How should the movement in trade payables appear in the operating activities section of the statement of cash flows for year ended 30 June 2013? (a) (d) 2,000 decrease in trade payables added to profit before tax 2,000 increase in trade payables added to profit before tax 2,000 decrease in trade payables subtracted from profit before tax 2,000 increase in trade payables subtracted from profit before tax. Answer either Question 4 or Question 5 4. Many accounting standards require or permit the use of fair values in measuring assets and liabilities. However, there has not always been consistency between these standards regarding the method of arriving at fair value. IFRS 13 Fair Values was issued in May 2011 as an attempt to remedy this problem. The IFRS aims to define fair value, sets out a framework for measuring fair values, and standardises disclosures about the use of fair values by entities in their financial statements. It does not attempt to give guidance regarding the use of the resulting fair value figures, leaving this to the relevant standard dealing with the asset or liability in question. IFRS 13 makes it clear that fair value is market-based as opposed to being entity-specific. Hence the intentions of an entity regarding an asset or liability are not relevant when determining fair value. Krannog plc is an investment company which holds a portfolio of securities linked to the real-estate market in Ruritania. The following information is available at 31 July 2013 regarding this portfolio: The portfolio cost 13 million 2 years ago. Real-estate prices in Ruritania are generally accepted to have dropped by 20-30% in the past 2 years. The portfolio of securities held by Krannog is difficult to value, as there is no active market. However, it has received an offer of 2.6 million for this portfolio from an investor. It has no intention of accepting this offer although some similar companies have accepted offers from this investor due to financial difficulties. A normal sale in the present climate could be reasonably expected to yield 6 million, based on an analysis of transactions in similar assets. Krannog s valuation models suggest that the real estate market in Ruritania will recover, and it expects that the portfolio will generate 12 million (at present value) over the next three years. REQUIREMENT: (a) Discuss the meaning of the term the term Fair Value as defined by IFRS 13 Fair Values. (8 marks) Outline the 3 level hierarchy proposed by IFRS 13 to evaluate informational inputs into the measurement of fair values. (6 marks) Advise the amount at which Krannog plc should state its investment portfolio in its financial statements to 31 July 2013, assuming it wishes to use fair value as measured in accordance with IFRS 13 principles. (6 marks) [Total: 20 MARKS] OR Page 6
5. IAS 2 Inventories was first issued in October 1975, and most recently revised in December 2003. Its most important principle is that inventories be measured at the lower of their cost and their net realisable value. Herald plc (Herald) manufactures plastic water tanks for the farming industry. On 31 May 2013, its closing inventory consisted of 950kg of plastic resin raw material, and also 250 finished units (plastic water tanks). Plastic: The purchase price of plastic resin was 3 per kg throughout the year to 31 May 2013. Delivery costs an additional 0.50 per kg. Herald has a policy of always keeping plenty of plastic resin in inventory, as its supply can be unreliable. However, close to the year-end, the price of plastic resin collapsed due to market oversupply. The purchase price of Herald s raw material is now 2.10 per kg plus the 0.50 per kg delivery charge. The existing inventory of plastic resin can be sold in the market for 1.80 per kg net of all costs. Tanks: Each tank requires 10 kg of plastic to manufacture, plus each unit incurs 25 in conversion costs (labour and overhead). Herald sells the tanks for 100. It is expected that this price will drop to 90 as a result of the fall in the market price of plastic. All completed units sold by Herald incur a 6 selling and distribution cost. REQUIREMENT: (a) Describe how the cost of inventory is determined under IAS 2 (5 marks) Discuss the principles for determining the Net Realisable Value of inventory under IAS 2. (5 marks) Calculate the value of closing inventory in the books of Herald plc at 31 May 2013 applying the principles of IAS 2. (10 marks) [Total: 20 MARKS] END OF PAPER Page 7
SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION AUGUST 2013 Solution 1: Marking scheme: (a) Calculation of goodwill on acquisition 2 Retranslation of goodwill at reporting date 1 Treatment of exchange gain 1 Subtotal 4 Statement Consolidation plan (100% R + 100% H * 8/12 + 100% K) 5 Translation of Kelson 3 Depreciation on FVA (calculation and inclusion in expenses) 1 Goodwill impairment (inclusion in expenses) 1 Intra-group revenue and purchases (exclusion) 2 Unrealised profit (calculation and addition to cost of sales) 1 Intragroup dividend (exclusion) 1 Calculation of exchange gain on net assets 3 Calculation and attribution of results to NCI and owners of parent 3 Presentation 1 Subtotal 21 Written question Functional currency explanation 2 Discussion of factors for determining functional currency (3 X 1 mark) 3 Subtotal 5 [Total: 30 Marks] Page 9
Suggested solution Group structure: Rooster plc Parent Houseton plc 70% subsidiary for 8 months therefore include 100% of results * 8/12 Kelson plc 60% subsidiary, include 100 % of results for full year Requirement (a) Goodwill on acquisition of Kelson 1 August 2012 US$ m rate m Cost of Investment 510 1.35 377.78 Value of NCI 300 1.35 222.22 Fair value of net assets at acquisition (750) 1.35 (555.56) Goodwill at acquisition 60 44.44 Impairment losses to 31 July 2013 NIL Exchange gain (balancing figure) 3.56 Goodwill at 31 July 2013 60 1.25 48.00 The exchange gain of 3.56 million is recognised as other comprehensive income for the year. It is attributable to the parent and the NCI if the goodwill was calculated using the fair value method. If however the partial method was used the answer would be the same. In this case the NCI would not share of the gain. Both are accepted for full marks. Rooster plc: Consolidated statement of comprehensive income for year ended 31 July 2013 (100% Rooster + 100% Houseton * 8/12 + 100% Kelson) million Revenue +(2,640 +450*8/12 +468.75(i) -24(iv)) 3,384.75 Cost of Sales -(1,230 +120*8/12 +210.94(i) +4(iii) -24(iv) +3(iv)) (1,503.94) Gross Profit 1,880.81 Operating expenses -(270 +120*8/12 +140.63 (i) +20 (ii)) (510.63) Finance costs -(60 +30*8/12 +15.63 (i)) (95.63) Other income +(20) 20.00 Investment income +(40-35 (v)) 5.00 Profit before taxation 1,299.55 Taxation -(275 + 24*8/12 +31.25 (i)) (322.25) Profit for the year 977.30 Other comprehensive income (net of tax): Gains on revaluation of property (290 + 45*8/12 + 7.81 (i)) 327.81 Exchange gain on translation of goodwill (see part (a) above) 9.48 Exchange gain on translation of other net assets (vi) 46.33 Total comprehensive income for the year 1,360.92 Profit for the year attributable to: Owners of the parent (balancing figure) 926.08 Non-controlling interest (23.1 + 28.12) (vii) 51.22 977.30 Total comprehensive income attributable to: Owners of the parent (balancing figure) 1,277.62 Non-controlling interest (32.1 + 51.2) (vii) 83.30 1,360.92 Working (i) Translate Kelson s SPLOCI (use average rate for year) million Revenue (600/1.28) 468.75 Cost of Sales (270 / 1.28) (210.94) Gross Profit 257.81 Operating expenses (180 / 1.28) (140.63) Finance costs (20/1.28) (15.63) Profit before taxation 101.55 Taxation (40/1.28) (31.25) Profit for the year 70.30 Other comprehensive income (net of tax): Gains on revaluation of property (10/1.28) 7.81 Total comprehensive income for the year 78.11 Page 10
Working (ii) Impairment loss on consolidated goodwill 20m is included as operating expense in year of recognition. NCI is affected as goodwill was calculated using the fair value method. Working (iii) Additional depreciation from fair value adjustment 24m / 4 years * 8/12 = 4m Current year s amount included as cost of sales expense this year. NCI is affected as it is Houseton s asset that is being adjusted. Working (iv) Eliminate intra-group sales and purchases ( 24m) in full from group revenue and group cost of sales. Closing unrealised profit provision required = 24m * 60/160 * 1/3 = 3m Houseton s NCI is affected as Houseton was the internal selling company which recorded the gain. Working (v) Eliminate intragroup dividend from investment income 50m * 70% = 35m. No effect on NCI. Working (vi) - Exchange gain (loss) on other net assets of Kelson (excl goodwill) Net assets of Kelson at acquisition: As translated at acquisition date (750 / 1.35) 555.56 As translated at reporting date (750 / 1.25) 600.00 Gain 44.44 Net assets earned during year ended 31 July 2013 (TCI): As translated per SPLOCI (100 / 1.28) (W(i)) 78.11 As translated at reporting date (100 / 1.25) 80.00 Gain 1.89 Total gain 46.33 Gain is recognised as OCI for the year. NCI shares in this gain as they are 40% shareholders in Kelson. Working (vii) non-controlling interest Houseton Kelson Profit m TCI m Profit m TCI m per SPLOCI 104 134 70.30 78.11 Goodwill impairment (ii) (20) (20) Exchange gain on goodwill (a) 3.56 Exchange gain on other net assets (vi) 46.33 Depreciation of FVA (iii) (4) (4) Unrealised profit in inventory (iv) (3) (3) Adjusted figures 77 107 70.30 128.00 NCI percentage 30% 30% 40% 40% NCI amount 23.1 32.1 28.12 51.2 Functional currency: The functional currency of an entity can be understood literally as the currency in which the entity functions. The choice of functional currency is a judgment which must be made under IAS 21. The judgment involves assessing the facts, and deciding the currency on which the entity is most dependent economically. For most entities, the functional currency is a clear judgment, in that most entities operate primarily within a single economy or currency zone. However IAS 21 does offer some guidance should the judgment prove difficult. This can happen if more than one currency is important to the entity and it is not clear which is the most significant. IAS 21 requires that the entity consider: Primary considerations: The currency which most affects sales prices; and The currency in which purchases and other costs are incurred. Secondary considerations: The currency of the most significant providers of capital; and The currency in which operating receipts are retained. Page 11
Solution 2: Marking scheme: (a) Statement of profit or loss and other comprehensive income Transfer of figures from trial balance to appropriate headings 2 Eliminate sale proceeds of plant from revenue 1 Revaluation loss on land (calculation and inclusion in OCI) 1 Depreciation on buildings (calculation and inclusion in expenses) 1 Depreciation on plant & equipment 1 Finance cost (calculation and inclusion in expenses) 1 Loss on investment property (calculation and inclusion in P/L) 1 Adjustment to admin expenses re warranty provision 1 Loss on disposal of plant 1 Tax (recognition in P/L) 1 Gain on investments (calculation and recognition in OCI) 1 Presentation 1 Subtotal 13 Statement of Changes in Equity Transfer of figures from trial balance to appropriate headings 1 Calculate opening share capital and share premium 1 Transfer of SPLOCI figures to correct equity account 2 Calculation of dividend proposed 1 Subtotal 5 Statement of Financial Position Transfer of figures from trial balance to appropriate headings 2 Depreciation & disposal of plant 2 Depreciation & revaluation of land & buildings 2 Loss on investment property (calculation and inclusion in NCA) 1 Gain on equity investments (calculation and recognition in NCA) 1 Transfer of figures from SOCIE 1 Dividends (calculation and inclusion in liabilities) 1 Tax (recognition as liability net of existing balance) 1 Debenture interest (calculation and recognition as liability) 1 Warranty provision (calculation and inclusion of correct amount in liabilities 1 Presentation 1 Subtotal 14 - Max 12 Suggested solution (a) Knightsfield plc: Statement of Profit or Loss and Other Comprehensive Income for year ended 31 May 2013 million Revenue (60.2-5 (iii) 55.2 Cost of Sales (19.2 +2 (ii) +6.8 (iii) (28.0) Gross profit 27.2 Distribution costs (6.1 (6.1) Administration expenses (3-0.6 (2.4) Finance costs (vii) (0.6) Loss on disposal of plant (iii) (1.4) Loss on revaluation of investment properties (iv) (3.0) Profit before tax 13.7 Tax (vi) (1.7) Profit for the year 12.0 Other comprehensive income: Loss on revaluation of land (ii) (1.0) Gain on revaluation of investments (v) 1.1 Total comprehensive income for the year 12.1 Page 12
Knightsfield plc Statement of Changes in Equity for year ended 31 May 2013 million Share Share Revaluation Equity Retained Total Capital Premium Surplus Investments Earnings Equity million million million million million million Balance 1 June 2012 16 29 6 1.4 12.8 65.2 Issue of share capital 4 6 10 Total comprehensive income (1) 1.1 12.0 12.1 Dividends declared (1.92) (1.92) Balance 31 May 2013 20 35 5 2.5 22.88 85.38 Knightsfield plc Statement of Financial Position as at 31 May 2013 million Non-current assets: Land & buildings, (40-2 1 (ii) -2 (ii) 35.00 Plant & equipment (65-31 -6.4 (iii) 6.8(iii) 20.80 Investment property (32-3 (iv)) 29.00 Equity investments (8.4 +1.1 (v)) 9.50 94.30 Current assets: Inventory 6.20 Trade receivables 6.90 Cash & bank 8.80 21.90 Total assets: 116.20 Equity: Equity share capital 20.00 Share premium 35.00 Revaluation surplus (6 1(ii)) 5.00 Equity investment reserve (1.4+1.1(v) 2.50 Retained earnings 22.88 85.38 Non-current liabilities: 12% debenture (20) 20.00 Current liabilities: Trade payables 4.60 Provision for warranty claim (3-0.6(i)) 2.40 Corporation tax due (-0.4 +1.7 (vi)) 1.30 Interest accrued (vii) 0.60 Final dividend due (viii) 1.92 10.82 Total equity & liabilities 116.20 Working (i) Reduce administration expenses and provision for warranty by 0.6 million Working (ii) Reduce value of land by 1 million to 5 million. Take loss of 1 million to OCI and revaluation surplus. Depreciate buildings by 2 million [(40-6)/ 17 years]. Take to Cost of Sales expense, and reduce land & buildings. Working (iii) Eliminate 5 million from sales revenue. Depreciation for year ended 31 May 2013: million Cost 65 Accumulated Depn to 1 June 2012 (31) Opening NBV 34 Depreciation at 20% 6.8 Note: Depreciation for the year includes depreciation on the plant disposed of as it was in use for the full year. Page 13
Recognise gain (loss) on disposal as follows: million million Proceeds 5 Carrying value: Cost 10 Less depreciation year 1 (to 31 May 2012) (2) Less depreciation year 2 (current year) [20% * (10-2)] (1.6) NBV at date of sale (6.4) Loss on disposal (separate line as material amount) (1.4) Eliminate the NBV at disposal 6.4m from the plant & equipment accounts. Working (iv) Decrease the investment properties balance by 3 million. Charge the loss to profit or loss as per IAS 40. Working (v) Increase the investment in equity instruments by 1.1 million. Recognise the gain in OCI and in the equity investments reserve as instructed. Working (vi) Corporation tax due is charged to P/L and recognised as a liability. There is an existing balance of 0.4 million debit. Hence the total charge to be recognised is 1.7 million. Charge to profit or loss and credit to liabilities after offsetting the existing debit balance. P/L charge 1.7m, liability 1.3m Working (vii) The debentures were issued on 1 March 2013. Therefore 3 months interest should be accrued. 20m * 12% * 3/12 = 0.6m. This is charged to P/L and recognised as a liability. Working (viii) Final ordinary dividend of 1.2c is declared on each share of the issued share capital ranking for dividend. The relevant share capital is 20 million, of which 4 million does not rank for dividend. Hence 16 million of the equity share capital ranks for dividend. As the shares have a nominal value of 10c each, this represents 160 million shares. The total dividend declared is therefore 160m * 1.2c = 1.92 million. The declaration was made prior to the reporting date, so it is a liability at the reporting date. The amount is deducted from retained earnings and recognised as a liability. Page 14
Solution 3 Marking scheme: 2.5 marks per correct answer Total 20 marks Suggested solution (plus tutorial notes) 1. Answer (a) R&D expenditure for the year totals: Wages & salaries 350,000 Depreciation on equipment 125,000 (750,000 / 6 years) Overheads 140,000 Materials USED 360,000 45% of this total should be capitalized as 45% of the department s time was spent on projects meeting the IAS 38 criteria for capitalisation. Hence capitalise 45% of 975,000 or 438,750. 2. Answer The non-controlling interest in the profit of Joe will be based on: m Profit for year 42 Less unrealised profit (as goods sold by Joe) [ 18 * 25/125 * 40%] (1.44) Profit for consolidation 40.56 NCI share 30% 12.168 3. Answer Whilst all of the answers could be considered to be valid objectives of financial statements, only is suggested by the conceptual framework to be the primary objective. 4. Answer (d) Either statement could be true, but neither statement MUST be true. To illustrate, consider some sample numbers: 2012 2011 Revenue 600 1,000 Cost of sales 270 600 Gross profit 330 400 Gross margin 55% 40% In the above situation, gross profit was lower in 2012 despite the gross profit margin being higher. Sales prices could be anything. For example 2011 could be 100 units at 10, and 2012 could be 80 units at 7.50. 5. Answer This is a financial asset and should be accounted for under the amortised cost method. It was purchased at the beginning of the current financial year. The finance cost is based on the carrying value times the effective rate. For year 1, the initial carrying amount is cost 30m plus 10% premium ( 33m), plus we add issue costs, 0.5m. Finance income for year 1 is therefore 8.6% of 33.5 million = 2,881,000. Other answers are arrived at if errors were made in calculating the initial capitalized cost, or if the 10% nominal rate was taken in error. 6. Answer (d) (i) (ii) This is a non-adjusting event. Therefore it is recognised in the period it occurred. This is an adjusting event. However the amount recognised is limited to the amount outstanding on the reporting date 48,000. The balance is an expense of the following period. Page 15
7. Answer During the period from 1 July 2012 to 1 January 2013, the property was being used by Murrin plc. Therefore depreciation should be charged for the 6 months amount 10,000 (400,000 * 1/20 * 6/12). The building is revalued at that date to its fair value of 425,000. This creates a revaluation gain of 35,000 (425 390) which is taken to OCI in accordance with IAS 16. On 1 January 2013 the property becomes an investment property under IAS 40. No depreciation is charged for this period. The increase in fair value of 15,000 is recognised in profit or loss in accordance with IAS 40. Hence for the year as a whole, a gain of 15,000 less depreciation of 10,000 is recognised in profit or loss. A gain of 35,000 is recognised in OCI. 8. Answer The movement in trade payables for adjustment to operating cash flow should not include creditors relating to the purchase of non-current assets. Hence these need to be excluded. Opening trade payables 45,000 2,000 = 43,000 Closing trade payables 47,000 6,000 = 41,000 Decrease over the year 2,000 A decrease in trade payables is cash negative, as cash was absorbed in paying them off. Therefore it is subtracted from profit before tax. Page 16
Solution 4: Marking scheme: (a) Definition: Fair value definition 4 Discussion of definition 4 Subtotal 8 Hierarchy: 3 levels named (3 X 1 marks) 3 3 levels explained (3 X 1 marks) 3 Subtotal 6 Application: Analysis of three methods suggested, and selection of most appropriate 6 Total 20 Suggested solution (a) IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (ie an exit price). The above definition of fair value emphasises that fair value is a market-based measurement, not an entityspecific measurement. When measuring fair value, an entity uses the assumptions that market participants would use when pricing the asset or liability under current market conditions, including assumptions about risk. As a result, an entity s intention to hold an asset or to settle or otherwise fulfill a liability is not relevant when measuring fair value. The IFRS explains that a fair value measurement requires an entity to determine the following: (a) the particular asset or liability being measured; (d) for a non-financial asset, the highest and best use of the asset and whether the asset is used in combination with other assets or on a stand-alone basis; the market in which an orderly transaction would take place for the asset or liability; and the appropriate valuation technique(s) to use when measuring fair value. The valuation technique(s) used should maximise the use of relevant observable inputs and minimise unobservable inputs. Those inputs should be consistent with the inputs a market participant would use when pricing the asset or liability. To increase consistency and comparability in fair value measurements and related disclosures, the IFRS establishes a fair value hierarchy that categorises into three levels the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1 inputs) and the lowest priority to unobservable inputs (Level 3 inputs). Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. Page 17
There are a number of potential values that could be used here. However not all are of equal quality. There is an offer for the asset of 2.6 million. However Krannog has no intention of accepting this offer, so it is not an active market price. An orderly sale would be expected to yield 6 million. This figure is arrived at after analyzing transactions in similar assets. Therefore this would seem to qualify as a level 2 input, and would seem reasonable to use as the basis of valuation. The valuation models are level 3, as they are unobservable. Therefore they are inferior to level 2 inputs. However, the fact that the models seem to be anticipating a recovery would suggest that the valuation determined by them would not be attainable in the current market. Therefore this value would not meet the IFRS 13 definition of fair value. Hence, the best estimate of fair value in this situation would be 6 million. Page 18
Solution 5: Marking scheme: (a) Detailed description of Cost Subtotal 5 Discussion of Net Realisable Value Subtotal 5 Application: Calculation of cost and net realisable value for each item of inventory 6 Recognition that raw materials are still expected to be profitably used no writedown 4 Subtotal 10 Total 20 Suggested Solution: (a) Cost is defined as cost of purchase, costs of conversion, plus any costs that are incurred in bringing the inventory items to their present location and condition. Cost of purchase is deemed to include any import duties, irrecoverable purchase taxes, transport, handling and all other directly attributable costs of purchase. Trade discounts are deducted but not settlement discounts. Costs of conversion include any directly attributable labour and overhead costs incurred in converting units of raw material to a finished product. They also include a systematic allocation of production costs which are indirectly attributable to manufacturing or conversion. Any apportionment of fixed overhead is based on normal output conditions. Other costs may be included in certain circumstances, provided they are incurred in bringing the inventory items to their present location and condition. Net realisable value (NRV) is calculated as the expected sale proceeds less any selling costs to be incurred in achieving the sale proceeds. If there is further work to be carried out in order to bring the goods into a saleable condition, these costs should be deducted also. As NRV is an estimate, care should be taken that the estimate is based on reliable evidence. If there are a number of possible ways of realizing the value of inventory, it is acceptable to select the most advantageous method when estimating net realisable value. NRV is reviewed at each reporting date and a revised value is recorded in the books if the NRV estimate changes. In no case can a revision cause the goods to be recorded at a value higher than their cost. Page 19
The inventory of Herald should be valued as follows: Finished goods: Cost per unit: Material 10kg * 3 30 Conversion 25 Total 55 Net realisable value: Expected selling price 90 Less selling costs estimate (6) Net realisable value 84 As the Net Realisable Value exceeds the cost, the finished goods are valued in the books at cost. Hence a value of 250 * 55 = 13,750 will be entered into the books as closing inventory of finished goods. Raw Material: Cost per unit: Purchase price 3.00 Delivery costs 0.50 Total cost 3.50 Net realisable value: Expected sale proceeds if sold as inventory 1.80 Expected sale proceeds if sold as finished units 90 Less selling cost (6) Less completion costs: Conversion (25) Net realisable value 59 NRV per kg of raw material 5.90 The NRV of the raw material if sold as raw material is lower than the cost. However the NRV if processed into finished units is higher than cost. Therefore the inventory should not be written down, and should be recorded in the books at cost. Hence a value of 950 * 3.50 = 3,325 will be entered into the books as closing inventory. Total closing inventory = 3,325 + 13,750 = 17,075 Page 20