CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION - AUGUST 2012

Transcription

1 CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION - AUGUST 2012 NOTES: You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5. (If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for Questions 4 or 5 will be marked.) PRO-FORMA STATEMENT OF COMPREHENSIVE INCOME BY NATURE, STATEMENT OF COMPREHENSIVE INCOME BY FUNCTION AND STATEMENT OF FINANCIAL POSITION ARE PROVIDED. TIME ALLOWED: 3.5 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Please read each Question carefully. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded to pay particular attention to your communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of your answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

2 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION AUGUST 2012 Time allowed 3.5 hours, plus 10 minutes to read the paper. You are required to answer Questions 1, 2 and 3. You are also required to answer either Question 4 or 5. (If you provide answers to both Questions 4 and 5, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first answer to hand for Questions 4 or 5 will be marked.) You are required to answer Questions 1, 2 and Inca plc (Inca) is a large public limited company based in Ireland. It has shareholdings in two other companies. These are called Java plc (Java) and Lava plc (Lava). Statements of Financial Position are shown below for all three companies as at 31 July Statements of Financial Position as at 31 July 2012 Inca plc Java plc Lava plc million million million Non-current assets: Property, plant & equipment Investments Current assets: Inventories Receivables Cash & bank Total assets Equity: Equity share capital of 1 each Share premium Retained earnings Current liabilities: Payables Bank overdraft 7 Dividends proposed Total equity & liabilities The following additional information is to be taken into account insofar as it is relevant: (i) (ii) (iii) Inca bought 45m equity shares in Java on 1 August The consideration consisted of an immediate cash payment of 58 million together with a deferred payment of 30 million due on 1 August The 58 million has been accounted for in the accounts of Inca, but no record has been made of the deferred payment. Inca s cost of capital can be taken to be 10%. Inca also bought 10m equity shares in Lava on 1 November 2011, paying an amount of 25m cash for these shares. This investment has been correctly recorded at cost. The equity share capital and share premium of Java and Lava have not changed since their respective dates of acquisition. The retained earnings reserves were as follows on the respective acquisition dates: Java 10.6m, Lava 9m. Page 1

3 (iv) (v) (vi) (vii) (viii) (ix) (x) Group accounting policy is to value non-controlling interests at fair value at the date of acquisition, and goodwill should be calculated accordingly. On 1 August 2011, the fair value of the non-controlling interest in Java was 9.2 million. No impairment losses are considered necessary at 31 July On the acquisition date, the fair values of the assets of Java were equivalent to their book values with two exceptions. Certain plant was worth 4m in excess of its book value on the date Inca acquired its holding. Also, Java s investments, carried at 27 million, had a fair value of 28 million at the acquisition date. The plant was estimated to have had a five-year useful life from the date of acquisition. The value of the investments has not changed since the acquisition date. During the financial year ended 31 July 2012, Java had sold goods to Inca amounting to 6m. These goods were sold inclusive of a mark-up of 50% on cost. 30% of these goods remained in the inventory of Inca at the reporting date. Since acquiring its holding in Lava, Inca purchased 3 million of goods from Lava which had cost Lava 2 million. All of these remained in inventory at the reporting date. There was an intra-group balance of 2.2m owed by Inca to Java at the reporting date. This amount was the same in the books of both companies. An amount of 1.5 million was owed by Inca to Lava at the reporting date. Both sets of books were again in agreement on the amount outstanding. Inca has not accounted for any dividend receivable from its group companies. Both Inca and Java have proposed dividends as shown in current liabilities. Java s proposed dividend relates to the post-acquisition period only. Inca exercises significant influence over its investment in Lava. (xi) The present value interest factors for 10% may be taken as follows: Year 1 = 0.91, Year 2 = 0.83 REQUIREMENT: (a) (b) Prepare the Consolidated Statement of Financial Position for the Inca group as at 31 July 2012 in accordance with International Financial Reporting Standards. (22 marks) Format & Presentation (2 marks) Write a short memorandum to a client explaining the two methods permitted by IFRS 3 Business Combinations for calculating goodwill on the acquisition of a subsidiary. (5 marks) Format & Presentation (1 mark) [Total: 30 MARKS] Page 2

4 2. Clawhammer plc is a public listed manufacturing company. Its summarised financial statements for the year ended 30 April 2012 (and 2011 comparatives) are as follows: Statements of Comprehensive Income for the year ended 30 April: million million Revenue Cost of sales (270) (260) Gross profit Distribution costs (10) (8) Administrative expenses (49) (39) Investment income - 2 Finance costs (6) (5) Profit (loss) before taxation (25) 50 Income tax (expense) relief 4 (15) Profit (loss) for the year (21) 35 Other comprehensive income (net of tax) Revaluation losses (45) - Total comprehensive income (loss) for the year (66) 35 Statements of Financial Position as at 30 April: million million Assets Non-current assets: Property, plant and equipment Investments at fair value through profit or loss Current assets: Inventory and work-in-progress Trade receivables Tax refund due 6 - Bank Total assets Equity and liabilities Equity: Equity shares of 1 each Share premium 10 - Revaluation reserve - 45 Retained earnings Non-current liabilities: Bank loan Long term provisions Current liabilities Trade payables Current tax payable Total equity and liabilities Page 3

5 The following additional information is available: (i) Market conditions during the year ended 30 April 2012 proved very challenging due largely to difficulties in the global economy as a result of a sharp recession. This has led to steep falls in share prices and property values. Clawhammer plc s properties have suffered revaluation losses of 60 million in the year. The excess of these losses over previous surpluses has led to a charge to cost of sales of 15 million in addition to the normal depreciation charge. (ii) (iii) (iv) (v) (vi) The portfolio of investments at fair value through profit and loss has been marked to market (fair valued) resulting in a loss of 16 million which is included in administrative expenses. There were no additions to, or disposals of, non-current assets during the year. In response to the downturn in the economy, the company has had to make a number of employees redundant incurring severance costs of 3 million. These are included in cost of sales. The difficulty in the credit markets has meant that the finance cost of the variable rate bank loan has increased from 4.5% to 8% from 1 May In order to help cash flows, the company made a rights issue of shares during the year ending 30 April 2012, all of which ranked for dividend. No shares were issued during the year ended 30 April (vii) The dividend per share has been reduced by 50% for year ended 30 April REQUIREMENT: (a) (b) Prepare a statement of changes in equity for years ended 30 April 2011 and 2012 insofar as the above information permits. (5 marks) Format & Presentation (1 mark) Analyse and discuss the financial performance and position of Clawhammer plc as portrayed in the financial statements and in the additional information provided. Your analysis should be supported by ratios (8 marks are available for calculation of suitable ratios, and 10 marks for analysis). (18 marks) (c) Identify and explain briefly the factors limiting your analysis at (b) above. (6 marks) [Total: 30 MARKS] Page 4

6 3. The following multiple choice question contains eight sections, each of which is followed by a choice of answers. Only one of each set of answers is strictly correct. Each question carries equal marks. REQUIREMENT: Record your answer to each section in the answer sheet provided. [Total: 20 MARKS] 1. Macroly plc prepared draft financial statements to year ended 31 December 2011 showing inventory at cost price 760,000. Following investigations the auditors found this inventory included the following two items: (1) A batch of electric guitars was carried at 60,000 but, due to obsolescence, these were expected to fetch only 36,000 on sale. Costs of selling and delivery are expected to be 1,500. (2) A batch of pianos was carried at 70,000, but sold during January and February 2012 for a total of 17,500 net of all selling costs. The reason for the low price was damage caused by a flood which took place in the warehouse in early January What is the correct inventory figure for inclusion in Macroly s 2011 year-end accounts in the light of the above information? (a) 736,000 (b) 734,500 (c) 683,500 (d) 682, During the year ended 31 December 2011, Thornbird plc acquired 80% of the equity of another entity. The consideration payable was 56 million comprising 12 million immediate cash, 30 million fair value of equity issued as consideration, and 14 million fair value of contingent consideration (payable in 2014). The fair value of the net assets of the entity acquired was 52 million, including cash of 15 million. What figure should appear in Thornbird s Consolidated Statement of Cash Flows under the heading Cash Flows from Investing Activities in respect of the above acquisition? (a) 12 million outflow (b) 26 million outflow (c) 3 million inflow (d) 2.4 million inflow 3. At the reporting date 31 December 2011, Jay plc carried a receivable from Kay Ltd, a major customer, at 10 million. The signing date of the financial statements was 16 February Kay Ltd declared bankruptcy on 14 February What should Jay plc do in respect of its 2011 financial statements? (a) Disclose the fact that Kay Ltd has declared bankruptcy in the notes. (b) Make a provision for this event in its financial statements (as opposed to disclosure in footnotes). (c) Ignore the event and wait for the outcome of the bankruptcy because the event took place after the yearend. (d) Reverse the sale pertaining to this receivable in the comparatives for the prior period and treat this as an error under IAS Lee plc is a construction contractor. At its reporting date of 31 March 2012 it had a contract in progress. The contract price was 2.4 million, costs incurred were 0.5 million, and Lee plc s engineers estimated the costs remaining to complete the contract would be 1.6 million. The best estimate of stage of completion at the reporting date was 22%. Lee plc s accounting policy is to consider the outcome of construction contracts to be reasonably foreseeable once they are 25% complete. How much should be recognised as revenue, costs and profit in the Statement of Comprehensive Income of Lee plc for year ended 31 March 2012? Revenue Costs Profit (a) nil nil nil (b) 500, ,000 nil (c) 528, ,000 28,000 (d) 528, ,000 66,000 Page 5

7 5. Ming plc has estimated its corporation tax liability for year ended 29 February 2012 at 79,000. The provision for year ended 28 February 2011 was 91,000 of which only 87,000 was required to meet the actual tax liability for that year. The journal entry required to incorporate the 2012 provision into the accounts is which of the following? Debit Credit (a) Profit or loss (tax expense) 75,000 Tax provision 75,000 (b) Profit or loss (tax expense) 79,000 Tax provision 79,000 (c) Profit or loss (tax expense) 83,000 Tax provision 83,000 (d) Profit or loss (tax expense) 79,000 Tax provision 4, Which of the following is not a condition that must be met in order to record revenue from the sale of goods under IAS 18 Revenue? (a) (b) (c) (d) The amount of revenue can be measured reliably. Stage of completion of the work can be measured reliably. Costs incurred in respect of the transaction can be measured reliably. The seller has transferred to the buyer effective control of the goods being supplied. 7. Smasher plc has an unfortunate history of causing serious environmental pollution. It addresses environmental issues or pollution it has caused only when compelled to do so by law. At its reporting date 31 March 2012, Smasher plc has caused environmental damage through its actions which would cost 2 million to rectify. 1.5 million of this is in Ireland, where strict anti-pollution laws require it to clean up. 0.5 million is in Hallyland, a developing country which has no laws requiring the clean-up of pollution damage. What provision should Smasher plc make in its accounts for year ended 31 March 2012 in order to comply with IAS 37 Provisions, Contingent Liabilities and Contingent Assets? (a) (b) (c) (d) None, as no expenditure has yet been incurred. None, but make disclosure of the expected cost as a result of damage caused. 1.5 million, as this is the expected cost to Smasher plc of rectifying the damage caused by its actions to date and it is probable that Smasher plc will have to pay this amount. 2 million, as this is the amount of damage caused by Smasher plc to date. 8. Trent plc sometimes receives grants from the government in order to support certain investments. During financial year ended 30 April 2012 it bought equipment for 100,000 and received a grant of 30,000 to assist with this purchase. The following proposals are made to record this transaction: (i) Record the equipment at its gross cost of 100,000 and depreciate over its useful economic life whilst simultaneously recording the grant as deferred income, releasing it to profit or loss over the life of the equipment to which it relates. (ii) Record the equipment at its cost net of grant 70,000 and depreciate over its useful economic life. How should Trent plc record this transaction under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance? (a) (i) only is correct. (b) (ii) only is correct. (c) The entity may choose either (i) or (ii). (d) Neither (i) nor (ii) is correct. Page 6

8 Answer either Question 4 or Question 5 4. The International Accounting Standards Board is currently in the process of updating its conceptual framework for financial reporting. The updated project is being conducted in phases. To date, two chapters of the updated framework have been issued: Chapter 1: The Objective of General Purpose Financial Reporting, and Chapter 3: Qualitative Characteristics of Useful Financial Information. Chapter 4 of the conceptual framework contains the remaining text of the approved 1989 conceptual framework. Within this chapter, it describes the elements of financial statements and discusses definitions of each. REQUIREMENT: (a) (i) Explain the objective of General Purpose Financial Reporting as described in Chapter 1 of the revised conceptual framework; and (5 Marks) (ii) Discuss the usefulness of Chapter 1 in helping accountants determine appropriate accounting policies and practices. (5 marks) (b) Prepare a short memo for your Finance Director in which you briefly discuss the recognition and measurement of one element of financial statements relating to financial performance and another element relating to financial position. (10 marks) OR [Total: 20 MARKS] 5. Weathervane plc reported profits of 460,000 for year ended 31 March On 1 April 2011, its capital structure consisted of 2.5 million equity shares of 1 each, and 600,000 8% preference shares of 1 each. The preference dividend was paid during the year. An ordinary dividend of 60,000 was also paid during the year. Neither dividend has been taken account of in the above profit figure. The reported basic earnings per share for year ended 31 March 2011 was 8c. During the year ended 31 March 2012, the following changes took place to the issued share capital of Weathervane plc: 500,000 equity shares were issued in conjunction with the acquisition of another business. These were issued at full market price at the date of issue, 1 July To help fund expansion of the business, 1.8 million ordinary shares were issued for cash to existing shareholders on 1 September The issue price was 1.40 per share, which represented a discount of 64c on the traded price immediately before the issue, which was On 31 March 2012, a bonus issue was completed of one share for every two held at that date. REQUIREMENT: (a) From the information above, calculate the basic Earnings Per Share (EPS) of Weathervane plc to be reported in the financial statements for year ended 31 March Show also the recalculated comparative figure for the preceding year. (12 marks) (b) In another entity s recent financial report you noticed that profit for the year increased from 300,000 to 500,000, yet the basic EPS increased from 30c to just 36c. Identify and explain potential reasons for this. (3 marks) (c) Briefly explain why EPS is considered an important measure of a company s financial performance and briefly explain some of the limitations of EPS. (5 marks) [Total: 20 MARKS] END OF PAPER Page 7

9 SUGGESTED SOLUTIONS THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND CORPORATE REPORTING PROFESSIONAL 1 EXAMINATION AUGUST 2012 SOLUTION 1 Marking scheme: (a) Statement Basic consolidation plan (100% I + 100% J + parent SC & SP) 4 FVA of PPE and investments (calculation and inclusion in SOFP) 1 Depreciation on FVA (calculation and inclusion in reserves) 1 Goodwill (calculation incl FVA) 3 Intra-group trading (elimination of URP) 1 Intra-group balances (elimination) 1 Trading with associate (elimination of URP) 1 Intragroup dividend (exclusion) 1 Calculation of NCI 2 Calculation of investment in associate 2 Calculation of group reserves 5 Presentation 2 Subtotal 24 (b) Memorandum Description of partial method in concept 1.5 Method of calculation 1 Description of full method in concept 1.5 Method of calculation 1 Presentation mark 1 Subtotal 6 Overall total 30 Page 8

10 (a) Inca plc: Consolidated statement of financial position as at 31 July 2012 (100% Inca + 100% Java) million Non-current assets: Property, plant & equipment ( (W6)) Investments ( (W6)) 28 Investment in associate W Goodwill W Current assets: Inventories ( (W7)) 68.4 Receivables ( (W9)) 43.8 Cash & bank (8 + 2) Total assets Equity: Equity capital 100 Share premium 75 Retained earnings W Non-controlling interest W Non-current liabilities: Deferred consideration (24.9(W2) + 2.5(W3)) 27.4 Current liabilities: Payables ( (W9) 44.8 Dividends proposed ( (W10) Total equity & liabilities W1 - Group structure: Inca plc Parent Java plc 90% subsidiary at reporting date therefore include 100% of assets & liabilities. Lava 40% associate, significant influence exerted, include under equity accounting method. W2 Goodwill m m Cost of investment: Immediate cash (note i) 58 Deferred cash (note i)(30 * 0.83) Value of non-controlling interest at acquisition (note iv) 9.2 Fair value of net assets at acquisition: Equity share capital 50 Share premium 20 Retained earnings (note iii) 10.6 Fair value adjustments (W6) 5 (85.6) Goodwill 6.5 Page 9

11 W3 Group Retained earnings at 31 July 2012 Inca Java Lava m m m Balance per SOFP Less: balance at acquisition (10.6) (9) Interest on deferred consideration (2.5) Depreciation on fair value adjustment (W6) (0.8) URP Inventory (W7) (0.6) URP on trade with associate (W8) (0.4) Dividend receivable (W10) 4.5 Adjusted balances 4 3 Consolidate Java 4 * 90% 3.6 Consolidate Lava 3 * 40% 1.2 Total W4 Non-controlling interest Java m Balance at acquisition 9.2 Add: share of post-acquisition results W3 (4* 10%) W5 Investment in associate Lava m Balance at acquisition 25 Less URP adjustment (W8) (0.4) Add: share of post-acquisition results W3 (3 * 40%) W6 Fair value adjustments At acq Movement At y/e m m m Plant 4 (0.8) 3.2 Investments 1-1 Total 5 (0.8) 4.2 W7 Intra group trading (note (vi)) Unrealised profit is eliminated from inventory and reserves of selling company. Amount: 6m *50/150 * 30% = 0.6m W8 Unrealised profit on trading with associate (note (vii) Eliminate 40% of Lava s gain on goods remaining in group inventory Amount: 1m * 40% = 0.4m (reduce investment in associate and group reserves would also accept reduction to inventory instead of investment in associate) W9 intra-group balances at y/e (note viii) Eliminate 2.2m from receivables and payables W10 intra-group dividend (note ix) Dividend receivable by Inca from Java not recorded: 5m * 90% = 4.5m Increase Inca s reserves, reduce Java s dividend payable. Page 10

12 (b) Memorandum: To: Directors of Inca plc From: Accountant Re: Explanation of calculation of goodwill on acquisition of subsidiary Date: 1st September 2012 Under IFRS 3 (revised) there are two permissible approaches to calculating goodwill. The only difference between them is how the non-controlling interest (NCI) in the acquired entity is calculated at the date of acquisition. The first, called the partial method, is based on the concept that goodwill is calculated only on the parent s share of the acquired entity. This is consistent with the logic that only purchased goodwill is recognised in the books. As only the parent s share is purchased, therefore that share is all we recognise. Following this approach, the NCI s value at the acquisition date consists only of its share of the identifiable net assets. It follows from this approach that any revisions to the value of goodwill (arising due to impairment losses or exchange movements) are borne by the parent only. The second method, called the full method or fair value method, is based on the concept that goodwill is an asset of the entire entity acquired. Therefore the NCI s share of this needs to be calculated and recognised as an asset. This is achieved by assigning to the NCI at acquisition date a fair value. This fair value is deemed to include not only its share of identifiable net assets at the acquisition date, but also a portion of the entity s goodwill. It follows that the share of goodwill attributed to the NCI may not be proportional in value to the parent s figure. If this method is adopted, any subsequent changes to the value of goodwill are shares between the parent and the NCI. However the ratio in which this is shared is their respective profit-sharing ratio, not proportional to their respective goodwill values. This gives rise to inconsistencies at times. The full method is widely adopted in the USA, and the IASB has adopted it as part of the convergence programme with the US Financial Accounting Standards Board. It is likely that the partial method will be phased out eventually. Page 11

13 SOLUTION 2 Marking scheme: (a) Statement of changes in equity Equity capital 1 Share premium 1 Revaluation reserve 1 Retained earnings 2 Presentation 1 Subtotal 6 (b) (c) Analysis Ratio calculation (10 ratios for each 1 mark each) 8 Analysis (up to) 10 Subtotal 18 Limitations Any 6 relevant limitations X 1 mark each 6 Overall total 30 Note regarding the marking of analysis: Analysis marks are awarded for quality and depth rather than simply number of points. To get higher than 50%, the candidate needs to demonstrate understanding of the information given by a ratio, and a capability to draw meaningful conclusions from it. In order to gain 70% plus, the candidate must show deep understanding, and the ability to adjust ratios to allow for one-off items etc. The ability to make sensible recommendations is especially welcomed. SUGGESTED SOLUTION (a) Clawhammer plc: Statement of changes in equity for years ended 30 April 2011 and 2012 Equity Share Revaluation Retained Total capital premium Res Earnings million million million million million Balance 1 May nil * Profit for year Dividends paid (working) (14.8) (14.8) Balance 30 Apr nil Profit for year (21) (21) Revaluation loss (45) (45) Share issue Dividends paid (bal fig) (8) (8) Balance 30 April nil Working: 8 million was paid in dividends in y/e 30 April 2012 calculated by balancing the retained earnings reserve. This was 6.15c per share (130m shares in issue). This was 50% less that previous year (per note (vii)). Therefore dividend for year ended 30 April 2010 was12.31c per share. As there were 120m shares in issue that year, the total dividend paid must have been m, or 14.8m. Page 12

14 (b) Analysis Ratio calculation: 30 Apr Apr 2011 Gross margin Gross profit / Revenue 40/310 = 12.9% 100/360 = 27.8% Net margin PBIT / Revenue -19/310 = -6% 55/360 = 15.3% ROCE PBIT / TALCL -19/228 = -8.3% 55/287 = 19.2% ROE PAT / Closing Equity -21/176 = -11.9% 35/230 = 15.2% Current ratio CA / CL 62/34 = 1.8:1 48/46 = 1.04:1 Acid test ratio (CA stock) / CL 40/34 = 1.2:1 29/46 = 0.63:1 Interest cover PBIT / Interest n/m 55/5 = 11 tms Gearing Interest bearing debt / Equity 40/176 = 22.7% 50/230=21.7% Inventory days Closing inventory / COS * /270*365 = 30 days 19/260*365 = 27 days Receivables days Closing receivables / revenue * /310*365 = 26 days 28/360*365 = 28 days Payables days Closing payables / COS * /270*365 = 46 days 33/260*365 = 46 days Restate 2012 SOCI excluding one-off items: m Revenue 310 Cost of sales ( ) (252) Gross profit 58 Distribution costs (10) Admin expenses (49-16) (33) Finance costs (6) Profit before tax 9 Revised 2012 ratios based on underlying performance: Gross margin 58/310 = 18.7% Net margin 15/310 = 4.8% ROCE 15/228 = 6.6% Interest cover 15/6 = 2.5 times Inventory days 22/252*365 = 32 days Payables days 34/252*365 = 49 days Several of the following points should be made in a high quality answer. Many other points could also be made, and would score equal marks. Profitability The performance of the entity has definitely deteriorated from 2010 to The gross margin, net margin and both ROCE and ROE have declined markedly. However, when the effect of the one-off items is excluded, the decline is a lot less severe than at first glance. Examples of ratios should be given to illustrate this. It is particularly concerning to see underlying gross margins dropping as well as sales volume. This trend has the potential to destroy the business if not arrested immediately. Liquidity The business does not appear to have a serious liquidity issue. Although the liquidity ratios could be better, they have improved over the course of the period reviewed. The business was able to raise new equity even in tough times. This shows the business has shareholders who believe in it and are willing to support it. The interest cover has declined precipitously, though excluding the one-off items is still a reasonable 2.5 times. The low gearing gives some comfort as the business can survive tough times easier than if gearing were higher. The bank loan is a big uncertainty. The fact that none appears in current liabilities suggests that it is not due immediately. However if this were repayable soon it could cause liquidity issues. Operations Inventory, receivables and payables days are well within normal ranges, although it is difficult to be definitive on this without knowing industry averages. One major concern is the rate of depreciation of property plant and equipment. If the revaluation loss of 60 million is excluded, the depreciation for year ended 30 April 2012 was only 9 million or 5%. It might be worth checking if this is adequate, especially in the light of the downward trend in asset values. Page 13

15 (c) Limitations of the above analysis There are several limitations to ratio analysis in general, but some that are particularly relevant to this analysis are as follows: ROE was not calculated after excluding one-off items as it is not possible to measure the tax which would have been charged had these items not been incurred. Industry average figures would be very useful in order to evaluate performance better. It would be useful to know the repayment schedule for the bank loan. There is no indication as to what the long term provisions are for. General points: Figures are historic, therefore out of date. More up-to-date information should be sought to improve the quality of analysis. Many estimates go into preparing a set of accounts. These may or may not be reasonable. The effect of inflation is ignored in IFRS financial statements. Page 14

16 SOLUTION 3 Marking scheme: 2.5 marks per correct answer Total 20 marks Suggested solution (plus tutorial notes) 1. Answer (b) Batch (1) should be included at its net realisable value 34,500, for a reduction of 25,500 Batch (2) should be included at cost 70,000 as the event causing the damage had not existed at the reporting date. 2. Answer (c) The cash paid out was 12 million. Cash received as part of the acquisition was 15 million. As the group controls the subsidiary, 100% of its net assets are consolidated. Hence the effect of the group financial statements of this transaction is a net increase in cash of 3 million. 3. Answer (b) IAS 10 specifically provides that the bankruptcy of a debtor in the period after the reporting date should be treated as an adjusting event. 4. Answer (b) The contract is too early for the outcome to be reasonable foreseeable, hence no profit is recognised. Revenue is recognised to the maximum extent of costs incurred provided they are expected to be recovered. 5. Answer (a) The over provision of 4,000 from the previous year means that the amount required to be provided for the current year is lower by that amount. 6. Answer (d) This condition relates to the supply of goods, and is not relevant to the rendering of services. 7. Answer (c) IAS 37 requires that a provision be made (1) when an obligating event has occurred which causes a present obligation, (2) it is probable that a cash outflow will be required to settle this obligation, and (3) a reliable estimate can be made of the amount require to settle. This is the case in respect of the 1.5 million. However in the case of the 0.5 million there is no probability that an outflow of economic benefits will be required to settle. Hence no provision will be made for this. 8. Answer (c) IAS 20 allows a choice between the two treatments outlined. Page 15

17 SOLUTION 4 MARKING SCHEME: (a) Explanation: Objective of general purpose financial reporting 5 How useful in helping accountants determine appropriate policies and procedures 5 Subtotal 10 (b) Elements: Definitions (2 X 2.5 marks) 5 Explanations (2 X 2.5 marks) 5 Subtotal 10 Total 20 SUGGESTED SOLUTION (a) (i) The conceptual framework says that The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. These decision involve buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit. As these individuals are taking risks with their capital, it is important that they have the best possible information with which to inform their decisions. Absence of reliable information leads to sub-optimal decisions being made. This means capital has been misallocated, and an opportunity to create wealth lost as a result. The type of information financial statements are designed to provide includes information about: Financial position of a reporting entity, including information about an entity s resources and claims against those resources; The effects of transactions or other events that change an entity s resources and claims. Most market participants cannot access sufficient information from their own resources. Therefore to them the company s financial statements are the most important source of reliable information. Other users exist also, but some have alternative sources of information available to them, and others have no entitlement to information, so why should the reporting entity incur costs to meet their needs? The IASB in considering who are the most important users, focused on the above because it believes that information satisfying their needs is likely to also satisfy the needs of most other user groups. (ii) This chapter is hugely important as it provides a higher purpose to guide accountants when making decisions about accounting for transactions and events. For example an accountant may be under pressure to make an estimate in such a way as to increase reported profit, because management bonuses depend on a certain target being hit. However, this chapter requires the accountant to think of the usefulness of the resulting information to users in priority to other such concerns. It can provide moral support to the accountant trying to do the right thing against an attitude like Tell me where it says I can t do that. Whilst IFRSs provide application guidance in several areas, it is common in practice to come across transactions not covered by any IFRS, or one that can be interpreted in different ways. In situations like this, considering the purpose of financial statements can guide us towards the best solution. Page 16

18 (b) In answering the question, the candidate will indicate which element selected for discussion relates to financial performance and which elemnets relates to financial positions. There are five elements of financial statements identified by the conceptual framework. These are as follows: Asset: A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow. This definition has three main parts to it. First, the concept of control is key. The definition never mentions ownership, because it is not necessary for an entity to own an asset in order to recognise it on the entity s books. It is however necessary that the entity control it, in order to generate future economic benefits. An example of this in an asset leased under a finance lease. Legally it is not owned by the lessee, but IAS 17 requires that we record it as if it were. Second, the asset must result from a past event. It cannot be dependent on a future event for its existence. Third, the asset must be expected to generate economic value. This can be from use or sale. Liability: A present obligation of the entity as a result of past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Again, this definition has three main parts. First, there must be a present obligation, an obligation being an unavoidable performance duty, usually to pay somebody money! Second, this obligation arises because something happened in the past to cause it. Thirdly, it is expected that a transfer of economic benefit (again, usually cash) will be required to settle it. Equity: What is left when all liabilities are deducted from an entity s assets. Also called owners interest. [Any ONE of the above, plus any ONE of the following are sufficient for full marks] Gain (Income): This is a transaction that results in an increase in an entity s equity, but which does not result from owners contributions. Sale of goods at a profit is an excellent example. Loss (expense): This is the direct opposite a transaction that results in a decrease in an entity s equity, but which is not the result of a distribution to owners. The definitions of gains and losses are dependent on the definition of equity, which is itself dependent on the definitions of assets and liabilities. Therefore it is clear that all elements of financial statements derive from the definitions of assets and liabilities. Page 17

19 SOLUTION 5 Marking scheme: (a) Calculations Calculate correct earnings - deduct pref divs, not equity divs 2 Treatment of issue at full market value 2 Treatment of rights issue no. of shares added 1 Treatment of right issue retrospective effect (incl TERP) 3 Treatment of bonus issue retrospective effect 2 Recalculation of comparative 2 Subtotal 12 (b) (c) Explanation: Recognition of differential in percentage increases in profit and EPS 1 Suggestion of 2 possible reasons 2 Subtotal 3 Importance and limitations of EPS: Importance (up to 3 points at 1 mark each) 3 Limitations (up to 3 points at 1 mark each) 3 Maximum 5 Total 20 Suggested solution (a) EPS consists of two figures, (1) Earnings relevant to equity shareholders, and (2) weighted average number of equity shares in issue for the period. Earnings for the year here are 460,000. We must subtract the preference dividend from this figure, as this portion of profits must be paid to them, therefore it is not relevant to the equity holder. Equity dividends are NOT subtracted as these form part of the equity shareholders return. Hence the correct earnings figure for EPS purposes is 460,000 (600,000 * 8%) = 412,000 The weighted average number of equity shares in issue must take into account the changes that happened during the year. These were the issue at full market price, rights issue at a discount and bonus issue. Every time there is a bonus issue (shares issued for free), the earning power of issued shares declines, as more shares exist to share in the same resources of the business. If shares are issued at a discount, this is equivalent to a partial bonus issue, as the average earning power of each share declines here also, although not by the same degree. Hence we must adjust for this effect in our calculations. As the effect of a bonus issue is permanent, in order to have valid comparisons we must adjust comparative figures to the new reality. We use bonus fractions for these adjustments. A bonus fraction quantifies the amount by which the value per share has been reduced by increasing the number of shares to share in a given business. For a pure bonus issue, the bonus fraction = (No. of shares after bonus issue / No. of shares before bonus issue). Here, as the bonus issue is one new share for every two held, the bonus fraction is 3/2 For a rights issue, we must compute the bonus fraction based on relative valuations, before and after the rights issue. The value before the issue will be a market fact. Here it is The value after will be an average of the existing price and the price of the new shares issued. Here, there were 3 million shares in issue on the date of the rights issue. 1.8 million further shares were issued at the discounted price. Hence the average value per share after the rights issue is (3 million * 2.04) + (1.8 million * 1.40) / 4.8 million (new total no of shares). This is called the theoretical ex-rights price and works out at Therefore the bonus fraction is 2.04/1.80 The bonus fractions are applied to periods prior to the relevant share issue only. Page 18

20 Date Shares in existence Bonus adjustors Weighting No. of shares Apr 1 Jun 30 2,500, / 1.80 * 3/2 3/12 1,062,500 Jul 1 Aug 31 3,000, / 1.80 * 3/2 3/12 1,275,000 Sep 1- Mar 31 4,800,000 3/2 6/12 3,600,000 Total weighted average 5,937,500 EPS for year ended 31 March 2012 = 412,000 / 5,937, c Restate comparative EPS: 8c * 1.8/2.04 * 2/3 4.7c (b) (c) This illustrates the power of EPS as an indicator of performance. Profit has gone up by 66.7% yet the EPS went up by just 20%. This could only have happened due to an increase in the number of shares. This could be due to either a bonus issue or an issue for cash. It could also arise due to the conversion of another instrument into equity shares, or the exercise of share options. Most stockmarket investors pay close attention to the EPS figure as it measures the earnings of the company in terms of each unit of ownership. This is most relevant to an investor as it controls for issue or redemption of shares by the entity. In addition, it is an intuitive measure, being easy to understand. It is widely quoted in the press. It forms the denominator for the P/E ratio, an important measure of an entity s value. Its calculation is standardised by IAS 33, validating comparisons across different entities. It does have several limitations. It includes one-off items such as exceptional write-offs etc. This can impair its usefulness as a predictor of future results. Also it does not include other comprehensive income, for example revaluation gains. OCI is arguably important as it adds value to an equity investment. However it is excluded on the grounds that it is not yet realised. However even when it is realised (for example on subsequent disposal of the asset) the gains do not find their way into the EPS figure. Many investors get round these limitations by calculating their own version of EPS in addition to IAS 33 EPS. It is therefore important that financial reports give users sufficient information to enable them do this if they wish. Page 19