KC-01 Practice Revision Kit

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C A S R I L A N K A C U R R I C U L U M 2 0 1 5

P R A C T I C E & R E V I S I O N K I T

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ii

First edition 2015

ISBN 9781 4727 1065 9

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the

British Library

Published by

BPP Learning Media Ltd

BPP House, Aldine Place

142-144 Uxbridge Road

London W12 8AA

www.bpp.com/learningmedia

The copyright in this publication is owned by

BPP Learning Media Ltd.

All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system or transmitted in

any form or by any means, electronic, mechanical,

photocopying, recording or otherwise, without the prior

written permission of the copyright holder.

The contents of this book are intended as a guide and not

professional advice and every effort has been made to

ensure that the contents of this book are correct at the time

of going to press by CA Sri Lanka, BPP Learning Media, the

Editor and the Author.

Every effort has been made to contact the copyright holders

of any material reproduced within this publication. If any

have been inadvertently overlooked, CA Sri Lanka and BPP

Learning Media will be pleased to make the appropriate

credits in any subsequent reprints or editions.

We are grateful to CA Sri Lanka for permission to reproduce

the Learning Outcomes and past examination questions, thecopyright of which is owned by CA Sri Lanka, and to the

Association of Chartered Certified Accountants for use of

past examination questions in which the Association holds

the copyright

©

BPP Learning Media Ltd

2015



Contents

iii

Contents

Page

Question Index iv

Introduction vi

How to use this Practice & Revision Kit vii

Exam techniques ix

Action verbs xi

Questions 3

Answers 69Mock exam 189



KC1 Corporate Financial Reportingiv

Question index

PageTitle

Marks

allocated

Timeallocated

(Minutes) Question Answer

Part A: Interpretation and Application of Sri Lanka Accounting Standards

1 Accounting queries 25 45 3 69

2 Prochain 25 45 4 73

3 Panel 25 45 6 76

4 Ambush 25 45 8 80

5 Engina 25 45 9 84

6 Masham 25 45 11 86

Part B: Preparation and Presentation of Consolidated Financial Statements

7 Glove 25 45 14 91

8 Angel 25 45 16 96

9 Ejoy 25 45 17 102

10 Memo 25 45 19 108

11 Swing 25 45 22 115

Part C: Analysis, Interpretations and Communication of Financial Results

12 Ghorse 25 45 24 117

13 Commonsizing 25 45 26 121

Part D: Corporate Governance and Recent Developments in Financial

Reporting

14 Calcula 25 45 28 125

15 Glowball 25 45 29 129



Question Indexv

Page

TitleMarks

allocated

Time

allocated

(Minutes) Question Answer

Part E: Case study questions covering multiple syllabus areas

16 Johan 50 90 31 133

17 Carpart 50 90 35 138

18 Mica 41 74 39 145

19 Robby 50 90 43 152

20 Ashanti 50 90 49 161

21 Rose 50 90 54 171

22 Warrburt 50 90 58 180



KC1 Corporate Financial Reportingvi

Introduction

Welcome to this first edition Practice & Revision Kit for the Institute of Chartered

Accountants of Sri Lanka professional examinations for curriculum 2015.

One of the key criteria for achieving exam success is question practice. There is

generally a direct correlation between candidates who revise all topics and practise

exam questions and those who are successful in their real exams. This Practice &

Revision Kit gives you ample opportunity for such practice in the run up to your

exams.

The Practice & Revision Kit is structured to follow the modules of the Study Text, and

comprises banks of non-complex mini scenario and functional scenario questions as

appropriate. Suggested solutions to all questions are supplied.

We welcome your feedback. If you have any comments about this Practice &

Revision Kit, or would like to suggest areas for improvement, please e-mail

[email protected].

Good luck in your exams!

BPP LEARNING MEDIA



How to use this Practice & Revision Kitvii

How to use this Practice & Revision Kit

This Practice & Revision Kit comprises banks of practice questions of the style that

you will encounter in your exam. It is the ideal tool to use during the revision phase of

your studies.

Questions in your exam may test any part of the syllabus so you must revise the

whole syllabus. Selective revision will limit the number of questions you can answer

and hence reduce your chances of passing. It is better to go into the exam knowing a

reasonable amount about most of the syllabus rather than concentrating on a few

topics to the exclusion of the rest. You should at all costs avoid falling into the trap of

question spotting, that is trying to predict what are likely to be popular areas for

questions, and restricting your revision and question practice to those.

Practising as many exam-style questions as possible will be the key to passing this

exam. You must do questions under timed conditions and ensure you write full

answers to the discussion parts as well as doing the calculations.

Planning your revision

When you begin your course you should make a plan of how you will manage your

studies, taking into account the volume of work that you need to do and your other

commitments, both work and domestic.

In this time, you should go through your notes to ensure that you are happy with allareas of the syllabus and practise as many questions as you can. You can do this in

different ways, for example:

Revise the subject matter a module at a time and then attempt the questions

relating to that module; or

Revise all the modules and then build an exam out of the questions in this

Practice & Revision Kit.

Using the practice questions

The best approach is to select a question and then allocate to it the time that you

would have in the real exam. All the questions in this Practice & Revision Kit have

mark allocations, so you can calculate the amount of time that you should spend on

the question.

Using the suggested solutions

Avoid looking at the answer until you have finished a question. It can be very

tempting to do so, but unless you give the question a proper attempt under exam

conditions you will not know how you would have coped with it in the real exam

scenario.



KC1 Corporate Financial Reportingviii

When you do look at the answer, compare it with your own and give some thought to

why your answer was different, if it was.

If you did not reach the correct answer make sure that you work through the

explanation or workings provided, to see where you went wrong. If you think that

you do not understand the principle involved, go back to your own notes or your

study materials and work through and revise the point again, to ensure that you will

understand it if it occurs in the exam.

Our suggested solutions are comprehensive, but in some discursive questions it may

be that you have made points that are not included in the suggested solution that are

equally valid. In the real exams you should be given credit for such points.



Exam techniquesix

Exam techniques

Using the right technique in the real exam can make all the difference between

success and failure.

Here are a few pointers:

1. During the 20 minute reading time at the start, read through the questions and

decide in what order you are going to attempt the exam. You have to write

your answers in the order set out in the question and answer booklet, but you

can attempt the questions in any order that you like.

Some candidates like to attempt the easiest questions first, on the basis that will

enable them to gain the easiest available marks quickly, and build up their

confidence.

If you select a question on a topic area about which you feel confident, and do

that first, you will build up your confidence right at the start, which will help to

calm you if you are nervous and set the tone for the rest of the exam. You should

decide what approach is best for you.

2. Having established the order that you are going to do the exam, allocate the

time available to the questions and work out at what time you will need to

stop working on one question and move on to the next. When you reach the end

of the allocated time for the question that you are working on, STOP. It is mucheasier to gain the straight forward marks for the next question than to spend a

long time working on the previous question in the hope of gaining one or two

final marks.

3. Read the question. Read it carefully once, and then read it again to ensure that

you have picked everything up. Make sure that you understand what the

question wants you to do, rather than what you might like the question to be

asking you.

4. Answer all parts of the question. Even if you cannot do all of the calculationelements, you will still be able to gain marks in the discussion parts.

5. Don’t worry if you think that you have made a mistake in a computational part

of a question. You will not earn the mark for that particular part, but you will

still be able to gain credit for correct application in the later parts of the

question, even if you are using the wrong figure.

6. When starting to read a question, especially a long case study, read the

requirement first . You will then find yourself considering the requirement as



KC1 Corporate Financial Reportingx

you read the data in the scenario, helping you to focus on exactly what you have

to do.

7. Plan your answer before you start to write your response, especially for longer

case studies. This will help you to focus on the requirements of the question and

to avoid irrelevance.

8. Try to make sure that your answer relates to the specifics of the question

itself. If you are asked to consider the impact of the scenario on someone named

in the question, make sure that you do that, so your answer is as relevant as

possible.

9. If you finish the exam with time to spare, use the rest of the time to review your

answers and to make sure that you answered every requirement for every

question.



Action verbsxi

Action verbs checklist

Knowledge Process Verb List Verb Definitions

Define Describe exactly the nature, scope or meaning

Draw Produce (a picture or diagram)

Identify Recognise, establish or select after

consideration

List Write the connected items one below the other

Relate To establish logical or causal connections

Tier – 1 Remember

Recall important

information

State Express something definitely or clearly

Calculate/Compute Make a mathematical computation

Discuss Examine in detail by argument showing

different aspects, for the purpose of arriving at

a conclusion

Explain Make a clear description in detail revealing

relevant facts

Interpret Present in understandable terms or to translate

Recognise To show validity or otherwise, using knowledge

or contextual experience

Record Enter relevant entries in detail

Tier – 2 Comprehension

Explain important

information

Summarise Give a brief statement of the main points (in

facts or figures)



KC1 Corporate Financial Reportingxii


Apply Put to practical use

Assess Determine the value, nature, ability or quality

Demonstrate Prove, especially with examples

Graph Represent by means of a graph

Prepare Make ready for a particular purpose

Prioritise Arrange or do in order of importance

Reconcile Make consistent with another

Tier – 3 Application

Use knowledge in a setting

other than the one in which

it was learned/solve close-

ended problems

Solve To find a solution through calculations and/or

explanations

Analyse Examine in detail in order to determine the

solution or outcome

Compare Examine for the purpose of discoveringsimilarities

Contrast Examine in order to show unlikeness or

differences

Differentiate Constitute a difference that distinguishes

something

Tier – 4 Analysis

Draw relations among ideas

and to compare andcontrast/solve open-ended

problems

Outline Make a summary of significant features



Action verbsxiii


Advise Offer suggestions about the best course of

action in a manner suited to the recipient

Convince To persuade others to believe something using

evidence and/or argument

Criticise Form and express a judgment

Evaluate To determine the significance by careful

appraisal

Recommend A suggestion or proposal as to the best course

of action

Resolve Settle or find a solution to a problem or

contentious matter

Tier – 5 Evaluate

Formation of judgments and

decisions about the value of

methods, ideas, people or

products

Validate Check or prove the accuracy

Compile Produce by assembling information collectedfrom various sources

Design Devise the form or structure according to a plan

Develop To disclose, discover, perfect or unfold a plan or

idea

Tier – 6 Synthesis

Solve unfamiliar problems

by combining different

aspects to form a unique or

novel solution

Propose To form or declare a plan or intention for

consideration or adoption



KC1 | Corporate Financial Reporting

KC1 Corporate Financial Reportingxiv






2 CA Sri Lanka



KC1 | Practice Questions

CA Sri Lanka 3

PART A: INTERPRETATION AND APPLICATION OF SRI LANKA ACCOUNTING

STANDARDS

Questions 1 to 6 cover Interpretation and Application of Sri Lanka Accounting

Standards.

1 Accounting queries

You are a manager with a medium-sized firm of accountants. You have been asked

to assist some of your clients with their accounting queries.

(1) Penn Co has a defined benefit pension plan and wishes to recognise the full

deficit in its statement of financial position.

The opening plan assets were Rs 3.6 Mn on 1 January 20X9 and plan

liabilities at this date were Rs 4.3 Mn.Company contributions to the plan during the year amounted to Rs. 550,000.

Pensions paid to former employees amounted to Rs. 330,000 in the year.

The yield on high quality corporate bonds at 31 December 20X9 was 8% and

the actual return on plan assets was Rs. 295,000.

During the year, five staff were made redundant, and an extra Rs. 58,000 in

total was added to the value of their pensions.

Current service costs as provided by the actuary are Rs. 275,000.

The actuary valued the plan liabilities at 31 December 20X9 as Rs 4.54 Mn.

Required

Design extracts from the statement of financial position as at 31 December

20X9 and the statement of comprehensive income for the year ended 31

December 20X9 to illustrate the relevant presentation and disclosures for

this plan. Ignore taxation.

(9 marks)

(2) Sion Co operates a defined benefit pension plan for its employees. Thefollowing details relate to the plan. The present value of the obligation was

Rs. 40m at 1 January 20X8, as was the market value of plan assets.

20X8 20X9

Rs'000 Rs'000

Current service cost 2,500 2,860

Benefits paid out 1,974 2,200

Contributions paid by entity 2,000 2,200

Present value of obligation at end of the year 46,000 40,800

Market value of plan assets at end of the year 43,000 35,680

Yield on corporate bonds at end of year 8% 9%




4 CA Sri Lanka

During 20X8, the benefits available under the plan were improved. The

resulting increase in the present value of the defined benefit obligation was

Rs. 2 million.

On the final day of 20X9, Sion Co divested part of its business and, as part of

the sale agreement, transferred the relevant part of its pension fund to the

buyer. The present value of the defined benefit obligation transferred was

Rs. 11.4 million and the fair value of plan assets transferred was

Rs. 10.8 million. Sion also made a cash payment of Rs. 400,000 to the buyer

in respect of the plan.

Assume that all transactions occur at the end of the year.

Required

Analyse the recognition and measurement of the net defined liability at the

end of 20X8 and 20X9.

(9 marks)

(3) Bed Investment Co entered into a contract on 1 July 20X9 with Em Bank. The

contract consisted of a deposit of a principal amount of Rs. 10 million,

carrying an interest rate of 2.5% per annum and with a maturity date of 30

June 20Y1. Interest will be receivable at maturity together with the principal

and Bed has the intention of holding the investment until this time. In

addition, a further 3% interest per annum will be payable by Em Bank if the

exchange rate of the rupee against the Ruritanian Kroner (RKR) exceeds or is

equal to Rs. 1.15 to RKR 1. Bed's functional currency is the rupee.

Required

Advise how Bed should classify the above investment in the financial

statements for the year ended 31 December 20X9.

(7 marks)

(LO 1.1.1, 1.1.2) (Total = 25 marks)

2 Prochain

Prochain, a public limited company, operates in the fashion industry and has a

financial year-end of 31 May 20X6.

The company sells its products in department stores throughout the world.

Prochain insists on creating its own selling areas within the department stores,

which are called 'model areas'. Prochain is allocated space in the department store

where it can display and market its fashion goods. The company feels that thishelps to promote its merchandise. Prochain pays for all the costs of the 'model




CA Sri Lanka 5

areas' including design, decoration and construction costs. The areas are used for

approximately two years after which the company has to dismantle the 'model

areas'. The costs of dismantling the 'model areas' are normally 20% of the original

construction cost and the elements of the area are worthless when dismantled.

The current accounting practice followed by Prochain is to charge the full cost ofthe 'model areas' against profit or loss in the year when the area is dismantled.

The accumulated cost of the 'model areas' shown in the statement of financial

position at 31 May 20X6 is Rs. 20 million. The company has estimated that the

average age of the 'model areas' is eight months at 31 May 20X6.

(7 marks)

Prochain acquired 100% of a sports goods and clothing manufacturer, Badex, a

private limited company, on 1 June 20X5. Prochain intends to develop its own

brand of sports clothing which it will sell in the department stores. The

shareholders of Badex valued the company at Rs. 125 million based upon profit

forecasts which assumed significant growth in the demand for the 'Badex' brand

name. Prochain had taken a more conservative view of the value of the company

and measured the fair value as being in the region of Rs. 108 million to Rs. 112

million of which Rs. 20 million relates to the brand name 'Badex'. Prochain is only

prepared to pay the full purchase price if profits from the sale of 'Badex' clothing

and sports goods reach the forecast levels. The agreed purchase price was Rs. 100

million plus a further payment of Rs. 25 million in two years, on 31 May 20X7. This

further payment comprises a guaranteed payment of Rs. 10 million with noperformance conditions and a further payment of Rs. 15 million if the actual

profits during this two-year period from the sale of Badex clothing and goods

exceed the forecast profit. The forecast profit on Badex goods and clothing over

the two year period is Rs. 16 million and the actual profits in the year to 31 May

20X6 were Rs. 4 million. Prochain did not feel at any time since acquisition that

the actual profits would meet the forecast profit levels. (8 marks)

After the acquisition of Badex, Prochain started developing its own sports clothing

brand 'Pro'. The expenditure in the period to 31 May 20X6 was as follows:

Period from Expenditure type Rs Mn

1.6.X5 – 31.8.X5 Research as to the extent of the market 3

1.9.X5 – 30.11.X5 Prototype clothing and goods design 4

1.12.X5 – 31.1.X6 Employee costs in refinement of products 2

1.2.X6 – 30.4.X6 Development work undertaken to finalise design of product

5

1.5.X6 – 31.5.X6 Production and launch of products 6

20




6 CA Sri Lanka

The costs of the production and launch of the products include the cost of

upgrading the existing machinery (Rs. 3 million), market research costs (Rs. 2

million) and staff training costs (Rs. 1 million). Currently an intangible asset of

Rs. 20 million is shown in the financial statements for the year ended 31 May

20X6. (6 marks)

Prochain owns a number of prestigious apartments, which it leases to famous

persons who are under a contract of employment to promote its fashion clothing.

The apartments are let at below the market rate. The lease terms are short and are

normally for six months. The leases terminate when the contracts for promoting

the clothing terminate. Prochain wishes to account for the apartments as

investment properties with the difference between the market rate and actual

rental charged to be recognised as an employee benefit expense. (4 marks)

Required

Analyse the information provided in order to recommend how the above items

should be dealt with in the financial statements of Prochain for the year ended 31

May 20X6 under Sri Lanka Financial Reporting Standards. (Assume a discount rate

of 5.5% where necessary and work to the nearest Rs100,000.)

(LO 1.1.3) (Total = 25 marks)

3 Panel

The directors of Panel, a public limited company, are reviewing the procedures for

the calculation of the deferred tax liability for their company. They are quite

surprised at the impact on the liability caused by changes in accounting standards

such as SLFRS 1 First time adoption of International Financial Reporting Standards

and SLFRS 2 Share-based payment . Panel is adopting Sri Lanka Financial Reporting

Standards for the first time as at 31 October 20X5 and the directors are unsure

how the deferred tax provision will be calculated in its financial statements ended

on that date including the opening provision at 1 November 20X3.

Required

(1) Explain how changes in accounting standards are likely to have an impact

on the deferred tax liability under LKAS 12 Income taxes. (5 marks)

(2) Explain the basis for the calculation of the deferred taxation liability on first

time adoption of SLFRS including the provision in the opening SLFRS

statement of financial position. (4 marks)




CA Sri Lanka 7

Additionally the directors wish to know how the provision for deferred

taxation would be calculated in the following situations under LKAS 12

Income taxes:

(i) On 1 November 20X3, the company had granted ten million share

options subject to a two year vesting period. The options had a fairvalue of $40million on the grant date and all are expected to vest. Local

tax law allows a tax deduction at the exercise date of the intrinsic value

of the options. The intrinsic value of the ten million share options at

31 October 20X4 was Rs. 16 million and at 31 October 20X5 was

Rs. 46 million. The increase in the share price in the year to 31 October

20X5 could not be foreseen at 31 October 20X4. The options were

exercised at 31 October 20X5. The directors are unsure how to account

for deferred taxation on this transaction for the years ended

31 October 20X4 and 31 October 20X5.

(ii) Panel is leasing plant under a finance lease over a five-year period. The

asset was recorded at the present value of the minimum lease

payments of Rs. 12 million at the inception of the lease which was

1 November 20X4. The asset is depreciated on a straight-line basis over

the five years and has no residual value. The annual lease payments are

Rs. 3 million payable in arrears on 31 October and the effective interest

rate is 8% per annum. The directors have not leased an asset under a

finance lease before and are unsure as to its treatment for deferredtaxation. The company can claim a tax deduction for the annual rental

payment as the finance lease does not qualify for tax relief.

(iii) A wholly owned subsidiary, Pins, a limited liability company, sold

goods costing Rs. 7 million to Panel on 1 September 20X5, and these

goods had not been sold by Panel before the year end of 31 October

20X5. Panel had paid Rs. 9 million for these goods. The directors do not

understand how this transaction should be dealt with in the financial

statements of the subsidiary and the group for taxation purposes. Pins

pays tax locally at 30%.

(iv) Nails, a limited liability company, is a wholly owned subsidiary of

Panel, and is a cash generating unit in its own right. The value of the

property, plant and equipment of Nails at 31 October 20X5 was

Rs. 6 million and purchased goodwill was Rs. 1 million before any

impairment loss. The company had no other assets or liabilities. An

impairment loss of Rs. 1.8 million had occurred at 31 October 20X5.

The tax base of the property, plant and equipment of Nails was

Rs. 4 million as at 31 October 20X5. The directors wish to know how




8 CA Sri Lanka

the impairment loss will affect the deferred tax liability for the year.

Impairment losses are not an allowable expense for taxation purposes.

(3) Required

Advise, with suitable computations, how the situations (i) to (iv) above will

impact on the accounting for deferred tax under LKAS 12 Income taxes in the

group financial statements of Panel. Assume a tax rate of 30%. (The

situations in (i) to (iv) above carry equal marks.) (16 marks)


4 Ambush

Ambush loaned Rs. 200,000 to Bromwich on 1 December 20X3. The effective and

stated interest rate for this loan was 8%. Interest is payable by Bromwich at theend of each year and the loan is repayable on 30 November 20X7. At 30 November

20X5, the directors of Ambush have heard that Bromwich is in financial difficulties

and is undergoing a financial reorganisation. The directors feel that it is likely that

they will only receive Rs. 100,000 on 30 November 20X7 and no future interest

payment. Interest for the year ended 30 November 20X5 had been received. The

financial year-end of Ambush is 30 November 20X5.

Required

(1) Compare the approaches of LKAS 39 and SLFRS 9 as regards the impairment

of financial assets. (6 marks)

(2) Recommend the accounting treatment under LKAS 39 of the loan to

Bromwich in the financial statements of Ambush for the year ended

30 November 20X5. (4 marks)

The impairment of trade receivables has been calculated using a formulaic

approach, which is based on a specific percentage of the portfolio of trade

receivables. The general provision approach has been used by the company at 30

November 20X5. At 30 November 20X5, one of the credit customers, Tray, has

come to an arrangement with Ambush whereby the amount outstanding of Rs. 4

million from Tray will be paid on 30 November 20X6 together with a penalty of

Rs. 100,000. The total amount of trade receivables outstanding at 30 November

20X5 was Rs. 11 million including the amount owed by Tray. The following is the

analysis of the trade receivables.

Balance Cash expected Due date

Rs Mn Rs Mn

Tray 4 4.1 30 November 20X6

Milk 2 2.0 31 January 20X5

Other receivables 5 4.6 On average 31.1.X5

11 10.7




CA Sri Lanka 9

Ambush has made an allowance of Rs. 520,000 against trade receivables which

represents the difference between the cash expected to be received and the

balance outstanding plus a 2% general allowance. Milk has a similar credit risk to

the 'other receivables'. (Use a discount rate of 5% in any calculations.)

Required

(3) Advise Ambush as to the acceptability of its approach towards the

impairment of trade receivables under LKAS 39, and recommend an

alternative acceptable approach if required. (8 marks)

Ambush is reviewing the accounting treatment of its buildings. The company uses

the revaluation model for its buildings. The buildings had originally cost Rs. 10

million on 1 December 20X3 and had a useful economic life of 20 years. They are

being depreciated on a straight-line basis to a nil residual value. The buildings

were revalued downwards on 30 November 20X4 to Rs. 8 million, which was thebuildings' recoverable amount. At this date the remaining useful life was

unchanged. At 30 November 20X5 the fair value of the buildings had risen to

Rs. 11 million, which is to be included in the financial statements. The company is

unsure how to treat the above events.

Required

(4) Advise the appropriate treatment for Ambush's property resulting from

these changes in value. You should work to the nearest Rs. 10,000.

(7 marks)

(LO 1.1.1, 1.1.2, 1.1.3) (Total = 25 marks)

5 Engina

Engina, a foreign company, has approached a partner in your firm to assist in

obtaining a local Stock Exchange listing for the company. Engina is registered in a

country where transactions between related parties are considered to be normal

but where such transactions are not disclosed. The directors of Engina are

reluctant to disclose the nature of their related party transactions as they feel thatalthough they are a normal feature of business in their part of the world, it could

cause significant problems politically and culturally to disclose such transactions.

The partner in your firm has requested a list of all transactions with parties

connected with the company and the directors of Engina have produced the

following summary:

(a) Every month, Engina sells Rs. 50,000 of goods per month to Mr Satay, the

Finance Director at cost price. The annual turnover of Engina is Rs. 300

million. Additionally Mr Satay has purchased his car from the company for




10 CA Sri Lanka

Rs. 45,000 (market value Rs. 80,000). The director, Mr Satay, earns a salary

of Rs. 500,000 a year, and has a personal fortune of many millions of rupees.

(b) A hotel property had been sold to a brother of Mr Soy, the Managing Director

of Engina, for Rs. 3.5 million (net of selling cost of Rs. 0.2 million). The

market value of the property was Rs. 4.3 million but in the foreign country,

property prices were falling rapidly. The carrying amount of the hotel in the

books of Engina was Rs. 5 million and its value in use was Rs. 3.6 million.

There was an oversupply of hotel accommodation due to government

subsidies in an attempt to encourage hotel development and the tourist

industry.

(c) Mr Satay owns several companies and the structure of the group is as

follows:

Mr Satay

100% ownership 80% ownership

of Car Limited of Wheel Limited

100% ownership

of Engina Limited

Engina earns 60% of its profits from transactions with Car and 40% of its

profits from transactions from Wheel.

Mr Satay's 80% ownership of Wheel Limited is established by his

shareholding of 100% of the Class A voting shares in that company. The

remaining 20% of the company is owned by Exhaust Limited (which is not

related to Mr Satay). Exhaust Limited holds 100% of the Class B voting

shares in Wheel Limited.

Required

(1) Evaluate the information provided and apply the requirements of LKAS 24

to identify whether a related party transaction exists and advise on the

disclosures to be made in respect of related parties in Engina's financial

statements. (20 marks)

(2) During the year, Wheel Ltd paid a dividend to its shareholders. Wheel and

Exhaust agreed that an unwanted property would be transferred from Wheel

to Exhaust in lieu of a Class B share cash dividend, since this was more

advantageous for tax purposes. The property had a carrying amount of

Rs. 450,000 at the date of transfer and a fair value of Rs. 520,000.

Outline the appropriate accounting treatment for this transaction.

(5 marks)

(LO 1.1.1, 1.1.2, 1.1.7) (Total = 25 marks)




CA Sri Lanka 11

6 Masham

Masham is a diversified company that operates in the agricultural and food

produce sectors. It operates a number of tea plantations and dairy farms

throughout Sri Lanka, as well as three food processing plants. The company hasrecently employed a new financial accountant, Richard Perera, who has sent you

the following email in your capacity as a senior working on Masham's external

audit and advisory team.

To: Lucy Da Silva

From: Richard Perera

Date: 21 January 20X3

Subject: Accounting issues

Dear Lucy

I am starting to work on the preparation of the financial statements for Masham

for the year ended 31 December 20X3, and I would like some advice on a number

of matters.

In particular I would like to know how to account for the following issues and the

effect that they will have on the financial statements.

(1) The Finance Director tells me that I must consider the effects of SLFRS 13

when preparing the financial statements and perform a fair value exercise on

certain assets. This is a relatively new standard and one that I didn't study at

college, so I really am a little lost. The assets in question are as follows:

(a) A piece of farm machinery met the criteria to be classified as held for

sale at 31 December 20X3. At that date it had a carrying amount of

Rs. 220,000. The company hasn't yet secured a buyer, however has

identified active markets for the machine in India and Thailand.

Neither of these markets is greater than the other in terms of the

number of sales transactions of similar machines. The market price of

such a machine is Rs. 244,680 in India and Rs. 237,800 in Thailand. Ifthe machine were sold to an Indian buyer, transaction costs would

amount to Rs. 4,600 and transport costs to Rs. 29,300. If the machine

were sold to a Thai buyer, transaction costs would be Rs. 3,900 and

transport costs Rs. 18,660.

(b) The company owns land which it accounts for under the LKAS 16

revaluation model. The land was donated to Masham by a party that

specified it must be used for agricultural purposes. Masham is not

restricted from selling the land but it is not clear whether the usagerestriction would transfer with title. We are trying to clarify this.




12 CA Sri Lanka

Without the restriction, the land could be used for commercial

development and would have a higher market value than it does for the

current use. The owner of the adjacent property has a legal right of way

to access his property via the land – without this right, the land would

be worth approximately 5% more. (10 marks)

(2) The food processing plants are each classified as a cash-generating unit for

the purposes of impairment testing. At 31 December 20X3, the carrying

amount of each plant was:

The goodwill in CGU 1 arose when an 80% stake in a competitor was

acquired. The previous owners retained the other 20% shareholding; this

NCI was measured as a proportion of net assets for the purpose of

acquisition accounting.

The brand is used across all Masham processed food; I've allocated it to CGU

2 on the basis that the carrying amount of that CGU seemed very low.

The Finance Director has asked me to conduct an impairment test as a result

of poor market conditions and has provided me with the following

information:

I'm not quite sure what to do with this information though – I'd appreciate

guidance. (10 marks)

(3) I think I am correct in saying that both tea bushes and dairy cattle are

biological assets and so must be accounted for in accordance with LKAS 41.

That is an accounting standard that I studied at college, although as I have

never used it in practice I am a little rusty. Please could you confirm my

CGU 1

Rs'000

CGU 2

Rs'000

CGU 3

Rs'000

Fair value 45,150 80,000 33,250

Cost of disposal

– legal 250 190 200

– reorganization 100 35 30Value in use 43,950 79,500 33,500

CGU 1

Rs'000

CGU 2

Rs'000

CGU 3

Rs'000

PPE 30,000 46,000 16,000

Goodwill 5,000 - -

Net current assets 16,000 24,000 13,000

Brand 4,500

51,000 74,500 29,000




CA Sri Lanka 13

understanding that biological assets must be remeasured to fair value with

any changes recognised within equity? (5 marks)

Thanks very much – I look forward to hearing from you,

Kind regardsRichard

Required

Prepare notes in response to the financial accountant's email in preparation for a

telephone conversation to discuss the issues.

(LO 1.1.1, 1.1.2) (Total = 25 marks)




14 CA Sri Lanka

PART B: PREPARATION AND PRESENTATION OF CONSOLIDATED FINANCIAL

STATEMENTS

Questions 7 to 11 cover the Preparation and Presentation of Consolidated

Financial Statements.

7 Glove

The following draft statements of financial position relate to Glove, Body and Fit,

all public limited companies, as at 31 May 20X7.

Glove Body Fit Rs Mn Rs Mn Rs Mn

Assets Non-current assets

Property, plant and equipment 260 20 26 Investment in Body 60

Investment in Fit 30

Investments in equity instruments 10

Current assets 65 29 20

Total assets 395 79 46

Stated capital 150 40 20

Other reserves 30 5 8

Retained earnings 135 25 10 Total equity 315 70 38

Non-current liabilities 45 2 3

Current liabilities 35 7 5

Total liabilities 80 9 8

Total equity and liabilities 395 79 46

The following information is relevant to the preparation of the group financial

statements.

(a) Glove acquired 80% of the 40 million ordinary shares of Body on 1 June 20X5

when Body's other reserves were Rs. 4 million and retained earnings were

Rs. 10 million. The fair value of the net assets of Body was Rs. 60 million at

1 June 20X5. Body acquired 70% of the 20 million ordinary shares of Fit on

1 June 20X5 when the other reserves of Fit were Rs. 8 million and retained

earnings were Rs. 6 million. The fair value of the net assets of Fit at that date

was Rs. 39 million. The excess of the fair value over the net assets of Body and

Fit is due to an increase in the value of non-depreciable land of the companies.

There have been no issues of ordinary shares in the group since 1 June 20X5.




CA Sri Lanka 15

(b) Body owns several trade names which are highly regarded in the market

place. Body has invested a significant amount in marketing these trade

names and has expensed the costs. None of the trade names has been

acquired externally and, therefore, the costs have not been capitalised in the

statement of financial position of Body. On the acquisition of Body by Glove,a firm of valuation experts valued the trade names at Rs. 5 million and this

valuation had been taken into account by Glove when offering Rs. 60 million

for the investment in Body. The valuation of the trade names is not included

in the fair value of the net assets of Body above. Group policy is to amortise

intangible assets over ten years.

(c) On 1 June 20X5, Glove introduced a defined benefit retirement plan. During

the year to 31 May 20X7, loss on re-measurement on the defined benefit

obligation was Rs 1 Mn, and gain on re-measurement on the plan assets was

Rs. 900,000. These have not yet been accounted for and need to be treated in

accordance with LKAS 19. The net defined benefit liability is included in non-

current liabilities.

(d) Glove has issued 30,000 convertible loan stock with a three-year term

repayable at par. The loan stock was issued at par with a nominal value of

Rs. 1,000 per bond. Interest is payable annually in arrears at a nominal

interest rate of 6%. Loan stock can be converted after 3 years into 300

shares of Glove. The loan stock was issued on 1 June 20X6 when the market

interest rate for similar debt without the conversion option was 8% per

annum. Glove does not wish to account for the loan stock at fair value

through profit or loss. The interest has been paid and accounted for in the

financial statements. The loan stock has been included in non-current

liabilities at its nominal value of Rs. 30 million.

(e) On 31 May 20X7, Glove acquired plant with a fair value of Rs. 6 million. In

exchange for the plant, the supplier received land, which was currently not

in use, from Glove. The land had a carrying amount of Rs. 4 million and an

fair value of Rs. 7 million. In the financial statements at 31 May 20X7, Glovehad made a transfer of Rs. 4 million from land to plant in respect of this

transaction.

(f) Goodwill has been tested for impairment at 31 May 20X6 and 31 May 20X7

and no impairment loss occurred.

(g) It is the group's policy to measure the non-controlling interest at acquisition

at its proportionate share of the fair value of the subsidiary's identifiable net

assets.

(h) Ignore any taxation effects.




16 CA Sri Lanka

Required

Compile the consolidated statement of financial position of the Glove Group at

31 May 20X7 in accordance with Sri Lanka Financial Reporting Standards (SLFRS).

(LO 2.1.1) (25 marks)

8 Angel

Angel Co bought 70% of the stated capital of Shane Co for Rs. 120,000 on 1

January 20X6. At that date Shane Co's retained earnings stood at Rs. 10,000.

The statements of financial position at 31 December 20X8, summarised

statements of profit or loss and other comprehensive income to that date and

movement on retained earnings are given below.

Angel Co Shane CoRs'000 Rs'000

STATEMENTS OF FINANCIAL POSITION

Non-current assets Property, plant and equipment 200 80

Investment in Shane Co 120 –

320 80

Current assets 890 140

1,210 220

Equity Stated capital 500 100

Retained reserves 400 90

900 190

Current liabilities 310 30

1,210 220

SUMMARISED STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME

Profit before interest and tax 100 20

Income tax expense (40) (8)

Profit for the year 60 12 Other comprehensive income (not reclassified to P/L) ,net of tax

10 6

Total comprehensive income for the year 70 18

MOVEMENT IN RETAINED RESERVES

Balance at 31 December 20X7 330 72

Total comprehensive income for the year 70 18

Balance at 31 December 20X8 400 90




CA Sri Lanka 17

Angel Co sells one half of its holding in Shane Co for Rs. 120,000 on 30 June 20X8.

At that date, the fair value of the 35% holding in Shane was slightly more at

Rs. 130,000 due to a share price rise. The remaining holding is to be dealt with as

an associate. This does not represent a discontinued operation.

No entries have been made in the accounts for the above transaction.

Assume that profits and other comprehensive income accrue evenly throughout

the year.

It is the group's policy to measure the non-controlling interest at acquisition at fair

value. The fair value of the non-controlling interest on 1 January 20X6 was

Rs 51.4 Mn.

Required

Compile the consolidated statement of financial position, statement of profit orloss and other comprehensive income and a reconciliation of movement in

retained reserves for the year ended 31 December 20X8. (Ignore income taxes on

the disposal. No impairment losses have been necessary to date.)

(LO 2.1.1) (25 marks)

9 Ejoy

Ejoy, a public limited company, has acquired two subsidiaries. The details of the

acquisitions are as follows:

Company

Date of

acquisition

Ordinary

share

capital

Reserves

at acq.

Fair value

of net

assets at

acq.

Cost of

investment

% of share

capital

acquired

Rs Mn Rs Mn Rs Mn Rs MnZbay 1.6.X4 200 170 600 520 80Tbay 1 .12.X5 120 80 310 192 60




18 CA Sri Lanka

Any fair value adjustments relate to non-depreciable land. The draft statements of

profit or loss and other comprehensive income for the year ended 31 May 20X6 are:

Ejoy Zbay Tbay

Rs Mn Rs Mn Rs Mn

Revenue 2,500 1,500 800 Cost of sales (1,800) (1,200) (600)

Gross profit 700 300 200

Other income 70 10 –

Distribution costs (130) (120) (70)

Administrative expenses (100) (90) (60)

Finance costs (50) (40) (20)

Profit before tax 490 60 50

Income tax expense (200) (26) (20)

Profit for the year 290 34 30

Other comprehensive for the year

(not reclassified to profit or loss):

Gain on property revaluation net of tax 80 10 8

Total comprehensive income for the year 370 44 38

Total comprehensive income for year 31 .5.X5 190 20 15


statements.

(a) Tbay was acquired exclusively with a view to sale and at 31 May 20X6 meets

the criteria of being a disposal group. The fair value of Tbay at 31 May 20X6

is Rs. 344 million and the estimated selling costs of the shareholding in Tbay

are Rs. 5 million. Selling costs increase proportionately with the level of

shareholding.

(b) Ejoy entered into a joint arrangement with another company on

31 May 20X6, which met the SLFRS 11 definition of a joint venture. The joint

venture is a limited company and Ejoy has contributed assets at fair value of

Rs. 20 million (carrying value Rs. 14 million). Each party will hold fivemillion ordinary shares of Rs. 1 in the joint venture. The gain on the disposal

of the assets (Rs. 6 million) to the joint venture has been included in 'other

income'.

(c) Zbay has a loan asset which was carried at Rs. 60 million at 1 June 20X5. The

loan's effective interest rate is 6%. On 1 June 20X5 the company felt that,

because of the borrower's financial problems, it would receive Rs. 20 million

in approximately two years, on 31 May 20X7. At 31 May 20X6, the company

still expects to receive the same amount on the same date. The loan asset is

held at amortised cost.




CA Sri Lanka 19

(d) On 1 June 20X5, Ejoy purchased a five year bond with a principal amount of

Rs. 50 million and a fixed interest rate of 5% which was the current market

rate. The bond is classified as measured at fair value through profit or loss.

Because of the size of the investment, Ejoy has entered into a floating

interest rate swap. Ejoy has designated the swap as a fair value hedge of thebond. At 31 May 20X6, market interest rates were 6%. As a result, the fair

value of the bond has decreased to Rs. 48.3 million. Ejoy has received Rs. 0.5

million in net interest payments on the swap at 31 May 20X6 and the fair

value hedge has been 100% effective in the period, and you should assume

any gain/loss on the hedge is the same as the loss/gain on the bond. No

entries have been made in the statement of profit or loss and other

comprehensive income to account for the bond or the hedge.

(e) No impairment of the goodwill arising on the acquisition of Zbay had

occurred at 1 June 20X5. The recoverable amount of Zbay was Rs. 630

million and the value in use of Tbay was Rs. 334 million at 31 May 20X6.

Impairment losses on goodwill are charged to cost of sales.

(f) Assume that profits accrue evenly throughout the year and ignore any

taxation effects.

(g) It is the group's policy to measure the non-controlling interest at its

proportionate share of the fair value of the subsidiary's identifiable net

assets.

Required

Compile a consolidated statement of profit or loss and other comprehensive

income for the Ejoy Group for the year ended 31 May 20X6 in accordance with Sri

Lanka Financial Reporting Standards.

(LO 2.1.1) (25 marks)

10 Memo

Memo, a public limited company, owns 75% of the ordinary share capital of

Random, a public limited company which is situated in a foreign country. Memo

acquired Random on 1 May 20X3 for 120 million crowns (CR) when the retained

profits of Random were 80 million crowns. Random has not revalued its assets or

issued any share capital since its acquisition by Memo. The following financial

statements relate to Memo and Random:




20 CA Sri Lanka

STATEMENTS OF FINANCIAL POSITION AT 30 APRIL 20X4

Memo Random

Rs Mn CR Mn

Property, plant and equipment 297 146

Investment in Random 48 – Loan to Random 5 –

Current assets 355 102

705 248

Equity Stated capital 110 52

Retained earnings 360 95

470 147

Non-current liabilities 30 41

Current liabilities 205 60 705 248

STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR

YEAR ENDED 30 APRIL 20X4

Memo Random

Rs. CR Mn Revenue 200 142

Cost of sales (120) (96)

Gross profit 80 46 Distribution and administrative expenses (30) (20)

Profit from operations 50 26

Interest receivable 4 –

Interest payable – (2)

Profit before taxation 54 24

Income tax expense (20) (9)

Profit/total comprehensive income for the year 34 15

The following information is relevant to the preparation of the consolidated

financial statements of Memo.

(a) Goodwill is reviewed for impairment annually. At 30 April 20X4, the

impairment loss on recognised goodwill was CR4.2m.

(b) During the financial year Random has purchased raw materials from Memo

and denominated the purchase in crowns in its financial records. The details

of the transaction are set out below:

Date of transaction Purchase price Profit percentage

Rs Mn on selling price

Raw materials 1 February 20X4 6 20%




CA Sri Lanka 21

At the year end, half of the raw materials purchased were still in the

inventory of Random. The intragroup transactions have not been eliminated

from the financial statements and the goods were recorded by Random at

the exchange rate ruling on 1 February 20X4. A payment of Rs. 6 million was

made to Memo when the exchange rate was 2.2 crowns to Rs. 1. Anyexchange gain or loss arising on the transaction is still held in the current

liabilities of Random.

(c) Memo had made an interest free loan to Random of Rs. 5 million on 1 May

20X3. The loan was repaid on 30 May 20X4. Random had included the loan

in non-current liabilities and had recorded it at the exchange rate at 1 May

20X3.

(d) The fair value of the net assets of Random at the date of acquisition is to be

assumed to be the same as the carrying amount.

(e) The functional currency of Random is the Crown.

(f) The following exchange rates are relevant to the financial statements:

Crowns to Rs.

30 April/1 May 20X3 2.5

1 November 20X3 2.6

1 February 20X4 2.5

30 April 20X4 2.1

Average rate for year to 30 April 20X4 2.5

(g) It is the group's policy to measure the non-controlling interest at acquisition

at its proportionate share of the fair value of the subsidiary's identifiable net

assets.

Required

Compile a consolidated statement of profit or loss and other comprehensive

income for the year ended 30 April 20X4 and a consolidated statement of financial

position at that date in accordance with International Financial Reporting

Standards. (You should round their calculations to the nearest Rs. 100,000.)

(LO2.1.1) (25 marks)




22 CA Sri Lanka

11 Swing

On 1 September 20X5 Swing Co acquired 70% of Slide Co for Rs. 5,000,000

comprising Rs. 1,000,000 cash and 1,500,000 shares of Swing Co.

The statement of financial position of Slide Co at acquisition was as follows:

Rs'000

Property, plant and equipment 2,700

Inventories 1,600

Trade receivables 600

Cash 400

Trade payables (300)

Income tax payable (200)

4,800 The consolidated statement of financial position of Swing Co as at 31 December

20X5 was as follows:

20X5 20X4

Non-current assets Rs'000 Rs'000

Property, plant and equipment 35,500 25,000

Goodwill 1,400 –

36,900 25,000

Current assets

Inventories 16,000 10,000 Trade receivables 9,800 7,500

Cash 2,400 1,500

28,200 19,000

65,100 44,000

Equity attributable to owners of the parent

Stated capital 18,100 12,000

Revaluation surplus 350 –

Retained earnings

32,100

21,900 50,550 33,900

Non-controlling interest 1,750 –

52,300 33,900

Current liabilities Trade payables 7,600 6,100

Income tax payable 5,200 4,000

12,800 10,100

65,100 44,000




CA Sri Lanka 23

The consolidated statement of profit or loss and other comprehensive income of

Swing Co for the year ended 31 December 20X5 was as follows:

20X5

Rs'000

Profit before tax 16,500 Income tax expense (5,200)

Profit for the year 11,300

Other comprehensive income (not reclassified to P/L) Revaluation surplus 500

Total comprehensive income for the year 11,800

Profit attributable to: Owners of the parent 11,100

Non-controlling interest 200

11,300 Total comprehensive income for the year attributable to

Owners of the parent 11,450

Non-controlling interest 200 + (500 × 30%) 350

11,800

Notes:

1 Depreciation charged for the year was Rs. 5,800,000. The group made no

disposals of property, plant and equipment.

2 Dividends paid by Swing Co amounted to Rs. 900,000.

It is the group's policy to measure the non-controlling interest at acquisition at its

proportionate share of the fair value of the subsidiary's identifiable net assets.

Required

Compile the consolidated statement of cash flows of Swing Co for the year ended

31 December 20X5. No notes are required.

(LO 2.1.1) (25 marks)




24 CA Sri Lanka

PART C: ANALYSIS, INTERPRETATIONS AND COMMUNICATION OF

FINANCIAL RESULTS

Questions 12 to 13 cover Analysis, Interpretations and Communication of

Financial Results.

12 Ghorse

Ghorse, a public limited company, operates in the fashion sector and had

undertaken a group re-organisation during the current financial year to 31

October 20X7. As a result the following events occurred.

(a) Ghorse identified two manufacturing units, Cee and Gee, which it had

decided to dispose of in a single transaction. These units comprised non-

current assets only. One of the units, Cee, had been impaired prior to thefinancial year end on 30 September 20X7 and it had been written down to its

recoverable amount of Rs. 35 million. The criteria in SLFRS 5 Non-current

assets held for sale and discontinued operations, for classification as held for

sale had been met for Cee and Gee at 30 September 20X7. The following

information related to the assets of the cash generating units at

30 September 20X7:

Depreciated

historical cost

Fair value less costs to sell

and recoverable amount

Carrying amount

under SLFRS

Rs Mn Rs Mn Rs Mn Cee 50 35 35

Gee 70 90 70

120 125 105

The fair value less costs to sell had risen at 31 October 20X7 to Rs. 40 million

for Cee and Rs. 95 million for Gee. The increase in the fair value less costs of

disposal had not been taken into account by Ghorse. (7 marks)

(b) As a consequence of the re-organisation, and a change in government

legislation, the tax authorities have allowed a revaluation of the non-currentassets of the holding company for tax purposes to fair value at 31 October

20X7. There has been no change in the carrying amounts of the non-current

assets in the financial statements. The tax base and the carrying amounts

after the revaluation are as follows:

Carrying

amount at 31

October 20X7

Tax base at 31

October 20X7 after

revaluation

Tax base at 31

October 20X7 before

revaluation

Rs Mn Rs Mn Rs Mn

Property 50 65 48

Vehicles 30 35 28




CA Sri Lanka 25

Other taxable temporary differences amounted to Rs. 5 million at 31 October

20X7. Assume income tax is paid at 30%. The deferred tax liability at 31

October 20X7 had been calculated using the tax values before revaluation.

(6 marks)

(c) A subsidiary company had purchased computerised equipment for

Rs. 4 million on 31 October 20X6 to improve the manufacturing process. At 31

October 20X7, Ghorse had discovered that the manufacturer of the

computerised equipment was now selling the same system for Rs. 2.5 million.

The projected cash flows from the equipment are:

Cash flows

Rs.

Year ended 31 October

20X8 1.3

20X9 2.2

20Y0 2.3

The residual value of the equipment is assumed to be zero. The company

uses a discount rate of 10%. The directors think that the fair value less costs

to sell the equipment is Rs. 2 million. The directors of Ghorse propose to

write down the non-current asset to the new selling price of Rs. 2.5 million.

The company's policy is to depreciate its computerised equipment by 25%

per annum on the straight-line basis. (5 marks)

(d) The manufacturing property of the group, other than the head office, washeld on an operating lease over eight years. On re-organisation on

31 October 20X7, the lease has been renegotiated and the new term is twelve

years from that date at a rent of Rs. 5 million per annum paid in arrears. The

fair value of the property is Rs. 35 million and its remaining economic life is

thirteen years. The lease relates to buildings rather than land. The factor to

be used for an annuity at 10% for 12 years is 6.8137. (5 marks)

The directors are worried about the impact that the above changes will have

on its key performance indicator which is 'Return on Capital Employed'(ROCE). ROCE is defined as operating profit before interest and tax divided

by share capital, other reserves and retained earnings. Based on the draft

financial statements (before any adjustments are made in respect of the

issued above), the directors have calculated ROCE to be 13.6% (being

Rs. 30 million divided by Rs. 220 million).




26 CA Sri Lanka

Formation of opinion on impact on ROCE. (2 marks)

Required

Advise on an appropriate accounting treatment of the above transactions and

the impact that the resulting adjustments to the financial statements wouldhave on ROCE. Note. Your answer should include appropriate calculations

where necessary and a discussion of the accounting principles involved.


13 Commonsizing

The following are the statements of profit or loss of a company for the years ended

31 December 20X1 and 20X0.

20X1 20X0

Rs'000 Rs'000

Revenue 127,695 109,223

Cost of sales (91,975) (75,936)

Gross profit 35,720 33,287

Distribution costs (3,705) (2,384)

Administrative expenses (16,950) (14,870)

Operating profit 15,065 16,033

Interest payable (2,581) (1,549)

Profit before tax 12,484 14,484

Tax (4,062) (4,436)

Retained profit for the financial year 8,422 10,048

Dividends paid 3,574 3,418

Required

(1) Prepare common size statements for the years ended 31 December 20X1

and 20X0, using total revenue for each year as 100%. (6 marks)

(2) Assess the financial performance of the company as illustrated by the

common size statements, supporting your analysis by any additional

appropriate ratios. (9 marks)

(3) Outline the limitations of using a common size statement approach to the

analysis of a company's performance over a ten-year period. (5 marks)




CA Sri Lanka 27

(4) Criticise the following statements:

(i) The current ratio and the quick ratio help to assess whether a company

is able to meet its debts as they fall due. Therefore the higher these

ratios are the better placed the company is.

(ii) A high gearing ratio is advantageous to shareholders, because they

benefit from the income produced by investing the money borrowed.

(5 marks)





28 CA Sri Lanka

PART D: CORPORATE GOVERNANCE AND RECENT DEVELOPMENTS IN

FINANCIAL REPORTING

Questions 14 to 15 cover Corporate Governance and Recent Developments in

Financial Reporting.

14 Calcula

Asha Alexander has recently been appointed as the CEO of Calcula, a public limited

company. The company develops specialist software for use by accountancy

professionals. The specialist software market is particularly dynamic and fast

changing. It is common for competitors to drop out of the market place. The most

successful companies have been particularly focused on enhancing their offering

to customers through creating innovative products and investing heavily intraining and development for their employees.

Turbulent times

Calcula has been through a turbulent time over the last three years. During this

time there have been significant senior management changes, which resulted in

confusion among shareholders and employees as to the strategic direction of the

company. One investor complained that the annual accounts made it hard to know

where the company was headed.

The last CEO introduced an aggressive cost-cutting programme aimed atimproving profitability. At the beginning of the financial year the annual staff

training and development budget was significantly reduced and has not been

reviewed since the change in management.

Future direction

In response to the confusion surrounding the company's strategic direction, Asha

and the board published a new mission, the primary focus of which centres on

making Calcula the market leader of specialist accountancy software. Asha was

appointed as the CEO having undertaken a similar role at a competitor. The boardwere keen on her appointment as she is renowned in the industry for her

creativity and willingness to introduce 'fresh ideas'. In her previous role Asha

oversaw the introduction of an integrated approach to reporting performance.

This is something she is particularly keen to introduce at Calcula.

During the company's last board meeting, Asha was dismayed by the finance

director's reaction when she proposed introducing integrated reporting at Calcula.

The Finance Director made it clear that he was not convinced of the need for such

a change, arguing that 'all this talk of integrated reporting in the business press is

just a fad, requiring a lot more work, simply to report on things people do not care

about. Shareholders are only interested in the bottom line'.




CA Sri Lanka 29

Required

(1) Advise how integrated reporting may help Calcula to communicate its

strategy and improve the company's strategic performance. Your answer

should make reference to the concerns raised by the finance director.

(11 marks)

(2) Outline the likely implications of introducing 'integrated reporting' which

Calcula should consider before deciding to proceed with its adoption.

(6 marks)

(3) Advise the directors of Calcula as to what should be included in the

company's integrated report, referencing the eight key content elements

required by the <IR> Framework (8 marks)


15 Glowball

The directors of Glowball, a public limited company, have discovered that their

main competitors are applying the 'Global Reporting Initiative' (GRI) "G4"

guidelines and producing sustainability reports alongside their annual reports.

Glowball has a reputation for ensuring the preservation of the environment in its

business activities. It has produced environmental reports in the past and it

wishes to produce a sustainability report for 20X2, but the directors are worriedthat any sustainability report produced by the company may detract from its

image if the report does not comply with recognised standards. They are unsure

of the extra requirements of a sustainability report.

Further the directors have collected information in respect of a series of events

which they consider to be important and worthy of note, but are not sure as to

how they would be incorporated in the sustainability report.

The events are as follows.

(a) Glowball is a company that constructs pipelines and pipes gas from offshore

gas installations to major consumers. The company purchased its main

competitor during the year and found that there were environmental

liabilities arising out of the restoration of many miles of farmland that had

been affected by the laying of a pipeline. There was no legal obligation to

carry out the work but the company felt that there would be a cost of around

Rs. 150 million if the farmland was to be restored.




30 CA Sri Lanka

(b) Most of the offshore gas installations are governed by operating licenses,

which specify limits to the substances that can be discharged to the air and

water. These limits vary according to local legislation and tests are carried

out by the regulatory authorities. During the year the company was

prosecuted for infringements of an environmental law in the USA when toxicgas escaped into the atmosphere. In 20X2 the company was prosecuted five

times and in 20X1 11 times for infringement of the law. The final amount of

the fine/costs to be imposed by the courts has not been determined but is

expected to be around Rs. 5 million. The gas escape occurred over the sea

and it was considered that there was little threat to human life.

(c) The company produced statistics that measure their improvement in the

handling of emissions of gases that may have an impact on the environment.

The statistics deal with:

(i) Measurement of the release of gases with the potential to form acid

rain. The emissions have been reduced by 84% over five years due to

the closure of old plants.

(ii) Measurement of emissions of substances potentially hazardous to

human health. The emissions are down by 51% on 20W8 levels.

(iii) Measurement of emissions to water that removes dissolved oxygen and

substances that may have an adverse effect on aquatic life. Accurate

measurement of these emissions is not possible but the company isplanning to spend Rs. 70 million on research in this area.

(d) The company tries to reduce the environmental impact associated with the

siting and construction of its gas installations. In particular it aims to

minimise the impact on wildlife and human beings. Additionally when the

installations are at the end of their life, they are dismantled rather than sunk

into the sea. The current provision for the decommissioning of these

installations is Rs. 215 million.

You are a consultant with Sustainability Matters Co, and the directors have askedfor your advice on the compilation of their first sustainability report.

(1) Contrast the information that might be contained in an environmental

report with that required in a sustainability report. (4 marks)

(2) Recommend disclosures that might be made by Glowball in its

sustainability report in relation to each of the key areas of performance and

impact. Suggest suitable performance measures in each case. (12 marks)

(3) Advise Glowball how the issues above should be addressed in the

sustainability report. (9 marks)





CA Sri Lanka 31

PART E: CASE STUDY QUESTIONS

Questions 16 to 22 are case study questions, each one covering a variety of

syllabus areas.

16 Johan

Preseen

Johan, a public limited company, operates in the telecommunications industry.

The industry is capital intensive with heavy investment in licences and network

infrastructure.

Operations of Johan

The company is operated through three divisions: the Network Division, the Retail

Division and the Dealer Division.

Network Division

The Network Division of Johan operates telephone networks throughout Sri Lanka

and other South-East Asian countries.

The division operates a number of masts and base stations throughout the

countries in which it operates, and is continually striving to develop its network

and improve coverage in certain areas through the installation of new masts andbase stations.

The process to install a new mast and base station is as follows:

(1) Johan works with external advisers to identify a general location within a

geographical area for a new base station and masts.

(2) After this the company pays third party consultants to identify an exact

location within the general area where signal quality and coverage will be

optimised.

(3) The company then applies for planning permission and negotiates with the

owner of that land in order to achieve access or acquire the land.

Retail Division

The Retail Division of Johan purchases telephone handsets from a manufacturer

and sells them directly to customers together with call credit.

Dealer Division

The Dealer Division of Johan sells handsets to dealers and invoices the dealers for

those handsets. The dealer can return the handset up to the point when a servicecontract in respect of the handset has been signed by a customer. When the




32 CA Sri Lanka

customer signs a service contract, the customer receives the handset free of

charge. Johan allows the dealer a commission on the connection of a customer to

the network. The handset cannot be sold separately by the dealer.

Hash

Johan purchased the whole of the stated capital of Hash on 1 June 20X6. The whole

of the stated capital of Hash was formerly owned by the five directors of Hash.

This acquisition signaled a diversification of the operations of Johan, as Hash

operates in the construction sector. Hash has a number of commercial building

contracts in place and is currently engaged in the construction of an office block in

Columbo and a hotel complex on the west coast of Sri Lanka. Recently completed

projects include a regional airport, a length of motorway and a multi-storey car

park.

The management of Johan intend to start using Hash to build new base stations for

the Network Division in the future.

Employees

Johan values its employees highly and its remuneration packages are structured in

order to retain and reward excellent staff.

Cash salaries are competitive and, bonuses are regularly awarded based on the

performance of the individual and the company as a whole. Staff are also entitled

to medical benefits and receive a holiday allowance in excess of the statutoryminimum. They also benefit from in-house childcare facilities and a heavily

subsidised staff canteen and snack bar.

As extra incentive, Johan also operates share-option schemes whereby employees

are awarded options that vest over a three-year period.

Financial statements

Johan prepares consolidated financial statements to a reporting date of 31 May in

accordance with Sri Lankan Financial Reporting Standards.

Financial performance

Johan's recent performance has been described as 'exceptional' by its directors,

with all divisions reporting strong profits and a healthy financial position. The

company has expanded its network substantially and this has translated into

increased revenue and profits.

The company has also seen an increase in the number of handsets sold through

both its Retail and Dealer Divisions.

Hash has reported a strong growth in profits since its acquisition by Johan andcontinues to expand.




CA Sri Lanka 33

Unseen

Johan's Network Division has carried out a feasibility study during the year to 31

May 20X7 to extend its network. The design and planning department of Johan

identified five possible geographical areas for the extension of its network. The

internal costs of this study were Rs. 150,000 and the external costs were

Rs. 100,000 during the year to 31 May 20X7. Following the feasibility study, Johan

chose a geographical area where it was going to install a base station for the

telephone network. The location of the base station was dependent upon getting

planning permission. A further independent study has been carried out by third

party consultants in an attempt to provide a preferred location in the area. Johan

proposes to build a base station on the recommended site on which planning

permission has been obtained. The third party consultants have charged

Rs. 50,000 for the study. Additionally Johan has paid Rs. 300,000 as a single

payment together with Rs. 60,000 a month to the government of the region for

access to the land upon which the base station will be situated. The contract with

the government is for a period of 12 years and commenced on 1 May 20X7. There

is no right of renewal of the contract and legal title to the land remains with the

government.

Johan's Retail Division purchases telephone handsets from a manufacturer for

Rs. 200 each, and sells the handsets direct to customers for Rs. 150 if they

purchase call credit (call card) in advance on what is called a prepaid phone. The

costs of selling the handset are estimated at Rs. 1 per set. The customers using a

prepaid phone pay Rs. 21 for each call card at the purchase date. Call cards expire

six months from the date of first sale. There is an average unused call credit of

Rs. 3 per card after six months and the card is activated when sold.

The Dealer Division sells handsets (to dealers) for Rs. 150. The dealers act as

agents, selling phone packages, including handsets, on to customers. Johan allows

the dealer a commission of Rs. 280 on the connection of a customer and the

transaction with the dealer is settled net by a payment of Rs. 130 by Johan to the

dealer, being the cost of the handset to the dealer (Rs. 150) deducted from thecommission (Rs. 280). The service contract lasts for a 12 month period. Dealers do

not sell prepaid phones, and Johan receives monthly revenue from the service

contract.

Under the terms of the purchase agreement for Hash, the five directors of Hash

were to receive a total of three million ordinary shares of Johan on 1 June 20X6

(market value Rs. 6 million) and a further 5,000 shares per director on 31 May

20X7, if they were still employed by Johan on that date. All of the directors were

still employed by Johan at 31 May 20X7.




34 CA Sri Lanka

Johan granted and issued fully paid shares to its own employees on 31 May 20X7.

Normally share options issued to employees would vest over a three-year period,

but these shares were given as a bonus because of the company's exceptional

performance over the period. The shares issued had a market value of Rs. 3

million (one million ordinary shares at Rs. 3 per share) on 31 May 20X7 and anaverage fair value of Rs. 2.5 million (one million ordinary shares at Rs. 2.50 per

share) for the year ended 31 May 20X7. It is expected that Johan's share price will

rise to Rs. 6 per share over the next three years.

On 31 May 20X7, Johan purchased property, plant and equipment for its fair value

of Rs. 4 million. The supplier has agreed to accept payment for the property, plant

and equipment either in cash or in shares. The supplier can choose to receive either

1.5 million shares of the company, to be issued in six months, or a cash payment in

three months equivalent to the market value of 1.3 million shares. It is estimated

that the share price will be Rs. 3.50 in three months and Rs. 4 in six months.

Additionally, at 31 May 20X7, one of the directors recently appointed to the board

has been granted the right to choose either 50,000 shares of Johan or receive a

cash payment equal to the current value of 40,000 shares at the settlement date.

This right has been granted because of the performance of the director during the

year and is unconditional at 31 May 20X7. The settlement date is 1 July 20X8 and

the company estimates the fair value of the share alternative is Rs. 2.50 per share

at 31 May 20X7. The share price of Johan at 31 May 20X7 is Rs. 3 per share, and if

the director chooses the share alternative, they must be kept for a period of fouryears.

One of Hash's building contracts was for a regional airport. During the financial year

to 31 May 20X7, a section of an airport collapsed. Luckily the collapse happened in

the early hours of the morning and the airport was closed at the time, meaning that

no-one was hurt. The accident did, however, result in the closure of the airport

terminal. Investigation into the accident and reconstruction of the section of the

airport damaged is still in progress and no legal action has yet been brought in

connection with the accident. The expert report that is to be presented to the civil

courts, in order to determine the cause of the accident and to assess the respective

responsibilities of the various parties involved, is expected in 20X8. The directors of

Hash feel that at present, there is no requirement to record the impact of the

accident in the financial statements. If any compensation is eventually payable to

the airport operator, this is expected to be covered by Hash's insurance policies.

The directors of Hash feel that the conditions for recognising a provision or

disclosing a contingent liability have not been met. Therefore, Hash does not

intend to recognise a provision in respect of the accident nor disclose any related

contingent liability or a note setting out the nature of the accident and potential

claims in its financial statements for the year ended 31 May 20X7.




CA Sri Lanka 35

Required

(1) Analyse the information provided to determine whether the costs of

extending the network may be recognized as property, plant and equipment,

and critically analyse the amounts to be capitalised. (7 marks)

(2) Analyse the information provided so as to determine whether the payments

to the government may be treated as a finance lease. (4 marks)

(3) Advise the basis of measurement of the handsets purchased by the Retail

Division. (2 marks)

(4) Analyse how Johan should recognise revenue on the sale of call cards to

customers and revenue on sales to dealers. (9 marks)

(5) Assess the amounts to be included in Johan's financial statements for the

year ended 31 May 20X7 in respect of share-based payments. (18 marks)

(6) Evaluate the information provided to identify whether a provision needs to

be made in the financial statements of Hash for the year ended 31 May 20X7.

(10 marks)

(LO 1.1.1, 1.1.2) (Total = 50 marks)

17 Carpart

Preseen

Carpart is a public limited company based in Sri Lanka and listed on the Columbo

Stock Exchange. Its core business is twofold:

• It is a vehicle part manufacturer, and

• It sells vehicles purchased from the manufacturer to retail customers.

The business was established 50 years ago, by Luis Karava. He initially bought and

sold spare motor parts. Luis had held an interest in motor vehicles since a young

age, and establishing Carpart joined his hobby with his entrepreneurial spirit. The

business gradually grew and was incorporated. After ten years of trading, Luis

realised that he could improve profitability by manufacturing as well as

distributing motor components. Carpart duly acquired its first factory on the

outskirts of Columbo.

Parts were priced competitively, and soon the company built up a reputation for

providing low cost, quality parts. On the back of this reputation, the company

continued to expand, acquiring a further five factories over the next 40 years. The

company still operates from these properties, all of which are owned rather than

leased. Additional storage facilities are acquired as necessary by way of short-term leases.




36 CA Sri Lanka

Having forged excellent relationships with a number of car manufacturers over

the years, Carpart moved into vehicle sales 15 years ago. The company operates

from four showrooms, all of which are held under lease agreements. Carpart has

agreements with three international car manufacturers to supply their cars to the

general public.

Core operations

Vehicle parts

Carpart makes a number of spare parts that are integral to a motor vehicle. These

include car seats, exhaust pipes, gearboxes and batteries.

The company has a number of supply contracts in place; the biggest are with the

following companies:

• Vehiclex – for the supply of car seats• Autoseat – for the supply of car seats

• Venue – for the supply of exhausts

Carpart also supplies goods to a number of mid-size and small customers. Luis

Karava's son, Mikey, now runs the business and is particularly wary of over-

reliance on a few customers.

The vehicle parts division also distributes vehicle-testing systems for use by car

service centres and garages. The customer base for these products is made up of a

large number of customers.

Vehicle sales

Carpart sells vehicles to final customers on two or four year contracts. The

customer base is broad and there is a high level of repeat business, which

management believes is the result of continually high levels of customer service.

Carpart also holds a number of demonstration vehicles from each manufacturer

that it represents. These allow customers to 'try out' a variety of cars before

deciding on an appropriate make and model. When the demonstration vehicles

are no longer required, they are sold at a reduced price.

The Carpart Group

Since taking over as the Managing Director of Carpart, Mikey Karava has pursued

an aggressive acquisition strategy. This has resulted in the acquisition of

investments in several companies and the diversification of the business.

The Carpart Group now includes (as well as Carpart itself): four subsidiaries, an

investment in an associate and a number of trade investments.

The subsidiaries operate in a variety of business areas, including health clubs andfashion retail. These are areas in which Mikey has a personal interest and that he




CA Sri Lanka 37

felt would complement the core Carpart activities in terms of generation of profits.

There is no intragroup trade due to the disparate nature of the subsidiaries.

The associate company is run by Mikey's wife, Luisa. It operates two health and

beauty salons. This acquisition was made as a result of Luisa's business needing a

capital injection and Carpart having funds to invest.

The trade investments are in a number of stock exchange listed companies, and

are held for capital growth.

Financial reporting

Carpart prepares financial statements in accordance with Sri Lanka Financial

Reporting Standards to a reporting date of 30 April.

Unseen

Details of Carpart's recent operations are as follows:

Contract with Vehiclex

The contract will last for five years and Carpart will manufacture seats to a certain

specification, which will require the construction of machinery for the purpose.

The price of each car seat has been agreed so that it includes an amount to cover

the cost of constructing the machinery but there is no commitment to a minimum

order of seats to guarantee the recovery of the costs of constructing the

machinery. Carpart retains the ownership of the machinery and wishes to

recognise part of the revenue from the contract in its current financial statements

to cover the cost of the machinery that will be constructed over the next year.

Vehicle sales

Carpart sells vehicles on a contract for their market price (approximately

Rs. 20,000 each) at a mark-up of 25% on cost. The expected life of each vehicle is

five years. After four years, the car is repurchased by Carpart at 20% of its original

selling price. This price is expected to be significantly less than its fair value. The

car must be maintained and serviced by the customer in accordance with certain

guidelines and must be in good condition if Carpart is to repurchase the vehicle.

The same vehicles are also sold with an option that can be exercised by the buyer

two years after sale. Under this option, the customer has the right to ask Carpart

to repurchase the vehicle for 70% of its original purchase price. It is thought that

the buyers will exercise the option. At the end of two years, the fair value of the

vehicle is expected to be 55% of the original purchase price. If the option is not

exercised, then the buyer keeps the vehicle.

The two year and four year deals are mutually exclusive.




38 CA Sri Lanka

The vehicles that Carpart uses for demonstration purposes are normally used for

this purpose for an 18-month period. After this period, the vehicles are sold at a

reduced price based upon their condition and mileage.

Venue

Carpart also entered into a contract with Venue to provide exhausts at a value of

Rs. 1 million. The terms are that payment is due one month after the sale of the

goods. On the basis of experience with other customers with similar

characteristics, Carpart considers that there is a 5% risk that the customer will not

pay the amount due after the goods have been delivered and the property

transferred. At the reporting date, Venue had not paid the outstanding amount

and Carpart felt that the maximum amount it would receive from the customer

would be Rs. 0.8 million.

Other sales

Carpart has sold a vehicle testing system to a customer and, because of the current

difficulties in the market, Carpart has agreed to defer receipt of the selling price of

Rs. 2 million until two years after the hardware has been transferred to the

customer.

Carpart has been offering discounts to customers if products were sold with terms

whereby payment was due now but the transfer of the product was made in one

year. A sale has been made under these terms and payment of Rs. 3 million has

been received.

A discount rate of 4% should be used in any calculations.

Required

(1) Analyse the information given and advise the directors of Carpart how they

should account for the contract with Vehiclex. (7 marks)

(2) Analyse the information given so as to determine how revenue should be

recognised on the sale of vehicles. (12 marks)

(3) Analyse the information given and determine any impairment of the amount

outstanding from Venue. (3 marks)

(4) Analyse the other sales made by Carport and explain how revenue should be

recognised with respect to those sales. (6 marks)

Leases

On 1 May 20X4, Carpart entered into a short operating lease agreement with

Elpres to acquire use of another building. The lease will last for three years and is

currently Rs. 5 million per annum. However an inflation adjustment will be made

at the conclusion of leasing years 1 and 2. Currently inflation is 4% per annum.




CA Sri Lanka 39

The following discount factors are relevant (8%).

Single cash flow Annuity

Year 1 0.926 0.926

Year 2 0.857 1.783

Year 3 0.794 2.577

Year 4 0.735 3.312

Year 5 0.681 3.993

Carpart is considering entering into a three-year lease of a machine from Brooke

from 1 May 20X5. The machine has a total economic life of 20 years. The fair value

of the machine at 1 May 20X5 is Rs. 113,600.

The lease payments are Rs. 13,000 per year, and the present value of the lease

payments is Rs. 21,700, calculated using the rate Brooke charges Carpart.

The directors of Carpart have heard about the proposals for revising the

classification of leases but are unsure of the implications of this.

Required

(5) Analyse the subsequent measurement of the lease with Elpres, explaining

how the inflation adjustment should be treated. (3 marks)

(6) Explain the impact on the financial statements of ED/2013/6 on Leases on

the lease with Brooke. (15 marks)

Investments

Carpart has several investments, in subsidiaries, associates and other entities.

Required

(7) Outline the disclosure requirements of SLFRS 12 in relation to such

investments. (4 marks)

(LO 1.1.1, 1.1.2, 1.1.7, 4.2.1) (Total = 50 marks)

18 Mica

Preseen

Background

Mica Industries Limited (Mica) was set up by Andrew Dias and incorporated over

40 years ago, and has subsequently grown both organically and by acquisition to

become a diversified corporation. It has, however, retained its private status and

there are no intentions to obtain a listing for the company. Mica is based in

Columbo and has operations throughout Sri Lanka.




40 CA Sri Lanka

Business operations

Mica's core business was originally property construction, and it still has a strong

presence in this sector. Until recently the company operated only in the

commercial property construction sector, constructing office blocks, retail parks

and hotels to meet customers' specific requirements. In 20X4 the company

appointed a new business strategy consultant in the construction division, and as

a result Mica has, during the year ended 31 December 20X4, begun to develop a

presence in the residential property construction market.

As a natural extension of its commercial property construction operations, and in

response to customer demand, Mica began to offer a property maintenance

service 25 years ago. This proved particularly popular with hotel chains that were

keen to maintain the appearance of their properties in order to attract customers

and gain good reviews from tourist boards. The company now offers maintenanceservice contracts to all of its construction customers when their build is complete,

and has also extended this service to new maintenance-only customers. The

contracts last for 2-5 years and require Mica to attend a property at the request of

the owner in order to perform repairs and maintenance as required. The company

has approximately 120 of these contracts in place.

In 20W2, having constructed a number of hotels for customers, the Board of Mica

took a decision to build a hotel in central Columbo that would be operated by the

company itself. A new hospitality division was developed and an experienced

hotel manager was employed. Unlike many other hotel operators, the company's

focus was on business customers rather than tourists. The hotel proved to be a

success, and as a result a further two hotels were built in Kandy and Jaffna and put

under the control of the hotel manager.

Most recently, within the last 10 years, the Board of Mica has developed an

investment property division. This division owns a number of office blocks and

retail parks built by the construction division, and rents out individual units to

customers under operating leases. As a result, Mica has been able to tap into the

small business market.

Key personnel and ownership

Mica has a main Board with seven executive and three non-executive directors.

The CEO of the company is Luca Dias, the son of the founder Andrew Dias. Luca

Dias also owns, together with his extended family, a majority of shares in the

company. The remainder of the shares are owned by private investors.

Other executive Board members are: Max Boetz, the Managing Director; Ama

Balanchandran, the Finance Director; Tom Amaratunga, the Operations Director




CA Sri Lanka 41

(Construction); Hiruni Amour, the Operations Director (Diversified Operations);

Ravindu Vaduga, the Sales Director; and Lucy Guardia, the HR Director.

Financial reporting

Mica prepares its financial statements to a reporting date of 31 December inaccordance with Sri Lanka Financial Reporting Standards. It does not prepare

interim statements. The company has always prepared some form of commentary

on its social and environmental impact within the annual report, and Ama

Balanchandran is keen to develop this into a full sustainability report.

Capital structure

Mica pays a modest dividend, with most profits retained and reinvested in the

company. In order to fund diversification and expansion plans, the company has

made new issues of shares and obtained bank funding. The company currently has

two concurrent bank loans outstanding, each with restrictive covenants attached

related to liquidity ratios.

Financial health

Mica has been facing difficult trading conditions for the past few years and its

profits fell in 20X2 and again in 20X3. A slight drop is also expected in the current

year, 20X4. This has been attributed in large part to the hospitality division, which

experienced lower than expected occupancy rates. The Board of Mica attributed

this to two factors: the emergence of new competition, with several new

companies focusing solely on the hotel needs of business people; and the structure

of Mica's operations, meaning that the focus of the company remained on the core

construction and property businesses.

Ama Balanchandran believes that these core businesses of Mica will achieve a

healthy increase in profits in 20X5. A number of new construction contracts have

recently been agreed and it is expected that these, together with projected

increased tenancy levels in investment properties, will contribute to improved

financial health for the company.

Unseen

In February 20X4, as a result of continuing poor trading conditions, the hospitality

division was closed down and Mica's business restructured so that only its core

business relating to building and property activities remained.

During the year ended 31 December 20X4 the following occurred:

• On 1 January 20X4 Mica entered into a 5-year contract with Matara

Properties Limited (Matara) to provide a maintenance service for Matara's

portfolio of properties. The fee for the contract was Rs. 1.5m, to be paid in




42 CA Sri Lanka

full on 31 December 20X7. Ama Balachandran wishes to recognise the whole

of this amount in 20X4 as she claims it meets the conditions in LKAS 18.

• In 20X4, Mica purchased some land on which it will build some houses to be

sold to customers "off-plan." These houses will be sold with freehold title

and to a standard design.

The following assets had been used by the hospitality division prior to its closure

and have been retained by Mica:

• Speciality cookery equipment, which had a carrying amount at 31 December

20X4 of Rs. 750,000. This equipment has not been used since the closure of

the hospitality division and at 31 December, Mica was undecided as to

whether to sell it or to lease it to third parties under operating leases. The

fair value less selling costs of the equipment was estimated at Rs. 670,000

and its value in use was estimated at Rs. 710,000.

• Vans with a carrying amount at 31 December 20X4 of Rs. 310,000 were

retained by Mica on closure of the hospitality division for use in the new

maintenance business. The vans were eventually sold at auction in January

20X5 for Rs. 270,000 net of auction costs.

• After the closure of the hospitality division, Mica commenced a pre-sale

renovation of its headquarters in June 20X4. Asbestos was, however,

discovered in August 20X4 and the work to remove the asbestos was not

completed until January 20X5. The carrying amount of the property

(including renovation and removal of asbestos) as at 31 December was

Rs. 6.7m and the property was advertised for sale in February 20X5 at a

price of Rs. 8.3m. Selling costs were estimated at 2%.

Ama Balachandran has stated that she would like to simplify Mica's reporting and

use the Sri Lankan Financial Reporting Standard for Small and Medium Sized

Entities (SFRS for SMEs) as soon as possible. However her son, who is an auditor

with a Big Four accounting firm, has told him that there are strict criteria that

must be applied and that some of Mica's accounting policies may need to change.

Mica's imputed rate of interest according to LKAS 18 is 5%. Income tax is 17%.

Mica's year-end is 31 December 20X4.

Required

(1) Analyse the information provided so as to determine how revenue from the

maintenance contract should be recognised. Your answer should include

calculations of the amounts to be recognised. (15 marks)




CA Sri Lanka 43

(2) Assess how revenue should be recognised for the sale of the off-plan

properties in accordance with the guidance in IFRIC 15 Agreements for the

Construction of Real Estate. (10 marks)

(3) Assess the appropriate classification and measurement of the assets

formerly used by the hospitality business. (11 marks)

(4) Advise Ama Balachandran on whether Mica may adopt SLFRS for SMEs and

outline the differences between the accounting treatments given in SLFRS

for SMEs and full SLFRS in respect of:

• Purchased goodwill

• Owned properties (currently held at valuation)

• Provisions (9 marks)

At the date of the financial statements, 31 December 20X4, Mica's liquidity

position was quite poor, such that the directors described it as 'unsatisfactory' in

the management report. During the first quarter of 20X5, the situation worsened

with the result that Mica was in breach of certain loan covenants at 31 March

20X5. The financial statements were authorised for issue at the end of April 20X5.

The directors' and auditor's reports both emphasised the considerable risk of not

being able to continue as a going concern.

The notes to the financial statements indicated that there was 'ample' compliance

with all loan covenants as at the date of the financial statements. No additional

information about the loan covenants was included in the financial statements.Mica had been close to breaching the loan covenants in respect of free cash flows

and equity ratio requirements at 31 December 20X4.

Ama Balachandran feels that, given the existing information in the financial

statements, any further disclosure would be excessive and confusing to users.

Required

(5) Assess the adequacy of Mica's disclosures about this matter. (5 marks)

(LO 1.1.1, 1.1.2, 1.1.4, 1.1.7) (Total = 50 marks)

19 Robby

Preseen

Background

Robby PLC ('Robby') is a quoted public company listed on the Colombo Stock

Exchange. Robby and its subsidiaries operate in the energy industry, with

interests in the gas industry and the electrical power industry. Operations include

the extraction of natural gas, the manufacture of coal gas, electricity generationand distribution, and sales of both gas and electricity.




44 CA Sri Lanka

The company is viewed as one of the most successful energy companies listed on

the Columbo Stock Exchange and has won a number of awards for best practice in

corporate governance.

Development of Robby Group

On 1 June 20X0, Robby acquired 5% of the ordinary shares of Zinc. Zinc operates

in the electricity sector, and owns a hydroelectricity plant. This minority

shareholding was acquired by Robby with the intention that it would be increased

in due course to be a majority shareholding if the performance of Zinc met certain

defined thresholds. Such an acquisition would meet Robby's objectives to increase

its interests in renewable energy sources and generate power through low-

pollution activities.

The defined performance thresholds were met during 20X2 and the Board of

Robby aggressively pursued a further acquisition of shares in Zinc. A deal was

agreed with the previous owners in the summer of 20X2, and a further 55% of

Zinc was eventually acquired by Robby on 1 December 20X2.

On 1 June 20X1, Robby acquired 80% of the equity interests of Hail for cash

consideration of Rs. 50 million. This acquisition furthered Robby's strategy to

pursue renewable and environmentally friendly energy sources. Hail operates in

the areas of solar and wind energy. It has installed solar panels and wind turbines

at 'sun and wind farms' throughout Sri Lanka, which capture energy from sunlight

and the wind and convert it into electricity. This electricity is then distributedthroughout Sri Lanka via the national power grid.

Robby also has a 40% interest in a joint operation, being a natural gas station. The

construction of the station was completed on 1 June 20X2, and is expected to have

a useful life of 10 years. The other joint operator (owning 60% of the joint

operation) is Fabian PLC ('Fabian'), another Sri Lankan energy provider. Robby

and Fabian have an agreement whereby any decisions about the joint operation

require a 75% majority, and therefore unanimous consent is required. The

contract between the joint operators also states that revenue generated and costs

incurred by the joint operation are receivable and payable by Fabian. Any

amounts outstanding with Robby are settled after the year end.

Financial reporting

Robby PLC prepares consolidated financial statements to 31 May in accordance

with Sri Lanka Financial Reporting Standards. The following is an extract of the

accounting policies section of Robby's financial statements:




CA Sri Lanka 45

2. Accounting policies

2.1 Property, plant and equipment

Land and buildings held for use in the production or supply of goods or

services, or for administrative purposes, are stated in the statement offinancial position at their revalued amounts, being the fair value at the date

of revaluation less any subsequent accumulated depreciation and

subsequent accumulated impairment losses. Revaluations are performed

with sufficient regularity such that the carrying amount does not differ

materially from that which would be determined using fair values at the

reporting date.

2.8 Financial assets

Financial assets are classified into the following specified categories:financial assets at fair value through profit or loss (FVTPL), held to maturity

investments, available for sale (AFS) financial assets and loans and

receivables. The classification depends on the nature and purpose of the

financial assets and is determined at the time of initial recognition.

2.18 Non-controlling interests

Non-controlling interests in the net assets of consolidated subsidiaries are

identified separately from the Group's equity therein. Non-controlling

interests consist of the amount of those interests at the date of the originalbusiness combination and the non-controlling shareholders' share of

changes in equity since the date of the combination. The interest of non-

controlling shareholders in the acquiree is initially measured at fair value.

In line with Robby's strategy to develop renewable and green energy resources,

and in light of historic bad press about the impact of the energy sector, the Board

of Robby have in recent years started publishing a sustainability report alongside

the financial statements in the annual report. The Board are keen to develop the

annual report to become an integrated report in future years, however it does not

intend to implement this intention immediately and instead will wait two to three

years in order to understand and benefit from the experiences of other companies

adopting integrated reporting.

Cash management

Robby does not maintain high cash balances, instead investing spare cash in

projects and acquisitions. As a result the company occasionally finds itself needing

short-term injections of cash.

The Treasury department of Robby has adopted a number of strategies to obtainthese short-term cash injections in the past, including securing bank overdrafts




46 CA Sri Lanka

and short-term bridging loans, factoring receivables balances to banks, and

making sale and leaseback agreements and sale and repurchase agreements.

Unseen

The following draft statements of financial position relate to Robby, Hail and Zinc,all public limited companies, as at 31 May 20X3.

Robby Hail Zinc

Rs Mn Rs Mn Rs Mn

Assets Non-current assets Property, plant and equipment 112 60 26

Investments in subsidiaries: Hail 55

Zinc 19

Financial assets 9 6 14

Joint operation 6



Equity and liabilities Stated capital 25 20 10

Other components of equity 11 – –

Retained earnings 70 27 19

Total equity

106

47

29 Non-current liabilities: 53 20 21




statements of Robby.

(a) Robby has treated the investment in Hail as an available for sale financial

asset.

A dividend received from Hail on 1 January 20X3 of Rs. 2 million hassimilarly been credited to OCI.

The fair value of the non-controlling interest was Rs. 15 million on 1 June

20X1.

On 1 June 20X1, the fair value of the identifiable net assets of Hail was Rs. 60

million and the retained earnings of Hail were Rs. 16 million. The excess of

the fair value of the net assets is due to an increase in the value of non-

depreciable land.

(b) Robby measured the 5% investment in Zinc at fair value through profit orloss in the financial statements to 31 May 20X2.




CA Sri Lanka 47

The consideration for the acquisitions was as follows.

Shareholding Consideration Rs Mn

1 June 20X0 5% 2

1 December 20X2 55% 16 60% 18

At 31 May 20X3 the carrying amount of the investment in Zinc in Robby's

accounts represents the fair value of the initial 5% shareholding at 31 May

20X2 plus the cost of the additional 55% shareholding.

At 1 December 20X2, the fair value of the equity interest in Zinc held by

Robby before the business combination was Rs. 5 million.

The fair value of the non-controlling interest in Zinc was Rs. 9 million on

1 December 20X2.

The fair value of the identifiable net assets at 1 December 20X2 of Zinc was

Rs. 26 million, and the retained earnings were Rs. 15 million. The excess of

the fair value of the net assets is due to an increase in the value of property,

plant and equipment (PPE), which was provisional pending receipt of the

final valuations. These valuations were received on 1 March 20X3 and

resulted in an additional increase of Rs. 3 million in the fair value of PPE at

the date of acquisition. This increase does not affect the fair value of the non-

controlling interest at acquisition. PPE is to be depreciated on the straight-line basis over a remaining period of five years.

(c) The following information relates to the joint arrangement activities with

Fabian:

(i) Assets, liabilities, revenue and costs are apportioned on the basis of

shareholding.

(ii) The natural gas station cost Rs. 15 million to construct and is to be

dismantled at the end of its useful life. The present value of this

dismantling cost to the joint arrangement at 1 June 20X2, using a

discount rate of 5%, was Rs. 2 million.

(ii) In the year, gas with a direct cost of Rs. 16 million was sold for

Rs. 20 million. Additionally, the joint arrangement incurred operating

costs of Rs. 0.5 million during the year.

Robby has only contributed and accounted for its share of the construction

cost, paying Rs. 6 million.

(d) Robby purchased PPE for Rs. 10 million on 1 June 20X0. It has an expecteduseful life of twenty years and is depreciated on the straight-line method. On




48 CA Sri Lanka

31 May 20X2, the PPE was revalued to Rs. 11 million. This was accounted for

in accordance with LKAS 16. At 31 May 20X3, impairment indicators

triggered an impairment review of the PPE. The recoverable amount of the

PPE was Rs. 7.8 million. The only accounting entry posted for the year to 31

May 20X3 was to account for the depreciation based on the revalued amountas at 31 May 20X2. Robby's accounting policy is to make a transfer of the

excess depreciation arising on the revaluation of PPE.

(e) Robby held a portfolio of trade receivables with a carrying amount of

Rs. 4 million at 31 May 20X3. At that date, the entity entered into a factoring

agreement with a bank, whereby it transfers the receivables in exchange for

Rs. 3.6 million in cash. Robby has agreed to reimburse the factor for any

shortfall between the amount collected and Rs. 3.6 million. Once the

receivables have been collected, any amounts above Rs. 3.6 million, less

interest on this amount, will be repaid to Robby. Robby has derecognised the

receivables and charged Rs. 0.4 million as a loss to profit or loss.

(f) Immediately prior to the year end, Robby sold land to a third party at a price

of Rs. 16 million with an option to purchase the land back on 1 July 20X3 for

Rs. 16 million plus a premium of 3%. The market value of the land is Rs. 25

million on 31 May 20X3 and the carrying amount was Rs. 12 million. Robby

accounted for the sale, consequently eliminating the bank overdraft at

31 May 20X3.

Required

(1) Compile a consolidated statement of financial position of the Robby Group

at 31 May 20X3 in accordance with Sri Lanka Financial Reporting Standards.

(35 marks)

In the above scenario (information point (e)), Robby holds a portfolio of trade

receivables and enters into a factoring agreement with a bank, whereby it

transfers the receivables in exchange for cash. Robby additionally agreed to other

terms with the bank as regards any collection shortfall and repayment of any

monies to Robby. Robby derecognised the receivables. This is an example of the

type of complex transaction that can arise out of normal terms of trade.

Required

(2) Advise when financial assets should be derecognised in accordance with

LKAS 39 and apply these rules to the portfolio of trade receivables in

Robby's financial statements. (9 marks)

(3) Assess the legitimacy of Robby selling land just prior to the year end in

order to show a better liquidity position for the group and whether this




CA Sri Lanka 49

transaction is consistent with an accountant's responsibilities to ensure

accurate presentation of financial statements in a given set of circumstances.

(Note. Your answer should include reference to the above scenario.)

(6 marks)

(LO 2.1.1, 2.2.2, 1.1.1, 5.1.1) (Total = 50 marks)

20 Ashanti

Preseen

Background

Ashanti PLC ('Ashanti') is a quoted public company listed on the Colombo Stock

Exchange. Ashanti and its subsidiaries operate in the textiles and apparel

manufacturing industry. This industry employs approximately 15% of Sri Lanka'sworkforce and accounts for approximately half of the country's exports. Within

this market, Ashanti operates at the mid-tier; it is not one of the 'Apparel Giants' of

Sri Lanka, but it has a significant presence.

The company was established 35 years ago by the Bhaskaran family, just as the Sri

Lankan apparel industry began to grow as a result of the country's open economic

policy and trade and investment friendly environment. The Bhaskaran family

developed Ashanti over the next 20 years, establishing a number of factories

throughout the country. From its inception the company had a good reputation fortreating its workforce well, with good working conditions, fair pay, medical

provision and generous holiday allowances.

In its 25th anniversary year, Ashanti shares were listed on the Columbo Stock

Exchange. As a result the company raised funds which allowed it to expand

through acquisition. After the listing, the Bhaskaran family retained a minority

shareholding in Ashanti and continued to manage the company.

Development of Ashanti Group

On 1 May 20X3, Ashanti acquired 70% of the equity interests of Bochem, another

public limited company operating in the textiles and apparel industry. This was a

strategic acquisition allowing Ashanti to move into a growth market, being

children's apparel, whilst also achieving a number of cost-cutting strategies. The

remaining 30% of Bochem was owned by a number of disparate investors, so

allowing Ashanti a dominant influence over the company.

Bochem acquired 80% of the equity interests of Ceram, a public limited company,

on 1 May 20X3. Ceram is an apparel retailer which Bochem had supplied with

goods for many years and the acquisition signalled a diversification of operations

for Bochem and the Ashanti Group. Since the acquisition, it has, however become




50 CA Sri Lanka

apparent that Ceram is not a good strategic fit with the rest of the group, and the

Ashanti Board is considering how best to deal with this issue.

Financial Reporting

Ashanti PLC prepares consolidated financial statements to 30 April in accordance


accounting policies section of Ashanti's financial statements:


2.1 Property, plant and equipment

Land and buildings held for use in the production or supply of goods or

services, or for administrative purposes, are stated in the statement of

financial position at their revalued amounts, being the fair value at the date

of revaluation less any subsequent accumulated depreciation and

subsequent accumulated impairment losses. Revaluations are performed

with sufficient regularity such that the carrying amount does not differ

materially from that which would be determined using fair values at the

reporting date.

As a revaluation surplus is realised, it is transferred to retained earnings.

2.4 Loans and receivables

Trade receivables, loans and other receivables that have fixed or

determinable payments that are not quoted in an active market are classified

as 'loans and receivables'. Loans and receivables are measured at amortised

cost using the effective interest method, less any impairment. Interest

income is recognised by applying the effective interest rate, except for short-

term receivables when the recognition of interest would be immaterial.

2.8 Goodwill

Goodwill represents the excess of the cost of an acquisition (including the

non-controlling interest) over the fair value of the acquiree's identifiable net

assets at the date of acquisition.

Goodwill is tested for impairment at least annually. Any impairment isrecognised immediately in profit or loss. Subsequent reversals of

impairment losses for goodwill are not recognised.


Non-controlling interests consist of the amount of those interests at the date

of the original business combination and the non-controlling shareholders'

share of changes in equity since the date of the combination. The interest of

non-controlling shareholders in the acquiree is initially measured at fair

value in accordance with SLFRS 3. Non-controlling interests are reported

separately from the equity of the owners of the parent.




CA Sri Lanka 51

Social responsibility

Ashanti, together with the rest of the apparel industry of Sri Lanka, has invested

heavily in achieving a conscientious standpoint in apparel production. The

industry's trade association, Sri Lanka Apparel, runs a campaign called Garments

without Guilt which it uses to draw attention to its adherence to ethical

considerations. Sri Lanka is also a signatory to 39 conventions of the International

Labour Organisation, and it outlaws child labour. Sri Lankan law requires that an

employer contributes 3% of an employee's salary to a trust fund which the

employer receives after leaving the company.

These factors, together with Ashanti's generous human resources policies, have

led the Board of Ashanti to consider publishing a sustainability report as part of

the company's annual report.

Unseen

The following financial statements relate to Ashanti:

ASHANTI GROUP: STATEMENTS OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 APRIL 20X5

Ashanti Bochem Ceram Rs Mn Rs Mn Rs Mn

Revenue 810 235 142

Cost of sales (686) (137) (84)

Gross profit 124 98 58

Other income 31 17 12

Distribution costs (30) (21) (26)

Administrative costs (55) (29) (12)

Finance costs (8) (6) (8)

Profit before tax 62 59 24

Income tax expense (21) (23) (10)

Profit for the year 41 36 14

Other comprehensive income for the year,

net of tax –Items that will not be reclassified to

profit or loss:

AFS financial assets 20 9 6

Gains (net) on PPE revaluation 12 6 –

Actuarial losses on defined benefit plan (14) – –

Other comprehensive income for the 18 15 6

year, net of tax

Total comprehensive income 59 51 20




52 CA Sri Lanka

The following information is relevant to the preparation of the group statement of

profit or loss and other comprehensive income:

(i) The purchase consideration for Bochem comprised cash of Rs. 150 million

and the fair value of the identifiable net assets was Rs. 160 million at that

date. The fair value of the non-controlling interest in Bochem was Rs. 54

million on 1 May 20X3. The share capital and retained earnings of Bochem

were Rs. 55 million and Rs. 85 million respectively and other components of

equity were Rs. 10 million at the date of acquisition. The excess of the fair

value of the identifiable net assets at acquisition is due to an increase in the

value of plant, which is depreciated on the straight-line method and has a

five year remaining life at the date of acquisition. Ashanti disposed of a 10%

equity interest to the non-controlling interests (NCI) of Bochem on 30 April

20X5 for a cash consideration of Rs. 34 million. The carrying value of the net

assets of Bochem at 30 April 20X5 was Rs. 210 million before any

adjustments on consolidation. Goodwill had reduced in value by 15% at 30

April 20X4 and at 30 April 20X5 had lost a further 5% of its original value

before the sale of the equity interest to the NCI.

(ii) The purchase consideration for Ceram was cash of Rs. 136 million. Ceram's

identifiable net assets were fair valued at Rs. 115 million and the NCI of

Ceram attributable to Ashanti had a fair value of Rs. 26 million at that date.

On 1 November 20X4, Bochem disposed of 50% of the equity of Ceram for

cash consideration of Rs. 90 million. Ceram's identifiable net assets wereRs. 160 million and the consolidated value of the NCI of Ceram attributable

to Bochem was Rs. 35 million at the date of disposal. The remaining equity

interest of Ceram held by Bochem was fair valued at Rs. 45 million. After the

disposal, Bochem can still exert significant influence. Goodwill had been

impairment tested and no impairment had occurred. Ceram's profits are

deemed to accrue evenly over the year.

(iii) Ashanti has sold inventory to both Bochem and Ceram in October 20X4. The

sale price of the inventory was Rs. 10 million and Rs. 5 million respectively.

Ashanti sells goods at a gross profit margin of 20% to group companies and

third parties. At the year-end, half of the inventory sold to Bochem remained

unsold but the entire inventory sold to Ceram had been sold to third parties.

(iv) On 1 May 20X2, Ashanti purchased a Rs. 20 million five-year bond with semi-

annual interest of 5% payable on 31 October and 30 April. This was

classified as 'loans and receivables'. The purchase price of the bond was

Rs. 21·62 million. The effective annual interest rate is 8% or 4% on a semi-

annual basis. The bond is held at amortised cost. At 1 May 20X4 the

amortised cost of the bond was Rs. 21.046 million. The issuer of the bond didpay the interest due on 31 October 20X4 and 30 April 20X5, but was in




CA Sri Lanka 53

financial trouble at 30 April 20X5. Ashanti feels that as at 30 April 20X5, the

bond is impaired and that the best estimates of total future cash receipts are

Rs. 2.34 million on 30 April 20X6 and Rs. 8 million on 30 April 20X7. The

current interest rate for discounting cash flows as at 30 April 20X5 is 10%.

No accounting entries have been made in the financial statements for theabove bond since 30 April 20X4. (You should assume the annual compound

rate is 8% for discounting the cash flows.)

(v) Ashanti sold Rs. 5 million of goods to a customer who recently made an

announcement that it is restructuring its debts with its suppliers including

Ashanti. It is probable that Ashanti will not recover the amounts outstanding.

The goods were sold after the announcement was made although the order

was placed prior to the announcement. Ashanti wishes to make an additional

allowance of Rs. 8 million against the total receivable balance at the year-

end, of which Rs. 5 million relates to this sale.

(vi) Ashanti owned a piece of property, plant and equipment (PPE) which cost

Rs. 12 million and was purchased on 1 May 20X3. It is being depreciated

over ten years on the straight-line basis with zero residual value. On 30 April

20X4, it was revalued to Rs. 13 million and on 30 April 20X5, the PPE was

revalued to Rs. 8 million. The whole of the revaluation loss had been posted

to other comprehensive income and depreciation has been charged for the

year. It is Ashanti's company policy to make all necessary transfers for

excess depreciation following revaluation.

(vii) The salaried employees of Ashanti are entitled to 25 days paid leave each

year. The entitlement accrues evenly over the year and unused leave may be

carried forward for one year. The holiday year is the same as the financial

year. At 30 April 20X5, Ashanti has 900 salaried employees and the average

unused holiday entitlement is three days per employee. 5% of employees

leave without taking their entitlement and there is no cash payment when an

employee leaves in respect of holiday entitlement. There are 255 working

days in the year and the total annual salary cost is Rs. 19 million. No

adjustment has been made in the financial statements for the above and

there was no opening accrual required for holiday entitlement.

(viii) Investments in equity instruments (excluding shares group entities) have

been categorised as available for sale financial assets.

(ix) Ignore any taxation effects of the above adjustments and the disclosure

requirements of SLFRS 5 Non-current assets held for sale and discontinued

operations.




54 CA Sri Lanka

Required

(1) Compile a consolidated statement of profit or loss and other comprehensive

income for the year ended 30 April 20X5 for the Ashanti Group. (35 marks)

(2) Outline the factors which provide encouragement to companies such asAshanti to disclose sustainability information in their financial statements,

briefly discussing whether the content of such disclosure should be at the

company's discretion.

(8 marks)

(3) Discuss the nature of and incentives for 'management of earnings' and

whether such a process can be deemed to be ethically acceptable, given the

requirement for accountants to ensure that financial statements are

accurately presented in a given set of circumstances. (7 marks)

(LO 2.1.1, 4.1.3, 5.1.1) (Total = 50 marks)

21 Rose

Preseen

Background

Rose PLC ('Rose') is a quoted public company listed on the Colombo Stock

Exchange. Rose and its subsidiaries operate in the mining sector, mainly

extracting and selling graphite.

Sri Lanka is the only country in the world that produces super-grade lump and

chippy dust graphite containing between 95% and 99% pure carbon. Lump and

chippy dust graphite products are the highest-value graphite products found

globally, and prices are considerably higher than those for other products such as

flake or amorphous graphite.

Development of Rose Group

Sri Lanka has been mining graphite for 200 years and was a significant graphiteproducer and exporter at the start of the last century. Rose was set up almost 100

years ago to take advantage of this available resource. The company grew steadily

until the graphite sector was nationalised almost 50 years ago. At this stage, Rose

transferred its mining expertise to gem mining.

When the private sector was allowed back into the graphite industry, after 20

years, Rose was quick to re-establish itself, and has since continued to grow in the

graphite sector, whilst retaining interests in gem mining.

On 1 May 20X7, Rose acquired 70% of the equity interests of Petal, a public limitedcompany. This shareholding was increased to 80% on 30 April 20X8. Petal also




CA Sri Lanka 55

operates in the graphite mining sector, and its acquisition allowed operations to

be streamlined and cost-cutting strategies to be put in place. In addition it

allowed Rose to access certain advanced mining methods and technologies that

Petal had protected by way of patents.

Rose acquired 52% of the ordinary shares of Stem on 1 May 20X7. Stem is located

in central Africa and operates a gold mine. The acquisition was viewed as a

strategic move to offset the possible negative effects of the Sri Lankan graphite

mining industry being opened up to newer companies.

The income of Stem is denominated and settled in dinars. The output of the mine

is routinely traded in dinars and its price is determined initially by local supply

and demand. Stem pays 40% of its costs and expenses in Sri Lankan Rupees with

the remainder being incurred locally and settled in dinars. Stem's management

has a considerable degree of authority and autonomy in carrying out theoperations of Stem and is not dependent upon group companies for finance.

Financial reporting

Rose PLC prepares consolidated financial statements to 30 April in accordance


accounting policies section of Ashanti's financial statements:



Non-controlling interests consist of the amount of those interests at the date

of the original business combination and the non-controlling shareholders'

share of changes in equity since the date of the combination. The interest of

non-controlling shareholders in the acquiree is initially measured at fair

value in accordance with SLFRS 3. Non-controlling interests are reported

separately from the equity of the owners of the parent.

2.22 Foreign currencies

The individual financial statements of each group company are presented in

its functional currency. For the purposes of the consolidated financial

statements, the results and financial position of each group company are

expressed in Sri Lankan Rupees, which is the functional currency of the

Company and the presentation currency for the consolidated financial

statements.

Financial highlights

The Stem Group has reported healthy profits over recent years, the majority of

which are retained and reinvested in the group's operations. Other funding

requirements are met by way of loan stock issues and long term bank loans.




56 CA Sri Lanka

Future developments

Rose is considering acquiring a service company, MineConsult Co. This company

provides professional technical consultancy services to the mining and metals

sector throughout the world. It is experienced in providing multi-disciplinary

technical studies and due diligence for mineral assets including exploration

through to development, operation and mine closure. Rose, and the other

companies in the Group, have previously used the expertise of MineConsult Co.

The potential acquisition of the company would mark a change in group strategy

as, to date, the group has concentrated on expanding its mining operations. The

directors of Rose have stated that the acquisition is under consideration because

of the value of the human capital involved and the opportunity for synergies and

cross-selling opportunities.

Unseen

The draft statements of financial position of Rose, Petal and Stem are as follows, at

30 April 20X8.

Rose Petal Stem

Rs Mn Rs Mn Dinars Mn

Assets Non-current assets: Property, plant and equipment 370 110 380

Investment in subsidiaries

Petal 113 – –

Stem 46 – –

Financial assets 15 7 50

544 117 430





300

Other components of equity 7 4 –

Total equity 421 98 500






statements.

(a) The purchase consideration paid by Rose for Petal comprised cash of

Rs. 94 million. The fair value of the identifiable net assets recognised by Petal




CA Sri Lanka 57

was Rs. 120 million excluding the patent below. The identifiable net assets of

Petal at 1 May 20X7 included a patent which had a fair value of Rs. 4 million.

This had not been recognised in the financial statements of Petal. The patent

had a remaining term of four years to run at that date and is not renewable.

The retained earnings of Petal were Rs. 49 million and other components ofequity were Rs. 3 million at the date of acquisition. The remaining excess of

the fair value of the net assets is due to an increase in the value of land.

The fair value of the non-controlling interest in Petal was Rs. 46 million on

1 May 20X7. There have been no issues of ordinary shares since acquisition

and goodwill on acquisition is not impaired.

Rose paid cash consideration of Rs. 19 million for the further 10% interest in

Petal on 30 April 20X8.

(b) On 1 May 20X7 Stem's retained earnings were 220 million dinars. The fairvalue of the identifiable net assets of Stem on 1 May 20X7 was 495 million

dinars. The excess of the fair value over the net assets of Stem is due to an

increase in the value of land. The fair value of the non-controlling interest in

Stem at 1 May 20X7 was 250 million dinars.

There have been no issues of ordinary shares of Stem and no impairment of

goodwill in the company since acquisition.

The following exchange rates are relevant to the preparation of the group

financial statements.

Dinars to

Rs.

1 May 20X7 6

30 April 20X8 5

Average for year to 30 April 20X8 5.8

(c) Rose has a property located in the same country as Stem. The property was

acquired on 1 May 20X7 and is carried at a cost of 30 million dinars. The

property is depreciated over 20 years on the straight-line method. At 30

April 20X8, the property was revalued to 35 million dinars. Depreciation has

been charged for the year but the revaluation has not been taken into

account in the preparation of the financial statements as at 30 April 20X8.

(d) Rose commenced a long-term bonus scheme for employees at 1 May 20X7.

Under the scheme employees receive a cumulative bonus on the completion

of five years of service. The bonus is 2% of the total of the annual salary of

the employees. The total salary of employees for the year to 30 April 20X8

was Rs. 40 million and a discount rate of 8% is assumed. Additionally at 30

April 20X8, it is assumed that all employees will receive the bonus and that

salaries will rise by 5% per year.




58 CA Sri Lanka

(e) Rose purchased plant for Rs. 20 million on 1 May 20X4 with an estimated

useful life of six years. Its estimated residual value at that date was

Rs. 1.4 million. At 1 May 20X7, the estimated residual value changed to

Rs. 2.6 million. The change in the residual value has not been taken into

account when preparing the financial statements as at 30 April 20X8.

Required

(1) Recommend which currency should be used as the functional currency of

Stem, applying the principles set out in LKAS 21 The effects of changes in

foreign exchange rates. (8 marks)

(2) Compile a consolidated statement of financial position of the Rose Group at

30 April 20X8 in accordance with Sri Lanka Financial Reporting Standards

(SLFRS), showing the exchange difference arising on the translation of

Stem's net assets. Ignore deferred taxation. (35 marks)

Rose's accountant has measured the fair value of the assets of MineConsult Co

based on what Rose is prepared to pay for them. The directors of Rose have

further stated that what the company is willing to pay is influenced by its future

plans for the business.

MineConsult Co has contract-based customer relationships with well-known

domestic and international companies and some mining companies. Rose's

accountant has measured the fair value of all of these customer relationships at

zero, because Rose already enjoys relationships with the majority of these

customers.

(3) Evaluate the validity of the accounting treatment for MineConsult Co

proposed by Rose's accountant and whether such a proposed treatment

raises any ethical issues.

(7 marks)

(LO 1.1.2, 2.1.1, 5.1.1) (Total = 50 marks)

22 WarrburtPreseen

Warrburt PLC is listed on the Columbo Stock Exchange and, together with its

subsidiaries, manufactures and distributes beverages. The company was

established over 50 years ago and after an initial period of organic expansion,

achieved speedy growth through acquisitions.




CA Sri Lanka 59

Group structure

The parent company, Warburrt manufactures and distributes milkshake and fruit

juice style shrinks. It currently holds majority shareholdings in four subsidiaries.

The subsidiaries are:

• Fruitz, which makes fruit smoothie drinks which are distributed to

supermarkets and convenience stores throughout Sri Lanka;

• Chillz, which makes non-alcoholic bottled fruit cocktails that are sold to bars

and restaurants throughout Sri Lanka and marketed at older teenagers;

• Elephant Brewery, which brews and bottles a popular brand of lager and

distributes it throughout South East Asia; and

• Any14Tea, which makes canned iced tea drinks that are sold in Sri Lanka and

India.

Both Fruitz and Any14Tea are 100% owned by Warburrt; Chillz is 85% owned

and Elephant Brewery 95% owned. The minority shareholders in Chillz and

Elephant Group are, in both cases, the families that set the companies up.

At the start of December 20X7, Warburrt acquired a 25% interest in H200h, a

private family-run company that adds fruit extracts to mineral water in order to

create a high-end flavoured water product. The 25% shareholding acquired

afforded Warburrt significant influence over H200h.

Management and employees`

Warburrt is managed by a Board consisting of eight members, led by James

Dashani, the CEO. All Board members have extensive experience in the drinks and

beverages sector and are appropriately qualified in their respective fields.

The accounting team is led by Sharmini Cooper, a chartered accountant. Sharmini

has worked for Warburtt group companies for 15 years, progressing from

assistant financial accountant of Chillz to Group Finance Director.

The Group promotes fair employment policies and one of its continuing objectivesis to employ an ethnically diverse workforce with males and females represented

as equally as possible. Employees are encouraged to set personal development

objectives and receive training in order that they can achieve promotion

aspirations. All employees are rewarded with a generous remuneration package,

including holiday pay, paid sick leave, and an annual bonus. Certain employees are

also eligible to join the company's defined benefit pension scheme after an initial

period of employment.




60 CA Sri Lanka

Financial performance and position

Although the Warburrt Group is well-established and a big player in the beverage

market, it suffered a small loss in the year ended 30 November 20X6. A further,

increased loss was reported in the following year and in the year ended 30

November 20X8, the reported operating loss was Rs. 47 million.

Management has attributed the losses to a number of factors, above all the need to

cut selling prices aggressively due to competitor activities and the increase in raw

materials costs as the result of a series of poor fruit and wheat harvests. These

factors have particularly affected Fruitz and Elephant Brewery and as a result

goodwill in both companies has become impaired in the year ended 30 November

20X8.

Related to the continued losses, Warburrt 's cash position is deteriorating. Despite

this, its liquidity position, based on amounts reported in the statement of financial

position at 30 November 20X8 is strong, with a current ratio of 3.3:1 compared to

a current ratio at 30 November 20X7 of 3.0.

Future strategy

The strategy of the Warburrt Group remains focused on growth by acquisition,

although the Board feel that the export market should be explored further,

particularly for the Elephant Brewery, as they have heard about the popularity of

unusual beers in Europe and Australia.




CA Sri Lanka 61

Unseen

The following draft group financial statements relate to Warrburt:

WARRBURT GROUP: STATEMENT OF FINANCIAL POSITION AS AT 30 NOVEMBER 20X8

30 Nov 20X8 30 Nov 20X7 Rs Mn Rs Mn

Assets Non-current assets Property, plant and equipment 350 360

Goodwill 80 100

Other intangible assets 228 240

Investment in associate 100 –

Financial assets 142 150

900 850

Current assets Inventories 135 198

Trade receivables 92 163

Cash and cash equivalents 288 323

515 684

Total assets 1,415 1,534

Equity and liabilities

Equity attributable to owners of the parent: to

last million Stated capital 650 595


Revaluation surplus 6 4

Other components of equity 39 16

1,066 1,069

Non-controlling interest 46 53

Total equity 1,112 1,122

Non-current liabilities Long-term borrowing

20

64

Deferred tax 28 26

Long-term provisions 100 96

Total non-current liabilities 148 186

Current liabilities: Trade payables 115 180

Current tax payable 35 42

Short-term provisions 5 4

Total current liabilities 155 226

Total liabilities

303

412 Total equity and liabilities 1,415 1,534




62 CA Sri Lanka

WARRBURT GROUP: STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 30 NOVEMBER 20X8

Rs Mn Revenue 910

Cost of sales (886) Gross profit 24

Other income 7

Distribution costs (40)

Administrative expenses (35)

Finance costs (9)

Share of profit of associate 6

Loss before tax (47)

Income tax expense (29)

Loss for the year from continuing operations (76) Loss for the year (76)

Other comprehensive income for the year (after tax)

Investment in AFS financial assets 27

Gains on property revaluation 2

Remeasurement losses on defined benefit plan (4)

Other comprehensive income for the year (after tax) 25

Total comprehensive income for the year (51)

Loss attributable to:

Owners of the parent (74) Non-controlling interest (2)

(76)

Total comprehensive income attributable to: Owners of the parent (49)

Non-controlling interest (2)

(51)




CA Sri Lanka 63

WARRBURT GROUP: STATEMENT OF CHANGES IN EQUITY FOR THE YEAR

ENDED 30 NOVEMBER 20X8

Stated

capital

Retained

earnings

Other

comp of

equity

Reval'n

surplus

Total NCI Total

equity

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn

b/f 595 454 16 4 1,069 53 1,122

Share capital

issued

55 55 55

Dividends (9) (9) (5) (14)

Total

comprehensive

income for the

year

(74) 23 2 (49) (2) (51)

Balance at 30.11.X8 650 371 39 6 1,066 46 1,112

NOTE TO STATEMENT OF CHANGES IN EQUITY:

Rs Mn Profit/loss attributable to owners of parent (74)

Remeasurement losses on defined benefit plan (4)

Total comprehensive income for year – retained earnings (78)

The following information relates to the financial statements of Warrburt.

(i) Warrburt holds financial assets that are owned by the parent company. At

1 December 20X7, the total carrying amount of those investments was

Rs 150 Mn. Rs 112 Mn of this Rs 150 Mn are classified as available for sale

financial assets. The remaining Rs 38 Mn related to an investment in the

shares of Alburt, which has been designated as fair value through profit or

loss. During the year, the investment in Alburt was sold for Rs 45 Mn, with

the fair value gain shown in 'other income' in the financial statements. The

following schedule summarises the changes:

Alburt Other Total

Rs Mn Rs Mn Rs Mn Carrying amount at 1 December 20X7 38 112 150

Add gain on derecognition/reval'n 7 30 37

Less sales at fair value (45) – (45)

Carrying amount at 30 November 20X8 – 142 142

Deferred tax of Rs. 3 million arising on the Rs 30 Mn revaluation gain above

has been taken into account in other comprehensive income for the year.




64 CA Sri Lanka

(ii) The retirement benefit liability is shown as a long-term provision in the

statement of financial position and comprises the following:

Rs Mn Net defined benefit liability at 1 December 20X7 96

Expense for period 10 Contributions to scheme (paid) (10)

Remeasurement losses 4

Net defined benefit liability at 30 November 20X8 100

Warrburt recognises remeasurement gains and losses in other

comprehensive income in the period in which they occur, in accordance with

LKAS 19. The benefits paid in the period by the trustees of the scheme were

Rs. 3 million. There is no tax impact with regards to the retirement benefit

liability.

(iii) The property, plant and equipment (PPE) in the statement of financial

position comprises the following:

Rs Mn Carrying amount at 1 December 20X7 360

Additions at cost 78

Gains on property revaluation 4

Disposals (56)

Depreciation (36)

Carrying amount at 30 November 20X8 350 Plant and machinery with a carrying amount of Rs. 1 million had been

destroyed by fire in the year. The asset was replaced by the insurance

company with new plant and machinery, which was valued at Rs. 3 million.

The machines were acquired directly by the insurance company and no cash

payment was made to Warrburt. The company included the net gain on this

transaction in 'additions at cost' and as a deduction from administrative

expenses.

The disposal proceeds were Rs. 63 million. The gain on disposal is includedin administrative expenses. Deferred tax of Rs. 2 million has been deducted

in arriving at the 'gains on property revaluation' figure in other

comprehensive income..

The remaining additions of PPE comprised imported plant and equipment

from an overseas supplier on 30 June 20X8. The cost of the PPE was 380

million dinars with 280 million dinars being paid on 31 October 20X8 and

the balance to be paid on 31 December 20X8. The outstanding amount is

included within the trade payables balance in the statement of financial

position.




CA Sri Lanka 65

The rates of exchange were as follows:

Dinars to Rs. 1

30 June 20X8 5

31 October 20X8 4.9

30 November 20X8 4.8

Exchange gains and losses are included in administrative expenses.

(iv) The interest in H200h was acquired for cash on 1 December 20X7. The net

assets of H200h at the date of acquisition were Rs. 300 million. H200h made a

profit after tax of Rs. 24 million and paid a dividend of Rs. 8 million out of

these profits in the year ended 30 November 20X8.

(v) An impairment test had been carried out at 30 November 20X8 on goodwill

and other intangible assets. The result showed that goodwill was impaired

by Rs. 20 million and other intangible assets by Rs. 12 million.(vi) The short term provisions relate to finance costs which are payable within

six months.

Warrburt's CEO and Managing Director are concerned about the results for the

year in the statement of profit or loss and other comprehensive income and the

subsequent effect on the statement of cash flows. They have suggested that the

proceeds of the sale of property, plant and equipment and the sale of investments

in equity instruments should be included in 'cash generated from operations'. The

directors are afraid of an adverse market reaction to their results and aware of theimportance of meeting targets in order to ensure job security. They feel that the

adjustments for the proceeds would enhance the 'cash health' of the business.

Required

(1) Compile a group statement of cash flows for Warrburt for the year ended 30

November 20X8 in accordance with LKAS 7 Statement of cash flows, using

the indirect method. (35 marks)

(2) Outline the key issues which the statement of cash flows highlights

regarding the cash flow of the company. (10 marks)

(3) Assess the ethical responsibility of Sharmini Cooper in ensuring that

manipulation of the statement of cash flows, such as that suggested by the

directors, does not occur. (5 marks)

(LO 2.1.1, 3.2.1, 5.1.1) (Total = 50 marks)




66 CA Sri Lanka






68 CA Sri Lanka



KC1 | Answers to Practice Questions

CA Sri Lanka 69

PART A: INTERPRETATION AND APPLICATION OF SRI LANKA ACCOUNTING

STANDARDS

Questions 1 to 6 cover Interpretation and Application of Sri Lanka Accounting

Standards.

1 Accounting queries

(1) Penn

Statement of financial position (extract) at 31 December 20X9

Non-current liabilities Rs'000

Net defined benefit liability(4,115 – 4,540) 425

Statement of comprehensive income (extract) for the year

ended 31 December 20X9

Rs'000

Charged to profit or loss Current service cost 275

Net interest on net defined benefit liability (344 – 288) 56

Curtailment cost 58

389

Other comprehensive income Actuarial gain on obligation 107

Return on plan assets (excluding amounts in net interest) 7

Disclosure Note – Employee benefits

Reconciliation of pension plan movement Rs'000

Plan deficit at 1 Jan 20X9 (3,600 – 4,300) (700)

Company contributions 550

Profit or loss total (389)

Other comprehensive income total (107 + 7) 114

Plan deficit at 31 Dec 20X9 (4,115 – 4,540) (425)

Rs'000 Changes in the present value of the defined benefit obligation Defined benefit obligation at 1 Jan 20X9 4,300

Interest cost (4,300 8%) 344

Pensions paid (330)

Curtailment 58

Current service cost 275

Remeasurement gain through OCI (bal. Fig.) (107)

Defined benefit obligation at 31 Dec 20X9 4,540




70 CA Sri Lanka

Changes in the fair value of plan assets Rs'000

Fair value of plan assets at 1 Jan 20X9 3,600

Contributions 550

Pensions paid (330)

Interest on plan assets (3,600 8%) 288 Remeasurement gain through OCI (295 – 288) 7

Fair value of plan assets at 31 Dec 20X9 (bal. fig.) 4,115

(2) Sion Co

Calculation of net defined benefit liability

Changes in the present value of the defined benefit obligation

Rs'000

1 January 20X8 b/f 40,000

Interest at 8% 3,200 Current service cost 2,500

Past service cost 2,000

Benefits paid (1,974)

45,726

Re-measurement losses through OCI 274

31 December 20X8 c/f 46,000

The improvement in the plan during 20X8 leads to an increase in the defined

benefit obligation.


Interest at 9% 4,140

Current service cost 2,860

Settlement (11,400)


39,400

Re-measurement losses 1,400


The transfer of the pension liability to the buyer constitutes a settlement

and, since Sion will no longer have an obligation to the employees within the

part of the business sold, the defined obligation is reduced.




CA Sri Lanka 71

Changes in the fair value of plan assets

Rs'000



Benefits paid (1,974) Contributions paid in 2,000

43,226

Remeasurement losses (226)




Settlement (10,800)


Contributions paid in 2,200

36,070

Re-measurement losses (390)


As Rs 10.8 Mn of plan assets are withdrawn from Sion’s plan and transferred

to the purchaser, this reduces the value of the plan assets.

The overall gain on settlement is calculated as:

Rs'000

Present value of obligation settled 11,400

Fair value of plan assets transferred on settlement (10,800)

Cash transferred on settlement (400)

Gain 200

The pension fund will be presented in the financial statements as follows:

Financial statements extracts

STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER 20X8 20X9

Rs'000 Rs'000

Net defined benefit liability:

(46,000 – 43,000)/(40,800 – 35,680) 3,000 5,120




72 CA Sri Lanka

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 DECEMBER

20X8 20X9

Rs'000 Rs'000

Profit or lossCurrent service cost 2,500 2,860

Past service cost 2,000 –

Gain on settlement – (200)

Net interest: (3,200 – 3,200)/(4,140 – 3,870) – 270

Other comprehensive income

Re-measurement loss on defined pension

plan: (274 + 226)/(1,400 +390) 500 1,790

(3) Classification of financial instruments

Bed's investment is a financial asset, since it carries a contractual right to

receive cash from Em Bank.

There is also an embedded derivative, in the form of the possible receipt of

further cash, contingent upon the movement of the Ruritanian Kroner. This

meets the definition of a derivative in that it derives its value from the price

or rate of an underlying item, ie the exchange rate.

LKAS 39 requires that an embedded derivative be separated from its host

contract and accounted for separately if:

(a)

The economic characteristics and risks of the embedded derivative are

not closely related to those of the host contract; and

(b) A separate instrument with the same terms as the embedded

derivative would meet the definition of a derivative; and

(c) The hybrid instrument is not measured at fair value with changes

recognised in profit or loss (in which case there is no benefit to

separating the embedded derivative).

In this case, the value of the derivative is dependent on exchange rate

movements, so the economic characteristics and risks are different and

condition (a) is met.

Condition (b) is also met, in that there could be a separate instrument with

the same terms.

To assess condition (c), we must consider the classification of the host

instrument, ie the deposit with EM Bank. The deposit is a non-derivative

financial asset with fixed or determinable payments, it is not quoted in an

active market and Bed Investment Co does not intend to sell the investment

in the short term. Therefore, assuming that it has not been designated asavailable-or-sale, the deposit fits the “loans and receivables” classification,

and is measured at amortised cost.




CA Sri Lanka 73

As the deposit is not measured at fair value through profit or loss, the

embedded derivative should be separated out and accounted for separately.

It is classified as a financial asset at fair value through profit or loss. As the

name suggests, it is measured at fair value and changes in value are

recognised in profit or loss for the year.

2 Prochain

Model areas

LKAS 16 Property, plant and equipment is the relevant standard here. The model

areas are held for use in the supply of goods and are used in more than one

accounting period. The company should recognise the costs of setting up the

model areas as tangible non-current assets and should depreciate the costs over

their useful lives. Subsequent measurement should be based on cost. In theory the

company could measure the model areas at fair value if the revaluation model of

LKAS 16 were adopted, but it would be difficult to measure fair value reliably in

this case.

LKAS 16 states that the initial cost of an asset should include the initial estimate of

the costs of dismantling and removing the item and restoring the site where the

entity has an obligation to do so. A present obligation appears to exist, as defined

by LKAS 37 Provisions, contingent liabilities and contingent assets and therefore

the entity should also recognise a provision for that amount. The provision shouldbe discounted to its present value, and this amount initially recognised as both

part of the cost of the asset and a separate provision. The subsequent unwinding

of the discount on the provision is recognised in profit or loss.

At 31 May 20X6, the entity should recognise a non-current asset of Rs. 15.7 million

(cost of Rs. 23.6 million (W) less accumulated depreciation of Rs. 7.9 million (W))

and a provision of Rs. 3.7 million (W).

Working

PPE Rs Mn

Cost of model areas 20.0

Plus provision (20 20% 2

1

1.055(= 0.898)

3.6

Cost on initial recognition 23.6

Less accumulated depreciation (23.6 8/24) (7.9)

Carrying amount at 31 May 20X6 15.7

Provision

Provision: on initial recognition (20 20% 0.898) 3.6 Plus unwinding of discount (3.6 5.5% 8/12) 0.1

Provision at 31 May 20X6 3.7




74 CA Sri Lanka

Purchase of Badex

SLFRS 3 Business Combinations states that the consideration transferred in a

business combination must be measured at fair value at the acquisition date.

The Rs. 100 million cash paid on the acquisition date, 1 June 20X5 is recognised aspurchase consideration. The Rs. 25 million payable on 31 May 20X7 (two years

after acquisition) is split into the Rs. 10 million deferred consideration which is

discounted to its present value by two years (Rs. 10m 1/1.0552 = Rs. 8.98m) and

the contingent consideration of Rs. 15 million. The contingent consideration is

measured at its acquisition-date fair value. Here, as the profit forecast targets are

unlikely to be met, the fair value would be significantly less than Rs. 15 million but

as the percentage chance of the targets being met and other relevant information

is not given, it is not possible to establish a fair value.

Prochain should also recognise a corresponding financial liability for the deferred

and contingent consideration as this meets the definition of a financial liability in

LKAS 32 Financial Instruments: Presentation. This is because Prochain has a

contractual obligation to deliver cash on 31 May 20X7 providing the conditions of

the contingent consideration are met. At the year end 31 May 20X6, any changes

in the contingent consideration as a result of changes in expectations of the targets

being met are recognised in profit or loss (rather than as an adjustment to

goodwill).

Under SLFRS 3, any associated transaction costs are expensed to profit or lossunless they are the costs of issuing debt or equity, which are accounted for in

accordance with LKAS 32.

A further issue concerns the valuation and treatment of the 'Badex' brand name.

LKAS 38 Intangible Assets prohibits the recognition of internally generated brands

and therefore the brand will not be recognised in Badex's individual statement of

financial position prior to the acquisition. SLFRS 3, however, requires the

intangible assets of an acquiree to be recognised in a business combination if they

meet the identifiability criteria in LKAS 38. For an intangible to be identifiable, the

asset must be separable or it must arise from contractual or legal rights. Here,

these criteria appear to have been met as the brand could be sold separately from

the entity. Therefore, the 'Badex' brand should be recognised as a separate

intangible asset measured at Rs. 20m in the consolidated statement of financial

position, rather than subsumed within the measurement of goodwill.

Development of own brand

LKAS 38 Intangible assets divides a project such as this into a research phase and a

development phase. The research phase of a project involves investigation to gain

new scientific or technical knowledge and understanding. At this stage, an entity

cannot demonstrate that any expenditure incurred will generate probable future




CA Sri Lanka 75

economic benefits. Therefore expenditure on research must be recognised as an

expense when it occurs.

Development expenditure is the application of research findings to a plan or

design for the production of new or improved materials, products and processes

prior to the start of commercial production. Development costs are capitalised

when an entity demonstrates all the following.

(a) The technical feasibility of completing the project

(b) Its intention to complete the asset and use or sell it

(c) Its ability to use or sell the asset

(d) That the asset will generate probable future economic benefits

(e) The availability of adequate technical, financial and other resources to

complete the development and to use or sell it

(f) Its ability to reliably measure the expenditure attributable to the asset.

Once these criteria are met, subsequent development costs must be capitalised;

costs incurred prior to the criteria being met cannot be capitalised retrospectively.

Capitalised development costs should comprise all directly attributable costs

necessary to create the asset and to make it capable of operating in the manner

intended by management. Directly attributable costs do not include selling or

administrative costs, or training costs or market research. The cost of upgrading

existing machinery can be recognised as property, plant and equipment.

Therefore the expenditure on the ‘Pro’ project should be treated as follows:

Recognised in statement of financial position

Intangible Property, plant Expense (P/L) Assets and equipment

Rs Mn Rs Mn Rs Mn Research 3

Prototype design 4

Employee costs 2

Development work 5

Upgrading machinery 3

Market research 2

Training 1

6 11 3

Prochain should recognise Rs. 11 million as an intangible asset.




76 CA Sri Lanka

Apartments

The apartments are leased to persons who are under contract to the company.

Therefore they cannot be classified as investment property. LKAS 40 Investment

property specifically states that property occupied by employees is not investmentproperty. This is the case regardless of whether rent is paid at a market rate or

not. The apartments are property, plant and equipment, measured using the cost

or revaluation model and depreciated over their useful lives.

Although the rent is below the market rate the difference between the actual rent

and the market rate is simply income foregone (or an opportunity cost). In order

to recognise the difference as an employee benefit cost it would also be necessary

to gross up rental income to the market rate. The financial statements would not

present fairly the financial performance of the company. Therefore the company

cannot recognise the difference as an employee benefit cost.

3 Panel

(1) The impact of changes in accounting standards

LKAS 12 Income taxes is based on the idea that all changes in assets and

liabilities have unavoidable tax consequences. Where the recognition criteria

in SLFRS are different from those in tax law, the carrying amount of an asset

or liability in the financial statements is different from the amount at whichit is stated for tax purposes (its 'tax base'). These differences are known as

'temporary differences'. The practical effect of these differences is that a

transaction or event occurs in a different accounting period from its tax

consequences. For example, income from interest receivable is recognised in

the financial statements in one accounting period but it is only taxable when

it is actually received in the following accounting period.

LKAS 12 requires a company to make full provision for the tax effects of

temporary differences. Where a change in an accounting standard results in

a change to the carrying value of an asset or liability in the financial

statements, the amount of the temporary difference between the carrying

value and the tax base also changes. Therefore the amount of the deferred

tax liability is affected.

(2) Calculation of deferred tax on first time adoption of SLFRS

SLFRS 1 First time adoption of International Financial Reporting Standards

requires a company to prepare an opening SLFRS statement of financial

position and to apply LKAS 12 to temporary differences between the

carrying amounts of assets and liabilities and their tax bases at that date.

Panel prepares its opening SLFRS statement of financial position sheet at




CA Sri Lanka 77

1 November 20X3. The carrying values of its assets and liabilities are

measured in accordance with SLFRS 1 and other applicable SLFRSs in force

at 31 October 20X5. The deferred tax provision is based on tax rates that

have been enacted or substantially enacted by the end of the reporting

period. Any adjustments to the deferred tax liability under previous GAAPare recognised directly in equity (retained earnings).

(3) (i) Share options

Under SLFRS 2 Share based payment the company recognises an

expense for the employee services received in return for the share

options granted over the vesting period. The related tax deduction does

not arise until the share options are exercised. Therefore a deferred tax

asset arises, based on the difference between the intrinsic value of the

options and their carrying amount (normally zero).

At 31 October 20X4 the tax benefit is as follows:

Rs Mn

Carrying amount of share based payment –

Less: tax base of share based payment (16 ÷ 2) (8)

Temporary difference (8)

The deferred tax asset is Rs. 2.4 million (30% 8). This is recognised at

31 October 20X4 provided that taxable profit is available against which

it can be utilised.

Because the remuneration expense of $20m ($40,/2) is greater than

the tax deduction ($8m), deferred tax is recognised in profit or loss.

At 31 October 20X5 there is no longer a deferred tax asset because the

options have been exercised. The tax benefit receivable is

Rs. 13.8 million (30% Rs. 46 million). Therefore the deferred tax

asset of Rs. 2.4 million is no longer required.

(ii) Leased plant

An asset leased under a finance lease is recognised for accounting

purposes as:

(i) An asset owned by the company (initially recognised at the lower

of fair value or the present value of minimum lease payments and

subsequently depreciated), and

(ii) The related obligation to pay lease rentals (initially measured at

the same amount as the asset and subsequently increased by

interest accruing and decreased by lease payments.




78 CA Sri Lanka

The carrying amount of the lease for accounting purposes is therefore

the net of these two balances.:

Rs Mn Rs Mn Carrying amount in financial statements:

Asset: Net present value of future lease payments

at inception of lease

12

Less depreciation (12 ÷ 5) (2.4)

9.60

Less finance lease liability Liability at inception of lease 12.00

Interest (8% 12) 0.96

Lease rental (3.00)

(9.96)

(0.36)

For tax purposes:

• The tax base of an asset is the amount deductible for tax in future,

which is zero in this case, as capital allowances are not given on

leased assets.

• The tax base of a liability is its carrying amount less any future tax

deductible amounts,. In this case the carrying amount of the

liability is $9.96 million and the full amount of this is tax

deductible in the future, giving a tax base of zero.

• The net tax base of the lease arrangement is therefore zero.

Therefore at 31 October 20X5 a net temporary difference is calculated as:

Carrying amount (0.36)

Less tax base 0.00

Temporary difference (0.36)

This is a deductible temporary difference as the tax base is greater than

the carrying amount. Therefore a deferred tax asset of Rs. 108,000

(30% 360,000) arises.

(iii) Intra-group sale

Panel will recognise the goods at cost of Rs. 9 million in its individual

financial statements. The tax base of the goods for Panel is Rs. 9 million,

being the amount deductible for tax purposes in the future (the cost to

Panel). This is equal to the goods’ carrying amount and therefore no

deferred tax arises in Panel’s separate financial statements




CA Sri Lanka 79

From an accounting point of view, the separate financial statements of

Pins and Panel are consolidated and the unrealised profit of

Rs. 2 million is eliminated. Therefore the carrying amount of the goods

is Rs. 7 million in the consolidated financial statements. For tax

purposes, however, Pins and Panel remain two separate entities andeach is taxed separately on its reported results. Therefore the tax base

remains Rs. 7 million. As a result a deductible temporary difference of

Rs. 2 million arises and an associated deferred tax asset of Rs. 600,000

(30% Rs. 2 million) is recognised in the consolidated financial

statements.

(iv) Impairment loss

The impairment loss in the financial statements of Nails reduces the

carrying amount of property, plant and equipment, but is not allowablefor tax. Therefore the tax base of the property, plant and equipment is

different from its carrying amount and there is a temporary difference.

Under LKAS 36 Impairment of assets the impairment loss is allocated

first to goodwill and then to other assets:

Property,

plant and

Goodwill equipment Total

Rs Mn Rs Mn Rs Mn

Carrying amount at 1 6.0 7.0 31 October 20X5

Impairment loss (1) (0.8) (1.8)

– 5.2 5.2

LKAS 12 states that no deferred tax should be recognised on goodwill

and therefore only the impairment loss relating to the property, plant

and equipment affects the deferred tax position.

The effect of the impairment loss is as follows:

Before After Difference impairment impairment

Rs Mn Rs Mn Rs Mn Carrying amount 6 5.2

Tax base (4) (4)

Temporary difference 2 1.2 0.8

Tax liability (30%) 0.6 0.36 0.24

Therefore the impairment loss reduces deferred the tax liability by

Rs. 240,000.




80 CA Sri Lanka

4 Ambush

(1) Impairment of financial assets

LKAS 39 states that at each reporting date, an entity should assess whether

there is any objective evidence that a financial asset or group of assetsmeasured at amortised cost is impaired. Indications of impairment include

significant financial difficulty of the issuer; the probability that the borrower

will enter bankruptcy; or a default in interest or principal payments.

Where there is objective evidence of impairment, the entity should

determine the amount of any impairment loss, which is recognised

immediately in profit or loss. Only losses relating to past events can be

recognised. Two conditions must be met before an impairment loss is

recognised: There is objective evidence of impairment as a result of one or more

events that occurred after the initial recognition of the asset; and

The impact on the estimated future cash flows of the asset can be

reliably estimated.

This model whereby losses relating to past events only are recognised is

referred to as the ‘incurred loss’ model.

The SLFRS 9 approach differs from this in that an ‘expected loss’ model is

applied. Under this approach, expected credit losses are accounted for from

the date when financial instruments are first recognised. Entities must

recognise 12 month expected credit losses or, where credit risk has

increased significantly since initial recognition, lifetime expected credit

losses.

Expected credit losses are measured in a way that reflects:

An unbiased and probability weighted amount that is determined by

evaluating a range of possible outcomes;

The time value of money; and

Reasonable and supportable information that is available without

undue cost or effort at the reporting date about past events, current

conditions and forecasts of future economic conditions.

Under both approaches, for financial assets carried at amortised cost the

impairment loss is the difference between the asset's carrying amount and

its recoverable amount. The asset's recoverable amount is the present value

of estimated future cash flows, discounted at the financial instrument'soriginal effective interest rate.




CA Sri Lanka 81

For assets at fair value, changes in fair value are automatically recognised

immediately in profit or loss or other comprehensive income.

(2) Loan to Bromwich

The financial difficulties and reorganisation of Bromwich are objectiveevidence of impairment. The impairment loss is the difference between the

carrying amount of the loan at 30 November 20X5 and the present value of

the estimated future cash flows. As the stated and effective interest rate for

the loan are both 8%, the carrying amount at 30 November 20X5 is

Rs. 200,000. The present value of estimated future cash flows is Rs. 100,000

(on 30 November 20X7), discounted at the original effective interest rate of

8%.

This is Rs. 85,730 (100,000 1/1.082). Therefore the impairment loss is

Rs. 114,270 (200,000 – 85,730) and this is recognised immediately in profit

or loss.

(3) Trade receivables

LKAS 39 classifies trade receivables as loans and receivables.

LKAS 39 requires that loans and receivables are initially measured at fair

value (normally being the invoiced amount) and subsequently measured at

amortised cost using the effective interest rate method. This method, which

spreads the interest income over the life of the financial asset, may not seem

appropriate for short-term trade receivables with no stated interest rate, as

they do not normally bring in any interest income. It is therefore normally the

case that such receivables continue to be measured at the original invoiced

amount.

As with other financial assets, however, LKAS 39 requires an annual

impairment test, in order to assess, at each reporting date, whether the

receivable is impaired. The carrying amount of the trade receivable must be

compared with the present value of the estimated future cash flows. For other

assets, the cash flows would be discounted at the effective interest rate, butthis is not normally required for trade receivables unless the balance is not

due for an extended period such that the effect of discounting is material.

General allowance

Ambush has calculated a general allowance using a formulaic approach. This

is only acceptable if it produces an estimate sufficiently close to that

produced by the LKAS 39 method. It is not acceptable to use a formula based

on possible trends. The general allowance of two percent is not permitted

under LKAS 39, because it is not based on past experience and is unlikely tobe an accurate estimate of the cash flows that will be received.




82 CA Sri Lanka

Tray

Where it is probable that payment will not be received in full for an

individually significant balance, an allowance for impairment must be made.

Tray is expected to pay the full amount owed plus a penalty. However, thepayment will be in a year's time, and so discounting should be used to

calculate any impairment.

Milk

Where, as in the case of Milk, there is no objective evidence of impairment,

the individual asset is included in a group of assets with a similar credit risk,

and the group as a whole is assessed for impairment. Milk has a similar

credit risk to 'other receivables' and so will be grouped in with those.

Allowance for impairment

This is calculated as follows.

Cash to be

Balance Received

Rs Mn Rs Mn

Tray 4 3.9*

Milk and other receivables 7 6.6

11 10.5

*Rs 4.1 Mn 1/1.05

Ambush should reduce trade receivables by Rs 11 Mn – Rs 10.5 Mn =

Rs. 500,000 (or recognise a balance of Rs. 500,000 on the allowance

account).

(4) Buildings

Under LKAS 16 Property, plant and equipment, an increase in the carrying

amount of an asset measured using the revaluation model is recognised in

other comprehensive income (items that will not be reclassified to profit or

loss) and accumulated in equity under the heading of revaluation surplus.

An exception to this rule is where an increase reverses a revaluation

decrease (an impairment) of the same asset and this was previously

recognised in profit or loss. In this case the increase is recognised in profit or

loss, subject to the LKAS 36 Impairment of assets restrictions, to the extent

that it reverses the previously recognised loss. Thereafter it is recognised in

other comprehensive income. LKAS 36 Impairment of assets restricts the

reversal of an impairment loss recognised in profit or loss by stating that it

must not result in the asset having a carrying amount that exceeds the

carrying amount at that date as if no impairment had taken place.




CA Sri Lanka 83

If an asset's carrying amount is decreased as a result of a downwards

revaluation (impairment), the decrease is recognised in profit or loss. An

exception to this rule arises where the revaluation decrease reverses a

revaluation increase previously recognised as other comprehensive income.

In this case the decrease is recognised in other comprehensive income to theextent of any credit balance existing in the revaluation surplus in respect of

that asset. The decrease recognised in other comprehensive income reduces

the amount accumulated in equity under the heading of revaluation surplus.

These requirements are applied to the buildings of Ambush as follows:

Y/e 30.11.X4 Y/e 30.11.X5

Rs Mn Rs Mn

Cost/valuation 10.0 8.00

Depreciation (Note 1) (0.5) (0.42)

9.5 7.58

Impairment charged to profit or loss (1.5) –

Reversal of impairment charged to profit or

loss (Note 2)

– 1.42

Gain on revaluation to revaluation surplus 2.00

Carrying amount 8.0 11.00

Notes

1 Depreciation charged in the year to 30 November 20X5 is based on the

carrying amount at 30 November 20X4 spread over the remaining lifeof 19 years: Rs 8 Mn 19 = Rs. 421,053 rounded to Rs. 420,000.

2 The gain on revaluation in 20X5 is recognised in profit or loss to the

extent that it reverses the revaluation loss (impairment) charged in

20X4. However, as described above, LKAS 36 Impairment of Assets

restricts the reversal that is recognised in profit or loss to the amount

required to restore the asset’s carrying amount to that which would be

recognised if no impairment loss had occurred. Here the carrying

amount of the buildings at 30 November 20X5 would be Rs. 9 million

(Rs. 9.5 million – Rs. 500,000 depreciation) had no loss arisen in 20X4.

Therefore only Rs. 1.42 million (Rs. 9 million – Rs. 7.58 million) of the

gain in fair value is recognised as a reversal of the previous loss; the

remainder is recognised as a revaluation gain in other comprehensive

income.




84 CA Sri Lanka

5 Engina

(1) Sale of goods to the director

• Mr Satay is a director of Engina. As such he is likely to have authority

and responsibility for planning, directing and controlling the activitiesof Engina. Therefore as a member of Engina’s key management

personnel, Mr Satay is a related party of the company.

• Mr Satay has purchased Rs. 600,000 (12 Rs. 50,000) worth of goods

from the company and a car for Rs. 45,000, which is just over half its

market value.

• The issue is whether this is a related party transaction requiring

disclosure.

• A related party transaction is a transfer of resources, services or

obligations between a reporting entity and a related party, regardless

of whether a price is charged. Therefore the sale of goods and the car

do qualify as related party transactions.

• In this case a price is charged, but we must consider whether the

transaction is material; although LKAS 24 does not address the issue of

materiality, accounting standards do not apply to immaterial

transactions and therefore if the sale of goods and the car are deemed

immaterial, no disclosure is required.

• LKAS 1 states that omissions or misstatements are material if they

could individually or collectively influence the economic decisions that

users make on the basis of the financial statements. Materiality

depends on the size or nature of an item or a combination of both.

• The size of the transactions means that they are not material to the

company, and because Mr Satay has considerable personal wealth, they

are unlikely to be material to him either.

• It is, however, normally the case that a transaction with a director

(other than remuneration) is material by nature, and therefore

disclosure of the transactions is required. Disclosure should include the

amount of the transactions and any outstanding balances.

• In addition, LKAS 24 requires disclosure of compensation paid to

directors. Compensation includes subsidised goods and benefits in

kind.




CA Sri Lanka 85

Hotel property

• As Managing Director, Mr Soy is a member of the key management

personnel of Engina and so qualifies as a related party. It is not,

however, clear whether Mr Soy’s brother is related party or not.

• LKAS 24 states that close family members of key management

personnel are related parties of an entity, and so the answer depends

on whether Mr Soy’s brother qualifies as a close family member.

• LKAS 24 defines close family members as those who may influence or

be influenced by the key personnel in their dealings with the entity. It

says that this includes children and dependants and spouse, but does

not limit the definition to these people.

• Whether an individual is under the influence of his brother depends on

their relationship in individual circumstances. In this case the fact that

Mr Soy’s brother was given a substantial discount on the property

purchase would appear to suggest that he can influence Mr Soy.

• Therefore Mr Soy’s brother is a related party and the hotel property

sold to the Managing Director's brother should be treated as a related

party transaction.

• LKAS 24 requires disclosure of 'information about the transaction and

outstanding balances necessary for an understanding of the potential

effect of the relationship upon the financial statements'.

• The sale of the property was for Rs. 4 million, and it is this amount that

must be disclosed. This would highlight the nature of the transactions

within the existing property market conditions.

• The question of impairment also needs to be considered. The value of

the hotel has become impaired due to the fall in property prices, so the

carrying amount needs to be adjusted in accordance with LKAS 36

Impairment of assets. The hotel should be measured at the lower of

carrying amount (Rs 5 Mn) and the recoverable amount. The

recoverable amount is the higher of fair value less costs of disposal

(Rs 4.3 Mn – Rs 0.2 Mn = Rs 4.1 Mn) and value in use (Rs 3.6 Mn).

Therefore the hotel should be measured at Rs 4.1 Mn.

Group structure

• In addition to his role as Finance Director of Engina, Mr Satay controls

Wheel, which owns 100% of Engina. Therefore Mr Satay has indirect

control of Engina




86 CA Sri Lanka

• LKAS 24 requires disclosure of an entity’s 'ultimate controlling party'.

Therefore in Engina’s financial statements, Mr Satay is disclosed as the

ultimate controlling party..

• LKAS 24 requires disclosure of the related party relationship between

a parent and its subsidiary. Therefore Engina must disclose that Wheel

is its parent company.

• Engina must also disclose any transactions during the year with related

parties, and any outstanding balances at the period end and provisions

thereon.

• Therefore sales to Wheel Ltd must be disclosed.

• Engina's transactions with Car Ltd must also be disclosed. LKAS 24

states that companies under common control are related parties, and

the two companies are under the common control of Mr Satay.

(2) Dividend payment

• This payment is covered by IFRIC 17 Distribution of non-cash assets to

owners.

• IFRIC 17 applies only where all shareholders of the same class of equity

instruments are treated equally. Exhaust Limited is the sole Class B

shareholder in Wheel Limited and therefore it applies in this case.

• IFRIC 17 does not apply where the asset being transferred is controlled

by the same parties before and after the transfer. In this case Exhaust

does not control Wheel and so there is no common control. However, if

the transfer had been to Mr Satay, it would fall outside the scope of

IFRIC 17 since Mr Satay controls Wheel.

• IFRIC 17 states that the dividend payment should be recorded at the

fair value of the asset transferred, being Rs. 520,000.

• The difference of Rs. 70,000 between the fair value and the carrying

amount of the asset is recognised in profit and loss and disclosed.

6 Masham

(1) Fair value of assets

Farm machinery

The farm machinery is classified as held for sale and therefore it must be

measured at the lower of carrying amount or fair value less costs to sell.

SLFRS 13 requires that the fair value of an asset is established by reference

to exit, or selling, prices. In establishing the fair value of an asset, it is




CA Sri Lanka 87

assumed that the asset will be sold in its principal market. This is the market

with the greatest volume and level of activity for the asset.

It is made clear that neither India nor Thailand exceeds the other in terms of

sales volume of similar machines. Therefore neither is the principal market.

Therefore fair value is established by reference to the most advantageous

market.

The most advantageous market is that which maximises the amount that

would be received to sell the asset after taking into account transaction costs

and transport costs. The most advantageous market is therefore Thailand:

India

Rs.

Thailand

Rs.

Selling price 244,680 237,800

Transaction costs (4,600) (3,900)Transport costs (29,300) (18,660)

Net receipt 210,780 215,240

SLFRS 13 is clear that transaction costs do not form part of the calculation of

fair value, although they are used in order to establish the most

advantageous market. It is also clear that transport costs are not transaction

costs and therefore they do form part of the calculation of fair value.

The fair value of the machine is therefore equal to the selling price of the

asset less transport costs in the most advantageous market ie Thailand.

Therefore the fair value of the machine is Rs. 219,140 (237,800 – 18,660).

SLFRS 5 requires measurement of an asset held for sale at the lower of

carrying amount and fair value less costs to sell. Although the transaction

costs do not form part of fair value, they are costs to sell and therefore the

machine has a fair value less costs to sell of Rs. 215,240.

This is greater than the carrying amount of Rs. 220,000 and therefore the

machine must be written down to Rs. 215,240 and an impairment loss of Rs.

4,760 must be recognised in profit or loss in the year ended 31 December

20X3.

Land

SLFRS 13 requires that measurement of the fair value of non-financial assets

is based on the highest and best use of the asset. It would initially seem that

the highest and best use of the land is for commercial development as this

results in a higher market value.

We must, however, consider the impact of the neighbour’s right of way and

the restriction on use. The highest and best use takes into account the use of

the asset that is physically possible, legally permissible and financial feasible.




88 CA Sri Lanka

The legal right of way is related to the land and as such the neighbour

continues to have this right even if the land is passed on to a purchaser. The

fair value of the land must therefore take this into account.

If the restriction on the use of the land is specific to Masham and would not

pass to a purchaser, it would be permissible to develop the land for

commercial purposes and therefore its fair value at 31 December 20X3

would be based on this use. If the restriction on the use of land is transferred

with title, the land may not be used for anything other than agricultural

purposes and as such its fair value is lower.

(2) Food processing plants – impairment test

The first step in establishing whether an impairment loss has arisen is to

determine the carrying amount of each CGU.

In order to determine carrying amounts, the shared or ‘corporate’ assets are

allocated to the cash-generating units to which they relate ‘on a reasonable

and consistent basis’. It is therefore not appropriate to allocate the

Rs. 4.5million brand carrying amount to CGU 2 on the basis of its carrying

amount seeming low otherwise. A common way to allocate corporate assets

is based on the carrying amount of the net assets in each department.

In addition, the issue of the goodwill in CGU 1 must be addressed. As there is

a non-controlling interest and it is measured as a proportion of net assets,

the Rs. 5 million carrying amount of goodwill is parent goodwill only.

Goodwill within the recoverable amount will include all goodwill relevant to

the department and therefore the carrying amount of goodwill is notionally

increased for the non-controlling interest.

The revised carrying amount of each department is therefore as follows:

CGU1

Rs'000

CGU 2

Rs'000

CGU 3

Rs'000

PPE 30,000 46,000 16,000

Goodwill 5,000 - -

Net current assets 16,000 24,000 13,000

51,000 70,000 29,000

Brand

Rs 4.5 Mn split

51:70:29

1,530 2,100 870

Notional goodwill

20/80 5,000 1,250 - -

Carrying amount 53,780 72,100 29,870

Having established carrying amount, recoverable amount is determined.

Recoverable amount is the higher of fair value less costs of disposal and

value in use.




CA Sri Lanka 89

In the case of fair value less costs of disposal, LKAS 36 is clear that certain

costs do not constitute costs of disposal. Theses excluded costs comprise

termination benefits, and restructuring and reorganisation expenses.

Therefore the recoverable amount of each unit is as follows:

CGU 1

Rs'000

CGU 2

Rs'000

CGU 3

Rs'000

Fair value – costs of disposal 44,900 79,810 33,050

Value in use 43,950 79,500 33,500

Recoverable amount (higher) 44,900 79,810 33,500

Where carrying amount exceeds recoverable amount, an impairment loss is

recognised in profit or loss. The recoverable amount of CGUs 2 and 3 exceed

their carrying amount and therefore they are not impaired.

The recoverable amount of CGU 1 is less than its carrying amount and

therefore it is impaired. The impairment loss is Rs 53.78 Mn – Rs 44.9 Mn =

Rs. 8.88 million.

LKAS 36 requires that the impairment loss is allocated firstly to goodwill,

meaning that Rs 6.25 Mn is allocated to actual and notional goodwill. The

remaining Rs 2.63 Mn is allocated on a pro rata basis to the other assets of

the CGU that are within the scope of the standard. Note that the standard

scopes out current assets such as inventories and receivables.

Therefore the impairment loss is allocated as follows:

Pre

impairment

Rs'000

Impairment

Rs'000

Post

impairment

Rs'000

PPE (2.63 30/31.53) 30,000 (2,502) 27,498

Goodwill – actual 5,000 (5,000) 0

Goodwill – notional 1,250 (1,250) 0

Brand (2.63 1.53/31.53) 1,530 (128) 1,402

Net current assets 16,000 0 16,000

53,780 (8,880) 44,900

Amounts reported in Masham’s financial statements for the year ended 31December 20X3 are therefore as follows:

Statement of financial position

Rs'000

Property, plant and equipment

(27,498 + 46,000 + 16,000)

89,498

Brand (1,402+ 2,100 + 870) 4,372

Net current assets (16,000 + 24,000 + 13,000) 53,000




90 CA Sri Lanka

Statement of profit or loss

Rs'000

Impairment loss (8,880 – 1,250 re notional goodwill) 7,630

(3) Biological assets

A biological asset is defined as a living plant or animal and therefore both tea

bushes and dairy cattle are classified as biological assets.

It is however relevant that, with effect from 1 January 2016, LKAS 41 is

amended to identify certain types of biological asset as bearer plants. These

are living plants that:

• Are used in the production or supply of agricultural produce

• Are expected to bear produce for more than one period, and

• Have a remote likelihood of being sold as agricultural produce otherthan incidental scrap sales.

Therefore tea bushes are bearer plant biological assets; dairy cattle are not.

This distinction is important, because from 1 January 2016, bearer plants are

scoped out of LKAS 41 and will instead be accounted for as property, plant

and equipment within the scope of LKAS 16.

As regards the dairy cattle (and the tea bushes for the time being, unless

Masham chooses to adopt the LKAS 41 amendment early), LKAS 41 requires

that they are measured at fair value less costs to sell at initial recognition

and at each reporting date.

Changes in fair value are recognised as part of profit or loss for the year; they

are not recognised directly in equity.




CA Sri Lanka 91

PART B: PREPARATION AND PRESENTATION OF CONSOLIDATED FINANCIAL

STATEMENTS

Questions 7 to 11 cover the Preparation and Presentation of Consolidated

Financial Statements.

7 Glove

GLOVE GROUP

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X7

Rs Mn

Non-current assets

Property, plant and equipment 320.0

Goodwill 10.1

Other intangibles: trade name 4.0

Investments in equity instruments 10.0

Current assets: 344.1

114.0

Total assets 458.1

Equity and liabilities Equity attributable to owners of parent

Ordinary shares 150.0

Other reserves 30.7 Retained earnings 150.9

Equity reserve 1.6

333.2

Non-controlling interests 28.9

362.1

Non-current liabilities 49.0

Current liabilities: 47.0

96.0

Total equity and liabilities 458.1




92 CA Sri Lanka

Workings

GLOVE GROUP – CONSOLIDATION SCHEDULE AS AT 31 MAY 20X7

Glove Body Fit Total (W2(i)) (W2(ii)) (W3(i)) (W3 (ii)) (W4) (W5) (W6) (W7) Consolidated

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn

PPE 260 20 26 306 6 5 2 319

Goodwill 8 2.16 10.16Intangibles 5 (1) 4

Inv in B 60 60 (60) –

Inv in F 30 30 (24) (6) –

Inv in eq ins 10 10 10

C assets 65 29 20 114 114

395 79 46 520 457.16

St capital 150 40 20 210 (40) (20) 150

Other res 30 5 8 43 (4) (8) (0.2) (0.1) 30.7

Equity

reserve

1.6 1.6

Ret’d

earnings

135 25 10 170 (10) (6) (4.76) (0.8) (0.5) 2 149.94

315 70 38 423 332.24NCI 13 17.16 4.96 (6) (0.2) 28.92

361.16

Non-current

liabilities

45 2 3 50 0.1 (1.1) 49

Current

liabilities

35 7 5 47 47

80 9 8 97 96

395 79 46 520 457.16

1 Group structure

Glove

1 June 20X5 80% Retained earnings Rs 10 Mn Other reserves Rs 4 Mn

Body 1 June 20X5 70% Retained earnings Rs 6 Mn

Other reserves Rs 8 Mn

Fit %

Effective interest: 80% × 70% 56

... Non-controlling interest 44

100




CA Sri Lanka 93

2 Goodwill

Glove in Body Body in Fit

Rs Mn Rs Mn Rs Mn Rs Mn Consideration

transferred 60 (30 × 80%) 24.00 Non-controlling interests (65 × 20%) 13 (39 × 44%) 17.16 Fair value of net

assets at acq'n:

Stated capital 40 20


Other reserves 4 8

Fair value uplift – land 6 5

Trade name (W6) 5 –

(65) (39.00)

8 2.16

10.16

Note: The trade name is an internally generated intangible asset. While these are

not normally recognised under LKAS 38 Intangible assets, SLFRS 3 Business

combinations allows recognition if the fair value can be measured reliably.

Therefore an intangible asset is recognised on acquisition of Body (at 1 June

20X5). This will reduce the value of goodwill.

(i) The standing journal to recognise goodwill in Body is therefore (Rs Mn):

DEBIT Goodwill 8DEBIT Stated capital 40

DEBIT Retained earnings 10

DEBIT Other reserves 4

DEBIT PPE 6

DEBIT Intangible assets 5

CREDIT Investment in B 60

CREDIT NCI 13

To recognise the acquisition of Body.

(ii) The standing journal to recognise goodwill in Fit is therefore (Rs Mn):

DEBIT Goodwill 2.16

DEBIT Stated capital 20


DEBIT Other reserves 8

DEBIT PPE 5

CREDIT Investment in F 24

CREDIT NCI 17.16

To recognise the acquisition of Fit.




94 CA Sri Lanka

3 Allocation of post-acquisition profits and reserves to the NCI

Body Fit

Retained

earnings

Other

reserves

Retained

earnings

Other

reserves

Rs Mn Rs Mn Rs Mn Rs Mn At reporting date 25 5 10 8

At acquisition (10) (4) (6) (8)

Post-acquisition 15 1 4 -

NCI % (20% / 44%) 3 0.2 1.76

(i) These amounts are allocated to the NCI by (Rs Mn):

DEBIT Retained earnings ( 3 + 1.76) 4.76

DEBIT Other reserves 0.20

CREDIT NCI 4.96To allocate the NCI its share of retained earnings and reserves since

acquisition.

(ii) The carrying amount of the NCI is adjusted for its share of Body’s

investment in Fit (Rs Mn):

DEBIT NCI (30 × 20%) 6

CREDIT Investment in F 6

To eliminate the NCI in Body’s share of the cost of the investment in Fit.

4 Amortisation of intangible assets

The intangible assets recognised at acquisition are amortised over 10 years

therefore at the reporting date cumulative amortisation is Rs 5 Mn 2/10

years = Rs. 1 million.

The amortisation expense is allocated between the group and NCI interests

in Body. Therefore (Rs Mn)

DEBIT Retained earnings (80%) 0.8

DEBIT NCI (20%) 0.2

CREDIT Intangibles 1

To recognise amortisation of the intangible asset.

5 Defined benefit pension scheme

The amount to be recognised is as follows

Rs Mn

Loss on remeasurement through OCI on defined benefit obligation

(1.0)

Gain on remeasurement through OCI on plan assets 0.9

(0.1)




CA Sri Lanka 95

Therefore (Rs Mn):

DEBIT Other reserves Rs 0.1 Mn

CREDIT Net defined benefit liability Rs 0.1 Mn

To account for the remeasurement of the net defined benefit liability

6 Convertible loan stock

Under LKAS 32, the loan stock must be split into a liability and an equity

component:

Rs Mn Rs Mn

Proceeds: 30,000 × Rs. 1,000 30

Present value of principal in three years' time

Rs 30 Mn × 3

1

1.08

23.815

Present value of interest annuity Rs 30 Mn × 6% = Rs. 1,800,000

11.08

1.667

2

1

1.08

1.543

3

1

1.08

1.429

Liability component (28.454)

∴ Equity component 1.546

Rounded to Rs 1.5 Mn

Balance of liability at 31 May 20X7

Rs'000

Balance b/f at 1 June 20X6 28,454

Effective interest at 8% 2,276

Coupon interest paid at 6% (1,800) Balance c/f at 31 May 20X7 28,930

The accounting entries that have been made in respect of the loan stock are

(Rs Mn):

DEBIT Cash 30

CREDIT Non-current liability 30

And

DEBIT Finance cost (retained earnings) 1.8

CREDIT Cash 1.8




96 CA Sri Lanka

The accounting entries should have been (Rs Mn):

DEBIT Cash 30

CREDIT Non-current liability 28.4

CREDIT Equity reserve 1.6

AndDEBIT Finance cost 2.3

CREDIT Cash 1.8


Therefore a correction journal is (Rs Mn):

DEBIT Finance cost (retained

earnings)

0.5

DEBIT Non-current liability 1.6


CREDIT Equity reserve 1.67 Exchange of assets

The plant should be measured at initial recognition at its fair value, rather

than the carrying amount of the asset given up. An adjustment must be made

to the value of the plant, and to retained earnings.

Rs.

Fair value of plant 6 Carrying amount of land (4)

∴ Adjustment required (Rs Mn) 2

DEBIT PPE 2

CREDIT Retained earnings 2

8 Angel

ANGEL GROUP

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31.12.X8

Rs'000 Non-current assets Property, plant and equipment 200.00

Investment in Shane 133.15

333.15

Current assets 1,010.00

1,343.15

Equity attributable to owners of the parent Stated capital 500.00

Retained reserves 533.15

1,033.15

Current liabilities 310.00

1,343.15




CA Sri Lanka 97

ANGEL GROUP

CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 31.12.X8

Rs'000

Profit before interest and tax 110.00 Profit on disposal of shares in subsidiary 80.30

Share of profit of associate 2.10

Profit before tax 192.40

Income tax expense (44.00)

Profit for the year 148.40

Other comprehensive income (not reclassified to P/L) net of tax 13.00

Share of other comprehensive income of associate 1.05

Other comprehensive income for the year 14.05

Total comprehensive income for the year 162.45

Profit attributable to: Owners of the parent 146.60


148.40

Total comprehensive income attributable to: Owners of the parents 159.75


162.45

ANGEL GROUP

CONSOLIDATED RECONCILIATION OF MOVEMENT IN RETAINED RESERVES

Rs'000

Balance at 31 December 20X7 (W7) 373.40


Balance at 31 December 20X8 533.15




98 CA Sri Lanka

Workings

Consolidation schedule for Angel – statement of financial position at

31 December 20X8

Angel (W2) (W3(i)) (W6) ConsolidatedRs'000 Rs'000 Rs'000 Rs'000 Rs'000

PPE 200 200

Investment

in Shane/Ass

120 (60) 70 3.15 133.15

320 333.15

Current

assets

890 120 1,010

1,210 1,343.15

Stated capital 500 500

Retained

reserves

400 60 70 3.15 533.15

900 1,033.15

Current

liabilities

310 310

1,210 1,343.15

Consolidation schedule for Angel – statement of profit or loss and other

comprehensive income for the year ended 31 December 20X8




CA Sri Lanka 99

Angel Shane

(6/12)

Total (W2) (W3

(ii))

(W6) Consolidated

Rs'000 Rs'000 Rs'000 Rs'000 Rs'000 Rs'000 Rs'000

PBIT 100 10 110 110

Profit on

disposal

60 20.3 80.3

Share of

profit of

Shane

2.1 2.1

Tax (40) (4) (44) (44) Profit for

year

60 6 66 148.4

OCI net of

tax

10 3 13 13

Share ofOCI of

associate

1.05 1.05

TCI 70 9 79 162.45

Profit

attributable

to:

Owners of

Angel

60 4.2 64.2 60 20.3 2.1 146.6

NCI 1.8 1.8 1.8TCI

attributable

to:

Owners of

Angel

70 6.3 76.3 60 20.3 3.15 159.75

NCI 2.7 2.7 2.7

1 Timeline

1.1.X8 31.12.X8

Subsidiary – 6/12

Group gain

on disposal

Equity

account in

SOFP

30.6.X8

SOCIAssociate – 6/12




100 CA Sri Lanka

2 Parent gain on disposal

The disposal has not been recognised in Angel’s accounts. This is achieved by

(RS'000):

DEBIT Cash 120

CREDIT Investment (120/2) 60CREDIT Gain on disposal 60

To recognise the disposal in Angel’s accounts.

Note that the gain on disposal is accumulated in retained earnings in the

statement of financial position.

3 Group gain on disposal

The group gain on disposal is calculated as follows:

Rs'000

Rs'000 Fair value of consideration received 120.0

Fair value of 35% investment retained 130.0

Less share of carrying amount when control lost Net assets 190 – (18 × 6/12) 181.0

Goodwill (W4) 61.4

Less non-controlling interests (W5) (72.7)

(169.7)

80.3

This incorporates two elements:

(i) A gain of Rs. 70,000 on the revaluation of the retained holding from

cost of Rs. 60,000 to fair value of Rs. 130,000

(ii) A gain of Rs. 10.300 on the disposal.

The parent and group gains on the disposal of the 35% holding are

reconciled as follows:

Rs'000 Rs'000

Group gain on disposal 10.3

Group share of S’s profits from acquisition to disposal date

Disposal date (90 – (18 6/12)) 81

Acquisition date (10)

70% 49.7

Parent gain on disposal 60

Therefore by recognising the parent’s gain (see working 2), we have already

recognised the group gain on disposal together with 70% of the profits made

by Shane for the period that it was a subsidiary of Angel.




CA Sri Lanka 101

(i) Adjustment must, however, be made for the Rs70,000 gain on the

revaluation of the retained 35% (Rs’000):

DEBIT Investment in associate 70

CREDIT Retained earnings 70

To recognise the fair value uplift to the retained holding.

(ii) In addition for reporting purposes, the group gain on disposal rather

than the parent gain must be reported in the consolidated statement of

profit or loss (Rs’000):

DEBIT Retained earnings (80.3-60) 20.3

CREDIT Profit on disposal (SPLOCI) 20.3

To ensure that the group gain is reported in profit or loss.

Note that this journal cancels out within retained earnings; the journal

is to achieve the correct presentation only.

4 Goodwill – Shane

Rs'000 Rs'000

Consideration transferred 120.0

Non-controlling interests (FV) 51.4

Less: Stated capital 100

Retained reserves 10

(110.0) 61.4

5 Non-controlling interests at date of disposal

Rs'000 Rs'000

Non-controlling interest at acquisition (FV) 51.4

NCI share of post-acqn retained earnings (30% 71(W4)) 21.3

72.7

6 Investment in associate

The group share of the profits in the associate since 30 June 20X8 are 35% of

(6/12m Rs. 12,000) ie Rs. 2,100. The group share of OCI is 35% 6/12m

Rs. 6,000 = Rs. 1,050. These are recognised by (Rs’000):

DEBIT Investment in associate 4.20

CREDIT Share of profits of associate 3.15

CREDIT Share of OCI of associate 1.05

To recognise group share of the associate’s profits since the disposal date.

The credit entries accumulate in retained reserves in the statement of

financial position.




102 CA Sri Lanka

7 Retained reserves b/f - proof

Angel Shane Rs'000 Rs'000

Per Q 330.0 72

Less: Pre-acquisition retained reserves (10) 330.0 62

Shane – Share of post-acq. ret'd reserves (62 70%) 43.4

373.4

9 Ejoy

EJOY: CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER

COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 MAY 20X6

Rs Mn Continuing operations Revenue 4,000

Cost of sales (3,034.4)

Gross profit 965.6

Other income 77 Distribution costs (250)

Administrative expenses (190)

Finance income 5.8

Finance costs (133.9)Profit before tax 474.5

Income tax expense (226)

Profit for period from continuing operations 248.5

Discontinued operations Profit for the year from discontinued operations 13


Other comprehensive income for the year (not reclassified to P/L):

Gain on property revaluation net of tax: 94



Non-controlling interest 4.6

261.5

Total comprehensive income for the year attributable to: Owners of the parent 347.3

Non-controlling interest 8.2

355.5




CA Sri Lanka 103

Workings

Consolidation schedule for Ejoy – statement of profit or loss and other

comprehensive income for the year ended 31 May 20X6

Ejoy Zbay Tbay

(6m)

Total (W2) (W3) (W4) (W5(i)) (W5(ii)) (W6(i)) (W6(ii)) (W6(iii)) (W6(iv)) (W7) Consolidated

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn

Revenue 2,500 1,500 400 4,400 (400) 4,000

COS (1,800) (1,200) (300) (3,300) 300 (34.4) (3,034.4)

Gross profit 700 300 100 1,100 965.6

Other income

70 10 - 80 (3) 77

Distribution costs

(130) (120) (35) (285) 35 (250)

Admin expenses

(100) (90) (30) (220) 30 (190)

Finance income

1.1 2.5 1.7 0.5 5.8

Finance costs

(50) (40) (10) (100) 10 (42.2) (1.7) (133.9)

PBT 490 60 25 575 474.5

Tax (200) (26) (10) (236) 10 (226) Profit – continuing

operations

290 34 15 339 248.5

Profit – discontinued

operations

15 (2) 13

Profit for yr 290 34 15 339 261.5

OCI net of tax

80 10 4 94 94

TCI 370 44 19 433 355.5

Profit to: Owners of ejoy

(80%/60%)

290 27.2 9 326.2 (2) (3) (33.8) 0.9 2.5 (1.7) 1.7 0.5 (34.4) 256.9

NCI (20%/40%) 6.8 6 12.8 (8.4) 0.2 4.6

TIC to: Owners of Ejoy

(80%/60%)

370 35.2 11.4 416.6 (2) (3) (33.8) 0.9 2.5 (1.7) 1.7 0.5 (34.4) 347.3

NCI (20%/40%)

8.8 7.6 16.4 (8.4) 0.2 8.2

1 Group structure

Ejoy

160200 = 80% 72120 = 60% (owned for six months)

Zbay Tbay

Tbay is a discontinued operation (SLFRS 5).




104 CA Sri Lanka

Timeline

1.6.X5 1.12.X5 31.5.X6

Ejoy

Zbay

Tbay

2 Tbay

Tbay has been classified as a discontinued operation and therefore its profits

must be presented as a single line item in the statement of profit or loss

(Rs Mn):

DEBIT Revenue 400

CREDIT Cost of sales 300

CREDIT Distribution costs 35

CREDIT Administrative expenses 30

CREDIT Finance costs 10

CREDIT Tax 10

CREDIT Profit from discontinued

operations

15

To reclassify items of Tbay’s income and expenses as profits of discontinued

operations.

3 Re-measurement of Tbay

As Tbay is a disposal group, it is measured in accordance with SLFRS 5 at the

lower of fair value less costs to sell and carrying amount.

When comparing these amounts, care must be taken to ensure that like is

being compared with like; we are given the fair value of the whole of Tbay

and therefore must ensure that costs to sell and carrying amount (including

goodwill) also represent 100% of Tbay.

Fair value less costs to sell

Rs Mn

Fair value 344

Costs to sell 100/60% x 5 (8.3)

335.7




CA Sri Lanka 105

Carrying amount

Rs Mn

Fair value of net assets at acquisition (1 December 20X5) 310

Post-acquisition TCI (38 6/12) 19

Notional (unrecognised) NCI goodwill 100/60% x 6 (W4) 10 339

Working: Goodwill in Tbay

Rs Mn

Consideration transferred 192

NCI (310m 40%) 124

Fair value of net assets at acquisition (310)

6

Therefore an impairment loss of Rs 339 Mn – Rs 335.7 Mn = Rs 3.3 Mnarises. This is allocated against goodwill. As 60% of total goodwill is

recognised in the consolidated financial statements, 60% of the impairment

loss is recognised (Rs Mn):

DEBIT Profits of discontinued

operations (60% Rs 3.3 Mn)

2

CREDIT Assets of disposal group

(SOFP)

2

To recognise the impairment loss in Tbay.

The loss is allocated to the owners of the parent company.

4 Investment in joint venture

A gain of Rs. 6million has been recognised on a disposal to a joint venture.

LKAS 28 requires that only that part of the gain that is attributable to other

investors is recognised. Therefore 50% of the gain (Rs 3 Mn) is eliminated

against the cost of investment in the joint venture (Rs Mn):

DEBIT Other income 3

CREDIT Investment in joint venture 3

To eliminate the gain attributable to Ejoy against the investment in the joint

venture.

The adjustment is attributable to the owners of the parent company.




106 CA Sri Lanka

5 Loan asset

The loan asset was impaired at the start of the year.

Rs Mn

Carrying amount of loan at 1.6.X5 (a financial asset) 60.0

Impairment loss (balancing figure) (42.2) Present value of expected future cash flows 17.8 (20 1/1.062 ) 1.6.X5

(i) The loss is recognised by:

DEBIT Finance costs 42.2

CREDIT Loan asset 42.2

To recognise the impairment of the loan asset in Zbay.

The loan is held by Zbay and therefore the impairment loss is allocated

between the owners of Ejoy and the NCI in Zbay in proportion to their

ownership interests.

(ii) Interest income is recognised on the loan asset, calculated based on the

impaired amount:

Interest income (6% 17.8) 1.1

This is recognised by:

DEBIT Loan asset 1.1

CREDIT Finance income 1.1

To recognise income on the loan asset.

The loan is held by Zbay and therefore the income is allocated between

the owners of Ejoy and the NCI in Zbay in proportion to their

ownership interests.

6 Hedged bond

The carrying amount of the hedged bond at the period end is calculated as:

Rs Mn

1.6.X5 50.0 Interest income (5% × 50) 2.5

Interest received (2.5)

Fair value loss (balancing figure) (1.7)

Fair value at 31.5.X6 (per question) 48.3

(i) The interest income is recognised by (Rs Mn):

DEBIT Bond /cash 2.5


To recognise income on the bond.




CA Sri Lanka 107

(ii) The fair value loss is recognised by (Rs Mn):


CREDIT Bond 1.7

To recognise the remeasurement of the bond to fair value.

(iii) Since the interest rate swap is 100% effective as a fair value hedge, it

exactly offsets the loss in value of Rs. 1.7 million on the bond. Therefore

finance income of this amount is recognised by (Rs Mn):

DEBIT Swap financial asset 1.7


To recognise the swap at fair value at the reporting date.

(iv) The net settlement of interest is recognised by:

DEBIT Cash 0.5


To recognise settlement of interest.

All amounts recognised in profit or loss in respect of the bond are

allocated to owners of the parent, since the bond is held by Ejoy.

7 Impairment of Zbay

Zbay is tested for impairment by comparing the carrying amount of the

investment in the consolidated financial statements with its recoverable

amount of Rs. 630m.

Carrying amount

Rs Mn Fair value of net assets at acquisition (1 June 20X4) 600

Post-acquisition TCI(20 + 44) 64

Impairment of loan asset (W5) (42.2)

Interest income on loan asset 1.1

Notional (unrecognised) NCI goodwill 100/80% x 40 (W8) 50

672.9 Therefore an impairment loss of Rs 672.9 Mn – Rs 630 Mn = Rs 42.9 Mn

arises. This is allocated against goodwill. As 80% of total goodwill is

recognised in the consolidated financial statements, 80% of the impairment

loss is recognised (Rs Mn):

DEBIT Cost of sales (80% × Rs 42.9 Mn) 34.4

CREDIT Goodwill 34.4

To recognise the impairment loss in Zbay

The loss is allocated to the owners of the parent company.




108 CA Sri Lanka

8 Goodwill in Zbay

Rs Mn


NCI (310m 40%) 120

Fair value of net assets at acquisition (600) 40

10 Memo

MEMO

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AT 30 APRIL 20X4

Rs Mn

Assets Property, plant and equipment: 366.5

Goodwill 8

Current assets 403

777.5

Equity and liabilities Equity attributable to owners of the parent: Stated capital 110

Foreign exchange reserve 11.2

Retained earnings 362

483.2

Non-controlling interest 18

501.2


Current liabilities: 232.7

777.5




CA Sri Lanka 109

MEMO

CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE

INCOME FOR THE YEAR ENDED 30 APRIL 20X4

Rs Mn

Revenue 250.8 Cost of sales (153)

Gross profit 97.8 Distribution costs and administrative expenses (38)

Impairment of goodwill (2)

Interest receivable 4

Finance costs (0.8)

Exchange gains 1.5

Profit before tax 62.5

Income tax expense (23.6)Profit for the year 38.9

Other comprehensive income (items that may subsequently be

reclassified to profit or loss) Exchange differences on foreign operations 13.1


Profit attributable to Owners of the parent 37.0

Non-controlling interest (25% 7.9) (W4) 1.9

38.9 Total comprehensive income for the year attributable to

Owners of the parent 47.2

Non-controlling interest (7.9 + 9.7) 25% 4.8

52.0




110 CA Sri Lanka

Workings

Consolidation schedule – consolidated statement of financial position at 30 April 20X4

Memo Random

(W2)

Total (W6(i)) (W6(ii)) (W6(iii)) (W7) (W8(ii)) (W8(iii)) Consolidated

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn PPE 297 69.5 366.5 366.5

Goodwill 8.4 1.6 (2) 8

Inv in R 48 48 (48) –

Loan to R 5 5 (5)

C assets 355 48.6 403.6 (0.6) 403

705 118.1 823.1 777.5

St capital 110 20.8 130.8 (20.8) 110

FX reserve

11.5 11.5 1.6 (1.9) 11.2

Ret’d earnings

360 39.5 399.5 (32) (2) (2.9) (0.6) 362

470 71.8 541.8 483.2 NCI 13.2 4.8 18

501.2

Non current

liabilities

30 18.6 48.6 (5) 43.6

Current liabilities

205 27.7 232.7 232.7

235 46.3 281.3 276.3

705 118.1 823.1 777.5

Consolidation schedule – consolidated statement of profit or loss and other

comprehensive income for the year ended 30 April 20X4Memo Random Total (W6(ii)) (W6(iii)) (W8(i)) W8(ii)) Consolidated

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Revenue 200 56.8 256.8 (6) 250.8

Cost of sales (120) (38.4) (158.4) 6 (0.6) (153)

Gross profit 80 18.4 98.4 97.8

Expenses (30) (8) (38) (38)

Impairment of

goodwill

(2) (2)

Interest receivable

4 4 4

Interest payable – (0.8) (0.8) (0.8)

Exchange gains

____

1.5

1.5

1.5

PBT 54 11.1 65.1 62.5

Tax (20) (3.6) (23.6) (23.6)

Profit for the year

34 7.5 41.5 38.9

OCI 11.5 11.5 1.6 13.1

TCI 34 19 53 52

Profit attributable to:

Owners of M 34 5.6 39.6 (2) (0.6) 37

NCI 1.9 1.9 1.9

TCI attributable to:

Owners of M 34 14.2 48.2 1.6 (2) (0.6) 47.2

NCI 4.8 4.8 4.8




CA Sri Lanka 111

1 Group structure

Memo

1 May 20X3 75%

Random

2 Exchange differences arising in Random’s separate financial statements

(i) Memo loaned Random Rs. 5 million at the start of the year and Random

recorded this at Rs 5 Mn 2.5 = CR 12.5 million.

In Random’s accounts, at the year-end, the loan is retranslated using

the closing rate to Rs 5 Mn 2.1 = CR 10.5 million.

The gain is recognised by (CR Mn):

DEBIT Loan account 2CREDIT Exchange difference (profit or loss) 2

To recognise the gain on retranslation of the loan.

(ii) Memo sold Random goods from Rs 6 Mn during the year and Random

recorded the purchase and current liability at Rs 6 Mn 2.5 =

CR 15 Mn.

DEBIT Purchases 15

CREDIT Current liabilities 15

To recognise the purchase of goods at the spot rate.

Random paid the outstanding balance when the exchange rate was

2.2:1 and recorded the transaction by:

DEBIT Current liabilities (6 2.2) 13.2

CREDIT Cash 13.2

To recognise the payment of the balance outstanding at the spot rate

on settlement date.

Therefore a credit balance of CR 1.8m (15m – 13.2m) remains incurrent liabilities. This must be transferred to be recognised as an

exchange gain by:

DEBIT Current liabilities 1.8

CREDIT Exchange gain 1.8

To recognise the exchange gain on settlement.

The total exchange gain is therefore CR 3.8m

Cost = 120m crowns

PAR = 80m crowns




112 CA Sri Lanka

3 Translation of statement of profit or loss and other comprehensive income

CR Mn Rate Rs Mn

Revenue 142 2.5 56.8

Cost of sales (96) 2.5 (38.4)

Gross profit 46 18.4 Distribution and administrative

expenses

(20) 2.5 (8)

Interest payable (2) 2.5 (0.8)

Exchange gain (W2) 3.8 2.5 1.5

Profit before tax 27.8 11.1

Income tax expense (9) 2.5 (3.6)

Profit/total comprehensive income

for the year

18.8 7.5

OCI (W5) 11.5 Total comprehensive income for

the year

19.0

4 Translation of statement of financial position

CR Mn Rate Rs Mn Property, plant and equipment 146.0 2.1 69.5

Current assets 102.0 2.1 48.6

248.0 118.1

Stated capital 52.0 2.5 20.8

Retained earnings: Pre-acquisition 80.0 2.5 32.0

Post-acquisition: 15 + 3.8 (W2) 18.8 2.5 7.5

FX reserve (W5) 11.5

71.8

Non-current liabilities (41 – 2

(W2(i)))

39.0 2.1 18.6

Current liabilities (60 - 1.8

(W2(ii)))

58.2 2.1 27.7

248.0 118.1

5 Exchange difference on translation of financial statements

Rs Mn Rs Mn

Opening net assets at opening rate (52+80)/2.5 52.8 Opening net assets at closing rate (52+80)/2.1 62.9 Gain 10.1 Retained profit at average rate (18.8/2.5) 7.5

Retained profit at closing rate (18.8/2.1) 8.9

Gain 1.4

Gain on translation 11.5




CA Sri Lanka 113

In accordance with LKAS 21 the gain on translation of the financial

statements is recognised as other comprehensive income of the subsidiary

and accumulated in a separate foreign exchange reserve of the subsidiary.

6 Goodwill

CR Mn Rate Rs Mn Consideration transferred 120.0 2.5 48

Non-controlling interests (132 25%) 33.0 2.5 13.2

Less fair value of net assets at acq'n: Share capital 52 2.5 (20.8)

Retained earnings 80 2.5 (32)

21.0 8.4

Impairment losses (4.2) 2.1 (2.0)

FX gain – 1.6 At 30.4.X4 16.8 2.1 8.0

(i) Goodwill is recognised on the acquisition of Random by (Rs Mn):

DEBIT Goodwill 8.4

DEBIT Share capital 20.8


CREDIT Investment in Random 48

CREDIT NCI 13.2

To recognise goodwill on the acquisition of Random.

(ii) The goodwill is retranslated to Rs 10 Mn using the closing rate at the

period end (CR 21 Mn/2.1). The gain is recognised as other

comprehensive income (Rs Mn):

DEBIT Goodwill 1.6

CREDIT Other comprehensive income 1.6

To retranslate goodwill to the closing rate.

Goodwill is attributable to the parent company only as the NCI is

measured as a proportion of net assets; therefore the gain is

attributable to the owners of the parent company and accumulated in

the foreign exchange reserve.

(iii) The impairment loss of CR 4.2 Mn is recognised at the period end by

(Rs Mn):

DEBIT Impairment loss (4.2m/2.1) 2

CREDIT Goodwill 2

To recognise the impairment loss in goodwill.

The loss is again attributable to the owners of the parent company

only, and accumulated in retained earnings.




114 CA Sri Lanka

7 Allocate profits and OCI since acquisition to the NCI

25% of the Rs 7.5 Mn profits (W4) since acquisition as reported by Random

are allocated to the NCI. In addition 25% of the Rs 11.5 Mn other

comprehensive income is allocated.

By (Rs Mn):

DEBIT Retained earnings (7.5m × 25%) 1.9

DEBIT FX reserve (11.5m × 25%) 2.9

CREDIT NCI 4.8

To allocate a share of profits and OCI since acquisition to the NCI.

8 Intragroup transactions

(i) During the year Memo sold goods to Random for Rs. 6m. These were

translated at the spot rate and recognised at CR 15 Mn by Random. At theperiod end expenses are translated to the presentation currency using the

average rate for the year and these purchases translate to CR15 Mn/2.5 =

Rs 6 Mn. Therefore the sales and purchases are eliminated by (Rs Mn):

DEBIT Revenue 6


To eliminate intragroup sales.

(ii) As some of the items remain in stock at the period end, an unrealised

profit arises of Rs 6 Mn 20% ½ = Rs. 0.6 million. This is eliminated

by (Rs Mn):

DEBIT Cost of sales 0.6

CREDIT Current assets 0.6

To eliminate the unrealised profit.

The selling company was the parent and therefore the additional

expense in profit or loss is allocated to the owners of the parent and

accumulated in retained earnings.

(iii) The intragroup loan must be eliminated. Memo has recognised a loan

asset of Rs 5 Mn and Random, on receiving the loan, recorded it at

Rs 5 Mn × 2.5 = CR 12.5 Mn. At the period end this is retranslated in

Random’s accounts using the closing rate to Rs 5 × 2.1 = CR 10.5 Mn

(W2). Then on translation of Random’s accounts to the presentation

currency, the loan is translated to CR 10.5 Mn/2.1 = Rs 5 Mn

Therefore to eliminate the loan (Rs Mn):

DEBIT Non-current liabilities 5CREDIT Loan asset 5

To eliminate the intragroup loan.




CA Sri Lanka 115

11 Swing

Rs'000 Rs'000 Cash flows from operating activities Profit before tax

16,500

Adjustments for: Depreciation 5,800

Impairment losses (W1) 240

22,540

Increase in trade receivables (W4) (1,700)

Increase in inventories (W4) (4,400)

Increase in trade payables (W4) 1,200

Cash generated from operations 17,640

Income taxes paid (W3)

(4,200) Net cash from operating activities 13,440

Cash flows from investing activities Acquisition of subsidiary net of cash acquired (600)

Purchase of property, plant and equipment (W1) (13,100)

Net cash used in investing activities (13,700)

Cash flows from financing activities Proceeds from issue of share capital (W2) 2,100 Dividends paid (W2) (900)

Dividends paid to non-controlling interest (W2) (40)

Net cash from financing activities 1,160

Net increase in cash and cash equivalents 900

Cash and cash equivalents at the beginning of the period 1,500

Cash and cash equivalents at the end of the period 2,400

Workings

1 Assets

Property,

plant and

equipment GoodwillRs'000 Rs'000

b/f 25,000 –

OCI (revaluation) 500

Depreciation/ Impairment – balancing figure (5,800) (240)

Acquisition of sub/assoc 2,700 1,640 (W5)

Cash paid/(rec'd) – balancing figure 13,100 –

c/f 35,500 1,400




116 CA Sri Lanka

2 Equity

Share

capital

Retained

earnings

Non-

controlling

interest

Rs'000

Rs'000

Rs'000 b/f 12,000 21,900 –

SPLOCI 11,100 350

Acquisition of subsidiary 4,000 1,440 (W5)

Cash (paid)/rec'd – balancing

figure

2,100 (900)* (40)

c/f 18,100 32,100 1,750

*Dividend paid is given in question but working shown for clarity.

3 Liabilities

Tax payableRs'000

b/f 4,000

SPLOCI 5,200

Acquisition of subsidiary 200-

Cash (paid)/rec'd – balancing figure (4,200)

c/f 5,200

4 Working capital changes

Inventories Receivables Payables

Rs'000 Rs'000 Rs'000 Balance b/f 10,000 7,500 6,100

Acquisition of subsidiary 1,600 600 300

11,600 8,100 6,400

Increase/(decrease) – balancing

figure

4,400 1,700 1,200

Balance c/f 16,000 9,800 7,600

5 Purchase of subsidiary

Rs'000

Cash received on acquisition of subsidiary 400 Less cash consideration (1,000)

Cash outflow (600)

Note. Only the cash consideration is included in the figure reported in the

statement of cash flows. The shares issued as part of the consideration are

reflected in the share capital working (W2) above.

Goodwill on acquisition (before impairment):

Rs'000

Consideration 5,000

Non-controlling interest: 4,800 × 30% 1,440 Net assets acquired (4,800)

Goodwill 1,640




CA Sri Lanka 117

PART C: ANALYSIS, INTERPRETATIONS AND COMMUNICATION OF

FINANCIAL RESULTS

Questions 12 to 13 cover Analysis, Interpretations and Communication of

Financial Results.

12 Ghorse

(a) The criteria in SLFRS 5 Non-current assets held for sale and discontinued

operations have been met for Cee and Gee. As the assets are to be disposed of

in a single transaction, Cee and Gee together are deemed to be a disposal

group under SLFRS 5.

The disposal group as a whole is measured on the basis required for non-

current assets held for sale. Any impairment loss reduces the carryingamount of the non-current assets in the disposal group, the loss being

allocated in the order required by LKAS 36 Impairment of assets. Before the

manufacturing units are classified as held for sale, impairment is tested for

on an individual, cash generating unit basis. Once classified as held for sale,

the impairment testing is done on a disposal group basis.

A disposal group that is held for sale should be measured at the lower of its

carrying amount and fair value less costs to sell. Immediately before

classification of a disposal group as held for sale, the entity must recognise

impairment in accordance with applicable SLFRS. Any impairment loss is

generally recognised in profit or loss, but if the asset has been measured at a

revalued amount under LKAS 16 Property, plant and equipment or LKAS 38

Intangible assets, the impairment will be treated as a revaluation decrease.

Once the disposal group has been classified as held for sale, any impairment

loss will be based on the difference between the adjusted carrying amounts

and the fair value less cost to sell. The impairment loss (if any) will be

recognised in profit or loss.

A subsequent increase in fair value less costs to sell may be recognised inprofit or loss only to the extent of any impairment previously recognised. To

summarise:

Step 1 Immediately prior to classification as held for sale (on 30

September 20X7), calculate carrying amount under the individual

standard, here given as Rs. 105m.

Step 2 Classify as held for sale. Compare the carrying amount (Rs. 105m)

with fair value less costs to sell (Rs. 125m). Measure at the lower

of carrying amount and fair value less costs to sell, here Rs. 105m.




118 CA Sri Lanka

Step 3 At 31 October 20X7 determine fair value less costs to sell (see

below) and compare with carrying amount of Rs. 105m.

Ghorse has not taken account the increase in fair value less costs

to sell, but only part of this increase can be recognised, calculated

as follows.

Rs Mn Fair value less costs to sell: Cee 40

Fair value less costs to sell: Gee 95

135

Carrying amount (105)

Increase 30

Impairment previously recognised in Cee: Rs 15 Mn

(Rs 50 Mn – Rs 35 Mn)

Step 4 The change in fair value less costs to sell is recognised but the

gain recognised cannot exceed any impairment losses to date.

Here the gain recognised is Rs 50 Mn – Rs 35 Mn = Rs 15 Mn

Therefore carrying amount can increase by Rs 15 Mn to Rs 120 Mn as loss

reversals are limited to impairment losses previously recognised (under

SLFRS 5 or LKAS 36).

After adjusting for the increase in fair value less costs to sell, profit for the

year increases to Rs 45 Mn and capital employed increases to Rs 235 Mn;

ROCE can therefore be recalculated as 19%. This adjustment therefore

results in a significant improvement to ROCE.

(b) LKAS 12 Income taxes requires that deferred tax liabilities are recognised for

all taxable temporary differences. Deferred tax assets are recognised for

deductible temporary differences to the extent that taxable profits will be

available against which the deductible temporary differences may be utilised.

The differences between the carrying amounts and the tax base represent

temporary differences. These temporary differences are revised in the light of

the revaluation for tax purposes to fair value permitted by the government.

Deferred tax liability before revaluation

Carrying Taxable temporary

amount Tax base difference

Rs Mn Rs Mn Rs Mn

Property 50 48 2

Vehicles 30 28 2

4

Other taxable temporarydifferences 5

9




CA Sri Lanka 119

Deferred tax liability: 30% Rs 9 Mn = Rs 2.7 Mn

Deferred tax asset after revaluation

Carrying Deductible

temporary

amount Tax base differenceRs Mn Rs Mn Rs Mn

Property 50 65 15

Vehicles 30 35 5

Other taxable temporary

differences

(5)

15

Deferred tax asset: Rs 15 Mn 30% = Rs 4.5 Mn

This will have a considerable impact on ROCE. While the reversal of the

liability of Rs 2.7 Mn and the creation of the asset of Rs 4.5 Mn do not affect

the numerator, profit before interest and tax (although it will affect profit or

loss for the year), capital employed increases by Rs 7.2 Mn. Therefore ROCE

can be recalculated (after the effects of this adjustment alone, and ignoring

issue (a)) to be 13.2% (Rs 30 Mn/Rs 227.2 Mn). Therefore ROCE decreases

as a result of this adjustment.

(c) LKAS 36 Impairment of assets requires that no asset should be carried at

more than its recoverable amount. At each reporting date, Ghorse must

review all assets for indications of impairment, i.e. indications that thecarrying amount may be higher than the recoverable amount. Such

indications include fall in the market value of an asset or adverse changes in

the technological, economic or legal environment of the business. (LKAS 36

has an extensive list of criteria.) These indications may also be identified

during the accounting period. If impairment is indicated, either at the

reporting date or during the accounting period, then the asset's recoverable

amount must be calculated immediately. Here the manufacturer has reduced

the selling price, but this does not automatically mean that the asset is

impaired.

The recoverable amount is defined as the higher of the asset's fair value less

costs to sell and its value in use. If the recoverable amount is less than the

carrying amount, then an impairment loss is recognised. Unless the asset in

question has been revalued, this impairment loss is recognised in profit or

loss as an expense.

Value in use is the discounted present value of estimated future cash flows

expected to arise from the continuing use of an asset and from its disposal at

the end of its useful life. The value in use of the equipment is calculated asfollows:




120 CA Sri Lanka

Year ended 31 October Cash flows Discounted (10%)

Rs Mn Rs Mn

20X8 1.3 1.2

20X9 2.2 1.8

20Y0 2.3 1.7 Value in use 4.7

The fair value less costs to sell of the asset is estimated at Rs 2 Mn. The

recoverable amount must be the value in use of Rs. 4.7m, as this is higher.

Since the recoverable amount is higher than the carrying amount of Rs. 3m

(Rs 4 Mn 75%), the asset is not impaired.

Consequently there will be no effect on ROCE as neither capital employed

not profit before interest and tax is adjusted.

(d) The manufacturing property was held under an operating lease. LKAS 17Leases requires that operating lease payments are charged to profit or loss

over the term of the lease, generally on straight line basis.

The renegotiation of the lease means that its terms have changed

significantly, and it now falls to be classified as a finance lease. Reasons for

reclassification are as follows.

(i) The lease is for the major part of the economic life of the assets.

(ii) At the inception of the lease, the present value of the minimum lease

payments is Rs 5 mn 6.8137 = Rs 34.1 Mn. The fair value of the asset

is Rs 35 mn. Thus the present value of the minimum lease payments is

substantially all the fair value of the asset.

(iii) A finance lease does not require transfer of legal title.

Since the lease is now a finance lease, it is recognised as both an asset and an

associated finance lease obligation in the statement of financial position.

Both items are measured at the lower of fair value (Rs 35 Mn) and present

value of the minimum lease payments (Rs 34.1 Mn), ie at Rs 34.1 Mn. Since

both assets and liabilities increase, the effect on capital employed is nil and

this reclassification does not affect ROCE in the current year.




CA Sri Lanka 121

Cumulative effects of adjustments on ROCE

Rs Mn

Profit before interest and tax 30.0

Add increase in fair value less costs to sell of disposal group 15.0

45.0 Capital employed 220.0

Add increase in fair value less costs to sell of disposal group 15.0

Add reversal of deferred tax liability and recognition of deferred tax asset: 4.5 + 2.7 7.2

242.2

ROCE is 45/242.2 = 18.6%

The directors were concerned that the above changes would adversely affect

ROCE. In fact, the effect has been favourable, as ROCE has risen from 13.6%

to 18.6%, so the directors' fears were misplaced.

13 Commonsizing

(1) Common size statements

20X1 20X0 % %

Revenue 100.0 100.0

Cost of sales 72.0 69.5

Gross profit 28.0 30.5

Distribution costs 2.9 2.2

Administrative expenses 13.3 13.6

Operating profit 11.8 14.7

Interest payable 2.0 1.4

Profit before tax 9.8 13.3

Tax 3.2 4.1

Profit for the year 6.6 9.2

Dividends paid2.8 3.1

(2) Assessment of performance

Before looking at the information conveyed by the common size statements,

it should be noted that the absolute level of activity, as measured by revenue,

has increased by 16.9% from 20X0 to 20X1.

Turning to the common size statements, the following aspects of

performance in 20X1, as compared with that in 20X0, may be noted:




122 CA Sri Lanka

There is a significant fall in the gross profit margin, from 30.5% to

28%. The reasons behind the increased cost of sales need further

analysis and investigation. It may be that the number of units sold has

increased by a greater percentage than the 16.9% increase in revenue

as a result of a reduction in selling prices. If this is the case, andvolumes have increased by more than 16.9% but costs have not fallen,

it follows that costs will increase by a greater amount than revenue.

Relatively, distribution costs have increased, whilst administrative

expenses have fallen, resulting in a small increase in operating expense

percentage from 15.8% to 16.2%. Further analysis of these costs

between their fixed and variable elements will help to determine the

underlying causes of the changes. Although the increase in distribution

costs may be related to poor cost control or inefficient distribution

networks, it may equally be the case that the increase in these costs is

related to the increase in revenue and results from operating in a new

market. This would be beneficial for the company in the long term,

despite the immediate negative effect.

The total operating profit margin has fallen from 14.7% to 11.8%. This

is as a result of the increase in cost of sales and distribution costs as a

percentage of revenue, as discussed above.

Interest payable has increased from 1.4% (interest cover = 10.4 times)

to 2.0% (interest cover = 5.8 times). The extent to which this is due to

increases in interest rates and to increases in the amounts of

borrowing would be apparent from the statement of financial position.

If the increase is the result of increased borrowing levels, the reason

for the borrowings should be investigated; these may be related to

product or market development and be beneficial for the company in

the long-term.

There is a fall in the tax charge as a percentage of sales; however, this is

not a particularly helpful measure, as the tax charge is based upon

profits. Looking instead at the effective rate of tax on profits, an

increase from 30.6% in 20X0 to 32.5% in 20X1 is observed. Tax is,

however, outside the control of the company.

Again, whilst the level of dividends as a percentage of sales has fallen in

20X1, this is misleading. As a percentage of profits, dividends have

risen from 34% (dividend cover = 2.9 times) to 42.4% (dividend cover

= 2.4 times). This is likely to be in line with a policy of steadily

increasing dividends to maintain shareholder confidence and thusmarket value.




CA Sri Lanka 123

(3) Limitations

Limitations in general of using common size statements as an analysis of

performance include

Common size statements conceal underlying changes in absolutemeasures that may be of significance, erg the level of activity as

measured by revenue

The expression of figures as a percentage of sales is not appropriate in

some cases, and can be misleading. Examples of this are seen in (b) in

the cases of tax and dividends

As with all ratio analysis, care must be taken not to look at percentages,

and changes thereon, in isolation of the environment within which they

were generated. For example, it would be useful to look at the changes

highlighted in (b) in comparison with those of the industry within

which the company operates, or with other similar firms.

Using common size statements to analyse performance over a ten-year

period will have limitations that are brought about by changes in the

internal and external environment over the period, which are not reflected

in the percentage figures, including factors such as:

Market and competition

Relative price levels and other economic factors

Taxation legislation

Product range and mix

Group structure – acquisitions, disposals etc.

Accounting issues

(4) Criticism of statements

(i) The current and quick ratios provide an indication of a company’s

liquidity position. This does help with an assessment of whether a

company can meet its short-term liabilities as they fall due – for

example trade payables and other amounts due within a year. It will

not, however provide an indication of whether a company is in a

position to meet its longer-term debt commitments. For example a

bank loan due for repayment 13 months after a reporting date is not

considered in the calculation of the current and quick ratios; these may

reveal healthy liquidity, which is not representative of the true

position.

The assertion that the ‘higher these ratios are the better placed the

company is’ should also be considered.




124 CA Sri Lanka

Whilst liquidity ratios of 1 to 1.5 indicate that a company has sufficient

current assets to meet current liabilities as they fall due, an excessively

high current ratio means that resources are tied up in inventory,

receivables and cash instead of producing profits. Current assets

should generally be kept as low as is compatible with efficientproduction and paying liabilities as they fall due.

Liquidity ratios are also affected by the type of industry that a company

operates within. For example, companies in the service industry that

have no inventory are likely to have low liquidity ratios. Equally large

retailers are unlikely to have trade receivables (as customers are not

given credit) and they invest cash in long-term assets rather than

retain it, however they do have high levels of trade payables. This

business model results in very low liquidity ratios, however it must be

remembered that on any given trading day, the retailer will receive

cash from customers and therefore a low ratio should not immediately

be viewed as an indicator that it cannot pay amounts it owes.

(ii) There is some truth in this statement; high gearing refers to a high level

of debt, and where the borrowed money has been invested in

profitable projects, it may result in immediate dividend growth for

shareholders, together with longer-term capital growth as income

levels grow. This outcome is, however, dependent on borrowed funds

being invested in such profitable projects. As well as the potential for

high returns, high gearing means greater risk for the shareholders.

By taking on debt, a company is committing to pay its lenders interest,

and eventually repay the principal. Where invested funds do not

increase profits and cash flows, it may be that the shareholders’

dividends are cut to meet these obligations. In some cases high levels

of debt, which are not invested wisely, will even result in the failure of

a company.




CA Sri Lanka 125

PART D: CORPORATE GOVERNANCE AND RECENT DEVELOPMENTS IN

FINANCIAL REPORTING

Questions 14 to 15 cover Corporate Governance and Recent Developments in

Financial Reporting.

14 Calcula

(1) Benefits of integrated reporting at Calcula

Confusion

As a result of the recent management changes at Calcula, the company has

struggled to communicate its 'strategic direction' to key stakeholders. The

company's annual accounts have made it hard for shareholders tounderstand Calcula's strategy, which in turn has led to confusion.

Uncertainty among shareholders and employees is likely to increase the risk

of investors selling their shares and talented IT developers seeking

employment with competitors.

Communicating strategy

The introduction of integrated reporting may help Calcula to overcome these

issues as it places a strong focus on the organisation's future orientation. An

integrated report should detail the company's mission and values, the nature

of its operations, along with features on how it differentiates itself from its

competitors.

Including Calcula's new mission to become the market leader in the

specialist accountancy software industry would instantly convey what the

organisation stands for.

In line with best practice in integrated reporting, Calcula could supplement

its mission with how the board intend to achieve this strategy. Such detail

could focus on resource allocations over the short to medium term. For

example, plans to improve the company's human capital through hiring

innovative software developers working at competing firms would help to

support the company's long term mission. To assist users in appraising the

company's performance, Calcula should provide details on how it will

measure value creation in each 'capital'. 'Human capital' could be measured

by the net movement in new joiners to the organisation compared to the

previous year.

A key feature of integrated reporting focuses on the need for organisations

to use non-financial customer-oriented key performance measures (KPIs) to

help communicate the entity's strategy. The most successful companies in




126 CA Sri Lanka

Calcula's industry are committed to enhancing their offering to customers

through producing innovative products. Calcula could report through the use

of KPIs how it is delivering on this objective, measures could be set which for

example measure the number of new software programs developed in the

last two years or report on the number of customer complaints concerningnewly released software programs over the period.

Improving long term performance

The introduction of integrated reporting may also help Calcula to enhance its

performance. Historically, the company has not given consideration to how

decisions in one area have impacted on other areas. This is clearly indicated

by former CEO's cost cutting programme, which served to reduce the staff

training budget. Although, this move may have enhanced the company's

short-term profitability, boosting financial capital, it has damaged long termvalue creation.

The nature of the software industry requires successful organisations to

invest in staff training to ensure that the products they develop remain

innovative in order to attract customers. The decision to reduce the training

budget will most likely impact on future profitability if Calcula is unable to

produce what software customers' demand.

Finance Director's comments

As illustrated in the scenario, the Finance Director's comments indicate a

very narrow understanding of how the company's activities and 'capitals'

interact with each other in delivering value. To dismiss developments in

integrated reporting as simply being a 'fad', suggest that the Finance Director

is unaware of the commitment of many accounting bodies in promoting its

introduction.

However, some critics refute this and argue that the voluntary nature of

integrated reporting increases the likelihood that companies will choose not

to pursue its adoption. Such individuals highlight that until companies arelegally required to comply with integrated reporting guidelines, many will

simply regard it as an unnecessary effort and cost.

The Finance Director's assertion regarding shareholders is likely to some

degree to be correct. Investors looking for short-term results from an

investment might assess Calcula's performance based on improvements in

profitability. However, many shareholders will also be interested in how the

board propose to create value in the future. Ultimately, Calcula's aim to

appease both groups is its focus on maximising shareholder value, the

achievement of which requires the successful implementation of both short

and long term strategies.




CA Sri Lanka 127

Furthermore, unlike traditional annual reports, integrated reports highlight

the importance of considering a wider range of users. Key stakeholder

groups such as Calcula's customers and suppliers are likely to be interested

in assessing how the company has met or not met their needs beyond the

'bottom line'. Integrated reporting encourages companies to reportperformance measures that are closely aligned to the concepts of

sustainability and corporate social responsibility. This is implied by the

different capitals used: consideration of social relationships and natural

capitals do not focus on financial performance but instead are concerned, for

example, with the impact an organisation's activities have on the natural

environment.

Ultimately, as integrated reporting provides senior management with a

greater quantity of organisational performance data this should help in

identifying previously unrecognised areas which are in need of

improvement.

Clearly, a major downside to generating extensive additional data concerns

determining which areas to report on. This is made especially difficult as

there is no recognised criteria for determining the level of importance of

each 'capital'. As we shall explore in part (b), the Finance Director's remark

regarding the increase in the Calcula's employee workload to comply with

integrated reporting practices may have some merit.

It is debatable as to whether the production of an integrated report

necessarily leads to an improvement in organisational performance or

whether it simply leads to an improvement in the reporting of performance.

However, focusing management's attention on the non-financial aspects of

Calcula's performance as well as its purely financial performance, could be

expected to lead to performance improvements in those areas. For example,

if innovation is highlighted as a key factor in sustaining Calcula's long-term

value, a focus on innovation could help to encourage innovation within the

company.

(2) Implications of implementing integrated reporting

IT and IS costs

The introduction of integrated reporting at Calcula will most likely require

significant upgrades to be made to the company's IT and information system

infrastructure. Such developments will be needed to assist Calcula in

capturing both financial and non-financial KPI data. Due to the broad range

of business activities reported on using integrated reporting (customer,

finance and human resources) the associated costs in improving the

infrastructure to deliver relevant data about each area is likely to be




128 CA Sri Lanka

significant. It may, however, be the case that Calcula's existing information

systems are already capable of producing the required non-financial

performance data needed in which case it is likely that the focus here will be

on investigating which data sets should be included in the integrated report.

Time implications

The process of gathering and collating the data to include in an integrated

report is likely to require a significant amount of staff time. This may serve

to decrease staff morale especially if staff are expected to undertake this

work in addition to completing existing duties. In some cases this may

require Calcula to pay employees overtime to ensure all required

information is published in the report on time.

Staff costs

To avoid overburdening existing staff the board may decide to appoint

additional staff to undertake the work of analysing data for inclusion in the

integrated report. This will invariably lead to an increase in staff costs.

Consultancy costs

As this will be Calcula's first integrated report the board may seek external

guidance from an organisation that provides specialist consultancy on

reporting. Any advice is likely to focus on the contents of the report. The

consultant's fees are likely to be significant and will increase the associated

implementation costs of introducing integrated reporting.

Disclosure

A potential downside of adopting integrated reporting centres on Calcula

potentially volunteering more information about its operations than was

actually needed. In the event that Calcula fully disclosed the company's

planned strategies it is likely that this could be used by competitors. Such a

move is likely to undermine any future moves to out-manoeuvre other

industry players. In the event that Calcula have hired an external consultant

to support the introduction of integrated reporting it is likely that the advice

given by the consultant will stress the need to avoid disclosure of

commercially sensitive information.

(3) Content of the integrated report

The <IR> Framework prescribes the eight key content elements of an

integrated report:

1. Organisational overview and external environment: what Calcula

does and the circumstances under which it operates. Calcula couldexplain that it develops specialist accounting software and give

information about its customer types.




CA Sri Lanka 129

2. Governance: how Calcula’s governance structure supports its ability

to create value in the short, medium and long term. Calcula could

explain, for example, the composition of its board of directors and how

directors are selected on the basis of their experience and expertise. It

could explain how their remuneration is linked to value added withinthe company.

3. Business model: the organisation’s business model should be

explained. Calcula could explain how it identifies the need for and

develops its programs.

4. Risks and opportunities: the specific risks facing Calcula should be

identified and its risk management approach explained. Calcula could

discuss the intense competition in the market and how it responds by

investing in its employees.

5. Strategy and resource allocation: how Calcula intends to achieve its

strategic objectives. Calcula has stated that its mission is to become the

market leader of specialist accounting software so it should provide

information as to how it plans to achieve this.

6. Performance: whether Calcula achieved its strategic objectives for the

period and what its outcomes are in terms of effects on its different

types of capitals. For example, Calcula could mention its increased

intellectual capital due to new products patented and human capital interms of employee knowledge.

7. Outlook : the challenges and uncertainties that Calcula is likely to

encounter in pursuing its strategy. Calcula could discuss the challenges

faced from lower cost competitors and the problems of protecting its

intellectual property.

8. Basis of preparation and presentation: how Calcula determines

what matters to include in the report and how these matters are

quantified or evaluated. Calcula could explain the process by whichAsha Alexander and (presumably) other directors compile the report.

15 Glowball

(1) Environmental and sustainability reports

Environmental reports typically only contain information about an entity’s

impact on the environment ie air, water and land. Glowball, for example,

could disclose information about the effect of toxic gases in the air, chemicals

leaking into the sea, or damage to land caused by construction works.




130 CA Sri Lanka

Sustainability reports also provide information on economic, social and

governance issues.

Economic issues might include disclosure of economic performance (ie

profit, value added), market share and procurement practices.

Social issues can be considered in terms of a number of areas according to

the GRI G4 guidelines:

• Labour practices and decent work disclosures might include details of

health and safety, training and education and diversity and equal

opportunity practices.

• Human rights disclosures might include details of policies on child

labour, indigenous rights and supplier human rights.

• Society disclosures might detail the impact of the business and itssuppliers’ businesses on society and anti-corruption policies

• Product responsibility might include disclosure of customer health and

safety practices, product labelling and compliance procedures..

Governance issues might include disclosure of directors’ recruitment and

remuneration policies.

(2) Issues that could be considered in the sustainability report

Note: In each case, performance should be compared to previous years andagainst targets. Any unexpected performance should be explained.

Economic

• Market presence: Glowball could measure its market share in each of

its key markets. Market share would have increased in the current

period due to the acquisition of a competitor, so that should be

explained.

• New pipelines installed: Since this is a driver of revenue, a measure

would be useful. Glowball could measure the number of kilometres ofpipe laid, volume of gas transported in the new lines or the number of

new installations served. A distinction should be made between

organic growth and growth due to acquisition.

• Economic impacts: Glowball could discuss the impact of climate change

on the demand for its services, and how it tries to predict future

demand under conditions of uncertainty.




CA Sri Lanka 131

Environmental

• Supplier environmental assessment: Glowball could discuss the

number and type of assessments of its suppliers’ environmental

practices it has performed, for example of the suppliers of materials

that are used to construct the pipelines.

• Biodiversity: Glowball could provide detail of the impact of its pipe

laying on ocean bioversity and the practices it adopts to try to

minimise that impact.

• Energy: Glowball could detail its energy usage and measures taken to

establish energy efficient alternatives.

Social

• Training and education: Glowball could detail the amount spent ontraining, any education support given to employees (eg paying for

MBAs) and measures taken to retain well-trained staff.

• Occupational health and safety: Glowball could detail accidents,

perhaps distinguishing between fatal and non-fatal, and lost days due

to accidents.

• Security practices: As it may operate in dangerous parts of the world,

Glowball could detail the type and cost of security measures it has in

place to protect its assets and employees.

Governance

• Director selection: Glowball could detail how directors are recruited

and selected and could provide data on educational qualifications and

years of experience.

• Directors’ remuneration: Glowball could explain how directors’

remuneration is determined and could provide data on and

explanations for remuneration compared to performance.

• Risk assessment process: Glowball could provide information on howthe directors assess risks facing the company and the adequacy of

internal controls.

(3) Comments on 'environmental events'

(a) Glowball could explain how this issue arose. It could explain that,

although there is no legal obligation to restore the farmland, its policy

is to be environmentally responsible (the question refers to Glowball’s

reputation for preserving the environment). The report could mention

the cost of Rs. 150 million and the fact that a provision has been madein the financial statements, assuming that it has been made on the basis




132 CA Sri Lanka

of the constructive obligation. Specific examples of other restorations

of land could be included in the sustainability report.

(b) The LKAS 37 criteria to recognise a provision are met: there is a legal

obligation as a result of a past event, an outflow of economic resources

is probable and the amount can be estimated reliably. A provision

should therefore be recognised in the financial statements for the

estimated fine of Rs. 5m. This should be mentioned in the sustainability

report. The report might also put the fines into context by stating how

many tests have been carried out and how many times the company

has passed the tests. The directors may wish to point out the fact that

the number of prosecutions has been falling from year to year.

(c) These statistics are good news and need to be covered in the

sustainability report. However, the emphasis should be on accuratefactual reporting rather than boasting. It would be useful to provide

target levels for comparison, or an industry average if available. The

emissions statistics should be split into three categories:

Acidity to air and water

Hazardous substances

Harmful emissions to water

As regards the aquatic emissions, the Rs. 70m planned expenditure on

research should be mentioned in the sustainability report as it shows acommitment to benefiting the environment.

(d) The environmental report should mention the steps that the company

is taking to minimise the harmful impact on the environment in the

way it sites and constructs its gas installations. The report should also

explain the policy of dismantling the installations rather than sinking

them at the end of their useful life.

The sustainability should be referenced to the financial statements,

where an explanation of the accounting treatment and detail of thedecommissioning provision can be found.




CA Sri Lanka 133

PART E: CASE STUDY QUESTIONS

Questions 16 to 22 are case study questions, each one covering a variety of

syllabus areas.

16 Johan

(1) Costs incurred in extending the network

LKAS 16 states that the cost of an item of property, plant and equipment

should be recognised when two conditions have been fulfilled:

• It is probable that future economic benefits associated with the item

will flow to the entity.

• The cost of the item can be measured reliably.

The cost, according to LKAS 16, includes directly attributable costs of

bringing the asset to the location and condition necessary for it to be capable

of operating in a manner intended by management. Examples of such

directly attributable costs are site preparation costs and installation and

assembly costs.

The feasibility study relates to general site selection, ie selecting a general

geographical area in which the base station may be installed. Applying the

first criterion (probability of economic benefits) would exclude the

feasibility study costs, both internal and external, because (by definition) the

economic benefits of a feasibility study are uncertain. These costs, Rs.

250,000 in total, should be expensed as incurred.

The costs incurred to select a specific site within the chosen geographical

area are treated differently. Applying the LKAS 16 definition of directly

attributable costs, the selection of a base station site that meets the technical

conditions required for the optimal operation of the network is an inherent

part of the process of bringing the network assets to the location andcondition necessary for operation. The Rs. 50,000 paid to third party

consultants to find a suitable site is part of the cost of constructing the

network, and may therefore be capitalised.

(2) Lease

The other costs – a payment of Rs. 300,000 followed by Rs. 60,000 a month

for twelve years – is a lease, and is governed by LKAS 17. LKAS 17 defines a

lease as an agreement whereby the lessor conveys to the lessee, in return for

a payment or series of payments, the right to use an asset for an agreedperiod of time.




134 CA Sri Lanka

The question arises as to whether the payments are to be treated as a

finance lease or as an operating lease. LKAS 17 defines a finance lease as a

lease that transfers substantially all of the risks and rewards incidental to

ownership of the leased asset to the lessee. An operating lease is a lease

other than a finance lease.

In the case of the contract with the government for access to the land, there

is no transfer of ownership. The term of the lease is not for the major part of

the asset's life, because the land has an indefinite economic life. The lease

cannot therefore be said to transfer substantially all the risks and rewards of

ownership to Johan.

Accordingly, the contract should be treated as an operating lease. The initial

payment of Rs. 300,000 should be treated as a prepayment in the statement

of financial position, and charged to profit or loss for the year on a straight-line basis over the life of the contract. The monthly payments of Rs. 60,000

should be expensed as incurred. No amount is recognised for the lease

contract in the statement of financial position.

(3) Inventory of handsets

LKAS 2 states that inventories must be valued at the lower of cost and net

realisable value. The handsets cost Rs. 200, and the net realisable value is

selling price of Rs. 150 less costs to sell of Rs. 1, which is Rs. 149. All

handsets held in inventory by the Retail Division must be written down toRs. 149 per handset.

(4) Revenue recognition

Call cards

Under LKAS 18, revenue is recognised by reference to the stage of

completion of the transaction at the reporting date.

In the case of the call cards, revenue is generated by the provision of

services, not the sale of the card itself, and accordingly revenue should be

recognised as the services are provided.

The Rs. 21 received per call card is recognised as deferred revenue at the

point of sale. Of this, Rs. 18 per card is released and recognised as income

over the six month period from the date of the sale.

The Rs. 3 of unused credit – an average figure may be used rather than the

figure for each card – is recognised as revenue when the card expires, that is

when Johan has no further obligation to the customer.




CA Sri Lanka 135

Sales to dealers

Johan bears the risk of loss in value of the handset, as the dealer may return

any handsets before a service contract is signed with a customer. In addition,

Johan sets the price of the handset. Therefore the dealer, in this case, is

acting as an agent for the sale of the handset and service contract.

The handset cannot be sold separately from the service contract, so the two

transactions must be taken together because the commercial effect of either

transaction cannot be understood in isolation. Johan earns revenue from the

service contract with the final customer, not from the sale of the handset to

the dealer.

LKAS 18 deals with the issue of agency, and states that revenue for an agent

is not the amounts collected on behalf of the principal, but the commission

earned for collecting them.

From Johan's point of view revenue is not earned when the handsets are

transferred to the dealer, so revenue should not be recognised at this point.

Instead the net payment of Rs. 130 (commission paid to the agent less cost of

the handset) should be recognised as a customer acquisition cost, which may

qualify as an intangible asset under LKAS 38.

If it is so recognised, it will be amortised over the 12-month contract.

Revenue from the service contract will be recognised as the service is

rendered.

(5) Shares issued to the directors

The three million shares issued to the directors on 1 June 20X6 as part of the

purchase consideration for Hash are accounted for by Johann in accordance

with SLFRS 3 Business combinations rather than SLFRS 2 Share-based

payment. This is because the shares issued are not remuneration or

compensation, but simply part of the purchase price of the company.

The cost of the business combination is the total of the fair values of the

consideration given by Johan. The total fair value here is the market value of

the shares, being Rs. 6m.

The contingent consideration – 5,000 shares per director, to be received on

31 May 20X7 if the directors are still employed by Leigh – may, however, be

seen as compensation accounted for in accordance with SLFRS 2. The fact

that the additional payment of shares is linked to continuing employment

suggests that it is a compensation arrangement, and therefore SLFRS 2 does

apply.

SLFRS 2 requires that the transaction is measured at the fair value of the

instruments granted at at the grant date. The market value of each share at




136 CA Sri Lanka

that date is Rs. 2. (three million shares are valued at Rs. 6m.) Therefore the

total value of the compensation is 5 directors 5,000 shares Rs. 2 =

Rs. 50,000.

In the year ended 31 May 20X7, Rs. 50,000 is recognised in profit or loss as

part of staff costs with a corresponding increase in equity recognised in the

statement of financial position.

Shares issued to employees

These shares are remuneration and are accounted for under SLFRS 2.

The transaction is measured at the fair value of the instruments issued at the

date on which they are granted. Here, the grant date and issue date are the

same, and the fair value of each instrument at that date is Rs. 3 per share.

Therefore the transaction is measured at Rs. 3 million. As the shares are

given as a bonus they vest immediately and are presumed to be

consideration for past services.

Therefore the total of Rs 3 Mn is recognised in profit or loss as a staff cost

when the shares are issued with a corresponding increase to equity.

Purchase of property, plant and equipment

In accordance with SLFRS 2, the purchase of property, plant and equipment

is treated as a share-based payment in which the counterparty has a choice

of settlement, in shares or in cash.

Such transactions are treated as the issue of a compound financial

instrument, with a debt and an equity element.

The fair value of the equity element is the fair value of the goods or services

(in this case the property) less the fair value of the debt element of the

instrument. The fair value of the property is Rs. 4m. The fair value of the

liability component at 31 May 20X7, based on the share price at that date, is

1.3m × Rs. 3 = Rs. 3.9 million.

The journal entries are:

DEBIT Property, plant and equipment Rs 4 Mn

CREDIT Liability Rs 3.9 Mn

CREDIT Equity Rs 0.1 Mn

To recognise the acquisition of PPE and the share-based transaction.

In three months' time, the debt component is remeasured to its fair value.

Assuming the estimate of the future share price was correct at Rs. 3.50, the

liability at that date will be 1.3 million × Rs. 3.5 = Rs. 4.55. An adjustment is

recognised as follows:




CA Sri Lanka 137

DEBIT Expense (4.55 – 3.9) Rs 0.65 Mn

CREDIT Liability Rs 0.65 Mn

To re-measure the liability to fair value.

Choice of share or cash settlement

The share-based payment to the new director, which offers a choice of cash

or share settlement, is also treated as the issue of a compound instrument. In

this case, the fair value of the services is determined by the fair value of the

equity instruments given.

The fair value of the equity alternative is Rs. 2.50 50,000 = Rs. 125,000. The

cash alternative is valued at 40,000 Rs. 3 = Rs. 120,000. The difference

between these two values – Rs. 5,000 – is deemed to be the fair value of the

equity component. At the settlement date, the liability element is measured

at fair value and the method of settlement chosen by the director determines

the final accounting treatment.

At 31 May 20X7, the accounting entries are:

DEBIT Profit or loss – directors'

remuneration

Rs. 125,000

CREDIT Liability Rs. 120,000

CREDIT Equity Rs. 5,000

To recognise the share-based transaction.

In effect, the director surrenders the right to Rs. 120,000 cash in order to

obtain equity worth Rs. 125,000.

(6) Provision

A provision is defined by LKAS 37 Provisions, contingent liabilities and

contingent assets as a liability of uncertain timing or amount. LKAS 37 states

that a provision should only be recognised if:

There is a present obligation as the result of a past event

An outflow of resources embodying economic benefits is probable, and A reliable estimate of the amount can be made

If these conditions apply, a provision must be recognised.

The past event that gives rise, under LKAS 37, to a present obligation, is

known as the obligating event. The obligation may be legal, or it may be

constructive (as when past practice creates a valid expectation on the part of

a third party). The entity must have no realistic alternative but to settle the

obligation.

As at 31 May 20X7, Hash has no legal obligation to pay compensation to third

parties. No legal action has been brought in respect of the accident. Nor can




138 CA Sri Lanka

Hash be said to have a constructive obligation at the year end, because the

investigation has not been concluded, and the expert report will not be

presented to the civil courts until 20X8. Therefore under LKAS 37 Provisions,

contingent liabilities and contingent assets no provision is recognised.

The possible payment does, however, fall within the LKAS 37 definition of a

contingent liability, which is:

A possible obligation depending on whether some uncertain future

event occurs, or

A present obligation for which payment is not probable or the amount

cannot be measured reliably

There is uncertainty as to the outcome of the investigation and findings of

the report, and the extent of the damages and any compensation arising

remain to be confirmed. However, the uncertainty over these details is not so

great that the possibility of an outflow of economic benefits is remote.

Therefore in respect of the contingent liability, the details and, if possible an

estimate of the amount payable, must be disclosed in the notes to the


The question arises as to whether the possible recovery of the compensation

costs from the insurance company should be disclosed as a contingent asset

under LKAS 37.

LKAS 37 provides specific guidance on reimbursements ie where some or all

of the expenditure required to settle a provision is expected to be

reimbursed by another party. In this case, the standard states that the

reimbursement is recognised only when it is virtually certain that

reimbursement will be received if the entity settles the obligation.

As no provision has been recognised at the reporting date in respect of costs

associated with the airport’s collapse, it follows that no reimbursement asset

can be recognised either.

17 Carpart

(1) Vehiclex

Generally, LKAS 18 Revenue looks at each transaction as a whole. Sometimes,

however, transactions are more complicated, and it is necessary to break a

transaction down into its component parts.

In this case, the selling price charged per car seat related to two parts- the

provision of the car seat and a recharge to cover the cost of construction of

the machinery.




CA Sri Lanka 139

The selling price per car seat should be split into its component parts for

accounting purposes. LKAS 18 does not address the issue of splitting

revenue where goods are provided with the price including a recharge for a

capital item. It does however state that revenue should be measured at fair

value. It therefore follows that the part of the selling price allocated to theprovision of the car seat should be the fair value (standalone selling price) of

that car seat. This may be determined as the cost of the car seat (excluding

the cost of the machinery) plus Carpart’s standard margin.

The sale price allocated to each component part then needs to be assessed

separately in terms of recognition.

Provision of the car seat

The contract to manufacture and sell seats is a contract for the sale of goods,

not a service contract or a construction contract. Therefore, in accordance

with LKAS 18, that part of the selling price relating to the provision of a car

seat is recognised as revenue when the following LKAS 18 criteria are met:

(a) the significant risks and rewards of ownership have been transferred

by Carpart

(b) Carpart does not retain managerial involvement or effective control

over the goods

(c) The amount of revenue can be estimated reliably

(d) It is probable that economic benefits associated with the sale of the

seat will transfer to Carpart

(e) The costs associated with the transaction can be measured reliably.

Recharge for the machinery

In effect, Carpart has paid for the machinery and, through the sale of car

seats, is charging Vehiclex a total of some or all of the price it has paid

(dependent on the number of car seats sold).

Carpart is not selling the machinery to Vehiclex:

(i) There is no contract to sell the machinery to Vehiclex.

(ii) The machinery is for the use of Carpart only, and will not be sold

elsewhere.

(iii) The contract with Vehiclex is not a construction contract under LKAS

11 Construction contracts.

Equally it can be argued that the recharge amount does not meet the LKAS

18 definition of revenue, being the gross inflow of economic benefits during

the period arising in the course of the ordinary activities of an entity when




140 CA Sri Lanka

those inflows result in increases in equity. Here the inflow of economic

benefits directly compensates for an outflow of economic benefits (the

purchase of the machine) rather than increasing equity.

Therefore Carpart should not recognise revenue in respect of the machinery.

The question therefore remains as to how that part of the selling price is

accounted for, and what the credit entry to the accounts should be.

There is no relevant accounting standard and therefore the principles of the

Conceptual Framework should be applied. As a result an appropriate solution

would be to recognise the receipt of recharged amounts as a credit balance

in the statement of financial position and release it to profit or loss as income

to match depreciation over the useful life of the machinery.

(2) Vehicle sales

Sale and repurchase agreements

Carpart enters into a sale and repurchase agreement with its customers.

According to LKAS 18, such agreements must be analysed to determine

whether the seller has transferred the significant risks and rewards of

ownership to the buyer.

The transfer of risks and rewards can only be decided by examining each

transaction. If the risks and rewards of ownership have been transferred to

the customer, then revenue can be recognised; if significant risks andrewards remain with the seller, then the transaction is not a sale and

revenue cannot be recognised, even if legal title has been transferred. In such

cases, the substance of the transaction is a financing arrangement.

In the case of the vehicles that are repurchased by Carpart after 4 years,

there is evidence that the significant risks and rewards have been

transferred. Carpart's obligation to repurchase the vehicles at 20% of the

original selling price is not retention of significant risks because this is

considerably below the market price.

In addition, this repurchase takes place four years into the vehicles economic

life of five years, and the purchaser must maintain and service the vehicle

and return it in good condition.

Since the significant risks and rewards have been transferred, Carpart must

recognise revenue, measured at the fair value of consideration received,

when the LKAS 18 recognition criteria for the sale of goods are met..

The vehicles sold with an option for the buyer to require repurchase by

Carpart after two years are treated differently, as there is evidence thatCarpart has not transferred the risks and rewards of ownership.




CA Sri Lanka 141

The repurchase period is less than substantially all of the vehicles' economic

life (only two years into the five year life), and the repurchase price of 70%

of the original purchase price is greater than the fair value, which is 55% of

the original price. Importantly, the option is expected to be exercised, and so

the transaction should be accounted for as if it will be.

Until the option expires, the vehicles must be accounted for as operating

leases. They should be removed from inventories and debited to 'assets

under operating leases'. They should be depreciated over the two-year

period of the option, with the depreciable amount being adjusted for the

residual value.

The cash received is not recognised as revenue in the year, as it would be for

a sale, but is instead split between rentals received in advance (30%) and

long-term liabilities (70%). The rentals received in advance balance isreleased and recognised as operating lease income in profit or loss over the

two years on a straight-line basis.

Demonstration vehicles

These are not conventional inventory, but have the characteristics of

property, plant and equipment, because they are held for use in the business

(demonstrations) and are expected to be used in more than one accounting

period. They should be capitalised as property, plant and equipment and

depreciated over the 18 month period during which they are being used asdemonstration vehicles. At the end of the 18 month period, the vehicles are

reclassified back into inventories and are no longer depreciated. When the

LKAS 18 recognition criteria for the sale of goods are met, revenue is

recognised and the carrying amount of the cars is transferred to cost of sales.

(3) Venue

Under LKAS 18, revenue of Rs. 1m is recognised on the sale of the exhausts,

being the fair value of consideration receivable. A trade receivable of Rs. 1m

is also recognised.

At this stage Carpart believes that there is a 5% risk, based on experience

with other customers, that Venue will default. This is a general market risk

for which current standards make no arrangements and therefore no

adjustment is made to the recognised receivables balance.

The trade receivable is a financial asset within the scope of LKAS 39 and

therefore Carpart must assess at the end of each reporting period whether

there is objective evidence of an impairment. The deteriorating financial

situation of the customer is identified as an indicator of impairment by LKAS39.




142 CA Sri Lanka

The impairment loss is measured as the difference between the carrying

amount of the receivable (Rs 1 Mn) and the present value of estimated future

cash flows that it will give rise to (Rs. 0.8 million).

Therefore an impairment of Rs. 200,000 is recognised in profit or loss.

(4) Other sales

Revenue is measured at the fair value of consideration received or

receivable; where payment is deferred, LKAS 18 states that the fair value of

consideration may be less than the nominal value of cash receivable. In other

words, the substance of the arrangement is that there is both a sale and a

financing transaction. In this case, the fair value of the consideration is

determined by discounting future receipts to present value using the more

clearly determinable of:

• the prevailing interest rate for a similar instrument of an issuer with a

similar credit rating, or

• a rate of interest that discounts the nominal amount to the current cash

sale price.

In this case, receipt of the selling price of Rs 2 Mn is deferred for two years.

Using the 4% discount rate given, the present value of the consideration is

Rs 2 Mn/1.042 = Rs 1.85 Mn.

This is recognised by:

DEBIT Receivable Rs 1.85 Mn

CREDIT Revenue Rs 1.85 Mn

To recognise the revenue receivable at the discounted amount.

The unwinding of the discount is credited to profit or loss as finance income

over the two-year period as follows:

Year 1 Year 2

DEBIT Receivable (1.85 × 0.04/(1.85 × 1.04) × 0.04) Rs. 74,000 Rs. 76,960

CREDIT Finance income Rs. 74,000 Rs. 76,960

Regarding the Rs 3 Mn payment in advance, revenue is not recognised

immediately because the LKAS 18 revenue recognition criteria are not met;

instead a deferred income liability is recognised:

DEBIT Cash Rs 3 Mn

CREDIT Revenue Rs 3 mn

On delivery in a year's time, (and when the LKAS 18 revenue recognition

critier are met) revenue is recognised by:

DEBIT Deferred income Rs 3 MnCREDIT Revenue Rs 3 Mn




CA Sri Lanka 143

(5) Lease with Elpres

Inflation adjustments are effectively contingent rent, defined in LKAS 17

Leases as 'that part of the rent that is not fixed in amount, but based on the

future amount of a factor that changes other than with the passage of time'.

LKAS 17 provides no guidance on accounting for contingent rent and

operating leases. It does however state that where contingent rent is related

to finance leases, it is recognised as incurred. This guidance is normally

extended to operating leases.

On this basis, Carpart will recognise operating rental expenses as follows:

Year 1 Rs. 5 million

Year 2 Rs. 5 million plus (Rs 5 Mn × 4%) = Rs 5.2 Mn

Year 3 Rs. 5.2 million plus (Rs 5.2 Mn × 4%) = Rs 5.408 Mn

As LKAS 17 does not provide clear guidance in respect of contingent rent and

operating leases, it would not be incorrect to revert to standard guidance for

operating leases and recognise associated costs on a straight line basis over

the term of the lease.

(6) Lease with Brooke

LKAS 17

This lease meets the definition of an operating lease. Therefore no asset or

liability would be recognised in respect of the leased asset, and payments of

Rs. 13,000 would be recognised as expense on a straight-line basis in each of

the three years of the lease term.

ED/2013/6

The basic principle of the 2013 ED is that all leases are recognised in the

statement of financial position and entities do not distinguish between an

operating and finance lease.

A lessee is required to recognise a right-of-use asset and a lease liability for

all leases of more than 12 months, as the lease with Brooke is.

For leases of 12 months or less, a lessee is not required to recognise a right-

of-use asset and a lease liability, but may choose to do so.

A single accounting model for lessees would not reflect the true economics of

different assets. Accordingly, the IASB has developed a dual approach,

whereby leases are either Type A or Type B, with the type of lease based on

the amount of consumption of the underlying asset.

Type A leases are leases in which the lessee consumes part of the leasedasset. These are leases of depreciating assets, for example vehicles or

equipment, whose value declines over its useful life, generally faster in the




144 CA Sri Lanka

earlier years. They are not normally property, however, property will be

classified as a Type A lease in either of the following circumstances.

(1) The lease term is for the major part of the remaining economic life of

the underlying asset.

(2) The present value of the lease payments accounts for substantially all

of the fair value of the underlying asset at the commencement date.

Type B leases are leases in which the lessee consumes only an insignificant

part of the asset. Type B leases normally relate to property., however, leases

for assets other than property will be classified as type B leases in either of

the following circumstances.

(1) The lease term is for an insignificant part of the total economic life of

the underlying asset.

(2) The present value of the lease payments is insignificant relative to the

fair value of the underlying asset at the commencement date of the

lease.

In effect, therefore:

• The lessee pays for that part of a Type A leased asset that it consumes.

• The lessee pays for the use of a Type B leased asset.

Carpart should classify the lease of the machine as a Type A lease for the

following reasons.

(1) The underlying asset (the machine) is not property.

(2) The present value of the lease payments is 19% of the fair value of the

machine at the commencement date (Rs. 21,700/Rs. 113,600).

Although the term insignificant is not defined in ED/2013/6, 19% is

unarguably insignificant..

(3) The lease term is for more than an insignificant part of the total

economic life of the machine (3 years out of 20).In the case of a Type A asset, the proposed new standard requires that

Carpart would initially recognise a “right-of-use” asset and a lease liability at

the present value of the lease payments of Rs. 21,700.

In subsequent periods, the right-of-use asset would be amortised over the

lease term on a straight-line basis unless another systematic basis were

more representative of the consumption of the asset.

The carrying amount of the lease liability would be increased in each period

by the unwinding of the interest payment and decreased by the amount ofthe payments made. Therefore a finance cost would be recognised in profit

or loss.




CA Sri Lanka 145

Essentially this treatment is that currently applied to finance leases.

(7) Disclosure

In order to meet the objective of SLFRS 12 Disclosure of interests in other

entities, entities are required to make the following disclosures.(i) Significant judgements and assumptions made in determining control,

joint control or significant influence and type of joint arrangement

(ii) Information on interests in subsidiaries such that the composition of

the group and non-controlling interest is understood and restrictions,

risks and changes in ownership can be evaluated

(iii) Information on interests in associates and joint arrangements such that

the nature and extent of the interests, financial effects and associated

risks can be evaluated

(iv) Information on interests in unconsolidated structured entities such

that the nature and extent of the interests and associated risks can be

evaluated

18 Mica

(1) Maintenance contract

LKAS 18 states that where the outcome of a transaction involving therendering of services can be estimated reliably, the associated revenue

should be recognised by reference to the stage of completion of the

transaction at the end of the reporting period. The outcome of a transaction

can be estimated reliably when all of the following conditions are satisfied:

(a) the amount of revenue can be measured reliably;

(b) it is probable that the economic benefits associated with the

transaction will flow to the entity;

(c) the stage of completion of the transaction at the end of the reportingperiod can be measured reliably; and

(d) the costs incurred for the transaction and the costs to complete the

transaction can be measured reliably.

Where the outcome of the transaction involving the rendering of services

cannot be estimated reliably, revenue shall be recognised only to the extent

of the expenses recognised that are recoverable.

Ama Balachandran is wrong to believe that the whole of this revenue can be

recognised in 20X4, as the service will be provided over a 5 year term from 1January 20X4 to 31 December 20X8.




146 CA Sri Lanka

At the start of the contract, it seems likely that the first 3 conditions are met,

since the contractual revenue has been agreed and there is no reason to

suppose that Matara will not pay, provided that the agreed service is

performed .

LKAS 18 states that the stage of completion may be measured by reference

to:

• Surveys of work performed;

• Services performed to date as a percentage of total services to be

performed; or

• The proportion that costs to date bear to expected total costs

LKAS 18 also states that, when services are performed by an indeterminate

number of acts over a specified period of time, revenue is recognised on astraight line basis over the specified period unless there is evidence that

some other method better represents the stage of completion.

In this case it is suggested that services will be performed by an

indeterminate number of acts, and so revenue should be recognised on a

straight line basis over the life of the contract, i.e. at 20% per year.

It may be arguably uncertain as to whether the costs incurred can be

measured reliably, but Mica may be able to base estimates on similar

contracts in the past. Alternatively the total costs of fulfilling the contractcould be estimated based on costs incurred to date. For example at 31

December 20X4, total costs could be estimated as 5 x the costs incurred

during 20X4.

Assuming that Mica recognises the revenue on a straight-line basis according

to the stage of completion, the amount of revenue would be Rs. 300,000 per

year.

However, because the consideration is deferred until 31 December 20X7,

this must be discounted to present value and the discounted amount must berecorded in the periods preceding 20X7, and the discount unwound each

year.

Entries will be as follows:

Debit Credit

Rs. Rs.

31 December 20X4

Receivable 259,151

Revenue (300k/1.053) 259,151

To record the revenue for 20X4




CA Sri Lanka 147

Debit Credit

Rs. Rs.

31 December 20X5

Receivable 12,958

Interest income (259,151 × 5%) 12,958

To unwind the discount in respect of the receivable

Receivable 272,109

Revenue (300k/1.052) 272,109


31 December 20X6

Receivable 27,211

Interest income ((259,151 + 12,958 + 272,109) ×

5%)

27,211


Receivable 285,714Revenue (300k/1.05) 285,714


31 December 20X7

Receivables 42,857

Interest income 42,857

((259,151 + 12,958 + 272,109 + 27,211 + 285,714)

× 5%)


Cash 1,500,000Receivables 900,000

Revenue 300,000

Deferred income 300,000

To recognise receipt of cash, revenue for the year and

deferred income

20X8

Deferred income 300,000

Revenue 300,000

To recognise revenue for 2018

(2) Off-plan sales

Although Mica’s previous construction contracts would have been accounted

for in accordance with LKAS 11 Construction Contracts, the nature of these

contracts may be different.

Since each sale represents a sale of land plus an agreement for the

construction of real estate, the two components must be treated separately.

The total fair value of consideration received or receivable must be allocated

to each component.




148 CA Sri Lanka

LKAS 18 (para. 14) states that revenue from the sale of goods is recognised

when all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards

of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the

degree usually associated with ownership nor effective control over

the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the

transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the transaction can be

measured reliably.

In this case, the risks and rewards relating to the sale of land will pass to the

purchaser when a binding sales agreement is signed. Mica recognises

revenue in respect of the sale of land at this point.

The remaining component of the transaction is an agreement for the

construction of real estate and directly related services. This transaction falls

within the scope of either LKAS 11 Construction Contracts or LKAS 18

Revenue. IFRIC 15 Agreements for the Construction of Real Estate provides

guidance to determine which standard should be applied.

An agreement for the construction of real estate is within the scope of LKAS

11 when the buyer is able to specify the major structural elements of the

design of the real estate before construction begins and/or specify major

structural changes once construction is in progress (whether or not it

exercises that ability) (IFRIC 15 para 11).

An agreement for the construction of real estate is within the scope of LKAS

18 when buyers have limited ability to influence the design of real estate and

can specify only minor variations to the basic design.

Since the houses will be built to a standard design and the buyers of the

houses are likely to have only minimal input into design features (such as

kitchen styles), the sale falls within the scope of LKAS 18 rather than LKAS

11.

Next Mica should consider whether this component is an agreement only for

the rendering of services or is for the sale of goods. Since Mica will be

supplying the (standard) construction materials rather than the purchaser

supplying materials, this is an agreement for the sale of goods therefore theprovisions of LKAS 18 in relation to the sale of goods apply.




CA Sri Lanka 149

(3) Former hospitality division

SLFRS 5 states that an entity shall classify a non-current asset as held for sale

if its carrying amount will be recovered principally through a saletransaction rather than through continuing use.

For this to be the case:

1. the asset must be available for immediate sale in its present condition

2. its sale must be highly probable, meaning

(a) an appropriate level of management must be committed to a plan

to sell the asset

(b) there must be an active programme to locate a buyer(c) the asset (or disposal group) must be actively marketed for sale

at a price that is reasonable in relation to its current fair value

(d) the sale should be expected to qualify for recognition as a

completed sale within one year from the date of classification

(e) it must be unlikely that significant changes to the plan will be

made

Cookery equipment

Since the decision has not fully been made as to whether to sell the

equipment or retain it and lease it, it cannot be categorised as held for sale.

The asset therefore continues to be classified as PPE, and must be tested for

impairment at each period end, if indicators of impairment exist. According

to LKAS 36, an indicator of possible impairment is a change in operations

resulting in a change in use of the asset. The cookery equipment is currently

idle and therefore an impairment test must be performed.

The carrying amount of the equipment is Rs. 750,000. The recoverable

amount, being the higher of fair value less costs of disposal and value in use,

is the value in use of Rs. 710,000. Therefore the equipment is impaired. An

impairment loss of Rs. 40,000 must be recognised in profit or loss, and

depreciation should continue to be charged on the written down amount

over the remaining useful life. If the decision is made to sell the equipment, it

will be transferred to be an asset held for sale when the SLFRS 5 criteria are

met, and will be measured and presented in accordance with that standard.

Vans

Although the vans were in fact sold in January 20X5, there is no indication

that they were intended to be sold as at 31 December 20X4.




150 CA Sri Lanka

SLFRS 5 states that if the criteria for assets to be classified as held for sale

are met after the reporting period, an entity must not classify a non-current

asset as held for sale in those financial statements i.e. it is a non-adjusting

event.

When those criteria are met after the reporting period but before the

authorisation of the financial statements for issue, the entity must make

additional disclosures. Therefore Mica shall disclose:

• a description of the vans

• a description of the facts and circumstances of their sale, and

• if relevant, the reportable segment in which the vans are presented in

accordance with SLFRS 8.

The vans are therefore presented in the statement of financial position as at31 December 20X4 within property, plant and equipment rather than assets

held for sale.

The sale so soon after the year-end at a price lower than carrying amount

could be an indicator that the vans were actually impaired at the year-end. If

the sale at less than carrying amount was due to conditions that existed at

the reporting date, then this is an adjusting event and the value of the vans

should be written down to Rs. 270,000 as at 31 December 20X4. If the loss of

value is due to events occurring after the year-end, then this is a non-

adjusting event, and should be disclosed if material.

Headquarters

Although Mica have clearly intended to sell the property since June 20X4, the

company decided to renovate the property prior to the sale. As a result of the

discovery of asbestos, the renovations are ongoing at the reporting date.

Therefore at no stage has the property been available for immediate sale in

its present condition. Furthermore, it was not advertised for sale until

February 20X5, meaning there was (understandably) not an active

programme to find a buyer.

Accordingly the property may not be designated as held for sale at 31

December 20X4, and should be recorded at carrying amount of Rs 6.7 Mn.

(4) SLFRS for SMEs

The SLFRS for SMEs may be applied by any company that meets the

definition of a Small or Medium Sized Entity (SME) and is not a Specified

Business Entity (SBE).

An SME is an entity that does not have public accountability and publishes

general purpose financial statements for external users.




CA Sri Lanka 151

Mica has retained its private status rather than seek a listing and therefore

does not have public accountability; equally it does produce general purpose

financial statements for external users.

An SBE is a company such as a bank or insurance company; it does not

include a property construction and management company.

Therefore Mica is eligible to apply the SLFRS for SMEs.

Purchased goodwill

SLFRS 3 requires that the NCI is measured as a proportion of the net assets

of the acquiree; there is no option to measure it at fair value. Therefore

recognised goodwill always represents the parent share of goodwill only.

SLFRS 3 requires that transaction costs on an acquisition are recognised in

profit or loss; the SLFRS for SMEs requires that these costs form part of theacquisition cost. As a result goodwill calculated in accordance with the

SLFRS for SMEs may be greater than that calculated in accordance with

SLFRS 3.

Full SLFRS require that recognised goodwill is not amortised, but instead is

tested for impairment annually. The SLFRS for SMEs simplifies this

treatment in a practical sense by requiring that goodwill is amortised over a

finite life (presumed to be 10 years) and is tested for impairment only if

there is an indicator of impairment.

Goodwill is therefore measured at cost less accumulated amortisation

charges less accumulated impairment losses.

Owned properties held at revalued amount

Unlike full SLFRS, the SLFRS for SMEs does not provide a choice of

measuring properties under either the revaluation or cost model. Instead it

requires all property, plant and equipment to be measured using the cost

model.

Provisions

The guidance contained within the SLFRS for SMEs on accounting for

provisions is identical to that contained within LKAS 37.

(5) Adequacy of disclosures

The applicable standards here are SLFRS 7 Financial instruments:

disclosures, and LKAS 10 Events after the reporting period.

According to SLFRS 7, Mica should have included additional information

about the loan covenants sufficient to enable the users of its financialstatements to evaluate the nature and extent of risks arising from financial

instruments to which the entity is exposed at the end of the reporting period.




152 CA Sri Lanka

Such disclosure is particularly important in Mica’s case because there was

considerable risk at the year-end (31 December 20X4) that the loan

covenants would be breached in the near future, as indicated by the

directors' and auditor’s doubts about the company continuing as a going

concern. Information should have been given about the conditions attachedto the loans and how close the entity was at the year-end to breaching the

covenants.

SLFRS 7 requires disclosure of additional information about the covenants

relating to each loan or group of loans, including headroom (the difference

between the amount of the loan facility and the amount required).

The actual breach of the loan covenants at 31 March 20X4 is a material event

after the reporting period as defined in LKAS 10. The breach, after the date of

the financial statements but before those statements were authorised, is anon-adjusting event, as it does not provide additional information

concerning year-end conditions. Therefore the event should have been

disclosed in accordance with LKAS 10.

Although the breach is a non-adjusting event, where such an event means

that an entity is no longer a going concern, LKAS 10 requires that the

financial statements are not prepared on a going concern basis. Here both

the directors' and auditor’s reports express going-concern doubts however

the information in the financial statements is prepared on a going-concern

basis. The directors should therefore assess the going concern status of the

company.

19 Robby

(1) ROBBY GROUP

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X3

Rs Mn

AssetsNon-current assets Property, plant and equipment: + 12 (W13) 241.13

Goodwill 6.00

Financial assets 29.00

276.13

Current assets + 4 (W12) 36.00

Total assets 312.13




CA Sri Lanka 153

Rs Mn

Equity and liabilities Equity attributable to owners of the parent

Ordinary shares 25.00

Other components of equity 2.00 Retained earnings 81.45

108.45


136.09


Current liabilities+ 3.6 (W12)+16 (W13) 81.20

Total equity and liabilities 312.13

Workings

Consolidation schedule – consolidated statement of financial position at

31 May 20X3Robby Hail Zinc (W2(i)) (W2(ii)) (W3) (W4(i)) (W4(ii)) (W5) (W6) (W7) (W8) (W9) (W10) Consolidated

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn

PPE 112 60 26 198 24 4 (0.4) 6.12 (2.59) 12 241.13

Goodwill 5 1 6

Inv in H 55 55 (5) (50) –

Inv in Z 19 19 (1) 3 (21) –

Financial assets

9 6 14 29 29

Joint operation

6 6 (6) -

C assets 5 7 12 24 8 4 36

206 73 52 331 312.13

St capital 25 20 10 55 (20) (10) 25

OC Equity 11 – – 11 (7) (2) 2 Ret’d earnings

70 27 19 116 2 (1) (16) 3 (15) (3.8) (0.24) 0.68 (0.59) 0.4 (4) 81.45

106 47 29 182 108.45

NCI 15 9 3.8 (0.16) 27.64

136.09

Non current

liabilities

53 20 21 94 0.84 94.84

Current liabilities

47 6 2 55 6.6 3.6 16 81.20

100 26 23 149 176.04

206 73 52 331 312.13

1 Group structure

1 June

X1

Robby 1 June

X2

1 Dec X2

80%

(sub)

5%

(IEI)

+ 55% = 60%

Pre-

acquisition

retained

earnings

Rs 16

MnHail Zinc

Pre-

acquisition

retained

earnings

N/A Rs 15 Mn




154 CA Sri Lanka

2 (i) Carrying amount of Hail

Hail was initially recognised at purchase consideration of Rs. 55

million and is subsequently classified as available for sale and

measured at fair value with changes recognised in other

comprehensive income. At the reporting date it is measured at its

fair value of Rs 55 Mn and therefore a cumulative revaluation

gain of Rs 55 Mn – Rs 50 Mn = Rs 5 Mn is represented in other

components of equity. This must be eliminated on consolidation.

In addition, Robby has recognised a dividend from Hail in other

comprehensive income (and so accumulated in other components

of equity). This must be transferred to retained earnings.

These are achieved by (Rs Mn):

DEBIT Other components of

equity (%m + 2m)

7m

CREDIT Investment in H 5m

CREDIT Retained earnings 2m

To eliminate the fair value gain on Hail in Robby’s separate

financial statements and transfer the dividend to retained

earnings.

(ii) Carrying amount of Zinc

Total consideration for the 60% investment in Zinc was

Rs. 18million. Whilst the second investment is carried at cost of

Rs. 16 million, the initial investment was measured at FVTPL and

a re-measurement of Rs 1 Mn was recognised at 31 May 20X2.

This is reversed by (Rs Mn):

DEBIT Retained earnings 1m

CREDIT Investment in Zinc 1m

To eliminate the fair value gain on Zinc in Robby’s separate


3 Goodwill (Hail)

Rs Mn Rs Mn


Non-controlling interest (fair value per q) 15

FV of identifiable net assets at acq'n: Stated capital 20


Fair value adjustment - land 24

(60) 5




CA Sri Lanka 155

The standing journal to recognise this is (Rs Mn):

DEBIT Goodwill 5m

DEBIT Stated capital 20m


DEBIT PPE 24mCREDIT Investment in H 50m

CREDIT NCI 15m

To recognise the acquisition of Hail and resulting goodwill.

4 Goodwill (Zinc)

(i) The previously held interest in Zinc has a carrying amount of

Rs. 2 million; on the acquisition date it is remeasured to its fair

value of Rs5m and, a gain of Rs. 3million is recognised in profit or

loss and accumulated in retained earnings (Rs Mn):DEBIT Investment in Z 3m

CREDIT Retained earnings 3m

To recognise the remeasurement to fair value of the existing

interest.

(ii) Goodwill is calculated as follows:

Rs Mn

Consideration transferred (55%) 16

Non-controlling interest at fair value (per question ) 9 Fair value of previously held interest (5%) 5

FV of identifiable net assets at acq'n:

Stated capital 10


Fair value adjustment (1 + 3)* 4

(29)

1

. * The fair value adjustment is provisionally Rs. 1 million at the

acquisition date, however is determined to be Rs. 3million higherwhen the final valuations are received 3 months later. This

adjustment takes place in the measurement period and SLFRS 3

requires that goodwill is retrospectively adjusted.

The standing journal to recognise this is (Rs Mn):

DEBIT Goodwill 1m

DEBIT Stated capital 10m


DEBIT PPE 4m

CREDIT Investment in Z (16 + 5) 21m

CREDIT NCI 9m




156 CA Sri Lanka

To recognise the acquisition of Hail and resulting goodwill.

5 Allocation of post-acquisition retained earnings to the NCI

Hail

Rs Mn

Zinc

Rs Mn

Retained earnings at reporting date 27 19

Retained earnings at acquisition (16) (15)

Post-acquisition 11 4

NCI share (20%/40%) 2.2 1.6

Therefore a total Rs 3.8 million (2.2m + 1.6m) of profits are allocated to

the NCI by (Rs Mn):

DEBIT Retained earnings 3.8m

CREDIT NCI 3.8m

To allocate profits since acquisition to the NCI.

6 Depreciation of fair value adjustment in Zinc

(Note the fair value adjustment in Hail was to non-depreciable land)

The fair value uplift of Rs. 4 million in Zinc is depreciated over a

remaining useful life of 5 years. Therefore the charge from acquisition

to the period end is Rs. 4m/5 years 6/12m = Rs. 400,000. This

additional expense is attributable to the group and NCI in their

ownership proportions and is recognised by:

DEBIT Retained earnings (60%) 0.24m

DEBIT NCI (40%) 0.16m

CREDIT PPE 0.4m

To recognise depreciation on the fair value uplift.

7 Joint operation (in Robby's books)

The accounting treatment of a joint operation is prescribed by SLFRS

11 Joint arrangements. Robby must recognise on a line-by-line basis itsassets, liabilities, revenues and expenses plus its share (40%) of the

joint assets, liabilities, revenue and expenses. The figures are calculated

as follows:




CA Sri Lanka 157

Profit or loss for the year

Rs Mn

Revenue: 20 × 40% 8.00

Cost of sales: 16 × 40% (6.40)

Operating costs: 0.5 × 40% (0.20)Depreciation (0.68)

Finance cost (unwinding of discount) (0.04)

Profit from joint operation (to retained earnings (W10) 0.68

Statement of financial position

Rs Mn

Property, plant and equipment: 1 June 20X2 cost: gas station (15 × 40%) 6.00

dismantling provision (2 × 40%) 0.80

6.80

Accumulated depreciation: 6.8/10 (0.68)

31 May 20X3 carrying amount 6.12

Trade receivables (from other joint operator):

20 (revenue) × 40%

8.00

Trade payables (to other joint operator):

16 + 0.5 (costs) × 40%

6.60

Dismantling provision:

At 1 June 20X2 (as above) 0.80 Finance cost (unwinding of discount): 0.8 × 5% 0.04

At 31 May 20X3 0.84

Robby has accounted only for its share of the construction cost of

Rs 6 Mn. The journal to correct this is therefore as follows (Rs Mn):

DEBIT Property, plant and equipment 6.12

DEBIT Trade receivables 8.00

CREDIT Joint operation 6.00

CREDIT Trade payables 6.60CREDIT Provision 0.84

CREDIT Retained earnings (Robby) 0.68

To recognise the joint operation in accordance with SLFRS 11.




158 CA Sri Lanka

8 Property, plant and equipment

Carrying

amount

Reval.

surplus

Rs Mn Rs Mn

1 June 20X0 Cost 10.00 Acc. depreciation 2/20 × 10

(1.00)

9.00

Revaluation gain(balancing figure ) 2.00 2.00

31 May 20X2 Revalued PPE c/d 11.00

Depreciation for year 1/18 × 11

(0.61)

Transfer to retained earnings: 0.61 – 0.50 (0.11)

31 May 20X3 Balance 10.39 1.89

Impairment loss

(balancing figure)

(2.59)

Recoverable amount 7.80

The impairment loss is charged to other comprehensive income and

therefore to other components of equity to the extent of the

revaluation surplus. The remainder is taken to profit or loss and

therefore to retained earnings. Therefore Rs. 1.89 is recognised as a

reduction in other components of equity and Rs. 2.59 – Rs. 1.89 =

Rs. 0.7 as a reduction in retained earnings.

The reserve transfer for excess depreciation is recorded by (Rs Mn):

DEBIT Other components of equity 0.11

CREDIT Retained earnings 0.11

To transfer the excess depreciation charge from OCE to retained

earnings.

The impairment loss is recognised by (Rs Mn):


DEBIT Retained earnings 0.70

CREDIT Property, plant and equipment 2.59

To recognise the impairment loss.

The net journal is therefore (Rs Mn):




To recognise the impairment and excess depreciation transfer.




CA Sri Lanka 159

9 Debt factoring

Robby should not have derecognised the receivables because the risks

and rewards of ownership have not been transferred. The receivables

must therefore be reinstated, the loss reversed and the proceeds

recognised as a liability (Rs Mn):

DEBIT Trade receivables 4.0

CREDIT Current liabilities 3.6

CREDIT Retained earnings (to reverse

loss)

0.4

To reverse the incorrect entry and recognise the factoring arrangement

correctly.

10 Sale and repurchase of land

Robby should not have derecognised the land from the financial

statements because the risks and rewards of ownership have not been

transferred. The substance of the transaction is a loan of Rs 16 Mn, and

the 5% 'premium' on repurchase is effectively an interest payment.

This is an attempt to manipulate the financial statements in order to

show a more favourable cash position. The sale must be reversed and

the land reinstated at its carrying amount before the transaction. The

repurchase, ie the repayment of the loan takes place one month after

the year end, and so this is a current liability (Rs Mn):

DEBIT Property, plant and equipment 12

DEBIT Retained earnings (to reverse profit on

disposal)(16 – 12) 4

CREDIT Current liabilities 16

To reverse the incorrect entry and recognise the sale and repurchase

arrangement correctly.

(2) Derecognition of a financial asset

Derecognition is the removal of a previously recognised financial instrumentfrom an entity's statement of financial position.

An entity should derecognise a financial asset when:

(1) The contractual rights to the cash flows from the financial asset expire,

or

(2) The entity transfers the financial asset or substantially all the risks and

rewards of ownership of the financial asset to another party.




160 CA Sri Lanka

LKAS 39 gives examples of where an entity has transferred substantially all

the risks and rewards of ownership. These include:

(1) An unconditional sale of a financial asset

(2) A sale of a financial asset together with an option to repurchase thefinancial asset at its fair value at the time of repurchase.

The standard also provides examples of situations where the risks and

rewards of ownership have not been transferred:

(1) A sale and repurchase transaction where the repurchase price is a fixed

price or the sale price plus a lender's return

(2) A sale of a financial asset together with a total return swap that

transfers the market risk exposure back to the entity

(3) A sale of short-term receivables in which the entity guarantees to

compensate the transferee for credit losses that are likely to occur.

It is possible for only part of a financial asset or liability to be derecognised.

This is allowed if the part comprises:

(1) Only specifically identified cash flows, or

(2) Only a fully proportionate (pro rata) share of the total cash flows

For example, if an entity holds a bond it has the right to two separate sets of

cash inflows: those relating to the principal and those relating to the interest.It could sell the right to receive the interest to another party while retaining

the right to receive the principal.

In the case of Robby, the substance of the transaction needs to be considered

rather than its legal form. Robby has transferred the receivables to the factor

in exchange for Rs 3.6 Mn cash, but it is liable for any shortfall between

Rs 3.6 Mn and the amount collected. In principle, Robby is liable for the

whole Rs 3.6 Mn, although it is unlikely that the default would be as much as

this. Robby therefore retains the credit risk. In addition, Robby is entitled to

receive the benefit (less interest) of repayments in excess of Rs 3.6 Mn once

the Rs. 3.6m has been collected. Therefore for amounts in excess of

Rs 3.6 Mn Robby also retains the late payment risk. Substantially all the risks

and rewards of the financial asset therefore remain with Robby, and the

receivables should continue to be recognised.

(3) Sale of land

Ethical behaviour in the preparation of financial statements, and in other

areas, is of paramount importance. This applies equally to preparers of

accounts, to auditors and to accountants giving advice to directors. Financial

statements may be manipulated for all kinds of reasons, for example to




CA Sri Lanka 161

enhance a profit-linked bonus. In this case, the purpose of the sale and

repurchase is to present a misleadingly favourable picture of the cash

position, which hides the fact that the Robby Group has severe liquidity

problems. The extent of the liquidity problems can be seen in the current

ratio of Rs 36 Mn/Rs 81.2 Mn = 0.44:1, and the gearing ratio of 0.83,calculated as follows:

-53 + 20 + 21 non current liabilities + 3.6 factored receivables + 16 land option

Equity interest including NCI

113.60= = 0.83

136.09

The effect of the sale just before the year-end was intended to eliminate the

bank overdraft and improve these ratios, although when the sale of land is

correctly accounted for as a loan, there is no improvement to gearing. Thesale as originally accounted for might forestall proceedings by the bank, but

as the substance of the transaction is a loan, it does not alter the true

position and gives a misleading impression of it.

Company accountants act unethically if they use 'creative' accounting in

accounts preparation to make the figures look better. To act ethically, the

directors must put the interests of the company and its shareholders first,

and must also have regard to other stakeholders such as potential investors

or lenders. If a treatment does not conform to acceptable accounting

practice, it is not ethical. Acceptable accounting practice includes conformity

with the qualitative characteristics set out in the Conceptual Framework

particularly fair presentation and verifiability. Conformity with the

Conceptual Framework precludes window-dressing transactions such as this,

and so the land needs to be reinstated in the accounts and a current liability

recognised for the repurchase.

20 Ashanti

(1) ASHANTI GROUP

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

FOR THE YEAR ENDED 30 APRIL 20X5

Rs Mn

Revenue

1,096.00

Cost of sales

(851.00)

Gross profit 245.00

Other income 57.80

Distribution costs (64.00) Administrative costs (96.01)




162 CA Sri Lanka

Rs Mn

Finance income 1.68

Finance costs

(32.70)

Share of profit of associate

2.10

Profit before tax 113.87 Income tax expense

(49.00)


Other comprehensive income (items that will not be reclassified

to profit or loss) Gain on AFS financial assets

32.00

Gain/loss on property revaluation 19.60

Remeasurement of defined benefit plan (14.00)

Share of other comprehensive income of associate

0.90

Other comprehensive income for the year net of tax 38.5 Total comprehensive income for the year 103.37



64.87

Total comprehensive income attributable to: Owners of the parent 82.89


103.37




CA Sri Lanka 163

Workings Ashanti Bochem Ceram Total (W2) (W3) (W5(i)) (W5(ii)) (W7(i)) (W7(ii)) (W8) (W9) (W10) (W11) Consolidated


Revenue 810 235 71 1,116 (15) (5) 1,096

Cost of sales (686) (137) (42) (865) 15 (1) (851)

Gross profit 124 98 29 251 245

Other

income

31 17 6 54 3.8 57.8

Distribution

costs

(30) (21) (13) (64) (64)

Admin costs (55) (29) (6) (90) (2.2) (2) (1.6) (0.21) (96.01)

Finance income

– – – – 1.68 1.68

Finance costs

(8) (6) (4) (18) (11.70) (3) (32.70)

Share of profit of

associate

–

_____

–

_____

–

__ _

–

__ __

2.1 2.10

PBT 62 59 12 133 113.87

Tax (21) (23) (5) (49) (49)

Profit for the

year

41 36 7 84 64.87

OCI AFS 20 9 3 32 32

Revaluation 12 6 – 18 1.6 19.6 Remeas’t of

DBP

(14) – – (14) (14)

Share of OCI

of associate

–

_____

–

_____

–

_____

–

______

0.9 0.9

TCI 59 51 10 120 103.37

Profit attributable

to:

Owners of A 41 25.2 3.92 70.12 (1.54) (1.4) 2.66 1.47 (1) (10.02) (8) (1.6) (0.21) 50.48

NCI (30%/44%)

10.8 3.08 13.88 (0.66) (0.6) 1.14 0.63 14.39

TCI attributable

to:

Owners of A 59 35.7 5.6 100.3 (1.54) (1.4) 2.66 2.1 (1) (10.02) (8) - (0.21) 82.89

NCI

(30%/44%)

15.3 4.4 19.7 (0.66) (0.6) 1.14 0.9 20.48




164 CA Sri Lanka

1 Group structure

Ashanti

1 May 20X3 30 April 20X5

70% – 10% = 60%

Bochem

1 May 20X3 1 Nov 20X4

80% – 50% = 30%

Effective interest to

1 Nov 20X4 56%

NCI (bal) 44%

Ceram 100%

Ashanti

Bochem Subsidiary with 30% NCI for whole year

Ceram

Subsidiary with 44% NCI 612

30% associate (with 30% NCI by

Ashanti)

2 Goodwill in Bochem

Rs Mn

Consideration transferred: per 150.0

question/136

70%

Fair value of non-controlling interest 54.0

Fair value of net assets (160.0)

44.0

Impairment loss to 30.4. 20X4: 44 15% (6.6)

37.4

Impairment loss to 30.4.20X5: 44 5% (2.2)

35.2

The impairment loss in the year is recognised by (Rs Mn):

DEBIT Administrative costs 2.2

CREDIT Goodwill (SOFP) 2.2

To recognise the impairment of goodwill in the year.

1.5.X41.11.X4 30.4.X5




CA Sri Lanka 165

As the goodwill is attributable to both the group and the NCI, the loss is

allocated between the owners of Ashanti and the NCI in proportion to

their ownership interests.

3 Fair value adjustment

Rs Mn

Fair value of net asset at acquisition 160

Book value of net assets at acquisition (55+85+10) (150)

Fair value upift 10

The fair value uplift is depreciated over 5 years, therefore (Rs Mn):

DEBIT Administrative costs

(10m/5yrs)

2

CREDIT PPE (SOFP) 2

To recognise additional depreciation in the year.

4 Disposal of 10% of Bochem

As control is not lost, there is no effect on the consolidated statement of

profit or loss and other comprehensive income.

The sale is, in effect, a transfer between owners (Ashanti and the non-

controlling interest). It is accounted for as an equity transaction

directly in equity, and only reflected in the statement of changes in

equity.

Although no adjustment is required, the disposal journal is shown for

completeness (Rs Mn):

DEBIT Cash 34

CREDIT Non-controlling interest (251.2 * 10%) 25.12

CREDIT Adjustment directly to parent's equity 8.88

* Net assets of Bochem at date of sale:

Rs Mn

Net assets at 30 April 20X5

210.0 FV adjustments (W3) 6.0

216.0

Goodwill (W2) 35.2

251.2




166 CA Sri Lanka

5 Disposal of Ceram

Rs Mn Rs Mn

Fair value of consideration received 90.0

Fair value of equity interest retained 45.0

Carrying amount of Ceram at date of disposal Net assets 160.0

Goodwill (W6) 6.2

166.2

Less NCI per question (35.0)

(131.2)

3.8

(i) The disposal is recognised by (Rs Mn):

DEBIT Cash (SOFP) 90

DEBIT NCI (SOFP) 35

DEBIT Interest in associate

(SOFP)

45

CREDIT Net assets (SOFP) 160

CREDIT Goodwill (SOFP) 6.2

CREDIT Other income 3.8

To recognise the gain on the part-disposal of Ceram.

The gain is attributable between the owners of the parent and the

NCI in Bochem in proportion to their ownership interests.

(ii) Ceram is now an associate and therefore after the disposal, the

group share of its profit after tax and OCI is recognised as income

from an associate (Rs Mn):

DEBIT Investment in associate

(SOFP)

3

CREDIT Share of profit of

associate (Rs 14 Mn ×30% × 6/12m)

2.1

CREDIT Share of OCI of associate

(Rs 10 Mn × 30% ×

6./12m)

0.9

To recognise income from Ceram as an associate.

This income is attributable to the owners of Ashanti and the NCI in

Bochem in proportion to their ownership interests.




CA Sri Lanka 167

6 Goodwill on acquisition of Ceram

Rs Mn

Consideration transferred (136m

70%) 95.2

Fair value of non-controlling interest 26.0

Fair value of net assets (115.0) Goodwill on acquisition 6.2

7 Intragroup sales

(i) Intragroup sales/purchases must be eliminated by (Rs Mn):

DEBIT Revenue (10m + 5m) 15


To eliminate intragroup sales.

(ii) The unrealised profit on sales from Ashanti to Bochem is

cancelled by (Rs Mn):

DEBIT Cost of sales (10 ½ 20%) 1

CREDIT Inventory (SOFP) 1

To eliminate the unrealised profit in inventory.

As the selling company was Ashanti, the adjustment is attributable to

the owners of Ashanti only.

8 Bond impairment

In order to calculate the impairment, the carrying amount of the bondat 30 April 20X5 is compared with the present value of future cash

flows associated with the bond. Therefore

Carrying amount Rs m

1 May 20X4 amortised cost 21.046

Effective interest @ 4% 0.842

31 October 20X4 cash received (20 5%) (1.000)

20.888

Effective interest @ 4% 0.836

30 April 20X5 cash received (1.000) 30 April 20X5 carrying amount 20.724

As no accounting entries have been made in the year, the amortisation

of the bond must be recognised by (Rs Mn):

DEBIT Cash 2

CREDIT Financial asset (SOFP) (21,046 – 20,724) 0.32

CREDIT Finance income (0.842 + 0.836) 1.68

To recognise amortisation of the bond for the year

Present value of future cash flows Rs Mn

30 April 20X6 Rs 2.34 Mn 1/1.08 2.167

30 April 20X7 Rs 8 Mn 1/1.082 6.859




168 CA Sri Lanka

9.026

Therefore an impairment loss of Rs 11.698 Mn (Rs 20.724 Mn –

Rs 9.026 Mn) arises. This is rounded and recognised by (Rs Mn):


CREDIT Financial asset (SOFP) 11.70To recognise the impairment loss on the bond.

All amounts are attributable to the owners of Ashanti.

9 Allowance for receivables

The revenue of Rs. 5m should not have been recorded, as it is not

probable that future economic benefits from the sale will flow to

Ashanti. The revenue should only be recorded when the customer pays

for the goods.

It is not appropriate to include the Rs 5 Mn in the allowance fordoubtful debts of Rs 8 Mn, and so the allowance must be limited to

Rs 3 Mn.

The required adjustments are recorded by (Rs Mn):

DEBIT Revenue 5

CREDIT Receivables (SOFP) 5

DEBIT Finance costs (impairment of

receivable)

3

CREDIT Allowance for receivables

(SOFP)

3

To reverse the recorded revenue and recognise the increase in

allowance for receivables.

The costs are allocated to the owners of Ashanti.

10 Property, plant and equipment

SOFP

Reval’n

surplus

Rs Mn Rs Mn 1 May 20X3 Cost 12.000

Depreciation (12m/10yrs)

(1.200)

Revaluation (balancing figure) 2.200 2.200

30 April 20X4 Revalued PPE c/f 13.000

Depreciation for year (13m/9 years)

(1.444)

Transfer to retained earnings: 1.444 – 1.2 (0.244)

1.956

Revaluation loss (balancing figure) (3.556) (1.956)

30 April 20X5 Revalued PPE c/f 8.000 0.000

Ashanti has recorded the revaluation loss by (Rs Mn):

DEBIT Other comprehensive income 3.56




CA Sri Lanka 169


It should have (Rs Mn):

DEBIT Other comprehensive income 1.96

DEBIT Profit or loss (balancing figure) 1.6


Therefore the journal required to correct the entry is (Rs Mn):

DEBIT Administrative costs Rs 1.6 Mn

CREDIT Other comprehensive income Rs 1.6 Mn

To correctly recognise the downwards revaluation.

The PPE is owned by Ashanti and therefore the loss is attributable to

the owners of the parent only.

11 Holiday pay accrual

LKAS 19 Employee benefits requires that an accrual be made for holiday

entitlement carried forward to next year.

Number of days c/f: 900 3 95% = 2,565 days

Number of working days: 900 255 = 229,500

Accrual =2,565

229,500 Rs 19 Mn = Rs 0.21 Mn

Therefore (Rs Mn):

DEBIT Administrative costs 0.21

CREDIT Accruals 0.21

To recognise the holiday accrual.

This is attributable to the owners of Ashanti.

(2) Sustainability reporting

Sustainability may also be known as corporate citizenship or social

responsibility. It includes anything from environmental awareness to

involvement in local community issues to modifying business processes toreduce the operational use of energy resources.

A sustainability report is an organisational report that provides information

about a company’s economic, social and environmental performance and

impact. Such reports are becoming increasingly important to stakeholders

who use them to evaluate the long term viability of a company.

There are a number of factors that encourage companies to provide a

sustainability report with their financial statements.

As stated, public interest in corporate social responsibility is steadilyincreasing. Although financial statements are primarily intended for

investors and their advisers, there is growing recognition that companies




170 CA Sri Lanka

actually have a number of different stakeholders. These include customers,

employees and the general public, all of whom are potentially interested in

the way in which a company's operations affect the natural environment and

the wider community.

These stakeholders can have a considerable effect on a company's

performance. As a result many companies now deliberately attempt to build

a reputation for social, economic and environmental responsibility.

Therefore the disclosure of sustainability information is essential. There is

also growing recognition that corporate social responsibility is actually an

important part of an entity's overall performance. Responsible practice in

areas such as reduction of damage to the environment and the promotion of

good employee relations increase shareholder value. Companies that act

responsibly and provide sustainability reports are perceived as better

investments than those that do not.

In the Sri Lanka textiles and apparel industry, and particularly in Ashanti, it

is also the case that excellent practice in employee recruitment and relations

has already been established. This is, in itself, an incentive to promote

sustainability reporting, in that there exists good practice to report upon.

Another factor is growing interest by governments and professional bodies.

Although there are no SLFRSs that specifically require sustainability

reporting, it may be required by company legislation. There are now a

number of awards for high quality sustainability disclosure in financial

statements. These provide further encouragement to disclose information.

At present companies are normally able to disclose as much or as little

information as they wish in whatever manner that they wish. This causes a

number of problems. Companies tend to disclose information selectively and

it is difficult for users of the financial statements to compare the

performance of different companies. However, there are good arguments for

continuing to allow companies a certain amount of freedom to determine the

information that they disclose. If detailed rules are imposed, companies arelikely to adopt a 'checklist' approach and will present information in a very

general and standardised way, so that it is of very little use to stakeholders.

(3) Management of earnings

'Earnings management' involves exercising judgement with regard to

financial reporting, and structuring transactions so as to achieve stable and

predictable result, and in some cases, give a misleadingly optimistic picture

of a company's performance. This is done with the intention, whether

consciously or not, of influencing outcomes that depend on stakeholders'assessments. For example, a bank, or a supplier or customer may decide to

do business with a company on the basis of a favourable performance or




CA Sri Lanka 171

position. A director may wish to delay a hit to profit or loss for the year in

order to secure a bonus that depends on profit. Indeed earnings

management, sometimes called 'creative accounting' may be described as

manipulation of the financial reporting process for private gain.

A director may also wish to present the company favourably in order to

maintain a strong position within the market. The motive is not directly

private gain – he or she may be thinking of the company's stakeholders, such

as employees, suppliers or customers – but in the long term earnings

management is not a substitute for sound and profitable business, and

cannot be sustained.

'Aggressive' earnings management is a form of fraud and differs from

reporting error. Nevertheless, all forms of earnings management may be

ethically questionable, even if not illegal.

A more positive way of looking at earnings management is to consider the

benefits of not manipulating earnings:

(i) Stakeholders can rely on the data. Word gets around that the company

'tells it like it is' and does not try to bury bad news.

(ii) It encourages management to safeguard the assets and exercise

prudence.

(iii) Management set an example to employees to work harder to make

genuine profits, not arising from the manipulation of accruals.

(iv) Focus on cash flow rather than accounting profits keeps management

anchored in reality.

Earnings management goes against the principle of corporate social

responsibility. Companies have duty not to mislead stakeholders, whether

their own shareholders, suppliers, employees or the government. Because

the temptation to indulge in earnings management may be strong,

particularly in times of financial crisis, it is important to have ethical

frameworks and guidelines in place. The letter of the law may not be enough.

21 Rose

(1) Factors to consider in determining functional currency of Stem

LKAS 21 The effects of changes in foreign exchange rates defines functional

currency as 'the currency of the primary economic environment in which the

entity operates'. Each entity, whether an individual company, a parent of a

group, or an operation within a group, should determine its functionalcurrency and measure its results and financial position in that currency.




172 CA Sri Lanka

An entity should consider the following factors:

(1) What is the currency that mainly influences sales prices for goods and

services (this will often be the currency in which sales prices for its

goods and services are denominated and settled)?

(2) What is the currency of the country whose competitive forces and

regulations mainly determine the sales prices of its goods and services?

(3) What is the currency that mainly influences labour, material and other

costs of providing goods or services? (This will often be the currency in

which such costs are denominated and settled.)

Applying the first of these, it appears that Stem's functional currency is the

dinar. The price it charges is denominated and settled in dinars and is

determined by local supply and demand. However, when it comes to costs

and expenses, Stem pays in a mixture of dollars, dinars and the localcurrency, so that aspect is less clear- cut.

Other factors may also provide evidence of an entity's functional currency:

(1) It is the currency in which funds from financing activities are

generated.

(2) It is the currency in which receipts from operating activities are usually

retained.

Stem does not depend on group companies for finance. Furthermore, Stem

operates with a considerable degree of autonomy, and is not under the

control of the parent as regards finance or management. It also generates

sufficient cash flows to meet its cash needs. These aspects point away from

the dollar as the functional currency.

The position is not clear cut, and there are arguments on both sides.

However, on balance it is the dinar that should be considered as the

functional currency, since this most faithfully represents the economic

reality of the transactions, both operating and financing, and the autonomy

of Stem in relation to the parent company.

(2) ROSE GROUPCONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT

30 APRIL 20X8

Rs Mn Non-current assets Property, plant and equipment 603.65

Goodwill 22.20

Intangible assets 3.00

Financial assets 32.00

660.85 Current assets 284.00

944.85




CA Sri Lanka 173

Rs Mn Equity and liabilities Share capital 158.00

Retained earnings 277.39

Other components of equity 6.98 442.37


532.20

Non-current liabilities 130.65 Current liabilities 282.00

412.65

944.85

Workings

Consolidation schedule – consolidated statement of financial position at

30 April 20X8Rose Petal Stem Total (W4(i) ) (W4(ii)) (W5(i)) (W5(ii)) (W5(iii)) (W6) (W7) (W8) (W9) (W10) Consolidated


PPE 370 110 76 556 30 12.5 2.5 2.25 0.4 603.65

Goodwill 16 5.17 1.03 22.2

Inv in P 113 113 (94) (19) -

Inv in S 46 46 (46) -

Intangible

assets

4 (1) 3

Financial assets

15 7 10 32 32

Current assets

118 100 66 284 284

662 217 152 1,031 944.85

St capital 158 38 33.33 229.33 (38) (33.33) 158

OCE 7 4 11 (3) (0.3) 2.25 (2.97) 6.98

FX reserve 16.21 16.21 0.54 1 .3 (7.78) 10.27

Ret’d earnings

256 56 50.46 362.46 (49) (0.7) (36.67) (8.72) (0.65) 0.4 267.12

421 98 100 619

NCI 46 (0.3) 41.67 0.49 1.2 16.8 (16.03) 89.93

532.2

Non current

liabilities

56 42 32 130 0.65 130.65

Current liabilities

185 77 20 282 282

241

119

52

412

412.65

662 217 152 1,031 944.85




174 CA Sri Lanka

1 Group structure

Cost

FV NCI

FV NA

RE

OCE

Rs94m

Rs46m

Rs120m

Rs49m

Rs3m

Rs19m80% 52%

+

1 May 20X7

70%

1 May 20X7

52%

Cost

FV NCI

FV NA

RE

OCE

Rs46m

250m

495m

220m

dinars

dinars

dinars

Rose

Petal Stem

30 April 20X8

10% = 80%

2 Translation of SOFP of Stem at 30 April 20X8

Dinars (m) Rate Rs Mn

Property, plant and equipment 380 5 76.00

Financial assets 50 5 10.00

Current assets 330 5 66.00

760 152.00

Share capital 200 6 33.33

Retained earnings Pre-acqn 220

6 36.67

Post-acqn 80 5.8 13.79

FX Reserve

-

(W3)

16.21

500 100.00

Non-current liabilities 160 5 32.00

Current liabilities 100 5 20.00

760 152.00

3 Exchange difference arising on translation

Rs Mn Rs Mn Opening net assets (200m +220m) At opening rate of 6 70

At closing rate of 5 84 Gain 14

Retained profit for the year (80m) At average rate of 5.8 13.79

At closing rate of 5 16

Gain 2.21

Gain recognised as OCI of Stem and accumulated in foreign exchange reserve

16.21




CA Sri Lanka 175

4 Acquisition of Petal

(i) Goodwill Rs Mn Consideration transferred 94

Fair value of non-controlling interests 46

Fair value of identifiable net assets at acquisition: Stated capital (38)

Retained earnings (49)

Other components of equity (3)

Patent (4)

Fair value adjustment – land (120 – 38 – 49 – 3) (30)

16

This is recognised by (Rs Mn):

DEBIT Goodwill 16



DEBIT Other components of equity 3

DEBIT Intangible assets 4

DEBIT PPE 30

CREDIT Investment in P 94

CREDIT NCI 46

To recognise the acquisition of Petal and resulting goodwill.

(ii) The intangible asset is amortised over 4 years. Amortisation to date is

Rs. 1 million (4m/4years). It is recognised by (Rs Mn):

DEBIT Retained earnings (70% 1m) 0.7

DEBIT NCI (30% 1m) 0.3

CREDIT Intangible assets 1

To recognise amortisation on the intangible asset recognised on

consolidation.

5 Acquisition of Stem

(i) Goodwill is calculated as:

Dinars(m) Rate Rs Mn

Consideration transferred (Rs 46 Mn 6) 276 6 46.00

Non-controlling interests 250 6 41.67

Less fair value of net assets at acq'n

Stated capital (200) 6 (33.33)

Retained earnings (220) 6 (36.67)

FV adjustment to land (75) 6 (12.5)

At 1 May 20X7 31 6 5.17




176 CA Sri Lanka


DEBIT Goodwill 5.17

DEBIT Stated capital 33.33


DEBIT PPE 12.5


CREDIT NCI 41.67

To recognise the acquisition of Stem and resulting goodwill.

(ii) Goodwill is retranslated at the year-end using the closing rate to

Rs 6.2 Mn (31m/5). Therefore a gain of Rs 1.03 Mn is recognised. This

is allocated between the owners of Rose and the NCI in Stem by

(Rs Mn):

DEBIT Goodwill 1.03

CREDIT NCI (48% 1.03m) 0.49CREDIT FX reserve (52% 1.03m) 0.54

To recognise the retranslation of goodwill using the closing rate.

(iii) The fair value adjustment is also retranslated at the year-end using the

closing rate to Rs 15 Mn(75m/5). The Rs 2.5 Mn gain is allocated

between the owners of Rose and the NCI. It is recognised by (Rs Mn):

DEBIT PPE 2.5

CREDIT FX Reserve (52% 2.5) 1.3

CREDIT NCI (48% 2.5) 1.2

To recognise the retranslation of the fair value adjustment using the

closing rate.

6 Allocation of post-acquisition reserves movements to the NCI

Petal Stem

Retained earnings

Rs Mn

OCE Rs Mn

Retained earnings

Rs Mn

FX reserve Rs Mn

At reporting date 56 4 50.46 16.21

At acquisition (49) (3) (36.67) –

Post-acquisition 7 1 13.79 16.21

NCI share

(30%/48%)

2.1 0.3 6.62 7.78

The NCI share of reserves movements are allocated by:

DEBIT Retained earnings (2.1 + 6.62) 8.72


DEBIT FX reserve 7.78CREDIT NCI 16.8




CA Sri Lanka 177

To allocate the NCI its share of post-acquisition profits and OCI.

7 Rose – property

Dinars m Rs Mn

Cost at 1 May 20X7 30 @ 6 dinars: Rs. 1 5.00

Depreciation (30m/20) (1.5) 5m / 20yrs (0.25)

Carrying amount at 30 April 20X8 28.5 4.75

Revaluation (balancing figure) 6.5 2.25

Revalued amount at 30 April 20X8 35 @ 5 dinars: Rs. 1 7.00

The revaluation surplus of Rs 2.25 Mn is recognised in other components of

equity by (Rs Mn):

DEBIT PPE 2.25

CREDIT OCE 2.25

To recognise the revaluation surplus.

8 Bonus scheme

The cumulative bonus payable is Rs 4.42 Mn, calculated as follows, with a

5% annual increase:

Bonus as at: Rs Mn

30 April 20X8 Rs 40 Mn × 2% 0.800

30 April 20X9 Rs 0.8 Mn × 1.05 0.840

30 April 20Y0 Rs 0.8 Mn × 1.052 0.882

30 April 20Y1 Rs 0.8 Mn × 1.053 0.926 30 April 20Y2 Rs 0.8 Mn × 1.054 0.972

4.420

This is Rs. 884,000 (Rs. 4.42/5 years) per year. The current service cost is

the present value of Rs. 884,000 at 30 April 20X8: Rs. 884,000 × 1/1.084 =

Rs 0.65 Mn

This is recorded by (Rs Mn):


CREDIT Non-current liabilities 0.65

To recognise the long-term bonus scheme.

9 Rose – plant

The change in residual value is a change in accounting estimate and is

applied prospectively from the date of change (1 May 20X7):




178 CA Sri Lanka

Rs Mn Rs Mn

Depreciation for the year based on

original residual value

(20 – 1.4) ÷ 6 3.10

Depreciation for the year based on

revised amount

(20 – (3.1 × 3 years) – 2.6) ÷ 3 years

2.70

Adjustment 0.40

The adjustment is recognised by (Rs Mn):

DEBIT PPE 0.4


To record depreciation correctly based on the revised residual value.

10 Increased shareholding in Petal

The subsequent acquisition of a 10% holding in Petal for Rs. 19 million hasbeen recognised by Rose by:

DEBIT Investment in P 19

CREDIT Cash 19

In the consolidated accounts this acquisition is dealt with as a transaction

between shareholders and is accounted for by adjusting the carrying amount

of the NCI from 30% to 20%. The amount of the decrease is calculated in W5

as Rs. 16.03m. The adjustment to parent's equity, which is recognised in

other components of equity is calculated as follows:

Rs Mn

NCI at acquisition (W4(i)) 46.00

NCI share of amortisation of intangible (W4(ii)) (0.3)

NCI share of post-acq. retained earnings (W6) 2.1

NCI share of post-acquisition OCE (W6) 0.3

48.10

Adjustment 10%/30% x Rs. 48.1m 16.03

The adjustment to NCI is recognised in the parent’s equity by (Rs Mn):

DEBIT Non-controlling interest 16.03

DEBIT Other components of equity (balancing

figure)

2.97


To eliminate the cost of the 10% investment in Petal and adjust equity to

reflect the acquisition.




CA Sri Lanka 179

(3) Acquisition of MineConsult Co

Rose's proposed valuation of MoneConsult Co's assets (based on what it is

prepared to pay for them, which is, in turn, influenced by future plans for the

business) does not comply with SLFRS.

Such a valuation needs to be based on the following SLFRS:

(i) SLFRS 3 Business combinations. Under SLFRS 3, an acquirer must

allocate the cost of a business combination by recognising the

acquiree's identifiable assets, liabilities and contingent liabilities that

satisfy the recognition criteria at their fair values at the date of the

acquisition.

(ii) SLFRS 13 Fair value measurement defines fair value as as 'the price that

would be received to sell an asset or paid to transfer a liability in an

orderly transaction between market participants at the measurement

date.' This is also known as 'exit price'.

(iii) LKAS 38 Intangible assets states that intangible assets acquired in

business combinations can normally be measured sufficiently reliably

to be recognised separately from goodwill.

Measuring MineConsult Co's assets on the basis of their value to Rose does

not accord with the above standards. First, the standards may recognise as

assets items that Rose does not identify. Secondly, there has been no attempt

to apply the SLFRS 13 definition of fair value, which specifies the price that

would be paid by market participants, and implies that Rose's judgement

alone would not be sufficient.

With respect to the contract-based customer relationships that MineConsult

Co has, in proposing to value these at zero on the grounds that Rose already

has good relationships with customers, Rose is failing to apply LKAS 38.

Under LKAS 38, part of the cost of the acquisition should be allocated to

these relationships, which will have a value separate from goodwill at the

date of the acquisition. The fair value of the customer relationships should

not be based on Rose's judgement of their worth but on that of a market

participant such as a well-informed buyer.

Ethical behaviour in the preparation of financial statements, and in other

areas, is of paramount importance. Directors and company accountants act

unethically if they use 'creative' accounting in accounts preparation to make

the figures look better, in particular if their treatment would mislead users,

as here. Motivation for misleading treatments can include market

expectations, market position or expectation of a bonus.




180 CA Sri Lanka

To act ethically, the directors must put the interests of the company and its

shareholders first, and must also have regard to other stakeholders such as

potential investors or lenders. If a treatment does not conform to acceptable

accounting practice, it is not ethical.

If the aim of the proposed treatment is to deliberately mislead users of

financial statements, then it is unethical, and should not be put into practice.

It is possible that non-compliance with SLFRS 3, SLFRS 13 and LKAS 38 is a

genuine mistake. If so, the mistake needs to be corrected in order to act

ethically. There is, in any case a duty of professional competence in the

preparation of financial statements, which would entail keeping up to date

with SLFRS and local legislation.

22 Warrburt(1) WARRBURT GROUP

STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 NOVEMBER 20X8

Rs Mn Rs Mn Operating activities Net loss before tax (47)

Adjustments for Gain on revaluation of investment in equity instruments (Alburt – fair value on disposal less FV at 1.12.X7 (W1) (7)

Retirement benefit expense 10

Depreciation 36

Profit on sale of property plant and equipment:

Rs 63 Mn – Rs 56 Mn

(7)

Profit on insurance claim: Rs 3 Mn – Rs 1 Mn (2)

Foreign exchange loss (W6) Rs 1.1 Mn + Rs 0.83 Mn 2

Share of profit of associate (6)

Impairment losses: Rs 20 Mn + Rs 12 Mn 32

Interest expense 9

20 Decrease in trade receivables (W4) 71

Decrease in inventories (W4) 63

Decrease in trade payables (W4) (86)

Cash generated from operations 68

Retirement benefit contributions* (10)

Interest paid (W5) (8)

Income taxes paid (W3) (39)

Net cash from operating activities 11




CA Sri Lanka 181

Rs Mn Rs Mn Investing activities Purchase of PPE: Rs 56 Mn (W1) + Rs 1.1 Mn (W6) (57)

Proceeds from sale of property, plant and equipment 63

Proceeds from sale of financial asset investments 45 Acquisition of associate (W1) (96)

Dividend received from associate: (W1) 2

Net cash used in investing activities (43)

Financing activities Proceeds from issue of ordinary shares (W2) 55

Repayment of long-term borrowings (W3) (44)

Dividends paid (9)

Dividends paid to non-controlling shareholders (W3) (5)

Net cash used in financing activities (3) Net decrease in cash and cash equivalents (35)

Cash and cash equivalents at beginning of year 323

Cash and cash equivalents at end of year 288

*Note. Only the contributions paid are reported in the cash flow, because this is

the only movement of cash. The amounts paid by the trustees are not included,

because they are not paid by the company.

Workings

1 Assets

PPE Goodwill

Intan.

assets Associate

Financial

assets

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn

b/f 360 100 240 0 150

P/L 6

OCI (revaluation) 4 30**

FV gain on investment in Alburt

7

Dep'n/Impairment/ (36) (20) β (12) βAcquisition of

associate

96

Asset destroyed (1)

Replacement from ins. company (at FV)

3

Disposals (56)

Non-cash additions (on credit)*

20

8 × 25%

Cash paid/(rec'd) 56 0 0 (2) (45)

c/f 350 80 228 100 142




182 CA Sri Lanka

Bold figures in the table above are calculated as balancing figures.

Notes

* The additions are translated at the historic rate. Adjustment for exchange

rate differences are dealt with in (W9). Rs Mn

Additions (cash)280

5= 56

Additions (credit)

1005

20

Total (excluding destroyed assets replaced): 78 – (3 – 1) 76

** This is the gain on revaluation, which is shown in the statement of profit

or loss and other comprehensive income net of deferred tax of Rs 3 Mn (W3),

that is at Rs 27 Mn. The gross gain is therefore Rs 30 Mn and is the amount

reflected in this working.

2 Equity

Stated

capital

Retained

earnings

Reval

Surplus OCE NCI

Rs Mn Rs Mn Rs Mn Rs Mn Rs Mn b/f 595 454 4 16 53

P/L (74) (2)

OCI 2 23

Cash (paid)/rec'd 55 (9) ** (5) **

c/f 650 371 6 39 46

* *Cash flow given in question, but working shown for clarity

3 Liabilities

Long-term

borrowings

Tax payable

Retirement benefit

liability

Rs Mn Rs Mn Rs Mn b/f 64 (26 + 42) 68 96

P/L

29

10 OCI ( 3 + 2) *

5

4

Cash (paid)/rec'd (44) (39) (10)**

c/f 20 63

(28+ 35)

100


* On revaluation gain on PPE + revaluation gain on AFS financial assets

** Only the contributions paid are reported in the cash flow, because this is

the only movement of cash. The amounts paid by the trustees are not

included, because they are not paid by the company.




CA Sri Lanka 183

4 Working capital changes

Inventories Trade receivables Trade payables

Rs Mn Rs Mn Rs Mn

b/f 198 163 180.00

Exchange loss (W6) 20.83 Increase/(decrease) (63) (71) (85.83)

c/f 135 92 115


5 Interest payable

Rs Mn Balance b/f (short-term provisions) 4

Profit or loss for year 9

Cash paid (balancing figure)

(8) Balance c/f (short-term provisions) 5

6 Exchange loss

At 30 June 20X8:

DEBIT Property, plant and equipment (W1)380

5 Rs 76 Mn

CREDIT Payables380

5 Rs 76 Mn

To record purchase of property, plant and equipment

At 31 October 20X8;

DEBIT Payables280

5 Rs 56 Mn

DEBIT Profit/loss (loss) Rs 1.1 Mn

CREDIT Cash2804.9

Rs 57.1 Mn

To record payment of 280 million dinars

At 30 November 20X8:

DEBIT P/L (loss) Rs 0.83 MnCREDIT

Payables

100 100= 20.83 – = 20

4.8 5

Rs 0.83 Mn

To record loss on re-translation of payable at the year end.

Notes

1 The Rs. 20.83m was wrongly included in trade payables, so must be

removed from the decrease in trade payables in the SOCF.

2 The unrealised loss on retranslation of the payable (Rs 0.83 Mn) must

always be adjusted. The realised loss on the cash payment of Rs 1.1would not normally be adjusted, but it relates to a non-operating item,

so is transferred to 'purchase of PPE'.




184 CA Sri Lanka

(2) Key issues arising from the statement of cash flows

Cash is the life-blood of business, and is less able to be manipulated than

profit. It is particularly important to look at where the cash has come from

and what it has been spent on.

If cash coming into a business is from trading activity, rather than, for

example, a share issue, this is sustainable and is likely to continue into the

future.

If cash has been spent on, for example, acquiring non-current assets, this is

investment in the future of the company and is likely to increase or maintain

revenue levels in coming years. Conversely, cash spent on the payment of

dividends, although it provides a necessary return to investors, is lost to the

company.

Although Warrburt has made a loss before tax of Rs. 47m, net cash generated

by operations is Rs. 68m. This indicates that the loss is in some part due to

the effect of accounting policies and conventions. In the case of Warburrt,

for example, the non-cash expenses of depreciation and impairment total Rs.

68 million.

Having taken account of these and other items, but before adjusting for

changes in working capital, the loss before tax becomes a positive cash

inflow of Rs. 20m.

The question arises, however, as to whether this cash generation can

continue if profitability does not improve.

The cash inflow from operations further benefits from decreasing the levels

of cash tied up in receivables and inventories. The Rs. 134m cash released by

this action more than offsets the cash used to achieve a reduction in the level

of trade payables.

Although the effect of working capital management on the cash flows of

Warburrt is beneficial, the effect on the business should also be considered.

A decrease in trade receivables and inventories in this case may be related to

a fall in trading levels; the reduction of trade receivables, whilst releasing

cash, may be the result of aggressively chasing (and so alienating)

customers; the reduction of inventories may result in future supply

problems.

The Rs. 68million cash generated by operations adequately covers the

mandatory operating cash outflows to meet interest and tax commitments,

as well as the defined benefit pension contribution. This leaves a ‘free cash

flow’ of Rs. 11million.




CA Sri Lanka 185

Other than those arising from operating activities, further cash inflows arise

from the sale of PPE and financial asset investments, and the proceeds of

share issues. None of these are sustainable sources of cash in the long term,

however they are acceptable where ‘matched’ with a cash outflow.

The proceeds from sale of PPE, for example, is offset to some extent by

expenditure on new PPE, indicating that Warburrt has not decreased its non-

current asset base and continues to invest in PPE for the future good of the

group.

The proceeds from sale of financial asset investments have clearly been used

to invest in H200h, which will provide dividend income as well as capital

growth in the future.

Equally, the proceeds of the share issue appear to have been used in part to

fund the repayment of long-term borrowings. This is encouraging because

gearing will reduce, which is particularly important in the light of possible

problems sustaining profitability and cash flows from trading activities.

The level of dividends is modest given other cash flows, and appears to

provide shareholders with an acceptable return on their investment.

Overall, there is a net cash outflow of Rs. 35 million. It can be concluded that

this is largely due to the high cost of the investment in H200h, which is not

wholly covered by the cash raised from the sale of other assets; in other

words, cash is tied up in long-term rather than short-term investment.

It will be the intention of the directors of Warburrt that this investment

should generate future profits that will sustain and increase the operating

cash flow of the group, however whether this is achieved remains to be seen.

(3) Ethical responsibility of Sharmini Cooper

Directors may, particularly in times of falling profit and cash flow, wish to

present a company's results in a favourable light. This may involve

manipulation by creative accounting techniques such as window dressing,

or, as is proposed here, an inaccurate classification.

If the proceeds of the sale of financial asset investments and property, plant

and equipment are presented in the statement of cash flows as part of 'cash

generated from operations', the picture is misleading. Operating cash flow is

crucial, in the long term, for the survival of the company, because it derives

from trading activities, which is the purpose of the company’s existence. .

Sales of assets generate short term cash flows that cannot be repeated year-

on-year, unless there are to be no assets left to generate trading profits with.

As a professional, Ms Cooper has a duty, not only to the company she works

for, but to CASL, stakeholders in the company, and to the principles of




186 CA Sri Lanka

independence and fair presentation of financial statements. It is essential

that Ms Cooper tries to persuade the CEO and Managing Director not to

proceed with the adjustments, which she must know violates LKAS 7, and

may well go against the requirements of local legislation. If, despite Sharmini

Cooper’s protests, the two directors insist on the misleading presentation,then Ms Cooper has a duty to bring this to the attention of the auditors.






188 CA Sri Lanka



KC1 | Mock Exam Questions

CA Sri Lanka 189

SECTION A

There are 2 questions of 25 marks each. Both questions are compulsory.

This section has 50 marks in total.

Recommended time for this section is 90 minutes.

Question 1

(a) Havanna owns a chain of health clubs and has entered into binding contracts

with sports organisations, which earn income over given periods. The

services rendered in return for such income include access to Havanna's

database of members, and admission to health clubs, including the provision

of coaching and other benefits. These contracts are for periods of betweennine and 18 months. Havanna feels that because it only assumes limited

obligations under the contract mainly relating to the provision of coaching,

this could not be seen as the rendering of services for accounting purposes.

As a result, Havanna's accounting policy for revenue recognition is to

recognise the contract income in full at the date when the contract was

signed. (7 marks)

(b) In May 20X3, Havanna decided to sell one of its regional business divisions

through a mixed asset and share deal. The decision to sell the division at a

price of Rs. 40 million (net of costs to sell)_was made public in November

20X3 and gained shareholder approval in December 20X3. It was decided

that the payment of any agreed sale price could be deferred until 30

November 20X5. The business division was presented as a disposal group in

the statement of financial position as at 30 November 20X3. At the initial

classification of the division as held for sale, its net carrying amount was Rs.

90 million. In writing down the disposal group's carrying amount, Havanna

accounted for an impairment loss of Rs. 30 million which represented the

difference between the carrying amount and value of the assets measured inaccordance with applicable Sri Lanka Financial Reporting Standards

(SLFRS).

In the financial statements at 30 November 20X3, Havanna showed the

following costs as provisions relating to the continuing operations. These

costs were related to the business division being sold and were as follows.

(i) A loss relating to a potential write-off of a trade receivable owed by

Cuba Sport, which had gone into liquidation. Cuba Sport had sold the

goods to a third party and the division had guaranteed the receipt ofthe sale proceeds to the Head Office of Havanna




190 CA Sri Lanka

(ii) A provision was recognised relating to the expected transaction costs

of the sale including legal advice and lawyer fees

The directors wish to know how to treat the above transactions. (9 marks)

(c) Havanna has decided to sell its main office building to a third party and leaseit back on a ten-year lease. The lease has been classified as an operating

lease. The current fair value of the property is Rs. 5 million and the carrying

amount of the asset is Rs. 4.2 million. The following prices have been

achieved in the market during the last few months for similar office

buildings.

(i) Rs. 5 million

(ii) Rs. 6 million

(iii) Rs. 4.8 million

(iv) Rs. 4 million

Havanna would like advice on how to account for the sale and leaseback,

with an explanation of the effect which the different selling prices would

have on the financial statements. (9 marks)

Advise Havanna on how the above transactions should be dealt with in its

financial statements with reference to Sri Lanka Financial Reporting Standards

where appropriate. (Note. The mark allocation is shown against each of the three

issues above.) (Total = 25 marks)




CA Sri Lanka 191

Question 2

(a) Bental, a listed bank, has a subsidiary, Hexal, which has two classes of shares,

A and B. A-shares carry voting powers and B-shares are issued to meet

Hexal's regulatory requirements. Under the terms of a shareholders'agreement, each B shareholder is obliged to capitalise any dividends in the

form of additional investment in B-shares. The shareholder agreement also

stipulates that Bental agrees to buy the B-shares of the minority

shareholders through a put option under the following conditions

(i) The minority shareholders can exercise their put options when their

ownership in B-shares exceeds the regulatory requirement, or

(ii) The minority shareholders can exercise their put options every three

years. The exercise price is the original cost paid by the shareholders.

In Bental's consolidated financial statements, the B-shares owned by

minority shareholders are to be reported as a non-controlling interest.

(8 marks)

(b) Bental entered into a number of swap arrangements during 20X3. Some of

these transactions qualified for cash flow hedge accounting in accordance

with LKAS 39 Financial instruments: recognition and measurement. The

hedges were considered to be effective. At 30 November 20X3, Bental

decided to cancel the hedging relationships and had to pay compensation.The forecast hedged transactions were still expected to occur and Bental

recognised the entire amount of the compensation in profit or loss.

Additionally, Bental also has an investment in a foreign entity over which it

has significant influence and therefore accounts for the entity as an

associate. The entity's functional currency differs from Bental's and in the

consolidated financial statements, the associate's results fluctuate with

changes in the exchange rate. Bental wishes to designate the investment as a

hedged item in a fair value hedge in its individual and consolidated financial

statements. (7 marks)

(c) On 1 September 20X3, Bental entered into a business combination with

another listed bank, Lental. The business combination has taken place in two

stages, which were contingent upon each other. On 1 September 20X3,

Bental acquired 45% of the share capital and voting rights of Lental for cash.

On 1 November 20X3, Lental merged with Bental and Bental issued new A-

shares to Lental's shareholders for their 55% interest.

On 31 August 20X3, Bental had a market value of Rs. 70 million and Lental a

market value of Rs. 90 million. Bental's business represents 45% and

Lental's business 55% of the total value of the combined businesses.




192 CA Sri Lanka

After the transaction, the former shareholders of Bental excluding those of

Lental owned 51% and the former shareholders of Lental owned 49% of the

votes of the combined entity. The Chief Operating Officer (COO) of Lental is

the biggest individual owner of the combined entity with a 25% interest. The

purchase agreement provides for a board of six directors for the combinedentity, five of whom will be former board members of Bental with one seat

reserved for a former board member of Lental. The board of directors

nominates the members of the management team. The management

comprised the COO and four other members, two from Bental and two from

Lental. Under the terms of the purchase agreement, the COO of Lental is the

COO of the combined entity.

Bental proposes to account for the transaction as a business combination

and identify Lental as the acquirer. (10 marks)

Evaluate the accounting practices and policies outlined above and consider

whether they are acceptable under Sri Lanka Financial Reporting Standards.

(Note. The mark allocation is shown against each of the three issues above.)

(Total = 25 marks)




CA Sri Lanka 193

SECTION B

This section has one question which is compulsory.

This section has 50 marks.

Recommended time for this section is 90 minutes.

Question 3

Preseen

Minny is a public limited company that operates in the pharmaceuticals sector,

producing and distributing pharmaceuticals, biologics, vaccines and consumer

healthcare. The company was formed 60 years ago and has since grown

significantly. Its head office is in Kandy, Sri Lanka.

Operations

Minny is operated as four distinct divisions: Drugs and Vaccines, Healthcare

Products, Consumer Products and Home Consumables.

Minny manufactures drugs and vaccines for major diseases including diabetes,

asthma and cancer. These drugs and vaccines take years to develop, with only a

small proportion of candidate vaccines progressing to be licensed for clinical use

by the authorities. The drugs developed by Minny’s Drugs and Vaccines division

are protected by patent; these patents allow only Minny to sell the drugs that it

has developed. During this period Minny is normally able to generate sufficient

profit to recoup the cost of developing a particular drug or vaccine. After the

expiry of a patent (between 10 and 15 years), competitors can produce and sell

generic versions of the drug.

The company’s over-the-counter health-care products, manufactured and sold by

the Healthcare Products division include generic cold and flu remedies, nicotine

replacements and pain relief products.

The Consumer Products division of Minny manufactures and sells oral healthcare

products (toothpastes, mouthwashes etc) and nutritional products (such as high

fibre bars, protein shakes, energy drinks and weight loss shakes). The company

invests a considerable amount of money in developing new nutritional products,

as the route to market is more straightforward than that for regulated drugs and

vaccines, and as a result returns arise more quickly.

Minny also manufactures and sells a small number of cleaning products for

consumers through its Home Consumables division. These include anti-bacterial

sprays, bleach products and furniture and floor polishes.

Development of the group




194 CA Sri Lanka

Minny acquired 70% of the equity shares in Bower (a public limited company) on

1 December 20X0 for a cash price of Rs. 730 million. This was a strategic

acquisition, made with the intention of acquiring know-how and patents owned by

Bower. As a result of the acquisition, Minny was able to develop its product base

and access the market for drugs for blood disorders such as anaemia, lymphomaand myeloma (blood cancers).

An 80% share in the equity of Heeny (a public limited company) was acquired on

1 December 20X1 at a cost of Rs. 320 million, paid in cash. This acquisition was

made in order that Minny could achieve rapid market expansion. Heeny has a

well-established sales and distribution network in Africa, a market that Minny had

not previously entered.

Minny acquired a 14% interest in Puttin, a public limited company, on 1 December

20X0 for a cash consideration of Rs. 21 million. The investment was accounted forat cost. On 1 June 20X2, Minny acquired an additional 16% interest in Puttin for a

cash consideration of Rs. 27 million and achieved significant influence. Puttin

operates in consumer healthcare products such as shampoos, conditioners and

toothpastes. As such this investment was seen to be a good strategic fit for

Minny’s Consumer Products division. In time it is expected that the investment

may be increased and control over Puttin achieved.

Financial reporting and accounting policies

The financial statements of Minny are prepared to a reporting date of 30November. Financial statements are prepared in accordance with SLFRS and

Columbo Stock Exchange regulations. They are presented in an annual report

together with a social and environmental impact report, which the Board of Minny

intends to develop into a full sustainability report.

The Board of Minny is aware that SLFRS 3 allows a choice of method to measure

the non-controlling interest on an acquisition-by-acquisition basis. In order to

maximise reported goodwill, it has elected to measure the non-controlling interest

in both subsidiaries at fair value at the acquisition date.

Goodwill arising from the acquisitions is not amortised, but is tested for

impairment at each reporting date in accordance with the requirements of SLFRS.

Development costs are capitalised when the LKAS 38 criteria are met. They are

amortised over a relevant period. In the case of drugs and vaccines, this is the

period for which the product is patent protected; for nutritional products it is

usually 10 years.

The company adopts the LKAS 16 revaluation model for its properties, and

revaluation exercises are performed with sufficient frequency that carryingamounts are in line with fair values at each reporting date.




CA Sri Lanka 195

Financial performance

Analysis of the recent financial performance of Minny Group indicates strong

performance from the Drugs and Vaccines division. This is largely due to the

launch to market of a drug to treat the effects of a new strain of flu. This drug has

been licensed for use by a number of healthcare authorities throughout Asia and

as a result has generated significant revenues since its launch.

The Healthcare Products division is considered to be a ‘cash cow’ by the Board of

Minny; it continues to require little investment in comparison to other divisions

and returns steady profits.

The Consumer Products division has shown steady growth in revenue over the

past year, which can be attributed to the continued consumer trend towards

exercise and weight loss plans, and Minny’s ability to respond to consumer

demand in these areas.

In recent years the Home Consumables division has not performed as well as the

other divisions of Minny, contributing the lowest profit margins of the group.

Revenue is relatively stagnant, and the Board consider that there are two viable

routes for this division: either dispose of it or commit to invest in it and develop it.

Unseen

(a) The draft statements of financial position of Minny, Bower and Heeny are as

follows at 30 November 20X2:




196 CA Sri Lanka

Minny Bower Heeny Rs Mn Rs Mn Rs Mn

Assets Non-current assets

Property, plant and equipment 920 300 310 Investment in subsidiaries:

Bower 730 Heeny 320

Investment in Puttin 48

Intangible assets 198 30 35

1,896 650 345


Total assets 2,791 1,130 595


Other components of equity 73 37 25

Retained earnings 895 442 139

Total equity 1,888 879 364




Total equity and liabilities 2,791 1,130 595

The following information is relevant to the preparation of the group


(i) At acquisition, the fair value of the non-controlling interest in Bower

was Rs. 295 million. On 1 December 20X0, the fair value of the

identifiable net assets acquired was Rs. 835 million and retained

earnings of Bower were Rs. 319 million and other components of

equity were Rs. 27 million. The excess in fair value is due to non-

depreciable land.

(ii) The fair value of a 20% non-controlling interest in Heeny at 1

December 20X1 was Rs. 72 million; a 30% holding was Rs. 108 million

and a 44% holding was Rs. 161 million. At the date of acquisition, the

identifiable net assets of Heeny had a fair value of Rs. 362 million,

retained earnings were Rs. 106 million and other components of equity

were Rs. 20 million. The excess in fair value is due to non-depreciable

land.

(iii) Both Bower and Heeny were tested for impairment at 30 November

20X2. The recoverable amounts of both cash generating units as statedin the individual financial statements at 30 November 20X2 were




CA Sri Lanka 197

Bower, Rs. 1,425 million, and Heeny, Rs. 604 million, respectively. The

directors of Minny felt that any impairment of assets was due to the

poor performance of the intangible assets. The recoverable amount has

been determined without consideration of liabilities which all relate to

the financing of operations.

(iv) Puttin made profits after tax of Rs. 20 million and Rs. 30 million for the

years to 30 November 20X1 and 30 November 20X2 respectively. On

30 November 20X2, Minny received a dividend from Puttin of Rs. 2

million, which has been credited to other components of equity.

(v) Minny purchased patents of Rs. 10 million to use in a project to develop

a new weight loss shake product on 1 December 20X1. Minny has

completed the investigative phase of the project, incurring an

additional cost of Rs. 7 million, and has determined that the productcan be developed profitably. An effective test batch was created at a

cost of Rs. 4 million and in order to put the shake into a condition for

sale, a further Rs. 3 million was spent. Finally, marketing costs of Rs. 2

million were incurred. All of the above costs are included in the

intangible assets of Minny.

(vi) Minny intends to dispose of the Home Consumables division. At the

date the held for sale criteria were met, the carrying amount of the

assets and liabilities comprising the division were:

Rs Mn

Property, plant and equipment (PPE) 49 Inventory 18 Current liabilities 3

It is anticipated that Minny will realise Rs. 30 million for the business.

No adjustments have been made in the financial statements in relation

to the above decision.

Prepare the consolidated statement of financial position for the Minny

Group as at 30 November 20X2. (35 marks)

(b) Minny intends to dispose of the Home Consumables division and has stated

that the held for sale criteria were met under SLFRS 5 Non-current assets

held for sale and discontinued operations. The criteria in SLFRS 5 are very

strict and regulators have been known to question entities on the application

of the standard. The two criteria which must be met before an asset or

disposal group will be defined as recovered principally through sale are: that

it must be available for immediate sale in its present condition, and the sale

must be highly probable.




198 CA Sri Lanka

Outline what is meant in SLFRS 5 by 'available for immediate sale in its

present condition' and 'the sale must be highly probable', setting out briefly

why regulators may question entities on the application of the standard.

(7 marks)

(c) Bower has a property which has a carrying amount of Rs. 2 million at 30

November 20X2. This property had been revalued at the year-end and a

revaluation surplus of Rs. 400,000 had been recorded in other components

of equity. The directors intended to sell the property to Minny for Rs. 1

million shortly after the year-end. Bower previously used the historical cost

basis for measuring property.

Evaluate the ethical and accounting implications of the above intended sale

of assets to Minny by Bower. You are not required to adjust your answer to

part (a). (8 marks)

(Total = 50 marks)





KC1 | Mock Exam Answers

200 CA Sri Lanka




CA Sri Lanka 201

SECTION A

Question 1

(a) Contracts with sports organisations

The applicable standard relating to the contracts is LKAS 18 Revenue. In

general revenue is recognised when it is probable that future economic

benefits will flow to the entity and these benefits can be measured reliably.

This applies to services as well as goods.

The rendering of services typically involves the performance by the entity of

a contractually agreed task over an agreed period of time. The basic

principles of LKAS 18 are applied differently for the provision of goods and

services:

– revenue is recognised at a point in time in respect of the provision of

goods

– revenue is recognised over a period of time in respect of the provision

of services.

Therefore in the first instance it is important to establish whether Havanna

is providing goods or services.

Havanna argues that the 'limited obligations' under the contracts (coaching

and access to its membership database) do not constitute rendering of

services. The Illustrative Guidance that accompanies LKAS 18 does, however,

identify that admission fees, initiation and membership fees and franchise

fees constitute the provision of services and associated revenue is

recognised over time. Therefore the contracts with sports organisations

should be considered as for the provision of services.

Under LKAS 18, when the outcome of a transaction involving services

rendered can be estimated reliably, the revenue from this transaction mustbe recognised by reference to the stage of completion of the transaction at

the reporting date. This applies to all transactions, regardless of the length of

the contract term.

The recognition of revenue by reference to the stage of completion of a

transaction is often referred to as the percentage of completion method.

Under this method, revenue is recognised in the accounting periods in which

the services are rendered, that is on a basis that 'reflects the extent to which

services are performed'. LKAS 18 also requires that when services are

performed by an indeterminate number of acts over a specified period of




202 CA Sri Lanka

time, as is the case for Havanna, revenue is recognised on a straight-line

basis over the specified period unless there is evidence that some other

method better represents the stage of completion.

When a specific act is much more significant than any other acts, the

recognition of revenue is postponed until the significant act is executed.

However, in Havanna's case there is no evidence that one act is much more

significant than any other act.

There is no justification for Havanna's treatment, that is recognising the

contract income in full when the contract is signed. The 'limited obligations'

argument is not supported by LKAS 18. Accordingly, Havanna must

apportion the income arising from the contracts over the period of the

contracts, as required by the standard.

(b) Sale of division

Impairment loss

A division (or disposal group) is classified as held for sale when it is available

for immediate sale in its present condition and the sale is highly probable.

For a sale to be probable, management must be committed to a sale plan, and

the plan must have been announced or its implementation begun.

Here the plan has been announced and so the division to be sold meets the

criteria in SLFRS 5 to be classified as held for sale. It has therefore been

correctly classified as a disposal group under SLFRS 5.

Measurement of a disposal group on classification as held for sale is

determined in two steps:

Step 1

Immediately before classification as held for sale, the assets and liabilities of

a disposal group are re-measured in accordance with applicable SLFRS. Any

impairment loss is generally recognised in profit or loss, but if the asset has

been measured at a revalued amount under LKAS 16 Property, plant andequipment or LKAS 38 Intangible assets, the impairment is treated as a

revaluation decrease.

Step 2

On classification as held for sale, a disposal group is measured at the lower of

its carrying amount and fair value less costs to sell.

At this stage an impairment loss will arise if the adjusted carrying amount of

the disposal group exceeds its fair value less costs to sell. The impairment

loss (if any) is recognised in profit or loss.




CA Sri Lanka 203

For assets carried at fair value prior to initial classification, the requirement

to deduct costs to sell from fair value will result in an immediate charge to

profit or loss.

Havanna has calculated the step 1 impairment as Rs. 30m, being the

difference between the carrying amount at initial classification and the value

of the assets measured in accordance with SLFRS.

Step 1 Calculate carrying amount under applicable SLFRS: Rs. 90m – Rs.

30m = Rs. 60m

Step 2 Classified as held for sale. Compare the adjusted carrying amount

under applicable SLFRS (Rs. 60m) with fair value less costs to sell

(Rs. 40m). Measure at the lower of carrying amount and fair

value less costs to sell, here Rs. 40m. Recognise a Rs. 20m

impairment loss in profit or loss.

Other costs

Certain other costs relating to the division being sold are currently

recognised as provisions relating to continuing operations. This treatment is

not correct:

(i) The trade receivable from Cuba Sports should have been tested for

impairment immediately before classification of the division as held for

sale.An impairment loss equal to the amount of the trade receivable should

have been recognised; this would have reduced the carrying amount of

the division prior to its initial classification as held for sale. The write

down of the receivable balance replaces the provision recognised in the

books of the continuing operations.

In addition, the division has guaranteed the sale proceeds to

Havanna's Head Office.

As the amount owing has not been collected and the receivable isimpaired, the regional business division must bear the cost of making

good the guarantee.

Therefore a liability should be recognised for the disposal group.

Additionally, the sales price of the division (and hence the fair value

less costs to sell) should be adjusted to reflect this amount.

(ii) The provision for transaction costs should not have been recognised in

continuing operations. The costs (legal advice and lawyers' fees)

should be considered as part of 'costs to sell' when calculating fairvalue less costs to sell.




204 CA Sri Lanka

Both items affect fair value less costs to sell, and item (i), the trade

receivable, also affects the carrying amount of the division on classification

as held for sale.

(c) Sale and leaseback

Where, as here, a lessee enters a sale and leaseback transaction resulting in

an operating lease, the original asset should be derecognised.

If the transaction is at fair value then the profit or loss is recognised as it

arises.

If the transaction is at a price above fair value, then the profit based on fair

value is recognised immediately and sales proceeds in excess of fair value

are deferred and amortised over the period for which the asset is expected

to be used.

If the sales price is below fair value, the operating lease rentals may have

been adjusted downwards to compensate for the loss. The accounting

treatment depends on whether this is the case.

If this is not the case, any resulting profit or loss is recognised immediately.

If this is the case, and a loss is made, that loss is deferred and amortised over

the period that the asset will be used.

Havanna has been given a range of selling prices, and should in each case

compare the potential sales proceeds with the fair value (Rs 5 million) in

order to determine the accounting treatment as well as comparing the sales

price with the carrying amount (Rs. 4.2m) to determine the gain.

(i) Sales price Rs. 5 million

In this case the sales price is equal to the fair value. In effect, this is a

normal sales transaction and the whole gain of Rs. 0.8m (Rs. 5m – Rs.

4.2m) is recognised immediately in profit or loss.

(ii) Sales price Rs. 6 millionHere the sales price is greater than fair value. Therefore the profit

based on fair value of Rs. 0.8m (see (i) above) is recognised

immediately. The excess of sales price over fair value of Rs. 1m (Rs. 6m

– Rs. 5m) is deferred and amortised over the period for which the asset

is expected to be used (ten years), giving an amortisation charge of Rs.

100,000 per annum..

(iii) Sales price Rs. 4.8 million

Here the sales price is below fair value. The difference is small, andgiven that property valuations are estimates, Rs. 4.8m may simply be a




CA Sri Lanka 205

better reflection of genuine fair value than Rs. 5m. In this case,

therefore, the sales proceeds are recognised in full and a gain of Rs.

0.6m (Rs. 4.8m – Rs. 4.2m) is recognised.

(iv) Sales price Rs. 4 million

Here the sales price is also below fair value. However, the difference is

significant, and cannot be explained by estimation tolerances in the

valuation. The price appears to be artificially low, and it is likely that

the lease rentals are low to reflect this. Therefore it is appropriate to

recognise the sales proceeds of Rs. 4m, but the Rs. 200,000 loss on

disposal is not recognised, being an artificial loss. Instead, it is deferred

and amortised over the ten year life of the lease, that is at Rs. 20,000

per annum.

Question 2

(a) Classification of B-shares

It is not always easy to distinguish between debt and equity in an entity's

statement of financial position, partly because many financial instruments

have elements of both.

The distinction is important, since the classification of a financial instrument

as either debt or equity can have a significant impact on the entity's reportedearnings and gearing ratio, which in turn can affect debt covenants.

Companies may wish to classify a financial instrument as equity, in order to

give a favourable impression of gearing, but this may in turn have a negative

effect on the perceptions of existing shareholders if it is seen as diluting

existing equity interests.

LKAS 32 Financial instruments: presentation brings clarity and consistency to

this matter, so that the classification is based on principles rather than

driven by perceptions of users.

Bental has classified the B-shares as non-controlling interest (equity) but

this does not comply with LKAS 32. LKAS 32 defines an equity instrument as:

'any contract that evidences a residual interest in the assets of an entity after

deducting all of its liabilities'. It must first be established that an instrument

is not a financial liability, before it can be classified as equity.

A key feature of the LKAS 32 definition of a financial liability is that it is a

contractual obligation to deliver cash or another financial asset to another

entity.




206 CA Sri Lanka

A financial instrument is an equity instrument if there is an unconditional

right to avoid delivering cash or another financial asset to another entity.

An instrument may be classified as an equity instrument if it contains a

contingent settlement provision requiring settlement in cash or a variable

number of the entity's own shares only on the occurrence of an event which

is very unlikely to occur – such a provision is not considered to be genuine.

If the contingent payment condition is beyond the control of both the entity

and the holder of the instrument, then the instrument is classified as a

financial liability.

The shareholders' agreement imposes on Bental a clear contractual

obligation to buy B-shares from the non-controlling shareholders on the

terms set out in the agreement.

It does not have an unconditional right to avoid delivering cash or another

financial asset to settle the obligation. The circumstance above, where the

contingent settlement provision is not considered genuine because an event

is unlikely to occur, does not apply here: the minority shareholders' can

exercise their put option at least every three years, and more frequently if

their ownership in B-shares exceeds the regulatory requirement.

Accordingly, the minority shareholders' holdings of B shares should be

treated as a financial liability in the consolidated financial statements of

Bental.

(b) Hedging

Swap arrangements

LKAS 39 Financial instruments: recognition and measurement sets out

requirements for when hedge accounting is discontinued.

Cash flow hedge accounting should be discontinued if the hedging

instrument expires or is sold, terminated or exercised, if the criteria for

hedge accounting are no longer met, a forecast transaction is no longerexpected to occur or if the entity revokes the designation.

If hedge accounting ceases for a cash flow hedge relationship because the

forecast transaction is no longer expected to occur, gains and losses deferred

in other components of equity are recognised in profit or loss immediately. If

the transaction is still expected to occur and the hedge relationship ceases,

the amounts accumulated in equity are retained in equity until the hedged

item affects profit or loss.

In the case of Bental, the forecast hedged transactions are still expected tooccur. Bental should recognise the cash payments of compensation against




CA Sri Lanka 207

the fair value of the swaps, so there is no immediate effect on profit or loss.

The amounts accumulated in equity are reclassified to profit or loss in the

period when the item that was hedged affects profit or loss.

Investment in foreign entity

The foreign entity is an associate and Bental therefore accounts for it using

the equity method in its consolidated accounts.

Under LKAS 39, an equity method investment cannot be a hedged item in a

fair value hedge because the equity method recognises in profit or loss the

investor's share of the associate's profit or loss, rather than changes in the

investment's fair value.

A hedge of a net investment in a foreign operation is different because it is a

hedge of the foreign currency exposure, not a fair value hedge of the

change in the value of the investment.

Bental may, however, be able to designate the investment as a hedged item

in a fair value hedge in its individual financial statements, provided its fair

value can be measured reliably.

(c) Business combination

SLFRS 3 Business Combinations requires an acquirer to be identified in all

business combinations, even where the business combination looks like a

merger of equals. The acquirer is the combining entity that obtains control ofthe entity with which it is combined.

It is not always easy to determine which party is the acquirer, and SLFRS 3

defers to IFRS 10 in respect of guidance on the matter. The key point is

control, rather than mere ownership, but this may not be easy to assess.

SLFRS 10 states that an investor controls an investee if and only if it has all

of the following.

(i) Power over the investee

(ii) Exposure, or rights, to variable returns from its involvement with the

investee, and

(iii) The ability to use its power over the investee to affect the amount of

the investor's returns.

Power is defined as existing rights that give the current ability to direct the

relevant activities of the investee. There is no requirement for that power to

have been exercised.

Relevant activities are activities of the investee that significantly affect theinvestee’s returns. They may include selling and purchasing goods or




208 CA Sri Lanka

services, managing financial assets, electing, acquiring and disposing of

assets, researching and developing new products and processes and

determining a funding structure or obtaining funding.

In some cases assessing power is straightforward, for example, where power

is obtained directly and solely from having the majority of voting rights or

potential voting rights, and as a result the ability to direct relevant activities.

In other cases, assessment is more complex and more than one factor must

be considered. SLFRS 10 gives the following examples of rights, other than

voting or potential voting rights, which individually, or alone, can give an

investor power.

(i) Rights to appoint, reassign or remove key management personnel who

can direct the relevant activities

(ii) Rights to appoint or remove another entity that directs the relevant

activities

(iii) Rights to direct the investee to enter into, or veto changes to

transactions for the benefit of the investor

(iv) Other rights, such as those specified in a management contract.

If it is not clear which is the acquirer from applying SLFRS 10. SLFRS 3

Business combinations gives a number of other factors to consider; in

particular the acquirer is usually the entity which transfers cash or otherassets.

Applying the above criteria produces arguments in favour of either party

being the acquirer.

Arguments in favour of Bental being the acquirer

(i) Bental is the entity giving up cash amounting to 45% of the purchase

price, which is a significant share of the total purchase consideration.

(ii) In a business combination effected primarily by exchanging equityinterests, as here, the acquirer is usually the entity that issues its equity

interests. Thus Bental appears to be the acquirer.

(ii) Other factors need to be taken into consideration in determining which

of the combining entities has the power to govern the financial and

operating policies of the other entity. Usually that is the one whose

shareholders retain or receive the largest proportion of the voting

rights in the combined entity, here Bental which has 51% immediately

after the transaction.




CA Sri Lanka 209

(iv) A controlling share does not always mean that the party that has it has

the power to govern the combined entity's financial and operating

policies so as to obtain benefits from its activities. Power may also be

given by rights to appoint, reassign or remove key management

personnel who can direct the relevant activities of the combined entity.Five out of the six directors of the combined entity are former board

members of Bental, which points to Bental being the acquirer.

Arguments in favour of Lental being the acquirer

(i) Despite the above, arguably the former management of Lental has

greater representation on the management team. The management

team consists of the Chief Operating Officer and two former employees

of Lental, while Bental has only two former employees on the

management team.

(ii) The Chief Operating Officer of Lental has, as an individual, the largest

share of the combined entity, which at 25%, gives him a great deal of

influence over the team, especially taking into account the composition

of the team. Although the board nominates the team, this individual

influence points towards Lental being the acquirer.

(iii) Lental may also be seen as the acquirer when the relative size of the

combining entities is taken into account, for example in terms of assets,

revenue or profit.. The fair value of Lental is Rs. 90m, which issignificantly greater than that of Bental, (Rs. 70m) and this is an

indication of control.

Conclusion

Identifying the acquirer is not easy, and there are arguments on both sides.

In the case of Lental, the Chief Operating Officer of Lental is the source of

much of Lental's power, whereas Bental has a balance of other factors in its

favour, the most important of which are:

(i) Bental is the entity transferring the cash

(ii) Bental issued the equity interest

(iii) Bental has the marginal controlling interest.

It is possible to conclude that Bental is the acquirer, but this is not a clear-cut

case.




210 CA Sri Lanka

SECTION B

Question 3

(a) MINNY GROUP

CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30.11.20X2

Rs Mn Non-current assets Property, plant and equipment 1,606.0

Goodwill 190.0

Intangible assets 227.0

Investment in associate: 48 + 4.5 – 2 50.5

2,073.5

Current assets 1,607.0

Disposal group held for sale 33.0

Total assets 3,713.5

Equity and liabilities Equity attributable to owners of the parent

Stated capital 920.00

Retained earnings 936.08

Other components of equity 77.80

1,933.88


2,328.50


Current liabilities 671.00

Current liabilities associated with disposal group 3.00

Total equity and liabilities 3,713.50




CA Sri Lanka 211

Workings

1 Group structure

Minny 1 Dec 20X0 70% (Consideration =

Rs. 730m)

FV NA Rs 835 Mn

Retained earnings Rs 319 Mn

OCE Rs 27 Mn

FV NCI Rs 295 Mn

Bower

1 Dec 20X1 80% (Consideration =

Rs. 320m)

FV NA Rs 362 Mn

Retained earnings Rs 106 Mn

OCE Rs 20 Mn

FV NCI Rs 161 Mn Heeny

%

Effective interest: 70% × 80% 56

... Non-controlling interest 44

100

2 Goodwill

Bower Heeny

Rs Mn Rs Mn

Consideration transferred 730 320 70% 224

Non-controlling interests 295 (44%) 161

FV of identifiable net assets at acq'n:

Stated capital (400) (200)

Retained earnings (319) (106)

OCE (27) (20)

FV uplift – land (89) (36)

190 23

Impairment losses (W4) (-) (23)

190 -

(i) The acquisition of Bower is recognised by (Rs Mn):

DEBIT Goodwill 190



DEBIT OCE 27

DEBIT PPE 89CREDIT Investment in B 730




212 CA Sri Lanka

CREDIT NCI 295

(ii) The acquisition of Heeny is recognised by (Rs Mn):

DEBIT Goodwill 23



DEBIT OCE 20

DEBIT PPE 36

CREDIT Investment in Heeny 224

CREDIT NCI 161

3 Allocation of profits to the NCI

The increase in retained earnings and OCE since acquisition in both

companies is calculated as follows (Rs Mn):

Bower Heeny

Retained

earnings

OCE Retained

earnings

OCE

At reporting date 442 37 139 25

At acquisition (319) (27) (106) (20)

Increase 123 10 33 5

NCI share

(30%/44%)

36.9 3 14.52 2.2

(i) The allocation of these amounts to the NCI is recognised by(Rs Mn):

DEBIT Retained earnings

(36.9 + 14.52)

51.42

DEBIT OCE (3 + 2.2) 5.2

CREDIT NCI 56.62

(ii) The NCI cost of Bower’s investment in Heeny is eliminated

against the NCI by (Rs Mn):

DEBIT NCI (30% 320) 96

CREDIT Investment in Heeny 96

4 Impairment

Bower Heeny

Rs Mn Rs Mn Carrying amount Assets (separate SOFP) 1,130 595

Fair value adjustments (W2) 89 36

Goodwill (W2) 190 23

1,409 654 Recoverable amount (1,425) (604)




CA Sri Lanka 213

Bower Heeny

Rs Mn Rs Mn Impairment loss – 50

Allocated to: goodwill

23 Intangible assets (balancing figure) 27

50

Bower is not impaired as the carrying amount is below the recoverable

amount, but Heeny's assets are impaired.

The impairment loss is allocated first to goodwill and then to the

intangible assets, because the directors believe that it is the poor

performance of the intangible assets that is responsible for the

reduction in the recoverable amount.

The impairment loss is recognised by (Rs Mn):

DEBIT Retained earnings (56%) 28

DEBIT NCI (44%) 22

CREDIT Goodwill 23


Note that the loss is allocated to the NCI as well as group retained

earnings. This includes the impairment loss in respect of goodwill

because goodwill is ‘full goodwill’ ie it includes NCI goodwill.

5 Investment in associate

The associate is already measured at cost in the financial statements of

Minny. In order to apply equity accounting, the group share of Puttin’s

profits since gaining significant influence are recognised by (Rs Mn):.

DEBIT Investment in associate

(30% Rs 30 Mn 6/12m)

4.5


In addition the dividend received and credited to OCE is transferred to

reduce the carrying amount of the investment in the associate (Rs Mn):

DEBIT OCE 2

CREDIT Investment in associate 2

6 Disposal group

Assets and liabilities of the disposal group are re-classified as current

and shown as separate line items in the statement of financial position.

The disposal group is impaired, and the impairment loss is calculatedas follows.




214 CA Sri Lanka

Rs Mn

Property, plant and equipment 49

Inventory 18

Current liabilities (3)

Carrying amount 64Anticipated proceeds (FV less costs to sell) (30)

Impairment loss 34


DEBIT Current liabilities 3

DEBIT Assets of disposal group

(49 + 18 – 34)

33


CREDIT PPE 49CREDIT Inventory 18

CREDIT Liabilities of disposal group 3

7 Development costs

Rs Mn

Patent 10 Intangible asset

Investigation phase 7 Profit or loss

Prototype 4 Intangible asset: development costs

Preparation for sale 3 Intangible asset: development costsMarketing 2 Profit or loss

The adjustment required to eliminate the items which should be

recognised in profit or loss is (Rs Mn):

DEBIT Profit or loss (retained earnings) 9


(b) Held for sale criteria under SLFRS 5 Non-current assets held for sale and

discontinued operations

The held for sale criteria in SLFRS 5 Non-current assets held for sale anddiscontinued operations are very strict, and often decision to sell an asset or

disposal group is made well before they are met. It may be difficult for

regulators, auditors or users of accounts to determine whether an entity

genuinely intends to dispose of the asset or group of assets.

SLFRS 5 requires an asset or disposal group to be classified as held for sale

where it is available for immediate sale in its present condition subject only

to terms that are usual and customary and the sale is highly probable.

The standard does not give guidance on terms that are usual and customarybut the guidance notes give examples. Such terms may include, for example,




CA Sri Lanka 215

a specified period of time for the seller to vacate a headquarters building

that is to be sold, or it may include contracts or surveys. However, they

would not include terms imposed by the seller that are not customary, for

example, a seller could not continue to use its headquarters building until

construction of a new headquarters building had taken place.

For a sale to be highly probable:

• Management must be committed to the sale.

• An active programme to locate a buyer must have been initiated.

• The asset must be marketed at a price that is reasonable in relation to

its own fair value.

• Completion of the sale must be expected within one year from the date

of classification.

• It is unlikely that significant changes will be made to the plan or the

plan withdrawn.

Regulators may question entities' application of this standard because the

definition of highly probable as 'significantly more likely than probable' is

subjective. Entities may wish to separate out an unprofitable/impaired part

of the business in order to show a more favourable view of continuing

operations, and so regulators have reason look very closely at whether the

classification as held for sale is genuine.

(c) Transfer of property

The proposed transfer of property from Bower to its parent Minny is not a

normal sale. The property's carrying amount of Rs. 2m reflects the current

value as it was revalued at the year end, but the 'sale' price is only Rs. 1m. In

effect, this is a distribution of profits of Rs. 1m, the shortfall on the transfer.

Distributions of this kind are not necessarily wrong or illegal. Bower's

retained earnings of Rs. 442m, plus the 'realised' revaluation surplus of Rs.

400,000 more than cover the distribution, so, depending on the distributable

profits rules in the jurisdiction in which it operates, it is likely to be legal.

Certain SLFRS may apply to the transfer.

(i) If the asset meets the held for sale criteria under SLFRS 5 Non-current

assets held for sale and discontinued operations, it will continue to be

included in the consolidated financial statements, but it will be

presented separately from other assets in the consolidated statement

of financial position. An asset that is held for sale should be measured

at the lower of its carrying amount and fair value less costs to sell.




Immediately before classification of the asset as held for sale, the entity

must update any impairment test carried out.

(ii) As the transfer is from a subsidiary to its parent, LKAS 24 Related party

disclosures will apply and in the individual financial statements of

Bower and Minny, although it would be eliminated on consolidation.Knowledge of related party relationships and transactions affects the

way in which users assess a company's operations and the risks and

opportunities that it faces. Even if the company's transactions and

operations have not been affected by a related party relationship,

disclosure puts users on notice that they may be affected in future, but

in this case the related party relationship clearly has affected the price

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