f7 mocks 09

Final Assessment

KAPLAN PUBLISHING of 11

ACCA FINAL ASSESSMENT

Financial

Reporting

JUNE 2009

QUESTION PAPER

Time allowed Reading time: 15 minutes Writing time: 3 hours

All FIVE questions are compulsory and MUST be attempted

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

Kaplan Publishing/Kaplan Financial

ACCA F7 (INT) Financial Reporting

© Kaplan Financial Limited, 2008 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

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Final Assessment

All FIVE questions are compulsory and MUST be attempted QUESTION 1 During the year Air, a public listed company acquired share capital in Blade Ltd and Ripsaw Ltd. The financial statements at 31 March 2008 are as follows:

Air Blade Ripsaw $000 $000 $000

Non-current assets PPE 51,250 43,500 47,120Investments 18,750 3,750 –

70,000 47,250 47,120Current assets Inventory 12,380 6,000 9,880Receivables 17,000 10,750 18,000Bank 1,500 4,750 –

30,880 21,500 27,880

100,880 68,750 75,000

Equity Ordinary $1 shares 25,000 37,500 25,000Share premium 10,000 2,500 –Retained earnings 13,250 10,630 10,000

48,250 50,630 35,000NCL 8% Loan note 20,000 5,250 15,000Current liabilities Trade payables 20,630 8,620 17,000Bank overdraft – – 5,620Tax payable 12,000 4,250 2,380

32,630 12,870 25,000

100,880 68,750 75,000

The following information is relevant: (i) Air purchased 30,000,000 shares in Blade on 1 April 2007. The purchase was agreed

by way of a share exchange of two shares in Air for every three shares in Blade plus payment of cash at $1 per share purchased, payable in three years from the date of acquisition. The terms of the agreement were such that this cash would only be paid if Blade makes profits of $3 million during that payment period. The directors are not confident that the profit will be made during that time. The cost of capital of Air is 10% and its share price at the acquisition date was $2. The acquisition of Blade has not yet been recorded in the financial statements of Air.

(ii) On 1 October 2007 Air purchased 7,500,000 shares in Ripsaw paying cash of $2.50

per share on that date. The acquisition of Ripsaw has already been accounted for by Air.



(iii) Extract from SOCIE for the year ended 31 March 2008

Blade Ripsaw $000 $000

Retained earnings – 1 Apr 07 5,000 2,500 Profit for the year 5,630 7,500

Retained earnings – 31 Mar 08 10,630 10,000

(iv) The current accounts between Air and Blade were reconciled at the year-end with

Blade owing Air $650,000.

The current accounts between Air and Ripsaw disagreed at the year-end due to a cash remittance to Air of $33,000 not being received until after the year-end. Before adjusting for this Ripsaw’s debit balance in Airs accounts was $78,000.

(v) Some of the book values of Blades net assets at the date of acquisition differed to their fair values, the details of which are shown below:

Carrying value $000

Fair value $000

Land 8,000 13,000 Plant 12,000 16,000

The plant had 2 years UEL remaining at the date of acquisition.

(vi) Air’s policy is to value the non-controlling interest at fair value at the date of acquisition. The fair value of Blade at the date of acquisition was $11,250,000.

(vii) During the year Blade had sold goods to Air at a price of $6 million. These goods had

originally cost Blade $4.5 million. During the year Air had sold $5million (at cost to Air) of these goods for $7.5 million.

Required: (a) Prepare the consolidated statement of financial position of Air as at 31 March 2008.

(20 marks)

(b) Discuss the main changes following the update to IFRS 3 Business Combinations and its impact on the way group accounts are now prepared. (5 marks)

(Total: 25 marks)


Final Assessment

QUESTION 2 Nemesis is a well known company manufacturing thrill rides. During the current economic climate, Nemesis has experienced some difficulties and unfortunately has had to close down its Merry Go Round division. The company’s trial balance at 31 October 2008 is as follows:

$000 $000

Revenue 216,000 Cost of sales 91,080 Distribution costs 21,180 Administrative expenses 23,760 Investment income 4,680 Investment property 45,000 Interest paid 2,880 Income tax 1,800 PPE NBV at 1 November 2007 210,000 Investments 60,000 Inventories – 31 October 2008 18,000 Trade receivables 22,500 Bank 10,800 Payables 7,200 Deferred tax – 1 November 2007 12,600 8% Loan note 72,000 $1 Ordinary shares 90,000 Retained earnings – 1 November 2007 _______ 100,920 _______ 505,200 _______ 505,200 _______ Note 1 Revenue includes cash sales of $12 million for goods sold in October 2007 to Abbeyfax Plc, a bank. The goods are marked up at 25% on cost, Abbeyfax has the option to require Nemesis to repurchase these goods within 3 months of the year end at their original selling price plus a fee of $360,000. Note 2 Included within PPE is a building with a NBV of $9 million. On 1 November 2007 it was revalued at $12 million. The building had an estimated life of 25 years when it was purchased ten years prior to the revaluation date, this has not changed as a result of the revaluation. The directors of Nemesis wish to incorporate this value in the financial statements for the year ended 31 October 2008. All other PPE is to be depreciated at 20% per annum on the reducing balance basis. All depreciation is to be charged to cost of sales.



Note 3 The investments in the trial balance are classed as available for sale. The fair value of the investments at 31 October 2008 is $55,000. Note 4 On 1 October 2008, Nemesis closed down its Merry Go Round division. The results of the division from 1 November 2007 to the date of closure are included in the above trial balance figures. These results are as follows:

$000

Revenue 9,800 Cost of sales 6,450 Distribution costs 2,040 Admin expenses 1,980

The net assets of the division were sold at a loss of $3.2 million and are currently included within cost of sales. Note 5 The investment property owned by Nemesis has risen in value during the year by 3%. This rise is to be incorporated into the financial statements. Nemesis uses the fair value model to value investment property, as allowed by IAS 40. Note 6 The provision for income tax for the year ended 31 October 2008 has been estimated at $23,400,000. For the deferred tax provision, the only temporary differences are accelerated capital allowances. At 31 October, these were $21,600,000. Income tax is charged at 30%. Required: Prepare a statement of comprehensive income for the year ended 31 October 2008 for Nemesis along with a statement of changes in equity and a statement of financial position at that date.

(25 marks)


Final Assessment

QUESTION 3 The financial statements for Katona Plc for the year ended 31 March 20X8 are as follows: Statement of Financial Positions at 31 March

20X8 20X7 $000 $000

Non-current assets Intangibles 600 400 Property, plant and equipment 6,900 3,200 Investments 800 ______ 400 ______ 8,300 ______ 4,000 ______ Current assets Inventories 6,400 4,000 Receivables 4,800 4,000 Investments − 200 Cash at bank and in hand 64 ______ 960 ______ 11,264 ______ 9,160 ______ Total assets 19,564 ______ 13,160 ______ Equity and liabilities Shares of $1 each 6,000 4,000 Share premium 1,716 1,200 Revaluation reserve 2,000 − Retained earnings 2,220 ______ 1,108 ______ 11,936 ______ 6,308 ______ Non-current liabilities Deferred tax 160 420 Loan notes 3,000 ______ 3,500 ______ 3,160 ______ 3,920 ______ Current liabilities Trade payables 2,400 2,000 Taxation 1,040 932 Bank overdraft 1,028 ______ − ______ 4,468 ______ 2,932 ______ 19,564 ______ 13,160 ______



Statement of Comprehensive Income for the year ended 31 March 20X8

$000

Revenue 20,000 COS (14,200)______

Gross profit 5,800 Operating expenses (2,048)______

Profit from operations 3,752 Interest receivable 100 Interest payable (640)______

Profit before tax 3,212 Tax (1,300)______

Profit for the year 1,912 Other comprehensive income: Gain on land revaluation 2,000 ______ Total comprehensive income 3,192 ______

Statement of Changes in Equity for the year ended 31 March 2008 Share

capital Share

premium Revaluation

reserve Retained earnings

Total

Balance at 1 April 20X7 4,000 1,200 – 1,108 6,308 Profit per I/S 1,912 1,912 Share issue 2,000 516 2,516 Dividend paid (800) (800) Revaluation _____ _____ 2,000 _____ _____ 2,000 ______ Balance at 31 March 20X8 6,000 _____ 1,716 _____ 2,000 _____ 2,220 _____ 11,936 ______

The following information may also be relevant: (1) Non-current assets

20X8 20X7 Cost Depreciation Cost Depreciation $000 $000 $000 $000

Intangibles 1,400 800 800 400 Property, plant and equipment 10,000 3,100 6,000 2,800

(2) At 1 April 20X7, freehold land was revalued from $2,000,000 to $4,000,000. (3) During the year, plant and machinery which had cost $1,200,000 and had a carrying

amount of $200,000 was sold for $500,000.


Final Assessment

(4) Development costs of $600 were capitalised during the year as the recognition criteria per IAS 38 were met.

(5) Part of the loan notes had reached their redemption period during the year and were

repaid accordingly. (6) Ordinary shares were issued for cash during the year. (7) Current asset investments at 1 April 20X7 were sold during the year for $188,000.

These had never been classed as a cash equivalent. The profit or loss on disposal was included in operating expenses.

Required: (a) Prepare a statement of cash flow for Katona plc for the year ended 31 March 20X8

which meets the requirements of IAS 7 Statement of Cash Flows. (18 marks) (b) Comment on the changes in cash flow and financial position of Katona during the

year using the information given in the question and the statement of cash flow calculated at part (a). (7 marks)

(Total: 25 marks)



QUESTION 4 The International Accounting Standards Board’s Framework for the Preparation and Presentation of Financial Statements identifies the qualitative characteristics that make the information provided in financial statements useful to users. Required: Identify the four qualitative characteristics and explain what is meant by each of these terms, giving an example of each from specific IASs or IFRSs. Discuss the practical difficulties in achieving all of these characteristics at the same time. (15 marks)


Final Assessment

QUESTION 5 Rita is a large speedway company. The finance director is working on the published accounts for the year ended 31 March 2008. The chief accountant has prepared the following notes which will have to be resolved before the accounts can be finalised. (a) One of Rita’s customers using the speedway was injured during a race. The customer

claims that the accident was Rita’s fault due to there being a divot on track. Rita’s lawyers have advised that the customer has a very strong case, but will be unable to estimate the financial outcome until further medical evidence becomes available.

(3 marks) (b) Rita has recently expanded its overseas market building speedway tracks in areas

with no such activity. It is expected that the speedways will be abandoned in five years time. At which point the speedway will need to be dismantled and the area restored to its original condition in accordance with current legislation. The estimated cost of doing this is expected to be $4 million. The cost of capital of the company is 10%. (7 marks)

Required: Explain how the matters treated in part (a) and (b) should be treated in the published accounts for the year ended 31 March 2008. Where applicable you should show the impact on the financial statements in the first year. You should assume that all amounts are material.

(Total: 10 marks)


Final Assessment

ACCA

Paper F7 (INT)

Financial Reporting June 2009

Final Assessment – Answers

To gain maximum benefit, do not refer to these answers until you have completed the final assessment questions and submitted them for marking.

KAPLAN PUBLISHING Page 1 of 20


© Kaplan Financial Limited, 2008 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

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Final Assessment

ANSWER 1 (a) Consolidated statement of financial position for Air group as at 31 March 2008

$000 $000

Non-current assets Goodwill (W3) 19,789 Property, plant and equipment (51,250 + 43,500 + 5,000 (land fv adj) + 4,000 (plant fv adj) – 2000 (plant fv dep’n)

101,750 Investments (18,750 + 3,750 – 18,750 (investment in Ripsaw))

3,750

Investment in associate (W6) 19,875 _______ 145,164 Current assets Inventory (12,380 + 6,000 – 250 (W7)) 18,130 Receivables (17,000 + 10,750 – 650 (inter co adj)) 27,100 Bank (1,500 + 4,750) 6,250 ______

51,480 _______ 196,644 _______ Equity and liabilities Equity Share capital (25,000 + 20,000 (W3)) 45,000 Share premium (10,000 + 20,000 (W3)) 30,000 Group reserves (W5) 14,825 Non-controlling interests (W4) 11,926 _______ 101,751 Non-current liabilities

8% Loan note (20,000 + 5,250) 25,250 Deferred cash (22,530 (W3) + 2,253 (W8)) 24,793 ______

50,043 Current liabilities Trade payables (20,630 + 8,620 – 650 (inter co adj)) 28,600 Taxation (12,000 + 4,250) 16,250 ______

44,850 _______ 196,644 _______



Working paper (W1) Group structure

Air

Blade

Ripsaw

30000 = 80% 37500 7500 = 30%

25000 01/10/07 = 6 months ago

01/04/07 1 year ago

(W2) Net assets

@ reporting date

@ acquisition

Post- acquisition

Blade Share capital 37,500 37,500 Share premium 2,500 2,500 Retained earnings 10,630 5,000 5,630 Fair value adj: Land (13,000 – 8,000) 5,000 5,000 Plant (16,000 – 12,000) 4,000 4,000 Fair vale dep’n: (4,000 / 2yrs) (2,000) (2,000) PURP (W7) (when sub = seller) (250)______ ______ (250)_____

57,380 ______ 54,000 ______ 3,380 _____ Ripsaw

Share capital 25,000 25,000 Retained earnings 10,000

______

6,250 (β) ______

3,750 (7,5 12) 00 × 6/_____

35,000 ______ 31,250 ______ 3,750 _____


Final Assessment

(W3) Goodwill

Blade $000 $000 Cost of investment Share exchange (30,000 × 2/3) × $2

40,000

Cr share capital $20,000 Cr share premium $20,000

Deferred cash* (30,000 × $1) × 1/(1 + .10)3

22,539 ______

Cr NCL – deferred cash

62,539 For: 80% net assets at acquisition (80% × $54,000 (W2))

(43,200)______

Goodwill – parents share 19,339 FV of NCI 11,250 For: 20% net assets at acquisition (20% × $54,000 (W2))

(10,800)______

Goodwill – NCI share 450 ______

Total goodwill 19,789 ______

*Deferred cash now recognised at acquisition whether probable or not per the update to IFRS 3 Ripsaw Cost of investment (7,500 × $2.50)

18,750

For: 30% net assets at acquisition (30% × $31,250 (W2))

(9,375)______

9,375 ______

(W4) Non-controlling interest

$000

20% net assets at reporting date (20% × $57,380 (W2)) 11,476 NCI Share of goodwill 450 ______ 11,926 ______

(W5) Group reserves

$000

100% Air’s retained earnings 13,250 80% Blade post-acq profit (80% × $3,380 (W2)) 2,704 30% Ripsaw post-acq profit (30% × $3,750 (W2)) 1,125 Unwind discount (W8) (2,253)______

14,825 ______



(W6) Investment in associate

$000

30% net assets at reporting date (30% × $35,000 (W2)) 10,500 Goodwill (W3) 9,375 ______ 19,875 ______ OR: Cost of investment 18,750 30% Ripsaw post-acq profit (30% × $3,750 (W2)) 1,125 ______ 19,875 ______

(W7) PURP

$000

Sales 6,000 COS 4,500 ______ Gross profit 1,500 ______

NB: Sub = seller so; Dr Group reserves (W5) – 80% 200 Dr NCI (W4) – 20% 50 Cr Inventory – 100% 250 Or: Dr Update (W2) 250 Cr Inventory 250

Left in inventory = $6,000 – $5,000 = £1,000 PURP = $1,000 left in inventory × $1,500 / $6,000 = $250

(W8) Unwinding the discount $22,539 (W3) × 10% = $2,254 Dr Group reserves (W5) Cr NCL – deferred cash

(b) IFRS 3 Update

NCI and Goodwill impact It has long been argued that the traditional (‘old’) method of calculating goodwill only recognises the goodwill acquired by the parent, and is based on the parent’s ownership interest rather than the goodwill controlled by the parent. In other words, any goodwill attributable to the NCI is not recognised. The standard now allows the acquirer (parent) to measure any non-controlling interest (NCI) in one of two ways: - at fair value (the ‘new’ method) - at the NCI’s proportionate share of the acquiree’s (subsidiary’s) identifiable

net assets (this is the ‘old’ method).


Final Assessment

Under the ‘new’ method NCI are to be measured at their ‘fair value’, rather than at ‘its proportionate share of the (fair value of the) acquiree’s identifiable net assets’. The difference between these two values is, effectively, the NCI share of goodwill which may or may not be proportionate to the parent’s share of goodwill. The overall impact is that 100% of the goodwill can now be shown in the group non-current assets and that the “real NCI value is also shown). Contingent consideration The previous version of IFRS 3 required contingent consideration to be accounted for only if it was probable that it would become payable. The revised standard requires the acquirer to recognise the acquisition date fair value of contingent consideration as part of the consideration for the acquiree. Acquisition costs In the previous IFRS 3, directly related acquisition costs such as professional fees (legal, accounting, valuation, etc) could be included as part of the cost of the acquisition. This has now been stopped and such costs must be expensed. The costs of issuing debt or equity are to be accounted for under the rules of IAS 39, Financial Instruments: Recognition and Measurement.

MARKING GUIDE

Marks

(a) Goodwill 4 PPE 2 ½ Investments ½ Investment in associate 2 Inventory 1 Receivables 1 Share capital 1 Share premium 1 Group reserves 2 NCI 2 8% Loan note ½ Deferred cash 1 Trade payables 1 Tax ½

20 (b) Goodwill and NCI impact 3 Acquisition costs 1 Contingent consideration 1 5 TOTAL 25



ANSWER 2 Statement of comprehensive income for Nemesis for the year ended 31 October 2008 $000

Continuing operations Revenue (216,000 – 12,000 – 9,800) 194,200 COS (W3) (112,830)_______

Gross profit 81,370 Distribution costs (21,180 – 2,040) (19,140) Administration expenses (23,760 – 1,980) (21,780)_______

Profit from operations 40,450 Finance costs Accrued interest Abbeyfax (W1) (360) Loan note interest (72,000 × 8%) (5,760) Investment income (4,680 + 1,350 (W6)) 6,030 _______ Profit before tax 40,360 Tax (W7) (15,480)_______

Profit for year from continuing operations 24,880 Discontinuing operations Loss on discontinuing operation (W5) (3,870)_______

Total profit for the year 21,010 Other comprehensive Income Revaluation gain 3,000 _______ Total comprehensive income 24,010 _______ Statement of financial position for Nemesis as at 31 October 2008

$000 $000

Non-current assets Property, Plant and Equipment (W9) 172,000 Investments (W2) (60,000 – 5,000) 55,000 Investment Property (W6) 46,350 _______ 273,350 Current assets Inventory (18,000 + 9,600) 27,600 Trade receivables 22,500 Bank 10,800 ______

60,900 _______ 334,250 _______


Final Assessment

Equity and liabilities Equity Share capital 90,000 Retained earnings (W4) 116,930 Revaluation (W9) 3,000 _______ 209,930 Non-current liabilities 8% Loan note 72,000 Deferred tax (W8) 6,480 ______

78,480 Current liabilities Loan from Abbeyfax (W1) 12,000 Accrued interest 360 Tax payable 23,400 Interest payable (5,760 – 2,880) Payable – paid

2,880

Trade payables 7,200 ______

45,840 _______ 334,250 _______ Statement of changes in equity for Nemesis for the year ended 31 October 2008

Share capital Retained earnings

Revaluation Reserve

Total

Bal at 01/11/07 90,000 100,920 – 190,920 Profit for year as per income statement

21,010

21,010

Decrease in investments (W2) (5,000) (5,000) Revaluation gain (W9) ______ _______ 3,000 _____ 3,000 _______ Bal at 31/10/08 90,000 ______ 116,930 _______ 3,000 _____ 209,930 _______ Working paper (W1) Sale and repurchase agreement “This is not a true sale but a short-term loan received from Abbeyfax, with a finance cost of $360,000”. - Remove sale and treat as loan

Dr Revenue – I/S 12,000 Cr Loan from Abbeyfax – SFP 12,000

- Bring goods back into inventory

(12,000/120*100)

Sales 12,000 125% COS 9,600 100%

Dr Closing inventory – SFP 9,600 Cr Closing inventory – I/S 9,600



- Account for finance cost Dr Finance costs – I/S 360 Cr Accrued interest – SFP 360

(W2) Investments

$000

Bal at 01/11/07 60,000 Bal at 31/10/08 55,000 ______

Dr Retained earnings Cr Investments

Decrease in investments 5,000 ______ (W3) Cost of sales

$000

Per TB 91,080 Sale and repurchase (W1) (9,600) Discontinued operation – COS (6,450) Discontinued operation – loss on disposal (3,200) Depreciation (W10) 41,000 ______ 112,830 ______

(W4) Retained earnings

$000

Bal at 01/11/07 100,920 Decrease in investment (W2) (5,000) Profit per income statement 21,010 ______ 116,930 ______

(W5) Discontinued operations

$000

Revenue 9,800 COS (6,450) Distribution costs (2,040) Admin expenses (1,980) Loss on disposal (3,200)______

Loss in discontinued operations (3,870)______

(W6) Investment property

$000

Bal at 01/11/07 45,000 Bal at 31/10/08 (45,000 + 3%) 46,350 ______ 1,350 ______

Dr Investment property – SFP Cr Investment income – I/S


Final Assessment

(W7) Tax expense

$000

Year end estimate 23,400 Decrease in DT (W8) (6,120) Over provision (1,800)______

15,480 ______ (W8) Deferred tax

$000

Bal at 01/11/07 12,600 Decrease in DT required 6,120 ______

Bal at 31/10/08 (21,600 × 30%) 6,480 ______ (W9) Property, plant and equipment

$000

NBV at 01/11/07 210,000 Revaluation (12,000 – 9,000) 3,000 Depreciation (W10) (41,000)______

Dr PPE Cr Revaluation

NBV at 31/10/08

172,000 ______

(W10) Depreciation

$000

Building (12,000 / 15 years) 800 NB: depreciation applied to revalued amount as took place at the start of the year.

Other PPE (213,000 – 12,000) × 20% 40,200 ______ 41,000 ______

Dr Dep’n expense Cr Accumulated dep’n



MARKING GUIDE

Marks

Statement of comprehensive income Revenue 1½ COS 3 Distribution ½ Admin ½ Finance costs 1 Investment income 1 Tax 1½ Loss on discontinued operation 2 Other comp income – revaluation gain 1

12

Statement of financial position PPE 1 Investment property 1 Investments 1 Inventory 1 Receivables ½ Bank ½ Equity section (1 mark for own figure – as long as it agrees to SOCIE) 1 8% Loan note ½ Deferred tax 1 Loan from Abbey fax + interest 1 Tax payable ½ Loan note interest accrual ½ Trade payables ½

10

SOCIE B/fwd ½ Profit per income statement (1 mark for own figure if agrees to profit on I/S) ½ Decrease in investments + revaluation gain (1 mark each) 2

3 TOTAL 25


Final Assessment

ANSWER 3 (a) Statement of Cash Flow for Katona plc for the year ended 31 March 20X8

$000 $000

Cash flows from operating activities Operating profit 3,752 Adjustment for: Depreciation (W1) 1,300 Amortisation (800 – 400) 400 Profit on disposal of PPE (500 – 200) (300) Loss on sale of investments (200 − 188) 12 _____ Operating profit before working capital changes 5,164 Increase in inventories (6,400 – 4,000) (2,400) Increase in receivables (4,800 − 4,000) (800) Increase in trade payables (2,400 − 2,000) 400 _____ Cash generated from operations 2,364 Interest paid (per I/S) (640) Tax paid (W2) (1,452)_____

Net cash from operating activities 272

Cash flows from investing activities Purchase of intangibles (1,400 - 800) (600) Purchase of property, plant and equipment (W3) (3,200) Proceeds of sale of property, plant and equipment 500 Purchase of non-current asset investments (800 − 400) (400) Proceeds of sale of current asset investments 188 Interest received (per I/S) 100 _____

Net cash used in investing activities (3,412)

Cash flows from financing activities Issue of shares (6,000 − 4,000 + 1716 – 1,200) 2,516 Repayment of loans (3,000 – 3,500) (500) Dividends paid (800)_____

Net cash from financing activities 1,216 _____ Decrease in cash and cash equivalents (1,924) Cash and cash equivalents at 1 April 20X7 960 _____ Cash and cash equivalents at 31 March 20X8 (-1,028 + 64) (964)_____



Workings

(W1) Depreciation

$000 Bal c/d 3,100 D (1,200 – 200) 1,000 _____ isposal

4,100 _____

$000 Bal b/d 2,800 Charge (bal fig) 1,300 _____ 4,100 _____

(W2) Tax

$000 Bal c/d – tax payable 1,040 Bal c/d – deferred tax 160 Paid (bal fig) 1,452 _____ 2,652 _____

$000 Bal b/d – tax payable 932 Bal b/d – deferred tax 420 Income statement 1,300 _____ 2,652 _____

(W3) Property, plant and equipment (cost)

$000 Balance b/d 6,000 Revaluation 2,000 Additions (bal fig) 3,200 _____ 11,200 _____

$000 Disposal 1,200 Balance c/d 10,000 _____ 11,200 _____

(b) Changes in cash flow and position

During the year cash has deteriorated turning a positive bank balance into a bank overdraft. Making use of an overdraft facility can be common place for many businesses, however it is worth noting that this should mainly be used in the short-term as an overdraft is both risky (repayable on demand) and expensive (higher rates of interest associate with it).

Katona is reporting a profit from operations during the year, but an analysis of the statement of cash flow reveals that this was not backed by operating cash. Operating cash flow was only $2.364 million whereas the profit associated with it was $3.752 million.

Further investigation reveals that the main reason for this is due to the movement in working capital as inventory and receivables have increased massively compared to the trade payables movement. Further information would be required surrounding this working capital – particularly to the reference to closing inventory. We would need to consider why there has been such a large increase? Maybe the company has taken advantage of a bulk buying discount or maybe our inventory has become slow moving or even damaged and therefore a write down required.

The company appears to be showing signs of increased trade and need to ensure that they are not “overtrading”. This is where the business expands rapidly and does not have sufficient funding to enable the expansion. The large movement in inventory has certainly had a major impact in our operating cash flow.

Even though there was a drain on cash in the year following the increase in inventory, operating cash flow was still sufficient to meet our compulsory cash outflow payments of interest and tax. However, a substantial dividend has been paid during the year and operating cash was not sufficient to cover this so it has had to be funded from elsewhere – probably through the use of the overdraft. A dividend is not compulsory therefore this drain on cash could have been avoided. It will be interesting to determine if the company will be able to maintain this level of dividend in the future.


Final Assessment

A further drain on cash during the year can be seen when looking at the investing activities section of the statement of cash flow. Intangible assets and property, plant and equipment have been purchased. These assets have been financed it would appear via the disposal of existing assets, investment income and in part a share issue. It is a good sign that such a substantial investment has been made in NCA as it shows the management commitment to the company. The cash spent on the assets are a drain on cash now but should have a positive impact on performance in the future. Cash as mentioned above has been raised through an issue of shares which is a positive sign as investors are still willing to invest in the business. However, shareholders are demanding so equity finance is often seen as being more expensive than debt finance. Finally, it can be noted that the company has managed to repay some of its loans during the current accounting year. This will reduce the business risk that the company has as there is now less debt in the capital structure. It is worth noting however that from a cash flow point of view interest payments are tax deductible whereas dividends are not. Conclusion During the current year the activities have had an adverse effect on cash. If the lack of operating cash flows occur into the future Katona could find themselves struggling to meet future interest commitments or further business expansion. Katona should not see the overdraft as a long-term source of finance and if needs to consider what is to be done about the high closing inventory balance.

MARKING GUIDE

Marks

(a) Operating profit ½ Depreciation 1 Amortisation 1 Profit on disposal 1 Loss on investments 1 Increase in inventory 1 Increase in receivables 1 Increase in payables 1 Interest paid ½ Tax paid 2 Purchase of intangibles 1 Purchase of PPE 1 Proceeds on disposal ½ Purchase on non-current asset investments 1 Proceeds of sale of NCA investments ½ Interest received ½ Issue of shares 1 Repayment of loans 1 Dividend paid ½ Decrease in cash 1

18

(b) One mark per sensible comment (max 7) 7

TOTAL 25



ANSWER 4 Understandability An essential quality of information provided by financial statements is that it is readily understandable by users. The IASB Framework’s approach is based on the assumption that users have a reasonable knowledge of business and economic activities and accounting, and a willingness to study information with reasonable diligence. IAS 1 Presentation of Financial Statements seeks to avoid making the main financial statements over-complex by restricting the number of items which are required to be shown on the face of the statement of financial position, the income statement and the statement of changes in equity. Relevance Information has the quality of relevance when it influences the decisions of users by helping them evaluate past, present or future events, or confirming or correcting their past evaluations. Relevance is affected by its nature and its materiality. Materiality is an element of relevance as by definition, information is material only if its omission or misstatement could influence users. The requirements of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations result in the separation of the financial position and financial performance of those activities which will continue into the future from those which will not. This provides a clearer base for projections into the future than if the position and performance of both types of activity were merely amalgamated. Another aspect of relevance is whether current value information is more relevant than historic cost. For example, per IAS 16 a company is allowed to revalue its NCA to fair value and such valuations should be kept up-to-date. It can be argued that revaluing the assets can give a more complete picture of performance. Reliability Information has the quality of reliability when it is free from material error and bias, and can be depended on by users to represent faithfully that which it purports, or could reasonably be expected, to represent. The inclusion of faithful representation within reliability leads to the requirement that transactions and other events should be accounted for by reference to their substance, not merely their legal form. For example an asset held under a finance lease per IAS 17 is in substance an asset of the company using the asset but not the legal owner. Reliability also requires information to be neutral, i.e. free from bias, that prudence is exercised in the preparation of financial statements (in that a degree of caution is used in making the estimates necessary under conditions of uncertainty) and that information is complete within the bounds of materiality and cost.


Final Assessment

Often uncertainties surround the preparation of financial statements such as estimating for the useful economic lives of assets and in making allowances for receivables. Prudence is followed when allowing for such estimates but it must not be used to deliberately understate profit or create excessive provisions. If an error is found after financial statements have been published and the error relates to information available at the time they were prepared and could reasonably be expected to have been taken into account, then the usefulness of those financial statements is called into question. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors therefore requires such errors to be accounted for retrospectively, by restating the previous period. Comparability Users must be able to compare the financial statements of an entity over time and those of different entities. Hence the measurement and display of transactions and other events must be consistent across an entity over time and between entities. Compliance by all entities with IFRS helps to achieve comparability between entities. Comparability is enhanced by the use of consistent accounting policies. An important implication is that users are informed of an entity’s accounting policies, of any changes in them and of the financial effect of such changes. IAS 8 allows a change in accounting policy only when it is required by an IAS/IFRS or when it results in a relevant and more reliable presentation of transactions and other events. The change in accounting policy is applied retrospectively by restating the prior year and opening retained earnings. IAS 16 Property, Plant and Equipment require entities which revalue their property, plant and equipment to produce a note of the carrying amounts under the cost model. This allows the results of entities which use the revaluation model to be compared with those which use the cost model. Practical difficulties Some of the components of reliability may appear to be in conflict with each other. For example, the requirement for neutrality would lead to an estimate being made by reference to the most likely outcome, while the requirement for the exercise of prudence in making estimates might lead to a less likely, but more cautious, estimate being made. Difficult judgements may have to be made in deciding whether the cost of producing information is outweighed by the benefit of it being available. There is the potential for conflict between relevance and reliability, in that the time taken to establish reliable information may result in that information becoming available at a time when it no longer has relevance for decision making. Some transactions and other events are by their very nature extremely complex. It may then be difficult to present them in the financial statements in a way which is intelligible.



MARKING GUIDE

Marks

Understandability Characteristic ½ Meaning 1 Example 1½ Relevance Characteristic ½ Meaning 1 Example 1½ Reliability Characteristic ½ Meaning 1 Example 1½ Comparability Characteristic ½ Meaning 1 Example 1½ Practical difficulties (one mark per sensible comment) 3 TOTAL 15


Final Assessment

ANSWER 5 (a) Rita is being sued by the customer and therefore will need to consider whether or not

a provision should be made for the potential future liability.

A provision is a liability of uncertain timing or amount. But before a provision can be recognised in the accounts the recognition criteria per IAS 37 must be met. There is a present obligation as a result of the customer becoming injured during the race (being the past event leading to the case). It appears that it is probable that the customer will win given that they have a very strong case. However, the lawyers are unable at present to make a reliable estimate. Therefore as not all the recognition criteria have been met a provision cannot be made. Instead the potential liability should be treated as a contingent liability and disclosed in a note to the financial statements.

(b) It would appear that Rita has a future liability of $4 million dollars – this will be provided for and brought into the accounts now if the recognition criteria for a provision are met.

A provision is a liability of uncertain timing or amount. A liability per the IASB framework is “an obligation to transfer future economic benefit as a result of a past event”. There is a present obligation to dismantle the speedway and restore the area to its natural condition following use of the speedway. It would appear that this is a legal obligation but the information is not clear so this would need to be confirmed. If the obligation is not legal then it could be constructive i.e. where we have raised a valid expectation in a third party that we will restore the speedway to its natural state. It is probable that the outflow of cash will be required as the speedway is expected to be abandoned in five years time. A reliable estimate has been made for $4 million which is the anticipated cost to be incurred in the future. To find the “fair value” however of the liability from day one, this anticipated future cost should be discounted to its present value. As all the recognition criteria appear to have been met, a liability for the future costs should be recognised immediately. Initial recognition To recognise the provision: Dr Cost of asset a/c $2,483,685 Cr Provision $2,483,685 ($4 million × (1/1 + 0.10)5



Subsequent accounting Account for the asset: Dr Depreciation expense $496,737 Cr Accumulated depreciation $496,737 ($2,483,685 / 5 years)

Unwind the discount: Dr Finance costs $248,369 Cr Provisions $248,369 ($2,483,685 × 10%)

MARKING GUIDE

Marks

(a) Definition of provision IAS 37 recognition criteria: Present obligation Probable Reliable estimate

(To get one mark per point must relate to the info in the question, otherwise half mark for just stating criteria)

Conclusion

½ 1 1 1

½

4

(b) IAS 37 recognition criteria: Present obligation Reliable estimate

(To get one mark per point must relate to the info in the question, otherwise half mark for just stating criteria)

1 1

Conclusion 1

Initial accounting 1

Depreciation 1

Unwind the discount 1

6

TOTAL 10


f7 mocks 09

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