AAMP2 UNIVERSITY OF BRIGHTON BRIGHTON BUSINESS SCHOOL ASSOCIATION OF CHARTERED CERTIFIED ACCOUNTANTS PROFESSIONAL STAGE PAPER P2 Corporate Reporting June 2016 Instructions to Candidates Time allowed: READING AND PLANNING 15 MINUTES (During reading and planning time, only the question paper may be annotated) WRITING THREE HOURS Number of questions on paper: FOUR. Section A, Question 1 is compulsory. Section B, answer 2 out of 3 questions. Non-programmable calculators are permitted. No notes or text books allowed. This examination draws upon questions provided by the ACCA for the Professional Paper, P2.
Section A THIS ONE question is compulsory and MUST be attempted Question 1 a) Ajax plc is a public company operating in the media sector. It has investments in two companies - Hector and Paris. The draft statements of financial position of the companies as at 31 December 2015 are as set out below: Assets: Non-current assets Ajax Hector Paris m m m Property, plant and equipment 3,295 2,000 1,200 Investments: in Hector 1,675 in Paris 700 Current Assets 985 861 150 Total Assets 6,655 2,861 1,350 Equity and liabilities: Ordinary share capital 850 1,020 600 Other components of equity 250 80 40 Retained earnings 3,340 980 350 Total equity 4,440 2,080 990 Non-current liabilities 1,895 675 200 Current liabilities 320 106 160 Total liabilities 2,215 781 360 Total equity and liabilities 6,655 2,861 1,350 The following information is relevant to the preparation of the group financial statements: 1) Ajax acquired 30% of the ordinary shares of Hector on 1 January 2013 for a cash consideration of 600 million. At that date the fair value of Hector's identifiable net assets was 1,840 million. Ajax treated Hector as an associate and equity accounted for Hector up to 31 December 2014. In the period up to 31 December 2014 Ajax's share of Hector's undistributed profits amounted to 90 million and its share of a revaluation gain amounted to 10 million. Page 2 of 12
On 1 January 2015 Ajax acquired an additional 40% of Hector's ordinary shares for a cash consideration of 975 million. At 1 January 2015 the fair value of Hector's identifiable net assets was 2,250 million. At that date the retained earnings and other components of equity of Hector were 900 million and 70 million respectively. On 1 January 2015 the fair value of Ajax's existing 30% holding was assessed as 705 million and the fair value of the non-controlling interest was assessed at 620 million. It is group policy to measure the non-controlling interest at fair value. The excess of the fair value of Hector's identifiable net assets over their carrying value at 1 January 2015 is attributable to an increase in the value of non-depreciable land and the contingent liability referred to below. 2) In determining the fair value of Hector's identifiable net assets of 2,250 million at the time of the business combination, Ajax included an unrecognised contingent liability of 6 million in respect of a warranty claim in progress against Hector at that time. In April 2015 the criteria were met for a provision in respect of the warranty claim to be recognised in the financial statements of Hector and the amount of the provision was adjusted to 5 million. 3) Additionally, buildings with a carrying value of 200 million had been included in the fair value of Hector's identifiable net assets at 1 January 2015. Ajax had commissioned an independent valuation of the buildings of Hector, but it was not complete at 1 January 2015. The valuations were subsequently received on 1 May 2015 and showed a decrease of 40 million in the fair value of the buildings. This reduction in value has not been recorded in the statement of financial position of Hector at 31 December 2015. Buildings are depreciated on a straight line basis with the estimated remaining life of the buildings having been determined as 20 years as at 1 January 2015. The decrease in the valuation of the buildings does not affect the fair value of the non-controlling interest at the date of business combination. 4) On 1 January 2015, Ajax acquired 80% of the ordinary share capital of Paris, a private company, for a cash consideration of 700 million. Because the former owners of Paris needed to dispose of the investment quickly, they did not have sufficient time to market the investment to many potential buyers. At the date of acquisition, Ajax determined that the fair value of Paris's identifiable net assets was 960 million and that the fair value of the non-controlling interest was 250 million. The retained earnings and other components of equity of Paris at 1 January 2015 were 300 million and 40 million respectively. The excess of the fair value of Paris's identifiable net assets over their carrying values is due to an unrecognised franchise right, which Ajax granted to Paris on 1 January 2014 for 5 years. At the time of the acquisition, the franchise right could be sold for its market value. It is group policy to measure the non-controlling interest at fair value. Page 3 of 12
5) At 31 December 2014, Ajax carried a property in its statement of financial position at its revalued amount of 14 million. Ajax had chosen to adopt the revaluation model in accordance with IAS 16 Property, Plant and Equipment. Depreciation is charged at 300,000 per annum on a straight line basis. In April 2015, the management of Ajax took the decision to sell the property and it was advertised for immediate sale. By 30 April 2015, there was an active programme to locate a buyer in place and the property was being marketed at a realistic price in relation to the existing market. As such at that date the sale was considered to be highly probable. At 30 April 2015, the property's fair value was 15.4 million and its value in use was 15.8 million. Costs to sell the property were estimated at 300,000. On 31 December 2015, the property was sold for 15.3 million (net of selling costs). The accounting for the property has remained unchanged since 31 December 2014 and no transactions have been effected in respect of the property in the financial statements for the year ended 31 December 2015, as the proceeds from the sale of the building were not received until January 2016. 6) Ajax has announced two major restructuring plans. The first plan is to rationalise its operations by the closure of some of its smaller and noncore activities. These have already been identified and will lead to the redundancy of 400 employees, who have all been individually selected and communicated with. The costs of this plan are 9 million in redundancy costs, 4 million in retraining costs and 5 million in lease termination costs. The second plan is to reorganise the finance and IT departments over a one year period but it is not proposed to commence this for a further two years. The costs of this plan are 10 million in redundancy costs, 6 million in retraining costs and 7 million in equipment lease termination costs. No entries have been made in the financial statements for the above restructuring plans. Prepare the consolidated statement of financial position of the Ajax group as at 31 December 2015. (35 marks) Page 4 of 12
b) Ajax is seeking to expand its publishing activities and as of 1 January 2016 entered into a one year arrangement with Wayfarer Publishing ("WP"), a public limited company. Under the arrangement WP provides content for a range of books and online publications while Ajax has sole responsibility for all printing, binding, and platform maintenance of the online website. Ajax selects the content to be covered in the publications but WP has the right of veto over the content. The agreement states that key strategic sales and marketing decisions must be agreed jointly. Under the terms of the agreement WP is entitled to a royalty representing 10% of sales and 30% of the gross profit from the sale of the publications. Ajax has projected sales and cost of sales under the arrangement for the year ending 31 December 2016 of 5 million and 2 million respectively. If the arrangement proves successful after one year, Ajax and WP are considering setting up a legal entity, AWP, with equal shares and voting rights. WP would continue to contribute content to AWP, but would not receive royalties. Ajax would continue to be responsible for printing, binding and the platform maintenance. Ajax would finance the operations of AWP. Explain how Ajax would account for the arrangement with WP in its financial statements for the year ending 31 December 2016. You should use illustrative figures, where possible. Explain how the accounting treatment would differ if the decision was made to proceed with the proposal to set up the legal entity, AWP. (8 marks) Page 5 of 12
c) Ajax's directors feel that they need a significant injection of funds in order to finance the increased working capital arising from projected sales growth. The group's bankers have strict lending criteria requiring borrowers to demonstrate good projected cash flows as well as the ability to operate within any overdraft facility granted. However, the current projected cash flows would not satisfy the bank's criteria for lending. The directors have nevertheless advised the bank that the company is in an excellent financial position, that the financial results and cash flow projections will meet the lending criteria and that the Group Financial Controller will forward a report to this effect shortly. The Group Financial Controller has recently joined Ajax having qualified with one of the major Accountancy practices. He has indicated that he cannot afford to lose his job because of his personal financial commitments. Discuss the potential ethical conflicts which may arise in the above scenario and the ethical principles which would guide how a professional accountant should respond in this situation. (7 marks) (Total 50 marks) Page 6 of 12
Section B TWO questions only to be attempted Question 2 Pegasus plc ("Pegasus"), a public limited company, is an international business developing software applications for use in a range of business applications. a) At 31 December 2015, 70% of Pegasus's total assets were represented by internally developed intangible assets comprising the capitalised costs of the development and production of software applications. It is Pegasus's policy to carry intangible assets at historic cost. The software applications are considered to have an indefinite useful life, which is reconsidered annually when the intangible assets are tested for impairment. Pegasus generates all of its revenue from its various software applications. The costs incurred in maintaining the software applications to accepted levels of performance are expensed to the Statement of Profit or Loss. In determining the value in use of the software applications, Pegasus uses budgeted future cash flows, which include the costs of maintenance and the capital costs incurred in developing versions of existing software applications for use in different business sectors. The budgeted future cash flows also include the expected increase in revenue arising from the above mentioned expenditure. Budgeted future cash flows have been expressed post - tax. Pegasus has not been in the practice of investigating differences which have arisen previously between its budgeted future cash flows and its actual cash flows. (7 marks) b) In its consolidated financial statements for the year ended 31 December 2015, Pegasus recognised a net deferred tax asset of 14 million, which was material in the context of its total net assets. The asset comprised 4 million of taxable temporary differences and 18 million relating to the carry forward of unused tax losses. Tax regulation in the territories in which Pegasus operates allows unused tax losses to be carried forward indefinitely. Pegasus expects that within 5 years future taxable profits will be available against which the unused tax losses could be offset. This expectation is based upon budgets Pegasus has prepared for the period 2016-2020. The budgets were primarily based on general assumptions about the development of software applications and economic improvement indicators. In addition, while Pegasus had experienced significant impairments to trade receivables and property in recent years, it did not expect such impairments to continue and that this would result in a substantial increase in future taxable profit. Page 7 of 12
Pegasus had reported material losses during the previous 5 years with an average annual loss of 18 million. A comparison of Pegasus s budgeted results for the previous two years to its actual results indicated material differences relating principally to impairment losses. In its interim financial statements for the first half of the year ended 31 December 2015, Pegasus recognised impairment losses equal to budgeted impairment losses for the whole year. In its financial statements for the year ended 31 December 2015, Pegasus disclosed a material uncertainty about its ability to continue as a going concern. In calculating its net deferred tax asset, Pegasus had applied current tax rates in its jurisdiction of 30% and at the same time discounted the net deferred tax asset to present value. In the jurisdiction in which Pegasus operates, tax legislation has recently reduced tax rates for future periods to 25%. (10 marks) c) In the notes to Pegasus s financial statements for the year ended 31 December 2015, the tax expense included an amount in respect of Adjustments to current tax in respect of prior years and this amount had been treated as a prior year adjustment. The amount related to adjustments arising from tax audits by the authorities in certain territories in which Pegasus operated and in relation to previous reporting periods. The issues which resulted in the tax audit adjustment were not a breach of tax law in these territories but related predominately to transfer pricing issues. These were matters of interpretation, for which there was a range of possible outcomes. Negotiations on these possible outcomes were concluded with the tax authorities in the year ended 31 December 2015. In preparing its financial statements for the year ended 31 December 2014, Pegasus had accounted for all known issues arising from the tax audits at that time and no additional tax adjustments were foreseen at that date. No penalties were applied by the tax authorities in negotiating the outcome of the tax audits. (6 marks) Discuss the validity of the accounting treatment of the above in Pegasus s financial statements for the year ended 31 December 2015. The mark allocation is shown against each of the three accounting treatments above. Professional marks will be awarded in question 2 for clarity and expression. (2 marks) (Total 25 marks) Page 8 of 12
Section B TWO questions only to be attempted Question 3 a) IAS 19 Employee benefits deals with how employee benefit costs are recognised, measured, presented and disclosed in entities financial statements. Explain and discuss the nature of defined contribution plans and defined benefit plans and discuss why different methods of accounting are required. (6 marks) b) Dionysus plc ( Dionysus ) operates a defined benefit plan for its employees. It is currently preparing its financial statements for the year ended 31 March 2016 and requires advice on how it should account for the defined benefit plan. The following information is available: The fair value of the plan assets at 1 April 2015 was 3,450,000 and the present value of the plan obligations at the same date amounted to 4,200,000. The yield on high-quality fixed rate corporate bonds is currently 8%. Dionysus made contributions to the plan during the year of 870,000. Pensions paid to retired members amounted to 280,000. As of 31 March 2016, Dionysus sold a subsidiary business to one of its competitors. As a consequence, members of the defined benefit plan employed by this subsidiary opted to transfer their pension entitlements to their new employer s plan. The resultant reduction in the present value of the plan obligation was estimated by the actuaries as 320,000. Assets with a market value of 300,000 were transferred to the competitor s pension plan to cover the accumulated pension entitlements of the plan members employed by the subsidiary sold. The actuaries have assessed the current service cost for the year as 600,000. Additionally they have assessed the fair value of the plan assets at 31 March 2016 as 3,900,000 and the present value of the plan obligation at the same date as 4,400,000. The fair value of the plan assets and the present value of the plan obligations at 31 March 2016 are stated after taking into account all of the above transactions. All transactions may be assumed to have occurred at 31 March 2016. Using the above information, calculate and set out what Dionysus would need to report in its financial statements for the year ended 31 March 2016 under IAS 19 Employee Benefits. (9 marks) Page 9 of 12
c) On 1 April 2014 Dionysus had granted 100 share options to each of its 1,200 group employees. Each grant was conditional upon the employee working for Dionysus until 31 March 2017. The fair value of each share option was 7. At the time of granting the share options, Dionysus estimated that 15% of employees would leave over the period to 31 March 2017. As a consequence of the sale of the subsidiary business referred to above, Dionysus has now had to revise its estimate and it now expects 25% of employees to leave over the period to 31 March 2017. Calculate the remuneration expense which would be recognised in respect of the share based payment transaction in the financial statements of Dionysus for the year ended 31 March 2016. (4 marks) d) Discuss the reasons behind the introduction of IFRS 2 Share based payment and discuss some of the common reservations commentators and analysts have about the Accounting standard. (4 marks) Professional marks will be awarded in question 3 for clarity and expression (2 marks) (Total 25 marks) Page 10 of 12
Section B TWO questions only to be attempted Question 4 a) IAS 17 Leases has been the subject of debate for some time and various amendments have been proposed under a series of Exposure drafts. Discuss the reasons for the proposed changes to the accounting standard and the main provisions of the Exposure Draft. Your answer should also refer to current developments. (9 marks) b) Athena plc ( Athena ) operates as a car dealership. It offers its customers the option either to purchase vehicles outright or to acquire them on finance lease terms over 3 years. In order to secure sales on finance lease terms, Athena offers very attractive interest terms. The interest rate implicit in their leases is 2.013%. On 1 May 2016, Athena sold vehicles on finance lease terms to Kappa plc for a total consideration of 180,000, which represented full list price of the vehicles and was considered to be the fair value. The lease terms required Kappa to make lease payments of 61,200 annually in advance. Athena was entitled to a discount of 35% on full list price from the manufacturer. Commercial rates of interest would be 8.2% per annum. Using relevant calculations, show how the above transactions would be dealt with in the financial statements of Athena for the year ended 30 April 2016. (6 marks) c) Kappa plc ( Kappa ) is a UK steel manufacturer. At 1 November 2015, Kappa had 200,000 tonnes of steel in inventory at a cost of 32 per tonne. In order to hedge the fluctuation in the market value of steel, Kappa entered into a futures contract on 1 November 2015 to deliver 200,000 tonnes of steel on 31 October 2016 at a futures price of 35 per tonne. As a consequence of oversupply in the steel sector, the market price of steel on 30 April 2016 had fallen to 27 per tonne. At the same date the futures price for delivery stood at 29 per tonne. Using relevant calculations, explain the implications for Kappa of the above in preparing its financial statements for the year ended 30 April 2016. (4 marks) Page 11 of 12
d) Kappa had purchased an item of plant on 1 May 2014 for 1,000,000. The asset is being depreciated over 5 years on the straight line basis with no expected residual value. At 30 April 2015, the asset was revalued to 1,200,000, but at 30 April 2016, the asset s value had fallen to 400,000. Kappa has adopted the practice of transferring from revaluation reserve to retained earnings any excess depreciation, as the asset is used. Using relevant calculations, show how the above transactions would be dealt with in the financial statements of Kappa from the date of purchase of the asset. (4 marks) Professional marks will be awarded in question 4 for clarity and quality of presentation. (2 marks) (Total 25 marks) Page 12 of 12