PROFESSIONAL STAGE FINANCIAL ACCOUNTING OT EXAMINER S COMMENTS

PROFESSIONAL STAGE FINANCIAL ACCOUNTING OT EXAMINER S COMMENTS The performance of candidates in the March 2013 objective test questions section for the Professional Stage Financial Accounting paper was consistent with recent sittings and the long-term average. When practising OT items, care should always be taken to ensure that the principles underlying any particular item are understood rather than rote learning the answer. In particular, candidates should ensure that they read all items very carefully. The following table summarises how well* candidates answered each syllabus content area. Syllabus area Number of questions Well answered Poorly answered LO1 3 2 1 LO2 7 6 1 LO3 5 4 1 Total 15 12 3 *If 50% or more of the candidates gave the correct answer, then the question was classified as well answered. Comments on the most poorly answered question (below 40% of candidates gave the correct answer), on LO1 (accounting and reporting concepts) are given below: Item 1 This item tested candidates understanding of the term fair presentation with many candidates not understanding the full relationship between IFRS standards and fair presentation. Copyright ICAEW 2013. All rights reserved. Page 1 of 15

MARK PLAN AND EXAMINER S COMMENTARY The mark plan set out below was that used to mark these questions. Markers are encouraged to use discretion and to award partial marks where a point was either not explained fully or made by implication. More marks are available than could be awarded for each requirement, where indicated. This allows credit to be given for a variety of valid points, which are made by candidates. Question 1 Overall marks for this question can be analysed as follows: Total: 25 General comments This question was a typical question testing the preparation of an income statement and statement of financial position from a trial balance, with an additional requirement to prepare an extract from the statement of changes in equity. A number of adjustments were required to be made, including revaluation adjustments, depreciation, a held for sale asset, an onerous provision and an operating lease. Bouvardia Ltd Statement of financial position as at 30 September 2012 ASSETS Non-current assets Property, plant and equipment (185,940 (W4) + 400,000 + 435,000 + 580,000 (W5)) 1,600,940 Current assets Inventories 27,300 Trade and other receivables 61,500 Cash at bank 5,100 93,900 Non-current asset held for sale 6,500 100,400 Total assets 1,701,340 Equity Ordinary share capital 672,600 Revaluation surplus (SCE) 135,000 Retained earnings (SCE) 594,740 Equity 1,402,340 Non-current liabilities Lease liability (27,600 18,000) (W3) 9,600 Provision (W2) 25,200 Current liabilities Trade and other payables 199,800 Taxation 56,000 Provisions (W2) 8,400 34,800 264,200 Total equity and liabilities 1,701,340 Copyright ICAEW 2013. All rights reserved. Page 2 of 15

Bouvardia Ltd Income statement for the year ended 30 September 2012 Revenue 1,057,000 Cost of sales (W1) (396,685) Gross profit 660,315 Administrative expenses (W1) (274,700) Other operating costs (W1) (148,100) Profit before tax 237,515 Income taxation (56,000) Net profit for the period 181,815 Note: Marks will be awarded if items are included in a different line item in the income statement provided that the heading used is appropriate. Statement of changes in equity as at 30 September 2012 (extract) Retained earnings Reval. surplus At 1 October 2011 576,875 518,000 Total comprehensive income for year (77,500 456,000) 181,515 (378,500) Dividend on ordinary shares (168,150) Transfer to retained earnings (W6) 4,500 (4,500) At 30 September 2012 594,740 135,000 W1 Expenses Cost of sales Admin expenses Other operating costs Trial balance 344,000 216,200 86,900 Opening inventories 31,800 Closing inventories (27,300) Provision charge (W2) 33,600 Lease payments (W3) 27,600 Depreciation charge plant & machinery(w4) 47,305 Depreciation charge property (W5) 34,500 Downward valuation (480,000 456,000) (W5) 24,000 Held for sale asset (8,200 820) 6,500) 880 396,685 274,700 148,100 W2 Provision onerous lease Current liabilities ((3,000 2,300) x 12) 8,400 Non-current liabilities (8,400 x 3yrs) 25,200 33,600 Copyright ICAEW 2013. All rights reserved. Page 3 of 15

W3 Operating lease Payments: 18,000 x 7yrs 126,000 36,000 x 8yrs 288,000 414,000 414,000 / 15 years = 27,600 pa W4 Plant & machinery Cost b/fwd 385,000 Accumulated depreciation b/fwd (144,375) Held for sale asset carrying amount (8,200) 232,425 Depreciation charge for year 232,425 x 20% 46,485 Held for sale (8,200 x 20% x 6/12) 820 (47,305) Classified as held for sale: Depreciation in year 820 Carrying amount at 30 September 2012 185,940 W5 Property valuations Property A Property B Carrying amount at 1 Oct 2011 372,000 1,080,000 Valuation at 1 Oct 2011 (449,500) (600,000) Revaluation gain/loss 77,500 (480,000) Valuation at 1 Oct 2011 449,500 600,000 Depreciation charge for year (Prop A: 31yrs / Prop B:30 yrs) (14,500) (20,000) Carrying amount at 30 Sept 2012 435,000 580,000 W6 Revaluation surplus transfer Property A Depreciation charge based on revalued amount (W5) 14,500 Depreciation charge based on HC (400,000 / 40yrs) (10,000) 4,500 Copyright ICAEW 2013. All rights reserved. Page 4 of 15

Presentation was generally good, with the quality of presentation of the statement of changes in equity much better than has previously been seen. However, sub-totals were, as usual, often missing for one or more categories on the statement of financial position. Most candidates included the held for sale asset as the last line item in current assets, although a few included this higher up in current assets and others under noncurrent assets. The figure taken to the statement of financial position for the held for sale asset was almost always correct, although in calculating the impairment loss (which was not always then included in the income statement and was often wrongly included in the calculation of the closing balance on property, plant and equipment) many omitted to charge depreciation up to the date of classification as held for sale. The vast majority of candidates used a costs matrix to calculate the figures for cost of sales, administrative expenses and other operating costs. Almost all candidates dealt correctly with opening and closing inventories and allocated own-figure depreciation charges to two categories, as instructed in the question. However, few included that portion of the downward revaluation on Property B which needed to be charged to the income statement, even if they had correctly restricted the downwards revaluation taken to the revaluation surplus (which many candidates did not). Similarly, even where candidates had arrived at a correct statement of financial position for either of the leases, it was rare to also see the correct income statement figure included in the costs matrix. It was this overall lack of understanding of basic double entry that was evident throughout the question and highlighted candidates lack of basic understanding of accounts preparation and led to a low question average. Although a significant number of candidates prepared an extract from the statement of changes in equity almost all then also prepared a separate working for both retained earnings and revaluation surplus, again highlighting a lack of basic understanding as to how statements link together. Candidates generally calculated closing balances on retained earnings and the revaluation surplus. Where separate workings were prepared for these closing balances it was not unusual for them to arrive at different figures, such that the closing figures in their statement of changes in equity did not always agree to the figures on their statement of financial position. Most candidates attempted to calculate the transfer between retained earnings and the revaluation surplus for the excess depreciation, but often used an incorrect number of years for calculating depreciation charges (on cost and/or on the revalued amounts). Other common errors included the following: Charging depreciation on plant and machinery on cost instead of on a reducing balance basis. When calculating a provision for the onerous lease, not reducing that provision by the expected rental income. A number of candidates made no attempt at all to deal with the onerous lease or the operating lease. Most candidates provided an adequate audit trail but some scripts were messy and disorganised and made it difficult to match figures on the face of their financial statements to workings. Total possible marks Maximum full marks 26 25 Copyright ICAEW 2013. All rights reserved. Page 5 of 15

Question 2 Overall marks for this question can be analysed as follows: Total: 21 General comments This question required the preparation of a consolidated statement of cash flows. Candidates were required to deal with the acquisition of both an associate and a subsidiary during the year. Movements in relation to property, plant and equipment and share capital were required, along with the impact of a finance lease. Eremurus plc Statement of cash flows for the year ended 30 September 2012 Cash flows from operating activities Cash generated from operations (Note) 692,020 Interest paid (728) Income tax paid (W1) (76,000) Net cash from operating activities 615,292 Cash flows from investing activities Purchase of property, plant and equipment (50,000) Proceeds from sale of licence (W3) 21,600 Acquisition of associate (10,000) Acquisition of subsidiary (58,800 8,700) (50,100) Net cash used in investing activities (88,500) Cash flows from financing activities Proceeds from issue of ordinary share capital (W4) 36,500 Payment of finance lease liabilities (3,500 728) (2,772) Non-controlling interest dividend (W6) (47,550) Dividends paid (W5) (490,000) Net cash from financing activities (503,822) Net decrease in cash and cash equivalents 22,970 Cash and cash equivalents at beginning of period 4,400 Cash and cash equivalents at end of period 27,370 Note: Reconciliation of profit before tax to cash generated from operations Profit before tax 626,140 Finance cost 728 Associate (24,700) Depreciation charge (W2) 153,330 Amortisation charge 8,200 Increase in inventories (57,300 46,900) (10,400) Increase in trade and other receivables (75,900 51,930 6,450) (17,520) Decrease in trade and other payables (48,792 82,600 9,950) (43,758) Cash generated from operations 692,020 Copyright ICAEW 2013. All rights reserved. Page 6 of 15

Workings (1) Tax paid Cash (β) 76,000 B/d 65,000 C/d 143,700 IS 154,700 219,700 219,700 (2) PPE B/d 791,500 Acquisition of subsidiary 105,000 Depreciation (β) 153,330 Additions (50,000 + 12,130) 62,130 C/d 805,300 958,630 958,630 (3) Intangible assets B/d 33,450 Amortisation charge 8,200 Disposal (β) 21,600 Additions (Goodwill (W7)) 25,150 C/d 28,800 58,600 58,600 (4) Share capital and premium B/d (170,000+ 227,500) 397,500 Non-cash issue ((35,000 + 15,000) x 1.40) 70,000 C/d (245,000 + 259,000) 504,000 Cash issue (β) 36,500 504,000 504,000 (5) Retained earnings Dividends paid (β) 490,000 B/d 238,280 C/d 163,920 IS 415,640 653,920 653,920 (6) Non-controlling interest Dividends paid (β) 47,550 B/d 144,800 Acquisition 27,550 C/d 180,600 IS 55,800 228,150 228,150 Copyright ICAEW 2013. All rights reserved. Page 7 of 15

(7) Acquisition of Genistra Ltd Consideration: Share consideration (35,000 x 1.40) 49,000 Cash consideration 58,800 107,800 Net assets at acquisition 110,200 Less: Attributable to NCI (110,200 x 25%) (27,550) (82,650) Goodwill 25,150 Copyright ICAEW 2013. All rights reserved. Page 8 of 15

Candidates generally perform well on the preparation of a statement of cash flow style questions, although performance in consolidated statements is generally lower than that of the single entity style. However, candidates again under performed on this question confirming that these students were weaker than we have seen recently. In the main, workings took the form of T-accounts, although a minority of candidates then failed to carry through their figures to the main statement. Presentation of the consolidated statement of cash flows was generally good, although many candidates used abbreviations such as PPE and NCI which lost them presentation marks. Others produced a complete but messy statement. Some candidates lost marks as they had presented items under the incorrect heading, the most common errors being to show dividends to the parent and/or the non-controlling interest or the payment of finance lease liabilities as investing activities instead of financing activities. Almost all candidates arrived at the correct figure for income tax paid, although a few showed this as an inflow of cash, as opposed to an outflow. Many candidates arrived at correct figures for proceeds from sale of licence (which meant arriving at the correct figure for goodwill arising on the acquisition of the subsidiary, and correctly including that figure in an intangible s T-account), dividends to the parent and proceeds from the issue of shares. Where errors were made on these calculations they included the following: Omitting to debit the goodwill arising on the acquisition of the subsidiary to the intangibles T- account. Crediting the nominal value of the shares issued to acquire the subsidiary instead of the market value of the shares at the date of acquisition. Crediting the whole of the profit for the year to the retained earnings T-account instead of just the group share. A minority of candidates arrived at the correct figure for the payment of finance lease liabilities, although many produced a T-account working, which was not needed. Others showed the total repayment as a cash outflow, failing to reduce that total by the interest element. Similarly, although a good number of candidates included the correct figure for the acquisition of the associate, many produced an unnecessary T-account working and arrived at a figure for dividends received because they omitted the share of the associate s profit from their calculation. Most candidates made a very good attempt at the reconciliation note with almost all including the necessary figures. The most common errors were on the movements in trade and other receivables/payables, where a good number failed to adjust for assets acquired with the subsidiary, or adjusted for them in the wrong direction. Candidates who did not provide workings for these movements and arrived at incorrect figures risked losing all of the marks for these items. Other common errors included the following: Failing to credit the non-controlling interest acquired in the year to a non-controlling interest T- account, even if that figure had been correctly calculated when calculating goodwill arising on the acquisition of the subsidiary. Failing to reduce the cash paid for the subsidiary by the cash acquired (with some adjusting closing cash and cash equivalents by this amount). A small minority included the share consideration. Missing one or more of the three sources of property, plant and equipment acquired in the year when constructing the property, plant and equipment T-account (the cash purchase, the purchase of the leased asset and/or the property, plant and equipment acquired with the subsidiary). Merging the figures for acquisition of the subsidiary and acquisition of the associate but calling them one or the other. Total possible marks Maximum full marks 21 21 Copyright ICAEW 2013. All rights reserved. Page 9 of 15

Question 3 Overall marks for this question can be analysed as follows: Total: 13 General comments This question mixed two discrete topics. Part (a) required extracts from the drafted financial statements in respect of other receivables and provisions, revenue and profit for the year. Topics covered were revenue recognition, contingent assets and provisions. Part b) covered conceptual issues, candidates were required to identify and explain the inherent limitations of financial statements with reference to the two fundamental qualitative characteristics. Caribea Ltd (1) Revenue Draft 1,160,800 Advertising ((6,600 x 5) x 3/12) (8,250) Franchise revenue (((12,000 x 6) x 3/12) + (12,000 x 4) x 11/12)) (62,000) Agency sales (9,300 x 85%) (7,905) 1,082,645 (2) Profit for the year Draft 549,700 Revenue adjustment (8,250 + 62,000 + 7,905) (78,155) Contingent asset crystallised (8,000 x 75%) 6,000 Provision increase (115,000 100,000) (15,000) 462,545 (3) Other receivables Draft 8,400 Receivable contingent asset 6,000 14,400 (4) Provisions Draft 145,000 Increase in year 15,000 160,000 Copyright ICAEW 2013. All rights reserved. Page 10 of 15

Answers to this part of the question were disappointing with very few candidates gaining full marks even with the headroom given in the answer. A significant number of candidates simply missed out this part of the question thus affecting the average reported for the question as nil responses are not separately reported in the final results. This question had some very straight forward elements to it and a number of marks were available simply for transferring figures from the questions into candidate workings. Many answers were not clearly laid out frequently a number of calculations were given but there was no indication as to whether the numbers were to be added or subtracted and/or whether they related to profit and/or revenue. Few candidates seemed to understand the difference between a contingent asset previously disclosed which could now be recognised and a provision that had been recognised but needed to be adjusted to reflect the amount actually settled. Other common errors included: Failing to adjust the advertising revenue for the three months relating to the following year and/or not recognising that there were five customers who had each paid for advertising up front. Time apportioning the initial set up fees re the franchise agreements. Only adjusting profit (rather than revenue and profit) for the impact of the franchise fees. Adjusting revenue as well as/instead of profit for the impact of the contingent asset and liability. A number of candidates seemed to misread the scenario completely and made adjustments to increase rather than decrease revenue. Total possible marks Maximum full marks 8 7 Copyright ICAEW 2013. All rights reserved. Page 11 of 15

(b) Limitations of financial statements The two fundamental qualitative characteristics are relevance and faithful presentation. The financial statements have a number of limitations: - The statement of financial position is prepared to a specific date, the information, when published is therefore historic. Although, historic information is useful as it is exact, reliable, it does not provide users with current valuation information, ie how much the assets are currently worth and therefore is not as relevant to a user as it could be. However, for information to be complete and therefore faithful it needs to be prepared to a specified date in time. - The statement of financial position is prepared in a standardised manner in terms of overall format and presentation with much of the information aggregated. While this means that it is easier to compare information between companies because it is presented in a similar manner it also means that the content of standardised and aggregated information may be difficult to identify. This does mean that again information may not be as relevant to a user as it could be, as specific information may be hidden by being aggregated, however it does mean that it is neutral as there is less ability to manipulate information via presentation and hence the financial statements are presented faithfully - Financial statements generally, only contain a limited amount of narrative information about the business, which includes information about the assets and liabilities of the company. Narrative information provides valuable information about what the company s plans are for the future and the risks it faces. - Internally generated assets, such as goodwill (the reputation of the company), are not recognised in the statement of the financial position even though this is usually a significant part of a company s value. If a company did provide information about the value that it placed on its business reputation this would not be suitable to form part of the financial statements. Again this means that the relevance of the financial statements is limited. - Financial statements include the use of estimates and judgements which limits the exact nature of figures. For example, a provision is uncertain by its very nature. Overall performance on this part of the question was disappointing although not inconsistent with previous sittings. The vast majority of candidates correctly identified the two fundamental qualitative characteristics. However many candidates spent the majority of their time giving lengthy explanations of what these characteristics meant and/or focusing on the advantages of applying the characteristics. Most candidates did manage to come up with some sensible disadvantages although answers were often too brief to obtain really good marks. Total possible marks Maximum full marks 9½ 6 Copyright ICAEW 2013. All rights reserved. Page 12 of 15

Question 4 Overall marks for this question can be analysed as follows: Total: 21 General comments This question required the preparation of a consolidated statement of financial position. The group had a subsidiary and an associate. Fair value adjustments were required on acquisition of both companies. Intercompany trading took place during the year between the parent and associate and the parent sold a noncurrent asset to the subsidiary during the period. Tritoma plc (a) Consolidated statement of financial position as at 30 September 2012 Assets Non-current assets Property, plant and equipment (1,174,000 + 216,200 10,000) 1,380,200 Investments (878,000 78,000 300,000) 500,000 Investment in associate (W4) 80,030 Goodwill (W2) 104,415 2,064,645 Current assets Inventories (121,600 + 78,800 + 8,850 (W1) + 1,275 (W1)) 210,525 Trade and other receivables (41,600 + 49,600) 91,200 Cash and cash equivalents (24,800 + 1,900) 26,700 328,425 Total assets 2,393,070 Equity and liabilities Equity Ordinary share capital 620,000 Share premium account 405,000 Revaluation surplus (410,800 + (50,000 x 85%)) 453,300 Retained earnings (W5) 636,889 Attributable to the equity holders of Tritoma plc 2,115,189 Non-controlling interest (W3) 51,131 Equity 2,166,320 Current liabilities Trade and other payables (148,300 + 11,700) 160,000 Taxation (62,700 + 4,050) 66,750 226,750 Total equity and liabilities 2,393,070 Workings (1) Net assets Scabiosa Ltd 30 Sept 2012 Acquisition Post acq Share capital 80,000 80,000 Share premium account 40,000 40,000 Retained earnings 90,750 31,600 59,150 Inventory sale or return (11,800 x 75%) 8,850 8,850 FV adj inventories (62,000 53,500) / (x 15%) 1,275 8,500 (7,225) 220,875 160,100 60,775 Revaluation surplus 120,000 70,000 50,000 340,875 230,100 110,775 Copyright ICAEW 2013. All rights reserved. Page 13 of 15

(2) Goodwill Scabiosa Ltd Consideration transferred 300,000 Net assets at acquisition (W1) (230,100) Non-controlling interest at acquisition (230,100 (W1) x 15%) 34,515 104,415 (3) Non-controlling interest Scabiosa Ltd share of net assets (340,875 (W1) x 15%) 51,131 (4) Investments in associates Anemone Ltd Cost 78,000 Add: Share of post-acquisition profits ((84,050 52,250) x 35%) 11,130 Less: FV depreciation ((50,000 / 20yrs) x 35% x 10yrs) (8,750) Less: PURP (W6) (350) 80,030 (5) Retained earnings Tritoma plc 593,200 Scabiosa Ltd (60,775 (W1) x 85%) 51,659 Anemone Ltd (W4) 11,130 Less: FV depreciation (W4) (8,750) Less: PURP (W6) (350) Less: PPE PURP (W7) (10,000) 636,889 (6) PURP Scabiosa Ltd % SP 100 10,000 Cost (20,000 / 30,000 x 70%) (70) (7,000) GP 30 3,000 X 1 / 3 1,000 Scabiosa Ltd 1,000 x 35% = 350 (7) PPE PURP Tritoma plc Asset now in Scabiosa Ltd s books at 90,000 x 5/6 yrs 75,000 Asset would have been in Tritoma plc s books at 78,000 x 5/6 yrs (65,000) 10,000 Copyright ICAEW 2013. All rights reserved. Page 14 of 15

Candidate performance on this question was fairly reasonable. The most common error related to the treatment of the goods sold on a sale or return basis with many candidates completely ignoring this information or sometimes calculating the relevant cost and profit but then failing to make the appropriate adjustments for it. Other common errors included: Failing to add the parent company s share of the post acquisition movement on the subsidiary s revaluation surplus to the consolidated revaluation surplus (either by adding 100% of the movement or 100% of the closing balance or ignoring it). Deducting, rather than adding, the fair value adjustment relating to inventory held at acquisition (even candidates who did deal correctly with this in the net asset working often then deducted it from inventory on the face of the consolidated statement of financial position). Failing to recognise only the group share of the PURP re the inventory sold to the associate. Failing to recognise that the extra depreciation to reflect the fair value of the property held by the associate at acquisition needed to be a cumulative adjustment (ie for the ten years since acquisition) and/or, failing to recognise only the group share. Not demonstrating a clear understanding of which figures should appear in both retained earnings and investment in associate. Finally it was also very noticeable that those candidates who calculated the PURP on the noncurrent asset transfer in two steps (ie profit on disposal followed by the impact on depreciation) nearly always added the two figures rather than netting them off. Total possible marks Maximum full marks 23 21 Copyright ICAEW 2013. All rights reserved. Page 15 of 15