Sample ACCA STUDY QUESTION BANK. Paper F7 FINANCIAL REPORTING. December 2014 June 2015 Edition

Transcription

1 December 2014 June 2015 Edition STUDY QUESTION BANK ACCA Paper F7 FINANCIAL REPORTING ATC International became a part of Becker Professional Education in ATC International has 20 years of experience providing lectures and learning tools for ACCA Professional Qualifications. Together, Becker Professional Education and ATC International offer ACCA candidates high quality study materials to maximize their chances of success.

2 In 2011 Becker Professional Education, a global leader in professional education, acquired ATC International. ATC International has been developing study materials for ACCA for 20 years, and thousands of candidates studying for the ACCA Qualification have succeeded in their professional examinations through its Platinum and Gold ALP training centers in Central and Eastern Europe and Central Asia.* Becker Professional Education has also been awarded ACCA Approved Content Provider Status for materials for the Diploma in International Financial Reporting (DipIFR). Nearly half a million professionals have advanced their careers through Becker Professional Education's courses. Throughout its more than 50-year history, Becker has earned a strong track record of student success through world-class teaching, curriculum and learning tools. Together with ATC International, we provide a single destination for individuals and companies in need of global accounting certifications and continuing professional education. *Platinum Moscow, Russia and Kiev, Ukraine. Gold Almaty, Kazakhstan Becker Professional Education's ACCA Study Materials All of Becker s materials are authored by experienced ACCA lecturers and are used in the delivery of classroom courses. Study System: Gives complete coverage of the syllabus with a focus on learning outcomes. It is designed to be used both as a reference text and as part of integrated study. It also includes the ACCA Syllabus and Study Guide, exam advice and commentaries and a Study Question Bank containing practice questions relating to each topic covered. Revision Question Bank: Exam style and standard questions together with comprehensive answers to support and prepare students for their exams. The Revision Question Bank also includes past examination questions (updated where relevant), model answers and alternative solutions and tutorial notes. Revision Essentials*: A condensed, easy-to-use aid to revision containing essential technical content and exam guidance. *Revision Essentials are substantially derived from content reviewed by ACCA s examining team.

3 ACCA PAPER F7 FINANCIAL REPORTING (INTERNATIONAL) STUDY QUESTION BANK For Examinations to June DeVry/Becker Educational Development Corp. All rights reserved. (i)

4 No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the author, editor or publisher. This training material has been prepared and published by Becker Professional Development International Limited: 16 Elmtree Road Teddington TW11 8ST United Kingdom Copyright 2014 DeVry/Becker Educational Development Corp. All rights reserved. The trademarks used herein are owned by DeVry/Becker Educational Development Corp. or their respective owners and may not be used without permission from the owner. No part of this training material may be translated, reprinted or reproduced or utilised in any form either in whole or in part or by any electronic, mechanical or other means, now known or hereafter invented, including photocopying and recording, or in any information storage and retrieval system without express written permission. Request for permission or further information should be addressed to the Permissions Department, DeVry/Becker Educational Development Corp. Acknowledgement Past ACCA examination questions are the copyright of the Association of Chartered Certified Accountants and have been reproduced by kind permission. (ii) 2014 DeVry/Becker Educational Development Corp. All rights reserved.

5 STUDY QUESTION BANK FINANCIAL REPORTING (F7) CONTENTS Question Page Answer Marks Date worked INTERNATIONAL FINANCIAL REPORTING STANDARDS 1 IASB (ACCA J98) CONCEPTUAL FRAMEWORK 2 Nette (ACCA J04) Limitations Framework Regulatory Framework Four Concepts (ACCA D98) Comparability (ACCA J04) ACCOUNTING FOR SUBSTANCE 8 Substance over form Hughes and Custom cars IAS 1 PRESENTATION OF FINANCIAL STATEMENTS 10 Objectives (ACCA Pilot Paper 97) Mercury Sulphur Cayman Oscar IAS 8 ACCOUNTING POLICIES 15 Perseus (ACCA J01) IAS 18 REVENUE 16 Jenson IAS 2 INVENTORY 17 Allrights Inc Sampi (ACCA J98) IAS 11 CONSTRUCTION CONTRACTS 19 William Merryview IAS 16 PROPERTY, PLANT AND EQUIPMENT 21 Adjustments Fam Stoat (ACCA D99) IAS 23 BORROWING COSTS 24 Dawes (ACCA D97) DeVry/Becker Educational Development Corp. All rights reserved. (iii)

6 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Question Page Answer Marks Date worked IAS 20 GOVERNMENT GRANTS 25 Sponger IAS 40 INVESTMENT PROPERTY 26 Monet IAS 38 INTANGIBLE ASSETS 27 Intellectual Individuals Lamond (ACCA D00) IFRS 5 HELD FOR SALE ASSETS AND DISCONTINUED OPERATIONS 29 Davis IAS 36 IMPAIRMENT OF ASSETS 30 Justin (ACCA D99) IAS 17 LEASES 31 XYZ Snow IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS 33 Rovers (ACCA J97) IAS 10 EVENTS AFTER THE REPORTING PERIOD 34 Earley Accounting treatment IAS 12 INCOME TAXES 36 Shep (I) Shep (II) Shep (III) Shep (IV) Broken dreams FINANCIAL INSTRUMENTS 41 Simpkins Iota REGULATORY FRAMEWORK 43 Danny Picant BASIC PRINCIPLES CONSOLIDATED STATEMENT OF FINANCIAL POSITION 45 Consolidations Haggis (iv) 2014 DeVry/Becker Educational Development Corp. All rights reserved.

7 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Question Page Answer Marks Date worked INTER-COMPANY ADJUSTMENTS 47 Hatton Hammer Hat FURTHER CONSOLIDATION ADJUSTMENTS 50 Hut CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME 51 Honey Humphrey High Happy IAS 28 INVESTMENTS IN ASSOCIATES 55 Haley Hamish Hydrogen ANALYSIS AND INTERPRETATION 58 Witton Way Rapido Not-for-profit IAS 7 STATEMENT OF CASH FLOWS 61 Standard Fallen IAS 33 EARNINGS PER SHARE 63 Earnings per share FURTHER PRACTICE QUESTIONS 64 Angelino (ACCA D06) Substance over form Fresno (ACCA J94) Accounts preparation Wellmay (ACCA J07) Accounts preparation Candel (ACCA D08) Accounts preparation Dune (ACCA J10 adapted) Accounts preparation Torrent (ACCA J06) IAS Shiplake (ACCA J02) IAS Highveldt (ACCA J05) Group accounts Hedra (ACCA D05) Group accounts Picant (ACCA J10) Group accounts Minster (ACCA D06) IAS Mocha (ACCA D11) IAS DeVry/Becker Educational Development Corp. All rights reserved. (v)

8 FINANCIAL REPORTING (F7) STUDY QUESTION BANK (vi) 2014 DeVry/Becker Educational Development Corp. All rights reserved.

9 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Question 1 IASB Required: (a) (b) State the objectives of the International Accounting Standards Board (IASB). (4 marks) Explain how the IASB approaches the task of producing a standard, with particular reference to the way in which comment or feedback from interested parties is obtained. (8 marks) Question 2 NETTE (12 marks) Nette, a public limited company, manufactures mining equipment and extracts natural gas. The directors are uncertain about the role of the IASB s Conceptual Framework for Financial Reporting (the Framework ) in corporate reporting. Their view is that accounting is based on the transactions carried out by the company and these transactions are allocated to the company s accounting period by using the matching and prudence concepts. The argument put forward by the directors is that the Framework does not take into account the business and legal constraints within which companies operate. Required: Explain the importance of the Framework to the reporting of corporate performance and whether it takes into account the business and legal constraints placed upon companies. Question 3 LIMITATIONS (6 marks) Financial statements identify position, performance and changes in position over a period of time. The main statements include Statement of Financial Position, Statement of Comprehensive Income and Statement of Cash Flows. These statements are intended to show how well a company has performed and give an indication of the value of the business. However, many accountants feel that the financial statements are limited in their value to the users of financial statements. Required: Identify and discuss the limitations of financial statements. Question 4 THE FRAMEWORK (a) (8 marks) State the main purpose of the Conceptual Framework for Financial Reporting ( The Framework ) adopted by the International Accounting Standards Board (IASB). (4 marks) (b) Explain the status of The Framework. (2 marks) (c) State the underlying assumption of financial statements identified by The Framework. (2 marks) (8 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 1

10 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Question 5 REGULATORY FRAMEWORK Required: Briefly explain what a regulatory framework is and discuss the reasons why there is a need for a regulatory framework in financial reporting. (5 marks) Question 6 FOUR CONCEPTS Required: Define the following accounting concepts and explain for each their implications for the preparation of financial statements: (a) The entity concept (4 marks) (b) Going concern (4 marks) (c) Materiality (4 marks) (d) Fair presentation (true and fair view) (4 marks) Question 7 COMPARABILITY (16 marks) Comparability is an enhancing qualitative characteristic which adds to the usefulness of financial statements. Required: (a) (b) Explain what is meant by the term comparability in financial statements, referring to TWO types of comparison that users of financial statements may make. (4 marks) Explain TWO ways in which the IASB s Conceptual Framework for Financial Reporting and the requirements of accounting standards aid the comparability of financial information. (4 marks) Question 8 SUBSTANCE OVER FORM (8 marks) The accounting treatment and disclosure of the vast majority of transactions will remain the same whether they are accounted for on the basis of substance or form. However, some transactions will have a commercial effect not fully indicated by their legal form, and where this is the case, it will not be sufficient to account for them merely by recording that form. Required: Discuss the proposal that accounts should always reflect the commercial substance of transactions. (12 marks) DeVry/Becker Educational Development Corp. All rights reserved.

11 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Question 9 HUGHES AND CUSTOM CARS (a) (b) On 10 December 2012, Hughes sold inventory with a production cost of $30 million to the Wodwo Bank for $36 million cash. Hughes has a call option (an option to repurchase) on the goods exercisable on 10 January 2013 at a price of $37.8 million. The Wodwo Bank has a put option (an option to resell to the seller) exercisable on 10 February 2013 at a price of $39.7 million. Required: Discuss how the transaction should be accounted for in the accounts of Hughes at 31 December (4 marks) Custom Cars customises standard sports cars purchased from a major manufacturer, Sigma, by fitting extras (spoilers, skirts, tinted windows, etc) at its workshop premises. It sells them from its showroom on the same site, which it owns. During the year, the showroom was renovated and enlarged by means of an extension to the existing building. Sigma contributed many of the interior fitments, such as display stands for the cars, free of charge and also made a cash payment toward the total costs. Required: Discuss whether or not the extension and fittings should be shown in the statement of financial position of Custom Cars. (4 marks) Question 10 OBJECTIVES (8 marks) The objective of financial statements is to provide information about financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. Required: (a) (b) State five potential users of company published financial statements, briefly explaining for each one their likely information needs from those statements. (10 marks) Briefly discuss whether you think that the company published financial statements, prepared in accordance with IFRS, achieve the objective stated above, giving your reasons. Include in your answer two ways in which you think the quality of the information disclosed in financial statements could be improved. (10 marks) (20 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 3

12 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Question 11 MERCURY The trial balance of Mercury at 30 June 2013 was as follows: Dr Cr $000 $000 7% Preferred shares of $1 500 Ordinary shares of 50 cents 250 Share premium account 180 Retained earnings, at 1 July Inventory, 1 July Land at cost 300 Buildings at cost 900 Buildings, accumulated depreciation, 1 July Plant at cost 1,020 Plant, accumulated depreciation, 1 July Trade payables 900 Trade receivables 600 Allowance for doubtful debts, at 1 July Purchases 2,030 Administrative expenses 205 Revenue 3,000 Distribution costs 240 Other expenses 50 Bank balance 110 Ordinary dividend paid 25 10% Loan notes 500 You are provided with the following additional information: (i) (ii) 5,930 5,930 Depreciation on buildings is to be provided at 5% per year on cost and allocated to administrative expenses. Plant is to be depreciated at 20% per year using the reducing balance method and included in distribution costs. (iii) Closing inventory is valued at $500,000. (iv) (v) (vi) (vii) (viii) The allowance for doubtful debts is to be maintained at 5% of trade accounts receivable balances. An accrual for distribution wages of $30,000 is required. Interest on the loan notes has not been paid during the year. During June, a bonus (or scrip) issue of two for five was made to ordinary shareholders. This has not been entered into the books. The bonus shares do not rank for dividend for the current financial year. Provisions are to be made for the following: the preferred dividend for the year; an income tax charge of $55,000 for the year DeVry/Becker Educational Development Corp. All rights reserved.

13 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Required: Prepare for Mercury for the year ended 30 June 2013, in accordance with IAS 1 Presentation of Financial Statements: (a) a statement of profit or loss; and (8 marks) (b) a statement of changes in equity; and (5 marks) (c) a statement of financial position. (9 marks) Notes to the accounts are NOT required. Question 12 SULPHUR The balances listed below were extracted from the records of Sulphur Co on 30 June 2013: $ Revenue 530,650 Purchases 298,400 Returns (inwards) 1,880 Delivery vehicles (carrying amount) 19,230 Factory plant and equipment (carrying amount) 24,000 Land and buildings (carrying amount) 350,000 Factory overheads 66,420 Administrative expenses 18,710 Rent received 12,000 Investments (unlisted) 30,000 Investment income 1,500 Inventory at 1 July ,680 Trade receivables 15,690 Trade payables 34,700 Distribution costs 44,280 Cash in hand 410 Bank overdraft 4,820 Ordinary shares ($1 each) 150,000 Retained earnings at 1 July ,030 (22 marks) The following transactions and events occurred on 30 June 2013, after the above balances had been extracted: (1) Sulphur received $460 from a customer. (2) Inventory was valued at $29,170 at the close of business. (3) Sulphur received an electricity bill for $1,240 relating to the factory for the three months to 30 June The bill was paid in July (4) Sulphur paid $690 to a supplier in full settlement of an invoice for $700. (5) The company s land and buildings were valued by a chartered surveyor at $390,000 and the new value is to be included in the statement of financial position. (6) Depreciation was provided on the reducing balance basis at the following annual rates: Delivery vehicles 20% Factory plant and equipment 10% (7) Bonus shares were issued on the basis of one for every two held on 29 June (8) Income tax for the financial year ended 30 June 2013 was estimated at $38, DeVry/Becker Educational Development Corp. All rights reserved. 5

14 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Required: Prepare for Sulphur for the year ended 30 June 2013, in accordance with IAS 1 Presentation of Financial Statements: (i) a statement of total comprehensive income using the cost of sales (i.e. function of expense) method; (7 marks) (ii) a statement of changes in equity; and (3 marks) (iii) a statement of financial position. (7 marks) Notes to the financial statements are NOT required. Question 13 CAYMAN (17 marks) Cayman prepares annual financial statements to 30 September. At 30 September 2012, the company s list of account balances was as follows: $000 $000 Revenue 7,400 Production costs 4,140 Inventory at 1 October Distribution costs 540 Administrative expenses 730 Loan interest expense 120 Land at valuation 5,250 Buildings cost 4,000 accumulated depreciation at 1 October ,065 Plant and equipment cost 6,400 accumulated depreciation at 1 October ,240 Trade accounts receivable 2,060 Trade accounts payable 1,120 Bank overdraft 40 Issued shares (50 cent ordinary) at 30 September ,000 Share premium account at 30 September ,000 Revaluation surplus 1,500 Retained earnings 1,570 12% loan (payable 2019) 1,000 23,935 23, DeVry/Becker Educational Development Corp. All rights reserved.

15 STUDY QUESTION BANK FINANCIAL REPORTING (F7) The following matters are relevant to the preparation of the financial statements for the year ended 30 September 2012: (1) Inventory at 30 September 2012 amounted to $780,000 at cost before adjusting for the following: (i) (ii) Items which had cost $40,000 and which would normally sell for $60,000 were found to be faulty. $10,000 needs to be spent on these items in order to sell them for $45,000. Goods sent to a customer on a sale or return basis have been omitted from inventory and included as sales in September The cost of these items was $8,000 and they were included in revenue at $12,000. The goods were returned by the customer in October (2) Depreciation is to be provided on cost as follows: Buildings: Plant and equipment: 2% per year 20% per year 80% of the depreciation is to be charged to cost of sales and 10% to each of distribution costs and administrative expenses. (3) Land is to be revalued to $5,000,000. (4) Accrued expenses and prepayments were: Accrued expenses Prepayments $000 $000 Distribution costs Administrative expenses (5) During the year 4 million ordinary shares were issued at 75 cents each. The directors of Cayman declared an interim dividend of 2 cents per share in September No dividends were paid during the year. (6) Loan interest is paid annually, in arrears, on 30 September each year. Required: Prepare for Cayman for the year ended 30 September 2012: (i) a statement of total comprehensive income; (10 marks) (ii) a statement of financial position; and (10 marks) (iii) a statement of changes in equity, (6 marks) in accordance with IAS 1 Presentation of Financial Statements. Notes to the financial statements are NOT required. (26 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 7

16 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Question 14 OSCAR A trial balance has been extracted from the books of account of Oscar as at 31 March 2013 as follows: $000 $000 Administrative expenses 210 Share capital (ordinary shares of $1 fully paid) 600 Receivables 470 Bank overdraft 80 Income tax (overprovision in 2012) 25 Provision for pollution costs 180 Distribution costs 420 Listed financial asset investments 560 Investment income 75 Plant and machinery: Cost 750 Accumulated depreciation (at 31 March 2013) 220 Retained earnings (at 1 April 2012) 180 Purchases 960 Inventory (at 1 April 2012) 140 Trade payables 260 Sales revenue 2,010 Interim dividend paid 120 3,630 3,630 Additional information (1) Inventory at 31 March 2013 was valued at $150,000. (2) The following items are already included in the balances listed in the above trial balance: Distribution Administrative costs expenses $000 $000 Depreciation (for the year to 31 March 2013) 27 5 Hire of plant and machinery Auditors remuneration 30 Directors emoluments 45 (3) The income tax rate is 33%. (4) The income tax charge based on the profits for the year is estimated to be $74,000. (5) The provision for pollution costs is to be increased by $16,000. (6) Authorised ordinary share capital consists of 1,000,000 ordinary shares of $1 each. (7) There were no purchases or disposals of fixed assets during the year. (8) The market value of the listed financial asset investments, which are classed as fair value through profit or loss as at 31 March 2013 was $580,000. There were no purchases or sales of such investments during the year. Required: Insofar as the information permits, prepare the company s statement of profit or loss for the year to 31 March 2012 and a statement of financial position as at that date in accordance with IAS 1. (18 marks) DeVry/Becker Educational Development Corp. All rights reserved.

17 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Question 15 PERSEUS The list of account balances of Perseus, a limited liability company, contains the following items at 31 December 2012: Dr Cr $ $ Opening inventory 3,850,000 Accounts receivable ledger balances 2,980,000 1,970 Accounts payable ledger balances 14,300 1,210,400 Prepayments 770,000 Cash at bank A 940,000 Overdraft at bank B 360,000 The closing inventory amounted to $4,190,000, before allowing for the adjustments required by items (2) and (3) below. In the course of preparing the financial statements at 31 December 2012, the need for a number of adjustments emerged, as detailed below: (1) The opening inventory was found to have been overstated by $418,000 as a result of errors in calculations of values in the inventory sheets. (2) Some items included in closing inventory at cost of $16,000 were found to be defective and were sold after the end of the reporting period for $10,400. Selling costs amounted to $600. (3) Goods with a sales value of $88,000 were in the hands of customers at 31 December 2012 on a sale or return basis. The goods had been treated as sold in the records and the full sales value of $88,000 had been included in trade receivables. After the end of the reporting period, the goods were returned in good condition. The cost of the goods was $66,000. (4) Accounts receivable amounting to $92,000 are to be written off. (5) An allowance for doubtful debts is to be set up for 5% of the accounts receivable total. (6) The manager of the main selling outlet of Perseus is entitled, from 1 January 2012, to a commission of 2% of the company s profit after charging that commission. The profit amounted to $1,101,600 before including the commission, and after adjusting for items (1) to (5) above. The manager has already received $25,000 on account of the commission due during the year ended 31 December Required: (a) (i) Explain how adjustment should be made for the error in the opening inventory, according to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. (Assume that it constitutes a material error.) (b) (ii) State two disclosures required by IAS 8 in the financial statements at 31 December 2012 for the adjustment in (i) above. (6 marks) Show how the final figures for current assets should be presented in the statement of financial position at 31 December (14 marks) (20 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 9

18 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Question 16 JENSON The timing of revenue (income) recognition has long been an area of debate and inconsistency in accounting. Industry practice in relation to revenue recognition varies widely; the following are examples of different points in the operating cycle of businesses that revenue and profit can be recognised: on the acquisition of goods; during the manufacture or production of goods; on delivery/acceptance of goods; when certain conditions have been satisfied after the goods have been delivered; receipt of payment for credit sales; on the expiry of a guarantee or warranty. In the past the critical event approach has been used to determine the timing of revenue recognition. The International Accounting Standards Board in its Conceptual Framework for Financial Reporting ( the Framework ) has defined the elements of financial statements, and it uses these to determine when a gain or loss occurs. Required: (a) (b) Explain what is meant by the critical event in relation to revenue recognition and discuss the criteria used in the Framework for determining when a gain or loss arises. (5 marks) For each of the stages of the operating cycle identified above, explain why it may be an appropriate point to recognise revenue and, where possible, give a practical example of an industry where it occurs. (12 marks) (c) Jenson has entered into the following transactions/agreements in the year to 31 March 2013: (i) (ii) Goods, which had cost of $20,000, were sold to Wholesaler for $35,000 on 1 June Jenson has an option to repurchase the goods from Wholesaler at any time within the next two years. The repurchase price will be $35,000 plus interest charged at 12% per year from the date of sale to the date of repurchase. It is expected that Jenson will repurchase the goods. Jenson owns the rights to a fast food franchise. On 1 April 2012 it sold the right to open a new outlet to Mr Cody. The franchise is for five years. Jenson received an initial fee of $50,000 for the first year and will receive $5,000 per year thereafter. Jenson has continuing service obligations on its franchise for advertising and product development that amount to approximately $8,000 per year per franchised outlet. A reasonable profit margin on rendering the continuing services is deemed to be 20% of revenues received. (iii) On 1 September 2012 Jenson received total subscriptions in advance of $240,000. The subscriptions are for 24 monthly publications of a magazine produced by Jenson. At the year end Jenson had produced and despatched six of the 24 publications. The total cost of producing the magazine is estimated at $192,000 with each publication costing a broadly similar amount. Required: Describe how Jenson should treat each of the above examples in its financial statements in the year to 31 March (8 marks) (25 marks) DeVry/Becker Educational Development Corp. All rights reserved.

19 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Question 17 ALLRIGHTS Allrights is an old established company operating in the highly competitive business of manufacturing and marketing radios and television sets. A new board of directors is considering the draft accounts, prepared under the historical cost convention, for the year ended 31 March The main executive directors involved in the policy discussions are: Stevie Striver (managing) Charlie Chatty (sales) Gordon Gloome (production) You are in attendance to give advice. A standard model radio has the following disclosed costs: $ Direct labour and material 38 Bought-in components 5 Factory overhead costs 8 Royalty on sale payable to the owner of a patent 2 For 1,000 radio sets, the other overhead costs are $14,000 made up as follows: $ Salary and space costs of executive responsible for production planning 4,000 General office administration 2,500 Selling and distribution costs, including a fixed $4 per set commission payable to salesmen 7,500 The advertised selling price of the model has recently been reduced to $60 because of intensive competition. The three directors have expressed the following views on the most appropriate method of valuing the company s closing inventories: (1) Stevie Striver A most prudent approach is necessary, particularly as the company has a cash flow problem which means that the amount locked up in inventory should be kept as low as possible. I propose a valuation of $43 per set. (2) Charlie Chatty All the functions of the company are directed towards the production and sale of a good finished product and therefore I think each set should be valued at the total cost involved, including the other overhead costs. (3) Gordon Gloome $47 per set, because that s what the production cost would have been if we had been more efficient and kept in line with budgets. Required: Draft, for inclusion in a report, your opinions on the views expressed by each director, stating the principles involved. (8 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 11

20 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Question 18 SAMPI (a) (b) IAS 2 Inventories requires inventories of raw materials and finished goods to be valued in financial statements at the lower of cost and of net realisable value. Required: (i) (ii) Describe three methods of arriving at cost of inventory which are acceptable under IAS 2 and explain how they are regarded as acceptable. (5 marks) Explain how the cost of an inventory of finished goods held by the manufacturer would normally be arrived at when obtaining the figure for the financial statements. (3 marks) Sampi is a manufacturer of garden furniture. The company has consistently used FIFO (first in, first out) in valuing inventory, but it is interested to know the effect on its inventory valuation of using weighted average cost instead of FIFO At 28 February 2013 the company had inventory of 4,000 standard plastic tables, and has computed its value on each side of the two bases as: Basis Unit Total cost value $ $ FIFO 16 64,000 Weighted average 13 52,000 During March 2013 the movements on the inventory of tables were as follows: Received from factory: Production Number cost per Date of units unit $ 8 March 3, March 6, Revenue: Number of units 12 March 5, March 2, March 3, March 2,000 On a FIFO basis the inventory at 31 March was $32,400. Required: Compute what the value of the inventory at 31 March 2013 would be using weighted average cost (5 marks) In arriving at the total inventory values you should make calculations to two decimal places (where necessary) and deal with each inventory movement in date order. (13 marks) DeVry/Becker Educational Development Corp. All rights reserved.

21 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Question 19 WILLIAM William, a company which designs and builds racecourses, commenced a four year contract early in The price was initially agreed at $12,000,000. Profit, which was reasonably foreseeable from the year ended 31 December 2009, is to be taken on a costs basis, and revenue is to be taken on a consistent basis. Relevant figures are as follows: $000 $000 $000 $000 Costs incurred in year 2,750 3,000 4,200 1,150 Anticipated future costs 7,750 7,750 1,550 Work certified and invoiced to date 3,000 5,000 11,000 12,500 Required: Show how the above would be disclosed in the statement of profit or loss and statement of financial position of William for each of the four years ended 31 December (12 marks) Question 20 MERRYVIEW Merryview specialises in construction contracts. One of its contracts, with Better Homes, is to build a complex of luxury flats. The price agreed for the contract is $40 million and its scheduled date of completion is 31 December Details of the contract to 31 March 2012 are: Commencement date 1 July 2011 Contract costs: $000 Architects and surveyors fees 500 Materials delivered to site 3,100 Direct labour costs 3,500 Overheads are apportioned at 40% of direct labour costs Estimated cost to complete (excluding depreciation see below) 14,800 Plant and machinery used exclusively on the contract cost $3,600,000 on 1 July At the end of the contract it is expected to be transferred to a different contract at a value of $600,000. Depreciation is to be based on a time apportioned basis. Inventory of materials on site at 31 March 2012 is $300,000. Better Homes paid a progress payment of $12,800,000 to Merryview on 31 March At 31 March 2013 the details for the construction contract have been summarised as: Contract costs to date (i.e. since the start of the contract) excluding all depreciation 20,400 Estimated cost to complete (excluding depreciation) 6,600 A further progress payment of $16,200,000 was received on 31 March Merryview accrues profit on its construction contracts using the percentage of completion basis as measured by the percentage of the cost to date compared to the total estimated contract cost DeVry/Becker Educational Development Corp. All rights reserved. 13

22 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Required: Prepare extracts of the financial statements of Merryview for the construction contract with Better Homes for: (i) the year to 31 March 2012; (8 marks) (ii) the year to 31 March (7 marks) (15 marks) Question 21 ADJUSTMENTS Adjustments manufactures items for use in engineering products. You note that amongst its many tangible non-current assets it has the following: (a) (b) (c) Required: A lathe was purchased on 1 January 2006 for $150,000. The plant had an estimated useful life of twelve years, residual value of nil. Depreciation is charged on the straight line basis. On 1 January 2012, when the asset s carrying amount is $75,000, the directors decide that the asset s total useful life is only 10 years. A grinder was purchased on 1 January 2009 for $100,000. The plant had an estimated useful life of 10 years and a residual value of Nil. Depreciation is charged on the straight line basis. On 1 January 2012, when the asset s carrying amount is $70,000, the directors decide that it would be more appropriate to depreciate this asset using the sum of digits approach. The remaining useful life is unchanged. The company purchased a fifty year lease some years ago for $1,000,000. This was being depreciated over its life on a straight line basis. On 1 January 2012, when the carrying amount is $480,000 and twenty-four years of the lease are remaining, the asset is revalued to $1,500,000. This revised value is being incorporated into the accounts. As the company s financial accountant, prepare a memorandum for the attention of the board explaining the effects of these changes on the depreciation charge and indicating what additional disclosures need to be made in the accounts for the year to 31 December Question 22 FAM Fam had the following tangible non-current assets at 31 December 2011: (15 marks) Cost Depreciation Carrying amount $000 $000 $000 Land Buildings Plant and machinery 1, ,155 Fixtures and fittings Assets under construction , , DeVry/Becker Educational Development Corp. All rights reserved.

23 STUDY QUESTION BANK FINANCIAL REPORTING (F7) In the year ended 31 December 2012 the following transactions occur: (1) Further costs of $53,000 are incurred on buildings being constructed by the company. A building costing $100,000 is completed during the year. (2) A deposit of $20,000 is paid for a new computer system which is undelivered at the year end. (3) Additions to plant are $154,000. (4) Additions to fixtures, excluding the deposit on the new computer system, are $40,000. (5) The following assets are sold: Cost Depreciation Proceeds brought forward $000 $000 $000 Plant Fixtures (6) Land and buildings were revalued at 1 January 2012 to $1,500,000, of which land is worth $900,000. The revaluation was performed by Messrs Jackson & Co, Chartered Surveyors, on the basis of existing use value on the open market. (7) The useful economic life of the buildings is unchanged. The buildings were purchased 10 years before the revaluation. (8) Depreciation is provided on all assets in use at the year end at the following rates: Required: Buildings Plant Fixtures 2% per year straight line 20% per year straight line 25% per year reducing balance Show the disclosure under IAS 16 in relation to non-current assets in the notes to the published accounts for the year ended 31 December (14 marks) Question 23 STOAT The directors of Stoat, a limited liability company, are reviewing the company s draft financial statements for the year ended 30 June Two matters under discussion are depreciation and non-current asset valuation several directors are of the opinion that the company s depreciation methods and rates are unsatisfactory, and that the statement of financial position values of some of the non-current assets are unrealistic. Required: Draft a memorandum for the directors dealing with the following matters: (a) The purpose of depreciation and the factors affecting the assessment of useful life according to IAS 16 Property, Plant and Equipment. (7 marks) (b) Three items of evidence obtainable from inside or outside the company, to check whether the company s depreciation rates are in fact likely to be too low. (3 marks) 2014 DeVry/Becker Educational Development Corp. All rights reserved. 15

24 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Answer 1 IASB (a) (b) Objectives To formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their world-wide acceptance and observance. To work generally for the improvement and harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements. Producing an IFRS A Steering Committee is set up, chaired by a Board representative, and usually including representatives of at least three other countries. The Steering Committee identifies and reviews all the accounting issues associated with the topic. These will include: the application of the IASB Conceptual Framework for Financial Reporting; and review of existing national and regional accounting requirements and practice. The Steering Committee then submits a Point Outline to the Board. After receiving comments from the Board, the Steering Committee prepares and publishes a Draft Statement of Principles. Comments are invited from all interested parties during an exposure period, usually between four and six months. The next stage is the preparation of a final Statement of Principles, which is submitted to the Board by the Steering Committee. This final Statement is used as a basis for preparing an Exposure Draft of a proposed IFRS. The final Statement of Principles is available to the public on request, but is not formally published. The Steering Committee prepares a draft Exposure Draft for approval by the Board. After revision, and with the approval of at least 9 members of the board, the Exposure Draft is published. Comments are invited from all interested parties during an exposure period, usually six months. The Steering Committee reviews the comments and prepares a draft IFRS for review by the Board. After revision, and with the approval of at least 9 members of the board, the IFRS is published. During the process, the Board may decide to issue a Discussion Paper for comment, or to issue more than one Exposure Draft DeVry/Becker Educational Development Corp. All rights reserved. 1001

25 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Answer 2 NETTE The Conceptual Framework for Financial Reporting provides a conceptual underpinning for the International Financial Reporting Standards (IFRS). The framework is in the process of being updated by the IASB and as at 2012 it is a mixture of the old framework document plus two new chapters that have been issued by the IASB as a replacement for sections of the old framework. IFRS are based on the Framework and its aim is to provide a framework for the formulation of accounting standards. If accounting issues arise which are not covered by accounting standards then the Framework can provide a basis for the resolution of such issues. The Framework deals with several areas: the objective of financial statements the underlying assumption the qualitative characteristics of useful financial information the elements of financial statements recognition in financial statements measurement in financial statements concepts of capital and capital maintenance The Framework adopts an approach which builds corporate reporting around the definitions of assets and liabilities and the criteria for recognising and measuring them in the statement of financial position. This approach views accounting in a different way to most companies. The notion that the measurement and recognition of assets and liabilities is the starting point for the determination of the profit of the business does not sit easily with most practising accountants who see the transactions of the company as the basis for accounting. The Framework provides a useful basis for discussion and is an aid to academic thought. However, it seems to ignore the many legal and business roles that financial statements play. In many jurisdictions, the financial statements form the basis of dividend payments, the starting point for the assessment of taxation, and often the basis for executive remuneration. A statement of financial position, fair value system which the IASB seems to favour would have a major impact on the above elements, and would not currently fit the practice of accounting. Very few companies fit this practice of accounting. Very few companies take into account the principles embodied in the Framework unless those principles themselves are embodied in an accounting standard. Some International Financial Reporting Standards are inconsistent with the Framework primarily because they were issued earlier than the Framework. The Framework is a useful basis for financial reporting but a fundamental change in the current basis of financial reporting will be required for it to have any practical application. The IASB seems intent on ensuring that this change will take place. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors makes reference to the use of the Framework where there is no IFRS or IFRIC in issue. The standard says in making the judgement, management shall refer to, and consider the applicability of, the following sources in descending order: the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the framework DeVry/Becker Educational Development Corp. All rights reserved.

26 STUDY QUESTION BANK FINANCIAL REPORTING (F7) Answer 3 LIMITATIONS The following list includes some of the limitations of financial statements: Nowadays, financial statements prepared under a financial reporting framework (e.g. IFRS) contain very complex and detailed information. Most users will not be able to fully understand what the financial statements are trying to communicate. For example, accounting for financial instruments encompasses detailed rules, which even accountants may struggle to understand. Decision-making processes undertaken by management require timely information on matters that are not incorporated in financial statements. Therefore financial statements are of limited use to management. The values used in financial statements are mixed in nature. Some transactions and balances are accounted for at historic cost whilst others are incorporated at fair value. Without detailed knowledge of how these figures have been determined, their meaning can be difficult to construe. The financial statements are mainly historic in nature and summarise what has happened, not what is going to happen. They cannot be used to make predictions about the future. Many items are excluded from the financial statements. For example, many internallygenerated intangible assets (e.g. a brand name) can never be recognised in the statement of financial position of the reporting entity. The only way in which such assets can be recognised is if the entity is acquired, but even then they are recognised only in the consolidated statement of financial position of the acquiring company. Management may be very creative in how information is presented in the financial statements. Much of the information which is required to be disclosed is subjective in nature and management may interpret the accounting requirements to portray information in a particular light. Enron is the classic example of management being creative and, in doing so, the financial statements not showing a realistic picture. How the financial market perceives an entity cannot be recognised in the financial statements. The market value of a company is very different to the carrying value presented in the financial statements because market value reflects, for example, shareholders expectations of future returns. It can be quite difficult to judge at what point revenue should be recognised. When complex contractual agreements are made between parties it may also be difficult to specify an appropriate amount of revenue to be included. Therefore the statement of comprehensive income may be inadequate in reflecting the amount of profit made in a period. Financial statements are drawn up at a specified point in time. A cut-off therefore has to be established to be able to prepare the financial statements. The point of cut-off could be in the middle of a very detailed or complex transaction or related transactions which again the financial statements may not be able to reflect fully. From the end of the reporting period to when the statements are authorised for publication is usually a minimum of three months. A lot can happen in that three-month period, so the statements become out of date very quickly. Many transactions take place between related parties. Although certain disclosures should be made regarding related party transactions it is still difficult for the financial statements to fully reflect the impact of these transactions DeVry/Becker Educational Development Corp. All rights reserved. 1003

27 FINANCIAL REPORTING (F7) STUDY QUESTION BANK Answer 4 FRAMEWORK (a) Main purpose (b) (c) To assist the Board of IASCF in developing future International Financial Reporting Standards (IFRSs) and reviewing existing ones To promote harmonisation of regulations by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs To assist national standard-setting bodies in developing national standards To assist preparers of accounts in applying IFRSs and in dealing with topics that have yet to be covered by an IFRS. To assist auditors in forming an opinion on whether the accounts comply with IFRS. To assist users of financial statements in the interpretation of information contained in those statements. To provide those who are interested in the work of the IASB with information about its approach to the formulation of standards. Status The Framework is not an IFRS hence it does not define standards. Nothing in the framework overrides any specific IFRS. In a limited number of cases where a conflict between the framework and an IFRS arises, the IFRS prevails. Underlying assumption Going concern Financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Therefore is assumed that the enterprise has neither intention nor need to liquidate or curtail materially the scale of operations. If such an intention or need exist, the financial statements may have to be prepared on a different basis (and the basis used is disclosed). Answer 5 REGULATORY FRAMEWORK A regulatory framework has been defined as a system of regulations and the means to enforce them, usually established by a governing body to regulate a specific activity. Without such a framework the system would fail to function properly and ad hoc rules and regulations would emerge which individuals and bodies would not be able to understand fully. There would be no direction or guidelines governing the content, or rules, that should be followed and parties would devise their own rules. 1 per point to max max 2 ½ ½ max DeVry/Becker Educational Development Corp. All rights reserved.

28 STUDY QUESTION BANK FINANCIAL REPORTING (F7) A regulatory framework is needed for financial reporting to ensure that all relevant parties understand exactly what should be reported by the entity, and how. The framework may be a set of rules and regulations detailing exactly what and to whom an entity should report or it may be a less formal framework providing guidance for reporting. Company law and/or accounting standards can be issued to create Generally Accepted Accounting Practice (GAAP) for reporting entities to follow when preparing their financial statements. There is a need for some form of regulatory framework in financial reporting to ensure there is consistency in accounting treatments so that comparisons can be made between financial statements (e.g. year-on-year and between companies). Under IFRS the IASB has issued the Conceptual Framework for Financial Reporting. This is a conceptual framework which is used by the IASB to assist relevant parties in the needs and requirements of users of financial statements. It is used in conjunction with International Financial Reporting Standards to form a set of principles with which reporting entities should comply when preparing and presenting their financial statements. The conceptual framework is not in itself a regulatory framework as there is no formal means of enforcing the issued standards, and as they are principles-based they are open to interpretation. Other GAAPs have formed regulatory frameworks in order to regulate the financial reporting activities of their members. UK GAAP is formed of company law issued by the UK government and accounting standards issued by the Accounting Standards Board. The ASB has a body within it, the Financial Reporting Review Panel, whose function is to police the financial statements issued by UK companies. It aims to ensure that published financial statements are prepared in conformity with the UK regulatory framework. Answer 6 FOUR CONCEPTS (a) (b) (c) Entity concept In accounting, it is necessary to define the boundaries of the entity concerned. In the case of a limited liability company, only transactions of that company must be included. There must be no confusion between the transactions of the company and the transactions of its owners and managers. If the entity concept is not followed, the profit, financial position and cash flow may all be distorted to the point where they become meaningless. A limited liability company is therefore a separate entity which can sue and be sued in its own name. Going concern concept The going concern is that financial statements are prepared on the basis that the entity will continue for the foreseeable future that there is no intention or necessity to liquidate or curtail the scale of operations. If the going concern concept is followed when it is not appropriate, assets may be overstated, liabilities may continue to be shown as non-current when the collapse of the going concern status of the entity renders them current liabilities, and the profit is likely to be overstated. statements. Materiality Information is material if its omission from, or misstatement in, the financial statements could influence the economic decisions of users. Materiality cannot always be measured in monetary or percentage terms, but a commonly used measure is 5% of normal pre-tax profit. Above that level, for example, the transaction would need to be disclosed in the financial 2014 DeVry/Becker Educational Development Corp. All rights reserved. 1005