general fin reporting 2013 exam w solutions

FAC3701/102/3/2013

Tutorial letter 102/3/2013 General Financial Reporting

FAC3701 Semesters 1 & 2 Department of Financial Accounting

IMPORTANT INFORMATION:

This tutorial letter contains important information about your module.

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CONTENTS

Page 1. INTRODUCTION AND WELCOME ................................................................................... 3 2. LECTURERS AND CONTACT DETAILS ......................................................................... 3 3. MAY 2010 EXAMINATION PAPER WITH SOLUTION .................................................. 4 4. OCTOBER 2010 EXAMINATION PAPER WITH SOLUTION ...................................... 17 5. MAY 2011 EXAMINATION PAPER WITH SOLUTION ................................................ 30 6. OCTOBER 2011 EXAMINATION PAPER WITH SOLUTION ...................................... 43 7. MAY 2012 EXAMINATION PAPER WITH SOLUTION ................................................ 55

FAC3701/102

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1 INTRODUCTION AND WELCOME Dear Student, Attached please find the examination papers for May 2010, October 2010, May 2011, October 2011 and May 2012 with the suggested solution. We suggest that you do these examination papers under exam conditions. Once you have completed the examination papers, you should then compare your answer to the suggested solution. Your answers to these examination papers must not be submitted to Unisa. These examination papers will indicate to you the standard required of you and will help you to identify areas of weaknesses that you must pay attention to. 2 LECTURERS AND CONTACT DETAILS

Please use only the following e-mail address for all communication with the lecturers: Students registered for first semester: [email protected] Students registered for second semester: [email protected]

Please use the following telephone number for all communication with the lecturers: 012 429-4266

Lecturers Office number Mrs R Horn AJH van der Walt building 2-48 Mrs L Labuschagne Mr Y Mohamed Mr J Oberholzer Mr JWC Riekert

AJH van der Walt building 2-49 AJH van der Walt building 2-51 AJH van der Walt building 2-50 AJH van der Walt building 2-52

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3. MAY 2010 EXAMINATION PAPER WITH SOLUTION

QUESTION 1 (35 marks) (42 minutes)

Capresso Limited is a manufacturer and retailer of coffee machines which are either leased to customers or sold, with a one year warranty, for cash. The current issued share capital of Capresso Limited consists of: R 500 000 ordinary shares 500 000 200 000 10% redeemable preference shares 200 000 700 000 The 200 000 redeemable preference shares were issued on 1 March 2009 and are compulsory redeemable on 28 February 2012. On 28 February 2010 R20 000 preference dividends were declared and paid to all preference shareholders. Included in the profit before tax of Capresso Limited for the year ended 28 February 2010 amounting to R1 650 000 are the following items: R Foreign income received from the United Kingdom (Capresso Limited paid foreign taxes of R10 000 on this income)

40 000

Profit on sale of equipment 777 500 Provision for warranty costs 200 000 Reversal for provision for warranty costs (2009:R Nil) 50 000 The manufacturing process of the coffee machines is mainly performed by equipment which was purchased on 1 March 2007 for R2 100 000. The carrying amount and tax base of this equipment at 28 February 2009 amounted to R1 680 000 and R1 260 000 respectively. On 30 November 2009 the directors of Capresso Limited sold this equipment for R2 300 000. On the date of sale the carrying amount and tax base of this equipment amounted to R1 522 500 and R840 000 respectively. No other equipment was purchased or disposed of during the year. Subsequently, the directors decided to lease all equipment used to manufacture the coffee machines in future rather than to purchase them due to the difficulties to finance the capital required. On 1 December 2009 a contract was concluded with Marks Limited for the lease of equipment. The lease, payable six monthly in advance, in respect of this equipment amounted to R60 000 per month, and was paid on 1 December 2009. On 1 February 2009, Capresso Limited received rental income of R40 000 for coffee machines relating to March 2009. For the year ended 28 February 2010 there was no rental income received in advance in respect of coffee machines rented out. The provision for warranty costs in respect of the coffee machines which were sold for cash during the current financial year was calculated consistently with the past years. It is based on the expected frequency of returns and the corresponding cost of repairs, assuming that 40% of the items sold are returned with defects.

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QUESTION 1 (continued) The balance of the provision for warranty costs in the statement of financial position of Capresso Limited for the respective years was as follows:

Year ended 28 February 2010



R R R 200 000 110 000 105 000

Actual warranty costs paid are debited directly to the provision for warranty costs account. The SA Revenue Service general ledger account in the books of Capresso Limited on 28 February 2010 consisted of the following:

Dr SA Revenue Service Current tax Cr 30/8/2009 Bank (for 2009 tax year) 60 000 1/3/2009 Opening balance b/d 65 000 31/8/2009 Bank (for 2010 tax year) 60 000 28/2/2010 Current tax expense ? 28/2/2010 Bank (for 2010 tax year) 60 000 28/2/2010 Closing balance c/d ? ? ? 1/3/2010 Opening balance b/d ? Capresso Limited accepted the 2009 tax assessment and paid it on 30 August 2009. The SA Normal tax rate changed from 29% in 2009 to 28% in 2010. 66.6% of all capital gains are taxable. The company provides for deferred tax on all temporary differences according to the statement of financial position approach. There are no other exempt or temporary differences except those mentioned in the question. There is certainty beyond any reasonable doubt, that the company will have sufficient taxable profit in future against which any deductible temporary differences can be utilised. Assume all amounts are material.

REQUIRED:

1. Motivate with reasons, why the issue of the preferences shares on 1 March 2009 should

be recorded as a liability in the books of Capresso Limited for the year ended 28 February 2010, according to the requirements for a liability in terms of the Conceptual Framework for Financial Reporting 2010. (5)

2. Disclose the provision for warranty costs in the notes to the annual financial statements of

Capresso Limited for the year ended 28 February 2010 according to the requirements of IAS 37 Provisions, contingent liabilities and contingent assets.

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QUESTION 1 (continued)

Comparative amounts are required. No other notes are required. No accounting policy notes are required. (7)

3. Calculate the current tax due to the SA Revenue Service by Capresso Limited for the

year ended 28 February 2010. (12) 4. Calculate the deferred tax balance in the statement of financial position of Capresso

Limited for the year ended 28 February 2009, using the statement of financial position approach. Indicate if the balance is a deferred tax asset or deferred tax liability. (3)

5. Disclose the tax rate reconciliation, using R-values only in the annual financial

statements of Capresso Limited for the year ended 28 February 2010, according to the requirements of IAS 12 Income taxes.

All calculations must be shown. Comparative amounts are not required. (7)

QUESTION 2 (32 marks)(38 minutes)

Flex Limited sells and repairs classic, collectable cars, as well as accessories for these collectable classic cars. The profit before tax of Flex Limited for the year ended 28 February 2010 amounted to R1 750 000, before taking into account the following information: 1. A Computer Virus in the general ledger software computer programme arose during the

current financial year. This Computer Virus resulted in 10% of all income from repairs rendered during the current financial year to be allocated to the income from the accessories account. This error was compounded by the fact that every financial year Flex Limited pays royalties of 2% on all income generated from the sale of motor accessories at the end of the year. The royalties payable are not directly debited to the income from sale of accessories account but allocated as royalties expenses in the statement of profit and loss and other comprehensive income. The following amounts are included in the above profit before tax of Flex Limited on 28 February 2010:

R Income from sale of collectable classic cars (including VAT of 14%) 1 400 000 Income from sale of accessories account (excluding VAT of 14%) 350 000 Income from repairs of collectable classic cars (excluding VAT of 14%) 630 000

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QUESTION 2 (continued) 2. On 1 March 2007 modification costs to machinery were incurred at a cost of R600 000.

During the interim audit the auditors discovered that these modification costs were expensed in the statement of profit and loss and other comprehensive income of Flex Limited for the financial year ended 28 February 2008 instead of being capitalised. The current depreciation that the company claims on machinery is 20% p.a. according to the straight-line method, which is in agreement with the policy applied by the SA Revenue Service. The effect of this is considered material. The SA Revenue Service indicated that they will re-open the previous years tax assessments.

3. On 1 December 2009 Flex Limited paid R60 000 to Castro Media Limited for advertisements that will be broadcast on its radio station during January 2010. From the past sales history Flex Limited expects to receive the following benefits from the advertising campaign: During January 2010 40% During February 2010 25% During March 2010 20% During April 2010 15%

4. As a result of the significant decline of car sales in the motor industry and Flex Limiteds

recent sales history, Flex Limited decided to also sell its classic cars on an instalment sales agreement. On 1 February 2010 Flex Limited sold a vintage classic car to Mr Claasens to be paid in 2 annual instalments of R250 000 each, payable in arrears, at an interest rate of 7,32125%. The cash price of the vintage car is R450 000, excluding 14% VAT. This vintage car was sold at a gross profit of 25% on cost price.

5. A letter of notification was received from the lawyers of Jabulani Limited that on

10 March 2010 the company which they represent was placed under liquidation as its liabilities far exceeds its assets and no cash was available to pay its creditors. Flex Limited currently holds a 15% share in Jabulani Limited. The liquidation of Jabulani Limited arose as a result of years of mismanagement of the company and misappropriation of its assets. During the financial year 28 February 2010 the amount owing by Jabulani Limited to Flex Limited amounted to R40 000 for sales made by Flex Limited to Jabulani Limited. The investment in Jabulani Limited is disclosed at a cost of R290 000 in the statement of financial position at 28 February 2010.

6. The tax rate has remained unchanged at 28% for the past few years. 7. The financial statements of Flex Limited for the financial year ended 28 February 2010

were presented to the board of directors for authorisation for issue on 30 April 2010. 8. Assume all amounts are material.

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REQUIRED:

1. State the amount of revenue in (3) that Castro Media Limited should recognise as

revenue from the advertisement campaign it has entered into with Flex Limited for the financial year ended 31 December 2009. Give reasons to support your answer. Your answer should comply with the requirements of IAS 18 Revenue. (2)

2. Prepare the journal entries for transaction (2) in the books of Flex Limited for the financial

year ended 28 February 2010. No journal narrations are required. Ignore any tax implications. (7)

3. Calculate the profit before tax of Flex Limited for the year ended 28 February 2010. (10) 4. Disclose (2) in the notes to the annual financial statements of Flex Limited for the year

ended 28 February 2010 according to the requirements of only IAS 8 Accounting policies, changes in accounting estimates and errors. No accounting policy notes are required. (12)

QUESTION 3 (33 marks)(40 minutes)

Roma Limited is an importer of Italian ceramic tiles and distributes and sells them through their own chain of stores throughout South Africa.

1. The following information is an extract from the draft financial statements of Roma Limited

for the year ended 28 February 2010: 2010 2009 R R

Dr/(Cr) Dr/(Cr) Profit before tax (470 000) (750 000) Inventory 190 000 280 000 Delivery trucks - Cost 900 000 900 000 Accumulated depreciation ? (170 000)

2. Roma Limited has a fleet of delivery trucks, acquired on 1 March 2008, which are used to

transport the tiles from the harbour to the different retail stores and then to the clients. After a physical inspection of the delivery trucks at 28 February 2010 to determine their roadworthiness, the operations manager of Roma Limited indicated that the remaining useful life of these trucks are only 3 years due to the fact that they are used to their full capacity. The financial director therefore decided to change the depreciation method for the current year for these trucks from the reducing balance method at 20% p.a. to the straight-line method.

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QUESTION 3 (continued) Based on the operations managers assessment of the trucks, the financial director also decided to change the residual value of the trucks from R50 000 to R10 000 to reflect the increased usage of the trucks. No depreciation charge for these trucks has been accounted for in the current financial year. No other delivery trucks were acquired or disposed of since 1 March 2008. The SA Revenue Service allows a 20% p.a. wear and tear allowance on the trucks according to the straight-line method.

3. Roma Limited keeps a limited quantity of tiles as inventory, due to the fact that the tiles can be imported and delivered to the client within 6 weeks after order date. Exchange rate fluctuations also have a direct effect on the cost and sales price of these tiles. After the draft financial statements for the year ended 28 February 2010 had been prepared, the directors decided to change the valuation method of the tiles held as inventory because it does not give a reliable presentation of the effect of exchange rate fluctuations on the companys profits. The valuation method was therefore changed from the weighted average method to the first-in-first-out method

The value of inventory based on the different valuation methods was as follows:

Weighted average

First-in- first-out

Difference

R R R 28 February 2007 164 000 220 000 56 000 29 February 2008 170 000 240 000 70 000 28 February 2009 280 000 344 000 64 000 28 February 2010 190 000 220 000 30 000

The SA Revenue Service indicated that they will accept the new inventory valuation method and will reopen the 2009 tax assessment but not the tax assessments before 2009.

4. Due to the fact that their own delivery trucks did not have the capacity to transport the load of tiles, Roma Limited used outside transport contractors to deliver tiles to a faraway destination in Limpopo. The tiles were to be used for the tiling of the floors of an exclusive bush lodge. Unfortunately, due to the poor road conditions, approximately 15% of the tiles were already cracked on arrival at the bush lodge. On 15 January 2010, the client instituted a claim of R150 000 against Roma Limited for the damaged tiles they were unable to use. At year end the legal advisor of Roma Limited is of the opinion that it is probable that Roma Limited will not be found liable for the claim. As a result of the above mentioned claim, Roma Limited decided on 31 January 2010 to sue the relevant outside transport contractor for R95 000 for damages incurred. Due to the lack of the necessary packaging material used by the outside transport contractor to compensate for the poor condition of the roads, the financial manager of Roma Limited is of the opinion that it is probable that Roma Limited will be successful with their claim.

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5. The taxable income/(loss) of Roma Limited before taking into account the change in inventory valuation method amounted to income of R220 000 and a loss of R125 000 for the years ended 28 February 2010 and 28 February 2009 respectively. The wear and tear allowance on the delivery trucks has already been taken into account in taxable income/(loss) for the years ended 28 February 2009 and 28 February 2010.

6. The company provides for deferred tax on all temporary differences according to the statement of financial position approach. These are no other exempt or temporary differences except those mentioned in the question. There is certainty beyond any reasonable doubt, that the company will have sufficient taxable profit in future against which any deductible temporary differences can be utilised.

7. The SA normal tax rate has remained unchanged at 28% for the past few years.

8. Assume all amounts are material.

REQUIRED:

1. Calculate the profit before tax of Roma Limited for both the years ended

28 February 2010 and 28 February 2009. (5)

2. Calculate the current tax expense (if any) of Roma Limited for both the years ended 28 February 2010 and 28 February 2009. In your answer start with the taxable income of R220 000 and loss of R125 000. (4)

3. Calculate the deferred tax balance of Roma Limited for the year ended 28 February 2009, using the statement of financial position approach. Indicate if it is a deferred tax asset or liability. (3)

4. Disclose (3) and (4) in the notes to the annual financial statements of Roma Limited for

the year ended 28 February 2010, according to the requirements of IAS 8 Accounting policies, changes in accounting estimates and errors and IAS 37 Provisions, contingent liabilities and contingent assets. No accounting policy notes are required. Comparative figures are required. (20)

Please note: For all the capital gains tax calculations use 28% x 66,6% to ensure that rounding does not affect your answer. Do not round the CGT rate.

FAC3701/102

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SOLUTION

QUESTION 1 In order to recognise the preference shares as a liability both the definition of a liability as well as the recognition criteria of a liability must be met in terms of the Conceptual Framework for Financial Reporting 2010 In terms of the liability definition

There must be a present obligation As a result of a past event The settlement of which is expected to result in an outflow of future economic

benefits (Par.4.4(b)) In terms of the recognition criteria a liability which meets the definition of a liability may only be recognised if:

It is probably that future economic benefits will flow from the entity. The element has a cost or value that can be measured reliably. (Par.4.46)

Discussion The issue of the shares meets the definition of a liability

Capresso Limited has a present obligation since the preference shares are compulsory redeemable.

As a result of the past event the past event is the issue of the shares on 1 March 2009.

There will be a settlement in the form of future economic benefits flowing from Capresso Limited in respect of the value of the shares and the annual dividend of R20 000 x 3 = R60 000

The issue of the shares meets the recognition criteria.

The outflow of future economic benefits is probable. The value can be measured reliably.

Conclusion Since the definition and the recognition criteria are met the preference shares should be treated as a liability in the financial statements.

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QUESTION 1 (continued) 2. CAPRESSO LIMITED NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010 Provision for warranty costs 2010 2009 R R Carrying amount beginning of year 110 000 105 000 Amount used during the year (110 000 50 000) (60 000) (105 000) Reversal of unused amounts (50 000) - Provision created for the year 200 000 110 000 Carrying amount end of year 200 000 110 000 Provision for warranty costs is made based on the expected value of the cost of repairs, assuming that 40% of the coffee machines are returned with defects. 3. Calculation of current tax due to the SA Revenue Service for the year ended

28 February 2010 R Profit before tax 1 650 000 Exempt differences (106 800) Foreign income (40 000) Capital profit on sale of equipment (2 300 000 2 100 000) x (100%-66.6%) (66 800) Profit after exempt differences 1 543 200 Temporary differences 290 000 Depreciation equipment (1680 000 1 522 500) 157 500 Wear and tear on equipment (1 260 000 840 000) (420 000) Rent prepaid (3 x 60 000) (180 000) Profit on sale of equipment (2 100 000 1 522 500) (577 500) Recoupment on sale of equipment (2 100 000 840 000) 1 260 000 Provision for warranty costs (200 000 50 000) 150 000 Rental received in advance in 2009 (40 000) Actual warranty costs paid(110 000 50 000) (60 000)

Taxable income 1 833 200

Current tax expense (1 833 200 x 28%) 513 296 Less: Provisional tax payments made (60 000 + 60 000) (120 000) Tax due to South African Revenue Service 393 296

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QUESTION 1 (continued) 4. Calculation of the deferred tax balance of Capresso Limited for the year ended

28 February 2009.

Carrying amount

Tax base

Temporary differences

Deferred tax asset/(liability)

@ 29% R R R R Equipment 1 680 000 1 260 000 420 000 (121 800) Provision for warranty costs 110 000 - 110 000 31 900 Rent received in advance 40 000 - 40 000 11 600 Deferred tax liability (78 300)

5. Tax rate reconciliation

R Standard tax rate (1 650 000 x 28%) 462 000 Adjusted for exempt differences: Overprovision prior year (65 000 60 000) (5 000) Foreign income (40 000 x 28%) 10 000 (1 200) Capital profit on sale of machinery (66 800 x 28%) (18 704) Tax rate change (78 300 x 1/29) (2 700)

434 396 QUESTION 2 1. Revenue from advertising commissions are recognised when an advert appears before

the public (par 12 IAS 18). Since the advert is broadcasted during January 2010, which forms part of the next financial year of Castro Media Limited no amount should be recognised as revenue.

2. Journal entries for the financial year ended 28 February 2010 Dr Cr R R J1. Depreciation 120 000

Accumulated depreciation: Property, plant and equipment 120 000 Accounting for depreciation on modification costs to machinery (600 000 x 20%)

J2. Machinery 600 000 Retained earnings

(600 000 (600 000 x 20% x 2)) 360 000

Accumulated depreciation: Property, plant and equipment (600 000 x 20% x 2)

240 000

Accounting for depreciation on modification costs to machinery and capitalisation of machinery

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QUESTION 2 (continued) 3. Calculation of profit before tax for the year ended 28 February 2010 R Profit before tax before adjustments 1 750 000 VAT portion on sale of collectable cars (1 400 000 x 14/114) (171 930) Royalties incorrectly calculated (630 000/90% x 10% x 2%) 1 400 Credit losses written off Jabulani Limited (40 000) Cost of investment written off Jabulani Limited (290 000) Advertisement expense (60 000 x 40%) + (60 000 x 25%) (39 000) Sale of motor vehicle Mr Claasens 450 000 Interest recognised (450 000 x 7,32125% x 1/12) 2 745 Cost of sales on inventory (450 000 x 100/125) (360 000) Depreciation on motor vehicle claimed (600 000 x 20%) (120 000)

1 183 215 4. FLEX LIMITED

NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010. 1. Prior period error The company incorrectly expensed modification costs on machinery rather than being capitalized in its accounting records. The effect of the correction has been accounted for retrospectively and comparative amounts have been appropriately restated:

2009 1/3/2008 R R Increase in depreciation (600 000 x 20%) (120 000) Decrease in current tax (120 000 x 28%) 33 600

Decrease in profit (86 400)

Increase in property plant and equipment (600 000 (600 000 x 20% x 2)); 600 000 (600 000 x 20% )

360 000 480 000

Increase in current tax due (360 000 x 28%); (480 000 x 28%)

(100 800) (134 400)

Increase in equity 259 200 345 600 Adjustment to retained earnings beginning of 2009 (480 000 (480 000 x 28%)

345 600

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QUESTION 3 1. Profit before tax 2010 2009 R R Profit before tax (given) 470 000 750 000 Change in accounting policy (30 000 64 000) (34 000) (64 000 70 000) (6 000) Depreciation ((900 000 170 000) 10 000) /3 (240 000) - 196 000 744 000 2. Current tax 2010 2009 R R Taxable income / (loss) 220 000 (125 000) (Decrease)/Increase in profit due to change in closing inventory (64 000 30 000)

(34 000) 64 000

Loss carried forward to 2010 - (61 000) Less: assessed loss: 2009 (61 000) Taxable income 125 000 Current tax @ 28% (125 000 x 28%) 35 000 3. Calculation of deferred tax balance of Roma Limited for the year ended

28 February 2009 Carrying

amount Tax base Temporary

difference Deferred tax

asset/ (liability) @

28% R R R R Delivery trucks 730 0001 720 0002 10 000 (2 800) Assessed loss - 61 000 61 000 17 080 Deferred tax asset 14 280 1 900 000 170 000 2 900 000 (900 000 x 20%)

4. ROMA LIMITED NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010 1. Change in accounting policy

During the year the company changed the inventory valuation method from the weighted average method to the first-in-first-out method in order to give a reliable presentation of the effect of exchange rate fluctuations on the companys profits. This change in accounting policy has been accounted for retrospectively and the comparative amounts have been appropriate restated:

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QUESTION 3 (continued) 2010 2009 1/3/2008 R R R Increase in cost of sales (34 000) (6 000) (64 000 30 000); (70 000 64 000) Decrease in current tax expense (34 000 x 28%); (6 000 x 28%) 9 520 1 680 Decrease in profit 24 480 4 320 Increase in inventory 30 000 64 000 70 000 Increase in current tax liability (30 000 x 28%); (64 000 x 28%)

(8 400) (17 920)

Increase in deferred tax liability (70 000 x 28%) (19 600) Increase in equity 21 600 46 080 50 400

Adjustment to retained earnings at beginning of 2009 50 400 2. Contingent liability A client instituted a claim of R150 000 against Roma Limited for delivering damaged tiles that they were unable to use. At year end the legal advisor of Roma Limited is of the opinion that it is probable that Roma Limited will not be found liable. 3. Contingent asset Roma Limited sued the outside transport contractor for R95 000 for damages incurred, due to the lack of the necessary packaging material used by the outside transport contractor to compensate for the poor condition of the roads. The financial manager of Roma Limited is of the opinion that it is probable that Roma Limited will be successful with their claim.

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4. OCTOBER 2010 EXAMINATION PAPER WITH SOLUTION


Zakare Limited is a company that manufactures and sells health equipment and is situated in Parys in the Free State. Mr Swahile, an article clerk has drawn up the annual financial statements for the year ended 31 December 2009 of Zakare Limited. Your assistance is required to finalise these annual financial statements according to the requirements of International Financial Reporting Standards. Additional information 1. The profit before tax of Zakare Limited for the year ended 31 December 2009 amounted

to R986 000. The profit before tax includes the following: R Income Foreign income received from the United Kingdom (refer 1.1) 100 000 Reversal of unused provision for cost of repairs (refer 2) 38 000 Expenses Depreciation (refer 4) 362 000 Traffic fines (not tax deductible) 10 500 Allowance for credit losses (refer 1.2) 120 000 Provision for cost of repairs created (refer 2) 87 000 Subscription fees for health magazines (refer 1.3)

300

1.1. Foreign income received from the United Kingdom is not taxable in the RSA in terms of a double taxation agreement. Zakare Limited paid foreign taxes of R18 000 on this income.

1.2. The SA Revenue Service allows 25% of the allowance for credit losses as a deduction. In

previous financial years Zakare Limited made no allowance for credit losses because the company had no credit sales.

1.3. Subscription fees for health magazines relates to health magazines which was received

during the period January 2009 to June 2009. The subscription fees were paid on 1 December 2008.

2. During the previous year, an intrinsic defect was discovered in the slimming health

machines manufactured by Zakare Limited. As a result thereof slimming health machines sold, on hand and already manufactured will have to be repaired by Zakare Limited free of charge to customers. The financial manager of Zakare Limited therefore raised a provision for these costs to be incurred from the financial year ended 31 December 2008. The balance of the provision for the cost of these repairs for the year ended 31 December 2008 and 31 December 2009 amounted to R103 000 and R87 000 respectively. Actual repair costs incurred are debited directly against the provision for cost of repairs.

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QUESTION 1 (continued) 3. During your discussions with Mr Swahile the following matters come to your attention: 3.1. The following journal entry was recorded in the accounting records of Zakare Limited for

the financial year ended 31 December 2009:

Dr Insurance (P/L) R180 000 Cr Insurance liability loss (SFP) R180 000

On requesting the supporting invoices for the insurance charge, Mr Swahile explained that the financial director had cancelled the insurance policy as of 1st of January 2009 and would in future self insure. This was due to the fact that although Zakare Limited made the insurance payments no claim for any moneys had ever been instituted against the insurance company. Zakare Limited will therefore bear all possible future losses. Instead of paying the insurance company R15 000 per month the above liability has been created.

3.2. Zakare Limited has an investment portfolio whereby it invests excess cash on the stock

exchange. At 31 December 2009 the cost and the market value of the investments amounted to R550 000. Mr Swahile informed you that the market value of the investments on 31 January 2010 had decreased to R425 000. The investments were disclosed at R550 000 in the statement of financial position as at 31 December 2009.

4. Property, plant and equipment 4.1. Mr Swahile has finalised schedules relating to the carrying amounts and tax base of the

assets of Zakare Limited before taking into account 4.2 below.

Administration building

Distribution vehicles

Total

R R R Carrying amount 31 December 2008

950 000

1 248 000

2 198 000

31 December 2009 900 000 936 000 1 836 000 Depreciation rate (straight-line) 5% 20% Tax base 31 December 2008

N/A

1 170 000

1 170 000

31 December 2009 N/A 780 000 780 000 Capital allowances (straight-line) None 25%

The distribution vehicles are used to distribute health equipment to customers of Zakare Limited.

4.2. Sale of distribution vehicle

On 31 December 2009 Zakare Limited sold a distribution vehicle with a cost price of R110 000 for R76 900.

Mr Swahile had prepared the above schedules (refer 4.1) before the sale of the distribution vehicle (refer 4.2) had taken place.

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QUESTION 1 (continued) The only journal entry recorded by Mr Zwahile in respect of the sale of the distribution vehicle in the accounting records of Zakare Limited for the financial year ended 31 December 2009 was as follows: Dr Bank R76 900 Cr Sales of distribution vehicle R76 900

Details of the distribution vehicle sold are as follows on 31 December 2009: R Cost - 1 January 2008 110 000 Accumulated depreciation - 31 December 2009 44 000

During the current financial year no other assets were purchased or sold.

5. On 30 November 2009 the production manager of Zakare Limited informed the

management of Zakare Limited of the possibility that the appearance of its health treadmills will have to change after complaints were received from its main competitor, Flex Limited. Flex Limited claims that the appearance of its treadmills is similar to those manufactured by Zakare Limited and started legal proceedings of R50 000 against Zakare Limited. However, on 31 December 2009 the legal advisors of Zakare Limited are of the opinion that it is not probable that Flex Limited will be successful with their claim against the company.

6. The SA Normal rate changed from 29% in 2008 to 28% in 2009. 7. The annual financial statements of Zakare Limited for the year ended 31 December 2009

were presented to the board of directors for authorisation for issue on 20 February 2010. 8. The company provides for deferred tax on all temporary differences according to the

statement of financial position approach. There are no other exempt or temporary differences except those mentioned in the question. It is probable that future taxable profits will be available against which any deductible temporary differences can be utilised.

9. Assume all amounts are material.

REQUIRED:

1. Discuss, with reasons, if you agree with the financial director (refer 3.1) whether the

insurance liability loss should be treated as a liability in the statement of financial position of Zakare Limited for the financial year ended 31 December 2009 according to the requirements of a liability in terms of the Conceptual Framework for Financial Reporting 2010. (5)

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QUESTION 1 (continued) 2. Motivate, with reasons, why the decrease in market value of investments (refer 3.2) will

not require an adjustment to the financial statements of Zakare Limited for the financial year ended 31 December 2009. In your answer also motivate any disclosure requirements that may be necessary. Your answer must comply with the requirements of IAS 10 - Events after the reporting period. (3)

3. Using the additional information points (1) (3) and (4) calculate the correct profit before

tax of Zakare Limited for the year ended 31 December 2009. (3) 4. Calculate the current tax expense of Zakare Limited for the year ended

31 December 2009. Use the profit before tax as calculated in (3) above as your starting point. (12)

5. Calculate the deferred tax balance in the statement of financial position for both the years

ended 31 December 2008 and 31 December 2009 using the statement of financial position approach. Indicate if the balance is a deferred tax asset or deferred tax liability. (10)

6. Disclose the tax rate reconciliation, using R-values only, in the notes to the annual

financial statements of Zakare Limited for the year ended 31 December 2009, according to the requirements of IAS 12 - Income taxes.

All calculations must be shown. Calculations are to be done to the nearest R1 Comparative amounts are not required. (7)

7. Disclose additional information points (2) and (5) above in the notes to the annual

financial statements of Zakare Limited for the year ended 31 December 2009 according to the requirements of IAS 37 - Provisions, contingent liabilities and contingent assets.

Comparative figures are required. No other notes are required. No accounting policy notes are required. (8)


The annual financial statements of Maximor Limited, a retailer and manufacturer of new motor vehicles, for the year ended 28 February 2010, were presented to the board of directors for authorisation for issue on 25 April 2010. The profit before tax of Maximor Limited (including the provision for obsolete inventory at 5% (Refer 1) for the years ended 28 February 2010 and 28 February 2009 amounted to R950 000 and R650 000 respectively.

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QUESTION 2 (continued) The company provides for deferred tax on all temporary differences according to the statement of financial position approach. There are no other exempt or temporary differences except those mentioned in the question. There is certainly beyond reasonable doubt that there will be sufficient taxable profit in future against which deductible temporary differences can be utilised. The SA normal tax rate has remained unchanged at 28% for the past three years. Assume all amounts to be material. Additional information 1. After the draft financial statements for the year ended 28 February 2010 had been

prepared, the directors decided at a board meeting held on 5 April 2010 that the current inventory valuation method does not give a realistic presentation of the effect of inflation on the company's profit. Hence the directors decided to change the accounting policy in respect of the valuation of inventory from the last-in, first-out method to the first-in, first-out method. Due to a change in the materials used to manufacture the motor vehicles the directors also decided to increase the provision for obsolete inventory to 10%, while the provision in previous years was based on 5% of the value of inventory. The SA Revenue Service will not reopen the previous years tax assessments but they will accept the new inventory valuation method from the 2010 financial year.

A summary of the value of inventory based on the different valuation methods after taking into account the applicable provision for obsolete inventory is as follows:

2008

Inventory value after provision

for obsolete inventory @ 5%

R

2009 Inventory value after provision


R



R



R First-in, first-out method

375 250

399 000

437 000

414 000

Last-in, first-out method

(362 900)

(375 250)

(399 000)

(378 000)

12 350 23 750 38 000 36 000 2. On 15 August 2009 Maximor Limited introduced its new range of apache motor vehicles.

On 1 September 2009 an apache motor vehicle was sold to Mr. Wild for R147 500 including a 90 000 km service plan. The amount charged for each service within the 90 000 km service plan period is R880. The cost of each service is marked up at 33% on the cost of labour. The apache motor vehicle is required to be serviced every 15 000 km in order for the guarantees on the apache motor vehicle to be valid. Maximor Limited realises a gross profit percentage of 25% on the sale of new apache motor vehicles

On 28 February 2010 Mr Wild brought his apache motor vehicle to the premises of Maximor Limited for its first service.

22


As a result of the production of the apache motor vehicles the current premises were inadequate and the directors decided to terminate the current operating lease agreement and to move to bigger premises on the outskirts of the city. The terms of the current lease agreement state that early termination would result in a penalty payment of 80% of the remaining lease payments. The current lease agreement would have terminated on 28 February 2011. The lease rental is R50 000 per annum payable in arrears. All the lease payments for the year ended 28 February 2010 are up to date. The abovementioned has not yet been recorded in the accounting records of Maximor Limited for the year ended 28 February 2010.

3. During the current years audit of the PAYE records it was discovered that PAYE for the

staff in the customer service department, had not been recorded since incorporation of the company four years ago. The PAYE system of this department was not linked to the salaries and wages account of the mainframe computer. The salaries and wages account in the statement of profit and loss and other comprehensive income for the four years respectively is as follows: 28 February 2010

R 28 February 2009

R 28 February 2008

R 28 February 2007

R 690 000 640 000 520 000 410 000

The PAYE due to the SA Revenue Service in respect of staff in the customer service department for the four years is as follows: 28 February 2010

R 28 February 2009

R 28 February 2008

R 28 February 2007

R 75 900 60 500 48 000 42 500

The effect thereof is considered to be material. The SA Revenue Service indicated that they will reopen the tax assessment for the prior years in respect of this matter.

REQUIRED:

1. Motivate with reasons why the sale of the service plan as per additional information (2)

should be recognised as "Revenue" over the duration of the service plan in the accounting records of Maximor Limited. Calculations need not form part of your answer. Your answer should comply with the requirements of IAS 18 - Revenue. (6)

2. Prepare all the necessary journals as per additional information (2) to record the

transactions in the accounting records of Maximor Limited for the year ended 28 February 2010. Journal narrations are not required. Ignore the tax implications. (10)

3. Calculate the deferred tax movement in the statement of profit and loss and other

comprehensive income of Maximor Limited for the year ended 28 February 2010 using the statement of financial position approach. Indicate if your answer is a debit or credit movement to the statement of profit and loss and other comprehensive income. (5)

FAC3701/102

23

QUESTION 2 (continued) 4. Disclose the information as per additional information (1) and (3) in the notes to the

annual financial statements of Maximor Limited for the year ended 28 February 2010 according to the requirements of IAS 8 - Accounting policies, changes in accounting estimates and errors.

No accounting policy notes are required. Comparative figures are required. All calculations are to be done to the nearest Rand. (28)

SOLUTION

QUESTION 1 1. Discussion in terms of the Conceptual Framework for Financial Report 2010 In terms of the liability definition: There must be a present obligation As a result of a past event The settlement of which is expected to result in a outflow of future economic benefits.

(Par.4.4(b)) In terms of the recognition criteria a liability which meets the definition of a liability may only be recognised in the financial statements if: It is probable that future economic benefits will flow to/from the entity and The element has a cost or value that can be measured reliably. (Par.4.46)

Discussion Although a possible outflow of economic benefits would result in the event of damages and theft, this outflow is not expected since: No past transaction has occured, and no insurance contract has been signed, requiring

the payment of insurance premiums. There is no present obligation. Furthermore, there is no obligation as the company is not

obliged,legally or otherwise, to repair or replace any items that may have been damaged. It can be argued that the cost of R180 000 is reliably measured, as it represents the best

estimate of the insurance expense based on past experience. Although the liability has been estimated based on past insurance contributions, this can be argued to be acceptable on the grounds that this is a prudent approach.

However the outflow of economic benefits is not probable since no past event has occured; the outflow is only possible at this stage.

24

QUESTION 1 (continued) Conclusion Since the recognition criteria and definition of a liability is not met the liability cannot be recognised in the accounting records of Zakare Limited. The journal entry will therefore have to be reversed in the accounting records of Zakare Limited. 2. Discussion of decrease in the market value of investments The decrease in the market value of investments is a non adjusting event. Non adjusting events are those events that are indicative of conditions that arose after the reporting date. The decline in market value of investments is indicative of an event that occured after the reporting period. No condition of the decline in market value was apparent at the end of the reporting period and the decline in value is clearly indicative of a post reporting period event. Although no adjustment is required to the market value of investments disclosure of the decrease in market value must be made in the notes to the annual financial statements of Zakare Limited for the year ended 31 December 2009. Disclosure must include: The nature of the event and An estimate of its financial effect.

3. Calculation of profit before tax for the year ended 31 December 2009 R Profit before tax (given) 986 000 Insurance paid reversed (refer 1) 180 000 Sales reversed (76 900) Profit on sale of distribution vehicle (76 900 (110 000 44 000)) 10 900 Profit before tax - 31 December 2009 1 100 000 4. Calculation of current tax expense for the year ended 31 December 2009 R Profit before tax 1 100 000 Exempt differences (39 500) Traffic fines 10 500 Depreciation admin building (950 000 900 000) 50 000 Foreign income (100 000) Profit after exempt differences 1 060 500 Temporary differences 7 300 Depreciation: distribution vehicles (1 248 000 936 000) 312 000 Wear and tear:distribution vehicles (1 170 000 780 000) (390 000) Profit on sale of distribution vehicle (10 900) Recoupment on sale of distribution vehicle (76 900 (110 000 - (110 000 x 25% x 2))

21 900

Allowances for credit losses (acc) 120 000 Allowances for credit losses (tax) (120 000 x 25%) (30 000) Subscriptions paid in advance 300 Provision for cost of repairs (87 000 38 000) 49 000 Actual repair costs incurred (103 000 38 000) (65 000) Taxable income 1 067 800 Current tax (1 067 800 x 28%) 298 984

FAC3701/102

25

QUESTION 1 (continued) 5. Calculation of the deferred tax balance in the statement of financial position of

Zakare Limited for the year ended 31 December 2008 and 31 December 2009.

Carrying amount

Tax base

Temporary difference

Deferred tax asset/ (liability) @ 29%

R R R R 2008 Distribution vehicles 1 248 000 1 170 000 78 000 (22 620) Provision for cost of repairs 103 000 - 103 000 29 870 Subscription prepaid 300 - 300 (87) Deferred tax asset - 31 December 2008 7 163

Carrying amount

Tax base


Deferred tax asset/ (liability)

@ 28% R R R R 2009 Distribution vehicles 870 0001 725 0002 145 000 (40 600) Provision for cost of repairs 87 000 - 87 000 24 360 Allowance for credit losses 120 000 30 0003 90 000 25 200 Deferred tax asset - 31 December 2009 8 960 1 936 000 (110 000 44 000) 2 780 000 [110 000 (25% x 2 x 110 000)] 3 120 000 x 25% 6. Tax rate reconciliation R Standard tax rate (110 000 x 28%) 308 000 Adjusted for excempt differences Fines paid (10 500 X 28%) 2 940 Depreciation admin building (50 000 x 28%) 14 000 Foreign income [(100 000 x 28%) 18 000] (10 000) Tax rate change (7 163 x 1/29) 247 315 187

26

QUESTION 1 (continued) 7. ZAKARE LIMITED NOTES FOR THE YEAR ENDED 31 DECEMBER 2009 1. Provision for repairs R R Carrying amount beginning of year 103 000 - Provision created for the year 87 000 103 000 Provision used for the year (103 000 38 000) (65 000) - Unused provision reversed (38 000) - Carrying amount end of year 87 000 103 000 During December 2009 an intrinsic defect was discovered in the slimming health machines manufactured by Zakare Limited. A provision of R87 000 has been recognised for the current year for expected costs to repair these slimming health machines. 2. Contingent liability On 30 December 2009 the production director informed management that the appearance of its health treadmills will have to change after complaints were received from its main competitor, Flex Limited, and they started legal proceedings against the company for R50 000. They claim that the appearance of the health treadmills are similar to those manufactured by them. On 31 December 2009 the legal advisors of Zakare Limited is of the opinion that it is not probable that Flex Limited wil win their legal action. QUESTION 2 1. In terms of IAS 18.20, revenue from the sale of the service plan can be accounted for as

revenue since the following conditions are met: 1.1. It is possible to measure the amount of revenue reliably. Customers are usually charged

R880 for each service performed for them and therefore, the amount measurable is reliable.

1.2. It is probable that economic benefits will flow to the entity since R147 500 is received

from Mr Wild. 1.3. It is possible to measure the stage of completion of the transaction reliably. Stage of

completion is measured when a customer brings in his motor vehicles for a service. 1.4. The cost incurred for the transaction can be measured reliably as Maximor limited marks

up costs on labour of 33%.

FAC3701/102

27

QUESTION 2 (continued) 2. Journals 2.1 Bank

Revenue 147 500 (880 x ) Deferred maintenance liability

Debit R

147 500

Credit R

142 220 5 280

2.2 Deferred maintenance liability Revenue

880

880 2.3 Cost of sales (142 220 x 75%)

Labour costs 880 x Inventory

106 665

660

107 325 2.4 Penalty (50 000 x 80%) Provision for onerous contract

40 000

40 000 3. Calculation of deferred tax movement 2009

Carrying amount

R

Tax base R


R

Deferred tax asset / (liability) @

28% R

Inventory 399 000 375 250 23 750 (6 650) Deferred tax liability 6 650 2010 Income received in advance (5 280 - 880)

4 400

-

4 400

1 232

Provision for onerous contract 40 000 - 40 000 11 200 Deferred tax asset 12 432 Deferred tax movement R Deferred tax liability 1 March 2009 6 650 Deferred tax asset 28 February 2010 12 432 Deferred tax movement (credit to statement of profit and loss and other comprehensive income)

19 082

28

QUESTION 2 (continued) 4. MAXIMOR LIMITED NOTES FOR THE YEAR ENDED 28 FEBRUARY 2010

4.1. Profit before tax Included in cost of sales is a change in estimate regarding the provision for obsolete inventory. The provision is now based on 10% of the value of inventory compared to 5% as in the past. The effect of the change in estimate is a decrease in profit of R23 000 (R437 000 R414 000). Since future inventory values are not known it is not possible to calculate the future effect of the change. 4.2. Change in accounting policy During the year the company changed its accounting policy in respect of the valuation of inventory from the last in first out method to the first in first out method. This change was necessary to ensure fair presentation of the effects of inflation on the company's statement of financial position. The change in policy was accounted for retrospectively and comparative amounts have been appropriately restated. The effect of this change is as follows:

2010 R

2009 R

1/3/2008 R

Decrease in cost of sales (36 000 23 750) ; (23 750 12 350)

12 250

11 400

Increase in income tax expense (12 250 x 28%) ; (11 400 x 28%)

(3 430)

(3 192)

Increase in profit 8 820 8 208 Increase in inventory 36 000 23 750 12 350 Increase in current tax liability (36 000 x 28%)

(10 080)

-

-

Increase in deferred tax liability (23 750 x 28%) ; (12 350 x 28%)

-

(6 650)

(3 458)

Increase in equity 25 920 17 100 8 892 Adjustment retained earnings at the beginning of 2009 (12 350 - (12 350 x 28%))

8 892

4.3. Correction of error Correction of error in respect of PAYE due to the SA Revenue in respect of Employees PAYE in the customer service department. The effect of the correction has been accounted for retrospectively and comparative amounts have been appropriately restated.

FAC3701/102

29

QUESTION 2 (continued) 2009

R 1/3/2008

R Increase in expenses (salaries and wages) 60 500 Decrease in current tax expense (60 500 x 28%) (16 940) Decrease in profit 43 560 Increase in accounts payable/creditors/SA Revenue Service (60 500 + 48 000 + 42 500) ; (48 000 + 42 500)

151 000

90 500

Decrease in current tax due/liability (SA Revenue Service) (151 000 x 28%) ; (90 500 x 28%)

(42 280)

(25 340)

Decrease in equity 108 720 65 160

30

5. MAY 2011 EXAMINATION PAPER WITH SOLUTION


LTea Limited bottles and distributes ice tea. The financial manager of LTea Limited, Mr G Nhamo, completed the draft financial statements for the year ended 30 September 2010 on 15 November 2010. On 30 November 2010 the board of directors reviewed and authorised the financial statements for issue. Included in the profit before tax of LTea Limited for the year ended 30 September 2010, amounting to R1 450 000, are the following items: 2010 R Income Annual agency fees (refer 4) 600 000 Profit on sale of machine (refer 1) 80 000 Expenses Depreciation - administration building (refer 2) 90 000 Depreciation machinery (refer 1) 74 000 Depreciation - furniture and fittings (refer 2) 150 000 Additional information: 1. On 31 December 2009 the directors of LTea Limited decided to replace an old machine

used for the bottling of ice tea with a new machine. On 31 December 2009 the old machine was sold for R290 000. The old machine was acquired on 1 October 2008 at a cost of R280 000. On the date of sale the carrying amount and tax base of the old machine amounted to R210 000 and R192 500 respectively. On 2 January 2010 a new machine was acquired for R400 000 and immediately brought into use. The carrying amount and tax base of the newly acquired machine on 30 September 2010 amounted to R340 000 and R325 000 respectively. Depreciation on machinery is written off at 20% per annum according to the straight-line method. Wear and tear on machinery is written off over 4 years (pro-rata) according to the straight-line method. Wear and tear on machinery for the year ended 30 September 2010 amounted to R92 500. No other machinery were acquired or sold during the year.

2. On 1 August 2009, LTea Limited signed a contract with Lester Limited to repair all the office furniture in their eight storey administration building. The contract stipulated the contract price to be R200 000, payable on completion of the contract. Lester Limited estimated that the total cost to repair all the furniture in the administration building of LTea Limited would amount to R120 000. At 30 September 2009, Lester Limited completed 25% of the repairs of the furniture (based on the costs incurred to date to total expected costs). On 30 June 2010 Lester Limited completed the remainder of the contract. After inspection of the repair work done, LTea Limited issued a cheque on 2 July 2010 for the work completed. The repair expense has been recorded in the accounting records of LTea Limited according to the requirements of International Finan-

FAC3701/102

31

QUESTION 1 (continued) cial Reporting Standards. The SA Revenue Service will allow the repair costs as a deduction when these costs are actually paid. Depreciation on the administration building is written off at 2% per annum according to the straight-line method. The SA Revenue Service does not allow any capital allowances on the administration building. Furniture and fittings are depreciated at 20% per annum according to the straight-line method which is consistent with the capital allowance on furniture and fittings allowed by the SA Revenue Service.

3. As a result of the increase in the demand for ice tea, the current warehouse used by

LTea Limited to store the ice tea has become too small. On 30 September 2010 the directors decided to relocate to a bigger warehouse in a nearby town. Upon cancellation of the operating lease agreement of the current warehouse, which only expires on 30 September 2011, a penalty of 60% of the outstanding amounts will be payable. The rental of the warehouse currently amount to R3 500 per month, payable in arrears. The lease payments for the year ended 30 September 2010 have been paid up to date. The lease contract stipulates that LTea Limited cannot sublet the warehouse.

4. LTea Limited use independent distribution agents to distribute their ice tea throughout Africa. These agents need to sign a contract and pay a special agency fee of R90 000 for the exclusive right to distribute the ice tea in a specific area. These agency fees are payable in advance in three equal annual instalments over the contract period. The first instalment of R30 000 is payable on the commencement date of the contract. The annual agency fees included in profit before tax of LTea Limited for the year ended 30 September 2010 consist of the following: R First instalments received relating to contracts commencing on 1 October 2009

240 000

Second instalments received relating to contracts commencing on 1 October 2008

360 000

600 000

The first instalment of agency fees in respect of contracts which only commences on 1 October 2010, amounting to R180 000, was also received in advance in the current year.

5. LTea Limited increases their inventory levels of ice tea closer to September in order to provide for the increased demand for ice tea during the summer months. After the draft financial statements for the year ended 30 September 2010 had been prepared, the directors decided to change the inventory valuation method of the ice tea in order to comply with International Financial Reporting Standards. The valuation method was changed from the last-in-first-out method to the first-in-first-out method. The change in the inventory valuation method has not been accounted for yet in the accounting records of LTea Limited for the year ended 30 September 2010.

32

QUESTION 1 (continued) The value of inventory based on the different valuation methods was as follows: Last-in,

First-out First-in,

First-out Difference

R R R 30 September 2008 190 000 230 000 40 000 30 September 2009 296 000 344 000 48 000 30 September 2010 305 000 355 000 50 000

The SA Revenue Service indicated that they will accept the new inventory valuation method for tax purposes and that they will not reopen the previous years tax assessments.

6. The company provides for deferred tax on all temporary differences according to the

statement of financial position approach. There is certainty beyond any reasonable doubt, that the company will have sufficient taxable profit in future against which any deductible temporary differences can be utilised. There are no other exempt or temporary differences except those mentioned in the question.

7. The SA Normal tax rate has remained unchanged at 28% for the past few years. All

capital gains are taxable at 66.6%. 8. The tax assessment of LTea Limited for the year ended 30 September 2009, which was

received on 31 January 2010, showed that the company had an assessed loss of R130 000, which was in agreement with the accounting records of the company.

9. LTea Limited made the following provisional tax payments for the financial year ended

30 September 2010: R 31 March 2010 110 000 30 September 2010 70 000 180 000

10. Assume that all amounts are material.

REQUIRED:

1. Prepare the relevant journal entries for additional information (2) above to recognise

revenue in the accounting records of Lester Limited for both the financial years ended 30 September 2009 and 30 September 2010 according to the requirements of IAS 18 Revenue. The accounting policy of Lester Limited states that the percentage of completion method is used to recognise revenue. The stage of completion is determined based on the total costs incurred to date to the total estimated costs.

FAC3701/102

33

QUESTION 1 (continued) Journal narrations are not required. Ignore the implications of tax. (5)

2. Motivate, with reasons, why the repairs to the office furniture in the administration building in additional information (2) above should be recognised as an expense in the statement of profit and loss and other comprehensive income of LTea Limited for the year ended 30 September 2010, according to the requirements of an expense in terms of the Conceptual Framework for Financial Reporting 2010. (5)

3. Calculate the current tax due by LTea Limited to the SA Revenue Service for the year ended 30 September 2010. (14)

4. Calculate the deferred tax balance in the statement of financial position of LTea Limited

using the statement of financial position approach for both the years ended 30 September 2009 and 30 September 2010. Indicate if the balance is a deferred tax asset or deferred tax liability. (10)

5. Disclose the tax rate reconciliation, using R-values only, in the annual financial

statements of LTea Limited for the year ended 30 September 2010, according to the requirements of IAS 12 Income taxes. All calculations must be shown. Comparative figures are not required. (4)

6. Disclose only additional information (5) above in the notes to the annual financial statements of LTea Limited for the year ended 30 September 2010 according to the requirements of IAS 8 Accounting policies, changes in accounting estimates and errors. Comparative figures are required. No other notes are required. No accounting policy notes are required. (14)


Stoneridge Limited is a manufacturer and retailer of car polish and tyres. The annual financial statements of Stoneridge Limited for the year ended 28 February 2011 were presented to the board of directors for authorisation for issue on 30 April 2011. The profit before tax of Stoneridge Limited, before taking into account the additional information below, for the years ended 28 February 2011 and 28 February 2010 amounted to R980 000 and R890 000 respectively. The SA Normal tax rate has remained unchanged at 28% for the past three years. The company provides for deferred tax on all temporary differences according to the statement of financial position approach. There is certainty beyond any reasonable doubt, that the company will have sufficient taxable profit in future against which any deductible temporary differences can be utilised. There are no other exempt or temporary differences except those mentioned in the question

34

QUESTION 2 (continued) Assume that all amounts are material. Additional information: 1. The accounts receivable balance in the draft statement of financial position of Stoneridge

Limited comprised of the following debtors: 28 February

2011 R

28 February 2010

R Dash Limited 80 000 90 000 Save Security Limited 120 000 120 000 Glow Limited 110 000 - Glasstop Limited 60 000 -

370 000 210 000

When the auditors performed the current years debtors circulation it was discovered that no monies were owed by Save Security Limited (refer above). Stoneridge Limited made a payment of R120 000 on 1 November 2009 for security services rendered for the period from 1 November 2009 to 31 October 2010. This payment was then incorrectly allocated to the accounts receivable account. The effect of this is considered to be material. The SA Revenue Service indicated that they will re-open the previous years tax assessments.

On 1 November 2010 Stoneridge Limited cancelled the security services arrangement with Save Security Limited and instituted a claim of R50 000 against Save Security Limited for failing to protect the premises and warehouse of Stoneridge Limited (refer 3). The court case is scheduled for 5 April 2011. According to the legal advisors of Stoneridge Limited there is sufficient evidence against Save Security Limited to prove that they were negligent when they rendered their services and it is probable that Stoneridge Limited will be successful with their claim.

2. Stoneridge Limited sells its tyres with a six month warranty against all material defects,

excluding normal wear and tear. The tyres returned will then either be repaired or replaced free of charge to the customer. The provision for warranty costs for the current year, which has already been recorded in the accounting records of Stoneridge Limited, amounted to R100 000 and is based on the following assumptions: 80% of the tyres sold will have no defects, 15% of the tyres sold will have minor defects, and 5% of the tyres sold will have major defects.

However, the recent quality control surveys conducted by Stoneridge Limited during the financial year ended 28 February 2011 showed that the tyres sold are actually returned as follows: 90% of the tyres sold will have no defects, 6% of the tyres sold will have minor defects, and 4% of the tyres sold will have major defects.

FAC3701/102

35


Subsequently the directors decided at a recent board meeting that the warranty provision does not give an appropriate presentation of the actual warranty costs incurred and that it should rather be based on the results of the recent quality control surveys. According to recent quality control surveys, if minor defects are detected in all tyres sold, repair costs will amount to R400 000 and if major defects are detected in all tyres sold, repair costs will amount to R800 000.

Actual warranty costs paid in respect of tyres sold with a material defect for the year ended 28 February 2011 amounted to R90 000 (2010 R70 000). Actual warranty costs and reversals for warranty costs are debited against the provision for warranty costs and have already been recorded in the accounting records of Stoneridge Limited. The balance of the provision for warranty costs for the years ended 28 February 2010 and 28 February 2009 amounted to R120 000 and R80 000 respectively.

3. After recent unrest amongst employees at the premises of Stoneridge Limited three employees of Stoneridge Limited were dismissed. Subsequently, the trade union to which these employees belonged instituted a claim of R55 000 against Stoneridge Limited for the unfair dismissal of these employees. At year end on 28 February 2011 the lawyers of Stoneridge Limited indicated that the claim against them will probably not succeed. The recent unrest at the premises of Stoneridge Limited also resulted in extensive damage to Stoneridge Limiteds warehouse as well as the neighbouring company, Glasstop Limiteds warehouse. Unfortunately Glasstop Limited was not insured and the damage to their warehouse led to the company filing for insolvency on 10 April 2011. Glasstop Limited was also a debtor of Stoneridge Limited and R60 000 relating to Glasstop Limited (also refer to 1 above) is included in the accounts receivable balance in the statement of financial position of Stoneridge Limited on 28 February 2011. The liquidators of Glasstop Limited announced on 20 April 2011 that 0,20 cents in the R1 will be paid on liquidation. On 1 April 2011 Stoneridge Limited concluded a contract, amounting to R100 000, with Max Contractors Limited to repair the damage to Stoneridge Limiteds warehouse.

4. The following transactions for the current financial year with National Tyres Limited, a new

customer of Stoneridge Limited, have not been accounted for yet in the accounting records of Stoneridge Limited:

Tyres with a cost price of R20 000 were sold to National Tyres Limited on consignment. These tyres are sold at a gross profit of 20% on sales price. At year end on 28 February 2011 National Tyres Limited had not sold 60% of these tyres supplied to them.

On 1 June 2010 Stoneridge Limited acquired tyre tubes from National Tyres Limited in exchange for a wheel alignment machine. The fair value of the tyre tubes and wheel alignment machine amounted to R80 000 and R82 000 respectively. The selling price and cost price of the wheel alignment machine amounted to R90 000 and R70 000 respectively.

On 24 February 2011, Stoneridge Limited sold polish drums with a cost price of R16 000 for R22 000 on a cash on delivery basis to National Tyres Limited. At year end on 28 February 2011 payment for the full order was received. However, on 28 February 2011 only 70% of the polish drums had actually been delivered to the premises of National Tyres Limited due to transport problems.

36


REQUIRED:

1. Prepare the necessary correcting journal entry for additional information (2) above in the

accounting records of Stoneridge Limited for the year ended 28 February 2011. Journal narrations are not required. All calculations must be done to the nearest Rand. Ignore the effects of taxation. (3)

2. Calculate the profit before tax of Stoneridge Limited for both the years ended

28 February 2011 and 28 February 2010, taking into account all the additional information above. (11)

3. Calculate the deferred tax balance of Stoneridge Limited for the year ended

28 February 2011, using the statement of financial position approach. Indicate if the balance is a deferred tax asset or liability. (4)

4. Disclose additional information (1), (2) and (3) above in the notes to the annual financial

statements of Stoneridge Limited for the year ended 28 February 2011, according to the requirements of IAS 8 Accounting policies, changes in accounting estimates and errors, IAS 10 Events after the reporting period and IAS 37 Provisions, contingent liabilities and contingents assets.

Comparative figures are required. No other notes are required. No accounting policy notes are required. (27)

Please note: For all the capital gains tax calculations use 28% x 66,6% to ensure that rounding does not affect your answer. Do not round the CGT rate.

FAC3701/102

37

SOLUTION

QUESTION 1 1. Relevant Revenue Journal Entries R R Debit Credit 2009 Accounts receivable (25% x 200 000) 50 000 Revenue from services 50 000 2010 Bank 200 000 Accounts receivable 50 000 Revenue (200 000 50 000) 150 000 2. In terms of the definition of an expense it represents:

A decrease in economic benefits During the accounting period In the form of outflows (through a decrease (depletion) in assets or an increase

(incurrence) in liabilities) That result in decreases in equity.(par. 4.25 (b))

Recognition criteria for an expense: Recognised in the statement of profit and loss and other comprehensive income when a

decrease in future economic benefit related to a decrease in an asset or an increase of a liability has arisen.

That can be measured reliably.(par. 4.49)

Discussion of the expense: The amount of the payment is reliably measured in terms of a contract. The payment for the repairs is made during the current accounting period. There is a decrease in the bank (assets). There is a decrease in equity and therefore the payment could be expensed.

Conclusion The payment for the repairs of the furniture meets both the definition and recognition criteria and therefore should be expensed in the statement of profit and loss and other comprehensive income.

38

QUESTION 1 (continued) 3. Calculation of current tax expense for the year ended 30 September 2010 R

Profit before tax 1 450 000 Change in accounting policy accounting (50 000 48 000) 2 000 Adjusted profit before tax 1 452 000 Exempt differences: 86 660 Depreciation administration building 90 000 Capital gain of machine [(290 000 280 000) x (100%-66.6%)] (3 340) Profit after exempt differences 1 538 660 Temporary difference: 202 200 Depreciation (150 000 + 74 000) 224 000 Wear and tear (150 000 + 92 500) (242 500) Profit on sale of asset (280 000 210 000) (70 000) Recoupment on sale of asset (280 000 192 500) 87 500 Provision onerous contract ((3 500 x 12) x 60%) 25 200 Agency fees received in advance 180 000 Change in accounting policy accounting (50 000 48 000) (2 000) Change in accounting policy tax 50 000 Actual repairs incurred (given) (200 000) Repairs debited to P/L [200 000 (200 000 x 25%)] 150 000 Taxable income 1 740 860 Less: Assessed loss (130 000) Taxable income 1 610 860 Current tax @ 28% (R1 610 860 x 28%) 451 041 Provisional tax payments (110 000 + 70 000) (180 000) Amount due to the SA Revenue Service 271 041

FAC3701/102

39

QUESTION 1 (continued) 4. Calculation of deferred tax balance 2009 Carrying

amount Tax

base Temporary

difference Deferred

tax asset/ (liability)@

28% R R R R Provision for repairs (25% x 200 000)

50 000 - 50 000 14 000

Inventory 344 000 296 000 48 000 (13 440) Machinery 224 000 210 000 14 000 (3 920) Assessed loss - 130 000 130 000 36 400 Deferred tax asset 33 040 280 000 (280 000 x 20%) 280 000 (280 000 x 25%)

2010 Carrying

amount Tax base Temporary

difference Deferred

tax asset/ (liability)@

28%

R R R R Machinery 340 000 325 000 15 000 (4 200) Agency fees received in advance

180 000

-

180 000

50 400

Provision onerous contract 25 200 - 25 200 7 056 Deferred tax asset 53 256

(3 500 x 12) x 60%

5. Tax rate reconciliation R

Standard rate of tax (1 452 000 x 28%) 406 560 Adjusted for exempt differences: Depreciation administration building (90 000 x 28%) 25 200 Capital profit on sale of machinery (3 340 x 28%) (935) 430 825

6. LTEA LIMITED NOTES FOR THE YEAR ENDED 30 SEPTEMBER 2010 1. Change in accounting policy During the year the company changed its accounting policy in respect of the valuation of inventory from the last-in-first-out method to the first-in-first-out method. This change was necessary to ensure that the company complies with International Financial Reporting Standards . The change in policy was accounted for retrospectively and comparative amounts

40

QUESTION 1 (continued) have been appropriately restated. The effect of this change is as follows: 2010 2009 1/10/2008 R R R Decrease in cost of sales (50 000 48 000); (48 000 40 000)

2 000 8 000

Increase in income tax expenses (2 000 x 28%); (8 000 x 28%)

(560) (2 240)

Increase in profit 1 440 5 760 2010 2009 1/10/2008 R R R Increase in inventory

50 000

48 000

40 000

Increase in current tax liability/SA Revenue Service (50 000 x 28%)

(14 000)

-

-

Increase in deferred tax liability (48 000 x 28%);(40 000 x 28%)

-

(13 440)

(11 200)

Increase in equity 36 000 34 560 28 800 Adjustment to retained earnings at the beginning of 2009 (40 000 x 72%)

28 800

QUESTION 2 1. Correcting journal entry

R R Debit Credit

Provision for warranty costs 44 0001 Warranty Costs 44 000

1[100 000 (400 000 x 6%) (800 000 x 4%)]

FAC3701/102

41


2. Calculation of profit before tax 2011 2010 R R Profit before tax (given) 980 000 890 000 Security services incorrectly allocated (120 000 x );(120 000 x )

(80 000) (40 000)

Provision for warranties 44 000 - [100 000 (6% x 400 000) (4% x 800 000)] Bad debts written off neighbouring warehouse (48 000) - (60 000 x (100 - 20)) Consignment sales (20 000 x x (100 60)) 10 000 - Cost of sales (20 000 x (100 60)) (8 000) - Sales recognised at fair value tyre tubes 80 000 - Cost of sales on wheel alignment machine (given) (70 000) - Sales COD sales (22 000 x 70%) 15 400 - Cost of sales COD Sales (16 000 x 70%) (11 200) - 912 200 850 000

3. Calculation of deferred tax balance at 28 February 2011

Carrying Amount

Tax base


Deferred tax asset/ (liability)@28%

R R R R COD sales 6 600 - 6 600 1 848 Provision for warranties 56 000 - 56 000 15 680 Deferred tax asset 17 528

22 000 x (100% - 70%) (400 000 x 6%) + (800 000 x 4%)

4. STONERIDGE LIMITED NOTES FOR THE YEAR ENDED 28 FEBRUARY 2011. Profit before tax

1. Change in warranty provision Included in profit before tax is a change in accounting estimate that arose from the decision to change the estimates used as a basis for making the provision for warranty costs due to the results of recent quality control surveys. This change in estimate resulted in a decrease in provision for warranty claims created of R44 000. The cumulative effect of this on future periods is unknown.

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QUESTION 2 (continued) 2. Prior year error Correction of security expenses incorrectly accounted for as debtors. The comparative amounts have been appropriately restated. The effect of this error on the results of 2010 is as follows: 2010

R Increase in expenses (120 000 x ) 40 000 Decrease in tax expense (40 000 x 28%) (11 200) Decrease in profit 28 800 Decrease in accounts receivable 120 000 Increase in expenses prepaid (120 000 x ) (80 000) 40 000 Decrease in current tax liability/SARS (40 000 x 28%) (11 200) Decrease in equity 28 800 3. Provision for warranty cost 2011 2010 R R Carrying amount beginning of the year 120 000 80 000 Amount used during the year (90 000) (70 000) Reversal of unused provision (30 000) (10 000) (120 000 - 90 000), ( 80 000 - 70 000) Provision created for the year (6% x 400 000) + (4% x 800 000) 56 000 120 000 Carrying amount end of year 56 000 120 000 A provision of R56 000 has been recognised for the current year for expected warranty costs for tyres sold based on recent quality control surveys. 4. Events after reporting period.

Contracts for capital expenditure/repairs. On 1 April 2011 a contract was concluded with Max Contractors limited to repair damages to a warehouse for R100 000 due to labour unrest. 5. Contingent liability

During the year, the employees trade union of Stoneridge limited instituted a claim of R55 000 for dismissal of its three employees. At year end the lawyers of Stoneridge Limited have indicated that the claim against Stoneridge Limited will probably not succeed. 6. Contingent asset

Stoneridge Limited instituted a claim against Save Security Limited during the financial year of R50 000 for failing to protect the premises of Stoneridge Limited. The companys legal advisors are of the opinion that Stoneridge Limiteds claim will probably succeed.

FAC3701/102

43

6. OCTOBER 2011 - EXAMINATION PAPER WITH SOLUTION


The following information relates to Rainbow Limited, a manufacturer and retailer of paints, for the year ended 28 February 2011: 1. The profit before tax of Rainbow Limited for the year ended 28 February 2011 amounted

to R690 000, according to the draft financial statements compiled by an inexperienced accounting clerk. The revenue of Rainbow Limited for the year ended 28 February 2011 consisted of the following: royalties received amounting to R485 000 (2010: R220 000), cash on delivery sales amounting to R350 000 (2010: R50 000) and credit sales amounting to R250 000 (2010: R40 000). Included in cash on delivery sales above is an amount of R40 000 received on

2 February 2011 from Glow Limited in respect of an order for paints which was only despatched to Glow Limited on 10 March 2011.

Included in credit sales above is an amount of R10 000 owing by Stone Limited to Rainbow Limited. However on 10 April 2011 Stone Limited indicated that they are unable to pay the moneys due as they were placed under liquidation and its creditors will probably only receive 10 cent in the rand as a liquidation dividend.

Included in other income of Rainbow Limited for the year ended 28 February 2011 are dividends received from an unlisted investment amounting to R60 000 (2010: R20 000) and an amount of R12 000 in respect of a profit realised on the sale of Machine Max. Machine Max was originally purchased on 1 March 2008 at a cost of R20 000 and sold on 1 March 2010 for R24 000. The carrying amount and tax base of Machine Max on date of sale amounted to R12 000 and R10 000 respectively.

2. Rainbow Limited purchased all its machinery on 1 March 2008 at a cost of R500 000

(excluding Machine Max) on which date it was estimated that the machinery will have a useful life of 5 years and a Rnil residual value. After the draft financial statements have been prepared, the directors of Rainbow Limited re-estimated the remaining useful life of machinery and determined that their remaining useful life is actually only 2 years as they are already used to their full capacity. The residual value of the machinery remained unchanged at Rnil. On 28 February 2010 the carrying amount and the tax base of the machinery (excluding Machine Max) amounted to R300 000 and R250 000 respectively. This change in the useful life of machinery has not been recorded yet in the draft financial statements of Rainbow Limited for the year ended 28 February 2011. The SA Revenue Service allows a capital allowance on machinery over 4 years according to the straight-line method. No other machinery were purchased or sold during the year except for Machine Max.

3. Included in current liabilities in the statement of financial position of Rainbow Limited at

28 February 2011 is an amount of R20 000 in respect of royalties received for the period from 1 March 2011 to 30 June 2011 for the patent rights of quick dry paint manufactured by Rainbow Limited.

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4. The inexperienced accounting clerk made the following entries for the current year in the current tax due to the SA Revenue Service account in the general ledger of Rainbow Limited:

Dr SA Revenue Service current tax Cr 31/08/2010 30/09/2010

Bank (1st provisional tax payment for 2011) Bank (final payment of assessment for 2010, including R4 000 interest and R6 000 penalties for the late submission of tax return)

50 000

15 000

01/03/2010 Balance (relating to 2010 tax year)

b/d 20 000

28/02/2011 Balance c/d 115 000

28/02/2011 Bank (2nd provisional tax payment for 2011)

70 000

135 000 135 000

01/03/2011 Balance b/d 115 000

No provision for current tax has been made yet in the draft financial statements for the year ended 28 February 2011.

5. The SA Normal tax rate changed from 29% in 2010 to 28% in 2011. 66.6% of all capital gains are taxable. The company provides for deferred tax on all temporary differences according to the statement of financial position approach. There are no other exempt or temporary differences except those mentioned in the question. There is certainty beyond any reasonable doubt, that the company will have sufficient taxable profit in the future against which any deductible temporary differences can be utilised. The deferred tax liability balance on 28 February 2010 amounted to R15 080, which you can assume to be correct.

6. The financial statements of Rainbow Limited for the year ended 28 February 2011 were presented to the board of directors for authorisation for issue on 20 April 2011.

7. Ignore any VAT implications.

8. Assume all amounts to be material.

FAC3701/102

45


REQUIRED:

general fin reporting 2013 exam w solutions

Documents

examination papers

suggested solution

solution question

redeemable preference

minutes capresso limited

tax of capresso limited

r foreign income

warranty costs