F7 Financial Reporting - INT Final Mock December 2010 by KAPLAN Publishing

ACCA FINAL ASSESSMENT

Financial Reporting

December 2010

Time allowed

Reading and planning: 15 minutes

Writing: 3 hours

All FIVE questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.

This question paper must not be removed from the examination hall.

Kaplan Publishing/Kaplan Financial

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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 QUESTIONS

KAPLAN PUBLISHING 3

All FIVE questions are compulsory and MUST be attempted

QUESTION 1

During the year Air, a public listed company acquired share capital in Blade Ltd and Ripsaw Ltd. The financial statements at 31 March 2008 are as follows:

Air Blade Ripsaw $000 $000 $000 Non-current assets PPE 51,250 43,500 47,120Investments 18,750 3,750 – –––––– –––––– –––––– 70,000 47,250 47,120Current assets Inventory 12,380 6,000 9,880Receivables 17,000 10,750 18,000Bank 1,500 4,750 – –––––– –––––– –––––– 30,880 21,500 27,880 –––––– –––––– –––––– 100,880 68,750 75,000 –––––– –––––– ––––––Equity Ordinary $1 shares 25,000 37,500 25,000Share premium 10,000 2,500 –Retained earnings 13,250 10,630 10,000 –––––– –––––– –––––– 48,250 50,630 35,000NCL 8% Loan note 20,000 5,250 15,000Current liabilities Trade payables 20,630 8,620 17,000Bank overdraft – – 5,620Tax payable 12,000 4,250 2,380 –––––– –––––– –––––– 32,630 12,870 25,000 –––––– –––––– –––––– 100,880 68,750 75,000 –––––– –––––– ––––––

The following information is relevant:

(i) Air purchased 30,000,000 shares in Blade on 1 April 2007. The purchase was agreed by way of a share exchange of two shares in Air for every three shares in Blade plus payment of cash at $1 per share purchased, payable in three years from the date of acquisition. The terms of the agreement were such that this cash would only be paid if Blade makes profits of $3 million during that payment period. The directors are not confident that the profit will be made during that time. The cost of capital of Air is 10% and its share price at the acquisition date was $2. The acquisition of Blade has not yet been recorded in the financial statements of Air.


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(ii) On 1 October 2007 Air purchased 7,500,000 shares in Ripsaw paying cash of $2.50 per share on that date. The acquisition of Ripsaw has already been accounted for by Air.

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

Blade Ripsaw $000 $000 Retained earnings – 1 Apr 07 5,000 2,500 Profit for the year 5,630 7,500 ––––– ––––– Retained earnings – 31 Mar 08 10,630 10,000 ––––– –––––

(iv) The current accounts between Air and Blade were reconciled at the year-end with Blade owing Air $650,000.

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

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

Carrying value $000

Fair value $000

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

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

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

(vii) During the year Blade had sold goods to Air at a price of $6 million. These goods had originally cost Blade $4.5 million. During the year Air had sold $5million (at cost to Air) of these goods for $7.5 million.

Required:

(a) Prepare the consolidated statement of financial position of Air as at 31 March 2008. (20 marks)

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

(Total: 25 marks)


KAPLAN PUBLISHING 5

QUESTION 2

Nemesis is a well known company manufacturing thrill rides. During the current economic climate, Nemesis has experienced some difficulties and unfortunately has had to close down its Merry Go Round division.

The company’s trial balance at 31 October 2008 is as follows:

$000 $000 Revenue 216,000 Cost of sales 91,080 Distribution costs 21,180 Administrative expenses 23,760 Investment income 4,680 Investment property 45,000 Interest paid 2,880 Income tax 1,800 PPE NBV at 1 November 2007 210,000 Investments 60,000 Inventories – 31 October 2008 18,000 Trade receivables 22,500 Bank 10,800 Payables 7,200 Deferred tax – 1 November 2007 12,600 8% Loan note 72,000 $1 Ordinary shares 90,000

Retained earnings – 1 November 2007 _______ 100,920 _______

505,200 _______ 505,200 _______

Note 1

Revenue includes cash sales of $12 million for goods sold in October 2008 to Abbeyfax Plc, a bank. The goods are marked up at 25% on cost, Abbeyfax has the option to require Nemesis to repurchase these goods within 3 months of the year end at their original selling price plus a fee of $360,000.

Note 2

Included within PPE is a building with a NBV of $9 million. On 1 November 2007 it was revalued at $12 million. The building had an estimated life of 25 years when it was purchased ten years prior to the revaluation date, this has not changed as a result of the revaluation. The directors of Nemesis wish to incorporate this value in the financial statements for the year ended 31 October 2008.

All other PPE is to be depreciated at 20% per annum on the reducing balance basis. All depreciation is to be charged to cost of sales.


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Note 3

The investments in the trial balance are classed as available for sale. The fair value of the investments at 31 October 2008 is $55,000.

Note 4

On 1 October 2008, Nemesis closed down its Merry Go Round division. The results of the division from 1 November 2007 to the date of closure are included in the above trial balance figures. These results are as follows:

$000 Revenue 9,800 Cost of sales 6,450 Distribution costs 2,040 Admin expenses 1,980

The net assets of the division were sold at a loss of $3.2 million and are currently included within cost of sales.

Note 5

The investment property owned by Nemesis has risen in value during the year by 3%. This rise is to be incorporated into the financial statements. Nemesis uses the fair value model to value investment property, as allowed by IAS 40.

Note 6

The provision for income tax for the year ended 31 October 2008 has been estimated at $23,400,000. For the deferred tax provision, the only temporary differences are accelerated capital allowances. At 31 October, these were $21,600,000. Income tax is charged at 30%.

Required:

Prepare a statement of comprehensive income for the year ended 31 October 2008 for Nemesis along with a statement of changes in equity and a statement of financial position at that date.

(25 marks)


KAPLAN PUBLISHING 7

QUESTION 3

The financial statements of Armstong Plc, a retailer of electronic products, are given below:

Statement of financial position 20X9 20X8 $000 $000 $000 $000 Non-current assets Property, plant & equipment 15,313 13,221 Intangible assets 1,439 1,765 Available for sale investments 791 697 –––––– –––––– 17,543 15,683 Current assets Inventories 10,931 9,480 Receivables 4,429 3,892 Cash at bank and in hand 3,658 7,518 –––––– –––––– 19,018 20,890 –––––– –––––– 36,561 36,573 –––––– –––––– Equity Equity shares of $1 each 450 400 Share premium 1,600 1,500 Retained earnings 8,951 8,824 –––––– –––––– 11,001 10,724 Non-current liabilities 7% Loan notes 6,950 1,500 Obligations under finance leases 993 356 Deferred taxation 234 108 –––––– –––––– 8,177 1,964 Current liabilities Trade payables 14,299 23,162 Overdraft 2,123 – Taxation 300 250 Warranty provision 511 428 Obligations under finance leases 150 45 –––––– –––––– 17,383 23,885 –––––– –––––– 36,561 36,573 –––––– ––––––


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Statement of comprehensive income for the year ended 31 October 20X9

$000 Revenue 83,386 Cost of sales (70,876) –––––– Gross profit 12,510 Operating expenses (10,446) –––––– Profit from operations 2,064 Finance costs (809) –––––– Profit before tax 1,255 Taxation (672) –––––– Profit for the year 583 Other comprehensive income: Gain in available for sale investments 44 –––––– Total comprehensive income for the year 627 ––––––

Statement of changes in equity for the year ended 31 October 20X9

Share capital

Share premium

Retained earnings

Total

$000 $000 $000 $000 Opening balance 400 1,500 8,824 10,724 Comprehensive income for the year 627 627 Dividends paid (500) (500) Issue of shares 50 100 150 –––– ––––– ––––– –––––– Closing balance 450 1,600 8,951 11,001 –––– ––––– ––––– ––––––

Additional information:

(i) An item of plant with a carrying amount of $965,000 was sold at a loss of $50,000 during the year. Depreciation of $2,395,000 was charged (to operating expenses) for property, plant and equipment in the year ended 31 October 20X9.

(ii) New assets were acquired under finance leases in the year. The fair value of these assets at acquisition was $960,000.

(iii) There were no acquisitions or disposals of intangible assets during the year.

(iv) The company acquired additional long term investments in the year and issued new shares at full market value.

(v) Armstrong gives a 12 month warranty on the majority of the products it sells. The amounts shown in current liabilities as warranty provision are an accurate assessment, based on past experience, of the amount of claims likely to be made in respect of warranties outstanding at each year end. Warranty costs are included in cost of sales.


KAPLAN PUBLISHING 9

Required:

(a) Prepare a statement of cash flows for Armstrong plc for the year ended 31 October 20X9 in accordance with IAS 7 Statement of Cash-flows by the indirect method. (15 marks)

(b) The directors of Armstrong plc are looking to grow the business and are hoping to raise a mix of equity and debt to finance this growth. Armstrong’s price earnings ratio at 31 October 20X9 is 4.6 and the industry average is 8.3.

(i) Explain how the price earnings ratio is calculated and what it represents. (2 marks)

(ii) Calculate gearing for 20X9 and 20X8. For the purpose of calculating debt all finance lease obligations should be treated as long-term interest bearing borrowings. (2 marks)

(iii) Briefly comment on Armstrong’s cash flow position and their prospects of raising further long term equity and debt finance. (6 marks)

(Total: 25 marks)

QUESTION 4

(a) The principle of recording the substance of transactions rather than their legal form lies at the heart of the IASB’s Framework for Preparation and Presentation of Financial Statements as well as numerous International Accounting Standards.

Required:

Explain why it is important to record the substance rather than the legal form of transactions and describe features that may indicate that the substance of a transaction is different from its legal form. (5 marks)

(b) (i) On 1 April 2009 Ramsden sold maturing inventory that had a carrying value of $4 million (at cost) to Funders plc, a finance house, for $6.5 million. The fair value of the inventory at 1 April 2009 was considered to be higher than $6.5 million. The inventory will not be ready for sale until 31 March 2013 and will remain on Ramsden’s premises until this date.

The sale contract includes a clause allowing Ramsden to repurchase the inventory at any time up to 31 March 2013 at a price of $6.5 million plus interest at 10% per annum compounded from 1 April 2009.

The proceeds of the sale have been debited to the bank and the sale has been included in Ramsden’s revenue. (5 marks)

(ii) Ramsden raised finance of $20 million on 1 April 2009 by issuing 20 million 8% redeemable preference shares of $1 each at par. They are redeemable at a large premium which gives them an effective finance cost of 12% per annum.

Ramsden has recorded the $20 million cash inflow as equity and has deducted the first year’s dividend of $1.6 million from the retained earnings reserve. (5 marks)


10 KAPLAN PUBLISHING

Required:

Describe how the above arrangements should be reflected in the financial statements of Ramsden Limited for the year ended 31 March 2010, explaining where relevant the difference between the legal form of the transactions and their substance.

Note: the mark allocation is shown against each of the scenarios.

(Total: 15 marks)

QUESTION 5

The IASB’s Framework for the preparation and presentation of financial statements (Framework) stresses that an entity’s financial statements should be reliable.

Required:

Explain what is meant by reliability and discuss how IAS 17 Leases incorporates this qualitative characteristic. (4 marks)

Peri Ltd entered into a lease agreement on 1 October 2009 with Finance Plc to lease a sauce making machine with a market price of $150,000. The machine was modified slightly for Peri Ltd’s use, the cost of which was incorporated into the rentals. Peri Ltd is responsible for insuring the machine over the lease term and will undertake regular maintenance checks.

The lease requires five annual payments of $35,000 payable in advance, commencing on 1 October 2009. Peri Ltd is expected to return the machine at the end of the five year period. This type of lease has an implicit interest rate of 8.36%. The finance assistant is unsure if this is an operating lease or a finance lease.

Required:

Explain to the finance assistant what type of lease the Peri machine would be categorised as according to IAS 17 Leases and prepare extracts of the financial statements for the year ended 31 March 2010. (6 marks)

(Total: 10 marks)

ACCA

Paper F7 (INT)

Financial Reporting

December 2010

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.


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 Air group as at 31 March 2008

$000 $000

Non-current assets

Goodwill (W3) 19,789

Property, plant and equipment (51,250 + 43,500 + 5,000 (land fv adj) + 4,000 (plant fv adj) – 2000 (plant fv dep’n)

101,750

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

3,750

Investment in associate (W6) 19,875 _______

145,164

Current assets

Inventory (12,380 + 6,000 – 250 (W7)) 18,130

Receivables (17,000 + 10,750 – 650 (inter co adj)) 27,100

Bank (1,500 + 4,750) 6,250 ______

51,480 _______

196,644 _______

Equity and liabilities

Equity

Share capital (25,000 + 20,000 (W3)) 45,000

Share premium (10,000 + 20,000 (W3)) 30,000

Group reserves (W5) 14,825

Non-controlling interests (W4) 11,926 _______

101,751

Non-current liabilities

8% Loan note (20,000 + 5,250) 25,250

Deferred cash (22,539 (W3) + 2,254 (W8)) 24,793 ______

50,043

Current liabilities

Trade payables (20,630 + 8,620 – 650 (inter co adj)) 28,600

Taxation (12,000 + 4,250) 16,250 ______

44,850 _______

196,644 _______


4 KAPLAN PUBLISHING

Working paper

(W1) Group structure

(W2) Net assets

@ reporting date

@ acquisition

Post- acquisition

Share capital 37,500 37,500

Share premium 2,500 2,500

Retained earnings 10,630 5,000 5,630

Fair value adj:

Land (13,000 – 8,000) 5,000 5,000

Plant (16,000 – 12,000) 4,000 4,000

Fair vale dep’n: (4,000 / 2yrs) (2,000) (2,000)

PURP (W7) (when sub = seller) (250) ______ ______ (250) _____

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

(W3) Goodwill

Method 1:

$000 $000

Cost of investment

Share exchange (30,000 × 2/3) × $2

40,000

Cr share capital $20,000

Cr share premium $20,000

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

22,539 ______

Cr NCL – deferred cash

62,539

Fair value of NCI 11,250 ______

73,789

Less: net assets at acquisition (54,000)

______

Total goodwill 19,789 ______

*Deferred cash now recognised at acquisition whether probable or not per the update to IFRS 3

Air

Ripsaw

30000 = 80%

37500 7500 = 30%

25000

01/10/07 = 6 months ago

01/04/07

1 year ago


KAPLAN PUBLISHING 5

Method 2:

$000 $000

Cost of investment

Share exchange (30,000 × 2/3) × $2

40,000

Cr share capital $20,000

Cr share premium $20,000

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

22,539 ______


62,539

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

(43,200) ______

Goodwill – parents share 19,339

Fair value of NCI 11,250

For:

20% net assets at acquisition (20% × $54,000 (W2))

(10,800) ______

Goodwill – NCI share 450 ______

Total goodwill 19,789 ______

*Deferred cash now recognised at acquisition whether probable or not per the update to IFRS 3

(W4) Non-controlling interest

Method 1:

$000

Fair value of NCI 11,250

20% Blade post-acq profit (20% × $3,380 (W2)) 676 ______

11,926 ______

Method 2:

$000

20% net assets at reporting date (20% × $57,380 (W2)) 11,476

NCI Share of goodwill 450 ______

11,926 ______


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(W5) Group reserves

$000

100% Air’s retained earnings 13,250

80% Blade post-acq profit (80% × $3,380 (W2)) 2,704

30% Ripsaw post-acq profit (30% × $3,750 (W2)) 1,125

Unwind discount (W8) (2,253) ______

14,825 ______

(W6) Investment in associate

$000

Cost of investment 18,750

30% Ripsaw post-acq profit (30% × $3,750 (W2)) 1,125 ______

19,875 ______

(W7) PURP

$000

Sales 6,000

COS 4,500 ______

Gross profit 1,500 ______

Left in inventory = $6,000 – $5,000 = £1,000

PURP = $1,000 left in inventory × $1,500 / $6,000

= $250

(W8) Unwinding the discount

$22,539 (W3) × 10% = $2,254

Dr Group reserves (W5)


NB: Sub = seller so;

Dr Group reserves (W5) – 80% 200

Dr NCI (W4) – 20% 50

Cr Inventory – 100% 250

Or:

Dr Update (W2) 250

Cr Inventory 250


KAPLAN PUBLISHING 7

(b) IFRS 3 Update

NCI and Goodwill impact

It has long been argued that the traditional (‘old’) method of calculating goodwill only recognises the goodwill acquired by the parent, and is based on the parent’s ownership interest rather than the goodwill controlled by the parent. In other words, any goodwill attributable to the NCI is not recognised.

The standard now allows the acquirer (parent) to measure any non-controlling interest (NCI) in one of two ways:

– at fair value (the ‘new’ method)

– at the NCI’s proportionate share of the acquiree’s (subsidiary’s) identifiable net assets (this is the ‘old’ method).

Under the ‘new’ method NCI are to be measured at their ‘fair value’, rather than at ‘its proportionate share of the (fair value of the) acquiree’s identifiable net assets’. The difference between these two values is, effectively, the NCI share of goodwill which may or may not be proportionate to the parent’s share of goodwill.

The overall impact is that 100% of the goodwill can now be shown in the group non-current assets and that the “real NCI value is also shown).

Contingent consideration

The previous version of IFRS 3 required contingent consideration to be accounted for only if it was probable that it would become payable. The revised standard requires the acquirer to recognise the acquisition date fair value of contingent consideration as part of the consideration for the acquiree.

Acquisition costs

In the previous IFRS 3, directly related acquisition costs such as professional fees (legal, accounting, valuation, etc) could be included as part of the cost of the acquisition. This has now been stopped and such costs must be expensed. The costs of issuing debt or equity are to be accounted for under the rules of IAS 39, Financial Instruments: Recognition and Measurement.


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ANSWER 2

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

$000 Continuing operations Revenue (216,000 – 12,000 – 9,800) 194,200 COS (W3) (112,830) ––––––– Gross profit 81,370 Distribution costs (21,180 – 2,040) (19,140) Administration expenses (23,760 – 1,980) (21,780) ––––––– Profit from operations 40,450 Finance costs Accrued interest Abbeyfax (W1) (360) Loan note interest (72,000 × 8%) (5,760) Investment income (4,680 + 1,350 (W6)) 6,030 ––––––– Profit before tax 40,360 Tax (W7) (15,480) ––––––– Profit for year from continuing operations 24,880 Discontinuing operations Loss on discontinuing operation (W5) (3,870) ––––––– Total profit for the year 21,010 Other comprehensive Income Available for sale financial asset (5,000) Revaluation gain 3,000 ––––––– Total comprehensive income 19,010 –––––––


KAPLAN PUBLISHING 9

Statement of financial position for Nemesis as at 31 October 2008

$000 $000 Non-current assets Property, Plant and Equipment (W9) 172,000 Investments (W2) (60,000 – 5,000) 55,000 Investment Property (W6) 46,350 ––––––– 273,350 Current assets Inventory (18,000 + 9,600) 27,600 Trade receivables 22,500 Bank 10,800 –––––– 60,900 ––––––– 334,250 ––––––– Equity Share capital 90,000 Retained earnings (W4) 116,930 Revaluation (W9) 3,000 ––––––– 209,930 Non-current liabilities 8% Loan note 72,000 Deferred tax (W8) 6,480 –––––– 78,480 Current liabilities Loan from Abbeyfax (W1) 12,000 Accrued interest 360 Tax payable 23,400 Interest payable (5,760 – 2,880) 2,880 Trade payables 7,200 –––––– 45,840 ––––––– 334,250 –––––––



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

Share capital Retained earnings

Revaluation Reserve

Total

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

21,010

21,010

Decrease in investments (W2) (5,000) (5,000) Revaluation gain (W9) 3,000 3,000 –––––– ––––––– ––––– ––––––– Bal at 31/10/08 90,000 116,930 3,000 209,930 –––––– ––––––– ––––– –––––––

Working paper

(W1) Sale and repurchase agreement

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

– Remove sale and treat as loan

Dr Revenue – I/S 12,000

Cr Loan from Abbeyfax – SFP 12,000

– Bring goods back into inventory

Dr Closing inventory – SFP 9,600

Cr Closing inventory – I/S 9,600

– Account for finance cost

Dr Finance costs – I/S 360

Cr Accrued interest – SFP 360

(W2) Investments

$000 Bal at 01/11/07 60,000

Bal at 31/10/08 55,000

______

Decrease in investments 5,000 ______

Sales 12,000 125%

COS 9,600 100%

(12,000/120*100)

Dr Retained earnings

Cr Investments


KAPLAN PUBLISHING 11

(W3) Cost of sales

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

112,830 ______

(W4) Retained earnings

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

116,930 ______

(W5) Discontinued operations

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

Loss in discontinued operations (3,870) ______

(W6) Investment property

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

1,350 ______

(W7) Tax expense

$000 Year end estimate 23,400 Decrease in DT (W8) (6,120) Over provision (1,800) ______

15,480 ______

Dr Investment property – SFP

Cr Investment income – I/S



(W8) Deferred tax

$000 Bal at 01/11/07 12,600 Decrease in DT required 6,120 ______

Bal at 31/10/08 (21,600 × 30%) 6,480 ______

(W9) Property, plant and equipment

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

NBV at 31/10/08

172,000 ______

(W10) Depreciation

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

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

41,000 ______

Dr 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 1,255 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 –––––– 4,918 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 (5,933) Interest paid (809) Tax paid (W1) (496) –––––– Net cash from operating activities (7,238) Cash from investing activities: Proceeds from sale of property (965 – 50) 915 Purchase of plant and equipment (W2) (4,492) Purchase of investments (791 – 697 – 44) (50) –––––– Net cash from investing activities (3,627) 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 13,221 F. lease assets 960 Disposal 965 Cash paid for new assets (bal fig)

4,492 Depreciation 2,395

c/f 15,313 ––––– ––––– 18,673 18,673 ––––– –––––

(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

F7 Financial Reporting - INT Final Mock December 2010 by KAPLAN Publishing

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