acca f7 int final assessment answers j11

ACCA

Paper F7 (INT)

Financial Reporting

June 2011

Final Assessment – Answers

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

ACCA F7 (INT) FINANCIAL REPORTING

2 KAPLAN PUBLISHING

© Kaplan Financial Limited, 2010

The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials.

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.

FINAL ASSESSMENT ANSWERS

KAPLAN PUBLISHING 3

ANSWER 1

(a) Consolidated Statement of Financial Position for Pierre group as at 31 December 2008

Non-current assets $000 $000Goodwill (W3) 14,000

Property, plant and equipment (144,000 + 100,000 + (5,000 + 4,000 – 1,500 fair value adj (W2))

251,500

Investment in Associate (W6) 28,000

Investments (113,000 – 90,000 (W3) – 15,000 (W3))

8,000

––––––– 301,500 Current assets Inventory (40,000 + 32,000 – 5,000 (W7)) 67,000

Receivables (48,800 + 30,000 – 5,000 intra-company receivable) 73,800

Bank (9,000 + 8,000) 17,000

––––––– 157,800 ––––––– 459,300 ––––––– Equity Share capital 100,000

Group reserves (W5) 172,800

Non-controlling interests (W4) 24,500

––––––– 297,300


4 KAPLAN PUBLISHING

Non-current liabilities Loan notes (60,000 + 36,000) 96,000

Contingent consideration 10,000

–––––– 106,000 Current liabilities Trade payables (30,000 + 18,000 – 5,000 inter-co payable) 43,000

Taxation (6,000 + 7,000) 13,000

–––––– 56,000 –––––– 459,300 ––––––

Working paper

(W1) Group structure

Pierre

Simone

56,000 / 70,000 = 80% Alberta

01/10/06 = 2 years ago

25%

01/04/07 = 18 months ago


KAPLAN PUBLISHING 5

(W2) Net assets

@ acq’n @ reporting date

$000 $000

Share capital 70,000 70,000

Retained earnings 30,000 39,000

––––––– ––––––– 100,000 109,000

Fair value adj:

Land (15,000 – 10,000) 5,000 5,000

Plant (44,000 – 40,000) 4,000 4,000

Fair value dep’n: ((4,000 / 4yrs) × 1 ½ years) –

(1,500)

––––––– ––––––– 109,000 116,500 ––––––– ––––––– (W3)

$7,500 (W4 / W5)

post-acq profit


6 KAPLAN PUBLISHING

(W3) Goodwill

$000 Parent holding at fair value – Cash paid – Contingent consideration (at fair value)

90,000

10,000

_______

100,000

NCI value at acquisition

23,000

_______ 123,000

Fair value of net assets at acquisition (W2)

(109,000)

–––––––

Total goodwill 14,000 _______

(W4) Non-controlling interest

$000 NCI value at acquisition 23,000

20% post-acquisition profit (20% × $7,500 (W2))

1,500

______ 24,500

______


KAPLAN PUBLISHING 7

(W5) Group reserves

$000 100% Pierre retained earnings 158,800

80% Simone post-acq profit

(80% × $7,500 (W2))

6,000

25% Alberta post-acq profit

(25% × $56,000 (W2))

14,000

PURP (W7) – Simone (5,000)

PURP (W7) – Alberta

(1,000)

______ 172,800

______

(W6) Investment in Associate

Cost of investment 15,000

25% post-acq profit (25% × $56,000 (W2))

14,000

PURP (W7) – Alberta (1,000)

______ 28,000

______

(W7) PURP

$000

Simone

Left in stock $20,000

($20,000 / 133.3 × 33.3)

5,000

Alberta

Left in stock $16,000

($16,000 / 133.3 × 33.3) = $4,000 × 25%

1,000

Tutorial note: Parent = seller therefore goods remain with associate and as the associate was NOT added in on a line by line basis you cannot remove the goods from inventory!

Parent = seller, therefore:

Dr Group reserves – (W5)

Cr Inventory – CSFP

Parent = seller, therefore:

Dr Group reserves – (W5)

Cr Investment in associate – (W6)


8 KAPLAN PUBLISHING

(b) The difference in accounting treatment for Simone and Alberta is primarily due to the weighting of shares that Pierre holds in these companies.

Simone

Pierre has invested in 80% of the equity share capital of Simone which is likely to give them control over the operating and financial policies of the company. Simone is therefore treated as a subsidiary of Pierre. Consolidated statements are required to be prepared from the date of acquisition reflecting the group as a single economic entity.

Alberta

Pierre has invested in 25% of the equity share capital of Alberta which generally will not give control over the company operating and financial policies. Instead Pierre is generally deemed to have a significant influence over Alberta’s policies. The results of Alberta are not required to be consolidated but instead we equity account in accordance with IAS 28.


KAPLAN PUBLISHING 9

ANSWER 2

Statement of comprehensive income for Nemesis for the year ended 31 October 2008

$000 Continuing operations Revenue (216,000 – 12,000 (W1) – 9,800 (W3)) 194,200

COS (W2) (124,830)

––––––– Gross profit 69,370

Distribution costs (21,180 – 2,040 (W3)) (19,140)

Administration expenses (23,760 – 1,980 (W3)) (21,780)

––––––– Profit from operations 28,450

Finance costs:

Accrued interest Abbeyfax (W1) (360)

Loan note interest (72,000 × 8%) (5,760)

Investment income (4,680 + 1,350 (W4)) 6,030

––––––– Profit before tax 28,360

Tax (W5) (15,480)

––––––– Profit for year from continuing operations 12,880

Discontinuing operations Loss on discontinuing operation (W3) (3,870) ––––––– Total profit for the year 9,010

Other comprehensive Income Revaluation gain (W7) 3,000 ––––––– Total comprehensive income 12,010 –––––––


10 KAPLAN PUBLISHING

Statement of financial position for Nemesis as at 31 October 2008

$000 $000 Non-current assets Property, Plant and Equipment (W7) 220,000

Investment Property (W4) 46,350 ––––––– 266,350 Current assets Inventory (18,000 + 9,600 (W1)) 27,600

Trade receivables 22,500

Bank 10,800

–––––– 60,900 ––––––– 327,250 ––––––– Equity Share capital 90,000 Retained earnings (SOCIE) 109,930 Revaluation (SOCIE) 3,000 ––––––– 202,930 Non-current liabilities 8% Loan note 72,000

Deferred tax (W6) 6,480

–––––– 78,480 Current liabilities Loan from Abbeyfax (W1) 12,000

Accrued interest on sale and repurchase loan (W1) 360

Tax payable 23,400

Loan interest accrual (5,760 (payable) – 2,880 (paid)) 2,880

Trade payables 7,200

–––––– 45,840 ––––––– 327,250 –––––––


KAPLAN PUBLISHING 11

Statement of changes in equity for Nemesis for the year ended 31 October 2008

Share capital Retained earnings

Revaluation Reserve

Total

Bal at 1 November 2007 90,000 100,920 – 190,920

Profit for year (per income statement)

9,010

9,010

Revaluation gain (W7) 3,000 3,000

–––––– ––––––– ––––– ––––––– Bal at 31 October 2008 90,000 109,930 3,000 209,930 –––––– ––––––– ––––– –––––––

Working paper

(W1) Sale and repurchase agreement

“This is not a true sale but a short-term loan received from Abbeyfax, with a finance cost of $360,000”.

– Remove sale and treat as loan

Dr Revenue – I/S 12,000

Cr Loan from Abbeyfax – SFP 12,000

– Bring goods back into inventory

Dr Closing inventory – SFP 9,600

Cr Closing inventory – I/S 9,600

– Account for finance cost

Dr Finance costs – I/S 360

Cr Accrued interest – SFP 360

(W2) Cost of sales

$000 Per TB 91,080

Sale and repurchase (W1) (9,600)

Discontinued operation – COS (6,450)

Discontinued operation – loss on disposal (3,200)

Depreciation (W8) 53,000 ______

124,830 ______

Sales 12,000 125%

COS 9,600 100%

(12,000/120*100)



(W3) Discontinued operations

$000 Revenue 9,800 Cost of sales (6,450) Distribution costs (2,040) Admin expenses (1,980) Loss on disposal (3,200) ______

Loss in discontinued operations (3,870) ______

(W4) Investment property

$000 Bal at 1 November 2007 45,000 Bal at 31 October 2008 (45,000 + 3%)

46,350 ______

1,350 ______

(W5) Tax expense

$000 Year end estimate 23,400 Decrease in DT (W6) (6,120) Over provision (1,800) ______

15,480 ______

(W6) Deferred tax

$000 Bal at 1 November 2007 12,600 Decrease in deferred tax required 6,120 ______

Bal at 31 October 2008 (21,600 × 30%)

6,480 ______

Dr Investment property – SFP

Cr Investment income – I/S



(W7) Property, plant and equipment

$000 Carrying value at 1 November 2007 270,000 Revaluation (12,000 – 9,000) 3,000 Depreciation (W8) (53,000) ______

Carrying value at 31 October 2008

220,000 ______

(W8) Depreciation

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

Other PPE (273,000 – 12,000) × 20% 52,200 ______

53,000 ______

Dr PPE

Cr Revaluation

Dr Dep’n expense

Cr Accumulated dep’n



ANSWER 3

(a) Statement of cash flows for the year ended 31 October 20X9

$000 $000 Cash flows from operating activities: Profit before tax 1,299

Finance costs 809

Depreciation 2,395

Amortisation of intangible assets (1,439– 1,765) 326

Increase in warranty provision (511 – 428) 83

Loss on sale of assets 50

–––––– 4,962

Increase in inventories (10,931 – 9,480) (1,451)

Increase in receivables (4,429 – 3,892) (537)

Decrease in payables (14,299 – 23,162) (8,863)

–––––– Cash generated from operations (5,889)

Interest paid (809)

Tax paid (W1) (496)

–––––– Net cash from operating activities (7,194)

Cash from investing activities: Proceeds from sale of property (965 – 50) 915

Purchase of plant and equipment (W2) (4,586)

–––––– Net cash from investing activities (3,671)



Cash flows from financing activities:

Issue of share capital (450 – 400 + 1,600 – 1,500) 150

Issue of interest bearing borrowings (6,950 – 1,500) 5,450

Repayment of finance leases (W3) (218)

Dividends paid (500)

–––––– Net cash from financing activities 4,882

–––––– Increase in cash and cash equivalents (3,658 – 7,518 + (2,123)) (5,983)

Cash and cash equivalents b/f 7,518

–––––– Cash and cash equivalents c/f (3,658 – 2,123) 1,535

––––––

Workings

(W1) Tax paid

Dr Cr $000 $000 b/f (108 + 250) 358 Income stat charge 672 Cash paid (bal fig) 496 c/f (234 + 300) 534 ––––– ––––– 1,030 1,030 ––––– –––––

(W2) Cash paid to acquire new non-current assets

Dr Cr $000 $000 b/f 13,918 F. lease assets 960 Disposal 965 Cash paid for new assets (bal fig)

4,586 Depreciation 2,395

c/f 16,104 ––––– ––––– 19,464 19,464 ––––– –––––



(W3) Cash paid under a finance lease

Dr Cr $000 $000 b/f (356 + 45) 401 Cash paid (bal fig) 218 New leases 960 c/f (993 + 150) 1,143 ––––– ––––– 1,361 1,361 ––––– –––––

(b) (i) The price earnings ratio is calculated by dividing market value per share by earnings per share. The ratio is a major stock market indicator of performance. A high P/E ratio suggests that there is confidence in the future prospects of the entity and that high growth is to be expected.

(ii) Gearing 20X9

Debt = 6,950 + 993 + 150 = 8,093

Ratio = 8,093 / (8,093 + 11,001) = 42.4% or 8,093 / 11,001 = 73.5%

Gearing 20X8

Debt = 1,500 + 356 + 45 = 1,901

Ratio = 1,901 / (1,901 + 10,724) = 15.1% or 1,901 / 10,724 = 17.7%

(iii) The gearing ratio has risen from a modest 15% in 20X8 to a moderate 42% in 20X9. There has been a significant increase in the level of borrowings and from the statement of cash flows it can be seen that, although some of this has been used for further investment in property, plant and equipment, it has also been used to finance the working capital of the business.

Both inventory and receivables have increased in the year and this, together with a considerable reduction in payables, is the most notable reason for the fall in the company’s cash balance of almost $6 million. The reason for the reduction in payables is not clear however it could be due to a withdrawal of or tightening of credit terms from suppliers.

Given the increase in borrowings this year the company may struggle to attract further debt finance in the near future, particularly given the relatively low interest cover, with profit from operations covering finance cost only 2.6 times (2,064/809).

To improve the gearing ratio, the company could look to raise further equity finance instead. However, its P/E ratio is below average which suggests a lack of confidence in the future prospects of the business. The share issue during the year has raised a premium of $2 (100/50) per share whereas previous issues appear to have raised an average of $3.75 (1,500/400).

Perhaps the company should concentrate on improving its working capital before seeking any further long term finance. It also holds some available for



ANSWER 4

(a) One of the primary characteristics of financial statements is reliability, i.e. they must faithfully represent the transactions and other events that have occurred. It can be possible for the economic substance of a transaction to be different from its strict legal position or ‘form’. Thus financial statements can only give a faithful representation of a company’s performance if the substance of its transactions is reported.

It is worth stressing that there will be very few transactions where their substance is different from their legal form, but for those where it is, they are usually very important. This is because they are material in terms of size or incidence, or because they may be intended to mislead.

Common features which may indicate that the substance of a transaction (or series of connected transactions) is different from its legal form are:

• Where the ownership of an asset does not rest with the party that is expected to experience the risks and reward relating to it (i.e. equivalent to control of the asset)

• Where a transaction is linked with other transactions. It is necessary to assess the substance of the series of connected transactions as a whole.

• The use of options within contracts. It may be that options are either almost certain to be (or not to be) exercised. In such cases these are not really options at all and should be ignored in determining commercial substance.

• Where assets are sold at values that differ from their fair values (either above or below).

Many complex transactions often contain several of the above features. Determining the true substance of transactions can be a difficult and sometimes subjective procedure.

(b) (i) Although this transaction has been treated as a sale, this is probably not its substance. The clause allowing Ramsden to repurchase the inventory makes this a sale and repurchase agreement. Assuming Ramsden acts rationally it will repurchase the inventory if its retail value at 31 March 2012 is more than $9,516,650 ($6.5 million plus compound interest at 10% for four years).

There is no indication in the question as to what the inventory is likely to be worth on 31 March 2012, however it is unlikely that a finance company will really want to acquire this inventory (it is not its normal line of business) and thus it would not have entered into the contract unless it believed Ramsden would repurchase the inventory.

If the above is correct the substance of the transaction is that of a secured loan rather than a sale. The required adjustments would therefore be:

• Remove $6.5 million from sales (debit) and treat this as a long term (4 year) loan

• Remove $4 million from cost of sales and treat this as inventory

• Accrued interest of $650,000 ($6.5 million x 10%) should be charged to the income statement and added to the carrying value of the loan.



(ii) Ramsden have treated the preference shares as equity however this is inappropriate. In substance, the preference shares have the characteristics of debt, as they are repayable and carry a fixed rate of return over the period up to redemption.

The preference shares should therefore be treated as a liability in the statement of financial position and a finance cost should be recognised, using the amortised cost method, based on the effective rate of 12%. This is in accordance with IASs 32 and 39.

In the year ended 31 March 2010 a finance cost of $2.4 million should be expensed and the closing balance on the preference share liability at the year end should be $20.8 million (= $20 million opening balance plus $2.4 million finance cost less $1.6 million cash paid).

i.e.

Year b/fwd Int – 12% Paid – 8% c/fwd

1 20,000 2,400 1,600 20,800

The adjustments required are therefore as follows:

• Record $20.8 million as a liability (credit)

• Reduce equity by $18.4 million – representing the $20 million balance recorded less the dividend deducted of $1.6 million (debit)

• Reduce profit (increase finance costs) by $2.4 million reflecting the finance cost (debit)



ANSWER 5

(a) In order to be useful, information must be reliable and the two main components of reliability are freedom from material error and faithful representation. The Framework describes faithful representation as where the financial statements (or other information) have the characteristic that they faithfully represent the transactions and other events that have occurred. Thus a statement of financial position should faithfully represent transactions that result in assets, liabilities and equity of an entity. Some would refer to this as showing a true and fair view.

An essential element of faithful representation is the application of the concept of substance over form. IAS 17 Leases applies the concept of substance over form to assets that a company may use, but not legally own. A finance lease is a lease that substantially transfers the risks and rewards of ownership of an asset to the lessee. Even though the lessee does not legally own the asset, if it controls it and then retains the risks and rewards of ownership the asset and liability should be recognised in the lessee’s financial statements. This is so the commercial reality (purchase an asset with finance from the leasing company) of the transaction can be shown rather than its legal form.

(b) The lease should be categorised as a finance lease in accordance with IAS 17 Leases as the risks and rewards associated with the ownership of an asset have been passed to the lessee (i.e. Peri pays to insure, repair & maintain the asset and gets to use it for its useful economic life). In addition, the lease has been modified for Peri’s use which makes it more difficult for the leasing company to sell/re-lease the asset

Income statement extract

$ Depreciation expense (W2) 15,000 Finance costs (W3) 4,807

Statement of financial position extract

$ Non-current assets Cost (W1) 150,000 Accumulated depreciation (W2) (15,000) –––––– 135,000 Non-current liabilities Obligations under a finance lease(W3) 89,614 Current liabilities Accrued interest (W3) 4,807 Obligations under a finance lease (W3) (119,807 – 89,614 – 4,807)

25,386



Workings

(W1) Recognise lease asset and liability at inception

Dr Non-current asset cost a/c $150,000

Cr Finance lease obligation $150,000

(W2) Depreciation

Dr Depreciation expense $15,000

Cr Accumulated depreciation $15,000

(150,000/5 × 6/12)

(W3) Finance lease liability – amortised cost

Year b/fwd Rental Interest 8.36% (6/12)

c/fwd 31/03/10

Interest 8.36% (6/12)

c/fwd 30/09/10

1 150,000 (35,000) 4,807 119,807 4,807 124,614

2 124,614 (35,000) 89,614

acca f7 int final assessment answers j11

Documents

final assessment answers

equity share capital

faithfully represent

working capital

financial statements

financial position

acca f7

kaplan publishing