P2 Mock Exam

ACCA P2 Corporate Reporting(INT)

June2014

Final Mock Exam Question+Answer Paper

© Lesco Group Limited, April 2014

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 Lesco Group Limited.

Q1 The following financial statements relate to Ashanti, a public limited company.

consolidated statement of profit or loss and other comprehensive income for the

year ended 30 April 2014

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

profit or loss and other comprehensive income:

(i) On 1 May 2012, Ashanti acquired 70% of the equity interests of Bochem, a

public limited company. The purchase consideration comprised cash of $150 million

and the fair value of the identifiable net assets was $160 million at that date. The

fair value of the non-controlling interest in Bochem was $54 million on 1 May 2012.

Ashanti wishes to use the ‘full goodwill’ method for all acquisitions. The share

capital and retained earnings of Bochem were $55 million and $85 million

respectively and other components of equity were $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 2014 for a cash consideration of $34 million. The carrying value of the

net assets of Bochem at 30 April 2014 was $210 million before any adjustments on

consolidation. Goodwill has been impairment tested annually and as at 30 April

2013 had reduced in value by 15% and at 30 April 2014 had lost a further 5% of its

original value before the sale of the equity interest to the NCI. The goodwill

impairment should be allocated between group and NCI on the basis of equity

shareholding.

(ii) Bochem acquired 80% of the equity interests of Ceram, a public limited

company, on 1 May 2012. The purchase consideration was cash of $136 million.

Ceram’s identifiable net assets were fair valued at $115 million and the NCI of

Ceram attributable to Ashanti had a fair value of $26 million at that date. On 1

November 2013, Bochem disposed of 50% of the equity of Ceram for a

consideration of $90 million.

Ceram’s identifiable net assets were $160 million and the consolidated value of the

NCI of Ceram attributable to Bochem was $35 million at the date of disposal. The

remaining equity interest of Ceram held by Bochem was fair valued at $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 2013. The

sale price of the inventory was $10 million and $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 2011, Ashanti purchased a $20 million five-year bond with semi

annual interest of 5% payable on 31 October and 30 April. The purchase price of

the bond was $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 2013 the amortised

cost of the bond was $21.046 million. The issuer of the bond did pay the interest

due on 31 October 2013 and 30 April 2014, but was in financial trouble at 30 April

2014. Ashanti feels that as at 30 April 2014, the bond is impaired and that the best

estimates of total future cash receipts are $2·34 million on 30 April 2015 and $8

million on 30 April 2016. The current interest rate for discounting cash flows as at

30 April 2014 is 10%. No accounting entries have been made in the financial

statements for the above bond since 30 April 2013. (You should assume the annual

compound rate is 8% for discounting the cash flows.)

(v) Ashanti sold $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 $8 million

against the total receivable balance at the year end, of which $5 million relates to

this sale.

(vi) Ashanti owned a piece of property, plant and equipment (PPE) which cost $12

million and was purchased on 1 May 2012. It is being depreciated over 10 years on

the straight-line basis with zero residual value. On 30 April 2013, it was revalued to

$13 million and on 30 April 2014, the PPE was revalued to $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

2014, 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 $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) As permitted by IFRS 9 Financial instruments all group companies have made

an irrecoverable election to recognise changes in the fair value of investments in

equity instruments in other comprehensive income (items that will not be

reclassified to profit or loss).

(ix) Ignore any taxation effects of the above adjustments and the disclosure

requirements of IFRS 5 Non-current assets held for sale and discontinued

operations.

Required

(a) Prepare a consolidated statement of profit or loss and other comprehensive

income for the year ended 30 April 2014 for the Ashanti Group. (35 marks)

(b) Ashanti Group has three distinct business segments. The management has

calculated the net assets, turnover and profit before common costs, which are to be

allocated to these segments. However, they are unsure as to how they should

allocate certain common costs and whether they can exercise judgement in the

allocation process. They wish to allocate head office management expenses;

pension expense; the cost of managing properties and interest and related interest

bearing assets. They also are uncertain as to whether the allocation of costs has to

be in conformity with the accounting policies used in the financial statements.

Required:

Advise the management of Ashanti Group on the points raised in the above

paragraph. (7 marks)

(c) Segmental information reported externally is more useful if it conforms to information

used by management in making decisions. The information can differ from that reported in

the financial statements. Although reconciliations are required, these can be complex and

difficult to understand. Additionally, there are other standards where subjectivity is involved

and often the profit motive determines which accounting practice to follow. The directors

have a responsibility to shareholders in disclosing information to enhance corporate value

but this may conflict with their corporate social responsibility.

Required:

Discuss how the ethics of corporate social responsibility disclosure are difficult to

reconcile with shareholder expectations. (6 marks)

Professional marks will be awarded in part (c) for clarity and expression of your discussion.

(2 marks)

(50 marks)

Q2

Blackcutt is a local government organisation whose financial statements are prepared using

International Financial Reporting Standards.

(a) Blackcutt wishes to create a credible investment property portfolio with a view to

determining if any property may be considered surplus to the functional objectives and

requirements of the local government organisation. The following portfolio of property is

owned by Blackcutt.

Blackcutt owns several plots of land. Some of the land is owned by Blackcutt for capital

appreciation and this may be sold at any time in the future. Other plots of land have no

current purpose as Blackcutt has not determined whether it will use the land to provide

services such as those provided by national parks or for short-term sale in the ordinary

course of operations.

The local government organisation supplements its income by buying and selling property.

The housing department regularly sells part of its housing inventory in the ordinary course

of its operations as a result of changing demographics. Part of the inventory, which is not

held for sale, is to provide housing to low-income employees at below market rental. The

rent paid by employees covers the cost of maintenance of the property.

(7 marks)

(b) Blackcutt has outsourced its waste collection to a private sector provider called Waste

and Co and pays an annual amount to Waste and Co for its services. Waste and Co

purchases the vehicles and uses them exclusively for Blackcutt’s waste collection. The

vehicles are painted with the Blackcutt local government organisation name and colours.

Blackcutt can use the vehicles and the vehicles are used for waste collection for nearly all of

the asset’s life. In the event of Waste and Co’s business ceasing, Blackcutt can obtain legal

title to the vehicles and carry on the waste collection service. (6 marks)

(c) Blackcutt owns a warehouse. Chemco has leased the warehouse from Blackcutt and is

using it as a storage facility for chemicals. The national government has announced its

intention to enact environmental legislation requiring property owners to accept liability for

environmental pollution. As a result, Blackcutt has introduced a hazardous chemical policy

and has begun to apply the policy to its properties. Blackcutt has had a report that the

chemicals have contaminated the land surrounding the warehouse. Blackcutt has no

recourse against Chemco or its insurance company for the clean-up costs of the pollution. At

30 November 2012, it is virtually certain that draft legislation requiring a clean up of land

already contaminated will be enacted shortly after the year end. (4 marks)

(d) On 1 December 2006, Blackcutt opened a school at a cost of $5 million. The estimated

useful life of the school was 25 years. On 30 November 2012, the school was closed

because numbers using the school declined unexpectedly due to a population shift caused

by the closure of a major employer in the area. The school is to be converted for use as a

library, and there is no expectation that numbers using the school will increase in the

future and thus the building will not be reopened for use as a school. The current

replacement cost for a library of equivalent size to the school is $2·1 million. Because of the

nature of the non-current asset, value-in-use and net selling price are unrealistic estimates

of the value of the school. The change in use would have no effect on the estimated life of

the building. (6 marks)

Required:

Discuss how the above events should be accounted for in the financial statements

of Blackcutt.

Note: The mark allocation is shown against each of the four events above.

Professional marks will be awarded in question 3 for the clarity and quality of the

presentation and discussion.

(2 marks)

(25 marks)

Q3

(a) Janne is a real estate company, which specialises in industrial property.

Investment properties including those held for sale constitute more than 80% of its

total assets.

It is considering leasing land from Maret for a term of 30 years. Janne plans to use

the land for its own office development but may hold the land for capital gain. The

title will remain with Maret at the end of the initial lease term. Janne can lease the

land indefinitely at a small immaterial rent at the end of the lease or may purchase

the land at a 90% discount to the market value after the initial lease term. Janne is

to pay Maret a premium of $3 million at the commencement of the lease, which

equates to 70% of the value of the land. Additionally, an annual rental payment is

to be made, based upon 4% of the market value of the land at the commencement

of the lease, with a market rent review every five years. The rent review sets the

rent at the higher of the current rent or 4% of the current value of the land. Land

values have been rising for many years.

Additionally, Janne is considering a suggestion by Maret to incorporate a clean

break clause in the lease which will provide Janne with an option of terminating the

agreement after 25 years without any further payment and also to include an early

termination clause after 10 years that would require Janne to make a termination

payment which would recover the lessor’s remaining investment. (12 marks)

(b) Janne measures its industrial investment property using the fair value method,

which is measured using the ‘new-build value less obsolescence’. Valuations are

conducted by a member of the board of directors. In order to determine the

obsolescence, the board member takes account of the age of the property and the

nature of its use. According to the board, this method of calculation is complex but

gives a very precise result, which is accepted by the industry. There are sales

values for similar properties in similar locations available as well as market rent

data per square metre for similar industrial buildings. (5 marks)

(c) Janne operates through several subsidiaries and reported a subsidiary as held

for sale in its annual financial statements for both 2012 and 2013. On 1 January

2012, the shareholders had, at a general meeting of the company, authorised

management to sell all of its holding of shares in the subsidiary within the year.

Janne had shown the subsidiary as an asset held for sale and presented it as a

discontinued operation in the financial statements at 31 May 2012. This accounting

treatment had been continued in Janne’s 2013 financial

statements.

Janne had made certain organisational changes during the year to 31 May 2013,

which resulted in additional activities being transferred to the subsidiary. Also

during the year to 31 May 2013, there had been draft agreements and some

correspondence with investment bankers, which showed in principle only that the

subsidiary was still for sale. (6 marks)

Required:

Advise Janne on how the above accounting issues should be dealt with in its

financial statements.

Note: The mark allocation is shown against each of the three issues above.

Professional marks will be awarded in question 3 for clarity and quality of

presentation. (2 marks)

(25 marks)

Q4

The publication of IFRS 9, Financial Instruments, represents the completion of the first

stage of a three-part project to replace IAS 39 Financial Instruments: Recognition and

Measurement with a new standard. The new standard purports to enhance the ability of

investors and other users of financial information to understand the accounting of financial

assets and reduces complexity.

Required:

(a)

(i) Discuss the approach taken by IFRS 9 in measuring and classifying financial

assets and the main effect that IFRS 9 will have on accounting for financial assets.

(11 marks)

(ii) Grainger, a public limited company, has decided to adopt IFRS 9 prior to January 2012

and has decided to restate comparative information under IAS 8 Accounting Policies,

Changes in Accounting Estimates and Errors. The entity has an investment in a financial

asset which was carried at amortised cost under IAS 39 but will be valued at fair value

through profit and loss (FVTPL) under IFRS 9. The carrying value of the assets was

$105,000 on 30 April 2010 and $110,400 on 30 April 2011. The fair value of the asset was

$106,500 on 30 April 2010 and $111,000 on 30 April 2011. Grainger has determined that

the asset will be valued at FVTPL at 30 April 2011.

Required:

Discuss how the financial asset will be accounted for in the financial statements of

Grainger in the year ended 30 April 2011. (4 marks)

(b) Recently, criticisms have been made against the current IFRS impairment model for

financial assets (the incurred loss model). The issue with the incurred loss model is that

impairment losses (and resulting write-downs in the reported value of financial assets) can

only be recognised when there is evidence that they exist and have been incurred.

Reporting entities are not allowed currently to consider the effects of expected losses. There

is a view that earlier recognition of loan losses could potentially reduce the problems

incurred in a credit crisis.

Grainger has a portfolio of loans of $5 million which was initially recognised on 1 May 2010.

The loans mature in 10 years and carry an interest rate of 16%. Grainger estimates that no

loans will default in the first two years, but from the third year onwards, loans will default at

an annual rate of about 9%. If the loans default as expected, the rate of return from the

portfolio will be approximately 9·07%. The number of loans are fixed without any new

lending or any other impairment provisions.

Required:

(i) Discuss briefly the issues related to considering the effects of expected losses

in dealing with impairment of financial assets. (4 marks)

(ii) Calculate the impact on the financial statements up to the year ended 30 April

2013 if Grainger anticipated the expected losses on the loan portfolio in year three.

(4 marks)

Professional marks will be awarded in question 4 for clarity and quality of discussion. (2

marks)

(25 marks)

ACCA P2 Corporate Reporting(INT)

June2014

Final Mock Exam Answer Paper

© Lesco Group Limited, April 2014

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 Lesco Group Limited.

Q1

Q2

(a) Definition

An investment property is a property held for capital appreciation or to earn rental income.

Classification: Investment purpose The company holds the property to each capital appreciation or rental income.

Complete The property must be substantially complete.

Owned use This property can’t be used by the company in the normal course of business activities.

Subsequent measurement The subsequent measurement for this is to use fair value model where Blackcutt will

take fair value changes directly to the statement of comprehensive income.

Land So the land held by Blackcutt should be classified as investment property as this is considered to enjoy capital appreciation while other plots of land would be considered

to enjoy capital appreciation if there’s no other current purpose. Supplement

Sales of property are in the ordinary course of its operations and are routinely occurring, then the housing stock held for sale will be classified as inventory per IAS2 inventory.

Low-income employees The part of the inventory held to provide housing to low-income employees at below market rental and this is held to provide housing services rather than rentals so can’t

be classified as investment property but as property, plant and equipment per IAS16.

(b)

Finance lease Finance lease is a lease where it transfer substantial risks and rewards from the lessor to the lessee.

Operating lease Operating lease is a lease when the lease it’s not a finance lease.

Substance over form The classification of the lease will depend on the substance of the transaction rather

than its legal form. Blackcutt

Even though Blackcutt owns the legal title of property eventually but because: 1, it has transferred risks and rewards of vehicles to Waster&Co, ie, Waste&Co can use them to earn money by collecting wastage;

2, Waste&Co can use them for nearly all of the asset’s life; 3, At the end of the life of vehicle the title will be transferred back to Blacutt.

So this transaction is a finance lease.

Accounting So blackcutt should derecognize the PP&E in its FS and recognize a corresponding finance lease obligation but this will depend on the FV of asset at inception.

(c)

A provision should be recognized if: 1, Probable

Blackcutt has no recourse against the entity or

its insurance company and so resulting an economic outflow.

2, Obligation

There’s an obligation for Blackcutt because it’s virtual certainty of legislation requiring the clean up as a result of contaminating the land.

3, Reliably estimate To recognize a provision the amount should be reliably estimated by Blackcutt as well.

Impairment Because the land has been contaminated and we should consider any impairment of land as a result of this by performing an impairment test as per IAS36.

(d)

Prudence According to the prudence principle we can’t overstate the asset value in the FS.

indicator if there’s an indicator suggesting the building is impaired then an impairment test would need to be performed and because in Blackcutt the purpose of using the building has

changed from education to library because of the fall in number of students then this is an impairment indicator.

Impairment test Management in blackcutt at the end of each year should perform an impairment test to see if the carrying value of the asset is greater than its recoverable amount then an

impairment expense should be recognized. Recoverable amount

The recoverable amount for the building is determined as the higher of value in use and net realizable value and because they are not both provided then we can use depreciated replacement cost.

Accounting:

asset Cost | replacement

cost Accum depreciation CV| replacement cost

School 5000 5,000x6/25 =1200 3,800 Library 2100 2100X6/25=504 (1,596)--RV 2204

So blackcutt would DR I/S 2204 CR PP&E 2204

Q3 answer

(a) [Only 12 points required]

Finance lease

Finance lease is a lease where it transfer substantial risks and rewards from the

lessor to the lessee.

Operating lease

Operating lease is a lease when the lease it’s not a finance lease.

Substance over form

The classification of the lease will depend on the substance of the transaction rather

than its legal form.

5 scenarios of finance lease:

1, ownership of asset has been transferred from lessor to lessee.

2, lessee has the option to purchase asset at a price which is sufficiently lower than

its FV.

3, lease term is almost the same as the major part of economic life of asset.

4, at the start of the lease, PV of minimum lease payment is close to FV of asset.

5, leased assets are specified nature and can only be used by lessee and they can

be used by others if any significant modification to assets occurs.

Scenarios:

1. Jane can rent the land at small rate at the end of lease or purchase at 90%

discount of the land implies this is a finance lease.

2.Jane is to pay Maret 70% of the land value at the start of the lease which implies

this is a finance lease.

3. the lessor review the rent and this makes sure lessor recovers fair value of asset

and makes return on investment of it and this is an indicator of finance lease.

Premium

This is an operating lease indicator because operating lease requires upfront

payment and if this is the case then the payment should be kept separate from the

lease and expense to the income statement.

Accounting treatment

If this is a finance lease then Janne should capitalize the premium as a PP&E and

recognize a liability (finance lease obligation) and depreciate it.

Also it has to recognize the finance cost relating to the unwinding of liability over

the lease term.

Investment property

But Janne would hold the land for capital gain and hence it may be treated under

IAS40 investment properties and any gains or loss of the asset would be taken into

the income statement.

Clean break clause

It allows lessee to walk away without any penalty payment and hence the lease

term would be from start of the lease up to the earliest point that option is

exercised.

If there is early termination payment then lessor would ensure they would get

return from it and this is a finance lease indicator.

(b)

Investment property

An investment property is a property that entity holds in order to enjoy capital gain

or rental income.

Subsequent measurement

We normally use fair value model because it would better reflect the market

condition, ie, take fair value changes to income statement.

Fair value

There are three levels to determine fair value according to IFRS 13 fair value

measurement:

Level1: quoted price

If there is an active market then the market price from that market on the

measurement date should be used.

Level2: similar quoted price

If level one fails then level two requires that similar market data should be used to

establish the approximated market value.

Level3: unobservable inputs(management best estimate, eg, present value)

If level one and two fails to determine the fair value then you can use level three

where you can use financial model to determine fair value.

Scenario:

* They can use level 2 to determine fair value like using sales/square meter.

* Or they can use level 3 to determine fair value like using cash flow forecast.

* But management has used “new-build value minus obsolescence” to determine

fair value but this does reflect the above 3 levels required by IFRS13.

Conclusion

So management’s calculation of fair value is not correct.

(c) [only 6points required]

Discontinued operation

A discontinued operation is an operation if it’s closed or sold during the year or held

for sale at the year end.

And its carrying amount will be recovered principally through sale rather than

continuing use.

Non-current assets held for sale

In order to classify the asset into non-current assets held for sale, it needs to fulfill

following criteria:

Selling purposes by management

Available for sale under current condition

Locate a buyer actively

Expected to complete within 12 months from the year end

Scenario:

There is selling purpose by management because this is authorized by sharheolders

for management to sell all of subsidiary shares.

But it may not be available for sale immediately because given changes made

during to 31 May 2013 which resulted in some activities being transaferred to

subsidiary.

And there is some correspondence with investment bankers and this means

directors are actively locating a buyer.

But given the authorization for sale is just within 1 year and maybe the sale would

not be proceeded more than 1 year.

So it doesn’t meet the IFRS5 criteria for non-current assets held for sale and so the

current figures should reclassify the sub as continuing and the comparatives require

restatement.

Q4 answer

(a)

(i)

IFRS9 uses 2 questions to determine financial asset using amortized cost or fair value.

Business model test ie, Hold it till maturity?

Contractual cash flow characteristic(CCC) test ie, does debt contain principle and

interest only?

If there are 2 yes from those questions then the financial assets would be measured

using amortized cost.

If only 1 yes from those questions then financial assets would be measured using fair

value.

The gains or losses would be taken into income statement or other comprehensive

income.

And this is based on “intent”, ie, intent to hold the assets or sell the assets.

If entity shows strategic long term investment then gains/losses would be taken into

other comprehensive income.

Entity can carry financial assets at fair value when otherwise they would be carried at

amortized cost.

And this occurs when there’s an accounting mismatch which is a financial liability carried

at fair value and related financial assets carried at amortized cost.

(ii)

Per IAS 8 if a new standard arises then its adoption is a change in accounting policy.

We should therefore

(i) adjust opening reserves for the change

(ii) adjust comparatives figures from the previous year in the statement of profit or loss

and SFP.

In the year ended 30/4/2011 we will have to change the opening balance for financial

assets so

DR financial assets 1,500(106,500-105,000)

CR retained earnings b/f 1,500

When we prepare the comparative statement of profit or loss for the year ended 30/4/11,

we will use FV .TPL to measure the financial asset at SFP date.

This gives a value of $111,000(from $106,500) so

DR SFP- financial assets 4,500

CR I/S : gain on fair value 4,500

(b)

(i)

Expected losses issues

(i)how are the expected losses to be calculated. It will involve forecasting and judgment.

This will increase the subjectivity in the SFP.

(ii)it will require changes to systems and data collection to allow expected losses to be

calculated.

(iii)it may increase volatility of SFP as economic conditions change from one year to another.

(iv) likely to require extra disclosures in the note to explain how the losses have been

estimated

(ii)

Graingers(9%)

Current position: use interest rate applicable when asset was acquired

Date Asset i/s(16%) Outstanding installment c/f 1.5.10 5,000 800 (800)-16% 5,000

1.5.11 5,000 800 (800)-16% 5,000

1.5.12 5,000 800 So: (728) 4,550

Default of 9%---4,550

Expected loss model

Use expected return of 9.07%

year Asset(op) i/s(9.07%) Outstanding Installment(16%) c/f 1.5.10 5,000 453 (800) 4,653

1.5.11 4,653 422 (800) 4,275

1.5.12 4,275 388 (800) 3,933

Under proposals the value of financial asset will be much lower.