Mock One Financial Reporting School - booksg.combooksg.com/images/files/free acca books/READY/June 2017 F7 Exam/… · of accounting policy. ... in this case 12 months. ... Study

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Financial Reporting F7FR-MK1-Z16-A Answers & Marking Scheme

©2016 DeVry/Becker Educational Development Corp.

®

Mock One

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©2016 DeVry/Becker Educational Development Corp. All rights reserved. 2

Question Answer Mark Question Answer Mark

Section A Section B

1 C 2 16 D 2

2 D 2 17 B 2

3 B 2 18 C 2

4 A 2 19 D 2

5 D 2 20 A 2

6 C 2 21 B 2

7 B 2 22 C 2

8 C 2 23 B 2

9 C 2 24 A 2

10 B 2 25 A 2

11 C 2 26 B 2

12 C 2 27 C 2

13 B 2 28 D 2

14 B 2 29 C 2

15 A 2 30 B 2

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Section A

Item Answer Justification

1 C This is a payment in advance and should not be recognised as revenue until the contract between the two parties has been finalised and GY has satisfied any performance obligation of the contract.

2 D

3 B There are 500,000 ÷ 0.50 = 1 million shares in issue. Dividends are accounted for only when declared for payment, not when they are merely proposed (as this does not give rise to a liability). The statement of changes in equity will therefore include dividends declared and paid in the year: $000 20X5 Final dividend (1m × 0.1) 100 20X6 Interim dividend (1m × 0.05) 50 ––– 150 –––

4 A B is a change in estimate. IFRS 3 allows an entity to use either method for each subsidiary separately and so C is acceptable. D is a change in business and would therefore require a new policy on the change in business method; it is not a change of accounting policy.

5 D The gains of $125,000 and $12,000 are unrealised. Therefore they must be credited to a revaluation reserve. This is a component of total equity, but is not included in retained profits.

If an asset which has previously been revalued suffers an impairment, the fall in value may be debited to the revaluation reserve, provided there is a credit balance – relating to that asset – which exceeds the impairment.

Therefore, the revaluation reserve will have increased by $137,000 ($125,000 + $12,000) over the first two years. The impairment of $30,000 in the most recent year will reduce this to $107,000.

6 C In the first action, Dash has been informed it is likely to lose and therefore a provision for the loss should be made.

The second action gives rise to a contingent asset and disclosure of the transaction should be made.

7 B $ Carrying amount 754,860 Tax base 543,875 ––––––– Taxable temporary difference 210,985 ––––––– Provision required at 20% 42,197 Brought forward 39,853 ––––––– Increase (charge to profit or loss) 2,344 –––––––

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8 C $ Operating loss (5,000) Depreciation 20,000 Interest expense 12,000 Interest paid (10,000) ––––––– 17,000 –––––––

9 C Cash inflows from the continuing use of the asset, so this will included (3) revenue based on items produced by the plant. It will also take into account cash outflows that are necessary to help generate any cash inflows, this will include the annual labour costs (1) and the servicing cost (5). Item (2) is an enhancing cost and item (4) is specifically excluded by IAS 36.

10 B Unrealised profit = ($30,000 × 20/120) × 80% = $4,000 $

Able 427,000 Cain post-acquisition ((151,000 – 107,000) – 4,000 (unrealised profit)) × 75% 30,000 ––––––– 457,000 –––––––

The unrealised profit for 20X5 will have no effect on the calculation of retained earnings at 31 December 20X6. It will only affect the statement of profit or loss.

11 C $ Initial proceeds (500,000 × 0.95) 475,000 Interest at 10.5% 49,875 Cash paid (500,000 × 6%) (30,000) ––––––– Balance at 31 Dec 20X5 494,875 ––––––– 20X6 Interest at 10.5% 51,962

12 C Liability as at 31 December 20X6 = 12,000 + (12,000 × 12%) – 7,080 = 6,360

13 B IAS 40 gives examples of property that would be classified as investment property;

it includes land with uncertain use (3). The standard states that owner occupied property is not investment property, but if the occupied portion is insignificant, as in (1) then the property will still be classed as investment property.

14 B ROCE = Profit before interest and tax ÷ Capital employed (i.e. equity + non-current liabilities) PBIT = 17,600 + 6,270 + 9,465 = $33,335 Capital employed = 127,920 + 63,200 = $191,120

ROCE = 17.4%

15 A IAS 23 requires that all borrowing costs incurred in the construction of a qualifying asset be capitalised into the cost of that asset. Any funds invested, the return on those funds should be offset against the amount of borrowing costs capitalised.

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Section B

Item Answer Justification

16 D IAS 36 defines recoverable amount as the higher of value in use and fair value less costs of disposal

17 B Lower of: Cost $120,000 and Net realisable value (SP – cost to sell) (117 – 5) $112,000

18 C Impairment loss is $100,000, of which $50,000 will be written off against goodwill leaving a further $50,000 to be allocated to remaining assets other than inventory.

Factory building ÷ Total assets (excluding inventory) = (260 ÷ 530) × 50 = $24,528

19 D A decrease in market rates of interest will increase value in use and output significantly below budget is an internal indicator of impairment

20 A PV of future cash flows using effective interest rate of 8%:

$000 20X7 (($260 – $60) × 0.93) 186 20X8 ($320 × 0.86) 275.2 20X9 (($140 + $10) × 0.79) 118.5 ––––––

579.7 ––––––

21 B Total cash flow from the contract is $720; this must be allocated to the stand-alone selling prices of the handset and airtime (300 and 600). Therefore revenue earned from handset is 720 × (300 ÷ 900) = $240; this is the amount of revenue recognised from the sale of the handset.

Airtime is a performance indicator fulfilled over time, in this case 12 months. Revenue allocated to airtime is $480 (720 – 240) leading to revenue of $40 per month.

Revenue earned in 20X6 is therefore $240 + $120 (40 × 3) = $360

22 C An agent earns commission and they sell goods on behalf of the principal, who is the party that will bear any inventory risk

23 B $ Revenue is the selling price discounted 2 years (7,497 ÷ 1.052) 6,800 Finance income is interest (5% × 6,800 × 6/12) 170

––––– Total credit to profit or loss 6,970 –––––

Tutorial note: The question asks for the total credit to profit or loss, not just revenue.

24 A IFRS 15 specifically states (1) to be an indicator that performance obligation is fulfilled over a period of time. Whereas, that the customer has significant risks and rewards of ownership of an asset is an indicator that the performance obligation is satisfied at a point in time.

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25 A Revenue will be recognised for the full $100.

Tutorial note: A provision will be recognised to reflect the 5% probability that customers will ask for a refund within the six month time frame.

26 B $000 Balance 1 January (trial balance) 18,937 Interest at 8% (effective rate) 1,515 Cash paid (1,000) –––––– Balance at 31 December 19,452 ––––––

27 C $000 Deferred tax 31 December (26,000 × 30%) 7,800 Deferred tax 1 January (6,070) ––––– Increase in deferred tax 1,730 Current tax for period 1,480 Under-provision prior year 200 ––––– Tax expense for year 3,410 –––––

28 D Theoretical ex-rights price $

4 shares @ $1.60 6.40 1 share @ $1.20 1.20 –––– 5 shares 7.60 –––– Therefore 1 share (7.60 ÷ 5) 1.52

29 C IAS 12 requires recognition of all taxable temporary differences even if an entity

does not intend to sell the revalued asset; the standard does not allow any discounting of deferred tax balances. As the asset has been revalued with any gain going through other comprehensive income the deferred tax consequences will also be recognised in other comprehensive income

30 B Convertible preference shares and share options are both examples of potential ordinary shares and will be included in the diluted earnings per share calculation

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Section C

31 BIGWOOD CO

(a) Statement of cash flows for the year to 30 September 20X6

Note: figures in brackets are in $000 $000 $000 Profit before tax 700 Adjustments for: depreciation – non-current assets (W1) 3,800 loss on disposal of fixtures (W1) 1,250 interest expense 300 5,350 ––––– ––––– Operating profit before working capital changes 6,050 increase in inventory (2,900 – 1,500) (1,400) increase in trade receivables (100 – 50) (50) increase in trade payables (3,100 – 2,150) 950 ––––– Cash generated from operations 5,550 Interest paid (300) Income tax paid (W2) (480) ––––– Net cash from operating activities 4,770 Cash flow from investing activities Purchase of property, plant and equipment (W1) (10,500) Disposal costs of fixtures (W1) (50) (10,550) ––––– ––––– (5,780) Cash flows from financing activities Issue of ordinary shares (2,000 + 1,000) 3,000 Long term loans (3,000 – 1,000) 2,000 Equity dividend paid (600) 4,400 ––––– ––––– Net decrease in cash and cash equivalents (1,380) Cash and cash equivalents at beginning of period 450 ––––– Cash and cash equivalents at end of period (930) –––––

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WORKINGS (all figures in $000)

(1) Property, plant and equipment – cost

Balance b/f 9,500 Disposal (3,000) Balance c/f (17,000) –––––– Difference cash purchase (10,500) –––––– Depreciation Balance b/f (3,000) Disposal (3,000 – 1,200) 1,800 Balance c/f 5,000 –––––– Difference charge for year 3,800 –––––– Disposal Cost 3,000 Depreciation (1,800) –––––– Net book value 1,200 Cost of disposal 50 –––––– Total loss on disposal (1,250) ––––––

(2) Income tax paid

Provision b/f (450) Tax charge (profit or loss) (250) Provision c/f 220 –––––– Difference cash paid (480) ––––––

(b) Analysis of performance

Operating performance

Bigwood’s overall performance as measured by the return on capital employed has deteriorated markedly. This ratio is effectively a composite of the company’s profit margins and its asset utilisation. The expansion represented by the acquisition of the five new stores has considerably increased investment in net assets. Asset turnover (a measure of asset utilisation) has fallen from 3·3 times to just 2·1 times. This is a relatively large fall and is partly responsible for the deteriorating performance. However, it often takes some time before new investment generates the same level of sales as existing capacity so it may be that the situation will improve in future years.

½ for bals and ½ for disposal

½ for bals and ½ for disposal

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½ for bals and ½ for P or L

1 mark per relevant comment to max 5

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Of more concern in the current year is the deteriorating gross profit margin of Bigwood’s clothes sales. This has fallen from 18·6% to 9·4%. The effect of this is all the more marked because clothes sales (in the current year) represent nearly 70% of turnover. It should also be noted that the inventory holding period of clothes has also increased significantly from 39 days in 20X5 to 68 days in the current year. This may be a reflection of a company policy to increase inventory levels in order to attract more sales, but it may also be an indication that there is some slow-moving or obsolete inventory. The clothes industry is notoriously susceptible to fashion changes, the new designs may not have gone down well with the buying public. By contrast, the profit margin on food sales has increased substantially (from 25% to 32·1%) as indeed have sales (up 75% on last year). These improvements have helped to offset the weaker performance of clothes sales.

Comparing the profit margins of clothes and food it can be seen that food retailing has been far more profitable than clothes retailing and the gap in margins has increased during the current year.

This deterioration in trading margins has continued through to net profit margins (falling from 7·1% to only 2·0%). It can be observed that operating expenses have increased considerably, but this is to be expected and is probably in line with the increase in the number of stores.

In summary, the increase in capacity has focused on clothes rather than food retailing. This seems misguided as the performance of food retailing was better than that of clothes (in 20X5) and this has continued (even more so) during the current year.

Liquidity/solvency

The increase in the investment in new stores and the refurbishment of existing stores has been largely financed by increasing long term loans by $2 million and issuing $3 million of equity. The effect of this is an increase in gearing from 17% to 28%. Although the level of gearing is still modest, the interest cover has fallen from a very healthy 25 times to a worrying low 3·3 times. The investment has also taken its toll on the bank balance falling from $450,000 in hand to an overdraft of $930,000. This probably explains why Bigwood has stretched its payment of accounts payable to 59 days in 20X6 from 50 days in 20X5.

Bigwood’s current liquidity position has deteriorated slightly from 0·77 : 1 to 0·71 : 1. No quick ratios have been given, nor would they be useful. Liquidity ratios are difficult to assess for retailers. Most of the sales generated by retailers are for cash (thus there will be few trade receivables) and normal liquidity benchmarks are not appropriate. The cash flow statement reveals cash flows generated from operating activities of $5,550,000. This is a far more reliable indicator of Bigwood’s liquidity position. $5,550,000 is more than adequate to service the tax and the dividend payments. Indeed the operating cash flows have contributed significantly to the financing of the expansion programme.

Share price and dividends

Bigwood’s share price has halved from $6·00 to $3·00 during the current year. The dilution effect of the share issue at $1·50 per share (2 million shares for $3 million) would account for some of this fall (to approximately $4·20), but the further fall probably represents the market’s expectations of Bigwood’s performance. It is worth noting that Bigwood has maintained its dividends at $600,000 despite an after tax profit of only $450,000. Although this dividend policy cannot be maintained indefinitely (at the current level of profits), the directors may be trying to convey to the market a feeling of confidence in the future profitability of Bigwood. It may also be a reaction designed to support the share price. It should also be noted that although the total dividend has been maintained, the dividend per share will have decreased due to the share issue during the year.



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Summary

The above analysis of performance seems to give mixed messages; Bigwood has invested heavily in new and upgraded stores, but operating performance has deteriorated and the expansion may have been mis-focused. This appears to have affected the share price adversely. Alternatively, it may be that the expansion will take a little time to bear fruit and the deterioration may be a reflection of the current state of the economy. Cash generation remains sound and if this continues, the poor current liquidity position will soon be reversed.

32 GOLD CO

(a) Goodwill on acquisition of Silver

$000 $000 Cost of investment 5,020 Non-controlling interest (400 ÷ 0.50) × 40% × $10.40 3,328 Net assets on acquisition Share capital 400 Share premium 900 Retained earnings 6,740 Fair value adjustment 60

______ (8,100)

______

248

______

Silver was acquired two years ago and goodwill has been impaired by $68,000 in the year ended 30 September 20X5, leaving a value of $180,000. The value of goodwill at 30 September 20X6 is given as $120,000 meaning that the impairment charge against profits for 20X6 is $60,000.

The fair value adjustment relates to plant and equipment which has a remaining life of four years at the date of acquisition. This additional $60,000 is depreciated in the consolidated financial statements, giving a charge to the current year’s statement of profit or loss of $15,000 and an adjustment against the opening consolidated retained earnings of $15,000.

(b) Value of investment in Bronze

$000 Cost of investment Share for share exchange (400 × 30%) × $3 360 Cash payment 83.4

______

443.4 Post-acquisition profit Profit for year (96 × 8/12 × 30%) 19.2

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462.6

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As the recoverable amount of the investment in Bronze is greater than its year-end carrying amount there is no impairment of the investment to charge to the statement of profit or loss.

1 mark for good summary

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(c) Consolidated statement of profit or loss for the year ended 30 September 20X6

$000 Revenue 5,312 Cost of sales (4,233) ______

Gross profit 1,079 Operating expenses (444) Dividend income 40 Income from associated companies 19.2 ______

Profit before tax 694.2 Tax (225) ______

Profit after tax 469.2 ______

Non-controlling interest 64.4 Shareholders of Gold 404.8 ______

Profit for year 469.2 ______

Consolidation schedule

Gold Silver Adjustments Total $000 $000 $000 $000 Revenue (W1) 3,016 2,636 (120) 5,312 (220) Cost of sales (W1) (2,413) (2,108) 120 220 Unrealised profit (W2) (8) (44) (4,233) ______

Gross profit 1,079 Operating expenses (212) (168) Goodwill (60) Depreciation on fair value (15) (444) Depreciation on intra-group sale 11 Dividends from non-group companies (W4) 30 10 40 Income from investment in associate (W3) 19.2 19.2 ______

Profit before tax 694.2 Tax (135) (90) (225) ______ ______

Profit after tax 161 469.2 Non-controlling interest 40% (64.4) ______

Profit for year 404.8 ______

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Do not double count the following marks

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WORKINGS

(1) Intra-group sales

Reduce both revenue and cost of sales for intra-group sales between Gold and Silver, $120,000 and $220,000. Do not adjust for transaction with Bronze; the revenue and costs of associates are not included in the consolidated statement of profit or loss.

(2) Unrealised profit

Gold sells to Silver

$120,000 × 25/125 = 24,000 × 1/3 = $8,000 Increase Gold’s cost of sales by $8,000

Silver sells to Gold and Gold treats the goods as non-current assets

$220,000 × 25/125 = $44,000 Increase Silver’s cost of sales by $44,000

As Gold treats the goods as non-current assets which are being depreciated over 4 years there is a need to reduce Gold’s operating expenses to the extent of one year’s depreciation of $11,000.

(3) Income from associate

Profit after tax ($96,000 × 8/12) 64,000 Gold’s share 30% ______

19,200 ______

(4) Dividend income

Silver paid a dividend of $150,000 during the year of which $90,000 would have been included in Gold’s profit or loss. This would leave dividend income from non-group companies of $30,000; adding this to the $10,000 income in Silvers’ profit or loss gives dividend income from non-group companies to be included in the consolidated profit or loss of $40,000.

Do not double count these marks

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oolMOCK EXAM FEEDBACK SUMMARY – PAPER F7 MOCK 1 SECTION C


Q Topic Study Text ref

RQB coverage

Commentary

31(a) Cash flow statement

26 Q55 Crosswire

Q56 Deltoid

Ensure you gain the easy marks, many of the numbers to be entered are a lift from the question

The format is important, you could lose marks if you do not produce a statement of cash flows in good format

When it comes to movement in working capital items ensure that you have the correct sign for the number, the examiner has stated in the past that if the sign is wrong, then no marks will be earned even if the figure is correct.

Reconstruct NCA and find the missing figures, in this question it is the cost of purchase and depreciation charge that is missing.

Issue of share capital doesn’t need to be split into nominal value and share premium, one combined figure will do.

The starting point for a cash flow statement is the profit before tax; this is then adjusted for any non-cash items included in that profit figure.

31(b) Interpretation of financial statements

25 Q51 Harbin Q52 Victular

Do not waste time calculating ratios; they have been done for you.

Comment on both the food and the clothing sectors, as well as the company as a whole.

Make comments relevant, it is no good saying the ratio has gone up.

Refer back to the cash flow statement in your analysis, as required by the question.

It will be useful to include a summarising statement.

Use information that has been given in the question, you are informed that share price has fallen from $6 to $3 per share – comment on why this might have happened.

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oolMOCK EXAM FEEDBACK SUMMARY – PAPER F7 MOCK 1 SECTION C


Q Topic Study Text ref

RQB coverage

Commentary

32 Consolidated SOCI, with goodwill calculation

21-23 Q38 Patronic Q41 Pandar

Take account of fair value adjustment when calculating net assets on acquisition.

If goodwill is incorrect in (a) marks will still be awarded for the correct follow through treatment in the profit or loss.

Time apportion Bronze profit for year in net asset on acquisition calculation.

Question gives mark-up on cost to find unrealised profit; do not use a margin calculation.

Gold is treating goods purchased as non-current assets; take account of depreciation adjustment.

Do not include any revenue or expenses of associate; use equity accounting to reflect single one line entry.

NCI calculation is based on adjusted profit after dealing with unrealised profit and goodwill impairment. As NCI are valued at fair value on acquisition and credited with goodwill, any impairment loss must be shared between parent and NCI.

Mock One Financial Reporting School - booksg.combooksg.com/images/files/free acca books/READY/June 2017 F7 Exam/… · of accounting policy. ... in this case 12 months. ... Study

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