The Examiner's Answers F1 - Financial Operations March 2013 Some of the answers that follow are fuller and more comprehensive than would be expected from a wellprepared candidate. They have been written in this way to aid teaching, study and revision for tutors and candidates alike. SECTION A Answers to Question One Question One consists of 10 objective test sub-questions. These are drawn from all sections of the syllabus. They are designed to examine breadth across the syllabus and thus cover many learning outcomes. 1.1 D 1.2 B 1.3 To ensure that for similar investments all entities are allowed the same rates of depreciation for tax purposes. Entities can use any rate for accounting depreciation, so to ensure that all entities are taxed equally the tax authority sets rates for tax depreciation for all entities. The tax depreciation rates then replace accounting depreciation in the tax computations. 1.4 B 1.5 D 1.6 C 1.7 B Financial Operations 1 March 2013
1.8 Any four from: Investors Lenders Employees Business contacts customers, suppliers, competitors General public Government 1.9 A 1.10 C March 2013 2 Financial Operations
SECTION B Answers to Question Two (a) To test candidates knowledge of possible enquiry and investigation powers of tax authorities. Tests learning outcome A1c. List four taxes that are likely to require detailed records to be maintained by an entity. Identify records that an entity would be required to keep to support its VAT or sales tax returns. (i) Corporate income tax VAT or sales tax PAYE or similar employee tax Capital gains tax (ii) An entity would normally be required to keep the following records to support its VAT or sales tax returns: Orders and delivery notes Purchase and sales invoices Credit and debit notes Purchase and sales books Cashbooks and receipts Bank statements Import and export documents VAT account Financial Operations 3 March 2013
(b) To test the candidates understanding of income tax calculations. Tests learning outcome A3a. Calculate accounting depreciation and tax depreciation. Adjust profit before tax for disallowed expenses and non-taxable income. Adjust for losses brought forward and calculate tax due. $ Accounting profit 167,000 Add disallowed expenses (4,000+5,000) 9,000 Less non-taxable income (12,000) Add depreciation 11,600 Less tax depreciation (10,250) Taxable profit for year 165,350 Less brought forward losses (49,000) 116,350 Tax due at 25% 29,088 Depreciation: 50,000 + 8,000 = 58,000 x 1/5 = 11,600 Tax depreciation: 1/1/11 1/1/12 Cost 50,000 First year allowance 2011 25,000 25,000 8,000 Allowances 2012 First year allowance 4,000 Annual allowance 6,250 Total allowance 10,250 March 2013 4 Financial Operations
(c) To test candidates understanding of IFRS 5. Tests learning outcome C2a. Explain how the revenue and expenses should be shown in the statement of comprehensive income. Explain how the loss on disposal of the assets should be treated. Explain how the restructuring should be treated. A single figure should be shown on the statement of comprehensive income, comprising the loss after tax and loss incurred on the disposal of assets. Therefore a separate section Discontinued operations will be shown after the section of the statement of comprehensive income headed Continuing operations. The heading will be loss for the period from discontinued operations and the amount shown will be ($42,000). The notes to the statement of comprehensive income will need to disclose each of the amounts included in the loss after tax, i.e. $000 Revenue 95 Operating expenses (110) Operating loss (15) Loss on disposal of assets (30) Tax refund Loss 3 (42) Comparative information for prior periods must be restated using the current classification, that is division C results for prior periods will be shown as discontinued operations. The restructuring expense is not included in discontinued operations as according to IFRS 5 Non-current assets held for sale and discontinued operations this is an expense that relates to ongoing operations and should be included under continuing operations. As the $75,000 restructuring is a material item in the context of continuing operations, it will need to be shown as a separate item on the statement of comprehensive income as required by IAS 1 Presentation of financial statements.. Financial Operations 5 March 2013
(d) To test candidates knowledge of why governments impose excise duty on some goods. Tests learning outcome A1b. Explain why an excise duty may be imposed on certain types of goods by a government. Give an example of each reason. An excise duty may be imposed on certain types of goods by a government: to discourage over-consumption of products which may harm the consumer or others for example alcohol; to alter the distribution of income by taxing luxuries, for example, in the USA there are excise duties on fishing equipment, firearms and airplane tickets; to seek to allow for externalities and to place the burden of paying the tax on the consumer of the product/service. For example the social and environmental cost of consuming the product is paid for by the consumer of products such as tobacco to help pay for the increased cost of healthcare of smokers. to improve infrastructure and other facilities. For example excise duty on petrol and diesel is used by some governments to build and maintain roads, bridges and mass transit systems. to protect or promote growth of home industries by increasing the price of imports with taxes, for example car manufacturing. to raise revenue for government by taxing goods with inelastic demand, thus enabling revenue to be raised without distorting consumption, for example luxury goods. March 2013 6 Financial Operations
(e) To test candidates understanding of permanent establishment in a country, residency for tax purposes and the impact of a tax treaty. Tests learning outcome A2a. Explain, with reasons, which country/countries OW will be regarded as resident in for tax purposes. Explain the meaning of permanent establishment and the effect that has on tax in a country. Explain the effect of a tax treaty with country Z. (i) OW s production facility and head office are located in Country X and all the directors board meetings are held in Country X so OW s effective management is in Country X. Both countries have double tax treaties with each other based on the OECD model tax convention so the OECD model tax convention will apply to OW. Where an entity is deemed to be taxable in several countries, the OECD model suggests that the entity is resident in the country of its effective management. OW will therefore be regarded as resident in Country X for tax purposes and will be taxable in Country X. (ii) The OECD model tax convention states that an entity s profits will only be taxed in a country if the entity has a permanent establishment in the country. OW has a number of branch offices in Country Z, each office provides services to customers and sells OW s products. The OECD model tax convention states that a branch office is a permanent establishment, so OW will have a permanent establishment in Country Z. Profits made by OW s branch offices in Country Z will be taxable in Country Z. As OW is resident in Country X its worldwide profits will be taxed in Country X, irrespective of where they arise. As both countries have double tax treaties with each other based on the OECD model tax convention any tax paid in Country Z will be able to be relieved under the double taxation agreement. Financial Operations 7 March 2013
(f) To test candidates knowledge of the purpose of the Framework. Tests learning outcome B1d. Explain the purpose of the Framework. According to the Framework, its purpose is to: assist the IASB in the development of future IFRSs and in its review of existing IFRSs; assist the IASB in promoting harmonisation of regulations, accounting standards and procedures by providing a basis for reducing the number of alternative treatments permitted by IFRSs; assist national standard-setting bodies in developing national standards; assist pr eparers of f inancial s tatements i n ap plying I FRSs and in de aling with t opics t hat ha ve yet t o be covered in an IFRS; assist auditors in forming an opinion as to whether financial statements comply with IFRSs; assist users in interpreting the information contained in a set of financial statements that are prepared using IFRSs; provide information about how the IASB has formulated its approach to the development of IFRSs. (Any 5 of the above) March 2013 8 Financial Operations
SECTION C Question Three To test candidates ability to prepare a set of financial statements for a single entity, including the application of a number of IFRS/IAS. Tests learning outcome C1a. Prepare the non-current asset depreciation calculations. Prepare workings for Cost of sales, administrative expenses and distribution costs. Prepare all other required workings. Prepare the statement of comprehensive income. Prepare the statement of financial position. Prepare the statement of changes in equity. CQ - Statement of comprehensive income for the year ended 31 December 2012 $000 $000 Revenue 1,992 Cost of sales W2 (1,107) Gross Profit 885 Administrative expenses W3 (407) Distribution costs W3 (140) (547) Profit from operations 338 Finance cost W4 (35) Profit before tax 303 Income tax expense W5 (67) Profit for the period 236 Financial Operations 9 March 2013
CQ Statement of financial position as at 31 December 2012 Non-current assets $000 $000 Property, plant and equipment (W1) 1,472 Intangible assets Patent (W7) 65 1,537 Current Assets Inventory (W8) 170 Trade receivables 249 Cash and cash equivalents 192 Total Assets Equity and liabilities 611 2,148 Equity Share capital 750 Share premium 225 Retained earnings 374 Total equity 1,349 Non-current Liabilities Bank loan 375 Deferred tax (W5) 168 Finance lease (W6) 27 Total non-current liabilities 570 Current liabilities Trade payables 140 Tax payable (W5) 77 Finance lease (W6) 12 Total current liabilities Total equity and liabilities 229 2,148 CQ Statement of changes in equity for the year ended 31 December 2012 Equity Share Retained Total Shares Premium earnings $000 $000 $000 $000 Balance at 1 January 2012 500 150 168 818 Shares issued during year 250 75 325 Profit for period 236 236 Dividend paid (30) (30) Balance at 750 225 374 1,349 March 2013 10 Financial Operations
Workings - All figures in $000 (W1) Tangible Non-current Assets Cost/Valuation Land Buildings Plant & Equip. Vehicle Total $000 $000 $000 $000 $000 Balance 1/1/12 1,015 400 482 0 1,897 Finance lease 46 46 Depreciation Balance 1/1/12 (120) (279) 0 (399) Charge for year (12) (51) (9) (72) Net book value at 31/12/12 1,015 268 152 37 1,472 Depreciation Buildings 400 x 3% = 12 Plant and equipment Reducing balance = 482 279 = 203 x 25% = 51 Vehicle over lease period 46 x 1/5 = 9 (W2) Cost of sales Inventory 1/1/12 196 Purchases 996 1,192 Less inventory 31/12/12 (W8) (170) Amortisation & impairment (W7) 25 Depreciation plant and equipment (W1) 51 Vehicle depreciation (W1) 9 Totals 1,107 (W3) Administration Distribution Per trial balance 395 140 Buildings depreciation (W1) 12 0 407 140 (W4) Finance charge Years loan interest (375x8%) 30 Finance lease (W6) 5 35 (W5) Tax Last Year b/f 32 Current year 77 109 Decrease in deferred tax (42) 67 Deferred tax Per trial balance 210 Decrease in year (42) 168 Financial Operations 11 March 2013
(W6) Lease Opening balance Paid Sub-total Interest @ 15% Closing balance Year to 31/12/12 46 (12) 34 5 39 Year to 31/12/13 39 (12) 27 4 31 (W7) Patent Cost 180 Amortisation year (18) - b/f (90) Carrying value 72 Fair value 65 Impairment 7 Amortisation 18 25 (W8) Inventory Balance 31/12/12 183 Obsolete items (13) 170 March 2013 12 Financial Operations
Question Four To test candidates understanding of the conditions for an entity to be a subsidiary. Tests learning outcome C1b. To test candidates ability to prepare a set of financial statements for a group of entities. Tests learning outcome C1c and C1d. (a) Explain the circumstances that can give rise to a parent/subsidiary relationship other than a majority shareholding. (b) Calculate the fair value of SX s net assets at acquisition. Calculate goodwill arising on acquisition of SX. Calculate investment in associated entity LW. Prepare workings for intra-group activities. Calculate consolidated retained earnings. Prepare consolidated statement of financial position. (a) IAS 27 Consolidated and separate financial statements states that the key concept that determines whether an entity is a subsidiary of another entity is that of control. Any situation that gives an entity control of another creates a parent/subsidiary relationship. IAS 27 provides the following instances where control can be achieved with fewer than 50% of equity shares: Power over more than 50% of voting rights by virtue of an agreement with other investors Power to govern the financial and operating policies of the entity under a statute or agreement Power to appoint or remove the majority of the members of the board of directors or equivalent governing body and control of the entity is by that board or body Power to cast the majority of votes at meetings of the board of directors or equivalent governing body and control of the entity is by that board or body Financial Operations 13 March 2013
(b) Workings (All workings in $000) (i) Fair value of net assets of SX at acquisition Equity Shares 360 Retained earnings 110 Fair value adjustment 72 542 (ii) Goodwill - Cost 530 Fair value of net assets acquired: Goodwill 542 (12) (iii) Investment in associate - Cost 190 Add group share of post acquisition profits (120 70) = 50 x 30% = Investment at 31 March 2012 (iv) Intra-group trading Mark up on cost 33 1 / 3 % = 25% margin on selling price. Selling price 44; unrealised profit = 44 x 25% = 11 All goods remain in inventory - 15 205 Dr. Cr. Consolidated retained earnings 11 Consolidated current assets - inventory 11 Consolidated Trade Receivables TX 98 SX 75 Less intra-group sales (44) Less cheque in transit (15) 114 Consolidated Trade Payables TX 156 SX 47 Less intra-group sales (44) 159 (v) Excess depreciation Fair value adjustment 72 Economic life 18 years, straight line basis Excess depreciation = 4 (vi) Consolidated Retained Earnings TX 300 SX (140-110) 30 LW (120-70) = 50 x 30% = 15 Negative goodwill 12 Unrealised profit (11) Excess depreciation Balance 31 Dec 2012 (4) 342 (vii) Consolidated Property, plant and equipment TX 545 SX 480 Fair value adjustment 72 Excess depreciation (4) 1,093 March 2013 14 Financial Operations
TX - Consolidated Statement of Financial Position as at 31 December 2012 $000 $000 Non-Current Assets Property, plant and equipment (vii) 1,093 Goodwill (ii) 0 Investment in associate (iii) 205 1,298 Current Assets Inventory (221+55-11) 265 Trade receivables (iv) 114 Cash and cash equivalents (72+15) 87 Total assets 466 1,764 Equity and Liabilities Equity Shares 800 Share premium 400 Retained Earnings (vi) 342 1,542 Current Liabilities Trade payables (iv) 159 Bank overdraft 63 222 1,764 Financial Operations 15 March 2013