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| CIMA F1 1
CIMA F1 Financial Reporting and Taxation
Student Notes
| CIMA F1 1
Contents
CIMA F1 ................................................................................................................................................................. 1
Syllabus Structure .................................................................................................................................................. 1
Exam Structure ...................................................................................................................................................... 1
Topic 1: Principles of Business Taxation ................................................................................................................. 1
The modern tax system ...................................................................................................................................... 1
Types of Tax........................................................................................................................................................... 1
Trading income .................................................................................................................................................. 1
Capital taxes ...................................................................................................................................................... 1
Indirect taxes ..................................................................................................................................................... 1
VAT .................................................................................................................................................................... 1
Employee Taxation ................................................................................................................................................ 1
International tax ................................................................................................................................................ 1
Administration ................................................................................................................................................... 1
Topic 2: Investments in Subsidiaries and Associates ............................................................................................... 1
Topic 3: The Consolidated statement of financial position ..................................................................................... 1
Topic 4: Consolidated Statement of profit or loss ................................................................................................... 1
Topic 5: Associates -CSOFP .................................................................................................................................... 1
Topic 6 – The Regulatory Environment ................................................................................................................... 1
International Financial Reporting Standards (IFRSs) ........................................................................................... 1
Topic 7: The Conceptual Framework ...................................................................................................................... 1
Topic 8: External Audit ........................................................................................................................................... 1
Topic 9: Code of ethics ........................................................................................................................................... 1
Topic 10: Corporate Governance ........................................................................................................................... 1
Topic 11: An introduction to published accounts ................................................................................................... 1
Topic 12: The Statement of cash flows ................................................................................................................... 1
Topic 13: Non current assets – Property, plant and equipment .............................................................................. 1
Intangible non-current assets ................................................................................................................................ 1
IAS 36: Impairment Testing .................................................................................................................................... 1
Topic 14: Non- current assets held for sale and discontinued operations ............................................................... 1
Topic 15: IAS 20 government grants and IAS 40 investment properties .................................................................. 1
IAS 40 Investment Properties ................................................................................................................................. 1
Topic 16: IAS 2, 8, 10, 34 and IFRS 8 ....................................................................................................................... 1
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IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.................................................................. 1
IAS 10 Events after the reporting date ................................................................................................................... 1
IFRS 8 Operating segments .................................................................................................................................... 1
Topic 17: IAS 12: Income Taxes .............................................................................................................................. 1
IAS 21: The effects of changes in foreign exchange rates........................................................................................ 1
Topic 19: IAS 19: Employee benefits ...................................................................................................................... 1
Topic 20: WCM – short-term finance and investments ........................................................................................... 1
Topic 21: Working Capital Management (WCM) .................................................................................................... 1
Investment in working capital ................................................................................................................................ 1
Topic 22: Working Capital Management – accounts receivable and payable .......................................................... 1
Topic 23: Working Capital Management – inventory control .................................................................................. 1
Topic 24: Working Capital Management – cash control .......................................................................................... 1
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A Regulatory environment for financial reporting and
corporate governance
10%
B Financial Accounting and Reporting 45%
C Management of working capital, cash and sources of short
term finance
20%
D Fundamentals of business taxation 25%
Maths Tables and formulae are also provided (see following page)
Syllabus Structure
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The exam will comprise of 60 questions covering all the learning outcomes for the syllabus. The time for each
exam is 90 minutes.
The types of questions that will be required to answer are:
Multiple choice
Multiple response
Fill the gap
Pull down list
Drag and drop
Item set
Exam Structure
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The Verb Hierarchy
Learning Objective Verbs Used Definition
1 Knowledge
What are you expected to
know
List
State
Define
Make a list of
Express, fully or clearly, the details of/facts of
Give the exact meaning of
2 Comprehension
What you are expected to
understand
Describe
Distinguish
Explain
Identify
Illustrate
Communicate the features of
Highlight the differences between
Make clear or intelligible / State the meaning of
Recognise, establish or select after consideration
Use an example to describe or explain something
3 Application
How you are expected to
apply the knowledge
Apply
Calculate / compute
Demonstrate
Prepare
Reconcile
Solve
Tabulate
Put to practical use
Ascertain or reckon mathematically
Prove with certainty or to exhibit by practical
means
Make or get ready for use
Make or prove consistent/compatible
Find an answer to
Arrange in a table
4 Analysis
How you are expected to
analyse the detail of what
you have learned
Analyse
Categorise
Compare and contrast
Construct
Discuss
Interpret
Produce
Examine in detail the structure of
Place into a defined class or division
Show the similarities and/or differences between
Build up or compile
Examine in detail by argument
Translate into intelligible or familiar terms
Create or bring into existence
5 Evaluation
How you are expected to
use your learning to
evaluate, make decision or
recommendations
Advise
Evaluate
Recommend
Counsel, inform or notify
Appraise or assess the value of
Advise on a course of action
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Learning outcome D1a – discuss the features of the types of indirect and direct taxation that typically apply to
an incorporated entity.
The principles of a modern tax system are:
Equity – to be fairly levied between one taxpayer and another
Efficiency – cheap and easy to collect
Economic impact – considers the way in which a tax should be collected
In Wealth of Nations, Adam Smith proposed that a good tax system should have the following characteristics:
Fair
Absolute
Convenient
Efficient
Topic 1: Principles of Business Taxation
The modern tax system
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Tax is either a direct or indirect tax
Direct taxes
Definition:
Tax imposed directly on the person or enterprise
required to pay the tax.
Indirect tax
Definition:
Tax is imposed on one part of the economy with the
intention that the burden is passed on to another.
Tax is imposed on the final consumer of the goods or
services
Examples:
Wages – income tax, usually deducted at source
Profits – trading income / business tax
Gains – tax on profits generated by the disposal of
an asset
Examples:
Unit taxes –excise duties A levy is $10 per litre
Ad valorem taxes –e.g sales tax
Property taxes on rental profits
Wealth taxes –on pension funds, insurance policies
and works of art
Consumption taxes – taxes imposed on the
consumption of goods and added to the purchase
price.
Taxable person is the person who is accountable for the tax payment.
However the person who pays the tax over maybe different. This is referred to as incidence.
Incidence is who is paying the tax. This can be split in to two categories:
Formal incidence
This is the individual who has direct contact with the
tax authorities.
- Legally obliged to pay the tax.
- VAT – the entity making the sale and charging
VAT on its sales and paying its net VAT to the tax
authority, through submitting a vat return
Actual / effective incidence
This is the person who actually ends up bearing the
cost of the tax.
- VAT – the consumer who bears the cost of the
tax when they purchase the goods
- CT – an entity being assessed for corporate
income tax by the tax authority
- An employee having tax deducted from salary
trough the PAYE system.
Types of Tax
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Terminology
Competent jurisdiction
The tax authority that has the legal power to assess and collect the taxes.
This is usually the responsibility of the central government and local authorities in that country. The tax law is
enforceable by sanction (fines and imprisonment)
Hypothecation
Certain taxes are devoted entirely to certain types of expenditure.
Tax gap
The difference between the total amount of tax due to be paid and the amount actually collected by the tax
authority. The tax authorities will aim to minimise this gap.
Tax rate structure
There are three types of taxes
1. Progressive taxes
These take an increasing proportion of income as income rises. The more you earn the higher the rate of
tax.
2. Proportional taxes
These take the same proportion of income as income rises. The rate will stay the same regardless of the
level of income
3. Regressive taxes
These take decreasing proportion of income as income rises. The rate decrease when income exceeds a
threshold.
Tax base
A tax base is something that is liable to tax, e.g. income or consumption of goods
Tax bases regularly used by governments are:
income – for example, income taxes and taxes on an entity’s profits;
capital or wealth – for example, taxes on capital gains and taxes on inherited wealth;
consumption – for example, excise duties and sales taxes/VAT.
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Scheduler system
Most countries separate different types of income into categories and have a set of rules to determine how that
income will be taxed. This is referred to as a scheduler system.
A scheduler system of taxation is a system that has a number of schedules that sets out how the different types of
income should be treated for tax purposes.
Different types of income being, trade, property interest etc...
Apply Your Knowledge 1
A customer purchases goods for $200, inclusive of VAT. From the customer’s point of view the VAT could be
said to be:
A: a direct tax with formal incidence.
B: an indirect tax with formal incidence.
C: a direct tax with effective incidence.
D: an indirect tax with effective incidence.
Apply Your Knowledge 2
Complete the following sentence.
A scheduler system of tax is ................................................................................... .
Apply Your Knowledge 3
Which ONE of the following defines the meaning of “hypothecation”?
A: a new tax law has to be passed each year to allow taxes to be legally collected.
B: the difference between the total amount of tax due to be paid and the amount actually collected by
the tax authority.
C: tax is deducted from amounts due before they are paid to the recipient.
D: the products of certain taxes are devoted to specific types of public expenditure.
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Learning outcome D3a – produce a corporate income tax computations from a given set of rules
The accounting profit needs to be adjusted for tax purposes as in many countries there are differences between
what the accounting standards allow and what the tax system allow.
To calculate the taxable trading profit there is a set proforma
Accounting profit x
Less income exempt from tax or taxed under other rules1
Add disallowable expenditure2
Depreciation3 x
Amortisation x
Entertaining x
Taxes x
Donation to political parties x
Loss on disposal of asset (SP – CV)3 x
Less Tax depreciation (x)
Taxable profit/(loss) x/(x)
The profits will then be charged at the appropriate rate for that accounting period. This rate will always be given
in the question.
1 is any income included in the accounting profit which does not relate to the main trading activity.
2 are expenses that have been deducted from the accounting profit, but for tax purposes are not allowed
3 The calculation is too subjective; this is replaced with tax deprecation.
Trading income
This detail is given in the
exam question
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Tax depreciation
An example of tax depreciation could be:
50% of additions to property, plant and equipment in the accounting period in
which they are recorded;
25% per year of the written-down value (i.e. cost minus previous allowances) in
subsequent accounting periods except that in which the asset is disposed of;
When an asset is disposed of a balancing charge or allowance will occur
This is calculated by taking
Proceeds x
Less: tax written down value (TWDV) (x)
Balancing allowance/ charge x
If proceeds greater than the TWDV = balancing charge (ADD)
If proceed are less than TWDV = balancing allowance (DEDUCT)
No tax depreciation is allowed on land.
Trading losses
When a company makes a trading loss the assessment for the tax year will be nil.
The company can claim loss relief based on the rules of the country’s tax regime.
The four methods that a Country can choose from when relieving trading losses of an entity are:
i. Carry forward against future trading profits of the same trade
ii. Offset against other income and chargeable gains of the same period
iii. Offset against other income and chargeable gains of the previous period
iv. Group relief
A company would transfer its loss to another group entity, so that entity could then offset the loss against taxable
profits. As a result the total group tax payable would be reduced for the year.
The question may tell you what to do with the losses.
Cessation of a business
Trading losses in the last period of trade can be carried back against profits of previous years to generate a tax
refund.
This detail is
given the
question
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Apply Your Knowledge 4
For the year ended 30 June 20X2 QC’s statement of profit or loss included a profit before tax of $131,000. QC’s
expenses included political donations of $7,000 and entertaining expenses of $5,000.
QC’s statement of financial position at 30 June 20X2 included plant and machinery with a carrying value of
$151,500. This is comprised of plant purchased on 1 July 20X0 at a cost of $180,000 and machinery purchased
on 1 October 20X1 at a cost of $50,000.
QC depreciates all plant and machinery on the straight line basis at 25% per year.
For QC the following information is relevant:
All expenses other than depreciation, amortisation, entertaining, taxes paid to other public bodies and
donations to political parties are tax deductible.
Tax depreciation is deductible as follows:
o 50% of additions to property, plant and equipment in the accounting period in which they are
recorded;
o 25% per year of the written-down value (i.e. cost minus previous allowances) in subsequent
accounting periods except that in which the asset is disposed of;
o No tax depreciation is allowed on land.
The corporate tax on profits is at a rate of 25%.
Required:
Calculate the tax payable by QC for the year to 30 June 20X2.
Apply Your Knowledge 5
BMX sold an asset on 31 March 20X3 for $20,000. The asset cost $180,000 and at 31 March 20X3 had
accumulated depreciation of $170,000.
The asset was eligible for tax depreciation and at 31 March 20X3 its accumulated tax depreciation was
$151,520.
What was the balancing charge on the disposal of the asset?
A: $8,480
B: $10,000
C: $18,480
D: $28,480
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Apply Your Knowledge 6
SMT is a small local corporate entity that delivers products to local businesses. The following is a summary of
SMT’s statement of profit or loss for the year ended 31 March 20X3:
$
Revenue 210,000
Expenses 167,000
Profit before tax 43,000
Expenses include depreciation charges of $17,500 for property. These properties qualified for tax depreciation
allowances of $20,600 in the year ended 31 March 20X3.
On 1 April 20X2 SMT had to replace its only delivery vehicle. The vehicle was sold for $2,000. At the date of
disposal the vehicle had a carrying value of $3,000 and a tax written down value of $2,000.
SMT’s replacement vehicle cost $37,000, has an expected useful life of 5 years with a residual value of $7,000.
The appropriate accounting entries for these vehicles have been included in the accounts.
SMT’s expenses include $5,400 for entertainment costs.
For SMT the following information is relevant:
All expenses other than depreciation, amortisation, entertaining, taxes paid to other public bodies and
donations to political parties are tax deductible.
Tax depreciation is deductible as follows:
o 50% of additions to property, plant and equipment in the accounting period in which they are
recorded;
o 25% per year of the written-down value (i.e. cost minus previous allowances) in subsequent
accounting periods except that in which the asset is disposed of;
o No tax depreciation is allowed on land.
The corporate tax on profits is at a rate of 25%.
Required:
Calculate the amount of tax that SMT is due to pay for the year ended 31 March 20X3.
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Apply Your Knowledge 7
CF, an entity resident in Country Y, had an accounting profit for the year ended 31 December 20X2 of
$840,000. The accounting profit was after charging depreciation of $62,000 and amortisation of development
costs of $25,000.
CF was entitled to a tax depreciation allowance of $61,000 for the year to 31 December 20X2.
For CF the following information is relevant:
All expenses other than depreciation, amortisation, entertaining, taxes paid to other public bodies and
donations to political parties are tax deductible.
The corporate tax on profits is at a rate of 25%.
CF’s tax payable for the year ended 31 December 20X2 is:
A: $202,250
B: $206,500
C: $212,750
D: $216,500
Apply Your Knowledge 8
Arnold Ltd has an accounting period ending 31/12/X2 and a taxable profit of £1,000,000.
The rates are as follows
01/04/X1 – 31/03/X2 25%
01/04/X2 – 31/03/X3 20%
Required:
Calculate the tax liability for the period ending 31/12/X2.
| CIMA F1 15
Capital losses
Most countries keep capital losses separate from trading activities.
Possible ways of relieving capital losses are:
Carry forward against future capital gains;
Carry back against previous capital gains;
Offset against trading income in the current period.
The examiner will tell you the treatment in the exam.
Group loss relief
Trading losses
Tax consolidation enables a tax group to be recognised, allowing
Trading losses to be surrendered to companies in the group, to save tax for the group as a whole
Surrendered only between resident companies
Maybe restricted to current accounting period losses only
Each company in the group will still
Produce their own individual accounts
Taxed individually
Capital losses
Usually cannot be surrendered between group companies
Can transfer ownership of assets under a nil gain/nil loss transfer
Gains and losses can then be matched when disposed to a third party, utilising the offset rules of gains
against capital losses
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Learning outcome D3b - produce a capital tax computations from a given set of rules
Capital tax gain is triggered when an entity sells and makes profits (gains) or losses on the disposal of investments
or other assets.
Examples
Properties, listed stocks and shares
To calculate the gain you would use the following proforma:
Notes
Selling price x Sale proceeds
Less selling costs x Legal fees, estate agent fees
Less allowable costs
Purchase x Original cost
Purchase costs x Legal fees, estate agent fees
Enhancement / improvement x
Import duties x
(x)
Less indexation allowance
(Cost X %) (x) Indexation % will be given to you in exam
Taxable Gain x
Tax at tax rate (Gain X %) x
The chargeable gain will be charged at the appropriate tax rate for that accounting period.
Some countries will allow an Annual exemption, which is an amount of the gain that will be tax free, so only the
amount in excess will be taxable. You will be told this amount if applicable.
Capital taxes
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Apply Your Knowledge 9
EHH is resident in Country Y. EHH purchased an asset on 1 April 20X1 for $620,000, incurring additional import
duties of $50,000. The relevant index increased by 30% in the period from 1 April 20X1 to 31 March 20X7.
EHH sold the asset on 31 March 20X7 for $900,000, incurring selling costs of $20,000.
The corporate tax on profits is at a rate of 25%.
Assume all purchase and selling costs are allowable for tax purposes.
Required:
How much tax was due from EHH on disposal of its asset?
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Interaction of corporate tax system with the personal tax system
Learning outcome D1a – discuss the features of the types of indirect and direct taxation that typically apply to
an incorporated entity.
Shareholder Business making profits
Dividends being paid to S/H
Classical system – The shareholder is treated as an independent entity from the company and therefore the
dividend is taxed twice
Imputation system – The shareholder receives a tax credit equal to the underlying corporate income tax paid by
the company. This will result in the dividends only being taxed once.
Partial imputation system – a tax credit to the shareholder but only for part of the underlying corporate income
tax paid by the company. (This is what happens in the UK)
Split rate system – These systems distinguish between distributed profits and retained profits and charge a lower
rate of corporate income tax on distributed profits to avoid the double taxation of dividends.
| CIMA F1 19
Re-characterising debt
As a general rule interest is an allowable deduction and dividends are not. It is therefore advantageous from a tax
point of view to obtain funds via loans instead of shares.
Governments have anti avoidance legislation in place to deter this from happening, called thin capitalisation.
The interest allowable will be capped, and the excess interest will be classified as a dividend and therefore not
allowable.
| CIMA F1 20
Apply Your Knowledge 11
COR is resident in Country X. COR makes a taxable profit of $750,000 and pays an equity dividend of
$350,000.
Equity shareholders pay tax on their dividend income at a rate of 30%.
If COR and its equity shareholders pay a total of $205,000 tax between them, what method of corporate
income tax is being used in Country X?
A: The classical system
B: The imputation system
C: The partial imputation system
D: The split rate system
(2 marks)
Apply Your Knowledge 12
JY, an entity resident in Country X, reported a taxable profit for the year to 31 June 20X2 and declared a
dividend for the year.
BM, a director and shareholder of JY, received a dividend payment from JY and is certain that the dividend he
received will have been taxed twice.
Country X applies a full imputation system to corporate income taxes.
Required:
Explain to BM how the imputation system of corporate income tax works AND whether his dividend will have
been taxed twice.
| CIMA F1 21
D1a – discuss the features of the types of indirect and direct taxation that typically apply to an incorporated
entity.
Unit taxes – this is a tax based on the number or weight of items e.g. excise duties a levy is $10 per litre
Characteristics of commodities
Few large producers
Inelastic demand with no close substitutes
Large sales volumes
Easy to define products covered by the duty
Ad valorem taxes – this is based on the value of items e.g. sales tax
Property taxes on rental profits
Wealth taxes – these are taxes on pension funds, insurance policies and works of art
Consumption taxes – taxes imposed on the consumption of goods and added to the purchase price.
Two types
Single stage taxes
Single stage sales tax is payable on sales at a specific
part of the trade cycle, e.g. retail sales. There is no
credit given to an entity for sales tax paid on
purchases.
Multi-stage sales tax
Tax charged each time a component or product is
sold
Two types
Cascade tax
Value added tax
Indirect taxes
| CIMA F1 22
Cascade tax
This is where tax is taken at each stage of production and is a business cost. An entity cannot claim the tax back.
Example
A peddle manufacturer sell peddles to a wholesaler who then sells it to a bike retailer. The bike retailer then
sells it to a consumer (James).
Peddle manufacture sells to the wholesaler for $100, the wholesaler sells to the bike retailer for $150, the
retailer then sells to James for $200. The tax rate is 15%
Calculate the total sales tax due.
Answer
100 x 15% = 15
150 x 15% = 22.5
200 x 15% = 30
Total vat on sales $67.50
Each business has to charge tax and pay over to the tax authorities. The $67.50 is not recoverable.
Apply Your Knowledge 13
An entity earns a profit of $60,000 for the year to 31 March 20X3. The entity is assessed as owing $15,000 tax
for the year. Which ONE of the following types of tax would best describe the tax due?
A: Capital tax.
B: Income tax.
C: Wealth tax.
D: Consumption tax.
Apply Your Knowledge 14
(i) Explain the difference between an excise duty and a single stage sales tax.
| CIMA F1 23
D1a – discuss the features of the types of indirect and direct taxation that typically apply to an incorporated
entity.
This is a tax based on the value of the items.
A taxable person making a taxable supply of goods or services must register for VAT in most countries once their taxable turnover reaches a certain limit.
VAT is charged each time a component or product is sold but the government allows businesses to claim back all the tax they have paid.
The entire tax burden is passed on to the final consumer.
Taxable supplies are standard rated and zero rated supplies. This results in Input VAT being reclaimed
If a company sell exempt supplies this is not an example of a taxable supply, therefore the entity cannot claim the VAT back on goods purchased for these exempt supplies.
Business Process
VAT
To calculate the VAT amount
Buzz words:
Exclusive (net of VAT)
Net x % = VAT
Inclusive (Gross) including VAT
Gross / (100 + Tax Rate) x Tax
Rate
Income statement if the company is VAT
registered;
Sales (net) Std/ zero x
Exempt supplies (gross) x
Less Taxable expenses (net) (x)
Exempt supplies (gross) (x)
Profit x
Goods being purchased (Input VAT)
Standard rated – 15% Rates table
Zero Rated – 0% Rates table
Higher Rate - Rates table
Exempt – Not subject to VAT (therefore no VAT)
Goods being sold (Output / sales tax)
Standard rated – 15% Rates table
Zero Rated – 0% Rates table
Exempt – Not subject to VAT (therefore no VAT)
| CIMA F1 24
Once registered for VAT the regulations will normally require an entity to:
Issue VAT invoices
Keep appropriate VAT records
Charge VAT on taxable supplies to customers
Complete a quarterly VAT return
Make payments to VAT authority and be able to claim back VAT when due
Apply Your Knowledge 15
HB is registered for VAT in Country X. HB is partially exempt for VAT purposes.
During the latest VAT period HB purchased materials and services costing $890,000 including VAT at standard
rate. These goods and services were used to produce standard rated, zero rated and exempt goods.
Goods supplied to customers (excluding VAT) were:
$
Goods at standard rate 920,000
Goods at zero rate 100,000
Exempt goods 250,000
The VAT rate is 20%
Assume HB had no other VAT related transactions.
Required:
(i) Once registered for VAT an entity must abide by the VAT regulations.
Identify FOUR typical requirements of VAT regulations.
(ii) Calculate the net VAT balance shown on HB’s VAT return for the period.
| CIMA F1 25
Apply Your Knowledge 16
JG sells two types of product, A and B. A is standard rated for VAT purposes and B is zero rated. All purchases
have incurred VAT at standard rate.
JG’s sales (inclusive of VAT where applicable) for the three months to 31 March 20X3 were:
$
A 68,750
B 24,150
92,900
JG’s purchases for the three months to 31 March 20X3 were $37,833 exclusive of VAT.
The VAT rate is 15%
Calculate the amount of VAT that JG is due to pay for the three months to 31 March 20X3.
(2 marks)
Apply Your Knowledge 17
JJ is registered for VAT in Country X.
JJ purchased a consignment of goods for $90,000 plus VAT at the standard rate and then sold the goods for
$161,000 inclusive of VAT at the standard rate.
The VAT rate is 15%
How much profit should JJ record in its statement of comprehensive income for this consignment?
A: $50,000
B: $57,500
C: $68,000
D: $77,130
(2 marks)
| CIMA F1 26
Apply Your Knowledge 18
T is an entity supplying goods and services to other businesses. T is registered for Value Added Tax (VAT) in
Country X. T is partially exempt for VAT purposes.
During the last VAT period T purchased materials and services costing $600,000 excluding VAT. T used these
goods and services to produce both standard and exempt supplies. VAT was payable at standard rate on all
purchases.
T supplied goods and services to its customers, some of these were at standard rate VAT and some were
exempt VAT.
Excluding VAT: $
Standard rate goods and services 650,000
Exempt supplies 150,000
At the end of the period T prepared a VAT return. Assume T had no other VAT related transactions.
The VAT rate is 22%
Required:
(i) Explain the difference between the treatment of items that are zero rated and items that are exempted
from VAT.
(ii) Calculate the net VAT balance shown on T’s VAT return.
Apply Your Knowledge 19
LM imports luxury goods in bulk. LM repackages the products and sells them to retailers. LM is registered for
Value Added Tax (VAT) in Country X.
LM imported a consignment of perfume costing $50,000, paying excise duty of 20% of cost. The consignment
was subject to VAT on the total (including duty). LM paid $9,775 repackaging costs, including VAT and sold the
perfume for $105,800 including VAT.
LM had not paid or received any VAT payments to or from the VAT authorities for this consignment.
The VAT rate is 15%
Required:
(i) Calculate the net VAT due to be paid by LM on the perfume consignment.
(ii) Calculate LM’s net profit on the perfume consignment.
| CIMA F1 27
Apply Your Knowledge 20
F is a business in Country X, that uses locally grown grapes to make country wines.
During 20X3 F paid $50,000 plus VAT for the ingredients and other running costs.
When the wine is bottled F pays $1 tax per bottle to the tax authority. During 20X3 F produced 12,000 bottles.
F sold all the wine to retailers for an average price of $9.05 per bottle, including VAT at standard rate.
The VAT rate is 15%
Required:
(i) Explain the difference between unit taxes and ad valorem taxes, using the scenario above to illustrate your
answer.
(3 marks)
(ii) Calculate the amounts of indirect tax payable by F for the year ended 31 December 20X3.
(2 marks)
Total for sub-question = (5 marks)
| CIMA F1 28
D1a – discuss the features of the types of indirect and direct taxation that typically apply to an incorporated
entity.
Employees are taxed on their earning under income tax:
The basis of assessment is based on the individual country; the examiner will state the basis.
Employees will be able to deduct allowable expenditure, which are wholly, exclusively and necessary for
employment.
Proforma for calculating the taxable employment income
Earnings
Salaries x
Bonuses x
Commissions x
Benefits – company cars, accommodation, medical insurance etc. x
Less allowable expenses
Business travel (x)
Contributions to company pension schemes (x)
Donations to charities under a payroll giving scheme (x)
Professional subscriptions (x)
Less personal allowance 1 (x)
Taxable employment income x
1 Personal allowance is an amount of an individual’s income that is tax free.
The entity pay the income tax on behalf of the employee, referred to as Pay As You Earn (PAYE).
The entity also pays social security taxes based on the salaries paid to the employees and on behalf of the
employee (in the UK this is national insurance).
Employee Taxation
| CIMA F1 29
The taxable income will be charged at the appropriate tax rate for the tax year. The tax year is the time frame that
is taxable.
Advantages of this type of collection for the government
Most of the administration costs are borne by the employer.
Government receives a higher proportion of the tax due as defaults and late payments are fewer.
Tax collected at source, making it less likely for the tax payer to default on payment
Tax authorities receive regular payments helps to budget cash flows for the government
Apply Your Knowledge 21
Danielle is a 22 year old accounts assistant and earns $20,000 per annum.
During the tax year, she also received a bonus of $5,000, and has a taxable benefit made up of a company car
and medical insurance worth $3, 500.
She also pays her accounting subscriptions of $200 which her company will not pay for.
Required:
Calculate the income tax liability for Danielle assuming the following:
a) The personal allowance is $10,000
b) The tax rates are as follows based on taxable earnings:
- 10% on the first 2,000
- 20% after that.
| CIMA F1 30
Learning outcome D1c – Explain the taxation issues that may apply to an incorporated entity that operates
internationally.
A company will pay tax on their worldwide income in the country they are resident in.
Resident status
An entity is deemed to be resident for tax purposes either
In the place of incorporation or
Place of control / central management
Under the OECD model tax convention an entity will generally have residence for tax purposes in the country of
its effective management
For example, where the decisions have been made, board meetings held, head office located.
The OECD model states that business profits of an entity will only be taxable in a state if an enterprise has a
permanent establishment in that country. A permanent establishment could include the following
A factory
An office
A branch
A place of management
The problem with the worldwide approach is that it leads to double taxation as income will usually be taxed in the
country where it is earned and again in the country where the holding entity is resident.
Double tax relief exists to reduce the total amount of tax payable on income earned in other countries. The effect
of double tax relief is to reduce the total tax payable to the higher of the two, the home country or overseas tax
rate.
Most countries applying the worldwide approach grant some form of relief from double taxation. Double tax
relief is given according to double tax agreements that a country has entered into.
The three main methods of giving double taxation relief are:
1. Exemption – the countries involved agree the types of income that will be exempt in one country or the
other.
International tax
| CIMA F1 31
2. Deduction – the foreign tax is deducted from the foreign income and the net amount is taxable in the
country of residence.
3. Tax credit – the tax paid in one country is allowed as a tax credit, at the lower tax rate (lower of the
foreign tax rate and country of residence tax rate) in another country.
Types of overseas operations
Subsidiary
Definition: a company incorporated and managed
overseas owned by a UK company.
Tax implication:-
Holding company will only pay tax on any
dividends received from the subsidiary
Loss relief is NOT available for the group
Assets transferred from holding company
may result in capital gains tax
The overseas subsidiary can NOT claim tax
depreciation on assets
Branch
Definition: an extension of the UK activity, for
example a factory
Tax implication:-
All profits will be subject to UK tax
Loss relief is available
Assets can be transferred between the
branch and holding company at a no gain/
no loss
The branch can claim tax depreciation on all
assets
Types of foreign tax
Withholding tax
This is overseas tax on income such as
Interest
Royalties
Rent
Gains
Dividends
The net income (gross payment less tax) is then received by the beneficiary in the foreign country.
The gross income (plus withholding and underlying tax) will be taxed at the relevant rate in the accounting period.
Which will result in the income being tax twice and triggering double taxation relief.
| CIMA F1 32
Underlying tax
Underlying tax is tax on the profits out of which an overseas entity has paid a dividend to its holding entity. E.g. A
subsidiary or associated entity pays a dividend out of its taxed profits. The underlying tax is the tax on its profits.
This is because the company’s profits have been taxed, and then the dividends which have been paid out of those
profits will also be taxed in the country of receipt.
This is known as underlying tax. It is calculated as follows:
Note : You will not be assessed on the calculation of foreign taxation but you should have a general appreciation
what it represents.
Apply Your Knowledge 22
Assume that Countries M; N; O and P each has a double tax treaty with each other based on the OECD model
tax convention.
JZ is incorporated in Country M
JZ earns the majority of its revenue from Country N
JZ holds its management board meetings in Country O
JZ raises most of its finance and operating capital in Country P
In which country will JZ be deemed to be resident for tax purposes?
A. Country M
B. Country N
C. Country O
D. Country P
(2 marks)
Tax on foreign profits
Foreign Profit after tax
X Gross dividends
| CIMA F1 33
Apply Your Knowledge 23
HND acquired an 80% holding in SUD on 1 April 20X2.
HND received a dividend from SUD of $156,000, the amount received is after deduction of withholding tax of
20%. SUD profit before tax was $650,000 and it paid corporate income tax of $130,000 in respect of these
profits.
Required:
(i) Explain the meaning of “underlying tax”.
(ii) Calculate the amount of underlying tax that HND can claim for double tax relief.
Apply Your Knowledge 24
HOC, resident in Country X for tax purposes, owns 100% of shares in a foreign entity, OC.
OC operates in a country that has a double taxation treaty with Country X that provides for the use of the tax
credit method of double taxation relief.
OC reported profits before tax of $800,000 with corporate income tax of $176,000 for the year ended 31
March 20X3.
OC paid HOC a dividend for the year ended 31 March 2013 of $250,000 gross which was subject to withholding
tax of 10%.
Required:
(i) Calculate the total foreign tax suffered on the dividend.
| CIMA F1 34
Learning outcome D1b – discuss the regulatory environment for taxation, including the distinction between tax
evasion and tax avoidance.
Record keeping
Corporate income tax
Must retain:
all records required to support the financial statement,
working papers to support the tax workings.
Sales tax
Must retain all the sales and purchases records
Orders and delivery notes
Purchase and sales invoices (UK and overseas)
Credit and debit notes
Purchase, sales, cash day books
Bank statements
VAT accounts
Overseas subsidiaries
Transfer pricing1 policy
1 Transfer pricing occurs when a connected company sells goods or services under market value. The tax authorities will want
an adjustment to go through the accounts to represent the same price as it would be charged to a third party.
Employee tax
Must retain
Detailed records of employee tax
Social security contributions
Year end returns
Details of the employees
Administration
| CIMA F1 35
Tax authorities set deadline for the payment of tax and submission of the tax return. The tax authorities will then
check the tax return to confirm if the correct tax has been paid.
Minimum retention of records
There will be a minimum length of time for retention of records (in the UK 6 years)
The purpose of this is to enable the tax authorities to question or challenge records earlier or later. Interest will
be charged on late payments of tax.
Powers of tax authorities
Tax authorities may be given various powers to enable them to enforce the tax regulations. These powers may
include:
Power to impose penalties and charge interest on late payments of tax.
Power to review and query tax returns filed by entities.
Power to request special reports from an entity if they believe the entity has given incorrect information.
Power to enter an entity’s premises and to search for and seize documents
Power to examine documents of previous years
Power to give information to foreign tax authorities
Tax evasion
Tax evasion is the illegal manipulation of the tax system to avoid paying tax.
Tax avoidance
Tax avoidance is tax planning to arrange tax affairs, within the scope of the law, to minimise the tax liability.
Imprecise and vague tax laws and very high tax rates are most likely to encourage an increase in the incidence of
tax avoidance or tax evasion.
The tax authorities use various methods to prevent both tax avoidance and tax evasion:
Reducing the opportunity
Simplifying tax structure
Auditing tax returns and payments
Developing good communication between tax authorities and enterprises
Changing social attitudes towards evasion and avoidance
Reducing lost revenue by reviewing the penalty structure
| CIMA F1 36
Source of tax rules
Legislation produced by a national government of the country
Precedents based on previous legislation, interpretations
Directives from international bodies
Agreements with different countries
Apply Your Knowledge 25
Maggie has reduced her tax bill by taking advice from a tax expert and investing her surplus cash in
government securities. The income from government securities is free of tax.
Steve works as a carer for a local entity and also has a job working in a garden centre during the day. Steve has
reduced his tax bill by declaring only his day job income on his annual tax return.
Required:
Explain the difference between tax evasion and tax avoidance, using Maggie and Steve to illustrate your answer.
| CIMA F1 37
B3a – Explain whether an investment in another entity constitutes a subsidiary or an associate relationship in
accordance with relevant international financial reporting standards
Purchase of shares in other companies
When one company purchases shares in another the basic accounting in their individual company accounts is
straightforward:
DR Investment in XX
CR Cash
(Assuming cash is used to finance the investment, as when one company buys shares in another it is relatively
common for one company to use another form of consideration, such as a share issue to finance the purchase).
The issue of group accounts
If the purchase of shares gives the investor no influence at all over the investee company then the issue of group
accounts will not arise. The investment is treated per IFRS 9 as a basic investment in shares. However if the
investment in shares is enough to give influence over the investee company then in addition to preparing
individual company accounts the investor company has a second set of accounts to prepare- the group accounts.
Group accounts are also known as consolidated financial statements.
Influence
Sometimes one company owns enough shares in another company that they actually control the investee
company. You will have control if you have power of the investee including the ability to direct its activities and
use that power to affect the amount of returns.
Control
IFRS 10 Consolidated financial statements adopts a principles based approach to determining control but the
clearest indicator is when the investor exercises the majority of the voting rights in an investee.
When control exists we refer to the investor as the parent and the investee as the subsidiary and we will need to
apply IFRS 3 Business combinations in preparing our consolidated financial statements.
Topic 2: Investments in Subsidiaries and Associates
| CIMA F1 38
Exemption from preparing financial statements
A parent need not present consolidated financial statements if and only if:
the parent itself is a wholly owned subsidiary or a partially owned subsidiary and all its other owners,
(including those not otherwise entitled to vote) have been informed about and do not object to the parent
not preparing consolidated financial statements.
the parent's debt or equity instruments are not traded in a public market.
the parent did not file its financial statements with a securities commission or other regulatory organisation.
the ultimate or any immediate parent of the parent produces consolidated financial statements available for
public use that comply with International Financial Reporting Standards.
| CIMA F1 39
Learning outcome B3c – produce consolidated statement of financial positon in accordance with relevant IFRS
for a group comprising of one or more subsidiaries (being wholly partially directly owned) including interest
acquired part way through the year
A group
A group exists where one entity controls another. Control is usually achieved by the purchase of more than 50%
of a company’s equity share capital (ESC).
This is because the first company, that is referred to as the holding or parent company (P say), has enough voting
power to appoint all the directors of the second company that we call the subsidiary (S say). P is, in effect, able to
manage S as if it were merely a department of P, rather than a separate entity. In strict legal terms P and S remain
distinct, but in economic substance (commercial reality) they can be regarded as a single unit (a ‘group’).
Topic 3: The Consolidated statement of financial position
P (Parent)
100%
S (Subsidiary)
| CIMA F1 40
Economic substance
The key principle underlying group accounts is the need to reflect the economic substance of the relationship. This
issue of control is much more than just owning 50%+ of the shares and IFRS 10 Consolidated Financial Statements
covers the issue of 'control' in full. For this session though we will assume that once a company has purchased at
least 51% of another company that 'control' exists.
To reflect the true economic substance of a group of companies we need to produce group accounts in addition to
the individual accounts prepared for each company within the group. One of the main methods of doing this is to
prepare ‘consolidated’ accounts using the ‘acquisition’ method.
The single entity concept
Business combinations consolidate the results and net assets of group members so as to display the group’s
affairs as those of a single economic entity. As already mentioned, this conflicts with the strict legal position that
each company is a distinct entity. Applying the single entity concept is a good example of the accounting principle
of showing economic substance over legal form.
| CIMA F1 41
Mechanics of Consolidation
When one company buys shares in another company the cash paid is recorded as an investment in the acquiring
company’s statement of financial position*.
A standard group accounting question will present you with the accounts of the parent company and the
accounts of the subsidiary and will require you to prepare consolidated accounts. Consolidated statement of
financial position* questions should be approached using the following set of standard workings.
Workings Required
(W1) Group structure and PURP
P
S
S
| CIMA F1 42
PURP – Provision for unrealised profit
We will be considering this in later questions. We always need to know if either the parent sold goods to the
subsidiary or the subsidiary sold goods to the parent.
If any of these goods are still held in inventory at the year end we will have an unrealised profit situation against
which we must make a provision.
(W2) Net assets of subsidiary
At date of acquisition At reporting date
$ $
Share Capital X X
Reserves:
Share Premium X X
Revaluation Reserve X X
Retained earnings X X
X X
(W3) (W4)
| CIMA F1 43
(W3) Goodwill
$
Cost of Parent holding (investment) at fair
value
X
Fair value of non-controlling interest X
Less
Fair value of net assets at acquisition (W2) (X)
Goodwill on acquisition X
Impairment (X)
Carrying value of Goodwill in SOFP X
(W4) Non-controlling interest
$
Fair value of NCI at date of acquisition (W3) X
Add
NCI % of subsidiary’s post acquisition
retained earnings
X
Less NCI % of impairment (Fair value method
only)
(X)
Carrying value of NCI in SOFP X
| CIMA F1 44
(W5) Group retained earnings
$
100% Parent retained earnings X
Parent’s % of subsidiary’s post acquisition retained
earnings
Less parent’s share of impairment (W3)
X
(X)
X
Other reserves (other components of equity):
Each reserve has a separate calculation still based on ownership so the calculation is the same as for retained
earnings
Having completed these core workings we then consolidate the statement of financial position itself – based on control and representing the single economic entity
IFRS 3 Business Combinations - Goodwill
Purchased goodwill is the difference between the purchase consideration and the fair value of the identifiable
assets, liabilities and contingent liabilities.
The group recognises goodwill at cost at the date of acquisition as an intangible non-current asset. Goodwill is
reviewed annually for any impairment.
Negative goodwill arises when the purchase consideration is less than the fair value of the net assets acquired.
The first step is to check the accuracy of the calculation. If it proved accurate it should be credited directly to the
income statement.
Inherent goodwill or non-purchased goodwill should never be included in the statement of financial position.
Goodwill methods
IFRS 3 allows two methods to be used to calculate the value of NCI's holding at the date of acquisition:
Fair value
Proportion of net assets
| CIMA F1 45
Fair value method
The fair value of the NCI's interests may be calculated using the market value of the subsidiary's shares at the
date of acquisition or other valuation techniques if the subsidiary's shares are not traded in an active market. You
will be given the fair value of the NCI in the assessment if you are asked to use this method.
Proportion of net assets method
Under this method, the NCI's holding is measured by calculating their share of the fair value of the subsidiary's
net assets at acquisition (W2).
| CIMA F1 46
Consolidated Statement of Financial Position at 31 December 20X4
$’000
Non Current Assets
Goodwill (W3) X
Tangible (100% P + S) X
Current Assets
Inventory (100% P + S) X
Receivables (100% P + S) X
Bank & cash (100% P + S) X
X
Share Capital (Parent only) X
Share Premium (Parent Only) X
Group retained earnings (W5)
Non controlling Interest (W4)
X
X
Non-current liabilities (100% P + S) X
Current liabilities (100% P + S) X
X
| CIMA F1 47
Apply Your Knowledge 1
Summarised statements of financial position for the year to 31 December 20X8 Paula Sophie $ $ Non Current Assets PPE 2,000 1.000 Investment in Sophie 1,200 -
Current Assets 1,600 1,200
4,800 2,200
Equity Shares of $1 each 1,000 400 Retained earnings 1,600 800 Current liabilities 2,200 1,000
4,800 2,200
1) Paula purchased 80% of the ordinary shares of Sophie for $1,200 two years ago when Sophie had
retained earnings of $200.
2) Goodwill arising on acquisition of Sophie has suffered no impairment to date.
3) NCI should be valued using proportion of net assets method. Required:
a) Prepare the consolidated statement of financial position for the Paula Group as at 31 December 20X8. b) Prepare the consolidated statement of financial position for Paula groups as at 31 December 20X8 using
the fair value method assuming goodwill was valued at a fair value method assuming NCI was valued at $300,000 at acquisition.
| CIMA F1 48
Impairment of goodwill
IFRS 3 requires that goodwill is tested at each reporting date for impairment. This means that goodwill is
reviewed to ensure that its value is not overstated in the consolidated statement of financial position.
Fair value method
When valuing NCI at the fair value method we should record the impairment loss by:
Dr NCI to reduce NCI (W4) by the NCI % of the impairment loss
DR GRE to reduce retained earnings for the group (W5) by the parent's % of the impairment loss
Cr goodwill to reduce goodwill (W3) by the full impairment loss
Proportion of net assets method
When valuing NCI at the proportion of net assets method we should record the impairment loss by:
Dr GRE to reduce retained earnings for the group (W5) by the full impairment loss
Cr Goodwill to reduce goodwill (W3) by the full impairment loss
Intra group transactions
IFRS 10 requires all transaction and balances between group companies to be eliminated on consolidation.
Consolidated financial statements treat the two companies as if they are one. If the parent has sold goods to the
subsidiary there could be receivable and payable balances between them at the end of the year.
If this is the case, ask yourself this – will the parent receive cash from outside the group and, will the subsidiary
pay cash outside the group?
NO! Therefore these balances are not true outstanding balances from a group point of view and need to be
cancelled otherwise receivables and payables would be overstated. The same is true for any balance between
parent and subsidiary.
When goods are sold by one company in a group to another in the same group a cancellation would be required to
remove, in accordance with IFRS 10’s single entity concept, the receivable/payable amount on the group statement
of financial position.
| CIMA F1 49
Unrealised Profit – Inventory
If, for example, a parent sells to a subsidiary and the subsidiary has not sold on the goods by the year end an extra
adjustment is required to remove the ‘profit’ on the transaction.
STEP 1 Calculate the PURP (Provision for unrealised profit)
STEP 2 Make the adjustment
Seller Buyer
Cancel profit Reduce inventory
cost to the group
Apply Your Knowledge 1
P sells $100,000 (selling price) worth of goods to S (an 80% subsidiary) at cost plus 25% (25% mark-up).
S had not sold any of the goods outside the group by the end of the year.
Required:
Calculate the PUP and show the double entry for this transaction
Apply Your Knowledge 2
In the post acquisition period A’s sales to B were $50 million on which A had made a margin of 10% on these
sales. Of these goods, $7 million (at selling price to A) were still in the inventory of B at its year-end of 30
September 20X1. A holds a controlling interest of 70% in B.
Required:
Calculate the PUP and show the double entry for this transaction.
upMark
upMarkinventoryunsold
100
| CIMA F1 50
Apply Your Knowledge 3
Summarised statements of financial position as at 31 December 20X8 Mike Susan $ $ Non Current Assets PPE 1,800 1,000 Investment in Susan 1,600 -
Current Assets 1,400 1,200
4,800 2,200
Equity shares of $1 each 1,000 400 Retained earnings 1,600 800 Current liabilities 2,200 1,000
4,800 2,200
1) Mike purchased 75% of the ordinary shares of Susan for $1,600 two years ago when Susan retained earnings showed a balance of $400.
2) The fair value of non controlling interest at the date of acquisition was $600
3) Mike and Susan traded with each other during the year. At the end of the year Susan owed Mike $300. This is included in both sets of individual company figures. Also included in the inventory of Mike was $60 of goods purchased from Susan at mark up on cost of 25%.
Required:
Prepare the consolidated statement of financial position for the Mike Group as at 31 December 20X8 where impairment is $400.
| CIMA F1 51
Unrealised Profit – Non-current assets
It’s not just inventory that can be sold between group companies. It’s possible that non-current assets could also be transferred between group companies. Exactly the same principles apply – any profit made on the transfer should be cancelled and the non-current asset reduced to cost to the group.
The additional consideration would be depreciation. You must remember that the depreciation needs to be based on cost to the group. An adjustment to the NBV of the asset and profit may be necessary.
Apply Your Knowledge 4
On 1 July 2007 Max acquired 100% of the ordinary share capital of Paddy. The Max Group are now preparing group financial statements for the year ended 30 June 2008.
On the acquisition date Max sold an item of equipment to Paddy for $84,000. The asset originally cost $96,000 and has been written down to $64,000 as at 30 June 2007. Both companies depreciate plant and equipment on a straight line basis over 6 years. Paddy depreciated the cost of the asset over it’s remaining useful life of 4 years.
Required:
Show the journal adjustment that would be made for this intra-group transaction when preparing the group accounts for the year ended 30 June 2008.
Apply Your Knowledge 5
Club purchased 75% of the share capital of Green on the 1 April 20X2. Green sold a piece of machinery to Club
on 1 April 20X2 for $115,000. The machinery had previously been used in Green’s business and had been
included in green’s property, plant and equipment at a carrying value of $90,000. Green had recognised the
profit on disposal in revenue. The machinery had a remaining useful life of 5 years on 1 April 20X2.
Club’s year end is the 31st March 20X3
Required:
What adjustment is required for the 31 March 20X3 in reaction to the above transaction?
| CIMA F1 52
Apply Your Knowledge 6
Summarised statements of financial position as at 31 December 20X8 Bree Orson $ $ Non Current Assets PPE 4,000 1,600 Investment in Orson 1,800 -
Current Assets Inventory 500 360 Receivables 600 400 Bank 180 100
7,080 2,460
Equity shares of $1 each 2,000 400 Retained earnings 1,800 700 Non-current liabilities 1,000 200 Current liabilities 2,280 1,160
7,080 2,460
1) Bree purchased 70% of Orson for $1,800 three years ago when Orson’s retained earnings showed a
balance of $200.
2) Bree and Orson traded with each other during the year. At the year end Orson owed Bree $100. This is
included in both sets of individual company accounts. Also included in the inventory of Orson is goods
purchased from Bree for $100 at a mark up on cost of 25%.
3) Goodwill arising on acquisition of Orson has been impaired by $600.
4) NCI should be valued using the proportion of net assets method
Required:
Prepare the consolidated statement of financial position for the Bree Group as at 31 December 20X8.
| CIMA F1 53
Apply Your Knowledge 7
Summarised statements of financial position as at 31 May 20X9
Brooke Lucas
$ $ Non Current Assets PPE 20,000 12,000 Investments 12,000 -
Current Assets Inventory 12,000 2,000 Receivables 10,000 12,000 Bank 2,000 4,000
56,000 30,000
Equity shares of $1 each
24,000 8,000
Retained earnings 26,000 16,000 Current liabilities 6,000 6,000
56,000 30,000
1) Brooke acquired 80% of the ordinary shares of Lucas for $10,000 two years ago when retained earnings
of Lucas were $1,000. Brooke owed Lucas $1,500 in respect of group trading that had occurred during
the year. This balance is reflected in both companies’ statements of financial position.
2) Goodwill on acquisition has been impaired by a total of $150.
3) During the year Lucas sold $1,000 goods to Brooke at a mark-up of 25% on cost. Three quarters of these
goods had been sold by Brooke by the year end.
4) The fair value of non controlling interest at the date of acquisition was $2.50 per share of Lucas.
Required:
Prepare the consolidated statement of financial position as at 31 May 20X9
| CIMA F1 54
Learning outcome B3c – produce the statement of profit or loss and other comprehensive income in
accordance with relevant IFRS for a group comprising of one or more subsidiaries (being wholly partially
directly owned) including interest acquired part way through the year
Proforma CSOPL for a group with a 100% subsidiary.
Consolidated statement of profit or loss for the year ended …….....
$000 $000
Revenue (100% of P and S), less inter-company sales
Cost of sales (100% of P and S), less inter-company purchases, add unrealised profit in inventory
Gross profit (cast down)
Distribution costs (100% of P and S)
Administrative expenses (100% of P and S)
Profit from operations
Investment income (external only)
Finance cost (external only)
Profit before tax (cast down)
Income tax expense (100% P and S)
Profit for the year
OTHER COMPREHENSIVE INCOME
Revaluation gains (100% P and S)
Total comprehensive income
Amount attributable to:
Non-controlling interest
Group
Topic 4: Consolidated Statement of profit or loss
| CIMA F1 55
Apply Your Knowledge 1
Statements of profit or loss for the year ended 30 September 20X7
Peter Sasha
$ $
Revenue 200,000 160,000
Cost of sales (100,000) (60,000)
Gross profit 100,000 100,000
Operating expenses (40,000) (70,000)
Operating profit 60,000 30,000
Investment income
Finance costs
20,000
(8,000)
-
(9,000)
Profit before tax 72,000 21,000
Income tax expense (20,000) (10,000)
Profit for the year 52,000 11,000
1) Peter acquired 80% of Sasha on 1 October 20X6. The goodwill on acquisition of Sasha was $8,000 and
has been impaired by a total of $1,000 during the year. Impairment should be charged to operating expenses.
2) During the year Sasha sold $10,000 goods to Peter at a mark-up of 25% on cost, ¼ of those goods are
in inventory at the year end. 3) Sasha paid a dividend of $5,000 during the year which is included in the investment income of Peter.
4) Peter purchased 100,000 of Sasha’s 6% $1 loan notes on 1 October 20X6. Required:
a) Prepare the consolidated statement of profit or loss for the year to 30 September 20X7.
| CIMA F1 56
Mid year acquisition
If a subsidiary is acquired during the year then the results need to be time apportioned when preparing the group statement of profit or loss.
i.e. With a year end of December a subsidiary acquired on 1 October is only controlled by the group for 3 months
so only 3/12 of the results would go in the group statement of profit or loss.
Apply Your Knowledge 2
Statements of profit or loss for the year ended 31 December 20X8
Posh Spice
$m $m
Revenue 100 80
Cost of sales (60) (20)
Gross profit 40 60
Operating Expenses (25) (5)
Profit from operations 15 55
Investment income 12 -
Profit before tax 27 55
Income tax expense (5) (10)
Profit after tax 22 45
Retained earnings bfwd
30
10
Profit for the year
Dividend paid
Retained earnings cfwd
22
(5)
47
45
(10)
45
1) Posh acquired 80% of Spice on 1 October 20X8. Goodwill on the acquisition was $12m of which $4m has been impaired during this year.
2) Posh sold goods to Spice invoiced at $2m, including a mark up of 50%, half the goods remain in Spices’ inventory at the year end.
3) Spice paid a dividend of $10 million on 31 December 20X8
Required:
Prepare the consolidated statement of profit or loss for the Posh group for the year ended 31 December 20X8.
| CIMA F1 57
Learning outcome B3c – produce consolidated statement of financial positon and the statement of profit or loss
and other comprehensive income in accordance with relevant IFRS for a group comprising of one or more
subsidiaries (being wholly partially directly owned) or associates, including interest acquired part way through
the year
A shareholding of between 20% and 50% is assumed to give the investing company significant influence over its
investment.
This means it is treated as an associate and equity is accounted for in accordance with IAS 28 (no line by line
consolidation).
IAS 28 states that significant influence can be shown by:
Representation on the board of directors
Participation in the policy making processes
Material transactions between the investor and investee
Interchange of managerial personnel
Provision of essential technical information
The Mechanics of Equity accounting
Group Statement of financial position
Group structure, net assets and goodwill calculations are all calculated in the same way as they would be for a
subsidiary. No non-controlling interest calculation is needed. Group reserves are required as normal.
An extra working (W6) is required. This is entitled investment in associate and is calculated as follows:
Cost of investment in A
X
ADD post acquisition reserves (W5)
LESS impairment of associates goodwill
X
(X)
X
In non-current assets section of the Group
Statement of Financial Position
Topic 5: Associates -CSOFP
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Apply Your Knowledge 1
Statements of Financial Position at 30 September 20X2:
AZ PQ SY
$000 $000 $000
Non-Current Assets
PPE (note vii) 400 297 380
Investments:
100,000 Equity shares
in PQ at cost(i) to (iii)
500 - -
80,000 Equity shares
in SY at cost (iv)
125 - -
1,025 297 380
Current Assets
Inventory (vi) 190 60 160
Trade Receivables 144 63 88
Cash and cash equivalents
48 21 73
382 144 321
Total Assets 1,407 441 701
Equity and Liabilities
Equity shares of $1 each 900 100 400
Share premium 300 50 100
Retained earnings 111 112 95
Revaluation Reserve 60
1,311 322 595
Current liabilities
Trade payables 96 119 106
Total Equity and Liabilities 1,407 441 701
Additional information:
(i) AZ acquired 75% of PQ’s equity shares on 1 October 20X0 for $500,000. PQ’s retained earnings at 1 October 20X0 were $38,000.
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(ii) AZ carried out an impairment review of the goodwill arising on acquisition of PQ and found that as at 30 September 20X2 the goodwill had been impaired by $20,000.
(iii) AZ purchased its shareholding in SY on 1 October 20X1for $125,000. The fair value of all SY’s net assets was the same as their carrying value at that date. AZ exercises significant influence over all aspects of SY’s financial and operating policies.
(iv) The Statements of profit or loss for the year ended 30 September 20X2 showed the following amounts for the profit for the year for each entity:
$000
AZ 67
PQ 49
SY 55
(v) During August 20X2 PQ sold goods to AZ for $52,000 at a mark up of 331/3 on cost. At 30 September 20X2 all of the goods remained in AZ’s closing inventory & AZ had not paid for the goods.
(vi) AZ sold a piece of machinery to PQ on 1 October 20X1 for $74,000. The machinery had previously been used in AZ’s business and had been included in AZ’s property, plant and equipment at a carrying value of $50,000. The machine had a remaining useful life of 4 years at that date. Profit on disposal was included in revenue.
(vii) AZ made a payment to PQ for $60,000 on 30September 20X2 which was not recorded by PQ until 5 October 20X2.
(viii) NCI should be calculated using the fair value method assuming a value at acquisition of $125,000 Required: Prepare the consolidated statement of financial position for AZ as at 30 September 20X2, in accordance with the requirements of IFRS.
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Associates in a Consolidate statement of profit or loss
The income from associate goes under operating profit on the group statement of profit or loss.
A proforma CSPL- 100% Sub and 30% Associate
$000 $000
Sales revenue (100% of P and S), less inter-company sales
Cost of sales (100% of P and S), less inter-company purchases , add unrealised profit in inventory
Gross profit
Administrative expenses (100% of P and S)
Distribution costs (100% of P and S)
Profit from operations
Share of profits of associates(30% of Assoc PAT) – impairment of associates goodwill
Investment income (external only)
Interest payable (100% P and S)
Profit before tax (cast down)
Taxation
Group (100% P and S)
Profit for the year
OTHER COMPREHENSIVE INCOME
Revaluation gains
Total comprehensive income
Amount attributable to:
Equity holders of the parent
Non-controlling interests (20% of S’s profit after tax)
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Unrealised profit in inventory
Although the associate is not in the group the equity method introduces part of the results and balances of the
associate into the group. If there has been trading between the group and the associate, then inventory balances
may mean adjustments are necessary.
However, it will only ever be the groups share of the associate that is introduced so the unrealised profit
calculation is
x GROUP SHARE
Examples:
Parent sells to the associate – the parent has recognised profits on inventory that will be brought back into the
group within the share of net assets of the associate.
CSOFP
Dr Group retained earnings (cancel profit on goods still in the group)
Cr Investment in associate (reduce goods to cost to the group)
Associate sells to the parent – the associate has recognised profits on inventory that are still in the group, within
the inventory of the parent.
Dr Group retained earnings (cancel profit on goods still in the group)
Cr Group inventory (reduce goods to cost to the group)
upMark
upMarkinventoryunsold
100
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Apply Your Knowledge 2
The draft statements of financial position at 30 September 20X4 and statements of profit or loss for the year
ended 30 September 20X4 for three entities, HC, SU and AS are given below:
Statements of Financial Position as at 30 September 20X4:
Notes HC SU AS
Statements of profit or loss for the year ended 30 September 20X4
HC SU AS
$000 $000 $000
Revenue 1,925 480 285 Cost of sales (925) (230) (119) Gross profit 1,000 250 166 Expenses (240) (54) (42)
760 196 124
Interest received 25 0 0 Finance cost (27) (45) 0
758 151 124
Income tax expense (147) (38) (27) Profit for the year 611 113 97
Notes: (i) HC acquired 80% of SU’s equity shares on 1 October 20X3 by issuing 600,000 new HC shares. The
agreed purchase consideration was $1,356,000, however HC has not yet recorded the acquisition in its accounting records. SU’s retained earnings were $319,000 on 1 October 20X3.
(ii) HC carried out an impairment review of goodwill arising on acquisition of SU and found that as at
$000 $000 $000
Non-current Assets Property, plant and equipment
2,192 920 684
Investments: (i) Loan to SU (iii) 250 0 0
Investment in AS (ii) 384 0 0
2,826 920 684
Current Assets Inventory (iv) 1,810 782 52 Trade and other receivables
2,292 686 57
Cash and cash equivalents (iv) 113 70 19
4,215 1,538 128
Total Assets
7,041 2,458 812
Equity and Liabilities Equity Equity shares of $1 each
5,520 720 320
Retained earnings
796 457 229
6,316 1,177 549
Non-current liabilities Long term loans (iii) 0 650 0
Current liabilities Payables and accruals
725 631 263
Total Equity and Liabilities
7,041 2,458 812
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30 September 20X4 the goodwill had been impaired by 15%. (iii) HC purchased 96,000 $1 equity shares in AS on 1 October 20X3 for
$384,000 when AS’s retained earnings were $132,000. The fair value of AS’s net assets was the same as its carrying value at that date. HC exercises significant influence over all aspects of AS’s financial and operating policies.
(iv) On 1 October 20X3 HC advanced SU a 10 year loan of $250,000 at 10% interest per year. SU paid the interest due on 25 September 20X4.
(v) HC occasionally trades with SU. During September 20X4 HC sold SU goods for $170,000. HC uses a mark-up of 25% on cost. At 30 September 20X4 50% of the goods remained in SU’s inventory. SU paid $90,000 to HC on 29 September 20X4. HC did not receive the payment until 2 October 20X4.
Required: Prepare the consolidated statement of profit or loss for HC for the year ended 30 September 20X4 AND a consolidated statement of financial position for HC as at 30 September 20X4, in accordance with the requirements of International Financial Reporting Standards.
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Learning outcome A1a: Explain the need for the regulation of the financial reporting information of incorporated entities and the key elements of an ethical regulatory environment for such information
Learning outcome A1b: Explain the roles and structures of the key bodies involved in the regulation of financial reporting information.
Need for regulation
Because of the importance of published accounts giving a fair presentation to the users of these accounts, they
need to be regulated. Without such regulation consistency of accounts preparation is undermined.
Regulatory bodies
The IFRS Foundation 22 Trustees
IFRS Advisory Council
International Accounting
Standards Board
IFRS Interpretations
Committee
Appoints members
Advises
Reports
Topic 6 – The Regulatory Environment
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IFRS Advisory Council
The IFRS Advisory Council (formally called the SAC) provides a forum for organisations and individuals to participate in the standard-setting process. It is way the IASB consults with the outside world. The objectives of the IFRS Advisory Council Care:
To give advice to the IASB on agenda decisions and priorities in its work;
To inform the IASB of the views of organisations and individuals on the Council on major standard-setting
projects;
To give other advice to the Board or to the Trustees.
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IFRS Interpretations Committee (IFRS IC)
The IFRS Interpretations Committee (formally known as the International Financial Reporting Interpretations committee or IFRIC) was originally established in 2002. They provide guidance on specific practical issues in the interpretation of IFRS. Note that despite the name change. Interpretations issued by the IFRS Interpretations Committee are still known as IFRIC interpretations. In your exam, you may see the IFRS Interpretations Committee referred to as the IFRS IC.
The responsibilities of the IFRS IC:
1. To review on a timely basis , newly identified financial reporting issues not specifically addressed in IFRSs
2. To clarify issues where unsatisfactory or conflicting interpretations have developed, or seem likely to
develop in the absence of authoritative guidance, with a view to reaching a consensus on the appropriate
treatment.
Apply Your Knowledge 1
What is the role of the IFRS Interpretations committee?
A. To develop and issue a set of globally accepted international financial reporting standards
B. To clarify issues in the application of IFRS s where unsatisfactory or conflicting interpretations has
developed
C. To take account of the financial reporting needs of small and medium sized entities
D. To provide a forum for the IASB to consult with the national accounting standard setters, academics
and other interested parties
Apply Your Knowledge 2
Which of the following is responsible for developing and issuing IFRSs (International Financial Reporting
Standards)?
A. IFRS Foundation
B. IFRS Interpretations committee
C. International Accounting Standards Board (IASB)
D. IFRS Advisory Council
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Learning outcome A1c: Explain the scope of IFRS and how they are developed.
There are currently 41 IASs and 13 IFRSs in issue.
The use and application of FRSs
PLEASE NOTE THROUGHOUT THIS COURSE WE WILL USE THE ABBREVIATION IFRSs TO INCLUDE BOTH IFRSs
AND IASs.
The IFRSs have helped to improve and harmonise financial reporting around the world. The standards are used in
the following ways:
1. As national requirements
2. As the basis for all or some national requirements
3. As an international benchmark for those counties which develop their own requirements
4. By regulatory authorities for domestic and foreign companies
5. By companies themselves
In the UK the consolidated accounts of listed companies have had to be produced in accordance with IFRSs since
January 2005.
Standard-setting process
The IASB prepares IFRSs in accordance with due process.
Establishment of a consultative group to give advice on the issues arising on the project. The IASB will consult
with this committee and IFRS advisory council throughout the process.
On acceptance of a project a steering committee is set up (chaired by board members);
On major projects, the IASB develops and publishes a Discussion Document for public comment;
Following the receipt and review of comments, an Exposure Draft is produced for public comment;
Following the receipt and review of comments, the final IFRS will be issued.
International Financial Reporting Standards (IFRSs)
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Scope and application of IFRSs
Any limitation of the applicability of a specific IFRS is made clear within that standard. IFRSs are not intended to be applied to immaterial items, nor are they retrospective. Within each individual country local regulations will govern, to a greater or lesser degree.
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Learning outcome A1a: Explain the need for the regulation of the financial reporting information of incorporated entities and the key elements of an ethical regulatory environment for such information
Purpose and status of the conceptual Framework
The IASB’s Framework for the Preparation and Presentation of Financial Statements sets out the concepts underlying the preparation and presentation of financial statements for external users. In detail, the intended role of the Framework is to:
assist the IASB in its development of future accounting standards and in its review of existing accounting standards
assist the IASB by providing a basis for reducing the number of alternative accounting treatments permitted by law and accounting standards
assist preparers of financial statements in applying accounting standards and in dealing with topics that do not form the subject of an accounting standard
assist auditors in forming an opinion as to whether financial statements conform with accounting standards
help users of financial statements to interpret the information contained in financial statements prepared in conformity with accounting standards
provide those who are interested in the work of the IASB with information about its approach to the formulation of accounting standards.
The Framework is not itself an accounting standard nor can it override the requirements of any existing accounting standard.
The objective general purpose financial reporting
You must learn the objective of financial statements, the qualitative characteristics of financial statements and
the underlying assumptions. These are a ‘need to learn’.
At the user
The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
These decisions involve buying, selling or holding investments in shares or debt instruments, and providing or settling loans and other forms of credit.
Topic 7: The Conceptual Framework
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Decisions made by users depend upon the returns that they expect to receive, for example dividend income, principal and interest payments or market price increases. Consequently users need information that helps them assess the prospects for future net cash inflows to an entity.
To assess the entity's prospects for future net cash inflows users need information about:
the resources of the entity
claims against the entity
how efficiently and effectively the entity's management and governing board have discharged their responsibilities to use the entity's resources.
Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely upon general purpose financial reports for much of the financial information they need. Consequently they are the primary users to whom general purpose financial reports are directed.
Underlying assumption
Going concern
Going concern is the underlying assumption adopted whenever we are preparing financial statements. You will
have learnt about this from your first introduction to double-entry bookkeeping.
Although the accruals concept is no longer considered to be an underlying assumption it is still covered by the
Conceptual Framework as an important concept of financial accounting. The accruals concept states events
should be dealt with in the accounting period they occur, rather than the period they are paid.
Fundamental qualitative characteristics of financial statements
The framework splits qualitative characteristics into two categories:
(i) Fundamental qualitative characteristics
- Relevance
- Faithfull representation
(ii) Enhancing qualitative characteristics:
- Comparability
- Verifiability
- Timeliness
- Understandability
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Relevance
Relevance – to be useful, information must be relevant to the decision making needs of the user. Information is
relevant when it influences the economic decisions of users by helping them to evaluate past, present or future
events or confirming or correcting their past evaluations.
The relevance of information is affected by its nature and materiality. (Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements)
Faithful representation
Faithful representation – a transaction or other event is faithfully represented if the way in which it is recognised,
measured or presented in the financial statements corresponds closely to the effect of that transaction or event.
Substance over form – the economic substance of a transaction should be recorded rather than simply its legal
form.
Example: A company acquired a non-current asset under a hire purchase agreement; the legal position is that
ownership does not pass until the final instalment has been paid. However, substance of the transaction is that
the company is purchasing an asset and taking out a loan to pay for it. Therefore, the asset and the loan are
recorded in the accounts.
Neutrality (objectivity) – information is not neutral if it has been selected or presented in such a way as to
influence the making of a decision or judgement in order to achieve a predetermined result or outcome.
Free from error – Within the bounds of materiality information must be free from error. This does not mean
perfectly accurate. Estimates are acceptable but must be described clearly as such.
Completeness- Financial information must be complete, within the restrictions of materiality and cost, to be
reliable. Omission may cause information to be misleading.
Enhancing qualitative characteristics of financial statements
Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the
usefulness of information that is relevant and faithfully represented. The enhancing qualitative characteristics
may also help determine which of two ways should be used to depict a phenomenon if both are considered
equally relevant and faithfully represented.
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Comparability
Users must be able to compare financial statements over a period of time in order to identify trends in financial
position and performance. Users must also be able to compare financial statements of different entities to be
able to assess their relative financial position and performance.
In order to achieve comparability, similar items should be treated in a consistent manner from one period to the
next and from one entity to another. However, it is not appropriate for an entity to continue accounting for
transactions in a certain manner if alternative treatments exist that would be more relevant and reliable.
Disclosure of accounting policies should also be made so that users can identify any changes in these policies or
differences between the policies of different entities.
Verifiability
Verification can be direct or indirect. Direct verification means verifying an amount or other representation
through direct observation i.e. counting cash. Indirect verification means checking the inputs to a model, formula
or other technique and recalculating the outputs using the same methodology i.e. recalculating inventory
amounts using the same cost flow assumption such as first-in, first-out method.
Timeliness
Timeliness means having information available to decision makers in time to be capable of influencing their
decisions. Generally, the older the information is the less useful it becomes.
Understandability
Information needs to be readily understandable by users. Information that may be relevant to decision making
should not be excluded on the grounds that it may be too difficult for certain users to understand.
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The elements of financial statements
Asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.
Liabilities are an entity’s obligations to transfer economic benefits as a result of past transactions or events.
Equity is the residual amount found by deducting all liabilities of the entity from all of the entity’s assets.
Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from equity participants.
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
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Recognition of the elements of financial statements
In order to recognise anything in the statement of financial position and income statement it must meet all three of the following criteria:
Meet the definition of the element (as above)
Probable future economic benefit will flow to or from the entity
The item can be measured reliably
Measurement of the elements of financial statements
Historical cost - cash price or fair value at acquisition or obligation. Most commonly used but widely criticised
Current cost – what would be the cash price today
Realisable value - what could be realised/satisfied today
Present value – discounted future cash flows
The Framework does not state which of the four should be used
Concepts of capital and capital maintenance.
The concept of capital maintenance is concerned with how an entity defines the capital that it seeks to maintain.
It provides the linkage between the concepts of capital and the concepts of profit because it provides the point
of reference by which profit is measured; it is a prerequisite for distinguishing between an entity’s return on
capital and its return of capital; only inflows of assets in excess of amounts needed to maintain capital may be
regarded as profit and therefore as a return on capital. Hence, profit is the residual amount that remains after
expenses (including capital maintenance adjustments, where appropriate) have been deducted from income. If
expenses exceed income the residual amount is a loss.
Financial capital maintenance is measured in either nominal monetary units or units of constant purchasing power.
Physical capital maintenance requires the adoption of the current cost basis of measurement – an appreciation of
what it would cost to replace assets at current prices.
The main difference between the two is how they treat the effects of increases in prices of assets and liabilities.
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Apply Your Knowledge 1
Under the IASB’s Framework for the preparation and presentation of financial statements which of the
following is the ‘threshold quality’ of useful information.
A. Relevance
B. Reliability
C. Materiality
D. Understandability
Apply Your Knowledge 2
THE IASB’s Framework identifies qualitative characteristics
i. Relevance
ii. Comparability
iii. Verifiability
iv. Understandability
v. Faithful Representation
Which of the above are not listed as an enhancing characteristic?
A. (i), (iv) and (v)
B. (ii), (iii) and (iv)
C. (ii) and (iii)
D. (i) and (v)
Apply Your Knowledge 3
According to ‘The Framework’ what is the main objective of financial reporting?
Providing useful information to:
A. The government
B. The employees
C. The customers
D. The investors
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Apply Your Knowledge 4
Which THREE of the following are uses of financial statements as identified by ‘The Framework’?
A. The general public
B. Trade unions
C. Lenders
D. Analyst/ advisors
E. The European Union
F. Competitors
Apply Your Knowledge 5
Which are the THREE main financial statements as identified by ‘The Framework’?
A. The statement of liabilities
B. The statement of expenses
C. The income statement
D. The statement of financial position
E. The statement of cash flows
F. The statement of Obligations
Apply Your Knowledge 6
According to ’The Framework’ which qualitative characteristics enhance the usefulness of information that
is:
A. Comparability, understandability, timeliness, verifiability
B. Consistency, prudence, measureability, verifiability
C. Consistency, reliability, measurability, timeliness
D. Materiality, understandability, measureability, reliability
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Apply Your Knowledge 7
Which THREE of the following are qualitative characteristics of financial statements as identified by
A. Relevance
B. Materiality
C. Reliability
D. Timeliness
E. Measurability
F. Prudence
Apply Your Knowledge 8
Which THREE of the following are elements of financial statements as identified by ‘The Framework’
A. Revenue
B. Expenses
C. Profits
D. Losses
E. Capital
F. Obligations
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Learning outcome A1d: Describe the role of the external auditor in the context of the financial reporting
information of incorporated entities and the content and significance of the audit report.
What is an External audit?
An external audit is when an independent person examines and checks the financial statements. The auditor will
then prepare a report to present to the shareholders.
The objective of an audit is for the auditor to express an opinion as to whether the financial statements are fairly
presented, i.e. that they
show a true (accurate) and fair (unbiased) view;
have been prepared in accordance with ‘specific legislation’ (this will vary internationally).
materially correct.
(This implies that either accounting standards have been complied with or that non-compliance with the
accounting standards was necessary in order to show a true and fair view.)
Materiality
Materiality is an error or misstatement that will influence the user’s decision.
Purpose
To give users confidence in the financial statements and reduce the risk of fraud and error.
This is not 100% guarantee, but reasonable assurance.
Topic 8: External Audit
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Duties of directors
Duties of directors can vary from country to country. Typically the legal duties of the directors will include a
requirement to:
safeguard the company's assets and to prevent fraud and errors in the company;
ensure that the company keeps proper accounting records;
prepare annual financial statements showing the financial position, financial performance and changes in
the financial position during the reporting period;
deliver to the relevant national regulatory authority a copy of the company's audited financial statements
within a defined time limit;
set up an internal control system in the company to ensure that all of the above requirements are met.
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Duties of auditors
To report to the shareholders of the entity on whether or not the financial statements show a true and fair
view and have been prepared in accordance with the applicable reporting framework.
Auditors also have a duty to report by exception, which means they have a duty to report any problems to
shareholders. Again, their duties will vary from country to country but typically they would report on the
following matters:
R returns from branches have been received
A accounts are in agreement with underlying accounting records
P proper accounting records have been kept
I information and explanations has been received
D directors report is consistent with the financial statements, e.g. director's emoluments, related party
transactions.
Rights of auditors
In order to carry out their duties, auditors are given certain rights:
access to accounting records;
require information and explanations as necessary;
receive notice of, attend and speak at general meetings of shareholders;
rights relating to their removal, resignation and retirement.
Benefits Disadvantages
Independent confirmation to directors of profits Cost of the audit fee
Assurance of compliance with accounting standards Time consuming and may disrupt management and
staff time
Can make recommendations on systems In a small company the directors and shareholders are
likely to be the same, so no real benefit.
Adds credibility to financial information
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Audit Process
Auditors appointed
Auditor agrees terms with client
Auditor will plan what tests to do
Auditor will gather the evidence
Review
Audit opinion
Audit report
Auditor attends AGM
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The Audit report
Title
Addressee
Introductory paragraph
Statement of responsibilities
- Management
- Auditors
Scope paragraph
Opinion
Signature
Date
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Types of audit reports
Audit Report
UNMODIFIED REPORT
FS are materially misstated
MODIFIED REPORT
Auditor unable to obtain sufficient
appropriate evidence
‘Fair Presentation’ or
‘True and Fair’
MODIFIED OPINION
Other Matter
Emphasis of Matter
DISCLAIMER OF OPINION
QUALIFIED OPINION
ADVERSE OPINION
QUALIFIED OPINION
material not pervasive
material not pervasive
material and pervasive
material and pervasive
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Pervasive
Pervasive effects on the financial statements are those that, in the auditor’s judgement:
I. Are not confined to specific elements. Accounts or items of the financial statements;
II. If so confined, represent or could represent a substantial proportion of the financial statements; or
III. In relation to disclosures, are fundamental to users’ understanding of the financial statements.
Apply Your Knowledge 1
You are a trainee accountant working for DDD, which is listed on the local stock exchange. A new chief
executive has recently been appointed and has queried the benefits to DDD of having an external audit carried
out each year.
Required:
Prepare a short briefing note that highlights the benefits of an external audit to DDD.
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Apply Your Knowledge 2
AT’s profits have suffered due to a slow-down in the economy of the country in which it operates. AT’s draft
financial statements show revenue of $35 million and profit before tax of $4 million for the year ended 31
March 2012.
AT’s external auditors have identified a significant quantity of inventory that is either obsolete or seriously
impaired in value. The audit senior has calculated the inventory write-down of $2 million. AT’s directors have
been asked by the audit senior to record this in the financial statements for the year ended 31 March 2012.
AT’s directors are refusing to write-down the inventory at 31 March 2012, claiming that they were not aware of
any problems at that date and furthermore do not agree with the auditor that there is a problem now. The
directors are proposing to carry out a stock-take at 31 July 2013 and to calculate their own inventory
adjustment, if required. If necessary the newly calculated figure will be used to adjust inventory values in the
year to 31 December 2013.
Required:
(i) Explain the objective of an external audit.
(ii) Assuming that AT’s directors continue to refuse to amend the financial statements, explain the type of audit
report that would be appropriate for the auditors to issue.
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Apply Your Knowledge 3
An external auditor has completed an audit and is satisfied that proper records have been maintained and that the financial statements reflect those transactions.
However the auditor has one disagreement with the management of the entity. The disagreement involves the treatment of one large item of expenditure that has been classified by management as an increase in non-current assets.
The auditor is of the opinion that the item should have been classified as maintenance and charged as an expense to the statement of profit or loss. The amount is material in the context of the reported profit for the year.
Assuming that the management refuse to change their approach, which ONE of the following modified audit reports should the auditor use?
A: Emphasis of matter
B: “Except for” qualification
C: Adverse opinion
D: Disclaimer of opinion
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Learning outcome A1a Explain the need for the regulation of the financial reporting information of incorporated entities and the key elements of an ethical regulatory environment for such information
Importance
Ethics is more a guide to behaviour, principals instead of rules; ethics describes “how” an entity does its business
not what it does.
Sources of ethical guidance
IFAC Code of Ethics – governs audits carried out under ISAs.
CIMA Code of Ethics – to be followed by CIMAs, but is practically identical to the IFAC code.
Enforcement; Discipline members through a process of disciplinary hearings which can result in:
Fines
Suspension of membership
Withdrawal of membership
To ensure that CIMA members protect the good standing and reputation of the profession, members must inform
the institute if they are convicted or disqualified from acting as an officer of a company, or if they are subject to
any sanction resulting from disciplinary action taken by another professional body.
Conceptual Framework Approach
Identify
Evaluate
Mitigate / Address
Issues
Topic 9: Code of ethics
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The Fundamental ethical principles for CIMA members are:
Principles
Objectivity Members should not allow bias, conflict of interest or
undue influence to over-ride professional or business
judgements
Professional Competence & Due Care Members have a continuing duty to maintain professional
knowledge and skills at a level required to ensure that a
client receives competent professional services.
Act in accordance with applicable technical and professional
standards when providing professional services.
Professional Behaviour Members should comply with relevant laws and regulations
and should avoid any action that discredits the profession.
Integrity Members should be straightforward and honest in all
professional and business relationships.
Confidentiality Members should not disclose information to third parties
without proper and specific authority unless there is a legal
or professional right or duty to disclose, and information
should not be used to personal advantage.
OPPIC
Conflicts of interest
Definition: Difficult situations to manage, with no obvious “correct” solution. If you are under pressure to do
something that you think is unethical, or against your principles.
CIMA members should be constantly conscious of, and be alert to factors which give rise to conflicts of interest.
Avoid conflicts of interest wherever possible.
| CIMA F1 89
General threats to objectivity
Self-interest threats – can occur as a result of your own or your close family interests, financial or
otherwise
Self-review threats – occur when you are required to evaluate your own previous work or judgement
Familiarity threats – can be present when you become so sympathetic to interests of others
Intimidation threats – occur when you are deterred from acting objectively by actual or perceived threats
Advocacy – threats occur when you are promoting or been seen to represent someone or something
| CIMA F1 90
Examples
Specific
threats
Why Safeguards/ recommendations / how do we mitigate
Not declaring
information
Lack of integrity, maybe a conflict
of interest if you report to the
individual not disclosing
Inform manager about concerns and if not addressed
the director or audit committee
Trainee has
lied about the
attempts of
exam papers.
Lack of integrity
Trainee disciplined through the formal disciplinary
channels
Depending on the severity the trainee could be
dismissed
Hospitality or
other benefits
Could be perceived as a bribe,
and we need to be seen to be
independent
Lose professional scepticism
Company should have a policy
Basic idea is that they should be modest
Should not accept, so politely decline the offer
Represent a
client in court
Being perceived as taking the
viewpoint of the client –
therefore losing professional
scepticism and integrity
Individual should resign from that appointment or not
accept the offer of representing them in court
Advised on the
systems that
should be in
place and then
reviewing the
effectiveness
of the systems
Self-review threat as if we as the
individual review our work and
we find an error we may hide
those errors to save face, or lose
professional scepticism.
Get someone else to do the work
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General Safeguards
Safeguards
Professional, legal and
regulation
Work environment
Individual's actions
Education and training
Corporate governance
requirements
Disciplinary procedures
External reviews
Internal control systems
Recruit the right staff
Whistle blowing procedures
Disciplinary process
Leadership that drives ethical behaviour
Grievance procedures
Maintaining records of
contentious issues
Ethical conflict resolution
Seek legal advice
| CIMA F1 92
Ethical Conflict Resolution
Raise your concerns internally
Manager
Trusted colleague
Director
Board
Non-executive director
Audit committee
Internal whistle blowing procedure
If not being addressed seek advice externally
Auditors
Trade or industry regulator
Seek legal advice regarding confidentiality
Finally
Remove yourself from the situation
Team / client / refuse to be associated with a report
Resign
Check factsEscalate
internallyEscalate
externally
Refuse to remain
associated with the conflict
Document the issue
Seek professional or legal advice
| CIMA F1 93
Apply Your Knowledge 1
Which ONE of the following is NOT a fundamental ethical principle identified in CIMA’s code of ethics?
A. Professional competence.
B. Professional behaviour.
C. Integrity.
D. Independence
Apply Your Knowledge 2
Which ONE of the following is NOT a common threat identified in CIMA’s code of ethics?
A. Self interest
B. Bias
C. Self review
D. Familiarity
Apply Your Knowledge 3
JT an employee, prepares monthly management accounting information for BBB which includes detailed
performance data that is used to calculate staff bonuses. Based on information prepared by JT this year’s
bonuses will be lower than expected.
JT has had approaches from other staff offering various incentives to make accruals for additional revenue and
other reversible adjustments, to enable all staff (including JT) to receive increased or higher bonuses.
Required:
Explain the requirements of the CIMA Code of Ethics for Professional Accountants in relation to the
preparation and reporting of information AND the ethical problems that JT faces.
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Apply Your Knowledge 4
CP, a professional accountant, is facing a dilemma. She is working on the preparation of a long term profit
forecast required by the local stock market listing regulations prior to a new issue of equity shares.
At a previous management board meeting, her projections had been criticised by board members as being too
pessimistic. She was asked to review her assumptions and increase the profit projections.
She revised her assumptions, but this had only marginally increased the forecast profits.
At yesterday’s management board meeting the board members had discussed her assumptions and specified
new values to be used to prepare a revised forecast. In her view the new values grossly overestimate the
forecast profits.
The management board intends to publish the final revised forecasts.
Required:
Explain the ethical problems that CP faces and identify her possible options. You should refer to CIMA’s Code
of ethics for professional accountants
| CIMA F1 95
Learning outcome A2a Discuss the need form and scope of corporate governance regulation
Learning outcome A2b Compare and contrast the approach to corporate governance in different markets.
The purpose of corporate governance is to control the board of a listed company to ensure that they act in the
best interests of that company.
“Corporate governance is the system by which companies are directed and controlled”
The separation of ownership and control
Systems of corporate governance
Principles based approaches
Rules based approaches
Topic 10: Corporate Governance
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Principles of Corporate Governance
The UK Combined Code has issued principles in relation to
Leadership
Effectiveness
Accountability
Remuneration
Relations with Shareholders
Corporate Governance in action
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Corporate
governance in action
Segregation of roles Committees Internal audit
Audit
Chairman CEO
Remuneration
Nomination
Risk
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Features of governance codes
Leadership
Effective board responsible for the long-term success of the company
Chairman/CEO
Non-executive directors
Committees
Nomination
Remuneration
Effectiveness
Formal, rigorous, transparent appointments
Induction, CPD, board performance
Timely information
Retirement by rotation – re-election at regular intervals
Accountability and Audit
Balanced and understandable assessment of company’s current and future prospects
Sound system of control
Risk based approach
Independent external auditors
Audit committee
| CIMA F1 99
Directors remuneration
Sufficient to attract, retain and motivate, but not excessive
Significant proportion should be linked to performance
Align interest
No director should influence or set own salary
Unethical to pay poor performance
Relations with shareholders
Use of the AGM
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Benefits of corporate governance
Reduces risk
Stimulates performance
Improves access to capital markets
Enhances the marketability of goods and services
Improves leadership
Demonstrates transparency and social accountability
Failures of corporate governance:
Domination by a single individual
Lack of board involvement
Ineffective internal control
Poor supervision
Lack of independent scrutiny
Poor communication with shareholders
Emphasis on short-term profitability
Misleading accounts
OECD Framework
The OECD consists of 34 countries who want a free market economy with one set of rules for corporate
governance.
6 Principles
1. Effective corporate governance framework
2. Shareholders right of ownership
3. Fair treatment for shareholders
4. Stakeholders role and rights
5. Disclosure and transparency
6. Responsibilities of the board
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The US Sarbanes –Oxley Act 2002 (SOX)
In 2002, following a number of corporate governance scandals such as Enron and WorldCom, tough new
corporate governance regulations were introduced in the US by SOX.
SOX Key Points:
Auditor independence
Audit committee
Internal control report
Increased financial disclosures
US stock exchange regulations
| CIMA F1 102
Learning outcome: B1a - describe the main elements of financial statements prepared in accordance with IFRS
Learning outcome B2a – produce the primary financial statements from a trial balance for an individual entity
in accordance with IFRS
IAS 1 PRESENTATION OF FINANCIAL STATEMENTS
The objective of this Standard is to outline the basis for presentation of general purpose financial statements, to
ensure comparability both with the entity’s financial statements of previous periods and with the financial
statements of all other entities. IAS 1 sets out overall requirements for the presentation of financial statements,
guidelines for their structure and minimum requirements for their content.
A complete set of financial statements comprises:
a statement of financial position
a comprehensive income statement
a statement showing changes in equity
a statement of cash flows
notes for accounting policies and other explanatory notes.
IAS 1 provides the following formats within its Implementation Guidance for the first three statements. These are
shown below for a basic incorporated company only. The statement of cash flow will be considered later in the
chapter under IAS 7.
Fair presentation and compliance with IFRS’s
Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in
accordance with the definitions and recognition criteria set out in the Framework.
Topic 11: An introduction to published accounts
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THE STATEMENT OF FINANCIAL POSITION
Statement of Financial Position as at 31 December 2008
ASSETS $ $
Non-current assets
Property, plant and equipment X
Goodwill X
Other intangible assets X
Available-for-sale investments X
––
X
Current assets
Inventories X
Trade receivables X
Other current assets X
Cash and cash equivalents X
––
X
––
Total assets X
––
EQUITY AND LIABILITIES
Capital and reserves
Share capital X
Other reserves X
Retained earnings X
––
X
––
Total equity X
Non-current liabilities
Long-term borrowings X
Long-term provisions X
––
X
Current liabilities
Trade and other payables X
Short-term borrowings X
Current portion of long term borrowings X
Current tax payable X
Short-term provisions X
––
X
––
Total equity and liabilities X
| CIMA F1 104
THE STATEMENT OF PROFIT OR LOSS
Two formats are provided by IAS 1 but we shall consider the most likely to be examined.
Classification of expenses by function
Statement of profit or loss for the year ended 31 December 2008
$
Revenue X
Cost of sales (X)
––
Gross profit X
Distribution costs (X)
Administrative expenses (X)
––
Profit from operations* X
Investment income
Finance costs (X)
––
Profit before tax X
Income tax expense (X)
––
Profit or loss for the period X
OTHER
* There is no requirement to show profit from operations in IAS1 but it is often beneficial for you to do so.
| CIMA F1 105
STATEMENT OF CHANGES IN EQUITY
The statement of changes in equity provides a comprehensive summary of all movements in the share capital and
reserves during the year.
Statement of Changes in Equity for the year ended 31 December 2008
Share
capital
Share
premium
Revln
reserve
Retained
earnings
Total
$ $ $ $ $
Balance at 31 December 2007 X X X X X
Changes in accounting policy (X)
(X)
–– –– –– –– ––
Restated balance X X X X X
Surplus on revaluation of properties X X
Deficit on revaluation of
investments
(X) (X)
–– –– –– –– ––
Net gains and losses not
recognised in the income
statement
X X
Net profit for the period X X
Dividends (X) (X)
Issue of share capital X X X
–– –– –– –– ––
Balance at 31 December 2008 X X X X X
NOTES TO THE FINANCIAL STATEMENTS
It is unlikely full sets of notes would be requested. It is more likely that specific notes would be requested. Many
disclosures are laid out in the standard itself e.g. IAS 16 property, plant & equipment.
| CIMA F1 106
Apply Your Knowledge 1
Alexandra Ltd- trial balance as at 30 September 20X9
DR CR
$000 $000
Revenue 103,500
Inventories at 1October 20X8 5,460
Purchases 67,206
Distribution costs 8,000
Salespeople commission 2,920
Administrative salaries 2,280
Manufacturing wages 2,000
Finance costs 540
Administrative expenses 5,000
3% Debenture loans 18,000
Equity share capital 60,000
Retained earnings at 1st October 20X8 8,495
Cash 2,685
Dividends paid 2,820
Revaluation reserve @1st October 20X8 6,000
Trade Payables 5,861
Land and buildings –value/cost 92,578
Accumulated depreciation 25,000
Plant and equipment 35,000
Accumulated depreciation 15,313
Trade receivables 16,395
Accruals 715
242,884 242,884
Further Information (a) Inventories were valued at $7,850,000 on 30 September 20X9.
(b) Depreciation is to be provided for the year to 30 September 20X9 as follows:
Buildings 10% per annum straight line basis
Plant and Equipment 25% per annum reducing balance basis
Depreciation is to be apportioned as follows:
Cost of Sales 55%
| CIMA F1 107
Distribution costs 30%
Administrative expenses 15%
Land and buildings in the trial balance includes a value for land at $42,578. It is be be revalued at $61,000 and this revaluation is to be included in the financial statements for 30 September 20X9.
(c) An irrecoverable debt of $21,000 which is included in trade receivables is to be written off.
(d) Administrative expenses of $85,000 owing at 30 September 20X9 are to be provided for.
(e) The company’s tax charge for the year has been estimated as $1,500,000.
Required:
Prepare a statement of profit or loss and a statement of changes in equity for Alexandra Ltd for the year ended 30 September 20X9 and also a statement of financial position as at that date.
They must comply with IAS 1 – Presentation of financial statements.
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IAS 7 STATEMENT OF CASH FLOWS
The statement of cash flow is a primary statement that will be produced by a company alongside the statement of profit or loss, statement of financial position and statement of changes in equity.
Definitions:
Cash
Cash on hand and demand deposits
Cash equivalents
Short term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value
Statement of cash flows
Inflows and outflows of cash and cash equivalents
HEADINGS OF THE STATEMENT OF CASH FLOWS
Operating activities
The principal revenue producing activities of the entity and other activities that are not investing or financing activities.
Investing activities
The acquisition and disposal of long term assets and other investments not included in cash equivalents.
Financing activities
Activities that result in changes in the size and composition of the contributed equity and borrowings of the entity
Some examples of what would be included under these headings are shown in the pro forma. This pro forma follows the indirect method approach. The direct method approach is considered later.
Topic 12: The Statement of cash flows
| CIMA F1 109
Statement of cash flows for the year ended 31 December 2008
$ $
Cash flows from operating activities
Net profit before tax X Adjustments for: Interest expense X Investment income (X) Depreciation X Amortisation X Impairment X Increase/Decrease in provisions X/(X) Profit/loss on disposal (X)/X ––––
Operating profit before working capital changes X Increase in trade receivables (X) Increase in inventories (X) Increase in trade payables X ––––
Cash generated from operations X Interest paid (X) Income taxes paid (X) ––––
Net cash from operating activities X
Cash flows from investing activities
Purchases of property, plant and equipment (X) Proceeds of sale of property, plant and equipment X Purchase of intangibles (X) Purchase of investments (X) Interest received X Investment income received X
––––
Net cash used in investing activities (X)
| CIMA F1 110
Cash flows from financing activities
Proceeds from issue of shares X Proceeds from issue of debt X Redemption of debt (X) Dividends paid (X) ––––
Net cash used in financing activities (X)
Net increase in cash and cash equivalents X Cash and cash equivalents at beginning of period X –––
Cash and cash equivalents at end of period X –––
| CIMA F1 111
DIRECT AND INDIRECT METHOD
IAS 7 allows the statement of cash flows to be prepared using either of the two methods below. It is important to
note that both methods should give the same overall outcome.
Direct method Indirect method $000 $000 Cash received from customers X Profit before taxation X Cash payments to suppliers and employees
X Depreciation X
Investment income (X) Interest expense X Increase in inventories (X) Increase in receivables (X)
_____ Increase in payables
X _____
Cash flow from operating activities SAME _____
Cash flow from operating activities SAME _____
| CIMA F1 112
Apply Your Knowledge 1
The financial statements of Moma at 31 August 2008 and 2009 are given below:
Statement of profit or loss for the year ended 31 August 2009
$’000
Revenue 10,050
Cost of sales (6,040)
Gross profit 4,010
Operating expenses (2,300)
Profit from operations 1,710
Finance costs (150)
Profit from operations before tax 1,560
Income tax expense (500)
Profit from operations after tax 1,060
Continued over page
| CIMA F1 113
Statement of Financial Position
Note 31.8.2008 31.8.2009
$000 $000 $000 $000
Non-current assets 1 6,400 8,500
Current assets
Inventories 1,200 1,400
Trade receivables 1,500 1,400
Cash at bank 200 300
2,900 3,100
9,300 11,600
Capital and reserves
Called up share capital 2,000 2,200
Share premium account 2,340 2,540
Revaluation reserve
Retained earnings
–
2,400
1,000
2,960
Non-current liabilities
Loan notes
Current Liabilities
3
6,740
800
8,700
1,000
Trade payables 800 700
Taxation 600 1,000
Bank overdraft 360 200
1,760
9,300
1,900
11,600
Continued over page
| CIMA F1 114
Notes 1. Movements in non-current assets:
LAND BUILDINGS PLANT AND
EQUIPMENT
TOTAL
$000 $000 $000 $000
Cost or valuation
At 1 September 2008 2,000 3,000 3,400 8,400
Additions 2,500 2,500
Disposals (1,000) (1,000)
Revaluation 1,000 1,000
____
____
____
____
At 31 August 2009 3,000 3,000 4,900 10,900
____
____
____
____
ACCUMULATED DEPRECIATION
At 1 September 2008 400
1,600
2,000
Charge for year 60
1,140
1,200
Disposals (800) (800)
____
____
____
At 31 August 2009 460 1,940 2,400
____
____
____
Net book value 3,000
2,540 2,960 8,500
At 31 August 2009 ____ ____
____
____
At 1 September 2008 2,000
2,600
1,800
6,400
2. Dividends paid during the year amounted to $500,000. 3. Issue of loan notes – a further $500,000 of 10% loan notes was issued at par on 1 September 2008.
Interest on all loan notes is paid on 28 February and 31 August each year. 4. Plant sold during the year realised $250,000.
Required:
Prepare a statement of cash flows for Moma for the year ended 31 August 2009, complying as far as possible with IAS 7, using the indirect method.
| CIMA F1 115
Apply Your Knowledge 2
The following is an extract from the statement of financial position of KJB at 31 July 20X7 and 20X8
20X8 20X7
$000 $000
Receivables 14,500 17,800
Inventory 28,700 26,300
Payables 19,900 20,100
What is the net effect on the calculation of cash generated from operations?
A. Positive $700,000
B. Negative $700,000
C. Positive $1,100,000
D. Negative $1,100,000
Apply Your Knowledge 3
Extracts from the statement of financial position for honeycomb at 30 June 20X8 and 20X9
$ $
Net book value 435,000 405,000
Revaluation reserve 89,000 64,000
An asset was disposed of in the year, raising proceeds of $12,000. The asset had originally cost $40,000 and
made a profit on disposal of $2,000.
Accumulated depreciation at the start of the year was $110,000 and at 30 June 20X8 was $125,000.
What was the amount of cash paid to acquire new PPE for the year ending 30 June 20X8?
A. $45,000
B. $60,000
C. $85,000
D. $105,000
| CIMA F1 116
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for non-current assets.
IAS 16 Property, plant and equipment
Tangible assets that:
Are held by an entity for use in the production or supply of goods and services, for rental to others, or for
administrative purposes; and
Are expected to be used during more than one period
Cost
Fair value
Carrying amount
DEBIT Non-current asset – cost $X
CREDIT Cash (or payable, if a credit transaction) $X
Purchase price, including any import duties paid, but excluding any trade discount and sales tax paid
Initial estimate of costs of dismantling and removing the item and restoring the site on which it is located
Directly attributable costs of bringing the asset to working condition for its intended use, e.g.:
The cost of site preparation, e.g. levelling the floor of the factory so that the machine can be installed
Initial delivery and handling costs
Installation and assembly costs
Professional fees (lawyers, architects, engineers)
Cost of testing whether the asset is working properly, after deducting the net proceeds from selling
samples produced when testing equipment
Only staff costs arising directly from the construction or acquisition of the asset can be capitalised.
Topic 13: Non current assets – Property, plant and
equipment
| CIMA F1 117
Subsequent expenditure
Improves
Modification
Upgrade
Adoption of a new production process
| CIMA F1 118
Depreciation accounting
Method must be found of spreading the cost of the asset over its useful life
Depreciation is the allocation of the depreciable amount of an asset over its estimated useful life. Depreciation
for the accounting period is charged to net profit or loss for the period either directly, or indirectly
Useful life
Useful life is either:
The period which a depreciable asset is expected to be used by the enterprise; or
The number of production or similar units expected to be obtained from the asset by the enterprise
Should be reviewed at least annually
The assessment of useful life requires judgement
The residual value is the net amount which the entity expects to obtain for an assets at the end of its useful life
after deducting the expected costs of disposal
| CIMA F1 119
Depreciation methods
Depreciation is a means of spreading the cost of a non-current asset over its useful life, in order to match the cost
of the asset with the profits it earns for the business
The straight line method
The annual depreciation charge is calculated as: Cost of asset – residual value
Expected useful life of asset
The straight line method is a fair allocation of the total depreciable amount between the different accounting
periods provided that it is reasonable to assume that the business enjoys equal benefits from the use of an asset
in every period throughout its life.
A non-current asset costing $20,000 with an estimated life of 10 years and no residual value would be
depreciated at the rate of:
$20,000 = $2,000 per annum
10 years
A non-current asset costing $60,000 has an estimated life of 5 years and a residual value of $7,000. The
annual depreciation charge using the straight line method would be:
$(60,000 – 7,000) = $10,600 per annum
5 years
| CIMA F1 120
The reducing balance method
The reduced balance method of depreciation calculates the annual depreciation charge as a fixed percentage of
the carrying amount of the asset, as at the end of the previous accounting period.
A non-current asset costing $10,000 with an estimated life of 10 years and an estimated residual value of
$2,160. The business uses the reducing balance method to depreciate the asset, and calculates that the
rate of depreciation should be 40% of the reducing (carrying) amount of the asset.
| CIMA F1 121
Change in method of depreciation
Depreciation should be applied consistently from year to year
Apply Your Knowledge 1
Genius Co purchased an asset for $100,000 on 1.1.x1. It had an estimated useful life of 5 years and it was
depreciated using the reduced balance method at a rate of 40%. On 1.1.x3 it was decided to change the
method to straight line.
Required
Show the depreciation charge for each year (to 31 December) of the asset’s life.
| CIMA F1 122
Change in expected useful life or residual value of an asset
The depreciation charge on a non-current asset depends not only on the cost (or value) of the asset and its
estimated residual value, but also on its estimated useful life.
Carrying amount at time of life readjustment – residual value
New estimate of remaining useful life
Apply Your Knowledge 2
A business purchased a non-current asset costing $12,000 with an estimated life of 4 years and no residual
value. The business uses the straight line method to depreciate the asset.
After two years the business decides the useful life of the asset has been underestimated and it still has five more years in use to come (making its total life 7 years).
NEED TO LEARN
New depreciation = Carrying amount – residual value
Revised useful life of asset
DEBIT Depreciation expense (income statement)
CREDIT Accumulated depreciation account (statement of financial position)
With the depreciation charge for the period
| CIMA F1 123
Revaluation of non-current assets
IAS 16 allows entities to revalue non-current assets to fair value
When a non-curent asset is revalued, depreciation is charged on the revalued amount
IAS 16 requires that when an item of property, plant and equipment is revalued, the whole class of assets to
which it belongs should be revalued.
Apply Your Knowledge 3
Andrew Inc, which makes up its accounts to 31 December each year, buys an asset on 1 January 20X1 for $10,000. The asset has an estimated useful economic life of ten years with no residual value. Therefore, straight-line depreciation will be $1,000 pa and, on 31 December 20X2, the asset will be included in the statement of financial position* as follows:
$
Non-current assets at cost 10,000
Accumulated depreciation (2,000)
8,000
On 1st January 20X3, Andrew revalues the asset to $16,000. The total useful economic life remains at ten years
from 1st January 20X1.
Required:
A. Show the journal to record the revaluation.
B. Show the journal to record the revised depreciation charge and reserves transfer.
| CIMA F1 124
Revaluation downwards
If after a year it becomes clear that Andrews asset is now overvalued , it will need to be revalued downwards
DR Revaluation Surplus (revaluation reserve)
CR Asset account
Non-current asset disposal
When a non-current asset is sold, there is likely to be a profit or loss on disposal. This is the difference between
the net sale price of the asset and its carrying amount at the time of disposal.
Apply Your Knowledge 4
A business purchased a non-current asset on 1 January 20X1 for $25,000 with an estimated life of 6 years and
an estimated residual value of $17,000. The business uses the straight line method to depreciate the asset.
After three years the asset was eventually sold to another trader who paid $17,500 for it.
| CIMA F1 125
Non-current asset disposal – Disposal of a revalued asset
Apply Your Knowledge 5: Andrew, revisited
Andrew Inc, which makes up its accounts to 31 December each year, buys an asset on 1 January 20X1 for
$10,000. The asset has an estimated useful economic life of ten years with no residual value. Therefore,
straight-line depreciation will be $1,000 pa and, on 31 December 20X2, the asset will be included in the
statement of financial position* as follows:
$
Non-current assets at cost 10,000
Accumulated depreciation (2,000)
8,000
On 1st January 20X3, Andrew revalues the asset to $16,000. The total useful economic life remains at ten years
from 1st January 20X1.
Required:
Andrew sells the asset on 1 January 20X4 for $15,000. Show how the disposal is recorded.
| CIMA F1 126
Disclosure note
IAS 16 requires a reconciliation of the opening and closing carrying amounts of non-current assets to be given
in the financial statements.
The main disclosure required for property, plant and equipment is shown below:
Land and buildings
$’000
Plant
$’000
Motor Vehicles
$’000
Total
$’000
Cost or valuation: At (b.fwd date) X X X X Additions 1 X X X X Disposals (X) (X) (X) (X) Revaluation 1 X X X X –––– –––– –––– –––– At (c/fwd date) X X X X –––– –––– –––– –––– Accumulated depreciation: At (b/fwd date) X X X X Charge for year 11 X X X X Disposal (X) (X) (X) (X) Revaluation 1 (X) (X) (X) (X) –––– –––– –––– –––– At (c/fwd date) X X X X –––– –––– –––– –––– Carrying value (b/fwd date) X X X X –––– –––– –––– –––– Carrying value (c/fwd date) X X X X –––– –––– –––– ––––
| CIMA F1 127
Apply Your Knowledge 6
Which of the following items should be capitalised within the initial carrying amount of an item of plant?
i. Cost of transporting the plant to the factory
ii. Cost of installing a new power supply required to operate the plant
iii. A deduction to reflect the estimated realisable value
iv. Cost of a three-year maintenance agreement
v. Cost of a three-week training course for staff to operate the plant
A. (i) and (ii) only
B. (i), (ii) and (iii)
C. (ii), (iii) and (iv)
D. (i), (iv) and (v)
Apply Your Knowledge 7
Lucas has an accounting year end of 31 January 20X7. Property costing $100,000 and a useful life of 20 years
was purchased on 1 February 20X2. The property was revalued to its market value of $120,000 on 31 January
20X6 with no changes to its remaining useful economic life.
If Lucas elects to make the annual transfer for excess depreciation to retained earnings what amounts should
be shown in the financial statements at 31 January 20X7?
Property, plant and equipment Revaluation reserve
$ $
A 112,000 45,000
B 114,000 44,000
C 120,000 45,000
D 112,000 42,000
| CIMA F1 128
Apply Your Knowledge 8
Pompidou incurred the following expenditure on improving and maintaining its property plant and equipment
in the year.
$
Expenditure to increase the operating capacity of its machinery 250,000
Expenditure to redecorate the reception area of its building 20,000
Expenditure to extend the warehouse to increase storage capacity 145,000
Expenditure to repair the roof of a warehouse caused by storm damage 55,000
What total amount can be capitalised as part of subsequent expenditure in the year on property, plant and
equipment?
A. $75,000
B. $215,000
C. $395,000
D. $415,000
| CIMA F1 129
IAS 23 BORROWING COSTS
Definitions:
Borrowing cost
Interest and other costs incurred by an entity in connection with the borrowing of funds.
Qualifying asset
An asset that necessarily takes a substantial period of time to get ready for its intended use or sale
Accounting:
Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset
shall be capitalised as part of the cost of that asset.
Amount to be capitalised
The borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset are
those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been
made.
Specific Borrowings:
To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of
borrowing costs eligible for capitalisation on that are the actual borrowing costs incurred less any investment
income on the temporary investment of those borrowings.
Commencement,
Capitalisation commences when;
Expenditures for the asset are being incurred;
Borrowing costs are being incurred; and
Activities that are necessary to prepare the asset for its intended use or sale are in progress
Suspension
Suspension of capitalisation of borrowing costs shall occur during extended periods in which active development
is interrupted.
| CIMA F1 130
Cessation
Capitalisation of borrowing costs shall cease when substantially all the activities necessary to prepare the
qualifying asset for its use or sale are complete.
Apply Your Knowledge 9
Wooden constructed a golf course at a cost of $200 million over eight months from 1 January to 31 August. In
order to finance the project Wooden took out a $160 million 10% loan on 1 January. The loan was repaid on 31
December. The golf course did not open until the following year.
Required:
Calculate the initial cost of the golf course.
| CIMA F1 131
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for non-current assets.
An identifiable non-monetary asset without physical substance.
Accounting treatment
Capitalise and amortise over useful economic life
Cost- residual value
Estimated useful economic life
Amorisation?
To Amortise literally means ‘to spread’ , so amortisation is exactly the same as depreciation, but by
convention we depreciated tangibles and amortise intangibles
Intangible non-current assets
| CIMA F1 132
IAS 38 Intangible assets
Initial recognition of an intangible asset
An intangible asset is recognised if, and only if;
It is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
The cost of the asset can be measured reliably
An intangible asset shall be measured initially at cost.
DEBIT Non-current asset (intangible) – cost $X
CREDIT Cash (or payable, if a credit transaction) $X
Purchase price,
import duties and
non-refundable purchase taxes less any trade discounts
Any directly attributable costs of preparing the asset for its intended use e.g. professional fees, testing,
costs of employee benefits arising directly from bringing the asset to its working condition
Internal expenditure – internally generated intangibles
Internally generated goodwill shall not be recognised.
Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance should not
be recognised as intangible assets.
| CIMA F1 133
Research and Development costs
IAS 38 All costs incurred in research are written off directly to the statement of profit or
loss.
DEBIT Income statement – research cost $X
CREDIT Cash (or payable, if a credit transaction) $X
An intangible asset arising from development shall be recognised if, and only if, an entity can demonstrate ALL of
the following:
The technical feasibility of completing the intangible asset so that it will be available for use or sale.
Its intention to complete the intangible asset and use or sell it.
Its ability to use or sell the intangible asset.
How the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
The availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset.
Its ability to measure reliably the expenditure attributable to the intangible asset during its development.
DEBIT Non-current asset (intangible- development asset $X
CREDIT Cash (or payable, if a credit transaction) $X
| CIMA F1 134
Method must be found of spreading the cost of the asset over its useful life
If an intangible has a finite life then it should be amortised on a systematic basis over its useful economic life.
Residual value is normally assumed to be zero unless there is a commitment from a buyer to purchase at the end
of its useful life or an active market exists.
Amortisation begins when the asset is available for use.
An intangible could be considered to have an indefinite useful life if there is no foreseeable limit to the period
over which the asset is expected to generate net cash flows for the entity. An intangible asset with an indefinite
useful life shall not be amortised. It will need to be tested for impairment every year
If no active market exists the intangible must be carried at cost less any accumulated amortisation and impairment
losses.
Apply Your Knowledge 10
Proudfoot Co is a pharmaceutical company and has incurred development expenditure of $500,000 and
research expenditure of $400.000 in the year ended 31 December 20X1. The development expenditure has
been capitalised in accordance with IAS 38. The asset developed is now available for use. Proudfoot Co have a
policy of amortising capitalised development expenditure over 25 years.
What balances related to research and development would appear in the financial statements of Proudfoot
for the year ended 31 December 20X1?
SOFP Statement of P/L
A $900,000 $nil
B $500,000 $400,000
C $864,000 $436,000
D $480,000 $420,000
| CIMA F1 135
Revaluation of an Intangible asset
Intangible assets may be revalued to their fair value. The fair value should be determined by an active market.
An active market exists where all of the following conditions are met:
items traded in the market are homogenous
willing buyers and sellers can be found at any time
prices are available to the public.
IAS 38 states it is ‘uncommon’ for an active market to exist for intangible assets.
IAS 38 requires the following disclosure requirements:
For each class of intangible assets:
The useful lives or amortisation rates used.
The amortisation methods used.
The gross carrying amount and accumulated amortisation at the beginning and end of the period.
The amount of amortisation charged for the period to the statement of profit or loss.
A reconciliation between the beginning and end of the year balances, i.e. additions, disposals, changes
due to impairments or revaluations, amortisation during the period.
| CIMA F1 136
The intangible note (IAS 38) shows the movements in the year for each category of asset.
Development Patents Trademarks Total
$000 $000 $000 $000
Cost
At 1 January 20X4 X X X X
Additions X X X X
Disposals (X) (X) (X) (X)
–– –– –– ––
At 31 December 20X4 X X X X
–– –– –– ––
Accumulated amortisation/impairment:
At 1 January 20X4 X X X X
Charged during the year X X X X
Disposals (X) (X) (X) (X)
–– –– –– ––
At 31 December 20X4 X X X X
–– –– –– ––
Carrying amount
At 1 January 20X4 X X X X
–– –– –– ––
At 31 December 20X4 X X X X
–– –– –– ––
| CIMA F1 137
Apply Your Knowledge 11
Dempsey’s year end is 30 September 2014. Dempsey commenced the development stage of a project to
produce a new pharmaceutical drug on 1 January 2014. Expenditure of $40,000 per month was incurred until
the project was completed on 30 June 2014 when the drug went into immediate production. The directors
became confident of the project’s success on 1 March 2014. The drug has an estimated life span of five years;
time apportionment is used by Dempsey where applicable.
What amount will Dempsey charge to profit or loss for development costs, including any amortisation, for the
year ended 30 September 2014?
A. $12,000
B. $98,667
C. $48,000
D. $88,000
Apply Your Knowledge 12
Which of the following items below can be classified as intangible assets according to IAS 38 Intangible assets?
i. market knowledge e.g. customer lists, relationship and loyalty
ii. scientific/technical knowledge
iii. investment properties
iv. licenses and quotas
v. plant and equipment
A. i, ii and iii
B. i, ii and v
C. ii, iii and iv
D. i, ii and iv
| CIMA F1 138
Apply Your Knowledge 13
A whisky distiller incurs the following costs: $38,000 developing new distilling techniques that will be put in
place shortly to cut the production cost of making malt whisky; $27,000 researching a new process to improve
the quality of standard whisky and $8,000 on market research into the commercial viability of a new type of
malt whisky. It is company policy to capitalise costs whenever permitted by IAS 38.
How much should be charged as research and development expenditure in profit or loss ? (ignore
amortisation)
A. $73,000
B. $35,000
C. $27,000
D. $38,000
| CIMA F1 139
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for impairments.
THE KEY RULE
An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
Recoverable amount
Is the Higher is
Fair value less costs to sell Value in use
(present value of future
cash flows arising from
use and disposal of
asset)
WHEN TO TEST FOR IMPAIRMENT
The following situations may indicate that an asset has been impaired:
decline in market value
technological, legal or economic changes
physical damage
plans to dispose of asset.
IAS 36: Impairment Testing
| CIMA F1 140
Apply Your Knowledge 1
Mary Inc is a manufacturer of cardboard boxes. However a change in the market means that the inventory
produced by the machine that makes small gift boxes is being sold below its cost. Due to this impairment
circumstance an impairment test needs to be carried out.
The following information is relevant:
The carrying value of the productive machinery at depreciated historical cost is $290,000 and its net selling price
is estimated at $120,000. The anticipated net cash inflows from the machines are now $100,000 per annum for
the next three years. The current cost of capital is 10%. An annuity factor for this rate over this period is 2.487
Required:
Advise the directors of Mary on how to treat the above item in the financial statements
| CIMA F1 141
Impairment of a previously revalued assets
Apply Your Knowledge 2
Lock holds a non-current asset, which was purchased for $10 million on 1 December 2006 with an expected
useful life of 10 years. On 1 December 2008, it was revalued to $8· 8 million. At 30 November 2009, the asset
was reviewed for impairment and written down to its recoverable amount of $5·5 million.
Required:
Advise the directors of Lock on how to treat the above items in the financial statements for the year ended 3o
November 2009.
| CIMA F1 142
THE CASH GENERATING UNIT
Apply Your Knowledge 3
Path owns a company called Taylor. Extracts from Path’s Statement of Financial Position relating to Taylor:
$000
Goodwill 160,000
Franchise costs 100,000
Restored furniture (at cost) 180,000
Buildings 200,000
Other net assets 100,000
–––––––
740,000
–––––––
The restored furniture has an estimated realisable value of $230 million. The franchise agreement contains a ‘sell back’ clause, which allows Taylor to relinquish the franchise and gain a repayment of $60 million from the franchisor. An impairment review at 31 March 2013 has estimated that the value of Taylor as a going concern is only $480 million. Required: Show how the impairment would be dealt with.
Disclosures
IAS 36 requires the following disclosure requirements:
For each class of property, plant and equipment:
The amount of impairment losses recognised in the statement of profit or loss during the period and
where it has been included, i.e. which expense category.
The amount of reversals for impairment losses recognised in the statement of profit or loss during the
period and where it has been included.
The amount of impairment losses recognised directly in equity during the period.
The amount of reversals of impairment losses recognised directly in equity during the period.
| CIMA F1 143
Apply Your Knowledge 4
The net assets of Fyngle, a cash generating unit (CGU), are:
$
Property, plant and equipment 200,000
Allocated goodwill 50,000
Product patent 20,000
Net current assets (at net realisable value) 30,000
––––––––
300,000
––––––––
As a result of adverse publicity, Fyngle has a recoverable amount of only $200,000.
What would be the value of Fyngle’s property, plant and equipment after the allocation of the impairment loss?
A. $154,545
B. $170,000
C. $160,000
D. $133,333
Apply Your Knowledge 5
Riley acquired a non-current asset on 1 October 2009 at a cost of $100,000 which had a useful economic life of
ten years and a nil residual value. The asset had been correctly depreciated up to 30 September 2014. At that date
the asset was damaged and an impairment review was performed. On 30 September 2014, the fair value of the
asset less costs to sell was $30,000 and the expected future cash flows were $8,500 per annum for the next five
years. The current cost of capital is 10% and a five year annuity of $1 per annum at 10% would have a present
value of $3.79
What amount would be charged to profit or loss for the impairment of this asset for the year ended 30 September
2014?
A. $17,785
B. $20,000
C. $30,000
D. $32,215
| CIMA F1 144
Apply Your Knowledge 6
Which of the following is NOT an indicator of impairment?
A. Advances in the technological environment in which an asset is employed have an adverse impact on its
future use
B. An increase in interest rates which increases the discount rate an entity uses
C. The carrying amount of an entity’s net assets is higher than the entity’s number of shares in issue
multiplied by its share price
D. The estimated net realisable value of inventory has been reduced due to fire damage although this value
is greater than its carrying amount
| CIMA F1 145
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of reporting
of performance.
IFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS The objective of IFRS 5 is to specify the accounting for assets held for sale and the presentation and disclosure of discontinued operations.
Assets held for sale
An asset is classified as held for sale if its carrying amount will be recovered principally through a sale transaction
rather than through continuing use.
For this to be the case the asset must be available for immediate sale and its sale highly probable i.e.:
Management commitment to the sale
Available for immediate sale in its present condition
Actively marketed
Sale is highly probable- i.e offered at a reasonable price
Sale must be expected to complete with one year
Accounting
The non-current asset should be held at the lower of its carrying value and fair value less costs to sell. The asset or
group of assets are removed from Non-current assets in the statement of financial position and moved into the
current assets section as a Non-current asset held for sale:
Statement of financial position as at xx/xx/xxx
$000 $000
Current Assets
Inventory xx
Trade receivables xx
Cash and cash equivalents xx
xx
Non-current asset held for sale xx
Total Assets xx
Topic 14: Non- current assets held for sale and
discontinued operations
| CIMA F1 146
An asset classified as held for sale will not be depreciated.
Discontinued operation
A component of an entity that either has been disposed of or is classified as held for sale and;
Represents a separate major line of business or geographical area of operations,
Is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations
Is a subsidiary acquired exclusively with a view to resale.
If it needs to be adjusted to comply with the measurement rule of lower of its carrying value and fair value less
costs to sell this is treated as an impairment loss and it will need to be expensed via profit in the normal way (but
the presentation is radically different) :
Proforma statement of profit or loss presentation
$ Continuing operations Revenue x Cost of sales (x) ____
Gross profit x Distribution costs (x) Administration expenses (x) ____
Operating profit x Finance costs (x) ____
Profit before tax x Income tax expenses (x) ____
Profit for the period from continuing operations x
Discontinued operations Profit for the period from discontinued operations*
x
____
Total profit for the period x
* detail given in the notes
| CIMA F1 147
Presentation in the statement of profit or loss
An enterprise must disclose a single amount on the face of the statement of profit or loss, comprising the total of:
The post-tax profit or loss of discontinued operations; and
The post-tax gain or loss recognised on the measurement to fair value less costs to sell, or on the disposal, of the assets constituting the discontinued operation.
Apply Your Knowledge 1
On 1 January 2007 Rolf introduced a new production line at a cost of $500,000. It has an expected useful life of
10 years but will realise nothing on final disposal. On 31 December 2008, after just two years of using the asset,
it was decided to upgrade again so the production must be sold.
A plan was put in place and instructions given to locate a buyer. The plant is in great demand so Rolf is confident
that the machine will be sold quickly. Its current market value is $300,000. As the production line is a
considerable size dismantling costs to make it available for sale will be incurred at $10,000.
Required:
Show how the asset should be presented in the statement of financial position for the year ended 31 December
2008.
| CIMA F1 148
IFRS 5 and published accounts questions
IFRS 5 will be frequently examined in published accounts questions. These can be the trickiest of the published
accounts questions
Apply Your Knowledge 2
As at 30 September 2013 Dune’s property in its statement of financial position was:
Property at cost (useful life 15 years) $45 million
Accumulated depreciation $6 million
On 1 April 2014, Dune decided to sell the property. The property is being marketed by a property agent at a price
of $42 million, which was considered a reasonably achievable price at that date. The expected costs to sell have
been agreed at $1 million. Recent market transactions suggest that actual selling prices achieved for this type of
property in the current market conditions are 10% less than the price at which they are marketed.
At 30 September 2014 the property has not been sold.
At what amount should the property be reported in Dune’s statement of financial position as at 30 September
2014?
A. $36 million
B. $37·5 million
C. $36·8 million
D. $42 million
| CIMA F1 149
Apply Your Knowledge 3
GZ is a small mining entity, which operated a single gold mine for many years. The gold mine ceased operations on 31 October 20X7 and was closed on 1 January 20X8.
On 1 November 20X7, GZ commenced operating a new silver mine.
The trial balance for GZ at 31 October 20X8 was as follows:
$000 $000 4% Loan notes (redeemable 1 April 20X9) 1,900 Administrative expenses 1,131 FVTOCI investments at market value 31 October 20X7 2,177 Cash and cash equivalents 2,025 Direct operating expenses (excluding depreciation) 6,253 Distribution costs 879 Dividend paid 1 March 20X8 550 Equity shares $1 each, fully paid 5,900 Government operating licence, silver mine at cost (see note (ii)) 100 Income tax 13 Interest paid on loan notes – half year to 30 April 20X8 38 Inventory at 31 October 20X8 2,410 Investment income received 218 Mine properties at cost (see note (iv)) 6,719 Plant acquired during the year 900 Plant and equipment at 31 October 20X7 3,025 Provision for depreciation at 31 October 20X7: Mine properties (see note (iv)) 2,123 Plant and equipment 370 Receipt from sale of plant (see note (iii)) 2 Retained earnings at 31 October 20X7 4,491 Revaluation reserve at 31 October 20X7 80 Revenue 9,600 Suspense account (see note (xii)) 1,820 Trade payables 2,431
Additional information provided:
i. Each mine requires a government operating licence for 20 years and is expected to be productive for that time. After 20 years, the mine will be closed and decommissioned.
ii. On 1 November 20X7, GZ received a government operating licence to operate the new silver mine. The licence cost $100,000 and is for 20 years. Included in the licence is a condition that, on closure of the mine, all above-ground structures must be removed and the ground landscaped. GZ has estimated this cost and discounted it to a present value of $3,230,000 at 31 October 20X8. The trial balance excludes this decommissioning provision.
iii. GZ sold old plant and equipment from the gold mine for $2,000 (original cost $200,000, net book value $5,000). The gold mine property is now surplus to GZ’s requirements. At 31 October 20X8, the gold mine property had a market value of $520,000 with estimated selling and legal costs of $27,000.
iv. (The mine property balances in the trial balance comprised:
| CIMA F1 150
Mine property Gold Mine Silver Mine Total
$000 $000 $000
Cost 2,623 4,096 6,719
Provision for depreciation 2,123 0 2,123
––––– ––––– –––––
500 4,096 4,596
v. The market value of the available for sale investments at 31 October 20X8 was $2,311,000. vi. There were no sales or purchases of available for sale investments during the year ended 31 October
20X8 and no acquisitions of other non-current assets, except for those in note (ix) below. vii. Income tax due for the year ended 31 October 20X8 is estimated at $375,000.
viii. Depreciation is charged on mining property using the straight-line basis at 5% per annum. Plant and equipment is depreciated using the reducing balance method at 25%. The depreciation policy is to charge a full year’s depreciation in the year of acquisition and no depreciation in the year of disposal. Depreciation is regarded as a cost of production.
ix. The 4% loan notes are ten-year loans due for repayment 1 April 20X9. GZ incurred no other interest charges in the year to 31 October 20X8.
x. The final dividend for the year to 31 October 20X7 was paid on 1 March 20X8. xi. GZ made a new issue of 1,400 equity shares on 31 October 20X8 at a premium of 30%. The cash
received was debited to the bank account and credited to the suspense account.
Required:
(a) Prepare GZ’s Property, Plant and Equipment note to the financial statements for the year to 31 October 20X8.
(b) Prepare GZ’s Statement of profit or loss and other comprehensive income and a statement of changes in equity for the year to 31 October 20X8 and a statement of financial position at that date, in a form suitable for presentation to the shareholders and in accordance with the requirements of International Financial Reporting Standards. (All workings should be to the nearest $000).
Notes to the financial statements, except as indicated in part (a) above, are NOT required, but all workings must be clearly shown. Do NOT prepare a statement of accounting policies.
| CIMA F1 151
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for government grants.
IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT
ASSISTANCE
Definitions:
Government
Government, government agencies and similar bodies whether local, national or international
Government grants
Assistance by government in the form of transfers of resources to an entity in return for past or future
compliance with certain conditions relating to the operating activities of the entity.
Government assistance
Action by government designed to provide an economic benefit specific to an entity or range of entities qualifying
under certain criteria. Government assistance for the purpose of this standard does not include benefits provided
only indirectly through action affecting general trading conditions.
General principles
IAS 20 follows two general principles when determining the treatment of grants:
Prudence: grants should not be recognised until the conditions for receipt have been complied with and there is
reasonable assurance the grant will be received.
Accruals: grants should be matched with the expenditure towards which they were intended to contribute.
Recognition – general principles
A grant should not be recognised until there is reasonable assurance that:
a) The entity will comply with the conditions attaching to them; and
b) The grants will be received
Topic 15: IAS 20 government grants and IAS 40
investment properties
| CIMA F1 152
Capital grants- accounting
Statement of financial position
Two methods of presentation in the financial statements of capital grants;
a) Set up the grant as deferred income and recognise income on a systematic basis over the useful life of the
asset
b) Deduct the grant from the cost of the asset and recognise as part of the depreciation charge
Revenue grants- accounting
Statement of profit or loss
Government grants shall be recognised as income over the periods necessary to match them with the related
costs which they are intended to compensate, on a systematic basis.
Two presentation approaches are acceptable:
Present as a credit in the statement of profit or loss
Present as a deduction from the related expense
| CIMA F1 153
Apply Your Knowledge 1
Star buys an item of plant for a total cost of $200,000. They applied for a government grant and, having
complied with all relevant conditions, have just received $20,000 towards the cost of the plant.
The useful economic life of the plant is estimated at ten years.
Required:
Prepare extracts from the statement of profit or loss and statement of financial position if Star adopts;
A. deferred income approach B. off-set grant against asset approach
Apply Your Knowledge 2
Gloria received a government grant towards purchasing a new building. The building has a useful life of 25
years and had a total cost of $250,000 on 1 July 20X5 and Gloria received a grant of $100,000on the same date.
Assuming Gloria uses the deferred income method for government grants, what is the total impact on the
statement of profit or loss for the year ended 30 June 20X6 and what is the value of the non-current asset as at
30 June 20X6?
A. SPL $6,000 expenses, Asset value $240,000
B. SPL $6,000 expenses, Asset value $144,000
C. SPL $10,000 expense, Asset Value $240,000
D. SPL $10,000 expenses, Asset value $144,000
Apply Your Knowledge 3
Manny received a government grant of $10,000 for the purchase of a new property costing $80,000 on 1 April
20X5. The asset has a life of 10 years and Manny adopts the deferred income method permitted in IAS 20
Government Grants.
What amounts would appear in the statement of financial position as at 31 March 20X6?
Deferred income Current liability Deferred income non current liability
A $1,000 $9,000
B $1,000 $8,000
C $700 $6,300
D $700 $5,600
| CIMA F1 154
Apply Your Knowledge 4
Phil received a government grant of $4,500 against the purchase of a piece of equipment costing $30,000 on 1
July 20X4. The assets has a useful life of 6 years and Phil adopts the deferred income method permitted in IAS
20 Government grants.
What amounts will appear in the statement of cash flow for the year ended 30 June 20X5?
Operating activities- Investing activities-
Amortisation of government grant Grant income received
A $500 $4,500
B $750 $4,500
C $500 $nil
D $750 $nil
| CIMA F1 155
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for non-current assets.
Definitions
Investment property
Land or building or part of a building, or both held to earn rentals or for capital appreciation or both, rather than
for:
a) Use in the production or supply of goods or services or for administrative purposes; or; b) Sale in the ordinary course of business
Owner occupied
Property held for use in the production or supply of goods or services or for administrative purposes.
Accounting
Initial Recognition
An investment property is initially measured at cost including transaction costs.
Subsequent measurement
An entity can choose from the following policies but must apply the policy consistently
Cost model
The property is accounted for in accordance with IAS 16.
Fair value model
Carry the property at its fair value with any gains or losses recognised in the statement of profit or loss in the
period that it arises. It should be carried at fair value until disposal.
Fair value should reflect market conditions at each statement of financial position date.
If a fair value cannot be established then the cost model must be used.
IAS 40 Investment Properties
| CIMA F1 156
Apply Your Knowledge 5
Penny purchases an office block for $50m on 1 January 2007 with a view to earning rentals and for its capital
appreciation. The property is expected to have a useful life of 50 years. At 31 December 2008, market
conditions indicated that the fair value of the property has risen to $72m.
Required:
Show how the property would be presented in the financial statements as at 31 December 2008 if Warrior
follows the:
(a) cost model
(b) fair value model
| CIMA F1 157
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for inventories.
IAS 2 Inventory
Definition:
Assets:
Held for sale in the ordinary course of business;
In the process of production for such sale; or
In the form of materials or supplies to be consumed in the production process or in the rendering of
services
Types of inventory held
Goods for resale Finished goods Work in progress Raw materials
Cost of sales
Goods might be unsold at the end of an accounting period and so still be held in inventory. The purchase cost of
these goods should not be included therefore in the cost of sales of the period.
Topic 16: IAS 2, 8, 10, 34 and IFRS 8
| CIMA F1 158
Counting inventories
The quantity of inventories held at the year end is established by means of a physical count of inventory in an
annual accounting exercise, or by a ‘continuous’ inventory count.
Valuing inventories
IAS 2 INVENTORIES
“Inventories should be measured at the lower of cost and net realisable value.”
Lower of
Cost Historical cost - purchase price FIFO – first in first out AVCO – average weighted cost
Net realisable value Expected sale price – costs incurred in getting the items ready for sale
The value of inventories is calculated at the lower of cost and net realisable value for each separate item or
group of items.
FIFO (first in, first out)
FIFO assumes that materials are issued out of inventory in the order in which they were delivered into
inventory. This happens a lot with food beacuse of the sell by dates.
AVCO (average cost)
The cumulative weighted average pricing method calculates a weighted average price for all units in inventory.
Issues are priced at this average cost, and the balance of inventory remaining would have the same unit
valuation.
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A new weighted average price is calculated whenever a new delivery of materials into store is received. This is the
key feature of cumulative weighted average pricing.
Cost
The cost of inventories shall comprise all costs of purchase, costs of conversion and other cost incurred in bringing
the inventories to their present location and condition
Cost of purchase comprises of:
Purchase price, import duties, irrecoverable taxes, transport, handling and other costs directly attributable to the
acquisition of finished goods, materials and services.
Trade discounts are deducted but cash or settlement discounts are not.
Costs of conversion comprises of:
Costs directly related to the units of production, such as direct labour.
Exclusions: abnormal costs, storage costs, administration costs and selling costs.
Net realisable value
The estimated selling price in the ordinary course of business less the estimated costs of completion and the
estimated costs necessary to make the sale
Apply your knowledge 1
Daisy paid $3 per unit for the raw materials of its products. To complete each unit incurred $2 per unit in direct labour.
Production overheads for the year based on normal output of 12,000 units was $72,000.
Due to industrial action only 10,000 units were produced and 1,000 units were in inventory at the end of the year.
As a result of the industrial action some units were badly stored and became damaged. It’s is estimated that 200 of the units will now only be sold for $12 each after minor repairs of $2 each
Required:
What figure for closing inventory would be shown in the statement of financial position?
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Apply your knowledge 2
The following figures relate to inventory held at the year end.
A B C
$ $ $
Cost 20 9 12
Selling price 30 12 22
Modification cost to enable sale - 2 8
Marketing costs 7 2 2
Units held 200 150 300
Required:
Calculate the value of inventory held.
E.g. if we buy and sell tyres we may get to a 31 December year end with 200 tyres in our warehouse but our
transactions in December were as follows:
1st December – Warehouse empty
2nd December –Purchase 200 tyres costing $15 each
10th December – Purchase 100 tyres costing $18 each
16th December- Sell 250 tyres at $30 each
20th December – Purchase 150 units at $20 per unit
So with costs ranging from $15- $20 how will we value the 200 tyres in the warehouse at the year end?
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Apply your knowledge 3
On the 1 October 2012 a company held 300 units of finished goods, these were valued at £12 per unit. During
October 2012 the following transactions occurred:
Date Activity Cost per unit
10 October Purchased 400 $12.50
14 October Sold 500
20 October Purchased 400 $14
21 October Sold 500
25 October Purchased 400 $15
28 October Sold 100
Units were sold for $20 each
Required:
Calculate the profit for October and the closing inventory if valued under
a. FIFO
b. AVCO (using cumulative weighted average costing)
Apply your knowledge 4
On 30 September 2014, Razor’s closing inventory was counted and valued at its cost of $1 million. Some items
of inventory which had cost $210,000 had been damaged in a flood (on 15 September 2014) and are not
expected to achieve their normal selling price which is calculated to achieve a gross profit margin of 30%. The
sale of these goods will be handled by an agent who sells them at 80% of the normal selling price and charges
Razor a commission of 25%.
At what value will the closing inventory of Razor be reported in its statement of financial position as at 30
September 2014?
A. $1 million
B. $790,000
C. $180,000
D. $970,000
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Learning outcome: B1a Describe the main elements of financial statements prepared in accordance with IFRS
Accounting policies
The specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting the
financial statements.
Selecting accounting policies
In selecting accounting policies an entity must firstly consider the requirements of the applicable accounting
standards.
In all other situations policies should be selected so as to result in information that is relevant and reliable in line
with the framework.
Relevant – to the economic decision making needs of users; and
Reliable
Faithful representation
Reflect the substance
Neutral, free from bias
Prudent
Complete in all material respect.
Changing accounting policies
Once chosen accounting policies should be applied consistently unless changing the policy would result in fairer
presentation. Policies may also need amending where changes in standards take place.
This change should be applied retrospectively. This will result in the restatement of opening balances and
comparatives. The retrospective adjustment is referred to as a prior period adjustment and shown in the statement
of changes in equity.
For a change to be truly a change in accounting policy it must affect any one of the following; recognition,
presentation or measurement. Otherwise it will be a change in an accounting estimate.
IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors Apply Your Knowledge 4
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Apply Your Knowledge 1
Paddy construction incurs considerable finance costs on its financing for the construction of motorway bridges. Its accounting policy to date has been expense the finance costs as incurred. The final accounts for the year ended 31 December 2007, and the 2008 draft accounts, reflect this policy and show the following.
2008 2007 $000 $000 Profit from operations 9,000 6,000 Finance costs (3,000)
______ (2,000)
______ Profit before tax Income tax expense Profit for the year
6,000 (2,000) ______
4,000
4,000 (1,500) ______
2,500 Retained earnings brought forward 24,500
______ 22,000
______ Retained earnings carried forward 28,500
====== 24,500
======
The directors have now decided to change the accounting policy to one of capitalisation of finance costs to give a fairer presentation. This decision has been supported by paddy’s auditors. The finance costs above all relate to the construction of the bridges.
Paddy had 5m $1 ordinary shares.
Required:
Show how the change in accounting policy will be reflected in the financial statements for the year ended 31 December 2008. Assume there are no tax implications
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Changes in accounting estimates
As a result of inherent uncertainties in a business many estimates will be made. As estimates revisions will obviously
need to be made.
Changes in estimates are adjusted prospectively in the current years statement of profit or loss but not retrospectively
as with changes in accounting policy.
Prior period errors
Apply Your Knowledge 2
Material prior period errors should be corrected retrospectively by adjustment against the opening balance of retained earnings in the statement of changes in equity.
Required:
According to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, which ONE of the following is a change in accounting policy?
A. The depreciation method of vehicles being changed from straight line to reducing balance. B. The provision for warranty claims being recalculated using a different method. C. Recognising a provision for a legal claim which had been disclosed as a contingent liability in the previous
year’s financial statements. D. Presenting depreciation in cost of sales which had previously been presented in administrative expenses.
Apply Your Knowledge 3
Which of the following would be a change in accounting policy in accordance with IAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors?
A. Adjusting the financial statements of a subsidiary prior to consolidation as its accounting policies differ from those of its parent
B. A change in reporting depreciation charges as cost of sales rather than as administrative expenses C. Depreciation charged on reducing balance method rather than straight line D. Reducing the value of inventory from cost to net realisable value due to a valid adjusting event after the
reporting period
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Apply Your Knowledge 4
Which of the following is a change of accounting policy under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors?
A. Classifying commission earned as revenue in the statement of profit or loss, having previously classified it as other operating income
B. Switching to purchasing plant using finance leases from a previous policy of purchasing plant for cash C. Changing the value of a subsidiary’s inventory in line with the group policy for inventory valuation when
preparing the consolidated financial statements D. Revising the remaining useful life of a depreciable asset
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Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of events
after the reporting period.
Events after the reporting date
Those events, favourable and unfavourable, that occurred between the end of the reporting period and the date
when the financial statements are authorised for issue.
Adjusting events
Those events that provide additional evidence of conditions that existed at the end of the reporting period.
Non-adjusting events
Those that are indicative of conditions that arose after the reporting period.
These events will be disclosed when material.
Nature of the event
Estimate of the financial effect, or a statement that such an estimate cannot be made.
Dividends
If an entity declares dividends to holders of equity instruments (IAS32) after reporting period, the entity shall not
recognise those dividends as a liability at the end of the reporting
Apply Your Knowledge 1
Should each of the following be treated as an adjusting or non-adjusting event?
(i) the company makes an issue of 100,000 shares which raises $200,000 shortly after the reporting date.
(ii) a legal action had brought against the company for breach of contract prior to the year end. The outcome was decided shortly after the reporting date, and as a result the company will have to pay costs and damages totalling $80,000. No provision has currently been made for this event.
(iii) inventory included in the accounts at the year end at cost $30,000 was subsequently sold for $10,000.
IAS 10 Events after the reporting date
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Apply Your Knowledge 2
A company has a year end 31 December 20X1. The accounts were then signed on the 4 April 20X2. The following events took place between the year end and the date of signing.
According to IAS 10 ‘Events After the Reporting Period’, which events should have been adjusted for in the 20X1 accounts?
1. The directors decided on the 25 March 20X2 to cease trading at the end of 20X2.
2. A legal dispute arising in 20X1, previously not provided for, has been settled on 25 February 20X2 resulting in the company being ordered to pay damages of $3,000.
3. After a successful year in 20X1 the directors have decided that, based on the 20X1 draft accounts, sufficient profits have arisen and declared a dividend on 1 January 20X2.
A. None of the above
B. All of the above
C. 1 & 2 only
D. 2 & 3 only
Apply Your Knowledge 3
Which TWO of the following events which occur after the reporting date of a company but before the financial statements are authorised for issue are classified as ADJUSTING events in accordance with IAS 10 Events after the Reporting Period?
(i) A change in tax rate announced after the reporting date, but affecting the current tax liability
(ii) The discovery of a fraud which had occurred during the year
(iii) The determination of the sale proceeds of an item of plant sold before the year end
(iv) The destruction of a factory by fire
A. (i) and (ii) B. (i) and (iii) C. (ii) and (iii) D. (iii) and (iv)
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Learning outcome: B1a Describe the main elements of financial statements prepared in accordance with IFRS
IFRS 8 sets out requirements for disclosure of information about an entity’s operating segments, the entity’s
products and services, the geographical areas in which it operates and its major customers.
An operating segment is a component of an entity:
a) that engages in business activities from which it may earn revenue and incur expenses
b) whose operating results are regularly reviewed by the entity’s chief operating decision maker
c) for which discrete financial information is available.
A segment should be classified as a reportable segment if it contributes more than 10% of the total of any of the
following:
revenue (internal and external)
profitable segments
loss making segments
assets
If, after allocating segments according to the 10% rule, the external revenue of reportable segments is less than
75% of the total revenue of the entity, additional segments will be classified as reportable segments even though
they do not meet the 10% rule.
Disclosure
IFRS 8 requires the disclosure of the following:
factors used to identify the entity’s reportable segments, including the basis of segmentation (for
example, whether operating segments are based on products or services or geographical areas)
types of products and services from which each segment derives its revenue
For each reportable segment an entity should report:
profit or loss
revenues
total assets
total liabilities
IFRS 8 Operating segments
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Apply Your Knowledge 1
Which of the following is a feature of an operating in accordance with IFRS 8 operating segments?
A. a component for which financial information is available
B. it is a significant area of the entity’s operations
C. a part of the operations that is expected to be discontinued within the next twelve months
D. it is a loss making area of the business
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Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for taxation.
IAS 12 INCOME TAXES
Definitions
Accounting profit
The profit or loss for a period before deducting tax expense.
Taxable profit
The profit or loss for a period determined in accordance with the rules established by the taxation authorities,
upon which income taxes are payable (recoverable)
Current tax
The amount of income taxes payable (recoverable) in respect of the taxable profit/( tax loss) for a period
Topic 17: IAS 12: Income Taxes
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Current tax
At the end of the financial year a company will estimate the amount of tax payable on profits for the period. This
amount is charged to the statement or profit or loss and shown as a current liability in the statement of financial
position.
DR Income tax expense (SOPL)
CR Income tax liability (SOFP)
Often this estimate is not the exact amount that is actually paid resulting in an over or under provision of income
taxes.
This balance will then be incorporated to the current year’s tax charge as you cannot go back and restate last year’s
figures.
Income tax expense:
Current tax charge for the year x
Under/over provision from previous year x/(x)
_____
Total tax charge for the year x
_____
Apply Your Knowledge 1
At 31 December 2007 Terry estimates that its current tax liability for the year will be $200,000.
In August 2008 Terry pays its tax liability for the year ended 31 December 2007 at $170,000.
At 31 December 2008 Terry again estimates it income tax liability, this time at $210,000.
Required:
Show the statement of profit or loss and statement of financial position extracts to reflect the above for the
two years ended 31 December 2008.
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Apply Your Knowledge 2
At 31 December 2007 Mckay estimates that its current tax liability for the year will be $100,000. In August
2008 Mckay pays its tax liability for the year ended 31 December 2007 at $120,000.
At 31 December 2008 Mckay again estimates it income tax liability, this time at $130,000.
Required:
Show the statement of profit or loss and statement of financial position extracts to reflect the above for the
two years ended 31 December 2008.
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Apply Your Knowledge 3
TYV is a manufacturing entity and produces a range of products in several factories. TYV’s trial balance at 30
September 2014 is shown below:
Notes $000 $000 Accumulated depreciation at 30 September 2013:
Buildings (i)
1,700 Plant and equipment (iv)
4,510
Administrative expenses
1,820 Cash and cash equivalents
272
Cost of sales
10,200 Distribution costs
1,110
Equity dividend paid
350 Equity shares $1 each, fully paid at 30 September 2014
6,625
Finance charges for new factory building
113 Income tax (v) 80 Inventory at 30 September 2014
575
Land and buildings at cost at 30 September 2013 (ii)&(iii) 17,386 Long term borrowings (vi)
5,000
Long term borrowings loan interest (vi) 233 New factory building cost
1,014
Plant and equipment at cost at 30 September 2013 (iv) 7,750 Receipt from disposal of plant and equipment (iv)
7
Retained earnings at 30 September 2013
491 Sales revenue
19,460
Share premium at 30 September 2014
850 Short term loan (iii)
1,500
Suspense account (ii)
1,130 Trade payables
1,880
Trade receivables
2,250 .
43,153 43,153
Notes:
i. On 1 October 2013 two of TYV’s factories, factory A and factory B, were deemed obsolete and no
longer suitable for TYV’s use. On 1 June 2014 both factories were closed and production moved to
a new facility. TYV disposed of factory B with all legal formalities completed and cash received on
31 August 2014. Factory A was not sold by the financial year end, however at 30 September 2014
negotiations for the sale of factory A were well advanced and TYV’s management expected to
conclude the sale by 31 December 2014. The cost and accumulated depreciation included in land
and buildings along with the fair value of each factory is shown below:
Factory Cost Depreciation at 30 September 2013
Fair value less cost of disposal at 30 Sept. 2014
Land Buildings
A $1,375,000 $455,000 $364,000 $1,420,000 B $1,120,000 $325,000 $286,000 $1,130,000
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ii. The suspense account is the cash received from the disposal of factory B. The only entries made in
the ledgers for this item was in cash and cash equivalents and suspense account.
iii. The cost of land included in land and buildings was $11,000,000 on 1 October 2013. TYV built the
new factory on land it already owned, commencing on 1 October 2013 and completing it on 30
June 2014. To fund the project TYV raised a short term loan on 1 October 2013, repayable on 30
September 2015.
iv. Plant and equipment in factories A and B was relocated to the new factory, except for plant and
equipment with a carrying value of $55,000 (cost $175,000) that was sold as scrap, realising
$7,000. Buildings are depreciated at 2% per annum on the straight line basis. Buildings
depreciation is treated as an administrative expense. Plant and equipment is depreciated at 25%
per annum using the reducing balance method and is charged to cost of sales. TYV’s accounting
policy for depreciation is to charge a full year in the year of acquisition and none in the year of
disposal.
v. The director estimate the income tax charge on the year’s profits at $940,000. The balance on the
income tax account represents the under-provision for the previous year’s tax charge.
vi. The long term borrowings consist of one loan issued in 2000 for 20 years at 7% interest per year.
Interest is paid half yearly on 1 June and 1 December.
Required:
Prepare TYV’s statement of profit or loss and a statement of changes in equity for the year ended 30
September 2014 and a statement of financial position at that date, in accordance with the requirements of
international financial reporting standards.
(All workings should be to the nearest $000).
Notes to the financial statements are not required but all workings must be clearly shown. Do not prepare a
statement of accounting policies.
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Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of reporting
of performance.
Introduction Foreign currency transactions and financial statements should be translated at rates that are both compatible
with the impact of their rate changes on cash flows and which also maintain the true and fair view of results
required.
Functional currency
This is the main currency in which an entity operates (ie the currency of their primary economic environment). It
is used for measurement in the financial statements. Any other currencies are treated as foreign currencies.
Presentation currency
This can be any currency that the entity chooses, there are specific rules which apply when translating from
functional currency to presentation currency. The translation of foreign operations is the same as for functional
currency.
FUNCTIONAL CURRENCY
Definition: As per IAS 21, this is the currency of the primary economic environment in which the entity operates.
Identifying an entity’s functional currency
Key indicators of an entity’s functional currency are as follows:
main influence on sales prices for goods and services (i.e. used to state prices)
is the currency of the country where the regulations and markets mainly determine the sales prices
main influence on labour, material and other costs (i.e. used to pay costs)
is the currency in which finances are generated
is the currency in which receipts from operating activities are usually retained.
IAS 21: The effects of changes in foreign exchange rates
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Impact on reporting in functional currency
At transaction date: using the spot exchange rate at the date of transaction
At SOFP date:
Monetary assets and liabilities Restate at closing rate
Non-monetary assets and liabilities Do not restate
Non-monetary assets at FV Use rate when FV was determined
Recognition of exchange differences
Differences are recognised in profit and loss in the period that they are incurred. Differences arising from trading
transactions are usually recognised in “Other income/expense” and differences from financing transactions are
usually recognised in “Finance income/costs”.
Apply Your Knowledge 1
Aston plc (who use the dollar as their functional currency) have an year end of 31 December 20X1 entered into
the following transaction:
25-10-X1 Purchased goods from a Swedish supplier for 286,000 euros
31-12-X1 Not yet paid at year-end
31-01-X2 Pay for the goods
The exchange rates are as follows:
SwK/$
25-10-X1 11.16
31-12-X1 11.02
31-01-X2 10.87
Required:
Show how this would be accounted for in the records of Aston for the year ended 31-12-X1 and the year ended
31-12-X2.
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Changes to the functional currency
Usually there is no change to this currency, it would only be changed if there was a change to the currency which
impacted on the transactions of the entity.
Presentation currency
Definition: As per IAS 21, this is the currency in which the financial statements are presented.
Apply Your Knowledge 2
An entity based in the EU sells goods to the UK on 10 March 20X5 when the exchange rates was €1 = £0.65. The
customer pays in May 20X5 then the rate was €1 = £0.60.
What is the gain or loss on exchange when the payment is made in May 20X5?
A. Gain of €102,564
B. Loss of €102,564
C. Gain of €40,000
D. Loss of €40,000
Apply Your Knowledge 3
A French entity buys a noncurrent asset from a US entity for $200,000 when the exchange rate was $/EUR 0.76.
At the year end the French entity has not paid its US $ payable. The exchange rate at the year end is $/EUR 0.82.
Prepare the journal entries to record the initial acquisition of the noncurrent asset and any journal entries
required at the year end.
Apply Your Knowledge 4
An entity based in the Europe sells goods to the UK for £800,000 on 20 April 20X5 when the exchange rate was
€1 = £0.65. The customer pays in May 20X5 when the rate was €1 = £0.60.
How does the entity account for the sale on 20 April 20X5?
A. Dr Receivables €480,000 Cr Sales €480,000
B. Dr Receivables €1,333,334 Cr sales €1,333,334
C. Dr Receivables € 520,000 Cr sales €520,000
D. Dr Receivables €1,203,769 Cr sales €1,203,769
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NB The entity can choose its presentation currency
Learning outcome B2b: Apply the rules contained in IFRS to generate accounting entries in respect of
accounting for employee benefits.
A pension plan (sometimes called a post-employment benefit scheme) consists of a pool of assets and a liability
for pensions owed to employees. Pension plan assets normally consist of investments, cash and (sometimes)
properties. The return earned on the assets is used to pay pensions.
There are two main types of pension plan:
defined contribution plans
defined benefit plans
Defined contribution plans
The pension payable on retirement depends on the contributions paid into the plan by the employee and the
employer.
The employer’s contribution is usually a fixed percentage of the employee’s salary. The employer has no
further obligation after this amount is paid.
Therefore, the annual cost to the employer is reasonably predictable.
Defined contribution plans present few accounting problems.
Topic 19: IAS 19: Employee
benefits
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Defined benefit plans
The pension payable on retirement normally depends on either the final salary or the average salary of the
employee during their career.
The employer undertakes to finance a pension income of a certain amount, e.g.
2/3 × final salary × (years of service/40 years)
The employer has an ongoing obligation to make sufficient contributions to the plan to fund the pensions.
An actuary calculates the amount that must be paid into the plan each year in order to provide the
promised pension. The calculation is based on various estimates and assumptions including:
o life expectancy
o expected length of service to retirement/employee turnover
o investment returns
o wage inflation.
Therefore, the cost of providing pensions is not certain and varies from year to year.
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Accounting for Defined contribution plans
The expense of providing pensions in the period is normally the same as the amount of contributions paid.
The entity should charge the agreed pension contribution to profit or loss as an employment expense in
each period.
An asset (prepayment) or liability (accrual) for pensions only arises if the cash paid does not equal the
amount of contributions due.
IAS 19 requires disclosure of the amount recognised as an expense in the period.
Apply Your Knowledge 1
Max Co agrees to contribute 6% of employee’s total remuneration into a post-employment plan each period.
For the year ended 31-12-07 the company paid total salaries of $20 million and a bonus of $4 million based on the income for the period was paid to the employees in February.
The company had paid $480,000 into the plan by 31-12-X7.
Required:
What will the impact of these transactions be on the financial statements as at 31-12-X7?
Defined benefit plans
An entity will set up a defined benefit pension plan on behalf of its employees. Both employees and the employer
(the entity), will pay into the plan. It is important to note that the pension plan is separate from the entity.
The entity recognises the net defined benefit liability (or asset) in the statement of financial position.
If the pension plan liability exceeds its assets, there is a deficit (the usual situation) and a liability is reported in
the statement of financial position of the entity.
If the pension plan assets exceeds its liability, there is a surplus and an asset is reported in the statement of
financial position of the entity.
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Measuring the pension plan assets and liabilities.
Defined Benefit Scheme Assets should be measured at fair value i.e. market value. Defined Benefit Scheme Liabilities should be measured in the same way, at fair value which will be discounted to present value.
Presentation in the statement of profit or loss and other comprehensive income
Profit or loss
Service costs component
Net interest component
Other comprehensive income
remeasurement component
Service Cost Component
Current service cost – the additional costs of an employee working for an extra year meaning that they
are now entitled to an extra year of benefit from the plan. This increases the obligations of the plan, but
needs to be discounted to present value.
Past service cost- is the increase in the present value of the scheme liabilities related to employee service
in prior periods arising in the current period as a result of the introduction of, or improvement to,
retirement benefits.
Curtailment and settlement gains/losses - arise when significant reductions are made to the number of
employees covered by the plan or the benefits promised to them.
Net interest component
Interest costs – the liabilities of the plan must be compounded back up each year to account for the fact
that the plan is now one year nearer to settlement.
Remeasurement component - principally comprises actuarial gains and losses and also includes any
return on plan assets not already recognised in the net interest component.
Actuarial gains and losses result from increases or decreases in the pension asset or liability that
occur either because the actuarial assumptions have changed or because of differences between the
previous actuarial assumptions and what has actually happened (experience adjustments).
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Presentation in the statement of financial position
Present value of the plan liability
Fair value of the plan assets
Apply Your Knowledge 2
Harry has a defined benefit pension plan and makes up financial statements to 31 March each year. The net
pension liability (i.e. obligation less plan assets) at 31 March 20X3, was $100 million ($90 million at 31 March
20X2). The following additional information is relevant for the year ended 31 March 20X3:
The discount rate relevant to the net liability at the start of the year was 10%.
The current service cost was $65 million.
At the end of the year the entity granted additional benefits to existing pensioners that have a present
value of $23 million. These were not allowed for in the original actuarial assumptions.
The entity paid pension contributions of $65 million.
Required:
Calculate the re-measurement component gains/losses arising in the year ended 31 March 20X3.
Prepare extracts from the statement of profit or loss and other comprehensive income for the year ended 31 March 20X3 and the statement of financial position at 31 March 20X3 showing how the defined benefit scheme would be presented.
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Apply Your Knowledge 3
The following data relates to a defined benefit scheme for the year ended 31 July 20X9.
$000
Discount rate 10% per annum
Pension liabilities at start of year 2,575
Pension asset at start of year 2,525
Current service costs 350
Past service costs 88
Curtailment costs 38
Benefits paid out 263
Contributions paid in 275
Pension liability at year end 3,200
Pension asset at year end 3,100
Required:
Prepare extracts from the statement of profit or loss and other comprehensive income for the year ended 31
July 20X9 and the statement of financial position at 31 July 20X9 showing how the defined benefit scheme
would be presented.
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Apply Your Knowledge 4
Let us assume that Bowser makes up its financial statements to 31 December each year. The company offers its
staff a defined benefit (final salary pension scheme). It employs the services of an actuary to model the liability
and advise upon contributions to an asset fund. To keep the computations simple, all transactions are assumed
to occur at the year-end. The present value of the obligation and the market value of the plan assets were both
$1,000 at 1 January 20X1. The following information is available from the actuary re the model:
20X1 20X2
Discount rate at the start of the year 10% 9%
$ $
Current service cost 180 140
Benefits paid 150 180
Contributions paid 90 100
Present value of obligations at31 December 1,100 1,380
Market value of plan assets at 31 December 1,190 1,372
Required:
Prepare extracts from Bowsers accounts to show how this pension scheme will be accounted for
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Apply Your Knowledge 5
Fenton operates a defined pension plan for its employees. At 1 January 20X5 the fair value of the pension plan
was $5.4 million and the present value of the plan liabilities were $6 million. The discount rate on the assets
and liabilities was estimated at 7%.
The actuary estimates that the current service cost for the year ended 31 December 20X5 is $750,000. Fenton
made contributions into the pension plan of $850,000 in the year.
The pension plan paid $480,000 to retired member in the year 31 December 20X5.
At 31 December 20X5 the fair value of the pension plan assets was $5.2 million and the present value of the
plan liabilities was $6.3 million.
Calculate the net expense that will be included in Fenton’s statement of profit or loss for the year ended 31
December 20X5 in accordance with IAS 19 Employee Benefits.
Calculate your answer to the nearest $000
Apply Your Knowledge 6
Jay operates a defined pension plan for its employees. At 1 January 20X5 the fair value of the pension plan was
$22 million and the present value of the plan liabilities were $23.5 million. The discount rate on the assets and
liabilities was estimated at 5%.
The actuary estimates that the current service cost for the year ended 31 December 20X5 is $3 million. Jay
made contributions into the pension plan of $5 million in the year.
The pension plan paid $2.5 million to retired member in the year 31 December 20X5.
At 31 December 20X5 the fair value of the pension plan assets was $22.8 million and the present value of the
plan liabilities was $25 million.
Calculate the re-measurement component gains/losses on pension plan assets and liabilities that will be
included in other comprehensive income for the year ended 31 December 20X5 in accordance with IAS 19
Employee Benefits.
Calculate your answer to the nearest $000
| CIMA F1 186
Learning outcome C1a – describe the sources of short term finance and methods of short term cash investment
available to an entity
Short-term finance
Trade payable
Bank overdrafts and short-term loans
Factoring
Trade payables
Advantages
alleviates cash flow difficulties
cash can earn a return whilst still in the
paying company's account
No interest charges
Disadvantages
loss of any settlement discount
could obtain a poor credit rating
supplier may stop further supplies
supplier may increase future selling prices
to compensate
could face legal action from the supplier
Bank overdrafts
Advantages
Flexibility as can use up to the overdraft
limit
Only pay for what is used, so cheaper
Disadvantages
Repayable on demand
May require security
Variable finance costs as they tend to alter
with the base cost
Loans
Advantages
Greater security as set for a period
Interest rates similar to overdrafts
Disadvantages
Less flexibility
May require security
Variable finance costs as they tend to alter
with the base cost
Topic 20: WCM – short-term finance and investments
| CIMA F1 187
Interest paid on the whole sum for the loan
duration
Factoring
The outsourcing of the credit control department to a third party.
The debts of the company are effectively sold to a factor. The factor takes on the responsibility to collect the debt for a fee. The factor offers three services:
1. Debt collection
2. Financing
3. Credit insurance.
The factor is often more successful at enforcing credit terms leading a lower level of debts outstanding. Factoring is therefore not only a source of short-term finance but also an external means of controlling or reducing the level of debtors.
Invoice discounting
A service also provided by a factoring company.
Selected invoices are used as security against which the company may borrow funds. This is a temporary source of finance repayable when the debt is cleared. The key advantage of invoice discounting is that it is a confidential service, the customer need not know about it.
Export finance
Selling goods overseas may involve offering longer credit periods than for similar domestic sales. The credit
customer may not be as well known as a domestic customer. There is potentially a greater risk of delay or non-
payment for goods. Entities may seek to raise finance in such circumstances to ease cash-flow problems.
Export factoring
Export factoring is essentially the same as for domestic factoring described above, with the factor providing a cash
advance, typically of about 80 per cent of invoice value. The credit insurance element of the factor’s service will
also protect against bad-debt risk.
Whereas factoring and the methods of finance mentioned above are relevant to an entity to finance domestic or
export sales, there are methods of finance that are specifically associated with financing export sales.
| CIMA F1 188
Bill of exchange
A bill of exchange is defined in CIMA’s Management Accounting: Official Terminology as follows:
A negotiable instrument, drawn by one party on another, for example, by a supplier of goods on a customer,
who by accepting (signing) the bill, acknowledges the debt, which may be payable immediately (a sight draft) or
at some future date (a time draft). The holder of the bill can thereafter use an accepted time draft to pay a debt
to a third party, or can discount it to raise cash.
The bill of exchange is essentially a written acknowledgement of a debt. They are more commonly used for export
transactions than for domestic transactions.
A bill of exchange is a device that may enable the supplier to receive the benefit of payment well before the
customer actually pays. The way it works is like this:
1. The supplier draws up a simple document (the bill of exchange) requiring the customer to pay the amount
due at some fixed future date. (The supplier is the drawer of the bill.)
2. The supplier signs the bill and sends it to the customer, who also signs it to signify that he/she agrees to
pay, and returns the bill to the supplier. (The customer is the acceptor of the bill.)
3. The supplier now has a piece of paper that is worth money, because it constitutes an agreement on the
customer’s part to pay the debt on the due date. The supplier can now do one of three things:
a. hold the bill until the due date and collect the money;
b. arrange to transfer the benefit of the bill to the bank in exchange for immediate cash. The bank will
make a charge for what is effectively a loan, so the amount received by the supplier will be less
than the face value of the bill. This is called discounting the bill of exchange with the bank;
c. transfer the bill to his/her own supplier in a settlement of the debt. That supplier may in turn pass
the bill to one of his/her own supplier, discount it or hold it to maturity.
4. When the due date of the bill arrives, the person holding it at that time presents it to the original acceptor
for payment. If the acceptor pays, that is the end of the matter. If the acceptor does not pay on the due
date, the bill is said to be dishonoured. Legal action by the parties concerned may then be initiated to
recover the money from the original acceptor. A bank bill is a bill of exchange drawn on a bank and is
typically used for arranging payment for imports.
Documentary credits
Documentary credits, or letters of credit as they are also called, provide an exporter with a secure method of
obtaining payment for overseas sales. Documentary credits also provide the exporter with a method of raising
short-term finance from a bank.
CIMA’s Management Accounting: Official Terminology defines a letter of credit as follows:
A document issued by a bank on behalf of a customer authorising a person to draw money to a specified amount
from its branches or correspondents, usually in another country, when the conditions set out in the document
have been met.
| CIMA F1 189
Forfaiting
Forfaiting is an arrangement whereby exporters, normally of capital goods or raw materials, can obtain medium-
term finance. The forfaiting bank buys at a discount to face value a series of promissory notes (or bills of exchange)
usually extending over a period of between 6 months and 5 years.
The promissory notes may be in any of the world’s major currencies. For promissory notes to be eligible for
forfaiting (and to provide the forfaiting bank’s security), the notes must be guaranteed or avalised by a highly rated
international bank (often in the importer’s country).
Forfaiting is non-recourse, with no claim on the exporter after the notes have been purchased by the bank; payment
of the notes is guaranteed by the avalising bank.
Short-term investments
Cash surpluses can be invested in a range of short-term interest-earning investments such as:
Interest-bearing bank accounts
Negotiable instruments
Short-dated government bonds
Other short-term investments
Investment criteria
When a business has surplus cash to invest temporarily, it has to decide which investments to select from the
different choices available. There are several criteria that should be considered when making these choices:
maturity
return
risk
liquidity
diversification
| CIMA F1 190
Calculating the MV of a bond
A bond’s market value is the PV of its interest inflows, plus the PV of its redemption amount, all discounted at the
yield to maturity.
| CIMA F1 191
Interest earned
Coupon rate
This is the rate of interest payable on the face value on a bond or loan. This is different to the redemption yield.
Apply Your Knowledge 1
A $100 bond has a yield to maturity of 6% per annum and is due to mature in three years’ time. The next
interest payment is due in one year’s time. Today’s market value of the bond is $108.06.
Required:
Calculate the coupon rate on the bond.
Redemption yield
The yield on a bond investment is usually measured as a redemption yield. The redemption yield can be
calculated as the discounted annual rate of return (internal rate of return) at which the present value of the
future interest payments and the redemption value of the bond at maturity are equal to the current market value
of the bond.
Apply Your Knowledge 2
A bond with a coupon rate of 7% is redeemable in eight years’ time for $100. Its current purchase price is $82
ex-interest. Calculate the percentage yield to maturity.
Apply Your Knowledge 3
GF wants to sell an unquoted bond. The bond has a coupon rate of 5% and will repay its face value of $1,000 at
the end of four years.
GF estimates that the market requires a yield to maturity of 11% from this type of bond. GF has asked you to
recommend a selling price for the bond.
Calculate the selling price for the bond.
| CIMA F1 192
Learning outcome C2b – discuss approaches to the financing of working capital investment levels
Working capital is the level of investment in day-to-day operations of the business.
What is working capital?
Profitability V’s Liquidity
Working capital management
The management of all aspects of both current assets and liabilities, to minimise the risk of insolvency while
maximising the return on assets. If not managed appropriately:
The company may not be able to pay bills
Demands on cash during periods of growth being too great (Overtrading)
Overstocking
Topic 21: Working Capital Management (WCM)
| CIMA F1 193
Apply Your Knowledge 1
Which of the following would NOT be associated with a company that is overtrading?
A. A dramatic reduction in sales revenue
B. A rapid increase in the outstanding overdraft amount
C. A rapid increase in the volume of inventory
D. A rapid increase in sales revenue
| CIMA F1 194
Learning outcome C2a – Analyse trade receivables, trade payables and inventory ratio’s
Working capital ratios
Current ratio
Measures how much of the total current assets are financed by current liabilities.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Quick (acid test) ratio
Measures how well current liabilities are covered by liquid current assets.
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠−𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
| CIMA F1 195
The working capital cycle
The working capital cycle is the time span between production costs and receiving cash returns.
The faster the cycle the lower its investment in working capital will be.
Length of the cycle depends on:
liquidity versus profitability decisions
management efficiency
industry norms, e.g. retail versus construction.
| CIMA F1 196
Calculation of the working capital cycle
Raw materials holding period x
Less: payables’ payment period (x)
WIP holding period x
Finished goods holding period x
Receivables’ collection period x
–––
x
–––
The cycle may be measured in days, weeks or months and it is advisable, when answering an exam question, to
use the measure used in the question.
Apply Your Knowledge 2
A company’s working capital cycle can be calculated as:
A. Inventory days plus accounts receivable days less accounts payable days
B. Accounts receivable days plus accounts payable days less inventory days
C. Inventory days plus accounts payable days less accounts receivable days
D. Accounts payable days plus accounts receivable days plus inventory days
Apply Your Knowledge 3
A company’s trade payables days outstanding at 30 September 20X9 were 45 days. Purchases for the year to
30 September 20X9 were $324,444 occurring evenly throughout the year.
The company’s budgeted purchases for the year ending 30 September 20Y0 are $356,900 occurring evenly
throughout the year.
Calculate the budgeted trade payables days outstanding at 30 September 20Y0.
(Assume that the trade payables outstanding balance at 30 September 20Y0 will be the same amount as at 30
September 20X9.)
| CIMA F1 197
Apply Your Knowledge 4
Calculate the following ratios, to the nearest 0.1 days, for PQ for 2011
(i) Receivables days
(ii) Payables days
(iii) Inventory days
Performance Operations 4 November 2012
1.5 JK has budgeted sales for next year of 24,000 units and inventory levels are expected
to remain constant throughout the year. Each unit produced will require 3 labour hours and the budgeted labour rate will be $15 per hour. It is estimated that 10% of units produced will be wasted.
It is expected that 15% of the total hours worked will be paid at overtime rates. 10% of the total hours will be paid at the basic rate plus an overtime premium of 50% of the basic rate. 5% of the total hours will be paid at the basic rate plus an overtime premium of 100% of the basic rate.
The labour cost budget for next year is:
A $ 1,350,000
B $ 1,306,800
C $ 1,188,000
D $ 1,320,000 (2 marks)
1.6 RS reviews the financial performance of potential customers before setting a credit
limit. The summarised financial statements for PQ, a potential major customer operating in the retail industry, are shown below.
Summary Statement of Financial Position for PQ at year end
2011 2010 $000 $000
Non-current assets 6,400 5,600 Inventories 1,200 1,120 Trade receivables 800 840 Cash 200 40 Trade payables (1,120) (1,160) Non-current liabilities (3,600) Net assets
(3,200) 3,880 3,240
Share capital 2,400 2,400 Retained earnings 1,480
840 3,880 3,240
Summary Income Statement for PQ for the years
2011 2010
$000 $000 Sales 12,000 10,000 Cost of sales 6,400 5,200 Operating profit 2,400 1,800
Required:
Calculate the following ratios, to the nearest 0.1 days, for PQ for 2011 (i) Receivables days (ii) Payables days (iii) Inventory days
(3 marks)
| CIMA F1 198
Apply Your Knowledge 5
A company has annual sales revenues of $48 million. The company earns a constant gross margin of 40% on sales. All sales and purchases are on credit and are evenly distributed over the year.
The following are maintained at a constant level throughout the year:
Inventory $8 million
Trade receivables $10 million
Trade payables $5 million
The company’s cash operating cycle to the nearest day is:
A. 99 days
B. 114 days
C. 89 days
D. 73 days
| CIMA F1 199
Learning outcome - C2d discuss approaches to the financing of working capital investment levels
Working Capital Decisions
There are two decisions that a business must make with regards to its working capital:
The level of investment
The type of finance used
The Investment Decision
A HIGH level of working capital
Always able to respond to changes in requirements
BUT holding high levels of inventory/receivables/cash is expensive
A LOW level of working capital
Less expensive
BUT company may not be able to respond to a change in demand
The level of investment will also depend on the following factors:
1. The nature of the business,
2. Certainty in supplier deliveries,
3. The level of activity of the business,
4. The company’s credit policy.
Investment in working capital
| CIMA F1 200
The Financing Decision
Current assets can be classed as either permanent or fluctuating.
Permanent current assets – a level of current assets that is always present e.g. a buffer level of inventory, a
minimum level of cash kept in the bank
Fluctuating current assets – the element of current assets that always changes e.g. increases/decreases in
receivables/payables
Time
Assets
Fluctuating
current assets
Permanent
current assets
Non-current
assets
Short-term
funds
Short-term
funds or
Long-term
funds
Long-term
funds
| CIMA F1 201
Both types of current assets require funding. A number of different approaches can be adopted:
conservative
aggressive
moderate
Conservative
Mostly long term finance used.
All permanent and most fluctuating current assets are funded using long term finance.
Aggressive
Mostly short term finance used.
All fluctuating and part of the permanent current assets are funded using short term finance.
Moderate
Permanent current assets are funded using long term finance.
Fluctuating current assets are funded using short term finance.
| CIMA F1 202
Overtrading
Overtrading is the term applied to a company which rapidly increases its turnover without having sufficient capital backing, hence the alternative term “under-capitalisation”.
Output increase are often obtained by more intensive utilisation of existing fixed assets, and growth tends to be financed by more intensive use of working capital.
Overtrading companies are often unable or unwilling to raise long-term capital and thus tend to rely more heavily on short-term sources such as overdraft and trade creditors. Debtors usually increase sharply as the company follows a more generous trade credit policy in order to win sales, while stock tends to increase as the company attempts to produce at a faster rate ahead of increase demand.
Overtrading is thus characterised by rising borrowings and a declining liquidity position in terms of the quick ratio, if not always according to the current ratio.
Symptoms of overtrading
1. Rapid increase in turnover
2. Fall in liquidity ratio or current liabilities exceed current assets
3. Sharp increase in the sales-to-fixed assets ratio
4. Increase in the trade payables period
5. Increase in short term borrowing and a decline in cash balance
6. Fall in profit margins.
Overtrading is risky because short-term finance may be withdrawn relatively quickly if creditors lose confidence in the business, or if there is general tightening of credit in the economy resulting to liquidity problems and even bankruptcy, even though the firm is profitable.
The fundamental solution to overtrading is to replace short-term finance with long-term finance such as term loan or equity funds.
| CIMA F1 203
Learning outcome – c2b discuss policies for the management of the level of investment and working capital and
for the individual elements of working capital
Learning outcome – C2c evaluate working capital policies
Accounts receivables
Management of receivables has four key aspects:
Assessing creditworthiness
The creditworthiness of all new customers must be assessed before credit is offered, it is a privilege and not a
right. Existing customers must also be re-assessed on a regular basis. The following may be used to assess credit
status of a company
1. Bank references
2. Trade references
3. Published accounts
4. Credit rating agencies
5. Company’s own sales record.
Setting credit limits
Given that we are willing to offer credit to a company, we must now consider the limits to the agreement.
This may include:
1. Credit limit value
2. Number of days credit
3. Discount on early payment
4. Interest on overdue account.
Invoicing promptly and collecting overdue debts
Monitoring the credit system
The credit policy is dependent on the credit controllers implementing a set of simple but rigorous procedures.
Topic 22: Working Capital Management – accounts
receivable and payable
| CIMA F1 204
Time line Action
After 30 days Send statement of account
+7 days Reminder sent
+7 days 2nd reminder
+7 days Legal action threat
+7 days Take action to recover funds
Company credit terms will be influenced by:
demand for products
competitors' terms
risk of irrecoverable debts
financing costs
costs of credit control
| CIMA F1 205
The cost of financing receivables
Finance cost = receivables balance x Interest (overdraft) rate
Factoring Calculations
Apply Your Knowledge 1
Paisley Co has sales of $20m for the previous year, receivables at the year-end were $4m, and the cost of
financing receivables is covered by an overdraft at the interest rate of 12%.
Calculate:
i) the receivable days
ii) the annual cost of financing receivables
• Factors will get payments in more quickly.
• This will reduce receivables turnover.Receivables turnover
• If receivables turnover (days) reduces, receivables are also reduced.Receivables = Sales x Days/365
• We assume receivables are funded using an overdraft.Overdraft interest
• A reduction in receivables means a reduction in overdraft interest.Interest saving
• The saving in interest is compared to the cost of the factoring service.Comparison
| CIMA F1 206
Early settlement discounts
Cash discounts are given to encourage early payment by customers. The cost of the discount is balanced against
the savings the company receives from a lower balance and a shorter average collecting period.
You may be asked to calculate:
The net benefit/cost of offering the early settlement discount
The effective annual interest rate of the early settlement discount
Apply Your Knowledge 2
Paisley is now offering its customers a 3% discount for paying within 30 days. It is estimated that 50% of customers will accept the discount. Determine whether Paisley should offer the discount.
Apply Your Knowledge 3
A supplier has offered CB an early settlement discount of 3% if payment is made within 20 days of the invoice date. CB currently takes 58 days to pay this supplier.
Required:
Calculate, to the nearest 0.1%, the effective annual interest rate to CB of the early settlement discount. You should assume a 365 day year and use a compound interest methodology.
| CIMA F1 207
Apply Your Knowledge 4
GH is a manufacturer of leather goods. The company has recently won a contract to supply CD, a major
department store chain, with a range of products. The contract will require significant investment in non-
current assets and working capital. GH will raise a loan from its bank for the investment in non-current assets
but is considering alternative methods of reducing the required investment in working capital. These methods
include offering early settlement discounts and debt factoring.
CD’s normal credit term from its suppliers is 90 days. GH is considering offering an early settlement discount of
3% for payments received within ten days in order to reduce the working capital requirement.
Required:
(i) Calculate, to the nearest 0.1%, the effective annual interest rate to GH of the early settlement discount. You
should assume a 365-day year and use a compound interest methodology.
(ii) State TWO disadvantages to GH of using a bank loan to finance the additional working capital.
| CIMA F1 208
Factoring
Factoring is the 'sale of debts to a third party (the factor) at a discount in return for prompt cash'
The debts of the company are effectively sold to a factor (normally owned by a bank). The factor takes on the
responsibility of collecting the debt for a fee. The company can choose one or both of the following services
offered by the factor:
Debt collection and administration – The factor takes over the whole of the company’s sales ledger, issuing
invoices and collecting debts.
Non-recourse –protects the client against irrecoverable debts, the factor bears the loss
Recourse – client bears the cost of irrecoverable debts, so has to reimburse the factor any money received for
that debt.
Advantages Disadvantages
Saving in administration costs.
Reduction in the need for management control.
Particularly useful for small and fast growing
businesses where the credit control department
may not be able to keep pace with volume
growth.
Non-recourse is a convenient way of obtaining
insurance
Likely to be more costly than an efficiently run
internal credit control department.
Factoring has a bad reputation associated with
failing companies; using a factor may suggest your
company has money worries.
Customers may not wish to deal with a factor.
Once you start factoring it is difficult to revert
easily to an internal credit control system.
The company may give up the opportunity to
decide to whom credit may be given (non-
recourse factoring).
| CIMA F1 209
Apply Your Knowledge 5
A company is considering factoring as a way of managing its trade receivables. It currently has a balance
outstanding on trade receivables of $250,000. It has annual sales revenue of $1,500,000 which occurs evenly
throughout the year. Trade receivables are expected to continue at the same level for the next year.
The factor will advance 80% of invoiced sales and will charge interest at a rate of 10% per annum.
The interest charge for next year payable to the factor will be:
A. $25,000
B. $150,000
C. $20,000
D. $120,000
Apply Your Knowledge 6
a) A company manufactures office equipment in England but sells it in the UK and to overseas customers.
Current situation
UK customers (£2·1m annual revenue)
The company offers a cash discount of 3% for payment within 10 days to UK customers. Approximately 40% of
customers take advantage of the early payment discount whilst the remainder pay in 30 days.
Overseas customers (£0·9m annual revenue)
All sales are on credit but customers are required to pay a 20% deposit when they place their orders and the
balance in 60 days.
Debt factoring
The company is thinking about debt factoring. Investigations have revealed that a non- recourse factor will
accept 85% of the company’s UK customers. It is assumed that the remaining 15% will not take advantage of
the early settlement discount.
Required:
Calculate, based on a 365-day year, the total debtors’ days if
(i) the current situation continues
(ii) debt factoring is introduced
b) Discuss the non-financial factors that a company would need to consider before making a decision to
factor its debts.
| CIMA F1 210
Aged debt analysis
Apply Your Knowledge 7
Performance Operations 6 November 2012
SECTION B – 30 MARKS
[You are advised to spend no longer than 9 minutes on each sub-question in this
section.]
ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE.
Question Two
(a) FG is concerned that the payment record of one of its customers is extremely poor. An
extract from the trade receivable account for the customer, for the period 1 July to 31
October, is shown below: Date Narrative Debit Credit Balance $ $ $ 01/07/2011 Balance b/fwd 142 08/07/2011 Invoice No. 345 102 244 12/07/2011 Invoice No. 423 234 478 15/07/2011 Credit note No. C85 (Balance b/fwd) 78 400 23/07/2011 Receipt No. R69 (Balance b/fwd and Invoice No. 345) 166 234 04/08/2011 Invoice No. 460 156 390 11/08/2011 Invoice No. 489 87 477 14/08/2011 Invoice No. 558 34 511 05/09/2011 Receipt No. R92 (Invoice No. 558) 34 477 18/09/2011 Invoice No. 576 183 660 20/09/2011 Invoice No. 615 263 923 04/10/2011 Receipt No. R121 (Invoice No. 489) 87 836 16/10/2011 Invoice No. 678 128 964
Required:
(i) Prepare an aged debt analysis showing the outstanding debt of the customer at 31 October analysed by month.
(3 marks)
The credit control department has been chasing the outstanding invoices by telephone, email and post.
(ii) State TWO further actions that FG may take after reviewing the information
shown in the aged debt analysis prepared in part (i). (2 marks)
(Total for sub-question (a) = 5 marks)
| CIMA F1 211
Learning outcome – C2b discuss policies for the management of the total level of investment in working capital
and for the individual elements of working capital.
Objective: to reduce the levels of inventory held to the minimum required.
The lowest possible amount to minimise the level of capital employed to be funded, and ensure there is enough
inventory held, so there is no stock outs.
Costs of holding high inventory
The return the cash could get from else where
Holding costs
Storage
Store admin
Theft
Damage
Obsolescence
Cost of holding low inventory
Stock outs
Lost contribution
Production stoppages
Loss of goodwill from customers
Emergency orders
High re-order costs
Lost quantity discounts
Economic order quantity (EOQ)
The aim of the EOQ model is to minimise the total cost of holding and ordering inventory.
When the re-order quantity chosen minimises the total cost of holding and ordering, it is known as the EOQ.
Topic 23: Working Capital Management – inventory
control
| CIMA F1 212
Assumptions
The following assumptions are made:
demand and lead time are constant and known
purchase price is constant
no buffer inventory held as it is assumed that it is not needed since demand and lead times are known
with certainty.
Calculating EOQ
The EOQ can be more quickly found using a formula (given in the examination):
where:
CO = cost per order
D = annual demand
CH = cost of holding one unit for one year.
| CIMA F1 213
Dealing with quantity discounts
Discounts may be offered for ordering in large quantities. If the EOQ is different to the order
size needed for a discount, should the order size be changed?
Step 1: Calculate EOQ, ignoring discounts.
Step 2: If the EOQ is below the quantity qualifying for a discount, calculate the total annual inventory cost arising
from using the EOQ.
Step 3: Recalculate total annual inventory costs using the order size required to just obtain each discount.
Step 4: Compare the cost of Steps 2 and 3 with the saving from the discount, and select the minimum cost
alternative.
Step 5: Repeat for all discount levels.
| CIMA F1 214
Apply Your Knowledge 1
FP is a retailer of office products. For one particular model of calculator there is an annual demand of 26,000 units. Demand is predictable and spread evenly throughout the year.
Supplies are received 2 weeks after placing the order and no buffer inventory is required.
The calculators cost $14 each. Ordering costs are $160 per order. The annual cost of holding one calculator in inventory is estimated to be 10% of the purchase cost.
The economic order quantity (EOQ) for this model of calculator will be:
A 2,438 units
B 771 units
C 67 units
D 2,060 units
Total annual cost
This is the total annual ordering cost plus the total annual holding cost.
𝐶𝑜𝐷
𝑄+
𝐶ℎ𝑄
2
FP has decided not to use the EOQ and has decided to order 2,600 calculators each time an order is placed. The total ordering and holding costs per annum will be:
A $5,240
B $19,800
C $208,014
D $3,420
| CIMA F1 215
Just in Time (JIT)
CIMA official definition
“A system whose objective is to produce or to procure products or components as they are required by a
customer for us, rather than for inventory. A just in time system is a ‘pull’ system which responds to demand,
rather than a ‘pull’ system in which inventory act as buffers between the different elements of the system, such
as purchasing, production and sales.”
In other words, little or no stock is held on site.
Characteristics
nil/negligible stock levels
nil/negligible stock costs
items only produced after an order has been placed
little room for error
higher quality
good supplier relations
frequent deliveries of small orders
| CIMA F1 216
Learning outcome – C3a discuss measures to manage short term cash position of an entity.
Why hold cash?
Transactions motive: To pay for every day expenditure
Precautionary motive: Anything goes wrong
Investment motive: To take advantage of opportunities
The objective is to have enough money to pay the bills, but not to hold too much that it becomes an idle asset.
Cash budgets and cash flow forecasts
Cash forecast: is an estimate of cash receipts and payments for a future period under existing conditions
Cash budget: is a commitment to a plan for cash receipts and payments for a future period after taking any action
necessary to bring the forecast in line with the overall business plan.
Topic 24: Working Capital Management – cash control
| CIMA F1 217
| CIMA F1 218
Apply Your Knowledge 1
A company commenced business on 1 August. Total sales revenue in August was $200,000 and is expected to increase at a rate of 2% per month. Credit sales represent 60% of total sales revenue and the remaining 40% is cash sales. The credit period allowed is one month. Bad debts are expected to be 3% of credit sales but the remaining credit sales customers are expected to pay on time.
The estimated receipts in September from cash and credit sales are:
A $195,552
B $196,400
C $198,000
D $201,600
(2 marks)
Apply Your Knowledge 2
The following details have been extracted from the accounts payable records of RS.
Invoices paid in the month of purchase 15% of total value
Invoices paid in the first month after purchase 65% of total value
Invoices paid in the second month after purchase 20% of total value
The pattern of payments is expected to continue in the future and has been used to produce RS’s cash budget for October to December.
Purchases for October to December are budgeted as follows:
October November December
$280,000 $250,000 $300,000
A settlement discount of 5% is taken on invoices paid in the month of purchase.
The amount budgeted to be paid to suppliers in December is:
A $264,500
B $261,250
C $250,325
D $263,500
| CIMA F1 219
Apply Your Knowledge 3
JL is preparing its cash budget for the next three quarters. The following data have been extracted from the
operational budgets:
Sales revenue Quarter 1 $500,000
Quarter 2 $450,000
Quarter 3 $480,000
Direct material purchases Quarter 1 $138,000
Quarter 2 $151,200
Quarter 3 $115,600
Additional information is available as follows:
JL sells 20% of its goods for cash. Of the remaining sales value, 70% is received within the same quarter as sale
and 30% is received in the following quarter. It is estimated that trade receivables will be $125,000 at the
beginning of Quarter 1. No bad debts are anticipated.
50% of payments for direct material purchases are made in the quarter of purchase, with the remaining 50% in
the quarter following purchase. It is estimated that the amount owing for direct material purchases will be
$60,000 at the beginning of Quarter 1.
JL pays labour and overhead costs when they are incurred. It has been estimated that labour and overhead
costs in total will be $303,600 per quarter. This figure includes depreciation of $19,600.
JL expects to repay a loan of $100,000 in Quarter 3.
The cash balance at the beginning of Quarter 1 is estimated to be $49,400 positive.
Required: Prepare a cash budget for each of the THREE quarters.
| CIMA F1 220
Measures to improve a cash forecast situation
additional short-term borrowing
negotiating a higher overdraft limit with the bank
the sale of short-term investments, if the company has any
using different forms of financing to reduce cash flows in the short term, such as leasing instead of buying
outright
changing the amount of discretionary cash flows, deferring expenditures or bringing forward revenues.
(Dividends)
shortening the operating cycle by reducing the time taken to collect receivables, perhaps by offering a
discount or using a factor or invoice discounting
shortening the operating cycle by delaying payment to payables.
The Baumol model This is based on the EOQ formula from earlier
√2𝐶𝑜𝐷
𝐶ℎ
Where Co = the administration cost of selling or buying treasury bills D = annual demand for cash (cash consumed in a year) Ch = interest rate Baumol assumed that many companies would hold an inventory of marketable securities, which could be sold in order to replenish the cash balance The EOQ now gives the optimum amount of treasury bills to sell by value each time the cash balance needs replenishing
Apply Your Knowledge 4
Troy has asked you to calculate the optimum amount of cash to be transferred each time using the Baumol
model, when:
A. Outgoings are $300,000 per annum
B. Money on deposit earns 10% per annum
C. Switching costs $20 per transaction
| CIMA F1 221
The Miller Orr Model
Miller and Orr did not assume that cash is consumed at a constant rate. Instead they assumed that cash flows
were entirely unpredictable.
They determined upper and lower cash limits of a company.
When the company hits the upper limit, they will buy up short term investments to reduce the cash in the bank.
When the company hits the lower limit, they will sell these investments to increase the cash in the bank
Whether buying or selling investments, the aim is to always bring the cash balance back to the same return point.
| CIMA F1 222
Formulae needed
Spread between upper and lower limit
3 𝑥 (
34
𝑥 𝑡𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡 𝑥 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 𝑜𝑓 𝑑𝑎𝑖𝑙𝑦 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒)
1/3
Lower limit will be given
Upper limit
𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 𝑆𝑝𝑟𝑒𝑎𝑑
Return point
𝐿𝑜𝑤𝑒𝑟 𝑙𝑖𝑚𝑖𝑡 + 1/3(𝑆𝑝𝑟𝑒𝑎𝑑)
Apply Your Knowledge 5
Ryan has asked you to investigate the Miller-Orr model when:
1 Lower limit is $1000
2 Interest rate is 0.025 per cent per day
3 The standard deviation of daily cash flows is $500, so the variance is $250,000 (the variance is the
standard deviation squared)
4 Switching costs $20 per transaction
Required:
Calculate the spread, the upper limit and the return point.