Answers

Diploma in Financial Reporting June 2011 Answers

Marks1 (a) Consolidated statement of comprehensive income for the year ended 31 March 2011

$000Revenue (W1) 886,000 1 (W1)Cost of sales (balancing figure) (482,145)

Gross profit (W2) 403,855 16 (W2)Distribution costs (18,000 + 17,000) (35,000) Administrative expenses (19,000 + 16,000) (35,000) Investment income (W6) 2,800 1 (W6)Finance cost (W7) (139,132) 4 (W7)Share of losses of associate (W9) (7,000) 2 (W9)

Profit before tax 190,523Income tax expense (41,000 + 33,000) (74,000)

Net profit for the year 116,523Other comprehensive income (W10) 5,900 2 (W10)

Comprehensive income for the year 122,423

Net profit attributable toNon-controlling interest (W11) 17,464 2 (W11)Controlling interest 99,059

Net profit for the year 116,523

Comprehensive income attributable toNon-controlling interest 17,464 Controlling interest 104,959

Comprehensive income for the year 122,423

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(b) Consolidated statement of changes in equity for the year ended 31 March 2011

Controlling Non-controlling Totalinterest interest$000 $000 $000

Balance at 1 April 2010 (W12 & W13) 602,981 100,994 703,975 2 (W12)+ 1 (W13)

Comprehensive income for the year 104,959 17,464 122,423 1Equity component of convertible bonds (W14) 35,850 35,850 1 (W14)Dividends (52,000) (10,000) (62,000) 1

Balance at 31 March 2011 691,790 108,458 800,248 7

WORKINGS

Working 1 revenue

$000Alpha + Beta 904,000 Sales from Alpha Beta (see tutorial note 1) (18,000) 1

886,000 1

Working 2 gross profit

$000Alpha + Beta 430,000 Environmental provision (3,000 + 2,000) (5,000) 1Unrealised profit adjustments:Beta: (1/4 (3,600 2,100)) (375) 1Gamma: (1/4 x 2,700 x 40%) (270) 1Extra depreciation (W3) (11,000) 1 (W3)Change in the fair value of contingent consideration ($64 million $58 million see tutorial note 2) (6,000) 1

Impairment of goodwill (W4) (3,500) 9 (W4) 403,855 16

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MarksTutorial Note 1 (marks allocated in workings 1 & 2)

IAS 28 Investments in associates requires partial elimination of unrealised profits on transactionsbetween associates and group entities. Profits can only be included to the extent that they relate to thenon-group share. This means that the group share of such profits is eliminated and an adjustment of$270,000 is required to profit in this case (see working 2 above). The IAS does not specify exactly howsuch an adjustment should be reported in the consolidated statement of comprehensive income. Theapproach taken here is to make no adjustment to revenue whatever. Given the required adjustment togross profit of $270,000, this would alter cost of sales by an equal and opposite amount.

An alternative approach would be to reduce consolidated revenue by the group share of the revenue thatrelates to the inventory that is unsold by Gamma at the year-end. Given the required adjustment to grossprofit of $210,000, the adjustment to cost of sales follows as the balancing figure.

Either approach would earn full marks.

Tutorial note 2

The change in fair value of the contingent consideration could have been shown in other sections of thestatement of comprehensive income for example as an administration cost. If the correct figure isshown in another reasonable part of the statement then full marks will be awarded.

Working 3 extra depreciation and amortisation

$000Depreciation of PPE x ($280 million $240 million) 10,000 1Amortisation of brand 1/30 x $30 million 1,000

11,000 1 (W2)

Working 4 impairment of goodwill on acquisition of Beta

$000Carrying value of Beta in the consolidated financial statements at 31 March 2011:Per own financial statements 435,000 Fair value adjustments:PPE ($280 million $240 million) x (25/4) 25,000 1Brand $30 million x (285/30) 28,500 1Goodwill (W5) 65,000 6 (W5)

553,500

Recoverable amount (550,000)

So impairment equals 3,500

9 (W2)

Working 5 goodwill on acquisition of Beta

$000 $000Fair value of consideration given:Share exchange 75,000 x 2/3 x $6 300,000 1Contingent 55,000 1Acquisition costs Nil 1

355,000

Fair value of non-controlling interest 25,000 x $320 80,000 1Fair value of net assets of Beta at 1 October 2009:Per own financial statements 300,000 Fair value adjustment PPE ($280 million $240 million) 40,000 Fair value adjustment brand 30,000

(370,000)

So goodwill equals 65,000 6 W4

Working 6 investment income

$000Alpha + Beta 37,300 Dividend received from Beta (75% x 40,000) (30,000) Profit on disposal recorded to be treated in accordance with IFRS 9 (AppB para 5.12) (4,500)

In consolidated statement of comprehensive income 2,800 1

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MarksWorking 7 finance costs

$000Alpha + Beta 133,000 Finance cost of convertible loan notes incorrectly recorded by Alpha (15,000) Correct finance cost of convertible loan notes (W8) 21,132 3 (W8)

In consolidated statement of comprehensive income 139,132 4

Working 8 finance costs of convertible loan notes

$000Liability element of compound financial instrument at 1 April 2010:(15,000 x $399) + (300,000 x $0681) 264,150 2

So finance cost at 8% (264,150 x 008) 21,132 1

3 W7

Working 9 share of losses of associate

$000Loss after tax of Gamma (26,000)

(26,000) x 40% x 6/12 equals (5,200) 1Impairment of investment (1,800)

(7,000) 2

Working 10 other comprehensive income

$000Gain on revaluation of investment in Epsilon 1,400 1Profit on disposal recorded to be treated in accordance with IFRS 9 (AppB para 5.12) 4,500 1

5,900 2

Working 11 non-controlling interest in Beta

$000Net profit of Beta 85,000 Unrealised profit on intercompany sales (375 + 270) (W2) (645) Extra depreciation and amortisation (W3) (11,000) Impairment of goodwill of Beta (W4) (3,500)

69,855

Non-controlling interest (25%) 17,464

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Working 12 consolidated equity at 1 April 2010

Alpha 540,000 Beta post acquisition per own records (390,000 300,000) 90,000 Extra depreciation and amortisation (11,000 (W3) x 05) (5,500) Unrealised profit on opening inventory (1/4 x 2,100) (525)

83,975

Group share (75%) 62,981 602,981 2

Working 13 non-controlling interest in opening equity of Beta

Fair value of non-controlling interest at date of acquisition (W5) 80,000 Consolidated post-acquisition increase in equity from date of acquisition to start of the period (W12) 83,975

Non-controlling interest (25%) 20,994

100,994 1

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MarksWorking 14 equity element of convertible bonds

$000Total issue proceeds 300,000 Liability component (W8) (264,150)

So equity component equals 35,850 1

2 Transaction one

1. Statement of financial position

31 March 2011 31 March 2010$000 $000

Current assets inventory of fuel 58 Nil 1Current liabilities financial instrument Nil (20) 1

2. Statement of comprehensive income

Year ended 31 March2011 2010$000 $000

Cost of sales cost of fuel used (642) Nil 1Other comprehensive income:Losses arising on cash flow hedges (5) (20) 1Reclassification adjustment 25 Nil 1

3. ExplanationThe signing of the contract to purchase fuel on 31 January 2010 does not create a liability as it is an executory contract 1

The contract to buy 500,000 euros is a derivative financial instrument that needs to be recognised from 31 January 2010 at fair value, initially zero 1

Since the contract to buy 500,000 euros is designated as a cash flow hedge of the commitment to buyfuel, any gains or losses (in this case losses) on re-measurement are initially recognised as other comprehensive income 1

When the fuel is recognised in the financial statements, the cumulative loss arising on the derivative isadded to the carrying value of the inventory or reclassified from other comprehensive income into profit and loss as the inventory is used (see tutorial note below) 1

The initial carrying value of the inventory is $700,000 (500,000 x 135 + 25,000) or $675,000 (see tutorial note below) 1

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Tutorial noteAs an alternative to taking the loss of $25,000 on the derivative as a basis adjustment to the carrying value of inventory at30 April 2010, IAS 39 allows the inventory to be measured using the spot rate at that date. This would mean that the carryingvalue was $675,000 (500,000 x $135) at 30 April 2010 and $56,000 (675,000 x 1/12) at 31 March 2011. The costof sales would be $619,000 (675,000 x 11/12) under this approach. A further consequence is that the reclassificationadjustment is made as the inventory is recognised as an expense, i.e. when the inventory is sold. In such circumstances thereclassification adjustment for the year ended 31 March 2011 is $23,000 (25,000 x 11/12). The combination of the costof sales ($619,000) and the reclassification adjustment ($23,000) gives a charge to profit and loss of $642,000, which isthe same as the cost of sales under the basis adjustment method. Either approach is acceptable under IAS 39 and eitherapproach would attract full marks. The relative impact of the two approaches on the statement of comprehensive income forthe year ended 31 March 2011 is as shown in the table below (there would be no difference between the two approachesfor the year ended 31 March 2010):

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MarksAdopted approach Alternative approach

$000 $000Cost of sales cost of fuel used (642) (619)Reclassification adjustment Nil (23)

Net effect on profit for the year (642) (642)Other comprehensive income:Losses arising on cash flow hedges (5) (5)Reclassification adjustment 25 23

Net effect on total comprehensive income for the year (622) (624)

The difference of $2,000 (622,000 624,000) between the overall amounts recognised incomprehensive income is equal to the different carrying values of closing inventory under the twoapproaches of $2,000 (58,000 56,000) under the two approaches.

Transaction 2

1. Statement of financial position

31 March 2011 31 March 2010$000 $000

Non-current assets property, plant and equipment 3,508 3,703 1Current liabilities operating lease rentals (100) Nil Non-current liabilities:Operating lease rentals (1,700) (1,400) Provision for restoration costs (873) (824) See 3 below

2. Statement of comprehensive income

Year ended 31 March2011 2010$000 $000

Operating costs:Operating lease rentals (400) (400) See 3 belowDepreciation of leasehold improvements (195) (97) (for 2010 figure)Finance costs unwinding of discount (49) (24) See 3 below

3. ExplanationThe total operating lease rentals are $8 million ((36 x 250,000) 1 million). Therefore the annual charge is $400,000 (8 million/20) 1

The total lease liability at 31 March 2010 is $1,400,000 (1 million reverse premium plus 400,000rental). This increases to $1,800,000 by 31 March 2011 (1,400,000 brought forward plus 400,000 rental). The liability is reduced by $100,000 (2 x 250,000 400,000) over the next 18 years 1

The costs of altering the office block are capitalised and depreciated over their useful economic life 19 years from 1 October 2009

The obligation to restore the block needs to be recognised as a provision because the completion of the alterations constitutes an obligating event from 1 October 2009

The initial amount of the provision is $800,000 (25 million x 032) 1

The debit entry for the provision is to PPE since it provides access to future economic benefits

The initial carrying value of the PPE is $3,800,000 (3 million + 800,000) and the annual depreciation is $195,000 (38 million/195)

The unwinding for the six months to 31 March 2010 is $24,000 (800,000 x 006 x 6/12) and the closing provision $824,000 (800,000 + 24,000) 1

The unwinding for the 12 months to 31 March 2011 is $49,000 (824,000 x 006) and the closing provision $873,000 (824,000 + 49,000) 1

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Marks3 (a) An intangible asset is an identifiable non-monetary asset without physical substance. Four key factors

need to be in place before recognition is appropriate:

1. The asset needs to be identifiableAn asset is identifiable either if it is separable (can be sold without disposing of the business as awhole) or if it arises from contractual or other legal rights, irrespective of separability.

2. The entity needs control over the economic benefits derivable from the assetControl involves the power to obtain the future economic benefits flowing from the asset and torestrict the access of others to those benefits. The capacity of an entity to control the futureeconomic benefits would normally, but not necessarily, stem from legal rights that are enforceablein a court of law.

3. A clear probable source of future economic benefits needs to be identifiedThese benefits may include revenue from the sale of products or services, but could also includecost savings or other benefits arising from the use of the asset by the entity.

4. The asset needs to have a cost that can be measured reliablyCost will often be the cost of purchasing or developing the asset. In the case of an asset acquiredin a business combination, cost will be the fair value of the asset at the date of acquisition,assuming this fair value can be reliably measured.

Following recognition intangible items can be measured using either the cost model or the revaluationmodel. However, the revaluation model can only be used if the intangible asset has a readilyascertainable market value. For this to be the case the intangible asset has to be capable of being readilytraded in an active market of substantially similar items. Since intangible assets often tend, by theirnature, to be fairly unique the revaluation model is rarely used.

Intangible assets with a finite useful economic life are amortised over that useful life. Where the usefuleconomic life is estimated to be indefinite no amortisation is charged but the asset is reviewed forimpairment on an annual basis.

(b) Details Amount Explanation$000

Development project 2,925 Only costs incurred after the conditions have beensatisfied can be capitalised (3 million in this case)(1 mark). All previous costs must be expensed,even those arising earlier in the same accountingperiod (1/2 mark). Amortisation of the capitalisedcosts begins when the process is commerciallyexploited (1/2 mark) and a full years charge wouldbe 300,000 (3 million/10). The charge in the yearended 31 March 2011 is 75,000 (300,000 x3/12) (1 mark). 3

Brand name 9,000 Brand name capitalised at fair value and amortised over useful economic life. 2

Workforce Nil Per IAS 38 an assembled workforce fails thecontrol test as they could leave and take theirexpertise elsewhere. Their value is effectivelyincluded in the goodwill on acquisition of Omicron. 2

Production licence 180 Separately purchased intangibles are recognisedat cost, and amortised over their useful economiclives (15 marks). Although the assets net sellingprice is only $175,000, the value in use is$185,000 so the recoverable amount of the assetis above $185,000 and no impairment has occurred (15 marks). 3

Revaluation policy relating to all assets There is no question of revaluing the itemsrecognised as intangible assets as no active market exists (1 mark). 1

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Marks4 (a) Transaction One

1. Statement of financial position

As at 31 March2011 2010$000 $000

In equity 912 304

2. Statement of comprehensive income

Year ending 31 March2011 2010$000 $000

In operating expenses 608 304

3. ExplanationThe total expected cost at 31 March 2010 = $912,000 (19 x 10,000 x $48) 1

1/3 is recognised in equity as this is an equity settled share based payment 1

The total expected cost at 31 March 2011 = $1,368,000 (19 x 15,000 x $48) 1

2/3 is recognised in equity at 31 March 2011. Amounts can be shown as a separate component of equity or credited to retained earnings 1

The vesting condition relating to share price is ignored in the estimation of the total expected costas it is one of the factors that is used to compute the fair value of the share option at the grant date i.e. it is a market related vesting condition 1

The cost recognised in 2010 is the cost to date since this is the first year of the vesting period

The cost recognised in 2011 is the difference between cumulative costs carried and brought forward 1

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(b) Transaction Two

1. Statement of comprehensive income

Year ended 31 March2011 2010$000 $000

Depreciation operating expenses 15,000 15,000 1

2. Statement of changes in equity year ended 31 March 2011

$000Adjustment to retained earnings brought forward (3,000) 1

3. ExplanationIAS 16 Property, plant and equipment recognises that certain assets need a major inspectionor overhaul in order to continue to be used. The cost of the overhaul is capitalised separately from the rest of the asset and depreciated over the period to the next overhaul. 1

Therefore, the asset of $120 million should be split into two parts for depreciation purposes. $30 million of the total cost should be depreciated over five years and the remaining balance of $90 million (120m 30m) depreciated over 10 years. 1

Last year Omega should have applied component depreciation to this asset and chargeddepreciation of $15 million (30m x 1/5 + 90m x 1/10). They only charged $12 million and soundercharged depreciation by $3 million. The impact of this error will not affect the statement ofcomprehensive income for the year ended 31 March 2011. It will instead be included in thestatement of changes in equity as a retrospective adjustment to opening retained earnings. Thedepreciation charge in the statement of comprehensive income for the year ended 31 March 2011 will be $15 million. 1

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Marks(c) Transaction three

1. Statement of financial position as at 31 March 2011

$000Non-current liabilities deferred service revenue 750 Current liabilities deferred service revenue 500

2. Statement of comprehensive income year ended 31 March 2011

$000Revenue from sale of machine 6,000 Service revenue 250 Cost of sale of the machine (4,000) Cost of service element (200)

2,050

3. ExplanationThe total revenue arising on the contract is split into a sales element and a service element. Theexpected total costs of the service element are $1,200,000 (200,000 x 2 x 3). Therefore if anormal gross margin on servicing contracts is 20%, the revenue that is allocated to the servicingelement is $1,500,000 (1,200,000 x 100/80). This revenue of $1,500,000 is recognised evenly over the three-year servicing period, with the balance shown as deferred income. 2

$250,000 (500 x 6/36) of the service revenue is recognised in the six months to 31 March 2011.Of the deferred income of $1,250,000 (1,500,000 250,000), $500,000 (1,500,000 x 12/36) is shown in current liabilities and $750,000 (1,250,000 500,000) in non-current liabilities. 2

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Diploma in Financial Reporting June 2011 Marking Scheme

Marks1 As indicated on model answer 40

2 As indicated on model answer 20

3 (a) General definition ( each) 1 Discussion of identifiability 1Discussion of control 1Discussion of future economic benefits 1Discussion of cost measurement 1 Subsequent measurement cost or revaluation model 1Amortisation/impairment issues 1

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(b) As indicated on model answer 11

Total 20

4 As indicated on model answer 20

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