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ACCA
Paper F7 (INT)
Financial Reporting
June 2011
Final Assessment – Answers
To gain maximum benefit, do not refer to these answers until you have completed the final assessment questions and submitted them for marking.
ACCA F7 (INT) FINANCIAL REPORTING
2 KAPLAN PUBLISHING
© Kaplan Financial Limited, 2010
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FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 3
ANSWER 1
(a) Consolidated Statement of Financial Position for Pierre group as at 31 December 2008
Non-current assets $000 $000Goodwill (W3) 14,000
Property, plant and equipment (144,000 + 100,000 + (5,000 + 4,000 – 1,500 fair value adj (W2))
251,500
Investment in Associate (W6) 28,000
Investments (113,000 – 90,000 (W3) – 15,000 (W3))
8,000
––––––– 301,500 Current assets Inventory (40,000 + 32,000 – 5,000 (W7)) 67,000
Receivables (48,800 + 30,000 – 5,000 intra-company receivable) 73,800
Bank (9,000 + 8,000) 17,000
––––––– 157,800 ––––––– 459,300 ––––––– Equity Share capital 100,000
Group reserves (W5) 172,800
Non-controlling interests (W4) 24,500
––––––– 297,300
ACCA F7 (INT) FINANCIAL REPORTING
4 KAPLAN PUBLISHING
Non-current liabilities Loan notes (60,000 + 36,000) 96,000
Contingent consideration 10,000
–––––– 106,000 Current liabilities Trade payables (30,000 + 18,000 – 5,000 inter-co payable) 43,000
Taxation (6,000 + 7,000) 13,000
–––––– 56,000 –––––– 459,300 ––––––
Working paper
(W1) Group structure
Pierre
Simone
56,000 / 70,000 = 80% Alberta
01/10/06 = 2 years ago
25%
01/04/07 = 18 months ago
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 5
(W2) Net assets
@ acq’n @ reporting date
$000 $000
Share capital 70,000 70,000
Retained earnings 30,000 39,000
––––––– ––––––– 100,000 109,000
Fair value adj:
Land (15,000 – 10,000) 5,000 5,000
Plant (44,000 – 40,000) 4,000 4,000
Fair value dep’n: ((4,000 / 4yrs) × 1 ½ years) –
(1,500)
––––––– ––––––– 109,000 116,500 ––––––– ––––––– (W3)
$7,500 (W4 / W5)
post-acq profit
ACCA F7 (INT) FINANCIAL REPORTING
6 KAPLAN PUBLISHING
(W3) Goodwill
$000 Parent holding at fair value – Cash paid – Contingent consideration (at fair value)
90,000
10,000
_______
100,000
NCI value at acquisition
23,000
_______ 123,000
Fair value of net assets at acquisition (W2)
(109,000)
–––––––
Total goodwill 14,000 _______
(W4) Non-controlling interest
$000 NCI value at acquisition 23,000
20% post-acquisition profit (20% × $7,500 (W2))
1,500
______ 24,500
______
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 7
(W5) Group reserves
$000 100% Pierre retained earnings 158,800
80% Simone post-acq profit
(80% × $7,500 (W2))
6,000
25% Alberta post-acq profit
(25% × $56,000 (W2))
14,000
PURP (W7) – Simone (5,000)
PURP (W7) – Alberta
(1,000)
______ 172,800
______
(W6) Investment in Associate
Cost of investment 15,000
25% post-acq profit (25% × $56,000 (W2))
14,000
PURP (W7) – Alberta (1,000)
______ 28,000
______
(W7) PURP
$000
Simone
Left in stock $20,000
($20,000 / 133.3 × 33.3)
5,000
Alberta
Left in stock $16,000
($16,000 / 133.3 × 33.3) = $4,000 × 25%
1,000
Tutorial note: Parent = seller therefore goods remain with associate and as the associate was NOT added in on a line by line basis you cannot remove the goods from inventory!
Parent = seller, therefore:
Dr Group reserves – (W5)
Cr Inventory – CSFP
Parent = seller, therefore:
Dr Group reserves – (W5)
Cr Investment in associate – (W6)
ACCA F7 (INT) FINANCIAL REPORTING
8 KAPLAN PUBLISHING
(b) The difference in accounting treatment for Simone and Alberta is primarily due to the weighting of shares that Pierre holds in these companies.
Simone
Pierre has invested in 80% of the equity share capital of Simone which is likely to give them control over the operating and financial policies of the company. Simone is therefore treated as a subsidiary of Pierre. Consolidated statements are required to be prepared from the date of acquisition reflecting the group as a single economic entity.
Alberta
Pierre has invested in 25% of the equity share capital of Alberta which generally will not give control over the company operating and financial policies. Instead Pierre is generally deemed to have a significant influence over Alberta’s policies. The results of Alberta are not required to be consolidated but instead we equity account in accordance with IAS 28.
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 9
ANSWER 2
Statement of comprehensive income for Nemesis for the year ended 31 October 2008
$000 Continuing operations Revenue (216,000 – 12,000 (W1) – 9,800 (W3)) 194,200
COS (W2) (124,830)
––––––– Gross profit 69,370
Distribution costs (21,180 – 2,040 (W3)) (19,140)
Administration expenses (23,760 – 1,980 (W3)) (21,780)
––––––– Profit from operations 28,450
Finance costs:
Accrued interest Abbeyfax (W1) (360)
Loan note interest (72,000 × 8%) (5,760)
Investment income (4,680 + 1,350 (W4)) 6,030
––––––– Profit before tax 28,360
Tax (W5) (15,480)
––––––– Profit for year from continuing operations 12,880
Discontinuing operations Loss on discontinuing operation (W3) (3,870) ––––––– Total profit for the year 9,010
Other comprehensive Income Revaluation gain (W7) 3,000 ––––––– Total comprehensive income 12,010 –––––––
ACCA F7 (INT) FINANCIAL REPORTING
10 KAPLAN PUBLISHING
Statement of financial position for Nemesis as at 31 October 2008
$000 $000 Non-current assets Property, Plant and Equipment (W7) 220,000
Investment Property (W4) 46,350 ––––––– 266,350 Current assets Inventory (18,000 + 9,600 (W1)) 27,600
Trade receivables 22,500
Bank 10,800
–––––– 60,900 ––––––– 327,250 ––––––– Equity Share capital 90,000 Retained earnings (SOCIE) 109,930 Revaluation (SOCIE) 3,000 ––––––– 202,930 Non-current liabilities 8% Loan note 72,000
Deferred tax (W6) 6,480
–––––– 78,480 Current liabilities Loan from Abbeyfax (W1) 12,000
Accrued interest on sale and repurchase loan (W1) 360
Tax payable 23,400
Loan interest accrual (5,760 (payable) – 2,880 (paid)) 2,880
Trade payables 7,200
–––––– 45,840 ––––––– 327,250 –––––––
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 11
Statement of changes in equity for Nemesis for the year ended 31 October 2008
Share capital Retained earnings
Revaluation Reserve
Total
Bal at 1 November 2007 90,000 100,920 – 190,920
Profit for year (per income statement)
9,010
9,010
Revaluation gain (W7) 3,000 3,000
–––––– ––––––– ––––– ––––––– Bal at 31 October 2008 90,000 109,930 3,000 209,930 –––––– ––––––– ––––– –––––––
Working paper
(W1) Sale and repurchase agreement
“This is not a true sale but a short-term loan received from Abbeyfax, with a finance cost of $360,000”.
– Remove sale and treat as loan
Dr Revenue – I/S 12,000
Cr Loan from Abbeyfax – SFP 12,000
– Bring goods back into inventory
Dr Closing inventory – SFP 9,600
Cr Closing inventory – I/S 9,600
– Account for finance cost
Dr Finance costs – I/S 360
Cr Accrued interest – SFP 360
(W2) Cost of sales
$000 Per TB 91,080
Sale and repurchase (W1) (9,600)
Discontinued operation – COS (6,450)
Discontinued operation – loss on disposal (3,200)
Depreciation (W8) 53,000 ______
124,830 ______
Sales 12,000 125%
COS 9,600 100%
(12,000/120*100)
ACCA F7 (INT) FINANCIAL REPORTING
12 KAPLAN PUBLISHING
(W3) Discontinued operations
$000 Revenue 9,800 Cost of sales (6,450) Distribution costs (2,040) Admin expenses (1,980) Loss on disposal (3,200) ______
Loss in discontinued operations (3,870) ______
(W4) Investment property
$000 Bal at 1 November 2007 45,000 Bal at 31 October 2008 (45,000 + 3%)
46,350 ______
1,350 ______
(W5) Tax expense
$000 Year end estimate 23,400 Decrease in DT (W6) (6,120) Over provision (1,800) ______
15,480 ______
(W6) Deferred tax
$000 Bal at 1 November 2007 12,600 Decrease in deferred tax required 6,120 ______
Bal at 31 October 2008 (21,600 × 30%)
6,480 ______
Dr Investment property – SFP
Cr Investment income – I/S
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 13
(W7) Property, plant and equipment
$000 Carrying value at 1 November 2007 270,000 Revaluation (12,000 – 9,000) 3,000 Depreciation (W8) (53,000) ______
Carrying value at 31 October 2008
220,000 ______
(W8) Depreciation
$000 Building (12,000 / 15 years) 800 NB: depreciation applied to revalued amount as took place at the start of the year.
Other PPE (273,000 – 12,000) × 20% 52,200 ______
53,000 ______
Dr PPE
Cr Revaluation
Dr Dep’n expense
Cr Accumulated dep’n
ACCA F7 (INT) FINANCIAL REPORTING
14 KAPLAN PUBLISHING
ANSWER 3
(a) Statement of cash flows for the year ended 31 October 20X9
$000 $000 Cash flows from operating activities: Profit before tax 1,299
Finance costs 809
Depreciation 2,395
Amortisation of intangible assets (1,439– 1,765) 326
Increase in warranty provision (511 – 428) 83
Loss on sale of assets 50
–––––– 4,962
Increase in inventories (10,931 – 9,480) (1,451)
Increase in receivables (4,429 – 3,892) (537)
Decrease in payables (14,299 – 23,162) (8,863)
–––––– Cash generated from operations (5,889)
Interest paid (809)
Tax paid (W1) (496)
–––––– Net cash from operating activities (7,194)
Cash from investing activities: Proceeds from sale of property (965 – 50) 915
Purchase of plant and equipment (W2) (4,586)
–––––– Net cash from investing activities (3,671)
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 15
Cash flows from financing activities:
Issue of share capital (450 – 400 + 1,600 – 1,500) 150
Issue of interest bearing borrowings (6,950 – 1,500) 5,450
Repayment of finance leases (W3) (218)
Dividends paid (500)
–––––– Net cash from financing activities 4,882
–––––– Increase in cash and cash equivalents (3,658 – 7,518 + (2,123)) (5,983)
Cash and cash equivalents b/f 7,518
–––––– Cash and cash equivalents c/f (3,658 – 2,123) 1,535
––––––
Workings
(W1) Tax paid
Dr Cr $000 $000 b/f (108 + 250) 358 Income stat charge 672 Cash paid (bal fig) 496 c/f (234 + 300) 534 ––––– ––––– 1,030 1,030 ––––– –––––
(W2) Cash paid to acquire new non-current assets
Dr Cr $000 $000 b/f 13,918 F. lease assets 960 Disposal 965 Cash paid for new assets (bal fig)
4,586 Depreciation 2,395
c/f 16,104 ––––– ––––– 19,464 19,464 ––––– –––––
ACCA F7 (INT) FINANCIAL REPORTING
16 KAPLAN PUBLISHING
(W3) Cash paid under a finance lease
Dr Cr $000 $000 b/f (356 + 45) 401 Cash paid (bal fig) 218 New leases 960 c/f (993 + 150) 1,143 ––––– ––––– 1,361 1,361 ––––– –––––
(b) (i) The price earnings ratio is calculated by dividing market value per share by earnings per share. The ratio is a major stock market indicator of performance. A high P/E ratio suggests that there is confidence in the future prospects of the entity and that high growth is to be expected.
(ii) Gearing 20X9
Debt = 6,950 + 993 + 150 = 8,093
Ratio = 8,093 / (8,093 + 11,001) = 42.4% or 8,093 / 11,001 = 73.5%
Gearing 20X8
Debt = 1,500 + 356 + 45 = 1,901
Ratio = 1,901 / (1,901 + 10,724) = 15.1% or 1,901 / 10,724 = 17.7%
(iii) The gearing ratio has risen from a modest 15% in 20X8 to a moderate 42% in 20X9. There has been a significant increase in the level of borrowings and from the statement of cash flows it can be seen that, although some of this has been used for further investment in property, plant and equipment, it has also been used to finance the working capital of the business.
Both inventory and receivables have increased in the year and this, together with a considerable reduction in payables, is the most notable reason for the fall in the company’s cash balance of almost $6 million. The reason for the reduction in payables is not clear however it could be due to a withdrawal of or tightening of credit terms from suppliers.
Given the increase in borrowings this year the company may struggle to attract further debt finance in the near future, particularly given the relatively low interest cover, with profit from operations covering finance cost only 2.6 times (2,064/809).
To improve the gearing ratio, the company could look to raise further equity finance instead. However, its P/E ratio is below average which suggests a lack of confidence in the future prospects of the business. The share issue during the year has raised a premium of $2 (100/50) per share whereas previous issues appear to have raised an average of $3.75 (1,500/400).
Perhaps the company should concentrate on improving its working capital before seeking any further long term finance. It also holds some available for
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 17
ANSWER 4
(a) One of the primary characteristics of financial statements is reliability, i.e. they must faithfully represent the transactions and other events that have occurred. It can be possible for the economic substance of a transaction to be different from its strict legal position or ‘form’. Thus financial statements can only give a faithful representation of a company’s performance if the substance of its transactions is reported.
It is worth stressing that there will be very few transactions where their substance is different from their legal form, but for those where it is, they are usually very important. This is because they are material in terms of size or incidence, or because they may be intended to mislead.
Common features which may indicate that the substance of a transaction (or series of connected transactions) is different from its legal form are:
• Where the ownership of an asset does not rest with the party that is expected to experience the risks and reward relating to it (i.e. equivalent to control of the asset)
• Where a transaction is linked with other transactions. It is necessary to assess the substance of the series of connected transactions as a whole.
• The use of options within contracts. It may be that options are either almost certain to be (or not to be) exercised. In such cases these are not really options at all and should be ignored in determining commercial substance.
• Where assets are sold at values that differ from their fair values (either above or below).
Many complex transactions often contain several of the above features. Determining the true substance of transactions can be a difficult and sometimes subjective procedure.
(b) (i) Although this transaction has been treated as a sale, this is probably not its substance. The clause allowing Ramsden to repurchase the inventory makes this a sale and repurchase agreement. Assuming Ramsden acts rationally it will repurchase the inventory if its retail value at 31 March 2012 is more than $9,516,650 ($6.5 million plus compound interest at 10% for four years).
There is no indication in the question as to what the inventory is likely to be worth on 31 March 2012, however it is unlikely that a finance company will really want to acquire this inventory (it is not its normal line of business) and thus it would not have entered into the contract unless it believed Ramsden would repurchase the inventory.
If the above is correct the substance of the transaction is that of a secured loan rather than a sale. The required adjustments would therefore be:
• Remove $6.5 million from sales (debit) and treat this as a long term (4 year) loan
• Remove $4 million from cost of sales and treat this as inventory
• Accrued interest of $650,000 ($6.5 million x 10%) should be charged to the income statement and added to the carrying value of the loan.
ACCA F7 (INT) FINANCIAL REPORTING
18 KAPLAN PUBLISHING
(ii) Ramsden have treated the preference shares as equity however this is inappropriate. In substance, the preference shares have the characteristics of debt, as they are repayable and carry a fixed rate of return over the period up to redemption.
The preference shares should therefore be treated as a liability in the statement of financial position and a finance cost should be recognised, using the amortised cost method, based on the effective rate of 12%. This is in accordance with IASs 32 and 39.
In the year ended 31 March 2010 a finance cost of $2.4 million should be expensed and the closing balance on the preference share liability at the year end should be $20.8 million (= $20 million opening balance plus $2.4 million finance cost less $1.6 million cash paid).
i.e.
Year b/fwd Int – 12% Paid – 8% c/fwd
1 20,000 2,400 1,600 20,800
The adjustments required are therefore as follows:
• Record $20.8 million as a liability (credit)
• Reduce equity by $18.4 million – representing the $20 million balance recorded less the dividend deducted of $1.6 million (debit)
• Reduce profit (increase finance costs) by $2.4 million reflecting the finance cost (debit)
FINAL ASSESSMENT ANSWERS
KAPLAN PUBLISHING 19
ANSWER 5
(a) In order to be useful, information must be reliable and the two main components of reliability are freedom from material error and faithful representation. The Framework describes faithful representation as where the financial statements (or other information) have the characteristic that they faithfully represent the transactions and other events that have occurred. Thus a statement of financial position should faithfully represent transactions that result in assets, liabilities and equity of an entity. Some would refer to this as showing a true and fair view.
An essential element of faithful representation is the application of the concept of substance over form. IAS 17 Leases applies the concept of substance over form to assets that a company may use, but not legally own. A finance lease is a lease that substantially transfers the risks and rewards of ownership of an asset to the lessee. Even though the lessee does not legally own the asset, if it controls it and then retains the risks and rewards of ownership the asset and liability should be recognised in the lessee’s financial statements. This is so the commercial reality (purchase an asset with finance from the leasing company) of the transaction can be shown rather than its legal form.
(b) The lease should be categorised as a finance lease in accordance with IAS 17 Leases as the risks and rewards associated with the ownership of an asset have been passed to the lessee (i.e. Peri pays to insure, repair & maintain the asset and gets to use it for its useful economic life). In addition, the lease has been modified for Peri’s use which makes it more difficult for the leasing company to sell/re-lease the asset
Income statement extract
$ Depreciation expense (W2) 15,000 Finance costs (W3) 4,807
Statement of financial position extract
$ Non-current assets Cost (W1) 150,000 Accumulated depreciation (W2) (15,000) –––––– 135,000 Non-current liabilities Obligations under a finance lease(W3) 89,614 Current liabilities Accrued interest (W3) 4,807 Obligations under a finance lease (W3) (119,807 – 89,614 – 4,807)
25,386
ACCA F7 (INT) FINANCIAL REPORTING
20 KAPLAN PUBLISHING
Workings
(W1) Recognise lease asset and liability at inception
Dr Non-current asset cost a/c $150,000
Cr Finance lease obligation $150,000
(W2) Depreciation
Dr Depreciation expense $15,000
Cr Accumulated depreciation $15,000
(150,000/5 × 6/12)
(W3) Finance lease liability – amortised cost
Year b/fwd Rental Interest 8.36% (6/12)
c/fwd 31/03/10
Interest 8.36% (6/12)
c/fwd 30/09/10
1 150,000 (35,000) 4,807 119,807 4,807 124,614
2 124,614 (35,000) 89,614